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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
 
FORM 10-Q
 
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2014
 
OR
 
(  ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                                                                  to                                                             
 
Commission File No. 0-25023
 
First Capital, Inc.
(Exact name of registrant as specified in its charter)
 
  Indiana 35-2056949  
 
(State or other jurisdiction of
incorporation or organization)
 (I.R.S. Employer
Identification Number)
 
 
 220 Federal Drive NW, Corydon, Indiana  47112
(Address of principal executive offices) (Zip Code)
 
Registrant's telephone number including area code 1-812-738-2198
 
  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     X      No ____
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes __X__No _____
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a small reporting company.  See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
(Check one): Large Accelerated Filer ___ Accelerated Filer ___
  Non-accelerated Filer ___ Smaller Reporting Company      X   
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes ____   No    X   
 
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:  2,740,502 shares of common stock were outstanding as of October 31, 2014.
 
 
 

 
FIRST CAPITAL, INC.
 
INDEX
 
Part I
Financial Information
Page
     
  3
     
 
     
 
     
 
     
 
     
 
 
 
 
 
     
 
 
 
 
 
     
 
     
     
Part II
Other Information
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
     
   
 
 
- 2 -

 
PART I - FINANCIAL INFORMATION
FIRST CAPITAL, INC. AND SUBSIDIARIES
(Unaudited)
 
 
   
September 30,
2014
   
December 31,
2013
 
   
(In thousands)
 
ASSETS
           
Cash and due from banks
  $ 9,918     $ 10,058  
Interest bearing deposits with banks
    3,822       467  
Federal funds sold
    6,423       611  
Total cash and cash equivalents
    20,163       11,136  
                 
Interest-bearing time deposits
    6,635       4,425  
Securities available for sale, at fair value
    100,491       108,762  
Securities-held to maturity
    7       9  
Loans, net
    302,275       288,506  
Loans held for sale
    1,039       1,611  
Federal Home Loan Bank stock, at cost
    2,820       2,820  
Foreclosed real estate
    58       466  
Premises and equipment
    10,334       10,347  
Accrued interest receivable
    1,607       1,716  
Cash value of life insurance
    6,123       6,332  
Goodwill
    5,386       5,386  
Other assets
    3,354       2,868  
                 
Total Assets
  $ 460,292     $ 444,384  
                 
LIABILITIES
               
Deposits:
               
Noninterest-bearing
  $ 71,998     $ 56,436  
Interest-bearing
    329,051       317,394  
Total deposits
    401,049       373,830  
                 
Retail repurchase agreements
    0       9,310  
Advances from Federal Home Loan Bank
    0       5,500  
Accrued interest payable
    154       192  
Accrued expenses and other liabilities
    2,799       2,213  
Total liabilities
    404,002       391,045  
                 
EQUITY
               
Preferred stock of $.01 par value per share Authorized 1,000,000 shares; none issued
    0       0  
Common stock of $.01 par value per share Authorized 5,000,000 shares; issued 3,164,416 shares; outstanding 2,740,502 shares (2,784,088 in 2013)
    32       32  
Additional paid-in capital
    24,313       24,313  
Retained earnings-substantially restricted
    39,550       36,947  
Accumulated other comprehensive income (loss)
    540       (720 )
Less treasury stock, at cost - 423,914 shares (380,328 shares in 2013)
    (8,253 )     (7,345 )
Total First Capital, Inc. stockholders' equity
    56,182       53,227  
                 
Noncontrolling interest in subsidiary
    108       112  
Total equity
    56,290       53,339  
                 
Total Liabilities and Equity
  $ 460,292     $ 444,384  
 
See accompanying notes to consolidated financial statements.
 
 
- 3 -

 
PART I - FINANCIAL INFORMATION
FIRST CAPITAL, INC. AND SUBSIDIARY
(Unaudited)
 
 
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
   
(In thousands, except per share data)
 
INTEREST INCOME
                               
Loans, including fees
  $ 4,057     $ 4,011     $ 11,931     $ 11,860  
Securities:
                               
Taxable
    289       307       909       970  
Tax-exempt
    249       287       813       821  
Federal Home Loan Bank dividends
    27       25       92       74  
Federal funds sold and interest bearing deposits with banks
    24       19       66       54  
Total interest income
    4,646       4,649       13,811       13,779  
INTEREST EXPENSE
                               
Deposits
    278       355       858       1,145  
Retail repurchase agreements
    0       7       12       22  
Advances from Federal Home Loan Bank
    2       46       5       139  
Total interest expense
    280       408       875       1,306  
Net interest income
    4,366       4,241       12,936       12,473  
Provision for loan losses
    75       100       190       575  
Net interest income after provision for loan losses
    4,291       4,141       12,746       11,898  
NONINTEREST INCOME
                               
Service charges on deposit accounts
    816       823       2,361       2,327  
Commission income
    237       102       435       297  
Gain on sale of securities
    0       8       54       29  
Gain on sale of mortgage loans
    180       194       499       675  
Mortgage brokerage fees
    15       20       29       37  
Increase in cash surrender value of life insurance
    35       38       112       122  
Other income
    155       26       214       74  
Total noninterest income
    1,438       1,211       3,704       3,561  
NONINTEREST EXPENSE
                               
Compensation and benefits
    1,957       1,757       5,628       5,232  
Occupancy and equipment
    298       281       910       880  
Data processing
    404       373       1,168       1,084  
Professional fees
    138       164       436       534  
Advertising
    82       80       215       189  
Other operating expenses
    712       615       1,882       1,979  
Total noninterest expense
    3,591       3,270       10,239       9,898  
Income before income taxes
    2,138       2,082       6,211       5,561  
Income tax expense
    611       653       1,862       1,721  
Net Income
    1,527       1,429       4,349       3,840  
Less: net income attributable to noncontrolling interest in subsidiary
    3       3       10       10  
Net Income Attributable to First Capital, Inc.
  $ 1,524     $ 1,426     $ 4,339     $ 3,830  
                                 
Earnings per common share attributable to First Capital, Inc.
                               
Basic
  $ 0.56     $ 0.51     $ 1.57     $ 1.38  
Diluted
  $ 0.56     $ 0.51     $ 1.57     $ 1.38  
                                 
Dividends per share
  $ 0.21     $ 0.20     $ 0.63     $ 0.60  
 
See accompanying notes to consolidated financial statements.
 
 
- 4 -

 
PART I - FINANCIAL INFORMATION
FIRST CAPITAL, INC. AND SUBSIDIARY
(Unaudited)
 
 
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
   
(In thousands)
 
                         
Net Income
  $ 1,527     $ 1,429     $ 4,349     $ 3,840  
                                 
OTHER COMPREHENSIVE INCOME (LOSS)
                               
Unrealized gains (losses) on securities available for sale:
                               
Unrealized holding gains (losses) arising during the period
    257       (781 )     2,130       (3,605 )
Income tax (expense) benefit
    (101 )     309       (837 )     1,428  
Net of tax amount
    156       (472 )     1,293       (2,177 )
                                 
Less: reclassification adjustment for realized gains included in net income
    0       (7 )     (54 )     (29 )
Income tax expense
    0       3       21       11  
Net of tax amount
    0       (4 )     (33 )     (18 )
                                 
Other Comprehensive Income (Loss), net of tax
    156       (476 )     1,260       (2,195 )
                                 
Comprehensive Income
    1,683       953       5,609       1,645  
Less: comprehensive income attributable to the noncontrolling interest in subsidiary
    3       3       10       10  
                                 
Comprehensive Income Attributable to First Capital, Inc.
  $ 1,680     $ 950     $ 5,599     $ 1,635  
 
See accompanying notes to consolidated financial statements.
 
 
- 5 -

 
PART I - FINANCIAL INFORMATION
(Unaudited)
 
 
         
Additional
   
Accumulated
Other
                   
(In thousands)
 
Common
Stock
   
Paid-in
Capital
   
Retained
Earnings
   
Comprehensive
Income (Loss)
   
Treasury
Stock
   
Noncontrolling
Interest
   
Total
 
                                           
Balances at January 1, 2013
  $ 32     $ 24,313     $ 34,101     $ 1,704     $ (7,326 )   $ 112     $ 52,936  
                                                         
Net income
    0       0       3,830       0       0       10       3,840  
                                                         
Other comprehensive loss
    0       0       0       (2,195 )     0       0       (2,195 )
                                                         
Cash dividends
    0       0       (1,670 )     0       0       (14 )     (1,684 )
                                                         
Purchase of treasury shares
    0       0       0       0       (10 )     0       (10 )
                                                         
Balances at September 30, 2013
  $ 32     $ 24,313     $ 36,261     $ (491 )   $ (7,336 )   $ 108     $ 52,887  
                                                         
                                                         
Balances at January 1, 2014
  $ 32     $ 24,313     $ 36,947     $ (720 )   $ (7,345 )   $ 112     $ 53,339  
                                                         
Net income
    0       0       4,339       0       0       10       4,349  
                                                         
Other comprehensive income
    0       0       0       1,260       0       0       1,260  
                                                         
Cash dividends
    0       0       (1,736 )     0       0       (14 )     (1,750 )
                                                         
Purchase of treasury shares
    0       0       0       0       (908 )     0       (908 )
                                                         
Balances at September 30, 2014
  $ 32     $ 24,313     $ 39,550     $ 540     $ (8,253 )   $ 108     $ 56,290  
 
See accompanying notes to consolidated financial statements.
 
 
- 6 -

 
PART I - FINANCIAL INFORMATION
FIRST CAPITAL, INC. AND SUBSIDIARY
(Unaudited)
 
 
   
Nine Months Ended
September 30,
 
   
2014
   
2013
 
   
(In thousands)
 
CASH FLOWS FROM OPERATING ACTIVITIES
               
Net income
  $ 4,349     $ 3,840  
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:
               
Amortization of premiums and accretion of discounts on securities, net
    530       712  
Depreciation and amortization expense
    527       533  
Deferred income taxes
    (116 )     87  
Increase in cash value of life insurance
    (112 )     (122 )
Gain on life insurance
    (129 )     0  
Gain on sale of securities
    (54 )     (29 )
Provision for loan losses
    190       575  
Proceeds from sales of loans
    20,596       32,090  
Loans originated for sale
    (19,525 )     (28,506 )
Gain on sale of loans
    (499 )     (675 )
Decrease in accrued interest receivable
    109       82  
Decrease in accrued interest payable
    (38 )     (65 )
Net change in other assets/liabilities
    (64 )     722  
Net Cash Provided By Operating Activities
    5,764       9,244  
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Investment in interest-bearing time deposits
    (2,210 )     (820 )
Purchase of securities available for sale
    (20,657 )     (23,460 )
Proceeds from maturities of securities available for sale
    16,655       19,047  
Proceeds from sales of securities available for sale
    5,669       517  
Principal collected on mortgage-backed obligations
    8,120       10,446  
Net increase in loans receivable
    (13,962 )     (9,473 )
Proceeds from sale of foreclosed real estate
    411       299  
Purchase of premises and equipment
    (514 )     (238 )
Net Cash Used In Investing Activities
    (6,488 )     (3,682 )
 
               
CASH FLOWS FROM FINANCING ACTIVITIES
               
Net increase (decrease) in deposits
    27,219       (7,336 )
Net decrease in advances from Federal Home Loan Bank
    (5,500 )     (100 )
Net decrease in retail repurchase agreements
    (9,310 )     (3,655 )
Purchase of treasury stock
    (908 )     (10 )
Dividends paid
    (1,750 )     (1,684 )
Net Cash Provided By (Used In) Financing Activities
    9,751       (12,785 )
                 
Net Increase (Decrease) in Cash and Cash Equivalents
    9,027       (7,223 )
Cash and cash equivalents at beginning of period
    11,136       21,811  
Cash and Cash Equivalents at End of Period
  $ 20,163     $ 14,588  
 
See accompanying notes to consolidated financial statements.
 
 
- 7 -

 
FIRST CAPITAL, INC.
(Unaudited)
 
1.           Presentation of Interim Information
 
First Capital, Inc. (“Company”) is the savings and loan holding company for First Harrison Bank (“Bank”). The information presented in this report relates primarily to the Bank's operations.  First Harrison Investments, Inc. and First Harrison Holdings, Inc. are wholly-owned Nevada corporate subsidiaries of the Bank that jointly own First Harrison, LLC, a Nevada limited liability corporation that holds and manages an investment portfolio.  First Harrison REIT, Inc. (“REIT”) was incorporated as a wholly-owned subsidiary of First Harrison Holdings, Inc. to hold a portion of the Bank’s real estate mortgage loan portfolio.  On January 21, 2009, the REIT issued 105 shares of 12.5% redeemable cumulative preferred stock with an aggregate liquidation value of $105,000 in a private placement offering in order to satisfy certain ownership requirements to qualify as a real estate investment trust.   At September 30, 2014, this noncontrolling interest represented 0.2% ownership of the REIT.  On September 23, 2014, the Company formed FHB Risk Mitigation Services, Inc. (“Captive”).  The Captive is a wholly-owned insurance subsidiary of the Company that will provide property and casualty insurance coverage to the Company, the Bank and all subsidiaries and reinsurance to five other third party insurance captives for which insurance may not be currently available or economically feasible in today’s insurance marketplace.
 
In the opinion of management, the unaudited consolidated financial statements include all adjustments considered necessary to present fairly the financial position as of September 30, 2014, and the results of operations for the three months and nine months ended September 30, 2014 and 2013 and the cash flows for the nine months ended September 30, 2014.  All of these adjustments are of a normal, recurring nature.  Such adjustments are the only adjustments included in the unaudited consolidated financial statements.  Interim results are not necessarily indicative of results for a full year or any other period.
 
The accompanying unaudited consolidated financial statements and notes have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial statements and are presented as permitted by the instructions to Form 10-Q. Accordingly, they do not contain certain information included in the Company’s annual audited consolidated financial statements and related footnotes for the year ended December 31, 2013 included in the Company’s Annual Report on Form 10-K.
 
The unaudited consolidated financial statements include the accounts of the Company and its subsidiaries.  All material intercompany balances and transactions have been eliminated in consolidation.
 
 
- 8 -

 
FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
2.           Investment Securities
 
Debt and equity securities have been classified in the consolidated balance sheets according to management’s intent.  Investment securities at September 30, 2014 and December 31, 2013 are summarized as follows:
 
(In thousands)
 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
                         
September 30, 2014
                       
Securities available for sale:
                       
Agency mortgage-backed securities
  $ 30,408     $ 173     $ 160     $ 30,421  
Agency CMO
    15,813       108       205       15,716  
Other debt securities:
                               
Agency notes and bonds
    22,555       35       162       22,428  
Municipal obligations
    30,884       1,172       135       31,921  
Subtotal - debt securities
    99,660       1,488       662       100,486  
                                 
Mutual funds
    5       0       0       5  
                                 
Total securities available for sale
  $ 99,665     $ 1,488     $ 662     $ 100,491  
                                 
Securities held to maturity:
                               
Agency mortgage-backed securities
  $ 7     $ 0     $ 0     $ 7  
                                 
Total securities held to maturity
  $ 7     $ 0     $ 0     $ 7  
                                 
December 31, 2013
                               
Securities available for sale:
                               
Agency mortgage-backed securities
  $ 18,408     $ 205     $ 244     $ 18,369  
Agency CMO
    20,486       96       341       20,241  
Other debt securities:
                               
Agency notes and bonds
    31,594       49       729       30,914  
Municipal obligations
    36,200       778       938       36,040  
Subtotal - debt securities
    106,688       1,128       2,252       105,564  
                                 
Mutual funds
    3,238       0       40       3,198  
                                 
Total securities available for sale
  $ 109,926     $ 1,128     $ 2,292     $ 108,762  
                                 
Securities held to maturity:
                               
Agency mortgage-backed securities
  $ 9     $ 0     $ 0     $ 9  
                                 
Total securities held to maturity
  $ 9     $ 0     $ 0     $ 9  

 
 
- 9 -

 
FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
(2 – continued)
 
Agency notes and bonds, agency mortgage-backed securities and agency collateralized mortgage obligations (CMO) include securities issued by the Government National Mortgage Association (GNMA), a U.S. government agency, and the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC) and the Federal Home Loan Bank (FHLB), which are government-sponsored enterprises.
 
The amortized cost and fair value of debt securities as of September 30, 2014, by contractual maturity, are shown below.  Expected maturities of mortgage-backed securities may differ from contractual maturities because the mortgages underlying the obligations may be prepaid without penalty.
 
   
Securities Available for Sale
   
Securities Held to Maturity
 
   
Amortized
Cost
   
Fair
Value
   
Amortized
Cost
   
Fair
Value
 
(In thousands)
                       
                         
Due in one year or less
  $ 120     $ 122     $ 0     $ 0  
Due after one year through five years
    13,653       13,782       0       0  
                                 
Due after five years through ten years
    23,602       23,945                  
Due after ten years
    16,064       16,500       0       0  
      53,439       54,349       0       0  
Mortgage-backed securities and CMO
    46,221       46,137       7       7  
                                 
    $ 99,660     $ 100,486     $ 7     $ 7  
 
Information pertaining to investment securities available for sale with gross unrealized losses at September 30, 2014, aggregated by investment category and the length of time that individual investment securities have been in a continuous position, follows:
 
   
Number of
Investment
Positions
   
Fair
Value
   
Gross
Unrealized
Losses
 
(Dollars in thousands)
                 
                   
Continuous loss position less than twelve months:
                 
Agency notes and bonds
    5     $ 2,013     $ 4  
Agency CMO
    2       1,620       8  
Agency mortgage-backed securities
    20       15,653       75  
Muncipal obligations
    2       323       1  
                         
Total less than twelve months
    29       19,609       88  
                         
Continuous loss position more than twelve months:
                       
Agency notes and bonds
    10       11,473       158  
Agency CMO
    10       8,187       197  
Agency mortgage-backed securities
    7       6,192       85  
Muncipal obligations
    16       7,300       134  
                         
Total more than twelve months
    43       33,152       574  
                         
Total securities available for sale
    72     $ 52,761     $ 662  
 
 
 
- 10 -

 
FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
(2 – continued)
 
Management evaluates securities for other-than-temporary impairment at least quarterly, and more frequently when economic or market concerns warrant such evaluation.  Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recover in fair value.
 
At September 30, 2014, the 72 U.S. government agency debt securities, including agency notes and bonds, mortgage-backed securities and CMO, and municipal obligations in a loss position had depreciated approximately 1.3% from the amortized cost basis.  All of the U.S. government agency securities and municipal obligations are issued by U.S. government agencies, government-sponsored enterprises and municipal governments, or are secured by first mortgage loans and municipal project revenues.  These unrealized losses related principally to current interest rates for similar types of securities.  In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government, its agencies or other governments, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition.  As the Company has the ability to hold the debt securities until maturity, or the foreseeable future if classified as available for sale, no declines are deemed to be other-than-temporary.
 
During the nine months ended September 30, 2014, the Company realized gross gains on sales of available for sale municipal securities and U.S. government agency mortgage-backed securities of $66,000 and $5,000, respectively and a loss of $17,000 on the sale of mutual funds.  During the three months ended September 30, 2014, the Company realized gross gains on sales of available for sale municipal securities and U.S. government agency mortgage-backed securities of $12,000 and $5,000, respectively and a loss of $17,000 on the sale of mutual funds.  During the nine months ended September 30, 2013, the Company realized gross gains on sales of available for sale municipal securities and U.S. government agency debt securities of $21,000 and $8,000, respectively.  The Company realized gross gains on sales of available for sale U.S. government agency debt securities of $8,000 during the three months ended September 30, 2013.
 
In June 2014, the Company acquired an additional 31,750 shares of common stock in another financial institution, in addition to the 100,000 shares acquired in December 2013, representing approximately 9% of the outstanding common stock of the entity, for a total investment of $711,000.  The investment is accounted for using the cost method of accounting and is included in other assets in the consolidated balance sheet.
 
3.
Loans and Allowance for Loan Losses
 
The Company’s loan and allowance for loan loss policies are as follows:
 
Loans are stated at unpaid principal balances, less net deferred loan fees and the allowance for loan losses.  The Company grants real estate mortgage, commercial business and consumer loans.  A substantial portion of the loan portfolio is represented by mortgage loans to customers in southern Indiana.  The ability of the Company’s customers to honor their loan agreements is dependent upon the real estate and general economic conditions in this area.
 
 
- 11 -

 
FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
(3 – continued)
 
Loan origination and commitment fees, as well as certain direct costs of underwriting and closing loans, are deferred and amortized as a yield adjustment to interest income over the lives of the related loans using the interest method.  Amortization of net deferred loan fees is discontinued when a loan is placed on nonaccrual status.
 
The recognition of income on a loan is discontinued and previously accrued interest is reversed, when interest or principal payments become ninety (90) days past due unless, in the opinion of management, the outstanding interest remains collectible. Past due status is determined based on contractual terms. Generally, by applying the cash receipts method, interest income is subsequently recognized only as received until the loan is returned to accrual status. The cash receipts method is used when the likelihood of further loss on the loan is remote. Otherwise, the Company applies the cost recovery method and applies all payments as a reduction of the unpaid principal balance until the loan qualifies for return to accrual status.  Interest income on impaired loans is recognized using the cost recovery method, unless the likelihood of further loss on the loan is remote.
 
A loan is restored to accrual status when all principal and interest payments are brought current and the borrower has demonstrated the ability to make future payments of principal and interest as scheduled, which generally requires that the borrower demonstrate a period of performance of at least six consecutive months.
 
For portfolio segments other than consumer loans, the Company’s practice is to charge-off any loan or portion of a loan when the loan is determined by management to be uncollectible due to the borrower’s failure to meet repayment terms, the borrower’s deteriorating or deteriorated financial condition, the depreciation of the underlying collateral, the loan’s classification as a loss by regulatory examiners, or for other reasons.  A partial charge-off is recorded on a loan when the uncollectibility of a portion of the loan has been confirmed, such as when a loan is discharged in bankruptcy, the collateral is liquidated, a loan is restructured at a reduced principal balance, or other identifiable events that lead management to determine the full principal balance of the loan will not be repaid.  A specific reserve is recognized as a component of the allowance for estimated losses on loans individually evaluated for impairment.  Partial charge-offs on nonperforming and impaired loans are included in the Company’s historical loss experience used to estimate the general component of the allowance for loan losses as discussed below.  Specific reserves are not considered charge-offs in management’s analysis of the allowance for loan losses because they are estimates and the outcome of the loan relationship is undetermined.  At September 30, 2014, the Company had 12 loans on which partial charge-offs of $480,000 had been recorded.
 
Consumer loans not secured by real estate are typically charged off at 90 days past due, or earlier if deemed uncollectible, unless the loans are in the process of collection.  Overdrafts are charged off after 45 days past due.  Charge-offs are typically recorded on loans secured by real estate when the property is foreclosed upon.
 
The allowance for loan losses reflects management’s judgment of probable loan losses inherent in the loan portfolio at the balance sheet date.  Additions to the allowance for loan losses are made by the provision for loan losses charged to earnings.  Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
 
 
- 12 -

 
FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
(3 – continued)
 
The Company uses a disciplined process and methodology to evaluate the allowance for loan losses on at least a quarterly basis that is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
 
The allowance consists of specific and general components.  The specific component relates to loans that are individually evaluated for impairment or loans otherwise classified as doubtful, substandard, or special mention.  For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.
 
The general component covers non-classified loans and classified loans that are found, upon individual evaluation, to not be impaired.  Such loans are pooled by segment and losses are modeled using annualized historical loss experience adjusted for qualitative factors.  The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent twelve calendar quarters unless the historical loss experience is not considered indicative of the level of risk in the remaining balance of a particular portfolio segment, in which case an adjustment is determined by management.  The Company’s historical loss experience is then adjusted by an overall loss factor weighting adjustment based on a qualitative analysis prepared by management and reviewed on a quarterly basis.  The overall loss factor considers changes in underwriting standards, economic conditions, changes and trends in past due and classified loans and other internal and external factors.
 
Management also applies additional loss factor multiples to loans classified as watch, special mention and substandard that are not individually evaluated for impairment.  The loss factor multiples for classified loans are based on management’s assessment of historical trends regarding losses experienced on classified loans in prior periods.  See below for additional discussion of the overall loss factor and loss factor multiples for classified loans as of September 30, 2014 and December 31, 2013, as well as a discussion of changes in management’s allowance for loan losses methodology from 2013 to 2014.
 
Management exercises significant judgment in evaluating the relevant historical loss experience and the qualitative factors.  Management also monitors the differences between estimated and actual incurred loan losses for loans considered impaired in order to evaluate the effectiveness of the estimation process and make any changes in the methodology as necessary.
 
Management utilizes the following portfolio segments in its analysis of the allowance for loan losses:  residential real estate, land, construction, commercial real estate, commercial business, home equity and second mortgage, and other consumer loans.  Additional discussion of the portfolio segments and the risks associated with each segment can be found in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.
 
 
- 13 -

 
FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
(3 – continued)
 
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
 
Values for collateral dependent loans are generally based on appraisals obtained from independent licensed real estate appraisers, with adjustments applied for estimated costs to sell the property, costs to complete unfinished or repair damaged property and other factors.  New appraisals are generally obtained for all significant properties when a loan is identified as impaired, and a property is considered significant if the value of the property is estimated to exceed $200,000.  Subsequent appraisals are obtained as needed or if management believes there has been a significant change in the market value of the property.  In instances where it is not deemed necessary to obtain a new appraisal, management bases its impairment and allowance for loan loss analysis on the original appraisal with adjustments for current conditions based on management’s assessment of market factors and management’s inspection of the property.
 
Loans at September 30, 2014 and December 31, 2013 consisted of the following:
 
(In thousands)
 
September 30,
2014
   
December 31,
2013
 
             
Real estate mortgage loans:
           
Residential
  $ 103,955     $ 107,029  
Land
    10,459       10,309  
Residential construction
    15,948       14,423  
Commercial real estate
    79,991       76,496  
Commercial real estate contruction
    1,118       1,715  
Commercial business loans
    29,687       21,956  
Consumer loans:
               
Home equity and second mortgage loans
    36,656       34,815  
Automobile loans
    25,520       23,983  
Loans secured by savings accounts
    1,026       1,138  
Unsecured loans
    3,416       3,541  
Other consumer loans
    4,818       4,824  
Gross loans
    312,594       300,229  
Less undisbursed portion of loans in process
    (5,723 )     (7,142 )
                 
Principal loan balance
    306,871       293,087  
                 
Deferred loan origination fees, net
    459       341  
Allowance for loan losses
    (5,055 )     (4,922 )
                 
Loans, net
  $ 302,275     $ 288,506  
 
 
- 14 -

 
FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
(3 – continued)
 
The following table provides the components of the Company’s recorded investment in loans at September 30, 2014:
 
   
Residential
Real Estate
   
Land
   
Construction
   
Commercial
Real Estate
   
Commercial
Business
   
Home Equity &
2nd Mtg
   
Other
Consumer
   
Total
 
   
(In thousands)
 
Recorded Investment in Loans:
                                               
Principal loan balance
  $ 103,955     $ 10,459     $ 11,343     $ 79,991     $ 29,687     $ 36,656     $ 34,780     $ 306,871  
                                                                 
Accrued interest receivable
    365       50       27       198       91       127       147       1,005  
                                                                 
Net deferred loan origination fees and costs
    63       3       (2 )     (32 )     (7 )     434       0       459  
                                                                 
Recorded investment in loans
  $ 104,383     $ 10,512     $ 11,368     $ 80,157     $ 29,771     $ 37,217     $ 34,927     $ 308,335  
                                                                 
                                                                 
Recorded Investment in Loans as Evaluated for Impairment:
                                                               
Individually evaluated for impairment
  $ 1,297     $ 107     $ 0     $ 1,709     $ 1,864     $ 170     $ 0     $ 5,147  
Collectively evaluated for impairment
    103,086       10,405       11,368       78,448       27,907       37,047       34,927       303,188  
Acquired with deteriorated credit quality
    0       0       0       0       0       0       0       0  
                                                                 
Ending balance
  $ 104,383     $ 10,512     $ 11,368     $ 80,157     $ 29,771     $ 37,217     $ 34,927     $ 308,335  
 
 
- 15 -

 
FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
(3 – continued)
 
The following table provides the components of the Company’s recorded investment in loans at December 31, 2013:
 
   
Residential
Real Estate
   
Land
   
Construction
   
Commercial
Real Estate
   
Commercial
Business
   
Home Equity &
2nd Mtg
   
Other
Consumer
   
Total
 
   
(In thousands)
 
Recorded Investment in Loans:
                                               
Principal loan balance
  $ 107,029     $ 10,309     $ 8,996     $ 76,496     $ 21,956     $ 34,815     $ 33,486     $ 293,087  
                                                                 
Accrued interest receivable
    427       49       22       202       56       126       168       1,050  
                                                                 
Net deferred loan origination fees and costs
    52       2       0       (32 )     (9 )     328       0       341  
                                                                 
Recorded investment in loans
  $ 107,508     $ 10,360     $ 9,018     $ 76,666     $ 22,003     $ 35,269     $ 33,654     $ 294,478  
                                                                 
                                                                 
Recorded Investment in Loans as Evaluated for Impairment:
                                                               
Individually evaluated for impairment
  $ 2,040     $ 120     $ 0     $ 2,586     $ 1,898     $ 276     $ 0     $ 6,920  
Collectively evaluated for impairment
    105,468       10,240       9,018       74,080       20,105       34,993       33,654       287,558  
Acquired with deteriorated credit quality
    0       0       0       0       0       0       0       0  
                                                                 
Ending balance
  $ 107,508     $ 10,360     $ 9,018     $ 76,666     $ 22,003     $ 35,269     $ 33,654     $ 294,478  
 
 
- 16 -

 
FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
(3 – continued)
 
An analysis of the allowance for loan losses as of September 30, 2014 is as follows:
 
   
Residential
Real Estate
   
Land
   
Construction
   
Commercial
Real Estate
   
Commercial
Business
   
Home Equity &
2nd Mtg
   
Other
Consumer
   
Total
 
   
(In thousands)
 
Ending allowance balance attributable to loans:
                                               
                                                 
Individually evaluated for impairment
  $ 53     $ 0     $ 0     $ 13     $ 1,226     $ 16     $ 0     $ 1,308  
Collectively evaluated for impairment
    772       156       77       1,248       221       929       344       3,747  
Acquired with deteriorated credit quality
    0       0       0       0       0       0       0       0  
                                                                 
Ending balance
  $ 825     $ 156     $ 77     $ 1,261     $ 1,447     $ 945     $ 344     $ 5,055  
 
An analysis of the allowance for loan losses as of December 31, 2013 is as follows:
 
   
Residential
Real Estate
   
Land
   
Construction
   
Commercial
Real Estate
   
Commercial
Business
   
Home Equity &
2nd Mtg
   
Other
Consumer
   
Total
 
   
(In thousands)
 
Ending allowance balance attributable to loans:
                                               
                                                 
Individually evaluated for impairment
  $ 112     $ 0     $ 0     $ 145     $ 1,259     $ 13     $ 0     $ 1,529  
Collectively evaluated for impairment
    699       152       63       1,139       187       864