CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, including information included or incorporated by reference in this document, contains statements which constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1934. We desire to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1996 and are including this statement for the express purpose of availing the Company of protections of such safe harbor with respect to all "forward-looking statements" contained in this Form 10-Q. Forward -looking statements may relate to, among other matters, the financial condition, results of operations, plans, objectives, future performance, and business of our Company. Forward-looking statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors that are beyond our control. The words "may," "would," "could," "should," "will," "expect," "anticipate," "predict," "project," "potential," "continue," "assume," "believe," "intend," "plan," "forecast," "goal," and "estimate," as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ materially from those anticipated in our forward-looking statements include, without limitations, those described under the "Cautionary Statement Regarding Forward-Looking Statements" section of Part 1 of our Annual Report on Form 10-K for the year endedDecember 31, 2021 as filed with theSEC and the following: ? Risk from changes in economic, monetary policy, and industry conditions ? Changes in interest rates, shape of the yield curve, deposit rates, the net interest margin and funding sources
? Market risk (including net income at risk analysis and economic value of
equity risk analysis) and inflation ? Risk inherent in making loans including repayment risks and changes in the value of collateral
? Loan growth, the adequacy of the allowance for loan losses, provisions for
loan losses, and the assessment of problem loans
? Level, composition, and re-pricing characteristics of the securities
portfolio
? Deposit growth, change in the mix or type of deposit products and services
? Continued availability of senior management and ability to attract and retain key personnel ? Technological changes ? Ability to control expense ? Ability to compete in our industry and competitive pressures among depository and other financial institutions ? Changes in compensation ? Risks associated with income taxes including potential for adverse adjustments ? Changes in accounting policies and practices ? Changes in regulatory actions, including the potential for adverse adjustments ? Recently enacted or proposed legislation and changes in political conditions ? Reputational risk ? Pandemic risk ? Impact of COVID-19 on the collectability of loans ? Changes in legislation as related to PPP loans
? Credit risks, determination of deficiency, or complete loss if SBA denies
PPP loans 21
We will undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events. In addition, certain statements in future filings with theSEC , in our press releases, and in oral and written statements, which are not statements of historical fact, constitute forward-looking statements. OverviewBank of South Carolina Corporation (the "Company") is a financial institution holding company headquartered inCharleston, South Carolina , with$665.0 million in assets as ofMarch 31, 2022 . The Company offers a broad range of financial services through its wholly-owned subsidiary,The Bank of South Carolina (the "Bank"). The Bank is a state-chartered commercial bank which operates primarily in theCharleston ,Dorchester andBerkeley counties ofSouth Carolina . The Bank's original and current concept is to be a full-service financial institution specializing in personal service, responsiveness, and attention to detail to foster long standing relationships. We derive most of our income from interest on loans and investments (interest-earning assets). The primary source of funding for making these loans and investments is our interest and non-interest-bearing deposits. Consequently, one of the key measures of our success is the amount of net interest income, or the difference between the income on our interest-earning assets and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities. A consequence of lending activities is that we may incur credit losses. The amount of such losses will vary depending upon the risk characteristics of the loan and lease portfolio as affected by economic conditions such as rising interest rates and the financial performance of borrowers. The reserve for credit losses consists of the allowance for loan losses (the "allowance") and a reserve for unfunded commitments (the "unfunded reserve"). The allowance provides for probable and estimable losses inherent in our loan portfolio while the unfunded reserve provides for potential losses related to unfunded lending commitments. In addition to earning interest on loans and investments, we earn income through fees and other expenses we charge to the customer. The various components of non-interest income as well as non-interest expense are described in the following discussion. The discussion and analysis also identify significant factors that have affected our financial position and operating results as of and for the periods endingMarch 31, 2022 andDecember 31, 2021 , and should be read in conjunction with the financial statements and the related notes included in this report. In addition, a number of tables have been included to assist in the discussion. COVID-19 Effects of COVID-19 may negatively impact management assumptions and estimates, such as the allowance for loan losses. However, it is difficult to assess or predict how, and to what extent, COVID-19 will affect the Bank in the future. Refer to Note 3: Loans and Allowance for Loan Losses for additional information about COVID-19 and programs that were established to assist borrowers.
Critical Accounting Policies
Our critical accounting policies, which involve significant judgments and assumptions that have a material impact on the carrying value of certain assets and liabilities, and used in the preparation of the Consolidated Financial Statements as ofMarch 31, 2022 , have remained unchanged from the disclosures presented in our Annual Report on Form 10-K for the year endedDecember 31 ,
2021. Balance Sheet Cash and Cash Equivalents Total cash and cash equivalents decreased 50.5% or$70.7 million to$69.4 million as ofMarch 31, 2022 , from$140.1 million as ofDecember 31, 2021 . The decrease in total cash and cash equivalents is primarily due to purchases of investment securities available for sale, net of proceeds from sales, calls and maturities, and to a lesser extent, a net increase in loans and a net decrease in deposit accounts.
Investment Securities Available for Sale
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 continuing assessment of cash flows, the level of current and expected loan production, current interest rate risk strategies and the assessment of potential future direction of market interest rate changes. Investment securities differ in terms of default, interest rate, liquidity and expected rate of return risk.
We use the investment securities portfolio to serve as a vehicle to manage interest rate and prepayment risk, to generate interest and dividend income from investment of funds, to provide liquidity to meet funding requirements, and to provide collateral for pledging of public funds. 22
As ofMarch 31, 2022 , our available for sale investment portfolio includedU.S. Treasury Notes,Government-Sponsored Enterprises andMunicipal Securities with a fair market value of$257.9 million and an amortized cost of$272.8 million for a net unrealized loss of approximately$14.9 million . As ofMarch 31, 2022 andDecember 31, 2021 , our investment securities portfolio represented approximately 38.78% and 31.26% of our total assets, respectively. The average yield on our investment securities was 1.03% and 1.02% atMarch 31, 2022 andDecember 31, 2021 , respectively. Loans We focus our lending activities on small and middle market businesses, professionals and individuals in our geographic markets. Substantially all of our loans are to borrowers located in our market area ofCharleston ,Dorchester andBerkeley counties ofSouth Carolina .
Net loans increased
InJanuary 2020 , the Bank began originating 30-year, fixed rate consumer mortgage loans in excess of the conforming loan amount which are held for investment rather than for sale in the secondary market. Prior toJanuary 2020 , all consumer mortgage loans made by the Bank were originated for the purpose of sale and reflected on the consolidated balance sheet as mortgage loans held for sale. This mortgage product continues to be well-received by the Bank's customers, and the associated volume of originations has continued to contribute to the increase inConsumer Real Estate lending. The following table is a summary of our loan portfolio composition (net of deferred fees and costs of$342,835 and$488,481 atMarch 31, 2022 andDecember 31, 2021 , respectively) and the corresponding percentage of total loans as
of the dates indicated. March 31, 2022 December 31, 2021 Amount Percent Amount Percent Commercial$ 47,360,745 15.04 %$ 45,804,434 14.94 %
Commercial Real Estate Construction 14,750,474 4.68 %
12,054,095 3.93 % Commercial Real Estate Other 167,967,452 53.34 % 165,719,078 54.04 % Consumer Real Estate 76,712,257 24.36 % 71,307,488 23.26 % Consumer Other 3,677,522 1.17 % 3,768,531 1.23 % Payroll Protection Program 4,437,525 1.41 % 7,978,603 2.60 % Total loans 314,905,975 100.00 % 306,632,229 100.00 % Allowance for loan losses (4,304,502 ) (4,376,987 ) Total loans, net$ 310,601,473 $ 302,255,242 The decrease in the deferred fees is primarily associated with the amortization of the processing fees the Bank received from the SBA for the PPP loans. The fees are deferred and amortized over the life of the loans in accordance with ASC 310-20. Nonperforming Assets Nonperforming Assets include real estate acquired through foreclosure or deed taken in lieu of foreclosure and loans on nonaccrual status. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when we believe, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that collection of the contractual principal or interest on the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is recognized as a reduction in principal when received. As ofMarch 31, 2022 , there were no loans 90 days past due still accruing interest.
The following table is a summary of our Nonperforming Assets:
March 31, 2022 December 31, 2021 Commercial $ - $ 178,975 Commercial Real Estate Other 621,358 625,953 Consumer Real Estate - - Consumer Other 9,022 9,686 Total nonaccruing loans 630,380 814,614 Total nonperforming assets$ 630,380 $ 814,614 23 Allowance for Loan Losses The allowance for loan losses was$4.3 million as ofMarch 31, 2022 and$4.4 million as ofDecember 31, 2021 , or 1.39% and 1.47%, respectively, of outstanding loans, net of PPP loans. Because PPP loans are 100% guaranteed by the SBA and did not undergo the Bank's typical underwriting process, they are not graded and do not have an associated reserve. AtMarch 31, 2022 andDecember 31, 2021 , the allowance for loan losses represented 682.84% and 537.31%, respectively, of the total amount of nonperforming loans. Based on the level of coverage on nonperforming loans and analysis of our loan portfolio, we believe the allowance for loan losses atMarch 31, 2022 is adequate. AtMarch 31, 2022 , impaired loans totaled$2.9 million , of which$1.2 million of these loans had a reserve of approximately$0.2 million allocated in the allowance for loan losses. Comparatively, impaired loans totaled$3.4 million as ofDecember 31, 2021 , and$0.4 million of these loans had a reserve of approximately$0.2 million allocated in the allowance for loan losses. During the three months endedMarch 31, 2022 , we recorded$2,045 in charge-offs and$4,560 of recoveries on loans previously charged-off, for net recoveries of$2,515 . Deposits Deposits remain our primary source of funding for loans and investments. Average interest-bearing deposits provided funding for 53.85% of average earning assets for the three months endedMarch 31, 2022 , and 56.60% for the three months endedMarch 31, 2021 . The Company encounters strong competition from other financial institutions as well as consumer and commercial finance companies, insurance companies and brokerage firms located in the primary service area of the Bank. However, the percentage of funding provided by deposits has remained stable. The breakdown of total deposits by type and the respective percentage of total deposits are as follows: March 31, 2022 December 31, 2021 Amount Percent Amount Percent Deposits Non-interest bearing demand$ 258,738,170 42.86 %$ 255,783,644 41.98 % Interest bearing demand 159,954,068 26.49 % 165,335,038 27.14 % Money market accounts 92,136,722 15.26 % 98,113,942 16.11 % Time deposits$250,000 and over 7,668,871 1.27 % 7,417,864 1.22 % Other time deposits 13,424,001 2.22 % 13,870,356 2.28 % Other savings deposits 71,849,648 11.90 % 68,670,732 11.27 % Total deposits$ 603,771,480 100.00 %$ 609,191,576 100.00 % Deposits decreased 0.89% or$5.4 million fromDecember 31, 2021 toMarch 31, 2022 primarily due to a decrease in the balances of a related group of demand deposit accounts. The higher balance in 2021 for these demand deposit accounts was temporary in nature.
At
Comparison of Three Months Ended
Net income decreased$0.3 million or 19.11% to$1.5 million , or basic and diluted earnings per share of$0.26 for the three months endedMarch 31, 2022 , from$1.8 million , or basic and diluted earnings per share of$0.33 and$0.32 , respectively, for the three months endedMarch 31, 2021 . Our annualized returns on average assets and average equity for the three months endedMarch 31, 2022 were 0.88% and 11.24%, respectively, compared with 1.37% and 13.26%, respectively, for the three months endedMarch 31, 2021 .
Net Interest Income
Net interest income is affected by the size and mix of our balance sheet components as well as the spread between interest earned on assets and interest paid on liabilities. Net interest margin is a measure of the difference between interest income on earning assets and interest paid on interest bearing liabilities relative to the amount of interest-bearing assets. Net interest income decreased$0.4 million or 8.03% to$4.2 million for the three months endedMarch 31, 2022 from$4.6 million for the three months endedMarch 31, 2021 . Average loans decreased$20.4 million or 6.18% to$310.5 million for the three months endedMarch 31, 2022 , compared to$330.9 million for the three months endedMarch 31, 2021 . The yield on average loans (including fees) was 4.99% and 5.52% for the three months endedMarch 31, 2022 andMarch 31, 2021 , respectively. Interest income on loans decreased$0.5 million for the three months endedMarch 31, 2022 to$3.6 million from$4.1 million for the three months endedMarch 31, 2021 . The average balance of interest bearing deposits at theFederal Reserve increased$23.4 million or 49.29% to$70.9 million for the three months endedMarch 31, 2022 , with a yield of 0.20% as compared to$47.5 million for the three months endedMarch 31, 2021 , with a yield of 0.10%. 24 Provision for Loan Losses
We have established an allowance for loan losses through a charge (credit) to the provision for loan losses on our consolidated statements of income. We review our loan portfolio periodically to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of our allowance for loan losses. For the three months endedMarch 31, 2022 , we recorded a$75,000 reduction to the allowance for loan losses as compared with a provision of$120,000 for the same period in the prior year. The net decrease in the provision for loan losses was based on our analysis of the adequacy of the allowance for loan losses. For additional information about the changes in the allowance and an allocation of the allowance by class, refer to Note 3. Loans and Allowance for Loan Losses.
Non-Interest Income
Other income decreased$0.3 million or 32.5% to$0.6 million for the three months endedMarch 31, 2022 , from$0.9 million for the three months endedMarch 31, 2021 . This decrease was primarily due to a$0.4 million decrease in mortgage banking income, partially offset by$0.1 million of gain on sales of investment securities. The Bank sold$17.7 million of mortgage loans held for sale during the three months endedMarch 31, 2022 as compared with$47.7 million during the three months endedMarch 31, 2021 .
Non-Interest Expense
Non-interest expense was$3.0 million for both the three months endedMarch 31, 2022 and 2021 For the three months endedMarch 31, 2022 , marginal increases in salaries and employee benefits and net occupancy expense were offset by decreases in data processing fees and other operating expenses.
Income Tax Expense
Income tax expense was$0.4 million for the three months endedMarch 31, 2022 as compared to$0.6 million during the same period in 2021. Our effective tax rate was 23.39% and 23.81% for the three months endedMarch 31, 2022 and 2021, respectively.
Off-Balance Sheet Arrangements
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on our credit evaluation of the borrower. Collateral held varies but may include accounts receivable, negotiable instruments, inventory, property, plant and equipment, and real estate. Commitments to extend credit, including unused lines of credit, amounted to$140.8 million and$117.5 million atMarch 31, 2022 andDecember 31, 2021 , respectively. Standby letters of credit represent our obligation to a third-party contingent upon the failure of our customer to perform under the terms of an underlying contract with the third party or obligates us to guarantee or stand as surety for the benefit of the third party. The underlying contract may entail either financial or nonfinancial obligations and may involve such things as the shipment of goods, performance of a contract, or repayment of an obligation. Under the terms of a standby letter, generally drafts will be drawn only when the underlying event fails to occur as intended. We can seek recovery of the amounts paid from the borrower. The majority of these standby letters of credit are unsecured. Commitments under standby letters of credit are usually for one year or less. The maximum potential amount of undiscounted future payments related to standby letters of credit at bothMarch 31, 2022 andDecember 31, 2021 was$0.6 million . We originate certain fixed rate residential loans and commit these loans for sale. The commitments to originate fixed rate residential loans and the sales commitments are freestanding derivative instruments. We had forward sales commitments on mortgage loans held for sale totaling$2.6 million and$2.8 million atMarch 31, 2022 andDecember 31, 2021 , respectively. The fair value of these commitments was not significant atMarch 31, 2022 orDecember 31, 2021 . We had no embedded derivative instruments requiring separate accounting treatment. Once we sell certain fixed rate residential loans, the loans are no longer reportable on our balance sheet. With most of these sales, we have an obligation to repurchase the loan in the event of a default of principal or interest on the loan. This recourse period ranges from three to nine months. Misrepresentation or fraud carries unlimited time for recourse. The unpaid principal balance of loans sold with recourse was$17.6 million atMarch 31, 2022 . There were no loans repurchased during the three months endedMarch 31, 2022 and 2021.
Liquidity
Historically, we have maintained our liquidity at levels believed to be adequate to meet requirements of normal operations, potential deposit outflows and strong loan demand and still allow for optimal investment of funds and return on assets. We manage our assets and liabilities to ensure there is sufficient liquidity to enable management to fund deposit withdrawals, loan demand, capital expenditures, reserve requirements, operating expenses, dividends and to manage daily operations on an ongoing basis. Funds are primarily provided by the Bank through customer deposits, principal and interest payments on loans, mortgage loan sales, the sale or maturity of securities, temporary investments and earnings. 25 Proper liquidity management is crucial to ensure that we are able to take advantage of new business opportunities as well as meet the credit needs of our existing customers. Investment securities are an important tool in our liquidity management. Our primary liquid assets are cash and due from banks, investment securities available for sale, interest-bearing deposits at theFederal Reserve , and mortgage loans held for sale. Our primary liquid assets accounted for 49.61% and 52.30% of total assets atMarch 31, 2022 andDecember 31, 2021 , respectively. Securities classified as available for sale, which are not pledged, may be sold in response to changes in interest rates and liquidity needs. All of the investment securities presently owned are classified as available for sale. Net cash provided by operations and deposits from customers have been the primary sources of liquidity. AtMarch 31, 2022 , we had unused short-term lines of credit totaling approximately$41.0 million (which can be withdrawn at the lender's option). Additional sources of funds available to us for liquidity include borrowing on a short-term basis from theFederal Reserve System , increasing deposits by raising interest rates paid and sale of mortgage loans held for sale. We established a Borrower-In-Custody arrangement with theFederal Reserve . This arrangement permits us to retain possession of assets pledged as collateral to secure advances from the Federal Reserve Discount Window. AtMarch 31, 2022 , we could borrow up to$74.7 million . There have been no borrowings under this arrangement. Our core deposits consist of non-interest-bearing accounts, NOW accounts, money market accounts, time deposits and savings accounts. We closely monitor our level of certificates of deposit greater than$250,000 and other large deposits. We maintain a Contingency Funding Plan ("CFP') that identifies liquidity needs and weighs alternate courses of action designed to address these needs in emergency situations. We perform a quarterly cash flow analysis and stress test the CFP to evaluate the expected funding needs and funding capacity during a liquidity stress event. We believe our liquidity sources are adequate to meet our operating needs and do not know of any trends, events or uncertainties that may result in a significant adverse effect on our liquidity position. AtMarch 31, 2022 andDecember 31, 2021 , our liquidity ratio was 52.67% and 56.43%,
respectively. Capital Resources Our capital needs have been met to date through the$10.6 million in capital raised in our initial offering, the retention of earnings less dividends paid and the exercise of stock options to purchase stock. Total shareholders' equity as ofMarch 31, 2022 was$45.0 million . The rate of asset growth since our inception has not negatively impacted this capital base. OnJuly 2, 2013 , theFederal Reserve Board approved the final rules implementing theBasel Committee on Banking Supervision's ("BCBS") capital guidelines for US banks ("Basel III"). Following the actions by theFederal Reserve , theFDIC also approved regulatory capital requirements onJuly 9, 2013 . TheFDIC's rule is identical in substance to the final rules issued by theFederal Reserve Bank . The Bank adopted the community bank leverage ratio ("CBLR") framework, a simplified measure of capital adequacy for qualifying community banking organizations, as ofMarch 31, 2020 and upon adoption is no longer subject to other capital and leverage requirements. To be considered well capitalized, the required CBLR was 8.5% for the year endedDecember 31, 2021 and will be 9.0% thereafter. Additionally, the qualifying community banking institution must be a non-advanced approachesFDIC supervised institution. If an electing bank later does not feet any of the eligibility criteria, it would have a two-quarter "grace" period to return to CBLR compliance or revert to the generally applicable rule. If an electing bank's leverage ratio falls below 9.0%, the bank would be deemed well capitalized during the grace period as long as the bank's leverage ratio remains above 8.0%. If an electing bank's leverage ratio falls to 8.0% or less, it would be required to revert immediately to the generally applicable rule. As ofDecember 31, 2021 , the Bank's CBLR of 8.66% was above the required CBRL of 8.5% to be categorized as "well capitalized." As ofMarch 31, 2022 , the Bank's CBRL was 8.56%, which was above the required 8.0% during the two-quarter grace period.
Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a material effect on the financial statements.
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