Attached files
file | filename |
---|---|
EX-31.1 - EXHIBIT 31.1 - FIRST SOUTH BANCORP INC /VA/ | v439445_ex31-1.htm |
EX-32 - EXHIBIT 32 - FIRST SOUTH BANCORP INC /VA/ | v439445_ex32.htm |
EX-31.2 - EXHIBIT 31.2 - FIRST SOUTH BANCORP INC /VA/ | v439445_ex31-2.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2016.
OR
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___ to ___ .
Commission File Number: 0-22219
FIRST SOUTH BANCORP, INC.
(Exact name of registrant as specified in its charter)
Virginia | 56-1999749 |
(State or other jurisdiction of | (IRS Employer |
incorporation or organization) | Identification No.) |
1311 Carolina Avenue, Washington, North Carolina 27889
(Address of principal executive offices)
(Zip Code)
(252) 946-4178
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨
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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
Large Accelerated Filer ¨ | Accelerated Filer ¨ |
Non-Accelerated Filer ¨ | Smaller Reporting Company x |
(Do not check if a Smaller Reporting Company) |
Indicate by check mark whether registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).
Yes ¨ No x
Number of shares of common stock outstanding as of May 13, 2016: 9,493,776.
CONTENTS
First South Bancorp, Inc. and Subsidiary
Consolidated Statements of Financial Condition
March 31, | December 31, | |||||||
2016 | 2015 | |||||||
(Unaudited) | ||||||||
Assets | ||||||||
Cash and due from banks | $ | 17,729,075 | $ | 19,425,747 | ||||
Interest-bearing deposits with banks | 18,385,994 | 18,565,521 | ||||||
Investment securities available-for-sale, at fair value | 213,011,148 | 248,294,725 | ||||||
Investment securities held-to-maturity | 508,746 | 508,456 | ||||||
Mortgage loans held for sale | 2,489,873 | 3,943,798 | ||||||
Loans and leases held for investment | 639,044,574 | 607,014,247 | ||||||
Allowance for loan and lease losses | (8,135,054 | ) | (7,866,523 | ) | ||||
Net loans and leases held for investment | 630,909,520 | 599,147,724 | ||||||
Premises and equipment, net | 12,143,734 | 13,664,937 | ||||||
Assets held for sale | 1,083,320 | - | ||||||
Other real estate owned | 5,956,092 | 6,125,054 | ||||||
Federal Home Loan Bank stock, at cost | 1,828,700 | 2,369,300 | ||||||
Accrued interest receivable | 2,845,975 | 2,874,506 | ||||||
Goodwill | 4,218,576 | 4,218,576 | ||||||
Mortgage servicing rights | 1,247,005 | 1,265,589 | ||||||
Identifiable intangible assets | 1,824,432 | 1,895,514 | ||||||
Bank-owned life insurance | 17,653,186 | 15,635,140 | ||||||
Prepaid expenses and other assets | 8,272,379 | 8,348,385 | ||||||
Total assets | $ | 940,107,755 | $ | 946,282,972 | ||||
Liabilities and Stockholders' Equity | ||||||||
Deposits: | ||||||||
Non-interest bearing demand | $ | 164,244,311 | $ | 169,545,849 | ||||
Interest bearing demand | 244,323,710 | 246,376,521 | ||||||
Savings | 146,254,503 | 135,369,668 | ||||||
Large denomination certificates of deposit | 119,229,985 | 116,299,196 | ||||||
Other time deposits | 144,614,799 | 143,730,993 | ||||||
Total deposits | 818,667,308 | 811,322,227 | ||||||
Borrowings | 21,500,000 | 37,000,000 | ||||||
Junior subordinated debentures | 10,310,000 | 10,310,000 | ||||||
Other liabilities | 5,451,329 | 5,479,971 | ||||||
Total liabilities | 855,928,637 | 864,112,198 | ||||||
Common stock, $.01 par value, 25,000,000 shares authorized; 9,493,776 and 9,489,222 shares outstanding, respectively | 94,938 | 94,892 | ||||||
Additional paid-in capital | 35,957,524 | 35,936,911 | ||||||
Retained earnings | 44,914,635 | 43,691,073 | ||||||
Accumulated other comprehensive income | 3,212,021 | 2,447,898 | ||||||
Total stockholders' equity | 84,179,118 | 82,170,774 | ||||||
Total liabilities and stockholders' equity | $ | 940,107,755 | $ | 946,282,972 |
The accompanying notes are an integral part of these consolidated financial statements.
1 |
First South Bancorp, Inc. and Subsidiary
Consolidated Statements of Operations
Three Months Ended March 31, 2016 and 2015
(Unaudited)
Three Months Ended | ||||||||
March 31, | ||||||||
2016 | 2015 | |||||||
Interest income: | ||||||||
Interest and fees on loans | $ | 7,191,595 | $ | 5,934,518 | ||||
Interest on investments and deposits | 1,480,252 | 1,829,978 | ||||||
Total interest income | 8,671,847 | 7,764,496 | ||||||
Interest expense: | ||||||||
Interest on deposits | 669,276 | 569,748 | ||||||
Interest on borrowings | 73,086 | 95 | ||||||
Interest on junior subordinated notes | 140,039 | 138,500 | ||||||
Total interest expense | 882,401 | 708,343 | ||||||
Net interest income | 7,789,446 | 7,056,153 | ||||||
Provision for credit losses | 225,000 | - | ||||||
Net interest income after provision for credit losses | 7,564,446 | 7,056,153 | ||||||
Non-interest income: | ||||||||
Deposit fees and service charges | 1,907,407 | 1,872,195 | ||||||
Loan fees and charges | 56,985 | 53,148 | ||||||
Mortgage loan servicing fees | 234,001 | 238,742 | ||||||
Gain on sale and other fees on mortgage loans | 413,861 | 384,985 | ||||||
Gain (loss) on sale of other real estate, net | (12,168 | ) | 45,867 | |||||
Gain on sale of investment securities | 283,514 | 250,781 | ||||||
Other income | 692,285 | 334,144 | ||||||
Total non-interest income | 3,575,885 | 3,179,862 | ||||||
Non-interest expense: | ||||||||
Compensation and fringe benefits | 5,039,954 | 4,733,622 | ||||||
Federal deposit insurance premiums | 161,609 | 133,243 | ||||||
Premises and equipment | 1,373,809 | 1,373,927 | ||||||
Advertising | 187,818 | 162,684 | ||||||
Data processing | 796,487 | 1,106,845 | ||||||
Amortization of intangible assets | 131,527 | 127,459 | ||||||
Other real estate owned expense | 93,674 | 206,742 | ||||||
Other | 1,321,048 | 1,409,722 | ||||||
Total non-interest expense | 9,105,926 | 9,254,244 | ||||||
Income before income tax expense | 2,034,405 | 981,771 | ||||||
Income tax expense | 573,611 | 256,694 | ||||||
NET INCOME | $ | 1,460,794 | $ | 725,077 | ||||
Per share data: | ||||||||
Basic earnings per share | $ | 0.15 | $ | 0.08 | ||||
Diluted earnings per share | $ | 0.15 | $ | 0.08 | ||||
Dividends per share | $ | 0.025 | $ | 0.025 | ||||
Average basic shares outstanding | 9,491,201 | 9,570,820 | ||||||
Average diluted shares outstanding | 9,514,797 | 9,590,979 |
The accompanying notes are an integral part of these consolidated financial statements.
2 |
First South Bancorp, Inc. and Subsidiary
Consolidated Statements of Comprehensive Income
Three Months Ended March 31, 2016 and 2015
(Unaudited)
Three Months Ended | ||||||||
March 31, | ||||||||
2016 | 2015 | |||||||
Net income | $ | 1,460,794 | $ | 725,077 | ||||
Other comprehensive income (loss): | ||||||||
Unrealized holding gains on securities available for sale | 1,682,318 | 2,054,282 | ||||||
Tax effect | (611,483 | ) | (750,909 | ) | ||||
Unrealized holding gains on securities available for sale, net of tax | 1,070,835 | 1,303,373 | ||||||
Reclassification adjustment for realized gains included in net income | (283,514 | ) | (250,781 | ) | ||||
Tax effect | 79,938 | 65,579 | ||||||
Reclassification adjustment for realized gains, net of tax | (203,576 | ) | (185,202 | ) | ||||
Unrealized gains (losses) on interest rate hedge position | (164,491 | ) | (103,977 | ) | ||||
Tax effect | 61,355 | 38,783 | ||||||
Unrealized losses on interest rate hedge position, net of tax | (103,136 | ) | (65,194 | ) | ||||
Other comprehensive income, net of tax | 764,123 | 1,052,977 | ||||||
Comprehensive income | $ | 2,224,917 | $ | 1,778,054 |
The accompanying notes are an integral part of these consolidated financial statements.
3 |
First South Bancorp, Inc. and Subsidiary
Consolidated Statements of Changes in Stockholders' Equity
Three Months Ended March 31, 2016 and 2015
(Unaudited)
Accumulated | ||||||||||||||||||||
Additional | other | |||||||||||||||||||
Common | paid-in | Retained | comprehensive | |||||||||||||||||
Three Months Ended March 31, 2016 | stock | capital | earnings | income, net | Total | |||||||||||||||
Balance at December 31, 2015 | $ | 94,892 | $ | 35,936,911 | $ | 43,691,073 | $ | 2,447,898 | $ | 82,170,774 | ||||||||||
Net income | 1,460,794 | 1,460,794 | ||||||||||||||||||
Other comprehensive income, net | 764,123 | 764,123 | ||||||||||||||||||
Vesting of restricted stock awards, net | 35 | (35 | ) | - | ||||||||||||||||
Exercise of stock options | 11 | (11 | ) | - | ||||||||||||||||
Stock based compensation expense | 20,659 | 20,659 | ||||||||||||||||||
Dividends | (237,232 | ) | (237,232 | ) | ||||||||||||||||
Balance at March 31, 2016 | $ | 94,938 | $ | 35,957,524 | $ | 44,914,635 | $ | 3,212,021 | $ | 84,179,118 |
Accumulated | ||||||||||||||||||||
Additional | other | |||||||||||||||||||
Common | paid-in | Retained | comprehensive | |||||||||||||||||
Three Months Ended March 31, 2015 | stock | capital | earnings | income, net | Total | |||||||||||||||
(As restated) | ||||||||||||||||||||
Balance at December 31, 2014 | $ | 95,980 | $ | 35,869,195 | $ | 40,868,919 | (a) | $ | 3,168,482 | $ | 80,002,576 | |||||||||
Net income | 725,077 | 725,077 | ||||||||||||||||||
Other comprehensive income, net | 1,052,977 | 1,052,977 | ||||||||||||||||||
Vesting of restricted stock awards, net | 34 | (989 | ) | (955 | ) | |||||||||||||||
Retirement of common shares | (724 | ) | (588,535 | ) | (589,259 | ) | ||||||||||||||
Stock based compensation expense | 17,886 | 17,886 | ||||||||||||||||||
Dividends | (239,952 | ) | (239,952 | ) | ||||||||||||||||
Balance at March 31, 2015 | $ | 95,290 | $ | 35,886,092 | $ | 40,765,509 | $ | 4,221,459 | $ | 80,968,350 |
(a) - revised for prior period error
The accompanying notes are an integral part of these consolidated financial statements.
4 |
First South Bancorp, Inc. and Subsidiary
Consolidated Statements of Cash Flows
Three Months Ended March 31, 2016 and 2015
(Unaudited)
Three
Months Ended March 31, | ||||||||
2016 | 2015 | |||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 1,460,794 | $ | 725,077 | ||||
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | ||||||||
Provision for credit losses | 225,000 | - | ||||||
Depreciation | 385,802 | 450,888 | ||||||
Amortization of intangibles | 131,527 | 127,459 | ||||||
Accretion of discounts and premiums on securities, net | 402,583 | 541,059 | ||||||
Loss on disposal of premises and equipment | 1,597 | - | ||||||
(Gain) loss on sale of other real estate owned | 12,168 | (45,867 | ) | |||||
Gain on sale of loans held for sale | (215,733 | ) | (218,162 | ) | ||||
Gain on sale of investment securities available for sale | (283,514 | ) | (250,781 | ) | ||||
Stock based compensation expense | 20,659 | 17,886 | ||||||
Originations of loans held for sale, net | (3,894,820 | ) | (7,566,385 | ) | ||||
Proceeds from sale of loans held for sale | 5,564,478 | 4,630,157 | ||||||
Other operating activities | (507,985 | ) | (2,820,843 | ) | ||||
Net cash provided by (used in) operating activities | 3,302,556 | (4,409,512 | ) | |||||
Cash flows from investing activities: | ||||||||
Proceeds from sale of investment securities available for sale | 30,691,198 | 13,771,793 | ||||||
Proceeds from principal repayments of mortgage-backed securities available for sale | 5,871,823 | 7,557,231 | ||||||
Originations of loans held for investment, net of principal repayments | (32,343,661 | ) | (9,130,268 | ) | ||||
Proceeds from disposal of other real estate owned | 506,369 | 1,248,449 | ||||||
Proceeds from disposal of premises and equipment | 129,965 | - | ||||||
Purchases of bank-owned life insurance | (2,018,046 | ) | (126,730 | ) | ||||
Sale (purchase) of FHLB stock | 540,600 | (190,300 | ) | |||||
Purchase of premises and equipment | (164,852 | ) | (110,088 | ) | ||||
Net cash used in investing activities | 3,213,396 | 13,020,087 | ||||||
Cash flows from financing activities: | ||||||||
Net (decrease) increase in deposit accounts | 7,345,081 | (4,255,625 | ) | |||||
Net decrease in FHLB borrowings | (15,500,000 | ) | - | |||||
Cash paid for dividends | (237,232 | ) | (239,952 | ) | ||||
Retirement of common shares | - | (589,259 | ) | |||||
Vesting of restricted stock awards, net | - | (955 | ) | |||||
Net cash provided by financing activities | (8,392,151 | ) | (5,085,791 | ) | ||||
Increase (decrease) in cash and cash equivalents | (1,876,199 | ) | 3,524,784 | |||||
Cash and cash equivalents, beginning of period | 37,991,268 | 56,116,677 | ||||||
Cash and cash equivalents, end of period | $ | 36,115,069 | $ | 59,641,461 | ||||
Supplemental disclosures: | ||||||||
Other real estate acquired in settlement of loans | $ | 356,865 | $ | 573,672 | ||||
Cash paid for interest | $ | 904,074 | $ | 714,435 |
The accompanying notes are an integral part of these consolidated financial statements.
5 |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Basis of Presentation. The accompanying unaudited consolidated financial statements are prepared in accordance with the instructions for Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (“GAAP”) for complete financial statements. In the opinion of management, all adjustments necessary for fair presentation of the financial position and results of operations for the periods presented are included, none of which are other than normal recurring accruals. The financial statements of First South Bancorp, Inc. (the “Company”) and First South Bank (the “Bank”) are presented on a consolidated basis. The results of operations for the three months ended March 31, 2016, are not necessarily indicative of the results of operations that may be expected for the year ended December 31, 2016.
2. Earnings Per Share. Basic and diluted earnings per share for the three months ended March 31, 2016 and 2015 are based on weighted average shares of common stock outstanding. Diluted earnings per share include the potentially dilutive effects of the Company’s stock-based compensation plans. For the three months ended March 31, 2016 and 2015, there were 23,596 and 20,159 stock-based compensation shares, respectively, that were dilutive because their exercise prices were less than the average market price of the Company’s common stock.
3. Comprehensive Income and Accumulated Other Comprehensive Income. Comprehensive income includes net income and changes in other comprehensive income. The components of other comprehensive income primarily include net changes in unrealized gains and losses on available for sale securities, and the reclassification of net gains and losses on available for sale securities recognized in income during the respective reporting periods. The following table presents changes in accumulated other comprehensive income (AOCI), net of taxes for the three months ended March 31, 2016 and 2015:
Unrealized Holding Gains on Investment Securities Available-For-Sale | Unrealized Holding Losses on Cash Flow Hedging Activities | Total Accumulated Other Comprehensive Income | ||||||||||
Quarter Ended March 31, 2016 | (In thousands) | |||||||||||
Balance at December 31, 2015 | $ | 2,695 | $ | (247 | ) | $ | 2,448 | |||||
Other comprehensive income (loss) before reclassifications | 1,071 | (103 | ) | 968 | ||||||||
Amounts reclassified from AOCI | (204 | ) | - | (204 | ) | |||||||
Net current period other comprehensive income (loss) | 867 | (103 | ) | 764 | ||||||||
Balance at March 31, 2016 | $ | 3,562 | $ | (350 | ) | $ | 3,212 | |||||
Quarter Ended March 31, 2015 | ||||||||||||
Balance at December 31, 2014 | $ | 3,422 | $ | (254 | ) | $ | 3,168 | |||||
Other comprehensive income (loss) before reclassifications | 1,303 | (65 | ) | 1,238 | ||||||||
Amounts reclassified from AOCI | (185 | ) | - | (185 | ) | |||||||
Net current period other comprehensive income (loss) | 1,118 | (65 | ) | 1,053 | ||||||||
Balance at March 31, 2015 | $ | 4,540 | $ | (319 | ) | $ | 4,221 |
4. Investment Securities. The following is a summary of the securities portfolio by major category, with the amortized cost and fair value and gross unrealized gains and losses of each category at March 31, 2016 and December 31, 2015:
Amortized | Gross | Gross | Fair | |||||||||||||
Securities available-for-sale: | Cost | Unrealized Gains | Unrealized Losses | Value | ||||||||||||
(In thousands) | ||||||||||||||||
March 31, 2016 | ||||||||||||||||
Government agencies | $ | 22,177 | $ | 696 | $ | - | $ | 22,873 | ||||||||
Mortgage-backed securities | 107,078 | 3,783 | 8 | 110,853 | ||||||||||||
Municipal securities | 50,929 | 1,523 | - | 52,452 | ||||||||||||
Corporate bonds | 27,082 | 81 | 330 | 26,833 | ||||||||||||
Total | $ | 207,266 | $ | 6,083 | $ | 338 | $ | 213,011 | ||||||||
December 31, 2015 | ||||||||||||||||
Government agencies | $ | 30,850 | $ | 541 | $ | 6 | $ | 31,385 | ||||||||
Mortgage-backed securities | 128,820 | 3,141 | 277 | 131,684 | ||||||||||||
Municipal securities | 55,534 | 1,305 | 8 | 56,831 | ||||||||||||
Corporate bonds | 28,744 | - | 349 | 28,395 | ||||||||||||
Total | $ | 243,948 | $ | 4,987 | $ | 640 | $ | 248,295 |
6 |
4. Investment Securities (Continued)
Amortized | Gross | Gross | Fair | |||||||||||||
Securities held-to-maturity: | Cost | Unrealized Gains | Unrealized Losses | Value | ||||||||||||
(In thousands) | ||||||||||||||||
March 31, 2016 | ||||||||||||||||
Government agencies | $ | 509 | $ | 3 | $ | - | $ | 512 | ||||||||
Total | $ | 509 | $ | 3 | $ | - | $ | 512 | ||||||||
December 31, 2015 | ||||||||||||||||
Government agencies | $ | 508 | $ | 2 | $ | - | $ | 510 | ||||||||
Total | $ | 508 | $ | 2 | $ | - | $ | 510 |
The following table presents a summary of realized gains and losses from the sale of available for sale investment securities:
Quater Ended March 31, | ||||||||
2016 | 2015 | |||||||
(In thousands) | ||||||||
Proceeds from Sale | $ | 30,691 | $ | 13,772 | ||||
Gross realized gains on sales | 409 | 251 | ||||||
Gross realized losses on sales | (125 | ) | - | |||||
Total realized gains (losses), net | $ | 284 | $ | 251 |
The following table summarizes gross unrealized losses on investment securities, fair value and length of time the securities were in a continuous unrealized loss position at March 31, 2016 and December 31, 2015. The Company deems these unrealized losses to be temporary and recoverable prior to or at maturity. The Company has the ability and intent to hold the investment securities for a reasonable period of time sufficient for a market price recovery or until maturity.
Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
Value | Losses | Value | Losses | Value | Losses | |||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||
March 31, 2016 | ||||||||||||||||||||||||
Mortgage-backed securities | 9,346 | 8 | - | - | 9,346 | 8 | ||||||||||||||||||
Corporate bonds | 9,234 | 38 | 11,217 | 292 | 20,451 | 330 | ||||||||||||||||||
Total | $ | 18,580 | $ | 46 | $ | 11,217 | $ | 292 | $ | 29,797 | $ | 338 | ||||||||||||
December 31, 2015 | ||||||||||||||||||||||||
Government agencies | $ | 3,785 | $ | 12 | $ | - | $ | - | $ | 3,785 | $ | 12 | ||||||||||||
Mortgage-backed securities | 51,956 | 264 | 2,641 | 7 | 54,597 | 271 | ||||||||||||||||||
Municipal securities | 1,530 | 8 | - | - | 1,530 | 8 | ||||||||||||||||||
Corporate bonds | 16,115 | 120 | 11,280 | 229 | 27,395 | 349 | ||||||||||||||||||
Total | $ | 73,386 | $ | 404 | $ | 13,921 | $ | 236 | $ | 87,307 | $ | 640 |
7 |
4. Investment Securities (Continued)
The following table summarizes the amortized cost and fair values of the investment securities portfolio at March 31, 2016, by contractual maturity. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Less Than | One to | Five to | Over | |||||||||||||
One Year | Five Years | Ten Years | Ten Years | |||||||||||||
(In thousands) | ||||||||||||||||
Securities available-for-sale: | ||||||||||||||||
Government agencies | ||||||||||||||||
Amortized cost | $ | - | $ | 11,697 | $ | 10,480 | $ | - | ||||||||
Fair value | - | 11,880 | 10,993 | - | ||||||||||||
Mortgage-backed securities | ||||||||||||||||
Amortized cost | - | 50,155 | 36,126 | 20,797 | ||||||||||||
Fair value | - | 51,596 | 36,832 | 22,425 | ||||||||||||
Municipal securities | ||||||||||||||||
Amortized cost | 1,569 | 18,790 | 27,887 | 2,683 | ||||||||||||
Fair value | 1,600 | 19,321 | 28,760 | 2,771 | ||||||||||||
Corporate bonds | ||||||||||||||||
Amortized cost | - | 17,084 | 9,998 | - | ||||||||||||
Fair value | - | 17,095 | 9,738 | - | ||||||||||||
Total Amortized cost | $ | 1,569 | $ | 97,726 | $ | 84,491 | $ | 23,480 | ||||||||
Total Fair value | $ | 1,600 | $ | 99,892 | $ | 86,323 | $ | 25,196 | ||||||||
Securities held-to-maturity: | ||||||||||||||||
Government agencies | ||||||||||||||||
Amortized cost | $ | - | $ | 509 | $ | - | $ | - | ||||||||
Fair value | - | 512 | - | - | ||||||||||||
Total Amortized cost | $ | - | $ | 509 | $ | - | $ | - | ||||||||
Total Fair value | $ | - | $ | 512 | $ | - | $ | - |
Federal Home Loan Bank (“FHLB”) Agency Bonds with an amortized cost of $10.4 million were pledged as collateral for public deposits at March 31, 2016, compared to $11.8 million at December 31, 2015. In addition, a government agency bond with an amortized cost of $509,000 and $508,000 was pledged as collateral on an interest rate swap transaction at March 31, 2016 and December 31, 2015, respectively.
Prior to purchasing any security, the Bank ensures the security is “investment grade”. For a security to be investment grade it must: (1) have a low risk of default by the obligor, and (2) the Bank must expect the full and timely repayment of principal and interest over the expected life. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), certain investments are deemed investment grade. These include: U.S. Treasury securities, Federal Agency securities, Revenue Bonds, and Unlimited-Tax General Obligation Municipals. Other securities undergo a pre-purchase analysis to ensure they are investment grade.
To determine if a security is investment grade, if available, management utilizes the ratings of the Nationally Recognized Statistical Rating Organizations (“NRSRO”). However, they are not the sole basis of determining if a security is investment grade. In addition, on a pre-purchase basis, at least one of the following criteria pertaining to the obligor is acquired and reviewed as part of the Bank’s credit analysis: Data from debt offerings (prospectus/offering circular); data from regulatory filings (Securities and Exchange Commission Forms 10-K, 10-Q, 8-K); data available from the obligor’s website (annual reports, press releases); data obtained from a third party (bond broker, analyst); NRSRO report on the initial offering and/or subsequent reviews of the issuer; or other pertinent available financial information. There have been no instances where the NRSRO’s credit rating has significantly differed from that of the Bank’s credit analysis.
8 |
4. Investment Securities (Continued)
At March 31, 2016, the investment securities portfolio included 49 taxable and tax-exempt debt instruments issued by various U.S. states, counties, cities, municipalities and school districts. The following table is a summary, by U.S. state, of the Company’s investment in the obligations of state and political subdivisions:
March 31, 2016 | ||||||||
Amortized Cost | Fair Value | |||||||
(In thousands) | ||||||||
Obligations of state and political subdivisions: | ||||||||
General obligation bonds: | ||||||||
Pennsylvania | $ | 3,880 | $ | 3,962 | ||||
California | 3,629 | 3,762 | ||||||
Washington | 3,419 | 3,453 | ||||||
Indiana | 2,454 | 2,476 | ||||||
North Carolina | 2,068 | 2,120 | ||||||
South Carolina | 1,918 | 1,972 | ||||||
Alabama | 1,834 | 1,862 | ||||||
Texas | 1,807 | 1,840 | ||||||
Other (10 states) | 8,876 | 9,256 | ||||||
Total general obligation bonds | 29,885 | 30,703 | ||||||
Revenue bonds: | ||||||||
New York | 7,278 | 7,549 | ||||||
North Carolina | 3,762 | 3,907 | ||||||
Mississippi | 2,341 | 2,384 | ||||||
Oklahoma | 2,271 | 2,371 | ||||||
Pennsylvania | 1,845 | 1,893 | ||||||
Other (3 states) | 3,547 | 3,645 | ||||||
Total revenue bonds | 21,044 | 21,749 | ||||||
Total obligations of state and political subdivisions | $ | 50,929 | $ | 52,452 |
The largest exposure in general obligation bonds was one bond issued by Ambridge Area School District, Pennsylvania, with a total amortized cost basis and total fair value of $2.4 million at March 31, 2016.
The following table is a summary of the revenue sources related to the Company’s investment in revenue bonds:
March 31, 2016 | ||||||||
Amortized Cost | Fair Value | |||||||
(In thousands) | ||||||||
Revenue bonds by revenue source: | ||||||||
University and college | $ | 8,668 | $ | 8,967 | ||||
Public improvements | 5,028 | 5,226 | ||||||
Pension funding | 1,845 | 1,893 | ||||||
Refunding bonds | 1,108 | 1,127 | ||||||
Other | 4,395 | 4,536 | ||||||
Total revenue bonds | $ | 21,044 | $ | 21,749 |
The largest single exposure in revenue bonds is an issue from the Dormitory Authority of the State of New York (DASNY). DASNY was created in 1944 to finance and build dormitories for state teachers’ colleges. Its mission has expanded over time and in 1995 DASNY became the largest public authority issuer of tax-exempt bonds in the country. The debt is secured by a dedication of 25% of the New York State personal income tax. As of March 31, 2016, this issue had an amortized cost of $2.9 million and fair value of $3.0 million.
9 |
5. Loans Held for Sale. The Bank originates residential mortgage loans for sale in the secondary market. Pursuant to Accounting Standards Codification (ASC) 825, Financial Instruments, at March 31, 2016 and December 31, 2015, the Bank marked these mortgage loans to market. Mortgage loans held for sale at March 31, 2016 and December 31, 2015, had estimated fair market values of $2.5 million and $3.9 million, respectively. The Bank originates mortgage loans for sale that are approved by secondary investors. Their terms are set by secondary investors, and they are transferred within 120 days after the Bank funds the loans. The Bank issues rate lock commitments to borrowers, and depending on market conditions, may enter into forward contracts with secondary market investors to minimize interest rate risk related to mortgage loan forward sales commitments. The Bank uses forward contracts to minimize interest rate risk related to mortgage loan forward sales commitments to economically hedge a percentage of the locked-in pipeline. The Bank receives origination fees from borrowers and servicing release premiums from investors that are recognized in income when loans are sold. The following table summarizes forward contract positions of the Bank at March 31, 2016 and December 31, 2015:
March 31, 2016 | December 31, 2015 | |||||||||||||||
Fair | Notional | Fair | Notional | |||||||||||||
Value | Value | Value | Value | |||||||||||||
(In thousands) | ||||||||||||||||
Forward Contracts | ||||||||||||||||
Mortgage Loan Forward Sales Commitments | $ | 60 | $ | 5,460 | $ | 78 | $ | 2,882 |
6. Loans Held for Investment. Loans held for investment at March 31, 2016 and December 31, 2015 are listed below:
March 31, 2016 | December 31, 2015 | |||||||||||||||
Amount | Percent of Total | Amount | Percent of Total | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Loans Held for Investment | ||||||||||||||||
Mortgage loans: | ||||||||||||||||
Residential real estate | $ | 69,193 | 10.8 | % | $ | 68,229 | 11.2 | % | ||||||||
Residential construction | 4,515 | 0.7 | 3,934 | 0.6 | ||||||||||||
Residential lots and raw land | 153 | 0.0 | 157 | 0.1 | ||||||||||||
Total mortgage loans | 73,861 | 11.5 | 72,320 | 11.9 | ||||||||||||
Commercial loans and leases: | ||||||||||||||||
Commercial real estate | 352,192 | 55.0 | 338,714 | 55.7 | ||||||||||||
Commercial construction | 52,354 | 8.2 | 42,987 | 7.1 | ||||||||||||
Commercial lots and raw land | 29,494 | 4.6 | 28,271 | 4.7 | ||||||||||||
Commercial and Industrial | 49,313 | 7.7 | 45,481 | 7.5 | ||||||||||||
Lease receivables | 18,333 | 2.9 | 17,235 | 2.8 | ||||||||||||
Total commercial loans and leases | 501,686 | 78.4 | 472,688 | 77.8 | ||||||||||||
Consumer loans: | ||||||||||||||||
Consumer real estate | 17,690 | 2.8 | 17,239 | 2.8 | ||||||||||||
Consumer construction | 162 | 0.1 | 196 | 0.1 | ||||||||||||
Consumer lots and raw land | 9,418 | 1.5 | 9,643 | 1.6 | ||||||||||||
Home equity lines of credit | 30,588 | 4.7 | 29,709 | 4.8 | ||||||||||||
Consumer other | 6,468 | 1.0 | 6,070 | 1.0 | ||||||||||||
Total consumer loans | 64,326 | 10.1 | 62,857 | 10.3 | ||||||||||||
Gross loans held for investment | 639,873 | 100.0 | % | 607,865 | 100.0 | % | ||||||||||
Less deferred loan origination fees, net | 828 | 850 | ||||||||||||||
Less allowance for loan and lease losses | 8,135 | 7,867 | ||||||||||||||
Net loans held for investment | $ | 630,910 | $ | 599,148 |
The Bank has pledged eligible loans as collateral for potential borrowings from the FHLB and the Federal Reserve Bank of Richmond (FRB). At March 31, 2016, the Bank pledged $236.5 million and $117.6 million of loans to the FHLB and FRB, respectively. See Note 13 below, for additional information.
10 |
6. Loans Held for Investment (Continued)
The following tables detail non-accrual loans held for investment, including troubled debt restructured (“TDR”) loans accounted for on a non-accrual status, segregated by class of loans, at March 31, 2016 and December 31, 2015:
March 31, 2016 | December 31, 2015 | |||||||
(Dollars in thousands) | ||||||||
Non-accrual loans held for investment: | ||||||||
Non-TDR loans accounted for on a non-accrual status: | ||||||||
Residential real estate | $ | 848 | $ | 635 | ||||
Residential lots and raw land | - | - | ||||||
Commercial real estate | 559 | 594 | ||||||
Commercial construction | - | - | ||||||
Commercial lots and raw land | - | - | ||||||
Commercial and Industrial | - | - | ||||||
Lease receivables | 95 | 95 | ||||||
Consumer real estate | 68 | 148 | ||||||
Consumer lots and raw land | 178 | 140 | ||||||
Home equity lines of credit | 89 | 81 | ||||||
Consumer other | 3 | 2 | ||||||
Total non-TDR loans accounted for on a nonaccrual status | 1,840 | 1,695 | ||||||
TDR loans accounted for on a nonaccrual status: | ||||||||
Past Due TDRs: | ||||||||
Residential real estate | - | - | ||||||
Commercial real estate | - | - | ||||||
Commercial construction | - | - | ||||||
Commercial lots and raw land | - | - | ||||||
Commercial and Industrial | - | - | ||||||
Consumer real estate | 154 | 159 | ||||||
Total Past Due TDRs | 154 | 159 | ||||||
Current TDRs: | ||||||||
Residential real estate | 508 | 809 | ||||||
Commercial real estate | 339 | 534 | ||||||
Commercial construction | - | - | ||||||
Commercial lots and raw land | - | - | ||||||
Commercial and Industrial | - | - | ||||||
Consumer lots and raw land | - | - | ||||||
Total Current TDRs | 847 | 1,343 | ||||||
Total TDR loans accounted for on a nonaccrual status | 1,001 | 1,502 | ||||||
Total non-performing loans | $ | 2,841 | 3,197 | |||||
Percentage of total loans held for investment, net | 0.5 | % | 0.5 | % | ||||
Loans over 90 days past due, still accruing | $ | 153 | $ | 115 | ||||
Other real estate owned | 5,956 | 6,125 | ||||||
Total non-performing assets | $ | 8,950 | $ | 9,437 |
Cumulative interest income not recorded on loans accounted for on a non-accrual status was $74,227 and $71,723 at March 31, 2016 and December 31, 2015, respectively.
11 |
6. Loans Held for Investment (Continued)
The following table presents an age analysis of past due loans held for investment, segregated by class of loans as of March 31, 2016 and December 31, 2015:
30-59 | 60-89 | 90 Days | Total | Total | 90 Days or | |||||||||||||||||||||||
Days | Days | or More | Past | Financing | More and | |||||||||||||||||||||||
Past Due | Past Due | Past Due | Due | Current | Receivables | Accruing | ||||||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||||||
Past due loans held for investment: | ||||||||||||||||||||||||||||
March 31, 2016 | ||||||||||||||||||||||||||||
Residential real estate | $ | 2,180 | $ | - | $ | 575 | $ | 2,755 | $ | 66,438 | $ | 69,193 | $ | 116 | ||||||||||||||
Residential construction | - | - | - | - | 4,515 | 4,515 | - | |||||||||||||||||||||
Residential lots and raw land | - | - | - | - | 153 | 153 | - | |||||||||||||||||||||
Commercial real estate | 1,685 | 505 | 150 | 2,340 | 349,852 | 352,192 | 37 | |||||||||||||||||||||
Commercial construction | - | - | - | - | 52,354 | 52,354 | - | |||||||||||||||||||||
Commercial lots and raw land | 71 | - | - | 71 | 29,423 | 29,494 | - | |||||||||||||||||||||
Commercial and Industrial | 4 | 2 | - | 6 | 49,307 | 49,313 | - | |||||||||||||||||||||
Lease receivables | - | - | 95 | 95 | 18,238 | 18,333 | - | |||||||||||||||||||||
Consumer real estate | 191 | 319 | 20 | 530 | 17,160 | 17,690 | - | |||||||||||||||||||||
Consumer construction | - | - | - | - | 162 | 162 | - | |||||||||||||||||||||
Consumer lots and raw land | - | 3 | 177 | 180 | 9,238 | 9,418 | - | |||||||||||||||||||||
Home equity lines of credit | 120 | 19 | 27 | 166 | 30,422 | 30,588 | - | |||||||||||||||||||||
Consumer other | 56 | 3 | 3 | 62 | 6,406 | 6,468 | - | |||||||||||||||||||||
Total | $ | 4,307 | $ | 851 | $ | 1,047 | $ | 6,205 | $ | 633,668 | $ | 639,873 | $ | 153 |
30-59 | 60-89 | 90 Days | Total | Total | 90 Days or | |||||||||||||||||||||||
Days | Days | or More | Past | Financing | More and | |||||||||||||||||||||||
Past Due | Past Due | Past Due | Due | Current | Receivables | Accruing | ||||||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||||||
Past due loans held for investment: | ||||||||||||||||||||||||||||
December 31, 2015 | ||||||||||||||||||||||||||||
Residential real estate | $ | 2,238 | $ | 107 | $ | 354 | $ | 2,699 | $ | 65,530 | $ | 68,229 | $ | 115 | ||||||||||||||
Residential construction | 120 | - | - | 120 | 3,814 | 3,934 | - | |||||||||||||||||||||
Residential lots and raw land | - | - | - | - | 157 | 157 | - | |||||||||||||||||||||
Commercial real estate | 1,054 | 227 | 103 | 1,384 | 337,330 | 338,714 | - | |||||||||||||||||||||
Commercial construction | - | - | - | - | 42,987 | 42,987 | - | |||||||||||||||||||||
Commercial lots and raw land | 69 | - | - | 69 | 28,202 | 28,271 | - | |||||||||||||||||||||
Commercial and Industrial | 3 | - | - | 3 | 45,478 | 45,481 | - | |||||||||||||||||||||
Lease receivables | - | - | 95 | 95 | 17,140 | 17,235 | - | |||||||||||||||||||||
Consumer real estate | 429 | 113 | 237 | 779 | 16,460 | 17,239 | - | |||||||||||||||||||||
Consumer construction | - | - | - | - | 196 | 196 | - | |||||||||||||||||||||
Consumer lots and raw land | 211 | - | 140 | 351 | 9,292 | 9,643 | - | |||||||||||||||||||||
Home equity lines of credit | 122 | 72 | 34 | 228 | 29,481 | 29,709 | - | |||||||||||||||||||||
Consumer other | 3 | 2 | 1 | 6 | 6,064 | 6,070 | - | |||||||||||||||||||||
Total | $ | 4,249 | $ | 521 | $ | 964 | $ | 5,734 | $ | 602,131 | $ | 607,865 | $ | 115 |
12 |
6. Loans Held for Investment (Continued)
The following table presents information on loans that were considered impaired as of March 31, 2016 and December 31, 2015. Impaired loans include loans modified as a TDR, whether on accrual or non-accrual status. At March 31, 2016, impaired loans included $2.3 million of TDRs, compared to $2.4 million at December 31, 2015.
Contractual | YTD Average | Interest Income | ||||||||||||||||||
Recorded | Unpaid Principal | Related | Recorded | Recognized on | ||||||||||||||||
Investment | Balance | Allowance | Investment | Impaired Loans | ||||||||||||||||
(In thousands) | ||||||||||||||||||||
Impaired Loans March 31, 2016 | ||||||||||||||||||||
With no related allowance recorded: | ||||||||||||||||||||
Residential real estate | $ | 785 | $ | 993 | $ | - | $ | 936 | $ | 10 | ||||||||||
Commercial real estate | 8,852 | 8,927 | - | 9,187 | 123 | |||||||||||||||
Commercial construction | 631 | 631 | - | 603 | 10 | |||||||||||||||
Commercial lots and raw land | 2,402 | 2,402 | - | 2,509 | 31 | |||||||||||||||
Commercial and Industrial | 41 | 41 | - | 41 | 1 | |||||||||||||||
Consumer real estate | 195 | 203 | - | 198 | 3 | |||||||||||||||
Consumer lots and raw land | 47 | 47 | - | 49 | 1 | |||||||||||||||
Home equity lines of credit | 47 | 49 | - | 48 | 1 | |||||||||||||||
Consumer other | 41 | 41 | - | 42 | - | |||||||||||||||
Subtotal: | 13,041 | 13,334 | - | 13,613 | 180 | |||||||||||||||
With an allowance recorded: | ||||||||||||||||||||
Commercial real estate | 814 | 816 | 342 | 818 | 11 | |||||||||||||||
Commercial and Industrial | 11 | 11 | 11 | 12 | - | |||||||||||||||
Consumer lots and raw land | 719 | 719 | 211 | 721 | 9 | |||||||||||||||
Home equity lines of credit | 23 | 25 | 24 | 12 | 1 | |||||||||||||||
Subtotal | 1,567 | 1,571 | 588 | 1,563 | 21 | |||||||||||||||
Totals: | ||||||||||||||||||||
Residential | 785 | 993 | - | 936 | 10 | |||||||||||||||
Commercial | 12,751 | 12,828 | 353 | 13,170 | 176 | |||||||||||||||
Consumer | 1,072 | 1,084 | 235 | 1,070 | 15 | |||||||||||||||
Grand Total | $ | 14,608 | $ | 14,905 | $ | 588 | $ | 15,176 | $ | 201 |
Contractual | YTD Average | Interest Income | ||||||||||||||||||
Recorded | Unpaid Principal | Related | Recorded | Recognized on | ||||||||||||||||
Investment | Balance | Allowance | Investment | Impaired Loans | ||||||||||||||||
(In thousands) | ||||||||||||||||||||
Impaired Loans December 31, 2015 | ||||||||||||||||||||
With no related allowance recorded: | ||||||||||||||||||||
Residential real estate | $ | 1,087 | $ | 1,384 | $ | - | $ | 1,180 | $ | 62 | ||||||||||
Commercial real estate | 9,521 | 9,573 | - | 10,883 | 564 | |||||||||||||||
Commercial construction | 574 | 574 | - | 305 | 14 | |||||||||||||||
Commercial lots and raw land | 2,616 | 2,616 | - | 2,764 | 139 | |||||||||||||||
Commercial and Industrial | 42 | 42 | - | 44 | 2 | |||||||||||||||
Consumer real estate | 201 | 207 | - | 277 | 8 | |||||||||||||||
Consumer lots and raw land | 50 | 50 | - | 55 | 3 | |||||||||||||||
Home equity lines of credit | 50 | 51 | - | 56 | 2 | |||||||||||||||
Consumer other | 42 | 42 | - | 44 | 2 | |||||||||||||||
Subtotal: | 14,183 | 14,539 | - | 15,608 | 796 | |||||||||||||||
With an allowance recorded: | ||||||||||||||||||||
Commercial real estate | 821 | 823 | 365 | 1,434 | 57 | |||||||||||||||
Commercial and Industrial | 14 | 14 | 14 | 61 | 2 | |||||||||||||||
Consumer real estate | 79 | 79 | 30 | 100 | 2 | |||||||||||||||
Consumer lots and raw land | 723 | 723 | 209 | 619 | 35 | |||||||||||||||
Subtotal | 1,637 | 1,639 | 618 | 2,214 | 96 | |||||||||||||||
Totals: | ||||||||||||||||||||
Residential | 1,087 | 1,384 | - | 1,180 | 62 | |||||||||||||||
Commercial | 13,588 | 13,642 | 379 | 15,491 | 778 | |||||||||||||||
Consumer | 1,145 | 1,152 | 239 | 1,151 | 52 | |||||||||||||||
Grand Total | $ | 15,820 | $ | 16,178 | $ | 618 | $ | 17,822 | $ | 892 |
13 |
6. Loans Held for Investment (Continued)
Credit Quality Indicators. The Bank assigns a risk grade to each loan in the portfolio as part of the on-going monitoring of the credit quality of the loan portfolio.
Commercial loans are graded on a scale of 1 to 9 as follows:
• | Risk Grade 1 (Excellent) - Loans in this category are considered to be of the highest quality. The borrower(s) has significant financial strength, stability, and liquidity. Proven cash flow is significantly more than required to service current and proposed debt with consistently strong earnings. Collateral position is very strong and a secondary source of repayment is self-evident. Guarantors may not be necessary to support the debt. |
• | Risk Grade 2 (Above Average) - Loans are supported by above average financial strength and stability. Cash flow is more than sufficient to meet current demands. Earnings are strong and reliable, but may differ from year to year. Collateral is highly liquid and sufficient to repay the debt in full. Guarantors may qualify for the loan on a direct basis. |
• | Risk Grade 3 (Average) - Credits in this group are supported by upper tier industry-average financial strength and stability. Liquidity levels fluctuate and need for short-term credit is demonstrated. Cash flow is steady and adequate to meet demands but can fluctuate. Earnings should be consistent but operating losses have not occurred recently. Collateral is generally pledged at an acceptable loan to value, but the credit can support some level of unsecured exposure. Guarantors with demonstrable financial strength are typically required on loans to business entities, but may not be on loans to individual borrowers. |
• | Risk Grade 4 (Acceptable) - Credits in this group are supported by lower end industry-average financial strength and stability. Liquidity levels fluctuate but are acceptable and need for short term credit is demonstrated. Cash flow is adequate to meet demands but can fluctuate. Earnings may be inconsistent but operating losses have not occurred recently. Collateral is generally pledged at an acceptable loan to value ratio. Guarantors with demonstrable financial strength are required on loans to business entities, but may not be on loans to individual borrowers. |
• | Risk Grade 5 (Watch) - An asset in this category is one that has been identified by the lender, or credit administration as a loan that has shown some degree of deterioration from its original status. These loans are typically protected by collateral but have potential weaknesses that deserve management’s close attention, but are not yet at a point to become a classified asset. There may be unsecured loans that are included in this category. These are loans that management feels need to be watched more closely than those rated as acceptable and if left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset to warrant including them as classified assets. |
• | Risk Grade 6 (Special Mention) - An asset in this category is currently protected by collateral but has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. |
• | Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the debtor(s) or of the collateral pledged, if any. These credits have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. There is a distinct possibility the Bank will sustain some loss if the deficiencies are not corrected. |
• | Risk Grade 8 (Doubtful) - A loan graded in this category has all the weaknesses inherent in one graded Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values highly questionable and improbable. |
• | Risk Grade 9 (Loss) - A loan graded as Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted. This grade does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future. |
Consumer loans are graded on a scale of 1 to 9 as follows:
• | Risk Grades 1 - 5 (Pass) - Loans in this category generally show little to no signs of weakness or have adequate mitigating factors that minimize the risk of loss. Some of the characteristics of these loans include, but are not limited to, adequate financial strength and stability, adequate cash flow, collateral with an acceptable loan to value ratio, additional repayment sources, and reliable earnings. |
• | Risk Grade 6 (Special Mention) - An asset in this category is currently protected by collateral but has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Bank’s position at some future date. |
• | Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the debtor(s) or of the collateral pledged, if any. These credits have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. There is a distinct possibility the Bank will sustain some loss if the deficiencies are not corrected. |
14 |
6. Loans Held for Investment (Continued)
• | Risk Grade 8 (Doubtful) - A loan graded in this category has all the weaknesses inherent in one graded Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values highly questionable and improbable. |
• | Risk Grade 9 (Loss) - A loan graded as Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted. This grade does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future. |
Mortgage loans are graded on a scale of 1 to 9 as follows:
• | Risk Grades 1 - 4 (Pass) - Loans in this category generally show little to no signs of weakness or have adequate mitigating factors that minimize the risk of loss. Some of the characteristics of these loans include, but are not limited to, adequate financial strength and stability, acceptable credit history, adequate cash flow, collateral with an acceptable loan to value ratio, additional repayment sources, and reliable earnings. |
• | Risk Grade 5 (Pass -Watch) – Watch loans have shown credit quality changes from the original status. These loans are typically protected by collateral but have potential weaknesses that deserve management’s close attention, but are not yet at a point to become a classified asset. These are loans that management feels need to be watched more closely than those rated as Pass and if left uncorrected may result in the deterioration of the repayment prospects for the asset to warrant including them as classified assets. |
• | Risk Grade 6 (Special Mention) – Special Mention loans are currently protected by collateral but have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. |
• | Risk Grade 7 (Substandard) - Substandard loans are inadequately protected by the sound net worth and paying capacity of the borrower(s). Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. |
• | Risk Grade 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. |
• | Risk Grade 9 (Loss) - Loans classified Loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future. |
The following table presents information on risk ratings of the commercial, consumer, mortgage and lease receivable portfolios, segregated by loan class as of March 31, 2016 and December 31, 2015:
March 31, 2016 | ||||||||||||||||
Commercial Credit Exposure by Assigned Risk Grade | Commercial Real Estate | Commercial Construction | Commercial Lots and Raw Land | Commercial and Industrial | ||||||||||||
(In thousands) | ||||||||||||||||
1-Excellent | $ | - | $ | - | $ | - | $ | - | ||||||||
2-Above Average | 2,721 | - | 159 | 3,582 | ||||||||||||
3-Average | 107,655 | 10,670 | 2,256 | 6,852 | ||||||||||||
4-Acceptable | 212,706 | 39,957 | 19,674 | 34,246 | ||||||||||||
5-Watch | 13,885 | 362 | 3,689 | 2,591 | ||||||||||||
6-Special Mention | 7,793 | 734 | 2,510 | 31 | ||||||||||||
7-Substandard | 7,432 | 631 | 1,206 | 2,011 | ||||||||||||
8-Doubtful | - | - | - | - | ||||||||||||
9-Loss | - | - | - | - | ||||||||||||
Total | $ | 352,192 | $ | 52,354 | $ | 29,494 | $ | 49,313 |
15 |
6. Loans Held for Investment (Continued)
March 31, 2016 | ||||||||||||||||||||
Consumer Credit Exposure by Assigned Risk Grade | Consumer Real Estate | Consumer Construction | Consumer Lots and Raw Land | Home Equity Line of Credit | Consumer Other | |||||||||||||||
(In thousands) | ||||||||||||||||||||
Pass | $ | 16,801 | $ | 162 | $ | 8,921 | $ | 30,309 | $ | 6,421 | ||||||||||
6-Special Mention | 668 | - | 273 | 95 | 3 | |||||||||||||||
7-Substandard | 221 | - | 224 | 184 | 44 | |||||||||||||||
8-Doubtful | - | - | - | - | - | |||||||||||||||
9-Loss | - | - | - | - | - | |||||||||||||||
Total | $ | 17,690 | $ | 162 | $ | 9,418 | $ | 30,588 | $ | 6,468 |
March 31, 2016 | ||||||||||||||||
Mortgage and Lease Receivable Credit Exposure by Assigned Risk Grade | Residential Real Estate | Residential Construction | Residential Lots and Raw Land | Lease Receivable | ||||||||||||
(In thousands) | ||||||||||||||||
Pass | $ | 66,980 | $ | 4,515 | $ | 153 | $ | 18,238 | ||||||||
6-Special Mention | 857 | - | - | - | ||||||||||||
7-Substandard | 1,356 | - | - | 95 | ||||||||||||
8-Doubtful | - | - | - | - | ||||||||||||
9-Loss | - | - | - | - | ||||||||||||
Total | $ | 69,193 | $ | 4,515 | $ | 153 | $ | 18,333 |
December 31, 2015 | ||||||||||||||||
Commercial Credit Exposure by Assigned Risk Grade | Commercial Real Estate | Commercial Construction | Commercial Lots and Raw Land | Commercial and Industrial | ||||||||||||
(In thousands) | ||||||||||||||||
1-Excellent | $ | - | $ | - | $ | - | $ | - | ||||||||
2-Above Average | 2,788 | - | 160 | 3,757 | ||||||||||||
3-Average | 98,148 | 10,023 | 2,247 | 8,095 | ||||||||||||
4-Acceptable | 209,936 | 31,139 | 18,086 | 30,218 | ||||||||||||
5-Watch | 11,877 | 391 | 3,821 | 1,350 | ||||||||||||
6-Special Mention | 7,872 | 860 | 2,715 | 41 | ||||||||||||
7-Substandard | 8,093 | 574 | 1,242 | 2,020 | ||||||||||||
8-Doubtful | - | - | - | - | ||||||||||||
9-Loss | - | - | - | - | ||||||||||||
Total | $ | 338,714 | $ | 42,987 | $ | 28,271 | $ | 45,481 |
December 31, 2015 | ||||||||||||||||||||
Consumer Credit Exposure by Assigned Risk Grade | Consumer Real Estate | Consumer Construction | Consumer Lots and Raw Land | Home Equity Line of Credit | Consumer Other | |||||||||||||||
(In thousands) | ||||||||||||||||||||
Pass | $ | 16,253 | $ | 196 | $ | 7,906 | $ | 29,523 | $ | 6,000 | ||||||||||
6-Special Mention | 679 | - | 1,270 | 61 | 26 | |||||||||||||||
7-Substandard | 307 | - | 277 | 125 | 44 | |||||||||||||||
8-Doubtful | - | - | 190 | - | - | |||||||||||||||
9-Loss | - | - | - | - | - | |||||||||||||||
Total | $ | 17,239 | $ | 196 | $ | 9,643 | $ | 29,709 | $ | 6,070 |
December 31, 2015 | ||||||||||||||||
Mortgage and Lease Receivable Credit Exposure by Assigned Risk Grade | Residential Real Estate | Residential Construction | Residential Lots and Raw Land | Lease Receivable | ||||||||||||
(In thousands) | ||||||||||||||||
Pass | $ | 65,977 | $ | 3,934 | $ | 157 | $ | 17,140 | ||||||||
6-Special Mention | 791 | - | - | - | ||||||||||||
7-Substandard | 1,461 | - | - | 95 | ||||||||||||
8-Doubtful | - | - | - | - | ||||||||||||
9-Loss | - | - | - | - | ||||||||||||
Total | $ | 68,229 | $ | 3,934 | $ | 157 | $ | 17,235 |
16 |
7. Allowance for Loan and Lease Losses. The following table presents a roll forward summary of activity in the allowance for loan and lease losses (“ALLL”), by loan category, for the three months ended March 31, 2016 and 2015:
March 31, 2016 | ||||||||||||||||||||||||
Beginning | Charge- | Ending | Total | |||||||||||||||||||||
Balance | Offs | Recoveries | Provisions | Balance | Loans | |||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||
Collectively evaluated for impairment: | ||||||||||||||||||||||||
Residential real estate | $ | 730 | $ | - | $ | - | $ | 25 | $ | 755 | $ | 68,408 | ||||||||||||
Residential construction | 47 | - | - | 5 | 52 | 4,515 | ||||||||||||||||||
Residential lots and raw land | 2 | - | - | - | 2 | 153 | ||||||||||||||||||
Commercial real estate | 4,065 | - | 8 | 109 | 4,182 | 342,526 | ||||||||||||||||||
Commercial construction | 518 | - | 70 | 41 | 629 | 51,723 | ||||||||||||||||||
Commercial lots and raw land | 303 | - | - | 11 | 314 | 27,092 | ||||||||||||||||||
Commercial and industrial | 641 | - | 1 | 10 | 652 | 49,261 | ||||||||||||||||||
Lease receivables | 196 | - | - | 8 | 204 | 18,333 | ||||||||||||||||||
Consumer real estate | 198 | - | 6 | (5 | ) | 199 | 17,044 | |||||||||||||||||
Consumer construction | 2 | - | - | - | 2 | 196 | ||||||||||||||||||
Consumer lots and raw land | 125 | (1 | ) | - | 6 | 130 | 8,877 | |||||||||||||||||
Home equity lines of credit | 351 | - | - | 2 | 353 | 29,639 | ||||||||||||||||||
Consumer other | 71 | (4 | ) | 7 | (1 | ) | 73 | 6,029 | ||||||||||||||||
Total | 7,249 | (5 | ) | 92 | 211 | 7,547 | 623,796 | |||||||||||||||||
Individually evaluated for impairment: | ||||||||||||||||||||||||
Residential real estate | - | (2 | ) | 1 | 1 | - | 785 | |||||||||||||||||
Commercial real estate | - | (11 | ) | 1 | 352 | 342 | 9,666 | |||||||||||||||||
Commercial construction | - | - | - | - | - | 631 | ||||||||||||||||||
Commercial lots and raw land | 365 | - | - | (365 | ) | - | 2,402 | |||||||||||||||||
Commercial and industrial | 14 | - | - | (3 | ) | 11 | 52 | |||||||||||||||||
Consumer real estate | 30 | (36 | ) | - | 6 | - | 195 | |||||||||||||||||
Consumer lots and raw land | 209 | - | 2 | - | 211 | 766 | ||||||||||||||||||
Home equity lines of credit | - | - | 1 | 23 | 24 | 70 | ||||||||||||||||||
Consumer other | - | - | - | - | - | 41 | ||||||||||||||||||
Total | 618 | (49 | ) | 5 | 14 | 588 | 14,608 | |||||||||||||||||
Grand Total | $ | 7,867 | $ | (54 | ) | $ | 97 | $ | 225 | $ | 8,135 | $ | 638,404 |
17 |
7. Allowance for Loan and Lease Losses (Continued)
March 31, 2015 | ||||||||||||||||||||||||
Beginning | Charge- | Ending | Total | |||||||||||||||||||||
Balance | Offs | Recoveries | Provisions | Balance | Loans | |||||||||||||||||||
Collectively evaluated for impairment: | (In thousands) | |||||||||||||||||||||||
Residential real estate | $ | 982 | $ | (84 | ) | $ | - | $ | 158 | $ | 1,056 | $ | 63,865 | |||||||||||
Residential construction | 17 | - | - | 4 | 21 | 1,631 | ||||||||||||||||||
Residential lots and raw land | 11 | - | - | - | 11 | 808 | ||||||||||||||||||
Commercial real estate | 3,516 | - | 9 | (56 | ) | 3,469 | 248,603 | |||||||||||||||||
Commercial construction | 375 | - | - | (1 | ) | 374 | 28,283 | |||||||||||||||||
Commercial lots and raw land | 377 | - | - | (25 | ) | 352 | 23,763 | |||||||||||||||||
Commercial and industrial | 400 | - | 2 | (16 | ) | 386 | 29,530 | |||||||||||||||||
Lease receivables | 172 | - | - | 12 | 184 | 12,637 | ||||||||||||||||||
Consumer real estate | 250 | - | 6 | (36 | ) | 220 | 17,635 | |||||||||||||||||
Consumer construction | 19 | - | - | 1 | 20 | 1,583 | ||||||||||||||||||
Consumer lots and raw land | 152 | - | - | 9 | 161 | 9,817 | ||||||||||||||||||
Home equity lines of credit | 405 | - | 1 | (27 | ) | 379 | 27,142 | |||||||||||||||||
Consumer other | 52 | (3 | ) | 6 | 12 | 67 | 5,381 | |||||||||||||||||
Total | 6,728 | (87 | ) | 24 | 35 | 6,700 | 470,678 | |||||||||||||||||
Individually evaluated for impairment: | ||||||||||||||||||||||||
Residential real estate | 185 | (185 | ) | - | - | - | 1,109 | |||||||||||||||||
Commercial real estate | 167 | - | 2 | (34 | ) | 135 | 13,318 | |||||||||||||||||
Commercial construction | - | - | - | - | - | 103 | ||||||||||||||||||
Commercial lots and raw land | 251 | (3 | ) | - | (218 | ) | 30 | 2,857 | ||||||||||||||||
Commercial and industrial | - | - | - | 224 | 224 | 289 | ||||||||||||||||||
Consumer real estate | 19 | - | - | - | 19 | 470 | ||||||||||||||||||
Consumer lots and raw land | 165 | (69 | ) | - | (1 | ) | 95 | 617 | ||||||||||||||||
Home equity lines of credit | 5 | - | 1 | (6 | ) | - | - | |||||||||||||||||
Consumer other | - | - | - | - | - | - | ||||||||||||||||||
Total | 792 | (257 | ) | 3 | (35 | ) | 503 | 18,763 | ||||||||||||||||
Grand Total | $ | 7,520 | $ | (344 | ) | $ | 27 | $ | - | $ | 7,203 | $ | 489,441 |
8. Troubled Debt Restructurings. The following table details performing TDR loans at March 31, 2016 and December 31, 2015, segregated by class of financing receivables:
March 31, 2016 | December 31, 2015 | |||||||
Performing TDRs accounted for on accrual status: | (Dollars in thousands) | |||||||
Residential real estate | $ | - | $ | - | ||||
Commercial real estate | 397 | 765 | ||||||
Commercial construction | - | - | ||||||
Commercial lots and raw land | - | - | ||||||
Commercial and Industrial | 4 | 5 | ||||||
Consumer real estate | - | - | ||||||
Consumer lots and raw land | 103 | 107 | ||||||
Home equity lines of credit | - | - | ||||||
Consumer other | - | - | ||||||
Total | $ | 504 | $ | 877 | ||||
Percentage of total loans, net | 0.0 | % | 0.1 | % |
18 |
8. Troubled Debt Restructurings (Continued)
The following table presents a roll forward of performing TDR loans for the three months ended March 31, 2016 and 2015:
Performing TDRs | Beginning Balance | Additions (1) | Charge-offs (2) | Other (3) | Ending Balance | |||||||||||||||
(In thousands) | ||||||||||||||||||||
March 31, 2016 | ||||||||||||||||||||
Residential mortgage | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||
Commercial | 770 | - | - | (369 | ) | 401 | ||||||||||||||
Consumer | 107 | - | - | (4 | ) | 103 | ||||||||||||||
Total | $ | 877 | $ | - | $ | - | $ | (373 | ) | $ | 504 | |||||||||
March 31, 2015 | ||||||||||||||||||||
Residential mortgage | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||
Commercial | 1,141 | - | - | (15 | ) | 1,126 | ||||||||||||||
Consumer | 281 | - | - | (51 | ) | 230 | ||||||||||||||
Total | $ | 1,422 | $ | - | $ | - | $ | (66 | ) | $ | 1,356 |
The following table presents a roll forward of non-performing TDR loans for the three months ended March 31, 2016 and 2015:
Non-Performing TDRs | Beginning Balance | Additions (1) | Charge-offs (2) | Other (4) | Ending Balance | |||||||||||||||
(In thousands) | ||||||||||||||||||||
March 31, 2016 | ||||||||||||||||||||
Residential mortgage | $ | 809 | $ | - | $ | (2 | ) | $ | (299 | ) | $ | 508 | ||||||||
Commercial | 534 | - | - | (195 | ) | 339 | ||||||||||||||
Consumer | 159 | - | - | (5 | ) | 154 | ||||||||||||||
Total | $ | 1,502 | $ | - | $ | (2 | ) | $ | (499 | ) | $ | 1,001 | ||||||||
March 31, 2015 | ||||||||||||||||||||
Residential mortgage | $ | 834 | $ | - | $ | - | $ | (7 | ) | $ | 827 | |||||||||
Commercial | 2,355 | - | - | (833 | ) | 1,522 | ||||||||||||||
Consumer | 51 | - | - | - | 51 | |||||||||||||||
Total | $ | 3,240 | $ | - | $ | - | $ | (840 | ) | $ | 2,400 |
1. | Includes new TDRs and increases to existing TDRs. |
2. | Post modification charge-offs. |
3. | Includes principal payments, paydowns and performing loans previously restructured at market rates that are no longer reported as TDRs. |
4. | Includes principal payments, paydowns and loans previously designated as non-performing that are currently performing in compliance with their modified terms. |
The Bank performs restructurings on certain troubled loan workouts, whereby existing loans are restructured into a multiple note structure (i.e., Note A and Note B structure). The Bank separates a portion of the current outstanding debt into a new legally enforceable note (Note A) that is reasonably assured of repayment and performance according to prudently modified terms. The portion of the debt that is not reasonably assured of repayment (Note B) is adversely classified and charged-off as appropriate. The following table provides information on multiple note restructures for certain commercial real estate loan workouts as of March 31, 2016 and 2015:
March 31, 2016 | March 31, 2015 | |||||||
Note A Structure | (In thousands) | |||||||
Commercial real estate (1) | $ | 266 | $ | 275 | ||||
Note B Structure | ||||||||
Commercial real estate (2) | $ | 174 | $ | 174 | ||||
Reduction of interest income (3) | $ | 2 | $ | 3 |
(1) | If Note A was on nonaccrual status, it may be placed back on accrual status based on sustained historical payment performance of generally nine months. |
(2) | Note B is immediately charged-off upon restructuring; however, payment in full is due at maturity of the note. |
(3) | Reflects amount of interest income reduction during the three months ended March 31, 2015, as a result of multiple note restructures. |
19 |
8. Troubled Debt Restructurings (Continued)
The benefit of this workout strategy is for the A note to remain a performing asset for which the borrower has the willingness and ability to meet the restructured payment terms and conditions. In addition, this workout strategy reduces the prospects of further write downs and charge offs, and also reduces the prospects of a potential foreclosure. Following this restructuring, the Note A credit classification generally improves from “substandard” to an unclassified risk grade.
The general terms of the new loans restructured under the Note A and Note B structure differ as follows:
· | Note A: First lien position; fixed or adjustable current market interest rate; fixed month term to maturity; payments – interest only to maturity, or full principal and interest to maturity. Note A is underwritten in accordance with the Bank’s customary underwriting standards and is on an accrual basis. |
· | Note B: Second lien position; fixed or adjustable below current market interest rate; fixed month term to maturity; payments – due in full at maturity. Note B is underwritten in accordance with the Bank’s customary underwriting standards, except for the below market interest rate and payment terms, and is on a nonaccrual basis. |
9. Other Real Estate Owned. The following table reflects the changes in other real estate owned (“OREO”) during the three months ended March 31, 2016 and 2015:
Beginning | Fair Value | Ending | ||||||||||||||||||
Three Months Ended: | Balance | Additions | Sales, net | Adjustments | Balance | |||||||||||||||
(In thousands) | ||||||||||||||||||||
March 31, 2016 | $ | 6,125 | $ | 357 | $ | (519 | ) | $ | (7 | ) | $ | 5,956 | ||||||||
March 31, 2015 | $ | 7,756 | $ | 574 | $ | (1,204 | ) | $ | (44 | ) | $ | 7,082 |
Fair value adjustments are recorded in order to adjust the carrying values of OREO properties to estimated fair market values. In most cases, estimated fair market values are derived from an initial appraisal, an updated appraisal or other forms of internal evaluations. In certain instances when a listing agreement is renewed for a lesser amount, carrying values will be adjusted to the lesser fair value amount. Additionally, in certain instances when an offer to purchase is received near the end of a quarterly accounting period for less than the carrying value, and the sale does not close until the next accounting period, the carrying value will be adjusted to the lesser fair value amount. At March 31, 2016, OREO consisted of residential and commercial properties, developed lots and raw land.
10. Premises and Equipment. The following table presents premises and equipment at March 31, 2016 and December 31, 2015, respectively:
March 31, 2016 | December 31, 2015 | |||||||
Land | $ | 2,829,935 | $ | 3,680,886 | ||||
Office buildings and improvements | 9,640,806 | 10,138,594 | ||||||
Furniture, fixtures and equipment | 10,219,425 | 10,183,020 | ||||||
Vehicles | 621,238 | 621,238 | ||||||
Projects/work in process | 56,494 | 86,032 | ||||||
23,367,898 | 24,709,770 | |||||||
Less accumulated depreciation | 11,224,164 | 11,044,833 | ||||||
Total | $ | 12,143,734 | $ | 13,664,937 |
The Bank leases certain branch facilities and equipment under separate agreements that expire at various dates through October 30, 2027. Rental expense of $348,860 and $292,380 during the three months ended March 31, 2016 and 2015, respectively, is included in premises and equipment expense on the accompanying consolidated statements of operations. Future rentals under these leases are as follows:
2016 | $ | 962,276 | ||
2017 | 1,127,320 | |||
2018 | 991,911 | |||
2019 | 768,519 | |||
2020 | 145,800 | |||
Thereafter | 2,493,547 | |||
Total | $ | 6,489,373 |
20 |
11. Goodwill and Other Intangibles. The following table presents activity for goodwill and other intangible assets for the three months ended March 31, 2016 and 2015, respectively:
Three Months Ended March 31, 2016: | Goodwill | Other Intangibles | Total | |||||||||
Balance at December 31, 2015 | $ | 4,218,576 | $ | 1,895,513 | $ | 6,114,089 | ||||||
Amortization | - | (71,081 | ) | (71,081 | ) | |||||||
Balance at March 31, 2016 | $ | 4,218,576 | $ | 1,824,432 | $ | 6,043,008 |
Three Months Ended March 31, 2015 | ||||||||||||
Balance at December 31, 2014 | $ | 4,218,576 | $ | 2,182,909 | $ | 6,401,485 | ||||||
Amortization | - | (71,848 | ) | (71,848 | ) | |||||||
Balance at March 31, 2015 | $ | 4,218,576 | $ | 2,111,061 | $ | 6,329,637 |
The following table presents a rollforward of the gross carrying amount, new acquisitions, accumulated amortization and net book value for the Company’s core deposit intangible (CDI), which is the only identifiable intangible asset subject to amortization at March 31, 2016 and December 31, 2015, respectively:
Other Intangibles | ||||
Net book value at December 31, 2014 (1) | $ | 2,182,909 | ||
Accumulated amortization | (287,396 | ) | ||
Net book value at December 31, 2015 | 1,895,513 | |||
Accumulated amortization | (71,081 | ) | ||
Net book value at March 31, 2016 | $ | 1,824,432 |
________________
(1) | CDI related to the acquisition of branch offices from Bank of America, N.A. on December 12, 2014. |
The following table presents estimated future amortization expense of the CDI. At March 31, 2016, the remaining life of the CDI was 9 years.
2016 | $ | 213,246 | |||
2017 | 241,678 | ||||
2018 | 223,002 | ||||
2019 | 223,002 | ||||
2020 | 223,002 | ||||
Thereafter | 700,502 | ||||
Total | $ | 1,824,432 |
12. Deposits. The following table presents the distribution of the Bank’s deposit accounts as of March 31, 2016 and December 31, 2015:
March 31, 2016 | December 31, 2015 | |||||||
(In thousands) | ||||||||
Demand accounts: | ||||||||
Non-interest bearing checking | $ | 164,244 | $ | 169,546 | ||||
Interest bearing checking | 171,324 | 173,934 | ||||||
Money market | 73,000 | 72,442 | ||||||
Savings accounts | 146,254 | 135,370 | ||||||
Certificate accounts | 263,845 | 260,030 | ||||||
Total deposits | $ | 818,667 | $ | 811,322 |
At March 31, 2016, the scheduled maturities of certificate accounts were as follows:
$250,000 or Less | More than $250,000 | Total | ||||||||||
(In thousands) | ||||||||||||
Three months or less | $ | 26,806 | $ | 11,205 | $ | 38,011 | ||||||
Over three months through one year | 76,383 | 7,830 | 84,213 | |||||||||
Over one year through three years | 106,078 | 14,970 | 121,048 | |||||||||
Over three years | 17,029 | 3,544 | 20,573 | |||||||||
Total time deposits | $ | 226,296 | $ | 37,549 | $ | 263,845 |
The aggregate amount of time deposits with balances of $250,000 or more was $37,549,031 and $35,556,760 at March 31, 2016 and December 31, 2015, respectively.
21 |
13. Borrowed Money. The Bank had $21.5 million of FHLB borrowings outstanding at March 31, 2016 compared to $37.0 million at December 31, 2015. The Bank pledges its stock in the FHLB and certain loans as collateral for actual or potential FHLB advances. At March 31, 2016 and December 31, 2015, the Bank had approximately $236.4 million and $228.2 million, respectively, of credit available with the FHLB. At March 31, 2016, the Bank had lendable collateral value with the FHLB totaling $174.1 million. Additional collateral would be required in order to access total borrowings up to the credit availability limit.
The following table details the Bank’s FHLB advances outstanding and the related interest rates at March 31, 2016:
Maturity | Interest Rate | Amount | ||||||
(Dollars in thousands) | ||||||||
Overnight | 0.51 | % | $ | 8,500 | ||||
December 27, 2016 | 0.74 | % | 1,000 | |||||
June 26, 2017 | 0.95 | % | 2,000 | |||||
June 29, 2017 | 0.93 | % | 1,000 | |||||
June 22, 2018 | 1.33 | % | 1,000 | |||||
June 25, 2018 | 1.36 | % | 2,000 | |||||
June 29, 2018 | 1.34 | % | 1,000 | |||||
July 8, 2019 | 1.62 | % | 2,000 | |||||
June 29, 2020 | 1.98 | % | 2,000 | |||||
July 6, 2020 | 1.89 | % | 1,000 | |||||
$ | 21,500 |
14. Junior Subordinated Debentures. The Company has sponsored a trust, First South Preferred Trust I (the Trust), of which 100% of the common equity is owned by the Company. The Trust was formed for the purpose of issuing company-obligated trust preferred securities (the Trust Preferred Securities) to third-party investors and investing the proceeds from the sale of such Trust Preferred Securities solely in junior subordinated debt securities of the Company (the Debentures). The Debentures held by the Trust are the sole assets of the Trust. Distributions on the Trust Preferred Securities issued by the Trust are payable quarterly at a rate equal to the interest rate being earned by the Trust on the Debentures held by the Trust. The Trust Preferred Securities are subject to mandatory redemption, in whole or in part, upon repayment of the Debentures. The Company has entered into an agreement, which fully and unconditionally guarantees the Trust Preferred Securities subject to the terms of the guarantee. The Debentures held by the Trust are first redeemable, in whole or in part, by the Company on or after September 30, 2008. Subject to certain limitations, the Junior Subordinated Debentures qualify as Tier 1 capital for the Company under current Federal Reserve Board guidelines.
In July of 2013, the banking regulators issued the final Basel III capital rules. Under these rules, bank holding companies with less than $15 billion in consolidated total assets as of December 31, 2009, that issued trust preferred securities prior to May 19, 2010, are permanently grandfathered as Tier 1 or Tier 2 capital.
Consolidated debt obligations as of March 31, 2016 related to a subsidiary Trust holding solely Debentures of the Company follows:
LIBOR
+ 2.95% junior subordinated debentures owed to | $ | 10,000,000 | ||
LIBOR + 2.95% junior subordinated debentures owed to First South Preferred Trust I due September 26, 2033 | 310,000 | |||
Total junior subordinated debentures owed to unconsolidated subsidiary trust | $ | 10,310,000 |
The trust preferred securities bear interest at three-month LIBOR plus 2.95% payable quarterly. Effective December 30, 2014, the Company swapped the interest rate on these debentures to a fixed rate of 5.54% for the ensuing five year period. This strategy was executed to provide the Company with protection to a rising rate environment.
15. Regulatory Capital. The Bank is subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Management believes, as of March 31, 2016, that the Bank meets all capital adequacy requirements to which it is subject. The Company’s most significant asset is its investment in the Bank. Consequently, the information concerning capital ratios is essentially the same for the Company and the Bank. Beginning with the quarter ended March 31, 2015, the Bank became subject to new Basel III Capital Rules. As a result, certain items in the risk-based capital calculation have changed. In addition, a new ratio, the Common Equity Tier 1 Risk-Based Capital Ratio, is now being measured and monitored.
22 |
15. Regulatory Capital (Continued)
For the Bank’s capital structure, the Common Equity Tier 1 Risk-Based Capital Ratio and the Tier 1 Risk-Based Capital Ratio are identical. The Bank's actual regulatory capital amounts and ratios as of March 31, 2016, and December 31, 2015, are listed below:
March 31, 2016 | December 31, 2015 | |||||||||||||||
Regulatory Capital Ratios | Amount | Ratio | Amount | Ratio | ||||||||||||
(Dollars in thousands) | ||||||||||||||||
Total Capital (to Risk Weighted Assets) | $ | 89,620 | 13.10 | % | $ | 88,074 | 13.29 | % | ||||||||
Common Equity Tier 1 Capital (to Risk Weighted Assets) | 81,189 | 11.87 | 79,871 | 12.06 | ||||||||||||
Tier 1 Capital (to Risk Weighted Assets) | 81,189 | 11.87 | 79,871 | 12.06 | ||||||||||||
Tier 1 Capital (to Average Assets) | 81,189 | 8. 74 | 79,871 | 8.67 |
16. Stock-Based Compensation. The Company had two stock-based compensation plans at March 31, 2016. The shares outstanding are for grants under the Company’s 1997 Stock Option Plan (the “1997 Plan”) and the 2008 Equity Incentive Plan (the “2008 Plan”). The 1997 Plan matured on April 8, 2008 and no additional options may be granted under the 1997 Plan. At March 31, 2016, the 1997 Plan had 23,500 granted unexercised stock option shares. At March 31, 2016, the 2008 Plan included 135,000 granted unexercised stock option shares, 12,150 granted nonvested restricted stock award shares and 800,900 shares available to be granted.
Stock Option Grants. Options granted under the 2008 Plan are granted at the closing price of the Company’s common stock on the NASDAQ Stock Market on the date of grant. Stock options expire ten years from the date of grant and vest over service periods ranging from one year to five years. The Company settles stock option exercises with authorized unissued shares. The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model. The risk-free interest rate is based on the U.S. Treasury rate for the expected life at the time of grant. Volatility is based on the average volatility of the Company based upon previous trading history. The expected life and forfeiture assumptions are based on historical data. Dividend yield is based on the yield at the time of the option grant.
A summary of option activity under the Plans as of March 31, 2016 and 2015, and changes during the three month periods ended March 31, 2016 and 2015 is presented below:
Quarter Ended March 31, 2016: | Options Outstanding | Price | Aggregate Intrinsic Value | |||||||||
Outstanding at December 31, 2015 | 165,750 | $ | 10.76 | |||||||||
Granted | - | - | ||||||||||
Forfeited | (3,000 | ) | 27.87 | |||||||||
Expired | (1,250 | ) | 33.27 | |||||||||
Exercised | (3,000 | ) | 5.40 | |||||||||
Outstanding at March 31, 2016 | 158,500 | 10.37 | $ | 202,480 | ||||||||
Vested and Exercisable at March 31, 2016 | 118,500 | $ | 11.52 | $ | 148,818 |
Quarter Ended March 31, 2015: | ||||||||||||
Outstanding at December 31, 2014 | 169,500 | $ | 11.38 | |||||||||
Granted | 14,000 | 8.01 | ||||||||||
Forfeited | (750 | ) | 6.52 | |||||||||
Expired | (7,500 | ) | 17.47 | |||||||||
Exercised | - | - | ||||||||||
Outstanding at March 31, 2015 | 175,250 | 10.87 | $ | 195,900 | ||||||||
Vested and Exercisable at March 31, 2015 | 110,150 | $ | 13.37 | $ | 103,072 |
The following weighted-average assumptions were used for grants awarded in the three months ended March 31, 2016 and 2015:
Three Months Ended 3/31/16 | Three Months Ended 3/31/15 | |||||||
Dividend growth rate | 0.0 | % | 1.0 | % | ||||
Expected volatility | 0.0 | % | 96.9 | % | ||||
Average risk-free interest rate | 0.0 | % | 1.5 | % | ||||
Expected lives - years | - | 7 |
23 |
16. Stock-Based Compensation (Continued)
The following table summarizes additional information about the Company’s outstanding options and exercisable options as of March 31, 2016, including weighted-average remaining contractual term expressed in years ("Life") and weighted average exercise price (“Price”):
Outstanding | Exercisable | |||||||||||||||||||
Range of Exercise Price | Shares | Life | Price | Shares | Price | |||||||||||||||
$4.00 – 10.00 | 97,000 | 6.62 | $ | 6.18 | 57,000 | $ | 5.65 | |||||||||||||
$10.01 – 17.00 | 27,000 | 3.45 | 11.01 | 27,000 | 11.01 | |||||||||||||||
$17.01 – 26.00 | 29,250 | 2.01 | 20.65 | 29,250 | 20.65 | |||||||||||||||
$26.01 – 34.00 | 5,250 | 0.20 | 27.08 | 5,250 | 27.08 | |||||||||||||||
158,500 | 5.01 | $ | 10.37 | 118,500 | $ | 11.52 |
A summary of nonvested option shares as of March 31, 2016 and 2015, and vesting changes during the three months ended March 31, 2016 and 2015, is presented below:
Period Ended March 31, 2016: | Shares | Price | ||||||
Nonvested at December 31, 2015 | 53,300 | $ | 6.67 | |||||
Granted | - | - | ||||||
Forfeited | - | - | ||||||
Vested | (13,300 | ) | 5.90 | |||||
Nonvested at March 31, 2016 | 40,000 | $ | 6.93 |
Period Ended March 31, 2015: | ||||||||
Nonvested at December 31, 2014 | 62,700 | $ | 6.14 | |||||
Granted | 14,000 | 8.01 | ||||||
Forfeited | (600 | ) | 6.52 | |||||
Vested | (11,000 | ) | 5.47 | |||||
Nonvested at March 31, 2015 | 65,100 | $ | 6.65 |
Net compensation expense recognized for stock options was $11,780 and $10,623 for the three months ended March 31, 2016 and 2015, respectively. As of March 31, 2016, total unrecognized compensation cost on granted unexercised shares was $126,033, and is expected to be recognized during the next 4.0 years.
Restricted Stock Awards. The Company measures the fair value of restricted shares based on the price of its common stock on the grant date and compensation expense is recorded over the vesting period. During the three months ended March 31, 2016, 3,000 restricted stock awards were granted with a four year vesting period, and 2,200 restricted stock awards were granted with a five year vesting period. There were no restricted stock awards granted during the three months ended March 31, 2015. Total compensation expense recognized for restricted stock awards for the three months ended March 31, 2016 and 2015 was $8,879 and $7,263, respectively. As of March 31, 2016, there was $94,023 of total unrecognized compensation cost related to nonvested restricted stock granted under the 2008 Plan, which will be recognized over a remaining period of 5.0 years. A summary of nonvested restricted stock awards as of March 31, 2016 and 2015, and vesting changes during the respective three month periods is presented below:
Period Ended March 31, 2016: | Shares | Price | ||||||
Nonvested at December 31, 2015 | 10,425 | $ | 8.36 | |||||
Granted | 5,200 | 8.15 | ||||||
Vested | (3,475 | ) | 8.36 | |||||
Forfeited | - | - | ||||||
Nonvested at March 31, 2016 | 12,150 | $ | 8.27 |
Period Ended March 31, 2015: | ||||||||
Nonvested at December 31, 2014 | 13,900 | $ | 8.36 | |||||
Granted | - | - | ||||||
Vested | (3,475 | ) | 8.36 | |||||
Forfeited | - | - | ||||||
Nonvested at March 31, 2015 | 10,425 | $ | 8.36 |
24 |
16. Stock-Based Compensation (Continued)
The following table reflects the combined impact of fair value compensation cost recognition for stock options and restricted stock awards on income before income taxes, net income, basic earnings per share and diluted earnings per share for the three month periods ended March 31, 2016 and 2015:
March 31, 2016 | March 31, 2015 | |||||||
Decrease net income before income taxes | $ | 20,659 | $ | 17,886 | ||||
Decrease net income | $ | 20,659 | $ | 17,886 | ||||
Decrease basic earnings per share | $ | 0.01 | $ | 0.00 | ||||
Decrease diluted earnings per share | $ | 0.01 | $ | 0.00 |
17. Fair Value Measurement. Fair value is defined as the price that would be received on the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy prioritizes the inputs of valuation techniques used to measure fair value of nonfinancial assets and liabilities. The inputs are evaluated and an overall level for the fair value measurement is determined. This overall level is an indication of the market observability of the fair value measurement. In order to determine the fair value, the Bank must determine the unit of account, highest and best use, principal market, and market participants. These determinations allow the Bank to define the inputs for fair value and level of hierarchy. Outlined below is the application of the fair value hierarchy to the Bank’s financial assets that are carried at fair value.
Level 1: inputs to the valuation methodology are quoted prices in active markets for identical assets or liabilities that the Bank has the ability to access at the measurement date. A quoted price in an active market provides the most reliable evidence of fair value and is used to measure fair value whenever available. The type of assets carried at Level 1 fair value generally includes investments such as U.S. Treasury and U.S. government agency securities.
Level 2: inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets and price quotations can vary substantially either over time or among market makers. The type of assets carried at Level 2 fair value generally includes mortgage-backed securities issued by Government Sponsored Enterprises (“GSEs”), municipal bonds, corporate debt securities, mortgage loans held for sale and bank-owned life insurance.
Level 3: inputs to the valuation methodology are unobservable to the extent that observable inputs are not available. Unobservable inputs are developed based on the best information available in the circumstances and might include the Bank’s own assumptions. The Bank considers information about market participant assumptions that is reasonably available without undue cost and effort. The type of assets carried at Level 3 fair value generally include investments backed by non-traditional mortgage loans or certain state or local housing agency obligations, of which the Bank has no such assets or liabilities. Level 3 also includes impaired loans and other real estate owned.
Quoted market price for similar assets in active markets is the valuation technique for determining fair value of securities available for sale and held to maturity. Unrealized gains on available for sale securities are included in the “accumulated other comprehensive income” component of the Stockholders’ Equity section of the Consolidated Statements of Financial Condition. The estimated fair value of loans held for sale is based on commitments from investors within the secondary market for loans with similar characteristics. The Bank does not record loans held for investment at fair value on a recurring basis. However, when a loan is considered impaired, an impairment write down is taken based on the loan’s estimated fair value. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those loans not requiring a write down represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans, and are not included below.
25 |
17. Fair Value Measurement (Continued)
Assets measured at fair value on a recurring basis as of March 31, 2016 and December 31, 2015:
Fair Value | Quoted Prices In Active Markets for Identical Assets | Significant Observable Inputs- Outputs | Significant Unobservable Inputs | |||||||||||||
(In thousands) | ||||||||||||||||
Description | March 31, 2016 | Level 1 | Level 2 | Level 3 | ||||||||||||
Securities available for sale: | ||||||||||||||||
Government agencies | $ | 22,873 | $ | 22,873 | $ | - | $ | - | ||||||||
Mortgage-backed securities | 110,853 | - | 110,853 | - | ||||||||||||
Municipal securities | 52,452 | - | 52,452 | - | ||||||||||||
Corporate bonds | 26,833 | - | 26,833 | - | ||||||||||||
Mortgage loans held for sale | 2,490 | - | 2,490 | - | ||||||||||||
Bank-owned life insurance | 17,653 | - | 17,653 | - | ||||||||||||
Total March 31, 2016 | $ | 233,154 | $ | 22,873 | $ | 210,281 | $ | - |
Description | December 31, 2015 | Level 1 | Level 2 | Level 3 | ||||||||||||
Securities available for sale: | ||||||||||||||||
Government agencies | $ | 31,385 | $ | 31,385 | $ | - | $ | - | ||||||||
Mortgage-backed securities | 131,684 | - | 131,684 | - | ||||||||||||
Municipal securities | 56,831 | - | 56,831 | - | ||||||||||||
Corporate bonds | 28,395 | - | 28,395 | - | ||||||||||||
Mortgage loans held for sale | 3,944 | - | 3,944 | - | ||||||||||||
Bank-owned life insurance | 15,635 | - | 15,635 | - | ||||||||||||
Interest rate swap | (394 | ) | - | (394 | ) | - | ||||||||||
Total December 31, 2015 | $ | 267,480 | $ | 31,385 | $ | 236,095 | $ | - |
Assets measured at fair value on a non-recurring basis as of March 31, 2016 and December 31, 2015:
Fair Value | Quoted Prices In Active Markets for Identical Assets | Significant Observable Inputs- Outputs | Significant Unobservable Inputs | |||||||||||||
(In thousands) | ||||||||||||||||
Description | March 31, 2016 | Level 1 | Level 2 | Level 3 | ||||||||||||
Impaired loans, net | $ | 14,020 | $ | - | $ | - | $ | 14,020 | ||||||||
Other real estate owned | 5,956 | - | - | 5,956 | ||||||||||||
Total March 31, 2016 | $ | 19,976 | $ | - | $ | - | $ | 19,976 |
Description | December 31, 2015 | Level 1 | Level 2 | Level 3 | ||||||||||||
Impaired loans, net | $ | 15,202 | $ | - | $ | - | $ | 15,202 | ||||||||
Other real estate owned | 6,125 | - | - | 6,125 | ||||||||||||
Total December 31, 2015 | $ | 21,327 | $ | - | $ | - | $ | 21,327 |
Impaired loans at March 31, 2016 and December 31, 2015 include $13.0 million and $14.2 million, respectively, of loans identified as impaired, even though an impairment analysis calculated pursuant to ASC 310-10-35 resulted in no allowance.
Impaired loans where a write down is taken based on fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Bank records the impaired loan as non-recurring Level 3. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Bank classifies the impaired loan as non-recurring Level 3.
26 |
17. Fair Value Measurement (Continued)
OREO is recorded at fair value upon transfer of the loans to foreclosed assets, based on the appraised market value of the property. OREO is reviewed quarterly and values are adjusted as determined appropriate. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When an appraised value is not available or management determines the fair value of the collateral is impaired below the appraised value and there is no observable market price, the Bank classifies the foreclosed asset as non-recurring Level 3. Fair value adjustments of $7,209 and $44,228 were made to OREO during the three months ended March 31, 2016 and 2015, respectively.
No liabilities were measured at fair value on a recurring or non-recurring basis as of March 31, 2016 or December 31, 2015.
18. Fair Value of Financial Instruments. The following table represents the recorded carrying values, estimated fair values and fair value hierarchy within which the fair value measurements of the Company’s financial instruments are categorized at March 31, 2016 and December 31, 2015:
Level in | March 31, 2016 | December 31, 2015 | ||||||||||||||||
Fair Value | Estimated | Carrying | Estimated | Carrying | ||||||||||||||
Hierarchy | Fair Value | Amount | Fair Value | Amount | ||||||||||||||
(In thousands) | ||||||||||||||||||
Financial assets: | ||||||||||||||||||
Cash and due from banks | Level 1 | $ | 17,729 | $ | 17,729 | $ | 19,426 | $ | 19,426 | |||||||||
Interest-bearing deposits in other banks | Level 1 | 18,386 | 18,386 | 18,566 | 18,566 | |||||||||||||
Securities available for sale | Level 1 | 22,873 | 22,873 | 31,385 | 31,385 | |||||||||||||
Securities available for sale | Level 2 | 190,138 | 190,138 | 216,910 | 216,910 | |||||||||||||
Securities held to maturity | Level 2 | 512 | 509 | 510 | 508 | |||||||||||||
Loans held for sale | Level 2 | 2,490 | 2,490 | 3,944 | 3,944 | |||||||||||||
Loans and leases HFI, net, less impaired loans | Level 2 | 623,762 | 616,890 | 586,494 | 583,946 | |||||||||||||
Stock in FHLB of Atlanta | Level 2 | 1,829 | 1,829 | 2,369 | 2,369 | |||||||||||||
Accrued interest receivable | Level 2 | 2,846 | 2,846 | 2,875 | 2,875 | |||||||||||||
Interest rate swap | Level 2 | - | - | (394 | ) | (394 | ) | |||||||||||
Bank-owned life insurance | Level 2 | 17,653 | 17,653 | 15,635 | 15,635 | |||||||||||||
Impaired loans HFI, net | Level 3 | 14,020 | 14,020 | 15,202 | 15,202 | |||||||||||||
Mortgage servicing rights | Level 3 | 2,122 | 1,247 | 2,301 | 1,266 | |||||||||||||
Financial liabilities: | ||||||||||||||||||
Deposits | Level 2 | $ | 819,456 | $ | 818,667 | $ | 811,089 | $ | 811,322 | |||||||||
Junior subordinated debentures | Level 2 | 10,310 | 10,310 | 10,310 | 10,310 |
Fair values of financial assets and liabilities have been estimated using data which management considers as the best available, and estimation methodologies deemed suitable for the pertinent category of financial instrument. With regard to financial instruments with off-balance sheet risk, it is not practicable to estimate the fair value of future financing commitments. The estimation methodologies used by the Bank are as follows:
Financial assets:
Cash and Due from Banks and Interest –Bearing Deposits in Other Banks: The carrying amounts for cash and due from banks and interest bearing deposits in other banks are equal to their fair value. Fair value hierarchy Input level 1.
Investment Securities Available for Sale and Held to Maturity: The estimated fair value of investment securities is provided in Note 2 of the Notes to Consolidated Financial Statements. These are based on quoted market prices, when available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Fair value hierarchy Input levels 1 and 2.
Loans Held for Sale. The estimated fair value of loans held for sale is based on commitments from investors within the secondary market for loans with similar characteristics. Fair value hierarchy Input level 2.
Loans and Leases Held for Investment, net, less Impaired Loans: Fair values are estimated for portfolios of loans and leases held for investment with similar financial characteristics. Loans and leases are segregated by collateral type and by fixed and variable interest rate terms. The fair value of each category is determined by discounting scheduled future cash flows using current interest rates offered on loans or leases with similar characteristics. Fair value hierarchy Input level 2.
Stock in Federal Home Loan Bank of Atlanta: The fair value for FHLB stock approximates carrying value, based on the redemption provisions of the Federal Home Loan Bank. Fair value hierarchy Input level 2.
Accrued Interest Receivable: The carrying amount of accrued interest receivable approximates fair value because of the short maturities of these instruments. Fair value hierarchy Input level 2.
27 |
18. Fair Value of Financial Instruments (Continued)
Interest Rate Swap: The Company has entered into a pay-fixed receive-floating swap to hedge our $10.0 million of floating rate Trust Preferred debt. The primary objective of the swap is to minimize future interest rate risk. The effective date of the swap is December 30, 2014. Fair value hierarchy Input level 2.
Bank-Owned Life Insurance: The carrying value of bank-owned life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the issuer. Fair value hierarchy Input level 2.
Impaired Loans Held for Investment, Net: Fair values for impaired loans and leases are estimated based on discounted cash flows or underlying collateral values, where applicable. Fair value hierarchy Input Level 3.
Mortgage Servicing Rights (“MSRs”): The fair value of MSRs is estimated for those loans sold with servicing retained. The loans are stratified into pools by product type and within product type by interest rate and maturity. The fair value of the MSR is based upon the present value of estimated future cash flows using current market assumptions for prepayments, servicing costs and other factors. Fair value hierarchy Input level 3.
Financial liabilities:
Deposits: The fair value of demand deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated using rates currently offered for similar instruments with similar remaining maturities. Fair value hierarchy Input level 2.
Junior Subordinated Debentures: The carrying amount of junior subordinated debentures approximates fair value of similar instruments with similar characteristics and remaining maturities. Fair value hierarchy Input level 2.
19. Interest Rate Hedging. The Company has executed certain strategies targeted at hedging the impact of rising interest rates on its future earnings. The Company has entered into a pay-fixed receive-floating swap to hedge our $10.0 million of floating rate Trust Preferred debt. The primary objective of the swap is to minimize future interest rate risk. The effective date of the swap was December 30, 2014, and it has a five year term.
20. Recent Accounting Pronouncements. The following are Accounting Standards Updates (“ASU”) recently issued by the Financial Accounting Standards Board (“the FASB”) and their expected impact on the Company. Other accounting standards issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. This ASU was developed as a joint project with the International Accounting Standards Board to remove inconsistencies in revenue requirements and provide a more robust framework for addressing revenue issues. The ASU’s core principle is that an entity should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. ASU 2015-14, issued in August 2015, amended the effective date of this ASU to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This ASU provides U.S. GAAP guidance on management’s responsibility in evaluating whether there is substantial doubt about a company’s ability to continue as a going concern and related footnote disclosures. For each reporting period, management will be required to evaluate whether there are conditions or events that raise substantial doubt about a company’s ability to continue as a going concern within one year from the date the financial statements are issued. This ASU is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes. Topic 740, Income Taxes, requires an entity to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classified statement of financial position. Deferred tax liabilities and assets are classified as current or noncurrent based on the classification of the related asset or liability for financial reporting. Deferred tax liabilities and assets that are not related to an asset or liability for financial reporting are classified according to the expected reversal date of the temporary difference. To simplify the presentation of deferred income taxes, the amendments in this ASU require that deferred income tax liabilities and assets be classified as noncurrent in a classified statement of financial position. For public entities, this ASU is effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The Company does not expect this ASU to have a material impact on its consolidated financial statements, as it does not have a classified balance sheet.
28 |
20. Recent Accounting Pronouncements (Continued)
In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities. The amendments in this ASU require all equity investments to be measured at fair value with changes in the fair value recognized through net income (other than those accounted for under the equity method of accounting or those that result in consolidation of the investee). The amendments in this ASU also require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. In addition, the amendments in this ASU eliminate the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities and the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet for public business entities. For public entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This ASU created Topic 842 (Leases), and superseded the leases requirements in Topic 840 (Leases). Topic 842 specifies the accounting for leases. The objective of Topic 842 is to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease. Under the new guidance, a lessee will be required to recognize assets and liabilities for leases with lease terms of more than 12 months. The recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee will depend on its classification as a finance or operating lease. This ASU will require both types of leases to be recognized on the balance sheet. For public entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-05, Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships. The term novation refers to replacing one counterparty to a derivative instrument with a new counterparty. That change occurs for a variety of reasons, including financial institution mergers, intercompany transactions, an entity exiting a particular derivatives business or relationship, an entity managing against internal credit limits, or in response to laws or regulatory requirements. The amendments in this ASU clarify that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under Topic 815 (Derivatives and Hedging), does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. For public entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-06, Contingent Put and Call Options in Debt Instruments. Topic 815 requires that embedded derivatives be separated from the host contract and accounted for separately as derivatives if certain criteria are met, including the “clearly and closely related” criterion. This ASU clarifies the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. An entity performing the assessment under the amendments is required to assess the embedded call (put) options solely in accordance with the four-step decision sequence. The amendments in this ASU apply to all entities that are issuers of or investors in debt instruments (or hybrid financial instruments that are determined to have a debt host) with embedded call (put) options. For public entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-07, Simplifying the Transition to the Equity Method of Accounting. To simplify the accounting for equity method investments, the amendments in the ASU eliminate the requirement in Topic 323 (Investments-Equity Method and Joint Ventures) that an entity retroactively adopt the equity method of accounting if an investment qualifies for use of the equity method as a result of an increase in the level of ownership or degree of influence. The amendments in this ASU require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. The amendments in this ASU also require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. The amendments in this ASU are effective for all entities for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net). The amendments in this ASU affect entities with transactions included within the scope of Topic 606 (Revenue from Contracts with Customers). The scope of Topic 606 includes entities that enter into contracts with customers to transfer goods or services (that are an output of the entity’s ordinary activities) in exchange for consideration. The amendments in this ASU clarify the implementation guidance on principal versus agent considerations. The effective date and transition requirements for this ASU are the same as the effective date of ASU 2014-9 above. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
29 |
In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. This ASU was issued as part of an initiative to reduce complexity in accounting standards. The areas for simplification in this ASU involve several aspects of the accounting for employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Some of the areas for simplification apply only to nonpublic entities. In addition, the amendments in this ASU eliminate the guidance in Topic 718 (Compensation-Stock Compensation) that was indefinitely deferred shortly after the issuance of FASB Statement No. 123 (revised 2004), Share-Based Payment. For public entities, the amendments in this ASU are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In April 2016, the FASB issued ASU 2016-10, Identifying Performance Obligations and Licensing. The amendments in this ASU affect entities with transactions included within the scope of Topic 606 noted above. This ASU clarifies guidance related to identifying performance obligations and licensing implementation guidance contained in the new revenue recognition standard. The ASU seeks to proactively address areas in which diversity in practice potentially could arise, as well as to reduce the cost and complexity of applying certain aspects of the guidance both at implementation and on an ongoing basis. The effective date and transition requirements for this ASU are the same as the effective date and transition requirements in Topic 606 (and any other Topic amended by ASU 2014-9 above). The Company will evaluate the impact this ASU may have on its consolidated financial statements.
21. Subsequent Events. We have evaluated subsequent events after March 31, 2016, and concluded that no material transactions occurred, that provided additional evidence about conditions that existed at or after March 31, 2016, that required adjustments to or disclosure in the Consolidated Financial Statements.
30 |
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
First South Bancorp, Inc. (the "Company") was formed for the purpose of issuing common stock and owning 100% of the stock of First South Bank (the "Bank") and operating through the Bank a commercial banking business. The discussion below focuses primarily on the Bank's results of operations. The Bank has one significant operating segment, providing commercial and retail banking services to its markets located in the state of North Carolina. The Company’s common stock is traded on the NASDAQ Global Select Market under the symbol "FSBK".
Comparison of Financial Condition at March 31, 2016, and December 31, 2015. Total assets were $940.1 million at March 31, 2016, compared to $946.3 million at December 31, 2015. Earning assets were $873.4 million at March 31, 2016, compared to $878.3 million at December 31, 2015. The ratio of earning assets to total assets was 92.9% and 92.8% at March 31, 2016 and December 31, 2015, respectively.
Interest-bearing deposits with banks were $18.4 million at March 31, 2016, compared to $18.6 million at December 31, 2015. Overnight deposits are available to fund securities purchases, loan originations, deposit withdrawals, liquidity management activities and daily operations of the Bank.
The investment securities portfolio declined to $213.5 million at March 31, 2016, from $248.8 million at December 31, 2015. This reduction was the result of cash flows from scheduled amortization, calls and maturities, as well as sales of securities available-for-sale, with the proceeds used to support growth in loan portfolio. During the quarter ended March 31, 2016, we sold $30.4 million of investment securities to fund growth in our loans and leases held for investment. The Bank may also sell investment securities to manage sensitivity to future interest rate changes. See “Note 4. Investment Securities” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Loans held for sale totaled $2.5 million at March 31, 2016, compared to $3.9 million at December 31, 2015, reflecting the net effect of current period mortgage lending activity. During the three months ended March 31, 2016, there were $5.6 million of loan sales, $3.9 million of loan originations net of principal payments and $216,000 of net realized gains. Proceeds from mortgage loan sales are primarily used to fund the Bank’s liquidity needs, including loan originations, deposit withdrawals and general bank operations. Loans serviced for others were $293.5 million at March 31, 2016, compared to $297.5 million at December 31, 2015, as principal repayments exceeded the volume of new loans sold service retained. See “Note 5. Loans Held for Sale” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Total loans and leases held for investment grew by $32.0 million during the current quarter. As a result of this net growth, total loans and leases held for investment increased to $639.0 million at March 31, 2016, from $607.0 million at December 31, 2015. During the three months ended March 31, 2016, there were $32.4 million of originations net of principal payments and $357,000 of transfers to OREO.
Improving asset quality metrics continues as a key component of the Bank’s short-term and long-term performance objectives. Loans held for investment on nonaccrual status, including troubled debt restructurings (“TDRs”) on nonaccrual status declined to $2.8 million at March 31, 2016, from $3.2 million at December 31, 2015. The decline in non-accrual loans reflects management’s resolution of nonaccrual loan relationships during the current period. The ratio of loans held for investment on nonaccrual status to total loans held for investment was 0.44% at March 31, 2016, compared to 0.53% at December 31, 2016.
Loans are generally placed on nonaccrual status and accrued unpaid interest is reversed when management determines that collectability of interest, but not necessarily principal, is doubtful. This generally occurs when payments are delinquent in excess of 90 days. Consumer loans more than 180 days past due are generally charged off or a specific allowance is provided for any expected loss. All other loans are charged off when management concludes that they are uncollectible. Management has thoroughly evaluated all nonperforming loans and believes they are either well collateralized or adequately reserved. However, there can be no assurance in the future that regulators, increased volume and risks in the loan portfolio, adverse changes in economic conditions or other factors will not require additional adjustments to the allowance for loan and lease losses. Aside from the loans identified on nonaccrual status, there were no loans at March 31, 2016 where known information about possible credit problems of borrowers caused management to have serious concerns as to the ability of the borrowers to comply with their current loan repayment terms.
31 |
The Bank maintains the allowance for loan and lease losses (“ALLL”) at levels management believes is adequate to absorb probable losses inherent in the loan and lease portfolio. The Bank has developed policies and procedures for assessing the adequacy of the ALLL that reflect the assessment of credit risk and impairment analysis. This assessment includes a quarterly analysis of qualitative and quantitative trends in the levels of classified loans. In developing this analysis, the Bank relies on historical loss experience, estimates and exercises judgment in assessing credit risk. Future assessments of credit risk may yield different results, depending on changes in the qualitative and quantitative trends, which may require adjustments in the ALLL.
The Bank uses various modeling, calculation methods and estimation tools for measuring credit risk and performing impairment analysis, which is the basis used in developing the ALLL. The factors supporting the ALLL do not diminish the fact that the entire ALLL is available to absorb probable losses in the loan and lease portfolio. The Bank’s principal focus is on the adequacy of the ALLL. Based on the overall credit quality of the loan and lease portfolio, management believes the ALLL is adequate and has been established pursuant to generally accepted accounting principles, and has taken into account the views of its regulators and the current economic environment.
The quarterly assessment of ALLL adequacy includes an analysis of actual historical loss percentages of both classified and pass loans, as well as qualitative risk factors allocated among specific categories of loans. In developing this analysis, the Bank relies on actual loss history for the most recent twelve quarters and uses management’s best judgment in assessing credit risk. The assessment of qualitative factors includes various subjective components assessed in terms of basis points used in determining the ALLL adequacy. The evaluation of qualitative risk factors will result in a positive or negative adjustment to the ALLL methodology. Adjustments for each qualitative risk component may range from +25 basis points to -10 basis points. A component score of 0 basis points indicates no effect on the ALLL. A component rating of +25 basis points indicates the assessed maximum potential of increased risk to the ALLL adequacy. A -10 basis point component rating indicates the most positive effect on the ALLL. There were no changes in accounting policy and methodology used to estimate the ALLL during the three months ended March 31, 2016.
The ALLL was $8.1 million at March 31, 2016, compared to $7.9 million at December 31, 2015. During the three months ended March 31, 2016, there were $225,000 of provision for credit losses and $44,000 of net recoveries. The ratio of the ALLL to loans and leases held for investment was 1.27% at March 31, 2016, compared to 1.30% at December 31, 2015. See “Note 7. Allowance for Loan and Lease Losses” of “Notes to Consolidated Financial Statements (Unaudited)”and “Critical Accounting Policies - Loan Impairment and Allowance for Loan and Lease Losses” for additional information.
Based on an impairment analysis of loans held for investment, there were $14.6 million of loans classified as impaired, net of $297,000 in write-downs at March 31, 2016, compared to $15.8 million classified as impaired, net of $358,000 in write-downs at December 31, 2015. At March 31, 2016 and December 31, 2015, the ALLL included $588,000 and $618,000 specifically provided for impaired loans, respectively.
A loan is considered impaired, based on current information and events, if it is probable that the Bank will be unable to collect scheduled payments of principal and interest when due according to the contractual terms of the loan arrangement. All collateral-dependent loans are measured for impairment based on the fair value of the collateral, while uncollateralized loans and other loans determined not to be collateral dependent are measured for impairment based on the present value of expected future cash flows discounted at the historical effective interest rate. The Bank uses several factors in determining if a loan is impaired. The internal asset classification procedures include a thorough review of significant loans and lending relationships and include the accumulation of related data. This data includes loan payments status, borrowers’ financial data and borrowers’ operating factors such as cash flows, operating income or loss, and various other matters. See “Note 6. Loans Held for Investment”, “Note 7. Allowance for Loan and Lease Losses” and “Note 8. Troubled Debt Restructurings” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
32 |
In determining the allowance for loan and lease losses, the Bank considers TDRs and subsequent defaults in restructuring in its estimate. As a result, the allowance may be increased, adjustments may be made in the allocation of the allowance, or charge-offs may be taken to further write down the carrying value of the loan. The Bank’s primary objective in granting concessions to borrowers having financial difficulties is an attempt to protect as much of its investment as possible. The Bank faces significant challenges when working with borrowers who are experiencing diminished operating cash flows, depreciated collateral values, or prolonged sales and rental absorption periods. While borrowers may experience deterioration in their financial condition, many continue to be creditworthy customers who have the willingness and capacity to repay their debts. In such cases, the Bank finds it mutually beneficial to work constructively with its borrowers, and that prudent restructurings are often in the best interest of the Bank and the borrower. The Bank offers a variety of TDR programs on a loan-by-loan basis in which, for economic or legal reasons related to an individual borrower’s financial condition, it grants a concession to the borrower that would not otherwise be considered. The restructuring of a troubled loan may include, but is not limited to any one or combination of the following: a modification of the loan terms such as a reduction of the contractual interest rate, principal, payment amount or accrued interest; an extension of the maturity date at a stated interest rate lower than the current market rate for a new debt with similar risks; a change in payment type, e.g. from principal and interest, to interest only with all principal and interest due at maturity; a substitution or acceptance of additional collateral; and a substitution or addition of new debtors for the original borrower.
The Bank’s restructuring success includes but is not limited to any one or combination of the following: improves the prospects for repayment of principal and interest; reduces the prospects of further write downs and charge-offs; reduces the prospects of potential additional foreclosures; helps borrowers to maintain a creditworthy status; and ultimately will reduce the volume of classified, criticized and/or non-accrual loans. The Bank identifies loans for potential restructuring on a loan-by-loan basis using a variety of sources which may include, but is not limited to any one or combination of the following: being approached or contacted by the borrower to modify loan terms; review of borrower’s financial statements indicates borrower may be experiencing financial difficulties; past due payment reports; loans extending past their stated maturity date; and non-accrual loan reports.
On a loan-by-loan basis, the Bank restructures loans that were either on non-accrual basis or on accrual basis prior to restructuring. If a loan was on nonaccrual basis prior to restructuring, it remains on nonaccrual basis until the borrower has demonstrated a willingness and ability to meet the terms and conditions of the restructuring and to make the restructured loan payments, generally for a period of at least six months. The Bank has not immediately placed any restructured loan on accrual status that was on nonaccrual status prior to restructuring. If a restructured loan was on accrual basis prior to restructuring and the Bank expects the borrower to perform to the terms and conditions of the loan after restructuring (i.e. the loan was current, on accrual basis, and the borrower has the ability to make the restructured loan payments), the loan remains on an accrual basis and placement on nonaccrual is not required. See “Note 8. Troubled Debt Restructurings” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
OREO acquired from foreclosures was $6.0 million at March 31, 2016, compared to $6.1 million at December 31, 2015. During the three months ended March 31, 2016, there were $519,000 of disposals, $7,000 of valuation adjustments and $357,000 of additions. OREO consists of residential and commercial properties, developed lots and raw land. The Bank believes the adjusted carrying values of these properties are representative of their fair market values, although there can be no assurances that ultimate sales will be equal to or greater than the carrying values. See “Note 9. Other Real Estate Owned” and “Note 17. Fair Value Measurement” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
The Bank’s investment in bank-owned life insurance (“BOLI”) increased to $17.7 million at March 31, 2016, from $15.6 million at December 31, 2015. The Bank’s investment returns from the BOLI are utilized to recover a portion of the cost of providing benefit plans to our employees.
Goodwill was $4.2 million at March 31, 2016 and December 31, 2015, respectively, and is not being amortized pursuant to provisions of financial accounting standards. The unamortized balance of the Company’s goodwill is tested for impairment annually. The Company’s most recent annual impairment test determined there was no goodwill impairment. Identifiable intangible assets were $1.8 million at March 31, 2016, compared to $1.9 million at December 31, 2015, reflecting the core deposit intangible associated with a prior period branch acquisition transaction, which is being amortized over a ten year period. See “Note 11. Goodwill and Other Intangibles” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Total deposits increased to $818.7 million at March 31, 2016, from $811.3 million at December 31, 2015. For the current three month period, non-maturity deposits (personal and business checking accounts and money market accounts) and savings accounts grew by $3.5 million to $554.8 million at March 31, 2016, from $551.3 million at December 31, 2015.
33 |
Certificates of deposit (“CDs”) grew by $3.8 million to $263.8 million at March 31, 2016, from $260.0 million at December 31, 2015. CDs represented 32.2% and 32.1% of total deposits at March 31, 2016 and December 31, 2015, respectively. The Bank attempts to manage its cost of deposits through a combination of monitoring the volume and pricing of new and maturing CDs and growth in non-maturity deposits, in relationship to current funding needs and market interest rates. See “Note 12. Deposits” of “Notes to Consolidated Financial Statements (Unaudited)” and “Interest Expense” below for additional information regarding deposits and the cost of funds.
FHLB borrowings declined to $21.5 million at March 31, 2016, from $37.0 million at December 31, 2015. The Bank may use FHLB borrowings as a funding source to provide an effective means of managing its overall cost of funds or to manage its exposure to interest rate risk. There were $10.3 million of junior subordinated debentures outstanding at both March 31, 2016 and December 31, 2015. See “Note 13. Borrowed Money” and “Note 14. Junior Subordinated Debentures” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Stockholders' equity increased $2.0 million to $84.2 million at March 31, 2016, from $82.2 million at December 31, 2015. This increase reflects the $1.5 million of net income earned for the quarter ended March 31, 2016 and a $764,000 increase in accumulated other comprehensive income resulting from the mark-to-market adjustment of the available-for-sale securities portfolio, net of $237,000 of dividends declared. There were 9,493,776 common shares outstanding at March 31, 2016, compared to 9,489,222 shares outstanding at December 31, 2015, reflecting the effect of 3,475 shares issued pursuant to the vesting of restricted stock awards and 1,079 shares issued pursuant to a stock option exercise during the current period. See "Consolidated Statements of Changes in Stockholders' Equity" for additional information.
Accumulated other comprehensive income increased to $3.2 million at March 31, 2016, from $2.4 million at December 31, 2015, reflecting an increase in the mark-to-market adjustment in net unrealized gains in the available-for-sale investment securities portfolio, based on current market prices. See “Consolidated Statements of Comprehensive Income” and “Note 3. Comprehensive Income and Accumulated Other Comprehensive Income” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
The tangible equity to assets ratio was 8.31% at March 31, 2016, compared to 8.04% at December 31, 2015. The tangible book value per common share increased to $8.23 at March 31, 2016, from $8.02 at December 31, 2015.
The Bank is subject to various regulatory capital requirements administered by its federal and state banking regulators. As of March 31, 2016, the Bank's regulatory capital ratios were in excess of all regulatory requirements and the Bank’s regulatory capital position is categorized as well capitalized. There are no conditions or events since March 31, 2016 that management believes have changed the Bank's well capitalized category. See “Note 15. Regulatory Capital” of “Notes to Consolidated Financial Statements (Unaudited)” and “Liquidity and Capital Resources” below for additional information.
34 |
Comparison of Operating Results – Three Months Ended March 31, 2016 and 2015.
General. Net income for the three months ended March 31, 2016 increased to $1.5 million, or $0.15 per diluted common share, from net income of $725,000, or $0.08 per diluted common share earned for the comparative three month period ended March 31, 2015. Net income for the three months ended March 31, 2015 reflects the impact of $425,000 of one-time pre-tax transaction expenses associated with the acquisition of nine branch offices from Bank of America (BOA) in mid-December of 2014.
Interest Income. Interest income increased to $8.7 million for the three months ended March 31, 2016, from $7.8 million for the three months ended March 31, 2015. The year-over-year growth in interest income is due primarily to changes in the composition and volume of our earning asset base, and an increase in yields on earning assets. The tax equivalent yield on average earning assets increased by 10 basis points to 4.07% for the three months ended March 31, 2016, from 3.97% for the three months ended March 31, 2015. Average earning assets increased to $865.5 million for the three months ended March 31, 2016, from $802.4 million for the comparative 2015 three month period.
Interest Expense. Interest expense increased to $882,000 for the three months ended March 31, 2016, from $708,000 for the three months ended March 31, 2015. Interest expense during the current period was primarily impacted by increased interest expense on deposits and borrowings, reflecting the growth in deposits and volume of FHLB borrowings discussed above.
The cost of average interest-bearing liabilities increased by 8 basis points to 0.52% for the three months ended March 31, 2016, from 0.44% for the three months ended March 31, 2015. The Bank’s cost of interest-bearing liabilities has been impacted by a combination of growth in lower cost non-maturity deposits and pricing of new and renewed CDs in the current interest rate environment.
Average interest-bearing liabilities increased to $685.1 million for the three months ended March 31, 2016, from $645.6 million for the comparable 2015 three month period. Average noninterest-bearing demand deposits increased to $163.3 million for the three months ended March 31, 2015, from $147.6 million for the comparable 2015 three month period.
Net Interest Income. Net interest income for the quarter ended March 31, 2016 increased to $7.8 million, from $7.1 million for the comparable 2015 three month period. The tax equivalent net interest margin increased to 3.66% for the current quarter, from 3.62% for the comparable 2015 quarter. Yields on earning assets have been impacted by renewal of existing loans and origination of new loans in a highly competitive, low interest rate environment. This impact has been mitigated by a significant change in the mix of our earning assets over comparative periods. On the liability side of the balance sheet, while we continue to seek expansion of our non-maturity deposit base, we have also taken steps to protect the Company from a rising rate environment by adding some longer-term funding.
Yield/Cost Analysis. Table 1 below contains comparative information relating to the Company’s average balance sheet and reflects the yield on average earning assets and the average cost of interest-bearing liabilities for the three months ended March 31, 2016 and 2015, presented on a tax equivalent yield basis. Tax equivalent yields related to certain investment securities exempt from federal income tax are stated on a fully taxable basis, using a 34% federal statutory tax rate and reduced by a disallowed portion of the tax exempt interest income. Average balances are derived from average daily balances. The interest rate spread represents the difference between the tax equivalent yield on average earning assets and the cost of average interest-bearing liabilities. The tax equivalent net interest margin represents tax adjusted net interest income divided by average earning assets.
35 |
Table 1 - Yield/Cost Analysis | Quarter Ended March 31, 2016 | Quarter Ended March 31, 2015 | ||||||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
Average | Average | |||||||||||||||||||||||
Average | Yield/ | Average | Yield/ | |||||||||||||||||||||
Balance | Interest | Cost | Balance | Interest | Cost | |||||||||||||||||||
Interest earning assets: | ||||||||||||||||||||||||
Loans receivable | $ | 621,345 | $ | 7,192 | 4.59 | % | $ | 489,583 | $ | 5,935 | 4.86 | % | ||||||||||||
Investments and deposits (1) | 244,118 | 1,480 | 2.73 | % | 312,804 | 1,830 | 2.59 | % | ||||||||||||||||
Total earning assets (1) | 865,463 | 8,672 | 4.07 | % | 802,387 | 7,765 | 3.97 | % | ||||||||||||||||
Nonearning assets | 73,239 | 77,177 | ||||||||||||||||||||||
Total assets | $ | 938,702 | $ | 879,564 | ||||||||||||||||||||
Interest bearing liabilities: | ||||||||||||||||||||||||
Deposits | $ | 641,460 | 669 | .42 | % | $ | 635,212 | 570 | .36 | % | ||||||||||||||
Borrowings | 33,313 | 73 | .87 | % | 54 | — | .38 | % | ||||||||||||||||
Junior subordinated debentures | 10,310 | 140 | 5.37 | % | 10,310 | 139 | 5.37 | % | ||||||||||||||||
Total interest-bearing liabilities | 685,083 | 882 | .52 | % | 645,576 | 709 | .44 | % | ||||||||||||||||
Noninterest bearing demand deposits | 163,269 | 0 | .00 | % | 147,559 | 0 | .00 | % | ||||||||||||||||
Total sources of funds | 848,352 | 882 | .42 | % | 793,135 | 709 | .36 | % | ||||||||||||||||
Other liabilities and stockholders’ equity: | ||||||||||||||||||||||||
Other liabilities | 6,085 | 5,549 | ||||||||||||||||||||||
Stockholders' equity | 84,265 | 81,880 | ||||||||||||||||||||||
Total liabilities and stockholders' equity | $ | 938,702 | $ | 879,564 | ||||||||||||||||||||
Net interest income | $ | 7,790 | $ | 7,056 | ||||||||||||||||||||
Interest rate spread (1) (2) | 3.55 | % | 3.53 | % | ||||||||||||||||||||
Net interest margin (1) (3) | 3.66 | % | 3.62 | % | ||||||||||||||||||||
Ratio of earning assets to interest bearing liabilities | 126.33 | % | 124.29 | % |
(1) | Yield shown as a tax-adjusted yield. |
(2) | Represents the difference between the average yield on earning assets and the average cost of funds. |
(3) | Represents net interest income divided by average earning assets. |
Provision for Credit Losses. The Bank's methodology for determining its provision for credit losses includes amounts specifically allocated to credits that are individually determined to be impaired and general provisions allocated to groups of loans that have not been individually assessed for impairment. The Bank recorded $225,000 of provision for credit losses in the three months ended March 31, 2016, compared to none recorded in the three months ended March 31, 2015. The increase in provision for credit losses is primarily attributable to support the $32.0 million net growth in loans held for investment during the current quarter. Provision for credit losses is necessary to maintain the ALLL at a level that management believes is adequate to absorb probable future losses in the loan and lease portfolio. See “Note 7. Allowance for Loan and Lease Losses” of “Notes to Consolidated Financial Statements (Unaudited)” and “Allowance for Loan and Lease Losses” and “Critical Accounting Policies - Loan Impairment and Allowance for Loan and Lease Losses” for additional information.
Noninterest Income. Total noninterest income increased to $3.6 million for the three months ended March 31, 2016, from $3.2 million for the comparable 2015 three month period. Noninterest income consists of deposit fees and service charges; loan fees and charges; mortgage loan servicing fees; gain on sale and other fees on mortgage loans, gain on investment securities and OREO sales; and other miscellaneous income. Fees and service charges on deposits, and fees on loans and loan servicing fees earned during each period are influenced by the volume of deposits and loans outstanding, the volume of the various types of deposit and loan account transactions processed, the volume of loans serviced for others and the collection of related fees and service charges.
Service charges and fees remained relatively consistent at $2.0 million for the three months ended March 31, 2016 and $1.9 million for the comparable 2015 three month period. The current volume of service charges and fees has been enhanced by the BOA branch acquisition transaction. We anticipate additional service charge revenue from deposits going forward, as we focus on growing our core deposit base through new customer acquisition, cross-selling to existing customers and offering new revenue generating products.
36 |
Total non-interest income generated from the sale and servicing of mortgage loans and loan fees increased to $648,000 for the three months ended March 31, 2016, from $624,000 for the comparable 2015 three month period. Revenue from mortgage banking in the first quarter of 2016 was primarily driven by mortgage applications taken in the last two months of 2015 and the first month of 2016. Application volume decreased during that period due to a temporary spike in long term rates. We continue to explore various strategies to enhance our non-interest income, including the purchasing of mortgage servicing rights.
Net gains from investment securities sales increased to $284,000 for the first quarter of 2016, from $251,000 for the comparable 2015 first quarter. During the first quarter of 2016, $30.4 million of investment securities were sold primarily to fund the growth in loans held for investment as discussed above.
Sales of OREO properties resulted in a $12,000 net loss for the first quarter of 2016, compared to a net gain of $46,000 for the 2015 first quarter, as the Bank continues in its efforts of disposing of these nonperforming assets. See “Note 9. Other Real Estate Owned” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Other non-interest income for the first quarter of 2016 totaled $692,000, which includes a $230,000 non-recurring item as well as $144,000 of Small Business Administration (“SBA”) related revenue. While the Bank has made SBA loans in the past, we only recently began the process of actively selling and servicing these credits. Other non-interest income totaled $334,000 for the comparative first quarter of 2015. Also included in other non-interest income is revenue from investments in BOLI of $135,000 for the first quarter of 2016, compared to $127,000 for the 2015 first quarter.
Total core non-interest income, excluding net gains from securities and OREO sales, and the non-recurring item, improved to $3.1 million for the first quarter of 2016, from $2.9 million for the 2015 first quarter.
Noninterest Expense. Total noninterest expense declined to $9.1 million for the three months ended March 31, 2016, from $9.3 million for the comparable 2015 three month period.
Compensation and benefit expenses, the largest component of non-interest expenses, increased to $5.0 million for the first quarter of 2016, from $4.7 million for the 2015 first quarter. First quarter 2016 expenses included $65,000 of severance costs associated with branch consolidations during the period. The Bank will continue to manage staffing levels to ensure we meet the ongoing needs of our customers and to support our future growth.
FDIC insurance premiums increased to $162,000 for the first quarter of 2016, from $133,000 for the 2015 first quarter, reflecting period over period balance sheet growth. Recently announced changes in the FDIC insurance premium calculation should have a positive impact on these expenses going forward.
Premises and equipment expense remained consistent at $1.4 million for both the first quarter of 2016 and the first quarter of 2015. Premises and equipment costs for the first quarter of 2015 included $57,000 of one-time acquisition expenses. During the first quarter of 2016, we consolidated three branch locations with other nearby facilities. While branch consolidations typically result in some customer loss, particularly with cash intensive customers, our retention rate is very high due to the relationships we have built and our electronic banking capabilities. We continue to strive to enhance our operating leverage and further improve efficiency.
Advertising expense increased to $188,000 for the first quarter of 2016, from $163,000 for the 2015 first quarter. Advertising expense for the 2015 first quarter included $15,000 of one-time acquisition expenses. Over the past fifteen months, the Bank has increased marketing expense to enhance its brand awareness throughout our footprint and more specifically in the new markets. We anticipate that marketing expenses will remain at or below current levels as we look to take a more product targeted approach.
Data processing costs declined to $796,000 for the first quarter of 2016, from $1.1 million for the 2015 first quarter. Data processing expense for the 2015 first quarter included $173,000 of one-time acquisition expenses. Data processing costs fluctuate in conjunction with changes in the number of customer accounts and transaction activity volumes.
Total amortization of intangible assets, including mortgage servicing rights and identifiable intangible assets, was $132,000 for the first quarter of 2016, compared to $127,000 for the 2015 first quarter. Amortization of mortgage servicing rights was $60,000 the first quarter of 2016, compared to $56,000 for the 2015 first quarter. Amortization of the Company’s core deposit intangible, which is the only identifiable intangible asset subject to amortization, was $71,000 the first quarter of 2016, compared to $72,000 for the 2015 first quarter. See “Note 11. Goodwill and Other Intangibles” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
37 |
In conjunction with the decline in the Bank’s OREO, total expenses attributable to ongoing maintenance, property taxes and insurance, as well as valuation adjustments for OREO properties have also declined. These OREO expenses declined to $94,000 for the 2016 first quarter, from $207,000 for the comparative 2015 first quarter.
Other non-interest expense was $1.3 million for the first quarter of 2016, compared to $1.4 million for the 2015 first quarter. As previously discussed, during the first quarter of 2016 the Bank consolidated three existing branches into nearby locations. Of the locations that were consolidated, two of the facilities are leased and the third is owned. The Bank has entered into a contract to sell the owned location and realized an $85,000 pre-tax loss, which is included in other expense during the current period. Other expense for the 2015 first quarter included $180,000 of one-time acquisition expenses.
Income tax expense increased to $574,000 for the first quarter of 2016, from $257,000 for the 2015 first quarter. The effective income tax rates were 28.20% for the first quarter of 2016, compared to 26.15% for the 2015 first quarter. The Bank’s investment in BOLI and tax-exempt municipal bonds contribute to more favorable effective income tax rates, which has been partially offset by the strong growth in the loan portfolio. See “Critical Accounting Policies” below for additional information.
Key Performance Ratios. Some of our key performance ratios are return on average assets (ROA), return on average equity (ROE) and the efficiency ratio. ROA increased to 0.63% for the first quarter of 2016, from 0.33% for the 2015 first quarter. ROE increased to 6.97% for the first quarter of 2016, from 3.61% for the 2015 first quarter. The efficiency ratio (noninterest expenses as a percentage of net interest income plus noninterest income) improved to 80.74% for the first quarter of 2016, from 91.30% for the 2015 first quarter. The efficiency ratio measures the proportion of net operating revenues that are absorbed by overhead expenses and has elevated over the course of the last twelve months due primarily to franchise expansion. We anticipate the efficiency ratio to improve as we continue to execute on the branch acquisition strategy and explore opportunities to increase operating leverage and gain efficiencies from our branch network.
Liquidity and Capital Resources. Liquidity generally refers to the Bank's ability to generate adequate amounts of funds to meet its cash needs. Adequate liquidity guarantees that sufficient funds are available to meet deposit withdrawals, fund future loan commitments, maintain adequate reserve requirements, pay operating expenses, provide funds for debt service, and meet other general commitments. FDIC policy requires banks to maintain an average daily balance of liquid assets in an amount which it deems adequate to protect the safety and soundness of the bank. The FDIC currently has no specific level which it requires.
At March 31, 2016, the Bank had cash, deposits in banks, investment securities and loans held for sale totaling $252.1 million, compared to $290.7 million at December 31, 2015. The Bank calculates its liquidity position under policy guidelines based on liquid assets in relationship to deposits and short-term borrowings. Based on its calculation guidelines, the Bank’s liquidity ratio was 29.5% at March 31, 2016, compared to 33.8% at December 31, 2015, which management believes is more than adequate.
The Bank believes it can meet future liquidity needs with existing funding sources. The Bank's primary sources of funds are deposits, principal payments on loans and mortgage-backed securities, earnings and funds provided from operations, the ability to borrow from the FHLB of Atlanta and other lines of credit, and the availability of loans and investment securities available for sale. At March 31, 2016, the Bank had $236.4 million of credit availability with the FHLB, of which there was lendable collateral value totaling $174.1 million. Additional collateral would be required in order to access total borrowings up to the credit availability limit. In addition, at March 31, 2016, the Bank had additional capacity to borrow $75.9 million from the FRB Discount Window and $70.0 million of pre-approved, but unused lines of credit.
The FDIC requires the Bank to meet the following minimum capital requirements: total risk-based capital, Tier 1 risk-based capital, leverage capital and common equity Tier 1 risk-based capital. The required minimum capital ratios are as follows: Total capital ratio of 8% of risk-weighted assets; Tier 1 capital ratio of 6% of risk-weighted assets; Leverage ratio of 4% of average total assets; and Common equity Tier 1 capital ratio of 4.5% of risk-weighted assets. The Bank was in compliance with all regulatory capital requirements at March 31, 2016, and December 31, 2015. See “Note 15. Regulatory Capital” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
38 |
Critical Accounting Policies. The Company has identified the policies below as critical to its business operations and the understanding of its results of operations. The impact and any associated risks related to these policies on the Company’s business operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect reported and expected financial results.
Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. Estimates affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Loan Impairment and Allowance for Loan and Lease Losses. A loan or lease is considered impaired, based on current information and events, if it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease agreement. Uncollateralized loans are measured for impairment based on the present value of expected future cash flows discounted at the historical effective interest rate, while all collateral-dependent loans are measured for impairment based on the fair value of the collateral. The Bank uses several factors in determining if a loan or lease is impaired. The internal asset classification procedures include a thorough review of significant loans, leases and lending relationships and include the accumulation of related data. This data includes loan and lease payment status, borrowers' financial data and borrowers' operating factors such as cash flows, operating income or loss, etc.
The ALLL is increased by charges to income and decreased by charge-offs, net of recoveries. Management's periodic evaluation of the adequacy of the ALLL is based on past loan and lease loss experience, known and inherent risks in loans and leases and unfunded loan commitments, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, and current economic conditions. While management believes that it has established the ALLL in accordance with accounting principles generally accepted in the United States of America and has taken into account the views of its regulators and the current economic environment, there can be no assurance in the future that regulators or risks in its loans and leases portfolio will not require additional adjustments to the ALLL.
Income Taxes. Deferred tax asset and liability balances are determined by application to temporary differences in the tax rate expected to be in effect when taxes will become payable or receivable. Temporary differences are differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that will result in taxable or deductible amounts in future years. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.
Off-Balance Sheet Arrangements. The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and involve elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company's exposure to credit loss in the event of non-performance by a party to a financial instrument for commitments to extend credit, is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Forward Looking Statements. The Private Securities Litigation Reform Act of 1995 states that disclosure of forward looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward looking statements by corporate management. This Form 10-Q, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward looking statements that involve risk and uncertainty. In order to comply with the terms of the safe harbor, the Company notes that a variety of risks and uncertainties could cause its actual results and experience to differ materially from anticipated results or other expectations expressed in the Company's forward looking statements. There are risks and uncertainties that may affect the operations, performance, development, growth projections and results of the Company's business. They include, but are not limited to, economic growth, interest rate movements, timely development of technology enhancements for products, services and operating systems, the impact of competitive products, services and pricing, customer requirements, regulatory changes and similar matters. Readers of this report are cautioned not to place undue reliance on forward looking statements that are subject to influence by these risk factors and unanticipated events, as actual results may differ materially from management's expectations.
39 |
Item 3. Quantitative and Qualitative Disclosures about Market Risk. Smaller reporting companies are not required to provide information required by this item.
Item 4. Controls and Procedures. As of the end of the period covered by this report, management of the Company carried out an evaluation, under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures. Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. It should be noted that the design of the Company’s disclosure controls and procedures is based in part upon certain reasonable assumptions about the likelihood of future events, and there can be no reasonable assurance that any design of disclosure controls and procedures will succeed in achieving its stated goals under all potential future conditions, regardless of how remote, but the Company’s principal executive and financial officers have concluded that the Company’s disclosure controls and procedures are, in fact, effective at a reasonable assurance level.
In addition, there have been no changes in the Company’s internal control over financial reporting (to the extent that elements of internal control over financial reporting are subsumed within disclosure controls and procedures) identified in connection with the evaluation described in the above paragraph that occurred during the Company’s last fiscal quarter, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item l. Legal Proceedings: The Company is currently not engaged in any material legal proceedings. From time to time, the Bank is a party to legal proceedings within the ordinary course of business wherein it enforces its security interest in loans, and other matters of similar nature.
Item 1A. Risk Factors: Smaller reporting companies are not required to provide information required by this item.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds: Not applicable
Item 3. Defaults Upon Senior Securities: Not applicable
Item 4. Mine Safety Disclosures: Not applicable.
Item 5. Other Information: Not applicable
Item 6. Exhibits: The following exhibits are filed herewith:
Number | Title | |
31.1 | Rule 13a-14(a) Certification of Chief Executive Officer | |
31.2 | Rule 13a-14(a) Certification of Chief Financial Officer | |
32 | Section 1350 Certification | |
101 | Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Statements of Financial Condition as of March 31, 2016 (unaudited) and December 31, 2015; (ii) Consolidated Statements of Operations for the Three Months Ended March 31, 2016 and 2015 (unaudited); (iii) Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2016 and 2015 (unaudited); (iv) Consolidated Statements of Changes in Stockholders’ Equity for the Three Months Ended March 31, 2016 and 2015 (unaudited); (v) Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2016 and 2015 (unaudited); and (vi) Notes to Consolidated Financial Statements (unaudited) as of March 31, 2016 and December 31, 2015, and for the Three Months Ended March 31, 2016 and 2015. |
40 |
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.
FIRST SOUTH BANCORP, INC. | |||
By: | /s/ Scott C. McLean | ||
Scott C. McLean | |||
Executive Vice President | |||
Chief Financial Officer | |||
(Principal Financial and Accounting Officer) | |||
Date: May 13, 2016 |
41 |