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As filed with the Securities and Exchange Commission on June 10, 2011.

Registration No.             

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Macon Financial Corp.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

North Carolina  

6036

  56-0306860

(State or Other Jurisdiction of

Incorporation or Organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

220 One Center Court

Franklin, North Carolina 28734

(828) 524-7000

(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

 

 

Mr. Roger D. Plemens

President and Chief Executive Officer

220 One Center Court

Franklin, North Carolina 28734

(828) 524-7000

(Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent for Service)

 

 

Copies to:

 

Robert A. Singer, Esq.

Brooks, Pierce, McLendon, Humphrey & Leonard, L.L.P.

230 N. Elm Street, Suite 2000

Greensboro, North Carolina 27401

(336) 373-8850

 

Joel E. Rappoport, Esq.

Kilpatrick, Townsend & Stockton, LLP

607 14th Street, NW, Suite 900

Washington, DC 20005

(202) 508-5800

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after this registration statement becomes effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box:  ¨

If this Form is filed to register additional shares for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering:  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering:  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering:  ¨

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   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   x

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to be Registered

 

Amount

to be

Registered

 

Proposed

Maximum

Offering Price

per Share

 

Proposed

Maximum Aggregate

Offering Price

  Amount of
Registration Fee

Common Stock, no par value per share

  6,612,500 shares   $10.00   $66,125,000 (1)   $7,678
 
 
(1) Estimated solely for the purpose of calculating the registration fee.

 

 

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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PROSPECTUS

[LOGO]

MACON FINANCIAL CORP.

(Proposed Holding Company for Macon Bank, Inc.)

Up to 5,750,000 Shares of Common Stock

Macon Financial Corp., a North Carolina corporation, is offering shares of common stock for sale in connection with the conversion of Macon Bancorp from the mutual to the stock form of organization, and the merger of Macon Bancorp with and into Macon Financial Corp. We expect that our common stock will be listed for trading on the NASDAQ Global Market under the symbol “        ” upon conclusion of the offering. There is currently no public market for our common stock.

We are offering up to 5,750,000 shares of common stock for sale. We may sell up to 6,612,500 shares of common stock to reflect regulatory considerations, changes in market and financial conditions, and/or demand for the common stock that would increase our pro forma market value in excess of $57.5 million (5,750,000 shares multiplied by the $10.00 purchase price per share) without resoliciting subscribers. We must sell a minimum of 4,250,000 shares in order to complete the offering.

We are offering the shares in a “subscription offering” to eligible depositors and borrowers of Macon Bank, Inc., the banking subsidiary of Macon Bancorp. Shares not purchased in the subscription offering may be offered for sale to the general public in a “community offering.” We also may offer for sale shares not purchased in the subscription offering or community offering through a “syndicated offering” managed by Raymond James & Associates, Inc.

All shares are being offered for sale at a price of $10.00 per share. You will not pay any commission for your purchases. The minimum number of shares you may order is 25 shares. Unless increased, the maximum number of shares that may be ordered by any person in the subscription offering, the community offering or the syndicated offering is 75,000 shares, and, no person, together with any associate or group of persons acting in concert, may purchase more than 125,000 shares in the offering. The offering is expected to expire at         p.m., Eastern Daylight Time, on [            ]. Upon notice to you on or before             , we may extend this expiration date to no later than             . Once submitted, orders are irrevocable unless the offering is terminated or is extended beyond [extension date], or the number of shares to be sold is increased to more than 6,612,500 shares or decreased to fewer than 4,250,000 shares. If the offering is extended beyond [            ], or the number of shares to be sold is increased to more than 6,612,500 shares or decreased to fewer than 4,250,000 shares, we will resolicit subscribers, giving them an opportunity to change or cancel their orders. Funds received during the offering will be held in a segregated account at Macon Bank and will earn interest calculated at Macon Bank’s statement savings rate, which is currently     % per annum.

Raymond James & Associates, Inc. will assist us in selling our shares of common stock on a best efforts basis. Raymond James & Associates, Inc. is not required to purchase any shares that are being offered for sale. Purchasers will not pay a commission to purchase shares in the offering. Raymond James & Associates, Inc. has advised us that following the offering it intends to make a market in the common stock, but is under no obligation to do so.

This investment involves a degree of risk, including the possible loss of your investment. Please read “Risk Factors” beginning on page 13.

OFFERING SUMMARY

Price: $10.00 per Share

 

     Minimum      Midpoint      Maximum      Adjusted
Maximum
 

Number of shares

     4,250,000         5,000,000         5,750,000         6,612,500   

Gross offering proceeds

   $ 42,500,000       $ 50,000,000       $ 57,500,000       $ 66,125,000   

Estimated offering expenses (excluding selling agent fees and expenses)

     1,721,250         2,002,500         2,283,750         2,607,188   

Estimated selling agent fees and expenses (1)(2)

     949,325         949,325         949,325         949,325   

Estimated net proceeds

   $ 39,829,425       $ 47,048,175       $ 54,266,925       $ 62,568,487   

Estimated net proceeds per share

   $ 9.37       $ 9.41       $ 9.44       $ 9.46   

 

(1) Includes: (i) selling commissions payable by us to Raymond James & Associates, Inc. in connection with the offering equal to (a) 6.0% of the aggregate amount of common stock sold to investors other than eligible depositors and borrowers of Macon Bank, assumed to equal 50% of the total offering, plus (b) 1.5% of the aggregate amount of common stock sold to eligible depositors and borrowers of Macon Bank, assumed to equal 50% of the total offering; provided that no commission will be charged for shares sold to our officers, directors or employees, or the officers, directors or employees of Macon Bank (together, “affiliates”), or approximately $2.5 million, at the adjusted maximum of the offering range; and (ii) other costs and expenses of the offering payable to Raymond James & Associates, Inc. as managing agent estimated to be $150,000. For information regarding compensation to be received by Raymond James & Associates, Inc. and the other broker-dealers that may participate in the syndicated offering, including the assumptions regarding the number of shares that may be sold in the subscription and community offerings, and the syndicated offering to determine the estimated offering expenses, see “Pro Forma Data” on page     and “The Conversion – Marketing and Distribution; Compensation” on page     .
(2) If all shares of common stock are sold to investors other than eligible depositors and borrowers of Macon Bank, or their affiliates, the maximum selling agent commissions and expenses would be approximately $2.6 million at the minimum, $3.0 million at the midpoint, $3.5 million at the maximum, and $4.0 million at the adjusted maximum.

These securities are not deposits or savings accounts and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. None of the Securities and Exchange Commission, the North Carolina Commissioner of Banks, the Federal Deposit Insurance Corporation, the Board of Governors of the Federal Reserve System, nor any state securities regulator has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

For assistance, please call the Stock Information Center, toll free, at                     .

Raymond James & Associates, Inc.

The date of this prospectus is [                    ].


Table of Contents

LOGO


Table of Contents

TABLE OF CONTENTS

 

SUMMARY

     1   

RISK FACTORS

     13   

SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA

     23   

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

     25   

HOW WE INTEND TO USE THE PROCEEDS FROM THE OFFERING

     25   

OUR POLICY REGARDING DIVIDENDS

     26   

MARKET FOR THE COMMON STOCK

     27   

HISTORICAL AND PRO FORMA REGULATORY CAPITAL COMPLIANCE

     27   

CAPITALIZATION

     28   

PRO FORMA DATA

     28   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     31   

OUR BUSINESS

     58   

SUPERVISION AND REGULATION

     66   

TAXATION

     74   

OUR MANAGEMENT

     75   

SUBSCRIPTIONS BY DIRECTORS AND EXECUTIVE OFFICERS

     88   

THE CONVERSION

     89   

RESTRICTIONS ON ACQUISITION OF MACON FINANCIAL

     104   

DESCRIPTION OF CAPITAL STOCK

     107   

EXPERTS

     108   

LEGAL MATTERS

     108   

WHERE YOU CAN FIND ADDITIONAL INFORMATION

     108   

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

     F-1   

 

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SUMMARY

The following summary highlights material information in this prospectus. It may not contain all of the information that is important to you. For additional information, you should read this entire prospectus carefully, including the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements.

In this prospectus, the terms “Bancorp” or “Macon Bancorp” mean Macon Bancorp, a North Carolina chartered mutual holding company; “Macon Financial” means Macon Financial Corp., a North Carolina corporation; and “Bank” or “Macon Bank” mean Macon Bank, Inc., Bancorp’s North Carolina chartered bank subsidiary. Terms such as “we, “our,” and “us” refer collectively to Bancorp, Macon Financial and the Bank, unless the context indicates another meaning; and “you” and “your” refer to subscribers of Macon Financial’s common stock.

The Companies

Macon Financial. This offering is being made by Macon Financial, a newly formed North Carolina corporation, that will own all of the outstanding shares of common stock of Macon Bank upon completion of this offering and the mutual-to-stock conversion of Macon Bancorp. Other than matters of an organizational nature, Macon Financial has not engaged in any business to date. Following the conversion and the offering, Macon Financial will be renamed “Macon Bancorp”.

Macon Bancorp. Macon Bancorp is a North Carolina chartered mutual holding company headquartered in Franklin, North Carolina. It was organized in 1997, when the Bank converted from a mutual savings bank to a stock savings bank, and owns 100% of the outstanding shares of common stock of the Bank. Bancorp also has one non-bank subsidiary, Macon Capital Trust I, a Delaware statutory trust, formed in 2003 to facilitate the issuance of trust preferred securities. On a consolidated basis, as of March 31, 2011, Bancorp had total assets of $932.8 million, total loans of $667.7 million, total deposits of $782.1 million and total equity of $56.3 million. As a mutual holding company, Bancorp has no shareholders and is controlled by the depositors and borrowers of the Bank.

Pursuant to the terms of our plan of conversion, Macon Bancorp will merge with and into Macon Financial and, in doing so, will convert from a mutual form of organization to a stock form of organization. Upon the completion of the conversion, Bancorp will cease to exist, and the Bank will become a wholly-owned subsidiary of Macon Financial which will be renamed “Macon Bancorp”.

Macon Bank. Macon Bank is a North Carolina chartered stock savings bank headquartered in Franklin, North Carolina. It was organized in 1922, as a North Carolina chartered mutual savings and loan association. In 1992, it converted to a North Carolina chartered mutual savings bank. In 1997, upon the formation of Bancorp, it converted to a North Carolina chartered stock savings bank. For questions regarding the conversion or the offering, please call our Stock Information Center, toll free, at                     , Monday through Friday between          a.m. and          p.m., Eastern Daylight Time. The Stock Information Center will be closed on weekends and bank holidays.

Our Executive Offices. Our executive offices are located at 220 One Center Court, Franklin, North Carolina 28734 and the telephone number at this address is (828) 524-7000. Our website address is www.maconbank.com. Information on our website is not incorporated into this prospectus and should not be considered part of this prospectus.

Our Business

Overview. The Bank was organized as a mutual savings and loan association. As a mutual savings and loan association or “thrift,” the Bank’s primary purpose was to promote home ownership through mortgage lending, financed by locally gathered deposits. Surviving the Great Depression of the 1930’s, we remained a single-office bank until we opened our second office in downtown Murphy, North Carolina in 1981. Between 1993 and 2002, we added eight more branches in North Carolina, including a second office in Franklin, one in each of Highlands, Brevard, Sylva, Cashiers and Arden, and two in Hendersonville. In 2007, we opened two more branches in Columbus and Saluda, North Carolina.

Today, in addition to our corporate headquarters, we have 11 branches located throughout the Western North Carolina counties of Cherokee, Henderson, Jackson, Macon, Polk and Transylvania, which we consider our primary market area. Our business consists primarily of accepting deposits from individuals and small businesses and investing those deposits, together with funds generated from operations and borrowings, primarily in loans secured by real estate, including commercial real estate loans, one- to four-family residential loans, construction loans, home equity loans and lines of credit. We also originate commercial business loans and invest in investment securities. Through our mortgage loan production operations, we originate loans for sale in the secondary markets to Fannie Mae and others, generally retaining the servicing

 

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rights in order to generate cash flow, supplement our core deposits with escrow deposits and maintain relationships with local borrowers. We offer a variety of deposit accounts, including savings accounts, certificates of deposit, money market accounts, commercial and regular checking accounts, and individual retirement accounts.

In addition to making loans within our primary market area, we also regularly extend loans to customers located in neighboring counties, including Buncombe, Clay, Haywood and Rutherford in North Carolina; Rabun, Towns and Union in Georgia; and Cherokee, Greenville, Oconee, Pickens and Spartanburg in South Carolina, which we consider our secondary market area.

We encounter significant competition in our primary and secondary market areas. We compete with commercial banks, savings institutions, finance companies, credit unions and other financial services companies. Many of our larger commercial bank competitors have greater name recognition and offer certain services that we do not. However, we believe that our long-time presence in our primary market area and focus on superior service are instrumental to our success and leading deposit market share. Between 2000 and 2010, we increased our share of the combined deposits of all banks and thrifts operating in our primary market area from 9.4% in 2000 to 17.4% in 2010, and now lead our competitors in total deposits within our primary market area, as shown below.

Competing Banks and Thrifts

 

Total

Deposit

Rank

2010

  

Institution

   Institution City    Institution
Headquarters
State
   Total
Active
Branches
2000
     Total
Active
Branches
2010
     Total  deposits
(1)

2000
(thousands)
     Total
Deposit
Market
Share
2000
(%)
    Total  deposits
(1)

2010
(thousands)
     Total
Deposit
Market
Share
2010
(%)
 
1    Macon Bank    Franklin    NC      9         11         250,605         9.4     820,204         17.4
2   

First-Citizens Bank &

Trust Co.

   Raleigh    NC      22         17         490,284         18.4     736,358         15.6
3    Wells Fargo Bank NA    Sioux Falls    SD      14         9         461,851         17.3     489,042         10.4
4    United Community Bank    Blairsville    GA      10         11         296,203         11.1     465,146         9.9
5   

Mountain 1st Bank &

Trust Co.

   Hendersonville    NC      0         6         —           0.0     435,959         9.2
6    TD Bank NA    Wilmington    DE      4         8         157,604         5.9     344,581         7.3
7    Home Trust Bank    Clyde    NC      4         3         211,025         7.9     321,634         6.8
8    RBC Bank (USA)    Raleigh    NC      10         7         313,509         11.8     245,719         5.2
9    Bank of America NA    Charlotte    NC      4         4         144,960         5.4     154,829         3.3
10    SunTrust Bank    Atlanta    GA      5         4         176,660         6.6     149,169         3.2

 

(1) Total deposits represent the six counties in which Macon Bank has branches.

Source: FDIC

In addition to successfully building our branch network and growing our core deposits, we have sought to create an infrastructure that will accommodate future growth. One of our core strengths has been our successful mortgage loan operation, through which we originate and sell mortgage loans in the secondary markets to Fannie Mae and others. In 1999, we opened a call center, to better and more efficiently serve our customers. In 2001, we consolidated our corporate headquarters, loan processing and training facilities into a single 36,000 square foot building in Franklin, North Carolina.

We have sought to improve our level of service and overall efficiencies through the use of technology, offering online banking for retail customers, which we market as Macon eCom; online banking for businesses, which we market as Macon eCorp; and remote deposit capture. We also provide investment services through our affiliation with Morgan Stanley/Smith Barney, merchant credit card services for business customers, and ATM services.

Recently, in anticipation of our mutual-to-stock conversion, we added two experienced bankers to supplement our executive management team, W. David Sweatt, Executive Chairman of the Bank, and Gary L. Brown, our First Vice President and Chief Credit Officer. We hired Mr. Sweatt and Mr. Brown because of their experience with commercial lending, resolving problem assets, working with regulatory agreements, and running public companies. Mr. Sweatt has 30 years of banking experience, having held a number of senior executive and operational positions, including chairman, president and chief executive officer, within a variety of financial institutions throughout the Southeast. Mr. Brown has 34 years of banking experience, including president and chief executive officer of a community bank, and most recently, post closing asset manager in the Division of Resolutions and Receiverships of the Federal Deposit Insurance Corporation, Jacksonville, Florida.

We remain committed to supporting our local communities and offering personal, one-on-one service to our customers. Our employees, officers and directors personally know many of our customers, live within the communities we serve, and play key roles in community organizations. In addition, we sponsor numerous local community events and strive to be a good corporate citizen in all of the communities that we serve. We believe we have a loyal base of employees. Our employees have an average of nine years service with the Bank. More than one in six of our employees have served the Bank for over 20 years. We believe that the longevity of employee-service is critical to maintaining personal relationships with our customers. Such longevity of service is exemplified by our President and Chief Executive Officer, Roger D. Plemens, who has served the Bank since 1978, in various capacities, including as a mortgage officer, a manager of mortgage lending, and the chief lending officer. Our guiding principle is simple. We are committed to maintaining our culture of community banking and focused upon bringing value to our customers through innovations, technology, products and services of the 21st century.

Recent Operating Challenges and Losses. We grew significantly in the last decade, increasing our loan portfolio from $333.5 million at December 31, 2000, to a high of $832.6 million at December 31, 2007, before declining to $690.8 million at March 31, 2011. Our construction and development loans grew from $12.2 million at December 31, 2000, to $298.3 million at December 31, 2007, before declining to $154.8 million at March 31, 2011, representing the majority of our loan growth. Many of these construction and development loans were collateralized by developments for second homes. As the national housing bubble burst, the value of the collateral for our construction and development loans and our other loans declined. The decline in real estate values and impact of the recession resulted in a significant level of loan defaults.

 

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Accordingly, our level of non-performing assets increased from $4.6 million at December 31, 2000, to $8.0 million at December 31, 2007, and to $96.7 million at March 31, 2011.

The recent increase in our level of non-performing assets resulted in large loan loss provisions, large loan losses and high REO expenses. During the three years ended December 31, 2010 and the quarter ended March 31, 2011, we recorded aggregate net losses of $24.5million. These losses were driven by cumulative provisions for loan losses of $56.8 million over the same period. Our total equity has decreased from $88.7 million at December 31, 2008 to $56.3 million at March 31, 2011. The increase in non-performing assets has also negatively impacted our operations by reducing our level of earning assets and increasing our level of operating expenses to manage these problem assets. Furthermore, due to our increased risk profile, we increased our level of liquidity, which effectively reduced our net interest income.

As a result of the increase in our non-performing assets, the decrease in our equity capital, and other factors, we have received an increased level of scrutiny from our regulators. As described in the section entitled “– Memoranda of Understanding” on page     , the Bank and Bancorp have each entered into a Memorandum of Understanding, or MOU, with their respective banking regulators. The Bank has agreed to, among other things, increase its regulatory capital, reduce lines of credit which are subject to adverse classification, reduce its reliance on volatile liabilities to fund longer term assets, establish and maintain an adequate allowance for loan losses, and establish an enhanced loan loss reserve policy. In addition, the Bank must obtain regulatory approval prior to paying any dividends to Bancorp. Bancorp has agreed to, among other things, not declare or pay any dividends without prior regulatory approval and not take dividends from or otherwise reduce the capital of the Bank without prior regulatory approval. The Bank MOU requires it to maintain a leverage ratio of 8.0% and a total risk-based capital ratio of 12.0%. At March 31, 2011, the Bank had a leverage ratio of 7.07%, and a total risk-based capital ratio of 11.55%.

Operating Strategy and Reasons for the Conversion. We have developed an operating strategy to reposition the Bank so that it may return to profitability and explore opportunities for growth. However, we need a significant amount of capital to execute this strategy, and we cannot raise this level of capital as a mutual financial institution. We have considered current market conditions and the amount of capital needed in deciding to conduct the conversion at this time, and have established the following three-part operating strategy in order to effectively and efficiently use the proceeds from the offering.

Address Current Challenges. Our first priority is to reduce our level of non-performing and classified assets both in the aggregate and as a percentage of total assets. We also want to be in full compliance with our MOUs as quickly as possible.

Improve asset quality. As described in the section entitled “                    ” on page     , our non-performing assets have increased during the current adverse credit cycle and were $96.7 million or 10.36% of our total assets at March 31, 2011. During 2010, management appointed an experienced special assets manager and reassigned employees as support staff to increase collection efforts, expedite foreclosure actions, and liquidate real estate owned. We are aggressively addressing our level of non-performing assets through write-downs, collections, modifications and sales of non-performing loans and the sale of properties once they become real estate owned by the Bank. For the years 2007 through 2010 and through March 31, 2011, we have recorded cumulative net charge-offs of approximately $46.0 million. We are taking proactive steps to resolve our non-performing loans, including negotiating repayment plans, loan modifications and loan extensions with our borrowers when appropriate, working with developers to promote discounted sales events to increase sales and accepting short payoffs on delinquent loans, particularly when such payoffs result in a smaller loss to us than foreclosure. In late 2010, management increased the frequency for problem loan appraisals to six to 12 month intervals, from 12 to 24 months, which resulted in additional loan write-downs. In 2010 and the first quarter of 2011, the Bank liquidated $28.7 million in real estate owned based on loan values at the time of foreclosure, realizing $15.9 million in net proceeds or 55.3% of the foreclosed loan balances. The Bank’s current real estate owned portfolio is comparably valued at 59.8% of loan value at the time of foreclosure. In addition to continuing to pursue the above steps to improve our asset quality, we may consider bulk sales of non-performing assets in order to expedite our strategy for improving asset quality, although we have no firm plans to do so at this time.

We have taken several actions to improve our credit administration practices and reduce the risk in our loan portfolio. We also added experienced personnel, including Gary Brown who was appointed Chief Credit Officer in February, 2011, to our loan department to enable us to better identify problem loans in a timely manner and reduce our exposure to a further deterioration in asset quality. Also, since 2008, we have regularly engaged an independent loan review consulting firm to perform a review of our loan portfolio. The Bank has added new support systems that have improved our underwriting global cash flow analysis, portfolio credit risk assessment, risk grade migration, and loan loss allowance calculation. We have made an effort to reduce our exposure to riskier types of loan structures and collateral both through

 

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asking borrowers to pledge additional collateral and by reducing certain segments of our loan portfolio. We have reduced our construction and other construction and land development loan portfolio from $298.3 million at December 31, 2007 to $154.8 million at March 31, 2011.

Compliance with Memoranda of Understanding. As described in the section entitled “– Memoranda of Understanding” on page     , we have taken and continue to take prompt and aggressive action to respond to the issues raised in the Memoranda, including submitting quarterly reports to our banking regulators. Except for the elevated capital requirements, which we anticipate we will satisfy once the conversion is completed, we believe that we are generally in compliance with the Memoranda. However, the Memoranda will each remain in effect until modified, terminated, lifted, suspended or set aside by the applicable banking regulators, and no assurance can be given as to the time that either of the Memoranda will be terminated. While we will seek to demonstrate as soon as possible to our banking regulators that we have fully complied with the requirements of the Memoranda and that they should be terminated, we expect that the Memoranda will remain in effect for the immediate future.

Restore Profitability. Until the current adverse credit cycle, the Bank enjoyed a long history of strong earnings, continuously reporting a profit every year from 1982 through 2008. While we expect to record losses as we continue to resolve non-performing assets, we are focused on returning to profitability.

Improve our net interest margin. Net interest income is our largest source of revenue. Our net interest margin has declined over the past four years. The increase in non-earning assets, especially non-accrual loans and real estate owned, has factored into this decline. We have also maintained an elevated level of liquidity as a result of reduced loan demand in recent periods, which has contributed to our reduced net interest margin. We believe that our net interest margin will improve as we resolve non-performing assets and invest those proceeds into earning assets. Additionally, we took the step of prepaying $42.5 million of high-cost Federal Home Loan Bank advances in the first quarter of 2011, which we anticipate will result in an increase in net interest income. Finally, we are working to further improve our base of core deposits and lower our cost of funds.

Increase noninterest income. The majority of the Bank’s noninterest income is the result of our mortgage banking business and customer service fees. We believe that we have the opportunity to increase noninterest income by adding additional lines of business. We have plans to become an active lender of Small Business Administration, or SBA, loans and would hope to sell the SBA guaranteed portion of those loans at a gain. We also believe that expanding our focus on small business and private banking customers will increase our opportunities to earn noninterest income.

Continue history of operating expense discipline. Our core efficiency ratio for the quarter ended March 31, 2011 was 67.7%, reflecting the increased expense related to resolving non-performing assets. Historically we have operated more efficiently on a core basis. For the five years 2006 through 2010, our average core efficiency ratio was under 60.0%. This success is the result of a disciplined approach to spending. We have also leveraged technology to drive efficiency throughout our organization. We recently renegotiated our data processing contract and are planning to convert to a debit card processing platform, which we anticipate will result in substantial savings in 2011, and in future years. While our level of core operating expenses will increase as a public company and we will continue to incur expenses to resolve non-performing assets, we are committed to carefully managing expenses.

Increase Small Business and Private Banking Customer Focus and Explore Growth Opportunities. As we implement our operating strategy, we will work to diversify our customer base, and explore various growth opportunities, including those described below. We have no current arrangements or agreements concerning any specific growth opportunities at this time.

Increase small business and private banking customer focus. We believe that we can enhance our franchise value by increasing our focus on small business and private banking customers. We believe that small business and private banking customers value the personalized service that has been our hallmark. These customers also present attractive loan and deposit opportunities that will allow us to diversify our loan portfolio and further increase our level of core deposits. The new members of our management team have substantial experience targeting these types of banking customers. We have enhanced training for our existing lenders in commercial and industrial, and SBA lending. Additionally, we will hire lenders, relationship officers and credit officers experienced in these areas as we grow these lines of business.

Expand into larger, contiguous markets. We are located in close proximity to a number of larger markets with attractive growth opportunities. Many of these markets have a high number of attractive small business and private banking customers. In addition to diversifying our customer mix, these markets would provide geographic diversification for our lending collateral. For instance, we have existing branch offices located near Asheville, North Carolina (30 minutes traveling

 

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time along I-26), northwest of Spartanburg, South Carolina (30 minutes traveling time along I-26); and northwest of Greenville, South Carolina (1 hour traveling time along I-26 and I-85). We are also located near Atlanta, Georgia (2 hours), Chattanooga, Tennessee (1.5 hours), Knoxville, Tennessee (2 hours) and Johnson City, Tennessee (1.5 hours).

Capitalize on market disruption. We anticipate that both current and expected consolidation within the banking industry and the increasing number of troubled banks will give rise to attractive growth opportunities. As a result of mergers between banks and recent bank failures, we believe that many customers and bankers may become dissatisfied with their new bank. Many banks do not have sufficient capital to make new loans and are having to cut back on customer service as they focus on managing their problems. We believe that these challenges will result in customer dissatisfaction, which will present us with a better opportunity to do business with these customers. Additionally, we believe that bankers will be dissatisfied with their current employers, and we will have the opportunity to hire away experienced personnel. We believe that we have the appropriate infrastructure and management depth to accommodate future growth, including our use of technology, mortgage loan production operations, call center, and corporate headquarters with centralized loan processing and training facilities.

Organic growth. We are well-established in our primary market area, leading our competitors in market share as of June 30, 2010, according to the most recent publicly reported figures. We believe that this solid market position will allow us to continue to increase our market share. We also believe our core strength in our primary market will enable us to grow into adjacent areas. We have experience opening offices in new markets, having successfully entered new markets in the 1990’s and 2000’s. We are already making loans in a number of adjacent counties, some of which have similar demographics to our primary market area. We will consider opportunities as they arise to open loan production offices or branch offices in adjacent markets, particularly markets in which we have lending experience.

Future acquisition opportunities. While we are currently focused on repositioning the Bank in the near term, we expect to be able to consider acquisition opportunities in the future. Smaller banks may struggle to support anticipated compliance costs resulting from the adoption of last year’s Dodd-Frank Wall Street Reform and Consumer Protection Act. Additionally, smaller banks have fewer ways to raise the capital they need to address current problems and support growth. We believe that these two factors will lead many smaller banks to seek a merger partner. Additionally, we expect to see other banks sell branches either to shrink their balance sheet or to focus on core markets. We will carefully evaluate any future acquisition opportunity to understand the potential impacts, both positive and negative, along with the risks of any transaction.

For further information about our reasons for the conversion and offering, please see “– Reasons for the Conversion” on page     .

Terms of the Conversion and the Offering

Under the plan of conversion, Bancorp will merge with and into Macon Financial, and, in doing so, will convert from a mutual form of organization to a stock form of organization. Upon the completion of the conversion, Bancorp will cease to exist, and the Bank will become a wholly-owned subsidiary of Macon Financial, which will be renamed “Macon Bancorp.” In connection with the conversion, Macon Financial is offering between 4,250,000 and 5,750,000 shares of common stock to eligible depositors and borrowers of the Bank in a “subscription offering,” and, if shares remain available, to the general public in a “community offering.” To the extent shares remain available after the community offering, we may also offer for sale, shares of common stock to the general public in a “syndicated offering,” managed by Raymond James & Associates, Inc. The number of shares of common stock to be sold may be increased up to 6,612,500 to reflect regulatory considerations, changes in market and financial conditions, and/or demand for the common stock. Unless the number of shares of common stock to be offered is increased to more than 6,612,500 or decreased to less than 4,250,000 or the offering is extended beyond [            ], subscribers will not have the opportunity to change or cancel their stock orders.

The purchase price of each share of common stock to be issued in the offering is $10.00. All investors will pay the same purchase price per share. Investors will not be charged a commission to purchase shares of common stock in the offering.

Persons Who May Order Shares of Common Stock in the Offering

We are offering the shares of common stock in a “subscription offering” in the following descending order of priority:

 

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First, to eligible depositors of the Bank with aggregate account balances of at least $100.00 as of the close of business on December 31, 2009.

 

   

Second, to eligible depositors of the Bank with aggregate account balances of at least $100.00 as of the close of business on [            , 2011].

 

   

Third, to other eligible depositors and borrowers of the Bank as of the close of business on [Voting Record Date for Special Meeting].

Shares of common stock not purchased in the subscription offering may be offered for sale in a “community offering” to members of the general public, with a preference given to natural persons residing in Buncombe, Clay, Cherokee, Graham, Haywood, Henderson, Jackson, Macon, Polk, Swain and Transylvania Counties, North Carolina, and Rabun County, Georgia. The community offering may begin concurrently with, during or promptly after the subscription offering as we may determine at any time. If shares remain available for sale following the subscription offering or community offering, we also may offer for sale shares of common stock through a “syndicated offering” managed by Raymond James & Associates, Inc. We have the right to accept or reject, in our sole discretion, orders received in the community offering or syndicated offering.

To ensure a proper allocation of stock, each subscriber eligible to purchase stock in the subscription offering must list on his, her or its stock order form all loans and/or deposit accounts in which he, she or it had an ownership interest at the applicable eligibility date(s). Failure to list all loans and accounts, or providing incorrect information, could result in the loss of all or part of a subscriber’s stock allocation. Our interpretation of the terms and conditions of the plan of conversion and of the acceptability of the order forms will be final.

If we receive orders for more shares than we are offering, we may not be able to fully or partially fill your order. Shares will be allocated first, in the order of priority, to subscribers in the subscription offering before any shares are allocated in the community offering and, in turn, the syndicated offering.

For a detailed description of the offering, including share allocation procedures, please see “The Conversion” on page     .

How We Determined the Offering Range

The amount of common stock that we are offering is based on an independent appraisal of Macon Financial’s estimated market value assuming the conversion and the offering are completed. RP Financial, L.C., our independent appraiser, has estimated that, as of May 13, 2011, the market value, was $50.0 million. The market value constitutes the midpoint of a valuation range, with a minimum of $42.5 million and a maximum of $57.5 million. Based on this market value, the offering ranges from a minimum of 4,250,000 shares to a maximum of 5,750,000 shares, with a midpoint of 5,000,000 shares. To reflect regulatory considerations, changes in market and financial conditions, and/or demand for the common stock, the market value can be increased to $66.1 million, and the offering can be increased to 6,612,500 shares.

RP Financial advised our Board of Directors that the appraisal was prepared in conformance with the regulatory appraisal methodology. That methodology requires a valuation based on an analysis of the trading prices of comparable public companies whose stocks have traded for at least one year prior to the valuation date. RP Financial selected a group of 11 comparable public companies for this analysis that comprised the peer group for valuation purposes. Consistent with applicable appraisal guidelines, the appraisal applied three primary methodologies: the pro forma price-to-book value approach applied to both reported book value and tangible book value; the pro forma price-to-earnings approach applied to reported and core earnings; and the pro forma price-to-assets approach. Based on RP Financial’s belief that asset size is not a strong determinant of market value, RP Financial did not place significant weight on the pro forma price-to-assets approach in reaching its conclusions. Since Bancorp’s price-to-earning multiples were not meaningful due to its negative pro forma earnings, RP Financial placed the greatest emphasis on the price-to-book and price-to-tangible book approaches in estimating pro forma market value. The market value ratios applied in the three methodologies were based upon the current market valuations of the peer group companies identified by RP Financial, subject to valuation adjustments applied by RP Financial to account for differences between us and the peer group. Downward adjustments were applied in the valuation for financial condition and profitability, growth and viability of earnings, our primary market area, capacity to pay dividends, marketing of the common stock and the effect of government regulations and regulatory reform. No adjustment was applied in the valuation for liquidity of the common stock. The downward valuation adjustments considered, among other factors, less favorable asset quality, weaker earnings, the Bank MOU, the Bancorp MOU and our primary market area (lower per capita income and higher unemployment) versus the peer group and the valuation considerations applied by potential investors in

 

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purchasing a newly issued stock that has no prior trading history in a volatile market for thrift and savings bank common stock.

The appraisal peer group consists of the following companies, with the asset sizes as of March 31, 2011, unless otherwise stated.

 

Company Name and Ticker Symbol

   Exchange    Headquarters    Total Assets  
     (in millions)  

CFS Bancorp, Inc. (CITZ)

   NASDAQ    Munster, IN    $ 1,122  (1) 

Community Financial Corp. (CFFC)

   NASDAQ    Staunton, VA    $ 528  (1) 

First Clover Leaf Financial Corp. (FCLF)

   NASDAQ    Edwardsville, IL    $ 575  (1) 

First Defiance Financial Corp. (FDEF)

   NASDAQ    Defiance, OH    $ 2,062   

First Savings Financial Group, Inc. (FSFG)

   NASDAQ    Clarksville, IN    $ 513   

HF Financial Corp. (HFFC)

   NASDAQ    Sioux Falls, SD    $ 1,207   

Home Bancorp, Inc (HBCP)

   NASDAQ    Lafayette, LA    $ 700   

HopFed Bancorp, Inc. (HFBC)

   NASDAQ    Hopkinsville, KY    $ 1,083  (1) 

MutualFirst Financial Inc. (MFSF)

   NASDAQ    Muncie, IN    $ 1,407  (1) 

Pulaski Financial Corp. (PULB)

   NASDAQ    St. Louis, MO    $ 1,338   

Teche Holding Company (TSH)

   NASDAQ    New Iberia, LA    $ 754  (1) 

 

(1) 

Figures as of December 31, 2010.

The following table presents a summary of selected pricing ratios for us and our peer group companies (on a pro forma basis). The pricing ratios are based on earnings and other information as of and for the 12 months ended March 31, 2011, stock price information as of May 13, 2011, as reflected in RP Financial’s appraisal report, dated May 13, 2011, and the number of shares assumed to be outstanding as described in “Pro Forma Data.” Compared to the average pricing of the peer group, our pro forma pricing ratios at the maximum of the offering range indicated a discount of 25.7% on a price-to-book value basis and a discount of 31.7% on a price-to-tangible book value basis. Compared to the median pricing of the peer group, our pro forma pricing ratios at the maximum of the offering range indicated a discount of 24.5% on a price-to-book value basis and a discount of 38.0% on a price-to-tangible book value basis.

 

      Price-to-Earnings
Multiple
    Price to
Book Value
    Price to Tangible
Book Value
 

Macon Financial (pro forma):

      

Maximum, as adjusted, of offering range

     NM     55.62     55.62

Maximum of offering range

     NM     52.00        52.00   

Midpoint of offering range

     NM     48.33        48.33   

Minimum of offering range

     NM     44.21        44.21   

Peer group companies:

      

Average

     14.29     70.01        76.14   

Median

     12.07     68.85        83.84   

 

* 

Not meaningful

We carefully reviewed the information provided to us by RP Financial through the appraisal process, but did not make any determination regarding whether prior standard mutual-to-stock conversions have been undervalued. Instead, we engaged RP Financial to help us understand regulatory guidance as it applies to the appraisal and to advise our Board of Directors as to how much capital we would be required to raise under the regulatory appraisal guidelines.

RP Financial will update the independent appraisal prior to the completion of the conversion. If the estimated appraised value, including offering shares, changes to either below $42.5 million or above $66.1 million, we will resolicit persons who submitted stock orders, giving them an opportunity to change or cancel their orders. See “– Share Pricing and Number of Shares to be Issued” on page     .

The independent appraisal does not indicate per share market value. You should not assume or expect that the valuation of RP Financial as indicated above means that, after the conversion and the offering, our shares of

 

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common stock will trade at or above the $10.00 offering price. Furthermore, the pricing ratios presented above were utilized by RP Financial to estimate our market value and not to compare the relative value of shares of our common stock with the value of the capital stock of the peer group. The value of the capital stock of a particular company may be affected by a number of factors such as financial performance, asset size and market location.

For a more complete discussion of the amount of common stock we are offering for sale and the independent appraisal, including a comparison of selected pro forma pricing ratios compared to pricing ratios of the peer group, see “– Share Pricing and Number of Shares to be Issued” on page     .

Limits on How Much Common Stock You May Purchase

The minimum number of shares of common stock that may be purchased is 25. Generally, no individual may purchase more than 75,000 shares ($750,000) of common stock in any single category of the offering, i.e., the subscription offering, the community offering or the syndicated offering; or 125,000 shares ($1,250,000) of common stock in all categories of the offering. If any of the following persons purchases shares of common stock, then, unless the maximum purchase limitations are increased, their purchases, in all categories of the offering, when combined with your purchases, cannot exceed 125,000 shares ($1,250,000):

 

   

your spouse or relatives of you or your spouse living in your house;

 

   

most companies, trusts or other entities in which you are a trustee, have a substantial beneficial interest or hold a senior management position; or

 

   

other persons who may be your associates, affiliates or persons acting in concert with you.

See the detailed descriptions of “acting in concert,” “affiliate” and “associate” in “– Limitations on Common Stock Purchases” on page     .

We may decrease or increase the purchase limitations to not more than 4.99% of the shares issued in the offering. In the event that the maximum purchase limitation is increased to 4.99%, this limitation may be further increased to 9.99%, provided that orders for common stock exceeding 4.99% shall not exceed in the aggregate 10% of the shares of common stock issued in the offering. See “– Limitations on Common Stock Purchases” on page     .

How You May Purchase Shares of Common Stock

In the subscription offering and community offering, you may pay for your shares only by:

 

   

delivering a personal check, money order or bank draft made payable to “Macon Financial Corp.”; or

 

   

authorizing us to withdraw funds from the types of deposit accounts with the Bank permitted on the stock order form.

We will not lend funds to anyone for the purpose of purchasing shares of common stock in the offering. Additionally, you may not submit a check drawn on a Macon Bank line of credit to pay for shares of common stock. Please do not submit cash.

You can subscribe for shares of common stock in the offering by delivering a signed and completed original stock order form, together with full payment or authorization to withdraw from one or more of your Macon Bank deposit accounts, so that it is received (not postmarked) before 4:00 p.m., Eastern Daylight Time, on [expiration date], which is the expiration of the offering period. You may submit your stock order form by mail using the order reply envelope provided or by overnight courier to our Stock Information Center, at the address indicated on the order form. We will not accept faxed order forms. Other than our Stock Information Center, we will not accept stock order forms at our banking offices.

You may be able to subscribe for shares of common stock using funds in your individual retirement account or other retirement account. If you wish to use some or all of the funds in your individual retirement account held at the Bank or other retirement accounts held at the Bank to purchase our common stock, the applicable funds must first be transferred to a self-directed account maintained by an independent trustee, such as a brokerage firm, and the purchase must be made through that account. Because individual circumstances differ and processing of retirement fund orders takes additional time, we recommend that you contact our Stock Information Center promptly, preferably at least two weeks before [expiration date], the expiration of the offering period, for assistance with purchases using funds from any retirement account held at the Bank or any retirement account that you may have elsewhere. Whether you may use such funds for the purchase of shares in the

 

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offering may depend on time constraints and, possibly, limitations imposed by the brokerage firm or institution where your funds are held.

See “– Procedure for Purchasing Shares” on page      for a complete description of how to purchase shares in the offering.

Deadline for Orders of Common Stock

The deadline for purchasing shares of common stock in the offering is          p.m., Eastern Daylight Time, on [            , 2011]. Your stock order form, with full payment, must be received (not postmarked) by          p.m., Eastern Daylight Time on [            , 2011].

Although we will make reasonable attempts to provide a prospectus and offering materials to holders of subscription rights, the subscription offering and all subscription rights will expire at          p.m., Eastern Daylight Time, on [            , 2011], whether or not we have been able to locate each person entitled to subscription rights.

See “– Procedure for Purchasing Shares” on page      for a complete description of how to purchase shares in the offering.

Delivery of Shares of Common Stock in the Subscription and Community Offerings

Information regarding shares of common stock sold in the subscription and community offerings will be mailed by regular mail to the persons entitled thereto at the stock registration address noted on the stock order form, as soon as practicable following completion of the conversion and offering. It is possible that, until this information is delivered, purchasers may not be able to sell the shares of common stock that they ordered, even though the common stock will have begun trading. In order to reduce non-essential costs, we do not intend to issue paper stock certificates, unless a shareholder specifically requests a paper stock certificate. Instead, except for shareholders who specifically request a paper stock certificate, the holdings of each shareholder will be recorded in “book entry” form on our records and we will issue shareholders a written statement, containing all of the information usually provided in the certificate.

After-Market Stock Price Performance Provided by Independent Appraiser

The following table presents stock price performance information for all reported standard mutual-to-stock conversions completed between January 1, 2010 and May 13, 2011. None of these companies was included in the group of 11 comparable public companies utilized in RP Financial’s valuation analysis.

 

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Mutual-to-Stock Conversion Offerings with Closing Dates

between January 1, 2010 and May 13, 2011

 

                          Price Performance from Initial Trading Date (1)  

Transaction

  

Exchange

     Closing Date      Offering Size      1 Day     1 Week     1 Month     5-13-2011  
                   ($ in millions)                           

NASDAQ Listed Companies

                 

Franklin Financial Corp. (FRNK)

     NASDAQ         04/28/11       $ 138.9         19.7     17.7     NA        18.0

Anchor Bancorp (ANCB)

     NASDAQ         01/26/11       $ 25.5         0.0     0.3     4.5     -4.4

Wolverine Bancorp, Inc. (WBKC)

     NASDAQ         01/20/11       $ 25.1         24.5     22.4     35.0     49.0

SP Bancorp, Inc. (SPBC)

     NASDAQ         11/01/10       $ 17.3         -6.0     -6.6     -8.0     18.6

Standard Financial Corp. (STND)

     NASDAQ         10/07/10       $ 33.6         19.0     18.9     29.5     54.0

Peoples Federal Bancshares, Inc. (PEOP)

     NASDAQ         07/07/10       $ 66.1         4.0     6.9     4.2     42.4

OBA Financial Services, Inc. (OBAF)

     NASDAQ         01/22/10       $ 46.3         3.9     1.1     3.0     48.0

OmniAmerican Bancorp, Inc. (OABC)

     NASDAQ         01/21/10       $ 119.0         18.5     13.2     9.9     46.2

Athens Bancshares, Inc. (AFCB)

     NASDAQ         01/07/10       $ 26.8         16.0     13.9     10.6     35.5

Sunshine Financial, Inc. (SSNF)

     OTC         04/06/11       $ 12.3         12.5     11.0     14.0     14.0

Fraternity Community Bancorp (FRTR)

     OTC         04/01/11       $ 15.9         10.0     11.7     10.0     4.0

Madison Bancorp, Inc. (MDSN)

     OTC         10/07/10       $ 6.1         25.0     25.0     25.0     5.0

Century Next Financial Corp. (CTUY)

     OTC         10/01/10       $ 10.6         25.0     15.0     10.0     60.0

United-American Savings Bank (UASB)

     OTC         08/06/10       $ 2.5         0.0     -5.0     5.0     30.5

Fairmont Bancorp, Inc. (FMTB)

     OTC         06/03/10       $ 4.4         10.0     20.0     10.0     65.0

Harvard Illinois Bancorp, Inc. (HARI)

     OTC         04/09/10       $ 7.9         0.0     0.0     -1.0     -10.0

Versailles Financial Corp. (VERF)

     OTC         01/13/10       $ 4.3         0.0     0.0     0.0     0.0

Average

         $ 33.1         10.7     9.7     10.1     29.8

Median

         $ 17.3         10.0     11.7     10.0     30.5

NASDAQ Average

         $ 55.4         11.1     9.8     11.1     34.1

NASDAQ Median

         $ 33.6         16.0     13.2     7.2     42.4

 

(1) 

Closing prices based on published financial sources.

Stock price performance is affected by many factors, including, but not limited to: general market and economic conditions; the interest rate environment; the amount of proceeds a company raises in its offering; and numerous factors relating to the specific company, including the experience and ability of management, historical and anticipated operating results, the nature and quality of the company’s assets, and the company’s market area. None of the companies listed in the table above are exactly similar to us. The pricing ratios for their offerings were different from the pricing ratios for our common stock and the market conditions in which these offerings were completed were, in most cases, different from current market conditions. The performance of these stocks may not be indicative of how our stock will perform.

There can be no assurance that our stock price will not trade below $10.00 per share, as has been the case for many mutual-to-stock conversions. Before you make an investment decision, we urge you to carefully read this prospectus, including, but not limited to, the section entitled “Risk Factors” beginning on page 13.

Steps We May Take If We Do Not Receive Orders for the Minimum Number of Shares

If we do not receive orders for at least 4,250,000 shares of common stock, we may take the following steps to issue the minimum number of shares of common stock in the offering range:

 

   

increase the maximum purchase limitations; and/or

 

   

extend the offering beyond [            , 2011], so long as we resolicit subscriptions that we have previously received in the offering.

If one or more purchase limitations are increased, subscribers in the subscription offering who ordered the maximum amount, will be given the opportunity to increase their subscription up to the then-applicable limit.

Possible Change in the Offering Range

RP Financial will update its appraisal before we complete the offering. Without further notice to you, the number of shares of common stock to be sold may be increased up to 6,612,500 to reflect regulatory considerations, changes in market

 

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and financial conditions, and/or demand for the common stock. If our pro forma market value at that time is either below $42.5 million or above $66.1 million, then we may:

 

   

terminate the offering and promptly return all funds;

 

   

extend the offering beyond [extension date], so long as we resolicit subscriptions that we have previously received in the offering;

 

   

set a new offering range; or

 

   

take such other actions as may be permitted (or not prohibited) by the North Carolina Commissioner of Banks, the Board of Governors of the Federal Reserve System and the Securities and Exchange Commission.

In the event that we extend the offering and conduct a resolicitation, we will notify subscribers of the extension of time and of the rights of subscribers to maintain, change or cancel their stock orders within a specified period. If a subscriber does not respond during the period, his, her or its stock order will be canceled and payment will be returned promptly, with interest calculated at the Bank’s statement savings rate, and deposit account withdrawal authorizations will be canceled.

Possible Termination of the Offering

We may terminate the offering at any time and for any reason prior to the special meeting of voting members that is being called to vote upon the conversion, and at any time after member approval, and any required approval of the North Carolina Commissioner of Banks and the Board of Governors of the Federal Reserve System. If we terminate the offering, we will promptly return your funds with interest calculated at the Bank’s statement savings rate, and we will cancel deposit account withdrawal authorizations.

How We Intend to Use the Proceeds From the Offering

We intend to invest up to 90% of the net proceeds from the offering in the Bank as capital and retain the remainder of the net proceeds from the offering. Therefore, assuming we sell 5,750,000 shares of common stock in the offering, and we have net proceeds of $54.3 million, we intend to invest up to $48.8 million in the Bank and retain the remaining $5.4 million of the net proceeds.

The following table summarizes how we intend to use the net proceeds from the offering, based on the sale of shares at the minimum, midpoint, maximum and adjusted maximum of the offering range:

 

     Minimum
(4,250,000 shares)
    Midpoint
(5,000,000 shares)
    Maximum
(5,750,000 shares)
    Adjusted Maximum
(6,612,500 shares)
 
     Amount     % of  Net
Proceeds
    Amount     % of  Net
Proceeds
    Amount     % of  Net
Proceeds
    Amount     % of  Net
Proceeds
 
     (Dollars in thousands)  

Offering proceeds

   $ 42,500        $ 50,000        $ 57,500        $ 66,125     

Less: offering expenses

     (2,671       (2,952       (3,233       (3,557  
                                        

Net offering proceeds

     39,829        100.0     47,048        100     54,267        100.0     62,568        100.0

Use of net proceeds:

                

Proceeds contributed to Macon Bank

   $ 35,846        90.0   $ 42,343        90.0   $ 48,840        90.0   $ 56,311        90.0

Proceeds remaining for Macon Financial

     3,983        10.0     4,705        10.0     5,427        10.0     6,257        10.0

Subject to receiving any necessary regulatory approvals, we may use the funds we retain for investments, to pay cash dividends, to repurchase shares of common stock and for other general corporate purposes. Additionally, the Bank may use the proceeds it receives from Macon Financial to support increased lending and other products and services.

Please see the section entitled “How We Intend to Use the Proceeds from the Offering” on page      for more information on the proposed use of the proceeds from the offering.

 

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You May Not Sell or Transfer Your Subscription Rights

You may not sell or transfer your subscription rights. If you order shares of common stock in the subscription offering, you will be required to state that you are purchasing the shares of common stock for yourself and that you have no agreement or understanding to sell or transfer your subscription rights. We will not accept your order if we have reason to believe that you have sold or transferred your subscription rights. When completing your stock order form, you should not add the name(s) of persons who do not have subscription rights or who qualify in a lower subscription offering priority than you do. In addition, the stock order form requires that you list all loans and deposit accounts, giving all names on each loan and account and the account number at the applicable eligibility record date. Your failure to provide this information, or providing incomplete or incorrect information, may result in a loss of part or all of your share allocation.

Purchases by Officers and Directors

We expect our directors and executive officers, together with their associates, to subscribe for 152,000 shares ($1.5 million) of common stock in the offering, or 3.5% of the shares to be sold at the minimum of the offering range. The purchase price paid by our directors and executive officers for their shares will be the same $10.00 per share price paid by all other persons who purchase shares of common stock in the offering.

See “Subscriptions by Directors and Executive Officers” on page      for more information on the proposed purchases of our shares of common stock by our directors and executive officers.

Benefits to Management and Potential Dilution to Shareholders Following the Conversion

The plan of conversion permits the Bank’s tax-qualified employee benefit plans (if any) to purchase shares of common stock in the subscription offering. However, no employee benefit plans will participate in the offering.

Our current intention is to adopt one or more stock-based benefit plans no earlier than 12 months after completion of the conversion. Shareholder approval of these plans will be required. Shares for such plans may be issued out of authorized but unissued shares or repurchased shares and/or may be purchased in the open market. We have not yet determined the number of shares that would be reserved for issuance under these plans.

In addition to the stock-based benefit plans that we may adopt, we intend to enter into employment and change of control agreements and severance and non-competition agreements with certain of our executive and other officers. See “– Executive Officer Compensation” and “– Benefits to be Considered Following Completion of the Conversion” on page      for a further discussion of these agreements, including their terms and potential costs, as well as a description of other benefits arrangements. In addition, for further information with respect to the expenses related to the stock-based benefit plans, see “Risk Factors – The implementation of stock-based benefit plans may dilute your ownership interest and increase our costs, which will reduce our income,” on page      and “– Benefits to be Considered Following Completion of the Conversion” on page     .

Market for Common Stock

We expect that our common stock will be listed for trading on the NASDAQ Global Market under the symbol “            .” Raymond James & Associates, Inc. currently intends to make a market in the shares of our common stock, but is under no obligation to do so. See “– Market for the Common Stock” on page     .

Our Policy Regarding Dividends

Following completion of the offering, our Board of Directors will have the authority to declare dividends on our common stock, subject to statutory and regulatory requirements. Under the Bancorp MOU, we may not declare or pay any dividends without the prior approval of the Federal Reserve Bank of Richmond. Initially, we do not intend to pay any cash dividends following the offering. The payment and amount of any future dividend payments will depend upon a number of factors.

For further information, see “Our Policy Regarding Dividends” on page     .

 

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Tax Consequences

As a general matter, the conversion will not be a taxable transaction for federal or state income tax purposes to Macon Financial, Bancorp, the Bank, or persons eligible to subscribe in the subscription offering. See “– Material Income Tax Consequences” on page      for additional information.

Conditions to Completion of the Conversion and the Offering

We cannot complete the conversion and the offering unless:

 

   

the plan of conversion is approved by at least a majority of votes eligible to be cast by Bancorp’s voting members. A special meeting of voting members to consider and vote upon the plan of conversion has been set for [            , 2011];

 

   

we have received and accepted orders to purchase at least the minimum number of shares of common stock offered; and

 

   

we receive all requisite regulatory approvals to complete the conversion and the offering, including approvals from the North Carolina Commissioner of Banks and the Board of Governors of the Federal Reserve System.

How You Can Obtain Additional Information

Our branch office personnel may not assist with investment-related questions about the offering. If you have any questions regarding the conversion or the offering, please call our Stock Information Center, toll free, at             , Monday through Friday between          a.m. and          p.m., Eastern Daylight Time. The Stock Information Center will be closed on weekends and bank holidays.

TO ENSURE THAT EACH PERSON RECEIVES A PROSPECTUS AT LEAST 48 HOURS PRIOR TO THE EXPIRATION DATE OF [            , 2011], NO PROSPECTUS WILL BE MAILED OR HAND-DELIVERED ANY LATER THAN FIVE DAYS OR TWO DAYS, RESPECTIVELY, PRIOR TO [             , 2011].

RISK FACTORS

You should consider carefully the following risk factors in evaluating an investment in our shares of common stock.

Risks Related to Our Business

The Bank is subject to the Bank MOU and Bancorp is subject to the Bancorp MOU (together, the “Memoranda”) which require elevated capital ratios and other actions; failure to comply with the terms of the Memoranda may result in adverse consequences. In accordance with the terms of the Bank MOU, the Bank has agreed to, among other things, (1) increase regulatory capital to achieve and maintain a Tier I Leverage Capital ratio of not less than 8% and a Total Risk-Based Capital ratio of not less than 12%, (2) develop specific plans and proposals for the reduction and improvement of lines of credit which are subject to adverse classification, (3) review its overall liquidity objectives and develop plans and procedures aimed at reducing reliance on volatile liabilities to fund longer term assets, (4) establish and maintain an adequate allowance for loan losses, and (5) approve an enhanced loan loss reserve policy to incorporate recommendations of the Federal Deposit Insurance Corporation (“FDIC”) and the North Carolina Commissioner of Banks (“Commissioner,” and together with the FDIC, the “Bank Supervisory Authorities”). In addition, the Bank must obtain regulatory approval prior to paying any dividends to Bancorp. The Bank MOU will remain in effect until modified, terminated, lifted, suspended or set aside by the Bank Supervisory Authorities.

Under the Bancorp MOU, Bancorp has agreed to, among other things, (1) not declare or pay any dividends, including payments on its trust preferred securities, without the prior approval of the Federal Reserve Bank of Richmond (“FRB”), (2) not directly or indirectly take dividends or any other form of payments representing a reduction in capital from the Bank without the prior written approval of the FRB, (3) not, directly or indirectly, incur, increase, or guarantee any debt without the prior written approval of the FRB, (4) preserve our cash assets and not dissipate those assets except for the benefit of the Bank, and (5) take appropriate steps to ensure that the Bank complies with any order, or other supervisory action entered into with the Bank’s federal and state regulators. The Bancorp MOU will remain in effect until modified, terminated, lifted, suspended or set aside by the FRB.

 

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Bancorp and the Bank have taken and continue to take prompt and aggressive action to respond to the issues raised in the Memoranda. A material failure to comply with the terms of the Memoranda could subject Bancorp or the Bank to additional regulatory actions, including a consent order or other action, and further regulation, which may have a material adverse effect on our future business, results of operations and financial condition. For additional information regarding the Memoranda, see “– Memoranda of Understanding” on page     .

We must raise sufficient capital to comply with the elevated capital requirements of the Bank MOU. The resulting capital cushion may not be sufficient to absorb additional loan losses and maintain such compliance. As part of the Bank MOU, the Bank Supervisory Authorities require the Bank to maintain a Tier I Leverage Capital ratio of not less than 8% and a Total Risk-Based Capital ratio of not less than 12%. At March 31, 2011, the Bank had a Tier I Leverage Capital ratio of 7.07%, and a Total Risk-Based Capital ratio of 11.55%. Even though we expect the Bank to exceed these higher capital requirements after the offering, its capital cushion may not be sufficient to cover future losses. At the minimum offering, the Bank’s pro forma Total Risk-Based Capital ratio is expected to be 16.61% with a capital cushion of $31.9 million in excess of the required capital level. Any increased provision expenses to fund its allowance for loan losses and increased real estate liquidation expenses will negatively impact the Bank’s capital cushion. If the Bank’s capital cushion is impacted such that its capital ratios do not comply with the requirements of the Bank MOU, the Bank Supervisory Authorities could take additional enforcement action against the Bank, including the imposition of monetary penalties, as well as further operating restrictions.

We initially will not pay dividends or repurchase our common stock after the offering. Under the Bancorp MOU, we may not declare or pay any dividends without the prior approval of the FRB. Following the conversion and offering, we initially will not pay dividends on our common stock and will not repurchase our common stock, which may negatively impact our stock price. For further information, see “Our Policy Regarding Dividends” on page     .

We recorded losses in the last three months and last two full fiscal years and losses may continue in the future, which may negatively impact our stock price. During the three months ended March 31, 2011, and the years ended December 31, 2010 and 2009, we recorded net losses of $8.9 million, $14.3 million and $7.8 million, respectively. These losses were primarily due to provisions for loan losses of $9.8 million, $18.9 million and $21.9 million, respectively. Another contributing factor has been our high levels of non-performing assets, for which we do not record interest income. These assets totaled $96.7 million at March 31, 2011; $97.1 million at December 31, 2010; and $66.5 million at December 31, 2009. Our ability to return to profitability will depend, in part, on reducing the amount of our provision for loan losses and other expenses, and reducing our level of non-performing assets. Continued losses may negatively impact our stock price.

We may be required to increase the valuation allowance against our deferred tax assets. As of March 31, 2011, we had net deferred tax assets of $17.4 million before a valuation allowance. During 2010, we reached a three-year pre-tax cumulative loss position. Under accounting principles generally accepted in the United States (“GAAP”), a cumulative loss position is considered significant evidence which makes it very difficult for us to rely on future earnings as a reliable source of future taxable income to realize deferred tax assets. Accordingly, we have established a valuation allowance against our net deferred tax assets as of March 31, 2011, totaling $11.8 million because we believe that it is not likely that all of these assets will be realized. This valuation allowance resulted in an unreserved net deferred tax asset of $5.6 million at March 31, 2011. In determining the amount of the valuation allowance, we considered the reversal of deferred tax liabilities, and the ability to carry back losses to prior years. This process required significant judgment by management about matters that are by nature uncertain. It is likely we will need to increase our valuation allowance in the coming quarters as we work through some of our problem assets, which could have a material adverse effect on our results of operations and financial condition.

Our estimate for losses in our loan portfolio may be inadequate, which would cause our results of operations and financial condition to be adversely affected. We maintain an allowance for loan losses, which is a reserve established through a provision for possible loan losses charged to our expenses and represents management’s best estimate of probable losses within our existing portfolio of loans. Our allowance for loan losses amounted to $20.9 million at March 31, 2011, as compared to $17.2 million at December 31, 2010. The level of the allowance reflects management’s estimates and judgments as to specific credit risks, evaluation of industry concentrations, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio, which have been increasing in light of recent economic conditions. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires management to make significant estimates of current credit risks and future trends, all of which may undergo material changes. An independent third party recently reviewed a significant portion of our loans, completing its review in January of 2011. Based on its estimates using the highest range of potential losses, our expense relating to the additional provision for loan losses could be increased substantially. In addition, we anticipate that bank regulatory agencies will review our allowance for loan losses during our next examination, and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs. Finally, the

 

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appointment of a new Chief Credit Officer in February of 2011 may result in changes to our loan loss methodology and increases in our provisions for loan losses. Any such increases may have a material adverse effect on our results of operations, financial condition and the value of our common stock.

Our construction and land development, commercial real estate, and home equity and line of credit lending may expose us to a greater risk of loss and hurt our earnings and profitability. Historically, our business strategy has centered, in part, on offering construction and land development, commercial, and home equity and line of credit loans secured by real estate in order to expand our net interest margin. These types of loans generally have higher risk-adjusted returns and shorter maturities than traditional one- to four-family residential mortgage loans. At March 31, 2011, construction and land development, commercial, and home equity loans and lines of credit secured by real estate totaled $430.5 million, which represented 62.3% of total loans. Such loans increase our credit risk profile relative to other financial institutions that have higher concentrations of one- to four-family loans.

Loans secured by commercial or land development real estate properties are generally for larger amounts and involve a greater degree of risk than one- to four-family residential mortgage loans. Payments on loans secured by these properties generally are dependent on the income produced by the underlying properties which, in turn, depends on the successful operation and management of the properties. Accordingly, repayment of these loans is subject to adverse conditions in the real estate market or the local economy. While we seek to minimize these risks in a variety of ways, there can be no assurance that these measures will protect against credit-related losses.

Construction financing typically involves a higher degree of credit risk than financing on improved, owner-occupied real estate. Risk of loss on a construction loan is largely dependent upon the accuracy of the initial estimate of the property’s value at completion of construction and the bid price and estimated cost (including interest) of construction. If the estimate of construction costs proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of the value proves to be inaccurate, we may be confronted, at or prior to the maturity of the loan, with a project whose value is insufficient to assure full repayment. When lending to builders, the cost of construction breakdown is provided by the builder, as well as supported by the appraisal. Although our underwriting criteria are designed to evaluate and minimize the risks of each construction loan, there can be no guarantee that these practices will safeguard against material delinquencies and losses to our operations.

At March 31, 2011, we had loans of $154.8 million, or 22.4% of total loans, outstanding to finance construction and land development. Construction and land development loans are dependent on the successful completion of the projects they finance, however, in many cases such construction and development projects in our primary market area are not being completed in a timely manner, if at all.

Home equity loans and lines of credit typically involve a greater degree of risk than one- to four-family residential mortgage loans. Equity line lending allows customer to access an amount up to his, her or its line of credit limit for the term specified in their agreement. At the expiration of the term of an equity line, a customer may have the entire principal balance outstanding as opposed to a one- to four-family residential mortgage loan where the principal is disbursed entirely at closing and amortizes throughout the term of the loan. We cannot predict when and to what extent our customers will access their equity lines. While we seek to minimize this risk in a variety of ways, including attempting to employ conservative underwriting criteria, there can be no assurance that these measures will protect against credit-related losses.

Repayment of our commercial business loans is primarily dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value. We offer different types of commercial loans to a variety of small to medium-sized businesses, and intend to increase our commercial business loan portfolio in the future. The types of commercial loans offered are business lines of credit and term equipment financing. Our commercial business loans are primarily underwritten based on the cash flow of the borrowers and secondarily on the underlying collateral, including real estate. The borrowers’ cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Some of our commercial business loans are collateralized by equipment, inventory, accounts receivable or other business assets, and the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use.

As of March 31, 2011, our commercial business loans totaled $15.1 million, or 2.2% of our total loan portfolio. Non-accruing commercial business loans totaled $0.9 million and $1.1 million as of March 31, 2011 and December 31, 2010, respectively.

Our lending on vacant land may expose us to a greater risk of loss and may have an adverse effect on results of operations. A portion of our residential and commercial lending is secured by vacant or unimproved land. Loans secured by

 

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vacant or unimproved land are generally more risky than loans secured by improved property for one- to four-family residential mortgage loans. Since vacant or unimproved land is generally held by the borrower for investment purposes or future use, payments on loans secured by vacant or unimproved land will typically rank lower in priority to the borrower than a loan the borrower may have on their primary residence or business. At March 31, 2011, loans secured by vacant or unimproved property totaled $44.4 million, or 6.4% of our loan portfolio. These loans are susceptible to adverse conditions in the real estate market and local economy.

We continue to hold and acquire a significant amount of other real estate, which has led to increased operating expenses and vulnerability to additional declines in real property values. We foreclose on and take title to real estate serving as collateral for many of our loans as part of our business. Real estate owned by us and not used in the ordinary course of our operations is referred to as “real estate owned” or “REO.” At March 31, 2011, we had REO with an aggregate book value of $23.5 million, compared to $21.5 million at December 31, 2010. We obtain appraisals prior to taking title to real estate and periodically thereafter. However, due to the continued deterioration in real estate prices in our market areas, there can be no assurance that such valuations will reflect the amount which may be paid by a willing purchaser in an arms-length transaction at the time of the final sale. Moreover, we cannot assure investors that the losses associated with REO will not exceed the estimated amounts, which would adversely affect future results of our operations.

The calculation for the adequacy of write-downs of our REO is based on several factors, including the appraised value of the real property, economic conditions in the property’s sub-market, comparable sales, current buyer demand, availability of financing, entitlement and development obligations and costs and historic loss experience. All of these factors have caused further write-downs in recent periods and can change without notice based on market and economic conditions. High levels of non-performing assets indicate that REO balances will continue to be high for the foreseeable future. Increased REO balances have led to greater expenses as we incur costs to manage and dispose of the properties. We expect that our earnings will continue to be negatively affected by various expenses associated with REO, including personnel costs, insurance and taxes, completion and repair costs, valuation adjustments and other expenses associated with property ownership, as well as by the funding costs associated with assets that are tied up in REO. Moreover, our ability to sell REO is affected by public perception that banks are inclined to accept large discounts from market value in order to quickly liquidate properties. Any further decrease in market prices may lead to further REO write-downs, with a corresponding expense in our statement of operations. Further write-downs on REO or an inability to sell REO properties could have a material adverse effect on our results of operations and financial conditions. Furthermore, the management and resolution of non-performing assets, which include REO, increases our costs and requires significant commitments of time from our management and directors, which can be detrimental to the performance of their other responsibilities. The expenses associated with REO and any further property write-downs could have a material adverse effect on our financial condition and results of operations.

A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate market could hurt our business. A significant portion of our loan portfolio is secured by real estate. As of March 31, 2011, approximately 97% of our loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. A continued weakening of the real estate market in our market areas could continue to result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and shareholders’ equity could be adversely affected. The declines in home prices in the markets we serve, along with the reduced availability of mortgage credit, also may result in increases in delinquencies and losses in our portfolio of loans related to residential real estate construction and development. Further declines in home prices coupled with a deepened economic recession and continued rises in unemployment levels could drive losses beyond that which is provided for in our allowance for loan losses. In that event, our earnings could be adversely affected.

Additionally, recent weakness in the secondary market for residential lending could have an adverse impact on our profitability. Significant ongoing disruptions in the secondary market for residential mortgage loans have limited the market for and liquidity of most mortgage loans other than conforming Fannie Mae and Freddie Mac loans. The effects of ongoing mortgage market challenges, combined with the ongoing correction in residential real estate market prices and reduced levels of home sales, could result in further price reductions in single family home values, adversely affecting the value of collateral securing mortgage loans held, mortgage loan originations and gains on sale of mortgage loans. Continued declines in real estate values and home sales volumes, and financial stress on borrowers as a result of job losses or other factors, could have further adverse effects on our borrowers that result in higher delinquencies and greater charge-offs in future periods, which could adversely affect our financial condition or results of operations.

 

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Continued and sustained deterioration in the housing sector and related markets and prolonged elevated unemployment levels may adversely affect our business and financial results. During 2009 and much of 2010, general economic conditions continued to worsen nationally as well as in our market areas. Our lending business is tied, in large part, to the real estate market. Declines in home prices and increases in foreclosures and unemployment have adversely impacted the credit performance of real estate related loans, resulting in the write-down of asset values. The continuing housing slump has resulted in reduced demand for the construction of new housing, further declines in home prices, and increased delinquencies on construction, residential and commercial mortgage loans. The ongoing concern about the stability of the financial markets in general has caused many lenders to reduce or cease providing funding to borrowers. These conditions may also cause a further reduction in loan demand, and increases in our non-performing assets, net charge-offs and provisions for loan losses. A worsening of these negative economic conditions could adversely impact our prospects for growth and asset valuations and could result in a decrease in our interest income and a material increase in our provision for loan losses.

Concentration of collateral in our primary market area, which has recently experienced declines in valuations, may increase the risk of increased non-performing assets. Our primary market area consists of the Western North Carolina counties of Cherokee, Henderson, Jackson, Macon, Polk and Transylvania. At March 31, 2011, approximately $506.8 million, or 73.4%, of our loans were secured by real estate located within this area. Declines in the valuations of real estate within our primary market area have adversely impacted the credit performance of real estate related loans, resulting in the write-down of asset values and an increase in non-performing assets. According to the multiple listing service (MLS) data available for the Franklin, North Carolina area, the median sales price for existing single family homes in this area decreased from $182,071 in 2007 to $135,224 in 2010. We believe that this change in median sales prices is indicative of changes throughout our primary market area. By contrast, the median sales price for existing homes in the U.S. decreased from $217,900 in 2007 to $173,100 in 2010. A continued decline in real estate values in our primary market area would lower the value of the collateral securing loans on properties in this area, and may increase our level of non-performing assets.

High loan-to-value ratios on a significant portion of our other construction and land and residential construction loan portfolio expose us to greater risk of loss. Many of our loans have high loan-to-value ratios, i.e. 85% and above for residential construction loans, 75% and above for land development and lot loans and commercial land loans, and 65%and above for undeveloped land loans. At March 31, 2011, approximately $28.0 million, or 18% of our other construction and land and residential construction loans had high loan-to-value ratios, and we had commitments to extend an additional $0.5 million related to these loans. Because real estate values have declined in our market areas, many of our loans that once were below the regulatory thresholds now exceed these loan-to-value thresholds. Loans with high loan-to-value ratios are more sensitive to declining property values than those with lower loan-to-value ratios and, therefore, experience a higher incidence of default and severity of losses. In addition, if our borrowers sell the properties, they may be unable to repay their loans in full from the proceeds of the sales. Furthermore, most of our acquisition, development and construction loans have adjustable interest rates. As a result, these loans may experience a higher rate of default in a rising interest rate environment due to the loans repricing upward as market rates rise. For these reasons, these loans may experience higher rates of delinquencies, defaults and losses.

Future changes in interest rates could reduce our profits. Our ability to make a profit largely depends on our net interest income, which could be negatively affected by changes in interest rates. Net interest income is the difference between:

 

   

the interest income we earn on our interest-earning assets, such as loans and securities; and

 

   

the interest expense we pay on our interest-bearing liabilities, such as deposits and borrowings.

Timing differences that can result from our interest-earning assets not repricing at the same time as our interest-bearing liabilities can negatively impact our net interest income. In addition, the amount of change in interest-earning assets and interest-bearing liabilities can also vary and present a risk to the amount of net interest margin earned. We generally employ market indexes when making portfolio loans in order to reduce the interest rate risk in our loan portfolio. Those indexes may not move in tandem with changes in rates of our funding sources, depending on market demand. As part of our achieving a balanced earning asset portfolio and earning acceptable yields, we also invest in longer term fixed rate municipal securities and in securities which have issuer callable features. These securities could reduce our net interest income or lengthen the average life during periods of high interest rate volatility. We also employ forecasting models to measure and manage the risk within stated policy guidelines. Notwithstanding these tools and practices, we are not assured that we can reprice our assets commensurately to interest rate changes in our funding sources, particularly during periods of high interest rate volatility. The difference in the timing of repricing our assets and liabilities may result in a decline in our earnings.

 

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As we take steps to implement our operating strategy, our total loan balance may decline, which may negatively impact our net interest income. At March 31, 2011, our non-owner occupied commercial real estate and other construction and real estate loans totaled $253.0 million, or 35%, of our total loan portfolio. Since mid-2007, we have sought to reduce our concentration in this and other higher risk loan categories. In the future, we intend to increase our focus on small business and private banking customers. As we seek to change the mix of our loan portfolio and reduce our higher risk loan concentrations, it is possible that our total loan balance may decline, which in turn may negatively impact interest income.

Strong competition within our market areas may limit our growth and profitability. Competition in the banking and financial services industry is intense. In our market areas, we compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Some of our competitors have greater name recognition and market presence that benefit them in attracting business, and offer certain services that we do not or cannot provide. In addition, larger competitors may be able to price loans and deposits more aggressively than we do, which could affect our ability to grow and remain profitable on a long-term basis. Our profitability depends upon our continued ability to successfully compete in our market areas. If we must raise interest rates paid on deposits or lower interest rates charged on our loans, our net interest margin and profitability could be adversely affected. For additional information see “– Competition” on page     .

The financial services industry could become even more competitive as a result of continuing technological changes and increasing consolidation. Technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than we can.

We are subject to extensive regulation and oversight, and, depending upon the findings and determinations of our regulatory authorities, we may be required to make adjustments to our business, operations or financial position and could become subject to formal or informal regulatory action. We are subject to extensive regulation and supervision, including examination by federal and state banking regulators. Federal and state regulators have the ability to impose substantial sanctions, restrictions and requirements on us if they determine, upon conclusion of their examination or otherwise, violations of laws with which we must comply or weaknesses or failures with respect to general standards of safety and soundness, including, for example, in respect of any financial concerns that the regulators may identify and desire for us to address. Such enforcement may be formal or informal and can include directors’ resolutions, memoranda of understanding, consent orders, civil money penalties and termination of deposit insurance and bank closure. Enforcement actions may be taken regardless of the capital levels of the institutions, and regardless of prior examination findings. In particular, institutions that are not sufficiently capitalized in accordance with regulatory standards may also face capital directives or prompt corrective actions. Enforcement actions may require certain corrective steps (including staff additions or changes), impose limits on activities (such as lending, deposit taking, acquisitions, paying dividends or branching), prescribe lending parameters (such as loan types, volumes and terms) and require additional capital to be raised, any of which could adversely affect our financial condition and results of operations. The imposition of regulatory sanctions, including monetary penalties, may have a material impact on our financial condition and results of operations and/or damage our reputation. In addition, compliance with any such action could distract management’s attention from our operations, cause us to incur significant expenses, restrict us from engaging in potentially profitable activities and limit our ability to raise capital. See “– Memoranda of Understanding” on page     .

Financial reform legislation enacted by Congress in 2010 is expected to increase our costs of operations. In 2010, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). This new law significantly changes the current bank regulatory structure and affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations. Although some of these regulations have been promulgated or issued for comment in recent months, many of these required regulations are still being drafted. Consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.

Certain provisions of the Dodd-Frank Act will have a near-term effect on us. For example, the federal prohibitions on paying interest on demand deposits will be eliminated on July 21, 2011, thus allowing businesses to have interest-bearing checking accounts. Depending on competitive responses, this significant change to existing law could have an adverse effect

 

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on our interest expense and could adversely impact our ability to compete with larger financial institutions that have more diverse sources of revenues which may allow them to offer higher interest rates on certain types of demand deposit accounts.

The Dodd-Frank Act permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008, and noninterest bearing transaction accounts have unlimited deposit insurance through December 31, 2012. This increase will result in a larger amount of insured deposits, thereby possibly increasing the amounts of deposit insurance assessments imposed by the FDIC. The Dodd-Frank Act also broadened the base for insurance fund assessments by calculating the assessment owed by an institution in relation to its average consolidated total assets less its tangible equity capital. It also required that institutions having more than $10 billion in assets bear a disproportionate share of the assessments necessary to raise the FDIC’s reserve ratio to 1.35% of insured deposits by 2020. Although the broadening of the assessment base and the placing of a disproportionate share upon larger institutions have had a positive impact upon the deposit insurance expense of the Bank and other community financial institutions, there can be no assurance that a variety of factors, including the increase in insured deposits covered by FDIC deposit insurance, a continued high incidence of bank failures, and possible increases in the FDIC reserve ratio beyond 1.35%, will not cause the Bank’s deposit insurance expense to increase significantly in the future.

The Dodd-Frank Act requires publicly traded companies to provide shareholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and authorizes the Securities and Exchange Commission (“SEC”) to promulgate rules that would allow shareholders to nominate their own candidates using a company’s proxy materials. The legislation also directs the Board of Governors of the Federal Reserve System (the “Federal Reserve”) to promulgate rules prohibiting excessive compensation paid to executives of banks and bank holding companies having more than $1.0 billion in assets, regardless of whether the company is publicly traded or not.

The Dodd-Frank Act creates a new Consumer Financial Protection Bureau (the “Bureau”) with broad powers to supervise and enforce consumer protection laws. The Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Bureau also has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Smaller banks and savings institutions will be examined by their applicable bank regulators. The Dodd-Frank Act also weakens the federal preemption rules that have been applicable for national banks and federal savings associations, and gives state attorneys general the ability to enforce federal consumer protection laws.

It is expected that the Dodd-Frank Act and the regulations it requires could increase the interest and operating expenses of the Bank and comparable financial institutions. It is also expected that a number of the provisions of the Dodd-Frank Act and related regulations could adversely impact the mortgage loan and small business loan activities of the Bank and other community financial institutions. These include restricting the methods by which the compensation of mortgage originators may be calculated; creating potential defenses to foreclose upon defaulted home mortgage loans not meeting characteristics established by federal banking regulators; limiting the ability of community financial institutions to originate and sell certain types of home mortgages to securitizers of mortgage-backed securities; and requiring the collection and reporting of substantial data and certain types of small business loan applications. Although neither the possible increase in the Bank’s interest and operating expenses, nor any one or more of the other aspects of the Dodd-Frank Act discussed above may have a material effect upon our future financial performance by themselves, the specific impact of the Dodd-Frank Act cannot be determined with specificity until after all required or otherwise proposed regulations are issued in final form. We believe that our operating income will be adversely affected, as will the operating income of other community financial institutions, in the future as a consequence of the implementation of the Dodd-Frank Act. Because of the current uncertainty about the schedule of implementation, the breadth of the regulations expected to be issued, and other similar factors, we cannot quantify the amount of any adverse impact.

We depend on our management team to implement our business strategy and execute successful operations and we could be harmed by the loss of their services. We are dependent upon the services of our management team. Our strategy and operations are directed by the executive management team. Any loss of the services of our President and Chief Executive Officer or other members of our management team could impact our ability to implement our business strategy, and have a material adverse effect on our results of operations and our ability to compete in our markets.

The fair value of our investments could decline. As of March 31, 2011, our entire investment portfolio was designated as available-for-sale. Unrealized gains and losses in the estimated value of the available-for-sale portfolio must be “marked to market” and reflected as a separate item in shareholders’ equity (net of tax) as accumulated other comprehensive income. Shareholders’ equity will continue to reflect the unrealized gains and losses (net of tax) of these investments. The fair value of our investment portfolio may decline, causing a corresponding decline in shareholders’ equity.

 

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Continued or further declines in the value of certain investment securities could require write-downs, which would reduce our earnings. Our securities portfolio includes securities that have declined in value due to negative perceptions about the health of the municipal securities sector. A prolonged decline in the value of these or other securities could result in an other-than-temporary impairment write-down which would reduce our earnings.

If our investment in the common stock of the Federal Home Loan Bank (“FHLB”) of Atlanta is classified as other-than-temporarily impaired or as permanently impaired, our earnings and shareholders’ equity could decrease. We own common stock of the FHLB of Atlanta. We hold this stock to qualify for membership in the FHLB system and to be eligible to borrow funds under the FHLB of Atlanta’s credit advances program. The aggregate cost and fair value of our FHLB of Atlanta common stock as of March 31, 2011 was $11.0 million, based on its par value. There is no market for this stock.

Published reports indicate that certain member banks of the FHLB system may be subject to accounting rules and asset quality risks that could result in materially lower regulatory capital levels. In an extreme situation, it is possible that the capital of a FHLB, including the FHLB of Atlanta, could be substantially diminished or reduced to zero. Consequently, we believe that there is a risk that our investment in FHLB of Atlanta common stock could be impaired at some time in the future, and if this occurs, it would cause our earnings and shareholders’ equity to decrease by the after-tax amount of the impairment charge.

Changes in accounting standards could affect reported earnings. The accounting standard setters, including the Public Company Accounting Oversight Board (“PCAOB”), the Financial Accounting Standards Board (“FASB”), the SEC and other regulatory bodies, periodically change the financial accounting and reporting standards that governs or will govern, following the conversion, the preparation of our consolidated financial statements. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply new or revised guidance retroactively.

We are subject to environmental liability risk associated with our lending activities. A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations of enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations.

Severe weather, natural disasters, acts of war or terrorism, and other external events could significantly impact our business. Severe weather, natural disasters, acts of war or terrorism, and other adverse external events could have a significant impact on our ability to conduct business. Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue, and/or cause us to incur additional expenses. Although management has established disaster recovery plans and procedures, the occurrence of any such event could have a material adverse effect on our business, financial condition, and results of operations.

Risks Related to the Offering

We have broad discretion in using the net proceeds of the offering. Our failure to effectively use such proceeds could reduce our profits. We will contribute up to 90% of the net proceeds to the Bank to strengthen its capital position and help expedite plans to dispose of adversely classified assets. Subject to the terms of the Bancorp MOU, if it has not then been terminated, we may use the remaining net proceeds to pay dividends to shareholders, repurchase shares of our common stock, purchase investment securities, make further investments in the Bank, acquire other financial services companies or for other general corporate purposes. Subject to any required regulatory approvals, the Bank may use the proceeds it receives to fund new loans, establish or acquire new branches, purchase investment securities, reduce a portion of our borrowings, or for general corporate purposes. We have not identified specific amounts of proceeds for any of these purposes and we will have significant flexibility in determining the amount of net proceeds we apply to different uses and the timing of such applications. Our failure to utilize these funds effectively could reduce our profitability. We have not established a timetable

 

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for the effective deployment of the proceeds and we cannot predict how long we will require to effectively deploy the proceeds.

The future price of our common stock may be less than the purchase price in the offering. If you purchase shares of common stock in the offering, you may not be able to sell them at or above the purchase price in the offering. The aggregate purchase price of the shares of common stock sold in the offering is determined by an independent, third-party appraisal. The appraisal is not intended, and should not be construed, as a recommendation of any kind as to the advisability of purchasing shares of common stock. Following the completion of the offering, our aggregate pro forma market value will be based on the market trading price of the shares, and not the final, approved independent appraisal, which may result in our stock trading below the initial offering price of $10.00 per share.

We have never issued capital stock and there is no guarantee that a liquid market will develop. We have never issued capital stock and there is no established market for our common stock. We expect that our common stock will be listed for trading on the NASDAQ Global Market under the symbol “        ,” subject to completion of the offering and compliance with certain conditions, including the presence of at least three registered and active market makers. Raymond James & Associates, Inc. has advised us that it intends to make a market in shares of our common stock following the offering, but it is under no obligation to do so or to continue to do so once it begins. While we will attempt before completion of the offering to obtain commitments from at least two other broker-dealers to make a market in shares of our common stock, we may not be able to obtain such commitments. This would result in our common stock not being listed for trading on the NASDAQ Global Market, which could reduce the liquidity of our common stock.

Our ability to realize our deferred tax asset and deduct certain future losses could be limited if we experience an ownership change as defined in the Internal Revenue Code of 1986, as amended (“Code”). Section 382 of the Code may limit the benefit of both net operating losses incurred to date and future “built-in-losses” which exist at the time of an “ownership change.” A Section 382 “ownership change” occurs if a shareholder or a group of shareholders who are deemed to own at least 5% of our common stock increase their ownership by more than 50% over their lowest ownership percentage within a rolling three-year period. If an “ownership change” occurs, Section 382 would impose an annual limit on the amount of losses we can use to reduce our taxable income equal to the product of the total value of our outstanding equity immediately prior to the “ownership change” and the federal long-term tax-exempt interest rate in effect for the month of the “ownership change.” A number of special rules apply to calculating this limit. The limitations contained in Section 382 apply for a five-year period beginning on the date of the “ownership change” and any losses that are limited by Section 382 may be carried forward and reduce our future taxable income for up to 20 years, after which they expire. The completion of this offering could cause us to experience an “ownership change”. Even if we do not experience an “ownership change” immediately following the closing of the offering, the conversion and the offering materially increase the risk that we could experience an “ownership change” in the future. The relevant calculations under Section 382 are technical and highly complex. If an “ownership change” were to occur, it is possible that the limitations imposed could cause a net increase in our federal income tax liability and cause federal income taxes to be paid earlier than if such limitations were not in effect. Any such “ownership change” could have a material adverse effect on our results of operations and financial condition.

We will need to implement additional finance and accounting systems, procedures and controls in order to satisfy our new public company reporting requirements. This will increase our operating expenses. In connection with the offering, we are becoming a public company. Following the conversion, federal securities laws and regulations of the SEC will require that we file annual, quarterly and current reports and that we maintain effective disclosure controls and procedures and internal control over financial reporting. We expect that the obligations of being a public company, including substantial public reporting obligations, will require significant expenditures and place additional demands on our management team. These obligations will increase our operating expenses and could divert our management’s attention from our operations. Compliance with the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) and the related rules and regulations of the SEC will require us to certify the adequacy of our internal controls and procedures, which will require us to upgrade our accounting and reporting processes, and hire additional accounting, internal audit and/or compliance personnel, which will increase our operating costs.

The implementation of stock-based benefit plans may dilute your ownership interest and increase our costs, which will reduce our income. Historically, shareholders have approved these stock-based benefit plans. We intend to adopt one or more stock-based benefit plans, no sooner than 12 months after the offering, which will allow participants to be awarded shares of common stock (at no cost to them) or options to purchase shares of our common stock, following the offering. Any awards of common stock will be expensed by us over their vesting period at the fair market value of the shares on the date they are awarded. These stock-based benefit plans will be funded through either open market purchases of shares of common stock and/or from the issuance of authorized but unissued shares of common stock. Our ability to repurchase

 

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shares of common stock to fund these plans will be subject to many factors, including, but not limited to, applicable regulatory restrictions on stock repurchases, the availability of stock in the market, the trading price of the stock, our capital levels, alternative uses for our capital and our financial performance. If we do not repurchase shares of common stock to fund these plans, then shareholders would experience a reduction in their ownership interest.

Although the implementation of the stock-based benefit plan will be subject to shareholder approval, historically, the overwhelming majority of stock-based benefit plans adopted by savings institutions and their holding companies following mutual-to-stock conversions have been approved by shareholders.

We intend to enter into employment and change of control agreements with certain of our officers, all of which may increase our compensation costs or increase the cost of acquiring us. We intend to enter into employment and change of control agreements with Roger D. Plemens, our President and Chief Executive Officer, W. David Sweatt, Executive Chairman of the Bank, and Gary L. Brown, our First Vice President and Chief Credit Officer. In the event of termination of employment of all three of these persons other than for cause, or in the event of certain types of termination following a change in control, as set forth in the agreements, and assuming the agreements were in effect, the agreements provide for cash severance benefits that would cost up to approximately $         million in the aggregate.

Bancorp has outstanding subordinated debentures, which will rank senior to our common stock. Bancorp has issued $14.4 million in subordinated debentures in connection with the issuance of trust preferred securities by its trust subsidiary. These debentures will rank senior to shares of our common stock. As a result, we must make dividend payments on the trust preferred securities before any dividends can be paid on the common stock and, in the event of our bankruptcy, dissolution or liquidation, the holders of the trust preferred securities must be satisfied before any distributions can be made on the common stock. In order to preserve capital, as required by the Bancorp MOU, Bancorp has deferred payment of dividends on the trust preferred securities since December 30, 2010, and we do not intend to seek FRB approval to resume paying dividends until after the offering closes. If we do not resume payment of dividends on the trust preferred securities including payment of any deferred dividends and applicable interest, no dividends may be paid on the common stock. If we do not resume payment of dividends on the trust preferred securities including payment of any deferred dividends and applicable interest, before December 2015, we will be considered to be in default.

Our articles of incorporation and bylaws may prevent or impede the holders of our common stock from obtaining representation on the Board of Directors and may impede any takeovers of us; this may negatively affect our stock price. Provisions in our articles of incorporation (our “Articles”) and bylaws (our “Bylaws”) may prevent or impede holders of our common stock from obtaining representation on our Board of Directors and may make takeovers of us more difficult. For example, it is anticipated that following our first annual meeting of shareholders our Board of Directors will be divided into three staggered classes. A classified board of directors makes it more difficult for shareholders to change a majority of the directors because it generally takes at least two annual elections of directors for this to occur. Our Articles include a provision that for three years following the conversion, no person will be entitled to vote any shares of our common stock in excess of 10% of our outstanding shares of common stock. Our Articles and Bylaws restrict who may call special meetings of shareholders and how directors may be removed from office. Additionally, in certain instances, a supermajority vote of our shareholders may be required to approve a merger or other business combination with a large shareholder, if the proposed transaction is not approved by a majority of our directors. See “– Certain Restrictions Having Anti-Takeover Effect” on page     .

Our common stock will not be FDIC insured. Our common stock is not a savings or deposit account or other obligation of any bank and is not insured by the FDIC or any other governmental agency and is subject to investment risk, including the possible loss of principal. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this prospectus and is subject to the same market forces that affect the price of common stock in any company. As a result, holders of our common stock may lose some or all of their investment.

 

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SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA

The summary financial information presented below is derived in part from our Consolidated Financial Statements. The following is only a summary and you should read it in conjunction with the Consolidated Financial Statements and Notes beginning on page     . The information at December 31, 2010 and 2009 and for the years ended December 31, 2010 and 2009 is derived in part from our audited Consolidated Financial Statements that appear in this prospectus. The operating data for the three months ended March 31, 2011 and 2010 and the financial condition data at March 31, 2011 and 2010, was not audited. However, in the opinion of our management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the results of operations for the unaudited periods have been made. No adjustments were made other than normal recurring entries. The results of operations for the three months ended March 31, 2011 are not necessarily indicative of the results of operations that may be expected for the entire year.

 

     At March  31,
2011
     At December 31,  
      2010      2009      2008      2007      2006  
     (Dollars in thousands)  

Selected Financial Condition Data:

                 

Total assets

   $ 932,845       $ 1,021,777       $ 1,078,537       $ 1,114,528       $ 1,047,901       $ 988,363   

Cash and cash equivalents

     20,290         18,048         34,344         26,629         16,145         14,360   

Securities available for sale

     154,803         216,797         193,577         208,484         139,784         135,521   

Loans receivable, net

     667,714         698,309         753,966         802,804         819,615         784,578   

Bank owned life insurance

     18,476         18,315         17,701         17,074         10,631         11,739   

FHLB stock, at cost

     10,979         10,979         12,288         12,616         13,522         10,065   

Real estate owned

     23,491         21,511         22,829         5,531         2,198         1,651   

Deposits

     782,135         798,419         790,408         716,005         675,896         697,989   

FHLB advances

     65,900         128,400         178,400         238,400         259,950         183,500   

Securities sold under agreements to repurchase

     —           —           —           —           —           10,000   

Other borrowings

     —           —           —           40,000         —           —     

Junior subordinated debt

     14,433         14,433         14,433         14,433         14,433         14,433   

Total net worth

     56,330         65,968         81,631         88,744         81,080         69,792   

 

     For the three months ended March 31,     For the years ended December 31,  
     2011     2010     2010     2009     2008      2007      2006  
     (Dollars in thousands)  

Selected Operating Data:

                

Interest and dividend income

   $ 10,314      $ 12,521      $ 47,326      $ 56,020      $ 64,725       $ 71,599       $ 64,934   

Interest expense

     4,243        5,508        20,451        26,115        33,296         38,323         32,364   
                                                          

Net interest income

     6,071        7,013        26,875        29,905        31,429         33,276         32,570   

Provision for loan losses

     9,765        3,849        18,926        21,851        6,210         1,995         1,695   
                                                          

Net interest and dividend income (loss) after provision for loan losses

     (3,694     3,164        7,949        8,054        25,219         31,281         30,875   

Noninterest income

     2,682        2,006        6,689        8,292        6,412         6,221         6,281   

Noninterest expense

     7,885        5,870        25,191        30,224        22,206         21,588         20,251   
                                                          

Income (loss) before income tax expense (benefit)

     (8,897     (700     (10,553     (13,878     9,425         15,914         16,905   

Income tax expense (benefit)

     —          (463     3,705        (6,091     2,964         5,206         6,364   
                                                          

Net income (loss)

   $ (8,897   $ (237   $ (14,258   $ (7,787   $ 6,461       $ 10,708       $ 10,541   
                                                          

 

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    At or for the three months ended
March 31,
    At or for the years ended December 31,  
    2011     2010     2010     2009     2008     2007     2006  

Selected Financial Ratios and Other Data (1) :

             

Performance Ratios:

             

Return on average assets (ratio of net income to average total assets)

    (3.49 )%      (0.09 )%      (1.32 )%      (0.70 )%      0.60     1.05     1.10

Return on average equity (ratio of net income to average equity)

    (56.94     (1.16     (17.98     (8.82     7.68        14.17        16.51   

Tax equivalent net interest rate spread

    2.58        2.75        2.61        2.70        2.76        2.95        3.30   

Tax equivalent net interest margin

    2.71        2.93        2.77        2.95        3.13        3.43        3.65   

Efficiency ratio (2)

    90.08        65.08        75.05        79.13        58.68        54.66        52.12   

Core efficiency ratio (3)

    67.72        54.67        57.19        54.44        55.84        54.34        51.78   

Noninterest expense to average total assets

    3.10        2.17        2.33        2.71        2.05        2.11        2.11   

Average interest-earning assets to average interest-bearing liabilities

    107.07        107.95        108.17        109.88        111.55        112.26        109.58   

Equity to assets

    6.04        7.54        6.46        7.57        7.96        7.74        7.06   

Tangible equity to tangible assets (4)

    5.80        7.29        6.22        7.31        7.71        7.42        6.76   

Average equity to average assets

    6.14        7.54        7.34        7.91        7.76        7.38        6.66   

Asset Quality Ratios:

             

Non-performing loans to total loans (5)

    10.59     6.34     10.53     5.64     5.31     0.69     0.54

Non-performing assets to total assets (5)

    10.36        6.71        9.50        6.17        4.40        0.76        0.60   

Allowance for loan losses to non-performing loans

    28.52        20.11        22.75        40.67        30.27        165.11        188.23   

Allowance for loan losses to total loans

    3.03        2.42        2.40        2.30        1.61        1.15        1.02   

Net charge-offs to average loans

    3.48        1.76        2.61        2.17        0.31        0.07        0.02   

Loan loss provision/ net charge-offs

    160.19        114.42        97.04        126.70        242.29        1,042.04        1,086.54   

Capital Ratios (Bank level only):

             

Total capital (to risk-weighted assets)

    11.55     13.46     12.18     13.36     13.86     12.94     12.10

Tier I capital (to risk-weighted assets)

    10.28        12.20        10.91        12.10        12.60        11.75        11.03   

Tier I capital (to average assets)

    7.07        8.78        7.63        8.55        9.25        9.18        8.44   

Capital Ratios (Company):

             

Total capital (to risk-weighted assets)

    11.54     13.48     12.18     13.38     13.88     12.96     12.12

Tier I capital (to risk-weighted assets)

    10.27        12.22        10.92        12.12        12.63        11.78        11.06   

Tier I capital (to average assets)

    7.06        8.79        7.64        8.57        9.30        9.20        8.46   

Other Data:

             

Number of offices

    11        11        11        11        11        11        10   

Full time equivalent employees

    175        178        175        179        188        196        192   

 

(1) Financial ratios for the quarters ended March 31, 2011 and 2010 are annualized.
(2) The efficiency ratio represents noninterest expense divided by the sum of net interest income and noninterest income.
(3) The core efficiency ratio represents noninterest expense excluding loss on real estate owned, real estate owned expense, and, in the March 31, 2011 quarter, gain on sale of investments and FHLB advance prepayment fee expense, divided by the sum of net interest income and noninterest income. Quarter ended March 31, 2011 securities gains and FHLB advance prepayment expense resulted from a one-time portfolio restructuring. See “Comparison of Operating results for the Three Months Ended March 31, 2011 and 2010” on page    .
(4) Tangible equity and tangible assets are net of mortgage servicing rights, which are the only intangible asset.
(5) Non-performing loans include non-accruing loans, loans delinquent 90 days or greater and still accruing interest, and troubled debt restructurings still accruing interest.

The following table shows the differences between the efficiency ratio and core efficiency ratio for the periods indicated, and the adjustments to reconcile equity to tangible equity.

 

     For the three months ended
March 31,
    For the years ended December 31,  
     2011     2010     2010     2009     2008     2007     2006  

Efficiency ratio

     90.08     65.08     75.05     79.13     58.68     54.66     52.12

Non interest expense - GAAP

   $ 7,885      $ 5,870      $ 25,191      $ 30,224      $ 22,206      $ 21,588      $ 20,251   

Effect to adjust non interest expense:

              

Loss on real estate owned

     845        827        5,127        8,690        837        30        26   

Real estate owned expense

     806        112        870        738        237        96        107   

FHLB advance prepayment - restructuring transaction

     1,412        —          —          —          —          —          —     
                                                        

Core Non interest expense

   $ 4,822      $ 4,931      $ 19,194      $ 20,796      $ 21,132      $ 21,462      $ 20,118   

Non interest income - GAAP

   $ 2,682      $ 2,006      $ 6,689      $ 8,292      $ 6,412      $ 6,221      $ 6,281   

Effect to adjust non interest income:

              

Gain on sale of investments - restructuring transaction

     1,633        —          —          —          —          —          —     
                                                        

Core non interest income

   $ 1,049      $ 2,006      $ 6,689      $ 8,292      $ 6,412      $ 6,221      $ 6,281   

Net interest income - GAAP

     6,071        7,013        26,875        29,905        31,429        33,276        32,570   

Net effect to adjust core efficiency ratio

     22.36     10.41     17.87     24.68     2.84     0.32     0.34

Core efficiency ratio

     67.72        54.67        57.19        54.44        55.84        54.34        51.78   
     For the quarter ended
March 31,
     For the years ended December 31,  
     2011      2010      2009      2008      2007      2006  

Equity

   $ 56,330       $ 65,968       $ 81,631       $ 88,744       $ 81,080       $ 69,792   

Effect to adjust for intangibles:

                 

Mortgage loan servicing rights

     2,370         2,533         3,024         3,042         3,582         3,210   
                                                     

Tangible equity

   $ 53,960       $ 63,435       $ 78,607       $ 85,702       $ 77,498       $ 66,582   

The core efficiency ratio above excludes the effects of loss from the sale of REO, and REO expenses from the maintenance of properties while held as REO. The core efficiency ratio also excludes the March 31, 2011 quarter gain on sale of investments income and FHLB prepayment fees that resulted from restructuring to our balance sheet.

 

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may” and words of similar meaning. These forward-looking statements include, but are not limited to:

 

   

statements of our goals, intentions and expectations;

 

   

statements regarding our business plans, prospects, growth and operating strategies;

 

   

statements regarding the asset quality of our loan and investment portfolios; and

 

   

estimates of our risks and future costs and benefits.

These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. We are under no duty to and do not take any obligation to update any forward-looking statements after the date of this prospectus.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

 

   

our failure to comply with the terms of the Memoranda;

 

   

the effect of the requirements of the Memoranda to which we are subject and any further regulatory actions;

 

   

our failure to secure the timely termination of the Memoranda;

 

   

general economic conditions, either nationally or in our market areas, that are worse than expected;

 

   

credit quality deterioration which could cause an increase in the provision for credit losses;

 

   

competition among depository and other financial institutions;

 

   

inflation and changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments;

 

   

adverse changes in the securities markets;

 

   

changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;

 

   

our ability to enter new markets successfully and capitalize on growth opportunities;

 

   

our ability to successfully integrate acquired entities, if any;

 

   

changes in consumer spending, borrowing and savings habits;

 

   

changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, FASB, the SEC and the PCAOB;

 

   

changes in our key personnel, and our compensation and benefit plans;

 

   

changes in our financial condition or results of operations that reduce capital available to pay dividends; and

 

   

changes in the financial condition or future prospects of issuers of securities that we own.

Because of these and a wide variety of other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. Please see “Risk Factors” beginning on page     .

HOW WE INTEND TO USE THE PROCEEDS FROM THE OFFERING

Although we cannot determine what the actual net proceeds from the sale of the shares of common stock in the offering will be until the offering is completed, we anticipate that the net proceeds will be between $39.8 million and $54.3 million, or $62.6 million if the offering range is increased by 15%.

We intend to use the net proceeds from the offering as follows:

 

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     Minimum
(4,250,000 shares)
    Midpoint
(5,000,000 shares)
    Maximum
(5,750,000 shares)
    Adjusted Maximum
(6,612,500 shares)
 
     Amount     % of Net
Proceeds
    Amount     % of Net
Proceeds
    Amount     % of Net
Proceeds
    Amount     % of Net
Proceeds
 
                 (Dollars in thousands)              

Offering proceeds

   $ 42,500        $ 50,000        $ 57,500        $ 66,125     

Less: offering expenses

     (2,671       (2,952       (3,557       (3,557  
                                        

Net offering proceeds

     39,829        100.0     47,048        100     54,267        100.0     62,568        100.0

Use of net proceeds:

                

Proceeds contributed to Macon Bank

   $ 35,846        90.0   $ 42,343        90.0   $ 48,840        90.0   $ 56,311        90.0

Proceeds remaining for Macon Financial

     3,983        10.0     4,705        10.0     5,427        10.0     6,257        10.0

The net proceeds may vary because the total expenses of the offering may be more or less than our estimates. For example, our expenses, specifically the commission payable to Raymond James & Associates, Inc., would increase if more shares of common stock are sold in a community or syndicated offering to investors other than our officers, directors or employees that are not otherwise eligible to participate in the subscription offering.

Over time we intend to use the proceeds we retain from the offering:

 

   

to invest in securities issued by the U.S. Government, U.S. Government agencies and/or U.S. Government sponsored enterprises, mortgage-backed securities and equities, collateralized mortgage obligations and municipal securities;

 

   

to resume payment of dividends on our trust preferred securities, as well as previously deferred dividends and applicable interest;

 

   

to pay cash dividends to shareholders;

 

   

to repurchase shares of our common stock; and

 

   

for other general corporate purposes.

We have not quantified our plans for use of the offering proceeds for any of the foregoing purposes. Initially, we intend to invest a substantial portion of the net proceeds in short-term investments, investment-grade debt obligations and mortgage-backed securities.

The Bank intends to use the net proceeds it receives from the offering:

 

   

to strengthen its capital position;

 

   

to fund new loans;

 

   

to repay borrowings;

 

   

to invest in mortgage-backed securities and collateralized mortgage obligations, and debt securities issued by the U.S. Government, U.S. Government agencies and/or U.S. Government sponsored enterprises;

 

   

to expand its banking franchise by establishing or acquiring new branches, or by acquiring other financial institutions or other financial services companies; and

 

   

for other general corporate purposes.

The Bank has not quantified its plans for use of the offering proceeds for any of the foregoing purposes. Our short-term and long-term growth plans anticipate that, upon completion of the offering, we will experience growth through increased lending and investment activities and, possibly, acquisitions. We currently have no understandings or agreements to establish or acquire new branches, acquire other banks, thrifts, or other financial services companies. Additionally, there can be no assurance that we will be able to consummate any acquisition.

OUR POLICY REGARDING DIVIDENDS

Notwithstanding the completion of the offering, our Board of Directors may not declare dividends on our shares of common stock, unless and until we have resumed paying dividends on our trust preferred securities and, if the Bancorp MOU has not been terminated, we receive the prior approval of the FRB. Upon satisfying these conditions, our Board of Directors

 

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will have the authority to declare dividends on our shares of common stock subject to statutory and regulatory requirements generally applicable to bank holding companies. However, initially we do not intend to pay cash dividends.

In determining whether to pay a cash dividend in the future and the amount of such cash dividend, our Board of Directors is expected to take into account a number of factors, including capital requirements, our consolidated financial condition and results of operations, tax considerations, statutory and regulatory limitations and general economic conditions. No assurances can be given that the Bancorp MOU will be terminated following the conversion, or that if not terminated, the FRB will approve either payments for our trust preferred securities or dividends on our common stock. No assurances can be given that any dividends will be paid or that, if paid, will not be reduced or eliminated in the future. We will file a consolidated federal tax return with the Bank. Accordingly, it is anticipated that any cash distributions made by us to our shareholders would be treated as cash dividends and not as a non-taxable return of capital for federal and state tax purposes.

Pursuant to our Articles, we are authorized to issue preferred stock. If we issue preferred stock, the holders thereof could have a priority over the holders of our shares of common stock with respect to the payment of dividends. For a further discussion concerning the payment of dividends on our shares of common stock, see “– Common Stock” on page     . Initially, dividends we can declare and pay will depend upon the proceeds retained from the offering, the earnings received from the investment of those proceeds and prior approval of the FRB or termination of the Bancorp MOU. In the future, dividends will depend in large part upon receipt of dividends from the Bank, because we expect to have limited sources of income other than dividends from the Bank. A regulation of the Commissioner imposes limitations on “capital distributions” by savings institutions. See “– Capital Distributions” on page     .

Any payment of dividends by the Bank to us that would be deemed to be drawn out of the Bank’s bad debt reserves, if any, would require a payment of taxes at the then-current tax rate by the Bank on the amount of earnings deemed to be removed from the reserves for such distribution. The Bank does not intend to make any distribution to us that would create such a tax liability.

MARKET FOR THE COMMON STOCK

We have never issued capital stock and there is no established market for our shares of common stock. We expect that our shares of common stock will be listed for trading on the NASDAQ Global Market under the symbol “    ,” subject to completion of the offering and compliance with certain conditions, including the presence of at least three registered and active market makers. Raymond James & Associates, Inc. has advised us that it intends to make a market in shares of our common stock following the offering, but it is under no obligation to do so or to continue to do so once it begins. While we will attempt, before completion of the offering, to obtain commitments from at least two other broker-dealers to make a market in shares of our common stock, there can be no assurance that we will be successful in obtaining such commitments.

The development and maintenance of a public market, having the desirable characteristics of depth, liquidity and orderliness, depends on the presence of willing buyers and sellers, the existence of which is not within our control or that of any market maker. The number of active buyers and sellers of shares of our common stock at any particular time may be limited, which may have an adverse effect on the price at which shares of our common stock can be sold. There can be no assurance that persons purchasing the shares of common stock will be able to sell their shares at or above the $10.00 offering purchase price per share. You should have a long-term investment intent if you purchase shares of our common stock and you should recognize that there may be a limited trading market in the shares of common stock.

HISTORICAL AND PRO FORMA REGULATORY CAPITAL COMPLIANCE

At March 31, 2011 and December 31, 2010, Bancorp and the Bank exceeded all of the applicable regulatory capital ratios to be considered “well capitalized” under the regulatory framework for prompt corrective action. However, pursuant to the Bank MOU, the Bank is required to maintain elevated capital levels. At March 31, 2011, the Bank did not satisfy the elevated capital ratios required by the Bank MOU. The table below sets forth the historical equity capital and regulatory capital of the Bank at March 31, 2011, and the pro forma regulatory capital of the Bank after giving effect to the sale of shares of common stock at a $10.00 per share purchase price. The table assumes the receipt by the Bank of 90% of the net offering proceeds. See “How We Intend to Use the Proceeds from the Offering” on page     .

 

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Table of Contents
           Pro Forma at March 31, 2011  
     Actual, as of
March 31, 2011
    Minimum     Midpoint     Maximum     Maximum as
Adjusted
 
     Amount     Percent
of Assets (1)
    Amount      Percent
of Assets
    Amount      Percent
of Assets
    Amount      Percent
of Assets
    Amount      Percent
of Assets
 
     (Dollars in thousands)  

Capital and retained earnings under GAAP Bank level

   $ 70,405        7.55   $ 106,251         10.97   $ 112,748         11.56   $ 119,245         12.15   $ 126,716         12.81
                                                                                    

Tier 1 leverage (2)

   $ 70,394        7.07   $ 106,240         10.30   $ 112,737         10.86   $ 119,234         11.41   $ 126,705         12.04

Requirement

     79,687        8.00     82,555         8.00     83,074         8.00     83,594         8.00     84,192         8.00
                                                                                    

Excess (Deficit)

   ($ 9,293     -0.93   $ 23,685         2.30   $ 29,663         2.86   $ 35,640         3.41   $ 42,513         4.04
                                                                                    

Tier I risk-based (2)

   $ 70,394        10.28   $ 106,240         15.35   $ 112,737         16.26   $ 119,234         17.16   $ 126,705         18.20

Requirement

     54,791        8.00     55,365         8.00     55,469         8.00     55,573         8.00     55,692         8.00
                                                                                    

Excess (Deficit)

   $ 15,603        2.28   $ 50,875         7.35   $ 57,266         8.26   $ 63,661         9.16   $ 71,013         10.20
                                                                                    

Total risk-based (3)

   $ 79,109        11.55   $ 114,955         16.61   $ 121,452         17.52   $ 127,949         18.42   $ 135,420         19.45

Requirement

     82,187        12.00     83,047         12.00     83,203         12.00     83,359         12.00     83,538         12.00
                                                                                    

Excess (Deficit)

   ($ 3,078     -0.45   $ 31,908         4.61   $ 38,249         5.52   $ 44,590         6.42   $ 51,882         7.45
                                                                                    

 

(1) 

Tier 1 leverage capital levels are shown as a percentage of adjusted total assets of $996.1 million. Risk-based capital levels are shown as a percentage of risk-weighted assets of $684.9 million.

(2) 

See note      of the Notes to Consolidated Financial Statements for a reconciliation of total capital under GAAP and each of tangible capital, core capital, Tier 1 risked-based capital and total risk-based capital.

(3) 

Pro forma amounts and percentages assume net proceeds are invested in assets that carry a 20% risk-weighting.

CAPITALIZATION

The following table presents our historical consolidated capitalization at March 31, 2011 and our pro forma consolidated capitalization after giving effect to the conversion and the offering, based upon the assumptions set forth in the “Pro Forma Data” section.

 

           As of March 31, 2011  
     Actual, as of
March  31, 2011
    Minimum
4,250,000
Price of
$10.00
per share
    Midpoint
5,000,000
Price of
$10.00
per share
    Maximum
5,750,000
Price of
$10.00
per share
    Maximum
as Adjusted
6,612,500
Price of
$10.00
per share
 

Shares Sold in Offering:

          

Deposits (1)

   $ 782,135      $ 782,135      $ 782,135      $ 782,135      $ 782,135   

Borrowings

     80,333        80,333        80,333        80,333        80,333   
                                        

Total deposits and borrowed funds

   $ 862,468      $ 862,468      $ 862,468      $ 862,468      $ 862,468   
                                        

Shareholders’ equity:

          

Preferred stock, no par value, 10,000,000 shares authorized; none issued or outstanding

   $ —        $ —        $ —        $ —        $ —     

Common stock, no par value, 50,000,000 shares authorized; assuming shares outstanding shown

   $ —        $ 43      $ 50      $ 58      $ 66   

Additional paid-in capital

     —          39,787        46,998        54,210        62,502   

Retained earnings

     56,559        56,559        56,559        56,559        56,559   

Accumulated other comprehensive income (loss)

     (229     (229     (229     (229     (229
                                        

Total shareholders’ equity

   $ 56,330      $ 96,159      $ 103,378      $ 110,597      $ 118,898   
                                        

Total shareholder’s equity as % of pro forma assets

     6.04     9.89     10.55     11.20     11.94

 

(1) 

Does not reflect any reduction in deposits caused by withdrawals for purchase of shares in the offering.

PRO FORMA DATA

The following tables summarize our historical data and pro forma data at and for the three months ended March 31, 2011, and at and for the year ended December 31, 2010. This information is based on assumptions set forth below and in the

 

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table, and should not be used as a basis for projections of market value of the shares of common stock following the conversion and offering.

The net proceeds in the tables are based upon the following assumptions:

 

   

150,000 shares of common stock will be purchased by our executive officers and directors;

 

   

Raymond James & Associates, Inc. will receive a fee equal to (a) 6.0% of the aggregate dollar amount of common stock sold to investors other than eligible depositors and borrowers of the Bank, plus (b) 1.5% of the aggregate dollar amount of common stock sold to eligible depositors and borrowers of the Bank; provided that no commission shall be charged for shares sold to officers, directors, employees or employee benefit plans (if any) of the Bank; and

 

   

expenses of the offering, other than fees and expenses to be paid to Raymond James & Associates, Inc., are estimated to be $949,325.

We calculated pro forma consolidated net income for the three months ended March 31, 2011 and at and for the year ended December 31, 2010, as if the estimated net proceeds we received had been invested at an assumed interest rate of 2.24% (1.36% on an after-tax basis). This represents the yield on the five-year U.S. Treasury Note as of March 31, 2011, which, in light of current market interest rates, we consider to more accurately reflect the pro forma reinvestment rate than the arithmetic average of the weighted average yield earned on our interest-earning assets and the weighted average rate paid on our deposits.

We calculated historical and pro forma per share amounts by dividing historical and pro forma amounts of consolidated net income and shareholders’ equity by the indicated number of shares of common stock. We computed per share amounts for each period as if the shares of common stock were outstanding at the beginning of each period, but we did not adjust per share historical or pro forma shareholders’ equity to reflect the earnings on the estimated net proceeds.

As discussed under “How We Intend to Use the Proceeds from the Offering” on page     , we intend to contribute up to 90% of the net proceeds from the offering to the Bank, and we will retain the remainder of the net proceeds.

The pro forma table does not give effect to:

 

   

withdrawals from deposit accounts for the purpose of purchasing shares of common stock in the offering;

 

   

our results of operations after the offering; or

 

   

changes in the market price of the shares of common stock after the offering.

The following pro forma information may not represent the financial effects of the offering at the date on which the offering actually occurs and you should not use the table to indicate future results of operations. Pro forma shareholders’ equity represents the difference between the stated amount of our assets and liabilities, computed in accordance with GAAP. We did not increase or decrease shareholders’ equity to reflect the difference between the carrying value of loans and other assets and their market values. Pro forma shareholders’ equity is not intended to represent the fair market value of the shares of common stock and may be different than the amounts that would be available for distribution to shareholders if we liquidated. Pro forma shareholders’ equity does not give effect to the impact of intangible assets, the liquidation account we will establish in the conversion or tax bad debt reserves in the unlikely event we are liquidated.

 

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     At or for the three months ended March 31, 2011  
     Minimum
4,250,000
$10.00
per share
    Midpoint
5,000,000
$10.00
per share
    Maximum
5,750,000
$10.00
per share
    Maximum as
Adjusted
6,612,500
$10.00
per share
 
     (Dollars in thousands, except per share amounts)  

Gross proceeds of offering

   $ 42,500      $ 50,000      $ 57,500      $ 66,125   

Less expenses

     (2,671     (2,952     (3,233     (3,557
                                

Estimated net cash proceeds

   $ 39,829      $ 47,048      $ 54,267      $ 62,568   
                                

For the three months ended March 31, 2011

        

Consolidated net (loss)

        

Historical

   ($ 8,897   ($ 8,897   ($ 8,897   ($ 8,897

Pro forma income on net proceeds

     135        160        184        212   
                                

Pro forma net (loss)

   ($ 8,764   ($ 8,738   ($ 8,713   ($ 8,687
                                

Per share net (loss)

        

Historical

   ($ 2.09   ($ 1.78   ($ 1.55   ($ 1.34

Pro forma income on net proceeds

     0.03        0.03        0.03        0.03   
                                

Pro forma net (loss) per share

   ($ 2.06   ($ 1.75   ($ 1.52   ($ 1.31
                                

Offering price as a multiple of pro forma net earnings (loss) per share

     NM        NM        NM        NM   

Number of shares outstanding for pro forma net income per share calculation

     4,250,000        5,000,000        5,750,000        6,612,500   

At March 31, 2011

        

Shareholders’ equity:

        

Historical

   $ 56,330      $ 56,330      $ 56,330      $ 56,330   

Estimated net proceeds

     39,829        47,048        54,267        62,568   
                                

Pro forma shareholders’ equity

   $ 96,159      $ 103,378      $ 110,597      $ 118,898   
                                

Shareholders’ equity per share

        

Historical

   $ 13.25      $ 11.27      $ 9.79      $ 8.52   

Estimated net proceeds

     9.37        9.42        9.44        9.46   
                                

Pro forma shareholders’ equity per share

   $ 22.62      $ 20.69      $ 19.23      $ 17.98   
                                

Offering price as a percentage of pro forma shareholders’ equity per share

     44.21     48.33     52.00     55.62

Number of shares outstanding for pro forma book value per share calculations

     4,250,000        5,000,000        5,750,000        6,612,500   

 

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     At or for the year ended December 31, 2010  
     Minimum
4,250,000
$10.00
per share
    Midpoint
5,000,000
$10.00
per share
    Maximum
5,750,000
$10.00
per share
    Max, As Adj.
6,612,500
$10.00
per share
 
     (Dollars in thousands, except per share amounts)  

Gross Proceeds of Offering

   $ 42,500      $ 50,000      $ 57,500      $ 66,125   

Less Expenses

     (2,671     (2,952     (3,233     (3,557
                                

Estimated net cash proceeds

   $ 39,829      $ 47,048      $ 54,267      $ 62,568   
                                

For the Year Ended December 31, 2010

        

Consolidated net income

        

Historical

   ($ 14,258   ($ 14,258   ($ 14,258   ($ 14,258

Pro forma income on net proceeds

     540        638        735        848   
                                

Pro forma net income

   ($ 13,718   ($ 13,620   ($ 13,523   ($ 13,410
                                

Per share net income

        

Historical

   ($ 3.36   ($ 2.85   ($ 2.48   ($ 2.16

Pro forma income on net proceeds

     0.13        0.13        0.13        0.13   
                                

Pro forma net income per share

   ($ 3.23   ($ 2.72   ($ 2.35   ($ 2.03
                                

Offering price as a multiple of pro forma net earnings per share

     NM        NM        NM        NM   

Number of shares outstanding for pro forma net Income per share calculation

     4,250,000        5,000,000        5,750,000        6,612,500   

At December 31, 2010

        

Shareholders’ equity:

        

Historical

   $ 65,968      $ 65,968      $ 65,968      $ 65,968   

Estimated net proceeds

     39,829        47,048        54,267        62,568   
                                

Pro forma shareholders’ equity

   $ 105,797      $ 113,016      $ 120,235      $ 128,536   
                                

Shareholders’ equity per share

        

Historical

   $ 15.52      $ 13.19      $ 11.47      $ 9.98   

Estimated net proceeds

     9.37        9.41        9.44        9.46   
                                

Pro forma shareholders’ equity per share

   $ 24.89      $ 22.60      $ 20.91      $ 19.44   
                                

Offering price as a percentage of pro forma shareholders’ equity per share

     40.18     44.25     47.82     51.44

Number of shares outstanding for pro forma book value per share calculations

     4,250,000        5,000,000        5,750,000        6,612,500   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF CONSOLIDATED

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This offering is being made by Macon Financial, a newly formed North Carolina corporation. Upon completion of this offering and the mutual-to-stock conversion, Bancorp, the mutual holding company parent of the Bank, will be merged into Macon Financial, with Macon Financial as the surviving entity, whereby the Bank will become a wholly-owned subsidiary of Macon Financial. Accordingly, this section references the consolidated financial condition and results of operations of Macon Bancorp and Macon Bank.

This section is intended to help potential investors understand our financial performance through a discussion of the factors affecting our consolidated financial condition at March 31, 2011, December 31, 2010 and 2009, and our consolidated results of operations for the three months ended March 31, 2011 and 2010, and the years ended December 31, 2010, and 2009. This section should be read in conjunction with the Consolidated Financial Statements and Notes to the Consolidated Financial Statements that appear elsewhere in this prospectus.

Our Business

Macon Bancorp is a North Carolina chartered mutual holding company headquartered in Franklin, North Carolina. It was organized in 1997, when the Bank converted from a mutual savings bank to a stock savings bank, and owns 100% of the outstanding shares of common stock of the Bank. Bancorp also has one non-bank subsidiary, Macon Capital Trust I, a Delaware statutory trust, formed in 2003 to facilitate the issuance of trust preferred securities. As a mutual holding company, Bancorp has no shareholders and is controlled by the depositors and borrowers of the Bank.

 

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Pursuant to the terms of our plan of conversion, Macon Bancorp will merge with and into Macon Financial, and, in doing so, will convert from a mutual form of organization to a stock form of organization. Upon the completion of the conversion, Bancorp will cease to exist, and the Bank will become a wholly-owned subsidiary of Macon Financial, which will be renamed “Macon Bancorp”.

Macon Bank is a North Carolina chartered stock savings bank headquartered in Franklin, North Carolina. It was organized in 1922, as a North Carolina chartered mutual savings and loan association, and it converted to a North Carolina chartered mutual savings bank in 1992. In 1997, upon the formation of Bancorp, it converted to a North Carolina chartered stock savings bank.

In addition to our corporate headquarters, we have 11 branches located throughout the Western North Carolina counties of Cherokee, Henderson, Jackson, Macon, Polk and Transylvania, which we consider our primary market area. Our business consists primarily of accepting deposits from individuals and small businesses and investing those deposits, together with funds generated from operations and borrowings, primarily in loans secured by real estate, including commercial real estate loans, one- to four-family residential loans, construction loans, home equity loans and lines of credit. We also originate commercial business loans and invest in investment securities. Through our mortgage loan production operations, we originate loans for sale in the secondary markets to Fannie Mae and others, generally retaining the servicing rights in order to generate cash flow, supplement our core deposits with escrow deposits and maintain relationships with local borrowers. We offer a variety of deposit accounts, including savings accounts, certificates of deposit, money market accounts, commercial and regular checking accounts, and individual retirement accounts.

In addition to making loans within our primary market area, we also regularly extend loans to customers located in neighboring counties, including Buncombe, Clay, Haywood and Rutherford in North Carolina; Rabun, Towns and Union in Georgia; and Cherokee, Greenville, Oconee, Pickens and Spartanburg in South Carolina, which we consider our secondary market area. The following table shows deposit market share within the Bank’s primary market area.

Competing Banks and Thrifts

 

Total

Deposit

Rank

2010

  

Institution

   Institution City    Institution
Headquarters
State
   Total
Active
Branches
2000
     Total
Active
Branches
2010
     Total  deposits
(1)

2000
(thousands)
     Total
Deposit
Market
Share
2000
(%)
    Total  deposits
(1)

2010
(thousands)
     Total
Deposit
Market
Share
2010
(%)
 
1    Macon Bank    Franklin    NC      9         11         250,605         9.4     820,204         17.4
2   

First-Citizens Bank &

Trust Co.

   Raleigh    NC      22         17         490,284         18.4     736,358         15.6
3    Wells Fargo Bank NA    Sioux Falls    SD      14         9         461,851         17.3     489,042         10.4
4    United Community Bank    Blairsville    GA      10         11         296,203         11.1     465,146         9.9
5   

Mountain 1st Bank &

Trust Co.

   Hendersonville    NC      0         6         —           0.0     435,959         9.2
6    TD Bank NA    Wilmington    DE      4         8         157,604         5.9     344,581         7.3
7    Home Trust Bank    Clyde    NC      4         3         211,025         7.9     321,634         6.8
8    RBC Bank (USA)    Raleigh    NC      10         7         313,509         11.8     245,719         5.2
9    Bank of America NA    Charlotte    NC      4         4         144,960         5.4     154,829         3.3
10    SunTrust Bank    Atlanta    GA      5         4         176,660         6.6     149,169         3.2

 

(1) Total deposits represent the six counties in which Macon Bank has branches.

Source: FDIC

Recent Operating Challenges and Losses.

We grew significantly in the last decade, increasing our loan portfolio from $333.5 million at December 31, 2000, to a high of $832.6 million at December 31, 2007, before declining to $690.8 million at March 31, 2011. Our construction and development loans grew from $12.2 million at December 31, 2000, to $298.3 million at December 31, 2007, before declining to $154.8 million at March 31, 2011, representing the majority of our loan growth. Many of these construction and development loans were collateralized by developments for second homes. As the national housing bubble burst, the value of the collateral for our construction and development loans and our other loans declined. The decline in real estate values and impact of the recession resulted in a significant level of loan defaults. Accordingly, our level of non-performing assets increased from $4.6 million at December 31, 2000, to $8.0 million at December 31, 2007, and to $96.7 million at March 31, 2011.

The recent increase in our level of non-performing assets resulted in large loan loss provisions, large loan losses and high REO expenses. During the three years ended December 31, 2010 and the quarter ended March 31, 2011, we recorded aggregate net losses of $24.5million. These losses were driven by cumulative provisions for loan losses of $56.8 million over the same period. Our total equity has decreased from $88.7 million at December 31, 2008 to $56.3 million at March 31, 2011. The increase in non-performing assets has also negatively impacted our operations by reducing our level of earning assets and increasing our level of operating expenses to manage these problem assets. Furthermore, due to our increased risk profile, we increased our level of liquidity, which effectively reduced our net interest income.

As a result of the increase in our non-performing assets, our recent losses, the decrease in our equity capital, and other factors, we have received an increased level of scrutiny from our regulators. As described in the section entitled “– Memoranda of Understanding” on page     , the Bank and Bancorp have each entered into an MOU, with their respective banking regulators. The Bank has agreed to, among other things, increase its regulatory capital, reduce lines of credit which are subject to adverse classification, reduce its reliance on volatile liabilities to fund longer term assets, establish and maintain an adequate allowance for loan losses, and establish an enhanced loan loss reserve policy. In addition, the Bank must obtain regulatory approval prior to paying any dividends to Bancorp. Bancorp has agreed to, among other things, not declare or pay any dividends without prior regulatory approval and not take dividends from or otherwise reduce the capital of

 

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the Bank without prior regulatory approval. The Bank MOU requires it to maintain a leverage ratio of 8.0% and a total risk-based capital ratio of 12.0%. The Bank’s capital ratios were below those mandated levels at March 31, 2011.

Operating Strategy and Reasons for the Conversion.

We have developed an operating strategy to reposition the Bank so that it may return to profitability and explore opportunities for growth. We need a significant amount of capital to execute this strategy, and cannot raise this level of capital as a mutual financial institution. We have considered current market conditions and the amount of capital needed in deciding to conduct the conversion at this time, and have established the following three-part operating strategy in order to effectively and efficiently use the proceeds from the offering.

Address Current Challenges. Our first priority is to reduce our level of non-performing and classified assets both in the aggregate and as a percentage of total assets. We also want to become in full compliance with the Memoranda as quickly as possible.

Improve asset quality. As described in the section entitled “                    ” on page     , our non-performing assets have increased during the current adverse credit cycle and were $96.7 million or 10.36% of our total assets at March 31, 2011. During 2010, management appointed an experienced special assets manager and reassigned employees as support staff to increase collection efforts, expedite foreclosure actions, and liquidate real estate owned. We are aggressively addressing our level of non-performing assets through write-downs, collections, modifications and sales of non-performing loans and the sale of properties once they become REO. For the years 2007 through 2010 and through March 31, 2011, we have recorded cumulative net charge-offs of approximately $46.0 million. We are taking proactive steps to resolve our non-performing loans, including negotiating repayment plans, loan modifications and loan extensions with our borrowers when appropriate, working with developers to promote discounted sales events to increase sales and accepting short payoffs on delinquent loans, particularly when such payoffs result in a smaller loss to us than foreclosure. In late 2010, management increased the frequency for problem loan appraisals to six to 12 month intervals, from 12 to 24 months, which resulted in additional loan write-downs. In 2010 and the first quarter of 2011, the Bank liquidated $28.7 million in real estate owned based on loan values at the time of foreclosure, realizing $15.9 million in net proceeds or 55.3% of the foreclosed loan balances. The Bank’s current real estate owned portfolio is comparably valued at 59.8% of loan value at the time of foreclosure. In addition to continuing to pursue the above steps to improve our asset quality, we may consider bulk sales of non-performing assets in order to expedite our strategy for improving asset quality, although we have no firm plans to do so at this time.

We have taken several actions to improve our credit administration practices and reduce the risk in our loan portfolio. We also added experienced personnel, including Gary Brown who was appointed Chief Credit Officer in February, 2011, to our loan department to enable us to better identify problem loans in a timely manner and reduce our exposure to a further deterioration in asset quality. Also, since 2008, we have regularly engaged an independent loan review consulting firm to perform a review of our loan portfolio. The Bank has added new support systems that have improved our underwriting global cash flow analysis, portfolio credit risk assessment, risk grade migration, and loan loss allowance calculation. We have made an effort to reduce our exposure to riskier types of loan structures and collateral both through asking borrowers to pledge additional collateral and by reducing certain segments of our loan portfolio. We have reduced our construction and other construction and land development loan portfolio from $298.3 million at December 31, 2007 to $154.8 million at March 31, 2011.

Compliance with Memoranda of Understanding. As described in the section entitled “– Memoranda of Understanding” on page     , we have taken and continue to take prompt and aggressive action to respond to the issues raised in the Memoranda, including submitting quarterly reports to our banking regulators. Except for the elevated capital requirements, which we anticipate we will satisfy once the conversion is completed, we believe that we are generally in compliance with the Memoranda. However, the Memoranda will each remain in effect until modified, terminated, lifted, suspended or set aside by the applicable banking regulators, and no assurance can be given as to the time that either of the Memoranda will be terminated. While we will seek to demonstrate as soon as possible to our banking regulators that we have fully complied with the requirements of the Memoranda and that they should be terminated, we expect that the Memoranda will remain in effect for the immediate future.

Restore Profitability. Until the current adverse credit cycle, the Bank enjoyed a long history of strong earnings, continuously reporting a profit every year from 1982 through 2008. While we expect to record losses as we continue to resolve non-performing assets, we are focused on returning to profitability.

 

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Improve our net interest margin. Net interest income is our largest source of revenue. Our net interest margin has declined over the past four years. The increase in non-earning assets, especially non-accrual loans and real estate owned, has factored into this decline. We have also maintained an elevated level of liquidity as a result of reduced loan demand in recent periods, which has contributed to our reduced net interest margin. We believe that our net interest margin will improve as we resolve non-performing assets and invest those proceeds into earning assets. Additionally, we took the step of prepaying $42.5 million of high-cost FHLB advances in the first quarter of 2011, which we anticipate will result in an increase in net interest income. Finally, we are working to further improve our base of core deposits and lower our cost of funds.

Increase noninterest income. The majority of the Bank’s noninterest income is the result of our mortgage banking business and customer service fees. We believe that we have the opportunity to increase noninterest income by adding additional lines of business. We have plans to become an active lender of SBA loans and would hope to sell the SBA guaranteed portion of those loans at a gain. We also believe that expanding our focus on small business and private banking customers will increase our opportunities to earn noninterest income.

Continue history of operating expense discipline. Our core efficiency ratio for the quarter ended March 31, 2011 was 67.7%, reflecting the increased expense related to resolving non-performing assets. Historically we have operated more efficiently on a core basis. For the five years 2006 through 2010, our average core efficiency ratio was under 60.0%. This success is the result of a disciplined approach to spending. We have also leveraged technology to drive efficiency throughout our organization. We recently renegotiated our data processing contract and are planning to convert to a debit card processing platform, which we anticipate will result in substantial savings in 2011, and in future years. While our level of core operating expenses will increase as a public company and we will continue to incur expenses to resolve non-performing assets, we are committed to carefully managing expenses.

Increase Small Business and Private Banking Customer Focus and Explore Growth Opportunities. As we implement our operating strategy, we will work to diversify our customer base, and explore various growth opportunities, including those described below. We have no current arrangements or agreements concerning any specific growth opportunities at this time.

Increase small business and private banking customer focus. We believe that we can enhance our franchise value by increasing our focus on small business and private banking customers. We believe that small business and private banking customers value the personalized service that has been our hallmark. These customers also present attractive loan and deposit opportunities that will allow us to diversify our loan portfolio and further increase our level of core deposits. The new members of our management team have substantial experience targeting these types of banking customers. We have enhanced training for our existing lenders in commercial and industrial, and SBA lending. Additionally, we will hire lenders, relationship officers and credit officers experienced in these areas as we grow these lines of business.

Expand into larger, contiguous markets. We are located in close proximity to a number of larger markets with attractive growth opportunities. Many of these markets have a high number of attractive small business and private banking customers. In addition to diversifying our customer mix, these markets would provide geographic diversification for our lending collateral. For instance, we have existing branch offices located near Asheville, North Carolina (30 minutes traveling time along I-26), northwest of Spartanburg, South Carolina (30 minutes traveling time along I-26); and northwest of Greenville, South Carolina (1 hour traveling time along I-26 and I-85). We are also located near Atlanta, Georgia (2 hours), Chattanooga, Tennessee (1.5 hours), Knoxville, Tennessee (2 hours) and Johnson City, Tennessee (1.5 hours).

Capitalize on market disruption. We anticipate that both current and expected consolidation within the banking industry and the increasing number of troubled banks will give rise to attractive growth opportunities. As a result of mergers between banks and recent bank failures, we believe that many customers and bankers may become dissatisfied with their new bank. Many banks do not have sufficient capital to make new loans and are having to cut back on customer service as they focus on managing their problems. We believe that these challenges will result in customer dissatisfaction, which will present us with a better opportunity to do business with these customers. Additionally, we believe that bankers will be dissatisfied with their current employers, and we will have the opportunity to hire away experienced personnel. We believe that we have the appropriate infrastructure and management depth to accommodate future growth, including our use of technology, mortgage loan production operations, call center, and corporate headquarters with centralized loan processing and training facilities.

Organic growth. We are well-established in our primary market area, leading our competitors in market share as of June 30, 2010, according to the most recent publicly reported figures. We believe that this solid market position will allow us to continue to increase our market share. We also believe our core strength in our primary market will enable us to grow into adjacent areas. We have experience opening offices in new markets, having successfully entered new markets in the 1990’s

 

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and 2000’s. We are already making loans in a number of adjacent counties, some of which have similar demographics to our primary market area. We will consider opportunities as they arise to open loan production offices or branch offices in adjacent markets, particularly markets in which we have lending experience.

Future acquisition opportunities. While we are currently focused on repositioning the Bank in the near term, we expect to be able to consider acquisition opportunities in the future. Smaller banks may struggle to support the compliance costs resulting from the adoption of last year’s Dodd-Frank Act. Additionally, smaller banks have fewer ways to raise the capital they need to address current problems and support growth. We believe that these two factors will lead many smaller banks to seek a merger partner. Additionally, we expect to see other banks sell branches either to shrink their balance sheet or to focus on core markets. We will carefully evaluate any future acquisition opportunity to understand the potential impacts, both positive and negative, along with the risks of any transaction.

For further information about our reasons for the conversion and offering, please see “– Reasons for the Conversion” on page     .

Overview

Our results of operations depend primarily on our net interest income, which is the difference between the interest income we earn on our loan and investment portfolios and the interest expense we incur on our deposits and borrowings. Results of operations are also affected by service charges and other fees, provisions for loan losses, gains on sales of loans originated for sale and other income. Our noninterest expense consists primarily of salaries and employee benefits, net occupancy and equipment expense, data processing, professional and services fees, FDIC deposit insurance and other REO expense.

As evidenced by the current economic recession, our results of operations are significantly affected by general economic and competitive conditions in our market areas and nationally, as well as changes in interest rates, sources of funding, government policies and actions of regulatory authorities. Future changes in applicable laws, regulations or government policies may materially affect our financial condition and results of operations.

We do not offer loans that provide for negative amortization of principal, such as “Option ARM” loans, where the borrower can pay less than the interest owed on his or her loan, resulting in an increased principal balance during the life of the loan. We do not offer “sub-prime loans,” i.e., loans that are made with low down-payments to borrowers that have had payment delinquencies, previous loan charge-offs, judgments and bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios.

Historically, the majority of the loans that we originate for sale in secondary markets have been underwritten and sold to Fannie Mae. Since 2003, approximately 93% of all loans sold by us have been sold to Fannie Mae. We originated a small number of “no documentation” and “Alt-A” loans between 2003 and 2005. In 2009, we repurchased one permanent loan at a loss of $50,000, and one construction-permanent loan without loss. Otherwise, we have not repurchased any of our loans. Of the $301.6 million in loans that we serviced for third parties as of March 31, 2011, approximately $5.3 million, or 1.76%, were past due greater than 90 days.

At March 31, 2011, approximately $506.8 million, or 73.4%, of our total loan portfolio is to borrowers resident within our primary market area, and $631.8 million, or 91.5%, of our loans are to borrowers resident in North Carolina, Georgia, or South Carolina. Approximately $651.3 million, or 97.0%, of our total real estate collateral is located within our primary market area. Our largest single loan is a performing $10.6 million loan secured by multi-use residential and commercial properties. We have 27 loan participations purchased from third parties for a total of $16.7 million, including a $2.7 million commercial real estate loan which is on non-accrual status.

At March 31, 2011, the fair value of our investment portfolio totaled $154.8 million, or 16.6%, of our total assets and represented the second largest component of our interest-earning assets. Our portfolio consists primarily of U.S. Government agency securities, agency mortgage-backed securities, collateralized mortgage obligations, and municipal securities. Our U.S. Government structured obligations consisted solely of Fannie Mae and Freddie Mac securities, are all callable, and include a step-up interest rate feature should the issuer not call the security. All of our securities are classified as “available-for-sale.”

At March 31, 2011, deposits totaled $782.1 million. Our primary source of deposits are from customers within our primary market area, supplemented by brokered and internet deposits. We have consistently focused on building broader customer relationships and targeting small business customers to increase our core deposits. We offer a variety of deposit

 

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accounts with a range of interest rates and terms. Our deposit accounts consist of savings accounts, certificates of deposit, money market accounts, commercial and regular checking accounts and individual retirement accounts. Interest rates paid, maturity terms, service fees and withdrawal penalties are established on a periodic basis. Deposit rates and terms are based primarily on current operating strategies and market interest rates, liquidity requirements, and our deposit growth goals. In order to lower our interest expense, we reduced our brokered deposits to $120.2 million at March 31, 2011, or 15.4% of total deposits, from $152.9 million, or 19.2%, of total deposits at December 31, 2010.

Anticipated Increase in Noninterest Expense

Following the completion of the offering, we anticipate that salary, professional fees, and miscellaneous noninterest expense will increase as a result of the increased costs associated with managing a public company. Also, following the offering, we intend to adopt one or more stock-based benefit plans that will provide for grants of stock options and restricted stock awards to our directors, officers and other employees. Any such stock-based benefit plans will be established no sooner than 12 months after the offering closes, and will require the approval of our shareholders by a majority of votes cast.

Critical Accounting Policies

We consider accounting policies that require management to exercise significant judgment or discretion or make significant assumptions that have, or could have, a material impact on the carrying value of certain assets or on income, to be critical accounting policies. We consider the following to be our critical accounting policies.

Allowance for Loan Losses. We maintain an allowance for loan losses at an amount estimated to equal all credit losses inherent in our loan portfolio that are both probable and reasonable to estimate at a balance sheet date. Management’s determination of the adequacy of the allowance is based on evaluations, at least quarterly, of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective, as it requires an estimate of the loss content for each risk rating and for each impaired loan, an estimate of the amounts and timing of expected future cash flows, and an estimate of the value of collateral. Based on our estimate of the level of allowance for loan losses required, we record a provision for loan losses to maintain the allowance for loan losses at an appropriate level.

All loan losses are charged to the allowance for loan losses and all recoveries are credited to it. Additions to the allowance for loan losses are provided by charges to income based on various factors which in our judgment deserve current recognition in estimating probable losses. When any loan or portion thereof is classified Doubtful or Loss, the loan will be charged down or charged off against the allowance for loan losses. Loans are deemed Doubtful or Loss based on a variety of credit, collateral, documentation and other issues. When collateral is foreclosed or repossessed, any principal charge-off related to that transaction, based upon the most current appraisal or evaluation, along with estimated sales expenses is taken at that time.

The determination of the allowance for loan losses is based on management’s current judgments about the loan portfolio credit quality and management’s consideration of all known relevant internal and external factors that affect loan collectability, as of the reporting date. We cannot predict with certainty the amount of loan charge-offs that will be incurred and, as was the case in the first quarter of 2011, we may make a business decision to accept a short sale in order to move a loan out of the portfolio. We provide both general and specific reserves. We value non-homogeneous loans in our portfolio for specific impairment. We value homogeneous loans based on our historical experience within individual loan types. Qualitative/Environmental factors in our loan loss allowance are used to measure unimpaired non-qualified loans and classified loans are adjusted to provide a measure for this market weakness. We have modified loans and classified them as troubled debt restructurings (“TDRs”) when the restructuring meets defined criteria. All TDRs are included in our impaired loans. In addition, our various regulatory agencies, as part of their examination processes, periodically review our allowance for loan losses. Such agencies may require that we recognize additions to the allowance for loan losses based on their judgments about information available to them at the time of their examination.

Troubled Debt Restructurings (TDRs). In accordance with accounting standards, we classify loans as TDRs when certain modifications are made to the loan terms and concessions are granted to the borrowers due to their financial difficulty. Our practice is to only restructure loans for borrowers in financial difficulty that have designed a viable business plan to fully pay off all outstanding debt, interest and fees, either by generating additional income from the business or through liquidation of assets. Generally, these loans are restructured to provide the borrower additional time to execute its business plan. With respect to TDRs, we grant concessions by reducing the stated interest rate for a specific time period, generally shorter than the remaining original life of the debt, or extending the maturity date at a stated interest rate lower than the current market rate for new debt with similar risk. TDRs with an extended maturity date generally include periods where payments are made on an interest-only or capitalized interest basis, and are formally recorded in forbearance agreements. In certain cases, these

 

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extended payment terms are also combined with a reduction of the stated interest rate. In situations where a TDR is unsuccessful and the borrower is unable to satisfy the terms of the restructured agreement, the loan is placed on non-accrual status and is written down to the underlying collateral value.

Impaired loans. A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. All TDRs are classified as impaired loans.

Other-Than-Temporary Impairment. In estimating other-than-temporary impairment of investment securities, securities are evaluated periodically, and at least quarterly, to determine whether a decline in their value is other than temporary.

We consider numerous factors when determining whether potential other-than-temporary impairment exists over the period which a security is expected to recover. The principal factors considered are the length of time and the extent to which the fair value has been less than the amortized cost basis; the financial condition of the issuer (and guarantor, if any) and adverse conditions specifically related to the security, industry or geographic area; any failure of the issuer of the security to make scheduled interest or principal payments; any changes to the rating of a security by a rating agency; and the presence of credit enhancements, if any, including the guarantee of the federal government or any of its agencies.

For debt securities, other-than-temporary impairment is considered to have occurred if we intend to sell the security, it is more likely than not we will be required to sell the security before recovery of its amortized cost basis, or the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. In determining the present value of expected cash flows, we discount the expected cash flows at the effective interest rate implicit in the security at the date of acquisition or, for debt securities that are beneficial interests in securitized financial assets, at the current rate used to accrete the beneficial interest. In estimating cash flows expected to be collected, we use available information with respect to security prepayment speeds, expected deferral rates and severity, whether subordinated interests, if any, are capable of absorbing estimated losses, and the value of any underlying collateral.

Deferred Tax Assets. The provision for income taxes is based upon income in our Consolidated Financial Statements, rather than amounts reported on our income tax return. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on our deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date. Under GAAP, a valuation allowance is required to be recognized if it is more likely than not that a deferred tax asset will not be realized. The determination as to whether we will be able to realize a deferred tax asset is highly subjective and dependent upon judgment concerning our evaluation of both positive and negative evidence, our forecasts of future income, applicable tax planning strategies, and assessments of current and future economic and business conditions. Positive evidence includes the existence of taxes paid in available carryback years as well as the probability that taxable income will be generated in future periods, while negative evidence includes any cumulative losses in the current year and prior two years and general business and economic trends. We had net cumulative losses for the three years ended December 31, 2010. This extended period of losses, combined with our analysis of future earnings, resulted in us taking an $8.5 million deferred tax valuation allowance at December 31, 2010 which increased $3.3 million to $11.8 million at March 31, 2011 due to continued losses. Should we continue to experience losses while we work through our problem assets, then it is likely that we will be required to establish an increased valuation allowance in the coming quarters.

Mortgage Servicing Rights. Mortgage servicing rights are recognized as separate assets when those rights are acquired through purchase or through sale of financial assets. Generally, purchased servicing rights are capitalized at the price paid to acquire the rights. For sales of mortgage loans, a portion of the cost of originating the loan is allocated to the servicing rights based on relative fair value. Fair value is based on market prices for comparable mortgage servicing rights, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net

 

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servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. If the fair value of these rights is less than its carrying value, we would be required to take a charge against earnings to write down these assets to the lower value. Servicing rights are valued annually by a third party for impairment.

Real Estate Owned (REO). REO, consisting of properties obtained through foreclosure or through a deed in lieu of foreclosure in satisfaction of loans, is reported at the lower of cost or fair value, determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources. The cost or fair value is then reduced by estimated selling costs. Management also considers other factors, including changes in absorption rates, length of time the property has been on the market and anticipated sales values, which have resulted in adjustments to the collateral value estimates indicated in certain appraisals. At the time of foreclosure or initial possession of collateral, any excess of the loan balance over the fair value of the REO is treated as a charge against the allowance for loan losses.

Subsequent declines in the fair value of REO below the new cost basis are recorded through valuation adjustments. Significant judgments and complex estimates are required in estimating the fair value of REO, and the period of time within which such estimates can be considered current is significantly shortened during periods of market volatility. In response to market conditions and other economic factors, management may utilize liquidation sales as part of its problem asset disposition strategy. As a result of the significant judgments required in estimating fair value and the variables involved in different methods of disposition, the net proceeds realized from sales transactions could differ significantly from appraisals, comparable sales, and other estimates used to determine the fair value of REO. Management reviews the value of REO each quarter and adjusts the values as appropriate. Any subsequent adjustments to the value, and gains or losses on sales are recorded as “Loss on REO”. Revenue and expenses from REO operations are recorded as “REO expense”. Both are components of noninterest expense.

Bank-Owned Life Insurance. We have purchased life insurance policies on certain key employees and directors. These policies are recorded in other assets at their cash surrender values, or the amounts that can be realized. Income from these policies and changes in the net cash surrender value are recorded in noninterest income.

Balance Sheet Analysis: March 31, 2011 compared to December 31, 2010

Total assets decreased $88.9 million, or 8.7%, to $932.8 million at March 31, 2011, from $1.0 billion at December 31, 2010. The decline in total assets is a result of continued weak loan demand from qualified borrowers and our deliberate efforts to reduce the size of our consolidated balance sheet to maintain our capital ratios. Net loans declined $30.6 million, or 4.4%, and investment securities declined $62.0 million, or 28.6%, from December 31, 2010 to March 31, 2011. These reductions were partially offset by a $2.2 million increase in cash and cash equivalents, a $2.0 million increase in REO and a $0.6 million aggregate increase in all other asset categories during the quarter. Weak loan demand and proceeds from the sale of securities in turn allowed us to repay FHLB borrowings totaling $62.5 million and brokered deposits totaling $32.7 million during the first quarter of 2011.

Cash and Cash Equivalents. Cash and cash equivalents increased $2.2 million, or 12.4%, to $20.3 million at March 31, 2011, from $18.0 million at December 31, 2010. Interest-earning deposits at the FHLB of Atlanta increased $4.0 million, or 38.1%, to $14.5 million at March 31, 2011, from $10.5 million at December 31, 2010. Cash and due from banks declined $1.7 million, or 23.3%, from $7.5 million to $5.8 million over the same period. Interest-earning deposits are temporary overnight investments and balances are used to meet cash demands. Liquid funds were used to repay maturing brokered deposits and FHLB advances during the quarter ended March 31, 2011.

Loans. The following table presents our loan portfolio composition and the corresponding percentage of total loans at the dates indicated. Residential one- to four-family construction loans include speculative construction loans and permanent construction loans for individuals still in the construction phase. Other construction and land loans include residential acquisition and development loans, commercial undeveloped land, and improved and unimproved lots. Commercial business loans include commercial unsecured loans and commercial loans secured by business assets.

 

     At March 31,     At December 31,  
     2011     2010  
     Amount      Percent     Amount      Percent  
     (Dollars in thousands)  

Real estate loans:

          

One-to four-family residential

   $ 241,163         34.8   $ 254,160         35.4

Commercial

     202,122         29.3        201,219         28.0   

Home equity loans and lines of credit

     73,600         10.7        75,322         10.5   

One-to four-family residential construction

     15,207         2.2        15,552         2.2   

Other construction and land

     139,615         20.2        151,894         21.2   

Commercial business

     15,122         2.2        15,395         2.1   

Consumer

     3,941         0.6        4,288         0.6   
                                  

Total loans

     690,770         100.0     717,830         100.0
                      

Less other items:

          

Deferred loan fees, net

     2,192           2,326      

Allowance for loan losses

     20,864           17,195      
                      

Total loans, net

   $ 667,714         $ 698,309      
                      

Net loans declined $30.6 million, or 4.4%, to $667.7 million at March 31, 2011, compared to $698.3 million at December 31, 2010. During this period, one- to four-family residential loans decreased $13.0 million, other construction and

 

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land loans decreased $12.3 million, home equity loans and lines of credit decreased $1.7 million, and our allowance for loan losses increased $3.7 million. Net loans represented 71.6% of total assets at March 31, 2011, compared to 68.3% at December 31, 2010. Net loans declined at a slower pace than total assets during the period. The percentage increase reflects the reduction in the size of our consolidated balance sheet at March 31, 2011.

Delinquent Loans. When a loan is 15 days past due, we contact the borrower to inquire as to why the loan is past due. When a loan is 30 days or more past due, we increase collection efforts to include all available forms of communication. When the loan is 45 days past due, we generally issue a demand letter and further explore the reasons for non-repayment, discuss repayment options, and inspect the collateral. In the event the loan officer or collections staff has reason to believe restructuring will be mutually beneficial to the borrower and Bank, the borrower will be referred to the Bank’s Loss Mitigation Manager to explore restructuring alternatives to foreclosure. Once the demand period has expired and it has been determined restructuring is not a viable option, the Bank’s counsel is instructed to pursue foreclosure.

Loans are automatically placed on non-accrual status when payment of principal and/or interest is 90 days or more past due. Loans are also placed on non-accrual status if full collection of principal or interest cannot be reasonably assured. When loans are placed on non-accrual status, unpaid accrued interest is fully reversed. The loan may be returned to accrual status if payments are made, bringing the loan to less than 90 days past due, and full payment of principal and interest is reasonably expected, generally after six consecutive months of performance on reasonable terms. Cash payments on non-accrual loans are applied against principal until the loan is returned to accrual status.

The following table sets forth certain information with respect to our loan portfolio delinquencies at the dates indicated. We have no loans greater than 90 days past due that are accruing interest. Residential one- to four-family construction loans include speculative construction loans and permanent construction loans for individuals that are still in the construction phase. Other construction and land includes residential acquisition and development loans, commercial undeveloped land and one- to four-family improved and unimproved lots. Commercial loans not secured by real estate include commercial unsecured loans and commercial loans secured by business assets.

 

     Delinquent loans  
     30-89 Days
Amount
     90 Days and over  (1)
Amount
     Total
Amount
 
     (Dollars in thousands)  

At March 31, 2011

        

Real estate loans:

        

One-to four-family residential

   $ 3,786       $ 12,838       $ 16,624   

Commercial

     5,241         9,500         14,741   

Home equity loans and lines of credit

     1,452         1,079         2,531   

One- to four-family residential construction

     —           3,161         3,161   

Other construction and land

     6,768         22,414         29,182   

Commercial business

     2,386         883         3,269   

Consumer

     22         11         33   
                          

Total loans

   $ 19,655       $ 49,886       $ 69,541   

At December 31, 2010

        

Real estate loans:

        

One-to four-family residential

   $ 5,949       $ 17,525       $ 23,474   

Commercial

     7,179         4,906         12,085   

Home equity loans and lines of credit

     1,674         1,362         3,036   

One- to four-family residential construction

     475         1,777         2,252   

Other construction and land

     5,600         20,661         26,261   

Commercial business

     185         957         1,142   

Consumer

     90         9         99   
                          

Total loans

   $ 21,152       $ 47,197       $ 68,349   
                          

 

(1) All 90 day and over loans are on non-accrual status.

Total delinquent loans increased $1.2 million, or 1.7%, to $69.5 million at March 31, 2011, from $68.3 million at December 31, 2010. Of this amount, loans 30-89 days past due decreased $1.5 million, or 7.1%, to $19.7 million at March 31, 2011, from $21.2 million at December 31, 2010, while loans 90 days and over increased $2.7 million, or 5.7%, to $49.9 million at March 31, 2011, from $47.2 million at December 31, 2010.

Total outstanding loans 90 days or more past due, including the percentage of loans past due to net loans receivable, are shown below at the dates indicated.

 

     Number of loans      Amount      Percentage of loans
Receivable, net
 
     (Dollars in thousands)  

At March 31, 2011

     145       $ 49,886         7.47

At December 31, 2010

     150         47,197         6.76   

Non-performing Assets. The table below sets forth the amounts and categories of our non-performing assets at the dates indicated, including TDRs.

 

     At March 31,
2011
    At December 31,
2010
 
     (Dollars in Thousands)  

Non-accrual loans:

    

Real estate loans:

    

One- to four-family residential

   $ 13,028      $ 21,118   

Commercial

     15,371        9,338   

Home equity loans and lines of credit

     1,869        1,362   

One- to four-family residential construction

     3,161        1,777   

Other construction and land

     24,847        25,822   

Commercial business

     889        1,056   

Consumer

     11        9   
                

Total non-accrual loans

     59,176        60,482   
                

Loans delinquent 90 days or greater and still accruing:

    

Real estate loans:

    

One- to four-family residential

     —          —     

Commercial

     —          —     

Home equity loans and lines of credit

     —          —     

One- to four-family residential construction

     —          —     

Other construction and land

     —          —     

Commercial business

     —          —     

Consumer

     —          —     
                

Total loans delinquent 90 days or greater and still accruing

     —          —     
                

Troubled debt restructurings still accruing

     13,989        15,095   
                

Total non-performing loans

     73,165        75,577   

Foreclosed real estate:

    

One- to four-family residential

     7,095        5,712   

Commercial

     2,805        2,244   

Other construction and land

     9,467        10,200   

Residential lots

     4,124        3,355   
                

Total foreclosed real estate

     23,491        21,511   
                

Total non-performing assets

   $ 96,656      $ 97,088   
                

Ratios:

    

Non-performing loans to total loans

     10.59     10.53

Non-performing assets to total assets

     10.36     9.50

Non-performing assets include non-accrual loans, loans 90 days or more past due and still accruing interest, TDRs that are still accruing interest, and REO. Total non-performing assets decreased $0.4 million, or 0.4%, to $96.7 million at March 31, 2011, from $97.1 million at December 31, 2010. During the first quarter of 2011, the Bank acquired $6.1 million in REO in satisfaction of mortgage loans. At March 31, 2011, non-accrual loans totaled $59.2 million compared to $60.5 million at December 31, 2010, a decrease of $1.3 million. During the same period, non-accruing one- to four-family

 

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residential loans decreased $8.1 million to $13.0 million, commercial real estate loans increased $6.1 million to $15.4 million, and other construction and land which includes land development loans, decreased $1.0 million to $24.8 million.

Accruing TDRs are included as non-performing assets. Accruing TDRs decreased $1.1 million, or 7.3%, at March 31, 2011, to $14.0 million from $15.1 million at December 31, 2010. We classify loans as TDRs when certain modifications are made to the loan terms and concessions are granted to the borrowers due to their financial difficulty. Our practice is to only restructure loans for borrowers in financial difficulty that have designed a viable business plan to fully pay off all outstanding debt, interest and fees, either by generating additional income from the business or through liquidation of assets. These loans may continue to accrue interest as long as the borrower complies with the revised terms and conditions and has demonstrated repayment performance with the modified terms.

The following table presents unrecognized interest income on non-accrual loans for the period indicated.

 

      For the quarters ended  
     March 31,      March 31,  
     2011      2010  
     (Dollars in thousands)  

Gross interest income that would have been recognized

   $ 1,113       $ 512   

Interest income recognized

     181         80   
                 

Interest income foregone

   $ 932       $ 432   
                 

Classification of Assets. Our policies, consistent with regulatory guidelines, provide for the classification of loans and other assets that are considered to be of lesser quality as Substandard, Doubtful, or Loss. An asset is considered Substandard if it displays identifiable weakness without appropriate mitigating factors. These loans may include some deterioration in repayment capacity and/or loan-to-value of underlying collateral. Substandard assets include those assets characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Assets classified as Doubtful have all of the weaknesses inherent in those classified Substandard, with the added characteristic that collection in full is highly questionable or improbable. Assets classified as Loss are those considered uncollectible and of such little value that their continuance as assets is not warranted. Assets that do not expose us to risk sufficient to warrant classification in one of the aforementioned categories, but which possess potential weaknesses that deserve our close attention, are required to be designated as special mention.

We maintain an allowance for loan losses at an amount estimated to equal all credit losses incurred in our loan portfolio that are both probable and reasonable to estimate at a balance sheet date. We review our asset portfolio no less frequently than quarterly to determine whether any assets require classification in accordance with applicable regulations.

The following table sets forth our classified assets and criticized assets at the dates indicated.

 

     At March 31,
2011
     At December 31,
2010
 
     (Dollars in thousands)  

Classified loans:

     

Substandard

   $ 113,761       $ 113,178   

Doubtful

     —           —     

Loss

     —           —     
                 

Total classified loans

     113,761         113,178   

Special mention

     71,724         64,386   
                 

Total criticized loans

   $ 185,485       $ 177,564   
                 

Total criticized loans increased $7.9 million, or 4.5%, to $185.5 million at March 31, 2011, from $177.6 million at December 31, 2010, primarily as a result of a $7.3 million increase in special mention loans. This increase is due to the downgrade of a $9.1 million performing loan from “Pass” to “Special Mention.” The subject loan is secured by income producing real estate that is leased at near 100% occupancy. The downgrade was the result of the borrower’s outside investment in a land development project that has been delayed.

Potential Problem Loans. Potential problem loans, which are not included in non-performing assets, amounted to approximately $6.2 million, or 0.9% of total net loans outstanding, at March 31, 2011, compared to $4.2 million, or 0.6% of total loans outstanding, at December 31, 2010. Potential problem loans include impaired loans that are not TDRs and are still accruing. Potential problem loans represent those loans with a well-defined weakness which has caused management to have serious doubts about the borrower’s ability to comply with present repayment terms.

The Bank had no loans with interest reserves outstanding at March 31, 2011.

Allowance for Loan Losses. We provide for loan losses based upon consistent application of our documented allowance for loan loss methodology. All loan losses are charged to the allowance for loan losses and all recoveries are credited to it. Additions to the allowance for loan losses are provided by charges to income based on various factors which in our judgment deserve current recognition in estimating probable losses. When any loan or portion thereof is classified Doubtful or Loss, the loan will be charged down or charged off against the allowance for loan losses. Loans are deemed Doubtful or Loss based on a variety of credit, collateral, documentation and other issues. When collateral is foreclosed or repossessed, any principal charge-off related to that transaction, based upon the most current appraisal or evaluation, along with estimated sales expenses is taken at that time. A committee consisting of members of lending management, credit risk

 

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management, and accounting meets periodically, and at least quarterly, to review our allowance and the credit quality of our portfolio. The allocated allowance consists primarily of two components:

(1) Specific allowances established for impaired loans (as defined by GAAP). The amount of impairment provided for a specific allowance is represented by the deficiency, if any, between the estimated fair value of the loan, or the loan’s observable market price, if any, or the underlying collateral, if the loan is collateral dependent, adjusted for sales costs, and the carrying value of the loan. Impaired loans for which the estimated fair value of the loan, or the loan’s observable market price or the fair value of the underlying collateral, if the loan is collateral dependent, adjusted for sales costs, exceeds the carrying value of the loan are not considered in establishing specific allowances for loan losses; and

(2) General allowances established for loan losses on a portfolio basis for loans that do not meet the definition of impaired loans. The portfolio is grouped into similar risk characteristics, primarily loan type and regulatory classification. We segregate unimpaired loans between classified and non-classified loans and apply an estimated loss rate to each group. The loss rate within each group can vary based on the type of loan. The loss rates applied are based upon our historical loss experience of each risk group for the past three years, adjusted, as appropriate, for the environmental factors discussed below. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revisions based upon changes in economic and real estate market conditions.

The adjustments to historical loss experience are based on our evaluation of several qualitative and environmental factors, including:

 

   

changes in any concentration of credit (including, but not limited to, concentrations by geography, industry or collateral type);

 

   

changes in the number and amount of non-accrual loans, criticized loans and past due loans;

 

   

changes in national, state and local economic trends;

 

   

changes in the types of loans in the loan portfolio;

 

   

changes in the experience and ability of personnel and management in the mortgage loan origination and loan servicing departments;

 

   

changes in the value of underlying collateral for collateral dependent loans;

 

   

changes in lending strategies; and

 

   

changes in lending policies and procedures.

In addition, we may establish an unallocated allowance to provide for probable losses that are inherent as of the reporting date but are not reflected in the allocated allowance.

We evaluate the allowance for loan losses based upon the combined total of the specific and general components.

Generally when the loan portfolio increases or decreases, absent other factors, the allowance for loan loss methodology results in a higher or lower dollar amount, respectively, of estimated probable losses than would be the case without the change.

Different types of loans generally have varying degrees of credit risk. Other construction and land, residential construction, commercial real estate, and commercial business loans generally have greater credit risks compared to one- to four-family residential mortgage loans we originate, as they typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties typically depends on the successful operation of the related business and thus may be subject to a greater extent to adverse conditions in the real estate market and in the general economy.

The following table shows our allowance for loan losses at and for the quarters ended March 31, 2011 and 2010.

 

     At or for the three months ended March 31,  
     2011     2010  
     (Dollars in thousands)  

Balance at beginning of period

   $ 17,195      $ 17,772   

Charge-offs:

    

Real Estate:

    

One- to four-family residential

     2,548        1,324   

Commercial

     145        156   

Home equity loans and lines of credit

     518        1,377   

One- to four-family residential construction

     75        76   

Other construction and land

     3,188        894   

Commercial business

     11        58   

Consumer

     379        33   
                

Total charge-offs

     6,864        3,918   
                

Recoveries:

    

Real Estate:

    

One- to four-family residential

     75        18   

Commercial

     50        —     

Home equity loans and lines of credit

     205        177   

One- to four-family r