Attached files

file filename
EXCEL - IDEA: XBRL DOCUMENT - SIERRA BANCORPFinancial_Report.xls
EX-31.2 - EXHIBIT 31.2 - SIERRA BANCORPv391985_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - SIERRA BANCORPv391985_ex31-1.htm
EX-32 - EXHIBIT 32 - SIERRA BANCORPv391985_ex32.htm

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2014

Commission file number: 000-33063

 

Sierra Bancorp

(Exact name of Registrant as specified in its charter)

 

California 33-0937517
(State of Incorporation) (IRS Employer Identification No)

 

86 North Main Street, Porterville, California 93257

(Address of principal executive offices)         (Zip Code)

 

(559) 782-4900

(Registrant’s telephone number, including area code)

 

Not Applicable

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

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes R           No ¨

 

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

Yes R           No ¨

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.

Large accelerated filer ¨ Accelerated filer R
Non-accelerated filer ¨ (Do not check if a smaller reporting company) Smaller Reporting Company ¨

 

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

Yes ¨           No R

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Common stock, no par value, 13,787,587 shares outstanding as of October 31, 2014

 

 
 

 

FORM 10-Q

 

Table of Contents

  Page
Part I - Financial Information 1
Item 1. Financial Statements (Unaudited) 1
Consolidated Balance Sheets 1
Consolidated Statements of Income 2
Consolidated Statements of Comprehensive Income 3
Consolidated Statements of Cash Flows 4
Notes to Unaudited Consolidated Financial Statements 5
   
Item 2. Management’s Discussion & Analysis of Financial Condition & Results of Operations 30
Forward-Looking Statements 30
Critical Accounting Policies 30
Overview of the Results of Operations and Financial Condition 31
Earnings Performance 32
Net Interest Income and Net Interest Margin 32
Provision for Loan and Lease Losses 36
Non-interest Income and Non-Interest Expense 37
Provision for Income Taxes 40
Balance Sheet Analysis 40
Earning Assets 40
Investments 40
Loan and Lease Portfolio 42
Nonperforming Assets 43
Allowance for Loan and Lease Losses 44
Off-Balance Sheet Arrangements 46
Other Assets 46
Deposits and Interest-Bearing Liabilities 47
Deposits 47
Other Interest-Bearing Liabilities 48
Non-Interest Bearing Liabilities 48
Liquidity and Market Risk Management 48
Capital Resources 51
   
Item 3. Qualitative & Quantitative Disclosures about Market Risk 52
   
Item 4. Controls and Procedures 52
   
Part II - Other Information 53
Item 1. - Legal Proceedings 53
Item 1A. - Risk Factors 53
Item 2. - Unregistered Sales of Equity Securities and Use of Proceeds 53
Item 3. - Defaults upon Senior Securities 53
Item 4. - (Removed and Reserved) 53
Item 5. - Other Information 53
Item 6. - Exhibits 54
   
Signatures 55

 

 
 

 

PART I - FINANCIAL INFORMATION

Item 1 – Financial Statements

SIERRA BANCORP

CONSOLIDATED BALANCE SHEETS

(dollars in thousands)

 

   September 30, 2014   December 31, 2013 
  (unaudited)   (audited) 
ASSETS          
Cash and due from banks  $37,179   $51,342 
Interest-bearing deposits in banks   2,499    26,664 
Total cash & cash equivalents   39,678    78,006 
Investment securities available for sale   467,688    425,044 
Loans held for sale   -    105 
Loans and leases:          
Gross loans and leases   883,675    803,242 
Allowance for loan and lease losses   (11,012)   (11,677)
Deferred loan and lease fees, net   1,506    1,522 
Net loans and leases   874,169    793,087 
Premises and equipment, net   20,982    20,393 
Foreclosed assets   4,719    8,185 
Goodwill   5,544    5,544 
Other assets   76,244    79,885 
TOTAL ASSETS  $1,489,024   $1,410,249 
           
LIABILITIES AND SHAREHOLDERS' EQUITY          
LIABILITIES          
Deposits:          
Non-interest bearing  $361,388   $365,997 
Interest bearing   861,658    808,182 
Total deposits   1,223,046    1,174,179 
Federal funds purchased and repurchase agreements   7,170    5,974 
Short-term borrowings   22,390    - 
Junior subordinated debentures   30,928    30,928 
Other liabilities   19,250    17,494 
TOTAL LIABILITIES   1,302,784    1,228,575 
SHAREHOLDERS' EQUITY          
Common stock, no par value; 24,000,000 shares authorized; 13,841,342 and 14,217,199 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively   64,649    65,780 
Additional paid in capital   2,526    2,648 
Retained earnings   115,712    112,817 
Accumulated other comprehensive income   3,353    429 
TOTAL SHAREHOLDERS' EQUITY   186,240    181,674 
           
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY  $1,489,024   $1,410,249 

 

The accompanying notes are an integral part of these consolidated financial statements

 

1
 

 

SIERRA BANCORP

CONSOLIDATED STATEMENTS OF INCOME

(dollars in thousands, except per share data, unaudited)

 

   Three months ended September 30,   Nine months ended September 30, 
   2014   2013   2014   2013 
Interest income:                    
Interest and fees on loans  $11,237   $10,932   $32,644   $33,207 
Interest on investment securities:                    
Taxable   2,008    1,132    5,709    3,328 
Non-Taxable   729    699    2,203    1,990 
Interest on federal funds sold and interest-bearing deposits   4    28    55    72 
Total interest income   13,978    12,791    40,611    38,597 
                     
Interest expense:                    
Interest on deposits   503    606    1,614    1,894 
Interest on short-term borrowings   6    4    16    16 
Interest on long-term borrowings   -    -    -    33 
Interest on mandatorily redeemable trust preferred securities   177    180    526    536 
Total interest expense   686    790    2,156    2,479 
                     
Net Interest Income   13,292    12,001    38,455    36,118 
                     
Provision for loan losses   -    800    350    2,850 
                     
Net Interest Income after Provision for Loan Losses   13,292    11,201    38,105    33,268 
                     
Non-interest income:                    
Service charges on deposit accounts   2,214    2,354    6,139    6,642 
Gains on investment securities available-for-sale   -    -    287    6 
Other income, net   1,571    1,965    5,084    5,808 
Total non-interest income   3,785    4,319    11,510    12,456 
                     
Non-interest expense:                    
Salaries and employee benefits   5,459    5,394    16,772    16,717 
Occupancy expense   1,662    1,554    4,700    4,702 
Other   4,629    4,542    12,014    12,608 
Total non-interest expense   11,750    11,490    33,486    34,027 
                     
Income before income taxes   5,327    4,030    16,129    11,697 
                     
Provision for income taxes   1,776    663    4,543    2,198 
                     
Net Income  $3,551   $3,367   $11,586   $9,499 
                     
PER SHARE DATA                    
Book value  $13.46   $12.54   $13.46   $12.54 
Cash dividends  $0.09   $0.07   $0.25   $0.19 
Earnings per share basic  $0.25   $0.24   $0.82   $0.67 
Earnings per share diluted  $0.25   $0.23   $0.81   $0.67 
Average shares outstanding, basic   13,939,152    14,176,732    14,083,649    14,139,697 
Average shares outstanding, diluted   14,072,783    14,329,177    14,217,150    14,256,782 
                     
Total shareholder equity (in thousands)  $186,240   $178,056   $186,240   $178,056 
Shares outstanding   13,841,342    14,194,659    13,841,342    14,194,659 
Dividends Paid  $1,260,823   $991,908   $3,528,478   $2,685,932 

 

The accompanying notes are an integral part of these consolidated financial statements

 

2
 

 

SIERRA BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(dollars in thousands, unaudited)

 

   Three months ended September 30,   Nine months ended September 30, 
   2014   2013   2014   2013 
                 
Net Income  $3,551   $3,367   $11,586   $9,499 
Other comprehensive income, before tax:                    
Unrealized gains on securities:                    
Unrealized holding (losses) gains arising during period   (237)   (100)   5,256    (6,342)
Less: reclassification adjustment for gains (1)   -    -    (287)   (6)
Other comprehensive (loss) income, before tax   (237)   (100)   4,969    (6,348)
Income tax expense (benefit) related to items of other comprehensive income (loss), net of tax   97    41   (2,045)   2,613 
Other comprehensive income (loss) gain   (140)   (59)   2,924    (3,735)
                     
Comprehensive Income  $3,411   $3,308  $14,510   $5,764 

 

(1) Amounts are included in net gains on investment securities available-for-sale on the Consolidated Statements of Income in non-interest revenue. Income tax expense associated with the reclassification adjustment for the nine months ended September 30, 2014 and 2013 was $118 thousand and $2 thousand respectively.

 

The accompanying notes are an integral part of these consolidated financial statements

 

3
 

  

SIERRA BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands, unaudited)

 

   Nine months ended September 30, 
   2014   2013 
Cash flows from operating activities:          
Net income  $11,586   $9,499 
Adjustments to reconcile net income to net cash provided by operating activities:          
Gain on sales of securities   (287)   (6)
Gain on sales of loans   (3)   (92)
Loss (gain) on disposal of fixed assets   1    (15)
(Gain) loss on sale on foreclosed assets   (531)   568 
Writedowns on foreclosed assets   286    695 
Share-based compensation expense   57    218 
Provision for loan losses   350    2,850 
Depreciation   1,569    1,639 
Net amortization on securities premiums and discounts   4,925    6,441 
Increase in unearned net loan fees   (16)   (90)
Increase in cash surrender value of life insurance policies   (1,001)   (1,389)
Proceeds from sales of loans portfolio   108    3,662 
Increase in loans held-for-sale   -    (3,627)
Decrease in interest receivable and other assets   1,923    3,119 
Decrease in other liabilites   1,756    1,161 
Net (increase) decrease in FHLB stock   (190)   438 
Deferred income tax provision   864    378 
Excess tax benefit from equity based compensation   -    (253)
Net cash provided by operating activities   21,397    25,196 
           
Cash flows from investing activities:          
Maturities of securities available for sale   995    1,399 
Proceeds from sales/calls of securities available for sale   11,055    3,454 
Purchases of securities available for sale   (111,425)   (120,352)
Principal pay downs on securities available for sale   57,062    76,815 
Net (increase) decrease in loans receivable, net   (82,126)   61,039 
Purchases of premises and equipment, net   (2,159)   (275)
Proceeds from sales of foreclosed assets   4,421    13,116 
Net cash (used in) provided by investing activities   (122,177)   35,196 
           
Cash flows from financing activities:          
Increase (decrease) in deposits   48,867    (22,556)
Increase (decrease) in borrowed funds   22,390    (41,650)
Increase in repurchase agreements   1,196    4,277 
Cash dividends paid   (3,528)   (2,686)
Repurchases of common stock   (7,284)   - 
Stock options exercised   811    1,121 
Excess tax benefit from equity based compensation   -    253 
Net cash provided by (used in) financing activities   62,452    (61,241)
           
Decrease in cash and due from banks   (38,328)   (849)
           
Cash and cash equivalents          
Beginning of period   78,006    61,818 
End of period  $39,678   $60,969 

 

The accompanying notes are an integral part of these consolidated financial statements

 

4
 

 

Sierra Bancorp

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

 

Note 1 – The Business of Sierra Bancorp

 

Sierra Bancorp (the “Company”) is a California corporation headquartered in Porterville, California, and is a registered bank holding company under federal banking laws. The Company was formed to serve as the holding company for Bank of the Sierra (the “Bank”), and has been the Bank’s sole shareholder since August 2001. The Company exists primarily for the purpose of holding the stock of the Bank and of such other subsidiaries it may acquire or establish. At the present time, the Company’s only other subsidiaries are Sierra Statutory Trust II and Sierra Capital Trust III, which were formed in March 2004 and June 2006, respectively, solely to facilitate the issuance of capital trust pass-through securities (TRUPS). Pursuant to the Financial Accounting Standards Board’s (FASB’s) standard on the consolidation of variable interest entities, these trusts are not reflected on a consolidated basis in the Company’s financial statements. References herein to the “Company” include Sierra Bancorp and its consolidated subsidiary, the Bank, unless the context indicates otherwise.

 

The Bank is a California state-chartered bank headquartered in Porterville, California, that offers a full range of retail and commercial banking services primarily to communities in the central and southern regions of the San Joaquin Valley. Our branch footprint stretches from Fresno on the north to Bakersfield on the south, and on the southern end extends east through the Tehachapi plateau and into the northwestern tip of the Mojave Desert. The Bank was incorporated in September 1977 and opened for business in January 1978, and in the ensuing years has grown to be the largest independent bank headquartered in the South San Joaquin Valley. Our growth has primarily been organic, but includes the acquisition of Sierra National Bank in 2000. We currently operate 25 full service branch offices throughout our geographic footprint, as well as an internet branch which provides the ability to open deposit accounts online. The Bank has received regulatory approval for another branch in Bakersfield, California, which is expected to commence operations in the first quarter of 2015. In addition to our full-service branches the Bank has specialized lending units which include a real estate industries center, an agricultural credit center, and an SBA lending unit, and we operate offsite ATMs at six different non-branch locations. The Bank’s deposit accounts are insured by the Federal Deposit Insurance Corporation (FDIC) up to maximum insurable amounts.

 

On July 17, 2014 the Company entered into a definitive agreement to acquire Santa Clara Valley Bank (OTC: SCVE) of Santa Paula, California, a community bank with $129 million in assets and branches located in Santa Paula, Santa Clarita, and Fillmore, California. The agreement calls for the payment of cash consideration of $12.3 million, or $6.00 per share, to SCVE’s common shareholders and cash consideration of $3.0 million to SCVE’s preferred shareholders to retire outstanding preferred stock and associated warrants. Included in the $12.3 million payment is $700,000 that the Company will pay to cash out existing in-the-money warrants. All requisite regulatory approvals have been received, and the acquisition was approved by the shareholders of Santa Clara Valley Bank at a special meeting held October 29, 2014. The transaction is expected to close in the fourth quarter of 2014. One-time acquisition costs totaled $267,000 in the third quarter of 2014, and if the transaction is consummated in the anticipated time frame management has projected that they will add around $2.0 million to Sierra Bancorp’s pre-tax non-interest expense in the fourth quarter of 2014.

 

Note 2 – Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in a condensed format, and therefore do not include all of the information and footnotes required by US generally accepted accounting principles (GAAP) for complete financial statements. The information furnished in these interim statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for such period. Such adjustments are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q. In preparing the accompanying consolidated financial statements, management has taken subsequent events into consideration and recognized them where appropriate. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for any other quarter, or for the full year. Certain amounts reported for 2013 have been reclassified to be consistent with the reporting for 2014. The interim financial information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the Securities and Exchange Commission.

 

5
 

 

Note 3 – Current Accounting Developments

 

In May 2014, the FASB issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU is the result of a joint project initiated by the FASB and the International Accounting Standards Board (IASB) to clarify the principles for recognizing revenue, and to develop a common revenue standard and disclosures for U.S. and international accounting standards that would: (1) remove inconsistencies and weaknesses in revenue requirements; (2) provide a more robust framework for addressing revenue issues; (3) improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets; (4) provide more useful information to users of financial statements through improved disclosure requirements; and (5) simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. The guidance affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets. The core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance provides steps to follow to achieve the core principle. An entity should disclose sufficient information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Qualitative and quantitative information is required with regard to contracts with customers, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. This ASU is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. The Company is currently evaluating the potential effects of this guidance on its financial statements and disclosures.

 

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, to provide additional flexibility with regard to accounting for investments in qualified affordable housing projects. ASU 2014-01 modifies the conditions that must be met to present the pretax impact and related tax benefits of such investments as a component of income taxes (“net” within income tax expense), to enable more investors to elect to use a “net” presentation for those investments. Investors that do not qualify for “net” presentation under the new guidance will continue to account for such investments under the equity method or cost method, which results in losses recognized in pretax income and tax benefits recognized in income taxes (“gross” presentation of investment results). For investments that qualify for the “net” presentation of investment performance, ASU 2014-01 introduces a “proportional amortization method” that can be elected to amortize the investment basis. If elected, the method is required for all eligible investments in qualified affordable housing projects. ASU 2014-01 also requires enhanced recurring disclosures for all investments in qualified affordable housing projects, regardless of the accounting method used for those investments. It is effective for interim and annual periods beginning after December 15, 2014, and early adoption is permitted. The Company currently expects to adopt ASU 2014-01 as of the first quarter of 2015. We will likely continue to account for our low-income housing tax credit investments using the equity method subsequent to our adoption of ASU 2014-01 and thus do not expect any impact on our income statement or balance sheet, but our disclosures with regard to low-income housing tax credit investments will be updated to reflect the new requirements.

 

In January 2014, the 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, to resolve diversity in practice with respect to a creditor’s reclassification of a collateralized consumer mortgage loan to other real estate owned (OREO). Current US GAAP requires a loan to be reclassified to OREO upon a troubled debt restructuring that is “in substance a repossession or foreclosure”, where the creditor receives “physical possession” of the debtor's assets regardless of whether formal foreclosure proceedings take place. The terms “in substance a repossession or foreclosure” and “physical possession” are not defined in US GAAP; therefore, questions have arisen about when a creditor should reclassify a collateralized mortgage loan to OREO. ASU 2014-04 requires a creditor to reclassify a collateralized consumer mortgage loan to real estate property upon obtaining legal title to the real estate collateral, or when the borrower voluntarily conveys all interest in the real estate property to the lender to satisfy the loan through a deed in lieu of foreclosure or similar legal agreement. ASU 2014-04 is effective for public business entities for interim and annual periods beginning after December 15, 2014. It will be adopted by the Company for the first quarter of 2015, and we do not expect any impact upon our financial statements or operations upon adoption.

 

6
 

 

Note 4 – Supplemental Disclosure of Cash Flow Information

 

During the nine months ended September 30, 2014 and 2013, cash paid for interest due on interest-bearing liabilities was $2.219 million and $2.621 million, respectively. There was $160,000 in cash paid for income taxes during the nine months ended September 30, 2014, but no cash paid for income taxes for the nine months ended September 30, 2013. Assets totaling $184,000 and $4.068 million were acquired in settlement of loans for the nine months ended September 30, 2014 and September 30, 2013, respectively. We received $4.421 million in cash from the sale of foreclosed assets during the first nine months of 2014 relative to $11.926 million during the first nine months of 2013, which represents sales proceeds less loans extended to finance such sales.

 

Note 5 – Share Based Compensation

 

The 2007 Stock Incentive Plan (the “2007 Plan”) was adopted by the Company in 2007. Our 1998 Stock Option Plan (the “1998 Plan”) was concurrently terminated, although options to purchase 122,000 shares that were granted under the 1998 Plan were still outstanding as of September 30, 2014 and remain unaffected by that plan’s termination. The 2007 Plan provides for the issuance of both “incentive” and “nonqualified” stock options to officers and employees, and of “nonqualified” stock options to non-employee directors of the Company. The 2007 Plan also provides for the potential issuance of restricted stock awards to these same classes of eligible participants, on such terms and conditions as are established at the discretion of the Board of Directors or the Compensation Committee. The total number of shares of the Company’s authorized but unissued stock reserved for issuance pursuant to awards under the 2007 Plan was initially 1,500,000 shares, although the number remaining available for grant as of September 30, 2014 was 838,560. The dilutive impact of stock options outstanding is discussed below in Note 6, Earnings per Share. No restricted stock awards have been issued by the Company.

 

Pursuant to FASB’s standards on stock compensation, the value of each option granted is reflected in our income statement as employee compensation or directors’ expense by amortizing the value over the vesting period of such option or by expensing it as of the grant date for immediately vested options. The Company is utilizing the Black-Scholes model to value stock options, and the “multiple option” approach is used to allocate the resulting valuation to actual expense. Under the multiple option approach an employee’s options for each vesting period are separately valued and amortized, which appears to be the preferred method for option grants with graded vesting. A charge of $24,000 was reflected in the Company’s income statement during the third quarter of 2014 and $67,000 was charged during the third quarter of 2013, as expense related to stock options. For the first nine months, the charges totaled $57,000 in 2014 and $218,000 in 2013.

 

Note 6 – Earnings per Share

 

The computation of earnings per share, as presented in the Consolidated Statements of Income, is based on the weighted average number of shares outstanding during each period. There were 13,939,152 weighted average shares outstanding during the third quarter of 2014, and 14,176,732 during the third quarter of 2013. There were 14,083,649 weighted average shares outstanding during the first nine months of 2014, and 14,139,697 during the first nine months of 2013.

 

Diluted earnings per share include the effect of the potential issuance of common shares, which for the Company is limited to shares that would be issued on the exercise of “in-the-money” stock options. The dilutive effect of options outstanding was calculated using the treasury stock method, excluding anti-dilutive shares and adjusting for unamortized expense and windfall tax benefits. For the third quarter and first nine months of 2014 the dilutive effect of options outstanding calculated under the treasury stock method totaled 133,631 shares and 133,501 shares, respectively, which were added to basic weighted average shares outstanding for purposes of calculating diluted earnings per share. Likewise, for the third quarter and first nine months of 2013 shares totaling 152,445 and 117,085, respectively, were added to basic weighted average shares outstanding in order to calculate diluted earnings per share.

 

Note 7 – Comprehensive Income

 

As presented in the Consolidated Statements of Comprehensive Income, comprehensive income includes net income and other comprehensive income. The Company’s only source of other comprehensive income is unrealized gains and losses on available-for-sale investment securities. Gains or losses on investment securities that were realized and included in net income of the current period, which had previously been included in other comprehensive income as unrealized holding gains or losses in the period in which they arose, are considered to be reclassification adjustments that are excluded from other comprehensive income in the current period.

 

7
 

 

Note 8 – Financial Instruments with Off-Balance-Sheet Risk

 

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business, in order to meet the financing needs of its customers. Those financial instruments consist of unused commitments to extend credit and standby letters of credit. They involve, to varying degrees, elements of risk in excess of the amount recognized in the balance sheet. The Company’s exposure to credit loss in the event of nonperformance by counterparties for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and issuing letters of credit as it does for originating loans included on the balance sheet. The following financial instruments represent off-balance-sheet credit risk (dollars in thousands):

 

   September 30, 2014   December 31, 2013 
Commitments to extend credit  $395,368   $420,707 
Standby letters of credit  $6,871   $8,703 
Commercial letters of credit  $7,592   $8,070 

 

Commitments to extend credit consist primarily of the unused or unfunded portions of the following: home equity lines of credit; commercial real estate construction loans, where disbursements are made over the course of construction; commercial revolving lines of credit; mortgage warehouse lines of credit; unsecured personal lines of credit; and formalized (disclosed) deposit account overdraft lines. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many commitments are expected to expire without being drawn upon, the unused portions of committed amounts do not necessarily represent future cash requirements.

 

Standby letters of credit are generally unsecured and are issued by the Company to guarantee the performance of a customer to a third party, while commercial letters of credit represent the Company’s commitment to pay a third party on behalf of a customer upon fulfillment of contractual requirements. The credit risk involved in issuing letters of credit is essentially the same as the risk involved in extending loans to customers.

 

The Company is also utilizing an $88 million letter of credit issued by the Federal Home Loan Bank on the Company’s behalf as security for certain deposits. The letter of credit is backed by loans which are pledged to the Federal Home Loan Bank by the Company.

 

Note 9 – Fair Value Disclosures and Reporting, the Fair Value Option and Fair Value Measurements

 

FASB’s standards on financial instruments, and on fair value measurements and disclosures, require all entities to disclose in their financial statement footnotes the estimated fair values of financial instruments for which it is practicable to estimate fair values. In addition to disclosure requirements, FASB’s standard on investments requires that our debt securities, which are classified as available for sale, and our equity securities that have readily determinable fair values, be measured and reported at fair value in our statement of financial position. Certain impaired loans are also reported at fair value, as explained in greater detail below, and foreclosed assets are carried at the lower of cost or fair value. FASB’s standard on financial instruments permits companies to report certain other financial assets and liabilities at fair value, but we have not elected the fair value option for any additional financial assets or liabilities.

 

Fair value measurements and disclosure standards also establish a framework for measuring fair values. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants on the measurement date. Further, the standards establish a fair value hierarchy that encourages an entity to maximize the use of observable inputs and limit the use of unobservable inputs when measuring fair values. The standards describe three levels of inputs that may be used to measure fair values:

 

·Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
   
·Level 2: Significant observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

 

8
 

 

·Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the factors that market participants would likely consider in pricing an asset or liability.

 

Fair value estimates are made at a specific point in time based on relevant market data and information about the financial instruments. The estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments. In addition, the tax ramifications related to realized gains and losses could have a significant effect on fair value estimates but have not been considered in any estimates. Because no market exists for a significant portion of the Company’s financial instruments, fair value disclosures are based on judgments regarding current economic conditions, risk characteristics of various financial instruments and other factors. The estimates are subjective and involve uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly affect the fair values presented. The following methods and assumptions were used by the Company to estimate the fair value of its financial instruments disclosed at September 30, 2014 and December 31, 2013:

 

·Cash and cash equivalents and fed funds sold: The carrying amount is estimated to be fair value.
   
·Investment securities: Fair values are determined by obtaining quoted prices on nationally recognized securities exchanges or by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities by relying on their relationship to other benchmark quoted securities when quoted prices for specific securities are not readily available.
   
·Loans and leases: For variable-rate loans and leases that re-price frequently with no significant change in credit risk or interest rate spread, fair values are based on carrying values. Fair values for other loans and leases are estimated by discounting projected cash flows at interest rates being offered at each reporting date for loans and leases with similar terms, to borrowers of comparable creditworthiness. The carrying amount of accrued interest receivable approximates its fair value.
   
·Loans held for sale: Since loans designated by the Company as available-for-sale are typically sold shortly after making the decision to sell them, realized gains or losses are usually recognized within the same period and fluctuations in fair values are not relevant for reporting purposes. If available-for-sale loans are on our books for an extended period of time, the fair value of those loans is determined using quoted secondary-market prices.
   
·Collateral-dependent impaired loans: Collateral-dependent impaired loans are carried at fair value when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the original loan agreement and the loan has been written down to the fair value of its underlying collateral, net of expected disposition costs where applicable.
   
·Cash surrender value of life insurance policies: Fair values are based on net cash surrender values at each reporting date.
   
·Investments in, and capital commitments to, limited partnerships: The fair values of our investments in WNC Institutional Tax Credit Fund Limited Partnerships and any other limited partnerships are estimated using quarterly indications of value provided by the general partner. The fair values of undisbursed capital commitments are assumed to be the same as their book values.
   
·Other investments: Certain investments for which no secondary market exists are carried at cost unless an impairment analysis indicates the need for adjustments, and the carrying amount for those investments approximates their estimated fair value.
   
·Deposits: Fair values for non-maturity deposits are equal to the amount payable on demand at the reporting date, which is the carrying amount. Fair values for fixed-rate certificates of deposit are estimated using a cash flow analysis, discounted at interest rates being offered at each reporting date by the Bank for certificates with similar remaining maturities. The carrying amount of accrued interest payable approximates its fair value.
   
·Short-term borrowings: The carrying amounts approximate fair values for federal funds purchased, overnight FHLB advances, borrowings under repurchase agreements, and other short-term borrowings maturing within ninety days of the reporting dates. Fair values of other short-term borrowings are estimated by discounting projected cash flows at the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

 

9
 

 

·Long-term borrowings: Fair values are estimated using projected cash flows discounted at the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
   
·Subordinated debentures: Fair values are determined based on the current market value for like instruments of a similar maturity and structure.
   
·Commitments to extend credit and letters of credit: If funded, the carrying amounts for currently unused commitments would approximate fair values for the newly created financial assets at the funding date. However, because of the high degree of uncertainty with regard to whether or not those commitments will ultimately be funded, fair values for loan commitments and letters of credit in their current undisbursed state cannot reasonably be estimated, and only notional values are disclosed in the table below.

 

10
 

 

Estimated fair values for the Company’s financial instruments are as follows, as of the dates noted:

 

Fair Value of Financial Instruments                
(dollars in thousands, unaudited)  September 30, 2014 
       Estimated Fair Value 
   Carrying
Amount
   Quoted Prices in
Active Markets
for
Identical Assets
(Level 1)
   Significant
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   Total 
Financial assets:                         
Cash and cash equivalents  $39,678   $39,678   $-   $-   $39,678 
Investment securities available for sale   467,688    2,562    465,126    -    467,688 
Loans and leases, net held for investment   858,309    -    869,307    -    869,307 
Collateral dependent impaired loans   15,860    -    15,860    -    15,860 
Loans held-for-sale   -    -    -    -    - 
Cash surrender value of life insurance policies   40,425    -    40,425    -    40,425 
Other investments   6,122    -    6,122    -    6,122 
Investment in limited partnership   7,579    -    7,579    -    7,579 
Accrued interest receivable   5,248    -    5,248    -    5,248 
                          
Financial liabilities:                         
Deposits:                         
Noninterest-bearing  $361,388   $361,388   $-   $-   $361,388 
Interest-bearing   861,658    -    861,857    -    861,857 
Fed funds purchased and repurchase agreements   7,170    -    7,170    -    7,170 
Short-term borrowings   22,390    -    22,390    -    22,390 
Long-term borrowings   -    -    -    -    - 
Subordinated debentures   30,928    -    11,347    -    11,347 
Limited partnership capital commitment   914    -    914    -    914 
Accrued interest payable   122    -    122    -    122 
                          
   Notional Amount                     
Off-balance-sheet financial instruments:                         
Commitments to extend credit  $395,368                     
Standby letters of credit   6,871                     
Commercial lines of credit   7,592                     

 

   December 31, 2013 
       Estimated Fair Value 
   Carrying
Amount
   Quoted Prices in
Active Markets
for
Identical Assets
(Level 1)
   Significant
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   Total 
Financial assets:                         
Cash and cash equivalents  $78,006   $78,006   $-   $-   $78,006 
Investment securities available for sale   425,044    2,456    422,588    -    425,044 
Loans and leases, net held for investment   778,382    -    797,383    -    797,383 
Collateral dependent impaired loans   14,705    -    14,705    -    14,705 
Loans held-for-sale   105    105    -    -    105 
Cash surrender value of life insurance policies   39,424    -    39,424    -    39,424 
Other Investments   5,932    -    5,932    -    5,932 
Investment in limited partnership   9,204    -    9,204    -    9,204 
Accrued interest receivable   4,990    -    4,990    -    4,990 
                          
Financial liabilities:                         
Deposits:                         
Noninterest-bearing  $365,997   $365,997   $-   $-   $365,997 
Interest-bearing   808,182    -    808,182    -    808,182 
Fed funds purchased and repurchase agreements   5,974    -    5,974    -    5,974 
Short-term borrowings   -    -    -    -    - 
Long-term borrowings   -    -    -    -    - 
Subordinated debentures   30,928    -    11,175    -    11,175 
Limited partnership capital commitment   962    -    962    -    962 
Accrued interest payable   186    -    186    -    186 
                          
   Notional Amount                     
Off-balance-sheet financial instruments:                         
Commitments to extend credit  $420,707                     
Standby letters of credit   8,703                     
Commercial lines of credit   8,070                     

 

11
 

 

For financial asset categories that were actually reported at fair value at September 30, 2014 and December 31, 2013, the Company used the following methods and significant assumptions:

 

·Investment securities: Fair values are determined by obtaining quoted prices on nationally recognized securities exchanges or by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities by relying on their relationship to other benchmark quoted securities.
   
·Collateral-dependent impaired loans: Collateral-dependent impaired loans are carried at fair value when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the original loan agreement and the loan has been written down to the fair value of its underlying collateral, net of expected disposition costs where applicable.
   
·Foreclosed assets: Repossessed real estate (OREO) and other foreclosed assets are carried at the lower of cost or fair value. Fair value is the appraised value less expected selling costs for OREO and some other assets such as mobile homes, and for any other foreclosed assets fair value is represented by the estimated sales proceeds as determined using reasonably available sources. Foreclosed assets for which appraisals can be feasibly obtained are periodically measured for impairment using updated appraisals. Fair values for other foreclosed assets are adjusted as necessary, subsequent to a periodic re-evaluation of expected cash flows and the timing of resolution. If impairment is determined to exist, the book value of a foreclosed asset is immediately written down to its estimated impaired value through the income statement, thus the carrying amount is equal to the fair value and there is no valuation allowance.

 

12
 

 

Assets reported at fair value on a recurring basis are summarized below:

 

Fair Value Measurements - Recurring                
(dollars in thousands, unaudited)                
   Fair Value Measurements at September 30, 2014, using 
   Quoted Prices in
Active Markets
for
Identical Assets
(Level 1)
   Significant
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   Total 
Investment securities                    
US Government agencies  $-   $4,389   $-   $4,389 
Mortgage-backed securities   -    362,114    -    362,114 
State and poltical subdivisions   -    98,623    -    98,623 
Equity securities   2,562    -    -    2,562 
                     
Total available-for-sale securities  $2,562   $465,126   $-   $467,688 

 

   Fair Value Measurements at December 31, 2013, using 
   Quoted Prices in
Active Markets
for
Identical Assets
(Level 1)
   Significant
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   Total 
Investment securities                    
US Government agencies  $-   $5,304   $-   $5,304 
Mortgage-backed securities   -    320,721    -    320,721 
State and poltical subdivisions   -    96,563    -    96,563 
Equity securities   2,456    -    -    2,456 
                     
Total available-for-sale securities  $2,456   $422,588   $-   $425,044 

 

13
 

 

Assets reported at fair value on a nonrecurring basis are summarized below:

 

Fair Value Measurements - Nonrecurring
(dollars in thousands, unaudited)
   Fair Value Measurements at September 30, 2014, using 
   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   Total 
Collateral dependent impaired loans  $-   $15,860   $-   $15,860 
Foreclosed assets  $-   $4,719   $-   $4,719 

 

   Fair Value Measurements at December 31, 2013, using 
   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   Total 
Collateral dependent impaired loans  $-   $14,705   $-   $14,705 
Foreclosed assets  $-   $8,185   $-   $8,185 

 

The table above includes collateral-dependent impaired loan balances for which a specific reserve has been established or on which a write-down has been taken. Information on the Company’s total impaired loan balances, and specific loss reserves associated with those balances, is included in Note 11 below, and in Management’s Discussion and Analysis of Financial Condition and Results of Operation in the “Nonperforming Assets” and “Allowance for Loan and Lease Losses” sections.

 

The unobservable inputs are based on management’s best estimates of appropriate discounts in arriving at fair market value. Increases or decreases in any of those inputs could result in a significantly lower or higher fair value measurement. For example, a change in either direction of actual loss rates would have a directionally opposite change in the calculation of the fair value of unsecured impaired loans.

 

Note 10 – Investments

 

Although the Company currently has the intent and the ability to hold the securities in its investment portfolio to maturity, the securities are all marketable and are classified as “available for sale” to allow maximum flexibility with regard to interest rate risk and liquidity management. Pursuant to FASB’s guidance on accounting for debt and equity securities, available for sale securities are carried on the Company’s financial statements at their estimated fair market values, with monthly tax-effected “mark-to-market” adjustments made vis-à-vis accumulated other comprehensive income in shareholders’ equity.

 

14
 

 

Amortized Cost And Estimated Fair Value

 

The amortized cost and estimated fair value of investment securities available-for-sale are as follows (dollars in thousands, unaudited):

 

   September 30, 2014 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated
Fair Value
 
                 
US Government agencies  $4,464   $6   $(81)  $4,389 
Mortgage-backed securities   359,954    3,804    (1,644)   362,114 
State and poltical subdivisions   96,199    2,923    (499)   98,623 
Equity securities   1,373    1,189    -    2,562 
Total investment securities  $461,990   $7,922   $(2,224)  $467,688 

 

   December 31, 2013 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated
Fair Value
 
                 
US Government agencies  $5,395   $18   $(109)  $5,304 
Mortgage-backed securities   320,223    3,269    (2,771)   320,721 
State and political subdivisons   97,361    1,723    (2,521)   96,563 
Equity securities   1,336    1,120    -    2,456 
Total investment securities  $424,315   $6,130   $(5,401)  $425,044 

 

At September 30, 2014 and December 31, 2013, the Company had 164 securities and 197 securities, respectively, with unrealized losses. Management has evaluated those securities as of the respective dates, and does not believe that any of the associated unrealized losses are other than temporary. Gross unrealized losses on our investment securities as of the indicated dates are disclosed in the table below, categorized by investment type and by the duration of time that loss positions on individual securities have continuously existed (over or under twelve months).

 

15
 

 

Investment Portfolio - Unrealized Losses    
(dollars in thousands, unaudited)  September 30, 2014 
   Less than Twelve Months   Over Twelve Months 
   Gross
Unrealized
Losses
   Fair Value   Gross
Unrealized
Losses
   Fair Value 
                 
US Government agencies  $(19)  $1,260   $(62)  $1,937 
Mortgage-backed securities   (576)   99,447    (1,068)   68,444 
State and political subdivisions   (10)   2,451    (489)   23,571 
Other securities   -    -    -    - 
Total  $(605)  $103,158   $(1,619)  $93,952 

 

   December 31, 2013 
   Less than Twelve Months   Over Twelve Months 
   Gross
Unrealized
Losses
   Fair Value   Gross
Unrealized
Losses
   Fair Value 
                 
US Government agencies  $(92)  $1,913   $(17)  $1,920 
Mortgage-backed securities   (642)   21,747    (2,129)   124,317 
State and political subdivisions   (461)   6,799    (2,060)   38,083 
Other securities   -    -    -    - 
Total  $(1,195)  $30,459   $(4,206)  $164,320 

 

The table below summarizes the Company’s gross realized gains and losses as well as gross proceeds from the sales of securities, for the periods indicated:

 

Investment Portfolio - Realized Gains/(Losses)

(dollars in thousands, unaudited)

 

   Three months ended September 30,   Nine months ended September 30, 
   2014   2013   2014   2013 
                 
Proceeds from sales of securities available for sale  $-   $-   $8,360   $723 
                     
Gross gains on sale of securities available for sale  $-   $-   $289   $6 
Gross losses on sale of securities available for sale   -    -    (2)   - 
Net gains on sale of securities available for sale  $-   $-   $287   $6 

 

The amortized cost and estimated fair value of investment securities available-for-sale at September 30, 2014 and December 31, 2013 are shown below, by the remaining time to contractual maturity dates. The expected life of investment securities may not be consistent with contractual maturity dates, since the issuers of the securities could have the right to call or prepay obligations with or without penalties.

 

16
 

 

Estimated Fair Value of Contractual Maturities        
(dollars in thousands, unaudited)  September 30, 2014 
   Amortized
Cost
   Fair Value 
         
Maturing within one year  $1,204   $1,212 
Maturing after one year through five years   213,652    216,249 
Maturing after five years through ten years   76,629    77,761 
Maturing after ten years   50,748    51,294 
           
Investment securities not due at a single maturity date:     
U.S Government agencies collateralized by mortgage obligations   118,384    118,610 
Other securities   1,373    2,562 
   $461,990   $467,688 

 

   December 31, 2013 
   Amortized
Cost
   Fair Value 
         
Maturing within one year  $2,294   $2,316 
Maturing after one year through five years   241,396    242,493 
Maturing after five years through ten years   59,572    59,402 
Maturing after ten years   49,674    47,737 
           
Investment securities not due at a single maturity date:     
U.S Government agencies collateralized by mortgage obligations   70,043    70,640 
Other securities   1,336    2,456 
   $424,315   $425,044 

 

At September 30, 2014, the Company’s investment portfolio included securities issued by 268 different government municipalities and agencies located within 27 states with a fair value of $98.6 million. The largest exposure to any single municipality or agency was a $4.5 million (fair value) bond issued for water utility improvements by the Arizona State Water Infrastructure Finance Authority, to be repaid by future water revenue.

 

The Company’s investments in bonds issued by states, municipalities and political subdivisions are evaluated in accordance with Supervision and Regulation Letter 12-15 (SR 12-15) issued by the Board of Governors of the Federal Reserve System, “Investing in Securities without Reliance on Nationally Recognized Statistical Rating Organization Ratings”, and other regulatory guidance. Credit ratings are considered in our analysis only as a guide to the historical default rate associated with similarly-rated bonds. There have been no significant differences in our internal analyses compared with the ratings assigned by the third party credit rating agencies.

 

The following table summarizes the amortized cost and fair values of general obligation and revenue bonds in the Company’s investment securities portfolio at the indicated dates, identifying the state in which the issuing municipality or agency operates for our largest geographic concentrations:

 

17
 

 

Revenue and General Obligation Bonds by Location            
dollars in thousands, unaudited  September 30, 2014   December 31, 2013 
   Amortized   Fair Market   Amortized   Fair Market 
General obligation bonds  Cost   Value   Cost   Value 
State of issuance                    
California  $20,026   $21,219   $20,638   $21,272 
Texas   12,831    12,958    11,340    11,024 
Illinois   8,287    8,392    8,965    8,702 
Ohio   7,640    7,703    7,659    7,485 
Washington   5,981    6,109    5,487    5,340 
Arizona   2,077    2,417    2,100    2,050 
Other states   19,776    19,930    20,666    20,429 
Total General Obligation Bonds   76,618    78,728    76,855    76,302 
                     
Revenue bonds                    
State of issuance                    
Arizona   4,617    4,508    4,700    4,341 
Texas   3,284    3,394    2,762    2,719 
California   2,219    2,284    2,519    2,579 
Washington   1,168    1,204    1,170    1,211 
Ohio   322    335    324    339 
Other states   7,971    8,170    6,758    6,742 
Total Revenue Bonds   19,581    19,895    18,233    17,931 
                     
Certificates of participation (All California)   -    -    2,273    2,330 
                     
Total Obligations of States and Political Subdivisions  $96,199   $98,623   $97,361   $96,563 

 

The revenue bonds in the Company’s investment securities portfolios were issued by government municipalities and agencies to fund public services such as utilities (water, sewer, and power), educational facilities, and general public and economic improvements. The primary sources of revenue for these bonds are delineated in the table below, which shows the amortized cost and fair market values for the largest revenue concentrations as of the indicated dates.

 

Revenue Bonds by Type        
dollars in thousands, unaudited  September 30, 2014   December 31, 2013 
   Amortized   Fair Market   Amortized   Fair Market 
Revenue bonds  Cost   Value   Cost   Value 
Revenue source:                    
Water  $8,010   $8,010   $7,409   $7,144 
College & University   2,731    2,840    2,203    2,187 
Electric & Power   1,882    1,921    1,888    1,895 
Sales Tax   1,672    1,715    1,673    1,688 
Lease   1,356    1,344    1,155    1,063 
Other sources   3,930    4,065    3,905    3,954 
Total Revenue Bonds  $19,581   $19,895   $18,233   $17,931 

 

18
 

 

Note 11 – Credit Quality and Nonperforming Assets

 

Credit Quality Classifications

 

The Company monitors the credit quality of loans on a continuous basis using the regulatory and accounting classifications of pass, special mention, substandard and impaired to characterize the associated credit risk. Balances classified as “loss” are immediately charged off. The Company conforms to the following definitions for risk classifications utilized:

 

·Pass: Larger non-homogeneous loans not meeting the risk rating definitions below, and smaller homogeneous loans that are not assessed on an individual basis.

 

·Special mention: Loans which have potential issues that deserve the close attention of management. If left uncorrected, those potential weaknesses could eventually diminish the prospects for full repayment of principal and interest according to the contractual terms of the loan agreement, or could result in deterioration of the Company’s credit position at some future date.

 

·Substandard: Loans that have at least one clear and well-defined weakness which could jeopardize the ultimate recoverability of all principal and interest, such as a borrower displaying a highly leveraged position, unfavorable financial operating results and/or trends, uncertain repayment sources or a deteriorated financial condition.

 

·Impaired: A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans include all nonperforming loans, restructured troubled debt (TDRs), and certain other loans that are still being maintained on accrual status. A TDR may be nonperforming or performing, depending on its accrual status and the demonstrated ability of the borrower to comply with restructured terms (see “Troubled Debt Restructurings” section below for additional information on TDRs).

 

Credit quality classifications for the Company’s loan balances were as follows, as of the dates indicated:

 

19
 

 

Credit Quality Classifications

(dollars in thousands, unaudited)

   September 30, 2014 
   Pass   Special
Mention
   Substandard   Impaired   Total 
Real Estate:                         
1-4 family residential construction  $4,908   $-   $-   $-   $4,908 
Other construction/land   19,050    253    10    4,522    23,835 
1-4 family - closed end   100,113    527    597    12,820    114,057 
Equity lines   44,832    514    1,244    700    47,290 
Multi-family residential   7,245    422    -    -    7,667 
Commercial real estate - owner occupied   171,724    20,983    2,797    3,572    199,076 
Commercial real estate - non-owner occupied   92,438    3,363    226    12,830    108,857 
Farmland   129,553    2,700    77    -    132,330 
Total real estate   569,863    28,762    4,951    34,444    638,020 
                          
Agricultural   23,902    592    -    127    24,621 
Commercial and industrial   99,550    2,379    305    2,925    105,159 
Mortgage Warehouse   96,459    -    -    -    96,459 
Consumer loans   16,191    266    21    2,938    19,416 
Total gross loans and leases  $805,965   $31,999   $5,277   $40,434   $883,675 

 

   December 31, 2013 
   Pass   Special
Mention
   Substandard   Impaired   Total 
Real Estate:                         
1-4 family residential construction  $1,720   $-   $-   $-   $1,720 
Other construction/land   18,243    334    203    6,751    25,531 
1-4 family - closed end   67,051    1,305    770    17,898    87,024 
Equity lines   51,019    254    1,429    1,021    53,723 
Multi-family residential   8,059    426    -    -    8,485 
Commercial real estate - owner occupied   158,155    17,033    3,261    7,563    186,012 
Commercial real estate - non-owner occupied   89,475    3,630    240    13,495    106,840 
Farmland   105,623    1,780    819    282    108,504 
Total real estate   499,345    24,762    6,722    47,010    577,839 
                          
Agricultural   24,178    532    -    470    25,180 
Commercial and industrial   93,224    3,358    1,236    5,444    103,262 
Mortgage Warehouse   73,425    -    -    -    73,425 
Consumer loans   19,387    478    208    3,463    23,536 
Total gross loans and leases  $709,559   $29,130   $8,166   $56,387   $803,242 

 

Past Due and Nonperforming Assets

 

Nonperforming assets are comprised of loans for which the Company is no longer accruing interest, and foreclosed assets, including mobile homes and other real estate owned (OREO). OREO consists of properties acquired by foreclosure or similar means, which the Company is offering or will offer for sale. Nonperforming loans and leases result when reasonable doubt surfaces with regard to the ability of the Company to collect all principal and interest. At that point, we stop accruing interest on the loan or lease in question and reverse any previously-recognized interest to the extent that it is uncollected or associated with interest-reserve loans. Any asset for which principal or interest has been in default for 90 days or more is also placed on non-accrual status even if interest is still being received, unless the asset is both well secured and in the process of collection. An aging of the Company’s loan balances is presented in the following tables, by number of days past due as of the indicated dates:

 

20
 

 

Loan Portfolio Aging

(dollars in thousands, unaudited)

   September 30, 2014 
   30-59 Days
Past Due
   60-89 Days
Past Due
  

90 Days Or More

Past Due(1)

   Total Past
Due
   Current   Total
Financing
Receivables
  

Non-Accrual

Loans(2)

 
Real Estate:                                   
1-4 family residential construction  $-   $-   $-   $-   $4,908   $4,908   $- 
Other construction/land   638    -    3,338    3,976    19,859    23,835    3,338 
1-4 family - closed end   68    529    8,384    8,981    105,076    114,057    8,446 
Equity lines   447    -    -    447    46,843    47,290    385 
Multi-family residential   -    -    -    -    7,667    7,667    - 
Commercial real estate - owner occupied   139    345    1,143    1,627    197,449    199,076    2,359 
Commercial real estate - non-owner occupied   206    -    7,045    7,251    101,606    108,857    7,655 
Farmland   109    -    -    109    132,221    132,330    - 
Total real estate   1,607    874    19,910    22,391    615,629    638,020    22,183 
                                    
Agricultural   893    -    127    1,020    23,601    24,621    127 
Commercial and industrial   642    103    98    843    104,316    105,159    791 
Mortgage Warehouse   -    -    -    -    96,459    96,459    - 
Consumer loans   287    4    4    295    19,121    19,416    775 
Total gross loans and leases  $3,429   $981   $20,139   $24,549   $859,126   $883,675   $23,876 

 

(1) As of September 30, 2014 there were no loans over 90 days past due and still acrruing.

(2) Included in total financing receivables

 

   December 31, 2013 
   30-59 Days
Past Due
   60-89 Days
Past Due
  

90 Days Or More

Past Due(1)

   Total Past
Due
   Current   Total
Financing
Receivables
  

Non-Accrual

Loans(2)

 
Real Estate:                                   
1-4 family residential construction  $-   $-   $-   $-   $1,720   $1,720   $- 
Other construction/land   294    -    116    410    25,121    25,531    5,528 
1-4 family - closed end   2,181    300    171    2,652    84,372    87,024    13,168 
Equity lines   98    -    288    386    53,337    53,723    778 
Multi-family residential   -    -    -    -    8,485    8,485    - 
Commercial real estate - owner occupied   1,917    144    2,011    4,072    181,940    186,012    5,516 
Commercial real estate - non-owner occupied   -    -    7,667    7,667    99,173    106,840    8,058 
Farmland   331    -    -    331    108,173    108,504    282 
Total real estate   4,821    444    10,253    15,518    562,321    577,839    33,330 
                                    
Agricultural   892    327    125    1,344    23,836    25,180    470 
Commercial and industrial   1,318    587    1,298    3,203    100,059    103,262    2,622 
Mortgage Warehouse   -    -    -    -    73,425    73,425    - 
Consumer loans   181    -    -    181    23,355    23,536    992 
Total gross loans and leases  $7,212   $1,358   $11,676   $20,246   $782,996   $803,242   $37,414 

 

(1) As of December 31, 2013 there were no loans over 90 days past due and still accruing.

(2) Included in total financing receivables

 

Troubled Debt Restructurings

 

A loan that is modified for a borrower who is experiencing financial difficulty is classified as a troubled debt restructuring (TDR), if the modification constitutes a concession. At September 30, 2014, the Company had a total of $32.2 million in TDRs, including $19.2 million in TDRs that were on non-accrual status. Generally, a non-accrual loan that has been modified as a TDR remains on non-accrual status for a period of at least six months to demonstrate the borrower’s ability to comply with the modified terms. However, performance prior to the modification, or significant events that coincide with the modification, could result in a loan’s return to accrual status after a shorter performance period or even at the time of loan modification. TDRs may have the TDR designation removed in the calendar year following the restructuring, if the loan is in compliance with all modified terms and is yielding a market rate of interest. Regardless of the period of time that has elapsed, if the borrower’s ability to meet the revised payment schedule is uncertain then the loan will be kept on non-accrual status. Moreover, a TDR is generally considered to be in default when it appears that the customer will not likely be able to repay all principal and interest pursuant to the terms of the restructured agreement.

 

21
 

 

The Company may agree to different types of concessions when modifying a loan or lease. The tables below summarize TDRs which were modified during the noted periods, by type of concession:

 

Troubled Debt Restructurings, by Type of Loan Modification

(dollars in thousands, unaudited)

   Nine months ended September 30, 2014 
   Rate
Modification
   Term
Modification
   Interest Only
Modification
   Rate & Term
Modification
   Rate &
Interest Only
Modification
   Term &
Interest Only
Modification
   Rate, Term
& Interest
Only
Modification
   Total 
                                 
Real estate:                                        
Other construction/land  $-   $-   $-   $-   $-   $-   $-   $- 
1-4 family - closed-end   -    13    -    -    -    -    -    13 
Equity lines   -    548    -    29    -    -    -    577 
Commercial real estate - owner occupied   279    123    -    -    -    -    -    402 
Total real estate loans   279    684    -    29    -    -    -    992 
Commercial and industrial   -    133    -    4    -    30    -    167 
Consumer loans   -    9    -    103    -    -    -    112 
   $279   $826   $-   $136   $-   $30   $-   $1,271 

 

   For the year ended December 31, 2013 
   Rate
Modification
   Term
Modification
   Interest Only
Modification
   Rate & Term
Modification
   Rate &
Interest Only
Modification
   Term &
Interest Only
Modification
   Rate, Term
& Interest
Only
Modification
   Total 
                                 
Real Estate:                                        
Other construction/land  $-   $416   $-   $-   $-   $-   $-   $416 
1-4 family - closed-end   -    3,338    -    238    -    -    102    3,678 
Equity lines   -    -    40    -    -    -    -    40 
Commercial real estate - owner occupied   -    -    -    557    -    -    -    557 
Total real estate loans   -    3,754    40    795    -    -    102    4,691 
Commercial and industrial   -    1,563    -    308    -    -    -    1,871 
Consumer loans   -    469    -    -    -    -    92    561 
   $-   $5,786   $40   $1,103   $-   $-   $194   $7,123 

 

22
 

 

The following tables present, by class, additional details related to loans classified as TDRs during the referenced periods, including the recorded investment in the loan both before and after modification and balances that were modified during the period:

 

Troubled Debt Restructurings

(dollars in thousands, unaudited)

   For the three months ended September 30, 2014 
                     
   Number of
Loans
   Pre-
Modification
Outstanding
Recorded
Investment
   Post-
Modification
Outstanding
Recorded
Investment
   Reserve
Difference(1)
   Reserve 
Real Estate:                         
Other Construction/Land  -   $-   $-   $-   $- 
1-4 family - closed-end  -    -    -    -    - 
Equity Lines  3    227    227    11    20 
Commercial RE- owner occupied  -    -    -    -    - 
Total Real Estate Loans       227    227    11    20 
                         
Commercial and Industrial  -    -    -    -    - 
Consumer loans  1    103    103    14    15 
        $330   $330   $25   $35 

 

(1) This represents the change in the ALLL reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan loss methodology.

 

   For the nine months ended September 30, 2014 
                     
   Number of
Loans
   Pre-
Modification
Outstanding
Recorded
Investment
   Post-
Modification
Outstanding
Recorded
Investment
  

Reserve

Difference(1)

   Reserve 
Real Estate:                         
Other Construction/Land  -   $-   $-   $-   $- 
1-4 family - closed-end  1    13    13    -    - 
Equity Lines  6    577    577    180    33 
Commercial RE- owner occupied  2    402    402    -    136 
Total Real Estate Loans       992    992    180    169 
                         
Commercial and Industrial  5    167    167    53    57 
Consumer loans  4    112    112    15    15 
        $1,271   $1,271   $248   $241 

 

(1) This represents the change in the ALLL reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan loss methodology.

 

23
 

 

The tables below summarize TDRs that defaulted during the periods noted, and any charge-offs on those TDRs resulting from such default.

 

Troubled Debt Restructurings

(dollars in thousands, unaudited)

   Subsequent default three months ended September 30, 2014 
             
   Number of
Loans
   Recorded
Investment
   Charge-Offs 
Real Estate:               
Other Construction/Land  -   $-   $- 
1-4 family - closed-end  -    -    - 
Commercial real estate- owner occupied  1    715    - 
Total Real Estate Loans       715    - 
Commercial and Industrial  -    -    - 
Consumer Loans  -    -    - 
        $715   $- 

 

   Subsequent default nine months ended September 30, 2014 
             
   Number of
Loans
   Recorded
Investment
   Charge-Offs 
             
Real Estate:               
Other Construction/Land  3   $1,546   $- 
1-4 family - closed-end  2    8,305    - 
Commercial real estate- owner occupied  2    937    31 
Total Real Estate Loans       10,788    31 
Commercial and Industrial  1    127    - 
Consumer Loans  2    133    58 
        $11,048   $89 

 

Note 12 – Allowance for Loan and Lease Losses

 

The Company’s allowance for loan and lease losses, a contra-asset, is established through a provision for loan and lease losses. The allowance is maintained at a level that is considered adequate to absorb probable losses on certain specifically identified loans, as well as probable incurred losses inherent in the remaining loan portfolio. Specifically identifiable and quantifiable losses are immediately charged off against the allowance; recoveries are generally recorded only when cash payments are received subsequent to the charge off. We employ a systematic methodology, consistent with FASB guidelines on loss contingencies and impaired loans, for determining the appropriate level of the allowance for loan and lease losses and adjusting it at least quarterly. Pursuant to that methodology, impaired loans and leases are individually analyzed and a criticized asset action plan is completed specifying the financial status of the borrower and, if applicable, the characteristics and condition of collateral and any associated liquidation plan. A specific loss allowance is created for each impaired loan, if necessary.

 

The following tables disclose the unpaid principal balance, recorded investment, average recorded investment, and interest income recognized for impaired loans on our books as of the dates indicated. Balances are shown by loan type, and are further broken out by those that required an allowance and those that did not, with the associated allowance disclosed for those that required such. Included in the valuation allowance for impaired loans shown in the tables below are specific reserves allocated to TDRs, totaling $3.333 million at September 30, 2014 and $3.321 million at December 31, 2013.

 

24
 

 

Impaired Loans  September 30, 2014 
(dollars in thousands, unaudited) 

Unpaid

Principal

Balance(1)

  

Recorded

Investment(2)

   Related
Allowance
   Average
Recorded
Investment
  

Interest

Income

Recognized(3)

 
With an allowance recorded                         
Real Estate:                         
Other construction/land  $4,513   $4,513   $578   $5,271   $69 
1-4 Family - closed-end   12,820    12,820    1,111    14,000    201 
Equity lines   406    406    37    491    11 
Commercial real estate- owner occupied   2,856    2,746    1,416    3,068    42 
Commercial real estate- non-owner occupied   3,700    3,700    741    3,771    198 
Farmland   -    -    -    -    - 
Total real estate   24,295    24,185    3,883    26,601    521 
Agriculture   127    127    3    335    - 
Commercial and industrial   2,901    2,888    873    2,958    94 
Consumer loans   2,854    2,843    422    3,104    116 
    30,177    30,043    5,181    32,998    731 
With no related allowance recorded                         
Real estate:                         
Other construction/land   9    9    -    18    - 
1-4 family - closed-end   -    -    -    -    1 
Equity lines   297    294    -    297    - 
Commercial real estate- owner occupied   1,855    826    -    1,932    - 
Commercial real estate- non-owner occupied   9,278    9,130    -    9,844    88 
Farmland   -    -    -    -    - 
Total real estate   11,439    10,259    -    12,091    89 
Agriculture   -    -    -    -    - 
Commercial and industrial   56    37    -    81    - 
Consumer loans   257    95    -    322    - 
    11,752    10,391    -    12,494    89 
Total  $41,929   $40,434   $5,181   $45,492   $820 

 

(1)Contractual principal balance due from customer.

(2)Principal balance on Company's books, less any direct charge offs.

(3)Interest income is recognized on performing balances on a regular accrual basis.

 

25
 

 

   December 31, 2013 
  

Unpaid

Principal

Balance(1)

  

Recorded

Investment(2)

   Related
Allowance
   Average
Recorded
Investment
  

Interest

Income

Recognized(3)

 
With an allowance recorded                         
Real estate:                         
1-4 family residential construction  $-   $-   $-   $-   $- 
Other construction/land   2,972    2,972    502    3,000    98 
1-4 family - closed-end   13,522    13,522    1,324    13,630    260 
Equity lines   528    528    123    530    13 
Commercial real estate- owner occupied   2,047    2,047    217    2,069    135 
Commercial real estate- non-owner occupied   3,715    3,715    701    3,813    238 
Farmland   -    -    -    -    - 
Total real estate   22,784    22,784    2,867    23,042    744 
Agriculture   125    125    126    131    - 
Commercial and industrial   4,580    4,345    1,925    4,496    131 
Consumer loans   3,411    3,411    431    3,591    172 
    30,900    30,665    5,349    31,260    1,047 
With no related allowance recorded                         
Real estate:                         
1-4 family residential construction   -    -    -    -    - 
Other construction/land   4,176    3,779    -    3,885    - 
1-4 family - closed-end   4,655    4,376    -    4,687    1 
Equity lines   565    493    -    493    - 
Commercial real estate- owner occupied   7,436    5,516    -    5,568    - 
Commercial real estate- non-owner occupied   10,077    9,780    -    9,820    115 
Farmland   282    282    -    290    - 
Total real estate   27,191    24,226    -    24,743    116 
Agriculture   345    345    -    837    - 
Commercial and industrial   1,249    1,099    -    1,607    57 
Consumer loans   241    52    -    77    - 
    29,026    25,722    -    27,264    173 
Total  $59,926   $56,387   $5,349   $58,524   $1,220 

 

(1)Contractual principal balance due from customer.

(2)Principal balance on Company's books, less any direct charge offs.

(3)Interest income is recognized on performing balances on a regular accrual basis.

 

The specific loss allowance for an impaired loan generally represents the difference between the book value of the loan and either the fair value of underlying collateral less estimated disposition costs, or the loan’s net present value as determined by a discounted cash flow analysis. The discounted cash flow approach is typically used to measure impairment on loans for which it is anticipated that repayment will be provided from cash flows other than those generated solely by the disposition or operation of underlying collateral. However, historical loss rates may be used to determine a specific loss allowance if they indicate a higher potential reserve need than the discounted cash flow analysis. Any change in impairment attributable to the passage of time is accommodated by adjusting the loss allowance accordingly.

 

26
 

 

For loans where repayment is expected to be provided by the disposition or operation of the underlying collateral, impairment is measured using the fair value of the collateral. If the collateral value, net of the expected costs of disposition where applicable, is less than the loan balance, then a specific loss reserve is established for the shortfall in collateral coverage. If the discounted collateral value is greater than or equal to the loan balance, no specific loss reserve is required. At the time a collateral-dependent loan is designated as nonperforming, a new appraisal is ordered and typically received within 30 to 60 days if a recent appraisal is not already available. We generally use external appraisals to determine the fair value of the underlying collateral for nonperforming real estate loans, although the Company’s licensed staff appraisers may update older appraisals based on current market conditions and property value trends. Until an updated appraisal is received, the Company uses the existing appraisal to determine the amount of the specific loss allowance that may be required, and adjusts the specific loss allowance, as necessary, once a new appraisal is received. Updated appraisals are generally ordered at least annually for collateral-dependent loans that remain impaired. Current appraisals were available for 84% of the Company’s impaired real estate loan balances at September 30, 2014. Furthermore, the Company analyzes collateral-dependent loans on at least a quarterly basis, to determine if any portion of the recorded investment in such loans can be identified as uncollectible and would therefore constitute a confirmed loss. All amounts deemed to be uncollectible are promptly charged off against the Company’s allowance for loan and lease losses, with the loan then carried at the fair value of the collateral, as appraised, less estimated costs of disposition if applicable. Once a charge-off or write-down is recorded, it will not be restored to the loan balance on the Company’s accounting books.

 

Our methodology also provides that a “general” allowance be established for probable incurred losses inherent in loans and leases that are not impaired. Unimpaired loan balances are segregated by credit quality, and are then evaluated in pools with common characteristics. At the present time, pools are based on the same segmentation of loan types presented in our regulatory filings. While this methodology utilizes historical loss data and other measurable information, the classification of loans and the establishment of the allowance for loan and lease losses are both to some extent based on management’s judgment and experience. Our methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan and lease losses that management believes is appropriate at each reporting date. Quantitative information includes our historical loss experience, delinquency and charge-off trends, and current collateral values. Qualitative factors include the general economic environment in our markets and, in particular, the condition of the agricultural industry and other key industries in our market areas. Lending policies and procedures (including underwriting standards), the experience and abilities of lending staff, the quality of loan review, credit concentrations (by geography, loan type, industry and collateral type), the rate of loan portfolio growth, and changes in legal or regulatory requirements are additional factors that are considered. The total general reserve established for probable incurred losses on unimpaired loans was $5.831 million at September 30, 2014.

 

During the three months ended September 30, 2014, changes to the methodology used to determine our allowance for loan and lease losses include extending the historical loan loss look-back period from 12 months to 24 months, with more recent periods given higher weighting, and adjusting our qualitative factors accordingly. The potential impact of drought conditions in our markets was also given greater consideration in qualitative factors. As we add new products and expand our geographic coverage, and as the economic environment changes, we expect to continue to enhance our methodology to keep pace with the size and complexity of the loan and lease portfolio and respond to pressures created by external forces. We engage outside firms on a regular basis to assess our methodology and perform independent credit reviews of our loan and lease portfolio. In addition, the Company’s external auditors, the FDIC, and the California DBO review the allowance for loan and lease losses as an integral part of their audit and examination processes. Management believes that the current methodology is appropriate given our size and level of complexity.

 

27
 

 

The tables that follow detail the activity in the allowance for loan and lease losses for the periods noted:

 

Allowance for Credit Losses and Recorded Investment in Financing Receivables

(dollars in thousands, unaudited)

   For the three months ended September 30, 2014 
                         
   Real Estate   Agricultural   Commercial and
Industrial
   Consumer   Unallocated   Total 
                         
Allowance for credit losses:                              
Beginning Balance  $7,278   $1,353   $1,516   $1,463   $24   $11,634 
Charge-offs   (1,053)   -    (170)   (424)   -    (1,647)
Recoveries   291    1    538    195    -    1,025 
Provision   247    (539)   26    288    (22)   - 
                               
Ending Balance  $6,763   $815   $1,910   $1,522   $2   $11,012 

 

   For the nine months ended September 30, 2014 
                         
   Real Estate   Agricultural   Commercial and
Industrial
   Consumer   Unallocated   Total 
                         
Allowance for credit losses:                              
Beginning Balance  $5,544   $978   $3,787   $1,117   $251   $11,677 
Charge-offs   (1,485)   (124)   (583)   (1,410)   -    (3,602)
Recoveries   1,490    4    635    458    -    2,587 
Provision   1,214    (43)   (1,929)   1,357    (249)   350 
                               
Ending Balance  $6,763   $815   $1,910   $1,522   $2   $11,012 
                               
Reserves:                              
Specific  $3,883   $3   $873   $422   $-   $5,181 
General   2,880    812    1,037    1,100   $2    5,831 
                               
Ending Balance  $6,763   $815   $1,910   $1,522   $2   $11,012 
                               
Loans evaluated for impairment:                              
Individually  $34,444   $127   $2,925   $2,938   $-   $40,434 
Collectively   603,576    24,494    198,693    16,478    -    843,241 
                               
Ending Balance  $638,020   $24,621   $201,618   $19,416   $-   $883,675 

 

28
 

 

   For the Year Ended December 31, 2013 
                         
   Real Estate   Agricultural   Commercial and
Industrial
   Consumer   Unallocated   Total 
                         
Allowance for credit losses:                              
Beginning Balance  $8,034   $258   $3,467   $2,114   $-   $13,873 
Charge-offs   (4,205)   (473)   (1,668)   (1,917)   -    (8,263)
Recoveries   618    -    802    297    -    1,717 
Provision   1,097    1,193    1,186    623    251    4,350 
                               
Ending balance  $5,544   $978   $3,787   $1,117   $251   $11,677 
                               
Reserves:                              
Specific  $2,867   $126   $1,925   $431        $5,349 
General   2,677    852    1,862    686    251    6,328 
                               
Ending balance  $5,544   $978   $3,787   $1,117   $251   $11,677 
                               
Loans evaluated for impairment:                              
Individually  $47,010   $470   $5,444   $3,463   $-   $56,387 
Collectively   530,829    24,710    171,243    20,073    -    746,855 
                               
Ending balance  $577,839   $25,180   $176,687   $23,536   $-   $803,242 

 

29
 

 

PART I - FINANCIAL INFORMATION

 

ITEM 2

 

MANAGEMENT’S DISCUSSION AND

ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

 

FORWARD-LOOKING STATEMENTS

 

This Form 10-Q includes forward-looking statements that involve inherent risks and uncertainties. Words such as “expects”, “anticipates”, “believes”, “projects”, and “estimates” or variations of such words and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed, forecast in, or implied by such forward-looking statements.

 

A variety of factors could have a material adverse impact on the Company’s financial condition or results of operations, and should be considered when evaluating the Company’s potential future financial performance. They include, but are not limited to, unfavorable economic conditions in the Company’s service areas; risks associated with fluctuations in interest rates; liquidity risks; increases in nonperforming assets and credit losses that could occur, particularly in times of weak economic conditions or rising interest rates; reductions in the market value of available-for-sale securities that could result if interest rates increase substantially or an issuer has real or perceived financial difficulties; the Company’s ability to attract and retain skilled employees; the Company’s ability to successfully deploy new technology; the success of acquisitions or branch expansion; and risks associated with the multitude of current and prospective laws and regulations to which the Company is and will be subject.

 

CRITICAL ACCOUNTING POLICIES

 

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States. The financial information and disclosures contained within those statements are significantly impacted by management’s estimates and judgments, which are based on historical experience and incorporate assumptions that are believed to be reasonable under current circumstances. Actual results may differ from estimates under divergent conditions.

 

Critical accounting policies are those that involve the most complex and subjective decisions and assessments, and have the greatest potential impact on the Company’s stated results of operations. In management’s opinion, the Company’s critical accounting policies deal with the following areas: the establishment of the Company’s allowance for loan and lease losses, as explained in detail in Note 12 to the consolidated financial statements and the “Provision for Loan and Lease Losses” and “Allowance for Loan and Lease Losses” sections of this discussion and analysis; the valuation of impaired loans and foreclosed assets, which is discussed in Note 11 to the consolidated financial statements and in the “Nonperforming Assets” and “Allowance for Loan and Lease Losses” sections of this discussion and analysis; income taxes, especially with regard to the ability of the Company to recover deferred tax assets, as discussed in the “Provision for Income Taxes” and “Other Assets” sections of this discussion and analysis; and goodwill, which is evaluated annually for impairment based on the fair value of the Company as discussed in the “Other Assets” section of this discussion and analysis. Critical accounting areas are evaluated on an ongoing basis to ensure that the Company’s financial statements incorporate the most recent expectations with regard to those areas.

 

30
 

 

OVERVIEW OF THE RESULTS OF OPERATIONS

AND FINANCIAL CONDITION

 

results of operations Summary

 

Third Quarter 2014 compared to Third Quarter 2013

 

Net income for the quarter ended September 30, 2014 was $3.551 million, representing an increase of $184,000, or 5%, relative to net income of $3.367 million for the quarter ended September 30, 2013. Basic and diluted earnings per share for the third quarter of 2014 were $0.25, compared to $0.24 basic earnings per share and $0.23 diluted earnings per share for the third quarter of 2013. The Company’s annualized return on average equity was 7.51% and annualized return on average assets was 0.95% for the quarter ended September 30, 2014, compared to 7.60% and 0.97%, respectively, for the quarter ended September 30, 2013. The primary drivers behind the quarter over quarter variance in net income are as follows:

 

·Net interest income increased $1.291 million, or 11%, due primarily to a $123 million increase in average interest-earning assets and a higher level of non-recurring interest income.

 

·There was no loan loss provision recorded in the third quarter of 2014, relative to $800,000 in the third quarter of 2013.

 

·Total non-interest income was down $534,000 for the quarterly comparison, representing a drop of 12% due to lower income on overdrafts and returned items, reduced income on bank-owned life insurance (BOLI) associated with deferred compensation plans, declining fees on merchant accounts and higher expense accruals associated with our low-income housing tax credit investments.

 

·Total non-interest expense increased $260,000, or 2%, primarily due to costs associated with our new core banking system that was implemented in February 2014, residual costs related to our recent rebranding efforts, non-recurring acquisition costs incurred in the third quarter of 2014, loan sale expenses and higher occupancy expense, partially offset by lower deferred compensation accruals and a reduction in net expenses associated with foreclosed assets.

 

·The Company’s provision for income taxes was 33% of pre-tax income for the third quarter of 2014 as compared to 16% for the third quarter of 2013, with the increase resulting from a higher level of taxable income relative to the Company’s available tax credits as well as an adjustment of $310,000 to true-up tax accruals subsequent to the filing of our prior-year income tax returns in September 2014.

 

First Nine Months 2014 compared to First Nine Months 2013

 

Net income for the first nine months of 2014 was $11.586 million, representing an increase of $2.087 million, or 22%, relative to net income of $9.499 million for the first nine months of 2013. Basic and diluted earnings per share for the first nine months of 2014 were $0.82 and $0.81, respectively, compared to $0.67 basic and diluted earnings per share for the first nine months of 2013. The Company’s annualized return on average equity was 8.33% and annualized return on average assets was 1.06% for the nine months ended September 30, 2014, compared to a return on equity of 7.23% and return on assets of 0.91% for the nine months ended September 30, 2013. The primary drivers behind the variance in year-to-date net income are as follows:

 

·The single largest impact on the comparative year-to-date results came from a reduction of $2.500 million, or 88%, in the loan loss provision.

 

·Net interest income increased $2.337 million, or 6%, due to an $80 million increase in average interest-earning assets and a higher level of non-recurring interest income.

 

·Total non-interest income declined by $946,000, or 8%, for the comparative year-to-date periods due in large part to a drop in service charges on deposits, lower BOLI income, lower merchant fees and higher expense accruals associated with our tax credit investments, partially offset by an increase in gains realized on the sale of investment securities.

 

·Total non-interest expense fell by $541,000, or 2%, as higher marketing, data processing, deposit, and non-recurring acquisition and loan sale costs were more than offset by a reduction of $2.013 million in net costs associated with foreclosed assets, a drop in deferred compensation expense accruals, lower telecommunications costs, and a reduction in legal and accounting costs.

 

·The Company’s provision for income taxes was 28% of pre-tax income for the first nine months of 2014 relative to 19% for the first nine months of 2013, with the rate impacted by the same factors outlined in the quarterly comparison.

 

31
 

 

Financial Condition Summary

 

September 30, 2014 relative to December 31, 2013

 

The most significant characteristics of, and changes in, the Company’s balance sheet during the nine months ended September 30, 2014 are outlined below:

 

·The Company’s assets totaled $1.489 billion at September 30, 2014, an increase of $79 million, or 6%, relative to total assets of $1.410 billion at December 31, 2013 due to growth in loans and investments net of reductions in foreclosed assets and balances due from banks.

 

·Gross loans increased by $80 million, or 10%, due to the purchase of $33 million in residential mortgage loans in the first quarter of 2014 and strong organic growth in agricultural real estate loans, mortgage warehouse loans and commercial real estate loans.

 

·Total nonperforming assets were reduced by $17 million, or 37%, during the first nine months of 2014, with the bulk sale of a total of $10 million in nonperforming loans in the second and third quarters contributing to the reduction. The Company’s ratio of nonperforming assets to loans plus foreclosed assets was 3.22% at September 30, 2014, compared to 5.62% at December 31, 2013.

 

·Cash and due from banks was down $38 million, or 49%, as we deployed excess liquidity into longer-term bonds, and investment securities thus increased by $43 million, or 10%.

 

·Deposits reflect growth of $49 million, or 4%, for the nine months ended September 30, 2014, but experienced a decline during the third quarter due to seasonal deposit runoff. Core non-maturity deposits were up $67 million, or 8%, but growth in non-maturity deposits was partially offset by the runoff of $13 million in customer time deposits and a $5 million reduction in wholesale brokered deposits.

 

·Total capital increased by $4.6 million, or 3%, to $186 million at September 30, 2014, due primarily to the addition of net income to retained earnings, net of the impact of cash dividends paid and the Company’s share repurchases. While still robust, our consolidated total risk-based capital ratio declined to 20.06% at September 30, 2014 from 21.67% at year-end 2013 due to growth in risk-adjusted assets. Our tier one risk-based capital ratio was 18.94% and our tier one leverage ratio was 13.61% at September 30, 2014.

 

EARNINGS PERFORMANCE

 

The Company earns income from two primary sources. The first is net interest income, which is interest income generated by earning assets less interest expense on interest-bearing liabilities. The second is non-interest income, which consists mainly of customer service charges and fees but also comes from non-customer sources such as bank-owned life insurance. The majority of the Company’s non-interest expense is comprised of operating costs that relate to providing a full range of banking services to our customers.

 

Net interest income AND NET INTEREST MARGIN

 

Net interest income increased by $1.291 million, or 11%, for the third quarter of 2014 relative to the third quarter of 2013, and by $2.337 million, or 6%, for the first nine months of 2014 compared to the first nine months of 2013. The level of net interest income recognized in any given period depends on a combination of factors including the average volume and yield for interest-earning assets, the average volume and cost of interest-bearing liabilities, and the mix of products which comprise the Company’s earning assets, deposits, and other interest-bearing liabilities. Net interest income is also impacted by the reversal of interest for loans placed on non-accrual status during the reporting period, and the recovery of interest on loans that had been on non-accrual and were paid off, sold or returned to accrual status.

 

32
 

 

The following tables show average balances for significant balance sheet categories and the amount of interest income or interest expense associated with each applicable category for the noted periods. The tables also display the calculated yields on each major component of the Company’s investment and loan portfolios, the average rates paid on each key segment of the Company’s interest-bearing liabilities, and our net interest margin for the noted periods.

 

Average Balances and Rates  For the three months ended   For the three months ended 
(dollars in thousands, except per share data)  September 30, 2014   September 30, 2013 
Assets 

Average

Balance (1)

   Income/
Expense
  

Average

Rate/Yield (2)(3)

  

Average

Balance (1)

   Income/
Expense
  

Average

Rate/Yield (2)(3)

 
Investments:                              
Federal funds sold/due from time  $6,149   $4    0.25%  $44,791   $28    0.24%
Taxable   361,918    1,935    2.09%   299,278    1,132    1.48%
Non-taxable   97,819    729    4.42%   87,902    699    4.71%
Equity   2,523    73    11.32%   2,360    -    - 
Total investments   468,409    2,741    2.60%   434,331    1,859    2.00%
                               
Loans and Leases:(4)                              
Real estate   641,766    8,403    5.19%   564,174    7,898    5.55%
Agricultural   25,926    244    3.73%   27,086    279    4.09%
Commercial   98,552    1,078    4.34%   95,121    1,183    4.93%
Consumer   20,297    501    9.79%   24,607    519    8.37%
Mortgage Warehouse Lines   95,323    966    4.02%   82,198    1,015    4.90%
Direct financing leases   2,266    31    5.43%   2,773    38    5.44%
Other   305    14    18.21%   7    -    - 
Total loans and leases   884,435    11,237    5.04%   795,966    10,932    5.45%
Total interest earning assets (5)   1,352,844    13,978    4.21%   1,230,297    12,791    4.24%
Other earning assets   6,122              5,932           
Non-earning assets   126,454              140,017           
Total assets  $1,485,420             $1,376,246           
                               
Liabilities and shareholders' equity                              
Interest bearing deposits:                              
Demand deposits  $109,825   $76    0.27%  $84,181   $74    0.35%
NOW   251,825    84    0.13%   193,289    88    0.18%
Savings accounts   153,670    44    0.11%   135,255    73    0.21%
Money market   74,014    16    0.09%   67,859    20    0.12%
CDAR's   12,817    8    0.25%   13,812    10    0.29%
Certificates of deposit<$100,000   75,713    80    0.42%   85,406    102    0.47%
Certificates of deposit>$100,000   199,666    172    0.34%   210,273    201    0.38%
Brokered deposits   6,337    23    1.44%   11,793    38    1.28%
Total interest bearing deposits   883,867    503    0.23%   801,868    606    0.30%
Borrowed Funds:                              
Federal funds purchased   1    -    -    4    -    - 
Repurchase agreements   5,289    5    0.38%   3,255    4    0.49%
Short term borrowings   6,413    1    0.06%   -    -    - 
Long term borrowings   -    -    -    -    -    - 
TRUPS   30,928    177    2.27%   30,928    180    2.31%
Total borrowed funds   42,631    183    1.70%   34,187    184    2.14%
Total interest bearing liabilities   926,498    686    0.29%   836,055    790    0.37%
Demand deposits - non-interest bearing   355,994              353,110           
Other liabilities   15,320              11,375           
Shareholders' equity   187,608              175,706           
Total liabilities and shareholders' equity  $1,485,420             $1,376,246           
                               
Interest income/interest earning assets             4.21%             4.24%
Interest expense/interest earning assets             0.20%             0.25%
  Net interest income and margin(6)       $13,292    4.01%       $12,001    3.99%

 

(1)Average balances are obtained from the best available daily or monthly data and are net of deferred fees and related direct costs.
(2)Yields and net interest margin have been computed on a tax equivalent basis utilizing a 34% effective tax rate.
(3)Annualized
(4)Loan costs have been included in the calculation of interest income. Loan costs were approximately $259 thousand and $52 thousand for the quarters ended September 30, 2014 and 2013. Loans are gross of the allowance for possible loan losses.
(5)Non-accrual loans have been included in total loans for purposes of total earning assets.
(6)Net interest margin represents net interest income as a percentage of average interest-earning assets.

 

33
 

 

Average Balances and Rates  For the nine months ended   For the nine months ended 
(dollars in thousands, except per share data)  September 30, 2014   September 30, 2013 
Assets 

Average

Balance (1)

   Income/
Expense
  

Average

Rate/Yield (2)(3)

  

Average

Balance (1)

   Income/
Expense
  

Average

Rate/Yield (2)(3)

 
Investments:                              
Federal funds sold/Due from time  $28,239   $55    0.26%  $38,720   $72    0.25%
Taxable   351,507    5,636    2.11%   308,138    3,311    1.42%
Non-taxable   97,193    2,203    4.53%   83,719    1,990    4.75%
Equity   2,526    73    3.81%   2,149    17    1.04%
Total Investments   479,465    7,967    2.50%   432,726    5,390    1.95%
                               
Loans and Leases:(4)                              
Real Estate   618,600    24,626    5.32%   556,369    23,221    5.58%
Agricultural   24,798    737    3.97%   25,047    760    4.06%
Commercial   97,493    3,253    4.46%   97,294    3,692    5.07%
Consumer   21,747    1,469    9.03%   25,840    1,616    8.36%
Mortgage Warehouse Lines   77,343    2,429    4.20%   101,772    3,796    4.99%
Direct Financing Leases   2,367    96    5.42%   3,067    122    5.32%
Other   293    34    15.51%   9    -    - 
Total Loans and Leases   842,641    32,644    5.18%   809,398    33,207    5.49%
Total Interest Earning Assets (5)   1,322,106    40,611    4.22%   1,242,124    38,597    4.26%
Other Earning Assets   6,043              6,157           
Non-Earning Assets   129,603              140,929           
Total Assets  $1,457,752             $1,389,210           
                               
Liabilities and Shareholders' Equity                              
Interest Bearing Deposits:                              
Demand Deposits  $104,481   $209    0.27%  $85,035   $225    0.35%
NOW   239,614    253    0.14%   195,016    281    0.19%
Savings Accounts   151,362    195    0.17%   129,911    209    0.22%
Money Market   73,035    57    0.10%   71,359    74    0.14%
CDAR's   12,999    24    0.25%   13,933    30    0.29%
Certificates of Deposit<$100,000   77,797    258    0.44%   92,362    326    0.47%
Certificates of Deposit>$100,000   201,697    546    0.36%   212,597    630    0.40%
Brokered Deposits   6,256    72    1.54%   11,648    119    1.37%
Total Interest Bearing Deposits   867,241    1,614    0.25%   811,861    1,894    0.31%
Borrowed Funds:                              
Federal Funds Purchased   15    -    -    2    -    - 
Repurchase Agreements   5,753    14    0.33%   2,314    10    0.58%
Short Term Borrowings   2,408    2    0.11%   4,675    6    0.17%
Long Term Borrowings   -    -    -    1,392    33    3.17%
TRUPS   30,928    526    2.27%   30,928    536    2.32%
Total Borrowed Funds   39,104    542    1.85%   39,311    585    1.99%
Total Interest Bearing Liabilities   906,345    2,156    0.32%   851,172    2,479    0.39%
Demand deposits- non interest bearing   347,942              345,939           
Other liabilities   17,415              16,394           
Shareholders' equity   186,050              175,705           
Total liabilities and shareholders' equity  $1,457,752             $1,389,210           
                               
Interest Income/Interest Earning Assets             4.22%             4.26%
Interest Expense/Interest Earning Assets             0.22%             0.26%
  Net Interest Income and Margin(6)       $38,455    4.00%       $36,118    4.00%

 

(1)Average balances are obtained from the best available daily or monthly data and are net of deferred fees and related direct costs.
(2)Yields and net interest margin have been computed on a tax equivalent basis utilizing a 34% effective tax rate.
(3)Annualized
(4)Loan costs have been included in the calculation of interest income. Loan costs were approximately $608 thousand and $84 thousand for the nine months ended September 30, 2014 and 2013. Loans are gross of the allowance for possible loan losses.
(5)Non-accrual loans have been included in total loans for purposes of total earning assets.
(6)Net interest margin represents net interest income as a percentage of average interest-earning assets.

 

34
 

 

The Volume and Rate Variances table below sets forth the dollar difference in interest earned or paid for each major category of interest-earning assets and interest-bearing liabilities for the noted periods, and the amount of such change attributable to fluctuations in average balances (volume) or differences in average interest rates. Volume variances are equal to the increase or decrease in average balance multiplied by prior period rates, and rate variances are equal to the increase or decrease in rate times prior period average balances. Variances attributable to both rate and volume changes, calculated by multiplying the change in rate by the change in average balance, have been allocated to the rate variance.

 

Volume & Rate Variances  Three months ended September 30,   Nine months ended September 30, 
(dollars in thousands)  2014 over 2013   2014 over 2013 
   Increase(decrease) due to   Increase(decrease) due to 
Assets:  Volume   Rate   Net   Volume   Rate   Net 
Investments:                              
Federal funds sold / Due from time  $(24)  $-   $(24)  $(19)  $2   $(17)
Taxable   237    566    803    466    1,859    2,325 
Non-taxable(1)   79    (49)   30    320    (107)   213 
Equity   -    73    73    3    53    56 
Total Investments   292    590    882    770    1,807    2,577 
Loans and Leases:                              
Real Estate   1,086    (581)   505    2,597    (1,192)   1,405 
Agricultural   (12)   (23)   (35)   (8)   (15)   (23)
Commercial   43    (148)   (105)   8    (447)   (439)
Consumer   (91)   73    (18)   (256)   109    (147)
Mortgage Warehouse   162    (211)   (49)   (911)   (456)   (1,367)
Direct Financing Leases   (7)   -    (7)   (28)   2    (26)
Other   -    14    14    -    34    34 
Total Loans and Leases   1,181    (876)   305    1,402    (1,965)   (563)
Total Interest Earning Assets  $1,473   $(286)  $1,187   $2,172   $(158)  $2,014 
Liabilities                              
Interest Bearing Deposits:                              
Demand Deposits  $23   $(21)  $2   $51   $(67)  $(16)
NOW   27    (31)   (4)   64    (92)   (28)
Savings Accounts   10    (39)   (29)   35    (49)   (14)
Money Market   2    (6)   (4)   2    (19)   (17)
CDAR's   (1)   (1)   (2)   (2)   (4)   (6)
Certificates of Deposit < $100,000   (12)   (10)   (22)   (51)   (17)   (68)
Certificates of Deposit > $100,000   (10)   (19)   (29)   (32)   (52)   (84)
Brokered Deposits   (18)   3    (15)   (55)   8    (47)
Total Interest Bearing Deposits   21    (124)   (103)   12    (292)   (280)
Borrowed Funds:                              
Federal Funds Purchased   -    -    -    -    -    - 
Repurchase Agreements   2    (1)   1    15    (11)   4 
Short Term Borrowings   -    1    1    (3)   (1)   (4)
Long Term Borrowings   -    -    -    (33)   -    (33)
TRUPS   -    (3)   (3)   -    (10)   (10)
Total Borrowed Funds   2    (3)   (1)   (21)   (22)   (43)
Total Interest Bearing Liabilities   23    (127)   (104)   (9)   (314)   (323)
Net Interest Margin/Income  $1,450   $(159)  $1,291   $2,181   $156   $2,337 

 

(1) Yields on tax exempt income have not been computed on a tax equivalent basis.

 

35
 

 

The volume variance calculated for the third quarter of 2014 relative to the third quarter of 2013 was a favorable $1.450 million, due primarily to a $123 million increase in the average balance of interest-earning assets. The volume variance for the comparative quarters was enhanced by migration from time deposits into lower-cost non-maturity deposits.

 

The impact of interest rate changes resulted in an unfavorable rate variance of $159,000 in net interest income for the comparative quarters. Our weighted average yield on interest-earning assets fell 3 basis points due to a 41 basis point decline in loan yields stemming from continued competition for quality loans, partially offset by a higher investment portfolio yield. Investment yields were up due to favorable trends in prepayment rates on mortgage-backed securities, which impacted the amortization of premiums and accretion of discounts. Primarily because of a drop in customer deposit rates, the weighted average cost of interest-bearing liabilities was 8 basis points lower for the quarter. Even though this was more than double the decline in our yield on earning assets, the quarter-over-quarter rate variance was still unfavorable due to the volume differential between interest-earning assets and interest-bearing liabilities. That differential averaged $394 million for the third quarter of 2013, the base period for the rate variance calculation, thus the decrease in our earning asset yield was applied to a much higher balance than the rate decrease for interest-bearing liabilities and had a greater impact on net interest income. Partially alleviating the negative pressure on our rate variance was non-recurring interest income such as interest recovered on non-accrual loans resolved during the quarter and prepayment penalties (net of interest reversals for loans placed on non-accrual status), which totaled $135,000 in the third quarter of 2014 relative to $39,000 in the third quarter of 2013.

 

The Company’s net interest margin, which is tax-equivalent net interest income as a percentage of average interest-earning assets, is affected by the same factors discussed above relative to rate and volume variances. Our net interest margin was 4.01% in the third quarter of 2014, an increase of two basis points relative to the third quarter of 2013. The principal developments favorably impacting our net interest margin in the third quarter of 2014 include a higher level of non-recurring interest income, an increase in the yield on investments, lower deposit rates, and a shift from higher-cost time deposits into lower-cost non-maturity deposits. Partially offsetting those favorable factors were competitive pressures on loan yields.

 

For the comparative year-to-date periods ended September 30, 2014 and 2013, the favorable variance in net interest income attributable to volume changes was $2.181 million, and there was also a small favorable rate variance of $156,000. The year-to-date volume variance was primarily due to an $80 million increase in average interest-earning assets, which was enhanced by relatively strong growth in the average balances of low-cost customer deposits and equity. The volume variance was negatively impacted by a large increase in the average balance of lower yielding investments, which were up 11% relative to an increase of only 4% in average loan balances. The favorable rate variance for the year-to-date period is the result of a four basis point drop in the yield on average interest-earning assets relative to a seven basis point decline in the cost of interest-bearing liabilities, partially offset by the impact of the volume differential between interest-earning assets and interest-bearing liabilities. As with the quarter, non-recurring interest income favorably impacted the rate variance for the year-to-date comparison. Net interest recoveries and prepayment penalties totaled $423,000 for the first nine months of 2014, relative to only $161,000 in the first nine months of 2013. The Company’s net interest margin for the first nine months of 2014 was 4.00%, the same as our net interest margin for the first nine months of 2013.

 

Provision for loan and LEASE losses

 

Credit risk is inherent in the business of making loans. The Company sets aside an allowance for loan and lease losses, a contra-asset account, through periodic charges to earnings which are reflected in the income statement as the provision for loan and lease losses. The Company was not required to record a loan loss provision for the third quarter of 2014 due to continued improvement in credit quality, but the loan loss provision was $800,000 in the third quarter of 2013. The loan loss provision was $350,000 for the first nine months of 2014, representing a reduction of $2.500 million, or 88%, relative to the same period in 2013. Our loan loss provision in 2014 has been utilized primarily to replenish reserves subsequent to charge-offs.

 

The Company’s loan loss provision has been sufficient to maintain our allowance for loan and lease losses at a level that, in management’s judgment, is adequate to absorb probable loan losses related to specifically-identified impaired loans as well as probable incurred losses in the remaining loan portfolio. Specifically identifiable and quantifiable loan losses are immediately charged off against the allowance. We had $622,000 in net loans charged off in the third quarter of 2014 relative to $1.156 million in the third quarter of 2013, for a reduction of $534,000, or 46%. There were $1.015 million in net loan charge-offs in the first nine months of 2014 relative to $4.899 million in the first nine months of 2013, for a reduction of $3.884 million, or 79%. Gross charge-offs increased slightly for the third quarter due to charge-offs recorded when $5 million in nonperforming assets were sold, but declined on a year-to-date basis. A significant level of principal recoveries for both the quarter and year-to-date periods contributed to the relatively low level of net charge-offs in 2014. Additional factors which helped reduce our need for reserve replenishment via the loan loss provision in 2014 include the fact that many of our loan charge-offs have been recorded against reserves established in previous periods, and the fact that the credit quality of our performing loan portfolio continues to improve as newer loans have been underwritten utilizing more stringent criteria than older vintage loans.

 

36
 

 

The Company’s policies for monitoring the adequacy of the allowance and determining loan amounts that should be charged off, and other detailed information with regard to changes in the allowance, are discussed in note 12 to the consolidated financial statements and below under “Allowance for Loan and Lease Losses.” The process utilized to establish an appropriate allowance for loan and lease losses can result in a high degree of variability in the Company’s loan loss provision, and consequently in our net earnings.

 

NON-INTEREST INCOME and NON-INTEREST expense

 

The following table provides details on the Company’s non-interest income and non-interest expense for the three-month and nine-month periods ended September 30, 2014 and 2013 (dollars in thousands):

 

   Three months ended September 30,   Nine months ended September 30, 
NON-INTEREST INCOME:  2014   % of Total   2013   % of Total   2014   % of Total   2013   % of Total 
Service charges on deposit accounts  $2,214    58.49%  $2,354    54.50%  $6,139    53.34%  $6,642    53.32%
Other service charges, commissions & fees   1,359    35.90%   1,420    32.88%   4,144    36.00%   4,283    34.39%
Gains on sales of loans   -    -    24    0.56%   3    0.03%   92    0.74%
Gains on securities   -    -    -    -    287    2.49%   6    0.05%
Loan servicing income   1    0.03%   2    0.05%   3    0.03%   6    0.05%
Bank owned life insurance   156    4.12%   435    10.07%   844    7.33%   1,259    10.11%
Other   55    1.46%   84    1.94%   90    0.78%   168    1.34%
Total non-interest income  $3,785    100.00%  $4,319    100.00%  $11,510    100.00%  $12,456    100.00%
As a % of average interest-earning assets (1)        1.11%        1.39%        1.16%        1.34%
                                         
NON-INTEREST EXPENSE:                                        
Salaries and employee benefits  $5,459    46.46%  $5,394    46.95%  $16,772    50.09%  $16,717    49.13%
Occupancy costs                                        
Furniture & equipment   458    3.90%   455    3.96%   1,378    4.12%   1,489    4.38%
Premises   1,204    10.25%   1,099    9.56%   3,322    9.92%   3,213    9.44%
Advertising and marketing costs   468    3.98%   352    3.06%   1,679    5.01%   1,195    3.51%
Data processing costs   673    5.73%   404    3.52%   1,937    5.78%   1,166    3.43%
Deposit services costs   657    5.59%   619    5.39%   1,935    5.78%   1,832    5.38%
Loan services costs                                        
Loan processing   572    4.87%   339    2.95%   1,033    3.08%   711    2.09%
Foreclosed assets   51    0.43%   887    7.72%   (334)   -1.00%   1,679    4.93%
Other operating costs                                        
Telephone & data communications   329    2.80%   350    3.05%   804    2.40%   1,223    3.59%
Postage & mail   221    1.88%   202    1.76%   571    1.71%   544    1.60%
Other   147    1.25%   241    2.09%   499    1.49%   529    1.55%
Professional services costs                                        
Legal & accounting   310    2.64%   367    3.19%   952    2.84%   1,320    3.88%
Other professional service   744    6.33%   563    4.90%   1,791    5.35%   1,723    5.06%
Stationery & supply costs   331    2.82%   142    1.24%   859    2.57%   455    1.34%
Sundry & tellers   126    1.07%   76    0.66%   288    0.86%   231    0.69%
Total non-interest expense  $11,750    100.00%  $11,490    100.00%  $33,486    100.00%  $34,027    100.00%
As a % of average interest-earning assets (1)        3.45%        3.71%        3.39%        3.66%
Efficiency Ratio (2)   65.85%        69.10%        66.59%        66.70%     

 

(1) Annualized

(2) Tax Equivalent

 

37