(cid:38)(cid:36)(cid:53)(cid:50)(cid:47)(cid:44)(cid:49)(cid:36)(cid:3)(cid:41)(cid:44)(cid:49)(cid:36)(cid:49)(cid:38)(cid:44)(cid:36)(cid:47)
(cid:38)(cid:50)(cid:53)(cid:51)(cid:50)(cid:53)(cid:36)(cid:55)(cid:44)(cid:50)(cid:49)
(cid:21)(cid:19)(cid:20)(cid:21)(cid:3)(cid:36)(cid:49)(cid:49)(cid:56)(cid:36)(cid:47)(cid:3)(cid:53)(cid:40)(cid:51)(cid:50)(cid:53)(cid:55)
(cid:66)(cid:66)(cid:66)(cid:66)(cid:66)(cid:66)(cid:66)(cid:66)(cid:66)(cid:66)(cid:66)(cid:66)(cid:66)(cid:66)(cid:66)(cid:66)(cid:66)(cid:66)
March 15, 2013
Dear Shareholder,
Carolina Financial Corporation is pleased to report record net income for the year ended December 31, 2012 of
$16.9 million, or $8.80 per diluted share, as compared to a net loss of $971,000, or ($0.51) per diluted share
during the comparable prior year period. I am pleased to announce that CresCom Bank was reported as having
the #1 return on assets and #1 return on equity of all banks in South Carolina for fiscal 2012, as reported by
Financial Management Consulting Group.
In addition to Carolina Financial reporting record earnings, fiscal 2012 has been a year of significant
accomplishments.
• Significantly Improved in Asset Quality
• Significantly Increased Capital Levels
• Crescent Mortgage Company reported record earnings, production and margin
• Over 15% growth in Core Deposits during fiscal 2012
• Resolved two of the three litigation matters addressed in the prior year’s Annual Report
• Growth in total assets to $888.7 million
These items were accomplished despite the announcement of an approximate $4 million kite fraud perpetrated by
a business customer against CresCom Bank identified in May 2012. I am pleased to announce that we have
completed the restructuring of our operations group under the leadership of Jamin Hujik, CPA. In addition, under
Mr. Hujik’s leadership the Company has hired an SVP of Deposit Operations with over 30 years of banking
experience. We believe the changes we have initiated along with our new Operations Leadership Team will
greatly reduce these risks in the future and position our Company for growth.
The Company continues to be very focused on improving its asset quality and reducing non-performing assets
(NPAs). NPAs have decreased 46.6% from $40.3 million at December 31, 2011, to $21.5 million at December
31, 2012, or 2.42% of total assets. This represents our lowest level of NPAs at a quarter-end since December
2008. As a result, the Company’s provision for loan losses declined significantly from $10.7 in fiscal 2011 to
$2.7 million in fiscal 2012.
Throughout 2012, the Company continued to increase its capital levels. At December 31, 2012, CresCom Bank’s
Tier 1 Capital was 10.0% compared to 8.2% at December 31, 2011. CresCom Bank’s Total Risk Based Capital
was 16.0% compared to 13.7% in the prior year. The Bank substantially exceeds the Tier 1 Well Capitalized and
Risk Based Well Capitalized levels of 10% and 5%, respectively.
During fiscal 2012, Crescent Mortgage Company (“CMC”) originated approximately $2.2 billion in loans held for
sale compared to $1.3 billion in 2011. Net income from CMC increased to a record high $21.0 million for the
year ended December 31, 2012 compared to $4.2 million for the year ended December 31, 2011. The mortgage
banking industry is predicting that origination levels will decrease approximately 25% to 30% in 2013. CMC
expects to experience a decrease in volume and margin on loans sold during 2013. As anticipated, year-to-date
February 2013, we are seeing a slight decrease in originations versus originations a year earlier, with a decline in
margins compared to year end 2012.
For fiscal 2012, Carolina Financial Corporation experienced a decline in loans receivables, net of $11.6 million or
2.3%, primarily resulting from the decline in non-performing loans. However, we are pleased to report that loans
- 1 -
receivable, net, increased by $8.4 million, or 1.7% in the fourth quarter 2012. Our fourth quarter marks the first
material increase in our loan portfolio since September 2008. The Company is very focused on achieving
material loan growth during 2013.
The Company continues to report significant growth in core deposits, defined as checking, money market and
statement savings accounts. Core deposits increased $47.3 million, or almost 16%, compared to the prior year.
The number of checking accounts also increased by 15% during fiscal 2012 compared to 2011. We remain very
pleased with our growth in core deposits and plan significant marketing campaigns in 2013. You may have seen
one of our checking ads on television, recently as they are being shown in both the Charleston and Myrtle Beach
markets.
Total assets of the Company increased from $826.2 million at December 31, 2011 to $888.7 million at December
31, 2012. During 2013, the Company expects that loans held for sale will decrease but will be more than offset
by our planned increase in our loans receivable portfolio. The Company expects to increase lending personnel in
2013 and is actively seeking to increase its commercial and residential lending opportunities.
During 2013 we expect to roll out several technology initiatives that will improve our Customer’s banking
experience. In the first quarter 2013, we began offering our new state of the art bill pay product. In addition, we
expect CMC to enter new markets and are aggressively evaluating new branching opportunities for the Bank.
We remain focused on Bank profitability, growing core deposits, increasing cross sale opportunities, continuing to
improve asset quality, and seeing renewed growth in our loans receivable. Management and the Board are
confident that with focus, commitment, and action, we will continue sustained profitability and the financial
strength to grow and thrive in the current economic environment.
Sincerely,
Jerry L. Rexroad
President and Chief Executive Officer
- 2 -
CAROLINA FINANCIAL CO RPORATI ON
TABLE OF CONTENTS
Letter to Stockholders
Summary of Financial Data
Financial Discussion
Independent Auditor’s Report
Consolidated Financial Statements
Consolidated Statements of Financial Condition
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Income (Loss)
Consolidated Statements of Changes in Stockholders’ Equity
Consolidated Statements of Changes of Cash Flows
Notes to Consolidated Financial Statements
1
4-5
6-32
33
34
35
36
36
37-38
39-77
- 3 -
CAROLINA FINANCIAL CO RPORATI ON
SUMMARY OF SELECTED FI NANCIAL DATA
Set forth below is selected consolidated financial and other data of the Company at and for the periods indicated. The
information below is only a summary and should be read together with the accompanying Financial Discussion, which
follows this data, and the consolidated financial statements presented herein.
Operating Data:
Interest income
Interest expense
Net interest income
Provision for loan losses
Net interest income (loss) after
provision for loan losses
Noninterest income
Noninterest expense
Income (loss) before income taxes
Income tax expense (benefit)
Net income (loss)
Balance Sheet Data:
Total assets
Interest-bearing cash
Securities available for sale
Securities held to maturity
Federal Home Loan Bank stock
Loans held for sale
Loans receivable, net
Allowance for loan losses
Deposits
Short-term borrowed funds
Long-term debt
Stockholders' equity
2012
$
35,358
7,513
27,845
2,707
25,138
52,284
50,149
27,273
10,395
16,878
$
For The Years Ended December 31,
2010
(In thousands)
2011
2009
38,441
11,113
27,328
10,735
16,593
19,721
37,413
(1,099)
(128)
(971)
46,842
17,077
29,765
30,755
(990)
21,600
39,070
(18,460)
(5,872)
(12,588)
56,736
25,019
31,717
10,460
21,257
27,938
37,673
11,522
4,353
7,169
2008
63,049
33,227
29,822
6,361
23,461
9,227
23,882
8,806
3,256
5,550
2012
2011
At December 31,
2010
(In thousands)
2009
2008
$
888,724
11,340
149,670
9,166
6,413
144,849
501,691
9,520
653,247
82,482
64,840
67,514
826,218
16,679
136,944
9,401
7,185
80,007
513,335
12,039
621,803
63,484
80,390
45,655
930,749
21,415
151,574
9,848
11,129
82,615
583,995
14,263
689,814
57,759
123,339
46,494
1,078,757
17,759
104,401
125,633
12,456
71,233
690,163
13,032
761,108
43,787
203,638
56,138
1,138,994
16,285
120,988
113,689
11,874
28,283
776,621
11,300
717,389
148,090
218,465
46,591
- 4 -
CAROLINA FINANCIAL CO RPORATI ON
SUMMARY OF SELECTED FI NANCIAL DATA
2012
For The Years Ended December 31,
2010
(Dollars in thousands)
2009
2011
2008
Selected Average Balances:
Total assets
Loans receivable, net
Deposits
Stockholders' equity
Performance Ratios:
$
837,066
495,889
641,085
54,002
858,432
545,556
649,002
47,003
1,018,130
640,646
742,409
50,065
1,114,132
737,448
767,814
51,949
1,090,787
774,183
750,110
47,552
Return on average equity
Return on average assets
Average earning assets to average total assets
Average loans receivable, net to average deposits
Average equity to average assets
Net interest margin
Net charge-offs to average loans receivable, net
Non-performing assets to period end loans receivable, net
Non-performing assets to total assets
Non-performing loans to total loans
Allowance for loan losses as a percentage of
loans receivable (end of period)
Allowance for loan losses as a percentage of
nonperforming loans
31.25%
2.02%
92.29%
77.35%
6.45%
3.60%
1.05%
4.29%
2.42%
2.98%
(2.07)%
(0.11)%
92.24%
84.06%
5.48%
3.45%
2.38%
7.84%
4.87%
6.50%
(25.14)%
(1.24)%
94.24%
86.29%
4.92%
3.10%
4.61%
11.69%
7.33%
9.60%
13.80%
0.64%
94.59%
96.05%
4.66%
3.01%
1.18%
5.17%
3.31%
3.96%
11.67%
0.51%
95.66%
103.21%
4.36%
2.86%
0.66%
2.71%
1.85%
1.77%
1.86%
2.29%
2.38%
1.85%
1.43%
62.43%
35.24%
24.84%
46.83%
81.08%
2012
At or For The Years Ended December 31,
2010
2011
2009
2008
Per Share Data:
Book value (end of period)
Basic earnings (loss)
Diluted earnings (loss)
$
35.18
8.80
8.80
23.79
(0.51)
(0.51)
24.23
(6.58)
(6.58)
29.35
3.75
3.72
24.36
2.95
2.83
Average common shares - basic
Average common shares - diluted
1,918,992
1,918,992
1,918,992
1,918,992
1,913,240
1,913,240
1,912,449
1,924,720
1,883,101
1,960,362
- 5 -
CAROLINA FINANCIAL CO RPORATI ON
FINANCIAL DISCUSSION
Financial Discussion
The accompanying Financial Discussion is provided to assist the reader in understanding the consolidated financial
statements of Carolina Financial Corporation (the “Company”) and its wholly-owned subsidiary bank, CresCom Bank (the
“Bank”). The Company is not a publicly traded company and therefore is not subject to the reporting and disclosure
requirements of the Securities and Exchange Commission (the “SEC”) as enumerated in Article 9 of Regulation S-X, Guide 3
or any other requirements for SEC registrants. The Company also does not have an actively traded market for its stock. The
Financial Discussion is not intended to comply with disclosure requirements of the SEC as enumerated above.
Effective July 31, 2011, the Company merged its wholly-owned subsidiary bank, Community FirstBank of Charleston
(“Community FirstBank”), with and into its other wholly-owned subsidiary bank, Crescent Bank. In conjunction with this
internal reorganization, Crescent Bank’s name was changed to CresCom Bank and Crescent Mortgage Company (“Crescent
Mortgage”), formerly a wholly-owned subsidiary of Community FirstBank, became a wholly-owned subsidiary of CresCom
Bank.
Discussion of Forward-Looking Statements
The accompanying Financial Discussion contains certain "forward-looking statements" within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 concerning risks and uncertainties about
the financial condition and future operations of the Company, the Bank, and its wholly-owned subsidiary service corporation,
Carolina Services Corporation of Charleston (“Carolina Services”). These statements are based on many assumptions and
estimates and are not guarantees of future performance. The Company’s actual results may differ materially from those
anticipated in any forward-looking statements, as they will depend on many factors about which the Company is unsure,
including many factors which are beyond the Company’s control. The words “may,” “would,” “could,” “should,” “will,”
“expect,” “anticipate,” “predict,” “project,” “potential,” “believe,” “continue,” “assume,” “intend,” “plan,” and “estimate,” as
well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that
could cause the Company’s actual results to differ from those anticipated in any forward-looking statements include, but are
not limited to, those described below under “Risk Factors” and the following:
•
•
•
•
•
•
•
•
•
•
•
•
•
credit losses as a result of declining real estate values, increasing interest rates, increasing
unemployment, or changes in payment behavior or other factors;
credit losses due to loan concentrations;
changes in the amount of the Company’s loan portfolio collateralized by real estate and weaknesses in
the South Carolina and national real estate markets;
restrictions or conditions imposed by the Company’s regulators on the Company’s operations;
increases in competitive pressure in the banking and financial services industries;
changes in the interest rate environment which could reduce anticipated or actual margins;
changes in political conditions or the legislative or regulatory environment, including governmental
initiatives affecting the financial services industry;
changes in economic conditions resulting in, among other things, a deterioration in credit quality;
changes occurring in business conditions and inflation;
changes in access to funding or increased regulatory requirements with regard to funding;
increased cybersecurity risk, including potential business disruptions or financial losses;
changes in deposit flows;
changes in technology;
6
CAROLINA FINANCIAL CO RPORATI ON
FINANCIAL DISCUSSION
•
•
•
•
•
•
•
•
•
the adequacy of the level of the Company’s allowance for loan losses and the amount of loan loss
provisions required in future periods;
examinations by the Company’s regulatory authorities, including the possibility that the regulatory
authorities may, among other things, require the Company to increase its allowance for loan losses or
write-down assets;
changes in monetary and tax policies;
changes in accounting policies and practices;
the rate of delinquencies and amounts of loans charged-off;
the Company’s ability to maintain appropriate levels of capital and to comply with its capital ratio
requirements;
the Company’s ability to attract and retain key personnel;
the Company’s ability to retain our existing clients, including our deposit relationships; and
adverse changes in asset quality and resulting credit risk-related losses and expenses.
If any of these risks or uncertainties materialize, or if any of the assumptions underlying such forward-looking
statements proves to be incorrect, the Company’s results could differ materially from those expressed in, implied
or projected by, such forward-looking statements. For information with respect to factors that could cause actual
results to differ from the expectations stated in the forward-looking statements, see “Risk Factors” contained
herein. The Company urges investors to consider all of these factors carefully in evaluating the forward-looking
statements contained in this report. The Company makes these forward-looking statements as of the date of this
document and does not intend, and assumes no obligation, to update the forward-looking statements or to update
the reasons why actual results could differ from those expressed in, or implied or projected by, the forward-
looking statements.
Risk Factors
The Company operates in a business environment that has inherent risks. In addition to the risks and uncertainties described
below, other risks and uncertainties not currently known to us or items we currently deem to be immaterial may become
material and adversely affect our business, financial condition and results of operations.
Our Business Has Been Adversely Affected By Downturns In The Local Economies Of Our Market Areas And Further
Downturns Could Significantly Adversely Impact Our Business.
Our business is directly affected by market conditions, industry and finance trends, legislative and regulatory changes, and
changes in governmental monetary and fiscal policies and inflation, all of which are beyond our control. Currently our
markets are experiencing a prolonged economic downturn and continue to reflect weakness in business and economic
conditions that may result in (i) a decrease in the demand for loans and other products and services offered by the Company,
(ii) a further decrease in the value of loan collateral, or (iii) a further increase in the number of customers and counterparties
who become delinquent, file for bankruptcy protection under bankruptcy laws or default on their loans or other obligations.
A further increase in the number of delinquencies, bankruptcies or defaults could result in a higher level of nonperforming
assets, net charge-offs, provision for loan losses, and increased collection expenses that could adversely impact our results of
operations and financial condition.
Further Downturns In The Real Estate Markets In Our Primary Market Area Could Significantly Adversely Impact Our
Business.
Our business activities and credit exposure are primarily concentrated in Charleston, Dorchester, and Horry counties in South
Carolina. The Company’s primary markets in Charleston and Dorchester counties are heavily influenced by the Port of
Charleston, the military, the medical industry and national and international industries. The Company’s primary market areas
7
CAROLINA FINANCIAL CO RPORATI ON
FINANCIAL DISCUSSION
in Horry County are heavily influenced by tourism, retirement living, and retail. The real estate markets have experienced a
significant decline in these markets and, if these economic drivers experience further downturns, real estate in the Company’s
markets may experience further declines. As of December 31, 2012, the Company’s loan portfolio is primarily secured by
real estate located in South Carolina. If real estate values continue to decline, the collateral for these loans will provide less
security. As a result, the borrower’s ability to pay, or the Company’s ability to recover on defaulted loans by selling the
underlying collateral, would be diminished.
An Increase In Our Non-Performing Assets Would Adversely Impact Our Earnings.
At December 31, 2012, we had total non-performing assets of $21.5 million or 2.42% of total assets, compared to $40.3
million or 4.87% of total assets at December 31, 2011. Our non-performing assets may increase in future periods. Non-
performing assets adversely affect our net income in various ways. We do not record interest income on non-accrual loans or
investments or on real estate owned. We must establish an allowance for loan losses that reserves for losses inherent in the
loan portfolio that are both probable and reasonably estimable through current period provisions for loan losses, which are
recorded as a charge to income. From time to time, we also write down the other real estate owned portfolio to reflect
changing market values. Additionally, there are legal fees associated with the resolution of problem assets as well as carrying
costs such as taxes, insurance and maintenance related to the other real estate owned. Further, the resolution of non-
performing assets requires the active involvement of management, which can distract them from our overall supervision of
operations and other income-producing activities.
We Earned Net Income In Fiscal 2012, But Experienced Net Losses In Fiscal 2011 And 2010.
We earned net income of $16.9 million in 2012, primarily due to the strong performance of the Company’s wholesale
mortgage business. However, we experienced a net loss of $1.0 million and $12.6 million for fiscal 2011 and 2010,
respectively. In each of these years, the Company experienced significant losses related to historically elevated levels of non-
performing assets, which necessitated a provision for loan losses of $2.7 million for fiscal 2012, $10.7 million for fiscal 2011,
and $30.8 million for fiscal 2010. We had net charge offs of $5.2 million of loans during 2012, compared to $13.0 million of
loans during 2011 and $29.5 million of charge offs during 2010. Non-accrual loans (generally loans 90 days or more past due
in principal or interest payments) totaled $15.2 million, or 2.98% of total loans, net at December 31, 2012 compared to $29.9
million, or 5.70% of total loans, net at December 31, 2011. We also recognized other-than-temporary impairment losses
related to our investment portfolio of $913,000 in the consolidated statements of operations for fiscal 2012, $1.8 million for
fiscal 2011 and $2.5 million for fiscal 2010. Although the credit quality indicators generally showed improvement during
fiscal 2012, if we experience further deterioration in our loan portfolio in addition to other factors and conditions out of our
control such as weakness in our local economy, we may not be able to maintain profitability in the future.
Commercial Real Estate Loans, Commercial Business Loans And Construction And Development Loans Increase Our
Exposure To Credit Risks.
At December 31, 2012, our exposure to commercial real estate loans totaled $240.8 million, or 45.5% of total gross loans
receivable, our exposure to commercial business loans totaled $38.7 million, or 7.3% of total gross loans receivable, and our
exposure to construction and development loans totaled $68.1 million, or 12.9% of total gross loans receivable. Commercial
real estate loans and commercial business loans generally expose us to a greater risk of nonpayment and loss than one-to-four
family residential real estate loans because repayment of such loans often depends on the successful business operations and
income stream of the borrowers. Similarly, construction and development loans expose us to a greater risk of nonpayment
and loss because repayment is dependent upon the successful completion of the project and the ability of the contractor or
builder to repay the loan from the sale of the property or obtaining permanent financing. Additionally, such loans typically
involve larger loan balances to single borrowers or groups of related borrowers compared to residential real estate loans.
Many of our borrowers have more than one commercial loan or construction and development loan outstanding with us.
Consequently, an adverse development with respect to one loan or one credit relationship may expose us to a significantly
greater risk of loss compared to an adverse development with respect to a one-to-four family residential real estate loan.
Finally, if we foreclose on a commercial real estate, commercial business or construction and development loan, our holding
period for the collateral, if any, typically is longer than for one-to-four family residential mortgage loans because there are
fewer potential purchasers of the collateral. The risks of commercial and construction and development loans have been
exacerbated by the extended recession in commercial real estate and commercial land values, and the downturn in residential
construction, particularly in our market areas. During fiscal 2012, we had net charge offs of $1.2 million, $723,000 and
$766,000 of commercial real estate loans, commercial business loans and construction and development loans, respectively.
8
CAROLINA FINANCIAL CO RPORATI ON
FINANCIAL DISCUSSION
Our Decisions Regarding Allowance For Loan Losses And Credit Risk May Materially And Adversely Affect Our
Business.
Making loans and other extensions of credit is an essential element of our business. Although we seek to mitigate risks
inherent in lending by adhering to specific underwriting practices, our loans and other extensions of credit may not be repaid.
The risk of nonpayment is affected by a number of factors, including:
•
•
•
•
the duration of the credit;
credit risks of a particular customer;
changes in economic and industry conditions; and
in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.
We attempt to maintain an appropriate allowance for loan losses to provide for probable losses in our loan portfolio. We
periodically determine the amount of the allowance based on consideration of several factors, including:
•
•
•
•
•
an ongoing review of the quality, mix, and size of our overall loan portfolio;
our historical loan loss experience;
evaluation of economic conditions;
regular reviews of loan delinquencies and loan portfolio quality; and
the amount and quality of collateral, including guarantees, securing the loans.
The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity
and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material
changes. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans,
identification of additional problem loans and other factors, both within and outside of our control, may require an increase in
the allowance for loan losses. In addition, regulatory agencies periodically review our allowance for loan losses and may
require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments
different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, we will
need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result
in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and
results of operations.
We Could Record Other-Than-Temporary Impairment on our Securities Portfolio. In Addition, We May Not Receive Full
Future Interest Payments On These Securities.
We review our investment securities portfolio at least quarterly and more frequently when economic conditions warrant,
assessing whether there is any indication of other-than-temporary impairment (“OTTI”). Factors considered in the review
include estimated future cash flows, length of time and extent to which market value has been less than cost, the financial
condition and near term prospect of the issuer, and our intent and ability to retain the security to allow for an anticipated
recovery in market value. If the review determines that there is OTTI, then an impairment loss is recognized in earnings equal
to the difference between the investment’s cost and its fair value at the balance sheet date of the reporting period for which the
assessment is made, or a portion may be recognized in other comprehensive income. The fair value of investments on which
OTTI is recognized then becomes the new cost basis of the investment.
At December 31, 2012, the Company had twenty-six individual securities available-for-sale in an unrealized loss position. In
addition, the Company had nine individual investments held to maturity that were in unrealized loss in held-to-maturity
consisting of pooled trust preferred securities. The Company believes, based on industry analyst reports and third-party OTTI
evaluations, that the deterioration in the value of these securities is attributable to a combination of the lack of liquidity in
these securities, credit ratings and credit quality concerns.
Management has performed various analyses, including cash flows, and has recorded OTTI expense of $625,000 related to
four securities available for sale during fiscal 2012. These four securities available for sale were subsequently sold during
fiscal 2012. In addition, OTTI expense totaling $288,000 was recorded related to two held-to-maturity securities during fiscal
2012. There is one additional held-to-maturity security that had OTTI expense recorded in prior years, but did not incur OTTI
expense during fiscal 2012. Other than these three held-to-maturity securities, management believes that there are no other
9
CAROLINA FINANCIAL CO RPORATI ON
FINANCIAL DISCUSSION
securities other-than-temporarily impaired at December 31, 2012. The Company does not intend to sell these securities and it
is more likely than not that the Company will not be required to sell these securities before recovery of their amortized cost.
Management continues to monitor these securities with a high degree of scrutiny. There can be no assurance that the
Company will not conclude in future periods that conditions existing at that time indicate some or all of the securities may be
sold or are other-than-temporarily impaired, which would require a charge to earnings in such periods.
A number of factors or combinations of factors could require us to conclude in one or more future reporting periods that an
unrealized loss that exists with respect to our securities portfolio constitutes additional impairment that is other than
temporary, which could result in material losses to us. These factors include, but are not limited to, a continued failure by an
issuer to make scheduled interest payments, an increase in the severity of the unrealized loss on a particular security, an
increase in the continuous duration of the unrealized loss without an improvement in value or changes in market conditions
and/or industry or issuer specific factors that would render us unable to forecast a full recovery in value. In addition, the fair
values of securities could decline if the overall economy and the financial condition of some of the issuers continue to
deteriorate and there remains limited liquidity for these securities.
Future Changes In Interest Rates Could Impact Our Financial Condition And Results Of Operations.
Net income is the amount by which net interest income and non-interest income exceeds non-interest expense and the
provision for loan losses. Net interest income makes up a significant portion of our income and is based on the difference
between:
•
•
interest income earned on interest-earning assets, such as loans held for sale, loans and securities; and
interest expense paid on interest-bearing liabilities, such as deposits and borrowings.
A substantial percentage of our interest-earning assets, such as residential and commercial mortgage loans, have longer
maturities than our interest-bearing liabilities, which consist primarily of savings and demand accounts, certificates of deposit
and borrowings. As a result, our net interest income is adversely affected if the average cost of our interest-bearing liabilities
increases more rapidly than the average yield on our interest-earning assets.
The Board of Governors of the Federal Reserve (the “Federal Reserve Board”) maintained the federal funds rate at the
historically low rate of 0.25% during fiscal 2012 and 2011. The federal funds rate has a direct correlation to general rates of
interest, including our interest-bearing deposits. Our mix of asset and liabilities are considered to be sensitive to interest rate
changes. In a low rate environment, we may be susceptible to the payoff or refinance of high rate mortgage loans that could
reduce net interest income. On the other hand, if interest rates rise, net interest income could be reduced because interest paid
on interest-bearing liabilities, including deposits and borrowings, increases more quickly than interest received on interest-
earning assets, including loans and mortgage-backed and related securities. In addition, rising interest rates may negatively
affect income because higher rates may reduce the demand for loans, including loan production in the Company’s mortgage
operations, and the value of mortgage-related and investment securities.
We May Not Be Able To Continue To Support The Realization Of Our Deferred Tax Asset.
We calculate income taxes in accordance with ASC 740 Income Taxes (formerly Statement of Financial Accounting
Standards No. 109, “Accounting for Income Taxes”), which requires the use of the asset and liability method. In accordance
with ASC 740, we regularly assess available positive and negative evidence to determine whether it is more likely than not
that our deferred tax asset balances will be recovered from reversals of deferred tax liabilities, potential utilization of net
operating loss carrybacks, tax planning strategies and future taxable income. At December 31, 2012, our net deferred tax
asset was $6.8 million, for which we have not established a valuation allowance. We recognized the deferred tax asset
because management believes, based on earnings and detailed financial projections, that it is more likely than not, that we
will have sufficient future earnings to utilize this asset to offset future income tax liabilities. Realization of a deferred tax
asset requires us to apply significant judgment and is inherently speculative because it requires the future occurrence of
circumstances that cannot be predicted with certainty. We cannot be assured that we will achieve sufficient future taxable
income as the basis for the ultimate realization of our deferred tax asset and therefore we may have to establish a full or
partial valuation allowance at some point in the future. If we determine that a valuation allowance is necessary, this would
require us to incur a charge to operations that would adversely affect our capital position.
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At December 31, 2012, we had $6.8 million of allowable net deferred tax assets for regulatory capital purposes, which is the
amount that is expected to be recovered based on a two-year net operating loss carryback and the next four quarters
calculation. There is no assurance that we will be able to continue to recognize any, or all, of the deferred tax asset for
regulatory capital purposes.
Our Ability To Service The Company’s Debt And Pay Other Obligations Of The Company As They Come Due Is
Substantially Dependent On Capital Distributions From The Company’s Subsidiaries. These Distributions Are Subject
To Regulatory Limits And Other Restrictions, Including Directives From The FDIC Which Prohibit Distributions By The
Bank Without Prior Regulatory Approval.
The Company is a bank holding company and relies upon dividends from the Bank and its other subsidiaries to fund a
significant portion of its operations. We use these dividends to service the Company’s debt obligations (including our
outstanding line of credit and our trust preferred securities), and to otherwise fund the Company’s operations and to meet its
obligations. The ability of the Bank to pay dividends or make other capital distributions to the Company is subject to the
regulatory authority of the FDIC and the South Carolina Board of Financial Institutions (the "South Carolina Board"). In
general, a South Carolina state bank may not pay dividends from capital. All dividends must be paid out of undivided profits
then on hand, after deducting expenses, including reserves for losses and bad debts. Unless otherwise instructed by the South
Carolina Board, the Bank is generally permitted under South Carolina state banking regulations to pay cash dividends of up
to 100% of net income in any calendar year without obtaining the prior approval of the South Carolina Board. However,
given the restrictions imposed by the Bank’s regulators, at December 31, 2012 the Bank cannot pay dividends without prior
approval from the appropriate regulatory agencies. In addition, under the Federal Deposit Insurance Corporation
Improvement Act, the Bank may not pay a dividend if, after paying the dividend, the Bank would be undercapitalized. The
Federal Reserve Board may also prevent the payment of a dividend by the Bank if it determines that the payment would be an
unsafe and unsound banking practice.
If the Bank or Carolina Services are unable to pay dividends to the Company, the Company may not be able to service its
debts as they come due and, in such event, our creditors may seek remedies against us that would adversely affect our
business and the value of your shares of common stock.
Beginning with the scheduled payment date of December 31, 2010, the Company has deferred the payment of interest on its
outstanding trust preferred securities for a period not to exceed 20 consecutive quarterly periods. This and any future
deferred distributions will continue to accrue interest. Distributions on these trust preferred securities are cumulative.
Therefore, in accordance with generally accepted accounting principles, the Company will continue to accrue the monthly
cost of the trust preferred securities as it has since issuance. The balance of deferred payments at December 31, 2012 is
approximately $1.2 million.
The Dodd-Frank Wall Street Reform And Consumer Protection Act Could Increase Our Regulatory Compliance Burden
And Associated Costs, Place Restrictions On Certain Products And Services, And Limit Our Future Capital Raising
Strategies.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) has and will continue to
significantly change bank regulatory structure and affect the lending, deposit, investment, trading and operating activities of
financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad
range of new rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given
significant discretion in drafting and implementing rules and regulations, and consequently, many of the details and much of
the impact of the Dodd-Frank Act may not be known for many months or years.
The Dodd-Frank Act also created the Bureau of Consumer Financial Protection and gives it broad rule-making authority for a
wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit
“unfair deceptive or abusive” acts and practices.
Proposals for further regulation of the financial services industry are continually being introduced to the Congress of the
United States of America. The agencies regulating the financial services industry also periodically adopt changes to their
regulations. It is possible that additional legislative proposals may be adopted or regulatory changes may be made that would
have any adverse effect on our business. In addition, it is expected that such regulatory changes will increase our operating
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and compliance cost. We can provide no assurance regarding the manner in which any new laws and regulations will affect
us.
Changes In Economic Conditions, In Particular An Economic Slowdown In South Carolina, Could Materially And
Negatively Affect Our Business.
Our business is directly impacted by factors such as economic, political and market conditions, broad trends in industry and
finance, legislative and regulatory changes, changes in government monetary and fiscal policies and inflation, all of which
are beyond our control. Any further deterioration in economic conditions, whether caused by national or local concerns, in
particular any further economic slowdown in South Carolina, could result in the following consequences, any of which could
hurt our business materially: loan delinquencies may increase; problem assets and foreclosures may increase; demand for our
products and services may decrease; low cost or noninterest bearing deposits may decrease; and collateral for loans made by
us, especially real estate, may decline in value, in turn reducing customers’ borrowing power, and reducing the value of assets
and collateral associated with our existing loans. The State of South Carolina and certain local governments in our market
area continue to face fiscal challenges upon which the long-term impact on the State’s or the local economy cannot be
predicted.
Continuation Of The Economic Downturn Could Reduce Our Customer Base, Our Level Of Deposits, And Demand For
Financial Products Such As Loans.
Our success significantly depends upon the growth in population, income levels, deposits, and housing starts in our markets.
The current economic downturn has negatively affected the markets in which we operate and, in turn, the quality of our loan
portfolio. If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally
remain unfavorable, our business may not succeed. A continuation of the economic downturn or prolonged recession would
likely result in the continued deterioration of the quality of our loan portfolio and reduce our level of deposits, which in turn
would hurt our business. Interest received on loans represented approximately 85% of our interest income for the year ended
December 31, 2012. If the economic downturn continues or a prolonged economic recession occurs in the economy as a
whole, borrowers will be less likely to repay their loans as scheduled. Moreover, in many cases the value of real estate or
other collateral that secures our loans has been adversely affected by the economic conditions and could continue to be
negatively affected. Unlike many larger institutions, we are not able to spread the risks of unfavorable local economic
conditions across a large number of diversified economies. A continued economic downturn could, therefore, result in losses
that materially and adversely affect our business.
Our Small-To-Medium-Sized Business Target Markets May Have Fewer Financial Resources To Weather A Downturn In
The Economy.
We target the banking and financial services needs of small- and medium-sized businesses. These businesses generally have
fewer financial resources in terms of capital borrowing capacity than larger entities. If general economic conditions continue
to negatively impact these businesses in the markets in which we operate, our business, financial condition, and results of
operation may be adversely affected.
Recently Enacted Consumer Protection Regulations Related to Automated Overdraft Payment Programs Could Adversely
Affect the Company’s Business Operations, Net Income and Profitability.
The Federal Reserve Board and FDIC recently enacted consumer protection regulations related to automated overdraft
payment programs offered by financial institutions. The Company has implemented changes to its business practices relating
to overdraft payment programs in order to comply with these regulations. For the years ended December 31, 2010 and 2009,
the Company’s overdraft and insufficient funds fees represented a significant amount of non-interest fees collected by the
Bank. Since taking effect on July 1, 2011, the fees received by the Bank for automated overdraft payment services have
decreased, thereby adversely impacting the Bank’s non-interest income. Complying with these regulations has resulted in
increased operational costs. The actual impact of these regulations in future periods could vary due to a variety of factors,
including changes in customer behavior, economic conditions and other factors, which could adversely the Company’s
business operations, net income and profitability.
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A Failure In Or Breach Of Our Operational Or Security Systems Or Infrastructure, Or Those Of Our Third Party
Vendors And Other Service Providers Or Other Third Parties, Including As A Result Of Cyber Attacks, Could Disrupt
Our Businesses, Result In The Disclosure Or Misuse Of Confidential Or Proprietary Information, Damage Our
Reputation, Increase Our Costs, And Cause Losses.
We rely heavily on communications and information systems to conduct our business. Information security risks for
financial institutions such as ours have generally increased in recent years in part because of the proliferation of new
technologies, the use of the internet and telecommunications technologies to conduct financial transactions, and the increased
sophistication and activities of organized crime, hackers, and terrorists, activists, and other external parties. As client, public,
and regulatory expectations regarding operational and information security have increased, our operating systems and
infrastructure must continue to be safeguarded and monitored for potential failures, disruptions, and breakdowns. Our
business, financial, accounting, and data processing systems, or other operating systems and facilities may stop operating
properly or become disabled or damaged as a result of a number of factors, including events that are wholly or partially
beyond our control. For example, there could be electrical or telecommunication outages; natural disasters such as
earthquakes, tornadoes, and hurricanes; disease pandemics; events arising from local or larger scale political or social
matters, including terrorist acts; and as described below, cyber attacks.
As noted above, our business relies on our digital technologies, computer and email systems, software and networks to
conduct its operations. Although we have information security procedures and controls in place, our technologies, systems,
networks, and our clients’ devices may become the target of cyber attacks or information security breaches that could result
in the unauthorized release, gathering, monitoring, misuse, loss, or destruction of our or our clients’ or other third parties’
business operations. Third parties with whom we do business or that facilitate our business activities, including financial
intermediaries, or vendors that provide service or security solutions for our operations, and other third parties, including the
South Carolina Department of Revenue, which had records exposed in a 2012 cyber attack, could also be sources of
operational and information security risk to us, including from breakdowns or failures of their own systems or capacity
constraints.
While we have disaster recovery and other policies and procedures designed to prevent or limit the effect of the failure,
interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or
security breaches will not occur or, if they do occur, that they will be adequately addressed. Our risk and exposure to these
matters remains heightened because of the evolving nature of these threats. As a result, cybersecurity and the continued
development and enhancement of our controls, processes, and practices designed to protect our systems, computers, software,
data, and networks from attack, damage or unauthorized access remain a focus for us. As threats continue to evolve, we may
be required to expend additional resources to continue to modify or enhance our protective measures or to investigate and
remediate information security vulnerabilities. Disruptions or failures tin the physical infrastructure or operating systems that
support our businesses and clients, or cyber attacks or security breaches of the network, systems or devices that our clients
use to access our products and services could result in client attrition, regulatory fines, penalties or intervention, reputation
damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could have a material
effect on our results of operations or financial condition.
The Company Relies On Other Companies To Provide Key Components Of Its Business Infrastructure.
Third party vendors provide certain key components of the Company’s business infrastructure such as internet connections,
network access and core transactional and financial systems. While the Company has selected third party vendors carefully,
it does not control their operations. Any problems caused by these third parties, including those which result from their
failure to provide services for any reason or their poor performance of services, could adversely impact the Company’s ability
to deliver products and services to its customers and otherwise to conduct its business. Replacing these third parties could
also entail significant delay and expense.
We May Be Required To Pay Significantly Higher FDIC Premiums Or Special Assessments That Could Adversely Affect
Our Earnings.
Market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured
deposits. As a result, we may be required to pay significantly higher premiums or additional special assessments that could
adversely affect our earnings. In addition, on November 12, 2009, the FDIC adopted a rule requiring banks to prepay, on
December 30, 2009, three years’ worth of premiums to replenish the depleted insurance fund. As a result, the amount of our
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prepaid assessment was approximately $5.7 million. Prepaid FDIC premiums at December 31, 2012 totaled $2.0 million. It
is possible that the FDIC may impose additional special assessments in the future as part of its restoration plan. We are
generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there is additional
bank or financial institution failures, we may be required to pay even higher FDIC premiums. Any future increases or
required prepayments in FDIC insurance premiums may materially adversely affect our results of operations.
The Fiscal And Monetary Policy Of The Federal Government And Its Agencies Could Have A Material Adverse Effect On
Our Earnings.
The Federal Reserve Board regulates the supply of money and credit in the United States. Its policies determine in large part
the cost of funds for lending and investing and the return earned on those loans and investments, both of which affect the net
interest margin. Its policies also can materially decrease the value of financial instruments that we hold, such as debt
securities and mortgage servicing rights. Its policies also can adversely affect borrowers, potentially increasing the risk that
they may fail to repay their loans. Further, our mortgage subsidiary’s loan production volumes are significantly affected by
changes in long-term interest rates. Changes in Federal Reserve Board policies are beyond our control and difficult to
predict; consequently, the impact of these changes on our activities and results of operations is difficult to predict.
Our Funding Sources May Prove Insufficient To Replace Deposits And Support Future Growth.
We rely on customer deposits, including brokered deposits, advances from the Federal Home Loan Bank (“FHLB”) and
Federal Reserve Bank (“FRB”), and other borrowings to fund operations. Although the Company has historically been able
to replace maturing deposits and advances, if desired, no assurance can be given that we would be able to replace such funds
in the future if the financial condition of the FHLB or programs sponsored by the FRB, regulatory restrictions on brokered
deposits or regulatory restrictions on the pricing of local deposits or other market conditions were to change. In addition,
certain borrowing sources are on a secured basis. The FHLB has become more restrictive on the types of collateral it will
accept and the amount of borrowings allowed on acceptable collateral. Due to changes applied by rating agencies on bonds,
changes in collateral requirements or deteriorating loan quality, outstanding borrowings could be required to be repaid,
incurring prepayment penalties. Our financial flexibility will be severely constrained if we are unable to maintain access to
funding at acceptable interest rates. Finally, if we are required to rely more heavily on more expensive funding sources to
support future operations, our revenues may not increase proportionally to cover these costs.
In addition, Crescent Mortgage funds mortgage loans held for sale through a warehouse line of credit and a purchase and sale
agreement. A decline in economic conditions could result in sources of warehouse lending decreasing and could affect
Crescent Mortgage’s ability to fund loans held for sale.
The Company Is Subject To Liquidity Risk.
The inability of the Company to raise funds through deposits, including brokered deposits, borrowings, sale of securities or
other sources could have a substantial negative impact on the Company’s liquidity. Factors that could detrimentally impact
the Company’s access to liquidity include a decrease in the level of the Company’s business activity or adverse regulatory
action against the Company. The Company’s ability to borrow could be impaired by such factors as a disruption in the
financial markets or negative views and expectations of the prospects for the financial services industry. Although the
Company’s current sources of funds are considered adequate for its current liquidity needs, there can be no assurance in this
regard for the future. If additional debt is needed in the future, there can be no assurance that such debt would be available
or, if available, would be on favorable terms. The ability of the Company to raise capital or borrow in the debt markets has
been negatively affected by recent economic conditions. If additional financing sources are unavailable or not available on
reasonable terms, the Company’s financial condition, results of operations and future prospects could be adversely affected.
The Short-Term And Long-Term Impact Of The Changing Regulatory Capital Requirements And Anticipated New
Capital Rules Is Uncertain.
On September 12, 2010, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on
Banking Supervision, announced an agreement to a strengthened set of capital requirements for internationally active banking
organizations in the U.S. and around the world, known as Basel III. On June 7, 2012, the Federal Reserve Board, the Office
of the Comptroller of the Currency and the FDIC issued a joint notice of proposed rulemaking that would implement sections
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of the Dodd-Frank Act that encompass certain aspects of Basel III with respect to capital and liquidity. On November 9,
2012, following a public comment period, the U.S. federal banking agencies announced that the originally proposed January
1, 2013 effective date for the proposed rules was being delayed so that the agencies could consider operational and
transitional issues identified in the large volume of public comments received. The propose rules, if adopted, would lead to
significantly higher capital requirements and more restrictive leverage and liquidity ratios than those currently in place.
Various provisions of the Dodd-Frank Act increase the capital requirements of bank holding companies, such as the
Company, and non-bank financial companies that are supervised by the Federal Reserve Board. The leverage and risk-based
capital ratios of these entities may not be lower than the leverage and risk-based capital ratios for insured depository
institutions. In particular, bank holding companies, many of which have long relied on trust preferred securities as a
component of their regulatory capital, will no longer be permitted to issue new trust preferred securities that count toward
their Tier 1 capital. While the Basel III changes and other regulatory capital requirements will likely result in generally higher
regulatory capital standards, it is difficult at this time to predict how new standards will ultimately be applied to the Company
and the Bank.
In addition, in the current economic and regulatory environment, regulators of banks and bank holding companies have
become more likely to impose capital requirements on bank holding companies and banks that are more stringent than those
required by applicable existing regulations.
The application of more stringent capital requirements for the Company and the Bank could, among other things, result in
lower returns on invested capital, require the issuance of additional capital, adversely affect our ability to pay dividends,
require us to reduce business levels and result in regulatory actions if we were to be unable to comply with such
requirements.
We May Elect Or Be Compelled To Seek Additional Capital In The Future, But That Capital May Not Be Available When
It Is Needed.
We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. Should we
elect or be required by regulatory authorities to raise additional capital, we may seek to do so through the issuance of, among
other things, our common or preferred stock. Our ability to raise additional capital, if needed, will depend on conditions in
the capital markets, economic conditions and a number of other factors, many of which are outside of our control, and our
financial performance. Accordingly, there is no assurance that we will have the ability to raise additional capital if needed or
on terms acceptable to us. Failure to be able to raise additional capital could result in the Company not meeting our
regulatory capital standards.
If Our Investment In The Federal Home Loan Bank Of Atlanta Were Impaired In The Future, Our Earnings And
Stockholders’ Equity Would Decrease.
We own common stock of the FHLB of Atlanta. We hold this stock to qualify for membership in the FHLB System and to
be eligible to borrow funds under the FHLB’s advance program. There is no market for our FHLB of Atlanta common stock.
Recent published reports indicate that certain member banks of the FHLB System may be subject to accounting rules and
asset quality risks that could result in materially lower regulatory capital levels. In an extreme situation, it is possible that the
capitalization of a FHLB, including the FHLB of Atlanta, could be substantially diminished. Consequently, there is a risk
that our investment in FHLB of Atlanta common stock could be impaired at some time in the future. If this occurs, it would
cause our earnings and stockholders’ equity to decrease.
The Company Is Subject To Extensive Governmental Regulation, Which Could Have An Adverse Impact On Our
Operations.
The banking and mortgage banking industry is extensively regulated and supervised under both federal and state law. The
Company is subject to the regulation and supervision of the Federal Reserve Board, the FDIC, and the South Carolina Board
as well as a number of states where Crescent Mortgage originates or purchases loans. These regulations are intended
primarily to protect depositors, the public and the FDIC insurance fund, and not our shareholders. These regulations govern
matters ranging from the maintenance of adequate capital to the general business operations and financial condition of the
Company. Any changes in federal and state law, as well as regulations and governmental policies, income tax laws and
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accounting principles, could affect the Company in substantial and unpredictable ways, including ways that could adversely
affect its business, financial condition or results of operations.
Our Operating Results In Fiscal 2012, 2011 and 2010 Have Been Highly Dependent Upon The Results Of Our Mortgage
Subsidiary.
There are a number of items that could adversely affect the volumes and margin of the Company’s mortgage banking
operations. These include, but are not limited to, the Federal Reserve Board’s monetary policy including its quantitative
easing program, aggressively low rates, reduction in prices paid by the mortgage banking aggregators, aggressive
competition, the housing market recovery, the status and financial condition of Fannie Mae and Freddie Mac, potential
changes in Fannie Mae and Freddie Mac lending guidelines and programs, proposed changes in the FHA lending
requirements, extensive regulatory changes and liquidity. Should these factors significantly impact production of mortgages,
it is likely that the Company’s earnings would be adversely affected.
Our Mortgage Subsidiary’s Operations Are Exposed To Significant Repurchase Risk.
Crescent Mortgage is exposed to significant repurchase risk on mortgage loan production related to potential reimbursements
for loans sold to third parties for borrower fraud, underwriting and documentation issues, early defaults and prepayments of
sold loans. If the Company experiences significant losses related to repurchase risk, it is possible that the reserve established
for such exposure is not adequate. The Company continues to receive repurchase requests. The Company evaluates each
request and provides estimated reserves as necessary. We believe that the reserve related to repurchase risk is adequate to
absorb probable losses; however, we cannot predict these losses or whether our reserve will be adequate. Any of these
occurrences could materially and adversely affect our business, financial condition and profitability.
The Value Of Our Loan Servicing Portfolio May Become Impaired In The Future.
As of December 31, 2012, Crescent Mortgage serviced approximately $2.2 billion of loans. At that date, our mortgage loan
servicing rights were recorded as an asset with a carrying value of approximately $12.0 million. We expect that our loan
servicing portfolio will increase in the future. If interest rates decline and the actual and expected mortgage loan prepayment
rates increase, the Company could incur an impairment of its mortgage loan servicing asset.
Competition With Other Financial Institutions May Have An Adverse Effect On Our Ability To Retain And Grow Our
Client Base, Which Could Have A Negative Effect On Our Financial Condition Or Results Of Operations.
The banking and financial services industry is very competitive and includes services offered from other banks, savings and
loan associations, credit unions, mortgage companies, other lenders, and institutions offering uninsured investment
alternatives. Legal and regulatory developments have made it easier for new and sometimes unregulated competitors to
compete with us. The financial services industry has and is experiencing an ongoing trend towards consolidation in which
fewer large national and regional banks and other financial institutions are replacing many smaller and more local banks.
These larger banks and other financial institutions hold a large accumulation of assets and have significantly greater resources
and a wider geographic presence or greater accessibility. In some instances, these larger entities operate without the
traditional brick and mortar facilities that restrict geographic presence. Some competitors have more aggressive marketing
campaigns and better brand recognition, and are able to offer more services, more favorable pricing or greater customer
convenience than our Bank. In addition, competition has increased from new banks and other financial services providers that
target our existing or potential customers. As consolidation continues among large banks, we expect other smaller institutions
to try to compete in the markets we serve. This competition could reduce our net income by decreasing the number and size
of the loans that we originate and the interest rates we charge on these loans. Additionally, these competitors may offer
higher interest rates, which could decrease the deposits we attract or require us to increase rates to retain existing deposits or
attract new deposits. Increased deposit competition could adversely affect our ability to generate the funds necessary for
lending operations which could increase our cost of funds.
The financial services industry could become even more competitive as a result of legislative, regulatory and technological
changes and continued consolidation. Banks, securities firms and insurance companies can merge as part of a financial
holding company, which can offer virtually any type of financial service, including banking, securities underwriting,
insurance (both agency and underwriting) and merchant banking. Technological developments have allowed competitors,
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including some non-depository institutions, to compete more effectively in local markets and have expanded the range of
financial products, services and capital available to our target customers. If we are unable to implement, maintain and use
such technologies effectively, we may not be able to offer products or achieve cost-efficiencies necessary to compete in the
industry. In addition, some of these competitors have fewer regulatory constraints and lower cost structures.
Hurricanes And Other Natural Disasters May Adversely Affect Loan Portfolios And Operations And Increase The Cost
Of Doing Business.
The Company operates in markets that are susceptible to natural disasters. Large-scale natural disasters may significantly
affect loan portfolios by damaging properties pledged as collateral, affecting the economies our borrowers live in, and by
impairing the ability of the borrower to repay their loans.
Negative Public Opinion Surrounding The Company And The Financial Institutions Industry Generally Could Damage
Our Reputation And Adversely Impact Our Earnings.
Reputation risk, or the risk to our business, earnings and capital from negative public opinion surrounding our Company and
the financial institutions industry generally, is inherent in our business. Negative public opinion can result from our actual or
alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and from
actions taken by government regulators and community organizations in response to those activities. Negative public opinion
can adversely affect our ability to keep and attract clients and employees and can expose us to litigation and regulatory
action. Although we take steps to minimize reputation risk in dealing with our clients and communities, this risk will always
be present given the nature of our business.
The Company And Its Subsidiaries Are Involved In Litigation.
In the course of ordinary business, the Bank is, from time to time, named a party to legal actions and proceedings, primarily
related to the collection of loans and foreclosed assets. In accordance with generally accepted accounting principles, the
Company establishes reserves for litigation and regulatory matters when those matters present loss contingencies that are
both probable and estimable. When loss contingencies are not both probable and estimable, the Company does not establish
reserves.
The Bank also has a claim against it relating to one of its former executive officers. Effective July 31, 2011, the Company
combined its wholly-owned subsidiary bank, Community FirstBank, with and into its other wholly-owned subsidiary bank,
Crescent Bank, effectuating an internal reorganization. The resultant bank was renamed CresCom Bank. The former
executive officer had an employment agreement with Community FirstBank and claims the internal reorganization triggered
the severance provisions of the employment agreement. The former executive officer initially claimed he is due an aggregate
amount of approximately $1.8 million but has since amended his complaint seeking approximately $10 million in damages.
The Company hired special counsel to review the claims made by the former executive officer. Based upon the review by
special counsel, the Company strongly disagrees with the former executive officer’s assertion that the internal reorganization
triggered the severance provisions of the employment agreement and intends to vigorously defend its position, including
potentially making certain counterclaims against the former executive officer. Management believes there is not sufficient
information available at this time to make an evaluation as to the likelihood of an unfavorable outcome of this claim or to
estimate the amount of potential loss, if any. Accordingly, no amounts have been accrued in the accompanying balance sheet
as of December 31, 2012.
There Is No Active Public Trading Market For Our Common Stock, And One Is Not Expected To Develop.
Our common stock is not listed for trading on any securities exchange, and we presently do not intend to apply to list our
common stock on any national securities exchange at any time in the foreseeable future. Consequently, the liquidity of our
common stock, and our investors ability to sell shares of our common stock, will depend upon the interest of the Company,
existing shareholders and other potential purchasers. As a result of this limited market, it may be difficult to identify buyers to
whom our investors can sell their shares of our common stock, and our investors may be unable to sell their shares at an
established market price, at a price that is favorable to the investors, or at all. This limited market will restrict our investors
ability to sell shares of our common stock at a desirable or stable price or at all, at any one time. Our investors should be
prepared to own our common stock indefinitely.
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We May Issue Additional Shares Of Common Or Preferred Stock, Which May Dilute The Interests Of Our Shareholders
And May Adversely Impact The Market Price Of Our Common Stock.
We are currently authorized to issue up to 6,800,000 shares of common stock, of which 1,918,992 shares were outstanding as
of March 15, 2013, and up to 200,000 shares of preferred stock, of which no shares are outstanding. We may need to incur
additional debt or equity financing in the future to strengthen our capital position or to make strategic acquisitions or
investments. If we determine, for any reason, that we need to raise capital, our Board of Directors generally has the authority,
without action by or vote of the shareholders, to issue all or part of any authorized but unissued shares of stock for any
corporate purpose, including issuance of equity-based incentives under or outside of our equity compensation plans.
Additionally, we are not restricted from issuing additional common stock or preferred stock, including any securities that are
convertible into or exchangeable for, or that represent the right to receive, common stock or preferred stock or any
substantially similar securities. Any issuance of additional shares of common stock or preferred stock will dilute the
percentage ownership interest of our shareholders and may dilute the book value per share of our common stock.
Shares Of Our Common Stock Are Not Insured Bank Deposits And Are Subject To Market Risk.
Our shares of common stock are not deposits, savings accounts or other obligations of the Company, our Bank or any other
depository institution, are not guaranteed by us or any other entity, and are not insured by the FDIC or any other
governmental agency.
Overview
Carolina Financial Corporation, a bank holding company, is a Delaware corporation that was incorporated in 1996 and began
operations in 1997. We operate principally through CresCom Bank, a South Carolina state-chartered bank. Our assets are
approximately $888.7 million at December 31, 2012 and approximately $826.2 million at December 31, 2011.
Our subsidiaries provide a full range of financial services designed to meet the financial needs of our customers, including:
• Commercial and retail banking;
• Mortgage banking; and
• Cash management.
Carolina Financial Corporation, through CresCom Bank, currently conducts business through 10 bank branches located in the
following counties: Charleston (4), Dorchester (2), and Horry (4) in South Carolina. Effective July 31, 2011, Carolina
Financial Corporation merged its wholly-owned subsidiary bank, Community FirstBank of Charleston (“Community
FirstBank”), with and into its other wholly-owned subsidiary bank, Crescent Bank. In conjunction with this internal
reorganization, Crescent Bank’s name was changed to CresCom Bank and Crescent Mortgage, formerly a wholly-owned
subsidiary of Community FirstBank, became a wholly-owned subsidiary of CresCom Bank. Crescent Mortgage is located in
DeKalb County, Georgia, and is qualified to originate loans in 42 states.
The following discussion describes our results of operations for 2012 as compared to 2011 and 2011 as compared to 2010
and also analyzes our financial condition as of December 31, 2012 as compared to December 31, 2011. Like most
community banks, we derive most of our income from interest we receive on our loans and investments. Our primary source
of funds for making these loans and investments is our deposits, both interest-bearing and noninterest-bearing.
Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the
income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such
as deposits and borrowed funds. In order to maximize our net interest income, we must not only manage the volume of these
balance sheet items, but also the yields that we earn on our interest-earning assets and the rates that we pay on interest-
bearing liabilities.
Of course, there are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on
existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan
losses against our operating earnings.
In addition to earning interest on our loans and investments, we derive a substantial portion of our income from Crescent
Mortgage through net gain on sale of loans held for sale. We also earn income through fees that we charge to our customers.
18
CAROLINA FINANCIAL CO RPORATI ON
FINANCIAL DISCUSSION
Likewise, we incur other operating expenses as well. We describe the various components of this noninterest income, as well
as our noninterest expense, in the following discussion.
Comparison of Operating Results for the Years Ended December 31, 2012 and 2011
Net Income (Loss). Net income increased $17.8 million to net income of $16.9 million, or $8.80 diluted earnings per share,
during the year ended December 31, 2012 compared to a net loss of $971,000, or $(0.51) diluted loss per share, during the
year ended December 31, 2011. The increase in net income primarily resulted from an increase in net interest income of
$517,000 and a decrease in provision for loan losses of $8.0 million to $2.7 million during the year ended December 31, 2012
compared to $10.7 million during the year ended December 31, 2011. In addition, noninterest income increased by $32.6
million to $52.3 million during the year ended December 31, 2012 compared to $19.7 million during the year ended
December 31, 2011. Noninterest expense increased by $12.7 million to $50.1 million during the year ended December 31,
2012 compared to $37.4 million during the year ended December 31, 2011. Income tax expense totaled $10.4 million during
fiscal 2012 related to pre-tax income of $27.3 million compared to income tax benefit of $128,000 on pre-tax loss of $1.1
million during fiscal 2011.
Net Interest Income. Net interest income increased $517,000, or 1.9%, to $27.8 million during the year ended December 31,
2012 from $27.3 million during the year ended December 31, 2011.
Average interest-earning assets decreased $19.2 million to $772.6 million during the year ended December 31, 2012 as
compared to $791.8 million during the year ended December 31, 2011 with a corresponding decrease in average yield of 27
basis points during that same period. The reduction in average interest-earning assets is primarily the result of a decrease in
nonperforming assets. During that same period, interest-bearing liabilities also decreased $55.8 million to $679.2 million
with a corresponding decrease in the average interest rate paid of 40 basis points. The reduction in average interest-bearing
liabilities was primarily due to reduced funds needed to support its balance sheet. The reduction in the average interest rate
paid was due primarily to the re-pricing of liabilities in a low rate environment during the period. The overall change in
interest-earning assets and interest-bearing liabilities with their corresponding changes in interest yields earned and interest
rates paid resulted in an increase in the net interest margin during the period of 15 basis points. During the year ended
December 31, 2012, the Company also focused on increasing checking and money market deposits.
Total interest income decreased $3.0 million, or 8.0%, to $35.4 million during the year ended December 31, 2012 from $38.4
million during the year ended December 31, 2011. Average loans held for sale increased $56.7 million, or 113.7%, to $106.6
million during the year ended December 31, 2012 from $49.9 million during the comparable period in 2011. The significant
increase in the average loans held for sale balances is the result of favorable government programs, a low interest rate
environment and management’s focus on customer service. The average yield earned on loans held for sale decreased to
3.67% from 4.31% during the years ended December 31, 2012 and 2011, respectively. As a result, interest income increased
$1.8 million to $3.9 million during fiscal 2012 from $2.1 million during fiscal 2011. Average loans receivable, net decreased
$49.7 million, or 9.1%, to $495.9 million during the year ended December 31, 2012 from $545.6 million during the
comparable period in 2011. A significant portion of this reduction was due to management’s focus on reducing
nonperforming assets. The average yield earned on loans receivable, net decreased to 5.28% from 5.43% during the years
ended December 31, 2012 and 2011, respectively. At December 31, 2012 and 2011, approximately 52% and 59%,
respectively, of the outstanding loans receivable balance consisted of adjustable rate loans and 48% and 41%, respectively,
are fixed rate loans. The Company significantly reduced total nonperforming loans during the year to $21.5 million at
December 31, 2012 from $40.3 million at December 31, 2011. This reduction reduced the Company’s need for interest-
bearing liabilities. Lost interest, interest not recorded in the accompanying consolidated statements of operations related to
loans on nonaccrual, loans charged off during the period, and loans transferred to real estate acquired through foreclosure,
totaled approximately $1.6 million and $3.5 million for the years ended December 31, 2012 and 2011, respectively. The
average balance of securities available for sale decreased $9.8 million, or 6.7%, to $138.0 million during 2012 from $147.8
million during 2011. The yield earned on securities available for sale decreased to 3.56% from 4.25% during the year ended
December 31, 2012 and 2011, respectively. The average balance of securities held-to-maturity decreased 2.7%, to $9.4
million during the year ended December 31, 2012 from $9.6 million during the comparable period in 2011. The average
yield earned on securities held-to-maturity decreased to 2.25% from 2.30% during the years ended December 31, 2012 and
2011, respectively.
Total interest expense decreased $3.6 million, or 32.4%, to $7.5 million during the year ended December 31, 2012 from
$11.1 million during the year ended December 31, 2011. Average interest-bearing liabilities decreased $55.8 million, or
19
CAROLINA FINANCIAL CO RPORATI ON
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7.6%, to $679.2 million during the year ended December 31, 2012 from $735.0 million during the comparable period in
2011. Average money market balances remained constant during the years ended December 31, 2012 and 2011 at
approximately $199 million. However, the average interest rate paid on money markets during the year ended December 31,
2012 decreased to 0.62% compared to 0.74% during the comparable period in 2011. Average certificates of deposit balances
decreased $39.1 million, or 11.3%, to $306.7 million during the year ended December 31, 2011 from $345.8 million during
the comparable period in 2011. In addition, the average interest rate paid on certificates of deposit during the year ended
December 31, 2012 decreased significantly to 0.91% compared to 1.44% during the comparable period in 2011. Average
short-term borrowing balances decreased $1.5 million, or 3.4%, to $42.4 million during the year ended December 31, 2012
from $43.8 million during the comparable period in 2011. The average rate paid during the year ended December 31, 2012
on these borrowings declined significantly to 1.51% compared to 2.38% during the comparable period in 2011. Average
long-term borrowing balances decreased $24.7 million, or 23.5%, to $80.3 million during the year ended December 31, 2012
from $105.0 million during the comparable period in 2011. The average rate paid during the year ended December 31, 2012
on these borrowings was 3.36% compared to 3.32% during the comparable period in 2011.
Provision for Loan Losses. The provision for loan losses decreased $8.0 million to $2.7 million during the year ended
December 31, 2012 compared to $10.7 million during the year ended December 31, 2011. The reduction in the provision for
loan losses reflects lower net charge-offs and a significant improvement in our credit quality measures over the last year.
Specifically, the Company had net charge-offs of $5.2 million or 1.05% of average loans receivable, net during the year
ended December 31, 2012 compared to net charge-offs of $13.0 million or 2.38% of average loans receivable, net during the
comparable period in 2011. The allowance for loan losses was 1.86% of loans receivable, or $9.5 million at December 31,
2012, a decrease of $2.5 million from the allowance for loan losses of $12.0 million or 2.29% of the loans receivable, at
December 31, 2011. The 43 basis point decrease in the allowance for loan losses as a percentage of loans receivable is
primarily due to the decrease in non-performing loans to total loans to 2.98% at December 31, 2012 from 6.5% at December
31, 2011.
Noninterest Income. Total noninterest income increased $32.6 million, or 165.1%, to $52.3 million during the year ended
December 31, 2012 from $19.7 million during the comparable period in 2011. This increase is primarily attributable to an
increase in the gain on sale of loans held for sale of $31.6 million. In addition, noninterest income reflected a net decrease in
other-than-temporary impairment of $840,000, a decrease in net gain on sale of securities of $3.3 million, and an increase in
the loss on extinguishment of debt of $530,000.
The Company’s mortgage company experienced a significant increase in loan production and a corresponding increase in
margin due to favorable government programs, a low interest-rate environment and management’s focus on customer service
resulting in an increase of $31.6 million in gain on sale of loans held for sale.
During the years ended December 31, 2012 and 2011, the Company had investment securities that experienced other-than-
temporary impairment. Other-than-temporary impairment expense reflected in the accompanying income statement totaled
$913,000 and $1.8 million at December 31, 2012 and 2011, respectively.
Net loss on sale of securities during the year ended December 31, 2012 totaled $3.0 million compared to a net gain on sale of
securities of $306,000 during the comparable period in 2011. Included in the $3.0 million net loss during fiscal 2012, the
Company specifically sold the four securities that incurred OTTI expense as noted above to improve asset quality. As a
result of the sale of those securities, the Company incurred a loss of $3.2 million.
Certain borrowings were prepaid to manage the cost of funds and related interest rate sensitivity, resulting in a net loss on the
extinguishment of debt of $1.6 million and $1.1 million during 2012 and 2011, respectively
Noninterest Expense. Total noninterest expense increased $12.7 million, or 34.0%, to $50.1 million during the year ended
December 31, 2012 from $37.4 million during the comparable period in 2011. This increase is primarily attributable to an
increase in mortgage loan repurchase losses expense of $1.4 million, salaries and employee benefits of $5.7 million, legal
expense of $376,000, net of a decrease in FDIC insurance expense of $313,000, other real estate expense of $779,000, and
other expenses of $5.4 million.
As a result of the significant increase in the Company’s mortgage company subsidiary production, additional expense related
to mortgage loan repurchase loss exposure was recorded.
20
CAROLINA FINANCIAL CO RPORATI ON
FINANCIAL DISCUSSION
Salaries and benefits expense increased a net $5.7 million, consisting of a net increase at the Company’s mortgage company
subsidiary related to the increased production totaling $6.5 million and a net reduction in salaries and benefits at the
Company’s banking subsidiary of $0.7 million.
During fiscal 2012, the Company experienced a $4 million loss related to a kite that is reflected in other expense.
Income Tax Benefit. Net income for 2012 was $16.9 million and the net loss for 2011 was $971,000. Accordingly, the
income tax benefit decreased $10.5 million to an expense of $10.4 million during the year ended December 31, 2012 from an
income tax benefit of $128,000 during the comparable period in 2011. The Company’s effective tax rate was 38% during the
year ended December 31, 2012 and the effective benefit rate was 11.6% during the year ended December 31, 2011.
Comparison of Operating Results for the Years Ended December 31, 2011 and 2010
Net Income (Loss). Net loss decreased $11.6 million, or 92.3%, to a net loss of $971,000, or $(0.51) diluted loss per share,
during the year ended December 31, 2011 compared to a net loss of $12.6 million, or $(6.58) diluted loss per share, during
the year ended December 31, 2010. The reduction in the net loss primarily resulted from a decrease in net interest income of
$2.4 million and a decrease in provision for loan losses of $20.0 million to $10.7 million during the year ended December 31,
2011 compared to $30.8 million during the year ended December 31, 2010. In addition, noninterest income decreased by
$1.9 million to $19.7 million during the year ended December 31, 2011 compared to $21.6 million during the year ended
December 31, 2010. Noninterest expense decreased by $1.7 million to $37.4 million during the year ended December 31,
2011 compared to $39.1 million during the year ended December 31, 2010. Income taxes reflected a benefit of $128,000
during fiscal 2011 related to a pre-tax loss of $1.1 million compared to income tax benefit of $5.9 million on pre-tax loss of
$18.5 million during fiscal 2010.
Net Interest Income. Net interest income decreased $2.4 million, or 8.2%, to $27.3 million during the year ended December
31, 2011 from $29.8 million during the year ended December 31, 2010.
Average interest-earning assets decreased $167.7 million to $791.8 million during the year ended December 31, 2011 as
compared to $959.5 million during the year ended December 31, 2010 with a corresponding decrease in average yield of 3
basis points during that same period. The reduction in average interest-earning assets is primarily the result of a decrease in
nonperforming assets and a decision by management to shrink the balance sheet to preserve capital. During that same period,
interest-bearing liabilities also decreased $174.6 million to $735.0 million with a corresponding decrease in the average
interest rate paid of 37 basis points. The reduction in average interest-bearing liabilities was primarily due to reduced funds
needed resulting from the Company’s decision to shrink its balance sheet to preserve capital. The reduction in the average
interest rate paid was due primarily to the re-pricing of liabilities in a falling rate environment during the period. The overall
change in interest-earning assets and interest-bearing liabilities with their corresponding changes in interest yields earned and
interest rates paid resulted in an increase in the net interest margin during the period of 35 basis points. During the year
ended December 31, 2011, the Company also focused on increasing checking and money market deposits and reducing
brokered deposits and higher-rate certificates of deposits.
Total interest income decreased $8.4 million, or 17.9%, to $38.4 million during the year ended December 31, 2011 from
$46.8 million during the year ended December 31, 2010. Average loans receivable, net decreased $95.1 million, or 14.8%, to
$545.6 million during the year ended December 31, 2011 from $640.6 million during the comparable period in 2010. The
average yield earned on loans receivable, net increased to 5.43% from 5.42% during the years ended December 31, 2011 and
2010, respectively. At December 31, 2011 and 2010, approximately 59% and 60%, respectively, of the loan portfolio
consisted of adjustable rate loans and approximately 41% and 40%, respectively, consisted of fixed rate loans. Additionally,
the Company’s net interest income was adversely affected by the increase in the average balance of nonaccrual loans that
increased to $36.0 million during the year ended December 31, 2011 from $35.3 million during the year ended December 31,
2010. Lost interest, interest not recorded in the accompanying consolidated statements of operations related to loans on
nonaccrual, loans charged off during the period, and loans transferred to real estate acquired through foreclosure, totaled
approximately $3.5 million and $3.2 million for the years ended December 31, 2011 and 2010, respectively. The average
balance of securities available for sale increased $41.2 million, or 38.7%, to $147.8 million during 2011 from $106.6 million
during 2010. The yield earned on securities available for sale increased to 4.25% from 3.76% during the year ended
December 31, 2011 and 2010, respectively. During 2010, the Company transferred 30 mortgage-backed securities held-to-
maturity totaling $91.5 million to securities available-for-sale and subsequently sold 16 of these securities totaling $63.9
million. The Company received $59.4 million of gross proceeds related to the sale of these securities and recognized gross
21
CAROLINA FINANCIAL CO RPORATI ON
FINANCIAL DISCUSSION
gains of $157,000 and gross losses of $4.6 million. The Company’s original intent was to hold these securities to maturity.
However, these securities experienced significant deterioration in the issuer’s creditworthiness. In addition, due to credit
rating agency downgrades in these securities, the risk weights used for regulatory risk-based capital purposes increased.
Accordingly, the Company changed its intent to hold these securities to maturity. Management believes that these held-to-
maturity securities were sold under exceptions “a.” and “d.” of ASC 320-10-25-6. As a result, the sale of these securities is
not considered inconsistent with the original intent and classification and, therefore, does not taint the remaining securities
held-to-maturity portfolio. During 2011, the Company did not transfer any securities from held-to-maturity to available-for-
sale. The average balance of securities held-to-maturity decreased $96.0 million, or 90.9%, to $9.6 million during the year
ended December 31, 2011 from $105.7 million during the comparable period in 2010. The average yield earned on securities
held-to-maturity decreased to 2.30% from 5.05% during the years ended December 31, 2011 and 2010, respectively.
Total interest expense decreased $6.0 million, or 34.9%, to $11.1 million during the year ended December 31, 2011 from
$17.1 million during the year ended December 31, 2010. Average interest-bearing liabilities decreased $174.6 million, or
19.2%, to $735.0 million during the year ended December 31, 2011 from $909.6 million during the comparable period in
2010. Average money market balances increased $23.6 million, or 13.4%, to $199.5 million during the year ended December
31, 2011 from $176.0 million during the comparable period in 2010. In addition, the average interest rate paid on money
markets during the year ended December 31, 2011 decreased to 0.74% compared to 1.30% during the comparable period in
2010. Average certificates of deposit balances decreased $139.3 million, or 28.7%, to $345.8 million during the year ended
December 31, 2010 from $485.1 million during the comparable period in 2010. In addition, the average interest rate paid on
certificates of deposit during the year ended December 31, 2011 decreased to 1.44% compared to 1.94% during the
comparable period in 2010. Average short-term borrowing balances increased $21.1 million, or 93.0%, to $43.8 million
during the year ended December 31, 2011 from $22.7 million during the comparable period in 2010. The average rate paid
during the year ended December 31, 2011 on these borrowings was 2.38% compared to 3.12% during the comparable period
in 2010. Average long-term borrowing balances decreased $83.6 million, or 44.3%, to $105.0 million during the year ended
December 31, 2011 from $188.5 million during the comparable period in 2010. The average rate paid during the year ended
December 31, 2011 on these borrowings was 3.32% compared to 2.40% during the comparable period in 2010.
Provision for Loan Losses. The provision for loan losses decreased $20.0 million to $10.7 million during the year ended
December 31, 2011 compared to $30.8 million during the year ended December 31, 2010. The reduction in the provision for
loan losses reflects lower net charge-offs and a significant improvement in our credit quality measures over the prior year.
Specifically, the Company had net charge-offs of $13.0 million or 2.38% of average loans receivable, net during the year
ended December 31, 2011 compared to net charge-offs of $29.5 million or 4.61% of average loans receivable, net during the
comparable period in 2010. The allowance for loan losses was 2.29% of loans receivable, or $12.0 million at December 31,
2011, a decrease of $2.2 million from the allowance for loan losses of $14.3 million or 2.38% of the loans receivable, at
December 31, 2010. The 9 basis point decrease in the allowance for loan losses as a percentage of loans receivable is
primarily due to the decrease in non-performing loans to gross loans receivable to 6.50% at December 31, 2011 from 9.60%
at December 31, 2010.
Noninterest Income. Total noninterest income decreased $1.9 million, or 8.7%, to $19.7 million during the year ended
December 31, 2011 from $21.6 million during the comparable period in 2010. This decrease is primarily attributable to a
reduction in the gain on sale of loans held for sale of $6.1 million, net of a decrease in other-than-temporary impairment of
$727,000, an increase in net gain on sale of securities of $2.3 million, and a decrease in the loss on extinguishment of debt of
$1.5 million.
During the years ended December 31, 2011 and 2010, the Company had investment securities that experienced other-than-
temporary impairment. Other-than-temporary impairment expense reflected in the accompanying income statement totaled
$1.8 million and $2.5 million, respectively.
Net gain on sale of securities during the year ended December 31, 2011 totaled $306,000 compared to a net loss on sale of
securities of $2.0 million during the comparable period in 2010.
In connection with the Company’s balance sheet management to preserve capital and improve the cost of funds, certain
borrowings were prepaid to manage the related interest rate sensitivity, resulting in a net loss on the extinguishment of debt
of $1.1 million and $2.5 million during 2011 and 2010, respectively
22
CAROLINA FINANCIAL CO RPORATI ON
FINANCIAL DISCUSSION
Noninterest Expense. Total noninterest expense decreased $1.7 million, or 4.2%, to $37.4 million during the year ended
December 31, 2011 from $39.1 million during the comparable period in 2010. This decrease is primarily attributable to a
decrease in mortgage loan repurchase losses of $1.8 million, salaries and employee benefits of $613,000, and FDIC insurance
expense of $409,000, net of an increase in other real estate expense of $700,000, legal expense of $280,000 and other
expenses related to wholesale mortgage loan production and other loan collection activities.
Income Tax Benefit. Net loss for 2011 and 2010 was $971,000 and $12.6 million, respectively. Accordingly, the income
tax benefit decreased $5.7 million to $128,000 during the year ended December 31, 2011 from income tax benefit of $5.9
million during the comparable period in 2010. The Company’s effective benefit rate was 11.6% and 31.8% during the years
ended December 31, 2011 and 2010, respectively. The Company files a consolidated federal income tax return that reflects a
consolidated net operating loss carryback benefit. Separate state income tax returns are filed for the Crescent Mortgage, the
Bank and the Company and its nonbank subsidiary. Since the Crescent Mortgage generated earnings, state income taxes
were due. For the South Carolina and North Carolina returns of the bank and the holding company and its nonbank
subsidiary, there is no net operating loss carryback provision. Accordingly, the company did not recognize a tax benefit
related to these losses.
23
CAROLINA FINANCIAL CO RPORATI ON
FINANCIAL DISCUSSION
Yields on Average Interest-Earning Assets and Rates on Average Interest-Bearing Liabilities
The following table summarizes the Company’s yields on average interest-earning assets and rates on average interest-
bearing liabilities during the periods indicated:
2012
Interest Average
Yield/
Rate
Paid/
Earned
For The Years Ended December 31,
2011
Interest Average
Yield/
Rate
Paid/
Earned
(Dollars in thousands)
Average
Balance
Average
Balance
3,914
26,160
41
4,908
211
107
17
35,358
110
1,227
47
2,794
640
2,695
7,513
3.67% 49,895
5.28% 545,556
0.24% 29,070
3.56% 147,808
9,624
2.25%
9,431
1.94%
3.66%
465
4.58% 791,849
66,583
858,432
0.27% 34,129
0.62% 199,528
0.50%
6,725
0.91% 345,823
1.51% 43,845
3.36% 104,963
1.11% 735,013
62,797
13,619
47,003
2,150
29,640
52
6,280
221
81
17
38,441
4.31%
5.43%
0.18%
4.25%
2.30%
0.86%
3.66%
4.85%
95
1,470
36
4,977
1,045
3,490
11,113
0.28%
0.74%
0.54%
1.44%
2.38%
3.32%
1.51%
56,855
640,646
37,212
106,598
105,658
12,029
465
959,463
58,667
1,018,130
34,160
175,966
3,130
485,126
22,720
188,541
909,643
44,027
14,395
50,065
Average
Balance
$
106,626
495,889
16,765
137,956
9,361
5,508
465
772,570
64,496
$
837,066
41,361
199,062
9,468
306,691
42,367
80,272
679,221
84,503
19,340
54,002
2010
Interest Average
Yield/
Rate
Paid/
Earned
2,647
34,720
69
4,013
5,334
42
17
46,842
4.66%
5.42%
0.19%
3.76%
5.05%
0.35%
3.66%
4.88%
138
2,285
19
9,408
708
4,519
17,077
0.40%
1.30%
0.61%
1.94%
3.12%
2.40%
1.88%
$
837,066
858,432
1,018,130
3.47%
3.34%
3.00%
3.60%
3.45%
27,845
27,328
3.10%
29,765
Interest-earning assets:
Loans held for sale
Loans receivable, net (1)
Interest-bearing cash
Securities available for sale
Securities held to maturity
Federal Home Loan Bank stock
Other investments
Total interest-earning assets
Non-earning assets
Total assets
Interest-bearing liabilities:
Demand accounts
M oney market accounts
Savings accounts
Certificates of deposit
Short-term borrowed funds
Long-term debt
Total interest-bearing liabilities
Noninterest-bearing deposits
Other liabilities
Stockholders' equity
Total liabilities and
Stockholders' equity
Net interest spread
Net interest margin
Net interest income
(1) Average balances of loans include non-accrual loans.
24
CAROLINA FINANCIAL CO RPORATI ON
FINANCIAL DISCUSSION
Analysis of Changes in Net Interest Income
The following table shows changes in interest income and interest expense based upon changes in volume and changes in
interest rates during the periods indicated:
For The Years Ended December 31,
2012 vs. 2011
2011 vs. 2010
Increase (decrease)
due to
Volume
Rate
$
2,446
(2,737)
(21)
(420)
(5)
(34)
-
(771)
20
(3)
15
(564)
(35)
(827)
(1,394)
623
$
(319)
(818)
17
(1,020)
(5)
102
-
(2,043)
(4)
(241)
(3)
(1,826)
(383)
42
(2,415)
372
Loans held for sale
Loans receivable, net
Interest-bearing cash
Securities available for sale
Securities held to maturity
FHLB stock
Other investments
Interest income
Demand accounts
M oney market accounts
Savings accounts
Certificates of deposit
Short-term borrowed funds
Long-term debt
Interest expense
Net interest income
Loans by Type
Rate/
Net
Dollar
Volume Change Volume
(In thousands)
Increase (decrease)
due to
Rate/
Volume
Net
Dollar
Change
24
(10)
1
202
2,641
(13)
-
2,845
(2)
(132)
(3)
697
(156)
(769)
(365)
3,210
(497)
(5,080)
(17)
2,267
(5,113)
39
-
(8,401)
(43)
(815)
17
(4,431)
337
(1,029)
(5,964)
(2,437)
Rate
(199)
64
(4)
522
(2,906)
61
-
(2,462)
(48)
(989)
(2)
(2,426)
(166)
1,746
(1,885)
(577)
(363)
75
(7)
68
-
(42)
-
(269)
(1)
1
(1)
207
13
(10)
209
(478)
1,764
(3,480)
(11)
(1,372)
(10)
26
-
(3,083)
15
(243)
11
(2,183)
(405)
(795)
(3,600)
517
(322)
(5,134)
(14)
1,543
(4,848)
(9)
-
(8,784)
7
306
22
(2,702)
659
(2,006)
(3,714)
(5,070)
The following table summarizes loans by type and percent of total at the end of the periods indicated:
At December 31,
2012
2011
Loans secured by real estate:
One-to-four family
Home equity
Commercial real estate
Construction and development
Consumer loans
Commercial business loans
Total gross loans receivable
Less:
Undisbursed loans in process
Allowance for loan losses
Deferred fees, net
Total loans receivable, net
% of Total
Loans
Amount
(Dollars in thousands)
% of Total
Loans
23.10%
6.52%
46.46%
14.09%
0.94%
8.89%
100.00%
124,604
35,173
250,560
75,985
5,085
47,933
539,340
13,898
12,039
68
513,335
Amount
$
146,333
31,278
240,764
68,113
3,762
38,714
27.66%
5.91%
45.52%
12.88%
0.71%
7.32%
528,964
100.00%
17,690
9,520
63
501,691
$
25
CAROLINA FINANCIAL CO RPORATI ON
FINANCIAL DISCUSSION
Non-Performing and Problem Assets
The following table summarizes non-performing and problem assets at the end of the periods indicated.
At December 31,
2012
2011
(Dollars in thousands)
Loans secured by real estate:
Nonaccrual loans-renegotiated loans
Nonaccrual loans-other
Accruing loans 90 days or more delinquent
Real estate acquired through foreclosure, net
Total Non-Performing Assets
$
$
10,733
4,515
-
6,284
21,532
18,704
11,227
4,231
6,097
40,259
Problem Assets not included in Non-Performing Assets-
Accruing renegotiated loans outstanding
$
17,195
23,421
Substantially all of the nonaccrual loans, accruing loans 90 days or more delinquent and accruing renegotiated loans for fiscal
2012 and 2011 are collateralized by real estate. Management believes based on information known and available currently,
the probable losses related to problem assets are adequately reserved in the allowance for loan losses.
Although non-performing assets remain at an elevated level, credit quality indicators generally showed improvement during
2012 as the Company experienced reduced loan migrations to nonaccrual status, lower loss severity on individual problem
assets and a significant reduction in non-performing assets through December 31, 2012. The Company believes this general
trend in reduced loans migrating into nonaccrual status is an indication of improving credit quality in the Company’s overall
loan portfolio and a leading indicator of reduced credit losses going forward. Nevertheless, the Company can make no
assurances that non-performing assets will continue to improve in future periods. The Company continues to monitor the
loan portfolio and foreclosed assets very carefully and is continually working to reduce its problem assets.
Market Risk Management and Interest Rate Risk
The effective management of market risk is essential to achieving the Company’s objectives. As a financial institution, the
Company’s most significant market risk exposure is interest rate risk. The primary objective of managing interest rate risk is
to minimize the effect that changes in interest rates have on net income. This is accomplished through active asset and
liability management, which requires the strategic pricing of asset and liability accounts and management of appropriate
maturity mixes of assets and liabilities. The expected result of these strategies is the development of appropriate maturity and
re-pricing opportunities in those accounts to produce consistent net income during periods of changing interest rates. The
Bank’s Asset/Liability Management Committee ("ALCO") monitor loan, investment and liability portfolios to ensure
comprehensive management of interest rate risk. These portfolios are analyzed for proper fixed-rate and variable-rate mixes
under various interest rate scenarios. The asset/liability management process is designed to achieve relatively stable net
interest margins and assure liquidity by coordinating the volumes, maturities or re-pricing opportunities of interest-earning
assets, deposits and borrowed funds. It is the responsibility of the ALCO to determine and achieve the most appropriate
volume and mix of interest-earning assets and interest-bearing liabilities, as well as ensure an adequate level of liquidity and
capital, within the context of corporate performance goals. The ALCO meets regularly to review the Company’s interest rate
risk and liquidity positions in relation to present and prospective market and business conditions, and adopts funding and
balance sheet management strategies that are intended to ensure that the potential impact on earnings and liquidity as a result
of fluctuations in interest rates is within acceptable standards. The Board of Directors also sets policy guidelines and
establishes long-term strategies with respect to interest rate risk exposure and liquidity.
The Company uses interest rate sensitivity analysis to measure the sensitivity of projected net interest income to changes in
interest rates. Management monitors the Company’s interest sensitivity by means of a computer model that incorporates
current volumes, average rates earned and paid, and scheduled maturities, payments of asset and liability portfolios, together
with multiple scenarios of prepayments, repricing opportunities and anticipated volume growth. Interest rate sensitivity
analysis shows the effect that the indicated changes in interest rates would have on net interest income as projected for the
26
CAROLINA FINANCIAL CO RPORATI ON
FINANCIAL DISCUSSION
next twelve months under the current interest rate environment. The resulting change in net interest income reflects the level
of sensitivity that net interest income has in relation to changing interest rates.
The following table summarizes the Company’s interest rate sensitivity position at the Bank as of December 31, 2012:
Interest Rate Scenario
Change
0.00%
1.00%
2.00%
3.00%
Prime Rate
3.25%
4.25%
5.25%
6.25%
Annualized Hypothetical
Percentage Change in
Net Interest Income
0.00%
(2.00%)
(3.90%)
(1.90%)
The Company also uses derivatives intended to reduce interest rate risk incurred as a result of market movements. These
derivatives primarily consist of mortgage loan interest rate lock commitments, mortgage loan forward sales commitments and
options to deliver mortgage-backed securities. A derivative is a financial instrument that derives its cash flows, and therefore
its value, by reference to an underlying instrument, index or referenced interest rate. The Company uses derivatives primarily
to minimize interest rate risk related to its pipeline of loan interest rate lock commitments issued on residential mortgage
loans in the process of origination for sale or loans held for sale. Mortgage loan forward sales commitments and options to
deliver mortgage-backed securities that generally correspond with the composition of the locked pipeline are used to
economically hedge a percentage of the Company’s locked pipeline. Crescent Mortgage’s Asset/Liability Committee has
developed a comprehensive hedging policy to monitor the use of derivatives to reduce interest rate risk. The Company’s
derivative positions are classified as trading assets and liabilities, and as such, the changes in the fair market value of the
derivative positions are recognized in the consolidated statement of operations.
The derivative positions of the Company at December 31, 2012 and 2011 are as follows:
At December 31,
2012
2011
Fair
Value
Notional
Value
Fair
Value
(In thousands)
Notional
Value
Derivative assets:
M ortgage loan interest rate lock commitments
M ortgage loan forward sales commitments
M ortgage-backed securities forward sales commitments
$
$
4,783
1,692
67
6,542
289,584
59,177
308,000
656,761
2,832
1,168
-
4,000
218,465
47,992
-
266,457
Derivative liabilities:
M ortgage-backed securities forward sales commitments
$
-
-
1,234
167,000
Liquidity and Financial Condition
The Company’s assets and liabilities are monitored on a daily basis to ensure funds are available to meet liquidity
requirements. The Company also utilizes borrowing facilities in order to maintain adequate liquidity including: the FHLB of
Atlanta advance window, the Federal Reserve Bank (“FRB”), federal funds purchased, and warehouse lines of credit. The
Company also uses wholesale deposit products, including brokered deposits as well as national certificate of deposit services.
Additionally, the Company has certain investment securities classified as available for sale that are carried at market value
with changes in market value, net of tax, recorded through stockholders’ equity.
Lines of credit with the FHLB of Atlanta are based upon FHLB-approved percentages of Bank assets, but must be supported
by appropriate collateral to be available. The Company has pledged first lien residential mortgage, second lien residential
mortgage, residential home equity line of credit, commercial mortgage and multifamily mortgage portfolios under blanket
lien agreements resulting in approximately $151.8 million of collateral for these advances. In addition, at December 31,
2012, the Company has pledged $6.8 million of securities for these advances. Assuming sufficient collateral was available at
27
CAROLINA FINANCIAL CO RPORATI ON
FINANCIAL DISCUSSION
December 31, 2012, the Company had maximum FHLB lines of $266.1 million based on FHLB limits. At December 31,
2012, collateral totaling $158.6 million was pledged to support FHLB advances. At December 31, 2012 the Company had
FHLB advances of $115.0 million outstanding with excess collateral pledged to the FHLB during those periods that would
support additional borrowings of approximately $43.6 million.
Lines of credit with the FRB are based on collateral pledged. The Company has pledged certain non-mortgage commercial,
acquisition and development, and lot loan portfolios under blanket lien agreements resulting in approximately $34.3 million
of collateral to the FRB for these advances. At December 31, 2012 the Company had lines available with the FRB for $34.3
million. At December 31, 2012 the Company had no FRB advances outstanding.
At December 31, 2012, Crescent Mortgage had a mortgage loan warehouse line of credit from a correspondent with a $35.0
million credit limit, of which $33.1 million is still available. The facility is secured by Crescent Mortgage’s residential
mortgage loans held for sale and other assets.
Effective October 1, 2011, the Company modified a $3.0 million unsecured line of credit with a correspondent bank, of
which $2.8 million and $3.0 million was outstanding at December 31, 2012 and December 31, 2011, respectively. The
unsecured line of credit bears interest at prime plus 1.50% and the term expires October 1, 2013. In connection with this
modification, the Company will make quarterly principal payments of $50,000 that began on October 1, 2011 and will
continue on the same day of each quarter through and including July 1, 2013. The line of credit also has debt covenants, the
more restrictive of which requires the Company to maintain certain capital ratios and nonperforming asset ratios. As of
December 31, 2012 the Company is in compliance with all of the covenants. At December 31, 2012, $2.8 million of this
unsecured line of credit is included in Short-Term Borrowed Funds.
Capital Resources
The Company and the Bank are subject to numerous regulatory capital requirements administered by federal banking
agencies. If these capital requirements are not met, regulators can initiate certain mandatory – and possibly additional
discretionary – actions that, if undertaken, could affect operations. Under capital adequacy guidelines and the regulatory
framework for corrective action, the Company and the Bank must meet certain capital guidelines, which involve quantitative
measures of the Company’s and the Bank’s assets, liabilities and certain off-balance sheet items as calculated under
regulatory accounting practices. The Company’s and the Bank’s capital amounts and classification are subject to qualitative
judgments by the regulators about components, risk weightings and certain other factors.
Quantitative measures set up by regulation to guarantee capital adequacy require the Company and the Bank to sustain
minimum amounts and ratios of Tier 1 capital and total risk based capital to risk-weighted assets and Tier 1 capital to total
average assets. The Company and the Bank are required to maintain minimum Tier 1 capital and total risk based capital to
risk weighted assets, and Tier 1 capital to total average assets of 4%, 8%, and 3%, respectively. To be considered “Well
Capitalized”, the Company and the Bank must maintain at least Tier 1 capital and total risk based capital to risk weighted
assets, and Tier 1 capital to total average assets of 6%, 10%, and 5%, respectively. As of December 31, 2012, the Company
and the Bank are considered “Well Capitalized” under regulatory capital adequacy guidelines.
The following schedule shows the Company’s and the Bank’s actual capital amounts and ratios at December 31, 2012 and
2011, respectively:
Carolina Financial Corporation
Tier 1 capital (to risk weighted assets)
Total risk based capital (to risk weighted assets)
Tier 1 capital (to total average assets)
CresCom Bank
Tier 1 capital (to risk weighted assets)
Total risk based capital (to risk weighted assets)
Tier 1 capital (to total average assets)
At December 31,
2012
2011
Amount
Ratio
Amount
Ratio
(Dollars in thousands)
13.11%
15.52%
9.65%
13.57%
15.97%
10.01%
65,876
83,357
65,876
10.48%
13.27%
7.94%
68,240
85,706
68,240
10.88%
13.67%
8.18%
$
82,839
98,030
82,839
85,537
100,714
85,537
28
CAROLINA FINANCIAL CO RPORATI ON
FINANCIAL DISCUSSION
In June 2012, U.S. banking regulators issued the Basel III Notice of Proposed Rulemaking (NPR) to implement Basel III
regulatory capital reforms from the Basel Committee on Banking Supervision and changes required by the Financial Reform
Act. The Basel III NPR proposes material changes to the deduction of certain assets from capital, new minimum capital
ratios and buffer requirements, a Standardized Approach that provides a floor to the calculation of risk-weighted assets, and
significant changes to the calculation of credit and counterparty credit risk.
The Basel III NPR addressing standardized risk-weighting of assets would significantly change the risk-weighting of certain
assets for almost all U.S. financial institutions beginning in 2015. To what extent the NPR will be adopted as proposed is not
known; however, management estimates that the Company would remain a well-capitalized institution under its
interpretation of the proposed increased capital requirements and risk-weighted asset revisions if the proposal had been fully
in effect as of December 31, 2012.
Many of the changes to capital deductions are subject to a transition period where the impact is recognized in 20%
increments beginning on January 1, 2014 through January 1, 2018. The majority of the other aspects of the Basel III NPR
were proposed to become effective January 1, 2013. However, this effective date was postponed in November 2012. The
delay is expected to be a six-month time period. The phase-in period for the new minimum capital requirements and related
buffers is proposed to occur between 2013 and 2019.
Management expects to comply with the final rules when issued and effective. To prepare for the implementation of the new
capital rules, management continues to build capital through retained earnings and is evaluating strategies to maximize the
Company’s capital under the Basel III NPR.
Recently Adopted Accounting Pronouncements
The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and
disclosure of financial information by the Company.
In April 2011 the FASB issued ASU 2011-02 to assist creditors with their determination of when a restructuring is a
Troubled Debt Restructuring (“TDR”). The determination is based on whether the restructuring constitutes a concession and
whether the debtor is experiencing financial difficulties as both events must be present. The new guidance was effective for
the Company beginning January 1, 2012 and did not have a material effect on the Company’s TDR determinations.
In April 2011, the criteria used to determine effective control of transferred assets in the Transfers and Servicing topic of the
ASC was amended by ASU 2011-03. The requirement for the transferor to have the ability to repurchase or redeem the
financial assets on substantially the agreed terms and the collateral maintenance implementation guidance related to that
criterion were removed from the assessment of effective control. The other criteria to assess effective control were not
changed. The amendments were effective for the Company on January 1, 2012 and did not have a material effect on the
financial statements.
ASU 2011-04 was issued in May 2011 to amend the Fair Value Measurement topic of the ASC by clarifying the application
of existing fair value measurement and disclosure requirements and by changing particular principles or requirements for
measuring fair value or for disclosing information about fair value measurements. The amendments were effective for the
Company beginning January 1, 2012 and did not have a material effect on the financial statements.
The Comprehensive Income topic of the ASC was amended in June 2011. The amendment eliminates the option to present
other comprehensive income as a part of the statement of changes in stockholders’ equity and requires consecutive
presentation of the statement of net income and other comprehensive income. The amendments were applicable to the
Company on January 1, 2012 and have been applied retrospectively. In December 2011, the topic was further amended to
defer the effective date of presenting reclassification adjustments from other comprehensive income to net income on the face
of the financial statements. Companies should continue to report reclassifications out of accumulated other comprehensive
income consistent with the presentation requirements in effect prior to the amendments while FASB finalizes it conclusions
regarding future requirements.
29
CAROLINA FINANCIAL CO RPORATI ON
FINANCIAL DISCUSSION
Recently Issued Accounting Pronouncements
The Balance Sheet topic of the ASC was amended in December 2011 for companies with financial instruments and derivative
instruments that offset or are subject to a master netting agreement. The amendments require disclosure of both gross
information and net information about instruments and transactions eligible for offset or subject to an agreement similar to a
master netting agreement. The amendments are effective for reporting periods beginning on or after January 1, 2013 and
must be provided retrospectively for all comparative periods presented. The Company does not expect these amendments to
have a material effect on its financial statements.
The FASB amended the Comprehensive Income topic of the ASC in February 2013. The amendments address reporting of
amounts reclassified out of accumulated other comprehensive income. Specifically, the amendments do not change the
current requirements for reporting net income of other comprehensive income in financial statements. However, the
amendments do require an entity to provide information about the amounts reclassified out of accumulated other
comprehensive income by component. In addition, in certain circumstances an entity is required to present, either on the fact
of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other
comprehensive income by the respective line items of net income. The amendments will be effective for the Company on a
prospective basis for reporting periods beginning after December 15, 2013. Earlier adoption is permitted. The Company
does not expect these amendments will have a material effect on its financial statements.
In February 2013 the FASB also amended the Financial Instruments topic of the ASC to address the scope and applicability
of certain disclosures to nonpublic companies. The amendments clarify that the requirement to disclose “the level of the fair
value hierarchy within the fair value measurements are categorized in their entirety (Level 1, 2, or 3)” does not apply to
nonpublic entities for items that are not measured at fair value in the statement of financial position but for which fair value is
disclosed. The Company does not expect these amendments to have a material effect on its financial statements.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected
to have a material impact on the Company’s financial position, results of operations or cash flows.
Effect of Inflation and Changing Prices
The consolidated financial statements have been prepared in accordance with generally accepted accounting principles that
require the measurement of financial position and results of operations in terms of historical dollars without consideration of
changes in the relative purchasing power over time due to inflation.
Unlike many other industries, nearly all assets and liabilities of a financial institution are monetary in nature. Therefore,
interest rates usually have a more significant impact on a financial institution’s performance than does the effect of inflation.
Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services since
such prices are affected by inflation. We are committed to continuing to actively manage the gap between our interest-
sensitive assets and interest-sensitive liabilities.
New Legislation
On July 21, 2010, the U.S. President signed into law the Dodd-Frank Act. The Dodd-Frank Act is intended to effect a
fundamental restructuring of federal banking regulation. Among other things, the Dodd-Frank Act created a new Financial
Stability Oversight Council to identify systemic risks in the financial system and gave federal regulators new authority to take
control of and liquidate financial firms. The Dodd-Frank Act also created a new independent federal regulator to administer
federal consumer protection laws. Many of the provisions of the Dodd-Frank Act have delayed effective dates and the
legislation requires various federal agencies to promulgate numerous and extensive implementing regulations over the next
several years. Although the substance and scope of these regulations cannot be completely determined at this time, it is
expected that the legislation and implementing regulations will increase the Company’s operating and compliance costs. The
following discussion summarizes certain significant aspects of the Dodd-Frank Act:
• The Dodd-Frank Act requires the Federal Reserve Board to apply consolidated capital requirements to depository
institution holding companies that are no less stringent than those currently applied to depository institutions. Under
these standards, trust preferred securities will be excluded from Tier 1 capital unless such securities were issued
30
CAROLINA FINANCIAL CO RPORATI ON
FINANCIAL DISCUSSION
prior to May 19, 2010 by a bank holding company with less than $15 billion in assets such as the Company. The
Dodd-Frank Act additionally requires capital requirements to be countercyclical so that the required amount of
capital increases in times of economic expansion and decreases in times of economic contraction, consistent with
safety and soundness.
• The Dodd-Frank Act permanently increased the maximum deposit insurance amount for financial institutions to
$250,000 per depositor, and extended unlimited deposit insurance to noninterest bearing transaction accounts
through December 31, 2012. The Dodd-Frank Act also broadened the base for FDIC insurance assessments.
Assessments are now based on the average consolidated total assets less tangible equity capital of a financial
institution. The Dodd-Frank Act required the FDIC to increase the reserve ratio of the Deposit Insurance Fund from
1.15% to 1.35% of insured deposits by 2020 and eliminated the requirement that the FDIC pay dividends to insured
depository institutions when the reserve ratio exceeds certain thresholds. Effective July 21, 2011, the Dodd-Frank
Act eliminated the federal statutory prohibition against the payment of interest on business checking accounts.
• The Dodd-Frank Act requires publicly traded companies to give shareholders a non-binding vote on executive
compensation at their first annual meeting taking place six months after the date of enactment and at least every
three years thereafter and on so−called “golden parachute” payments in connection with approvals of mergers and
acquisitions unless previously voted on by shareholders. The new legislation also authorizes the SEC to promulgate
rules that would allow shareholders to nominate their own candidates using a company’s proxy materials.
Additionally, the Dodd-Frank Act directs the federal banking regulators to promulgate rules prohibiting excessive
compensation paid to executives of depository institutions and their holding companies with assets in excess of $1.0
billion, regardless of whether the institution is publicly traded or not. The Dodd-Frank Act gives the SEC authority
to prohibit broker discretionary voting on elections of directors and executive compensation matters.
• Effective July 21, 2011, the Dodd-Frank Act prohibits a depository institution from converting from a state to
federal charter or vice versa while it is the subject of a cease and desist order or other formal enforcement action or a
memorandum of understanding with respect to a significant supervisory matter unless the appropriate federal
banking agency gives notice of the conversion to the federal or state authority that issued the enforcement action and
that agency does not object within 30 days. The notice must include a plan to address the significant supervisory
matter. The converting institution must also file a copy of the conversion application with its current federal
regulator which must notify the resulting federal regulator of any ongoing supervisory or investigative proceedings
that are likely to result in an enforcement action and provide access to all supervisory and investigative information
relating hereto.
• The Dodd-Frank Act authorizes national and state banks to establish branches in other states to the same extent as a
bank chartered by that state would be permitted to branch. Previously, banks could only establish branches in other
states if the host state expressly permitted out-of-state banks to establish branches in that state. Accordingly, banks
will be able to enter new markets more freely.
• Effective as of July 21, 2012, the Dodd-Frank Act expands the definition of affiliate for purposes of quantitative and
qualitative limitations of Section 23A of the Federal Reserve Act to include mutual funds advised by a depository
institution or its affiliates. The Dodd-Frank Act applies Section 23A and Section 22(h) of the Federal Reserve Act
(governing transactions with insiders) to derivative transactions, repurchase agreements and securities lending and
borrowing transaction that create credit exposure to an affiliate or an insider. Any such transactions with affiliates
must be fully secured. Historically, an exception has existed that exempts covered transactions between depository
institutions and their financial subsidiaries from the 10% of capital and surplus limitation set forth in Section 23A.
However, the Dodd-Frank Act eliminated this exception for covered transactions entered into after July 21, 2012.
Effective as of July 21, 2011, the Dodd-Frank Act also prohibits an insured depository institution from purchasing
an asset from or selling an asset to an insider unless the transaction is on market terms and, if representing more than
10% of capital, is approved in advance by the disinterested directors.
• The Dodd-Frank Act required that the amount of any interchange fee charged by a debit card issuer with respect to a
debit card transaction must be reasonable and proportional to the cost incurred by the issuer. Effective October 1,
2011, the Federal Reserve Board set new caps on interchange fees at $0.21 per transaction, plus an additional five
basis-point charge per transaction to help cover fraud losses. An additional $0.01 per transaction is allowed if
31
CAROLINA FINANCIAL CO RPORATI ON
FINANCIAL DISCUSSION
certain fraud-monitoring controls are in place. While the restrictions on interchange fees do not apply to banks that,
together with their affiliates, have assets of less than $10 billion, such as the Bank, the new restrictions could
negatively impact bank card services income for smaller banks if the reductions that are required of larger banks
cause industry-wide reduction of swipe fees.
• The Dodd-Frank Act creates a new, independent federal agency called the Consumer Financial Protection Bureau
(“CFPB”), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer
financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement
Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of
the Gramm-Leach-Bliley Act and certain other statutes. The CFPB will have examination and primary enforcement
authority with respect to depository institutions with $10 billion or more in assets. Depository institutions with less
than $10 billion in assets, such as the Bank, will be subject to rules promulgated by the CFPB but will continue to be
examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB will have
authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial
products. The Dodd-Frank Act also authorizes the CFPB to establish certain minimum standards for the origination
of residential mortgages, including a determination of the borrower’s ability to repay. Under the Dodd-Frank Act,
financial institutions may not make a residential mortgage loan unless they make a “reasonable and good faith
determination” that the consumer has a “reasonable ability” to repay the loan. In addition, the Dodd-Frank Act will
allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as
defined by the CFPB. On January 10, 2013, the CFPB published final rules to, among other things, define “qualified
mortgage” and specify the types of income and assets that may be considered in the ability-to-repay determination,
the permissible sources for verification, and the required methods of calculating the loan’s monthly payments. For
example, the rules extend the requirement that creditors verify and document a borrower’s “income and assets” to
include all “information” that creditors rely on in determining repayment ability. The rules also provide further
examples of third-party documents that may be relied on for such verification, such as government records and
check-cashing or funds-transfer service receipts. The new rules will take effect on January 10, 2014. The Dodd-
Frank Act also permits states to adopt consumer protection laws and standards that are more stringent than those
adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with
both the state and federal laws and regulations.
Management continues to review the provisions of the Dodd-Frank Act to assess its probable impact on our business,
financial condition, and results of operations.
From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as
by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies
and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation
could change banking statutes and the operating environment of the Company in substantial and unpredictable ways. If
enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect
the competitive balance among banks, savings associations, credit unions, and other financial institutions. The Company
cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing
regulations, would have on its financial condition or results of operations. A change in statutes, regulations or regulatory
policies applicable to the Company or the Bank could have a material effect on their business.
32
Independent Auditor's Report
The Board of Directors
Carolina Financial Corporation
Charleston, South Carolina
Report on the Financial Statements
We have audited the accompanying consolidated financial statements of Carolina Financial Corporation and its Subsidiaries (the
“Company”) which comprise the consolidated statements of financial condition as of December 31, 2012 and 2011, and the
related consolidated statements of operations, comprehensive income (loss), changes in stockholders’ equity and cash flows and
the related notes to the consolidated financial statements for each of the three years in the period ended December 31, 2012.
Management’s Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance
with accounting principles generally accepted in the United States of America; this includes the design, implementation, and
maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are
free from material misstatement, whether due to fraud or error.
Auditor’s Responsibility
Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our
audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of
material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial
statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material
misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the
auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial
statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing
an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes
evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by
management, as well as evaluating the overall presentation of the consolidated financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a reasonable basis for our audit
opinion.
Opinion
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial
position of Carolina Financial Corporation and its Subsidiaries as of December 31, 2012 and 2011, and the results of its operations
and its cash flows for each of the three years in the period ended December 31, 2012, in accordance with accounting principles
generally accepted in the United States of America.
Charleston, South Carolina
March 15, 2013
33
CAROLINA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2012 AND 2011
December 31,
2012
2011
ASSETS
Cash and due from banks
Interest-bearing cash
Cash and cash equivalents
Securities available for sale (cost of $145,774 at December 31, 2012 and
$140,312 at December 31, 2011)
Securities held to maturity (fair value of $5,549 at December 31, 2012 and
$2,773 at December 31, 2011)
Federal Home Loan Bank stock, at cost
Other investments
Derivative assets
Loans held for sale
Loans receivable, net of allowance for loan losses of $9,520 at December 31,
2012 and $12,039 at December 31, 2011
Premises and equipment, net
Accrued interest receivable
Real estate acquired through foreclosure, net
Deferred tax assets, net
Income taxes receivable
Prepaid FDIC insurance
M ortgage servicing rights
Other assets
Total assets
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Noninterest-bearing deposits
Interest-bearing deposits
Total deposits
Short-term borrowed funds
Long-term debt
Derivative liabilities
Drafts outstanding
Advances from borrowers for insurance and taxes
Accrued interest payable
Income taxes payable
M ortgage buy-back reserve
Accrued expenses and other liabilities
Total liabilities
Commitments and contingencies
Stockholders' equity:
Preferred stock, par value $.01; 200,000 shares authorized; no shares
issued or outstanding
Common stock, par value $.01; 6,800,000 shares authorized;
1,918,992 issued and outstanding at December 31, 2012 and 2011
Additional paid-in capital
Retained earnings, restricted
Accumulated other comprehensive loss, net of tax benefit
Total stockholders' equity
Total liabilities and stockholders' equity
See accompanying notes to consolidated financial statements.
34
$
(In thousands)
6,499
11,340
17,839
4,109
16,679
20,788
149,670
136,944
9,166
6,413
465
6,542
144,849
501,691
16,397
3,203
6,284
6,782
-
2,035
12,039
5,349
888,724
$
$
82,004
571,243
653,247
82,482
64,840
-
3,010
613
1,599
3,459
4,882
7,078
821,210
9,401
7,185
465
4,000
80,007
513,335
16,078
3,086
6,097
8,940
6,202
3,035
6,452
4,203
826,218
62,906
558,897
621,803
63,484
80,390
1,234
4,516
509
1,371
-
3,623
3,633
780,563
-
-
19
22,068
45,752
(325)
67,514
888,724
$
19
21,982
28,874
(5,220)
45,655
826,218
CAROLINA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010
Interest income
Loans
Debt securities
Dividends
Interest-bearing cash
Total interest income
Interest expense
Deposits
Short-term borrowed funds
Long-term debt
Total interest expense
Net interest income
Provision for loan losses
Net interest income (loss) after provision for loan losses
Noninterest income
Net gain on sale of loans held for sale
Deposit service charges
Income from ATM and debit card transactions
Income from sales of non-depository products
Net loss on extinguishment of debt
Net (loss) gain on sale of securities
Other-than-temporary impairment of securities
Net loss on sale of real estate acquired through foreclosure
Net unrealized gain on derivatives
Net gain on sale of servicing assets
Other
Total noninterest income
Noninterest expense
Salaries and employee benefits
Occupancy and equipment
M arketing and public relations
FDIC insurance
Expense from ATM and debit card transactions
Other real estate expense
Provision for mortgage loan repurchase losses
Legal expense
Other
Total noninterest expense
Income (loss) before income taxes
Income tax expense (benefit)
Net income (loss)
Earnings (loss) per common share:
Basic
Diluted
Average common shares outstanding:
Basic
Diluted
See accompanying notes to consolidated financial statements.
35
For the Years Ended December 31,
2012
2010
2011
(In thousands, except share data)
$
30,074
5,136
107
41
35,358
4,178
640
2,695
7,513
27,845
2,707
25,138
48,987
1,604
766
-
(1,591)
(3,031)
(913)
(227)
3,776
-
2,913
52,284
25,632
3,274
1,360
1,076
453
1,646
2,189
1,978
12,541
50,149
27,273
10,395
16,878
$
$
8.80
$
8.80
31,790
6,518
81
52
38,441
6,578
1,045
3,490
11,113
27,328
10,735
16,593
17,340
1,610
574
624
(1,061)
306
(1,753)
(1,037)
714
299
2,105
19,721
19,981
3,200
479
1,389
450
2,425
785
1,602
7,102
37,413
(1,099)
(128)
(971)
(0.51)
(0.51)
37,367
9,364
42
69
46,842
11,850
708
4,519
17,077
29,765
30,755
(990)
23,481
1,765
377
884
(2,536)
(1,955)
(2,480)
(108)
601
526
1,045
21,600
20,594
3,439
630
1,798
360
1,725
2,627
1,322
6,575
39,070
(18,460)
(5,872)
(12,588)
(6.58)
(6.58)
1,918,992
1,918,992
1,918,992
1,918,992
1,913,240
1,913,240
CAROLINA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) AND
CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
For the Years Ended December 31,
2012
2011
2010
(In thousands)
Net income
$
16,878
(971)
(12,588)
Other comprehensive income, net of tax:
Unrealized gain on securities, net of tax of $1,708, $41 and $766 for the
years ended December 31, 2012, 2011 and 2010, respectively
Reclassification adjustment for losses (gains) included in earnings, net
of tax of $1,106, $(104) and $713 for the years ended
December 31, 2012, 2011 and 2010, respectively
Other comprehensive income (loss), net of tax
2,970
63
1,311
1,925
4,895
(202)
(139)
1,242
2,553
Comprehensive income (loss)
$
21,773
(1,110)
(10,035)
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Common Stock
Shares
Amount
Additional
Paid-in
Capital
Accumulated
Other
Retained Comprehensive
Income (Loss)
Earnings
Total
(In thousands, except share data)
Balance, December 31, 2009
Restricted stock awards
Stock-based compensation expense, net
Net loss
Other comprehensive income, net of tax
Balance, December 31, 2010
Stock-based compensation expense, net
Net loss
Other comprehensive loss, net of tax
Balance, December 31, 2011
Stock-based compensation expense, net
Net income
Other comprehensive income, net of tax
1,912,492
6,500
-
-
19
$
-
-
-
1,918,992
-
-
1,918,992
-
-
19
-
-
19
-
-
21,320
-
391
-
21,711
271
-
21,982
86
-
42,433
-
-
(12,588)
29,845
-
(971)
28,874
-
16,878
Balance, December 31, 2012
1,918,992
$
19
22,068
45,752
(7,634)
-
-
-
2,553
(5,081)
-
-
(139)
(5,220)
-
-
4,895
(325)
56,138
-
391
(12,588)
2,553
46,494
271
(971)
(139)
45,655
86
16,878
4,895
67,514
See accompanying notes to consolidated financial statements.
36
CAROLINA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010
Cash flows from operating activities:
Net income (loss)
Adjustments to reconcile net income (loss) to net cash
provided by (used for) operating activities:
Provision for loan losses
Deferred tax expense (benefit)
Amortization of unearned discount/premiums on investments, net
Amortization of deferred loan fees
Amortization of mortgage servicing rights
Loss (gain) on sale of available for sale securities, net
Gain on sale of loans held for sale, net
Originations of loans held for sale
Proceeds from sale of loans held for sale
Loss on extinquishment of debt
M ortgage loan buyback provision
M ortgage loan losses paid, net of recoveries
Gain on derivatives, net
Stock-based compensation
Depreciation
Loss on disposals of premises and equipment
Loss on sale of real estate acquired through foreclosure
Write-down of real estate acquired through foreclosure
Gain on sale of servicing assets
Proceeds from the sale of servicing assets
Originations of mortgage servicing assets
Decrease (increase) in:
Accrued interest receivable
Income taxes receivable
Prepaid FDIC insurance
Other assets
Increase (decrease) in:
Accrued interest payable
Income taxes payable
Accrued expenses and other liabilities
Cash flows provided by (used in) operating activities
For the Years Ended December 31,
2011
2012
2010
(In thousands)
$
16,878
(971)
(12,588)
2,707
(657)
1,361
(5,328)
1,464
3,031
(48,987)
(2,313,236)
2,297,381
1,591
2,189
(930)
(3,776)
86
833
11
227
1,049
-
-
10,735
1,233
1,291
(3,367)
1,036
(306)
(17,340)
(1,352,873)
1,372,821
1,061
785
(2,438)
(714)
271
856
55
1,037
1,966
(299)
1,043
30,755
(1,470)
1,348
(3,904)
651
1,955
(23,481)
(1,652,257)
1,667,033
2,536
2,627
(382)
(601)
391
1,290
3
108
2,063
(526)
1,810
(7,051)
(2,983)
(5,387)
(117)
5,789
1,000
(1,146)
228
3,459
3,445
(38,499)
397
(782)
1,126
3,475
432
-
219
17,766
1,067
(6,416)
1,516
(4,149)
(545)
-
(955)
2,492
37
Continued
CAROLINA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010
Cash flows from investing activities:
Activity in available-for-sale securities:
Purchases
M aturities, payments and calls
Proceeds from sales
Activity in held-to-maturity securities-
M aturities, payments and calls
(Increase) decrease in Federal Home Loan Bank stock
Decrease in loans receivable, net
Purchase of premises and equipment
Proceeds from disposals of premises and equipment
Proceeds from sale of real estate acquired through foreclosure
Cash flows provided by investing activities
Cash flows from financing activities:
Net increase (decrease) in deposit accounts
Net decrease in Federal Home Loan Bank advances
Net decrease in other short-term borrowed funds
Principal repayment of subordinated debt
Net increase in drafts outstanding
Net increase in advances from borrowers for insurance and taxes
Cash flows used in financing activities
Cash and cash equivalents, beginning of year
Cash and cash equivalents, end of year
Supplemental disclosure
Cash paid for:
Interest on deposits and borrowed funds
Income taxes paid, net of (refunds)
For the Years Ended December 31,
2010
2011
2012
(In thousands)
$
(79,907)
42,618
27,735
794
772
4,858
(1,182)
19
7,944
3,651
31,444
23,409
(21,252)
(300)
(1,506)
104
31,899
(2,949)
20,788
17,839
$
(36,655)
44,052
5,572
1,357
3,944
53,283
(181)
-
11,725
83,097
(68,011)
(36,560)
(1,425)
(300)
1,371
113
(104,812)
(3,949)
24,737
20,788
(83,078)
41,887
88,898
21,633
1,327
65,695
(736)
78
5,813
141,517
(71,294)
(53,536)
(15,103)
(225)
28
198
(139,932)
4,077
20,660
24,737
$
7,285
1,424
10,681
(810)
17,622
2,014
Non-cash investing and financing activities:
Other-than-temporary impairment reflected through accumulated
other comprehensive income
87
685
1,685
Other-than-temporary impairment reflected through the statement
of operations
Transfer of loans receivable to real estate acquired through foreclosure
Transfer of held to maturity securities to available for sale securities
Unrealized gain in securities available for sale, net
913
9,407
-
2,970
1,753
10,009
-
63
2,480
10,947
91,512
1,311
See accompanying notes to consolidated financial statements.
38
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Carolina Financial Corporation (“Carolina Financial” or the “Company”), incorporated under the laws of the State of Delaware, is
a bank holding company with two wholly-owned subsidiaries, CresCom Bank (the “Bank”) and Carolina Services Corporation of
Charleston (“Carolina Services”). Effective July 31, 2011, Carolina Financial combined its wholly-owned subsidiary bank,
Community FirstBank of Charleston (“Community FirstBank”), with and into its other wholly-owned subsidiary bank, Crescent
Bank. In conjunction with this internal reorganization, Crescent Bank’s name was changed to CresCom Bank. Crescent Mortgage
Company (“Crescent Mortgage”), formerly a wholly-owned subsidiary of Community FirstBank, became a wholly-owned
subsidiary of CresCom Bank. The consolidated financial statements include the accounts of the Company and its wholly-owned
subsidiaries, CresCom Bank and Carolina Services. In consolidation, all material intercompany accounts and transactions have
been eliminated. The results of operations of the businesses acquired in transactions accounted for as purchases are included only
from the dates of acquisition. All majority-owned subsidiaries are consolidated unless control is temporary or does not rest with
the Company.
At December 31, 2012, 2011 and 2010, statutory business trusts (“Trusts”) created by the Company had outstanding trust preferred
securities with an aggregate par value of $15,000,000. The principal assets of the Trusts are $15,465,000 of the Company’s
subordinated debentures with identical rates of interest and maturities as the trust preferred securities. The Trusts have issued
$465,000 of common securities to the Company and are included in other investments in the accompanying consolidated balance
sheets. The Trusts are not consolidated subsidiaries of the Company.
Management’s Estimates
The financial statements are prepared in accordance with generally accepted accounting principles in the United States of America
which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and
expenses during the reporting periods. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the
allowance for loan losses, including valuation for impaired loans, the valuation of real estate acquired in connection with
foreclosure or in satisfaction of loans, the valuation of securities, the valuation of derivative instruments, the valuation of mortgage
servicing rights, the determination of the reserve for mortgage loan repurchase losses, asserted and unasserted legal claims and
deferred tax assets or liabilities. In connection with the determination of the allowance for loan losses and foreclosed real estate,
management obtains independent appraisals for significant properties. Management must also make estimates in determining the
estimated useful lives and methods for depreciating premises and equipment.
Management uses available information to recognize losses on loans and foreclosed real estate. However, future additions to the
allowance may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of
their examination process, periodically review the Bank’s allowances for loan losses and foreclosed real estate. Such agencies
may require the Bank to recognize additions to the allowances based on their judgments about information available to them at the
time of their examination. Because of these factors, it is reasonably possible that the allowances for loan losses and foreclosed real
estate may change materially in the near term.
Subsequent Events
Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued.
Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date
of the balance sheet, including the estimates inherent in the process of preparing financial statements. Non-recognized subsequent
events are events that provide evidence about conditions that did not exist at the date of the statement of financial condition but
arose after that date. Management has reviewed events occurring through March 15, 2013, the date the financial statements were
available to be issued and no subsequent events occurred requiring accrual or disclosure.
Cash and Cash Equivalents
Cash and cash equivalents consists of cash and due from banks and interest-bearing cash with banks. Substantially all of the
interest-bearing cash at December 31, 2012 and 2011 is Federal Reserve Bank and Federal Home Loan Bank overnight deposits.
Cash and cash equivalents have maturities of three months or less. Accordingly, the carrying amount of such instruments is
considered a reasonable estimate of fair value. The Bank is required to maintain average balances on hand or with the Federal
39
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
Reserve Bank. At December 31, 2012 and 2011, these reserve balances amounted to $4.7 million and $1.9 million, respectively.
In addition, the mortgage company is required to keep $1.0 million in cash related to its warehouse line of credit.
Securities
Investment securities are classified into three categories: (a) Held to Maturity – debt securities that the Company has positive
intent and ability to hold to maturity, which are reported at amortized cost; (b) Trading – debt and equity securities that are bought
and held principally for the purpose of selling them in the near term, which are reported at fair value, with unrealized gains and
losses included in earnings; and (c) Available for Sale – debt and equity securities that may be sold under certain conditions, which
are reported at fair value, with unrealized gains and losses excluded from earnings and reported in accumulated other
comprehensive income.
The Company determines investment and mortgage-backed securities classification at the time of purchase. If a security is
transferred from available for sale to held to maturity, the fair value at the time of transfer becomes the held to maturity security’s
new cost basis. Premiums and discounts on securities are accreted and amortized as an adjustment to interest yield over the
estimated life of the security using a method which approximates a level yield. Dividends and interest income are recognized
when earned. Unrealized losses on securities, reflecting a decline in value judged by the Company to be other-than-temporary, are
charged to income in the consolidated statements of operations.
The cost basis of securities sold is determined by specific identification. Purchases and sales of securities are recorded on a trade
date basis.
Loans Held for Sale
The Company’s residential mortgage lending activities for sale in the secondary market are comprised of accepting residential
mortgage loan applications, qualifying borrowers to standards established by investors, funding residential mortgage loans and
selling mortgage loans to investors under pre-existing commitments. Funded residential mortgages held for sale to investors are
reported at the lower of aggregate cost or estimated fair value. Net unrealized losses, if any, are recognized in a valuation
allowance by charges to operations. Gains or losses realized on the sales of loans are recognized at the time of sale and are
determined by the difference between the net sales proceeds and the carrying value of the loans sold, adjusted for any servicing
asset or liability retained. Gains and losses on sales of loans are included in noninterest income.
The Company issues rate lock commitments to borrowers on prices quoted by secondary market investors. Derivatives related to
these commitments are recorded as either assets or liabilities in the balance sheet and are measured at fair value. Changes in the
fair value of the derivatives are reported in current earnings or other comprehensive income depending on the purpose for which
the derivative is held and whether the derivative qualifies for hedge accounting. The Company does not currently engage in any
activities that qualify for hedge accounting. Accordingly, changes in fair values of these derivative instruments are included in
noninterest income in the consolidated statements of operations.
Loans Receivable, Net
Loans that management has the intent and ability to hold for the foreseeable future are reported at their outstanding principal
balances net of any unearned income, charge-offs, deferred fees or costs on originated loans and unamortized premiums or
discounts on purchased loans. The net amount of nonrefundable loan origination fees, commitment fees and certain direct costs
associated with the lending process are deferred and amortized to interest income over the contractual lives of the loans using
methods that approximate a level yield or noninterest income when the loan is sold. Discounts and premiums on purchased loans
are amortized to interest income over the estimated life of the loans using methods that approximate a level yield, or noninterest
income when the loan is sold. Commercial loans and substantially all installment loans accrue interest on the unpaid balance of the
loans.
A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all
amounts due according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of
expected future cash flows discounted at the loan’s effective interest rate, or as a practical expedient, at the loan’s observable
market price or the fair value of the collateral if the loan is collateral-dependent. When the fair value of the impaired loan is less
than the recorded investment in the loan, the impairment is recorded through a specific reserve allocation that is a component of
the allowance for loan losses. A loan is charged-off against the allowance for loan losses when all meaningful collection efforts
have been exhausted and the loan is viewed as uncollectible in the immediate or foreseeable future.
40
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
Troubled Debt Restructurings (“TDRs”)
The Company designates loan modifications as TDRs when, for economic or legal reasons related to the borrower’s financial
difficulties, it grants a concession to the borrower that it would not otherwise consider. Loans on nonaccrual status at the date of
modification are initially classified as nonaccrual TDRs. Loans on accruing status at the date of modification are initially
classified as accruing TDRs at the date of modification, if the note is reasonably assured of repayment and performance is in
accordance with its modified terms. Such loans may be designated as nonaccrual loans subsequent to the modification date if
reasonable doubt exists as to the collection of interest or principal under the restructuring agreement. Nonaccrual TDRs are
returned to accrual status when there is economic substance to the restructuring, there is well documented credit evaluation of the
borrower’s financial condition, the remaining balance is reasonably assured of repayment in accordance with its modified terms,
and the borrower has demonstrated repayment performance in accordance with the modified terms for a reasonable period of time
(generally a minimum of six months).
Mortgage Servicing Rights, Fees and Costs
The Company initially measures servicing assets and liabilities retained related to the sale of residential loans held for sale
(“mortgage servicing rights”) at fair value, if practicable. For subsequent measurement purposes, the Company measures servicing
assets and liabilities based on the lower of cost or market.
Mortgage servicing rights are amortized in proportion to, and over the period of, estimated net servicing income. The amortization
of the mortgage servicing rights is analyzed periodically and is adjusted to reflect changes in prepayment rates and other estimates.
The Company evaluates potential impairment of mortgage servicing rights based on the difference between the carrying amount
and current estimated fair value of the servicing rights. In determining impairment, the Company aggregates all servicing rights
and stratifies them into tranches based on predominant risk characteristics. If impairment exists, a valuation allowance is
established for any excess of amortized cost over the current estimated fair value by a charge to income. If the Company later
determines that all or a portion of the impairment no longer exists for a particular tranche, a reduction of the allowance may be
recorded as an increase to income.
Service fee income is recorded for fees earned for servicing mortgage loans under servicing agreements with the Federal National
Mortgage Association (“FNMA”), the Federal Home Loan Mortgage Corporation (“FHLMC”), Government National Mortgage
Association (“GNMA”) and certain private investors. The fees are based on a contractual percentage of the outstanding principal
balance of the loans serviced and are recorded as income when received. The amortization of mortgage servicing rights is netted
against loan servicing fee income. Mortgage servicing costs are charged to expense when incurred. Service fee income, net of
amortization and servicing costs, is recorded in other income.
Nonperforming Assets
Nonperforming assets include loans on which interest is not being accrued, accruing loans that are 90 days or more delinquent and
foreclosed property. Foreclosed property consists of real estate and other assets acquired as a result of a borrower’s loan default.
Loans are generally placed on nonaccrual status when concern exists that principal or interest is not fully collectible, or when any
portion of principal or interest becomes 90 days past due, whichever occurs first. Loans past due 90 days or more may remain on
accrual status if management determines that concern over the collectability of principal and interest is not significant. When loans
are placed on nonaccrual status, interest receivable is reversed against interest income in the current period. Interest payments
received thereafter are applied as a reduction to the remaining principal balance as long as concern exists as to the ultimate
collection of the principal. Loans are removed from nonaccrual status when they become current as to both principal and interest
and when concern no longer exists as to the collectability of principal or interest.
Assets acquired as a result of foreclosure are initially recorded at fair value less estimated selling costs at the date of foreclosure,
establishing a new cost basis. Subsequent to foreclosure, such properties are generally appraised annually, and the carrying value,
if greater than the fair value less estimated selling costs, is adjusted with a charge to noninterest expense. Routine maintenance
costs and declines in market value are included in noninterest expense. Net gains or losses on sale are included in noninterest
income.
Allowance for Loan Losses
The allowance for loan losses is Management’s estimate of probable credit losses inherent in the loan portfolio at the balance sheet
date. Management determines the allowance based on an ongoing evaluation. This evaluation is inherently subjective because it
requires material estimates and is based on evaluations of the collectability of loans. Impaired loans, including nonaccrual loans,
loans past due 90 or more days and still accruing, troubled-debt restructured loans, and loans in excess of a defined threshold that
41
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
are not paying in accordance with contractual terms, are evaluated for specific impairment. The specific reserves are determined on
a loan-by-loan basis based on Management’s evaluation of the Company’s exposure for each credit, given the current payment
status of the loan and the value of any underlying collateral. Management’s estimate of losses in the remainder of the portfolio is
based on certain observable data that Management believes are most reflective of the underlying credit losses being estimated.
This evaluation includes credit quality trends; collateral values; portfolio aging; loan volumes; geographic, borrower and industry
concentrations; seasoning of the loan portfolio; the findings of internal credit quality assessments and results from external bank
regulatory examinations.
While Management uses the best information available to establish the allowance for loan losses, future adjustments to the
allowance may be necessary if economic conditions differ substantially from the assumptions used in making the valuations or, if
required by regulators, based upon information available to them at the time of their examinations. Such adjustments to original
estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels
may vary from previous estimates.
Guarantees
Standby letters of credit obligate the Company to meet certain financial obligations of its customers, under the contractual terms of
the agreement, if the customers are unable to do so. Payment is only guaranteed under these letters of credit upon the borrower’s
failure to perform its obligations to the beneficiary. The Company can seek recovery of the amounts paid from the borrower;
however, these standby letters of credit are generally not collateralized. Commitments under standby letters of credit are usually
one year or less. At December 31, 2012 the Company had recorded no liability for the current carrying amount of the obligation to
perform as a guarantor; as such amounts are not considered material. The maximum potential amount of undiscounted future
payments related to standby letters of credit at December 31, 2012 was $396,000.
Premises and Equipment, Net
Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method
over the asset’s estimated useful life. Estimated lives range up to forty years for buildings and improvements and up to ten years
for furniture, fixtures and equipment. Maintenance and repairs are charged to expense as incurred. Improvements that extend the
lives of the respective assets are capitalized. When property or equipment is sold or otherwise disposed of, the cost and related
accumulated depreciation are removed from the respective accounts and the resulting gain or loss is reflected in income.
Advertising
The Company expenses advertising costs as incurred. These expenses are reflected as marketing and public relations in the
accompanying consolidated statements of operations.
Income Taxes
The provision for income taxes is based upon income or loss before taxes for financial statement purposes, adjusted for nontaxable
income and nondeductible expenses. Deferred income taxes have been provided when different accounting methods have been
used in determining income for income tax purposes and for financial reporting purposes. Deferred tax assets and liabilities are
recognized based on future tax consequences attributable to differences arising from the financial statement carrying values of
assets and liabilities and their tax bases. In the event of changes in the tax laws, deferred tax assets and liabilities are adjusted in
the period of the enactment of those changes, with the cumulative effects included in the current year’s income tax provision.
Positions taken by the Company’s tax returns may be subject to challenge by the taxing authorities upon examination. The
benefits of uncertain tax positions are initially recognized in the financial statements only when it is more likely than not the
position will be sustained upon examination by the tax authorities. Such tax positions are both initially and subsequently measured
as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement with the tax authority,
assuming full knowledge of the position and all relevant facts. The Company believes that its income tax filing positions taken or
expected to be taken in its tax returns will more likely than not be sustained upon audit by the taxing authorities and does not
anticipate any adjustments that will result in a material adverse impact on the Company’s financial condition, results of operations,
or cash flow. Therefore, no reserves for uncertain tax positions have been recorded. The Company’s federal income tax returns
were examined for the years 2008 through 2010. No changes were proposed.
Interest and penalties on income tax uncertainties are classified within income tax expense in the statement of operations. The
Company paid $1,000 of penalties and $400 interest during fiscal 2012. The Company paid $7,000 of penalties and no interest
during fiscal 2011. The Company had no interest or penalties during fiscal 2010.
42
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
It is management’s belief that the realization of the remaining net deferred tax assets is more likely than not. Accordingly, no
reserve was considered necessary.
Drafts Outstanding
The Company invests excess funds on deposit at other banks (including amounts on deposit for payment of outstanding
disbursement checks) on a daily basis in an overnight interest-bearing account. Accordingly, outstanding checks are reported as a
liability.
Reserve for Mortgage Loan Repurchase Losses
The Company sells mortgage loans to various third parties, including government-sponsored entities, under contractual provisions
that include various representations and warranties that typically cover ownership of the loan, compliance with loan criteria set
forth in the applicable agreement, validity of the lien securing the loan, absence of delinquent taxes or liens against the property
securing the loan, and similar matters. The Company may be required to repurchase the mortgage loans with identified defects,
indemnify the investor or insurer, or reimburse the investor for credit loss incurred on the loan (collectively “repurchase”) in the
event of a material breach of such contractual representations or warranties. Risk associated with potential repurchases or other
forms of settlement is managed through underwriting and quality assurance practices and by servicing mortgage loans to meet
investor and secondary market standards.
The Company establishes mortgage repurchase reserves related to various representations and warranties that reflect
management’s estimate of losses based on a combination of factors. Such factors incorporate estimated levels of defects on
internal quality assurance, default expectations, historical investor repurchase demand and appeals success rates, reimbursement by
correspondent and other third party originators, and projected loss severity. The Company establishes a reserve at the time loans
are sold and continually updates the reserve estimate during the estimated loan life. The reserve for repurchases was $4.9 million
and $3.6 million at December 31, 2012 and 2011, respectively. For the years ended December 31, 2012, 2011 and 2010, the
Company recorded mortgage repurchase reserve expense of $2.2 million, $785,000 and $2.6 million, respectively. The expense is
reflected in noninterest expense in the accompanying consolidated statements of operations. In addition, the Company incurred
mortgage repurchase losses, net of recoveries, for the years ended December 31, 2012, 2011 and 2010 of $930,000, $2.4 million
and $383,000, respectively. To the extent that economic conditions and the housing market do not recover or future investor
repurchase demand and appeals success rates differ from past experience, the Company could continue to have increased demands
and increased loss severities on repurchases, causing future additions to the repurchase reserve.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over
transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains
the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and
(3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before
their maturity.
Comprehensive Income (Loss)
Comprehensive income (loss) consists of net income or loss and net unrealized gains (losses) on securities and is presented in the
consolidated statements of comprehensive income (loss). The Company’s other comprehensive income (loss) for the years ended
December 31, 2012, 2011 and 2010 and accumulated other comprehensive income (loss) as of December 31, 2012 and 2011 are
comprised solely of unrealized gains (losses) on certain investment securities.
Off-Balance-Sheet Financial Instruments
In the ordinary course of business, the Company entered into off-balance-sheet financial instruments consisting of commitments to
extend credit, commitments under revolving credit agreements, and standby letters of credit. Such financial instruments are
recorded in the financial statements when they are funded.
Stock-Based Compensation
At December 31, 2012 and 2011, the Company had two stock-based payment plans for directors, officers and other key
employees, which are described below.
When share options are issued, the fair value at the date of grant of the stock option is estimated using the Black-Scholes option-
pricing model based on certain assumptions. The dividend yield is based on estimated future dividend yields. The risk-free rate for
periods within the contractual term of the share option is based on the U.S. Treasury yield curve in effect at the time of grant.
43
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
Expected volatilities are generally based on historical volatilities. The expected term of share options granted is generally derived
from historical experience. Compensation expense is recognized on a straight-line basis over the stock option vesting period. There
were no options issued during fiscal 2012 and 2011.
The Company adopted the 2006 Recognition and Retention Plan under which an aggregate of 60,000 shares of common stock have
been reserved for issuance by the Company. The plan provides for the grant of stock to key employees and Directors of the
Company and its subsidiaries. The non-vested common stock vests ratably over a five-year period. During 2010, 6,500 shares of
non-vested restricted common stock of the Company were granted to employees and non-employees of the Company at $8.11 per
share. No restricted common stock of the Company was granted during fiscal 2012 and 2011. As of December 31, 2012, a total of
56,500 shares have been awarded under the plan, of which 50,600 shares have vested and 5,900 shares are unvested.
Additionally, the Company has adopted the 2002 Stock Option Plan under which an aggregate of 138,750 shares have been
reserved for issuance by the Company upon the grant of stock options or limited rights, of which 8,240 are outstanding. The plan
provided for the grant of options to key employees and Directors as determined by the Board of Directors. No additional options
can be awarded under this plan. The options vest ratably over a five-year period and have a ten-year term, both of which begin at
the date of grant.
The expense recognition of employee stock option and restricted stock awards resulted in net expense of approximately $86,000,
$271,000 and $391,000 during the twelve months ended December 31, 2012, 2011 and 2010, respectively.
A summary of the status of the Company’s stock option plans at December 31, 2012, 2011 and 2010 and changes during the years
then ended is presented below:
At and For the Year Ended December 31,
2011
2012
2010
Weighted
Average
Exercise
Price
$
15.63
-
-
(15.00)
23.29
$
S hares
140,480
-
-
(132,240)
8,240
Weighted
Average
Exercise
Price
$
15.83
-
-
(22.22)
15.63
$
Shares
144,980
-
-
(4,500)
140,480
Weighted
Average
Exercise
Price
$
15.83
-
-
-
15.83
$
Shares
144,980
-
-
-
144,980
Outstanding at beginning of year
Granted
Exercised
Forfeited or expired
Outstanding at end of year
Options exercisable at end of year
8,240
$
23.29
140,480
$
15.63
144,570
$
15.77
The following table summarizes information about the options outstanding at December 31, 2012:
At December 31, 2012
Options Outstanding
Weighted Avg.
Remaining Years
Weighted
Average
Options Exercisable
Number
Weighted
Average
Number
Range of Exercise Prices
$ 15.00 to $20.00
$ 20.01 to $25.00
$ 35.00 to $40.00
Outstanding Contractual Life Exercise Price Outstanding Exercise Price
20.00
$
24.00
38.50
23.29
4,000
3,540
700
8,240
4,000
3,540
700
8,240
20.00
24.00
38.50
23.29
1.3
2.5
3.8
2.0
$
$
$
There were no options granted during the years ended December 31, 2012, 2011 and 2010. No stock options were exercised
during the year ended December 31, 2012. Fair values have been retroactively restated for all stock dividends since the date the
option was granted. As of December 31, 2012, there was approximately $55,000 of total unrecognized compensation cost related
to non-vested share-based compensation arrangements. Unrecognized cost is projected to be recognized over a weighted average
44
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
period of approximately one year. The Company generally issues authorized but previously unissued shares to satisfy option
exercises.
Reclassification
Certain reclassifications of accounts reported for previous periods have been made in these consolidated financial statements.
Such reclassifications had no effect on stockholders’ equity or the net income (loss) as previously reported.
Recently Adopted Accounting Pronouncements
The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and disclosure of
financial information by the Company.
In April 2011 the FASB issued ASU 2011-02 to assist creditors with their determination of when a restructuring is a Troubled
Debt Restructuring (“TDR”). The determination is based on whether the restructuring constitutes a concession and whether the
debtor is experiencing financial difficulties as both events must be present. The new guidance was effective for the Company
beginning January 1, 2012 and did not have a material effect on the Company’s TDR determinations.
In April 2011, the criteria used to determine effective control of transferred assets in the Transfers and Servicing topic of the ASC
was amended by ASU 2011-03. The requirement for the transferor to have the ability to repurchase or redeem the financial assets
on substantially the agreed terms and the collateral maintenance implementation guidance related to that criterion were removed
from the assessment of effective control. The other criteria to assess effective control were not changed. The amendments were
effective for the Company on January 1, 2012 and did not have a material effect on the financial statements.
ASU 2011-04 was issued in May 2011 to amend the Fair Value Measurement topic of the ASC by clarifying the application of
existing fair value measurement and disclosure requirements and by changing particular principles or requirements for measuring
fair value or for disclosing information about fair value measurements. The amendments were effective for the Company
beginning January 1, 2012 and did not have a material effect on the financial statements.
The Comprehensive Income topic of the ASC was amended in June 2011. The amendment eliminates the option to present other
comprehensive income as a part of the statement of changes in stockholders’ equity and requires consecutive presentation of the
statement of net income and other comprehensive income. The amendments were applicable to the Company on January 1, 2012
and have been applied retrospectively. In December 2011, the topic was further amended to defer the effective date of presenting
reclassification adjustments from other comprehensive income to net income on the face of the financial statements. Companies
should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation
requirements in effect prior to the amendments while FASB finalizes it conclusions regarding future requirements.
Recently Issued Accounting Pronouncements
The Balance Sheet topic of the ASC was amended in December 2011 for companies with financial instruments are derivative
instruments that offset or are subject to a master netting agreement. The amendments require disclosure of both gross information
and net information about instruments and transactions eligible for offset or subject to an agreement similar to a master netting
agreement. The amendments are effective for reporting periods beginning on or after January 1, 2013 and must be provided
retrospectively for all comparative periods presented. The Company does not expect these amendments to have a material effect
on its financial statements.
The FASB amended the Comprehensive Income topic of the ASC in February 2013. The amendments address reporting of
amounts reclassified out of accumulated other comprehensive income. Specifically, the amendments do not change the current
requirements for reporting net income of other comprehensive income in financial statements. However, the amendments do
require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by
component. In addition, in certain circumstances an entity is required to present, either on the fact of the statement where net
income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the
respective line items of net income. The amendments will be effective for the Company on a prospective basis for reporting
periods beginning after December 15, 2013. Earlier adoption is permitted. The Company does not expect these amendments will
have a material effect on its financial statements.
In February 2013 the FASB also amended the Financial Instruments topic of the ASC to address the scope and applicability of
certain disclosures to nonpublic companies. The amendments clarify that the requirement to disclose “the level of the fair value
hierarchy within the fair value measurements are categorized in their entirety (Level 1, 2, or 3)” does not apply to nonpublic
45
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
entities for items that are not measured at fair value in the statement of financial position but for which fair value is disclosed. The
Company does not expect these amendments to have a material effect on its financial statements.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to
have a material impact on the Company’s financial position, results of operations or cash flows.
Risks and Uncertainties
In the normal course of its business, the Company encounters two significant types of risks: economic and regulatory. There are
three main components of economic risk: interest rate risk, credit risk, and market risk. The Company is subject to interest rate
risk to the degree that its interest-bearing liabilities mature or re-price at different speeds, or on a different basis, than its interest-
earning assets. Credit risk is the risk of default on the loan portfolio or certain securities that results from borrowers’ inability or
unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans
receivable and the valuation of real estate held by the Company. The Company is subject to the regulations of various
governmental agencies. These regulations can and do change significantly from period to period. Periodic examinations by the
regulatory agencies may subject the Company to further changes with respect to asset valuations, amounts of required loss
allowances and operating restrictions from the regulators’ judgments based on information available to them at the time of their
examination.
NOTE 2 - SECURITIES
The amortized cost, gross unrealized gains, gross unrealized losses and fair value of investments securities available for sale and
held to maturity at December 31, 2012 and 2011 follows:
2012
2011
At December 31,
Gross
Amortized Unrealized Unrealized
Gains
Losses
Gross
Cost
Fair
Value
Gross
Amortized Unrealized Unrealized
Gains
Losses
Gross
Cost
Securities available-for-sale:
M unicipal securities
GNM A
M ortgage-backed securities
Total securities
$
17,630
22,188
105,956
252
823
3,025
(In thousands)
17,769
23,011
108,890
1,118
22,857
116,337
(113)
-
(91)
19
1,136
2,646
-
(2)
(7,167)
Fair
Value
1,137
23,991
111,816
available for sale
$
145,774
4,100
(204)
149,670
140,312
3,801
(7,169)
136,944
Securities held-to-maturity:
Asset-backed securities
Total securities held
to maturity
$
9,166
$
9,166
580
580
(4,197)
5,549
9,401
(4,197)
5,549
9,401
-
-
(6,628)
2,773
(6,628)
2,773
46
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
The amortized cost and fair value of debt securities by contractual maturity at December 31, 2012 follows:
2012
Amortized
Cost
Fair
Value
(In thousands)
S ecurities available-for-sale:
Six to ten years
After ten years
Total
S ecurities held-to-maturity:
Six to ten years
After ten years
Total
$
7,894
137,880
145,774
$
-
$
9,166
9,166
$
7,958
141,712
149,670
-
5,549
5,549
The contractual maturity dates of the securities were used for mortgage-backed securities and asset-backed securities. No
estimates were made to anticipate principal repayments.
During 2012, the Company sold 14 securities available-for-sale totaling $30.8 million. The Company received gross proceeds of
$27.7 million related to the sale of these securities and recognized gross gains of $426,000 and gross losses of $3.5 million.
During 2011, the Company sold 5 securities available-for-sale totaling $5.3 million. The Company received gross proceeds of
$5.6 million related to the sale of these securities and recognized gross gains of $357,000 and gross losses of $51,000.
At December 31, 2012, the Company has pledged $6.8 million of securities for FHLB advances. See Note 9 – Short-Term
Borrowed Funds for further discussion.
The gross unrealized losses and fair value of the Company’s investments available for sale with unrealized losses that are not
deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at December 31, 2012 are as follows:
Less than 12 Months
Fair
Value
Amortized
Cost
Unrealized Amortized
Unrealized Amortized
Losses
Cost
Losses
Cost
At December 31, 2012
12 Months or Greater
Fair
Value
(In thousands)
Total
Fair
Value
Unrealized
Losses
S ecurities available-for-sale:
M unicipal securities
M ortgage-backed
$
8,554
8,441
securities
Total
13,078
$
21,632
13,023
21,464
(113)
(55)
(168)
-
-
1,927
1,927
1,891
1,891
-
(36)
(36)
8,554
8,441
15,005
23,559
14,914
23,355
(113)
(91)
(204)
S ecurities held-to-maturity:
Asset-backed
securities
$
-
-
-
9,082
4,885
(4,197)
9,082
4,885
(4,197)
The gross unrealized losses and fair value of the Company’s investments available for sale with unrealized losses that are not
deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at December 31, 2011 are as follows:
47
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
Less than 12 M onths
Fair
Value
Amortized
Cost
Unrealized Amortized
Unrealized Amortized
Losses
Cost
Losses
Cost
At December 31, 2011
12 M onths or Greater
Fair
Value
(In thousands)
Total
Fair
Value
Unrealized
Losses
Securities available-for-sale:
GNM A
$
M ortgage-backed
2,218
2,216
(2)
-
-
-
2,218
2,216
(2)
securities
Total
11,944
14,162
$
11,767
13,983
(177)
(179)
27,939
27,939
20,949
20,949
(6,990)
(6,990)
39,883
42,101
32,716
34,932
(7,167)
(7,169)
Securities held-to-maturity:
Asset-backed
securities
$
-
-
-
9,401
2,773
(6,628)
9,401
2,773
(6,628)
At December 31, 2012 and 2011, the Company had 26 and 21, respectively, individual investments available-for-sale that were in
an unrealized loss position. The unrealized losses on the Company’s investments in GNMA securities, mortgage-backed securities
and asset-backed securities summarized above were attributable primarily to credit quality, credit rating changes and liquidity.
Management has performed various analyses, including cash flows, and has recorded OTTI expense of $625,000 related to 4
securities available for sale during fiscal 2012. These 4 securities available for sale were subsequently sold during fiscal 2012. In
addition, OTTI expense totaling $288,000 was recorded related to 2 held-to-maturity securities during fiscal 2012. There is one
additional held-to-maturity security that had OTTI expense recorded in prior years, but did not incur OTTI expense during fiscal
2012. Other than these 3 held-to-maturity securities, management believes that there are no other securities other-than-temporarily
impaired at December 31, 2012. The Company does not intend to sell these securities and it is more likely than not that the
Company will not be required to sell these securities before recovery of their amortized cost. Management continues to monitor
these securities with a high degree of scrutiny. There can be no assurance that the Company will not conclude in future periods that
conditions existing at that time indicate some or all of the securities may be sold or are other-than-temporarily impaired, which
would require a charge to earnings in such periods.
The Company reviews its investment securities portfolio at least quarterly and more frequently when economic conditions warrant,
assessing whether there is any indication of other-than-temporary impairment (“OTTI”). Factors considered in the review include
estimated future cash flows, length of time and extent to which market value has been less than cost, the financial condition and
near term prospect of the issuer, and our intent and ability to retain the security to allow for an anticipated recovery in market
value. If the review determines that there is OTTI, then an impairment loss is recognized in earnings equal to the difference
between the investment’s cost and its fair value at the balance sheet date of the reporting period for which the assessment is made,
or a portion may be recognized in other comprehensive income. The fair value of investments on which OTTI is recognized then
becomes the new cost basis of the investment.
The unrealized loss in asset-backed securities relates to valuations on 14 individual pooled trust preferred securities. The
Company believes, based on industry analyst reports and third-party other-than-temporary loss impairment evaluations, that the
deterioration in the value of these securities is attributable to a combination of the lack of liquidity in these securities, credit ratings
and credit quality concerns.
The Company, as a member of the Federal Home Loan Bank ("FHLB") of Atlanta, is required to own capital stock in the FHLB of
Atlanta based generally upon a membership-based requirement and an activity based requirement. FHLB capital stock is pledged
to secure FHLB advances. No secondary market exists for this stock, and it has no quoted market price. However, redemption
through the FHLB of this stock has historically been at par value. The Company’s investment in FHLB capital stock was $6.4
million and $7.2 million at December 31, 2012 and 2011, respectively.
Other investments at December 31, 2012 and 2011 consisted of $465,000 invested in capital stock of statutory business trusts (See
Note 10 – Long-term debt).
48
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
NOTE 3 – DERIVATIVES
The derivative positions of the Company at December 31, 2012 and 2011 are as follows:
At December 31,
2012
2011
Fair
Value
Notional
Value
Fair
Value
(In thousands)
Notional
Value
Derivative assets:
M ortgage loan interest rate lock commitments
M ortgage loan forward sales commitments
M ortgage-backed securities forward sales commitments
$
$
4,783
1,692
67
6,542
289,584
59,177
308,000
656,761
2,832
1,168
-
4,000
218,465
47,992
-
266,457
Derivative liabilities:
M ortgage-backed securities forward sales commitments
$
-
-
1,234
167,000
The Company uses derivatives to reduce interest rate risk incurred as a result of market movements. These derivatives primarily
consist of mortgage loan interest rate lock commitments, mortgage loan forward sales commitments and options to deliver
mortgage-backed securities. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference
to an underlying instrument, index or referenced interest rate. The Company uses derivatives primarily to minimize interest rate
risk related to its pipeline of loan interest rate lock commitments issued on residential mortgage loans in the process of origination
for sale or loans held for sale. Mortgage loan forward sales commitments and options to deliver mortgage-backed securities that
generally correspond with the composition of the locked pipeline are used to economically hedge a percentage of the Company’s
locked pipeline. Crescent Mortgage ALCO Committee has developed a comprehensive hedging policy to monitor the use of
derivatives to reduce interest rate risk. The Company’s derivative positions are classified as trading assets and liabilities, and as
such, the changes in the fair market value of the derivative positions are recognized in the consolidated statement of operations.
NOTE 4 - LOANS RECEIVABLE, NET
Loans receivable, net at December 31, 2012 and 2011 are summarized by category as follows:
At December 31,
2012
2011
Loans secured by real estate:
One-to-four family
Home equity
Commercial real estate
Construction and development
Consumer loans
Commercial business loans
Total gross loans receivable
Less:
Undisbursed loans in process
Allowance for loan losses
Deferred fees, net
Total loans receivable, net
% of Total
Loans
Amount
(Dollars in thousands)
% of Total
Loans
23.10%
6.52%
46.46%
14.09%
0.94%
8.89%
100.00%
124,604
35,173
250,560
75,985
5,085
47,933
539,340
13,898
12,039
68
513,335
Amount
$
146,333
31,278
240,764
68,113
3,762
38,714
27.66%
5.91%
45.52%
12.88%
0.71%
7.32%
528,964
100.00%
17,690
9,520
63
501,691
$
49
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
The composition of gross loans outstanding, net of undisbursed amounts, by rate type is as follows:
At December 31,
2012
2011
(Dollars in thousands)
Variable rate loans
Fixed rate loans
Total loans outstanding
$
$
265,657
245,617
511,274
51.96%
48.04%
100.00%
312,188
213,254
525,442
59.41%
40.59%
100.00%
The following table presents activity in the allowance for credit losses. Allocation of a portion of the allowance to one category of
loans does not preclude its availability to absorb losses in other categories.
Allowance for loan losses:
At December 31, 2012
Loans S ecured by Real Estate
Commercial Construction
One-to-
four
family
Home
equity
real
estate
and
Development Consumer
(In thousands)
Commercial
business
1,216
54
(319)
-
951
3,167
761
(1,432)
231
2,727
3,021
125
(1,506)
740
2,380
108
(109)
(84)
172
87
1,304
389
(1,169)
446
970
Total
12,039
2,707
(7,190)
1,964
9,520
Balance at January 1, 2012
Provision for loan losses
Charge-offs
Recoveries
Balance at December 31, 2012
$
3,223
1,487
(2,680)
375
2,405
$
One-to-
four
family
At December 31, 2011
Loans S ecured by Real Estate
Commercial Construction
Home
equity
real
estate
and
Development Consumer
(In thousands)
Commercial
business
Total
Balance at January 1, 2011
$
4,627
1,376
Provision for loan losses
Charge-offs
Recoveries
1,669
(3,837)
764
51
(211)
-
Balance at December 31, 2011
$
3,223
1,216
2,705
3,828
(3,548)
182
3,167
4,040
4,821
(6,043)
203
3,021
163
125
(221)
41
108
1,352
14,263
241
(929)
640
10,735
(14,789)
1,830
1,304
12,039
Balance at January 1, 2010
Provision for loan losses
Charge-offs
Recoveries
Balance at December 31, 2010
Total
$
13,032
30,755
(29,786)
262
14,263
$
50
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
One-to-
four
family
Loans S ecured by Real Estate
Commercial Construction
Home
equity
real
estate
and
Development Consumer
(In thousands)
Commercial
business
Total
At December 31, 2012:
Allowance for loan losses ending balances:
Individually evaluated for impairment
Collectively evaluated for impairment
$
312
2,093
2,405
$
Loans receivable:
Ending balances:
Individually evaluated for impairment
Collectively evaluated for impairment
Total loans receivable
$
7,392
138,937
146,329
$
At December 31, 2011:
Allowance for loan losses ending balances:
Individually evaluated for impairment
Collectively evaluated for impairment
$
485
2,738
3,223
$
-
951
951
359
2,368
2,727
429
1,951
2,380
25
62
87
273
697
970
1,398
8,122
9,520
-
30,710
30,710
18,177
218,053
236,230
3,265
60,210
63,475
74
3,428
3,502
3,535
27,493
31,028
32,443
478,831
511,274
22
1,194
1,216
85
3,082
3,167
212
2,809
3,021
36
72
108
405
899
1,304
1,245
10,794
12,039
Loans receivable:
Ending balances:
Individually evaluated for impairment
Collectively evaluated for impairment
Total loans receivable
$
10,571
114,019
$
124,590
326
33,787
34,113
27,203
218,746
245,949
13,747
60,846
74,593
96
4,746
4,842
5,640
35,715
41,355
57,583
467,859
525,442
The following table presents impaired loans individually evaluated for impairment in the segmented portfolio categories as of
December 31, 2012. The recorded investment is defined as the original amount of the loan, net of any deferred costs and fees, less
any principal reductions and direct charge-offs. Unpaid principal balance includes amounts previously included in charge-offs.
51
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
At and for the Year Ended December 31, 2012
Recorded
Investment
Unpaid
Principal
Balance
Average
Recorded
Investment
Interest
Income
Recognized
Related
Allowance
(In thousands)
180
2
945
222
8
143
1,500
19
-
1
9
1
1
31
199
2
946
231
9
144
1,531
With no related allowance recorded:
Loans secured by real estate:
One-to-four family
Home equity
Commercial real estate
Construction and development
Consumer loans
Commercial business loans
$
4,310
-
13,891
658
43
2,419
With an allowance recorded:
Loans secured by real estate:
One-to-four family
Home equity
Commercial real estate
Construction and development
Consumer loans
Commercial business loans
Total:
Loans secured by real estate:
One-to-four family
Home equity
Commercial real estate
Construction and development
Consumer loans
Commercial business loans
7,115
319
14,746
921
427
3,473
27,001
3,282
-
4,286
4,504
31
1,116
-
-
-
-
-
-
-
312
-
359
429
25
273
5,575
257
16,142
5,393
49
2,687
30,103
2,863
-
4,420
3,037
28
1,247
21,321
3,082
-
4,286
2,607
31
1,116
11,122
13,219
1,398
11,595
7,392
-
18,177
3,265
74
3,535
32,443
$
10,397
319
19,032
5,425
458
4,589
40,220
312
-
359
429
25
273
1,398
8,438
257
20,562
8,430
77
3,934
41,698
52
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
At and for the Year Ended December 31, 2011
Recorded
Investment
Unpaid
Principal
Balance
Average
Recorded
Investment
Interest
Income
Recognized
Related
Allowance
(In thousands)
With no related allowance recorded:
Loans secured by real estate:
One-to-four family
Home equity
Commercial real estate
Construction and development
Consumer loans
Commercial business loans
With an allowance recorded:
Loans secured by real estate:
One-to-four family
Home equity
Commercial real estate
Construction and development
Consumer loans
Commercial business loans
Total:
Loans secured by real estate:
One-to-four family
Home equity
Commercial real estate
Construction and development
Consumer loans
Commercial business loans
$
9,598
-
26,987
13,234
59
5,048
54,926
973
326
216
513
37
592
2,657
10,571
326
27,203
13,747
96
5,640
57,583
$
13,226
-
29,774
19,359
531
7,010
69,900
990
350
216
558
39
603
2,756
14,216
350
29,990
19,917
570
7,613
72,656
-
-
-
-
-
-
-
485
22
85
212
36
405
1,245
485
22
85
212
36
405
1,245
11,639
308
23,285
17,473
167
5,801
58,673
244
87
55
128
10
151
675
11,883
395
23,340
17,601
177
5,952
59,348
262
13
557
380
38
256
1,506
32
-
1
(8)
1
3
29
294
13
558
372
39
259
1,535
The Bank is not committed to advance additional funds in connection with impaired loans.
A loan is considered past due if the required principal and interest payment has not been received as of the due date. The
following schedule is an aging of past due loans receivable by portfolio segment as of December 31, 2012 and 2011.
53
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
At December 31, 2012
Real estate loans
Commercial Construction
Home
equity
-
546
-
546
30,164
30,710
real
estate
1,142
2,227
5,534
8,903
227,327
236,230
and
Development Consumer
(In thousands)
Commercial
business
173
317
3,092
3,582
59,893
63,475
106
-
26
132
3,370
3,502
378
21
1,136
1,535
29,493
31,028
Total
2,099
3,722
14,035
19,856
491,418
511,274
One-to-
four
family
$
300
611
4,247
5,158
141,171
146,329
$
$
-
-
-
-
-
-
-
At December 31, 2011
Real estate loans
Commercial Construction
Home
equity
473
-
-
473
33,640
34,113
real
estate
8,785
903
14,117
23,805
222,144
245,949
and
Development Consumer
(In thousands)
Commercial
business
27
620
7,072
7,719
66,874
74,593
54
-
81
135
4,707
4,842
220
-
1,810
2,030
39,325
41,355
Total
14,411
3,532
30,699
48,642
476,800
525,442
One-to-
four
family
$
4,852
2,009
7,619
14,480
110,110
124,590
$
$
-
-
4,184
-
47
-
4,231
30-59 days past due
60-89 days past due
90 days or more past due
Total past due
Current
Total loans receivable
Recorded investment greater than
90 days and still accruing
30-59 days past due
60-89 days past due
90 days or more past due
Total past due
Current
Total loans receivable
Recorded investment greater than
90 days and still accruing
Loans are generally placed in nonaccrual status when the collection of principal and interest is 90 days or more past due, unless the
obligation is both well-secured and in the process of collection. When interest accrual is discontinued, all unpaid accrued interest
is reversed. Interest payments received while the loan is on nonaccrual is applied to the principal balance. No interest income was
recognized on impaired loans subsequent to the nonaccrual status designation. A loan is returned to accrual status when the
borrower makes consistent payments according to contractual terms and future payments are reasonably assured.
The following is a schedule of loans receivable, by portfolio segment, on nonaccrual at December 31, 2012 and 2011.
At December 31,
2012
2011
Loans secured by real estate:
One-to-four family
Home equity
Commercial real estate
Construction and development
Consumer loans
Commercial business loans
$
$
(In thousands)
4,817
-
5,956
8,861
326
10,143
3,251
52
1,172
15,248
$
8,011
72
2,518
29,931
$
54
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
There were no loans past due 90 days or more and still accruing at December 31, 2012. There were $4.2 million of loans past due
90 days or more and still accruing at December 31, 2011.
The Company uses several metrics as credit quality indicators of current or potential risks as part of the ongoing monitoring of
credit quality of its loan portfolio. The credit quality indicators are periodically reviewed and updated on a case-by-case basis.
The Company uses the following definitions for the internal risk rating grades, listed from the least risk to the highest risk.
Outstanding: The borrower is typically a long established, well-seasoned company with a significant market position. It
possesses unquestioned asset quality, liquidity, and excellent sales and earnings trends. Leverage, if present, is well below
industry norms. Borrowers appear to have capacity to meet all of its obligations under almost any circumstances. The borrowing
entity’s management has extensive experience and depth.
Excellent: The borrower demonstrates a strong and liquid financial condition based upon current financial information and
qualifies to borrow on an unsecured basis under most circumstances. If borrowing is secured, collateral is readily marketable and
amply margined. Repayment sources are well defined and more than adequate. Credit checks and prior lending experiences with
the company, if any, are fully satisfactory. The borrower’s cash flow comfortably exceeds total current obligations.
Good: The borrower provides current financial information reflecting a satisfactory financial condition and reasonable debt
service capacity. If borrowing is secured, collateral is marketable, adequately margined at the present time, and expected to afford
coverage to maturity. Repayment sources are considered adequate, and repayment terms are appropriate. Credit checks and prior
experience, if any, are satisfactory. The borrower is usually established and is attractive to other financial institutions. The
borrower’s balance sheet is stable and sales and earnings are steady and predictable.
Acceptable: While clearly an acceptable credit risk to the Company, the borrower will generally demonstrate a higher leveraged,
less liquid balance sheet and capacity to service debt, while steady, may be less well-defined. Repayment terms may not be
appropriate for individual transactions. Borrower is generally acceptable to other financial institutions; however, secured
borrowing is the norm. Collateral marketability and margin are acceptable at the present time but may not continue to be so.
Credit checks or prior experience, if any, reveals some, but not serious, slowness of paying. If a business, its management
experience may be limited or have less depth than a satisfactory borrower. Sensitivity to economic or credit cycles exists, and
staying power could be a problem.
Management Watch: Loans to borrowers with generally acceptable credit strength, but with manageable weaknesses or
uncertainty evident in one or more factors. Earnings may be erratic, with marginal cash flows or declining sales. Borrowers
reflect leveraged financial condition and marginal liquidity. The borrower’s management may be new and a track record of
performance has yet to be developed. Financial information may be incomplete and reliance on secondary repayment sources may
be increasing.
Special Mention: While loans to a borrower in this rating category are currently protected (no loss of principal or interest is
envisioned), they may pose undue or unwarranted credit risks if weaknesses are not checked or corrected. Weaknesses may be
limited to one or several trends or developments. Weaknesses may include one or more of the following: a potentially over-
extended financial condition, a questionable repayment program, an uncertain level of continuing employment or income,
inadequate or deteriorating collateral, inadequate or untimely financial information, management competence or succession issues,
or a high degree of vulnerability to outside forces.
Substandard: Assets in this category are inadequately protected by the current creditworthiness and paying capacity of the
obligor or of the collateral pledged, if any. Assets so classified have a well-defined weakness or weakness that jeopardizes the
liquidation of the debt. They are characterized by the distinct possibility that the company will sustain some loss if the deficiencies
are not corrected. Nonaccrual loans, reduced-earnings loans, and loans to borrowers engaged in bankruptcy proceedings are
automatically rated Substandard or lower.
Doubtful: A loan rated Doubtful has all of the weaknesses inherent in one rated Substandard with the added characteristic that the
weakness may make collection or liquidation in full, based on currently existing facts, highly improbable. A Doubtful rating
generally is used when the amount of loss can be projected and that projection exceeds one-third of the balance of outstanding debt
but does not exceed two-thirds of that balance. A Doubtful rating is generally applied when the likelihood of significant loss is
high.
55
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
Loss: A Loss rating should be applied when the borrower’s outstanding debt is considered uncollectible or of such little value that
its continuance as a bankable asset is not warranted. This rating does not suggest that there is absolutely no recovery or salvage
value, but that it is not practical or desirable to defer writing off the debt even though a partial recovery may be affected in the
future.
The Company uses the following definitions:
Nonperforming: Loans on nonaccrual status plus loans greater than ninety days past due still accruing interest.
Performing: All current loans plus loans less than ninety days past due. The following is a schedule of the credit quality of loans
receivable, by portfolio segment, as of December 31, 2012 and 2011.
One-to-
four
family
At December 31, 2012
Real estate loans
Commercial Construction
Home
equity
real
estate
and
Development Consumer
(In thousands)
Commercial
business
Total
Internal Risk Rating Grades:
Acceptable or better
M anagement Watch
Special M ention
Substandard
Total loans receivable
Performing
Nonperforming:
$
$
123,047
15,073
3,476
4,733
146,329
29,871
375
-
464
30,710
153,649
50,629
23,745
8,207
236,230
$
141,512
30,710
230,274
90 days or more and still accruing
Nonaccrual
Total nonperforming
Total loans receivable
-
4,817
4,817
146,329
$
-
-
-
30,710
-
5,956
5,956
236,230
37,694
17,285
5,391
3,105
63,475
60,224
-
3,251
3,251
63,475
3,467
-
-
35
3,502
3,450
-
52
52
3,502
21,974
5,535
2,000
1,519
31,028
369,702
88,897
34,612
18,063
511,274
29,856
496,026
-
1,172
1,172
31,028
-
15,248
15,248
511,274
One-to-
four
family
At December 31, 2011
Real estate loans
Commercial Construction
Home
equity
real
estate
and
Development Consumer
(In thousands)
Commercial
business
Total
Internal Risk Rating Grades:
Acceptable or better
M anagement Watch
Special M ention
Substandard
Total loans receivable
Performing
Nonperforming:
$
90,792
6,414
14,330
13,054
124,590
$
29,448
1,461
2,070
1,134
34,113
130,828
33,881
55,439
25,801
245,949
$
115,729
33,787
231,622
90 days or more and still accruing
Nonaccrual
Total nonperforming
Total loans receivable
-
8,861
8,861
124,590
$
-
326
326
34,113
4,184
10,143
14,327
245,949
56
34,256
17,287
9,856
13,194
74,593
66,582
-
8,011
8,011
74,593
4,212
162
372
96
4,842
4,723
47
72
119
4,842
28,747
4,940
3,159
4,509
41,355
318,283
64,145
85,226
57,788
525,442
38,837
491,280
-
2,518
2,518
41,355
4,231
29,931
34,162
525,442
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
Troubled Debt Restructurings
The following is a schedule of troubled debt restructurings, by portfolio segment, as of December 31, 2012 and 2011.
At December 31, 2012
Pre-Modification Post-Modification
Number of
Contracts
Outstanding
Recorded
Investment
Outstanding
Recorded
Investment
(In thousands)
Troubled Debt Restructurings:
Loans secured by real estate:
One-to-four family
Home equity
Commercial real estate
Construction and development
Consumer loans
Commercial business loans
6
4
9
-
-
3
22
$
4,928
-
6,313
5,732
-
959
17,932
$
4,263
-
5,751
2,938
-
588
13,540
At December 31, 2011
Pre-Modification Post-Modification
Outstanding
Outstanding
Number of
Contracts
Recorded
Investment
Recorded
Investment
(In thousands)
-
-
12
17
14
9
52
$
6,621
-
20,942
11,063
-
4,698
43,324
$
6,092
-
20,867
10,336
-
4,319
41,614
Troubled Debt Restructurings:
That S ubsequently Defaulted
During the Period:
Loans secured by real estate:
One-to-four family
Home equity
Commercial real estate
Construction and development
Consumer loans
Commercial business loans
During the year ended December 31, 2012, the Bank modified five loans that were considered troubled debt restructurings. We
extended the terms for all five of these loans at market rates. No loans restructured in the twelve months prior to December 31,
2012 went into default during the year.
Loans serviced for the benefit of others under loan participation arrangements amounted to $15.9 million and $20.1 million at
December 31, 2012 and 2011, respectively.
Activity in loans to officers, directors and other related parties for the years ended December 31, 2012 and 2011 is summarized as
follows:
57
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
At December 31,
2012
2011
(In thousands)
Balance at beginning of year
New loans
Repayments
Balance at end of year
$
$
19,702
4,619
(11,356)
12,965
22,921
12,750
(15,969)
19,702
In management’s opinion, related party loans are made on substantially the same terms, including interest rates and collateral, as
those prevailing at the time for comparable transactions with an unrelated person and generally do not involve more than the
normal risk of collectability.
The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to extend credit. These instruments involve, to varying
degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.
The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for
commitments to extend credit is represented by the contractual amount of these instruments. The Company uses the same credit
policies in making commitments as for on-balance sheet instruments. At December 31, 2012 and 2011, the Company had
commitments to extend credit in the amount of $31.9 million and $30.8 million, respectively. At December 31, 2012 and 2011,
the Company had standby letters of credit in the amount of $396,000 and $481,000, respectively.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in
the contract. Commitments generally have fixed expiration dates or other termination clauses and may require a payment of a fee.
Since commitments may expire without being drawn upon, the total commitments do not necessarily represent future cash
requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the party.
Collateral held varies, but may include inventory, property and equipment, residential real estate and income producing
commercial properties.
Standby letters of credit obligate the Company to meet certain financial obligations of its customers, if, under the contractual terms
of the agreement, the customers are unable to do so. Payment is only guaranteed under these letters of credit upon the borrower’s
failure to perform its obligations to the beneficiary. The Company can seek recovery of the amounts paid from the borrower and
the letters of credit are generally not collateralized. Commitments under standby letters of credit are usually one year or less. At
December 31, 2012, the Company has recorded no liability for the current carrying amount of the obligation to perform as a
guarantor; as such amounts are not considered material. The maximum potential of undiscounted future payments related to
standby letters of credit at December 31, 2012 was approximately $396,000.
NOTE 5 - PREMISES AND EQUIPMENT, NET
Premises and equipment, net at December 31, 2012 and 2011 consists of the following:
At December 31,
2012
2011
Land
Buildings
Furniture, fixtures and equipment
Construction in process
Total premises and equipment
Less: accumulated depreciation
Premises and equipment, net
58
$
(In thousands)
5,029
11,277
7,345
44
23,695
(7,298)
16,397
5,029
11,277
7,756
-
24,062
(7,984)
16,078
$
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
Depreciation expense included in operating expenses for the years ended December 31, 2012, 2011 and 2010 amounted to
$833,000, $856,000, and $1.3 million, respectively. There was no interest capitalized during fiscal 2012 and 2011.
NOTE 6 – REAL ESTATE ACQUIRED THROUGH FORECLOSURE
Transactions in other real estate owned for the years ended December 31, 2012 and 2011 are summarized below:
At December 31,
2012
2011
Balance at beginning of year
Additions
Sales
Write downs
Balance at end of year
(In thousands)
6,097
9,407
(8,171)
(1,049)
6,284
10,816
10,009
(12,762)
(1,966)
6,097
$
$
A summary of the composition of real estate acquired through foreclosure follows:
At December 31,
2012
2011
(In thousands)
Real estate loans:
One-to-four family
Commercial real estate
Construction and development
NOTE 7 – MORTGAGE SERVICING RIGHTS
$
$
1,010
1,902
3,372
6,284
1,192
819
4,086
6,097
Mortgage loans serviced for others are not included in the accompanying statement of financial condition. The value of mortgage
servicing rights is included in other assets on the Company’s statement of financial condition. The unpaid principal balances of
loans serviced for others were $2.2 billion and $1.1 billion, respectively, at December 31, 2012 and 2011.
The economic estimated fair values of mortgage servicing rights were $18.1 million and $10.9 million, respectively, at December
31, 2012 and 2011. The estimated fair value of servicing rights at December 31, 2012 were determined using discount rates
ranging from 11.00% to 15.50%, prepayment speed assumptions (“PSA”) ranging from 114.6 to 1,451.2, depending upon the
stratification of the specific servicing right, and a weighted average delinquency rate of 1.24% as determined by a third party. The
estimated fair value of servicing rights at December 31, 2011 were determined using discount rates ranging from 9.50% to
14.00%, prepayment speed assumptions (“PSA”) ranging from 123.7 to 1,298.6, depending upon the stratification of the specific
servicing right, and a weighted average delinquency rate of .86% as determined by a third party.
During 2011 and 2010, servicing rights related to approximately $124.6 million and $191.8 million, respectively, of unpaid loan
principal serviced for others were sold. The Company received $1.1 million and $1.8 million, respectively, in net proceeds and
recognized a gain in the accompanying consolidated statement of operations of $299,000 and $526,000, respectively. No servicing
rights were sold during 2012.
The following summarizes the activity in mortgage servicing rights, along with the aggregate activity in the related valuation
allowances, for the years ended December 31, 2012 and 2011:
59
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
At December 31,
2012
2011
M SR beginning balance
Amount capitalized
Amount sold
Amount amortized
M SR ending balance
(In thousands)
6,452
7,051
-
(1,464)
12,039
5,249
2,983
(744)
(1,036)
6,452
$
$
There was no allowance for loss in fair value in mortgage servicing rights for the years ended December 31, 2012 and 2011.
The estimated amortization expense for mortgage servicing rights for the years ended December 31, 2013, 2014, 2015, 2016, 2017
and thereafter is $1.7 million, $1.5 million, $1.3 million, $1.1 million, $1.0 million and $5.4 million, respectively. The estimated
amortization expense is based on current information regarding loan payments and prepayments. Amortization expense could
change in future periods based on changes in the volume of prepayments and economic factors.
At December 31, 2012 and 2011, servicing related trust funds of approximately $27.1 million, and $10.7 million, respectively,
representing both principal and interest due investors and escrows received from borrowers, are on deposit in custodial accounts
and are included in noninterest-bearing deposits in the accompanying financial statements.
At December 31, 2012 and 2011, the Company had blanket bond and errors and omissions coverages of $5.0 million each.
NOTE 8 - DEPOSITS
Deposits outstanding by type of account at December 31, 2012 and 2011 are summarized as follows:
Noninterest-bearing demand accounts
Interest-bearing demand accounts
Savings accounts
M oney market accounts
Certificates of deposit
0.20% to 2.99%
3.00% to 4.99%
5.00% to 7.99%
Total certificates of deposit
Total deposits
At December 31,
2012
2011
(In thousands)
$
82,004
51,490
10,882
207,299
298,576
2,996
-
301,572
653,247
$
62,906
39,225
8,006
194,262
313,520
3,624
260
317,404
621,803
The aggregate amount of certificates of deposit, excluding brokered deposits, with a minimum denomination of $100,000 was
$86.0 million and $32.1 million at December 31, 2012 and 2011, respectively. The aggregate amount of brokered certificates of
deposit was $29.9 million and $27.7 million at December 31, 2012 and 2011, respectively. The aggregate amount of institutional
certificates of deposit was $40.0 million and $40.4 million at December 31, 2012 and 2011, respectively.
The amounts and scheduled maturities of certificates of deposit at December 31, 2012 and 2011 are as follows:
At December 31,
2012
2011
(In thousands)
M aturing within one year
M aturing one through three years
M aturing after three years
$
$
220,024
44,280
37,268
301,572
60
265,535
44,602
7,267
317,404
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
The Company has pledged $2.0 million of mortgage-backed securities as of December 31, 2012 to secure public agency funds.
NOTE 9 – SHORT-TERM BORROWED FUNDS
Short-term borrowed funds at December 31, 2012 and 2011 are summarized as follows:
At December 31,
2012
2011
Balance
Interest
Rate
Balance
(Dollars in thousands)
Unsecured line of credit
Short-term FHLB advances
M ortgage loan warehouse line of credit
TLGP
Subordinated debenture, due 2020
Total short-term borrowed funds
$
2,750
77,500
1,932
-
300
82,482
$
4.75%
0.16%-.82%
2.5%-4.5%
-
2.81%
200
40,000
2,584
20,400
300
63,484
Interest
Rate
4.75%
0.14%-.35%
3.5%-6.25%
2.74%
2.82%
Lines of credit with the FHLB of Atlanta are based upon FHLB-approved percentages of Bank assets, but must be supported by
appropriate collateral to be available. The Company has pledged first lien residential mortgage, second lien residential mortgage,
residential home equity line of credit, commercial mortgage and multifamily mortgage portfolios under blanket lien agreements
resulting in approximately $151.8 million of collateral for these advances. In addition, at December 31, 2012, the Company has
pledged $6.8 million of securities for these advances. Assuming sufficient collateral was available at December 31, 2012, the
Company had maximum FHLB lines of $266.1 million based on FHLB limits. At December 31, 2012, collateral totaling $158.6
million was pledged to support FHLB advances. At December 31, 2012 the Company had FHLB advances of $115.0 million
outstanding with excess collateral pledged to the FHLB during those periods that would support additional borrowings of
approximately $43.6 million.
Lines of credit with the Federal Reserve Board (“FRB”) are based on collateral pledged. The Company has pledged certain non-
mortgage commercial, acquisition and development, and lot loan portfolios under blanket lien agreements resulting in
approximately $34.3 million of collateral to the FRB for these advances. At December 31, 2012 the Company had lines available
with the FRB for $34.3 million. At December 31, 2012 the Company had no FRB advances outstanding.
At December 31, 2012, Crescent Mortgage had a mortgage loan warehouse line of credit from a correspondent with a $35.0
million credit limit, of which $33.1 million is still available. The facility is secured by Crescent Mortgage’s residential mortgage
loans held for sale and other assets.
Effective October 1, 2011, the Company modified a $3.0 million unsecured line of credit with a correspondent bank, of which $2.8
million and $3.0 million was outstanding at December 31, 2012 and December 31, 2011, respectively. The unsecured line of
credit bears interest at prime plus 1.50% and the term expires October 1, 2013. In connection with this modification, the Company
will make quarterly principal payments of $50,000 that began on October 1, 2011 and will continue on the same day of each
quarter through and including July 1, 2013. The line of credit also has debt covenants, the more restrictive of which requires the
Company to maintain certain capital ratios and nonperforming asset ratios. As of December 31, 2012 the Company is in
compliance with all of the covenants.
The Company has a subordinated debenture totaling $3.0 million that has principal repayments that began in 2010. See Note 10 –
Long-Term Debt for additional disclosure.
Certain borrowings were prepaid to manage the cost of funds and related interest rate sensitivity, resulting in a net loss on the
extinguishment of debt of $1.6 million, $1.1 million and $2.5 million during 2012, 2011 and 2010, respectively.
61
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
NOTE 10 – LONG-TERM DEBT
Long-term debt at December 31, 2012 and 2011 are summarized as follows:
Unsecured line of credit
Long-term FHLB advances, due 2013 through 2021
Subordinated debentures, due 2016 through 2020
Subordinated debentures issued to Carolina Financial Capital Trust I, due 2032
Subordinated debentures issued to Carolina Financial Capital Trust II, due 2034
Total long-term debt
Unsecured line of credit
Long-term FHLB advances, due 2013 through 2021
Subordinated debentures, due 2016 through 2020
Subordinated debentures issued to Carolina Financial Capital Trust I, due 2032
Subordinated debentures issued to Carolina Financial Capital Trust II, due 2034
Total long-term debt
December 31, 2012
Balance
Interest
Rate
(Dollars in thousands)
$
-
37,500
11,875
5,155
10,310
64,840
$
0.00%
0.52%-4.00%
1.84%-2.81%
3.75%
3.39%
December 31, 2011
Balance
$
Interest
Rate
(Dollars in thousands)
2,750
50,000
12,175
5,155
10,310
80,390
4.75%
0.82%-4.23%
1.90%-2.82%
3.75%
3.45%
$
As of December 31, 2012, the principal amounts due on long-term debt in 2013, 2014, 2015, 2016, 2017 and thereafter were $82.5
million, $5.3 million, $2.8 million, $10.3 million, $300,000 and $46.1 million, respectively. As of December 31, 2012, there were
no principal amounts callable by the FHLB on advances.
At December 31, 2012 and 2011, statutory business trusts (“Trusts”) created by the Company had outstanding trust preferred
securities with an aggregate par value of $15.0 million. The trust preferred securities have floating interest rates ranging from
3.39% to 3.75% at December 31, 2012 and maturities ranging from December 31, 2032 to January 7, 2034. The principal assets of
the Trusts are $15.5 million of the Company’s subordinated debentures with identical rates of interest and maturities as the trust
preferred securities. The Trusts have issued $465,000 of common securities to the Company.
The trust preferred securities, the assets of the Trusts and the common securities issued by the Trusts are redeemable in whole or in
part beginning on or after December 31, 2008, or at any time in whole but not in part from the date of issuance on the occurrence
of certain events. The obligations of the Company with respect to the issuance of the trust preferred securities constitutes a full
and unconditional guarantee by the Company of the Trusts’ obligations with respect to the trust preferred securities. Subject to
certain exceptions and limitations, the Company may elect from time to time to defer subordinated debenture interest payments,
which would result in a deferral of distribution payments on the related trust preferred securities.
Beginning with the scheduled payment date of December 31, 2010, the Company has deferred the payment of interest on its
outstanding trust preferred securities for an indefinite period which can be no longer than twenty consecutive quarterly periods. At
December 31, 2012, the Company has deferred these payments for nine quarters and still has eleven quarter of deferral available.
These as well as any future deferred distributions will continue to accrue interest. Distributions on the trust preferred securities are
cumulative. Therefore, in accordance with generally accepted accounting principles, the Company will continue to accrue the
monthly cost of the trust preferred securities as it has since issuance. The balance of deferred payments at December 31, 2012 is
approximately $1.2 million. Subsequent to December 31, 2012, the Company deferred an additional $118,000 on its outstanding
subordinated debentures.
As currently defined by the FRB, the Company had $15.0 million of long-term debt that qualified as Tier 1 capital at December
31, 2012 and 2011, respectively. The Company had $7.3 million and $9.6 million of long-term debt that qualified as Tier 2 capital
at December 31, 2012 and 2011, respectively.
62
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
The Company has $2.8 million outstanding on an unsecured line of credit with a correspondent bank. See Note 9 – Short-Term
Borrowed Funds for additional disclosure. At December 31, 2012, all of the $2.8 million of this unsecured line of credit is
included in Short-Term Borrowed Funds.
NOTE 11 - INCOME TAXES
Deferred tax assets are recognized for future deductible amounts resulting from differences in the financial statement and tax bases
of assets and liabilities and operating loss carry forwards. A valuation allowance is then established to reduce that deferred tax
asset to the level that it is "more likely than not" that the tax benefit will be realized. The realization of a deferred tax benefit by
the Company depends upon having sufficient taxable income of an appropriate character in the future periods.
Income tax expense for the years ended December 31, 2012, 2011 and 2010 consists of the following:
Current income tax expense (benefit)
Federal
State
Deferred income tax expense (benefit)
Federal
State
Total income tax expense (benefit)
For the Year Ended December 31,
2011
2012
2010
(In thousands)
(1,509)
148
(1,361)
9,900
1,152
11,052
(4,837)
435
(4,402)
$
(599)
(58)
(657)
10,395
$
1,124
109
1,233
(128)
(1,433)
(37)
(1,470)
(5,872)
A reconciliation from expected Federal tax expense to actual income tax expense for the years ended December 31, 2012, 2011
and 2010, using the base federal tax rates of 35%, 34% and 34%, respectively, follows:
Computed federal income taxes (benefit)
State income tax, net of federal benefit
Change in valuation allowance
Other, net
Total income tax expense (benefit)
For the Year Ended December 31,
2012
2011
2010
(In thousands)
(374)
170
-
9,546
757
-
$
(6,276)
263
(16)
157
(5,872)
92
10,395
$
76
(128)
63
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
The following is a summary of the tax effects of temporary differences that give rise to significant portions of the deferred tax
assets and liabilities at December 31, 2012 and 2011:
At December 31,
2012
2011
Deferred tax assets:
Loan loss reserve
Loan fees
Unrealized loss on securities available for sale
Tax vs. book gain on loans held for sale
Debt issuance costs
Net operating loss carryforwards
Reserve for mortgage loan buy-back
OREO write-downs
Securities yield adjustments
Other
Valuation allowance
Total gross deferred tax assets
Deferred tax liabilities:
Depreciation
Stock-based compensation
Short-term disability accrual
Total gross deferred tax liabilities
Deferred tax assets, net
$
(In thousands)
3,499
$
(137)
187
803
95
214
3,879
61
3,001
14
93
286
1,827
413
-
422
7,323
(271)
7,052
(368)
98
-
(270)
6,782
$
1,310
345
158
329
9,476
(196)
9,280
(387)
47
-
(340)
8,940
A portion of the annual change in the net deferred income tax asset relates to unrealized gains and losses on debt and equity
securities. The deferred income tax (benefit) related to the unrealized gains and losses on debt and equity securities of $2.8 million
and ($63,000), respectively, for the years ended December 31, 2012 and 2011, respectively, was recorded directly to stockholders’
equity as a component of accumulated other comprehensive income. The balance of the change in the net deferred tax asset of
$656,000 of deferred tax benefit and $1.5 million of deferred tax, respectively, for the years ended December 31, 2012 and 2011,
respectively, is reflected as a deferred income tax expense in the consolidated statement of operations. The valuation allowances
relate to state net operating loss carry-forwards. It is management’s belief that the realization of the remaining net deferred tax
assets is more likely than not. The Company’s federal income tax returns were examined for the years 2008 through 2010. No
changes were proposed.
NOTE 12 - COMMITMENTS AND CONTINGENCIES
The Company has entered into agreements to lease certain office facilities under non-cancellable operating lease agreements
expiring on various dates through June 2020. The Company’s rental expense for its office facilities for the years ended December
31, 2012, 2011 and 2010 totaled $595,000, $562,000 and $556,000, respectively.
Minimum rental commitments (in thousands) under the leases are as follows:
Year 1
Year 2
Year 3
Year 4
Year 5
After Year 5
Total
$
547
417
120
80
30
73
1,267
$
64
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
In the course of ordinary business, the Bank is, from time to time, named a party to legal actions and proceedings, primarily related
to the collection of loans and foreclosed assets. In accordance with generally accepted accounting principles, the Company
establishes reserves for litigation and regulatory matters when those matters present loss contingencies that are both probable and
estimable. When loss contingencies are not both probable and estimable, the Company does not establish reserves.
The Bank also has a claim against it relating to one of its former executive officers. Effective July 31, 2011, the Company
combined its wholly-owned subsidiary bank, Community FirstBank, with and into its other wholly-owned subsidiary bank,
Crescent Bank, effectuating an internal reorganization. The resultant bank was renamed CresCom Bank. The former executive
officer had an employment agreement with Community FirstBank and claims the internal reorganization triggered the severance
provisions of the employment agreement. The former executive officer initially claimed he is due an aggregate amount of
approximately $1.8 million but has since amended his complaint seeking approximately $10 million in damages. The Company
hired special counsel to review the claims made by the former executive officer. Based upon the review by special counsel, the
Company strongly disagrees with the former executive officer’s assertion that the internal reorganization triggered the severance
provisions of the employment agreement and intends to vigorously defend its position, including potentially making certain
counterclaims against the former executive officer. Management believes there is not sufficient information available at this time
to make an evaluation as to the likelihood of an unfavorable outcome of this claim or to estimate the amount of potential loss, if
any. Accordingly, no amounts have been accrued in the accompanying balance sheet as of December 31, 2012.
NOTE 13 – ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
Current accounting literature requires disclosures about the fair value of all financial instruments whether or not recognized in the
balance sheet, for which it is practicable to estimate the value. In cases where quoted market prices are not available, fair values
are based on estimates using present value or other techniques. Those techniques are significantly affected by the assumptions
used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be
substantiated by comparison to independent markets and, in many cases, could not be realized through immediate settlement of the
instrument. Certain items are specifically excluded from disclosure requirements, including the Company’s stock, premises and
equipment, accrued interest receivable and payable and other assets and liabilities.
The fair value of a financial instrument is an amount at which the asset or obligation could be exchanged in a current transaction
between willing parties, other than in a forced sale. Fair values are estimated at a specific point in time based on relevant market
information and information about the financial instruments. Because no market value exists for a significant portion of the
financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic
conditions, risk characteristics of various financial instruments, and other factors.
The Company has used Management’s best estimate of fair value based on the above assumptions. Thus the fair values presented
may not be the amounts that could be realized in an immediate sale or settlement of the instrument. In addition, any income taxes
or other expenses that would be incurred in an actual sale or settlement are not taken into consideration in the fair values presented.
Cash and due from banks - The carrying amounts of these financial instruments approximate fair value. All mature within 90 days
and present no anticipated credit concerns.
Interest-bearing cash - The carrying amount of these financial instruments approximate fair value.
Securities available for sale and securities held to maturity – Fair values for investment securities available for sale and securities
held to maturity are based upon quoted prices, if available. If quoted prices are not available, fair values are measured using
independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for
the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions.
FHLB stock and other non-marketable equity securities - The carrying amount of these financial instruments approximate fair
value.
Derivative assets – Fair values are based on quoted market prices, where available. As such, the fair value adjustments for
derivatives with fair values based on quoted market prices are recurring Level 1. If quoted market prices are not available,
estimated fair values are based on quoted market prices of comparable instruments. As such, the fair values of derivatives
computed based on quoted market prices of comparable instruments are recurring Level 2.
65
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
Loans held for sale and loans receivable, net - For variable-rate loans that re-price frequently and have no significant change in
credit risk, estimated fair values are based on carrying values. Estimated fair values for certain mortgage loans, credit card loans,
and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions,
adjusted for differences in loan characteristics. Estimated fair values for commercial real estate and commercial loans are
estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to
borrowers of similar credit quality. Estimated fair values for impaired loans are estimated using discounted cash flow analyses or
underlying collateral values, where applicable.
Accrued interest receivable - The fair value approximates the carrying value.
Mortgage Servicing Rights - The Company initially measures servicing assets and liabilities retained related to the sale of
residential loans held for sale (“mortgage servicing rights”) at fair value, if practicable. For subsequent measurement purposes, the
Company measures servicing assets and liabilities based on the lower of cost or market.
Deposits - The estimated fair value of demand deposits, savings accounts, and money market accounts is the amount payable on
demand at the reporting date. The estimated fair value of fixed-maturity certificates of deposits is estimated by discounting the
future cash flows using rates currently offered for deposits of similar remaining maturities.
Short-term borrowed funds - The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and
other short-term borrowings maturing within 90 days approximate their fair values. Estimated fair values of other short-term
borrowings are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for
similar types of borrowing arrangements.
Long-term debt - The estimated fair values of the Company’s long-term debt are estimated using discounted cash flow analyses
based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
Derivative liabilities - Fair values are based on quoted market prices, where available. If quoted market prices are not available,
estimated fair values are based on quoted market prices of comparable instruments.
Commitments to extend credit – The carrying amounts of these commitments are considered to be a reasonable estimate of fair
value because the commitments underlying interest rates are based upon current market rates.
Accrued interest payable - The fair value approximates the carrying value.
Off-Balance Sheet Financial Instruments – Contract values and fair values for off-balance sheet, credit-related financial
instruments are based on estimated fees currently charged to enter into similar agreements, taking into account the remaining terms
of the agreements and counterparties’ credit standing.
66
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
The carrying amount and estimated fair value of the Company's financial instruments at December 31, 2012 and 2011 are as
follows:
Financial assets:
Cash and due from banks
Interest-bearing cash
Securities available for sale
Securities held to maturity
Federal Home Loan Bank stock
Other investments
Derivative assets
Loans held for sale
Loans receivable, net
Accrued interest receivable
M ortgage servicing rights
Financial liabilities:
Deposits
Short-term borrowed funds
Long-term debt
Derivative liabilities
Accrued interest payable
At December 31,
2012
2011
Carrying
Amount
Fair
Value
Carrying
Amount
Fair
Value
$
6,499
11,340
149,670
9,166
6,413
465
6,542
144,849
501,691
3,203
12,039
(In thousands)
6,499
11,340
149,670
5,549
6,413
465
6,542
149,151
502,735
3,203
18,165
4,109
16,679
136,944
9,401
7,185
465
4,000
80,007
513,335
3,086
6,452
653,247
82,482
64,840
-
1,599
654,090
82,480
58,874
-
1,599
621,803
63,484
80,390
1,234
1,371
4,109
16,679
136,944
2,773
7,185
465
4,000
81,924
523,673
3,086
9,748
622,915
66,350
84,497
1,234
1,371
Notional
Amount
Estimated
Fair Value
Notional
Amount
Estimated
Fair Value
Off-Balance Sheet Financial Instruments:
(In thousands)
Commitments to extend credit
Standby letters of credit
Derivative assets:
M ortgage loan interest rate lock commitments
M ortgage loan forward sales commitments
M ortgage-backed securities forward sales commitments
$
31,916
396
289,584
59,177
308,000
-
-
4,783
1,692
67
30,755
481
218,465
47,992
-
-
-
2,832
1,168
-
Derivative liabilities:
M ortgage-backed securities forward sales commitments
-
-
167,000
1,234
In determining appropriate levels, the Company performs a detailed analysis of the assets and liabilities that are subject to fair
value disclosures. At each reporting period, all assets and liabilities for which the fair value measurement is based on significant
unobservable inputs are classified as Level 3.
Assets and liabilities that are carried at fair value are classified in one of the following three categories based on a hierarchy for
ranking the quality and reliability of the information used to determine fair value:
Level 1 Quoted prices in active markets for identical assets or liabilities.
Level 2 Observable market based inputs or unobservable inputs that are corroborated by market data.
Level 3 Unobservable inputs that are not corroborated by market data.
67
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
Following is a description of valuation methodologies used for assets recorded at fair value on a recurring and non-recurring basis.
Investment Securities Available for Sale
Measurement is on a recurring basis upon quoted market prices, if available. If quoted market prices are not available, fair values
are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash
flows, adjusted for prepayment assumptions, projected credit losses, and liquidity. Level 1 securities include those traded on an
active exchange or by dealers or brokers in active over-the-counter markets. Level 2 securities include securities issued by
government sponsored enterprises, municipal enterprises, and mortgage-backed securities issued by government sponsored
enterprises. Generally, these fair values are priced from established pricing models. At December 31, 2012 and 2011, the
Company’s investment securities available for sale are recurring Level 2.
Mortgage Loans Held for Sale
Mortgage loans held for sale are carried at the lower of cost or market value. The fair values of mortgage loans held for sale are
based on commitments on hand from investors within the secondary market for loans with similar characteristics. As such, the fair
value adjustments for mortgage loans held for sale is recurring Level 2.
Impaired Loans
Loans that are considered impaired are recorded at fair value on a non-recurring basis. Once a loan is considered impaired, the fair
value is measured using one of several methods, including collateral liquidation value, market value of similar debt and discounted
cash flows. Those impaired loans not requiring a specific charge against the allowance represent loans for which the fair value of
the expected repayments or collateral meet or exceed the recorded investment in the loan. At December 31, 2012, substantially all
of the total impaired loans were evaluated based on the fair value of the underlying collateral. When the Company records the fair
value based on a current appraisal, the fair value measurement is considered a Level 2 measurement. When a current appraisal is
not available or there is estimated further impairment below the current appraised value, the measurement is considered a Level 3
measurement.
Derivative Assets
Fair values are based on quoted market prices, where available. As such, the fair value adjustments for derivatives with fair values
based on quoted market prices are recurring Level 1. If quoted market prices are not available, estimated fair values are based on
quoted market prices of comparable instruments. As such, the fair values of derivatives computed based on quoted market prices
of comparable instruments are recurring Level 2.
Other Real Estate Owned (OREO)
Other real estate owned is adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, OREO owned is
carried at the lower of carrying value or fair value. Fair value is based on independent market prices, appraised values of the
collateral or management's estimation of the value of the collateral. When the fair value of the collateral is based on an observable
market price or a current appraised value, the Bank records the other real estate owned as non-recurring Level 2. When an
appraisal value is not available or management determines the fair value of the collateral is further impaired below the appraised
value and there is no observable market price, the Company records that OREO as non-recurring Level 3.
68
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
Assets and liabilities measured at fair value on a recurring basis are as follows as of December 31, 2012 and 2011:
Quoted market price
in active markets
(Level 1)
S ignificant other
observable inputs
(Level 2)
(In thousands)
S ignificant other
unobservable inputs
(Level 3)
December 31, 2012
Available-for-sale investment securities:
M unicipals
GNM A
M ortgage-backed securities
Loans held for sale
Derivative assets:
-
$
-
-
-
M ortgage loan interest rate lock commitments
M ortgage loan forward sales commitments
M ortgage-backed securities forward sales commitments
Total
-
-
-
$
-
December 31, 2011
Available-for-sale investment securities:
M unicipals
GNM A
M ortgage-backed securities
Loans held for sale
Derivative assets:
M ortgage loan interest rate lock commitments
M ortgage loan forward sales commitments
Derivative liabilities-
-
$
-
-
-
-
M ortgage-backed securities forward sales commitments
Total
-
$
-
17,769
23,011
108,890
144,849
4,783
1,692
67
301,061
1,137
23,991
111,816
80,007
2,832
1,168
1,234
222,185
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
Assets measured at fair value on a nonrecurring basis are as follows as of December 31, 2012 and 2011:
December 31, 2012
Impaired loans
Real estated owned
Total
December 31, 2011
Impaired loans
Real estated owned
Total
Quoted market price
in active markets
(Level 1)
S ignificant other
observable inputs
(Level 2)
(In thousands)
S ignificant other
unobservable inputs
(Level 3)
$
-
-
$
-
-
$
-
$
-
31,045
6,284
37,329
56,338
6,097
62,435
-
-
-
-
-
-
The Company predominantly lends with real estate serving as collateral on a substantial majority of loans. Loans that are deemed
to be impaired are primarily valued at fair values of the underlying real estate collateral.
69
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
NOTE 14 - OFF-BALANCE SHEET FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK
The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to extend credit. These instruments involve, to varying
degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.
The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for
commitments to extend credit is represented by the contractual amount of these instruments. The Company uses the same credit
policies in making commitments as for on-balance sheet instruments. At December 31, 2012 and 2011, the Company had
commitments to extend credit in the amount of $31.9 million and $30.8 million, respectively. At December 31, 2012 and 2011,
the Company had standby letters of credit in the amount of $396,000 and $481,000, respectively.
Standby letters of credit obligate the Company to meet certain financial obligations of its customers, if, under the contractual terms
of the agreement, the customers are unable to do so. Payment is only guaranteed under these letters of credit upon the borrower’s
failure to perform its obligations to the beneficiary. The Company can seek recovery of the amounts paid from the borrower and
the letters of credit are generally not collateralized. Commitments under standby letters of credit are usually one year or less. At
December 31, 2012, the Company has recorded no liability for the current carrying amount of the obligation to perform as a
guarantor; as such amounts are not considered material. The maximum potential of undiscounted future payments related to
standby letters of credit at December 31, 2012 was approximately $396,000.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in
the contract. Commitments generally have fixed expiration dates or other termination clauses and may require a payment of a fee.
Since commitments may expire without being drawn upon, the total commitments do not necessarily represent future cash
requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the party.
Collateral held varies, but may include inventory, property and equipment, residential real estate and income producing
commercial properties.
The Company uses derivatives primarily to neutralize interest rate risk related to its pipeline of interest rate lock commitments
issued on residential mortgage loans in the process of origination for sale. At December 31, 2012 and 2011, the Company’s
outstanding mortgage interest rate lock commitments totaled $289.6 million and $218.5 million, respectively. The Company uses
mortgage loan forward sales commitments and mortgage-backed securities forward sales commitments that generally correspond
with the composition of the locked pipeline to hedge a percentage of the Company’s pipeline of mortgage loan interest rate lock
commitments and loans held for sale. At December 31, 2012 and 2011, the Company’s outstanding mortgage loan forward sales
commitments totaled $59.2 million and $48.0 million, respectively. At December 31, 2012 and 2011, the Company’s outstanding
mortgage-backed securities forward sales commitments totaled $308.0 million and $167.0 million, respectively. The Company’s
derivative positions are marked to market as shown in Note 3 - Derivatives.
Management closely monitors its credit concentrations and attempts to diversify the portfolio within its market area. The
Company’s markets are concentrated along coastal South Carolina. A summary of commercial real estate credit concentrations
follows:
At December 31,
2011
2012
(In thousands)
Commercial real estate loans, excluding owner occupied
and unfunded commitments
Loans secured by owner occupied commercial real estate
Unfunded commitments of commercial real estate
Total
NOTE 15 - EMPLOYEE BENEFIT PLANS
$
$
174,680
122,498
9,172
306,350
191,958
126,009
5,999
323,966
The Company maintains a 401(k) plan that covers substantially all employees of CresCom Bank, Carolina Services (“CFC
participants”) and Crescent Mortgage (“CMC Participants”). Participants may contribute up to the maximum allowed by the
regulation. During fiscal 2012 and 2011, the Company matched 75% of an employee’s contribution up to 6.00% of the
70
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
participant’s compensation of the CFC Participants and the CMC Participants. For the years ended December 31, 2012, 2011 and
2010, the Company made matching contributions of $461,000, $424,000 and $448,000, respectively.
The Company has an arrangement with two executives whereby the Company made payments to an insurance company on behalf
of the executives. The advance is treated as a loan to the executive and the cash surrender value of the payment to the insurance
company is included in other assets in the accompanying consolidated statements of financial condition. The cash surrender value
of the advance at December 31, 2012 and 2011 is $813,000 and $1.1 million, respectively. The executive is entitled to the increase
in cash value above the Company’s original cash value insurance contributions. The executive pays the Company imputed interest
on the loan balance and the increase in the cash value is recorded as compensation to the executives. The insurance policy
premiums are paid in full by the executives. Generally, each executive is entitled to receive a $1.0 million death benefit and the
Company will receive a $1.8 million death benefit. Since the executive pays the insurance premiums, the insurance proceeds
would be taxable to the Company.
NOTE 16 - EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share are calculated by dividing net income (loss) by the weighted average number of common shares
outstanding during the period. Diluted earnings (loss) per share is calculated by dividing net income (loss) by the weighted
average number of common shares outstanding plus the weighted average number of additional common shares that would have
been outstanding if the dilutive potential common shares had been issued. Diluted earnings (loss) per share include the effects of
outstanding stock options issued by the Company if dilutive. The number of additional shares is calculated by assuming that
outstanding stock options were exercised and that the proceeds from such exercises were used to acquire shares of common stock
at the average market price during the reporting period.
The following is a summary of the reconciliation of average shares outstanding for the years ended December 31, 2012, 2011 and
2010:
2012
December 31,
2011
2010
Basic
Diluted
Basic
Diluted
Basic
Diluted
Weighted average shares outstanding
Effect of dilutive securities - stock options
Average shares outstanding
1,918,992
-
1,918,992
1,918,992
-
1,918,992
1,918,992
-
1,918,992
1,918,992
-
1,918,992
1,913,240
-
1,913,240
1,913,240
-
1,913,240
The average market price used in calculating the dilutive securities under the treasury stock method for the years ended December
31, 2012, 2011 and 2010 was $15.12, $10.71, and $14.90, respectively. For the years ended December 31, 2012, 2011 and 2010,
8,240, 140,480 and 140,480 option shares, respectively, were excluded from the calculation of diluted earnings per share during
the period because the exercise prices were greater than the average market price of the common shares, and therefore would have
been anti-dilutive. The Company does not have an actively traded market for its shares and, accordingly, the average market price
used in calculating dilutive securities is based either on a very limited number of transactions or on a valuation model.
NOTE 17 - CAPITAL REQUIREMENTS AND OTHER RESTRICTIONS
The Company and the Bank are subject to various federal and state regulatory requirements, including regulatory capital
requirements. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary
actions that if undertaken could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific
capital guidelines that involve quantitative measures of the Company’s and the Bank’s assets, liabilities, and certain off-balance
sheet items as calculated under regulatory methods. The Company’s and the Bank’s capital amounts and classifications are also
subject to qualitative judgments by the regulators about components, risk weighting and other factors. As of December 31, 2012,
the most recent notification from federal banking agencies categorized the Company and the Bank as “well capitalized” under the
regulatory framework. In order to be considered “adequately capitalized”, the Company and the Bank are required to maintain
minimum Tier 1 capital and total risk based capital to risk weighted assets and Tier 1 capital to total average assets of 4%, 8%, and
3%, respectively. In order to be considered “well capitalized”, the Company and the Bank are required to maintain minimum Tier
1 capital and total risk based capital to risk weighted assets and Tier 1 capital to total average assets of 6%, 10%, and 5%,
71
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
respectively. Since December 31, 2011, there have been no events or conditions that management believes have changed the
Company’s or the Bank’s regulatory capital categories.
The actual capital amounts and ratios for the Company and the Bank at December 31, 2012 and 2011 are as follows:
Carolina Financial Corporation
Tier 1 capital (to risk weighted assets)
Total risk based capital (to risk weighted assets)
Tier 1 capital (to total average assets)
CresCom Bank
Tier 1 capital (to risk weighted assets)
Total risk based capital (to risk weighted assets)
Tier 1 capital (to total average assets)
At December 31,
2012
2011
Amount
Ratio
Amount
Ratio
(Dollars in thousands)
$
82,839
98,030
82,839
85,537
100,714
85,537
13.11%
15.52%
9.65%
13.57%
15.97%
10.01%
65,876
83,357
65,876
10.48%
13.27%
7.94%
68,240
85,706
68,240
10.88%
13.67%
8.18%
A South Carolina state bank may not pay dividends from capital. All dividends must be paid out of undivided profits then on hand,
after deducting expenses, including reserves for losses and bad debts. Unless otherwise instructed by the South Carolina Board of
Financial Institutions, the Bank is generally permitted under South Carolina state banking regulations to pay cash dividends of up to
100% of net income in any calendar year without obtaining the prior approval of the South Carolina Board of Financial Institutions.
However, given the restrictions imposed by the Bank’s regulators, at December 31, 2012 the Bank cannot pay dividends without
prior approval from the appropriate regulatory agencies. In addition, under the Federal Deposit Insurance Corporation
Improvement Act, the Bank may not pay a dividend if, after paying the dividend, the Bank would be undercapitalized. The FRB
may also prevent the payment of a dividend by the Bank if it determines that the payment would be an unsafe and unsound banking
practice.
In June 2012, U.S. banking regulators issued the Basel III Notice of Proposed Rulemaking (NPR) to implement Basel III
regulatory capital reforms from the Basel Committee on Banking Supervision and changes required by the Financial Reform Act.
The Basel III NPR proposes material changes to the deduction of certain assets from capital, new minimum capital ratios and
buffer requirements, a Standardized Approach that provides a floor to the calculation of risk-weighted assets, and significant
changes to the calculation of credit and counterparty credit risk.
The Basel III NPR addressing standardized risk-weighting of assets would significantly change the risk-weighting of certain assets
for almost all U.S. financial institutions beginning in 2015. To what extent the NPR will be adopted as proposed in not known;
however, management estimates that the Company would remain a well-capitalized institution under its interpretation of the
proposed increased capital requirements and risk-weighted asset revisions if the proposal had been fully in effect as of December
31, 2012.
Many of the changes to capital deductions are subject to a transition period where the impact is recognized in 20% increments
beginning on January 1, 2014 through January 1, 2018. The majority of the other aspects of the Basel III NPR were proposed to
become effective January 1, 2013. However, this effective date was postponed in November 2012. The delay is expected to be a
six-month time period. The phase-in period for the new minimum capital requirements and related buffers is proposed to occur
between 2013 and 2019.
Management expects to comply with the final rules when issued and effective. To prepare for the implementation of the new
capital rules, management continues to build capital through retained earnings and is evaluating strategies to maximize the
Company’s capital under the Basel III NPR.
NOTE 18 – SUPPLEMENTAL SEGMENT INFORMATION
The Company has three reportable segments: community banking, mortgage banking and other. The community banking segment
provides traditional banking services offered through CresCom Bank. The mortgage banking segment provides mortgage loan
72
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
origination and servicing offered through Crescent Mortgage. The other segment provides managerial and operational support to
the other business segments through Carolina Services and Carolina Financial.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The
Company evaluates performance based on net income.
The Company accounts for intersegment revenues and expenses as if the revenue/expense transactions were to third parties, that is,
at current market prices.
The Company’s reportable segments are strategic business units that offer different products and services. They are managed
separately because each segment has different types and levels of credit and interest rate risk.
The following tables present selected financial information for the Company’s reportable business segments for the years ended
December 31, 2012, 2011 and 2010:
Community Mortgage
Banking
Banking
Other
(In thousands)
Eliminations
Total
1,801
397
1,404
-
54,660
618
21,972
1,099
33,611
12,603
21,008
54,204
853
27,046
-
1,932
18
748
(730)
-
59
5,813
5,744
-
(602)
(183)
(419)
88,344
-
-
-
18,365
13
(9)
22
-
-
(6,431)
-
(5,952)
(457)
(156)
(301)
(128,178)
(607)
-
(2,239)
(151)
35,358
7,513
27,845
2,707
52,284
-
50,149
-
27,273
10,395
16,878
888,724
501,691
144,849
653,247
147,322
For the Year Ended December 31, 2012
Interest income
Interest expense
Net interest income (expense)
Provision for loan losses
Noninterest income (expense) from external customers
Intersegment noninterest income
Noninterest expense
Intersegment noninterest expense
Income (loss) before income taxes
Income tax expense (benefit)
Net income (loss)
$
33,526
6,377
27,149
2,707
(2,435)
-
22,433
4,853
(5,279)
(1,869)
(3,410)
$
Assets
Loans receivable, net
Loans held for sale
Deposits
Borrowed funds
$
874,354
501,445
117,803
655,486
127,176
73
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
For the Year Ended December 31, 2011
Interest income
Interest expense
Net interest income (expense)
Provision for loan losses
Noninterest income (expense) from external customers
Intersegment noninterest income
Noninterest expense
Intersegment noninterest expense
Income (loss) before income taxes
Income tax expense (benefit)
Net income (loss)
Assets
Loans receivable, net
Loans held for sale
Deposits
Borrowed funds
For the Year Ended December 31, 2010
Interest income
Interest expense
Net interest income (expense)
Provision for loan losses
Noninterest income from external customers
Intersegment noninterest income
Noninterest expense
Intersegment noninterest expense
Income (loss) before income taxes
Income tax expense (benefit)
Net income (loss)
Assets
Loans receivable, net
Loans held for sale
Deposits
Borrowed funds
Community
Banking
M ortgage
Banking
Other
(In thousands)
Eliminations
Total
$
37,483
10,262
27,221
10,735
6
-
19,090
4,853
(7,451)
(2,513)
(4,938)
$
$
816,257
512,353
64,076
624,443
122,876
952
136
816
-
19,521
-
12,567
960
6,810
2,588
4,222
28,773
1,132
15,931
-
2,584
17
726
(709)
-
194
5,813
5,756
-
(458)
(203)
(255)
70,800
-
-
-
18,565
(11)
(11)
-
-
-
(5,813)
-
(5,813)
-
-
-
(89,612)
(150)
-
(2,640)
(151)
38,441
11,113
27,328
10,735
19,721
-
37,413
-
(1,099)
(128)
(971)
826,218
513,335
80,007
621,803
143,874
Community
Banking
M ortgage
Banking
Other
(In thousands)
Eliminations
Total
891
467
424
-
24,631
-
14,600
960
9,495
3,608
5,887
29,669
529
14,883
-
3,959
18
718
(700)
-
1,042
5,812
5,776
-
378
152
226
71,063
-
-
-
18,665
(22)
(22)
-
-
-
(5,812)
-
(5,812)
-
-
-
(87,774)
(200)
-
(1,155)
(201)
46,842
17,077
29,765
30,755
21,600
-
39,070
-
(18,460)
(5,872)
(12,588)
930,749
583,995
82,615
689,814
181,098
$
45,955
15,914
30,041
30,755
(4,073)
-
18,694
4,852
(28,333)
(9,632)
(18,701)
$
$
917,791
583,666
67,732
690,969
158,675
74
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
NOTE 19 - PARENT COMPANY FINANCIAL INFORMATION
The condensed financial statements for the parent company are presented below:
Carolina Financial Corporation
Condensed Statements of Financial Condition
At December 31,
2012
2011
(In thousands)
$
439
85,213
643
465
1
213
86,974
$
1,245
2,750
15,465
67,514
86,974
$
375
63,020
439
465
1
511
64,811
741
200
18,215
45,655
64,811
For the Year
Ended December 31,
2011
(In thousands)
2012
2010
$
150
18
-
168
739
451
1,190
(1,022)
(398)
(624)
-
-
17,297
205
17,502
16,878
$
500
17
143
660
714
625
1,339
(679)
(474)
(205)
-
-
(715)
(51)
(766)
(971)
300
18
1,042
1,360
697
653
1,350
10
(99)
109
(793)
(12,021)
-
117
(12,697)
(12,588)
Assets:
Cash and cash equivalents
Investment in bank subsidiaries
Investment in non-bank subsidiaries
Investment in unconsolidated statutory business trusts
Securities available for sale
Other assets
Total assets
Liabilities and stockholders' equity:
Accrued expenses and other liabilities
Short-term debt
Long-term debt
Stockholders' equity
Total liabilities and stockholders' equity
Carolina Financial Corporation
Condensed Statements of Operations
Dividend income from non-bank subsidiaries
Interest income
Gain on sale of securities available for sale
Total income
Interest expense
General and administrative expenses
Total expenses
Income (loss) before income taxes and equity in undistributed earnings
(losses) of subsidiaries
Income tax benefit
Income (loss) before equity in undistributed earnings of subsidiaries
Equity in undistributed earnings (losses) of Community FirstBank
Equity in undistributed earnings (losses) of Crescent Bank
Equity in undistributed earnings (losses) of CresCom Bank
Equity in undistributed earnings (losses) of Carolina Services
Total equity in undistributed earnings (losses) of subsidiaries
Net income (loss)
75
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
Carolina Financial Corporation
Condensed Statements of Cash Flows
Cash flows from operating activities:
Net income (loss)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Equity in undistributed earnings (losses) in subsidiaries
Gain on sale of securities available for sale
Stock-based compensation
(Increase) decrease in other assets
Increase (decrease) in other liabilities
Net cash provided by (used in) operating activities
Cash flows from investing activities:
Proceeds from the sale of securities available for sale
Equity investment in bank subsidiaries
Net cash provided by (used in) financing activities
Cash flows from financing activities -
Principal repayment of short term debt
Net cash used in financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of year
Cash and cash equivalents, end of year
For the Year
Ended December 31,
2011
(In thousands)
2012
2010
$
16,878
(971)
(12,588)
(17,502)
-
86
298
504
264
-
-
-
(200)
(200)
64
375
439
$
766
(143)
271
(366)
607
164
150
(200)
(50)
(50)
(50)
64
311
375
12,697
(1,042)
391
144
(251)
(649)
1,065
(1,000)
65
-
-
(584)
895
311
NOTE 20 – QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The tables below represent the quarterly results of operations for the years ended December 31, 2012, 2011 and 2010 respectively:
For the Year Ended December 31, 2012
First
S econd
Third
Fourth
(In thousands, except per share data)
Total interest income
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Noninterest income
Noninterest expense
Income before taxes
Income tax expense
Net income
Basic earnings per share
Diluted earnings per share
76
$
8,954
2,036
6,918
2,067
4,851
9,632
11,007
3,476
1,376
2,100
1.09
1.09
$
$
$
8,920
1,887
7,033
115
6,918
11,136
15,258
2,796
1,202
1,594
0.83
0.83
8,870
1,819
7,051
250
6,801
13,962
12,007
8,756
3,308
5,448
2.84
2.84
8,614
1,771
6,843
275
6,568
17,554
11,877
12,245
4,509
7,736
4.04
4.04
CAROLINA FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
For the Year Ended December 31, 2011
First
Second
Third
Fourth
(In thousands, except per share data)
Total interest income
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Noninterest income
Noninterest expense
Income (loss) before taxes
Income tax expense (benefit)
Net income (loss)
Basic earnings (losses) per share
Diluted earnings (losses) per share
Total interest income
Total interest expense
Net interest income
Provision for loan losses
Net interest income (loss) after provision for loan losses
Noninterest income
Noninterest expense
Loss before taxes
Income tax benefit
Net loss
Basic loss per share
Diluted loss per share
$
10,187
3,167
7,020
1,700
5,320
4,848
8,973
1,195
488
707
0.37
0.37
$
$
$
9,653
2,892
6,761
3,550
3,211
4,776
8,613
(626)
(147)
(479)
(0.25)
(0.25)
9,412
2,631
6,781
2,580
4,201
5,799
10,270
(270)
(53)
(217)
(0.11)
(0.11)
9,189
2,423
6,766
2,905
3,861
4,298
9,557
(1,398)
(416)
(982)
(0.52)
(0.52)
For the Year Ended December 31, 2010
First
Second
Third
Fourth
(In thousands, except per share data)
12,242
4,580
7,662
9,630
(1,968)
5,432
9,102
(5,638)
(2,037)
(3,601)
(1.88)
(1.88)
11,657
4,158
7,499
8,030
(531)
7,658
10,563
(3,436)
(885)
(2,551)
(1.33)
(1.33)
10,380
3,631
6,749
8,155
(1,406)
3,326
10,963
(9,043)
(2,862)
(6,181)
(3.23)
(3.23)
$
12,563
4,708
7,855
4,940
2,915
5,184
8,442
(343)
(88)
(255)
$
$
(0.14)
$
(0.14)
77
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