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EX-31.2 - EXHIBIT 31.2 - FIRST CAPITAL INCexh_312.htm
EX-32.1 - EXHIBIT 32.1 - FIRST CAPITAL INCexh_321.htm
EX-31.1 - EXHIBIT 31.1 - FIRST CAPITAL INCexh_311.htm
EX-32.2 - EXHIBIT 32.2 - FIRST CAPITAL INCexh_322.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 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 No. 0-25023

First Capital, Inc.
(Exact name of registrant as specified in its charter)

  Indiana   35-2056949  
  (State or other jurisdiction of   (I.R.S. Employer  
  incorporation or organization)   Identification Number)  
         

220 Federal Drive NW, Corydon, Indiana 47112
(Address of principal executive offices) (Zip Code)

Registrant's telephone number including area code 1-812-738-2198

  Not applicable  
  (Former name, former address and former fiscal year, if changed since last report)  

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes __X__ No _____

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

(Check one): Large Accelerated Filer ___ Accelerated Filer ___
     
  Non-accelerated Filer ___ Smaller Reporting Company   X  
     

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 2,758,586 shares of common stock were outstanding as of October 29, 2015.

 

 

FIRST CAPITAL, INC.

INDEX

Part I Financial Information Page
     
  Item 1. Consolidated Financial Statements  
     
  Consolidated Balance Sheets as of September 30, 2015 and December 31, 2014 (unaudited) 3
     
  Consolidated Statements of Income for the three months and nine months ended September 30, 2015 and 2014 (unaudited) 4
     
  Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2015 and 2014 (unaudited) 5
     
  Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended September 30, 2015 and 2014 (unaudited) 6
     
  Consolidated Statements of Cash Flows for the nine months ended September 30, 2015 and 2014 (unaudited) 7
     
  Notes to Consolidated Financial Statements (unaudited) 8-38
     
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 39-44
     
  Item 3. Quantitative and Qualitative Disclosures About Market Risk 45-48
     
  Item 4. Controls and Procedures 49
     
Part II Other Information  
     
  Item 1. Legal Proceedings 50
     
  Item 1A. Risk Factors 50
     
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 50
     
  Item 6. Exhibits 51
     
Signatures 52

 

- 2 -
 

PART I - FINANCIAL INFORMATION

FIRST CAPITAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

   September 30,
2015
  December 31,
2014
   (In thousands)
ASSETS          
Cash and due from banks  $10,121   $13,653 
Interest bearing deposits with banks   855    865 
Federal funds sold   13,435    18,725 
Total cash and cash equivalents   24,411    33,243 
           
Interest-bearing time deposits   11,635    8,270 
Securities available for sale, at fair value   95,210    100,226 
Securities-held to maturity   5    6 
Loans, net   305,082    300,603 
Loans held for sale   324    1,608 
Federal Home Loan Bank stock, at cost   1,550    2,241 
Foreclosed real estate   516    78 
Premises and equipment   10,236    10,208 
Accrued interest receivable   1,523    1,580 
Cash value of life insurance   6,036    6,161 
Goodwill   5,386    5,386 
Other assets   3,305    3,151 
           
Total Assets  $465,219   $472,761 
           
LIABILITIES          
Deposits:          
Noninterest-bearing  $73,502   $73,042 
Interest-bearing   329,084    339,594 
Total deposits   402,586    412,636 
           
Accrued interest payable   90    127 
Accrued expenses and other liabilities   2,943    2,765 
Total liabilities   405,619    415,528 
           
EQUITY          
Preferred stock of $.01 par value per share Authorized 1,000,000 shares; none issued   0    0 
Common stock of $.01 par value per share Authorized 5,000,000 shares; issued 3,182,916 shares, (3,164,416 in 2014); outstanding 2,758,586 shares, (2,740,502 in 2014)   32    32 
Additional paid-in capital   24,766    24,313 
Retained earnings-substantially restricted   42,587    40,229 
Unearned stock compensation   (400)   0 
Accumulated other comprehensive income   770    800 
Less treasury stock, at cost - 424,330 shares (423,914 in 2014)   (8,263)   (8,253)
Total First Capital, Inc. stockholders' equity   59,492    57,121 
           
Noncontrolling interest in subsidiary   108    112 
Total equity   59,600    57,233 
           
Total Liabilities and Equity  $465,219   $472,761 

 

See accompanying notes to consolidated financial statements.

- 3 -
 

PART I - FINANCIAL INFORMATION

FIRST CAPITAL, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

 
 
 
 
Three Months Ended
September 30,
 
 
Nine Months Ended
September 30,
   2015  2014  2015  2014
INTEREST INCOME  (In thousands, except per share data)
Loans, including fees  $3,983   $4,057   $11,876   $11,931 
Securities:                    
Taxable   267    289    797    909 
Tax-exempt   243    249    733    813 
Federal Home Loan Bank dividends   20    27    72    92 
Federal funds sold and interest bearing deposits with banks   40    24    126    66 
Total interest income   4,553    4,646    13,604    13,811 
INTEREST EXPENSE                    
Deposits   220    278    702    858 
Retail repurchase agreements   0    0    0    12 
Advances from Federal Home Loan Bank   0    2    0    5 
Total interest expense   220    280    702    875 
Net interest income   4,333    4,366    12,902    12,936 
Provision for loan losses   0    75    50    190 
Net interest income after provision for loan losses   4,333    4,291    12,852    12,746 
NONINTEREST INCOME                    
Service charges on deposit accounts   897    816    2,527    2,361 
Commission income   121    237    305    435 
Gain on sale of securities   0    0    0    54 
Gain on sale of mortgage loans   131    180    617    499 
Mortgage brokerage fees   15    15    61    29 
Increase in cash surrender value of life insurance   34    35    101    112 
Other income   28    155    193    214 
Total noninterest income   1,226    1,438    3,804    3,704 
NONINTEREST EXPENSE                    
Compensation and benefits   1,885    1,957    5,866    5,628 
Occupancy and equipment   317    298    940    910 
Data processing   441    404    1,271    1,168 
Professional fees   258    138    839    436 
Advertising   92    82    240    215 
Other operating expenses   658    712    1,935    1,882 
Total noninterest expense   3,651    3,591    11,091    10,239 
Income before income taxes   1,908    2,138    5,565    6,211 
Income tax expense   507    611    1,463    1,862 
Net Income   1,401    1,527    4,102    4,349 
Less: net income attributable to noncontrolling interest in subsidiary   3    3    10    10 
Net Income Attributable to First Capital, Inc.  $1,398   $1,524   $4,092   $4,339 
                     
Earnings per common share attributable to First Capital, Inc.                    
Basic  $0.51   $0.56   $1.49   $1.57 
Diluted  $0.51   $0.56   $1.49   $1.57 
                     
Dividends per share  $0.21   $0.21   $0.63   $0.63 

 

See accompanying notes to consolidated financial statements.

 

- 4 -
 

PART I - FINANCIAL INFORMATION

FIRST CAPITAL, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

   2015  2014  2015  2014
  (In thousands)  (In thousands)
Net Income  $1,401   $1,527   $4,102   $4,349 
                     
OTHER COMPREHENSIVE INCOME (LOSS)                    
Unrealized gains (losses) on securities available for sale:                    
Unrealized holding gains (losses) arising during the period   588    257    (49)   2,130 
Income tax (expense) benefit   (229)   (101)   19    (837)
Net of tax amount   359    156    (30)   1,293 
                     
Less: reclassification adjustment for realized gains included in net income   0    0    0    (54)
Income tax expense   0    0    0    21 
Net of tax amount   0    0    0    (33)
                     
Other Comprehensive Income (Loss), net of tax   359    156    (30)   1,260 
                     
Comprehensive Income   1,760    1,683    4,072    5,609 
Less: comprehensive income attributable to the noncontrolling interest in subsidiary   3    3    10    10 
                     
Comprehensive Income Attributable to First Capital, Inc.  $1,757   $1,680   $4,062   $5,599 

 

 

 

See accompanying notes to consolidated financial statements.

 

- 5 -
 

PART I - FINANCIAL INFORMATION

FIRST CAPITAL, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

(Unaudited)

 

(In thousands, except share and per share data) 

Common

Stock

 

Additional

Paid-in

Capital

 

Retained

Earnings

 

Accumulated

Other

Comprehensive

Income (Loss)

 

Unearned

Stock

Compensation

 

Treasury

Stock

 

Noncontrolling

Interest

  Total
                         
Balances at January 1, 2014  $32   $24,313   $36,947   $(720)  $0   $(7,345)  $112   $53,339 
                                         
Net income   0    0    4,339    0    0    0    10    4,349 
                                         
Other comprehensive income   0    0    0    1,260    0    0    0    1,260 
                                         
Cash dividends   0    0    (1,736)   0    0    0    (14)   (1,750)
                                         
Purchase of treasury shares   0    0    0    0    0    (908)   0    (908)
                                         
Balances at September 30, 2014  $32   $24,313   $39,550   $540   $0   $(8,253)  $108   $56,290 
                                         
                                         
Balances at January 1, 2015  $32   $24,313   $40,229   $800   $0   $(8,253)  $112   $57,233 
                                         
Net income   0    0    4,092    0    0    0    10    4,102 
                                         
Other comprehensive loss   0    0    0    (30)   0    0    0    (30)
                                         
Cash dividends   0    0    (1,734)   0    0    0    (14)   (1,748)
                                         
Restricted stock grants, net of forfeitures   0    453    0    0    (453)   0    0    0 
                                         
Stock compensation expense   0    0    0    0    53    0    0    53 
                                         
Purchase of treasury shares   0    0    0    0    0    (10)   0    (10)
                                         
Balances at September 30, 2015  $32   $24,766   $42,587   $770   $(400)  $(8,263)  $108   $59,600 

 

See accompanying notes to consolidated financial statements.

 

- 6 -
 

PART I - FINANCIAL INFORMATION

FIRST CAPITAL, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

   Nine Months Ended
September 30,
   2015  2014
CASH FLOWS FROM OPERATING ACTIVITIES  (In thousands)
Net income  $4,102   $4,349 
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:          
Amortization of premiums and accretion of discounts on securities, net   516    530 
Depreciation and amortization expense   533    527 
Deferred income taxes   492    (116)
Stock compensation expense   53    0 
Increase in cash value of life insurance   (101)   (112)
Gain on life insurance   (110)   (129)
Gain on sale of securities   0    (54)
Provision for loan losses   50    190 
Proceeds from sales of loans   22,193    20,596 
Loans originated for sale   (20,292)   (19,525)
Gain on sale of loans   (617)   (499)
Decrease in accrued interest receivable   57    109 
Decrease in accrued interest payable   (37)   (38)
Net change in other assets/liabilities   (122)   (64)
Net Cash Provided By Operating Activities   6,717    5,764 
           
CASH FLOWS FROM INVESTING ACTIVITIES          
Investment in interest-bearing time deposits   (3,610)   (2,210)
Proceeds from maturities and sales of interest-bearing time deposits   245    0 
Purchase of securities available for sale   (20,375)   (20,657)
Proceeds from maturities of securities available for sale   15,863    16,655 
Proceeds from sales of securities available for sale   0    5,669 
Principal collected on mortgage-backed obligations   8,973    8,120 
Net increase in loans receivable   (5,124)   (13,962)
Proceeds from redemption of Federal Home Loan Bank stock   691    0 
Proceeds from sale of foreclosed real estate   157    411 
Purchase of premises and equipment   (561)   (514)
Net Cash Used In Investing Activities   (3,741)   (6,488)
           
CASH FLOWS FROM FINANCING ACTIVITIES          
Net increase (decrease) in deposits   (10,050)   27,219 
Net decrease in advances from Federal Home Loan Bank   0    (5,500)
Net decrease in retail repurchase agreements   0    (9,310)
Purchase of treasury stock   (10)   (908)
Dividends paid   (1,748)   (1,750)
Net Cash Provided By (Used In) Financing Activities   (11,808)   9,751 
           
Net Increase (Decrease) in Cash and Cash Equivalents   (8,832)   9,027 
Cash and cash equivalents at beginning of period   33,243    11,136 
Cash and Cash Equivalents at End of Period  $24,411   $20,163 

 

See accompanying notes to consolidated financial statements.

 

- 7 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.Presentation of Interim Information

First Capital, Inc. (“Company”) is the savings and loan holding company for First Harrison Bank (“Bank”). The information presented in this report relates primarily to the Bank's operations. First Harrison Investments, Inc. and First Harrison Holdings, Inc. are wholly-owned Nevada corporate subsidiaries of the Bank that jointly own First Harrison, LLC, a Nevada limited liability corporation that holds and manages an investment portfolio. First Harrison REIT, Inc. (“REIT”) was incorporated as a wholly-owned subsidiary of First Harrison Holdings, Inc. to hold a portion of the Bank’s real estate mortgage loan portfolio. On January 21, 2009, the REIT issued 105 shares of 12.5% redeemable cumulative preferred stock with an aggregate liquidation value of $105,000 in a private placement offering in order to satisfy certain ownership requirements to qualify as a real estate investment trust. At September 30, 2015, this noncontrolling interest represented 0.2% ownership of the REIT. On September 23, 2014, the Company formed FHB Risk Mitigation Services, Inc. (“Captive”). The Captive is a wholly-owned insurance subsidiary of the Company that provides property and casualty insurance coverage to the Company, the Bank and the Bank’s subsidiaries, and reinsurance to eight other third party insurance captives for which insurance may not be currently available or economically feasible in the insurance marketplace.

In the opinion of management, the unaudited consolidated financial statements include all adjustments considered necessary to present fairly the financial position as of September 30, 2015, and the results of operations for the three months and nine months ended September 30, 2015 and 2014 and the cash flows for the nine months ended September 30, 2015 and 2014. All of these adjustments are of a normal, recurring nature. Such adjustments are the only adjustments included in the unaudited consolidated financial statements. Interim results are not necessarily indicative of results for a full year or any other period.

The accompanying unaudited consolidated financial statements and notes have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial statements and are presented as permitted by the instructions to Form 10-Q. Accordingly, they do not contain certain information included in the Company’s annual audited consolidated financial statements and related footnotes for the year ended December 31, 2014 included in the Company’s Annual Report on Form 10-K.

The unaudited consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.

 

2.Proposed Merger

On June 4, 2015, the Company and Peoples Bancorp, Inc. of Bullitt County (“Peoples”) entered into an Agreement and Plan of Merger (the “Agreement”) pursuant to which Peoples will merge with and into the Company, with the Company as the surviving corporation. Subsequent to the merger, The Peoples Bank of Bullitt County, a wholly-owned subsidiary of Peoples, will merge with and into the Bank, with the Bank as the surviving bank.

- 8 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(2 – continued)

The Agreement provides that shareholders of Peoples may elect to receive either 382.83 shares of Company common stock or $9,475 in cash for each share of Peoples common stock owned, subject to proration provisions specified in the Agreement that provide for a targeted aggregate mix of total consideration of 50% common stock and 50% cash. At the effective time of the merger, the exchange ratio and cash price per share may be adjusted based on provisions in the Agreement for changes in the price of the Company’s common stock or a decrease in the consolidated net book value of Peoples. Shareholders of Peoples also may receive an additional cash payment as specified in the Agreement if Peoples sells certain specified assets prior to the effective time of the merger, or the Company sells such assets within twenty-four months after the effective time of the merger.

Subject to the approval of the merger by the shareholders of both the Company and Peoples, receipt of regulatory approvals and satisfaction of other customary closing conditions, the parties anticipate completing the merger in the fourth quarter of 2015.

 

 

 

 

- 9 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

3.Investment Securities

Debt and equity securities have been classified in the consolidated balance sheets according to management’s intent. Investment securities at September 30, 2015 and December 31, 2014 are summarized as follows:

(In thousands) 

Amortized

Cost

 

Gross

Unrealized

Gains

 

Gross

Unrealized

Losses

 

Fair

Value

             
September 30, 2015            
Securities available for sale:                    
Agency mortgage-backed securities  $34,495   $281   $48   $34,728 
Agency CMO   10,341    61    57    10,345 
Other debt securities:                    
Agency notes and bonds   16,751    43    2    16,792 
Municipal obligations   31,825    994    79    32,740 
Subtotal - debt securities   93,412    1,379    186    94,605 
                     
Mutual Funds   605    0    -    605 
                     
Total Securities available for sale  $94,017   $1,379   $186   $95,210 
                     
Securities held to maturity:                    
Agency mortgage-backed securities  $5   $0   $0   $5 
                     
Total securities held to maturity  $5   $0   $0   $5 
                     
December 31, 2014                    
Securities available for sale:                    
Agency mortgage-backed securities  $32,135   $240   $79   $32,296 
Agency CMO   14,461    74    150    14,385 
Other debt securities:                    
Agency notes and bonds   18,136    32    48    18,120 
Municipal obligations   32,178    1,242    78    33,342 
Subtotal - debt securities   96,910    1,588    355    98,143 
                     
Mutual Funds   2,083    0    0    2,083 
                     
Total Securities available for sale  $98,993   $1,588   $355   $100,226 
                     
Securities held to maturity:                    
Agency mortgage-backed securities  $6   $0   $0   $6 
                     
Total securities held to maturity  $6   $0   $0   $6 

 

- 10 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(3 – continued)

Agency notes and bonds, agency mortgage-backed securities and agency collateralized mortgage obligations (CMO) include securities issued by the Government National Mortgage Association (GNMA), a U.S. government agency, and the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC) and the Federal Home Loan Bank (FHLB), which are government-sponsored enterprises.

The amortized cost and fair value of debt securities as of September 30, 2015, by contractual maturity, are shown below. Expected maturities of mortgage-backed securities may differ from contractual maturities because the mortgages underlying the obligations may be prepaid without penalty.

   Securities Available for Sale  Securities Held to Maturity
   Amortized
Cost
  Fair
Value
  Amortized
Cost
  Fair
Value
(In thousands)            
             
Due in one year or less  $1,513   $1,516   $0   $0 
Due after one year through five years   18,298    18,434    0    0 
Due after five years through ten years   15,809    16,195           
Due after ten years   12,956    13,387    0    0 
    48,576    49,532    0    0 
                     
Mortgage-backed securities and CMO   44,836    45,073    5    5 
                     
   $93,412   $94,605   $5   $5 

Information pertaining to investment securities available for sale with gross unrealized losses at September 30, 2015, aggregated by investment category and the length of time that individual investment securities have been in a continuous position, follows:

 
 
 
 
 
 
Number of
Investment
Positions
 
 
 
 
Fair
Value
 
 
 
Gross
Unrealized
Losses
(Dollars in thousands)         
          
Continuous loss position less than twelve months:               
Agency notes and bonds   2   $1,398   $2 
Agency mortgage-backed securities   10    7,284    22 
Municipal obligations   8    3,021    31 
                
Total less than twelve months   20    11,703    55 
                
Continuous loss position more than twelve months:               
Agency CMO   9    6,249    57 
Agency mortgage-backed securities   4    4,294    26 
Municipal obligations   5    2,336    48 
                
Total more than twelve months   18    12,879    131 
                
Total securities available for sale   38   $24,582   $186 

 

- 11 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(3 – continued)

Management evaluates securities for other-than-temporary impairment at least quarterly, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

At September 30, 2015, the 38 U.S. government agency debt securities, including agency notes and bonds, mortgage-backed securities and CMO, and municipal obligations in a loss position, had depreciated approximately 0.8% from the amortized cost basis. All of the U.S. government agency securities and municipal obligations are issued by U.S. government agencies, government-sponsored enterprises and municipal governments, or are secured by first mortgage loans and municipal project revenues. These unrealized losses related principally to current interest rates for similar types of securities. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government, its agencies or other governments, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition. As the Company has the ability to hold the debt securities until maturity, or the foreseeable future if classified as available for sale, no declines are deemed to be other-than-temporary.

During the three and nine months ended September 30, 2015, the Company did not have any security sales. During the nine months ended September 30, 2014, the Company realized gross gains on sales of available for sale municipal securities and U.S. government agency mortgage-backed securities of $66,000 and $5,000, respectively and a loss of $17,000 on the sale of mutual funds. During the three months ended September 30, 2014, the Company realized gross gains on sales of available for sale municipal securities and U.S. government agency mortgage-backed securities of $12,000 and $5,000, respectively and a loss of $17,000 on the sale of mutual funds.

In June 2014, the Company acquired an additional 31,750 shares of common stock in another financial institution, in addition to the 100,000 shares acquired in December 2013, representing approximately 9% of the outstanding common stock of the entity, for a total investment of $711,000. The investment is accounted for using the cost method of accounting and is included in other assets in the consolidated balance sheet.

4.Loans and Allowance for Loan Losses

The Company’s loan and allowance for loan loss policies are as follows:

Loans are stated at unpaid principal balances, less net deferred loan fees and the allowance for loan losses. The Company grants real estate mortgage, commercial business and consumer loans. A substantial portion of the loan portfolio is represented by mortgage loans to customers in southern Indiana. The ability of the Company’s customers to honor their loan agreements is dependent upon the real estate and general economic conditions in this area.

Loan origination and commitment fees, as well as certain direct costs of underwriting and closing loans, are deferred and amortized as a yield adjustment to interest income over the lives of the related loans using the interest method. Amortization of net deferred loan fees is discontinued when a loan is placed on nonaccrual status.

 

- 12 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(4 – continued)

The recognition of income on a loan is discontinued and previously accrued interest is reversed, when interest or principal payments become ninety (90) days past due unless, in the opinion of management, the outstanding interest remains collectible. Past due status is determined based on contractual terms. Generally, by applying the cash receipts method, interest income is subsequently recognized only as received until the loan is returned to accrual status. The cash receipts method is used when the likelihood of further loss on the loan is remote. Otherwise, the Company applies the cost recovery method and applies all payments as a reduction of the unpaid principal balance until the loan qualifies for return to accrual status. Interest income on impaired loans is recognized using the cost recovery method, unless the likelihood of further loss on the loan is remote.

A loan is restored to accrual status when all principal and interest payments are brought current and the borrower has demonstrated the ability to make future payments of principal and interest as scheduled, which generally requires that the borrower demonstrate a period of performance of at least six consecutive months.

For portfolio segments other than consumer loans, the Company’s practice is to charge-off any loan or portion of a loan when the loan is determined by management to be uncollectible due to the borrower’s failure to meet repayment terms, the borrower’s deteriorating or deteriorated financial condition, the depreciation of the underlying collateral, the loan’s classification as a loss by regulatory examiners, or for other reasons. A partial charge-off is recorded on a loan when the uncollectibility of a portion of the loan has been confirmed, such as when a loan is discharged in bankruptcy, the collateral is liquidated, a loan is restructured at a reduced principal balance, or other identifiable events that lead management to determine the full principal balance of the loan will not be repaid. A specific reserve is recognized as a component of the allowance for estimated losses on loans individually evaluated for impairment. Partial charge-offs on nonperforming and impaired loans are included in the Company’s historical loss experience used to estimate the general component of the allowance for loan losses as discussed below. Specific reserves are not considered charge-offs in management’s analysis of the allowance for loan losses because they are estimates and the outcome of the loan relationship is undetermined. At September 30, 2015, the Company had 12 loans on which partial charge-offs of $483,000 had been recorded.

Consumer loans not secured by real estate are typically charged off at 90 days past due, or earlier if deemed uncollectible, unless the loans are in the process of collection. Overdrafts are charged off after 45 days past due. Charge-offs are typically recorded on loans secured by real estate when the property is foreclosed upon.

The allowance for loan losses reflects management’s judgment of probable loan losses inherent in the loan portfolio at the balance sheet date. Additions to the allowance for loan losses are made by the provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

- 13 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(4 – continued)

The Company uses a disciplined process and methodology to evaluate the allowance for loan losses on at least a quarterly basis that is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific and general components. The specific component relates to loans that are individually evaluated for impairment or loans otherwise classified as doubtful, substandard, or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.

The general component covers non-classified loans and classified loans that are found, upon individual evaluation, to not be impaired. Such loans are pooled by segment and losses are modeled using annualized historical loss experience adjusted for qualitative factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent twelve calendar quarters unless the historical loss experience is not considered indicative of the level of risk in the remaining balance of a particular portfolio segment, in which case an adjustment is determined by management. The Company’s historical loss experience is then adjusted by an overall loss factor weighting adjustment based on a qualitative analysis prepared by management and reviewed on a quarterly basis. The overall loss factor considers changes in underwriting standards, economic conditions, changes and trends in past due and classified loans and other internal and external factors.

Management also applies additional loss factor multiples to loans classified as watch, special mention and substandard that are not individually evaluated for impairment. The loss factor multiples for classified loans are based on management’s assessment of historical trends regarding losses experienced on classified loans in prior periods. See below for additional discussion of the overall loss factor and loss factor multiples for classified loans as of September 30, 2015 and December 31, 2014, as well as a discussion of changes in management’s allowance for loan losses methodology from 2014 to 2015.

Management exercises significant judgment in evaluating the relevant historical loss experience and the qualitative factors. Management also monitors the differences between estimated and actual incurred loan losses for loans considered impaired in order to evaluate the effectiveness of the estimation process and make any changes in the methodology as necessary.

Management utilizes the following portfolio segments in its analysis of the allowance for loan losses: residential real estate, land, construction, commercial real estate, commercial business, home equity and second mortgage, and other consumer loans. Additional discussion of the portfolio segments and the risks associated with each segment can be found in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

 

- 14 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(4 – continued)

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Values for collateral dependent loans are generally based on appraisals obtained from independent licensed real estate appraisers, with adjustments applied for estimated costs to sell the property, costs to complete unfinished or repair damaged property and other factors. New appraisals are generally obtained for all significant properties when a loan is identified as impaired, and a property is considered significant if the value of the property is estimated to exceed $200,000. Subsequent appraisals are obtained as needed or if management believes there has been a significant change in the market value of the property. In instances where it is not deemed necessary to obtain a new appraisal, management bases its impairment and allowance for loan loss analysis on the original appraisal with adjustments for current conditions based on management’s assessment of market factors and management’s inspection of the property.

At September 30, 2015, the recorded investments in loans secured by residential real estate properties for which formal foreclosure proceedings are in process was $593,000.

Loans at September 30, 2015 and December 31, 2014 consisted of the following:

(In thousands)  September 30,
2015
  December 31,
2014
           
Real estate mortgage loans:          
Residential  $113,502   $106,679 
Land   11,543    11,028 
Residential construction   14,049    10,347 
Commercial real estate   74,372    78,314 
Commercial real estate contruction   304    1,422 
Commercial business loans   23,164    28,282 
Consumer loans:          
Home equity and second mortgage loans   38,094    37,513 
Automobile loans   27,496    25,274 
Loans secured by savings accounts   910    1,018 
Unsecured loans   3,470    3,316 
Other consumer loans   6,282    5,075 
Gross loans   313,186    308,268 
Less undisbursed portion of loans in process   (5,179)   (3,325)
           
Principal loan balance   308,007    304,943 
           
Deferred loan origination fees, net   569    506 
Allowance for loan losses   (3,494)   (4,846)
           
Loans, net  $305,082   $300,603 

 

- 15 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(4 – continued)

The following table provides the components of the Company’s recorded investment in loans at September 30, 2015:

 

   Residential
Real Estate
  Land  Construction  Commercial
Real Estate
  Commercial
Business
  Home Equity &
2nd Mtg
  Other
Consumer
  Total
   (In thousands)
Recorded Investment in Loans:                                        
Principal loan balance  $113,502   $11,543   $9,174   $74,372   $23,164   $38,094   $38,158   $308,007 
                                         
Accrued interest receivable   362    41    23    182    66    130    145    949 
                                         
Net deferred loan origination                                        
fees and costs   58    6    0    (38)   (7)   550    0    569 
                                         
Recorded investment in loans  $113,922   $11,590   $9,197   $74,516   $23,223   $38,774   $38,303   $309,525 
                                         
Recorded Investment in Loans as Evaluated for Impairment:               
Individually evaluated for impairment  $1,345   $22   $0   $1,786   $0   $141   $0   $3,294 
Collectively evaluated for impairment   112,577    11,568    9,197    72,730    23,223    38,633    38,303    306,231 
Acquired with deteriorated credit quality   0    0    0    0    0    0    0    0 
                                         
Ending balance  $113,922   $11,590   $9,197   $74,516   $23,223   $38,774   $38,303   $309,525 

 

- 16 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(4 – continued)

The following table provides the components of the Company’s recorded investment in loans at December 31, 2014:

   Residential
Real Estate
  Land  Construction  Commercial
Real Estate
  Commercial
Business
  Home Equity &
2nd Mtg
  Other
Consumer
  Total
   (In thousands)
Recorded Investment in Loans:                                        
Principal loan balance  $106,679   $11,028   $8,444   $78,314   $28,282   $37,513   $34,683   $304,943 
                                         
Accrued interest receivable   368    48    20    186    131    131    152    1,036 
                                         
Net deferred loan origination                                        
fees and costs   49    4    (1)   (20)   (7)   481    0    506 
                                         
Recorded investment in loans  $107,096   $11,080   $8,463   $78,480   $28,406   $38,125   $34,835   $306,485 
                                         
Recorded Investment in Loans as Evaluated for Impairment:                     
Individually evaluated for impairment  $1,411   $16   $0   $1,819   $1,642   $151   $0   $5,039 
Collectively evaluated for impairment   105,685    11,064    8,463    76,661    26,764    37,974    34,835    301,446 
Acquired with deteriorated credit quality   0    0    0    0    0    0    0    0 
                                         
Ending balance  $107,096   $11,080   $8,463   $78,480   $28,406   $38,125   $34,835   $306,485 

 

- 17 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(4 – continued)

An analysis of the allowance for loan losses as of September 30, 2015 is as follows:

   Residential
Real Estate
  Land  Construction  Commercial
Real Estate
  Commercial
Business
  Home Equity &
2nd Mtg
  Other
Consumer
  Total
   (In thousands)
Ending allowance balance attributable to loans:                  
                         
Individually evaluated for impairment  $43   $0   $0   $8   $0   $11   $0   $62 
Collectively evaluated for impairment   541    161    49    1,605    185    633    258    3,432 
Acquired with deteriorated credit quality   0    0    0    0    0    0    0    0 
                                         
Ending balance  $584   $161   $49   $1,613   $185   $644   $258   $3,494 

 

An analysis of the allowance for loan losses as of December 31, 2014 is as follows:

   Residential
Real Estate
  Land  Construction  Commercial
Real Estate
  Commercial
Business
  Home Equity &
2nd Mtg
  Other
Consumer
  Total
   (In thousands)
Ending allowance balance attributable to loans:                  
                         
Individually evaluated for impairment  $47   $0   $0   $11   $1,293   $0   $0   $1,351 
Collectively evaluated for impairment   562    201    60    1,490    187    720    275    3,495 
Acquired with deteriorated credit quality   0    0    0    0    0    0    0    0 
                                         
Ending balance  $609   $201   $60   $1,501   $1,480   $720   $275   $4,846 

 

- 18 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(4 – continued)

An analysis of the changes in the allowance for loan losses for the three months and nine months ended September 30, 2015 is as follows:

 
 
 
 
Residential
Real Estate
 
 
 
Land
 
 
 
Construction
 
 
Commercial
Real Estate
 
 
Commercial
Business
 
 
Home Equity &
2nd Mtg
 
 
Other
Consumer
 
 
 
Total
   (In thousands)
Allowance for loan losses:                        
Changes in Allowance for Loan Losses for the three-months ended September 30, 2015         
Beginning balance  $634   $173   $51   $1,669   $161   $648   $264   $3,600 
Provisions for loan losses   (15)   (12)   (2)   (60)   19    26    44    0 
Charge-offs   (41)   0    0    0    0    (36)   (79)   (156)
Recoveries   6    0    0    4    5    6    29    50 
                                         
Ending balance  $584   $161   $49   $1,613   $185   $644   $258   $3,494 
                                         
                                         
Changes in Allowance for Loan Losses for the nine-months ended September 30, 2015               
Beginning balance  $609   $201   $60   $1,501   $1,480   $720   $275   $4,846 
Provisions for loan losses   27    (40)   (11)   96    (97)   (20)   95    50 
Charge-offs   (61)   0    0    0    (1,205)   (68)   (203)   (1,537)
Recoveries   9    0    0    16    7    12    91    135 
                                         
Ending balance  $584   $161   $49   $1,613   $185   $644   $258   $3,494 

 

- 19 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(4 – continued)

An analysis of the changes in the allowance for loan losses for the three months and nine months ended September 30, 2014 is as follows:

 
 
 
 
Residential
Real Estate
 
 
 
Land
 
 
 
Construction
 
 
Commercial
Real Estate
 
 
Commercial
Business
 
 
Home Equity &
2nd Mtg
 
 
Other
Consumer
 
 
 
Total
   (In thousands)
Allowance for loan losses:                        
Changes in Allowance for Loan Losses for the three-months ended September 30, 2014         
Beginning balance  $843   $153   $78   $1,280   $1,444   $932   $336   $5,066 
Provisions for loan losses   36    3    (1)   (19)   (5)   1    60    75 
Charge-offs   (56)   0    0    0    0    0    (84)   (140)
Recoveries   2    0    0    0    8    12    32    54 
                                         
Ending balance  $825   $156   $77   $1,261   $1,447   $945   $344   $5,055 
                                         
                                         
Changes in Allowance for Loan Losses for the nine-months ended September 30, 2014              
Beginning balance  $811   $152   $63   $1,284   $1,446   $877   $289   $4,922 
Provisions for loan losses   148    4    14    (23)   (12)   (69)   128    190 
Charge-offs   (140)   0    0    0    0    (54)   (172)   (366)
Recoveries   6    0    0    0    13    191    99    309 
                                         
Ending balance  $825   $156   $77   $1,261   $1,447   $945   $344   $5,055 

 

- 20 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(4 – continued)

At September 30, 2015 and December 31, 2014, management applied specific qualitative factor adjustments to the residential real estate, construction, commercial real estate, commercial business, vacant land, and home equity and second mortgage portfolio segments as they determined that the historical loss experience was not indicative of the level of risk in the remaining balance of those portfolio segments. These adjustments increased the loss factors by 0.25% to 20% for certain loan groups, and increased the estimated allowance for loan losses related to those portfolio segments by approximately $1.4 million and $1.6 million at September 30, 2015 and December 31, 2014, respectively. These changes were made to reflect management’s estimates of inherent losses in these portfolio segments at September 30, 2015 and December 31, 2014.

At September 30, 2015 and December 31, 2014, for each loan portfolio segment, management applied an overall qualitative factor of 1.18 to the Company’s historical loss factors. The overall qualitative factor is derived from management’s analysis of changes and trends in the following qualitative factors: underwriting standards, economic conditions, past due loans and other internal and external factors. Each of the four factors above was assigned an equal weight to arrive at an average for the overall qualitative factor of 1.18 at September 30, 2015 and December 31, 2014, respectively. The effect of the overall qualitative factor was to increase the estimated allowance for loan losses by $472,000 and $520,000 at September 30, 2015 and December 31, 2014, respectively. Additional discussion of the overall qualitative factor can be found in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. There were no changes in management’s assessment of the overall qualitative factor components from December 31, 2014 to September 30, 2015.

Management also adjusts the historical loss factors for loans classified as watch, special mention and substandard that are not individually evaluated for impairment. The adjustments consider the increased likelihood of loss on classified loans based on the Company’s separate historical experience for classified loans. The effect of the adjustments for classified loans was to increase the estimated allowance for loan losses by $444,000 and $664,000 at September 30, 2015 and December 31, 2014, respectively.

- 21 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(4 – continued)

The following table summarizes the Company’s impaired loans as of September 30, 2015 and for the three months and nine months ended September 30, 2015. The Company did not recognize any interest income on impaired loans using the cash receipts method of accounting for the three or nine month periods ended September 30, 2015:

   At September 30, 2015  Three Months Ended September 30, 2015  Nine  Months Ended September 30, 2015
 
 
 
 
 
 
 
Recorded
Investment
 
 
 
Unpaid
Principal
Balance
 
 
 
 
Related
Allowance
 
 
 
Average
Recorded
Investment
 
 
 
Interest
Income
Recognized
 
 
 
Average
Recorded
Investment
 
 
 
Interest
Income
Recognized
   (In thousands)
Loans with no related allowance recorded:                                   
Residential  $1,232   $1,599   $0   $1,177   $5   $1,211   $14 
Land   22    25    0    21    0    19    0 
Construction   0    0    0    0    0    0    0 
Commercial real estate   1,748    1,790    0    1,755    19    1,768    57 
Commercial business   0    0    0    0    1    7    1 
Home equity/2nd mortgage   61    78    0    62    1    66    1 
Other consumer   0    0    0    0    0    0    0 
                                    
    3,063    3,492    0    3,015    26    3,071    73 
                                    
Loans with an allowance recorded:                                   
Residential   113    117    43    205    0    223    0 
Land   0    0    0    0    0    0    0 
Construction   0    0    0    0    0    0    0 
Commercial real estate   38    63    8    38    0    39    0 
Commercial business   0    0    0    0    0    419    0 
Home equity/2nd mortgage   80    81    11    80    0    80    0 
Other consumer   0    0    0    0    0    0    0 
                                    
    231    261    62    323    0    761    0 
                                    
Total:                                   
Residential   1,345    1,716    43    1,382    5    1,434    14 
Land   22    25    0    21    0    19    0 
Construction   0    0    0    0    0    0    0 
Commercial real estate   1,786    1,853    8    1,793    19    1,807    57 
Commercial business   0    0    0    0    1    426    1 
Home equity/2nd mortgage   141    159    11    142    1    146    1 
Other consumer   0    0    0    0    0    0    0 
                                    
   $3,294   $3,753   $62   $3,338   $26   $3,832   $73 

 

- 22 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(4 – continued)

The following table summarizes the Company’s impaired loans for the three months and nine months ended September 30, 2014. The Company did not recognize any interest income on impaired loans using the cash receipts method of accounting for the three or nine month periods ended September 30, 2014:

   Three Months Ended September 30, 2014  Nine Months Ended September 30, 2014
   Average
Recorded
Investment
  Interest
Income
Recognized
  Average
Recorded
Investment
  Interest
Income
Recognized
    
Loans with no related allowance recorded:                    
Residential  $1,113   $8   $1,331   $25 
Land   110    0    116    0 
Construction   0    0    65    0 
Commercial real estate   1,713    19    1,588    53 
Commercial business   188    0    142    0 
Home equity/2nd mortgage   85    0    167    2 
Other consumer   0    0    0    0 
                     
    3,209    27    3,409    80 
                     
Loans with an allowance recorded:                    
Residential   259    0    394    0 
Land   0    0    2    0 
Construction   0    0    0    0 
Commercial real estate   477    0    809    0 
Commercial business   1,676    0    1,709    0 
Home equity/2nd mortgage   48    0    38    0 
Other consumer   0    0    0    0 
                     
    2,460    0    2,952    0 
                     
Total:                    
Residential   1,372    8    1,725    25 
Land   110    0    118    0 
Construction   0    0    65    0 
Commercial real estate   2,190    19    2,397    53 
Commercial business   1,864    0    1,851    0 
Home equity/2nd mortgage   133    0    205    2 
Other consumer   0    0    0    0 
                     
   $5,669   $27   $6,361   $80 

 

- 23 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(4 – continued)

The following table summarizes the Company’s impaired loans as of December 31, 2014:

   Recorded
Investment
  Unpaid
Principal
Balance
  Related
Allowance
   (In thousands)
Loans with no related allowance recorded:               
Residential  $1,141   $1,446   $0 
Land   16    18    0 
Construction   0    0    0 
Commercial real estate   1,777    1,808    0 
Commercial business   0    0    0 
Home equity/2nd mortgage   71    87    0 
Other consumer   0    0    0 
                
    3,005    3,359    0 
                
Loans with an allowance recorded:               
Residential   270    304    47 
Land   0    0    0 
Construction   0    0    0 
Commercial real estate   42    65    11 
Commercial business   1,642    1,909    1,293 
Home equity/2nd mortgage   80    98    0 
Other consumer   0    0    0 
                
    2,034    2,376    1,351 
                
Total:               
Residential   1,411    1,750    47 
Land   16    18    0 
Construction   0    0    0 
Commercial real estate   1,819    1,873    11 
Commercial business   1,642    1,909    1,293 
Home equity/2nd mortgage   151    185    0 
Other consumer   0    0    0 
                
   $5,039   $5,735   $1,351 

 

- 24 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(4 – continued)

Nonperforming loans consists of nonaccrual loans and loans over 90 days past due and still accruing interest. The following table presents the recorded investment in nonperforming loans at September 30, 2015 and December 31, 2014:

   September 30, 2015  December 31, 2014
    
Nonaccrual
Loans
  Loans 90+ Days
Past Due
Still Accruing
  Total
Nonperforming
Loans
  Nonaccrual
Loans
  Loans 90+ Days
Past Due
Still Accruing
  Total
Nonperforming
Loans
   (In thousands)
                   
Residential  $998   $0   $998   $919   $68   $987 
Land   22    0    22    16    0    16 
Construction   0    0    0    0    0    0 
Commercial real estate   429    0    429    433    0    433 
Commercial business   0    66    66    1,642    0    1,642 
Home equity/2nd mortgage   121    14    135    129    14    143 
Other consumer   0    0    0    0    3    3 
                               
   Total  $1,570   $80   $1,650   $3,139   $85   $3,224 

 

The following table presents the aging of the recorded investment in loans at September 30, 2015:

   30-59 Days
Past Due
  60-89 Days
Past Due
  90 Days or More
Past Due
  Total
Past Due
  Current  Total
Loans
   (In thousands)
                   
Residential  $2,237   $563   $431   $3,231   $110,691   $113,922 
Land   57    0    22    79    11,511    11,590 
Construction   0    0    0    0    9,197    9,197 
Commercial real estate   235    0    55    290    74,226    74,516 
Commercial business   67    6    66    139    23,084    23,223 
Home equity/2nd mortgage   669    0    97    766    38,008    38,774 
Other consumer   200    26    0    226    38,077    38,303 
                               
Total  $3,465   $595   $671   $4,731   $304,794   $309,525 

 

- 25 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(4 – continued)

The following table presents the aging of the recorded investment in loans at December 31, 2014:

   30-59 Days
Past Due
  60-89 Days
Past Due
  90 Days or More
Past Due
  Total
Past Due
  Current  Total
Loans
   (In thousands)
                   
Residential  $3,070   $551   $308   $3,929   $103,167   $107,096 
Land   24    124    0    148    10,932    11,080 
Construction   0    0    0    0    8,463    8,463 
Commercial real estate   54    133    42    229    78,251    78,480 
Commercial business   0    0    0    0    28,406    28,406 
Home equity/2nd mortgage   153    23    97    273    37,852    38,125 
Other consumer   263    26    3    292    34,543    34,835 
                               
Total  $3,564   $857   $450   $4,871   $301,614   $306,485 

 

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, public information, historical payment experience, credit documentation, and current economic trends, among other factors. The Company classifies loans based on credit risk at least quarterly. The Company uses the following regulatory definitions for risk ratings:

 

Special Mention: Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

 

Substandard: Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

 

Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as 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.

 

Loss: Loans classified as loss are considered uncollectible and of such little value that their continuance on the institution’s books as an asset is not warranted.

 

Loans not meeting the criteria above that are analyzed individually as part of the described process are considered to be pass rated loans.

 

- 26 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(4 – continued)

The following table presents the recorded investment in loans by risk category as of the date indicated:

 

   Residential
Real Estate
  Land  Construction  Commercial
Real Estate
  Commercial
Business
  Home Equity &
2nd Mtg
  Other
Consumer
  Total
   (In thousands)
September 30, 2015                        
Pass  $110,479   $8,710   $9,197   $71,833   $22,176   $38,532   $38,228   $299,155 
Special Mention   1,707    91    0    1,947    501    0    60    4,306 
Substandard   738    2,767    0    307    546    121    15    4,494 
Doubtful   998    22    0    429    0    121    0    1,570 
Loss   0    0    0    0    0    0    0    0 
                                         
Total  $113,922   $11,590   $9,197   $74,516   $23,223   $38,774   $38,303   $309,525 
                                         
December 31, 2014                                        
Pass  $104,780   $7,969   $7,722   $73,204   $26,137   $37,860   $34,770   $292,442 
Special Mention   105    94    741    2,648    298    2    49    3,937 
Substandard   1,292    3,001    0    2,195    329    134    16    6,967 
Doubtful   919    16    0    433    1,642    129    0    3,139 
Loss   0    0    0    0    0    0    0    0 
                                         
Total  $107,096   $11,080   $8,463   $78,480   $28,406   $38,125   $34,835   $306,485 

 

- 27 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(4 – continued)

The following table summarizes the Company’s troubled debt restructurings (TDRs) by accrual status as of September 30, 2015 and December 31, 2014:

 

   September 30, 2015  December 31, 2014
   Accruing  Nonaccrual  Total  Related Allowance
for Loan Losses
  Accruing  Nonaccrual  Total  Related Allowance
for Loan Losses
   (In thousands)
Troubled debt restructurings:                                        
Residential real estate  $347   $315   $662   $0   $492   $166   $658   $6 
Commercial real estate   1,358    328    1,686    0    1,386    338    1,724    0 
Commercial business   0    0    0    0    0    1,642    1,642    1,292 
Home equity and 2nd mortgage   20    0    20    0    22    0    22    0 
                                         
Total  $1,725   $643   $2,368   $0   $1,900   $2,146   $4,046   $1,298 

 

At September 30, 2015 and December 31, 2014, there were no commitments to lend additional funds to debtors whose loan terms have been modified in a TDR.

- 28 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(4 – continued)

There were no TDRs that were restructured during the three or nine months ended September 30, 2015.

 

The following table summarizes information in regard to TDRs that were restructured during the three and nine months ended September 30, 2014:

   Three months ended September 30, 2014  Nine months ended September 30, 2014
   Number of
Contracts
  Pre-Modification
Outstanding
Balance
  Post-Modification
Outstanding
Balance
  Number of
Contracts
  Pre-Modification
Outstanding
Balance
  Post-Modification
Outstanding
Balance
   (Dollars in thousands)  (Dollars in thousands)
                   
Troubled debt restructurings:                              
Commercial real estate   1   $115   $115    4   $657   $657 
                               
Total   1   $115   $115    4   $657   $657 

 

For the TDRs listed above, the terms of modification included a temporary decrease in the borrowers’ monthly payments. There were no principal charge-offs recorded as a result of TDRs during the three months and nine months ended September 30, 2014, and there was no specific allowance for loan losses related to TDRs modified during the three months and nine months ended September 30, 2014.

 

There were no TDRs modified within the previous 12 months for which there was a subsequent payment default (defined as the loan becoming more than 90 days past due, being moved to nonaccrual status, or the collateral being foreclosed upon) during the three months and nine months ended September 30, 2015 and 2014. In the event that a TDR subsequently defaults, the Company evaluates the restructuring for possible impairment. As a result, the related allowance for loan losses may be increased or charge-offs may be taken to reduce the carrying amount of the loan. 

- 29 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

5.Supplemental Disclosure for Earnings Per Share
   Three Months Ended  Nine Months Ended
   9/30/2015  9/30/2014  9/30/2015  9/30/2014
             
Basic  (Dollars in thousands, except for share and per share data)
Earnings:                    
Net income attributable to First Capital, Inc.  $1,398   $1,524   $4,092   $4,339 
                     
Shares:                    
Weighted average common shares outstanding   2,740,631    2,741,065    2,740,608    2,760,672 
                     
Net income attributable to First Capital, Inc. per common share, basic  $0.51   $0.56   $1.49   $1.57 
                     
Diluted                    
Earnings:                    
Net income attributable to First Capital, Inc.  $1,398   $1,524   $4,092   $4,339 
                     
Shares:                    
Weighted average common shares outstanding   2,740,631    2,741,065    2,740,608    2,760,672 
Add: Dilutive effect of restricted stock   838    0    373    0 
                     
Weighted average common shares outstanding, as adjusted   2,741,469    2,741,065    2,740,981    2,760,672 
                     
Net income attributable to First Capital, Inc. per common share, diluted  $0.51   $0.56   $1.49   $1.57 

 

Nonvested restricted stock shares are not considered as outstanding for purposes of computing weighted average common shares outstanding.

 

6.Stock Option Plan

 

On May 20, 2009, the Company adopted the 2009 Equity Incentive Plan (the “Plan”). The Plan provides for the award of stock options, restricted stock, performance shares and stock appreciation rights. The maximum aggregate number of shares of the Company’s common stock available for issuance under the Plan is 223,000 shares. The Company may grant both non-statutory and statutory (incentive) stock options which may not have a term exceeding ten years. In the case of incentive stock options, the aggregate fair value of the stock (determined at the time the incentive stock option is granted) for which any optionee may be granted incentive options which are first exercisable during any calendar year shall not exceed $100,000. Option prices may not be less than the fair market value of the underlying stock at the date of the grant. An award of a performance share is a grant of a right to receive shares of the Company’s common stock which is contingent upon the achievement of specific performance criteria or other objectives set at the grant date. Stock appreciation rights are equity or cash settled share-based compensation arrangements whereby the number of shares that will ultimately be issued or the cash payment is based upon the appreciation of the Company’s common stock. Awards granted under the Plan may be granted either alone, in addition to, or in tandem with, any other award granted under the Plan.

 

- 30 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(6 – continued)

The fair market value of stock options granted is estimated at the date of grant using an option pricing model. Expected volatilities are based on historical volatility of the Company's stock. The expected term of options granted represents the period of time that options are expected to be outstanding and is based on historical trends. The risk free rate for the expected life of the options is based on the U.S. Treasury yield curve in effect at the time of grant. As of September 30, 2015, no stock options had been granted under the Plan.

 

On February 17, 2015, the Company granted 19,500 restricted stock shares to directors, officers and key employees at a grant-date price of $24.50 per share for a total of $478,000. The restricted stock vests ratably from the grant date through July 1, 2020, with 20% of the shares vesting each year on July 1 beginning July 1, 2016. Compensation expense is measured based on the fair market value of the restricted stock at the grant date and is recognized ratably over the period during which the shares are earned (the vesting period). Compensation expense related to restricted stock recognized for the three-month and nine-month periods ended September 30, 2015 amounted to $15,000 and $53,000, respectively.

 

A summary of the Company’s nonvested restricted shares activity under the Plan as of September 30, 2015 and changes during the nine-month period then ended is presented below.

 

   Weighted
Number
of
Shares
  Average
Grant Date
Fair Value
       
Nonvested at January 1, 2015   -    - 
Granted   19,500   $24.50 
Vested   500    24.50 
Forfeited   1,000    24.50 
           
Nonvested at September 30, 2015   18,000   $24.50 

 

There were 500 restricted shares that vested during the nine-month period ended September 30, 2015, upon the retirement of a director. The total fair value of restricted shares that vested during the nine-month period ended September 30, 2015 was $13,000. At September 30, 2015, there was $400,000 of total unrecognized compensation expense related to nonvested restricted shares. The compensation expense is expected to be recognized over the remaining vesting period of 4.75 years.

 

7.Supplemental Disclosures of Cash Flow Information
   Nine Months Ended
September 30,
   2015  2014
   (In thousands)
Cash payments for:          
Interest  $740   $912 
Taxes   1,035    1,819 
           
Noncash investing activities:          
Transfers from loans to real estate acquired through foreclosure   605    188 

- 31 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

8.Fair Value Measurements

Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 820, Fair Value Measurements, provides the framework for measuring fair value. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under FASB ASC Topic 820 are described as follows:

 

Level 1:Inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets

Level 2:Inputs to the valuation methodology include quoted market prices for similar assets or liabilities in active markets; quoted market prices for identical or similar assets or liabilities in markets that are not active; or inputs that are derived principally from or can be corroborated by observable market data by correlation or other means.

Level 3:Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Level 3 assets and liabilities include financial instruments whose value is determined using discounted cash flow methodologies, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth on the following page. These valuation methodologies were applied to all of the Company’s financial and nonfinancial assets carried at fair value or the lower of cost or fair value. The table below presents the balances of assets measured at fair value on a recurring and nonrecurring basis as of September 30, 2015 and December 31, 2014. The Company had no liabilities measured at fair value as of September 30, 2015 or December 31, 2014.

 

- 32 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(8 – continued)

   Carrying Value
(In thousands)  Level 1  Level 2  Level 3  Total
             
September 30, 2015                    
Assets Measured on a Recurring Basis                    
Securities available for sale:                    
Agency mortgage-backed securities  $0   $34,728   $0   $34,728 
Agency CMO   0    10,345    0    10,345 
Agency notes and bonds   0    16,792    0    16,792 
Municipal obligations   0    32,740    0    32,740 
Mutual funds   605    0    0    605 
Total securities available for sale  $605   $94,605   $0   $95,210 
                     
Assets Measured on a Nonrecurring Basis                    
Impaired loans:                    
Residential real estate  $0   $0   $1,302   $1,302 
Land   0    0    22    22 
Construction   0    0    0    0 
Commercial real estate   0    0    1,778    1,778 
Commercial business   0    0    0    0 
Home equity and second mortgage   0    0    130    130 
Total impaired loans  $0   $0   $3,232   $3,232 
                     
Loans held for sale  $0   $324   $0   $324 
                     
Foreclosed real estate:                    
Residential real estate  $0   $0   $36   $36 
Commercial real estate   0    0    480    480 
Total foreclosed real estate  $0   $0   $516   $516 
                     
December 31, 2014                    
Assets Measured on a Recurring Basis                    
Securities available for sale:                    
Agency mortgage-backed securities  $0   $32,296   $0   $32,296 
Agency CMO   0    14,385    0    14,385 
Agency notes and bonds   0    18,120    0    18,120 
Municipal obligations   0    33,342    0    33,342 
Mutual funds   2,083    0    0    2,083 
Total securities available for sale  $2,083   $98,143   $0   $100,226 
                     
Assets Measured on a Nonrecurring Basis                    
Impaired loans:                    
Residential real estate  $0   $0   $1,364   $1,364 
Land   0    0    16    16 
Construction   0    0    0    0 
Commercial real estate   0    0    1,808    1,808 
Commercial business   0    0    349    349 
Home equity and second mortgage   0    0    151    151 
Total impaired loans  $0   $0   $3,688   $3,688 
                     
Loans held for sale  $0   $1,608   $0   $1,608 
                     
Foreclosed real estate:                    
Residential real estate  $0   $0   $78   $78 
Total foreclosed real estate  $0   $0   $78   $78 

 

- 33 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(8 – continued)

Fair value is based upon quoted market prices, where available. If quoted market prices are not available, fair value is based on internally developed models or obtained from third parties that primarily use, as inputs, observable market-based parameters or a matrix pricing model that employs the Bond Market Association’s standard calculations for cash flow and price/yield analysis and observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value, or the lower of cost or fair value. These adjustments may include unobservable parameters. Any such valuation adjustments have been applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

 

Securities Available for Sale. Securities classified as available for sale are reported at fair value on a recurring basis.  These securities are classified as Level 1 of the valuation hierarchy where quoted market prices from reputable third-party brokers are available in an active market. If quoted market prices are not available, the Company obtains fair value measurements from an independent pricing service.  These securities are reported using Level 2 inputs and the fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, U.S. government and agency yield curves, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the security’s terms and conditions, among other factors. Changes in fair value of securities available for sale are recorded in other comprehensive income, net of income tax effect.

 

Impaired Loans. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly. The fair value of impaired loans is classified as Level 3 in the fair value hierarchy.

 

Impaired loans are carried at the present value of estimated future cash flows using the loan's effective interest rate or the fair value of collateral less estimated costs to sell if the loan is collateral dependent. At September 30, 2015 and December 31, 2014, all impaired loans were considered to be collateral dependent for the purpose of determining fair value. Collateral may be real estate and/or business assets, including equipment, inventory and/or accounts receivable. The fair value of the collateral is generally determined based on real estate appraisals or other independent evaluations by qualified professionals, adjusted for estimated costs to sell the property, costs to complete or repair the property and other factors to reflect management’s estimate of the fair value of the collateral given the current market conditions and the condition of the collateral. At September 30, 2015 and December 31, 2014, the significant unobservable inputs used in the fair value measurement of impaired loans included a discount from appraised value for estimates of changes in market conditions, the condition of the collateral and estimated costs to sell the collateral ranging from 10% to 20%. The Company recognized provisions for loan losses of $83,000 and $37,000 for the nine months ended September 30, 2015 and 2014, respectively, for impaired loans. The Company recognized provisions for loan losses of $1,000 and $16,000 for the three months ended September 30, 2015 and 2014, respectively.

- 34 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(8 – continued)

Loans Held for Sale. Loans held for sale are carried at the lower of cost or market value. The portfolio is comprised of residential real estate loans and fair value is based on specific prices of underlying contracts for sales to investors.  These measurements are classified as Level 2.

 

Foreclosed Real Estate. Foreclosed real estate is reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly. The fair value of foreclosed real estate is classified as Level 3 in the fair value hierarchy.

 

Foreclosed real estate is reported at fair value less estimated costs to dispose of the property. The fair values are determined by real estate appraisals which are then discounted to reflect management’s estimate of the fair value of the property given current market conditions and the condition of the collateral. At September 30, 2015, the significant unobservable inputs used in the fair value measurement of foreclosed real estate included a discount from appraised value for estimates of changes in market conditions, the condition of the collateral and estimated costs to sell the property ranging from 28% to 60%, with a weighted average of 32%. At December 31, 2014, the discount from appraised value ranged from 10% to 60%, with a weighted average of 40%. There were no charges to write down foreclosed real estate recognized in income for the three months and nine months ended September 30, 2015, or the three months and nine months ended September 30, 2014.

 

There have been no changes in the valuation techniques and related inputs used for assets measured at fair value on a recurring and nonrecurring basis during the nine month periods ended September 30, 2015 and 2014. There were no transfers into or out of the Company’s Level 3 financial assets for the nine month periods ended September 30, 2015 and 2014. In addition, there were no transfers into or out of Levels 1 and 2 of the fair value hierarchy during the nine month periods ended September 30, 2015 and 2014.

- 35 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(8 – continued)

GAAP requires disclosure of the fair value of financial assets and financial liabilities, whether or not recognized in the balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The estimated fair values of the Company's financial instruments are as follows:

 

   Carrying  Fair  Fair Vale Measurements Using
(In thousands)  Value  Value  Level 1  Level 2  Level 3
                
September 30, 2015                         
Financial assets:                         
Cash and cash equivalents  $24,411   $24,411   $24,411   $0   $0 
Interest-bearing time deposits   11,635    11,766    0    11,766    0 
Securities available for sale   95,210    95,210    605    94,605    0 
Securities held to maturity   5    5    0    5    0 
Loans held for sale   324    332    0    332    0 
Loans, net   305,082    305,161    0    0    305,161 
FHLB stock   1,550    1,550    0    1,550    0 
Accrued interest receivable   1,523    1,523    0    1,523    0 
Cost method investment (included in other assets)   711    711    0    711    0 
                          
Financial liabilities:                         
Deposits   402,586    402,255    0    0    402,255 
Accrued interest payable   90    90    0    90    0 
                          
December 31, 2014:                         
Financial assets:                         
Cash and cash equivalents  $33,243   $33,243   $33,243   $0   $0 
Interest-bearing time deposits   8,270    8,370    0    8,370    0 
Securities available for sale   100,226    100,226    2,083    98,143    0 
Securities held to maturity   6    6    0    6    0 
Loans held for sale   1,608    1,641    0    1,641    0 
Loans, net   300,603    301,864    0    0    301,864 
FHLB stock   2,241    2,241    0    2,241    0 
Accrued interest receivable   1,580    1,580    0    1,580    0 
Cost method investment (included in other assets)   711    711    0    711    0 
                          
Financial liabilities:                         
Deposits   412,636    412,282    0    0    412,282 
Accrued interest payable   127    127    0    127    0 

 

- 36 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(8 – continued)

The carrying amounts in the preceding table are included in the consolidated balances sheets under the applicable captions. The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value:

Cash and Cash Equivalents and Interest-Bearing Time Deposits

For cash and short-term investments, including cash and due from banks, interest-bearing deposits with banks, federal funds sold, and interest-bearing time deposits with other financial institutions, the carrying amount is a reasonable estimate of fair value.

Investment Securities

For marketable equity securities, the fair values are based on quoted market prices. For debt securities, the Company obtains fair value measurements from an independent pricing service and the fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, U.S. government and agency yield curves, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the security’s terms and conditions, among other factors. For FHLB stock, a restricted equity security, the carrying amount is a reasonable estimate of fair value because it is not marketable. For other cost method equity investments where a quoted market value is not available, the carrying amount is a reasonable estimate of fair value.

Loans

The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The carrying amount of accrued interest receivable approximates its fair value. The fair value of loans held for sale is based on specific prices of underlying contracts for sale to investors.

Deposits

The fair value of demand deposits, savings accounts, money market deposit accounts and other transaction accounts is the amount payable on demand at the balance sheet date. The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities. The carrying amount of accrued interest payable approximates its fair value.

Borrowed Funds

The carrying amounts of retail repurchase agreements approximate their fair value. The fair value of advances from FHLB is estimated by discounting the future cash flows using the current rates at which similar loans with the same remaining maturities could be obtained.

- 37 -
 

FIRST CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

9.Recent Accounting Pronouncements

The following is a summary of recently issued accounting pronouncements that impact the accounting and reporting practices of the Company:

In May 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606). The update provides a five-step revenue recognition model for all revenue arising from contracts with customers and affects all entities that enter into contracts to provide goods or services to their customers (unless the contracts are included in the scope of other standards). The guidance requires an entity to recognize the revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. For public entities, the guidance was originally effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. However, with the issuance of ASU No. 2015-14 in August 2015, the FASB deferred the effective date of ASU No. 2014-09 by one year for all entities, making the amendments effective for public entities for annual reporting periods beginning after December 15, 2017, including interim periods within those reporting periods. Companies have the option to apply ASU No. 2014-09 as of the original effective date. Management is evaluating the new guidance, but does not expect the adoption of this guidance to have a material impact on the Company’s consolidated financial position or results of operations.

In September 2015, the FASB issued ASU No. 2015-16, Business Combinations (Topic 805) – Simplifying the Accounting for Measurement-Period Adjustments. The guidance eliminates the requirement for an acquirer in a business combination to retrospectively account for measurement-period adjustments. Instead, acquirers must recognize measurement-period adjustments during the reporting period in which the adjustment amounts are determined, and the effect of the adjustments on the income statement must be calculated as if the accounting had been completed at the acquisition date. In addition, the update requires an entity to present separately on the face of the income statement or 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 in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. For public entities, the guidance is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The guidance should be applied prospectively to adjustments to provisional amounts that occur after the effective date, with earlier application permitted for financial statements that have not been issued. The adoption of this update is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

- 38 -
 

PART I - ITEM 2
MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FIRST CAPITAL, INC.

Safe Harbor Statement for Forward-Looking Statements

This report may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not historical facts; rather they are statements based on management’s current expectations, goals and objectives regarding its business strategies, their intended results and the Company’s future performance. Forward-looking statements are preceded by terms such as “expects,” “believes,” “anticipates,” “intends” and similar expressions.

Forward-looking statements are not guarantees of future performance. Numerous risks and uncertainties could cause or contribute to the Company’s actual results, performance and achievements being materially different from those expressed or implied by the forward-looking statements. Factors that may cause or contribute to these differences include, without limitation, general economic conditions, including changes in market interest rates and changes in monetary and fiscal policies of the federal government; legislative and regulatory changes; the quality and composition of the loan and investment securities portfolio; loan demand; deposit flows; competition; the potential that we do not obtain requisite shareholder and regulatory approvals for the Peoples merger; our ability to realize expected cost savings, synergies and other financial benefits from the proposed merger with Peoples Bancorp, Inc. of Bullitt County; our ability to integrate acquisitions, including the acquisition of Peoples; and changes in accounting principles and guidelines. Additional factors that may affect our results are discussed in Part II of this Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2014 under “Item 1A. Risk Factors.” These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, the Company assumes no obligation and disclaims any obligation to update any forward-looking statements.

Critical Accounting Policies

During the nine months ended September 30, 2015, there was no significant change in the Company’s critical accounting policies or the application of critical accounting policies as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

Financial Condition

Total assets decreased from $472.8 million at December 31, 2014 to $465.2 million at September 30, 2015, a decrease of 1.6%.

Net loans receivable (excluding loans held for sale) increased $4.5 million from $300.6 million at December 31, 2014 to $305.1 million at September 30, 2015. Residential mortgage loans and other consumer loans increased $6.8 million and $3.5, respectively, during the nine months ended September 30, 2015 while commercial business loans and commercial real estate loans decreased $5.1 million and $3.9 million, respectively, during the period.

Securities available for sale decreased $5.0 million from $100.2 million at December 31, 2014 to $95.2 million at September 30, 2015. Purchases of $20.4 million of securities classified as available for sale were made during the nine months ended September 30, 2015 and consisted primarily of U.S. government agency notes and bonds and mortgage-backed securities. Maturities and principal repayments of available for sale securities totaled $15.9 million and $9.0 million, respectively, during the nine months ended September 30, 2015.

- 39 -
 

PART I - ITEM 2
MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FIRST CAPITAL, INC.

Cash and cash equivalents decreased from $33.2 million at December 31, 2014 to $24.4 million at September 30, 2015, primarily due to decreases of $5.3 million and $3.5 million in federal funds sold and in cash and due from banks, respectively.

Total deposits decreased 2.4% from $412.6 million at December 31, 2014 to $402.6 million at September 30, 2015. Time deposits decreased $10.9 million over the nine month period as customers opted not to lock in to longer terms in the current low-rate environment. Noninterest-bearing checking accounts and interest-bearing checking and savings accounts increased $460,000 and $385,000, respectively, during the period.

Total stockholders' equity attributable to the Company increased from $57.1 million at December 31, 2014 to $59.5 million at September 30, 2015 primarily due to retained net income of $2.4 million.

Results of Operations

Net income for the nine-month periods ended September 30, 2015 and 2014. Net income attributable to the Company was $4.1 million ($1.49 per share) for the nine months ended September 30, 2015 compared to $4.3 million ($1.57 per share) for the same time period in 2014. The decrease is primarily due to an increase in noninterest expense partially offset by increases in net interest income after provision for loans losses and noninterest income.

Net income for the three-month periods ended September 30, 2015 and 2014. Net income attributable to the Company was $1.4 million ($0.51 per share) for the three months ended September 30, 2015 compared to $1.5 million ($0.56 per share) for the three months ended September 30, 2014. The decrease is primarily due to a decrease in noninterest income and an increase in professional fees related to the previously announced agreement to acquire Peoples (see Note 2 to the Consolidated Financial Statements).

Net interest income for the nine-month periods ended September 30, 2015 and 2014. Net interest income decreased $34,000 for the nine months ended September 30, 2015 compared to the same period in 2014 primarily due to a decrease in the interest rate spread offset by an increase in the ratio of average interest-earning assets to average interest-bearing liabilities.

Total interest income decreased $207,000 for the nine months ended September 30, 2015 compared to the same period in 2014. For the nine months ended September 30, 2015, the average balance of interest-earning assets and their tax-equivalent yield were $437.6 million and 4.29%, respectively. During the same period in 2014, the average balance of those assets was $427.9 million and the tax-equivalent yield was 4.45%. The decrease in the tax-equivalent yield was due to a decrease in yields across all asset types because the Federal Open Market Committee (FOMC) has kept interest rates near historic low levels. The increase in the average balance of interest-earning assets was primarily due to increases in average balances of federal funds sold, interest bearing deposits with banks and loans receivable, which increased $14.2 million, $4.1 million and $3.5 million, respectively, when comparing the two periods. This was partially offset by a decrease of $12.2 million in the average balance of investment securities when comparing the same two periods.

- 40 -
 

PART I - ITEM 2
MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FIRST CAPITAL, INC.

Total interest expense decreased $173,000 for the nine months ended September 30, 2015 compared to the same period in 2014. The average rate paid on interest-bearing liabilities decreased from 0.35% for the nine months ended September 30, 2014 to 0.28% for the same period in 2015. The average balance of interest-bearing liabilities increased from $337.6 million for 2014 to $339.6 million for 2015 primarily due to an increase of $9.7 million in the average balance of interest-bearing deposits partially offset by a $7.7 million decrease in the average balance of borrowed funds. As a result, the tax-equivalent interest rate spread decreased from 4.10% for the nine-month period ended September 30, 2014 to 4.01% for the same period in 2015. The ratio of average interest-earning assets to average interest-bearing liabilities increased from 126.8% for 2014 to 128.8% for 2015.

Net interest income for the three-month periods ended September 30, 2015 and 2014. Net interest income decreased $33,000 for the three months ended September 30, 2015 compared to the three months ended September 30, 2014 primarily due to a decrease in the interest rate spread.

Total interest income decreased $93,000 for the three months ended September 30, 2015 compared to the same period in 2014. For the three months ended September 30, 2015, the average balance of interest-earning assets and their tax-equivalent yield were $433.2 million and 4.34%, respectively. During the same period in 2014, the average balance of those assets was $434.1 million and the tax-equivalent yield was 4.43%. The decrease in yield was primarily due to the previously mentioned low rate environment and a change in asset mix. The average balance of federal funds sold and interest bearing deposits with banks increased $9.2 million and $3.7 million, respectively, while the average balance of investment securities decreased $13.3 million when comparing the two periods.

Total interest expense decreased $60,000 for the three months ended September 30, 2015 compared to the three months ended September 30, 2014. The average balance of interest-bearing liabilities decreased from $335.0 million to $333.1 million when comparing the two periods and the average rate paid on those liabilities decreased from 0.33% for the three months ended September 30, 2014 to 0.26% for the same period in 2015. As a result, the tax-equivalent interest rate spread decreased from 4.10% for the three months ended September 30, 2014 to 4.08% for the three months ended September 30, 2015. The ratio of average interest-earning assets to average interest-bearing liabilities increased from 129.6% for 2014 to 130.1% for 2015.

Provision for loan losses. The provision for loan losses decreased from $190,000 for the nine-month period ended September 30, 2014 to $50,000 for the same period in 2015. For the three months ended September 30, 2014 the provision for loan losses was $75,000. However, no provision for loan losses was recorded for the three months ended September 30, 2015. The reduction in the provision was based on management’s analysis of the allowance for loan losses and a general improvement in the Bank’s loan portfolio evidenced by a decrease in nonperforming loans from $3.2 million at December 31, 2014 to $1.7 million at September 30, 2015. The Bank recognized net charge-offs of $1.4 million for the nine months ended September 30, 2015 compared to $57,000 during the same period in 2014. The net charge-offs recognized in 2015 primarily related to a $1.2 million charge-off on a commercial loan that had been fully reserved for in prior periods.

- 41 -
 

PART I - ITEM 2
MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FIRST CAPITAL, INC.

Provisions for loan losses are charged to earnings to maintain the total allowance for loan losses at a level considered adequate by management to provide for probable known and inherent loan losses based on management’s evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specified impaired loans and economic conditions. Although management uses the best information available, future adjustments to the allowance may be necessary due to changes in economic, operating, regulatory and other conditions that may be beyond the Bank’s control. While the Bank maintains the allowance for loan losses at a level that it considers adequate to provide for estimated losses, there can be no assurance that further additions will not be made to the allowance for loan losses and that actual losses will not exceed the estimated amounts.

The methodology used in determining the allowance for loan losses includes segmenting the loan portfolio by identifying risk characteristics common to groups of loans, determining and measuring impairment of individual loans based on the present value of expected future cash flows or the fair value of collateral, and determining and measuring impairment for groups of loans with similar characteristics by applying loss factors that consider the qualitative factors which may affect the loss rates.

The allowance for loan losses was $3.5 million at September 30, 2015 and $4.8 million at December 31, 2014. Management has deemed these amounts as adequate at each date based on its best estimate of probable known and inherent loan losses at each date. As previously mentioned, at September 30, 2015, nonperforming loans amounted to $1.7 million compared to $3.2 million at December 31, 2014. Included in nonperforming loans at September 30, 2015 are loans 90 days or more past due and still accruing interest of $80,000. These loans are accruing interest because the estimated value of the collateral and collection efforts are deemed sufficient to ensure full recovery. At September 30, 2015 and December 31, 2014, nonaccrual loans amounted to $1.6 million and $3.1 million, respectively.

Noninterest income for the nine-month periods ended September 30, 2015 and 2014. Noninterest income for the nine months ended September 30, 2015 increased $100,000 compared to the nine months ended September 30, 2014. The increase was primarily due to increases in service charges on deposits and gains on the sale of loans of $166,000 and $118,000, respectively, when comparing the two periods. The increase in the gains on the sale of loans is primarily due to an increase in the Bank’s sales activity of commercial Small Business Administration loans during 2015.

Noninterest income for the three-month periods ended September 30, 2015 and 2014. Noninterest income for the quarter ended September 30, 2015 decreased $212,000 to $1.2 million compared to $1.4 million for the quarter ended September 30, 2014. The decrease was primarily due to decreases in commission income and other income. The decrease in other income was primarily due to a gain on life insurance of $129,000 recognized during the quarter ended September 30, 2014.

Noninterest expense for the nine-month periods ended September 30, 2015 and 2014. Noninterest expense for the nine months ended September 30, 2015 increased $852,000 compared to the same period in 2014 primarily due to increases in professional fees and compensation and benefits expense. Compensation and benefits expense increased $238,000 when comparing the two periods, primarily due to the addition of staff in the commercial and residential lending areas as well as normal increases in salaries and benefits. Professional fees increased $403,000 primarily due to fees totaling $353,000 associated with the previously announced agreement to acquire Peoples (see Note 2 to the Consolidated Financial Statements).

- 42 -
 

PART I - ITEM 2
MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FIRST CAPITAL, INC.

Noninterest expense for the three-month periods ended September 30, 2015 and 2014. Noninterest expense for the quarter ended September 30, 2015 increased $60,000 compared to the quarter ended September 30, 2014. Professional fees increased $120,000 when comparing the two periods primarily due to fees totaling $86,000 associated with the Peoples acquisition (see Note 2 to the Consolidated Financial Statements).

Income tax expense. Income tax expense for the nine-month period ended September 30, 2015 was $1.5 million, for an effective tax rate of 26.3%, compared to $1.9 million, for an effective tax rate of 30.0%, for the same period in 2014. For the three-month period ended September 30, 2015, income tax expense and the effective tax rate were $507,000 and 26.6%, respectively, compared to $611,000 and 28.6%, respectively, for the same period in 2014. The decrease in effective tax rates is primarily due to the tax effect of the Company’s formation of a captive insurance subsidiary in September 2014.

Liquidity and Capital Resources

The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company, on a stand-alone basis, is responsible for paying any dividends declared to its shareholders. The Board of Directors of the Company also has authorized the repurchase of shares of its common stock. The Company’s primary source of income is dividends received from the Bank. The amount of dividends that the Bank may declare and pay to the Company in any calendar year, without the receipt of prior approval from the Office of the Comptroller of the Currency (“OCC”) but with prior notice to the OCC, cannot exceed net income for that year to date plus retained net income (as defined in the applicable OCC regulations) for the preceding two calendar years. On a stand-alone basis, the Company had liquid assets of $135,000 at September 30, 2015.

The Bank’s primary sources of funds are customer deposits, proceeds from loan repayments, maturing securities and FHLB advances. While loan repayments and maturities are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by market interest rates, general economic conditions and competition. At September 30, 2015, the Bank had cash and cash equivalents of $24.4 million and securities available-for-sale with a fair value of $95.2 million. If the Bank requires funds beyond its ability to generate them internally, it has additional borrowing capacity with the FHLB of Indianapolis and additional collateral eligible for repurchase agreements.

The Bank’s primary investing activity is the origination of one-to-four family mortgage loans and, to a lesser extent, consumer, multi-family, commercial real estate and residential construction loans. The Bank also invests in U.S. Government and agency securities and mortgage-backed securities issued by U.S. Government agencies.

The Bank must maintain an adequate level of liquidity to ensure the availability of sufficient funds to support loan growth and deposit withdrawals, to satisfy financial commitments and to take advantage of investment opportunities. Historically, the Bank has been able to retain a significant amount of its deposits as they mature.

- 43 -
 

PART I - ITEM 2
MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FIRST CAPITAL, INC.

The Bank is required to maintain specific amounts of capital pursuant to regulatory requirements. As of September 30, 2015, the Bank was in compliance with all regulatory capital requirements that were effective as of such date with Tier 1 capital to average assets, common equity Tier 1 capital to risk-weighted assets, Tier 1 capital to risk-weighted assets and total capital to risk-weighted assets ratios of 11.2%, 15.1%, 15.1% and 16.2%, respectively. The regulatory requirements at that date to be considered “well-capitalized” under applicable regulations were 5.0%, 6.5%, 8.0% and 10.0%, respectively. At September 30, 2015, the Bank was considered “well-capitalized” under applicable regulatory guidelines.

Off-Balance Sheet Arrangements

In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with GAAP, are not recorded on the Company’s financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are primarily used to manage customers’ requests for funding and take the form of loan commitments and letters of credit. A further presentation of the Company’s off-balance sheet arrangements is presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

For the nine months ended September 30, 2015, the Company did not engage in any off-balance sheet transactions reasonably likely to have a material effect on the Company’s financial condition, results of operations or cash flows.

 

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PART I – ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
FIRST CAPITAL, INC.

Qualitative Aspects of Market Risk. Market risk is the risk that the estimated fair value of the Company’s assets and liabilities will decline as a result of changes in interest rates or financial market volatility, or that the Company’s net income will be significantly reduced by interest rate changes.

The Company’s principal financial objective is to achieve long-term profitability while reducing its exposure to fluctuating market interest rates. The Company has sought to reduce the exposure of its earnings to changes in market interest rates by attempting to manage the mismatch between asset and liability maturities and interest rates. In order to reduce the exposure to interest rate fluctuations, the Company has developed strategies to manage its liquidity, shorten its effective maturities of certain interest-earning assets and decrease the interest rate sensitivity of its asset base. Management has sought to decrease the average maturity of its assets by emphasizing the origination of short-term commercial and consumer loans, all of which are retained by the Company for its portfolio. The Company relies on retail deposits as its primary source of funds. Management believes retail deposits, compared to brokered deposits, reduce the effects of interest rate fluctuations because they generally represent a more stable source of funds.

Quantitative Aspects of Market Risk. The Company does not maintain a trading account for any class of financial instrument nor does the Company engage in hedging activities or purchase high-risk derivative instruments. Furthermore, the Company is not subject to foreign currency exchange rate risk or commodity price risk.

Potential cash flows, sales, or replacement value of many of our assets and liabilities, especially those that earn or pay interest, are sensitive to changes in the general level of interest rates. This interest rate risk arises primarily from our normal business activities of gathering deposits, extending loans and investing in investment securities. Many factors affect the Company’s exposure to changes in interest rates, such as general economic and financial conditions, customer preferences, historical pricing relationships, and re-pricing characteristics of financial instruments. The Company’s earnings can also be affected by the monetary and fiscal policies of the U.S. Government and its agencies, particularly the Federal Reserve Board.

An element in the Company’s ongoing process is to measure and monitor interest rate risk using a Net Interest Income at Risk simulation to model the interest rate sensitivity of the balance sheet and to quantify the impact of changing interest rates on the Company. The model quantifies the effects of various possible interest rate scenarios on projected net interest income over a one-year horizon. The model assumes a semi-static balance sheet and measures the impact on net interest income relative to a base case scenario of hypothetical changes in interest rates over twelve months and provides no effect given to any steps that management might take to counter the effect of the interest rate movements. The scenarios include prepayment assumptions, changes in the level of interest rates, the shape of the yield curve, and spreads between market interest rates in order to capture the impact from re-pricing, yield curve, option, and basis risks.

- 45 -
 

PART I – ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
FIRST CAPITAL, INC.

Results of the Company’s simulation modeling, which assumes an immediate and sustained parallel shift in market interest rates, project that the Company’s net interest income could change as follows over a one-year horizon, relative to our base case scenario, based on September 30, 2015 and December 31, 2014 financial information:

   At September 30, 2015  At December 31, 2014
Immediate Change  One Year Horizon  One Year Horizon
in the Level  Dollar  Percent  Dollar  Percent
of Interest Rates  Change  Change  Change  Change
   (Dollars in thousands)
300bp  $38    0.22%  $(193)   (1.08)%
200bp   353    2.01    192    1.08 
100bp   349    1.99    241    1.35 
Static   0    0    0    0 
(100)bp   (441)   (2.50)   (367)   (2.05)

 

At September 30, 2015 and December 31, 2014, the Company’s simulated exposure to a change in interest rates shows that an immediate and sustained increase in rates of 1.00% or 2.00% would increase the Company’s net interest income over a one year horizon compared to a flat interest rate scenario. Alternatively, an immediate and sustained decrease in rates of 1.00% would decrease the Company’s net interest income at both time periods over a one year horizon compared to a flat interest rate scenario. At September 30, 2015, an immediate and sustained increase in rates of 3.00% would increase the Company’s net interest income over a one year horizon compared to a flat interest rate scenario while at December 31, 2014, the same change would have resulted in a decrease.

The Company also has longer term interest rate risk exposure, which may not be appropriately measured by Net Interest Income at Risk modeling. Therefore, the Company also uses an Economic Value of Equity (“EVE”) interest rate sensitivity analysis in order to evaluate the impact of its interest rate risk on earnings and capital. This is measured by computing the changes in net EVE for its cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. EVE modeling involves discounting present values of all cash flows for on and off balance sheet items under different interest rate scenarios and provides no effect given to any steps that management might take to counter the effect of the interest rate movements. The discounted present value of all cash flows represents the Company’s EVE and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items. The amount of base case EVE and its sensitivity to shifts in interest rates provide a measure of the longer term re-pricing and option risk in the balance sheet.

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PART I – ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
FIRST CAPITAL, INC.

Results of the Company’s simulation modeling, which assumes an immediate and sustained parallel shift in market interest rates, project that the Company’s EVE could change as follows, relative to the Company’s base case scenario, based on September 30, 2015 and December 31, 2014 financial information:

   At September 30, 2015
Immediate Change  Economic Value of Equity  Economic Value of Equity as a
in the Level  Dollar  Dollar  Percent  Percent of Present Value of Assets
of Interest Rates  Amount  Change  Change  EVE Ratio  Change
                
300bp  $60,967   $(11,673)   (16.07)%   14.14%   (160)bp
200bp   68,737    (3,903)   (5.37)   15.59    (15)bp
100bp   74,025    1,385    1.91    16.41    67bp
Static   72,640    0    0    15.74    0bp
(100)bp   68,727    (3,913)   (5.39)   14.56    (118)bp

 

   At December 31, 2014
Immediate Change  Economic Value of Equity  Economic Value of Equity as a
in the Level  Dollar  Dollar  Percent  Percent of Present Value of Assets
of Interest Rates  Amount  Change  Change  EVE Ratio  Change
                
300bp  $59,328