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EXCEL - IDEA: XBRL DOCUMENT - METRO BANCORP, INC.Financial_Report.xls
EX-11 - EXHIBIT 11 - METRO BANCORP, INC.exhibit1110-qcomputationof.htm
EX-3.II - EXHIBIT 3(II) - METRO BANCORP, INC.exhibit3ii-metrobancorpbyl.htm
EX-31.1 - EXHIBIT 31.1 - METRO BANCORP, INC.exhibit31110-qcertificatio.htm
EX-31.2 - EXHIBIT 31.2 - METRO BANCORP, INC.exhibit31210-qcertificatio.htm
EX-32 - EXHIBIT 32 - METRO BANCORP, INC.exhibit3210-qcertification.htm



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

[ X ]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
 
September 30, 2014
[     ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
 
 
to
 
Commission File Number:
 
000-50961
 
 
 

 
METRO BANCORP, INC.
 
 
(Exact name of registrant as specified in its charter)
 
Pennsylvania
25-1834776
(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification No.)
3801 Paxton Street,  Harrisburg, PA
 
17111
(Address of principal executive offices)
 
(Zip Code)
888-937-0004
(Registrant's telephone number, including area code)
 
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
 
Yes
X
 
No
 

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).
Large accelerated filer
 
 
Accelerated filer
X
 
Non-accelerated filer
 
 
Smaller Reporting Company
 
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes
 
 
No
X
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:
14,206,703
Common shares outstanding at
October 31, 2014


1




METRO BANCORP, INC.

INDEX
 
 
Page
 
 
 
PART I.
FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements
 
 
 
 
 
Consolidated Balance Sheets (Unaudited)
 
 
September 30, 2014 and December 31, 2013
 
 
 
 
Consolidated Statements of Income (Unaudited)
 
 
Three months and nine months ended September 30, 2014 and September 30, 2013
 
 
 
 
Consolidated Statements of Comprehensive Income (Unaudited)
 
 
Three months and nine months ended September 30, 2014 and September 30, 2013
 
 
 
 
Consolidated Statements of Stockholders' Equity  (Unaudited)
 
 
Nine months ended September 30, 2014 and September 30, 2013
 
 
 
 
Consolidated Statements of Cash Flows (Unaudited)
 
 
Nine months ended September 30, 2014 and September 30, 2013
 
 
 
 
Notes to the Interim Consolidated Financial Statements (Unaudited)
 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition
 
 
and Results of Operations
 
 
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
 
 
Item 4.
Controls and Procedures
 
 
 
PART II.
OTHER INFORMATION
 
 
 
 
Item 1.
Legal Proceedings
 
 
 
Item 1A.
Risk Factors
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
Item 3.
Defaults Upon Senior Securities
 
 
 
Item 4.
Mine Safety Disclosures
 
 
 
Item 5.
Other Information
 
 
 
Item 6.
Exhibits
 
 
 
 
 


2




Part I - FINANCIAL INFORMATION

Item 1. Financial Statements
 
Metro Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheets
 
September 30, 2014
 
December 31, 2013
(in thousands, except share and per share amounts)
(Unaudited)
 
 
Assets
 
 
 
Cash and cash equivalents
$
45,621


$
44,996

Securities, available for sale at fair value
557,098


585,923

Securities, held to maturity at cost (fair value 2014: $320,140; 2013: $263,697)
330,417


283,814

Loans, held for sale
5,088


6,225

Loans receivable, net of allowance for loan losses
(allowance 2014: $24,540; 2013: $23,110)
1,889,080


1,727,762

Restricted investments in bank stock
21,660


20,564

Premises and equipment, net
74,587


75,783

Other assets
36,296


36,051

Total assets
$
2,959,847


$
2,781,118

 
 

 
 

Liabilities and Stockholders' Equity
 

 
 

Deposits:
 

 
 

Noninterest-bearing
$
494,082


$
443,287

Interest-bearing
1,837,767


1,796,334

      Total deposits
2,331,849


2,239,621

Short-term borrowings
359,200


277,750

Long-term debt


15,800

Other liabilities
15,436


17,764

Total liabilities
2,706,485


2,550,935

Stockholders' Equity:
 

 
 

Preferred stock - Series A noncumulative; $10.00 par value; $1,000 liquidation preference;
 
 
 
      (1,000,000 shares authorized; 40,000 shares issued and outstanding)
400


400

Common stock - $1.00 par value; 25,000,000 shares authorized;
 
 
 
      (issued and outstanding shares 2014: 14,205,904;  2013: 14,157,219)
14,206


14,157

Surplus
159,882


158,650

Retained earnings
88,957


73,491

Accumulated other comprehensive loss
(10,083
)
 
(16,515
)
Total stockholders' equity
253,362


230,183

Total liabilities and stockholders' equity
$
2,959,847


$
2,781,118

See accompanying notes.



3




Metro Bancorp, Inc. and Subsidiaries
Consolidated Statements of Income (Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
(in thousands, except per share amounts)
2014
 
2013
 
2014
 
2013
Interest Income
 
 
 
 
 
 
 
Loans receivable, including fees:
 
 
 
 
 
 
 
Taxable
$
20,761

 
$
18,752

 
$
59,909

 
$
55,239

Tax-exempt
824

 
908

 
2,519

 
2,744

Securities:
 
 
 
 
 
 
 
Taxable
5,187

 
5,021

 
15,251

 
15,387

Tax-exempt
229

 
185

 
610

 
553

Total interest income
27,001

 
24,866

 
78,289

 
73,923

Interest Expense
 
 
 
 
 

 
 

Deposits
1,490

 
1,503

 
4,325

 
4,647

Short-term borrowings
331

 
189

 
840

 
501

Long-term debt
325

 
307

 
939

 
974

Total interest expense
2,146

 
1,999

 
6,104

 
6,122

Net interest income
24,855

 
22,867

 
72,185

 
67,801

Provision for loan losses
2,100

 
1,200

 
4,100

 
5,300

 Net interest income after provision for loan losses
22,755

 
21,667

 
68,085

 
62,501

Noninterest Income
 
 
 
 
 

 
 

Card income
3,828

 
3,778

 
11,643

 
10,946

Service charges on deposit accounts
2,399

 
2,347

 
6,668

 
6,945

Other
1,122

 
1,243

 
3,326

 
3,502

Net gains on sales of loans
254

 
148

 
528

 
811

Net gains on sales/calls of securities
26

 

 
37

 
21

Total noninterest income
7,629

 
7,516

 
22,202

 
22,225

Noninterest Expenses
 
 
 
 
 

 
 

Salaries and employee benefits
11,204

 
10,761

 
33,686

 
31,977

Occupancy
2,133

 
2,205

 
6,712

 
6,478

Furniture and equipment
908

 
1,114

 
2,932

 
3,386

Advertising and marketing
519

 
358

 
1,288

 
1,103

Data processing
3,223

 
3,206

 
9,793

 
9,688

Regulatory assessments and related costs
544

 
588

 
1,697

 
1,673

Telephone
838

 
888

 
2,664

 
2,716

Loan expense
153

 
306

 
1,169

 
1,675

Pennsylvania shares tax
545

 
552

 
1,631

 
1,690

Other
2,309

 
2,465

 
6,607

 
6,746

Total noninterest expenses
22,376

 
22,443

 
68,179

 
67,132

Income before taxes
8,008

 
6,740

 
22,108

 
17,594

Provision for federal income taxes
2,507

 
2,064

 
6,582

 
5,225

Net income
$
5,501

 
$
4,676

 
$
15,526

 
$
12,369

Net Income per Common Share
 
 
 
 
 

 
 

Basic
$
0.39

 
$
0.33

 
$
1.09

 
$
0.87

Diluted
0.38

 
0.32

 
1.07

 
0.86

Average Common and Common Equivalent Shares Outstanding
 
 
 
 
 

 
 

Basic
14,201

 
14,145

 
14,182

 
14,138

Diluted
14,442

 
14,335

 
14,391

 
14,262

See accompanying notes.


4




Metro Bancorp, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
 
Three Months Ended
Nine Months Ended
 
September 30,
September 30,
(in thousands)
2014
2013
2014
2013
Net income
$
5,501

$
4,676

$
15,526

$
12,369

Other comprehensive income (loss), net of tax:
 
 
 
 
Net unrealized holding gains (losses) arising during the period
(net of taxes for the three months 2014: ($695); 2013: ($1,450);
net of taxes for the nine months 2014: $3,472; 2013: ($9,586))
(1,290
)
(2,692
)
6,449

(18,118
)
Reclassification adjustment for net realized (gains) losses on securities recorded in income [1]
(net of taxes for the three months 2014: ($9);
net of taxes for the nine months 2014: ($9); 2013: $125)
(17
)

(17
)
233

   Other comprehensive income (loss)
(1,307
)
(2,692
)
6,432

(17,885
)
Total comprehensive income (loss)
$
4,194

$
1,984

$
21,958

$
(5,516
)

[1] Amounts are included in net gains on sales/calls of securities on the Consolidated Statements of Income in total noninterest income.
See accompanying notes.



5




Metro Bancorp, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity (Unaudited)

(in thousands, except share amounts)
Preferred Stock
Common Stock
Surplus
Retained Earnings
Accumulated Other Comprehensive Income (Loss)
Total
January 1, 2013
$
400

$
14,131

$
157,305

$
56,311

$
7,240

$
235,387

Net income



12,369


12,369

Other comprehensive loss




(17,885
)
(17,885
)
Dividends declared on preferred stock



(60
)

(60
)
Common stock of 17,510 shares issued under
stock option plans, including tax benefit of $34

18

234



252

Common stock of 30 shares issued under
employee stock purchase plan


1



1

Proceeds from issuance of 1,934 shares of
common stock in connection with dividend
reinvestment and stock purchase plan

2

68



70

Common stock share-based awards


807



807

September 30, 2013
$
400

$
14,151

$
158,415

$
68,620

$
(10,645
)
$
230,941


(in thousands, except share amounts)
Preferred Stock
Common Stock
Surplus
Retained Earnings
Accumulated Other Comprehensive Income (Loss)
 Total
January 1, 2014
$
400

$
14,157

$
158,650

$
73,491

$
(16,515
)
$
230,183

Net income



15,526


15,526

Other comprehensive income




6,432

6,432

Dividends declared on preferred stock



(60
)

(60
)
Common stock of 46,670 shares issued under
stock option plans, including tax benefit of $110

47

647



694

Common stock of 60 shares issued under
employee stock purchase plan






Proceeds from issuance of 1,955 shares of
common stock in connection with dividend
reinvestment and stock purchase plan

2

41



43

Common stock share-based awards


544



544

September 30, 2014
$
400

$
14,206

$
159,882

$
88,957

$
(10,083
)
$
253,362


See accompanying notes.


6




Metro Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
 
Nine Months Ended
 
 
September 30,
(in thousands)
 
2014
 
2013
Operating Activities
 
 
 
 
Net income
 
$
15,526

 
$
12,369

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Provision for loan losses
 
4,100

 
5,300

Provision for depreciation and amortization
 
3,517

 
3,907

Deferred income tax benefit
 
(192
)
 
(781
)
Amortization of securities premiums and accretion of discounts (net)
 
174

 
722

(Gains) losses on sales of available for sales securities (net)
 
(26
)
 
358

Gains on sales/calls of held to maturity securities
 
(11
)
 
(379
)
Proceeds/payments from sales of loans originated for sale
 
26,563


55,836

Loans originated for sale
 
(24,927
)

(44,796
)
Gains on sales of loans (net)
 
(528
)

(811
)
Losses on write-down on foreclosed real estate
 

 
27

(Gains) losses on sales of foreclosed real estate (net)
 
(73
)
 
48

Losses on disposal of premises and equipment (net)
 
94

 
216

Stock-based compensation
 
544


807

Amortization of deferred loan origination fees and costs (net)
 
2,560


2,031

Increase in other assets
 
(1,182
)

(74
)
Increase (decrease) in other liabilities
 
(2,328
)

1,127

Net cash provided by operating activities
 
23,811


35,907

Investing Activities
 
 

 
 

Securities available for sale:
 
 

 
 

 Proceeds from principal repayments, calls and maturities
 
50,598

 
116,049

 Proceeds from sales
 
10,652

 
76,262

 Purchases
 
(22,749
)
 
(157,777
)
Securities held to maturity:
 
 

 
 
 Proceeds from principal repayments, calls and maturities
 
10,573

 
62,629

 Proceeds from sales
 
614

 
13,600

 Purchases
 
(57,708
)
 
(83,292
)
Proceeds from sale of loans receivable
 
1,506

 
4,952

Proceeds from sales of foreclosed real estate
 
1,927

 
1,547

Increase in loans receivable (net)
 
(173,643
)
 
(186,249
)
Purchase of restricted investment in bank stock (net)
 
(1,096
)
 
(3,088
)
Proceeds from sale of premises and equipment
 

 
316

Purchases of premises and equipment
 
(2,415
)
 
(2,098
)
Net cash used in investing activities
 
(181,741
)
 
(157,149
)
Financing Activities
 
 

 
 

Increase (decrease) in demand, interest checking, money market, and savings deposits (net)
 
61,661

 
(40,477
)
Increase (decrease) in time and other noncore deposits (net)
 
30,567

 
(13,743
)
Increase in short-term borrowings (net)
 
81,450

 
203,000

Repayment of long-term borrowings
 
(15,800
)
 
(25,000
)
Proceeds from common stock options exercised
 
584

 
218

Proceeds from dividend reinvestment and common stock purchase plan
 
43

 
70

Tax benefit on exercise of stock options
 
110

 
34

Cash dividends on preferred stock
 
(60
)
 
(60
)
Net cash provided by financing activities
 
158,555

 
124,042

Increase in cash and cash equivalents
 
625

 
2,800

Cash and cash equivalents at beginning of year
 
44,996

 
56,582

Cash and cash equivalents at end of period
 
$
45,621

 
$
59,382

Supplemental disclosure of cash flow information:
 
 

 
 

Cash paid for interest on deposits and borrowings
 
$
6,029

 
$
6,211

Cash paid for income taxes
 
5,950

 
4,925

Supplemental schedule of noncash activities:
 
 
 
 
Transfer of loans to foreclosed assets
 
4,264

 
2,732

See accompanying notes.


7




METRO BANCORP, INC. AND SUBSIDIARIES
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
(Unaudited)

NOTE 1.
Summary of Significant Accounting Policies
 
Consolidated Financial Statements
 
The consolidated balance sheet at December 31, 2013 has been derived from audited consolidated financial statements and the consolidated interim financial statements included herein have been prepared without audit pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements were prepared in accordance with GAAP for interim financial statements and with instructions for Form 10-Q and Regulation S-X Section 210.10-01. Further information on Metro Bancorp, Inc.'s (Metro or the Company) accounting policies are available in Note 1 (Significant Accounting Policies) of the Notes to Consolidated Financial Statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. The accompanying consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary to reflect a fair statement of the results for the interim periods presented. Such adjustments are of a normal, recurring nature.
 
These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. Events occurring subsequent to the balance sheet date through the date of issuance have been evaluated for potential recognition or disclosure in the consolidated financial statements. The results for the nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014.
 
The consolidated financial statements include the accounts of the Company and its consolidated subsidiaries including Metro Bank (the Bank). All material intercompany transactions have been eliminated.

Use of Estimates

The consolidated financial statements are prepared in conformity with GAAP. Accounting principles generally accepted in the United States of America require management to make estimates and assumptions that affect reported amounts of assets and liabilities and require disclosure of contingent assets and liabilities. In the opinion of management, all adjustments considered necessary for fair presentation have been included and are of a normal, recurring nature. Actual results could differ from these estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses (allowance or ALL), impaired loans, the valuation of foreclosed assets, the valuation of securities available for sale, the valuation of deferred tax assets, the determination of other-than-temporary impairment (OTTI) on the Company's investment securities portfolio and other fair value measurements.

Recent Accounting Standards
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606)(“ASU 2014-09”), which specifies how and when to recognize revenue and includes additional disclosures. ASU 2014-09 will be effective for financial statements issued for the first interim period within annual reporting periods beginning after December 15, 2016, and does not permit early adoption. We will adopt ASU 2014-09 in the first quarter of 2017 and are currently evaluating the impact it will have on our Financial Statements.

In July 2013, FASB issued guidance on the presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carry forward, a Similar Tax Loss, or a Tax Credit Carry forward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carry forward, a similar tax loss, or a tax credit carry forward, except as follows: to the extent a net operating loss carry forward, a similar tax loss, or a tax credit carry forward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The effective date of


8




this update for public entities is for fiscal years and interim periods that began after December 15, 2013. The adoption of this guidance did not have a material impact on our consolidated financial statements.

In January 2014, FASB clarified the Receivables – Troubled Debt Restructurings by Creditors guidance regarding Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. The guidance clarifies when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan should be derecognized and the real estate property recognized. The effective date of the adoption of this guidance is for interim and annual reporting periods beginning after December 15, 2014. We do not believe the adoption of the amendment to this guidance will have a material impact on our consolidated financial statements.

Reclassifications
 
Certain amounts in the 2013 financial statements have been reclassified to conform to the 2014 presentation format. Such reclassifications had no impact on the Company's net operations and stockholders' equity.

NOTE 2.
Stock-based Compensation
 
The fair value of each stock option grant was established at the date of grant using the Black-Scholes option pricing model. The Black-Scholes model used the following weighted-average assumptions for options granted during the nine months ended September 30, 2014 and 2013, respectively: risk-free interest rates of 2.0% and 1.4%; volatility factors of the expected market price of the Company's common stock of 34% and 41%; assumed forfeiture rates of 10.30% and 11.20%; weighted-average expected lives of the options of 7.2 years and 7.5 years; and no cash dividends in either year. For the nine months ended September 30, 2014 and 2013, respectively, options vest at 25% per year after one year from date of grant. Using these assumptions, the weighted-average fair value of options granted for the nine months ended September 30, 2014 and 2013 was $7.72 and $7.55 per option, respectively. In the first nine months of 2014, the Company granted 116,990 options to purchase shares of the Company's stock at exercise prices ranging from $19.55 to $21.57 per share.
 
The Company recorded net stock-based compensation expense of approximately $544,000 and $807,000 during the first nine months ended September 30, 2014 and September 30, 2013, respectively. In accordance with Financial Accounting Standards Board (FASB) guidance on stock-based payments, during the first nine months of 2014 and 2013 the Company reversed $268,000 and $135,000, respectively, of expense that had been recorded in prior periods as a result of the reconcilement of projected option forfeitures to actual option forfeitures for all stock options granted during the first quarters of 2010 and 2009, respectively.

NOTE 3.    Securities

The amortized cost and fair value of securities are summarized in the following tables:
 
September 30, 2014
(in thousands)
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
Available for Sale:
 
 
 
 
 
 
 
U.S. Government agency securities
$
33,995

 
$

 
$
(2,168
)
 
$
31,827

Residential mortgage-backed securities
61,585

 
26

 
(1,109
)
 
60,502

Agency collateralized mortgage obligations
447,049

 
1,408

 
(13,528
)
 
434,929

Municipal securities
29,982

 
177

 
(319
)
 
29,840

Total
$
572,611

 
$
1,611

 
$
(17,124
)
 
$
557,098

Held to Maturity:
 

 
 

 
 

 
 

U.S. Government agency securities
$
149,109

 
$

 
$
(8,089
)
 
$
141,020

Residential mortgage-backed securities
14,387

 
344

 
(45
)
 
14,686

Agency collateralized mortgage obligations
152,215

 
307

 
(2,949
)
 
149,573

Corporate debt securities
5,000

 
89

 

 
5,089

Municipal securities
9,706

 
77

 
(11
)
 
9,772

Total
$
330,417

 
$
817

 
$
(11,094
)
 
$
320,140




9




 
December 31, 2013
(in thousands)
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
Available for Sale:
 
 
 
 
 
 
 
U.S. Government agency securities
$
33,995

 
$

 
$
(4,069
)
 
$
29,926

Residential mortgage-backed securities
65,795

 

 
(3,295
)
 
62,500

Agency collateralized mortgage obligations
483,591

 
1,141

 
(17,668
)
 
467,064

Municipal securities
27,950

 

 
(1,517
)
 
26,433

Total
$
611,331

 
$
1,141

 
$
(26,549
)
 
$
585,923

Held to Maturity:


 


 


 


U.S. Government agency securities
$
149,096

 
$

 
$
(16,082
)
 
$
133,014

Residential mortgage-backed securities
7,849

 
197

 

 
8,046

Agency collateralized mortgage obligations
118,893

 
251

 
(4,465
)
 
114,679

Corporate debt securities
5,000

 
149

 

 
5,149

Municipal securities
2,976

 

 
(167
)
 
2,809

Total
$
283,814

 
$
597

 
$
(20,714
)
 
$
263,697


The amortized cost and fair value of debt securities by contractual maturity at September 30, 2014 are shown in the following table. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations.

 
 
Available for Sale
 
Held to Maturity
(in thousands)
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Due in one year or less
$


$


$
5,000


$
5,089

Due after one year through five years
3,879


3,838





Due after five years through ten years
49,554


47,435


77,831


73,976

Due after ten years
10,544


10,394


80,984


76,816

 
63,977


61,667


163,815


155,881

Residential mortgage-backed securities
61,585


60,502


14,387


14,686

Agency collateralized mortgage obligations
447,049


434,929


152,215


149,573

Total
$
572,611


$
557,098


$
330,417


$
320,140

 
During the third quarter of 2014, the Company sold one security from the available for sale portfolio with a total fair market value of $10.7 million. The Company had no securities that were called by their respective issuers. The Company realized a securities gain of $26,000 on the sale.

During the third quarter of 2013, the Company did not sell any securities and had no securities that were called by their respective issuers.

During the first nine months of 2014, the Company sold two securities with a total fair market value of $11.3 million and realized total net gains of $37,000. One security was from the held to maturity (HTM) portfolio, however, it was an amortizing security that had already returned more than 85% of its principal and could be sold without tainting the remaining HTM portfolio. The Company had no securities that were called by their respective issuers.

During the first nine months of 2013, the Company sold 21 securities with a total fair market value of $89.9 million. The Company also had $50.0 million of agency debentures that were called by their respective issuers. In total, the Company realized net security gains of $21,000. Of the investments sold, five were from the HTM portfolio, four of which were amortizing securities that had already returned at least 85% of their respective principal, and one of which was a corporate bond within three months of its maturity date. In all cases, these could be sold without tainting the remaining HTM portfolio.

The Company does not maintain a trading portfolio and there were no transfers of securities between the available for sale (AFS) and HTM portfolios. The Company uses the specific identification method to record security sales.



10




At September 30, 2014, securities with a carrying value of $666.1 million were pledged to secure public deposits and for other purposes as required or permitted by law.
 
The following table summarizes the Company's gains and losses on the sales or calls of debt securities and credit losses (if any) recognized for the OTTI of investments:
(in thousands)
Gross Realized Gains
 
Gross Realized Losses
 
OTTI Credit Losses
 
Net Gains
Three Months Ended:
 
 
 
 
 
 
 
September 30, 2014
$
26

 
$

 
$

 
$
26

September 30, 2013

 

 

 

Nine Months Ended:
 
 
 
 
 
 
 
September 30, 2014
$
37

 
$

 
$

 
$
37

September 30, 2013
1,183

 
(1,162
)
 

 
21


In determining fair market values for its portfolio holdings, the Company receives information from a third party provider which management evaluates and corroborates using amounts from one of its securities brokers. Under the current guidance, these values are considered Level 2 inputs, based upon mathematically derived matrix pricing and observed data from similar assets. They are not Level 1 direct quotes, nor do they reflect Level 3 inputs that would be derived from internal analysis or judgment. As the Company does not manage a trading portfolio and typically only sells from its AFS portfolio in order to manage interest rate risk or credit exposure, direct quotes, or street bids, are warranted on an as-needed basis.

The following table shows the fair value and gross unrealized losses associated with the Company's investment portfolio, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position: 
 
September 30, 2014
 
Less than 12 months
12 months or more
Total
 (in thousands)
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Available for Sale:
 
 
 
 
 
 
U.S. Government agency securities
$

$

$
31,827

$
(2,168
)
$
31,827

$
(2,168
)
Residential mortgage-backed securities
26,051

(19
)
31,547

(1,090
)
57,598

(1,109
)
Agency collateralized mortgage obligations
110,667

(1,181
)
204,489

(12,347
)
315,156

(13,528
)
Municipal securities
1,017

(4
)
8,337

(315
)
9,354

(319
)
Total
$
137,735

$
(1,204
)
$
276,200

$
(15,920
)
$
413,935

$
(17,124
)
Held to Maturity:
 
 
 
 
 
 
U.S. Government agency securities
$

$

$
141,020

$
(8,089
)
$
141,020

$
(8,089
)
Residential mortgage-backed securities
6,926

(45
)


6,926

(45
)
Agency collateralized mortgage obligations
87,527

(631
)
34,961

(2,318
)
122,488

(2,949
)
Municipal securities
1,013

(3
)
632

(8
)
1,645

(11
)
Total
$
95,466

$
(679
)
$
176,613

$
(10,415
)
$
272,079

$
(11,094
)



11




 
December 31, 2013
 
Less than 12 months
12 months or more
Total
 (in thousands)
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Available for Sale:
 
 
 
 
 
 
U.S. Government agency securities
$
8,077

$
(918
)
$
21,849

$
(3,151
)
$
29,926

$
(4,069
)
Residential mortgage-backed securities
62,500

(3,295
)


62,500

(3,295
)
Agency collateralized mortgage obligations
363,993

(16,182
)
15,574

(1,486
)
379,567

(17,668
)
Municipal securities
26,433

(1,517
)


26,433

(1,517
)
Total
$
461,003

$
(21,912
)
$
37,423

$
(4,637
)
$
498,426

$
(26,549
)
Held to Maturity:
 
 
 
 
 
 
U.S. Government agency securities
$
110,435

$
(13,661
)
$
22,579

$
(2,421
)
$
133,014

$
(16,082
)
Agency collateralized mortgage obligations
98,082

(4,465
)


98,082

(4,465
)
Municipal securities
2,809

(167
)


2,809

(167
)
Total
$
211,326

$
(18,293
)
$
22,579

$
(2,421
)
$
233,905

$
(20,714
)
 
The Company's investment securities portfolio consists of U.S. Government agency debentures, U.S. Government sponsored agency mortgage-backed securities (MBSs), agency collateralized mortgage obligations (CMOs), corporate bonds and municipal bonds. The Company considers securities of the U.S. Government sponsored agencies and the U.S. Government MBS/CMOs to have little credit risk because their principal and interest payments are backed by an agency of the U.S. Government.

The unrealized losses in the Company's investment portfolio at September 30, 2014 were associated with two distinct types of securities. The first type, those backed by the U.S. Government or one of its agencies, included 11 debentures, 43 CMOs and 11 MBSs. Management believes that the unrealized losses on these investments were primarily caused by the movement of interest rates from the date of purchase and notes the contractual cash flows of those investments are guaranteed by an agency of the U.S. Government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost of the Company's investment. The Company also owns nine municipal bonds that were in an unrealized loss position as of September 30, 2014. In all cases, the bonds are general obligations of either a Pennsylvania municipality or school district and are backed by the ad valorem taxing power of the entity. In all cases, the bonds carry an investment grade rating of no lower than single-A by either Moody's or Standard and Poors. The Company, however, conducts its own periodic, independent review and believes the unrealized losses in its municipal bond portfolio are the result of movements in long-term interest rates and are not reflective of any credit deterioration. The Company does not intend to sell these debt securities prior to recovery and it is more likely than not that the Company will not have to sell these debt securities prior to recovery.

The Company did not incur any OTTI credit losses during either the three or nine months ended September 30, 2014 or 2013.

NOTE 4.
Loans Receivable and Allowance for Loan Losses
 
Loans receivable that management has the intent and ability to hold for the foreseeable future, or until maturity or payoff, are stated at their outstanding unpaid principal balances, net of an allowance for loan losses (allowance or ALL) and any deferred fees and costs. Interest income is accrued on the unpaid principal balance. Loan origination fees and costs are deferred and recognized as an adjustment of the yield (interest income) of the related loans. The Company is generally amortizing these amounts over the contractual life of the loan or to the first review date if the loan is on demand. Certain qualifying loans of the Bank totaling $591.9 million at September 30, 2014, collateralize a letter of credit and a line of credit commitment the Bank has with the Federal Home Loan Bank (FHLB).



12




A summary of the Bank's loans receivable at September 30, 2014 and December 31, 2013 is as follows:
(in thousands)
September 30, 2014
 
December 31, 2013
Commercial and industrial
$
478,605

 
$
447,144

Commercial tax-exempt
75,986

 
81,734

Owner occupied real estate
312,032

 
302,417

Commercial construction and land development
122,314

 
133,176

Commercial real estate
594,004

 
473,188

Residential
107,707

 
97,766

Consumer
222,972

 
215,447

 
1,913,620

 
1,750,872

Less: allowance for loan losses
24,540

 
23,110

Net loans receivable
$
1,889,080

 
$
1,727,762


The following table summarizes nonaccrual loans by loan type at September 30, 2014 and December 31, 2013:
(in thousands)
September 30, 2014
 
December 31, 2013
Nonaccrual loans:
 
 
 
   Commercial and industrial
$
7,974

 
$
10,217

   Commercial tax-exempt

 

   Owner occupied real estate
6,954

 
4,838

   Commercial construction and land development
3,254

 
8,587

   Commercial real estate
6,407

 
6,705

   Residential
6,157

 
7,039

   Consumer
2,421

 
2,577

Total nonaccrual loans
$
33,167

 
$
39,963


Generally, the Bank's policy is to move a loan to nonaccrual status when it becomes 90 days past due or when the Bank does not believe it will collect all of the contractual principal and interest payments. In addition, when a loan is placed on nonaccrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against the ALL. Interest received on nonaccrual loans generally is either applied against principal or reported as interest income, according to management's judgment as to the collectibility of principal. If a loan is substandard and accruing, accrued interest is recognized as income. Once a loan is on nonaccrual status, it is not returned to accrual status unless loan payments have been current for at least six consecutive months and the borrower and/or any guarantors demonstrate the ability to repay the loan in accordance with its contractual terms. Under certain circumstances such as bankruptcy, if a loan is under collateralized, or if the borrower and/or guarantors do not show evidence of the ability to pay, the loan may be placed on nonaccrual status even though it is not past due by 90 days or more. The total nonaccrual loan balance of $33.2 million exceeds the balance of total loans that are 90 days past due of $20.0 million at September 30, 2014 as presented in the aging analysis tables that follow.

No additional funds were committed on nonaccrual loans including restructured loans that were nonaccruing. Typically, commitments are canceled and no additional advances are made when a loan is placed on nonaccrual.


13




The following tables are an age analysis of past due loans receivable as of September 30, 2014 and December 31, 2013:
 
 
Past Due Loans
 
 
Recorded Investment in Loans 90 Days and Greater and Still Accruing
(in thousands)
Current
30-59 Days Past Due
60-89 Days Past Due
90 Days Past Due and Greater
Total Past Due
Total Loans Receivable
September 30, 2014
 
 
 
 
 
 
 
Commercial and industrial
$
468,201

$
6,450

$

$
3,954

$
10,404

$
478,605

$

Commercial tax-exempt
75,986





75,986


Owner occupied real estate
303,016

2,175

1,201

5,640

9,016

312,032


Commercial construction and
land development
122,262

52



52

122,314


Commercial real estate
587,144

1,951

969

3,940

6,860

594,004

8

Residential
101,929

90

1,171

4,517

5,778

107,707


Consumer
219,405

1,399

231

1,937

3,567

222,972


Total
$
1,877,943

$
12,117

$
3,572

$
19,988

$
35,677

$
1,913,620

$
8


 
 
Past Due Loans
 
 
Recorded Investment in Loans 90 Days and Greater and Still Accruing
(in thousands)
Current
30-59 Days Past Due
60-89 Days Past Due
90 Days Past Due and Greater
Total Past Due
Total Loans Receivable
December 31, 2013
 
 
 
 
 
 
 
Commercial and industrial
$
438,522

$
1,830

$
1,041

$
5,751

$
8,622

$
447,144

$
17

Commercial tax-exempt
81,734





81,734


Owner occupied real estate
295,278

2,618

1,674

2,847

7,139

302,417


Commercial construction and
land development
124,240

3,355

342

5,239

8,936

133,176


Commercial real estate
465,765

2,142

444

4,837

7,423

473,188

235

Residential
85,352

4,194

6,304

1,916

12,414

97,766

117

Consumer
210,906

2,095

1,335

1,111

4,541

215,447


Total
$
1,701,797

$
16,234

$
11,140

$
21,701

$
49,075

$
1,750,872

$
369



14




A summary of the ALL and balance of loans receivable by loan class and by impairment method as of September 30, 2014 and December 31, 2013 is detailed in the tables that follow:
(in thousands)
Comm. and industrial
Comm. tax-exempt
Owner occupied real estate
Comm. construction and land development
Comm. real estate
Residential
Con
sumer
Unallocated
Total
 
 
 
 
 
 
 
 
 
 
September 30, 2014
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
Individually evaluated
for impairment
$
3,243

$

$
1,142

$

$

$
1,114

$
465

$

$
5,964

Collectively evaluated
for impairment
6,741

67

830

4,022

4,747

490

901

778

18,576

Total ALL
$
9,984

$
67

$
1,972

$
4,022

$
4,747

$
1,604

$
1,366

$
778

$
24,540

Loans receivable:
 
 
 
 
 
 
 
 
 
Loans evaluated
  individually
$
13,336

$

$
6,987

$
3,876

$
10,523

$
6,843

$
2,977

$

$
44,542

Loans evaluated
  collectively
465,269

75,986

305,045

118,438

583,481

100,864

219,995


1,869,078

Total loans receivable
$
478,605

$
75,986

$
312,032

$
122,314

$
594,004

$
107,707

$
222,972

$

$
1,913,620


(in thousands)
Comm. and industrial
Comm. tax-exempt
Owner occupied real estate
Comm. construction and land development
Comm. real estate
Residential
Con
sumer
Unallocated
Total
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
Individually evaluated
for impairment
$
1,559

$

$
1,366

$
1,660

$

$
524

$
476

$

$
5,585

Collectively evaluated
for impairment
6,619

72

814

3,899

4,161

436

827

697

17,525

Total ALL
$
8,178

$
72

$
2,180

$
5,559

$
4,161

$
960

$
1,303

$
697

$
23,110

Loans receivable:
 
 
 
 
 
 
 
 
 
Loans evaluated
  individually
$
13,055

$

$
5,822

$
11,669

$
10,953

$
7,979

$
3,121

$

$
52,599

Loans evaluated
  collectively
434,089

81,734

296,595

121,507

462,235

89,787

212,326


1,698,273

Total loans receivable
$
447,144

$
81,734

$
302,417

$
133,176

$
473,188

$
97,766

$
215,447

$

$
1,750,872


The Bank may create a specific allowance for all of or a part of a particular loan in lieu of a charge-off or charge-down as a result of management's evaluation of impaired loans. In these instances, the Bank has determined that a loss is not imminent based upon available information surrounding the credit at the time of the analysis including, but not limited to, unresolved legal matters; however, management believes an allowance is appropriate to acknowledge the probable risk of loss.

Typically, commercial construction and land development and commercial real estate loans present a greater risk of nonpayment by a borrower than other types of loans. The market value of and cash flow from real estate, particularly real estate held for investment, can fluctuate significantly in a relatively short period of time. Commercial and industrial, tax exempt and owner occupied real estate loans generally carry a lower risk factor comparatively within the commercial portfolio because the repayment of these loans relies primarily on the cash flow from a business which is typically more stable and predictable.

Consumer loan collections are dependent on the borrower's continued financial stability and thus are more likely to be affected by adverse personal circumstances. Consumer and residential loans are also impacted by the market value of real estate. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount that can be recovered on these loans. The risk of nonpayment is affected by changes in economic conditions, the credit risks of a


15




particular borrower, the term of the loan and, in the case of a collateralized loan, uncertainties as to the value of the collateral and other factors.

Management bases its quantitative analysis of probable future loan losses (when determining the ALL) on those loans collectively reviewed for impairment on a two-year period of actual historical losses. Management may increase or decrease the historical loss period at some point in the future based on the state of the local, regional and national economies and other factors.

The qualitative factors such as changes in levels and trends of charge-offs and delinquencies; material changes in the mix, volume or duration of the loan portfolio; changes in lending policies and procedures including underwriting standards; changes in the experience, ability and depth of lending management and other relevant staff; the existence and effect of any concentrations of credit; changes in the overall values of collateral; changes in the quality of the loan review program and changes in national and local economic trends and conditions among other things, are factors which have not been identified by the quantitative processes. The determination of qualitative factors inherently involves a higher degree of subjectivity and considers risk factors that may not have yet manifested themselves in historical loss experience.

The following tables summarize the transactions in the ALL for the three and nine months ended September 30, 2014 and 2013
(in thousands)
Comm. and industrial
Comm. tax-exempt
Owner occupied real estate
Comm. construction and land development
Comm. real estate
Residential
Consumer
Unallocated
Total
2014
 
 
 
 
 
 
 
 
 
Balance at July 1
$
7,100

$
67

$
2,233

$
6,696

$
4,840

$
1,061

$
1,333

$
941

$
24,271

Provision charged to operating expenses
3,047


(98
)
(1,954
)
260

581

427

(163
)
2,100

Recoveries of loans previously charged-off
137


24

34

2


58


255

Loans charged-off
(300
)

(187
)
(754
)
(355
)
(38
)
(452
)

(2,086
)
Balance at September 30
$
9,984

$
67

$
1,972

$
4,022

$
4,747

$
1,604

$
1,366

$
778

$
24,540

(in thousands)
Comm. and industrial
Comm. tax-exempt
Owner occupied real estate
Comm. construction and land development
Comm. real estate
Residential
Consumer
Unallocated
Total
2014
 
 
 
 
 
 
 
 
 
Balance at January 1
$
8,178

$
72

$
2,180

$
5,559

$
4,161

$
960

$
1,303

$
697

$
23,110

Provision charged to operating expenses
1,575

(5
)
(135
)
(489
)
1,481

964

628

81

4,100

Recoveries of loans previously charged-off
1,386


310

245

176

20

97


2,234

Loans charged-off
(1,155
)

(383
)
(1,293
)
(1,071
)
(340
)
(662
)

(4,904
)
Balance at September 30
$
9,984

$
67

$
1,972

$
4,022

$
4,747

$
1,604

$
1,366

$
778

$
24,540

(in thousands)
Comm. and industrial
Comm. tax-exempt
Owner occupied real estate
Comm. construction and land development
Comm. real estate
Residential
Consumer
Unallocated
Total
2013
 
 
 
 
 
 
 
 
 
Balance at July 1
$
10,549

$
74

$
2,207

$
7,810

$
5,059

$
863

$
1,258

$
218

$
28,038

Provision charged to operating expenses
(437
)
1

4

(33
)
801

45

562

257

1,200

Recoveries of loans previously charged-off
613



(21
)

7

11


610

Loans charged-off
(1,462
)

(34
)
(267
)
(109
)
(36
)
(515
)

(2,423
)
Balance at September 30
$
9,263

$
75

$
2,177

$
7,489

$
5,751

$
879

$
1,316

$
475

$
27,425



16




(in thousands)
Comm. and industrial
Comm. tax-exempt
Owner occupied real estate
Comm. construction and land development
Comm. real estate
Residential
Consumer
Unallocated
Total
2013
 
 
 
 
 
 
 
 
 
Balance at January 1
$
9,959

$
83

$
2,129

$
7,222

$
3,983

$
324

$
793

$
789

$
25,282

Provision charged to operating expenses
1,085

(8
)
315

82

2,100

711

1,329

(314
)
5,300

Recoveries of loans previously charged-off
945


3

477


10

69


1,504

Loans charged-off
(2,726
)

(270
)
(292
)
(332
)
(166
)
(875
)

(4,661
)
Balance at September 30
$
9,263

$
75

$
2,177

$
7,489

$
5,751

$
879

$
1,316

$
475

$
27,425


The following table presents information regarding the Company's impaired loans as of September 30, 2014 and December 31, 2013. The recorded investment represents the contractual obligation less any charged off principal.
 
September 30, 2014
December 31, 2013
(in thousands)
Recorded Investment
Unpaid Principal Balance
Related Allowance
Recorded Investment
Unpaid Principal Balance
Related Allowance
Loans with no related allowance:
 
 
 
 
 
 
   Commercial and industrial
$
8,367

$
9,136

$

$
9,838

$
12,587

$

   Commercial tax-exempt






   Owner occupied real estate
5,845

6,208


4,456

4,664


   Commercial construction and land
     development
3,876

3,876


8,514

9,047


   Commercial real estate
10,523

10,644


10,953

12,795


   Residential
3,774

4,014


4,901

5,366


   Consumer
2,512

2,723


2,645

2,868


Total impaired loans with no related
  allowance
34,897

36,601


41,307

47,327


Loans with an allowance recorded:
 
 
 
 
 
 
   Commercial and industrial
4,969

4,969

3,243

3,217

3,217

1,559

   Owner occupied real estate
1,142

1,142

1,142

1,366

1,366

1,366

   Commercial construction and land
     development



3,155

3,155

1,660

   Residential
3,069

3,069

1,114

3,078

3,078

524

   Consumer
465

465

465

476

476

476

Total impaired loans with an
  allowance recorded
9,645

9,645

5,964

11,292

11,292

5,585

Total impaired loans:
 
 
 
 
 
 
   Commercial and industrial
13,336

14,105

3,243

13,055

15,804

1,559

   Commercial tax-exempt






   Owner occupied real estate
6,987

7,350

1,142

5,822

6,030

1,366

   Commercial construction and land
     development
3,876

3,876


11,669

12,202

1,660

   Commercial real estate
10,523

10,644


10,953

12,795


   Residential
6,843

7,083

1,114

7,979

8,444

524

   Consumer
2,977

3,188

465

3,121

3,344

476

Total impaired loans
$
44,542

$
46,246

$
5,964

$
52,599

$
58,619

$
5,585




17




The following table presents additional information regarding the Company's impaired loans for the three and nine months ended September 30, 2014 and 2013:
 
Three Months Ended
Nine Months Ended
 
September 30, 2014
September 30, 2013
September 30, 2014
September 30, 2013
(in thousands)
Average Recorded Investment
Interest Income Recognized
Average Recorded Investment
Interest Income Recognized
Average Recorded Investment
Interest Income Recognized
Average Recorded Investment
Interest Income Recognized
Loans with no related allowance:
 
 
 
 
 
 
 
   Commercial and industrial
$
8,964

$
129

$
9,501

$
47

$
8,310

$
205

$
9,320

$
121

   Commercial tax-exempt








   Owner occupied real estate
4,858


3,808


4,514

10

2,841


   Commercial construction and
     land development
3,357

8

6,366

43

5,243

39

7,399

133

   Commercial real estate
9,137

40

10,229

96

9,981

128

11,550

351

   Residential
4,074

8

5,355

13

4,261

35

4,942

49

   Consumer
2,535

6

3,190

8

2,655

23

3,186

22

Total impaired loans with no
  related allowance
32,925

191

38,449

207

34,964

440

39,238

676

Loans with an allowance recorded:
 
 
 
 
 
 
 
   Commercial and industrial
1,990


4,587


2,526


5,030


   Owner occupied real estate
1,909


1,399


1,973


1,418


   Commercial construction and
     land development
3,142


8,848


4,256


8,168


   Commercial real estate


5,129




4,486


   Residential
3,069


3,091


3,072


1,381


   Consumer
465


478


469


214


Total impaired loans with an
  allowance recorded
10,575


23,532


12,296


20,697


Total impaired loans:
 
 
 
 
 
 
 
 
   Commercial and industrial
10,954

129

14,088

47

10,836

205

14,350

121

   Commercial tax-exempt








   Owner occupied real estate
6,767


5,207


6,487

10

4,259


   Commercial construction and
     land development
6,499

8

15,214

43

9,499

39

15,567

133

   Commercial real estate
9,137

40

15,358

96

9,981

128

16,036

351

   Residential
7,143

8

8,446

13

7,333

35

6,323

49

   Consumer
3,000

6

3,668

8

3,124

23

3,400

22

Total impaired loans
$
43,500

$
191

$
61,981

$
207

$
47,260

$
440

$
59,935

$
676


Impaired loans averaged approximately $47.3 million and $59.9 million for the nine months ended September 30, 2014 and 2013, respectively. All nonaccrual loans are considered impaired and interest income is handled as discussed earlier in the nonaccrual section of this Note 4. Interest income continued to accrue on certain impaired loans totaling $440,000 and $676,000 for the nine months ended September 30, 2014 and 2013, respectively.
 
The Bank assigns loan risk ratings to commercial loans as credit quality indicators of its loan portfolio: pass, special mention, substandard accrual, substandard nonaccrual and doubtful. Monthly, the Bank tracks loans that are no longer pass rated. We review the cash flow, operating results and financial condition of the borrower and any guarantors, as well as the collateral position against established policy guidelines as a means of providing a targeted list of loans and loan relationships that require additional attention within the loan portfolio. Special mention loans are those loans that are currently adequately protected, but potentially weak. The potential weaknesses may, if not corrected, weaken the loan's credit quality or inadvertently jeopardize the Bank's credit position in the future. Substandard accrual and substandard nonaccrual assets are characterized by well-defined weaknesses that jeopardize the liquidation of the debt and by the possibility that the Bank will sustain some loss if the weaknesses are not corrected. Substandard accrual loans would move from accrual to nonaccrual when the Bank does not believe it will collect all of its contractual principal and interest payments. Some identifiers used to determine the collectibility are as follows: when the loan is 90 days past due in


18




principal or interest, there are triggering events in the borrower's or any guarantor's financial statements that show continuing deterioration, the borrower's or any guarantor's source of repayment is depleting, or if bankruptcy or other legal matters are present, regardless if the loan is 90 days past due or not. Doubtful loans have all of the weaknesses inherent in those classified as substandard accrual and substandard nonaccrual with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable. Pass rated loans are reviewed throughout the year through the recurring review process of an independent loan review function and through the application of other credit metrics.
Credit quality indicators for commercial loans broken out by loan type are presented in the following tables for the periods ended September 30, 2014 and December 31, 2013. There were no loans classified as doubtful for the periods ended September 30, 2014 or December 31, 2013.
 
September 30, 2014
(in thousands)
Pass
Special Mention
Substandard Accrual
Substandard Nonaccrual
Total
Commercial credit exposure:






   Commercial and industrial
$
436,885

$
14,475

$
19,271

$
7,974

$
478,605

   Commercial tax-exempt
75,986




75,986

   Owner occupied real estate
293,622

2,407

9,049

6,954

312,032

   Commercial construction and land development
117,308


1,752

3,254

122,314

   Commercial real estate
584,745

1,061

1,791

6,407

594,004

     Total
$
1,508,546

$
17,943

$
31,863

$
24,589

$
1,582,941


 
December 31, 2013
(in thousands)
Pass
Special Mention
Substandard Accrual
Substandard Nonaccrual
Total
Commercial credit exposure:
 
 
 
 
 
   Commercial and industrial
$
410,530

$
8,064

$
18,333

$
10,217

$
447,144

   Commercial tax-exempt
81,734




81,734

   Owner occupied real estate
285,416

3,624

8,539

4,838

302,417

   Commercial construction and land development
120,687


3,902

8,587

133,176

   Commercial real estate
464,408

318

1,757

6,705

473,188

     Total
$
1,362,775

$
12,006

$
32,531

$
30,347

$
1,437,659

 
Consumer loan credit exposures are rated either performing or nonperforming as detailed below at September 30, 2014 and December 31, 2013:
 
September 30, 2014
(in thousands)
Performing
Nonperforming
Total
Consumer credit exposure:
 
 
 
   Residential
$
101,550

$
6,157

$
107,707

   Consumer
220,551

2,421

222,972

     Total
$
322,101

$
8,578

$
330,679


 
December 31, 2013
(in thousands)
Performing
Nonperforming
Total
Consumer credit exposure:
 
 
 
   Residential
$
90,727

$
7,039

$
97,766

   Consumer
212,870

2,577

215,447

     Total
$
303,597

$
9,616

$
313,213


A troubled debt restructuring (TDR) is a loan in which the contractual terms have been modified, resulting in the Bank granting a concession to a borrower which is experiencing financial difficulties, in order for the Bank to have a greater chance of collecting


19




the indebtedness from the borrower. An additional benefit to the Bank in granting a concession is to possibly avoid foreclosure or repossession of loan collateral at a time when collateral values are low.

The following table presents the recorded investment at the time of restructure of new TDRs and their concession, modified during the three and nine month periods ended September 30, 2014 and 2013. The recorded investment at the time of restructure was the same pre-modification and post-modification, therefore there was no financial effect of the modification on the recorded investment. The loans included are considered TDRs as a result of the Bank implementing one or more of the following concessions: granting a material extension of time, entering into a forbearance agreement, adjusting the interest rate, accepting interest only payments for an extended period of time, a change in the amortization period or a combination of any of these concessions.
New TDRs with Concession Type:
Three Months Ended
Nine Months Ended
 
September 30, 2014
September 30, 2013
September 30, 2014
September 30, 2013
(dollars in thousands)
Number of Contracts
 
Recorded Investment at Time of Restructure
Number of Contracts
 
Recorded Investment at Time of Restructure
Number of Contracts
 
Recorded Investment at Time of Restructure
Number of Contracts
 
Recorded Investment at Time of Restructure
Commercial and industrial:
 
 
 
 
 
 
 
 
 
 
 
 
   Forbearance agreement

 
$


 
$

1

 
$
229


 
$

   Change in amortization period

 


 

3

 
261

7

 
1,022

   Combination of concessions

 


 

1

 
30

1

 
125

Owner occupied real estate:
 
 
 
 
 
 
 
 
 
 
 
 
   Forbearance agreement

 


 


 

1

 
193

   Accepting interest only for
a period of time

 


 

3

 
1,601


 

   Change in amortization period

 


 

1

 
128


 

Commercial construction and land development:
 
 
 
 
 
 
 
 
 
 
 
 
   Material extension of time
1

 
34

1

 
1,749

2

 
276

4

 
2,801

   Forbearance agreement

 


 

3

 
2,185


 

   Change in amortization period

 


 

1

 
214


 

   Combination of concessions
1

 
3,546


 

1

 
3,546


 

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
   Change in amortization period

 


 

14

 
1,893


 

   Combination of concessions
1

 
3,275


 

1

 
3,275

3

 
2,945

Residential:
 
 
 
 
 
 
 
 
 
 
 
 
   Material extension of time

 

1

 
134


 

2

 
394

   Forbearance agreement

 

1

 
3,096


 

1

 
3,096

   Interest rate adjustment

 


 

1

 
143


 

   Change in amortization period

 

1

 
346


 

1

 
346

Consumer:
 
 
 
 
 
 
 
 
 
 
 
 
   Material extension of time

 


 


 

1

 
35

   Forbearance agreement

 

1

 
480


 

1

 
480

Total
3

 
$
6,855

5

 
$
5,805

32

 
$
13,781

22

 
$
11,437




20




The following table represents loans receivable modified as TDR within the 12 months previous to September 30, 2014 and 2013, respectively, and that subsequently defaulted during the three and nine month periods ended September 30, 2014 and 2013, respectively. The Bank's policy is to consider a loan past due or delinquent if payment is not received on or before the due date.
TDRs That Subsequently Payment Defaulted:
Three Months Ended
Nine Months Ended
 
September 30, 2014
September 30, 2013
September 30, 2014
September 30, 2013
(dollars in thousands)
Number of Contracts
 
Recorded Investment
Number of Contracts
 
Recorded Investment
Number of Contracts
 
Recorded Investment
Number of Contracts
 
Recorded Investment
   Commercial and industrial

 
$

1

 
$
179

7

 
$
1,288

10

 
$
5,051

   Owner occupied real estate

 


 

4

 
1,792

2

 
1,580

   Commercial construction
     and land development
2

 
448


 

4

 
2,376

2

 
2,426

   Commercial real estate

 


 


 

3

 
2,943

   Residential
1

 
341

1

 
3,089

4

 
3,811

2

 
3,348

   Consumer

 

1

 
477

1

 
476

2

 
575

Total
3

 
$
789

3

 
$
3,745

20

 
$
9,743

21

 
$
15,923


Of the 20 contracts that subsequently payment defaulted during the nine month period ended September 30, 2014, seven were still in payment default at September 30, 2014.

All TDRs are considered impaired and, therefore, are individually evaluated for impairment in the calculation of the ALL. Prior to their classification as TDRs, certain of these loans had been collectively evaluated for impairment in the calculation of the ALL. 

NOTE 5.
Loan Commitments and Standby Letters of Credit

Loan commitments are made to accommodate the financial needs of the Company's customers. Standby letters of credit commit the Company to make payments on behalf of customers when certain specified future events occur. They primarily are issued to facilitate the customers' normal course of business transactions. Standby performance letters of credit are written conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Historically, almost all of the Company's standby letters of credit expire unfunded.
 
The credit risk associated with letters of credit is essentially the same as that of traditional loan facilities and are subject to the Company's normal underwriting and credit policies. Since the majority of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future funding requirements. Commitments generally have fixed expiration dates or other termination clauses. Management believes that the proceeds obtained through a liquidation of collateral, the enforcement of guarantees and normal collection activities against the borrower would be sufficient to cover the potential amount of future payment required under the corresponding letters of credit.

The Company had $37.1 million and $37.2 million of standby letters of credit at September 30, 2014 and December 31, 2013, respectively. The Company does not issue any guarantees that would require liability recognition or disclosure, other than standby letters of credit. There was no liability for guarantees under standby letters of credit for the periods ended September 30, 2014 and December 31, 2013.

In addition to standby letters of credit, in the normal course of business there are unadvanced loan commitments. The Company had $628.4 million and $561.0 million in total unused commitments, including the standby letters of credit, at September 30, 2014 and December 31, 2013, respectively. Management does not anticipate any material losses as a result of these transactions.
 











21




NOTE 6.
Commitments and Contingencies
 
The Company is subject to certain routine legal proceedings and claims arising in the ordinary course of business. It is management's opinion that the ultimate resolution of these claims will not have a material adverse effect on the Company's financial position and results of operations.

Future Facilities
 
The Company has entered into a land lease for the premises located at 2121 Lincoln Highway East, East Lampeter Township, Lancaster County, Pennsylvania and is currently constructing a full-service store on this property which is scheduled to open in early December 2014.

The Company has entered into a land lease for the premises located at the corner of Airport Rd & Rt. 501 (Lititz Pike), Manheim Township, Lancaster County, PA.  The Company plans to construct a full-service store on this property to be opened in the future.
 
The Company owns land at 105 N. George Street, York City, York County, Pennsylvania. The Company plans to construct a full-service store on this property to be opened in the future.

NOTE 7.
Fair Value Measurements
 
The Company uses its best judgment in estimating the fair value of its financial instruments and certain nonfinancial assets; however, there are inherent weaknesses in any estimation technique due to assumptions that are susceptible to significant change. Therefore, for substantially all financial instruments and certain nonfinancial assets, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sale transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective period-ends and have not been reevaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments and certain nonfinancial assets subsequent to the respective reporting dates may be different than the amounts reported at each period-end.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company uses the following fair value hierarchy in selecting inputs with the highest priority given to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements): 
 
Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2: Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability;

Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported with little or no market activity).

















22




As required, financial and certain nonfinancial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The following table sets forth the Company's financial assets that were measured at fair value on a recurring basis at September 30, 2014 and December 31, 2013, respectively, by level within the fair value hierarchy: 
 
 
 
 Fair Value Measurements at Reporting Date Using
Description
 
 
Quoted Prices in
Active Markets for
Identical Assets
 
Significant Other
Observable Inputs
 
Significant
Unobservable
Inputs
(in thousands)
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
September 30, 2014
 
 
 
 
 
 
 
U.S. Government agency securities
$
31,827

 
$

 
$
31,827

 
$

Residential MBSs
60,502

 

 
60,502

 

Agency CMOs
434,929

 

 
434,929

 

Municipal securities
29,840

 

 
29,840

 

Securities available for sale
$
557,098

 
$

 
$
557,098

 
$


 
 
 
Fair Value Measurements at Reporting Date Using
Description
 
 
Quoted Prices in
Active Markets for
Identical Assets
 
Significant Other
Observable Inputs
 
Significant
Unobservable
Inputs
(in thousands)
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
December 31, 2013
 
 
 
 
 
 
 
U.S. Government agency securities
$
29,926

 
$

 
$
29,926

 
$

Residential MBSs
62,500

 

 
62,500

 

Agency CMOs
467,064

 

 
467,064

 

Municipal securities
26,433

 

 
26,433

 

Securities available for sale
$
585,923

 
$

 
$
585,923

 
$

 
As of September 30, 2014 and December 31, 2013, the Company did not have any liabilities that were measured at fair value on a recurring basis.

Impaired Loans (Generally Carried at Fair Value)
 
Impaired loans, measured at fair value, include those loans that the Company has measured impairment of based on the fair value of the loan's collateral. Fair value is generally determined based upon independent third party appraisals or valuations of the collateral properties. The discount rates used on collateral dependent loans vary based on the type of collateral. The range of discount rates used for real estate collateral ranged from 15% to 35% at September 30, 2014 ; the weighted-average rate was 20% as of September 30, 2014 as compared to 21% at December 31, 2013; inventory is generally discounted at 50%, equipment is generally discounted by 30% to 50% and accounts receivable are generally discounted by 20%. These assets are included as Level 3 fair values, based upon the lowest level of unobservable input that is significant to the fair value measurements. The fair value consists of the loan balance less any valuation allowance. The valuation allowance amount is calculated as the difference between the recorded investment in a loan and the present value of expected future cash flows or it is calculated based on discounted collateral values if the loan is collateral dependent.

At September 30, 2014, the cumulative fair value of seven impaired loans with individual allowance allocations totaled $3.7 million, net of valuation allowances of $6.0 million and the current fair value of impaired loans that were partially charged off during the first nine months of 2014 totaled $2.8 million at September 30, 2014, net of charge-offs of $1.1 million. At December 31, 2013, the cumulative fair value of six impaired loans with individual allowance allocations totaled $5.7 million, net of valuation allowances of $5.6 million and the current fair value of impaired loans that were partially charged off during 2013 totaled $10.4 million, net of charge-offs of $2.9 million. The Company's impaired loans are more fully discussed in Note 4.






23




Foreclosed Assets (Carried at Lower of Cost or Fair Value)
 
The fair value of real estate acquired through foreclosure is based on independent third party appraisals of the properties, less estimated selling costs. A standard discount rate of 15%, to cover estimated costs to sell the property, is generally used on the most recent appraisal to determine the fair value of the real estate. These assets are included as Level 3 fair values, based upon the lowest level of unobservable input that is significant to the fair value measurements. At September 30, 2014, there were no foreclosed assets with a valuation allowance recorded subsequent to initial foreclosure. At December 31, 2013, the carrying value of foreclosed assets with valuation allowances recorded subsequent to initial foreclosure was $1.9 million, which was net of a valuation allowance of $62,000.

The determination of the fair value of assets measured on a nonrecurring basis is sensitive to changes in economic conditions and can fluctuate in a relatively short period of time. For assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used were as follows: 
 
 
Fair Value Measurements at Reporting Date Using
Description
 
Quoted Prices in
Active Markets for
Identical Assets
Significant Other
Observable Inputs
Significant
Unobservable
Inputs
(in thousands)
Total
(Level 1)
(Level 2)
(Level 3)
September 30, 2014
 
 
 
 
Impaired loans with specific allocation
$
3,681

$

$

$
3,681

Impaired loans net of partial charge-offs
2,821



2,821

Total
$
6,502

$

$

$
6,502

 
 
 
Fair Value Measurements at Reporting Date Using
 Description
 
Quoted Prices in
Active Markets for
Identical Assets
Significant Other
Observable Inputs
Significant
Unobservable
Inputs
(in thousands)
Total
(Level 1)
(Level 2)
(Level 3)
December 31, 2013
 
 
 
 
Impaired loans with specific allocation
$
5,707

$

$

$
5,707

Impaired loans net of partial charge-offs
10,428



10,428

Foreclosed assets
1,938



1,938

Total
$
18,073

$

$

$
18,073

 
The Company's policy is to recognize transfers between levels as of the beginning of the period. There were no transfers between Levels 1 and 2 or between Levels 2 and 3 for the nine months ended September 30, 2014.

The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company's assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company's disclosures and those of other companies may not be meaningful. The following valuation techniques were used to estimate the fair values of the Company's financial instruments at September 30, 2014 and December 31, 2013:
  
Cash and Cash Equivalents (Carried at Cost)
 
Cash and cash equivalents include cash and balances due from banks, all of which have original maturities of 90 days or less. The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets' fair values.
 
Securities
 
The fair value of securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities' relationship to other benchmark prices. In determining fair market values for its portfolio holdings, the Company receives information from a third party provider which management evaluates and corroborates. Under the current guidance, these values are considered Level 2 inputs, based


24




upon mathematically derived matrix pricing and observed data from similar assets. They are not Level 1 direct quotes, nor do they reflect Level 3 inputs that would be derived from internal analysis or judgment. As the Company does not manage a trading portfolio and typically only sells from its AFS portfolio in order to manage interest rate risk or credit exposure, direct quotes, or street bids, are warranted on an as-needed basis only.

Loans Held for Sale (Carried at Lower of Cost or Fair Value)
 
The fair value of loans held for sale is determined, when possible, using quoted secondary-market prices.  If no such quoted prices exist, the fair value of a loan is determined using quoted prices for a similar loan or loans, adjusted for the specific attributes of that loan. The Company did not write down any loans held for sale during the nine months ended September 30, 2014 or the year ended December 31, 2013.

Loans Receivable (Carried at Cost)
 
The fair value of loans receivable, excluding all nonaccrual loans and accruing loans deemed impaired loans with specific loan allowances, are estimated using a discounted cash flow analysis, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the respective loans. Projected future cash flows are calculated based upon contractual maturity, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.
 
Restricted Investments in Bank Stock (Carried at Cost)

The carrying amount of restricted investments in bank stock approximates fair value and considers the limited marketability of such securities. The restricted investments in bank stock consisted of FHLB and Atlantic Community Bankers Bank (ACBB) stock at September 30, 2014 and December 31, 2013.

Accrued Interest Receivable and Payable (Carried at Cost)
 
The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value.
 
Deposit Liabilities (Carried at Cost)
 
The fair values disclosed for demand deposits (e.g., interest and noninterest-bearing checking) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The fair value of savings and money market accounts are reported based on the carrying amount. Fair values for fixed-rate certificates of deposits (CDs) are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.
 
Short-Term Borrowings (Carried at Cost)
 
The carrying amounts of short-term borrowings approximate their fair values.
 
Long-Term Debt (Carried at Cost)
 
Long-term debt was estimated using a discounted cash flow analysis, based on quoted prices from a third party broker for new debt with similar characteristics, terms and remaining maturity. The price was obtained in an inactive market where these types of instruments are not traded regularly. 
 
Off-Balance Sheet Financial Instruments (Disclosed at Cost)
 
Fair values for the Company's off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of the agreements and the counterparties' credit standing.


25




The estimated fair values of the Company's financial instruments were as follows at September 30, 2014 and December 31, 2013:
Fair Value Measurements at September 30, 2014
 
 
 
Quoted Prices in
Active Markets for
Identical Assets
Significant Other
Observable Inputs
Significant
Unobservable
Inputs
(in thousands)
Carrying
Amount
Fair 
Value
(Level 1)
(Level 2)
(Level 3)
Financial assets:
 
 
 
 


     Cash and cash equivalents
$
45,621

$
45,621

$
45,621

$

$

     Securities
887,515

877,238


877,238


     Loans, held for sale
5,088

5,132



5,132

     Loans receivable, net
1,889,080

1,896,605



1,896,605

     Restricted investments in bank stock
21,660

21,660



21,660

     Accrued interest receivable
7,553

7,553

7,553



Financial liabilities:
 

 

 
 
 
     Deposits
$
2,331,849

$
2,334,469

$

$

$
2,334,469

     Short-term borrowings
359,200

359,200

359,200



     Accrued interest payable
260

260

260



Off-balance sheet instruments:
 

 

 
 
 
     Standby letters of credit
$

$

$

$

$

     Commitments to extend credit






Fair Value Measurements at December 31, 2013
 
 
 
Quoted Prices in
Active Markets for
Identical Assets
Significant Other
Observable Inputs
Significant
Unobservable
Inputs
(in thousands)
Carrying
Amount
Fair 
Value
(Level 1)
(Level 2)
(Level 3)
Financial assets:
 
 
 
 
 
     Cash and cash equivalents
$
44,996

$
44,996

$
44,996

$

$

     Securities
869,737

849,620


849,620


     Loans, held for sale
6,225

6,371



6,371

     Loans receivable, net
1,727,762

1,734,609



1,734,609

     Restricted investments in bank stock
20,564

20,564



20,564

     Accrued interest receivable
7,059

7,059

7,059



Financial liabilities:
 

 

 
 
 
     Deposits
$
2,239,621

$
2,241,179

$

$

$
2,241,179

     Short-term borrowings
277,750

277,750

277,750



     Long-term debt
15,800

12,642



12,642

     Accrued interest payable
218

218

218



Off-balance sheet instruments:
 

 

 
 
 
     Standby letters of credit
$

$

$

$

$

     Commitments to extend credit














26




NOTE 8.
Income Taxes

The tax provision for federal income taxes was $2.5 million for the third quarter of 2014, compared to $2.1 million for the same period in 2013. The effective tax rates were 31% for both the quarters ended September 30, 2014 and September 30, 2013, respectively.

The tax provision for federal income taxes was $6.6 million for the first nine months of 2014, compared to $5.2 million for the same period in 2013. The effective tax rates were 30% for both the first nine months months ended September 30, 2014 and September 30, 2013, respectively. 

NOTE 9.
Long-term Debt

In September 2014, the Company redeemed $15.0 million of 7.75% fixed rate Trust Capital Securities at 100% of the principal.  The redemption activities included $800,000 which represented the Company’s ownership interest in the subsidiary Trust.



27




Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
 
The following is Management's Discussion and Analysis of Financial Condition and Results of Operations (Management's Discussion and Analysis) which analyzes the major elements of Metro Bancorp Inc.'s (Metro or the Company) balance sheet as of September 30, 2014 compared to December 31, 2013 and in some instances September 30, 2013 and statements of income for the three and nine months ended September 30, 2014 compared to the same periods in 2013. This section should be read in conjunction with the Company's consolidated financial statements and accompanying notes.
 
Forward-Looking Statements
 
This Form 10-Q and the documents incorporated by reference contain forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, which we refer to as the Securities Act and Section 21E of the Securities Exchange Act of 1934, which we refer to as the Exchange Act, with respect to the financial condition, liquidity, results of operations, future performance and business of Metro. These forward-looking statements are intended to be covered by the safe harbor for "forward-looking statements" provided by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are those that are not historical facts. These forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors (some of which are beyond our control). The words "may," "could," "should," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan" and similar expressions are intended to identify forward-looking statements. 
 
While we believe our plans, objectives, goals, expectations, anticipations, estimates and intentions as reflected in these forward-looking statements are reasonable, we can give no assurance that any of them will be achieved. You should understand that various factors, in addition to those discussed elsewhere in this Form 10-Q, in the Company's Form 10-K and incorporated by reference in this Form 10-Q, could affect our future results and could cause results to differ materially from those expressed in these forward-looking statements, including:  
the effects of and changes in, trade, monetary and fiscal policies, including in particular interest rate policies of the Board of Governors of the Federal Reserve System, including the duration of such policies;
general economic or business conditions, either nationally, regionally or in the communities in which we do business, may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and loan performance or a reduced demand for credit;
federal budget and tax negotiations and their effects on economic and business conditions in general and our customers in particular;
the federal government’s inability to reach a deal to permanently raise the debt ceiling and the potential negative results on economic and business conditions;
the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and other changes in financial services’ laws and regulations (including laws concerning taxes, banking, securities and insurance as well as enhanced expectations of regulators);
possible impacts of the capital and liquidity requirements of the Basel III standards as implemented or to be implemented by the Federal Reserve and other US regulators, as well as other regulatory pronouncements and prudential standards;
changes in regulatory policies on positions relating to capital distributions;
ability to generate sufficient earnings to justify capital distributions;
continued effects of the aftermath of recessionary conditions and the impacts on the economy in general and our customers in particular, including adverse impacts on loan utilization rates as well as delinquencies, defaults and customers' ability to meet credit obligations;
our ability to manage current levels of impaired assets;
continued levels of loan volume origination;
the adequacy of the allowance for loan losses or any provisions;
the views and actions of the Consumer Financial Protection Bureau regarding consumer credit protection laws and regulations;
changes resulting from legislative and regulatory actions with respect to the current economic and financial industry environment;


28




changes in the Federal Deposit Insurance Corporation (FDIC) deposit fund and the associated premiums that banks pay to the fund;
interest rate, market and monetary fluctuations;
the results of the regulatory examination and supervision process;
unanticipated regulatory or legal proceedings and liabilities and other costs;
compliance with laws and regulatory requirements of federal, state and local agencies, including regulatory expectations regarding enhanced compliance programs;
our ability to continue to grow our business internally or through acquisitions and successful integration of new or acquired entities while controlling costs;
deposit flows;
inability to achieve anticipated cost savings in the amount of time expected, and the emergence of unexpected offsetting costs in the compliance or risk management areas or otherwise;
changes in consumer spending and saving habits relative to the financial services we provide;
the ability to hedge certain risks economically and effectively;
the loss of key officers or other personnel;
changes in accounting principles, policies and guidelines as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board (FASB), and other accounting standards setters;
the timely development of competitive new products and services by us and the acceptance of such products and services by customers;
the willingness of customers to substitute competitors’ products and services for our products and services and vice versa, based on price, quality, relationship or otherwise;
other economic, competitive, governmental, regulatory and technological factors affecting the Company’s operations, pricing, products and services;
rapidly changing technology;
continued relationships with major customers;
effect of terrorist attacks and threats of actual war;
interruption or breach in security of our information systems, including cyber-attacks, resulting in failures or disruptions in customer account management, general ledger processing and loan or deposit systems or disclosure of confidential information;
our ability to maintain compliance with the exchange rules of The Nasdaq Stock Market, Inc.;
our ability to maintain the value and image of our brand and protect our intellectual property rights;
disruptions due to flooding, severe weather or other natural disasters or Acts of God; and
our success at managing the risks involved in the foregoing.

Because such forward-looking statements are subject to risks and uncertainties, actual results may differ materially from those expressed or implied by such statements. The foregoing list of important factors is not exclusive and you are cautioned not to place undue reliance on these factors or any of our forward-looking statements, which speak only as of the date of this document or, in the case of documents incorporated by reference, the dates of those documents. We do not undertake to update any forward-looking statements, whether written or oral, that may be made from time to time by or on behalf of us except as required by applicable law.

EXECUTIVE SUMMARY

For the three and nine months ended September 30, 2014, we continued our focus on strong balance sheet growth as well as the Company's profitability which resulted in the highest single quarterly net income in Metro's 29 year history. The net income figure of $5.5 million recorded for the third quarter of 2014 also represents Metro's seventh straight quarter of posting record net income.


29




The $15.5 million of net income recorded for the first nine months of 2014 also represents record results for the first nine months of the year.

Income Statement Highlights:

The Company recorded net income of $5.5 million, or $0.38 per diluted common share, for the third quarter of 2014 compared to net income of $4.7 million, or $0.32 per diluted common share, for the same period one year ago; an $825,000, or 18%, increase. Net income for the first nine months of 2014 totaled $15.5 million, or $1.07 per diluted common share; up $3.2 million, or 26%, over $12.4 million, or $0.86 per diluted common share recorded for the first nine months of 2013.

Total revenues (net interest income plus noninterest income) for the third quarter of 2014 were $32.5 million, up $2.1 million, or 7%, over total revenues of $30.4 million for the same quarter one year ago. Total revenues for the first nine months of 2014 increased $4.4 million, or 5%, over the first nine months of 2013.

Return on average stockholders' equity (ROE) was 8.67% for the third quarter of 2014, compared to 8.14% for the same period last year. ROE for the first nine months of 2014 was 8.47%, compared to 7.10% for the first nine months of 2013.

The Company's net interest margin on a fully-taxable basis for the third quarter of 2014, which continued to be compressed by the Federal Reserve's monetary policy and resultant interest rate environment, was 3.57%, compared to 3.58% for the third quarter of 2013. The Company's deposit cost of funds for the third quarter was 0.27% and compared to 0.28% for the same period one year ago.

The provision for loan losses totaled $2.1 million for the third quarter of 2014, compared to $1.2 million for the third quarter one year ago. The provision for loan losses for the first nine months of 2014 was down $1.2 million, or 23%, from the first nine months of 2013.

Noninterest expenses for the third quarter of 2014 were $22.4 million, down $67,000, from the same quarter last year. Total noninterest expenses for the first nine months of 2014 were up $1.0 million, or 2%, compared to the first nine months of 2013.

Balance Sheet Highlights:

Loan growth continues to be strong as net loans grew $61.5 million, or 3%, on a linked quarter basis to $1.89 billion and were up $213.8 million, or 13%, over the third quarter 2013.

Nonperforming assets were 1.36% of total assets at September 30, 2014, compared to 1.71% of total assets one year ago.

Deposits totaled $2.33 billion, up $154.8 million, or 7%, compared to same quarter last year.

Metro's capital levels remain strong with a Tier 1 Leverage ratio of 8.96% and a total risk-based capital ratio of 13.58%.

Stockholders' equity totaled $253.4 million, or 8.56% of total assets, at the end of the third quarter 2014. At September 30, 2014, the Company's book value per share was $17.76. The market price of Metro's common stock increased by 15% from $21.01 per common share at September 30, 2013 to $24.25 per common share at September 30, 2014.



30




Summarized below are financial highlights for the three and nine months ended September 30, 2014 compared to the same periods in 2013:
 
TABLE 1
 
At or for the Three Months Ended September 30,
For the Nine Months Ended September 30,
(in thousands, except per share data)
2014
2013
% Change
2014
2013
% Change
Total assets
$
2,959,847

$
2,755,982

7
 %
 
 
 
Total loans (net)
1,889,080

1,675,251

13

 
 
 
Total deposits
2,331,849

2,177,071

7

 
 
 
Total stockholders' equity
253,362

230,941

10

 
 
 
Total revenues
$
32,484

$
30,383

7
 %
$
94,387

$
90,026

5
 %
Provision for loan losses
2,100

1,200

75

4,100

5,300

(23
)
Total noninterest expenses
22,376

22,443


68,179

67,132

2

Net income
5,501

4,676

18

15,526

12,369

26

Diluted net income per common share
0.38

0.32

19

1.07

0.86

24


In mid-October of 2014, the Company announced a comprehensive set of shareholder return and cost-savings initiatives, which we believe will allow Metro to continue to improve profitability, grow the value of the franchise and drive long-term shareholder value. The recently announced initiatives to increase shareholder returns and improve profitability even further include:

The initiation of an annual dividend of $0.28 per common share, beginning in the first quarter of 2015;

A 5% share repurchase program, beginning in the fourth quarter of 2014;

An estimated $3 million reduction of annual operating expenses, when completed;

A delay in the development of two branch locations, saving approximately $650,000 in expenses in 2015 and $1.4 million in 2016; and

The redemption of $15 million of outstanding Trust Preferred Securities, completed in September 2014, saving approximately $1.1 million in annual interest expense.
 
APPLICATION OF CRITICAL ACCOUNTING POLICIES
 
Our accounting policies are fundamental to understanding Management's Discussion and Analysis of Financial Condition and Results of Operations. Our accounting policies are more fully described in Note 1 of the Notes to Consolidated Financial Statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). These principles require our management to make estimates and assumptions about future events that affect the amounts reported in our consolidated financial statements and accompanying notes. Since future events and their effects cannot be determined with absolute certainty, actual results may differ from those estimates. Management makes adjustments to its assumptions and estimates when facts and circumstances dictate. We evaluate our estimates and assumptions on an ongoing basis and predicate those estimates and assumptions on historical experience and on various other factors that are believed to be reasonable under the circumstances. Management has identified the accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to understanding Metro’s Unaudited Consolidated Financial Statements and Management’s Discussion and Analysis at September 30, 2014, which were unchanged from the policies disclosed in Metro’s 2013 Form 10-K. Management believes the following critical accounting policies encompass the more significant assumptions and estimates used in preparation of our consolidated financial statements.

Allowance for Loan Losses. The allowance for loan losses (allowance or ALL) represents the amount available for estimated probable losses embedded in Metro Bank's (the Bank) loan portfolio. While the allowance is maintained at a level believed to be adequate by management for estimated probable losses in the loan portfolio, the determination of the allowance is inherently subjective, as it involves significant estimates by management, all of which may be susceptible to significant change.
 


31




While management uses available information to make such evaluations, future adjustments to the allowance and to the provision for loan losses may be necessary if economic conditions or loan credit quality differ materially from the estimates and assumptions used in making the evaluations. The use of different assumptions could materially impact the level of the allowance and, therefore, the provision for loan losses to be charged against earnings. Such changes could impact future financial results.
 
Monthly, the Bank performs systematic reviews of its loan portfolios to identify probable losses and assess the overall probability of collection. These reviews include an analysis of historical loss experience, which results in the identification and quantification of loss factors. These loss factors are used in determining the appropriate level of allowance to cover estimated probable losses in specific loan types. The estimates of loss factors can be impacted by many variables, such as the number of years of actual loss history included in the evaluation.

As part of the quantitative analysis of the adequacy of the ALL, management based its calculation of probable future loan losses on those loans collectively reviewed for impairment on a rolling two-year period of actual historical losses. Management may adjust the number of years used in the historical loss calculation depending on the state of the local, regional and national economies and other factors and the period of time which management believes will most accurately forecast future losses.
 
Significant estimates are involved in the determination of any loss related to impaired loans. The evaluation of an impaired loan is based on either (1) the discounted cash flows using the loan's effective interest rate, (2) the fair value of the collateral for collateral-dependent loans, or (3) the observable market price of the impaired loan. Each of these estimates involves management's judgment.

In addition to calculating the loss factors, the Bank may periodically adjust the factors for changes in levels and trends of charge-offs, delinquencies and nonaccrual loans; material changes in the mix, volume, or duration of the loan portfolio; changes in lending policies and procedures including underwriting standards; changes in the experience, ability and depth of lending management and other relevant staff; the existence and effect of any concentrations of credit and changes in the level of such concentrations; and changes in national and local economic trends and conditions, among other things. Management judgment is exercised at many levels in making these evaluations.
 
An integral aspect of our risk management process is allocating the allowance to various components of the loan portfolio based upon an analysis of risk characteristics, demonstrated losses, industry and other segmentations and other judgmental factors.
 
Fair Value Measurements. The Company is required to disclose the fair value of its financial instruments that are measured at fair value within a fair value hierarchy. The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value, giving the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurement) and the lowest priority to unobservable inputs (level 3 measurements). Judgment is involved not only with deriving the estimated fair values but also with classifying the particular assets recorded at fair value in the fair value hierarchy. Estimating the fair value of impaired loans or the value of collateral securing foreclosed assets requires the use of significant unobservable inputs (level 3 measurements). The fair value of collateral securing impaired loans or constituting foreclosed assets is generally determined based upon independent third party appraisals of the properties, recent offers, or prices on comparable properties in the proximate vicinity. Such estimates can differ significantly from the amounts the Company would ultimately realize from the loan or disposition of the underlying collateral.

The Company's available for sale (AFS) investment security portfolio constitutes 99% of the total assets measured at fair value and all securities are classified as a level 2 fair value measurement (quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability). Management utilizes third party service providers to aid in the determination of the fair value of the portfolio. Most securities are not quoted on an exchange, but are traded in active markets and fair values were obtained from matrix pricing on similar securities.
 
Deferred Taxes. 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 tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be used.  

The Company assesses whether or not the deferred tax assets would be realized in the future if the Company would not have future taxable income to use as an offset. If future taxable income is not expected to be available to use, a valuation allowance is required to be recognized. A valuation allowance would result in additional income tax expense in the period. The Company assesses if it is more likely than not that a deferred tax asset will not be realized. The determination of a valuation allowance is subjective and dependent upon judgment concerning both positive and negative evidence to support that the net deferred tax assets will be utilized. In order to evaluate whether or not a valuation allowance is necessary, the Company uses current forecasts of future income, the


32




ability to carryback losses to preceding years, reviews possible tax planning strategies and assesses current and future economic and business conditions. Negative evidence utilized would include any cumulative losses in previous years and general business and economic trends. At September 30, 2014, the Company conducted such an analysis to determine if a valuation allowance was required and concluded that a valuation allowance was not necessary. A valuation allowance, if required, could have a significant impact on the Company's future earnings.

RESULTS OF OPERATIONS

Total revenues were $32.5 million for the third quarter of 2014, up $2.1 million, or 7%, over total revenues of $30.4 million for the third quarter in 2013.

For the first nine months of 2014, total revenues were $94.4 million, up $4.4 million, or 5%, compared to $90.0 million earned in the comparable period of 2013.

We derive total revenues from various sources, including:
Interest income from our loan portfolio;
Interest income from our securities portfolio;
Electronic banking services;
Fees associated with customer deposit accounts;
Fees from issuing loan commitments and standby letters of credit;
Fees from various cash management services; and
Sales of loans and securities.

Average Balances and Average Interest Rates

Table 2 sets forth balance sheet items on a daily average basis for the three and nine months ended September 30, 2014 and 2013, respectively, and presents the daily average interest rates earned on assets and the daily average interest rates paid on liabilities for these periods.

Third Quarter 2014 compared to Third Quarter 2013

Interest-earning assets averaged $2.81 billion for the third quarter of 2014, up 9% compared to $2.59 billion for the third quarter in 2013. This was primarily the result of a 13% increase in average loans receivable balances over the past twelve months. For the quarter ended September 30, 2014, total loans receivable including loans held for sale, averaged $1.89 billion compared to $1.67 billion for the third quarter in 2013. Total investment securities, including restricted investments in bank stock, averaged $923.1 million and $910.9 million for the third quarter of 2014 and 2013, respectively, a 1% increase. The Company continues to experience strong loan growth as evidenced by the $210.7 million increase in average loans outstanding for the third quarter 2014 compared to the same period in the prior year. During the third quarter of 2014, twelve securities totaling $79.6 million were purchased with a tax effective yield of 2.64%. The Bank had only purchased $1.0 million of securities during the first six months of 2014 and no securities purchases are planned for the fourth quarter of 2014. The growth in total interest-earning assets was funded by an increase in average deposits and average borrowings as discussed below.
 
The fully-taxable equivalent yield on interest-earning assets for the third quarter of 2014 was 3.87%, a decrease of one basis point (bp) from the comparable period in 2013. The decrease resulted from lower yields on the Company's loans receivable portfolio, offset partially by an increase in yield on the securities portfolio. The decrease in yield on the loan portfolio was the result of the continued low level of general market interest rates as legacy loans outstanding with higher yields continue to pay down contractually and are replaced with loans at lower current market yields. Our floating rate loans currently provide lower yields than our fixed rate loans and represented approximately 44% of our total loans receivable portfolio as of September 30, 2014.

As a result of the current low level of interest rates, coupled with the Federal Reserve's stated intention to maintain this current low-level of short-term interest rates for the foreseeable future, we expect the yields we receive on our interest-earning assets could continue at their current levels, throughout the remainder of 2014 and in 2015 as well.

The average balance of total deposits increased $98.1 million, or 5%, for the third quarter of 2014 over the third quarter of 2013, from $2.12 billion to $2.22 billion. Total average interest-bearing deposits increased by $44.0 million, or 3%, and total average noninterest-bearing deposits increased by $54.1 million, or 13%. Short-term borrowings, which consist of overnight advances from the Federal Home Loan Bank (FHLB), averaged $428.4 million for the third quarter of 2014 compared to $329.9 million for the same quarter of 2013. The slight decrease in the average balance of long-term debt during the third quarter of 2014 compared


33




to the same quarter the prior year, was the result of the redemption of $15.8 million Trust Preferred Securities in late September 2014 which will save the Company approximately $1.1 million in annual interest expense.

The average rate paid on our total interest-bearing liabilities for both the third quarter of 2014 and 2013 was 0.39%. Our deposit cost of funds decreased one bp from 0.28% in the third quarter of 2013 to 0.27% for the third quarter of 2014. The average rate paid on core deposits (total deposits less public time deposits and other noncore deposits) decreased across all categories during the third quarter of 2014 compared to third quarter of 2013. The decrease in the Company's deposit cost of funds is primarily related to the combination of time deposits that matured and renewed at lower rates as well as lower rates paid on savings accounts. These decreases were a result of the continued low level of general market interest rates. As certificates of deposits (CDs) that were originated in past years at higher interest rates have matured over the past twelve months, these funds have been either renewed into new CDs with lower interest rates or shifted by our customers to their checking and/or savings accounts. As a result, our weighted-average rate paid on retail time deposits, decreased by 8 bps from 1.19% for the third quarter of 2013 to 1.11% for the third quarter of 2014. At September 30, 2014, $655.4 million, or 28%, of our total deposits were those of local municipalities, school districts, not-for-profit organizations or corporate cash management customers, where the interest rates paid are generally indexed to an internally managed index rate. If short-term market interest rates increase, the cost of these deposits will increase according to the increase in the respective index to which their interest rates are tied.

The average cost of short-term borrowings was 0.30% for the third quarter of 2014 as compared to 0.22% for the third quarter of 2013. The average cost of long-term debt was 8.71% for the third quarter of 2014, compared to 7.77% and 2013. The increased cost reflected the recognition of remaining start-up expenses associated with the $15.0 million Trust Preferred Security due to its third quarter redemption. The aggregate average cost of all funding sources for the Company was 0.32% for both the third quarter of 2014 and for the same quarter of the prior year.

Nine Months Ended September 30, 2014 compared to Nine Months Ended September 30, 2013

Interest-earning assets averaged $2.74 billion for the first nine months of 2014, up 8%, compared to $2.54 billion for the first nine months of 2013. For the same two periods, total loans receivable including loans held for sale, averaged $1.83 billion in 2014 and $1.62 billion in 2013, respectively, a 13% increase. Total securities, including restricted investments in bank stock, averaged $906.5 million and $925.7 million for the first nine months of 2014 and 2013, respectively.
The fully-taxable equivalent yield on interest-earning assets for the first nine months of 2014 was 3.87%, a decrease of 7 bps versus the comparable period in 2013. This decrease primarily resulted from the continued overall lower level of interest rates as yields declined for loans. The average fully-taxable equivalent yield on the loan portfolio declined 25 bps from 4.86% during the first nine months of 2013 to 4.61% during the first nine months of 2014. The average fully-taxable equivalent yield on the investment portfolio increased 4 bps from 2.34% during the first nine months of 2013 to 2.38% during the first nine months of 2014.

The Company funded the growth in earning assets over the past twelve months both with an increase in short-term borrowings and with the growth of deposits. Short-term borrowings averaged $391.1 million and $295.0 million in the first nine months of 2014 and 2013, respectively. Total average deposits, including noninterest-bearing funds, increased by $73.7 million, or 3%, for the first nine months of 2014 over the same period of 2013 from $2.11 billion to $2.18 billion.

The average rate paid on interest-bearing liabilities for the first nine months of 2014 was 0.38%, compared to 0.41% for the first nine months of 2013. Our deposit cost of funds decreased from 0.29% in the first nine months of 2013 to 0.26% for the same period in 2014. The aggregate cost of all funding sources was 0.31% for the first nine months of 2014, compared to 0.34% for the same period in 2013.















34




In the following table, nonaccrual loans have been included in the average loans receivable balances. Securities include securities available for sale, securities held to maturity and restricted investments in bank stock. Securities available for sale are carried at amortized cost for purposes of calculating the average rate received on taxable securities. Yields on tax-exempt securities and loans are computed on a tax-equivalent basis, assuming a 35% tax rate for both years.

TABLE 2
 
Three months ended,
 
Nine months ended,
 
September 30, 2014
September 30, 2013
 
September 30, 2014
September 30, 2013
 
Average
 
Avg.
Average
 
Avg.
 
Average
 
Avg.
Average
 
Avg.
(dollars in thousands)
Balance
Interest
Rate
Balance
Interest
Rate
 
Balance
Interest
Rate
Balance
Interest
Rate
Earning Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
Taxable
$
885,232

$
5,187

2.34
%
$
881,068

$
5,021

2.28
%
 
$
873,251

$
15,251

2.33
%
$
895,782

$
15,387

2.29
%
Tax-exempt
37,869

353

3.73

29,873

284

3.80

 
33,271

939

3.76

29,871

851

3.80

Total securities
923,101

5,540

2.40

910,941

5,305

2.33

 
906,522

16,190

2.38

925,653

16,238

2.34

Total loans
1,885,057

22,027

4.59

1,674,334

20,150

4.73

 
1,831,028

63,782

4.61

1,619,215

59,460

4.86

Total earning assets
$
2,808,158

$
27,567

3.87
%
$
2,585,275

$
25,455

3.88
%
 
$
2,737,550

$
79,972

3.87
%
$
2,544,868

$
75,698

3.94
%
Sources of Funds
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits:
 
 
 
 
 
 
 
 
 
 
 
 
 
  Regular savings
$
461,451

$
323

0.28
%
$
458,105

$
348

0.30
%
 
$
462,189

$
978

0.28
%
$
432,453

$
1,009

0.31
%
  Interest checking and money market
1,058,220

728

0.27

1,039,800

735

0.28

 
1,053,907

2,155

0.27

1,052,330

2,270

0.29

  Time deposits
129,524

363

1.11

123,044

368

1.19

 
126,740

1,011

1.07

130,506

1,212

1.24

  Public time and other noncore deposits
80,861

76

0.37

65,145

52

0.32

 
71,609

181

0.34

60,026

156

0.35

Total interest-bearing deposits
1,730,056

1,490

0.34

1,686,094

1,503

0.35

 
1,714,445

4,325

0.34

1,675,315

4,647

0.37

Short-term borrowings
428,440

331

0.30

329,868

189

0.22

 
391,132

840

0.28

294,978

501

0.22

Long-term debt
14,941

325

8.71

15,800

307

7.77

 
15,511

939

8.07

22,760

974

5.70

Total interest-bearing liabilities
2,173,437

2,146

0.39

2,031,762

1,999

0.39

 
2,121,088

6,104

0.38

1,993,053

6,122

0.41

Demand deposits (noninterest-bearing)
485,564

 
 
431,438

 
 
 
469,578

 

 

435,026

 

 

Sources to fund earning assets
2,659,001

2,146

0.32

2,463,200

1,999

0.32

 
2,590,666

6,104

0.31

2,428,079

6,122

0.34

Noninterest-bearing funds (net)
149,157

 
 
122,075

 
 
 
146,884

 

 

116,789

 

 

Total sources to fund earning assets
$
2,808,158

$
2,146

0.30
%
$
2,585,275

$
1,999

0.31
%
 
$
2,737,550

$
6,104

0.30
%
$
2,544,868

$
6,122

0.32
%
Net interest income and margin on
  a tax-equivalent basis
 
$
25,421

3.57
%
 
$
23,456

3.58
%
 
 
$
73,868

3.57
%
 
$
69,576

3.62
%
Tax-exempt adjustment
 
566

 
 
589

 
 
 
1,683

 
 
1,775

 
Net interest income and margin
 
$
24,855

3.49
%
 
$
22,867

3.49
%
 
 
$
72,185

3.49
%
 
$
67,801

3.53
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other Balances:
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
$
44,680

 
 
$
50,839

 
 
 
$
43,740

 
 
$
48,182

 
 
Other assets
75,097

 
 
71,101

 
 
 
71,533

 
 
84,412

 
 
Total assets
2,927,935

 
 
2,707,215

 
 
 
2,852,823

 
 
2,677,462

 
 
Other liabilities
17,252

 
 
16,157

 
 
 
16,943

 
 
16,558

 
 
Stockholders' equity
251,682

 
 
227,858

 
 
 
245,214

 
 
232,825

 
 

Net Interest Income and Net Interest Margin
 
Net interest income is the difference between interest income earned on loans, investment securities and other interest-earning assets and the interest expense paid on deposits, borrowed funds and long-term debt. Changes in net interest income and net interest margin result from the interaction between the volume and composition of interest-earning assets and their related yields; and the volume and composition of interest-bearing liabilities and their associated funding costs. Net interest income is our primary source of earnings. There are several factors that affect net interest income, including:
 
the volume, pricing mix and maturity of interest-earning assets and interest-bearing liabilities;
market interest rate fluctuations; and
the level of nonperforming loans.



35




Net interest income on a fully-taxable equivalent basis (which adjusts for the tax-exempt status of income earned on certain loans and investment securities in order to show such income as if it were taxable) for the third quarter of 2014 increased by $2.0 million, or 8%, over the same period in 2013. Interest income, on a fully-taxable equivalent basis, on interest-earning assets totaled $27.6 million for the third quarter of 2014 versus $25.5 million for the third quarter of 2013. Interest income on loans receivable including loans held for sale, increased by $1.9 million, or 9%, over the third quarter of 2013 from $20.2 million to $22.0 million. This was the result of a 13% increase in average loans outstanding partially offset by a decrease of 14 bps in the yield on the total loan portfolio compared to the third quarter one year ago.
 
Total interest expense for the third quarter increased $147,000, or 7%, in 2014. Interest expense on short-term borrowings increased by $142,000 as a result of an increase in the average balance of borrowings as well as an 8 bps increase in rate.

Net interest income, on a fully tax-equivalent basis, for the first nine months of 2014 increased by $4.3 million, or 6%, over the same period in 2013. Interest income on interest-earning assets totaled $80.0 million for the first nine months of 2014, an increase of $4.3 million, compared to the same period in 2013. The increase in interest income earned was primarily the result of the 13% increase in the average balance of loans receivable that helped to offset a 25 bp decrease in the yield on those loans due to the continued low interest rate environment. Total interest expense for the first nine months decreased $18,000 in 2014 versus the the first nine months of 2013. Interest expense on deposits decreased by $322,000, or 7%, for the first nine months of 2014 versus the same period of 2013. Interest expense on short-term borrowings increased by $339,000 for the first nine months of 2014 compared to the same period in 2013. The increase in interest expense associated with short-term borrowings was due to a combination of the higher average balance of such borrowings as well as a 6 bps increase in the average rate paid on such borrowings for the first nine months of 2014 compared to the same period in 2013. The decrease in interest expense on long-term debt was primarily due to the maturity of a $25 million FHLB borrowing with an interest rate of 1.01% which matured in March 2013. Additionally, the Company redeemed $15.0 million of outstanding Trust Preferred Securities, in September 2014, which will save approximately $1.1 million in annual interest expense going forward.

Changes in net interest income are frequently measured by two statistics: net interest rate spread and net interest margin. Net interest rate spread is the difference between the average rate earned on interest-earning assets and the average rate incurred on interest-bearing liabilities. Our net interest rate spread on a fully tax-equivalent basis was 3.48% during the third quarter of 2014 compared to 3.49% during the same period in the previous year and was 3.49% during the first nine months of 2014 versus 3.53% during the first nine months of 2013. Net interest margin represents the difference between interest income, including net loan fees earned, and interest expense, reflected as a percentage of average interest-earning assets. The fully-taxable equivalent net interest margin decreased 1 bp, from 3.58% for the third quarter of 2013 to 3.57% for the third quarter of 2014. For the first nine months of 2014 and 2013, the fully tax-equivalent net interest margin was 3.57% and 3.62%, respectively. This decrease is a result of the previously discussed decrease in yield on interest-earning assets.


36




The following table demonstrates the relative impact on net interest income of changes in the volume of earning assets and interest-bearing liabilities and changes in rates earned and paid by us on such assets and liabilities. For purposes of this table, nonaccrual loans have been included in the average loan balances and tax-exempt loans and securities are reported on a fully-taxable equivalent basis.

TABLE 3
 
Three Months Ended
 
Nine Months Ended
 
Increase (Decrease)
 
Increase (Decrease)
2014 versus 2013
Due to Changes in (1)
 
Due to Changes in (1)
(in thousands)
Volume
 
Rate
 
Total
 
Volume
 
Rate
 
Total
Interest on securities:
 
 
 
 
 
 
 
 
 
 
 
Taxable
$
65

 
$
101

 
$
166

 
$
(290
)
 
$
154

 
$
(136
)
Tax-exempt
73

 
(4
)
 
69

 
97

 
(9
)
 
88

Interest on loans
2,494

 
(617
)
 
1,877

 
7,407

 
(3,085
)
 
4,322

Total interest income
2,632

 
(520
)
 
2,112

 
7,214

 
(2,940
)
 
4,274

Interest on deposits:
 

 
 

 
 

 
 

 
 

 
 

Regular savings
16

 
(41
)
 
(25
)
 
68

 
(99
)
 
(31
)
Interest checking and money market
(7
)
 

 
(7
)
 
(60
)
 
(55
)
 
(115
)
Time deposits
(1
)
 
(4
)
 
(5
)
 
(88
)
 
(113
)
 
(201
)
Public funds time and other noncore deposits
14

 
10

 
24

 
29

 
(4
)
 
25

Short-term borrowings
66

 
76

 
142

 
188

 
151

 
339

Long-term debt
(17
)
 
35

 
18

 
(44
)
 
9

 
(35
)
Total interest expense
71

 
76

 
147

 
93

 
(111
)
 
(18
)
Net increase (decrease)
$
2,561

 
$
(596
)
 
$
1,965

 
$
7,121

 
$
(2,829
)
 
$
4,292

(1) 
Changes due to both volume and rate have been allocated on a pro rata basis to either rate or volume.  

Provision for Loan Losses
 
Management undertakes a rigorous and consistently applied process in order to evaluate the ALL and to determine the level of provision for loan losses, as previously stated in the Application of Critical Accounting Policies. As stated in this policy, the Company uses a two-year period of actual historical losses. Management continuously assesses the quality of the Company's loan portfolio in conjunction with the current state of the economy and its impact on our borrowers repayment ability and on loan collateral values in order to determine the appropriate probable loss period to use in our quantitative analysis. Considering these factors, management continued to use a two-year probable loss period in the third quarter of 2014 in determining the adequacy of the ALL.

The following table presents the allowance for loan losses and nonperforming loan balances along with related ratios at September 30, 2014 and 2013 as well as at December 31, 2013:
 
TABLE 4
(dollars in thousands)
September 30, 2014
December 31, 2013
September 30, 2013
Allowance for loan losses
$
24,540

$
23,110

$
27,425

Allowance as a percentage of total period-end loans
1.28
%
1.32
%
1.61
%
Total nonperforming loans
$
33,175

$
40,332

$
43,494

Nonperforming loans to total loans
1.73
%
2.30
%
2.55
%



37




Management believes that the provision for loan losses for the three and nine months ended September 30, 2014 adequately supports the allowance balance at September 30, 2014. The following table presents information regarding the provision for loan losses and net loan charge-offs for the three and nine months ended September 30, 2014 compared to the same periods in 2013:
 
TABLE 5
 
Three Months Ended
Nine Months Ended
 
September 30,
September 30,
(in thousands)
2014
2013
2014
2013
Provision for loan losses
$
2,100

$
1,200

$
4,100

$
5,300

Net loan charge-offs
(1,831
)
(1,813
)
(2,670
)
(3,157
)

See the Loan and Asset Quality and the Allowance for Loan Losses sections presented later in this Management's Discussion and Analysis for further discussion regarding nonperforming loans and our methodology for determining the provision for loan losses.

Noninterest Income

Total noninterest income for the third quarter of 2014 increased by $113,000, or 2%, over the same period in 2013. The increase was related to a higher level of gains recognized on the sale of residential mortgages on the secondary market. Noninterest income is comprised of service charges on deposit accounts, card income, gains on sales of loans, and gains or losses on sales/calls of securities.

Total noninterest income for the first nine months of 2014 decreased by $23,000 from the same period in 2013. Card income increased by $697,000, or 6%, for the first nine months of 2014 compared to the first nine months of 2013 as the volume of transactions continues to increase.  Conversely, service charges on deposits and other income decreased $277,000 and $176,000, respectively, for the first nine months of 2014 compared to the same period in 2013. Additionally, gains on sales of loans decreased by $283,000, or 35%, directly related to a decrease in the volume of residential loans sold compared to the same period in 2013.

Noninterest Expenses

Third Quarter 2014 compared to Third Quarter 2013

Noninterest expenses decreased by $67,000 for the third quarter of 2014 compared to the same period in 2013. A detailed comparison of noninterest expenses for certain categories for the three months ended September 30, 2014 and September 30, 2013 is presented in the following paragraphs.

Salary and employee benefits expenses, which represent the largest component of noninterest expenses, increased by $443,000, or 4%, for the third quarter of 2014 compared to the third quarter of 2013. This increase was primarily a result of an increase in employee benefits including medical coverage.

Furniture and equipment expenses totaled $908,000 for the third quarter of 2014, a decrease of $206,000, or 18%, from the third quarter of 2013. This decrease was due to certain equipment the Bank had fully depreciated in 2013, resulting in less depreciation expense in the third quarter of 2014.

Advertising and marketing expenses increased $161,000, or 45%, to $519,000 for the third quarter of 2014 compared to the third quarter of 2013. This increase was related to an overall higher level of marketing activity in the third quarter of 2014.
 
Loan expense totaled $153,000 for the third quarter of 2014, a decrease of $153,000, or 50%, from the third quarter of 2013. This decrease resulted from the sale of the Company's credit card portfolio in the third quarter of 2013, thus eliminating credit card expenses combined with a decrease in other loan related expenses.

The remaining noninterest expense categories with the exception of one category, shown on the Consolidated Statements of Income incurred minor decreases for the third quarter of 2014 compared to the third quarter of 2013.
 
Nine Months Ended September 30, 2014 compared to Nine Months Ended September 30, 2013

For the first nine months of 2014, noninterest expenses increased by $1.0 million, or 2%, compared to the first nine months of 2013. A detail of noninterest expenses for certain categories is presented in the following paragraphs.


38





Salary expenses and employee benefits for the first nine months of 2014 were $33.7 million, an increase of $1.7 million, or 5%, compared to the first nine months of 2013. This increase was primarily a combined result of an increase in employee compensation levels and benefits including medical coverage.

Furniture and equipment expenses totaled $2.9 million for the first nine months of 2014, a decrease of $454,000, or 13%, from the first nine months of 2013.  The decrease was due to the previously mentioned reduction in depreciation expense as well as a reduction in disposal losses.

Advertising and marketing expenses for the first nine months of 2014 was $1.3 million, an increase of $185,000, or 17%, compared to the first nine months of 2013. This increase resulted from an overall higher level of marketing activity for the first nine months of 2014 compared to the same period in 2013.

Loan expenses totaled $1.2 million for the first nine months of 2014, a decrease of $506,000, or 30%, compared to the same period in 2013 due in large part to decrease in credit card expenses as a result of the Company selling its credit card portfolio in the third quarter of 2013 as well as the recovery of legal fees and other related expenses that were expensed in prior periods on a few problem commercial real estate loans.

Each of the remaining noninterest expense categories shown on the Consolidated Statements of Income incurred minor increases or decreases for the first nine months of 2014 compared to the same period in 2013.

One key measure that management utilizes to monitor progress in controlling overhead expenses is the ratio of annualized net noninterest expenses to average assets. For purposes of this calculation, net noninterest expenses equal noninterest expenses less noninterest income and nonrecurring expense. For the third quarters of 2014 and 2013 this ratio equaled 2.00% and 2.18%, respectively, reflecting continued disciplined expense management in the third quarter of 2014 despite an 8% increase in average assets. For the nine months ended September 30, 2014, the ratio equaled 2.15% compared to 2.24% for the nine months ended September 30, 2013, again reflecting the Company's focus on containing costs while showing strong balance sheet growth.

Another productivity measure utilized by management is the operating efficiency ratio. This ratio expresses the relationship of noninterest expenses to net interest income plus noninterest income. For the quarter ended September 30, 2014, the operating efficiency ratio was 68.9%, compared to 73.7% for the same period in 2013. The decrease in the operating efficiency ratio relates to a 7% increase in total revenues combined with a flat level of noninterest expenses. The efficiency ratio equaled 72.2% for the first nine months of 2014, compared to 74.5% for the first nine months of 2013. The decrease for the nine months ended September 30, 2014 versus September 30, 2013 was mostly due to a 5% increase in total revenues partially offset by a 2% increase in total noninterest expenses.

Provision for Federal Income Taxes

The following table presents information regarding the provision for federal income taxes and the effective and statutory tax rates for the three and nine months ended September 30, 2014 compared to the same periods in 2013:
 
TABLE 6
 
Three Months Ended
Nine Months Ended
 
September 30,
September 30,
(dollars in thousands)
2014
2013
2014
2013
Provision for federal income taxes
$
2,507

$
2,064

$
6,582

$
5,225

Effective tax rate
31
%
31
%
30
%
30
%
Statutory tax rate
35
%
35
%
35
%
35
%



39




Net Income and Net Income per Common Share
 
The major categories of the income statement and their respective impact to the increase in net income for the three and nine months ended September 30, 2014 and September 30, 2013 is presented below:

TABLE 7
 
For the Three Months Ended September 30,
For the Nine Months Ended September 30,
(in thousands, except per share data)
2014
2013
$ Change
% Change
2014
2013
$ Change
% Change
Net interest income
$
24,855

$
22,867

$
1,988

9
 %
$
72,185

$
67,801

$
4,384

6
 %
Provision for loan losses
2,100

1,200

900

75

4,100

5,300

(1,200
)
(23
)
Noninterest income
7,629

7,516

113

2

22,202

22,225

(23
)

Noninterest expenses
22,376

22,443

(67
)

68,179

67,132

1,047

2

Provision for income taxes
2,507

2,064

443

21

6,582

5,225

1,357

26

Net income
$
5,501

$
4,676

$
825

18
 %
$
15,526

$
12,369

$
3,157

26
 %
Net Income per Common Share
 
 
 
 
 
 
 
 
   Basic
$
0.39

$
0.33

$
0.06

18
 %
$
1.09

$
0.87

$
0.22

25
 %
   Diluted
0.38

0.32

0.06

19

1.07

0.86

0.21

24


Return on Average Assets and Average Stockholders' Equity
 
Return on average assets (ROA) measures our net income in relation to our total average assets. Return on average stockholders' equity (ROE) indicates how effectively we can generate net income on the capital invested by our stockholders. ROE is calculated by dividing annualized net income by average stockholders' equity.

The annualized ratios for ROA and ROE are presented in the following table for the three and nine months ended September 30, 2014 compared to the same periods in 2013:
 
TABLE 8
 
Three Months Ended
Nine Months Ended
 
September 30,
September 30,
 
2014
2013
2014
2013
Return on average assets
0.75
%
0.69
%
0.73
%
0.62
%
Return on average stockholders' equity
8.67

8.14

8.47

7.10


FINANCIAL CONDITION

Securities
 
The Company maintains a securities portfolio in order to provide liquidity, to manage interest rate risk and to use as collateral on certain deposits and borrowings. The investment securities portfolio totaled $887.5 million at September 30, 2014, a $17.8 million increase over $869.7 million at December 31, 2013 primarily due to reinvestment of cash flows in both the available for sale (AFS) and held to maturity (HTM) portfolios. Net of tax, the unrealized loss position on AFS securities included in stockholders' equity as accumulated other comprehensive income (loss) decreased by $6.4 million from an unrealized loss of $16.5 million at December 31, 2013 to an unrealized loss of $10.1 million at September 30, 2014 as the general level of market interest rates declined during the first nine months of September 30, 2014, thus increasing the fair market value associated with the Company's AFS portfolio.

See Note 3 of the Notes to the Interim Consolidated Financial Statements for the period ended September 30, 2014, included herein, for further analysis regarding the Company's securities portfolio.






40




Loans Receivable
 
Commercial loans outstanding are comprised of commercial and industrial, tax-exempt, owner occupied real estate, commercial construction and land development and commercial real estate loans. Consumer type loans consist of residential real estate mortgages, home equity loans, consumer lines of credit and other consumer-related loans. We manage risk associated with our loan portfolio in part through diversification, with what we believe are sound policies and underwriting procedures that are reviewed, updated and approved at least annually, as well as through our ongoing loan monitoring efforts. Additionally, we monitor concentrations of loans or loan relationships by purpose, collateral or industry.

During the first nine months of 2014, total gross loans receivable increased by $162.7 million, or 9% (nonannualized), from $1.75 billion at December 31, 2013 to $1.91 billion at September 30, 2014. Gross loans receivable represented 82% of total deposits and 65% of total assets at September 30, 2014, as compared to 78% and 63%, respectively, at December 31, 2013. The Bank experienced growth in all but two loan categories over the first nine months of 2014 primarily as a result of continued general economic improvement in the markets we serve.

The Company's particularly strong growth in commercial real estate loans reflects a steady progression over the past four quarters in this portfolio, owing to continued strengthening in the real estate markets the Bank serves combined with increased opportunities.

The following table reflects the composition of the Company's loan portfolio as of September 30, 2014 and as of December 31, 2013, respectively:
 
TABLE 9
(dollars in thousands)
 
September 30, 2014
 
% of Total
 
December 31, 2013
 
% of Total
 
$
Change
 
%
Change
Commercial and industrial
 
$
478,605

 
25
%
 
$
447,144

 
25
%
 
$
31,461

 
7
 %
Commercial tax-exempt
 
75,986

 
4

 
81,734

 
5

 
(5,748
)
 
(7
)
Owner occupied real estate
 
312,032

 
16

 
302,417

 
17

 
9,615

 
3

Commercial construction and land
development
 
122,314

 
6

 
133,176

 
8

 
(10,862
)
 
(8
)
Commercial real estate
 
594,004

 
31

 
473,188

 
27

 
120,816

 
26

Residential
 
107,707

 
6

 
97,766

 
6

 
9,941

 
10

Consumer
 
222,972

 
12

 
215,447

 
12

 
7,525

 
3

Gross loans
 
$
1,913,620

 
100
%
 
$
1,750,872

 
100
%
 
$
162,748

 
9
 %
Less: ALL
 
24,540

 
 

 
23,110

 
 

 
1,430

 
6

Net loans receivable
 
$
1,889,080

 
 

 
$
1,727,762

 
 

 
$
161,318

 
9
 %

Loan and Asset Quality
 
Nonperforming Assets
Nonperforming assets include nonperforming loans, loans past due 90 days or more and still accruing interest and foreclosed assets. Nonaccruing troubled debt restructurings (TDRs) are included in nonperforming loans. A TDR is a loan in which the contractual terms have been modified resulting in the Bank granting a concession to a borrower who is experiencing financial difficulties in order for the Bank to have a greater opportunity of collecting the indebtedness from the borrower. 


41




The table that follows presents information regarding nonperforming assets at September 30, 2014 and at the end of the previous four quarters. Nonaccruing and accruing TDRs are broken out at the bottom portion of the table. Additionally, relevant asset quality ratios are presented.

TABLE 10
(dollars in thousands)
September 30, 2014
June 30, 2014
March 31, 2014
December 31, 2013
September 30, 2013
Nonperforming Assets
 
 
 
 
 
Nonaccrual loans:
 
 
 
 
 
   Commercial and industrial
$
7,974

$
4,291

$
9,014

$
10,217

$
9,967

   Commercial tax-exempt





   Owner occupied real estate
6,954

6,401

6,005

4,838

4,924

   Commercial construction and land development
3,254

9,028

10,734

8,587

11,723

   Commercial real estate
6,407

5,793

6,043

6,705

6,904

   Residential
6,157

6,341

6,551

7,039

7,316

   Consumer
2,421

2,479

2,524

2,577

2,541

Total nonaccrual loans
33,167

34,333

40,871

39,963

43,375

Loans past due 90 days or more and still
  accruing
8

2,335


369

119

Total nonperforming loans
33,175

36,668

40,871

40,332

43,494

Foreclosed assets
7,162

4,020

3,990

4,477

3,556

Total nonperforming assets
$
40,337

$
40,688

$
44,861

$
44,809

$
47,050

Troubled Debt Restructurings
 
 
 
 
 
Nonaccruing TDRs (included in nonaccrual
  loans above)
$
12,495

$
17,748

$
19,862

$
17,149

$
23,621

Accruing TDRs
10,791

11,309

9,970

12,091

11,078

Total TDRs
$
23,286

$
29,057

$
29,832

$
29,240

$
34,699

Nonperforming loans to total loans
1.73
%
1.98
%
2.27
%
2.30
%
2.55
%
Nonperforming assets to total assets
1.36
%
1.42
%
1.57
%
1.61
%
1.71
%
Nonperforming loan coverage
74
%
66
%
59
%
57
%
63
%
Nonperforming assets / capital plus ALL
15
%
15
%
17
%
18
%
18
%

The Bank continues to manage nonperforming assets to either exit the relationship, work with the borrower to return the relationship to a performing status, or sell the collateral in the case of foreclosed real estate. The Bank's nonperforming assets and the reasons for changes in the balances of those components between December 31, 2013 and September 30, 2014 are discussed in the paragraphs that follow.
 
Nonaccrual Loans

The Bank generally places a loan on nonaccrual status and ceases accruing interest when the loan is past due 90 days or more, unless the loan is both well-secured and in the process of collection.

Loans which have been partially charged off remain on nonaccrual status and are subject to the Bank's standard recovery policies and procedures, including, but not limited to, foreclosure proceedings, a forbearance agreement, or restructuring that results in classification as a TDR, unless collectibility of the entire balance of principal and interest is no longer in doubt and the loan is current or will be brought current within a short period of time.

Total nonaccrual loans decreased by $6.8 million in the first nine months of 2014 to $33.2 million compared to $40.0 million at December 31, 2013.


42




The following table details the change in the total of nonaccrual loan balances for the three and nine months ended September 30, 2014:

TABLE 11
 
Three Months Ended
Nine Months Ended
(in thousands)
September 30, 2014
Nonaccrual loans beginning balance
$
34,333

$
39,963

Additions
9,333

18,933

Principal charge-offs
(2,086
)
(4,862
)
Pay downs
(4,610
)
(13,222
)
Upgrades to accruing status
(44
)
(3,381
)
Transfers to foreclosed assets
(3,759
)
(4,264
)
Nonaccrual loans ending balance
$
33,167

$
33,167


During the third quarter of 2014, the additions to nonaccrual status of $9.3 million consisted of 15 commercial loans ranging from $3,000 to approximately $3.3 million and 23 consumer loans averaging $76,000 each of unpaid principal balances. The pay downs of $4.6 million along with charge-offs of $2.1 million and transfers to foreclosed real estate of $3.8 million, ultimately caused the reduction of nonaccrual loans during the third quarter. Current nonaccrual commercial loans are not concentrated in any particular industry or business. As reflected above, the portfolio is frequently changing with new additions, pay downs, upgrades, transfers to foreclosed real estate, and charge-offs when necessary.



43




The table and discussion that follow provide additional details of the components of our nonaccrual commercial loan categories.

TABLE 12
 
Nonaccrual Loans
 
(dollars in thousands)
September 30, 2014
June 30, 2014
March 31, 2014
December 31, 2013
September 30, 2013
Commercial and Industrial:
 
 
 
 
 
Number of loans
34

28

36

35

38

Number of loans greater than $1 million
2

1

2

3

3

Average outstanding balance of those loans:
 

 
 
 
 
Greater than $1 million
$
2,193

$
1,079

$
1,918

$
1,807

$
1,824

Less than $1 million
$
121

$
130

$
153

$
150

$
129

Owner Occupied Real Estate:
 
 
 
 
 
Number of loans
19

19

18

13

16

Number of loans greater than $1 million
1

1

3

2

2

Average outstanding balance of those loans:
 

 
 
 
 
Greater than $1 million
$
1,142

$
1,317

$
1,253

$
1,448

$
1,475

Less than $1 million
$
325

$
297

$
166

$
199

$
160

Commercial Construction and Land Development:
 
 
 
 

 
Number of loans
2

7

7

4

10

Number of loans greater than $1 million
1

3

4

3

4

Average outstanding balance of those loans:
 

 
 
 
 
Greater than $1 million
$
3,054

$
2,556

$
2,508

$
2,798

$
2,704

Less than $1 million
$
208

$
342

$
237

$
203

$
153

Commercial Real Estate:
 
 
 
 
 
Number of loans
26

27

28

29

29

Number of loans greater than $1 million
1

1

1

1

1

Average outstanding balance of those loans:
 
 
 
 
 
Greater than $1 million
$
2,291

$
1,793

$
1,846

$
2,346

$
2,257

Less than $1 million
$
166

$
155

$
156

$
157

$
167

 
Foreclosed Assets
Foreclosed assets totaled $7.2 million at September 30, 2014 compared to $4.5 million at December 31, 2013. The total is comprised of eight properties at September 30, 2014 with the largest property carried at $2.2 million. The increase in foreclosed real estate during the third quarter of 2014 is the result of the transfer in of four properties totaling $3.8 million with two properties making up 98% of the quarterly transfer in, offset partially by the sale of four properties with a combined carrying value of $617,000.
The increase in foreclosed real estate during the first nine months of 2014 is the result of the transfer in of seven properties totaling $4.3 million offset partially by the sale of 11 properties with a combined carrying value of $1.6 million. The sales of these properties resulted in a net gain of $73,000.
The Bank obtains third party appraisals on foreclosed real estate to support the fair market value of the collateral. Appraisals are ordered by the Company's Real Estate Loan Administration Department which is independent of both the loan workout and loan production functions. All appraisals are performed by a Board approved, certified general appraiser. The Company charges down loans based on the fair value of the collateral as determined by the current appraisal less any unpaid real estate taxes and any costs to sell before the properties are transferred to foreclosed real estate. Subsequent to transferring a property to foreclosed real estate, the Company may incur additional write-down expense based on updated appraisals, and offers for purchase or prices on comparable properties in the proximate vicinity.
Troubled Debt Restructurings
As mentioned previously, a troubled debt restructuring (TDR) is a loan in which the contractual terms have been modified, resulting in the Bank granting a concession to a borrower who is experiencing financial difficulties, in order for the Bank to have a greater


44




opportunity of collecting the indebtedness from the borrower. Concessions could include, but are not limited to, granting a material extension of time, entering into a forbearance agreement, adjusting the interest rate, accepting interest only payments for an extended period of time, a change in the amortization period or a combination of any of these concessions. An additional benefit to the Bank in granting a concession is to avoid foreclosure or repossession of collateral in an attempt to minimize losses. All TDRs are impaired loans, however, a loan may still be accruing even though it has been restructured. Management evaluates these loans using the same guidelines it uses for all loans to determine if there is reasonable assurance of repayment. For further discussion of these guidelines, see the following section on Impaired and Other Problem Loans.

Nonaccrual TDRs may be reclassified as accruing TDRs when the borrower has consistently made contractual payments of principal and interest for at least six consecutive months and the Bank expects full repayment of the modified loan's principal and interest. The loan will no longer be classified as a TDR when the interest rate is equal to or greater than the rate that the Bank was willing to accept at the time of the restructuring for a new loan with comparable risk and the loan is no longer impaired based on the terms specified by the restructuring agreement.

Impaired and Other Problem Loans
Impaired loans include nonaccrual loans in addition to loans which the Bank, based on current information, does not expect to receive both the principal and interest amounts due from a borrower according to the contractual terms of the original loan agreement. These loans totaled $44.5 million at September 30, 2014 with an aggregate specific allowance allocation of $6.0 million compared to impaired loans totaling $52.6 million at December 31, 2013 with a $5.6 million aggregate specific allowance allocation. The total combined specific allowance allocations at September 30, 2014 related to five loan relationships compared to four loan relationships at December 31, 2013.
Impaired loans have been evaluated as to risk exposure in determining the adequacy of the ALL. See Note 4 of Notes to Consolidated Financial Statements for the period ended September 30, 2014, included herein, for an age analysis of loans receivable and tables that detail impaired loans and credit quality indicators.
The past due portfolio is constantly in various stages of collection efforts which include: restructures when appropriate, foreclosures or charge-off. During the first nine months of 2014, $15.0 million of the 49.1 million of past due loans at December 31, 2013 improved to current status at September 30, 2014. Another $8.3 million of past due loan balances paid off during the first nine months of 2014. Additionally, $3.5 million and $4.3 million of those loans past due at December 31, 2013, were charged off and moved to foreclosed real estate, respectively. A total of $18.2 million in current loans at December 31, 2013, subsequently became delinquent and were reported as past due at September 30, 2014. Out of the $18.2 million of loans that became past due after December 31, 2013, $10.3 million were 30-59 days past due, $1.6 million were 60-89 days past due while the remainder, or $6.3 million were 90 days past due or greater at September 30, 2014, with $9.7 million of those loans classified as nonaccrual.

The Bank generally obtains third party appraisals ordered by the Real Estate Loan Administration Department on nonperforming loans secured by real estate at the time the loan is determined to be impaired. The Bank charges down loans based on the appropriate discounted fair value of the collateral as determined by the current appraisal or other collateral valuations less any unpaid real estate taxes and any costs to sell. The charge-down of any impaired loan is done upon receipt and satisfactory review of the appraisal or other collateral valuation and, in no event, later than the end of the quarter in which the appraisal or valuation was accepted by the Bank. No significant time lapses during this process have occurred for any period presented.

The Bank also considers the volatility of the fair value of the collateral, timing and reliability of the appraisal, timing of the third party's inspection of the collateral, confidence in the Bank's lien on the collateral, historical losses on similar loans and other factors based on the type of real estate securing the loan. As deemed necessary, the Bank will perform inspections of the collateral to determine if an adjustment of the value of the collateral is necessary.
The Bank may create a specific allowance for all or a part of a particular loan in lieu of a charge-off as a result of management's evaluation of the impaired loan. In these instances, the Bank has determined that a loss is probable, but not imminent based upon available information surrounding the credit at the time of the analysis, however, management believes a reserve is appropriate to acknowledge the probable risk of loss.
Management's ALL Committee has performed a detailed review of the impaired loans and of the collateral related to these credits and believes, to the best of its knowledge, that the ALL remains adequate for the level of risk inherent in these loans at September 30, 2014.
Any criticized or classified loan not considered impaired is reviewed to determine if impairment exists. Such loan classifications totaled $44.9 million at September 30, 2014 compared to $38.6 million at December 31, 2013 and were comprised of $17.2 million


45




of special mention rated loans and $27.7 million of substandard accruing loans which were not deemed impaired. These problem loans were included in the general pool of loans to determine the adequacy of the ALL at September 30, 2014.

While it is difficult to forecast impaired loans due to numerous variables, the Bank, through its credit risk management tools and other credit metrics, believes it has currently identified the material problem loans in the portfolio.
As a result of continued economic uncertainty affecting unemployment, consumer spending, home sales and collateral values, it is possible that the Company may experience increased levels of nonperforming assets and additional losses in the future.

Allowance for Loan Losses
 
The majority of the Company’s charge-offs come from loans deemed impaired. Nonaccrual loans are all considered impaired.  Once a loan is impaired, an analysis is performed specifically on the loan and loan relationships to determine whether or not a probable loss exists. Regardless of whether a charge-off is recorded or a specific reserve has been allocated, both are taken into consideration when calculating the adequacy of the allowance. At September 30, 2014, approximately 40%, of the $6.0 million specific reserves were included in the allowance as a specific reserve at December 31, 2013

The ALL as a percentage of total loans receivable was 1.28% at September 30, 2014, compared to 1.32% at December 31, 2013. The increase in the dollar amount of the ALL balance from December 31, 2013 to September 30, 2014 was primarily the result of additional provisioning related to the overall increase in total loans receivable. The nonperforming loan coverage, defined as the ALL as a percentage of total nonperforming loans, was 74% as of September 30, 2014 compared to 57% at December 31, 2013. See the Application of Critical Accounting Policies earlier in this Management's Discussion and Analysis for a detailed discussion of the calculation of the ALL.

Deposits
 
Total deposits at September 30, 2014 were $2.33 billion, up $92.2 million, or 4% (nonannualized), over total deposits of $2.24 billion at December 31, 2013. The composition of the Company's deposits at September 30, 2014 and December 31, 2013 was as follows:

TABLE 13
(in thousands)
September 30, 2014
December 31, 2013
$ Change
% Change (non-annualized)
Noninterest-bearing demand
$
494,082

$
443,287

$
50,795

11
 %
Interest checking and money market
1,157,981

1,110,568

47,413

4
 %
Savings
459,526

496,495

(36,969
)
(7
)%
Time
220,260

189,271

30,989

16
 %
Total
$
2,331,849

$
2,239,621

$
92,228

4
 %

Short-Term Borrowings
 
Short-term borrowings consist of short-term and overnight advances from the FHLB. At September 30, 2014, short-term borrowings totaled $359.2 million as compared to $277.8 million at December 31, 2013. This large increase was to help fund the previously mentioned $162.7 million growth in loans outstanding. Average short-term borrowings for the first nine months of 2014 were $391.1 million as compared to $295.0 million for the first nine months of 2013. The year over year increase was the result of utilizing such borrowings to supplement deposit growth in order to fund the year over year increase in average earning assets. The average rate paid on the short-term borrowings was 0.28% for the first nine months of 2014 compared to 0.22% for the first nine months of 2013.

Long-Term Debt
 
At September 30, 2014 the Company had no long-term debt compared to $15.8 million at December 31, 2013. During late September of 2014, the Company called and retired $15.0 million of 7.75% fixed rate Trust Capital Securities at par. The retirement of this debt will reduce the Company's pretax interest expense by $1.1 million annually going forward. The December 31, 2013 long-term debt balance consisted of this $15.8 million of Trust Capital Securities through Trust III, our Delaware business trust subsidiary. At December 31, 2013, the Capital Trust Securities qualified as Tier I capital for regulatory capital purposes.


46





Stockholders' Equity
 
At September 30, 2014, stockholders' equity increased $23.2 million, or 10% (nonannualized), over December 31, 2013. Net income of $15.5 million for the nine months ended September 30, 2014 contributed to the majority of the increase in stockholders' equity. The increase in stockholders' equity was also partially the result of a decrease of $6.4 million in other comprehensive loss as the increase in quoted market prices on the Company's AFS securities portfolio decreased their unrealized loss position, net of income tax impacts, from December 31, 2013 to September 30, 2014. A summary of the Company's stockholders' equity section for the current quarter ended compared to December 31, 2013 is presented in Table 14 and the Company's equity to asset ratios are presented in Table 15.

TABLE 14
(dollars in thousands)
September 30, 2014
December 31, 2013
$ Change
% Change
Preferred stock
$
400

$
400

$

 %
Common stock
14,206

14,157

49


Surplus
159,882

158,650

1,232

1

Retained earnings
88,957

73,491

15,466

21

Accumulated other comprehensive loss
(10,083
)
(16,515
)
6,432

(39
)
Total stockholders' equity
$
253,362

$
230,183

$
23,179

10
 %

Supplemental Reporting of Non-GAAP Based Financial Measures

Tangible common equity to tangible assets is a non-GAAP based financial measure calculated using non-GAAP based amounts. Total stockholders' equity to total assets is the most directly comparable measure, which is calculated using GAAP-based amounts. The Company calculates the tangible common equity to tangible assets by excluding the balance of preferred stock and any intangible assets; however, the Company did not have any intangible assets at either September 30, 2014 or December 31, 2013. Management believes that tangible common equity to tangible assets has been a focus for some investors and assists in analyzing Metro's capital position without regard to the effect of preferred stock. Although this non-GAAP financial measure is frequently used by investors to evaluate a company, non-GAAP financial measurements have inherent limitations as analytical tools, and should not be considered in isolation, or as a substitute for analyses of results as reported under GAAP. A reconciliation of tangible common equity to tangible assets is set forth in the table that follows:

TABLE 15
 
September 30, 2014
December 31, 2013
Total stockholders' equity to assets (GAAP)
8.56
%
8.28
%
Less: Effect of excluding preferred stock
0.03
%
0.04
%
Tangible common equity to tangible assets
8.53
%
8.24
%

Capital Adequacy

Banks are evaluated for capital adequacy based on the ratio of capital to risk-weighted assets and total assets. The risk-based capital standards require all banks to have Tier 1 capital of at least 4% and total capital (including Tier 1 capital) of at least 8% of risk-weighted assets. Tier 1 capital includes common stockholders' equity and qualifying perpetual preferred stock together with related surpluses and retained earnings. Total capital includes total Tier 1 capital, limited life preferred stock, qualifying debt instruments and the ALL. The capital standard based on average assets, also known as the "leverage ratio", requires all, but the most highly-rated, banks to have Tier 1 capital of at least 4% of total average assets. At September 30, 2014, the Bank met the definition of a "well-capitalized" institution.



47




The following tables provide a comparison of the Company's and the Bank's risk-based capital ratios and leverage ratios to the minimum regulatory requirements for the periods indicated:

TABLE 16
 
Company
 
Bank
Minimum Regulatory Requirements
Regulatory Guidelines for “Well Capitalized”
 
September 30, 2014
December 31, 2013
 
September 30, 2014
December 31, 2013
Total Capital
13.58
%
14.59
%
 
13.54
%
14.09
%
8.00
%
10.00
%
Tier 1 Capital
12.42

13.41

 
12.38

12.91

4.00

6.00

Leverage ratio (to total
 average assets)
8.96

9.39

 
8.93

9.04

4.00

5.00


The decrease in each of the capital ratios shown above is primarily a result of the Company's 13% year over year net loan growth combined with the redemption of $15 million of Trust Preferred Securities which were included in Tier 1 and Total Risk-Based Capital.

Regulatory Capital Changes

In July 2013, the federal banking agencies issued final rules to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. The phase-in period for community banking organizations begins January 1, 2015, while larger institutions (generally those with assets of $250 billion or more) began compliance on January 1, 2014. The final rules call for the following capital requirements:
A minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5%.

A minimum ratio of tier 1 capital to risk-weighted assets of 6%.

A minimum ratio of total capital to risk-weighted assets of 8% (no change from the current rule).

A minimum leverage ratio of 4%.

In addition, the final rules establish a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets applicable to all banking organizations. If a banking organization fails to hold capital above the minimum capital ratios and the capital conservation buffer, it will be subject to certain restrictions on capital distributions and discretionary bonus payments. The phase-in period for the capital conservation and countercyclical capital buffers for all banking organizations will begin on January 1, 2016.
The Company is in the process of assessing the impact of these changes on the regulatory ratios as well as on the capital, operations, liquidity and earnings of the Company and the Bank.

Interest Rate Sensitivity 

The management of interest rate sensitivity seeks to avoid fluctuating net interest margins and to provide consistent net interest income through periods of changing interest rates.

Our risk of loss arising from adverse changes in the fair value of financial instruments, or market risk, is composed primarily of interest rate risk. The primary objective of our asset/liability management activities is to maximize net interest income while maintaining acceptable levels of interest rate risk. Our Asset/Liability Committee (ALCO) is responsible for establishing policies to limit exposure to interest rate risk and to ensure procedures are established to monitor compliance with those policies. Our board of directors reviews the guidelines established by ALCO.
 
Our management believes the simulation of net interest income in different interest rate environments provides a meaningful measure of interest rate risk. Income simulation analysis captures not only the potential of all assets and liabilities to mature or reprice, but also the probability that they will do so. Income simulation also attends to the relative interest rate sensitivities of these items and projects their behavior over an extended period of time. Finally, income simulation permits management to assess the probable effects on the balance sheet not only of changes in interest rates, but also of proposed strategies for responding to them.


48




 
Our income simulation model analyzes interest rate sensitivity by projecting net interest income over the next 24 months in a flat rate scenario versus net interest income in alternative interest rate scenarios. Our management continually reviews and refines its interest rate risk management process in response to the changing economic climate. Currently, our model projects up to a plus 500 bp increase and a 100 bp decrease during the next year, with rates remaining constant in the second year. The minus 100 bp scenario is not considered very likely, given the low absolute level of short-term interest rates.
 
Our ALCO policy has established that income sensitivity will be considered acceptable in the 100 bp and 200 bp scenarios if overall net interest income volatility is within 4% of forecasted net interest income in the first year and within 5% using a two-year time frame. In the 300 bp and 400 bp scenarios income sensitivity will be considered acceptable if net interest income volatility is within 5% of forecasted net interest income in the first year and within 6% using a two-year time frame. In the 500 bp scenario income sensitivity will be considered acceptable if net interest income volatility is within 6% of forecasted net interest income in the first year and within 7% using a two-year time frame.

The following table compares the impact on forecasted net interest income at September 30, 2014 and 2013 of a plus 300, plus 200 and plus 100 bp change in interest rates.

TABLE 17
 
 
September 30,
2014
 
September 30,
2013
 
 
12 Months
 
24 Months
 
12 Months
 
24 Months
Plus 300
 
(1.70
)%
 
2.26
%
 
(2.12
)%
 
0.12
 %
Plus 200
 
(1.44
)
 
1.12

 
(1.70
)
 
(0.31
)
Plus 100
 
(0.99
)
 
0.13

 
(1.15
)
 
(0.65
)
 
This quarter's net interest income changes as shown above, indicate negative first year impacts to net interest income in all scenarios presented, but positive two year impacts in all scenarios. The negative one year impacts reflect the funding of a portion of fixed rate investment and loan growth that has occurred over the last two years with overnight borrowings with rates that increase immediately in rising interest rate scenarios and result in shrinking net interest margins. The Company’s current projections call for the extension of a portion of its borrowing position into three to five year maturity term advances to provide long-term protection from rising interest rates. In addition, the Company is aggressively attracting reasonably-priced, long-term CD accounts to further insulate its future interest expense from any negative impacts of rising rates. The combination of these actions is projected to contribute to the positive two year impact to net interest income in the rising rate scenarios as shown above.

Management continues to evaluate additional strategies in conjunction with the Company's ALCO to effectively manage the interest rate risk position. Such strategies could include the sale of a portion of our AFS investment portfolio, purchasing floating rate securities, altering the mix of our deposits by type and therefore rate paid, the use of risk management tools such as interest rate swaps and caps, adjusting the investment leverage position funded by short-term borrowings and further extending the maturity structure of the Bank's short-term borrowing position.
 
Management uses many assumptions to calculate the impact of changes in interest rates. Actual results may not be similar to our projections due to several factors including the timing and frequency of rate changes, market conditions and the shape of the yield curve. In general, a flattening of the interest rate yield curve would result in reduced net interest income compared to a normal-shaped interest rate curve scenario and proportionate rate shift assumptions. Actual results may also differ due to management's actions, if any, in response to the changing rates.
 
Management also monitors interest rate risk by utilizing a market value of equity model. The model assesses the impact of a change in interest rates on the market value of all our assets and liabilities, as well as any off balance sheet items. Market value of equity is defined as the market value of assets less the market value of liabilities plus the market value of off-balance sheet items. The model calculates the market value of equity in the current rate scenario and then compares the market value of equity given immediate increases and decreases in rates. Our ALCO policy indicates that the level of interest rate risk is unacceptable in the 100 bp immediate interest rate change scenarios if there is a resulting loss of more than 15% of the market value calculated in the current rate scenario. In the 200 bp immediate interest rate change scenario a loss of more than 25% loss of market value is deemed unacceptable. A loss of more than 35% is defined as unacceptable in the 300 bp immediate interest rate change scenario, while a loss of more than 40% is unacceptable in immediate interest rate change scenarios of 400 bps or more. At September 30, 2014 the


49




market value of equity calculation indicated acceptable levels of interest rate risk in all scenarios per the policies established by our ALCO.
 
The market value of equity model reflects certain estimates and assumptions regarding the impact on the market value of our assets and liabilities given immediate changes in rates. One of the key assumptions is the market value assigned to our core deposits, or the core deposit premiums. Using an independent consultant, we have completed and updated comprehensive core deposit studies in order to assign our own core deposit premiums as permitted by regulation. The studies have consistently confirmed management's assertion that our core deposits have stable balances over long periods of time, are generally insensitive to changes in interest rates and have significantly longer average lives and durations than our loans and investment securities. Thus, these core deposit balances provide an internal hedge to market fluctuations in our fixed rate assets. Management believes the core deposit premiums produced by its market value of equity model at September 30, 2014 provide an accurate assessment of our interest rate risk. The most recent study calculates an average life of our core deposit transaction accounts of 9.6 years.

Liquidity
 
The objective of liquidity risk management is to ensure our ability to meet our financial obligations. These obligations include the payment of deposits on demand at their contractual maturity; the repayment of borrowings as they mature; the payment of lease obligations as they become due; the ability to fund new and existing loans and other funding commitments; and the ability to take advantage of new business opportunities. There are two fundamental risks in our liquidity risk management. The first is if we are unable to meet our funding requirements at a reasonable and profitable cost. The second is the potential inability to operate our business because adequate contingency liquidity is not available in a stressed environment or under adverse conditions.

We manage liquidity risk at both the Bank and the holding company (the Parent) levels to help ensure that we can obtain cost-effective funding to meet current and future obligations and to help ensure that we maintain an appropriate level of contingent liquidity. The board of directors is responsible for approving our Liquidity Policy to be managed by the ALCO and management.

Liquidity is measured and monitored daily, allowing management to better understand and react to balance sheet trends. On a quarterly basis, a comprehensive liquidity analysis is reviewed by our board of directors. The analysis provides a summary of the current liquidity measurements, projections and future liquidity positions given various levels of liquidity stress. Management also maintains a detailed Liquidity Contingency Plan designed to respond to an overall decline in the financial condition of the banking industry or a problem specific to the Company.

Bank Level Liquidity - Uses

At the bank level, primary liquidity obligations include funding loan commitments, satisfying deposit withdrawal requests and maturities and debt service related to bank borrowings. We also maintain adequate bank liquidity to meet future potential loan demand, purchase investment securities and provide for other business needs as necessary.

Bank Level Liquidity - Sources

Liquidity sources are found on both sides of the balance sheet. Our single largest source of bank liquidity is the deposit base that comes from our retail, commercial business and government deposit customers. Liquidity is also provided on a continuous basis through scheduled and unscheduled principal reductions and interest payments on outstanding loans and investments, maturing short-term assets, the ability to sell marketable securities and from borrowings.
 
Our investment portfolio consists primarily of U.S. Government agency collateralized mortgage obligations (CMOs) and mortgage-backed securities (MBSs). Cash flows from such investments are dependent upon the performance of the underlying mortgage loans and may be influenced by the level of interest rates. As rates increase, cash flows generally decrease as prepayments on the underlying mortgage loans slow. As rates decrease, cash flows generally increase as prepayments increase. The current market environment has negatively impacted the fair market value of certain securities in the Company's investment portfolio and therefore the Company is not inclined to act on a sale of such securities for liquidity purposes at this time. With short-term interest rates at or near record-lows, the Company would more likely be inclined to borrow from one of the sources discussed in the following paragraph.

We also maintain secondary sources of liquidity which can be drawn upon if needed. These secondary sources of liquidity as of September 30, 2014 included a $15.0 million line of credit through a correspondent bank, a $20.0 million line of credit through another correspondent bank and $770.1 million of borrowing capacity at the FHLB. The Bank is a member of the FHLB-Pittsburgh and, as such, has access to advances secured generally by residential mortgage and other mortgage-related loans. In addition we have the ability to borrow at the Federal Reserve Bank of Philadelphia's (FRB) Discount Window to meet short-term liquidity


50




requirements. The FRB, however, is not viewed as the primary source of our borrowings, but rather as a potential source of liquidity under certain circumstances, in a stressed environment or during a market disruption. This potential source is secured by agency residential MBSs and CMOs, as well as agency debentures.

The Company's potential and available liquidity through FHLB and other secondary sources for September 30, 2014 and December 31, 2013 are presented in the following table.

TABLE 18
 
 
 
Increase/
(in thousands)
September 30, 2014
December 31, 2013
(Decrease)
Potential liquidity
$
805,115

$
722,453

$
82,662

Available liquidity
395,766

369,577

26,189


The $82.7 million increase in potential liquidity in the first nine months of 2014 was due to an increase in the Bank's borrowing capacity primarily as a result of a higher level of qualifying collateral. FHLB borrowing capacity is determined based on asset levels on a quarterly lag basis. The $26.2 million increase in available liquidity occurred as a result of the aforementioned capacity increase, partially offset by the need for a higher borrowing level in the first nine months of 2014.

The Parent Company Liquidity - Uses

At the parent level, primary liquidity obligations include unallocated corporate expenses, funding its subsidiaries, dividend payments to Metro shareholders and common stock or preferred stock share repurchases or acquisitions.

The Parent Company Liquidity - Sources

The principal source of the Parent's liquidity is dividends it receives from the subsidiary Bank, which may be impacted by: Bank-level capital needs, laws and regulations, corporate policies, or other factors. The Bank issued $7.0 million in dividends to the Parent during the first nine months of 2014 to help cover the cash needed to redeem the $15 million of Trust Preferred Securities. The Bank is subject to regulatory restrictions on its ability to pay dividends to the Parent.

In addition to dividends from Metro Bank, other sources of liquidity for the parent company include proceeds from common stock options exercised as well as proceeds from the issuance of common stock under Metro's stock purchase plan. We could also generate liquidity for Metro and its subsidiaries through the issuance of debt and equity securities.

Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
Our exposure to market risk principally includes interest rate risk, which was previously discussed. The information presented in the Interest Rate Sensitivity subsection of Part I, Item 2 of this Report, Management's Discussion and Analysis of Financial Condition and Results of Operations, is incorporated by reference into this Item 3.
 
Item 4. Controls and Procedures
 
Quarterly evaluation of the Company's Disclosure Controls and Internal Controls. As of the end of the period covered by this quarterly report, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures (Disclosure Controls). This evaluation (Controls Evaluation) was done under the supervision and with the participation of management, including the Chief Executive Officer (CEO) and Chief Financial Officer (CFO).
 
Limitations on the Effectiveness of Controls. The Company's management, including the CEO and CFO, does not expect that their Disclosure Controls or their internal controls and procedures for financial reporting will prevent all errors and all fraud. The Company's Disclosure Controls are designed to provide reasonable assurance that the information provided in the reports we file under the Exchange Act, including this quarterly Form 10-Q report, is appropriately recorded, processed and summarized. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by


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collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. The Company conducts periodic evaluations to enhance, where necessary, its procedures and controls.
 
Based upon the Controls Evaluation, the CEO and CFO have concluded that, subject to the limitations noted above, there have not been any changes in the Company's controls and procedures for the quarter ended September 30, 2014 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. Additionally, the CEO and CFO have concluded that the Disclosure Controls are effective in reaching a reasonable level of assurance that management is timely alerted to material information relating to the Company during the period when its periodic reports are being prepared.


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Part II  OTHER INFORMATION
 
Item 1. Legal Proceedings.
 
The Company is subject to certain legal proceedings and claims arising in the ordinary course of business. It is management's opinion that the ultimate resolution of these claims will not have a material adverse effect on the Company's financial position and results of operations.

Item 1A.  Risk Factors.
 
See Item 1A. - Risk Factors -  in our Annual Report on Form 10-K for the year ended December 31, 2013 for a detailed discussion of risk factors affecting the Company. Below is an update of previously disclosed risk factors. 

Our ability to pay dividends depends upon the results of operations of our subsidiaries.

Historically, neither the Company nor the Bank has declared or paid cash dividends on its common stock since the Bank began operations in June 1985. Our board of directors had followed a policy of retaining earnings for the purpose of increasing the Company's and the Bank's capital for the foreseeable future. On October 14, 2014, the Company announced that the board of directors has decided to initiate an annual cash dividend of $0.28 per common share, payable quarterly at $0.07 per common share commencing in the first quarter of 2015.
 
Holders of our common stock are entitled to receive dividends if, as and when declared from time to time by our board of directors in its sole discretion out of funds legally available for that purpose, after debt service payments and payments of dividends required to be paid on our outstanding preferred stock, if any.  
 
While we are not subject to certain restrictions on dividends applicable to a bank, our ability to pay dividends to the holders of our common stock will depend to a large extent upon the amount of dividends paid by the Bank to Metro. The Company is a legal entity separate and distinct from its subsidiary, the Bank. There are various legal and regulatory limitations on the extent to which the Bank can, among other things, finance, or otherwise supply funds to, the Company. Specifically, dividends from the Bank are the principal source of the Company's cash funds and there are certain legal restrictions under Pennsylvania law and Pennsylvania banking regulations on the payment of dividends by state-chartered banks. The relevant regulatory agencies also have authority to prohibit the Company and the Bank from engaging in what, in the opinion of such regulatory body, constitutes an unsafe or unsound banking practice. The payment of dividends could, depending upon the financial condition of the Company and the Bank, be deemed to constitute such an unsafe or unsound practice.

Our executive officers, directors and other five percent or greater shareholders own a significant percentage of our Company and could influence matters requiring approval by our shareholders.
 
As of October 31, 2014, our executive officers and directors as a group owned and had the right to vote approximately 7.6% of our outstanding stock and other five percent or greater shareholders, which are institutional holders who have sole or shared voting power with the beneficial owners of the stock, owned and had the right to vote approximately 43% of our outstanding common stock. These shareholders, acting together, would be able to influence matters requiring approval by our shareholders, including the election of directors. This concentration of ownership might also have the effect of delaying or preventing a change of control of Metro.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
 
No items to report for the quarter ended September 30, 2014.
 
Item 3. Defaults Upon Senior Securities.
 
No items to report for the quarter ended September 30, 2014.
 
Item 4. Mine Safety Disclosures
 
No items to report for the quarter ended September 30, 2014.

Item 5. Other Information.
 


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No items to report for the quarter ended September 30, 2014.

Item 6. Exhibits.
 
See Exhibit Index for a list of the exhibits required by Item 601 of Regulation S-K and filed as part of this report.




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SIGNATURES

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

METRO BANCORP, INC.
(Registrant)
 
 
 
 
11/10/2014
 
/s/ Gary L. Nalbandian
(Date)
 
Gary L. Nalbandian
 
 
President/CEO
 
 
 
 
 
 
11/10/2014
 
/s/ Mark A. Zody
(Date)
 
Mark A. Zody
 
 
Chief Financial Officer
 
 
 


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EXHIBIT INDEX
 
3(ii)
Amended and Restated Bylaws of Metro Bancorp, Inc.
11
 
Computation of Net Income Per Common Share
 
31.1
 
Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended (Exchange Act)
 
31.2
 
Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under Exchange Act
 
32
Certification of the Company's Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 
101
Interactive data file containing the following financial statements formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets at September 30, 2014 and December 31, 2013; (ii) the Consolidated Statements of Income for the three months and nine months ended September 30, 2014 and 2013; (iii) the Consolidated Statements of Comprehensive Income for the three months and nine months ended September 30, 2014 and 2013; (iv) the Consolidated Statements of Stockholders' Equity for the nine months ended September 30, 2014 and 2013; (v) the Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013; and, (vi) the Notes to Consolidated Financial Statements.