10-Q 1 fnbn-20130630x10q.htm 10-Q FNBN-2013.06.30-10Q


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
FORM 10-Q

 
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
 
For the quarterly period ended June 30, 2013
 
Commission File Number 0-13823

COMMUNITYONE BANCORP
(Exact name of Registrant as specified in its Charter)
 
North Carolina
 
56-1456589
(State of Incorporation)
 
(I.R.S. Employer Identification No.)
1017 E. Morehead Street
 
 
Charlotte, North Carolina
 
28204
(Address of principal executive offices)
 
(Zip Code)
 
(336) 626-8300
(Registrant's telephone number, including area code)
  
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
Smaller reporting Company  o
 
 
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

As of August 1, 2013 (the most recent practicable date), the Registrant had outstanding approximately 21,736,873 shares of Common Stock.



CommunityOne Bancorp and Subsidiaries
Report on Form 10-Q
June 30, 2013

TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
 
Item 1
 
 
 
 
 
 
Item 2
Item 3
Item 4
PART II. OTHER INFORMATION
 
Item 1
Item 1A
Item 2
Item 3
Item 4
Item 5
Item 6
 



i

PART I.    FINANCIAL INFORMATION
Item 1.    Financial Statements
CommunityOne Bancorp and Subsidiaries
Consolidated Balance Sheets (unaudited)
(in thousands, except share and per share data)
 
June 30, 2013
 
December 31, 2012*
Assets
 
 
 
 
Cash and due from banks
 
$
34,959

 
$
38,552

Interest-bearing bank balances
 
53,511

 
201,058

Investment securities:
 
 
 
 
Available-for-sale, at estimated fair value (amortized cost of $471,542 in 2013
and $558,818 in 2012)
 
453,410

 
564,850

Held-to-maturity (estimated fair value of $148,745 in 2013)
 
154,797

 
—

Loans held for sale
 
4,076

 
6,974

Loans held for investment
 
1,189,413

 
1,177,035

Less: Allowance for loan losses
 
(25,085
)
 
(29,314
)
Net loans held for investment
 
1,164,328

 
1,147,721

Premises and equipment, net
 
52,430

 
52,725

Other real estate owned and property acquired in settlement of loans
 
35,762

 
63,131

Core deposit premiums and other intangibles
 
7,403

 
7,495

Goodwill
 
4,205

 
4,205

Bank-owned life insurance
 
39,364

 
38,792

Other assets
 
32,068

 
26,062

Total Assets
 
$
2,036,313

 
$
2,151,565

Liabilities
 
 
 
 
Deposits:
 
 
 
 
Noninterest-bearing demand deposits
 
$
304,992

 
$
251,235

Interest-bearing deposits:
 
 
 
 
Demand, savings and money market deposits
 
857,489

 
892,576

Time deposits of $100 or more
 
240,910

 
290,166

Other time deposits
 
408,094

 
473,011

Total deposits
 
1,811,485

 
1,906,988

Retail repurchase agreements
 
9,109

 
8,675

Federal Home Loan Bank advances
 
58,306

 
58,328

Junior subordinated debentures
 
56,702

 
56,702

Other liabilities
 
24,665

 
22,427

Total Liabilities
 
1,960,267

 
2,053,120

Shareholders' Equity
 
 
 
 
Preferred stock Series A, $10.00 par value; authorized 200,000 shares, no shares issued and outstanding in 2013 and 2012
 
—

 
—

Preferred stock, $1.00 par value, authorized 15,000,000 shares, no shares issued and outstanding in 2013 and 2012
 
—

 
—

Common stock, no par value; authorized 2,500,000,000 shares, issued 21,736,873 shares in 2013 and 21,698,115 in 2012
 
461,266

 
460,955

Accumulated deficit
 
(369,966
)
 
(362,187
)
Accumulated other comprehensive loss
 
(15,254
)
 
(323
)
Total Shareholders' Equity
 
76,046

 
98,445

Total Liabilities and Shareholders' Equity
 
$
2,036,313

 
$
2,151,565

See accompanying notes to consolidated financial statements.
* Derived from audited consolidated financial statements

1

CommunityOne Bancorp and Subsidiaries
Consolidated Statements of Operations (unaudited)
(in thousands, except share and per share data)
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Interest Income
 
 
 
 
 
 
 
Interest and fees on loans
$
14,422

 
$
17,235

 
$
29,207

 
$
34,194

Interest and dividends on investment securities:
 
 
 
 
 
 
 
Taxable income
3,518

 
2,887

 
6,578

 
5,571

Non-taxable income
—

 
—

 
14

 
—

Other interest income
197

 
310

 
409

 
660

Total interest income
18,137

 
20,432

 
36,208

 
40,425

Interest Expense
 
 
 
 
 
 
 
Deposits
2,090

 
3,701

 
4,337

 
7,924

Retail repurchase agreements
4

 
9

 
9

 
17

Federal Home Loan Bank advances
365

 
387

 
747

 
666

Other borrowed funds
264

 
286

 
528

 
589

Total interest expense
2,723

 
4,383

 
5,621

 
9,196

Net Interest Income before Provision for Loan Losses
15,414

 
16,049

 
30,587

 
31,229

Provision for (recovery of) loan losses
(1,057
)
 
7,778

 
(947
)
 
10,845

Net Interest Income after Provision for Loan Losses
16,471

 
8,271

 
31,534

 
20,384

Noninterest Income
 
 
 
 
 
 
 
Service charges on deposit accounts
1,681

 
1,830

 
3,057

 
3,646

Mortgage loan income
921

 
287

 
1,665

 
323

Cardholder and merchant services income
1,174

 
1,176

 
2,243

 
2,317

Trust and investment services
394

 
256

 
635

 
458

Bank owned life insurance
276

 
314

 
538

 
620

Other service charges, commissions and fees
337

 
271

 
595

 
525

Securities gains, net
345

 
2,002

 
2,723

 
1,956

Other income
119

 
396

 
324

 
513

Total noninterest income
5,247

 
6,532

 
11,780

 
10,358

Noninterest Expense
 
 
 
 
 
 
 
Personnel expense
10,807

 
10,581

 
21,486

 
20,607

Net occupancy expense
1,671

 
1,608

 
3,502

 
3,169

Furniture, equipment and data processing expense
2,094

 
2,141

 
4,462

 
4,213

Professional fees
760

 
1,250

 
2,253

 
2,792

Stationery, printing and supplies
187

 
153

 
373

 
294

Advertising and marketing
179

 
125

 
844

 
254

Other real estate owned expense
3,332

 
12,473

 
4,214

 
17,992

Credit/debit card expense
473

 
437

 
898

 
847

FDIC insurance
664

 
1,225

 
1,334

 
1,823

Loan collection expense
1,408

 
514

 
2,979

 
1,260

Merger-related expense
1,989

 
(840
)
 
3,498

 
1,418

Core deposit intangible amortization
352

 
352

 
704

 
704

Other expense
749

 
2,896

 
2,457

 
4,390

Total noninterest expense
24,665

 
32,915

 
49,004

 
59,763

Loss from continuing operations, before income taxes
(2,947
)
 
(18,112
)
 
(5,690
)
 
(29,021
)
Income tax expense (benefit) - continuing operations
236

 
26

 
2,089

 
(51
)
Loss from continuing operations, net of tax
(3,183
)
 
(18,138
)
 
(7,779
)
 
(28,970
)
Loss from discontinued operations, net of tax
—

 
—

 
—

 
(27
)
Net loss
$
(3,183
)
 
$
(18,138
)
 
$
(7,779
)
 
$
(28,997
)
 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding - basic and diluted
21,729,329

 
21,190,848

 
21,713,808

 
21,146,758

Net loss per common share from continuing operations - basic and diluted
$
(0.15
)
 
$
(0.86
)
 
$
(0.36
)
 
$
(1.37
)
Net loss per common share from discontinued operations - basic and diluted
—

 
—

 
—

 
—

Net loss per common share - basic and diluted
(0.15
)
 
(0.86
)
 
(0.36
)
 
(1.37
)

See accompanying notes to consolidated financial statements.

2

CommunityOne Bancorp and Subsidiaries
Consolidated Statements of Comprehensive Loss (unaudited)
(dollars in thousands)
Three Months Ended June 30,
 
2013
 
2012
Net loss
$
(3,183
)
 
$
(18,138
)
Other comprehensive income:

 

Unrealized holdings gains (losses) arising during the period on available-for-sale securities
(16,514
)
 
4,026

 Tax effect
6,523

 
(1,563
)
Unrealized holdings gains (losses) arising during the period on available-for-sale securities, net of tax
(9,991
)
 
2,463

Reclassification adjustment for (gain) losses on available-for-sale securities included in net income
(345
)
 
(2,002
)
     Tax effect
136

 
790

Reclassification adjustment for (gain) losses on available-for-sale securities included in net income, net of tax
(209
)
 
(1,212
)
Change in defined benefit plans liability
(255
)
 
—

Tax effect
101

 
—

Change in defined benefit plans liability, net of tax
(154
)
 
—

Other comprehensive income (loss), net of tax:
(10,354
)
 
1,251

Comprehensive loss
$
(13,537
)
 
$
(16,887
)


(dollars in thousands)
Six Months Ended June 30,
 
2013
 
2012
Net loss
$
(7,779
)
 
$
(28,997
)
Other comprehensive income:
 
 
 
Unrealized holdings gains (losses) arising during the period on available-for-sale securities
(21,448
)
 
5,184

 Tax effect
8,472

 
(2,020
)
Unrealized holdings gains (losses) arising during the period on available-for-sale securities, net of tax
(12,976
)
 
3,164

Reclassification adjustment for (gain) losses on available-for-sale securities included in net income
(2,723
)
 
(1,956
)
     Tax effect
1,076

 
773

Reclassification adjustment for (gain) losses on available-for-sale securities included in net income, net of tax
(1,647
)
 
(1,183
)
Change in defined benefit plans liability
(509
)
 
—

Tax effect
201

 
—

Change in defined benefit plans liability, net of tax
(308
)
 
—

Other comprehensive income (loss), net of tax:
(14,931
)
 
1,981

Comprehensive loss
$
(22,710
)
 
$
(27,016
)



See accompanying notes to consolidated financial statements.


3

CommunityOne Bancorp and Subsidiaries
Consolidated Statements of Shareholders’ Equity (unaudited)
For Six Months Ended June 30, 2013 and 2012
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
(dollars in thousands, except share and per share data)
 
 
 
 
 
 
 
 
 
 
 
Other
 
 
 
Preferred Stock
 
Common Stock
 
Accumulated
 
Comprehensive
 
 
 
 
Shares
 
Amount
 
Shares
 
Amount
 
Deficit
 
Loss
 
Total
Balance, December 31, 2011
 
—

 
$
—

 
21,102,668

 
$
455,166

 
$
(322,182
)
 
$
(3,969
)
 
$
129,015

Comprehensive loss:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss
 
—

 
—

 
—

 
—

 
(28,997
)
 
—

 
(28,997
)
Other comprehensive income, net of tax
 
—

 
—

 
—

 
—

 
—

 
1,981

 
1,981

Total comprehensive loss
 
 
 
 
 
 
 
 
 
 
 
 
 
(27,016
)
Expense related to 2011 issuance of common stock
 
—

 
—

 
—

 
(913
)
 
—

 
—

 
(913
)
Return of common stock not received for fractional shares rounding purposes in the 1:100 reverse stock split
 
—

 
—

 
(586
)
 
—

 
—

 
—

 
—

Stock options:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Compensation expense recognized
 
—

 
—

 
—

 
1

 
—

 
—

 
1

Exercise of warrants related to stock offering
 
 
 
 
 
10

 
 
 
 
 
 
 
 
Stock offering, net of issuance costs of $158
 
—

 
—

 
485,788

 
6,915

 
—

 
—

 
6,915

Balance, June 30, 2012
 
—

 
$
—

 
21,587,880

 
$
461,169

 
$
(351,179
)
 
$
(1,988
)
 
$
108,002

Balance, December 31, 2012
 
—

 
$
—

 
21,698,115

 
$
460,955

 
$
(362,187
)
 
$
(323
)
 
$
98,445

Comprehensive loss:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss
 
—

 
—

 
—

 
—

 
(7,779
)
 
—

 
(7,779
)
Other comprehensive income, net of tax
 
—

 
—

 
—

 
—

 
—

 
(14,931
)
 
(14,931
)
Total comprehensive loss
 
 
 
 
 
 
 
 
 
 
 
 
 
(22,710
)
Stock options:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Compensation expense recognized
 
—

 
—

 
—

 
297

 
—

 
—

 
297

Restricted stock:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Shares issued as compensation to directors
 
—

 
—

 
935

 
14

 
—

 
—

 
14

Issuance of restricted stock award
 
—

 
—

 
37,823

 
—

 
—

 
—

 
—

Balance, June 30, 2013
 
—

 
$
—

 
21,736,873

 
$
461,266

 
$
(369,966
)
 
$
(15,254
)
 
$
76,046


See accompanying notes to consolidated financial statements.    

4

CommunityOne Bancorp and Subsidiaries
Consolidated Statements of Cash Flows (unaudited)
 (dollars in thousands)
 
Six Months Ended June 30,
 
 
2013
 
2012
Operating Activities
 
 
 
 
Net loss
 
$
(7,779
)
 
$
(28,997
)
Net loss from discontinued operations
 
—

 
(27
)
Net loss from continuing operations
 
(7,779
)
 
(28,970
)
Adjustments to reconcile net loss to cash used in operating activities:
 
 
 
 
Depreciation and amortization of premises and equipment
 
1,829

 
1,957

Provision for (recovery of) loan losses
 
(947
)
 
10,845

Deferred income taxes (benefit)
 
2,089

 
(51
)
Deferred loan fees and costs, net
 
(1,093
)
 
(3,648
)
Premium amortization and discount accretion of investment securities, net
 
2,334

 
4,700

Net (gain) loss on sale of investment securities
 
(2,723
)
 
(1,956
)
Amortization of core deposit premiums
 
704

 
704

Net accretion of purchase accounting adjustments
 
(8,744
)
 
(14,397
)
Adjustment to goodwill
 
—

 
(300
)
Stock compensation expense
 
311

 
1

Increase in cash surrender value of bank-owned life insurance, net
 
(572
)
 
(657
)
Loans held for sale:
 
 
 
 
Origination of loans held for sale
 
(67,783
)
 
(3,039
)
Net proceeds from sale of loans held for sale
 
71,958

 
1,749

Net loss (gain) on sale of loans held for sale
 
(1,277
)
 
(34
)
Mortgage servicing rights capitalized
 
(724
)
 
—

Mortgage servicing rights amortization
 
113

 
—

Net loss on sales and write-downs of other real estate owned
 
2,764

 
14,470

Changes in assets and liabilities:
 
 
 
 
Decrease (increase) in accrued interest receivable and other assets
 
1,881

 
(605
)
Increase in accrued interest payable and other liabilities
 
1,729

 
(498
)
Net cash used in operating activities of continuing operations
 
(5,930
)
 
(19,729
)
Net effect of discontinued operations
 
—

 
(874
)
Net cash used in operating activities
 
(5,930
)
 
(20,603
)
Investing Activities
 
 
 
 
Available-for-sale securities:
 
 
 
 
Proceeds from sales
 
174,492

 
118,049

Proceeds from maturities, calls and principal repayments
 
41,895

 
83,454

Purchases
 
(128,681
)
 
(245,492
)
Held-to-maturity securities:
 
 
 
 
Proceeds from maturities, calls and principal repayments
 
556

 
—

Purchases
 
(155,394
)
 
—

Net (increase) decrease in loans held for investment
 
(12,483
)
 
(69,984
)
Proceeds from sales of other real estate owned
 
30,675

 
23,878

Purchases of premises and equipment
 
(1,603
)
 
(1,163
)
Proceeds from sales of premises and equipment
 
37

 
34

Expenses paid in 2012 related to 2011 capital raise
 
—

 
(913
)
Net cash (used in) provided by investing activities
 
(50,506
)
 
(92,137
)
Financing Activities
 
 
 
 
Net decrease in deposits
 
(95,116
)
 
(86,309
)
Increase in retail repurchase agreements
 
434

 
2,617

Decrease in Federal Home Loan Bank advances
 
(22
)
 
(20
)
Issuance of common stock, net of expense
 
—

 
6,915

Net cash used in financing activities of continuing operations
 
(94,704
)
 
(76,797
)
Net effect of discontinued operations
 
—

 
—

Net cash used in financing activities
 
(94,704
)
 
(76,797
)
Net Decrease in Cash and Cash Equivalents
 
(151,140
)
 
(189,537
)
Cash and Cash Equivalents at Beginning of Period
 
239,610

 
553,416

Cash and Cash Equivalents at End of Period
 
$
88,470

 
$
363,879

 
 
 
 
 
Supplemental disclosure of cash flow information
 

 
 
Cash paid during the period for:
 
 
 
 
Interest
 
$
5,525

 
$
9,567

Noncash transactions:
 
 
 
 
Foreclosed loans transferred to other real estate owned
 
6,793

 
15,020

Loans to facilitate the sale of other real estate owned
 
488

 
778

Transfer of loans from held for investment to held for sale
 
—

 
600

Transfer of loans from held for sale to held for investment
 
—

 
(3,885
)
Unrealized securities gains/(losses), net of income taxes
 
(14,623
)
 
1,981

Employee benefit plan costs, net of income taxes
 
(308
)
 
—

See accompanying notes to consolidated financial statements.

5


CommunityOne Bancorp and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)

1. Basis of Presentation
Nature of Operations
CommunityOne Bancorp, or "COB" or the "Company" (which also refers to us and our subsidiaries on a consolidated basis), is a bank holding company incorporated in 1984 under the laws of the State of North Carolina. Through our ownership of CommunityOne Bank, N.A., or the "Bank", a national banking association headquartered in Asheboro, North Carolina, we offer a complete line of consumer, wealth management, mortgage and business banking services, including loan, deposit, cash management, investment management and trust services, to individual and business customers through operations located throughout central, southern and western North Carolina, including the counties of Alamance, Alexander, Ashe, Burke, Caldwell, Catawba, Chatham, Gaston, Guilford, Iredell, Mecklenburg, Montgomery, Moore, Orange, Randolph, Richmond, Rowan, Scotland, Watauga and Wilkes. The Bank also holds the stock of Dover Mortgage Company (“Dover”) and First National Investor Services, Inc. Dover previously engaged in the business of originating, underwriting and closing mortgage loans for sale in the secondary market. Dover ceased operations in the first quarter of 2011 and filed for Chapter 11 bankruptcy on February 15, 2012. First National Investor Services, Inc. holds deeds of trust for the Bank.
COB also owns Granite Mortgage, Inc., which ceased mortgage operations in 2009 and filed for Chapter 11 bankruptcy on February 15, 2012, and FNB United Statutory Trust I, FNB United Statutory Trust II, and Catawba Valley Capital Trust II, which were formed to facilitate the issuance of trust preferred securities.
On October 21, 2011, as part of the recapitalization of COB, COB acquired Bank of Granite Corporation and its subsidiary bank, Bank of Granite, through the merger of a wholly owned subsidiary of ours into Granite Corp. (the “Merger”). Bank of Granite was merged into the Bank on June 8, 2013. Our shareholders approved an amendment in our articles of incorporation to change our name from FNB United Corp to CommunityOne Bancorp on June 20, 2013. This change, along with a change in our stock symbol from FNBN to COB, was implemented on July 1, 2013.
General
The accompanying consolidated financial statements, prepared without audit, include the accounts of COB and its subsidiaries. All significant intercompany balances and transactions have been eliminated. Descriptions of the organization and business of COB, accounting policies followed by COB and other relevant information are contained in our Annual Report on Form 10-K for the year ended December 31, 2012 (the "Form 10-K"), including the notes to the consolidated financial statements filed as part of that report. This quarterly report should be read in conjunction with the Form 10-K.
In the opinion of management, the accompanying condensed consolidated financial statements contain the adjustments, all of which are normal recurring adjustments, necessary to present fairly the financial position of COB as of June 30, 2013 and December 31, 2012, and the results of its operations and cash flows for the three and six months ended June 30, 2013 and 2012, respectively.
All financial information is reported on a continuing operations basis, unless otherwise noted. See Note 2 to the consolidated financial statements for a discussion regarding discontinued operations and certain assets and liabilities at June 30, 2013 and December 31, 2012.
Use of Estimates
We have made a number of estimates and assumptions relating to the reporting of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States ("GAAP"). Actual results could differ from those estimates. Material estimates subject to change in the near term include, among other items, the allowances for loan losses (“ALL”), estimated cash flows of purchased impaired loans, the carrying value of other real estate owned (“OREO”), the carrying value of intangible assets and the realization of deferred tax assets.
Reclassification
Certain reclassifications have been made to the prior period consolidated financial statements to place them on a comparable basis with the current period consolidated financial statements. These reclassifications have no effect on net income or shareholders' equity as previously reported.
Recent Accounting Pronouncements
Comprehensive Income - In February 2013, the FASB issued ASU No. 2013-02 Comprehensive Income (Topic 220): "Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income" (“ASU No. 2013-02”). This pronouncement requires an

6

entity to report the effect of significant reclassifications out of accumulated other comprehensive income for each applicable component of net income, as well as a roll forward of the components of accumulated other comprehensive income on a prospective basis. This pronouncement is effective beginning January 1, 2013. The provisions of ASU No. 2013-02 relate only to financial statement presentation of other comprehensive income and, accordingly, its adoption did not have a material effect on COB's financial statements. These new disclosures appear in Note 10.
FASB - From time to time, the Financial Accountings Standards Board (“FASB”) issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards.
Management considers the effect of the proposed statements on the consolidated financial statements of COB and monitors the status of changes to and proposed effective dates of exposure drafts. 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 our financial position, results of operations or cash flows.
2. Discontinued Operations
All operations of Dover, a subsidiary of the Bank, were discontinued as of March 17, 2011. Dover, acquired by us in 2003, originated, underwrote and closed mortgage loans for sale into the secondary market. It maintained a retail origination network based in Charlotte, North Carolina, which originated loans for properties located in North Carolina. Dover also engaged in the wholesale mortgage origination business and conducted retail mortgage origination business outside of North Carolina. Operations outside of the State of North Carolina and the wholesale mortgage origination business were discontinued in February 2011, and all remaining operations were discontinued on March 17, 2011. Dover filed for Chapter 11 bankruptcy on February 15, 2012 in the United States Bankruptcy Court for the Western District of North Carolina. All of the assets and liabilities of Dover were written off at that time.
The results of operations of a component of an entity that has been disposed of shall be reported in discontinued operations if both the operations and cash flows of the component have been, or will be, eliminated from ongoing operations of the entity as a result of the disposal transaction and the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction. As a result, the Consolidated Balance Sheets, Statements of Operations and Statement of Cash Flows for all periods reflect retrospective application of Dover's classification as a discontinued operation.
There were no assets and liabilities of discontinued operations as of June 30, 2013 and December 31, 2012.
Net loss from discontinued operations, net of tax, at the dates indicated were as follows:
(dollars in thousands)
 
Six Months Ended June 30,
 
 
2013
 
2012
Interest Income
 
 
 
 
Total interest income
 
$
—

 
$
—

Interest Expense
 
 
 
 
Total interest expense
 
—

 
—

Net Interest Income before Provision for Loan Losses
 
—

 
—

Provision for loan losses
 
—

 
—

Net Interest Income after Provision for Loan Losses
 
—

 
—

Noninterest Income
 
 
 
 
Total noninterest income
 
—

 
—

Noninterest Expense
 
 
 
 
Personnel expense
 
—

 
1

Net occupancy expense
 
—

 
1

Professional fees
 
—

 
25

Total noninterest expense
 
—

 
27

Loss before income taxes
 
—

 
(27
)
Income tax (benefit)/expense
 
—

 
—

Net loss from discontinued operations, net of tax
 
$
—

 
$
(27
)
All financial information in the consolidated financial statements and notes to the consolidated financial statements reflects continuing operations, unless otherwise noted.


7

3. Goodwill and Other Intangible Assets
We accounted for the Merger as a business combination under the acquisition method of accounting. As a result, we have recognized in our financial statements the identifiable net assets acquired and an amount of goodwill (representing the difference between the purchase price and the identifiable net assets). During the measurement period following a business combination, the amount of identifiable net assets recognized is subject to further adjustment to reflect new information obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date. GAAP requires that the measurement period cannot exceed one year from the acquisition date. During the first six months of 2012, we recognized $0.3 million in additional goodwill from the Merger. This additional amount resulted from new valuations received on OREO acquired in the Merger, which were written down to our best estimate of fair value.
Goodwill and other intangible assets deemed to have indefinite lives generated from purchase business combinations are not subject to amortization and are instead tested for impairment no less than annually. Impairment exists when the carrying value of goodwill exceeds its implied fair value. An impairment loss would be recognized in an amount equal to that excess and would be included in noninterest expense in the Consolidated Statements of Operations. None of the goodwill recognized in the Merger is expected to be deductible for income tax purposes.
Our intangible assets with definite lives are core deposit premiums ("CDP") and mortgage servicing rights ("MSR"). CDPs are amortized over their useful lives to their estimated residual value and reviewed for impairment at least quarterly. The amortization expense represents the estimated decline in the value of the underlying deposits. MSRs are amortized over the expected lives of the underlying mortgages including prepayment estimates.

4. Investment Securities
Securities designated as available-for-sale are carried at fair value. However, the unrealized difference between amortized cost and fair value of securities available-for-sale is excluded from net income unless there is an other than temporary impairment and is reported, net of deferred taxes, as a component of shareholders' equity as accumulated other comprehensive income (loss). Securities held-to-maturity are carried at amortized cost, as the bank has the ability, and management has the positive intent, to hold these securities to maturity. Premiums and discounts on securities are amortized and accreted according to the interest method.
Our primary objective in managing the investment portfolio is to maintain a portfolio of high quality, highly liquid investments yielding competitive returns. We are required under federal regulations to maintain adequate liquidity to ensure safe and sound operations. We maintain investment balances based on a continuing assessment of cash flows, the level of loan production, current interest rate risk strategies and an assessment of the potential future direction of market interest rate changes. Investment securities differ in terms of default, interest rate, liquidity and expected rate of return risks.
The following table summarizes the amortized cost and estimated fair value of investment securities and presents the related gross unrealized gains and losses:

8

June 30, 2013
 
 
 
 
 
 
 
 
(dollars in thousands)
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Available for Sale:
 
 
 
 
 
 
 
 
Obligations of:
 
 
 
 
 
 
 
 
U.S. government sponsored enterprises
 
$
2,063

 
$
21

 
$
—

 
$
2,084

Residential mortgage-backed securities-GSE
 
386,628

 
1,013

 
18,658

 
368,983

Residential mortgage-backed securities-Private
 
21,220

 
1,614

 
10

 
22,824

Commercial mortgage backed securities-GSE
 
22,959

 
—

 
1,461

 
21,498

Commercial mortgage-backed securities-Private
 
10,430

 
—

 
855

 
9,575

Corporate notes
 
28,242

 
204

 
—

 
28,446

Total available for sale
 
$
471,542

 
$
2,852

 
$
20,984

 
$
453,410

Held to Maturity:
 
 
 
 
 
 
 
 
Residential mortgage-backed securities-GSE
 
144,723

 
—

 
5,324

 
139,399

Commercial mortgage-backed securities-Private
 
10,074

 
—

 
728

 
9,346

     Total held to maturity
 
$
154,797

 
$
—

 
$
6,052

 
$
148,745

Total investment securities
 
$
626,339

 
$
2,852

 
$
27,036

 
$
602,155

 
 
 
 
 
 
 
 
 
December 31, 2012
 
 
 
 
 
 
 
 
(dollars in thousands)
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Available for Sale:
 
 
 
 
 
 
 
 
Obligations of:
 
 
 
 
 
 
 
 
U.S. Treasury and government agencies
 
$
6,646

 
$
335

 
$
—

 
$
6,981

U.S. government sponsored enterprises
 
22,118

 
55

 
—

 
22,173

States and political subdivisions
 
5,918

 
120

 
—

 
6,038

Residential mortgage-backed securities-GSE
 
436,344

 
5,678

 
948

 
441,074

Residential mortgage-backed securities-Private
 
22,649

 
750

 
454

 
22,945

Commercial mortgage backed securities-GSE
 
23,150

 
209

 
—

 
23,359

Commercial mortgage backed securities-Private
 
5,283

 
34

 
—

 
5,317

Corporate notes
 
36,710

 
270

 
17

 
36,963

Total
 
$
558,818

 
$
7,451

 
$
1,419

 
$
564,850

As a member of the Federal Home Loan Bank of Atlanta (“FHLB”), the Bank is required to own capital stock in the FHLB based generally upon the balances of total assets and FHLB advances. FHLB capital stock is pledged to secure FHLB advances. This investment is carried at cost since no ready market exists for FHLB stock and there is no quoted market value. However, redemption of this stock has historically been at par value. The Bank owned a total of $5.2 million of FHLB stock at June 30, 2013 and $6.3 million at December 31, 2012. Due to the redemption provisions of FHLB stock, we have estimated that fair value approximated cost and that this investment was not impaired at June 30, 2013. FHLB stock is included in other assets at its original cost basis.
As a member bank of the Federal Reserve Bank of Richmond (“FRBR”), the Bank also is required to own capital stock of the FRBR based upon a percentage of the bank's common stock and surplus. This investment is carried at cost since no ready market exists for FRBR stock and there is no quoted market value. At June 30, 2013 and December 31, 2012, the Bank owned a total of $2.6 million and $3.1 million of FRBR stock, respectively. Due to the nature of this investment in an entity of the U.S. government, we have estimated that fair value approximated the cost and that this investment was not impaired at June 30, 2013. FRBR stock is included in other assets at its original cost basis.
At June 30, 2013, $97.0 million of the investment securities portfolio was pledged to secure public deposits, $13.0 million was pledged to retail repurchase agreements and $2.1 million was pledged to others, leaving $490.1 million available as lendable collateral.

9

During the three and six months ended June 30, 2013, the Bank sold securities with a book value of $25.7 million and $171.8 million respectively, and recognized gains of $0.3 million and $2.7 million, respectively. During the three and six months ended June 30, 2012, the Bank sold securities with a book value of $112.7 million and recognized gains of $2.0 million. The Bank sold these securities in order to manage our interest rate sensitivity profile.
The following tables show our investments' estimated fair value and gross unrealized losses, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at June 30, 2013 and December 31, 2012. The change in unrealized losses during the three and six month periods ending June 30, 2013 was attributed to changes in interest rates and not to changes in the credit quality of these securities. All unrealized losses on investment securities are considered by management to be temporary given the credit ratings on these investment securities or the short duration of the unrealized loss, or both.
 
Less than 12 Months
 
12 Months or More
 
Total
(dollars in thousands)
Estimated Fair Value
Gross Unrealized Losses
 
Estimated Fair Value
Gross Unrealized Losses
 
Estimated Fair Value
Gross Unrealized Losses
June 30, 2013
 
 
 
 
 
 
 
 
Available for Sale:
 
 
 
 
 
 
 
 
Residential mortgage-backed securities-GSE
$
322,395

$
18,658

 
$
—

$
—

 
$
322,395

$
18,658

Residential mortgage-backed securities-Private
—

—

 
643

10

 
643

10

Commercial mortgage-backed securities-GSE
21,498

1,461

 
—

—

 
21,498

1,461

Commercial mortgage-backed securities-Private
9,575

855

 
—

—

 
9,575

855

Total available for sale
$
353,468

$
20,974

 
$
643

$
10

 
$
354,111

$
20,984

Held to Maturity:
 
 
 
 
 
 
 
 
Residential mortgage-backed securities-GSE
$
119,794

$
5,324

 
$
—

$
—

 
$
119,794

$
5,324

Commercial mortgage-backed securities-Private
9,346

728

 
—

—

 
9,346

728

Total held to maturity
$
129,140

$
6,052

 
$
—

$
—

 
$
129,140

$
6,052

Total
$
482,608

$
27,026

 
$
643

$
10

 
$
483,251

$
27,036

 
 
 
 
 
 
 
 
 
December 31, 2012
 
 
 
 
 
 
 
 
Obligations of:
 
 
 
 
 
 
 
 
Residential mortgage-backed securities-GSE
$
123,489

$
904

 
$
7,027

$
44

 
$
130,516

$
948

Residential mortgage-backed securities-Private
7,499

454

 
—

—

 
7,499

454

Corporate notes
3,249

17

 
—

—

 
3,249

17

Total
$
134,237

$
1,375

 
$
7,027

$
44

 
$
141,264

$
1,419

At June 30, 2013 and December 31, 2012, there were one and four available-for-sale securities that were in an unrealized loss position for longer than 12 months, respectively.
If an entity has a debt security that has been in a loss position for over 12 months and it cannot assert it is more likely than not that it will not have to sell the security before recovery, then other than temporary impairment ("OTTI") must be taken. The amount of impairment is bifurcated between impairment due to credit (which is recorded through earnings) and noncredit impairment (which becomes a component of other comprehensive income (“OCI”) for both available-for-sale and held-to-maturity securities). For held-to-maturity securities, the amount in OCI will be amortized prospectively over the security's remaining life. After analyzing its securities portfolio at June 30, 2013, and after considering ratings, fair value, cash flows and other factors, we did not have any OTTI during the three or six months ended June 30, 2013 and June 30, 2012.
The aggregate amortized cost and fair value of securities at June 30, 2013, by remaining contractual maturity, are shown in the following table. Actual expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.


10

 
 
Available-for-Sale
 
Held-to-Maturity
(dollars in thousands)
 
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Due in one year or less
 
$
8,139

 
$
8,193

 
$
—

 
$
—

Due after one year through five years
 
18,884

 
18,994

 
—

 
—

Due after five years through 10 years
 
3,282

 
3,342

 
—

 
—

Due after 10 years
 
—

 
—

 
—

 
—

Total
 
30,305

 
30,529

 
—

 
—

Mortgage-backed securities
 
441,237

 
422,881

 
154,797

 
148,745

Total
 
$
471,542

 
$
453,410

 
$
154,797

 
$
148,745


5. Loans and Allowance for Loan Losses
General

Loans held for investment are stated at the principal amounts outstanding adjusted for purchase premiums/discounts, deferred net loan fees and costs, and unearned income.  We report our loan portfolio by segments and classes, which are disaggregations of portfolio segments.  Our portfolio segments are:  Commercial and agricultural, Real estate, and Consumer loans.  The Commercial and agricultural loan and Consumer loan portfolios are not further segregated into classes.  The classes within the Real estate portfolio segment include Real estate - construction and Real estate mortgage, which is further broken into 1-4 family residential mortgage and Commercial real estate mortgage loans.

Loan fees and the incremental direct costs associated with originating a loan are deferred and subsequently recognized over the life of the loan as an adjustment to interest income.

In addition to originating loans we also purchase loans. At acquisition, purchased loans are designated as either purchased contractual loans ("PC loans") or purchased impaired loans ("PI loans"). PC loans are acquired loans where management believes it is probable that it will receive all principal as of the date of acquisition.  These loans are accounted for under the contractual cash flow method, under ASC 310-20. Any discount or premium paid on PC loans is recorded in interest income using the effective yield method over the expected life of the loans.

PI loans are acquired loans where management believes, at acquisition date, it is probable that all principal on the acquired loans will not be received.  PI loans are placed in homogeneous risk based pools where accounting for projected cash flows is performed, as allowed under ASC 310-30.  Once a pool is established the individual loans within each pool do not change.  As management obtains new information related to changes in expected principal loss and expected cash flows, by pool, we record either an increase in yield when new expected cash flows increase, an allowance for loan losses when new expected cash flows decline, or a decrease in yield when there is only a timing difference in expected cash flows.

Loans acquired in the Merger ("Granite Purchased Loans") included PI loans and PC loans. Loans designated as PC loans included performing revolving consumer and performing revolving commercial loans on acquisition date.

During the six months ended June 30, 2013, we purchased $119.0 million of performing residential mortgage loans, including premiums of $1.6 million. During the six months ended June 30, 2012, we purchased $137.4 million of performing residential mortgage loans, including premiums of $3.7 million. These loan purchases are accounted for as PC loans.

ALL Methodology
COB's ALL, which is utilized to absorb actual losses in the loan portfolio, is maintained at a level consistent with management's best estimate of probable loan losses to be incurred as of the balance sheet date. Management assesses COB's ALL quarterly. This assessment includes a methodology that separates the total loan portfolio into homogeneous loan classifications for purposes of evaluating risk. The required allowance is calculated by applying a risk adjusted reserve requirement to the dollar volume of loans within a homogenous group. For purposes of the ALL, we have grouped our loans into pools according to the loan segmentation regime employed on schedule RC-C of the FFIEC's Consolidated Report of Condition and Income. Major loan portfolio subgroups include: risk graded commercial loans, mortgage loans, home equity loans, retail loans and retail credit lines. Management also analyzes the loan portfolio on an ongoing basis to evaluate current risk levels, and risk grades are adjusted

11

accordingly. While management uses the best information available to make evaluations, future adjustments may be necessary, if economic or other conditions differ substantially from the assumptions used.
Historical loss rates are calculated by associating losses to the risk-graded pool to which they relate for each of the previous eight quarters. Then, using a look back period beginning in third quarter 2006, loss factors are calculated for each risk-graded pool.

In addition to our ability to use our own historical loss data and migration between risk grades, we have a rigorous process for computing the qualitative factors that impact the ALL. A committee, independent of the historical loss migration team, reviews risk factors that may impact the ALL. Some factors are statistically quantifiable, such as concentration, growth, delinquency, and nonaccrual risk by loan type, while other factors are qualitative in nature, such as staff competency, competition within our markets and economic and regulatory changes impacting the loans held for investment.

We lend primarily in North Carolina. As of June 30, 2013, a substantial majority of the principal amount of the loans held for investment in our portfolio was to businesses and individuals in North Carolina. This geographic concentration subjects the loan portfolio to the general economic conditions within this area. The risks created by this concentration have been considered by management in the determination of the adequacy of the ALL. Management believes the ALL is adequate to cover estimated losses on loans at each balance sheet date.

During the three month period ended June 30, 2013, we charged off $6.1 million in loans and realized $2.6 million in recoveries, for $3.5 million of net charge-offs. During the six month period ended June 30, 2013, we charged off $9.1 million in loans and realized $5.8 million in recoveries, for $3.3 million of net charge-offs. The majority of the loans charged off were loans that were previously impaired and had specific reserves assigned in prior periods.

The ALL, as a percentage of loans held for investment, was 2.11% at June 30, 2013, compared to 3.01% at June 30, 2012. At December 31, 2012, the ALL, as a percentage of loans held for investment, was 2.49%.

Risk Grades

The risk-grade categories presented in the following table, which are standard categories used by the bank regulators, are:

Pass - Loans categorized as Pass are higher quality loans that have adequate sources of repayment and little risk of collection.
Special Mention - A Special Mention loan has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution's credit position at some future date. Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.
Substandard - A Substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of Substandard loans, does not have to exist in individual assets classified Substandard.
Doubtful - A loan classified as Doubtful has all the weaknesses inherent in one classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonable specific pending factors, which may work to the advantage of strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans.
Loans categorized as Special Mention or worse are considered Criticized. Loans categorized as Substandard or Doubtful are considered Classified. Purchased loans acquired in the Merger are recorded at estimated fair value on the date of acquisition without the carryover of related ALL. The table below includes $46.7 million and $60.6 million in Granite Purchased Loans categorized as Substandard or Doubtful at June 30, 2013 and December 31, 2012, respectively.
The following table presents loans held for investment balances by risk grade as of June 30, 2013:

12

(dollars in thousands)
 
Pass
 
Special Mention
 
Substandard
 
Doubtful
 
 
 
 
(Ratings 1-5)
 
(Rating 6)
 
(Rating 7)
 
(Rating 8)
 
Total
Commercial and agricultural
 
$
62,760

 
$
1,861

 
$
4,722

 
$
—

 
$
69,343

Real estate - construction
 
46,440

 
1,891

 
16,305

 
—

 
64,636

Real estate - mortgage:
 
 
 
 
 
 
 
 
 
 
1-4 family residential
 
569,013

 
13,692

 
27,932

 
107

 
610,744

Commercial
 
300,265

 
29,702

 
70,805

 
—

 
400,772

Consumer
 
42,971

 
180

 
493

 
274

 
43,918

Total
 
$
1,021,449

 
$
47,326

 
$
120,257

 
$
381

 
$
1,189,413

The following table presents loans held for investment balances by risk grade as of December 31, 2012:
(dollars in thousands)
 
Pass
 
Special Mention
 
Substandard
 
Doubtful
 
 
 
 
(Ratings 1-5)
 
(Rating 6)
 
(Rating 7)
 
(Rating 8)
 
Total
Commercial and agricultural
 
$
69,003

 
$
3,447

 
$
6,953

 
$
301

 
$
79,704

Real estate - construction
 
40,117

 
2,031

 
16,266

 
—

 
58,414

Real estate - mortgage:
 
 
 
 
 
 
 
 
 
 
1-4 family residential
 
504,819

 
15,855

 
32,625

 
239

 
553,538

Commercial
 
296,271

 
50,275

 
95,126

 
164

 
441,836

Consumer
 
42,495

 
178

 
426

 
444

 
43,543

Total
 
$
952,705

 
$
71,786

 
$
151,396

 
$
1,148

 
$
1,177,035

Loans included in the preceding loan composition table are net of participations sold. Loans are increased by net loan premiums and deferred loan discounts or fees of $2.5 million at June 30, 2013. Loans are increased by net deferred loan discounts or fees of $3.6 million at December 31, 2012.
At June 30, 2013 and December 31, 2012, loans held for sale consisted of originated residential mortgage loans held for sale at the lower of cost or fair market value.
Loans serviced for others are not included in the consolidated balance sheet. The unpaid principal balance of loans serviced for others amounted to $146.6 million at June 30, 2013 and $65.1 million at December 31, 2012.
Loans Pledged
To borrow from the FHLB, members must pledge collateral to secure advances and letters of credit. Acceptable collateral includes, among other types of collateral, a variety of residential, multifamily, home equity lines and second mortgages, and commercial loans. Gross loans of $232.9 million and $270.2 million were pledged to collateralize FHLB advances and letters of credit at June 30, 2013 and December 31, 2012, respectively, of which there was $10.0 million and $19.1 million of credit availability for borrowing, respectively. At June 30, 2013, $11.1 million of loans were pledged to collateralize potential borrowings from the Federal Reserve Discount Window, of which $9.8 million was available as borrowing capacity. We could also access $70.9 million of additional borrowings under credit lines by pledging additional collateral.
Nonaccruing and Impaired Loans
Interest income on loans is calculated by using the interest method based on the daily outstanding balance. The recognition of interest income is discontinued when, in management's opinion, the collection of all or a portion of interest becomes doubtful. Loans are returned to accrual status when the factors indicating doubtful collectability cease to exist and the loan has performed in accordance with its terms for a demonstrated period of time. The past due status of loans is based on the contractual payment terms. Had nonaccruing loans been on accruing status, interest income would have been higher by $0.8 million and $1.5 million for the three months ended June 30, 2013 and June 30, 2012, respectively, and higher by $1.7 million and $2.9 million for the six months ended June 30, 2013 and June 30, 2012, respectively. At June 30, 2013 and December 31, 2012, COB had certain impaired loans of $59.0 million and $79.2 million, respectively, which were on nonaccruing interest status.
All loan classes are considered past due when the contractual amounts due with respect to principal and interest are not received within 30 days of the contractual due date. When we cannot reasonably expect full and timely repayment of its loan, the loan is placed on nonaccrual.

13

All loan classes on which principal or interest is in default for 90 days or more are put on nonaccrual status, unless there is sufficient documentation to conclude that the loan is well secured and in the process of collection. A debt is "well-secured" if collateralized by liens on or pledges of real or personal property, including securities, that have a realizable value sufficient to discharge the debt in full; or by the guarantee of a financially responsible party. A debt is "in process of collection" if collection is proceeding in due course either through legal action, including judgment enforcement procedures, or, in appropriate circumstances, through collection efforts not involving legal action that are reasonably expected to result in repayment of the debt or its restoration to a current status.
Loans that are less than 90 days delinquent may also be placed on nonaccrual if deterioration in the financial condition of the borrower has increased the probability of less than full repayment.
At the time a loan is placed on nonaccrual, all accrued, unpaid interest is charged off, unless it is documented that repayment of all principal and presently accrued but unpaid interest is probable. Charge-offs of accrued and unpaid interest are charged against the current year's interest income and not against the current ALL.
For all loan classes, a nonaccrual loan may be returned to accrual status when we can reasonably expect continued timely payments until payment in full. All prior arrearage does not have to be eliminated, nor do all previously charged-off amounts need to have been recovered, but the loan can still be returned to accrual status if the following conditions are met: (1) all principal and interest amounts contractually due (including arrearage) are reasonably assured of repayment within a reasonable period; and (2) there is a sustained period of repayment performance (generally a minimum of six months) by the borrower, in accordance with the contractual terms involving payments of cash or cash equivalents.
For all classes within all loan portfolios, cash receipts received on nonaccrual loans are applied entirely against principal until the loan or lease has been collected in full, after which time any additional cash receipts are recognized as interest income.
For all loan classes, as soon as any loan becomes uncollectible, the loan will be charged down or charged off as follows:
•
If unsecured, the loan must be charged off in full.
•
If secured, the outstanding principal balance of the loan should be charged down to the net liquidation value of the collateral.
Loans should be considered uncollectible when:
•
No regularly scheduled payment has been made within four months and the determination is made that any further payment is unlikely, or
•
The loan is unsecured, the borrower has filed for bankruptcy protection and there is no other (guarantor, etc.) support from an entity outside of the bankruptcy proceedings.
Based on a variety of credit, collateral and documentation issues, loans with lesser degrees of delinquency or obvious loss may also be deemed uncollectible.

14

The following table presents an aging analysis of accruing and nonaccruing loans as of June 30, 2013:
(dollars in thousands)
 
Accruing
 
 
 
 
 
 
 
 
 
 
30-59 days past due
 
60-89 days past due
 
More than 90 days past due
 
Nonaccrual
 
Total past due and nonaccrual
 
Current and accruing
 
Total Loans
PC and Originated Loans
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and agricultural
 
$
433

 
$
—

 
$
—

 
$
1,654

 
$
2,087

 
$
55,293

 
$
57,380

Real estate - construction
 
419

 
—

 
—

 
9,783

 
10,202

 
44,171

 
54,373

Real estate - mortgage:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1-4 family residential
 
1,038

 
19

 
—

 
15,917

 
16,974

 
560,957

 
577,931

Commercial
 
410

 
—

 
—

 
31,380

 
31,790

 
236,003

 
267,793

Consumer
 
156

 
11

 
—

 
269

 
436

 
42,341

 
42,777

Total
 
$
2,456

 
$
30

 
$
—

 
$
59,003

 
$
61,489

 
$
938,765

 
$
1,000,254

PI loans
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and agricultural
 
$
79

 
$
1,059

 
$
701

 
$
—

 
$
1,839

 
$
10,124

 
$
11,963

Real estate - construction
 
189

 
—

 
2,725

 
—

 
2,914

 
7,349

 
10,263

Real estate - mortgage:
 
 
 
 
 

 
 
 
 
 
 
 
 
1-4 family residential
 
73

 
143

 
3,113

 
—

 
3,329

 
29,484

 
32,813

Commercial
 
2,019

 
255

 
15,119

 
—

 
17,393

 
115,586

 
132,979

Consumer
 
1

 
—

 
—

 
—

 
1

 
1,140

 
1,141

Total
 
$
2,361

 
$
1,457

 
$
21,658

 
$
—

 
$
25,476

 
$
163,683

 
$
189,159

Total Loans
 
$
4,817

 
$
1,487

 
$
21,658

 
$
59,003

 
$
86,965

 
$
1,102,448

 
$
1,189,413


The following table presents an aging analysis of accruing and nonaccruing loans as of December 31, 2012:
(dollars in thousands)
 
Accruing
 
 
 
 
 
 
 
 
 
 
30-59 days past due
 
60-89 days past due
 
More than 90 days past due
 
Nonaccrual
 
Total past due and nonaccrual
 
Current and accruing
 
Total Loans
PC and Originated Loans
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and agricultural
 
$
515

 
$
—

 
$
50

 
$
2,746

 
$
3,311

 
$
61,727

 
$
65,038

Real estate - construction
 
26

 
119

 
—

 
14,297

 
14,442

 
41,290

 
55,732

Real estate - mortgage:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1-4 family residential
 
6,173

 
880

 
—

 
18,372

 
25,425

 
488,898

 
514,323

Commercial
 
617

 
—

 
177

 
43,621

 
44,415

 
226,948

 
271,363

Consumer
 
24

 
—

 
—

 
206

 
230

 
41,957

 
42,187

Total
 
$
7,355

 
$
999

 
$
227

 
$
79,242

 
$
87,823

 
$
860,820

 
$
948,643

PI loans
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and agricultural
 
$
100

 
$
1

 
$
1,103

 
$
—

 
$
1,204

 
$
13,462

 
$
14,666

Real estate - construction
 
117

 
—

 
655

 
—

 
772

 
1,910

 
2,682

Real estate - mortgage:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1-4 family residential
 
1,308

 
495

 
4,678

 
—

 
6,481

 
32,734

 
39,215

Commercial
 
2,559

 
4,300

 
17,384

 
—

 
24,243

 
146,230

 
170,473

Consumer
 
4

 
—

 
13

 
—

 
17

 
1,339

 
1,356

Total
 
$
4,088

 
$
4,796

 
$
23,833

 
$
—

 
$
32,717

 
$
195,675

 
$
228,392

Total Loans
 
$
11,443

 
$
5,795

 
$
24,060

 
$
79,242

 
$
120,540

 
$
1,056,495

 
$
1,177,035

All PI loans are considered to be accruing for all periods presented, in accordance with ASC 310-30.

15


A loan is considered impaired, based on current information and events, if it is probable that we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. If the loan has been modified to provide relief to the borrower, the loan is deemed to be impaired if all principal and interest will not be repaid according to the original contract. All loans meeting the definition of Doubtful should be considered impaired.
When a loan has been determined to be impaired, the amount of the impairment is measured using the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, the observable market price of the loan, or the fair value of the collateral if the loan is collateral dependent. When the present value of expected future cash flows is used, the effective interest rate is the original contractual interest rate of the loan adjusted for any premium or discount. When the contractual interest rate is variable, the effective interest rate of the loan changes over time. A specific reserve is established as a component of the ALL when a loan has been determined to be impaired. Subsequent to the initial measurement of impairment, if there is a significant change to the impaired loan's expected future cash flows, or if actual cash flows are significantly different from the cash flows previously estimated, we recalculate the impairment and appropriately adjust the specific reserve. Similarly, if we measure impairment based on the observable market price of an impaired loan or the fair value of the collateral of an impaired collateral-dependent loan, we will adjust the specific reserve if there is a significant change in either of those bases.
When a loan is impaired and principal and interest is in doubt when contractually due, interest income is not recognized. Cash receipts received on nonaccruing impaired loans within any class are generally applied entirely against principal until the loan has been collected in full, after which time any additional cash receipts are recognized as interest income. Cash receipts received on accruing impaired loans within any class are applied in the same manner as accruing loans that are not considered impaired.
The following table summarizes information relative to impaired loans for the dates indicated:
 
 
June 30, 2013
 
December 31, 2012
(dollars in thousands)
 
Balance
Associated Reserves
 
Balance
Associated Reserves
Impaired loans, not individually reviewed for impairment
 
$
9,313

$
—

 
$
6,017

$
—

Impaired loans, individually reviewed, with no impairment
 
51,557

—

 
62,282

—

Impaired loans, individually reviewed, with impairment
 
5,935

763

 
15,312

1,737

Total impaired loans, excluding purchased impaired *
 
$
66,805

$
763

 
$
83,611

$
1,737

 
 
 
 
 
 
 
Purchased impaired loans with subsequent deterioration
 
$
161,278

4,066

 
$
192,115

5,373

Purchased impaired loans with no subsequent deterioration
 
$
27,881

—

 
$
36,277

—

Total Reserves
 
 
$
4,829

 
 
$
7,110

 
 
 
 
 
 
 
Average impaired loans calculated using a simple average
 
$
72,917

 
 
$
94,754

 
* Included at June 30, 2013 and December 31, 2012 were $4.3 million and $4.5 million, respectively, in restructured and performing loans.

The following table presents loans held for investment on nonaccrual status by loan class for the dates indicated:

16

(dollars in thousands)
 
 
 
 
 
 
June 30, 2013
 
December 31, 2012
Loans held for investment:
 
 
 
 
Commercial and agricultural
 
$
1,654

 
$
2,746

Real estate - construction
 
9,783

 
14,297

Real estate - mortgage:
 
 
 
 
1-4 family residential
 
15,917

 
18,372

Commercial
 
31,380

 
43,621

Consumer
 
269

 
206

Total nonaccrual loans
 
$
59,003

 
$
79,242

Loans more than 90 days delinquent, still on accrual
 
—

 
227

Total nonperforming loans
 
$
59,003

 
$
79,469

There were no loans held for sale on nonaccrual status as of June 30, 2013 or December 31, 2012.


17

The following table presents individually reviewed impaired loans and purchased impaired loans with subsequent credit deterioration, segregated by portfolio segment, and the corresponding reserve for impaired loan losses as of June 30, 2013:
 
 
 
 
Unpaid
 
 
(dollars in thousands)
 
Recorded
 
Principal
 
Related
 
 
Investment
 
Balance
 
Allowance
With no related allowance recorded:
 
 
 
 
 
 
  Commercial and agricultural
 
$
1,366

 
$
1,700

 
$
—

  Real estate - construction
 
9,029

 
14,230

 
—

  Real estate - mortgage:
 
 
 
 
 
 
1-4 family residential
 
12,218

 
17,109

 
—

Commercial
 
28,944

 
36,430

 
—

  Consumer
 
—

 
—

 
—

Total
 
$
51,557

 
$
69,469

 
$
—

With an allowance recorded:
 
 
 
 
 
 
  Commercial and agricultural
 
$
107

 
$
316

 
$
15

  Real estate - construction
 
218

 
218

 
20

  Real estate - mortgage:
 
 
 
 
 
 
1-4 family residential
 
1,615

 
1,704

 
209

Commercial
 
3,845

 
5,197

 
369

  Consumer
 
150

 
155

 
150

Total
 
$
5,935

 
$
7,590

 
$
763

Total individually evaluated impaired loans
 
 
 
 
 
 
  Commercial and agricultural
 
$
1,473

 
$
2,016

 
$
15

  Real estate - construction
 
9,247

 
14,448

 
20

  Real estate - mortgage:
 
 
 
 
 
 
1-4 family residential
 
13,833

 
18,813

 
209

Commercial
 
32,789

 
41,627

 
369

  Consumer
 
150

 
155

 
150

Total
 
$
57,492

 
$
77,059

 
$
763

 
 
 
 
 
 
 
PI loans with subsequent credit deterioration:
 
 
 
 
 
 
  Commercial and agricultural
 
$
9,429

 
$
9,375

 
$
26

  Real estate - construction
 
8,202

 
8,795

 
759

  Real estate - mortgage:
 
 
 
 
 
 
     1-4 family residential
 
29,875

 
30,226

 
504

     Commercial
 
112,641

 
114,601

 
2,585

  Consumer
 
1,131

 
907

 
192

Total
 
$
161,278

 
$
163,904

 
$
4,066


18

The following table presents individually reviewed impaired loans, and purchased impaired loans with subsequent credit deterioration, segregated by portfolio segment, and the corresponding reserve for impaired loan losses as of December 31, 2012:
 
 
 
 
Unpaid
 
 
(dollars in thousands)
 
Recorded
 
Principal
 
Related
 
 
Investment
 
Balance
 
Allowance
With no related allowance recorded:
 
 
 
 
 
 
  Commercial and agricultural
 
$
1,755

 
$
2,608

 
$
—

  Real estate - construction
 
11,875

 
18,553

 
—

  Real estate - mortgage:
 
 
 
 
 
 
1-4 family residential
 
16,437

 
20,764

 
—

Commercial
 
32,215

 
38,585

 
—

  Consumer
 
—

 
—

 
—

Total
 
$
62,282

 
$
80,510

 
$
—

With an allowance recorded:
 
 
 
 
 
 
  Commercial and agricultural
 
$
579

 
$
602

 
$
282

  Real estate - construction
 
1,658

 
1,843

 
82

  Real estate - mortgage:
 
 
 
 
 
 
1-4 family residential
 
1,681

 
1,745

 
607

Commercial
 
11,394

 
14,714

 
766

  Consumer
 
—

 
—

 
—

Total
 
$
15,312

 
$
18,904

 
$
1,737

Total individually evaluated impaired loans
 
 
 
 
 
 
  Commercial and agricultural
 
$
2,334

 
$
3,210

 
$
282

  Real estate - construction
 
13,533

 
20,396

 
82

  Real estate - mortgage:
 
 
 
 
 
 
1-4 family residential
 
18,118

 
22,509

 
607

Commercial
 
43,609

 
53,299

 
766

  Consumer
 
—

 
—

 
—

Total
 
$
77,594

 
$
99,414

 
$
1,737

PI loans with subsequent credit deterioration:
 
 
 
 
 
 
  Commercial and agricultural
 
$
11,533

 
$
11,728

 
$
524

  Real estate - construction
 
2,285

 
2,236

 
200

  Real estate - mortgage:
 
 
 
 
 
 
     1-4 family residential
 
34,961

 
35,802

 
711

     Commercial
 
141,974

 
145,704

 
3,388

  Consumer
 
1,362

 
1,147

 
550

Total
 
$
192,115

 
$
196,617

 
$
5,373




19

The following summary includes impaired loans individually reviewed as well as impaired loans held for sale. Average recorded investment and interest income recognized on impaired loans, segregated by portfolio segment, is shown in the following tables as of June 30, 2013 and June 30, 2012:
 
 
For Three Months Ended
 
For Three Months Ended
 
 
June 30, 2013
 
June 30, 2012
 
 
Average
 
Interest
 
Average
 
Interest
(dollars in thousands)
 
Recorded
 
Income
 
Recorded
 
Income
 
 
Investment
 
Recognized
 
Investment
 
Recognized
With no related allowance recorded:
 
 
 
 
 
 
 
 
  Commercial and agricultural
 
$
1,398

 
$
1

 
$
2,170

 
$
3

  Real estate - construction
 
9,513

 
—

 
10,918

 
30

  Real estate - mortgage:
 
 
 
 
 
 
 
 
1-4 family residential
 
12,662

 
9

 
15,944

 
60

Commercial
 
30,466

 
25

 
33,630

 
76

  Consumer
 
—

 
—

 
1,000

 
15

Total
 
$
54,039

 
$
35

 
$
63,662

 
$
184

With an allowance recorded:
 
 
 
 
 
 
 
 
  Commercial and agricultural
 
$
107

 
$
—

 
$
1,790

 
$
—

  Real estate - construction
 
219

 
3

 
16,567

 
7

  Real estate - mortgage:
 
 
 
 
 
 
 
 
1-4 family residential
 
1,662

 
1

 
8,760

 
76

Commercial
 
3,912

 
—

 
15,832

 
151

  Consumer
 
164

 
—

 
652

 
13

Total
 
$
6,064

 
$
4

 
$
43,601

 
$
247

Total:
 
 
 
 
 
 
 
 
  Commercial and agricultural
 
$
1,505

 
$
1

 
$
3,960

 
$
3

  Real estate - construction
 
9,732

 
3

 
27,485

 
37

  Real estate - mortgage:
 
 
 
 
 
 
 
 
1-4 family residential
 
14,324

 
10

 
24,704

 
136

Commercial
 
34,378

 
25

 
49,462

 
227

  Consumer
 
164

 
—

 
1,652

 
28

Total
 
$
60,103

 
$
39

 
$
107,263

 
$
431


20

 
 
For Six Months Ended
 
For Six Months Ended
 
 
June 30, 2013
 
June 30, 2012
 
 
Average
 
Interest
 
Average
 
Interest
(dollars in thousands)
 
Recorded
 
Income
 
Recorded
 
Income
 
 
Investment
 
Recognized
 
Investment
 
Recognized
With no related allowance recorded:
 
 
 
 
 
 
 
 
  Commercial and agricultural
 
$
1,414

 
$
8

 
$
2,651

 
$
10

  Real estate - construction
 
9,705

 
—

 
12,166

 
34

  Real estate - mortgage:
 
 
 
 
 
 
 
 
1-4 family residential
 
12,643

 
33

 
17,071

 
66

Commercial
 
31,042

 
144

 
31,720

 
106

  Consumer
 
—

 
—

 
699

 
15

Total
 
$
54,804

 
$
185

 
$
64,307

 
$
231

With an allowance recorded:
 
 
 
 
 
 
 
 
  Commercial and agricultural
 
$
107

 
$
—

 
$
1,729

 
$
—

  Real estate - construction
 
220

 
6

 
14,308

 
9

  Real estate - mortgage:
 
 
 
 
 
 
 
 
1-4 family residential
 
1,682

 
4

 
10,862

 
94

Commercial
 
3,933

 
—

 
15,177

 
159

  Consumer
 
167

 
1

 
432

 
13

Total
 
$
6,109

 
$
11

 
$
42,508

 
$
275

Total:
 
 
 
 
 
 
 
 
  Commercial and agricultural
 
$
1,521

 
$
8

 
$
4,380

 
$
10

  Real estate - construction
 
9,925

 
6

 
26,474

 
43

  Real estate - mortgage:
 
 
 
 
 
 
 
 
1-4 family residential
 
14,325

 
37

 
27,933

 
160

Commercial
 
34,975

 
144

 
46,897

 
265

  Consumer
 
167

 
1

 
1,131

 
28

Total
 
$
60,913

 
$
196

 
$
106,815

 
$
506


Impaired loans also include loans for which we may elect to grant a concession, providing terms more favorable than those prevalent in the market (e.g., rate, amortization term), and formally restructure due to the weakening credit status of a borrower. Restructuring is designed to facilitate a repayment plan that minimizes the potential losses that we otherwise may have to incur. If these impaired loans are on nonaccruing status as of the date of restructuring, the loans are included in nonperforming loans. Nonperforming restructured loans will remain as nonperforming until the borrower can demonstrate adherence to the restructured terms for a period of no less than six months and when it is otherwise determined that continued adherence is reasonably assured. Some restructured loans continue as accruing loans after restructuring if the borrower is not past due at the time of restructuring, adequate collateral valuations support the restructured loans, and the cash flows of the underlying business appear adequate to support the restructured debt service. Not included in nonperforming loans are loans that have been restructured that were performing as of the restructure date. At June 30, 2013, there was $16.3 million in restructured loans, of which $4.3 million in loans were accruing and in a performing status. At December 31, 2012, there was $20.8 million in restructured loans, of which $4.5 million in loans were accruing and in a performing status.
Sale of Problem Loans
During 2012, we sold loans to third party buyers in order to reduce our problem loan exposure. These loans were transferred to loans held for sale at the time we received a signed contract for the purchase of the loans. Prior to transferring these loans to loans held for sale, the loans were marked down to the contract price less associated selling costs. All transactions were conducted at arm's length and loans were sold without recourse.


21

The following table presents sold loans by portfolio segment for the periods indicated below:
 
For Three Months Ended
 
For Three Months Ended
 
June 30, 2013
 
June 30, 2012
(dollars in thousands)
Number
 
Recorded
 
Contract
 
Number
 
Recorded
 
Contract
 
of Loans
 
Investment
 
Pricing
 
of Loans
 
Investment
 
Pricing
Commercial and agricultural
—

 
$
—

 
$
—

 
—

 
$
—

 
$
—

Real estate - construction
—

 
—

 
—

 
—

 
—

 
—

Real estate - mortgage:
 
 
 
 
 
 
 
 
 
 
 
1-4 family residential
—

 
—

 
—

 
6

 
1,715

 
1,746

Commercial
—

 
—

 
—

 
—

 
—

 
—

Consumer
—

 
—

 
—

 
—

 
—

 
—

Total
—

 
$
—

 
$
—

 
6


$
1,715


$
1,746

 
For Six Months Ended
 
For Six Months Ended
 
June 30, 2013
 
June 30, 2012
(dollars in thousands)
Number
 
Recorded
 
Contract
 
Number
 
Recorded
 
Contract
 
of Loans
 
Investment
 
Pricing
 
of Loans
 
Investment
 
Pricing
Commercial and agricultural
—

 
$
—

 
$
—

 
—

 
$
—

 
$
—

Real estate - construction
—

 
—

 
—

 
—

 
—

 
—

Real estate - mortgage:
 
 
 
 
 
 
 
 
 
 
 
1-4 family residential
—

 
—

 
—

 
7

 
1,865

 
1,896

Commercial
—

 
—

 
—

 
1

 
3,800

 
4,050

Consumer
—

 
—

 
—

 
—

 
—

 
—

Total
—

 
$
—

 
$
—

 
8


$
5,665

 
$
5,946

 
Granite Purchased Loans
Granite Purchased Loans include PI loans and PC loans. PC loans include performing revolving consumer and commercial loans on October 21, 2011, the acquisition date.
PI loans are segregated into pools and recorded at estimated fair value on the date of acquisition without the carryover of the related ALL. PI loans are accounted for under ASC 310-30 when the loans have evidence of credit deterioration since origination and it is probable at the date of acquisition we will not collect all contractually required principal and interest payments. Evidence of credit quality deterioration as of the date of acquisition may include statistics such as past due status, nonaccrual status and risk grade. PI loans generally meet our definition for nonaccrual status; however, even if the borrower is not currently making payments, we will classify loans as accruing if we can reasonably estimate the amount and timing of future cash flows. All Granite Purchased PI loans are presented on an accruing basis. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference.
Periodically, we estimate the expected cash flows for each pool of the PI loans and evaluate whether the expected cash flows for each pool have changed from prior estimates. Decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges, or reclassification from nonaccretable difference to accretable yield with a positive impact on future interest income. Excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows.
We have elected to account for the Granite Purchased PI loans under ASC 310-30 and the Granite Purchased PC loans under ASC 310-20.

22

At June 30, 2013, and December 31, 2012, our financial statements reflected a PI loan ALL of $4.1 million and $5.4 million, respectively, and an ALL for PC loans of $0.7 million and $0.5 million, respectively.

The following table presents the balance of all Granite Purchased Loans:
 
 
At June 30, 2013
(dollars in thousands)
 
Purchased Impaired
 
Purchased Contractual
 
Total Purchased Loans
 
Unpaid
Principal
Balance
Commercial and agricultural
 
$
11,964

 
$
4,647

 
$
16,611

 
$
15,971

Real estate - construction
 
10,263

 
—

 
10,263

 
10,095

Real estate - mortgage:
 
 
 
 
 
 
 
 
   1-4 family residential
 
32,813

 
24,130

 
56,943

 
58,197

   Commercial
 
132,978

 
390

 
133,368

 
135,404

Consumer
 
1,141

 
—

 
1,141

 
937

       Total
 
$
189,159

 
$
29,167

 
$
218,326

 
$
220,604

 
 
At December 31, 2012
(dollars in thousands)
 
Purchased Impaired
 
Purchased Contractual
 
Total
Purchased Loans
 
Unpaid
Principal
Balance
Commercial and agricultural
 
$
14,666

 
$
7,311

 
$
21,977

 
$
21,692

Real estate - construction
 
2,682

 
—

 
2,682

 
2,677

Real estate - mortgage:
 
 
 
 
 
 
 
 
   1-4 family residential
 
39,215

 
27,484

 
66,699

 
69,200

   Commercial
 
170,467

 
49

 
170,516

 
176,347

Consumer
 
1,362

 
—

 
1,362

 
1,144

       Total
 
$
228,392

 
$
34,844

 
$
263,236

 
$
271,060

The tables below include only those Granite Purchased Loans accounted for under the expected cash flow method (PI loans) for the periods indicated. These tables do not include PC loans, including Granite Purchased PC loans or purchased performing residential mortgage loans.
 
 
For Three Months Ended
 
For Three Months Ended
 
 
June 30, 2013
 
June 30, 2012
 
 
Purchased Impaired
 
Purchased Impaired
(dollars in thousands)
 
Carrying
Amount
 
Future
Accretion
 
Carrying
Amount
 
Future Accretion
Balance, beginning of period
 
$
205,884

 
$
26,096

 
$
310,389

 
$
42,032

  Accretion
 
4,191

 
(4,191
)
 
5,491

 
(5,491
)
  Increase in future accretion
 
—

 
6,801

 
—

 
4,592

  Payments received
 
(20,403
)
 
—

 
(27,791
)
 
—

  Foreclosed and transferred to OREO
 
(513
)
 
—

 
(997
)
 
—

Subtotal before allowance
 
189,159

 
28,706

 
287,092

 
41,133

Allowance for credit losses
 
(4,066
)
 
—

 
(3,336
)
 
—

Net carrying amount, end of period
 
$
185,093

 
$
28,706

 
$
283,756

 
$
41,133


23

 
 
For Six Months Ended
 
For Six Months Ended
 
 
June 30, 2013
 
June 30, 2012
 
 
Purchased Impaired
 
Purchased Impaired
(dollars in thousands)
 
Carrying
Amount
 
Future
Accretion
 
Carrying
Amount
 
Future Accretion
Balance, beginning of period
 
$
228,392

 
$
30,299

 
$
330,836

 
$
47,804

  Accretion
 
8,394

 
(8,394
)
 
11,263

 
(11,263
)
Increase in future accretion
 
—

 
6,801

 
—

 
4,592

  Payments received
 
(46,331
)
 
—

 
(50,901
)
 
—

  Foreclosed and transferred to OREO
 
(1,296
)
 
—

 
(4,106
)
 
—

Subtotal before allowance
 
189,159

 
28,706

 
287,092

 
41,133

Allowance for credit losses
 
(4,066
)
 
—

 
(3,336
)
 
—

Net carrying amount, end of period
 
$
185,093

 
$
28,706

 
$
283,756

 
$
41,133


Allowance for Loan Losses
An analysis of the changes in the ALL is as follows:
 
 
For Three Months Ended
 
For Six Months Ended
(dollars in thousands)
 
June 30, 2013
 
June 30, 2012
 
June 30, 2013
 
June 30, 2012
Balance, beginning of period
 
$
29,641

 
$
39,795

 
$
29,314

 
$
39,360

Provision for losses charged to continuing operations
 
(1,057
)
 
7,778

 
(947
)
 
10,845

Net charge-offs:
 
 
 
 
 
 
 
 
Charge-offs
 
(6,102
)
 
(10,285
)
 
(9,113
)
 
(14,300
)
Recoveries
 
2,603

 
1,263

 
5,831

 
2,646

Net recoveries (charge-offs)
 
(3,499
)
 
(9,022
)
 
(3,282
)
 
(11,654
)
Balance, end of period
 
$
25,085

 
$
38,551

 
$
25,085

 
$
38,551

Annualized net charge-offs (recoveries) during the period to average loans
 
1.26
%
 
2.83
%
 
0.59
%
 
1.87
%
Annualized net charge-offs (recoveries) during the period to ALL
 
55.79
%
 
94.13
%
 
26.17
%
 
60.79
%
Allowance for loan losses to loans held for investment (1)
 
2.11
%
 
3.01
%
 
2.11
%
 
3.01
%
(1) Excludes discontinued operations.

The following table presents ALL activity by portfolio segment for the three months ended June 30, 2013:
 
 
 
 
 
 
Real Estate - Mortgage
 
 
 
 
(dollars in thousands)
 
Commercial and Agricultural
 
Real Estate - Construction
 
1-4 Family Residential
 
Commercial
 
Consumer
 
Total

 
 
 
 
 
 
 
 
 
 
 
 
ALL:
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance at April 1, 2013
 
$
3,373

 
$
5,594

 
$
8,803

 
$
9,291

 
$
2,580

 
$
29,641

Charge-offs
 
(875
)
 
(584
)
 
(2,537
)
 
(1,371
)
 
(735
)
 
(6,102
)
Recoveries
 
633

 
271

 
492

 
1,075

 
132

 
2,603

Provision
 
(939
)
 
371

 
642

 
(1,608
)
 
477

 
(1,057
)
Ending balance at June 30, 2013
 
$
2,192

 
$
5,652

 
$
7,400

 
$
7,387

 
$
2,454

 
$
25,085


24


The following table presents ALL activity by portfolio segment for the three months ended June 30, 2012:
 
 
 
 
 
 
Real Estate - Mortgage
 
 
 
 
(dollars in thousands)
 
Commercial and Agricultural
 
Real Estate - Construction
 
1-4 Family Residential
 
Commercial
 
Consumer
 
Total
ALL:
 
 
 
 
 
 
 
 
 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance at April 1, 2012
 
$
6,005

 
$
10,912

 
$
12,103

 
$
8,799

 
$
1,976

 
$
39,795

Charge-offs
 
(937
)
 
(4,521
)
 
(2,454
)
 
(954
)
 
(1,419
)
 
(10,285
)
Recoveries
 
235

 
244

 
244

 
262

 
278

 
1,263

Provision
 
1,848

 
4,685

 
(1,109
)
 
1,111

 
1,243

 
7,778

Ending balance at June 30, 2012
 
$
7,151

 
$
11,320

 
$
8,784

 
$
9,218

 
$
2,078

 
$
38,551


The following table presents ALL activity by portfolio segment for the six months ended June 30, 2013:
 
 
 
 
 
 
Real Estate - Mortgage
 
 
 
 
(dollars in thousands)
 
Commercial and Agricultural
 
Real Estate - Construction
 
1-4 Family Residential
 
Commercial
 
Consumer
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
ALL:
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance at January 1, 2013
 
$
3,238

 
$
4,987

 
$
8,701

 
$
9,627

 
$
2,761

 
$
29,314

Charge-offs
 
(1,194
)
 
(928
)
 
(3,169
)
 
(2,262
)
 
(1,560
)
 
(9,113
)
Recoveries
 
911

 
1,067

 
677

 
2,007

 
1,169

 
5,831

Provision
 
(763
)
 
526

 
1,191

 
(1,985
)
 
84

 
(947
)
Ending balance at June 30, 2013
 
$
2,192

 
$
5,652

 
$
7,400

 
$
7,387

 
$
2,454

 
$
25,085


The following table presents ALL activity by portfolio segment for the six months ended June 30, 2012:
 
 
 
 
 
 
Real Estate - Mortgage
 
 
 
 
(dollars in thousands)
 
Commercial and Agricultural
 
Real Estate - Construction
 
1-4 Family Residential
 
Commercial
 
Consumer
 
Total
ALL:
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance at January 1, 2012
 
$
5,776

 
$
11,995

 
$
8,885

 
$
11,063

 
$
1,641

 
$
39,360

Charge-offs
 
(1,631
)
 
(6,296
)
 
(3,159
)
 
(992
)
 
(2,222
)
 
(14,300
)
Recoveries
 
489

 
845

 
377

 
336

 
599

 
2,646

Provision
 
2,517

 
4,776

 
2,681

 
(1,189
)
 
2,060

 
10,845

Ending balance at June 30, 2012
 
$
7,151

 
$
11,320

 
$
8,784

 
$
9,218

 
$
2,078

 
$
38,551

The following table details the recorded investment in loans related to each segment in the allowance for loan losses by portfolio segment and disaggregated on the basis of impairment evaluation methodology at June 30, 2013:

25

 
 
 
 
 
 
Real Estate - Mortgage
 
 
 
 
(dollars in thousands)
 
Commercial and Agricultural
 
Real Estate - Construction
 
1-4 Family Residential
 
Commercial
 
Consumer
 
Total
ALL:
 
 
 
 
 
 
 
 
 
 
 
 
  Individually evaluated for impairment
 
$
15

 
$
20

 
$
209

 
$
369

 
$
150

 
$
763

  Collectively evaluated for impairment
 
2,151

 
4,873

 
6,687

 
4,433

 
2,112

 
20,256

  PI loans evaluated for credit impairment
 
26

 
759

 
504

 
2,585

 
192

 
4,066

  PI loans with no credit deterioration
 
—

 
—

 
—

 
—

 
—

 
—

Total ALL
 
$
2,192

 
$
5,652

 
$
7,400

 
$
7,387

 
$
2,454

 
$
25,085

Loans held for investment
 
 
 
 
 
 
 
 
 
 
 
 
  Individually evaluated for impairment
 
$
1,473

 
$
9,247

 
$
13,833

 
$
32,789

 
$
150

 
$
57,492

  Collectively evaluated for impairment
 
55,906

 
45,126

 
564,098

 
235,005

 
42,627

 
942,762

  PI loans with subsequent credit deterioration
 
9,429

 
8,202

 
29,875

 
112,641

 
1,131

 
161,278

  PI loans with no credit deterioration
 
2,535

 
2,061

 
2,938

 
20,337

 
10

 
27,881

Total loans
 
$
69,343

 
$
64,636

 
$
610,744

 
$
400,772

 
$
43,918

 
$
1,189,413

The following table details the recorded investment in loans related to each segment in the allowance for loan losses by portfolio segment and disaggregated on the basis of impairment evaluation methodology at December 31, 2012:
 
 
 
 
 
 
Real Estate - Mortgage
 
 
 
 
(dollars in thousands)
 
Commercial and Agricultural
 
Real Estate - Construction
 
1-4 Family Residential
 
Commercial
 
Consumer
 
Total
ALL:
 
 
 
 
 
 
 
 
 
 
 
 
  Individually evaluated for impairment
 
$
282

 
$
82

 
$
607

 
$
766

 
$
—

 
$
1,737

  Collectively evaluated for impairment
 
2,432

 
4,705

 
7,383

 
5,473

 
2,211

 
22,204

  PI loans evaluated for credit impairment
 
524

 
200

 
711

 
3,388

 
550

 
5,373

  PI loans with no credit deterioration
 
—

 
—

 
—

 
—

 
—

 
—

Total ALL
 
$
3,238

 
$
4,987

 
$
8,701

 
$
9,627

 
$
2,761

 
$
29,314

Loans held for investment
 
 
 
 
 
 
 
 
 
 
 
 
  Individually evaluated for impairment
 
$
2,334

 
$
13,533

 
$
18,118

 
$
43,609

 
$
—

 
$
77,594

  Collectively evaluated for impairment
 
62,704

 
42,199

 
496,205

 
227,760

 
42,181

 
871,049

  PI loans with subsequent credit deterioration
 
11,533

 
2,285

 
34,961

 
141,974

 
1,362

 
192,115

  PI loans with no credit deterioration
 
3,133

 
397

 
4,254

 
28,493

 
—

 
36,277

Total loans
 
$
79,704

 
$
58,414

 
$
553,538

 
$
441,836

 
$
43,543

 
$
1,177,035


26

Troubled Debt Restructuring
The following tables presents a breakdown of troubled debt restructurings that were restructured during the three months and six months ended June 30, 2013 and June 30, 2012, segregated by portfolio segment:
 
 
Three Months Ended June 30, 2013
 
For Three Months Ended June 30, 2012
 
 
 
 
Pre-Modification
 
Post-Modification
 
 
 
Pre-Modification
 
Post-Modification
 
 
 
 
Outstanding
 
Outstanding
 
 
 
Outstanding
 
Outstanding
(dollars in thousands)
 
Number
 
Recorded
 
Recorded
 
Number
 
Recorded
 
Recorded
 
 
of Loans
 
Investment
 
Investment
 
of Loans
 
Investment
 
Investment
Commercial and agricultural
 
—

 
$
—

 
$
—

 
—

 
$
—

 
$
—

Real estate - construction
 
1

 
114

 
114

 
4

 
369

 
329

Real estate - mortgage:
 
 
 
 
 
 
 
 
 
 
 
 
   1-4 family residential
 
4

 
915

 
894

 
—

 
—

 
—

   Commercial
 
1

 
460

 
421

 
3

 
617

 
614

Consumer
 
—

 
—

 
—

 
—

 
—

 
—

    Total
 
6

 
$
1,489

 
$
1,429

 
7

 
$
986

 
$
943


 
 
For Six Months Ended June 30, 2013
 
For Six Months Ended June 30, 2012
 
 
 
 
Pre-Modification
 
Post-Modification
 
 
 
Pre-Modification
 
Post-Modification
 
 
 
 
Outstanding
 
Outstanding
 
 
 
Outstanding
 
Outstanding
(dollars in thousands)
 
Number
 
Recorded
 
Recorded
 
Number
 
Recorded
 
Recorded
 
 
of Loans
 
Investment
 
Investment
 
of Loans
 
Investment
 
Investment
Commercial and agricultural
 
—

 
$
—

 
$
—

 
—

 
$
—

 
$
—

Real estate - construction
 
1

 
114

 
114

 
9

 
2,526

 
1,603

Real estate - mortgage:
 
 
 
 
 
 
 
 
 
 
 
 
   1-4 family residential
 
8

 
2,692

 
2,667

 
2

 
58

 
58

   Commercial
 
2

 
1,611

 
1,228

 
8

 
1,356

 
1,353

Consumer
 
—

 
—

 
—

 
—

 
—

 
—

    Total
 
11

 
$
4,417

 
$
4,009

 
19

 
$
3,940

 
$
3,014


During the three months ended June 30, 2013, we modified six loans that were considered to be troubled debt restructurings. We extended the terms for two of these loans, modified the interest rate for one of these loans, and modified the remaining three loans in both ways. During the three months ended June 30, 2012, we modified seven loans that were considered to be troubled debt restructurings. We extended the terms for five of these loans, the interest rate was lowered for one of these loans, and the remaining loan was modified for multiple reasons.
During the six months ended June 30, 2013, we modified eleven loans that were considered to be troubled debt restructurings. We extended the terms for two of these loans, modified the interest rate for one of these loans, and modified the remaining eight loans in both ways. During the six months ended June 30, 2012, we modified 19 loans that were considered to be troubled debt restructurings. We extended the terms for 14 of these loans, the interest rate was lowered for two of these loans, and the remaining three loans were modified for multiple reasons.
There were no loans restructured in the twelve months prior to June 30, 2013 that went into default during the three months or six months ended June 30, 2013. There were also no loans restructured in the twelve months prior to June 30, 2012 that went into default during the three months or six months ended June 30, 2012.
In the determination of the ALL, management considers troubled debt restructurings and any subsequent defaults in these restructurings as impaired loans. The amount of the impairment is measured using the present value of expected future cash flows discounted at the loan's effective interest rate, the observable market price of the loan, or the fair value of the collateral if the loan is collateral dependent.



27

Unfunded Commitments
The reserve for unfunded commitments, which is included in other liabilities, is calculated by determining the type of commitment and the remaining unfunded commitment for each loan. Based on the type of commitment, an expected usage percentage to the remaining unfunded balance is applied. The expected usage percentage is multiplied by the historical losses and qualitative and environmental factors for each loans pool as defined in the regular ALL calculation to determine the appropriate level of reserve. The following describes our method for determining the unfunded commitment:
•
Straight Lines of Credit - Unfunded balance of line of credit
•
Revolving Lines of Credit - Average Utilization (for the last 12 months) less Current Utilization
•
Letters of Credit - a 10% utilization is applied
The reserve for unfunded commitments was $0.5 million as of June 30, 2013 and $0.6 million at December 31, 2012.

6. Other Real Estate Owned and Personal Property Acquired in Settlement of Loans
OREO consists of real estate acquired through foreclosure or deed in lieu thereof. The property is classified as held for sale. The property is initially carried at fair value based on recent appraisals, less estimated costs to sell. Declines in the fair value of properties included in other real estate below carrying value are recognized by a charge to income.
Total OREO and personal property acquired in settlement of loans decreased $27.4 million during the first six months of 2013 from $63.1 million at December 31, 2012, to $35.8 million at June 30, 2013. This represents 31% of total nonperforming assets. At December 31, 2012, OREO and personal property acquired in settlement of loans represented 44% of total nonperforming assets.
The following table summarizes OREO and personal property acquired in settlement of loans at the periods indicated:
(dollars in thousands)
 
June 30, 2013
 
December 31, 2012

Real estate acquired in settlement of loans
 
$
35,662

 
$
62,796

Personal property acquired in settlement of loans
 
100

 
335

Total property acquired in settlement of loans
 
$
35,762

 
$
63,131

The following tables summarize the changes in real estate acquired in settlement of loans at the periods indicated:
 
 
For Three Months Ended
(dollars in thousands)
 
June 30, 2013
 
June 30, 2012
Real estate acquired in settlement of loans, beginning of period
 
$
46,307

 
$
104,193

Plus: New real estate acquired in settlement of loans
 
2,824

 
6,085

Less: Sales of real estate acquired in settlement of loans
 
(10,422
)
 
(13,502
)
Less: Write-downs and net loss on sales charged to expense
 
(3,047
)
 
(10,593
)
Real estate acquired in settlement of loans, end of period
 
$
35,662

 
$
86,183


 
 
For Six Months Ended
(dollars in thousands)
 
June 30, 2013
 
June 30, 2012
Real estate acquired in settlement of loans, beginning of period
 
$
62,796

 
$
110,009

Plus: New real estate acquired in settlement of loans
 
6,793

 
15,020

Less: Sales of real estate acquired in settlement of loans
 
(30,661
)
 
(24,376
)
Less: Write-downs and net loss on sales charged to expense
 
(3,266
)
 
(14,470
)
Real estate acquired in settlement of loans, end of period
 
$
35,662

 
$
86,183


At June 30, 2013, 17 assets with a net carrying amount of $4.5 million were under contract for sale. Estimated losses on these sales have been recognized in the Consolidated Statements of Operations in the first six months of 2013.

28

7. Earnings Per Share
Basic net loss per share, or basic earnings/(loss) per share (“EPS”), is computed by dividing net loss to common shareholders by the weighted average number of common shares outstanding for the period. We retired our preferred stock in 2011.
Diluted EPS reflects the potential dilution that could occur if COB's potential common stock, which consists of dilutive stock options and a common stock warrant, were issued. As required for entities with complex capital structures, a dual presentation of basic and diluted EPS is included on the face of the income statement, and a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation is provided in this note.
(dollars in thousands, except per share data)
 
For Three Months Ended
 
For Six Months Ended
 
 
June 30, 2013
 
June 30, 2012
 
June 30, 2013
 
June 30, 2012
Loss from continuing operations, net of tax
 
$
(3,183
)
 
$
(18,138
)
 
$
(7,779
)
 
$
(28,970
)
Loss from discontinued operations, net of tax
 
—

 
—

 
—

 
(27
)
Net loss to common shareholders
 
$
(3,183
)
 
$
(18,138
)
 
$
(7,779
)
 
$
(28,997
)
Weighted average number of common shares outstanding - basic and diluted
 
21,729,329

 
21,190,848

 
21,713,808

 
21,146,758

Net loss per common share from continuing operations - basic and diluted
 
$
(0.15
)
 
$
(0.86
)
 
$
(0.36
)
 
$
(1.37
)
Net loss per common share from discontinued operations - basic and diluted
 
—

 
—

 
—

 
—

Net loss per common share - basic and diluted
 
$
(0.15
)
 
$
(0.86
)
 
$
(0.36
)
 
$
(1.37
)

As a result of the net loss for the three and six months ended June 30, 2013 and 2012, all stock options and the common stock warrant were considered antidilutive and thus are not included in this calculation. For the three months and six months ended June 30, 2013, there were 66,627 and 44,771 antidilutive shares, respectively. For the three and six months ended June 30, 2012, there were 23,027 antidilutive shares. Of the antidilutive shares, the number of shares relating to stock options were 44,555 for the three months ended June 30, 2013, 22,699 for the six months ended June 30, 2013, and 955 for both the three months and six months ended June 30, 2012, while the number relating to the warrant was 22,072 for all periods presented.

8. Derivatives and Financial Instruments
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. These instruments include interest rate swaps, caps, floors, collars, options or other financial instruments designed to hedge exposures to interest rate risk or for speculative purposes.
Accounting guidance requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet, and measure those instruments at fair value. Changes in the fair value of those 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.
Mortgage banking derivatives used in the ordinary course of business consist of mandatory forward sales contracts or forward contracts and rate lock loan commitments. The fair value of our derivative instruments is primarily measured by obtaining pricing from broker-dealers recognized to be market participants.
During 2012, we began originating residential mortgage loans for sale in the secondary market. We have established guidelines in originating, selling loans to Fannie Mae, and retaining or selling the loan servicing rights. The commitments to borrowers to originate residential mortgage loans and the forward sales commitments to investors are freestanding derivative instruments. As such, they do not qualify for hedge accounting treatment, and the fair value adjustments for these instruments is recorded through the income statement in mortgage loan income. The fair market value of mortgage banking derivatives at June 30, 2013 was recorded in the consolidated balance sheet in Other Assets.


29

 
 
Gain (Loss) Recognized
(dollars in thousands)
 
For Three Months Ended
 
For Six Months Ended
 
 
June 30, 2013
 
June 30, 2012
 
June 30, 2013
 
June 30, 2012
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
Mortgage loan rate lock commitments
 
$
(19
)
 
$
—

 
$
(11
)
 
$
—

Mortgage loan forward sales and MBS
 
(15
)
 
178

 
(93
)
 
178

Total
 
$
(34
)
 
$
178

 
$
(104
)
 
$
178

 
 
 
 
 
 
 
 
 


9. Fair Values of Assets and Liabilities
We use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale, derivative assets and liabilities, certain FHLB advances hedged by interest rate swaps designated as fair value hedges, performing mortgage loans held for sale, and mortgage servicing rights are recorded at fair value on a recurring basis. Additionally, from time-to-time, we may be required to record at fair value other assets and liabilities on a nonrecurring basis, such as non-performing loans held for sale, loans held for investment, impaired loans and certain other assets and liabilities. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets or liabilities.
Fair Value Hierarchy
We group assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
Level 1: Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3: Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.
The following is a description of valuation methodologies used for assets and liabilities recorded at fair value:
Investments Securities Available-for-Sale
Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is 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. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 may include asset-backed securities in less liquid markets.
Liquidity is a significant factor in the determination of the fair values of available-for-sale debt securities. Market price quotes may not be readily available for some positions, or positions within a market sector where trading activity has slowed significantly or ceased. Some of these instruments are valued using a discounted cash flow model, which estimates the fair value of the securities using internal credit risk, interest rate and prepayment risk models that incorporate management's best estimate of current key assumptions such as default rates, loss severity and prepayment rates. Principal and interest cash flows are discounted using an observable discount rate for similar instruments with adjustments that management believes a market participant would consider in determining fair value for the specific security. Underlying assets are valued using external pricing services, where available, or matrix pricing based on the vintages and ratings. Situations of illiquidity generally are triggered by the market's perception of credit uncertainty regarding a single company or a specific market sector. In these instances, fair value is determined based on limited available market information and other factors, principally from reviewing the issuer's financial statements and changes in credit ratings made by one or more ratings agencies.
Loans Held for Sale

30

Loans held for sale are carried at the lower of cost or fair value less estimated costs to sell. Once sold, the loans are beyond the reach of COB in all respects and the purchasing investor has all rights of ownership, including the ability to pledge or exchange the loans. Most of the loans sold are without recourse. Gains or losses on loan sales are recognized at the time of sale, are determined by the difference between net sales proceeds and the carrying value of the loan sold, and are included in Consolidated Statements of Operations. Since loans held for sale are carried at the lower of cost or fair value, the fair value of loans held for sale is based on contractual agreements with independent third-party buyers. As such, we classify loans held for sale subjected to nonrecurring fair value adjustments as Level 2.
Loans Held for Investment
We do not record loans held for investment at fair value on a recurring basis. However, from time to time, a loan is considered impaired and the related impairment is charged against the allowance or a specific allowance is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as impaired, management determines the fair value of the loan to quantify impairment, should such exist. The fair value of impaired loans is estimated using one of several methods, including collateral net liquidation value, market value of similar debt, enterprise value, and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value of the expected repayments or collateral meet or exceed the recorded investments in such loans. At June 30, 2013 and December 31, 2012, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. We record impaired loans as nonrecurring Level 3.
Other Real Estate Owned
OREO is adjusted to fair value upon transfer of the loans to OREO. Subsequently, OREO is carried at the lower of carrying value or fair value less estimated costs to sell. Fair value is based upon independent market prices, appraised values of the collateral or management's estimation of the value of the collateral. Given the lack of observable market prices for identical properties, we record OREO as nonrecurring Level 3.
Interest Rate Locks and Forward Loan Sale Commitments
We enter into interest rate lock commitments and commitments to sell mortgages.  The fair value of interest rate lock commitments is based on servicing rate premium, origination income net of origination costs, fall out rates and changes in loan pricing between the commitment date and the balance sheet date. We record interest rate lock commitments as recurring level 3, and based on their immaterial value, has excluded them from the fair value table.
Mortgage Servicing Rights
The fair value of mortgage serving rights (MSR) is dependent upon a number of assumptions including the fee per loan, the cost to service, the expected loan prepayment rate, and the discount rate.  In determining the fair value of the existing MSR management reviews the key assumptions, analyzes pricing in the market for comparable MSR, and uses a third party provider to independently calculate the fair value of its MSR. We record mortgage servicing rights as recurring Level 3.
Assets and Liabilities Recorded at Fair Value on a Recurring Basis
Assets and liabilities carried at fair value on a recurring basis at June 30, 2013 for continuing operations are summarized in the following table:
(dollars in thousands)
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
Available-for-sale debt securities:
 
 
 
 
 
 
 
 
U.S. government sponsored agencies
 
$
2,084

 
$
—

 
$
2,084

 
$
—

Residential mortgage-backed securities-GSE
 
368,983

 
—

 
368,983

 
—

Residential mortgage-backed securities-Private
 
22,824

 
—

 
22,824

 
—

Commercial mortgage-backed securities-GSE
 
21,498

 
 
 
21,498

 
 
Commercial mortgage-backed securities-Private
 
9,575

 
—

 
9,575

 
—

Corporate notes
 
28,446

 
—

 
28,446

 
—

Total available-for-sale debt securities
 
453,410

 
—

 
453,410

 
—

Mortgage servicing rights
 
1,337

 
—

 
—

 
1,337

Total assets at fair value from continuing operations
 
$
454,747

 
$
—

 
$
453,410

 
$
1,337


31

Assets and liabilities carried at fair value on a recurring basis at December 31, 2012 for continuing operations are summarized in the following table:
(dollars in thousands)
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
Available-for-sale debt securities:
 
 
 
 
 
 
 
 
U.S. Treasury and government agencies
 
$
6,981

 
$
—

 
$
6,981

 
$
—

U.S. government sponsored agencies
 
22,173

 
—

 
22,173

 
—

States and political subdivisions
 
6,038

 
—

 
6,038

 
—

Residential mortgage-backed securities-GSE
 
441,074

 
—

 
441,074

 
—

Residential mortgage-backed securities-Private
 
22,945

 
—

 
22,945

 
—

Commercial mortgage-backed securities-GSE
 
23,359

 
—

 
23,359

 
—

Commercial mortgage-backed securities-Private
 
5,317

 
—

 
5,317

 
—

Corporate notes
 
36,963

 
—

 
36,963

 
—

Total available-for-sale debt securities
 
564,850

 
—

 
564,850

 
—

Mortgage servicing rights
 
726

 
—

 
—

 
726

Total assets at fair value from continuing operations
 
$
565,576

 
$
—

 
$
564,850

 
$
726

The following tables present a reconciliation of all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the periods indicated:
 
 
Fair Value Measurements Using Significant
 
 
Unobservable Inputs (Level 3)
 
 
Mortgage Servicing Rights
(dollars in thousands)
 
Three Months Ended June 30,
 
 
2013
 
2012
Beginning balance at April 1,
 
$
1,028

 
$
—

Total gains or losses (realized/unrealized):
 
 
 
 
Included in earnings, gross
 
376

 
25

      Less amortization
 
(67
)
 
—

Ending balance at June 30,
 
$
1,337

 
$
25


 
 
Fair Value Measurements Using Significant
 
 
Unobservable Inputs (Level 3)
 
 
Mortgage Servicing Rights
(dollars in thousands)
 
Six Months Ended June 30,
 
 
2013
 
2012
Beginning balance at January 1,
 
$
726

 
$
—

Total gains or losses (realized/unrealized):
 
 
 
 
Included in earnings, gross
 
724

 
25

      Less amortization
 
(113
)
 
—

Ending balance at June 30,
 
$
1,337

 
$
25


Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis
We may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. This is due to further deterioration in the value of the assets.

32



Assets measured at fair value on a nonrecurring basis are included in the following table at June 30, 2013 for continuing operations:
(dollars in thousands)
 
Total
 
Level 1
 
Level 2
 
Level 3
Impaired loans, net
 
$
5,171

 
$
—

 
$
—

 
$
5,171

Other real estate owned
 
30,487

 
—

 
—

 
30,487

Total assets at fair value from continuing operations
 
$
35,658

 
$
—

 
$
—

 
$
35,658

Assets measured at fair value on a nonrecurring basis are included in the following table at December 31, 2012 for continuing operations:
(dollars in thousands)
 
Total
 
Level 1
 
Level 2
 
Level 3
Impaired loans, net
 
$
13,575

 
$
—

 
$
—

 
$
13,575

Other real estate owned
 
48,480

 
—

 
—

 
48,480

Total assets at fair value from continuing operations
 
$
62,055

 
$
—

 
$
—

 
$
62,055

There are no assets or liabilities measured at fair value on a nonrecurring basis at June 30, 2013 or December 31, 2012 for discontinued operations.
Quantitative Information about Level 3 Fair Value Measurements
(dollars in thousands)
 
Fair Value at June 30, 2013
 
Valuation Techniques
 
Unobservable
Input
 
Range
Nonrecurring measurements:
 
 
 
 
 
 
 
 
Impaired loans, net
 
$
5,171

 
Discounted appraisals
 
Collateral discounts
 
6.00% - 40.00%
Other real estate owned
 
30,487

 
Discounted appraisals
 
Collateral discounts
 
6.00% - 40.00%
Mortgage servicing rights
 
1,337

 
Discounted cash flows
 
Prepayment rate
 
10.00% - 30.00%
Mortgage servicing rights
 
 
 
 
 
Discount rate
 
6.00% - 12.00%

(dollars in thousands)
 
Fair Value at
December 31, 2012
 
Valuation Techniques
 
Unobservable
Input
 
Range
Nonrecurring measurements:
 
 
 
 
 
 
 
 
Impaired loans, net
 
$
13,575

 
Discounted appraisals
 
Collateral discounts
 
6.00%-40.00%
Other real estate owned
 
48,480

 
Discounted appraisals
 
Collateral discounts
 
6.00%-40.00%
Mortgage servicing rights
 
726

 
Discounted cash flows
 
Prepayment rate
 
10.00% - 30.00%
Mortgage servicing rights
 
 
 
 
 
Discount rate
 
6.00% - 12.00%
Level 3 Valuation Methodologies. Following is a description of the unobservable inputs used for Level 3 fair value measurements.
Disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value is required. Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time our entire holdings of a particular financial instrument.
Because no market exists for a portion of our 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. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value for each class of COB's financial instruments.

33

Cash and cash equivalents. Fair value equals the carrying value of such assets due to their nature and is classified as Level 1.
Investment securities. The fair value of investment securities is based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. The fair value of equity investments in the restricted stock of the FRBR and FHLB approximates the carrying value. The fair value of investment securities is classified as Level 2.
Loans held for sale. Substantially all residential mortgage loans held for sale are pre-sold and their carrying value approximates fair value. We classified the fair value of loans held for sale as Level 2.
Loans held for investment. The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The fair value of variable rate loans with frequent repricing and negligible credit risk approximates book value. The fair value of loans is further discounted by credit and liquidity factors. We classified the fair value of loans as Level 3.
Accrued interest receivable and payable. The carrying amounts of accrued interest payable and receivable approximate fair value and are classified as Level 2 if the related asset or liability is classified as Level 2, or Level 3 if the related asset or liability is classified as Level 3.
Deposits. The fair value of noninterest-bearing and interest-bearing demand deposits and savings are the amounts payable on demand because these products have no stated maturity. The fair value of time deposits is estimated using the rates currently offered for deposits of similar remaining maturities and are classified as Level 2.
Borrowed funds. The carrying value of retail repurchase agreements and federal funds purchased is considered to be a reasonable estimate of fair value. The fair value of FHLB advances and other borrowed funds is estimated using the rates currently offered for advances of similar remaining maturities and is classified as Level 2.
Junior subordinated debentures. Included in junior subordinated debentures are variable rate trust preferred securities issued by COB. Fair values for the trust preferred securities were estimated by developing cash flow estimates for each of these debt instruments based on scheduled principal and interest payments and current interest rates. Once the cash flows were determined, a rate for comparable subordinated debt was used to discount the cash flows to the present value. The estimated fair value for our junior subordinated debentures have declined due to wider credit spreads (i.e., spread to LIBOR) on similar trust preferred issues. This is due, in part, to proposed bank regulatory changes in bank capital structure. We classified the fair value of junior subordinated debentures as Level 3.
Financial instruments with off-balance sheet risk. The fair value of financial instruments with off-balance sheet risk is considered to approximate carrying value, since the large majority of these future financing commitments would result in loans that have variable rates and/or relatively short terms to maturity. For other commitments, generally of a short-term nature, the carrying value is considered to be a reasonable estimate of fair value.

34

The estimated fair values of financial instruments for continuing operations are as follows at the periods indicated:
 
 
At June 30, 2013
(dollars in thousands)
 
Carrying Value
 
Estimated Fair Value
 
Level 1
 
Level 2
 
Level 3
Financial Assets of Continuing Operations:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
88,470

 
$
88,470

 
$
88,470

 
$
—

 
$
—

Investment securities: Available-for-sale
 
453,410

 
453,410

 
—

 
453,410

 
—

Investment securities: Held-to-maturity
 
154,797

 
148,745

 
—

 
148,745

 
—

Loans held for sale
 
4,076

 
4,076

 
—

 
4,076

 
—

Loans, net
 
1,164,328

 
1,134,103

 
—

 
—

 
1,134,103

Accrued interest receivable
 
5,846

 
5,846

 
—

 
1,945

 
3,901

Financial Liabilities of Continuing Operations:
 
 
 
 
 
 
 
 
 
 
Deposits
 
1,811,485

 
1,812,134

 
—

 
1,812,134

 
—

Retail repurchase agreements
 
9,109

 
9,109

 
—

 
9,109

 
—

Federal Home Loan Bank advances
 
58,306

 
62,115

 
—

 
62,115

 
—

Junior subordinated debentures
 
56,702

 
21,652

 
—

 
—

 
21,652

Accrued interest payable
 
2,207

 
2,207

 
—

 
505

 
1,702

 
 
At December 31, 2012
(dollars in thousands)
 
Carrying Value
 
Estimated Fair Value
 
Level 1
 
Level 2
 
Level 3
Financial Assets of Continuing Operations:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
239,610

 
$
239,610

 
$
239,610

 
$
—

 
$
—

Investment securities: Available-for-sale
 
564,850

 
564,850

 
—

 
564,850

 
—

Loans held for sale
 
6,974

 
6,974

 
—

 
6,974

 
—

Loans, net
 
1,147,721

 
1,140,088

 
—

 
—

 
1,140,088

Accrued interest receivable
 
6,102

 
6,102

 
—

 
1,812

 
4,290

Financial Liabilities of Continuing Operations:
 
 
 
 
 
 
 
 
 
 
Deposits
 
1,906,988

 
1,910,927

 
—

 
1,910,927

 
—

Retail repurchase agreements
 
8,675

 
8,675

 
—

 
8,675

 
—

Federal Home Loan Bank advances
 
58,328

 
62,950

 
—

 
62,950

 
—

Junior subordinated debentures
 
56,702

 
18,760

 
—

 
—

 
18,760

Accrued interest payable
 
2,111

 
2,111

 
—

 
937

 
1,174

There were no transfers between valuation levels for any assets during the three and six months ended June 30, 2013. If different valuation techniques are deemed necessary, we would consider those transfers to occur at the end of the period when the assets are valued.



35

10. Accumulated Other Comprehensive Income

The following table presents the changes in our accumulated other comprehensive income (loss), net of tax, by component for the period indicated:

(Dollars in thousands)
 
Unrealized Gains (Losses) on Available For Sale Securities
 
Defined Benefit Plan Items
 
Total
 
 
 
 
 
 
 
Beginning balance January 1, 2013
 
$
3,650

 
$
(3,973
)
 
$
(323
)
   Other comprehensive income before reclassifications
 
(12,976
)
 
—

 
(12,976
)
   Amounts reclassified from accumulated other comprehensive income
 
(1,647
)
 
(308
)
 
(1,955
)
Net current period other comprehensive income
 
(14,623
)
 
(308
)
 
(14,931
)
Ending balance June 30, 2013
 
$
(10,973
)
 
$
(4,281
)
 
$
(15,254
)


The following table presents the reclassifications out of our accumulated other comprehensive income (loss) for the three and six months ended June 30, 2013:

(Dollars in thousands)
Amount Reclassified from AOCI
 
 
 
Three Months Ended June 30, 2013
 
Six Months Ended June 30, 2013
 
Line Item in the Statement Where Net Income is Presented
Available for sale securities:
 
 
 
 
 
 
$
(346
)
 
$
(2,723
)
 
Net realized gains on sale of securities
 
137

 
1,076

 
Income tax benefit (expense)
 
(209
)
 
(1,647
)
 
Total, net of tax
Defined benefit plan items:
 
 
 
 
 
   Net actuarial gains
(255
)
 
(509
)
 
Personnel expense
 
101

 
201

 
Income tax benefit (expense)
 
(154
)
 
(308
)
 
Total, net of tax
Total reclassifications for the period
$
(363
)
 
$
(1,955
)
 
Total, net of tax






36

Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations
The following presents management's discussion and analysis of the financial condition and results of operations of COB. Certain reclassifications have been made to prior periods to place them on a basis comparable with the current period presentation. This discussion should be read in conjunction with the financial statements and related notes included elsewhere in this quarterly Report on Form 10-Q. Results of operations for the periods included in this review are not necessarily indicative of results to be obtained during any future period.
Important Note Regarding Forward-Looking Statements
This quarterly Report on Form 10-Q contains statements that we believe are forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. These statements generally relate to our financial condition, results of operations, plans, objectives, future performance or business. They usually can be identified by the use of forward-looking terminology, such as “believes,” “expects,” or “are expected to,” “plans,” “projects,” “goals,” “estimates,” “may,” “should,” “could,” “would,” “intends to,” “outlook” or “anticipates,” or variations of these and similar words, or by discussions of strategies that involve risks and uncertainties. You should not place undue reliance on these statements, as they are subject to risks and uncertainties, including but not limited to, those described in this quarterly Report on Form 10-Q. When considering these forward-looking statements, you should keep in mind these risks and uncertainties, as well as any cautionary statements we may make. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information actually known to us at the time. We undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
Forward-looking statements contained in this quarterly Report on Form 10-Q are based on current expectations, estimates and projections about our business, management's beliefs and assumptions made by management. These statements are not guarantees of our future performance and involve certain risks, uncertainties and assumptions (called Future Factors), which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in the forward-looking statements. Future factors include, without limitation:
•
financial resources in the amount, at the times and on the terms required to support our future business;
•
changes in interest rates, spreads on earning assets and interest-bearing liabilities, the shape of the yield curve and interest rate sensitivity;
•
a prolonged period of low interest rates;
•
continued and increased credit losses and material changes in the quality of our loan portfolio;
•
continued decline in the value of our OREO;
•
increased competitive pressures in the banking industry or in our markets;
•
less favorable general economic conditions, either nationally or regionally, resulting in, among other things, a reduced demand for credit or other services;
•
a slowdown in the housing markets, or an increase in interest rates, either of which may reduce demand for mortgages;
•
changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board;
•
the outcome of legislation and regulation affecting the financial services industry, including COB, including the effects resulting from the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Basel III capital rules;
•
changes in accounting principles and standards;
•
adverse changes in financial performance or condition of our borrowers, which could affect repayment of such borrowers' outstanding loans;
•
repurchase risk in connection with our mortgage line of business;
•
reducing costs and expenses;
•
increasing price and product/service competition by competitors;
•
rapid technological development and changes;
•
the effect of any mergers, acquisitions or other transactions to which we or our subsidiaries may from time to time be a party;
•
the inaccuracy of assumptions underlying the establishment of our ALL;
•
loss of one or more members of executive management;
•
disruptions in or manipulations of our operating systems or the systems of our vendors due to, among other things, cybersecurity risks or otherwise; and
•
our success at managing the risks involved in the foregoing.

All forward-looking statements speak only as of the date on which such statements are made, and COB undertakes no obligation to update any statement, to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.



37

Financial highlights are presented in the accompanying table.
Selected Financial Data
(dollars in thousands, except per share data)
 
As of and for Three Months Ended
 
As of and for Six Months Ended
 
 
June 30, 2013
 
June 30, 2012
 
June 30, 2013
 
June 30, 2012
Income Statement Data
 
 
 
 
 
 
 
 
Net interest income
 
$
15,414

 
$
16,049

 
$
30,587

 
$
31,229

Provision for (recovery of) loan losses
 
(1,057
)
 
7,778

 
(947
)
 
10,845

Noninterest income
 
5,247

 
6,532

 
11,780

 
10,358

Noninterest expense
 
24,665

 
32,915

 
49,004

 
59,763

Loss from continuing operations, before income taxes
 
(2,947
)
 
(18,112
)
 
(5,690
)
 
(29,021
)
Loss from continuing operations, net of tax
 
(3,183
)
 
(18,138
)
 
(7,779
)
 
(28,970
)
Loss from discontinued operations, net of tax
 
—

 
—

 
—

 
(27
)
Net loss
 
(3,183
)
 
(18,138
)
 
(7,779
)
 
(28,997
)
Net loss to common shareholders
 
(3,183
)
 
(18,138
)
 
(7,779
)
 
(28,997
)
Period End Balances
 
 
 
 
 
 
 
 
Assets
 
$
2,036,313

 
$
2,301,761

 
$
2,036,313

 
$
2,301,761

Loans held for sale (1)
 
4,076

 
1,324

 
4,076

 
1,324

Loans held for investment (2)
 
1,189,413

 
1,281,823

 
1,189,413

 
1,281,823

Allowance for loan losses (1)
 
25,085

 
38,551

 
25,085

 
38,551

Goodwill
 
4,205

 
4,205

 
4,205

 
4,205

Deposits
 
1,811,485

 
2,041,770

 
1,811,485

 
2,041,770

Borrowings
 
124,117

 
126,507

 
124,117

 
126,507

Shareholders' equity
 
76,046

 
108,002

 
76,046

 
108,002

Average Balances
 
 
 
 
 
 
 
 
Assets
 
$
2,061,891

 
$
2,328,045

 
$
2,084,737

 
$
2,359,605

Loans held for sale (1)
 
4,861

 
3,349

 
4,739

 
4,562

Loans held for investment (2)
 
1,109,980

 
1,283,673

 
1,126,265

 
1,251,181

Allowance for loan losses (1)
 
29,323

 
38,729

 
29,545

 
39,262

Goodwill
 
4,205

 
4,205

 
4,205

 
4,055

Deposits
 
1,826,297

 
2,058,844

 
1,845,523

 
2,087,464

Borrowings
 
123,156

 
123,605

 
123,526

 
123,513

Shareholders' equity
 
88,047

 
119,619

 
92,283

 
123,173

Per Common Share Data
 
 
 
 
 
 
 
 
Net loss per common share from continuing operations - basic and diluted
 
$
(0.15
)
 
$
(0.86
)
 
$
(0.36
)
 
$
(1.37
)
Net loss per common share from discontinued operations - basic and diluted
 
—

 
—

 
—

 
—

Net loss per common share - basic and diluted
 
(0.15
)
 
(0.86
)
 
(0.36
)
 
(1.37
)
Book value (3)
 
3.50

 
5.00

 
3.50

 
5.00

Tangible book value (3)
 
2.96

 
4.46

 
2.96

 
4.46

Performance Ratios
 
 
 
 
 
 
 
 
Return on average assets
 
(0.62
)%
 
(3.13
)%
 
(0.75
)%
 
(2.47
)%
Return on average tangible assets (3)
 
(0.62
)
 
(3.15
)
 
(0.76
)
 
(2.48
)
Return on average equity
 
(14.50
)
 
(60.99
)
 
(17.00
)
 
(47.34
)

38

Return on average tangible equity (3)
 
(16.67
)
 
(67.73
)
 
(19.42
)
 
(52.42
)
Net interest margin (tax equivalent)
 
3.27

 
3.06

 
3.23

 
2.94

Core noninterest expense as a percentage of average assets (3)
 
3.54

 
3.38

 
3.59

 
3.22

Asset Quality Ratios
 
 
 
 
 
 
 
 
Allowance for loan losses to period end loans held for investment (1)
 
2.11
 %
 
3.01
 %
 
2.11
 %
 
3.01
 %
Nonperforming loans to period end allowance for loan losses (1)
 
235.21

 
247.82

 
235.21

 
247.82

Net annualized charge-offs (recoveries) to average loans held for investment
 
1.26

 
2.83

 
0.59

 
1.87

Nonperforming loans to loans held for investment (4)
 
4.96

 
7.45

 
4.96

 
7.45

Nonperforming assets to total assets (4)
 
4.65

 
7.90

 
4.65

 
7.90

Capital and Liquidity Ratios
 
 
 
 
 
 
 
 
Average equity to average assets
 
4.27
 %
 
5.14
 %
 
4.43
 %
 
5.22
 %
Leverage capital
 
5.37

 
5.83

 
5.37

 
5.83

Tier 1 risk-based capital
 
8.71

 
9.62

 
8.71

 
9.62

Total risk-based capital
 
12.02

 
12.19

 
12.02

 
12.19

Average loans held for investment to average deposits
 
60.78

 
62.35

 
61.03

 
59.94

Average loans held for investment to average deposits and borrowings
 
56.94

 
58.82

 
57.20

 
56.59


(1) Excludes discontinued operations.
(2) Loans held for investment, net of unearned income, before allowance for loan losses.
(3) Refer to the "Non-GAAP Measures" section in Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
(4) Nonperforming loans and nonperforming assets include loans past due 90 days or more that are still accruing interest.


39

Overview
CommunityOne Bancorp, or "COB" or the "Company"(which also refers to us and our subsidiaries on a consolidated basis), is a bank holding company incorporated in 1984 under the laws of the State of North Carolina. Through our ownership of CommunityOne Bank, N.A., or the "Bank", a national banking association headquartered in Asheboro, North Carolina, we offer a complete line of consumer, wealth management, mortgage and business banking services, including loan, deposit, cash management, investment management and trust services, to individual and business customers through operations located throughout central, southern and western North Carolina, including the counties of Alamance, Alexander, Ashe, Burke, Caldwell, Catawba, Chatham, Gaston, Guilford, Iredell, Mecklenburg, Montgomery, Moore, Orange, Randolph, Richmond, Rowan, Scotland, Watauga and Wilkes. The Bank also holds the stock of Dover Mortgage Company (“Dover”) and First National Investor Services, Inc. Dover previously engaged in the business of originating, underwriting and closing mortgage loans for sale in the secondary market. Dover ceased operations in the first quarter of 2011 and filed for Chapter 11 bankruptcy on February 15, 2012. First National Investor Services, Inc. holds deeds of trust for the Bank.
COB also owns Granite Mortgage, Inc., which ceased mortgage operations in 2009 and filed for Chapter 11 bankruptcy on February 15, 2012, and FNB United Statutory Trust I, FNB United Statutory Trust II, and Catawba Valley Capital Trust II, which were formed to facilitate the issuance of trust preferred securities.
On October 21, 2011, as part of the recapitalization of COB, COB acquired Bank of Granite Corporation and its subsidiary bank, Bank of Granite, through the merger of a wholly owned subsidiary of ours into Granite Corp. (the “Merger”). Bank of Granite was merged into the Bank on June 8, 2013. Our shareholders approved an amendment in our articles of incorporation to change our name from FNB United Corp to CommunityOne Bancorp on June 20, 2013. This change, along with a change in our stock symbol from FNBN to COB, was implemented on July 1, 2013.
We earn revenue primarily from interest on loans and securities investments, mortgage banking income and fees charged for financial services provided to our customers. Offsetting these revenues are the cost of deposits and other funding sources, provision for loan losses and write-downs in the value of, gains and losses on disposition of and holding costs associated with our OREO, and other operating costs such as: salaries and employee benefits, occupancy, data processing expenses, merger related expenses and tax expense.
Progress on 2013 goals
During the second quarter we made significant progress towards successfully completing our four 2013 goals to (1) complete the merger of Bank of Granite into the Bank during the second quarter of 2013, (2) continue to reduce problem asset levels and improve asset quality, (3) return the Company to profitability in the second half of 2013, and (4) continue efforts to restore COB and the Bank to a satisfactory condition.
On June 8, 2013, we successfully completed the merger of Bank of Granite into the Bank. As part of this bank merger, we consolidated six overlapping branches and our ATM network, completed our consolidation of operational functions, and completed the merger-related expense generating activities. The bank merger allows us to better serve customers throughout our footprint by offering one product set under one brand and reduces the Bank's ongoing operating costs. In conjunction with the bank merger, during the first half of 2013, we recorded $3.5 million of merger-related expenses. On June 28, 2013, we closed two additional branches to further reduce operating costs, and during the first half of 2013 we incurred $602,000 in branch closure and restructuring costs.
During the second quarter, we continued to make progress in reducing the level of non-performing assets. As a result, asset quality improved again during the second quarter, with non-performing loans declining 16%, or $11.5 million, to 4.96% of loans. OREO declined 23%, or $10.8 million during the second quarter. In total, for the second quarter, non-performing assets were reduced by $22.3 million, or 19%. We accelerated OREO appraisals for all OREO into the second quarter, and recorded $3.0 million of OREO write-downs (net of gains and losses on sales). We do not expect significant additional OREO write-downs net of recoveries during the remainder of the year. Our year to date annualized loan charge-off rate was 0.59%, and we recorded $3.5 million in net loan charge-offs and $1.1 million recovery of loan loss provision during the second quarter.
With respect to our third goal, we expect to return to profitability in the third quarter of this year. Our after-tax net loss during the second quarter of $3.2 million was the lowest quarterly loss for the Company since the second quarter of 2009. Net of non-core items, our core earnings (see "Non-GAAP Measures" for further discussion) were $2.1 million in the second quarter. Net interest margin increased to 3.27% in the second quarter from 3.20% in the first quarter of 2013, as we deployed excess cash positions into the loan and securities portfolios, increasing the earning asset yield during the quarter by 5 basis points to 3.85%. The yield on the securities portfolio rose to 2.44%, from 2.20% in the first quarter of 2013, based on portfolio additions and yield increases in mortgage backed securities as a result of declines in expected prepayment speeds. The cost of interest-bearing deposits fell 3 basis points during the quarter to 0.54%, from 0.57% the previous quarter, as a result of deposit mix and relationship focus strategies.

40

We also continued our progress to restore our Company to a satisfactory condition. In this connection, on June 10, 2013, the Office of the Comptroller of the Currency (“OCC”) terminated the Consent Order that the Bank entered into with the OCC on July 22, 2010. While the Bank has continuing obligations to, among other things, adhere to its 2013 Business Plan including maintaining the capital ratios contained in the Plan, we believe that we are currently in compliance with that Plan. As a result of the lifting of the Consent Order, the Bank is now designated as “well capitalized” under applicable provisions of the Federal Deposit Insurance Act. The bank merger also has increased the Bank's capital and earnings capacity and reduced operational risk through the consolidation of the operations functions and processes. As a result of the bank merger, the leverage capital ratio at CommunityOne Bank improved from 6.15% at the end of the first quarter to 6.95% this quarter.
Results of Operations
Net Interest Income
Our principal source of revenue is net interest income. Net interest income is the difference between interest income earned on interest-earning assets, primarily loans and investment securities, and interest expense paid on interest-bearing deposits and other interest-bearing liabilities. The net interest margin measures how effectively we manage the mix of interest-earning assets and interest-bearing liabilities and the difference between the interest income earned on interest-earning assets and the interest expense paid for funds to support those assets. Changes in the mix of interest-earning assets and interest-bearing liabilities, changes in the interest rates earned on interest-earning assets and interest rates paid on interest-bearing liabilities, the rate of growth of the interest-earning assets and interest-bearing liabilities base, the ratio of interest-earning assets to interest-bearing liabilities, and the management of interest rate sensitivity factor into fluctuations within net interest income. An analysis is presented in the Average Balances and Net Interest Income Analysis - Second Quarter for the three month periods ended June 30, 2013 and 2012, and in the Average Balances and Net Interest Income Analysis - Six Months for the six month periods ended June 30, 2013 and 2012.
Net interest income on a taxable equivalent basis was $15.5 million for the three month period ended June 30, 2013, a decrease of $0.6 million from $16.1 million for the same period in 2012. The decrease in interest income as a result of a reduced earning asset base has been partially offset by a decrease in the amount of earning assets represented by low yielding cash invested at low interest rates, a decrease in interest-bearing liability levels, an increase in the amount of low cost core deposits and a reduction in the rates paid on those liabilities.
Net interest margin (taxable equivalent) improved 21 basis points from 3.06% in the second quarter of 2012 to 3.27% in the second quarter of 2013. The increase was attributable primarily to management's strategy to shift the mix of deposits to lower rate demand, savings and money market deposits. The yield on average earning assets decreased by 4 basis points during the second quarter of 2013 to 3.85% from 3.89% in the second quarter of 2012. The decrease in average yield was the result of declines in loan and investment securities portfolio yields. The cost of interest-bearing liabilities declined during the second quarter of 2013 by 26 basis points to 0.65% compared to 0.91% in the second quarter of 2012, primarily as a result of the deposit mix shift, declines in interest rates on all deposit products, and the impact of the accretion of fair value marks on deposits acquired from Granite. During the second quarter of 2013 we restructured $50 million of Federal Home Loan Bank advances from fixed rate to floating rate, which we expect to further reduce interest costs. The cost of interest-bearing deposits declined 29 basis points, or 35%, from 0.83% for the second quarter of 2012 to 0.54% for the second quarter of 2013 as the percentage of CD's in our deposit portfolio declined from 44.6% to 35.8% at June 30, 2012 and 2013, respectively.
The following table summarizes the average balance sheets and net interest income/margin analysis for the three months ended June 30, 2013 and 2012. The interest yield earned on interest-earning assets and interest rate paid on interest-bearing liabilities shown in the table are derived by dividing interest income and expense by the average balances of interest-earning assets or interest-bearing liabilities, respectively.

41

Average Balances and Net Interest Income Analysis - Second Quarter
 
Three Months Ended June 30,
 
2013
 
2012
 
 
 
 
 
Average
 
 
 
 
 
Average
(dollars in thousands)
Average
 
Income /
 
Yield /
 
Average
 
Income /
 
Yield /
 
Balance (3)
 
Expense
 
Rate
 
Balance (3)
 
Expense
 
Rate
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Loans (1)(2)
$
1,114,841

 
$
14,470

 
5.21
%
 
$
1,287,022

 
$
17,283

 
5.40
%
Taxable investment securities
577,463

 
3,518

 
2.44

 
457,414

 
2,887

 
2.54

Other earning assets
202,833

 
197

 
0.39

 
370,593

 
310

 
0.34

  Total earning assets
1,895,137

 
18,185

 
3.85

 
2,115,029

 
20,480

 
3.89

 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
32,420

 
 
 
 
 
20,395

 
 
 
 
Goodwill and other intangible assets
11,465

 
 
 
 
 
11,908

 
 
 
 
Other assets, net
122,869

 
 
 
 
 
180,713

 
 
 
 
  Total assets
$
2,061,891

 
 
 
 
 
$
2,328,045

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing demand deposits
$
352,953

 
$
275

 
0.31
%
 
$
350,235

 
$
379

 
0.44
%
Savings deposits
80,604

 
20

 
0.10

 
72,480

 
27

 
0.15

Money market deposits
447,887

 
248

 
0.22

 
439,132

 
486

 
0.45

Time deposits
670,533

 
1,547

 
0.93

 
941,206

 
2,809

 
1.20

  Total interest-bearing deposits
1,551,977

 
2,090

 
0.54

 
1,803,053

 
3,701

 
0.83

Retail repurchase agreements
8,141

 
4

 
0.20

 
8,547

 
9

 
0.42

Federal Home Loan Bank advances
58,313

 
365

 
2.51

 
58,356

 
387

 
2.67

Other borrowed funds
56,702

 
264

 
1.87

 
56,702

 
286

 
2.03

  Total interest-bearing liabilities
1,675,133

 
2,723

 
0.65

 
1,926,658

 
4,383

 
0.91

 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-bearing liabilities and shareholders' equity:
 
 
 
 
 
 
 
 
 
 
 
Noninterest-bearing demand deposits
274,320

 
 
 
 
 
255,791

 
 
 
 
Other liabilities
24,391

 
 
 
 
 
25,977

 
 
 
 
Shareholders' equity
88,047

 
 
 
 
 
119,619

 
 
 
 
  Total liabilities and shareholders' equity
$
2,061,891

 
 
 
 
 
$
2,328,045

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income and net yield on earning assets (4)
 
 
$
15,462

 
3.27
%
 
 
 
$
16,097

 
3.06
%
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate spread (5)
 
 
 
 
3.20
%
 
 
 
 
 
2.98
%
(1) The fully tax equivalent basis is computed using a federal tax rate of 35%.
(2) Average loan balances include nonaccruing loans and loans held for sale.
(3) Average balances include market adjustments to fair value for securities and loans held for sale.
(4) Net yield on earning assets is computed by dividing net interest income by average earning assets.
(5) Earning asset yield minus interest bearing liabilities rate.





42

Net interest income on a taxable equivalent basis was $30.7 million for the six month period ended June 30, 2013, a decrease of $0.6 million from $31.3 million for the same period in 2012. The decrease in interest income as a result of a reduced earning asset base has been partially offset by a decrease in the amount of earning assets represented by low yielding cash invested at low interest rates, a decrease in interest-bearing liability levels, an improvement in the level of low cost core deposits and a decrease in the rates paid on those liabilities.
Net interest margin (taxable equivalent) improved 29 basis points from 2.94% in the first six months of 2012 to 3.23% in the first six months of 2013. As described above, the increase was attributable primarily to management's strategy to shift the mix of deposits to lower rate demand, savings and money market deposits. The yield on average earning assets increased by 3 basis points during the first half of 2013 to 3.83% from 3.80% in the comparable portion of 2012. The increase in average yield was the result of deploying cash invested at low short term rates into higher-yielding and longer term securities, partially offset by a decline in loan and investment securities portfolio yields. The cost of interest-bearing liabilities declined during the first six months of 2013 by 28 basis points to 0.66% compared to 0.94% in the same period of 2012, primarily as a result of the deposit mix shift, declines in interest rates on all deposit products, and the impact of the accretion of fair value marks at Granite. The cost of interest-bearing deposits declined 32 basis points, or 37%, from 0.87% for the first half of 2012 to 0.55% for the comparable period of 2013.
The following table summarizes the average balance sheets and net interest income/margin analysis for the six months ended June 30, 2013 and 2012. The interest yield earned on interest-earning assets and interest rate paid on interest-bearing liabilities shown in the table are derived by dividing interest income and expense by the average balances of interest-earning assets or interest-bearing liabilities, respectively.



























43



Average Balances and Net Interest Income Analysis - Six Months
 
Six Months Ended June 30,
 
2013
 
2012
 
 
 
 
 
Average
 
 
 
 
 
Average
(dollars in thousands)
Average
 
Income /
 
Yield /
 
Average
 
Income /
 
Yield /
 
Balance (3)
 
Expense
 
Rate
 
Balance (3)
 
Expense
 
Rate
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Loans (1)(2)
$
1,131,004

 
$
29,303

 
5.22
%
 
$
1,255,743

 
$
34,289

 
5.49
%
Taxable investment securities
571,378

 
6,592

 
2.33

 
447,637

 
5,571

 
2.50

Other earning assets
210,555

 
409

 
0.39

 
439,172

 
660

 
0.30

  Total earning assets
1,912,937

 
36,304

 
3.83

 
2,142,552

 
40,520

 
3.80

 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
32,175

 
 
 
 
 
20,180

 
 
 
 
Goodwill and other intangible assets
11,504

 
 
 
 
 
11,934

 
 
 
 
Other assets, net
128,121

 
 
 
 
 
184,772

 
 
 
 
Assets of discontinued operations
—

 
 
 
 
 
167

 
 
 
 
  Total assets
$
2,084,737

 
 
 
 
 
$
2,359,605

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing demand deposits
$
354,759

 
$
531

 
0.30
%
 
$
349,083

 
$
764

 
0.44
%
Savings deposits
78,723

 
39

 
0.10

 
71,239

 
53

 
0.15

Money market deposits
452,514

 
493

 
0.22

 
436,315

 
982

 
0.45

Time deposits
695,076

 
3,274

 
0.95

 
982,680

 
6,125

 
1.25

  Total interest-bearing deposits
1,581,072

 
4,337

 
0.55

 
1,839,317

 
7,924

 
0.87

Retail repurchase agreements
8,506

 
9

 
0.21

 
8,450

 
17

 
0.40

Federal Home Loan Bank advances
58,318

 
747

 
2.58

 
58,361

 
666

 
2.29

Other borrowed funds
56,702

 
528

 
1.88

 
56,702

 
589

 
2.09

  Total interest-bearing liabilities
1,704,598

 
5,621

 
0.66

 
1,962,830

 
9,196

 
0.94

 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-bearing liabilities and shareholders' equity:
 
 
 
 
 
 
 
 
 
 
 
Noninterest-bearing demand deposits
264,451

 
 
 
 
 
248,147

 
 
 
 
Other liabilities
23,405

 
 
 
 
 
24,286

 
 
 
 
Shareholders' equity
92,283

 
 
 
 
 
123,173

 
 
 
 
Liabilities of discontinued operations
—

 
 
 
 
 
1,169

 
 
 
 
  Total liabilities and shareholders' equity
$
2,084,737

 
 
 
 
 
$
2,359,605

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income and net yield on earning assets (4)
 
 
$
30,683

 
3.23
%
 
 
 
$
31,324

 
2.94
%
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate spread (5)
 
 
 
 
3.17
%
 
 
 
 
 
2.86
%
(1) The fully tax equivalent basis is computed using a federal tax rate of 35%.
(2) Average loan balances include nonaccruing loans and loans held for sale.
(3) Average balances include market adjustments to fair value for securities and loans held for sale.
(4) Net yield on earning assets is computed by dividing net interest income by average earning assets.
(5) Earning asset yield minus interest bearing liabilities rate.

44


Provision for Loan Losses
The provision for loan loss provides a level of allowance considered appropriate to absorb management's estimate of losses inherent in the loan portfolio. The amount of this charge is affected by several considerations, including management's evaluation of various risk factors in determining the adequacy of the allowance (see additional discussion under “Asset Quality”), actual loan loss experience and changes in the composition of the loan portfolio.

During the three month and six months periods ended June 30, 2013, the provision for (recovery of) loan losses, excluding discontinued operations, was $(1.1) million and $(947) thousand, respectively, compared to $7.8 million and $10.8 million, respectively, in the same periods of 2012, as a result of reductions in nonperforming loans, and an increase in forecasted cash flows for Granite PI loans that resulted in the reversal of previously recorded impairment on pools of loans within this portfolio.

We have also experienced lower net charge-offs, reduced levels of classified assets and lower levels of past dues compared to 2012, primarily as a result of reductions in the overall size of the loan portfolio and lower levels of nonperforming loans. During the three and six month periods ended June 30, 2013, net charge-offs totaled $3.5 million and $3.3 million, respectively, or 1.26% and 0.59% of annualized average loans, respectively. These charge-off levels are improved from net charge-offs of $9.0 million and $11.7 million, respectively, or 2.83% and 1.87% of annualized average loans, respectively, for the three and six month periods ended June 30, 2012.

Noninterest Income

Noninterest income includes mortgage banking income, fees and service charges on deposit accounts, fees from cardholder and merchant services, fees and commissions related to trust and investment services, gains and losses on the sales of securities, and all other types of noninterest revenue.

For the three months ended June 30, 2013, noninterest income was $5.2 million compared to $6.5 million for the same period in 2012, a decrease of $1.3 million, or 20%, primarily the result of $2.0 million of net gains on sales of investment securities in the second quarter of 2012, compared to $345 thousand of net gains in the same period in 2013. Core noninterest income, which excludes securities gains and losses, was $4.9 million, an increase of $0.4 million from the second quarter of 2012. See "Non-GAAP Measures" for further discussion. Mortgage loan income increased $0.6 million over the prior year's quarter as we began selling loans to Fannie Mae in June of 2012. Service charge income was $0.1 million lower as compared to the second quarter of 2012, primarily as a result of a one-time 60 day fee waiver given to customers at the Bank as part of the product conversion completed in February of 2013, and the impact of changes to NSF policies and overdraft protection products beginning in the second half of 2012.

For the six months ended June 30, 2013, noninterest income was $11.8 million compared to $10.4 million for the same period in 2012, an increase of $1.4 million, or 14%, primarily the result of a $0.8 million increase in net gains on sales of investment securities in the first six months of 2013, compared to the same period in 2012. Core noninterest income was $9.1 million, compared to $8.4 million in the first six months of 2012. Mortgage loan income increased $1.3 million as we had a full six months of loan sales to Fannie Mae in 2013. Service charge income was $0.6 million lower as compared to the second quarter of 2012 for the same reasons described in the paragraph above for the second quarter of 2013 and 2012.



45

 
Three Months Ended
 
Six Months Ended
(dollars in thousands)
June 30, 2013
 
June 30, 2012
 
June 30, 2013
 
June 30, 2012
Noninterest Income
 
 
 
 
 
 
 
    Service charges on deposit accounts
$
1,681

 
$
1,830

 
$
3,057

 
$
3,646

    Mortgage loan income
921

 
287

 
1,665

 
323

    Cardholder and merchant services income
1,174

 
1,176

 
2,243

 
2,317

    Trust and investment services
394

 
256

 
635

 
458

    Bank owned life insurance
276

 
314

 
538

 
620

    Other service charges, commissions and fees
337

 
271

 
595

 
525

    Securities gains, net
345

 
2,002

 
2,723

 
1,956

    Other income
119

 
396

 
324

 
513

        Total noninterest income
5,247

 
6,532

 
11,780

 
10,358

Less:
 
 
 
 
 
 
 
    Securities gains, net
345

 
2,002

 
2,723

 
1,956

        Core noninterest income (1)
$
4,902

 
$
4,530

 
$
9,057

 
$
8,402

(1) See "Non-GAAP Measures
Noninterest Expense
Noninterest expense includes salary and employee benefits, occupancy and equipment, and other expenses associated with our operations, in addition to credit related expenses related to OREO and loan collections, and one-time merger-related expenses incurred to acquire and integrate Granite.

Noninterest expenses were $24.7 million in the second quarter of 2013 compared to $32.9 million in the same period of 2012, a decrease of $8.3 million, or 25%. The decrease in noninterest expense was primarily attributable to a $9.1 million decrease in OREO expense, as a result of our substantial reduction in OREO assets from the prior year and stabilizing real estate prices during 2013. Loan collection expenses were $0.9 million higher primarily on increased legal expenses associated with the higher level of loan recoveries during 2013. Merger related expenses increased $2.8 million from 2012 to 2013, as a result of the completion of the bank merger in 2013, while FDIC insurance premiums declined by $0.6 million as a result of our improved risk profile and lower asset balances.

For the six months ended June 30, 2013, noninterest expenses declined $10.8 million, or 18%, from the same period of 2012, to $49.0 million. OREO expense declined $13.8 million from the first half of 2012, as a result of the decline in the OREO portfolio and stabilizing real estate prices during 2013 described above. Loan collection expenses rose $1.7 million, and merger-related expense rose $2.1 million, from the prior year comparable period, for the reasons described above, while personnel expenses rose $0.9 million from the first six month of 2012, as we have added credit staff to manage the problem asset portfolio, and added mortgage staff and incurred mortgage commission expenses in connection with rebuilding our mortgage activities.
As a result of the level of problem assets, actions taken to dispose of assets, actions taken to restructure the balance sheet, and the expenses to acquire and integrate Granite, there are a significant number of non-core items within our noninterest expense. Excluding the items that we identify as non-core, other real estate expenses, loan collection expenses, merger-related expense, branch closure and restructuring expenses, Granite Mortgage and litigation accrulas and rebranding expenses, the core noninterest expense ("Core NIE"), was $18.2 million in the second quarter of 2013. See "Non-GAAP Measures" for further discussion. This Core NIE was $1.4 million lower than Core NIE of $19.7 million in the same quarter in 2012. On a comparative basis, Core NIE as a percent of average assets was 3.54% in the second quarter of 2013, up slightly from 3.38% in the same quarter of 2012, but improved from 3.65% in the first quarter of this year. For the six months ended June 30, 2013, Core NIE was $37.5 million, or $0.5 million lower than Core NIE of $38.0 million in the same period of 2012. Despite the reduction in Core NIE year over year, Core NIE as a percent of average assets was 3.59% in the first half of 2013, 37 basis points higher than 3.22% in the same period of 2012, primarily as a result of the declining asset base. After the completion of the merger and the non-merger related closure of two branches in the second quarter of 2013, we expect that cost synergies related to branch, back office and vendor consolidation will result in a lower Core NIE and Core NIE to average assets ratio in future periods.
Full-time equivalent employees averaged 628 employees for the second quarter of 2013 versus 634 employees for the second quarter of 2012. At June 30, 2013, there were 607 full-time equivalent employees.


46

 
Three Months Ended
 
Six Months Ended
(dollars in thousands)
June 30, 2013
 
June 30, 2012
 
June 30, 2013
 
June 30, 2012
Noninterest Expense
 
 
 
 
 
 
 
    Personnel expense
$
10,807

 
$
10,581

 
$
21,486

 
$
20,607

    Net occupancy expense
1,671

 
1,608

 
3,502

 
3,169

    Furniture, equipment and data processing expense
2,094

 
2,141

 
4,462

 
4,213

    Professional fees
760

 
1,250

 
2,253

 
2,792

    Stationery, printing and supplies
187

 
153

 
373

 
294

    Advertising and marketing
179

 
125

 
844

 
254

    Other real estate owned expense
3,332

 
12,473

 
4,214

 
17,992

    Credit/debit card expense
473

 
437

 
898

 
847

    FDIC insurance
664

 
1,225

 
1,334

 
1,823

    Loan collection expense
1,408

 
514

 
2,979

 
1,260

    Merger-related expense
1,989

 
(840
)
 
3,498

 
1,418

    Core deposit intangible amortization
352

 
352

 
704

 
704

    Other expense
749

 
2,896

 
2,457

 
4,390

        Total noninterest expense
24,665

 
32,915

 
49,004

 
59,763

Less:
 
 
 
 
 
 
 
    Other real estate owned expense
3,332

 
12,473

 
4,214

 
17,992

    Merger-related expense
1,989

 
(840
)
 
3,498

 
1,418

    Loan collection expense
1,408

 
514

 
2,979

 
1,260

    Rebranding expenses
58

 
—

 
610

 
—

    Granite mortgage and litigation accrual
(370
)
 
1,100

 
(370
)
 
1,100

    Branch closure and restructuring expense
15

 
—

 
602

 
—

        Core noninterest expense (1)
$
18,233

 
$
19,668

 
$
37,471

 
$
37,993

(1) See "Non-GAAP Measures"

Provision for Income Taxes
Excluding discontinued operations, we had income tax expense totaling $0.2 million for the second quarter of 2013 and $26 thousand for the first three months of 2012. For the first six months of 2013, we recorded income tax expense of $2.1 million, compared to income tax benefit of $51 thousand during the first six months of 2012. Our provision for income taxes, as a percentage of loss before income taxes, excluding discontinued operations, was 8.0% and 0.1% for the three months ended June 30, 2013 and June 30, 2012, respectively, and was 36.7% and (0.2)% for the six months ended June 30, 2013 and June 30, 2012, respectively.
Income tax expense in the first six months of 2013 is primarily the result of the reduction of deferred tax liabilities during the period, offset by an increase in the deferred tax assets arising from losses in the investment securities portfolio for which no valuation allowance is required. Because we maintain a valuation allowance for net deferred tax assets equal to the gross deferred tax asset (less deferred tax assets for which no valuation allowance is required), net of any deferred tax liabilities, reductions in deferred tax liabilities during the first six months of 2013 resulted in an increase in the required valuation reserve and a corresponding increase in income tax expense.

Balance Sheet Review
Total assets at June 30, 2013 were $2,036.3 million, a decrease of $115.3 million, or 5.4%, compared to total assets of $2,151.6 million at December 31, 2012.
Cash and interest-bearing balances were $88.5 million at June 30, 2013, a decrease of $151.1 million, or 63%, compared to $239.6 million at December 31, 2012, primarily attributable to the use of cash to purchase investment securities, purchase of residential loan pools and to fund reductions in the deposit portfolio.

47

Total investment securities increased $43.4 million during the first six months of 2013, from $564.9 million at December 31, 2012 to $608.2 million at June 30, 2013, an increase of 8%. The portfolio is comprised of U.S. federal agency securities and federal agency MBSs (GSE), private residential MBSs, commercial MBSs (GSE), private commercial MBSs and corporate debt securities. During the first quarter of 2013 we began to purchase investment securities to be held to maturity. At June 30, 2013 there were $154.8 million of investment securities so designated.
Gross loans held for investment increased $12.4 million, or 1%, during the first six months of 2013, from $1,177.0 million at December 31, 2012 to $1,189.4 million at June 30, 2013. During the six month period, we purchased $119.0 million of residential mortgage pools, reduced criticized loans by $56.4 million, and received principal payments of $43.8 million on the residential mortgage pools purchased in 2012. The pass rated loan portfolio has grown $68.7 million, or 7%, in 2013.
Other real estate owned ("OREO") and other foreclosed property decreased $27.4 million during the first six months of 2013, from $63.1 million at December 31, 2012 to $35.8 million at June 30, 2013, as a result of $30.7 million of OREO sales and $3.3 million of write-downs and losses, partially offset by the addition of $6.8 million of OREO properties. At June 30, 2013, 17 assets with a net carrying amount of $4.5 million were under contract for sale. Estimated losses, if any, with these sales have been recognized in the Consolidated Statements of Operations in the first six months of 2013. Actual gains, if any, will be recorded at sale.
Total deposits were $1,811.5 million at June 30, 2013, a decline of $95.5 million, or 5% from $1,907.0 million at December 31, 2012. We continued to shift the mix of deposits from higher cost time deposits, including higher rate CD's and brokered CD's, towards lower rate demand, savings and money market deposits. At June 30, 2013, CD's comprised 35.8% of total deposits compared to 40.0% at December 31, 2012. Noninterest-bearing deposits increased $53.8 million, or 21%, from $251.2 million at December 31, 2012 to $305.0 million at June 30, 2013. This was primarily the result of certain accounts being mapped from interest bearing to noninterest bearing during the bank merger in June 2013. Total cost of interest-bearing deposits declined by 32 basis points from 0.87% in the first six months of 2012 to 0.55% in the first six months of 2013. The cost of all deposits, including noninterest-bearing deposits, fell to 0.47% for the first six months of 2013, a decline of 29 basis points from 0.76% for the first six months of 2012.
Shareholders' equity at June 30, 2013 was $76.0 million as compared to $98.4 million at December 31, 2012. The book value per share was $3.50 and average equity to average assets was 4.43% at June 30, 2013 as compared to a book value per share of $4.54 and average equity to average assets of 5.00% at December 31, 2012. The change in shareholders' equity reflects a net loss to common shareholders for the six months ended June 30, 2013 of $7.8 million as well as $14.9 million other comprehensive loss, net of tax, including unrealized loss on available-for-sale securities described below. We did not declare common dividends during the six months ended June 30, 2013, and will not be able to pay any dividends until such time as we return to profitability and either receive or are not required to receive regulatory approval for the payment of dividends. We do not expect to pay dividends to shareholders for the foreseeable future.
Investment Securities
We evaluate all securities on a quarterly basis, and more frequently as economic conditions warrant, to determine if an other-than-temporary impairment (“OTTI”) exists. In evaluating the possible impairment of securities, consideration is given to the length of time and the extent to which the fair value has been less than book value, the financial conditions and near-term prospects of the issuer, and the ability and intent of COB to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer's financial condition, we may consider whether the securities are issued by the federal government or its agencies or government sponsored agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer's financial condition. If management determines that an investment experienced an OTTI, the loss is recognized in the income statement as a realized loss. Any recoveries related to the value of these securities are recorded as an unrealized gain (as other comprehensive income (loss) in shareholders' equity) and not recognized in income until the security is ultimately sold. As of June 30, 2013, there were no securities considered by COB to have OTTI.
During the second quarter of 2013, changes in the overall level of interest rates resulted in unrealized losses of $16.9 million in our available-for-sale portfolio. As a result, an unrealized loss of $10.2 million in the second quarter of 2013, net of deferred taxes of $6.7 million, was recorded in Other Comprehensive Income. We do not expect to sell these securities and realize these losses.
Asset Quality
Management considers asset quality to be of primary importance. A formal loan review function, independent of loan origination, is used to identify and monitor problem loans. This function reports directly to the Risk Management Committee of the Board of Directors, and is independent of loan origination.
During 2013 our asset quality has continued to improve. Since December 31, 2012, nonperforming loans have declined 26% and OREO has declined 43%. We recorded net loan charge-offs of $3.5 million in the second quarter of 2013, and OREO write-downs, net of gain on sale of OREO, were $3.0 million.
Acquired Loans

48

Loans acquired in the Merger ("Granite Purchased Loans") include purchased impaired loans ("PI loans") and purchased contractual ("PC loans") revolving consumer and commercial loans. At June 30, 2013 there were $218.3 million of Granite Purchased Loans, of which $29.2 million were PC loans, $27.9 million were PI loans with no subsequent credit deterioration and $161.3 million were PI loans with subsequent credit deterioration.
PI loans are segregated into pools and recorded at estimated fair value on the date of acquisition without the carryover of the related ALL. PI loans are accounted for under ASC 310-30 when the loans have evidence of credit deterioration since origination and it is probable at the date of acquisition we will not collect all contractually required principal and interest payments. Evidence of credit quality deterioration as of the date of acquisition may include statistics such as past due status, nonaccrual status and risk grade. PI loans generally meet our definition for nonaccrual status, however, even if the borrower is not currently making payments, we will classify loans as accruing if we can reasonably estimate the amount and timing of future cash flows. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference.
Periodically, we estimate the expected cash flows for each pool of the PI loans and evaluate whether the expected cash flows for each pool have changed from prior estimates. Decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges, or reclassification from nonaccretable difference to accretable yield with a positive impact on future interest income. Excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows. During the second quarter of 2013 we recorded a recovery of loan loss provision of $1.1 million associated with an improved cash flow forecast for the Granite PI loans.
We have elected to treat the Granite portfolio under ASC 310-30, with the exception of performing revolving consumer and commercial loans, which are being accounted for under ASC 310-20.
At June 30, 2013, an ALL of $4.1 million was required for the PI loans, and those loans are presented on an accruing basis.
Nonperforming Assets
Nonperforming assets are comprised of nonaccrual loans, accruing loans past due 90 days or more, other repossessed assets and OREO. Nonperforming loans are loans placed in nonaccrual status when, in management's opinion, the collection of all or a portion of interest becomes doubtful. Loans are returned to accrual status when the factors indicating doubtful collectability cease to exist and the loan has performed in accordance with its terms for a demonstrated period of time. OREO represents real estate acquired through foreclosure or deed in lieu of foreclosure and is generally carried at fair value, less estimated costs to sell.
The level of nonperforming loans continued to decline, from $79.5 million or 6.75% of loans held for investment at December 31, 2012, to $59.0 million, or 4.96% of loans held for investment at June 30, 2013. OREO and repossessed assets were $35.8 million at June 30, 2013, compared to $63.1 million at December 31, 2012, a decline of $27.4 million. During the second quarter of 2013 we accelerated the periodic reappraisal of our OREO portfolio and received third party appraisals on our entire OREO portfolio. During the first six months of 2013, we recorded net write-downs (net of gains on sales) of OREO of $3.3 million as compared to $14.5 million during the first six months of 2012. We have experienced stabilizing real estate prices in 2013, as well as robust interest in our OREO portfolio assets. Total nonperforming assets declined 34% from $142.6 million at December 31, 2012 to $94.8 million at June 30, 2013, and represented 4.65% of total assets, an improvement from 6.63% at December 31, 2012.
Commercial real estate secured lending (including commercial, construction and land development) is a significant but decreasing portion of our commercial loan portfolio. These categories constitute $465.4 million, or approximately 39%, of our total loans held for investment portfolio at June 30, 2013, down from 43% at December 31, 2012. These categories are generally affected by changes in economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax and other laws and acts of nature.
Allowance for Loan Losses
In determining the ALL and any resulting provision to be charged against earnings, particular emphasis is placed on the results of the loan review process. Consideration is also given to a review of individual loans, historical loan loss experience, the value and adequacy of collateral, as well as the economic conditions in our market area. For loans determined to be impaired, the allowance is based on discounted cash flows using the loan's initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. In addition, as an integral part of its examination process, the OCC periodically reviews the Bank's ALL and may require the Bank to recognize changes to the allowance based on its judgments about information available to it at the time of its examinations. Loans are charged off when, in the opinion of management, they are deemed to be uncollectible. Recognized losses are charged against the allowance, and subsequent recoveries are added to the allowance.

49

Estimated credit losses should meet the criteria for accrual of a loss contingency, i.e., a provision to the ALL, set forth in GAAP. Our methodology for determining the ALL is based on the requirements of GAAP, the Interagency Policy Statement on the Allowance for Loan and Lease Losses and other regulatory and accounting pronouncements. The ALL is determined by the sum of three separate components:  (i) the impaired loan component, which addresses specific reserves for impaired loans; (ii) the general reserve component, which addresses reserves for pools of homogeneous loans; and (iii) an unallocated reserve component (if any) based on management's judgment and experience. The loan pools and impaired loans are mutually exclusive; any loan that is impaired should be excluded from its homogenous pool for purposes of that pool's reserve calculation, regardless of the level of impairment. However, we have established a de minimis threshold for loan exposures that, if found to be impaired, will have impairment determined by applying the same general reserve rate as nonimpaired loans within the same pool.
The allowance for loan losses of $29.3 million at December 31, 2012 decreased by 14% to $25.1 million at June 30, 2013. The ALL, as a percentage of loans held for investment, amounted to 2.11% at June 30, 2013 compared to 2.49% at December 31, 2012. Net charge-offs were $3.5 million in the first six months of 2013 compared to net charge-offs of $11.7 million in the first six months of 2012. Annualized charge-offs in the first six months of 2013 were 0.59% of average loans, compared to net charge-offs of 1.87% in the same period of 2012. A substantial portion of 2013 charge-offs were related to impaired loans, and consisted of loans considered wholly impaired and loans with partial impairment.
Actual past due loans and loan charge-offs have declined and management continues to diligently work to improve asset quality. Management believes the ALL of $25.1 million at June 30, 2013 is adequate to cover probable losses inherent in the loan portfolio; however, assessing the adequacy of the allowance is a process that requires considerable judgment. Management's judgments are based on numerous assumptions about current events that it believes to be reasonable, but which may or may not be valid. Thus, there can be no assurance that loan losses in future periods will not exceed the current allowance or that future increases in the allowance will not be required. No assurance can be given that management's ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the allowance, thus adversely affecting the operating results of COB. Additional information on the ALL is presented in Note 5 to the consolidated financial statements.
Historical loss rates are calculated by associating losses to the risk-graded pool to which they relate for each of the previous eight quarters. Then, using a look back period beginning with the third quarter of 2006, loss factors are calculated for each risk-graded pool.

In addition to the Bank's ability to use its own historical loss data and migration between risk grades, it has a rigorous process for computing the qualitative factors that impact the ALL. A committee, independent of the historical loss migration team, reviews risk factors that may impact the ALL. Some factors are statistically quantifiable, such as concentration, growth, delinquency, and nonaccrual risk by loan type, while other factors are qualitative in nature, such as staff competency, competition within our markets, economic and regulatory changes impacting the loans held for investment.

The following table presents COB's investment in loans considered to be impaired and related information on those impaired loans as of June 30, 2013 and December 31, 2012:
 
 
June 30, 2013
 
December 31, 2012
(dollars in thousands)
 
Balance
 
Associated Reserves
 
Balance
 
Associated Reserves
Impaired loans, not individually reviewed for impairment
 
$
9,313

 
$
—

 
$
6,017

 
$
—

Impaired loans, individually reviewed, with no impairment
 
51,557

 
—

 
62,282

 
—

Impaired loans, individually reviewed, with impairment
 
5,935

 
763

 
15,312

 
1,737

Total impaired loans *
 
$
66,805

 
$
763

 
$
83,611

 
$
1,737

 
 
 
 
 
 
 
 
 
Purchased impaired loans with subsequent deterioration
 
161,278

 
4,066

 
192,115

 
5,373

Purchased impaired loans with no subsequent deterioration
 
27,881

 
—

 
36,277

 
—

Total Reserves
 
 
 
4,829

 
 
 
7,110

 
 
 
 
 
 
 
 
 
Average impaired loans calculated using a simple average
 
$
72,917

 
 
 
$
94,754

 
 
* Included at June 30, 2013 and December 31, 2012 were $4.3 million and $4.5 million, respectively, in restructured and performing loans.
Liquidity Management
Liquidity management refers to the ability to meet day-to-day cash flow requirements based primarily on activity in loan and deposit accounts of COB's customers. Deposit withdrawals, loan funding and general corporate activity create a need for liquidity. Liquidity

50

is derived from sources such as deposit growth, maturity, calls, or sales of investment securities, principal and interest payments on loans and access to borrowed funds or lines of credit.
Consistent with the general approach to liquidity, loans and other assets of COB are funded primarily by local core deposits. To date, a stable retail deposit base and a modest amount of brokered deposits have been adequate to meet our loan obligations, while maintaining the desired level of immediate liquidity. Additionally, an investment securities portfolio is available for both immediate and secondary liquidity purposes.
During the first quarter of 2012, we resumed deferring the payment of cash dividends on its outstanding junior subordinated debentures.
As of June 30, 2013, available borrowing under credit lines totaled $19.8 million, compared to $41.4 million at December 31, 2012. The Company can also access $70.9 million of additional borrowings under credit lines by pledging additional collateral.
At June 30, 2013, $97.0 million of the investment securities portfolio was pledged to secure public deposits, $13.0 million was pledged to retail repurchase agreements, and $2.1 million was pledged to others, leaving $490.1 million available as lendable collateral.

Asset/Liability Management and Interest Rate Sensitivity
One of the primary objectives of asset/liability management is to maximize the net interest margin while minimizing the earnings risk associated with changes in interest rates. One method used to manage interest rate sensitivity is to measure, over various time periods, the interest rate sensitivity positions, or gaps. This method, however, addresses only the magnitude of timing differences and does not address earnings or market value. Therefore, management uses an earnings simulation model to prepare, on a regular basis, earnings projections based on a range of interest rate scenarios to more accurately measure interest rate risk.
COB's balance sheet continued to be asset-sensitive at June 30, 2013. During the quarter, increases in long-term interest rates that extended the duration of our fixed-rate mortgage backed investment securities portfolio, purchases of $119 million of fixed-rate residential mortgage pools and the conversion of $50 million of fixed rate FHLB advances to floating rate have reduced our overall level of asset sensitivity. An asset-sensitive position means that net interest income will generally move in the same direction as interest rates. For instance, if interest rates increase, net interest income can be expected to increase, and if interest rates decrease, net interest income can be expected to decrease. COB's asset sensitivity is primarily derived from cash and due from banks position, prime-based commercial loans that adjust as the prime interest rate changes and the long duration of its indeterminate term deposits. These prime-based loans are primarily funded by deposits that are not expected to reprice as quickly as the loans. Since the prime rate is not expected to decline below current levels, management believes COB's risk to lower interest rates is low.
Capital Adequacy and Resources
Under guidelines established by the Federal Reserve Board and the OCC, capital adequacy is currently measured for regulatory purposes by certain risk-based capital ratios, supplemented by a leverage capital ratio. The guidelines define an institution's total qualifying capital as having two components: Tier 1 capital, which must be at least 50% of total qualifying capital and is mainly comprised of common equity, retained earnings and qualifying preferred stock, less certain intangibles; and Tier 2 capital, which may include the ALL up to a maximum of 1.25% of risk weighted assets, qualifying subordinated debt, qualifying preferred stock and hybrid capital instruments. The requirements also define the weights assigned to assets and off-balance sheet items to determine the risk weighted asset components of the risk-based capital rules.
Under the requirements, the minimum capital standards that must be met by any bank holding company or bank include a Tier 1 capital ratio of at least 4%, a total risk based capital ratio of at least 8% and a leverage capital ratio of at least 4% (except for those institutions with the highest regulatory ratings and not experiencing significant growth or expansion). The leverage capital ratio, which serves as a minimum capital standard, considers Tier 1 capital only and is expressed as a percentage of average total assets for the most recent quarter, after reduction of those assets for goodwill and other disallowed intangible assets at the measurement date. Risks such as concentration of credit risks and the risk arising from non-traditional activities, as well as the institution's exposure to a decline in the economic value of its capital due to changes in interest rates, and an institutions ability to manage those risks are important factors that are to be taken into account by the federal banking agencies in assessing an institution's overall capital adequacy.
The prompt corrective action provisions of federal law require the federal bank agencies to take prompt corrective action to resolve problems of insured depository institutions such as the Bank. The extent of these powers depends upon whether the institution is designated as well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized or critically undercapitalized, as defined by the law. The minimum capital requirements to be characterized as “well-capitalized” and “adequately capitalized,” as defined by the applicable provisions of federal law, and COB and the Bank's capital ratios as of June 30, 2013 were as follows:

51

 
 
 
Minimum Regulatory Requirement
 
CommunityOne Bancorp
CommunityOne
Bank
Adequately
Capitalized
Well-
Capitalized
Leverage capital ratio
5.38%
6.95%
4.00%
5.00%
Tier 1 risk-based capital ratio
8.76%
11.31%
4.00%
6.00%
Total risk-based capital ratio
12.08%
12.57%
8.00%
10.00%

On June 10, 2013, the OCC terminated the Bank Consent Order; however, the Bank has continuing obligations to, among other things, adhere to its 2013 Business Plan, including maintaining the capital ratios in the Plan, and will continue to have restrictions on its ability to pay dividends. With the lifting of the Consent Order, the Bank is now considered “well-capitalized” under the applicable provisions of the Federal Deposit Insurance Act.
The federal banking agencies have issued revised capital rules that would change the leverage and risk-based capital requirements (including the prompt corrective action framework), which will become effective for community banks as of January 1, 2015. Under these final rules, the definition of the regulatory capital components and minimum capital requirements will materially change. Among the most important of these changes is that a new common equity Tier 1 risk based capital ratio of 4.5% has been added, and the overall Tier 1 risk-based capital ratio has been raised to 6%. Certain deductions from common equity will be expanded and others, including mortgage servicing assets and deferred tax assets subject to temporary timing differences, will be subject to threshold deductions. In addition, the agencies are requiring a capital conservation buffer of up to 2.5% above each of the capital ratio requirements (common equity tier 1, tier 1, and total risk-based capital) which must be met for a bank to be able to pay dividends, engage in share buybacks or make discretionary bonus payments to executive management without restriction. This capital conservation buffer will be phased in over a four year period starting on January 1, 2016. The rulemakings also change the risk-weighting of certain assets, including “high volatility” commercial real estate, past due assets, structured securities and equity holdings. We are still evaluating the changes, but believe that they will not have a material effect on COB or the Bank at this time.
Application of Critical Accounting Policies
Our accounting policies are in accordance with GAAP and with general practice within the banking industry and are fundamental to understanding management's discussion and analysis of results of operations and financial condition. Our significant accounting policies are discussed in detail in Note 1 of the consolidated financial statements contained in the Annual Report on Form 10-K for the year ended December 31, 2012, as amended ("Form 10-K"), and are described below.
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, valuation of OREO, carrying value of investment securities, estimated cash flows for purchased impaired loans and treatment of deferred tax assets.
Allowance for Loan Losses
The ALL, which is utilized to absorb actual losses in the loan portfolio, is maintained at a level consistent with management's best estimate of probable loan losses incurred as of the balance sheet date. Our ALL is assessed quarterly by management. This assessment includes a methodology that separates the total loan portfolio into homogeneous loan classifications for purposes of evaluating risk. The required allowance is calculated by applying a risk adjusted reserve requirement to the dollar volume of loans within a homogenous group. We have grouped our loans into pools according to the loan segmentation regime employed on schedule RC-C of the FFIEC's Consolidated Report of Condition and Income. Management analyzes the loan portfolio on an ongoing basis to evaluate current risk levels, and risk grades are adjusted accordingly. While management uses the best information available to make evaluations, future adjustments may be necessary, if economic or other conditions differ substantially from the assumptions used. See additional discussion under "Asset Quality".
Valuation of Other Real Estate Owned
Other real estate owned represents properties acquired through foreclosure or deed in lieu thereof. The property is classified as held for sale and is carried at fair value based on recent appraisals, less estimated costs to sell. Declines in the fair value of properties included in other real estate below carrying value are recognized by a charge to income. An increase in fair value is not recognized until the property is sold.
Carrying Value of Securities
Securities designated as available-for-sale are carried at fair value. However, the unrealized difference between amortized cost and fair value of securities available-for-sale is excluded from net income unless there is an other than temporary impairment and is reported, net of deferred taxes, as a component of shareholders' equity as accumulated other comprehensive income (loss). Securities held-to-maturity are carried at amortized cost, as the banks have the ability, and management has the positive intent, to hold these securities to maturity. Premiums and discounts on securities are amortized and accreted according to the interest method.

52

Purchased Loans Accounting
Purchased impaired ("PI") loans are recorded at fair value at acquisition date. Therefore, amounts deemed uncollectible at acquisition date become part of the fair value determination and are excluded from the allowance for loan and lease losses. Following acquisition, we periodically review PI loans to determine if changes in estimated cash flows have occurred. Subsequent decreases in the amount expected to be collected result in a provision for loan losses with a corresponding increase in the allowance for loan losses. Subsequent increases in the amount expected to be collected result in a reversal of any previously recorded provision for loan losses and related allowance for loan losses, if any, or prospective adjustment to the accretable yield if no provision for loan losses had been recorded. Results of operations of an acquired business are included in the statement of earnings from the date of acquisition. Acquisition-related costs, including conversion and restructuring charges, are expensed as incurred.
Treatment of Deferred Tax Assets
Management's determination of the realization of deferred tax assets is based upon its judgment of various future events and uncertainties, including the timing and amount of future income earned by certain subsidiaries and the implementation of various tax plans to maximize realization of the deferred tax assets. In evaluating the positive and negative evidence to support the realization of the asset under current guidance, there is insufficient positive evidence to support a conclusion that it is more likely than not this asset will be realized in the foreseeable future. Examinations of the income tax returns or changes in tax law may impact our tax liabilities and resulting provisions for income taxes.
A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more-likely-than-not that some portion or the entire deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. In making such judgments, significant weight is given to evidence that can be objectively verified. As a result of the increased credit losses, COB continues to be in a three-year cumulative pre-tax loss position as of June 30, 2013. A cumulative loss position is considered significant negative evidence in assessing the realizability of a deferred tax asset, which is difficult to overcome. Our estimate of the realization of its deferred tax assets was based on the scheduled reversal of deferred tax liabilities and taxable income available in prior carry back years and estimated unrealized losses in the available-for-sale investment portfolio. In total, we have a net deferred tax asset of $193.0 million which is offset by a valuation allowance of $184.5 million. We did not consider future taxable income in determining the realizability of its deferred tax assets. We expect our income tax expense (benefit) will be negligible except for expense and benefit related to the change in the deferred tax liability related to available for sale securities until profitability has been restored for a reasonable time and such profitability is considered sustainable. At that time, the valuation allowance would be reversed. Reversal of the valuation allowance requires a great deal of judgment and will be based on the circumstances that exist as of that future date. If future events differ significantly from our current forecasts, we may need to increase this valuation allowance, which could have a material adverse effect on the results of operations and financial condition.
The Merger was considered a change in control for Granite Corp. under Internal Revenue Code Section 382 and the Regulations, thereunder. Accordingly, we are required to evaluate potential limitation or deferral of its ability to carryforward pre-acquisition net operating losses and to determine the amount of net unrealized built-in losses (“NUBIL”), which may be subject to similar limitation or deferral. Under the Internal Revenue Code and Regulations, NUBIL realized within 5 years of the change in control are subject to potential limitation, which for us is October 20, 2016. Through that date, we will continue to analyze our ability to utilize such losses to offset anticipated future taxable income, however, this estimate will not be known until the five-year recognition period expires. Losses limited under these provisions are generally limited to a carryforward period of 20 years, subject to the annual limitation and expire if not used by the end of that period. As of June 30, 2013, net deferred tax assets attributable to Granite Corp. and subsidiaries were approximately $39.1 million which is offset by a valuation allowance of $35.5 million. We anticipate that some of these benefits from the net operating losses and built-in losses will not ultimately be realized; however, that amount is subject to continuing analysis and has not yet been determined.
Summary
Management believes the accounting estimates related to the ALL, the valuation of OREO, the carrying value of securities, purchased loan accounting, and the valuation allowance for deferred tax assets are “critical accounting estimates” because: (1) the estimates are highly susceptible to change from period to period as they require management to make assumptions concerning the changes in the types and volumes of the portfolios and anticipated economic conditions, and (2) the impact of recognizing an impairment or loan loss could have a material effect on the COB's assets reported on the balance sheet as well as its net earnings.
Non-GAAP Measures
This quarterly Report on Form 10-Q contains financial information determined by methods other than in accordance with GAAP. We use these non-GAAP measures in our analysis of COB's performance. Some of these non-GAAP measures exclude goodwill, core deposit premiums and other intangibles from the calculations of return on average assets and return on average equity. We believe presentations of financial measures excluding the impact of goodwill, core deposit premiums and other intangible assets provide useful supplemental information that is essential to a proper understanding of the operating results of our core businesses. In addition, certain designated net interest income amounts are presented on a taxable equivalent basis. We believe that the presentation of net

53

interest income on a taxable equivalent basis aids in the comparability of net interest income arising from taxable and tax-exempt sources. We believe that other non-GAAP measures that exclude credit and non-recurring income and expenses provide useful supplemental information that enhances the understanding of our core operating results.
These disclosures should not be viewed as a substitute for results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.
The non-GAAP financial measures used in this Report are “tangible equity,” “tangible assets”, “tangible book value”, "core earnings", "core and non-core noninterest expense" and "core and non-core noninterest income." Our management, financial services companies, bank stock analysts, and bank regulators use these non-GAAP measures in their analysis of our performance.

•
“Tangible shareholders' equity” is shareholders' equity reduced by recorded goodwill and other intangible assets.
•
“Tangible assets” are total assets reduced by recorded goodwill and other intangible assets.
•
“Tangible book value” is defined as total equity reduced by recorded goodwill and other intangible assets divided by total common shares outstanding. This measure discloses changes from period-to-period in book value per share exclusive of changes in intangible assets. Goodwill, an intangible asset that is recorded in a purchase business combination, has the effect of increasing total book value while not increasing the tangible assets of a company. Companies utilizing purchase accounting in a business combination, as required by GAAP, must record goodwill related to such transactions.
•
“Non-core Noninterest Expense ” is defined as OREO expenses, loan collection expenses, nonrecurring items such as merger-related expense, mortgage servicing rights impairment, prepayment penalty on borrowings, goodwill impairment and loss on loans held for sale. This measure identifies items which are elevated during periods of elevated problem asset activity and items which are nonrecurring in nature.
•
"Core Noninterest Expense (NIE)" is defined as total noninterest expense reduced by Non-core Noninterest expense. This measure reduces noninterest expense by items which are elevated during periods of elevated problem asset activity and items which are nonrecurring in nature.
•
"Non-core Noninterest Income" is defined as gains and losses on securities and any other nonrecurring noninterest income items. This measure identifies noninterest income items which are nonrecurring in nature.
•
“Core Noninterest Income (NII)” is defined as total noninterest income reduced by Non-core Noninterest Income. This measure reduces noninterest income by items which are nonrecurring in nature.
•
"Core Earnings" is defined as income (loss) from continuing operations, before income taxes, increased by Non-core Noninterest Expense, decreased by Non-core Noninterest Income, and increased by provision for loan losses or decreased by recovery of loan losses. This measure identifies the Company's pre-tax earnings excluding items which are elevated during periods of elevated problem asset activity and items which are nonrecurring in nature.


The following tables provide a more detailed analysis of these non-GAAP measures:
(dollars in thousands, except per share data)
 
June 30, 2013
 
December 31, 2012
 
June 30, 2012
Total shareholders' equity
 
$
76,046

 
$
98,445

 
$
108,002

Less:
 
 
 
 
 
 
Goodwill
 
4,205

 
4,205

 
4,205

Core deposit and other intangibles
 
7,403

 
7,495

 
7,473

Tangible shareholders' equity
 
$
64,438

 
$
86,745

 
$
96,324

Total assets
 
$
2,036,313

 
$
2,151,565

 
$
2,301,761

Less:
 
 
 
 
 
 
Goodwill
 
4,205

 
4,205

 
4,205

Core deposit and other intangibles
 
7,403

 
7,495

 
7,473

Tangible assets
 
$
2,024,705

 
$
2,139,865

 
$
2,290,083

Book value per common share
 
$
3.50

 
$
4.54

 
$
5.00

Effect of intangible assets
 
(0.54
)
 
(0.54
)
 
(0.54
)
Tangible book value per common share
 
2.96

 
4.00

 
4.46




54

(dollars in thousands)
 
Three Months Ended
 
Six Months Ended
 
 
June 30, 2013
 
June 30, 2012
 
June 30, 2013
 
June 30, 2012
Total noninterest expense
 
$
24,665

 
$
32,915

 
$
49,004

 
$
59,763

Less:
 
 
 
 
 
 
 
 
     Other real estate owned expense
 
3,332

 
12,473

 
4,214

 
17,992

     Loan collection expense
 
1,408

 
514

 
2,979

 
1,260

     Merger-related expense
 
1,989

 
(840
)
 
3,498

 
1,418

     Rebranding expenses
 
58

 
—

 
610

 
—

     Granite mortgage and litigation accrual
 
(370
)
 
1,100

 
(370
)
 
1,100

     Branch closure and restructuring expense
 
15

 
—

 
602

 
—

Total non-core noninterest expense
 
6,432

 
13,247

 
11,533

 
21,770

          Core noninterest expense
 
$
18,233

 
$
19,668

 
$
37,471

 
$
37,993

 
 
 
 
 
 
 
 
 
Total noninterest income
 
$
5,247

 
$
6,532

 
$
11,780

 
$
10,358

Less:
 
 
 
 
 
 
 
 
    Securities gains (losses), net
 
345

 
2,002

 
2,723

 
1,956

Total non-core noninterest income
 
345

 
2,002

 
2,723

 
1,956

        Core noninterest income
 
$
4,902

 
$
4,530

 
$
9,057

 
$
8,402

 
 
 
 
 
 
 
 
 
Loss from continuing operations, before income taxes
 
$
(2,947
)
 
$
(18,112
)
 
$
(5,690
)
 
$
(29,021
)
Non-core noninterest expense
 
6,432

 
13,247

 
11,533

 
21,770

Less: Non-core noninterest income
 
(345
)
 
(2,002
)
 
(2,723
)
 
(1,956
)
Provision for (recovery of) loan losses
 
(1,057
)
 
7,778

 
(947
)
 
10,845

   Core earnings
 
$
2,083

 
$
911

 
$
2,173

 
$
1,638


Item 3.    Quantitative and Qualitative Disclosures About Market Risk
The objective of our asset/liability management function is long term maximization of net interest income within our risk guidelines. This objective is accomplished through management of our balance sheet composition, liquidity, and interest rate risk exposures arising from changing economic conditions, interest rates and customer preferences.
Management considers interest rate risk our most significant market risk. Interest rate risk is the exposure to adverse changes in net interest income due to changes in interest rates. Consistency of our net interest income is largely dependent upon the effective management of interest rate risk.
To identify and manage its interest rate risk, we employ an earnings simulation model to analyze net interest income sensitivity to changing interest rates. The model is based on contractual cash flows and repricing characteristics and incorporates market-based assumptions regarding the effect of changing interest rates on the prepayment rates of certain assets and liabilities. The model also includes management projections for activity levels in each of the product lines offered by the Bank. Assumptions are inherently uncertain and the measurement of net interest income or the impact of rate fluctuations on net interest income cannot be precisely predicted. Actual results may differ from simulated results due to timing, magnitude, and frequency of interest changes as well as changes in market conditions and management strategies.
COB's Asset/Liability Management Committee (“ALCO”), which includes senior management representatives and reports to the Board of Directors, monitors and manages interest rate risk. See "Asset/Liability Management and Interest Rate Sensitivity" in Item 2 of this Form 10-Q for further discussion.
Item 4.    Controls and Procedures
Evaluation of Disclosure Controls and Procedures
An evaluation of our disclosure controls and procedures (as defined in Sections 13(a)-15(e) and 15(d)-15(e) of the Securities Exchange Act of 1934), was carried out under the supervision and with the participation of COB's Chief Executive Officer and Chief Financial Officer and several other members of senior management as of June 30, 2013, the last day of the period covered by this Quarterly Report. COB's Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2013 in ensuring that the information required to be disclosed in the reports we file or submit under the

55

Securities Exchange Act of 1934 is (i) accumulated and communicated to management (including COB's Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized, and reported within the time periods specified in the SEC's rules and forms.
Internal Control Changes
We assess the adequacy of our internal control over financial reporting quarterly and enhance our internal controls in response to internal control assessments and internal and external audit and regulatory recommendations. No control enhancements during the quarter ended June 30, 2013 have materially affected, or are reasonably likely to materially affect, COB’s internal control over financial reporting.



56

PART II. OTHER INFORMATION
Item 1.    Legal Proceedings
In the ordinary course of operations, COB is party to various legal proceedings. Other than noted below, COB is not involved in, nor has it terminated during the six months ended June 30, 2013, any pending legal proceedings other than routine, nonmaterial proceedings occurring in the ordinary course of business.
As described in Item 3., Legal Proceedings, of the Form 10-K, Howe Barnes Hoefer & Arnett, Inc., an affiliate of Raymond James Financial, Inc., filed a complaint in Wake County Superior Court in North Carolina seeking monetary damages against COB and the Bank. The parties have executed a formal settlement agreement, which received regulatory non-objection and was effective as of July 25, 2013. The settlement involves a note secured by Bank stock. As a result of the settlement, the parties filed a stipulation of dismissal of the complaint as of July 31, 2013.
Item 1A.     Risk Factors
There have been no material changes to the risk factors that we have previously disclosed in Item 1A - “Risk Factors” in our Form 10-K.
Item 2.    Unregistered Sales of Equity Securities and Repurchases
Not Applicable
Item 3.    Defaults Upon Senior Securities
Not Applicable
Item 4.    Mine Safety Disclosures
Not Applicable
Item 5. Other Information
None
Item 6.    Exhibits
Exhibits to this report are listed in the Index to Exhibits section of this report.

57

SIGNATURES


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


CommunityOne Bancorp
(Registrant)


Date: August 5, 2013                    By:    /s/ DAVID L. NIELSEN        
David L. Nielsen
Executive Vice President and Chief
Financial Officer
(Principal Financial and Accounting Officer)


58

INDEX TO EXHIBITS
            
Exhibit No.
Description of Exhibit
3.1
Articles of Amendment to the Company's Articles of Incorporation to change the name of the Company from FNB United Corp. to CommunityOne Bancorp
4.1
Form of Certificate of Voting Common Stock
31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101
Financial Statements submitted in XBRL format




59