Attached files
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EX-32 - EXHIBIT 32 - FIRST SOUTH BANCORP INC /VA/ | v452560_ex32.htm |
EX-31.2 - EXHIBIT 31.2 - FIRST SOUTH BANCORP INC /VA/ | v452560_ex31-2.htm |
EX-31.1 - EXHIBIT 31.1 - FIRST SOUTH BANCORP INC /VA/ | v452560_ex31-1.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2016.
OR
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______.
Commission File Number: 0-22219
FIRST SOUTH BANCORP, INC. |
(Exact name of registrant as specified in its charter) |
Virginia | 56-1999749 |
(State or other jurisdiction of | (IRS Employer |
incorporation or organization) | Identification No.) |
1311 Carolina Avenue, Washington, North Carolina 27889
(Address of principal executive offices)
(Zip Code)
(252) 946-4178
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
Large Accelerated Filer ¨ | Accelerated Filer ¨ | |
Non-Accelerated Filer ¨ | Smaller Reporting Company x | |
(Do not check if a Smaller Reporting Company) |
Indicate by check mark whether registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).
Yes ¨ No x
Number of shares of common stock outstanding as of November 10, 2016: 9,494,935.
CONTENTS
First South Bancorp, Inc. and Subsidiary
Consolidated Statements of Financial Condition
September 30, | December 31, | |||||||
2016 | 2015 | |||||||
(Unaudited) | ||||||||
Assets | ||||||||
Cash and due from banks | $ | 19,272,704 | $ | 19,425,747 | ||||
Interest-bearing deposits with banks | 37,936,276 | 18,565,521 | ||||||
Investment securities available-for-sale, at fair value | 193,255,580 | 248,294,725 | ||||||
Investment securities held-to-maturity | 509,328 | 508,456 | ||||||
Mortgage loans held for sale | 7,312,568 | 3,943,798 | ||||||
Loans and leases held for investment | 682,465,668 | 607,014,247 | ||||||
Allowance for loan and lease losses | (8,498,061 | ) | (7,866,523 | ) | ||||
Net loans and leases held for investment | 673,967,607 | 599,147,724 | ||||||
Premises and equipment, net | 11,608,966 | 13,664,937 | ||||||
Assets held for sale | 192,720 | - | ||||||
Other real estate owned | 4,810,434 | 6,125,054 | ||||||
Federal Home Loan Bank stock, at cost | 1,701,200 | 2,369,300 | ||||||
Accrued interest receivable | 3,118,482 | 2,874,506 | ||||||
Goodwill | 4,218,576 | 4,218,576 | ||||||
Mortgage servicing rights | 2,090,680 | 1,265,589 | ||||||
Identifiable intangible assets | 1,682,269 | 1,895,514 | ||||||
Bank-owned life insurance | 17,937,292 | 15,635,140 | ||||||
Prepaid expenses and other assets | 6,180,717 | 8,348,385 | ||||||
Total assets | $ | 985,795,399 | $ | 946,282,972 | ||||
Liabilities and Stockholders' Equity | ||||||||
Deposits: | ||||||||
Non-interest bearing demand | $ | 189,872,662 | $ | 169,545,849 | ||||
Interest bearing demand | 264,114,729 | 246,376,521 | ||||||
Savings | 141,701,335 | 135,369,668 | ||||||
Large denomination certificates of deposit | 124,416,507 | 116,299,196 | ||||||
Other time deposits | 139,725,846 | 143,730,993 | ||||||
Total deposits | 859,831,079 | 811,322,227 | ||||||
Borrowings | 20,000,000 | 37,000,000 | ||||||
Junior subordinated debentures | 10,310,000 | 10,310,000 | ||||||
Other liabilities | 7,360,372 | 5,479,971 | ||||||
Total liabilities | 897,501,451 | 864,112,198 | ||||||
Common stock, $.01 par value, 25,000,000 shares authorized; 9,494,935 and 9,489,222 shares outstanding, respectively | 94,949 | 94,892 | ||||||
Additional paid-in capital | 35,998,472 | 35,936,911 | ||||||
Retained earnings | 47,851,299 | 43,691,073 | ||||||
Accumulated other comprehensive income | 4,349,228 | 2,447,898 | ||||||
Total stockholders' equity | 88,293,948 | 82,170,774 | ||||||
Total liabilities and stockholders' equity | $ | 985,795,399 | $ | 946,282,972 |
The accompanying notes are an integral part of these consolidated financial statements.
1
First South Bancorp, Inc. and Subsidiary
Consolidated Statements of Operations
Three and Nine Months Ended September 30, 2016 and 2015
(Unaudited)
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Interest income: | ||||||||||||||||
Interest and fees on loans | $ | 7,915,133 | $ | 6,639,177 | $ | 22,748,826 | $ | 18,834,471 | ||||||||
Interest on investments and deposits | 1,295,051 | 1,577,440 | 4,131,333 | 5,047,181 | ||||||||||||
Total interest income | 9,210,184 | 8,216,617 | 26,880,159 | 23,881,652 | ||||||||||||
Interest expense: | ||||||||||||||||
Interest on deposits | 728,106 | 598,081 | 2,094,809 | 1,730,070 | ||||||||||||
Interest on borrowings | 55,886 | 54,077 | 187,683 | 61,593 | ||||||||||||
Interest on junior subordinated notes | 127,011 | 141,578 | 408,628 | 421,656 | ||||||||||||
Total interest expense | 911,003 | 793,736 | 2,691,120 | 2,213,319 | ||||||||||||
Net interest income | 8,299,181 | 7,422,881 | 24,189,039 | 21,668,333 | ||||||||||||
Provision for credit losses | 220,000 | 335,000 | 770,000 | 475,000 | ||||||||||||
Net interest income after provision for credit losses | 8,079,181 | 7,087,881 | 23,419,039 | 21,193,333 | ||||||||||||
Non-interest income: | ||||||||||||||||
Deposit fees and service charges | 1,907,878 | 2,093,101 | 5,746,336 | 6,067,959 | ||||||||||||
Loan fees and charges | 72,578 | 62,960 | 268,212 | 179,196 | ||||||||||||
Mortgage loan servicing fees | 343,081 | 263,679 | 850,770 | 807,126 | ||||||||||||
Gain on sale and other fees on mortgage loans | 812,754 | 528,745 | 1,795,017 | 1,486,278 | ||||||||||||
Gain (loss) on sale of other real estate, net | 77,416 | (63,402 | ) | 50,932 | 9,814 | |||||||||||
Gain on sale of investment securities | - | 502,576 | 467,470 | 954,514 | ||||||||||||
Other income | 477,643 | 378,574 | 1,636,428 | 1,057,395 | ||||||||||||
Total non-interest income | 3,691,350 | 3,766,233 | 10,815,165 | 10,562,282 | ||||||||||||
Non-interest expense: | ||||||||||||||||
Compensation and fringe benefits | 4,970,846 | 4,935,133 | 14,955,785 | 14,475,105 | ||||||||||||
Federal deposit insurance premiums | 157,142 | 163,200 | 479,276 | 445,081 | ||||||||||||
Premises and equipment | 1,349,243 | 1,312,123 | 4,103,726 | 3,976,577 | ||||||||||||
Advertising | 151,304 | 218,827 | 568,556 | 598,477 | ||||||||||||
Data processing | 757,200 | 818,680 | 2,303,418 | 2,805,101 | ||||||||||||
Amortization of intangible assets | 136,882 | 129,527 | 401,981 | 386,597 | ||||||||||||
Other real estate owned expense | 119,065 | 99,234 | 425,622 | 462,825 | ||||||||||||
Other | 1,287,041 | 1,330,098 | 3,842,879 | 4,137,281 | ||||||||||||
Total non-interest expense | 8,928,723 | 9,006,822 | 27,081,243 | 27,287,044 | ||||||||||||
Income before income tax expense | 2,841,808 | 1,847,292 | 7,152,961 | 4,468,571 | ||||||||||||
Income tax expense | 947,496 | 610,680 | 2,185,841 | 1,352,983 | ||||||||||||
NET INCOME | $ | 1,894,312 | $ | 1,236,612 | $ | 4,967,120 | $ | 3,115,588 | ||||||||
Per share data: | ||||||||||||||||
Basic earnings per share | $ | 0.20 | $ | 0.13 | $ | 0.52 | $ | 0.33 | ||||||||
Diluted earnings per share | $ | 0.20 | $ | 0.13 | $ | 0.52 | $ | 0.33 | ||||||||
Dividends per share | $ | 0.030 | $ | 0.025 | $ | 0.085 | $ | 0.075 | ||||||||
Average basic shares outstanding | 9,494,861 | 9,500,885 | 9,493,285 | 9,532,393 | ||||||||||||
Average diluted shares outstanding | 9,525,302 | 9,520,943 | 9,520,216 | 9,552,298 |
The accompanying notes are an integral part of these consolidated financial statements.
2
First South Bancorp, Inc. and Subsidiary
Consolidated Statements of Comprehensive Income
Three and Nine Months Ended September 30, 2016 and 2015
(Unaudited)
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Net income | $ | 1,894,312 | $ | 1,236,612 | $ | 4,967,120 | $ | 3,115,588 | ||||||||
Other comprehensive income (loss): | ||||||||||||||||
Increase (decrease) in unrealized holding gains on securities available for sale | (1,110,351 | ) | 2,311,993 | 3,679,996 | 1,230,573 | |||||||||||
Tax effect | 425,001 | (833,326 | ) | (1,351,969 | ) | (381,712 | ) | |||||||||
Unrealized holding gains (losses) on securities available for sale, net of tax | (685,350 | ) | 1,478,667 | 2,328,027 | 848,861 | |||||||||||
Reclassification adjustment for realized gains included in net income | - | (502,576 | ) | (467,470 | ) | (954,514 | ) | |||||||||
Tax effect | - | 145,747 | 134,276 | 276,809 | ||||||||||||
Reclassification adjustment for realized gains, net of tax | - | (356,829 | ) | (333,194 | ) | (677,705 | ) | |||||||||
Unrealized gains (losses) on interest rate hedge position | 48,953 | (136,527 | ) | (138,097 | ) | (148,089 | ) | |||||||||
Tax effect | (25,176 | ) | 50,925 | 44,594 | 55,237 | |||||||||||
Unrealized gains (losses) on interest rate hedge position, net of tax | 23,777 | (85,602 | ) | (93,503 | ) | (92,852 | ) | |||||||||
Other comprehensive income (loss), net of tax | (661,573 | ) | 1,036,236 | 1,901,330 | 78,304 | |||||||||||
Comprehensive income | $ | 1,232,739 | $ | 2,272,848 | $ | 6,868,450 | $ | 3,193,892 |
The accompanying notes are an integral part of these consolidated financial statements.
3
First South Bancorp, Inc. and Subsidiary
Consolidated Statements of Changes in Stockholders' Equity
Nine Months Ended September 30, 2016 and 2015
(Unaudited)
Accumulated | ||||||||||||||||||||
Additional | other | |||||||||||||||||||
Common | paid-in | Retained | comprehensive | |||||||||||||||||
Nine Months Ended September 30, 2016 | stock | capital | earnings | income, net | Total | |||||||||||||||
Balance at December 31, 2015 | $ | 94,892 | $ | 35,936,911 | $ | 43,691,073 | $ | 2,447,898 | $ | 82,170,774 | ||||||||||
Net income | 4,967,120 | 4,967,120 | ||||||||||||||||||
Other comprehensive income, net | 1,901,330 | 1,901,330 | ||||||||||||||||||
Vesting of restricted stock awards, net | 35 | (35 | ) | - | ||||||||||||||||
Exercise of stock options | 22 | (22 | ) | - | ||||||||||||||||
Stock based compensation expense | 61,618 | 61,618 | ||||||||||||||||||
Dividends | (806,894 | ) | (806,894 | ) | ||||||||||||||||
Balance at September 30, 2016 | $ | 94,949 | $ | 35,998,472 | $ | 47,851,299 | $ | 4,349,228 | $ | 88,293,948 | ||||||||||
Accumulated | ||||||||||||||||||||
Additional | other | |||||||||||||||||||
Common | paid-in | Retained | comprehensive | |||||||||||||||||
Nine Months Ended September 30, 2015 | stock | capital | earnings | income, net | Total | |||||||||||||||
(As restated) | (As restated) | |||||||||||||||||||
Balance at December 31, 2014 | $ | 95,980 | $ | 35,869,195 | $ | 40,868,919 | (a) | $ | 3,168,482 | $ | 80,002,576 | (a) | ||||||||
Net income | 3,115,588 | 3,115,588 | ||||||||||||||||||
Other comprehensive loss, net | 78,304 | 78,304 | ||||||||||||||||||
Vesting of restricted stock awards, net | 35 | (989 | ) | (954 | ) | |||||||||||||||
Retirement of common shares | (1,123 | ) | (908,049 | ) | (909,172 | ) | ||||||||||||||
Stock based compensation expense | 52,727 | 52,727 | ||||||||||||||||||
Dividends | (715,778 | ) | (715,778 | ) | ||||||||||||||||
Balance at September 30, 2015 | $ | 94,892 | $ | 35,920,933 | $ | 42,360,680 | $ | 3,246,786 | $ | 81,623,291 |
(a) - revised for prior period error
The accompanying notes are an integral part of these consolidated financial statements.
4
First South Bancorp, Inc. and Subsidiary
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2016 and 2015
(Unaudited)
Nine Months Ended | ||||||||
September 30, | ||||||||
2016 | 2015 | |||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 4,967,120 | $ | 3,115,588 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Provision for credit losses | 770,000 | 475,000 | ||||||
Depreciation | 1,351,295 | 1,361,056 | ||||||
Amortization of intangibles | 213,245 | 215,546 | ||||||
Amortization of mortgage servicing rights | 188,736 | 171,050 | ||||||
Accretion of discounts and premiums on securities, net | 1,123,998 | 1,566,061 | ||||||
Loss on disposal of premises and equipment | 1,651 | - | ||||||
Loss on sale of assets held for sale | 87,121 | - | ||||||
Gain on sale of other real estate owned | (50,932 | ) | (9,814 | ) | ||||
Gain on sale of loans held for sale | (1,020,678 | ) | (800,972 | ) | ||||
Gain on sale of investment securities available for sale | (467,470 | ) | (954,514 | ) | ||||
Valuation allowance on other real estate owned | 111,170 | 95,639 | ||||||
Stock based compensation expense | 61,618 | 52,727 | ||||||
Originations of loans held for sale, net | (30,707,244 | ) | (23,177,279 | ) | ||||
Proceeds from sale of loans held for sale | 28,359,152 | 24,741,771 | ||||||
Other operating activities | 2,492,897 | (1,142,277 | ) | |||||
Net cash provided by operating activities | 7,481,679 | 5,709,582 | ||||||
Cash flows from investing activities: | ||||||||
Proceeds from sale of investment securities available-for-sale | 40,631,309 | 37,712,331 | ||||||
Proceeds from principal repayments of mortgage-backed securities available-for-sale | 16,962,962 | 17,431,329 | ||||||
Proceeds from sale of assets held for sale | 803,479 | - | ||||||
Mortgage servicing rights from loans sold with servicing retained | (235,435 | ) | (221,637 | ) | ||||
Purchase of mortgage servicing rights portfolio | (778,392 | ) | - | |||||
Originations of loans held for investment, net of principal repayments | (76,054,408 | ) | (88,054,764 | ) | ||||
Proceeds from disposal of other real estate owned | 1,718,907 | 1,924,976 | ||||||
Proceeds from disposal of premises and equipment | 336,709 | - | ||||||
Purchases of investment securities available for sale | - | (11,533,456 | ) | |||||
Purchases of bank-owned life insurance | (2,302,152 | ) | (381,537 | ) | ||||
Sale (purchase) of FHLB stock | 668,100 | (1,592,800 | ) | |||||
Purchase of premises and equipment | (717,004 | ) | (829,347 | ) | ||||
Net cash used in investing activities | (18,965,925 | ) | (45,544,905 | ) | ||||
Cash flows from financing activities: | ||||||||
Net (decrease) increase in deposit accounts | 48,508,852 | (4,969,056 | ) | |||||
Net (decrease) increase in FHLB borrowings | (17,000,000 | ) | 33,000,000 | |||||
Cash paid for dividends | (806,894 | ) | (715,778 | ) | ||||
Retirement of common shares | - | (909,172 | ) | |||||
Vesting of restricted stock awards, net | - | (954 | ) | |||||
Net cash provided by financing activities | 30,701,958 | 26,405,040 | ||||||
Increase (decrease) in cash and cash equivalents | 19,217,712 | (13,430,283 | ) | |||||
Cash and cash equivalents, beginning of period | 37,991,268 | 56,116,677 | ||||||
Cash and cash equivalents, end of period | $ | 57,208,980 | $ | 42,686,394 | ||||
Supplemental disclosures: | ||||||||
Other real estate acquired in settlement of loans | $ | 464,525 | $ | 761,322 | ||||
Transfer of premises to assets held for sale | 1,083,320 | - | ||||||
Cash paid for interest | $ | 2,667,742 | $ | 2,221,151 |
The accompanying notes are an integral part of these consolidated financial statements.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Basis of Presentation. The accompanying unaudited consolidated financial statements are prepared in accordance with the instructions for Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (GAAP) for complete financial statements. In the opinion of management, all adjustments necessary for fair presentation of the financial position and results of operations for the periods presented are included, none of which are other than normal recurring accruals. The financial statements of First South Bancorp, Inc. (the “Company”) and First South Bank (the “Bank”) are presented on a consolidated basis. The results of operations for the three and nine months ended September 30, 2016, are not necessarily indicative of the results of operations that may be expected for the year ended December 31, 2016.
2. Earnings Per Share. Basic and diluted earnings per share for the three and nine months ended September 30, 2016 and 2015 are based on weighted average shares of common stock outstanding. Diluted earnings per share include the potentially dilutive effects of the Company’s stock-based compensation plans. For the three and nine months ended September 30, 2016 and 2015, there were 30,441 and 26,931 stock options and 20,058 and 19,905 stock options, respectively, that were dilutive because their exercise prices were less than the average market price of the Company’s common stock.
3. Comprehensive Income and Accumulated Other Comprehensive Income. Comprehensive income includes net income and changes in other comprehensive income. The components of other comprehensive income primarily include net changes in unrealized gains and losses on available-for-sale securities, and the reclassification of net gains and losses on available-for-sale securities recognized in income during the respective reporting periods. The following table presents changes in accumulated other comprehensive income (AOCI), net of taxes for the nine months ended September 30, 2016 and 2015:
Unrealized
Holding Gains on Investment Securities Available- For-Sale | Unrealized
Holding Losses on Cash Flow Hedging Activities | Total
Accumulated Other Comprehensive Income | ||||||||||
Nine Months Ended September 30, 2016 | (In thousands) | |||||||||||
Balance at December 31, 2015 | $ | 2,695 | $ | (247 | ) | $ | 2,448 | |||||
Other comprehensive income (loss) before reclassifications | 2,328 | (94 | ) | 2,234 | ||||||||
Amounts reclassified from AOCI | (333 | ) | - | (333 | ) | |||||||
Net current period other comprehensive income (loss) | 1,995 | (94 | ) | 1,901 | ||||||||
Balance at September 30, 2016 | $ | 4,690 | $ | (341 | ) | $ | 4,349 | |||||
Nine Months Ended September 30, 2015 | ||||||||||||
Balance at December 31, 2014 | $ | 3,422 | $ | (254 | ) | $ | 3,168 | |||||
Other comprehensive income (loss) before reclassifications | 849 | (93 | ) | 756 | ||||||||
Amounts reclassified from AOCI | (677 | ) | - | (677 | ) | |||||||
Net current period other comprehensive income (loss) | 172 | (93 | ) | 79 | ||||||||
Balance at September 30, 2015 | $ | 3,594 | $ | (347 | ) | $ | 3,247 |
4. Investment Securities. The following is a summary of the securities portfolio by major category, with the amortized cost and fair value and gross unrealized gains and losses of each category at September 30, 2016 and December 31, 2015:
Amortized | Gross | Gross | Fair | |||||||||||||
Securities available-for-sale: | Cost | Unrealized Gains | Unrealized Losses | Value | ||||||||||||
(In thousands) | ||||||||||||||||
September 30, 2016 | ||||||||||||||||
Government agencies | $ | 11,549 | $ | 768 | $ | - | $ | 12,317 | ||||||||
Mortgage-backed securities | 97,562 | 4,297 | 3 | 101,856 | ||||||||||||
Municipal securities | 49,569 | 2,605 | - | 52,174 | ||||||||||||
Corporate bonds | 27,016 | 92 | 200 | 26,908 | ||||||||||||
Total | $ | 185,696 | $ | 7,762 | $ | 203 | $ | 193,255 | ||||||||
December 31, 2015 | ||||||||||||||||
Government agencies | $ | 30,850 | $ | 541 | $ | 6 | $ | 31,385 | ||||||||
Mortgage-backed securities | 128,820 | 3,141 | 277 | 131,684 | ||||||||||||
Municipal securities | 55,534 | 1,305 | 8 | 56,831 | ||||||||||||
Corporate bonds | 28,744 | - | 349 | 28,395 | ||||||||||||
Total | $ | 243,948 | $ | 4,987 | $ | 640 | $ | 248,295 |
6
4. Investment Securities (Continued)
Amortized | Gross | Gross | Fair | |||||||||||||
Securities held-to-maturity: | Cost | Unrealized Gains | Unrealized Losses | Value | ||||||||||||
(In thousands) | ||||||||||||||||
September 30, 2016 | ||||||||||||||||
Government agencies | $ | 509 | $ | 3 | $ | - | $ | 512 | ||||||||
Total | $ | 509 | $ | 3 | $ | - | $ | 512 | ||||||||
December 31, 2015 | ||||||||||||||||
Government agencies | $ | 508 | $ | 2 | $ | - | $ | 510 | ||||||||
Total | $ | 508 | $ | 2 | $ | - | $ | 510 |
The following table presents a summary of realized gains and losses from the sale of available-for-sale investment securities:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
(In thousands) | ||||||||||||||||
Proceeds from sale | - | $ | 14,907 | $ | 40,631 | $ | 37,712 | |||||||||
Gross realized gains on sales | - | 503 | 594 | 960 | ||||||||||||
Gross realized losses on sales | - | - | (127 | ) | (5 | ) | ||||||||||
Total realized gains, net | $ | - | $ | 503 | $ | 467 | $ | 955 |
The following table summarizes gross unrealized losses on investment securities, fair value and length of time the securities were in a continuous unrealized loss position at September 30, 2016 and December 31, 2015. The Company deems these unrealized losses to be temporary and recoverable prior to or at maturity. The Company has the ability and intent to hold the investment securities for a reasonable period of time sufficient for a market price recovery or until maturity.
Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
Value | Losses | Value | Losses | Value | Losses | |||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||
September 30, 2016 | ||||||||||||||||||||||||
Government agencies | $ | 1,642 | $ | 3 | $ | - | $ | - | $ | 1,642 | $ | 3 | ||||||||||||
Corporate bonds | 1,002 | 1 | 9,303 | 200 | 10,305 | 201 | ||||||||||||||||||
Total | $ | 2,644 | $ | 4 | $ | 9,303 | $ | 200 | $ | 11,947 | $ | 204 | ||||||||||||
December 31, 2015 | ||||||||||||||||||||||||
Government agencies | $ | 3,785 | $ | 12 | $ | - | $ | - | $ | 3,785 | $ | 12 | ||||||||||||
Mortgage-backed securities | 51,956 | 264 | 2,641 | 7 | 54,597 | 271 | ||||||||||||||||||
Municipal securities | 1,530 | 8 | - | - | 1,530 | 8 | ||||||||||||||||||
Corporate bonds | 16,115 | 120 | 11,280 | 229 | 27,395 | 349 | ||||||||||||||||||
Total | $ | 73,386 | $ | 404 | $ | 13,921 | $ | 236 | $ | 87,307 | $ | 640 |
7
4. Investment Securities (Continued)
The following table summarizes the amortized cost and fair values of the investment securities portfolio at September 30, 2016, by contractual maturity. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Less Than | One to | Five to | Over | |||||||||||||
One Year | Five Years | Ten Years | Ten Years | |||||||||||||
(In thousands) | ||||||||||||||||
Securities available-for-sale: | ||||||||||||||||
Government agencies | ||||||||||||||||
Amortized cost | $ | - | $ | 1,063 | $ | 10,486 | $ | - | ||||||||
Fair value | - | 1,096 | 11,221 | - | ||||||||||||
Mortgage-backed securities | ||||||||||||||||
Amortized cost | 388 | 72,519 | 7,710 | 16,945 | ||||||||||||
Fair value | 425 | 75,053 | 7,970 | 18,408 | ||||||||||||
Municipal securities | ||||||||||||||||
Amortized cost | 1,410 | 18,160 | 29,999 | - | ||||||||||||
Fair value | 1,424 | 18,747 | 32,003 | - | ||||||||||||
Corporate bonds | ||||||||||||||||
Amortized cost | - | 19,016 | 8,000 | - | ||||||||||||
Fair value | - | 19,093 | 7,815 | - | ||||||||||||
Total amortized cost | $ | 1,798 | $ | 110,758 | $ | 56,195 | $ | 16,945 | ||||||||
Total fair value | $ | 1,849 | $ | 113,989 | $ | 59,009 | $ | 18,408 | ||||||||
Securities held-to-maturity: | ||||||||||||||||
Government agencies | ||||||||||||||||
Amortized cost | $ | 509 | $ | - | $ | - | $ | - | ||||||||
Fair value | 512 | - | - | - | ||||||||||||
Total amortized cost | $ | 509 | $ | - | $ | - | $ | - | ||||||||
Total fair value | $ | 512 | $ | - | $ | - | $ | - |
United States government agency securities and mortgage-backed securities with an amortized cost of $33.2 million were pledged as collateral for public deposits at September 30, 2016, compared to $11.8 million at December 31, 2015. In addition, a government agency bond with an amortized cost of $509,000 and $508,000 was pledged as collateral on an interest rate swap transaction at September 30, 2016 and December 31, 2015, respectively.
Prior to purchasing any security, the Bank ensures the security is “investment grade”. For a security to be investment grade it must: (1) have a low risk of default by the obligor, and (2) the Bank must expect the full and timely repayment of principal and interest over the expected life. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), certain investments are deemed investment grade. These include: U.S. Treasury securities, Federal Agency securities, Revenue Bonds, and Unlimited-Tax General Obligation Municipals. Other securities undergo a pre-purchase analysis to ensure they are investment grade.
To determine if a security is investment grade, if available, management utilizes the ratings of the Nationally Recognized Statistical Rating Organizations (NRSRO). However, they are not the sole basis of determining if a security is investment grade. In addition, on a pre-purchase basis, at least one of the following criteria pertaining to the obligor is acquired and reviewed as part of the Bank’s credit analysis: Data from debt offerings (prospectus/offering circular); data from regulatory filings (Securities and Exchange Commission Forms 10-K, 10-Q, 8-K); data available from the obligor’s website (annual reports, press releases); data obtained from a third party (bond broker, analyst); NRSRO report on the initial offering and/or subsequent reviews of the issuer; or other pertinent available financial information. There have been no instances where the NRSRO’s credit rating has significantly differed from that of the Bank’s credit analysis.
8
4. Investment Securities (Continued)
At September 30, 2016, the investment securities portfolio included 45 taxable and tax-exempt debt instruments issued by various U.S. states, counties, cities, municipalities and school districts. The following table is a summary, by U.S. state, of the Company’s investment in the obligations of state and political subdivisions:
September 30, 2016 | ||||||||
Amortized Cost | Fair Value | |||||||
(In thousands) | ||||||||
Obligations of state and political subdivisions: | ||||||||
General obligation bonds: | ||||||||
Pennsylvania | $ | 3,876 | $ | 3,942 | ||||
California | 3,662 | 3,952 | ||||||
Washington | 3,396 | 3,513 | ||||||
Indiana | 2,426 | 2,461 | ||||||
Alabama | 1,826 | 1,917 | ||||||
Utah | 1,795 | 1,861 | ||||||
Nevada | 1,348 | 1,395 | ||||||
Missouri | 1,307 | 1,486 | ||||||
Other (11 states) | 8,458 | 8,883 | ||||||
Total general obligation bonds | 28,094 | 29,410 | ||||||
Revenue bonds: | ||||||||
New York | 7,226 | 7,729 | ||||||
North Carolina | 4,259 | 4,438 | ||||||
Mississippi | 2,326 | 2,467 | ||||||
Oklahoma | 2,258 | 2,436 | ||||||
Pennsylvania | 1,882 | 1,952 | ||||||
Other (3 states) | 3,524 | 3,742 | ||||||
Total revenue bonds | 21,475 | 22,764 | ||||||
Total obligations of state and political subdivisions | $ | 49,569 | $ | 52,174 |
The largest exposure in general obligation bonds was one bond issued by Ambridge Area School District, Pennsylvania, with a total amortized cost basis and total fair value of $2.4 million at September 30, 2016.
The following table is a summary of the revenue sources related to the Company’s investment in revenue bonds:
September 30, 2016 | ||||||||
Amortized Cost | Fair Value | |||||||
(In thousands) | ||||||||
Revenue bonds by revenue source: | ||||||||
University and college | $ | 8,615 | $ | 9,227 | ||||
Public improvements | 4,994 | 5,279 | ||||||
Pension funding | 1,882 | 1,952 | ||||||
Refunding bonds | 1,635 | 1,718 | ||||||
Other | 4,349 | 4,588 | ||||||
Total revenue bonds | $ | 21,475 | $ | 22,764 |
The largest single exposure in revenue bonds is an issue from the Dormitory Authority of the State of New York (DASNY). DASNY was created in 1944 to finance and build dormitories for state teachers’ colleges. Its mission has expanded over time and in 1995 DASNY became the largest public authority issuer of tax-exempt bonds in the country. The debt is secured by a dedication of 25% of the New York State personal income tax. As of September 30, 2016, this issue had an amortized cost of $2.9 million and fair value of $3.1 million.
9
5. Loans Held for Sale. The Bank originates residential mortgage loans for sale in the secondary market. Pursuant to Accounting Standards Codification (ASC) 825, Financial Instruments, at September 30, 2016 and December 31, 2015, the Bank marked these mortgage loans to market. Mortgage loans held for sale at September 30, 2016 and December 31, 2015, had estimated fair market values of $7.3 million and $3.9 million, respectively. The Bank originates mortgage loans for sale that are approved by secondary investors. Their terms are set by secondary investors, and they are transferred within 120 days after the Bank funds the loans. The Bank issues rate lock commitments to borrowers, and depending on market conditions, may enter into forward contracts with secondary market investors to minimize interest rate risk related to mortgage loan forward sales commitments. The Bank uses forward contracts to minimize interest rate risk related to mortgage loan forward sales commitments to economically hedge a percentage of the locked-in pipeline. The Bank receives origination fees from borrowers and servicing release premiums from investors that are recognized in income when loans are sold. The following table summarizes forward contract positions of the Bank at September 30, 2016 and December 31, 2015:
September 30, 2016 | December 31, 2015 | |||||||||||||||
Fair | Notional | Fair | Notional | |||||||||||||
Value | Value | Value | Value | |||||||||||||
(In thousands) | ||||||||||||||||
Forward Contracts | ||||||||||||||||
Mortgage Loan Forward Sales Commitments | $ | 152 | $ | 4,972 | $ | 78 | $ | 2,882 |
6. Loans Held for Investment. Loans held for investment at September 30, 2016 and December 31, 2015 are listed below:
September 30, 2016 | December 31, 2015 | |||||||||||||||
Amount | Percent of Total | Amount | Percent of Total | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Loans Held for Investment | ||||||||||||||||
Mortgage loans: | ||||||||||||||||
Residential real estate | $ | 68,573 | 10.0 | % | $ | 68,229 | 11.2 | % | ||||||||
Residential construction | 6,372 | 0.9 | 3,934 | 0.6 | ||||||||||||
Residential lots and raw land | 160 | 0.1 | 157 | 0.1 | ||||||||||||
Total mortgage loans | 75,105 | 11.0 | 72,320 | 11.9 | ||||||||||||
Commercial loans and leases: | ||||||||||||||||
Commercial real estate | 371,829 | 54.4 | 338,714 | 55.7 | ||||||||||||
Commercial construction | 54,854 | 8.0 | 42,987 | 7.1 | ||||||||||||
Commercial lots and raw land | 32,476 | 4.8 | 28,271 | 4.7 | ||||||||||||
Commercial and Industrial | 59,751 | 8.7 | 45,481 | 7.5 | ||||||||||||
Lease receivables | 20,452 | 3.0 | 17,235 | 2.8 | ||||||||||||
Total commercial loans and leases | 539,362 | 78.9 | 472,688 | 77.8 | ||||||||||||
Consumer loans: | ||||||||||||||||
Consumer real estate | 17,722 | 2.6 | 17,239 | 2.8 | ||||||||||||
Consumer construction | 252 | 0.1 | 196 | 0.1 | ||||||||||||
Consumer lots and raw land | 9,342 | 1.4 | 9,643 | 1.6 | ||||||||||||
Home equity lines of credit | 34,974 | 5.1 | 29,709 | 4.8 | ||||||||||||
Consumer other | 6,523 | 0.9 | 6,070 | 1.0 | ||||||||||||
Total consumer loans | 68,813 | 10.1 | 62,857 | 10.3 | ||||||||||||
Gross loans held for investment | 683,280 | 100.0 | % | 607,865 | 100.0 | % | ||||||||||
Less deferred loan origination fees, net | 814 | 850 | ||||||||||||||
Less allowance for loan and lease losses | 8,498 | 7,867 | ||||||||||||||
Net loans held for investment | $ | 673,968 | $ | 599,148 |
The Bank has pledged eligible loans as collateral for actual or potential borrowings from the Federal Home Loan Bank (FHLB) and the Federal Reserve Bank of Richmond (FRB). At September 30, 2016, the Bank pledged $265.2 million and $151.7 million of loans to the FHLB and FRB, respectively. See Note 13 below, for additional information.
10
6. Loans Held for Investment (Continued)
The following tables detail nonaccrual loans held for investment, including troubled debt restructured (TDR) loans accounted for on a nonaccrual status, segregated by class of loans, at September 30, 2016 and December 31, 2015:
September 30, 2016 | December 31, 2015 | |||||||
(Dollars in thousands) | ||||||||
Non-accrual loans held for investment: | ||||||||
Non-TDR loans accounted for on a non-accrual status: | ||||||||
Residential real estate | $ | 797 | $ | 635 | ||||
Residential lots and raw land | - | - | ||||||
Commercial real estate | 612 | 594 | ||||||
Commercial construction | - | - | ||||||
Commercial lots and raw land | - | - | ||||||
Commercial and Industrial | - | - | ||||||
Lease receivables | - | 95 | ||||||
Consumer real estate | 249 | 148 | ||||||
Consumer lots and raw land | 52 | 140 | ||||||
Home equity lines of credit | 148 | 81 | ||||||
Consumer other | - | 2 | ||||||
Total non-TDR loans accounted for on a nonaccrual status | 1,858 | 1,695 | ||||||
TDR loans accounted for on a nonaccrual status: | ||||||||
Past Due TDRs: | ||||||||
Residential real estate | - | - | ||||||
Commercial real estate | 98 | - | ||||||
Commercial construction | - | - | ||||||
Commercial lots and raw land | - | - | ||||||
Commercial and Industrial | - | - | ||||||
Consumer real estate | 150 | 159 | ||||||
Total Past Due TDRs | 248 | 159 | ||||||
Current TDRs: | ||||||||
Residential real estate | 499 | 809 | ||||||
Commercial real estate | 201 | 534 | ||||||
Commercial construction | - | - | ||||||
Commercial lots and raw land | - | - | ||||||
Commercial and Industrial | - | - | ||||||
Consumer lots and raw land | 92 | - | ||||||
Total Current TDRs | 792 | 1,343 | ||||||
Total TDR loans accounted for on a nonaccrual status | 1,040 | 1,502 | ||||||
Total non-performing loans | $ | 2,898 | 3,197 | |||||
Percentage of total loans held for investment, net | 0.4 | % | 0.5 | % | ||||
Loans over 90 days past due, still accruing | $ | - | $ | 115 | ||||
Other real estate owned | 4,810 | 6,125 | ||||||
Total non-performing assets | $ | 7,708 | $ | 9,437 |
Cumulative interest income not recorded on loans accounted for on a nonaccrual status was $93,287 and $71,723 at September 30, 2016 and December 31, 2015, respectively.
11
6. Loans Held for Investment (Continued)
The following table presents an age analysis of past due loans held for investment, segregated by class of loans as of September 30, 2016 and December 31, 2015:
30-59 Days Past Due | 60-89 Days Past Due | 90 Days or More Past Due | Total Past Due | Current | Total Financing Receivables | 90 Days or More and Accruing | ||||||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||||||
Past due loans held for investment: | ||||||||||||||||||||||||||||
September 30, 2016 | ||||||||||||||||||||||||||||
Residential real estate | $ | - | $ | 237 | $ | 629 | $ | 866 | $ | 67,707 | $ | 68,573 | $ | - | ||||||||||||||
Residential construction | - | - | - | - | 6,372 | 6,372 | - | |||||||||||||||||||||
Residential lots and raw land | - | - | - | - | 160 | 160 | - | |||||||||||||||||||||
Commercial real estate | 1,504 | - | 237 | 1,741 | 370,088 | 371,829 | - | |||||||||||||||||||||
Commercial construction | - | - | - | - | 54,854 | 54,854 | - | |||||||||||||||||||||
Commercial lots and raw land | 75 | - | - | 75 | 32,401 | 32,476 | - | |||||||||||||||||||||
Commercial and Industrial | - | 29 | - | 29 | 59,722 | 59,751 | - | |||||||||||||||||||||
Lease receivables | - | - | - | - | 20,452 | 20,452 | - | |||||||||||||||||||||
Consumer real estate | 153 | - | 362 | 515 | 17,207 | 17,722 | - | |||||||||||||||||||||
Consumer construction | - | - | - | - | 252 | 252 | - | |||||||||||||||||||||
Consumer lots and raw land | 71 | - | 52 | 123 | 9,219 | 9,342 | - | |||||||||||||||||||||
Home equity lines of credit | 238 | 7 | 95 | 340 | 34,634 | 34,974 | - | |||||||||||||||||||||
Consumer other | 10 | 2 | - | 12 | 6,511 | 6,523 | - | |||||||||||||||||||||
Total | $ | 2,051 | $ | 275 | $ | 1,375 | $ | 3,701 | $ | 679,579 | $ | 683,280 | $ | - | ||||||||||||||
30-59 Days Past Due | 60-89 Days Past Due | 90
Days or More Past Due | Total Past Due | Current | Total Financing Receivables | 90
Days or More and Accruing | ||||||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||||||
Past due loans held for investment: | ||||||||||||||||||||||||||||
December 31, 2015 | ||||||||||||||||||||||||||||
Residential real estate | $ | 2,238 | $ | 107 | $ | 354 | $ | 2,699 | $ | 65,530 | $ | 68,229 | $ | 115 | ||||||||||||||
Residential construction | 120 | - | - | 120 | 3,814 | 3,934 | - | |||||||||||||||||||||
Residential lots and raw land | - | - | - | - | 157 | 157 | - | |||||||||||||||||||||
Commercial real estate | 1,054 | 227 | 103 | 1,384 | 337,330 | 338,714 | - | |||||||||||||||||||||
Commercial construction | - | - | - | - | 42,987 | 42,987 | - | |||||||||||||||||||||
Commercial lots and raw land | 69 | - | - | 69 | 28,202 | 28,271 | - | |||||||||||||||||||||
Commercial and Industrial | 3 | - | - | 3 | 45,478 | 45,481 | - | |||||||||||||||||||||
Lease receivables | - | - | 95 | 95 | 17,140 | 17,235 | - | |||||||||||||||||||||
Consumer real estate | 429 | 113 | 237 | 779 | 16,460 | 17,239 | - | |||||||||||||||||||||
Consumer construction | - | - | - | - | 196 | 196 | - | |||||||||||||||||||||
Consumer lots and raw land | 211 | - | 140 | 351 | 9,292 | 9,643 | - | |||||||||||||||||||||
Home equity lines of credit | 122 | 72 | 34 | 228 | 29,481 | 29,709 | - | |||||||||||||||||||||
Consumer other | 3 | 2 | 1 | 6 | 6,064 | 6,070 | - | |||||||||||||||||||||
Total | $ | 4,249 | $ | 521 | $ | 964 | $ | 5,734 | $ | 602,131 | $ | 607,865 | $ | 115 |
12
6. Loans Held for Investment (Continued)
The following table presents information on loans that were considered impaired as of September 30, 2016 and December 31, 2015. Impaired loans include loans modified as a TDR, whether on accrual or nonaccrual status. At September 30, 2016, impaired loans included $1.6 million of TDRs, compared to $2.4 million at December 31, 2015.
Contractual | YTD Average | Interest Income | ||||||||||||||||||
Recorded | Unpaid Principal | Related | Recorded | Recognized on | ||||||||||||||||
Investment | Balance | Allowance | Investment | Impaired Loans | ||||||||||||||||
(In thousands) | ||||||||||||||||||||
Impaired Loans September 30, 2016 | ||||||||||||||||||||
With no related allowance recorded: | ||||||||||||||||||||
Residential real estate | $ | 774 | $ | 982 | $ | - | $ | 856 | $ | 31 | ||||||||||
Commercial real estate | 7,308 | 7,373 | - | 8,032 | 361 | |||||||||||||||
Commercial lots and raw land | 2,325 | 2,325 | - | 2,424 | 92 | |||||||||||||||
Commercial and Industrial | 68 | 68 | - | 48 | 2 | |||||||||||||||
Consumer real estate | 295 | 305 | - | 266 | 8 | |||||||||||||||
Consumer lots and raw land | 101 | 154 | - | 75 | 6 | |||||||||||||||
Home equity lines of credit | 30 | 32 | - | 45 | 2 | |||||||||||||||
Consumer other | 39 | 39 | - | 41 | 2 | |||||||||||||||
Subtotal: | 10,940 | 11,278 | - | 11,787 | 504 | |||||||||||||||
With an allowance recorded: | ||||||||||||||||||||
Commercial real estate | 201 | 205 | 159 | 652 | 12 | |||||||||||||||
Consumer real estate | 104 | 106 | 24 | 26 | 4 | |||||||||||||||
Consumer lots and raw land | 684 | 709 | 133 | 697 | 28 | |||||||||||||||
Home equity lines of credit | 23 | 25 | 23 | 17 | 2 | |||||||||||||||
Subtotal | 1,012 | 1,045 | 339 | 1,392 | 46 | |||||||||||||||
Totals: | ||||||||||||||||||||
Residential | 774 | 982 | - | 856 | 31 | |||||||||||||||
Commercial | 9,902 | 9,971 | 159 | 11,156 | 467 | |||||||||||||||
Consumer | 1,276 | 1,370 | 180 | 1,167 | 52 | |||||||||||||||
Grand Total | $ | 11,952 | $ | 12,323 | $ | 339 | $ | 13,179 | $ | 550 | ||||||||||
Contractual | YTD Average | Interest Income | ||||||||||||||||||
Recorded | Unpaid Principal | Related | Recorded | Recognized on | ||||||||||||||||
Investment | Balance | Allowance | Investment | Impaired Loans | ||||||||||||||||
(In thousands) | ||||||||||||||||||||
Impaired Loans December 31, 2015 | ||||||||||||||||||||
With no related allowance recorded: | ||||||||||||||||||||
Residential real estate | $ | 1,087 | $ | 1,384 | $ | - | $ | 1,180 | $ | 62 | ||||||||||
Commercial real estate | 9,521 | 9,573 | - | 10,883 | 564 | |||||||||||||||
Commercial construction | 574 | 574 | - | 305 | 14 | |||||||||||||||
Commercial lots and raw land | 2,616 | 2,616 | - | 2,764 | 139 | |||||||||||||||
Commercial and Industrial | 42 | 42 | - | 44 | 2 | |||||||||||||||
Consumer real estate | 201 | 207 | - | 277 | 8 | |||||||||||||||
Consumer lots and raw land | 50 | 50 | - | 55 | 3 | |||||||||||||||
Home equity lines of credit | 50 | 51 | - | 56 | 2 | |||||||||||||||
Consumer other | 42 | 42 | - | 44 | 2 | |||||||||||||||
Subtotal: | 14,183 | 14,539 | - | 15,608 | 796 | |||||||||||||||
With an allowance recorded: | ||||||||||||||||||||
Commercial real estate | 821 | 823 | 365 | 1,434 | 57 | |||||||||||||||
Commercial and Industrial | 14 | 14 | 14 | 61 | 2 | |||||||||||||||
Consumer real estate | 79 | 79 | 30 | 100 | 2 | |||||||||||||||
Consumer lots and raw land | 723 | 723 | 209 | 619 | 35 | |||||||||||||||
Subtotal | 1,637 | 1,639 | 618 | 2,214 | 96 | |||||||||||||||
Totals: | ||||||||||||||||||||
Residential | 1,087 | 1,384 | - | 1,180 | 62 | |||||||||||||||
Commercial | 13,588 | 13,642 | 379 | 15,491 | 778 | |||||||||||||||
Consumer | 1,145 | 1,152 | 239 | 1,151 | 52 | |||||||||||||||
Grand Total | $ | 15,820 | $ | 16,178 | $ | 618 | $ | 17,822 | $ | 892 |
13
6. Loans Held for Investment (Continued)
Credit Quality Indicators. The Bank assigns a risk grade to each loan in the portfolio as part of the on-going monitoring of the credit quality of the loan portfolio.
Commercial loans are graded on a scale of 1 to 9 as follows:
• | Risk Grade 1 (Excellent) - Loans in this category are considered to be of the highest quality. |
• | Risk Grade 2 (Above Average) - Loans are supported by above average financial strength and stability. |
• | Risk Grade 3 (Average) - Credits in this group are supported by upper tier industry-average financial strength and stability. |
• | Risk Grade 4 (Acceptable) - Credits in this group are supported by lower end industry-average financial strength and stability. |
• | Risk Grade 5 (Watch) - An asset in this category is one that has been identified by the lender, or credit administration as a loan that has shown some degree of deterioration from its original status. |
• | Risk Grade 6 (Special Mention) - An asset in this category is currently protected by collateral but has potential weaknesses that deserve management’s close attention. |
• | Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the debtor(s) or of the collateral pledged, if any. |
• | Risk Grade 8 (Doubtful) - A loan graded in this category has all the weaknesses inherent in one graded Substandard with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable. |
• | Risk Grade 9 (Loss) - A loan graded as Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted. |
Consumer loans are graded on a scale of 1 to 9 as follows:
• | Risk Grades 1 - 5 (Pass) - Loans in this category generally show little to no signs of weakness or have adequate mitigating factors that minimize the risk of loss. |
• | Risk Grade 6 (Special Mention) - An asset in this category is currently protected by collateral but has potential weaknesses that deserve management’s close attention. |
• | Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the debtor(s) or of the collateral pledged, if any. |
• | Risk Grade 8 (Doubtful) - A loan graded in this category has all the weaknesses inherent in one graded Substandard with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable. |
• | Risk Grade 9 (Loss) - A loan graded as Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted. |
Mortgage loans are graded on a scale of 1 to 9 as follows:
• | Risk Grades 1 - 4 (Pass) - Loans in this category generally show little to no signs of weakness or have adequate mitigating factors that minimize the risk of loss. |
• | Risk Grade 5 (Pass -Watch) – Watch loans have shown credit quality changes from the original status. |
• | Risk Grade 6 (Special Mention) – Special Mention loans are currently protected by collateral but have potential weaknesses that deserve management’s close attention. |
• | Risk Grade 7 (Substandard) - Substandard loans are inadequately protected by the sound net worth and paying capacity of the borrower(s). |
• | Risk Grade 8 (Doubtful) - Loans classified Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable. |
• | Risk Grade 9 (Loss) - Loans classified Loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. |
14
6. Loans Held for Investment (Continued)
The following table presents information on risk ratings of the commercial, consumer, mortgage and lease receivable portfolios, segregated by loan class as of September 30, 2016 and December 31, 2015:
September 30, 2016 | ||||||||||||||||
Commercial Credit Exposure by Assigned Risk Grade | Commercial Real Estate | Commercial Construction | Commercial Lots and Raw Land | Commercial and Industrial | ||||||||||||
(In thousands) | ||||||||||||||||
1-Excellent | $ | - | $ | - | $ | - | $ | 10 | ||||||||
2-Above Average | 2,601 | - | 219 | 761 | ||||||||||||
3-Average | 110,601 | 11,677 | 2,404 | 13,862 | ||||||||||||
4-Acceptable | 234,455 | 40,793 | 23,035 | 40,829 | ||||||||||||
5-Watch | 13,352 | 2,060 | 3,105 | 1,969 | ||||||||||||
6-Special Mention | 5,567 | 324 | 3,168 | 341 | ||||||||||||
7-Substandard | 5,253 | - | 545 | 1,979 | ||||||||||||
8-Doubtful | - | - | - | - | ||||||||||||
9-Loss | - | - | - | - | ||||||||||||
Total | $ | 371,829 | $ | 54,854 | $ | 32,476 | $ | 59,751 |
September 30, 2016 | ||||||||||||||||||||
Consumer Credit Exposure by Assigned Risk Grade | Consumer Real Estate | Consumer Construction | Consumer Lots and Raw Land | Home Equity Line of Credit | Consumer Other | |||||||||||||||
(In thousands) | ||||||||||||||||||||
Pass | $ | 17,042 | $ | 252 | $ | 8,984 | $ | 34,647 | $ | 6,520 | ||||||||||
6-Special Mention | 259 | - | 214 | 87 | 2 | |||||||||||||||
7-Substandard | 421 | - | 144 | 240 | 1 | |||||||||||||||
8-Doubtful | - | - | - | - | - | |||||||||||||||
9-Loss | - | - | - | - | - | |||||||||||||||
Total | $ | 17,722 | $ | 252 | $ | 9,342 | $ | 34,974 | $ | 6,523 |
September 30, 2016 | ||||||||||||||||
Mortgage and Lease Receivable Credit Exposure by Assigned Risk Grade | Residential Real Estate | Residential Construction | Residential Lots and Raw Land | Lease Receivable | ||||||||||||
(In thousands) | ||||||||||||||||
Pass | $ | 66,509 | $ | 6,372 | $ | 160 | $ | 20,452 | ||||||||
6-Special Mention | 768 | - | - | - | ||||||||||||
7-Substandard | 1,296 | - | - | - | ||||||||||||
8-Doubtful | - | - | - | - | ||||||||||||
9-Loss | - | - | - | - | ||||||||||||
Total | $ | 68,573 | $ | 6,372 | $ | 160 | $ | 20,452 |
15
6. Loans Held for Investment (Continued)
December 31, 2015 | ||||||||||||||||
Commercial Credit Exposure by Assigned Risk Grade | Commercial Real Estate | Commercial Construction | Commercial Lots and Raw Land | Commercial and Industrial | ||||||||||||
(In thousands) | ||||||||||||||||
1-Excellent | $ | - | $ | - | $ | - | $ | - | ||||||||
2-Above Average | 2,788 | - | 160 | 3,757 | ||||||||||||
3-Average | 98,148 | 10,023 | 2,247 | 8,095 | ||||||||||||
4-Acceptable | 209,936 | 31,139 | 18,086 | 30,218 | ||||||||||||
5-Watch | 11,877 | 391 | 3,821 | 1,350 | ||||||||||||
6-Special Mention | 7,872 | 860 | 2,715 | 41 | ||||||||||||
7-Substandard | 8,093 | 574 | 1,242 | 2,020 | ||||||||||||
8-Doubtful | - | - | - | - | ||||||||||||
9-Loss | - | - | - | - | ||||||||||||
Total | $ | 338,714 | $ | 42,987 | $ | 28,271 | $ | 45,481 |
December 31, 2015 | ||||||||||||||||||||
Consumer Credit Exposure by Assigned Risk Grade | Consumer Real Estate | Consumer Construction | Consumer Lots and Raw Land | Home Equity Line of Credit | Consumer Other | |||||||||||||||
(In thousands) | ||||||||||||||||||||
Pass | $ | 16,253 | $ | 196 | $ | 7,906 | $ | 29,523 | $ | 6,000 | ||||||||||
6-Special Mention | 679 | - | 1,270 | 61 | 26 | |||||||||||||||
7-Substandard | 307 | - | 277 | 125 | 44 | |||||||||||||||
8-Doubtful | - | - | 190 | - | - | |||||||||||||||
9-Loss | - | - | - | - | - | |||||||||||||||
Total | $ | 17,239 | $ | 196 | $ | 9,643 | $ | 29,709 | $ | 6,070 |
December 31, 2015 | ||||||||||||||||
Mortgage and Lease Receivable Credit Exposure by Assigned Risk Grade | Residential Real Estate | Residential Construction | Residential Lots and Raw Land | Lease Receivable | ||||||||||||
(In thousands) | ||||||||||||||||
Pass | $ | 65,977 | $ | 3,934 | $ | 157 | $ | 17,140 | ||||||||
6-Special Mention | 791 | - | - | - | ||||||||||||
7-Substandard | 1,461 | - | - | 95 | ||||||||||||
8-Doubtful | - | - | - | - | ||||||||||||
9-Loss | - | - | - | - | ||||||||||||
Total | $ | 68,229 | $ | 3,934 | $ | 157 | $ | 17,235 |
16
7. Allowance for Loan and Lease Losses. The following table presents a roll forward summary of activity in the allowance for loan and lease losses (“ALLL”), by loan category, for the nine months ended September 30, 2016 and 2015:
September 30, 2016 | ||||||||||||||||||||||||
Beginning | Charge- | Ending | Total | |||||||||||||||||||||
Balance | Offs | Recoveries | Provisions | Balance | Loans | |||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||
Collectively evaluated for impairment: | ||||||||||||||||||||||||
Residential real estate | $ | 730 | $ | - | $ | - | $ | 2 | $ | 732 | $ | 67,799 | ||||||||||||
Residential construction | 47 | - | - | 27 | 74 | 6,372 | ||||||||||||||||||
Residential lots and raw land | 2 | - | - | - | 2 | 160 | ||||||||||||||||||
Commercial real estate | 4,065 | (33 | ) | 22 | 465 | 4,519 | 364,320 | |||||||||||||||||
Commercial construction | 518 | - | 70 | 91 | 679 | 54,854 | ||||||||||||||||||
Commercial lots and raw land | 303 | - | - | 52 | 355 | 30,151 | ||||||||||||||||||
Commercial and industrial | 641 | (2 | ) | 4 | 126 | 769 | 59,683 | |||||||||||||||||
Lease receivables | 196 | - | - | 28 | 224 | 20,452 | ||||||||||||||||||
Consumer real estate | 198 | (6 | ) | 11 | (5 | ) | 198 | 17,323 | ||||||||||||||||
Consumer construction | 2 | - | - | 1 | 3 | 252 | ||||||||||||||||||
Consumer lots and raw land | 125 | (4 | ) | - | 4 | 125 | 8,557 | |||||||||||||||||
Home equity lines of credit | 351 | (13 | ) | 1 | 65 | 404 | 34,921 | |||||||||||||||||
Consumer other | 71 | (40 | ) | 21 | 23 | 75 | 6,484 | |||||||||||||||||
Total | 7,249 | (98 | ) | 129 | 879 | 8,159 | 671,328 | |||||||||||||||||
Individually evaluated for impairment: | ||||||||||||||||||||||||
Residential real estate | - | (2 | ) | 1 | 1 | - | 774 | |||||||||||||||||
Commercial real estate | - | (68 | ) | 3 | 224 | 159 | 7,509 | |||||||||||||||||
Commercial construction | - | - | - | - | - | - | ||||||||||||||||||
Commercial lots and raw land | 365 | - | - | (365 | ) | - | 2,325 | |||||||||||||||||
Commercial and industrial | 14 | - | - | (14 | ) | - | 68 | |||||||||||||||||
Consumer real estate | 30 | (36 | ) | - | 30 | 24 | 399 | |||||||||||||||||
Consumer lots and raw land | 209 | (73 | ) | 2 | (5 | ) | 133 | 785 | ||||||||||||||||
Home equity lines of credit | - | - | 4 | 19 | 23 | 53 | ||||||||||||||||||
Consumer other | - | - | - | - | - | 39 | ||||||||||||||||||
Total | 618 | (179 | ) | 10 | (110 | ) | 339 | 11,952 | ||||||||||||||||
Grand Total | $ | 7,867 | $ | (277 | ) | $ | 139 | $ | 769 | $ | 8,498 | $ | 683,280 |
17
7. Allowance for Loan and Lease Losses (Continued)
September 30, 2015 | ||||||||||||||||||||||||
Beginning | Charge- | Ending | Total | |||||||||||||||||||||
Balance | Offs | Recoveries | Provisions | Balance | Loans | |||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||
Collectively evaluated for impairment: | ||||||||||||||||||||||||
Residential real estate | $ | 982 | $ | (108 | ) | $ | - | $ | 33 | $ | 907 | $ | 66,048 | |||||||||||
Residential construction | 17 | - | - | 33 | 50 | 4,306 | ||||||||||||||||||
Residential lots and raw land | 11 | - | - | (9 | ) | 2 | 162 | |||||||||||||||||
Commercial real estate | 3,516 | (3 | ) | 42 | 184 | 3,739 | 304,920 | |||||||||||||||||
Commercial construction | 375 | - | - | 103 | 478 | 40,307 | ||||||||||||||||||
Commercial lots and raw land | 377 | - | - | (67 | ) | 310 | 22,919 | |||||||||||||||||
Commercial and industrial | 400 | - | 1 | 254 | 655 | 37,756 | ||||||||||||||||||
Lease receivables | 172 | - | - | (12 | ) | 160 | 14,438 | |||||||||||||||||
Consumer real estate | 250 | - | 15 | (77 | ) | 188 | 16,547 | |||||||||||||||||
Consumer construction | 19 | - | - | (15 | ) | 4 | 321 | |||||||||||||||||
Consumer lots and raw land | 152 | - | - | (20 | ) | 132 | 9,339 | |||||||||||||||||
Home equity lines of credit | 405 | - | 1 | (61 | ) | 345 | 28,470 | |||||||||||||||||
Consumer other | 52 | (10 | ) | 93 | (66 | ) | 69 | 5,935 | ||||||||||||||||
Total | 6,728 | (121 | ) | 152 | 280 | 7,039 | 551,468 | |||||||||||||||||
Individually evaluated for impairment: | ||||||||||||||||||||||||
Residential real estate | 185 | (185 | ) | 1 | (1 | ) | - | 1,095 | ||||||||||||||||
Commercial real estate | 167 | (157 | ) | 24 | 338 | 372 | 11,240 | |||||||||||||||||
Commercial construction | - | - | - | - | - | 448 | ||||||||||||||||||
Commercial lots and raw land | 251 | (33 | ) | - | (218 | ) | - | 2,683 | ||||||||||||||||
Commercial and industrial | - | - | - | 21 | 21 | 64 | ||||||||||||||||||
Consumer real estate | 19 | (33 | ) | - | 45 | 31 | 402 | |||||||||||||||||
Consumer lots and raw land | 165 | (85 | ) | 8 | 19 | 107 | 665 | |||||||||||||||||
Home equity lines of credit | 5 | - | 4 | (9 | ) | - | 46 | |||||||||||||||||
Consumer other | - | - | - | - | - | 43 | ||||||||||||||||||
Total | 792 | (493 | ) | 37 | 195 | 531 | 16,686 | |||||||||||||||||
Grand Total | $ | 7,520 | $ | (614 | ) | $ | 189 | $ | 475 | $ | 7,570 | $ | 568,154 |
8. Troubled Debt Restructurings. The following table details performing TDR loans at September 30, 2016 and December 31, 2015, segregated by class of financing receivables:
September 30, 2016 | December 31, 2015 | |||||||
(Dollars in thousands) | ||||||||
Performing TDRs accounted for on accrual status: | ||||||||
Residential real estate | $ | - | $ | - | ||||
Commercial real estate | 468 | 765 | ||||||
Commercial construction | - | - | ||||||
Commercial lots and raw land | - | - | ||||||
Commercial and Industrial | - | 5 | ||||||
Consumer real estate | - | - | ||||||
Consumer lots and raw land | 98 | 107 | ||||||
Home equity lines of credit | - | - | ||||||
Consumer other | - | - | ||||||
Total | $ | 566 | $ | 877 | ||||
Percentage of total loans, net | 0.0 | % | 0.1 | % |
18
8. Troubled Debt Restructurings (Continued)
The following table presents a roll forward of performing TDR loans for the nine months ended September 30, 2016 and 2015:
Performing TDRs | Beginning Balance | Additions (1) | Charge-offs (2) | Other (3) | Ending Balance | |||||||||||||||
(In thousands) | ||||||||||||||||||||
September 30, 2016 | ||||||||||||||||||||
Residential mortgage | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||
Commercial | 770 | 92 | - | (394 | ) | 468 | ||||||||||||||
Consumer | 107 | - | - | (9 | ) | 98 | ||||||||||||||
Total | $ | 877 | $ | 92 | $ | - | $ | (403 | ) | $ | 566 | |||||||||
September 30, 2015 | ||||||||||||||||||||
Residential mortgage | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||
Commercial | 1,141 | - | (8 | ) | (351 | ) | 782 | |||||||||||||
Consumer | 281 | - | - | (166 | ) | 115 | ||||||||||||||
Total | $ | 1,422 | $ | - | $ | (8 | ) | $ | (517 | ) | $ | 897 |
The following table presents a roll forward of non-performing TDR loans for the nine months ended September 30, 2016 and 2015:
Non-Performing TDRs | Beginning Balance | Additions (1) | Charge-offs (2) | Other (4) | Ending Balance | |||||||||||||||
(In thousands) | ||||||||||||||||||||
September 30, 2016 | ||||||||||||||||||||
Residential mortgage | $ | 809 | $ | - | $ | (2 | ) | $ | (308 | ) | $ | 499 | ||||||||
Commercial | 534 | - | - | (235 | ) | 299 | ||||||||||||||
Consumer | 159 | 92 | - | (9 | ) | 242 | ||||||||||||||
Total | $ | 1,502 | $ | 92 | $ | (2 | ) | $ | (552 | ) | $ | 1,040 | ||||||||
September 30, 2015 | ||||||||||||||||||||
Residential mortgage | $ | 834 | $ | - | $ | - | $ | (19 | ) | $ | 815 | |||||||||
Commercial | 2,355 | - | (152 | ) | (1,468 | ) | 735 | |||||||||||||
Consumer | 51 | - | (33 | ) | 145 | 163 | ||||||||||||||
Total | $ | 3,240 | $ | - | $ | (185 | ) | $ | (1,342 | ) | $ | 1,713 |
1. | Includes new TDRs and increases to existing TDRs. |
2. | Post modification charge-offs. |
3. | Includes principal payments, paydowns and performing loans previously restructured at market rates that are no longer reported as TDRs. |
4. | Includes principal payments, paydowns and loans previously designated as non-performing that are currently performing in compliance with their modified terms. |
The Bank performs restructurings on certain troubled loan workouts, whereby existing loans are restructured into a multiple note structure (i.e., Note A and Note B structure). The Bank separates a portion of the current outstanding debt into a new legally enforceable note (Note A) that is reasonably assured of repayment and performance according to prudently modified terms. The portion of the debt that is not reasonably assured of repayment (Note B) is adversely classified and charged-off as appropriate. The following table provides information on multiple note restructures for certain commercial real estate loan workouts as of September 30, 2016 and 2015:
September 30, 2016 | September 30, 2015 | |||||||
(In thousands) | ||||||||
Note A Structure | ||||||||
Commercial real estate (1) | $ | 352 | $ | 271 | ||||
Note B Structure | ||||||||
Commercial real estate (2) | $ | 207 | $ | 174 | ||||
Reduction of interest income (3) | $ | 8 | $ | 7 |
(1) | If Note A was on nonaccrual status, it may be placed back on accrual status based on sustained historical payment performance of generally nine months. |
(2) | Note B is immediately charged-off upon restructuring; however, payment in full is due at maturity of the note. |
(3) | Reflects amount of interest income reduction during the nine months ended September 30, 2016 and 2015, as a result of multiple note restructures. |
19
8. Troubled Debt Restructurings (Continued)
The benefit of this workout strategy is for the A note to remain or become a performing asset for which the borrower has the willingness and ability to meet the restructured payment terms and conditions. In addition, this workout strategy reduces the prospects of further write downs and charge offs, and also reduces the prospects of a potential foreclosure. Following this restructuring, the Note A credit classification generally improves to an unclassified risk grade after a period of sustained payments.
The general terms of the new loans restructured under the Note A and Note B structure differ as follows:
· | Note A: First lien position; fixed or adjustable current market interest rate; fixed month term to maturity; payments – interest only to maturity, or full principal and interest to maturity. Note A is underwritten in accordance with the Bank’s customary underwriting standards and is generally on an accrual basis. |
· | Note B: Second lien position; fixed or adjustable below current market interest rate; fixed month term to maturity; payments – due in full at maturity. Note B is underwritten in accordance with the Bank’s customary underwriting standards, except for the below market interest rate and payment terms, is on a nonaccrual basis and is charged off. |
9. Other Real Estate Owned. The following table reflects the changes in other real estate owned (OREO) during the nine months ended September 30, 2016 and 2015:
Beginning | Fair Value | Ending | ||||||||||||||||||
Nine Months Ended: | Balance | Additions | Sales, net | Adjustments | Balance | |||||||||||||||
(In thousands) | ||||||||||||||||||||
September 30, 2016 | $ | 6,125 | $ | 464 | $ | (1,668 | ) | $ | (111 | ) | $ | 4,810 | ||||||||
September 30, 2015 | $ | 7,756 | $ | 761 | $ | (1,915 | ) | $ | (96 | ) | $ | 6,506 |
Fair value adjustments are recorded in order to adjust the carrying values of OREO properties to estimated fair market values. In most cases, estimated fair market values are derived from an initial appraisal, an updated appraisal or other forms of internal evaluations. In certain instances when a listing agreement is renewed for a lesser amount, carrying values will be adjusted to the lesser fair value amount. Additionally, in certain instances when an offer to purchase is received near the end of a quarterly accounting period for less than the carrying value, and the sale does not close until the next accounting period, the carrying value will be adjusted to the lesser fair value amount. At September 30, 2016, OREO consisted of residential and commercial properties, developed lots and raw land.
10. Premises and Equipment. The following table presents premises and equipment at September 30, 2016 and December 31, 2015, respectively:
September 30, 2016 | December 31, 2015 | |||||||
Land | $ | 2,817,308 | $ | 3,680,886 | ||||
Office buildings and improvements | 9,650,220 | 10,138,594 | ||||||
Furniture, fixtures and equipment | 10,171,859 | 10,183,020 | ||||||
Vehicles | 621,238 | 621,238 | ||||||
Projects/work in process | 516,129 | 86,032 | ||||||
23,776,754 | 24,709,770 | |||||||
Less accumulated depreciation | 12,167,788 | 11,044,833 | ||||||
Total | $ | 11,608,966 | $ | 13,664,937 |
The Bank leases certain branch facilities and equipment under separate agreements that expire at various dates through October 30, 2027. Rental expense of $344,166 and $1,032,125 during the three and nine months ended September 30, 2016, and $300,305 and $894,954 during the three and nine months ended September 30, 2015, respectively, is included in premises and equipment expense on the accompanying consolidated statements of operations. Future rental expenses under these leases as of September 30, 2016 are as follows:
2016 | $ | 325,105 | ||
2017 | 1,167,033 | |||
2018 | 1,036,054 | |||
2019 | 809,128 | |||
2020 | 761,629 | |||
Thereafter | 2,093,116 | |||
Total | $ | 6,192,065 |
20
11. Goodwill and Other Intangibles. The following table presents activity for goodwill and other intangible assets for the nine months ended September 30, 2016 and 2015, respectively:
Nine Months Ended September 30, 2016: | Goodwill | Identifiable Intangibles | Total | |||||||||
Balance at December 31, 2015 | $ | 4,218,576 | $ | 1,895,514 | $ | 6,114,090 | ||||||
Amortization | - | (213,245 | ) | (213,245 | ) | |||||||
Balance at September 30, 2016 | $ | 4,218,576 | $ | 1,682,269 | $ | 5,900,845 | ||||||
Nine Months Ended September 30, 2015 | ||||||||||||
Balance at December 31, 2014 | $ | 4,218,576 | $ | 2,182,909 | $ | 6,401,485 | ||||||
Amortization | - | (215,546 | ) | (215,546 | ) | |||||||
Balance at September 30, 2015 | $ | 4,218,576 | $ | 1,967,363 | $ | 6,185,939 |
The following table presents a rollforward of the gross carrying amount, new acquisitions, accumulated amortization and net book value for the Company’s core deposit intangible (CDI), which is the only identifiable intangible asset subject to amortization at September 30, 2016 and December 31, 2015, respectively:
Identifiable Intangibles | ||||
Net book value at December 31, 2014 (1) | $ | 2,182,909 | ||
Accumulated amortization | (287,395 | ) | ||
Net book value at December 31, 2015 | 1,895,514 | |||
Accumulated amortization | (213,245 | ) | ||
Net book value at September 30, 2016 | $ | 1,682,269 |
(1) | CDI related to the acquisition of branch offices from Bank of America, N.A. on December 12, 2014. |
The following table presents estimated future amortization expense of the CDI. At September 30, 2016, the remaining life of the CDI was 8.25 years.
2016 | $ | 71,082 | ||
2017 | 241,678 | |||
2018 | 223,002 | |||
2019 | 223,002 | |||
2020 | 223,002 | |||
Thereafter | 700,503 | |||
Total | $ | 1,682,269 |
12. Deposits. The following table presents the distribution of the Company’s deposit accounts as of September 30, 2016 and December 31, 2015:
September 30, 2016 | December 31, 2015 | |||||||
(In thousands) | ||||||||
Demand accounts: | ||||||||
Non-interest bearing checking | $ | 189,873 | $ | 169,546 | ||||
Interest bearing checking | 176,034 | 173,934 | ||||||
Money market | 88,081 | 72,442 | ||||||
Savings accounts | 141,701 | 135,370 | ||||||
Certificate accounts | 264,142 | 260,030 | ||||||
Total deposits | $ | 859,831 | $ | 811,322 |
At September 30, 2016, the scheduled maturities of certificate accounts were as follows:
$250,000 or Less | More than $250,000 | Total | ||||||||||
(In thousands) | ||||||||||||
Three months or less | $ | 29,475 | $ | 4,794 | $ | 34,269 | ||||||
Over three months through one year | 63,723 | 12,901 | 76,624 | |||||||||
Over one year through three years | 113,778 | 17,937 | 131,715 | |||||||||
Over three years | 16,749 | 4,785 | 21,534 | |||||||||
Total time deposits | $ | 223,725 | $ | 40,417 | $ | 264,142 |
The aggregate amount of time deposits with balances of $250,000 or more was $40.4 million and $35.6 million at September 30, 2016 and December 31, 2015, respectively.
21
13. Borrowed Money. The Bank had $20.0 million of FHLB borrowings outstanding at September 30, 2016 compared to $37.0 million at December 31, 2015. The Bank pledges its stock in the FHLB and certain loans as collateral for FHLB advances. At September 30, 2016 and December 31, 2015, the Bank had approximately $240.1 million and $228.2 million, respectively, of credit available with the FHLB. At September 30, 2016, the Bank had lendable collateral value with the FHLB totaling $195.9 million. Additional collateral would be required in order to access total borrowings up to the credit availability limit.
The following table details the Bank’s FHLB advances outstanding and the related maturity dates and interest rates at September 30, 2016:
Maturity | Interest Rate | Amount | ||||||
(Dollars in thousands) | ||||||||
November 25, 2016 | 0.450 | % | 2,000 | |||||
December 27, 2016 | 0.740 | % | 1,000 | |||||
February 22, 2017 | 0.590 | % | 2,000 | |||||
June 26, 2017 | 0.790 | % | 1,000 | |||||
June 26, 2017 | 0.950 | % | 2,000 | |||||
June 29, 2017 | 0.930 | % | 1,000 | |||||
June 22, 2018 | 1.330 | % | 1,000 | |||||
June 25, 2018 | 0.870 | % | 1,000 | |||||
June 25, 2018 | 1.360 | % | 2,000 | |||||
June 29, 2018 | 1.340 | % | 1,000 | |||||
June 24, 2019 | 1.048 | % | 1,000 | |||||
July 8, 2019 | 1.620 | % | 2,000 | |||||
June 29, 2020 | 1.980 | % | 2,000 | |||||
July 6, 2020 | 1.890 | % | 1,000 | |||||
$ | 20,000 |
14. Junior Subordinated Debentures. The Company has sponsored a trust, First South Preferred Trust I (the “Trust”), of which 100% of the common equity is owned by the Company. The Trust was formed for the purpose of issuing company-obligated trust preferred securities (Trust Preferred Securities) to third-party investors and investing the proceeds from the sale of such Trust Preferred Securities solely in junior subordinated debt securities of the Company (Debentures). The Debentures held by the Trust are the sole assets of the Trust. Distributions on the Trust Preferred Securities issued by the Trust are payable quarterly at a rate equal to the interest rate being earned by the Trust on the Debentures held by the Trust. The Trust Preferred Securities are subject to mandatory redemption, in whole or in part, upon repayment of the Debentures. The Company has entered into an agreement which fully and unconditionally guarantees the Trust Preferred Securities subject to the terms of the guarantee. The Debentures held by the Trust are first redeemable, in whole or in part, by the Company on or after September 30, 2008. Subject to certain limitations, the Junior Subordinated Debentures qualify as Tier 1 capital for the Company under current Federal Reserve Board guidelines. In July of 2013, the banking regulators issued the final Basel III capital rules. Under these rules, trust preferred securities issued prior to May 19, 2010 by bank holding companies with less than $15 billion in consolidated total assets as of December 31, 2009, are permanently grandfathered as Tier 1 or Tier 2 capital.
Consolidated debt obligations as of September 30, 2016 related to the Trust holding solely Debentures of the Company follows:
LIBOR + 2.95% junior subordinated debentures owed to First South Preferred Trust I due September 26, 2033 | $ | 10,000,000 | ||
LIBOR + 2.95% junior subordinated debentures owed to First South Preferred Trust I due September 26, 2033 | 310,000 | |||
Total junior subordinated debentures owed to unconsolidated subsidiary trust | $ | 10,310,000 |
The Trust Preferred Securities bear interest at three-month LIBOR plus 2.95% payable quarterly. Effective December 30, 2014, the Company swapped the interest rate on the Debentures to a fixed rate of 5.54% for the ensuing five year period. This strategy was executed to provide the Company with protection to a rising rate environment. During the third quarter of 2016, the Company restructured the terms of this swap to lower the fixed rate cost and extend its maturity. As a result the restructured fixed rate effective June 30, 2016, is 4.97% and the maturity date of the swap is December 30, 2024.
15. Regulatory Capital. The Bank is subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Management believes, as of September 30, 2016, that the Bank meets all capital adequacy requirements to which it is subject. The Company’s most significant asset is its investment in the Bank. Consequently, the information concerning capital ratios is essentially the same for the Company and the Bank. Beginning with the quarter ended September 30, 2015, the Bank became subject to the Basel III Capital Rules. As a result, certain items in the risk-based capital calculation have changed. In addition, a new ratio, the Common Equity Tier 1 Risk-Based Capital Ratio, is now being measured and monitored.
22
15. Regulatory Capital (Continued)
For the Bank’s capital structure, the Common Equity Tier 1 Risk-Based Capital Ratio and the Tier 1 Risk-Based Capital Ratio are identical. The Bank's actual regulatory capital amounts and ratios as of September 30, 2016, and December 31, 2015, are listed below:
September 30, 2016 | December 31, 2015 | |||||||||||||||
Regulatory Capital Ratios | Amount | Ratio | Amount | Ratio | ||||||||||||
(Dollars in thousands) | ||||||||||||||||
Total Capital (to Risk Weighted Assets) | $ | 94,137 | 13.10 | % | $ | 88,074 | 13.29 | % | ||||||||
Common Equity Tier 1 Capital (to Risk Weighted Assets) | 85,337 | 11.88 | 79,871 | 12.06 | ||||||||||||
Tier 1 Capital (to Risk Weighted Assets) | 85,337 | 11.88 | 79,871 | 12.06 | ||||||||||||
Tier 1 Capital (to Average Assets) | 85,337 | 8. 89 | 79,871 | 8.67 |
16. Stock-Based Compensation. The Company had two stock-based compensation plans at September 30, 2016. The shares outstanding are for grants under the Company’s 1997 Stock Option Plan (1997 Plan) and the 2008 Equity Incentive Plan (2008 Plan). The 1997 Plan matured on April 8, 2008, and no additional options may be granted under the 1997 Plan. At September 30, 2016, the 1997 Plan had 19,000 granted unexercised stock option shares. At September 30, 2016, the 2008 Plan included 130,000 granted unexercised stock option shares, 11,950 granted nonvested restricted stock award shares and 802,650 shares available to be granted.
Stock Option Grants. Options granted under the 2008 Plan are granted at the closing price of the Company’s common stock on the NASDAQ Stock Market on the date of grant. Stock options expire ten years from the date of grant and vest over service periods ranging from one year to five years. The Company settles stock option exercises with authorized unissued shares. The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model. The risk-free interest rate is based on the U.S. Treasury rate for the expected life at the time of grant. Volatility is based on the average volatility of the Company based upon previous trading history. The expected life and forfeiture assumptions are based on historical data. Dividend yield is based on the yield at the time of the option grant.
A summary of option activity under the Plans as of September 30, 2016 and 2015, and changes during the nine month periods ended September 30, 2016 and 2015, is presented below:
Options Outstanding | Price | Aggregate
Intrinsic Value | ||||||||||
Period Ended September 30, 2016: | ||||||||||||
Outstanding at December 31, 2015 | 165,750 | $ | 10.76 | |||||||||
Granted | - | - | ||||||||||
Forfeited | (4,550 | ) | 20.90 | |||||||||
Expired | (5,750 | ) | 27.71 | |||||||||
Exercised | (6,450 | ) | 5.84 | |||||||||
Outstanding at September 30, 2016 | 149,000 | 10.01 | $ | 348,910 | ||||||||
Vested and Exercisable at September 30, 2016 | 112,800 | $ | 11.00 | $ | 240,059 | |||||||
Period Ended September 30, 2015: | ||||||||||||
Outstanding at December 31, 2014 | 169,500 | $ | 11.38 | |||||||||
Granted | 14,000 | 8.01 | ||||||||||
Forfeited | (6,000 | ) | 7.13 | |||||||||
Expired | (7,500 | ) | 17.47 | |||||||||
Exercised | - | - | ||||||||||
Outstanding at September 30, 2015 | 170,000 | 10.99 | $ | 184,015 | ||||||||
Vested and Exercisable at September 30, 2015 | 112,100 | $ | 13.24 | $ | 102,180 |
There were no grants awarded in the nine months ended September 30, 2016. The following weighted-average assumptions were used for grants awarded in the nine months ended September 30, 2015:
Nine Months Ended 9/30/15 | ||||
Dividend growth rate | 1.0 | % | ||
Expected volatility | 96.9 | % | ||
Average risk-free interest rate | 1.5 | % | ||
Expected lives - years | 7 |
23
16. Stock-Based Compensation (Continued)
The following table summarizes additional information about the Company’s outstanding options and exercisable options as of September 30, 2016, including weighted-average remaining contractual term expressed in years (Life) and weighted average exercise price (Price):
Outstanding | Exercisable | |||||||||||||||||||
Range of Exercise Price | Shares | Life | Price | Shares | Price | |||||||||||||||
$4.00 – 10.00 | 92,000 | 6.22 | $ | 6.16 | 55,800 | $ | 5.65 | |||||||||||||
$10.01 – 17.00 | 27,000 | 2.94 | 11.01 | 27,000 | 11.01 | |||||||||||||||
$17.01 – 26.00 | 29,250 | 1.51 | 20.65 | 29,250 | 20.65 | |||||||||||||||
$26.01 – 34.00 | 750 | 0.05 | 32.53 | 750 | 32.53 | |||||||||||||||
149,000 | 4.67 | $ | 10.01 | 112,800 | $ | 11.00 |
A summary of nonvested option shares as of September 30, 2016 and 2015, and vesting changes during the nine months ended September 30, 2016 and 2015, is presented below:
Shares | Price | |||||||
Period Ended September 30, 2016: | ||||||||
Nonvested at December 31, 2015 | 53,300 | $ | 6.67 | |||||
Granted | - | - | ||||||
Forfeited | 950 | 7.39 | ||||||
Vested | (16,150 | ) | 6.03 | |||||
Nonvested at September 30, 2016 | 36,200 | $ | 6.94 | |||||
Period Ended September 30, 2015: | ||||||||
Nonvested at December 31, 2014 | 62,700 | $ | 6.14 | |||||
Granted | 14,000 | 8.01 | ||||||
Forfeited | (4,400 | ) | 7.19 | |||||
Vested | (14,400 | ) | 5.74 | |||||
Nonvested at September 30, 2015 | 57,900 | $ | 6.61 |
Total compensation expense charged to income for stock options was $10,019 and $33,582, respectively, for the three and nine months ended September 30, 2016, compared to compensation expense of $9,762 and $30,938, respectively, for the three and nine months ended September 30, 2015. As of September 30, 2016, total unrecognized compensation cost on granted unexercised shares was $101,278, and is expected to be recognized during the next 3.5 years.
Restricted Stock Awards. The Company measures the fair value of restricted shares based on the price of its common stock on the grant date and compensation expense is recorded over the vesting period. During the nine months ended September 30, 2016, 3,000 restricted stock awards were granted with a four year vesting period, and 2,200 restricted stock awards were granted with a five year vesting period. There were no restricted stock awards granted during the nine months ended September 30, 2015. Total compensation expense recognized for restricted stock awards for the three and nine months ended September 30, 2016 was $9,470 and $28,036, respectively, compared to $7,263 and $21,789, respectively, for the three and nine months ended September 30, 2015. As of September 30, 2016, there was $73,236 of total unrecognized compensation cost related to nonvested restricted stock granted under the 2008 Plan, which will be recognized over a remaining period of 4.5 years. A summary of nonvested restricted stock awards as of September 30, 2016 and 2015, and vesting changes during the respective nine month periods is presented below:
Shares | Price | |||||||
Period Ended September 30, 2016: | ||||||||
Nonvested at December 31, 2015 | 10,425 | $ | 8.36 | |||||
Granted | 5,200 | 8.15 | ||||||
Vested | (3,475 | ) | 8.36 | |||||
Forfeited | (200 | ) | 8.15 | |||||
Nonvested at September 30, 2016 | 11,950 | $ | 8.27 | |||||
Period Ended September 30, 2015: | ||||||||
Nonvested at December 31, 2014 | 13,900 | $ | 8.36 | |||||
Granted | - | - | ||||||
Vested | (3,475 | ) | 8.36 | |||||
Forfeited | - | - | ||||||
Nonvested at September 30, 2015 | 10,425 | $ | 8.36 |
24
16. Stock-Based Compensation (Continued)
The following table reflects the combined impact of fair value compensation cost recognition for stock options and restricted stock awards on income before income taxes, net income, basic earnings per share and diluted earnings per share for the three and nine month periods ended September 30, 2016 and 2015:
Three Months Ended 9/30/16 | Three Months Ended 9/30/15 | Nine Months Ended 9/30/16 | Nine Months Ended 9/30/15 | |||||||||||||
Decrease net income before income taxes | $ | 19,489 | $ | 17,025 | $ | 61,618 | $ | 52,727 | ||||||||
Decrease net income | $ | 19,489 | $ | 17,025 | $ | 61,618 | $ | 52,727 | ||||||||
Decrease basic earnings per share | $ | 0.00 | $ | 0.00 | $ | 0.01 | $ | 0.00 | ||||||||
Decrease diluted earnings per share | $ | 0.00 | $ | 0.00 | $ | 0.01 | $ | 0.00 |
17. Fair Value Measurement. Fair value is defined as the price that would be received on the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy prioritizes the inputs of valuation techniques used to measure fair value of nonfinancial assets and liabilities. The inputs are evaluated and an overall level for the fair value measurement is determined. This overall level is an indication of the market observability of the fair value measurement. In order to determine the fair value, the Bank must determine the unit of account, highest and best use, principal market, and market participants. These determinations allow the Bank to define the inputs for fair value and level of hierarchy. Outlined below is the application of the fair value hierarchy to the Bank’s financial assets that are carried at fair value.
Level 1: inputs to the valuation methodology are quoted prices in active markets for identical assets or liabilities that the Bank has the ability to access at the measurement date. A quoted price in an active market provides the most reliable evidence of fair value and is used to measure fair value whenever available. The type of assets carried at Level 1 fair value generally includes investments such as U.S. Treasury securities.
Level 2: inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets. Price quotations can vary substantially either over time or among market makers. The type of assets carried at Level 2 fair value generally includes securities and mortgage-backed securities issued by Government Sponsored Enterprises (GSEs), municipal bonds, corporate debt securities, mortgage loans held for sale and bank-owned life insurance.
Level 3: inputs to the valuation methodology are unobservable to the extent that observable inputs are not available. Unobservable inputs are developed based on the best information available in the circumstances and might include the Bank’s own assumptions. The Bank considers information about market participant assumptions that is reasonably available without undue cost and effort. The type of assets carried at Level 3 fair value generally include investments backed by non-traditional mortgage loans or certain state or local housing agency obligations, of which the Bank has no such assets or liabilities. Level 3 also includes impaired loans and other real estate owned.
Quoted market price for similar assets in active markets is the valuation technique for determining fair value of securities available-for-sale and held-to-maturity. Unrealized gains on available-for-sale securities are included in the “accumulated other comprehensive income” component of the Stockholders’ Equity section of the Consolidated Statements of Financial Condition. The estimated fair value of loans held for sale is based on commitments from investors within the secondary market for loans with similar characteristics. The Bank does not record loans held for investment at fair value on a recurring basis. However, when a loan is considered impaired, an impairment write down is taken based on the loan’s estimated fair value. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those loans not requiring a write down represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans, and are not included below.
25
17. Fair Value Measurement (Continued)
Assets measured at fair value on a recurring basis as of September 30, 2016 and December 31, 2015:
Fair Value | Quoted Prices In Active Markets for Identical Assets | Significant Observable Inputs- Outputs | Significant Unobservable Inputs | |||||||||||||
(In thousands) | ||||||||||||||||
Description | September 30, 2016 | Level 1 | Level 2 | Level 3 | ||||||||||||
Securities available-for-sale: | ||||||||||||||||
Government agencies | $ | 12,317 | $ | - | $ | 12,317 | $ | - | ||||||||
Mortgage-backed securities | 101,856 | - | 101,856 | - | ||||||||||||
Municipal securities | 52,174 | - | 52,174 | - | ||||||||||||
Corporate bonds | 26,908 | - | 26,908 | - | ||||||||||||
Mortgage loans held for sale | 7,313 | - | 7,313 | - | ||||||||||||
Bank-owned life insurance | 17,937 | - | 17,937 | - | ||||||||||||
Interest rate swap | (532 | ) | - | (532 | ) | - | ||||||||||
Total September 30, 2016 | $ | 217,973 | $ | - | $ | 217,973 | $ | - | ||||||||
Description | December 31, 2015 | Level 1 | Level 2 | Level 3 | ||||||||||||
Securities available-for-sale: | ||||||||||||||||
Government agencies | $ | 31,385 | $ | - | $ | 31,385 | $ | - | ||||||||
Mortgage-backed securities | 131,684 | - | 131,684 | - | ||||||||||||
Municipal securities | 56,831 | - | 56,831 | - | ||||||||||||
Corporate bonds | 28,395 | - | 28,395 | - | ||||||||||||
Mortgage loans held for sale | 3,944 | - | 3,944 | - | ||||||||||||
Bank-owned life insurance | 15,635 | - | 15,635 | - | ||||||||||||
Interest rate swap | (394 | ) | - | (394 | ) | - | ||||||||||
Total December 31, 2015 | $ | 267,480 | $ | - | $ | 267,480 | $ | - |
Assets measured at fair value on a non-recurring basis as of September 30, 2016 and December 31, 2015:
Fair Value | Quoted Prices In Active Markets for Identical Assets | Significant Observable Inputs- Outputs | Significant Unobservable Inputs | |||||||||||||
(In thousands) | ||||||||||||||||
Description | September 30, 2016 | Level 1 | Level 2 | Level 3 | ||||||||||||
Impaired loans, net | $ | 11,613 | $ | - | $ | - | $ | 11,613 | ||||||||
Other real estate owned | 4,810 | - | - | 4,810 | ||||||||||||
Total September 30, 2016 | $ | 16,423 | $ | - | $ | - | $ | 16,423 | ||||||||
Description | December 31, 2015 | Level 1 | Level 2 | Level 3 | ||||||||||||
Impaired loans, net | $ | 15,202 | $ | - | $ | - | $ | 15,202 | ||||||||
Other real estate owned | 6,125 | - | - | 6,125 | ||||||||||||
Total December 31, 2015 | $ | 21,327 | $ | - | $ | - | $ | 21,327 |
Impaired loans at September 30, 2016 and December 31, 2015 include $10.9 million and $14.2 million, respectively, of loans identified as impaired even though an impairment analysis calculated pursuant to ASC 310-10-35 resulted in no allowance.
Impaired loans where a write down is taken based on fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Bank records the impaired loan as non-recurring Level 3. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Bank classifies the impaired loan as non-recurring Level 3.
26
17. Fair Value Measurement (Continued)
OREO is recorded at fair value upon transfer of the loans to foreclosed assets, based on the appraised market value of the property. OREO is reviewed quarterly and values are adjusted as determined appropriate. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When an appraised value is not available or management determines the fair value of the collateral is impaired below the appraised value and there is no observable market price, the Bank classifies the foreclosed asset as non-recurring Level 3. Fair value adjustments of one thousand dollars and $111,170, respectively, were made to OREO during the three and nine months ended September 30, 2016, compared to fair value adjustments of $9,981 and $95,639 made to OREO during the three and nine months ended September 30, 2015, respectively.
No liabilities were measured at fair value on a recurring or non-recurring basis as of September 30, 2016 or December 31, 2015.
18. Fair Value of Financial Instruments. The following table represents the recorded carrying values, estimated fair values and fair value hierarchy within which the fair value measurements of the Company’s financial instruments are categorized at September 30, 2016 and December 31, 2015:
Level in | September 30, 2016 | December 31, 2015 | ||||||||||||||||
Fair Value | Estimated | Carrying | Estimated | Carrying | ||||||||||||||
Hierarchy | Fair Value | Amount | Fair Value | Amount | ||||||||||||||
(In thousands) | ||||||||||||||||||
Financial assets: | ||||||||||||||||||
Cash and due from banks | Level 1 | $ | 19,273 | $ | 19,273 | $ | 19,426 | $ | 19,426 | |||||||||
Interest-bearing deposits in other banks | Level 1 | 37,936 | 37,936 | 18,566 | 18,566 | |||||||||||||
Securities available-for-sale | Level 2 | 193,255 | 193,255 | 248,295 | 248,295 | |||||||||||||
Securities held-to-maturity | Level 2 | 511 | 509 | 510 | 508 | |||||||||||||
Loans held for sale | Level 2 | 7,313 | 7,313 | 3,944 | 3,944 | |||||||||||||
Loans and leases HFI, net, less impaired loans | Level 2 | 667,909 | 662,355 | 586,494 | 583,946 | |||||||||||||
Stock in FHLB of Atlanta | Level 2 | 1,701 | 1,701 | 2,369 | 2,369 | |||||||||||||
Accrued interest receivable | Level 2 | 3,118 | 3,118 | 2,875 | 2,875 | |||||||||||||
Interest rate swap | Level 2 | (532 | ) | (532 | ) | (394 | ) | (394 | ) | |||||||||
Bank-owned life insurance | Level 2 | 17,937 | 17,937 | 15,635 | 15,635 | |||||||||||||
Impaired loans HFI, net | Level 3 | 11,613 | 11,613 | 15,202 | 15,202 | |||||||||||||
Mortgage servicing rights | Level 3 | 2,717 | 2,090 | 2,301 | 1,266 | |||||||||||||
Financial liabilities: | ||||||||||||||||||
Deposits | Level 2 | $ | 860,568 | $ | 859,831 | $ | 811,089 | $ | 811,322 | |||||||||
Junior subordinated debentures | Level 2 | 10,310 | 10,310 | 10,310 | 10,310 |
Fair values of financial assets and liabilities have been estimated using data which management considers as the best available, and estimation methodologies deemed suitable for the pertinent category of financial instrument. With regard to financial instruments with off-balance sheet risk, it is not practicable to estimate the fair value of future financing commitments. The estimation methodologies used by the Bank are as follows:
Financial assets:
Cash and Due from Banks and Interest –Bearing Deposits in Other Banks: The carrying amounts for cash and due from banks and interest bearing deposits in other banks are equal to their fair value. Fair value hierarchy Input level 1.
Investment Securities Available-for-sale and Held-to-maturity: The estimated fair value of investment securities is provided in Note 4 of the Notes to Consolidated Financial Statements. These are based on quoted market prices, when available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Fair value hierarchy Input levels 1 and 2.
Loans Held for Sale. The estimated fair value of loans held for sale is based on commitments from investors within the secondary market for loans with similar characteristics. Fair value hierarchy Input level 2.
Loans and Leases Held for Investment, net, less Impaired Loans: Fair values are estimated for portfolios of loans and leases held for investment with similar financial characteristics. Loans and leases are segregated by collateral type and by fixed and variable interest rate terms. The fair value of each category is determined by discounting scheduled future cash flows using current interest rates offered on loans or leases with similar characteristics. Fair value hierarchy Input level 2.
Stock in Federal Home Loan Bank of Atlanta: The fair value for FHLB stock approximates carrying value, based on the redemption provisions of the FHLB. Fair value hierarchy Input level 2.
Accrued Interest Receivable: The carrying amount of accrued interest receivable approximates fair value because of the short maturities of these instruments. Fair value hierarchy Input level 2.
27
18. Fair Value of Financial Instruments (Continued)
Interest Rate Swap: The Company has entered into a pay-fixed receive-floating swap to hedge our $10.0 million of floating rate Trust Preferred debt. The primary objective of the swap is to minimize future interest rate risk. The effective date of the swap is December 30, 2014. Fair value hierarchy Input level 2.
Bank-Owned Life Insurance: The carrying value of bank-owned life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the issuer. Fair value hierarchy Input level 2.
Impaired Loans Held for Investment, Net: Fair values for impaired loans and leases are estimated based on discounted cash flows or underlying collateral values, where applicable. Fair value hierarchy Input Level 3.
Mortgage Servicing Rights (MSRs): The fair value of MSRs is estimated for those loans sold with servicing retained. The loans are stratified into pools by product type and within product type by interest rate and maturity. The fair value of the MSR is based upon the present value of estimated future cash flows using current market assumptions for prepayments, servicing costs and other factors. Fair value hierarchy Input level 3.
Financial liabilities:
Deposits: The fair value of demand deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated using rates currently offered for similar instruments with similar remaining maturities. Fair value hierarchy Input level 2.
Junior Subordinated Debentures: The carrying amount of junior subordinated debentures approximates fair value of similar instruments with similar characteristics and remaining maturities. Fair value hierarchy Input level 2.
19. Interest Rate Hedging. The Company has executed certain strategies targeted at hedging the impact of rising interest rates on its future earnings. The Company has entered into a pay-fixed receive-floating swap to hedge our $10.0 million of floating rate Trust Preferred debt. The primary objective of the swap is to minimize future interest rate risk. The effective date of the swap was December 30, 2014, and it has a five year term.
20. Recent Accounting Pronouncements. The following are Accounting Standards Updates (ASU) recently issued by the Financial Accounting Standards Board (FASB) and their expected impact on the Company. Other accounting standards issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. This ASU was developed as a joint project with the International Accounting Standards Board to remove inconsistencies in revenue requirements and provide a more robust framework for addressing revenue issues. The ASU’s core principle is that an entity should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. ASU 2015-14, issued in August 2015, amended the effective date of this ASU to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This ASU provides U.S. GAAP guidance on management’s responsibility in evaluating whether there is substantial doubt about a company’s ability to continue as a going concern and related footnote disclosures. For each reporting period, management will be required to evaluate whether there are conditions or events that raise substantial doubt about a company’s ability to continue as a going concern within one year from the date the financial statements are issued. This ASU is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes. Topic 740, Income Taxes, requires an entity to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classified statement of financial position. Deferred tax liabilities and assets are classified as current or noncurrent based on the classification of the related asset or liability for financial reporting. Deferred tax liabilities and assets that are not related to an asset or liability for financial reporting are classified according to the expected reversal date of the temporary difference. To simplify the presentation of deferred income taxes, the amendments in this ASU require that deferred income tax liabilities and assets be classified as noncurrent in a classified statement of financial position. For public entities, this ASU is effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The Company does not expect this ASU to have a material impact on its consolidated financial statements, as it does not have a classified balance sheet.
28
20. Recent Accounting Pronouncements (Continued)
In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities. The amendments in this ASU require all equity investments to be measured at fair value with changes in the fair value recognized through net income (other than those accounted for under the equity method of accounting or those that result in consolidation of the investee). The amendments in this ASU also require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. In addition, the amendments in this ASU eliminate the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities and the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet for public business entities. For public entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This ASU created Topic 842 (Leases), and superseded the leases requirements in Topic 840 (Leases). Topic 842 specifies the accounting for leases. The objective of Topic 842 is to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease. Under the new guidance, a lessee will be required to recognize assets and liabilities for leases with lease terms of more than 12 months. The recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee will depend on its classification as a finance or operating lease. This ASU will require both types of leases to be recognized on the balance sheet. For public entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-05, Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships. The term novation refers to replacing one counterparty to a derivative instrument with a new counterparty. That change occurs for a variety of reasons, including financial institution mergers, intercompany transactions, an entity exiting a particular derivatives business or relationship, an entity managing against internal credit limits, or in response to laws or regulatory requirements. The amendments in this ASU clarify that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under Topic 815 (Derivatives and Hedging), does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. For public entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-06, Contingent Put and Call Options in Debt Instruments. Topic 815 requires that embedded derivatives be separated from the host contract and accounted for separately as derivatives if certain criteria are met, including the “clearly and closely related” criterion. This ASU clarifies the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. An entity performing the assessment under the amendments is required to assess the embedded call (put) options solely in accordance with the four-step decision sequence. The amendments in this ASU apply to all entities that are issuers of or investors in debt instruments (or hybrid financial instruments that are determined to have a debt host) with embedded call (put) options. For public entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-07, Simplifying the Transition to the Equity Method of Accounting. To simplify the accounting for equity method investments, the amendments in the ASU eliminate the requirement in Topic 323 (Investments-Equity Method and Joint Ventures) that an entity retroactively adopt the equity method of accounting if an investment qualifies for use of the equity method as a result of an increase in the level of ownership or degree of influence. The amendments in this ASU require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. The amendments in this ASU also require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. The amendments in this ASU are effective for all entities for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net). The amendments in this ASU affect entities with transactions included within the scope of Topic 606 (Revenue from Contracts with Customers). The scope of Topic 606 includes entities that enter into contracts with customers to transfer goods or services (that are an output of the entity’s ordinary activities) in exchange for consideration. The amendments in this ASU clarify the implementation guidance on principal versus agent considerations. The effective date and transition requirements for this ASU are the same as the effective date of ASU 2014-9 above. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
29
20. Recent Accounting Pronouncements (Continued)
In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. This ASU was issued as part of an initiative to reduce complexity in accounting standards. The areas for simplification in this ASU involve several aspects of the accounting for employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Some of the areas for simplification apply only to nonpublic entities. In addition, the amendments in this ASU eliminate the guidance in Topic 718 (Compensation-Stock Compensation) that was indefinitely deferred shortly after the issuance of FASB Statement No. 123 (revised 2004), Share-Based Payment. For public entities, the amendments in this ASU are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In April 2016, the FASB issued ASU 2016-10, Identifying Performance Obligations and Licensing. The amendments in this ASU affect entities with transactions included within the scope of Topic 606. This ASU clarifies guidance related to identifying performance obligations and licensing implementation guidance contained in the new revenue recognition standard. The ASU seeks to address areas in which diversity in practice potentially could arise, as well as to reduce the cost and complexity of applying certain aspects of the guidance both at implementation and on an ongoing basis. The effective date for this ASU is the same as the effective date and transition requirements in Topic 606 (and any other Topic amended by ASU 2014-9 above). The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In May 2016, the FASB issued ASU 2016-11, Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting. This ASU rescinds Securities and Exchange Commission (SEC) paragraphs pursuant to the SEC Staff Announcement, “Rescission of Certain SEC Staff Observer Comments upon Adoption of Topic 606,” and the SEC Staff Announcement, “Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or Equity,” announced at the March 3, 2016 Emerging Issues Task Force (EITF) meeting. The Company does not expect this ASU to have a material impact on its consolidated financial statements.
In May 2016, the FASB issued ASU 2016-12, Narrow-Scope Improvements and Practical Expedients. The amendments in this ASU address narrow-scope improvements to the guidance on collectibility, noncash consideration, and completed contracts at transition. Additionally, the amendments in this ASU provide a practical expedient for contract modifications at transition and an accounting policy election related to the presentation of sales taxes and other similar taxes collected from customers. The effective date and transition requirements for the amendments in this ASU are the same as requirements of ASU 2014-9. ASU 2015-14, issued in August 2015, amended the effective date of ASU 2014-9 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments. The main objective of this ASU is to provide financial statement users with more decision-useful information about expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this ASU replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. For public entities that are SEC filers, the amendments in this ASU are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments. Current GAAP is either unclear or does not include guidance on certain cash flow issues included in the amendments in this ASU. The amendments are an improvement in GAAP because they provide guidance for each of the noted issues, thereby reducing the current and potential future diversity in accounting practice. This ASU addresses the following specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (COLIs) (including bank-owned life insurance policies (BOLIs)); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. For public business entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
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21. Compensated Absences. The Company has not accrued compensated absences because the amount cannot be reasonably estimated.
22. Subsequent Events. We have evaluated subsequent events after September 30, 2016, and concluded that no material transactions occurred that provided additional evidence about conditions that existed at or after September 30, 2016, that required adjustments to or disclosure in the Consolidated Financial Statements.
23. Reclassifications. Certain amounts in the unaudited consolidated financial statements for the three and nine months ended September 30, 2015 have been reclassified to conform with the presentation as of and for the respective three and nine month periods ended September 30, 2016. The reclassifications had no effect on previously reported net income or stockholders’ equity.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
First South Bancorp, Inc. (the "Company") was formed for the purpose of issuing common stock and owning 100% of the stock of First South Bank (the "Bank") and operating through the Bank a commercial banking business. The discussion below focuses primarily on the Bank's results of operations. The Bank has one significant operating segment, providing commercial and retail banking services to its markets located in the state of North Carolina. The Company’s common stock is traded on the NASDAQ Global Select Market under the symbol "FSBK".
Comparison of Financial Condition at September 30, 2016, and December 31, 2015. Total assets increased at an annualized growth rate of 5.6% to $985.8 million at September 30, 2016, from $946.3 million at December 31, 2015. Earning assets increased to $921.5 million at September 30, 2016, from $878.3 million at December 31, 2015. The increase is attributable to solid growth in the loan and lease portfolio and in interest-bearing deposits with banks. This growth was partially funded by the sale of investment securities as well as a $48.5 million increase in deposits over this same nine-month period. The ratio of earning assets to total assets was 93.5% and 92.8% at September 30, 2016 and December 31, 2015, respectively.
Interest-bearing deposits with banks increased to $37.9 million at September 30, 2016, from $18.6 million at December 31, 2015. Overnight deposits are available to fund securities purchases, loan originations, deposit withdrawals, liquidity management activities and daily operations of the Bank.
The investment securities portfolio declined to $193.8 million at September 30, 2016, from $248.8 million at December 31, 2015. This reduction was the result of cash flows from scheduled amortization and maturities, as well as sales of securities, with the proceeds used to support growth in loans outstanding. During the nine months ended September 30, 2016, the Bank sold $40.6 million of investment securities primarily to fund growth in our loans and leases held for investment. The Bank may also make changes in the securities portfolio to manage sensitivity to future interest rate changes. See “Note 4. Investment Securities” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Loans held for sale totaled $7.3 million at September 30, 2016, compared to $3.9 million at December 31, 2015, reflecting the net effect of current period mortgage lending activity. During the nine months ended September 30, 2016, there were $28.4 million of sales, $30.7 million of originations net of principal payments and $1.0 million of net realized gains from sales. Proceeds from mortgage loan sales are primarily used to fund the Bank’s liquidity needs, including loan originations, deposit withdrawals and general bank operations. See “Note 5. Loans Held for Sale” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Total loans and leases held for investment grew by $75.5 million during the current nine month period. As a result of this net growth, total loans and leases held for investment increased to $682.5 million at September 30, 2016, from $607.0 million at December 31, 2015. During the nine months ended September 30, 2016, there were $76.1 million of originations net of principal payments and $465,000 of transfers to other real estate owned (OREO). As a result of the Bank’s robust loan growth during 2016, the loans-to-deposits ratio has risen from 75.3% at December 31, 2015 to 80.2% at September 30, 2016. See “Note 6. Loans Held for investment” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Asset quality is as a key component of the Bank’s short-term and long-term performance objectives. Loans held for investment on nonaccrual status, including troubled debt restructurings (TDRs) on nonaccrual status declined to $2.9 million at September 30, 2016, from $3.2 million at December 31, 2015. Management and the Board of Directors are committed to improving asset quality, as we believe they are key drivers of stock price performance and overall shareholder value. The ratio of loans held for investment on nonaccrual status to total loans held for investment improved to 0.42% at September 30, 2016, from 0.53% at December 31, 2015.
Loans are generally placed on nonaccrual status and accrued unpaid interest is reversed when management determines that collectability of all interest, but not necessarily principal, payments are in doubt. This generally occurs when payments are delinquent in excess of 90 days. Consumer loans more than 180 days past due are generally charged off or a specific allowance is provided for any expected loss. All other loans are charged off when management concludes that they are uncollectible.
Management has thoroughly evaluated all nonperforming loans and believes they are either well collateralized or adequately reserved. However, there can be no assurance in the future that regulators, increased volume and risks in the loan portfolio, adverse changes in economic conditions or other factors will not require additional adjustments to the allowance for loan and lease losses (ALLL). Aside from the loans identified on nonaccrual status, there were no loans at September 30, 2016 where known information about possible credit problems of borrowers caused management to have serious concerns as to the ability of the borrowers to comply with their current loan repayment terms.
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The Bank maintains the ALLL at levels management believes are adequate to absorb probable losses inherent in the loan and lease portfolio. The Bank has developed policies and procedures for assessing the adequacy of the ALLL that reflect the assessment of credit risk and impairment analysis. This assessment includes a quarterly analysis of qualitative and quantitative trends in the levels of classified loans. In developing this analysis, the Bank relies on historical loss experience, estimates and exercises judgment in assessing credit risk. Future assessments of credit risk may yield different results, depending on changes in the qualitative and quantitative trends, which may require adjustments in the ALLL.
The Bank uses various modeling, calculation methods and estimation tools for measuring credit risk and performing impairment analysis, which is the basis used in developing the ALLL. The factors supporting the ALLL do not diminish the fact that the entire ALLL is available to absorb probable losses in the loan and lease portfolio. A principal focus of the Bank is on the adequacy of the ALLL. Based on the overall credit quality of the loan and lease portfolio, management believes the ALLL is adequate and has been established pursuant to generally accepted accounting principles, with consideration of the current economic environment.
The quarterly assessment of ALLL adequacy includes an analysis of actual historical loss percentages of both classified and pass loans, as well as qualitative risk factors allocated among specific categories of loans. In developing this analysis, the Bank relies on actual loss history for the most recent twelve quarters and uses management’s best judgment in assessing credit risk. The assessment of qualitative factors includes various subjective components assessed in terms of basis points used in determining the ALLL adequacy. The evaluation of qualitative risk factors will result in a positive or negative adjustment to the ALLL methodology. Adjustments for each qualitative risk component may range from +25 basis points to -10 basis points. A component score of 0 basis points indicates no effect on the ALLL. A component rating of +25 basis points indicates the assessed maximum potential of increased risk to the ALLL adequacy. A -10 basis point component rating indicates the most positive effect on the ALLL. There were no changes in accounting policy or methodology used to estimate the ALLL during the three and nine months ended September 30, 2016.
The ALLL was $8.5 million at September 30, 2016, compared to $7.9 million at December 31, 2015, and the ratio of the ALLL to loans and leases held for investment was 1.25% at September 30, 2016, compared to 1.30% at December 31, 2015. During the nine months ended September 30, 2016, there were $770,000 of provisions for credit losses and $138,000 of net charge-offs. See “Note 7. Allowance for Loan and Lease Losses” of “Notes to Consolidated Financial Statements (Unaudited)”and “Critical Accounting Policies - Loan Impairment and Allowance for Loan and Lease Losses” for additional information.
Based on an impairment analysis of loans held for investment, there were $12.0 million of loans classified as impaired, net of $371,000 in write-downs at September 30, 2016, compared to $15.8 million classified as impaired, net of $358,000 in write-downs at December 31, 2015. At September 30, 2016 and December 31, 2015, the ALLL included $339,000 and $618,000 specifically provided for impaired loans, respectively.
A loan is considered impaired, based on current information and events, if it is probable that the Bank will be unable to collect scheduled payments of all principal and interest when due according to the contractual terms of the loan arrangement. All collateral-dependent loans are measured for impairment based on the fair value of the collateral, while uncollateralized loans and other loans determined not to be collateral dependent are measured for impairment based on the present value of expected future cash flows discounted at the historical effective interest rate. The Bank uses several factors in determining if a loan is impaired. The internal asset classification procedures include a thorough review of significant loans and lending relationships and include the accumulation of related data. This data includes loan payments status, borrowers’ financial data and borrowers’ operating factors such as cash flows, operating income or loss, and various other matters. See “Note 6. Loans Held for Investment”, “Note 7. Allowance for Loan and Lease Losses” and “Note 8. Troubled Debt Restructurings” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
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In determining the adequacy of the ALLL, the Bank considers TDRs and subsequent defaults in restructuring in its estimate. As a result, the allowance may be increased, adjustments may be made in the allocation of the allowance, or charge-offs may be taken to further write down the carrying value of a loan. The Bank’s primary objective in granting concessions to borrowers having financial difficulties is an attempt to protect as much of its investment as possible. The Bank faces significant challenges when working with borrowers who are experiencing diminished operating cash flows, depreciated collateral values, or prolonged sales and rental absorption periods. While borrowers may experience deterioration in their financial condition, many continue to be creditworthy customers who have the willingness and capacity to repay their debts. In such cases, the Bank finds it mutually beneficial to work constructively with its borrowers, and that prudent restructurings are often in the best interest of the Bank and the borrower.
The Bank offers a variety of TDR programs on a loan-by-loan basis in which, for economic or legal reasons related to an individual borrower’s financial condition, it grants a concession to the borrower that would not otherwise be considered. The restructuring of a troubled loan may include, but is not limited to, any one or combination of the following: a modification of the loan terms such as a reduction of the contractual interest rate, principal, payment amount or accrued interest; an extension of the maturity date at a stated interest rate lower than the current market rate for a new debt with similar risks; a change in payment type, e.g. from principal and interest, to interest only with all principal and interest due at maturity; a substitution or acceptance of additional collateral; and a substitution or addition of new debtors for the original borrower.
The Bank’s restructuring success includes, but is not limited to, any one or combination of the following: improves the prospects for repayment of principal and interest; reduces the prospects of further write downs and charge-offs; reduces the prospects of potential additional foreclosures; helps borrowers to maintain a creditworthy status; and ultimately will reduce the volume of classified, criticized and/or nonaccrual loans. The Bank identifies loans for potential restructuring on a loan-by-loan basis using a variety of sources which may include, but is not limited to any one or combination of the following: being approached or contacted by the borrower to modify loan terms; review of borrower’s financial statements indicates borrower may be experiencing financial difficulties; past due payment reports; loans extending past their stated maturity date; and nonaccrual loan reports.
On a loan-by-loan basis, the Bank restructures loans that were either on nonaccrual or accrual basis prior to restructuring. If a loan was on nonaccrual prior to restructuring, it remains on nonaccrual until the borrower has demonstrated a willingness and ability to meet the terms and conditions of the restructuring and to make the restructured loan payments, generally for a period of at least nine months. If a restructured loan was on accrual basis prior to restructuring and the Bank expects the borrower to perform to the terms and conditions of the loan after restructuring (i.e. the loan was current, on accrual basis, and the borrower has the ability to make the restructured loan payments), the loan remains on an accrual basis. See “Note 8. Troubled Debt Restructurings” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
OREO acquired from foreclosures declined to $4.8 million at September 30, 2016, from to $6.1 million at December 31, 2015. During the nine months ended September 30, 2016, there were $1.7 million of disposals, $111,000 of valuation adjustments and $465,000 of additions. OREO consists of residential and commercial properties, developed lots and raw land. The Bank believes the adjusted carrying values of these properties are representative of their fair market values, although there can be no assurances that ultimate sales will be equal to the carrying values. See “Note 9. Other Real Estate Owned” and “Note 17. Fair Value Measurement” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Goodwill was $4.2 million at September 30, 2016, and December 31, 2015, respectively, and is tested for impairment annually. The Company’s most recent annual impairment test determined there was no goodwill impairment. Identifiable intangible assets were $1.7 million at September 30, 2016, compared to $1.9 million at December 31, 2015, reflecting the core deposit intangible associated with a prior period branch acquisition transaction, which is being amortized over a ten year period. See “Note 11. Goodwill and Other Intangibles” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Mortgage servicing rights (MSRs) increased to $2.1 million at September 30, 2016, from $1.3 million at December 31, 2015. During the three months ended September 30, 2016, the Bank purchased the MSRs of 452 high-quality Freddie Mac and Fannie Mae loans with an unpaid principal balance of $84.6 million. The selection of these mortgage loans to service was based on their quality as well as their geographic location. All of the loans acquired were current as to payment on the purchase date and the Bank had the ability to push-back any loans that prepaid or became delinquent within 90 days. In addition, all of these loans are located in the state of North Carolina and a significant portion of the borrowers reside within the Bank’s footprint. Mortgage loans serviced for others increased to $370.6 million at September 30, 2016, from $297.5 million at December 31, 2015, primarily due to these acquired loans.
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The Bank’s investment in bank-owned life insurance (BOLI) increased to $17.9 million at September 30, 2016, from $15.6 million at December 31, 2015. The Bank’s investment returns from the BOLI are utilized to offset a portion of the cost of providing benefit plans to our employees.
Total deposits increased to $859.8 million at September 30, 2016, from $811.3 million at December 31, 2015. For the current nine month period, non-maturity deposits (personal and business checking accounts and money market accounts and savings accounts) grew by $44.4 million to $595.7 million at September 30, 2016, from $551.3 million at December 31, 2015.
Certificates of deposit (CDs) grew by $4.1 million to $264.1 million at September 30, 2016, from $260.0 million at December 31, 2015. CDs represented 30.7% and 32.1% of total deposits at September 30, 2016, and December 31, 2015, respectively. The Bank attempts to manage its cost of deposits through a combination of monitoring the volume and pricing of new and maturing CDs and growth in non-maturity deposits, in relationship to current funding needs and market interest rates. See “Note 12. Deposits” of “Notes to Consolidated Financial Statements (Unaudited)” and “Interest Expense” below for additional information regarding deposits and the cost of funds.
Federal Home Loan Bank (FHLB) borrowings declined to $20.0 million at September 30, 2016, from $37.0 million at December 31, 2015. The Bank uses FHLB borrowings as a funding source to provide an effective means of managing its overall cost of funds or to manage its exposure to interest rate risk. There were $10.3 million of junior subordinated debentures outstanding at both September 30, 2016, and December 31, 2015. See “Note 13. Borrowed Money” and “Note 14. Junior Subordinated Debentures” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Stockholders' equity increased by $6.1 million to $88.3 million at September 30, 2016, from $82.2 million at December 31, 2015. This increase reflects the $5.0 million of net income earned for the first nine months of 2016 and a $1.9 million increase in accumulated other comprehensive income resulting from the mark-to-market adjustment of the available-for-sale securities portfolio, net of $807,000 of dividends declared. There were 9,494,935 common shares outstanding at September 30, 2016, compared to 9,489,222 shares outstanding at December 31, 2015, reflecting the effect of 3,475 shares issued pursuant to the vesting of restricted stock awards and 1,079 shares issued pursuant to a stock option exercise during the current period. See "Consolidated Statements of Changes in Stockholders' Equity" for additional information.
Accumulated other comprehensive income increased to $4.3 million at September 30, 2016, from $2.4 million at December 31, 2015, reflecting an increase in the mark-to-market adjustment in net unrealized gains in the available-for-sale investment securities portfolio, based on current market prices. See “Consolidated Statements of Comprehensive Income” and “Note 3. Comprehensive Income and Accumulated Other Comprehensive Income” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
The tangible equity to assets ratio increased to 8.36% at September 30, 2016, from 8.04% at December 31, 2015. The tangible book value per common share increased to $8.68 at September 30, 2016, from $8.02 at December 31, 2015.
The Bank is subject to various regulatory capital requirements administered by its federal and state banking regulators. As of September 30, 2016, the Bank's regulatory capital ratios were in excess of all regulatory requirements and the Bank’s regulatory capital position is categorized as “well capitalized”. There are no conditions or events since September 30, 2016, that management believes have changed the Bank's “well capitalized” status. See “Note 15. Regulatory Capital” of “Notes to Consolidated Financial Statements (Unaudited)” and “Liquidity and Capital Resources” below for additional information.
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Comparison of Operating Results – Three and Nine Months Ended September 30, 2016 and 2015. Net income for the three months ended September 30, 2016, increased 53.2% to $1.9 million, or $0.20 per diluted common share, from net income of $1.2 million, or $0.13 per diluted common share earned for the comparative three month period ended September 30, 2015. The improvement in net income on a comparative quarter basis is primarily due to an $876,000, or 11.8% increase in net interest income, while maintaining consistent volumes of non-interest income and non-interest expense. The improvement in comparative quarterly net income reflects the impact of strong loan growth over the past twelve months.
Net income for the nine months ended September 30, 2016, increased 59.4% to $5.0 million, or $0.52 per diluted common share, compared to net income of $3.1 million, or $0.33 per diluted common share earned in the nine months ended September 30, 2015. Earnings for the current nine month period were positively impacted by increases in net interest income and non-interest income, as well as a lower volume of non-interest expense, while being partially offset by an increase in the provision for credit losses associated with the strong loan portfolio growth. In addition, during the first nine months of 2015, the Bank incurred $425,000 of one-time pre-tax transaction expenses associated with acquiring nine branch offices.
Interest Income. Interest income increased to $9.2 million and $26.9 million for the three and nine months ended September 30, 2016, from $8.2 million and $23.9 million for the comparable 2015 periods. The year-over-year growth in interest income is due to a significant change in the mix and volume of our earning asset base, as we have replaced lower yielding investments with higher yielding loans. We have also experienced an increase in yields on earning assets over comparative periods. The tax equivalent yield on average earning assets increased to 4.13% and 4.12% for the three and nine months ended September 30, 2016, from 4.01% and 4.00% for the three and nine months ended September 30, 2015. Average earning assets increased to $895.3 million and $878.8 million for the three and nine months ended September 30, 2016, from $828.5 million and $810.8 million for the comparable 2015 periods.
Interest Expense. Interest expense increased to $911,000 and $2.7 million for the three and nine months ended September 30, 2016, from $794,000 and $2.2 million for the comparable 2015 periods. Interest expense was primarily impacted by increased interest paid on deposits between the comparative reporting periods, and was partially offset by a reduction of interest paid on junior subordinated notes. The cost of average interest-bearing liabilities increased to 0.52% for both the three and nine months ended September 30, 2016, from 0.48% and 0.46% for the comparable 2015 periods. The Bank’s cost of interest-bearing liabilities has been impacted by a combination of growth and pricing of new and renewed CDs.
Average interest-bearing liabilities increased to $692.8 million and $687.9 million for the three and nine months ended September 30, 2016, from $654.5 million and $645.6 for the comparable 2015 periods. Average non-interest-bearing demand deposits increased to $181.0 million and $171.5 million for the three and nine months ended September 30, 2016, from $162.4 million and $154.9 million for the comparable 2015 periods.
Net Interest Income. Net interest income for the three and nine months ended September 30, 2016, increased to $8.3 million and $24.2 million, from $7.4 million and $21.7 million for the comparable 2015 periods. The tax equivalent net interest margin increased to 3.73% and 3.72% for the three and nine months ended September 30, 2016, from 3.63% and 3.64% for the comparable 2015 periods. The improvement in the tax-equivalent net interest margin is due to the change in the mix of our earning assets, as we have replaced lower yielding investments with higher yielding loans. On the liability side of the balance sheet, while we continue to seek expansion of our non-maturity deposit base, we have also taken steps to protect the Company from a rising rate environment by adding some longer-term funding. We anticipate the level of our current margin remaining somewhat stable over the near-term, unless there are dramatic movements in interest rates.
Yield/Cost Analysis. Table 1 below contains comparative data relating to our average balance sheet and reflects the tax equivalent yield on average earning assets and the average cost of interest-bearing liabilities for the three and nine months ended September 30, 2016, and 2015. Tax equivalent yields related to certain investment securities exempt from federal income tax are stated on a fully taxable basis, using a 34% federal statutory tax rate and reduced by a disallowed portion of the tax exempt interest income. Average balances are derived from average daily balances. The interest rate spread represents the difference between the tax equivalent yield on average earning assets and the cost of average interest-bearing liabilities. The tax equivalent net interest margin represents tax adjusted net interest income divided by average earning assets.
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Table 1 – Yield/Cost Analysis | Three Months Ended September 30, | |||||||||||||||||||||||
2016 | 2015 | |||||||||||||||||||||||
Average Balance | Interest | Average Yield Cost | Average Balance | Interest | Average Yield Cost | |||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
Interest earning assets: | ||||||||||||||||||||||||
Loans receivable | $ | 685,441 | $ | 7,915 | 4.54 | % | $ | 558,302 | $ | 6,639 | 4.68 | % | ||||||||||||
Investments and deposits | 209,849 | 1,295 | 2.81 | (1) | 270,236 | 1,578 | 2.63 | (1) | ||||||||||||||||
Total earning assets | 895,290 | 9,210 | 4.13 | (1) | 828,538 | 8,217 | 4.01 | (1) | ||||||||||||||||
Nonearning assets | 73,439 | 75,479 | ||||||||||||||||||||||
Total assets | $ | 968,729 | $ | 904,017 | ||||||||||||||||||||
Interest bearing liabilities: | ||||||||||||||||||||||||
Deposits | $ | 663,983 | 728 | 0.44 | $ | 619,537 | 598 | 0.38 | ||||||||||||||||
Borrowings | 18,506 | 56 | 1.18 | 24,661 | 54 | 0.86 | ||||||||||||||||||
Junior subordinated debentures | 10,310 | 127 | 4.82 | 10,310 | 142 | 5.37 | ||||||||||||||||||
Total interest bearing liabilities | 692,799 | 911 | 0.52 | 654,508 | 794 | 0.48 | ||||||||||||||||||
Noninterest bearing demand deposits | 181,000 | - | - | 162,440 | - | - | ||||||||||||||||||
Total sources of funds | 873,799 | 911 | 0.41 | 816,948 | 794 | 0.38 | ||||||||||||||||||
Other liabilities | 6,449 | 5,094 | ||||||||||||||||||||||
Stockholders’ equity | 88,481 | 81,975 | ||||||||||||||||||||||
Total liabilities and equity | $ | 968,729 | $ | 904,017 | ||||||||||||||||||||
Net interest income | $ | 8,299 | $ | 7,423 | ||||||||||||||||||||
Interest rate spread (1)(2) | 3.61 | % | 3.53 | % | ||||||||||||||||||||
Net interest margin (1)(3) | 3.73 | % | 3.63 | % | ||||||||||||||||||||
Ratio of earning assets to interest bearing liabilities | 129.23 | % | 126.59 | % |
Nine Months Ended September 30, | ||||||||||||||||||||||||
2016 | 2015 | |||||||||||||||||||||||
Average Balance | Interest | Average Yield Cost | Average Balance | Interest | Average Yield Cost | |||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
Interest earning assets: | ||||||||||||||||||||||||
Loans receivable | $ | 654,696 | $ | 22,749 | 4.59 | % | $ | 520,404 | $ | 18,834 | 4.79 | % | ||||||||||||
Investments and deposits | 224,065 | 4,131 | 2.78 | (1) | 290,370 | 5,047 | 2.60 | (1) | ||||||||||||||||
Total earning assets | 878,761 | 26,880 | 4.12 | (1) | 810,774 | 23,881 | 4.00 | (1) | ||||||||||||||||
Nonearning assets | 72,970 | 76,396 | ||||||||||||||||||||||
Total assets | $ | 951,731 | $ | 887,170 | ||||||||||||||||||||
Interest bearing liabilities: | ||||||||||||||||||||||||
Deposits | $ | 653,116 | 2,095 | 0.43 | $ | 624,733 | 1,730 | 0.37 | ||||||||||||||||
Borrowings | 24,450 | 187 | 1.01 | 10,605 | 61 | 0.77 | ||||||||||||||||||
Junior subordinated debentures | 10,310 | 409 | 5.21 | 10,310 | 422 | 5.39 | ||||||||||||||||||
Total interest bearing liabilities | 687,876 | 2,691 | 0.52 | 645,648 | 2,213 | 0.46 | ||||||||||||||||||
Noninterest bearing demand deposits | 171,504 | - | - | 154,911 | - | - | ||||||||||||||||||
Total sources of funds | 859,380 | 2,691 | 0.42 | 800,559 | 2,213 | 0.37 | ||||||||||||||||||
Other liabilities | 6,126 | 4,621 | ||||||||||||||||||||||
Stockholders’ equity | 86,225 | 81,990 | ||||||||||||||||||||||
Total liabilities and equity | $ | 951,731 | $ | 887,170 | ||||||||||||||||||||
Net interest income | $ | 24,189 | $ | 21,668 | ||||||||||||||||||||
Interest rate spread (1)(2) | 3.60 | % | 3.55 | % | ||||||||||||||||||||
Net interest margin (1)(3) | 3.72 | % | 3.64 | % | ||||||||||||||||||||
Ratio of earning assets to interest bearing liabilities | 127.75 | % | 125.58 | % |
1. | Shown as a tax-adjusted yield. |
2. | Represents the difference between the average yield on earning assets and the average cost of funds. |
3. | Represents net interest income divided by average earning assets. |
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Provision for Credit Losses. The Bank's methodology for determining its provision for credit losses includes amounts specifically allocated to credits that are individually determined to be impaired, as well as general provisions allocated to groups of loans that have not been individually assessed for impairment. The Bank recorded $220,000 and $770,000 of provisions for credit losses in the three and nine months ended September 30, 2016, compared to $335,000 and $475,000 recorded in the 2015 three and nine month periods. The increase in provision for credit losses over the nine month periods is primarily attributable to support the net growth in loans held for investment during the periods, as previously discussed. Provisions for credit losses are necessary to maintain the ALLL at a level that management believes is adequate to absorb probable future losses in the loan portfolio. See “Note 7. Allowance for Loan and Lease Losses” of “Notes to Consolidated Financial Statements (Unaudited)” and “Allowance for Loan and Lease Losses” and “Critical Accounting Policies - Loan Impairment and Allowance for Loan and Lease Losses” included herein for additional information.
Non-interest Income. Total non-interest income was $3.7 million and $10.8 million for the three and nine months ended September 30, 2016, compared to $3.8 million and $10.6 million for the 2015 three and nine month periods. Non-interest income consists of deposit fees and service charges; loan fees and charges; mortgage loan servicing fees; gain on sale and other fees on mortgage loans, gain on investment securities and OREO sales; and other miscellaneous income. Fees and service charges on deposits, and fees on loans and loan servicing fees earned during each period are influenced by the volume of deposits and loans outstanding, the volume of the various types of deposit and loan account transactions processed, the volume of loans serviced for others and the collection of related fees and service charges.
Deposit fees and service charges declined marginally to $1.9 million and $5.7 million for the three and nine months ended September 30, 2016, compared to $2.1 million and $6.1 million for the 2015 three and nine month periods. Deposit fees and service charges represented 51.7% and 53.1% of total non-interest income for the three and nine months ended September 30, 2016, compared to 55.6% and 57.4% for the 2015 three and nine month periods. The amount of service charges and fees is generally dependent upon the volume of account transaction activity and the collection of related service charges and fees.
Total non-interest income generated from the sale and servicing, as well as other mortgage loan related fees, increased to $1.2 million and $2.6 million for the three and nine months ended September 30, 2016, compared to $792,000 and $2.3 million for the 2015 three and nine month periods. We continue to explore various strategies to enhance our non-interest income, including the purchase of mortgage servicing rights, as previously discussed.
The Bank may sell or securitize fixed-rate residential mortgage loans to reduce interest rate and credit risk exposure, and to provide a more balanced sensitivity to future interest rate changes, while retaining certain other mortgage loans. Proceeds from mortgage loan sales provide liquidity to support the Bank’s operating, financing and lending activities.
Gains on sales of investment securities available-for-sale were none and $467,000 for the three and nine months ended September 30, 2016, compared to $503,000 and $955,000 for the 2015 three and nine month periods. During the three and nine months ended September 30, 2016, the Bank sold none and $40.6 million of investment securities available-for-sale, compared to $14.8 million and $37.7 million sold in the 2015 three and nine month periods. Proceeds from investment securities sales were primarily used to fund net growth in our loan portfolio and to provide liquidity to support the Bank’s operating and financing activities.
During the three and nine months ended September 30, 2016, the Bank recorded net gains from the sale of OREO of $77,000 and $51,000, compared to a net loss of $63,000 and a net gain of $10,000 for the 2015 three and nine month periods. The Bank continues in its efforts of disposing of these nonperforming assets. See “Note 9. Other Real Estate Owned” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Other non-interest income increased to $477,000 and $1.6 million for the three and nine months ended September 30, 2016, from $379,000 and $1.1 million for the comparable 2015 periods. Included in other non-interest income is revenue from BOLI investments. BOLI earnings increased to $142,000 and $419,000 for the three and nine months ended September 30, 2016, from $127,000 and $382,000 for the 2015 three and nine month periods.
Other non-interest income also includes a $230,000 non-recurring item in the nine months ended September 30, 2016, and an increase in Small Business Administration (SBA) related revenue to $148,000 and $434,000 for the three and nine months ended September 30, 2016, from $51,000 for both the 2015 three and nine month periods. While the Bank has originated SBA loans in prior years, we began the process of actively selling and servicing these credits during 2016.
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Total core non-interest income, excluding net gains and losses from OREO and securities sales, improved to $3.6 million and $10.3 million for the three and nine months ended September 30, 2016, from $3.3 million and $9.6 million for the comparable 2015 periods.
Non-interest Expense. Total non-interest expense has remained stable at $8.9 million and $27.1 million for the three and nine months ended September 30, 2016, compared to $9.0 million and $27.3 million for the 2015 three and nine month periods.
Compensation and benefit expenses, the largest component of non-interest expense, were $5.0 million and $15.0 million for the three and nine months ended September 30, 2016, compared to $4.9 million and $14.5 million for the 2015 three and nine month periods. During the first nine months of 2016, the Bank consolidated three existing branches into nearby locations. The nine months ended September 30, 2016 included $65,000 of severance costs associated with these branch consolidations. The Bank will continue to manage staffing levels to ensure we meet the ongoing needs of our customers and to support our future growth.
FDIC insurance premiums were $157,000 and $479,000 for the three and nine months ended September 30, 2016, compared to $163,000 and $445,000 for the 2015 three and nine month periods. The increase in FDIC insurance premiums during the first nine months of 2016 was due to the growth in our balance sheet.
Premises and equipment expense remained relatively stable at $1.3 million and $4.1 million for the three and nine months ended September 30, 2016, compared to $1.3 million and $4.0 million for the 2015 three and nine month periods. Premises and equipment expense for the 2016 period includes the retirement of certain leasehold improvements and other fixed assets at branch locations that were consolidated and closed. We will continue to explore opportunities to gain efficiency and performance improvement from our branch network.
Advertising expense declined to $151,000 and $569,000 for the three and nine months ended September 30, 2016, from $219,000 and $598,000 for the 2015 three and nine month periods. The Bank continues to invest in building our brand awareness throughout our expanded footprint with its advertising and marketing efforts. We anticipate that advertising expenses will remain at or below current levels as we look to take a more product targeted approach.
Data processing costs declined to $757,000 and $2.3 million for the three and nine months ended September 30, 2016, from $819,000 and $2.8 million for the comparable 2015 three and nine month periods. Data processing expense for the first nine months of 2015 included $173,000 of one-time branch acquisition expenses. Data processing costs fluctuate in conjunction with changes in the number of customer accounts and transaction activity volumes.
Total amortization of intangible assets, including mortgage servicing rights and identifiable intangible assets, was $137,000 and $402,000 for the three and nine months ended September 30, 2016, compared to $130,000 and $387,000 for the 2015 three and nine month periods. Amortization of mortgage servicing rights was $66,000 and $189,000 for the three and nine months ended September 30, 2016, compared to $58,000 and $171,000 for the 2015 three and nine month periods. Amortization of the core deposit intangible, which is the only identifiable intangible asset subject to amortization, was $71,000 and $213,000 for the three and nine months ended September 30, 2016, compared to $72,000 and $216,000 for the 2015 three and nine month periods. See “Note 11. Goodwill and Other Intangibles” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Total expenses attributable to the ongoing maintenance, property taxes, insurance and valuation adjustments for OREO properties were $119,000 and $426,000 for the three and nine months ended September 30, 2016, compared to $99,000 and $463,000 for the 2015 three and nine month periods. OREO valuation adjustments included therein were none and $111,000 for the three and nine months ended September 30, 2016, compared to $10,000 and $96,000 for the 2015 three and nine month periods. Management continuously analyzes the carrying value of OREO and makes valuation adjustments as necessary.
Other non-interest expense remained relatively consistent at $1.3 million and $3.8 million for the three and nine months ended September 30, 2016, compared to $1.3 million and $4.1 million for the 2015 three and nine month periods. As previously discussed, during 2016 the Bank consolidated three existing branches into nearby locations. Two of these locations were leased and the third was owned. In first quarter of 2016, the Bank entered into a contract to sell the owned location and realized an $85,000 pre-tax loss as a result. Other expense for the first nine months of 2015 included $180,000 of one-time branch acquisition expenses.
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Income tax expense increased to $947,000 and $2.2 million for the three and nine months ended September 30, 2016, from $611,000 and $1.4 million for the 2015 three and nine month periods. The effective income tax rates were 33.3% and 30.6% for the three and nine months ended September 30, 2016, compared to 33.1% and 30.3% for the three and nine months ended September 30, 2015. Income tax expense for the three months ended September 30, 2016 and 2015 includes a $74,000 and $80,000 expense adjustment, respectively, due a write down of our deferred tax asset as a result of a reduction in the North Carolina statutory tax rate. Exclusive of the $74,000 and $80,000 adjustments, the effective income tax rates were 30.7 % and 29.5% for the three and nine months ended September 30, 2016, respectively; and 28.7% and 28.5% for the respective 2015 three and nine month periods.
The Bank’s investment in BOLI and tax-exempt municipal bonds contribute to more favorable effective income tax rates, which has been partially offset by the strong growth in the loan portfolio. See “Critical Accounting Policies” below for additional information.
Key Performance Ratios. Some of our key performance ratios are return on average assets (ROA), return on average equity (ROE) and efficiency. ROA improved to 0.78% and 0.70% for the three and nine months ended September 30, 2016, from 0.54% and 0.47% for the comparable 2015 three and nine month periods. ROE improved to 8.52% and 7.69% for the three and nine months ended September 30, 2016, from 5.99% and 5.08% for the comparable 2015 three and nine month periods. The efficiency ratio improved to 73.84% and 77.31% for the three and nine months ended September 30, 2016, from 82.26% and 85.63% for the comparable 2015 three and nine month periods. The efficiency ratio measures the proportion of net operating revenues that are absorbed by overhead expenses. We anticipate the efficiency ratio to improve as we continue to explore opportunities to increase operating leverage and gain efficiencies from our branch network.
Liquidity and Capital Resources. Liquidity generally refers to the Bank's ability to generate adequate amounts of funds to meet its cash needs. Adequate liquidity guarantees that sufficient funds are available to meet deposit withdrawals, fund future loan commitments, maintain adequate reserve requirements, pay operating expenses, provide funds for debt service, and meet other general commitments. FDIC policy requires banks to maintain an average daily balance of liquid assets in an amount which it deems adequate to protect the safety and soundness of the Bank.
At September 30, 2016, the Bank had cash, deposits in other banks, investment securities and loans held for sale totaling $258.3 million, compared to $290.7 million at December 31, 2015. The Bank calculates its liquidity position under policy guidelines based on liquid assets in relationship to deposits and short-term borrowings. Based on its calculation guidelines, the Bank’s liquidity ratio was 26.6% at September 30, 2016, compared to 33.8% at December 31, 2015, which management believes is adequate.
The Bank believes it can meet future liquidity needs with existing funding sources. The Bank's primary sources of funds are deposits, principal payments on loans and mortgage-backed securities, earnings and funds provided from operations, the ability to borrow from the FHLB of Atlanta and other lines of credit, and the availability of loans and investment securities available-for-sale. At September 30, 2016, the Bank had $240.1 million of credit availability with the FHLB, of which there was lendable collateral value totaling $195.9 million. Additional collateral would be required in order to access total borrowings up to the credit availability limit. At September 30, 2016, the Bank had additional capacity to borrow $106.7 million from the Federal Reserve Bank (FRB) Discount Window. At September 30, 2016, the Company and the Bank had $5.0 million and $70.0 million, respectively, of pre-approved, but unused lines of credit.
The FDIC requires the Bank to meet the following minimum capital requirements: Total capital ratio of 8% of risk-weighted assets; Tier 1 capital ratio of 6% of risk-weighted assets; Leverage ratio of 4% of average total assets; and Common equity Tier 1 capital ratio of 4.5% of risk-weighted assets. The Bank was in compliance with all regulatory capital requirements at September 30, 2016, and December 31, 2015. See “Note 15. Regulatory Capital” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
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Critical Accounting Policies. The Company has identified the policies below as critical to its business operations and the understanding of its results of operations. The impact and any associated risks related to these policies on the Company’s business operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect reported and expected financial results.
Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. Estimates affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Loan Impairment and Allowance for Loan and Lease Losses. A loan or lease is considered impaired, based on current information and events, if it is probable that the Bank will be unable to collect all the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease agreement. Uncollateralized loans are measured for impairment based on the present value of expected future cash flows discounted at the historical effective interest rate, while all collateral-dependent loans are measured for impairment based on the fair value of the collateral. The Bank uses several factors in determining if a loan or lease is impaired. The internal asset classification procedures include a thorough review of significant loans, leases and lending relationships and include the accumulation of related data. This data includes loan and lease payment status, borrowers' financial data and borrowers' operating factors such as cash flows and operating income or loss.
The ALLL is increased by charges to income and decreased by charge-offs, net of recoveries. Management's periodic evaluation of the adequacy of the ALLL is based on past loan and lease loss experience, known and inherent risks in loans and leases and unfunded loan commitments, adverse situations that may affect a borrower's ability to repay, the estimated value of any underlying collateral, and current economic conditions. While management believes that it has established the ALLL in accordance with accounting principles generally accepted in the United States of America and has taken into account the views of its regulators and the current economic environment, there can be no assurance in the future that regulators or risks in its loans and leases portfolio will not require additional adjustments to the ALLL.
Income Taxes. Deferred tax asset and liability balances are determined by application to temporary differences in the tax rate expected to be in effect when taxes will become payable or receivable. Temporary differences are differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that will result in taxable or deductible amounts in future years. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.
Off-Balance Sheet Arrangements. The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and involve elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company's exposure to credit loss in the event of non-performance by a party to a financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Forward Looking Statements. The Private Securities Litigation Reform Act of 1995 states that disclosure of forward looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward looking statements by corporate management. This Form 10-Q, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward looking statements that involve risk and uncertainty. In order to comply with the terms of the safe harbor, the Company notes that a variety of risks and uncertainties could cause its actual results and experience to differ materially from anticipated results or other expectations expressed in the Company's forward looking statements. There are risks and uncertainties that may affect the operations, performance, development, growth projections and results of the Company's business. They include, but are not limited to, economic growth, interest rate movements, timely development of technology enhancements for products, services and operating systems, the impact of competitive products, services and pricing, customer requirements, regulatory changes and similar matters. Readers of this report are cautioned not to place undue reliance on forward looking statements that are subject to influence by these risk factors and unanticipated events, as actual results may differ materially from management's expectations.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk. Smaller reporting companies are not required to provide information required by this item.
Item 4. Controls and Procedures. As of the end of the period covered by this report, management of the Company carried out an evaluation, under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures. Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. It should be noted that the design of the Company’s disclosure controls and procedures is based in part upon certain reasonable assumptions about the likelihood of future events, and there can be no reasonable assurance that any design of disclosure controls and procedures will succeed in achieving its stated goals under all potential future conditions, regardless of how remote, but the Company’s principal executive and financial officers have concluded that the Company’s disclosure controls and procedures are, in fact, effective at a reasonable assurance level.
In addition, there have been no changes in the Company’s internal control over financial reporting (to the extent that elements of internal control over financial reporting are subsumed within disclosure controls and procedures) identified in connection with the evaluation described in the above paragraph that occurred during the Company’s last fiscal quarter, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item l. Legal Proceedings: The Company is currently not engaged in any material legal proceedings. From time to time, the Bank is a party to legal proceedings within the ordinary course of business wherein it enforces its security interest in loans, and other matters of similar nature.
Item 1A. Risk Factors: Smaller reporting companies are not required to provide information required by this item.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds: Not applicable
Item 3. Defaults Upon Senior Securities: Not applicable
Item 4. Mine Safety Disclosures: Not applicable.
Item 5. Other Information: Not applicable
Item 6. Exhibits: The following exhibits are filed herewith:
Number | Title | |
31.1 | Rule 13a-14(a) Certification of Chief Executive Officer | |
31.2 | Rule 13a-14(a) Certification of Chief Financial Officer | |
32 | Section 1350 Certification | |
101 | Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Statements of Financial Condition as of September 30, 2016 (unaudited) and December 31, 2015; (ii) Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2016 and 2015 (unaudited); (iii) Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2016 and 2015 (unaudited); (iv) Consolidated Statements of Changes in Stockholders’ Equity for the Nine Months Ended September 30, 2016 and 2015 (unaudited); (v) Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2016 and 2015 (unaudited); and (vi) Notes to Consolidated Financial Statements (unaudited) as of September 30, 2016 and December 31, 2015, and for the Three and Nine Months Ended September 30, 2016 and 2015. |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
FIRST SOUTH BANCORP, INC. | |||
By: | /s/ Scott C. McLean | ||
Scott C. McLean | |||
Executive Vice President | |||
Chief Financial Officer | |||
(Principal Financial and Accounting Officer) | |||
Date: November 10, 2016 |
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