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EX-32 - FIRST COMMUNITY CORP /SC/e00583_ex32.htm
EX-31.2 - FIRST COMMUNITY CORP /SC/e00583_ex31-2.htm
EX-31.1 - FIRST COMMUNITY CORP /SC/e00583_ex31-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

xQuarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 2016
oTransition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ________ to ________

 

Commission File No. 000-28344

 

FIRST COMMUNITY CORPORATION
(Exact name of registrant as specified in its charter)
 
South Carolina 57-1010751

(State or other jurisdiction of incorporation

or organization)

(I.R.S. Employer Identification No.)
   

 5455 Sunset Boulevard, Lexington, South Carolina 29072

(Address of principal executive offices)   (Zip Code)

 

(803) 951-2265

(Registrant’s telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the 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  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).          x Yes o 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.

 

Large accelerated filer o Accelerated filer o Non-accelerated filer o Smaller reporting company x

 

Indicate by check mark whether the registrant is shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: On November 10, 2016, 6,703,317 shares of the issuer’s common stock, par value $1.00 per share, were issued and outstanding.

 
 

 TABLE OF CONTENTS

 

  Page
PART I - FINANCIAL INFORMATION 3
Item 1.   Financial Statements 3
  Consolidated Balance Sheets 4
  Consolidated Statements of Income 5
  Consolidated Statements of Comprehensive Income 6
  Consolidated Statements of Changes in Shareholders’ Equity 7
  Consolidated Statements of Cash Flows 8
  Notes to Consolidated Financial Statements 9
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 40
Item 3. Quantitative and Qualitative Disclosures About Market Risk   57
Item 4. Controls and Procedures 57
     
PART II – OTHER INFORMATION 58
Item 1. Legal Proceedings 58
Item 1A. Risk Factors 58
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 58
Item 3. Defaults Upon Senior Securities 58
Item 4. Mine Safety Disclosures 58
Item 5. Other Information 58
Item 6. Exhibits 58
     
SIGNATURES   59
INDEX TO EXHIBITS 60
EX-31.1 RULE 13A-14(A) CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER  
EX-31.2 RULE 13A-14(A) CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER  
EX-32 SECTION 1350 CERTIFICATIONS  
2
 

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

 

FIRST COMMUNITY CORPORATION
CONSOLIDATED BALANCE SHEETS

 

(Dollars in thousands, except par value)  September 30,
2016
   December 31,
2015
 
   (Unaudited)     
ASSETS          
Cash and due from banks  $13,751   $10,973 
Interest-bearing bank balances   24,345    11,375 
Federal funds sold and securities purchased under agreements to resell   599    593 
Investment securities - held to maturity   17,238    17,371 
Investment securities - available for sale   269,255    264,687 
Other investments, at cost   1,681    1,783 
Loans held for sale   4,250    2,962 
Loans   523,441    489,191 
Less,  allowance for loan losses   5,047    4,596 
   Net loans   518,394    484,595 
Property, furniture and equipment - net   29,951    29,929 
Land held for sale   1,055    1,080 
Bank owned life insurance   20,755    20,301 
Other real estate owned   1,198    2,458 
Intangible assets   1,177    1,419 
Goodwill   5,078    5,078 
Other assets   6,525    8,130 
    Total assets  $915,252   $862,734 
LIABILITIES          
Deposits:          
  Non-interest bearing  $177,267   $156,247 
  Interest bearing   588,656    559,904 
     Total deposits   765,923    716,151 
Securities sold under agreements to repurchase   22,232    21,033 
Federal Home Loan Bank advances   21,022    24,788 
Junior subordinated debt   14,964    14,964 
Other liabilities   6,903    6,760 
    Total liabilities   831,044    783,696 
            SHAREHOLDERS’ EQUITY          
Preferred stock, par value $1.00 per share, 10,000,000 shares authorized; none issued and outstanding        
Common stock, par value $1.00 per share; 10,000,000 shares authorized; issued and outstanding 6,703,317 at September 30, 2016 6,690,551 at December 31, 2015   6,703    6,690 
Common stock warrants issued   46    46 
Non-vested restricted stock   (313)   (297)
Additional paid in capital   75,921    75,761 
Accumulated deficit   (688)   (3,992)
Accumulated other comprehensive income   2,539    830 
    Total shareholders’ equity   84,208    79,038 
    Total liabilities and shareholders’ equity  $915,252   $862,734 

 

See Notes to Consolidated Financial Statements

3
 
FIRST COMMUNITY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME

 

   Nine   Nine 
   Months Ended   Months Ended 
   September 30,   September 30, 
   2016   2015 
(Dollars in thousands, except per share data)  (Unaudited)   (Unaudited) 
Interest income:          
  Loans, including fees  $17,582   $17,373 
  Taxable securities   2,903    2,771 
  Non taxable securities   1,428    1,216 
  Federal funds sold and securities purchased under resale agreements   56    22 
  Other   27    64 
       Total interest income   21,996    21,446 
Interest expense:          
  Deposits   1,358    1,304 
  Federal funds sold and securities sold under agreement to repurchase   32    26 
  Other borrowed money   941    1,211 
      Total interest expense   2,331    2,541 
Net interest income   19,665    18,905 
Provision for loan losses   536    990 
Net interest income after provision for loan losses   19,129    17,915 
Non-interest income:          
  Deposit service charges   1,064    1,083 
  Mortgage banking income   2,515    2,679 
  Investment advisory fees and non-deposit commissions   871    993 
  Gain on sale of securities   601    271 
  Gain (loss) on sale of other assets   (36)   24 
  Loss on early extinguishment of debt   (459)   (103)
  Other   2,184    1,928 
      Total non-interest income   6,740    6,875 
Non-interest expense:          
  Salaries and employee benefits   11,472    10,818 
  Occupancy   1,601    1,498 
  Equipment   1,308    1,233 
  Marketing and public relations   529    683 
  FDIC assessments   336    389 
  Other real estate expense   187    434 
  Amortization of intangibles   243    299 
  Other   3,582    3,202 
      Total non-interest expense   19,258    18,556 
Net income before tax   6,611    6,234 
Income taxes   1,721    1,708 
Net income  $4,890   $4,526 
           
Basic earnings per common share  $0.74   $0.69 
Diluted earnings per common share  $0.72   $0.68 

See Notes to Consolidated Financial Statements

4
 
FIRST COMMUNITY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME

 

   Three   Three 
   Months Ended   Months Ended 
   September 30,   September 30, 
   2016   2015 
(Dollars in thousands, except per share data)  (Unaudited)   (Unaudited) 
Interest income:          
  Loans, including fees  $5,977   $5,795 
  Taxable securities   944    860 
  Non taxable securities   445    430 
  Federal funds sold and securities purchased under resale agreements   24    8 
  Other   10    21 
       Total interest income   7,400    7,114 
Interest expense:          
  Deposits   465    443 
  Federal funds sold and securities sold under agreement to repurchase   12    11 
  Other borrowed money   272    407 
      Total interest expense   749    861 
Net interest income   6,651    6,253 
Provision for loan losses   179    193 
Net interest income after provision for loan losses   6,472    6,060 
Non-interest income:          
  Deposit service charges   377    390 
  Mortgage banking income   937    964 
  Investment advisory fees and non-deposit commissions   283    290 
  Gain on sale of securities   478     
  Gain on sale of other assets   45    17 
  Loss on early extinguishment of debt   (459)    
  Other   726    668 
      Total non-interest income   2,387    2,329 
Non-interest expense:          
  Salaries and employee benefits   3,888    3,595 
  Occupancy   531    513 
  Equipment   442    437 
  Marketing and public relations   240    129 
  FDIC assessment   60    113 
  Other real estate expense   115    126 
  Amortization of intangibles   80    98 
  Other   1,227    1,056 
      Total non-interest expense   6,583    6,067 
Net income before tax   2,276    2,322 
Income taxes   599    643 
Net income  $1,677   $1,679 
Basic earnings per common share  $0.26   $0.26 
Diluted earnings per common share  $0.25   $0.25 

 

See Notes to Consolidated Financial Statements    

5
 

FIRST COMMUNITY CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited) 

  

(Dollars in thousands)  Nine months ended September 30, 
   2016   2015 
Net income  $4,890   $4,526 
           
Other comprehensive income:          
Unrealized gain during the period on available-for-sale securities, net of taxes of $1,085 and $275, respectively   2,106    532 
           
Less: Reclassification adjustment for gain included in net income, net of taxes of $204 and $92, respectively   (397)   (179)
           
Other comprehensive income   1,709    353 
Comprehensive income  $6,599   $4,879 

 

(Dollars in thousands)  Three months ended September 30, 
   2016   2015 
         
Net income  $1,677   $1,679 
           
Other comprehensive income:          
Unrealized gain (loss) during the period on available-for-sale securities, net of taxes of $509 and $357, respectively   (989)   672 
           
Less: Reclassification adjustment for gain included in net income, net of taxes of $163 and $0, respectively   (315)    
           
Other comprehensive income (loss)   (1,304)   672 
Comprehensive income  $373   $2,351 

  

See Notes to Consolidated Financial Statements

6
 
FIRST COMMUNITY CORPORATION
Consolidated Statements of Changes in Shareholders’ Equity
Nine Months ended September 30, 2016 and September 30, 2015
(Unaudited)

 

(Dollars and shares in thousands)                          Accumulated     
           Common   Additional   Nonvested       Other     
   Shares   Common   Stock   Paid-in   Restricted   Accumulated   Comprehensive     
   Issued   Stock   Warrants   Capital   Stock   Deficit   Income (Loss)   Total 
Balance, December 31, 2014   6,664   $6,664   $48   $75,504   $(673)  $(8,286)  $1,271   $74,528 
Net income                            4,526         4,526 
Other comprehensive income net of tax of $183                                 353    353 
Issuance of restricted stock   13    13         137    (150)              
Restricted shares surrendered   (8)   (8)        (90)                  (98)
Amortization compensation restricted stock                       397              397 
Exercise of stock warrants   2    2    (2)                        
Dividends: Common ($0.21 per share)                            (1,371)        (1,371)
Dividend reinvestment plan   14    14         139                   153 
Balance, September 30, 2015   6,685   $6,685   $46   $75,690   $(426)  $(5,131)  $1,624   $78,488 
                                         
Balance, December 31, 2015   6,690   $6,690   $46   $75,761   $(297)  $(3,992)  $830   $79,038 
Net income                            4,890         4,890 
Other comprehensive income net of tax of $881                                 1,709    1,709 
Issuance of restricted stock   22    22         275    (297)              
Restricted shares surrendered   (26)   (26)        (327)                  (353)
Issuance of common stock   1    1         13                   14 
Amortization compensation restricted stock                       281              281 
Dividends: Common ($0.24 per share)                            (1,586)        (1,586)
Dividend reinvestment plan   16    16         199                   215 
Balance, September 30, 2016   6,703  $6,703   $46   $75,921   $(313)  $(688)  $2,539   $84,208 

 

See Notes to Consolidated Financial Statements

7
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

 

   Nine months
ended September 30,
 
(Dollars in thousands)  2016   2015 
Cash flows from operating activities:          
Net income  $4,890   $4,526 
Adjustments to reconcile net income to net cash provided from operating activities:          
       Depreciation   994    932 
       Premium amortization   3,044    3,093 
       Provision for loan losses   536    990 
       Writedowns of other real estate owned   76    201 
       Loss (gain) on sale of other real estate owned   36    (24)
       Sale of loans held-for-sale   69,880    80,571 
       Originations of loans held-for-sale   (71,169)   (80,016)
       Amortization of intangibles   243    299 
       Accretion on acquired loans   (804)   (709)
       Gain on sale of securities   601    271 
       Writedown of land held for sale   25    120 
       Loss on early extinguishment of debt   459    103 
       Decrease in other assets   343    1,305 
       Decrease in other liabilities   144    (153)
         Net cash provided from operating activities   8,096    10,967 
Cash flows from investing activities:          
Purchase of investment securities available-for-sale and other investments   (64,059)   (33,441)
Purchase of investment securities held-to-maturity       (6,065)
Maturity of investment securities available-for-sale   26,553    28,470 
Proceeds from sale of securities available-for-sale   33,215    17,061 
Proceeds from sale of other investments   486    1,133 
Increase in loans   (34,052)   (40,336)
Proceeds from sale of other real estate owned   1,597    479 
Purchase of property and equipment   (1,016)   (2,502)
         Net cash used in investing activities   (37,275)   (35,201)
Cash flows from financing activities:          
Increase in deposit accounts   49,711    34,871 
Increase in securities sold under agreements to repurchase   1,199    2,525 
Advances from the Federal Home Loan Bank   70,593    32,500 
Repayment of advances from Federal Home Loan Bank   (74,860)   (33,867)
Restricted shares surrendered   (353)   (98)
Issuance of common stock   14     
Dividends paid: Common Stock   (1,586)   (1,371)
Dividend reinvestment plan   215    153 
        Net cash provided from financing activities   44,933    34,713 
Net increase in cash and cash equivalents   15,754    10,479 
Cash and cash equivalents at beginning of period   22,941    22,532 
Cash and cash equivalents at end of period  $38,695   $33,011 
Supplemental disclosure:          
Cash paid during the period for:          
   Interest  $2,395   $2,566 
   Income taxes  $1,345   $2,220 
   Non-cash investing and financing activities:          
   Unrealized gain on securities  $1,709   $353 
   Transfer of loans to foreclosed property  $450   $193 

 

See Notes to Consolidated Financial Statements

8
 

FIRST COMMUNITY CORPORATION

  

Note 1 - Basis of Presentation

 

In the opinion of management, the accompanying unaudited consolidated balance sheets, and the consolidated statements of income, comprehensive income, changes in shareholders’ equity, and the cash flows of First Community Corporation (the “Company”), present fairly in all material respects the Company’s financial position at September 30, 2016 and December 31, 2015, and the Company’s results of operations and cash flows for the three and nine months ended September 30, 2016 and 2015. The results of operations for the three and nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.

 

In the opinion of management, all adjustments necessary to fairly present the consolidated financial position and consolidated results of operations have been made. All such adjustments are of a normal, recurring nature. All significant intercompany accounts and transactions have been eliminated in consolidation. The consolidated financial statements and notes thereto are presented in accordance with the instructions for Form 10-Q. The information included in the Company’s 2015 Annual Report on Form 10-K should be referred to in connection with these unaudited interim financial statements.   

9
 

Note 2 – Earnings Per Common Share

 

The following reconciles the numerator and denominator of the basic and diluted earnings per common share computation:

 

(In thousands except average market price)

 

   Nine months   Three months 
   Ended September 30,   Ended September 30, 
   2016   2015   2016   2015 
                 
Numerator (Net income)  $4,890   $4,526   $1,677   $1,679 
Denominator                    
Weighted average common shares outstanding for:                    
Basic earnings per share   6,583    6,554    6,573    6,584 
Dilutive securities:                    
Deferred compensation   39    38    42    38 
Warrants/Restricted stock – Treasury stock method   152    141    147    147 
Diluted earnings per share   6,774    6,733    6,762    6,769 
The average market price used in calculating assumed number of shares  $14.29   $14.00   $14.99   $14.00 

   

In the fourth quarter of 2011, we issued $2.5 million in 8.75% subordinated notes maturing December 16, 2019. On November 15, 2012, the subordinated notes were redeemed in full at par. Warrants for 107,500 shares of common stock at $5.90 per share were issued in connection with the issuance of the subordinated notes. At September 30, 2016 there were 97,180 warrants outstanding. These warrants expire on December 16, 2019 and are included in dilutive securities in the table above.

 

The Company has issued a total of 138,000 restricted shares to its employees and non-employee directors under the terms of its compensation plans and employment agreements. The employee shares cliff vest over a three-year period, and the non-employee director shares vest one year after issuance. The unrecognized compensation cost at September 30, 2016 for non-vested shares amounts to $313 thousand.

 

In 2006, the Company established a Non-Employee Director Deferred Compensation Plan, whereby a director may elect to defer all or any part of their annual retainer and monthly meeting fees payable with respect to service on the board of directors or a committee of the board. Units of common stock are credited to the director’s account at the time compensation is earned and are included in dilutive securities in the table above. At September 30, 2016 there were 99,638 units issued under the Plan. The accrued liability at September 30, 2016 amounted to $936.7 thousand and is included in “Other liabilities” on the balance sheet.

10
 

Note 3—Investment Securities

 

The amortized cost and estimated fair values of investment securities at September 30, 2016 and December 31, 2015 are summarized below:

AVAILABLE-FOR-SALE:

       Gross   Gross     
   Amortized   Unrealized   Unrealized     
(Dollars in thousands)  Cost   Gains   Losses   Fair Value 
September 30, 2016:                    
US Treasury securities  $1,540   $23   $   $1,563 
Government sponsored enterprises   956    70        1,026 
Mortgage-backed securities   153,070    1,588    420    154,238 
Small Business Administration pools   53,197    424    369    53,252 
State and local government   54,881    2,628    161    57,348 
Corporate and other securities   1,882        54    1,828 
   $265,526   $4,733   $1,004   $269,255 
December 31, 2015:                    
US Treasury securities  $1,547   $   $25   $1,522 
Government sponsored enterprises   950    42        992 
Mortgage-backed securities   146,935    498    1,172    146,261 
Small Business Administration pools   57,474    355    501    57,328 
State and local government   55,294    2,037    36    57,295 
Corporate and other securities   1,349        60    1,289 
   $263,549   $2,932   $1,794   $264,687 

 

HELD-TO-MATURITY:

(Dollars in thousands)  Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
September 30, 2016:                    
State and local government   $17,238   $627   $   $17,865 
   $17,238   $627   $   $17,865 
December 31, 2015:                    
State and local government   $17,371   $211   $27   $17,555 
   $17,371   $211   $27   $17,555 

 

During the nine months ended September 30, 2016 and 2015, the Company received proceeds of $33.2 million and $17.1 million, respectively, from the sale of investment securities available-for-sale.  For the nine months ended September 30, 2016, gross realized gains totaled $601 thousand and there were no gross realized losses.  For the nine months ended September 30, 2015, gross realized gains totaled $271 thousand and there were no gross realized losses.  During the three months ended September 30, 2016, the Company received proceeds of $19.1 million from the sale of investment securities available-for-sale, gross realized gains totaled $478 thousand and there were no gross realized losses.  For the three months ended September 30, 2015, there were no sales of investment securities.

 

At September 30, 2016, corporate and other securities available-for-sale included the following at fair value: mutual funds at $818.1 thousand, foreign debt of $60.3 thousand, and corporate preferred stock in the amount of $950.0 thousand. At December 31, 2015, corporate and other securities available-for-sale included the following at fair value: mutual funds at $839.2 thousand, foreign debt of $60.3 thousand, and corporate preferred stock in the amount of $416.8 thousand.

 

Other investments, at cost, include Federal Home Loan Bank (“FHLB”) stock in the amount of $1.7 million and $1.8 million at September 30, 2016 and December 31, 2015, respectively.

11
 

Note 3—Investment Securities

 

The following tables show gross unrealized losses and fair values, aggregated by investment category and length of time that individual securities have been in a continuous loss position, at September 30, 2016 and December 31, 2015. There were no held-to-maturity securities with gross unrealized losses at September 30, 2016.

 

   Less than 12 months   12 months or more   Total 
September 30, 2016
(Dollars in thousands)
  Fair
Value
   Unrealized
Loss
   Fair
Value
   Unrealized
Loss
   Fair
Value
   Unrealized
Loss
 
Available-for-sale securities:                              
Government Sponsored Enterprise mortgage-backed securities   $36,491   $185   $15,054   $230   $51,545   $415 
Small Business Administration pools    6,377    34    23,978    335    30,355    369 
Non-agency mortgage-backed securities    147    2    235    3    382    5 
State and local government   9,875    161            9,875    161 
Corporate bonds and other            818    54    818    54 
Total   $52,890   $382   $40,085   $622   $92,975   $1,004 
             
   Less than 12 months   12 months or more   Total 
December 31, 2015
(Dollars in thousands)
  Fair
Value
   Unrealized
Loss
   Fair
Value
   Unrealized
Loss
   Fair
Value
   Unrealized
Loss
 
Available-for-sale securities:                              
US Treasury  $1,522   $25   $   $   $1,522   $25 
Government Sponsored Enterprise mortgage-backed securities    69,112    731    17,593    439    86,705    1,170 
Small Business Administration pools    13,386    153    25,709    348    39,095    501 
Non-agency mortgage-backed securities            186    2    186    2 
State and local government   1,461    8    1,362    28    2,823    36 
Corporate bonds and other            812    60    812    60 
Total   $85,481   $917   $45,662   $877   $131,143   $1,794 
             
   Less than 12 months   12 months or more   Total 
December 31, 2015
(Dollars in thousands)
  Fair
Value
   Unrealized
Loss
   Fair
Value
   Unrealized
Loss
   Fair
Value
   Unrealized
Loss
 
Held-to-maturity securities:                              
State and local government  $3,473   $24   $444   $3   $3,917   $27 
Total   $3,473   $24   $444   $3   $3,917   $27 
12
 

Note 3—Investment Securities - continued

 

Government Sponsored Enterprise, Mortgage-Backed Securities: The Company owned mortgage-backed securities (“MBSs”), including collateralized mortgage obligations (“CMOs”), issued by government sponsored enterprises (“GSEs”) with an amortized cost of $152.6 million and $146.9 million and approximate fair value of $153.8 million and $146.3 million at September 30, 2016 and December 31, 2015, respectively. As of September 30, 2016 and December 31, 2015, all of the MBSs issued by GSEs were classified as “Available for Sale.” Unrealized losses on certain of these investments are not considered to be “other than temporary,” and we have the intent and ability to hold these until they mature or recover the current book value. The contractual cash flows of the investments are guaranteed by the GSE. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost of the Company’s investment. Because the Company does not intend to sell these securities and it is more likely than not the Company will not be required sell these securities before a recovery of its amortized cost, which may be maturity, the Company does not consider the investments to be other-than-temporarily impaired at September 30, 2016.

Non-agency Mortgage-Backed Securities: The Company held private label mortgage-backed securities (“PLMBSs”), including CMOs, at September 30, 2016 with an amortized cost of $445.4 thousand and approximate fair value of $441.3 thousand. The Company held PLMBSs, including CMOs, at December 31, 2015 with an amortized cost of $554.8 thousand and approximate fair value of $556.3 thousand.

 

State and Local Governments and Other: Management monitors these securities to identify any deterioration in the credit quality. Included in the monitoring is a review of the credit rating, a financial analysis and certain demographic data on the underlying issuer. The Company does not consider these securities to be other-than-temporarily impaired at September 30, 2016.

 

The following sets forth the amortized cost and fair value of investment securities at September 30, 2016 by contractual maturity. Expected maturities differ from contractual maturities because borrowers may have the right to call or prepay the obligations with or without prepayment penalties. MBSs are based on average life at estimated prepayment speeds.

 

   Available-for-sale   Held-to-maturity 
(Dollars in thousands)  Amortized
Cost
   Fair
Value
   Amortized
Cost
   Fair
Value
 
Due in one year or less   $7,707   $7,740   $   $ 
Due after one year through five years    145,109    146,279    4,976    5,089 
Due after five years through ten years    95,909    98,454    12,262    12,776 
Due after ten years    16,801    16,782         
   $265,526   $269,255   $17,238   $17,865 
13
 

Note 4—Loans

 

Loans summarized by category as of September 30, 2016, December 31, 2015, and September 30, 2015 are as follows:

   September 30,   December 31,   September 30, 
(Dollars in thousands)  2016   2015   2015 
Commercial, financial and agricultural   $38,790   $37,809   $38,020 
Real estate:               
Construction    41,228    35,829    33,127 
Mortgage-residential   49,330    49,077    49,135 
Mortgage-commercial   354,095    326,978    323,513 
Consumer:               
Home equity    31,743    30,906    31,154 
Other    8,255    8,592    8,982 
Total  $523,441   $489,191   $483,931 
14
 

Note 4—Loans-continued

 

The detailed activity in the allowance for loan losses and the recorded investment in loans receivable as of and for the nine months ended September 30, 2016 and 2015 and for the year ended December 31, 2015 is as follows:

 

(Dollars in thousands)                                
           Real estate   Real estate                 
       Real estate   Mortgage   Mortgage   Consumer   Consumer         
   Commercial   Construction   Residential   Commercial   Home equity   Other   Unallocated   Total 
September 30, 2016                                        
Allowance for loan losses:                                        
Beginning balance December 31, 2015  $75   $51   $223   $2,036   $127   $37   $2,047   $4,596 
Charge-offs           (2)   (94)   (8)   (52)       (156)
Recoveries   4        39    16    2    10        71 
Provisions   51    43    252    778    2    28    (618)   536 
Ending balance September 30, 2016  $130   $94   $512   $2,736   $123   $23   $1,429   $5,047 
                                         
Ending balances:                                        
Individually evaluated for impairment  $   $   $2   $   $   $   $   $2 
                                         
Collectively evaluated for impairment   130    94    510    2,736    123    23    1,429    5,045 
                                         
September 30, 2016
Loans receivable:
                                        
Ending balance-total  $38,790   $41,228   $49,330   $354,095   $31,743   $8,255   $   $523,441 
                                         
Ending balances:                                        
Individually evaluated for impairment           421    5,243    56            5,720 
                                        
Collectively evaluated for impairment  $38,790   $41,228   $48,909   $348,852   $31,687   $8,255   $   $517,721 
15
 

Note 4—Loans-continued

(Dollars in thousands)                                
           Real estate   Real estate                 
       Real estate   Mortgage   Mortgage   Consumer   Consumer         
   Commercial   Construction   Residential   Commercial   Home equity   Other   Unallocated   Total 
September 30, 2015                                        
Allowance for loan losses:                                        
Beginning balance December 31, 2014  $67   $45   $179   $1,572   $134   $44   $2,091   $4,132 
Charge-offs   (56)       (39)   (625)       (44)       (764)
Recoveries   5        6    16    3    80        110 
Provisions   154    130    53    861    (17)   (25)   (166)   990 
Ending balance September 30, 2015  $170   $175   $199   $1,824   $120   $55   $1,925   $4,468 
                                         
Ending balances:                                        
Individually evaluated for impairment  $   $   $3   $1   $   $   $   $4 
                                         
Collectively evaluated for impairment   170    175    196    1,823    120    55    1,925    4,464 
                                         
September 30, 2015
Loans receivable:
                                        
Ending balance-total  $38,020   $33,127   $49,135   $323,513   $31,154   $8,982   $   $483,931 
                                         
Ending balances:                                        
Individually evaluated for impairment   11        923    5,786                6,720 
                                         
Collectively evaluated for impairment  $38,009   $33,127   $48,212   $317,727   $31,154   $8,982   $   $477,211 
16
 

Note 4—Loans-continued

(Dollars in thousands)                                
           Real estate   Real estate                 
       Real estate   Mortgage   Mortgage   Consumer   Consumer         
   Commercial   Construction   Residential   Commercial   Home equity   Other   Unallocated   Total 
December 31, 2015                                        
Allowance for loan losses:                                        
Beginning balance December 31, 2014  $67   $45   $179   $1,572   $134   $44   $2,091   $4,132 
Charge-offs   (69)       (50)   (626)       (62)       (807)
Recoveries   6        7    33    3    84        133 
Provisions   71    6    87    1,057    (10)   (29)   (44)   1,138 
Ending balance December 31, 2015  $75   $51   $223   $2,036   $127   $37   $2,047   $4,596 
                                         
Ending balances:                                        
Individually evaluated for impairment  $   $   $3   $   $   $   $   $3 
                                         
Collectively evaluated for impairment   75    51    220    2,036    127    37    2,047    4,593 
                                         
December 31, 2015
Loans receivable:
                                        
Ending balance-total  $37,809   $35,829   $49,077   $326,978   $30,906   $8,592   $   $489,191 
                                         
Ending balances:                                        
Individually evaluated for impairment   9        848    5,620                6,477 
                                         
Collectively evaluated for impairment  $37,800   $35,829   $48,229   $321,358   $30,906   $8,592   $   $482,714 

Loans outstanding to bank directors, executive officers and their related business interests amounted to $8.3 million and $6.9 million at September 30, 2016 and September 30, 2015, respectively. Repayments on these loans during the nine months ended September 30, 2016 were $716 thousand and loans made totaled $139 thousand. Repayments on these loans during the nine months ended September 30, 2015 were $1.3 million and loans made totaled $4.1 million. Related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and generally do not involve more than the normal risk of collectability. 

17
 

Note 4—Loans-continued

 

The detailed activity in the allowance for loan losses as of and for the three months ended September 30, 2016 and the three months ended September 30, 2015 is as follows:

(Dollars in thousands)                                
           Real estate   Real estate                 
       Real estate   Mortgage   Mortgage   Consumer   Consumer         
   Commercial   Construction   Residential   Commercial   Home equity   Other   Unallocated   Total 
2016                                        
Allowance for loan losses:                                        
Beginning balance
June 30, 2016
  $71   $59   $207   $2,349   $93   $23   $2,075   $4,877 
Charge-offs           (1)   (36)       (19)       (56)
Recoveries   1        34    8        4        47 
Provisions   58    35    272    415    30    15    (646)   179 
Ending balance
September 30, 2016
  $130   $94   $512   $2,736   $123   $23   $1,429   $5,047 
                                 
(Dollars in thousands)                                
           Real estate   Real estate                 
       Real estate   Mortgage   Mortgage   Consumer   Consumer         
   Commercial   Construction   Residential   Commercial   Home equity   Other   Unallocated   Total 
2015                                        
Allowance for loan losses:                                        
Beginning balance
June 30, 2015
  $221   $124   $179   $1,774   $119   $60   $1,804   $4,281 
Charge-offs           (13)           (17)       (30)
Recoveries   2        4    11    1    6        24 
Provisions   (53)   51    29    39        6    121    193 
Ending balance
September 30, 2015
  $170   $175   $199   $1,824   $120   $55   $1,925   $4,468 

  

The following table presents at September 30, 2016 and December 31, 2015 loans individually evaluated and considered impaired under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 310 “Accounting by Creditors for Impairment of a Loan.” Impairment includes performing troubled debt restructurings (“TDRs”).

 

(Dollars in thousands)  September 30,   December 31, 
   2016   2015 
Total loans considered impaired   $5,720   $6,477 
Loans considered impaired for which there is a related allowance for loan loss:          
Outstanding loan balance    47    49 
Related allowance    2    3 
Loans considered impaired and previously written down to fair value    5,673    6,428 
Average impaired loans    9,207    9,518 
18
 

Note 4—Loans-continued

 

The following tables are by loan category and present at September 30, 2016, December 31, 2015 and September 30, 2015 loans individually evaluated and considered impaired under FASB ASC 310 “Accounting by Creditors for Impairment of a Loan.” Impairment includes performing TDRs.

 

(Dollars in thousands)              Nine months ended   Three months ended 
       Unpaid       Average   Interest   Average   Interest 
September 30, 2016  Recorded   Principal   Related   Recorded   Income   Recorded   Income 
   Investment   Balance   Allowance   Investment   Recognized   Investment   Recognized 
With no allowance recorded:                                   
  Commercial  $   $   $   $   $   $   $ 
  Real estate:                                   
    Construction                            
    Mortgage-residential   374    374        419        411     
    Mortgage-commercial   5,243    7,821        8,683    88    8,609    31 
  Consumer:                                  
    Home Equity   56    56        57        57     
    Other                            
                                    
With an allowance recorded:                                   
  Commercial                            
  Real estate:                                   
    Construction                            
    Mortgage-residential   47    47    2    48    2    47    1 
    Mortgage-commercial                            
  Consumer:                                  
    Home Equity                            
    Other                            
                                    
Total:                                   
  Commercial  $   $   $   $   $   $   $ 
  Real estate:                                   
    Construction                            
    Mortgage-residential   421    421    2    467    2    458    1 
    Mortgage-commercial   5,243    7,821        8,683    88    8,609    31 
  Consumer:                                  
    Home Equity   56    56        57        57     
    Other                            
   $5,720   $8,298   $2   $9,207   $90   $9,124   $32 
19
 

Note 4—Loans-continued

(Dollars in thousands)              Nine months ended   Three months ended 
       Unpaid       Average   Interest   Average   Interest 
September 30, 2015  Recorded   Principal   Related   Recorded   Income   Recorded   Income 
   Investment   Balance   Allowance   Investment   Recognized   Investment   Recognized 
With no allowance recorded:                                   
  Commercial  $11   $11   $   $14   $   $13   $ 
  Real estate:                                   
    Construction                            
    Mortgage-residential   873    952        1,140    71    1,133    1 
    Mortgage-commercial   5,753    8,149        8,388        8,293     
  Consumer:                                  
    Home Equity                            
    Other                            
                                    
With an allowance recorded:                                   
  Commercial                            
  Real estate:                                   
    Construction                            
    Mortgage-residential   50    50    3    51    2    50     
    Mortgage-commercial   33    33    1    34    2    34     
  Consumer:                                  
    Home Equity                            
    Other                            
                                    
Total:                                   
  Commercial  $11   $11   $   $14   $   $13   $ 
  Real estate:                                   
    Construction                            
    Mortgage-residential   923    1,002    3    1,191    73    1,183    1 
    Mortgage-commercial   5,786    8,182    1    8,422    2    8,327     
  Consumer:                                  
    Home Equity                            
    Other                            
   $6,720   $9,195   $4   $9,627   $75   $9,523   $1 
20
 

Note 4—Loans-continued

(Dollars in thousands)                    
December 31, 2015      Unpaid       Average   Interest 
   Recorded   Principal   Related   Recorded   Income 
   Investment   Balance   Allowance   Investment   Recognized 
With no allowance recorded:                         
  Commercial  $9   $9   $   $13   $ 
  Real estate:                         
    Construction                    
    Mortgage-residential   799    874        1,082    1 
    Mortgage-commercial   5,620    7,548        8,372    60 
  Consumer:                        
    Home Equity                    
    Other                    
                          
With an allowance recorded:                         
  Commercial                    
  Real estate:                         
    Construction                    
    Mortgage-residential   49    49    3    51    3 
    Mortgage-commercial                    
  Consumer:                        
    Home Equity                    
    Other                    
                          
Total:                         
  Commercial   9    9        13     
  Real estate:                         
    Construction                    
    Mortgage-residential   848    923    3    1,133    4 
    Mortgage-commercial   5,620    7,548        8,372    60 
  Consumer:                        
    Home Equity                    
    Other                    
   $6,477   $8,480   $3   $9,518   $64 

  

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt, including: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on a monthly basis. The Company uses the following definitions for risk ratings:

 

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date. Special mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

 

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

 

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as 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.

 

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered as pass rated loans. As of September 30, 2016 and December 31, 2015, and based on the most recent analysis performed, the risk category of loans by class of loans is shown in the table below. As of September 30, 2016 and December 31, 2015, no loans were classified as doubtful.

21
 

Note 4—Loans-continued

 

(Dollars in thousands)                    
September 30, 2016      Special             
   Pass   Mention   Substandard   Doubtful   Total 
Commercial, financial & agricultural   $38,563   $227   $   $   $38,790 
Real estate:                         
   Construction    41,077    151            41,228 
   Mortgage – residential    47,804    597    929        49,330 
   Mortgage – commercial    343,073    3,966    7,056        354,095 
Consumer:                         
  Home Equity    31,374    169    200        31,743 
  Other    8,255                8,255 
Total   $510,146   $5,110   $8,185   $   $523,441 

 

(Dollars in thousands)                    
December 31, 2015      Special             
   Pass   Mention   Substandard   Doubtful   Total 
Commercial, financial & agricultural   $37,501   $299   $9   $   $37,809 
Real estate:                         
   Construction    35,374    455            35,829 
   Mortgage – residential    46,580    1,378    1,119        49,077 
   Mortgage – commercial    310,367    7,555    9,056        326,978 
Consumer:                         
  Home Equity    30,587    180    139        30,906 
  Other    8,587    1    4        8,592 
Total   $468,996   $9,868   $10,327   $   $489,191 

 

At September 30, 2016 and December 31, 2015, non-accrual loans totaled $3.9 million and $4.8 million, respectively.

TDRs that are still accruing and included in impaired loans at September 30, 2016 and December 31, 2015 amounted to $1.8 million and $1.6 million, respectively. TDRs in non-accrual status at September 30, 2016 and December 31, 2015 amounted to $1.3 million and $1.8 million, respectively.

 

Loans greater than 90 days delinquent and still accruing interest were $98.7 thousand as of September 30, 2016. There were no loans greater than 90 days delinquent and still accruing interest as of December 31, 2015.

22
 

Note 4—Loans-continued

 

We account for acquisitions under FASB ASC Topic 805, Business Combinations, which requires the use of the acquisition method of accounting. All identifiable assets acquired, including loans, are recorded at fair value. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk.

 

Acquired credit-impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality, found in FASB ASC Topic 310-30, Receivables—Loans and Debt Securities Acquired with Deteriorated Credit Quality, and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loans. Loans acquired in business combinations with evidence of credit deterioration are considered impaired. Loans acquired through business combinations that do not meet the specific criteria of FASB ASC Topic 310-30, but for which a discount is attributable, at least in part to credit quality, are also accounted for under this guidance. Certain acquired loans, including performing loans and revolving lines of credit (consumer and commercial), are accounted for in accordance with FASB ASC Topic 310-20, where the discount is accreted through earnings based on estimated cash flows over the estimated life of the loan.

 

Purchase credit impaired (“PCI”) loans acquired totaled $4.2 million at estimated fair value, and acquired performing loans totaling $102.3 million at estimated fair value were not credit impaired. The gross contractual amount receivable for PCI loans and acquired performing loans was approximately $5.7 million and $116.0 million, respectively, as of the acquisition date. For the acquired performing loans, the best estimate at acquisition date of contractual cash flows not expected to be collected is $825 thousand. Determining the fair value of PCI loans at acquisition required the Company to estimate cash flows expected to result from those loans and to discount those cash flows at appropriate rates of interest. For such loans, the excess of cash flows expected to be collected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans and is called the accretable yield. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition reflects the impact of estimated credit losses and is called the nonaccretable difference. In accordance with GAAP, there was no carry-over of previously established allowance for credit losses from the acquired company.

 

In conjunction with the acquisition of Savannah River Financial Corporation of Augusta, Georgia, the bank holding company for Savannah River Banking Company (“Savannah River”), on February 1, 2014, the acquired PCI loan portfolio was accounted for at fair value as follows: 

 

(Dollars in thousands)  February 1,
 2014
 
Contractual principal and interest at acquisition  $5,717 
Nonaccretable difference   (1,205)
Expected cash flows at acquisition   4,512 
Accretable yield   (272)
Basis in PCI loans at acquisition – estimated fair value  $4,240 
23
 

Note 4—Loans-continued

 

A summary of changes in the accretable yield for PCI loans for the three and nine months ended September 30, 2016 and 2015 follows (in thousands): 

  

   Three Months   Nine Months 
   Ended   Ended 
   September 30,
2016
       September 30,
2016
 
Accretable yield, beginning of period  $53   $92 
           
Accretion   (17)   (150)
           
Reclassification of nonaccretable difference due to improvement in expected cash flows   18    112 
Accretable yield, end of period  $54   $54 
         
   Three Months   Nine Months 
   Ended   Ended 
   September 30,
2015
   September 30,
2015
 
Accretable yield, beginning of period  $135   $75 
           
Accretion   (42)   (513)
          
Reclassification of nonaccretable difference due to improvement in expected cash flows       531 
Accretable yield, end of period  $93   $93 
24
 

Note 4—Loans-continued

The following tables are by loan category and present loans past due and on non-accrual status as of September 30, 2016 and December 31, 2015:

(Dollars in thousands)
September 30, 2016
  30-59
Days
Past Due
   60-89
Days
Past Due
   Greater
than 90
Days and
Accruing
   Nonaccrual   Total
Past Due
   Current   Total
Loans
 
Commercial  $   $20   $   $   $20   $38,770   $38,790 
Real estate:                                   
  Construction   457                457    40,771    41,228 
  Mortgage-residential   595    211    99    374    1,279    48,051    49,330 
  Mortgage-commercial   457    471        3,475    4,403    349,692    354,095 
Consumer:                                   
  Home equity   292    144        56    492    31,251    31,743 
  Other   34    5            39    8,216    8,255 
Total  $1,835   $851   $99   $3,905   $6,690   $516,751   $523,441 
                             
(Dollars in thousands)
December 31, 2015
  30-59
Days
Past Due
   60-89
Days
Past Due
   Greater
than 90
Days and
Accruing
   Nonaccrual   Total
Past Due
   Current   Total
Loans
 
Commercial  $5   $   $   $9   $14   $37,795   $37,809 
Real estate:                                   
  Construction                       35,829    35,829 
  Mortgage-residential   126    195        799    1,120    47,957    49,077 
  Mortgage-commercial   1,180    290        4,031    5,501    321,477    326,978 
Consumer:                                   
  Home equity   135                135    30,771    30,906 
  Other   4    4            8    8,584    8,592 
Total  $1,450   $489   $   $4,839   $6,778   $482,413   $489,191 
25
 

Note 4—Loans-continued

The Company reviews TDRs in accordance with applicable regulatory and accounting guidance.

 

There were no loans determined to be TDRs that were restructured during the three and nine month periods ended September 30, 2015 or the three month period ended September 30, 2016.

 

The following table, by loan category, presents one loan determined to be a TDR during the nine month period ended September 30, 2016. The loan was modified to extend the term of the loan due to financial hardship of the borrower. The loan was subsequently paid off in June 2016.

 

Troubled Debt Restructurings  For the nine months ended September 30, 2016 
(Dollars in thousands)      Pre-Modification   Post-Modification 
   Number   Outstanding   Outstanding 
   of   Recorded   Recorded 
   Contracts   Investment   Investment 
Accrual               
Mortgage-Commercial   1   $413   $413 
Total Accrual   1   $413   $413 
                
Total TDRs   1   $413   $413 

 

During the three and nine month periods ended September 30, 2016 and 2015, there were no loans determined to be TDRs in the previous twelve months that had payment defaults. Defaulted loans are those loans that are greater than 89 days past due.

 

In the determination of the allowance for loan losses, all TDRs are reviewed to ensure that one of the three proper valuation methods (fair market value of the collateral, present value of cash flows, or observable market price) is adhered to. All non-accrual loans are written down to their corresponding collateral value. All troubled TDR accruing loans that have a loan balance that exceeds the present value of cash flows will have a specific allocation. All nonaccrual loans are considered impaired. Under ASC 310-10, a loan is impaired when it is probable that the Company will be unable to collect all amounts due including both principal and interest according to the contractual terms of the loan agreement.

26
 

Note 5 - Recently Issued Accounting Pronouncements

  

In May 2014, the FASB issued guidance to change the recognition of revenue from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. The guidance will be effective for the Company for reporting periods beginning after December 15, 2017. The Company will apply the guidance using a modified retrospective approach. The Company does not expect these amendments to have a material effect on its financial statements.

 

In January 2015, the FASB issued guidance to eliminate from U.S. GAAP the concept of an extraordinary item, which is an event or transaction that is both (1) unusual in nature and (2) infrequently occurring. Under the new guidance, an entity will no longer (1) segregate an extraordinary item from the results of ordinary operations; (2) separately present an extraordinary item on its income statement, net of tax, after income from continuing operations; or (3) disclose income taxes and earnings-per-share data applicable to an extraordinary item. The amendments will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, with early adoption permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The Company does not expect these amendments to have a material effect on its financial statements.

 

In February 2015, the FASB issued guidance which amends the consolidation requirements and significantly changes the consolidation analysis required under U.S. GAAP. Although the amendments are expected to result in the deconsolidation of many entities, the Company will need to reevaluate all its previous consolidation conclusions. The amendments became effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The Company does not expect these amendments to have a material effect on its financial statements.

 

In April 2015, the FASB issued guidance which changes the presentation of debt issuance costs. The amendments became effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The Company does not expect these amendments to have a material effect on its financial statements.

 

In April 2015, the FASB issued guidance which provides a practical expedient that permits the Company to measure defined benefit plan assets and obligations using the month-end that is closest to the Company’s fiscal year-end. The amendments became effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The Company does not expect these amendments to have a material effect on its financial statements.

 

In April 2015, the FASB issued guidance which provides guidance to customers about whether a cloud computing arrangement includes a software license. The amendments became effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The Company does not expect these amendments to have a material effect on its financial statements.

 

In May 2015, the FASB issued guidance which removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. The amendments became effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The Company does not expect these amendments to have a material effect on its financial statements.

 

In August 2015, the FASB deferred the effective date of ASU 2014-09, Revenue from Contracts with Customers. As a result of the deferral, the guidance in ASU 2014-09 will be effective for the Company for reporting periods beginning after December 15, 2017. The Company will apply the guidance using a modified retrospective approach. The Company does not expect these amendments to have a material effect on its financial statements.

 

In August 2015, the FASB issued amendments to the Interest topic of the Accounting Standards Codification to clarify the SEC staff’s position on presenting and measuring debt issuance costs incurred in connection with line-of-credit arrangements. The amendments were effective upon issuance. The Company does not expect these amendments to have a material effect on its financial statements.

27
 

Note 5 - Recently Issued Accounting Pronouncements-continued

 

In September 2015, the FASB amended the Business Combinations topic of the Accounting Standards Codification to simplify the accounting for adjustments made to provisional amounts recognized in a business combination by eliminating the requirement to retrospectively account for those adjustments. The amendments became effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. All entities are required to apply the amendments prospectively to adjustments to provisional amounts that occur after the effective date. The Company does not expect these amendments to have a material effect on its financial statements.

 

In November 2015, the FASB amended the Income Taxes topic of the Accounting Standards Codification to simplify the presentation of deferred income taxes by requiring that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments will be effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The Company will apply the guidance prospectively. The Company does not expect these amendments to have a material effect on its financial statements.

 

In January 2016, the FASB amended the Financial Instruments topic of the Accounting Standards Codification to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company will apply the guidance by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values will be applied prospectively to equity investments that exist as of the date of adoption of the amendments. The Company does not expect these amendments to have a material effect on its financial statements.

 

In February 2016, the FASB amended the Leases topic of the Accounting Standards Codification to revise certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. The amendments will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows.

 

In March 2016, the FASB amended the Liabilities topic of the Accounting Standards Codification to address the current and potential future diversity in practice related to the derecognition of a prepaid stored-value product liability. The amendments will be effective for financial statements issued for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company will apply the guidance using a modified retrospective transition method by means of a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year in which the guidance is effective to each period presented. The Company does not expect these amendments to have a material effect on its financial statements.

 

In March 2016, the FASB amended the Derivatives and Hedging topic of the Accounting Standards Codification to clarify that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. The amendments will be effective for financial statements issued for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company will apply the guidance prospectively to each period presented. The Company does not expect these amendments to have a material effect on its financial statements.

 

In March 2016, the FASB amended the Investments—Equity Method and Joint Ventures topic of the Accounting Standards Codification to eliminate the requirement to retroactively adopt the equity method of accounting. The amendments are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The Company will apply the guidance prospectively upon their effective date to increases in the level of ownership interest or degree of influence that result in the adoption of the equity method. The Company does not expect these amendments to have a material effect on its financial statements.

28
 

Note 5 - Recently Issued Accounting Pronouncements-continued

 

In March 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify the implementation guidance on principal versus agent considerations and address how an entity should assess whether it is the principal or the agent in contracts that include three or more parties. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

 

In March 2016, the FASB issued guidance to simplify several aspects of the accounting for share-based payment award transactions including the income tax consequences, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. Additionally, the guidance simplifies two areas specific to entities other than public business entities allowing them to apply a practical expedient to estimate the expected term for all awards with performance or service conditions that have certain characteristics and also allowing them to make a one-time election to switch from measuring all liability-classified awards at fair value to measuring them at intrinsic value. The amendments will be effective for the Company for annual periods beginning after December 15, 2016 and interim periods within those annual periods. The Company does not expect these amendments to have a material effect on its financial statements.

 

In April 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify guidance related to identifying performance obligations and accounting for licenses of intellectual property. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

 

In May 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify guidance related to collectability, noncash consideration, presentation of sales tax, and transition. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

 

In June 2016, the FASB issued guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. The Company is currently evaluating the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows.

 

In August 2016, the FASB amended the Statement of Cash Flows topic of the Accounting Standards Codification to clarify how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments will be effective for the Company for fiscal years beginning after December 15, 2017 including interim periods within those fiscal years. The Company does not expect these amendments to have a material effect on its financial statements.

 

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

29
 

Note 6 – Fair Value of Financial Instruments

 

The Company adopted FASB ASC Fair Value Measurement Topic 820, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

 

Level l

Quoted prices in active markets for identical assets or liabilities.

 

Level 2

Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

 

FASB ASC 825-10-50 “Disclosure about Fair Value of Financial Instruments”, requires the Company to disclose estimated fair values for its financial instruments. Fair value estimates, methods, and assumptions are set forth below.

 

Cash and Short Term Investments - The carrying amount of these financial instruments (cash and due from banks, interest-bearing bank balances, federal funds sold and securities purchased under agreements to resell) approximates fair value. All mature within 90 days and do not present unanticipated credit concerns and are classified as Level 1.

 

Investment Securities - Measurement is on a recurring basis based upon quoted market prices, if available. If quoted market prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for prepayment assumptions, projected credit losses, and liquidity. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, or by dealers or brokers in active over-the-counter markets. Level 2 securities include MBSs issued both by government sponsored enterprises and PLMBSs. Generally these fair values are priced from established pricing models. Level 3 securities include corporate debt obligations and asset–backed securities that are less liquid or for which there is an inactive market.

 

Loans Held for Sale - The Company originates fixed rate residential loans on a servicing released basis in the secondary market. Loans closed but not yet settled with an investor, are carried in the Company’s loans held for sale portfolio. These loans are fixed rate residential loans that have been originated in the Company’s name and have closed. Virtually all of these loans have commitments to be purchased by investors at a locked in price with the investors on the same day that the loan was locked in with the company’s customers. Therefore, these loans present very little market risk for the Company and are classified as Level 2. The carrying amount of these loans approximates fair value.

 

Loans - The fair value of loans are estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities and are classified as Level 2. As discount rates are based on current loan rates as well as management estimates, the fair values presented may not be indicative of the value negotiated in an actual sale. Loans which are deemed to be impaired are primarily valued on a nonrecurring basis at the fair value of the underlying real estate collateral. Such fair values are obtained using independent appraisals, which the Company considers to be Level 3 inputs.

30
 

Note 6 – Fair Value of Financial Instruments - continued

 

Other Real Estate Owned (OREO) - OREO is carried at the lower of carrying value or fair value on a non-recurring basis. Fair value is based upon independent appraisals or management’s estimation of the collateral and is considered a Level 3 measurement.

 

Accrued Interest Receivable - The fair value approximates the carrying value and is classified as Level 1.

 

Deposits - The fair value of demand deposits, savings accounts, and money market accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposits is estimated by discounting the future cash flows using rates currently offered for deposits of similar remaining maturities. Deposits are classified as Level 2.

 

Federal Home Loan Bank Advances - Fair value is estimated based on discounted cash flows using current market rates for borrowings with similar terms and are classified as Level 2.

 

Short Term Borrowings - The carrying value of short term borrowings (securities sold under agreements to repurchase and demand notes to the Treasury) approximates fair value. These are classified as Level 2.

 

Junior Subordinated Debentures - The fair values of junior subordinated debentures is estimated by using discounted cash flow analyses based on incremental borrowing rates for similar types of instruments. These are classified as Level 2.

 

Accrued Interest Payable -The fair value approximates the carrying value and is classified as Level 1.

 

Commitments to Extend Credit - The fair value of these commitments is immaterial because their underlying interest rates approximate market.

31
 

Note 6 – Fair Value of Financial Instruments - continued

 

The carrying amount and estimated fair value by classification level of the Company’s financial instruments as of September 30, 2016 and December 31, 2015 are as follows:

 

   September 30, 2016 
   Fair Value 
(Dollars in thousands)  Carrying
Amount
   Total   Level 1   Level 2   Level 3 
Financial Assets:                         
Cash and short term investments   $38,695   $38,695   $38,695   $   $ 
Held-to-maturity securities   17,238    17,865        17,865     
 Available-for-sale securities    269,255    269,255    818    267,487    950 
 Other investments, at cost    1,681    1,681            1,681 
 Loans held for sale    4,250    4,250        4,250     
 Net loans receivable    518,394    517,927        512,209    5,718 
 Accrued interest    2,784    2,784    2,784         
Financial liabilities:                         
 Non-interest bearing demand   $177,267   $177,267   $   $177,267   $ 
 NOW and money market accounts    325,800    325,800        325,800     
 Savings    76,516    76,516        76,516     
 Time deposits    186,340    186,541        186,541     
 Total deposits    765,923    766,124        766,124     
 Federal Home Loan Bank Advances    21,022    21,823        21,823     
 Short term borrowings    22,232    22,232        22,232     
 Junior subordinated debentures    14,964    14,982        14,982     
 Accrued interest payable    588    588    588         

 

   December 31, 2015 
   Fair Value 
(Dollars in thousands)  Carrying
Amount
   Total   Level 1   Level 2   Level 3 
Financial Assets:                         
Cash and short term investments   $22,941   $22,941   $22,941   $   $ 
Held-to-maturity securities   17,371    17,555        17,555     
Available-for-sale securities    264,687    264,687    812    263,458    417 
Other investments, at cost    1,783    1,783            1,783 
Loans held for sale    2,962    2,962        2,962     
Net loans receivable    484,595    484,669        478,195    6,474 
Accrued interest    2,877    2,877    2,877         
Financial liabilities:                         
Non-interest bearing demand deposits   $156,247   $156,247   $   $156,247   $ 
NOW and money market accounts    318,308    318,308        318,308     
Savings    60,699    60,699        60,699     
Time deposits    180,897    181,325        181,325     
Total deposits    716,151    716,579        716,579     
Federal Home Loan Bank Advances    24,788    25,841        25,841     
Short term borrowings    21,033    21,033        21,033     
Junior subordinated debentures    14,964    14,954        14,954     
Accrued interest payable    652    652    652         
32
 

Note 6 – Fair Value of Financial Instruments - continued

 

The following tables summarize quantitative disclosures about the fair value for each category of assets carried at fair value as of September 30, 2016 and December 31, 2015 that are measured on a recurring basis. There were no liabilities carried at fair value as of September 30, 2016 or December 31, 2015 that are measured on a recurring basis.

 

(Dollars in thousands)

Description  September 30,
2016
   Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
Available for sale securities                    
US Treasury  $1,563   $   $1,563   $ 
Government sponsored enterprises    1,026        1,026     
Mortgage-backed securities    154,238        154,238     
Small Business Administration securities    53,252        53,252     
State and local government    57,348        57,348     
Corporate and other securities    1,828    818    60    950 
               Total   $269,255   $818   $267,487   $950 
                 
(Dollars in thousands)                
Description  December 31,
2015
  

Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)

  

Significant
Other
Observable
Inputs
(Level 2)

  

Significant
Unobservable
Inputs
(Level 3)

 
Available for sale securities                    
US Treasury Securities  $1,522   $   $1,522   $ 
Government sponsored enterprises   992        992     
Mortgage-backed securities   146,261        146,261     
Small Business Administration securities   57,328        57,328     
State and local government   57,295        57,295     
Corporate and other securities   1,289    812    60    417 
               Total  $264,687   $812   $263,458   $417 
33
 

Note 6 – Fair Value of Financial Instruments – continued

 

The following table reconciles the changes in Level 3 financial instruments for the nine months ended September 30, 2016 and 2015 that are measured on a recurring basis.

 

   September 30, 
   2016   2015 
(Dollars in thousands)  Corporate
Preferred
Stock
   Corporate
Preferred
Stock
 
Beginning Balance  $417   $417 
Total gains or losses (realized/unrealized) Included in earnings        
           
Included in other comprehensive income        
           
Purchases, issuances, and settlements   950     
Maturities, sales, payoffs   (417)    
           
Transfers in and/or out of Level 3        
Ending Balance  $950   $417 

 

The following table reconciles the changes in Level 3 financial instruments for the three months ended September 30, 2016 and September 30, 2015 that are measured on a recurring basis.

 

   September 30, 
   2016   2015 
(Dollars in thousands)  Corporate
Preferred
Stock
   Corporate
Preferred
Stock
 
Beginning Balance  $950   $417 
Total gains or losses (realized/unrealized) Included in earnings        
           
Included in other comprehensive income        
           
Purchases, issuances, and settlements        
Maturities, sales, payoffs        
           
Transfers in and/or out of Level 3        
Ending Balance  $950   $417 
34
 

Note 6 – Fair Value of Financial Instruments – continued

  

The following tables summarize quantitative disclosures about the fair value for each category of assets carried at fair value as of September 30, 2016 and December 31, 2015 that are measured on a non-recurring basis.

 

(Dollars in thousands)                
Description  September 30,
2016
   Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
Impaired loans:                    
  Commercial & Industrial   $   $   $   $ 
  Real estate:                    
    Mortgage-residential    419            419 
    Mortgage-commercial    5,243            5,243 
  Consumer:                    
    Home equity    56            56 
    Other                 
      Total impaired    5,718            5,718 
Other real estate owned:                    
  Construction                 
  Mortgage-residential    337            337 
  Mortgage-commercial    861            861 
      Total other real estate owned    1,198            1,198 
Total   $6,916   $   $   $6,916 
35
 

Note 6 – Fair Value of Financial Instruments - continued

 

(Dollars in thousands)                
Description  December 31,
2015
   Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
Impaired loans:                    
  Commercial  $9   $   $   $9 
  Real estate:                    
    Mortgage-residential   845            845 
    Mortgage-commercial   5,620            5,620 
  Consumer:                    
    Home equity                
    Other                
      Total impaired   6,474            6,474 
Other real estate owned:                    
  Construction   276            276 
  Mortgage-residential   191            191 
  Mortgage-commercial   1,991            1,991 
  Total other real estate owned   2,458            2,458 
Total  $8,932   $

   $

   $8,932 

  

The Company has a large percentage of loans with real estate serving as collateral. Loans which are deemed to be impaired are primarily valued on a nonrecurring basis at the fair value of the underlying real estate collateral. Such fair values are obtained using independent appraisals, which the Company considers to be Level 3 inputs. Third party appraisals are generally obtained when a loan is identified as being impaired or at the time it is transferred to OREO. This internal process consists of evaluating the underlying collateral to independently obtained comparable properties. With respect to less complex or smaller credits, an internal evaluation may be performed. The independent and internal evaluations are generally updated annually. Factors considered in determining the fair value include geographic sales trends, the value of comparable surrounding properties as well as the condition of the property. The aggregate amount of impaired loans was $5.7 million and $6.5 million as of September 30, 2016 and December 31, 2015, respectively.

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Note 6 – Fair Value of Financial Instruments - continued

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of September 30, 2016 and December 31, 2015, the significant unobservable inputs used in the fair value measurements were as follows:

(Dollars in thousands) Fair Value as of
September 30,
2016
     Valuation Technique Significant
Observable
Inputs
Significant
Unobservable Inputs
Preferred stock $ 950   Estimation based on comparable non-listed securities Comparable transactions n/a
OREO $ 1,198   Appraisal Value/Comparison Sales/Other estimates Appraisals and or sales of comparable properties Appraisals discounted 6% to 16% for sales commissions and other holding cost
Impaired loans $ 5,718   Appraisal Value Appraisals and or sales of comparable properties Appraisals discounted 6% to 16% for sales commissions and other holding cost
           
(Dollars in thousands) Fair Value as of December 31, 2015   Valuation Technique Significant Observable Inputs Significant Unobservable Inputs
Preferred stock $ 417   Estimation based on comparable non-listed securities Comparable transactions n/a
OREO $ 2,458   Appraisal Value/Comparison Sales/Other estimates Appraisals and or sales of comparable properties Appraisals discounted 6% to 16% for sales commissions and other holding cost
Impaired loans $ 6,474   Appraisal Value Appraisals and or sales of comparable properties Appraisals discounted 6% to 16% for sales commissions and other holding cost

  

Note 7 — Deposits

 

The Company’s total deposits are comprised of the following at the dates indicated:

  

   September 30,   December 31, 
(Dollars in thousands)  2016   2015 
Non-interest bearing demand deposits  $177,267   $156,247 
NOW and money market accounts   325,800    318,308 
Savings   76,516    60,699 
Time deposits   186,340    180,897 
  Total deposits  $765,923   $716,151 

 

As of September 30, 2016 and December 31, 2015, the Company had time deposits greater than $250,000 of $37.4 million and $21.2 million, respectively.

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Note 8 – Reportable Segments

 

The Company’s reportable segments represent the distinct product lines the Company offers and are viewed separately for strategic planning by management. The Company has four reportable segments:

 

Commercial and retail banking: The Company’s primary business is to provide deposit and lending products and services to its commercial and retail customers.
Mortgage banking: This segment provides mortgage origination services for loans that will be sold to investors in the secondary market.
Investment advisory and non-deposit: This segment provides investment advisory services and non-deposit products.
Corporate: This segment includes the parent company financial information, including interest on parent company debt and dividend income received from First Community Bank (the “Bank”).

 

The following tables present selected financial information for the Company’s reportable business segments for the three and nine months ended September 30, 2016 and 2015:

  

Nine months ended September 30, 2016  Commercial       Investment             
(Dollars in thousands)  and Retail   Mortgage   advisory and             
   Banking   Banking   non-deposit   Corporate   Eliminations   Consolidated 
Dividend and Interest Income  $21,732   $142   $   $2,072   $(1,950)  $21,996 
Interest expense   1,968            363         2,331 
Net interest income  $19,764   $142   $   $1,709   $   $19,665 
Provision for loan losses   536                    536 
Noninterest income   3,353    2,516    871            6,740 
Noninterest expense   16,227    1,828    766    437        19,258 
Net income before taxes  $6,354   $830   $105   $1,272   $   $6,611 
Income tax (provision) benefit   (1,910)           189        (1,721)
Net income  $4,444   $830   $105   $1,461   $   $4,890 

 

Three months ended September 30, 2016  Commercial       Investment             
(Dollars in thousands)  and Retail   Mortgage   advisory and             
   Banking   Banking   non-deposit   Corporate   Eliminations   Consolidated 
Dividend and Interest Income  $7,336   $60   $   $658   $(654)  $7,400 
Interest expense   625            124         749 
Net interest income  $6,711   $60   $   $534   $   $6,651 
Provision for loan losses   179                    179 
Noninterest income   1,166    937    284            2,387 
Noninterest expense   5,506    672    249    156        6,583 
Net income before taxes  $2,192   $325   $35   $378   $   $2,276 
Income tax (provision) benefit   (677)           78        (599)
Net income  $1,515   $325   $35   $456   $   $1,677 
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Note 8 – Reportable Segments – continued

Nine months ended September 30, 2015  Commercial       Investment             
(Dollars in thousands)  and Retail   Mortgage   advisory and             
   Banking   Banking   non-deposit   Corporate   Eliminations   Consolidated 
Dividend and Interest Income  $21,244   $158   $   $1,677   $(1,633)  $21,446 
Interest expense   2,208            333         2,541 
Net interest income  $19,036   $158   $   $1,344   $   $18,905 
Provision for loan losses   990                    990 
Noninterest income   3,203    2,679    993            6,875 
Noninterest expense   15,197    2,003    730    626        18,556 
Net income before taxes  $6,052   $834   $263   $718   $   $6,234 
Income tax (provision) benefit   (1,975)           267        (1,708)
Net income  $4,077   $834   $263   $985   $   $4,526 

 

Three months ended September 30, 2015  Commercial       Investment             
(Dollars in thousands)  and Retail   Mortgage   advisory and             
   Banking   Banking   non-deposit   Corporate   Eliminations   Consolidated 
Dividend and Interest Income  $7,046   $50   $   $550   $(532)  $7,114 
Interest expense   748            113         861 
Net interest income  $6,298   $50   $   $437   $   $6,253 
Provision for loan losses   193                    193 
Noninterest income   1,076    963    290            2,329 
Noninterest expense   4,973    686    225    183        6,067 
Net income before taxes  $2,208   $327   $65   $254   $   $2,322 
Income tax (provision) benefit   (727)           84        (643)
Net income  $1,481   $327   $65   $338   $   $1,679 

 

   Commercial       Investment             
(Dollars in thousands)  and Retail   Mortgage   advisory and             
   Banking   Banking   non-deposit   Corporate   Eliminations   Consolidated 
Total Assets as of September 30, 2016  $907,006   $6,167   $35   $96,765   $(94,721)  $915,252 
                               
Total Assets as of December 31, 2015  $855,888   $4,355   $34   $93,296   $(90,839)  $862,734 

   

Note 8 – Subsequent Events

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements.  Nonrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.  Management has reviewed events occurring through the date the financial statements were available to be issued and no subsequent events occurred requiring accrual or disclosure.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

This report contains statements which constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may relate to, among other matters, the financial condition, results of operations, plans, objectives, future performance, and business of our Company. Forward-looking statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “continue,” “assume,” “believe,” “intend,” “plan,” “forecast,” “goal,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ materially from those anticipated in our forward-looking statements include, without limitation, those described under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2015 as filed with the Securities and Exchange Commission (the “SEC”) and the following:

credit losses as a result of, among other potential factors, declining real estate values, increasing interest rates, increasing unemployment, changes in customer payment behavior or other factors;
the amount of our loan portfolio collateralized by real estate and weaknesses in the real estate market;
restrictions or conditions imposed by our regulators on our operations;
the adequacy of the level of our allowance for loan losses and the amount of loan loss provisions required in future periods;
examinations by our regulatory authorities, including the possibility that the regulatory authorities may, among other things, require us to increase our allowance for loan losses or write-down assets;
reduced earnings due to higher other-than-temporary impairment charges resulting from additional decline in the value of our securities portfolio, specifically as a result of increasing default rates, and loss severities on the underlying real estate collateral;
increases in competitive pressure in the banking and financial services industries;
changes in the interest rate environment which could reduce anticipated or actual margins;
changes in political conditions or the legislative or regulatory environment, including governmental initiatives affecting the financial services industry;
general economic conditions resulting in, among other things, a deterioration in credit quality;
changes occurring in business conditions and inflation;
changes in access to funding or increased regulatory requirements with regard to funding;
increased cybersecurity risk, including potential business disruptions or financial losses;
changes in deposit flows;
changes in technology;
our current and future products, services, applications and functionality and plans to promote them;
changes in monetary and tax policies;
changes in accounting standards, policies, estimates, and practices;
40
 
our assumptions and estimates used in applying critical accounting policies, which may prove unreliable, inaccurate or not predictive of actual results;
the rate of delinquencies and amounts of loans charged-off;
the rate of loan growth in recent years and the lack of seasoning of a portion of our loan portfolio;
our ability to maintain appropriate levels of capital, including levels of capital required under the capital rules implementing Basel III;
our ability to attract and retain key personnel;
our ability to retain our existing clients, including our deposit relationships;
adverse changes in asset quality and resulting credit risk-related losses and expenses;
loss of consumer confidence and economic disruptions resulting from terrorist activities;
disruptions due to flooding, severe weather or other natural disasters; and
other risks and uncertainties detailed from time to time in our filings with the SEC.

Because of these and other risks and uncertainties, our actual future results may be materially different from the results indicated by any forward-looking statements. For additional information with respect to factors that could cause actual results to differ from the expectations stated in the forward-looking statements, see “Risk Factors” under Part I, Item 1A of our 2015 Annual Report on Form 10-K as filed with the SEC. In addition, our past results of operations do not necessarily indicate our future results. Therefore, we caution you not to place undue reliance on our forward-looking information and statements.

All forward-looking statements in this report are based on information available to us as of the date of this report. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee you that these expectations will be achieved. We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Overview

The following discussion describes our results of operations for the nine months and three months ended September 30, 2016 as compared to the nine month and three month periods ended September 30, 2015 and also analyzes our financial condition as of September 30, 2016 as compared to December 31, 2015. Like most community banks, we derive most of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.

There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the following section we have included a discussion of this process, as well as several tables describing our allowance for loan losses and the allocation of this allowance among our various categories of loans.

In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our customers. We describe the various components of this non-interest income, as well as our non-interest expense, in the following discussion.

41
 

The following discussion and analysis identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information also included in this report.

Critical Accounting Policies

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to our unaudited consolidated financial statements as of September 30, 2016 and our notes included in the consolidated financial statements in our 2015 Annual Report on Form 10-K as filed with the SEC.

 

Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgment and assumptions we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and our results of operations.

 

Allowance for Loan Losses

 

We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgment and estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the credit worthiness of borrowers, the estimated value of the underlying collateral, the assumptions about cash flow, determination of loss factors for estimating credit losses, the impact of current events, and conditions, and other factors impacting the level of probable inherent losses. Under different conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from management’s estimates provided in our consolidated financial statements. Refer to the portion of this discussion that addresses our allowance for loan losses for a more complete discussion of our processes and methodology for determining our allowance for loan losses.

 

Goodwill and Other Intangibles

 

Goodwill represents the excess of the purchase price over the sum of the estimated fair values of the tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. Qualitative factors are assessed to first determine if it is more likely than not (more than 50%) that the carrying value of goodwill is less than fair value. These qualitative factors include but are not limited to overall deterioration in general economic conditions, industry and market conditions, and overall financial performance. If determined that it is more likely than not that there has been a deterioration in the fair value of the carrying value than the first of a two-step process would be performed. The first step, used to identify potential impairment, involves comparing each reporting unit’s estimated fair value to its carrying value, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying value, goodwill is considered not to be impaired. If the carrying value exceeds estimated fair value, there is an indication of potential impairment and the second step is performed to measure the amount of impairment.

 

If required, the second step involves calculating an implied fair value of goodwill for each reporting unit for which the first step indicated impairment. The implied fair value of goodwill is determined in a manner similar to the amount of goodwill calculated in a business combination, by measuring the excess of the estimated fair value of the reporting unit, as determined in the first step, over the aggregate estimated fair values of the individual assets, liabilities and identifiable intangibles as if the reporting unit was being acquired in a business combination. If the implied fair value of goodwill exceeds the carrying value of goodwill assigned to the reporting unit, there is no impairment. If the carrying value of goodwill assigned to a reporting unit exceeds the implied fair value of the goodwill, an impairment charge is recorded for the excess. An impairment loss cannot exceed the carrying value of goodwill assigned to a reporting unit, and the loss establishes a new basis in the goodwill. Subsequent reversal of goodwill impairment losses is not permitted. Management has determined that the Company has four reporting units (See Note 8 to the Consolidated Financial Statements).

42
 

Core deposit intangibles consist of costs that resulted from the acquisition of deposits from Savannah River and First South. Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in this transaction. These costs are amortized over the estimated useful lives of the deposit accounts acquired on a method that we believe reasonably approximates the anticipated benefit stream from the accounts. The estimated useful lives are periodically reviewed for reasonableness.

Income Taxes and Deferred Tax Assets and Liabilities

Income taxes are provided for the tax effects of the transactions reported in our consolidated financial statements and consist of taxes currently due plus deferred taxes related to differences between the tax basis and accounting basis of certain assets and liabilities, including available-for-sale securities, allowance for loan losses, write downs of OREO properties, accumulated depreciation, net operating loss carry forwards, accretion income, deferred compensation, intangible assets, and pension plan and post-retirement benefits. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. A valuation allowance is recorded when it is “more likely than not” that a deferred tax asset will not be realized. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. We file a consolidated federal income tax return for the Bank. At September 30, 2016 and December 31, 2015, we were in a net deferred tax asset position.

43
 

Other-Than-Temporary Impairment

We evaluate securities for other-than-temporary impairment at least on a quarterly basis. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) the outlook for receiving the contractual cash flows of the investments, (4) the anticipated outlook for changes in the general level of interest rates, and (5) our intent and ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value or for a debt security whether it is more-likely-than-not that the Company will be required to sell the debt security prior to recovering its fair value (See Note 3 to the Consolidated Financial Statements).

 

Business Combinations, Method of Accounting for Loans Acquired

 

We account for acquisitions under FASB ASC Topic 805, Business Combinations, which requires the use of the acquisition method of accounting. All identifiable assets acquired, including loans, are recorded at fair value. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk.

 

Acquired credit-impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality, found in FASB ASC Topic 310-30, Receivables—Loans and Debt Securities Acquired with Deteriorated Credit Quality. and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loans. Loans acquired in business combinations with evidence of credit deterioration are considered impaired. Loans acquired through business combinations that do not meet the specific criteria of FASB ASC Topic 310-30, but for which a discount is attributable, at least in part to credit quality, are also accounted for under this guidance. Certain acquired loans, including performing loans and revolving lines of credit (consumer and commercial), are accounted for in accordance with FASB ASC Topic 310-20, where the discount is accreted through earnings based on estimated cash flows over the estimated life of the loan.

  

Comparison of Results of Operations for Nine Months Ended September 30, 2016 to the Nine Months Ended September 30, 2015

 

Net Income

 

Our net income for the nine months ended September 30, 2016 was $4.9 million or $0.72 diluted earnings per common share, as compared to $4.5 million or $0.68 diluted earnings per common share for the nine months ended September 30, 2015. Net interest income increased $760 thousand for the nine months ended September 30, 2016 as compared to the same period in 2015. This increase resulted from an increase in average earning assets, which increased by $51.1 million in the nine months ended September 30, 2016 as compared to the same period in 2015. Average earning assets were $759.3 million during the nine months ended September 30, 2015 as compared to $810.4 million during the nine months ended September 30, 2016. The net interest margin decreased to 3.24% during the first nine months of 2016 as compared to 3.33% during the first nine months of 2015. Non-interest income decreased by $135 thousand in the first nine months of 2016 compared to the first nine months of 2015. This was primarily attributable to a decrease in mortgage banking income and investment advisory fees and non-deposit commissions of $164 thousand and $122 thousand, respectively, in the nine months ended September 30, 2016 as compared to the same period in 2015. Non-interest expense in the nine months ended September 30, 2016 increased $702 thousand as compared to the same period in 2015, primarily as a result of an increase in salary and benefit expense of $654 thousand from $10.8 million in the first nine months of 2015 to $11.5 million in the first nine months of 2016.

Net Interest Income

 

Please refer to the table at the end of this Item 2 for the yield and rate data for interest-bearing balance sheet components during the nine-month periods ended September 30, 2016 and 2015, along with average balances and the related interest income and interest expense amounts.

44
 

Net interest income was $19.7 million for the nine months ended September 30, 2016 as compared to $18.9 million for the nine months ended September 30, 2015. The $760 thousand increase in net interest income was attributable to an increase in average earning assets of $51.7 million partially offset by a decrease of 9 basis points in the net interest margin between the two periods. Our net interest margin decreased 9 basis points from 3.33% for the nine months ended September 30, 2015 to 3.24% for the same period in 2016. The net interest margin was positively impacted during the first nine months of 2016 as a result of two pay-offs on purchased credit impaired loans. These two payoffs accounted for approximately 5 basis points in our net-interest margin for the nine months ended September 30, 2015. During the first nine months of 2016, the net interest margin was positively impacted by an investment that had been purchased at a discount and was called at par during the second quarter of 2016. The $82 thousand remaining discount recognized in interest income accounted for approximately 2 basis points of the net interest margin for the nine months ended September 30, 2016. The yield on earning assets decreased by 15 basis points in the first nine months of 2016 as compared to the same period in 2015. Average loans comprised 62.6% of average earning assets in the first nine months of 2016 as compared to 61.7% in the same period of 2015. The yield on our loan portfolio decreased 33 basis points in the nine month-period ended September 30, 2016 to 4.63% as compared to 4.96% during the same period in 2015. As previously noted, the yield on loans was positively impacted by recognizing the discount on two purchased impaired loans that paid off in the nine months ended September 30, 2015. The yield on our investment portfolio increased from 1.94% for the nine months ended September 30, 2015 to 2.04% for the same period in 2016. The previously mentioned $82 thousand discount recognized on a called bond accounted for approximately 4 basis points of the investment yield increase between the two periods. The cost of interest-bearing liabilities during the first nine months of 2016 was 0.50% as compared to 0.56% in the same period of 2015, reflecting a 6 basis point decrease. The continued focus and resulting shift in our deposit funding mix has continued to allow us to lower our overall cost of funds. Interest-bearing transaction accounts, money market accounts and savings deposits, which are typically our lower costing funds, represent 61.5% of our average interest bearing liabilities during the first nine months of 2016 as compared to 58.1% in the same period of 2015.

Provision and Allowance for Loan Losses

At September 30, 2016 and December 31, 2015, the allowance for loan losses was $5.0 million and $4.6 million, respectively. This represented 0.96% of total loans and 0.94% of total loans at September 30, 2016 and December 31, 2015, respectively. No allowance for loan losses related to the Savannah River acquired loans was recorded on the acquisition date, February 1, 2014, because the fair value of the loans acquired incorporates assumptions regarding credit risk. Loans acquired were recorded at the acquisition date fair value, which was based on expected cash flows and included an estimation of expected future loan losses for the purchased credit-impaired loans, including principal and interest. There have been no material adjustments to our original assumptions since the acquisition date. At September 30, 2016 and December 31, 2015, the allowance for loan losses plus the fair value adjustment related to credit as a percentage of total loans (excluding loans held for sale) was 1.03% and 1.15%, respectively. Our provision for loan losses was $536 thousand for the nine months ended September 30, 2016 as compared to $990 thousand for the nine months ended September 30, 2015. This provision is made based on our assessment of general loan loss risk and asset quality. The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. Our determination of the allowance for loan losses is based on evaluations of the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, the experience ability and depth of lending personnel, economic conditions (local and national) that may affect the borrower’s ability to repay, the amount and quality of collateral securing the loans, our historical loan loss experience, and a review of specific problem loans. We also consider subjective issues such as changes in the lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity of problem loans, quality of loan review and board of director oversight, and concentrations of credit. Periodically, we adjust the amount of the allowance based on changing circumstances. We charge recognized losses to the allowance and add subsequent recoveries back to the allowance for loan losses.

We perform an analysis quarterly to assess the risk within the loan portfolio. The portfolio is segregated into similar risk components for which historical loss ratios are calculated and adjusted for identified changes in current portfolio characteristics. Historical loss ratios are calculated by product type and by regulatory credit risk classification (See Note 4 – Loans). The annualized weighted average loss ratios over the last 36 months for loans classified substandard, special mention and pass have been approximately 5.70%, 3.11% and 0.04%, respectively. The allowance consists of an allocated and unallocated allowance. The allocated portion is determined by types and ratings of loans within the portfolio. The unallocated portion of the allowance is established for losses that exist in the remainder of the portfolio and compensates for uncertainty in estimating the loan losses. The allocated portion of the allowance is based on historical loss experience as well as certain qualitative factors as explained above. The qualitative factors have been established based on certain assumptions made as a result of the current economic conditions and are adjusted as conditions change to be directionally consistent with these changes. The unallocated portion of the allowance is composed of factors based on management’s evaluation of various conditions that are not directly measured in the estimation of probable losses through the experience formula or specific allowances. The unallocated allowance of the portfolio is primarily identified through discussions with senior credit management and through consideration of various portfolio specifics and other uncertainties outside of our markets that could impact the risk inherent in the portfolio. These include factors such as uncertainty as to a sustainable economic recovery, ongoing global economic conditions and sustained levels of high national unemployment. Given these uncertainties in economic conditions and particularly real estate valuations, we do not believe it would be prudent to reduce substantially the overall level of our allowance at this time. As economic conditions show sustainable improvement, we believe the unallocated portion of the allowance should decrease as a percentage of the total allowance.

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Our loan portfolio consists of a large percentage of real estate secured loans. Impaired values of the underlying real estate collateral as well as a slowdown in both residential and commercial real estate sales could impact our ability to sell collateral upon foreclosure.  The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended.  If real estate values decline, it is also more likely that we would be required to increase our allowance for loan losses.  If during a period of reduced real estate values we are required to liquidate the property collateralizing a loan to satisfy the debt or to increase the allowance for loan losses, it could materially reduce our profitability and adversely affect our financial condition.  

 

Non-performing assets were $5.2 million (0.57% of total assets) at September 30, 2016 as compared to $5.9 million (0.66% of total assets), $7.5 million (0.86% of total assets) and $7.3 million (0.85% of total assets) at June 30, 2016, March 31, 2016 and December 31, 2015, respectively. While we believe our amount of non-performing assets compares favorably to current industry results (both nationally and locally), we continue to be concerned about the impact of this economic environment on our customer base of local businesses and professionals. There were 40 loans, totaling $4.0 million, included in non-performing status (non-accrual loans and loans past due 90 days and still accruing) at September 30, 2016. The largest non-performing loan is a $964 thousand first mortgage on developed lots to be sold for residential use. The average balance of the remaining 38 loans is approximately $105.0 thousand and the majority of these loans are secured by first mortgage liens. At the time the loans are placed in non-accrual status, we typically obtain an updated appraisal and, if the loan balance exceeds fair value, write the balance down to the fair value. At September 30, 2016, we had one loan delinquent more than 90 days in the amount of $99 thousand and still accruing interest. At September 30, 2016, we had loans totaling $2.7 million that were delinquent 30 days to 89 days which represented 0.52% of total loans.

 

Our management continuously monitors non-performing, classified and past due loans to identify deterioration regarding the condition of these loans. We have identified one loan relationship in the amount of $1.1 million that is current as to principal and interest and not included in non-performing assets that could represent a potential problem loan. This balance is included as substandard loans in Note 4 of the financial statements.

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The following table summarizes the activity related to our allowance for loan losses for the periods indicated:

 

Allowance for Loan Losses

(Dollars in thousands)  Nine months Ended
September 30,
 
   2016   2015 
Average loans outstanding (including loans held for sale)  $507,326   $468,704 
Loans outstanding at period end  $523,441   $483,931 
Non-performing assets:          
     Nonaccrual loans  $3,905   $5,067 
     Loans 90 days past due still accruing   99    2 
     Foreclosed real estate   1,198    2,450 
Total non-performing assets  $5,202   $7,519 
           
Beginning balance of allowance  $4,596   $4,132 
Loans charged-off:          
  1-4 family residential mortgage   2    39 
  Non-residential real estate   94    625 
  Home equity   8     
  Commercial       56 
  Installment & credit card   52    44 
     Total loans charged-off   156    764 
Recoveries:          
  1-4 family residential mortgage   39    6 
  Non-residential real estate   16    16 
  Home equity   2    3 
  Commercial   4    5 
  Installment & credit card   10    80 
     Total recoveries   71    110 
Net loan charge offs   85    654 
Provision for loan losses   536    990 
Balance at period end  $5,047   $4,468 
           
Net charge -offs to average loans   0.02%   0.14%
Allowance as percent of total loans   0.96%   0.92%
Non-performing assets as % of total assets   0.57%   0.88%
Allowance as % of non-performing assets   97.02%   59.42%
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The following allocation of the allowance to specific components is not necessarily indicative of future losses or future allocations. The entire allowance is available to absorb losses in the portfolio.

 

Composition of the Allowance for Loan Losses

(Dollars in thousands)  September 30,  2016   December 31, 2015 
       % of loans in       % of   loans in 
   Amount   Category   Amount   Category 
Commercial, Financial and Agricultural  $130    7.4%  $75    7.7%
Real Estate – Construction   94    7.9%   51    7.3%
Real Estate Mortgage:                    
  Commercial   2,736    67.6%   2,036    66.9%
  Residential   512    9.4%   223    10.0%
Consumer:                    
  Home Equity   123    6.1%   127    6.3%
  Other   23    1.6%   37    1.8%
Unallocated   1,429          N/A    2,047    N/A 
Total  $5,047    100.0%  $4,596    100.0%

  

Accrual of interest is discontinued on loans when management believes, after considering economic and business conditions and collection efforts that a borrower’s financial condition is such that the collection of interest is doubtful. A delinquent loan is generally placed in nonaccrual status when it becomes 90 days or more past due. At the time a loan is placed in nonaccrual status, all interest, which has been accrued on the loan but remains unpaid is reversed and deducted from earnings as a reduction of reported interest income. No additional interest is accrued on the loan balance until the collection of both principal and interest becomes reasonably certain.

 

Non-interest Income and Non-interest Expense

Non-interest income during the first nine months of 2016 was $6.7 million as compared to $6.9 million during the same period in 2015. Mortgage banking income decreased $164 thousand during the first nine months of 2016 compared to the same period in 2015, resulting primarily from the resignation of one mortgage loan producer in the first quarter of 2016. Investment advisory fees and non-deposit commissions decreased by $122 thousand in the first nine months of 2016 as compared to the same period in 2015. During the first nine months of 2015, we had one transaction that is non-recurring that accounted for substantially all of the difference between the two periods. Management continues to focus on increasing this recurring source of revenue by increasing total assets under management. We had assets under management of $195.1 million and $168.6 million at September 30, 2016 and September 30, 2015, respectively. During the first nine months of 2016, we sold investment securities for a net gain of $601 thousand as compared to a gain on the sale of investment securities of $271 thousand in the same period of 2015. These gains in 2016 were partially offset by prepayment penalties in the amount of $459 thousand and $103 thousand for the nine months ended September 30, 2016 and 2015, respectively. During the nine months ended September 30, 2016, we paid down advances of $11.4 million as compared to $2.7 million in the same period of 2015. Non-interest income other increased by $256 thousand in the first nine months of 2016 as compared to the same period in 2015. This increase resulted from increased ATM/debit card income of $103 thousand in first nine months of 2016 as compared to the same period in 2015. In addition, income recognized on bank owned life insurance increased by $149 thousand in the 2016 period as compared to the 2015 period. At the end of 2015 the Bank purchased additional bank owned life insurance which accounts for the increased income.

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Total non-interest expense increased by $702 thousand, or 3.8%, during the first nine months of 2016 as compared to the same period in 2015. Salary and benefit expense increased $654 thousand from $10.8 million in the first nine months of 2015 to $11.5 million in the first nine months of 2016. This increase is primarily a result of the normal salary adjustments, the additional staff including the new Greenville loan production office staff in the first quarter of 2016, as well as increased medical benefit premiums. At September 30, 2015, we had 184 full time equivalent employees as compared to 201 at September 30, 2016. Occupancy expense increased $103 thousand in the first nine months of 2016 as compared to the first nine months of 2015. The increase in occupancy expense primarily relates to repair costs associated with the fourth quarter 2015 flooding and rain that were not previously identified and determined not to be covered by insurance in the approximate amount of $50 thousand as well as occupancy cost of $23 thousand associated with opening the Greenville loan production office. Marketing and public relations expense decreased from $683 thousand in the first nine months of 2015 to $529 thousand in the first nine months of 2016. The timing of our media campaigns impact the recognition of marketing expense and, in 2015, more of these costs were incurred in the first half of the year. It is expected that we will have higher media costs in the fourth quarter of 2016. Other real estate expense decreased $247 thousand in the first nine months of 2016 as compared to the same period in 2015. This reflects the overall decrease in the level of our repossessed real estate assets between the two periods. Non-interest expense “Other” increased by $380 thousand in the first nine months of 2016 as compared to the same period in 2015. This increase is primarily a result of increased ATM/debit card activity charges of $183 thousand during the first nine months of 2016 as compared to the same period in 2015. We incurred $64 thousand in costs associated with the mass reissue of our debit cards to implement the new EMV (chip) card in the first nine months of 2016. We have also had significantly higher levels of attempted fraud activity on our card base in the first nine months of 2016 as compared to the same period in 2015. There is a direct cost assessed by our processor for each card that is compromised or had attempted fraud activity. The higher level of fraud cases in the first nine months of 2016 accounted for approximately $43 thousand in debit card losses. We believe the “chip” card technology will ultimately reduce the level of fraud activity and losses on debit cards. Also included in the increase of “Other” non-interest expense were costs of approximately $23 thousand related to converting our current bill pay system to another vendor. This conversion was completed in the second quarter of 2016.

 

The following is a summary of the components of other non-interest expense for the periods indicated:

 

(Dollars in thousands)  Nine months ended 
   September 30, 
   2016   2015 
Data processing  $628   $445 
Supplies   101    108 
Telephone   261    271 
Correspondent services   187    157 
Subscriptions and publications   108    93 
Loss on limited partnership interest   123    136 
Insurance   207    204 
Postage   137    140 
Legal and Professional fees   536    437 
Director fees   294    283 
Loan closing costs/filing fees   163    85 
Shareholder expenses   113    94 
Other Miscellaneous   724    749 
   $3,582   $3,202 

  

Income Tax Expense

 

Our effective tax rate was 26.0% and 27.5% in the first nine months of 2016 and 2015, respectively. As a result of our current level of tax exempt securities in our investment portfolio, our effective tax rate is expected to remain at 26.0% to 27.0% throughout the remainder of 2016.

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Comparison of Results of Operations for Three Months Ended September 30, 2016 to the Three Months Ended September 30, 2015:

 

Net Income

 

Our net income for the three months ended September 30, 2016 and 2015 was substantially unchanged at $1.7 million, or $0.25 diluted earnings per common share, for each of these periods. Net interest income increased $398 thousand for the three months ended September 30, 2016 as compared to the same period in 2015. This increase was offset by increased non-interest expense of $516 thousand for the three months ended September 30, 2016 as compared to the same period of 2015.

Net Interest Income

 

Please refer to the table “Yields on Average Earning Assets and Rates on Average Interest-Bearing Liabilities” appearing at the end of this Item for the yield and rate data for interest-bearing balance sheet components during the three-month periods ended September 30, 2016 and 2015, along with average balances and the related interest income and interest expense amounts.

 

Net interest income increased by $398 thousand for the three months ended September 30, 2016 to $6.7 million as compared to $6.2 million in the same period in 2015. Our net interest margin in the third quarter of 2016 was 3.19% compared to 3.22% in the same period of 2015. The yield on average earning assets decreased 12 basis points to 3.55% in the third quarter of 2016 from 3.67% in the third quarter of 2015. The extended period of historically low interest rates continues to put pressure on our net interest margin. We believe we can continue to offset some of this margin pressure by continuing to remix our balance sheet asset mix out of investments into the loan portfolio. Average earning assets were $829.8 million during the third quarter of 2016 as compared to $769.5 million during the third quarter of 2015. Average loans were $520.1 million (62.7% of earning assets) in the third quarter of 2016 and $482.2 million (62.7% of earning assets) in the third quarter of 2015. The cost of interest bearing liabilities decreased to 0.47% in the third quarter of 2016 as compared to 0.57% in the third quarter of 2015. Interest-bearing transaction accounts, money market accounts and savings deposits, which are typically our lower costing funds, represent 61.9% of our average interest bearing liabilities during the third quarter of 2016 as compared to 58.6% in the same period of 2015. Due to the continued historically low interest rate environment, the cost of these funds has remained very stable over the last several years. The current low cost of these funds do not provide significant ability to offset further interest rate declines or a flattening of the yield curve.

 

Provision for Loan Losses

The provision for loan losses for the three months ended September 30, 2016 was $179 thousand as compared to $193 thousand for the three months ended September 30, 2015. As previously discussed, the provision is made based on our assessment of general loan loss risk and asset quality, historical loss experience and various other qualitative factors.

Non-interest Income and Non-interest Expense

 

For the three months ended September 30, 2016, we had non-interest income of $2.4 million as compared to non-interest income of $2.3 million in the same period of 2015. Mortgage banking income decreased slightly by $27 thousand during the third quarter of 2016, as compared to the same period in 2015. Gains on the sale of securities in the third quarter of 2016 amounted to $478 thousand. As noted above, the sales were offset by prepayment penalties of $459 thousand resulting from the pay down of approximately $11.4 million in Federal Home Loan Bank Advances. There were no gains on sale of securities or prepayment penalties during the third quarter of 2015. Non-interest income other increased by $58 thousand in the third quarter of 2016 as compared to the same period in 2015. As mentioned above, this increase resulted primarily from increased income recognized on bank owned life insurance.

 

Total non-interest expense increased $516 thousand in the third quarter of 2016, compared to the same period of 2015. Salaries and benefits increased $293 thousand in the third quarter of 2016 as compared to the same period in 2015. This increase is primarily a result of normal salary adjustments and additional staff to include the four employees that were added as a result of the expansion of the loan production office in Greenville, South Carolina. Marketing and public relations expense increased $111 thousand in the third quarter of 2016 as compared to the same period in 2015. As noted in the nine month results, the timing of our media marketing campaign was designed to be concentrated more in the first half of the year for 2015 and later in the year during 2016. FDIC assessments decreased by $53 thousand in the third quarter of 2016 as compared to the same period in 2015. Beginning on July 1, 2016, the FDIC adjusted the assessment formula and the new assessment should reduce our assessment by approximately 45% as compared to the last several years. Non-interest expense “Other” increased $171 thousand in the third quarter of 2016 as compared to the same period of 2015.

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Financial Position

 

Assets totaled $915.3 million at September 30, 2016 as compared to $862.7 million at December 31, 2015, an increase of $52.6 million. Loans increased by approximately $34.2 million during the nine months ended September 30, 2016. Loans (excluding loans held for sale) at September 30, 2016 were $523.4 million as compared to $489.2 million at December 31, 2015. Total loan production was $114.2 million during the first nine months of 2016. At September 30, 2016 and December 31, 2015, loans (excluding loans held for sale) accounted for 62.3% and 62.1% of earning assets, respectively. The loan-to-deposit ratio at September 30, 2016 was 68.9% as compared to 68.7% at December 31, 2015. Investment securities increased to $288.2 million at September 30, 2016 from $283.8 million at December 31, 2015. Deposits increased $49.7 million at September 30, 2016 as compared to December 31, 2015. Pure deposits (deposits less time deposits) represented 75.7% of total deposits as of September 30, 2016 as compared to 74.7% at December 31, 2015. We continue to focus on growing our pure deposits as a percentage of total deposits in order to better manage our overall cost of funds. Deposits were $765.9 million at September 30, 2016 as compared to $716.2 million at December 31, 2015. FHLB advances decreased $3.8 million from December 31, 2015 to September 30, 2016. This decrease represents pay downs of $11.4 million in term advances during the nine months ended September 30, 2016 and the addition of $8.0 million in overnight advances as of the end of the quarter.

 

The following table shows the composition of the loan portfolio by category at September 30, 2016 and December 31, 2015:

(In thousands)  September 30,   December 31, 
   2016   2015 
   Amount   Percent   Amount   Percent 
Commercial, financial & agricultural  $38,790    7.4%  $37,809    7.7%
Real estate:                    
   Construction   41,228    7.9%   35,829    7.3%
   Mortgage – residential   49,330    9.4%   49,077    10.0%
   Mortgage – commercial   354,095    67.6%   326,978    66.9%
Consumer:                    
   Home Equity   31,743    6.1%   30,906    6.3%
   Other   8,255    1.6%   8,592    1.8%
Total gross loans   523,441    100.0%   489,191    100.0%
Allowance for loan losses   (5,047)        (4,596)     
     Total net loans  $518,394        $484,595      

  

In the context of this discussion, a real estate mortgage loan is defined as any loan, other than loans for construction purposes and advances on home equity lines of credit, secured by real estate, regardless of the purpose of the loan. Advances on home equity lines of credit are included in consumer loans. We follow the common practice of financial institutions in our market areas of obtaining a security interest in real estate whenever possible, in addition to any other available collateral. This collateral is taken to reinforce the likelihood of the ultimate repayment of the loan and tends to increase the magnitude of the real estate loan components. Generally we limit the loan-to-value ratio to 80%.

Market Risk Management

 

The effective management of market risk is essential to achieving our strategic financial objectives. Our most significant market risk is interest rate risk. We have established an Asset/Liability Management Committee (“ALCO”) to monitor and manage interest rate risk. The ALCO monitors and manages the pricing and maturity of assets and liabil