News Column

SELECT BANCORP, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 11, 2014

Management's discussion and analysis is intended to assist readers in the understanding and evaluation of the financial condition and results of operations of Select Bancorp, Inc. (the "Company"). This report contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 relating to, without limitation, our future economic performance, plans and objectives for future operations, and projections of revenues and other financial items that are based on our beliefs, as well as assumptions made by and information currently available to us. The words "may," "will," "anticipate," "should," "would," "believe," "contemplate," "could," "project," "predict," "expect," "estimate," "continue," and "intend," as well as other similar words and expressions of the future, are intended to identify forward-looking statements. Our actual results, performance or achievements may differ materially from the results expressed or implied by our forward-looking statements. Factors that could influence actual results, performance or achievements include changes in national, regional and local market conditions, legislative and regulatory conditions, and the interest

rate environment. Overview The Company is a commercial bank holding company and has one banking subsidiary, Select Bank & Trust Company (referred to as the "Bank") and one unconsolidated subsidiary, New Century Statutory Trust I, which issued trust preferred securities in 2004 to provide additional capital for general corporate purposes. The Company's only business activity is the ownership of the Bank and New Century Statutory Trust I. This discussion focuses primarily on the financial condition and operating results of the Bank. The Bank's lending activities are oriented to the consumer/retail customer as well as to the small- to medium-sized businesses located in Harnett, Cumberland, Johnston, Pitt, Robeson, Sampson, Wake and Wayne counties in North Carolina. The Bank offers the standard complement of commercial, consumer, and mortgage lending products, as well as the ability to structure products to fit specialized needs. The deposit services offered by the Bank include small business and personal checking accounts, savings accounts and certificates of deposit. In October 2013, the Bank opened a full service office in Wake County. The Bank concentrates on customer relationships in building its customer deposit base and competes aggressively in the area of transaction accounts. Comparison of Financial Condition at June 30, 2014 and December 31, 2013 During the first six months of 2014, total assets decreased by $17.4 million to $508.3 million as of June 30, 2014. Earning assets at June 30, 2014 totaled $458.7 million and consisted of $327.4 million in net loans, $79.9 million in investment securities, $49.8 million in overnight investments and interest-bearing deposits in other banks and $1.6 million in non-marketable equity securities. Total deposits and shareholders' equity at the end of the second quarter of 2014 were $428.7 million and $57.6 million, respectively. Since the end of 2013, gross loans have decreased by $12.6 million to $333.9 million as of June 30, 2014 due to continued soft loan demand. Gross loans consisted of $31.7 million in commercial and industrial loans, $157.0 million in commercial real estate loans, $18.4 million in multi-family residential loans, $5.7 million in consumer loans, $30.7 million in residential real estate, $30.6 million in HELOC, and $60.5 million in construction loans. Deferred loan fees, net of costs, on these loans were $629,000. At June 30, 2014 and December 31, 2013, the Company held $3.0 million in federal funds sold. Interest-earning deposits in other banks were $46.7 million at June 30, 2014, a $3.0 million decrease from December 31, 2013. The Company's investment securities at June 30, 2014 were $79.9 million, a decrease of $3.9 million from December 31, 2013. The investment portfolio as of June 30, 2014 consisted of $27.2 million in government agency debt securities, $45.2 million in mortgage-backed securities and $7.5 million in municipal securities. The net unrealized gain on these securities was $757,000. 44

At June 30, 2014, the Company held an investment of $562,000 in the form of Federal Home Loan Bank ("FHLB") stock, which decreased by $234,000 from December 31, 2013 due to a redemption by the FHLB. Also, the Company had $1.0 million in other non-marketable securities at June 30, 2014, which decreased by $14,000 from December, 31, 2013 due to a security redemption. At June 30, 2014, non-earning assets were $49.6 million, an increase of $1.8 million from the $47.8 million as of December 31, 2013. Non-earning assets included $23.7 million in cash and due from banks, bank premises and equipment of $10.9 million, core deposit intangible of $124,000, accrued interest receivable of $1.5 million, foreclosed real estate of $1.2 million, $8.6 million in bank owned life insurance ("BOLI"), $2.2 million in deferred tax assets, and $1.4 million in all other assets. Since the income on BOLI is included in non-interest income, this asset is not included in the Company's calculation of earning assets.

Total deposits at June 30, 2014 were $428.7 million and consisted of $82.0 million in non-interest-bearing demand deposits, $118.8 million in money market and NOW accounts, $17.3 million in savings accounts, and $210.6 million in time deposits. Total deposits decreased by $19.7 million from $448.5 million as of December 31, 2013. The Bank had $497,000 in brokered demand deposits and no brokered time deposits as of June 30, 2014. Overall deposits decreased due to reduced funding needs as a result of lower asset balances.



As of June 30, 2014, the Company had $7.2 million in repurchase agreements with local customers that are classified as short-term debt and $12.4 million in junior subordinated debentures that are classified as long-term debt.

Total shareholders' equity at June 30, 2014 was $57.6 million, an increase of $1.6 million from $56.0 million as of December 31, 2013. Accumulated other comprehensive income relating to available for sale securities increased $583,000 during the six months ended June 30, 2014. Other changes in shareholders' equity included increases of $11,000 in stock-based compensation, net income of $885,000, and $68,000 from the exercise of stock options.



Past Due Loans, Non-performing Assets, and Asset Quality

At June 30, 2014, the Company had $513,000 in loans that were 30 to 89 days past due. This represented 0.15% of gross loans outstanding on that date. This is a decrease from December 31, 2013 when there were $874,000 in loans that were 30-89 days past due or 0.25% of gross loans outstanding. Non-accrual loans decreased from $9.3 million at December 31, 2013 to $7.6 million at June 30, 2014. The percentage of non-performing loans (non-accrual loans and accruing troubled debt restructurings) to total loans decreased from 4.58% at December 31, 2013 to 3.88% at June 30, 2014, due to a decrease in accruing troubled debt restructurings and non-accruals and reduced loan balances. At June 30, 2014, the Company had forty-three loans totaling $8.1 million that were considered to be troubled debt restructurings. Twenty-four of these loans totaling $5.3 million were still in accruing status with the remaining TDRs included in non-accrual loans. All TDRs are considered non-performing loans regardless of accrual status. The table below sets forth, for the periods indicated, information about the Company's non-accrual loans, loans past due 90 days or more and still accruing interest, total non-performing loans (non-accrual loans plus accruing TDRs), and total non-performing assets. 45 For Periods Ended June 30, December 31, 2014 2013 (Dollars in thousands) Non-accrual loans $ 7,607$ 9,319 Accruing TDRs 5,345 6,537 Total non-performing loans 12,952 15,856 Foreclosed real estate 1,169 2,008 Total non-performing assets $ 14,121$ 17,864

Accruing loans past due 90 days or more $ - $ - Allowance for loan losses $ 6,447



$ 7,054

Non-performing loans to period end loans 3.88 % 4.58 %



Non-performing loans and accruing loans past due 90 days or more to period end loans

3.88 % 4.58 % Allowance for loans losses to period end loans 1.93 % 2.04 % Allowance for loan losses to non-performing loans 50 % 44 % Allowance for loan losses to non-performing assets 46 % 39 %



Allowance for loan losses to non-performing assets and accruing loans past due 90 days or more

46 % 39 % Non-performing assets to total assets 2.78 % 3.40 % Non-performing assets and accruing loans past due 90 days or more to total assets 2.78 % 3.40 % Total non-performing assets (non-accrual loans, accruing TDRs, and foreclosed real estate) at June 30, 2014 and December 31, 2013 were $14.1 million and $17.9 million, respectively. The allowance for loan losses at June 30, 2014 represented 46% of non-performing assets compared to 39% at December 31, 2013. Total impaired loans at June 30, 2014 were $14.5 million. This includes $7.6 million in loans that were classified as impaired because they were in non-accrual and $6.9 million in loans that were determined to be impaired for other reasons. Of these loans, $4.1 million required a specific reserve of $776,000 at June 30, 2014. Total impaired loans at December 31, 2013 were $19.0 million. This includes $9.3 million in loans that were considered to be impaired due to being in non-accrual status and $9.7 million in loans that were deemed to be impaired for other reasons. Of these loans, $7.4 million required a specific reserve of $1.1 million at December 31, 2013. The allowance for loan losses was $6.4 million at June 30, 2014 or 1.93% of gross loans outstanding. This is a decrease from the 2.04% reported as a percentage of gross loans at December 31, 2013. The allowance for loan losses at June 30, 2014 represented 44.4% of impaired loans compared to 37.2% at December 31, 2013. It is management's assessment that the allowance for loan losses as of June 30, 2014 is appropriate in light of the risk inherent within the Company's loan portfolio. No assurances, however, can be made that further adjustments to the allowance for loan losses may not be deemed necessary in the future. 46 Other Lending Risk Factors

Besides monitoring non-performing loans and past due loans, management also monitors trends in the loan portfolio that may indicate more than normal risk. A discussion of certain other risk factors follows. Some loans or groups of loans may contain one or more of these individual loan risk factors. Therefore, an accumulation of the amounts or percentages of the individual loan risk factors may not necessarily be an indication of the cumulative risk in the total loan portfolio. Regulatory Loan to Value



The Company monitors its exposure to loans that exceed the guidelines established by regulators for loan to value ("LTV") ratios.

At June 30, 2014 and December 31, 2013 the Company had $3.5 million and $3.7 million in non 1-to-4 family residential loans that exceeded the regulatory LTV limits, respectively. At June 30, 2014 and December 31, 2013 the Company had $5.7 million and $6.1 million of 1-to-4 family residential loans that exceeded the regulatory LTV limits, respectively. The total amount of these loans represented 12.8% and 13.8% of total risk-based capital as of June 30, 2014 and December 31, 2013, which is less than the 100% maximum allowed. These loans may provide more than ordinary risk to the Company if the real estate market weakens in terms of both market activity and collateral valuations.



Business Sector Concentrations

Loan concentrations in certain business sectors can be impacted by lower than normal retail sales, higher unemployment, higher vacancy rates, and a weakening in real estate market conditions. The Company has established an internal commercial real estate guideline of 40% of risk-based capital for any single product line.

At June 30, 2014 the Company had one product type group which exceeded this guideline; Real Estate Construction - Speculative and Presold, which represented 41% of risk-based capital, or $29.4 million. All other commercial real estate groups were under the 40% threshold. At December 31, 2013, there were no product types exceeding this internal guideline. 47



Acquisition, Development, and Construction Loans ("ADC")

The tables below provide information regarding loans the Company originates for the purpose of acquisition, development, and construction of both residential and commercial properties as of June 30, 2014 and December 31, 2013. Acquisition, Development and Construction Loans (Dollars in thousands) June 30, 2014 December 31, 2013 Land and Land Land and Land Construction Development Total Construction Development Total

Total ADC loans $ 49,930$ 16,610$ 60,541$ 37,932$ 15,393$ 53,325 Average Loan Size $ 126 $ 346 $ 128 $ 358

Percentage of total loans 13.16 % 4.98 %

18.13 % 10.95 % 4.44 % 15.39 % Non-accrual loans $ 664 $ 224 $ 889 $ 660 $ 546 $ 1,206



Management monitors the ADC portfolio by reviewing funding based on project completeness, monthly and quarterly inspections as required by the project, collateral value, geographic concentrations, spec-to-presold ratios and performance of similar loans in the Company's market area.

Geographic Concentrations

Certain risks exist arising from the geographic location of specific types of higher than normal risk real estate loans. Below is a table showing geographic concentrations for ADC and HELOC loans at June 30, 2014 and December 31, 2013. June 30, 2014 December 31, 2013 ADC Loans Percent HELOC Percent ADC Loans Percent HELOC Percent (Dollars in thousands) Harnett County $ 4,755 7.85 % $ 6,088 19.92 % $ 3,862 7.24 % $ 6,258 19.64 % Cumberland County 26,751 44.19 % 6,350 20.78 % 20,737 38.89 % 6,416 20.13 % Johnston County 1,261 2.08 % 453 1.48 % 653 1.22 % 494 1.55 % Pitt County 4,602 7.60 % 105 0.34 % 5,825 10.92 % 268 0.84 % Robeson County 849 1.40 % 3,508 11.48 % 1,083 2.03 % 3,546 11.13 % Sampson County 148 0.25 % 1,571 5.14 % 357 0.67 % 1,745 5.48 % Wake County 10,422 17.21 % 823 2.69 % 7,863 14.75 % 709 2.23 % Wayne County 1,834 3.03 % 5,435 17.78 % 2,716 5.09 % 5,469 17.16 % Hoke County 2,771 4.58 % 138 0.45 % 3,084 5.78 % 166 0.52 % All other locations 7,148 11.81 % 6,090 19.93 % 7,145 13.41 % 6,792 21.32 % Total $ 60,541 100.00 % $ 30,561 100.00 % $ 53,325 100.00 % $ 31,863 100.00 % 48 Interest Only Payments Another risk factor that exists in the total loan portfolio pertains to loans with interest only payment terms. At June 30, 2014, the Company had $92.6 million in loans that had terms permitting interest only payments. This represented 27.7% of the total loan portfolio. At December 31, 2013, the Company had $89.6 million in loans that had terms permitting interest only payments. This represented 25.9% of the total loan portfolio. Recognizing the risk inherent with interest only loans, it is customary and general industry practice that loans in the ADC portfolio permit interest only payments during the acquisition, development, and construction phases of such projects. Large Dollar Concentrations Concentrations of high dollar loans or large customer relationships may pose additional risk in the total loan portfolio. The Company's ten largest loans or lines of credit totaled $47.1 million, or 14.1% of total loans, at June 30, 2014 compared to $44.7 million, or 12.9% of total loans, at December 31, 2013. The Company's ten largest customer relationships totaled $63.6 million, or 19.0% of total loans, at June 30, 2014 compared to $62.1 million, or 17.9% of total loans, at December 31, 2013. Deterioration or loss in any one or more of these high dollar loan or customer concentrations could have an immediate, significant adverse impact on the Company's capital position. 49 Comparison of Results of Operations for the Three months ended June 30, 2014 and 2013 General. During the second quarter of 2014, the Company had net income of $613,000 as compared with net income of $1.3 million for the second quarter of 2013. Net income per share for the second quarter of 2014 was $0.09, basic and diluted, compared with net income per share of $0.18, basic and diluted, for the second quarter of 2013. Results of operations for the second quarter of 2014 were primarily impacted by an increase of $398,000 in non-interest expense, merger expenses of $237,000, a decrease of $727,000 in loan interest income, and a larger recovery of loan losses of $427,000 compared to a recovery of $375,000 in the second quarter of 2013. Net interest margin of 3.64% in the second quarter of 2014 decreased 1 basis point from the same period in 2013. Net Interest Income. Net interest income declined to $4.6 million for the second quarter of 2014 from $5.0 million for the second quarter of 2013. The Company's total interest income was affected by a reduction in the balances and yield on interest-earning assets due to continued soft loan demand. Average total interest-earning assets were $463.8 million in the second quarter of 2014 compared with $511.1 million during the same period in 2013, while the yield on those assets decreased 18 basis points from 4.72% to 4.54%. The Company's average interest-bearing liabilities decreased by $47.8 million to $371.5 million for the quarter ended June 30, 2014 from $419.3 million for the same period one year earlier and the cost of those funds decreased from 1.30% to 1.20%, or 10 basis points. During the second quarter of 2014, the Company's net interest margin was 3.64% and net interest spread was 3.34%. In the same quarter ended one year earlier, net interest margin was 3.65% and net interest spread was 3.42%.

Provision for Loan Losses. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for loan losses, management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower's ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. In determining the loss history to be applied to its ASC 450 loan pools within the allowance for loan losses, the Company has previously used loss history based on the weighted average net charge off history for the most recent fourteen consecutive quarters, based on the risk-graded pool to which the loss was assigned. Historical loss rates are now calculated by using a loss migration analysis associating losses to the risk-graded pool to which they relate for each of the previous twelve quarters. Then, using a twelve quarter look back period, loss factors are calculated for each risk-graded pool. During the second quarter, the Company recorded a recovery of loan losses of $427,000 which is a larger recovery than the recovery that was recorded in the second quarter of 2013. In both 2014 and 2013, the recovery resulted from a low level of net charge-offs coupled with a reduction in overall loan balances. Non-Interest Income. Non-interest income for the quarter ended June 30, 2014 was $565,000, a decrease of $190,000 from the second quarter of 2013. Service charges on deposit accounts decreased $50,000 to $226,000 for the quarter ended June 30, 2014 from $276,000 for the same period in 2013, primarily due to a decline in overdraft charges. Fees from presold mortgages decreased $12,000 to $0 for the quarter ended June 30, 2014 from the same period in 2013. During the first quarter of 2013, the Company decided to close its mortgage division, while more efficient and profitable ways to generate income from the 1-4 family mortgage market are evaluated. Other non-deposit fees and income decreased $128,000 from the second quarter of 2013 to the second quarter of 2014 due to a decrease in income from non-marketable securities. 50

Non-Interest Expenses. Non-interest expenses increased by $398,000 to $4.2 million for the quarter ended June 30, 2014, from $3.8 million for the same period in 2013. In general, most categories of non-interest expenses increased, offset by decreases in professional fees, information systems and foreclosed real estate-related expenses. Non-interest expenses were also impacted by $237,000 in merger and restructuring charges related to the acquisition of Select Bancorp, Inc., and by the opening of the Raleigh branch in the fourth quarter of 2013. The following are highlights of the significant categories of non-interest expenses during the second quarter of 2014 versus the same period in 2013:



Personnel expenses increased $104,000 to $2.1 million, due to additions in

personnel.

Foreclosed real estate-related expense decreased $27,000, primarily due to

declining balances in the other real estate owned portfolio.

Merger related expenses incurred in the second quarter of 2014 were $237,000.

Other non-interest expenses increased by $33,000, due to small increases in

several categories of other non-interest expenses.

Provision for Income Taxes. The Company's effective tax rate was 38.8% and 36.6% for the quarters ended June 30, 2014 and 2013, respectively. The effective tax rate for the second quarter of 2014 was impacted by non-deductible merger expenses incurred in the second quarter of 2014. As of June 30, 2014 and December, 31, 2013, the Company had a net deferred tax asset in the amount of $2.2 million and $2.5 million, respectively. In evaluating whether the Company will realize the full benefit of the net deferred tax asset, management considered both positive and negative evidence, including among other things recent earnings trends, projected earnings, and asset quality. As of June 30, 2014 and December 31, 2013, management concluded that the net deferred tax assets were fully realizable. The Company will continue to monitor deferred tax assets closely to evaluate whether the full benefit of the net deferred tax asset will require a valuation allowance. Significant negative trends in credit quality or losses from operations, among other trends, could impact the realization of the deferred tax asset in the future. Comparison of Results of Operations for the Six months ended June 30, 2014 and 2013

General. During the first six months of 2014, the Company had net income of $885,000 as compared with net income of $2.1 million for the first six months of 2013. Net income per share for the first six months of 2014 was $0.13, basic and diluted, compared with net income per share of $0.30, basic and diluted, for the first six months of 2013. Results of operations for the first six months of 2014 were primarily impacted by an increase of $928,000 in non-interest expense, an increase in foreclosure-related expenses of $121,000, merger related expenses of $398,000, and lower interest income on loans of $9.7 million compared to $11.0 million in the first six months of 2013. Net interest margin of 3.58% in the first six months of 2014 increased 5 basis points from the same period in 2013. Net Interest Income. Net interest income declined to $8.4 million for the first six months of 2014 from $9.1 million for the first six months of 2013. The Company's total interest income was affected by a reduction in the balances and yield on interest-earning assets due to continued soft loan demand. Average total interest-earning assets were $467.5 million in the first six months of 2014 compared with $523.1 million during the same period in 2013, while the yield on those assets decreased 4 basis points from 4.60% to 4.56%. The Company's average interest-bearing liabilities decreased by $52.0 million to $375.0 million for the six months ended June 30, 2014 from $427.0 million for the same period one year earlier and the cost of those funds decreased from 1.31% to 1.22%, or 9 basis points. During the first six months of 2014, the Company's net interest margin was 3.58% and net interest spread was 3.34%. In the same quarter ended one year earlier, net interest margin was 3.53% and

net interest spread was 3.29%. 51

Provision for Loan Losses. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for loan losses, management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower's ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. In determining the loss history to be applied to its ASC 450 loan pools within the allowance for loan losses, the Company has previously used loss history based on the weighted average net charge off history for the most recent fourteen consecutive quarters, based on the risk-graded pool to which the loss was assigned. Historical loss rates are now calculated by using a loss migration analysis associating losses to the risk-graded pool to which they relate for each of the previous twelve quarters. Then, using a twelve quarter look back period, loss factors are calculated for each risk-graded pool. During the first six months of 2014, the Company recorded a recovery of loan losses of $476,000 which is a slightly larger recovery than the recovery that was recorded in the first six months of 2013. In both 2014 and 2013, the recovery resulted from a low level of net charge-offs coupled with a reduction in overall loan balances. Non-Interest Income. Non-interest income for the six months ended June 30, 2014 was $1.2 million, a decrease of $183,000 from the first six months of 2013. Service charges on deposit accounts decreased $95,000 to $453,000 for the six months ended June 30, 2014 from $548,000 for the same period in 2013, primarily due to a decline in overdraft charges. Fees from presold mortgages decreased $73,000 to $0 for the six months ended June 30, 2014 from the same period in 2013. During the first quarter of 2013, the Company decided to close its mortgage division, while more efficient and profitable ways to generate income from the 1-4 family mortgage market are evaluated. Other non-deposit fees and income decreased $15,000 from the first six months of 2013 to the first six months of 2014 due to a decrease in income from non-marketable securities. Non-Interest Expenses. Non-interest expenses increased by $928,000 to $8.6 million for the six months ended June 30, 2014, from $7.7 million for the same period in 2013. In general, most categories of non-interest expenses increased, offset by decreases in marketing and advertising and professional fees. Non-interest expenses were also impacted by $398,000 in merger and restructuring charges related to the acquisition of Select Bancorp, Inc., and by the opening of the Raleigh branch in the fourth quarter of 2013. The following are highlights of the significant categories of non-interest expenses during the first six months of 2014 versus the same period in 2013:



Personnel expenses increased $170,000 to $4.3 million, due to additions in

personnel.

Foreclosed real estate-related expense increased $121,000, primarily due to a

large loss on one property in the other real estate owned portfolio.

Merger related expenses incurred in the first six months of 2014 were $398,000.

Other non-interest expenses increased by $200,000, due to small increases in

several categories of other non-interest expenses.

Provision for Income Taxes. The Company's effective tax rate was 37.9% and 36.7% for the six months ended June 30, 2014 and 2013, respectively. The effective tax rate for the first six months of 2014 was impacted by non-deductible merger expenses incurred in 2014. As of June 30, 2014 and December, 31, 2013, the Company had a net deferred tax asset in the amount of $2.2 million and $2.5 million, respectively. In evaluating whether the Company will realize the full benefit of the net deferred tax asset, management considered both positive and negative evidence, including among other things recent earnings trends, projected earnings, and asset quality. As of June 30, 2014 and December 31, 2013, management concluded that the net deferred tax assets were fully realizable. The Company will continue to monitor deferred tax assets closely to evaluate whether the full benefit of the net deferred tax asset will require a valuation allowance. Significant negative trends in credit quality or losses from operations, among other trends, could impact the realization of the deferred tax asset in the future. 52 Liquidity The Company's liquidity is a measure of its ability to fund loans, withdrawals and maturities of deposits, and other cash outflows in a cost effective manner. The principal sources of liquidity are deposits, scheduled payments and prepayments of loan principal, maturities of investment securities, access to liquid deposits, and funds provided by operations. While scheduled loan payments and maturing investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. Liquid assets (consisting of cash and due from banks, interest-earning deposits with other banks, federal funds sold and investment securities classified as available for sale) comprised 30.2% of

total assets at June 30, 2014.

The Company has been a net seller of federal funds since its inception and strives to maintain a position of liquidity sufficient to fund future loan demand and to satisfy fluctuations in deposit levels. Should the need arise, the Company would have the capability to sell securities classified as available for sale or to borrow funds as necessary. As of June 30, 2014, the Company had existing credit lines with other financial institutions to purchase up to $59.0 million in federal funds. Also, as a member of the FHLB of Atlanta, the Company may obtain advances of up to 10% of total assets, subject to available collateral. A floating lien of $26.4 million of qualifying loans is pledged to the FHLB to secure borrowings. At June 30, 2014, the Company had no FHLB advances outstanding. Another source of short-term borrowings is securities sold under agreements to repurchase. At June 30, 2014, total borrowings consisted of securities sold under agreements to repurchase of $7.2 million and junior subordinated debentures of $12.4 million. Total deposits were $428.7 million at June 30, 2014. Time deposits, which are the only deposit accounts that have stated maturity dates, are generally considered to be rate sensitive. Time deposits represented 49.1% of total deposits at June 30, 2014. Time deposits of $100,000 or more represented 25.9% of the Company's total deposits at June 30, 2014. At quarter-end, the Company had no brokered time deposits and $497,000 in brokered demand deposits. Management believes most other time deposits are relationship-oriented. While the Bank will need to pay competitive rates to retain these deposits at their maturities, there are other subjective factors that will determine their continued retention. Based upon prior experience, the Company anticipates that a substantial portion of outstanding certificates of deposit will renew upon maturity. Management believes that current sources of funds provide adequate liquidity for the Bank's current cash flow needs. The Company maintains minimal cash balances at the parent holding company level. Management believes that the current cash balances will provide adequate liquidity for the Company's current cash flow needs. Capital Resources A significant measure of the strength of a financial institution is its capital base. Federal regulations have classified and defined capital into the following components: (1) Tier 1 capital, which includes common shareholders' equity and qualifying preferred equity, and (2) Tier 2 capital, which includes a portion of the allowance for loan losses, certain qualifying long-term debt and preferred stock which does not qualify as Tier 1 capital. Minimum capital levels are regulated by risk-based capital adequacy guidelines, which require a financial institution to maintain capital as a percentage of its assets, and certain off-balance sheet items adjusted for predefined credit risk factors (risk-adjusted assets). The Company's equity to assets ratio was 11.32% at

June 30, 2014. 53 As the following table indicates, at June 30, 2014, the Company and the Bank both exceeded minimum regulatory capital requirements as specified in the tables below. Actual Minimum



Former New Century Bancorp, Inc. Ratio Requirement

Total risk-based capital ratio 20.09 % 8.00 % Tier 1 risk-based capital ratio 18.84 % 4.00 % Leverage ratio 13.44 % 4.00 % Regulatory Actual Minimum Well-Capitalized New Century Bank Ratio Requirement Requirement

Total risk-based capital ratio 19.69 % 10.00 % 10.00 % Tier 1 risk-based capital ratio 18.44 % 6.00 %

6.00 % Leverage ratio 13.12 % 5.00 % 5.00 % During 2004, the Company issued $12.4 million of junior subordinated debentures to a newly formed subsidiary, New Century Statutory Trust I, which in turn issued $12.0 million of trust preferred securities. The proceeds from the sale of the trust preferred securities provided additional capital for the growth and expansion of the Bank. Under the current applicable regulatory guidelines, all of the proceeds from the issuance of these trust preferred securities qualify as Tier 1 capital as of June 30, 2014. Management expects that the Bank will remain "well-capitalized" for regulatory purposes, although there can be no assurance that additional capital will not be required in the future. Accounting and regulatory matters. On July 9, 2013, the FDIC joined the Federal Reserve and the Office of the Comptroller of the Currency in adopting a final rule that will revise the current risk-based and leverage capital requirements for banking organizations. The final rule is a continuation of joint notices of proposed rulemaking originally published in the Federal Register during August, 2012.

The final rule implements a revised definition of regulatory capital, a new common equity tier 1 minimum capital requirement, and a higher overall minimum tier 1 capital requirement, incorporating these new requirements into the existing prompt corrective action (PCA) framework. It also establishes limits on a banking organization's capital distributions and certain discretionary bonus payments if the organization does not hold a specified amount of common equity tier 1 capital in addition to the amount necessary to meet its minimum risk-based capital requirements. This additional capital is referred to as the "capital conservation buffer". The "countercyclical capital buffer" provisions from the proposed rule have also been adopted, however, they apply only to large financial institutions (banks and bank holding companies with total consolidated assets of $250 billion or more) implementing the "advanced approaches" framework and are not applicable to the Company or its subsidiary Bank.



The final rule permanently grandfathers the tier 1 capital treatment for certain non-qualifying capital instruments, including trust preferred securities, outstanding as of May 19, 2010.

Under the proposed rules released last August, banking organizations would have been required to recognize in regulatory capital all components of accumulated other comprehensive income (excluding accumulated net gains and losses on cash-flow hedges that relate to the hedging of items that are not recognized at fair value on the balance sheet). The final rule carries this requirement forward, with an exception for smaller banking organizations, such as the Company, which are not subject to the "advanced approaches" rule. Such organizations may make a one-time election not to include most elements of accumulated other comprehensive income (including unrealized gains and losses on securities designated as available-for-sale) in regulatory capital under the final rule. Organizations making this election will be permitted to use the currently existing treatment under the general risk-based capital rules that exclude most accumulated other comprehensive income elements from regulatory capital. The election must be made with the first call report or FR Y-9 report filed after the banking organization becomes subject to the final rule (January 2015 in the Company's case). 54 The new rule also amends the existing methodologies for determining risk-weighted assets for all banking organizations. Specifically, the final rule assigns a 50% or 100% risk weight to mortgage loans secured by one-to-four family residential properties. Generally, residential mortgage loans secured by a first lien on a one- to-four family residential property that are prudently underwritten and that are performing according to their original terms receive a 50% risk weight. All other one-to-four family residential mortgage loans, including loans secured by a junior lien on residential property, are assigned a 100% risk weight.

The mandatory compliance date for the Company and its subsidiary Bank will be January 1, 2015, with a transition period for the capital conservation buffer until January 1, 2016, and additional transition periods for certain other measures under the new rule. Management will continue to evaluate the potential effect of the new final rule over the coming quarters. As of the date of this report, management is not aware of any other known trends, events, uncertainties or current recommendations by regulatory authorities that will have or that are reasonably likely to have a material effect on the Company's liquidity, capital resources, or other operations. Legal Proceedings The Company is not currently engaged in, nor are any of its properties subject to, any material legal proceedings. From time to time, the Bank is a party to legal proceedings in the ordinary course of business wherein it attempts to collect loans, enforce its security interest in loans, or other matters of similar nature.


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Source: Edgar Glimpses


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