UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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Form 10-Q

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☒    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2014

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

For the transition period from _______ to _______

FIRST CAPITAL BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

4222 Cox Road, Glen Allen, Virginia 23060

(Address of principal executive offices)

804-273-1160

(Registrant’s telephone number, including area code)

N/A

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

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

Yes  ☒  No  ☐

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

Yes  ☒  No  ☐

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

 

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

Yes  ☐  No  ☒

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.

Yes  ☐  No  ☐

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

12,864,542 shares of Common Stock, par value $.01 per share, were outstanding at November 10, 2014.

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PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

 

First Capital Bancorp, Inc. and Subsidiary

Consolidated Statements of Financial Condition

 

 

*Derived from audited, consolidated financial statements

See notes to consolidated financial statements

 

 

 

 

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First Capital Bancorp, Inc. and Subsidiary

Consolidated Statements of Operations

 

 

See notes to consolidated financial statements

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First Capital Bancorp, Inc. and Subsidiary

Consolidated Statements of Comprehensive Income

 

See notes to consolidated financial statements

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First Capital Bancorp, Inc. and Subsidiary

Consolidated Statements of Stockholders’ Equity

Nine Months Ended September 30, 2014 and 2013

(Unaudited)

(Dollars in thousands)

 

 

See notes to consolidated financial statements

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First Capital Bancorp, Inc. and Subsidiary

Consolidated Statements of Cash Flows

For the Nine Months Ended September 30, 2014 and 2013

 

 

 

 

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First Capital Bancorp, Inc. and Subsidiary

Consolidated Statements of Cash Flows

For the Nine Months Ended September 30, 2014 and 2013

(Continued)

 

 

 

See notes to consolidated financial statements

 

 

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Note 1 – Basis of Presentation

First Capital Bancorp, Inc. (the “Company”) is the holding company of and successor to First Capital Bank (sometimes referred to herein as the “Bank”). Effective September 8, 2006, the Company acquired all of the outstanding stock of the Bank in a statutory share exchange transaction (the “Share Exchange”) pursuant to an Agreement and Plan of Reorganization dated September 5, 2006, between the Company and the Bank (the “Agreement”).  The Agreement was approved by the shareholders of the Bank at the annual meeting of shareholders held on May 16, 2006.  Under the terms of the Agreement, the shares of the Bank’s common stock were exchanged for shares of the Company’s common stock, par value $4.00 per share, on a one-for-one basis.  As a result, the Bank became a wholly owned subsidiary of the Company, the Company became the holding company of the Bank and the shareholders of the Bank became shareholders of the Company.  On May 21, 2014, the Board of Directors approved an amendment to the Company’s Articles of Incorporation whereby the par value of its common stock was changed from $4.00 per share to $.01 per share.  The amendment became effective on June 24, 2014.

The Company conducts all of its business activities through the branch offices of its wholly owned subsidiary bank, First Capital Bank.  First Capital Bank created RE1, LLC, and RE2, LLC, wholly owned Virginia limited liability companies in 2008 and 2011, respectively, for the sole purpose of taking title to property acquired in lieu of foreclosure.  RE1, LLC, and RE2, LLC have been consolidated with First Capital Bank.

The Company has one other wholly owned subsidiary, FCRV Statutory Trust 1 (the “Trust”), a Delaware Business Trust that was formed in connection with the issuance of trust preferred debt in September, 2006.  Pursuant to current accounting standards, the Company does not consolidate the Trust.

The consolidated financial statements include the accounts of First Capital Bancorp, Inc. and its wholly owned subsidiary, First Capital Bank.  All material intercompany balances and transactions have been eliminated.

In management’s opinion the accompanying unaudited consolidated financial statements, reflect all adjustments, consisting solely of normal recurring accruals, necessary for a fair presentation of the financial information as of September 30, 2014, and December 31, 2013 and for the three and nine months ended September 30, 2014, and 2013, in conformity with accounting principles generally accepted in the United States of America (“GAAP”).  Results for the three and nine month periods ended September 30, 2014 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2014.

The organization and business of the Company, accounting policies followed, and other related information are contained in the notes to the consolidated financial statements of the Company as of and for the year ended December 31, 2013, filed as part of the Company’s annual report on Form 10-K.  These interim consolidated financial statements should be read in conjunction with the annual financial statements.

The evaluation of the allowance for loan losses is based on management’s opinion of an amount that is adequate to absorb probable losses inherent in the Bank’s existing portfolio. The allowance for loan losses is an estimate of the losses that may be sustained in the loan portfolio. The allowance is based on two basic principles of accounting: (i) Accounting for Contingencies, which requires that losses be accrued when occurrence is probable and can be reasonably estimated, and (ii) specific reserves based on accounting for impaired loans, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

The Company’s allowance for loan losses is the accumulation of various components that are calculated based on independent methodologies. All components of the allowance represent an estimation performed pursuant to

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applicable GAAP. Management’s estimate of each homogenous pool component is based on certain observable data that management believes are most reflective of the underlying credit losses being estimated. This evaluation includes credit quality trends; collateral values; loan volumes; geographic, borrower and industry concentrations; seasoning of the loan portfolio; the findings of internal credit quality assessments and results from external bank regulatory examinations. These factors, as well as historical losses and current economic and business conditions, are used in developing estimated loss factors used in the calculations. 

Reserves for commercial loans are determined by applying estimated loss factors to the portfolio based on historical loss experience and management’s evaluation and “risk grading” of the commercial loan portfolio. Reserves are provided for noncommercial loan categories using historical loss factors applied to the total outstanding loan balance of each loan category. Additionally, environmental factors based on national and local economic conditions, as well as portfolio-specific attributes, are considered in estimating the allowance for loan losses. 

Applicable GAAP requires that the impairment of loans that have been separately identified for evaluation are measured based on the present value of expected future cash flows or, alternatively, the observable market price of the loans or the fair value of the collateral. However, for those loans that are collateral dependent (that is, if repayment of those loans is expected to be provided solely by the underlying collateral) and for which management has determined foreclosure is probable, the measure of impairment is based on the net realizable value of the collateral. This statement also requires certain disclosures about investments in impaired loans and the allowance for loan losses and interest income recognized on impaired loans.

Although management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if actual economic conditions differ substantially from the assumptions used in making the valuations or, if required by regulators, based upon information available to them at the time of their examinations. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels may vary from previous estimates.

Securities available-for-sale and certain mortgage loans held for sale are recorded at fair value on a recurring basis. From time to time, certain assets, consisting primarily of other real estate owned and impaired loans, may be recorded at fair value on a non-recurring basis. These non-recurring fair value adjustments typically are a result of the application of lower of cost or fair value accounting or a write-down occurring during the period. Management believes this is a critical accounting policy because the estimation of fair value involves a high degree of complexity and requires the Company to make subjective judgments that often include assumptions or estimates about various matters.

 

 

Note 2 – Use of Estimates

To prepare financial statements in conformity with GAAP management makes estimates and assumptions based on available information.  These estimates and assumptions affect the amounts reported in the consolidated financial statements and the disclosures provided, and actual results may be different.  In particular, the allowance for loan losses, valuation of other real estate owned, and fair values of financial instruments are subject to change.

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Note 3 – Income per share

Basic EPS excludes dilution and is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding for the period.  Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock that have a dilutive impact on shares outstanding were exercised or converted into common stock, or resulted in the issuance of common stock that then shared in the earnings of the entity.

The basic and diluted income per share calculations are as follows:

 

 

The Company has excluded options convertible into 31 thousand shares of common stock for the three and nine months ended September 30, 2014, from the calculation of diluted earnings per share because they were anti-dilutive since the strike price was greater than the average market price.

The Company excluded options convertible into 315 thousand shares of common stock for the three and nine months ended September, 30, 2013, from the calculation of diluted earnings per share because they were anti-dilutive since the strike price was greater than the average market price.  The Company also excluded 348 thousand shares of restricted common stock for the three and nine months ended September 30, 2013 from the calculation of diluted earnings per share because the shares were anti-dilutive since they were issued but not vested.

 

 

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Note 4 – Stock Options

 

Accounting standards require the Company to measure compensation cost for the type of stock-based awards the Company issues at fair value on the date of grant and recognize compensation expense in the consolidated statements of operations over the service period that the awards are expected to vest.

Stock-based compensation expensed during the three and nine months ended September 30, 2014, was $95 thousand and $253 thousand, respectively, and the amount expensed during the three and nine months ended September 30, 2013, was $111 thousand and $344 thousand, respectively. Expensed amounts are included in salaries and employee benefits.

 

 

Note 5 – Investment Securities

The amortized costs, gross unrealized gains, gross unrealized losses, and fair values for securities are as follows:

 

 

 

 

 

 

 

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The following table summarizes securities with unrealized losses at September 30, 2014, and December 31, 2013, aggregated by major security type and length of time in a continuous unrealized loss position. The unrealized losses are largely due to changes in interest rates and other market conditions.  At September 30, 2014, 63 out of 117 securities the Company held had fair values less than amortized cost primarily in municipal, CMO, and mortgage-backed securities.  At December 31, 2013, 39 out of 101 securities the Company held had fair values less than amortized cost, primarily in municipal and mortgage-backed securities.  All unrealized losses are considered by management to be temporary given investment security credit ratings, the intent and ability to retain these securities for a period of time sufficient to recover all unrealized losses, and because it is unlikely that the Company will be required to sell the impaired securities before their anticipated recovery.

 

As a result, management’s assessment of other than temporary impairment (“OTTI”) for the current quarter ended September 30, 2014, resulted in no write down of investment securities.

 

 

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Restricted equity securities consist primarily of Federal Home Loan Bank of Atlanta stock in the amount of $2.3 million and $2.0 million as of September 30, 2014, and December 31, 2013, respectively, and Federal Reserve Bank stock in the amount of $1.6 million at September 30, 2014, and $1.5 million at December 31, 2013.  Restricted equity securities are carried at cost.  The Federal Home Loan Bank requires the Bank to maintain stock in an amount equal to 4.5% of outstanding borrowings and a specific percentage of the Company’s total assets.  The Federal Reserve Bank of Richmond requires the Company to maintain stock with a par value equal to 3% of its outstanding capital.

Securities with a carrying value of approximately $8.9 million and $1.4 million were pledged as collateral at September 30, 2014, and December 31, 2013, respectively, to secure repurchase agreements.

 

 

Note 6 – Loans

Major classifications of loans are as follows:

 

A summary of risk characteristics by loan portfolio classification follows:

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Real Estate – Residential – This portfolio primarily consists of investor loans secured by properties in the Bank’s normal lending area.  These investor loans are typically five year rate adjustment loans and they generally have an original loan-to-value (“LTV”) of 80% or less.  This category also includes home equity lines of credit (“HELOC”).  The HELOCs generally have an adjustable rate tied to prime rate and a term of 10 years.  Given the declining value of residential properties over the past several years, these loans possess a higher than average level of risk of loss to the bank.  Multifamily residential real estate is moderately seasoned and is generally secured by properties in the Bank’s normal lending area.

Real Estate – Commercial – This portfolio consists of nonresidential improved real estate, which includes shopping centers, office buildings, etc.  These properties are generally located in the Bank’s normal lending area.  Decreased rental income due to the economic slowdown has caused some deterioration in values.  As a result, this category of loans has a higher than average level of risk.

Real Estate – Residential Construction – This portfolio has changed significantly over the past several years as fewer construction loans have been made during the economic downtown.  These loans are located in the Bank’s normal lending area.

Real Estate – Other Construction, Land Development and Other Land Loans – This portfolio includes raw undeveloped land and developed residential and commercial lots held by developers.  Given the significant decline in value for both developed and undeveloped land due to reduced demand, this portfolio possesses an increased level of risk compared to other loan portfolios.  Continuing deterioration in demand could result in significant decreases in the underlying collateral values and make repayment of the outstanding loans more difficult for customers.

Commercial – These loans include loans to businesses that are not secured by real estate.  These loans are typically secured by accounts receivable, inventory, equipment, and other business assets.  Commercial loans are typically granted to local businesses that have a strong track record of profitability and performance.

Consumer – Loans in this portfolio are either unsecured or secured by automobiles, marketable securities, etc.  They are generally granted to local customers that have a banking relationship with the Bank.

Activity in the allowance for loan losses for the nine months ended is as follows:

 

 

 

 

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The following table presents activity in the allowance for loan losses by portfolio segment:

 

 

 

 

The charging off of uncollectible loans is determined on a case-by-case basis.  Determination of a collateral shortfall, prospects for recovery, delinquency, and the financial resources of the borrower and any guarantor are all considered in determining whether to charge-off a loan.  Closed-end retail loans that become past due 120 cumulative days and open-end retail loans that become past due 180 cumulative days from the contractual due date will be charged off.

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The following table presents the aging of unpaid principal in loans as of September 30, 2014, and December 31, 2013:

 

 

 

 

 

Loans are determined past due or delinquent based on the contractual terms of the loan.  Payments past due 30 days or more are considered delinquent.  The accrual of interest is generally discontinued at the time the loan is 90 days delinquent, unless the credit is well-secured and in process of collection.  In all cases, loans are placed on nonaccrual at an earlier date if collection of principal or interest is considered doubtful or charged-off if a loss is considered imminent.

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All interest accrued but not collected for loans that are placed on nonaccrual is reversed against interest income when the loan is placed on nonaccrual status.  Because of the uncertainty of the expected cash flows, the Company accounts for nonaccrual loans under the cost recovery method, under which all cash payments are applied to principal.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future collection of principal and interest are reasonably assured.  The number of payments needed to meet this criteria varies from loan to loan.  However, as a general rule, this criteria will be considered to have been met with the timely payment of six consecutive regularly scheduled monthly payments.

The following table provides details of the Company’s loan portfolio internally assigned grade at September 30, 2014, and December 31, 2013:

 

 

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These credit quality grades are defined as follows:

Pass – A “pass” rated asset is not adversely classified because it does not display any of the characteristics for adverse classification.

Special Mention – A “special mention” asset has potential weaknesses that deserve management’s close attention. If left uncorrected, such potential weaknesses may result in deterioration of the repayment prospects or collateral position at some future date. Special mention assets are not adversely classified and do not warrant adverse classification.

Substandard – A “substandard” asset is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Assets classified as substandard generally have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. These assets are characterized by the distinct possibility of loss if the deficiencies are not corrected.

Doubtful – An asset classified “doubtful” has all the weaknesses inherent in an asset classified substandard with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable, on the basis of currently existing facts, conditions, and values.

Loss – Assets classified “loss” are considered uncollectible and of such little value that their continuing to be carried as an asset is not warranted. This classification is not necessarily equivalent to no potential for recovery or salvage value, but rather that it is not appropriate to defer a full write-off even though partial recovery may be effected in the future.

The loan risk rankings were updated for the quarter ended September 30, 2014 on September 16 and 17, 2014.  The loan risk rankings were updated for the year ended December 31, 2013 on December 10 and 11, 2013.

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The following table provides details regarding impaired loans by segment and class at September 30, 2014 and December 31, 2013:

 

 

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The following table provides details of the balance of the allowance for loan losses and the recorded investment in financing receivables by impairment method for each loan portfolio segment:

 

 

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 and interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining whether a loan is impaired include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Additionally, management’s policy is generally to evaluate only those substandard loans greater than $250 thousand for impairment as these are considered to be individually significant in relation to the size of the loan portfolio.  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 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.  The following tables present interest income recognized and the average recorded investment of impaired loans.

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Cash payments received on nonaccrual, impaired loans are applied on a cash basis with all cash receipts applied first to principal and any payments received in excess of the unpaid principal balance being applied to interest. Cash payments received on active, impaired loans are applied to both interest and principal.

Troubled Debt Restructurings

ASC 310 defines a troubled debt restructuring as a restructuring of a debt where a creditor for economic or legal reasons related to a debtor’s financial difficulties grants a concession to the debtor that it would not otherwise render.  The concession is granted by the creditor in an attempt to protect as much of its investment as possible.  The concession either stems from an agreement between the creditor and the debtor or is imposed by law or a court.  Troubled debt restructurings include modification of the terms of a debt, such as a reduction of the stated

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interest rate lower thant he current market for new debt with similar risk, a reduction of the face amount or maturity amount of the debt as stated in the instrument or other agreement, or a reduction of accrued interest.

Management reviews all restructured loans that occur during the year for identification as troubled debt restructurings.  Management identified as troubled debt restructurings certain loans for which the allowance for loan losses had previously been measured under a general allowance for loan losses methodology (ASC 450).  Upon identifying the reviewed loans as troubled debt restructurings, management also identified them as impaired under the guidance in ASC 310.

Modification Categories

The Company offers a variety of modifications to borrowers. The modification alternatives offered can generally be described in the following categories:

Rate Modification - A modification in which the interest rate is changed.

Term Modification - A modification in which the maturity date, timing of payments, or frequency of payments is changed.

Interest Only Modification – A modification in which the loan is converted to interest only payments for a period of time.

Payment Modification – A modification in which the dollar amount of the payment is changed, other than an interest only modification described above.

Combination Modification – Any other type of modification, including the use of multiple categories above.

As of September 30, 2014, and December 31, 2013, there were no available commitments outstanding for troubled debt restructurings.

The following tables present troubled debt restructurings as of September 30, 2014, and December 31, 2013:

 

 

 

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Loans reviewed for consideration of modification are reviewed for potential impairment at the time of the restructuring.  Any identified impairment is recognized as a reduction in the allowance.

The following tables present troubled debt restructurings that occurred during the three and nine months ended September 30, 2014:

 

 

 

 

 

 

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There were no newly restructured loans that occurred during the three or nine months ended September 30, 2013. There were no financing receivables modified as troubled debt restructurings and with a payment default, with the payment default occurring within 12 months of the restructure date, and the payment default occurring during the three or nine-month periods ended September 30, 2014 or 2013.

 

 

 

Note 7 – Other Real Estate Owned

Changes in other real estate owned were as follows for the periods indicated:

 

 

 

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Note 8 – Fair Value Disclosures

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures.  In accordance with the Fair Value Measurements and Disclosures topic ASC 825, the fair value of a financial instrument is the price that would be received in the sale of an asset or paid to transfer the liability in an orderly transaction between market participants at the measurement date.  Fair value is best determined based upon quoted market prices.  However, in many instances, there are no quoted market prices for the Company’s various financial instruments.  In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques.  Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows.  Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The recent fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions.  If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate.  In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment.  The fair value of a reasonable point within this range is most representative of fair value under current market conditions.

Fair Value Hierarchy

In accordance with this guidance, financial assets and financial liabilities are generally grouped based on fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine the fair value.

Level 1 – Valuation is based on quoted prices in active markets for identical assets or liabilities in active markets at the measurement date.  Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market.  Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 – Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.  The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

Level 3 – Valuation is based on unobservable data that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.  Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flows methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.

Following is a description of the valuation methodologies used for instruments measured as fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:

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Securities available for sale:  Securities available for sale are recorded at fair value on a recurring basis.  Fair value measurement is based upon quoted market prices, when available (Level 1).  If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data.  Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).  The Company obtains a single quote for all securities.  Quotes for all of the securities are provided by the securities accounting and safekeeping correspondent bank, which performs a review of pricing data by comparing prices received from third party vendors to the previous month’s quote for the same security and evaluates any substantial changes.

The following tables present the balances of financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2014, and December 31, 2013. Securities identified in Note 5 as restricted securities including stock in the Federal Home Loan Bank of Atlanta and the Federal Reserve Bank are excluded from the table below because there is no ability to sell these securities except when the FHLB or FRB require redemption based on either the borrowings at the FHLB, or, in the case of the FRB, changes in certain portions of the Company’s capital.

 

 

Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP.  Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual loans.

The following describes the valuation techniques used to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements.

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Impaired Loans:  Loans are designated as impaired when, in the judgment of management, based on current information and events, it is probable that all amounts when due according to the contractual terms of the loan agreement will not be collected.  The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral.  Fair value is measured based on the value of the collateral securing the loans.  Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable.  The vast majority of the collateral is real estate.  The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed external appraiser using observable market data (Level 2).  However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3.  If a real estate loan becomes a nonperforming loan, or if the valuation is over one year old, either an evaluation by an officer of the bank or an outside vendor, or an appraisal, is performed to determine current market value.  The Company considers the value of a partially completed project for the Company’s loan analysis.  For nonperforming construction loans, the Company obtains a valuation of each partially completed project “as is” from a third party appraiser.  The Company uses this third party valuation to determine if any charge-offs are necessary.

The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data.  Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3).  Impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis and the discount to reflect current market conditions ranged from 0% to 30% for each of the respective periods.  Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Operations.

Loans held for sale:  The fair value of loans held for sale is determined using quoted secondary-market prices.  As such, loans subjected to nonrecurring fair value adjustments are classified as Level 2.

Other Real Estate Owned:  Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis.  These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell.  Fair value is commonly based on recent real estate appraisals, which are updated at least annually.  These appraisals may utilize a single valuation approach or a combination of approaches such as comparable sales or the income approach.  Adjustments may be made during the appraisal process by the independent appraisers to account for differences between the valuation approaches used. Such adjustments may be significant to the fair value and typically result in a Level 3 classification.    Other real estate owned assets are evaluated by management on a quarterly basis for additional impairment and adjusted accordingly.  Such evaluations, considering current market conditions, may result in further discounts of independent appraisals and ranged from 0% to 30% for each of the respective periods presented, herein.

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The following tables summarize the Company’s financial assets that were measured at fair value on a nonrecurring basis during the periods noted.

 

 

The methods and assumptions, not previously presented, used by the Company in estimating fair values are as follows:

Cash and cash equivalents  – The carrying amounts of cash and cash equivalents approximate their fair value.

Loans receivable  – Fair values are based on carrying values for variable-rate loans that reprice frequently and have no significant change in credit risk.  Fair values for certain mortgage loans (for example, one-to-four family residential) and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics.  Fair values for commercial real estate and commercial loans are estimated using discounted cash flow analyses and interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.  The interest rates on loans at September 30, 2014, and December 31, 2013, are current market rates for their respective terms and associated credit risk.

Loans held for sale—Loans held for sale are carried at the lower of cost or market value.  These loans currently consist of residential real estate, owner occupied loans originated for sale in the secondary market.  Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different from cost due to the short duration between origination and sale (Level 2).  As such, the Company records any fair value adjustments on a nonrecurring basis.  No nonrecurring fair value adjustments were recorded on loans held for sale during the periods ended September 30, 2014, or December 31, 2013.  Gains and losses on the sale of loans are recorded as income on the consolidated statements of operations. 

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Deposits  – The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts).  The carrying amounts of variable-rate, fixed-term money market accounts approximate their fair values at the reporting date.  Fair values for fixed-rate CDs are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Accrued interest  – The carrying amounts of accrued interest approximate fair value.

Advances from Federal Home Loan Bank –  The carrying value of advances from the Federal Home Loan Bank due within ninety days from the balance sheet date approximate fair value.  Fair values for convertible advances are estimated using a discounted cash flow calculation that applies interest rates currently being offered on convertible advances with similar remaining maturities.

Repurchase agreements – The carrying value of repurchase agreements due within ninety days from the balance sheet date approximate fair value.

Subordinated Debt – The Company’s subordinated debt consists of variable rate instruments that re-price on a periodic basis, therefore, carrying value is adjusted for the repricing lag in order to approximate fair value.

Bank Owned Life Insurance – The carrying value of life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the insurer.

Off-balance-sheet instruments  – Fair values for off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and counterparties’ credit standings.  These commitments are not deemed to be material at September 30, 2014, and December 31, 2013.

The estimated fair values of the Company’s financial instruments as of September 30, 2014, and December 31, 2013, are as follows:

 

 

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The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of the Company’s normal operations.  As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to us.  The Company attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk.  However, borrowers with fixed rate obligations are less likely to repay in a rising rate environment.  Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment.  The Company monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.

 

 

Note 9 – Recently Issued Accounting Pronouncements

In January 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40) – Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.  The amendments are intended to clarify when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan should be derecognized and the real estate recognized.  These amendments clarify that an in substance repossession for foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either: (a) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure; or (b) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement.  Additional disclosures are required.  The amendments are effective for public business entities for annual periods and interim periods within those annual periods beginning after December 15, 2014.  The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.

In May of 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606).  The guidance in this Update superseded the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of Codification.  The guidance in this Update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of non-financial assets.  This amendment is intended to clarify that an entity recognizes 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 amendments are effective for public business entities for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted.  The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.

 

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In June of 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures  The amendments in this Update require that repurchase-to-maturity transactions be accounted for as secured borrowings consistent with the accounting for other repurchase agreements. In addition, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty (a repurchase financing), which will result in secured borrowing accounting for the repurchase agreement. The amendments require an entity to disclose information about transfers accounted for as sales in transactions that are economically similar to repurchase agreements, in which the transferor retains substantially all of the exposure to the economic return on the transferred financial asset throughout the term of the transaction. In addition the amendments require disclosure of the types of collateral pledged in repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions and the tenor of those transactions. The amendments are effective for public business entities for the first interim or annual period beginning after December 15, 2014, and for all other entities, the accounting changes are effective for annual periods beginning after December 15, 2014, and interim periods beginning after December 15, 2015.  The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.

 

In June of 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-12, Compensation – Stock Compensation (Topic 718) – Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.  The amendments in this Update require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition.  The amendments apply to reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target can be achieved after the requisite service period. For all entities, the amendments in this Update are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted.    The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements. 

 

 

Note 10 –Preferred Stock

The Preferred Shares have a $4.00 par value, with $1,000 liquidation preference.  With 2,000,000 authorized shares, there were 5,531 shares outstanding at December 31, 2013. 

 

On January 10, 2014, the Company redeemed the remaining 5,531 shares of its Cumulative Perpetual Preferred Stock, Series A (“Preferred Stock”), for $5.6 million.  The Preferred Stock paid a cumulative dividend quarterly at a rate of 5% per annum.  Effective April 2014, the dividend rate would have increased to 9% per annum.  The Preferred Stock was redeemable at the option of the Company subject to regulatory approval which was received in November 2013.  No shares of the Preferred Stock remain outstanding and 2,000,000 shares remain authorized as of September 30, 2014.

 

 

 

Note 11—Common Stock

In May 2014, the Board of Directors approved a change to the par value of the Company’s Common Stock from $4.00 per share to $.01 per share, and the change was effective on June 24, 2014.  Equity reclassifications related to this change in par value are included in the accompanying Consolidated Statements of Stockholders’ Equity.  With 30,000,000 authorized shares of Common Stock, at September 30, 2014, and at December 31, 2013, there were 12,864,542 and 12,551,952 shares outstanding, respectively.