Attached files

file filename
EX-31.1 - EX-31.1 - MERCHANTS BANCSHARES INCmbvt-20150930ex3113ca4af.htm
EX-31.2 - EX-31.2 - MERCHANTS BANCSHARES INCmbvt-20150930ex3123dfe97.htm
EX-32.1 - EX-32.1 - MERCHANTS BANCSHARES INCmbvt-20150930ex321803346.htm
EX-32.2 - EX-32.2 - MERCHANTS BANCSHARES INCmbvt-20150930ex32249b89e.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

 

[ X ]

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

 

For the quarterly period ended September 30, 2015

 

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 Number:

0-11595

 

Merchants Bancshares, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware

03-0287342

(State or other jurisdiction of

(I.R.S. Employer

incorporation or organization)

Identification No.)

 

 

275 Kennedy Drive, South Burlington, VT

05403

(Address of principal executive offices)

(Zip Code)

 

802-658-3400

(Registrant’s telephone number, including area code)

 

Not Applicable

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

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  [ X ] 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).  [X] Yes   [   ] No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a nonaccelerated 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.

 

 

 

 

 

Large Accelerated Filer [   ]

Accelerated Filer [ X ]

Nonaccelerated Filer [   ]

Smaller Reporting Company [   ]

 

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).  [   ] Yes     [ X ] No

 

As of October 27, 2015, there were 6,339,984 shares of the registrant’s common stock, par value $0.01 per share, outstanding.

 

 

 


 

MERCHANTS BANCSHARES, INC. AND SUBSIDIARIES

FORM 10-Q 

 

TABLE OF CONTENTS

 

 

 

 

 

PART I – FINANCIAL INFORMATION 

 

Page Reference

Item 1 

Financial Statements

 

 

 

 

 

 

 

Consolidated Balance Sheets (Unaudited)

 

 

 

As of September 30, 2015 and December 31, 2014

 

 

 

 

 

 

Consolidated Statements of Income (Unaudited)

 

 

 

Three and nine months ended September 30, 2015 and 2014

 

 

 

 

 

 

Consolidated Statements of Comprehensive Income (Unaudited)

 

 

 

Three and nine months ended September 30, 2015 and 2014

 

 

 

 

 

 

Consolidated Statements of Cash Flows (Unaudited)

 

 

 

Nine months ended September 30, 2015 and 2014

 

 

 

 

 

 

Notes to Interim Unaudited Consolidated Financial Statements

 

 

 

 

 

Item 2 

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

 

31 

Item 3 

Quantitative and Qualitative Disclosures about Market Risk

 

45 

Item 4 

Controls and Procedures

 

48 

 

 

 

 

PART II - OTHER INFORMATION 

 

 

Item 1 

Legal Proceedings

 

49 

Item 1A 

Risk Factors

 

49 

Item 2 

Unregistered Sales of Equity Securities and Use of Proceeds

 

49 

Item 3 

Defaults Upon Senior Securities

 

49 

Item 4 

Mine Safety Disclosure

 

49 

Item 5 

Other Information

 

49 

Item 6 

Exhibits

 

50 

 

Signatures

 

51 

 

 

2


 

ITEM 1 – FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

Merchants Bancshares, Inc.

Consolidated Balance Sheets

(Unaudited)

 

 

 

 

 

 

 

 

 

 

    

September 30,

    

December 31,

 

(In thousands except share and per share data)

 

2015

 

2014

 

ASSETS

 

 

 

 

 

 

 

Cash and due from banks

 

$

21,541

 

$

23,745

 

Interest earning deposits with banks and other short-term investments

 

 

89,918

 

 

130,714

 

Total cash and cash equivalents

 

 

111,459

 

 

154,459

 

Investments:

 

 

 

 

 

 

 

Securities available for sale, at fair value

 

 

282,083

 

 

203,473

 

Securities held to maturity (fair value of $125,875 and $139,171)

 

 

123,929

 

 

138,421

 

Total investments

 

 

406,012

 

 

341,894

 

Loans

 

 

1,257,932

 

 

1,182,334

 

Less: Allowance for loan losses

 

 

12,210

 

 

11,833

 

Net loans

 

 

1,245,722

 

 

1,170,501

 

Federal Home Loan Bank stock

 

 

4,378

 

 

4,378

 

Bank premises and equipment, net

 

 

15,019

 

 

15,492

 

Investment in real estate limited partnerships

 

 

5,982

 

 

5,196

 

Bank owned life insurance

 

 

10,492

 

 

10,311

 

Other assets

 

 

19,277

 

 

21,233

 

Total assets

 

$

1,818,341

 

$

1,723,464

 

LIABILITIES

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

Demand (noninterest bearing)

 

$

575,492

 

$

566,366

 

Savings, interest bearing checking and money market accounts

 

 

620,224

 

 

530,722

 

Time Deposits

 

 

191,757

 

 

211,684

 

Total deposits

 

 

1,387,473

 

 

1,308,772

 

Securities sold under agreements to repurchase

 

 

267,794

 

 

258,464

 

Other long-term debt

 

 

2,258

 

 

2,320

 

Junior subordinated debentures issued to unconsolidated subsidiary trust

 

 

20,619

 

 

20,619

 

Other liabilities

 

 

7,551

 

 

7,468

 

Total liabilities

 

 

1,685,695

 

 

1,597,643

 

 

 

 

 

 

 

 

 

SHAREHOLDERS' EQUITY

 

 

 

 

 

 

 

Preferred stock

 

 

 

 

 

 

 

Class A non-voting shares authorized - 200,000,  none outstanding

 

 

 —

 

 

 —

 

Class B voting shares authorized - 1,500,000,  none outstanding

 

 

 —

 

 

 —

 

Common stock, $.01 par value

 

 

67

 

 

67

 

Authorized: 10,000,000 shares; Issued: 6,651,760 at September 30, 2015 and December 31, 2014

 

 

 

 

 

 

 

Outstanding: 6,338,158 at September 30, 2015 and 6,327,226 at December 31, 2014

 

 

 

 

 

 

 

Capital in excess of par value

 

 

37,483

 

 

37,404

 

Retained earnings

 

 

105,686

 

 

100,697

 

Treasury stock, at cost: 313,602 shares at September 30, 2015 and 324,534 shares at December 31, 2014

 

 

(13,609)

 

 

(13,865)

 

Deferred compensation arrangements: 294,937 shares at September 30, 2015 and 308,670 shares at December 31, 2014

 

 

6,443

 

 

6,566

 

Accumulated other comprehensive (loss) income

 

 

(3,424)

 

 

(5,048)

 

Total shareholders' equity

 

 

132,646

 

 

125,821

 

Total liabilities and shareholders' equity

 

$

1,818,341

 

$

1,723,464

 

 

 

See accompanying notes to unaudited consolidated financial statements

 

3


 

Merchants Bancshares, Inc.

Consolidated Statements of Income

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended 

 

Nine Months Ended 

 

 

 

September 30,

 

September 30,

 

(In thousands except per share data)

    

2015

    

2014

    

2015

    

2014

    

INTEREST AND DIVIDEND INCOME

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest and fees on loans

 

$

11,055

 

$

10,642

 

$

32,478

 

$

32,160

 

Investment income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest and dividends on investment securities

 

 

1,961

 

 

1,885

 

 

5,784

 

 

6,145

 

Interest on interest earning deposits with banks and other short-term investments

 

 

25

 

 

37

 

 

157

 

 

110

 

Total interest and dividend income

 

 

13,041

 

 

12,564

 

 

38,419

 

 

38,415

 

INTEREST EXPENSE

 

 

 

 

 

 

 

 

 

 

 

 

 

Savings, interest bearing checking and money market accounts

 

 

354

 

 

370

 

 

1,075

 

 

1,283

 

Time deposits

 

 

318

 

 

433

 

 

975

 

 

1,358

 

Securities sold under agreement to repurchase and other short-term debt

 

 

97

 

 

62

 

 

403

 

 

241

 

Long-term debt

 

 

199

 

 

201

 

 

595

 

 

598

 

Total interest expense

 

 

968

 

 

1,066

 

 

3,048

 

 

3,480

 

Net interest income

 

 

12,073

 

 

11,498

 

 

35,371

 

 

34,935

 

Provision for credit losses

 

 

150

 

 

 —

 

 

250

 

 

150

 

Net interest income after provision for credit losses

 

 

11,923

 

 

11,498

 

 

35,121

 

 

34,785

 

NONINTEREST INCOME

 

 

 

 

 

 

 

 

 

 

 

 

 

Trust division income

 

 

886

 

 

856

 

 

2,666

 

 

2,537

 

Net debit card income

 

 

796

 

 

678

 

 

2,301

 

 

2,014

 

Overdraft income

 

 

548

 

 

639

 

 

1,327

 

 

1,919

 

Service charges on deposits

 

 

390

 

 

331

 

 

1,108

 

 

977

 

Net gains (losses) on investment securities

 

 

 —

 

 

(37)

 

 

 —

 

 

106

 

Losses on sale of other assets

 

 

 —

 

 

 —

 

 

 —

 

 

(35)

 

Other

 

 

829

 

 

409

 

 

1,470

 

 

1,217

 

Total noninterest income

 

 

3,449

 

 

2,876

 

 

8,872

 

 

8,735

 

NONINTEREST EXPENSE

 

 

 

 

 

 

 

 

 

 

 

 

 

Compensation and benefits

 

 

5,508

 

 

5,145

 

 

15,746

 

 

14,906

 

Occupancy expense

 

 

1,036

 

 

1,064

 

 

3,228

 

 

3,296

 

Equipment expense

 

 

726

 

 

754

 

 

2,224

 

 

2,151

 

Telephone expense

 

 

206

 

 

223

 

 

609

 

 

686

 

Legal and professional fees

 

 

414

 

 

490

 

 

1,394

 

 

1,440

 

Mobile & internet banking

 

 

399

 

 

363

 

 

1,195

 

 

1,062

 

Core / Item processing

 

 

450

 

 

415

 

 

1,289

 

 

1,338

 

Marketing

 

 

148

 

 

423

 

 

437

 

 

924

 

State franchise  taxes

 

 

404

 

 

340

 

 

1,094

 

 

1,096

 

FDIC insurance

 

 

218

 

 

218

 

 

653

 

 

651

 

Conversion costs

 

 

 —

 

 

442

 

 

 —

 

 

830

 

Merger costs

 

 

215

 

 

 —

 

 

363

 

 

 —

 

Other

 

 

867

 

 

848

 

 

2,847

 

 

2,594

 

Total noninterest expense

 

 

10,591

 

 

10,725

 

 

31,079

 

 

30,974

 

Income before provision for income taxes

 

 

4,781

 

 

3,649

 

 

12,914

 

 

12,546

 

Provision for income taxes

 

 

925

 

 

843

 

 

2,606

 

 

2,923

 

NET INCOME

 

$

3,856

 

$

2,806

 

$

10,308

 

$

9,623

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.61

 

$

0.44

 

$

1.63

 

$

1.52

 

Diluted earnings per common share

 

$

0.61

 

$

0.44

 

$

1.62

 

$

1.52

 

 

See accompanying notes to unaudited consolidated financial statements

4


 

Merchants Bancshares, Inc.

Consolidated Statements of Comprehensive Income 

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended 

 

Nine Months Ended 

 

 

 

September 30,

 

September 30,

 

(In thousands)

    

2015

    

2014

    

2015

    

2014

 

Net income

 

$

3,856

 

$

2,806

 

$

10,308

 

$

9,623

 

Other comprehensive (loss) income,  net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized  holding gain (losses) on securities available for sale, net of taxes of $650,  $(317),  $497 and $594

 

 

1,215

 

 

(589)

 

 

933

 

 

1,102

 

Unrealized holding gains (losses) arising during the period for securities transferred from available for sale to held to maturity, net of taxes of $0, $0 $0, and $4

 

 

 —

 

 

 —

 

 

 —

 

 

8

 

Amortization of unrealized holding losses of securities transferred from available for sale to held to maturity, net of taxes of $78, $68, $213 and $189

 

 

144

 

 

127

 

 

396

 

 

351

 

Reclassification adjustments for net securities losses (gains) included in net income, net of taxes of $0,  $13,  $0 and $(37)

 

 

 —

 

 

24

 

 

 —

 

 

(69)

 

Change in net unrealized loss on interest rate swaps, net of taxes of $39,  $36,  $50 and $71

 

 

73

 

 

66

 

 

94

 

 

131

 

Pension liability adjustment, net of taxes of $36,  $10,  $107 and $34

 

 

67

 

 

21

 

 

201

 

 

63

 

Other comprehensive (loss) income

 

 

1,499

 

 

(351)

 

 

1,624

 

 

1,586

 

Comprehensive (loss) income

 

$

5,355

 

$

2,455

 

$

11,932

 

$

11,209

 

 

See accompanying notes to unaudited consolidated financial statements

5


 

Merchants Bancshares, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30,

 

(In thousands)

    

2015

    

2014

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

Net income

 

$

10,308

 

$

9,623

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

Provision for credit losses

 

 

250

 

 

150

 

Depreciation and amortization

 

 

1,652

 

 

1,944

 

Amortization of investment security premiums and accretion of discounts, net

 

 

939

 

 

477

 

Stock based compensation

 

 

97

 

 

136

 

Net losses (gains) on sales of investment securities

 

 

 —

 

 

(106)

 

Deferred (gain) on sale of premises

 

 

(387)

 

 

(387)

 

Loss (gain) on sale of other real estate owned

 

 

 —

 

 

35

 

Equity in losses of real estate limited partnerships, net

 

 

846

 

 

981

 

Increase in cash surrender value of bank owned life insurance

 

 

(181)

 

 

(237)

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

Net change in interest receivable

 

 

111

 

 

673

 

Net change in other assets

 

 

1,247

 

 

4,118

 

Net change in interest payable

 

 

(32)

 

 

(43)

 

Net change in other liabilities

 

 

841

 

 

(1,722)

 

Net cash provided by operating activities

 

 

15,691

 

 

15,642

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

Proceeds from sales of investment securities available for sale

 

 

 —

 

 

56,889

 

Proceeds from maturities of investment securities available for sale

 

 

34,957

 

 

28,560

 

Proceeds from maturities of investment securities held to maturity

 

 

14,917

 

 

11,692

 

Proceeds from redemption of Federal Home Loan Bank stock

 

 

 —

 

 

3,118

 

Purchases of investment securities available for sale

 

 

(112,892)

 

 

(30,190)

 

Loan originations in excess of principal payments

 

 

(75,665)

 

 

9,449

 

Proceeds from sales of other real estate owned

 

 

 —

 

 

68

 

Real estate limited partnership investments

 

 

(1,594)

 

 

(1,823)

 

Purchases of bank premises and equipment

 

 

(1,179)

 

 

(2,293)

 

Net cash provided by (used in) investing activities

 

 

(141,456)

 

 

75,470

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

Net change in deposits

 

 

78,701

 

 

(19,495)

 

Net change in securities sold under agreement to repurchase, short-term

 

 

9,330

 

 

(62,157)

 

Principal payments on long-term debt

 

 

(62)

 

 

(62)

 

Cash dividends paid

 

 

(5,319)

 

 

(5,312)

 

Increase in deferred compensation arrangements

 

 

215

 

 

176

 

Repurchased restricted stock to pay taxes on vested awards

 

 

 —

 

 

(82)

 

Tax benefit from exercise of stock options and distribution of shares in deferred compensation arrangements

 

 

(100)

 

 

6

 

Net cash provided by financing activities

 

 

82,765

 

 

(86,926)

 

Increase (decrease) in cash and cash equivalents

 

 

(43,000)

 

 

4,186

 

Cash and cash equivalents beginning of period

 

 

154,459

 

 

115,471

 

Cash and cash equivalents end of period

 

$

111,459

 

$

119,657

 

 

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

 

 

 

 

 

 

 

Total interest payments

 

$

3,079

 

$

3,523

 

SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES

 

 

 

 

 

 

 

Distribution of stock under deferred compensation arrangements

 

$

514

 

$

553

 

Non-cash exercise of stock options

 

 

626

 

 

124

 

Transfer of securities from available for sale to held to maturity

 

 

 —

 

 

12,626

 

 

See accompanying notes to consolidated financial statements

6


 

Notes To Interim Unaudited Consolidated Financial Statements  

 

For additional information, see the Merchants Bancshares, Inc. (“Merchants,” “we,” “us,” “our”) Annual Report on Form 10-K for the fiscal year ended December 31, 2014, filed with the Securities and Exchange Commission (the “SEC”) on March 13, 2015.

 

NOTE 1: FINANCIAL STATEMENT PRESENTATION

 

Basis of Presentation

 

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and the instructions to the Quarterly Report on Form 10-Q and Rule 10-01 of Regulation S-X promulgated under the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. All adjustments necessary for a fair presentation of our interim consolidated financial statements as of September 30, 2015 and December 31, 2014 and for the three and nine months ended September 30, 2015 and 2014 have been included. The information was prepared from our unaudited financial statements and the unaudited financial statements of our subsidiaries, Merchants Bank and MBVT Statutory Trust I.  Amounts reported for prior periods are reclassified, where necessary, to be consistent with the current period presentation. 

 

Management’s Use of Estimates in Preparation of Financial Statements 

 

The preparation of financial statements in conformity with GAAP requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of income and expenses during the reporting periods. The most significant estimates include those used in determining the allowance for credit losses, income taxes, interest income recognition on loans and investments and analysis of other-than-temporary impairment of our investment securities portfolio. Operating results in the future may vary from the amounts derived from Management's estimates and assumptions.

 

NOTE 2: RECENT ACCOUNTING PRONOUNCEMENTS

 

FASB ASC 810 - In February 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2015-02—Consolidation (Topic 810), Amendments to the Consolidation Analysis. The Update amends existing standards regarding the evaluation of certain legal entities and their consolidation in the financial statements. The amendments modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities or voting interest entities and eliminate the presumption that a general partner should consolidate a limited partnership. The amendments also affect the consolidation analysis of reporting entities that are involved with variable interest entities and provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. The guidance becomes effective for us on January 1, 2016 and we are evaluating the impact of this guidance on our financial statements.

 

FASB ASC 860 – In June 2014, the FASB issued an update (ASU No. 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures) impacting FASB ASC 860, Transfers and Servicing. The amendments in this update change the accounting for repurchase-to-maturity transactions and linked repurchase financings to secured borrowing accounting, which is consistent with the accounting for other repurchase agreements. The amendments also require new disclosures. An entity is required to disclose information on transfers accounted for as sales in transactions that are economically similar to repurchase agreements. An entity must also provide additional information about the types of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings. An entity is required to present changes in accounting for transactions outstanding on the effective date as a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. The amendments in this update became effective for interim and annual periods beginning after December 15, 2014 and did not have a material impact on the consolidated financial statements. See footnote 4 for details.

7


 

 

FASB ASC 606 - In May 2014 the FASB amended existing guidance related to revenue from contracts with customers. This amendment supersedes and replaces nearly all existing revenue recognition guidance, including industry-specific guidance, establishes a new control-based revenue recognition model, changes the basis for deciding when revenue is recognized over time or at a point in time, provides new and more detailed guidance on specific topics and expands and improves disclosures about revenue. In addition, this amendment specifies the accounting for some costs to obtain or fulfill a contract with a customer. These amendments are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. The amendments should be applied retrospectively to all periods presented or retrospectively with the cumulative effect recognized at the date of initial application. The Company is currently evaluating the impact of this new accounting standard on the consolidated financial statements.

 

NOTE 3: INVESTMENT SECURITIES

 

Investments in securities are classified as available for sale or held to maturity as of September 30, 2015 and December 31, 2014. The amortized cost and fair values of the securities classified as available for sale and held to maturity as of September 30, 2015 are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

 

    

Gross

    

Gross

    

 

 

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

Fair

 

(In thousands)

 

Cost

 

Gains

 

Losses

 

Value

 

Available for Sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury Obligations

 

$

25,060

 

$

284

 

$

 —

 

$

25,344

 

U.S. Government Sponsored Enterprises ("U.S. GSEs")

 

 

16,947

 

 

153

 

 

 —

 

 

17,100

 

Federal Home Loan Bank ("FHLB") Obligations

 

 

46,160

 

 

484

 

 

 —

 

 

46,644

 

Residential Real Estate Mortgage-backed Securities ("Agency MBSs")

 

 

101,396

 

 

2,371

 

 

66

 

 

103,701

 

Agency Commercial Mortgage Backed Securities ("Agency CMBSs")

 

 

25,432

 

 

104

 

 

16

 

 

25,520

 

Agency Collateralized Mortgage Obligations ("Agency CMOs")

 

 

63,014

 

 

460

 

 

70

 

 

63,404

 

Asset Backed Securities ("ABSs")

 

 

333

 

 

37

 

 

 —

 

 

370

 

Total Available for Sale

 

$

278,342

 

$

3,893

 

$

152

 

$

282,083

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

 

 

Gross

    

Gross

    

    

 

 

 

 

 

Amortized

 

Unrecognized

 

Unrecognized

 

Fair

 

 

 

 

Cost

 

Gains

 

Losses

 

Value

 

 

Held to Maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Agency Obligations

 

$

20,332

 

$

693

 

$

 —

 

$

21,025

 

 

U.S. GSEs

 

 

9,541

 

 

288

 

 

 —

 

 

9,829

 

 

FHLB Obligations

 

 

4,748

 

 

182

 

 

 —

 

 

4,930

 

 

Agency CMOs

 

 

82,038

 

 

714

 

 

168

 

 

82,584

 

 

Agency MBSs

 

 

7,270

 

 

237

 

 

 —

 

 

7,507

 

 

Total Held to Maturity

 

$

123,929

 

$

2,114

 

$

168

 

$

125,875

 

 

 

8


 

The amortized cost and fair values of the securities classified as available for sale and held to maturity as of December 31, 2014 are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

 

    

Gross

    

Gross

    

 

 

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

Fair

 

(In thousands)

 

Cost

 

Gains

 

Losses

 

Value

 

Available for Sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury Obligations

 

$

25,048

 

$

57

 

$

12

 

$

25,093

 

Agency MBSs

 

 

92,827

 

 

2,680

 

 

100

 

 

95,407

 

Agency CMBSs

 

 

22,056

 

 

20

 

 

372

 

 

21,704

 

Agency CMOs

 

 

60,880

 

 

241

 

 

239

 

 

60,882

 

ABSs

 

 

351

 

 

36

 

 

 —

 

 

387

 

Total Available for Sale

 

$

201,162

 

$

3,034

 

$

723

 

$

203,473

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

    

 

    

Gross

    

Gross

    

    

 

 

 

 

Amortized

Unrealized

 

Unrealized

 

Fair

 

 

 

Cost

Gains

 

Losses

 

Value

 

Held to Maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Agency Obligations (SBA's only)

 

$

22,072

 

$

597

 

$

 —

 

$

22,669

 

U.S. GSEs

 

 

9,498

 

 

59

 

 

 —

 

 

9,557

 

FHLB Obligations

 

 

4,720

 

 

100

 

 

 —

 

 

4,820

 

Agency CMOs

 

 

94,022

 

 

280

 

 

519

 

 

93,783

 

Agency MBSs

 

 

8,109

 

 

233

 

 

 —

 

 

8,342

 

Total Held to Maturity

 

$

138,421

 

$

1,269

 

$

519

 

$

139,171

 

 

The contractual final maturity distribution of the debt securities classified as available for sale as of September 30, 2015, are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

    

 

    

After One

    

After Five

    

    

 

    

    

 

 

 

 

Within

But Within

 

But Within

 

After Ten

 

 

 

 

(In thousands)

 

One Year

Five Years

 

Ten Years

 

Years

 

Total

 

Available for Sale (at fair value):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury Obligations

 

$

 —

 

$

25,344

 

$

 —

 

$

 —

 

$

25,344

 

U.S. GSEs

 

 

 —

 

 

11,080

 

 

6,020

 

 

 —

 

 

17,100

 

FHLB Obligations

 

 

 —

 

 

30,054

 

 

16,590

 

 

 —

 

 

46,644

 

Agency MBSs

 

 

50

 

 

3,506

 

 

33,916

 

 

66,229

 

 

103,701

 

Agency CMBSs

 

 

479

 

 

13,294

 

 

7,656

 

 

4,091

 

 

25,520

 

Agency CMOs

 

 

 —

 

 

 —

 

 

1,788

 

 

61,616

 

 

63,404

 

ABSs

 

 

 —

 

 

 —

 

 

 —

 

 

370

 

 

370

 

Total Available for Sale

 

$

529

 

$

83,278

 

$

65,970

 

$

132,306

 

$

282,083

 

Available for Sale (at amortized cost):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury Obligations

 

$

 —

 

$

25,060

 

$

 —

 

$

 —

 

$

25,060

 

U.S. GSEs

 

 

 —

 

 

10,951

 

 

5,996

 

 

 —

 

 

16,947

 

FHLB Obligations

 

 

 —

 

 

29,810

 

 

16,350

 

 

 —

 

 

46,160

 

Agency MBSs

 

 

50

 

 

3,421

 

 

33,343

 

 

64,582

 

 

101,396

 

Agency CMBSs

 

 

476

 

 

13,296

 

 

7,577

 

 

4,083

 

 

25,432

 

Agency CMOs

 

 

 —

 

 

 —

 

 

1,778

 

 

61,236

 

 

63,014

 

ABSs

 

 

 —

 

 

 —

 

 

 —

 

 

333

 

 

333

 

Total Available for Sale

 

$

526

 

$

82,538

 

$

65,044

 

$

130,234

 

$

278,342

 

 

9


 

The contractual final maturity distribution of the debt securities classified as held to maturity as of September 30, 2015, are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

    

 

    

After One

    

After Five

    

    

 

    

    

 

 

 

 

Within

But Within

 

But Within

 

After Ten

 

 

 

 

(In thousands)

 

One Year

Five Years

 

Ten Years

 

Years

 

Total

 

Held to Maturity (at fair value):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Agency Obligations

 

$

 —

 

$

 —

 

$

 —

 

$

21,025

 

$

21,025

 

U.S. GSEs

 

 

 —

 

 

 —

 

 

9,829

 

 

 —

 

 

9,829

 

FHLB Obligations

 

 

 —

 

 

 —

 

 

4,930

 

 

 —

 

 

4,930

 

Agency CMOs

 

 

 —

 

 

 —

 

 

 —

 

 

82,584

 

 

82,584

 

Agency MBSs

 

 

4

 

 

 —

 

 

99

 

 

7,404

 

 

7,507

 

Total Held to Maturity

 

$

4

 

$

 —

 

$

14,858

 

$

111,013

 

$

125,875

 

Held to Maturity (at amortized cost):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Agency Obligations

 

$

 —

 

$

 —

 

$

 —

 

$

20,332

 

$

20,332

 

U.S. GSEs

 

 

 —

 

 

 —

 

 

9,541

 

 

 —

 

 

9,541

 

FHLB Obligations

 

 

 —

 

 

 —

 

 

4,748

 

 

 —

 

 

4,748

 

Agency CMOs

 

 

 —

 

 

 —

 

 

 —

 

 

82,038

 

 

82,038

 

Agency MBSs

 

 

4

 

 

 —

 

 

86

 

 

7,180

 

 

7,270

 

Total Held to Maturity

 

$

4

 

$

 —

 

$

14,375

 

$

109,550

 

$

123,929

 

 

Actual maturities will differ from contractual maturities because borrowers may have rights to call or prepay obligations. Maturities of Agency MBSs and Agency CMOs in the tables above are based on final contractual maturities.

 

The following table presents the proceeds, gross gains and gross losses on available for sale securities for the three and nine months ended September 30, 2015 and 2014.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended 

 

Nine Months Ended 

 

 

 

September 30,

 

September 30,

 

(In thousands)

    

2015

    

2014

    

2015

 

2014

 

Proceeds

 

$

 —

 

$

11,674

 

$

 —

 

$

56,889

 

Gross gains

 

 

 —

 

 

 —

 

 

 —

 

 

302

 

Gross losses

 

 

 —

 

 

(37)

 

 

 —

 

 

(196)

 

Net gains (losses)

 

$

 —

 

$

(37)

 

$

 —

 

$

106

 

 

Securities with a carrying amount of $347.64 million and $317.22 million at September 30, 2015 and December 31, 2014, respectively, were pledged to secure U.S. Treasury borrowings, public deposits, securities sold under agreements to repurchase, and for other purposes required by law.

 

10


 

Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in continuous unrealized loss position, at September 30, 2015 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less Than 12 Months

 

12 Months or More

 

Total

 

 

 

Fair

 

 

 

 

Fair

 

 

 

 

Fair

 

 

 

 

(In thousands)

    

Value

    

Loss

    

Value

    

Loss

    

Value

    

Loss

 

Available for Sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury Obligations

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

U.S. GSEs

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

FHLB Obligations

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Agency MBSs

 

 

15,843

 

 

66

 

 

 —

 

 

 —

 

 

15,843

 

 

66

 

Agency CMBSs

 

 

 —

 

 

 —

 

 

4,839

 

 

16

 

 

4,839

 

 

16

 

Agency CMOs

 

 

7,138

 

 

20

 

 

6,532

 

 

50

 

 

13,670

 

 

70

 

ABSs

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Total Available for Sale

 

$

22,981

 

$

86

 

$

11,371

 

$

66

 

$

34,352

 

$

152

 

Held to Maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Agency Obligations

 

 

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

U.S. GSEs

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

FHLB Obligations

 

$

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Agency CMOs

 

 

7,342

 

 

113

 

 

5,673

 

 

55

 

 

13,015

 

 

168

 

Agency MBSs

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Total Held to Maturity

 

$

7,342

 

$

113

 

$

5,673

 

$

55

 

$

13,015

 

$

168

 

 

Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in continuous unrealized loss position over our entire holding period, at December 31, 2014, were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less Than 12 Months

 

12 Months or More

 

 

Total

 

 

 

 

Fair

 

 

 

 

 

Fair

 

 

 

 

 

Fair

 

 

 

 

(In thousands)

    

 

Value

    

 

Loss

    

 

Value

    

 

Loss

    

 

Value

    

 

Loss

 

Available for Sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury Obligations

 

$

5,080

 

$

12

 

$

 —

 

$

 —

 

$

5,080

 

$

12

 

Agency MBSs

 

 

7,893

 

 

23

 

 

10,763

 

 

77

 

 

18,656

 

 

100

 

Agency CMBSs

 

 

 —

 

 

 —

 

 

17,478

 

 

372

 

 

17,478

 

 

372

 

Agency CMOs

 

 

11,384

 

 

49

 

 

10,962

 

 

190

 

 

22,346

 

 

239

 

ABSs

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Total Available for Sale

 

$

24,357

 

$

84

 

$

39,203

 

$

639

 

$

63,560

 

$

723

 

Held to Maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Agency Obligations

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

U.S. GSEs

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

FHLB Obligations

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Agency CMOs

 

 

14,338

 

 

108

 

 

43,911

 

 

411

 

 

58,249

 

 

519

 

Agency MBSs

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Total Held to Maturity

 

$

14,338

 

$

108

 

$

43,911

 

$

411

 

$

58,249

 

$

519

 

 

 

There were no securities classified as trading at September 30, 2015 and December 31, 2014.

 

11


 

Unrealized losses on investment securities result from the cost basis of the security being higher than its current fair value. These discrepancies generally occur because of changes in interest rates since the time of purchase, or because the credit quality of the issuer has deteriorated. We perform a quarterly analysis of each security in our portfolio to determine if impairment exists, and if it does, whether that impairment is other-than-temporary.

 

At September 30, 2015, all of our Agency MBSs and Agency CMOs held were issued by U.S. government-sponsored entities and agencies, primarily the Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corp (“FHLMC”), institutions which the government has affirmed its commitment to support.  Because the decline in fair value is attributable to changes in interest rates, and not credit quality, and because we do not have the intent to sell these securities and it is not likely that we will be required to sell the securities before their anticipated recovery, we do not consider these securities to be other-than-temporarily impaired at September 30, 2015.

 

We use external pricing services to obtain fair market values for our investment portfolio.   We have obtained and reviewed the service providers’ pricing and reference data documentation. Evaluations are based on market data and vary by asset class and incorporate available trade, bid and other market information.  Because many fixed income securities do not trade on a daily basis, the service provider’s evaluated pricing applications apply available information as applicable through processes such as benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing, to prepare evaluations.  In addition, model processes, such as the Option Adjusted Spread model are used to assess interest rate impact and develop prepayment scenarios, with inputs determined based on knowledge of the market.  We periodically test the values provided to us by the pricing service by obtaining prices on all bonds from an alternative pricing source.

 

During the first quarter of 2014 and the third and fourth quarters of 2013, we transferred securities from available for sale to held to maturity.  The unrealized holding loss at the time of transfer continues to be reported in accumulated other comprehensive income, net of tax and is amortized over the remaining lives of the securities as an adjustment of the yield.  The amortization of the unamortized holding loss reported in accumulated other comprehensive income will offset the effect on interest income of the discount for the transferred securities.  The remaining unamortized balance of the losses for the securities transferred from available for sale to held to maturity from prior years was $3.74 million, or $2.43 million, net of tax at September 30, 2015.  

 

12


 

NOTE 4: REPURCHASE AGREEMENTS

 

The following table presents the contractual maturity of our secured borrowings and class of collateral pledged:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At September 30, 2015

 

 

 

Remaining Contractual Maturity of the Agreements

 

 

 

Overnight and

 

 

 

 

 

 

 

Greater Than

 

 

 

 

(dollars in thousands)

    

Continuous

    

Up to 30 Days

    

30-90 Days

    

90 Days

    

Total

 

Repurchase Agreements:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available for Sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury Obligations

 

$

24,649

 

$

 —

 

$

 —

 

$

 —

 

$

24,649

 

U.S. GSEs

 

 

15,451

 

 

 

 

 

 

 

 

 —

 

 

15,451

 

FHLB Obligations

 

 

42,278

 

 

 

 

 

 

 

 

 —

 

 

42,278

 

Agency MBSs

 

 

43,848

 

 

 

 

 

 

 

 

401

 

 

44,249

 

Agency CMBSs

 

 

14,008

 

 

 

 

 

 

 

 

 —

 

 

14,008

 

Agency CMOs

 

 

29,994

 

 

 

 

 

 

 

 

 —

 

 

29,994

 

Total Available for Sale

 

$

170,228

 

$

 —

 

$

 —

 

$

401

 

$

170,629

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Held to Maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Agency Obligations

 

$

13,953

 

$

 —

 

$

 —

 

$

 —

 

$

13,953

 

Agency CMOs

 

 

64,519

 

 

 —

 

 

 —

 

 

 —

 

 

64,519

 

Agency MBSs

 

 

18,694

 

 

 —

 

 

 —

 

 

 —

 

 

18,694

 

Total Held to Maturity

 

$

97,166

 

$

 —

 

$

 —

 

$

 —

 

$

97,166

 

 

The fair value of securities pledged to secure repurchase agreements may decline. The Company manages this risk by having a policy to pledge securities valued at 100% above the gross outstanding balance of repurchase agreements.

 

NOTE 5: LOANS AND THE ALLOWANCE FOR CREDIT LOSSES

 

The composition of our loan portfolio at September 30, 2015 and December 31, 2014 was as follows:

 

 

 

 

 

 

 

 

 

(In thousands)

    

September 30, 2015

    

December 31, 2014

 

Commercial, financial and agricultural

 

$

207,067

 

$

177,597

 

Municipal loans

 

 

108,423

 

 

94,366

 

Real estate loans – residential

 

 

448,632

 

 

469,529

 

Real estate loans – commercial

 

 

450,673

 

 

412,447

 

Real estate loans – construction

 

 

40,748

 

 

23,858

 

Installment loans

 

 

2,370

 

 

4,504

 

All other loans

 

 

19

 

 

33

 

Total loans

 

$

1,257,932

 

$

1,182,334

 

 

We primarily originate residential real estate, commercial, commercial real estate, and municipal obligations to customers throughout the state of Vermont. There are no significant industry concentrations in the loan portfolio. Total loans in the table above included $802 thousand and $734 thousand of net deferred loan origination costs at September 30, 2015 and December 31, 2014, respectively. The aggregate amount of overdrawn deposit balances classified as loan balances was $323 thousand and $235 thousand at September 30, 2015 and December 31, 2014, respectively.

 

13


 

The following table reflects our loan loss experience and activity in the allowance for credit losses by portfolio segment for the three months ended September 30, 2015:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Commercial,

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

financial

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and

 

 

 

 

Real estate-

 

Real estate-

 

Real estate-

 

 

 

 

 

 

 

 

 

 

(In thousands)

 

agricultural

 

Municipal

 

residential

 

commercial

 

construction

 

Installment

 

All other

 

Totals

 

Allowance for credit losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

3,450

 

 

369

 

 

3,126

 

 

5,354

 

 

533

 

 

59

 

 

 —

 

$

12,891

 

Charge-offs

 

 

(11)

 

 

 —

 

 

(29)

 

 

 —

 

 

 —

 

 

(22)

 

 

 —

 

 

(62)

 

Recoveries

 

 

3

 

 

 —

 

 

7

 

 

1

 

 

 —

 

 

8

 

 

 —

 

 

19

 

Provision (credit)

 

 

(51)

 

 

291

 

 

(65)

 

 

(47)

 

 

11

 

 

11

 

 

 —

 

 

150

 

Ending balance

 

$

3,391

 

$

660

 

$

3,039

 

$

5,308

 

$

544

 

$

56

 

$

 —

 

$

12,998

 

 

The following table reflects our loan loss experience and activity in the allowance for credit losses by portfolio segment for the three months ended September 30, 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Commercial,

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

financial

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and

 

 

 

 

Real estate-

 

Real estate-

 

Real estate-

 

 

 

 

 

 

 

 

 

 

(In thousands)

 

agricultural

 

Municipal 

 

residential

 

commercial

 

construction

 

Installment

 

All other 

 

Totals

 

Allowance for credit losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

3,656

 

$

386

 

$

3,246

 

$

5,089

 

$

494

 

$

18

 

$

17

 

$

12,906

 

Charge-offs

 

 

 —

 

 

 —

 

 

(7)

 

 

 —

 

 

 —

 

 

 —

 

 

(48)

 

 

(55)

 

Recoveries

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

7

 

 

7

 

Provision (credit)

 

 

(253)

 

 

316

 

 

42

 

 

(45)

 

 

(94)

 

 

(2)

 

 

36

 

 

 —

 

Ending balance

 

$

3,403

 

$

702

 

$

3,281

 

$

5,044

 

$

400

 

$

16

 

$

12

 

$

12,858

 

 

The following table reflects our loan loss experience and activity in the allowance for credit losses by portfolio segment for the nine months ended September 30, 2015:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Commercial,

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

financial

 

 

 

 

Real

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and

 

 

 

 

estate-

 

Real estate-

 

Real estate

 

 

 

 

 

 

 

 

 

 

(In thousands)

 

agricultural

 

Municipal

 

residential

 

commercial

 

construction

 

Installment

 

All other 

 

Totals

 

Allowance for credit losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

3,331

 

$

636

 

$

3,127

 

$

5,251

 

$

415

 

$

13

 

$

42

 

$

12,815

 

Charge-offs

 

 

(28)

 

 

 —

 

 

(84)

 

 

 —

 

 

 —

 

 

(65)

 

 

 —

 

 

(177)

 

Recoveries

 

 

31

 

 

 —

 

 

36

 

 

2

 

 

 —

 

 

41

 

 

 —

 

 

110

 

Provision (credit)

 

 

57

 

 

24

 

 

(40)

 

 

55

 

 

129

 

 

67

 

 

(42)

 

 

250

 

Ending balance

 

$

3,391

 

$

660

 

$

3,039

 

$

5,308

 

$

544

 

$

56

 

$

 —

 

$

12,998

 

 

14


 

The following table reflects our loan loss experience and activity in the allowance for credit losses by portfolio segment for the nine months ended September 30, 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Commercial,

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

financial and

 

 

 

 

Real estate-

 

Real estate-

 

Real estate-

 

 

 

 

 

 

 

 

 

 

(In thousands)

 

agricultural

 

Municipal

 

residential

 

commercial

 

construction

 

Installment

 

All Other

 

Total

 

Allowance for credit losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

3,354

 

$

768

 

$

3,081

 

$

5,085

 

$

512

 

$

18

 

$

10

 

$

12,828

 

Charge-offs

 

 

(34)

 

 

 —

 

 

(25)

 

 

 —

 

 

 —

 

 

 —

 

 

(99)

 

 

(158)

 

Recoveries

 

 

3

 

 

 —

 

 

20

 

 

 —

 

 

 —

 

 

1

 

 

14

 

 

38

 

Provision (credit)

 

 

80

 

 

(66)

 

 

205

 

 

(41)

 

 

(112)

 

 

(3)

 

 

87

 

 

150

 

Ending balance

 

$

3,403

 

$

702

 

$

3,281

 

$

5,044

 

$

400

 

$

16

 

$

12

 

$

12,858

 

 

The allowance for credit losses consists of the allowance for loan losses and the reserve for undisbursed lines and letters of credit. The reserve for undisbursed lines and letters of credit is included in other liabilities on the balance sheet. The following presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based upon impairment method at September 30, 2015:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Commercial,

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

financial and

 

 

 

 

Real estate-

 

Real estate-

 

Real estate-

 

 

 

 

 

 

 

 

 

 

(In thousands)

 

agricultural

 

Municipal 

 

residential

 

commercial

 

construction

 

Installment 

 

All other 

 

Totals

 

Allowance for credit losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance individually evaluated for impairment

 

$

 —

 

$

 —

 

$

139

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

139

 

Ending balance collectively evaluated for impairment

 

 

3,391

 

 

660

 

 

2,900

 

 

5,308

 

 

544

 

 

56

 

 

 —

 

 

12,859

 

Totals

 

$

3,391

 

$

660

 

$

3,039

 

$

5,308

 

$

544

 

$

56

 

$

 —

 

$

12,998

 

Financing receivables:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance individually evaluated for impairment

 

$

566

 

$

 —

 

$

838

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

1,404

 

Ending balance collectively evaluated for impairment

 

 

206,501

 

 

108,423

 

 

447,794

 

 

450,673

 

 

40,748

 

 

2,370

 

 

19

 

 

1,256,528

 

Totals

 

$

207,067

 

$

108,423

 

$

448,632

 

$

450,673

 

$

40,748

 

$

2,370

 

$

19

 

$

1,257,932

 

Components:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses

 

$

2,833

 

$

631

 

$

2,959

 

$

5,238

 

$

493

 

$

56

 

$

 —

 

$

12,210

 

Reserve for undisbursed lines of credit

 

 

558

 

 

29

 

 

80

 

 

70

 

 

51

 

 

 —

 

 

 —

 

 

788

 

Total allowance for credit losses

 

$

3,391

 

$

660

 

$

3,039

 

$

5,308

 

$

544

 

$

56

 

$

 —

 

$

12,998

 

 

15


 

The following presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based upon impairment method at December 31, 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Commercial,

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

financial and

 

 

 

 

Real estate-

 

Real estate-

 

Real estate-

 

 

 

 

 

 

 

 

 

 

(In thousands)

 

agricultural

 

Municipal 

 

residential

 

commercial

 

construction

 

Installment 

 

All other 

 

Totals

 

Allowance for credit losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance individually evaluated for impairment

 

$

 —

 

$

 —

 

$

63

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

63

 

Ending balance collectively evaluated for impairment

 

 

3,331

 

 

636

 

 

3,064

 

 

5,251

 

 

415

 

 

13

 

 

42

 

 

12,752

 

Totals

 

$

3,331

 

$

636

 

$

3,127

 

$

5,251

 

$

415

 

$

13

 

$

42

 

$

12,815

 

Financing receivables:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance individually evaluated for impairment

 

$

134

 

$

 —

 

$

657

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

791

 

Ending balance collectively evaluated for impairment

 

 

177,463

 

 

94,366

 

 

468,872

 

 

412,447

 

 

23,858

 

 

4,504

 

 

33

 

 

1,181,543

 

Totals

 

$

177,597

 

$

94,366

 

$

469,529

 

$

412,447

 

$

23,858

 

$

4,504

 

$

33

 

$

1,182,334

 

Components:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses

 

$

2,583

 

$

623

 

$

3,038

 

$

5,209

 

$

325

 

$

13

 

$

42

 

$

11,833

 

Reserve for undisbursed lines of credit

 

 

748

 

 

13

 

 

89

 

 

42

 

 

90

 

 

 —

 

 

 —

 

 

982

 

Total allowance for credit losses

 

$

3,331

 

$

636

 

$

3,127

 

$

5,251

 

$

415

 

$

13

 

$

42

 

$

12,815

 

 

The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors.  The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by us over the most recent 5 years.  This actual loss experience is supplemented with other factors based on the risks present for each portfolio segment.  These factors include consideration of the following:  levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. Due to the added risks associated with loans which are graded as pass-watch, special mention, and substandard that are not classified as impaired, an additional analysis is performed to determine whether an allowance is needed that is not fully captured by the historical loss experience. While historical loss experience by loan segment and migration of loans into higher risk classifications are considered, the following factors are also considered in determining the level of needed allowance on such loans: the historical loss rates of loans specifically classified as pass-watch, special mention, or substandard; and the trends in the collateral on the loans included within these classifications. This analysis created an additional $664 thousand at September 30, 2015 compared to $1.23 million at December 31, 2014 in needed allowance for loan loss.

 

16


 

The table below presents the recorded investment of loans, including nonaccrual and restructured loans, segregated by class, with delinquency aging as of September 30, 2015:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

    

 

    

    

 

    

91 Days or

 

 

 

 

 

 

 

 

 

91 Days or

 

 

 

 

 

 

 

 

 

 

more past

 

 

 

31-60 Days

 

61-90 Days

 

More

 

Total Past

 

 

 

 

 

 

 

due and

 

(In thousands)

 

Past Due

 

Past Due

 

Past Due

 

Due

 

Current

 

Total

 

Accruing

 

Commercial, financial and agricultural

 

$

38

 

 

 —

 

 

 —

 

$

38

 

$

207,029

 

$

207,067

 

$

 —

 

Municipal

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

108,423

 

 

108,423

 

 

 —

 

Real estate-residential:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First mortgage

 

 

167

 

 

 —

 

 

587

 

 

754

 

 

413,328

 

 

414,082

 

 

 —

 

Second mortgage

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

34,550

 

 

34,550

 

 

 —

 

Real estate-commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Owner occupied

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

178,995

 

 

178,995

 

 

 —

 

Non-owner occupied

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

271,678

 

 

271,678

 

 

 —

 

Real estate-construction:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

2,118

 

 

2,118

 

 

 —

 

Commercial

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

38,630

 

 

38,630

 

 

 —

 

Installment

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

2,370

 

 

2,370

 

 

 —

 

Other

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

19

 

 

19

 

 

 —

 

Total

 

$

205

 

$

 —

 

$

587

 

$

792

 

$

1,257,140

 

$

1,257,932

 

$

 —

 

 

Of the total past due loans in the aging table above, $628 thousand are non-performing of which $0 are restructured loans and $0 were greater than 91 days past due and accruing.  There was a $164 thousand past due performing loan at September 30, 2015.

 

The table below presents the recorded investment of loans, including nonaccrual and restructured loans, segregated by class, with delinquency aging as of December 31, 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

    

 

    

    

 

    

91 Days or

 

 

 

 

 

 

 

 

 

91 Days or

 

 

 

 

 

 

 

 

 

 

more past

 

 

 

31-60 Days

 

61-90 Days

 

More

 

Total Past

 

 

 

 

 

 

 

due and

 

(In thousands)

 

Past Due

 

Past Due

 

Past Due

 

Due

 

Current

 

Total

 

Accruing

 

Commercial, financial and agricultural

 

$

49

 

$

 —

 

$

 —

 

$

49

 

$

177,548

 

$

177,597

 

$

 —

 

Municipal

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

94,366

 

 

94,366

 

 

 —

 

Real estate-residential:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First mortgage

 

 

157

 

 

 —

 

 

391

 

 

548

 

 

431,191

 

 

431,739

 

 

 —

 

Second mortgage

 

 

33

 

 

 —

 

 

79

 

 

112

 

 

37,678

 

 

37,790

 

 

 —

 

Real estate-commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Owner occupied

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

179,851

 

 

179,851

 

 

 —

 

Non-owner occupied

 

 

202

 

 

22

 

 

 —

 

 

224

 

 

232,372

 

 

232,596

 

 

 —

 

Real estate-construction:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

4,131

 

 

4,131

 

 

 —

 

Commercial

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

19,727

 

 

19,727

 

 

 —

 

Installment

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

4,504

 

 

4,504

 

 

 —

 

Other

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

33

 

 

33

 

 

 —

 

Total

 

$

441

 

$

22

 

$

470

 

$

933

 

$

1,181,401

 

$

1,182,334

 

$

 —

 

 

Of the total past due loans in the aging table above, $519 thousand are non-performing, of which $0 are restructured loans and $0 are greater than 91 days past due and accruing.  There were $414 thousand past due performing loans at December 31, 2014.

 

17


 

Impaired loans by class at September 30, 2015 and average balance for the three and nine months ended September 30, 2015 are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended 

 

 

Nine Months Ended 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2015

 

 

September 30, 2015

 

 

 

 

 

Unpaid

 

 

 

 

 

Average

 

 

 

Average

 

 

 

Recorded

 

Principal

 

Related

 

 

Recorded

 

 

 

Recorded

 

(In thousands)

    

Investment

    

Balance

    

Allowance

    

 

Investment

    

    

 

Investment

    

With no related allowance recorded

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, financial and agricultural

 

$

566

 

$

572

 

$

 —

 

$

571

 

 

$

303

 

Residential:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First mortgage

 

 

457

 

 

543

 

 

 —

 

 

293

 

 

 

200

 

Second mortgage

 

 

 —

 

 

 —

 

 

 —

 

 

52

 

 

 

70

 

Commercial Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Owner occupied

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 

 —

 

Non-owner occupied

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 

3

 

Construction:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 

 —

 

Commercial

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 

 —

 

Installment

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 

 —

 

With related allowance recorded

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, financial and agricultural

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 

166

 

Residential:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First mortgage

 

 

381

 

 

383

 

 

139

 

 

541

 

 

 

497

 

Second mortgage

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 

6

 

Commercial Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Owner occupied

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 

 —

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, financial and agricultural

 

 

566

 

 

572

 

 

 —

 

 

571

 

 

 

469

 

Residential:

 

 

838

 

 

926

 

 

139

 

 

886

 

 

 

773

 

Commercial Real Estate:

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 

3

 

Construction

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 

 —

 

Installment

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 

 —

 

Total

 

$

1,404

 

$

1,498

 

$

139

 

$

1,457

 

 

$

1,245

 

 

18


 

Impaired loans by class at December 31, 2014 and average balance for the three and nine months ended September 30, 2014 are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended 

 

Nine Months Ended 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2014

 

September 30, 2014

 

 

 

 

 

Unpaid

 

 

 

 

Average

 

 

Average

 

 

 

Recorded

 

Principal

 

Related

 

Recorded

 

 

Recorded

 

(In thousands)

    

Investment

    

Balance

    

Allowance

    

Investment

    

    

Investment

    

With no related allowance recorded

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, financial and agricultural

 

$

134

 

$

136

 

$

 —

 

$

66

 

 

$

65

 

Residential:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First mortgage

 

 

147

 

 

257

 

 

 —

 

 

283

 

 

 

284

 

Second mortgage

 

 

79

 

 

79

 

 

 —

 

 

131

 

 

 

156

 

Commercial Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Owner occupied

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 

17

 

Installment

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 

 —

 

With related allowance recorded

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, financial and agricultural

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 

16

 

Residential:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First mortgage

 

 

431

 

 

432

 

 

63

 

 

190

 

 

 

189

 

Second mortgage

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 

 —

 

Commercial Real Estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Owner occupied

 

 

 —

 

 

 —

 

 

 —

 

 

156

 

 

 

159

 

Installment

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 

 —

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, financial and agricultural

 

 

134

 

 

136

 

 

 —

 

 

66

 

 

 

81

 

Residential:

 

 

657

 

 

768

 

 

63

 

 

604

 

 

 

629

 

Commercial Real Estate:

 

 

 —

 

 

 —

 

 

 —

 

 

156

 

 

 

176

 

Installment

 

 

 —

 

 

 —

 

 

 —

 

 

-  

 

 

 

 —

 

Total

 

$

791

 

$

904

 

$

63

 

$

826

 

 

$

886

 

 

Residential and commercial loans serviced for others at September 30, 2015 and December 31, 2014 amounted to approximately $14.44 million and $13.53 million, respectively.

 

Nonperforming loans at September 30, 2015 and December 31, 2014 are as follows:

 

 

 

 

 

 

 

 

 

(In thousands)

    

September 30, 2015

    

December 31, 2014

 

Nonaccrual  loans

 

$

713

 

$

598

 

Loans greater than 90 days and accruing

 

 

 —

 

 

 —

 

Troubled debt restructurings ("TDRs")

 

 

691

 

 

193

 

Total nonperforming loans

 

$

1,404

 

$

791

 

 

Of the total TDRs in the table above, $51 thousand at September 30, 2015 and $63 thousand at December 31, 2014 were nonaccruing. We have reviewed all restructurings that occurred on or after January 1, 2015 for identification as TDRs. Loans with a balance of $88 thousand and $0 thousand were restructured during the three months ended September 30, 2015 and September 30, 2014, respectively and considered to be TDRs. Loans with a balance of $559 thousand were restructured during the nine months ended September 30, 2015 as compared to loan balances of $113 thousand for the nine months ended September 30, 2014 and considered to be TDRs.

 

TDRs represent balances where the existing loan was modified involving a concession in rate, term or payment amount due to the distressed financial condition of the borrower. All TDRs at September 30, 2015 continue to pay as agreed according to the modified terms and four of the six TDRs are considered well-secured.  At September 30, 2015, there were no commitments to lend additional funds to borrowers whose loans have been modified in a TDR. We had no commitments to lend additional funds to borrowers whose loans were in nonaccrual status or to borrowers whose loans were 91 days

19


 

past due and still accruing at September 30, 2015. Interest income on restructured loans during the three and nine months ended September 30, 2015 and 2014 was insignificant.

 

Nonaccrual loans by class as of September 30, 2015 and December 31, 2014 are as follows:

 

 

 

 

 

 

 

 

 

(In thousands)

    

September 30, 2015

    

December 31, 2014

 

Commercial, financial and agricultural

 

$

6

 

$

88

 

Real estate - residential:

 

 

 

 

 

 

 

First mortgage

 

 

707

 

 

431

 

Second mortgage

 

 

 —

 

 

79

 

Real estate - commercial:

 

 

 

 

 

 

 

Owner occupied

 

 

 —

 

 

 —

 

Non owner occupied

 

 

 —

 

 

 —

 

Installment

 

 

 —

 

 

 —

 

Total nonaccruing non-TDR loans

 

$

713

 

$

598

 

Nonaccruing TDR’s

 

 

 

 

 

 

 

Commercial, financial and agricultural

 

 

2

 

 

5

 

Real estate – residential:

 

 

 

 

 

 

 

First mortgage

 

 

49

 

 

58

 

Real estate - commercial:

 

 

 

 

 

 

 

Owner occupied

 

 

 —

 

 

 —

 

Total nonaccrual loans including TDRs

 

$

764

 

$

661

 

 

Commercial Grading System

 

We use risk rating definitions for our commercial loan portfolios and certain residential loans which are generally consistent with regulatory and banking industry norms. Loans are assigned a credit quality grade which is based upon Management’s on going assessment of risk based upon an evaluation of the quantitative and qualitative aspects of each credit. This assessment is a dynamic process and risk ratings are adjusted as each borrower’s financial situation changes. This process is designed to provide timely recognition of a borrower’s financial condition and appropriately focus Management resources.

 

Pass rated loans exhibit acceptable risk to the bank in terms of financial capacity to repay the loan as well as possessing acceptable fallback repayment sources, typically collateral and personal guarantees. Pass rated commercial loan relationships with a total exposure of $1 million or greater are subject to a formal annual review process; additionally, Management reviews the risk rating at the time of any late payments, overdrafts or other sign of deterioration in the interim.

 

Loans rated Pass-Watch require more than usual attention and monitoring by the account officer, though not to the extent that a formal remediation plan is warranted. Borrowers can be rated Pass-Watch based upon a weakened capital structure, marginally adequate cash flow and/or collateral coverage or early-stage declining trends in operations or financial condition.

 

Loans rated Special Mention possess potential weakness that may expose the bank to some risk of loss in the future. These loans require more frequent monitoring and formal reporting to Management.

 

Substandard loans reflect well-defined weaknesses in the current repayment capacity, collateral or net worth of the borrower with the possibility of some loss to the bank if these weaknesses are not corrected. Action plans are required for these loans to address the inherent weakness in the credit and are formally reviewed.

 

Residential Real Estate and Consumer Loans

 

We do not use a grading system for our performing residential real estate and consumer loans. Credit quality for these loans is based on performance and payment status.

 

20


 

Below is a summary of loans by credit quality indicator as of September 30, 2015:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

    

 

    

    

 

    

Pass-

    

Special

    

Sub- 

    

    

 

(In thousands)

 

Unrated

 

Pass

 

Watch

 

Mention

 

Standard

 

Total

 

Commercial, financial and agricultural

 

$

369

 

 

173,855

 

 

18,151

 

 

4,211

 

 

10,481

 

$

207,067

 

Municipal

 

 

69

 

 

95,495

 

 

10,991

 

 

1,868

 

 

 —

 

 

108,423

 

Real estate – residential:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First mortgage

 

 

411,221

 

 

2,015

 

 

166

 

 

 —

 

 

680

 

 

414,082

 

Second mortgage

 

 

34,550

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

34,550

 

Real estate – commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Owner occupied

 

 

129

 

 

147,644

 

 

14,236

 

 

3,583

 

 

13,403

 

 

178,995

 

Non-owner occupied

 

 

167

 

 

252,110

 

 

15,670

 

 

2,140

 

 

1,591

 

 

271,678

 

Real estate – construction:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential

 

 

51

 

 

2,067

 

 

 —

 

 

 —

 

 

 —

 

 

2,118

 

Commercial

 

 

172

 

 

34,147

 

 

2,474

 

 

 —

 

 

1,837

 

 

38,630

 

Installment

 

 

2,370

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

2,370

 

All other loans

 

 

19

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

19

 

Total

 

$

449,117

 

$

707,333

 

$

61,688

 

$

11,802

 

$

27,992

 

$

1,257,932

 

 

Below is a summary of loans by credit quality indicator as of December 31, 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

    

 

    

    

 

    

Pass-

    

Special

    

Sub- 

    

    

 

 

(In thousands)

 

Unrated

Pass

Watch

 

Mention

 

Standard

 

Total

 

Commercial, financial and agricultural

 

$

352

 

$

143,813

 

$

21,563

 

$

3,942

 

$

7,927

 

$

177,597

 

Municipal

 

 

40

 

 

75,337

 

 

17,101

 

 

1,888

 

 

 —

 

 

94,366

 

Real estate – residential:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First mortgage

 

 

428,073

 

 

3,046

 

 

170

 

 

 —

 

 

450

 

 

431,739

 

Second mortgage

 

 

37,790

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

37,790

 

Real estate – commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Owner occupied

 

 

127

 

 

142,741

 

 

17,136

 

 

1,378

 

 

18,469

 

 

179,851

 

Non-owner occupied

 

 

249

 

 

208,128

 

 

22,345

 

 

 —

 

 

1,874

 

 

232,596

 

Real estate – construction:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential

 

 

288

 

 

3,843

 

 

 —

 

 

 —

 

 

 —

 

 

4,131

 

Commercial

 

 

170

 

 

17,588

 

 

40

 

 

 —

 

 

1,929

 

 

19,727

 

Installment

 

 

4,504

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

4,504

 

All other loans

 

 

33

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

33

 

Total

 

$

471,626

 

$

594,496

 

$

78,355

 

$

7,208

 

$

30,649

 

$

1,182,334

 

 

 

 

NOTE 6: FAIR VALUE

 

We record certain assets and liabilities at fair value.  Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Fair value measurements are also utilized to determine the initial value of certain assets and liabilities, to perform impairment assessments, and for disclosure purposes. We use quoted market prices and observable inputs to the maximum extent possible when measuring fair value.  In the absence of quoted market prices, various valuation techniques are utilized to measure fair value.  When possible, observable market data for identical or similar financial instruments are used in the valuation.  When market data is not available, fair value is determined using valuation models that incorporate Management’s estimates of the assumptions a market participant would use in pricing the asset or liability.

 

Our valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While Management believes our valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein.  A more detailed description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

21


 

 

The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:

 

Ø

Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

 

Ø

Level 2 - Quoted prices for similar assets or liabilities in active markets, quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability.

 

Ø

Level 3 - Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported by little or no market activity).

 

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

 

The types of instruments valued based on quoted market prices in active markets include most U.S. government and agency securities, liquid mortgage products, active listed equities and most money market securities. Such instruments are generally classified within Level 1 or Level 2 of the fair value hierarchy. We do not adjust the quoted price for such instruments.

 

The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include most investment-grade and high-yield corporate bonds; less liquid mortgage products, agency securities, listed equities, state, municipal and provincial obligations; and certain physical commodities. Such instruments are generally classified within Level 2 of the fair value hierarchy.

 

Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions; valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, Management’s best estimate will be used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Subsequent to inception, Management only changes Level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows.

 

22


 

Financial instruments on a recurring basis

 

The table below presents the balance of financial assets and liabilities at September 30, 2015 measured at fair value on a recurring basis:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

 

    

    

 

    

Quoted Prices in

    

 

    

 

 

 

 

 

 

 

Active Markets for

 

Significant Other

 

Significant

 

 

 

 

 

 

Identical Assets

 

Observable Inputs

 

Unobservable Inputs

 

(In thousands)

 

Total

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Assets

    

 

    

    

 

    

    

 

    

    

 

    

 

U.S. Treasury Obligations

 

$

25,344

 

$

 —

 

$

25,344

 

$

 —

 

U.S. GSEs

 

 

17,100

 

 

 —

 

 

17,100

 

 

 —

 

FHLB Obligations

 

 

46,644

 

 

 —

 

 

46,644

 

 

 —

 

Agency MBSs

 

 

103,701

 

 

 —

 

 

103,701

 

 

 —

 

Agency CMBSs

 

 

25,520

 

 

 —

 

 

25,520

 

 

 —

 

Agency CMOs

 

 

63,404

 

 

 —

 

 

63,404

 

 

 —

 

ABSs

 

 

370

 

 

 —

 

 

370

 

 

 —

 

Interest rate swap agreements

 

 

1,363

 

 

 —

 

 

1,363

 

 

 —

 

Total assets

 

$

283,446

 

$

 —

 

$

283,446

 

$

 —

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swap agreements

 

 

1,313

 

 

 —

 

 

1,313

 

 

 —

 

Total liabilities

 

$

1,313

 

$

 —

 

$

1,313

 

$

 —

 

 

 

The table below presents the balance of financial assets and liabilities at December 31, 2014 measured at fair value on a recurring basis:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

 

    

    

 

    

Quoted Prices in

    

 

 

    

 

 

 

 

 

 

 

 

Active Markets for

 

Significant Other

 

Significant

 

 

 

 

 

 

Identical Assets

 

Observable Inputs

 

Unobservable Inputs

 

(In thousands)

 

Total

 

 (Level 1)

 

(Level 2)

 

(Level 3)

 

Assets

    

 

    

    

 

    

    

 

    

    

 

    

 

U.S. Treasury Obligations

 

$

25,093

 

$

 —

 

$

25,093

 

$

 —

 

Agency MBSs

 

 

95,407

 

 

 —

 

 

95,407

 

 

 —

 

Agency CMBSs

 

 

21,704

 

 

 —

 

 

21,704

 

 

 —

 

Agency CMOs

 

 

60,882

 

 

 —

 

 

60,882

 

 

 —

 

ABSs

 

 

387

 

 

 —

 

 

387

 

 

 —

 

Interest rate swap agreements

 

 

618

 

 

 —

 

 

618

 

 

 —

 

Total assets

 

$

204,091

 

$

 —

 

$

204,091

 

$

 —

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swap agreements

 

 

1,096

 

 

 —

 

 

1,096

 

 

 —

 

Total liabilities

 

$

1,096

 

$

 —

 

$

1,096

 

$

 —

 

 

Investment securities are reported at fair value utilizing Level 2 inputs. The prices for these instruments are obtained through an independent pricing service or dealer market participant with whom we have historically transacted both purchases and sales of investment securities. Prices obtained from these sources include market quotations and matrix pricing. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.  More information regarding our investment securities can be found in Note 3 to these consolidated financial statements.

 

The interest rate swaps are reported at their fair value utilizing Level 2 inputs from third parties. The fair value of our interest rate swaps are determined using prices obtained from a third party advisor.  The fair value measurement of the interest rate swap is determined by netting the discounted future fixed cash payments and the discounted expected variable cash receipts.  The variable cash receipts are based on the expectation of future interest rates derived from observed market interest rate curves.

23


 

 

There were no transfers between Level 1 and Level 2 for the nine months ended September 30, 2015 and 2014.  There were no Level 3 assets measured at fair value on a recurring basis at September 30, 2015 or December 31, 2014.

 

Financial instruments on a non-recurring basis

 

Certain financial assets are also measured at fair value on a non-recurring basis; however, they were not material at September 30, 2015 or December 31, 2014. These financial assets include impaired loans and OREO.

 

The table below presents the balance of financial instruments by class at September 30, 2015 measured at fair value:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Carrying

    

    

 

    

    

 

    

    

 

    

    

 

 

(In thousands)

 

Amount

 

Fair Value

 

Level 1

 

Level 2

 

Level 3

 

Cash and cash equivalents

 

$

111,459

 

$

111,459

 

$

111,459

 

$

 —

 

$

 —

 

Securities available for sale

 

 

282,083

 

 

282,083

 

 

 —

 

 

282,083

 

 

 —

 

Securities held to maturity

 

 

123,929

 

 

125,875

 

 

 —

 

 

125,875

 

 

 —

 

FHLB stock

 

 

4,378

 

 

N/A

 

 

N/A

 

 

N/A

 

 

N/A

 

Loans, net of allowance for loan losses

 

 

1,245,722

 

 

1,251,043

 

 

 —

 

 

 —

 

 

1,251,043

 

Interest rate swap agreement

 

 

1,363

 

 

1,363

 

 

 —

 

 

1,363

 

 

 —

 

Accrued interest receivable

 

 

3,676

 

 

3,676

 

 

 —

 

 

1,063

 

 

2,613

 

Total

 

$

1,772,610

 

$

1,775,499

 

$

111,459

 

$

410,384

 

$

1,253,656

 

Deposits

 

$

1,387,473

 

$

1,387,239

 

$

1,195,295

 

$

191,944

 

$

 —

 

Securities sold under agreement to repurchase

 

 

267,794

 

 

267,763

 

 

 —

 

 

267,763

 

 

 —

 

Other long-term debt

 

 

2,258

 

 

2,234

 

 

 —

 

 

2,234

 

 

 —

 

Junior subordinated debentures issued to unconsolidated subsidiary trust

 

 

20,619

 

 

15,219

 

 

 —

 

 

15,219

 

 

 —

 

Interest rate swap agreement

 

 

1,313

 

 

1,313

 

 

 —

 

 

1,313

 

 

 —

 

Accrued interest payable

 

 

133

 

 

133

 

 

12

 

 

121

 

 

 —

 

Total

 

$

1,679,590

 

$

1,673,901

 

$

1,195,307

 

$

478,594

 

$

 —

 

 

 

The table below presents the balance of financial instruments by class at December 31, 2014 measured at fair value:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Carrying

    

    

 

    

    

 

    

    

 

    

    

 

 

(In thousands)

 

Amount

 

Fair Value

 

Level 1

 

Level 2

 

Level 3

 

Cash and cash equivalents

 

$

154,459

 

$

154,459

 

$

154,459

 

$

 —

 

$

 —

 

Securities available for sale

 

 

203,473

 

 

203,473

 

 

 —

 

 

203,473

 

 

 —

 

Securities held to maturity

 

 

138,421

 

 

139,171

 

 

 —

 

 

139,171

 

 

 —

 

FHLB stock

 

 

4,378

 

 

N/A

 

 

N/A

 

 

N/A

 

 

N/A

 

Loans, net of allowance for loan losses

 

 

1,170,501

 

 

1,172,517

 

 

 —

 

 

 —

 

 

1,172,517

 

Interest rate swap agreement

 

 

618

 

 

618

 

 

 —

 

 

618

 

 

 —

 

Accrued interest receivable

 

 

3,787

 

 

3,787

 

 

 —

 

 

847

 

 

2,940

 

Total

 

$

1,675,637

 

$

1,674,025

 

$

154,459

 

$

344,109

 

$

1,175,457

 

Deposits

 

$

1,308,772

 

$

1,308,904

 

$

1,097,088

 

$

211,816

 

$

 —

 

Securities sold under agreement to repurchase

 

 

258,464

 

 

258,438

 

 

 —

 

 

258,438

 

 

 —

 

Other long-term debt

 

 

2,320

 

 

2,277

 

 

 —

 

 

2,277

 

 

 —

 

Junior subordinated debentures issued to unconsolidated subsidiary trust

 

 

20,619

 

 

14,476

 

 

 —

 

 

14,476

 

 

 —

 

Interest rate swap agreement

 

 

1,096

 

 

1,096

 

 

 —

 

 

1,096

 

 

 —

 

Accrued interest payable

 

 

165

 

 

165

 

 

19

 

 

146

 

 

 —

 

Total

 

$

1,591,436

 

$

1,585,356

 

$

1,097,107

 

$

488,249

 

$

 —

 

 

 

The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, accrued interest receivable and accrued interest payable approximate fair value. It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

 

The methodologies for other financial assets and financial liabilities are discussed below.

 

24


 

Loans - The fair value for loans is estimated using discounted cash flow analyses, using interest rates and spreads currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value.  The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

 

Deposits - The fair value of deposits with no stated maturity, which includes demand, savings, interest bearing checking and money market accounts, is equal to the amount payable on demand resulting in a Level 1 classification. The fair value of variable rate, fixed term certificates of deposit also approximates the carrying amount reported in the consolidated balance sheets. The fair value of fixed rate and fixed term certificates of deposit is estimated using a discounted cash flow method which applies interest rates currently being offered for deposits of similar remaining maturities resulting in a Level 2 classification.

 

Debt - The fair value of debt is estimated using current market rates for borrowings of similar remaining maturity resulting in a Level 2 classification.

 

Commitments to Extend Credit and Standby Letters of Credit - The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of financial standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties. The fair value of commitments to extend credit and standby letters of credit is approximately $62 thousand at September 30, 2015 and $47 thousand as of December 31, 2014, respectively.

 

Limitations ‑ Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instruments.  Because no market exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other such factors.

 

These estimates do not reflect any premium or discount that could result from offering for sale at one time our entire holdings of a particular financial instrument.  These estimates are subjective in nature and require considerable judgment to interpret market data. Accordingly, the estimates presented herein are not necessarily indicative of the amounts we could realize in a current market exchange, nor are they intended to represent the fair value of us as a whole.  The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.  The fair value estimates presented herein are based on pertinent information available to Management as of the respective balance sheet date.  Although we are not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein.

 

Other significant assets, such as premises and equipment, other assets, and liabilities not defined as financial instruments, are not included in the above disclosures.  Also, the fair value estimates for deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market.

 

NOTE 7: EMPLOYEE BENEFIT PLANS

 

Pension Plan

 

Prior to January 1995, we maintained a noncontributory defined benefit plan (the “Pension Plan”) covering all eligible employees. During 1995, the Pension Plan was curtailed. Accordingly, all accrued benefits were fully vested and no additional years of service or age will be accrued.

 

25


 

The following tables summarize the components of net periodic benefit cost and other changes in Pension Plan assets and benefit obligations recognized for the three and nine months ended September 30, 2015 and 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended 

 

Nine Months Ended 

 

 

 

September

 

 

September

 

(In thousands)

    

2015

    

2014

    

2015

    

2014

 

Interest cost

 

$

112

 

$

116

 

$

336

 

$

348

 

Expected return on plan assets

 

 

(264)

 

 

(265)

 

 

(791)

 

 

(795)

 

Service costs

 

 

13

 

 

11

 

 

39

 

 

33

 

Net loss amortization

 

 

103

 

 

31

 

 

308

 

 

97

 

Net periodic pension cost

 

$

(36)

 

$

(107)

 

$

(108)

 

$

(317)

 

 

We have no minimum required contribution for 2015.

 

Our Pension Investment Policy Statement sets forth the investment objectives and constraints of the Pension Plan. The purpose of the policy is to assist our Retirement Plan Committee in effectively supervising, monitoring, and evaluating the Pension Plan.

 

NOTE 8: EARNINGS PER SHARE

 

The following table presents reconciliations of the calculations of basic and diluted earnings per share for the three and nine months ended September 30, 2015 and 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended 

 

Nine Months Ended 

 

 

 

September 30,

 

September 30,

 

(In thousands except per share data)

    

2015

    

2014

    

2015

    

2014

    

Net income

 

$

3,856

 

$

2,806

 

$

10,308

 

$

9,623

 

Weighted average common shares outstanding

 

 

6,338

 

 

6,329

 

 

6,333

 

 

6,325

 

Dilutive effect of common stock equivalents

 

 

11

 

 

16

 

 

13

 

 

19

 

Weighted average common and common equivalent shares outstanding

 

 

6,349

 

 

6,345

 

 

6,346

 

 

6,344

 

Basic earnings per common share

 

$

0.61

 

$

0.44

 

$

1.63

 

$

1.52

 

Diluted earnings per common share

 

$

0.61

 

$

0.44

 

$

1.62

 

$

1.52

 

 

 

Basic earnings per common share were computed by dividing net income by the weighted average number of shares of common stock outstanding for the three and nine months ended September 30, 2015 and 2014. The computation of diluted earnings per share includes the effect of assumed exercises of outstanding stock options.

 

NOTE 9: STOCK REPURCHASE PROGRAM

 

We extended our stock buyback program through January 2016. Under the program, which was originally adopted in January 2007, we may repurchase up to 200,000 shares of our common stock on the open market from time to time, and have purchased 143,475 shares at an average price per share of $23.00 since the program’s adoption. We did not repurchase any of our shares during 2014 or during the nine months ended September 30, 2015, and do not expect to repurchase shares in the near future. 

 

NOTE 10: COMMITMENTS AND CONTINGENCIES

 

Financial Instruments with Off-Balance Sheet Risk

 

We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments primarily include commitments to extend credit and financial guarantees. Such instruments involve, to varying degrees, elements of credit and interest rate risk that are not recognized in the accompanying consolidated balance sheets.

 

Disclosures are required regarding liability-recognition for the fair value at issuance of certain guarantees. We do not issue any guarantees that would require liability-recognition or disclosure, other than our standby letters of credit. We have issued conditional commitments in the form of standby letters of credit to guarantee payment on behalf of a customer and guarantee the performance of a customer to a third party. Standby letters of credit generally arise in connection with lending relationships. The credit risk involved in issuing these instruments is essentially the same as that involved in extending loans to customers. Contingent obligations under standby letters of credit totaled approximately $6.19 million and $8.77 

26


 

million at September 30, 2015 and December 31, 2014, respectively, and represent the maximum potential future payments we could be required to make. Typically, these instruments have terms of 12 months or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements. Each customer is evaluated individually for creditworthiness under the same underwriting standards used for commitments to extend credit and on-balance sheet instruments. Our policies governing loan collateral apply to standby letters of credit at the time of credit extension. Loan-to-value ratios are generally consistent with loan-to-value requirements for other commercial loans secured by similar types of collateral.

 

We may enter into commitments to sell loans, which involve market and interest rate risk. There were no such commitments at September 30, 2015 or December 31, 2014.

 

Legal Proceedings

 

We have been named as defendants in various legal proceedings arising from our normal business activities. Although the amount of any ultimate liability with respect to such proceedings cannot be determined, in the opinion of Management, based upon input from counsel on the outcome of such proceedings, any such liability will not have a material effect on our financial condition and results of operations.

 

NOTE 11: ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

 

The following tables present the changes in accumulated other comprehensive (loss) by component, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Unrealized

    

Unrealized Gains

    

 

 

    

 

 

    

 

 

 

 

 

Gains (Losses)

 

(Losses) on Securities

 

 

 

 

 

 

 

 

 

 

 

 

on Securities

 

Transferred From

 

 

 

 

 

 

 

Accumulated Other

 

 

 

Available-For-

 

Available-For-Sale to

 

 

 

 

Interest Rate

 

Comprehensive

 

(In thousands)

 

Sale 

 

Held-To-Maturity

 

Pension Plan

 

Swaps

 

Income (Loss)

 

Beginning Balance June 30, 2015

 

$

1,200

 

$

(2,572)

 

$

(3,261)

 

$

(290)

 

$

(4,923)

 

Other comprehensive income before reclassifications

 

 

1,215

 

 

 —

 

 

 —

 

 

73

 

 

1,288

 

Transfer of securities from available-for-sale to held-to-maturity

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Accretion of unrealized losses of securities transferred from available-for-sale to held-to-maturity recognized in other comprehensive income

 

 

 —

 

 

144

 

 

 —

 

 

 —

 

 

144

 

Reclassification adjustments for (gains) losses reclassified into income

 

 

 —

 

 

 —

 

 

67

 

 

 —

 

 

67

 

Net current period other comprehensive (loss) income

 

 

1,215

 

 

144

 

 

67

 

 

73

 

 

1,499

 

Balance September 30, 2015

 

$

2,415

 

$

(2,428)

 

$

(3,194)

 

$

(217)

 

$

(3,424)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning Balance December 31, 2014

 

$

1,482

 

$

(2,824)

 

$

(3,395)

 

$

(311)

 

$

(5,048)

 

Other comprehensive income before reclassifications

 

 

933

 

 

 —

 

 

 —

 

 

94

 

 

1,027

 

Transfer of securities from available-for-sale to held-to-maturity

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Accretion of unrealized losses of securities transferred from available-for-sale to held-to-maturity recognized in other comprehensive income

 

 

 —

 

 

396

 

 

 —

 

 

 —

 

 

396

 

Reclassification adjustments for (gains) losses reclassified into income

 

 

 —

 

 

 —

 

 

201

 

 

 —

 

 

201

 

Net current period other comprehensive (loss) income

 

 

933

 

 

396

 

 

201

 

 

94

 

 

1,624

 

Balance September 30, 2015

 

$

2,415

 

$

(2,428)

 

$

(3,194)

 

$

(217)

 

$

(3,424)

 

 

 

27


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Unrealized

    

Unrealized Gains

    

 

 

    

 

 

    

 

 

 

 

 

Gains (Losses)

 

(Losses) on Securities

 

 

 

 

 

 

 

 

 

 

 

 

on Securities

 

Transferred From

 

 

 

 

 

 

 

Accumulated Other

 

 

 

Available-For-

 

Available-For-Sale to

 

 

 

 

Interest Rate

 

Comprehensive

 

(In thousands)

 

Sale 

 

Held-To-Maturity

 

Pension Plan

 

Swaps

 

Income (Loss)

 

Beginning Balance June 30, 2014

 

$

1,436

 

$

(3,064)

 

$

(1,748)

 

$

(407)

 

$

(3,783)

 

Other comprehensive income before reclassifications

 

 

(589)

 

 

 —

 

 

 —

 

 

66

 

 

(523)

 

Transfer of securities from available-for-sale to held-to-maturity

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Accretion of unrealized losses of securities transferred from available-for-sale to held-to-maturity recognized in other comprehensive income

 

 

 —

 

 

127

 

 

 —

 

 

 —

 

 

127

 

Reclassification adjustments for (gains) losses reclassified into income

 

 

24

 

 

 —

 

 

21

 

 

 —

 

 

45

 

Net current period other comprehensive (loss) income

 

 

(565)

 

 

127

 

 

21

 

 

66

 

 

(351)

 

Balance September 30, 2014

 

$

871

 

$

(2,937)

 

$

(1,727)

 

$

(341)

 

$

(4,134)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning Balance December 31, 2013

 

$

(162)

 

$

(3,296)

 

$

(1,790)

 

$

(472)

 

$

(5,720)

 

Other comprehensive income before reclassifications

 

 

1,110

 

 

 —

 

 

 —

 

 

131

 

 

1,241

 

Transfer of securities from available-for-sale to held-to-maturity

 

 

(8)

 

 

8

 

 

 —

 

 

 —

 

 

 —

 

Accretion of unrealized losses of securities transferred from available-for-sale to held-to-maturity recognized in other comprehensive income

 

 

 —

 

 

351

 

 

 —

 

 

 —

 

 

351

 

Reclassification adjustments for (gains) losses reclassified into income

 

 

(69)

 

 

 —

 

 

63

 

 

 —

 

 

(6)

 

Net current period other comprehensive (loss) income

 

 

1,033

 

 

359

 

 

63

 

 

131

 

 

1,586

 

Balance September 30, 2014

 

$

871

 

$

(2,937)

 

$

(1,727)

 

$

(341)

 

$

(4,134)

 

 

All amounts in the tables above are net of tax. Amounts in parentheses indicate debits.

 

28


 

Details of amounts reclassified from accumulated comprehensive income for the three and nine months ended September 30, 2015 and 2014 are presented below:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months

 

 

Nine Months

 

 

 

Details about Accumulated Other

 

 

Ended

 

 

Ended

 

 

 

Comprehensive Income Components

 

 

September 30,

 

 

September 30,

 

Affected Line Item in the Statement

 

(In thousands)

    

 

2015

    

 

2015

    

Where Net Income is Presented

 

Unrealized gains on securities

 

$

 -

 

$

 -

 

Net gains on investment securities

 

 

 

 

 

 

 

 

 

Total before tax

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

 

 

$

 -

 

$

 -

 

(Increase) / Decrease to Net Income

 

 

 

 

 

 

 

 

 

 

 

Amortization of actuarial loss for

 

 

 

 

 

 

 

 

 

defined benefit pension plan

 

$

103

 

$

308

 

Compensation and benefits expense

 

 

 

 

103

 

 

308

 

Total before tax

 

 

 

 

(36)

 

 

(107)

 

Provision for income taxes

 

 

 

$

67

 

$

201

 

Net of tax

 

 

 

 

 

 

 

 

 

 

 

Total reclassification adjustments

 

$

67

 

$

201

 

(Increase) / Decrease to Net Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months

 

 

Nine Months

 

 

 

Details about Accumulated Other

 

 

Ended

 

 

Ended

 

 

 

Comprehensive Income Components

 

 

September 30,

 

 

September 30,

 

Affected Line Item in the Statement

 

(In thousands)

 

 

2014

 

 

2014

 

Where Net Income is Presented

 

Unrealized gains on securities

 

$

37

 

$

(106)

 

Net -gains losses on investment securities

 

 

 

 

37

 

 

(106)

 

Total before tax

 

 

 

 

(13)

 

 

37

 

Provision for income taxes

 

 

 

$

24

 

$

(69)

 

Net of tax

 

Amortization of actuarial loss for

 

 

 

 

 

 

 

 

 

defined benefit pension plan

 

$

31

 

$

97

 

Compensation and benefits expense

 

 

 

 

31

 

 

97

 

Total before tax

 

 

 

 

(10)

 

 

(34)

 

Provision for income taxes

 

 

 

$

21

 

$

63

 

(Increase) / Decrease to Net Income

 

 

 

 

 

 

 

 

 

 

 

Total reclassification adjustments

 

$

45

 

$

(6)

 

(Increase) / Decrease to Net Income

 

 

NOTE 12: DERIVATIVE FINANCIAL INSTRUMENTS

 

At September 30, 2015 and December 31, 2014, we had an interest rate swap with a notional amount of $10 million that was designated as a cash flow hedge. The swap was used to convert a portion of the floating rate interest on our trust preferred issuance to a fixed rate of interest. Each quarter we assess the effectiveness of the hedging relationships by comparing the changes in cash flows of the derivative hedging instruments with the changes in cash flows of the designated hedged item. There was no ineffective portion recognized in earnings during the three and nine months ended September 30, 2015 and 2014. The fair value of $(335) thousand and $(479) thousand was reflected in other liabilities in the accompanying consolidated balance sheets at September 30, 2015 and December 31, 2014, respectively.

 

We entered into interest rate swaps with a notional amount of $37.8 million with certain of our commercial customers.  In order to minimize our risk, these customer derivatives (pay floating/receive fixed swaps) have been offset with essentially matching interest rate swaps with our counterparty totaling $37.8 million (pay fixed/receive floating swaps). At September

29


 

30, 2015, the weighted average receive rate of these interest rate swaps was 1.87%, the weighted average pay rate was 3.65% and the weighted average maturity was 11.3 years.  The fair values of $978 thousand and $978 thousand were reflected in other assets and other liabilities, respectively, in the accompanying consolidated balance sheets at September 30, 2015.  The fair values of $618 thousand and $618 thousand were reflected in other assets and other liabilities, respectively, in the accompanying consolidated balance sheets at December 31, 2014.  Hedge accounting has not been applied for these derivatives.  Because the terms of the swaps with our customer and the other financial institution offset each other, with the only difference being counterparty credit risk, changes in the fair value of the underlying derivative contracts are not materially different and do not significantly impact our results of operations.

 

We entered into interest rate swaps with notional amounts totaling $8.89 million at September  30, 2015, and $9.36 million at December 31, 2014, that were designated as fair value hedges of certain fixed rate loans with municipalities. At September 30, 2015, the weighted average receive rate of these interest rate swaps was 1.57%, the weighted average pay rate was 3.26% and the weighted average maturity was 16.8 years. The fair value of $385 thousand at September 30, 2015, was reflected as a reduction to loans and an increase to other assets. The ineffective portion of the interest swaps was immaterial and as such, amounts are not recognized in earnings.

 

We assessed our counterparty risk at September 30, 2015 and determined any credit risk inherent in our derivative contracts was insignificant. Information about the fair value of derivative financial instruments can be found in Note 6 to these consolidated financial statements.

 

NOTE 13:  BUSINESS COMBINATION

 

On April 27, 2015, we entered into an Agreement and Plan of Merger (the “merger agreement”) with NUVO Bank & Trust Company, Springfield, Massachusetts (“NUVO”) pursuant to which we will acquire NUVO in a transaction structured as a merger of NUVO with and into our wholly-owned subsidiary, Merchants Bank, with Merchants Bank surviving.

 

Pursuant to the merger agreement, each outstanding share of NUVO common stock will be converted into the right to receive, at the election of the shareholder and subject to the allocation and proration procedures described in the merger agreement, either: (i) 0.2416 shares of our common stock (the “stock consideration”), or (ii) $7.15 in cash, without interest (the “cash consideration”).  The value of the cash consideration will remain fixed while the value of the stock consideration will fluctuate with the market price of our common stock. At announcement of the proposed merger on April 27, 2015, the consideration to be paid was valued at approximately $21.8 million. All elections for the merger consideration are subject to allocation and proration procedures that are intended to ensure that approximately 75% of the total number of shares of NUVO common stock outstanding immediately prior to the effective time of the merger will be converted into shares of our common stock, and the remaining shares of NUVO common stock will be converted into cash.  This will result in NUVO shareholders owning up to 517,224 shares of our common stock, or approximately 8.2% of our outstanding shares, following the closing of the transaction.  Holders of NUVO common stock options will receive a cash payment for the difference between $7.15 and the exercise price of the option, while warrant holders of NUVO may either be cashed out in a similar fashion or receive an equivalent warrant to acquire our common stock.

 

We estimate that upon completion of the merger, our combined total assets, loans and deposits will approximate $2.00 billion, $1.42 billion and $1.53 billion, respectively. 

 

In conjunction with the planned merger, we have incurred certain non-recurring costs, including legal fees, investment banking fees, and other related expenses for the three and nine months ended September 30, 2015 of $215 thousand and $363 thousand, respectively.  These non-recurring costs are presented on the consolidated statements of income within non-interest expense as merger and acquisition costs. We expect to continue to incur related non-recurring costs through the closing of the planned merger with NUVO.

 

On September 30, 2015, the shareholders of NUVO approved the proposed merger.  The merger has also been approved by the FDIC and the Vermont Department of Financial Regulation.  An application for approval of the merger is pending with the Massachusetts Division of Banks. Subject to receipt of all required regulatory approvals and satisfaction of all other conditions, the parties expect the merger to close during the fourth quarter of 2015.

30


 

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

 

FORWARD-LOOKING STATEMENTS

 

Certain statements contained in this Quarterly Report on Form 10-Q that are not historical facts may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve risks and uncertainties. These statements, which are based on certain assumptions and describe Merchants’ future plans, strategies and expectations, can generally be identified by the use of the words “may,” “will,” “should,” “could,” “would,” “plan,” “potential,” “estimate,” “project,” “believe,” “intend,” “anticipate,” “expect,” “target” and similar expressions. Forward-looking statements are based on the current assumptions and beliefs of management and are only expectations of future results. Our actual results could differ materially from those projected in the forward-looking statements as a result of, among others, delays in completing the announced merger with NUVO Bank & Trust Company (“NUVO”); failure to obtain required regulatory approvals for the merger; disruptions to the parties’ businesses as a result of the announcement and pendency of the merger; costs or difficulties related to the integration of the business following the merger; continued weakness in general, national, regional or local economic conditions; the performance of our investment portfolio, quality of credits or the overall demand for services; changes in loan default and charge-off rates which could affect the allowance for credit losses; declines in the equity and financial markets; reductions in deposit levels which could necessitate increased and/or higher cost borrowing to fund loans and investments; declines in mortgage loan refinancing, equity loan and line of credit activity which could reduce net interest and non-interest income; changes in the domestic interest rate environment and inflation; changes in the carrying value of investment securities and other assets; misalignment of our interest-bearing assets and liabilities; increases in loan repayment rates affecting interest income and the value of mortgage servicing rights; changing business, banking, or regulatory conditions or policies, or new legislation affecting the financial services industry that could lead to changes in the competitive balance among financial institutions, restrictions on bank activities, changes in costs (including deposit insurance premiums), increased regulatory scrutiny, declines in consumer confidence in depository institutions, or changes in the secondary market for bank loan and other products; and changes in accounting rules, federal and state laws, IRS regulations, and other regulations and policies governing financial holding companies and their subsidiaries which may impact our ability to take appropriate action to protect our financial interests in certain loan situations.

 

Investors should not place undue reliance on our forward-looking statements, and are cautioned that forward-looking statements are inherently uncertain. Actual performance and results of operations may differ materially from those projected or suggested in the forward-looking statements due to certain risks and uncertainties, which are included in more detail in our Annual Report on Form 10-K, as updated by our Quarterly Reports on Form 10-Q and other filings submitted to the Securities and Exchange Commission. We do not undertake any obligation to update any forward-looking statement to reflect circumstances or events that occur after the date the forward-looking statements are made.

 

USE OF NON-GAAP FINANCIAL MEASURES

 

Certain information in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains financial information determined by methods other than in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  We use these “non-GAAP” measures in our analysis of our performance and believe that these non-GAAP financial measures provide a greater understanding of ongoing operations and enhance comparability of our results with prior periods and with the results of other financial institutions.  These disclosures should not be viewed as a substitute for operating results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.

 

In several places net interest income is presented on a fully taxable equivalent basis. Specifically included in interest income is tax-exempt interest income from certain tax-exempt loans. An amount equal to the tax benefit derived from this tax exempt income is added back to the interest income total, to produce net interest income on a fully taxable equivalent basis. We believe the disclosure of taxable equivalent net interest income information improves the clarity of financial analysis, and is particularly useful to investors in understanding and evaluating the changes and trends in our results of operations. Other financial institutions commonly present net interest income on a taxable equivalent basis. This adjustment is considered helpful in the comparison of one financial institution’s net interest income to that of another, as

31


 

each will have a different proportion of taxable exempt interest from its earning assets. Moreover, net interest income is a component of a second financial measure commonly used by financial institutions, net interest margin, which is the ratio of net interest income to average earning assets. For purposes of this measure as well, other financial institutions generally use taxable equivalent net interest income. We follow these practices. A reconciliation of taxable equivalent financial information to our consolidated financial statements prepared in accordance with GAAP appears at the bottom of the tables on pages 34 and 35.  A 35.0% tax rate was used in both 2015 and 2014.

 

GENERAL

 

The following discussion and analysis of financial condition as of September 30, 2015 and December 31, 2014 and results of operations of Merchants and its subsidiaries for the three and nine months ended September 30, 2015 and 2014 should be read in conjunction with the consolidated financial statements and notes thereto and selected statistical information appearing elsewhere in this Quarterly Report on Form 10-Q. The financial condition and results of operations of Merchants essentially reflect the operations of its principal subsidiary, Merchants Bank.

 

RESULTS OF OPERATIONS

 

Overview

 

We realized net income of $3.86 million and $10.31 million, or diluted earnings per share of $0.61 and $1.62 for the three and nine months ended September 30, 2015, respectively. This compares to net income of $2.81 million and $9.62 million, or diluted earnings per share of $0.44 and $1.52 for the three and nine months ended September 30, 2014, respectively. The return on average assets was 0.88% for the three months and 0.79% for the nine months ended September 30, 2015, compared to 0.68% and 0.77% for the same periods in 2014. The return on average equity was 11.93% and 10.75% for the three and nine months ended September 30, 2015, respectively, compared to 9.02% and 10.48% for the same periods in 2014. Merchants Bancshares’ Board of Directors approved a dividend of $0.28 per share, payable November 23, 2015, to shareholders of record as of November 9, 2015.

Shareholders’ equity ended the quarter at $132.6 million, and the book value per share increased by $1.04 to $20.93 per share at September 30, 2015 from $19.89 at December 31, 2014. At September 30, 2015 CET1 was 13.84%.  At September 30, 2015, the tier 1 leverage ratio increased to 8.93%, total risk-based capital ratio increased to 17.11% and the tangible capital ratio decreased slightly to 7.29% from 8.76%, 16.95% and 7.30%, respectively, at December 31, 2014. 

Ø

Net interest income - Our taxable equivalent net interest income was $12.60 million and $36.91 million for the three and nine months ended September 30, 2015, compared with $12.01 million and $36.50 million for the same periods in 2014. The increase in net interest income is attributable to growth in both total commercial loans and the investment portfolio. The taxable equivalent net interest margin was 2.96% and 2.95% for the quarter and nine months ended September 30, 2015, compared to 3.03% and 3.07% for the same periods in 2014. The decreases of seven and twelve basis points from the same periods in 2014 were primarily due to the decline in asset yields.

Ø

Provision for Credit Losses – The provision for credit losses was $250 thousand for the nine months ended September 30, 2015, compared to $150 thousand during the nine months ended September 30, 2014. The additional provision was a result of continued loan growth. The Bank continues to experience strong credit quality.

Ø

Loans - Average loan balances for the three months ended September 30, 2015 were $1.25 billion, $25.4 million higher on a linked quarter basis and $82.1 million higher from the fourth quarter of 2014.  Ending loan balances were $1.26 billion, an increase of $54.3 million from June 30, 2015 and $75.6 million from December 31, 2014.  The increase in loan balances reflects growth in commercial real estate loans and normal seasonal growth in municipal loans.

Ø

Deposits – Quarterly average deposit balances increased by $60 million to $1.40 billion, a 4% increase over quarterly averages for the third quarter of 2014. Securities sold under agreement to repurchase, which represent collateralized customer accounts, were $268 million at September 30, 2015, an increase of $80 million from September 30, 2014, due to an increase in municipal customers.

32


 

Ø

Non-interest income - Total noninterest income increased $573 thousand to $3.45 million for the third quarter of 2015 compared to the third quarter of 2014 and increased $137 thousand to $8.87 million for the first nine months of 2015. The increase for both the three and nine months ended September 30, 2015 is due to higher debit card income of $118 thousand and $287 thousand, respectively and higher miscellaneous income of $420 thousand and $253 thousand, respectively.

Ø

Non-interest expenseTotal noninterest expense for the third quarter of 2015 (excluding merger-related and severance costs for 2015, and conversion and severance expenses for 2014) was $10.05 million, an increase of $175 thousand from the third quarter in 2014. On a year-to-date basis, noninterest expenses (excluding merger-related costs for 2015 and conversion expenses for 2014) increased $572 thousand to $30.72 million.

 

Net Interest Income

 

As shown on the tables on pages 34 and 35, our taxable equivalent net interest income was $12.60 million and $36.91 million for the three and nine months ended September 30, 2015, respectively, compared to $12.01 million and $36.50 million, respectively, for the same periods in 2014.   Our taxable equivalent net interest margin was 2.96% and 2.95% for the quarter and nine months ended September 30, 2015, compared to 3.03% and 3.07%, respectively, for the same periods in 2014. The margin declined seven basis points from the third quarter of 2014 and twelve basis points on a year-to-date basis. The decline in the margin is driven by lower yields on loans and investments due to a prolonged low interest rate environment, which was not offset by corresponding declines in yields on deposits and borrowings.

 

33


 

The following tables present an analysis of net interest income and illustrate interest income earned and interest expense charged for each major component of interest earning assets and interest bearing liabilities. Yields/rates are computed on a fully taxable-equivalent basis, using a 35% tax rate.  Nonaccrual loans are included in the average loan balance outstanding.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended 

 

 

 

September 30, 2015

 

September 30, 2014

 

 

 

 

 

 

Interest

 

 

 

 

 

 

Interest

 

 

 

 

 

Average

 

Income/

 

Average

 

Average

 

Income/

 

Average

 

(In thousands, fully taxable equivalent)

 

Balance

 

Expense

 

Rate

 

Balance

 

Expense

 

Rate

 

ASSETS:

    

 

    

    

 

    

    

    

    

 

    

    

 

    

    

    

 

Loans, including fees on loans

 

$

1,245,861 

 

$

11,583 

 

3.69 

%  

$

1,162,236 

 

$

11,151 

 

3.81 

%  

Investments

 

 

395,560 

 

 

1,961 

 

1.98 

%  

 

341,165 

 

 

1,885 

 

2.19 

%  

Interest-earning deposits with banks and other short-term

 

 

52,795 

 

 

25 

 

0.19 

%  

 

72,400 

 

 

37 

 

0.20 

%  

investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest earning assets

 

 

1,694,216 

 

 

13,569 

 

3.19 

%  

 

1,575,801 

 

 

13,073 

 

3.29 

%  

Allowance for loan losses

 

 

(12,223)

 

 

 

 

 

 

 

(12,090)

 

 

 

 

 

 

Cash and due from banks

 

 

26,049 

 

 

 

 

 

 

 

27,871 

 

 

 

 

 

 

Bank premises and equipment, net

 

 

15,142 

 

 

 

 

 

 

 

15,923 

 

 

 

 

 

 

Bank owned life insurance

 

 

10,456 

 

 

 

 

 

 

 

10,190 

 

 

 

 

 

 

Other assets

 

 

26,103 

 

 

 

 

 

 

 

24,695 

 

 

 

 

 

 

Total assets

 

$

1,759,743 

 

 

 

 

 

 

$

1,642,390 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS' EQUITY:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Savings, interest bearing checking and money market accounts

 

$

613,337 

 

$

354 

 

0.23 

%  

$

612,811 

 

$

370 

 

0.24 

%  

Time deposits

 

 

195,044 

 

 

318 

 

0.65 

%  

 

247,297 

 

 

433 

 

0.70 

%  

Total interest bearing deposits

 

 

808,381 

 

 

672 

 

0.33 

%  

 

860,108 

 

 

803 

 

0.37 

%  

Short-term borrowings

 

 

9,649 

 

 

 

0.33 

%  

 

96 

 

 

 —

 

 —

%  

Securities sold under agreements to repurchase, short-term

 

 

195,410 

 

 

89 

 

0.18 

%  

 

152,451 

 

 

62 

 

0.16 

%  

Other long-term debt

 

 

2,265 

 

 

12 

 

2.01 

%  

 

2,348 

 

 

12 

 

2.04 

%  

Junior subordinated debentures issued to unconsolidated subsidiary trust

 

 

20,619 

 

 

187 

 

3.63 

%  

 

20,619 

 

 

189 

 

3.71 

%  

Total borrowed funds

 

 

227,943 

 

 

296 

 

0.52 

%  

 

175,514 

 

 

263 

 

0.60 

%  

Total interest bearing liabilities

 

 

1,036,324 

 

$

968 

 

0.37 

%  

 

1,035,622 

 

$

1,066 

 

0.41 

%  

Noninterest bearing deposits

 

 

586,773 

 

 

 

 

 

 

 

475,101 

 

 

 

 

 

 

Other liabilities

 

 

7,388 

 

 

 

 

 

 

 

7,250 

 

 

 

 

 

 

Shareholders' equity

 

 

129,258 

 

 

 

 

 

 

 

124,417 

 

 

 

 

 

 

Total liabilities and shareholders' equity

 

$

1,759,743 

 

 

 

 

 

 

$

1,642,390 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest earning assets

 

$

657,893 

 

 

 

 

 

 

$

540,179 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income (fully taxable equivalent)

 

 

 

 

$

12,601 

 

 

 

 

 

 

$

12,007 

 

 

 

Tax equivalent adjustment

 

 

 

 

 

(527)

 

 

 

 

 

 

 

(509)

 

 

 

Net interest income

 

 

 

 

$

12,073 

 

 

 

 

 

 

$

11,498 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest rate spread

 

 

 

 

 

 

 

2.82 

%  

 

 

 

 

 

 

2.88 

%  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest margin

 

 

 

 

 

 

 

2.96 

%  

 

 

 

 

 

 

3.03 

%  

 

 

34


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended 

 

 

 

September 30, 2015

 

September 30, 2014

 

 

 

Interest

 

Interest

 

 

    

Average

    

Income/

    

Average

    

Average

    

Income/

    

Average

 

(In thousands, fully taxable equivalent)

 

Balance

 

Expense

 

Rate

 

Balance

 

Expense

 

Rate

 

ASSETS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans, including fees on loans

 

$

1,218,067 

 

$

34,013

 

3.73

%  

$

1,166,197

 

$

33,727

 

3.86

%  

Investments

 

 

379,030 

 

 

5,784

 

2.04

%  

 

360,790

 

 

6,145

 

2.28

%  

Interest-earning deposits with banks and other short-term

 

 

73,630 

 

 

157

 

0.28

%  

 

64,328

 

 

110

 

0.23

%  

investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest earning assets

 

 

1,670,727 

 

 

39,954

 

3.20

%  

 

1,591,315

 

 

39,982

 

3.36

%  

Allowance for loan losses

 

 

(12,065)

 

 

 

 

 

 

 

(12,138)

 

 

 

 

 

 

Cash and due from banks

 

 

25,066 

 

 

 

 

 

 

 

27,646

 

 

 

 

 

 

Bank premises and equipment, net

 

 

15,362 

 

 

 

 

 

 

 

15,578

 

 

 

 

 

 

Bank owned life insurance

 

 

10,395 

 

 

 

 

 

 

 

10,110

 

 

 

 

 

 

Other assets

 

 

27,038 

 

 

 

 

 

 

 

26,858

 

 

 

 

 

 

Total assets

 

$

1,736,523 

 

 

 

 

 

 

$

1,659,369

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS' EQUITY:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Savings, interest bearing checking and money market accounts

 

$

577,006 

 

$

1,075

 

0.25

%  

$

715,869

 

$

1,283

 

0.24

%  

Time deposits

 

 

201,601 

 

 

975

 

0.65

%  

 

271,062

 

 

1,358

 

0.67

%  

Total interest bearing deposits

 

 

778,607 

 

 

2,050

 

0.35

%  

 

986,931

 

 

2,641

 

0.36

%  

Short-term borrowings

 

 

5,285 

 

 

13

 

0.33

%  

 

283

 

 

 —

 

 —

%  

Securities sold under agreements to repurchase, short-term

 

 

212,859 

 

 

390

 

0.24

%  

 

181,002

 

 

241

 

0.18

%  

Other long-term debt

 

 

2,286 

 

 

35

 

2.03

%  

 

2,369

 

 

37

 

2.09

%  

Junior subordinated debentures issued to unconsolidated subsidiary trust

 

 

20,619 

 

 

560

 

3.63

%  

 

20,619

 

 

561

 

3.70

%  

Total borrowed funds

 

 

241,049 

 

 

998

 

0.55

%  

 

204,273

 

 

839

 

0.55

%  

Total interest bearing liabilities

 

 

1,019,656 

 

$

3,048

 

0.40

%  

 

1,191,204

 

$

3,480

 

0.39

%  

Noninterest bearing deposits

 

 

581,351 

 

 

 

 

 

 

 

337,546

 

 

 

 

 

 

Other liabilities

 

 

7,640 

 

 

 

 

 

 

 

8,204

 

 

 

 

 

 

Shareholders' equity

 

 

127,876 

 

 

 

 

 

 

 

122,415

 

 

 

 

 

 

Total liabilities and shareholders' equity

 

$

1,736,523 

 

 

 

 

 

 

$

1,659,369

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest earning assets

 

$

651,072 

 

 

 

 

 

 

$

400,111

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income (fully taxable equivalent)

 

 

 

 

$

36,906

 

 

 

 

 

 

$

36,502

 

 

 

Tax equivalent adjustment

 

 

 

 

 

(1,535)

 

 

 

 

 

 

 

(1,567)

 

 

 

Net interest income

 

 

 

 

$

35,371

 

 

 

 

 

 

$

34,935

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest rate spread

 

 

 

 

 

 

 

2.80

%  

 

 

 

 

 

 

2.97

%  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest margin

 

 

 

 

 

 

 

2.95

%  

 

 

 

 

 

 

3.07

%  

 

 

The following tables present the extent to which changes in interest rates and changes in the volume of earning assets and interest bearing liabilities have affected interest income and interest expense during the periods indicated. Information is presented in each category with respect to: (i) changes attributable to changes in volume (changes in volume multiplied by prior rate), (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume) and (iii) changes in volume/rate (change in volume multiplied by change in rate).

 

35


 

Analysis of Changes in Fully Taxable Equivalent Net Interest Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended 

 

 

 

 

Due to

 

 

 

September 30,

 

Increase

 

 

 

 

 

 

 

Volume/

 

(In thousands)

 

2015

 

2014

 

(Decrease)

 

Volume

 

Rate

 

Rate

 

Fully taxable equivalent interest income:

    

 

    

    

 

    

    

 

    

    

 

    

    

 

    

    

 

    

 

Loans, including fees on loans

 

$

11,583

 

$

11,151

 

$

432

 

$

803

 

$

(356)

 

$

(15)

 

Investments

 

 

1,961

 

 

1,885

 

 

76

 

 

300

 

 

(178)

 

 

(46)

 

Federal funds sold, securities sold under agreements to repurchase and interest bearing deposits with banks

 

 

25

 

 

37

 

 

(12)

 

 

(10)

 

 

(3)

 

 

1

 

Total interest income

 

 

13,569

 

 

13,073

 

 

496

 

 

1,093

 

 

(537)

 

 

(60)

 

Less interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Savings, interest bearing checking and money market accounts

 

 

354

 

 

370

 

 

(16)

 

 

 —

 

 

(32)

 

 

16

 

Time deposits

 

 

318

 

 

433

 

 

(115)

 

 

(88)

 

 

(14)

 

 

(13)

 

Federal funds purchased and Federal Home Loan Bank short-term borrowings

 

 

8

 

 

 —

 

 

8

 

 

7

 

 

 —

 

 

1

 

Securities sold under agreements to repurchase, short-term

 

 

89

 

 

62

 

 

27

 

 

21

 

 

(4)

 

 

10

 

Other long-term debt

 

 

12

 

 

12

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Junior subordinated debentures issued to unconsolidated subsidiary trust

 

 

187

 

 

189

 

 

(2)

 

 

 —

 

 

(4)

 

 

2

 

Total interest expense

 

 

968

 

 

1,066

 

 

(98)

 

 

(60)

 

 

(54)

 

 

16

 

Net interest income

 

$

12,601

 

$

12,007

 

$

594

 

$

1,153

 

$

(483)

 

$

(76)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended 

 

 

 

 

Due to

 

 

 

September 30,

 

Increase

 

 

 

 

 

 

 

Volume/

 

(In thousands)

    

2015

    

2014

    

(Decrease)

    

Volume

    

Rate

    

Rate

 

Fully taxable equivalent interest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans, including fees on loans

 

$

34,013

 

$

33,727

 

$

286

 

$

1,498

 

$

(1,104)

 

$

(108)

 

Investments

 

 

5,784

 

 

6,145

 

 

(361)

 

 

311

 

 

(647)

 

 

(25)

 

Federal funds sold, securities sold under agreements to repurchase and interest bearing deposits with banks

 

 

157

 

 

110

 

 

47

 

 

16

 

 

26

 

 

5

 

Total interest income

 

 

39,954

 

 

39,982

 

 

(28)

 

 

1,825

 

 

(1,725)

 

 

(128)

 

Less interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Savings, interest bearing checking and money market accounts

 

 

1,075

 

 

1,283

 

 

(208)

 

 

(249)

 

 

50

 

 

(9)

 

Time deposits

 

 

975

 

 

1,358

 

 

(383)

 

 

(348)

 

 

(47)

 

 

12

 

Federal funds purchased and Federal Home Loan Bank short-term borrowings

 

 

13

 

 

 —

 

 

13

 

 

 —

 

 

1

 

 

12

 

Securities sold under agreements to repurchase, short-term

 

 

390

 

 

241

 

 

149

 

 

44

 

 

82

 

 

23

 

Securities sold under agreements to repurchase, long-term

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Other long-term debt

 

 

35

 

 

37

 

 

(2)

 

 

(1)

 

 

(1)

 

 

 —

 

Junior subordinated debentures issued to unconsolidated subsidiary trust

 

 

560

 

 

561

 

 

(1)

 

 

 —

 

 

(11)

 

 

10

 

Total interest expense

 

 

3,048

 

 

3,480

 

 

(432)

 

 

(554)

 

 

74

 

 

48

 

Net interest income

 

$

36,906

 

$

36,502

 

$

404

 

$

2,379

 

$

(1,799)

 

$

(176)

 

 

 

36


 

Provision for Credit Losses

 

Merchants Bancshares recorded a $250 thousand provision for credit losses during the nine months ended September 30, 2015, compared to $150 thousand during the nine months ended September 30, 2014. The additional provision was a result of continued loan growth. Nonperforming loans were 0.11% of total loans at September 30, 2015, compared to 0.07% of total loans at December 31, 2014 and 0.06% of total loans at September 30, 2014. The increase in nonperforming loans from the prior year-end was primarily attributable to one commercial credit that was placed in non-accrual during the second quarter of 2015. Accruing loans past due 31-90 days were 0.01% of total loans at September 30, 2015. The Bank continues to experience exceptionally strong credit quality. For a more detailed discussion of the Allowance and nonperforming assets, see “Credit Quality and Allowance for Credit Losses” beginning on page 39.

 

NONINTEREST INCOME AND EXPENSES

 

Noninterest income

 

Total noninterest income for the third quarter of 2015 was $3.45 million an increase of $573 thousand compared to the third quarter in 2014. For the first nine months of 2015, noninterest income was $8.87 million, an increase of $137 thousand from the same period a year ago. The increase for the third quarter is primarily due to higher debit card income of $118 thousand, which is reflective of increased volumes. Additionally, the Company recognized $440 thousand in miscellaneous income due to a one-time credit negotiated with a third-party vendor.

Noninterest expense

 

Total noninterest expense for the third quarter of 2015 (excluding merger-related and severance costs of $328 thousand for 2015, and conversion and severance expenses of $410 thousand for 2014) was $10.05 million, an increase of $175 thousand from the third quarter in 2014. The increase from the third quarter of 2014 was primarily attributable to higher benefit expense due to an increase in health care costs of $220 thousand and reduced pension benefit of $209 thousand, a reduction in franchise tax credits which caused the state franchise tax expense to increase $64 thousand, higher mobile & internet banking of $36 thousand which is a result of the shift in customer banking behavior to online banking. These increases were partially offset by lower marketing expense of $275 thousand. The 2014 third quarter expense included costs for a marketing campaign.

 

On a year-to-date basis, noninterest expenses (excluding merger-related costs for 2015 and conversion expenses for 2014) increased $572 thousand to $30.72 million. The primary drivers of the increase were higher compensation and benefits of $840 thousand and higher other noninterest expense of $253 thousand which was partially offset by lower marketing expense of $487 thousand, lower telephone expense of $77 thousand and lower core/item processing expense of $49 thousand.

·

Compensation expense increased over the prior nine months due to higher severance expense of $332 thousand. The higher severance was primarily related to a strategic initiative to align our resources with customer needs and behaviors, which resulted in a reduction of branch staffing in the third quarter of 2015;  

·

Benefit expense increased due to higher health care costs of $228 thousand;

·

Other noninterest expense increased due to higher correspondent bank expense of $94 thousand, higher postage expense of $91 thousand and higher loss and fraud expense of $137 thousand;

·

Marketing expense declined due to lower customer communication expense which increased in 2014 as a result of the core conversion;

·

Telephone line service expense declined in 2015 due to an initiative to reduce the number of phone lines by converting to voice over internet protocol (VoIP) telephones; and

·

Core/item processing expense was down slightly in 2015 due to recognized cost savings as a result of the core system conversion to Jack Henry.

 

37


 

The following table shows the components of other noninterest expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended 

 

Nine Months Ended 

 

 

 

September 30,

 

September 30,

 

(in thousands)

    

2015

    

2014

    

2015

    

2014

 

Postage

 

$

180

 

$

150

 

$

551

 

$

461

 

External Audit & Regulatory Fees

 

 

96

 

 

159

 

 

303

 

 

269

 

Director’s Fees

 

 

106

 

 

121

 

 

303

 

 

363

 

Correspondent Bank Service Charges

 

 

87

 

 

70

 

 

278

 

 

199

 

Donations

 

 

75

 

 

98

 

 

243

 

 

239

 

Supplies

 

 

30

 

 

88

 

 

135

 

 

255

 

Other

 

 

293

 

 

162

 

 

1,034

 

 

808

 

Total

 

$

867

 

$

848

 

$

2,847

 

$

2,594

 

 

Income Taxes

 

Merchants Bancshares’ effective tax rate was 19% and 20% for the three and nine months ended September 30, 2015, respectively, compared to 20% on a linked quarter basis, and 23% for the three and nine months ended September 30, 2014.  The effective tax rate declined from 2014 due to higher tax credits. 

BALANCE SHEET ANALYSIS

 

Loans

 

Average loan balances for the three months ended September 30, 2015 were $1.25 billion, $25.4 million higher on a linked quarter basis and $82.1 million higher from the fourth quarter of 2014.

 

The composition of our ending loan portfolio is shown in the following table as of the dates indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(In thousands)

 

September 30, 2015

 

June 30, 2015

 

December 31, 2014

 

September 30, 2014

 

Commercial, financial and agricultural

    

$

207,067

    

$

210,458

    

$

177,597

    

$

183,069

 

Municipal loans

 

 

108,423

 

 

59,035

 

 

94,366

 

 

96,258

 

Residential

 

 

448,632

 

 

454,114

 

 

469,529

 

 

472,986

 

Commercial Real Estate

 

 

450,673

 

 

438,622

 

 

412,447

 

 

381,301

 

Construction

 

 

40,748

 

 

38,435

 

 

23,858

 

 

17,970

 

Installment loans

 

 

2,370

 

 

2,950

 

 

4,504

 

 

4,793

 

All other loans

 

 

19

 

 

41

 

 

33

 

 

286

 

Total loans

 

$

1,257,932

 

$

1,203,655

 

$

1,182,334

 

$

1,156,663

 

 

Totals above are shown net of deferred loan fees of $802 thousand, $748 thousand, $734 thousand, and $646 thousand for September 30, 2015, June 30, 2015, December 31, 2014, and September 30, 2014, respectively. 

 

Ending loan balances were $1.26 billion, an increase of $54.3 million from June 30, 2015 and $75.6 million from December 31, 2014.  The increase in loan balances since June 30, 2015, reflects growth in commercial real estate loans and normal seasonal growth in municipal loans. Municipal balances increased approximately $49.4 million from June 30, 2015. Total commercial loans, defined as commercial, commercial real estate and construction, increased $11.0 million from June 30, 2015 to $698.5 million at September 30, 2015. Total commercial loans increased $84.6 million from December 31, 2014, which represents a year-to-date annualized commercial loan growth of 18.4%.

 

Investments

 

The average investment portfolio for the third quarter of 2015 was $396 million, an increase of $54 million from average balances for both the third quarter of 2014, and fourth quarter of, 2014.  The ending balance in the investment portfolio at September 30, 2015 was $410 million, compared to $333 million at September 30, 2014 and $346 million at December 31, 2014. The book balance of the portfolio at September 30, 2015 includes a $3.741 million net unrealized gain on the available for sale portion of the investment portfolio, compared to an unrealized gain of $2.31 million at December 31, 2014.

 

38


 

The composition of our investment portfolio as of September 30, 2015, including both available for sale and held to maturity securities, consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

Amortized

 

Fair

 

(In thousands)

    

Cost

    

Value

 

Available for Sale:

 

 

 

 

 

 

 

U.S. Treasury Obligations

 

$

25,060

 

$

25,344

 

U.S. Government Sponsored Enterprises ("U.S. GSEs")

 

 

16,947

 

 

17,100

 

Federal Home Loan Bank ("FHLB") Obligations

 

 

46,160

 

 

46,644

 

Residential Real Estate Mortgage-backed Securities ("Agency MBSs")

 

 

101,396

 

 

103,701

 

Agency Commercial Mortgage Backed Securities ("Agency CMBSs")

 

 

25,432

 

 

25,520

 

Agency Collateralized Mortgage Obligations ("Agency CMOs")

 

 

63,014

 

 

63,404

 

Asset Backed Securities ("ABSs")

 

 

333

 

 

370

 

Total Available for Sale

 

$

278,342

 

$

282,083

 

Held to Maturity:

 

 

 

 

 

 

 

U.S. Agency Obligations

 

$

20,332

 

$

21,025

 

U.S. GSEs

 

 

9,541

 

 

9,829

 

FHLB Obligations

 

 

4,748

 

 

4,930

 

Agency CMOs

 

 

82,038

 

 

82,584

 

Agency MBSs

 

 

7,270

 

 

7,507

 

Total Held to Maturity

 

 

123,929

 

 

125,875

 

Total Securities

 

$

402,271

 

$

407,958

 

 

Agency MBSs and Agency CMOs consist of pools of residential mortgages which are guaranteed by the FNMA, FHLMC, or Government National Mortgage Association (“GNMA”) with various origination dates and maturities.  Agency CMBSs consist of bonds backed by commercial real estate which are guaranteed by FNMA.

 

We do not intend to sell the investment securities that are in an unrealized loss position, and it is unlikely that we will be required to sell the investment securities before recovery of their amortized cost bases, which may be maturity.

 

Deposits and Other Liabilities

 

Quarterly average deposit balances increased by $60 million to $1.40 billion, a 4% increase over quarterly averages for the third quarter of 2014. Securities sold under agreement to repurchase, which represent collateralized customer accounts, were $268 million at September 30, 2015, an increase of $80 million from September 30, 2014, due to an increase in municipal customers. 

 

CREDIT QUALITY AND ALLOWANCE FOR CREDIT LOSSES

 

The United States economy continues to show improvement into 2015; however, high unemployment and foreclosure rates continue in certain parts of the country.  Although Vermont, our primary market, has not been immune to this economic turmoil, the state has one of the lowest foreclosure rates in the country, home price depreciation has been muted, and the unemployment rate is lower than the national average.

 

Credit quality

 

Credit quality is a major strategic focus and strength of our company.  Although we actively manage current nonperforming and classified loans, there is no assurance that we will not have increased levels of problem assets in the future.  The pool of nonperforming loans is dynamic with accounts moving in and out of this category over time.

 

39


 

The following table summarizes our nonperforming loans and nonperforming assets as of the dates indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(In thousands)

    

September 30, 2015

    

June 30, 2015

    

December 31, 2014

    

September 30, 2014

 

Nonaccrual loans

 

$

713

 

$

748

 

$

598

 

$

308

 

Loans past due greater than 90 days and accruing

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Troubled debt restructurings (“TDR”)

 

 

691

 

 

639

 

 

193

 

 

424

 

Total nonperforming loans

 

 

1,404

 

 

1,387

 

 

791

 

 

732

 

OREO

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Total nonperforming assets

 

$

1,404

 

$

1,387

 

$

791

 

$

732

 

 

Non-performing loans at September 30, 2015 were $1.40 million, 0.11% of total loans. Of the $1.40 million in nonperforming loans in the table above, $566 thousand are commercial and commercial real estate loans and $838 thousand are residential mortgages and home equity loans.

 

We originate traditional mortgage and home equity products that are fully documented and underwritten. We take a proactive risk management approach by conducting periodic stress-testing of the existing residential loan portfolio and adjusting underwriting requirements, if necessary, based upon the results of the analysis. The assumptions used in the stress testing include: credit score migration; calculation of possible losses using conservative assumptions of market decline; review of life-of-loan delinquency levels relative to loan size and credit score; analysis of the portfolio by loan size, and distribution within the portfolio by loan-to-value ratios. Based upon the results of assessments of the residential loan portfolio, Management concluded that current reserve levels were adequate.

 

Our analysis indicates that, through a combination of estimated collateral value and, where needed, an appropriately allocated reserve, any additional loss exposure on current non-accruing loans is minimal.

 

TDRs represent balances where the existing loan was modified involving a concession in rate, term or payment amount due to the distressed financial condition of the borrower. At September 30, 2015, $51 thousand of TDRs were in nonaccrual status and $640 thousand were accruing interest.

 

Excluded from the nonperforming balances discussed above are loans that are 31 to 90 days past due, which are not necessarily considered classified or impaired.  Accruing loans 31 to 90 days past due as a percentage of total loans as of the periods indicated are presented in the following table:

 

 

 

 

 

Period Ended

    

31-90 Days

 

September 30, 2015

 

0.01

%

June 30, 2015

 

0.04

%

March 31, 2015

 

0.02

%

December 31, 2014

 

0.04

%

September 30, 2014

 

0.02

%

 

Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days. If a loan or a portion of a loan is internally classified as impaired or is partially charged-off, the loan is generally classified as nonaccrual. Loans that are on a current payment status or past due less than 91 days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt. Income accruals are suspended on all nonaccruing loans, and all previously accrued and uncollected interest is charged against current income.

 

Loans may be returned to accrual status when there is a sustained period of repayment performance (generally a minimum of three months) by the borrower, in accordance with the contractual terms of the loans and all principal and interest amounts contractually due, including arrearages, are reasonably assured of repayment within an acceptable period of time.

While a loan is classified as nonaccrual and the future collectability of the recorded loan balance is uncertain, any payments received are generally applied to reduce the principal balance. When the future collectability of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan has been partially charged-off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded

40


 

loan balance at the contractual interest rate. Interest collections in excess of that amount are recorded as a reduction of principal.

 

A loan remains in nonaccruing status until the factors which suggest doubtful collectability no longer exist, the loan is liquidated, or when the loan is determined to be uncollectible, and is charged off against the allowance for loan losses.  In those cases where a nonaccruing loan is secured by real estate, we can, and may, initiate foreclosure proceedings.  The result of such action will either be to cause repayment of the loan with the proceeds of a foreclosure sale or to give us possession of the collateral in order to manage a future resale of the real estate.  Foreclosed property is recorded at the lower of its cost or estimated fair value, less any estimated costs to sell and is actively marketed.  Any cost in excess of the estimated fair value on the transfer date is charged to the allowance for loan losses, while further declines in market values are recorded as OREO expense in the consolidated statements of income. Impaired loans, which primarily consist of non-accruing residential mortgage and commercial real estate loans and TDRs, totaled $1.40 million and $791 thousand at September 30, 2015 and December 31, 2014, respectively.  At September 30, 2015, impaired loans with a recorded investment of $381 thousand had specific reserve allocations totaling $139 thousand while impaired loans with a total recorded investment of $1.02 million had no specific reserve allocation.

 

Substandard loans at September 30, 2015 totaled $27.99 million, of which $27.30 million in loans continue to accrue interest. Loans identified as substandard have well-defined weaknesses that, if not addressed, could result in a loss.  These accruing substandard loans have generally continued to pay promptly and Management conducts regularly scheduled comprehensive reviews of the borrowers’ financial condition, payment performance, accrual status and collateral.  These reviews also ensure that these troubled accounts are properly administered with a focus on loss mitigation and that any potential loss exposures are appropriately quantified, and reserved for. The findings of this review process are a key component in assessing the adequacy of our loan loss reserve.

 

Accruing substandard loans at September 30, 2015 reflect a $2.80 million decrease in balances since December 31, 2014. At September 30, 2015, accruing substandard loans related to owner-occupied commercial and construction real estate totaled $15.24 million, investor commercial real estate loans totaled $1.39 million, residential investment real estate loans totaled $201 thousand, and $10.48 million in substandard loans are outstanding to corporate borrowers in a variety of different industries. Eleven borrowers in a variety of industries account for 92% of the total accruing substandard loans, and approximately $8 thousand of the total accruing substandard loans carry some form of government guarantee.

 

To date, with very few exceptions, payments due from accruing substandard borrowers have been made as agreed and Management’s ongoing evaluation of these borrowers’ financial condition and collateral indicates a reasonable certainty that these exposures are adequately secured.

 

Management monitors asset quality closely and continuously performs detailed and extensive reviews on larger credits and problematic credits identified on the watched asset list, nonperforming asset listings and internal credit rating reports.  In addition to frequent financial analysis and review of well-rated and adversely graded loans, Management incorporates active monitoring of key credit and non-credit risks for each customer, assessing risk through the daily reviews of overdrafts, delinquencies and usage of electronic banking products and tracking for timely receipt of all required financial statements.

 

Allowance for Credit Losses

 

The Allowance is made up of two components: the allowance for loan losses (“ALL”) and the reserve for undisbursed lines and letters of credit.  The ALL is based on Management's estimate of the amount required to reflect the probable incurred losses in the loan portfolio, based on circumstances and conditions known at each reporting date. We review the adequacy of the ALL quarterly. Factors considered in evaluating the adequacy of the ALL include previous loss experience, the size and composition of the portfolio, risk rating composition, current economic and real estate market conditions and their effect on the borrowers, the performance of individual loans in relation to contractual terms and estimated fair values of properties that secure impaired loans.

 

The adequacy of the ALL is determined using a consistent, systematic methodology, consisting of a review of both specific reserves for loans identified as impaired and general reserves for the various loan portfolio classifications.  When a loan is

41


 

impaired, we determine its impairment loss by comparing the excess, if any, of the loan’s carrying amount over (1) the present value of expected future cash flows discounted at the loan’s original effective interest rate, (2) the observable market price of the impaired loan, or (3) the fair value of the collateral securing a collateral-dependent loan.  When a loan is deemed to have an impairment loss, the loan is either charged down to its estimated net realizable value, or a specific reserve is established as part of the overall allowance for loan losses if Management needs more time to evaluate all of the facts and circumstances relevant to that particular loan.

 

The general allowance for loan losses is a percentage-based reflection of historical loss experience adjusted for qualitative factors and assigns a required allocation by loan classification based on a fixed percentage of all outstanding loan balances. The general allowance for loan losses employs a risk-rating model that grades loans based on their general characteristics of credit quality and relative risk. Appropriate reserve levels are estimated based on Management’s judgments regarding the historical loss experience, current economic trends, trends in the portfolio mix, volume and trends in delinquencies and non-accrual loans.

 

Losses are charged against the ALL when Management believes that the collectability of principal is doubtful. To the extent Management determines the level of anticipated losses in the portfolio has increased or decreased, the ALL is adjusted through current earnings. Overall, Management believes that the ALL is maintained at an adequate level, in light of historical and current factors, to reflect the level of credit risk in the loan portfolio. Loan loss experience and nonperforming asset data are presented and discussed in relation to their impact on the adequacy of the ALL.

 

The following table reflects our loan loss experience and activity in the Allowance for the periods indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months

 

Nine Months

 

Twelve Months

 

Nine Months

 

 

 

Ended

 

Ended

 

Ended

 

Ended

 

(In thousands)

    

September 30, 2015

    

September 30, 2015

    

December 31, 2014

    

September 30, 2014

 

Average loans during the period

 

$

1,245,861

 

$

1,218,067

 

$

1,165,586

 

$

1,166,197

 

Allowance beginning of the year

 

 

12,891

 

 

12,815

 

 

12,828

 

 

12,828

 

Charge-offs:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, financial & agricultural

 

 

(11)

 

 

(28)

 

 

(34)

 

 

(34)

 

Residential

 

 

(29)

 

 

(84)

 

 

(25)

 

 

(25)

 

Commercial Real Estate

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Installment, Other

 

 

(22)

 

 

(65)

 

 

(172)

 

 

(99)

 

Total charge-offs

 

 

(62)

 

 

(177)

 

 

(231)

 

 

(158)

 

Recoveries:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, financial & agricultural

 

 

3

 

 

31

 

 

10

 

 

3

 

Residential

 

 

7

 

 

36

 

 

24

 

 

20

 

Commercial Real Estate

 

 

1

 

 

2

 

 

1

 

 

 —

 

Construction

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Installment, Other

 

 

8

 

 

41

 

 

33

 

 

15

 

Total recoveries

 

 

19

 

 

110

 

 

68

 

 

38

 

Net recoveries (charge-offs)

 

 

(43)

 

 

(67)

 

 

(163)

 

 

(120)

 

Provision for credit losses

 

 

150

 

 

250

 

 

150

 

 

150

 

Allowance end of period

 

$

12,998

 

$

12,998

 

$

12,815

 

$

12,858

 

Ratio of net (charge-offs) recoveries to average loans outstanding

 

 

0.00 

%  

 

(0.01)

%  

 

(0.01)

%  

 

(0.01)

%  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Components:

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses

 

$

12,210

 

$

12,210

 

$

11,833

 

$

12,019

 

Reserve for undisbursed lines and letters of credit

 

 

788

 

 

788

 

 

982

 

 

839

 

Allowance for credit losses

 

$

12,998

 

$

12,998

 

$

12,815

 

$

12,858

 

 

42


 

The following table reflects our nonperforming asset and coverage ratios as of the dates indicated:

 

 

 

 

 

 

 

 

 

 

 

 

    

September 30, 2015

    

June 30, 2015

    

December 31, 2014

    

September 30, 2014

    

NPL to total loans

 

0.11

%  

0.12

%  

0.07

%  

0.06

%  

NPA to total assets

 

0.08

%  

0.08

%  

0.05

%  

0.04

%  

Allowance for loan losses to total loans

 

0.97

%  

1.01

%  

1.00

%  

1.04

%  

Allowance for loan losses to NPL

 

870

%  

877

%  

1496

%  

1642

%  

 

We will continue to take all appropriate measures to restore nonperforming assets to performing status or otherwise liquidate these assets in an orderly fashion so as to maximize their value. There can be no assurances that we will be able to complete the disposition of nonperforming assets without incurring further losses.

 

Loan Portfolio Monitoring

 

Our Board of Directors grants each loan officer the authority to originate loans on our behalf, subject to certain limitations. The Board of Directors also establishes restrictions regarding the types of loans that may be granted and the distribution of loan types within our portfolio, and sets loan authority limits for each lender. These authorized lending limits are reviewed at least annually and are based upon the lender's experience. Loan requests that exceed a lender's authority require the signature of our Senior Lender, the Senior Credit Officer, and/or our President. With the exception of certain municipal loans, all extensions of credit of $5.0 million or greater to any one borrower, or related party interest, are reviewed and approved by the Loan Committee of Merchants Bank’s Board of Directors. Short-term revenue anticipation and tax anticipation extensions of credit of $8.0 million or greater to a municipality are reviewed and approved by the Loan Committee of Merchants Bank’s Board of Directors.

 

The Loan Committee and the credit department regularly monitor our loan portfolio. The entire loan portfolio, as well as individual loans, is reviewed for loan performance, compliance with internal policy requirements and banking regulations, creditworthiness, and strength of documentation. We monitor loan concentrations by individual borrowers, industries and loan types. As part of the annual credit policy review process, targets are set by loan type for the total portfolio. Credit risk ratings assessing inherent risk in individual loans are assigned to commercial loans at origination and are routinely reviewed by lenders and Management on a periodic basis according to total exposure and risk rating. These internal reviews assess the adequacy of all aspects of credit administration, additionally, we maintain an on-going active monitoring process of loan performance during the year.  We have also hired external loan review firms to assist in monitoring the commercial, municipal and residential loan portfolios. The commercial loan review firm annually reviews, approximately 50% in dollar volume of our commercial loan portfolio and certain transactions based on amount and maturity date for our municipal loan portfolio. These comprehensive reviews assessed the accuracy of our risk rating system as well as the effectiveness of credit administration in managing overall credit risks.

 

All loan officers are required to service their loan portfolios and account relationships. Loan officers, a commercial workout officer, or collection personnel take remedial actions to assure full and timely payment of loan balances as necessary, with the supervision of the Senior Lender and the Senior Credit Officer.

 

Liquidity and Capital Resource Management

 

General

 

Liquid assets are maintained at levels considered adequate to meet our liquidity needs.  Liquidity is adjusted as appropriate to meet asset and liability management objectives. Liquidity is monitored by the Asset and Liability Committee (“ALCO”) of Merchants Bank’s Board of Directors, based upon Merchants Bank’s policies. Our primary sources of liquidity are deposits, amortization and prepayment of loans, maturities of investment securities and other short-term investments, periodic principal repayments on mortgage-backed and other amortizing securities, advances from the FHLBB, and earnings and funds provided from operations. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan and investment prepayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competition. Interest rates on deposits are priced to maintain a desired level of total deposits.

43


 

 

As of September 30, 2015, we could borrow up to $65 million in overnight funds through unsecured borrowing lines established with correspondent banks.  We have established both overnight and longer term lines of credit with the FHLBB.  FHLBB borrowings are secured by residential mortgage loans. The total amount of loans pledged to the FHLBB for both short- and long-term borrowing arrangements totaled $265.37 million at September 30, 2015. We have additional borrowing capacity with the FHLBB of $251.26 million as of September 30, 2015.  We have also established a borrowing facility with the Board of Governors of the Federal Reserve System (“FRB”) which will enable us to borrow at the discount window. Additionally, we have the ability to borrow through the use of repurchase agreements, collateralized by Agency MBSs and Agency CMOs, with certain approved counterparties. Our investment portfolio, which is managed by the ALCO, has a cost basis of $402.27 million at September 30, 2015, of which $347.64 million was pledged. The Bank was required to pledge $218.05 million at September 30, 2015, which resulted in $129.59 million of excess pledged liquidity for the period. The portfolio is a reliable source of cash flow for us. We closely monitor our short term cash position.  Any excess funds are left on deposit at the FRB.

 

The following table presents information regarding our short-term borrowings as of the dates indicated:

 

 

 

 

 

 

 

 

 

 

 

    

Three Months Ended 

    

Nine Months Ended 

    

    

(Dollars in thousands)

 

September 30, 2015

 

September 30, 2015

 

 

Securities sold under agreement to repurchase, short-term

 

 

 

 

 

 

 

 

Amount outstanding at end of period

 

$

267,794

 

$

267,794

 

 

Maximum during the period amount outstanding

 

 

278,748

 

 

278,748

 

 

Average amount outstanding

 

 

195,410

 

 

212,859

 

 

Weighted average-rate during the period

 

 

0.18

%

 

0.24

%

 

Weighted average rate at period end

 

 

0.18

%

 

0.18

%

 

FHLBB and other short-term borrowings

 

 

 

 

 

 

 

 

Amount outstanding at end of period

 

$

 —

 

$

 —

 

 

Maximum during the period amount outstanding

 

 

37,000

 

 

63,000

 

 

Average amount outstanding

 

 

9,649

 

 

5,285

 

 

Weighted average-rate during the period

 

 

0.33

%  

 

0.33

%

 

Weighted average rate at period end

 

 

 —

%  

 

 —

%

 

 

Commitments and Off-Balance Sheet Risk

 

We are a party to financial instruments with off‑balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments primarily include commitments to extend credit and financial guarantees. Contingent obligations under standby letters of credit totaled approximately $6.19 million and $7.58 million at September 30, 2015 and September 30, 2014, respectively, and represent the maximum potential future payments we could be required to make. Typically, these instruments have terms of 12 months or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements. The fair value of our standby letters of credit at September 30, 2015 and 2014 was insignificant.

 

Capital Resources

 

We are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements results in certain mandatory, and the possibility of additional discretionary, actions by regulators that could have a direct material effect on our financial statements. Under capital adequacy guidelines, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. It is the policy of the FRB that banks and bank holding companies should pay dividends only out of current earnings and only if, after paying such dividends, the bank or bank holding company would remain adequately capitalized. We are also subject to the regulatory framework for prompt corrective action that requires us to meet specific capital guidelines to be considered well capitalized. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

 

44


 

Quantitative measures established by regulation to ensure capital adequacy require us to maintain minimum ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of September 30, 2015, that Merchants met all capital adequacy requirements to which it is subject.

 

As of September 30, 2015, the most recent notification from the FDIC categorized Merchants Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that Management believes have changed Merchants Bank’s category. We continue to be considered well capitalized under current applicable regulations.

 

Under rules effective January 1, 2015, a bank holding company, such as the Company, is considered “well capitalized” if the bank holding company (i) has a total risk based capital ratio of at least 10%, (ii) has a Tier I risk-based capital ratio of at least 8%, and (iii) is not subject to any written agreement order, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. In addition, the FDIC has amended its prompt corrective action rules to reflect the revisions made by the new capital rules implementing Basel III. Under the FDIC’s revised rules, which became effective January 1, 2015, an FDIC supervised institution is considered “well capitalized” if it (i) has a total risk-based capital ratio of 10.0% or greater; (ii) a Tier I risk-based capital ratio of 8.0% or greater; (iii) a common Tier I equity ratio of at least 6.5% or greater, (iv) a leverage capital ratio of 5.0% or greater; and (iv) is not subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure.  The final rule also requires unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt-out is exercised.  The Bank elected to opt-out of this regulatory capital provision.  By opting out of the provision, the bank retains what is known as the accumulated other comprehensive income filter.  The rule limits a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements. 

 

The following table represents our actual capital ratios and capital adequacy requirements as of September 30, 2015. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

.

    

    

 

    

    

    

    

 

    

    

    

To Be Well-

    

    

 

 

 

 

 

 

 

 

 

 

 

 

 

Capitalized Under

 

 

 

 

 

 

 

 

 

 

For Capital

 

 

 

Prompt Corrective

 

 

 

 

 

Actual

 

 

 

Adequacy Purposes

 

 

 

Action Provisions

 

 

 

(In thousands)

 

Amount

 

Percent

 

Amount

 

Percent

 

Amount

 

Percent

 

Merchants Bancshares, Inc.:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier 1 Leverage Capital

 

$

157,351

 

8.93

%

$

70,444

 

4.00

%

 

N/A

 

N/A

 

Tier 1 Risk-Based Capital

 

 

157,351

 

15.85

%

 

59,753

 

6.00

%

 

N/A

 

N/A

 

Total Risk-Based Capital

 

 

169,769

 

17.10

%

 

79,431

 

8.00

%

 

N/A

 

N/A

 

Common Equity Tier 1 Capital

 

 

137,351

 

13.83

%

 

44,680

 

4.50

%

 

N/A

 

N/A

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Merchants Bank:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier 1 Leverage Capital

 

$

153,812

 

8.72

%

$

70,582

 

4.00

%

$

88,228

 

5.00

%

Tier 1 Risk-Based Capital

 

 

153,812

 

15.40

%

 

59,940

 

6.00

%

 

79,920

 

8.00

%

Total Risk-Based Capital

 

 

166,305

 

16.65

%

 

79,920

 

8.00

%

 

99,900

 

10.00

%

Common Equity Tier 1 Capital

 

 

153,812

 

15.40

%

 

44,955

 

4.50

%

 

64,935

 

6.50

%

 

 

Capital amounts for Merchants Bancshares, Inc. include $20 million in trust preferred securities issued in December 2004. These hybrid securities qualify as regulatory capital up to certain regulatory limits.

 

ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

General

 

Our Management and Board of Directors are committed to sound risk management practices throughout the organization. We have developed and implemented a centralized risk management monitoring program. Risks associated with our business activities and products are identified and measured as to probability of occurrence and impact on us (low,

45


 

moderate, or high), and the control or other activities in place to manage those risks are identified and assessed. Periodically, department-level and senior managers re-evaluate and report on the risk management processes for which they are responsible. This documented program provides Management with a comprehensive framework for monitoring our risk profile from a macro perspective; it also serves as a tool for assessing internal controls over financial reporting as required under the Federal Deposit Insurance Corporation Improvement Act and the Sarbanes-Oxley Act of 2002.

 

Liquidity Risk

 

Our liquidity is measured by our ability to raise cash when needed at a reasonable cost.  We must be capable of meeting expected and unexpected obligations to customers at any time.  Given the uncertain nature of customer demands as well as the need to maximize earnings, we must have available reasonably priced sources of funds that can be accessed quickly in time of need.  As discussed previously under “Liquidity and Capital Resources,” we have several sources of readily available funds, including the ability to borrow using our loan and investment portfolios as collateral. We also monitor our liquidity in compliance with our Liquidity Contingency Plan.

 

Market Risk – Interest Rate Risk

 

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices, and equity prices. Our primary market risk exposure is interest rate risk. An important component of our asset and liability management process is the ongoing monitoring and management of this risk, which is governed by established policies that are reviewed and approved annually by our Bank’s Board of Directors. Our investment policy details the types of securities that may be purchased, and establishes portfolio limits and maturity limits for the various sectors. Our investment policy also establishes specific investment quality limits. Our Bank’s Board of Directors has established a Board-level ALCO, which delegates responsibility for carrying out the asset/liability management policies to the Management-level Asset and Liability Committee (“Management ALCO”). The Management ALCO, chaired by the Chief Financial Officer and composed of members of senior management, develops guidelines and strategies impacting our asset and liability management-related activities based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends. The Management ALCO manages the investment portfolio. Our goal is to maximize net interest income while mitigating market and interest rate risk.  We accomplish this through careful monitoring of the overall duration and average life of the portfolio, thorough analysis of securities we are considering for purchase, monitoring of individual securities, occasional repositioning of the investment portfolio, as well as selective sales of specific securities.

 

The Management ALCO is responsible for evaluating and managing the interest rate risk which arises naturally from imbalances in repricing, maturity and cash flow characteristics of our assets and liabilities. Techniques used by the Management ALCO take into consideration the cash flow and repricing attributes of balance sheet and off-balance sheet items and their relation to possible changes in interest rates. The Management ALCO manages interest rate exposure primarily by using on-balance sheet strategies, generally accomplished through the management of the duration, rate sensitivity and average lives of our various investments, and by extending or shortening maturities of borrowed funds, as well as carefully managing and monitoring the maturities and pricing of loans and deposits. The Management ALCO also considers the use of off-balance sheet strategies, such as interest rate caps and floors and interest rate swaps, to help minimize our exposure to changes in interest rates.  By using derivative financial instruments to hedge exposures to changes in interest rates we expose ourselves to credit risk and market risk.  Credit risk is the failure of the counterparty to perform under the terms of the derivative contract.  When the fair value of a derivative contract is positive, the counterparty owes us, which creates credit risk for us.  We minimize the credit risk in derivative instruments by entering into transactions only with high-quality counterparties and monitoring their financial condition.  The market risk associated with interest rate contracts is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken.

 

The ALCO is responsible for ensuring that our Bank’s Board of Directors receives accurate information regarding our interest rate risk position at least quarterly. The ALCO uses an outside consultant to perform rate shocks of our balance sheet, and to perform a variety of other analyses. The ALCO consultant meets with the Board and Management-level ALCOs on a quarterly basis. During these meetings, the ALCO consultant reviews our current position and discusses future strategies, as well as reviewing the result of rate shocks of our balance sheet and a variety of other analyses. The

46


 

consultant’s most recent review was as of September 30, 2015. The consultant ran a base simulation assuming no changes in rates as well as a 200 basis point rising and, because rates are quite low, a 100 basis point falling interest rate scenario which assumes a parallel and pro rata shift of the yield curve over a one-year period, and no growth assumptions.  The consultant also ran simulations in a 400 basis points rising scenario and a 200 and 500 basis point flattening scenario. Additionally, the consultant ran simulations with other changes in the yield curve and with prepayment speed changes.  A summary of the results is as follows:

 

Current/Flat Rates: If rates remain at current levels net interest income is projected to trend downward for the entire simulation as asset yields will continue to decline while funding costs provide little to no relief.

 

Falling Rates: If rates fall 100 basis points, our net interest income is projected to trend in line with the base case over the first year as we bring funding costs down to near zero.  Thereafter net interest income is reduced as increased prepayment speeds accelerate asset cash flow putting added pressure on asset yields, while deposit rate reductions are limited as they are at or near their floors.

 

Rising Rates: Higher rates are better for us under all scenarios. If rates rise in a parallel fashion net interest income rises above the base case immediately and continues to increase throughout the simulation as asset yields improve and outpace assumed funding costs increases.  This asset sensitivity holds true even if the yield curve were to flatten as rates rise.

 

We have established a target range for the change in net interest income in year one of zero to 7.5%. The net interest income simulation as of September 30, 2015 showed that the change in net interest income for the next 12 months from our expected or “most likely” forecast was as follows:

 

 

 

 

 

 

    

Percent Change in Net

 

Rate Change

 

Interest Income

 

Up 200 basis points

 

2.60

%

Down 100 basis points

 

(0.60)

%

 

The change in net interest income in the second year of the simulation shows a much more pronounced downward trend in the flat and down 100 basis points scenarios, the projected change is (1.9)% and (10.5)%, respectively, while the up 200 basis points simulation produces an increase of 8.2%.  The degree to which this exposure materializes will depend, in part, on our ability to manage our balance sheet as interest rates rise or fall.  

 

The preceding sensitivity analysis does not represent our forecast and should not be relied upon as being indicative of expected operating results.  These estimates are based upon numerous assumptions including, among others, the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, deposit run-off rates, pricing decisions on loans and deposits and reinvestment/replacement of asset and liability cash flows. While assumptions are developed based upon current economic and local market conditions, we cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.

 

The model used to perform the base case balance sheet simulation assumes a parallel shift of the yield curve over twelve months and reprices every interest earning asset and interest bearing liability on our balance sheet. Prepayment assumptions for all residential mortgage products take into account prepayment assumptions most recently published by Applied Financial Technologies. Prepayment assumptions for commercial loan and commercial mortgage products are derived through an analysis of historical prepayment patterns combined with analysis of the current characteristics of the portfolio. Investment securities with call provisions are examined on an individual basis in each rate environment to estimate the likelihood of a call. The model uses product-specific assumptions for deposits which are subject to repricing based on current market conditions

 

The most significant ongoing factor affecting market risk exposure of net interest income during the quarter ended September 30, 2015 was the sustained low interest rate environment.  Net interest income exposure is also significantly affected by the shape and level of the U.S. Government securities and interest rate swap yield curves, and changes in the size and composition of the loan, investment and deposit portfolios.

 

47


 

As market conditions vary from those assumed in the sensitivity analysis, actual results will likely differ due to: the varying impact of changes in the balances and mix of loans and deposits differing from those assumed, the impact of possible off balance sheet hedging strategies, and other internal/external variables. Furthermore, the sensitivity analysis does not reflect all actions that the ALCO might take in responding to or anticipating changes in interest rates.

 

Credit Risk

 

The Board of Directors reviews and approves our loan policy on an annual basis. Among other things, the loan policy establishes restrictions regarding the types of loans that may be granted, and the distribution of loan types within our portfolio. Our Board of Directors grants each loan officer the authority to originate loans on our behalf, subject to certain limitations. These authorized lending limits are reviewed at least annually and are based upon the lender’s experience. Loan requests that exceed a lender’s authority require the signature of our Credit Division Manager, Senior Loan Officer, and/or President. With the exception of certain municipal loans, all extensions of credit of $5.0 million or greater to any one borrower, or related party interest, are reviewed and approved by the Loan Committee of Merchants Bank’s Board of Directors. Short-term revenue anticipation and tax anticipation extensions of credit of $8.0 million or greater to a municipality are reviewed and approved by the Loan Committee of Merchants Bank’s Board of Directors. Our loan portfolio is continuously monitored for performance, creditworthiness and strength of documentation through the use of a variety of management reports and the assistance of an external loan review firm.  Credit ratings are assigned to commercial loans and are routinely reviewed. Loan officers, under the supervision of the Senior Lender and Senior Credit Officer, take remedial actions to assure full and timely payment of loan balances when necessary.  Our policy is to discontinue the accrual of interest on loans when scheduled payments become contractually more than 90 days past due and the ultimate collectability of principal or interest becomes  doubtful.  In certain instances the accrual of interest is discontinued prior to 91 days past due if Management determines that the borrower will not be able to continue making timely payments.

 

Item 4. Controls and Procedures

 

Our principal executive officer, principal financial officer, and other members of our senior management have evaluated our disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on this evaluation, our principal executive officer and principal financial officer have concluded that the disclosure controls and procedures effectively ensure that information required to be disclosed in our filings and submissions with the SEC under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to our management (including the principal executive officer and principal financial officer), and is recorded, processed, summarized and reported within the time periods specified by the SEC. In addition, we have reviewed our internal control over financial reporting and there have been no changes in our internal control over financial reporting during the quarter ended September 30, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

48


 

MERCHANTS BANCSHARES, INC.

PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings  

 

None.

 

Item 1A. Risk Factors  

 

In addition to the other information set forth in this report, please read the factors discussed in Part I – Item 1A, "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014 filed with the SEC on March 13, 2015, which could materially adversely affect our business, financial condition and operating results. These risks are not the only ones facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and operating results. 

 

Additional risk factors which have been identified subsequent to the filing of the 2014 Annual Report on Form 10-K include:

 

We May be Negatively Impacted by Certain Risks Inherent in Our Pending Acquisition.

 

We have pending a proposed acquisition of NUVO Bank & Trust Company, Springfield, Massachusetts (“NUVO”), which we expect will be completed in the fourth quarter of 2015.  The success of our acquisition of NUVO may depend on, among other things, our ability to realize anticipated revenue enhancements and cost savings from integrating NUVO’s business and operations into Merchants.  If we are not able to achieve these objectives, the anticipated benefits of an acquisition may not be realized fully or at all or may take longer to realize than expected.  The potential uncertainties and challenges to efficient and successful integration of NUVO into Merchants include difficulties in integrating NUVO’s personnel, conversion of NUVO’s data and information technology systems to those of Merchants, retention and expansion of NUVO’s customer base, acceptance of Merchants product offerings by the banking public in NUVO’s market area, retention of key NUVO employees, and managing banking operations in different states.  These and other factors could result in the acquisition not being as accretive as expected or accretive in the timeframe expected, or having a dilutive effect on our earnings per share.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

None. 

 

Item 3. Defaults Upon Senior Securities  

 

None. 

 

Item 4. Mine Safety Disclosure  

 

Not applicable. 

 

Item 5. Other Information  

 

None.

 

49


 

Item 6. Exhibits  

 

 

 

 

 

 

 

31.1*

Certification of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended

 

 

31.2*

Certification of Chief Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended

 

 

32.1**

Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

32.2**

Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

101*

The following materials from Merchants Bancshares, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2015 formatted in XBRL: (i) Consolidated Balance Sheets at September 30, 2015 and December 31, 2014; (ii) Consolidated Statements of Income for the three and nine months ended September 30, 2015 and 2014; (iii) Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2015 and 2014; (iv) Consolidated Statements of Cash Flows for the nine months ended September 30, 2015 and 2014; and (v) Notes to Interim Unaudited Consolidated Financial Statements. 


+Managed contract or compensatory plan or agreement

*Filed herewith

**Furnished herewith

 

50


 

MERCHANTS BANCSHARES, INC.

SIGNATURES  

 

Pursuant to the requirements 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.

 

 

 

 

 

 

Merchants Bancshares, Inc.

 

 

 

/s/ Michael R. Tuttle

 

Michael R. Tuttle

 

President & Chief Executive Officer

 

 

 

/s/ Thomas J. Meshako

 

Thomas J. Meshako

 

Chief Financial Officer & Treasurer Principal Accounting Officer

 

 

 

 

 

November 6, 2015

 

Date

 

 

 

51