Form 10-Q

U.S. Securities and Exchange Commission

Washington, D.C. 20549





x Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2007


¨ Transition Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period ended                     

Commission File Number 000-51513



(Exact name of registrant as specified in its charter)



NORTH CAROLINA   20-3035898

(State or other jurisdiction of

incorporation or organization)


(IRS Employer

Identification Number)


(Address of principal executive office)

(910) 509-2000

(Registrant’s telephone number)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  x

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

The number of shares of the registrant’s common stock outstanding as of May 4, 2007 was 3,586,911.


         Page No.

Part I.


Item 1 -

  Financial Statements (Unaudited)   

Consolidated Balance Sheets March 31, 2007 and December 31, 2006


Consolidated Statements of Operations Three Months Ended March 31, 2007 and 2006


Consolidated Statements of Cash Flows Three Months Ended March 31, 2007 and 2006


Notes to Consolidated Financial Statements


Item 2 -

  Management’s Discussion and Analysis of Financial Condition and Results of Operations    9

Item 3 -

  Quantitative and Qualitative Disclosures about Market Risk    15

Item 4 -

  Controls and Procedures    15

Part II.


Item 1 -

  Legal Proceedings    16

Item 1A-

  Risk Factors    16

Item 2 -

  Unregistered Sales of Equity Securities and Use of Proceeds    16

Item 3 -

  Defaults Upon Senior Securities    16

Item 4 -

  Submission of Matters to a Vote of Securities Holders    16

Item 5 -

  Other Information    16

Item 6 -

  Exhibits    16


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Item 1—Financial Statements





March 31,



December 31,


     (In thousands, except share data)  



Cash and due from banks

   $ 8,406     $ 7,209  

Interest earning deposits in other banks

     8,452       1,639  

Investment securities available for sale, at fair value

     70,941       69,565  

Time deposits in other banks

     199       298  


     344,743       334,409  

Allowance for loan losses

     (4,738 )     (4,536 )


     340,005       329,873  

Accrued interest receivable

     2,219       2,195  

Premises and equipment, net

     3,108       2,954  

Stock in Federal Home Loan Bank of Atlanta, at cost

     2,024       2,081  

Foreclosed real estate and repossessions

     616       616  

Bank owned life insurance

     9,573       5,491  

Other assets

     2,775       2,964  


   $ 448,318     $ 424,885  






   $ 34,277     $ 33,066  


     7,378       11,154  

Money market and NOW

     59,473       41,317  


     278,926       268,080  


     380,054       353,617  

Short-term borrowings

     —         3,000  

Long-term borrowings

     38,310       38,310  

Accrued interest payable

     766       745  

Accrued expenses and other liabilities

     1,649       2,161  


     420,779       397,833  

Shareholders’ Equity


Common stock, $3.50 par value, 12,500,000 shares authorized; 3,586,911 and 3,586,780 shares issued and outstanding at March 31, 2007 and December 31, 2006, respectively

     12,554       12,554  

Additional paid-in capital

     12,768       12,739  

Accumulated retained earnings

     2,528       2,092  

Accumulated other comprehensive loss

     (311 )     (333 )


     27,539       27,052  


   $ 448,318     $ 424,885  

* Derived from audited financial statements

See accompanying notes.


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Three Months Ended

March 31,

     2007    2006  
     (In thousands, except share and per share data)  




   $ 6,912    $ 5,402  

Investment securities available for sale

     839      571  

Other interest-earning assets

     97      193  


     7,848      6,166  



Money market, NOW and savings deposits

     548      309  

Time deposits

     3,546      2,422  

Short-term borrowings

     42      228  

Long-term borrowings

     499      120  


     4,635      3,079  


     3,213      3,087  


     75      293  




     3,138      2,794  



Service fees and charges

     165      151  

Gain/(loss) on sale of investments

     3      (10 )

Income from bank owned life insurance

     82      47  


     60      52  


     310      240  



Salaries and employee benefits

     1,549      1,127  

Occupancy and equipment

     423      327  


     897      620  


     2,869      2,074  


     579      960  


     144      356  


   $ 435    $ 604  




   $ 0.12    $ 0.17  


   $ 0.12    $ 0.16  






     3,586,849      3,586,518  

Effect of dilutive stock options

     90,277      93,631  


     3,677,126      3,680,149  

* All per share and outstanding share data has been restated for the 5% stock dividend effective 6/30/06

See accompanying notes.


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Three Months Ended

March 31

     2007     2006  
     (In thousands)  



Net income

   $ 435     $ 604  

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


Depreciation and amortization

     149       95  

Provision for loan losses

     75       293  

Loss on disposal of equipment

     3       7  

(Gain) loss on sale of investments

     (3 )     10  

Income from bank owned life insurance

     (82 )     (47 )

Stock based compensation

     29       29  

Change in assets and liabilities:


(Increase) decrease in other assets

     155       (126 )

Increase in accrued interest receivable

     (24 )     (65 )

Increase in accrued interest payable

     21       81  

Decrease in accrued expenses and other liabilities

     (512 )     (631 )


     246       250  



Purchase of investment securities available for sale

     (4,310 )     (7,655 )

Proceeds from calls and maturities of securities available for sale

     1,380       1,061  

Proceeds from sales of securities available for sale

     1,592       650  

Net redemptions/(purchases) of stock in FHLB

     57       (282 )

Maturity of time deposits in other banks

     99       —    

Net increase in loans

     (10,207 )     (12,539 )

Purchase of bank owned life insurance

     (4,000 )     —    

Purchases of bank premises and equipment

     (285 )     (336 )


     (15,674 )     (19,101 )



Net increase in deposits

     26,437       38,500  

Net decrease in borrowings

     (3,000 )     —    

Net proceeds from exercise of stock options

     1       —    


     23,438       38,500  


     8,010       19,649  


     8,848       7,273  


   $ 16,858     $ 26,922  


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In management’s opinion, the financial information, which is unaudited, reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the three month periods ended March 31, 2007 and 2006 in conformity with accounting principles generally accepted in the United States of America. The financial statements include the accounts of Cape Fear Bank Corporation (the “Company”) and its wholly owned subsidiary, Cape Fear Bank (the “Bank”). All significant inter-company transactions and balances are eliminated in consolidation. Operating results for the three month period ended March 31, 2007 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2007.

The organization and business of the Cape Fear Bank Corporation and subsidiary (the “Company”), accounting policies followed by the Company and other information are contained in the notes to the consolidated financial statements filed as part of the Company’s 2006 annual report on Form 10-K. This quarterly report should be read in conjunction with such annual report.


At March 31, 2007, loan commitments are as follows:


     (In thousands)

Undisbursed lines of credit

   $ 67,586

Commitments to extend credit


Letters of credit



Basic and diluted net income per share has been computed based on the weighted average number of shares outstanding during each period after retroactively adjusting for a 5% stock dividend on June 30, 2006. Diluted net income per share reflects the potential dilution that could occur if outstanding stock options were exercised.


A summary of comprehensive income is as follows:



Three Months Ended

March 31,

     2007     2006  
     (In thousands)  

Net income

   $ 435     $ 604  

Other comprehensive income (loss):


Unrealized gain (loss) on investment securities available for sale arising during the period

     39       (226 )

Tax effect

     (15 )     87  

Reclassification of (gains) losses recognized in net income

     (3 )     10  

Tax effect

     1       (4 )

Total other comprehensive income (loss)

     22       (133 )

Total comprehensive income

   $ 457     $ 471  


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The Company has two share-based compensation plans in effect at March 31, 2007. The compensation cost that has been charged against income for those plans was approximately $29 thousand for the three months ended March 31, 2007 and 2006. There have been no deferred tax assets recorded due to the fact that stock based compensation expense results solely from incentive stock options.

A summary of option activity under the stock option plans as of March 31, 2007 and changes during the three month period ended March 31, 2007 is presented below:


     Shares     Weighted

Outstanding at December 31, 2006

   414,305     $ 7.72      


   (131 )     3.97      


   —         —        


   —         —        


   —         —        

Outstanding at March 31, 2007

   414,174     $ 7.72    5.12 years    $ 1,607,861

Exerciseable at March 31, 2007

   329,792     $ 7.07    4.31 years    $ 1,493,744

There were 131 options exercised during the three months ended March 31, 2007 and none in 2006. For the three months ended March 31, 2007, the intrinsic value of options exercised was approximately $1 thousand.


Effective January 1, 2007, Cape Fear Bank Corporation adopted Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (the Interpretation).” This Interpretation provides guidance on financial statement recognition and measurement of tax positions taken, or expected to be taken, in tax returns. The initial adoption of this Interpretation had no impact on the Company’s financial statements.

The amount of unrecognized tax benefits may increase or decrease in the future for various reasons including amounts for current tax year positions, expiration of open income tax returns due to the statutes of limitation, changes in management’s judgment about the level of uncertainty, status of examinations, litigation and legislative activity and the addition or elimination of uncertain tax positions.

The Company’s policy is to report interest and penalties, if any, related to unrecognized tax benefits in income tax expense in the Consolidated Statements of Operations.

The Company’s federal and state income tax returns are open and subject to examination from the 2003 tax return year and forward.


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SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities” permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of this standard is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This statement is effective as of the beginning of fiscal years beginning after November 15, 2007, with early adoption permitted under certain circumstances. The Company has evaluated this statement, has elected not to early adopt SFAS 159, and does not anticipate that the adoption of this statement on January 1, 2008 will have a material effect on the consolidated financial statements.

From time to time the FASB issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of exposure drafts.


Certain items included in prior years’ quarterly consolidated financial statements have been reclassified to conform to the current year presentation. The reclassifications had no effect on the net income or shareholders’ equity as previously reported.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB 108, which is effective for years ending on or after November 15, 2006, was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements.

SAB 108 permits public companies to initially apply its provisions either by (i) restating prior financial statements as if the “dual approach” had always been applied or (ii) recording the cumulative effect of initially applying the “dual approach” as adjustments to the carrying values of assets and liabilities as of January 1, 2006 with an offsetting adjustment recorded to the opening balance of retained earnings.

As disclosed in our 2006 Annual Report on Form 10-K, the Company adopted SAB 108 during the quarter ended December 31, 2006 and elected to use the cumulative effect transition method in connection with the preparation of its financial statements.

Quarterly data for 2006 has been restated to reflect the effect of the adjustments resulting from the adoption of SAB 108. For additional information regarding the adoption and effect of SAB 108, see Note B of “Notes to Consolidated Financial Statements” included in the Annual Report Form 10-K for the year ended December 31, 2006.


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

Management’s discussion and analysis is intended to assist readers in the understanding and evaluation of the consolidated financial condition and results of operations of Cape Fear Bank Corporation (the “Company”). The analysis includes detailed discussions for each of the factors affecting the Company’s operating results and financial condition for the periods ended March 31, 2007 and 2006. The following discussion should be read in conjunction with the Company’s financial statements and the notes thereto located in this report and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. Because the Company has no separate operations and conducts no business on its own other than owning Cape Fear Bank, the discussion contained in this Management’s Discussion and Analysis concerns primarily the business of the Bank. However, for ease of reading and because the financial statements are presented on a consolidated basis, the Company and the Bank are collectively referred to herein as the Company unless otherwise noted. All significant intercompany transactions and balances are eliminated in consolidation.

Financial Condition at March 31, 2007 and December 31, 2006

During the first three months of 2007, our total consolidated assets increased from $424.9 million to $448.3 million, an increase of $23.4 million or 5.5%. This increase in assets was funded by an increase in deposits primarily in money market funds from our local market. Total customer deposits increased by $26.4 million during the same three-month period. The time deposit growth in the current period included $11.5 million of out-of-market and brokered deposits. Liquidity provided by this deposit growth, combined with our net income for the three-month period of $435 thousand, provided for growth of $6.8 million in interest-earning deposits in other banks, $1.4 million in investment securities available for sale, and $10.3 million in total loans receivable during the period. In addition, short-term borrowings decreased by $3.0 million during the current period. Also, we purchased an additional $4.0 million of bank owned life insurance in the current period. Our total shareholders’ equity increased by $487 thousand during the three months, principally due to retention of net income of $435 thousand earned during the period and an increase of $22 thousand in market value, net of taxes, of investment securities available for sale. Our regulatory capital was successfully maintained at “well capitalized” levels throughout the period.

Results of Operations for the Three Months Ended March 31, 2007 and 2006

Overview. The Company achieved net income of $435 thousand or $0.12 per diluted share for the three months ended March 31, 2007 as compared with net income of $604 thousand or $0.16 per diluted share for the first quarter of 2006. Comparing the two periods, net income decreased by $169 thousand principally due to increases in non-interest expenses related to branch expansion initiatives. Earnings per share for the 2006 period have been restated to reflect the 5% stock dividend effective June 30, 2006.

Net Interest Income. Interest income increased by $1.7 million when comparing the first quarters of 2007 and 2006, while interest expense increased by $1.6 million, resulting in the increase in net interest income of $126 thousand. This increase in the level of our net interest income resulted principally from the 16.7% increase in the level of our average interest earning assets offset by a 38 basis point decline, period to period, in our net interest margin to 3.11%. The level of our average interest bearing liabilities experienced similar growth, increasing 20.6%. The increase in the level of our interest earning assets resulted primarily from our loan and investment securities growth offset by a decline in interest earning deposits in other banks from the year ago period.

Provision for Loan Losses. The provision for loan losses was $75 thousand for the three months ended March 31, 2007 compared with a provision of $293 thousand for the three months ended March 31, 2006. The decrease in the level of loan loss provision in the current period is due to recoveries of $127


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thousand received in the current period along with moderated growth in lending related to a slow down in the real estate market. However, nonperforming loans as a percentage of total loans outstanding increased from 0.33% at March 31, 2006 to 0.39% at March 31, 2007 due to one large loan relationship. A total of $1.7 million in nonperforming assets are currently undergoing contract negotiations and are expected to close in the near future with no losses anticipated.

Non-Interest Income. Non-interest income increased to $310 thousand for the three months ended March 31, 2007 as compared with $240 thousand for the three months ended March 31, 2006. This increase in non-interest income resulted primarily from growth in income on bank owned life insurance, service fees and charges, and correspondent loan fees in the current period, as well as growth related increases.

Non-Interest Expenses. Non-interest expenses increased from $2.1 million for the first quarter of 2006 to $2.9 million for the first quarter of 2007, an increase of $795 thousand. A large component of this increase was a $422 thousand increase in salaries and employee benefits attributed to the addition of 22 full-time equivalent employees during the past year. This increase in employees is related to our expansion initiatives beginning with the opening of two new full service branches in Pender and Brunswick counties completed during April 2006 along with expansion of our administrative support services. We also have increases in our current salary expense related to staffing for two future branches scheduled for opening in the second quarter of 2007. Occupancy and equipment costs increased by $96 thousand related to the branch expansion previously mentioned. Other non-interest expense increased by $277 thousand from period to period, including increases of $123 thousand in audit and consulting fees associated with compliance with Section 404 of the Sarbanes Oxley Act of 2002, $61 thousand in advertising costs, $15 thousand in data processing and check processing costs along with other expenses associated with growth related changes.

Income Taxes. The Company recorded an income tax expense of $144 thousand for the three months ended March 31, 2007 compared to $356 thousand for the same period in 2006. The effective tax rate for the 2007 period was 24.9% versus 37.1% for the 2006 period. The lower effective tax rate for the 2007 period is primarily the result of an overall greater proportion of pre-tax income being comprised of non-taxable income earned on bank owned life insurance and municipal securities.

Asset Quality

Maintaining a high level of asset quality is a primary goal in our lending function, and we employ a formal internal loan review process to ensure adherence to the lending policies approved by our Board of Directors. A systematic evaluation process fundamentally drives the function of determining the allowance for loan losses. This ongoing process serves as the basis for determining, on a monthly basis, the allowance for loan losses and any resulting provision to be charged against earnings. Consideration is given to historical loan loss experience, the value and adequacy of collateral, economic conditions in our market area and other factors. For loans determined to be impaired, the allowance is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The allowance for loan losses represents management’s estimate of the appropriate level of reserve to provide for probable losses inherent in the loan portfolio.

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


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Nonperforming Assets. The following table sets forth information with respect to our nonaccrual loans, restructured loans, total nonperforming loans (nonaccrual loans plus restructured loans), and total nonperforming assets.



At March 31,


    At December 31,  
       2006     2005  
     (Dollars in thousands)  

Nonaccrual loans

   $ 1,343     $ 350     $ 1,174  

Restructured loans

     —         —         —    

Total nonperforming loans

     1,343       350       1,174  

Real estate owned

     616       616       —    

Total nonperforming assets

   $ 1,959     $ 966     $ 1,174  

Accruing loans past due 90 days or more

   $ —       $ —       $ —    

Allowance for loan losses

     4,738       4,536       3,510  

Nonperforming loans to period end loans

     0.39 %     0.10 %     0.42 %

Allowance for loan losses to period end loans

     1.37 %     1.36 %     1.26 %

Allowance for loan losses to nonperforming loans

     352.79 %     1296.00 %     298.98 %

Nonperforming assets to total assets

     0.44 %     0.23 %     0.34 %

Our nonperforming loans increased by $993 thousand, or by approximately 283.7%, from December 31, 2006 to March 31, 2007 primarily due to one large relationship of $1.1 million or 83.2% of the total nonperforming loans. The commercial real estate that secures the loan is currently being offered for sale and based on our assessment of the property value, we do not anticipate any loss of principal related to this loan. The amount of nonperforming loans as a percentage of our total loans increased from 0.10% to 0.39% during the same period due to the large loan relationship previously mentioned. At March 31, 2007, we had other real estate owned of $616 thousand. We are in the process of negotiating the terms of a sale of that property, and, based on our internal assessment of the value of the property, we do not expect to incur a loss on the sale.

Our financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on our loan portfolio, unless a loan is placed on a nonaccrual basis. Loans are placed on a nonaccrual basis when they become 90 days past due or whenever we believe that collection has become doubtful. Amounts received on non-accrual loans generally are applied first to principal and then to interest only after all principal has been collected. Restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal, have been granted due to the borrower’s weakened financial condition. Interest on restructured loans is accrued at the restructured rates when it is anticipated that no loss of original principal will occur. Loans are charged off when the collection of principal and interest has become doubtful and the loans no longer can be considered sound collectible assets (or, in the case of unsecured loans, when they become 90 days past due).

Total foregone interest on nonaccrual loans was approximately $156 thousand and $82 thousand at March 31, 2007 and 2006, respectively.

Allowance for Loan Losses. The allowance for loan losses is maintained at a level considered adequate by management to provide for probable loan losses based on management’s assessment of various factors affecting the loan portfolio, including a review of problem loans, business conditions and loss experience and an overall evaluation of the quality of the underlying collateral. The allowance is increased by provisions charged to operations and reduced by loans charged off, net of recoveries.


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While management believes that it uses the best information available to determine the allowance for loan losses, unforeseen market conditions could result in adjustments to the allowance for loan losses, and net income could be significantly affected, if circumstances differ substantially from the assumptions used in making the final determination. In addition, various regulatory agencies may require us to make adjustments to the allowance for loan losses based on their judgments about information available to them at the time of their examination. The following table shows the allocation of our allowance for loan losses at the dates indicated. The allocation is based on an evaluation of inherent loan risk, historical ratios of loan losses and other factors that may affect future loan losses in the categories of loans shown.


     At March 31,     At December 31,  
     2007     2006     2005  

% of total

loans (1)


% of total

loans (1)


% of total

loans (1)

     (Dollars in thousands)  

Balance applicable to:


Commercial and industrial

   $ 204    4.0 %   $ 286    4.4 %   $ 410    5.2 %

Real estate—mortgage

     4,382    86.2 %     4,116    85.7 %     2,611    84.8 %

Consumer loans

     45    0.8 %     38    0.7 %     38    1.3 %

Home equity lines of credit

     40    9.0 %     27    9.2 %     298    8.7 %

Total allocated

     4,671    100.0 %     4,467    100.0 %     3,357    100.0 %


     67        69        153   


   $ 4,738      $ 4,536      $ 3,510   

(1) Represents total of all outstanding loans in each category as a percent of total loans outstanding.


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The following table sets forth for the periods indicated information regarding changes in our allowance for loan losses.



At or for the

Three Months Ended

March 31,


At or for the

Years Ended

December 31,

     2007     2006     2006     2005  
     (Dollars in thousands)  

Balance at beginning of period

   $ 4,536     $ 3,510     $ 3,510     $ 2,106  



Real estate—mortgage

     —         —         —         —    

Home equity lines of credit

     —         (92 )     (92 )     (43 )

Commercial and industrial

     —         (290 )     (292 )     (131 )

Consumer loans

     —         (20 )     (23 )     (10 )

Total charge-offs

     —         (402 )     (407 )     (184 )



Real estate—mortgage

     1       1       —         4  

Home equity lines of credit

     —         —         4       74  

Commercial and industrial

     126       —         84       10  

Consumer loans

     —         —         5       1  

Total recoveries

     127       1       93       89  

Net (charge-offs) recoveries

     127       (401 )     (314 )     (95 )

Provision for loan losses

     75       293       1,340       1,499  

Balance at end of period

   $ 4,738     $ 3,402     $ 4,536     $ 3,510  

Ratio of net loan charge-offs to average loans outstanding

     -0.04 %     0.14 %     0.10 %     0.04 %

Ratio of allowance for loan losses to loans outstanding at period-end

     1.37 %     1.17 %     1.36 %     1.26 %

Liquidity and Capital Resources

Our sources of funds are customer deposits, cash and demand balances due from other banks, interest-earning deposits in other banks, investment securities available for sale, brokered time deposits and borrowings from the Federal Home Loan Bank and other correspondent banks. These funds, together with loan repayments, are used to make loans and to fund continuing operations. In addition, at March 31, 2007, we had credit availability with the Federal Home Loan Bank of Atlanta (“FHLB”) of approximately $67.2 million and credit lines with various financial institutions in the amount of $11.5 million. We had $28.0 million in borrowings outstanding under these credit facilities at March 31, 2007. In addition, the Company had $10.3 million in subordinated long-term debt payable to its unconsolidated subsidiary, BKWW Statutory Trust I (the “Trust”) in connection with the Trust’s issuance of trust preferred securities in October 2005. Total deposits were $380.1 million and $353.6 million at March 31, 2007 and December 31, 2006, respectively. Because loan demand has exceeded the rate of growth in core deposits, we have relied heavily on time deposits as a source of funds. Certificates of deposit are the only deposit accounts that have stated maturity dates, and those deposits are generally considered to be rate sensitive. At March 31, 2007 and December 31, 2006, time deposits represented 73.4% and 75.8%, respectively, of total deposits. Certificates of deposit of $100 thousand or more represented


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38.0% and 38.1% of total deposits at March 31, 2007 and December 31, 2006, respectively. The Bank advertises its certificate of deposit rates on the Internet, and we also obtain time deposits through deposit brokers. On March 31, 2007, those out-of-market deposits amounted to $105.9 million, or approximately 27.9% of total deposits and approximately 38.0% of total certificates of deposit. With the exception of these out-of-market deposits, management believes most of our other time deposits are relationship-oriented, but it will be necessary to pay competitive rates to retain those deposits at their maturities. Brokered deposits represent a source of fixed rate funds priced competitively with Federal Home Loan Bank borrowings but do not require collateralization like Federal Home Loan Bank borrowings. Based upon prior experience, management anticipates that a substantial portion of our outstanding certificates of deposit, including out-of-market deposits, will renew upon maturity.

Management anticipates that we will rely primarily upon customer deposits, loan repayments and current earnings to provide liquidity, and will use funds thus generated to make loans and to purchase securities, primarily securities issued by the federal government and its agencies, mortgage-backed securities, and municipal bonds. As of March 31, 2007, liquid assets (cash and due from banks, interest-earning bank deposits, time deposits in other banks and investment securities available for sale) were approximately $88.0 million, which represented 19.6% of total assets and 23.2% of total deposits. At March 31, 2007, outstanding commitments to extend credit were $18.4 million and available line of credit balances totaled $67.6 million. Management believes that the combined aggregate liquidity position of the Company is sufficient to meet the funding requirements of loan demand and deposit maturities and withdrawals in the near term.

We are subject to minimum capital requirements. The following table indicates the Company’s capital ratios at March 31, 2007. All capital ratios place the Company and the Bank in excess of the minimum necessary to be deemed “well capitalized” under regulatory guidelines.


     At March 31, 2007  







Well Capitalized



Total risk-based capital ratio…

   11.43 %   8.0 %   10.0 %

Tier 1 risk-based capital ratio……

   9.82 %   4.0 %   6.0 %

Leverage ratio………

   8.50 %   4.0 %   5.0 %

Forward-Looking Information

This Report and its exhibits contain statements relating to our financial condition, results of operations, plans, strategies, trends, projections of results of specific activities or investments, expectations or beliefs about future events or results, and other statements that are not descriptions of historical facts. Those statements may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “forecasts,” “potential” or “continue,” or similar terms or the negative of these terms, or other statements concerning opinions or judgments of our management about future events. Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, factors discussed in our Annual Report on Form 10-K and in other reports we file with the Securities and Exchange Commission from time to time. Copies of those reports are available directly through the Commission’s website at Other factors that could influence the accuracy of those forward-looking statements include, but are not limited to: (a) the financial success or changing strategies of our customers; (b) customer acceptance of our services, products and fee structure; (c) changes in competitive pressures among depository and other financial institutions or in our ability to compete


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effectively against larger financial institutions in our banking market; (d) actions of government regulators, or changes in laws, regulations or accounting standards, that adversely affect our business; (e) our ability to manage our growth and to underwrite increasing volumes of loans; (f) the impact on our profits of increased staffing and expenses resulting from expansion; (g) changes in the interest rate environment and the level of market interest rates that reduce our net interest margin and/or the volumes and values of loans we make and securities we hold; (h) weather and similar conditions, particularly the effect of hurricanes on our banking and operations facilities and on our customers and the coastal communities in which we do business; (i) changes in general economic or business conditions and the real estate market in our banking market (particularly changes that affect our loan portfolio, the abilities of our borrowers to repay their loans, and the values of loan collateral); and (j) other developments or changes in our business that we do not expect. Although our management believes that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. All forward-looking statements attributable to us are expressly qualified in their entirety by the cautionary statements in this paragraph. We have no obligation, and do not intend to update these forward-looking statements.


Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods. The Company’s market risk arises primarily from interest rate risk inherent in its lending and deposit-taking activities. Interest rate risk is the result of differing maturities or repricing intervals of interest-earning assets and interest-bearing liabilities and the fact that rates on these financial instruments do not change uniformly. These changes can have a direct impact on the Company’s overall earnings. The current structure of the Company’s loan and deposit portfolios is such that a significant decline in interest rates may have an adverse impact on net market values and net interest income. The Company does not maintain a trading account, nor is the Company subject to currency exchange risk or commodity price risk.

Management of the Company actively monitors interest rate risk through the development of and adherence to the Company’s asset/liability management policy. The Company also has established a Board Asset Liability Management Committee (“BALCO”) which monitors interest rate risk exposure, liquidity and funding strategies to ensure that their potential impact is within approved guidelines.


Item 4. Controls and Procedures

An evaluation of the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report has been performed by the Company’s management, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer. Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.

In connection with the above evaluation of the effectiveness of the Company’s disclosure controls and procedures, no change in the Company’s internal control over financial reporting was identified that occurred during the period covered by this report and that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.


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Item 1. Legal Proceedings



Item 1A. Risk Factors

Along with the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2006, which could materially affect our business, financial condition or future results. In addition to the risks described in our Annual Report on Form 10-K and investment risks that apply in the case of any financial institution, our business, financial condition and operating results could be harmed by other risks, including risks we have not yet identified or that we may believe are immaterial or unlikely.


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



Item 3. Defaults Upon Senior Debt



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



Item 5. Other Information

During February 2007, R. James MacLaren was appointed to serve as the Bank’s Chief Credit Officer, effective March 1, 2007. In that position, he replaced Larry W. Flowers, age 65, who had served as our Executive Vice President and the Bank’s Senior Vice President and Chief Credit Officer. Mr. Flowers continues as a part-time employee of the Bank in the role of Senior Management Advisor. In addition, during February 2007, A. Mark Tyler was appointed to serve as the Bank’s Chief Banking Officer, effective March 1, 2007.


Item 6. Exhibits

The following exhibits are being furnished or incorporated by reference with this report.


Exhibit No.




   Certification of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (furnished herewith)


   Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (furnished herewith)


   Certification by the Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith)


   Certification by the Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith)


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


Date: May 14, 2007   By:  

/s/ Cameron Coburn

    Cameron Coburn
    President and Chief Executive Officer


Date: May 14, 2007   By:  

/s/ Betty V. Norris

    Betty V. Norris
    Chief Financial Officer


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