Table of Contents

Exhibit 99.5

CONSOLIDATED FINANCIAL STATEMENTS AND

MANAGEMENT’S DISCUSSION AND ANALYSIS

Piedmont Community Bank Holdings, Inc.

As of March 31, 2014 and December 31, 2013 and for the three months ended March 31, 2014 and 2013.

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FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONSOLIDATED FINANCIAL STATEMENTS

PIEDMONT COMMUNITY BANK HOLDINGS. INC. AND SUBSIDIARIES

INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

		Page
Consolidated Balance Sheets as of March 31, 2014 and December 31, 2013			3
Consolidated Statements of Operations for the Three Months Ended March 31, 2014 and 2013			4
Consolidated Statements of Comprehensive Income (Loss) for the Three Months Ended March  31, 2014 and 2013			5
Consolidated Statement of Changes in Stockholders’ Equity for the Three Months Ended March  31, 2014			6
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2014 and 2013			7
Condensed Notes to Consolidated Financial Statements			8
Management’s Discussion and Analysis of Financial Condition and Results of Operations			32

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Financial Statements

PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (Unaudited)

As of March 31, 2014 and December 31, 2013

 

(Dollars in thousands, except share data)		March 31, 2014				December 31, 2013*
Assets
Cash and due from banks		$	30,969			$	29,081
Interest-earning deposits with banks			42,474				71,699
Investment securities available for sale, at fair value			407,231				404,388
Investment securities held to maturity			3,119				500
Loans held for sale			11,158				8,663
Loans			1,384,732				1,392,833
Allowance for loan losses			(7,213	)			(7,043	)
Net loans			1,377,519				1,385,790
Federal Home Loan Bank stock, at cost			8,455				8,929
Premises and equipment, net			44,350				44,875
Bank-owned life insurance			33,386				33,148
Foreclosed assets			9,505				10,518
Deferred tax asset, net			52,276				54,867
Goodwill			26,254				26,254
Other intangible assets, net			5,657				5,883
Accrued interest receivable and other assets			56,615				38,118
Total assets		$	2,108,968			$	2,122,713
Liabilities
Deposits:
Non-interest demand		$	195,570			$	217,581
Interest-bearing demand			356,134				351,921
Money market and savings			472,968				467,814
Time			630,132				634,915
Total deposits			1,654,804				1,672,231
Short-term borrowings			129,500				126,500
Long-term debt			69,961				72,921
Accrued interest payable and other liabilities			11,392				13,002
Total liabilities			1,865,657				1,884,654
Stockholders’ Equity
Preferred stock, $0.01 par value, 500,000 shares authorized			—				—
Common stock, $0.01 par value, 2,500,000 shares authorized, 1,466,664 shares issued and outstanding			15				15
Additional paid-in capital			155,578				154,168
Accumulated deficit			(9,413	)			(10,658	)
Accumulated other comprehensive loss			(1,588	)			(2,725	)
Total Piedmont Community Bank Holdings, Inc. stockholders’ equity			144,592				140,800
Non-controlling interests			98,719				97,259
Total stockholders’ equity			243,311				238,059
Total liabilities and stockholders’ equity		$	2,108,968			$	2,122,713

 

*	Derived from audited consolidated financial statements.

See accompanying Notes to Consolidated Financial Statements.

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

For the Three Months Ended March 31, 2014 and 2013

 

		Three Months Ended March 31,
(Dollars in thousands, except per share data)		2014				2013
Interest income
Loans		$	20,331			$	10,814
Investment securities			1,985				815
Federal funds sold and interest-earning deposits			26				16
Total interest income			22,342				11,645
Interest expense
Deposits			1,659				1,302
Short-term borrowings			78				12
Long-term debt			1,031				270
Total interest expense			2,768				1,584
Net interest income			19,574				10,061
Provision for loan losses			1,290				1,940
Net interest income after provision for loan losses			18,284				8,121
Non-interest income
Service charges and fees on deposit accounts			1,315				515
Government-guaranteed lending			2,341				1,119
Mortgage banking			318				391
Bank-owned life insurance			306				195
Gain on sales of available for sale securities			—				1,092
Other			387				150
Total non-interest income			4,667				3,462
Non-interest expense
Salaries and employee benefits			9,098				6,467
Occupancy and equipment			2,656				1,567
Data processing			1,030				644
FDIC deposit insurance premiums			390				227
Professional services			685				502
Foreclosed asset expenses, net			263				183
Loan, collection, and repossession expense			679				461
Merger and conversion costs			1,209				1,601
Restructuring charges			836				—
Other			2,190				1,552
Total non-interest expense			19,036				13,204
Income (loss) before income taxes			3,915				(1,621	)
Income tax expense (benefit)			1,681				(395	)
Net income (loss)			2,234				(1,226	)
Net income attributable to non-controlling interests			990				202
Net income (loss) attributable to Piedmont Community Bank Holdings, Inc.		$	1,244			$	(1,428	)
Net income (loss) per common share
Basic		$	0.85			$	(0.97	)
Diluted		$	0.85			$	(0.97	)
Weighted average common shares outstanding
Basic			1,466,664				1,466,664
Diluted			1,466,664				1,466,664

See accompanying Notes to Consolidated Financial Statements.

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)

For the Three Months Ended March 31, 2014 and 2013

 

		Three Months Ended March 31,
(Dollars in thousands)		2014				2013
Net income (loss)		$	2,234			$	(1,226	)
Other comprehensive income (loss):
Securities available for sale:
Unrealized holding gains (losses) on available for sale securities			3,311				(67	)
Tax effect			(1,275	)			27
Reclassification of gains on sales of securities recognized in earnings			—				(1,092	)
Tax effect			—				421
Net of tax amount			2,036				(711	)
Cash flow hedges:
Unrealized gains (losses) on cash flow hedges			(951	)			90
Tax effect			367				(34	)
Net of tax amount			(584	)			56
Total other comprehensive income (loss)			1,452				(655	)
Comprehensive income (loss)		$	3,686			$	(1,881	)

See accompanying Notes to Consolidated Financial Statements.

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)

For the Three Months Ended March 31, 2014

 

		Common Stock								Additional Paid-in Capital				Accumulated Deficit				Accumulated Other Comprehensive Loss				Piedmont Community Bank Holdings, Inc Total				Non-Controlling Interests				Total Stockholders’ Equity
(Dollars in thousands)		Shares				Amount
Balance at December 31, 2013			1,466,664			$	15			$	154,168			$	(10,658	)		$	(2,725	)		$	140,800			$	97,259			$	238,059
Net income			—				—				—				1,244				—				1,244				990				2,234
Other comprehensive income			—				—				—				—				1,041				1,041				411				1,452
Stock-based compensation			—				—				109				—				—				109				55				164
Common stock issuance, net of issuance costs			—				—				1,301				—				97				1,398				43,068				44,466
Stock options exercised			—				—				—				—				—				—				99				99
Preferred stock repurchase			—				—				—				—				—				—				(42,849	)			(42,849	)
Preferred stock dividends			—				—				—				—				—				—				(314	)			(314	)
Balance at March 31, 2014			1,466,664			$	15			$	155,578			$	(9,414	)		$	(1,587	)		$	144,592			$	98,719			$	243,311

See accompanying Notes to Consolidated Financial Statements.

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

For the Three Months Ended March 31, 2014 and 2013

 

		Three Months Ended March 31,
(Dollars in thousands)		2014				2013
Cash flows from operating activities
Net income (loss)		$	2,234			$	(1,226	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Stock-based compensation			164				310
Provision for loan losses			1,290				1,940
Accretion of acquisition discount on purchased loans			(5,084	)			(3,567	)
Depreciation			756				412
Amortization of core deposit intangible			226				109
Amortization of acquisition premium on time deposits			(614	)			(484	)
(Amortization) accretion of acquisition (premium) discount on long-term debt			(9	)			38
Gain on mortgage loan commitments			24				299
Gain on sales of loans held for sale			(2,519	)			(1,706	)
Originations of loans held for sale			(42,264	)			(72,982	)
Proceeds from sales of loans held for sale			42,288				82,456
Gains on sales of loans held for investment			(362	)			—
Increase in cash surrender value of bank-owned life insurance			(238	)			(162	)
Deferred income taxes			1,681				(395	)
Gain on sales of available for sale securities			—				(1,092	)
Net amortization of premiums on available for sale securities			624				150
Net loss on disposal of foreclosed assets			20				—
Valuation adjustments on foreclosed assets			62				180
Gains from change in fair value of interest rate swaps			—				(48	)
Change in assets and liabilities:
Decrease in accrued interest receivable			725				198
Decrease in other assets			840				2,864
Decrease in accrued interest payable			(445	)			(10	)
Decrease in other liabilities			(901	)			(5,911	)
Net cash provided by (used in) operating activities			(1,502	)			1,373
Cash flows from investing activities
Purchases of securities available for sale			(9,542	)			(42,664	)
Purchases of securities held to maturity			(3,119	)			—
Proceeds from maturities and repayments of securities available for sale			9,388				5,551
Proceeds from call of securities held to maturity			500				—
Proceeds from sales of securities available for sale			—				18,559
Loan originations and principal collections, net			11,301				(28,165	)
Proceeds from sales of loans			817				—
Purchases of trade accounts receivable, net			(21,037	)			—
Purchases of premises and equipment			(231	)			(946	)
Proceeds from disposal of foreclosed assets			1,240				1,473
Proceeds from (purchases of) Federal Home Loan Bank stock			474				(75	)
Net cash used in investing activities			(10,209	)			(46,267	)
Cash flows from financing activities
Net increase (decrease) in deposits			(16,813	)			31,380
Repayments of short-term borrowings, net			—				(1,500	)
Proceeds from issuance of long-term debt, net			50				9,000
Proceeds from issuance of common stock, net of issuance costs			44,466				—
Proceeds from exercise of stock options			99				99
Repurchase of preferred stock			(42,849	)			—
Dividends paid on preferred stock			(578	)			(311	)
Net cash provided by (used in) financing activities			(15,625	)			38,668
Net change in cash and cash equivalents			(27,336	)			(6,226	)
Cash and cash equivalents, beginning of period			100,779				50,513
Cash and cash equivalents, end of period		$	73,443			$	44,287
SUPPLEMENTAL DISCLOSURES:
Cash payments for:
Interest		$	3,836			$	2,040
Income taxes			—				—
Noncash investing activities:
Transfers of loans to foreclosed assets		$	309			$	568
Change in fair value of securities available for sale, net of tax			2,036				(711	)
Change in fair value of cash flow hedge, net of tax			(584	)			56

See accompanying Notes to Consolidated Financial Statements.

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

NOTE A – BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements include the accounts of Piedmont Community Bank Holdings, Inc. (the “Company” or “Piedmont”). Piedmont is a bank holding company incorporated under the laws of Delaware on May 7, 2009. The Company was formed to build a community banking franchise in North Carolina and surrounding markets. The Company owns approximately 58 percent of VantageSouth Bancshares, Inc. (“VantageSouth”), which is also a Delaware-chartered bank holding company. Both the Company and VantageSouth conduct their business operations primarily through VantageSouth Bank (the “Bank”), which is the wholly-owned banking subsidiary of VantageSouth. Piedmont also wholly owns VantageSouth Holdings, LLC (“VantageSouth Holdings”), which was formed on October 12, 2010 to hold certain loans purchased by Piedmont from the Bank. The Company’s headquarters are located in Raleigh, North Carolina.

The interim unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). They do not include all of the information and footnotes required by such accounting principles for complete financial statements, and therefore should be read in conjunction with the audited consolidated financial statements and accompanying footnotes in the Company’s audited consolidated financial statements as of and for the year ended December 31, 2013 (the “Company’s 2013 Financial Statements”).

In the opinion of management, all adjustments necessary for a fair presentation of the financial position and results of operations for the periods presented have been included, and all intercompany transactions have been eliminated in consolidation. Results of operations for the three months ended March 31, 2014 are not necessarily indicative of the results of operations that may be expected for the year ending December 31, 2014. The consolidated balance sheet as of December 31, 2013 has been derived from the Company’s 2013 Financial Statements. A description of the significant accounting policies followed by the Company are as set forth in Note B of the Notes to the Company’s 2013 Financial Statements.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates.

Recently Adopted and Issued Accounting Standards

In January 2014, the Financial Accounting Standards Board (“FASB”) issued ASU 2014-04, Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. The amendments in this update clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this update are effective for periods beginning after December 15, 2014. Adoption of this update is not expected to have a material impact on the Company’s financial position or results of operations.

In January 2014, the FASB issued ASU 2014-01, Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects. The amendments in this update permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The amendments in this update are effective for periods beginning after December 15, 2014. Adoption of this update is not expected to have a material impact on the Company’s financial position or results of operations.

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The amendments in this update require an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. GAAP to be reclassified in its entirety to net income. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. The amendments were effective for periods beginning after December 15, 2012. Adoption of this update did not have a material impact on the Company’s financial position or results of operations.

In July 2012, the FASB issued ASU 2012-02, Intangibles – Goodwill and Other (Topic 350) – Testing Indefinite-Lived Intangible Assets for Impairment. The amendments in this update give entities the option to first assess qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that an indefinite-lived intangible asset, other than goodwill, is impaired. If, after assessing the totality of events or circumstances, an entity determines it is more likely than not that an indefinite-lived intangible asset is impaired, then the entity must perform the quantitative impairment test. Permitting an entity to assess qualitative factors when testing indefinite-lived intangible assets for impairment results in guidance that is similar to the goodwill impairment testing guidance in ASU 2011-08. The amendments were effective beginning January 1, 2013. Adoption of this update did not have a material impact on the Company’s financial position or results of operations.

NOTE B – PER SHARE RESULTS

Basic and diluted net income per share are computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during each period. Diluted net income per share reflects the potential dilution that could occur if common stock options and warrants were exercised, resulting in the issuance of common stock that then shared in the net income of the Company.

Basic and diluted net income per share have been computed based upon net income available to common stockholders as presented in the accompanying consolidated statements of operations divided by the weighted average number of common shares outstanding or assumed to be outstanding as summarized below.

 

		Three Months Ended March 31,
		2014				2013
Weighted average number of common shares			1,466,664				1,466,664
Effect of dilutive stock options and warrants			—				—
Weighted average number of common shares and dilutive potential common shares			1,466,664				1,466,664
Anti-dilutive stock options and warrants			146,666				146,666

NOTE C – MERGERS AND ACQUISITIONS

Proposed Merger With Yadkin Financial Corporation

On January 27, 2014, Piedmont and VantageSouth entered into an Agreement and Plan of Merger with Yadkin Financial Corporation (“Yadkin”) under which Piedmont and VantageSouth will each merge with and into Yadkin (referred to collectively as the “Yadkin Merger”). Immediately following the completion of the Yadkin Merger, VantageSouth Bank will merge with and into Yadkin Bank, Yadkin’s wholly-owned banking subsidiary.

In the Yadkin Merger, each outstanding share of the VantageSouth’s common stock, other than shares held by Piedmont, will be converted into the right to receive 0.3125 shares of Yadkin common stock. Each share of Piedmont’s common stock will be converted into the right to receive (i) 6.28597 shares of Yadkin common stock, which is based on the effective exchange ratio for VantageSouth’s common stock; (ii) a pro rata portion of cash based on Piedmont’s deferred tax asset; (iii) a pro rata portion of cash in an amount equal to the aggregate amount of any cash held by Piedmont at the closing of the Yadkin Merger; and (iv) a right to receive a pro rata portion of certain shares of Yadkin voting common stock at a later date if such shares do not become payable under the Piedmont Phantom Equity Plan.

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

Pursuant to the Yadkin Merger Agreement, Yadkin will be the legal acquirer, but Piedmont and its consolidated subsidiaries (which includes VantageSouth) will be the accounting acquirer since Piedmont and other non-controlling VantageSouth stockholders will control approximately 55 percent of outstanding voting shares of the combined company. Based on recent filings, as of March 31, 2014, Yadkin had total assets of $1,813,487, deposits of $1,525,474, and shareholders’ equity of $188,776. The Yadkin Merger has received all stockholder and regulatory approvals and is expected to close on July 4, 2014, subject to the satisfaction of other customary closing conditions.

Yadkin Bank is a full-service community bank with thirty-three branches throughout its two regions in North and South Carolina. The Western Region serves Avery, Watauga, Ashe, Surry, Wilkes, Yadkin, Durham, and Orange Counties in North Carolina. The Southern Region serves Iredell, Mecklenburg, and Union Counties in North Carolina, and Cherokee and York Counties in South Carolina. Yadkin Bank provides mortgage lending services through its mortgage division, Yadkin Mortgage, headquartered in Greensboro, North Carolina. Securities brokerage services are provided by Yadkin Wealth, Inc., a Yadkin Bank subsidiary with offices located throughout the branch network.

ECB Bancorp, Inc. Merger

On April 1, 2013, the Company completed the merger of ECB Bancorp, Inc. (“ECB”) with and into VantageSouth (the “ECB Merger”). The ECB Merger was completed pursuant to an Agreement and Plan of Merger dated as of September 25, 2012 (the “Merger Agreement”). Immediately following the ECB Merger, The East Carolina Bank, a wholly-owned subsidiary of ECB, was merged with and into VantageSouth Bank. Upon the closing of the ECB Merger, each outstanding share of ECB common stock was converted into the right to receive 3.55 shares of common stock of VantageSouth. The aggregate merger consideration consisted of 10.3 million shares of VantageSouth’s common stock. Based upon the market price of VantageSouth’s common stock immediately prior to the ECB Merger, the transaction value was $40,629.

Pursuant to the Merger Agreement, the Company agreed to exchange each share of ECB’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, into one share of VantageSouth’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B (“Series B Preferred Stock”). The Series B Preferred Stock was redeemed by the company in February 2014. At the closing of the ECB Merger, VantageSouth also issued a warrant to purchase 514,693.2 shares of VantageSouth’s common stock to the U.S. Department of the Treasury (“Treasury”) in exchange for the warrant issued by ECB to Treasury on January 16, 2009 to purchase 144,984 shares of ECB’s common stock. The warrant issuance reflected the exchange ratio associated with the ECB Merger.

The following table presents the ECB assets acquired, liabilities assumed and other equity interests as of April 1, 2013 as well as the calculation of the transaction purchase price and gain on acquisition. The Company had a one-year measurement period from the acquisition date to finalize the recorded fair values of net assets acquired.

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

		As Reported by ECB at April 1, 2013				Initial Fair Value Adjustments				Measurement Period Adjustments				As Reported by the Company at April 1, 2013
Assets:
Cash and cash equivalents		$	24,008			$	—			$	—			$	24,008
Investment securities available for sale			289,058				301	(a)			—				289,359
Loans held for sale			3,857				9,790	(b)			(191	)(m)			13,456
Loans, net			483,474				(30,420	)(c)			—				453,054
Federal Home Loan Bank stock, at cost			3,150				—				—				3,150
Premises and equipment, net			25,633				(1,177	)(d)			135	(m)			24,591
Bank-owned life insurance			12,249				—				—				12,249
Foreclosed assets			7,090				(717	)(e)			(305	)(m)			6,068
Deferred tax asset, net			6,986				9,082	(f)			540	(m)			16,608
Other intangible assets, net			—				4,307	(g)			—				4,307
Other assets			10,423				(665	)(h)			(922	)(m)			8,836
Total assets			865,928				(9,499	)			(743	)			855,686
Liabilities:
Deposits		$	731,926			$	4,188	(i)		$	—			$	736,114
Short-term borrowings			34,284				—				—				34,284
Long-term debt			16,000				460	(j)			—				16,460
Other liabilities			2,867				148	(k)			116	(m)			3,131
Total liabilities			785,077				4,796				116				789,989
Net assets acquired			80,851				(14,295	)			(859	)			65,697
Other equity interests:
Preferred stock			17,660				(107	)(l)			—				17,553
Common stock warrant			878				(745	)(l)			—				133
Total other equity interests			18,538				(852	)			—				17,686
Gain on acquisition															7,382
Purchase price														$	40,629

Explanation of fair value adjustments

(a)	Adjustment reflects opening fair value of securities portfolio, which was established as the new book basis of the portfolio.

(b)	Adjustment reflect the reclassification of the fair value of certain loans identified by management as being held for sale at acquisition.

(c)	Adjustment reflects the estimated lifetime credit losses on the loan portfolio, the present value of the differences between contractual interest rates and market interest rates, and a reclassification of certain loans that were identified as held for sale at acquisition.

(d)	Adjustment reflects fair value adjustments on certain acquired branch offices as well as certain software and computer equipment.

(e)	Adjustment reflects the write down of certain foreclosed assets based on current estimates of property values given current market conditions and additional discounts based on the Company’s planned disposition strategy.

(f)	Adjustment reflects the tax impact of acquisition accounting fair value adjustments.

(g)	Adjustment reflects the fair value of the acquired core deposit intangible.

(h)	Adjustment reflects the impact of fair value adjustments on other assets, which include the write down of certain unusable prepaid expenses and the elimination of accrued interest on purchased credit-impaired loans.

(i)	Adjustment reflects the fair value premium on time deposits, which was calculated by discounting future contractual interest payments at a current market interest rate.

(j)	Adjustment reflects the fair value premium on FHLB advances, which was calculated by discounting future contractual interest payments at a current market interest rate. This fair value premium is also consistent with the prepayment penalty the FHLB would charge to terminate the advance.

(k)	Adjustment reflects the impact of fair value adjustments on other liabilities, which primarily includes the accrual of a preferred stock dividend at acquisition.

(l)

Amount reflects the adjustment to record other equity interests at fair value. The fair value of preferred stock issued to Treasury was estimated using by discounting future contractual dividend payments at a current market interest rate for preferred stocks of issuers with similar risk. The assumed liquidation date of the preferred stock was February 15, 2014, which was the date the dividend reset from 5 to 9 percent. The fair value of the common stock warrant issued to Treasury was estimated using a Black-Scholes option pricing model assuming a warrant life through the dividend reset date.

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

(m)

Adjustments reflect changes to acquisition date fair values of certain assets based on additional information received post-acquisition within the measurement period. Measurement period adjustments included tax-effected adjustments to reduce the fair value of a non-marketable investment, to dispose of other assets with no value at the merger, to reduce the fair value of certain distressed loans held for sale, to reduce the fair value of certain other real estate owned, to recognize a liability for outstanding ECB employee credit card balances, and to increase the fair value of a bank-owned office.

NOTE D – INVESTMENT SECURITIES

The following tables summarize the amortized cost, gross unrealized gains and losses, and fair value of investment securities available for sale and held to maturity by major classification.

 

		March 31, 2014
		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
Securities available for sale:
U.S. government-sponsored enterprise securities		$	14,846			$	—			$	123			$	14,723
SBA-guaranteed securities			64,271				57				614				63,714
Residential mortgage-backed securities (MBS)			218,376				76				8,767				209,685
Corporate bonds			111,159				1,899				321				112,737
Commercial MBS			4,133				53				—				4,186
Municipal obligations - non-taxable			600				1				—				601
Other debt securities			498				—				—				498
Marketable equity securities			700				387				—				1,087
Total securities available for sale		$	414,583			$	2,473			$	9,825			$	407,231
Securities held to maturity:
Municipal obligations - non-taxable		$	3,119			$	—			$	—			$	3,119

 

		December 31, 2013
		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
Securities available for sale:
U.S. government-sponsored enterprise securities		$	14,834			$	—			$	161			$	14,673
SBA-guaranteed securities			66,579				52				751				65,880
Residential MBS			216,818				69				11,627				205,260
Corporate bonds			109,423				1,800				483				110,740
Commercial MBS			5,867				71				—				5,938
Municipal obligations – non-taxable			600				1				—				601
Other debt securities			253				—				—				253
Marketable equity securities			677				366				—				1,043
Total securities available for sale		$	415,051			$	2,359			$	13,022			$	404,388
Securities held to maturity:
Corporate bonds		$	500			$	—			$	—			$	500

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

The following tables summarize gross unrealized losses and fair values, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.

 

		Less Than 12 Months								12 Months or More								Total
		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
March 31, 2014
U.S. government-sponsored enterprise securities		$	9,849			$	22			$	4,874			$	101			$	14,723			$	123
SBA-guaranteed securities			53,007				614				—				—				53,007				614
Residential MBS			183,744				7,893				21,391				874				205,135				8,767
Corporate bonds			24,606				321				—				—				24,606				321
Total temporarily impaired securities		$	271,206			$	8,850			$	26,265			$	975			$	297,471			$	9,825
December 31, 2013
U.S. government-sponsored enterprise securities		$	14,673			$	161			$	—			$	—			$	14,673			$	161
SBA-guaranteed securities			57,277				751				—				—				57,277				751
Residential MBS			198,885				11,627				—				—				198,885				11,627
Corporate bonds			19,420				483				—				—				19,420				483
Total temporarily impaired securities		$	290,255			$	13,022			$	—			$	—			$	290,255			$	13,022

All residential MBSs in the investment portfolio as of March 31, 2014 and December 31, 2013 were issued and backed by government-sponsored enterprises (“GSEs”). Unrealized losses on investment securities as of March 31, 2014 related to 67 residential MBSs issued by GSEs, 22 SBA-guaranteed securities, 8 investment grade corporate bonds, and 2 GSE securities. Unrealized losses on investment securities at December 31, 2013 related to 65 residential MBSs issued by GSEs, 23 SBA-guaranteed securities, 6 investment grade corporate bonds, and 2 GSE securities. As of March 31, 2014, eight securities had been in an unrealized loss position for more than a twelve month period. The Company had $321 in unrealized losses on corporate bonds, which were the only securities in a loss position that were not issued or guaranteed by a U.S. government agency or GSE. These corporate bonds were all issued by large national or international financial institutions, and the Company does not believe the unrealized losses on these bonds were due to issuer-related credit events.

The securities in an unrealized loss position as of March 31, 2014 continue to perform and are expected to perform through maturity, and the issuers have not experienced significant adverse events that would call into question their ability to repay these debt obligations according to contractual terms. Further, because the Company does not intend to sell these investments and does not believe that it will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, unrealized losses on such securities were not considered to represent other-than-temporary impairment as of March 31, 2014.

As of March 31, 2014, the Company held no individual investment securities with an aggregate book value greater than 10 percent of total stockholders’ equity. As of March 31, 2014 and December 31, 2013, investment securities with carrying values of $221,929 and $226,048, respectively, were pledged to secure public deposits, borrowings and for other purposes required or permitted by law.

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

The amortized cost and fair values of securities available for sale, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

		March 31, 2014								December 31, 2013
		Amortized Cost				Fair Value				Amortized Cost				Fair Value
Securities available for sale:
Due within one year		$	557			$	557			$	677			$	678
Due after one year through five years			179,875				180,364				182,777				182,713
Due after five years through ten years			173,568				168,492				173,624				166,765
Due after ten years			59,883				56,731				57,296				53,189
Equity securities			700				1,087				677				1,043
		$	414,583			$	407,231			$	415,051			$	404,388
Securities held to maturity:
Due after one year through five years		$	—			$	—			$	500			$	500
Due after five years through ten years			1,479				1,479				—				—
Due after ten years			1,640				1,640				—				—
		$	3,119			$	3,119			$	500			$	500

The following table summarizes securities gains (losses) for the periods presented.

 

		Three Months Ended March 31,
		2014				2013
Gross gains on sales of securities available for sale		$	—			$	1,092
Gross losses on sales of securities available for sale			—				—
Total securities gains		$	—			$	1,092

NOTE E – LOANS AND ALLOWANCE FOR LOAN LOSSES

The following table summarizes the Company’s loans by type.

 

		March 31, 2014				December 31, 2013
Commercial:
Commercial real estate		$	642,118			$	670,293
Commercial and industrial			232,684				230,614
Construction and development			197,940				175,794
Consumer:
Residential real estate			194,808				191,378
Construction and development			17,501				22,520
Home equity			92,597				94,390
Other consumer			7,589				8,332
Gross loans			1,385,237				1,393,321
Less:
Deferred loan fees			(505	)			(488	)
Allowance for loan losses			(7,213	)			(7,043	)
Net loans		$	1,377,519			$	1,385,790

As of March 31, 2014 and December 31, 2013, loans with a recorded investment of $454,396 and $424,414, respectively, were pledged to secure borrowings or available lines of credit with correspondent banks.

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

Purchased Credit-Impaired Loans

Loans for which it is probable at acquisition that all contractually required payments will not be collected are considered purchased credit-impaired (“PCI”) loans. The following table relates to PCI loans acquired in the ECB Merger and summarizes the contractually required payments, which includes principal and interest, expected cash flows to be collected, and the fair value of acquired PCI loans at the ECB Merger date.

 

		April 1, 2013
Contractually required payments		$	61,801
Nonaccretable difference			(11,433	)
Cash flows expected to be collected at acquisition			50,368
Accretable yield			(4,242	)
Fair value of PCI loans at acquisition		$	46,126

The following table summarizes changes in accretable yield, or income expected to be collected, related to all of the Company’s PCI loans for the periods presented.

 

		Three Months Ended March 31,
		2014				2013
Balance, beginning of period		$	25,349			$	27,632
Accretion of income			(3,077	)			(3,449	)
Reclassifications from nonaccretable difference			2,150				1,762
Other, net			(1,007	)			(501	)
Balance, end of period		$	23,415			$	25,444

The outstanding balance of PCI loans consists of the undiscounted sum of all amounts, including amounts deemed principal, interest, fees, penalties, and other under the loan, owed by the borrower at the reporting date, whether or not currently due and whether or not any such amounts have been written or charged off. The outstanding balance of PCI loans was $192,039 and $202,818 as of March 31, 2014 and December 31, 2013, respectively.

Purchased Non-impaired Loans

Purchased non-impaired loans are also recorded at fair value at acquisition, and the related fair value discount or premium is recognized as an adjustment to yield over the remaining life of each loan. The following table relates to purchased non-impaired loans acquired in the ECB Merger and provides the contractually required payments, fair value, and estimate of contractual cash flows not expected to be collected at the ECB Merger date.

 

		April 1, 2013
Contractually required payments		$	499,963
Fair value of acquired loans at acquisition		$	406,928
Contractual cash flows not expected to be collected		$	10,098

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

Allowance for Loan Losses

The following tables summarize the activity in the allowance for loan losses for the periods presented.

 

		Commercial Real Estate				Commercial and Industrial				Commercial Construction				Residential Real Estate				Consumer Construction				Home Equity				Other Consumer				Total
Three months ended March 31, 2014:
Beginning balance		$	2,419			$	805			$	1,400			$	1,673			$	187			$	476			$	83			$	7,043
Charge-offs			(242	)			(241	)			(196	)			(196	)			—				(188	)			(96	)			(1,159	)
Recoveries			4				5				—				11				—				12				7				39
Provision for loan losses			99				213				406				238				27				203				104				1,290
Ending balance		$	2,280			$	782			$	1,610			$	1,726			$	214			$	503			$	98			$	7,213
Three months ended March 31, 2013:
Beginning balance		$	1,524			$	798			$	597			$	940			$	18			$	85			$	36			$	3,998
Charge-offs			(13	)			(58	)			(61	)			(193	)			—				(92	)			(84	)			(501	)
Recoveries			14				8				10				53				—				2				3				90
Provision for loan losses			1,059				83				459				159				(1	)			119				62				1,940
Ending balance		$	2,584			$	831			$	1,005			$	959			$	17			$	114			$	17			$	5,527

The following tables summarize the ending allowance for loans losses and the recorded investment in loans by portfolio segment and impairment method.

 

		March 31, 2014
		Commercial Real Estate				Commercial and Industrial				Commercial Construction				Residential Real Estate				Consumer Construction				Home Equity				Other Consumer				Total
Allowance for loan losses:
Ending balance:
Individually evaluated for impairment		$	196			$	84			$	48			$	26			$	—			$	40			$	—			$	394
Collectively evaluated for impairment			1,356				698				1,301				763				214				362				75				4,769
Purchased credit-impaired			728				—				261				937				—				101				23				2,050
Total		$	2,280			$	782			$	1,610			$	1,726			$	214			$	503			$	98			$	7,213
Loans:
Ending balance:
Individually evaluated for impairment		$	4,092			$	380			$	2,280			$	1,151			$	—			$	419			$	—			$	8,322
Collectively evaluated for impairment			539,171				221,841				161,370				168,837				15,671				90,814				7,291				1,204,995
Purchased credit-impaired			98,855				10,463				34,290				24,820				1,830				1,364				298				171,920
Total		$	642,118			$	232,684			$	197,940			$	194,808			$	17,501			$	92,597			$	7,589			$	1,385,237

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

		December 31, 2013
		Commercial Real Estate				Commercial and Industrial				Commercial Construction				Residential Real Estate				Consumer Construction				Home Equity				Other Consumer				Total
Allowance for loan losses:
Ending balance:
Individually evaluated for impairment		$	57			$	323			$	—			$	—			$	—			$	270			$	2			$	652
Collectively evaluated for impairment			1,322				482				1,139				688				187				153				59				4,030
Purchased credit-impaired			1,040				—				261				985				—				53				22				2,361
Total		$	2,419			$	805			$	1,400			$	1,673			$	187			$	476			$	83			$	7,043
Loans:
Ending balance:
Individually evaluated for impairment		$	4,590			$	343			$	2,609			$	695			$	242			$	424			$	13			$	8,916
Collectively evaluated for impairment			562,081				219,251				137,911				164,106				20,447				92,592				7,982				1,204,370
Purchased credit-impaired			103,622				11,020				35,274				26,577				1,831				1,374				337				180,035
Total		$	670,293			$	230,614			$	175,794			$	191,378			$	22,520			$	94,390			$	8,332			$	1,393,321

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

 

•

Pass. These loans range from superior quality with minimal credit risk to loans requiring heightened management attention but that are still an acceptable risk and continue to perform as contracted.

 

•

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

 

•

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

 

•

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

The following tables summarize the risk category of loans by class of loans.

 

		Pass				Special Mention				Substandard				Doubtful				Total
March 31, 2014
Non-PCI Loans
Commercial:
Real estate		$	506,266			$	28,188			$	8,808			$	—			$	543,262
Commercial and industrial			212,095				7,007				3,095				24				222,221
Construction and development			157,171				3,732				2,548				199				163,650
Consumer:
Residential real estate			155,877				8,270				5,841				—				169,988
Construction and development			14,510				814				347				—				15,671
Home equity			85,928				2,456				2,850				—				91,234
Other consumer			6,973				125				193				—				7,291
Total		$	1,138,820			$	50,592			$	23,682			$	223			$	1,213,317
PCI Loans
Commercial:
Real estate		$	48,450			$	36,540			$	13,866			$	—			$	98,856
Commercial and industrial			8,205				1,442				816				—				10,463
Construction and development			7,743				18,286				7,492				769				34,290
Consumer:
Residential real estate			12,520				6,277				6,002				21				24,820
Construction and development			240				454				1,136				—				1,830
Home equity			27				789				547				—				1,363
Other consumer			17				272				9				—				298
Total		$	77,202			$	64,060			$	29,868			$	790			$	171,920
		Pass				Special Mention				Substandard				Doubtful				Total
December 31, 2013
Non-PCI Loans
Commercial:
Real estate		$	532,669			$	24,245			$	9,757			$	—			$	566,671
Commercial and industrial			210,382				5,195				3,993				24				219,594
Construction and development			134,074				3,400				2,847				199				140,520
Consumer:
Residential real estate			153,123				7,812				3,866				—				164,801
Construction and development			19,566				921				202				—				20,689
Home equity			87,891				2,524				2,601				—				93,016
Other consumer			7,773				43				179				—				7,995
Total		$	1,145,478			$	44,140			$	23,445			$	223			$	1,213,286
PCI Loans
Commercial:
Real estate		$	53,900			$	35,399			$	14,323			$	—			$	103,622
Commercial and industrial			7,921				2,382				669				48				11,020
Construction and development			9,666				17,408				7,124				1,076				35,274
Consumer:
Residential real estate			13,794				7,070				5,692				21				26,577
Construction and development			212				510				1,109				—				1,831
Home equity			28				850				496				—				1,374
Other consumer			21				281				35				—				337
Total		$	85,542			$	63,900			$	29,448			$	1,145			$	180,035

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

The following tables summarize the past due status of the loan portfolio (excluding PCI loans) based on contractual terms.

 

		30-89 Days Past Due				90 Days or Greater Past Due				Total Past Due				Current				Total Loans
March 31, 2014
Non-PCI Loans
Commercial:
Real estate		$	1,917			$	2,934			$	4,851			$	538,411			$	543,262
Commercial and industrial			2,151				999				3,150				219,071				222,221
Construction and development			158				746				904				162,746				163,650
Consumer:
Residential real estate			2,474				1,282				3,756				166,232				169,988
Construction and development			1,651				314				1,965				13,706				15,671
Home equity			722				721				1,443				89,791				91,234
Other consumer			154				133				287				7,004				7,291
Total		$	9,227			$	7,129			$	16,356			$	1,196,961			$	1,213,317

 

		30-89 Days Past Due				90 Days or Greater Past Due				Total Past Due				Current				Total Loans
December 31, 2013
Non-PCI Loans
Commercial:
Real estate		$	2,419			$	2,142			$	4,561			$	562,110			$	566,671
Commercial and industrial			1,945				505				2,450				217,144				219,594
Construction and development			146				1,316				1,462				139,058				140,520
Consumer:
Residential real estate			5,097				1,365				6,462				158,339				164,801
Construction and development			603				237				840				19,849				20,689
Home equity			990				701				1,691				91,325				93,016
Other Consumer			245				136				381				7,614				7,995
Total		$	11,445			$	6,402			$	17,847			$	1,195,439			$	1,213,286

The following table summarizes the recorded investment of loans on nonaccrual status and loans greater than 90 days past due and accruing (excluding PCI loans) by class.

 

		March 31, 2014								December 31, 2013
		Nonaccrual				Loans Greater Than 90 Days Past Due and Accruing				Nonaccrual				Loans Greater Than 90 Days Past Due and Accruing
Non-PCI Loans
Commercial:
Commercial real estate		$	3,829			$	—			$	4,747			$	—
Commercial and industrial			2,309				51				2,154				—
Construction and development			2,272				—				2,632				—
Consumer:
Residential real estate			2,471				—				2,450				—
Construction and development			347				—				653				—
Home equity			2,007				—				1,928				—
Other consumer			159				—				164				—
Total		$	13,394			$	51			$	14,728			$	—

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

The following table provides information on impaired loans, which excludes PCI loans and loans evaluated collectively as a homogeneous group.

 

		Recorded Investment With a Recorded Allowance				Recorded Investment With no Recorded Allowance				Total				Related Allowance				Unpaid Principal Balance
March 31, 2014
Non-PCI Loans
Commercial:
Commercial real estate		$	996			$	3,096			$	4,092			$	196			$	4,264
Commercial and industrial			360				20				380				84				391
Construction and development			930				1,350				2,280				48				2,782
Consumer:
Residential real estate			244				907				1,151				26				1,387
Construction and development			—				—				—				—				—
Home equity			330				89				419				40				442
Other consumer			—				—				—				—				—
Total		$	2,860			$	5,462			$	8,322			$	394			$	9,266
December 31, 2013
Non-PCI Loans
Commercial:
Commercial real estate		$	732			$	3,858			$	4,590			$	57			$	5,257
Commercial and industrial			323				20				343				323				343
Construction and development			—				2,609				2,609				—				3,042
Consumer:
Residential real estate			—				695				695				—				877
Construction and development			—				242				242				—				255
Home equity			334				90				424				270				442
Other consumer			13				—				13				2				13
Total		$	1,402			$	7,514			$	8,916			$	652			$	10,229

 

		Three Months Ended March 31, 2014								Three Months Ended March 31, 2013
		Average Balance				Interest Income				Average Balance				Interest Income
Non-PCI Loans
Commercial:
Commercial real estate		$	4,341			$	6			$	1,960			$	—
Commercial and industrial			352				—				—				—
Construction and development			2,445				—				335				—
Consumer:
Residential real estate			923				—				1,232				—
Construction and development			121				—				—				—
Home equity			422				—				1,595				—
Other consumer			7				—				191				—
Total		$	8,611			$	6			$	5,313			$	—

The Company may modify certain loans under terms that are below market in order to maximize the amount collected from a borrower that is experiencing financial difficulties. These modifications are considered to be troubled debt restructurings (“TDRs”). TDRs are evaluated individually for impairment based on the collateral value, if the loan is determined to be collateral dependent, or discounted expected cash flows, if the loan is not determined to be collateral dependent. The Company has no commitments to lend additional funds to any borrowers that have had a loan modified in a TDR. The following table provides the number and recorded investment of TDRs outstanding.

 

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Table of Contents

PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

		March 31, 2014								December 31, 2013
		Recorded Investment				Number				Recorded Investment				Number
TDRs:
Commercial real estate		$	1,713				5			$	815				2
Commercial and industrial			75				2				20				1
Commercial construction			159				1				161				1
Residential real estate			591				6				133				2
Home equity			128				3				90				2
Consumer			—				—				13				1
Total		$	2,666				17			$	1,232				9

The following table provides the number and recorded investment of TDRs modified during the three months ended March 31, 2014 and 2013.

 

		TDRs Modified
		Three Months Ended March 31, 2014								Three Months Ended March 31, 2013
		Recorded Investment				Number				Recorded Investment				Number
TDRs:
Below market interest rate modifications:
Commercial real estate		$	877				3			$	558			$	1
Commercial and industrial			75				2				—				—
Commercial construction			—				—				—				—
Residential real estate			442				3				—				—
Home equity			39				1				—				—
Consumer			—				—				—				—
Total		$	1,433				9			$	558			$	1

No TDRs that were modified in the twelve months ended March 31, 2014 subsequently defaulted during the three months ended March 31, 2014. The Company does not generally forgive principal or unpaid interest as part of when restructuring loans. Therefore, the recorded investment in TDRs during 2014 and 2013 did not change following the modifications.

NOTE F – SBA SERVICING ASSET

All sales of SBA guaranteed loans are executed on a servicing retained basis. The standard sale structure under the SBA Secondary Participation Guaranty Agreement provides for the Company to retain a portion of the cash flow from the interest payment received on the loan. This cash flow is commonly known as a servicing spread. SBA regulations require the lender to keep a minimum 100 basis points in servicing spread for any guaranteed loan sold for a premium. The minimum servicing spread is further defined as a minimum service fee of 40 basis points and a minimum premium protection fee of 60 basis points. The servicing spread is recognized as a servicing asset to the extent the spread exceeds adequate compensation for the servicing function. Industry practice recognizes adequate compensation for servicing SBA loans as the minimum service fee of 40 basis points. The fair value of the servicing asset is measured at the discounted present value of the premium protection fee over the expected life of the related loan using appropriate discount rates and prepayment assumptions based on industry statistics.

SBA servicing assets are initially recognized at fair value and amortized over the expected life of the related loans as a reduction to the servicing income recognized from the servicing spread. Gross servicing spread income, which is recorded within government-guaranteed lending income in the consolidated statements of operations, totaled $192 and $109 for the three months ended March 31, 2014 and 2013, respectively.

The table below summarizes the activity in the SBA servicing asset for the periods presented.

 

		Three Months Ended March 31,
		2014				2013
Balance at January 1		$	1,759				976
Additions			419				193
Amortization			(51	)			(61	)
Balance at March 31		$	2,127				1,108

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

The amortized basis in the servicing asset is tested for impairment quarterly. The fair value of the servicing asset is recalculated and compared to the amortized basis. If the amortized basis exceeds the fair value, the asset is considered impaired and is written down to fair value through a valuation allowance on the asset and a charge against earnings. There was no valuation allowance recorded on the SBA servicing asset at March 31, 2014 or December 31, 2013.

The risks inherent in the SBA servicing asset includes prepayments at different rates than anticipated or resolution of the loan at a date not consistent with the estimated expected life. These events would cause the value of the servicing asset to decline at a faster or slower rate than originally anticipated.

NOTE G – COMMITMENTS AND CONTINGENCIES

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the maximum exposure the Company has in particular classes of financial instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of conditions established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company, upon extension of credit is based on a credit evaluation of the borrower. Collateral obtained varies but may include real estate, equipment, stocks, bonds, and certificates of deposit.

The following table is a summary of the contractual amount of the Company’s exposure to off-balance sheet commitments.

 

		March 31, 2014				December 31, 2013
Commitments to extend credit		$	331,696			$	293,371
Financial standby letters of credit			5,768				8,571
Capital commitment to private investment funds			1,641				1,744

The reserve for unfunded commitments was $317 and $281 as of March 31, 2014 and December 31, 2013, respectively, which was recorded in other liabilities on the consolidated balance sheets.

NOTE H – DERIVATIVE FINANCIAL INSTRUMENTS

The Company uses derivative financial instruments to manage its interest rate risk. These instruments carry varying degrees of credit, interest rate, and market or liquidity risks. Derivative instruments are recognized as either assets or liabilities on the balance sheet and are measured at fair value. Subsequent changes in the fair value of derivatives are recognized in other comprehensive income for effective hedges, and changes in fair value are recognized in earnings for all other derivatives.

Derivative Instruments Related to FHLB Advances

In May 2013, the Company entered into a series of forward starting interest rate swaps on $75,000 of forecasted short-term FHLB advances to reduce its exposure to variability in interest payments attributable to changes in LIBOR. Beginning on the respective effective date, these interest rate swaps will exchange the 90-day LIBOR component of future variable rate interest on short-term borrowings with fixed interest rates ranging from 1.65 to 1.72 percent. Each 90-day FHLB advance, or other short-term borrowing, will be executed to correspond to the effective dates of the respective interest rate swaps and will continue to be rolled for the term of each respective swap. These interest rate swaps are expected to be highly effective and are accounted for as cash flow hedges with the change in fair value recognized in other comprehensive income (“OCI”). The purpose of these cash flow hedges is to better position the Company’s balance sheet for a potentially rising interest rate environment.

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

The following table summarizes key terms of each swap.

 

		Notional Amount				Effective Date		Maturity Date		Fixed Rate
Swap 1		$	25,000			April 6, 2015		April 5, 2020			1.650	%
Swap 2			25,000			May 5, 2015		May 5, 2020			1.683	%
Swap 3			25,000			June 5, 2015		June 5, 2020			1.720	%
		$	75,000

Derivative Instruments Related to Trust Preferred Securities

In August 2003, $8,000 in trust preferred securities (“TRUPs”) were issued through Crescent Financial Capital Trust I (the “Trust”). The Trust invested the total proceeds from the sale of its TRUPs in junior subordinated deferrable interest debentures, which fully and unconditionally guarantees the TRUPs. The TRUPs were adjusted to fair value in connection with the acquisition of Crescent Financial Bancshares, Inc. (“Crescent”), and as of March 31, 2014 and December 31, 2013, the carrying value was $5,577 and $5,560, respectively. The TRUPs pay cumulative cash distributions quarterly at an annual contract rate, reset quarterly, equal to three-month LIBOR plus 3.10 percent. The dividends paid to holders of the TRUPs, which are recorded as interest expense, are deductible for income tax purposes.

In May 2012, the Company entered into an interest rate cap contract which began in July 2012. This derivative financial instrument caps the interest rate on the full $8,000 notional amount of the TRUPs at 3.57 percent through July 2017. In the event that the variable rate on the TRUPs exceeds the cap rate, the counterparty would pay the Company the difference between the variable rate due to the holders of the debentures and the cap rate. This interest rate cap contract is classified as an effective cash flow hedge. Therefore, the change in fair value of the cap is recognized in OCI.

Derivative Instruments Related to Subordinated Term Loan

In September 2008, Crescent entered into an unsecured subordinated term loan agreement in the amount of $7,500. The agreement requires the Bank to make quarterly payments of interest at an annual contract rate, reset quarterly, equal to three-month LIBOR plus 4.00 percent. The subordinated term loan was adjusted to estimated fair value in with the acquisition of Crescent, and as of March 31, 2014 and December 31, 2013, the carrying value was $6,985 and $6,961, respectively.

In May 2012, the Company entered into an interest rate cap which began in July 2012. This derivative financial instrument caps the interest rate on the full $7,500 notional amount of the subordinated term loan at 4.47 percent through July 2017. In the event that the variable rate on the subordinated term loan exceeds the cap rate, the counterparty would pay the Company the difference between the variable rate due on the subordinated term loan and the cap rate. This interest rate cap contract is classified as an effective cash flow hedge. Therefore, the change in fair value of the cap is recognized in OCI.

Loan Commitments

Related to its mortgage banking business, the Company enters into interest rate lock commitments with customers and commitments to sell mortgages to investors under best-efforts contracts. The interest rate lock commitments are entered into to manage the interest rate risk associated with the best-efforts contracts and are considered derivative financial instruments.

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

The following table summarizes the balance sheet location and fair value amounts of derivative instruments.

 

						March 31, 2014								December 31, 2013
		Balance Sheet Location				Notional Amount				Fair Value				Notional Amount				Fair Value
FHLB advances:
Interest rate swaps			Other assets			$	75,000			$	3,028			$	75,000			$	3,962
Trust preferred securities:
Interest rate cap			Other assets				8,000				192				8,000				208
Subordinated term loan:
Interest rate cap			Other assets				7,500				178				7,500				193
Loan commitments:
Interest rate lock commitments			Other assets				18,034				331				17,654				354
										$	3,729							$	4,717

The following table summarizes activity in accumulated OCI related to cash flow hedges for the periods presented.

 

		Three Months Ended March,
		2014				2013
Accumulated OCI resulting from cash flow hedges at beginning of period, net of tax		$	2,381			$	(267	)
Other comprehensive income recognized, net of tax			(584	)			56
Accumulated OCI resulting from cash flow hedges at end of period, net of tax		$	1,797			$	(211	)

The Company monitors the credit risk of the counterparties to the interest rate swaps and caps.

NOTE I – FAIR VALUE MEASUREMENTS

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. For example, investment securities available for sale are recorded at fair value on a recurring basis. Additionally, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, impaired loans and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets. The following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Investment Securities. Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market exchange prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include marketable equity securities traded on an active exchange, such as the New York Stock Exchange. Level 2 securities include mortgage-backed securities and collateralized mortgage obligations, both issued by government sponsored entities, private label mortgage-backed securities, municipal bonds and corporate debt securities. Level 3 securities include certain corporate debt securities with limited trading activity. The following table provides the components of the change in fair value of level 3 available for sale securities for the periods presented.

 

		Three Months Ended March 31,
		2014				2013
Level 3 available for sale securities at beginning of period		$	7,583			$	—
Purchases			—				—
Sales, calls or maturities			(1,000	)			—
Unrealized gains			171				—
Level 3 available for sale securities at end of period		$	6,754			$	—

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

Derivatives. Derivative instruments include interest rate swaps and caps and are valued on a recurring basis using quoted market prices, dealer quotes, or third party pricing models that are primarily sensitive to market observable data. Currently outstanding derivatives are classified as Level 2 within the fair value hierarchy.

Loans. Loans are not recorded at fair value on a recurring basis. However, certain loans are determined to be impaired, and those loans are charged down to estimated fair value. The fair value of impaired loans that are collateral dependent is based on collateral value. For impaired loans that are not collateral dependent, estimated value is based on either an observable market price, if available, or the present value of expected future cash flows. Those impaired loans not requiring a charge-off represent loans for which the estimated fair value exceeds the recorded investments in such loans. When the fair value of an impaired loan is based on an observable market price or a current appraised value with no adjustments, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available, or the Company determines the fair value of the collateral is further impaired below the appraised value, and there is no observable market price, the impaired loan is classified as nonrecurring Level 3.

Interest Rate Lock Commitments. The fair value of interest rate lock commitments is based on servicing rate premium, origination income net of origination costs, fall out rates and changes in loan pricing between the commitment date and period end. There have been no changes in valuation techniques during the three months ended March 31, 2014. Interest rate lock commitments are measured at fair value on a recurring basis and are classified as Level 3. The following table provides the components of the change in fair value of interest rate lock commitments for the periods presented.

 

		Three Months Ended March 31,
		2014				2013
Interest rate lock commitments at beginning of period		$	354			$	795
Issuances			328				928
Settlements			(351	)			(1,227	)
Interest rate lock commitments at end of period		$	331			$	496

The difference between the gross issuances and settlements for the period is included in mortgage banking income within non-interest income.

Foreclosed Assets. Foreclosed assets are adjusted to fair value upon transfer of loans to foreclosed assets. Subsequently, foreclosed assets are carried at lower of cost or net realizable value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. Given the lack of observable market prices for identical properties and market discounts applied to appraised values, the Company classifies foreclosed assets as nonrecurring Level 3.

The following tables summarize information about assets and liabilities measured at fair value.

 

						Fair Value Measurements at March 31, 2014
Description		Assets/(Liabilities) Measured at Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Securities available for sale:
U.S. government-sponsored enterprise securities		$	14,723			$	—			$	14,723			$	—
SBA-guaranteed securities			63,714				63,714				—				—
Residential MBS			209,685				—				209,685				—
Corporate bonds			112,737				—				105,983				6,754
Commercial MBS			4,186				—				4,186				—
Municipal obligations – non-taxable			601				—				601				—
Other debt securities			498				498				—				—
Marketable equity securities			1,087				1,087				—				—
Impaired loans			7,928				—				—				7,928
Foreclosed assets			9,505				—				—				9,505
Interest rate lock commitments			331				—				—				331
Derivative assets			3,398				—				3,398				—

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

						Fair Value Measurements at December 31, 2013
		Assets/(Liabilities) Measured at				Quoted Prices in Active Markets for Identical Assets				Significant Other Observable Inputs				Significant Unobservable Inputs
Description		Fair Value				(Level 1)				(Level 2)				(Level 3)
Securities available for sale:
U.S. government-sponsored enterprise securities		$	14,673			$	—			$	14,673			$	—
SBA-guaranteed securities			65,880				65,880				—				—
Residential MBS			205,260				—				205,260				—
Corporate bonds			110,740				—				103,157				7,583
Commercial MBS			5,938				—				5,938				—
Municipal obligations – non-taxable			601				—				601				—
Municipal obligations – taxable			—				—				—				—
Other debt securities			253				253				—				—
Marketable equity securities			1,043				1,043				—				—
Impaired loans			8,264				—				—				8,264
Foreclosed assets			10,823				—				—				10,823
Interest rate lock commitments			354				—				—				354
Derivative assets			4,363				—				4,363				—

Quantitative Information about Level 3 Fair Value Measurements

The table below outlines the valuation techniques, unobservable inputs, and the range of quantitative inputs used in the valuations. No changes have been mode to any of these factors from December 31, 2013.

 

		Valuation Technique		Unobservable Input		Range				Fair Value at March 31, 2014
Recurring measurements:
Investment securities		Pricing model		Illiquidity or credit factor in discount rates			1-2	%		$	6,754
Interest rate lock commitments		Pricing model		Pull through rates			80-85	%		$	331
Nonrecurring measurements:
Impaired loans		Discounted appraisals		Collateral discounts			15-50	%		$	7,928
		Discounted expected cash flows		Expected loss rates			0-75	%
Foreclosed assets		Discounted appraisals		Collateral discounts			15-50	%		$	9,505

The significant unobservable input used in the fair value measurement of the Company’s interest rate lock commitments is the closing ratio (or pull through rate), which represents the percentage of loans currently in a lock position which management estimates will ultimately close. Generally, the fair value of an interest rate lock commitment is positive (negative) if the prevailing interest rate is lower (higher) than the interest rate lock commitment rate. Therefore, an increase in the pull through rates (i.e., higher percentage of loans estimated to close) will result in the fair value of the interest rate lock commitments increasing in a gain position, or decreasing in a loss position. The pull through ratio is largely dependent on the loan processing stage that a loan is currently in and the change in prevailing interest rates from the time of the rate lock. The pull through rate is computed based on historical internal data and the ratio is periodically reviewed by the Company’s mortgage banking division.

Due to the nature of the Company’s business, a significant portion of its assets and liabilities consist of financial instruments. Accordingly, the estimated fair values of these financial instruments are disclosed. Quoted market prices, if available, are utilized as an estimate of the fair value of financial instruments. The fair value of such instruments has been derived based on assumptions with respect to future economic conditions, the amount and timing of future cash flows and estimated discount rates. Different assumptions could significantly affect these estimates. Accordingly, the net amounts ultimately collected could be materially different from the estimates presented below. In addition, these estimates are only indicative of the values of individual financial instruments and should not be considered an indication of the fair value of the Company taken as a whole.

Cash and Cash Equivalents. The carrying amounts for cash and cash equivalents are equal to fair value.

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

Investment Securities Available for Sale. See discussion related to fair value estimates for securities available for sale in the fair value hierarchy section above. There have been no changes in valuation techniques for the three months ended March 31, 2014.

Investment Securities Held to Maturity. The fair value of the one corporate bond classified as held to maturity at December 31, 2013 was estimated based on recent issuance yields on subordinated debt from companies with a similar credit and liquidity profile. Due to the non-marketable nature of this bond, it was classified as Level 3. This bond was called at par by the issuer in the first quarter of 2014. The fair value of the municipal securities classified as held to maturity at March 31, 2014 are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. These securities are classified as Level 2 in the fair value hierarchy since the inputs used in the valuation are readily available market inputs.

Loans Held For Sale. The fair value of mortgage loans held for sale is based on commitments on hand from investors within the secondary market for loans with similar characteristics. There have been no changes in valuation techniques for the three months ended March 31, 2014.

Loans. Expected cash flows are forecasted over the remaining life of each loan and are discounted to present value at current market interest rates for similar loans considering loan collateral type and credit quality. There have been no changes in valuation techniques for the three months ended March 31, 2014.

Federal Home Loan Bank Stock. Given the option to redeem this stock at par through the FHLB, the carrying value of FHLB stock approximates fair value. There have been no changes in valuation techniques for the three months ended March 31, 2014.

Bank-Owned Life Insurance. Bank-owned life insurance investments are recorded at their cash surrender value, or the amount that can be realized upon surrender. Therefore, carrying value approximates fair value.

Purchased Accounts Receivable. Purchased accounts receivable, which are classified in other assets on the consolidated balance sheet, are initially recorded at fair value and generally have maturities between 30 and 60 days. Due to the short duration of these assets, the carrying value approximates fair value.

Deposits. The fair value of demand deposits, savings, money market and NOW accounts represents the amount payable on demand. The fair value of time deposits is estimated by calculating the present value of cash flows on the time deposit portfolio discounted using interest rates currently offered for instruments of similar remaining maturities. There have been no changes in valuation techniques for the three months ended March 31, 2014.

Short-term Borrowings and Long-term Debt. The fair value of short-term borrowings and long-term debt are based upon the discounted value when using current rates at which borrowings of similar maturity could be obtained. There have been no changes in valuation techniques for the three months ended March 31, 2014.

Accrued Interest Receivable and Accrued Interest Payable. The carrying amounts of accrued interest receivable and payable approximate fair value due to the short maturities of these instruments. There have been no changes in valuation techniques for the three months ended March 31, 2014.

Derivative Instruments. See discussion related to fair value estimates for derivative instruments in the fair value hierarchy section above. There have been no changes in valuation techniques for the three months ended March 31, 2014.

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

The following tables summarize the carrying amounts and estimated fair values of the Company’s financial instruments.

 

		March 31, 2014
		Carrying Amount				Fair Value				Level 1				Level 2				Level 3
Financial assets:
Cash and cash equivalents		$	73,443			$	73,443			$	73,443			$	—			$	—
Investment securities available for sale			407,231				407,231				65,299				335,178				6,754
Investment securities held to maturity			3,119				3,119				—				3,119				—
Loans held for sale			11,158				11,158				—				11,158				—
Loans, net			1,377,519				1,369,990				—				—				1,369,990
Federal Home Loan Bank stock			8,455				8,455				—				8,455				—
Bank-owned life insurance			33,386				33,386				—				33,386				—
Derivative assets			3,729				3,729				—				3,398				331
Purchased accounts receivable			39,762				39,762				—				39,762				—
Accrued interest receivable			4,631				4,631				—				4,631				—
Financial liabilities:
Deposits			1,654,804				1,656,092				—				1,656,092				—
Short-term borrowings			129,500				129,720				—				—				129,720
Long-term debt			69,961				72,314				—				—				72,314
Accrued interest payable			1,372				1,372				—				1,372				—

 

		December 31, 2013
		Carrying Amount				Fair Value				Level 1				Level 2				Level 3
Financial assets:
Cash and cash equivalents		$	100,779			$	100,779			$	100,779			$	—			$	—
Investment securities available for sale			404,388				404,388				67,176				329,882				7,583
Investment securities held to maturity			500				500				—				—				500
Loans held for sale			8,663				8,663				—				8,663				—
Loans, net			1,382,623				1,377,270				—				—				1,377,270
Federal Home Loan Bank stock			8,929				8,929				—				8,929				—
Bank-owned life insurance			33,148				33,148				—				33,148				—
Derivative assets			4,717				4,717				—				4,363				354
Purchased accounts receivable			18,725				18,725				—				18,725				—
Accrued interest receivable			5,387				5,387				—				5,387				—
Financial liabilities:
Deposits			1,675,309				1,677,253				—				1,677,253				—
Short-term borrowings			126,500				126,726				—				—				126,726
Long-term debt			72,921				72,397				—				—				72,397
Accrued interest payable			1,817				1,817				—				1,817				—

NOTE J - STOCKHOLDERS’ EQUITY

VantageSouth Series A Preferred Stock

Pursuant to the Treasury’s TARP Capital Purchase Program, Crescent issued $24,900 in Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”), on January 9, 2009. In addition, Crescent provided a warrant to the Treasury to purchase 833,705 shares of its common stock at an exercise price of $4.48 per share. This warrant was immediately exercisable and expired ten years from the date of issuance. The Series A Preferred Stock was non-voting, other than having class voting rights on certain matters, and paid cumulative dividends quarterly at a rate of 5 percent per annum for the first five years and 9 percent per annum thereafter.

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

The Company assigned a fair value to both the Series A Preferred Stock and common stock warrant in connection with Piedmont’s acquisition of Crescent. These securities represented non-controlling interests that were recorded at estimated fair value. The Series A Preferred Stock was valued based on forecasting expected cash flows with an assumed repayment date and discounting these cash flows based on current market yields for preferred stock with similar risk. For purposes of the discount rate, the Company used the market yield on an index of publicly traded preferred stocks adjusted for a liquidity factor. The Series A Preferred Stock was assigned a fair value of $24,400 at acquisition, and the discount between this value and the $24,900 redemption value was accreted as a reduction to retained earnings through the redemption date. The common stock warrant was valued at $1.59 per share, or $1,325 in the aggregate, at acquisition using a Black-Scholes option pricing model.

VantageSouth Series B Preferred Stock

Pursuant to the ECB Merger Agreement, VantageSouth agreed to exchange each share of ECB’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, into one share of its Series B Preferred Stock. The redemption value of the Series B Preferred Stock was $17,949. At the closing of the ECB Merger, VantageSouth also issued a warrant to purchase 514,693.2 shares of its common stock to the Treasury in exchange for the warrant issued by ECB to Treasury on January 16, 2009 to purchase 144,984 shares of ECB’s common stock. The warrant issuance reflected the exchange ratio associated with the ECB Merger. This warrant was immediately exercisable and expired ten years from the date of issuance. The Series B Preferred Stock was non-voting, other than having class voting rights on certain matters, and paid cumulative dividends quarterly at a rate of 5 percent per annum for the first five years and 9 percent per annum thereafter.

The Company assigned a fair value to both the Series B Preferred Stock and common stock warrant in connection with the ECB Merger. These securities represented non-controlling interests that were recorded at estimated fair value. The Series B Preferred Stock was valued based on forecasting expected cash flows with an assumed repayment date and discounting these cash flows based on current market yields for preferred stock with similar risk. For purposes of the discount rate, the Company used the market yield on an index of publicly traded preferred stocks adjusted for a liquidity factor. The Series B Preferred Stock was assigned a fair value of $17,553 at acquisition, and the discount between this value and the $17,949 redemption value was accreted as a reduction to retained earnings through the redemption date.

The common stock warrant was valued at $0.26 per share, or $132 in the aggregate, at acquisition using a Black-Scholes option pricing model. Assumptions used in the Black-Scholes option pricing model were as follows:

 

Risk-free interest rate*			0.14	%
Expected life of warrants			10.5 months
Expected dividend yield			—
Expected volatility			42.97	%

 

*	The risk-free interest rate was based on the market yield for one-year U.S. Treasury securities as of the ECB acquisition date.

VantageSouth Common Stock Offering and Preferred Stock Repurchase

On January 31, 2014, VantageSouth completed the sale of 9.2 million shares of its common stock for $46,900 in a private placement issuance to new and existing accredited investors, including certain members of VantageSouth’s Board of Directors and their affiliates (the “Capital Raise”). The net proceeds of the Capital Raise were primarily used to repurchase VantageSouth’s Series A and Series B Preferred Stock, which occurred on February 19, 2014 and to repurchase the outstanding warrants for VantageSouth common stock held by the Treasury, which occurred on June 11, 2014.

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

NOTE K - CHANGES IN ACCUMULATED OTHER COMPREHENSIVE INCOME

The following table summarizes the activity in accumulated other comprehensive income (loss), net of tax, for the periods presented.

 

		Investment Securities Available For Sale				Cash Flow Hedges				Accumulated Other Comprehensive Income (Loss)
Balance at January 1, 2014		$	(6,554	)		$	2,381			$	(4,173	)
Other comprehensive income (loss) before reclassifications, net of tax			2,036				(584	)			1,452
Amounts reclassified from accumulated other comprehensive income (loss), net of tax			—				—				—
Net other comprehensive income (loss) during period			2,036				(584	)			1,452
Balance at March 31, 2014			(4,518	)			1,797				(2,721	)
Non-controlling interests, net of tax			(1,882	)			748				(1,134	)
AOCI attributable to Piedmont at December 31, 2013		$	(2,636	)		$	1,049			$	(1,587	)
Balance at January 1, 2013		$	2,085			$	(267	)		$	1,818
Other comprehensive income (loss) before reclassifications, net of tax			(40	)			56				16
Amounts reclassified from accumulated other comprehensive income (loss), net of tax			(671	)			—				(671	)
Net other comprehensive income (loss) during period			(711	)			56				(655	)
Balance at March 31, 2013			1,374				(211	)			1,163
Non-controlling interests, net of tax			180				(28	)			152
AOCI attributable to Piedmont at December 31, 2013		$	1,194			$	(183	)		$	1,011

Amounts reclassified from accumulated other comprehensive are included in the consolidated statements of operations as follows.

 

Accumulated Other Comprehensive Income Component		Amount Reclassified								Line Item Within Statement of Operations
		Three Months Ended March 31, 2014				Three Months Ended March 31, 2013
Investment securities available for sale:
Gross reclassification		$	—			$	(1,092	)		Gain on sale of available for sale securities
Income tax expense			—				421			Income taxes
Reclassification, net of tax		$	—			$	(671	)

 

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PIEDMONT COMMUNITY BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

 

NOTE L - SUBSEQUENT EVENTS

For the purpose of the accompanying unaudited consolidated financial statements, subsequent events have been evaluated through July 3, 2014, which is the date these financial statements were available to be issued.

The Company completed the liquidation of loans held by VantageSouth Holdings, LLC in the second quarter of 2014 and dissolved the legal entity on June 25, 2014.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations

Piedmont Community Bank Holdings, Inc. (the “Company” or “Piedmont”) is a bank holding company incorporated under the laws of Delaware on May 7, 2009. The Company was formed to build a community banking franchise in North Carolina and surrounding markets. The Company owns approximately 58 percent of VantageSouth Bancshares, Inc. (“VantageSouth”), which is also a Delaware-chartered bank holding company. Both the Company and VantageSouth conduct their business operations primarily through VantageSouth Bank (the “Bank”), which is the wholly-owned banking subsidiary of VantageSouth.

Management’s discussion and analysis is intended to assist readers in understanding and evaluating the financial condition and consolidated results of operations of the Company. This discussion and analysis includes descriptions of significant transactions, trends and other factors affecting the Company’s operating results for the three months ended March 31, 2014 and 2013 as well as the financial condition of the Company as of March 31, 2014 and December 31, 2013. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and accompanying notes included in this report.

Mergers and Acquisitions

Proposed Merger With Yadkin Financial Corporation

On January 27, 2014, VantageSouth and Piedmont entered into an Agreement and Plan of Merger with Yadkin Financial Corporation (“Yadkin”) under which VantageSouth and Piedmont will each merge with and into Yadkin (referred to collectively as the “Yadkin Merger”). Immediately following the completion of the Yadkin Merger, VantageSouth Bank will merge with and into Yadkin Bank, Yadkin’s wholly-owned banking subsidiary.

In the Yadkin Merger, each outstanding share of VantageSouth’s common stock, other than shares held by Piedmont, will be converted into the right to receive 0.3125 shares of Yadkin common stock. Each share of Piedmont’s common stock will be converted into the right to receive (i) 6.28597 shares of Yadkin common stock, which is based on the effective exchange ratio for VantageSouth’s common stock; (ii) a pro rata portion of cash based on Piedmont’s deferred tax asset (with the precise amount to be determined by an independent evaluation); (iii) a pro rata portion of cash in an amount equal to the aggregate amount of any cash held by Piedmont at the closing of the Yadkin Merger; and (iv) a right to receive a pro rata portion of certain shares of Yadkin voting common stock at a later date if such shares do not become payable under the Piedmont Phantom Equity Plan. Pursuant to the Yadkin Merger Agreement, Yadkin will be the legal acquirer, but Piedmont and its consolidated subsidiaries (which includes VantageSouth) will be the accounting acquirer since Piedmont and other non-controlling VantageSouth stockholders will control approximately 55 percent of outstanding voting shares of the combined company. Based on recent filings, as of March 31, 2014, Yadkin had total assets of $1,813,487, deposits of $1,525,474, and shareholders’ equity of $188,776. The Yadkin Merger has been approved by all stockholders and required regulatory agencies.

Yadkin Bank is a full-service community bank with thirty-three branches throughout its two regions in North and South Carolina. The Western Region serves Avery, Watauga, Ashe, Surry, Wilkes, Yadkin, Durham, and Orange Counties in North Carolina. The Southern Region serves Iredell, Mecklenburg, and Union Counties in North Carolina, and Cherokee and York Counties in South Carolina. Yadkin Bank provides mortgage lending services through its mortgage division, Yadkin Mortgage, headquartered in Greensboro, North Carolina. Securities brokerage services are provided by Yadkin Wealth, Inc., a Yadkin Bank subsidiary with offices located throughout the branch network.

 

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ECB Bancorp, Inc. Merger

On April 1, 2013, the Company completed the merger of ECB Bancorp, Inc. (“ECB”) with and into VantageSouth (the “ECB Merger”). The ECB Merger was completed pursuant to an Agreement and Plan of Merger dated as of September 25, 2012 (the “Merger Agreement”). Immediately following the ECB Merger, The East Carolina Bank, a wholly-owned subsidiary of ECB, was merged with and into VantageSouth Bank. Upon the closing of the ECB Merger, each outstanding share of ECB common stock was converted into the right to receive 3.55 shares of common stock of VantageSouth. The aggregate merger consideration consisted of 10.3 million shares of VantageSouth’s common stock. Based upon the market price of VantageSouth’s common stock immediately prior to the ECB Merger, the transaction value was $40,629.

In connection with the ECB merger, the Company applied the acquisition method of accounting to ECB’s balance sheet. Therefore, all acquired assets and liabilities were adjusted to fair value, and the historical allowance for loan losses was eliminated. The Company recorded a one-time acquisition gain of $7.4 million in the second quarter of 2014, which reflected the amount by which the fair value of acquired net assets exceeded the combined purchase price and fair value of other equity interests. The Company had a one-year measurement period from the acquisition date to finalize the recorded fair values of net assets acquired. The Company’s results of operations and financial position were significantly impacted by the ECB Merger.

Executive Summary

The following is a summary of the Company’s financial results and significant events in the first quarter of 2014:

 

•

Net income was $2.2 million in 1Q 2014 compared to a net loss of $1.2 million in 1Q 2013. Net income in these periods was impacted by $1.6 million and $1.0 million, respectively, in combined merger and restructuring costs, net of tax.

 

•

Pre-tax, pre-provision operating earnings totaled $7.3 million in 1Q 2014, which was an increase from $828 thousand in 1Q 2013.

 

•

Annualized net operating return on average assets equaled 0.74 percent in 1Q 2014, which was an improvement from (0.31) percent in 1Q 2013.

 

•

Government-guaranteed, small business lending income improved to $2.3 million in 1Q 2014 from $1.1 million in 1Q 2013 while loan originations by this group totaled $30.7 million in the first quarter of 2014.

 

•

Operating efficiency ratio improved to 70.1 percent in 1Q 2014 from 93.3 percent in 1Q 2013.

 

•

Net interest margin in 1Q 2014 equaled 4.27 percent compared to 4.26 percent in 1Q 2013.

 

•

The Company announced a proposed merger with Yadkin Financial Corporation (“Yadkin”), which will create the largest community bank in North Carolina.

 

•

VantageSouth completed a private placement of $46.9 million of its common stock, which was primarily used to redeem its outstanding preferred stock previously issued to the U.S. Department of Treasury (“Treasury”).

Non-GAAP Financial Measures

Statements included in this management’s discussion and analysis include non-GAAP financial measures and should be read along with the accompanying tables which provide a reconciliation of non-GAAP financial measures to GAAP financial measures. The Company’s management uses these non-GAAP financial measures, including: (i) net operating earnings (loss); (ii) pre-tax, pre-provision operating earnings, (iii) operating non-interest expense, (iv) operating efficiency ratio, (v) adjusted allowance for loan losses to loans; and (vi) tangible common equity, in its analysis of the Company’s performance. The adjusted allowance for loan losses non-GAAP reconciliation is presented within the allowance for loan losses section of Management’s Discussion and Analysis of Financial Condition below. The tangible common equity non-GAAP reconciliations, which include tangible book value per share and the tangible common equity to tangible assets ratio, are presented within the capital section of Management’s Analysis of Financial Condition below.

 

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		Three Months Ended March 31,
(Dollars in thousands)		2014				2013
OPERATING EARNINGS
Net income (loss) (GAAP)		$	2,234			$	(1,226	)
Securities gains			—				(1,092	)
Merger and conversion costs			1,209				1,601
Restructuring charges			836				—
Income tax effect of adjustments			(452	)			(125	)
Net operating earnings (loss) (Non-GAAP)		$	3,827			$	(842	)
Net operating return on average assets			0.74	%			(0.31	)%
Net operating return on average equity			6.09	%			(1.89	)%
PRE-TAX, PRE-PROVISION OPERATING EARNINGS
Net income (loss) (GAAP)		$	2,234			$	(1,226	)
Provision for loan losses			1,290				1,940
Income tax expense (benefit)			1,681				(395	)
Pre-tax, pre-provision income			5,205				319
Securities gains			—				(1,092	)
Merger and conversion costs			1,209				1,601
Restructuring charges			836				—
Pre-tax, pre-provision operating earnings (Non-GAAP)		$	7,250			$	828
OPERATING NON-INTEREST EXPENSE
Non-interest expense (GAAP)		$	19,036			$	13,204
Merger and conversion costs			(1,209	)			(1,601	)
Restructuring charges			(836	)			—
Operating non-interest expense (Non-GAAP)		$	16,991			$	11,603
OPERATING EFFICIENCY RATIO
Efficiency ratio (GAAP)			78.53	%			97.64	%
Effect to adjust for securities gains			—	%			8.58	%
Effect to adjust for restructuring charges			(3.45	)%			—	%
Effect to adjust for merger and conversion costs			(4.99	)%			(12.88	)%
Operating efficiency ratio (Non-GAAP)			70.09	%			93.34	%

Management believes that non-GAAP financial measures provide additional useful information that allows readers to evaluate the ongoing performance of the Company without regard to transactional activities. Non-GAAP financial measures should not be considered as an alternative to any measure of performance or financial condition as promulgated under GAAP, and investors should consider the Company’s performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the Company. Non-GAAP financial measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of the Company’s results or financial condition as reported under GAAP.

Analysis of Results of Operations

Net income was $2.2 million in the first quarter of 2014, which was an improvement from a net loss of $1.2 million in the first quarter of 2013. Net income attributable to Piedmont was $1.2 million, or $0.85 per common share, in the first quarter of 2014 compared to a net loss attributable of $1.4 million, or $0.97 per common share, in the first quarter of 2013. Net operating earnings, which exclude securities gains, merger and conversion costs, and restructuring charges, improved to $3.8 million in the first quarter of 2014 from a net loss of $842 thousand in the first quarter of 2013 as the Company improved its financial performance following the ECB Merger by increasing net interest income, lowering provision for loan losses, increasing non-interest income, and by reducing its operating efficiency ratio. Similarly, pre-tax, pre-provision operating earnings increased to $7.3 million in the first quarter of 2014 from $828 thousand in the first quarter of 2013.

 

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Net Interest Income

Net interest income was $19.6 million in the first quarter of 2014 compared to $10.1 million in the first quarter of 2013. The increase in net interest income was the result of a significant increase in earning assets from organic business activity and the ECB Merger. Average earning assets increased from $960.7 million in the first quarter of 2013 to $1.86 billion in the first quarter of 2014. Over this period, average loan balances increased by $615.3 million, of which $466.5 million was from acquired ECB loans, and average investment securities balances increased by $264.4 million. In addition, average deposits increased by $771.6 million, of which $736.1 million was from the ECB Merger.

The Company’s net interest margin increased from 4.26 percent in the first quarter of 2013 to 4.27 percent in the first quarter of 2014. The increase in net interest margin was due lower costs on interest-bearing liabilities mostly offset by a reduction in yields on interest-earning assets. The yield on earning assets declined from 4.93 percent in the first quarter of 2013 to 4.87 percent in the first quarter of 2014, which reflected lower yields on investment securities partially offset by an increase in loan yields. Securities yields declined as the Company reinvested principal paydowns and proceeds from sales at lower current market rates. The increase in loan yields was a product of favorable impact of acquisition accounting fair value adjustments on loans following the ECB Merger partially offset by lower prevailing market loan rates on new loan originations.

The cost of interest-bearing liabilities declined from 0.76 percent in the first quarter of 2013 to 0.69 percent in the first quarter of 2014, which primarily reflected a lower cost of deposits as the Company adjusted interest rates it pays on certain checking and money market accounts in the second quarter of 2013 and incorporated the ECB deposit base. The Company also increased its level of short-term borrowings in the form of FHLB advances which lowered overall funding costs. These reductions were partially offset by an increase in the cost of long-term debt from the issuance of $38.1 million in 10-year subordinated notes at a fixed rate of 7.625 percent in the third quarter of 2013. These subordinated notes were issued to further strengthen and diversify the Company’s regulatory capital position.

Income accretion on purchased loans totaled $5.1 million in the first quarter of 2014, which consisted of $3.1 million of accretion on purchased credit-impaired (“PCI”) loans and $2.0 million of accretion income on purchased non-impaired loans. Income accretion on purchased loans in the first quarter of 2013 totaled $3.6 million, which included $3.4 million of accretion on PCI loans and $118 thousand of accretion income on purchased non-impaired loans. Accretion income on purchased non-impaired loans included $631 thousand of accelerated accretion due to principal prepayments in the first quarter of 2014. Fair value amortization on interest-bearing liabilities totaled $624 thousand in the first quarter of 2014 and $446 thousand in the first quarter of 2013, which reduced interest expense in both periods.

 

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The following table summarizes the major components of net interest income and the related yields and costs for the periods presented.

 

		Three months ended March 31, 2014												Three months ended March 31, 2013
(Dollars in thousands)		Average Balance				Interest*				Yield/Cost*				Average Balance				Interest*				Yield/Cost*
Assets
Loans (1)		$	1,402,868			$	20,331				5.88	%		$	787,612			$	10,814				5.57	%
Investment securities (2)			407,831				1,990				1.98				143,475				857				2.42
Federal funds and other			49,177				26				0.21				29,625				16				0.22
Total interest-earning assets			1,859,876				22,347				4.87	%			960,712				11,687				4.93	%
Non-interest-earning assets			242,890												134,260
Total assets		$	2,102,766											$	1,094,972
Liabilities and Equity
Interest-bearing demand		$	348,047				180				0.21	%		$	181,505				139				0.31	%
Money market and savings			469,288				349				0.30				264,917				343				0.53
Time			630,840				1,130				0.73				363,248				820				0.92
Total interest-bearing deposits			1,448,175				1,659				0.46				809,670				1,302				0.65
Short-term borrowings			116,900				78				0.27				7,200				12				0.68
Long-term debt			71,873				1,031				5.82				23,211				270				4.72
Total interest-bearing liabilities			1,636,948				2,768				0.69	%			840,081				1,584				0.76	%
Noninterest-bearing deposits			201,047												67,970
Other liabilities			10,115												6,444
Total liabilities			1,848,110												914,495
Stockholders’ equity			254,656												180,477
Total liabilities and stockholders’ equity		$	2,102,766											$	1,094,972
Net interest income, taxable equivalent						$	19,579											$	10,103
Interest rate spread (3)											4.18	%											4.17	%
Tax equivalent net interest margin (4)											4.27	%											4.26	%
Percentage of average interest-earning assets to average interest-bearing liabilities											113.62	%											114.36	%

 

*	Taxable equivalent basis

(1)	Loans include loans held for sale and nonaccrual loans.

(2)	Yields related to investment securities exempt from income taxes are stated on a taxable-equivalent basis assuming a federal income tax rates of 34.0 percent. The taxable-equivalent adjustment was $5 thousand, and $42 thousand for the 2014 and 2013 periods, respectively.

(3)	Net interest spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(4)	Net interest margin represents annualized net interest income divided by average interest-earning assets.

 

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Changes in interest income and interest expense can result from variances in both volume and rates. The following table presents the relative impact on tax-equivalent net interest income to changes in the average outstanding balances of interest-earning assets and interest-bearing liabilities and the rates earned and paid on such assets and liabilities.

 

		Change from 2013 to 2014 due to:
(Dollars in thousands)		Volume				Yield/Cost				Total Change
Interest earning assets:
Loans		$	8,881			$	636			$	9,517
Investment securities			1,316				(183	)			1,133
Federal funds and other interest-earning assets			11				(1	)			10
Total interest-earning assets			10,208				452				10,660
Interest-bearing liabilities:
Interest-bearing demand			97				(56	)			41
Money market and savings			193				(187	)			6
Time deposits			504				(194	)			310
Total interest-bearing deposits			794				(437	)			357
Short-term borrowings			77				(11	)			66
Long-term debt			685				76				761
Total interest-bearing liabilities			1,556				(372	)			1,184
Change in net interest income		$	8,652			$	824			$	9,476

Provision for Loan Losses

Provision for loan losses was $1.3 million in the first quarter of 2014 compared to $1.9 million in the first quarter of 2013. The allowance for loan and lease losses (“ALLL”) and related provision were calculated separately for non-PCI loans and PCI loans. In the first quarter of 2014, the non-PCI loan provision was $1.6 million which was offset by PCI loan provision recovery of $312 thousand. The following table summarizes the changes in the ALLL for each loan category in 1Q 2014 and 1Q 2013.

 

(Dollars in thousands)		Non-PCI Loans				PCI Loans				Total
1Q 2014:
Balance at January 1, 2014		$	4,682			$	2,361			$	7,043
Net charge-offs			(1,120	)			—				(1,120	)
Provision for loan losses			1,602				(312	)			1,290
Balance at March 31, 2014		$	5,164			$	2,049			$	7,213
1Q 2013:
Balance at January 1, 2013		$	2,720			$	1,278			$	3,998
Net charge-offs			(411	)			—				(411	)
Provision for loan losses			735				1,205				1,940
Balance at March 31, 2013		$	3,044			$	2,483			$	5,527

The decrease in provision for loan losses in the first quarter of 2014 compared to the prior year first quarter was primarily due to the recovery of $312 thousand in previous impairment on certain PCI loan pools in the first quarter of 2014 compared to $1.2 million impairment on certain PCI loan pools in the prior year. The reduction in provision expense on PCI loans was partially offset by higher provision on non-PCI loans during first quarter of 2014. Provision expense on non-PCI loans was impacted by higher net loan charge-offs which increased to 0.32 percent of average loans in the first quarter of 2014 from 0.21 percent in the first quarter of 2013.

The ALLL was $7.2 million, or 0.52 percent of total loans as of March 31, 2014, compared to $7.0 million, or 0.51 percent of total loans as of December 31, 2013, and $5.5 million, or 0.69 percent of total loans as of March 31, 2013. Nonperforming loans as a percentage of total loans was 1.49 percent as of March 31, 2014, which was a slight decrease from 1.50 percent as of December 31, 2013 and a slight increase from 1.48 percent as of March 31, 2013. Total nonperforming assets (which include nonaccrual loans, loans past due 90 days or more and still accruing, and foreclosed assets) as a percentage of total assets was 1.43 percent as of March 31, 2014, which was a decline from 1.48 percent as of December 31, 2013 and 1.48 percent as of March 31, 2013.

 

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Due to the significance of the Company’s acquired loan portfolio, traditional credit ratios should not be used when comparing prior periods to the current period or when comparing the Company to other financial institutions. Specifically, (i) the ALLL to total loans, (ii) ALLL to nonperforming loans, and (iii) ALLL to nonperforming assets should not be compared to prior periods or other financial institutions.

Loans acquired with evidence of credit deterioration since origination are accounted for as PCI loans. Subsequent to acquisition of these loans, estimates of cash flows expected to be collected are updated each reporting period based on assumptions regarding default rates, loss severities, and other factors that reflect current market conditions. If the Company has probable decreases in cash flows expected to be collected (other than due to decreases in interest rates), the provision for loan losses is charged, resulting in an increase to the allowance for loan losses. Events that would result in probable decreases in expected cash flows include; (i) reductions in estimated collateral values for collateral dependent loans, (ii) loans becoming collateral dependent during the period for which there is an estimated collateral shortfall, (iii) non-payment of cash flows expected to be collected in prior re-estimations, and (iv) deterioration in the weighted average credit grade or past due status for loans with cash flows estimated based on these factors. If there are probable and significant increases in cash flows expected to be collected, the Company will first reverse any previously established allowance for loan losses and then increase interest income as a prospective yield adjustment over the remaining life of the loans. Events that would result in probable increases in expected cash flows include; (i) increases in estimated collateral values for collateral dependent loans, (ii) loans becoming non-collateral dependent during the period for which there was an estimated collateral shortfall in prior estimations, (iii) actual cash flow collections in excess of prior estimates, and (iv) improvement in the weighted average credit grade or past due status for loans with cash flows estimated based on these factors.

Results of the Company’s first quarter 2014 cash flow re-estimation for PCI loans are summarized as follows.

 

(Dollars in thousands)		Impairment				Cash Flow Improvement				New Yield				Previous Yield
Loan pools with cash flow improvement		$	(446	)		$	581				7.18	%			6.92	%
Loan pools with impairment			134				—				8.04	%			8.04	%
Total		$	(312	)		$	581				7.29	%			7.09	%

The first quarter of 2014 cash flow re-estimation indicated a total improvement in the present value of estimated cash flows on PCI loan pools of $893 thousand. The $581 thousand of estimated cash flow improvement on loan pools without previous impairment will be recorded as additional interest income as a prospective yield adjustment over the remaining life of the loans. The $312 thousand impairment recovery was recorded as a reduction to provision expense in the first quarter of 2014. The pool-level impairment and cash flow improvement were calculated as the difference between the pool-level recorded investment and the net present value of estimated cash flows at the time of the cash flow re-estimation. The recovery of provision expense in the first quarter of 2014 was primarily the result of cash flow improvements in commercial real estate and residential real estate pools that had impairment in prior periods. The increase in expected cash flows in these pools was primarily the result of increases in estimated collateral values for collateral dependent loans and actual cash flows in excess of previous estimates.

Non-Interest Income

The following table provides a summary of non-interest income for the periods presented.

 

		Three Months Ended March 31,
(Dollars in thousands)		2014				2013
Service charges and fees on deposit accounts		$	1,315			$	515
Government-guaranteed lending			2,341				1,119
Mortgage banking			318				391
Bank-owned life insurance			306				195
Gain on sales of available for sale securities			—				1,092
Other			387				150
Total non-interest income		$	4,667			$	3,462

 

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Non-interest income totaled $4.7 million in the first quarter of 2014, which was an increase from $3.5 million in the first quarter of 2013. The increase was primarily the result of higher income from the Company’s government-guaranteed, small business lending program of $1.2 million on higher production and loan sales. The Company also realized higher income from service charges by $800 thousand primarily due to the acquisition of deposit accounts in the ECB merger. Bank-owned life insurance was also higher due to insurance policies acquired in the ECB merger. Gains on sales of available for sale securities declined by $1.1 million as no securities were sold in the first quarter of 2014.

Non-Interest Expense

The following table provides a summary of non-interest expense for the periods presented.

 

		Three Months Ended March 31,
(Dollars in thousands)		2014				2013
Salaries and employee benefits		$	9,098			$	6,467
Occupancy and equipment			2,656				1,567
Data processing			1,030				644
FDIC deposit insurance premiums			390				227
Professional services			685				502
Foreclosed asset expenses			263				183
Loan, collection, and repossession expense			679				461
Merger and conversion costs			1,209				1,601
Restructuring charges			836				—
Other			2,190				1,552
Total non-interest expense		$	19,036			$	13,204

Non-interest expense totaled $19.0 million in the first quarter of 2014, which was an increase from $13.2 million in the first quarter of 2013. Higher expenses were primarily due to increases in salaries and employee benefits, occupancy and equipment, data processing, and other non-interest expense categories due to the ECB Merger which added employees, branch and other facilities, and equipment to the Company’s expense base. The Company’s operating efficiency ratio, which excludes non-recurring merger and conversion costs and restructuring charges, improved from 93.3 percent in the first quarter of 2013 to 70.1 percent in the first quarter of 2014. Restructuring charges in the first quarter of 2014 consisted of severance expenses related to a branch optimization plan that will result in the closure or sale of five underperforming branches as well as an initiative to streamline the Company’s organizational structure in certain back office functions. The branch closures occurred in May 2014. The Company expects further restructuring charges and cost savings in the second quarter of 2014 as these cost cutting initiatives are fully implemented. Much of the improvement in the operating efficiency ratio was due to increased scale and operating leverage provided by the ECB merger combined with cost cutting measures implemented since the merger which will continue to benefit the Company going forward. For example, full time equivalent employees for the combined Company have decreased from 520 at the ECB merger date to 448 as of March 31, 2014.

Income Taxes

The Company’s income tax expense was $1.7 million in the first quarter of 2014 compared to an income tax benefit of $395 thousand in the first quarter of 2013. Taxable income is calculated using pre-tax net income adjusted for non-taxable municipal investment income, bank-owned life insurance income, and non-deductible merger costs.

Based on the Company’s analysis of positive and negative evidence regarding future realization of its deferred tax assets, which included an evaluation of historical and forecasted pre-tax earnings, net operating loss carryforward periods, asset quality trends, capital levels, and potential tax planning strategies, the Company determined that there was sufficient positive evidence to indicate that it would likely realize the full value of VantageSouth’s deferred tax assets and therefore determined that no valuation allowance on VantageSouth’s deferred tax assets was needed as of March 31, 2014. However, due to certain limitations on the utilization of deferred taxes at the Piedmont holding company level, the Company has placed a full valuation allowance totaling $5.0 million on deferred taxes generated at Piedmont.

 

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Analysis of Financial Condition

Total assets were $2.11 billion as of March 31, 2014, which was a decrease of $13.7 million as compared to December 31, 2013. Earning assets totaled $1.86 billion, or 88 percent of total assets, as of March 31, 2014 compared to $1.89 billion, or 89 percent of total assets, as of December 31, 2013. Earning assets as of March 31, 2014 consisted of $1.38 billion in gross loans, $11.2 million in loans held for sale, $418.8 million in investment securities, including FHLB stock, and $42.5 million in interest-earning deposits with correspondent banks. Deposits were $1.65 billion as of March 31, 2014, which was a decrease of $17.4 million as compared to December 31, 2013. Short-term borrowings increased by $3.0 million in the year-to-date period while long-term debt declined by $3.0 million. Stockholders’ equity increased by $5.3 million, which was primarily due to first quarter 2014 net income, other comprehensive income, and the net impact of VantageSouth’s common stock issuance, which was primarily used to redeem outstanding preferred stock previously issued to the Treasury.

The following table has provides the year-to-date changes in major balance sheet components.

 

(Dollars in thousands)		March 31, 2014				December 31, 2013				YTD Change
Cash and cash equivalents		$	73,443			$	100,780			$	(27,337	)
Investment securities available for sale			407,231				404,388				2,843
Loans held for sale			11,158				8,663				2,495
Loans			1,384,732				1,392,833				(8,101	)
Allowance for loan losses			(7,213	)			(7,043	)			(170	)
Other assets			239,617				223,092				16,525
Total assets		$	2,108,968			$	2,122,713			$	(13,745	)
Deposits		$	1,654,804			$	1,672,231			$	(17,427	)
Short-term borrowings			129,500				126,500				3,000
Long-term debt			69,961				72,921				(2,960	)
Other liabilities			11,392				13,002				(1,610	)
Total liabilities			1,865,657				1,884,654				(18,997	)
Stockholders’ equity			243,311				238,059				5,252
Total liabilities and stockholders’ equity		$	2,108,968			$	2,122,713			$	(13,745	)

Investment Securities

The amortized cost and fair value of the available-for-sale securities portfolio was $414.6 million and $407.2 million, respectively, as of March 31, 2014 compared to $415.1 million and $404.4 million, respectively, as of December 31, 2013. The fair value of available for sale securities increased by $2.8 million year-to-date through March 31, 2014, which reflected improving bond values due to decreased interest rates.

Marketable investment securities are accounted for as available for sale and are recorded at fair value with unrealized gains and losses charged to accumulated other comprehensive income. The investment securities portfolio as of March 31, 2014 consisted of U.S. government-sponsored enterprise (“GSE”) securities, securities guaranteed by the U.S. Small Business Administration (“SBA”), residential mortgage-backed securities (“MBS”), which were all issued by GSEs, investment grade corporate bonds, investment grade commercial MBS issued by financial institutions, investment grade non-taxable municipal obligations, and the common stock of other financial services companies. As of March 31, 2014 and December 31, 2013, the securities portfolio had $2.5 million and $2.4 million, respectively, of unrealized gains and $9.8 million and $13.0 million, respectively, of unrealized losses.

The securities in an unrealized loss position as of March 31, 2014 continue to perform and are expected to perform through maturity, and the issuers have not experienced significant adverse events that would call into question their ability to repay these debt obligations according to contractual terms. Further, because the Company does not intend to sell these investments and does not believe that it will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, unrealized losses on such securities were not considered to represent other-than-temporary impairment as of March 31, 2014.

 

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The following table summarizes the amortized cost and fair value of the securities portfolio.

 

		March 31, 2014								December 31, 2013
(Dollars in thousands)		Amortized Cost				Fair Value				Amortized Cost				Fair Value
U.S. government-sponsored enterprise securities		$	14,846			$	14,723			$	14,834			$	14,673
SBA-guaranteed securities			64,271				63,714				66,579				65,880
Residential MBS			218,376				209,685				216,818				205,260
Corporate bonds			111,159				112,737				109,423				110,740
Commercial MBS			4,133				4,186				5,867				5,938
Municipal obligations – non-taxable			600				601				600				601
Other debt securities			498				498				253				253
Marketable equity securities			700				1,087				677				1,043
Total securities available for sale		$	414,583			$	407,231			$	415,051			$	404,388

The following table summarizes debt securities in the investment portfolio as of March 31, 2014, segregated by major category with ranges of maturities and average yields.

 

		March 31, 2014
(Dollars in thousands)		Amortized Cost				Fair Value				Weighted Average Yield (1)
U.S. government-sponsored enterprise securities:
One to five years		$	14,846			$	14,723				1.11	%
Total			14,846				14,723				1.11
SBA-guaranteed securities:
One to five years			8,399				8,372				1.37
Five to ten years			54,389				53,856				1.44
After ten years			1,483				1,486				2.14
Total			64,271				63,714				1.45
Residential MBS (2):
Within one year			59				59				3.05
One to five years			54,417				53,203				1.61
Five to ten years			106,100				101,779				2.26
After ten years			57,800				54,644				2.80
Total			218,376				209,685				2.24
Corporate bonds:
One to five years			98,080				99,880				2.09
Five to ten years			13,079				12,857				2.32
Total			111,159				112,737				2.12
Commercial MBS (2):
One to five years			4,133				4,186				2.21
Total			4,133				4,186				2.21
Municipal obligations - non-taxable:
After ten years			600				601				6.44
Total			600				601				6.44
Other debt securities:
Within one year			498				498				1.10
Total			498				498				1.10
Total debt securities		$	413,883			$	406,144				2.05

 

(1)	Yields are calculated on a taxable equivalent basis using the statutory federal income tax rate of 34 percent. Yields are calculated based on the amortized cost of the securities.

(2)	Mortgage-backed securities, which are not due at a single maturity date, have been included in maturity groupings based on weighted average maturities anticipating future prepayments.

The Company also owned $8.5 million and $8.9 million of FHLB stock as of March 31, 2014 and December 31, 2013, respectively. This stock is recorded at cost and is classified separately from investment securities on the consolidated balance sheets.

 

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Loans

The primary goal of the Company’s lending function is to help clients achieve their financial goals by providing quality loan products that are fair to the client and profitable to the Company. In addition to the importance placed on client knowledge and continuous involvement with clients, the Company’s lending process incorporates the standards of a consistent company-wide credit culture and an in-depth knowledge of our local markets. Furthermore, the Company employs strict underwriting criteria governing the degree of assumed risk and the diversity of the loan portfolio. In this context, the Company strives to meet the credit needs of businesses and consumers in its markets while pursuing a balanced strategy of loan profitability, loan growth, and loan quality.

Loans, net of deferred loan fees, totaled $1.38 billion as of March 31, 2014, which was a decrease of $8.1 million from December 31, 2013. The modest decline in loan balances from year end 2013 was primarily the result of seasonal trends on agricultural loans. The composition of the Company’s loan portfolio as of March 31, 2014 was as follows: 46.4 percent in commercial real estate loans, 16.8 percent in commercial and industrial loans, 14.3 percent in commercial construction and land development loans, 14.1 percent in residential real estate loans, 1.3 percent in consumer construction and land development loans, 6.7 percent in home equity loans and lines of credit, and consumer loans at 0.5 percent. The composition of the loan portfolio as of December 31, 2013 was as follows: 48.1 percent in commercial real estate loans, 16.6 percent in commercial and industrial loans, 12.6 percent in commercial construction and land development loans, 13.7 percent in residential real estate loans, 1.6 percent in consumer construction and land development loans, 6.8 percent in home equity loans and lines of credit, and consumer loans at 0.6 percent.

Loans acquired in a transfer, including business combinations, where there is evidence of credit deterioration since origination and it is probable at the date of acquisition that we will not collect all contractually required principal and interest payments, are accounted for as PCI loans. Where possible, PCI loans with common risk characteristics are grouped into pools at acquisition. For PCI loan pools, the excess of the cash flows initially expected to be collected over the fair value of the loans at the acquisition date (i.e., the accretable yield) is accreted into interest income over the estimated remaining life of the PCI loans using the effective yield method, provided that the timing and the amount of future cash flows is reasonably estimable. Accordingly, such loans are not classified as nonaccrual and they are considered to be accruing because their interest income relates to the accretable yield recognized under accounting for PCI loans and not to contractual interest payments. The difference between the contractually required payments and the cash flows expected to be collected at acquisition, considering the impact of prepayments, is referred to as the nonaccretable difference. The recorded investment in PCI loans as of March 31, 2014 totaled $171.9 million, of which $170.4 million were grouped into pools and $1.5 million were accounted for on an individual loan basis. The recorded investment in PCI loans as of December 31, 2013 totaled $180.0 million, of which $178.4 million were grouped into pools and $1.6 million were accounted for on an individual loan basis.

For each acquired loan portfolio, the Company made fair value adjustments by projecting expected future principal and interest cash flows over the remaining life of each loan and then discounting those cash flows based on then-current market rates for similar loans. Because acquired loans are marked to fair value and the legacy allowance for loan losses is eliminated at acquisition, the Company believes an analysis of the loan portfolio carrying value and unpaid borrower principal balances (“UPB”) is important in evaluating the portfolio.

The following table summarizes the UPB and carrying amounts of the loan portfolio by type.

 

		March 31, 2014												December 31, 2013
(Dollars in thousands)		UPB				Carrying Amount				% of UPB				UPB				Carrying Amount				% of UPB
Commercial:
Commercial real estate		$	657,232			$	642,118				97.7	%		$	685,545			$	670,293				97.8	%
Commercial and industrial			236,486				232,684				98.4	%			234,905				230,614				98.2	%
Construction and development			205,309				197,940				96.4	%			183,682				175,794				95.7	%
Consumer:
Residential real estate			199,406				194,808				97.7	%			196,200				191,378				97.5	%
Construction and development			19,136				17,501				91.5	%			24,108				22,520				93.4	%
Home equity			96,659				92,597				95.8	%			98,527				94,390				95.8	%
Consumer			7,890				7,589				96.2	%			8,697				8,332				95.8	%
Total		$	1,422,118			$	1,385,237				97.4	%		$	1,431,664			$	1,393,321				97.3	%

 

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Acquired loans decreased from $708.0 million as of December 31, 2013 to $637.0 million as of March 31, 2014 while non-acquired loans increased from $685.3 million as of December 31, 2013 to $748.2 million as of March 31, 2014. As the portfolio mix becomes more heavily weighted toward non-acquired loans, the portfolio more closely reflects the Company’s current underwriting standards and its portfolio allocation strategy.

The following table summarizes the scheduled maturities of loans separated by fixed and variable rate loans.

 

		March 31, 2014
(Dollars in thousands)		Commercial Real Estate				Commercial Construction and Development				Commercial and Industrial				Residential Real Estate				Consumer Construction				Home Equity				Consumer				Total
Fixed Rate: (1)
1 year or less		$	33,413			$	11,500			$	9,523			$	13,075			$	3,510			$	729			$	1,930			$	73,680
1-5 years			317,071				32,575				49,888				66,760				10,837				2,828				3,480				483,439
After 5 years			73,678				2,665				10,581				22,922				888				258				526				111,518
Total			424,162				46,740				69,992				102,757				15,235				3,815				5,936				668,637
Variable Rate: (1)
1 year or less			29,538				91,808				79,517				10,329				1,677				3,428				800				217,097
1-5 years			129,401				44,016				47,098				12,434				589				8,261				525				242,324
After 5 years			59,017				15,376				36,077				69,288				—				77,093				328				257,179
Total			217,956				151,200				162,692				92,051				2,266				88,782				1,653				716,600
Total loans		$	642,118			$	197,940			$	232,684			$	194,808			$	17,501			$	92,597			$	7,589			$	1,385,237

 

(1)	Loan maturities are presented based on the final contractual maturity of each loan and do not reflect contractual principal payments prior to maturity on amortizing loans.

Nonperforming Assets

Loans are considered past due when the contractual amounts due with respect to principal and interest are not received within 30 days of the contractual due date. Loans are generally classified as nonaccrual if they are past due for a period of 90 days or more, unless such loans are well secured and in the process of collection. If a loan or a portion of a loan is classified as doubtful or as partially charged off, the loan is generally classified as nonaccrual. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt. Loans may be returned to accrual status when all principal and interest amounts contractually due are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance of interest and principal by the borrower in accordance with the contractual terms.

PCI loans with common risk characteristics are grouped in pools at acquisition. These loans are evaluated for accrual status at the pool level rather than the individual loan level and performance is based on management’s ability to reasonably estimate the amount and timing of future cash flows rather than a borrower’s ability to repay contractual loan amounts. Since management is able to reasonably estimate the amount and timing of future cash flows on the Company’s PCI loan pools, none of these loans have been identified as nonaccrual. However, PCI loans included in pools are identified as nonperforming if they are past due 90 days or more at acquisition or become 90 days or more past due after acquisition. The past due status is determined based on the contractual terms of the individual loans.

While a loan is classified as nonaccrual and the future collectability of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to the principal outstanding, except in the case of loans with scheduled amortizations where the payment is generally applied to the oldest payment due. When the future collectability of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan had been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered.

Assets acquired as a result of foreclosure are recorded at estimated fair value in other real estate (or foreclosed assets). Any excess of cost over estimated fair value at the time of foreclosure is charged to the allowance for loan losses. Valuations are periodically performed on these properties, and any subsequent write-downs are charged to earnings. Routine maintenance and other holding costs are included in non-interest expense.

 

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A loan, excluding pooled PCI loans, is classified as a troubled debt restructuring (“TDR”) by the Company when certain modifications are made to the loan terms and concessions are granted to the borrowers due to financial difficulty experienced by those borrowers. The Company grants concessions by (1) reduction of the stated interest rate for the remaining original life of the debt or (2) extension of the maturity date at a stated interest rate lower than the current market rate for new debt with similar risk. The Company does not generally grant concessions through forgiveness of principal or accrued interest.

The Company’s policy with respect to accrual of interest on loans restructured in a TDR follows relevant supervisory guidance. That is, if a borrower has demonstrated performance under the previous loan terms and shows capacity to perform under the restructured loan terms, continued accrual of interest at the restructured interest rate is likely. If a borrower was materially delinquent on payments prior to the restructuring but shows the capacity to meet the restructured loan terms, the loan will likely continue as nonaccrual until there is demonstrated performance under new terms. Lastly, if the borrower does not perform under the restructured terms, the loan is placed on non-accrual status. The Company closely monitors these loans and ceases accruing interest on them if management believes that the borrowers may not continue performing based on the restructured note terms.

PCI loans that were classified as TDRs prior to acquisition are not classified as TDRs by the Company after the acquisition date. Subsequent modification of a PCI loan accounted for in a pool that would otherwise meet the definition of a TDR is not reported, or accounted for, as a TDR as such loans are excluded from the scope of TDR accounting. A PCI loan not accounted for in a pool would be reported, and accounted for, as a TDR if modified in a manner that meets the definition of a TDR after the acquisition date.

Nonperforming loans as a percentage of total loans was 1.49 percent as of March 31, 2014, which was a slight decline from 1.50 percent as of December 31, 2013 and a slight increase from 1.48 percent as of March 31, 2013. Total nonperforming assets as a percentage of total assets as of March 31, 2014 totaled 1.43 percent, which was a decline from 1.48 percent as of December 31, 2013 and 1.48 percent as of March 31, 2013. The general decline in nonperforming assets was due to the ECB merger and the Company’s continuing efforts to resolve legacy problem assets while maximizing value. These resolution efforts have included a combination of asset sales through various channels and successful loan workout plans.

The following table summarizes the Company’s nonperforming assets.

 

(Dollars in thousands)		March 31, 2014				December 31, 2013
Nonaccrual loans		$	13,394			$	14,728
Accruing loans past due 90 days or more (1)			7,300				6,197
Foreclosed assets			9,505				10,518
Total nonperforming assets		$	30,199			$	31,443
Restructured loans not included above		$	985			$	534

 

(1)	Balances include PCI loans past due 90 days or more that are grouped in pools which accrue interest based on pool yields.

The following table summarizes the Company’s nonperforming loans by type.

 

		March 31, 2014								December 31, 2013
(Dollars in thousands)		Carrying Value				% of Loans in Category				Carrying Value				% of Loans in Category
Commercial:
Commercial real estate		$	7,902				1.23	%		$	8,152				1.22	%
Commercial and industrial			2,341				1.01	%			2,197				0.95	%
Construction and development			4,378				2.21	%			4,575				2.60	%
Consumer:
Residential real estate			3,214				1.65	%			2,938				1.54	%
Construction and development			541				3.09	%			847				3.76	%
Home equity			2,159				2.33	%			2,052				2.17	%
Consumer			159				2.10	%			164				1.97	%
Total nonperforming loans		$	20,694				1.49	%		$	20,925				1.50	%

 

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Allowance for Loan Losses

The ALLL and related provision are calculated separately for PCI loans and non-PCI loans. The following description of the Company’s ALLL methodology primarily relates to non-PCI loans. The evaluation of PCI loans for impairment follows a different methodology which is described above. The ALLL is a reserve established through a provision for probable loan losses charged to expense. Balances are charged against the ALLL when the collectability of principal is unlikely. Subsequent recoveries, if any, are credited to the ALLL. The ALLL is maintained at a level based on management’s best estimate of probable credit losses that are inherent in the loan portfolio. Management evaluates the adequacy of the ALLL on at least a quarterly basis.

For non-PCI loans, the evaluation of the adequacy of the ALLL includes both loans evaluated collectively for impairment and loans evaluated individually for impairment. The determination of loss rates on loans collectively evaluated for impairment involves considerations of historic loan loss experience as well as certain qualitative factors such as current delinquency levels and trends, loan growth, loan portfolio composition, prevailing economic conditions, the loan review function, and other relevant factors. The annualized trailing three-year historical loss rates are used in combination with the qualitative factors to determine appropriate loss rates for each identified risk category.

The Company utilizes an internal grading system to assign the degree of inherent risk on each loan in the portfolio. The risk grade is initially assigned by the lending officer and reviewed by the credit administration function. The internal risk grading system is reviewed and tested periodically by the loan review function. The Company’s ALLL model uses the internal loan grading system to segment each category of loans by risk grade. Calculated loss rates are weighted more heavily for higher risk loans.

A loan, excluding PCI loans, is considered individually impaired, based on current information and events, if it is probable that the Company will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Reserves, or charge-offs, on individually impaired loans that are collateral dependent are based on the fair value of the underlying collateral, less an estimate of selling costs, while reserves, or charge-offs, on loans that are not collateral dependent are based on either an observable market price, if available, or the present value of expected future cash flows discounted at the historical effective interest rate. PCI loans within pools are not evaluated individually for impairment.

The following table presents the allocation of the ALLL for the periods presented.

 

		March 31, 2014								December 31, 2013
(Dollars in thousands)		Amount				% of Total Allowance				Amount				% of Total Allowance
Commercial:
Commercial real estate		$	2,280				31.61	%		$	2,419				34.34	%
Commercial and industrial			782				10.84				805				11.43
Construction and development			1,610				22.32				1,400				19.88
Consumer:
Residential real estate			1,726				23.93				1,673				23.75
Construction and development			214				2.97				187				2.66
Home equity			503				6.97				476				6.76
Consumer			98				1.36				83				1.18
Total allowance for loan losses		$	7,213				100.00	%		$	7,043				100.00	%

 

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The following table summarizes changes in the ALLL for the periods presented.

 

		Three Months Ended March 31,
(Dollars in thousands)		2014				2013
ALLL, beginning of period		$	7,043			$	3,998
Charge-offs:
Commercial:
Commercial real estate			242				13
Commercial and industrial			241				58
Construction and development			196				61
Consumer:
Residential real estate			196				193
Home equity			188				92
Consumer			96				84
Total charge-offs			1,159				501
Recoveries:
Commercial:
Commercial real estate			4				14
Commercial and industrial			5				8
Construction and development			—				10
Consumer:
Residential real estate			11				53
Home equity			12				2
Consumer			7				3
Total recoveries			39				90
Net charge-offs			1,120				411
Provision for loan losses			1,290				1,940
ALLL, end of period		$	7,213			$	5,527
Net charge-offs to average loans (annualized)			0.32	%			0.21	%

The ALLL to total loans was 0.52 percent as of March 31, 2014, which was an increase from 0.49 percent as of December 31, 2013. Including acquisition accounting fair value discounts, the adjusted ALLL declined from 2.74 percent as of December 31, 2013 to 2.54 percent as of March 31, 2014. The decline in adjusted ALLL was primarily due to the accretion of fair value discounts. The following non-GAAP reconciliation provides a calculation of the adjusted ALLL and the related adjusted ALLL as a percentage of total loans for the periods presented.

 

(Dollars in thousands)		March 31, 2014				December 31, 2013
Allowance for loan losses (GAAP)		$	7,213			$	7,043
Net acquisition accounting fair value discounts to loans			27,906				31,152
Adjusted allowance for loan losses			35,119				38,195
Loans		$	1,384,732			$	1,392,833
Adjusted allowance for loan losses to loans (Non-GAAP)			2.54	%			2.74	%

Deposits

Total deposits as of March 31, 2014 were $1.65 billion, which was a decrease of $17.4 million from December 31, 2013. This decrease was primarily due to several large deposits that were deposited late in the fourth quarter of 2013 and withdrawn in the first quarter of 2014. As of March 31, 2014 and December 31, 2013, the Company had outstanding time deposits under $100 thousand of $264.9 million and $271.9 million, respectively, and time deposits over $100 thousand of $365.2 million and $363.1 million, respectively.

The composition of the deposit portfolio, by category, as of March 31, 2014 was as follows: 38.1 percent in time deposits, 28.6 percent in money market and savings, 21.5 percent in interest-bearing demand deposits, and 11.8 percent in non-interest bearing demand deposit. The composition of the deposit portfolio, by category, as of December 31, 2013 was as follows: 38.0 percent in time deposits, 28.0 percent in money market and savings, 21.0 percent in interest-bearing demand deposits, and 13.0 percent in non-interest bearing demand deposits.

 

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The following table summarizes the average balances outstanding and average interest rates for each major category of deposits for the periods presented.

 

		Three Months Ended March 31, 2014												Three Months Ended March 31, 2013
(Dollars in thousands)		Average Balance				% of Total				Average Rate				Average Balance				% of Total				Average Rate
Non-interest demand		$	201,047				12.19	%			—	%		$	67,970				7.74	%			—	%
Interest-bearing demand			348,047				21.10				0.21				181,505				20.68				0.31
Money market and savings			469,288				28.46				0.30				264,917				30.19				0.53
Time deposits			630,840				38.25				0.73				363,248				41.39				0.92
Total average deposits		$	1,649,222				100.00				0.41			$	877,640				100.00				0.60

The overall mix of average deposits shifted somewhat in the periods presented above as time deposits declined as a proportion of total average deposits while non-interest demand deposits increased following the ECB Merger. The Company believes its deposit product offerings are properly structured to attract and retain core low-cost deposit relationships. The average cost of deposits decreased to 0.41 percent in the first quarter of 2014 from 0.60 percent in the first quarter of 2013 as the Company adjusted interest rates it pays on certain checking and money market accounts after the ECB Merger and incorporated the ECB deposit base.

Short-Term Borrowings and Long-Term Debt

The Company uses short-term borrowings and long-term debt to provide both funding and, to a lesser extent, regulatory capital. Short-term borrowings totaled $129.5 million and $126.5 million as of March 31, 2014 and December 31, 2013, respectively, and consisted of FHLB advances maturing within twelve months. Long-term debt as of both March 31, 2014 and December 31, 2013 consisted of $7.0 million in a subordinated term loan issued to a non-affiliated financial institution and $5.6 million in junior subordinated debt issued in the form of trust preferred securities. As of March 31, 2014 and December 31, 2013, long-term debt also included $38.1 million in 10-year subordinated notes issued in August 2013. In addition, the Company had outstanding long-term FHLB advances of $16.0 million and $19.0 million as of March 31, 2014 and December 31, 2013, respectively.

Stockholders’ Equity

On January 31, 2014, VantageSouth completed the sale of 9.2 million shares of its common stock for approximately $47 million in a private placement issuance to new and existing accredited investors, including certain members of the Company’s Board of Directors and their affiliates (the “Capital Raise”). The net proceeds of the Capital Raise were primarily used to repurchase VantageSouth’s Series A and Series B Preferred Stock, which occurred on February 19, 2014.

Total stockholders’ equity was $243.3 million as of March 31, 2014, which was an increase of $5.3 million from December 31, 2013. This increase was primarily due to net income of $2.2 million, other comprehensive income of $1.0 million, and the net impact of the Capital Raise and the preferred stock redemption. Dividends and accretion on preferred stock totaled $314 thousand in the first quarter of 2014, which decreased stockholders’ equity.

Liquidity

Liquidity management involves the ability to fund the needs and requirements of depositors and borrowers, paying operating expenses and ensuring compliance with regulatory liquidity requirements. To ensure the Company is positioned to meet immediate and future cash demands, it relies on internal analysis of liquidity, knowledge of current economic and market trends and forecasts of future conditions. Investment portfolio principal payments and maturities, loan principal payments, deposit growth, brokered deposit sources, and available borrowings from the FHLB, the Federal Reserve Bank, and various federal funds lines from correspondent banks are the primary sources of liquidity for the Company. The primary uses of liquidity are repayments of borrowings, deposit maturities and withdrawals, disbursements of loan proceeds, and investment purchases.

 

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As of March 31, 2014, liquid assets (which include cash and due from banks, interest-earning deposits with banks, federal funds sold and investment securities available for sale) totaled $480.7 million, which represented 23 percent of total assets and 29 percent of total deposits. Supplementing this on-balance sheet liquidity, the Company has available off-balance sheet liquidity in the form of lines of credit from various correspondent banks which totaled $249.9 million as of March 31, 2014. As of March 31, 2014, outstanding commitments for undisbursed lines of credit and letters of credit totaled $337.5 million and outstanding capital commitments to a private investment fund were $1.6 million. Management believes that the aggregate liquidity position of the Company is sufficient to meet deposit maturities and withdrawals, borrowing commitments, loan funding requirements, and operating expenses. Core deposits (total deposits less brokered deposits), one of the Company’s most stable sources of liquidity, together with common equity capital funded $1.63 billion, or 77 percent, of total assets as of March 31, 2014 compared with $1.67 billion, or 79 percent, of total assets as of December 31, 2013.

Contractual Obligations

The following table presents the Company’s significant fixed and determinable contractual obligations by payment date. The payment amounts represent those amounts contractually due to the recipient. The table excludes liabilities recorded where management cannot reasonably estimate the timing of any payments that may be required in connection with these liabilities.

 

		March 31, 2014
(Dollars in thousands)		1 Year or Less				1 to 3 Years				3 to 5 Years				More Than 5 Years				Total
Time deposits		$	331,733			$	227,070			$	71,329			$	—			$	630,132
Short-term borrowings			129,500				—				—				—				129,500
Long-term debt			—				16,319				179				53,463				69,961
Operating leases			3,126				5,369				5,169				5,291				18,955
Total contractual obligations		$	464,359			$	248,758			$	76,677			$	58,754			$	848,548

Capital

The maintenance of appropriate levels of capital is a management priority and is monitored on a regular basis. The Company’s principal goals related to the maintenance of capital are to provide adequate capital to support the Company’s risk profile, provide financial flexibility to support future growth and client needs, comply with relevant laws, regulations, and supervisory guidance, and provide a competitive return to stockholders.

Banking regulators have defined capital into the following components: (1) Tier 1 capital, which includes common stockholders’ equity and qualifying preferred equity, and (2) Tier 2 capital, which includes a portion of the allowance for loan losses, certain qualifying long-term debt and preferred stock which does not qualify as Tier 1 capital. Minimum capital levels are regulated by risk-based capital adequacy guidelines which require a financial institution to maintain capital as a percent of its assets and certain off-balance sheet items adjusted for predefined credit risk factors (risk-adjusted assets). A financial institution is required to maintain, at a minimum, Tier 1 capital as a percentage of risk-adjusted assets of 4.0 percent and combined Tier 1 and Tier 2 capital as a percentage of risk-adjusted assets of 8.0 percent. In addition to the risk-based guidelines, federal regulations require the Bank to maintain a minimum leverage ratio (Tier 1 capital as a percentage of tangible assets) of 4.0 percent. The following table summarizes the calculation of the Piedmont’s and the Bank’s regulatory capital ratios.

 

(Dollars in thousands)		March 31, 2014
		As Reported by Piedmont				As Reported by VantageSouth Bank				Regulatory Minimum				Well Capitalized Requirement
Tier 1 capital		$	179,015			$	206,456
Tier 2 capital			52,740				14,690
Total capital		$	231,755			$	221,146
Average assets for leverage ratio		$	1,724,395			$	2,035,082
Risk-adjusted assets		$	2,037,888			$	1,720,687
Regulatory capital ratios:
Tier 1 leverage			8.78	%			10.14	%			4.00	%			5.00	%
Tier 1 risk-based capital			10.38	%			12.00	%			4.00	%			6.00	%
Total risk-based capital			13.44	%			12.85	%			8.00	%			10.00	%

 

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The Company’s tangible book value per common share was $86.75 as of March 31, 2014 compared to $81.74 as of December 31, 2013. The following table presents the calculation of tangible book value per common share and tangible common equity to tangible assets, which are non-GAAP financial metrics.

 

(Dollars in thousands)		March 31, 2014				December 31, 2013
Total stockholders’ equity		$	144,592			$	140,800
Less: goodwill and other intangible assets allocated to Piedmont, net of tax			17,365				20,920
Tangible common equity		$	127,227			$	119,880
Common shares outstanding			1,466,664				1,466,664
Tangible book value per common share		$	86.75			$	81.74

 

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