Attached files
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EX-31.1 - EXHIBIT 31.1 - COMMERCIAL BANCSHARES INC \OH\ | v423460_ex31-1.htm |
EX-31.2 - EXHIBIT 31.2 - COMMERCIAL BANCSHARES INC \OH\ | v423460_ex31-2.htm |
EX-32.1 - EXHIBIT 32.1 - COMMERCIAL BANCSHARES INC \OH\ | v423460_ex32-1.htm |
EX-32.2 - EXHIBIT 32.2 - COMMERCIAL BANCSHARES INC \OH\ | v423460_ex32-2.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Quarterly Period ended September 30, 2015. Commission File Number 000-27894
COMMERCIAL BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
OHIO | 34-1787239 | |
(State or other jurisdiction of | (IRS Employer | |
incorporation or organization) | Identification No.) |
118 S. Sandusky Avenue, Upper Sandusky, Ohio 43351
(Address of principal executive offices including zip code)
Registrant’s telephone number, including area code: (419) 294-5781
N/A
(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 Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes þ 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 þ 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. See definition of “large accelerated filer” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one).
Large accelerated filer ¨ | Accelerated filer ¨ | |
Non-accelerated filer ¨ | Smaller Reporting Company þ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
As of November 13, 2015, the latest practicable date, there were 1,197,124 outstanding of the registrant’s common stock, no par value.
COMMERCIAL BANCSHARES, INC.
INDEX
Page | |||
PART I - FINANCIAL INFORMATION | |||
Item 1. | Financial Statements (unaudited) | ||
Consolidated Balance Sheets | 3 | ||
Consolidated Statements of Income | 4 | ||
Consolidated Statements of Comprehensive Income | 5 | ||
Condensed Consolidated Statements of Changes in Shareholders’ Equity | 6 | ||
Condensed Consolidated Statements of Cash Flows | 7 | ||
Notes to Consolidated Financial Statements | 8 | ||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 26 | |
Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 43 | |
Item 4. | Controls and Procedures | 43 | |
Part II - Other Information | |||
Item 1. | Legal Proceedings | 44 | |
Item 2. | Unregistered Sales of Securities and Use of Proceeds | 44 | |
Item 3. | Defaults upon Senior Securities | 44 | |
Item 4. | Mine Safety Disclosures | 44 | |
Item 5. | Other Information | 44 | |
Item 6. | Exhibits | 45 | |
SIGNATURES | 46 | ||
EXHIBIT: | 13a-14(a) 302 Certification | ||
13a-14(a) 906 Certification |
2. |
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands)
(Unaudited) | ||||||||
September 30, | December 31, | |||||||
2015 | 2014 | |||||||
ASSETS | ||||||||
Cash and cash equivalents | $ | 5,893 | $ | 4,994 | ||||
Federal funds sold | 15,011 | 22,157 | ||||||
Cash equivalents and federal funds sold | 20,904 | 27,151 | ||||||
Securities available-for-sale | 10,629 | 11,027 | ||||||
Securities held-to-maturity | 740 | 0 | ||||||
Other investment securities | 2,209 | 2,209 | ||||||
Total loans | 283,485 | 279,151 | ||||||
Allowance for loan losses | (3,935 | ) | (4,126 | ) | ||||
Loans, net | 279,550 | 275,025 | ||||||
Premises and equipment, net | 5,736 | 6,068 | ||||||
Accrued interest receivable | 1,466 | 1,334 | ||||||
Bank-owned life insurance | 9,086 | 8,908 | ||||||
Other real estate owned and other repossessed assets | 179 | 2,255 | ||||||
Assets classified as held for sale | 0 | 1,178 | ||||||
Other assets | 1,390 | 1,374 | ||||||
Total assets | $ | 331,889 | $ | 336,529 | ||||
LIABILITIES | ||||||||
Deposits | ||||||||
Noninterest-bearing demand | $ | 49,967 | $ | 50,350 | ||||
Interest-bearing demand | 116,776 | 115,865 | ||||||
Savings and time deposits less than $250,000 | 119,482 | 125,337 | ||||||
Time deposits $250,000 and greater | 6,269 | 7,219 | ||||||
Total deposits | 292,494 | 298,771 | ||||||
FHLB advances | 1,604 | 1,692 | ||||||
Accrued interest payable | 80 | 51 | ||||||
Other liabilities | 1,653 | 1,789 | ||||||
Total liabilities | 295,831 | 302,303 | ||||||
SHAREHOLDERS' EQUITY | ||||||||
Common stock, no par value; 4,000,000 shares authorized, | ||||||||
1,208,607 shares issued and 1,204,043 outstanding in 2015 | ||||||||
1,193,248 shares issued and 1,193,078 outstanding in 2014 | 12,738 | 12,177 | ||||||
Retained earnings | 24,765 | 22,987 | ||||||
Unearned compensation | (306 | ) | (168 | ) | ||||
Deferred compensation plan shares; at cost | ||||||||
60,886 shares in 2015 and 55,360 shares in 2014 | (1,174 | ) | (1,022 | ) | ||||
Treasury stock; 4,564 shares in 2015 and 170 shares in 2014 | (134 | ) | (4 | ) | ||||
Accumulated other comprehensive income | 169 | 256 | ||||||
Total shareholders' equity | 36,058 | 34,226 | ||||||
Total liabilities and shareholders' equity | $ | 331,889 | $ | 336,529 |
See notes to the consolidated financial statements.
3. |
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollar amounts in thousands, except per share data)
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
Interest income | ||||||||||||||||
Interest and fees on loans | $ | 3,529 | $ | 3,577 | $ | 10,501 | $ | 10,363 | ||||||||
Interest on investment securities: | ||||||||||||||||
Taxable | 46 | 51 | 142 | 158 | ||||||||||||
Tax exempt | 71 | 80 | 207 | 244 | ||||||||||||
Federal funds sold | 8 | 7 | 39 | 22 | ||||||||||||
Total interest income | 3,654 | 3,715 | 10,889 | 10,787 | ||||||||||||
Interest expense | ||||||||||||||||
Interest on deposits | 204 | 203 | 631 | 621 | ||||||||||||
Interest on borrowings | 10 | 12 | 28 | 33 | ||||||||||||
Total interest expense | 214 | 215 | 659 | 654 | ||||||||||||
Net interest income | 3,440 | 3,500 | 10,230 | 10,133 | ||||||||||||
Provision for loan losses | 86 | 26 | 138 | 287 | ||||||||||||
Net interest income after provision for loan losses | 3,354 | 3,474 | 10,092 | 9,846 | ||||||||||||
Noninterest income | ||||||||||||||||
Service fees and overdraft charges | 362 | 378 | 1,044 | 1,113 | ||||||||||||
Gain on sale of bank premises and equipment | 0 | 0 | 0 | 42 | ||||||||||||
Other income | 152 | 161 | 474 | 460 | ||||||||||||
Total noninterest income | 514 | 539 | 1,518 | 1,615 | ||||||||||||
Noninterest expense | ||||||||||||||||
Salaries and employee benefits | 1,520 | 1,535 | 4,456 | 4,373 | ||||||||||||
Premises and equipment | 269 | 293 | 866 | 921 | ||||||||||||
Other real estate owned and miscellaneous loan expense | 66 | 172 | 479 | 281 | ||||||||||||
Professional fees | 87 | 103 | 293 | 307 | ||||||||||||
Data processing | 49 | 48 | 148 | 141 | ||||||||||||
Software maintenance | 111 | 104 | 338 | 306 | ||||||||||||
Advertising and promotional | 59 | 68 | 191 | 182 | ||||||||||||
FDIC deposit insurance | 64 | 57 | 184 | 185 | ||||||||||||
Franchise tax | 57 | 87 | 181 | 290 | ||||||||||||
Loss on repossessed asset sales, net | 2 | 7 | 34 | 24 | ||||||||||||
Other operating expense | 288 | 310 | 844 | 892 | ||||||||||||
Total noninterest expense | 2,572 | 2,784 | 8,014 | 7,902 | ||||||||||||
Income before income taxes | 1,296 | 1,229 | 3,596 | 3,559 | ||||||||||||
Income tax expense | 351 | 370 | 1,058 | 1,076 | ||||||||||||
Net income | $ | 945 | $ | 859 | $ | 2,538 | $ | 2,483 | ||||||||
Basic earnings per common share | $ | 0.79 | $ | 0.72 | $ | 2.12 | $ | 2.10 | ||||||||
Diluted earnings per common share | $ | 0.77 | $ | 0.71 | $ | 2.08 | $ | 2.06 |
See notes to the consolidated financial statements.
4. |
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Dollar amounts in thousands)
Three Months Ended | ||||||||
September 30, | ||||||||
2015 | 2014 | |||||||
Net Income | $ | 945 | $ | 859 | ||||
Unrealized holding gain (loss) on securities: | ||||||||
Net securities loss during period | (40 | ) | (55 | ) | ||||
Tax effect | (13 | ) | (19 | ) | ||||
Other comprehensive loss, net of tax | (27 | ) | (36 | ) | ||||
Comprehensive income, net of tax | $ | 918 | $ | 823 |
Nine Months Ended | ||||||||
September 30, | ||||||||
2015 | 2014 | |||||||
Net Income | $ | 2,538 | $ | 2,483 | ||||
Unrealized holding gain (loss) on securities: | ||||||||
Net securities loss during period | (130 | ) | (93 | ) | ||||
Tax effect | (43 | ) | (32 | ) | ||||
Other comprehensive loss, net of tax | (87 | ) | (61 | ) | ||||
Comprehensive income, net of tax | $ | 2,451 | $ | 2,422 |
See notes to the consolidated financial statements.
5. |
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS’ EQUITY
(Unaudited)
(Dollar amounts in thousands, except per share data)
Nine Months Ended | ||||||||
September 30, | ||||||||
2015 | 2014 | |||||||
Balance at beginning of period | $ | 34,226 | $ | 31,588 | ||||
Net income | 2,538 | 2,483 | ||||||
Other comprehensive loss | (87 | ) | (61 | ) | ||||
Stock-based compensation | 114 | 93 | ||||||
Issuance of treasury stock under stock option plans | 24 | 33 | ||||||
Issuance of common stock under stock option plans | 45 | 0 | ||||||
Deferred compensation plan activity | 111 | 62 | ||||||
Purchase of treasury stock | (156 | ) | 0 | |||||
Cash dividends ($0.63 per share in 2015 and $0.52 per share in 2014) | (757 | ) | (617 | ) | ||||
Balance at end of period | $ | 36,058 | $ | 33,581 |
See notes to the consolidated financial statements.
6. |
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended | ||||||||
September 30, | ||||||||
2015 | 2014 | |||||||
($ in thousands) | ||||||||
Cash flows from operating activities | ||||||||
Net income | $ | 2,538 | $ | 2,483 | ||||
Adjustments | 162 | 311 | ||||||
Net cash from operating activities | 2,700 | 2,794 | ||||||
Cash flows from investing activities | ||||||||
Securities available for sale: | ||||||||
Purchases | (1,040 | ) | 0 | |||||
Maturities, calls and repayments | 1,276 | 1,531 | ||||||
Securities held-to-maturity: | ||||||||
Purchases | (740 | ) | 0 | |||||
Net change in loans | (4,604 | ) | (10,086 | ) | ||||
Proceeds from sale of OREO and other repossessed assets | 2,121 | 104 | ||||||
Proceeds from the disposition of premises and equipment | 1,237 | 93 | ||||||
Bank premises and equipment expenditures | (98 | ) | (699 | ) | ||||
Net cash used in investing activities | (1,848 | ) | (9,057 | ) | ||||
Cash flows from financing activities | ||||||||
Net change in deposits | (6,277 | ) | 3,153 | |||||
Decrease in federal funds purchased | 0 | (1,757 | ) | |||||
FHLB advances | 5,000 | 7,000 | ||||||
Repayment of FHLB advances | (5,089 | ) | (3,587 | ) | ||||
Cash dividends paid | (757 | ) | (617 | ) | ||||
Issuance of treasury stock under stock option plans | 24 | 33 | ||||||
Issuance of common stock under stock option plans | 45 | 0 | ||||||
Purchase of treasury stock | (156 | ) | 0 | |||||
Deferred compensation plan activity | 111 | 62 | ||||||
Net cash used in (provided by) financing activities | (7,099 | ) | 4,287 | |||||
Net change in cash equivalents and federal funds sold | (6,247 | ) | (1,976 | ) | ||||
Cash equivalents and federal funds sold at beginning of period | 27,151 | 18,119 | ||||||
Cash equivalents and federal funds sold at end of period | $ | 20,904 | $ | 16,143 | ||||
Supplemental disclosures | ||||||||
Cash paid for interest | $ | 630 | $ | 641 | ||||
Cash paid for income taxes | 960 | 1,200 | ||||||
Non-cash transfer of loans to foreclosed/repossessed assets | 241 | 1,199 |
See notes to the consolidated financial statements.
7. |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The accompanying consolidated financial statements include the accounts of Commercial Bancshares, Inc. (the “Corporation”) and its wholly owned subsidiaries, Commercial Financial and Insurance Agency, LTD (“Commercial Financial”) and The Commercial Savings Bank (the “Bank”). All significant intercompany balances and transactions have been eliminated in consolidation.
The condensed consolidated financial statements have been prepared without audit. In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present fairly the Corporation’s financial position at September 30, 2015, and the results of operations and changes in cash flows for the periods presented have been made.
Certain information and footnote disclosures typically included in financial statements prepared in accordance with U.S. generally accepted principles have been omitted. The Annual Report for the year ended December 31, 2014, contains consolidated financial statements and related footnote disclosures, which should be read in conjunction with the accompanying consolidated financial statements. The results of operations for the nine months ended September 30, 2015 are not necessarily indicative of the operating results for the full year or any future interim period.
NOTE 2 EARNINGS PER SHARE
Weighted average shares used in determining basic and diluted earnings per share for the three months ended September 30, 2015 and 2014.
2015 | 2014 | |||||||
Weighted average shares outstanding during the period | 1,202,663 | 1,187,978 | ||||||
Dilutive effect of stock options | 24,134 | 20,970 | ||||||
Weighted average shares considering dilutive effect | 1,226,797 | 1,208,948 | ||||||
Anti-dilutive stock options not considered in computing diluted earnings per share | 0 | 1,000 |
Weighted average shares used in determining basic and diluted earnings per share for the nine months ended September 30, 2015 and 2014.
2015 | 2014 | |||||||
Weighted average shares outstanding during the period | 1,199,241 | 1,184,703 | ||||||
Dilutive effect of stock options | 22,713 | 18,569 | ||||||
Weighted average shares considering dilutive effect | 1,221,954 | 1,203,272 | ||||||
Anti-dilutive stock options not considered in computing diluted earnings per share | 0 | 12,000 |
8. |
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities at the dates indicated are presented in the following table.
Gross | Gross | Estimated | ||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
Cost | Gains | Losses | Value | |||||||||||||
Available-for-sale Securities | (In thousands) | |||||||||||||||
September 30, 2015: | ||||||||||||||||
U.S. Government Agency securities | $ | 2,524 | $ | 1 | $ | (10 | ) | $ | 2,515 | |||||||
State and political subdivisions | 5,900 | 134 | (4 | ) | 6,030 | |||||||||||
Mortgage-backed securities | 1,948 | 136 | 0 | 2,084 | ||||||||||||
Total securities available-for-sale | $ | 10,372 | $ | 271 | $ | (14 | ) | $ | 10,629 | |||||||
December 31, 2014: | ||||||||||||||||
U.S. Government Agency securities | $ | 2,000 | $ | 0 | $ | (35 | ) | $ | 1,965 | |||||||
State and political subdivisions | 6,337 | 259 | 0 | 6,596 | ||||||||||||
Mortgage-backed securities | 2,303 | 163 | 0 | 2,466 | ||||||||||||
Total securities available-for-sale | $ | 10,640 | $ | 422 | $ | (35 | ) | $ | 11,027 |
Gross | Gross | Estimated | ||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
Cost | Gains | Losses | Value | |||||||||||||
Held-to-maturity Securities | (In thousands) | |||||||||||||||
September 30, 2015: | ||||||||||||||||
State and political subdivisions | $ | 740 | $ | 0 | $ | 0 | $ | 740 | ||||||||
December 31, 2014: | ||||||||||||||||
State and political subdivisions | $ | 0 | $ | 0 | $ | 0 | $ | 0 |
The estimated fair values of investment securities at September 30, 2015, by contractual maturity are shown below. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately.
Available-for-sale | Held-to-maturity | |||||||||||||||
Estimated | Estimated | |||||||||||||||
Amortized | Fair | Amortized | Fair | |||||||||||||
(Dollar amount in thousands) | Cost | Value | Cost | Value | ||||||||||||
Due less than one year | $ | 979 | $ | 1,005 | $ | 0 | $ | 0 | ||||||||
Due after one year through five years | 4,472 | 4,532 | 0 | 0 | ||||||||||||
Due after five years through ten years | 2,973 | 3,008 | 740 | 740 | ||||||||||||
Due after ten years | 0 | 0 | 0 | 0 | ||||||||||||
Mortgage-backed securities | 1,948 | 2,084 | 0 | 0 | ||||||||||||
Total investment securities | $ | 10,372 | $ | 10,629 | $ | 740 | $ | 740 |
At September 30, 2015 and December 31, 2014, securities with a carrying value of $9,891,000 and $8,958,000, respectively, were pledged to secure public deposits and other deposits and liabilities as required or permitted by law.
9. |
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Gross unrealized losses on securities and the estimated fair value of the related securities aggregated by security category and length of time the individual securities have been in continuous loss positions at September 30, 2015 and December 31, 2014.
Less Than Twelve Months | More Than Twelve Months | |||||||||||||||
(Dollar amounts in thousands) | Gross | Estimated | Gross | Estimated | ||||||||||||
Unrealized | Fair | Unrealized | Fair | |||||||||||||
September 30, 2015 | Losses | Value | Losses | Value | ||||||||||||
U.S. Government Agency securities | $ | 0 | $ | 0 | $ | (10 | ) | $ | 1,990 | |||||||
State and political subdivisions | (4 | ) | 254 | 0 | 0 | |||||||||||
Mortgage-backed securities | 0 | 0 | 0 | 0 | ||||||||||||
Total available for sale | $ | (4 | ) | $ | 254 | $ | (10 | ) | $ | 1,990 |
Less Than Twelve Months | More Than Twelve Months | |||||||||||||||
(Dollar amounts in thousands) | Gross | Estimated | Gross | Estimated | ||||||||||||
Unrealized | Fair | Unrealized | Fair | |||||||||||||
December 31, 2014 | Losses | Value | Losses | Value | ||||||||||||
U.S. Government Agency securities | $ | 0 | $ | 0 | $ | (35 | ) | $ | 1,965 | |||||||
State and political subdivisions | 0 | 0 | 0 | 0 | ||||||||||||
Mortgage-backed securities | 0 | 0 | 0 | 0 | ||||||||||||
Total available for sale | $ | 0 | $ | 0 | $ | (35 | ) | $ | 1,965 |
At September 30, 2015 the Corporation held one security with an estimated fair value of $1,990,000 and an unrealized loss of $10,000 in a continuous unrealized loss position for more than twelve months and one security with an estimated fair value of $254,000 with an unrealized loss of $4,000 in a continuous loss position for less than twelve months. At December 31, 2014, the Corporation held one security with an estimated fair value of $1,965,000 and an unrealized loss of $35,000 in a continuous loss position for more than twelve months. There were no securities in a continuous unrealized loss position for less than twelve months at year-end 2014.
The unrealized losses that exist are primarily due to the changes in market interest rates subsequent to purchase. The Corporation does not consider these investments to be other than temporarily impaired at September 30, 2015 and December 31, 2014 since the decline in market value is primarily attributable to changes in interest rates and not credit quality. In addition, the Corporation does not intend to sell and does not believe that it is more likely than not that the Corporation will be required to sell these investments until there is a full recovery of the unrealized loss, which may be at maturity. As a result, management does not believe that the investment securities in an unrealized loss position at September 30, 2015, represent an other-than-temporary impairment.
Other investment securities are carried at cost and consist principally of stock in the Federal Home Loan Bank of Cincinnati.
10. |
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 ALLOWANCE FOR LOAN LOSSES
The following tables provide information on the activity in the allowance for loan losses by portfolio segment for the periods indicated.
Commercial | Real Estate | Consumer | Total | |||||||||||||
(Dollar amounts in thousands) | ||||||||||||||||
For the Three Months Ended September 30, 2015 | ||||||||||||||||
Beginning balance – July 1, 2015 | $ | 3,387 | $ | 280 | $ | 429 | $ | 4,096 | ||||||||
Charge-offs | (254 | ) | 0 | (13 | ) | (267 | ) | |||||||||
Recoveries | 15 | 0 | 5 | 20 | ||||||||||||
Net | (239 | ) | 0 | (8 | ) | (247 | ) | |||||||||
Provision | 44 | 14 | 28 | 86 | ||||||||||||
Ending Balance – September 30, 2015 | $ | 3,192 | $ | 294 | $ | 449 | $ | 3,935 |
Commercial | Real Estate | Consumer | Total | |||||||||||||
(Dollar amounts in thousands) | ||||||||||||||||
For the Three Months Ended September 30, 2014 | ||||||||||||||||
Beginning balance – July 1, 2014 | $ | 3,548 | $ | 261 | $ | 545 | $ | 4,354 | ||||||||
Charge-offs | (6 | ) | (31 | ) | (2 | ) | (39 | ) | ||||||||
Recoveries | 11 | 8 | 4 | 23 | ||||||||||||
Net | 5 | (23 | ) | 2 | (16 | ) | ||||||||||
Provision | (5 | ) | 31 | 0 | 26 | |||||||||||
Ending Balance – September 30, 2014 | $ | 3,548 | $ | 269 | $ | 547 | $ | 4,364 |
Commercial | Real Estate | Consumer | Total | |||||||||||||
(Dollar amounts in thousands) | ||||||||||||||||
For the Nine Months Ended September 30, 2015 | ||||||||||||||||
Beginning balance – January 1, 2015 | $ | 3,340 | $ | 277 | $ | 509 | $ | 4,126 | ||||||||
Charge-offs | (274 | ) | (13 | ) | (112 | ) | (399 | ) | ||||||||
Recoveries | 45 | 0 | 25 | 70 | ||||||||||||
Net | (229 | ) | (13 | ) | (87 | ) | (329 | ) | ||||||||
Provision | 81 | 30 | 27 | 138 | ||||||||||||
Ending Balance – September 30, 2015 | $ | 3,192 | $ | 294 | $ | 449 | $ | 3,935 |
Commercial | Real Estate | Consumer | Total | |||||||||||||
(Dollar amounts in thousands) | ||||||||||||||||
For the Nine Months Ended September 30, 2014 | ||||||||||||||||
Beginning balance – January 1, 2014 | $ | 3,517 | $ | 235 | $ | 591 | $ | 4,343 | ||||||||
Charge-offs | (219 | ) | (31 | ) | (75 | ) | (325 | ) | ||||||||
Recoveries | 26 | 8 | 25 | 59 | ||||||||||||
Net | (193 | ) | (23 | ) | (50 | ) | (266 | ) | ||||||||
Provision | 224 | 57 | 6 | 287 | ||||||||||||
Ending Balance – September 30, 2014 | $ | 3,548 | $ | 269 | $ | 547 | $ | 4,364 |
11. |
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the allocation of the allowance for loan losses and the recorded investment in loans (in thousands) by portfolio segment at September 30, 2015 and 2014.
Collectively Evaluated | Individually Evaluated | Total | ||||||||||||||||||||||
Allowance | Recorded | Allowance | Recorded | Allowance | Recorded | |||||||||||||||||||
for loan | investment | for loan | investment | for loan | investment | |||||||||||||||||||
losses | in loans | losses | in loans | losses | in loans | |||||||||||||||||||
September 30, 2015 | ||||||||||||||||||||||||
Commercial | $ | 3,069 | $ | 224,595 | $ | 123 | $ | 5,058 | $ | 3,192 | $ | 229,653 | ||||||||||||
Real estate | 294 | 23,505 | 0 | 0 | 294 | 23,505 | ||||||||||||||||||
Consumer | 449 | 30,327 | 0 | 0 | 449 | 30,327 | ||||||||||||||||||
Total | $ | 3,812 | $ | 278,427 | $ | 123 | $ | 5,058 | $ | 3,935 | $ | 283,485 | ||||||||||||
September 30, 2014 | ||||||||||||||||||||||||
Commercial | $ | 3,074 | $ | 215,900 | $ | 474 | $ | 9,068 | $ | 3,548 | $ | 224,968 | ||||||||||||
Real estate | 269 | 21,531 | 0 | 0 | 269 | 21,531 | ||||||||||||||||||
Consumer | 547 | 32,169 | 0 | 0 | 547 | 32,169 | ||||||||||||||||||
Total | $ | 3,890 | $ | 269,600 | $ | 474 | $ | 9,068 | $ | 4,364 | $ | 278,668 |
NOTE 5 CREDIT QUALITY INDICATORS
To facilitate the monitoring of credit quality within the loan portfolio and for purposes of analyzing historical loss rates used in the determination of the allowance for loan losses, the Corporation utilizes the following categories of credit grades: pass, special mention, substandard, doubtful and loss. The four categories, which are derived from standard regulatory rating definitions, are assigned upon initial approval of credit to borrowers and updated periodically thereafter. Pass ratings, which are assigned to those borrowers that do not have identified potential or well-defined weaknesses and for which there is a high likelihood of orderly repayment, are updated periodically based on the size and credit characteristics of the borrower. All other categories are updated on at least a quarterly basis. Loans are graded on a scale of 1 through 9, with a grade of 5 or below classified as “Pass” rated credits. Following is a description of the general characteristics of risk grades 6 through 9:
6 – Special Mention | Special mention credits have a level of potential weakness such that they warrant management’s closer attention than those on watch. These credits, opposed to watch credits, require correction or additional financial information for further analysis and verification of repayment capacity. If left uncorrected, these weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special mention assets are not considered adversely classified assets. Such credits, do however, warrant consideration of additional reserve. |
7 – Substandard | Substandard loans are inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Substandard loans are characterized by the distinct possibility that the Bank will sustain loss if the deficiencies are not corrected. |
8 – Doubtful | Loans classified doubtful have all the weaknesses inherent in those classified substandard 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. |
12. |
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9 – Loss | Loans are considered uncollectible and of such little value that continuing to carry them as assets on the institution’s financial statements is not feasible. Accordingly, the Bank does not carry loans classified as loss on the books, instead these loans are charged off. |
The Corporation’s strategy for credit risk management includes ongoing credit examinations and management reviews of loans exhibiting deterioration of credit quality. A deteriorating credit indicates an elevated likelihood of delinquency. When a loan becomes delinquent, its credit grade is reviewed and changed accordingly. Each downgrade to a classified credit results in a higher percentage of reserve to reflect the increased likelihood of loss for similarly graded credits. Further deterioration could result in a certain credit being deemed impaired, resulting in a collateral valuation for purposes of establishing a specific reserve which reflects the possible extent of such loss for that credit.
The following tables present the risk category of loans by class of loans based on the most recent analysis performed at September 30, 2015 and December 31, 2014.
Commercial Credit Exposure (dollar amounts in thousands)
Credit risk profile by credit worthiness category
Commercial | Commercial | |||||||||||||||||||||||||||||||||||||||
Commercial | Commercial | Real Estate | Real Estate | Total | ||||||||||||||||||||||||||||||||||||
Credit | Operating | Agricultural | 1-4 Family | Other | Commercial | |||||||||||||||||||||||||||||||||||
Grade | 09/30/15 | 12/31/14 | 09/30/15 | 12/31/14 | 09/30/15 | 12/31/14 | 09/30/15 | 12/31/14 | 09/30/15 | 12/31/14 | ||||||||||||||||||||||||||||||
Pass | $ | 25,620 | $ | 32,933 | $ | 43,871 | $ | 45,863 | $ | 42,860 | $ | 39,683 | $ | 112,756 | $ | 101,222 | $ | 225,107 | $ | 219,701 | ||||||||||||||||||||
6 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||||||||
7 | 816 | 956 | 898 | 159 | 156 | 793 | 2,676 | 3,899 | 4,546 | 5,807 | ||||||||||||||||||||||||||||||
8 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||||||||
Total | $ | 26,436 | $ | 33,889 | $ | 44,769 | $ | 46,022 | $ | 43,016 | $ | 40,476 | $ | 115,432 | $ | 105,121 | $ | 229,653 | $ | 225,508 |
Real Estate Credit Exposure (dollar amounts in thousands)
Credit risk by credit worthiness category
Real Estate | Real Estate | Total | ||||||||||||||||||||||
Credit | Construction | Other | Real Estate | |||||||||||||||||||||
Grade | 09/30/15 | 12/31/14 | 09/30/15 | 12/31/14 | 09/30/15 | 12/31/14 | ||||||||||||||||||
Pass | $ | 4,731 | $ | 4,214 | $ | 18,773 | $ | 17,951 | $ | 23,504 | $ | 22,165 | ||||||||||||
6 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||
7 | 0 | 0 | 1 | 18 | 1 | 18 | ||||||||||||||||||
8 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||
Total | $ | 4,731 | $ | 4,214 | $ | 18,774 | $ | 17,969 | $ | 23,505 | $ | 22,183 |
Consumer Credit Exposure (dollar amounts in thousands)
Credit risk by credit worthiness category
Consumer | Consumer | Consumer | Total | |||||||||||||||||||||||||||||
Credit | Equity | Auto | Other | Consumer | ||||||||||||||||||||||||||||
Grade | 09/30/15 | 12/31/14 | 09/30/15 | 12/31/14 | 09/30/15 | 12/31/14 | 09/30/15 | 12/31/14 | ||||||||||||||||||||||||
Pass | $ | 17,780 | $ | 17,987 | $ | 4,741 | $ | 4,650 | $ | 7,650 | $ | 8,616 | $ | 30,171 | $ | 31,253 | ||||||||||||||||
6 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||
7 | 132 | 199 | 0 | 0 | 24 | 8 | 156 | 207 | ||||||||||||||||||||||||
8 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||
Total | $ | 17,912 | $ | 18,186 | $ | 4,741 | $ | 4,650 | $ | 7,674 | $ | 8,624 | $ | 30,327 | $ | 31,460 |
13. |
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 SUMMARY OF IMPAIRED LOANS
Loans evaluated for impairment include loans classified as troubled debt restructurings and non-performing multi-family, commercial and construction loans. The following tables set forth certain information regarding the Corporation’s impaired loans, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary at September 30, 2015 and December 31, 2014.
(Dollar amounts in thousands) | Unpaid | |||||||||||
Recorded | Principal | Related | ||||||||||
September 30, 2015 | Investment | Balance | Allowance | |||||||||
With no related allowance recorded: | ||||||||||||
Commercial operating | $ | 538 | $ | 673 | $ | 0 | ||||||
Commercial real estate, 1-4 family | 0 | 0 | 0 | |||||||||
Commercial real estate, other | 2,646 | 2,764 | 0 | |||||||||
Subtotal | $ | 3,184 | $ | 3,437 | $ | 0 | ||||||
With an allowance recorded: | ||||||||||||
Commercial operating | 120 | 120 | 2 | |||||||||
Commercial real estate, 1-4 family | 1,558 | 1,680 | 119 | |||||||||
Commercial real estate, other | 196 | 196 | 2 | |||||||||
Subtotal | $ | 1,874 | $ | 1,996 | $ | 123 | ||||||
Total | $ | 5,058 | $ | 5,433 | $ | 123 |
Unpaid | ||||||||||||
Recorded | Principal | Related | ||||||||||
December 31, 2014 | Investment | Balance | Allowance | |||||||||
With no related allowance recorded: | ||||||||||||
Commercial operating | $ | 0 | $ | 0 | $ | 0 | ||||||
Commercial real estate, 1-4 family | 0 | 0 | 0 | |||||||||
Commercial real estate, other | 1,942 | 1,942 | 0 | |||||||||
Subtotal | $ | 1,942 | $ | 1,942 | $ | 0 | ||||||
With an allowance recorded: | ||||||||||||
Commercial operating | 797 | 919 | 128 | |||||||||
Commercial real estate, 1-4 family | 1,614 | 1,614 | 132 | |||||||||
Commercial real estate, other | 1,475 | 1,475 | 42 | |||||||||
Subtotal | $ | 3,886 | $ | 4,008 | $ | 302 | ||||||
Total | $ | 5,828 | $ | 5,950 | $ | 302 |
A loan is considered impaired, in accordance with the impairment accounting guidance (ASC 310-10-35), when based on current information and events, it is probable the Corporation will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include non-performing commercial loans but also include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties.
Impaired loans decreased $770,000 or 13.2% to $5,058,000 at September 30, 2015 from $5,828,000 at December 31, 2014, largely due to a partial payoff of $596,000 and the write down of the specified reserve of $118,000 on a large commercial real estate loan. Impaired loans with no related allowance recorded at September 30, 2015 was $3,184,000, an increase of $1,242,000 or 64.0% from $1,942,000 at year-end 2014, while loans with a specified reserve decreased $2,012,000 or 51.8% to $1,874,000 at September 30, 2015 from $3,886,000 at December 31, 2014. During the third quarter, the specified reserve on two loans was written off resulting in the shift between classifications. The specified reserve related to impaired loans totaled $123,000 at September 30, 2015 compared to $302,000 at December 31, 2014.
14. |
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following tables present the average recorded investment in impaired loans and the amount of interest income recognized on a cash basis for impaired loans after impairment by portfolio segment and class for the periods indicated. (All dollar amounts in thousands)
No Related | With Related | |||||||||||||||||||||||
Allowance Recorded | Allowance Recorded | Total | ||||||||||||||||||||||
Average | Total Interest | Average | Total Interest | Average | Total Interest | |||||||||||||||||||
Three Months Ended | Recorded | Income | Recorded | Income | Recorded | Income | ||||||||||||||||||
September 30, 2015 | Investment | Recognized | Investment | Recognized | Investment | Recognized | ||||||||||||||||||
Commercial: | ||||||||||||||||||||||||
Operating | $ | 583 | $ | 0 | $ | 120 | $ | 2 | $ | 703 | $ | 2 | ||||||||||||
Real estate, 1-4 family | 0 | 0 | 1,564 | 17 | 1,564 | 17 | ||||||||||||||||||
Real estate, other | 2,887 | 55 | 197 | 3 | 3,084 | 58 | ||||||||||||||||||
Total | $ | 3,470 | $ | 55 | $ | 1,881 | $ | 22 | $ | 5,351 | $ | 77 | ||||||||||||
Three Months Ended | ||||||||||||||||||||||||
September 30, 2014 | ||||||||||||||||||||||||
Commercial: | ||||||||||||||||||||||||
Operating | $ | 0 | $ | 0 | $ | 823 | $ | 2 | $ | 823 | $ | 2 | ||||||||||||
Real estate, 1-4 family | 0 | 0 | 1,638 | 16 | 1,638 | 16 | ||||||||||||||||||
Real estate, other | 4,068 | 69 | 2,547 | 23 | 6,615 | 92 | ||||||||||||||||||
Total | $ | 4,068 | $ | 69 | $ | 5,008 | $ | 41 | $ | 9,076 | $ | 110 |
No Related | With Related | |||||||||||||||||||||||
Allowance Recorded | Allowance Recorded | Total | ||||||||||||||||||||||
Average | Total Interest | Average | Total Interest | Average | Total Interest | |||||||||||||||||||
Nine Months Ended | Recorded | Income | Recorded | Income | Recorded | Income | ||||||||||||||||||
September 30, 2015 | Investment | Recognized | Investment | Recognized | Investment | Recognized | ||||||||||||||||||
Commercial: | ||||||||||||||||||||||||
Operating | $ | 642 | $ | 0 | $ | 122 | $ | 6 | $ | 764 | $ | 6 | ||||||||||||
Real estate, 1-4 family | 0 | 0 | 1,582 | 52 | 1,582 | 52 | ||||||||||||||||||
Real estate, other | 3,200 | 147 | 200 | 9 | 3,400 | 156 | ||||||||||||||||||
Total | $ | 3,842 | $ | 147 | $ | 1,904 | $ | 67 | $ | 5,746 | $ | 214 | ||||||||||||
Nine Months Ended | ||||||||||||||||||||||||
September 30, 2014 | ||||||||||||||||||||||||
Commercial: | ||||||||||||||||||||||||
Operating | $ | 0 | $ | 0 | $ | 828 | $ | 6 | $ | 828 | $ | 6 | ||||||||||||
Real estate, 1-4 family | 0 | 0 | 1,654 | 50 | 1,654 | 50 | ||||||||||||||||||
Real estate, other | 4,080 | 192 | 2,611 | 72 | 6,691 | 264 | ||||||||||||||||||
Total | $ | 4,080 | $ | 192 | $ | 5,093 | $ | 128 | $ | 9,173 | $ | 320 |
15. |
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 TROUBLED DEBT RESTRUCTURINGS
A modification of a loan constitutes a troubled debt restructured loan when a borrower is experiencing financial difficulty and the modification constitutes an economic concession. The Corporation offers various types of concessions when modifying a loan. Concessionary modifications may include, but are not limited to, delays in required payments of principal and interest for a specified period, reduction of the stated interest rate of the loan, reduction of accrued interest, extension of the maturity date or reduction of the face amount or maturity amount of the debt. A concession has been granted when, as a result of the restructuring, the Corporation does not expect to collect all amounts due, including interest at the original stated rate.
When the Corporation modifies a loan, it evaluates any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, or uses the current fair value of the collateral, less selling costs for collateral dependent loans. If the Corporation determines that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs and deferred loan fees or costs), impairment is recognized through a reserve for loan and lease losses estimate or a charge-off to the reserve for loan and lease losses. In periods subsequent to the modification, the Corporation evaluates all TDRs, including those that have payment defaults, for possible impairment and recognizes the impairment through the reserve for loan and lease losses.
There have been no financing receivables modified as troubled debt restructurings during the three and nine months ended September 30, 2015. There were no financing receivables modified as troubled debt restructurings during the three and nine months ended September 30, 2014.
There were no commitments to lend additional funds to borrowers classified as troubled debt restructurings at September 30, 2015.
NOTE 8 AGE ANALYSIS OF PAST DUE FINANCING RECEIVABLES
The following table presents the aging of the recorded investment in loans by past due category and class of loans at September 30, 2015 and December 31, 2014 (dollar amounts in thousands).
Recorded | ||||||||||||||||||||||||||||
30-59 | 60-89 | > 90 | Total | Investment | ||||||||||||||||||||||||
Days | Days | Days | Total | Financing | > 90 Days | |||||||||||||||||||||||
September 30, 2015 | Past Due | Past Due | Past Due | Past Due | Current | Receivables | and Accruing | |||||||||||||||||||||
Commercial | ||||||||||||||||||||||||||||
Operating | $ | 0 | $ | 0 | $ | 537 | $ | 537 | $ | 25,899 | $ | 26,436 | $ | 0 | ||||||||||||||
Agricultural | 0 | 0 | 0 | 0 | 44,769 | 44,769 | 0 | |||||||||||||||||||||
Real estate, 1-4 family | 45 | 0 | 0 | 45 | 42,971 | 43,016 | 0 | |||||||||||||||||||||
Real estate, other | 0 | 69 | 143 | 212 | 115,220 | 115,432 | 0 | |||||||||||||||||||||
Real estate | ||||||||||||||||||||||||||||
Construction | 0 | 0 | 0 | 0 | 4,731 | 4,731 | 0 | |||||||||||||||||||||
Other | 140 | 1 | 19 | 160 | 18,614 | 18,774 | 0 | |||||||||||||||||||||
Consumer | ||||||||||||||||||||||||||||
Equity | 19 | 0 | 24 | 43 | 17,869 | 17,912 | 0 | |||||||||||||||||||||
Auto | 0 | 0 | 0 | 0 | 4,741 | 4,741 | 0 | |||||||||||||||||||||
Other | 6 | 28 | 6 | 40 | 7,634 | 7,674 | 0 | |||||||||||||||||||||
Total | $ | 210 | $ | 98 | $ | 729 | $ | 1,037 | $ | 282,448 | $ | 283,485 | $ | 0 |
16. |
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Recorded | ||||||||||||||||||||||||||||
30-59 | 60-89 | > 90 | Total | Investment | ||||||||||||||||||||||||
Days | Days | Days | Total | Financing | > 90 Days | |||||||||||||||||||||||
December 31, 2014 | Past Due | Past Due | Past Due | Past Due | Current | Receivables | and Accruing | |||||||||||||||||||||
Commercial | ||||||||||||||||||||||||||||
Operating | $ | 0 | $ | 0 | $ | 673 | $ | 673 | $ | 33,216 | $ | 33,889 | $ | 0 | ||||||||||||||
Agricultural | 0 | 0 | 0 | 0 | 46,022 | 46,022 | 0 | |||||||||||||||||||||
Real estate, 1-4 family | 0 | 0 | 0 | 0 | 40,476 | 40,476 | 0 | |||||||||||||||||||||
Real estate, other | 33 | 0 | 36 | 69 | 105,052 | 105,121 | 0 | |||||||||||||||||||||
Real estate | ||||||||||||||||||||||||||||
Construction | 0 | 0 | 0 | 0 | 4,214 | 4,214 | 0 | |||||||||||||||||||||
Other | 20 | 14 | 0 | 34 | 17,935 | 17,969 | 0 | |||||||||||||||||||||
Consumer | ||||||||||||||||||||||||||||
Equity | 0 | 40 | 33 | 73 | 18,113 | 18,186 | 0 | |||||||||||||||||||||
Auto | 0 | 0 | 0 | 0 | 4,650 | 4,650 | 0 | |||||||||||||||||||||
Other | 15 | 0 | 8 | 23 | 8,601 | 8,624 | 0 | |||||||||||||||||||||
Total | $ | 68 | $ | 54 | $ | 750 | $ | 872 | $ | 278,279 | $ | 279,151 | $ | 0 |
NOTE 9 FINANCING RECEIVABLES ON NONACCRUAL STATUS
The following table summarizes loans (in thousands) on nonaccrual status by class at the dates indicated.
September 30, 2015 | December 31, 2014 | |||||||
Commercial operating | $ | 685 | $ | 673 | ||||
Commercial real estate, 1-4 family | 0 | 179 | ||||||
Commercial real estate, other | 173 | 69 | ||||||
Real estate, construction | 0 | 0 | ||||||
Real estate, other | 21 | 18 | ||||||
Consumer equity | 93 | 99 | ||||||
Consumer auto | 0 | 0 | ||||||
Consumer other | 6 | 23 | ||||||
Total | $ | 978 | $ | 1,061 |
NOTE 10 FAIR VALUES AND MEASUREMENTS OF FINANCIAL INSTRUMENTS
The Corporation records certain assets and liabilities at fair value. Fair value is defined as 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. Securities available-for-sale, trading securities, mortgage loans held for sale and derivative instruments are carried at fair value on a recurring basis. Fair value measurements are also utilized to determine the initial value of certain assets and liabilities, to perform impairment assessments and for disclosure purposes. The Corporation uses quoted market prices and observable inputs to the maximum extent possible when measuring fair value. In the absence of quoted market prices, various valuation techniques are utilized to measure fair value. When possible, observable market data for identical or similar financial instruments are used in the valuation. When market data is not available, fair value is determined using valuation models that incorporate management’s estimates of the assumptions a market participant would use in pricing the asset liability.
Fair value measurements are classified within one of three levels based on the observability of the inputs used to determine fair value, as follows:
· | Level 1 – The valuation is based on quoted prices in active markets for identical instruments. |
17. |
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
· | Level 2 – The valuation is based on observable inputs such as quoted prices for similar instruments in active markets, quoted prices for identical instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. |
· | Level 3 – The valuation is based on unobservable inputs that are supported by minimal or no market activity and that are significant to the fair value of the instrument. Level 3 valuations are typically performed using pricing models, discounted cash flow methodologies or similar techniques that incorporate management’s own estimates of assumptions that market participants would use in pricing the instrument or valuations that require significant management judgment or estimation. |
In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation.
State and political subdivisions
The Corporation obtains fair value measurements from a third party vendor that utilizes market valuation models maintained by a team of experienced evaluators and methodologists. Evaluators build internal yield curves, which are adjusted throughout the day based on trades and other pertinent market information. The criteria used to generate these curves and to arrive at the current day’s evaluations are based primarily on factors such as:
· | Established trading spreads between similar issuers or credits. |
· | Historical trading spreads over widely accepted market benchmarks. |
· | New issue scales. |
· | Market information from third party sources, such as reportable trades, broker-dealers, trustees/paying agents, issuers or from information prepared by an internal credit analysis department or by internally reviewing market sector correlations. |
Evaluators apply this information to bond sectors, and individual bond evaluations are then extrapolated. Within a given sector, evaluators have the ability to make daily spread adjustments for various attributes that include, but are not limited to, discounts, premiums, credit, alternative minimum tax (AMT), use of proceeds and callability. Analysts evaluate municipal securities backed by insurance, letters of credit, etc. When a municipal bond obtains insurance or other credit enhancements, a public rating is usually applied to the bond that is equal to the higher of (i) the published underlying rating or (ii) the rating of the bond insurer, guarantor, or other credit enhancing entity’s rating. Certain insured bonds with no published underlying ratings may receive an internal credit assessment. Evaluators may use internal credit ratings as an input in the evaluation process. The weight placed on internal credit ratings in the evaluation process may vary from one municipal security to another depending on the availability of other market data.
Multiple quality control evaluation processes review available market, credit and deal level information to support the evaluation of securities, such as:
· | Explanations required for all high yield municipal security evaluations adjusted on a per security basis. |
· | Explanations required for all high grade municipal security evaluation adjustments that break an internal tolerance level. |
· | Daily review of market information and data changes (including ratings) that may have an impact on evaluations. |
· | Review of unchanged evaluations and other applicable data. |
· | Daily review of category adjustments to confirm directional moves are tracking daily market movements. |
18. |
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
· | Daily reviews by managers of tolerance reports and of evaluator checklists to confirm processes are being followed. |
· | Monthly management reviews of evaluator work samples (tolerance reports, client challenges and other evaluation-related matters). |
U.S. Government and federal agencies and mortgage-backed securities
For agency/CMOs, depending upon the characteristics of a given tranche, a volatility-driven, multi-dimensional spread table based, single cash flow stream model or an option-adjusted spread (OAS) model is used. If call information is available, the pricing model computes both a yield to call and a yield to maturity to derive an evaluated price for the bond by assuming the most probable scenario. Alternatively, the evaluator may utilize market conventions if different from model-generated assumptions.
A team of experienced fixed income evaluators and methodologists closely monitor the structured product markets, interest rate movements, new issue information and other pertinent data. Evaluations of tranches (volatile and non-volatile) are based on the interactive data model’s interpretation of accepted market modeling, trading and pricing conventions. The Interactive data model determines tranche evaluations in four steps:
1 | Cash flows are generated with the deal files to determine principal and interest payments along with an average life. |
2 | Spreads/yields are determined for non-volatile fixed and floating-rate issues: |
· | For agency/GSE CMOs, the model takes the average life for each tranche and matches it to the yield of the nearest point on either the swap curve or the “I” Treasury curve. It then uses that benchmark yield as the base yield. |
· | Floating-rate issues are evaluated by a discount margin (DM) calculation. The DM measures the difference between the yield of the issue (at an assumed speed and current index) and the current value of the index over which the security resets. |
3 | Spreads are based on tranche characteristics such as average life, tranche type, tranche volatility, underlying collateral and the performance of the collateral and prevailing market conditions. Floating-rate issues take life caps into account. |
4 | The appropriate tranche spread or DM is applied to the corresponding benchmark. This value is then used to discount the cash flows to generate an evaluated price. |
The following table presents information about the Corporation’s assets and liabilities measured at fair value on a recurring basis as of September 30, 2015 and December 31, 2014, and the valuation techniques used by the Corporation to determine those fair values.
Quoted Prices in | Significant | Significant | ||||||||||||||
(Dollar amounts in thousands) | Active Markets | Observable | Unobservable | |||||||||||||
For Identical | Inputs | Inputs | ||||||||||||||
September 30, 2015 | Assets (Level 1) | (Level 2) | (Level 3) | Balance | ||||||||||||
Assets | ||||||||||||||||
U.S. Government Agency securities | $ | 0 | $ | 2,515 | $ | 0 | $ | 2,515 | ||||||||
State and political subdivisions | 0 | 6,030 | 0 | 6,030 | ||||||||||||
Mortgage-backed securities | 0 | 2,084 | 0 | 2,084 | ||||||||||||
Total Assets | $ | 0 | $ | 10,629 | $ | 0 | $ | 10,629 | ||||||||
Liabilities | $ | 0 | $ | 0 | $ | 0 | $ | 0 |
19. |
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Quoted Prices in | Significant | Significant | ||||||||||||||
(Dollar amounts in thousands) | Active Markets | Observable | Unobservable | |||||||||||||
For Identical | Inputs | Inputs | ||||||||||||||
December 31, 2014 | Assets (Level 1) | (Level 2) | (Level 3) | Balance | ||||||||||||
Assets | ||||||||||||||||
U.S. Government Agency securities | $ | 0 | $ | 1,965 | $ | 0 | $ | 1,965 | ||||||||
State and political subdivisions | 0 | 6,596 | 0 | 6,596 | ||||||||||||
Mortgage-backed securities | 0 | 2,466 | 0 | 2,466 | ||||||||||||
Total Assets | $ | 0 | $ | 11,027 | $ | 0 | $ | 11,027 | ||||||||
Liabilities | $ | 0 | $ | 0 | $ | 0 | $ | 0 |
Securities characterized as having Level 2 inputs generally consist of obligations of U.S. Government and federal agencies, government-sponsored organizations and obligations of state and political subdivisions. There were no transfers in or out of Levels 1 and 2 for the nine months ended September 30, 2015.
The Corporation also has assets that, under certain conditions, are subject to measurement at fair value on a non-recurring basis. These assets consist primarily of impaired loans and other real estate owned (“OREO”).
The following table presents financial assets and liabilities measured on a nonrecurring basis:
Fair Value Measurements at Reporting Date Using
Balance at | ||||||||||||||||
(In thousands) | September 30, | Level 1 | Level 2 | Level 3 | ||||||||||||
2015 | ||||||||||||||||
Impaired loans | $ | 4,935 | $ | 0 | $ | 0 | $ | 4,935 | ||||||||
Real estate acquired through foreclosure | 179 | 0 | 0 | 179 |
Balance at | ||||||||||||||||
(In thousands) | December 31, | Level 1 | Level 2 | Level 3 | ||||||||||||
2014 | ||||||||||||||||
Impaired loans | $ | 5,526 | $ | 0 | $ | 0 | $ | 5,526 | ||||||||
Real estate acquired through foreclosure | 2,255 | 0 | 0 | 2,255 |
The fair value of impaired loans were primarily measured based on the value of the collateral securing these loans. Impaired loans are classified within Level 3 of the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable. The Corporation determines the value of the collateral based on independent appraisals performed by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraised values are discounted for costs to sell and may be discounted further based on management’s historical knowledge, changes in market conditions from the date of the most recent appraisal and/or management’s expertise and knowledge of the customer and the customer’s business. Such discounts by management are subjective and are typically significant unobservable inputs for determining fair value. Impaired loans are subject to nonrecurring fair value adjustments to reflect (1) partial write-downs that are based on the observable market price or current appraised value of the collateral, or (2) the full charge-off of the loan carrying value. Included in the impaired balance at September 30, 2015 were troubled debt restructured loans with a balance of $4,376,000 and specified reserves of $123,000.
20. |
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value, based on the current appraised value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less costs to sell. Management has determined fair value measurements on other real estate owned primarily through evaluations of appraisals performed and current and past offers for the other real estate under evaluation. Due to the nature of the valuation inputs, foreclosed assets held for sale are classified within level 3 of the valuation hierarchy.
Appraisals of other real estate owned are obtained when the real estate is acquired and subsequently as deemed necessary by management. Appraisals are reviewed for accuracy and consistency by the Bank’s credit risk department and are selected from the list of approved appraisers maintained by management. Appraisals are sometimes further discounted based on management’s expertise and knowledge of the customer and the customer’s business. Such discounts are typically significant unobservable inputs for determining fair value. In cases where the carrying amount exceeds the fair value, less costs to sell, a loss is recognized in noninterest expense. Additionally, any operating costs incurred after acquisition are also expensed.
The tables below present the estimated fair values of the Corporation’s financial instruments for the periods indicated.
Quoted Prices | Significant | |||||||||||||||||||
In Active | Other | Significant | ||||||||||||||||||
(Dollar amounts in thousands) | Markets for | Observable | Unobservable | |||||||||||||||||
Carrying | Estimated | Identical Assets | Inputs | Inputs | ||||||||||||||||
September 30, 2015 | Amount | Fair Value | (Level 1) | (Level 2) | (Level 3) | |||||||||||||||
Financial Assets: | ||||||||||||||||||||
Cash equivalents and federal funds sold | $ | 20,904 | $ | 20,904 | $ | 20,904 | $ | 0 | $ | 0 | ||||||||||
Securities available-for-sale | 10,629 | 10,629 | 0 | 10,629 | 0 | |||||||||||||||
Securities held to maturity | 740 | 740 | 0 | 740 | 0 | |||||||||||||||
Other investment securities | 2,209 | 2,209 | 0 | 0 | 2,209 | |||||||||||||||
Loans, net of allowance for loan loss | 279,550 | 299,065 | 0 | 0 | 299,065 | |||||||||||||||
Accrued interest receivable | 1,466 | 1,466 | 0 | 0 | 1,466 | |||||||||||||||
Financial Liabilities: | ||||||||||||||||||||
Noninterest-bearing deposits | $ | (49,967 | ) | $ | (49,967 | ) | $ | (49,967 | ) | $ | 0 | $ | 0 | |||||||
Interest-bearing deposits | (145,468 | ) | (145,468 | ) | 0 | (145,468 | ) | 0 | ||||||||||||
Time deposits | (97,059 | ) | (96,895 | ) | 0 | (96,895 | ) | 0 | ||||||||||||
FHLB advances | (1,604 | ) | (1,307 | ) | 0 | (1,307 | ) | 0 | ||||||||||||
Accrued interest payable | (80 | ) | (80 | ) | 0 | 0 | (80 | ) |
21. |
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Quoted Prices | Significant | |||||||||||||||||||
In Active | Other | Significant | ||||||||||||||||||
(Dollar amounts in thousands) | Markets for | Observable | Unobservable | |||||||||||||||||
Carrying | Estimated | Identical Assets | Inputs | Inputs | ||||||||||||||||
December 31, 2014 | Amount | Fair Value | (Level 1) | (Level 2) | (Level 3) | |||||||||||||||
Financial Assets: | ||||||||||||||||||||
Cash equivalents and federal funds sold | $ | 27,151 | $ | 27,151 | $ | 27,151 | $ | 0 | $ | 0 | ||||||||||
Securities available-for-sale | 11,027 | 11,027 | 0 | 11,027 | 0 | |||||||||||||||
Other investment securities | 2,209 | 2,209 | 0 | 0 | 2,209 | |||||||||||||||
Loans, net of allowance for loan loss | 275,025 | 291,274 | 0 | 0 | 291,274 | |||||||||||||||
Accrued interest receivable | 1,334 | 1,334 | 0 | 0 | 1,334 | |||||||||||||||
Financial Liabilities: | ||||||||||||||||||||
Noninterest-bearing deposits | $ | (50,350 | ) | $ | (50,350 | ) | $ | (50,350 | ) | $ | 0 | $ | 0 | |||||||
Interest-bearing deposits | (142,022 | ) | (142,022 | ) | 0 | (142,022 | ) | 0 | ||||||||||||
Time deposits | (106,399 | ) | (106,283 | ) | 0 | (106,283 | ) | 0 | ||||||||||||
FHLB advances | (1,692 | ) | (1,374 | ) | 0 | (1,374 | ) | 0 | ||||||||||||
Accrued interest payable | (51 | ) | (51 | ) | 0 | 0 | (51 | ) |
The following describes the valuation methodologies used by management to measure financial assets and liabilities at fair value on a recurring basis as recognized in the Corporation’s accompanying balance sheets as well as the general classification of such assets and liabilities pursuant to the valuation hierarchy.
· | Cash equivalents and federal funds sold – The carrying value of cash, amounts due from banks and federal funds sold assumed to approximate fair value. |
· | Investment securities – Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated by using quoted prices of securities with similar characteristics or independent asset pricing services and pricing models, the inputs of which are market-based or independently sourced market parameters, including, but not limited to, yield curves, interest rates, volatilities, prepayments, defaults, cumulative loss projections and cash flows. Such securities are classified in level 2 of the valuation hierarchy. |
· | Other investment securities – principally consists of investments in Federal Home Loan Bank stock, which has limited marketability and is carried at cost. |
· | Loans – The loan portfolio includes adjustable and fixed rate loans, the fair value of which is estimated using discounted cash flow analyses. To calculate discounted cash flows, the loans are aggregated into pools of similar types and expected repayment terms. The expected cash flows are based on historical prepayment experiences and estimated credit losses for non-performing loans and are discounted using current rates at which similar loans would be made to borrowers with similar credit ratings and similar remaining maturities. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable. |
· | Accrued interest receivable – The carrying value of accrued interest receivable approximates fair value due to the short-term duration. |
· | Noninterest-bearing deposits – The fair value of noninterest-bearing demand deposits, which have no stated maturity, are considered equal to their carrying amount, representing the amount payable on demand. |
· | Interest-bearing deposits – The fair value of demand, money market and savings deposits, which have no stated maturity, are considered equal to their carrying amount, representing the amount payable on demand. |
22. |
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
· | Time deposits – The fair value for fixed rate time deposits is estimated using a discounted cash flow calculation that applies interest rates currently being offered for time deposits with similar terms and similar remaining maturities. |
· | FHLB advances – The fair value of long-term debt is estimated using a discounted cash flow calculation which utilizes the interest rates currently offered for borrowings of similar remaining maturities. |
· | Accrued interest payable – The carrying value of accrued interest payable approximates fair value due to the short-term duration. |
· | Other financial instruments – The fair value of other financial instruments, including loan commitments and unused letters of credit, is based on discounted cash flow analysis and is not material. |
NOTE 11 STOCK-BASED COMPENSATION
The Corporation has two share-based compensation plans in existence; the 1997 Stock Option Plan (expired but having outstanding options that may still be exercised) and the 2009 Incentive Stock Option Plan, which is described below.
The Corporation’s 2009 Incentive Stock Option Plan, which is shareholder approved, permits the granting of stock options to its employees. The plan permits the grant of incentive awards in the form of options, restricted stock and certain other stock-based awards to selected key employees on a periodic basis at the discretion of the board. The plan authorizes the issuance of up to 150,000 shares of common stock of which 28,850 shares are available for issuance at September 30, 2015. Option awards are granted with an exercise price equal to the market price of the Corporation’s common stock at the date of grant and have an expiration period of ten years.
The fair value of each option award is estimated on the date of grant using the Black Scholes option valuation model that uses the assumptions noted in the table below. Expected volatilities are based on several factors including historical volatility of the Corporation’s common stock, implied volatility determined from traded options and other factors. The Corporation uses historical data to estimate option exercises and employee terminations to estimate the expected life of options. The risk-free interest rate for the expected term of the options is based on the U.S. Treasury yield curve in effect at the time of the grant. The expected dividend yield is based on the Corporation’s expected dividend yield over the life of the options.
The fair value of options granted in 2015 and 2014 was determined using the following weighted-average assumptions as of the date of grant.
2015 | 2014 | |||||||
Dividend yield | 3.16 | % | 3.15 | % | ||||
Risk-free interest rate | 1.94 | % | 2.04 | % | ||||
Expected volatility | 22.29 | % | 22.59 | % | ||||
Weighted average expected life | 8 years | 8 years | ||||||
Weighted average per share fair value of options | $ | 4.47 | $ | 4.11 |
In the third quarter of 2015, 18,400 stock options were granted, subject to a three year vesting period with one third of the options vesting each year on the anniversary date of the grant.
Intrinsic value represents the amount by which the fair market value of the Corporation’s stock, $28.50 at September 30, 2015, exceeds the exercise price of the stock options. At September 30, 2015, the aggregate intrinsic value of stock options outstanding and exercisable was $695,000 and $621,000, respectively, compared to an aggregate intrinsic value of $654,000 and $539,000 at December 31, 2014.
23. |
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes stock option activity for the nine months ended September 30, 2015.
Weighted | ||||||||
Number | Average | |||||||
Of | Exercise | |||||||
Stock Options | Options | Price | ||||||
Outstanding options at January 1, 2015 | 69,375 | $ | 18.08 | |||||
Granted | 18,400 | 27.40 | ||||||
Exercised | (4,225 | ) | 17.04 | |||||
Forfeited | 0 | 0.00 | ||||||
Expired | 0 | 0.00 | ||||||
Outstanding options at September 30, 2015 | 83,550 | $ | 20.18 | |||||
Exercisable at September 30, 2015 | 54,499 | $ | 17.10 |
The fair value of options granted is amortized as compensation expense, recognized on a straight-line basis over the vesting period of the respective stock option grant. Compensation expense related to employees is included in personnel expense while compensation expense related to directors is included in other operating expense. The Corporation recognized compensation expense of $13,000 and $32,000 for the three and nine months ended September 30, 2015, respectively, related to the vesting of nonrestricted stock options, compared to compensation expense of $10,000 and $28,000 for the same periods in 2014. At September 30, 2015, the Corporation had $115,000 of unrecognized compensation expense related to nonrestricted stock options. This remaining cost is expected to be recognized over a weighted average vesting period of approximately 29 months.
The following is a summary of outstanding and exercisable stock options at September 30, 2015.
Number | Weighted Average | Number | ||||||||||||
Of Shares | Remaining | Of Shares | ||||||||||||
Exercise Price | Outstanding | Contractual Life | Exercisable | |||||||||||
$ | 12.30 | 11,900 | 3.87 years | 11,900 | ||||||||||
$ | 13.25 | 8,300 | 4.87 years | 8,300 | ||||||||||
$ | 17.40 | 9,800 | 5.87 years | 9,800 | ||||||||||
$ | 19.28 | 14,200 | 6.78 years | 14,200 | ||||||||||
$ | 21.35 | 9,950 | 7.86 years | 6,632 | ||||||||||
$ | 24.47 | 11,000 | 8.88 years | 3,667 | ||||||||||
$ | 27.40 | 18,400 | 9.88 years | 0 | ||||||||||
Total | 83,550 | 7.16 years | 54,499 |
The following table summarizes information about the Corporation’s nonvested stock option activity for the nine months ended September 30, 2015.
Number | Weighted | |||||||
Of | Average | |||||||
Nonvested Options | Options | Price | ||||||
Nonvested options at January 1, 2015 | 22,600 | $ | 22.41 | |||||
Granted | 18,400 | 27.40 | ||||||
Vested | (11,949 | ) | 21.45 | |||||
Forfeited | 0 | 0.00 | ||||||
Nonvested options at September 30, 2015 | 29,051 | $ | 25.97 |
24. |
COMMERCIAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In the third quarter of 2015, the Corporation granted 8,000 shares of restricted stock awards with a total grant date fair value of $219,000. The fair value of restricted stock is equal to the fair market value of the Corporation’s common stock on the date of grant. Restricted stock awards are recorded as unearned compensation, a component of shareholders’ equity, and amortized to compensation expense over the vesting period. The Corporation recognized compensation expense of $33,000 and $81,000 for the three and nine months ended September 30, 2015, respectively, related to restricted stock grants compared to $23,000 and $65,000 for the same periods in 2014. At September 30, 2015, the Corporation had approximately $306,000 of unrecognized compensation expense related to restricted stock awards. This remaining cost is expected to be recognized over a weighted average vesting period of approximately 28.5 months.
The following table summarizes restricted stock activity for the nine months ended September 30, 2015.
Weighted | ||||||||
Nonvested | Average | |||||||
Number of | Grant Date | |||||||
Restricted Stock | Shares | Fair Value | ||||||
Nonvested balance at January 1, 2015 | 12,900 | $ | 21.95 | |||||
Granted | 8,000 | 27.40 | ||||||
Vested | (2,200 | ) | 19.28 | |||||
Forfeited/expired | 0 | 0.00 | ||||||
Nonvested balance at September 30, 2015 | 18,700 | $ | 24.60 |
25. |
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
INTRODUCTION
The following review presents management’s discussion and analysis of the consolidated financial condition of Commercial Bancshares, Inc. and its wholly owned subsidiaries, Commercial Savings Bank and Commercial Financial and Insurance Agency, LTD at September 30, 2015, compared to December 31, 2014, and the consolidated results of operations for the three and nine-month periods ended September 30, 2015 compared to the same periods in 2014. The purpose of this discussion is to provide the reader with a more thorough understanding of the consolidated financial statements and related footnotes.
The Corporation is designated as a financial holding company by the Federal Reserve Bank of Cleveland. This status can help the Corporation take advantage of changes in existing law made by the Financial Modernization Act of 1999. As a result of being a financial holding company, the Corporation may be able to engage in an expanded array of activities determined to be financial in nature. This will help the Corporation remain competitive in the future with other financial service providers in the markets in which the Corporation does business. There are more stringent capital requirements associated with being a financial holding company. The Corporation intends to maintain its categorization as a “well capitalized” bank, as defined by regulatory capital requirements.
Management believes there have been no changes with respect to its determinations regarding the Corporation’s critical accounting policies as disclosed in the Corporation’s annual report on Form 10-K for the fiscal year ended December 31, 2014.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this report that are not historical facts are forward-looking statements that are subject to certain risks and uncertainties. Forward-looking statements include statements with respect to the Corporation’s beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions and future performance, and involve known and unknown risks, uncertainties and other factors which may be beyond the Corporation’s control and which may cause the actual results, performance, achievements or financial condition of the Corporation to be materially different from future results, performance, achievements or financial condition expressed or implied by such forward-looking statements.
Forward-looking statements are based on various assumptions and may be identified by reference to a future period or periods, or by the use of forward-looking terminology such as “believe”, “expect”, “estimate”, “anticipate”, “plan”, “intend”, or other similar terms or variations on those terms, or the future or conditional verbs such as “will”, “may”, “should”, and “would”. Forward-looking statements are subject to numerous assumptions, risks and uncertainties and actual results could differ materially from historical results or those anticipated by such statements. These forward-looking statements may not be realized due to a variety of factors, including, without limitation.
· | Governmental monetary and fiscal policies. |
· | Effects of future economic, business and market conditions and changes. |
· | Changes in accounting policies, rules and practices. |
· | Risks of changes in interest rates on the levels, composition and costs of deposit, loan demand and the values and liquidity of loan collateral, securities and interest sensitive assets and liabilities. |
· | Changes in borrower credit risks and payment behaviors. |
· | Effects of competition from a wide variety of local, regional, national and other providers of financial services. |
· | Failure of assumptions and estimates underlying the establishment of reserves for possible loan losses and other estimates. |
· | Changes in technology or products that may be more difficult, costly or less effective than anticipated. |
26. |
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
The Corporation has established various accounting policies which govern the application of U.S. generally accepted accounting principles (“GAAP”) in the preparation of its financial statements. Certain accounting policies involve significant judgments and assumptions by management which has a material impact on the reported amount of assets, liabilities, capital, revenues and expenses and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. The SEC has defined a company’s critical accounting policies as the ones that are most important to the portrayal of the company’s financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates on the matters that are inherently uncertain. Because of the nature of the judgments and assumptions made by management, actual results could differ from estimates and have a material impact on the carrying value of assets, liabilities, capital or the results of operations of the Corporation.
Allowance for loan losses: The Corporation assesses the adequacy of its allowance for loan losses as of the end of each calendar quarter. The level of the allowance is based upon management’s evaluation of the loan portfolio, past loan experience, current asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect a borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan loss rates and other pertinent factors. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Loans are charged off, in whole or in part, when management believes that the full collectability of the loan is unlikely. A loan may be partially charged off after a “confirming event” has occurred which serves to validate that full repayment pursuant to the terms of the loan agreement is unlikely.
The Corporation deems loans impaired when, based on current information and events, it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the loan agreement. Collection of all amounts due according to the contractual term means that both the interest and principal payments of a loan will be collected as scheduled in the loan agreement. An impairment allowance is recognized if the fair value of the loan is less than the recorded investment in the loan. The impairment is recognized through the allowance. Loans that are impaired are recorded at the present value of expected future cash flows discounted at the loan’s effective interest rate or if the loan is collateral dependent, impairment measurement is based on the fair value of the collateral, less estimated disposal costs.
In assessing the adequacy of the allowance, the Corporation also considers the results of its ongoing internal and independent loan review processes. The Corporation’s loan review process assists in determining whether there are loans in the portfolio whose credit quality has weakened over time and evaluating the risk characteristics of the entire loan portfolio. The Corporation’s loan review process includes the judgment of management, the input from independent loan reviewers and reviews that may have been conducted by bank regulatory agencies as part of their examination process. The Corporation incorporates loan review results in the determination of whether or not it is probable that it will be able to collect all amounts due according to the contractual terms of a loan.
The level of the allowance is believed by management to be adequate to absorb probable losses inherent in the loan portfolio at the balance sheet date. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries of amounts previously charged off.
Fair value estimates: Fair value is defined as the amount at which an asset or liability could be exchanged in a current transaction between willing, unrelated parties, other than in a forced or liquidation sale. Fair value is based on quoted market prices in an active market, or if market prices are not available, is estimated using models employing techniques such as matrix pricing or discounting expected cash flows. The significant assumptions used in the models, which include assumptions for interest rates, discount rates, prepayments and credit losses, are independently verified against observable market data where possible. Where observable market data is not available, the estimate of fair value becomes more subjective and involves a high degree of judgment. In this circumstance, fair value is estimated based on management’s judgment regarding the value that market participants would assign to the asset or liability. This valuation process takes into consideration factors such as market illiquidity. Imprecision in estimating these factors can impact the amount recorded on the balance sheet for a particular asset or liability with related impacts to earnings or other comprehensive income.
27. |
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Corporation’s profitability, as with most financial institutions, is significantly dependent upon net interest income, which is the difference between interest received on interest-earning assets, such as loans and securities and the interest paid on interest-bearing liabilities, principally deposits and borrowings. Results of operations are also affected by noninterest income, such as service charges on deposit accounts and fees on other services, income from lending activities and bank-owned life insurance as well as noninterest expenses such as salaries and employee benefits, occupancy, furniture and equipment, professional and other services, and other expenses, including income taxes. Economic conditions, competition and the monetary and fiscal policies of the Federal government significantly affect financial institutions.
Net income increased 2.2% to $2,538,000 for the nine months ended September 30, 2015 compared to $2,483,000 for the nine months ended September 30, 2014. Basic and diluted earnings per share for the nine months ended September 30, 2015 were $2.12 and $2.08, respectively, compared to $2.10 and $2.06 for the same period in 2014. The increase in net income for the nine months ended September 30, 2015 compared to the same period in 2014 can be largely attributed to a decrease in the provision for loan losses, partially offset by an increase in noninterest expense. Highlights for the nine months ended September 30, 2015:
· | Net loans totaled $279,550,000 at September 30, 2015, compared to $275,025,000 at year-end 2014, an increase of $4,525,000 or 1.7% with the growth predominantly in the commercial real estate portfolio. |
· | Deposits totaled $292,494,000 at September 30, 2015, compared to $298,771,000 at year-end 2014, a decrease of $6,277,000 or 2.1%, with the decline predominantly in CDARS certificates of deposit balances. |
· | The Corporation’s net interest margin, on a fully taxable equivalent basis, was 4.48% for the nine months ended September 30, 2015, compared to 4.64% for the nine months ended September 30, 2014. |
· | Net interest income increased $97,000 or 1.0% to $10,230,000 for the nine months ended September 30, 2015 from $10,133,000 for the same period in 2014, primarily due to the increase of $5,322,000 in average loan balances. |
· | OREO and other miscellaneous loan expense increased $198,000 or 70.5% to $479,000 for the nine months ended September 30, 2015 from $281,000 for the same period in 2014, due primarily to realized holding losses or write-downs on the valuation of OREO properties as well as increases in maintenance costs and property taxes associated with these assets. OREO related expenses are expected to decline as the Corporation’s largest commercial real estate properties have been sold and the overall OREO balance has been reduced to $179,000 as of September 30, 2015. |
· | The Corporation’s return on average equity and return on average assets for the nine months ended September 30, 2015 was 9.58% and 1.02%, respectively, compared to 10.11% and 1.04% for the same period in 2014. |
· | The Corporation’s efficiency ratio, on a fully taxable equivalent basis, was 67.60% for the nine months ended September 30, 2015, compared to 66.71% for the same period in 2014. The efficiency ratio measures the amount of expense incurred to generate a dollar of revenue and is calculated by dividing noninterest expense by the sum of taxable equivalent net interest income before provision and other noninterest income, excluding net gains (losses) on sales of investment securities and net gains (losses) on sales of fixed assets. |
· | The Corporation’s capital position remained strong with all regulatory capital ratios significantly exceeding the “well capitalized” thresholds established by regulators. At September 30, 2015, the Corporation’s Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital ratios were 10.79%, 12.72% and 13.97%, respectively, compared to Tier 1 leverage and risk-based capital ratios of 10.57%, 12.11% and 13.37% at December 31, 2014. |
28. |
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
Assets totaled $331,889,000 at September 30, 2015, compared to $336,529,000 as of December 31, 2014, reflecting a decrease of $4,640,000 or 1.4%, largely due to declines in cash equivalents and federal funds sold as well as the sale of two commercial real estate properties with a carrying value of $2,111,000. Total liabilities decreased 2.1% or $6,472,000 to $295,831,000 as of September 30, 2015 compared to $302,303,000 at December 31, 2014, primarily due to a decline in savings and time deposits less than $250,000. Shareholders’ equity increased 5.4% or $1,832,000 to $36,058,000 as of September 30, 2015 compared to $34,226,000 at December 31, 2014, primarily driven by an increase in retained earnings.
Cash equivalents and federal funds sold include working cash funds, due from banks, interest-bearing deposits in other financial institutions, items in process of collection and federal funds sold. The Bank is required to maintain average reserve balances with the Federal Reserve Bank based on average daily deposit balances and statutory reserve ratios prescribed by the type of deposit account. The average balance held in reserve for the nine months ended September 30, 2015 was $4,295,000, compared to $5,338,000 for the same period in 2014. Cash equivalents and federal funds sold decreased $6,247,000 or 23.0% to $20,904,000 at September 30, 2015 from $27,151,000 at December 31, 2014. Cash equivalents and federal funds sold were largely used to fund loan growth.
Total investment securities increased 2.6% to $13,578,000 at September 30, 2015 from $13,236,000 at December 31, 2014. The increase in investment securities was predominantly due to the purchase of two U.S. Government Agency securities during the first quarter and the purchase of a municipal security during the second quarter, totaling $1,780,000, partially offset with $1,276,000 in calls of municipal and Government Agency securities as well as pay downs and prepayments of mortgage-backed securities. Investment securities are reported at fair value with unrealized holding gains and losses, based on the difference between amortized cost and fair value, reported net of deferred tax, as accumulated other comprehensive income (loss), a separate component of shareholders’ equity. Declines in the fair value of individual securities below their cost that are other-than-temporary result in write downs of the individual securities to their fair values. Securities that are held as available-for-sale are used as a part of the Corporation’s asset/liability management strategy. Securities that may be sold in response to interest rate changes, changes in prepayment risk, the need to increase regulatory capital and other similar factors are classified as available-for-sale.
At September 30, 2015, the investment portfolio consisted primarily of obligations of state and political subdivisions, mortgage-backed securities and U.S. Government Agency securities. To reduce the Corporation’s income tax burden, $6,770,000 or 49.86% of the Corporation’s investment portfolio as of September 30, 2015, was invested in tax-exempt obligations of state and political subdivisions, compared to $6,596,000 or 49.83% at December 31, 2014.
Loans are reported at their outstanding principal balances less unearned income, the allowance for loan losses and any deferred fees or costs on originated loans. Interest income from loans is accrued based on the principal balance outstanding. Loan origination fees, net of certain loan origination costs, are deferred and recognized as an adjustment to the related loan yield. Loans make up the largest component of total assets. At September 30, 2015, net loans of $279,550,000, representing 84.23% of total assets, increased $4,525,000 or 1.7% from net loans of $275,025,000 at December 31, 2014. The increase in net loans between periods was largely due to an increase of $4,145,000, predominantly in the commercial real estate portfolio. Consumer real estate loans increased $1,322,000 or 6.0% while installment and home equity loans decreased $859,000 and $274,000, respectively.
The Corporation’s loan portfolio represents its largest and highest yielding assets. The fundamental lending business of the Corporation is based on understanding, measuring and controlling the credit risk inherent in the loan portfolio. The Corporation’s loan portfolio is subject to varying degrees of credit risk. Credit risk entails both general risks, which are inherent in the process of lending, and risk specific to individual borrowers. The Corporation’s credit risk is mitigated through portfolio diversification, which limits exposure to any single customer, industry or collateral type. Typically, each consumer and residential lending product has a generally predictable level of credit losses based on historical loss experience. Home mortgage and home equity loans and lines generally have the lowest credit loss experience, while loans secured by personal property, such as auto loans, are generally expected to experience more elevated credit losses. Credit risk in commercial lending can vary significantly, as losses as a percentage of outstanding loans can shift widely during economic cycles and are particularly sensitive to changing economic conditions. Generally, improving economic conditions result in improved operating results on the part of commercial customers, enhancing their ability to meet their particular debt service requirements. Improvements, if any, in operating cash flows can be offset by the impact of rising interest rates that may occur during improved economic times. Declining economic conditions have an adverse effect on the operating results of commercial customers, reducing their ability to meet debt service obligations. The Corporation believes the general economic outlook remains stable without any clear or substantive trends in employment rates, real estate values or overall consumer or commercial confidence, spending or investment.
29. |
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
To control and manage credit risk, management has a credit process in place to ensure credit standards are maintained along with strong oversight and review procedures. The primary purpose of loan underwriting is the evaluation of specific lending risks and involves the analysis of the borrower’s ability to service the debt as well as the assessment of the value of the underlying collateral. Oversight and review procedures include the monitoring of portfolio credit quality, early identification of potential problem credits and the aggressive management of problem credits. Executive management has implemented the following measures to proactively manage credit risk in the loan portfolios:
· | Reviewed all underwriting guidelines for various loan portfolios and have strengthened underwriting guidelines where needed. |
· | Evaluated outside loan review parameters, engaging the services of a well-established firm to continue with such loan review, addressing not only specific loans but underwriting analysis, documentation, credit evaluation and risk identification. |
· | Increased the frequency of quarterly internal reviews to monthly reviews of past due and delinquent loans to assess probable credit risks early in the delinquency process to minimize losses. |
· | Aggressively seeks ownership and control, when appropriate, of real estate properties, which would otherwise go through time consuming and costly foreclosure proceedings to effectively control the disposition of such collateral. |
· | Aggressively obtaining updated financial information on commercial credits and performing analytical reviews to determine debt source capacities in business performance trends. |
· | Engaged a well-established auditing firm to analyze the Corporation’s loan loss reserve methodology and documentation. |
The allowance for loan losses is established through a provision for loan losses charged to current earnings. The allowance for loan losses is maintained at a level estimated by management to absorb probable losses inherent in the loan portfolio and is based on management’s continuing evaluation of the portfolio, the related risk characteristics and the overall economic conditions affecting the portfolio. This estimation is inherently subjective as it requires measures that are susceptible to significant revision as more information becomes available.
The Corporation’s methodology in determining the allowance for loan losses includes segmenting the loan portfolio into various components and applying various loss factors to estimate the amount of probable losses. The largest segment of the loan portfolio is comprised of credit-rated commercial loans, comprising 81% of total loans at September 30, 2015 and December 31, 2014. Credit-rated commercial loans include commercial and industrial loans along with loans to commercial borrowers that are secured by real estate (commercial property, multi-family residential property, 1-4 family residential property, and construction and land). For each loan within this segment, a credit rating is assigned based on a review of specific risk factors including (1) historical and projected financial results of the borrower, (2) market conditions of the borrower’s industry that may affect the borrower’s future financial performance, (3) business experience of the borrower’s management, (4) nature of the underlying collateral, if any, and (5) borrower’s history of payment performance.
When assigning a credit rating to a loan, management uses an internal, nine-level rating system in which a rating of one carries the lowest level of credit risk and is used for borrowers exhibiting the strongest financial condition. Loans rated one through five are deemed to be acceptable quality and are considered “Pass”. Loans that are deemed to be of questionable quality are rated six (special mention). Loans with adverse classifications (substandard or doubtful) are rated seven and eight, respectively. A loan is considered substandard if it is inadequately protected by the current net worth and paying capacity of the borrower characterized by a well-defined weakness.
30. |
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The outstanding amounts of credit-rated commercial loans are aggregated by credit rating, and management estimates the allowance for losses for each credit rating using loss factors based on historical loss experience and qualitative adjustments reflecting the current economic conditions and outlook for housing, employment, manufacturing, and consumer spending. The economic adjustments reflect the imprecision that is inherent in the estimates of probable loan losses, and are intended to ensure adequacy of the overall allowance amount. The loss factors assigned to each credit rating are adjusted based on management’s judgment, along with certain qualitative factors such as the trend and severity of problem loans that can cause the estimation of inherent losses to differ from historical experience. Any change to an individual credit rating may affect the amount of the related allowance.
The Corporation’s internal review process results in the periodic review of assigned credit ratings to reflect changes in specific risk factors. Commercial lines of credit are generally issued with terms of one year, and upon annual renewal, a full review of the specific risk factors to assess the appropriateness of the assigned credit ratings. Furthermore, loans classified as special mention, substandard or doubtful are placed on an internal watch list and undergo a credit rating review on a quarterly basis, for special mention loans or monthly basis, for substandard and doubtful loans.
As part of the oversight and review process, the Corporation maintains an allowance for loan losses to absorb estimated and probable losses inherent in the loan portfolio at the balance sheet date. The allowance is based on two basic principles of accounting: (1) the requirement that a loss be accrued when it is probable that the loss has occurred at the date of the financial statements and the amount of the loss can be reasonably estimated and (2) the requirement that losses, if any, be accrued when it is probable that the Corporation will not collect all principal and interest payments according to the loan’s contractual terms.
The Corporation’s allowance for loan losses has two basic components: a general reserve reflecting historical losses by loan category and loan classification, as adjusted by several factors whose effects are not reflected in historical loss ratios, and specific allowances for individually identified loans. General reserves are based upon historical loss experience by portfolio segment measured and supplemented to address various risk characteristics of the Corporation’s loan portfolio including:
· | Trends in delinquencies and other non-performing loans. |
· | Changes in the risk profile related to large loans in the portfolio. |
· | Changes in the categories of loans comprising the loan portfolio. |
· | Concentrations of loans to specific industry segments. |
· | Changes in economic conditions on both a local and a national level. |
· | Changes in the Corporation’s credit administration and loan portfolio management processes. |
· | Quality of the Corporation’s credit risk identification process. |
The portion of the reserve representing specific allowances is derived by accumulating the specific allowances established on individually impaired loans that have significant conditions or circumstances that indicate that a loss may be probable. Specific reserves are calculated on individually impaired loans and are established based on the Corporation’s calculation of the probable losses inherent in an individual loan. For loans on which the Corporation has not elected to use the collateral value as a basis to establish the measure of impairment, the Corporation measures impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate. In determining the cash flows to be included in the discount calculation, the Corporation considers a number of factors that combined, are used to estimate the probability and severity of potential losses.
· | The borrower’s overall financial condition. |
· | Resources and payment record. |
· | Support available from financial guarantors. |
31. |
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
At September 30, 2015 the general reserve represented 97% of the total allowance for loan losses while the specified allowance accounted for 3% of the total allowance, compared to 93% and 7% at year-end 2014. The severity of estimated losses on impaired loans can differ substantially from actual losses. The general reserve is calculated in two parts based on an internal risk classification of loans within each portfolio segment. General reserves on loans considered to be “classified” under regulatory guidance are calculated separately from loans considered to be “pass” rated under the same guidance. This segregation allows the Corporation to monitor the reserves related to higher risk loans separate from the remainder of the portfolio in order to better manage risk and ensure the sufficiency of reserves.
The allowance for loan losses is established and maintained at a level management deems adequate to cover losses inherent in the loan portfolio as of the balance sheet date and is based on management’s evaluation of the risks in the loan portfolio and changes in the nature and volume of loan activity. The amount of the allowance is affected by: (1) loan charge-offs, which decrease the allowance; and (2) recoveries on loans previously charged off, which increase the allowance; and (3) the provision of possible loan losses charged to income, which increases the allowance. In determining the provision for possible loan losses, it is necessary for management to monitor fluctuations in the allowance resulting from actual charge-offs and recoveries and to periodically review the size and composition of the loan portfolio in light of current and anticipated economic conditions.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. The evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
At September 30, 2015 and December 31, 2014, the allowance for loan losses stood at $3,935,000 and $4,126,000, respectively. The ratio of the allowance for loan losses to total loans was 1.39% and 1.48%. The ratio of annualized net charge-offs to average outstanding loans was 0.16% at September 30, 2015, down from 0.19% at year-end 2014. The Corporation provided $86,000 and $138,000 to the allowance for loan losses for the three and nine months ended September 30, 2015, respectively, compared to $26,000 and $287,000 for the same periods in 2014. Net charge-offs totaled $247,000 and $329,000 for the three and nine month-periods ended September 30, 2015, respectively, compared to net charge-offs of $16,000 and $266,000 for the same periods last year.
The methodology used in the periodic review of the reserve adequacy, which is performed at least quarterly, is designed to be responsive to changes in portfolio credit quality and inherent credit losses. The changes are reflected in both the pooled formula reserve and in specific reserves as the collectability of large classified loans is regularly recalculated with new information as it becomes available.
In addition, bank regulators, as an integral part of their supervisory functions, periodically review the Corporation’s loan portfolio and related allowance for loan losses. These regulatory agencies may require the Corporation to increase its provision for loan losses or to recognize further loan charge-offs based upon their judgments. An increase in the allowance for loan losses by these regulatory agencies could materially adversely affect the Corporation’s financial condition and results of operations.
Before loans are charged off, they typically go through a phase of non-performing status. Various stages exist when dealing with such non-performance. The first stage is simple delinquency, where customers consistently start paying late, 30, 60 and 90 days at a time. These accounts may then be put on a list of loans to “watch” as they continue to under-perform according to original terms. Loans are placed on nonaccrual status when management believes the collection of the principal and interest is doubtful. A delinquent loan is generally placed on nonaccrual status when principal and/or interest is past due 90 days or more or if the financial strength of the borrower has declined, or other facts would make the repayment of the loan suspect, unless the loan is well secured, or in the process of collection. At September 30, 2015 and December 31, 2014, there were no 90 day delinquent loans that were on accrual status. In such cases, the loans are individually evaluated in order to determine whether to continue income recognition after 90 days beyond the due dates.
When a loan is placed on nonaccrual status, all interest which has been accrued is charged back against current earnings as a reduction in interest income, which adversely affects the yield on loans in the period of reversal. No additional interest is accrued on the loan balance until collection of both principal and interest becomes reasonably certain. Loans placed on nonaccrual status may be returned to accrual status after payments are received for a minimum of six consecutive months in accordance with the loan documents and any doubt as to the loan’s full collectability has been removed or the troubled loan is restructured and evidenced by a credit evaluation of the borrower’s financial condition and the prospects for full repayment.
32. |
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Corporation’s methodology for evaluating whether a loan is impaired begins with risk-rating credits on an individual basis. Loans with a pass rating represent those not classified on the Corporation’s rating scale for problem credits, as minimal credit risk has been identified. Loans classified as special mention have potential weaknesses that deserve management’s close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified as substandard have a well-defined weakness that jeopardizes the repayment of the debt. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans rated as doubtful in whole, or in part, are placed on nonaccrual status.
When management identifies a loan as impaired, the impairment is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the observable market price of the loan, except when the sole (remaining) source of repayment for the loan is the liquidation of the collateral. In this case, management uses the current fair value of the collateral, less selling costs when foreclosure is probable, instead of discounted cash flows. If management determines the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs and deferred loan fees or costs), impairment is recognized through an allowance estimate or a charge-off to the allowance. When management determines an impaired loan is a confirmed loss, the estimated impairment is directly charged off to the loan rather than creating a specific reserve for inclusion in the allowance for loan losses. However, not all impaired loans are in nonaccrual status because they may be current with regards to the payment terms. Their determination as an impaired loan is based on some inherent weakness in the credit that may, if certain circumstances occur, result in an inability to comply with the loan agreement’s contractual terms. Impaired loans exclude large groups of smaller homogenous loans that are collectively evaluated for impairment such as consumer real estate and installment loans.
The allowance for loan losses, specifically related to impaired loans at September 30, 2015 and December 31, 2014 was $123,000 and $302,000, respectively, related to loans with principal balances of $1,874,000 and $3,886,000. Impaired loans with no related allowance recorded at September 30, 2015 totaled $3,184,000 compared to $1,942,000 at December 31, 2014. The Corporation’s financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on the loan portfolio, unless a loan is placed on nonaccrual status. Amounts received on nonaccrual loans generally are applied first to principal and then to interest only after all principal has been collected. For the three and nine months ended September 30, 2015, the Corporation received interest payments of $77,000 and $214,000, respectively, related to impaired loans averaging $5,351,000 and $5,746,000, compared to interest payments of $110,000 and $320,000, related to impaired loans averaging $9,076,000 and $9,173,000 for the three and nine months ended September 30, 2014.
Management’s general practice is to proactively charge down loans individually evaluated for impairment to the fair value of the underlying collateral. Consistent with regulatory guidance, charge-offs on all loan segments are taken when specific loans, or portions thereof, are considered uncollectible. The Corporation’s policy is to promptly charge these loans off in the period the uncollectible loss is reasonably determined. Management believes that by taking a proactive approach to identifying problems and determining their ultimate collectability, using both internal and external portfolio loan reviews, that any potential losses which may be incurred on these credits in the future are incorporated into its analysis of the adequacy of the Corporation’s allowance for loan losses.
Due to the weakening credit status of a borrower, the Corporation may elect to formally restructure certain loans to facilitate a repayment plan that minimizes the potential losses the Corporation might incur. Restructured loans, or troubled debt restructurings (“TDRs”) are classified as impaired loans and may either be in accruing or nonaccruing status. In most cases the modification is either a concessionary reduction in interest rate, extension of the maturity date or reduction in the principal balance that would otherwise not be considered. Concessionary modifications are classified as troubled debt restructurings unless the modification results in only an insignificant delay in the payments to be received. Troubled debt restructured loans are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows discounted using the loan’s effective interest rate at inception or the fair value of the collateral, less selling costs if the loan is collateral dependent. If the recorded investment in the loan exceeds the measure of fair value, impairment is recognized by establishing a valuation allowance as part of the allowance for loan losses or a charge-off to the allowance for loan losses. In periods subsequent to the modification, all TDRs are evaluated individually, including those that have payment defaults, for possible impairment. A nonaccrual TDR may be returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Additionally, there should be a sustained period of repayment performance (generally a period of six months) by the borrower in accordance with the modified contractual terms.
33. |
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Troubled debt restructured loans totaled $4,376,000 at September 30, 2015, representing five credit relationships in which economic concessions were granted to borrowers to better align the terms of their loans with their current ability to repay. Troubled debt restructured balances are down slightly from $4,557,000 at December 31, 2014. As of September 30, 2015, 84% of all restructured loans were performing in accordance with the terms of the restructure. The specified reserve required for these TDRs, whether collateral dependent or not, was $123,000, representing 3% of the total loan loss reserve and 100% of the total specified reserve. There are no commitments to lend additional amounts to borrowers with loans classified as troubled debt restructurings as of September 30, 2015.
Non-performing assets include nonaccrual loans as well as other real estate owned and other repossessed assets. Non-performing loans are comprised of loans on nonaccrual status along with loans that are contractually past due 90 days or more but have not been classified as nonaccrual. At September 30, 2015, the Corporation had $978,000 in non-performing loans, or 0.35% of total loans, a slight decrease from non-performing loans of $1,061,000 or 0.38% of total loans at December 31, 2014. At September 30, 2015, non-performing loans by loan portfolio category were as follows: $537,000 in commercial operating loans; $321,000 in commercial real estate loans; $99,000 in consumer loans and $21,000 in residential mortgage loans. Management evaluated non-performing loans at September 30, 2015 and believes that they have charged off, written down or established adequate loss reserves on all identified problem loans.
Other assets, including premises and equipment, accrued interest receivable, bank-owned life insurance, OREO and other repossessed assets, assets classified as held for sale and other assets decreased $3,260,000 or 15.4% to $17,857,000 at September 30, 2015 from $21,117,000 at December 31, 2014. The decrease in other assets was primarily due to a decrease of $2,076,000 in OREO and other repossessed assets and a decrease of $1,178,000 in assets classified as held for sale. The decrease in assets classified as held for sale is due to the sale of a branch property during the first quarter that was valued at $1,178,000 and classified as assets held for sale at year-end 2014.
Other real estate owned acquired through partial or total satisfaction of non-performing loans is included in other assets and recorded at fair value less anticipated selling costs based upon the property’s appraised value at the date of transfer, with any difference between the fair value of the property less cost to sell, and the carrying value of the loan charged to the reserve for loan losses. Subsequent write-downs that may be required are expensed as incurred. Gains and losses realized from the sale of other real estate owned, as well as valuation adjustments, are included in noninterest expense as well as expenses of operation. During the nine months ended September 30, 2015, two properties with a total carrying value of $46,000 were transferred to OREO. Also during that time, capital improvement adjustments totaling $52,000 were made to an existing property in OREO. In addition, write-downs totaling $161,000 were taken against two existing properties held in OREO and was charged to earnings. During the nine months ended September 30, 2015, two properties with a carrying value of $2,111,000 were sold at a loss of $26,000. At September 30, 2015, the Corporation held two properties in OREO with a carrying value of $46,000, compared to two properties with a carrying value of $2,220,000 at December 31, 2014.
Other repossessed assets, resulting from loans where the Corporation has received title or physical possession of the borrower’s assets, is included in other assets and is recorded at fair value, less estimated selling costs. At the time of repossession, the recorded amount of the loan is written down to the fair value of the equipment or vehicle by a charge to the reserve for loan losses. Gains and losses realized from the sale of other repossessed assets, as well as valuation adjustments, are included in noninterest expense as well as expenses of operation. During the nine months ended September 30, 2015, additions to other repossessed assets totaled $143,000. During the same period, repossessed assets with a total carrying value of $44,000, sold at a loss of $8,000. Other repossessed assets at September 30, 2015 totaled $133,000 compared to $35,000 at December 31, 2014.
34. |
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Total deposits decreased $6,277,000 or 2.1% to $292,494,000 at September 30, 2015 from $298,771,000 at December 31, 2014. The decrease in deposits was largely due to the run off of higher costing certificates of deposits. The Bank offers a broad selection of deposit accounts, including noninterest-bearing demand deposits (such as checking accounts), interest-bearing checking accounts, money market accounts, savings accounts and certificates of deposits. Included in the certificates of deposit balances at September 30, 2015 was a total of $31,962,000 in reciprocal certificates of deposits offered under the Certificate Deposit Account Registry Service (“CDARs”), a program in which the Bank participates. Under the CDARS program, participating banks are able to match customer’s deposits that would otherwise exceed the limits for FDIC insurance with certificates of deposits offered at other participating banks, thereby providing FDIC insurance to these excess deposits.
The Corporation also offers a variety of deposit accounts designed for businesses operating in its market areas. Business banking deposit products include commercial checking accounts, commercial money market accounts and checking accounts specifically designed for small businesses. The Corporation also offers bill paying and cash management services through its online banking system as well as a remote deposit capture product. Interest rates paid are competitively priced for each particular deposit product and structured to meet the Corporation’s funding requirements. Management believes that additional funds can be attracted and deposit growth can be realized through deposit pricing if the Corporation experiences increased loan demand or other liquidity needs.
The Corporation utilizes both short-term and long-term borrowings as an alternate funding source to deposits and can be used to fund the Corporation’s liquidity needs. Short-term borrowings, which include federal funds purchased, are borrowings from other banks that mature daily. FHLB advances are loans from Federal Home Loan Bank that can mature daily or have longer maturities for fixed or floating rates of interest. FHLB borrowings are generally used to provide additional funding for loan growth when it is in excess of deposit growth and to manage interest rate risk, but can also be used as an additional source of liquidity for the Corporation. Borrowed funds totaled $1,604,000 at September 30, 2015, a decrease of $88,000 or 5.2%, from $1,692,000 at December 31, 2014. The Corporation’s borrowing capacity at FHLB totaled $30,498,000 of which $22,894,000 was available at September 30, 2015. Management believes the Corporation has adequate liquidity to meet their commitments for the foreseeable future.
Shareholders’ equity grew to $36,058,000 at September 30, 2015 from $34,226,000 at December 31, 2014, an increase of $1,832,000 or 5.4%. The increase in shareholders’ equity was primarily attributable to current earnings of $2,538,000 plus adjustments related to employee compensation costs, stock option accounting, treasury stock and deferred compensation plan activity of $138,000. The Corporation declared cash dividends of $0.63 per share for the nine months ended September 30, 2015, decreasing equity by $757,000. Included in shareholders’ equity is accumulated other comprehensive income which includes the net after-tax impact of unrealized gains on investment securities. Such unrealized gains or losses are generally due to changes in interest rates and represent the difference, net of applicable income tax effect, between the estimated fair value and amortized cost of investment securities.
During the nine months ended September 30, 2015, the Corporation returned 29.83% of earnings through dividends of $757,000 at $0.63 per share compared to a return on earnings of 24.84% through dividends of $617,000 at $0.52 per share for the same period in 2014. Average shareholders’ equity to average assets was 10.64% for the nine months ended September 30, 2015 compared to 10.26% for the nine months ended September 30, 2014.
RESULTS OF OPERATIONS
Net income, after taxes for the three months ended September 30, 2015 totaled $945,000 or $0.77 per diluted share compared to net income of $859,000 or $0.71 per diluted share for the same period in 2014. The increase in net income between periods was largely due to a decrease of $212,000 in noninterest expense, offset by a decrease of $120,000 in net interest income after the provision for loan losses as well as a decrease in noninterest income of $25,000. Net income, after taxes for the nine months ended September 30, 2015 totaled $2,538,000 or $2.08 per diluted share, an increase of $55,000 or 2.2%, compared to net income of $2,483,000 or $2.06 per diluted share for the same period in 2014. The increase in net income between periods was largely due to an increase of $246,000 in net interest income after the provision for loan losses, offset by an increase in noninterest expense of $112,000 and a decrease of $97,000 in noninterest income.
35. |
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The table that follows presents the Corporation’s (i) average assets, liabilities and shareholders’ equity, (ii) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (iii) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (iv) interest rate spread (the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities), and (v) net interest margin (net interest income as a percentage of total average interest-earning assets).
TABLE 1 YIELD ANALYSIS
For the three-month period ended September 30, 2015 and 2014.
(Dollar amounts in thousands)
Three Months Ended September 30, | ||||||||||||||||||||||||
2015 | 2014 | |||||||||||||||||||||||
Interest | Interest | |||||||||||||||||||||||
Average | Income/ | Yield/ | Average | Income/ | Yield/ | |||||||||||||||||||
Balance | Expense | Rate | Balance | Expense | Rate | |||||||||||||||||||
Federal funds sold | $ | 12,164 | $ | 8 | 0.26 | % | $ | 11,332 | $ | 7 | 0.25 | % | ||||||||||||
Investment securities: | ||||||||||||||||||||||||
Taxable securities (1) | 7,116 | 46 | 2.56 | 6,970 | 51 | 2.90 | ||||||||||||||||||
Tax-exempt securities (1) | 7,081 | 107 | 6.00 | 8,012 | 121 | 5.99 | ||||||||||||||||||
Loans (2) (3) | 277,716 | 3,529 | 5.04 | 272,463 | 3,578 | 5.21 | ||||||||||||||||||
Earning assets | 304,077 | 3,690 | 4.81 | % | 298,777 | 3,757 | 4.99 | % | ||||||||||||||||
Other assets | 22,755 | 24,890 | ||||||||||||||||||||||
Total assets | $ | 326,832 | $ | 323,667 | ||||||||||||||||||||
Interest-bearing demand deposits | $ | 114,918 | $ | 23 | 0.08 | % | $ | 120,931 | $ | 24 | 0.08 | % | ||||||||||||
Savings deposits | 28,009 | 2 | 0.03 | 25,750 | 2 | 0.03 | ||||||||||||||||||
Time deposits | 94,209 | 179 | 0.75 | 93,041 | 177 | 0.75 | ||||||||||||||||||
Borrowed funds | 2,895 | 10 | 1.37 | 6,143 | 12 | 0.78 | ||||||||||||||||||
Interest-bearing liabilities | 240,031 | 214 | 0.35 | % | 245,865 | 215 | 0.35 | % | ||||||||||||||||
Noninterest-bearing demand deposits | 49,208 | 42,761 | ||||||||||||||||||||||
Other liabilities | 1,539 | 1,522 | ||||||||||||||||||||||
Shareholders’ equity | 36,054 | 33,519 | ||||||||||||||||||||||
Total liabilities and shareholders’ equity | $ | 326,832 | $ | 323,667 | ||||||||||||||||||||
Net interest income | $ | 3,476 | $ | 3,542 | ||||||||||||||||||||
Interest rate spread | 4.46 | % | 4.64 | % | ||||||||||||||||||||
Net interest margin (4) | 4.54 | % | 4.70 | % |
(1) | Average yields on all securities have been computed based on amortized cost. Income on tax-exempt securities has been computed on a taxable-equivalent basis using a 34% federal tax rate and a 20% disallowance of interest expense deductibility under TEFRA rules. The amount of such adjustment was $36,000 and $42,000 for the three-month period ended September 30, 2015 and 2014. |
(2) | Average balance is net of deferred loan fees of $664,000 and $593,000 for the three months ended September 30, 2015 and 2014, respectively. |
(3) | Interest income includes loan fees of $128,000 and $169,000 for the three-month period ended September 30, 2015 and 2014, respectively, as well as $33,000 and $38,000 of deferred dealer reserve expense for the same years. |
(4) | Net interest margin is the ratio of annualized tax equivalent net interest income to average earning assets. |
36. |
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The table that follows presents the Corporation’s (i) average assets, liabilities and shareholders’ equity, (ii) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (iii) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (iv) interest rate spread (the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities), and (v) net interest margin (net interest income as a percentage of total average interest-earning assets).
TABLE 2 YIELD ANALYSIS
For the nine-month period ended September 30, 2015 and 2014.
(Dollar amounts in thousands)
Nine Months Ended September 30, | ||||||||||||||||||||||||
2015 | 2014 | |||||||||||||||||||||||
Interest | Interest | |||||||||||||||||||||||
Average | Income/ | Yield/ | Average | Income/ | Yield/ | |||||||||||||||||||
Balance | Expense | Rate | Balance | Expense | Rate | |||||||||||||||||||
Federal funds sold | $ | 21,027 | $ | 39 | 0.25 | % | $ | 12,239 | $ | 22 | 0.24 | % | ||||||||||||
Investment securities: | ||||||||||||||||||||||||
Taxable securities (1) | 7,259 | 142 | 2.62 | 7,125 | 158 | 2.96 | ||||||||||||||||||
Tax-exempt securities (1) | 6,911 | 312 | 6.04 | 8,195 | 368 | 6.00 | ||||||||||||||||||
Loans (2) (3) | 273,579 | 10,504 | 5.13 | 268,257 | 10,366 | 5.17 | ||||||||||||||||||
Earning assets | 308,776 | 10,997 | 4.76 | % | 295,816 | 10,914 | 4.93 | % | ||||||||||||||||
Other assets | 24,178 | 24,095 | ||||||||||||||||||||||
Total assets | $ | 332,954 | $ | 319,911 | ||||||||||||||||||||
Interest-bearing demand deposits | $ | 116,472 | $ | 69 | 0.07 | % | $ | 122,252 | $ | 72 | 0.08 | % | ||||||||||||
Savings deposits | 27,399 | 7 | 0.03 | 25,720 | 6 | 0.03 | ||||||||||||||||||
Time deposits | 100,913 | 555 | 0.74 | 89,436 | 543 | 0.81 | ||||||||||||||||||
Borrowed funds | 2,082 | 28 | 1.80 | 3,611 | 33 | 1.22 | ||||||||||||||||||
Interest-bearing liabilities | 246,866 | 659 | 0.36 | % | 241,019 | 654 | 0.36 | % | ||||||||||||||||
Noninterest-bearing demand deposits | 49,066 | 44,589 | ||||||||||||||||||||||
Other liabilities | 1,580 | 1,473 | ||||||||||||||||||||||
Shareholders’ equity | 35,442 | 32,830 | ||||||||||||||||||||||
Total liabilities and shareholders’ equity | $ | 332,954 | $ | 319,911 | ||||||||||||||||||||
Net interest income | $ | 10,338 | $ | 10,260 | ||||||||||||||||||||
Interest rate spread | 4.40 | % | 4.57 | % | ||||||||||||||||||||
Net interest margin (4) | 4.48 | % | 4.64 | % |
(1) | Average yields on all securities have been computed based on amortized cost. Income on tax-exempt securities has been computed on a taxable-equivalent basis using a 34% federal tax rate and a 20% disallowance of interest expense deductibility under TEFRA rules. The amount of such adjustment was $108,000 and $127,000 for the nine-month period ended September 30, 2015 and 2014. |
(2) | Average balance is net of deferred loan fees of $689,000 and $564,000 for the nine months ended September 30, 2015 and 2014, respectively. |
(3) | Interest income includes loan fees of $424,000 and $411,000 for the nine-month period ended September 30, 2015 and 2014, respectively, as well as $111,000 and $150,000 of deferred dealer reserve expense for the same years. |
(4) | Net interest margin is the ratio of annualized tax equivalent net interest income to average earning assets. |
37. |
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net interest income, the largest source of the Corporation’s operating revenue, is the difference between income on earning assets and the cost of funds supporting those assets. Significant categories of earning assets are loans and securities while deposits and borrowings represent the major portion of interest-bearing liabilities. For purposes of the following discussion, comparison of net interest income is done on a tax equivalent basis, which provides a common basis for comparing yields on earning assets exempt from federal income taxes to those which are fully taxable.
Net interest margin is significantly impacted by movements in interest rates and changes in the mix of earning assets and the liabilities that fund those assets. Net interest margin is calculated by expressing tax equivalent net interest income as a percentage of average interest-earning assets and represents the Corporation’s net yield on its earning assets. Net interest margin is an indicator of the Corporation’s effectiveness in generating income from its earning assets. Net interest margin is affected by the structure of the balance sheet as well as by competitive pressures, Federal Reserve regulatory and monetary policies and the economy. The Corporation’s net interest margin, on a fully taxable equivalent basis, was 4.54% for the three-month period ended September 30, 2015, compared to 4.70% for the same period in 2014. Interest rate spread, which is the average yield on interest-earning assets minus the average rate paid on interest-bearing liabilities, was 4.46% and 4.64% for the three months ended September 30, 2015 and 2014, respectively. For the nine months ended September 30, 2015, the Corporation’s net interest margin and interest rate spread was 4.48% and 4.40%, respectively, compared to net interest margin and interest rate spread of 4.64% and 4.57% for the same period in 2014. One of the largest contributors to the decrease in the Corporation’s net interest margin is primarily the result of disproportionately high average balances at the Federal Reserve Bank. Deposits invested at the Federal Reserve Bank bore interest at only 26 and 25 basis points for the three and nine-month periods ended September 30, 2015, respectively. Average deposits invested in other financial institutions and federal funds sold were $12,164,000 and $21,027,000 for the three and nine months ended September 30, 2015, respectively, compared to $11,332,000 and $12,239,000 for the same periods in 2014.
The Corporation actively monitors and proactively manages the rate sensitive components of both its assets and liabilities in a continuously changing and difficult market environment. Competition in the Corporation’s market areas continues to be intense, and market interest rates remain very low by historical measures. The Federal Reserve has maintained the short-term federal funds target rate at historic lows since December 2008, and has also indicated that it can be patient in beginning to normalize its stance on monetary policy.
Net interest income, on a fully taxable equivalent basis, for the three and nine months ended September 30, 2015, was $3,476,000 and $10,338,000, a decrease of $66,000 for the three-month period and an increase of $78,000 for the nine-month period. The decrease in net interest income for the three-month period was largely due to the continued downward pressure on loan yields while the increase in the YTD net interest income was primarily due to the increase in average loan balances. The Corporation’s overall cost of funds remained relatively constant between periods at 0.35% and 0.36%, for the three and nine months, respectively.
Interest and fee income, on a fully taxable equivalent basis totaled $3,690,000 for the three-month period ended September 30, 2015, a decrease of $67,000 or 1.8% from $3,757,000 for same period in 2014. Average net loans, representing 91.33% and 91.19% of average earning assets at September 30, 2015 and 2014, respectively, increased 1.9% or $5,253,000, while the average tax equivalent yield earned decreased 17 basis points. The decline in interest income on loans was largely due to the downward re-pricing of variable rate loans and new loans originating at lower market rates as well as maturities and repayments of loans with higher rates. Average federal funds sold, representing 4.00% and 3.79% of average earning assets at September 30, 2015 and 2014, respectively, increased 7.3% or $832,000, while the average yield earned increased 1 basis point. Average investment securities, representing 4.67% and 5.01% of average earning assets at September 30, 2015 and 2014, respectively, decreased 5.2% or $785,000, while the average tax equivalent yield earned decreased 27 basis points.
Interest and fee income, on a fully taxable equivalent basis was $10,997,000 for the nine months ended September 30, 2015, an increase of $83,000 or 0.8%, from $10,914,000 for the same period in 2014. Average net loans, representing 88.60% and 90.68% of average earning assets at September 30, 2015 and 2014, respectively, increased $5,322,000 or 2.0%, while the average tax equivalent yield earned decreased 4 basis points. Average federal funds sold, representing 6.81% and 4.14% of average earning assets at September 30, 2015 and 2014, respectively, increased 71.8% or $8,788,000, while the average yield earned increased 1 basis point. Average investment securities, representing 4.59% and 5.18% of average earning assets at September 30, 2015 and 2014, respectively, decreased 7.5% or $1,150,000, while the average tax equivalent yield earned decreased 31 basis points.
38. |
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Interest expense totaled $214,000 for the three months ended September 30, 2015, relatively unchanged from $215,000 for the three months ended September 30, 2014. Average interest-bearing demand deposits, representing 47.88% and 49.19% of average interest-bearing liabilities at September 30, 2015 and 2014, respectively, decreased $6,013,000 or 5.0%, with no change in the average rate paid between periods. Average time deposits, representing 39.25% and 37.84% of average interest-bearing liabilities at September 30, 2015 and 2014, respectively, increased $1,168,000 or 1.3%, with no change in the average rate paid between periods. Average borrowings, representing 1.21% and 2.50% of average interest-bearing liabilities at September 30, 2015 and 2014, respectively, decreased $3,248,000 or 52.9% while the average rate paid increased 59 basis points.
Interest expense totaled $659,000 for the nine months ended September 30, 2015, a slight increase of $5,000 from $654,000 for the nine months ended September 30, 2014. Average interest-bearing demand deposits, representing 47.18% and 50.72% of average interest-bearing liabilities at September 30, 2015 and 2014, respectively, decreased $5,780,000 or 4.7%, while the average rate paid decreased 1 basis point. Average time deposits, representing 40.88% and 37.11% of average interest-bearing liabilities at September 30, 2015 and 2014, respectively, increased $11,477,000 or 12.8%, while the average rate paid decreased 7 basis points. The increase in average time deposits between periods was largely driven by an increase of $14,100,000 in CDARS certificates of deposits. Average borrowings, representing 0.84% and 1.50% of average interest-bearing liabilities at September 30, 2015 and 2014, respectively, decreased $1,529,000 or 42.3%, while the average rate paid increased 58 basis points.
The Corporation establishes an allowance for loan losses through charges to earnings, which are shown in the statements of operations as the provision for loan losses. Through the provision for loan losses, an allowance is maintained that reflects management’s best estimate of probable incurred losses related to specifically identified loans as well as the inherent risk of loss related to the remaining portfolio. In evaluating the allowance for loan losses, management considers various factors that include loan growth, the amount and composition of the loan portfolio (including non-performing and potential problem loans), diversification, or conversely, concentrations by industry, geography or collateral within the portfolio, historical loan loss experience, current delinquency levels, the estimated value of the underlying collateral, prevailing economic conditions and other relevant factors. Loan charge-offs are recorded to this allowance when loans are deemed uncollectible, in whole or in part. Impacting the provision for loan losses in any accounting period are several factors including the amount of loan growth during the period, broken down by loan type, the level of charge-offs during the period, the changes in the amount of impaired loans, changes in risk ratings assigned to loans, specific loan impairments, credit quality and ultimately, the results of management’s assessment of the inherent risks of the loan portfolio.
The provision charged against income for the three and nine months ended September 30, 2015 was $86,000 and $138,000, respectively, compared to $26,000 and $287,000 for the same periods in 2014. Total charge-offs for the nine months ended September 30, 2015 and 2014 were $399,000 and $325,000, respectively, offset with total recoveries of $70,000 and $59,000 for the same periods. At September 30, 2015 the allowance for loan losses totaled $3,935,000 or 1.39% of total loans. Management considers the allowance for loan losses at September 30, 2015 adequate to cover loan losses based on its assessment of various factors affecting the loan portfolio, including the level of problem loans, overall delinquencies, business conditions, estimated collateral values and loss experience. A decline in local and national economic conditions, or other factors, could result in a material increase in the allowance for loan losses which could adversely affect the Corporation’s financial condition and results of operations. Further information relating to factors affecting the allowance for loan losses is discussed under Financial Condition.
Noninterest income consists primarily of fees and commissions earned on services that are provided to the Corporation’s banking customers, income generated from the leasing of office space, third-party mortgage referral fee income and other miscellaneous income. Noninterest income for the three and nine months ended September 30, 2015 was $514,000 and $1,518,000, respectively, compared to $539,000 and $1,615,000 for the three and nine months ended September 30, 2014. Following are some of the more significant factors affecting noninterest income in 2015:
39. |
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
· | A decrease of $16,000 and $69,000 in service and overdraft charges for the three and nine-month periods, respectively, primarily due to a decline in the volume of insufficient funds (“NSF”) activity. |
· | A decrease of $42,000 in the gain on sale of bank premises and equipment for the nine-month period primarily reflecting the sale of a drive-through branch during the first quarter of 2014. |
· | A decrease of $15,000 and $32,000 in rent income for the three and nine-month periods, respectively, largely due to lost income due to the sale of a branch office during the fourth quarter of 2014. The Corporation leased office space at this location. |
· | An increase of $2,000 and $43,000 in third-party mortgage referral fee income for the three and nine-month periods, respectively, largely due to increased mortgage production as a result of the escalated demand in home purchases and refinancing due in part to the sustained low interest rate environment. |
Noninterest expense consists primarily of personnel, occupancy, equipment and other expenses. Noninterest expense for the three and nine months ended September 30, 2015 was $2,572,000 and $8,014,000, respectively, compared to $2,784,000 and $7,902,000 for the three and nine months ended September 30, 2014. Following are some of the more significant factors affecting noninterest expense during 2015:
· | A decrease of $15,000 in salaries and employee benefits during the three-month period and an increase of $83,000 year-to-date. The decrease for the three-month period was largely due to a decrease in accrued bonus partially offset by increased group medical insurance plan expense. The YTD increase in salaries and employee benefit expense primarily reflects annual salary increases as well as an increase in employee compensation costs relating to stock option awards, partially offset by the decrease in medical insurance plan expense. |
· | A decrease of $24,000 and $55,000 in premises and equipment expense for the three and nine-month periods, respectively, largely reflecting decreases in depreciation expense, building maintenance and equipment maintenance contracts due to the sale of a branch office which was classified as held for sale at year-end 2014 and closed during the first quarter of 2015. The decrease in premises and equipment expense was partially offset by an increase in computer depreciation expense reflecting capital purchases during the fourth quarter of 2014, partially offset by an increase in computer depreciation expense reflecting capital purchases during the fourth quarter of 2014. |
· | A decrease of $106,000 in OREO and other miscellaneous loan expense for the three-month period and an increase of $198,000 year-to-date. The decrease during the three-month period is due primarily to the decrease in maintenance costs associated with the sale of two large commercial real estate properties during the second and third quarters of 2015. The YTD increase was largely due to increases in maintenance costs and property taxes associated with these assets which were incurred during the first and second quarters of 2015. |
· | An increase of $7,000 and $32,000 in software maintenance expense for the three and nine-month periods, respectively, largely reflecting increases due to new loan application software as well as risk management software. |
· | A decrease of $22,000 and $48,000 in other operating expenses for the three and nine-months periods, respectively, largely reflecting a credit adjustment of $17,000 related to the estimated loss taken on the sale of a branch office which was classified as held for sale at the end of 2014 and closed during the first quarter of 2015, as well as a decrease in deposit overdraft and charge-off expense. |
The Corporation’s pre-tax income for the three and nine months ended September 30, 2015 totaled $1,296,000 and $3,596,000, respectively, resulting in a tax provision of $351,000 and $1,058,000, compared to pre-tax income of $1,229,000 and $3,559,000 resulting in a tax provision of $370,000 and $1,076,000 for the same periods in 2014. The Corporation’s effective tax rate for the three and nine months ended September 30, 2015, was 27.08% and 29.42%, respectively, compared to 30.11% and 30.23% for the same periods in 2014. The difference between the Corporation’s effective tax rate and the statutory rate is primarily attributable to the Corporation’s tax-exempt income. Tax-exempt income includes income earned on certain state and political subdivisions securities that qualify for state and/or federal income tax exemption and the Corporation’s earnings on Bank-owned life insurance policies, which are exempt from federal taxation.
40. |
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY
Liquidity is the ability to satisfy demands for deposit withdrawals, lending commitments and other corporate needs. The Corporation’s liquidity primarily represented by cash equivalents and federal funds sold, is a result of its operating, investing and financing activities, which are summarized in the Condensed Consolidated Statements of Cash Flows. Primary sources of funds are deposits, prepayments and maturities of outstanding loans and securities. While scheduled payments from the amortization of loans and securities are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. Funds are primarily used to meet ongoing commitments, satisfy operational expenses, payout maturing certificates of deposit and savings withdrawals and fund loan demand, with excess funds being invested in short-term, interest-earning assets. Additional funds are generated through Federal Home Loan Bank advances, overnight borrowings and other sources.
The Corporation’s liquidity ratio at September 30, 2015 was 6.94% compared to 8.71% at year-end 2014. Another measure of liquidity is the relationship of net loans to deposits and borrowed funds with lower ratios indicating greater liquidity. At September 30, 2015, the ratio of net loans to deposits and borrowed funds was 95.05% compared to 91.53% at December 31, 2014. Management believes its sources of liquidity are adequate to meet the needs of the Corporation.
As presented in the accompanying unaudited Consolidated Statements of Cash Flows, the sources of liquidity vary between periods. The Corporation’s cash equivalents and federal funds sold totaled $20,904,000 at September 30, 2015 compared to $16,143,000 at September 30, 2014. The primarily sources of funds during the first nine months of 2015 included $5,000,000 in Federal Home Loan Bank advances, $2,700,000 in net cash provided by operating activities, $2,121,000 in proceeds from the sale of OREO and other repossessed assets, $1,276,000 in pay downs and maturities of investment securities and $1,237,000 in proceeds from the disposition of premises and equipment. The primary uses of funds during the nine months of 2015 included the $6,277,000 decrease in net deposits, the repayment of $5,089,000 in Federal Home Loan Bank advances, $4,604,000 in net loans, $1,780,000 in security investment purchases and cash dividends of $757,000.
The primary sources of funds during the nine months of 2014 included $7,000,000 in Federal Home Loan Bank advances, $3,153,000 increase in net deposits, $2,794,000 in net cash provided by operating activities and $1,531,000 in pay downs and maturities of investment securities. The primary uses of funds during the nine months of 2014 included $10,086,000 in net loans, the repayment of $3,587,000 in Federal Home Loan Bank advances, the repayment of $1,757,000 in federal funds purchased, capital expenditures of $699,000 and cash dividends of $617,000.
CAPITAL RESOURCES
Banking regulations have established minimum capital requirements for banks including risk-based capital ratios and leverage ratios. Regulations require all banks to have a minimum total risk-based capital ratio of 8.0%, with half of the capital composed of core capital. On January 1, 2015, the final rules of the Federal Reserve Board went into effect implementing in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.
41. |
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Under the final rule, minimum requirements increased for both the quality and quantity of capital held by banking institutions. The rule requires a new minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5 percent and a common equity tier 1 capital conservation buffer of 2.5 percent of risk-weighted assets that will apply to all supervised financial institutions. The capital conservation buffer does not come into effect until January 1, 2016. The rule also raises the minimum ratio of tier 1 capital to risk-weighted assets from 4 percent to 6 percent and includes a minimum leverage ratio of 4 percent for all banking institutions.
The Bank continues to be well-capitalized in accordance with Federal regulatory capital requirements as shown by the following capital ratios for the quarter ended September 30, 2015:
Common equity tier 1 capital ratio | 12.1 | % | ||
Tier 1 capital ratio | 12.1 | % | ||
Total capital ratio | 13.4 | % | ||
Tier 1 leverage ratio | 10.7 | % | ||
Capital conservation buffer (effective January 1, 2016) | N/A |
TABLE 3 CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The Corporation has certain obligations and commitments to make future payments under contract. The following table presents the Corporation’s contractual obligations and commitments (in thousands) at September 30, 2015:
Contractual Obligations
Payments Due by Period | ||||||||||||||||||||
Less Than | After | |||||||||||||||||||
Total | One Year | 1-3 Years | 3-5 Years | 5 Years | ||||||||||||||||
Time deposits and certificates of deposit | $ | 97,059 | $ | 51,455 | $ | 27,480 | $ | 14,040 | $ | 4,084 | ||||||||||
Borrowed funds | 1,604 | 0 | 0 | 0 | 1,604 | |||||||||||||||
Total contractual obligations | $ | 98,663 | $ | 51,455 | $ | 27,480 | $ | 14,040 | $ | 5,688 |
Other Commitments
Amount of Commitment – Expiration by Period | ||||||||||||||||||||
Less Than | After | |||||||||||||||||||
Total | One Year | 1-3 Years | 3-5 Years | 5 Years | ||||||||||||||||
Commitments to extend commercial credit | $ | 30,596 | $ | 19,190 | $ | 3,433 | $ | 0 | $ | 7,973 | ||||||||||
Commitments to extend consumer credit | 11,299 | 486 | 4,375 | 3,787 | 2,651 | |||||||||||||||
Standby letters of credit | 47 | 47 | 0 | 0 | 0 | |||||||||||||||
Total other commitments | $ | 41,942 | $ | 19,723 | $ | 7,808 | $ | 3,787 | $ | 10,624 |
Other obligations and commitments which are not included above include the deferred compensation plan, index plan reserve and split dollar life insurance. The timing of payments for these plans is unknown. See Note 1 of the 2014 Annual Report for additional details.
Items listed under “Contractual Obligations” represent standard bank financing activity under normal terms and practices. Such funds normally rollover or are replaced by like items depending on the then-current financing needs. Items shown under “Other Commitments” also represent standard bank activity, but for extending credit to bank customers. Commercial credits generally represent lines of credit or approved loans with drawable funds still available under the contract terms. On an on-going basis, approximately half of these amounts are expected to be drawn. Consumer credits generally represent amounts drawable under revolving home equity lines or credit card programs. Such amounts are usually deemed less likely to be drawn upon in total as consumers tend not to draw down all amounts on such lines. Utilization rates tend to be fairly constant over time. Standby letters of credit represent guarantees to finance specific projects whose primary source of financing comes from other sources. In the unlikely event of the other source’s failure to provide sufficient financing, the bank would be called upon to fill the need. The Corporation is also continually engaged in the process of approving new loans in a bidding competition with other banks. Management and Board committees approve the terms of these potential new loans with conditions and/or counter terms made to the applicant customers. Customers may accept the terms, make a counter proposal, or accept terms from a competitor. These loans are not yet under contract, but offers have been tendered, and would be required to be funded if accepted. Such agreements represent approximately $11,508,000 at September 30, 2015 in varying maturity terms.
42. |
COMMERCIAL BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk refers to the risk of loss arising from adverse changes in interest rates, foreign currency exchange rates, commodity prices, and other relevant market rates and prices. Management seeks to reduce fluctuations in its net interest margin and to optimize net interest income with acceptable levels of risk through periods of changing interest rates. Accordingly, the Corporation’s interest rate sensitivity and liquidity are monitored on an ongoing basis by its Asset and Liability Committee (“ALCO”). ALCO establishes risk measures, limits and policy guidelines for managing the amount of interest rate risk and its effect on net interest income and capital. A variety of measures are used to provide for a comprehensive view of the magnitude of interest rate risk, the distribution of risk, the level of risk over time and the exposure to changes in certain interest rate relationships. ALCO continuously monitors and manages the balance between interest rate sensitive assets and liabilities. The objective is to manage the impact of fluctuating market rates on net interest income within acceptable levels. In order to meet this objective, management may lengthen or shorten the duration of assets or liabilities. Management considers market interest rate risk to be one of the Corporation’s most significant ongoing business risk considerations.
The two primary methods to monitor and manage interest rate risk are rate-sensitivity gap analysis and review of the effects of various interest rate shock scenarios. Based upon ALCO’s review, there has been no significant change in the interest rate risk of the Corporation since year-end 2014. (See Quantitative and Qualitative Disclosures about Market Risk in the Annual Report to Shareholders for the year ended December 31, 2014)
Item 4. Controls and Procedures
Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, the Corporation conducted an evaluation of its disclosure controls and procedures, pursuant to Securities Exchange Act of 1934. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures were effective as of the end of the period covered by this report.
There was no change in the Corporation’s internal control over financial reporting that occurred during the Corporation’s fiscal quarter ended September 30, 2015 that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
43. |
COMMERCIAL BANCSHARES, INC.
FORM 10-Q
Quarter ended September 30, 2015
Item 1 | Legal Proceedings |
There are no matters required to be reported under this item.
Item 1A | Risk Factors |
There have been no material changes from risk factors as previously disclosed in Part 1, Item 1.A. of Commercial Bancshares, Inc.’s 10-K filed on March 16, 2015.
Item 2 | Unregistered Sales of Securities and Use of Proceeds |
For the three and nine months ended September 30, 2015, the Corporation purchased 1,121 and 6,109 shares, respectively, totaling $30,767 and $163,593 to fund acquisitions made by participating directors under the Commercial Savings Bank Deferred Compensation Plan, a nonqualified deferred compensation plan. Shares are purchased on the open market and are credited to the respective accounts of the deferred compensation plan participants. None of the acquisitions by plan participants were registered with the Securities and Exchange Commission, but were made in reliance upon the exemption from registration contained in Section 4(a)(2) of the Securities Act of 1933.
On August 14, 2015, the Corporation announced that its Board of Directors approved a one year stock repurchase program. The program allows the Corporation to purchase up to 59,000 shares of the Corporation’s outstanding common stock, commencing August 17, 2015 and ending on July 31, 2016. For the three months ended September 30, 2015, the Corporation purchased 5,280 shares of its common stock at a total of $155,467.
Maximum Number | ||||||||||||||||
Total Number of | (or Approximate | |||||||||||||||
Shares | Dollar Value) | |||||||||||||||
Total | Purchased as | of Shares that May | ||||||||||||||
Number | Average | Part of Publicly | Yet be Purchased | |||||||||||||
of Shares | Price Paid | Announced Plans | Under the Plans | |||||||||||||
Period | Purchased | per Share | or Programs | or Programs | ||||||||||||
07/01/15 – 07/31/15 | 446 | $ | 27.84 | 0 | N/A | |||||||||||
08/01/15 – 08/31/15 | 1,588 | $ | 28.25 | 913 | 58,087 | |||||||||||
09/01/15 – 09/30/15 | 4,367 | $ | 29.53 | 4,367 | 53,720 | |||||||||||
Total | 6,401 | $ | 29.09 | 5,280 | 53,720 |
Item 3 | Defaults upon Senior Securities |
There are no matters required to be reported under this item.
Item 4 | Mine Safety Disclosures |
Not applicable
Item 5 | Other Information |
There are no matters required to be reported under this item.
44. |
COMMERCIAL BANCSHARES, INC.
FORM 10-Q
Quarter ended September 30, 2015
PART II – OTHER INFORMATION
Item 6 | Exhibits: |
Exhibit | ||
Number | Description of Document | |
3.1.a. | Amended Articles of Incorporation of the Corporation | |
(incorporated by reference to Registrant’s Form 8-K dated April 27, 1995) | ||
3.1.b. | Amendment to the Corporation’s Amended Articles of Incorporation to increase the number of shares authorized for the issuance to 4,000,000 common shares, no par value (incorporated by reference to Appendix I to Registrant’s Definitive Proxy Statement filed March 13, 1997) | |
3.2 | Code of Regulations of the Corporation | |
(incorporated by reference to Registrant’s Form 8-K dated April 27, 1995) | ||
4 | Form of Certificate of Common Shares of the Corporation | |
(incorporated by reference to Registrant’s Form 8-K dated April 27, 1995) | ||
11 | Statement re computation of per share earnings (reference is hereby made to Note 2 of the Consolidated Financial Statements on page 8 hereof) | |
31.1 | Certification by CEO Pursuant to Sarbanes Oxley Section 302 | |
31.2 | Certification by CFO Pursuant to Sarbanes Oxley Section 302 | |
32.1 | Certification by CEO Pursuant to Sarbanes Oxley Section 906 | |
32.2 | Certification by CFO Pursuant to Sarbanes Oxley Section 906 | |
101.INS | XBRL Instance Document | |
101.SCH | XBRL Taxonomy Extension Schema Document | |
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | |
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | |
101.LAB | XBRL Taxonomy Extension Label Linkbase Document | |
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document |
45. |
COMMERCIAL BANCSHARES, INC.
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.
COMMERCIAL BANCSHARES, INC. | |||
(Registrant) | |||
Date: | November 13, 2015 | /s/ Robert E. Beach | |
(Signature) | |||
Robert E. Beach | |||
President and Chief Executive Officer | |||
Date: | November 13, 2015 | /s/ Scott A. Oboy | |
(Signature) | |||
Scott A. Oboy | |||
Executive Vice President and Chief Financial Officer |
46. |