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EX-32.2 - EXHIBIT 32.2 - WESTAMERICA BANCORPORATIONexh_322.htm
EX-32.1 - EXHIBIT 32.1 - WESTAMERICA BANCORPORATIONexh_321.htm
EX-31.2 - EXHIBIT 31.2 - WESTAMERICA BANCORPORATIONexh_312.htm
EX-31.1 - EXHIBIT 31.1 - WESTAMERICA BANCORPORATIONexh_311.htm

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2017

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: 001-09383

WESTAMERICA BANCORPORATION

(Exact Name of Registrant as Specified in Its Charter)

 

CALIFORNIA 94-2156203
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)

 

1108 FIFTH AVENUE, SAN RAFAEL, CALIFORNIA 94901

(Address of Principal Executive Offices) (Zip Code)

 

Registrant's Telephone Number, Including Area Code (707) 863-6000

 

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 ☒ No ☐

 

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

 

Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer ☒ Accelerated filer ☐ Non-accelerated filer ☐  (Do not check if a smaller reporting company)

Smaller reporting company ☐ Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes ☐ No ☒

 

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date:

 

Title of Class Shares outstanding as of April 25, 2017
   
Common Stock,
No Par Value
26,298,078

 

 

 
 

 

TABLE OF CONTENTS

 

 

   Page
Forward Looking Statements  3
PART I - FINANCIAL INFORMATION  
Item 1 Financial Statements  4
  Notes to Unaudited Consolidated Financial Statements  9
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 28
Item 3 Quantitative and Qualitative Disclosures about Market Risk 47
Item 4 Controls and Procedures 47
PART II - OTHER INFORMATION  
Item 1 Legal Proceedings 48
Item 1A Risk Factors 48
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 48
Item 3 Defaults upon Senior Securities 49
Item 4 Mine Safety Disclosures 49
Item 5 Other Information 49
Item 6 Exhibits 49
Signatures 50
Exhibit Index 51
Exhibit 31.1 - Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a) 52
Exhibit 31.2 - Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a) 53
Exhibit 32.1 - Certification of Chief Executive Officer Required by 18 U.S.C. Section 1350 54
Exhibit 32.2 - Certification of Chief Financial Officer Required by 18 U.S.C. Section 1350 55

 

 

 

 

 

 

 -2- 

 

FORWARD-LOOKING STATEMENTS

 

This report on Form 10-Q contains forward-looking statements about Westamerica Bancorporation (the “Company”) for which it claims the protection of the safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, future credit quality and performance, the appropriateness of the allowance for loan losses, loan growth or reduction, mitigation of risk in the Company’s loan and investment securities portfolios, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of the Company or its management or board of directors, including those relating to products or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as "believes", "anticipates", "expects", “estimates”, "intends", "targeted", "projected", “forecast”, "continue", "remain", "will", "should", "may" and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

 

These forward-looking statements are based on Management’s current knowledge and belief and include information concerning the Company’s possible or assumed future financial condition and results of operations. A number of factors, some of which are beyond the Company’s ability to predict or control, could cause future results to differ materially from those contemplated. These factors include but are not limited to (1) the length and severity of difficulties in the global, national and California economies and the effects of government efforts to address those difficulties; (2) liquidity levels in capital markets; (3) fluctuations in asset prices including, but not limited to stocks, bonds, real estate, and commodities; (4) the effect of acquisitions and integration of acquired businesses; (5) economic uncertainty created by terrorist threats and attacks on the United States, the actions taken in response, and the uncertain effect of these events on the national and regional economies; (6) changes in the interest rate environment; (7) changes in the regulatory environment; (8) competitive pressure in the banking industry; (9) operational risks including a failure or breach in data processing or security systems or those of third party vendors and other service providers, including as a result of cyber attacks or fraud; (10) volatility of interest rate sensitive loans, deposits and investments; (11) asset/liability management risks and liquidity risks; (12) the effect of natural disasters, including earthquakes, fire, flood, drought, and other disasters, on the uninsured value of the Company’s assets and of loan collateral, the financial condition of debtors and issuers of investment securities, the economic conditions affecting the Company’s market place, and commodities and asset values; (13) changes in the securities markets and (14) the outcome of contingencies, such as legal proceedings. However, the reader should not consider the above-mentioned factors to be a complete set of all potential risks or uncertainties.

 

Forward-looking statements speak only as of the date they are made. The Company undertakes no obligation to update any forward-looking statements in this Report to reflect circumstances or events that occur after the date forward looking statements are made, except as may be required by law. The reader is directed to the Company's annual report on Form 10-K for the year ended December 31, 2016, for further discussion of factors which could affect the Company's business and cause actual results to differ materially from those expressed in any forward-looking statement made in this report.

 

 -3- 

 

PART I - FINANCIAL INFORMATION

Item 1 Financial Statements

 

WESTAMERICA BANCORPORATION

CONSOLIDATED BALANCE SHEETS

(unaudited)

 

   At March 31,
2017
  At December 31,
2016
   (In thousands)
Assets:   
Cash and due from banks  $546,815   $462,271 
Investment securities available for sale   1,893,309    1,890,758 
Investment securities held to maturity, with fair values of: $1,296,738 at March 31, 2017 and $1,340,741 at December 31, 2016   1,298,414    1,346,312 
Loans   1,351,090    1,352,711 
Allowance for loan losses   (24,919)   (25,954)
Loans, net of allowance for loan losses   1,326,171    1,326,757 
Other real estate owned   2,136    3,095 
Premises and equipment, net   36,025    36,566 
Identifiable intangibles, net   6,127    6,927 
Goodwill   121,673    121,673 
Other assets   165,277    171,724 
Total Assets  $5,395,947   $5,366,083 
           
Liabilities:          
Noninterest-bearing deposits  $2,046,390   $2,089,443 
Interest-bearing deposits   2,651,583    2,615,298 
Total deposits   4,697,973    4,704,741 
Short-term borrowed funds   73,611    59,078 
Other liabilities   39,475    40,897 
Total Liabilities   4,811,059    4,804,716 
           
Contingencies (Note 10)          
           
Shareholders' Equity:          
Common stock (no par value), authorized - 150,000 shares Issued and outstanding: 26,283 at March 31, 2017 and 25,907 at December 31, 2016   422,670    404,606 
Deferred compensation   1,533    1,533 
Accumulated other comprehensive loss   (9,443)   (10,074)
Retained earnings   170,128    165,302 
Total Shareholders' Equity   584,888    561,367 
Total Liabilities and  Shareholders' Equity  $5,395,947   $5,366,083 

 

See accompanying notes to unaudited consolidated financial statements.

 

 -4- 

 

WESTAMERICA BANCORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

 

   For the
Three Months Ended
March 31,
   2017  2016
   (In thousands,
except per share data)
Interest and Fee Income:          
Loans  $15,780   $18,353 
Investment securities available for sale   10,249    7,967 
Investment securities held to maturity   7,295    7,327 
Total Interest and Fee Income   33,324    33,647 
Interest Expense:          
Deposits   469    543 
Short-term borrowed funds   11    9 
Total Interest Expense   480    552 
Net Interest and Fee Income   32,844    33,095 
Provision for Loan Losses   -    - 
Net Interest and Fee Income After Provision For Loan Losses   32,844    33,095 
Noninterest Income:          
Service charges on deposit accounts   4,923    5,248 
Merchant processing services   1,875    1,529 
Debit card fees   1,481    1,516 
Trust fees   702    661 
Other service fees   650    629 
ATM processing fees   575    658 
Financial services commissions   195    156 
Other noninterest income   1,256    1,332 
Total Noninterest Income   11,657    11,729 
Noninterest Expense:          
Salaries and related benefits   13,070    13,117 
Occupancy   3,633    3,398 
Outsourced data processing services   2,139    2,130 
Furniture and equipment   1,254    1,213 
Amortization of identifiable intangibles   800    905 
Professional fees   611    732 
Courier service   421    545 
Other real estate owned   (40)   111 
Other noninterest expense   2,727    3,707 
Total Noninterest Expense   24,615    25,858 
Income Before Income Taxes   19,886    18,966 
Provision for income taxes   4,837    4,740 
Net Income  $15,049   $14,226 
           
Average Common Shares Outstanding   26,171    25,445 
Average Diluted Common Shares Outstanding   26,329    25,468 
Per Common Share Data:          
Basic earnings  $0.58   $0.56 
Diluted earnings   0.57    0.56 
Dividends paid   0.39    0.39 

 

See accompanying notes to unaudited consolidated financial statements.

 

 -5- 

 

WESTAMERICA BANCORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

 

   For the Three Months Ended
March 31,
   2017  2016
   (In thousands)
Net income  $15,049   $14,226 
Other comprehensive income:          
Increase in net unrealized gains on securities available for sale   1,074    10,241 
Deferred tax expense   (452)   (4,306)
Increase in net unrealized gains on securities available for sale, net of tax   622    5,935 
Post-retirement benefit transition obligation amortization   15    15 
Deferred tax expense   (6)   (6)
Post-retirement benefit transition obligation amortization, net of tax   9    9 
Total other comprehensive income   631    5,944 
Total comprehensive income  $15,680   $20,170 

 

See accompanying notes to unaudited consolidated financial statements.

 

 -6- 

 

WESTAMERICA BANCORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

(unaudited)

 

   Common
Shares
Outstanding
  Common
Stock
  Deferred
Compensation
  Accumulated
Other
Comprehensive
Income (Loss)
  Retained
Earnings
  Total
   (In thousands)
                   
Balance, December 31, 2015   25,528   $378,858   $2,578   $675   $150,094   $532,205 
Net income for the period                       14,226    14,226 
Other comprehensive income                  5,944         5,944 
Exercise of stock options   40    1,717                   1,717 
Tax benefit decrease upon exercise and expiration of stock options        (181)                  (181)
Restricted stock activity        1,045    (1,045)             - 
Stock based compensation        390                   390 
Stock awarded to employees   -    15                   15 
Retirement of common stock   (130)   (1,951)             (3,473)   (5,424)
Dividends                       (9,919)   (9,919)
Balance, March 31, 2016   25,438   $379,893   $1,533   $6,619   $150,928   $538,973 
                               
Balance, December 31, 2016   25,907   $404,606   $1,533   $(10,074)  $165,302   $561,367 
Net income for the period                       15,049    15,049 
Other comprehensive income                  631         631 
Exercise of stock options   376    17,593                   17,593 
Stock based compensation        456                   456 
Stock awarded to employees   -    15                   15 
Dividends                       (10,223)   (10,223)
Balance, March 31, 2017   26,283   $422,670   $1,533   $(9,443)  $170,128   $584,888 

 

See accompanying notes to unaudited consolidated financial statements.

 

 -7- 

 

WESTAMERICA BANCORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

   For the Three Months
Ended March 31,
   2017  2016
   (In thousands)
Operating Activities:          
Net income  $15,049   $14,226 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization/accretion   5,754    4,065 
Net amortization of deferred net loan cost (fees)   26    (54)
Decrease in interest income receivable   1,744    1,379 
Life insurance premiums paid   (126)   (126)
Increase in income taxes payable   2,896    3,424 
Decrease in deferred tax asset   1,441    115 
Tax benefit decrease upon exercise and expiration of stock options   -    181 
Decrease (increase) in other assets   895    (5,476)
Stock option compensation expense   456    390 
Increase in interest expense payable   8    25 
Decrease in other liabilities   (2,864)   (4)
Writedown/loss on sale of premises and equipment   50    5 
Net gain on sale of foreclosed assets   (55)   (58)
Writedown of foreclosed assets   -    126 
Net Cash Provided by Operating Activities   25,274    18,218 
           
Investing Activities:          
Net repayments of loans   1,526    61,070 
Net receipts under FDIC(1) indemnification agreements   129    5,189 
Purchases of investment securities available for sale   (51,297)   (152,128)
Proceeds from sale/maturity/calls of securities available for sale   47,600    166,023 
Purchases of investment securities held to maturity   -    (56,182)
Proceeds from maturity/calls of securities held to maturity   45,640    33,531 
Purchases of premises and equipment   (501)   (283)
Proceeds from sale of FRB(2) stock   24    - 
Proceeds from sale of foreclosed assets   1,014    975 
Net Cash Provided by Investing Activities   44,135    58,195 
           
Financing Activities:          
Net change in deposits   (6,768)   (23,909)
Net change in short-term borrowings   14,533    (577)
Exercise of stock options/issuance of shares   17,593    1,717 
Tax benefit decrease upon exercise and expiration of stock options   -    (181)
Retirement of common stock   -    (5,424)
Common stock dividends paid   (10,223)   (9,919)
Net Cash Provided by (Used in) Financing Activities   15,135    (38,293)
Net Change In Cash and Due from Banks   84,544    38,120 
Cash and Due from Banks at Beginning of Period   462,271    433,044 
Cash and Due from Banks at End of Period  $546,815   $471,164 
           
Supplemental Cash Flow Disclosures:          
Supplemental disclosure of noncash activities:          
Loan collateral transferred to other real estate owned  $-   $217 
Securities purchases pending settlement   -    44,580 
Supplemental disclosure of cash flow activities:          
Interest paid for the period   504    526 
Income tax payments for the period   500    1,200 

 

See accompanying notes to unaudited consolidated financial statements.

(1) Federal Deposit Insurance Corporation ("FDIC")

(2) Federal Reserve Bank ("FRB")

 

 -8- 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1: Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission and follow general practices within the banking industry. The results of operations reflect interim adjustments, all of which are of a normal recurring nature and which, in the opinion of Management, are necessary for a fair presentation of the results for the interim periods presented. The interim results for the three months ended March 31, 2017 are not necessarily indicative of the results expected for the full year. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes as well as other information included in the Company's Annual Report on Form 10-K for the year ended December 31, 2016.

 

Note 2: Accounting Policies

 

The most significant accounting policies followed by the Company are presented in Note 1 to the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, Management has identified the allowance for loan losses accounting to be the accounting area requiring the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available. A discussion of the factors affecting accounting for the allowance for loan losses is included in the “Provision for Loan Losses,” “Loan Portfolio Credit Risk” and “Allowance for Loan Losses” discussion below. Certain amounts in prior periods have been reclassified to conform to the current presentation.

 

Application of these principles requires the Company to make certain estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain accounting policies inherently have a greater reliance on the use of estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment writedown or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available.

 

Recently Adopted Accounting Standards

 

FASB ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, was issued March 30, 2016. The provisions of the new standard changes several aspects of the accounting for share-based payment award transactions, including: (1) Accounting and Cash Flow Classification for Excess Tax Benefits, (2) Forfeitures, and (3) Tax Withholding Requirements and Cash Flow Classification. The Company adopted the ASU provisions effective January 1, 2017, which has the potential to create volatility in the book tax provision at the time nonqualified stock options are exercised or expire. During the first quarter 2017, 376 thousand shares were issued due to the exercise of nonqualified stock options resulting in a tax deduction exceeding related share based compensation by $1.6 million. First quarter 2017 income tax provision was $671 thousand lower than would have been under accounting standards prior to the adoption of ASU 2016-09. The Company elected to account for forfeitures as they occur.

 

Recently Issued Accounting Standards

 

FASB Accounting Standards Update (ASU) 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, was issued January 2016. The ASU addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Most notably, the ASU changes the income statement impact of equity investments held by the Company and the requirement for the Company to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes.

 

 -9- 

 

The Company will be required to adopt the ASU provisions on January 1, 2018. Management is evaluating the impact that the ASU will have on the Company’s financial statements.

 

FASB Accounting Standards Update (ASU) 2016-02, Leases (Topic 842), was issued February 25, 2016. The provisions of the new standard require lessees to recognize most leases on-balance sheet, increasing reported assets and liabilities. Lessor accounting remains substantially similar to current U.S. GAAP.


The Company will be required to adopt the ASU provisions January 1, 2019, utilizing the modified retrospective transition approach. Management is evaluating the impact that the ASU will have on the Company’s financial statements.

 

FASB ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, was issued on June 16, 2016. The ASU significantly changes estimates for credit losses related to financial assets measured at amortized cost and certain other contracts. For estimating credit losses, the FASB is replacing the incurred loss model with the current expected credit loss (CECL) model, which will accelerate recognition of credit losses. Additionally, credit losses relating to available-for-sale debt securities will be recorded through an allowance for credit losses under the new standard. The Company will also be required to provide additional disclosures related to the financial assets within the scope of the new standard.

 

The Company will be required to adopt the ASU provisions on January 1, 2020. Management is evaluating the impact that the ASU will have on the Company’s consolidated financial statements.

 

FASB ASU 2017-08, Receivables – Non-Refundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities, was issued March 2017. The ASU will shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity.

 

The Company will be required to adopt the ASU provisions on January 1, 2019. Management is evaluating the impact the ASU will have on the Company’s financial statements.

 

Note 3: Investment Securities

 

An analysis of the amortized cost, gross unrealized gains and losses accumulated in other comprehensive income, and fair value of the available for sale investment securities portfolio follows:

 

   Investment Securities Available for Sale
At March 31, 2017
   Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Fair
Value
   (In thousands)
Securities of U.S. Government sponsored entities  $141,595   $33   $(2,691)  $138,937 
Agency residential mortgage-backed securities (MBS)   742,713    825    (21,334)   722,204 
Non-agency residential MBS   196    -    -    196 
Non-agency commercial MBS   1,955    -    (16)   1,939 
Obligations of states and political subdivisions   176,739    5,425    (3,293)   178,871 
Asset-backed securities   355    -    -    355 
FHLMC(1) and FNMA(2) stock   749    8,651    -    9,400 
Corporate securities   843,249    2,037    (6,150)   839,136 
Other securities   2,005    456    (190)   2,271 
Total  $1,909,556   $17,427   $(33,674)  $1,893,309 

 

(1) Federal Home Loan Mortgage Corporation

(2) Federal National Mortgage Association

 

 -10- 

 

An analysis of the amortized cost, gross unrecognized gains and losses, and fair value of the held to maturity investment securities portfolio follows:

 

   Investment Securities Held to Maturity
At March 31, 2017
   Amortized
Cost
  Gross
Unrecognized
Gains
  Gross
Unrecognized
Losses
  Fair
Value
   (In thousands)
Securities of U.S. Government sponsored entities  $538   $-   $-   $538 
Agency residential MBS   634,958    1,007    (9,093)   626,872 
Non-agency residential MBS   5,103    62    -    5,165 
Agency commercial MBS   9,258    4    (123)   9,139 
Obligations of states and political subdivisions   648,557    8,503    (2,036)   655,024 
Total  $1,298,414   $9,576   $(11,252)  $1,296,738 

 

An analysis of the amortized cost, gross unrealized gains and losses accumulated in other comprehensive income, and fair value of the available for sale investment securities portfolio follows:

 

   Investment Securities Available for Sale
At December 31, 2016
   Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Fair
Value
   (In thousands)
Securities of U.S. Government sponsored entities  $141,599   $35   $(2,974)  $138,660 
Agency residential MBS   711,623    921    (21,045)   691,499 
Non-agency residential MBS   272    -    (1)   271 
Non-agency commercial MBS   2,041    -    (16)   2,025 
Obligations of states and political subdivisions   182,230    5,107    (3,926)   183,411 
Asset-backed securities   696    -    (1)   695 
FHLMC(1) and FNMA(2) stock   749    10,120    -    10,869 
Corporate securities   866,835    1,690    (7,668)   860,857 
Other securities   2,034    621    (184)   2,471 
Total  $1,908,079   $18,494   $(35,815)  $1,890,758 

 

(1) Federal Home Loan Mortgage Corporation

(2) Federal National Mortgage Association

 

An analysis of the amortized cost, gross unrecognized gains and losses, and fair value of the held to maturity investment securities portfolio follows:

 

   Investment Securities Held to Maturity
At December 31, 2016
   Amortized
Cost
  Gross
Unrecognized
Gains
  Gross
Unrecognized
Losses
  Fair
Value
   (In thousands)
Securities of U.S. Government sponsored entities  $581   $1   $-   $582 
Agency residential MBS   668,235    1,122    (8,602)   660,755 
Non-agency residential MBS   5,370    76    -    5,446 
Agency commercial MBS   9,332    11    (143)   9,200 
Obligations of states and political subdivisions   662,794    6,031    (4,067)   664,758 
Total  $1,346,312   $7,241   $(12,812)  $1,340,741 

 

 -11- 

 

The amortized cost and fair value of investment securities by contractual maturity are shown in the following table s at the dates indicated:

 

   At March 31, 2017
   Securities Available
for Sale
  Securities Held
to Maturity
   Amortized
Cost
  Fair
Value
  Amortized
Cost
  Fair
Value
   (In thousands)
Maturity in years:                    
1 year or less  $200,403   $200,533   $21,359   $22,112 
Over 1 to 5 years   687,340    683,836    296,478    298,933 
Over 5 to 10 years   226,589    228,155    303,309    306,228 
Over 10 years   47,606    44,775    27,949    28,289 
Subtotal   1,161,938    1,157,299    649,095    655,562 
MBS   744,864    724,339    649,319    641,176 
Other securities   2,754    11,671    -    - 
Total  $1,909,556   $1,893,309   $1,298,414   $1,296,738 

 

   At December 31, 2016
   Securities Available
for Sale
  Securities Held
to Maturity
   Amortized
Cost
  Fair
Value
  Amortized
Cost
  Fair
Value
   (In thousands)
Maturity in years:                    
1 year or less  $154,693   $154,835   $14,961   $15,639 
Over 1 to 5 years   750,834    745,219    292,024    292,062 
Over 5 to 10 years   238,077    239,153    318,580    319,587 
Over 10 years   47,756    44,416    37,810    38,052 
Subtotal   1,191,360    1,183,623    663,375    665,340 
MBS   713,936    693,795    682,937    675,401 
Other securities   2,783    13,340    -    - 
Total  $1,908,079   $1,890,758   $1,346,312   $1,340,741 

 

Expected maturities of mortgage-related securities can differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties. In addition, such factors as prepayments and interest rates may affect the yield on the carrying value of mortgage-related securities. At March 31, 2017 and December 31, 2016, the Company had no high-risk collateralized mortgage obligations as defined by regulatory guidelines.

 

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 -12- 

 

An analysis of the gross unrealized losses of the available for sale investment securities portfolio follows:

 

   Investment Securities Available for Sale
At March 31, 2017
   No. of  Less than 12 months  No. of  12 months or longer  No. of  Total
   Investment     Unrealized  Investment     Unrealized  Investment     Unrealized
   Positions  Fair Value  Losses  Positions  Fair Value  Losses  Positions  Fair Value  Losses
   ($ in thousands)
Securities of U.S. Government sponsored entities   9   $120,654   $(2,691)   -   $-   $-    9   $120,654   $(2,691)
Agency residential MBS   26    564,037    (16,571)   28    117,356    (4,763)   54    681,393    (21,334)
Non-agency residential MBS   1    177    -    -    -    -    1    177    - 
Non-agency commercial MBS   2    1,189    (9)   1    750    (7)   3    1,939    (16)
Obligations of states and political subdivisions   42    55,505    (3,272)   4    1,653    (21)   46    57,158    (3,293)
Corporate securities   48    360,788    (5,201)   25    88,217    (949)   73    449,005    (6,150)
Other securities   -    -    -    1    1,810    (190)   1    1,810    (190)
Total   128   $1,102,350   $(27,744)   59   $209,786   $(5,930)   187   $1,312,136   $(33,674)

 

An analysis of gross unrecognized losses of the held to maturity investment securities portfolio follows:

 

   Investment Securities Held to Maturity
At March 31, 2017
   No. of  Less than 12 months  No. of  12 months or longer  No. of  Total
   Investment     Unrecognized  Investment     Unrecognized  Investment     Unrecognized
   Positions  Fair Value  Losses  Positions  Fair Value  Losses  Positions  Fair Value  Losses
   ($ in thousands)
Agency residential MBS   66   $551,095   $(8,789)   3   $11,465   $(304)   69   $562,560   $(9,093)
Agency commercial MBS   -    -    -    1    7,175    (123)   1    7,175    (123)
Obligations of states and political subdivisions   137    128,434    (1,668)   13    12,905    (368)   150    141,339    (2,036)
Total   203   $679,529   $(10,457)   17   $31,545   $(795)   220   $711,074   $(11,252)

 

The unrealized losses on the Company’s investment securities were caused by market conditions for these types of investments, particularly changes in risk-free interest rates. The Company evaluates securities on a quarterly basis including changes in security ratings issued by rating agencies, changes in the financial condition of the issuer, and, for mortgage-backed and asset-backed securities, delinquency and loss information with respect to the underlying collateral, changes in the levels of subordination for the Company’s particular position within the repayment structure and remaining credit enhancement as compared to expected credit losses of the security. Substantially all of these securities continue to be investment grade rated by a major rating agency. In addition to monitoring credit rating agency evaluations, Management performs its own evaluations regarding the credit worthiness of the issuer or the securitized assets underlying asset backed securities.

 

The Company does not intend to sell any investments and has concluded that it is more likely than not that it will not be required to sell the investments prior to recovery of the amortized cost basis. Therefore, the Company does not consider these investments to be other-than-temporarily impaired as of March 31, 2017.

 

The fair values of the investment securities could decline in the future if the general economy deteriorates, inflation increases, credit ratings decline, the issuer’s financial condition deteriorates, or the liquidity for securities declines. As a result, other than temporary impairments may occur in the future.

 

As of March 31, 2017, $774,283  thousand of investment securities were pledged to secure public deposits and short-term borrowed funds. As of December 31, 2016, $768,845  thousand of investment securities were pledged to secure public deposits and short-term borrowed funds.

 

 -13- 

 

An analysis of gross unrealized losses  of investment securities available for sale follows:

 

   Investment Securities Available for Sale
At December 31, 2016
   No. of  Less than 12 months  No. of  12 months or longer  No. of  Total
   Investment     Unrealized  Investment     Unrealized  Investment     Unrealized
   Positions  Fair Value  Losses  Positions  Fair Value  Losses  Positions  Fair Value  Losses
   ($ in thousands)
Securities of U.S. Government sponsored entities   8   $117,227   $(2,974)   -   $-   $-    8   $117,227   $(2,974)
Agency residential MBS   21    524,269    (16,494)   28    122,901    (4,551)   49    647,170    (21,045)
Non-agency residential MBS   2    246    (1)   -    -    -    2    246    (1)
Non-agency commercial MBS   2    1,253    (9)   1    772    (7)   3    2,025    (16)
Obligations of states and political subdivisions   43    57,989    (3,905)   3    1,117    (21)   46    59,106    (3,926)
Asset-backed securities   -    -    -    1    695    (1)   1    695    (1)
Corporate securities   53    385,175    (6,551)   27    96,145    (1,117)   80    481,320    (7,668)
Other securities   -    -    -    1    1,816    (184)   1    1,816    (184)
Total   129   $1,086,159   $(29,934)   61   $223,446   $(5,881)   190   $1,309,605   $(35,815)

 

An analysis of gross unrecognized losses  of investment securities held to maturity follows:

 

   Investment Securities Held to Maturity
At December 31, 2016
   No. of  Less than 12 months  No. of  12 months or longer  No. of  Total
   Investment     Unrecognized  Investment     Unrecognized  Investment     Unrecognized
   Positions  Fair Value  Losses  Positions  Fair Value  Losses  Positions  Fair Value  Losses
   ($ in thousands)
Agency residential MBS   66   $569,876   $(8,285)   3   $10,480   $(317)   69   $580,356   $(8,602)
Agency commercial MBS   -    -    -    1    7,214    (143)   1    7,214    (143)
Obligations of states and political subdivisions   295    272,496    (3,710)   12    13,126    (357)   307    285,622    (4,067)
Total   361   $842,372   $(11,995)   16   $30,820   $(817)   377   $873,192   $(12,812)

 

The following table provides information about the amount of interest income earned on investment securities which is fully taxable and which is exempt from regular federal income tax:

 

 
 
 
 
For the Three Months
Ended March 31,
   2017  2016
   (In thousands)
       
Taxable  $12,147   $9,674 
Tax-exempt from regular federal income tax   5,397    5,620 
Total interest income from investment securities  $17,544   $15,294 

 

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 -14- 

 

Note 4: Loans and Allowance for Loan Losses

 

A summary of the major categories of loans outstanding is shown in the following tables at the dates indicated.

 

   At March 31, 2017  At December 31, 2016
   (In thousands)
Commercial  $354,500   $354,697 
Commercial Real Estate   565,604    542,171 
Construction   1,880    2,555 
Residential Real Estate   79,481    87,724 
Consumer Installment & Other   349,625    365,564 
Total  $1,351,090   $1,352,711 

 

Total loans outstanding reported above include purchased loans of $113,207 thousand and $121,210 thousand at March 31, 2017 and December 31, 2016, respectively. Purchased loans were separately reported in prior periods and have been reclassified into their respective categories in the current presentation.

 

Changes in the accretable yield for purchased loans were as follows:

 

   For the
Three Months Ended
March 31, 2017
  For the
Year Ended
December 31, 2016
Accretable yield:  (In thousands)
Balance at the beginning of the period  $1,237   $1,259 
Reclassification from nonaccretable difference   871    3,912 
Accretion   (970)   (3,934)
Balance at the end of the period  $1,138   $1,237 
           
Accretion  $(970)  $(3,934)
Change in FDIC indemnification   189    1,053 
(Increase) in interest income  $(781)  $(2,881)

 

The following summarizes activity in the allowance for loan losses:

 

   Allowance for Loan Losses
For the Three Months Ended March 31, 2017
   Commercial  Commercial
Real Estate
  Construction  Residential
Real Estate
  Consumer
Installment
and Other
  Unallocated  Total
   (In thousands)
Allowance for loan losses:                                   
Balance at beginning of period  $8,327   $3,330   $152   $1,330   $7,980   $4,835   $25,954 
Additions:                                   
Provision (reversal)   209    182    (40)   (116)   106    (341)   - 
Deductions:                                   
Chargeoffs   (103)   -    -    -    (1,739)   -    (1,842)
Recoveries   160    10    -    -    637    -    807 
Net loan recoveries (losses)   57    10    -    -    (1,102)   -    (1,035)
Total allowance for loan losses  $8,593   $3,522   $112   $1,214   $6,984   $4,494   $24,919 

 

   Allowance for Loan Losses
For the Three Months Ended March 31, 2016
   Commercial  Commercial
Real Estate
  Construction  Residential
Real Estate
  Consumer
Installment
and Other
  Unallocated  Total
   (In thousands)
Allowance for loan losses:                                   
Balance at beginning of period  $9,559   $4,212   $235   $1,801   $8,001   $5,963   $29,771 
Additions:                                   
Provision (reversal)   38    10    (48)   (94)   124    (30)   - 
Deductions:                                   
Chargeoffs   (1,171)   -    -    -    (1,006)   -    (2,177)
Recoveries   1,421    15    -    -    457    -    1,893 
Net loan recoveries (losses)   250    15    -    -    (549)   -    (284)
Total allowance for loan losses  $9,847   $4,237   $187   $1,707   $7,576   $5,933   $29,487 

 

 -15- 

 

The allowance for loan losses and recorded investment in loans evaluated for impairment were as follows:

 

 
 
 
 
Allowance for Loan Losses and Recorded Investment in Loans Evaluated for Impairment
At March 31, 2017
   Commercial  Commercial Real Estate  Construction  Residential Real Estate  Consumer Installment and Other  Unallocated  Total
   (In thousands)
Allowance for loan losses:                                   
Individually evaluated for impairment  $4,991   $-   $-   $-   $-   $-   $4,991 
Collectively evaluated for impairment   3,602    3,522    112    1,214    6,984    4,494    19,928 
Purchased loans with evidence of credit deterioration   -    -    -    -    -    -    - 
Total  $8,593   $3,522   $112   $1,214   $6,984   $4,494   $24,919 
Carrying value of loans:                                   
Individually evaluated for impairment  $11,128   $15,243   $-   $217   $-   $-   $26,588 
Collectively evaluated for impairment   343,345    549,838    1,880    79,264    349,303    -    1,323,630 
Purchased loans with evidence of credit deterioration   27    523    -    -    322    -    872 
Total  $354,500   $565,604   $1,880   $79,481   $349,625   $-   $1,351,090 

 

   Allowance for Loan Losses and Recorded Investment in Loans Evaluated for Impairment
At December 31, 2016
   Commercial  Commercial Real Estate  Construction  Residential Real Estate  Consumer Installment and Other  Unallocated  Total
   (In thousands)
Allowance for loan losses:                                   
Individually evaluated for impairment  $5,048   $-   $-   $-   $-   $-   $5,048 
Collectively evaluated for impairment   3,279    3,330    152    1,330    7,980    4,835    20,906 
Purchased loans with evidence of credit deterioration   -    -    -    -    -    -    - 
Total  $8,327   $3,330   $152   $1,330   $7,980   $4,835   $25,954 
Carrying value of loans:                                   
Individually evaluated for impairment  $11,174   $12,706   $-   $835   $-   $-   $24,715 
Collectively evaluated for impairment   343,494    528,957    2,555    86,889    365,236    -    1,327,131 
Purchased loans with evidence of credit deterioration   29    508    -    -    328    -    865 
Total  $354,697   $542,171   $2,555   $87,724   $365,564   $-   $1,352,711 

 

The Bank’s customers are small businesses, professionals and consumers. Given the scale of these borrowers, corporate credit rating agencies do not evaluate the borrowers’ financial condition. The Bank maintains a Loan Review Department which reports directly to the Board of Directors. The Loan Review Department performs independent evaluations of loans and assigns credit risk grades to evaluated loans using grading standards employed by bank regulatory agencies. Loans judged to carry lower-risk attributes are assigned a “pass” grade, with a minimal likelihood of loss. Loans judged to carry higher-risk attributes are referred to as “classified loans,” and are further disaggregated, with increasing expectations for loss recognition, as “substandard,” “doubtful,” and “loss.” Loan Review Department evaluations occur every calendar quarter. If the Bank becomes aware of deterioration in a borrower’s performance or financial condition between Loan Review Department examinations, assigned risk grades are re-evaluated promptly. Credit risk grades assigned by the Loan Review Department are subject to review by the Bank’s regulatory authorities during regulatory examinations.

 

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 -16- 

 

The following summarizes the credit risk profile by internally assigned grade:

 

   Credit Risk Profile by Internally Assigned Grade
At March 31, 2017
   Commercial  Commercial Real Estate  Construction  Residential Real Estate  Consumer Installment and Other  Total
   (In thousands)
Grade:                  
Pass  $339,296   $538,750   $1,880   $79,481   $346,864   $1,306,271 
Substandard   15,204    25,558    -    -    2,447    43,209 
Doubtful   -    1,296    -    -    -    1,296 
Loss   -    -    -    -    314    314 
Total  $354,500   $565,604   $1,880   $79,481   $349,625   $1,351,090 

 

(1) Credit risk profile reflects internally assigned grade of purchased covered loans without regard to FDIC indemnification.

 

   Credit Risk Profile by Internally Assigned Grade
At December 31, 2016
   Commercial  Commercial Real Estate  Construction  Residential Real Estate  Consumer Installment and Other  Total
   (In thousands)
Grade:                  
Pass  $340,973   $515,045   $2,555   $84,384   $362,597   $1,305,554 
Substandard   13,724    25,830    -    3,340    2,477    45,371 
Doubtful   -    1,296    -    -    10    1,306 
Loss   -    -    -    -    480    480 
Total  $354,697   $542,171   $2,555   $87,724   $365,564   $1,352,711 

 

(1) Credit risk profile reflects internally assigned grade of purchased covered loans without regard to FDIC indemnification.

 

The following tables summarize loans by delinquency and nonaccrual status:

 

   Summary of Loans by Delinquency and Nonaccrual Status
At March 31, 2017
   Current and Accruing  30-59 Days Past Due and Accruing  60-89 Days Past Due and Accruing  Past Due 90 Days or More and Accruing  Nonaccrual  Total Loans
   (In thousands)
Commercial  $351,417   $1,979   $1,072   $-   $32   $354,500 
Commercial real estate   553,637    4,922    605    -    6,440    565,604 
Construction   1,880    -    -    -    -    1,880 
Residential real estate   78,182    1,299    -    -    -    79,481 
Consumer installment and other   345,600    2,764    693    373    195    349,625 
Total  $1,330,716   $10,964   $2,370   $373   $6,667   $1,351,090 

 

   Summary of Loans by Delinquency and Nonaccrual Status
At December 31, 2016
   Current and Accruing  30-59 Days Past Due and Accruing  60-89 Days Past Due and Accruing  Past Due 90 Days or More and Accruing  Nonaccrual  Total Loans
   (In thousands)
Commercial  $353,497   $966   $40   $-   $194   $354,697 
Commercial real estate   533,377    1,460    445    -    6,889    542,171 
Construction   2,329    226    -    -    -    2,555 
Residential real estate   86,098    528    37    -    1,061    87,724 
Consumer installment and other   360,549    3,288    989    497    241    365,564 
Total  $1,335,850   $6,468   $1,511   $497   $8,385   $1,352,711 

 

 -17- 

 

There were no commitments to lend additional funds to borrowers whose loans were on nonaccrual status at March 31, 2017 and December 31, 2016.

 

The following summarizes impaired loans:

 

   Impaired Loans
At March 31, 2017
   Recorded
Investment
  Unpaid
Principal
Balance
  Related
Allowance
   (In thousands)
Impaired loans with no related allowance recorded:               
Commercial  $1,080   $1,148   $- 
Commercial real estate   15,766    17,788    - 
Construction   -    -    - 
Residential real estate   217    247    - 
Consumer installment and other   517    623    - 
                
Impaired loans with an allowance recorded:               
Commercial   10,106    10,115    4,991 
Commercial real estate   -    -    - 
Construction   -    -    - 
Residential real estate   -    -    - 
Consumer installment and other   -    -    - 
                
Total:               
Commercial  $11,186   $11,263   $4,991 
Commercial real estate   15,766    17,788    - 
Construction   -    -    - 
Residential real estate   217    247    - 
Consumer installment and other   517    623    - 

 

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 -18- 

 

   Impaired Loans
At December 31, 2016
   Recorded
Investment
  Unpaid
Principal
Balance
  Related
Allowance
   (In thousands)
Impaired loans with no related allowance recorded:               
Commercial  $1,234   $1,303   $- 
Commercial real estate   13,233    15,610    - 
Construction   -    -    - 
Residential real estate   1,279    1,309    - 
Consumer installment and other   569    675    - 
                
Impaired loans with an allowance recorded:               
Commercial   10,163    10,172    5,048 
Commercial real estate   -    -    - 
Construction   -    -    - 
Residential real estate   -    -    - 
Consumer installment and other   -    -    - 
                
Total:               
Commercial  $11,397   $11,475   $5,048 
Commercial real estate   13,233    15,610    - 
Construction   -    -    - 
Residential real estate   1,279    1,309    - 
Consumer installment and other   569    675    - 

 

Impaired loans include troubled debt restructured loans. Impaired loans at March 31, 2017, included $12,403 thousand of restructured loans, $5,172 thousand of which were on nonaccrual status. Impaired loans at December 31, 2016, included $12,381 thousand of restructured loans, $5,302 thousand of which were on nonaccrual status.

 

   Impaired Loans
For the Three Months Ended March 31,
   2017  2016
   Average
Recorded
Investment
  Recognized
Interest
Income
  Average
Recorded
Investment
  Recognized
Interest
Income
   (In thousands)
Commercial  $11,292   $118   $13,410   $133 
Commercial real estate   14,500    237    20,849    159 
Construction   -    -    271    - 
Residential real estate   748    4    810    4 
Consumer installment and other   543    7    347    6 
Total  $27,083   $366   $35,687   $302 

 

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 -19- 

 

The following table provides information on troubled debt restructurings:

 

   Troubled Debt Restructurings
At March 31, 2017
   Number of
Contracts
  Pre-Modification
Carrying Value
  Period-End
Carrying Value
  Period-End
Individual
Impairment
Allowance
   ($ in thousands)
Commercial   8   $2,768   $1,468   $107 
Commercial real estate   11    11,576    10,718    - 
Residential real estate   1    241    217    - 
Total   20   $14,585   $12,403   $107 

 

   Troubled Debt Restructurings
At December 31, 2016
   Number of
Contracts
  Pre-Modification
Carrying Value
  Period-End
Carrying Value
  Period-End
Individual
Impairment
Allowance
   ($ in thousands)
Commercial   7   $2,719   $1,489   $113 
Commercial real estate   10    11,257    10,673    - 
Residential real estate   1    241    219    - 
Total   18   $14,217   $12,381   $113 

 

During the three months ended March 31, 2017, the Company modified two loans with a carrying value of $273 thousand that were considered troubled debt restructurings. The two concessions granted in the first quarter 2017 consisted of modifications of payment terms to extend the maturity date to allow for deferred principal repayment and under-market terms. During the three months ended March 31, 2016, the Company modified three loans with a carrying value of $4,757 thousand that were considered troubled debt restructurings. The concessions granted in the first quarter 2016 consisted of two modifications of payment terms to extend the maturity date to allow for deferred principal repayment and under-market terms and one court order requiring under-market terms. There were no chargeoffs related to troubled debt restructurings made during the three months ended March 31, 2017 and March 31, 2016. During the three months ended March 31, 2017 and 2016, no troubled debt restructured loans defaulted within 12 months of the modification date. A troubled debt restructuring is considered to be in default when payments are ninety days or more past due.

 

There were no loans restricted due to collateral requirements at March 31, 2017 and December 31, 2016.

 

There were no loans held for sale at March 31, 2017 and December 31, 2016.

 

At March 31, 2017 and December 31, 2016, the Company held total other real estate owned (OREO) of $2,136 thousand net of reserve of $1,685 thousand and $3,095 thousand net of reserve of $1,816 thousand, respectively, of which $-0-  thousand was foreclosed residential real estate properties or covered OREO at both dates. The amount of consumer mortgage loans outstanding secured by residential real estate properties for which formal foreclosure proceedings were in process was $-0-  thousand at March 31, 2017 and December 31, 2016.

 

Note 5: Concentration of Credit Risk

 

Under the California Financial Code, credit extended to any one person owing to a commercial bank at any one time shall not exceed the following limitations: (a) unsecured loans shall not exceed 15 percent of the sum of the shareholders' equity, allowance for loan losses, capital notes, and debentures of the bank, or (b) secured and unsecured loans in all shall not exceed 25 percent of the sum of the shareholders' equity, allowance for loan losses, capital notes, and debentures of the bank. At March 31, 2017, Westamerica Bank did not have credit extended to any one entity exceeding these limits. At March 31, 2017, Westamerica Bank had 39 lending relationships each with aggregate loans exceeding $5 million. The Company has significant credit arrangements that are secured by real estate collateral. In addition to real estate loans outstanding as disclosed in Note 4, the Company had loan commitments related to real estate loans of $60,831 thousand and $57,721 thousand at March 31, 2017 and December 31, 2016, respectively. The Company requires collateral on all real estate loans with loan-to-value ratios at origination generally no greater than 75% on commercial real estate loans and no greater than 80% on residential real estate loans. At March 31, 2017, Westamerica Bank held corporate bonds in 50 issuing entities that exceeded $5 million for each issuer.

 

 -20- 

 

Note 6: Other Assets

 

Other assets consisted of the following:

 

   At March 31, 2017  At December 31, 2016
   (In thousands)
Cost method equity investments:          
Federal Reserve Bank stock (1)  $14,045   $14,069 
Other investments   201    201 
Total cost method equity investments   14,246    14,270 
Life insurance cash surrender value   52,177    51,535 
Net deferred tax asset   53,518    55,417 
Limited partnership investments   12,141    12,591 
Interest receivable   19,745    21,489 
Prepaid assets   4,997    4,825 
Other assets   8,453    11,597 
Total other assets  $165,277   $171,724 

 

(1)A bank applying for membership in the Federal Reserve System is required to subscribe to stock in the Federal Reserve Bank (FRB) in its district in a sum equal to six percent of the bank’s paid-up capital stock and surplus. One-half of the amount of the bank's subscription shall be paid to the FRB and the remaining half will be subject to call when deemed necessary by the Board of Governors of the Federal Reserve System.

 

The Company invests in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for low-income housing tax credits. At March 31, 2017, this investment totaled $12,141 thousand and $2,299  thousand of this amount represents outstanding equity capital commitments that are included in other liabilities. At December 31, 2016, this investment totaled $12,591 thousand and $2,299  thousand of this amount represented outstanding equity capital commitments. At March 31, 2017, the $2,299 thousand of outstanding equity capital commitments are expected to be paid as follows, $722 thousand in 2020, $131 thousand in 2023, $90 thousand in 2024 and $1,356 thousand in 2025 or thereafter.

 

The amounts recognized in net income for these investments include:

 

   For the Three Months Ended
March 31,
   2017  2016
   (In thousands)
Investment loss included in pre-tax income  $450   $675 
Tax credits recognized in provision for income taxes   463    598 

 

Note 7: Goodwill and Identifiable Intangible Assets

 

The Company has recorded goodwill and other identifiable intangibles associated with purchase business combinations. Goodwill is not amortized, but is evaluated for impairment at least annually. The Company did not recognize impairment during the three months ended March 31, 2017 and year ended December 31, 2016. Identifiable intangibles are amortized to their estimated residual values over their expected useful lives. Such lives and residual values are also periodically reassessed to determine if any amortization period adjustments are indicated. During the three months ended March 31, 2017 and year ended December 31, 2016, no such adjustments were recorded.

 

 -21- 

 

The carrying values of goodwill were:

 

   At March 31, 2017  At December 31, 2016
   (In thousands)
Goodwill  $121,673   $121,673 

 

The gross carrying amount of identifiable intangible assets and accumulated amortization was:

 

   At March 31, 2017  At December 31, 2016
   Gross
Carrying
Amount
  Accumulated
Amortization
  Gross
Carrying
Amount
  Accumulated
Amortization
   (In thousands)
Core Deposit Intangibles  $56,808   $(50,827)  $56,808   $(50,074)
Merchant Draft Processing Intangible   10,300    (10,154)   10,300    (10,107)
Total Identifiable Intangible Assets  $67,108   $(60,981)  $67,108   $(60,181)

 

As of March 31, 2017, the current period and estimated future amortization expense for identifiable intangible assets was:

 

   Core
Deposit
Intangibles
  Merchant
Draft
Processing
Intangible
  Total
   (In thousands)
For the Three Months ended March 31, 2017 (actual)  $753   $47   $800 
Estimate for the remainder of year ending December 31, 2017   2,160    117    2,277 
Estimate for year ending December 31, 2018   1,892    29    1,921 
2019   538    -    538 
2020   287    -    287 
2021   269    -    269 
2022   252    -    252 

 

Note 8: Deposits and Borrowed Funds

 

The following table provides additional detail regarding deposits.

 

   Deposits
   At March 31, 2017  At December 31, 2016
   (In thousands)
Noninterest-bearing  $2,046,390   $2,089,443 
Interest-bearing:          
Transaction   905,588    865,701 
Savings   1,494,854    1,493,427 
Time deposits less than $100 thousand   129,889    133,712 
Time deposits $100 thousand through $250 thousand   83,636    84,925 
Time deposits more than $250 thousand   37,616    37,533 
Total deposits  $4,697,973   $4,704,741 

 

Demand deposit overdrafts of $806  thousand and $2,679 thousand were included as loan balances at March 31, 2017 and December 31, 2016, respectively. Interest expense for aggregate time deposits with individual account balances in excess of $100 thousand was $106 thousand in the first quarter 2017 and $137 thousand in the first quarter 2016.

 

 -22- 

 

The following table provides additional detail regarding short-term borrowed funds.

 

   Repurchase Agreements (Sweep)
Accounted for as Secured Borrowings
   Remaining Contractual Maturity of the Agreements
Overnight and Continuous
   At March 31, 2017  At December 31, 2016
Repurchase agreements:  (In thousands)
Collateral securing borrowings:          
Securities of U.S. Government sponsored entities  $74,205   $74,031 
Agency residential MBS   62,217    63,277 
Corporate securities   90,598    90,554 
Total collateral carrying value  $227,020   $227,862 
Total short-term borrowed funds  $73,611   $59,078 

 

Note 9: Fair Value Measurements

 

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Available for sale investment securities are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as other real estate owned, impaired loans, certain loans held for investment, investment securities held to maturity, and other assets. These nonrecurring fair value adjustments typically involve the lower-of-cost or fair-value accounting of individual assets.

 

In accordance with the Fair Value Measurement and Disclosure topic of the Codification, the Company bases its fair values on the price that would be received to sell an asset or paid to transfer a liability in the principal market or most advantageous market for an asset or liability in an orderly transaction between market participants on the measurement date under current market conditions. A fair value measurement reflects all of the assumptions that market participants would use in pricing the asset or liability, including assumptions about the risk inherent in a particular valuation technique, the effect of a restriction on the sale or use of an asset, and the risk of nonperformance.

 

The Company groups its assets and liabilities measured at fair value into a three-level hierarchy, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. When the valuation assumptions used to measure the fair value of the asset or liability are categorized within different levels of the fair value hierarchy, the asset or liability is categorized in its entirety within the lowest level of the hierarchy. These levels are:

 

Level 1 – Valuation is based upon quoted prices for identical instruments traded in active exchange markets, such as the New York Stock Exchange. Level 1 includes U.S. Treasury and equity securities, which are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

 

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 2 includes federal agency securities, mortgage-backed securities, corporate securities, asset-backed securities, and municipal bonds.

 

Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

 

The Company relies on independent vendor pricing services to measure fair value for investment securities available for sale and investment securities held to maturity. The Company employs three pricing services. To validate the pricing of these vendors, the Company compares vendors’ pricing for each of the securities for consistency; significant pricing differences, if any, are evaluated using all available independent quotes with the quote closely affecting the market generally used as the fair value estimate. In addition, the Company conducts “other than temporary impairment (OTTI)” analysis on a quarterly basis; securities selected for OTTI analysis include all securities at a market price below 95 percent of par value. As with any valuation technique used to estimate fair value, changes in underlying assumptions used could significantly affect the results of current and future values. Accordingly, these fair value estimates may not be realized in an actual sale of the securities.

 

 -23- 

 

The Company regularly reviews the valuation techniques and assumptions used by its vendors and determines which valuation techniques are utilized based on observable market inputs for the type of securities being measured. The Company uses the information to determine the placement in the fair value hierarchy as level 1, 2 or 3. When the Company changes its valuation assumptions for measuring financial assets and financial liabilities at fair value, either due to changes in current market conditions or other factors, or reevaluates the valuation techniques and assumptions used by its vendors, it may need to transfer those assets or liabilities to another level in the hierarchy based on the new information. The Company recognizes these transfers at the end of the reporting period that the transfers occur. For the three months ended March 31, 2017 and year ended December 31, 2016, there were no transfers in or out of levels 1, 2 or 3.

 

Assets Recorded at Fair Value on a Recurring Basis

 

The tables below present assets measured at fair value on a recurring basis on the dates indicated.

 

   At March 31, 2017
   Fair Value  Quoted Prices in Active Markets for Identical Assets
(Level 1)
  Significant Other Observable Inputs
(Level 2)
  Significant Unobservable Inputs
(Level 3)
   (In thousands)
Securities of U.S. Government sponsored entities  $138,937   $-   $138,937   $- 
Agency residential MBS   722,204    -    722,204    - 
Non-agency residential MBS   196    -    196    - 
Non-agency commercial MBS   1,939    -    1,939    - 
Obligations of states and political subdivisions   178,871    -    178,871    - 
Asset-backed securities   355    -    355    - 
FHLMC and FNMA stock   9,400    12    9,388    - 
Corporate securities   839,136    -    839,136    - 
Other securities   2,271    461    1,810    - 
Total securities available for sale  $1,893,309   $473   $1,892,836   $- 

 

   At December 31, 2016
   Fair Value  Quoted Prices in Active Markets for Identical Assets
(Level 1)
  Significant Other Observable Inputs
(Level 2)
  Significant Unobservable Inputs
(Level 3)
   (In thousands)
Securities of U.S. Government sponsored entities  $138,660   $-   $138,660   $- 
Agency residential MBS   691,499    -    691,499    - 
Non-agency residential MBS   271    -    271    - 
Non-agency commercial MBS   2,025    -    2,025    - 
Obligations of states and political subdivisions   183,411    -    183,411    - 
Asset-backed securities   695    -    695    - 
FHLMC and FNMA stock   10,869    17    10,852    - 
Corporate securities   860,857    -    860,857    - 
Other securities   2,471    656    1,815    - 
Total securities available for sale  $1,890,758   $673   $1,890,085   $- 

 

 -24- 

 

Assets Recorded at Fair Value on a Nonrecurring Basis

 

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower-of-cost or fair-value accounting of individual assets. For assets measured at fair value on a nonrecurring basis that were recorded in the balance sheet at March 31, 2017 and December 31, 2016, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related assets at period end.

 

               For the
Three Months Ended
   At March 31, 2017  March 31, 2017
   Carrying Value  Level 1  Level 2  Level 3  Total Losses
   (In thousands)
Other real estate owned  $2,136   $-   $-   $2,136   $- 
Impaired loans   9,400    -    -    9,400    - 
Total assets measured at fair value on a nonrecurring basis  $11,536   $-   $-   $11,536   $- 

 

               For the
Year Ended
   At December 31, 2016  December 31, 2016
   Carrying Value  Level 1  Level 2  Level 3  Total Losses
   (In thousands)   
Other real estate owned  $3,095   $-   $-   $3,095   $(705)
Impaired loans   9,525    -    -    9,525    - 
Total assets measured at fair value on a nonrecurring basis  $12,620   $-   $-   $12,620   $(705)

 

Level 3 – Valuation is based upon present value of expected future cash flows, independent market prices, estimated liquidation values of loan collateral or appraised value of the collateral as determined by third-party independent appraisers, less 10% for selling costs, generally. Level 3 includes other real estate owned that has been measured at fair value upon transfer to foreclosed assets and impaired loans collateralized by real property and other business asset collateral where a specific reserve has been established or a chargeoff has been recorded. Losses on other real estate owned represent losses recognized in earnings during the period subsequent to its initial classification as foreclosed assets. The unobservable inputs and qualitative information about the unobservable inputs are not presented due to the unavailability from third party evaluators.

 

Disclosures about Fair Value of Financial Instruments

 

The following section describes the valuation methodologies used by the Company for estimating fair value of financial instruments not recorded at fair value in the balance sheet.

 

Cash and Due from Banks Cash and due from banks represent U.S. dollar denominated coin and currency, deposits at the Federal Reserve Bank and correspondent banks, and amounts being settled with other banks to complete the processing of customers’ daily transactions. Collectively, the Federal Reserve Bank and financial institutions operate in a market in which cash and due from banks transactions are processed continuously in significant daily volumes honoring the face value of the U.S. dollar.

 

Investment Securities Held to Maturity The fair values of investment securities were estimated using quoted prices as described above for Level 2 valuation.

 

Loans Loans were separated into two groups for valuation. Variable rate loans, except for those described below, which reprice frequently with changes in market rates were valued using historical cost. Fixed rate loans and variable rate loans that have reached their minimum contractual interest rates were valued by discounting the future cash flows expected to be received from the loans using current interest rates charged on loans with similar characteristics. Additionally, the allowance for loan losses of $24,919 thousand at March 31, 2017 and $25,954 thousand at December 31, 2016 was applied against the estimated fair values to recognize estimated future defaults of contractual cash flows. The Company does not consider these values to be a liquidation price for the loans.

 

 -25- 

 

Deposit Liabilities Deposits with no stated maturity such as checking accounts, savings accounts and money market accounts can be readily converted to cash or used to settle transactions at face value through the broad financial system operated by the Federal Reserve Bank and financial institutions. The fair value of deposits with no stated maturity is equal to the amount payable on demand. The fair values of time deposits were estimated by discounting estimated future contractual cash flows using current market rates for financial instruments with similar characteristics.

 

Short-Term Borrowed Funds The carrying amount of securities sold under agreement to repurchase and other short-term borrowed funds approximate fair value due to the relatively short period of time between their origination and their expected realization.

 

The table below is a summary of fair value estimates for financial instruments and the level of the fair value hierarchy within which the fair value measurements are categorized, excluding financial instruments recorded at fair value on a recurring basis. The values assigned do not necessarily represent amounts which ultimately may be realized for assets or paid to settle liabilities. In addition, these values do not give effect to adjustments to fair value which may occur when financial instruments are sold or settled in larger quantities. The carrying amounts in the following table are recorded in the balance sheet under the indicated captions.

 

The Company has not included assets and liabilities that are not financial instruments, such as goodwill, long-term relationships with deposit, merchant processing and trust customers, other purchased intangibles, premises and equipment, deferred taxes and other assets and liabilities. The total estimated fair values do not represent, and should not be construed to represent, the underlying value of the Company.

 

   At March 31, 2017
   Carrying Amount  Estimated Fair Value  Quoted Prices in Active Markets for Identical Assets
(Level 1)
  Significant Other Observable Inputs
(Level 2 )
  Significant Unobservable Inputs
(Level 3 )
Financial Assets:  (In thousands)
Cash and due from banks  $546,815   $546,815   $546,815   $-   $- 
Investment securities held to maturity   1,298,414    1,296,738    -    1,296,738    - 
Loans   1,326,171    1,332,148    -    -    1,332,148 
                          
Financial Liabilities:                         
Deposits  $4,697,973    4,695,676   $-   $4,446,832    248,844 
Short-term borrowed funds   73,611    73,611    -    73,611    - 

 

   At December 31, 2016
   Carrying Amount  Estimated Fair Value  Quoted Prices in Active Markets for Identical Assets
(Level 1)
  Significant Other Observable Inputs
(Level 2 )
  Significant Unobservable Inputs
(Level 3 )
Financial Assets:  (In thousands)
Cash and due from banks  $462,271   $462,271   $462,271   $-   $- 
Investment securities held to maturity   1,346,312    1,340,741    -    1,340,741    - 
Loans   1,326,757    1,337,774    -    -    1,337,774 
                          
Financial Liabilities:                         
Deposits  $4,704,741   $4,702,797   $-   $4,448,571   $254,226 
Short-term borrowed funds   59,078    59,078    -    59,078    - 

 

The majority of the Company’s standby letters of credit and other commitments to extend credit carry current market interest rates if converted to loans. No premium or discount was ascribed to these commitments because virtually all funding would be at current market rates.

 

 -26- 

 

Note 10: Commitments and Contingent Liabilities

 

Loan commitments are agreements to lend to a customer provided there is no violation of any condition established in the agreement. Commitments generally have fixed expiration dates or other termination clauses. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future funding requirements. Loan commitments are subject to the Company’s normal credit policies and collateral requirements. Unfunded loan commitments were $305,544 thousand and $304,508 thousand at March 31, 2017 and December 31, 2016, respectively. Standby letters of credit commit the Company to make payments on behalf of customers when certain specified future events occur. Standby letters of credit are primarily issued to support customers’ short-term financing requirements and must meet the Company’s normal credit policies and collateral requirements. Financial and performance standby letters of credit outstanding totaled $19,762 thousand and $21,732 thousand at March 31, 2017 and December 31, 2016, respectively. The Company also had commitments for commercial and similar letters of credit of $-0- thousand at March 31, 2017 and December 31, 2016. The Company had a reserve for unfunded commitments of $2,308 thousand at March 31, 2017 and $2,408 thousand at December 31, 2016, included in other liabilities.

 

Due to the nature of its business, the Company is subject to various threatened or filed legal cases. Based on the advice of legal counsel, the Company does not expect such cases will have a material, adverse effect on its financial position or results of operations. Legal liabilities are accrued when obligations become probable and the amount can be reasonably estimated.

 

Note 11: Earnings Per Common Share

 

The table below shows earnings per common share and diluted earnings per common share. Basic earnings per common share are computed by dividing net income by the average number of common shares outstanding during the period. Diluted earnings per common share are computed by dividing net income by the average number of common shares outstanding during the period plus the impact of common stock equivalents.

 

 
 
 
 
For the Three Months Ended
March 31,
   2017  2016
   (In thousands, except per share data)
Net income (numerator)  $15,049   $14,226 
Basic earnings per common share          
Weighted average number of common shares outstanding - basic (denominator)   26,171    25,445 
Basic earnings per common share  $0.58   $0.56 
Diluted earnings per common share          
Weighted average number of common shares outstanding - basic   26,171    25,445 
Add common stock equivalents for options   158    23 
Weighted average number of common shares outstanding - diluted (denominator)   26,329    25,468 
Diluted earnings per common share  $0.57   $0.56 

 

For the three months ended March 31, 2017 and 2016, options to purchase 299 thousand and 1,297 thousand shares of common stock, respectively, were outstanding but not included in the computation of diluted net income per share because the option exercise price exceeded the fair value of the stock such that their inclusion would have had an anti-dilutive effect.

 

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 -27- 

 

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

 

WESTAMERICA BANCORPORATION

FINANCIAL SUMMARY

 

   For the Three Months Ended
   March 31,  March 31,  December 31,
   2017  2016  2016
   (In thousands, except per share data)
Net Interest and Fee Income (FTE)(1)  $36,030   $36,447   $35,959 
Provision for Loan Losses   -    -    - 
Noninterest Income   11,657    11,729    11,545 
Noninterest Expense   24,615    25,858    24,577 
Income Before Income Taxes (FTE)(1)   23,072    22,318    22,927 
Provision for Income Taxes (FTE)(1)   8,023    8,092    8,474 
Net Income  $15,049   $14,226   $14,453 
                
Average Common Shares Outstanding   26,171    25,445    25,773 
Average Diluted Common Shares Outstanding   26,329    25,468    25,925 
Common Shares Outstanding at Period End   26,283    25,438    25,907 
                
Per Common Share:               
Basic Earnings  $0.58   $0.56   $0.56 
Diluted Earnings   0.57    0.56    0.56 
Book Value Per Common Share  $22.25   $21.19   $21.67 
                
Financial Ratios:               
Return On Assets   1.13%   1.11%   1.07%
Return On Common Equity   10.48%   10.85%   10.30%
Net Interest Margin (FTE)(1)   3.14%   3.34%   3.15%
Net Loan Losses to Average Loans   0.31%   0.08%   0.12%
Efficiency Ratio(2)   51.6%   53.7%   51.7%
                
Average Balances:               
Assets  $5,395,783   $5,174,804   $5,370,412 
Earning Assets   4,620,001    4,381,423    4,561,619 
Loans   1,355,250    1,500,616    1,356,350 
Deposits   4,692,746    4,537,548    4,702,129 
Shareholders' Equity   582,384    527,177    558,057 
                
Period End Balances:               
Assets  $5,395,947   $5,199,868   $5,366,083 
Earning Assets   4,542,813    4,417,305    4,589,781 
Loans   1,351,090    1,473,196    1,352,711 
Deposits   4,697,973    4,516,750    4,704,741 
Shareholders' Equity   584,888    538,973    561,367 
                
Capital Ratios at Period End:               
Total Risk Based Capital   16.91%   13.51%   15.95%
Tangible Equity to Tangible Assets   8.68%   8.04%   8.26%
                
Dividends Paid Per Common Share  $0.39   $0.39   $0.39 
Common Dividend Payout Ratio   68%   70%   70%

 

The above financial summary has been derived from the Company's unaudited consolidated financial statements. This information should be read in conjunction with those statements, notes and the other information included elsewhere herein. Percentages under the heading "Financial Ratios" are annualized with the exception of the efficiency ratio.

 

(1)Yields on securities and certain loans have been adjusted upward to an FTE basis in order to reflect the effect of income which is exempt from federal income taxation at the current statutory tax rate.
(2)The efficiency ratio is defined as noninterest expense divided by total revenue (net interest income on an FTE basis and noninterest income).

 

 -28- 

 

Financial Overview

 

Westamerica Bancorporation and subsidiaries’ (the Company”) principal source of revenue is net interest and loan fee income, which represents interest and fees earned on loans and investment securities (“earning assets”) reduced by interest paid on deposits and other borrowings (“interest-bearing liabilities”). Market interest rates declined considerably following the recession of 2008 and 2009. Interest rates remained historically low through 2016 as the Federal Open Market Committee’s (“FOMC”) monetary policy was highly accommodative. During this period, Management avoided originating long-dated, low-yielding loans given the potential impact of such assets on forward earning potential; as a result, loans declined and investment securities increased. The changing composition of the earning assets and low market interest rates has pressured the net interest margin to lower levels. The FOMC’s first post-recession increase in the federal funds rate occurred in December 2015, although longer-term rates declined. The FOMC’s second and third post-recession increases in the federal funds rate occurred in December 2016 and March 2017, and longer-term rates increased as well. The recent increase in rates has resulted in competitive loan yields, which are more appealing from a profitability perspective, in Management’s opinion. Total average loan volumes were stable during the first quarter 2017.

 

The funding of the Company’s earning assets is primarily customer deposits. The Company’s long-term strategy includes maximizing checking and savings deposits as these types of deposits are lower-cost and less sensitive to changes in interest rates compared to time deposits. The first quarter 2017 average volume of checking and savings deposits was 95 percent of average total deposits.

 

Credit quality improved during the first quarter 2017 with nonperforming assets declining $3 million to $9 million at March 31, 2017. The Company did not recognize a provision for loan losses in the first quarter 2017.

 

The Company’s long-term strategy also includes controlling operating costs, or “noninterest expense.” Noninterest expense of $24.6 million for the first quarter 2017 was $1.3 million lower than the comparable first quarter 2016.

 

The Company presents its net interest margin and net interest income on a FTE basis using the current statutory federal tax rate. Management believes the FTE basis is valuable to the reader because the Company’s loan and investment securities portfolios contain a relatively large portion of municipal loans and securities that are federally tax exempt. The Company’s tax exempt loans and securities composition may not be similar to that of other banks, therefore in order to reflect the impact of the federally tax exempt loans and securities on the net interest margin and net interest income for comparability with other banks, the Company presents its net interest margin and net interest income on a FTE basis.

 

The Company’s significant accounting policies (see Note 1 (“Summary of Significant Accounting Policies”) to Financial Statements in the Company’s 2016 Form 10-K) are fundamental to understanding the Company’s results of operations and financial condition. The Company adopted the FASB ASU 2016-09, Improvements to Employee Share-Based Payment Accounting effective January 1, 2017.

 

The Company reported first quarter 2017 net income of $15.0 million or $0.57 diluted earnings per common share. First quarter 2017 results reflect the Company’s prospective adoption of ASU 2016-09; first quarter 2017 diluted earnings per common share measured $0.02 higher than would have been measured under accounting standards applied in 2016. First quarter 2017 results compare to net income of $14.2 million or $0.56 diluted earnings per common share for the first quarter 2016 and $14.5 million or $0.56 diluted earnings per common share for the fourth quarter 2016.

 

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 -29- 

 

Net Income

 

Following is a summary of the components of net income for the periods indicated:

 

   For the Three Months Ended
   March 31,  December 31,
   2017  2016  2016
   (In thousands, except per share data)
Net interest and loan fee income (FTE)  $36,030   $36,447   $35,959 
Provision for loan losses   -    -    - 
Noninterest income   11,657    11,729    11,545 
Noninterest expense   24,615    25,858    24,577 
Income  before taxes (FTE)   23,072    22,318    22,927 
Income tax provision (FTE)   8,023    8,092    8,474 
Net income  $15,049   $14,226   $14,453 
                
Average diluted common shares   26,329    25,468    25,925 
Diluted earnings per common share  $0.57   $0.56   $0.56 
                
Average total assets  $5,395,783   $5,174,804   $5,370,412 
Net income to average total assets (annualized)   1.13%   1.11%   1.07%
Net income to average common shareholders' equity (annualized)   10.48%   10.85%   10.30%

 

Net income for the first quarter of 2017 was $823 thousand more than the same quarter of 2016. Net interest and loan fee income (FTE) decreased in the first quarter 2017 compared with first quarter 2016 mostly attributable to lower average balances of loans and lower yield on interest-earning assets, partially offset by higher average balances of investments and lower average balances of higher-costing time deposits. The provision for loan losses remained zero, reflecting Management's evaluation of losses inherent in the loan portfolio. Noninterest expense decreased mostly due to reductions in professional fees, courier costs, postage, correspondent service charges, OREO expense, insurance premiums, limited partnership operating losses and intangible amortization. The effective tax rate decreased to 34.8% in the first quarter 2017 from 36.3% in the first quarter 2016 primarily due to the adoption of ASU 2016-09.

 

Comparing the first quarter of 2017 with the fourth quarter of 2016, net income increased $596 thousand due to lower income tax provision (FTE) and higher noninterest income. The provision for loan losses remained zero, reflecting Management's evaluation of losses inherent in the loan portfolio. Noninterest income increased primarily due to higher merchant credit card fees.

 

Net Interest and Loan Fee Income (FTE)

 

Following is a summary of the components of net interest and loan fee income (FTE) for the periods indicated:

 

   For the Three Months Ended
   March 31,  December 31,
   2017  2016  2016
   (In thousands)
Interest and loan fee income  $33,324   $33,647   $33,209 
Interest expense   480    552    500 
FTE adjustment   3,186    3,352    3,250 
Net interest and loan fee income (FTE)  $36,030   $36,447   $35,959 
                
Average earning assets  $4,620,001   $4,381,423   $4,561,619 
Net interest margin (FTE) (annualized)   3.14%   3.34%   3.15%

 

Net interest and fee income (FTE) decreased during the first quarter 2017 by $417 thousand from the same period in 2016, mainly due to lower average balances of loans (down $145 million) and lower yield on interest-earning assets, partially offset by higher average balances of investments (up $384 million) and lower average balances of higher-costing time deposits (down $30 million).

 

 -30- 

 

Comparing the first quarter 2017 with the fourth quarter 2016, net interest and fee income (FTE) increased $71 thousand due to higher average balances of investments (up $59 million) and higher yield on those investments (up 0.01%), offset by lower net yield on loans (down 0.04%).

 

Yields on interest-earning assets declined due to relatively low interest rates prevailing in the market. The annualized net interest margin (FTE) was 3.14% in the first quarter 2017 compared with 3.34% in the first quarter 2016 and 3.15% in the fourth quarter 2016. The volume of older-dated higher-yielding loans declined due to principal maturities and paydowns. The Company, in anticipation of rising interest rates, has been purchasing shorter-duration investment securities with lower yields than longer-duration securities to increase liquidity. The Company’s high levels of liquidity will provide an opportunity to invest in higher yielding assets assuming market interest rates increase to levels higher than yields on maturing securities and security paydowns.

 

The Company has been replacing higher-cost funding sources with low-cost deposits and interest expense has declined to offset some of the decline in interest income. Average balances of time deposits declined $30 million from the first quarter 2016 to first quarter 2017 while lower-cost checking and savings deposits grew 4% in the same period. Average balances of checking and saving deposits accounted for 94.6% of average total deposits in the first quarter 2017 compared with 93.7% in the first quarter 2016 and 94.5% in the fourth quarter 2016.

 

Net Interest Margin (FTE)

 

The following summarizes the components of the Company's net interest margin for the periods indicated (percentages are annualized.):

 

   For the Three Months Ended
   March 31,  December 31,
   2017  2016  2016
          
Yield on earning assets (FTE)   3.18%   3.39%   3.19%
Rate paid on interest-bearing liabilities   0.07%   0.09%   0.07%
Net interest spread (FTE)   3.11%   3.30%   3.12%
Impact of noninterest-bearing funds   0.03%   0.04%   0.03%
Net interest margin (FTE)   3.14%   3.34%   3.15%

 

During 2016 and through the first quarter 2017, the net interest margin (FTE) was affected by historically low market interest rates. The changing composition of interest-earning assets and low market rates has pressured the net interest margin. Rates on interest-bearing liabilities were kept low by reducing the volume of higher-cost time deposits and increasing balances of checking and savings deposits, which earn relatively low interest rates and are less volatile than time deposits during periods of rising market interest rates.

 

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 -31- 

 

Summary of Average Balances, Yields/Rates and Interest Differential

 

The following tables present information regarding the consolidated average assets, liabilities and shareholders’ equity, the amounts of interest income earned from average interest earning assets and the resulting yields, and the amounts of interest expense incurred on average interest-bearing liabilities and the resulting rates. Average loan balances include nonperforming loans. Interest income includes reversal of previously accrued interest on loans placed on non-accrual status during the period and proceeds from loans on nonaccrual status only to the extent cash payments have been received and applied as interest income and accretion of purchased loan discounts. Yields on tax-exempt securities and loans have been adjusted upward to reflect the effect of income exempt from federal income taxation at the current statutory tax rate. Yields, rates and interest margins are annualized.

 

Distribution of Assets, Liabilities & Shareholders’ Equity and Yields, Rates & Interest Margin

 

   For the Three Months Ended March 31, 2017
      Interest   
   Average  Income/  Yields/
   Balance  Expense  Rates
   ($ in thousands)
Assets         
Investment securities:               
Taxable  $2,433,669   $12,147    2.00%
Tax-exempt (1)   831,082    8,294    3.99%
Total investments (1)   3,264,751    20,441    2.50%
Loans:               
Taxable   1,290,093    15,243    4.79%
Tax-exempt (1)   65,157    826    5.14%
Total loans (1)   1,355,250    16,069    4.81%
Total Interest-earning assets (1)   4,620,001    36,510    3.18%
Other assets   775,782           
Total assets  $5,395,783           
                
Liabilities and shareholders' equity               
Noninterest-bearing demand  $2,056,858   $-    -%
Savings and interest-bearing transaction   2,382,348    280    0.05%
Time less than $100,000   141,400    83    0.24%
Time $100,000 or more   112,140    106    0.38%
Total interest-bearing deposits   2,635,888    469    0.07%
Short-term borrowed funds   68,584    11    0.06%
Total interest-bearing liabilities   2,704,472    480    0.07%
Other liabilities   52,069           
Shareholders' equity   582,384           
Total liabilities and shareholders' equity  $5,395,783           
Net interest spread (1) (2)             3.11%
Net interest and fee income and interest margin (1) (3)       $36,030    3.14%

 

(1)Amounts calculated on an FTE basis using the current statutory federal tax rate.
(2)Net interest spread represents the average yield earned on interest-earning assets less the average rate incurred on interest-bearing liabilities.
(3)Net interest margin is computed by calculating the difference between interest income and expense, divided by the average balance of interest-earning assets. The net interest margin is greater than the net interest spread due to the benefit of noninterest-bearing demand deposits.

 

 -32- 

 

Distribution of Assets, Liabilities & Shareholders’ Equity and Yields, Rates & Interest Margin

 

   For the Three Months Ended March 31, 2016
      Interest   
   Average  Income/  Yields/
   Balance  Expense  Rates
   ($ in thousands)
Assets         
Investment securities:               
Taxable  $2,046,547   $9,674    1.89%
Tax-exempt (1)   834,260    8,636    4.14%
Total investments (1)   2,880,807    18,310    2.54%
Loans:               
Taxable   1,429,106    17,726    4.99%
Tax-exempt (1)   71,510    963    5.41%
Total loans (1)   1,500,616    18,689    5.01%
Total Interest-earning assets (1)   4,381,423    36,999    3.39%
Other assets   793,381           
Total assets  $5,174,804           
                
Liabilities and shareholders' equity               
Noninterest-bearing demand  $1,993,986   $-    -%
Savings and interest-bearing transaction   2,259,681    293    0.05%
Time less than $100,000   160,190    113    0.28%
Time $100,000 or more   123,691    137    0.44%
Total interest-bearing deposits   2,543,562    543    0.09%
Short-term borrowed funds   57,846    9    0.07%
Total interest-bearing liabilities   2,601,408    552    0.09%
Other liabilities   52,233           
Shareholders' equity   527,177           
Total liabilities and shareholders' equity  $5,174,804           
Net interest spread (1) (2)             3.30%
Net interest and fee income and interest margin (1) (3)       $36,447    3.34%

 

(1)Amounts calculated on an FTE basis using the current statutory federal tax rate.
(2)Net interest spread represents the average yield earned on interest-earning assets less the average rate incurred on interest-bearing liabilities.
(3)Net interest margin is computed by calculating the difference between interest income and expense, divided by the average balance of interest-earning assets. The net interest margin is greater than the net interest spread due to the benefit of noninterest-bearing demand deposits.

 

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 -33- 

 

Distribution of Assets, Liabilities & Shareholders’ Equity and Yields, Rates & Interest Margin

 

   For the Three Months Ended December 31, 2016
      Interest   
   Average  Income/  Yields/
   Balance  Expense  Rates
   ($ in thousands)
Assets         
Investment securities:               
Taxable  $2,351,530   $11,462    1.95%
Tax-exempt (1)   853,739    8,471    3.97%
Total investments (1)   3,205,269    19,933    2.49%
Loans:               
Taxable   1,290,372    15,693    4.84%
Tax-exempt (1)   65,978    833    5.02%
Total loans (1)   1,356,350    16,526    4.85%
Total interest-earning assets (1)   4,561,619    36,459    3.19%
Other assets   808,793           
Total assets  $5,370,412           
                
Liabilities and shareholders' equity               
Deposits:               
Noninterest-bearing demand  $2,077,213   $-    -%
Savings and interest-bearing transaction   2,364,695    288    0.05%
Time less than $100,000   146,440    90    0.24%
Time $100,000 or more   113,781    113    0.40%
Total interest-bearing deposits   2,624,916    491    0.07%
Short-term borrowed funds   56,669    9    0.06%
Total interest-bearing liabilities   2,681,585    500    0.07%
Other liabilities   53,557           
Shareholders' equity   558,057           
Total liabilities and shareholders' equity  $5,370,412           
Net interest spread (1) (2)             3.12%
Net interest and fee income and interest margin (1) (3)       $35,959    3.15%

 

(1)Amounts calculated on an FTE basis using the current statutory federal tax rate.
(2)Net interest spread represents the average yield earned on interest-earning assets less the average rate incurred on interest-bearing liabilities.
(3)Net interest margin is computed by calculating the difference between interest income and expense, divided by the average balance of interest-earning assets. The net interest margin is greater than the net interest spread due to the benefit of noninterest-bearing demand deposits.

 

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 -34- 

 

Summary of Changes in Interest Income and Expense due to Changes in Average Asset & Liability Balances and Yields Earned & Rates Paid

 

The following tables set forth a summary of the changes in interest income and interest expense due to changes in average assets and liability balances (volume) and changes in average interest yields/rates for the periods indicated. Changes not solely attributable to volume or yields/rates have been allocated in proportion to the respective volume and yield/rate components.

 

Summary of Changes in Interest Income and Expense

 

   For the Three Months Ended March 31, 2017
   Compared with
   For the Three Months Ended March 31, 2016
   Volume  Yield/Rate  Total
   (In thousands)
Increase (decrease) in interest and loan fee income:               
Investment securities:               
Taxable  $1,830   $643   $2,473 
Tax-exempt (1)   (33)   (309)   (342)
Total investments (1)   1,797    334    2,131 
Loans:               
Taxable   (1,697)   (786)   (2,483)
Tax-exempt (1)   (84)   (53)   (137)
Total loans (1)   (1,781)   (839)   (2,620)
Total increase (decrease) in interest and loan fee income (1)   16    (505)   (489)
Increase (decrease) in interest expense:               
Deposits:               
Savings and interest-bearing transaction   16    (29)   (13)
Time less than $100,000   (13)   (17)   (30)
Time $100,000 or more   (13)   (18)   (31)
Total interest-bearing deposits   (10)   (64)   (74)
Short-term borrowed funds   3    (1)   2 
Total decrease in interest expense   (7)   (65)   (72)
Increase (decrease) in net interest and loan fee income (1)  $23   $(440)  $(417)

 

(1)Amounts calculated on an FTE basis using the current statutory federal tax rate.

 

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 -35- 

 

Summary of Changes in Interest Income and Expense

 

   For the Three Months Ended March 31, 2017
   Compared with
   For the Three Months Ended December 31, 2016
   Volume  Yield/Rate  Total
   (In thousands)
Increase (decrease) in interest and loan fee income:               
Investment securities:               
Taxable  $400   $285   $685 
Tax-exempt (1)   (225)   48    (177)
Total investments (1)   175    333    508 
Loans:               
Taxable   (10)   (440)   (450)
Tax-exempt (1)   (16)   9    (7)
Total loans (1)   (26)   (431)   (457)
Total increase (decrease) in interest and loan fee income (1)   149    (98)   51 
Increase (decrease) in interest expense:               
Deposits:               
Savings and interest-bearing transaction   0    (8)   (8)
Time less than $100,000   (4)   (3)   (7)
Time $100,000 or more   (2)   (5)   (7)
Total interest-bearing deposits   (6)   (16)   (22)
Short-term borrowed funds   2    -    2 
Total decrease in interest expense   (4)   (16)   (20)
Increase (decrease) in net interest and loan fee income (1)  $153   $(82)  $71 

 

(1)Amounts calculated on an FTE basis using the current statutory federal tax rate.

 

Provision for Loan Losses

 

The Company manages credit costs by consistently enforcing conservative underwriting and administration procedures and aggressively pursuing collection efforts with debtors experiencing financial difficulties. The provision for loan losses reflects Management's assessment of credit risk in the loan portfolio during each of the periods presented.

 

The Company provided no provision for loan losses in the first quarter of 2017 and the first and fourth quarters of 2016. Management’s evaluation of credit quality includes originated and purchased loans. Classified loans declined $26.8 million (which included nonperforming loans of $6.7 million) during the period from March 31, 2016 to March 31, 2017. This development was reflected in Management’s evaluation of credit quality, the level of the provision for loan losses, and the adequacy of the allowance for loan losses at March 31, 2017. Management’s evaluation of credit quality includes originated and purchased loans. The Company recorded purchased loans at estimated fair value upon the acquisition dates. Such estimated fair values were recognized for individual loans, although small balance homogenous loans were pooled for valuation purposes. The valuation discounts recorded for purchased loans included Management’s assessment of the risk of principal loss under economic and borrower conditions prevailing on the dates of purchase. The purchased County Bank loans secured by single-family residential real estate are “covered” through February 6, 2019 by loss-sharing agreements the Company entered with the FDIC which mitigates losses during the term of the agreements. Any deterioration in estimated value related to principal loss subsequent to the acquisition dates requires additional loss recognition through a provision for loan losses. No assurance can be given future provisions for loan losses related to purchased loans will not be necessary. For further information regarding credit risk, net credit losses and the allowance for loan losses, see the “Loan Portfolio Credit Risk” and “Allowance for Loan Losses” sections of this Report.

 

 -36- 

 

Noninterest Income

 

The following table summarizes the components of noninterest income for the periods indicated.

 

   For the Three Months Ended
   March 31,  December 31,
   2017  2016  2016
   (In thousands)
          
Service charges on deposit accounts  $4,923   $5,248   $5,064 
Merchant processing services   1,875    1,529    1,678 
Debit card fees   1,481    1,516    1,566 
Trust fees   702    661    682 
Other service fees   650    629    620 
ATM processing fees   575    658    551 
Financial services commissions   195    156    157 
Other noninterest income   1,256    1,332    1,227 
Total  $11,657   $11,729   $11,545 

 

Noninterest income for the first quarter 2017 declined by $72 thousand from the same period in 2016. Service charges on deposits decreased $325 thousand due to declines in fees charged on overdrawn and insufficient funds accounts (down $259 thousand) and lower fees on analyzed accounts (down $95 thousand). Merchant processing services fees increased $346 thousand primarily due to increased transaction volumes.

 

In the first quarter 2017, noninterest income increased $112 thousand compared with the fourth quarter 2016 mostly due to a $197 thousand increase in merchant processing services fees primarily due to the improved margin mix of transaction volumes. Service charges on deposits decreased $141 thousand due to declines in fees charged on overdrawn and insufficient funds accounts (down $181 thousand) and lower fees on analyzed accounts (down $48 thousand), partially offset by fee increases and collection of annual IRA account fees.

 

Noninterest Expense

 

The following table summarizes the components of noninterest expense for the periods indicated.

 

   For the Three Months Ended
   March 31,  December 31,
   2017  2016  2016
   (In thousands)
          
Salaries and related benefits  $13,070   $13,117   $12,439 
Occupancy   3,633    3,398    3,570 
Outsourced data processing services   2,139    2,130    2,131 
Furniture and equipment   1,254    1,213    1,290 
Amortization of identifiable intangibles   800    905    863 
Professional fees   611    732    797 
Courier service   421    545    494 
Other real estate owned   (40)   111    7 
Other noninterest expense   2,727    3,707    2,986 
Total  $24,615   $25,858   $24,577 

 

Noninterest expense decreased $1.3 million in the first quarter 2017 compared with the same period in 2016 mostly due to reductions in professional fees, courier costs, OREO expense, intangible amortization and other noninterest expense. Other noninterest expense decreased $980 thousand primarily due to decreases in insurance premiums, correspondent bank service charges, limited partnership operating losses, postage and amortization of intangibles. Amortization of intangibles decreased $105 thousand as assets are amortized on a declining balance method. Professional fees decreased $121 thousand due to lower legal fees associated with nonperforming assets. Expenses of other real estate owned decreased in the first quarter 2017 due to gains on sale of disposition of foreclosed assets and because first quarter 2016 included net writedowns. Occupancy expense increased $235 thousand due to higher maintenance and utility costs.

 

 -37- 

 

In the first quarter 2017, noninterest expense increased $38 thousand compared with the fourth quarter 2016. Salaries and related benefits increased $631 thousand primarily due to seasonally higher payroll taxes. Professional fees decreased $186 thousand due to lower legal fees. Other noninterest expense decreased $259 thousand primarily due to lower correspondent bank service charges.

 

Provision for Income Tax

 

The Company’s first quarter 2017 income tax provision (FTE) was $8.0 million. Effective January 1, 2017, the Company adopted ASU 2016-09 which has the potential to create volatility in the book tax provision at the time nonqualified stock options are exercised or expire. During the first quarter 2017, 376 thousand shares were issued due to the exercise of nonqualified stock options resulting in a tax deduction exceeding related share based compensation by $1.6 million. First quarter 2017 income tax provision was $671 thousand lower than would have been under accounting standards prior to the adoption of ASU 2016-09. First quarter 2017 income tax provision (FTE) compared with $8.1 million and $8.5 million for the first and fourth quarters 2016, respectively. The current quarter provision represents an effective tax rate (FTE) of 34.8%, compared with 36.3% and 37.0% for the first and fourth quarters 2016, respectively. The first quarter 2017 effective tax rate (FTE) would have been 37.7% under accounting rules applied in 2016.

 

Investment Portfolio

 

The Company maintains an investment securities portfolio consisting of securities issued by U.S. Government sponsored entities, agency and non-agency mortgage backed securities, state and political subdivisions, corporations, and asset-backed and other securities. Investment securities are held in safekeeping by an independent custodian.

 

Management has increased the investment securities portfolio in response to deposit growth and loan volume declines. The carrying value of the Company’s investment securities portfolio was $3.2 billion as of March 31, 2017 and December 31, 2016.

 

Management continually evaluates the Company’s investment securities portfolio in response to established asset/liability management objectives, changing market conditions that could affect profitability, liquidity, and the level of interest rate risk to which the Company is exposed. These evaluations may cause Management to change the level of funds the Company deploys into investment securities and change the composition of the Company’s investment securities portfolio. In 2016 Management reduced securities of U.S. Government sponsored entities to reduce call optionality and increased agency residential MBS to develop more reliable cash flows.

 

As of March 31, 2017, substantially all of the Company’s investment securities continue to be investment grade rated by one or more major rating agencies. In addition to monitoring credit rating agency evaluations, Management performs its own evaluations regarding the credit worthiness of the issuer or the securitized assets underlying asset-backed securities. The Company’s procedures for evaluating investments in securities are in accordance with guidance issued by the Board of Governors of the Federal Reserve System, “Investing in Securities without Reliance on Nationally Recognized Statistical Rating Agencies” (SR 12-15) and other regulatory guidance. Credit ratings are considered in our analysis only as a guide to the historical default rate associated with similarly-rated bonds. There have been no significant differences in our internal analyses compared with the ratings assigned by the third party credit rating agencies.

 

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 -38- 

 

The following tables summarize the total general obligation and revenue bonds issued by states and political subdivisions held in the Company’s investment securities portfolios as of the dates indicated, identifying the state in which the issuing government municipality or agency operates.

 

At March 31, 2017, the Company’s investment securities portfolios included securities issued by 687 state and local government municipalities and agencies located within 44 states with a fair value of $833.9 million. None of the Company’s investment securities were issued by Puerto Rican government entities. The largest exposure to any one municipality or agency was $10.1 million (fair value) represented by nine general obligation bonds.

 

   At March 31, 2017
   Amortized  Fair
   Cost  Value
   (In thousands)
Obligations of states and political subdivisions:      
General obligation bonds:          
California  $102,125   $104,225 
Texas   68,829    68,944 
New Jersey   40,024    40,346 
Minnesota   30,703    30,947 
Pennsylvania   29,690    29,888 
Other (36 states)   277,881    278,999 
Total general obligation bonds  $549,252   $553,349 
           
Revenue bonds:          
California  $46,448   $47,514 
Kentucky   22,811    23,062 
Iowa   18,068    18,309 
Pennsylvania   16,067    16,179 
Colorado   15,553    15,739 
Washington   13,557    14,179 
Other (29 states)   143,540    145,564 
Total revenue bonds  $276,044   $280,546 
Total obligations of states and political subdivisions  $825,296   $833,895 

 

At December 31, 2016, the Company’s investment securities portfolios included securities issued by 698 state and local government municipalities and agencies located within 44 states with a fair value of $848.2 million. None of the Company’s investment securities were issued by Puerto Rican government entities. The largest exposure to any one municipality or agency was $10.0 million (fair value) represented by nine general obligation bonds.

 

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   At December 31, 2016
   Amortized  Fair
   Cost  Value
   (In thousands)
Obligations of states and political subdivisions:      
General obligation bonds:          
California  $105,129   $106,391 
Texas   69,017    68,671 
New Jersey   40,111    40,102 
Pennsylvania   37,384    37,543 
Minnesota   32,946    32,847 
Other (36 states)   280,488    279,571 
Total general obligation bonds  $565,075   $565,125 
           
Revenue bonds:          
California  $47,415   $48,429 
Kentucky   22,854    22,902 
Pennsylvania   18,568    18,683 
Iowa   18,086    18,302 
Colorado   15,574    15,674 
Other (30 states)   157,452    159,054 
Total revenue bonds  $279,949   $283,044 
Total obligations of states and political subdivisions  $845,024   $848,169 

 

At March 31, 2017 and December 31, 2016, the revenue bonds in the Company’s investment securities portfolios were issued by state and local government municipalities and agencies to fund public services such as water utility, sewer utility, recreational and school facilities, and general public and economic improvements. The revenue bonds were payable from 23 revenue sources. The revenue sources that represent 5% or more individually of the total revenue bonds are summarized in the following tables.

 

   At March 31, 2017
   Amortized  Fair
   Cost  Value
   (In thousands)
Revenue bonds by revenue source:          
Water  $55,334   $57,043 
Sewer   35,455    36,187 
Sales tax   31,119    31,951 
Lease (renewal)   24,208    24,411 
College & University   17,806    17,808 
Other (18 sources)   112,122    113,146 
Total revenue bonds by revenue source  $276,044   $280,546 

 

   At December 31, 2016
   Amortized  Fair
   Cost  Value
   (In thousands)
Revenue bonds by revenue source:          
Water  $55,401   $56,826 
Sewer   37,996    38,497 
Sales tax   31,146    31,835 
Lease (renewal)   24,242    24,235 
College & University   17,856    17,762 
Other (18 sources)   113,308    113,889 
Total revenue bonds by revenue source  $279,949   $283,044 

 

See Note 3 to the unaudited consolidated financial statements for additional information related to the investment securities.

 

 -40- 

 

Loan Portfolio Credit Risk

 

The Company extends loans to commercial and consumer customers which expose the Company to the risk borrowers will default, causing loan losses. The Company’s lending activities are exposed to various qualitative risks. All loan segments are exposed to risks inherent in the economy and market conditions. Significant risk characteristics related to the commercial loan segment include the borrowers’ business performance and financial condition, and the value of collateral for secured loans. Significant risk characteristics related to the commercial real estate segment include the borrowers’ business performance and the value of properties collateralizing the loans. Significant risk characteristics related to the construction loan segment include the borrowers’ performance in successfully developing the real estate into the intended purpose and the value of the property collateralizing the loans. Significant risk characteristics related to the residential real estate segment include the borrowers’ financial wherewithal to service the mortgages and the value of the property collateralizing the loans. Significant risk characteristics related to the consumer loan segment include the financial condition of the borrowers and the value of collateral securing the loans.

 

The preparation of the financial statements requires Management to estimate the amount of losses inherent in the loan portfolio and establish an allowance for credit losses. The allowance for credit losses is established by assessing a provision for loan losses against the Company’s earnings. In estimating credit losses, Management must exercise judgment in evaluating information deemed relevant, such as financial information regarding individual borrowers, overall credit loss experience, the amount of past due, nonperforming and classified loans, recommendations of regulatory authorities, prevailing economic conditions and other information. The amount of ultimate losses on the loan portfolio can vary from the estimated amounts. Management follows a systematic methodology to estimate loss potential in an effort to reduce the differences between estimated and actual losses.

 

The Company closely monitors the markets in which it conducts its lending operations and follows a strategy to control exposure to loans with high credit risk. The Bank’s organization structure separates the functions of business development and loan underwriting; Management believes this segregation of duties avoids inherent conflicts of combining business development and loan approval functions. In measuring and managing credit risk, the Company adheres to the following practices.

 

·The Bank maintains a Loan Review Department which reports directly to the Board of Directors. The Loan Review Department performs independent evaluations of loans and assigns credit risk grades to evaluated loans using grading standards employed by bank regulatory agencies. Those loans judged to carry higher risk attributes are referred to as “classified loans.” Classified loans receive elevated management attention to maximize collection.

 

·The Bank maintains two loan administration offices whose sole responsibility is to manage and collect classified loans.

 

Classified loans with higher levels of credit risk are further designated as “nonaccrual loans.” Management places classified loans on nonaccrual status when full collection of contractual interest and principal payments is in doubt. Uncollected interest previously accrued on loans placed on nonaccrual status is reversed as a charge against interest income. The Company does not accrue interest income on loans following placement on nonaccrual status. Interest payments received on nonaccrual loans are applied to reduce the carrying amount of the loan unless the carrying amount is well secured by loan collateral. “Nonperforming assets” include nonaccrual loans, loans 90 or more days past due and still accruing, and repossessed loan collateral (commonly referred to as “Other Real Estate Owned”).

 

   At March 31,  At December 31,
   2017  2016  2016
   (In thousands)
          
Nonperforming nonaccrual loans  $2,382   $15,806   $3