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EX-32 - EXHIBIT 32 - FIRST SOUTH BANCORP INC /VA/ | v424236_ex32.htm |
EX-31.1 - EXHIBIT 31.1 - FIRST SOUTH BANCORP INC /VA/ | v424236_ex31-1.htm |
EX-31.2 - EXHIBIT 31.2 - FIRST SOUTH BANCORP INC /VA/ | v424236_ex31-2.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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: 0-22219
FIRST SOUTH BANCORP, INC.
(Exact name of registrant as specified in its charter)
Virginia | 56-1999749 |
(State or other jurisdiction of | (IRS Employer |
incorporation or organization) | Identification No.) |
1311 Carolina Avenue, Washington, North Carolina 27889
(Address of principal executive offices)
(Zip Code)
(252) 946-4178
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
Large Accelerated Filer ¨ | Accelerated Filer ¨ |
Non-Accelerated Filer ¨ | Smaller Reporting Company x |
(Do not check if a Smaller Reporting Company) |
Indicate by check mark whether registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes ¨ No x
Number of shares of common stock outstanding as of November 12, 2015: 9,489,222.
CONTENTS
First South Bancorp, Inc. and Subsidiary
Consolidated Statements of Financial Condition
September 30, | December 31, | |||||||
2015 | 2014 | |||||||
(Unaudited) | (As restated) | |||||||
Assets | ||||||||
Cash and due from banks | $ | 17,825,684 | $ | 23,281,016 | ||||
Interest-bearing deposits with banks | 24,860,710 | 32,835,661 | ||||||
Investment securities available-for-sale, at fair value | 248,352,358 | 292,298,910 | ||||||
Investment securities held-to-maturity | 508,169 | 507,309 | ||||||
Mortgage loans held for sale | 4,029,423 | 4,792,943 | ||||||
Loans and leases held for investment | 567,304,315 | 480,436,270 | ||||||
Allowance for loan and lease losses | (7,569,573 | ) | (7,519,970 | ) | ||||
Net loans and leases held for investment | 559,734,742 | 472,916,300 | ||||||
Premises and equipment, net | 15,289,727 | 15,821,436 | ||||||
Other real estate owned | 6,506,062 | 7,755,541 | ||||||
Federal Home Loan Bank stock, at cost | 2,199,300 | 606,500 | ||||||
Accrued interest receivable | 2,678,319 | 2,851,650 | ||||||
Goodwill | 4,218,576 | 4,218,576 | ||||||
Mortgage servicing rights | 1,228,702 | 1,178,115 | ||||||
Identifiable intangible assets | 1,967,363 | 2,182,909 | ||||||
Income tax receivable | - | 1,591,105 | (a) | |||||
Bank-owned life insurance | 15,507,035 | 15,125,498 | ||||||
Prepaid expenses and other assets | 8,461,656 | 7,467,178 | (a) | |||||
Total assets | $ | 913,367,826 | $ | 885,430,647 | ||||
Liabilities and Stockholders' Equity | ||||||||
Deposits: | ||||||||
Non-interest bearing demand | $ | 157,609,019 | $ | 147,543,594 | ||||
Interest bearing demand | 236,116,807 | 268,472,945 | ||||||
Savings | 133,569,878 | 117,932,606 | ||||||
Large denomination certificates of deposit | 110,764,798 | 111,523,043 | ||||||
Other time | 145,250,812 | 142,808,182 | ||||||
Total deposits | 783,311,314 | 788,280,370 | ||||||
Borrowings | 33,000,000 | - | ||||||
Junior subordinated debentures | 10,310,000 | 10,310,000 | ||||||
Other liabilities | 5,123,221 | 6,837,701 | ||||||
Total liabilities | 831,744,535 | 805,428,071 | ||||||
Common stock, $.01 par value, 25,000,000 shares authorized; 9,489,222 and 9,598,007 shares outstanding, respectively | 94,892 | 95,980 | ||||||
Additional paid-in capital | 35,920,933 | 35,869,195 | ||||||
Retained earnings | 42,360,680 | 40,868,919 | (a) | |||||
Accumulated other comprehensive income | 3,246,786 | 3,168,482 | ||||||
Total stockholders' equity | 81,623,291 | 80,002,576 | ||||||
Total liabilities and stockholders' equity | $ | 913,367,826 | $ | 885,430,647 |
(a) - revised for prior period error
The accompanying notes are an integral part of these consolidated financial statements.
1
First South Bancorp, Inc. and Subsidiary
Consolidated Statements of Operations
Three and Nine Months Ended September 30, 2015 and 2014
(Unaudited)
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
(As restated) | (As restated) | |||||||||||||||
Interest income: | ||||||||||||||||
Interest and fees on loans | $ | 6,639,177 | $ | 6,068,196 | $ | 18,834,471 | $ | 17,966,829 | ||||||||
Interest on investments and deposits | 1,577,440 | 1,248,382 | 5,047,181 | 3,642,464 | ||||||||||||
Total interest income | 8,216,617 | 7,316,578 | 23,881,652 | 21,609,293 | ||||||||||||
Interest expense: | ||||||||||||||||
Interest on deposits | 598,081 | 522,861 | 1,730,070 | 1,608,913 | ||||||||||||
Interest on borrowings | 54,077 | 112,174 | 61,593 | 157,287 | ||||||||||||
Interest on junior subordinated notes | 141,578 | 81,371 | 421,656 | 242,651 | ||||||||||||
Total interest expense | 793,736 | 716,406 | 2,213,319 | 2,008,851 | ||||||||||||
Net interest income | 7,422,881 | 6,600,172 | 21,668,333 | 19,600,442 | ||||||||||||
Provision for credit losses | 335,000 | 400,000 | 475,000 | 1,100,000 | ||||||||||||
Net interest income after provision for credit losses | 7,087,881 | 6,200,172 | 21,193,333 | 18,500,442 | ||||||||||||
Non-interest income: | ||||||||||||||||
Deposit fees and service charges | 2,093,101 | 1,118,599 | 6,067,959 | 3,184,808 | ||||||||||||
Loan fees and charges | 62,960 | 39,057 | 179,196 | 117,615 | ||||||||||||
Mortgage loan servicing fees | 263,679 | 248,399 | 807,126 | 724,827 | ||||||||||||
Gain on sale and other fees on mortgage loans | 528,745 | 428,514 | 1,486,278 | 1,076,583 | ||||||||||||
Gain (loss) on sale of other real estate, net | (63,402 | ) | 8,949 | 9,814 | 82,369 | |||||||||||
Gain on sale of investment securities | 502,576 | - | 954,514 | 13,509 | ||||||||||||
Other income | 378,574 | 401,584 | 1,057,395 | 1,133,910 | ||||||||||||
Total non-interest income | 3,766,233 | 2,245,102 | 10,562,282 | 6,333,621 | ||||||||||||
Non-interest expense: | ||||||||||||||||
Compensation and fringe benefits | 4,935,133 | 3,826,855 | 14,475,105 | 11,454,632 | ||||||||||||
Federal deposit insurance premiums | 163,200 | 137,253 | 445,081 | 420,873 | ||||||||||||
Premises and equipment | 1,312,123 | 877,447 | 3,976,577 | 2,534,608 | ||||||||||||
Advertising | 218,827 | 126,892 | 598,477 | 295,905 | ||||||||||||
Data processing | 818,680 | 566,513 | 2,805,101 | 1,720,321 | ||||||||||||
Amortization of intangible assets | 129,527 | 55,796 | 386,597 | 164,008 | ||||||||||||
Other real estate owned expense | 99,234 | 167,164 | 462,825 | 395,652 | ||||||||||||
Other | 1,330,098 | 779,226 | 4,137,281 | 2,592,176 | ||||||||||||
Total non-interest expense | 9,006,822 | 6,537,146 | 27,287,044 | 19,578,175 | ||||||||||||
Income before income tax expense | 1,847,292 | 1,908,128 | 4,468,571 | 5,255,888 | ||||||||||||
Income tax expense | 610,680 | 489,347 | (a) | 1,352,983 | 1,315,896 | (a) | ||||||||||
NET INCOME | $ | 1,236,612 | $ | 1,418,781 | (a) | $ | 3,115,588 | $ | 3,939,992 | (a) | ||||||
Per share data: | ||||||||||||||||
Basic earnings per share | $ | 0.13 | $ | 0.15 | (a) | $ | 0.33 | $ | 0.41 | (a) | ||||||
Diluted earnings per share | $ | 0.13 | $ | 0.15 | (a) | $ | 0.33 | $ | 0.41 | (a) | ||||||
Dividends per share | $ | 0.025 | $ | 0.025 | $ | 0.075 | $ | 0.075 | ||||||||
Average basic shares outstanding | 9,500,885 | 9,598,007 | 9,532,393 | 9,626,346 | ||||||||||||
Average diluted shares outstanding | 9,520,943 | 9,616,004 | 9,552,298 | 9,644,834 |
(a) - revised for prior period error
The accompanying notes are an integral part of these consolidated financial statements.
2
First South Bancorp, Inc. and Subsidiary
Consolidated Statements of Comprehensive Income
Three and Nine Months Ended September 30, 2015 and 2014
(Unaudited)
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
(As restated) | (As restated) | |||||||||||||||
Net income | $ | 1,236,612 | $ | 1,418,781 | (a) | $ | 3,115,588 | $ | 3,939,992 | (a) | ||||||
Other comprehensive income: | ||||||||||||||||
Increase in unrealized holding gains on securities available for sale | 2,311,993 | 104,902 | 1,230,573 | 4,923,452 | ||||||||||||
Tax effect | (833,326 | ) | (39,863 | ) | (381,712 | ) | (1,870,912 | ) | ||||||||
Unrealized holding gains on securities available for sale, net of tax | 1,478,667 | 65,039 | 848,861 | 3,052,540 | ||||||||||||
Unrealized gains (losses) on interest rate hedge position | (136,527 | ) | 46,857 | (148,089 | ) | (218,242 | ) | |||||||||
Tax effect | 50,925 | (17,806 | ) | 55,237 | 82,932 | |||||||||||
Unrealized gains (losses) on interest rate hedge position, net of tax | (85,602 | ) | 29,051 | (92,852 | ) | (135,310 | ) | |||||||||
Reclassification adjustment for realized gains included in net income | (502,576 | ) | - | (954,514 | ) | (13,509 | ) | |||||||||
Tax effect | 145,747 | - | 276,809 | 5,133 | ||||||||||||
Reclassification adjustment for realized gains, net of tax | (356,829 | ) | - | (677,705 | ) | (8,376 | ) | |||||||||
Other comprehensive income, net of tax | 1,036,236 | 94,090 | 78,304 | 2,908,854 | ||||||||||||
Comprehensive income | $ | 2,272,848 | $ | 1,512,871 | (a) | $ | 3,193,892 | $ | 6,848,846 | (a) |
(a) - revised for prior period error
The accompanying notes are an integral part of these consolidated financial statements.
3
First South Bancorp, Inc. and Subsidiary
Consolidated Statements of Changes in Stockholders' Equity
Nine Months Ended September 30, 2015 and 2014
(Unaudited)
Accumulated | ||||||||||||||||||||
Additional | other | |||||||||||||||||||
Common | paid-in | Retained | comprehensive | |||||||||||||||||
Nine Months Ended September 30, 2015 | stock | capital | earnings | income, net | Total | |||||||||||||||
(As restated) | (As restated) | |||||||||||||||||||
Balance at December 31, 2014 | $ | 95,980 | $ | 35,869,195 | $ | 40,868,919 | (a) | $ | 3,168,482 | $ | 80,002,576 | (a) | ||||||||
Net income | 3,115,588 | 3,115,588 | ||||||||||||||||||
Other comprehensive income, net | 78,304 | 78,304 | ||||||||||||||||||
Vesting of restricted stock awards, net | 35 | (989 | ) | (954 | ) | |||||||||||||||
Retirement of common shares | (1,123 | ) | (908,049 | ) | (909,172 | ) | ||||||||||||||
Stock based compensation expense | 52,727 | 52,727 | ||||||||||||||||||
Dividends | (715,778 | ) | (715,778 | ) | ||||||||||||||||
Balance at September 30, 2015 | $ | 94,892 | $ | 35,920,933 | $ | 42,360,680 | $ | 3,246,786 | $ | 81,623,291 |
Accumulated | ||||||||||||||||||||
Additional | other | |||||||||||||||||||
Common | paid-in | Retained | comprehensive | |||||||||||||||||
Nine Months Ended September 30, 2014 | stock | capital | earnings | income, net | Total | |||||||||||||||
(As restated) | (As restated) | |||||||||||||||||||
Balance at December 31, 2013 | $ | 96,539 | $ | 35,809,397 | $ | 38,198,363 | (a) | $ | 102,881 | $ | 74,207,180 | (a) | ||||||||
Net income | 3,939,992 | (a) | 3,939,992 | (a) | ||||||||||||||||
Other comprehensive income, net | 2,908,854 | 2,908,854 | ||||||||||||||||||
Retirement of common shares | (559 | ) | (456,515 | ) | (457,074 | ) | ||||||||||||||
Stock based compensation expense | 44,765 | 44,765 | ||||||||||||||||||
Dividends | (722,599 | ) | (722,599 | ) | ||||||||||||||||
Balance at September 30, 2014 | $ | 95,980 | $ | 35,854,162 | $ | 40,959,241 | (a) | $ | 3,011,735 | $ | 79,921,118 | (a) |
(a) - revised for prior period error
The accompanying notes are an integral part of these consolidated financial statements.
4
First South Bancorp, Inc. and Subsidiary
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2015 and 2014
(Unaudited) | ||||||||
Nine Months Ended | ||||||||
September 30, | ||||||||
2015 | 2014 | |||||||
(As restated) | ||||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 3,115,588 | $ | 3,939,992 | (a) | |||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Provision for credit losses | 475,000 | 1,100,000 | ||||||
Depreciation | 1,361,056 | 1,503,537 | ||||||
Amortization of intangibles | 386,596 | 164,008 | ||||||
Accretion of discounts and premiums on securities, net | 1,566,061 | 742,035 | ||||||
Loss on disposal of premises and equipment | - | 1,821 | ||||||
Gain on sale of other real estate owned | (9,814 | ) | (82,369 | ) | ||||
Gain on sale of loans held for sale | (800,972 | ) | (447,888 | ) | ||||
Gain on sale of investment securities available for sale | (954,514 | ) | (13,509 | ) | ||||
Stock based compensation expense | 52,727 | 44,765 | ||||||
Originations of loans held for sale, net | (23,177,279 | ) | (16,805,469 | ) | ||||
Proceeds from sale of loans held for sale | 24,741,771 | 14,705,316 | ||||||
Other operating activities | (1,268,275 | ) | 1,418,409 | (a) | ||||
Net cash provided by operating activities | 5,487,945 | 6,270,648 | ||||||
Cash flows from investing activities: | ||||||||
Proceeds from sale of investment securities available for sale | 37,712,331 | 787,500 | ||||||
Proceeds from principal repayments of mortgage-backed securities available for sale | 17,431,329 | 10,890,995 | ||||||
Originations of loans held for investment, net of principal repayments | (88,054,764 | ) | (24,669,972 | ) | ||||
Proceeds from disposal of other real estate owned | 1,924,976 | 2,672,248 | ||||||
Purchases of investment securities available for sale | (11,533,456 | ) | (45,162,382 | ) | ||||
Purchases of bank-owned life insurance | (381,537 | ) | (3,897,503 | ) | ||||
Purchases of FHLB stock | (1,592,800 | ) | (1,445,200 | ) | ||||
Purchase of premises and equipment | (829,347 | ) | (2,239,903 | ) | ||||
Net cash used in investing activities | (45,323,268 | ) | (63,064,217 | ) | ||||
Cash flows from financing activities: | ||||||||
Net (decrease) increase in deposit accounts | (4,969,056 | ) | 16,344,499 | |||||
Net increase in FHLB borrowings | 33,000,000 | 37,500,000 | ||||||
Cash paid for dividends | (715,778 | ) | (722,599 | ) | ||||
Retirement of common shares | (909,172 | ) | (457,074 | ) | ||||
Vesting of restricted stock awards, net | (954 | ) | - | |||||
Net cash provided by financing activities | 26,405,040 | 52,664,826 | ||||||
Decrease in cash and cash equivalents | (13,430,283 | ) | (4,128,743 | ) | ||||
Cash and cash equivalents, beginning of period | 56,116,677 | 24,235,315 | ||||||
Cash and cash equivalents, end of period | $ | 42,686,394 | $ | 20,106,572 | ||||
Supplemental disclosures: | ||||||||
Other real estate acquired in settlement of loans | $ | 761,322 | $ | 1,412,093 | ||||
Cash paid for interest | $ | 2,221,151 | $ | 1,983,267 |
(a) - revised for prior period error
The accompanying notes are an integral part of these consolidated financial statements.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Basis of Presentation. The accompanying unaudited consolidated financial statements are prepared in accordance with the instructions for Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments necessary for fair presentation of the financial position and results of operations for the periods presented are included. The financial statements of First South Bancorp, Inc. (the “Company”) and First South Bank (the “Bank”) are presented on a consolidated basis. The results of operations for the three and nine months ended September 30, 2015, are not necessarily indicative of the results of operations that may be expected for the year ended December 31, 2015.
During the three months ended September 30, 2015, the Company identified historical errors related to its deferred tax asset and income tax receivable accounts as well as income tax expense. As a result of the historical error, the Company has determined that its income tax expense associated with prior periods had been understated by a net amount of $434,000. The Company assessed the impact of the errors on its prior period financial statements included in the December 31, 2014, Form 10-K and concluded that these errors were not material, individually or in the aggregate, to any of those financial statements. Although the effect of these errors was not material to any previously issued financial statements, the cumulative effect of correcting these historical errors in the current year would have been material for the fiscal year 2015. For the periods prior to December 31, 2014, the cumulative net income tax expense understatement was $651,000. Consequently, the Company has revised its prior period financial statements by adjusting ending retained earnings as of December 31, 2013, in the amount of $651,000. During 2014 the Company overstated income tax expense by $217,000. The Company has estimated the impact of this overstatement to be $76,000 and $209,000 for the three and nine month periods ending September 30, 2014. As a result, the Company has adjusted income tax expense accordingly.
The financial statements as of September 30, 2014, and for the three and nine month periods then ended and as of December 31, 2014, included herein have been prepared in light of the cumulative revisions above. The financial statements for all other periods affected by the revisions can continue to be relied upon, and will be revised to reflect the revisions discussed above, the next time such financial statements are included in future reports for comparative purposes.
The impact of the above adjustments compared to amounts previously presented is as follows:
December 31, 2014 | September 30, 2014 | December 31, 2013 | ||||||||||||||||||||||
As filed | As restated | As filed | As restated | As filed | As restated | |||||||||||||||||||
Consolidated Statement of Financial Condition | ||||||||||||||||||||||||
Income tax receivable | $ | 2,594,376 | $ | 1,591,105 | ||||||||||||||||||||
Prepaid expenses and other assets | $ | 6,898,192 | $ | 7,467,178 | $ | 6,816,223 | $ | 6,374,657 | $ | 9,599,143 | $ | 8,948,180 | ||||||||||||
Total assets | $ | 885,864,932 | $ | 885,430,647 | $ | 734,666,220 | $ | 734,224,654 | $ | 674,721,943 | $ | 674,070,980 | ||||||||||||
Retained earnings | $ | 41,303,204 | $ | 40,868,919 | $ | 41,400,807 | $ | 40,959,241 | $ | 38,849,326 | $ | 38,198,363 | ||||||||||||
Total stockholders' equity | $ | 80,436,861 | $ | 80,002,576 | $ | 80,362,684 | $ | 79,921,118 | $ | 74,858,143 | $ | 74,207,180 |
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2014 | 2014 | 2014 | 2014 | |||||||||||||
Consolidated Statement of Operations | As filed | As restated | As filed | As restated | ||||||||||||
Income tax expense | $ | 565,368 | $ | 489,347 | $ | 1,525,293 | $ | 1,315,896 | ||||||||
Net income | $ | 1,342,760 | $ | 1,418,781 | $ | 3,730,595 | $ | 3,939,992 | ||||||||
Basic earnings per share | $ | 0.14 | $ | 0.15 | $ | 0.39 | $ | 0.41 | ||||||||
Diluted earnings per share | $ | 0.14 | $ | 0.15 | $ | 0.39 | $ | 0.41 |
2. Earnings Per Share. Basic and diluted earnings per share for the three and nine months ended September 30, 2015 and 2014 are based on the weighted average shares of common stock outstanding. Diluted earnings per share includes the potentially dilutive effects of the Company’s stock-based compensation plans. For the three and nine months ended September 30, 2015 and 2014, there were 20,058 and 19,905 stock options and 17,997 and 18,488 stock options, respectively, that were dilutive because their exercise prices were less than the average market price of the Company’s common stock.
3. Comprehensive Income and Accumulated Other Comprehensive Income. Comprehensive income (loss) includes net income and changes in other comprehensive income. The components of other comprehensive income primarily include net changes in unrealized gains and losses on available for sale securities, and the reclassification of net gains and losses on available for sale securities recognized in income during the respective reporting periods. The following table presents changes in accumulated other comprehensive income (AOCI), net of taxes for the nine months ended September 30, 2015 and 2014:
6
3. Comprehensive Income and Accumulated Other Comprehensive Income. (Continued)
Unrealized Holding Gains on Investment Securities Available- For-Sale | Unrealized Holding Losses on Cash Flow Hedging Activities | Total Accumulated Other Comprehensive Income | ||||||||||
(In thousands) | ||||||||||||
Nine Months Ended September 30, 2015 | ||||||||||||
Balance at December 31, 2014 | $ | 3,422 | $ | (254 | ) | $ | 3,168 | |||||
Other comprehensive income (loss) before reclassifications | 849 | (93 | ) | 756 | ||||||||
Amounts reclassified from AOCI | (677 | ) | - | (677 | ) | |||||||
Net current period other comprehensive income (loss) | 172 | (93 | ) | 79 | ||||||||
Balance at September 30, 2015 | $ | 3,594 | $ | (347 | ) | $ | 3,247 | |||||
Nine Months Ended September 30, 2014 | ||||||||||||
Balance at December 31, 2013 | $ | 125 | $ | (22 | ) | $ | 103 | |||||
Other comprehensive income (loss) before reclassifications | 3,052 | (135 | ) | 2,917 | ||||||||
Amounts reclassified from AOCI | (8 | ) | - | (8 | ) | |||||||
Net current period other comprehensive income (loss) | 3,044 | (135 | ) | 2,909 | ||||||||
Balance at September 30, 2014 | $ | 3,169 | $ | (157 | ) | $ | 3,012 |
4. Investment Securities. The following is a summary of the securities portfolio by major category. The amortized cost and fair value of each category, with gross unrealized gains and losses at September 30, 2015 and December 31, 2014 are summarized as follows:
September 30, 2015 | ||||||||||||||||
Gross | Gross | |||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
Securities available for sale: | Cost | Gains | Losses | Value | ||||||||||||
(In thousands) | ||||||||||||||||
Government agencies | $ | 30,866 | $ | 907 | $ | - | $ | 31,773 | ||||||||
Mortgage-backed securities | 132,856 | 4,075 | 24 | 136,907 | ||||||||||||
Municipal securities | 50,044 | 1,190 | 115 | 51,119 | ||||||||||||
Corporate bonds | 28,790 | 12 | 249 | 28,553 | ||||||||||||
Total | $ | 242,556 | $ | 6,184 | $ | 388 | $ | 248,352 |
December 31, 2014 | ||||||||||||||||
Gross | Gross | |||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
Securities available for sale: | Cost | Gains | Losses | Value | ||||||||||||
(In thousands) | ||||||||||||||||
Government agencies | $ | 30,911 | $ | 397 | $ | 76 | $ | 31,232 | ||||||||
Mortgage-backed securities | 170,443 | 4,384 | 547 | 174,280 | ||||||||||||
Municipal securities | 54,014 | 1,797 | 109 | 55,702 | ||||||||||||
Corporate bonds | 31,411 | 36 | 362 | 31,085 | ||||||||||||
Total | $ | 286,779 | $ | 6,614 | $ | 1,094 | $ | 292,299 |
September 30, 2015 | ||||||||||||||||
Gross | Gross | |||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
Securities held to maturity: | Cost | Gains | Losses | Value | ||||||||||||
(In thousands) | ||||||||||||||||
Government agencies | $ | 508 | $ | 6 | $ | - | $ | 514 |
December 31, 2014 | ||||||||||||||||
Gross | Gross | |||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
Securities held to maturity: | Cost | Gains | Losses | Value | ||||||||||||
(In thousands) | ||||||||||||||||
Government agencies | $ | 507 | $ | 5 | $ | - | $ | 512 |
7
4. Investment Securities (Continued)
The following table summarizes investment securities gross unrealized losses, fair value and length of time the securities were in a continuous unrealized loss position at September 30, 2015 and December 31, 2014. The Company deems these unrealized losses to be temporary and recoverable prior to or at maturity. The Company has the ability and intent to hold the investment securities for a reasonable period of time sufficient for a market price recovery or until maturity.
September 30, 2015 | ||||||||||||||||||||||||
Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||
Government agencies | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||||
Mortgage-backed securities | 4,099 | 15 | 2,747 | 9 | 6,846 | 24 | ||||||||||||||||||
Municipal securities | 12,220 | 75 | 1,385 | 40 | 13,605 | 115 | ||||||||||||||||||
Corporate bonds | 13,698 | 88 | 9,343 | 161 | 23,041 | 249 | ||||||||||||||||||
Total | $ | 30,017 | $ | 178 | $ | 13,475 | $ | 210 | $ | 43,492 | $ | 388 |
December 31, 2014 | ||||||||||||||||||||||||
Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||
Government agencies | $ | 11,790 | $ | 76 | $ | - | $ | - | $ | 11,790 | $ | 76 | ||||||||||||
Mortgage-backed securities | 61,106 | 527 | 3,093 | 20 | 64,199 | 547 | ||||||||||||||||||
Municipal securities | 5,469 | 99 | 904 | 10 | 6,373 | 109 | ||||||||||||||||||
Corporate bonds | 21,670 | 256 | 3,894 | 106 | 25,564 | 362 | ||||||||||||||||||
Total | $ | 100,035 | $ | 958 | $ | 7,891 | $ | 136 | $ | 107,926 | $ | 1,094 |
The following table summarizes the amortized cost and fair values of the investment securities portfolio at September 30, 2015, by expected maturity. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Less Than One Year | One to Five Years | Five to Ten Years | Over Ten Years | |||||||||||||
(In thousands) | ||||||||||||||||
Securities available for sale: | ||||||||||||||||
Government agencies | ||||||||||||||||
Amortized cost | $ | - | $ | 11,785 | $ | 19,081 | $ | - | ||||||||
Fair value | - | 12,024 | 19,749 | - | ||||||||||||
Mortgage-backed securities | ||||||||||||||||
Amortized cost | 744 | 83,735 | 27,804 | 20,573 | ||||||||||||
Fair value | 778 | 85,703 | 28,318 | 22,108 | ||||||||||||
Municipal securities | ||||||||||||||||
Amortized cost | 1,919 | 21,962 | 19,072 | 7,091 | ||||||||||||
Fair value | 1,927 | 22,462 | 19,579 | 7,151 | ||||||||||||
Corporate bonds | ||||||||||||||||
Amortized cost | - | 18,792 | 9,998 | - | ||||||||||||
Fair value | - | 18,695 | 9,858 | - | ||||||||||||
Total Amortized cost | $ | 2,663 | $ | 136,274 | $ | 75,955 | $ | 27,664 | ||||||||
Total Fair value | $ | 2,705 | $ | 138,884 | $ | 77,504 | $ | 29,259 |
Less Than One Year | One to Five Years | Five to Ten Years | Over Ten Years | |||||||||||||
(In thousands) | ||||||||||||||||
Securities held to maturity: | ||||||||||||||||
Government agencies | ||||||||||||||||
Amortized cost | $ | - | $ | 508 | $ | - | $ | - | ||||||||
Fair value | - | 514 | - | - | ||||||||||||
Total Amortized cost | $ | - | $ | 508 | $ | - | $ | - | ||||||||
Total Fair value | $ | - | $ | 514 | $ | - | $ | - |
8
4. Investment Securities (Continued)
Federal Home Loan Bank agency bonds with an amortized cost of $11.4 million and $9.7 million were pledged as collateral for public deposits at September 30, 2015 and December 31, 2014, respectively. In addition, a government agency bond with an amortized cost of $507,000 was pledged as collateral on a forward starting interest rate swap transaction at September 30, 2015 and December 31, 2014, respectively.
At September 30, 2015, the investment securities portfolio included 50 taxable and tax-exempt debt instruments issued by various U.S. states, counties, cities, municipalities and school districts. The following table is a summary, by U.S. state, of the Company’s investment in the obligations of state and political subdivisions:
September 30, 2015 | ||||||||
Amortized Cost | Fair Value | |||||||
(dollars in thousands) | ||||||||
Obligations of state and political subdivisions: | ||||||||
General obligation bonds: | ||||||||
Texas | $ | 5,751 | $ | 6,011 | ||||
Pennsylvania | 6,471 | 6,571 | ||||||
California | 3,596 | 3,596 | ||||||
North Carolina | 1,843 | 1,873 | ||||||
New York | 3,932 | 4,047 | ||||||
South Carolina | 3,363 | 3,421 | ||||||
Other (9 states) | 11,026 | 11,201 | ||||||
Total general obligation bonds | 35,982 | 36,720 | ||||||
Revenue bonds: | ||||||||
North Carolina | 4,923 | 5,145 | ||||||
New York | 7,329 | 7,366 | ||||||
Pennsylvania | 1,810 | 1,888 | ||||||
Total revenue bonds | 14,062 | 14,399 | ||||||
Total obligations of state and political subdivisions | $ | 50,044 | $ | 51,119 |
The largest exposure in general obligation bonds is issued by King County, Washington, with a total amortized cost basis of $2.4 million and total fair value of $2.3 million at September 30, 2015.
The following table is a summary of the revenue sources related to the Company’s investment in revenue bonds:
September 30, 2015 | ||||||||
Amortized Cost | Fair Value | |||||||
(dollars in thousands) | ||||||||
Revenue bonds by revenue source: | ||||||||
Refunding bonds | $ | 1,123 | $ | 1,231 | ||||
University and college | 2,911 | 2,923 | ||||||
Public improvements | 3,779 | 3,849 | ||||||
Pension funding | 1,809 | 1,888 | ||||||
Other | 4,440 | 4,508 | ||||||
Total revenue bonds | $ | 14,062 | $ | 14,399 |
The largest single exposure in revenue bonds is an issue from the Dormitory Authority of the State of New York (DASNY). DASNY was created in 1944 to finance and build dormitories for state teachers’ colleges. Its mission has expanded over time and in 1995 DASNY became the largest public authority issuer of tax-exempt bonds in the country. The debt is secured by a dedication of 25% of the New York State personal income tax. As of September 30, 2015, this issue had an amortized cost and fair value of $1.9 million.
Prior to purchasing any security, the Bank ensures that the security is “investment grade”. For a security to be investment grade it must: (1) have a low risk of default by the obligor, and (2) expect the full and timely repayment of principal and interest over the expected life. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), certain investments are deemed investment grade. These include: U.S. Treasury securities, Federal Agency securities, Revenue Bonds, and Unlimited-Tax General Obligation Municipals. Other securities undergo a pre-purchase analysis to ensure they are investment grade. To determine if a security is investment grade, if available, management utilizes the ratings of the Nationally Recognized Statistical Rating Organizations (NRSRO). However, they are not the sole basis of determining if a security is investment grade. In addition, on a pre-purchase basis, at least one of the following items pertaining to the obligor is acquired and reviewed as part of the Bank’s internal credit analysis: data from debt offerings (prospectus/offering circular); data from regulatory filings (10-Q, 10-K, 8-K); data available from the obligor’s website (annual reports, press releases); data obtained from a third party (i.e. bond broker, analyst); NRSRO report on the initial offering and/or subsequent reviews of the issuer; or other pertinent available financial information. There have been no instances where the NRSRO’s credit rating has significantly differed from that of the Bank’s credit analysis.
9
4. Investment Securities (Continued)
In addition to the pre-purchase analysis performed on securities acquired, we perform ongoing monitoring of our corporate and municipal bond holdings. This monitoring includes staying abreast of material events that may impact the Bank’s ability to be repaid all principal and interest from an issuer in a timely manner. Given the recent disruptions to the oil and gas industry and our municipal holdings in Texas, we expanded the scope of our surveillance to municipalities in Texas. In addition to monitoring for material events, such as changes in NRSRO grades, we track the West Texas Intermediate (WTI) Crude Oil prices, both current and futures. Given the current depressed price, coupled with future expectations of WTI, the Bank thought it prudent to exit certain Texas municipal bond positions during the third quarter of 2015. Other investments in Texas municipalities, with solid credit support, remain in the Bank’s portfolio. We will continue to monitor these residual positions.
5. Loans Held for Sale. The Bank originates residential mortgage loans for sale in the secondary market. Pursuant to ASC 825, Financial Instruments, at September 30, 2015 and December 31, 2014, the Bank marked these mortgage loans to fair value. Mortgage loans held for sale at September 30, 2015 and December 31, 2014, had estimated fair values of $4.0 million and $4.8 million, respectively. The Bank originates mortgage loans for sale that are approved by secondary investors. Their terms are set by secondary investors, and they are transferred within 120 days after the Bank funds the loans. The Bank issues rate lock commitments to borrowers, and depending on market conditions, may enter into forward contracts with secondary market investors to minimize interest rate risk related to mortgage loan forward sales commitments. The Bank uses forward contracts to minimize interest rate risk related to mortgage loan forward sales commitments to economically hedge a percentage of the locked-in pipeline. The Bank receives origination fees from borrowers and servicing release premiums from investors that are recognized in income when loans are sold. The Bank had mortgage loan forward sales commitments with notional amounts outstanding of $6.5 million and $4.1 million at September 30, 2015 and December 31, 2014, respectively.
6. Loans Held for Investment. Loans held for investment at September 30, 2015 and December 31, 2014 are listed below:
September 30, 2015 | December 31, 2014 | |||||||||||||||
Amount | Percent of Total | Amount | Percent of Total | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Loans Held for Investment | ||||||||||||||||
Mortgage loans: | ||||||||||||||||
Residential real estate | $ | 67,143 | 11.8 | % | $ | 64,647 | 13.4 | % | ||||||||
Residential construction | 4,306 | 0.7 | 1,382 | 0.3 | ||||||||||||
Residential lots and raw land | 162 | 0.1 | 828 | 0.2 | ||||||||||||
Total mortgage loans | 71,611 | 12.6 | 66,857 | 13.9 | ||||||||||||
Commercial loans and leases: | ||||||||||||||||
Commercial real estate | 316,160 | 55.6 | 255,800 | 53.2 | ||||||||||||
Commercial construction | 40,755 | 7.2 | 27,646 | 5.7 | ||||||||||||
Commercial lots and raw land | 25,602 | 4.5 | 27,502 | 5.7 | ||||||||||||
Commercial and industrial | 37,820 | 6.7 | 28,379 | 5.9 | ||||||||||||
Lease receivables | 14,438 | 2.5 | 12,392 | 2.6 | ||||||||||||
Total commercial loans and leases | 434,775 | 76.5 | 351,719 | 73.1 | ||||||||||||
Consumer loans: | ||||||||||||||||
Consumer real estate | 16,949 | 3 | 18,863 | 3.9 | ||||||||||||
Consumer construction | 321 | 0.1 | 1,412 | 0.3 | ||||||||||||
Consumer lots and raw land | 10,004 | 1.8 | 10,430 | 2.2 | ||||||||||||
Home equity lines of credit | 28,516 | 5 | 28,059 | 5.8 | ||||||||||||
Consumer other | 5,978 | 1 | 3,932 | 0.8 | ||||||||||||
Total consumer loans | 61,768 | 10.9 | 62,696 | 13 | ||||||||||||
Gross loans held for investment | 568,154 | 100 | % | 481,272 | 100 | % | ||||||||||
Less deferred loan origination fees, net | 849 | 836 | ||||||||||||||
Less allowance for loan and lease losses | 7,570 | 7,520 | ||||||||||||||
Net loans held for investment | $ | 559,735 | $ | 472,916 |
10
6. Loans Held for Investment (Continued)
The Bank has pledged eligible real estate loans as collateral for potential borrowings from the Federal Home Loan Bank of Atlanta (“FHLB”) in the amount of $206.3 million at September 30, 2015, compared to $138.1 million at December 31, 2014. At September 30, 2015, the Bank has also pledged eligible loans as collateral to the Federal Reserve Bank of Richmond (“FRB”) in the amount of $102.6 million, compared to $81.3 million at December 31, 2014, for potential access to the FRB Discount Window.
The following tables detail non-accrual loans held for investment, including troubled debt restructured (“TDR”) loans accounted for on a non-accrual status, segregated by class of loans, at September 30, 2015 and December 31, 2014:
September 30, 2015 | December 31, 2014 | |||||||
(Dollars in thousands) | ||||||||
Non-accrual loans held for investment: | ||||||||
Non-TDR loans accounted for on a non-accrual status: | ||||||||
Residential real estate | $ | 767 | $ | 727 | ||||
Residential lots and raw land | 1 | 11 | ||||||
Commercial real estate | 548 | 554 | ||||||
Commercial lots and raw land | - | 32 | ||||||
Lease receivables | 95 | 69 | ||||||
Consumer real estate | 271 | 214 | ||||||
Consumer lots and raw land | 26 | 124 | ||||||
Home equity lines of credit | 52 | 61 | ||||||
Consumer other | 3 | 6 | ||||||
Total Non-TDR loans accounted for on a non-accrual status | $ | 1,763 | $ | 1,798 | ||||
TDR loans accounted for on a non-accrual status: | ||||||||
Past Due TDRs: | ||||||||
Commercial real estate | $ | 301 | $ | 1,182 | ||||
Consumer real estate | 163 | 51 | ||||||
Total Past Due TDRs on a non-accrual status | 464 | 1,233 | ||||||
Current TDRs: | ||||||||
Residential real estate | 815 | 834 | ||||||
Commercial real estate | 434 | 127 | ||||||
Commercial construction | - | - | ||||||
Commercial lots and raw land | - | 1,046 | ||||||
Total Current TDRs | 1,249 | 2,007 | ||||||
Total TDR loans accounted for on a non-accrual basis | $ | 1,713 | $ | 3,240 | ||||
Total non-accrual loans | $ | 3,476 | $ | 5,038 | ||||
Percentage of total loans held for investment, net | 0.6 | % | 1.1 | % | ||||
Loans over 90 days past due and still accruing | 183 | 389 | ||||||
Other real estate owned | $ | 6,506 | $ | 7,756 | ||||
Total non-performing assets | $ | 10,165 | $ | 13,183 |
Cumulative interest income not recorded on loans accounted for on a non-accrual status was $90,335 and $109,598 at September 30, 2015 and December 31, 2014, respectively.
11
6. Loans Held for Investment (Continued)
The following table presents an age analysis of past due loans held for investment, segregated by class of loans as of September 30, 2015 and December 31, 2014:
Past due loans held for investment: | 30-59 Days
Past Due | 60-89 Days
Past Due | Greater than 90 Days | Total Past
Due | Current | Total Financing Receivables | Over 90 Days and Accruing | |||||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||||||
September 30, 2015 | ||||||||||||||||||||||||||||
Residential real estate | $ | - | $ | 191 | $ | 626 | $ | 817 | $ | 66,326 | $ | 67,143 | $ | 43 | ||||||||||||||
Residential construction | - | - | - | - | 4,306 | 4,306 | - | |||||||||||||||||||||
Residential lots and raw land | - | - | - | - | 162 | 162 | - | |||||||||||||||||||||
Commercial real estate | 1,038 | 842 | 370 | 2,250 | 313,910 | 316,160 | 140 | |||||||||||||||||||||
Commercial construction | 106 | - | - | 106 | 40,649 | 40,755 | - | |||||||||||||||||||||
Commercial lots and raw land | 56 | 3 | - | 59 | 25,543 | 25,602 | - | |||||||||||||||||||||
Commercial and industrial | 92 | - | - | 92 | 37,728 | 37,820 | - | |||||||||||||||||||||
Lease receivables | - | - | 95 | 95 | 14,343 | 14,438 | - | |||||||||||||||||||||
Consumer real estate | 462 | 95 | 339 | 896 | 16,053 | 16,949 | - | |||||||||||||||||||||
Consumer construction | - | - | - | - | 321 | 321 | - | |||||||||||||||||||||
Consumer lots and raw land | 117 | - | 26 | 143 | 9,861 | 10,004 | - | |||||||||||||||||||||
Home equity lines of credit | 196 | - | 38 | 234 | 28,282 | 28,516 | - | |||||||||||||||||||||
Consumer other | - | 5 | 1 | 6 | 5,972 | 5,978 | - | |||||||||||||||||||||
Total | $ | 2,067 | $ | 1,136 | $ | 1,495 | $ | 4,698 | $ | 563,456 | $ | 568,154 | $ | 183 |
Past due loans held for investment: | 30-59 Days Past Due | 60-89 Days Past Due | Greater than 90 Days | Total Past Due | Current | Total Financing Receivables | Over 90 Days and Accruing | |||||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||||||
December 31, 2014 | ||||||||||||||||||||||||||||
Residential real estate | $ | 1,553 | $ | 361 | $ | 944 | $ | 2,858 | $ | 61,789 | $ | 64,647 | $ | 389 | ||||||||||||||
Residential construction | - | - | - | - | 1,382 | 1,382 | - | |||||||||||||||||||||
Residential lots and raw land | - | 2 | 9 | 11 | 817 | 828 | - | |||||||||||||||||||||
Commercial real estate | 1,099 | 444 | 1,182 | 2,725 | 253,075 | 255,800 | - | |||||||||||||||||||||
Commercial construction | - | - | - | - | 27,646 | 27,646 | - | |||||||||||||||||||||
Commercial lots and raw land | 307 | 39 | 32 | 378 | 27,124 | 27,502 | - | |||||||||||||||||||||
Commercial and industrial | 63 | - | - | 63 | 28,316 | 28,379 | - | |||||||||||||||||||||
Lease receivables | - | - | 69 | 69 | 12,323 | 12,392 | - | |||||||||||||||||||||
Consumer real estate | 501 | 164 | 149 | 814 | 18,049 | 18,863 | - | |||||||||||||||||||||
Consumer construction | - | - | - | - | 1,412 | 1,412 | - | |||||||||||||||||||||
Consumer lots and raw land | - | 21 | 124 | 145 | 10,285 | 10,430 | - | |||||||||||||||||||||
Home equity lines of credit | 45 | 30 | 46 | 121 | 27,938 | 28,059 | - | |||||||||||||||||||||
Consumer other | 12 | - | 6 | 18 | 3,914 | 3,932 | - | |||||||||||||||||||||
Total | $ | 3,580 | $ | 1,061 | $ | 2,561 | $ | 7,202 | $ | 474,070 | $ | 481,272 | $ | 389 |
The following table presents information on loans that were considered impaired as of September 30, 2015 and December 31, 2014. Impaired loans include loans modified as a TDR, whether on accrual or non-accrual status. At September 30, 2015, impaired loans included $2.6 million of TDRs, compared to $4.6 million at December 31, 2014.
12
6. Loans Held for Investment (Continued)
Contractual | YTD Average | Interest Income | ||||||||||||||||||
Impaired Loans | Recorded | Unpaid Principal | Related | Recorded | Recognized on | |||||||||||||||
September 30, 2015 | Investment | Balance | Allowance | Investment | Impaired Loans | |||||||||||||||
(In thousands) | ||||||||||||||||||||
With no related allowance recorded: | ||||||||||||||||||||
Residential real estate | $ | 1,095 | $ | 1,392 | $ | - | $ | 1,203 | $ | 47 | ||||||||||
Commercial real estate | 9,875 | 9,916 | - | 11,224 | 432 | |||||||||||||||
Commercial construction | 448 | 448 | - | 237 | 9 | |||||||||||||||
Commercial lots and raw land | 2,683 | 2,683 | - | 2,801 | 108 | |||||||||||||||
Commercial and industrial | 43 | 43 | - | 45 | 2 | |||||||||||||||
Consumer real estate | 323 | 335 | - | 296 | 13 | |||||||||||||||
Consumer lots and raw land | 53 | 53 | - | 56 | 2 | |||||||||||||||
Home equity lines of credit | 46 | 47 | - | 58 | 1 | |||||||||||||||
Consumer other | 43 | 43 | - | 45 | 2 | |||||||||||||||
Subtotal: | 14,609 | 14,960 | - | 15,965 | 616 | |||||||||||||||
With an allowance recorded: | ||||||||||||||||||||
Commercial real estate | 1,365 | 1,367 | 372 | 1,588 | 65 | |||||||||||||||
Commercial and industrial | 21 | 21 | 21 | 73 | 1 | |||||||||||||||
Consumer real estate | 79 | 79 | 31 | 105 | 2 | |||||||||||||||
Consumer lots and raw land | 612 | 612 | 107 | 593 | 23 | |||||||||||||||
Subtotal: | 2,077 | 2,079 | 531 | 2,359 | 91 | |||||||||||||||
Totals: | ||||||||||||||||||||
Mortgage | 1,095 | 1,392 | - | 1,203 | 47 | |||||||||||||||
Commercial | 14,435 | 14,478 | 393 | 15,968 | 617 | |||||||||||||||
Consumer | 1,156 | 1,169 | 138 | 1,153 | 43 | |||||||||||||||
Grand Total: | $ | 16,686 | $ | 17,039 | $ | 531 | $ | 18,324 | $ | 707 |
Contractual | YTD Average | Interest Income | ||||||||||||||||||
Impaired Loans | Recorded | Unpaid Principal | Related | Recorded | Recognized on | |||||||||||||||
December 31, 2014 | Investment | Balance | Allowance | Investment | Impaired Loans | |||||||||||||||
(In thousands) | ||||||||||||||||||||
With no related allowance recorded: | ||||||||||||||||||||
Residential real estate | $ | 1,505 | $ | 1,802 | $ | - | $ | 1,268 | $ | 74 | ||||||||||
Commercial real estate | 12,331 | 12,361 | - | 13,851 | 721 | |||||||||||||||
Commercial construction | 103 | 103 | - | 1,793 | 5 | |||||||||||||||
Commercial lots and raw land | 2,951 | 2,958 | - | 3,623 | 159 | |||||||||||||||
Commercial and industrial | 46 | 46 | - | 48 | 2 | |||||||||||||||
Consumer real estate | 192 | 192 | - | 258 | 6 | |||||||||||||||
Consumer lots and raw land | 59 | 59 | - | 477 | 4 | |||||||||||||||
Home equity lines of credit | 58 | 58 | - | 46 | 3 | |||||||||||||||
Consumer other | 46 | 46 | - | 76 | 2 | |||||||||||||||
Subtotal: | 17,291 | 17,625 | - | 21,440 | 976 | |||||||||||||||
With an allowance recorded: | ||||||||||||||||||||
Residential real estate | 235 | 235 | 185 | 47 | 11 | |||||||||||||||
Commercial real estate | 1,530 | 1,569 | 167 | 2,638 | 74 | |||||||||||||||
Commercial lots and raw land | 416 | 418 | 251 | 152 | 29 | |||||||||||||||
Consumer real estate | 132 | 132 | 19 | 139 | 6 | |||||||||||||||
Consumer lots and raw land | 643 | 643 | 165 | 584 | 31 | |||||||||||||||
Home equity lines of credit | 25 | 25 | 5 | 15 | - | |||||||||||||||
Subtotal: | 2,981 | 3,022 | 792 | 3,575 | 151 | |||||||||||||||
Totals: | ||||||||||||||||||||
Mortgage | 1,740 | 2,037 | 185 | 1,315 | 85 | |||||||||||||||
Commercial | 17,377 | 17,455 | 418 | 22,105 | 990 | |||||||||||||||
Consumer | 1,155 | 1,155 | 189 | 1,595 | 52 | |||||||||||||||
Grand Total: | $ | 20,272 | $ | 20,647 | $ | 792 | $ | 25,015 | $ | 1,127 |
13
6. Loans Held for Investment (Continued)
Credit Quality Indicators. The Bank assigns a risk grade to each loan in the portfolio as part of the on-going monitoring of the credit quality of the loan portfolio.
Commercial loans are graded on a scale of 1 to 9 as follows:
• | Risk Grade 1 (Excellent) - Loans in this category are considered to be of the highest quality. The borrower(s) has significant financial strength, stability, and liquidity. Proven cash flow is significantly more than required to service current and proposed debt with consistently strong earnings. Collateral position is very strong and a secondary source of repayment is self-evident. Guarantors may not be necessary to support the debt. |
• | Risk Grade 2 (Above Average) - Loans are supported by above average financial strength and stability. Cash flow is more than sufficient to meet current demands. Earnings are strong and reliable, but may differ from year to year. Collateral is highly liquid and sufficient to repay the debt in full. Guarantors may qualify for the loan on a direct basis. |
• | Risk Grade 3 (Average) - Credits in this group are supported by upper tier industry-average financial strength and stability. Liquidity levels fluctuate and need for short-term credit is demonstrated. Cash flow is steady and adequate to meet demands but can fluctuate. Earnings should be consistent but operating losses have not occurred recently. Collateral is generally pledged at an acceptable loan to value, but the credit can support some level of unsecured exposure. Guarantors with demonstrable financial strength are typically required on loans to business entities, but may not be on loans to individual borrowers. |
• | Risk Grade 4 (Acceptable) - Credits in this group are supported by lower end industry-average financial strength and stability. Liquidity levels fluctuate but are acceptable and need for short term credit is demonstrated. Cash flow is adequate to meet demands but can fluctuate. Earnings may be inconsistent but operating losses have not occurred recently. Collateral is generally pledged at an acceptable loan to value. Guarantors with demonstrable financial strength are required on loans to business entities, but may not be on loans to individual borrowers. |
• | Risk Grade 5 (Watch) - An asset in this category is one that has been identified by the lender, or credit administration as a loan that has shown some degree of deterioration from its original status. These loans are typically protected by collateral but have potential weaknesses that deserve management’s close attention, but are not yet at a point to become a classified asset. There may be unsecured loans that are included in this category. These are loans that management feels need to be watched more closely than those rated as acceptable and if left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset to warrant including them as classified assets. |
• |
Risk Grade 6 (Special Mention) - An asset in this category is currently protected by collateral but has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date.
|
• | Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the debtor(s) or of the collateral pledged, if any. These credits have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. There is a distinct possibility the Bank will sustain some loss if the deficiencies are not corrected. |
• | Risk Grade 8 (Doubtful) - A loan graded in this category has all the weaknesses inherent in one graded Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values highly questionable and improbable. |
• | Risk Grade 9 (Loss) - A loan graded as Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted. This grade does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future. |
Consumer loans are graded on a scale of 1 to 9 as follows:
• | Risk Grades 1 - 5 (Pass) - Loans in this category generally show little to no signs of weakness or have adequate mitigating factors that minimize the risk of loss. Some of the characteristics of these loans include, but are not limited to, adequate financial strength and stability, adequate cash flow, collateral with acceptable loan to value, additional repayment sources, and reliable earnings. |
• | Risk Grade 6 (Special Mention) - An asset in this category is currently protected by collateral but has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Bank’s position at some future date. |
• | Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the debtor(s) or of the collateral pledged, if any. These credits have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. There is a distinct possibility the Bank will sustain some loss if the deficiencies are not corrected. |
14
6. Loans Held for Investment (Continued)
• | Risk Grade 8 (Doubtful) - A loan graded in this category has all the weaknesses inherent in one graded Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values highly questionable and improbable. |
• | Risk Grade 9 (Loss) - A loan graded as Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted. This grade does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future. |
Mortgage loans are graded on a scale of 1 to 9 as follows:
• | Risk Grades 1 - 4 (Pass) - Loans in this category generally show little to no signs of weakness or have adequate mitigating factors that minimize the risk of loss. Some of the characteristics of these loans include, but are not limited to, adequate financial strength and stability, acceptable credit history, adequate cash flow, collateral with acceptable loan to value, additional repayment sources, and reliable earnings. |
• | Risk Grade 5 (Pass -Watch) – Watch loans have shown credit quality changes from the original status. These loans are typically protected by collateral but have potential weaknesses that deserve management’s close attention, but are not yet at a point to become a classified asset. These are loans that management feels need to be watched more closely than those rated as Pass and if left uncorrected may result in the deterioration of the repayment prospects for the asset to warrant including them as classified assets. |
• | Risk Grade 6 (Special Mention) – Special Mention loans are currently protected by collateral but have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. |
• | Risk Grade 7 (Substandard) - Substandard loans are inadequately protected by the sound net worth and paying capacity of the borrower(s). Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. |
• | Risk Grade 8 (Doubtful) - Loans classified Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions, and values, highly questionable and improbable. |
• | Risk Grade 9 (Loss) - Loans classified Loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future. |
The following table presents information on risk ratings of the commercial, consumer, mortgage and lease receivable portfolios, segregated by loan class as of September 30, 2015 and December 31, 2014:
September 30, 2015 | ||||||||||||||||
Commercial | Commercial | Commercial Lots | Commercial | |||||||||||||
Commercial Credit Exposure by Assigned Risk Grade | Real Estate | Construction | and Raw Land | and Industrial | ||||||||||||
(In thousands) | ||||||||||||||||
1-Excellent | $ | - | $ | - | $ | - | $ | - | ||||||||
2-Above Average | 2,854 | 507 | 59 | 1,960 | ||||||||||||
3-Average | 92,079 | 14,547 | 1,628 | 5,243 | ||||||||||||
4-Acceptable | 192,853 | 24,030 | 16,547 | 26,916 | ||||||||||||
5-Watch | 12,136 | 707 | 3,308 | 1,601 | ||||||||||||
6-Special Mention | 7,387 | 517 | 2,357 | 60 | ||||||||||||
7-Substandard | 8,851 | 447 | 1,703 | 2,040 | ||||||||||||
8-Doubtful | - | - | - | - | ||||||||||||
9-Loss | - | - | - | - | ||||||||||||
Total | $ | 316,160 | $ | 40,755 | $ | 25,602 | $ | 37,820 |
15
6. Loans Held for Investment (Continued)
September 30, 2015 | ||||||||||||||||||||
Consumer | Consumer | Consumer Lots | Home Equity | Consumer | ||||||||||||||||
Consumer Credit Exposure by Assigned Risk Grade | Real Estate | Construction | and Raw Land | Lines of Credit | Other | |||||||||||||||
(In thousands) | ||||||||||||||||||||
Pass | $ | 15,874 | $ | 321 | $ | 9,645 | $ | 28,335 | $ | 5,900 | ||||||||||
6-Special Mention | 641 | - | 280 | 64 | 27 | |||||||||||||||
7-Substandard | 434 | - | 79 | 117 | 51 | |||||||||||||||
8-Doubtful | - | - | - | - | - | |||||||||||||||
9-Loss | - | - | - | - | - | |||||||||||||||
Total | $ | 16,949 | $ | 321 | $ | 10,004 | $ | 28,516 | $ | 5,978 |
September 30, 2015 | ||||||||||||||||
Mortgage and Lease Receivable Credit Exposure by | Residential | Residential | Residential Lots | Lease | ||||||||||||
Assigned Risk Grade | Real Estate | Construction | and Raw Land | Receivables | ||||||||||||
(In thousands) | ||||||||||||||||
Pass | $ | 64,745 | $ | 4,306 | $ | 161 | $ | 14,343 | ||||||||
6-Special Mention | 799 | - | - | - | ||||||||||||
7-Substandard | 1,599 | - | 1 | 95 | ||||||||||||
8-Doubtful | - | - | - | - | ||||||||||||
9-Loss | - | - | - | - | ||||||||||||
Total | $ | 67,143 | $ | 4,306 | $ | 162 | $ | 14,438 |
December 31, 2014 | ||||||||||||||||
Commercial | Commercial | Commercial Lots | Commercial | |||||||||||||
Commercial Credit Exposure by Assigned Risk Grade | Real Estate | Construction | and Raw Land | and Industrial | ||||||||||||
(In thousands) | ||||||||||||||||
1-Excellent | $ | - | $ | - | $ | - | $ | - | ||||||||
2-Above Average | 2,030 | 778 | 24 | 955 | ||||||||||||
3-Average | 53,699 | 5,681 | 1,560 | 5,264 | ||||||||||||
4-Acceptable | 166,639 | 17,701 | 16,601 | 19,562 | ||||||||||||
5-Watch | 16,117 | 2,641 | 3,948 | 458 | ||||||||||||
6-Special Mention | 7,195 | 515 | 3,201 | 2,051 | ||||||||||||
7-Substandard | 10,120 | 330 | 2,168 | 89 | ||||||||||||
8-Doubtful | - | - | - | - | ||||||||||||
9-Loss | - | - | - | - | ||||||||||||
Total | $ | 255,800 | $ | 27,646 | $ | 27,502 | $ | 28,379 |
December 31, 2014 | ||||||||||||||||||||
Consumer | Consumer | Consumer Lots | Home Equity | Consumer | ||||||||||||||||
Consumer Credit Exposure by Assigned Risk Grade | Real Estate | Construction | and Raw Land | Lines of Credit | Other | |||||||||||||||
(In thousands) | ||||||||||||||||||||
Pass | $ | 17,796 | $ | 1,412 | $ | 9,958 | $ | 27,828 | $ | 3,866 | ||||||||||
6-Special Mention | 636 | - | 288 | 60 | 4 | |||||||||||||||
7-Substandard | 431 | - | 184 | 171 | 62 | |||||||||||||||
8-Doubtful | - | - | - | - | - | |||||||||||||||
9-Loss | - | - | - | - | - | |||||||||||||||
Total | $ | 18,863 | $ | 1,412 | $ | 10,430 | $ | 28,059 | $ | 3,932 |
December 31, 2014 | ||||||||||||||||
Mortgage and Lease Receivable Credit Exposure by | Residential | Residential | Residential Lots | Lease | ||||||||||||
Assigned Risk Grade | Real Estate | Construction | and Raw Land | Receivables | ||||||||||||
(In thousands) | ||||||||||||||||
Pass | $ | 61,779 | $ | 1,382 | $ | 817 | $ | 12,323 | ||||||||
6-Special Mention | 684 | - | - | - | ||||||||||||
7-Substandard | 2,095 | - | 11 | 69 | ||||||||||||
8-Doubtful | 89 | - | - | - | ||||||||||||
9-Loss | - | - | - | - | ||||||||||||
Total | $ | 64,647 | $ | 1,382 | $ | 828 | $ | 12,392 |
16
7. Allowance for Loan and Lease Losses. The following table presents a roll forward summary of activity in the allowance for loan and lease losses (“ALLL”), by loan category, for the nine months ended September 30, 2015 and 2014:
September 30, 2015 | ||||||||||||||||||||||||
Beginning | Charge- | Ending | Total | |||||||||||||||||||||
Balance | Offs | Recoveries | Provisions | Balance | Loans | |||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||
Collectively evaluated for impairment: | ||||||||||||||||||||||||
Residential real estate | $ | 982 | $ | (108 | ) | $ | - | $ | 33 | $ | 907 | $ | 66,048 | |||||||||||
Residential construction | 17 | - | - | 33 | 50 | 4,306 | ||||||||||||||||||
Residential lots and raw land | 11 | - | - | (9 | ) | 2 | 162 | |||||||||||||||||
Commercial real estate | 3,516 | (3 | ) | 42 | 184 | 3,739 | 304,920 | |||||||||||||||||
Commercial construction | 375 | - | - | 103 | 478 | 40,307 | ||||||||||||||||||
Commercial lots and raw land | 377 | - | - | (67 | ) | 310 | 22,919 | |||||||||||||||||
Commercial and industrial | 400 | - | 1 | 254 | 655 | 37,756 | ||||||||||||||||||
Lease receivables | 172 | - | - | (12 | ) | 160 | 14,438 | |||||||||||||||||
Consumer real estate | 250 | - | 15 | (77 | ) | 188 | 16,547 | |||||||||||||||||
Consumer construction | 19 | - | - | (15 | ) | 4 | 321 | |||||||||||||||||
Consumer lots and raw land | 152 | - | - | (20 | ) | 132 | 9,339 | |||||||||||||||||
Home equity lines of credit | 405 | - | 1 | (61 | ) | 345 | 28,470 | |||||||||||||||||
Consumer other | 52 | (10 | ) | 93 | (66 | ) | 69 | 5,935 | ||||||||||||||||
Total | 6,728 | (121 | ) | 152 | 280 | 7,039 | 551,468 | |||||||||||||||||
Individually evaluated for impairment: | ||||||||||||||||||||||||
Residential real estate | 185 | (185 | ) | 1 | (1 | ) | - | 1,095 | ||||||||||||||||
Commercial real estate | 167 | (157 | ) | 24 | 338 | 372 | 11,240 | |||||||||||||||||
Commercial construction | - | - | - | - | - | 448 | ||||||||||||||||||
Commercial lots and raw land | 251 | (33 | ) | - | (218 | ) | - | 2,683 | ||||||||||||||||
Commercial and industrial | - | - | - | 21 | 21 | 64 | ||||||||||||||||||
Consumer real estate | 19 | (33 | ) | - | 45 | 31 | 402 | |||||||||||||||||
Consumer lots and raw land | 165 | (85 | ) | 8 | 19 | 107 | 665 | |||||||||||||||||
Home equity lines of credit | 5 | - | 4 | (9 | ) | - | 46 | |||||||||||||||||
Consumer other | - | - | - | - | - | 43 | ||||||||||||||||||
Total | 792 | (493 | ) | 37 | 195 | 531 | 16,686 | |||||||||||||||||
Grand Total | $ | 7,520 | $ | (614 | ) | $ | 189 | $ | 475 | 7,570 | $ | 568,154 |
17
7. Allowance for Loan and Lease Losses (Continued)
September 30, 2014 | ||||||||||||||||||||||||
Beginning | Charge- | Ending | Total | |||||||||||||||||||||
Balance | Offs | Recoveries | Provisions | Balance | Loans | |||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||
Collectively evaluated for impairment: | ||||||||||||||||||||||||
Residential real estate | $ | 903 | $ | (34 | ) | $ | - | $ | 67 | $ | 936 | $ | 64,835 | |||||||||||
Residential construction | 17 | - | - | 3 | 20 | 1,416 | ||||||||||||||||||
Residential lots and raw land | 13 | - | - | (1 | ) | 12 | 878 | |||||||||||||||||
Commercial real estate | 3,647 | (174 | ) | 26 | 260 | 3,759 | 232,499 | |||||||||||||||||
Commercial construction | 343 | - | 1 | 92 | 436 | 29,753 | ||||||||||||||||||
Commercial lots and raw land | 415 | - | - | (20 | ) | 395 | 23,390 | |||||||||||||||||
Commercial and Industrial | 430 | (3 | ) | 9 | (66 | ) | 370 | 24,778 | ||||||||||||||||
Lease receivables | 113 | (1 | ) | - | 49 | 161 | 12,054 | |||||||||||||||||
Consumer real estate | 316 | - | 27 | (83 | ) | 260 | 18,660 | |||||||||||||||||
Consumer construction | 23 | - | - | (3 | ) | 20 | 1,381 | |||||||||||||||||
Consumer lots and raw land | 203 | (232 | ) | - | 181 | 152 | 9,746 | |||||||||||||||||
Home equity lines of credit | 463 | (12 | ) | 7 | (39 | ) | 419 | 27,381 | ||||||||||||||||
Consumer other | 60 | (11 | ) | 18 | (16 | ) | 51 | 3,408 | ||||||||||||||||
Total | 6,946 | (467 | ) | 88 | 424 | 6,991 | 450,179 | |||||||||||||||||
Individually evaluated for impairment: | ||||||||||||||||||||||||
Residential real estate | - | - | - | - | - | 1,124 | ||||||||||||||||||
Commercial real estate | 510 | (564 | ) | 5 | 217 | 168 | 17,431 | |||||||||||||||||
Commercial construction | - | - | 1 | (1 | ) | - | 169 | |||||||||||||||||
Commercial lots and raw land | - | (104 | ) | - | 328 | 224 | 3,637 | |||||||||||||||||
Commercial and Industrial | 23 | (49 | ) | - | 26 | - | 47 | |||||||||||||||||
Consumer real estate | 25 | (54 | ) | - | 48 | 19 | 499 | |||||||||||||||||
Consumer lots and raw land | 105 | (28 | ) | - | 20 | 97 | 700 | |||||||||||||||||
Home equity lines of credit | - | (1 | ) | 5 | 1 | 5 | 54 | |||||||||||||||||
Consumer other | - | (37 | ) | - | 37 | - | 47 | |||||||||||||||||
Total | 663 | (837 | ) | 11 | 676 | 513 | 23,708 | |||||||||||||||||
Grand Total | $ | 7,609 | $ | (1,304 | ) | $ | 99 | $ | 1,100 | $ | 7,504 | $ | 473,887 |
8. Troubled Debt Restructurings. The following table details performing TDR loans at September 30, 2015 and December 31, 2014, segregated by class of financing receivables:
September 30, 2015 | December 31, 2014 | |||||||
(Dollars in thousands) | ||||||||
Performing TDR loans accounted for on an accrual basis: | ||||||||
Commercial real estate | $ | 776 | $ | 1,132 | ||||
Commercial and industrial | 6 | 9 | ||||||
Consumer real estate | - | 165 | ||||||
Consumer lots and raw land | 110 | 60 | ||||||
Consumer other | 5 | 56 | ||||||
Total performing TDR loans accounted for on an accrual basis | $ | 897 | $ | 1,422 | ||||
Percentage of total loans, net | 0.2 | % | 0.3 | % |
The following table presents a roll forward of performing and non-performing TDR loans for the nine months ended September 30, 2015:
Performing TDRs September 30, 2015 | Beginning Balance | Additions (1) | Charge- Offs (2) | Other (3) | Ending Balance | |||||||||||||||
(In thousands) | ||||||||||||||||||||
Residential mortgage | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||
Commercial | 1,141 | - | (8 | ) | (351 | ) | 782 | |||||||||||||
Consumer | 281 | - | - | (166 | ) | 115 | ||||||||||||||
Total | $ | 1,422 | $ | - | $ | (8 | ) | $ | (517 | ) | $ | 897 |
18
8. Troubled Debt Restructurings (Continued)
Non-Performing TDRs September 30, 2015 | Beginning Balance | Additions (1) | Charge- Offs (2) | Other (4) | Ending Balance | |||||||||||||||
(In thousands) | ||||||||||||||||||||
Residential mortgage | $ | 834 | $ | - | $ | - | $ | (19 | ) | $ | 815 | |||||||||
Commercial | 2,355 | - | (152 | ) | (1,468 | ) | 735 | |||||||||||||
Consumer | 51 | - | (33 | ) | 145 | 163 | ||||||||||||||
Total | $ | 3,240 | $ | - | $ | (185 | ) | $ | (1,342 | ) | $ | 1,713 |
1. | Includes new TDRs and increases to existing TDRs. |
2. | Post modification charge-offs. |
3. | Includes principal payments, paydowns and performing loans previously restructured at market rates that are no longer reported as TDRs. |
4. | Includes principal payments, paydowns and loans previously designated as non-performing that are currently performing in compliance with their modified terms. |
In determining the allowance for loan and lease losses, the Bank considers TDRs and subsequent defaults in restructuring in its estimate. As a result, the allowance may be increased, adjustments may be made in the allocation of the allowance, or charge-offs may be taken to further write down the carrying value of the loan. The Bank’s primary objective in granting concessions to borrowers having financial difficulties is an attempt to protect as much of its investment as possible. The Bank faces significant challenges when working with borrowers who are experiencing diminished operating cash flows, depreciated collateral values, or prolonged sales and rental absorption periods. While borrowers may experience deterioration in their financial condition, many continue to be creditworthy customers who have the willingness and capacity to repay their debts. In such cases, the Bank finds it mutually beneficial to work constructively with its borrowers, and that prudent restructurings are often in the best interest of the Bank and the borrower. The Bank offers a variety of TDR programs on a loan-by-loan basis in which, for economic or legal reasons related to an individual borrower’s financial condition, it grants a concession to the borrower that would not otherwise be considered. The restructuring of a troubled loan may include, but is not limited to any one or combination of the following: a modification of the loan terms such as a reduction of the contractual interest rate, principal, payment amount or accrued interest; an extension of the maturity date at a stated interest rate lower than the current market rate for a new debt with similar risks; a change in payment type, e.g. from principal and interest, to interest only with all principal and interest due at maturity; a substitution or acceptance of additional collateral; and a substitution or addition of new debtors for the original borrower.
The Bank’s restructuring success includes but is not limited to any one or combination of the following: improves the prospects for repayment of principal and interest; reduces the prospects of further write downs and charge-offs; reduces the prospects of potential additional foreclosures; helps borrowers to maintain a creditworthy status; and ultimately will reduce the volume of classified, criticized and/or non-accrual loans. The Bank identifies loans for potential restructuring on a loan-by-loan basis using a variety of sources which may include, but is not limited to any one or combination of the following: being approached or contacted by the borrower to modify loan terms; review of borrower’s financial statements indicates borrower may be experiencing financial difficulties; past due payment reports; loans extending past their stated maturity date; and non-accrual loan reports.
On a loan-by-loan basis, the Bank restructures loans that were either on non-accrual basis or on accrual basis prior to restructuring. If a loan was on nonaccrual basis prior to restructuring, it remains on nonaccrual basis until the borrower has demonstrated a willingness and ability to meet the terms and conditions of the restructuring and to make the restructured loan payments, generally for a period of at least nine months. The Bank has not immediately placed any restructured loan on accrual status that was on nonaccrual status prior to restructuring. If a restructured loan was on accrual basis prior to restructuring and the Bank expects the borrower to perform to the terms and conditions of the loan after restructuring (i.e. the loan was current, on accrual basis, and the borrower has the ability to make the restructured loan payments), the loan remains on an accrual basis and placement on nonaccrual is not required.
The Bank performs restructurings on certain troubled loan workouts, whereby existing loans are restructured into a multiple note structure (i.e., Note A and Note B structure). The Bank separates a portion of the current outstanding debt into a new legally enforceable note (Note A) that is reasonably assured of repayment and performance according to prudently modified terms. The portion of the debt that is not reasonably assured of repayment (Note B) is adversely classified and charged-off as appropriate. The following table provides information on multiple note restructures for certain commercial real estate loan workouts as of September 30, 2015 and 2014.
September 30, 2015 | September 30, 2014 | |||||||
(In thousands) | ||||||||
Note A Structure | ||||||||
Commercial real estate (1) | $ | 271 | $ | 275 | ||||
Note B Structure | ||||||||
Commercial real estate (2) | $ | 174 | $ | 174 | ||||
Reduction of interest income (3) | $ | 7 | $ | 2 |
19
8. Troubled Debt Restructurings (Continued)
(1) | If Note A was on nonaccrual status, it may be placed back on accrual status based on sustained historical payment performance of generally nine months. |
(2) | Note B is immediately charged-off upon restructuring; however, payment in full is due at maturity of the note. |
(3) | Reflects amount of interest income reduction during the nine months ended September 30, 2015 and 2014, as a result of multiple note restructures. |
The benefit of this workout strategy is for the A note to remain a performing asset for which the borrower has the willingness and ability to meet the restructured payment terms and conditions. In addition, this workout strategy reduces the prospects of further write downs and charge offs, and also reduces the prospects of a potential foreclosure. Following this restructuring, the Note A credit classification generally improves from “substandard” to an unclassified risk grade.
The general terms of the new loans restructured under the Note A and Note B structure differ as follows:
· | Note A: First lien position; fixed or adjustable current market interest rate; fixed month term to maturity; payments – interest only to maturity, or full principal and interest to maturity. Note A is underwritten in accordance with the Bank’s customary underwriting standards and is on an accrual basis. |
· | Note B: Second lien position; fixed or adjustable below current market interest rate; fixed month term to maturity; payments – due in full at maturity. Note B is underwritten in accordance with the Bank’s customary underwriting standards, except for the below market interest rate and payment terms, and is on a nonaccrual basis. |
9. Other Real Estate Owned. The following table reflects the changes in other real estate owned (“OREO”) during the nine months ended September 30, 2015 and 2014:
Beginning | Fair Value | End | ||||||||||||||||||
of Period | Additions | Sales, net | Adjustments | of Period | ||||||||||||||||
(In thousands) | ||||||||||||||||||||
September 30, 2015 | ||||||||||||||||||||
OREO | $ | 7,756 | $ | 761 | $ | (1,915 | ) | $ | (96 | ) | $ | 6,506 | ||||||||
September 30, 2014 | ||||||||||||||||||||
OREO | $ | 9,354 | $ | 1,412 | $ | (2,590 | ) | $ | (73 | ) | $ | 8,103 |
Fair value adjustments made are recorded in order to adjust the carrying values of OREO properties to estimated fair market values. In most cases, estimated fair market values are derived from an initial appraisal, an updated appraisal or other forms of internal evaluations. In certain instances when a listing agreement is renewed for a lesser amount, carrying values will be adjusted to the lesser fair value amount. Additionally, in certain instances when an offer to purchase is received near the end of a quarterly accounting period for less than the carrying value, and the sale does not close until the next accounting period, the carrying value will be adjusted to the lesser fair value amount.
10. Fair Value Measurement. Fair value is defined as the price that would be received on the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy prioritizes the inputs of valuation techniques used to measure fair value of nonfinancial assets and liabilities. The inputs are evaluated and an overall level for the fair value measurement is determined. This overall level is an indication of the market observability of the fair value measurement. In order to determine the fair value, the Bank must determine the unit of account, highest and best use, principal market, and market participants. These determinations allow the Bank to define the inputs for fair value and level of hierarchy. The Bank groups financial assets at fair value in the three levels listed below based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
Level 1: inputs to the valuation methodology are quoted prices in active markets for identical assets or liabilities that the Bank has the ability to access at the measurement date. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available. The types of assets carried at Level 1 fair value generally include investments such as U.S. Treasury and U.S. government agency securities.
Level 2: inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets and price quotations can vary substantially either over time or among market makers. The types of assets carried at Level 2 fair value generally include mortgage-backed securities issued by Government Sponsored Enterprises (“GSEs”), municipal bonds, corporate debt securities, mortgage loans held for sale and bank-owned life insurance.
Level 3: inputs to the valuation methodology are unobservable to the extent that observable inputs are not available. Unobservable inputs are developed based on the best information available in the circumstances and might include the Bank’s own assumptions. The Bank shall not ignore information about market participant assumptions that is reasonably available without undue cost and effort. The types of assets carried at Level 3 fair value generally include investments backed by non-traditional mortgage loans or certain state or local housing agency obligations. Level 3 also includes impaired loans and other real estate owned.
20
10. Fair Value Measurement (Continued)
The following table presents assets measured at fair value on a recurring basis as of September 30, 2015 and December 31, 2014:
Fair Value | Quoted Prices In Active Markets for Identical Assets | Significant Observable Inputs-Other | Significant Unobservable Inputs | |||||||||||||
(In thousands) | ||||||||||||||||
Description | 9/30/15 | Level 1 | Level 2 | Level 3 | ||||||||||||
Securities available for sale: | ||||||||||||||||
Government securities | $ | 31,773 | $ | 31,773 | $ | - | $ | - | ||||||||
Mortgage-backed securities | 136,907 | - | 136,907 | - | ||||||||||||
Municipal securities | 51,119 | - | 51,119 | - | ||||||||||||
Corporate bonds | 28,553 | - | 28,553 | - | ||||||||||||
Mortgage loans held for sale | 4,029 | - | 4,029 | - | ||||||||||||
Bank-owned life insurance | 15,507 | - | 15,507 | - | ||||||||||||
Interest rate swap | (553 | ) | - | (553 | ) | - | ||||||||||
Total September 30, 2015 | $ | 267,335 | $ | 31,773 | $ | 235,562 | $ | - |
Description | 12/31/14 | Level 1 | Level 2 | Level 3 | ||||||||||||
Securities available for sale: | ||||||||||||||||
Government securities | $ | 31,232 | $ | 31,232 | $ | - | $ | - | ||||||||
Mortgage-backed securities | 174,280 | - | 174,280 | - | ||||||||||||
Municipal securities | 55,702 | - | 55,702 | - | ||||||||||||
Corporate bonds | 31,085 | - | 31,085 | - | ||||||||||||
Mortgage loans held for sale | 4,793 | - | 4,793 | - | ||||||||||||
Bank-owned life insurance | 15,125 | - | 15,125 | - | ||||||||||||
Interest rate swap | (405 | ) | - | (405 | ) | - | ||||||||||
Total December 31, 2014 | $ | 311,812 | $ | 31,232 | $ | 280,580 | $ | - |
The following table presents assets measured at fair value on a non-recurring basis as of September 30, 2015 and December 31, 2014:
Fair Value | Quoted Prices In Active Markets for Identical Assets | Significant Observable Inputs-Other | Significant Unobservable Inputs | |||||||||||||
(In thousands) | ||||||||||||||||
Description | 9/30/15 | Level 1 | Level 2 | Level 3 | ||||||||||||
Impaired loans, net | $ | 16,155 | $ | - | $ | - | $ | 16,155 | ||||||||
Other real estate owned | 6,506 | - | - | 6,506 | ||||||||||||
Total September 30, 2015 | $ | 22,661 | $ | - | $ | - | $ | 22,661 |
Description | 12/31/14 | Level 1 | Level 2 | Level 3 | ||||||||||||
Impaired loans, net | $ | 19,480 | $ | - | $ | - | $ | 19,480 | ||||||||
Other real estate owned | 7,756 | - | - | 7,756 | ||||||||||||
Total December 31, 2014 | $ | 27,236 | $ | - | $ | - | $ | 27,236 |
Impaired loans at September 30, 2015 and December 31, 2014 includes $14.6 million and $17.3 million, respectively, of loans identified as impaired, even though an impairment analysis calculated pursuant to ASC 310-10-35 resulted in no allowance.
Quoted market price for similar assets in active markets is the valuation technique for determining fair value of securities available for sale and held to maturity. Unrealized gains on available for sale securities are included in the “accumulated other comprehensive income” component of the Stockholders’ Equity section of the Consolidated Statements of Financial Condition. The estimated fair value of loans held for sale is based on commitments from investors within the secondary market for loans with similar characteristics.
The Company does not record loans held for investment at fair value on a recurring basis. However, when a loan is considered impaired an impairment write down is taken based on the loan’s estimated fair value. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those loans not requiring a write down represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans, and are not included above.
21
10. Fair Value Measurement (Continued)
Impaired loans where a write down is taken based on fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as non-recurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company classifies the impaired loan as non-recurring Level 3.
OREO is recorded at fair value upon transfer of the loans to foreclosed assets, based on the appraised market value of the property. OREO is reviewed quarterly and values are adjusted as determined appropriate. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When an appraised value is not available or management determines the fair value of the collateral is impaired below the appraised value and there is no observable market price, the Company classifies the foreclosed asset as non-recurring Level 3. Fair value adjustments of $9,981 and $95,639, respectively, were made to OREO during the three and nine months ended September 30, 2015, compared to fair value adjustments of $62,100 and $73,300 made to OREO during the three and nine months ended September 30, 2014, respectively.
Net gains (losses) realized on sales of OREO included in earnings for the three and nine months ended September 30, 2015 and 2014, respectively, are reported in other revenues as follows:
Three Months Ended 9/30/15 | Three Months Ended 9/30/14 | Nine months Ended 9/30/15 | Nine months Ended 9/30/14 | |||||||||||||
Net gain (loss) on sales of OREO | $ | (63,402 | ) | $ | 8,949 | $ | 9,814 | $ | 82,369 |
No liabilities were measured at fair value on a recurring or non-recurring basis at September 30, 2015 or December 31, 2014.
11. Fair Value of Financial Instruments. The following table represents the recorded carrying values, estimated fair values and the fair value hierarchy within which the fair value measurements of the Company’s financial instruments are categorized at September 30, 2015 and December 31, 2014:
Level in | September 30, 2015 | December 31, 2014 | ||||||||||||||||
Fair Value | Estimated | Carrying | Estimated | Carrying | ||||||||||||||
Hierarchy | Fair Value | Amount | Fair Value | Amount | ||||||||||||||
(In thousands) | ||||||||||||||||||
Financial assets: | ||||||||||||||||||
Cash and due from banks | Level 1 | $ | 17,826 | $ | 17,826 | $ | 23,281 | $ | 23,281 | |||||||||
Interest-bearing deposits in other banks | Level 1 | 24,861 | 24,861 | 32,836 | 32,836 | |||||||||||||
Securities available for sale | Level 1 | 31,773 | 31,773 | 31,232 | 31,232 | |||||||||||||
Securities available for sale | Level 2 | 216,579 | 216,579 | 261,067 | 261,067 | |||||||||||||
Securities held to maturity | Level 2 | 514 | 508 | 512 | 507 | |||||||||||||
Loans held for sale | Level 2 | 4,029 | 4,029 | 4,793 | 4,793 | |||||||||||||
Loans and leases HFI, net, less impaired loans | Level 2 | 547,768 | 543,580 | 460,062 | 453,436 | |||||||||||||
Stock in FHLB of Atlanta | Level 2 | 2,199 | 2,199 | 607 | 607 | |||||||||||||
Accrued interest receivable | Level 2 | 2,678 | 2,678 | 2,852 | 2,852 | |||||||||||||
Interest rate swap | Level 2 | (553 | ) | (553 | ) | (405 | ) | (405 | ) | |||||||||
Bank-owned life insurance | Level 2 | 15,507 | 15,507 | 15,125 | 15,125 | |||||||||||||
Impaired loans HFI, net | Level 3 | 16,155 | 16,155 | 19,480 | 19,480 | |||||||||||||
Mortgage servicing rights | Level 3 | 2,258 | 1,229 | 2,347 | 1,178 | |||||||||||||
Financial liabilities: | ||||||||||||||||||
Deposits | Level 2 | $ | 783,428 | $ | 783,311 | $ | 788,488 | 788,280 | ||||||||||
Junior subordinated debentures | Level 2 | 10,310 | 10,310 | 10,310 | 10,310 |
Fair values of financial assets and liabilities have been estimated using data which management considers as the best available, and estimation methodologies deemed suitable for the pertinent category of financial instrument. With regard to financial instruments with off-balance sheet risk, it is not practicable to estimate the fair value of future financing commitments. The estimation methodologies used by the Bank are as follows:
Financial assets:
Cash and Due from banks and Interest –Bearing Deposits in Other Banks: The carrying amounts for cash and due from banks and interest bearing deposits in other banks are equal to their fair value. Fair value hierarchy Input level 1.
22
11. Fair Value of Financial Instruments (Continued)
Investment Securities Available for Sale and Held to Maturity: The estimated fair value of investment securities is provided in Note 4 of the Notes to Consolidated Financial Statements. These are based on quoted market prices, when available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Fair value hierarchy Input levels 1 and 2.
Loans Held for Sale. The estimated fair value of loans held for sale is based on commitments from investors within the secondary market for loans with similar characteristics. Fair value hierarchy Input level 2.
Loans and Leases Held for Investment, net, less Impaired Loans: Fair values are estimated for portfolios of loans and leases held for investment with similar financial characteristics. Loans and leases are segregated by collateral type and by fixed and variable interest rate terms. The fair value of each category is determined by discounting scheduled future cash flows using current interest rates offered on loans or leases with similar characteristics. Fair value hierarchy Input level 2.
Stock in Federal Home Loan Bank of Atlanta: The fair value for FHLB stock approximates carrying value, based on the redemption provisions of the Federal Home Loan Bank. Fair value hierarchy Input level 2.
Accrued Interest Receivable: The carrying amount of accrued interest receivable approximates fair value because of the short maturities of these instruments. Fair value hierarchy Input level 2.
Interest Rate Swap: The Company has entered into a pay-fixed receive-floating swap to hedge our $10.0 million of floating rate Trust Preferred debt. The primary objective of the swap is to minimize future interest rate risk. The effective date of the swap is December 30, 2014. Fair value hierarchy Input level 2.
Bank-Owned Life Insurance: The carrying value of life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the issuer. Fair value hierarchy Input level 2.
Impaired Loans Held for Investment, Net: Fair values for impaired loans and leases are estimated based on discounted cash flows or underlying collateral values, where applicable. Fair value hierarchy Input Level 3.
Mortgage Servicing Rights (“MSRs”): The fair value of MSRs is estimated for those loans sold with servicing retained. The loans are stratified into pools by product type and within product type by interest rate and maturity. The fair value of the MSR is based upon the present value of estimated future cash flows using current market assumptions for prepayments, servicing costs and other factors. Fair value hierarchy Input level 3.
Financial liabilities:
Deposits: The fair value of demand deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposits is estimated using rates currently offered for similar instruments with similar remaining maturities. Fair value hierarchy Input level 2.
Junior Subordinated Debentures: The carrying amount of junior subordinated debentures approximates fair value of similar instruments with similar characteristics and remaining maturities. Fair value hierarchy Input level 2.
12. Deposits. The following table presents the distribution of the Bank’s deposit accounts as of September 30, 2015 and December 31, 2014:
9/30/15 | 12/31/14 | |||||||
(In thousands) | ||||||||
Demand accounts: | ||||||||
Non-interest bearing checking | $ | 157,609 | $ | 147,544 | ||||
Interest bearing checking | 167,673 | 180,558 | ||||||
Money market | 68,443 | 87,914 | ||||||
Savings accounts | 133,570 | 117,933 | ||||||
Certificate accounts | 256,016 | 254,331 | ||||||
Total deposits | $ | 783,311 | $ | 788,280 |
At September 30, 2015, the scheduled maturities of certificate accounts were as follows:
Less than $100,000 | $100,000 or more | Total | ||||||||||
(In thousands) | ||||||||||||
Three months or less | $ | 24,282 | $ | 12,497 | $ | 36,779 | ||||||
Over three months through one year | 54,541 | 48,756 | 103,297 | |||||||||
Over one year through three years | 53,931 | 43,713 | 97,644 | |||||||||
Over three years to five years | 12,497 | 5,799 | 18,296 | |||||||||
Total time deposits | $ | 145,251 | $ | 110,765 | $ | 256,016 |
The aggregate amount of time deposits with balances of $100,000 or more was $110,764,798 and $111,523,043 at September 30, 2015 and December 31, 2014, respectively.
23
13. Stock-Based Compensation. The Company had two stock-based compensation plans at September 30, 2015. The shares outstanding are for grants under the Company’s 1997 Stock Option Plan (the “1997 Plan”) and the 2008 Equity Incentive Plan (the “2008 Plan”). The 1997 Plan matured on April 8, 2008 and no additional options may be granted under the 1997 Plan. At September 30, 2015, the 1997 Plan had 30,750 granted unexercised stock option shares. At September 30, 2015, the 2008 Plan includes 139,250 granted unexercised stock option shares, 10,425 granted nonvested restricted stock award shares and 804,850 shares available to be granted.
Stock Option Grants. Options granted under the 2008 Plan are granted at the closing price of the Company’s common stock on the NASDAQ Stock Market on the date of grant. Stock options expire ten years from the date of grant and vest over service periods ranging from one year to five years. The Company settles stock option exercises with authorized unissued shares. The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model. The risk-free interest rate is based on the U.S. Treasury rate for the expected life at the time of grant. Volatility is based on the average volatility of the Company based upon previous trading history. The expected life and forfeiture assumptions are based on historical data. Dividend yield is based on the yield at the time of the option grant.
A summary of option activity under the Plans as of September 30, 2015 and 2014, and changes during the nine month periods ended September 30, 2015 and 2014 is presented below:
Options Outstanding | Price | Aggregate Intrinsic Value | ||||||||||
Period Ended September 30, 2015: | ||||||||||||
Outstanding at December 31, 2014 | 169,500 | $ | 11.38 | |||||||||
Granted | 14,000 | 8.01 | ||||||||||
Forfeited | (6,000 | ) | 7.13 | |||||||||
Expired | (7,500 | ) | 17.47 | |||||||||
Exercised | - | - | ||||||||||
Outstanding at September 30, 2015 | 170,000 | 10.99 | $ | 184,015 | ||||||||
Vested and Exercisable at September 30, 2015 | 112,100 | $ | 13.24 | $ | 102,180 | |||||||
Period Ended September 30, 2014: | ||||||||||||
Outstanding at December 31, 2013 | 160,375 | $ | 11.84 | |||||||||
Granted | 19,000 | 8.34 | ||||||||||
Forfeited | (2,250 | ) | 6.52 | |||||||||
Expired | (6,375 | ) | 16.41 | |||||||||
Exercised | - | - | ||||||||||
Outstanding at September 30, 2014 | 170,750 | 11.35 | $ | 205,710 | ||||||||
Vested and Exercisable at September 30, 2014 | 106,950 | $ | 14.45 | $ | 77,486 |
The following weighted-average assumptions were used for grants awarded in the nine months ended September 30, 2015 and 2014:
Nine Months Ended 9/30/15 | Nine Months Ended 9/30/14 | |||||||
Dividend growth rate | 1.0 | % | 1.0 | % | ||||
Expected volatility | 96.9 | % | 53.0 | % | ||||
Average risk-free interest rate | 1.5 | % | 1.9 | % | ||||
Expected lives - years | 7 | 6 |
The following table summarizes additional information about the Company’s outstanding options and exercisable options as of September 30, 2015, including weighted-average remaining contractual term expressed in years ("Life") and weighted average exercise price (“Price”):
Outstanding | Exercisable | |||||||||||||||||||
Range of Exercise Price | Shares | Life | Price | Shares | Price | |||||||||||||||
$4.00 – 10.00 | 101,250 | 7.08 | $ | 6.17 | 43,350 | $ | 5.58 | |||||||||||||
$10.01 – 17.00 | 27,000 | 3.95 | 11.01 | 27,000 | 11.01 | |||||||||||||||
$17.01 – 26.00 | 32,250 | 2.29 | 21.03 | 32,250 | 21.03 | |||||||||||||||
$26.01 – 34.00 | 9,500 | .94 | 28.14 | 9,500 | 28.14 | |||||||||||||||
170,000 | 5.33 | $ | 10.99 | 112,100 | $ | 13.24 |
24
13. Stock-Based Compensation (Continued)
A summary of nonvested option shares as of September 30, 2015 and 2014, and vesting changes during the nine months ended September 30, 2015 and 2014, is presented below:
Shares | Price | |||||||
Period Ended September 30, 2015: | ||||||||
Nonvested at December 31, 2014 | 62,700 | $ | 6.14 | |||||
Granted | 14,000 | 8.01 | ||||||
Forfeited | (4,400 | ) | 7.19 | |||||
Vested | (14,400 | ) | 5.74 | |||||
Nonvested at September 30, 2015 | 57,900 | $ | 6.61 | |||||
Period Ended September 30, 2014: | ||||||||
Nonvested at December 31, 2013 | 58,750 | $ | 5.38 | |||||
Granted | 19,000 | 8.34 | ||||||
Forfeited | (2,250 | ) | 6.52 | |||||
Vested | (11,700 | ) | 5.73 | |||||
Nonvested at September 30, 2014 | 63,800 | $ | 6.16 |
There were no income tax benefits realized from the exercise of stock options for the three and nine months ended September 30, 2015 or 2014, as no options were exercised during the respective periods.
Total compensation expense charged to income for stock options was $9,762 and $30,938, respectively, for the three and nine months ended September 30, 2015, compared to compensation expense of $8,784 and $25,397, respectively, for the three and nine months ended September 30, 2014. As of September 30, 2015, total unrecognized compensation cost on granted unexercised shares was $151,186, and is expected to be recognized during the next 4.5 years.
Restricted Stock Awards. The Company measures the fair value of restricted shares based on the price of its common stock on the grant date and compensation expense is recorded over the vesting period. During the nine months ended September 30, 2015 and 2014, none and 13,900 restricted stock awards, respectively, were granted with a four year vesting period. Total compensation expense recognized for restricted stock awards for the three and nine months ended September 30, 2015 was $7,263 and $21,789, respectively, compared to $7,263 and $19,365, respectively, for the three and nine months ended September 30, 2014. As of September 30, 2015, there was $67,785 of total unrecognized compensation cost related to nonvested restricted stock granted under the 2008 Plan, which will be recognized over a remaining period of 2.5 years. A summary of nonvested restricted stock awards as of September 30, 2015 and 2014, and vesting changes during the respective three month periods is presented below:
Shares | Price | |||||||
Period Ended September 30, 2015: | ||||||||
Nonvested at December 31, 2014 | 13,900 | $ | 8.36 | |||||
Granted | - | - | ||||||
Vested | (3,475 | ) | 8.36 | |||||
Forfeited | - | - | ||||||
Nonvested at September 30, 2015 | 10,425 | $ | 8.36 | |||||
Period Ended September 30, 2014: | ||||||||
Nonvested at December 31, 2013 | - | $ | - | |||||
Granted | 13,900 | 8.36 | ||||||
Vested | - | - | ||||||
Forfeited | - | - | ||||||
Nonvested at September 30, 2014 | 13,900 | $ | 8.36 |
The following table reflects the combined impact of fair value compensation cost recognition for stock options and restricted stock awards on income before income taxes, net income, basic earnings per share and diluted earnings per share for the three and nine month periods ended September 30, 2015 and 2014:
Three Months 9/30/15 | Three Months 9/30/14 | Nine Months 9/30/15 | Nine Months 9/30/14 | |||||||||||||
Decrease net income before income taxes | $ | 17,025 | $ | 16,047 | $ | 52,727 | $ | 44,765 | ||||||||
Decrease net income | $ | 17,025 | $ | 16,047 | $ | 52,727 | $ | 44,765 | ||||||||
Decrease basic earnings per share | $ | 0.00 | $ | 0.00 | $ | 0.00 | $ | 0.00 | ||||||||
Decrease diluted earnings per share | $ | 0.00 | $ | 0.00 | $ | 0.00 | $ | 0.00 |
25
14. Goodwill and Other Intangibles.
The following table presents activity for goodwill and other intangible assets for the nine months ended September 30, 2015 and 2014, respectively:
Goodwill | Other Intangibles | Total | ||||||||||
Nine Months Ended September 30, 2015: | ||||||||||||
Balance at December 31, 2014 | $ | 4,218,576 | $ | 2,182,909 | $ | 6,401,485 | ||||||
Amortization | — | (215,546 | ) | (215,546 | ) | |||||||
Balance at September 30, 2015 | $ | 4,218,576 | $ | 1,967,363 | $ | 6,185,939 | ||||||
Nine Months Ended September 30, 2014: | ||||||||||||
Balance at December 31, 2013 | $ | 4,218,576 | $ | 7,860 | $ | 4,226,436 | ||||||
Amortization | — | (7,860 | ) | (7,860 | ) | |||||||
Balance at September 30, 2014 | $ | 4,218,576 | $ | — | $ | 4,218,576 |
The following table presents a rollforward of the gross carrying amount, new acquisitions, accumulated amortization and net book value for the Company’s core deposit intangible (CDI), which is the only identifiable intangible asset subject to amortization at September 30, 2015 and December 31, 2014:
Other Intangibles | ||||
Gross carrying amount at December 31, 2013 (1) | $ | 287,832 | ||
Accumulated amortization | (279,972 | ) | ||
Net book value at December 31, 2013 | 7,860 | |||
Amortization | (7,860 | ) | ||
Acquisitions (2) | 2,182,909 | |||
Net book value at December 31, 2014 | 2,182,909 | |||
Accumulated amortization | (215,546 | ) | ||
Net book value at September 30, 2015 | $ | 1,967,363 |
(1) | CDI related to the acquisition of Green Street Financial Corp on November 30, 1999. |
(2) | CDI related to the acquisition of branch offices from Bank of America, N.A. on December 12, 2014. |
The following table presents estimated future amortization expense of the CDI. At December 31, 2014, the remaining life of the CDI was 10 years.
2015 | $ | 71,848 | ||
2016 | 284,327 | |||
2017 | 241,678 | |||
2018 | 223,002 | |||
2019 | 223,002 | |||
Thereafter | 923,506 | |||
Total | $ | 1,967,363 |
15. Regulatory Capital. The Bank is subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Management believes, as of September 30, 2015, that the Bank meets all capital adequacy requirements to which it is subject. The Company’s most significant asset is its investment in the Bank. Consequently, the information concerning capital ratios is essentially the same for the Company and the Bank. Beginning January 1, 2015, banks became subject to new Basel III Capital Rules. As a result, certain items in the risk-based capital calculation have changed. In addition, a new ratio, Common Equity Tier 1 Risk-Based Capital Ratio, is now measured and monitored. For the Bank and given its capital structure, the Common Equity Tier 1 Risk-Based Capital Ratio and the Tier 1 Risk-Based Capital Ratio are identical. The Bank's actual regulatory capital amounts and ratios as of September 30, 2015, and December 31, 2014, are listed below:
September 30, 2015 | December 31, 2014 | |||||||||||||||
Regulatory Capital Ratios | Amount | Ratio | Amount | Ratio | ||||||||||||
Total Risk-Based Capital Ratio (to Risk Weighted Assets) | $ | 85,084 | 13.7 | % | $ | 82,670 | 14.6 | % | ||||||||
Common Equity Tier 1 Risk-Based Capital Ratio (to Risk Weighted Assets) | 77,298 | 12.5 | — | — | ||||||||||||
Tier 1 Risk-Based Capital Ratio (to Risk Weighted Assets) | 77,298 | 12.5 | 75,568 | 13.3 | ||||||||||||
Tier 1 Leverage Capital Ratio (to Average Assets) | 77,298 | 8.7 | 75,568 | 9.7 |
26
16. Junior Subordinated Debentures.
The Company has sponsored a trust, First South Preferred Trust I (the Trust), of which 100% of the common equity is owned by the Company. The Trust was formed for the purpose of issuing company-obligated preferred trust securities (the Preferred Trust Securities) to third-party investors and investing the proceeds from the sale of such Preferred Trust Securities solely in junior subordinated debt securities of the Company (the Debentures). The Debentures held by the Trust are the sole assets of the Trust. Distributions on the Preferred Trust Securities issued by the Trust are payable quarterly at a rate equal to the interest rate being earned by the Trust on the Debentures held by that Trust. The Preferred Trust Securities are subject to mandatory redemption, in whole or in part, upon repayment of the Debentures. The Company has entered into an agreement, which fully and unconditionally guarantees the Preferred Trust Securities subject to the terms of the guarantee. The Debentures held by the Trust are first redeemable, in whole or in part, by the Company on or after September 30, 2008. Subject to certain limitations, the Junior Subordinated Debentures qualify as Tier 1 capital for the Company under current Federal Reserve Board guidelines.
In July of 2013, the banking regulators issued the final Basel III capital rules. Under these rules, bank holding companies with less than $15 billion in consolidated total assets as of December 31, 2009, that issued trust preferred securities prior to May 19, 2010, are permanently grandfathered as Tier 1 or Tier 2 capital.
Consolidated debt obligations as of September 30, 2015 related to a subsidiary Trust holding solely Debentures of the Company follows:
LIBOR + 2.95% junior subordinated debentures owed to First South Preferred Trust I due September 26, 2033 | $ | 10,000,000 | ||
LIBOR + 2.95% junior subordinated debentures owed to First South Preferred Trust I due September 26, 2033 | 310,000 | |||
Total junior subordinated debentures owed to unconsolidated subsidiary trust | $ | 10,310,000 |
The trust preferred securities bear interest at three-month LIBOR plus 2.95% payable quarterly. Effective December 30, 2014, the Company swapped the interest rate on these debentures to a fixed rate of 5.54% for the ensuing five year period. This strategy was executed to provide the Company with protection to a rising rate environment.
17. Interest Rate Hedging. The Company has executed certain strategies targeted at hedging the impact of rising interest rates on its future earnings. The Company has entered into a pay-fixed receive-floating swap to hedge our $10.0 million of floating rate Trust Preferred debt. The primary objective of the swap is to minimize future interest rate risk. The effective date of the swap was December 30, 2014, and it has a five year term.
18. Recent Accounting Pronouncements. The following are Accounting Standards Updates (“ASU”) recently issued by the Financial Accounting Standards Board (“the FASB”) and their expected impact on the Company. Other accounting standards issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s consolidated financial statements.
In January 2015, the FASB issued ASU 2015-01, Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items. The objective of this ASU is to simplify income statement presentation requirements by eliminating the concept of extraordinary items. Extraordinary items are events and transactions that are distinguished by their unusual nature and by the infrequency of their occurrence. Eliminating the extraordinary classification simplifies income statement presentation by removing the concept of extraordinary items from consideration. This ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs. The objective of this ASU is to simplify the presentation of debt issuance costs. The amendments in this ASU would require that debt issuance costs be presented in the balance sheet as a direct reduction from the carrying amount of debt liability, consistent with debt discounts and premiums. The recognition and measurement guidance for debt issuance costs would not be affected by the amendments in this ASU. This ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In June 2015, the FASB issued ASU 2015-10, Technical Corrections and Improvements. The amendments in this Update represent changes in the Codification, correct unintended application of guidance, or make minor improvements to the Codification that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
In August 2015, the FASB issued ASU 2015-14, Deferral of Effective Date. In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), with an effective date for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period for public business entities. The amendments in this ASU defer the effective date of ASU 2014-09. Public business entities should apply the guidance in Update 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
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In August 2015, the FASB issued ASU 2015-16, Simplifying the Accounting for Measurement-Period Adjustments. To simplify the accounting for adjustments made to provisional amounts, the amendments in the ASU require that the acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amount is determined. The acquirer is required to also record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. In addition an entity is required to present separately on the face of the income statement or disclose in the notes to the financial statements the portion of the amount recorded in current-period earnings by line item that would have been recorded. For public entities, this ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The Company will evaluate the impact this ASU may have on its consolidated financial statements.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
First South Bancorp, Inc. (the "Company") was formed for the purpose of issuing common stock and owning 100% of the stock of First South Bank (the "Bank") and operating through the Bank a commercial banking business. The discussion below focuses primarily on the Bank's results of operations. The Bank has one significant operating segment, providing commercial and retail banking services to its markets located in the state of North Carolina. The Company’s common stock is traded on the NASDAQ Global Select Market under the symbol "FSBK".
Comparison of Financial Condition at September 30, 2015, and December 31, 2014. Total assets increased to $913.4 million at September 30, 2015, from $885.9 million at December 31, 2014. Earning assets increased to $845.1 million at September 30, 2015 from $810.9 million at December 31, 2014. The ratio of earning assets to total assets was 92.5% at September 30, 2015, compared to 91.5% at December 31, 2014. The increase is attributable to a net increase in the volume of earning assets, resulting primarily from net growth in the loan and lease receivable portfolio, and partially offset by the sale of investment securities and a reduction in the level of cash on our balance sheet to help fund loan growth.
Interest-bearing deposits with banks declined to $24.9 million at September 30, 2015, from $32.8 million at December 31, 2015. Overnight deposits are available to fund securities purchases, loan originations, deposit withdrawals, liquidity management activities and daily operations of the Bank.
The investment securities portfolio declined to $248.9 million at September 30, 2015, from $292.8 million at December 31, 2014. During the nine months ended September 30, 2015, there were $11.5 million of purchases, $36.8 million of sales, $17.4 million of principal repayments, a $276,000 increase in unrealized holding gains, $1.0 million of net realized gains and $1.6 million of net accretion of premiums and discounts. In 2014 the Bank implemented a strategy to pre-invest a large portion of the anticipated proceeds from its 2014 branch acquisition transaction with Bank of America (“BOA”) into short and intermediate term investment securities until the funds could be converted to higher yielding assets. During the first nine months of 2015, the Bank sold $37.7 million of investment securities primarily to fund our loan portfolio growth and to exit certain municipal securities with exposure to the oil and gas industries. The Bank may also sell investment securities to manage sensitivity to future interest rate changes and/or to support funding needs. See “Note 4. Investment Securities” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Total loans held for sale were $4.0 million at September 30, 2015, compared to $4.8 million at December 31, 2014, reflecting the net effect of current mortgage lending activity. During the nine months ended September 30, 2015, there were $24.7 million of loan sales, $23.2 million of loan originations net of principal payments and $801,000 of net realized gains. Proceeds from mortgage loan sales are primarily used to fund the Bank’s liquidity needs, including loan originations, deposit withdrawals and general bank operations. Loans serviced for others declined to $297.8 million at September 30, 2015, from $306.8 million at December 31, 2014, as principal repayments exceeded the volume of new loan sales. See “Note 5. Loans Held for Sale” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Total loans and leases held for investment grew by $86.9 million during the current nine month period. This reflects the ninth consecutive quarter of net growth in loans and leases held for investment. As a result of this net growth, total loans and leases held for investment increased to $567.3 million at September 30, 2015, from $480.4 million at December 31, 2014. During the nine months ended September 30, 2015, there were $88.1 million of originations net of principal payments and $761,000 of transfers to other real estate owned.
Improving asset quality metrics continues as a key component of the Bank’s short-term and long-term performance objectives. Loans held for investment on nonaccrual status, including troubled debt restructured loans (“TDRs”) on nonaccrual status declined to $3.5 million at September 30, 2015, from $5.0 million at December 31, 2014. The decline in non-accrual loans results primarily from management’s resolution of nonaccrual loan relationships during the current period. The ratio of loans held for investment on nonaccrual status to total loans held for investment was 0.6% at September 30, 2015, compared to 1.1% at December 31, 2014.
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Loans are generally placed on nonaccrual status and accrued unpaid interest is reversed when management determines that collectability of interest, but not necessarily principal, is doubtful. This generally occurs when payments are delinquent in excess of 90 days. Consumer loans more than 180 days past due are generally charged off or a specific allowance is provided for any expected loss. All other loans are charged off when management concludes that they are uncollectible. Management has thoroughly evaluated all nonperforming loans and believes they are either well collateralized or adequately reserved. However, there can be no assurance in the future that regulators, increased volume and risks in the loan portfolio, adverse changes in economic conditions or other factors will not require additional adjustments to the allowance for loan and lease losses. Aside from the loans identified on nonaccrual status, there were no loans at September 30, 2015 where known information about possible credit problems of borrowers caused management to have serious concerns as to the ability of the borrowers to comply with their current loan repayment terms.
The Bank maintains the allowance for loan and lease losses (“ALLL”) at levels management believes is adequate to absorb probable losses inherent in the loan and lease portfolio. The Bank has developed policies and procedures for assessing the adequacy of the ALLL that reflect the assessment of credit risk and impairment analysis. This assessment includes a quarterly analysis of qualitative and quantitative trends in the levels of classified loans. In developing this analysis, the Bank relies on historical loss experience, estimates and exercises judgment in assessing credit risk. Future assessments of credit risk may yield different results, depending on changes in the qualitative and quantitative trends, which may require adjustments in the ALLL.
The Bank uses various modeling, calculation methods and estimation tools for measuring credit risk and performing impairment analysis, which is the basis used in developing the ALLL. The factors supporting the ALLL do not diminish the fact that the entire ALLL is available to absorb probable losses in the loan and leases portfolio. The Bank’s principal focus is on the adequacy of the ALLL. Based on the overall credit quality of the loan and lease portfolio, management believes the ALLL is adequate and has been established pursuant to generally accepted accounting principles, and has taken into account the views of its regulators and the current economic environment.
The quarterly assessment of ALLL adequacy includes an analysis of actual historical loss percentages of both classified and pass loans, as well as qualitative risk factors allocated among specific categories of loans. In developing this analysis, the Bank relies on actual loss history for the most recent twelve quarters and uses management’s best judgment in assessing credit risk. The assessment of qualitative factors includes various subjective components assessed in terms of basis points used in determining the ALLL adequacy. The evaluation of qualitative risk factors will result in a positive or negative adjustment to the ALLL methodology. Adjustments for each qualitative risk component may range from +25 basis points to -10 basis points. A component score of 0 basis points indicates no effect on the ALLL. A component rating of +25 basis points indicates the assessed maximum potential of increased risk to the ALLL adequacy. A -10 basis point component rating indicates the most positive effect on the ALLL.
The ALLL was $7.6 million at September 30, 2015, compared to $7.5 million at December 31, 2014. During the nine months ended September 30, 2015, there were $475,000 of provisions for credit losses and $425,000 of net charge-offs. The ratio of the ALLL to loans and leases held for investment was 1.33% at September 30, 2015, compared to 1.57% and December 31, 2014. See “Note 7. Allowance for Loan and Lease Losses” of “Notes to Consolidated Financial Statements (Unaudited)”and “Critical Accounting Policies - Loan Impairment and Allowance for Loan and Lease Losses” for additional information.
Based on an impairment analysis of loans held for investment, there were $16.7 million of loans classified as impaired, net of $353,000 in write-downs at September 30, 2015, compared to $20.3 million classified as impaired, net of $375,000 in write-downs at December 31, 2014. At September 30, 2015 and December 31, 2014, the ALLL included $531,000 and $792,000 specifically provided for impaired loans, respectively.
A loan is considered impaired, based on current information and events, if it is probable that the Bank will be unable to collect scheduled payments of principal and interest when due according to the contractual terms of the loan arrangement. All collateral-dependent loans are measured for impairment based on the fair value of the collateral, while uncollateralized loans and other loans determined not to be collateral dependent are measured for impairment based on the present value of expected future cash flows discounted at the historical effective interest rate. The Bank uses several factors in determining if a loan is impaired. The internal asset classification procedures include a thorough review of significant loans and lending relationships and include the accumulation of related data. This data includes loan payments status, borrowers’ financial data and borrowers’ operating factors such as cash flows, operating income or loss, and various other matters. See “Note 6. Loans Held for Investment”, “Note 7. Allowance for Loan and Lease Losses” and “Note 8. Troubled Debt Restructurings” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
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Other real estate owned (“OREO”) acquired from foreclosures declined to $6.5 million at September 30, 2015, from $7.8 million at December 31, 2014. During the nine months ended September 30, 2015, there were $1.9 million of disposals, $96,000 of valuation adjustments and $761,000 of additions. OREO consists of residential and commercial properties, developed lots and raw land. The Bank believes the adjusted carrying values of these properties are representative of their fair market values, although there can be no assurances that ultimate sales will be equal to or greater than the carrying values. See “Note 9. Other Real Estate Owned” and “Note 10. Fair Value Measurement” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
The Bank’s investment in bank-owned life insurance (“BOLI”) was $15.5 million at September 30, 2015, compared to $15.1 million at December 31, 2014, due to higher policy cash values. The investment returns from BOLI are used to recover a portion of the cost of providing benefit plans to our employees.
Goodwill related to prior period acquisitions was $4.2 million at September 30, 2015 and December 31, 2014, respectively, and is not being amortized pursuant to provisions of financial accounting standards. The balance of the Company’s goodwill is tested for impairment annually, and the most recent annual impairment test resulted in no goodwill impairment. Identifiable intangible assets were $2.0 million at September 30, 2015, compared to $2.2 million at December 31, 2014, reflecting the core deposit intangible associated with the BOA branch acquisition transaction, which is being amortized over a ten year period. See “Note 14. Goodwill and Other Intangibles” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Prepaid expenses, other assets and income tax receivable decreased by $597,000 during the current nine month period to $8.5 million at September 30, 2015, from $9.1 million at December 31, 2014, primarily reflecting changes in our deferred tax assets. See “Note 1. Basis of Presentation” of “Notes to Consolidated Financial Statements (Unaudited)” and Noninterest Expense below for additional information.
Total deposits declined by $5.0 million to $783.3 million at September 30, 2015, from $788.3 million at December 31, 2014. Non-interest bearing accounts, savings accounts and certificates of deposit grew by $10.1 million, $15.6 million and $1.7 million, respectively, and were offset by decreases of $32.4 million in interest bearing demand balances. Certificates of deposits represent 32.7% of total deposits at September 30, 2015, compared to 32.3% at December 31, 2014. Non-interest bearing accounts increased to 20.1% of total deposits at September 30, 2015, from 18.7% at December 31, 2014. The Bank strives to manage the cost of deposits by monitoring the volume and rates paid on maturing CDs in relationship to current funding needs and market interest rates. The Bank did not renew all maturing CDs during the nine months ended September 30, 2015, but was able to reprice some of the maturing CDs at lower rates, and a portion migrated internally to non-maturity deposits. See “Note 12. Deposits” of “Notes to Consolidated Financial Statements (Unaudited)” and “Interest Expense” below for additional information.
There were $33.0 million of Federal Home Loan Bank (“FHLB”) borrowings outstanding at September 30, 2015, compared to none at December 31, 2014. During the first nine months of 2015, the Bank has used FHLB borrowings as a low cost source of funds to support the loan portfolio growth and the net decline in total deposits. The Bank uses FHLB borrowings as a funding source to provide an effective means of managing its overall cost of funds and to manage its exposure to interest rate risk.
There were $10.3 million of junior subordinated debentures outstanding at both September 30, 2015 and December 31, 2014. See “Note 16. Junior Subordinated Debentures” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Stockholders' equity increased to $81.6 million at September 30, 2015, from $80.0 million at December 31, 2014. This increase primarily reflects the $3.1 million of net income earned for the first nine months of 2015, net of a $78,000 increase in accumulated other comprehensive income primarily resulting from the mark-to-market adjustment of the available-for-sale securities portfolio, $716,000 of cash dividends declared, and $909,000 used to acquire shares of the Company’s common stock pursuant to an announced repurchase program. The $78,000 increase in accumulated other comprehensive income reflects an increase in the mark-to-market of net unrealized gains in the available for sale investment securities portfolio, based on current market prices. See "Consolidated Statements of Changes in Stockholders' Equity", “Consolidated Statements of Comprehensive Income” and “Note 3. Comprehensive Income and Accumulated Other Comprehensive Income” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
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There were 9,489,222 common shares outstanding at September 30, 2015, compared to 9,598,007 shares outstanding at December 31, 2014, reflecting the net effect of 3,359 shares issued pursuant to the vesting of restricted stock awards and 112,144 shares repurchased and retired through the stock repurchase program.
The tangible equity to assets ratio was 8.26% at September 30, 2015, compared to 8.31% at December 31, 2014. Despite the decline in tangible equity, our tangible book value per common share increased to $7.95 at September 30, 2015, from $7.67 at December 31, 2014, primarily as a result of our share repurchases.
The Bank is subject to various regulatory capital requirements administered by its federal and state banking regulators. As of September 30, 2015, the Bank's regulatory capital ratios were in excess of all regulatory requirements and the Bank’s regulatory capital position was categorized as well capitalized. There are no conditions or events since September 30, 2015 that management believes have changed the Bank's well capitalized category. See “Note 15. Regulatory Capital” of “Notes to Consolidated Financial Statements (Unaudited)” and “Liquidity and Capital Resources” below for additional information.
Comparison of Operating Results – Three and Nine Months Ended September 30, 2015 and 2014.
General. For the three months ended September 30, 2015, net income was $1,237,000, or $0.13 per diluted common share, compared to net income of $1,419,000, or $0.14 per diluted common share earned for the three month period ended September 30, 2014. The change in our operating results between the reporting periods is primarily due to increases in net interest income and non-interest income, while being offset by an increase in non-interest expenses. The increase in net interest income reflects the impact of strong earning asset growth over the past twelve months, coupled with enhanced fee income from deposit service offerings as the benefits of the branch acquisition transaction with BOA in the fourth quarter of 2014 are being realized. Non-interest expenses in the current quarter exceeded that of the same quarter one year ago due primarily to infrastructure added in association with the branches acquired from BOA.
Net income for the nine months ended September 30, 2015 was $3,116,000, or $0.33 per diluted common share, compared to net income of $3,940,000, or $0.41 per diluted common share earned in the nine months ended September 30, 2014. Earnings for the current nine month period were positively impacted by increases in net interest income and non-interest income, as well as lower loan loss provisions. During this same period, non-interest expenses have increased with growth of our franchise and supporting infrastructure. In addition, during the first nine-months of 2015, the Bank incurred $425,000 of one-time, pre-tax transaction expenses associated with the nine newly acquired branch offices from BOA.
Interest Income. Interest income increased to $8.2 million and $23.9 million for the three and nine months ended September 30, 2015, from $7.3 million and $21.6 million for the comparative 2014 three and nine month periods. The year-over-year growth in interest income is due primarily to changes in the composition and volume of our earning asset base, and partially offset by a decline in yields on earning assets. Average earning assets for the three and nine month period ended September 30, 2015 increased to $828.5 million and $810.8 million, from $654.7 million and $640.8 million for the comparative period ended September 30, 2014.
Interest Expense. Interest expense increased to $794,000 and $2.2 million for the three and nine months ended September 30, 2014, from $716,000 and $2.0 million for the comparative 2014 three and nine month periods. Interest expense was primarily impacted by increased interest expense on deposits and junior subordinated debentures, while being partially offset by a reduction in interest paid on borrowings between the comparative reporting periods. Effective December 30, 2014, the Company swapped the interest rate on the junior subordinated debentures from three-month LIBOR plus 2.95%, to a fixed rate of 5.54% for the ensuing five year period. This strategy was executed to provide the Company with protection in the event of a rising rate environment.
The cost of average interest-bearing liabilities improved to 0.48% and 0.46% for the three and nine months ended September 30, 2015, from 0.53% and 0.51% for the comparative 2014 three and nine month periods. The Bank has managed its cost of interest-bearing liabilities by a combination of growth in lower cost non-maturity deposits, pricing new CDs and repricing maturing CDs in the lower interest rate environment, while being partially offset by additional cost of the junior subordinated debentures hedging strategy noted above. Although a portion of higher priced maturing longer-term CDs left the Bank, the residual renewed into lower priced CDs or migrated to non-maturity deposit products within the Bank.
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Average interest-bearing liabilities increased to $654.5 million and $645.6 million for the three and nine months ended September 30, 2015, from $536.1 million and $522.0 million for the comparable 2014 three and nine month periods. Average noninterest-bearing demand deposits increased to $162.4 million and $154.9 million for the three and nine months ended September 30, 2015, from $96.6 million and $96.0 million for the comparable 2014 three and nine month periods. These combined increases are also primarily related to the impact of the BOA branch acquisition.
Net Interest Income. Net interest income for the three and nine months ended September 30, 2015 increased to $7.4 million and $21.7 million, from $6.6 million and $19.6 million for the comparative 2014 three and nine month periods. The tax equivalent net interest margin declined to 3.63% and 3.64% for the three and nine months ended September 30, 2015, from 4.09% and 4.16% for the three and nine months ended September 30, 2014.
The Company’s margin has declined when compared to prior year periods due to a change in the mix of our earning assets coupled with reduced yields on loans and investment; however, the overall level of net interest income has increased. The change in our earning asset mix is due to an increase in bond portfolio holdings in the later portion of 2014 using the funds received from our branch acquisition transaction with BOA. A significant portion of these investments are shorter in duration and therefore have lower yields to provide additional cash flow to support future loan portfolio growth. In addition, we have experienced lower yields on our loan portfolio due to the current historically low rate environment coupled with strong competition for quality credit customers. While our yields are below historical levels, our efforts to increase our overall base of earning assets have resulted in growing net interest income. We anticipate our current margin to remain relatively stable over the near-term as the shift back to a more normalized earning asset mix should offset the impact of the current interest rate environment.
Yield/Cost Analysis. The table below contains comparative information relating to the Company’s average balance sheet and reflects the yield on average earning assets and the average cost of interest-bearing liabilities for the three and nine months ended September 30, 2015 and 2014, presented on a tax equivalent yield basis. Tax equivalent yields related to certain investment securities exempt from federal income tax are stated on a fully taxable basis, using a 34% federal statutory tax rate and reduced by a disallowed portion of the tax exempt interest income. Average balances are derived from average daily balances. The interest rate spread represents the difference between the tax equivalent yield on average earning assets and the cost of average interest-bearing liabilities. The tax equivalent net interest margin represents tax adjusted net interest income divided by average earning assets.
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Yield/Cost Analysis | Quarter Ended September 30, 2015 | Quarter Ended September 30, 2014 | ||||||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
Average | Average | |||||||||||||||||||||||
Average | Yield/ | Average | Yield/ | |||||||||||||||||||||
Balance | Interest | Cost | Balance | Interest | Cost | |||||||||||||||||||
Interest earning assets: | ||||||||||||||||||||||||
Loans receivable | $ | 558,302 | $ | 6,639 | 4.68 | % | $ | 477,477 | $ | 6,068 | 5.08 | % | ||||||||||||
Investments and deposits (1) | 270,236 | 1,578 | 2.63 | % | 177,223 | 1,248 | 2.82 | % | ||||||||||||||||
Total earning assets (1) | 828,538 | 8,217 | 4.01 | % | 654,700 | 7,316 | 4.52 | % | ||||||||||||||||
Nonearning assets | 75,479 | 62,391 | ||||||||||||||||||||||
Total assets | $ | 904,017 | $ | 717,091 | ||||||||||||||||||||
Interest bearing liabilities: | ||||||||||||||||||||||||
Deposits | $ | 619,537 | 598 | 0.38 | % | $ | 499,667 | 523 | 0.42 | % | ||||||||||||||
Borrowings | 24,661 | 54 | 0.86 | % | 26,170 | 112 | 1.68 | % | ||||||||||||||||
Junior subordinated debentures | 10,310 | 142 | 5.37 | % | 10,310 | 81 | 3.09 | % | ||||||||||||||||
Total interest-bearing liabilities | 654,508 | 794 | 0.48 | % | 536,147 | 716 | 0.53 | % | ||||||||||||||||
Noninterest bearing demand deposits | 162,440 | - | 0.00 | % | 96,643 | - | 0.00 | % | ||||||||||||||||
Total sources of funds | 816,948 | 794 | 0.38 | % | 632,790 | 716 | 0.45 | % | ||||||||||||||||
Other liabilities and stockholders’ equity: | ||||||||||||||||||||||||
Other liabilities | 5,094 | 4,058 | ||||||||||||||||||||||
Stockholders' equity | 81,975 | 80,243 | ||||||||||||||||||||||
Total liabilities and stockholders' equity | $ | 904,017 | $ | 717,091 | ||||||||||||||||||||
Net interest income | $ | 7,423 | $ | 6,600 | ||||||||||||||||||||
Interest rate spread (1) (2) | 3.53 | % | 3.99 | % | ||||||||||||||||||||
Net interest margin (1) (3) | 3.63 | % | 4.09 | % | ||||||||||||||||||||
Ratio of earning assets to interest bearing liabilities | 126.59 | % | 122.11 | % |
Yield/Cost Analysis | Nine Months Ended September 30, 2015 | Nine Months Ended September 30, 2014 | ||||||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
Average | Average | |||||||||||||||||||||||
Average | Yield/ | Average | Yield/ | |||||||||||||||||||||
Balance | Interest | Cost | Balance | Interest | Cost | |||||||||||||||||||
Interest earning assets: | ||||||||||||||||||||||||
Loans receivable | $ | 520,404 | $ | 18,834 | 4.79 | % | $ | 469,566 | $ | 17,967 | 5.10 | % | ||||||||||||
Investments and deposits (1) | 290,370 | 5,047 | 2.60 | % | 171,231 | 3,642 | 2.84 | % | ||||||||||||||||
Total earning assets (1) | 810,774 | 23,881 | 4.00 | % | 640,797 | 21,609 | 4.58 | % | ||||||||||||||||
Nonearning assets | 76,396 | 59,900 | ||||||||||||||||||||||
Total assets | $ | 887,170 | $ | 700,697 | ||||||||||||||||||||
Interest bearing liabilities: | ||||||||||||||||||||||||
Deposits | $ | 624,733 | 1,730 | 0.37 | % | $ | 495,054 | 1,609 | 0.43 | % | ||||||||||||||
Borrowings | 10,605 | 61 | 0.77 | % | 16,668 | 157 | 1.24 | % | ||||||||||||||||
Junior subordinated debentures | 10,310 | 422 | 5.39 | % | 10,310 | 243 | 3.10 | % | ||||||||||||||||
Total interest-bearing liabilities | 645,648 | 2,213 | 0.46 | % | 522,032 | 2,009 | 0.51 | % | ||||||||||||||||
Noninterest bearing demand deposits | 154,911 | - | 0.00 | % | 95,989 | - | 0.00 | % | ||||||||||||||||
Total sources of funds | 800,559 | 2,213 | 0.37 | % | 618,021 | 2,009 | 0.43 | % | ||||||||||||||||
Other liabilities and stockholders’ equity: | ||||||||||||||||||||||||
Other liabilities | 4,621 | 4,127 | ||||||||||||||||||||||
Stockholders' equity | 81,990 | 78,549 | ||||||||||||||||||||||
Total liabilities and stockholders' equity | $ | 887,170 | $ | 700,697 | ||||||||||||||||||||
Net interest income | $ | 21,668 | $ | 19,600 | ||||||||||||||||||||
Interest rate spread (1) (2) | 3.55 | % | 4.07 | % | ||||||||||||||||||||
Net interest margin (1) (3) | 3.64 | % | 4.16 | % | ||||||||||||||||||||
Ratio of earning assets to interest bearing liabilities | 125.58 | % | 122.75 | % |
(1) | Yield shown as a tax-adjusted yield. |
(2) | Represents the difference between the average yield on earning assets and the average cost of funds. |
(3) | Represents net interest income divided by average earning assets. |
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Provision for Credit Losses. The Bank's methodology for determining its provision for credit losses includes amounts specifically allocated to credits that are individually determined to be impaired, as well as general provisions allocated to groups of loans that have not been individually assessed for impairment. The Bank recorded $335,000 and $475,000 of provisions for credit losses for the three and nine months ended September 30, 2015, compared to $400,000 and $1.1 million recorded in the three and nine months ended September 30, 2014. The reduction in year-to-date provisions for credit losses is primarily attributable to the improvement in asset quality previously discussed. Provisions for credit losses are necessary to maintain the ALLL at a level that management believes is adequate to absorb probable future losses in the loan portfolio. See “Note 7. Allowance for Loan and Lease Losses” of “Notes to Consolidated Financial Statements (Unaudited)” and “Allowance for Loan and Lease Losses” and “Critical Accounting Policies - Loan Impairment and Allowance for Loan and Lease Losses” included herein for additional disclosure information.
Noninterest Income. Total noninterest income increased to $3.8 million and $10.6 million for the three and nine months ended September 30, 2015, from $2.2 million and $6.3 million for the three and nine months ended September 30, 2014. Noninterest income consists of deposit fees and service charges; loan fees and charges; mortgage loan servicing fees; gain on sale and other fees on mortgage loans, gain on sales of investment securities and OREO; and other miscellaneous income. Fees and service charges on deposits, and fees on loans and loan servicing fees earned during each period are influenced by the volume of deposits and loans outstanding, the volume of the various types of deposit and loan account transactions processed, the volume of loans serviced for others and the collection of related fees and service charges.
Deposit fees and service charges increased significantly to $2.1 million and $6.1 million for the three and nine months ended September 30, 2015, from $1.1 million and $3.2 million for the comparative 2014 three and nine month periods. Deposit fees and service charges represented 55.6% and 57.4%, respectively, of total non-interest income for the three and nine months ended September 30, 2015, compared to 49.8% and 50.3%, respectively, for the three and nine months ended September 30, 2014. This increase primarily reflects additional revenue generated from accounts acquired in the BOA branch acquisition transaction, as well as from the introduction of new products and product enhancements. We anticipate additional service charge revenue from deposits going forward, as we focus on growing our core deposit base through new customer acquisition.
Total non-interest income generated from the sale and servicing of mortgage loans and loan fees increased to $792,000 and $2.3 million for the three and nine months ended September 30, 2015, from $677,000 and $1.8 million for the comparative three and nine months ended September 30, 2014. Due to volatility in interest rates, mortgage originations declined slightly in the third quarter, as compared to the second quarter. We anticipate mortgage origination volumes to remain relatively unchanged during the fourth quarter of 2015. However, new loan volume may be somewhat dampened as new regulatory changes are implemented. We will continue to explore various strategies to enhance non-interest income from our mortgage division, including the purchasing of servicing rights.
The Bank may sell or securitize fixed-rate residential mortgage loans to reduce interest rate and credit risk exposure, and to provide a more balanced sensitivity to future interest rate changes, while retaining certain other held for sale mortgage loans for future securitization into available for sale mortgage-backed securities. Proceeds from mortgage loan sales provide liquidity to support the Bank’s operating, financing and lending activities.
Gains on sales of investment securities available for sale were $503,000 and $955,000 for the three and nine months ended September 30, 2015, compared to none and $14,000 for the respective 2014 three and nine month periods. As previously noted, during 2014, we implemented a strategy to pre-invest a large portion of the anticipated BOA branch acquisition transaction proceeds into short and intermediate term investment securities until the funds could be converted to higher yielding assets. During the three and nine months ended September 30, 2015, the Bank sold $14.8 million and $37.7 million, respectively, of investment securities primarily to fund our loan portfolio growth, to provide liquidity, to support the Bank’s operating and financing activities and to exit certain municipal securities with exposure to the oil and gas industries.
Included in other noninterest income is revenue from Bank-owned life insurance (BOLI) investments. BOLI earnings were $127,000 and $382,000 for the three and nine months ended September 30, 2015, compared to $133,000 and $398,000 for the respective 2014 three and nine month periods. The Bank utilizes the investment returns from the BOLI to recover a portion of the cost of providing employee benefit plans.
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The Bank recognized $63,000 of net losses and $10,000 of net gains from the sale of OREO for the three and nine months ended September 30, 2015, respectively, compared to net gains of $9,000 and $82,000 for the three and nine months ended September 30, 2014, as the Bank continues in its efforts of disposing of these nonperforming assets. See “Note 9. Other Real Estate Owned” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Total core non-interest income, excluding net gains and losses from OREO and investment securities sales, increased to $3.3 million and $9.6 million for the three and nine months ended September 30, 2015, from $2.2 million and $6.2 million for the respective 2014 three and nine month periods, primarily due to the increase in deposit fees and service charges.
Noninterest Expense. Total noninterest expense increased to $9.0 million and $27.3 million for the three and nine months ended September 30, 2015, from $6.5 million and $19.6 million for the comparable 2014 three and nine month periods. The year-over-year variation in noninterest expenses is attributable to the impact of $425,000 one-time acquisition transaction expenses, nine full months of operating expenses for the acquired BOA branch offices, the addition of a new commercial loan production office and a new customer care center.
Compensation and benefit expenses, the largest component of non-interest expenses, increased to $4.9 million and $14.5 million for the three and nine months ended September 30, 2015, from $3.8 million and $11.5 million for the comparative 2014 three and nine month periods. The increase for the respective 2015 periods is primarily attributable to the expense of the staff in the nine branch offices acquired from BOA, as well as administrative staff required to support those new offices and the addition of experienced bankers to generate earning asset growth. The Bank will continue to invest in professionals that allow us to expand our market share, meet the ongoing needs of our customers and support future growth.
FDIC insurance premiums were $163,000 and $445,000 for the three and nine months ended September 30, 2015, compared to $137,000 and $421,000 for the 2014 three and nine month periods. The increased quarterly FDIC insurance premium is primarily attributable to growth of the deposit insurance assessment calculation base resulting from the BOA branch acquisition transaction.
Premises and equipment expense was $1.3 million and $4.0 million for the three and nine months ended September 30, 2015, compared to $877,000 and $2.5 million for the 2014 three and nine month periods. While the recent branch acquisition has resulted in a larger infrastructure cost than our historical levels, we continue to explore opportunities to gain efficiency and performance improvement from our branch network. We will consider opportunities, such as expansions and consolidations, and as such, given our current branch structure, we would anticipate occupancy cost to maintain or improve from their current levels.
Advertising expense was $219,000 and $598,000 for the three and nine months ended September 30, 2015, compared to $127,000 and $296,000 for the comparative 2014 three and nine month periods. We are investing in building our brand awareness throughout our expanded footprint with additional marketing efforts, and anticipate that our advertising expenses will continue at current levels.
Data processing costs were $819,000 and $2.8 million for the three and nine months ended September 30, 2015, compared to $567,000 and $1.7 million for the 2014 three and nine month periods. Data processing costs fluctuate in conjunction with changes in the number of customer accounts and transaction activity volumes. As we continue to focus on new customer acquisition and to invest in emerging technology to better serve our customer base, we anticipate that data processing costs will continue at current levels.
Total amortization of intangible assets, including mortgage servicing rights and identifiable intangible assets, was $130,000 and $387,000 for the three and nine months ended September 30, 2015, compared to $56,000 and $164,000 of amortization expense for the 2014 three and nine month periods. Amortization of mortgage servicing rights was $58,000 and $171,000 for the three and nine months ended September 30, 2015, compared to $56,000 and $156,000 for the 2014 three and nine month periods. Amortization of the Company’s core deposit intangible, which is the only identifiable intangible asset subject to amortization, was $72,000 and $216,000 for the three and nine months ended September 30, 2015, compared to none and $8,000 for the 2014 three and nine month periods.
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Total OREO expenses were $99,000 and $463,000 for the three and nine months ended September 30, 2015, compared to $167,000 and $396,000 for the 2014 three and nine month periods. Expenses attributable to ongoing maintenance, property taxes and insurance for OREO properties were $89,000 and $367,000 for the three and nine months ended September 30, 2015, compared to $94,000 and $322,000 for the 2014 three and nine months periods. OREO valuation adjustments were $10,000 and $96,000 for the three and nine months ended September 30, 2015 second quarter, compared to $73,000 for both the respective three and nine month 2014 periods.
Other non-interest expense was $1.3 million and $4.1 million for the three and nine months ended September 30, 2015, compared to $779,000 and $2.6 million for the respective 2014 three and nine month periods. Other expense for the first nine months of 2015 includes $180,000 of one-time expenses related to the BOA branch acquisition transaction. The year-over-year increase in operating expenses is primarily due to the branch offices acquired.
Income tax expense was $611,000 and $1.4 million for the three and nine months ended September 30, 2015, compared to $489,000 and $1.3 million for the 2014 three and nine month periods. Taxes for the third quarter of 2015 includes a one-time $80,000 expense adjustment due a write down of our deferred tax asset given the impending decline in the North Carolina statutory tax rate for 2016. Exclusive of the $80,000 one-time adjustment noted above, the effective income tax rates were 28.73% and 28.49% for the three and nine months ended September 30, 2015, compared to 25.65% and 25.04% for the 2014 three and nine month periods. See “Note 1. Basis of Presentation” of “Notes to Consolidated Financial Statements (Unaudited)” and “Critical Accounting Policies” below for additional information.
During the third quarter of 2015, the Company determined that its income tax expense associated with prior periods had been understated by a net amount of $434,000. For the periods prior to 2014 the cumulative net income tax expense understatement was $651,000. During 2014 the Company overstated income tax expense by $217,000. As a result our deferred tax asset and our income tax receivable accounts have been adjusted to reflect the correction of this error, with a corresponding $434,000 reduction recorded to retained earnings. These corrections are similarly reflected as an adjustment to retained earnings as of December 31, 2014, in the Consolidated Statement of Changes in Shareholders’ Equity. Management has concluded that the error was not material to prior period financial statements.
Key Performance Ratios. Some of our key performance ratios are return on average assets (“ROA”), return on average equity (“ROE”) and efficiency. ROA was 0.54% and 0.47% for the three and nine months ended September 30, 2015, compared to 0.79% and 0.75% for the three and nine months ended September 30, 2014. ROE was 5.99% and 5.08% for the three and nine months ended September 30, 2015, compared to 7.05% and 6.74% for the three and nine months ended September 30, 2014. The efficiency ratio (noninterest expenses as a percentage of net interest income plus noninterest income) measures the proportion of net operating revenues that are absorbed by overhead expenses. The efficiency ratio was 82.26% and 85.63% for the three and nine months ended September 30, 2015, compared to 72.52% and 74.26% for the three and nine months ended September 30, 2014. The efficiency ratio has elevated over the course of the last twelve months due primarily to franchise expansion. We anticipate the efficiency ratio to improve over time as the investments we have made in additional infrastructure and staff are able to generate an increased level of earnings.
Liquidity and Capital Resources. Liquidity generally refers to the Bank's ability to generate adequate amounts of funds to meet its cash needs. Adequate liquidity guarantees that sufficient funds are available to meet deposit withdrawals, fund future loan commitments, maintain adequate reserve requirements, pay operating expenses, provide funds for debt service, and meet other general commitments. FDIC policy requires banks to maintain an average daily balance of liquid assets in an amount which it deems adequate to protect the safety and soundness of the bank. The FDIC currently has no specific level which it requires.
At September 30, 2015, the Bank had cash, deposits in banks, investment securities and loans held for sale totaling $295.6 million, compared to $353.7 million at December 31, 2014. The Bank calculates its liquidity position under policy guidelines based on liquid assets in relationship to deposits and short-term borrowings. Based on its calculation guidelines, the Bank’s liquidity ratio was 35.77% at September 30, 2015, compared to 44.19% at December 31, 2014, which management believes is adequate.
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The Bank believes it can meet future liquidity needs with existing funding sources. The Bank's primary sources of funds are deposits, principal payments on loans and mortgage-backed securities, earnings and funds provided from operations, the ability to borrow from the FHLB of Atlanta and other lines of credit, and the availability of loans and investment securities available for sale. At September 30, 2015, the Bank had $191.8 million of remaining credit availability with the FHLB, of which there was lendable collateral value available totaling $120.7 million. Additional collateral would be required in order to access total borrowings up to the credit availability limit. In addition, at September 30, 2015, the Bank had remaining capacity to borrow $64.3 million from the FRB Discount Window and $70.0 million of pre-approved, but unused lines of credit.
We are subject to various regulatory capital requirements administered by the federal banking agencies. Capital adequacy guidelines and the regulatory framework for prompt corrective action prescribe specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. We use our capital primarily to support our lending activities as well as for expansions of our business and other operating requirements.
In July 2013, the Federal Reserve Board approved and published the final Basel III Capital Rules establishing a new comprehensive capital framework for U.S. banking organizations. The rules implement the Basel Committee’s December 2010 framework (“Basel III”) for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act. The Basel III Capital Rules, among other things, (i) introduce a new capital measure called “Common Equity Tier 1” (“CET1”), (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, (iii) define CET1 narrowly by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) expand the scope of the deductions from and adjustments to capital as compared to existing regulations. The Basel III Capital Rules were effective for the Bank on January 1, 2015 (subject to a phase-in period for certain components). CET1 capital for the Bank consists of common stock, related paid-in capital, and retained earnings. In connection with the adoption of the Basel III Capital Rules, we elected to opt-out of the requirement to include most components of accumulated other comprehensive income in CET1. CET1 for the Bank is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities and subject to transition provisions.
Basel III limits capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.50% of CET1 capital, Tier 1 capital and total capital to risk-weighted assets in addition to the amount necessary to meet minimum risk-based capital requirements. The capital conservation buffer will be phased in beginning January 1, 2016, at 0.625% of risk-weighted assets, increasing each year until fully implemented at 2.50% on January 1, 2019. When fully phased in on January 1, 2019, Basel III will require (i) a minimum ratio of CET1 capital to risk-weighted assets of at least 4.50%, plus a 2.50% capital conservation buffer, (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.00%, plus the capital conservation buffer, (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.00%, plus the 2.50% capital conservation buffer and (iv) a minimum leverage ratio of 4.00%. The Bank continues to be well-capitalized under the Basel III rules. See “Note 15. Regulatory Capital” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.
Critical Accounting Policies. The Company has identified the policies below as critical to its business operations and the understanding of its results of operations. The impact and any associated risks related to these policies on the Company’s business operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect reported and expected financial results.
Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. Estimates 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 revenues and expenses during the reporting period. Actual results could differ from those estimates.
Loan Impairment and Allowance for Loan and Lease Losses. A loan or lease is considered impaired, based on current information and events, if it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease agreement. Uncollateralized loans are measured for impairment based on the present value of expected future cash flows discounted at the historical effective interest rate, while all collateral-dependent loans are measured for impairment based on the fair value of the collateral. The Bank uses several factors in determining if a loan or lease is impaired. The internal asset classification procedures include a thorough review of significant loans, leases and lending relationships and include the accumulation of related data. This data includes loan and lease payment status, borrowers' financial data and borrowers' operating factors such as cash flows, operating income or loss, etc.
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The ALLL is increased by charges to income and decreased by charge-offs, net of recoveries. Management's periodic evaluation of the adequacy of the ALLL is based on past loan and lease loss experience, known and inherent risks in loans and leases and unfunded loan commitments, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, and current economic conditions. While management believes that it has established the ALLL in accordance with accounting principles generally accepted in the United States of America and has taken into account the views of its regulators and the current economic environment, there can be no assurance in the future that regulators or risks in its loans and leases portfolio will not require additional adjustments to the ALLL. There were no changes in accounting policy and methodology used to estimate the ALLL during the nine months ended September 30, 2015.
Income Taxes. Deferred tax asset and liability balances are determined by application to temporary differences in the tax rate expected to be in effect when taxes will become payable or receivable. Temporary differences are differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that will result in taxable or deductible amounts in future years. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.
Off-Balance Sheet Arrangements. The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and involve elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company's exposure to credit loss in the event of non-performance by a party to a financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the borrower. Since many of the commitments are expected to expire without being drawn upon, they do not necessarily represent future cash requirements.
Forward Looking Statements. The Private Securities Litigation Reform Act of 1995 states that disclosure of forward looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward looking statements by corporate management. This Form 10-Q, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward looking statements that involve risk and uncertainty. The words “anticipates”, “believes”, “can”, “continue”, “could”, “estimates”, “expects”, “intends”, “seeks”, “may”, “might”, “plans”, “projects”, “should”, “would”, “targets”, “will”, and the negative thereof and similar words and expressions are intended to identify forward looking statements. In order to comply with terms of the safe harbor, the Company notes that a variety of risks and uncertainties could cause its actual results and experience to differ materially from anticipated results or other expectations expressed in the Company's forward looking statements. There are risks and uncertainties that may affect the operations, performance, development, growth projections and results of the Company's business. They include, but are not limited to, economic growth, interest rate movements, timely development of technology enhancements for products, services and operating systems, the impact of competitive products, services and pricing, customer requirements, regulatory changes and similar matters. Readers of this report are cautioned not to place undue reliance on forward looking statements that are subject to influence by these risk factors and unanticipated events, as actual results may differ materially from management's expectations.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk. Smaller reporting companies are not required to provide information required by this item.
Item 4. Controls and Procedures. As of the end of the period covered by this report, management of the Company carried out an evaluation, under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures. Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. It should be noted that the design of the Company’s disclosure controls and procedures is based in part upon certain reasonable assumptions about the likelihood of future events, and there can be no reasonable assurance that any design of disclosure controls and procedures will succeed in achieving its stated goals under all potential future conditions, regardless of how remote, but the Company’s principal executive and financial officers have concluded that the Company’s disclosure controls and procedures are, in fact, effective at a reasonable assurance level.
In addition, there have been no changes in the Company’s internal control over financial reporting (to the extent that elements of internal control over financial reporting are subsumed within disclosure controls and procedures) identified in connection with the evaluation described in the above paragraph that occurred during the Company’s last fiscal quarter, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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Item l. Legal Proceedings: The Company is currently not engaged in any material legal proceedings. From time to time, the Bank is a party to legal proceedings within the ordinary course of business wherein it enforces its security interest in loans, and other matters of similar nature.
Item 1A. Risk Factors: Smaller reporting companies are not required to provide information required by this item.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds: The following table sets forth information regarding the Company's repurchases of its common stock during the three months ended September 30, 2015:
Period | Total Number of Shares Purchased | Average Price Paid per Share | Total
Number of Announced Plan | Maximum
Number of Shares Yet to Be Purchased Under the Plan | ||||||||||||
July 2015 Beginning date: July 1 Ending date: July 31 | - | - | - | 142,548 | ||||||||||||
August 2015 Beginning date: August 1 Ending date: August 31 | 3,045 | $ | 7.74 | 3,045 | 139,503 | |||||||||||
September 2015 Beginning date: September 1 Ending date: September 30 | 11,697 | $ | 7.86 | 11,697 | 127,806 |
Shares may be purchased under a repurchase program announced on January 27, 2015. Under this program, the Company announced that it may purchase up to 2.5% of the outstanding shares of its common stock, or approximately 239,950 shares, over a one year period, effective as of February 1, 2015 and expiring on January 31, 2016.
Item 3. Defaults Upon Senior Securities: Not applicable
Item 4. Mine Safety Disclosures: Not applicable.
Item 5. Other Information: Not applicable
Item 6. Exhibits: The following exhibits are filed herewith:
Number | Title | |
3.2 | Bylaws of First South Bancorp, Inc., as amended September 24, 2015 (Incorporated herein by reference from Exhibit 3.2 to the Company’s Current Report on Form 8-K filed on September 25, 2015) | |
31.1 | Rule 13a-14(a) Certification of Chief Executive Officer | |
31.2 | Rule 13a-14(a) Certification of Chief Financial Officer | |
32 | Section 1350 Certification | |
101 | Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Statements of Financial Condition as of September 30, 2015 (unaudited) and December 31, 2014; (ii) Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2015 and 2014 (unaudited); (iii) Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2015 and 2014 (unaudited); (iv) Consolidated Statements of Changes in Stockholders’ Equity for the Nine Months Ended September 30, 2015 and 2014 (unaudited); (v) Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2015 and 2014 (unaudited); and (vi) Notes to Consolidated Financial Statements (unaudited) as of September 30, 2015 and December 31, 2014, and for the Three and Nine Months Ended September 30, 2015 and 2014. |
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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.
FIRST SOUTH BANCORP, INC. | ||
By: | /s/ Scott C. McLean | |
Scott C. McLean | ||
Executive Vice President | ||
Chief Financial Officer | ||
(Principal Financial and Accounting Officer) | ||
Date: November 12, 2015 |
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