10-K 1 bksc-10k_123120.htm ANNUAL REPORT

 

UNITED STATES  

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

 

FORM 10-K

 

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2020

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from __________ to __________

 

Commission file number: 0-27702

 

BANK OF SOUTH CAROLINA CORPORATION

 

(Exact name of registrant as specified in its charter)

 

 South Carolina   57-1021355
(State or other jurisdiction of   (IRS Employer
incorporation or organization)   Identification Number)
     
256 Meeting Street, Charleston, SC   29401
(Address of principal executive offices)   (Zip Code)

 

Issuer’s telephone number: (843) 724-1500

 

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

 

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

 

Securities registered under Section 12(b) of the Exchange Act:

 

  Common Stock  
   (Title of Class)  

 

Securities registered under Section 12(g) of the Exchange Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. 

☐ Yes ☒ No

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. 

☐ Yes ☒ No

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. 

Yes ☒ No ☐

 

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

Yes ☒ No ☐

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐

 

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

 

Large accelerated filer ☐ Accelerated filer ☐ Non-accelerated filer ☐ Smaller reporting company ☒
Emerging Growth Company ☐      

 

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

 

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

 

Aggregate market value of the voting stock held by non-affiliates, computed by reference to the closing price of such stock on June 30, 2020 was $60,802,216.

 

As of February 11, 2021, the Registrant has outstanding 5,520,469 shares of common stock.

 

 

 

 

 

 

 

BANK OF SOUTH CAROLINA CORPORATION

AND SUBSIDIARY

 

Table of Contents

 

PART I    

 

    Page
   
Item 1. Business 3
Item 1A. Risk Factors 9
Item 1B. Unresolved Staff Comments 9
Item 2. Properties 10
Item 3. Legal Proceedings 10
Item 4. Mine Safety Disclosures 10
   
PART II  
   
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 11
Item 6. Selected Financial Data 13
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 30
Item 8. Financial Statements and Supplementary Data 31
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure 66
Item 9A. Controls and Procedures 66
Item 9B. Other Information 66
   
PART III  
   
Item 10. Directors, Executive Officers, Promoters and Corporate Governance 67
Item 11. Executive Compensation 67
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 67
Item 13. Certain Relationships and Related Transactions, and Director Independence 68
Item 14. Principal Accounting Fees and Services 68
   
PART IV  
   
Item 15. Exhibits and Financial Statement Schedules

69

 

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PART I

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

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

 

  Risk from changes in economic, monetary policy, and industry conditions
  Changes in interest rates, shape of the yield curve, deposit rates, the net interest margin and funding sources
  Market risk (including net income at risk analysis and economic value of equity risk analysis) and inflation
  Risk inherent in making loans including repayment risks and changes in the value of collateral
  Loan growth, the adequacy of the allowance for loan losses, provisions for loan losses, and the assessment of problem loans
  Level, composition, and re-pricing characteristics of the securities portfolio
  Deposit growth and changes in the mix or type of deposit products and services
  Continued availability of senior management and ability to attract and retain key personnel
  Technological changes
  Increased cybersecurity risk, including potential business disruptions or financial losses
  Ability to control expenses
  Ability to compete in our industry and competitive pressures among depository and other financial institutions
  Changes in compensation
  Risks associated with income taxes including potential for adverse adjustments
  Changes in accounting policies and practices
  Changes in regulatory actions, including the potential for adverse adjustments
  Recently enacted or proposed legislation and changes in political conditions
  Pandemic risk, including COVID-19, and related quarantine and/or stay-at home policies and restrictions
  Impact of COVID-19 on the collectability of loans
  Changes in legislation related to Payroll Protection Program (“PPP”) loans
  Credit risks, determination of deficiency, or complete loss if SBA denies PPP loans

 

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

 

Item 1. Business

 

General

 

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

 

Market Area

 

The Bank operates as an independent, community oriented, commercial bank providing a broad range of financial services and products to the Charleston – North Charleston metro area, which includes Charleston, Berkeley, and Dorchester county. We have five banking house locations: 256 Meeting Street, Charleston, SC; 100 North Main Street, Summerville, SC; 1337 Chuck Dawley Boulevard, Mt. Pleasant, SC; 2027 Sam Rittenberg Boulevard, Charleston, SC; and 9403 Highway 78, North Charleston, SC.

 

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The Charleston – North Charleston metro area grew 16.56% from 2015 to 2019 according to the U.S. Bureau of Economic Analysis based on real gross domestic product. Charleston and Berkeley county are ranked in the top ten economies in the state based on real gross domestic product according to the U.S. Bureau of Economic Analysis. The largest nonfarm employers in our market area are trade, transportation, and utilities; government; and professional and business services. Trade, transportation and utilities has been the main economic driver of the growth in the area over the last five years. This includes manufacturing campuses for Boeing, Volvo Cars, and Mercedes-Benz Vans in the area. Based on October 2020 Bureau of Labor Statistics, the Charleston area unemployment rate was 4.0% compared to the 6.6% nationally. The Charleston area continues to rank higher than the other major metropolitan areas of the state of South Carolina in talent, innovative capacity, entrepreneurial and business environment, and livability.

 

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

 

The Company (ticker symbol: BKSC) is publicly traded on the National Association of Securities Dealers Automated Quotations (“NASDAQ”), and is under the reporting authority of the SEC. All of our electronic filings with the SEC, including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are accessible at no cost on our website, http://www.banksc.com, through the “Investor Relations” link. Our filings are also available through the SEC’s web site at http://www.sec.gov or by calling 1-800-SEC-0330.

 

Competition

 

The financial services industry is highly competitive. We face competition in attracting deposits and originating loans based upon a variety of factors including:

 

  interest rates offered on deposit accounts
  interest rates charged on loans
  credit and service charges
  the quality of services rendered
  the convenience of banking facilities and other delivery channels
  relative lending limits in the case of loans
  increase in non-banking financial institutions providing similar services
  continued consolidation, and
  legislative, regulatory, economic, and technological changes.

 

We compete with commercial banks, savings institutions, finance companies, credit unions and other financial services companies. Many of our larger commercial bank competitors have greater name recognition and offer certain services that we do not. However, we believe that we have developed an effective competitive advantage in our market area by emphasizing exceptional service and knowledge of local trends and conditions.

 

Lending Activities

 

We focus our lending activities on small and middle market businesses, professionals and individuals in our geographic markets and typically require personal guarantees. Our primary lending activities are for commercial, commercial real estate, and consumer purposes, with the largest category being commercial real estate. Most of our lending activity is to borrowers within our market area.

 

Commercial Loans

 

As of December 31, 2020, $51.0 million, or 15.91%, of our loan portfolio consisted of commercial loans. We originate various types of secured and unsecured commercial loans to customers in our market area in order to provide customers with working capital and funds for other general business purposes. The terms of these loans generally range from less than one year to 10 years. These loans bear either a fixed interest rate or an interest rate linked to a variable market index, depending on the individual loan, its purpose, and underwriting of that loan.

 

Commercial credit decisions are based upon our credit assessment of each applicant. We evaluate the applicant’s ability to repay in accordance with the proposed terms of the loan and assess the risks involved. In addition to evaluating the applicant’s financial statements, we consider the adequacy of the primary and secondary sources of repayment for the loan. Credit agency reports of the applicant’s personal credit history supplement our analysis of the applicant’s creditworthiness. In addition, collateral supporting a secured transaction is analyzed to determine its marketability. Commercial business loans generally have higher interest rates than residential loans of a similar duration because they have a higher risk of default with repayment generally depending on the successful operation of the borrower’s business and the adequacy of any collateral.

 

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Commercial Real Estate Loans

 

As of December 31, 2020, commercial real estate construction loans comprised $14.8 million, or 4.62%, of our loan portfolio. We make construction loans for commercial properties to businesses. Advances on construction loans are made in accordance with a schedule reflecting the cost of construction. Loans are typically underwritten with a maximum loan to value ratio of 80% based on current appraisals with value defined as the purchase price, appraised value, or cost of construction, whichever is lower. Repayment of construction loans on non-residential and income-producing properties is normally attributable to rental income, income from the borrower’s operating entity, or the sale of the property. Construction loans are interest-only during the construction period, which typically does not exceed twelve months, and are often amortized or paid-off with permanent financing.

 

Before making a commitment to fund a construction loan, we require an appraisal of the property by a state-certified or state-licensed appraiser. We review and inspect properties before disbursement of funds during the term of the construction loan.

 

Construction financing generally involves greater credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimated value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions. Construction loans also expose us to risk that improvements will not be completed on time in accordance with specifications and projected costs.

 

As of December 31, 2020, $146.2 million, or 45.57%, of our loan portfolio consisted of other commercial real estate loans, excluding commercial construction loans. Properties securing our commercial real estate loans are primarily comprised of business owner-occupied properties, small office buildings and office suites, and income-producing real estate.

 

We base our decision to lend primarily on the economic viability of the property and the creditworthiness of the borrower. In evaluating a proposed commercial real estate loan, we emphasize the ratio of the property’s projected net cash flow to the loan’s debt service requirement computed after a deduction for an appropriate vacancy factor and reasonable expenses. We typically require property casualty insurance, title insurance, earthquake insurance, wind and hail coverage, and, if appropriate, flood insurance, in order to protect our security interest in the underlying property.

 

Commercial real estate loans generally carry higher credit risks, as they typically involve larger loan balances concentrated with single borrowers or a group of related borrowers. In addition, the payment of loans secured by income-producing properties typically depends on the successful operation of the property, as repayment of the loan generally is largely dependent upon sufficient income from the property to cover operating expenses and debt service. Changes in economic conditions not within the control of the borrower or lender could affect the value of the underlying collateral or the future cash flow of the property.

 

Consumer Loans

 

Consumer real estate loans were $71.8 million, or 22.39%, of the loan portfolio as of December 31, 2020. Consumer real estate loans consist of consumer construction loans, HELOCs, and mortgage originations. We make mortgage and construction loans for owner-occupied residential properties. Advances on construction loans are in accordance with a schedule reflecting the cost of construction, but are limited to a maximum loan-to-value ratio of 80%. Before making a commitment to fund a construction loan, we require an appraisal of the property by a state-certified or state-licensed appraiser. We review and inspect properties before disbursement of funds during the term of the construction loan. Similar to commercial real estate construction financing, consumer construction financing generally involves greater credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimated value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions. Construction loans also expose us to risk that improvements will not be completed on time in accordance with plans, specifications, and projected costs.

 

This category of loans consists of loans secured by first or second mortgages on primary residences and originate as adjustable-rate or fixed-rate loans. Owner-occupied properties located in the Company’s market area serve as the collateral for these loans. The Company currently originates residential mortgage loans for our portfolio with a maximum loan-to-value ratio of 80% for traditional owner-occupied homes.

 

We offer home equity loans and lines of credit secured by the borrower’s primary or secondary residence. Our home equity loans and lines of credit currently originate with an adjustable- rate with a floor. We generally underwrite home equity loans and lines of credit with the same criteria that we use to underwrite mortgage loans to be sold. For a borrower’s primary and secondary residences, home equity loans and lines of credit are typically underwritten with a maximum loan-to-value ratio of 80% when combined with the principal balance of the existing mortgage loan. We require a current appraisal or internally prepared real estate evaluations on home equity loans and lines of credit. At the time we close a home equity loan or line of credit, we record a mortgage to perfect our security interest in the underlying collateral.

 

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Other consumer loans totaled $4.5 million, or 1.40% of the loan portfolio, as of December 31, 2020. These loans are originated for various purposes, including the purchase of automobiles, boats, and other personal items or needs.

 

Consumer loans may entail greater credit risk than mortgage loans to be sold, particularly in the case of consumer loans that are unsecured or are secured by rapidly depreciable assets, such as automobiles. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. The application of various federal and state laws, including bankruptcy and insolvency laws, may also limit the amount which can be recovered on such loans.

 

Paycheck Protection Program

 

Paycheck Protection Program (“PPP”) loans were $32.4 million, or 10.11% of the loan portfolio, as of December 31, 2020. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law, which established the Paycheck Protection Program (“PPP”) and allocated $349.0 billion of loans to be issued by financial institutions. Under the program, the Small Business Administration (“SBA”) will forgive loans, in whole or in part, made by approved lenders to eligible borrowers for Paycheck and other permitted purposes in accordance with the requirements of the program. These loans were originated to assist small businesses affected by the coronavirus. The Bank originated $37.8 million in PPP loans to 266 customers as of December 31, 2020.

 

These loans are 100% guaranteed by the SBA.

 

Loan Approval Procedures and Authority

 

Our lending activities follow written, non-discriminatory underwriting standards and loan origination procedures established by the Board of Directors of the Bank. The loan approval process is intended to assess the borrower’s ability to repay the loan and the value of the collateral that will secure the loan. To assess the borrower’s ability to repay, we review the borrower’s employment, credit history, and other information on the historical and projected income and expenses of the borrower.

 

The objectives of our lending program are to:

 

1. Establish a sound asset structure
2. Provide a sound and profitable loan portfolio to:
  a) Protect the depositor’s funds
  b) Maximize the shareholders’ return on their investment
3. Promote the stable economic growth and development of the market area served by the Bank
4. Comply with all regulatory agency requirements and applicable law

 

The underwriting standards and loan origination procedures include officer lending limits, which are approved by the Board of Directors. The individual secured/unsecured lending authority of the President/Chief Executive Officer of the Bank is set at $1,500,000 and the individual secured/unsecured lending authority of the Senior Lender/Executive Vice President is set at $750,000. The President/Chief Executive Officer of the Bank and the Senior Lender/Executive Vice President may jointly lend up to 10% of the Bank’s unimpaired capital for the previous quarter end. In the absence of either of the above, the other may, jointly with the approval of either the Chairman of the Board of Directors or a majority of the Loan Committee of the Board of Directors, lend up to 10% of the Bank’s unimpaired capital for the previous quarter end. The Board of Directors, with two-thirds vote, may approve the aggregate credit in excess of this limit but may not exceed 15% of the Bank’s unimpaired capital. Loan limits apply to the total direct and indirect liability of the borrower. All loans above the loan officer’s authority must have the approval of a loan officer with the authority to approve a loan of that amount. Pooling of loan authority is not allowed except as outlined above for the President/Chief Executive Officer, Senior Lender/Executive Vice President, Chairman of the Board of Directors, and a majority of the Loan Committee or two-thirds of the Board of Directors.

 

All new credit which results in aggregate direct, indirect, and related credit, not under an approved line of credit of a threshold set forth in our loan policy, with the exceptions of mortgage loans in the process of being sold to investors and loans secured by properly margined negotiable securities traded on an established market or other cash collateral, are reviewed in detail on a monthly basis by the Loan Committee. Certain new credits that meet a higher threshold than required for the Loan Committee are reviewed by the Board of Directors of the Bank at its regular monthly meeting.

 

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Employees

 

At December 31, 2020, we employed 76 people, with two individuals considered hourly, none of whom are subject to a collective bargaining agreement. We provide a variety of benefit programs including an Employee Stock Ownership Plan and Trust; Stock Incentive Plan; and health, life, disability and other insurance. We believe our relationship with our employees is excellent.

 

Supervision and Regulation

 

We are subject to extensive state and federal banking laws and regulations that impose specific requirements or restrictions and provide for general regulatory oversight of virtually all aspects of operations. The regulations are primarily intended to protect depositors, customers, and the integrity of the U.S. banking system and capital markets. The following information describes some of the more significant laws and regulations applicable to us. The description is qualified in its entirety by reference to the applicable laws and regulations. Proposals to change the laws and regulations governing the banking industry are frequently raised in Congress, state legislatures, and with the various bank regulatory agencies. Changes in applicable laws or regulations, or a change in the way such laws or regulations are interpreted by regulatory agencies or courts, may have a material impact on our business operations and earnings.

 

Dodd-Frank Act

 

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) became effective. This law has broadly affected the financial services industry by implementing changes to the financial regulatory landscape aimed at strengthening the sound operation of the financial services industry. This legislation will continue to significantly change the current bank regulatory structure and affect the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies, including the Company and the Bank.

 

The Dodd-Frank Act created the Consumer Financial Protection Bureau (the “CFPB”) to centralize responsibility for consumer financial protection, including implementing, examining and enforcing compliance with federal consumer financial laws. The CFPB exercises supervisory review of banks under its jurisdiction. The CFPB focuses its rulemaking in several areas, particularly in the areas of mortgage reform involving the Real Estate Settlement Procedures Act, the Truth in Lending Act, the Equal Credit Opportunity Act, and the Fair Debt Collection Practices Act. There are many provisions in the Dodd-Frank Act mandating regulators to adopt new regulations and conduct studies upon which future regulation may be based. Governmental intervention and new regulations could materially and adversely affect our business, financial condition and results of operations.

 

Volcker Rule

 

Section 619 of the Dodd-Frank Act, known as the “Volcker Rule,” prohibits any bank, bank holding company, or affiliate (referred to collectively as “banking entities”) from engaging in two types of activities: proprietary trading and the ownership or sponsorship of private equity or hedge funds that are referred to as covered funds. Proprietary trading, in general, is trading in securities on a short-term basis for a banking entity’s own account. In December 2013, federal banking agencies, the SEC and the Commodity Futures Trading Commission, finalized a regulation to implement the Volcker Rule. As of December 31, 2020, the Company has evaluated our securities portfolio and has determined that we do not hold any covered funds.

 

Bank Holding Company Act

 

The Company is a one-bank holding company under the Federal Bank Holding Company Act of 1956, as amended. As a result, the Company is primarily subject to the supervision, examination and reporting requirements of the Board of Governors (the “Federal Reserve Board”) of the Federal Reserve Bank (the “Federal Reserve”) under the act and its regulations promulgated thereunder.

 

Capital Requirements

 

The Federal Reserve Board imposes certain capital requirements on the Company under the Bank Holding Company Act, including a minimum leverage ratio and minimum ratio of “qualifying” capital to risk-weighted assets or a community bank leverage ratio for qualifying community banking organizations. These requirements are essentially the same as those that apply to the Bank and are described under “Regulatory Capital Requirements” in the notes to the financial statements (see Note 18). The ability of the Company to pay dividends to shareholders depends on the Bank’s ability to pay dividends to the Company, which is subject to regulatory restrictions as described below in “Dividends.”

 

Standards for Safety and Soundness

 

The Federal Deposit Insurance Act requires the federal banking regulatory agencies to prescribe, by regulation or guidelines, operational and managerial standards for all insured depository institutions relating to (1) internal controls, information systems and internal audit systems, (2) loan documentation, (3) credit underwriting, (4) interest rate risk exposure, and (5) asset growth. The agencies also must prescribe standards for asset quality, earnings, and stock valuation, as well as standards for compensation, fees, and benefits. The federal banking agencies have adopted regulations and “Interagency Guidelines Establishing Standards for Safety and Soundness” to implement these required standards. These guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired.

 

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Regulatory Examination

 

All insured institutions must undergo regular on-site examinations by their appropriate banking agency. The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate banking agency against each institution or affiliate, as it deems necessary or appropriate. Insured institutions are required to submit annual reports to the Federal Deposit Insurance Corporation (“FDIC”), their federal regulatory agency, and state supervisor, when applicable. As a state-chartered bank located in South Carolina, the Bank is also subject to the regulations of the South Carolina State Board of Financial Institutions.

 

The federal banking regulatory agencies prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating to, among other things, the following:

 

  Internal controls
  Information systems and audit systems
  Loan documentation
  Credit underwriting
  Interest rate risk exposure
  Asset quality
  Liquidity
  Capital adequacy
  Bank Secrecy Act
  Sensitivity to market risk

 

Transactions with Affiliates and Insiders

 

We are subject to certain restrictions on extensions of credit to executive officers, directors, certain principal shareholders, and their related interests. Such extensions of credit must be made on substantially the same terms, including interest rates, and collateral, as those prevailing at the time for comparable transactions with third parties and must not involve more than the normal risk of repayment or present other unfavorable features.

 

Dividends

 

The Company’s principal source of cash flow, including cash flow to pay dividends to its shareholders, is dividends it receives from the Bank. Statutory and regulatory limitations apply to the Bank’s payment of dividends to the Company. As a general rule, the amount of a dividend may not exceed, without prior regulatory approval, the sum of net income in the calendar year to date and the retained net earnings of the immediately preceding two calendar years. A depository institution may not pay any dividend, without regulatory approval, if payment would cause the institution to become undercapitalized or if it already is undercapitalized.

 

Consumer Protection Regulations

 

Activities of the Bank are subject to a variety of statutes and regulations designed to protect consumers. Interest and other charges collected by the Bank are subject to state usury laws and federal laws concerning interest rates. Our loan operations are also subject to federal laws applicable to credit transactions, such as:

 

  The federal Truth-In-Lending Act, which governs disclosures of credit terms to consumer borrowers
  The Home Mortgage Disclosure Act of 1975, which requires financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves
  The Fair Lending Act, which requires fair, equitable, and nondiscriminatory access to credit for consumers
  The Equal Credit Opportunity Act, which prohibits discrimination on the basis of race, creed or other prohibited factors in extending credit
  The Fair Credit Reporting Act of 1978, which governs the use and provision of information to credit reporting agencies
  The Fair Debt Collection Act, which governs the manner in which consumer debt may be collected by collection agencies
  The Gramm - Leach - Bliley Act, which governs the protection of consumer information
  The rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws

 

The deposit operations of the Bank also are subject to:

 

  The Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records

 

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The Electronic Funds Transfer Act and Regulation E, issued by the Federal Reserve Board to implement the act, which govern automatic deposits to and withdrawals from deposit accounts and customer’s rights and liabilities arising from the use of automated teller machines and other electronic banking services
  Regulation DD, which implements the Truth in Savings Act to enable consumers to make informed decisions about deposit accounts at depository institutions.

 

Enforcement Powers

 

The Company is subject to supervision and examination by the FDIC, the Federal Reserve and the South Carolina State Board of Financial Institutions. The Bank is subject to extensive federal and state regulations that significantly affect business and activities. These regulatory bodies have broad authority to implement standards and to initiate proceedings designed to prohibit depository institutions from engaging in activities that represent unsafe or unsound banking practices or constitute violations of applicable laws, rules, regulations, administrative orders, or written agreements with regulators. These regulatory bodies are authorized to take action against institutions that fail to meet such standards, including the assessment of civil monetary penalties, the issuance of cease-and-desist orders, and other actions.

 

Bank Secrecy Act/Anti-Money Laundering

 

We are subject to the Bank Secrecy Act and other anti-money laundering laws and regulations, including the USA Patriot Act of 2001 (“USA Patriot Act”). We must maintain a Bank Secrecy Act Program that includes established internal policies, procedures, and controls; a designated compliance officer; an ongoing employee-training program; and testing of the program by an independent audit function. The enactment of the USA Patriot Act amended and expanded the focus of the Bank Secrecy Act to facilitate information sharing among governmental entities and the Company for the purpose of combating terrorism and money laundering. It improves anti-money laundering and financial transparency laws, information collection tools and the enforcement mechanics for the U.S. government. These provisions include (a) standards for verifying customer identification at account opening; (b) rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (c) reports by nonfinancial trades and businesses filed with the U.S. Treasury’s Financial Crimes Enforcement Network for transactions exceeding $10,000; (d) suspicious activities reports by brokers and dealers if they believe a customer may be violating U.S. laws; and (e) regulations and enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons.

 

Similar in purpose to the Bank Secrecy Act, the Office of Foreign Assets Control (“OFAC”), a division of the U.S. Department of Treasury, controls and imposes economic and trade sanctions based on U.S. foreign policy and national security goals against targeted countries and individuals based on threats to foreign policy, national security, or the U.S. economy. OFAC has and will send banking regulatory agencies lists of names of individuals and organizations suspected of aiding, concealing, or engaging in terrorist acts. Among other things, the Bank must block transactions with or accounts of sanctioned persons and report those transactions after their occurrence.

 

Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.

 

Privacy and Credit Reporting

 

In connection with our lending activities, we are subject to a number of federal laws designed to protect borrowers and promote lending to various sectors of the economy and population. These include the Equal Credit Opportunity Act, the Truth-in-Lending Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, and the Community Reinvestment Act (the “CRA”). The CRA requires the appropriate federal banking agency, in connection with its examination of a bank, to assess the bank’s record in meeting the credit needs of the communities served by the bank, including low and moderate income neighborhoods. Under the CRA, institutions are assigned a rating of “outstanding,” “satisfactory,” “needs to improve,” or “substantial non-compliance.” In addition, federal banking regulators, pursuant to the Gramm-Leach-Bliley Act, have enacted regulations limiting the ability of banks and other financial institutions to disclose nonpublic consumer information to non-affiliated third parties. The regulations require disclosure of privacy policies and allow consumers to prevent certain personal information from being shared with nonaffiliated third parties.

 

Item 1A. Risk Factors

 

Under the filer category of “smaller reporting company”, as defined in Rule 12b-2 of the Exchange Act, the Company is not required to provide information requested by Part I, Item 1A of its Form 10-K.

 

Item 1B. Unresolved Staff Comments

 

None.

 

 9

 

 

Item 2. Properties

 

The Company’s headquarters is located at 256 Meeting Street in downtown Charleston, South Carolina. This site is also the location of the main office of the Bank. The Bank also operates from four additional locations: 100 North Main Street, Summerville, SC; 1337 Chuck Dawley Boulevard, Mount Pleasant, SC; 2027 Sam Rittenberg Boulevard, Charleston, SC; and 9403 Highway 78, North Charleston, SC. The Company owns the 2027 Sam Rittenberg Boulevard location, which houses the Operations Department of the Bank as well as a banking office. The Company leases all other locations. The owned location is not encumbered and all of the leases have renewal options. Each banking location is suitable and adequate for banking operations.

 

Item 3. Legal Proceedings

 

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

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

 10

 

 

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

At December 31, 2020, there were 5,818,935 shares issued and 5,520,469 shares outstanding of the 12,000,000 authorized shares of common stock of the Company. Our common stock is traded on the NASDAQ under the trading symbol “BKSC”.

 

Information regarding the historical market prices of our common stock and dividends declared on that stock is shown below.

 

    High   Low   Dividends 
2020             
Quarter ended March 31, 2020   $19.39   $11.65   $0.16 
Quarter ended June 30, 2020   $18.19   $13.75   $0.16 
Quarter ended September 30, 2020   $17.18   $15.69   $0.17 
Quarter ended December 31, 2020   $16.91   $15.95   $0.17 
                 
2019                
Quarter ended March 31, 2019   $19.30   $18.12   $0.16 
Quarter ended June 30, 2019   $20.01   $17.52   $0.16 
Quarter ended September 30, 2019   $19.32   $18.34   $0.26 
Quarter ended December 31, 2019   $18.99   $18.27   $0.16 
                 
2018                
Quarter ended March 31, 2018   $21.45   $18.90   $0.15 
Quarter ended June 30, 2018   $21.90   $17.55   $0.15 
Quarter ended September 30, 2018   $21.15   $19.50   $0.25 
Quarter ended December 31, 2018   $20.90   $17.89   $0.15 

 

The future payment of cash dividends is subject to the discretion of the Board of Directors and depends on a number of factors including future earnings, financial condition, cash requirements, and general business conditions. Cash dividends, when declared, are paid by the Bank to the Company for distribution to shareholders of the Company. Certain regulatory requirements restrict the dividend amount that the Bank can pay to the Company.

 

At our December 1995 Board Meeting, the Board of Directors authorized the repurchase of up to 140,918 shares of its common stock on the open market. At our October 1999 Board Meeting, the Board of Directors authorized the repurchase of up to 45,752 shares of its common stock on the open market and again at our September 2001 Board meeting, the Board of Directors authorized the repurchase of up to 54,903 shares of its common stock on the open market. At the Annual Meeting in 2020, the Board of Directors authorized a stock repurchase plan of up to $1.0 million. As of the date of this report, the Company owns 298,466 shares, adjusted for five 10% stock dividends and a 25% stock dividend. At the Annual Meeting in 2007, the shareholders voted to increase the number of authorized shares from 6,000,000 to 12,000,000.

  

THE BANK OF SOUTH CAROLINA EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST

 

During 1989, the Board of Directors of the Bank adopted an Employee Stock Ownership Plan and Trust Agreement (“ESOP”) to provide retirement benefits to eligible employees of the Bank for long and faithful service. An amendment and restatement was made to the ESOP effective January 1, 2007 and approved by the Board of Directors on January 18, 2007. Periodically, the Internal Revenue Service (“IRS”) requires a restatement of a qualified retirement plan to ensure that the plan document includes provisions required by legislative and regulatory changes made since the last restatement. There have been no substantive changes to the plan; however, to comply with the IRS rules, the Board of Directors approved a restated plan on January 26, 2012 (incorporated as Exhibit 10.5 in the 2011 10-K) and submitted the plan to the IRS for approval. The IRS issued a determination letter on September 26, 2013, stating that the plan satisfied the requirements of Code Section 4975 (e) (7). On January 26, 2017, the Board of Directors approved a restated plan (incorporated as Exhibit 10.6 in the 2016 10-K). The restated Plan was submitted to the IRS for approval and a determination letter was issued November 17, 2017, stating that the plan satisfies the requirements of Code Section 4975 (e) (7).

 

 11

 

 

The Board of Directors of the Bank approved a cash contribution of $540,000, $510,000, and $420,000 to the ESOP for the fiscal years ended December 31, 2020, 2019, and 2018, respectively. The contributions were made during the respective fiscal years.

 

An employee of the Bank who is not a member of an ineligible class of employees is eligible to participate in the plan upon reaching 21 years of age and being credited with one year of service (1,000 hours of service). All employees are eligible employees except for the following ineligible classes of employees:

 

  Employees whose employment is governed by a collective bargaining agreement between employee representatives and the Company in which retirement benefits were the subject of good faith bargaining unless the collective bargaining agreement expressly provides for the inclusion of such employees in the plan
  Employees who are non-resident aliens who do not receive earned income from the Company which constitutes income from sources within the United States
  Any person who becomes an employee as the result of certain asset or stock acquisitions, mergers, or similar transactions (but only during a transitional period)
  Certain leased employees
  Employees who are employed by an affiliated company that does not adopt the plan
  Any person who is deemed by the Company to be an independent contractor on his or her employment commencement date and on the first day of each subsequent plan year, even if such person is later determined by a court or a governmental agency to be or to have been an employee.

 

The employee may enter the Plan on the January 1st that occurs nearest the date on which the employee first satisfies the age and service requirements described above. No contributions by employees are permitted. The amount and time of contributions are at the sole discretion of the Board of Directors of the Bank. The contribution for all participants is based solely on each participant’s respective regular or base salary and wages paid by the Bank including commissions, bonuses and overtime, if any.

 

A participant becomes vested in the ESOP based upon the employee’s credited years of service. The vesting schedule is as follows:

 

  1 Year of Service 0% Vested  
  2 Years of Service 25% Vested  
  3 Years of Service 50% Vested  
  4 Years of Service 75% Vested  
  5 Years of Service 100% Vested  

 

The Bank is the Plan Administrator. Eugene H. Walpole, IV, Fleetwood S. Hassell, Sheryl G. Sharry and Douglas H. Sass, currently serve as the Plan Administrative Committee and Trustees for the Plan. At December 31, 2020, the Plan owned 344,384 shares of common stock of the Company.

 

THE BANK OF SOUTH CAROLINA STOCK INCENTIVE PLAN

 

We have two Stock Incentive Plans: the first was approved in 2010 with 300,000 (363,000 adjusted for two 10% stock dividends) shares reserved and another Stock Incentive Plan, which was approved in 2020, with 300,000 shares reserved. Under both plans, options are periodically granted to employees at a price not less than the fair market value of the shares at the date of grant. Participating employees become 20% vested after five years and then vest 20% each year until fully vested. The right to exercise each such 20% of the options is cumulative and will not expire until the tenth anniversary of the date of the grant. Employees are eligible to participate in this plan if the Executive/Long-Range Planning Committee, in its sole discretion, and the Compensation Committee as to Executive Officers who are members of the Executive/Long-Range Planning Committee, determines that an employee has contributed or can be expected to contribute to our profits or growth.

 

The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model. Expected volatilities are based on historical volatilities of our common stock. The expected term of the options granted will not exceed ten years from the date of grant (the amount of time options granted are expected to be outstanding). The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.

 

 12

 

 

Item 6. Selected Financial Data

 

The following table sets forth certain selected financial information concerning the Company and its wholly-owned subsidiary. The information was derived from audited consolidated financial statements. The information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which follows, and the audited consolidated financial statements and notes, which are presented elsewhere in this report.

 

   2020   2019   2018   2017   2016 
For December 31:                    
Net income  $6,460,631   $7,318,433   $6,922,934   $4,901,825   $5,247,063 
Selected year end balances:                         
Total assets   532,494,599    445,012,520    429,135,198    446,566,498    413,949,636 
Total loans(1)   333,768,406    279,134,958    275,863,705    272,274,363    264,962,325 
Investment securities available for sale   134,819,818    100,449,956    119,668,874    139,250,250    119,978,944 
Interest-bearing deposits at the Federal Reserve   42,348,085    39,320,526    25,506,784    24,034,194    18,101,300 
Earning assets   510,936,309    418,905,440    421,039,363    435,558,807    403,042,569 
Total deposits   462,197,631    379,191,655    382,378,388    402,888,300    372,522,851 
Total shareholders’ equity   54,980,356    51,168,032    45,462,561    42,764,635    40,612,974 
Weighted Average Shares Outstanding - basic   5,526,948    5,522,025    5,500,027    5,471,001    5,428,884 
Weighted Average Shares Outstanding - diluted   5,678,543    5,588,090    5,589,012    5,568,493    5,561,739 
                          
For the Year:                         
Selected average balances:                         
Total assets   502,628,318    440,615,140    430,495,412    428,174,359    410,581,560 
Total loans(1)   313,303,363    281,508,711    277,223,600    264,881,222    265,151,258 
Investment securities available for sale   112,970,054    106,421,507    123,347,669    130,161,937    110,762,289 
Interest-bearing deposits at the Federal Reserve   54,231,372    34,713,982    20,151,823    23,558,893    26,474,258 
Earning assets   480,504,789    422,644,200    420,723,092    418,602,052    402,387,805 
Total deposits   434,071,108    381,687,960    386,025,147    384,524,305    367,822,900 
Total shareholders’ equity   54,021,647    49,242,545    43,691,359    43,121,778    41,479,755 
                          
Performance Ratios:                         
Return on average equity   11.96%   14.86%   15.85%   11.37%   12.65%
Return on average assets   1.29%   1.66%   1.61%   1.14%   1.28%
Average equity to average assets   10.75%   11.18%   10.15%   10.07%   10.10%
Net interest margin   3.52%   4.28%   4.15%   3.76%   3.71%
Net (recoveries) charge-offs to average loans   0.02%   0.14%   -0.01%   0.01%   0.05%
Allowance for loan losses as a percentage of total  loans(2)   1.30%   1.46%   1.53%   1.43%   1.48%
                          
Per Share:                         
Basic income per common share(3)  $1.17   $1.33   $1.26   $0.90   $0.96 
Diluted income per common share(3)  $1.14   $1.31   $1.24   $0.88   $0.94 
Year end book value(3)  $9.96   $9.25   $8.25   $7.79   $7.45 
Dividends per common share  $0.66   $0.74   $0.58   $0.58   $0.54 
Dividend payout ratio   56.44%   55.88%   54.68%   58.87%   50.86%
Full time employee equivalents   76    79    79    77    74 

 

(1) Including mortgage loans to be sold.
(2) Excluding mortgage loans to be sold.
(3) Adjusted to retroactively reflect 10% stock dividend issued during the year ended December 31, 2018.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Management’s discussion and analysis is included to assist the shareholder in understanding our financial condition, results of operations, and cash flow. This discussion should be reviewed in conjunction with the audited consolidated financial statements and accompanying notes presented in Item 8 of this report and the supplemental financial data appearing throughout this report. Since the primary asset of the Company is its wholly-owned subsidiary, most of the discussion and analysis relates to the Bank.

 

OVERVIEW

 

The Company is a bank holding company headquartered in Charleston, South Carolina, with $532.5 million in assets as of December 31, 2020 and net income of $6.5 million for the year ended December 31, 2020. The Company offers a broad range of financial services through its wholly owned subsidiary, the Bank. The Bank is a state-chartered commercial bank, which operates principally in the Charleston, Dorchester, and Berkeley counties of South Carolina. The Bank’s original and current concept is to be a full service financial institution specializing in personal service, responsiveness, and attention to detail to foster long-standing relationships.

 

We derive most of our income from interest on loans and investment securities. The primary source of funding for making these loans and investment securities is our interest-bearing and non-interest-bearing deposits. Consequently, one of the key measures of our success is the amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.

 

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

 

In addition to earning interest on loans and investment securities, we earn income through fees and other expenses we charge to the customer. The various components of other income and other expenses are described in the following discussion. The discussion and analysis also identifies significant factors that have affected our financial position and operating results for the year ended as of December 31, 2020 as compared to December 31, 2019 and our operating results for 2019 compared to 2018, and should be read in conjunction with the consolidated financial statements and the related notes included in this report. In addition, a number of tables have been included to assist in the discussion.

 

CRITICAL ACCOUNTING POLICIES

 

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States (“GAAP”) and with general practices within the banking industry in the preparation of our consolidated financial statements. Our significant accounting policies are set forth in the notes to the consolidated financial statements of this report.

 

Certain accounting policies involve significant judgments and assumptions made by the Company that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on factors that we believe to be reasonable under the circumstances. Because of the number of judgments and assumptions that we make, actual results could differ and have a material impact on the carrying values of our assets and liabilities and our results of operations.

 

We consider our policy regarding the allowance for loan losses to be our most subjective accounting policy due to the significant degree of judgment. We have developed what we believe to be appropriate policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to our loan portfolio. Our assessments may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations and the discovery of information with respect to borrowers, which were not known at the time of the issuance of the consolidated financial statements. For additional discussion concerning our allowance for loan losses and related matters, see “Allowance for Loan Losses”.

 

 14

 

 

COVID-19

 

On March 11, 2020, the World Health Organization (“WHO”) declared COVID-19 a pandemic. Due to orders issued by the governor of South Carolina and in an abundance of caution for the health of our customers and employees, on March 23, 2020 the Bank closed lobbies to all 5 offices but has remained fully operational.

 

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law, which established the Paycheck Protection Program (“PPP”) and allocated $349.0 billion of loans to be issued by financial institutions. Under the program, the Small Business Administration (“SBA”) will forgive loans, in whole or in part, made by approved lenders to eligible borrowers for payroll and other permitted purposes in accordance with the requirements of the program. These loans carry a fixed rate of 1.00% and a term of two years, if not forgiven, in whole or in part. The loans are 100% guaranteed by the SBA and as long as the borrower submits its loan forgiveness application within ten months of completion of the covered period, the borrower is not required to make any payments until the forgiveness amount is remitted to the lender by the SBA. The Bank received a processing fee ranging from 1% to 5% based on the size of the loan from the SBA. The fees are deferred and amortized over the life of the loans in accordance with ASC 310-20. The Paycheck Protection Program and Health Care Enhancement Act (“PPP/ HCEA Act”) was signed into law on April 24, 2020. The PPP/HCEA Act authorized additional funding under the CARES Act of $310.0 billion for PPP loans to be issued by financial institutions through the SBA. The Bank has provided $37.8 million in funding to 266 customers through the PPP as of December 31, 2020. Because these loans are 100% guaranteed by the SBA and did not undergo the Bank’s typical underwriting process, they are not graded and do not have an associated reserve.

 

Borrowers must submit a forgiveness application within ten months of the completion of the covered period. Once the borrower has submitted the application, the Bank has 60 days to review, issue a lender decision, and submit the decision and application to the SBA. Once the application is submitted, the SBA has 90 days to review and remit the appropriate forgiveness amount to the Bank plus any interest accrued through the date of payment. The SBA began accepting PPP Forgiveness Applications on August 10, 2020. As of December 31, 2020, the Bank received 127 PPP forgiveness applications, in the amount of $13.9 million in principal, and submitted 57 applications and decisions to the SBA, in the amount of $5.4 million in principal. Of the 57 PPP submissions, 48 loans, in the amount of $4.6 million, were forgiven as of December 31, 2020. Upon forgiveness the Bank will recognize the deferred fee income in accordance with ASC 310-20. The Bank received processing fees of $1.4 million and recognized $0.6 million during the year ended December 31, 2020.

 

Regulatory agencies, as set forth in the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (initially issued on March 22, 2020 and revised on April 7, 2020), have encouraged financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19. In this statement, the regulatory agencies expressed their view of loan modification programs as positive actions that may mitigate adverse effects on borrowers due to COVID-19 and that the agencies will not criticize institutions for working with borrowers in a safe and sound manner. Moreover, the revised statement provides that eligible loan modifications related to COVID-19 may be accounted for under section 4013 of the CARES Act or in accordance with ASC 310-40. Under Section 4013 of the CARES Act, banks may elect not to categorize loan modifications as TDRs if the modifications are related to COVID-19, executed on a loan that was not more than 30 days past due as of December 31, 2019, and executed between March 1, 2020 and the earlier of December 31, 2020 or 60 days after the date of termination of the National Emergency. All short-term loan modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not considered TDRs. Beginning in March 2020, the Bank provided payment accommodations to customers, consisting of 60-day principal deferral to borrowers negatively impacted by COVID-19. The Bank processed approximately $0.7 million in principal deferments to 84 customers, with an aggregate loan of $29.7 million, during the year ended December 31, 2020. The principal deferments represent 0.24% of our total loan portfolio as of December 31, 2020. The Bank has examined the payment accommodations granted to borrowers in response to COVID-19 and classified 9 loans, with an aggregate loan balance of $4.0 million, that were granted payment accommodations as TDRs given the continued financial difficulty of the customer, associated industry risk, and multiple deferral requests. All other borrowers were current prior to relief, were not experiencing financial difficulty prior to COVID-19, and the Bank determined they were not considered TDRs. Additionally, of the 75 customers that received payment accommodations that are not classified as TDRs, 15 customers, with an aggregate loan balance of $2.9 million, have paid their loan in full, 7 customers, with an aggregate loan balance of $3.3 million, are past due less than 30 days, and 53 customers, with an aggregate loan balance of $18.6 million, have commenced paying as agreed as of December 31, 2020. There are no loans that received payment accommodation past due greater than 30 days. The Bank will continue to examine payment accommodations as requested by our borrowers.

 

On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (“Economic Aid Act”) was enacted, which reauthorized lending under the PPP program through March 31, 2021, with an additional $325 billion. Under this Act, the SBA will forgive loans, in whole or in part, made by approved lenders to eligible borrowers for payroll and other permitted purposes in accordance with the requirements of the program. These loans carry a fixed rate of 1.00% and a term of five years, if not forgiven, in whole or in part. The loans are 100% guaranteed by the SBA and as long as the borrower submits its loan forgiveness application within ten months of completion of the covered period, the borrower is not required to make any payments until the forgiveness amount is remitted to the lender by the SBA. The Bank will receive a processing fee based on the size of the loan from the SBA and a tiered structure. For loans up to $50,000 in principal, the lender processing fee will be the lesser of 50% of the principal amount or $2,500. For loans between $50,000 and $350,000 in principal, the lender processing fee will be 5% of the principal amount. For loans $350,000 and above, the lender processing fee will be 3% of the principal amount. The fees are deferred and amortized over the life of the loans in accordance with ASC 310-20. As of February 11, 2021 the Bank has received 126 applications with a total loan amount of $13.3 million. Of those 126 applications, the SBA has approved 95 applications in the aggregate amount of $10.7 million.

 

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While the effects of COVID-19 have impacted all industries to varying degrees, the Bank believes the retail and/or service, food and beverage, and short-term rental industries in our geographic area are considered a higher risk due to the primary source of repayment. These industries are dependent upon the hospitality industry and were affected by the mandates issued by the Governor of South Carolina to limit occupancy or close for a period of time.

 

The table below shows the total loans receivable for these segments as a percentage of total gross loans as of December 31, 2020.

 

   As of December 31, 2020 
   Amount   Percent of
Total Loans
 
Retail and/or service  $1,630,331    0.51%
Food and beverage   1,402,001    0.44%
Short-term rentals   9,663,044    3.01%
Total  $12,695,376    3.96%

 

These loans have been temporarily downgraded to our “Watch” category; the Bank is continuing to monitor the effects of COVID-19 on these segments of our loan portfolio. During the second quarter of 2020, the Bank granted payment accommodations in the amount of $0.1 million to 14 loans with an aggregate amount of $6.0 million, or 33.59% of these loans, as of June 30, 2020. As of December 31, 2020, 4 loans with an aggregate balance of $2.4 million paid off. Of the remaining 10 loans with an aggregate remaining balance of $3.5 million as of December 31, 2020, 1 loan with a balance of $0.1 million is past due, and 9 loans with an aggregate balance of $3.4 million are paying as agreed. There were principal paydowns of $0.1 million since the second quarter of 2020. The Bank will reevaluate these loans on a quarterly basis based on actual performance as the effects of COVID-19 continue.

 

Effects of COVID-19 may negatively impact management assumptions and estimates, such as the allowance for loan losses. However, it is difficult to assess or predict how, and to what extent, COVID-19 will affect the Bank in the future.

 

COMPARISON OF THE YEAR ENDED DECEMBER 31, 2020 TO DECEMBER 31, 2019

 

Net income decreased $0.9 million or 11.72% to $6.5 million, or basic and diluted income per share of $1.17 and $1.14, respectively, for the year ended December 31, 2020 from $7.3 million or basic and diluted income per share of $1.33 and $1.31, respectively, for the year ended December 31, 2019. This decrease was primarily due to interest and fee income received on loans tied to changes in variable interest rates as a result of the significant decrease in interest rates at the Federal Reserve during the end of the first quarter of 2020, combined with below market interest rates on PPP loans. Our returns on average assets and average equity for the year ended December 31, 2020 were 1.29% and 11.96%, respectively, compared to 1.66% and 14.86%, respectively, for the year ended December 31, 2019.

 

Net interest income decreased $1.2 million or 6.43% to $16.9 million for the year ended December 31, 2020 from $18.1 million for the year ended December 31, 2019. This decrease was primarily due to a decrease in interest and fees on loans. Interest and fees on loans decreased $0.9 million or 5.87% to $15.1 million for the year ended December 31, 2020 from $16.0 million for the year ended December 31, 2019, as the result of changes in variable interest rates as effected by the significant decrease in interest rates at the Federal Reserve during the end of the first quarter of 2020 combined with below market interest rates on PPP loans.

 

Average earning assets increased $57.9 million or 13.69% to $480.5 million for the year ended December 31, 2020 from $422.6 million for the year ended December 31, 2019. This is primarily related to the increase in the average balance of loans related to the PPP program and interest-bearing deposits at the Federal Reserve.

 

The provision to the allowance for loan losses for the year ended December 31, 2020 was $240,000 compared to $180,000 for the year ended December 31, 2019. The increase was primarily driven by the composition of our loan portfolio in accordance with our allowance for loan loss methodology. The Board of Directors determined that this provision was appropriate based upon the adequacy of our reserve. Charge-offs of $0.3 million and recoveries of $0.2 million, together with the provision to the allowance, resulted in an allowance for loan losses of $4.2 million or 1.30% of total loans as of December 31, 2020. The allowance for loan losses is 1.45% of total loans net of PPP loans.

 

Other income increased $1.2 million or 54.87% to $3.4 million for the year ended December 31, 2020, from $2.2 million for the year ended December 31, 2019. Our mortgage banking income increased $1.3 million or 141.04% to $2.3 million for the year ended December 31, 2020 from $0.9 million for the year ended December 31, 2019 due to increased volume associated with lower interest rates. Mortgage banking income is highly influenced by mortgage interest rates and the housing market.

 

Other expense increased $1.1 million or 9.89% to $11.7 million for the year ended December 31, 2020, from $10.6 million for the year ended December 31, 2019. Salaries and employee benefits increased approximately $0.6 million due to increased salaries and commissions on robust mortgage activity. Net occupancy expense increased approximately $0.6 million due to a full year of occupancy in our new North Charleston branch.

 

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For the year ended December 31, 2020, the Company’s effective tax rate was 23.33% compared to 22.91% during the year ended December 31, 2019.

 

COMPARISON OF THE YEAR ENDED DECEMBER 31, 2019 TO DECEMBER 31, 2018

 

Net income increased $0.4 million or 5.71% to $7.3 million, or basic and diluted income per share of $1.33 and $1.31, respectively, for the year ended December 31, 2019 from $6.9 million or basic and diluted income per share of $1.26 and $1.24, respectively, for the year ended December 31, 2018. The increase in net income was primarily due to rising interest rates in the first half of the year on interest-earning assets and a decrease in other operating expenses. Our returns on average assets and average equity for the year ended December 31, 2019 were 1.66% and 14.86%, respectively, compared with 1.61% and 15.85%, respectively, for the year ended December 31, 2018.

 

Net interest income increased $0.7 million or 3.75% to $18.1 million for the year ended December 31, 2019 from $17.4 million for the year ended December 31, 2018. This increase was primarily due to increases in interest and fees on loans. Interest and fees on loans increased $0.9 million or 5.74% to $16.0 million for the year ended December 31, 2019 from $15.1 million for the year ended December 31, 2018, as the result of the higher Federal Funds target rate set by the Federal Reserve during the first half of the year during an expansion of our loan portfolio.

 

Average earning assets increased $1.9 million or 0.46% to $422.6 million for the year ended December 31, 2019 from $420.7 million for the year ended December 31, 2018. This is primarily related to the increase in the average balance of loans and interest-bearing deposits at the Federal Reserve offset by decreases in average investment securities.

 

The provision to the allowance for loan losses for the year ended December 31, 2019 was $180,000 compared to $325,000 for the year ended December 31, 2018. The decrease was primarily driven by the composition of our loan portfolio in accordance with our allowance for loan loss methodology. The Board of Directors determined that this provision was appropriate based upon the adequacy of our reserve. Charge-offs of $407,027 and recoveries of $16,454, together with the provision to the allowance, resulted in an allowance for loan losses of $4.0 million or 1.46% of total loans at December 31, 2019.

 

Other income increased $0.2 million or 10.23% to $2.2 million for the year ended December 31, 2019, from $2.0 million for the year ended December 31, 2018. Our mortgage banking income increased $0.1 million or 19.54% to $0.9 million for the year ended December 31, 2019 from $0.8 million for the year ended December 31, 2018 due to increased volume. Mortgage banking income is highly influenced by mortgage interest rates and the housing market.

 

Other expense decreased $0.5 million or 4.14% to $10.6 million for the year ended December 31, 2019, from $11.1 million for the year ended December 31, 2018. Other operating expenses decreased $0.8 million to $2.2 million during the year ended December 31, 2019 from $3.0 million during the year ended December 31, 2018. This decrease is directly related to the amortization expense of $354,888 for our investment in a Federal Rehabilitation Tax Credit that was recorded during the year ended December 31, 2018.

 

For the year ended December 31, 2019, the Company’s effective tax rate was 22.91% compared to 13.81% during the year ended December 31, 2018. The increase in the effective tax rate is directly related to the expiration of our 2018 investment in a Federal Rehabilitation Tax Credit.

 

ASSET AND LIABILITY MANAGEMENT

 

We manage our assets and liabilities to ensure there is sufficient liquidity to enable management to fund deposit withdrawals, loan demand, capital expenditures, reserve requirements, operating expenses, and dividends; and to manage daily operations on an ongoing basis. Funds are primarily provided by the Bank through customer deposits, principal and interest payments on loans, mortgage loan sales, the sale or maturity of securities, temporary investments and earnings. The Asset Liability/Investment Committee (“ALCO”) manages asset and liability procedures though the ultimate responsibility rests with the President/Chief Executive Officer. At December 31, 2020, total assets increased 19.66% to $532.5 million from $445.0 million as of December 31, 2019 and total deposits increased 21.89% to $462.2 million from $379.2 million as of December 31, 2019.

 

As of December 31, 2020, earning assets, which are composed of U.S. Treasury, Government Sponsored Enterprises and Municipal Securities in the amount of $134.8 million, interest-bearing deposits at the Federal Reserve in the amount of $42.3 million and total loans, including mortgage loans held for sale, in the amount of $333.8 million, constituted approximately 95.95% of our total assets.

 

The yield on a majority of our earning assets adjusts in tandem with changes in the general level of interest rates. Some of the Company’s liabilities are issued with fixed terms and can be repriced only at maturity.

 

 17

 

 

MARKET RISK

 

Market risk is the risk of loss from adverse changes in market prices and interest rates. Our risk consists primarily of interest rate risk in our lending and investing activities as they relate to the funding by deposit and borrowing activities.

 

Our policy is to minimize interest rate risk between interest-earning assets and interest-bearing liabilities at various maturities and to attempt to maintain an asset sensitive position over a one-year period. By adhering to this policy, we anticipate that our net interest margins will not be materially affected, unless there is an extraordinary and or precipitous change in interest rates. The average net interest rate margin for 2020 decreased to 3.52% from 4.28% for 2019. At December 31, 2020 and 2019, our net cumulative gap was liability sensitive for periods less than one year and asset sensitive for periods of one year or more. The reason for the shift in sensitivity is the direct result of management’s strategic decision to invest excess funds held at the Federal Reserve into fixed rate investment securities that match our investment policy objectives. Management is aware of this departure from policy and will continue to closely monitor our sensitivity position going forward.

 

Since the rates on most of our interest-bearing liabilities can vary on a daily basis, we continue to maintain a loan portfolio priced predominately on a variable rate basis. However, in an effort to protect future earnings in a declining rate environment, we offer certain fixed rates, interest rate floors, and terms primarily associated with real estate transactions. We seek stable, long-term deposit relationships to fund our loan portfolio. Furthermore, we do not have any brokered deposits or internet deposits.

 

At December 31, 2020, the average maturity of the investment portfolio was 4.57 years with an average yield of 1.60% compared to 2.96 years with an average yield of 2.00% at December 31, 2019.

 

We do not take foreign exchange or commodity risks. In addition, we do not own mortgage-backed securities nor do we have any exposure to the sub-prime market or any other distressed debt instruments.

 

The following table summarizes our interest sensitivity position as of December 31, 2020.

 

   One Day   Less than three months   Three months to less than six months   Six months to less than one year   One year to less than five years   Five years or more   Total   Estimated Fair Value 
(in thousands)                                        
Interest-earning assets                                        
Loans(1)  $104,311   $18,917   $29,762   $27,463   $144,254   $9,736   $334,443   $308,722 
Investment securities available for sale(2)       21,786    5,000    40,460    45,022    20,438    132,706    134,820 
Interest-bearing deposits at the Federal Reserve   42,348                        42,348    42,348 
Total  $146,659   $40,703   $34,762   $67,923   $189,276   $30,174   $509,497   $485,890 
                                         
Interest-bearing liabilities                                        
CD’s and other time deposits less than $250,000  $   $5,964   $3,091   $4,141   $1,760   $   $14,956   $14,374 
CD’s and other time deposits $250,000 and over       2,382    547    2,814            5,743    5,921 
Money Market and Interest Bearing Demand Accounts   227,008                        227,008    394,455 
Savings   47,043                        47,043    47,043 
Total  $274,051   $8,346   $3,638   $6,955   $1,760   $   $294,750   $461,793 
                                         
Net  $(127,392)  $32,357   $31,124   $60,968   $187,516   $30,174   $214,747      
Cumulative       (95,035)   (63,911)  $(2,943)  $184,573   $214,747           

 

(1) Including mortgage loans to be sold and deferred fees.
(2) At amortized cost based on the earlier of the call date or scheduled maturity.

 

 18

 

 

LIQUIDITY

 

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

 

The following table summarizes future contractual obligations as of December 31, 2020.

 

   Total   Less than
one year
   One to
five years
   After five
years
 
Contractual Obligations                    
(in thousands)                    
Time deposits  $20,699   $18,939   $1,760   $ 
Operating leases   18,150    1,043    5,217    11,890 
Total contractual cash obligations  $38,849   $19,982   $6,977   $11,890 

 

Proper liquidity management is crucial to ensure that we are able to take advantage of new business opportunities as well as meet the credit needs of our existing customers. Investment securities are an important tool in our liquidity management. Our primary liquid assets are cash and due from banks, investments available for sale, interest-bearing deposits at the Federal Reserve, and mortgage loans held for sale. Our primary liquid assets accounted for 36.83% and 34.74% of total assets at December 31, 2020 and 2019, respectively. Investment securities classified as available for sale, which are not pledged, may be sold in response to changes in interest rates and liquidity needs. All of the investment securities presently owned are classified as available for sale. Net cash provided by operations and deposits from customers have been the primary sources of liquidity. At December 31, 2020, we had unused short-term lines of credit totaling approximately $23.0 million (which can be withdrawn at the lender’s option). Additional sources of funds available to us for liquidity include increasing deposits by raising interest rates paid and selling mortgage loans held for sale. We also established a Borrower-In-Custody arrangement with the Federal Reserve. This arrangement permits us to retain possession of assets pledged as collateral to secure advances from the Federal Reserve Discount Window. At December 31, 2020, we could borrow up to $58.7 million. There have been no borrowings under this arrangement.

 

Our core deposits consist of non-interest bearing demand accounts, NOW accounts, money market accounts, time deposits and savings accounts. We closely monitor our reliance on certificates of deposit greater than $250,000 and other large deposits. We maintain a Contingency Funding Plan (“CFP”) that identifies liquidity needs and weighs alternate courses of action designed to address these needs in emergency situations. We perform a quarterly cash flow analysis and stress test the CFP to evaluate the expected funding needs and funding capacity during a liquidity stress event. We believe our liquidity sources are adequate to meet our operating needs and do not know of any trends, events or uncertainties that may result in a significant adverse effect on our liquidity position. At December 31, 2020 and 2019, our liquidity ratio was 38.63% and 36.18%, respectively.

 

Average earning assets increased by $57.9 million from 2019 to 2020. This increase is primarily related to the increase in the average balance of loans related to the PPP program and interest-bearing deposits at the Federal Reserve.

 

The following table shows the composition of average assets over the past five fiscal years.

 

   2020   2019   2018   2017   2016 
Loans(1)  $313,303,363   $277,395,432    $277,223,600   $260,987,352   $261,587,734 
Investment securities available for sale   112,970,054    106,421,507    123,347,669    130,161,937    110,762,289 
Interest-bearing deposits at the Federal Reserve   54,231,372    34,713,982    20,151,823    23,558,893    26,474,258 
Non-earning assets   22,123,529    22,084,219    9,772,320    13,466,177    11,757,279 
Total average assets  $502,628,318   $440,615,140   430,495,412   $428,174,359   $410,581,560 

  

(1) Including mortgage loans to be sold and deferred fees.

 

 19

 

 

ANALYSIS OF CHANGES IN NET INTEREST INCOME

 

The following table shows changes in interest income and expense based upon changes in volume and changes in rates.

 

   2020 vs. 2019  2019 vs. 2018  2018 vs. 2017
   Volume  Rate  Net Dollar Change(1)  Volume  Rate  Net Dollar Change(1)  Volume  Rate  Net Dollar Change(1)
Loans(2)  $1,798,561  $(2,736,870)  $(938,309)  $237,995  $629,980  $867,975  $619,462  $1,219,536  $1,838,998
Investment securities available for sale   136,175    (324,518)   (188,343)   (364,113)   (64,792)   (428,905)   (133,820)   138,800    4,980 
Interest-bearing deposits at the Federal Reserve   409,494    (955,338)   (545,844)   284,163    52,108    336,271    (38,839)   162,625    123,786 
Interest income  $2,344,230   $(4,016,726)  $(1,672,496)  $158,045   $617,296   $775,341   $446,803   $1,520,961   $1,967,764 
                                              
Interest bearing transaction accounts  $56,917   $(443,183)  $(386,266)  $28,048   $137,012   $165,060   $(1,334)  $214,584   $213,250 
Savings   23,542    (81,423)   (57,881)   (4,507)   20,217    15,710    1,355    40,614    41,969 
Time deposits   (34,106)   (31,504)   (65,610)   (80,972)   20,987    (59,985)   (11,973)   27,277    15,304 
Interest expense  $46,353   $(556,110)  $(509,757)  $(57,431)  $178,216   $120,785   $(11,952)  $282,475   $270,523 
                                              
(Decrease) increase in net interest income            $(1,162,739)            $654,556             $1,697,241 

 

(1)

Volume/rate changes have been allocated to each category based on the percentage of each change to the total change.

(2)

Including mortgage loans to be sold.  

 

YIELDS ON AVERAGE EARNING ASSETS AND RATES ON AVERAGE INTEREST-BEARING LIABILITIES

 

The following table shows the yields on average earning assets and average interest-bearing liabilities.

 

   2020   2019   2018 
   Average Balance   Interest Paid/Earned   Average Yield/Rate(1)   Average Balance   Interest Paid/Earned   Average Yield/Rate(1)   Average Balance   Interest Paid/Earned   Average Yield/Rate(1) 
Interest-earning assets                                             
Loans(2)  $313,303,363   $15,055,981    4.81%  $281,508,711   $15,994,290    5.68%  $277,223,600   $15,126,316    5.46%
Investment Securities Available for Sale   112,970,054    1,999,751    1.77%   106,421,507    2,188,094    2.06%   123,347,669    2,616,998    2.12%
Federal Funds Sold & Interest bearing deposits   54,231,372    184,024    0.34%   34,713,982    729,868    2.10%   20,151,823    393,597    1.95%
Total earning assets  $480,504,789   $17,239,756    3.59%  $422,644,200   $18,912,252    4.47%  $420,723,092   $18,136,911    4.31%
                                              
Interest-bearing liabilities                                             
Interest-bearing transaction accounts  $208,940,724   $166,346    0.08%  $189,114,988   $552,612    0.29%  $176,796,964   $387,552    0.22%
Savings   40,770,588    39,826    0.10%   32,934,733    97,707    0.30%   34,857,035    81,997    0.24%
Time Deposits   20,964,940    99,242    0.47%   26,456,064    164,852    0.62%   41,325,783    224,837    0.54%
   $270,676,252   $305,414    0.11%  $248,505,785   $815,171    0.33%  $252,979,782   $694,386    0.27%
                                              
Net interest spread             3.48%             4.14%             4.04%
Net interest margin             3.52%             4.28%             4.15%
Net interest income       $16,934,342             $18,097,081             $17,442,525      

 

(1) The effect of forgone interest income as a result of non-accrual loans was not considered in the above analysis.
(2) Average loan balances include non-accrual loans and mortgage loans to be sold.

 

 20

 

 

INVESTMENT PORTFOLIO

 

The following tables summarize the carrying value of investment securities as of the indicated dates and the weighted-average yields of those securities at December 31, 2020.

 

    Amortized Cost      
     Within One Year      After One Year through Five Years      After Five Years through Ten Years      After
Ten Years 
     Total     Estimated
Fair Value
 
(in thousands)                              
U.S. Treasury Notes  $15,040   $4,997   $   $   $20,037   $20,411 
Government-Sponsored Enterprises   15,012    25,022    46,580    10,000    96,614    97,853 
Municipal Securities   2,193    10,005    3,857        16,055    16,556 
Total  $32,245   $40,024   $50,437   $10,000   $132,706   $134,820 
                               
Weighted average yields                              
U.S. Treasury Notes   1.73%   2.04%   0.00%   0.00%          
Government-Sponsored Enterprises   2.12%   1.75%   1.14%   1.35%          
Municipal Securities   2.28%   2.03%   1.82%   0.00%          
Total   1.95%   1.86%   1.19%   1.35%   1.59%     

 

The following tables present the amortized cost and estimated fair value of investment securities for the past three years.

 

December 31, 2020  Amortized Cost   Estimated
Fair Value
(in thousands)          
U.S. Treasury Notes  $20,037   $20,411 
Government-Sponsored Enterprises   96,614    97,853 
Municipal Securities   16,055    16,556 
Total  $132,706   $134,820 

 

December 31, 2019  Amortized
Cost
   Estimated
Fair Value
 
(in thousands)          
U.S. Treasury Notes  $23,080   $23,180 
Government-Sponsored Enterprises   50,140    50,498 
Municipal Securities   26,618    26,772 
Total  $99,838   $100,450 

 

         
December 31, 2018  Amortized
Cost
   Estimated
Fair Value
 
(in thousands)          
U.S. Treasury Notes  $32,966   $32,357 
Government-Sponsored Enterprises   60,685    59,369 
Municipal Securities   28,268    27,943 
Total  $121,919   $119,669 

 

As of December 31, 2020, we had no U.S. Treasury Notes or Municipal Securities with an unrealized loss. In comparison, we had no U.S. Treasury Notes with an unrealized loss and we had 10 Municipal Securities with an unrealized loss of $16,454 as of December 31, 2019. As of December 31, 2020, we had four Government-Sponsored Enterprises with an unrealized loss of $160,260 compared to one Government-Sponsored Enterprises with an unrealized loss of $43,100 as of December 31, 2019. The unrealized losses on these securities are related to the changes in the interest rate environment. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Therefore, these investments are not considered other-than-temporarily impaired. We have the ability to hold these investments until market price recovery or maturity.

 

The primary purpose of the investment portfolio is to fund loan demand, manage fluctuations in deposits and liquidity, satisfy pledging requirements and generate a favorable return on investment.  In doing these things, our main objective is to adhere to sound investment practices.  To that end, all purchases and sales of investment securities are made through reputable securities dealers that have been approved by the Board of Directors. The Board of Directors of the Bank reviews the entire investment portfolio at each regular monthly meeting, including any purchases, sales, calls, and maturities during the previous month.  Furthermore, the Credit Department conducts a financial underwriting assessment of all municipal securities and their corresponding municipalities annually and management reviews the assessments.

 

 21

 

 

LOAN PORTFOLIO COMPOSITION

 

We focus our lending activities on small and middle market businesses, professionals and individuals in our geographic market. At December 31, 2020, outstanding loans (including deferred loan fees of $676,155) totaled $320.8 million, which equaled 69.41% of total deposits and 60.25% of total assets.

 

The following table is a schedule of our loan portfolio, excluding both mortgage loans to be sold and deferred loan fees, as of December 31, 2020, compared to the prior four years.

 

(in thousands)  2020   2019   2018   2017   2016 
Commercial  $51,041   $52,848   $54,829   $51,723   $52,262 
Commercial real estate construction   14,814    12,491    7,304    2,318    1,209 
Commercial real estate other   146,188    143,824    143,703    140,187    122,968 
Consumer real estate   71,836    59,532    63,787    70,798    77,132 
Consumer other   4,481    5,378    5,040    5,155    7,005 
Paycheck protection program   32,443                 
Total  $320,803   $274,073   $274,663   $270,181   $260,576 

 

During the year ended December 31, 2020, total loans increased $46.7 million. This is primarily due to the creation of a residential real estate mortgage portfolio held for investment and participation in the Paycheck Protection Program.

 

We had no foreign loans or loans to fund leveraged buyouts at any time during the years ended December 31, 2016 through December 31, 2020.

 

The following table presents the contractual terms to maturity for loans outstanding at December 31, 2020. Demand loans, loans having no stated schedule of repayment or stated maturity, and overdrafts are reported as due in one year or less. The table does not include an estimate of prepayments, which can significantly affect the average life of loans and may cause our actual principal experience to differ from that shown.

 

   Selected Loan Maturity as of December 31, 2020 
(in thousands)  One Year
or Less
   Over One Year but Less Than 5 years   Over
5 Years
   Total 
Commercial  $28,645   $19,882   $2,514   $51,041 
Commercial real estate construction   6,243    8,571        14,814 
Commercial real estate other   33,367    103,733    9,088    146,188 
Consumer real estate   22,190    6,430    43,216    71,836 
Consumer other   1,206    3,248    27    4,481 
Paycheck protection program       32,443        32,443 
Total  $91,651   $174,307   $54,845   $320,803 
                     
Loans maturing after one year with:                    
Fixed interest rates                 $153,913 
Floating interest rates                   
Total                 $153,913 

  

IMPAIRED LOANS

 

A loan is impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement based on current information and events. All loans with a principal balance over $50,000 placed on non-accrual status are classified as impaired. However, not all impaired loans are on non-accrual status nor do they all represent a loss.

 

Impairment loss is measured by:

 

  a. The present value of the future cash flow discounted at the loan’s effective interest rate, or

 

 22

 

 

  b. The fair value of the collateral if the loan is collateral dependent.

 

The following is a schedule of our impaired loans and non-accrual loans as of December 31, 2016 through 2020.

 

   2020   2019   2018   2017   2016 
Non-accrual loans  $1,155,930   $1,666,301   $823,534   $831,859   $1,741,621 
Impaired loans  $7,805,600   $4,776,928   $4,278,347   $3,724,262   $5,901,784 

  

Beginning in March 2020, the Bank provided payment accommodations to customers, consisting of 60-day principal deferral to borrowers negatively impacted by COVID-19. The Bank processed approximately $0.7 million in principal deferments to 84 customers, with an aggregate loan of $29.7 million, during the year ended December 31, 2020. The principal deferments represent 0.24% of our total loan portfolio as of December 31, 2020. The Bank has examined the payment accommodations granted to borrowers in response to COVID-19 and classified 9 loans, with an aggregate loan balance of $4.0 million, that were granted payment accommodations as impaired and TDRs given the continued financial difficulty of the customer, associated industry risk, and multiple deferral requests.

 

TROUBLED DEBT RESTRUCTURINGS

 

According to GAAP, we are required to account for certain loan modifications or restructurings as a troubled debt restructuring (“TDR”), when appropriate. In general, the modification or restructuring of a debt is considered a TDR if we, for economic or legal reasons related to a borrower’s financial difficulties, grant a concession to the borrower that we would not otherwise consider. Three factors must always be present: 

 

1. An existing credit must formally be renewed, extended, or modified,  

2. The borrower is experiencing financial difficulties, and  

3. We grant a concession that we would not otherwise consider.

 

The following is a schedule of our TDR’s including the number of loans represented.

 

    2020   2019   2018   2017   2016 
Number of TDRs   $14   $3   $   $1   $2 
Amount of TDRs   $5,803,163   $573,473   $   $33,300   $378,382 

 

The Financial Accounting Standards Board Accounting (“FASB”) Standards Codification (“ASC”) 310-20-35-9 allows a loan to be removed from TDR status if the terms of the loan reflect current market rates and the loan has been performing under modified terms for an extended period of time or under certain other circumstances.

 

One TDR with a balance of $33,300 at December 31, 2017 was removed from TDR status during the year ended December 31, 2018 since, at the most recent renewal, the loan was amortized at market rate and no concessions were granted. One TDR with a balance of $345,082 at December 31, 2016 paid off during the year ended December 31, 2017. During the year ended December 31, 2016, one TDR was paid off with a balance of $72,919 at December 31, 2015. We do not know of any potential problem loans which will not meet their contractual obligations that are not otherwise discussed herein.

 

Regulatory agencies, as set forth in the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (initially issued on March 22, 2020 and revised on April 7, 2020), have encouraged financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19. In this statement, the regulatory agencies expressed their view of loan modification programs as positive actions that may mitigate adverse effects on borrowers due to COVID-19 and that the agencies will not criticize institutions for working with borrowers in a safe and sound manner. Moreover, the revised statement provides that eligible loan modifications related to COVID-19 may be accounted for under section 4013 of the CARES Act or in accordance with ASC 310-40. Under Section 4013 of the CARES Act, banks may elect not to categorize loan modifications as TDRs if the modifications are related to COVID-19, executed on a loan that was not more than 30 days past due as of December 31, 2019, and executed between March 1, 2020 and the earlier of December 31, 2020 or 60 days after the date of termination of the National Emergency. All short-term loan modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not considered TDRs. Beginning in March 2020, the Bank provided payment accommodations to customers, consisting of 60-day principal deferral to borrowers negatively impacted by COVID-19. The Bank has examined the payment accommodations granted to borrowers in response to COVID-19 and classified 9 loans, with an aggregate loan balance of $4.0 million, that were granted payment accommodations as TDRs given the continued financial difficulty of the customer, associated industry risk, and multiple deferral requests. The Bank will continue to examine payment accommodations as requested by the borrowers.

 

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ALLOWANCE FOR LOAN LOSSES

 

The allowance for loan losses represents our estimate of probable losses inherent in our loan portfolio. The adequacy of the allowance for loan losses (the “allowance”) is reviewed by the Loan Committee and by the Board of Directors on a quarterly basis. For purposes of this analysis, adequacy is defined as a level sufficient to absorb estimated losses in the loan portfolio as of the balance sheet date presented. To remain consistent with GAAP, the methodology employed for this analysis has been modified over the years to reflect the economic environment and new accounting pronouncements. The Credit Department reviews this calculation on a quarterly basis. In addition, an independent third party validates the allowance calculation on a periodic basis. The methodology is based on a reserve model that is comprised of the three components listed below:

 

  1) Specific reserve analysis for impaired loans based on FASB ASC 310-10-35, Receivables - Overall
  2) General reserve analysis applying historical loss rates based on FASB ASC 450-20, Contingencies: Loss Contingencies
  3) Qualitative or environmental factors.

 

Loans greater than $50,000 are reviewed for impairment on a quarterly basis if any of the following criteria are met: 

 

  1) The loan is on non-accrual
  2) The loan is a troubled debt restructuring
  3) The loan is over 60 days past due
  4) The loan is rated sub-standard, doubtful, or loss
  5) Excessive principal extensions are executed
  6) If we are provided information that indicates we will not collect all principal and interest as scheduled

 

Impairment is measured by the present value of the future cash flow discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. An impaired loan may not represent an expected loss.

 

A general reserve analysis is performed on all loans, excluding impaired loans. This analysis includes a pool of loans that are reviewed for impairment but are not found to be impaired. Loans are segregated into similar risk groups and a historical loss ratio is determined for each group over a five-year period. The five-year average loss ratio by loan type is then used to calculate the estimated loss based on the current balance of each group.

 

Qualitative and environmental loss factors are also applied against the portfolio, excluding impaired loans. These factors include external risk factors that we believe are representative of our overall lending environment. We believe that the following factors create a more comprehensive loss projection, which we can use to monitor the quality of the loan portfolio.

 

  1) Portfolio risk
  a) Levels and trends in delinquencies and impaired loans and changes in loan rating matrix
  b) Trends in volume and terms of loans
  c) Over-margined real estate lending risk
  2) National and local economic trends and conditions
  3) Effects of changes in risk selection and underwriting practices
  4) Experience, ability and depth of lending management staff
  5) Industry conditions
  6) Effects of changes in credit concentrations
  a) Loan concentration
  b) Geographic concentration
  c) Regulatory concentration
  7) Loan and credit administration risk
  a) Collateral documentation
  b) Insurance risk
  c) Maintenance of financial information risk
       

The sum of each component’s analysis contributes to the total “estimated loss” within our portfolio.

 

Portfolio Risk  

Portfolio risk includes the levels and trends in delinquencies, impaired loans and changes in the loan rating matrix, trends in volume and terms of loans, and overmargined real estate lending. We are satisfied with the stability of the past due and non-performing loans and believe there has been no decline in the quality of our loan portfolio due to any trend in delinquent or adversely classified loans. Sizable unsecured principal balances on a non-amortizing basis are monitored. Although the vast majority of our real estate loans are underwritten on a cash flow basis, the secondary source of repayment is typically tied to our ability to realize the collateral. Accordingly, we closely monitor loan to value ratios. The maximum collateral advance rate is 80% on all real estate transactions, with the exception of raw land at 65% and land development at 70%.

 

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Occasionally, we extend credit beyond our normal collateral advance margins in real estate lending. We refer to these loans as overmargined real estate loans. Although infrequent, the aggregate of these loans represents a notable part of our portfolio. Accordingly, these loans are monitored and the balances reported to the Board of Directors every quarter. An excessive level of this practice (as a percentage of capital) could result in additional regulatory scrutiny, competitive disadvantages and potential losses if forced to convert the collateral. The consideration of overmargined real estate loans directly relates to the capacity of the borrower to repay. We often request additional collateral to bring the loan to value ratio within the policy objectives and require a strong secondary source of repayment.

 

Although significantly under our policy threshold of 100% of capital (currently approximately $55.0 million), the number of overmargined real estate loans currently totals approximately $2.9 million or approximately 0.89% of our loan portfolio at December 31, 2020 compared to $4.8 million or approximately 1.74% of the loan portfolio at December 31, 2019.

 

A credit rating matrix is used to rate all extensions of credit and to provide a more specific picture of the risk each loan poses to the quality of the loan portfolio. There are eight possible ratings used to determine the quality of each loan based on the following characteristics: cash flow, collateral quality, guarantor strength, financial condition, management quality, operating performance, the relevancy of the financial statements, historical loan performance, debt coverage ratio, and the borrower’s leverage position. The matrix is designed to meet our standards and expectations of loan quality. It is based on experience with similarly graded loans, industry best practices, and regulatory guidance. Our loan portfolio is graded in its entirety, with the exception of PPP loans. Because PPP loans are 100% guaranteed by the SBA and did not undergo the Bank’s typical underwriting process, they are not graded.

 

National and local economic trends and conditions   

National and local economic trends and conditions are constantly changing and both positively and negatively impact borrowers. Most macroeconomic conditions are not controllable by us and are incorporated into the qualitative risk factors. Natural and environmental disasters, including the rise of sea levels, political uncertainty, and international instability are a few of the trends and conditions that are currently affecting the national and local economies. Additionally, the national and local economy has been affected by COVID-19 during the year ended December 31, 2020. These changes have impacted borrowers’ ability, in many cases, to repay loans in a timely manner. On occasion, a loan’s primary source of repayment (i.e. personal income, cash flow, or lease income) may be eroded as a result of unemployment, lack of revenues, or the inability of a tenant to make rent payments.

 

Effects of changes in risk selection and underwriting practices  

The quality of our loan portfolio is contingent upon our risk selection and underwriting practices. All new loans (except for mortgage loans in the process of being sold to investors and loans secured by properly margined negotiable securities traded on an established market or other cash collateral) with exposure over $300,000 are reviewed by the Loan Committee on a monthly basis. The Board of Directors review credits over $750,000 monthly. Annual credit analyses are conducted on credits over $500,000 upon the receipt of updated financial information. Prior to extensions of credit, significant loan opportunities go through sound credit underwriting. Our Credit Department conducts a detailed cash flow analysis on each proposal using the most current financial information.

 

Experience, ability and depth of lending management staff   

We have over 300 combined years of lending experience among our lending staff. We are aware of the many challenges currently facing the banking industry. As other banks look to increase earnings in the short term, we will continue to emphasize the need to maintain safe and sound lending practices and core deposit growth managed with a long-term perspective.

 

Industry conditions  

There continues to be an influx of new banks and consolidation of existing banks in our geographic area, which creates pricing competition. We believe that our borrowing base is well established and therefore unsound price competition is not necessary.

 

Effects of changes in credit concentrations  

The risks associated with the effects of changes in credit concentration include loan, geographic and regulatory concentrations. As of December 31, 2020, one Standard Industrial Code group, activities related to real estate, comprised more than 2% of our total outstanding loans.

 

Effects of changes in geographic concentrations  

We are located along the coast and on an earthquake fault line, increasing the chances that a natural disaster may impact our borrowers and us. We have a Disaster Recovery Plan in place; however, the amount of time it would take for our customers to return to normal operations is unknown. Our plan is reviewed and tested annually.

 

Loan and credit administration risk 

Loan and credit administration risk includes collateral documentation, insurance risk and maintaining financial information risk.

 

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The majority of our loan portfolio is collateralized with a variety of our borrowers’ assets. The execution and monitoring of the documentation to properly secure the loan is the responsibility of our lenders and loan department. We require insurance coverage naming us as the mortgagee or loss payee. Although insurance risk is also considered collateral documentation risk, the actual coverage, amounts of coverage and increased deductibles are important to management.

 

Financial Information Risk includes a function of time during which the borrower’s financial condition may change; therefore, keeping financial information up to date is important to us. Our policy requires all new loans (with a credit exposure of $10,000 or more), regardless of the customer’s history with us, to have updated financial information. In addition, we monitor appraisals closely as real estate values are appreciating.

 

Based on our analysis of the adequacy of the allowance for loan loss model, we recorded a provision for loan loss of $0.2 million for the year ended December 31, 2020 compared to $0.2 million for the year ended December 31, 2019. At December 31, 2020, the five-year average loss ratios were: 0.19% Commercial, 0.00% Commercial Real Estate Construction, -0.01% Commercial Real Estate Other, 0.03% Consumer Real Estate, and 0.63% Consumer Other.

 

During the year ended December 31, 2020, to charge-offs of $0.3 million and recoveries of $0.2 million were recorded to the allowance for loan losses, resulting in an allowance for loan losses of $4.2 million or 1.30% of total loans compared to charge-offs of $407,027 and recoveries of $16,454 were recorded to the allowance for loan losses, resulting in an allowance for loan losses of $4.0 million or 1.46% of total loans. As of December 31, 2020, the allowance for loan losses was 1.45% of total loans less PPP loans. PPP loans are 100% guaranteed by the SBA; therefore, these loans do not have an associated reserve. We believe loss exposure in the portfolio is identified, reserved against, and closely monitored to ensure that economic changes are promptly addressed in the analysis of reserve adequacy.

 

The accrual of interest is generally discontinued on loans which become 90 days past due as to principal or interest. The accrual of interest on some loans may continue even though they are 90 days past due if the loans are well secured or in the process of collection and we deem it appropriate. If non-accrual loans decrease their past due status to less than 30 days for a period of six to nine months, they are reviewed individually to determine if they should be returned to accrual status. At December 31, 2020 and 2019, there were no loans over 90 days past due still accruing interest.

 

The following table represents a summary of loan loss experience for the past five years.

 

   2020   2019   2018   2017   2016 
(in thousands)                         
Balance of the allowance of loan losses at the beginning of the period  $4,004   $4,214   $3,875   $3,852   $3,418 
                          
Charge-offs                         
Commercial   (172)   (399)   (31)       (33)
Commercial Real Estate Construction                    
Commercial Real Estate Other               (181)   (78)
Consumer Real Estate                   (82)
Consumer Other   (116)   (8)   (85)   (5)   (15)
Paycheck Protection Program   (2)                
Total charge-offs   (290)   (407)   (116)   (186)   (208)
                          
Recoveries                         
Commercial   89    12    14    6     
Commercial Real Estate Construction                    
Commercial Real Estate Other   100        57    87    65 
Consumer Real Estate           45    60     
Consumer Other   43    5    14