UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

for the Quarterly Period Ended September 30, 2015

or

for the Transition Period from              to            

Commission File Number No. 333-183118

 

FIRST PRIORITY FINANCIAL CORP.

 

 

Registrant’s telephone number, including area code: (877) 533-4420

 

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 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and has been subject to such filing requirements for the past 90 days.    Yes  x    No   ¨

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

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

 

Indicate by check mark if 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.

 

 

 

 

 

---

 

TABLE OF CONTENTS

 

 

 

 

 

---

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements, and as such, statements containing the words “believes,” “expects,” “anticipates,” “estimates,” “plans,” “projects,” “predicts,” “intends,” “seeks,” “will,” “may,” “should,” “would,” “continues,” “hope” and similar expressions, or the negative of these terms, constitute forward-looking statements that involve risks and uncertainties. Such statements are based on current expectations and are subject to risks, uncertainties and changes in condition, significance, value, and effect. Such risks, uncertainties and changes in condition, significance, value and effect could cause First Priority Financial Corp.’s actual results to differ materially from those anticipated.

Although the Company believes its plans, intentions, and expectations as reflected in or suggested by these forward-looking statements are reasonable, it can give no assurance that its plans, intentions, or expectations will be achieved. Accordingly, you should not place undue reliance on them. Listed below, and discussed elsewhere, are some important risks, uncertainties, and contingencies that could cause actual results, performances, or achievements to be materially different from the forward-looking statements made in this document. These factors, risks, uncertainties, and contingencies include, but are not limited to, the following:

The effects of these factors are difficult to predict. New factors emerge from time to time, and we are not able to assess the impact of any such factor on the business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement. Any forward-looking statements speak only as of the date of this document.

Because these forward-looking statements are subject to assumptions and uncertainties, actual results may differ materially from those expressed or implied by these forward-looking statements. You are cautioned not to place undue reliance on these statements, which speak only as of the date of this quarterly report or the date of any document incorporated by reference in this quarterly report.

 

 

 

 

1

---

 

PART I

Item 1.  Financial Statements.

First Priority Financial Corp.

Consolidated Balance Sheets

(Unaudited, in thousands, except share and per share data)

See notes to unaudited consolidated financial statements.

 

 

2

---

 

First Priority Financial Corp.

Consolidated Statements of Operations

(Unaudited, in thousands, except per share data)

 

See notes to unaudited consolidated financial statements.

 

 

 

 

3

---

 

First Priority Financial Corp.

Consolidated Statements of Comprehensive Income

(Unaudited, in thousands)

 

 

See notes to unaudited consolidated financial statements.

 

 

 

 

4

---

 

First Priority Financial Corp.

Consolidated Statements of Shareholders’ Equity

For the Nine Months Ended September 30, 2015 and 2014

(Unaudited, dollars in thousands)

 

 

See notes to unaudited consolidated financial statements.

 

 

 

 

5

---

 

First Priority Financial Corp.

Consolidated Statements of Cash Flows

(Unaudited, dollars in thousands)

 

See notes to unaudited consolidated financial statements.

 

 

6

---

 

First Priority Financial Corp.

Notes to Unaudited Consolidated Financial Statements

 

Note 1—Summary of Significant Accounting Policies

Organization and Nature of Operations

First Priority Financial Corp.

First Priority Financial Corp. (“First Priority,” the “Company”) is a bank holding company incorporated under the laws of the Commonwealth of Pennsylvania on February 13, 2007. On May 11, 2007, as a result of a reorganization and merger, First Priority Bank (the “Bank”) became a wholly-owned subsidiary of First Priority.  First Priority, primarily through the Bank, serves residents and businesses in the Delaware Valley with branches in Berks, Bucks, Chester and Montgomery counties in Pennsylvania.  The Bank, which has 8 retail branch office locations, is a locally managed community bank providing commercial banking products, primarily loans and deposits, headquartered in Malvern, PA.

First Priority provides banking services through First Priority Bank and does not engage in any activities other than banking and related activities. As of September 30, 2015, First Priority had total assets of $508.6 million and total shareholders’ equity of $51.7 million.

First Priority Bank

First Priority Bank is a state-chartered commercial banking institution which was incorporated under the laws of the Commonwealth of Pennsylvania on May 25, 2005. First Priority Bank’s deposits are insured by the FDIC up to the maximum amount permitted for all banks. As of September 30, 2015, First Priority Bank had total assets of $508.3 million, total loans of $399.1 million, total deposits of $397.0 million and total shareholder’s equity of $51.0 million.

First Priority Bank engages in a full service commercial and consumer banking business with strong private banking and individual wealth management services. First Priority Bank offers a variety of consumer, private banking and commercial loans, mortgage products and commercial real estate financing. The Company’s operations are significantly affected by prevailing economic conditions, competition, and the monetary, fiscal, and regulatory policies of governmental agencies. Lending activities are influenced by a number of factors, including the general credit needs of individuals and small and medium-sized businesses in the Company’s market area, competition, the current regulatory environment, the level of interest rates, and the availability of funds. Deposit flows and costs of funds are influenced by prevailing market rates of interest, competition, account maturities, and the level of personal income and savings in the market area.

First Priority Bank also offers certain financial planning and investment management services. These investment services are provided by First Priority Financial Services, a Division of First Priority Bank, through an agreement with a third party provider. In addition, various life insurance products are offered through First Priority Bank, and the Bank has also entered into solicitation agreements with several investment advisors to provide portfolio management services to customers of the Bank.

First Priority Bank currently seeks deposits and commercial and private banking relationships through its eight banking offices. The Bank provides deposit products that include checking, money market and savings accounts, and certificates of deposit as well as other deposit services, including cash management and electronic banking products and online account opening capabilities. The Bank obtains funding in the local community by providing excellent service and competitive rates to its customers and utilizes electronic and print media advertising to attract current and potential deposit customers. The Bank also uses brokered certificates of deposit as a cost effective funding alternative.

Basis of Presentation

The accompanying unaudited consolidated financial statements consist of the Company and the Company’s wholly owned consolidated subsidiary, the Bank.  All significant intercompany accounts and transactions have been eliminated in consolidation.

These statements are prepared in accordance with instructions to Form 10-Q, and therefore, do not include information or all footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States (“GAAP”). However, all normal recurring adjustments that, in the opinion of management, are necessary for a fair presentation of these financial statements have been included. These financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto for First Priority Financial Corp. for the year ended December 31, 2014, included in the Company’s Form 10-K filed with the Securities and Exchange Commission on

 

7

---

 

March 27, 2015. The results of interim periods presented are not necessarily indicative of the results that may be expected for the year ending December 31, 2015.  

Subsequent Events

Management has evaluated events and transactions occurring subsequent to September 30, 2015 for items that should potentially be recognized or disclosed in these Consolidated Financial Statements. The evaluation was conducted through the date these financial statements were issued.

  

On November 13, 2015, First Priority Bank entered into Subordinated Note Purchase Agreements with five accredited investors under which the Bank issued subordinated notes (the “Notes”) totaling $9.5 million, resulting in net proceeds of approximately $9.2 million after issuance costs. The Notes have a maturity date of November 30, 2025, and will bear interest at a fixed rate of 7.00% per annum.  The Notes are non-callable for an initial period of five years and include provisions for redemption pricing between 101.5% and 100.5% of the liquidation value, if called after five years but prior to the maturity date.  Pending approval from the Federal Reserve, First Priority Bank intends to distribute $6.0 million of the proceeds from the subordinated note issuance to First Priority, and correspondingly, First Priority intends to utilize the distribution from the Bank to redeem 6,000 of the 9,404 outstanding shares of its 9.00% Fixed Rate Cumulative Perpetual Preferred Stock, which was originally issued to the United States Department of the Treasury during 2009 as part of the TARP Capital Purchase Program, at their liquidation value of $1,000 per share, or $6.0 million, plus accrued dividends.  First Priority Bank will utilize the remainder of the issuance for general corporate purposes.  The distribution from First Priority Bank to First Priority has received required approvals from the FDIC and the Pennsylvania Department of Banking and Securities.

Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, stock-based compensation, impairment of goodwill, impairment of investments, the valuation of deferred tax assets and the valuation of other real estate owned.

Acquired Loans

Acquired loans are initially recorded at their acquisition date fair values. The carryover of allowance for loan losses is prohibited as any credit losses in the loans are included in the determination of the fair value of the loans at the acquisition date. Fair values for acquired loans are based on a discounted cash flow methodology that involves assumptions and judgments as to credit risk, prepayment risk, liquidity risk, default rates, loss severity, payment speeds, collateral values and discount rate.

Acquired loans that have evidence of deterioration in credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payments are accounted for as impaired loans under ASC 310-30. The excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized into interest income over the remaining life of the loans. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the non-accretable discount. The non-accretable discount represents estimated future credit losses expected to be incurred over the life of the loan. Subsequent decreases to the expected cash flows require the Company to evaluate the need for an allowance for loan losses on these loans. Subsequent improvements in expected cash flows result in the reversal of a corresponding amount of the non-accretable discount which the Company then reclassifies as an accretable discount that is recognized into interest income over the remaining life of the loans using the interest method.

Acquired loans that met the criteria for non-accrual of interest prior to acquisition may be considered performing upon acquisition, or in the future, regardless of whether the customer is contractually delinquent, if the Company can reasonably estimate the timing and amount of the expected cash flows on such loans and if the Company expects to fully collect the new carrying value of the loans. As such, the Company may no longer consider the loan to be non-accrual or non-performing and may accrue interest on these loans, including the impact of any accretable discount. For acquired loans that are not deemed impaired at acquisition, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value and amortized over the life of the asset. Subsequent to the acquisition date, the methods utilized to estimate the required allowance for loan losses for these loans is similar to originated loans, however, the Company records a provision for loan losses only when the required allowance exceeds any remaining pooled discounts for loans evaluated collectively for impairment.

 

8

---

 

Allowance for Loan Losses

The allowance for credit losses consists of the allowance for loan losses and the reserve for unfunded lending commitments. The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The reserve for unfunded lending commitments, totaling $35 thousand as of both September 30, 2015 and December 31, 2014, represents management’s estimate of losses inherent in its unfunded loan commitments and is recorded in other liabilities on the consolidated balance sheet. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. Because all identified losses are immediately charged off, no portion of the allowance for loan losses is restricted to any individual loan or groups of loans, and the entire allowance is available to absorb any and all loan losses.

The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available.

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as impaired. For loans that are 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 pools of loans by loan class including commercial loans not considered impaired, as well as smaller balance homogeneous loans, such as residential real estate, home equity and other consumer loans. These pools of loans are evaluated for loss exposure based upon historical loss rates for each of these categories of loans, adjusted for qualitative factors. These qualitative risk factors include:

Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a narrative accompanying the allowance for loan loss calculation.

A majority of the Company’s loans are to business owners of many types. The Company makes commercial loans for real estate development and other business purposes required by our customers.

The Company’s credit policies determine advance rates against the different forms of collateral that can be pledged against commercial loans. Typically, the majority of loans will be limited to a percentage of their underlying collateral values such as real estate values, equipment, eligible accounts receivable and inventory. Individual loan advance rates may be higher or lower depending upon the financial strength of the borrower and/or term of the loan. The assets financed through commercial loans are used within the business for its ongoing operation. Repayment of these kinds of loans generally comes from the cash flow of the business or the ongoing conversions of assets. Commercial real estate loans include long-term loans financing commercial properties. Repayment of this kind of loan is dependent upon either the ongoing cash flow of the borrowing entity or the resale of or lease of the subject property. Commercial real estate loans typically require a loan to value ratio of not greater than 80% and vary in terms.

 

9

---

 

Residential mortgages and home equity loans are secured by the borrower’s residential real estate in either a first or second lien position. Residential mortgages and home equity loans have varying loan rates depending on the financial condition of the borrower and the loan to value ratio. Residential mortgages have amortizations up to 30 years and home equity loans have maturities of no more than 15 years.  Residential mortgages and home equity loans typically require a loan to value ratio of not greater than 80%.

Other consumer loans include installment loans, car loans, and overdraft lines of credit. The majority of these loans are secured.

An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

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 for commercial and industrial loans, commercial real estate loans and commercial construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent.

An allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. The estimated fair values of substantially all of the Company’s impaired loans are measured based on the estimated fair value of the loan’s collateral.

For commercial loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. Appraised values may be discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.

For commercial and industrial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual residential mortgage loans, home equity loans and other consumer loans for impairment disclosures, unless such loans are the subject of a troubled debt restructuring agreement.

Acquired loans are recorded at acquisition date at their acquisition date fair values, and therefore, are excluded from the calculation of loan loss reserves as of the acquisition date. To the extent there is a decrease in the present value of cash flows expected from the acquired impaired loans after the date of acquisition, the Company records a provision for loan losses. During the three and nine months ended September 30, 2015, the Company recorded a provision for loan losses totaling $119 thousand and $184 thousand, respectively, for acquired impaired loans. During the three and nine months ended September 30, 2014, the Company recorded a provision for loan losses totaling $168 thousand $378 thousand, respectively, for acquired impaired loans.

For acquired loans that are not deemed impaired at acquisition, credit discounts representing principal losses expected over the life of the loan are a component of the initial fair value. Subsequent to the acquisition date, the methods used to estimate the required allowance for loan losses for these loans is similar to originated loans, however, the Company records a provision for loan losses only when the required allowance exceeds any remaining unamortized general credit fair value adjustment for loans evaluated collectively for impairment.

The allowance calculation methodology includes further segregation of loan classes into risk rating categories. The borrower’s overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated annually for commercial loans or when credit deficiencies arise, such as delinquent loan payments, for commercial and consumer loans. Credit quality risk ratings

 

10

---

 

include regulatory classifications of special mention, substandard, doubtful and loss. Loans criticized special mention have potential weaknesses that deserve management’s close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the allowance for loan losses. Loans not classified are rated pass.

In addition, Federal regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses and may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. Based on management’s comprehensive analysis of the loan portfolio, management believes the current level of the allowance for loan losses is adequate.

Comprehensive Income

Accounting principles generally accepted in the United States of America require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities are reported as a separate component of the shareholders’ equity section of the balance sheet, such items, along with net income, are components of total comprehensive income.

Total reclassifications from accumulated other comprehensive income (loss) for the periods presented are as follows:

 

 

Accumulated other comprehensive income (loss) as of September 30, 2015 and December 31, 2014 consisted of the following:

 

 

Note 2—Recently Issued Accounting Standards

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The amendments in this Update establish a comprehensive revenue recognition standard for virtually all industries under U.S. GAAP, including those that previously followed industry specific guidance such as the real estate, construction and software industries. The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this objective, the standard requires five basic steps: i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The amendments are effective for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted. Management does not believe the adoption of ASU 2014-09 will have a significant impact on the Company’s Consolidated Financial Statements.

 

11

---

 

In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810) guidance which amends existing standards regarding the evaluation of certain legal entities and their consolidation in the financial statements. The amendments modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities or voting interest entities and eliminate the presumption that a general partner should consolidate a limited partnership. The amendments also affect the consolidation analysis of reporting entities that are involved with variable interest entities and provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. The guidance becomes effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. We are evaluating the impact of this guidance on our financial statements.

 

Note 3—Earnings Per Common Share

Diluted earnings per common share take into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock. Proceeds assumed to have been received on such exercise or conversion, are assumed to be used to purchase shares of the Company’s common stock at the average market price during the period, as required by the “treasury stock method” of accounting for common stock equivalents. For purposes of calculating the basic and diluted earnings per share, the Company’s reported net income is adjusted for dividends on preferred stock and net accretion/amortization related to the issuance of preferred stock to determine the net income to common shareholders.  Securities that could potentially dilute basic earnings per common share in future periods that were not included in the computation of diluted earnings per common share because to do so would have been anti-dilutive amounted to 257,667 shares as of September 30, 2015 and 481,859 shares as of September 30, 2014.

 

The calculations of basic and diluted earnings per common share are presented below for the three and nine months ended September 30, 2015 and 2014:

 

 

 

12

---

 

The amount of preferred stock dividends and the net accretion or amortization related to each series of preferred stock are presented below for the three and nine months ended September 30, 2015 and 2014:

 

 

Note 4—Securities

Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date. Securities classified as available for sale are those securities that the Company intends to hold for an indefinite period of time, but not necessarily to maturity. Available for sale securities are carried at fair value.

Securities classified as held to maturity are those debt securities the Company has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are carried at cost adjusted for the amortization of premium and accretion of discount, computed by a method which approximates the interest method over the terms of the securities.

The Company previously transferred investment securities from available for sale to held to maturity securities.  Due to these transfers, securities classified as held to maturity have net unrealized holding gains, totaling $52 thousand as of September 30, 2015 and $77 thousand as of December 31, 2014, which are being amortized over the remaining life of the related securities as an adjustment of yield in a manner consistent with the accretion of discount on the same transferred debt securities. This will have no impact on the Company’s net income because the amortization of the unrealized holding loss reported in equity will offset the effect on the interest income of the accretion of the discount on these securities.

 

13

---

 

The amortized cost, unrealized gains and losses, and the fair value of the Company’s investment securities available for sale and held to maturity are as follows for the periods presented:

 

 

 

14

---

 

 

Included in unrealized losses are market losses on securities that have been in a continuous unrealized loss position for twelve months or more and those securities that have been in a continuous unrealized loss position for less than twelve months. The table below details the aggregate unrealized losses and aggregate fair value of the underlying securities whose fair values are below their amortized cost at September 30, 2015 and December 31, 2014.

 

 

 

As of September 30, 2015, management believes that the estimated fair value of the securities disclosed above is primarily dependent upon the movement in market interest rates, particularly given the minimal inherent credit risk associated with the issuers of these securities and that the unrealized losses in these portfolios are not the result of deteriorating credit within any investment category.

Securities issued by states and political subdivisions are all rated investment grade. Each holding is reviewed quarterly for impairment by management and our third party investment advisor. All mortgage backed securities and collateralized mortgage obligations are issued by U.S. government sponsored agencies; there are no holdings of private label mortgage backed securities or securities backed by loans classified as “Alt-A” or “Subprime”.

Although the fair value will fluctuate as market interest rates move, management believes that these fair values will recover as the underlying portfolios mature. The Company evaluates a variety of factors in concluding whether securities are other-than-temporarily impaired. These factors include, but are not limited to, the type and purpose of the bond, the underlying rating of the bond issuer, and the presence of credit enhancements (i.e. state guarantees, municipal bond insurance, collateral requirements, etc.). The Company does not intend to sell any of these securities and it is unlikely that it will be required to sell any of these securities before recovery.

 

15

---

 

Management does not believe any individual unrealized loss on individual securities, as of September 30, 2015, represents other than temporary impairment.

For the three and nine months ended September 30, 2015 there were realized gains of $125 thousand.  There were no realized gains or losses for the three or nine months ended September 30, 2014.

Securities with an estimated fair value of $29.3 million and $32.6 million were pledged at September 30, 2015 and December 31, 2014, respectively, to secure public fund deposits. In addition, securities pledged to secure borrowings by the Bank totaled $60 thousand and $89 thousand as of September 30, 2015 and December 31, 2014, respectively.

The amortized cost and fair value of securities as of September 30, 2015 by contractual maturity are shown below. Certain of these investment securities have call features which allow the issuer to call the security prior to its maturity date at the issuer’s discretion.

 

 

 

Note 5—Loans Receivable and Related Allowance for Loan Losses

Loans receivable consist of the following at September 30, 2015 and December 31, 2014.

 

 

 

16

---

 

During the third quarter of 2015 the Company purchased $9.8 million of performing residential real estate loans located in western Pennsylvania which were underwritten using similar underwriting standards as the Bank uses for its organic portfolio.

 

First Priority acquired various loans through the acquisition of Affinity Bancorp, Inc. on February 28, 2013 for which there was, at acquisition, evidence of deterioration of credit quality since origination, and for which it was probable that all contractually required payments would not be collected.  The carrying amounts of the acquired impaired loans included in the loan balances above are summarized as follows:

 

 

The following table presents the changes in accretable yield related to acquired credit-impaired loans for the nine months ended September 30, 2014 (dollars in thousands).  There was no remaining accretable yield for the nine months ended September 30, 2015:

 

The Company’s loans consist of credits to borrowers spread over a broad range of industrial classifications. The largest concentrations of loans are to lessors of nonresidential buildings and lessors of residential buildings and dwellings. As of September 30, 2015, these loans totaled $72.2 million and $55.4 million, respectively, or 18.1% and 13.9%, respectively, of the total loans outstanding. As of December 31, 2014, these same classifications of loans totaled $69.5 million and $54.7 million, respectively, or 18.5% and 14.6%, respectively, of the total loans outstanding at that time. These credits were subject to normal underwriting standards and did not present more than the normal amount of risk assumed by the Company’s other lending activities. The Company has no other concentration of loans which exceeds 10% of total loans.

The following tables summarize the activity in the allowance for loan losses by loan class for the three and nine months ended September 30, 2015 and 2014:

 

17

---

 

 

 

The following tables present the balance in the allowance for loan losses at September 30, 2015 and December 31, 2014 disaggregated on the basis of the Company’s impairment method by class of loans receivable along with the balance of loans receivable by class disaggregated on the basis of the Company’s impairment methodology:

 

 

 

 

18

---

 

The following tables summarize information in regard to impaired loans by loan portfolio class as of September 30, 2015 and December 31, 2014 as well as for the three and nine month periods ended September 30, 2015 and 2014, respectively:

 

 

 

19

---

 

 

The following table presents nonaccrual loans by classes of the loan portfolio as of September 30, 2015 and December 31, 2014:

 

 

The Company’s policy for interest income recognition on nonaccrual loans is to recognize income under the cash basis when the loans are both current and the collateral on the loan is sufficient to cover the outstanding obligation to the Company. The Company will not recognize income if these factors do not exist. Interest that would have been accrued on non-accruing loans under the original terms but was not recognized as interest income totaled $54 thousand and $179 thousand for the three and nine months ended September 30, 2015 and $91 thousand and $234 thousand for the three and nine months ended September 30, 2014, respectively.

 

20

---

 

The following tables present the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Company’s internal risk rating system as of September 30, 2015 and December 31, 2014:

 

 

 

The performance and credit quality of the loan portfolio is also monitored by analyzing the age of the loans receivable as determined by the length of time a recorded payment is past due. The following tables present the classes of the loan portfolio summarized by the past due status as of September 30, 2015 and December 31, 2014:

 

 

 

 

21

---

 

 

 

As of September 30, 2015, there were no loans 90 days past due and still accruing interest.  As of December 31, 2014, there was one residential mortgage loan totaling $70 thousand which was greater than 90 days past due and still accruing interest which has subsequently been paid current.

The Company may grant a concession or modification for economic or legal reasons related to a borrower’s declining financial condition that it would not otherwise consider resulting in a modified loan which is then identified as a troubled debt restructuring (“TDR”). The Company may modify loans through rate reductions, extensions of maturity, interest only payments, or payment modifications to better match the timing of cash flows due under the modified terms with the cash flows from the borrowers’ operations. Loan modifications are intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. TDRs are considered impaired loans for purposes of calculating the Company’s allowance for loan losses.

The Company identifies loans for potential restructure primarily through direct communication with the borrower and evaluation of the borrower’s financial statements, revenue projections, tax returns, and credit reports. Even if the borrower is not presently in default, management will consider the likelihood that cash flow shortages, adverse economic conditions, and negative trends may result in a payment default in the near future.

The following tables reflect information regarding TDR’s entered into by the Company for the three and nine month periods ended September 30, 2015 and 2014.

 

 

 

22

---

 

 

 

The following table reflects information regarding TDR’s entered into by the Bank for the year ended December 31, 2014:

 

 

As of September 30, 2015, a commercial loan, classified as a TDR, with an outstanding balance of $200 thousand became in default.

 

During the second quarter of 2015, a consumer installment loan, classified as non-accrual and TDR, became in default with an outstanding balance of $22 thousand as of September 30, 2015.  As of September 30, 2015 and 2014 and also December 31, 2014, a residential mortgage loan and TDR with a current balance of $76 thousand, acquired through the Affinity merger, has remained in default and is classified as non-accrual. Additionally two commercial loans, classified as TDR’s, with combined outstanding balances totaling $64 thousand as of March 31, 2015 were in default and remain classified as non-accrual status.

 

No other TDRs were subsequently in default as of the periods stated.

The carrying amount of foreclosed residential real estate properties held was $563 thousand as of September 30, 2015.  Consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure totaled $202 thousand as of September 30, 2015.

 

Note 6—Deposits

The components of deposits at September 30, 2015 and December 31, 2014 are as follows:

 

Included in time, other at September 30, 2015 and December 31, 2014 are brokered deposits of $110.5 million and $74.6 million, respectively.

 

23

---

 

At September 30, 2015, the scheduled maturities of time deposits were as follows:

 

 

 

Note 7—Shareholders’ Equity

On February 20, 2009, as part of the Treasury’s TARP Capital Purchase Program, the Company issued 4,579 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, $100 par value per share, having a liquidation preference of $1,000 per share (the “Series A Preferred Stock”), and a warrant (the “Warrant) to purchase, on a net basis, 229 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B, par value $100 per share (the “Series B Preferred Stock”), which was immediately exercised, for an aggregate purchase price of $4.58 million in cash, less $29 thousand in legal issuance costs. On December 18, 2009, the Company issued 4,596 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series C, $100 par value per share, having a liquidation preference of $1,000 per share (the “Series C Preferred Stock”), for an aggregate purchase price of $4.60 million in cash, less $8 thousand in legal issuance costs.

On February 8, 2013, the Treasury sold its entire holdings of the Company’s preferred stock to certain qualified or accredited institutional investors.

The Series A, Series B and Series C Preferred Stock pay cumulative dividends at a rate of 9% per annum. The Series A, B and C Preferred Stock have no maturity date and rank senior to common stock with respect to dividends and upon liquidation, dissolution, or winding up. The Company may redeem the Series A or Series C Preferred Stock, in whole or in part, at its liquidation preference plus accrued and unpaid dividends. The Company may redeem the Series B Preferred Stock only after all of Series A has been redeemed.

Note 8—Stock Compensation Program

In 2005, the Company adopted the 2005 Stock Compensation Program, which was amended at the Company’s annual meeting on April 23, 2009 as the 2009 Stock Compensation Program (the “Program”) and further amended effective March 18, 2010. The Program allows equity benefits to be awarded in the form of Incentive Stock Options, Compensatory Stock Options or Restricted Stock. The Program authorizes the Board of Directors to grant options up to an aggregate maximum of 1,207,957 shares to officers, other employees and directors of the Company, including 382,957 shares which were authorized for grant under this plan as a result of the merger with Affinity. Only employees of the Company will be eligible to receive Incentive Stock Options and such grants are subject to the limitations under Section 422 of the Internal Revenue Code.

All stock options granted under the Program fully vest in four years from the date of grant (or potentially earlier upon a change of control), excluding options issued in regards to the Company’s Severance Plan which vest only upon change in control, and options terminate ten years from the date of the grant. The exercise price of the options granted is the fair value of a share of common stock at the time of the grant, with a minimum exercise price of $10 per share for shares issued prior to March 18, 2010. Effective March 18, 2010, the Company’s stock compensation program was amended to eliminate the minimum exercise price.

 

24

---

 

A summary of the status of the Program is presented below for the nine months ended September 30, 2015:

 

The weighted average remaining contractual lives of all outstanding stock options and exercisable options at September 30, 2015 and December 31, 2014 were 6.57 years and 3.34 years, respectively and 6.15 years and 2.41 years, respectively. The aggregate intrinsic value of options outstanding was $487 thousand as of September 30, 2015 while the aggregate intrinsic value of exercisable options was $94 thousand as of this same date.

The fair value of each option granted in the nine months ended September 30, 2015 is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumption:

The dividend yield assumption is based on the Company’s history and expectation of dividend payouts.  Due to the Company’s lack of sufficient historical exercise data and the limited period of time for which shares have been issued, the “simplified” method is used to determine the expected life of options, calculated as the average of the sum of the vesting term and original contractual term for all periods presented. The expected volatility percentage is based on the average expected volatility of similar public financial institutions in the Company’s market area.  The risk-free interest rates for periods within the contractual life of the awards are based on the U.S. Treasury yield curve in effect at the time of grant.

As of September 30, 2015, there was $318 thousand of unrecognized compensation cost related to non-vested stock options granted after January 1, 2007, excluding those stock options issued in conjunction with the Company’s severance plan. That cost is expected to be recognized over a weighted average period of 3.58 years. There was no tax benefit recognized related to this stock-based compensation. There are 355,000 stock options issued in connection with the termination of the previously executed change in control agreements and the adoption of the severance plan, with $576 thousand of unrecognized compensation cost which will only be recognized if a change in control occurs, based on the options which remain outstanding and are probable to vest at that time.  During the third quarter of 2015, included in the current period options granted, there were 99,000 performance options issued to various employees.  Certain performance criteria must be achieved over the three year vesting period in order for the option granted to vest.  Performance is analyzed on a quarterly basis to determine if the specific required performance is more likely than not to be achieved.  Based on this evaluation, the outstanding non-vested options may be adjusted.

Employee Restricted Stock grants fully vest after a minimum of three years from the date of grant (or potentially earlier upon a change of control or retirement after the age of 66), subject to the recipient remaining an employee of the Company. Director Restricted Stock grants vest in one year to coincide with the required service period.  Upon issuance of the shares, resale of the shares is restricted during the vesting period, during which the shares may not be sold, pledged, or otherwise disposed of. Prior to the vesting date and in the event the recipient terminates association with Company for any reasons other than death, disability or change of control, the recipient forfeits all rights to the shares that would otherwise be issued under the grant. Compensation expense related to restricted stock awards granted under the Plan was recorded at the date of the award based on the estimated fair value of the shares. As of September 30, 2015, there was $443 thousand of unrecognized compensation cost related to restricted stock, which will be amortized through June 30, 2019.

 

25

---

 

A summary of restricted stock award activity is presented below for the nine months ended September 30, 2015:

 

 

Note 9—Financial Instruments with Off-Balance Sheet Risk

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

At September 30, 2015 and December 31, 2014, outstanding commitments to extend credit consisting of total unfunded commitments under lines of credit were $94.3 million and $83.2 million, respectively. In addition, as of each of these dates, there were $847 thousand and $349 thousand of performance standby letters of credit outstanding, respectively, and for both periods $1.1 million of financial standby letters of credit.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Bank evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation. Collateral held varies but may include residential or commercial real estate, accounts receivable, inventory and equipment.

In addition, as of December 31, 2014 the Bank pledged $214 thousand of deposit balances at a correspondent bank to support a letter of credit with a balance of $149 thousand issued by the correspondent on behalf of a customer of the Bank. This transaction was fully secured by the customer through a pledge of the customer’s deposits at the Bank.

 

Note 10—Regulatory Matters

The Dodd-Frank Act required the FRB to establish minimum consolidated capital requirements for bank holding companies that are as stringent as those required for insured depositary subsidiaries. The federal banking agencies approved rules that implemented the Dodd-Frank requirements and certain other regulatory capital reforms which were designed to enhance such requirements and implement the revised standards of the Basel Committee on Banking Supervision, commonly referred to as Basel III. These rules (i) introduced a new capital ratio pursuant to the prompt corrective action provisions, the common equity tier 1 capital to risk rated assets ratio, (ii) increased the adequately capitalized and well capitalized thresholds for the Tier 1 risk based capital ratios to 6% and 8% respectively, (iii) changed the treatment of certain capital components for determining Tier 1 and Tier 2 capital, and (iv) changed the risk weighting of certain assets and off balance sheet items in determining risk weighted assets. The new risk based capital rules became effective January 1, 2015.

Under the revised capital guidelines, First Priority Bank’s minimum capital to risk-adjusted assets requirements consist of a common equity tier 1 capital ratio of 4.5% (6.5% to be considered “well capitalized”) and a tier 1 capital ratio of 6.0%, increased from 4.0% (and increased from 6.0% to 8.0% to be considered “well capitalized”); the total capital ratio remains at 8.0% under the new rules (10.0% to be considered “well capitalized”).  In addition, First Priority Bank must maintain a minimum Tier 1 leverage ratio of at least 4.0% (5.0% to be considered “well capitalized”).  The new minimum capital requirements became effective on January 1, 2015.

 

26

---

 

Under the new rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity tier 1 capital above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets. The capital contribution buffer requirements phase in over a three-year period beginning January 1, 2016.

The Bank’s capital amounts (dollars in thousands) and ratios at September 30, 2015 and December 31, 2014 are presented below:

 

First Priority’s ability to pay cash dividends is dependent on receiving cash in the form of dividends from First Priority Bank. However, certain restrictions exist regarding the ability of First Priority Bank to transfer funds to First Priority in the form of cash dividends. All dividends are currently subject to prior approval of the Pennsylvania Department of Banking and Securities and the FDIC and are payable only from the undivided profits of First Priority Bank, with the exception of an exemption enacted by the Pennsylvania Department of Banking and Securities which allows the Bank to pay dividends related to the preferred stock originally issued under the U.S. Department of the Treasury’s Troubled Asset Relief Program—Capital Purchase Program. Additionally, First Priority has met the requirement of obtaining prior approval from the Federal Reserve Bank on any payment of dividends, including dividends on the aforementioned preferred stock, when net income for the past four quarters is not sufficient to fund the dividend payments over that same period, or when such payment would negatively impact capital adequacy of the Company.

Note 11—Fair Value Measurements and Fair Values of Financial Instruments

Management uses its best judgment in estimating the fair value of the Bank’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of September 30, 2015 and December 31, 2014 and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period-end.

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with FASB ASC Topic 820—Fair Value Measurements, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in some instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

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

 

27

---

 

FASB ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods 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 as follows:

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

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

Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported with little or no market activity). Management utilizes inputs that it believes a market participant would use.

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2015 and December 31, 2014 are as follows:

 

 

 

28

---

 

For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2015 and December 31, 2014 are as follows:

 

 

Management generally uses a discounted appraisal technique in valuing impaired assets, resulting in the discounting of the collateral values underlying each impaired asset. A discounted tax assessment rate has been applied for smaller assets to determine the discounted collateral value. All impaired loans are classified as Level 3 in the fair value hierarchy. Collateral may be real estate and/or business assets. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment.

Quantitative information about Level 3 fair value measurements at September 30, 2015 is included in the table below:

 

 

29

---

 

Quantitative information about Level 3 fair value measurements at December 31, 2014 is included in the table below:

 

 

  

Valuation of real estate collateral may be discounted based on the age of the existing appraisal. No discounts are taken for recent appraisals. Valuations related to business assets used as collateral are typically discounted more heavily due to the inherent level of uncertainty in determining the fair value of these types of assets. Liquidation costs relating to these assets are charged to expense.

Repossessed assets measured at fair value on a nonrecurring basis consist of personal property, specifically manufactured housing, that has been acquired for debts previously contracted and are included in other assets on the balance sheet. Costs relating to these assets are charged to expense. As of September 30, 2015 there were no repossessed assets. The Company had $42 thousand of repossessed assets as of December 31, 2014.

Other real estate owned measured at fair value on a nonrecurring basis consists of properties acquired as a result of accepting a deed in lieu of foreclosure, foreclosure or through other means related to collateral on Bank loans. Costs relating to the development or improvement of assets are capitalized and costs relating to holding the property are charged to expense. At September 30, 2015 and December 31, 2014, respectively, the fair value consists of other real estate owned balances of $1.4 million and $433 thousand, net of valuation allowances of $412 thousand and $328 thousand. Fair value is generally determined based upon independent third-party appraisals of the property.

Real estate properties acquired through, or in lieu of, foreclosure are to be sold and are carried at fair value less estimated cost to sell. Fair value is based upon independent market prices or appraised value of the property. These assets are included in Level 3 fair value based upon the lowest level of input that is significant to the fair value measurement.

The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful.

The following methods and assumptions were used to estimate the fair values of the Company’s financial instruments at September 30, 2015 and December 31, 2014:

 

30

---

 

Cash and Cash Equivalents

The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets’ fair values.

Securities

The fair value of securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices.

Loans Receivable

The fair values of loans are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal.

Impaired Loans

Impaired loans, which are included in loans receivable, are those that are accounted for under FASB ASC Topic 310, “Receivables”, in which the Company has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements. The fair value of the impaired loans consists of the loan balances, net of any valuation allowance. As of September 30, 2015 the fair value of impaired loans consisted of loan balances with an allowance recorded of $2.7 million, net of valuation allowances of $212 thousand and partial charge-offs of $2 thousand; and loan balances with no related allowance recorded of $2.8 million, net of partial charge-offs of $926 thousand. As of December 31, 2014 the fair value of impaired loans consisted of loan balances with an allowance recorded of $542 thousand, net of valuation allowances of $166 thousand and partial charge-offs of $28 thousand; and loan balances with no related allowance recorded of $2.9 million, net of partial charge-offs of $1.1 million.

Restricted Investment in Bank Stock

The carrying amount of restricted investment in bank stock approximates fair value, and considers the limited marketability of such securities.

Accrued Interest Receivable and Payable

The carrying amount of accrued interest receivable and accrued interest payable approximates fair value.

Deposit Liabilities

The fair values disclosed for demand deposits (interest and noninterest checking), money market and savings accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market to the maturities of the time deposits.

Short-Term Borrowings

The carrying amounts of short-term borrowings approximate their fair values.

Long-Term Debt

Fair values of FHLB advances are estimated using discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. These prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.

Off-Balance Sheet Financial Instruments

Fair values for the Company’s off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of the agreements and the counterparties’ credit standing.

 

 

31

---

 

At September 30, 2015 and December 31, 2014, the estimated fair values of the Company’s financial instruments were as follows:

 

 

 

 

 

 

32

---

 

The following discussion summarizes First Priority’s results of operations and highlights material changes for the three and nine months ended September 30, 2015 and 2014, and its financial condition as of September 30, 2015 and December 31, 2014. This discussion is intended to provide additional information about the significant changes in the results of operations presented in the accompanying consolidated financial statements for First Priority and its wholly owned subsidiary, First Priority Bank. First Priority’s consolidated financial condition and results of operations consist essentially of First Priority Bank’s financial condition and results of operations. Current performance does not guarantee, and may not be indicative of, similar performance in the future.  

You should read this discussion and analysis in conjunction with the unaudited consolidated financial statements for the period ended September 30, 2015 included herein as well as with the audited consolidated financial statements and the accompanying footnotes for the year ended December 31, 2014, included in the Company’s Form 10-K filed with the Securities and Exchange Commission.

This discussion and analysis of financial condition and results of operations contains forward-looking statements that involve risks and uncertainties, such as First Priority’s plans, objectives, expectations and intentions. Therefore, this analysis should be read in conjunction with the “Cautionary Statement Regarding Forward-Looking Statements” presented elsewhere in this document and the “Risk Factors” described in the Company’s Form 10-K for the period ended December 31, 2014.

Overview

The following table sets forth selected measures of First Priority’s financial position or performance for the dates or periods indicated.

 

(1)Total revenue equals net interest income plus non-interest income

Like most financial institutions, First Priority derives the majority of its income from interest it receives on its interest-earning assets, such as loans and investments. First Priority’s primary source of funds for making these loans and investments is its deposits, on which it pays interest. Consequently, one of the key measures of First Priority’s success is its amount of net interest income, or the difference between the income on its average interest-earning assets and the expense on its average interest-bearing liabilities, such as deposits and borrowings. Another key measure is the spread between the yield First Priority earns on these average interest-earning assets and the rate it pays on its average interest-bearing liabilities, which is called its net interest spread.

There are risks inherent in all loans, and First Priority maintains an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. This allowance is maintained by charging a provision for loan losses against operating earnings. A detailed discussion of this process, as well as several tables describing the allowance for loan losses is included herein.

In addition to earning interest on its loans and investments, First Priority earns income through other sources, such as fees and other charges to its banking customers and income from providing wealth management services, as well as net gains or losses realized from the sale of assets. The various components of non-interest income, as well as non-interest expense, are described in this section.

Critical Accounting Policies, Judgments and Estimates

First Priority has adopted various accounting policies that govern the application of accounting principles generally accepted in the United States of America and that are consistent with general practices within the banking industry in the preparation of its consolidated financial statements. First Priority’s significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements included in the Company’s Form 10-K as of December 31, 2014, filed with the Securities and Exchange Commission.

Certain accounting policies involve significant judgments and assumptions by First Priority that have a material impact on the carrying value of certain assets and liabilities. First Priority considers these accounting policies to be critical accounting estimates. The

 

33

---

 

judgment and assumptions used are based on historical experience and other factors, which First Priority believes to be reasonable under the circumstances and have been reasonably consistent with prior results. Because of the nature of the judgments and assumptions made, actual results could differ from these estimates, which could have a material impact on the carrying values of its assets and liabilities and its results of operations. Material estimates that are particularly susceptible to significant change in the near term relate to investment securities impairment evaluation, the valuation of acquired loans, the determination of the allowance for loan losses, valuation of other real estate owned, the analysis of potential impairment of goodwill, the valuation of deferred tax assets and accounting for stock-based compensation.

Investment Securities Impairment Evaluation. In estimating other-than-temporary impairment losses, management considers (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. When a determination is made that an other-than-temporary impairment exists but the Company does not intend to sell the debt security and it is more likely than not that it will not be required to sell the debt security prior to its anticipated recovery, the other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income. Management believes that there are no investment securities with other-than-temporary impairment for each of the reporting periods presented.

Acquired Loans. Fair values for loans acquired in business acquisitions are based on a discounted cash flow methodology that involves significant assumptions and judgments as to estimates of credit risk, prepayment risk, liquidity risk, default rates, loss severity, payment speeds, collateral values and discount rate.

Allowance for Loan Losses. The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans.

Pools of loans are evaluated for loss exposure based upon historical loss rates in each category of loans and adjusted for qualitative factors. Management assigned each factor a value to reflect improving, stable or declining conditions based on its best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a narrative accompanying the allowance for loan loss calculation.

An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

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 or the fair value of the collateral if the loan is collateral dependent.

See the Allowance for Loan Losses section related to Balance Sheet Review as of September 30, 2015 and December 31, 2014 for more information.

Other Real Estate Owned. Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Any write-down, at or prior to the dates the real estate is considered foreclosed, is charged to the allowance for loan losses. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell.

Goodwill. Goodwill represents the excess of the cost of an acquired entity over the fair value of the identifiable net assets acquired in accordance with the acquisition method of accounting. Goodwill is not amortized but is reviewed for potential impairment on an annual basis, or more often if events or circumstances indicate that there may be impairment.

Income Taxes. Deferred taxes are provided on the liability method whereby deferred tax assets (DTA) are recognized for deductible temporary differences, net operating loss carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. The Company files a consolidated federal income tax return with the Bank.

 

34

---

 

If management makes a determination based on the available evidence that it is more likely than not that some portion or all of the deferred tax assets will not be realized in future periods a valuation allowance is calculated and recorded. These determinations are inherently subjective and dependent upon estimates and judgments concerning management’s evaluation of both positive and negative evidence. The weight given to the potential effect of positive and negative evidence must be commensurate with the extent to which it can be objectively verified.

When determining the need for a valuation allowance, the Company assessed the possible sources of taxable income available under tax law to realize a tax benefit for deductible temporary differences and carryforwards, as defined by Accounting Standards Codification (“ASC”) Topic 740-10-30-18. This guidance related to when a valuation allowance on the DTA should be maintained, generally provides that the valuation allowance should be reversed, when in the judgment of management, it is more likely than not that the DTA will be realized.

Stock Based Compensation. Compensation costs related to share-based payment transactions are recognized in the financial statements over the period that an employee provides service in exchange for the award. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model based on management’s assumption.

Results of Operations

Income Statement Review

First Priority’s results of operations are affected by five major elements: (1) net interest income, or the difference between interest income earned on loans and investments and interest expense accrued on deposits and borrowed funds (2) the provision for loan losses, or the amount added to the allowance for loan losses to provide reserves for inherent losses on loans; (3) non-interest income, consisting of income from wealth management services, fees and other charges to our banking customers, and net gains or losses realized from the sale of assets; (4) non-interest expense, which consists primarily of salaries, employee benefits and other operating expenses; and (5) income taxes, including deferred taxes, when applicable. Each of these major elements is reviewed in more detail in the following discussion.

Results of Operations Comparative Summary

Shown in the table below are the three and nine month reported results of operations as well as the increase (decrease) for the respective periods.

 

 

Net Interest Income

First Priority’s primary source of revenue is net interest income. Net interest income is determined by the average balances of interest-earning assets and interest-bearing liabilities and the interest rates earned and paid on these balances. The amount of net interest income recorded by First Priority is affected by the rate, mix and amount of growth of interest-earning assets and interest-bearing

 

35

---

 

liabilities, the amount of interest-earning assets as compared to the amount of interest-bearing liabilities, and by changes in interest rates earned and interest rates paid on these assets and liabilities.

The following tables set forth, for the three and nine month periods ended September 30, 2015 and 2014, information related to First Priority’s average balances, yields on average assets, and costs of average liabilities. Average balances are derived from the daily balances throughout the periods indicated and yields are derived by dividing income or expense by the average balance of the corresponding assets or liabilities. Average loans are stated net of deferred costs. The net dollar amounts and percentage changes of interest income and expense are presented for comparative purposes.

 

 

36

---

 

 

 

37

---

 

Analysis of Changes in Net Interest Income

Net interest income can also be analyzed in terms of the impact of changing interest rates and changing volume as shown in the Changes in Net Interest Income table below which sets forth the effect which varying levels of average interest-earning assets, interest-bearing liabilities and the applicable yields and rates have had on changes in net interest income for the periods presented.

 

 

For the three months ended September 30, 2015, net interest income increased $192 thousand, or 4.8%, from $4.02 million as of September 30, 2014 to $4.21 million. Net interest margin declined 11 basis points from 3.64% for the third quarter of 2014 to 3.53% for the same period in 2015. Net interest spread, defined as the mathematical difference between the yield on average earning assets and the rate paid on average interest-bearing liabilities, decreased 12 basis points from 3.51% for the three months ended September 30, 2014 to 3.39% for the same period in 2015. When comparing these periods, incremental growth of balances accounted for an increase of $303 thousand while the change in our relative rate structure resulted in a decline in net interest income of $111 thousand.

Average interest earning assets for the current quarter of 2015 increased $35.8 million, or 8.2%, including increases in average loans of $25.7 million, or 7.0%, and an increase in average investment balances of $12.0 million, or 18.4%, when compared to the prior year quarter. This increased volume of average earning assets provided an additional $408 thousand in interest income, with $293 thousand provided from incremental loan balances. The average yield on earning assets declined 10 basis points in the current quarter compared to the prior year three month period from 4.29% to 4.19% which resulted in a rate related decline of interest income of $134 thousand between the periods, of which a decline of $135 thousand can be attributed to lower yields on loans.

Average interest bearing liabilities increased $31.4 million, or 8.7%, when comparing the current quarter to the prior year quarter. During this time, borrowed funds increased $3.4 million while overall average deposit balances increased $27.9 million, consisting of an increase in time deposits of $33.7 million, primarily from brokered time deposits totaling $27.9 million, partially offset by a decrease in interest bearing demand deposits of $2.3 million and money market and savings deposits of $3.5 million. The incremental growth of interest bearing liabilities resulted in an overall increase in interest expense of $105 thousand. At the same time, due to the change in mix of balances, the average rate on interest bearing liabilities increased slightly in the current quarter compared to the prior year three month period from 0.78% to 0.80%, however, due to the change in mix of balances, overall interest expense declined $23 thousand between the periods due to rate structures.

For the nine months ended September 30, 2015, net interest income increased 2.6%, or $310 thousand, to $12.08 million compared to $11.77 million for the same period in 2014. Net interest margin decreased from 3.74% for the first nine months of 2014 to 3.54% for the same period in 2015. Net interest spread decreased from 3.60% for the first nine months of 2014 to 3.39% for the same period in 2015. When comparing these periods, incremental growth of balances accounted for an increase of $867 thousand while the change in our relative rate structure resulted in a decline in net interest income of $557 thousand.

 

38

---

 

Average interest earning assets for the first nine months of 2015 increased $36.1 million, or 8.6%, including increases in average loans of $32.5 million, or 9.3%, and average investment balances of $5.8 million, or 8.9%, when compared to the prior year. This increased volume of average earning assets provided an additional $1.26 million in interest income, $1.13 million provided from incremental loan balances and $171 thousand from investment securities.  The average yield on earning assets declined 22 basis points in the current year compared to the prior year nine month period from 4.42% to 4.22%, which resulted in a rate related decline of interest income between the periods of $732 thousand. A decline of $805 was related to lower yields on loans.  Average interest bearing liabilities increased $33.7 million, or 9.8%, in 2015. During this time, borrowed funds increased $4.0 million while overall deposit balances increased $29.7 million, as interest bearing demand deposits decreased $8.9 million, money market and savings deposits decreased $2.4 million while time deposits increased $41.0 million. The incremental growth of interest bearing liabilities resulted in an increase of interest expense of $394 thousand. At the same time, the average rate on interest bearing liabilities increased 1 basis point from 0.82% for the first nine months of 2014 to 0.83% in the current year, which along with the change in mix of balances, accounted for a decline in interest expense of $175 thousand due to the change in our relative rate structure.

Provision for Loan Losses

The allowance for loan losses is established through provisions for loan losses charged against operations. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance as recoveries.

The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management’s periodic evaluation of the adequacy of the allowance is based on known or potential risks in the portfolio, adverse situations that may affect a borrower’s ability to repay, the estimated value of any underlying collateral, the composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revisions as more information becomes available or economic conditions change.

At the end of each quarter or more often, if necessary, First Priority analyzes the collectability of its loans and accordingly adjusts the loan loss allowance to an appropriate level. The allowance for loan losses covers estimated credit losses on individually evaluated loans that are determined to be impaired, as well as estimated credit losses inherent in the remainder of the loan portfolio. For a description of the process for determining the adequacy of the allowance for loan losses, see the “Allowance for Loan Losses” section below.

The provision for loan losses was $195 thousand for the three months ended September 30, 2015 compared to $212 thousand for the same period in 2014, and on a year to date basis was $445 thousand for the first nine months of 2015 compared to $572 thousand for the same period in 2014.  The level of provision is impacted by management’s analysis of impaired and non-performing loans, as well as by the level of incremental loan volume and net charge-offs of loans. The Company recorded net charge-offs of $118 thousand and $115 thousand for the three and nine months ended September 30, 2015, respectively, of which $97 thousand recorded in the current quarter related to loans secured by residential real estate whereby the properties were acquired by the Bank through Sheriff sales and the fair value of these properties required a write down.  Net charge-offs for the three months ended September 30, 2014 totaled $161 thousand and were $557 thousand for the first nine months of 2014.  Total loans increased $7.8 million in the current quarter and $23.9 million for the nine months ended September 30, 2015, compared to an increases of $9.0 million during the third quarter of 2014 and $36.0 million for the nine months ended September 30, 2014.  The allowance for loan losses was $2.6 million at September 30, 2015 and $2.3 million at December 31, 2014 which represented 0.66% and 0.62% of total loans outstanding at each respective date.

Acquired loans are initially recorded at acquisition date at their acquisition date fair values, and therefore, are excluded from the calculation of loan loss reserves as of the acquisition date. As acquired loans are paid off or are refinanced or extended under First Priority’s credit underwriting process, they are no longer considered acquired loans, but instead are prospectively considered originated loans and therefore, are included as part of the calculation of the allowance for loan losses. To the extent there is a decrease in the present value of cash flows from acquired impaired loans after the date of acquisition, the Company records a provision for loan losses. During the three and nine months ended September 30, 2015, the Company recorded a provision for loan losses totaling $119 thousand and $184 thousand related to acquired loans, of which $54 thousand and $111 thousand, respectively, related to net charge-offs on non-credit impaired purchased loans while net charge-offs related to acquired loans which were initially considered credit impaired loans as of the acquisition date were $65 thousand and $73 thousand for the three and nine months ended September 30, 2015, respectively.  During the three and nine months ended September 30, 2014, the Company recorded a provision for loan losses totaling $168 thousand and $378 thousand, respectively, related to acquired loans. There were charge-offs recorded during these same respective periods totaling $37 thousand and $216 thousand related to loans that were initially considered credit impaired loans as of the acquisition date while net charge-offs on non-credit impaired purchased loans totaled $126 thousand and $158 thousand for the three and nine months ended September 30, 2014, respectively.

 

39

---

 

Non-Interest Income

For the three and nine months ended September 30, 2015, non-interest income totaled $342 thousand and $834 thousand, respectively, compared to $246 thousand and $681 thousand, respectively, for the same periods in 2014. Non-interest income is comprised of wealth management fees which are principally non-recurring commissions and fees related to the sale of insurance products and annuities, service charges on deposit accounts, income resulting from the investment in bank owned life insurance, and other fees which First Priority Bank collects from its banking customers.  The decrease in wealth management income was due to several annuity insurance policies issued during the third quarter of 2014 which resulted in $49 thousand in related fees.  Gains from the sale of investment securities, totaling $125 thousand, were recorded in the current quarter from the sale of $7.5 million of U.S. Treasury securities to take advantage of favorable market conditions which occurred related to these investments.

Components of non-interest income are shown in the table below:

Non-Interest Expenses

For the three and nine months ended September 30, 2015, non-interest expenses were $3.53 million and $10.30 million, respectively, compared to $3.44 million and $10.06 million for the same periods in 2014, an increase of $85 thousand, or 2.5%, and $247 thousand, or 2.5%, respectively. The following table sets forth information related to the various components of non-interest expenses for each respective period.

 

Highlights of significant non-interest expenses items for the third quarter, 2015 compared to the third quarter, 2014

 

40

---

 

Nine months ended September 30, 2015 compared to prior year

Provision for Income Taxes

Income tax expense recorded in the three and nine months ended September 30, 2015 totaled $240 thousand and $681 thousand, respectively.  The Company recognized a tax benefit in the Statement of Operations of $4.71 million and $4.70 million for the three and nine months ended September 30, 2014, respectively, a result of reversing the valuation allowance on net deferred tax assets (“DTA”) during the third quarter of 2014, which established the net DTA position on the balance sheet of the Company.  Since the reversal of the valuation allowance, the Company records current tax expense in its Statement of Operations and reports

 

41

---

 

earnings of the Company to its shareholders and regulators on an after tax basis.  The Company’s effective tax rate for the nine months ended September 30, 2015 was 31.5%.

The Company’s net operating loss (“NOL”) carryforwards totaled $8.6 million as of September 30, 2015, including acquired NOLs. First Priority had NOL carryforwards of $6.2 million at September 30, 2015, which expire in 2027 through 2034; such NOL carryforwards, however, are available prior to expiration to reduce future federal income taxes until such time as the entire NOL is utilized.

First Priority acquired a NOL for tax purposes related to the acquisition of Prestige Community Bank, which initially totaled $2.0 million, with a remaining balance of $1.7 million at September 30, 2015, which is subject to certain limitations and expires in 2027 through 2028 if not fully utilized. In addition, an initial NOL carryforward balance of $940 thousand was recorded resulting from the merger with Affinity, of which $656 thousand remains available to reduce future federal income taxes as of September 30, 2015. This NOL is also subject to certain limitations and expires in 2026 through 2032 if not fully utilized.

Financial Condition as of September 30, 2015 and December 31, 2014

Balance Sheet Review

 

 

Total assets at September 30, 2015 were $508.6 million, representing an increase of $16.3 million or 3.3% when compared to total assets of $492.3 million at December 31, 2014.  Total assets at September 30, 2015 consisted of loans outstanding of $399.1 million, investment securities of $72.7 million and cash and cash equivalents of $19.5 million. At December 31, 2014, total assets consisted primarily of loans outstanding of $375.2 million, investment securities of $91.5 million and cash and cash equivalents of $7.9 million.

Deposits totaled $396.3 million at September 30, 2015 compared to $378.2 million at December 31, 2014, an increase of $18.1 million, or 4.8%. Of the total deposits at September 30, 2015, $171.4 million, or 43.2% of total deposits, are core deposits consisting of demand, money market and savings deposits.

Borrowings totaled $58.8 million at September 30, 2015 compared to $62.5 million at December 31, 2014, a decrease of $3.7 million, or 5.9%.

Shareholders’ equity at September 30, 2015 was $51.7 million, representing an increase of $1.5 million from $50.2 million at December 31, 2014.  

 

42

---

 

Investments

The investment portfolio totaled $72.7 million at September 30, 2015, compared to $91.5 million at December 31, 2014, a decline of $18.8 million, or 20.5%. This decline primarily relates to overnight investments of $30 million purchased at December 31, 2014 for tax planning purposes which matured in early January 2015, which was partially offset by investment purchases of municipal bonds totaling approximately $15.7 million in the first nine months of 2015.  Additionally, the Company purchased $10 million of U.S. Treasury securities during the first half of 2015, of which $7.5 million were sold during the third quarter of 2015 resulting in a gain on the sale of securities of $114 thousand.  Also, a municipal bond was also sold in the current quarter with a par value of $500 thousand which resulted in a gain of $11 thousand.  

As of September 30, 2015 and December 31, 2014, investments totaling $52.2 million and $75.5 million, respectively, were classified as available for sale while $20.5 million and $16.0 million, respectively, were classified as held to maturity. Total investments accounted for 14.3% and 18.6% of total assets at each respective date.

The Company previously transferred investment securities from available for sale to held to maturity securities.  Due to these transfers securities classified as held to maturity have net unrealized holding gains, totaling $52 thousand as of September 30, 2015, which are being amortized over the remaining life of the related securities as an adjustment of yield in a manner consistent with the accretion of discount on debt securities. This will have no impact on the Company’s net income because the amortization of the unrealized holding gains reported in equity will offset the effect on interest income of the accretion of the discount on these securities. The transfer of securities from available for sale to held to maturity was completed in order to mitigate the volatility to common equity caused by sudden market fluctuations and to lock in a predictable earnings on these related securities.

Securities classified as available for sale are accounted for at fair value, with the difference between fair value and amortized cost reflected in the capital account as other comprehensive income or loss. The Company had net unrealized gains on available for sale securities totaling $551 thousand at September 30, 2015 compared to unrealized losses of $86 thousand at December 31, 2014. Available for sale securities are securities that management intends to hold for an indefinite period of time or securities that may be sold in response to changes in interest rates, prepayment expectations, capital management and liquidity needs.

The total investment portfolio at September 30, 2015 was comprised of federal agency securities (25%), federal agency mortgage backed securities and federal agency collateralized mortgage obligations (25%), obligations of states and political subdivisions (49%), and corporate and other debt securities (1%). All investment securities were either government guaranteed, issued by a government agency or investment grade. First Priority had no investment securities deemed to have other than temporary impairment (“OTTI”) at September 30, 2015 or December 31, 2014 and recorded no OTTI charges during the three and nine months ended September 30, 2015 and 2014.

 

43

---

 

The following table sets forth information about the contractual maturities and weighted average yields of investment securities at September 30, 2015. Actual maturities may differ from contractual maturities due to scheduled principal payments and unscheduled prepayments of mortgage backed securities and, where applicable, the ability of an issuer to call a security prior to the contractual maturity date.

 

 

The amortized cost and fair value of First Priority’s investments, classified as available for sale or held to maturity, at September 30, 2015 and December 31, 2014 are shown in the following table:

 

 

44

---

 

Restricted investments in bank stocks

Restricted investments in bank stocks represent the investment in the common stock of correspondent banks required in order to transact business with those banks. Investments in restricted stock are carried at cost.

At both September 30, 2015 and December 31, 2014, First Priority Bank held $110 thousand in common stock of Atlantic Community Bankers Bank, Camp Hill, Pennsylvania. Additionally, First Priority had investments in the common stock of the FHLB Bank of Pittsburgh totaling $3.14 million and $2.87 million as of September 30, 2015 and December 31, 2014, respectively. The increase in the investment is attributable to incremental borrowings at the FHLB during the first nine months of 2015.

Loans

First Priority’s loan portfolio is the primary component of its assets. At September 30, 2015, total loans were $399.1 million, representing an increase of $23.9 million or 6.4% from total loans outstanding of $375.2 million at December 31, 2014. During the first nine months of 2015, loan growth included new organic loan production of approximately $48 million while continuing to experience a high level of unscheduled loan payoffs, which when combined with normal principal payments, totaled $34 million.  Also included in the current year loan growth is $9.8 million from the purchase of performing residential real estate loans located in western Pennsylvania which were underwritten using similar underwriting standards as the Bank uses for its organic portfolio.  The following table sets forth the classification of First Priority’s loan portfolio at September 30, 2015 and December 31, 2014.

 

 

Commercial mortgage loans consist of loans originated for commercial purposes which are secured by nonfarm, nonresidential properties, multifamily residential properties, or 1-4 family residential properties. As of September 30, 2015, commercial mortgage loans totaled $176.2 million, consisting of $121.1 million of loans to finance commercial business properties, of which 61% are owner occupied, $17.6 million to finance, and are secured by, multifamily properties, $33.2 million secured by 1-4 family residential dwelling properties for business purposes, and $4.3 million for other purposes. In addition, as of September 30, 2015, loans to lessors of non-residential buildings totaled $72.2 million, which is included in commercial mortgage loans; of this amount, $35.7 million, or 49%, of these loans are related to owner occupied buildings.

As of December 31, 2014, commercial mortgage loans totaled $169.0 million, consisting of $115.8 million of loans to finance commercial business properties, of which 60% are owner occupied, $15.4 million to finance, and are secured by, multifamily properties, $31.4 million secured by 1-4 family residential dwelling properties for business purposes, and $6.4 million for other purposes. In addition, as of December 31, 2014, loans to lessors of non-residential buildings totaled $69.5 million, which is included in commercial mortgage loans; of this amount, $33.7 million, or 48%, of these loans are related to owner occupied buildings.

The payment experience of certain non-owner occupied commercial mortgage loans may be dependent upon the successful operation of the real estate project. These risks can be significantly affected by supply and demand conditions in the market for office and retail space and for apartments and, as such, may be subject to a greater extent to adverse conditions in the economy. In dealing with these risk factors, First Priority generally limits itself to a real estate market or to borrowers with which First Priority has experience. First Priority generally concentrates on originating commercial real estate loans secured by properties located within its market area, and many of First Priority’s commercial real estate loans are secured by owner-occupied property with personal guarantees of the debt.

Regulatory guidance exists whereby total construction, land development and other land loans should not exceed 100% of total risk based capital and further guidance whereby total construction, land development and other land loans combined with real estate loans secured by multifamily or nonresidential properties and loans to finance commercial real estate or construction loans (not secured by

 

45

---

 

real estate) should not exceed 300% of total risk-based capital. First Priority Bank monitors these two ratios, which as of September 30, 2015, totaled 30% and 184% of total risk-based capital, respectively, both well within the regulatory suggested guidance.

Credit Quality

First Priority Bank’s written lending policies require specified underwriting, loan documentation and credit analysis standards to be met prior to funding, with additional credit department approval for the majority of new loan balances. The Loan Committee is comprised of senior members of management who oversee the loan approval process to monitor that proper standards are maintained.

The following table summarizes non-performing assets and performing troubled debt restructurings at the dates indicated.

 

 

Total non-performing loans were $3.5 million at September 30, 2015, a decline of $1.0 million from the $4.6 million at December 31, 2014. This decrease consisted of three loans totaling $185 thousand which were restored to performing based on improving financial positions of the borrowers, another loan of $70 thousand, previously reported as past due 90 days or more, which was paid current, and  two non-performing loans totaling $128 thousand that were paid down during this period.  Nine loan relationships with property fair values totaling $544 thousand were transferred to other real estate owned, while charge-offs in the first nine months of 2015 totaled $236 thousand.  Additionally, there were three new non-performing loans identified in the first nine months of 2015 totaling $181 thousand. Total non-performing loans as a percentage of total loans at September 30, 2015 was 0.89%, down from 1.21% at December 31, 2014. Other real estate owned totaled $1.5 million at September 30, 2015 compared to $1.3 million at December 31, 2014. As of September 30, 2015 there were no repossessed assets.  Repossessed assets totaled $42 thousand at December 31, 2014. Nonperforming assets totaled $5.0 million, or 0.99% of total assets, as of September 30, 2015, compared to $5.9 million, or 1.19% of total assets as of December 31, 2014.

While not considered non-performing, First Priority’s performing troubled debt restructurings are closely monitored as they consist of loans that have been modified where the borrower is experiencing financial difficulty. Troubled debt restructurings may be deemed to have a higher risk of loss than loans which have not been restructured. At September 30, 2015 and December 31, 2014, First Priority’s performing troubled debt restructurings totaled $1.7 million and $2.1 million, respectively.  

 

46

---

 

First Priority Bank’s management continues to monitor and explore potential options and remedial actions to recover First Priority Bank’s investment in non-performing loans. According to policy, First Priority Bank is required to maintain a specific reserve for impaired loans. See the “Allowance for Loan Losses” section below for further information.

First Priority Bank’s total delinquency amount is comprised of loans past due 30 to 89 days and still accruing plus the balance of nonperforming loans. As of September 30, 2015 and December 31, 2014, loans past due 30 to 89 days and still accruing totaled $1.6 million and $986 thousand, respectively, which when added to the non-performing loans for each period, resulted in a total delinquency ratio of 1.28% and 1.48%, respectively, of total loans outstanding.

Allowance for Loan Losses

The allowance for loan losses represents an amount that First Priority believes will be adequate to absorb estimated credit losses on loans that may become impaired. While First Priority applies the methodology discussed below in connection with the establishment of the allowance for loan losses, the allowance is subject to critical judgments on the part of management. Risks within the loan portfolio are analyzed on a continuous basis by the management of First Priority Bank, periodically analyzed by an external independent loan review function, and are also reviewed by the audit committee. A risk system, consisting of multiple grading categories, is utilized as an analytical tool to assess risk and appropriate allowances. In addition to the risk system, management further evaluates the risk characteristics of the loan portfolio under current and anticipated economic conditions and considers such factors as the financial condition of the borrower, past and expected loss experience, and other factors which management believes deserve recognition in establishing an appropriate allowance. These estimates are reviewed at least quarterly, and, as adjustments become necessary, they are realized in the periods in which they become known.

First Priority uses a quantitative and qualitative method to allocating its allowance to the various loan categories. An unallocated component, which is maintained to cover uncertainties that could affect management’s estimate of probable losses, reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

Additions to the allowance are made by provisions charged to expense, and the allowance is reduced by net charge-offs, which are loans judged to be uncollectible, less any recoveries on loans previously charged off. Although management attempts to maintain the allowance at an adequate level, future additions to the allowance may be required due to the growth of the loan portfolio, changes in asset quality, changes in market conditions and other factors. Additionally, various regulatory agencies periodically review the allowance for loan losses. These agencies may require additional provisions based upon their judgment about information available to them at the time of their examination. Although management uses what it believes to be the best information available, the level of the allowance for loan losses remains an estimate which is subject to significant judgment and short-term change.

Based on the information available as of September 30, 2015, management believes that the allowance for loan losses of $2.6 million is adequate as of that date.

 

47

---

 

The following table sets forth a summary of the changes in the allowance for loan losses for the periods indicated:

 

The allowance for loan losses was $2.6 million and $2.3 million at September 30, 2015 and December 31, 2014, respectively, which represented 0.66% and 0.62% of total loans outstanding at each respective date. As of September 30, 2015 and December 31, 2014, the unamortized portion of the general credit fair value adjustment totaled $250 thousand and $509 thousand, respectively, and the total specific credit market valuation adjustment totaled $362 thousand as of September 30, 2015 and $443 thousand as of December 31, 2014. Additionally, as of September 30, 2015 and December 31, 2014 the combination of these remaining credit fair value adjustments related to acquired loans, totaling $612 thousand and $952 thousand, respectively, and the allowance for loan losses of $2.6 million and $2.3 million, respectively, or a total of $3.3 million for both periods, would equate to 0.82% and 0.87% of total loans outstanding as of September 30, 2015 and December 31, 2014, respectively. Net charge-offs recorded totaled $115 thousand for the first nine months of 2015 compared to $557 thousand for the same period in 2014.

 

48

---

 

The following table sets forth the allocation of the allowance for loan losses by loan category. The specific allocations in any particular category may be reallocated in the future to reflect the then current conditions. Accordingly, management considers the entire allowance to be available to absorb losses in any category.

 

 

A specific allocation of the allowance for loan losses of $212 thousand has been provided on impaired loans of $5.2 million at September 30, 2015 compared to a specific allocation of $166 thousand related to $6.6 million of originated impaired loans at December 31, 2014.

The qualitative and quantitative analysis of the loan portfolio, after the effect of net charge-offs and the above mentioned specific allocation, resulted in the general portion of the allowance for loan losses totaling $1.7 million and $1.6 million as of September 30, 2015 and December 31, 2014, respectively.

Loan Concentrations

The Company’s loans consist of credits to borrowers spread over a broad range of industrial classifications. The largest concentrations of loans are to lessors of nonresidential buildings and lessors of residential buildings and dwellings. As of September 30, 2015, these loans totaled $72.2 million and $55.4 million, respectively, or 18.1% and 13.9%, respectively, of the total loans outstanding. As of December 31, 2014, these same classifications of loans totaled $69.5 million and $54.7 million, respectively, or 18.5% and 14.6%, respectively, of the total loans outstanding. These credits were subject to normal underwriting standards and did not present more than the normal amount of risk assumed by the Company’s other lending activities. Management believes this concentration does not pose abnormal risk when compared to the risk it assumes in other types of lending. The Company has no other concentration of loans which exceeds 10% of total loans.

Deposits

Deposits represent the primary source of funding for earning assets. Deposits totaled $396.3 million at September 30, 2015 compared to $378.2 million at December 31, 2014, representing an increase of $18.1 million or 4.8%. During the first nine months of 2015, an increase in brokered time deposits of $35.8 million was offset by declines of $1.1 million in demand deposits, $12.6 million in money market deposit and savings accounts and $4.0 million in retail time deposits. It continues to be a strategic objective of First Priority to develop its core deposit base and to supplement core deposits with cost effective alternative funding sources.

First Priority attracts deposits by offering competitive products and interest rates on a broad spectrum of deposit products to customers in its local marketplace, generally through its retail branch system, and also through its internet banking platform. First Priority Bank supplements deposits raised locally with the issuance of brokered deposits when cost effective relative to local market pricing. At September 30, 2015 and December 31, 2014, brokered deposits totaled $110.5 million and $74.6 million, respectively. The guidelines governing First Priority Bank’s participation in the brokered CD market are included in First Priority Bank’s Asset Liability Management Policy, which is reviewed, revised and approved annually by the asset liability management committee and the board of directors. The FDIC places restrictions on a depository institution’s use of brokered deposits based on the bank’s capital classification. A well-capitalized institution may accept brokered deposits without FDIC restrictions. An adequately capitalized institution must obtain a waiver from the FDIC in order to accept brokered deposits, while an undercapitalized institution is prohibited by the FDIC from accepting brokered deposits. First Priority Bank is classified as well-capitalized under prompt corrective action provisions (see Note 10 – “Regulatory Matters” of the Notes to Unaudited Consolidated Financial Statements) and, therefore, may accept brokered deposits without FDIC restrictions.

 

49

---

 

The following table sets forth the average balance of First Priority’s deposits and the average rates paid on deposits for the periods presented.

 

The maturity distribution of time deposits of $100,000 or more as of September 30, 2015, is as follows:

 

Short-Term Borrowed Funds

At September 30, 2015, First Priority had short-term borrowings totaling $43.8 million, compared to $51.5 million at December 31, 2014. Short-term borrowings consisted of overnight or less than 30 day advances from the FHLB as of each of these periods. The decrease in short-term borrowings resulted primarily from net funding requirements of growth in earning assets in conjunction with the growth in deposit balances. Advances from the FHLB at September 30, 2015 are collateralized by an investment in the common stock of the FHLB, by a specific pledge of First Priority Bank’s investment assets and by a blanket lien on qualifying mortgages within First Priority Bank’s loan portfolio.

The following table outlines First Priority’s various sources of short-term borrowed funds at or for each of the nine months ended September 30, 2015 and 2014. The maximum balance represents the highest indebtedness for each category of short-term borrowed funds at any month-end during each of the periods shown.

 

Long-Term Debt

Long-term debt totaled $15.0 million as of September 30, 2015 and $11.0 million as of December 31, 2014. These borrowings consisted of advances from the FHLB with a weighted average interest rate of 1.09% and 0.88%, respectively, as of each of these dates and an average remaining life of 2.2 years for each respective period. Advances from the FHLB are collateralized by an investment in the common stock of the FHLB, by a specific pledge of First Priority Bank’s investment assets and by a blanket lien on qualifying mortgages within First Priority Bank’s loan portfolio.  Balances of FHLB long-term debt averaged $12.2 million and $11.0

 

50

---

 

million during the nine months ended September 30, 2015 and 2014, respectively. The maximum month-end balance of these borrowings was $16.0 million for the first nine months of 2015 and $11 million for the same period in 2014.

Capital Resources

Shareholders’ equity at September 30, 2015 was $51.7 million, representing an increase of $1.5 million from $50.2 million at December 31, 2014. The enhanced capital position is attributable to net income of $1.5 million for the nine months ended September 30, 2015, stock based compensation costs of $238 thousand and a positive impact from market volatility related to the investment securities portfolio resulting in a net change in net unrealized gains (losses) totaling $404 thousand.  These increases were partially offset by preferred dividends paid of $589 thousand.

On February 20, 2009, First Priority issued 4,579 shares of First Priority’s Series A preferred stock and a warrant to purchase, on a net basis, 229 shares of First Priority’s Series B preferred stock, which was immediately exercised, for an aggregate purchase price of $4.6 million under the TARP CPP. On December 18, 2009, First Priority issued 4,596 shares of Series C preferred stock, $100.00 par value per share, having a liquidation preference of $1,000 per share, for an aggregate purchase price of $4.6 million.  See Note 1 of the notes to unaudited consolidated financial statements, subsequent events, related to issuance of subordinated debt and redemption of preferred stock to occur in the 4^th quarter of 2015.  

First Priority Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet the minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on First Priority Bank’s financial condition and results of operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, First Priority Bank must meet specific capital guidelines that involve quantitative measures of First Priority Bank’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. First Priority Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk-weightings and other factors.

First Priority Bank exceeds the minimum capital requirements established by regulatory agencies. Under the capital adequacy guidelines, capital is classified into two tiers. These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of common shareholders’ equity and qualifying preferred stock, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets plus trust preferred securities up to 25% of Tier 1 capital, with the excess being treated as Tier 2 capital. Tier 2 capital also consists of the allowance for loan losses, subject to certain limitations, and qualifying subordinated debt. In determining the amount of risk-weighted assets, all assets, including certain off balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on the risks believed inherent in the type of asset.

Quantitative measures established by regulation to ensure capital adequacy require First Priority Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets and of Tier 1 capital to average assets, known as the Tier 1 leverage ratio. The following table sets forth the capital ratios for both First Priority and First Priority Bank at September 30, 2015 and December 31, 2014.  First Priority currently meets the definition of a “small bank holding company” under the FRB’s regulations, and thus is not subject to any capital requirements; however, the Company meets the holding company regulatory requirements for “well-capitalized” for each stated period.  First Priority Bank was considered “well-capitalized” and met or exceeded its applicable regulatory requirements for both periods.    

 

The capital ratios above reflect the new capital requirements under "Basel III" effective during the nine months ended September 30, 2015. As of September 30, 2015, the Bank and the Company were in compliance with the new requirements. See Note 10 - Regulatory Matters for additional discussion regarding regulatory capital requirements.

 

51

---

 

Return on Average Equity and Assets

The following table shows the return on average assets (net income divided by total average assets), return on equity (net income divided by average equity), and the equity to assets ratio (average equity divided by total average assets) for the nine months ended September 30, 2015 and 2014.

 

The decline between the reported periods was primarily related to federal and state income tax expense totaling $681 thousand for the nine months ended September 30, 2015 compared to a tax benefit of $4.70 million recorded for the nine months ended September 30, 2014, which resulted from the Company reversing the valuation allowance on net deferred tax assets (“DTA”) during the third quarter of 2014, and established the net DTA position on the balance sheet of the Company.  Prior to September 30, 2014, the Company had a full valuation allowance recorded against its net deferred tax assets and accordingly, reported results did not include the impact of current income tax expense as a component of operating earnings.

Effect of Inflation and Changing Prices

The effect of relative purchasing power over time due to inflation has not been taken into effect in First Priority’s consolidated financial statements. Rather, the statements have been prepared on a historical cost basis in accordance with accounting principles generally accepted in the United States of America.

Unlike most industrial companies, the assets and liabilities of financial institutions, such as First Priority and First Priority Bank, are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on its performance than will the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude. First Priority seeks to manage the relationships between interest-sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation.

Off-Balance Sheet Arrangements

Through the operations of First Priority Bank, First Priority has made contractual commitments to extend credit, in the ordinary course of its business activities, to meet the financing needs of customers. Such commitments involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amount recognized on the balance sheets. These commitments are legally binding agreements to lend money at predetermined interest rates for a specified period of time and generally have fixed expiration dates or other termination clauses. The same credit and collateral policies are used in making these commitments as for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis and collateral is obtained, if necessary, based on the credit evaluation of the borrower. The amount of collateral obtained, if deemed necessary by First Priority Bank upon extension of credit, is based on management’s credit evaluation. Collateral held varies but may include personal or commercial real estate, accounts receivable, inventory and equipment.

At September 30, 2015 and December 31, 2014, outstanding commitments to extend credit consisting of total unfunded commitments under lines of credit were $94.3 million and $83.2 million, respectively. In addition, as of September 30, 2015 and December 31, 2014, there were $847 thousand and $349 thousand of performance standby letters of credit outstanding, respectively, and $1.1 million of financial standby letters of credit as of each respective date.

In addition, as of December 31, 2014 the Bank pledged $214 thousand of deposit balances at a correspondent bank to support a letter of credit with a balance of $149 thousand, issued by the correspondent on behalf of a customer of the Bank. This transaction is fully secured by the customer through a pledge of the customer’s deposits at the Bank.

 

52

---

 

First Priority is not involved in any other off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements or transactions that could result in liquidity needs or other commitments that could significantly impact earnings.  First Priority believes that it has adequate sources of liquidity to fund commitments that may be drawn upon by borrowers.

Liquidity

The objective of liquidity management is to assure that sufficient sources of funds are available, as needed and at a reasonable cost, to meet the ongoing and unexpected operational cash needs and commitments of First Priority and to take advantage of income producing opportunities as they arise. Sufficient liquidity must be available to meet the cash requirements of depositors wanting to withdraw funds and of borrowers wanting their credit needs met. Additionally, liquidity is needed to insure that First Priority has the ability to act at those times when profitable new lending and investment opportunities arise. While the desired level of liquidity may vary depending upon a variety of factors, it is a primary goal of First Priority to maintain adequate liquidity in all economic environments through active balance sheet management.

Liquidity management is the ongoing process of monitoring and managing First Priority’s sources and uses of funds. The primary sources of funds are deposits, scheduled amortization of loans outstanding, maturities and cash flow generated from the investment portfolio and funds provided by operations. Scheduled loan payments and investment maturities are relatively predictable sources of funds; however, deposit flows and loan prepayments are far less predictable and are influenced by the level of interest rates, economic conditions, local competition and customer preferences. Liquidity is also provided by unused lines of credit with correspondent banks and First Priority’s borrowing capacity at the FHLB. First Priority measures and monitors its liquidity position on an ongoing basis in order to better understand, predict and respond to balance sheet trends, unused borrowing capacity and liquidity needs. The liquidity position is managed on a daily basis as part of the daily settlement function and on an ongoing basis through the asset liability management function.

The key elements of First Priority’s liquidity planning process involve a primary focus on the development of a stable, core funding base; utilization of wholesale funding sources to supplement core funding; maintenance of an appropriate level of asset liquidity; management of the maturity structure of funding sources and of funding concentrations; and maintenance of borrowing facilities.

Wholesale funding sources utilized by First Priority Bank include brokered certificates of deposits, secured advances from the Federal Home Loan Bank of Pittsburgh, federal funds purchased and other secured borrowing facilities. At September 30, 2015, wholesale funding sources totaled $169.3 million and were comprised of $110.5 million of brokered certificates of deposit and $58.8 million of FHLB advances. At December 31, 2014, wholesale funding sources totaled $137.1 million and were comprised of $74.6 million of brokered certificates of deposit and $62.5 million of FHLB advances. Wholesale funding is generally used in managing the daily liquidity needs and when it is the most cost effective funding source available to First Priority. Management continually evaluates all available funding sources for cost and availability.

An integral part of First Priority Bank’s balance sheet management strategy is to establish and maintain borrowing facilities with correspondent banks for access to funding. Off balance sheet borrowing capacity provides the immediate availability of funds to meet short-term financing needs without requiring the bank to maintain excess liquidity in its investment portfolio, which may have a negative impact on earnings. In today’s environment of historically low interest rates, it also provides the most effective longer term funding, in terms of the cost and structure. Long term borrowings from the FHLB cannot be called prior to maturity, which provides much greater protection against a rise in interest rates when compared to retail deposits which can be redeemed early by the depositor at lower than market rate penalties.

As of September 30, 2015 and December 31, 2014, First Priority Bank had a borrowing facility with a correspondent bank totaling $10 million, available for short-term limited purpose usage, of which $2 million is available unsecured. The remaining $8 million is a secured line of credit.

At September 30, 2015 and December 31, 2014, First Priority Bank had a total borrowing capacity with the FHLB of $153 million and $144 million, respectively, with advances outstanding against this capacity of $58.8 million and $62.5 million, respectively.

Short-term liquid assets held in interest-bearing deposit accounts with correspondent banks totaled $15.1 million at September 30, 2015 compared to $2.8 million at December 31, 2014.

Interest Rate Sensitivity

It is the responsibility of the board of directors and senior management to understand and control the interest rate risk exposures assumed by First Priority. The board has delegated authority to the asset liability management committee (“ALCO”) for the development of ALCO policies and for the management of the asset liability management function. The ALCO committee is

 

53

---

 

comprised of senior management representing all primary functions of First Priority and meets monthly. ALCO has the responsibility for maintaining a level of interest rate risk exposures within board of director approved limits.

The primary objective of asset liability management is to optimize net interest income over time while maintaining a balance sheet mix that is prudent with respect to liquidity, capital adequacy and interest rate risk. The absolute level and volatility of interest rates can have a significant impact on the profitability of First Priority. Interest rate risk management is the process of identifying and controlling the potential adverse impact of interest rates movements on First Priority’s net interest income and on the fair value of its assets and liabilities.

One tool used to monitor interest rate risk is the measurement of its interest sensitivity “gap,” which is the positive or negative dollar difference between interest-earning assets and interest-bearing liabilities that are subject to interest rate repricing within a given period of time. Interest rate sensitivity can be managed by changing the mix, pricing and repricing characteristics of First Priority’s assets and liabilities, through management of its investment portfolio, loan and deposit product offerings, and through wholesale funding. Managing the amount of assets and liabilities repricing in the same time interval helps to hedge interest rate risk and minimize the impact on net interest income of rising or falling interest rates. First Priority generally would benefit from increasing market rates of interest when it has an asset-sensitive gap position and generally would benefit from decreasing market rates of interest when First Priority is liability-sensitive.

At September 30, 2015, First Priority was liability sensitive at the one-year gap position, as it has more liabilities subject to repricing in the subsequent twelve month period than assets. It must be noted, however, that the gap analysis is not a precise indicator of First Priority’s exposure to changing interest rates. The analysis presents only a static view of the timing of maturities and repricing opportunities, without taking into consideration that changes in interest rates do not affect all assets and liabilities equally. Furthermore, the results are influenced by management assumptions concerning the repricing characteristics of deposit products with no contractual maturities, the timing of the repricing of variable rate loans with interest rates currently fixed at interest rate floors, and prepayment speeds of loans and investments subject to prepayment prior to maturity. Additionally, net interest income performance may be impacted by other significant factors in a given interest rate environment, including changes in the volume and mix of interest-earning assets and interest bearing liabilities.

 

54

---

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

Risk identification and management are essential elements for the successful management of First Priority. In the normal course of business, First Priority is subject to various types of risk, including interest rate, credit, and liquidity risk. First Priority controls and monitors these risks with policies, procedures, and various levels of managerial and board oversight. First Priority’s objective is to optimize profitability while managing and controlling risk within board approved policy limits. Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the magnitude, direction, and frequency of changes in interest rates. Interest rate risk results from various repricing frequencies and the maturity structure of assets and liabilities. First Priority uses its asset liability management policy to control and manage interest rate risk.

Liquidity risk represents the inability to generate cash or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers, as well as, the obligations to depositors and debt holders. First Priority uses its asset liability management policy and contingency funding plan to control and manage liquidity risk.

Credit risk represents the possibility that a customer may not perform in accordance with contractual terms. Credit risk results from extending credit to customers, purchasing securities, and entering into certain off-balance sheet loan funding commitments. First Priority’s primary credit risk occurs in the loan portfolio. First Priority uses its credit policy and disciplined approach to evaluating the adequacy of the allowance for loan losses to control and manage credit risk. First Priority’s investment policy limits the degree of the amount of credit risk that may be assumed in the investment portfolio. First Priority’s principal financial market risks are liquidity risks and exposures to interest rate movements.

Item 4.  Controls and Procedures

Under the supervision and with the participation of our management, including the Chairman and Chief Executive Officer and the Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chairman and Chief Executive Officer and the Chief Financial Officer have concluded that, as of the end of such period, these disclosure controls and procedures are effective.

Changes in Internal Control Over Financial Reporting

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a–15(f) and 15d–15(f) under the Securities Exchange Act of 1934, as amended) during the fiscal period to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

55

---

 

PART II

Item 1.  Legal Proceedings

A certain amount of litigation arises in the ordinary course of the business of First Priority and First Priority Bank. In the opinion of the management of First Priority, there are no proceedings pending to which First Priority or First Priority Bank is a party or to which their property is subject, that, if determined adversely to them, would be material in relation to First Priority’s shareholders’ equity or financial condition, nor are there any proceedings pending other than ordinary routine litigation incident to the business of First Priority and First Priority Bank. In addition, no material proceedings are pending or are known to be threatened or contemplated against First Priority or First Priority Bank by governmental authorities.

 

Item 1A.  Risk Factors

Not Applicable

 

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

None.

 

Item 3.  Defaults Upon Senior Securities

None.

 

Item 4.  Mine Safety Disclosures

Not Applicable

 

Item 5.  Other Information

None.

 

 

 

 

56

---

 

Item 6.  Exhibits

 

 

 

 

57

---

 

SIGNATURES

In accordance with the requirements of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

 

 

---

 

Exhibit Index

 

 

 

59