Attached files
| file | filename |
|---|---|
| EX-32 - CERTIFICATION - FIRST SOUTH BANCORP INC /VA/ | v406452_ex32.htm |
| EX-31.2 - CERTIFICATION - FIRST SOUTH BANCORP INC /VA/ | v406452_ex31-2.htm |
| EX-31.1 - CERTIFICATION - FIRST SOUTH BANCORP INC /VA/ | v406452_ex31-1.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K/A
(Amendment No. 1)
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 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. 0-22219
| FIRST SOUTH BANCORP, INC. | ||
| (Exact name of registrant as specified in its charter) |
| Virginia | 56-1999749 | |
| (State or other jurisdiction of | (I.R.S. Employer | |
| incorporation or organization) | Identification No.) |
| 1311 Carolina Avenue, Washington, North Carolina | 27889-2047 | |
| (Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code: (888) 993-7664
Securities registered pursuant to Section 12(b) of the Act:
| Common Stock (par value $0.01 per share) | NASDAQ Global Select Market | |
| (Title of Class) | (Name of exchange on | |
| which registered) |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ¨ No x
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
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 (Check one):
| Large accelerated filer ¨ | Accelerated filer ¨ | |
| Non-accelerated filer ¨ (Do not check if a smaller reporting company) | 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
The aggregate market value of common stock held by nonaffiliates of the registrant at June 30, 2014, was approximately $68.1 million based on the closing sale price of the registrant’s Common Stock as listed on the NASDAQ Global Select Market as of the last business day of the registrant’s most recently completed second fiscal quarter. For purposes of this calculation, it is assumed that directors, executive officers and beneficial owners of more than 5% of the registrant’s outstanding voting stock are affiliates.
Number of shares of Common Stock outstanding as of April 1, 2015: 9,528,964.
DOCUMENTS INCORPORATED BY REFERENCE
The following lists the documents incorporated by reference and the Part of the Form 10-K (which this Form 10-K/A amends) into which the document is incorporated:
| 1. | Portions of the Proxy Statement for the 2015 Annual Meeting of Stockholders, which will be filed within 120 days after December 31, 2014. (Part III) |
FIRST SOUTH BANCORP, INC.
TABLE OF CONTENTS
| Page | ||
| Explanatory Note | 3 | |
| PART II | ||
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 4 |
| PART IV | ||
| Item 15. | Exhibits, Financial Statement Schedules | 18 |
| SIGNATURES | ||
| EXHIBITS | ||
| 2 |
The purpose of this Amendment No. 1 to the Annual Report on Form 10-K for the year ended December 31, 2014 (the “Form 10-K”) for First South Bancorp, Inc. (the “Company”) is to make a correction under Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, Interest Rate Risk and Asset/Liability Management, Table 1 – Projected Change in EVE and Net Interest Income.
In the Form 10-K filed on March 25, 2015, within the Interest Rate Risk and Asset/Liability Management section, Table 1 inadvertently contained data from December 31, 2013. We have corrected this table to include December 31, 2014 data.
As required by Rule 12b-15 under the Securities Exchange Act of 1934, new certifications of the Company’s principal executive officer and principal financial officer are also being filed as exhibits to this Amendment. This Amendment should be read in conjunction with the Form 10-K, which continues to speak as of its original filing date. Except as specifically noted above, this Amendment does not modify or update disclosures in the Form 10-K. Accordingly, this Amendment does not reflect events occurring after the filing of the Form 10-K or modify or update any related or other disclosures.
| 3 |
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
General. First South Bancorp, Inc. (the "Company") was formed to issue common stock, owning 100% of First South Bank (the "Bank") and operating through the Bank a commercial banking business; therefore, this discussion and analysis of consolidated financial condition and results of operation relates primarily to the Bank. The Company's common stock is listed and trades on the NASDAQ Global Select Market under the symbol FSBK.
The business of the Bank consists principally of attracting deposits from the general public and using them to originate secured and unsecured commercial and consumer loans, permanent mortgage and construction loans secured by single-family residences and other loans. The Bank's earnings depend primarily on its net interest income, the difference between interest earned on interest earning assets and interest paid on interest-bearing liabilities. The Bank’s earnings are also impacted by the volume of noninterest income received and noninterest expenses paid.
Prevailing economic conditions, competition, as well as federal and state regulations, affect the operations of the Bank. The Bank's cost of funds is influenced by interest rates paid on competing investments, rates offered on deposits by other financial institutions in the Bank's market area and by general market interest rates. Lending activities are affected by the demand for financing of real estate and various types of commercial, consumer and mortgage loans, and by the interest rates offered on such financing. The Bank's business emphasis is to operate as a well-capitalized, profitable and independent community oriented financial institution dedicated to providing quality customer service and meeting the financial needs of the communities it serves. The Bank believes it has been effective in serving its customers because of its ability to respond quickly and effectively to customer needs and inquiries. The Bank's ability to provide these services has been enhanced by the effectiveness of its senior management team.
Acquisition of Branch Offices. See “Part I, Item 1. Business – Acquisition of Branch Offices” above, and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation- Results of Operation-Comparison of Operating Results for the Years Ended December 31, 2014 and 2013-Impact of Acquisition Transaction Expenses”, below for additional information regarding the completion of an acquisition of nine branch banking offices in eastern North Carolina from Bank of America, N.A., announced on December 15, 2014.
Liquidity and Capital Resources. Liquidity generally refers to the Bank's ability to generate adequate amounts of cash to meet its funding needs. Adequate liquidity guarantees sufficient funds are available to meet deposit withdrawals, fund loan commitments, maintain adequate reserve requirements, pay operating expenses, provide funds for debt service, and meet other general commitments. The Bank maintains its liquidity position under policy guidelines based on liquid assets in relationship to deposits and short-term borrowings. The Bank's primary sources of funds are customer deposits, loan principal and interest payments, proceeds from loan and securities sales, and advances from the Federal Home Loan Bank of Atlanta. While maturities and scheduled amortization of loans are predictable sources of funds, deposit flows and loan prepayments are influenced by interest rates, economic conditions and local competition. The Bank’s primary investing activity is originating commercial, consumer and mortgage loans, lease financing receivables and purchases and sales of investment securities. The Bank’s primary financing activities are attracting checking, certificate, savings deposits and obtaining FHLB advances.
The levels of cash and cash equivalents depend on the Bank's operating, investing and financing activities during any given period. Cash and cash equivalents increased to $56.1 million at December 31, 2014, from $24.2 million at December 31, 2013. The Bank has other sources of liquidity if a need for additional funds arises. Investment securities available for sale, consisting of government agencies, mortgage-backed securities, municipal securities and corporate bonds, increased to $292.3 million at December 31, 2014, from $150.3 million at December 31, 2013. At December 31, 2014, the Bank also had investment securities held to maturity of $507,000. See Consolidated Statements of Cash Flows and Notes 1 and 2 of Notes to Consolidated Financial Statements for additional information on the Bank's operating, investing and financing activities.
| 4 |
Borrowings consisting of junior subordinated debentures were $10.3 million at December 31, 2014 and 2013, respectively. All FHLB advances outstanding during the year ended December 31, 2014, were repaid with a portion of the branch acquisition proceeds.
The Bank has pledged certain loans as collateral for actual or potential FHLB advances. The Bank has credit availability with the FHLB of 25% of the Bank’s total assets. The Bank had $221.3 million of credit availability with the FHLB at December 31, 2014, compared to $116.0 million at December 31, 2013. At December 31, 2014, the Bank had lendable collateral value with the FHLB totaling $137.6 million. Additional collateral would be required in order to access total borrowings up to the credit availability limit. As of December 31, 2014, the Bank had pledged $81.3 million of loans as collateral to the Federal Reserve Bank of Richmond which provided the institution with $51.6 million of borrowing capacity at the Discount Window. In addition, at December 31, 2014, the Bank had available contingency funding sources of $70.0 million of pre-approved but unused lines of credit. See Notes 1 and 13 of the Notes to Consolidated Financial Statements for additional information.
Junior subordinated debentures totaling $10.3 million were outstanding at December 31, 2014 and 2013, respectively. They were issued in 2003 through a private placement pooled trust preferred securities offering by First South Preferred Trust I, a Delaware statutory trust. The trust preferred securities bear interest at three-month LIBOR plus 2.95% payable quarterly. Effective December 30, 2014, the Company swapped the interest rate on these debentures to a fixed rate of 5.54% for the ensuing five year period. This strategy was executed to provide the Company with protection to a rising rate environment. The debentures have a 30-year maturity and were first redeemable, in whole or in part, on or after September 30, 2008, with certain exceptions. For regulatory purposes, $10.0 million of the trust preferred securities qualifies as Tier 1 capital for the Company, and for the Bank, as the Company invested the proceeds in the Bank as additional paid-in capital. Proceeds from the trust preferred securities were used by the statutory trust to purchase junior subordinated debentures issued by the Company. See Note 23 of the Notes to Consolidated Financial Statements for additional information. As described in Part I, “Item 1. Business – Depository Institution Regulation – Capital Requirements,” in June 2012, the federal bank regulatory agencies jointly issued proposed rules to implement the capital reforms of the Basel III framework. These proposed regulatory capital guidelines would phase out the Tier 1 capital treatment of trust preferred securities for institutions with less than $15 billion in total assets over a ten-year period, beginning in 2013, until they are fully phased out in 2022. In July 2013, the banking regulators issued final Basel III capital rules. Under these rules, bank holding companies with less than $15 billion in consolidated total assets as of December 31, 2009, that had issued trust preferred securities prior to May 19, 2010, are permanently grandfathered as Tier 1 or Tier 2 capital instruments.
As a North Carolina chartered commercial bank and a Federal Deposit Insurance Corporation (the "FDIC") insured institution, the Bank is required to meet various state and federal regulatory capital standards. The Bank's total regulatory capital was $82.7 million at December 31, 2014, compared to $81.2 million at December 31, 2013. The FDIC requires the Bank to meet a minimum leverage capital requirement of Tier 1 capital (consisting of retained earnings and common stockholders' equity, less any intangible assets) to assets ratio of at least 4%, and a total capital to risk-weighted assets ratio of 8%, of which 4% must be in the form of Tier 1 capital. The Bank is also subject to the capital requirements of North Carolina banking law, as described in Part I, “Item 1. Business – Depository Institution Regulation – North Carolina Capital Requirements and Regulatory Action.” The Bank was in compliance with all regulatory capital requirements at December 31, 2014 and 2013. See Note 15 of the Notes to Consolidated Financial Statements for a description of the Bank’s actual regulatory capital amounts and ratios as of December 31, 2014 and 2013.
As described in “Item 1. Business – Depository Institution Regulation – Capital Requirements – Basel III,” the federal banking regulators have issued a final rule implementing the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision. This rule will change the capital requirements applicable to the Company and the Bank. The rule requires the Company and the Bank to comply with the following new minimum capital ratios, effective January 1, 2015:
| 1. | a new common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; |
| 2. | a Tier 1 capital ratio of 6% of risk-weighted assets (increased from 4%); |
| 3. | a total capital ratio of 8% of risk-weighted assets (unchanged); |
| 4. | a leverage ratio of 4% of average total assets (unchanged). |
| 5 |
Interest Rate Risk and Asset/Liability Management. Interest rate risk reflects the risk of economic loss resulting from changes in interest rates. The risk of loss can be reflected in diminished and/or reduced potential net interest income in future periods. Interest rate risk arises primarily from interest rate risk inherent in lending and deposit taking activities. The Bank considers interest rate risk to be a significant risk, which could potentially have a material impact on earnings. The Bank measures its exposure to interest rate risk through net interest income simulation (“NII”) and calculating our economic value of equity ("EVE"). NII measures the Bank’s net interest income given various assumptions under various interest rate scenarios. EVE is derived by calculating the net present value of the cash flows from assets, liabilities and off-balance sheet items given a range of changes in market interest rates. The Bank's exposure to interest rates is reviewed on a quarterly basis by management and the ALCO. If the modeling results to net interest income and EVE are not within Board established targeted risk tolerance limits, the Board may direct management to adjust the Bank's asset and liability mix to bring interest rate risk within acceptable levels.
The Bank strives to maintain a consistent net interest margin and reduce its exposure to changes in interest rates. Factors beyond the Bank's control, such as market interest rates and competition, may also impact interest income and interest expense. Given our level of fixed rate lending, coupled with embedded floors in our floating rate loan portfolio and our level of interest-bearing non-maturity deposits that can reprice immediately, the Bank has potential exposure to a near-term rising interest rate environment, which could result in a net interest margin for the Company that is below that of historical levels. Management has taken steps to lessen this exposure by adding more defensive investments in the investment portfolio and longer-term fixed rate funding to the balance sheet.
Interest rate risk and trends, liquidity and capital ratios are reported to the ALCO and the Board on a regular basis. The ALCO reviews the maturities of the Bank's assets and liabilities and establishes policies and strategies designed to regulate the flow of funds and to coordinate the sources, uses and pricing of such funds. The first priority in structuring and pricing assets and liabilities is to maintain an acceptable interest rate spread while reducing the net effects of changes in interest rates. The Bank's management is responsible for administering the policies and determinations of the ALCO and the Board with respect to the Bank's asset and liability goals and strategies
Table 1 below does not reflect downward rate interest rates projections. Given the current historically low level of interest rates, management and the ALCO are focused on the institution’s exposure to a rising rate environment. The Board has adopted an interest rate risk management policy that establishes maximum decreases in EVE of 10%, 20%, 25% and 30%, and a maximum decrease in NII of 5%, 10%, 15% and 20%, in the event of sudden 100 to 400 basis point increase or decrease in interest rates.
Table 1 below presents a static simulation projection of changes in EVE and net interest income, before provision for credit losses, in the event of sudden increases in market interest rates for the various rate shock levels at December 31, 2014. At December 31, 2014, the Bank's estimated changes in EVE and net interest income were within the Board established target limits. The Bank utilizes the services of a third party to assist with its interest rate risk modeling.
Table 1 - Projected Change in EVE and Net Interest Income
| Economic Value of Portfolio Equity | Net Interest Income Before PCL | |||||||||||||||||||||||
| Change in Rates | Amount | Change | % Change | Amount | Change | % Change | ||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||||
| + 400 bp | $ | 120,746 | $ | (23,106 | ) | (16.1 | )% | $ | 30,609 | $ | 1,786 | 6.2 | % | |||||||||||
| + 300 bp | 129,095 | (14,757 | ) | (10.3 | ) | 30,852 | 2,029 | 7.0 | ||||||||||||||||
| + 200 bp | 139,252 | (4,600 | ) | (3.2 | ) | 30,436 | 1,613 | 5.6 | ||||||||||||||||
| + 100 bp | 143,812 | (40 | ) | (0.0 | ) | 29,859 | 1,036 | 3.6 | ||||||||||||||||
| Base | 143,852 | - | - | 28,823 | - | - | ||||||||||||||||||
| 6 |
Certain shortcomings are inherent in the method of analysis presented in Table 1. For example, although certain assets and liabilities may have similar maturities to repricing, they may react in differing degrees to changes in interest rates. Interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market rates, while interest rates on other types may lag behind changes in market rates. Certain assets, such as adjustable-rate loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. In addition, the proportion of adjustable-rate loans in the Bank's portfolio could decrease in future periods due to refinance activity if market interest rates remain at or decrease below current levels. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate from those assumed in the table. Also, the ability of many borrowers to repay their adjustable-rate debt may decrease in the event of an increase in interest rates.
Rate/Volume Analysis. A primary component of managing interest rate risk is based on changes in the volume of interest-earning assets and interest-bearing liabilities. Table 2 and Table 3 below summarize the changes in the volume of interest-earning assets and interest-bearing liabilities and their respective average balances during 2014 and 2013. Additionally, depending on market conditions existing at a given time, the Bank may sell fixed-rate residential mortgage loans in the secondary market. In managing its portfolio of available for sale investment securities, the Bank has the ability to sell securities should a need arise.
Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume on average interest-earning assets and average interest-bearing liabilities. Table 2 below represents the extent to which changes in interest rates and changes in the volume of average interest-earning assets and average interest-bearing liabilities have affected the Company's interest income and interest expense during the periods indicated. For each category of average interest-earning asset and average interest-bearing liability, information is provided on changes attributable to: (i) changes in volume (changes in volume multiplied by old rate); (ii) changes in rate (percentage change in rate multiplied by old volume); (iii) changes in rate-volume (percentage changes in rate multiplied by changes in volume); and (iv) net change (total of the previous columns).
| Table 2 – Rate/Volume Analysis | Year Ended December 31, | Year Ended December 31, | ||||||||||||||||||||||||||||||
| 2014 vs. 2013 | 2013 vs. 2012 | |||||||||||||||||||||||||||||||
| Increase (Decrease) Due to | Increase (Decrease) Due to | |||||||||||||||||||||||||||||||
| Volume | Rate | Rate Volume | Total | Volume | Rate | Rate Volume | Total | |||||||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||||||||||
| Interest income: | ||||||||||||||||||||||||||||||||
| Loans receivable | $ | 1,131 | $ | (1,806 | ) | $ | (83 | ) | $ | (758 | ) | $ | (2,677 | ) | $ | (1,965 | ) | $ | 180 | $ | (4,462 | ) | ||||||||||
| Investments and deposits | 374 | (102 | ) | (8 | ) | 264 | 257 | (685 | ) | (32 | ) | (460 | ) | |||||||||||||||||||
| Total earning assets | 1,505 | (1,908 | ) | (91 | ) | (494 | ) | (2,420 | ) | (2,650 | ) | 148 | (4,922 | ) | ||||||||||||||||||
| Interest expense: | ||||||||||||||||||||||||||||||||
| Deposits | 22 | (377 | ) | (3 | ) | (358 | ) | (258 | ) | (1,667 | ) | 99 | (1,826 | ) | ||||||||||||||||||
| Borrowings | 65 | 21 | 193 | 279 | (3 | ) | (1 | ) | - | (4 | ) | |||||||||||||||||||||
| Junior subordinated debentures | - | (16 | ) | - | (16 | ) | - | (24 | ) | - | (24 | ) | ||||||||||||||||||||
| Total interest-bearing liabilities | 87 | (372 | ) | 190 | (95 | ) | (261 | ) | (1,692 | ) | 99 | (1,854 | ) | |||||||||||||||||||
| Change in net interest income | $ | 1,418 | $ | (1,536 | ) | $ | (281 | ) | $ | (399 | ) | $ | (2,159 | ) | $ | (958 | ) | $ | 49 | $ | (3,068 | ) | ||||||||||
Analysis of Net Interest Income. Net interest income primarily represents the difference between income derived from interest-earning assets and interest expense on interest-bearing liabilities. Net interest income is affected by both the difference between the yield on earning assets and the average cost of funds ("interest rate spread"), and the relative volume of interest-earning assets, interest-bearing liabilities and noninterest-bearing deposits.
Table 3 below contains comparative information relating to the Company's average balance sheet for 2014, 2013, and 2012, presented on a tax equivalent yield basis. Tax equivalent yields related to certain investment securities exempt from federal income tax are stated on a fully taxable basis, using a 34% federal tax rate and reduced by a disallowed portion of the tax exempt interest income. Average balances are derived from average daily balances. The interest rate spread represents the difference between the tax equivalent yield on average earning assets and the average cost of funds. The tax equivalent net interest margin represents net interest income (tax adjusted basis) divided by average earning assets.
| 7 |
The marginal decline in net interest income for 2014, results primarily from continued low interest rate environment impacting yields on both loans and investment securities. This impact has been partially offset by an increase in the volume of average earning assets coupled with a continued reduction in funding costs. The decline in market interest rates continues to be influenced by the Federal Reserve’s policy of holding interest rates at low levels in efforts to stimulate current economic conditions. The increase in the volume of average earning assets has been influenced by a moderate net growth in loans held for investment, as well as growth in investment securities available for sale.
| Table 3 – Yield/Cost Analysis | Year Ended December 31, | |||||||||||||||||||||||||||||||||||
| 2014 | 2013 | 2012 | ||||||||||||||||||||||||||||||||||
| Average Balance | Interest | Average Yield Cost | Average Balance | Interest | Average Yield Cost | Average Balance | Interest | Average Yield Cost | ||||||||||||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||||||||||||||||
| Interest earning assets: | ||||||||||||||||||||||||||||||||||||
| Loans receivable | $ | 471,862 | $ | 23,948 | 5.08 | % | $ | 451,207 | $ | 24,706 | 5.48 | % | $ | 496,800 | $ | 29,168 | 5.87 | % | ||||||||||||||||||
| Investments and deposits | 191,774 | 5,230 | 2.73 | (1) | 178,353 | 4,966 | 3.07 | (1) | 170,279 | 5,426 | 3.19 | (1) | ||||||||||||||||||||||||
| Total earning assets | 663,636 | 29,178 | 4.47 | (1) | 629,560 | 29,672 | 4.79 | (1) | 667,079 | 34,594 | 5.15 | (1) | ||||||||||||||||||||||||
| Nonearning assets | 60,458 | 58,666 | 65,012 | |||||||||||||||||||||||||||||||||
| Total assets | $ | 724,094 | $ | 688,226 | $ | 732,091 | ||||||||||||||||||||||||||||||
| Interest bearing liabilities: | ||||||||||||||||||||||||||||||||||||
| Deposits | $ | 503,001 | 2,142 | 0.43 | $ | 498,545 | 2,500 | 0.50 | $ | 530,121 | 4,325 | 0.82 | ||||||||||||||||||||||||
| Borrowings | 27,865 | 286 | 1.01 | 2,700 | 7 | 0.26 | 3,865 | 11 | 0.28 | |||||||||||||||||||||||||||
| Junior subordinated debentures | 10,310 | 323 | 3.09 | 10,310 | 339 | 3.29 | 10,310 | 364 | 3.53 | |||||||||||||||||||||||||||
| Total interest bearing liabilities | 541,176 | 2,751 | 0.51 | 511,555 | 2,846 | 0.56 | 544,296 | 4,700 | 0.86 | |||||||||||||||||||||||||||
| Noninterest bearing demand deposits | 99,391 | - | - | 93,763 | - | - | 95,411 | - | - | |||||||||||||||||||||||||||
| Total sources of funds | 640,567 | 2,751 | 0.43 | 605,318 | 2,846 | 0.47 | 639,707 | 4,700 | 0.73 | |||||||||||||||||||||||||||
| Other liabilities | 4,180 | 6,239 | 7,089 | |||||||||||||||||||||||||||||||||
| Stockholders’ equity | 79,347 | 76,669 | 85,295 | |||||||||||||||||||||||||||||||||
| Total liabilities and equity | $ | 724,094 | $ | 688,226 | $ | 732,091 | ||||||||||||||||||||||||||||||
| Net interest income | $ | 26,427 | $ | 26,826 | $ | 29,894 | ||||||||||||||||||||||||||||||
| Interest rate spread (1)(2) | 4.04 | % | 4.32 | % | 4.42 | % | ||||||||||||||||||||||||||||||
| Net interest margin (1)(3) | 4.06 | % | 4.34 | % | 4.43 | % | ||||||||||||||||||||||||||||||
| Ratio of earning assets to interest bearing liabilities | 122.63 | % | 123.07 | % | 122.56 | % | ||||||||||||||||||||||||||||||
1. Shown as a tax-adjusted yield.
2. Represents the difference between the average yield on earning assets and the average cost of funds.
3. Represents net interest income divided by average earning assets.
Results of Operations
Comparison of Financial Condition at December 31, 2014 and 2013.
Total assets increased to $885.9 million at December 31, 2014 from $674.7 million at December 31, 2013. Earning assets increased to $810.9 million at December 31, 2014 from $617.2 million at December 31, 2013. The ratio of earning assets to total assets was 91.5% at December 31, 2014 and 2013, respectively. Total assets increased and our asset mix changed with loans held for investment growing $29.5 million during 2014 and as proceeds from the branch acquisition transaction were used to purchase investment securities, with the residual funds held in cash to support additional loan growth.
Interest-bearing deposits with banks increased to $32.8 million at December 31, 2014 from $12.4 million at December 31, 2013. Included in this total is an additional $8.4 million of investments in CD’s issued by other financial institutions purchased to provide a risk-free return of future cash flows designed to be reinvested in funding prospective loan originations.
| 8 |
Investment securities available for sale increased to $292.3 million at December 31, 2014 from $150.3 million at December 31, 2013. During 2014, there were $153.3 million of purchases, $788,000 of sales, $14.7 million of principal repayments, a $5.3 million increase in unrealized holding gains, and $1.1 million of net accretion of premiums and discounts. The Bank may sell investment securities and securitize mortgage loans held for sale into mortgage-backed securities in order to support a more balanced sensitivity to future interest rate changes and to support adequate cash flow levels to meet customer demands. Investment securities held to maturity were $507,000 at December 31, 2014 compared to $506,000 at December 31, 2013. During 2014, the Bank invested a portion of the net cash received from the branch acquisition transaction in a mix of cash, short and intermediate term investment securities. This strategy allowed the Bank to put the dollars received from the transaction into earning assets without delay. The short to intermediate terms utilized were done so to provide a return of cash flows over a window where the Bank can redeploy the funds to higher yielding loans in support of our marketplace. The Bank continued to diversify its investment portfolio by adding defensive investments. While these investments have a lower current yield than our legacy portfolio, they should help insulate earnings in a rising interest rate environment. The Bank anticipates utilizing the cash flow from interest payments, pay downs, and sales from securities to fund future loan growth. See Notes 1 and 2 of Notes to Consolidated Financial Statements and “Part I - Item 1. Business–Acquisition of Branch Offices” above, for additional information.
Total loans held for sale increased to $4.8 million at December 31, 2014, from $3.0 million at December 31, 2013, reflecting current mortgage lending activity. During 2014, there were $22.4 million of loan originations (net of principal payments), $21.3 million of loan sales and $642,000 of net realized gains. Loans serviced for others declined to $306.8 million at December 31, 2014, from $325.4 million at December 31, 2013. See Notes 1 and 3 of Notes to Consolidated Financial Statements for additional information.
Total loans and leases held for investment increased to $480.4 million at December 31, 2014, from $451.0 million at December 31, 2013. During 2014, there were $30.5 million of originations net of principal payments, $1.2 million of net charge-offs, $1.1 million of provisions for credit losses and $1.6 million of transfers to OREO. The Bank originates both fixed and adjustable rate secured and unsecured loans held for investment. Adjustable rate loans provide the ability to better manage exposure to market and interest rate risk due to changes in interest rates. The Bank continues to limit the origination of new acquisition and development loans, lot loans or land loans. After successfully reducing its acquisition, development and construction concentration, the Bank has resumed originations, in select markets within its footprint, of speculative and pre-sold construction loans on 1-to-4 family residential properties and construction loans for commercial projects with an emphasis on owner-occupied properties.
Total loans held for investment on nonaccrual status decreased to $5.0 million at December 31, 2014, from $5.6 million at December 31, 2013. The ratio of loans on nonaccrual status to total loans decreased to 1.1% at December 31, 2014, from 1.3% at December 31, 2013. Loans are generally placed on nonaccrual status, and accrued but unpaid interest is reversed, when in management’s judgment, it is determined that the collectability of interest, but not necessarily principal, is doubtful. Generally, this occurs when payment is delinquent in excess of 90 days. Consumer loans that have become more than 180 days past due are generally charged off or a specific allowance may be provided for any expected loss. All other loans are charged off when management concludes that they are uncollectible.
Management has thoroughly evaluated all nonperforming loans and believes they are either well collateralized or adequately reserved. However, there can be no assurance in the future that regulators, increased risks in the loan portfolio, adverse changes in economic conditions or other factors will not require additional adjustments to the allowance for loan and lease losses (“ALLL”). Aside from the loans identified on nonaccrual status, there were no loans at December 31, 2014, where known information about possible credit problems of borrowers caused management to have serious concerns as to the ability of the borrowers to comply with their current loan repayment terms. See Notes 1, 4 and 6 of Notes to Consolidated Financial Statements for additional information.
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The ALLL was $7.5 million at December 31, 2014, compared to $7.6 million at December 31, 2013, reflecting provisions for credit losses and net charge-offs. During 2014, there were $1.1 million of provisions for loan and lease losses and $1.2 million of net charge-offs. The ratio of the ALLL to loans and leases held for investment was 1.57% at December 31, 2014, compared to 1.69% at December 31, 2013. See Part I, “Item 1. Business–Lending Activities-Allowance for Credit Losses” and Notes 1 and 5 of Notes to Consolidated Financial Statements for additional information.
OREO acquired from foreclosures declined to $7.8 million at December 31, 2014, from $9.4 million at December 31, 2013. During 2014, there were $3.2 million of disposals, $204,000 of valuation adjustments, net of $1.6 million of additions. OREO consists of residential and commercial properties, developed lots and raw land. The Bank believes the adjusted carrying value of these properties are representative of their fair market value, although there are no assurances that ultimate sales will be equal to or greater than the carrying value. See Notes 1, 7 and 20 of Notes to Consolidated Financial Statements for additional information.
The Bank’s investment in bank-owned life insurance (“BOLI”) increased to $15.1 million at December 31, 2014, from $11.1 million at December 31, 2013. The investment returns from BOLI will be utilized to recover a portion of the cost of providing benefit plans to employees.
Goodwill related to prior period acquisitions was $4.2 million at December 31, 2014 and 2013, respectively, and is not being amortized pursuant to provisions of financial accounting standards. The unamortized balance of the Company’s goodwill is tested for impairment annually. The Company has performed annual impairment testing and determined there was no goodwill impairment as of December 31, 2014 and 2013, respectively. See Notes 1 and 9 of Notes to Consolidated Financial Statements for additional information.
Identifiable intangible assets increased to $2.2 million at December 31, 2014, reflecting the core deposit intangible associated with the BOA transaction, and will be amortized over a ten year period. See “Part I - Item 1. Business–Acquisition of Branch Offices” above, and Notes 1 and 9 of Notes to Consolidated Financial Statements and Interest Expense below for additional information.
Total deposits increased to $788.3 million at December 31, 2014, versus $585.7 million at December 31, 2013. The increase in total deposits during 2014 results primarily from the deposits acquired in the branch purchase transaction. Non-maturity deposits (personal and business checking accounts and money market accounts) and savings accounts increased to $534.0 million at December 31, 2014, from $337.5 million at December 31, 2013. Certificates of deposit (“CDs”) increased to $254.3 million, or 32.3% of total deposits, at December 31, 2014, from $248.2 million, or 42.4% of total deposits, at December 31, 2013. The Bank attempts to manage its cost of deposits by monitoring the volume and rates paid on maturing CDs in relationship to current funding needs and market interest rates. The Bank did not renew all maturing CDs during 2014, and was able to reprice some of the maturing CDs at lower rates, and a portion migrated to non-maturity deposits within the Bank. See “Part I - Item 1. Business–Acquisition of Branch Offices and Deposit Activity and Other Sources of Funds” above, and Note 10 of Notes to Consolidated Financial Statements and Interest Expense below for additional information.
There were no FHLB borrowings at December 31, 2014 or 2013. During 2014, the Bank used FHLB borrowings to fund the purchase of certain investment securities noted above, in order to pre-invest a portion of the anticipated proceeds from the branch acquisition. With receipt of the branch acquisition proceeds, all FHLB borrowings were repaid. The Bank may use FHLB borrowings as a funding source to provide an effective means of managing its overall cost of funds, or to manage its exposure to interest rate risk. There was $10.3 million of junior subordinated debentures outstanding at both December 31, 2014 and 2013. See “Part I - Item 1. Business–Deposit Activity and Other Sources of Funds-Borrowings” above, and Notes 13 and 23 of Notes to Consolidated Financial Statements for additional information.
Stockholders' equity increased to $80.4 million at December 31, 2014, from $74.9 million at December 31, 2013, reflecting $3.9 million of net income earned for the year ended December 31, 2014 and a $3.1 million increase in accumulated other comprehensive income; net of $963,000 of cash dividend payments, and $457,000 used to acquire 55,876 shares of the Company’s common stock pursuant to an announced repurchase plan. See Consolidated Statements of Changes in Stockholders' Equity for additional information.
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Accumulated other comprehensive income increased to $3.2 million at December 31, 2014, from $103,000 at December 31, 2013, reflecting an increase in the mark-to-market adjustment in net unrealized gains in the available for sale investment securities portfolio, based on current market prices, coupled with the net unrealized loss on interest rate swap. See “Consolidated Statements of Comprehensive Income (Loss)” and Note 1 Notes to Consolidated Financial Statements for additional information.
The tangible equity to assets ratio declined to 8.36% at December 31, 2014, from 10.47% at December 31, 2013, reflecting the significant increase in our asset base coupled with the core deposit intangible created in association with the BOA branch acquisition. There were 9,598,007 common shares outstanding at December 31, 2014, compared to 9,653,883 shares outstanding at December 31, 2013, reflecting the net effect of shares purchased through the Company’s stock repurchase program. Tangible book value per common share increased to $7.71 at December 31, 2014, from $7.32 at December 31, 2013.
During the year ended December 31, 2014, the Company’s Board of Directors reinstated quarterly cash dividend payments. The reinstatement of a dividend reflects the strong capital position of the Company, sound and improved financial performance and our desire to provide additional value to our shareholders. The Board will continue to review the status of future dividend payments, which will depend upon the Company’s financial condition, earnings, equity structure, capital needs and economic conditions.
The Bank is subject to various regulatory capital requirements administered by its federal and state banking regulators. As of December 31, 2014, the Bank's regulatory capital ratios were in excess of all regulatory requirements and the Bank’s regulatory capital position is categorized as well capitalized. There are no conditions or events since December 31, 2014, that management believes have changed the Bank's well capitalized category. See “Liquidity and Capital Resources” above and Note 15 of Notes to Consolidated Financial Statements for additional information.
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Comparison of Operating Results for the Years Ended December 31, 2014 and 2013.
General. The Company reported net income of $3.9 million for 2014, compared to $6.0 million for 2013. Net income per diluted common share was $0.40 per share for 2014, compared to $0.62 per share for 2013.
Impact of Acquisition Transaction Expenses. As reported in “Part I - Item 1. Business–Acquisition of Branch Offices” above, on December 15, 2014, the Bank announced the completion of an acquisition of nine branch banking offices in eastern North Carolina from BOA effective December 12, 2014. In connection with this transaction, the Bank incurred a number of one-time expenses that impacted our results of operations for the year ended December 31, 2014. Our results of operations were also impacted by a fee associated with the prepayment of $20.0 million of FHLB advances.
Pre-tax net income for 2014 reflects the impact of $1.7 million of one-time acquisition transaction expenses and the prepayment fee on FHLB advances. Excluding the net effects of these one-time expenses, net income for 2014 would have been $5.0 million, or $0.52 per diluted common share. Table 4 below presents net income for the year end December 31, 2014, adjusted for the impact of the one-time BOA acquisition transaction expenses and the FHLB prepayment fee:
| Table 4 – Adjustments for One-Time Expenses | Year Ended 12/31/14 | |||
| (In thousands) | ||||
| Reported Net Income | $ | 3,873 | ||
| Adjustments for One-Time Expenses: | ||||
| BOA Branch Acquisition Transaction | ||||
| Professional fees and services | 647 | |||
| Compensation and fringe benefits | 241 | |||
| Advertising | 205 | |||
| Other miscellaneous expenses | 133 | |||
| Premises and equipment | 94 | |||
| Total BOA Branch Acquisition Expenses | 1,320 | |||
| FHLB Advance Prepayment Fee | 345 | |||
| Total One-Time Adjustments | 1,665 | |||
| Income Tax Benefit (29.85%) | (497 | ) | ||
| Net Income Adjusted for One-Time Expenses | $ | 5,041 | ||
| Reported Diluted EPS | $ | 0.40 | ||
| Impact of One-Time Expenses on EPS | $ | 0.12 | ||
| Diluted EPS Adjusted for One-Time Expenses | $ | 0.52 | ||
While 2014 financial results were impacted by these one-time expenses late in the fourth quarter, the Bank continued to focus efforts on improving net interest income, core non-interest income and containing recurring non-interest expenses. The Bank remains focused on long-term strategies, including asset quality, maintaining adequate levels of capital and liquidity, improving efficiency in operations, building core customer relationships and improving franchise and stockholder value. The Bank continues to maintain a strong capital position in excess of the well-capitalized regulatory guidelines, which provides it with a solid foundation from which to grow.
Key Performance Ratios. Key performance ratios are return on average assets (ROA), return on average equity (ROE) and efficiency. For 2014, ROA and ROE were 0.53% and 4.93%, respectively, compared to 0.87% and 7.84%, respectively, for 2013. The efficiency ratio (noninterest expenses as a percentage of net interest income plus noninterest income) was 79.98% for 2014, compared to 72.61% for 2013. The efficiency ratio measures the proportion of net operating revenues that are absorbed by overhead expenses. The 2014 key ratios were negatively impacted by one-time BOA acquisition transaction expenses and the FHLB prepayment fee.
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Interest Income. Interest income declined marginally to $29.2 million for 2014, from $29.7 million for 2013. The year-over-year marginal decline in interest income is due primarily to a decline in yields on earning assets coupled with changes in the composition of the earning asset base. The tax equivalent yield on average interest-earning assets declined to 4.47% for 2014, from 4.79% for 2013. Average earning assets increased during 2014 to $663.6 million, from $629.6 million for 2013, reflecting net growth in loans and leases held for investment, investment securities and interest-bearing deposits. While the Company experienced growth in loans and investment securities during 2014, given the current low rate environment, yields on new loan production and investment security purchases were below historical levels.
Interest Expense. Interest expense was $2.8 million for the twelve month periods ended on December 31, 2014 and 2013, reflecting the reduced interest rates paid in the comparative reporting periods, partially offset by a change in the mix and increased volume of average interest-bearing liabilities. The average cost of interest-bearing liabilities, declined to 0.51% for 2014, from 0.56% for 2013. The Company improved its cost of interest-bearing liabilities by a combination of growth in lower cost non-maturity deposits, pricing new CDs and repricing maturing CDs in the lower interest rate environment. Average interest-bearing liabilities increased to $541.2 million for 2014, from $511.6 million for 2012. Average noninterest-bearing demand deposits increased to $99.4 million for 2014, from $93.8 million for 2013.
Net Interest Income. Net interest income also declined marginally to $26.4 million for 2014, from $26.8 million for 2013. The tax equivalent net interest margin for 2014 declined to 4.06%, from 4.34% for 2013. This decline in the net interest margin is primarily due to the continued low interest rate environment which is impacting yields on both loans and investment securities. This impact has been partially offset by an increase in the volume of average earning assets coupled with a continued reduction in funding costs. A significant portion of net proceeds from the branch acquisition transaction were invested into a mix of cash, short and intermediate term investment securities, until the funds can be converted to higher yielding assets. The immediate impact of this transaction, in conjunction with other defensive investments, is a reduction in the yield on our investment portfolio. However, we believe our balance sheet is well poised to respond to increases in interest rates and that we are in a position to take advantage of future opportunities as they present themselves.
While the Company has taken steps to help protect the Bank against the potential impacts of a rising rate environment, we anticipate that should interest rates remain unchanged, the repricing of higher yielding long-term assets, coupled with the issuance of organic loan growth in the current low rate environment and the change in our earning asset mix will result in a net interest margin for the Company that is below that of historical levels. See “Table 2 - Rate/Volume Analysis” and “Table 3 - Yield/Cost Analysis” above for additional information on interest income, interest expense, net interest income, average balances and yield/cost ratios.
Provision for Credit Losses. The Bank recorded $1.1 million of provisions for credit losses in 2014 and 2013, respectively. The Bank's methodology for determining its provision for credit losses includes amounts specifically allocated to credits that are individually determined to be impaired, as well as general provisions allocated to groups of loans that have not been individually assessed for impairment. The volume of current year provisions for credit losses is attributable to the net growth in loans and leases held for investment, as previously discussed. The provision for credit losses is necessary to maintain the ALLL at a level that management believes is adequate to absorb probable future losses in the loan portfolio. See Part I, “Item 1. “Business–-Lending Activities-Allowance for Credit Losses” and Notes 1 and 5 of the Notes to Consolidated Financial Statements for additional information.
Noninterest Income. Total noninterest income declined to $8.6 million for 2014, from $10.4 million for 2013. Noninterest income consists of fees and service charges collected on deposit accounts, fees and servicing fees earned on loans, net gains from loan and securities sales and other miscellaneous income. The Bank strives to increase its noninterest income earned across both deposit and loan service offerings. Fees and service charges on deposits, and fees on loans and loan servicing fees earned during each period are influenced by the volume of deposits and loans outstanding, the volume of the various types of deposit and loan account transactions processed, the volume of loans serviced for others and the collection of related fees and service charges.
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Deposit fees and service charges increased to $4.4 million for 2014, representing 51.1% of total non-interest income, from $4.2 million earned in 2013, representing 40.4% total non-interest income. We anticipate additional service charge revenue from deposits going forward, as we focus on growing our core deposit base through new customer acquisition, cross-selling to existing customers and the deposit accounts acquired from the branch purchase transaction and adding services .
The Bank’s mortgage division generates revenues through loan originations as well as loan servicing. Total non-interest income generated from the sale and servicing of mortgage loans and loan fees declined to $2.4 million in 2014, from $3.8 million for 2013. Revenue from mortgage banking activities declined with home purchases in the first half of the year, but rebounded in part of the year as low mortgage rates sparked refinance activity. We do not foresee mortgage refinancing regaining the levels reached over the recent past, however, we expect the level of new purchase activity to help fill this void as the overall economic climate improves in the Bank’s market area. As we sell the majority of our originated mortgage loans and retain the servicing rights, the decline in volume has also impacted recurring revenue from servicing. We continue to explore various strategies to enhance our non-interest income, including the purchasing of servicing rights.
The Bank sells fixed-rate residential mortgage loans to reduce interest rate and credit risk exposure, while retaining certain other held for sale mortgage loans for future securitization into available for sale mortgage-backed securities. The Bank sold $21.3 million of loans held for sale in 2014, compared to $65.9 million sold in 2013. Mortgage loan originations slowed during 2014, as new purchase activity has not fully replaced the reduction in refinance activity. The future levels of gains on sales of mortgage loans and loan servicing fees are dependent on the pricing and volume of new mortgage loan originations. We anticipate that mortgage loan originations in 2015 will be dependent on housing activity in our markets, the level of mortgage loan interest rates and our marketing efforts.
Gains from sales of investment securities available for sale was $14,000 for 2014, versus $548,000 for 2013. The Bank sold $788,000 of investment securities available for sale in 2014, compared to $43.2 million sold in 2013. The investment securities sold during 2013 were low coupon mortgage-backed securities that would not perform as well as alternative investments in a rising rate environment. Proceeds from investment securities sales also provide liquidity to support the Bank’s operating, financing and lending activities.
In its efforts of disposing of nonperforming assets, the Bank recorded net gains on sales of other real estate owned properties of $115,000 for 2014, compared to $609,000 for 2013. See Note 7 of Notes to Consolidated Financial Statements for additional information.
Included in other noninterest income is revenue from BOLI investments. BOLI earnings increased to $531,000 for 2014, from $293,000 for 2013. The Bank utilizes the investment returns from the BOLI to recover a portion of the cost of providing benefit plans to our employees.
Noninterest Expenses. Total non-interest expenses for 2014 were $28.5 million, compared to $27.0 million for 2013. The increase in total non-interest expenses for 2014 relate primarily to the $1.7 million of one-time expenses noted above.
Compensation and benefits expense, the largest component of non-interest expenses, was $15.8 million for 2014, compared to $15.1 million reported in 2013. The increase in compensation and benefits expense for 2014 includes $241,000 of expenses associated with the acquisition of nine branches from BOA. Additionally, there were approximately $120,000 of non-recurring compensation and benefits expenses related to additional FUTA taxes billed and severance pay. The Bank will continue to manage staffing levels to ensure we meet the ongoing needs of our customers and to support our future growth.
Premises and equipment expense was $3.6 million for 2014, compared to $3.0 million reported in 2013. The increase in premises and premises expense for 2014 includes $94,000 of acquisition related expenses. With the recent addition of nine new branch locations, we anticipate our level of expenses for premises and equipment going forward to be above that of prior periods.
FDIC insurance for 2014 declined to $566,000, from $850,000 reported in 2013. The change in volume of FDIC insurance is attributable to changes in the volume of the deposit insurance assessment calculation base.
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Advertising expense 2014 was $667,000, compared to $289,000 reported in 2013. The increase in advertising expense for 2014 included $205,000 of acquisition related expenses.
Data processing costs for 2014 and 2013 were $2.3 million for each respective year. Data processing costs fluctuate in conjunction with changes in the number of customer accounts and transaction activity volumes and therefore, with the addition of accounts and customers from the acquisition, we would expect these costs to increase going forward.
Expenses attributable to ongoing maintenance, property taxes and insurance for OREO properties declined to $446,000 for 2014, from $620,000 for 2013. Total OREO valuation adjustments declined to $204,000 for 2014, from $546,000 for 2013. See Notes 1 and 7 of Notes to Consolidated Financial Statements for additional information.
Other general and administrative expenses were $4.6 million for 2014, compared to $3.8 million for 2013. The increase in other expenses for 2014 includes acquisition related professional fees and other miscellaneous expenses of $647,000 and $133,000, respectively, and $345,000 of penalties related to prepaying $20.0 million of FHLB advances.
During 2013 the Bank initiated a strategy to obtain $20.0 million of long-term fixed-rate FHLB advances. These were forward starting advances that came onto the Bank’s books during 2014 to hedge the impact of potential rising interest rates and to provide liquidity during a period of extremely high CD maturity volume. When these advances were taken, we did not foresee the branch purchase transaction and related increased liquidity. With the volume of excess liquidity acquired in the branch purchase transaction, repaying the advances resulted in a one-time pretax charge of $345,000; however, during 2015 alone the interest expense savings on these advances of $438,000 well exceeds the cost of unwinding these positions.
Income Taxes. Income tax expense was $1.6 million for 2014, compared to $3.1 million for 2014. The effective income tax rate for 2014 declined to 28.8%, from 34.0% for 2013. Changes in the amount of income tax expense reflect changes in pretax income, deductible expenses, the application of permanent and temporary differences and the applicable income tax rates in effect during each period. The increased investment in BOLI and tax-exempt municipal bonds, combined with the income tax benefit related to the one-time expenses contributed to the decline in income tax expense and the effective income tax rates for year ended 2014. See Notes 1 and 14 of Notes to Consolidated Financial Statements for additional information.
In 2013, the North Carolina State Legislature made changes to the state’s tax laws. As a result the corporate income tax rate for 2014 was reduced from 6.9% to 6.0%. This rate is scheduled to reduce to 5.0% for 2015. We anticipate that this change in the tax code, in conjunction with the Bank’s increased level of investment in tax-exempt municipal securities, will result in further lowering of the Company’s effective tax rate over the near term.
Comparison of Operating Results for the Years Ended December 31, 2013 and 2012.
General. The Company reported net income of $6.0 million for 2013, compared to a net loss of $11.0 million for 2012. The net income per diluted common share was $0.62 per share for 2013, compared to net loss per diluted common share of $1.13 per share for 2012.
Disposition Plan. As disclosed in our Form 10-K for 2012, the Bank executed a Disposition Plan for a bulk sale of problem loans and significant fair value adjustments to loans and OREO, that were reflected in the 2012 year end operating results. The operating results for 2013 reflect the positive impact of those actions. Although a lower average volume of earning assets resulted in a decline in net interest income when compared with 2012, improvement in provisions for loan losses and non-interest expenses specifically related to OREO maintenance and valuation charges enhanced earnings growth. Subsequent to the Disposition Plan, the Bank maintained a strong capital position in excess of the well-capitalized regulatory guidelines.
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Key Performance Ratios. For 2013, ROA and ROE increased to 0.87% and 7.84%, respectively, from (1.50%) and (12.87%), respectively, for 2012. The efficiency ratio improved to 72.61% for 2013, from 87.30% for 2012. The ROA, ROE and efficiency ratios for 2012 were negatively impacted by the Disposition Plan.
Interest Income. Interest income declined to $29.7 million for 2013, from $34.6 million for 2012, due to a reduction in the volume and a change in the composition of earning assets. Average earning assets declined during 2013, as the amount of loans and leases held for investment was compressed, primarily due to the Disposition Plan. This reduction was partially offset by an increase in investment securities and interest-bearing cash. Average earning assets declined to $629.6 million for 2013, from $667.1 million for 2012. The tax equivalent yield on average interest-earning assets declined to 4.79% for 2013, from 5.15% for 2012.
Interest Expense. Interest expense declined to $2.8 million for 2013, from $4.7 million for 2012, reflecting a reduction in interest rates paid between the periods, as well as a change in the mix and reduced volume of average interest-bearing liabilities. Average interest-bearing liabilities declined to $511.6 million for 2013, from $544.3 million for 2012. Average noninterest-bearing demand deposits declined to $93.8 million for 2013, from $95.4 million for 2012. The average cost of interest-bearing liabilities, declined to 0.56% for 2013, from 0.86% for 2012. The cost of interest-bearing liabilities was improved by the repayment of borrowings and growth in lower cost non-maturity deposits, pricing new CDs and repricing maturing CDs in the lower interest rate environment.
Net Interest Income. Net interest income declined to $26.8 million for 2013, from $29.9 million for 2012. The tax equivalent net interest margin for 2013 declined to 4.34%, from 4.43% for 2012.
The decline in net interest income and the net interest margin in 2013 was primarily due to a reduction in the level and change in the composition of earning assets. Total average earning assets declined during 2013, as the average amount of loans and leases held for investment compressed, primarily due to the Disposition Plan. This reduction was partially offset by an increase in investment securities and interest-bearing cash. A portion of the bulk sale proceeds were redeployed into investment securities that perform better in a rising interest rate environment. The residual funds were retained in cash to be redeployed into future loan growth or other investments where returns will improve as rates increase.
Provision for Credit Losses. The Bank recorded $1.1 million of provisions for credit losses in 2013, compared to $23.3 million of provisions for credit losses in 2012, including $17.2 million associated with the Disposition Plan. The reduction in provisions for credit losses for 2013 is attributable to the impact of the Disposition Plan and improved asset quality.
Noninterest Income. Total noninterest income was $10.4 million for 2013, compared to $10.8 million for 2012. Fees and service charges on deposit accounts, the largest component of noninterest income, was $4.2 million for 2013, and was relatively consistent with the $4.3 million for 2012. The Bank implemented new deposit products in 2013 and the level of NSF fees declined to $1.6 million for 2013, from $1.9 million in 2012. However, during this same period the level of other deposit related fees increased $246,000 or 73% to $623,000 for 2013.
Mortgage loan servicing fees of $1.2 million for 2013, remained stable when compared to the $1.3 million recorded in 2012. However, revenue generated from the gain on sale and other fees on mortgage loans fell to $2.5 million for 2013, from $3.0 million for 2012. This change was due to home mortgage rates starting to rise off their historic low levels, causing a slowdown in mortgage activity, especially refinances. The Bank sold $65.9 million of loans held for sale in 2013, compared to $29.5 million sold in 2012. Mortgage loan originations slowed during the second half of 2013, as new purchase activity has not fully replaced the reduction in refinance activity
Gains from sales of investment securities available for sale declined to $548,000 for 2013, from $1.5 million for 2012. The Bank sold $43.2 million of investment securities available for sale in 2013, compared to $32.7 million sold in 2012. The investment securities sold during 2013 were low coupon mortgage-backed securities that would not perform as well as alternative investments in a rising rate environment.
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In its efforts of disposing of nonperforming assets, the Bank recorded net gains on sales of other real estate owned properties of $609,000 for 2013, compared to $529,000 of net losses recorded for 2012.
Noninterest Expenses. Total noninterest expense declined to $27.0 million for 2013, from $35.6 million for 2012. This was primarily attributable to a significant reduction in OREO valuation and maintenance expenses, as well as lower compensation and employee benefits expenses. Compensation and fringe benefits, the largest component of noninterest expense, declined to $15.1 million for 2013, from $16.7 million for 2012. The 2012 amount included approximately $1.5 million of additional non-recurring accruals for retirement benefits.
FDIC insurance premiums declined to $850,000 for 2013, from $987,000 for 2012, reflecting a reduction in the deposit insurance assessment calculation base. Data processing costs increased to $2.3 million for 2013, from $1.9 million for 2012, reflecting the expiration of favorable initial pricing received from a core data processing system conversion completed in March 2012.
Expenses attributable to valuation adjustments, renovating, maintenance and property taxes on OREO properties declined to $1.2 million for 2013, from $8.8 million for 2012, including $5.2 million of valuation charges under the Disposition Plan.
Premises and equipment, advertising, amortization of intangibles and other expense, remained relatively consistent during the respective 2013 and 2012 reporting periods.
Income Taxes. The Company recorded $3.1 million of income tax expense for 2013, compared to $7.1 million of income tax benefit for 2012, reflecting the tax benefits associated with the Disposition Plan. Pretax operating income was $9.1 million for 2013, compared to pretax loss of $18.1 million for 2012. The effective income tax expense rate for 2013 was 34.0%, compared to an effective income tax benefit rate of 39.4% for 2012.
Impact of Inflation and Changing Prices. The consolidated financial statements of the Company and accompanying footnotes have been prepared in accordance with accounting principles generally accepted in the United States of America. They require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time and due to inflation. The impact of inflation is reflected in the increased cost of the Bank's operations. Unlike most industrial companies, nearly all the assets and liabilities of the Bank are monetary. As a result, interest rates have a greater impact on the Bank's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services.
Accounting Standards Codification™. The Financial Accounting Standards Board (“FASB”) has issued the FASB Accounting Standards Codification™ (the “Codification”) as the source of authoritative accounting principles generally accepted in the United States of America (“GAAP”) recognized by the FASB to be applied to nongovernmental entities. All previous US GAAP standards issued by a standard setter are superseded and all other accounting literature not included in the Codification will be considered non-authoritative. See Note 1 of the Notes to Consolidated Financial Statements for additional information on recent accounting pronouncements and changes in accounting principles, the respective effective and adoption dates, and the expected impact on the Company’s consolidated financial statements.
Off-Balance Sheet Arrangements. The Bank is a party to certain financial instruments with off-balance sheet risk, to which in the normal course of business, to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. See Item 1. Business –“Lending Activities – Unfunded Commitments Composition” and Note 18 of the Notes to Consolidated Financial Statements for additional information.
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Item 15. Exhibits, Financial Statement Schedules
(a) List of Documents Filed as Part of this Report
(3) Exhibits. The following is a list of exhibits filed as part of this Annual Report on Form 10-K/A and is also the Exhibit Index.
| 31.1 | Rule 13a-14(a) Certification of Chief Executive Officer |
| 31.2 | Rule 13a-14(a) Certification of Chief Financial Officer |
| 32 | Certification pursuant to 18 U.S.C. Section 1350 |
| 18 |
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| FIRST SOUTH BANCORP, INC. | ||
| By: | /s/ Scott C. McLean | |
| Scott C. McLean | ||
| Executive Vice President and Chief Financial Officer | ||
| (Principal Financial and Accounting Officer) | ||
| Date: April 2, 2015 | ||