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Table of Contents

Exhibit 13

SELECTED FINANCIAL INFORMATION AND OTHER DATA

The following summary of selected financial information and other data does not purport to be complete and is qualified in its entirety by reference to the detailed information and Consolidated Financial Statements and accompanying Notes appearing elsewhere in this Report.

Financial Condition and Other Data

 

     At December 31,  
     2015      2014     2013      2012      2011  
     (Dollars in thousands)  

Total amount of:

             

Assets

   $ 903,154       $ 935,785      $ 973,649       $ 967,689       $ 1,040,820   

Loans receivable, net

     556,349         539,264        543,632         524,985         556,360   

Cash and due from banks

     46,926         34,389        37,229         31,563         44,389   

Federal Home Loan Bank stock

     4,428         4,428        4,428         4,428         4,428   

Securities available for sale

     237,177         303,628        318,910         356,345         383,782   

Deposits

     739,406         731,308        762,997         759,865         800,095   

Repurchase agreements

     45,770         57,358        52,759         43,508         43,080   

FHLB advances

     15,000         34,000        46,780         43,741         63,319   

Subordinated debentures

     10,310         10,310        10,310         10,310         10,310   

Total stockholders’ equity

     87,630         98,402        95,717         104,999         118,483   

Number of active:

             

Real estate loans Outstanding

     4,089         4,527        4,730         4,212         4,383   

Deposit accounts

     44,174         44,183        44,792         40,770         42,140   

Offices open

     18         18        18         18         18   
Operating Data              
     Year Ended December 31,  
     2015      2014     2013      2012      2011  
     (Dollars in thousands)  

Interest and dividend income

   $ 33,122       $ 34,680      $ 35,857       $ 40,840       $ 46,240   

Interest expense

     6,550         8,879        10,581         14,877         18,415   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Net interest income before provision for loan losses

     26,572         25,801        25,276         25,963         27,825   

Provision for loan losses

     1,051         (2,273     1,604         2,275         5,921   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Net interest income

     25,521         28,074        23,672         23,688         21,904   

Non-interest income

     7,602         7,840        9,372         9,639         10,193   

Non-interest expense

     30,445         33,916        28,638         28,441         28,693   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Income before income taxes

     2,678         1,998        4,406         4,886         3,404   

Provision for income taxes

     274         (201     644         817         484   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Net income

   $ 2,404       $ 2,199      $ 3,762       $ 4,069       $ 2,920   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Preferred stock dividend and accretion of stock warrants

     —           —          —           1,229         1,031   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Net income available to common stockholders

   $ 2,404       $ 2,199      $ 3,762       $ 2,840       $ 1,889   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Selected Quarterly Information (Unaudited)

 

     First
Quarter
     Second
Quarter
    Third
Quarter
     Fourth
Quarter
 
     ( Dollars in thousands)  

Year Ended December 31, 2015:

          

Interest and dividend income

   $ 9,195       $ 7,919      $ 8,012       $ 7,996   

Net interest income after provision for losses on loans

     7,347         6,037        6,104         6,033   

Non-interest income

     1,913         1,868        1,936         1,885   

Non-interest expense

     7,470         8,234        7,553         7,188   

Net income (loss)

     1,355         (117     510         656   

Year Ended December 31, 2014:

          

Interest and dividend income

   $ 8,658       $ 8,734      $ 8,994       $ 8,294   

Net interest income after provision for losses on loans

     5,940         6,641        7,700         7,793   

Non-interest income

     1,598         1,945        2,393         1,904   

Non-interest expense

     7,324         7,447        7,563         11,582   

Net income (loss)

     354         925        1,953         (1,033

 

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Table of Contents

Key Operating Ratios

 

     At or for the Year Ended December 31,  
     2015     2014     2013  

Performance Ratios

      

Return on average assets (net income available to common shareholders divided by average total assets)

     0.27     0.23     0.39

Return on average equity (net income available to common shareholders divided by average total equity)

     2.65     2.20     3.59

Interest rate spread (combined weighted average interest rate earned less combined weighted average interest rate cost)

     3.20     2.90     2.81

Net interest margin

     3.36     3.08     3.01

Ratio of average interest-earning assets to average interest-bearing liabilities

     119.43     117.88     116.15

Ratio of non-interest expense to average total assets

     3.41     3.57     2.99

Ratio of net interest income after provision for loan losses to non-interest expense

     86.68     85.81     86.44

Efficiency ratio (non-interest expense divided by sum of net interest income plus non-interest income)

     86.85     97.83     80.15

Asset Quality Ratios

      

Non-performing assets to total assets at end of period

     1.02     0.55     1.82

Non-accrual loans to total loans at end of period

     1.32     0.58     1.21

Allowance for loan losses to total loans at end of period

     1.01     1.15     1.57

Allowance for loan losses to non-performing loans at end of period

     76.80     198.08     86.25

Provision for loan losses to total loans receivable, net

     0.19     (0.42 %)      0.30

Net charge-offs to average loans outstanding

     0.29     0.02     0.66

Capital Ratios

      

Total equity to total assets at end of period

     9.72     10.52     9.83

Average total equity to average assets

     10.17     10.55     10.94

Regulatory Capital

 

     December 31, 2015  
     (Dollars in thousands)  
     Corporation      Bank  

Tier 1 Leverage capital to adjusted average assets

   $ 95,156       $ 93,328   

Less: Tier 1 Leverage capital requirement

     34,924         34,840   
  

 

 

    

 

 

 

Excess

     60,232         58,488   
  

 

 

    

 

 

 

Tier 1 Risk Based capital to risk weighted assets

   $ 95,156       $ 93,328   

Less: Tier 1 Risk Based capital requirement

     35,079         34,704   
  

 

 

    

 

 

 

Excess

     60,077         58,624   
  

 

 

    

 

 

 

Total risk-based capital to risk weighted assets

   $ 100,857       $ 99,029   

Less: Risk-based capital requirement

     46,772         46,272   
  

 

 

    

 

 

 

Excess

   $ 54,085       $ 52,757   
  

 

 

    

 

 

 

Common equity tier 1 capital to risk weighted assets

   $ 95,156       $ 93,328   

Less: Common equity tier 1 capital requirement

     26,309         26,028   
  

 

 

    

 

 

 

Excess

   $ 68,847       $ 67,300   
  

 

 

    

 

 

 

 

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Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

This discussion relates to the financial condition and results of operations of the Company, which consist of the consolidation of Heritage Bank USA, Inc. (“the Bank”) and HopFed Bancorp, Inc. (“the Corporation”), JBMM LLC, Heritage Interim Corporation, Heritage USA Title LLC, and Fort Webb LLC. The Corporation became the holding company for the Bank in February 1998. The principal business of the Bank consists of accepting deposits from the general public and investing these funds primarily in loans and in investment securities and mortgage-backed securities. The Bank’s loan portfolio consists primarily of loans secured by residential real estate located in its market area.

For the year ended December 31, 2015, the Company’s net loan portfolio increased by $17.1 million, or 3.2%, as compared to the balance at December 31, 2014. Loan portfolio growth was strong during the first half of the year and declined slightly during last quarter of the year. The majority of the growth in the loan portfolio was the result of the Company’s opening of a loan production office in Nashville, Tennessee (“LPO”). The Company’s LPO office had approximately $15.4 million in loans outstanding at December 31, 2015.

Management continues to focus on reducing our average cost of deposits. For the years ended December 31, 2015, and December 31, 2014, our average cost of total deposits was 0.69% and 0.75%, respectively. As a result of our efforts to reduce the Company’s interest expense, total time deposits declined by $17.3 million and $50.1 million in the years ended December 31, 2015, and December 31, 2014, respectively. At December 31, 2015, total time deposits now compose 42.6% of total deposits, as compared to 65.0% of total deposits at December 31, 2011. At December 31, 2015, the Company has $52.4 million in time deposits maturing in the first two months of 2016 that have a weighted average cost of 2.52%. The Company anticipates retaining a reasonable portion of these deposits at current market interest rates. However, at December 31, 2015, the Company has increased its cash balance to $54.7 million as compared to $40.4 million at December 31, 2014, to ensure we maintain acceptable levels of liquidity to meet customer needs.

The Company’s level of loans classified as substandard continues to decline. The Company’s level of classified loans peeked at $90.4 million in June 2012. In response to the high level of classified loans, management undertook aggressive action to remediate this issue. These actions included additional customer contact with problem credits, the review of interim financial statements to more closely monitor developing trends in customers’ finances and the establishment of a special assets department. The special assets department (“special assets”) assumes the responsibility for a smaller number of loan relationships that are adversely classified, have negative cash flow trends developing, are likely to face future foreclosing actions or may already be in the process of foreclosure. The purpose of special assets is to determine if a customer relationship can be saved by improved financial reporting and performance. If the Company determines that the customers’ finances are not likely to improve in the future, the special assets officer develops a strategy for the Company to exit the relationship. At December 31, 2015, the Company has $28.1 million in loans classified as substandard, representing 27.8% of the Company’s risk based capital as compared to $37.4 million in loans classified as substandard at December 31, 2014. It is the intent of the Company to continue to place a heavy emphasis on this strategy, with a goal to maintain our level of classified asset to risk based capital at less than 30%.

At December 31, 2015, approximately $10.6 million, or 47.3% of the Company’s land portfolio (non-agricultural related) is classified as substandard. At December 31, 2015, the Company has no land loans under development. At December 31, 2015, the inventory of land loans includes 84 lots available for sale with an aggregate loan balance of $2.7 million. The average lot has a loan balance of approximately $32,700. At December 31, 2015, the Company has one land loan, totaling $1.6 million, in non-accrual status. The loan has 33 unsold lots that are a mixture of commercial and residential with an average balance per lot of approximately $39,000. Also at December 31, 2015, the Company has $15.5 million land loans on property that is designated for future development in which no meaningful infrastructure has been financed. These loans represent 1,234 acres of land with an average price per acre of approximately $12,200.

 

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Table of Contents

At December 31, 2014, the inventory of land loans included 131 lots available for sale with an aggregate loan balance of $3.4 million. The average lot had an average loan balance of approximately $26,300. Also at December 31, 2014, the Company has $16.8 million in land loans on property that is designated for future development in which no meaningful infrastructure has been financed. These loans represent approximately 1,247 acres of land with an average price per acre of approximately $13,500. The remaining $6.5 million in land loans are considered to be used for personal and recreational purposes. At December 31, 2014, the Company had $18.5 million in land loans on property that is designated for future development in which no meaningful infrastructure has been started. These loans represented approximately 1,322 acres of land with an average price per acre of approximately $14,000. The reduction of land loans classified as substandard remains a high priority of management.

For the year ended December 31, 2015, the Company recorded net income available for common shareholders of $2.4 million, a return on average assets of 0.27% and a return on average equity of 2.65%. The Company’s small improvement in net income was the result of lower FHLB borrowing cost, which was largely offset by lower yields on interest earning assets, a lower volume of interest earning assets, the opening of the LPO and higher core operating expenses.

For the year ended December 31, 2014, the Company recorded net income available for common shareholders of $2.2 million, a return on average assets of 0.23% and a return on average equity of 2.2%. Company results for the year ended December 31, 2014, were adversely affected by the decision to prepay $35.9 million in FHLB advances and incurring a prepayment penalty of $2.5 million and a $1.8 million loss on the sale of a substandard rated commercial real estate loan.

For the year ended December 31, 2013, the Company recorded net income available for common shareholders of $3.8 million, a return on average assets of 0.39% and a return on average equity of 3.59%. Company results for the year ended December 31, 2013, improved as a result of the repurchase of preferred stock in December of 2012. On January 16, 2013, the Company repurchased the Warrant from the Treasury for $256,257.

The Company’s net income is dependent primarily on its net interest income, which is the difference between interest income earned on its loans, investment securities and mortgage-backed securities portfolios and interest paid on interest-bearing liabilities. Net interest income is determined by (i) the difference between yields earned on interest-earning assets and rates paid on interest-bearing liabilities (“interest rate spread”) and (ii) the relative amounts of interest-earning assets and interest-bearing liabilities. The Company’s interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. To a lesser extent, the level of non-interest expenses such as compensation, employee benefits, data processing expenses, local deposit and federal income taxes also affect the Company’s net income.

The operations of the Company and the entire financial services are significantly affected by prevailing economic conditions, competition and the monetary, fiscal and regulatory policies of governmental agencies. Lending activities are influenced by the demand for and supply of housing, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of funds are influenced by prevailing market rates of interest, primarily on competing investments, account maturities and the levels of personal income and savings in the Company’s market area.

 

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Table of Contents

Aggregate Contractual Obligations

 

     Maturity by Period  
December 31, 2015 (In thousands)    Less than     

Greater

than 1 year

    

Greater

than 3 year

    

Greater

than

        
     1 year      to 3 years      to 5 years      5 years      Total  

Deposits

   $ 626,071         97,256         16,079         —           739,406   

FHLB borrowings

     4,000         11,000         —           —           15,000   

Repurchase agreements

     45,770         —           —           —           45,770   

Subordinated debentures

     —           —           —           10,310         10,310   

Lease commitments

     212         249         18         —           479   

Purchase obligations

     2,140         3,495         1,380         —           7,015   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 678,193         112,000         17,477         10,310         817,980   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Deposits represent non-interest bearing, money market, savings, interest bearing checking accounts and certificates of deposits held by the Company. Amounts that have an indeterminate maturity period are included in the less than one-year category.

FHLB borrowings represent the amounts that are due to FHLB of Cincinnati. All amounts have fixed maturity dates. On December 30, 2014, the Company pre-paid $35.9 million in advances and incurred a $2.5 million prepayment penalty in the process. At December 31, 2015, the Company has three advances at the FHLB, a $4.0 million advance due in March 2016 at a rate of 5.34%, a $5.0 million advance due in October 2017 at a rate of 0.88% and a $6.0 million advance due in July 2018 at a rate of 1.18%.

Repurchase agreements represent both long term wholesale and short term retail repurchase accounts. The Company’s one remaining wholesale repurchase agreement has a $6.0 million balance, a rate of 4.36%, and matures on September 18, 2016. Retail repurchase agreements mature daily and pay interest based on their account balances.

Subordinated debentures represent the amount borrowed in a private pool trust preferred issuance group on September 25, 2003. The debentures are priced at the three-month LIBOR plus 3.10%. At December 31, 2015, the three-month LIBOR rate was 0.61%. The debentures re-price and pay interest quarterly and have a thirty-year final maturity. The debentures may be called at the issuer’s discretion on a quarterly basis after five years. The interest rate of the debentures reset on the 8th day of January, April, August and November of each year.

Lease commitments represent the total minimum lease payments under non-cancelable operating leases.

The most significant operating contract is for the Company’s data processing services, which re-prices monthly based on the number of accounts and other operational factors. The Company’s operating contract with the current data processing provider is currently set to expire September 30, 2019.

Off Balance Sheet Arrangements

 

     Maturity by Period  
December 31, 2015 (In thousands)    Less than     

Greater

than 1 year

    

Greater

than 3 year

    

Greater

than

        
     1 year      to 3 years      to 5 years      5 years      Total  

Commercial lines of credit

   $ 29,653         24,539         49         705         54,946   

Commitments to extend credit

     32,684         9,679         2,083         1,917         46,363   

Standby letters of credit

     56         12         —           —           68   

Home equity lines of credit

     317         2,282         4,310         23,080         29,989   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 62,710         36,512         6,442         25,702         131,366   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Standby letters of credit represent commitments by the Company to repay a third party beneficiary when a customer fails to repay a loan or debt instrument. The terms and risk of loss involved in issuing standby letters of credit are similar to those involved in issuing loan commitments and extending credit. In addition to credit risk, the Company also has liquidity risk associated with stand-by letters of credit because funding for these obligations could be required immediately. Unused lines of credit represent commercial and residential equity lines of credit with maturities ranging from one to fifteen years.

Accounting for Derivative Instruments and Hedging Activities

In October 2008, the Bank entered into a receive fixed pay variable swap transaction in the amount of $10.0 million with Compass Bank of Birmingham in which Heritage Bank will pay Compass a fixed rate of 7.27% quarterly for seven years while Compass paid Heritage Bank a rate equal to the three month LIBOR plus 3.10%, the rate banks in London charge one another for overnight borrowings. The Bank signed an inter-company transfer with the Company that allowed the Company to convert its variable rate subordinated debenture issuance to a fixed rate. The critical terms of the interest rate swap matched the term of the corresponding variable rate subordinated debt issuance. The Company considered the interest rate swap a cash flow hedge and conducted a quarterly analysis to ensure that the hedge was effective. The derivative matured on October 8, 2015.

Quantitative and Qualitative Disclosure about Market Risk

Quantitative Aspects of Market Risk. The principal market risk affecting the Company is risk associated with interest rate volatility (interest rate risk). The Company does not maintain a trading account for investment securities. The Company is not subject to foreign currency exchange rate risk or commodity price risk. Substantially all of the Company’s interest rate risk is derived from the Bank’s lending, deposit taking, and investment activities. This risk could result in reduced net income, loss in fair values of assets and/or increases in fair values of liabilities due to changes in interest rates.

Qualitative Aspects of Market Risk. The Company’s principal financial objective is to achieve long-term profitability while reducing its exposure to fluctuating market interest rates. The Company has sought to reduce the exposure of its earnings to changes in market interest rates by attempting to manage the mismatch between assets and liabilities maturities and interest rates. The principal element in achieving this objective is to increase the interest rate sensitivity of the Company’s interest-earning assets by retaining for its portfolio loans with interest rates subject to periodic adjustment to market conditions. The Company relies on retail deposits as its primary source of funds. However, management is utilizing brokered deposits, wholesale repurchase agreements and FHLB borrowings as sources of liquidity. As part of its interest rate risk management strategy, the Bank promotes demand accounts, overnight repurchase agreements and certificates of deposit with primarily terms of up to five years.

Asset / Liability Management

Key components of a successful asset/liability strategy are the monitoring and managing of interest rate sensitivity of both the interest-earning asset and interest-bearing liability portfolios. The Company has employed various strategies intended to minimize the adverse affect of interest rate risk on future operations by providing a better match between the interest rate sensitivity between its assets and liabilities. In particular, the Company’s strategies are intended to stabilize net interest income for the long-term by protecting its interest rate spread against increases in interest rates. Such strategies include the origination of adjustable-rate mortgage loans secured by one-to-four family residential real estate, and, to a lesser extent, multi-family real estate loans and the origination of other loans with interest rates that are more sensitive to adjustment based upon market conditions than long-term, fixed-rate residential mortgage loans. At December 31, 2015, approximately $125.3 million of the $181.4 million of one-to-four family residential loans originated by the Company (comprising 69.1% of such loans) had adjustable rates or will mature within one year.

 

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The U.S. government agency securities generally are purchased for a term of fifteen years or less. Securities may or may not have call options. A security with call options improves the yield on the security but also has little or no positive price convexity. Non-callable securities or securities with one time calls offer a lower yield but more positive price convexity and an improved predictability of cash flow. Generally, securities with the greater call options (continuous and quarterly) are purchased only during times of extremely low interest rates. The reasons for purchasing these securities generally focus on the fact that a non-callable or one time call is of little value if rates are exceptionally low.

At December 31, 2015, the Company owns one U.S. Treasury security with a market value of $2.0 million maturing on April 15, 2017. U.S. Treasury securities have the full faith and credit guarantee of the United States government. At December 31, 2015, the Company’s agency security portfolio consisted of $2.2 million of unsecured debt issued by Tennessee Valley Authority (“TVA”), $12.9 million issued by the Federal Home Loan Bank (FHLB) and $15.4 million issued by the Federal Farm Credit Bank (FFCB). All U.S. Agency debt securities have a credit rating of AA+ and continue to maintain the implicit backing of the United States of America with the exception of TVA debt, which maintains the full faith and credit of the United States of America.

At December 31, 2015, $4.2 million in agency securities were due within five years, approximately $22.3 million were due in five to ten years and approximately $4.0 million were due in more than ten years. At December 31, 2015, $9.4 million of these securities had a call provision, which authorizes the issuing agency to prepay the securities at face value on or before October 13, 2017 If, prior to their maturity dates, market interest rates decline below the rates paid on the securities, the issuing agency may elect to exercise its right to prepay the securities. At December 31, 2015, the non-amortizing agency portfolio has an estimated weighted average maturity is 6.5 years and an effective duration of 5.9 years.

The Company owns significant positions in agency securities issued by the Small Business Administration. These securities are classified as SBAPs, SBICs and SBA Pools. The SBAP notes have a twenty year maturity, pay interest monthly and principal semi-annually. The SBIC notes have a ten year final maturity and pay principal and interest quarterly. SBA pools are floating rate securities tied to prime that may have final maturities of ten, twenty-five or thirty years and pay principal and interest monthly. The interest rates on SBA pools reset either on a quarterly or monthly basis, providing the Company with lower price volatility as compared to fixed rate securities. The purchase of variable rate securities with low price volatility provides the Company with a source of lower risk liquidity should loan demand improve or interest rates increase. The risk in purchasing SBA Pools is that they are typically purchased at significant premiums and therefore carry a greater than higher level of prepayment risk while providing lower yields as compared to many long term fixed rate investment products.

All SBA securities, SBAP, SBIC’s and SBA Pools are backed by the full faith and credit of the United States Government and classified by the Company’s regulators as zero risk based assets. SBIC notes are ten year notes that typically are used to finance equipment for businesses. SBIC notes behave somewhat similar to a ten year mortgage backed security, with slow prepayments in their first two or three years and then an acceleration of prepayment. SBAP notes are twenty year amortizing notes typically used to finance commercial real estate. SBAP typically experience slower prepayment speeds as compared to 20 year GNMA mortgage backed securities as SBAP notes typically have prepayment penalties that make it cost prohibitive for many borrowers to prepay during the first five years of the loan. Current SBA pools are experiencing abnormally slow prepayment speeds as the loans tied to the prime rate provide relatively inexpensive financing for businesses requiring an SBA guarantee to meet their credit needs. Typically, SBA pools will experience an increase in prepayments as they become more than three years old.

At December 31, 2015, the Company’s agency bond portfolio includes approximately $53.3 million in SBAP securities, $6.0 million in SBIC securities and $3.1 million in SBA Pools. At December 31, 2015, the weighted average life of the Company’s amortizing U.S. Agency portfolio is 4.6 years and the portfolio has an effective duration of 4.0 years.

 

8


Table of Contents

The Company maintains a significant municipal bond portfolio. The majority of the municipal portfolio was purchased during 2008 and 2009 as municipal bond yields increased to levels not seen in the last ten years despite record low Treasury rates. The municipal bond portfolio largely consists of local school district and county courthouse bonds with guarantees from both the local counties and the State of Kentucky and general obligations bonds issued by municipalities in Kentucky. As outlined below, the Company’s exposure to municipal securities outside the Commonwealth of Kentucky is limited to $4.1 million at December 31, 2015. At December 31, 2015, the Company’s municipal portfolio consists of the following types of securities:

 

    

Market Value

(Dollars in Thousands)

 

•    Kentucky school bonds

   $ 21.8   

•    Kentucky courts and facilities

     7.2   

•    Kentucky general obligations

     7.2   

•    Other Kentucky bonds

     10.5   

•    Out of state bonds

     4.1   
  

 

 

 

Total

   $ 50.8   
  

 

 

 

At December 31, 2015, the Company has $44.6 million in tax free municipal bonds and $6.2 million in taxable municipal bonds. Tax free municipal bonds were purchased to provide long-term income stability and higher tax equivalent yields as compared to other portions of the Company’s investment portfolio. The Company’s investment policy limits municipal concentrations to 125% of the Bank’s Tier 1 Capital, currently $93.3 million. The investment policy places a concentration limit on the amounts of municipal bonds per issuer in Tennessee and Kentucky to 15% of the Bank’s Tier 1 Capital and out of market issuers to 10% of Tier 1 Capital. At December 31, 2015, the largest municipal bond concentration for one issuer was $2.9 million. The investment policy limits concentrations in the amounts a single state guarantee program can provide to a bond at 75% of Tier 1 Capital. The Company is currently within policy guidelines on all concentration limits.

At December 31, 2015, no municipal bonds were due in less than one year, $12.1 million were due within one to five years, $20.4 million were due in five to ten years, $14.1 million were due in ten to fifteen years and $4.2 million were due in fifteen years. At December 31, 2015, approximately $34.6 million of the Company’s municipal bond portfolio is callable with call dates ranging from March 2016 to December 2022. The majority of callable municipal bonds purchased by the Company were originally scheduled to have a call ten years after issuance. At December 31, 2015, approximately $2.6 million of municipal bonds had a call date of less than one year, approximately $27.2 million had a call date from one to five years and approximately $4.8 million and had a call date in more than five years but less than ten years. At December 31, 2015, the weighted average life of the tax free municipal bond portfolio is 3.9 years and its modified duration is 3.6 years. At December 31, 2015, the weighted average life of the taxable municipal bond portfolio is 4.8 years and its modified duration is 4.3 years.

Mortgage-backed securities entitle the Company to receive a pro-rata portion of the cash flow from an identified pool of mortgages. Although mortgage-backed securities generally offer lesser yields than the loans for which they are exchanged, mortgage-backed securities present lower credit risk by virtue of the guarantees that back them, are more liquid than individual mortgage loans, and may be used to collateralize borrowings or other obligations of the Company. Further, mortgage-backed securities provide a monthly stream of both interest and principal, thereby providing the Company with a cash flow to reinvest at current market rates and limit the Company’s interest rate risk. Mortgage backed securities may be collateralized by either single family or multi-family properties.

At December 31, 2015, the Company’s mortgage backed security portfolio consisted of $8.1 million issued by the FHLMC, $28.3 million issued by the FNMA and $30.0 million issued by the Government National Mortgage Agency (GNMA). GNMA securities are guaranteed by the full faith and credit of the U.S. Government while FHLMC and FHLB mortgage backed securities maintain the implicit backing of the United States of America.

 

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In 2015, the prepayment speeds of single family mortgage backed securities slowed considerable as most homeowners with a desire to refinance their home had already done so. At December 31, 2015, approximately $20.6 million of the Company’s mortgage back security portfolio consisted of adjustable rate mortgages. These mortgages are fixed for a period of one, three or five years and then revert to a one year adjustable rate mortgage. At December 31, 2015, the weighted average life of the fixed rate mortgage loan portfolio is approximately 4.7 years and an effective duration is approximately 4.1 years. At December 31, 2015, the weighted average life of the adjustable rate mortgage loan portfolio is approximately 6.2 years and an effective duration is approximately 5.4 years.

At December 31, 2015, the Company held approximately $19.5 million in Collateral Mortgage Obligations (CMO) issued by various agencies of the United States government, including $4.0 million by GNMA and $15.5 million by FNMA. A CMO is a mortgage-backed security that has a structured payment stream based on various factors and does not necessarily remit monthly principal and interest on a pro-rata basis. At December 31, 2015, approximately $7.5 million of the CMO portfolio consisted of pools of multi-family loans and $12.0 million consisted of pools of single family loans. At December 31, 2015, the Company’s CMO portfolio had a weighted average life of approximately 3.5 years and a modified duration of approximately 3.2 years.

At December 31, 2015, the Company held $177,000 of a private label CMO and $3.5 million in floating rate SLMA collateralized debt obligation (“CDO”) secured by federally guaranteed student loans. The CDO owned by the Company utilizes a pool of government guaranteed student loans as collateral and not mortgage loans. The CDO’s secured by SLMA collateral are floating rate securities tied to the one month LIBOR rate and re-price on a monthly basis.

In June of 2008, the Company purchased $2.0 million par value of a private placement subordinated debenture issued by First Financial Services Corporation (“FFKY”), the holding company for First Federal Savings Bank (“First Fed”). The debenture is a thirty year security with a coupon rate of 8.00%. FFKY was a NASDAQ listed commercial bank holding company located in Elizabethtown, Kentucky. In October of 2010, FFKY informed the owners of its subordinated trust, including the Company, that it would defer future dividend payments for up to five years as prescribed by the trust. FFKY and First Fed have significant asset quality issues that have resulted in negative earnings since 2009. In 2013, the Company recognized a $400,000 other than temporary impairment loss on the subordinated debenture issued by FFKY. The recognition of a loss was the result of the Company’s analysis that, despite a slowly improving financial condition, FFKY was not likely to resume dividend payments prior to the end of the five year interest rate extension period.

On January 1, 2015, FFKY was sold and merged into Community Bank Shares of Indiana, (“CBIN”). On January 12, 2015, the Company was notified by Wilmington Trust that its investment in First Federal Statutory Trust III, (“FFKY Trust”), had elected to terminate the extension period of interest payments effective January 1, 2015. All accrued interest due and payable to all owners of securities through March 15, 2015, was paid to the Trustee in January 2015 and remains current at December 31, 2015. On January 21, 2015, the Company determined that FFKY Trust is no longer impaired and has placed the investment back into accrual status. On July 1, 2015, CBIN changed its NASDAQ ticker symbol to YCB.

Interest Rate Sensitivity Analysis

The Company’s profitability is affected by fluctuations in interest rates. A sudden and substantial increase or decrease in interest rates may adversely impact the Company’s earnings to the extent that the interest rates on interest earning assets and interest bearing liabilities do not change at the same speed, to the same extent or on the same basis. As part of its effort to manage interest rate risk, the Bank monitors its net economic value of capital (“EVE”) by using our asset liability software to assist in modeling how changes in interest rates affect the values of various assets and liabilities on the Company’s balance sheet. By calculating our EVE, the Company is able to construct models that show the effect of different interest rate changes on its total capital. This risk analysis is a key tool that allows banks to prepare against constantly changing interest rates.

 

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Generally, EVE is a cash flow calculation that takes the present value of all asset cash flows and subtracts the present value of all liability cash flows. The application of the methodology attempts to quantify interest rate risk as the change in the EVE, which would result from a theoretical 200 basis point (1 basis point equals .01%) change in market rates. Both a 300 basis point increase in market interest rates and a 100 basis point decrease in market interest rates are considered.

The following table presents the Company’s EVE at December 31, 2015, as calculated by the Company’s asset liability model for the year period ending December 31, 2015.

 

Change    Net Portfolio Value  

In Rates

   $ Amount      $ Change      % Change  
     (Dollars in thousands)  

+300 bp

   $ 80,442       ($ 21,716      (21.3 %) 

+200 bp

     89,022         (13,136      (12.9 %) 

+100 bp

     96,589         (5,569      (5.5 %) 

      0 bp

     102,158         —           —     

-100 bp

     107,843         5,685         5.6

 

Interest Rate Risk Measures: 200 Basis Point (bp) Rate Shock

 

Tangible Common Equity Ratio at December 31, 2015

     9.7

Pre-Shock Tier 1 Capital Ratio at December 31, 2015

     10.9

Exposure Measure: 2% Increase in Rates

     8.3

The computation of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay rates, and should not be relied upon as indicative of actual results. The computations do not contemplate any actions the Company could undertake in response to changes in interest rates. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring an institution’s interest rate sensitivity “gap.” An asset or liability is said to be interest rate sensitive within a specific period if it will mature or re-price within that period.

Interest Income Analysis

As a part of the Company’s asset liability management process, an emphasis is placed on the effect that changes in interest rates have on the net interest income of the Company and the resulting change in the net present value of capital. As a part of its analysis, the Company uses third party software and analytical tools derived from the Company’s regulatory reporting models to analyze the re-pricing characteristics of both assets and liabilities and the resulting net present value of the Company’s capital given various changes in interest rates. The model also uses mortgage prepayment assumptions obtained from third party vendors to anticipate prepayment speeds on both loans and investments. The Company’s model uses incremental changes in interest rates. For example, a 3.0% change in annual rates includes a 75 basis point change in each of the next four quarters.

For the year ended December 31, 2015, the Company’s previous efforts to increase duration in our investment portfolio had a positive effect on its results of operations. At December 31, 2015, the investment portfolio’s duration has been reduced largely through the reduction in the six of the portfolio. The Company purchased a large volume of municipal bonds in 2008 and 2009 and those bonds are approaching their ten year call dates. The Company’s current models indicate that a large percentage of these bonds will be called in 2019 with a 2% increase in interest rates. The Company continues to analyze our municipal portfolio for future sale candidates given our concentration in Kentucky municipal bonds and the status of Commonwealth of Kentucky having to most underfunded public pension system in the United States.

 

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Management continues to focus on reducing the Company’s cost of interest bearing liabilities by reducing both the cost and dependency on time deposit funding and FHLB advances. The average balance and weighted average cost of time deposits has declined in each of the last two years. The average balance of time deposits for the year ended December 31, 2015 was $320.9 million, as compared to $356.1 million and $407.0 million for the years ended December 31, 2014, and December 31, 2013, respectively. The average balance of FHLB borrowings for the years December 31, 2015, 2014, and 2012 were $17.3 million, $42.4 million and $44.9 million, respectively.

The average cost of time deposits for the years ended December 31, 2015, December 31, 2014, and December 31, 2013, was 1.16%, 1.17% and 1.41%, respectively. In January and February of 2016, the Company has approximately $52.4 million in time deposits maturing with a weighted average cost of 2.52%. See Note 6 of the Consolidated Financial Statements for more details.

The average cost of FHLB borrowings for the years ended December 31, 2015, December 31, 2014, and December 31, 2013, was 1.67%, 3.92% and 3.96%, respectively. The Company has a $4.0 million FHLB borrowing maturing in March 2016 with a current cost of 5.36%. See Note 7 of the Consolidated Financial Statements for more details.

The amount of change in interest rate sensitivity eventually achieved by management will be largely dependent on its ability to make changes at a reasonable cost. The reduction of interest rate in the one to two year time frame can dramatically reduce the Company’s net income due to the severe upward slope of the interest rate yield curve. To the extent possible, management will reduce its balances in FHLB deposits to ensure greater flexibility in the event of a sudden change of interest rates.

The Company’s analysis at December 31, 2015, indicates that changes in interest rates are likely to result in modest changes in the Company’s annual net interest income. A summary of the Company’s analysis at December 31, 2015, for the year ending December 31, 2016, is as follows:

 

     Down 1.00%      No Change      Up 1.00%      Up 2.00%      Up 3.00%  
     (Dollars in Thousands)  

Net interest income

   $ 26,207       $ 27,754       $ 28,770       $ 29,477       $ 29,964   

Gap Analysis

The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or re-pricing within a specific time period and the amount of interest-bearing liabilities maturing or re-pricing within that time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities, and is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets.

At December 31, 2015, the Company had a negative one year or less interest rate sensitivity gap of 26.90% of total interest-earning assets. Generally, during a period of rising interest rates, a negative gap position would be expected to adversely affect net interest income while a positive gap position would be expected to result in an increase in net interest income. Conversely during a period of falling interest rates, a negative gap would be expected to result in an increase in net interest income and a positive gap would be expected to adversely affect net interest income. This analysis is considered less reliable as compared to the Company’s ALM models as changes in various interest rate spreads are not incorporated in Gap Analysis. Furthermore, the presence of non-interest bearing liabilities does not factor in the Company’s Gap Analysis but provides an additional source of funds that can offset the negative impact of changing interest rates. Gap Analysis does not give considerations to how much the yield on assets and the cost of liabilities may change in any given period. In the current rate environment, loans yields often re-price more quickly and more substantially as opposed to short-term deposits, which are currently priced at much lower levels.

 

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Table of Contents

The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2015, which are expected to mature, are likely to be called or re-priced in each of the time periods shown.

 

           Over one     Over Five     Over Ten     Over        
     One Year     Through     Through     Through     Fifteen        
     or Less     Five Years     Ten Years     Fifteen Years     Years     Total  

Interest-earning assets

            

Loans:

            

1 - 4 family residential

   $ 73,139        23,197        27,275        18,405        42,190        184,206   

Multi-family

     10,883        3,215        6,390        1,857        2,380        24,725   

Construction

     18,032        16,846        —          —          —          34,878   

Non-residential

     84,787        35,612        14,681        8,055        6,576        149,711   

Land

     13,680        7,514        136        554        569        22,453   

Farmland

     26,733        4,861        6,435        2,158        2,059        42,246   

Consumer

     14,289        5,687        299        49        —          20,324   

Commercial

     61,629        17,029        7,741        344        —          86,743   

Interest bearing deposits

     7,772        —          —          —          —          7,772   

Non-amortizing securities

     2,551        42,560        33,467        228        6,379        85,185   

Amortizing securities

     16,285        22,824        15,612        4,996        2,732        62,449   

Mortgage backed securities

     18,314        19,178        22,386        17,909        11,756        89,543   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     348,094        198,523        134,422        54,555        74,641        810,235   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest bearing liabilities:

            

Deposits

     501,001        113,335        —          —          —          614,336   

Borrowed funds

     65,080        6,000        —          —          —          71,080   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     566,081        119,335        —          —          —          685,416   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest sensitivity gap

   ($ 217,987     79,188        134,422        54,555        74,641        124,819   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cumulative interest sensitivity gap

   ($ 217,987     (138,799   ($ 4,377   $ 50,178      $ 124,819        124,819   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of interest-earning assets to interest bearing liabilities

     61.49     166.36     —          —          —          118.21
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of cumulative gap to total interest-earning assets

     (26.90 %)      (17.13 %)      (0.54 %)      6.19     15.41     15.41
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The preceding table was prepared based upon the assumption that loans will not be repaid before their respective contractual maturities, except for adjustable rate loans, which are classified, based upon their next re-pricing date. Further, it is assumed that fixed maturity deposits are not withdrawn prior to maturity and other deposits are withdrawn or re-priced within one year. Mortgage-backed securities are classified based on their three month prepayment speeds. Prepayment speeds on mortgage backed securities have slowed considerably as many outstanding mortgage loans have low coupons and are not prone to future refinancing. We anticipate that the majority of mortgage pools will exhibit historically low prepayment speeds for several years. The preceding table does not reflect possible changes in cash flows that may result from this change in Fannie Mae and Freddie Mac portfolio servicing practices or Small Business Administration lending practices. The actual interest rate sensitivity of the Company’s assets and liabilities could vary significantly from the information set forth in the table due to market and other factors. The retention of adjustable-rate mortgage loans in the Company’s investment and loan portfolios helps reduce the Company’s exposure to changes in interest rates. However, there are unquantifiable credit risks resulting from potential increased costs to borrowers as a result of re-pricing adjustable-rate mortgage loans. It is possible that during periods of rising interest rates, the risk of default on adjustable-rate mortgage loans may increase due to the upward adjustment of interest costs to the borrowers.

 

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Table of Contents

Average Balance, Interest and Average Yields and Rates

The following table sets forth certain information relating to the Company’s average interest-earning assets and average interest-bearing liabilities and reflects the average yield on assets and average cost of liabilities for the periods and at the date indicated. Such yields and costs are derived by dividing income or expense by the average monthly balance of assets or liabilities, respectively, for the periods presented. Average balances are derived from month-end balances. Management does not believe that the use of month-end balances instead of daily balances has caused any material difference in the information presented.

The table also presents information for the periods and at the date indicated with respect to the difference between the average yield earned on interest-earning assets and average rate paid on interest-bearing liabilities, or “interest rate spread,” which commercial banks have traditionally used as an indicator of profitability. Another indicator of an institution’s net interest income is its “net yield on interest-earning assets,” which is its net interest income divided by the average balance of interest-earning assets. Net interest income is affected by the interest rate spread and by the relative amounts of interest-earning assets and interest-bearing liabilities. When interest-earning assets approximate or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income. The following table is for the month of December 31, 2015.

 

     December 2015 Monthly Averages  
     Balance      Weighted
Average Yield/
Cost
 
     (Dollars in thousands)  

Interest-earning assets:

     

Loans receivable, net

   $ 561,665         4.65

Non taxable securities available for sale

     50,305         4.47 %* 

Taxable securities available for sale

     188,244         2.05

Federal Home Loan Bank stock

     4,428         3.75

Interest bearing deposits

     20,380         0.29
  

 

 

    

 

 

 

Total interest-earning assets

     825,022         3.92

Non-interest-earning assets

     72,601      
  

 

 

    

Total assets

   $ 897,623      
  

 

 

    

Interest-bearing liabilities:

     

Deposits

   $ 622,462         0.84

FHLB borrowings

     15,000         2.19

Repurchase agreements

     42,916         2.91

Subordinated debentures

     10,310         7.22
  

 

 

    

 

 

 

Total interest-bearing liabilities

     690,688         0.96

Non-interest-bearing liabilities

     119,305      
  

 

 

    

Total liabilities

     809,993      

Common stock

     79      

Additional paid-in capital

     58,624      

Retained earnings

     47,104      

Treasury stock

     (13,471   

Unearned ESOP shares

     (7,180   

Accumulated other comprehensive income

     2,474      
  

 

 

    

Total liabilities and equity

   $ 897,623      
  

 

 

    

Interest rate spread

        2.96
     

 

 

 

Net interest margin

        3.18
     

 

 

 

Ratio of interest-earning assets to interest-bearing liabilities

        119.45
     

 

 

 

 

* Tax equivalent yield at the Company’s 34% tax bracket and the Company’s month to date cost of funds rate of 0.96%.

 

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Table of Contents
     Years Ended December 31,  
     2015     2014     2013  
     Average
Balance
    Interest      Average
Yield/
Cost
    Average
Balance
    Interest      Average
Yield/
Cost
    Average
Balance
    Interest      Average
Yield /
Cost
 
     (Dollars in Thousands)  

Interest-earning assets:

                     

Loans receivable, net (a)

   $ 552,265        25,322         4.59   $ 534,404        26,038         4.87   $ 528,074        26,750         5.07

Taxable securities AFS

     203,160        6,149         3.03     262,154        6,548         2.50     269,304        6,873         2.55

Non-taxable securities AFS

     52,836        2,464         4.66     64,393        3,097         4.81     70,178        3,292         4.69

Other interest-bearing deposits

     8,528        22         0.26     10,461        26         0.25     9,060        24         0.26
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-earning assets

   $ 816,789        33,957         4.16   $ 871,412        35,709         4.10   $ 876,616        36,939         4.21
    

 

 

    

 

 

     

 

 

    

 

 

     

 

 

    

 

 

 

Non-interest-earning assets

     75,032             77,716             80,609        
  

 

 

        

 

 

        

 

 

      

Total assets

   $ 891,821           $ 949,128           $ 957,225        
  

 

 

        

 

 

        

 

 

      

Interest-bearing liabilities:

                     

Deposits

   $ 612,816        5,031         0.82   $ 640,676        5,603         0.87   $ 657,895        7,114         1.08

Borrowings

     71,084        1,519         2.14     98,574        3,276         3.32     96,823        3,467         3.58
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

     683,900        6,550         0.96     739,250        8,879         1.20     754,718        10,581         1.40
    

 

 

    

 

 

     

 

 

    

 

 

     

 

 

    

 

 

 

Non-interest-bearing liabilities

     117,215             109,766             97,762        
  

 

 

        

 

 

        

 

 

      

Total liabilities

     801,115             849,016             852,480        

Common stock

     79             79             79        

Common stock warrants

     —               —               18        

Additional paid-in capital

     58,544             58,384             75,353        

Retained earnings

     46,305             45,211             39,204        

Treasury stock

     (11,449          (5,998          (14,702     
                     

Unearned ESOP shares

     (5,709          —               —          
                     

Accumulated other comprehensive income

     2,936             2,436             4,793        
  

 

 

        

 

 

        

 

 

      

Total liabilities and equity

   $ 891,821           $ 949,128           $ 957,225        
  

 

 

        

 

 

        

 

 

      

Net interest income

       27,407             26,830             26,358      
    

 

 

        

 

 

        

 

 

    

Interest rate spread

          3.20          2.90          2.81
       

 

 

        

 

 

        

 

 

 

Net interest margin

          3.36          3.08          3.01
       

 

 

        

 

 

        

 

 

 

Ratio of average interest-earning assets to average interest-bearing liabilities

          119.43          117.88          116.15
       

 

 

        

 

 

        

 

 

 

 

(a) Average loans include non-performing loans.
(b) Interest income and yields are presented on a fully tax equivalent basis.

 

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Table of Contents

Rate Volume Analysis

The following table sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to: (i) changes in volume (changes in volume from year to year multiplied by the average rate for the prior year) and (ii) changes in rate (changes in the average rate from year to year multiplied by the prior year’s volume). All amounts are quoted on a tax equivalent basis using a cost of funds rate of 1.20% for 2014 and a 0.96% rate for 2015.

 

     Year Ended December 31,  
     2015 vs. 2014     2014 vs. 2013  
     Increase (Decrease)
due to
          Increase (Decrease)
due to
       
     Rate     Volume     Total
Increase
(Decrease)
    Rate     Volume     Total
Increase
(Decrease)
 
     (Dollars in thousands)  

Interest-earning assets:

            

Loans receivable

   $ (1,535     819        (716   $ (1,020     308        (712

Securities available for sale, taxable

     1,387        (1,786     (399     (146     (179     (325

Securities available for sale, non-taxable

     (94     (539     (633     83        (278     (195

Other interest-earning assets

     1        (5     (4     (2     4        2   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

     (241     (1,511     (1,752     (1,085     (145     (1,230
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-bearing liabilities:

            

Deposits

     (197     (375     (572     (1,100     (411     (1,511

Borrowings

     (1,310     (447     (1,757     (175     (16     (191
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

     (1,507     (822     (2,329     (1,275     (427     (1,702
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Increase (decrease) in net interest income

   $ 1,266        (689     577      $ 190        282        472   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Critical Accounting Policies and Estimates

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The financial information contained within these statements is, to a significant extent, financial information that is based on appropriate measures of the financial effects of transactions and events that have already occurred. Based on its consideration of accounting policies that involved the most complex and subjective decisions and assessments, management has identified its most critical accounting policy to be that related to the allowance for loan losses. The Company’s allowance for loan loss methodology incorporates a variety of risk considerations, both quantitative and qualitative; in establishing an allowance for loan loss that management believes is appropriate at each reporting date. Quantitative factors included the Company’s historical loss experience, delinquency and charge-off trends, collateral values, changes in non-performing loans, and other factors. Quantitative factors also incorporate known information about individual loans, including borrower’s sensitivity to economic conditions throughout the southeast and particular, the state of certain industries. Size and complexity of individual credits in relation to loan structure, existing loan policies and pace of portfolio growth are other qualitative factors that are considered in the methodology.

 

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As the Company adds new products and increases the complexity of the loan portfolio, its methodology accordingly may change. In addition, it may report materially different amounts for the provision for loan losses in the statement of operations if management’s assessment of the above factors changes in future periods. This discussion and analysis should be read in conjunction with the Company’s consolidated financial statements and the accompanying notes presented elsewhere herein. Although management believes the levels of the allowance for loan losses as of both December 31, 2015 and December 31, 2014, were adequate to absorb inherent losses in the loan portfolio, a decline in local economic conditions, or other factors, could result in increasing losses that cannot be reasonably predicted at this time. The Company also considers its policy on non-accrual loans as a critical accounting policy. Loans are placed on non-accrual when a loan is specifically determined to be impaired or when principal or interest is delinquent for 91 days or more.

Comparison of Financial Condition at December 31, 2015 and December 31, 2014

For the year ended December 31, 2015, the Company’s total assets declined by $32.6 million, to $903.2 million as compared to $935.8 million for the year ended December 31, 2014. At December 31, 2015, the Company’s non-interest checking account balances were $125.1 million, as compared to $115.1 million at December 31, 2014. The Company has sought to lower its cost of deposits for several years but placing a greater emphasis on growing our transaction account balances, making the transition away from a heavy dependence on time deposits for the bulk of the Company’s funding needs. As a result, we have experienced a decline in the balances of time deposits. The Company’s time deposit balances declined from $331.9 million at December 31, 2014, to $314.7 million at December 31, 2015. At December 31, 2015, the Company’s balance of borrowing from the FHLB declined to $15.0 million, as compared to $34.0 million at December 31, 2014.

The available for sale portfolio declined $66.4 million, from $303.6 million at December 31, 2014, to $237.2 million at December 31, 2015. The Company used cash flows from the investment portfolio to fund a reduction in time deposits, FHLB borrowings, to repurchase treasury stock and loan growth. At December 31, 2015, the Company’s investment in Federal Home Loan Bank stock was carried at an amortized cost of $4.4 million.

The Company’s net loan portfolio increased by $17.1 million during the year ended December 31, 2015. Net loans totaled $539.3 million and $556.3 million at December 31, 2014, and December 31, 2015, respectively. In 2015, the majority of the Company’s loan portfolio growth occurred as a result of opening a loan production office in Nashville, Tennessee, in October 2014. At December 31, 2015, the Nashville loan production office had outstanding loans of $15.4 million.

The allowance for loan losses totaled $5.7 million at December 31, 2015, a decline of $589,000 from the allowance for loan losses of $6.3 million at December 31, 2014. The ratio of the allowance for loan losses to total loans was 1.01% and 1.15% at December 31, 2015, and December 31, 2014, respectively. Also, at December 31, 2015, the Company’s non-accrual loans were approximately $7.4 million, or 1.32% of total loans, compared to $3.2 million or 0.58% of total loans, December 31, 2014. The Company’s ratio of allowance for loan losses to non-accrual loans at December 31, 2015 and December 31, 2014, was 76.80% and 198.08%, respectively.

 

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Comparison of Operating Results for the Years Ended December 31, 2015 and 2014

Net Income. The Company’s net income available for common shareholders for the year ended December 31, 2015, was $2.4 million compared to $2.2 million for the year ended December 31, 2014. The slight improvement in net income for the year ended December 31, 2015, as compared to December 31, 2014, was largely the result the collection of $800,000 of past due interest on a previously impaired investment security.

Net Interest Income. Net interest income for the year ended December 31, 2015, was $26.6 million, compared to $25.8 million for the year ended December 31, 2014. The increase in net interest income for the year ended December 31, 2015, was largely the result of a $2.3 million reduction in interest expense, offsetting a $1.6 million decline in interest income.

For the year ended December 31, 2015, the Company’s tax equivalent average yield on total interest-earning assets was 4.16% compared to 4.10% for the year ended December 31, 2014, and its average cost of interest-bearing liabilities was 0.96%, compared to 1.20% for the year ended December 31, 2014. As a result, the Company’s tax equivalent interest rate spread for the year ended December 31, 2015, was 3.20%, compared to 2.90% for the year ended December 31, 2014, and its tax equivalent net interest margin was 3.36% for the year ended December 31, 2015, compared to 3.08% for the year ended December 31, 2014.

Interest Income. Interest income declined $1.6 million from $34.7 million to $33.1 million, or approximately 4.5% during the year ended December 31, 2015, compared to the year ended December 31, 2014. The decline in interest income was largely attributable to a decline in yields on assets and a decline in the average balance of the Company’s available for sale portfolio. The average balance on taxable securities available for sale declined $59.0 million, from $262.2 million for the year ended December 31, 2014, to $203.2 million for the year ended December 31, 2015. The average yield on taxable securities available for sale was 3.03% and 2.50%, respectively, for the years ended December 31, 2015, and December 31, 2014, respectively. The average balance of non-taxable securities available for sale declined by approximately $11.6 million, from $64.4 million for the year ended December 31, 2014, to $52.8 million for the year ended December 31, 2015. The average yield on non-taxable securities available for sale decreased from 4.81% for the year ended December 31, 2014, to 4.66% for the year ended December 31, 2015. For the year ended December 31, 2015, the average balance of loans was $552.3 million, an increase of $17.9 million as compared to the year ended December 31, 2014. The average yield on loans declined from 4.87% for the year ended December 31, 2014, to 4.59% for the year ended December 31, 2015.

Interest Expense. Interest expense declined to $6.6 million for the year ended December 31, 2015, compared to $8.9 million for 2014. The decline in interest expense was largely attributable to the $1.8 million decline in interest expense on borrowed funds. The average cost of average interest-bearing deposits declined from 0.87% for the year ended December 31, 2014, to 0.82% for the year ended December 31, 2015. Over the same period, the average balance of interest bearing deposits declined from $640.7 million for the year ended December 31, 2014, to $612.8 million for the year ended December 31, 2015. The Company’s cost structure has benefited from its growth of non-interest bearing deposits. For the year ended December 31, 2015, the average balance of non-interest bearing deposits was $113.3 million, an increase of $8.4 million, or 8.0%, over the average balance of non-interest bearing deposits for the year ended December 31, 2014. The average balance of FHLB borrowings declined from $42.4 million for the year ended December 31, 2014, to $17.3 million for the year ended December 31, 2015, as the Company paid off a sizable portion of its FHLB borrowings. The average cost of FHLB borrowings decreased from 3.92% for the year ended December 31, 2014, to 1.67% for the year ended December 31, 2015.

Provision for Loan Losses. The Company determined that an additional $1.1 million in provision for loan losses was required for the year ended December 31, 2015. For the year ended December 31, 2014, the Company determined that significant improvements in our credit quality provided the opportunity to reduce the allowance for loan loss account by $2.3 million. The reduction in the allowance for loan loss account was the result of lower levels of past due loans, improving appraisal values on collateral securing loans classified as substandard, and a continued reduction in the amount of problem assets.

 

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Non-Interest Income. Non-interest income declined by $238,000 for the year ended December 31, 2015, to $7.6 million, compared to $7.8 million for the year ended December 31, 2014. The decline in non-interest income is largely the result of a $429,000 decline in service charge income. The decline in service charge income was partially offset by a $55,000 increase in merchant card income. For the year ended December 31, 2015, the Company’s financial services income declined by $295,000 as compared to the year ended December 31, 2014. For the year ended December 31, 2015, income from mortgage origination income was $1.2 million, as compared to $719,000 for the year ended December 31, 2014. For the year ended December 31, 2015, gains on the sale of securities were $691,000, as compared to $578,000 for the year ended December 31, 2014.

Non-Interest Expense. Total non-interest expense for the year ended December 31, 2015, was $30.4 million, compared to $33.9 million in 2014, a decline of $3.5 million, or approximately 10.3%. The decline in non-interest expense was heavily influenced by a $1.8 million loss on the sale of an adversely classified commercial real estate loan and the $2.5 million FHLB prepayment penalty during the year ended December 31, 2014. For the year ended December 31, 2015, the Company’s salaries and benefits expense increased by $588,000, or 3.9%, as compared to the year ended December 31, 2014. For the year ended December 31, 2015, professional services expenses increased by $175,000, or 13.1% as compared to the year ended December 31, 2014, due to changes implemented for disaster recovery purposes required by regulators. For the year ended December 31, 2015, losses on the sale of other real estate owned increased by $508,000, or 244.2% as compared to the year ended December 31, 2014. For the year ended December 31, 2015, expenses related to other real estate owned increased by $245,000, or 92.1%, due to an increase in the Company’s activities in acquiring and disposing of properties. For the year ended December 31, 2015, no other non-interest expense increased by more than $150,000 as compared to the year ended December 21, 2014.

Income Taxes. The effective tax rates for the years ended December 31, 2015, and December 31, 2014, were 10.2% and (10.1%), respectively. The Company’s effective tax rate remains well below historical levels due to a higher percentage of pre-tax income that is not subject to federal income tax. The Company’s sizable holdings in municipal bonds, life insurance contracts and certain tax credits earned have lowered our effective tax rate.

 

19


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Comparison of Operating Results for the Years Ended December 31, 2014 and 2013

Net Income. The Company’s net income available for common shareholders for the year ended December 31, 2014, was $2.2 million compared to $3.8 million for the year ended December 31, 2013. In 2014, the reduction in net income was largely the result of the Company’s decision to prepay $35.9 million in FHLB borrowings and incur a prepayment penalty of $2.5 million. This action will save the Company approximately $135,000 per month beginning in January 2015 and the Company will recoup our one time penalty in approximately 20 months. During 2014, the Company sold a loan note for a loss of approximately $1.8 million.

Net Interest Income. Net interest income for the year ended December 31, 2014, was $25.8 million, compared to $25.3 million for the year ended December 31, 2015. The increase in net interest income for the year ended December 31, 2014, was largely the result of a $1.5 million reduction in interest expense on deposits, offsetting a $1.2 million decline in interest income. For the year ended December 31, 2014, the Company’s tax equivalent average yield on total interest-earning assets was 4.10% compared to 4.21% for the year ended December 31, 2013, and its average cost of interest-bearing liabilities was 1.20%, compared to 1.40% for the year ended December 31, 2013. As a result, the Company’s tax equivalent interest rate spread for the year ended December 31, 2014, was 2.90%, compared to 2.81% for the year ended December 31, 2013, and its tax equivalent net interest margin was 3.08% for the year ended December 31, 2014, compared to 3.01% for the year ended December 31, 2013.

Interest Income. Interest income declined $1.2 million from $35.9 million to $34.7 million, or approximately 3.3% during the year ended December 31, 2014, compared to 2013. The decline in interest income was largely attributable to a decline in yields on assets and a decline in the average balance of interest earning assets. The average balance on taxable securities available for sale declined from $269.3 million for the year ended December 31, 2013, to $262.2 million for the year ended December 31, 2014. The average yield on taxable securities available for sale was 2.50% and 2.55%, respectively, for the years ended December 31, 2014, and December 31, 2013, respectively. The average balance of non-taxable securities available for sale declined by approximately $5.8 million, from $70.2 million for the year ended December 31, 2013, to $64.4 million for the year ended December 31, 2014. The average yield on non-taxable securities available for sale increased from 4.69% for the year ended December 31, 2013, to 4.81% for the year ended December 31, 2014. For the year ended December 31, 2014, the average balance of loans was $534.4 million, an increase of $6.3 million as compared to the year ended December 31, 2013. The average yield on loans declined from 5.07% for the year ended December 31, 2013, to 4.87% for the year ended December 31, 2014.

Interest Expense. Interest expense declined to $8.9 million for the year ended December 31, 2014, compared to $10.6 million for the year ended December 31, 2013. The decline in interest expense was attributable to the $1.5 million decline in interest expense on deposits. The average cost of average interest-bearing deposits declined to 0.87% for the year ended December 31, 2014, from 1.08% for the year ended December 31, 2013. Over the same period, the average balance of interest bearing deposits declined from $657.9 million for the year ended December 31, 2013, to $640.7 million for the year ended December 31, 2014. The Company’s cost structure has benefited from its growth of non-interest bearing deposits. For the year ended December 31, 2014, the average balance of non-interest bearing deposits was $104.9 million, an increase of $12.5 million, or 13.5%, over the average balance of non-interest bearing deposits for the year ended December 31, 2013. The average balance of FHLB borrowings declined from $44.9 million for the year ended December 31, 2013, to $42.4 million for the year ended December 31, 2014. The average cost of FHLB borrowings decreased from 3.96% for the year ended December 31, 2013, to 3.92% for the year ended December 31, 2014.

Provision for Loan Losses. The Company determined that an additional $1.6 million in provision for loan losses was required for the year ended December 31, 2013. For the year ended December 31, 2014, the Company determined that significant improvements in our credit quality provided the opportunity to reduce the allowance for loan loss account by $2.3 million. The reduction in the allowance for loan loss account was the result of lower levels of past due loans, improving appraisal values on collateral securing loans classified as substandard, and a continued reduction in the amount of problem assets.

 

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Non-Interest Income. Non-interest income declined by $1.6 million for the year ended December 31, 2014, to $7.8 million, compared to $9.4 million for the year ended December 31, 2013. The decline in non-interest income is largely the result of a $1.1 million decline in gains on the sale of securities. For the year ended December 31, 2014, the Company’s financial services income declined by $270,000 as compared to the year ended December 31, 2013, due to the sale of the Company’s insurance assets in December 2013, which resulted in a gain of $412,000 for the year ended December 31, 2013. For the year ended December 31, 2014, income from service charges declined $316,000, to $3.4 million, as compared to the year ended December 31, 2013.

Non-Interest Expense. Total non-interest expense for the year ended December 31, 2014, was $33.9 million, compared to $28.6 million in 2013, an increase of $5.3 million, or approximately 18.4%. The increase in non-interest expense was heavily influenced by a $1.8 million loss on the sale of an adversely classified commercial real estate loan and the $2.5 million FHLB prepayment penalty. Excluding these two expenses, non-interest expense increased by approximately $1.0 million, or 3.4%, for the year ended December 31, 2014, as compared to the year ended December 31, 2013. For the year ended December 31, 2014, the Company’s salaries and benefits expense increased by $489,000, or 3.3%, as compared to the year ended December 31, 2013. For the year ended December 31, 2014, state deposit taxes increased by $755,000, or 130% as compared to the year ended December 31, 2013, due to the charter change of the Company’s bank subsidiaries charter. For the year ended December 31, 2014, data processing expenses increased by $192,000, or 7.12% as compared to the year ended December 31, 2013, due to changes implemented for disaster recovery purposes required by regulators. For the year ended December 31, 2014, no other non-interest expense increased by more than $200,000 as compared to the year ended December 21, 2013. For the year ended December 31, 2014, the Company’s most significant reductions in non-interest expense included occupancy expenses and professional services expenses, which declined $258,000 and $442,000, respectively, for the year ended December 31, 2014, as compared to the year ended December 31, 2013.

Income Taxes. The effective tax rates for the years ended December 31, 2014, and December 31, 2013, was (10.1%) and 14.6%, respectively. The Company’s effective tax rate remains well below historical levels due to a higher percentage of pre-tax income that is not subject to federal income tax. The Company’s sizable holdings in municipal bonds, life insurance contracts and certain tax credits earned have lowered our effective tax rate.

Liquidity and Capital Resources

The Company’s primary business is that of the Bank. Management believes dividends that may be paid from the Bank to the Company will provide sufficient funds for the Company’s current and anticipated needs; however, no assurance can be given that the Company will not have a need for additional funds in the future. The Bank is subject to certain regulatory limitations with respect to the payment of dividends to the Company.

Capital Resources. At December 31, 2015, the Bank exceeded all regulatory minimum capital requirements. For a detailed discussion of the Kentucky Department of Financial Institutions (“KDFI”) and FDIC capital requirements, and for a tabular presentation of the Bank’s compliance with such requirements, see Note 16 of Notes to Consolidated Financial Statements. See the Company’s Risk Factors, located in our Annual Report filed on SEC form10-K for the year ended December 31, 2015, for comments related to effects that the implementation of Basel III will have on the Company’s future operations.

 

21


Table of Contents

Liquidity. Liquidity management is both a daily and long-term function of business management. If the Bank requires funds beyond its ability to generate them internally, the Bank believes that it could borrow funds from the FHLB. At December 31, 2015, the Bank had outstanding advances of $15.0 million from the FHLB and $32.5 million of letters of credit issued by the FHLB to secure municipal deposits. The Bank can immediately borrow an additional $54.0 million from the FHLB and the Company has the ability to pledge another $17.2 million in securities to the FHLB for additional borrowing capacity. The Bank can immediately borrow $8.0 million from its correspondent bank. See Note 7 of Notes to Consolidated Financial Statements.

Subordinated Debentures Issuance. On September 25, 2003, the Company issued $10,310,000 of subordinated debentures in a private placement offering. The securities have a thirty-year maturity and are callable at the issuer’s discretion on a quarterly basis beginning five years after issuance. The securities are priced at a variable rate equal to the three-month LIBOR (London Interbank Offering Rate) plus 3.10%. Interest is paid and the rate of interest may change on a quarterly basis. The Company’s subsidiary, a state chartered commercial bank supervised by the KDFI and the FDIC may recognize the proceeds of trust preferred securities as capital. KDFI and FDIC regulations provide that 25% of Tier I capital may consist of trust preferred proceeds. See Note 10 of Notes to Consolidated Financial Statements.

The Bank’s primary sources of funds consist of deposits, repayment of loans and mortgage-backed securities, maturities of investments and interest-bearing deposits, and funds provided from operations. While scheduled repayments of loans and mortgage-backed securities and maturities of investment securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by the general level of interest rates, economic conditions and competition. The Bank uses its liquidity resources principally to fund existing and future loan commitments, to fund maturing certificates of deposit and demand deposit withdrawals, to invest in other interest-earning assets, to maintain liquidity, and to meet operating expenses.

Management believes that loan repayments and other sources of funds will be adequate to meet the Bank’s liquidity needs for the immediate future. A portion of the Bank’s liquidity consists of cash and cash equivalents. At December 31, 2015, cash and cash equivalents totaled $54.7 million. The level of these assets depends upon the Bank’s operating, investing and financing activities during any given period.

Cash flows from operating activities for the years ended December 31, 2015, 2014 and 2013 were $6.4 million, $10.1 million, and $9.3 million, respectively.

Cash flows provided by investment activities were $42.5 million and $19.0 million for the years ended December 31, 2015, and December 31, 2014, respectively. For the year ended December 31, 2013, the Company’s investment activities used $4.3 million of the Company’s. A principal use of cash in this area has been purchases of securities available for sale of $56.9 million, offset by proceeds from sales, calls and maturities of securities of $120.4 million during 2015. The Company invested $19.0 million, $1.9 million and $21.6 million of cash in loans in 2015, 2014 and 2013, respectively. Sales and maturities of available for sale securities exceeded purchases by $63.5 million in 2015, $21.0 million in 2014 and $18.9 million in 2013.

At December 31, 2015, the Bank had $46.4 million in outstanding commitments to originate loans and unused lines of credit of $85.0 million. The Bank anticipates that it will have sufficient funds available to meet its current loan origination and lines of credit commitments. The Bank has certificates of deposit maturing in one year or less of $201.3 million at December 31, 2015. Based on historical experience, management believes that a significant portion of such deposits will remain with the Bank.

 

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Table of Contents

Impact of Inflation and Changing Prices

The consolidated financial statements and notes thereto presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time and due to inflation. The impact of inflation is reflected in the increased cost of the Company’s operations.

Unlike most industrial companies, nearly all the assets and liabilities of the Company are monetary in nature. As a result, changes in interest rates have a greater impact on the Company’s performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services.

Forward-Looking Statements

Management’s discussion and analysis includes certain forward-looking statements addressing, among other things, the Bank’s prospects for earnings, asset growth and net interest margin. Forward-looking statements are accompanied by, and identified with, such terms as “anticipates,” “believes,” “expects,” “intends,” and similar phrases. Management’s expectations for the Company’s future involve a number of assumptions and estimates. Factors that could cause actual results to differ from the expectations expressed herein include: substantial changes in interest rates, and changes in the general economy; changes in the Company’s strategies for credit-risk management, interest-rate risk management and investment activities. Accordingly, any forward-looking statements included herein do not purport to be predictions of future events or circumstances and may not be realized.

Stock Performance Comparison

The following graph, which was prepared by SNL Financial LC (“SNL”), shows the cumulative total return of the Common Stock of the Company since December 31, 2010, compared with the (1) NASDAQ Composite Index, comprised of all U.S. Companies quoted on NASDAQ, (2) the SNL Midwest Thrift Index, comprised of publically traded thrifts and thrift holding companies operating in the Midwestern United States, and (3) the SNL Midwest Bank Index, comprised of publically traded commercial banks and bank holding companies operating in the Midwestern United States. Cumulative total return on the Common Stock or the index equals the total increase in the value since December 31, 2010, assuming reinvestment of all dividends paid into the Common Stock or the index, respectively. The graph was prepared assuming that $100 was invested on December 31, 2010, in the Common Stock, the securities included in the indices. The stock price performance included in this graph is not necessarily indicative of future stock price performance.

 

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On June 5, 2013, the Company became a Kentucky state chartered commercial bank holding company. As such, the Company will compare the SNL Midwest Bank index in the current and in future periods.

 

LOGO

 

     Period Ending  

Index

   12/31/10      12/31/11      12/31/12      12/31/13      12/31/14      12/31/15  

HopFed Bancorp, Inc.

     100.00         74.67         100.79         134.62         152.38         145.65   

NASDAQ COMPOSITE

     100.00         99.21         116.82         163.75         188.03         201.40   

SNL Midwest Bank

     100.00         94.46         113.69         155.65         169.21         171.78   

 

24


Table of Contents

Consolidated Financial Statements

HopFed Bancorp, Inc.

and Subsidiaries

December 31, 2015, 2014 and 2013


Table of Contents

Table of Contents

 

     Page
Number
 
  

Report of Independent Registered Public Accounting Firm

     27   

Consolidated Balance Sheets as of December 31, 2015 and 2014

     28-29   

Consolidated Statements of Income for the Years ended December 31, 2015, 2014, and 2013

     30-31   

Consolidated Statements of Comprehensive Income (Loss) for the Years ended December 31, 2015, 2014 and 2013

     32   

Consolidated Statements of Changes in Stockholders’ Equity for the Years ended December  31, 2015, 2014 and 2013

     33-34   

Consolidated Statements of Cash Flows for the Years ended December 31, 2015, 2014 and 2013

     35-36   

Notes to Consolidated Financial Statements

     37-107   


Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

of HopFed Bancorp, Inc.

Hopkinsville, Kentucky

We have audited the accompanying consolidated balance sheets of HopFed Bancorp, Inc. and subsidiaries (the “Company”) as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income (loss), changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2015. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HopFed Bancorp, Inc. and subsidiaries as of December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), HopFed Bancorp, Inc.’s internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 3, 2016, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

 

(signed) Rayburn | Fitzgerald PC
Brentwood, Tennessee
March 3, 2016


Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Consolidated Balance Sheets

December 31, 2015 and 2014

(Dollars in Thousands)

 

     2015      2014  
Assets      

Cash and due from banks

   $ 46,926         34,389   

Interest-earning deposits

     7,772         6,050   
  

 

 

    

 

 

 

Cash and cash equivalents

     54,698         40,439   

Federal Home Loan Bank stock, at cost (note 2)

     4,428         4,428   

Securities available for sale (notes 2 and 8)

     237,177         303,628   

Loans held for sale

     2,792         1,444   

Loans receivable, net of allowance for loan losses of $5,700 at December 31, 2015, and $6,289 at December 31, 2014 (notes 3 and 7)

     556,349         539,264   

Accrued interest receivable

     4,139         4,576   

Real estate and other assets owned (note 14)

     1,736         1,927   

Bank owned life insurance

     10,319         9,984   

Premises and equipment, net (note 4)

     24,034         22,940   

Deferred tax assets (note 13)

     2,642         2,261   

Intangible asset (note 5)

     —           33   

Other assets

     4,840         4,861   
  

 

 

    

 

 

 

Total assets

   $ 903,154         935,785   
  

 

 

    

 

 

 
Liabilities and Stockholders’ Equity      

Liabilities:

     

Deposits (note 6):

     

Non-interest-bearing accounts

   $ 125,070         115,051   

Interest-bearing accounts:

     

Interest bearing checking accounts

     203,779         186,616   

Savings and money market accounts

     95,893         97,726   

Other time deposits

     314,664         331,915   
  

 

 

    

 

 

 

Total deposits

     739,406         731,308   

Advances from Federal Home Loan Bank (note 7)

     15,000         34,000   

Repurchase agreements (note 8)

     45,770         57,358   

Subordinated debentures (note 10)

     10,310         10,310   

Advances from borrowers for taxes and insurance

     614         513   

Dividends payable

     287         301   

Accrued expenses and other liabilities

     4,137         3,593   
  

 

 

    

 

 

 

Total liabilities

     815,524         837,383   
  

 

 

    

 

 

 

 

See accompanying notes to consolidated financial statements.

 

28


Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Consolidated Balance Sheets, Continued

December 31, 2015 and 2014

(Dollars in Thousands)

 

     2015     2014  

Stockholders’ equity

    

Preferred stock, par value $0.01 per share; authorized - 500,000 shares; no shares issued or outstanding at December 31, 2015 and December 31, 2014

   $ —          —     

Common stock, par value $.01 per share; authorized 15,000,000 shares; 7,951,699 issued and 6,865,811 outstanding at December 31, 2015, and 7,949,665 issued and 7,171,282 outstanding at December 31, 2014

     79        79   

Additional paid-in-capital

     58,604        58,466   

Retained earnings

     47,124        45,729   

Treasury stock- common (at cost 1,085,888 shares at December 31, 2015 and 778,383 shares at December 31, 2014)

     (13,471     (9,429

Unearned ESOP Shares (at cost 546,413 shares at December 31, 2015 and none at December 31, 2014)

     (7,180     —     

Accumulated other comprehensive income, net of taxes

     2,474        3,557   
  

 

 

   

 

 

 

Total stockholders’ equity

     87,630        98,402   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 903,154        935,785   
  

 

 

   

 

 

 

Commitments and contingencies (notes 11 and 15)

See accompanying notes to consolidated financial statements

 

29


Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Consolidated Statements of Income

For the Years ended December 31, 2015, 2014 and 2013

(Dollars in Thousands)

 

     2015      2014     2013  

Interest and dividend income

       

Loans receivable

   $ 25,300         26,025        26,741   

Securities available for sale

     6,149         6,548        6,873   

Nontaxable securities available for sale

     1,651         2,081        2,219   

Interest-earning deposits

     22         26        24   
  

 

 

    

 

 

   

 

 

 

Total interest and dividend income

     33,122         34,680        35,857   
  

 

 

    

 

 

   

 

 

 

Interest expense:

       

Deposits (note 6)

     5,031         5,603        7,114   

Advances from Federal Home loan Bank

     289         1,665        1,780   

Repurchase agreements

     491         874        954   

Subordinated debentures

     739         737        733   
  

 

 

    

 

 

   

 

 

 

Total interest expense

     6,550         8,879        10,581   
  

 

 

    

 

 

   

 

 

 

Net interest income

     26,572         25,801        25,276   
  

 

 

    

 

 

   

 

 

 

Provision for loan losses (note 3)

     1,051         (2,273     1,604   
  

 

 

    

 

 

   

 

 

 

Net interest income after provision for loan losses

     25,521         28,074        23,672   
  

 

 

    

 

 

   

 

 

 

Non-interest income:

       

Other-than-temporary impairment losses on debt securities

     —           —          (511

Portion of losses recognized in other comprehensive income

     —           —          111   
  

 

 

    

 

 

   

 

 

 

Net impairment losses recognized in earnings (note 2)

     —           —          (400

Service charges

     2,925         3,354        3,670   

Merchant card income

     1,130         1,075        983   

Mortgage origination income

     1,175         719        634   

Realized gain from sale of securities available for sale, net (note 2)

     691         578        1,661   

Income from bank owned life insurance

     335         307        354   

Financial services commission

     685         980        1,250   

Gain on sale of assets

     —           —          412   

Other operating income

     661         827        808   
  

 

 

    

 

 

   

 

 

 

Total non-interest income

     7,602         7,840        9,372   
  

 

 

    

 

 

   

 

 

 

 

See accompanying notes to consolidated financial statements.

30


Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Consolidated Statements of Income, Continued

For the Years ended December 31, 2015, 2014 and 2013

(Dollars in Thousands, Except Per Share and Share Amounts)

 

     2015      2014     2013  

Non-interest expenses:

       

Salaries and benefits (note 12)

     15,810         15,222        14,733   

Occupancy expense (note 4)

     3,077         3,217        3,475   

Data processing expense

     2,827         2,887        2,695   

State deposit tax

     1,018         1,336        581   

Intangible amortization

     33         97        162   

Professional services

     1,506         1,331        1,773   

Advertising expense

     1,302         1,341        1,236   

Postage and communications expense

     577         577        567   

Supplies expense

     527         627        495   

Deposit insurance and examination fees

     586         724        727   

Loss on sale of assets

     1         25        12   

Loss on sale of real estate owned

     716         208        140   

Expenses related to real estate owned

     511         266        402   

Loss on sale of loan note

     —           1,781        —     

Loss on early debt extinguishment

     —           2,510        —     

Other operating expenses

     1,954         1,767        1,640   
  

 

 

    

 

 

   

 

 

 

Total non-interest expense

     30,445         33,916        28,638   
  

 

 

    

 

 

   

 

 

 

Income before income tax expense

     2,678         1,998        4,406   

Income tax expense (benefit) (note 13)

     274         (201     644   
  

 

 

    

 

 

   

 

 

 

Net income

   $ 2,404         2,199        3,762   
  

 

 

    

 

 

   

 

 

 

Earnings per share available to common stockholders (note 18):

       

Basic

   $ 0.38         0.30        0.50   
  

 

 

    

 

 

   

 

 

 

Fully diluted

   $ 0.38         0.30        0.50   
  

 

 

    

 

 

   

 

 

 

Weighted average shares outstanding - basic

     6,372,277         7,306,078        7,483,606   
  

 

 

    

 

 

   

 

 

 

Weighted average shares outstanding - diluted

     6,372,277         7,306,078        7,483,606   
  

 

 

    

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

31


Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss)

For the Years ended December 31, 2015, 2014 and 2013

(Dollars in Thousands)

 

     2015     2014     2013  

Net income

   $ 2,404        2,199        3,762   

Other comprehensive income, net of tax:

      

Unrealized gain (loss) on non – Other than temporary impaired Investment securities available for sale, net of taxes

     (1,121     5,130        (10,568

Unrealized gain on OTTI securities, net of taxes

     237        —          —     

Unrealized gain on derivatives, net of taxes

     257        237        248   

Reclassification adjustment for gains and accretion included in net income, net of taxes

     (456     (381     (832
  

 

 

   

 

 

   

 

 

 

Total other comprehensive income (loss)

     (1,083     4,986        (11,152
  

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

   $ 1,321        7,185        (7,390
  

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

32


Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

For the Years ended December 31, 2015, 2014 and 2013

(Dollars in Thousands, Except Share Amounts)

 

     Common
Shares
    Preferred
Shares
    Common
Stock
     Common
Stock
Warrant
    Additional
Paid-in
Capital
    Retained
Earnings
    Preferred
Treasury
Stock
    Common
Treasury
Stock
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Equity
 

Balance December 31, 2012

     7,502,812        18,400      $ 79         556        76,288        41,829        (18,400     (5,076     9,723        104,999   

Net income

     —          —          —           —          —          3,762        —          —          —          3,762   

Restricted stock awards

     21,559        —          —           —          —          —          —          —          —          —     

Net change in unrealized losses on securities available for sale, net of tax benefit of $5,873

     —          —          —           —          —          —          —          —          (11,400     (11,400

Net change in unrealized losses on derivatives, net of taxes of ($128)

     —          —          —           —          —          —          —          —          248        248   

Preferred stock retired

     —          (18,400     —           —          (18,400     —          18,400        —          —          —     

Cash dividend to common stockholders’ ($0.12 per share)

     —          —          —           —          —          (897     —          —          —          (897

Common stock repurchase

     (76,468     —          —           —          —          —          —          (853     —          (853

Cash repurchase of warrant

     —          —          —           (556     299        —          —          —          —          (257

Compensation expense, restricted stock awards

     —          —          —           —          115        —          —          —          —          115   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance December 31, 2013

     7,447,903        —          79         —          58,302        44,694        —          (5,929     (1,429     95,717   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income

     —          —          —           —          —          2,199        —          —          —          2,199   

Restricted stock awards

     22,378        —          —           —          —          —          —          —          —          —     

Net change in unrealized gain on securities available for sale, net of taxes of ($2,446)

     —          —          —           —          —          —          —          —          4,749        4,749   

Net change in unrealized loss on derivatives, net of taxes of ($122)

     —          —          —           —          —          —          —          —          237        237   

Cash dividend to common stockholders’ ($0.16 per share)

     —          —          —           —          —          (1,164     —          —          —          (1,164

Common stock repurchase

     (298,999     —          —           —          —          —          —          (3,500     —          (3,500

Compensation expense, restricted stock awards

     —          —          —           —          164        —          —          —          —          164   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance December 31, 2014

     7,171,282        —          79         —          58,466        45,729        —          (9,429     3,557        98,402   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

33


Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

For the Years ended December 31, 2015, 2014 and 2013 (Continued)

(Dollars in Thousands, Except Share Amounts)

 

     Common
Shares
    Preferred
Shares
     Common
Stock
     Common
Stock
Warrant
     Additional
Paid-in
Capital
    Retained
Earnings
    Preferred
Treasury
Stock
     Common
Treasury
Stock
    Unearned
ESOP
Shares
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Equity
 

Brought Forward

     7,171,282        —           79         —           58,466        45,729        —           (9,429     —          3,557        98,402   

Net Income

     —          —           —           —           —          2,404        —           —          —          —          2,404   

Restricted stock awards

     2,034        —           —           —           —          —          —           —          —          —          —     

Net change in unrealized gain on securities available for sale, net of taxes of $690

     —          —           —           —           —          —          —           —          —          (1,340     (1,340

Net change in unrealized losses on derivatives, net of taxes of ($132)

     —          —           —           —           —          —          —           —          —          257        257   

Cash dividend to common stockholders’ ($0.16 per share)

     —          —           —           —           —          (1,009     —           —          —          —          (1,009

Common stock repurchase

     (907,505     —           —           —           —          —          —           (11,926     —          —          (11,926

Common stock issued

     600,000        —           —           —           —          —          —           7,884        (7,884     —          —     

ESOP Shares Earned

     —          —           —           —           (52     —          —           —          704        —          652   

Compensation expense, restricted stock awards

     —          —           —           —           190        —          —           —          —          —          190   
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance December 31, 2015

     6,865,811        —         $ 79         —           58,604        47,124        —           (13,471     (7,180     2,474        87,630   
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

34


Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

For the Years ended December 31, 2015, 2014 and 2013

(Dollars in Thousands)

 

     2015     2014     2013  

Cash flows from operating activities:

      

Net income

   $ 2,404        2,199        3,762   

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

      

Provision for loan losses

     1,051        (2,273     1,604   

Depreciation

     1,266        1,336        1,502   

Amortization of intangible assets

     33        97        162   

Amortization of investment premiums and discounts, net

     1,650        2,076        2,561   

Other than temporary impairment charge (recovery) on available for sale securities

     (17     —          400   

Expense (benefit) for deferred income taxes

     177        (231     566   

Stock compensation expense

     138        164        115   

Income from bank owned life insurance

     (335     (307     (354

Gain on sale of securities available for sale

     (691     (578     (1,661

Gain on sales of loans

     (1,175     (719     (634

Loss on sale of commercial real estate loan

     —          1,781        —     

Loss on sale of premises and equipment

     1        25        12   

Proceeds from sales of loans

     43,847        37,300        17,577   

Loss on sale of foreclosed assets

     716        208        140   

Originations of loans sold

     (44,020     (32,835     (16,943

(Increase) decrease in:

      

Accrued interest receivable

     437        657        165   

Other assets (increase)

     21        1,513        171   

Increase (decrease) in accrued expenses and other liabilities

     933        (277     170   
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     6,436        10,136        9,315   
  

 

 

   

 

 

   

 

 

 

Cash flows from investing activities

      

Proceeds from sales, calls and maturities of securities available for sale

     120,354        112,235        124,471   

Purchase of securities available for sale

     (56,875     (91,257     (105,605

Net (increase) decrease in loans

     (19,005     (1,908     (21,630

Proceeds from sale of foreclosed assets

     344        1,118        908   

Purchase of premises and equipment

     (2,361     (1,168     (2,473
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     42,457        19,020        (4,329
  

 

 

   

 

 

   

 

 

 

 

 

See accompanying notes to consolidated financial statements.

 

35


Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows, Continued

For the Years ended December 31, 2015, 2014 and 2013

(Dollars in Thousands)

 

     2015     2014     2013  

Cash flows from financing activities:

      

Net increase (decrease) in deposits

   $ 8,098        (31,689     3,132   

Increase (decrease) in advance payments by borrowers for taxes and insurance

     101        (8     125   

Advances from Federal Home Loan Bank

     41,000        57,000        23,000   

Repayment of advances from Federal Home Loan Bank

     (60,000     (69,780     (19,961

Increase (decrease) in repurchase agreements

     (11,588     4,599        9,251   

Repurchase of common stock

     (11,926     (3,500     (853

Repurchase of common stock warrant

     —          —          (257

Proceeds on repayment of ESOP loan

     704        —          —     

Dividends paid on common stock

     (1,023     (1,187     (751
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     (34,634     (44,565     13,686   
  

 

 

   

 

 

   

 

 

 

Increase (decrease) in cash and cash equivalents

     14,259        (15,409     18,672   

Cash and cash equivalents, beginning of period

     40,439        55,848        37,176   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 54,698        40,439        55,848   
  

 

 

   

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

      

Interest paid

   $ 6,587        8,977        10,840   
  

 

 

   

 

 

   

 

 

 

Income taxes paid (refund)

   ($ 900     (718     (487
  

 

 

   

 

 

   

 

 

 

Supplemental disclosures of non-cash investing and financing activities:

      

Loans charged off

   $ 1,867        1,232        4,444   
  

 

 

   

 

 

   

 

 

 

Loan transferred to held for sale

   $ —          6,987        —     
  

 

 

   

 

 

   

 

 

 

Foreclosures and in substance foreclosures of loans during year

   $ 869        1,579        1,379   
  

 

 

   

 

 

   

 

 

 

Net unrealized gains (losses) on investment securities classified as available for sale

   ($ 2,030     7,195        (17,273
  

 

 

   

 

 

   

 

 

 

Increase (decrease) in deferred tax asset related to unrealized gain (losses) on investments

   $ 691        (2,446     5,873   
  

 

 

   

 

 

   

 

 

 

Dividends declared and payable

   $ 287        301        325   
  

 

 

   

 

 

   

 

 

 

Sale and financing of stock to ESOP

   $ 7,884        —          —     
  

 

 

   

 

 

   

 

 

 

Issue of unearned restricted stock

   $ 25        260        232   
  

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

36


Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2015, 2014 and 2013

 

(1) Summary of Significant Accounting Policies:

Nature of Operations and Customer Concentration

HopFed Bancorp, Inc. (the Corporation) is a bank holding company incorporated in the state of Delaware and headquartered in Hopkinsville, Kentucky. The Corporation’s principal business activities are conducted through its wholly-owned subsidiary, Heritage Bank USA, Inc. (the Bank), a Kentucky state chartered commercial bank engaged in the business of accepting deposits and providing mortgage, consumer, construction and commercial loans to the general public through its retail banking offices. The Bank’s business activities are primarily limited to western Kentucky and middle and western Tennessee. The Bank is subject to competition from other financial institutions. Deposits at the Bank are insured up to the applicable limits by the Federal Deposit Insurance Corporation (FDIC).

As part of the enactment of the Dodd-Frank Financial Reform Act of 2010, the Corporation and Bank’s former regulator, the Office of Thrift Supervision, was eliminated on July 21, 2011. Prior to June 5, 2013, the Bank was subject to comprehensive regulation, examination and supervision by the Office of Comptroller of the Currency (OCC) and the FDIC. After June 5, 2013, the Bank’s legal name was changed to Heritage Bank USA, Inc. and the Bank was granted a Kentucky commercial bank charter and is now supervised by the Kentucky Department of Financial Institutions (“KDFI”) and the Federal Deposit Insurance Corporation (“FDIC”). Supervision of the Corporation continues to be conducted by the Federal Reserve Bank of Saint Louis (“FED”).

A substantial portion of the Bank’s loans are secured by real estate in the western Kentucky and middle and west Tennessee markets. In addition, foreclosed real estate is located in this same market. Accordingly, the ultimate ability to collect on a substantial portion of the Bank’s loan portfolio and the recovery of a substantial portion of the carrying amount of foreclosed real estate is susceptible to changes in local market conditions.

Principles of Consolidation

The consolidated financial statements include the accounts of the Corporation and the Bank (collectively the Company) for all periods. Significant inter-company balances and transactions have been eliminated in consolidation.

Accounting

The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States of America and conform to general practices in the banking industry.

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

 

(1) Summary of Significant Accounting Policies: (Continued)

 

Accounting, (Continued)

 

The Company determines whether it has a controlling financial interest in an entity by first evaluating whether the entity is a voting interest entity or a variable interest entity (VIE) under accounting principles generally accepted in the United States. Voting interest entities in which the total equity investment is a risk is sufficient to enable the entity to finance itself independently and provides the equity holders with the obligation to absorb losses, the right to receive residual returns and the right to make decision about the entity’s activities. The Company consolidates voting interest entities in which it has all, or at least a majority of, the voting interest. As defined in applicable accounting standards, VIE’s are entities in which it has all, or at least a majority of, the voting interest. A controlling financial interest in a VIE is present when an enterprise has both the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and an obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. The subsidiaries, HopFed Capital Trust I and Fort Webb LP, LLC are VIEs for which the Company is not the primary beneficiary. Accordingly, these accounts are not included in the Company’s consolidated financial statements.

The Company has evaluated subsequent events for potential impact and disclosure through the issue date of these consolidated financial statements.

Estimates

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated balance sheets and revenues and expenses for each year. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan losses and foreclosed real estate, management obtains independent appraisals for significant collateral.

Cash and Cash Equivalents

Cash and cash equivalents are defined as cash on hand, amounts due on demand from commercial banks, interest-earning deposits in other financial institutions and federal funds sold with maturities of three months or less. The Company is required to maintain reserve funds in either cash on hand or on deposit with the Federal Reserve Bank. At December 31, 2015, the Company’s reserve requirement was met to available cash on hand.

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

 

(1) Summary of Significant Accounting Policies: (Continued)

 

Securities

The Company reports debt, readily-marketable equity, mortgage-backed and mortgage related securities in one of the following categories: (i) “trading” (held for current resale) which are to be reported at fair value, with unrealized gains and losses included in earnings; and (ii) “available for sale” (all other debt, equity, mortgage-backed and mortgage related securities) which are to be reported at fair value, with unrealized gains and losses reported net of tax as a separate component of stockholders’ equity. At the time of new security purchases, a determination is made as to the appropriate classification. Realized and unrealized gains and losses on trading securities are included in net income. Unrealized gains and losses on securities available for sale are recognized as direct increases or decreases in stockholders’ equity, net of any tax effect. Cost of securities sold is recognized using the specific identification method. Interest income on securities is recognized as earned. The Company purchases many agency bonds at either a premium or discount to its par value. Premiums and discounts on agency bonds are amortized using the net interest method. For callable bonds purchased at a premium, the premium is amortized to the first call date. If the bond is not called on that date, the premium is fully amortized and the Company recognizes an increase in the net yield of the investment. The Company has determined that callable bonds purchased at a premium have a high likelihood of being called, and the decision to amortize premiums to their first call is a more conservative method of recognizing income and any variance from amortizing to contractual maturity is not material to the consolidated financial statements. For agency bonds purchased at a discount, the discount is accreted to the final maturity date. For callable bonds purchased at discount and called before maturity, the Company recognizes a gain on the sale of securities. The Company amortizes premiums and accretes discounts on mortgage back securities and collateralized mortgage obligations based on the securities three month average prepayment speed.

Other Than Temporary Impairment

A decline in the fair value of any available-for-sale security below cost that is deemed to be other-than-temporary results in a reduction in the carrying amount to fair value. To determine whether impairment is other-than-temporary, management considers whether the entity expects to recover the entire amortized cost basis of the security by reviewing the present value of the future cash flows associated with the security. The shortfall of the present value of the cash flows expected to be collected in relation to the amortized cost basis is referred to as a credit loss. If a credit loss is identified, management then considers whether it is more-likely-than-not that the Company will be required to sell the security prior to recovery. If management concludes that it is not more-likely-than-not that it will be required to sell the security, then the security is not other-than-temporarily impaired and the shortfall is recorded as a component of equity. If the security is determined to be other-than-temporarily impaired, the credit loss is recognized as a charge to earnings and a new cost basis for the security is established.

Other Securities

Other securities which are not actively traded and may be restricted, such as Federal Home Loan Bank (FHLB) stock are recognized at cost, as the value is not considered impaired.

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

 

(1) Summary of Significant Accounting Policies: (Continued)

 

Loans Receivable

Loans receivable are stated at unpaid principal balances, less the allowance for loan losses and deferred loan cost. The Statement of Financial Accounting Standards ASC 310-20, Nonrefundable Fees and Other Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases, requires the recognition of loan origination fee income over the life of the loan and the recognition of certain direct loan origination costs over the life of the loan. Uncollectible interest on loans that are contractually past due is charged off, or an allowance is established based on management’s periodic evaluation. The Company charges off loans after, in management’s opinion, the collection of all or a large portion of the principal or interest is not collectable. The allowance is established by a charge to interest income equal to all interest previously accrued, and income is subsequently recognized only to the extent that cash payments are received while the loan is classified as non-accrual, when the loan is ninety days past due. Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance by the borrower in accordance with the contractual terms of interest and principal.

The Company provides an allowance for loan losses and includes in operating expenses a provision for loan losses determined by management. Management’s periodic evaluation of the adequacy of 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, and current economic conditions. Management’s estimate of the adequacy of the allowance for loan loss can be classified as either a reserve for currently classified loans or estimates of future losses in the current loan portfolio.

Loans are considered to be impaired when, in management’s judgment, principal or interest is not collectible according to the contractual terms of the loan agreement. When conducting loan evaluations, management considers various factors such as historical loan performance, the financial condition of the borrower and adequacy of collateral to determine if a loan is impaired. Impaired loans and loans classified as Troubled Debt Restructurings (“TDR’s”) may be classified as either substandard or doubtful and reserved for based on individual loans risk for loss. Loans not considered impaired may be classified as either special mention or watch and may have an allowance established for it. Typically, unimpaired classified loans exhibit some form of weakness in either industry trends, collateral, or cash flow that result in a default risk greater than that of the Company’s typical loan. All classified amounts include all unpaid interest and fees as well as the principal balance outstanding.

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

 

(1) Summary of Significant Accounting Policies: (Continued)

 

Loans Receivable (Continued)

 

The measurement of impaired loans generally may be based on the present value of future cash flows discounted at the historical effective interest rate. However, the majority of the Company’s problem loans become collateral dependent at the time they are judged to be impaired. Therefore, the measurement of impaired requires the Company to obtain a new appraisal to obtain the fair value of the collateral. The appraised value is then discounted to an estimated of the Company’s net realizable value, reducing the appraised value by the amount of holding and selling cost. When the measured amount of an impaired loan is less than the recorded investment in the loan, the impairment is recorded as a charge to income and a valuation allowance, which is included as a component of the allowance for loan losses. For loans not individually evaluated, management considers the Company’s recent charge off history, the Company’s current past due and non-accrual trends, banking industry trends and both local and national economic conditions when making an estimate as to the amount to reserve for losses. Management believes it has established the allowance in accordance with accounting principles generally accepted in the United States of America and has taken into account the views of its regulators and the current economic environment.

Loans held for sale

Mortgage loans originated and intended for sale are carried at the lower of cost or estimated fair value as determined on a loan-by-loan basis. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. Realized gains and losses are recognized when legal title to the loans has been transferred to the purchaser and sales proceeds have been received and are reflected in the accompanying consolidated statement of operations in gains on mortgage loans sold, net of related costs such as compensation expenses. The Company does not securitize mortgage loans and maintains a very small percentage of servicing on loans sold.

Fixed Rate Mortgage Originations

The Company operates a mortgage division that originates mortgage loans in the name of assorted investors, including Federal Home Loan Mortgage Corporation (Freddie Mac). Originations for Freddie Mac are sold through the Bank while originations to other investors are processed for a fee. On a limited basis, loans sold to Freddie Mac may result in the Bank retaining loan servicing rights. In recent years, customers have chosen lower origination rates over having their loan locally serviced; thereby limiting the amount of new loans sold with servicing retained. At December 31, 2015, the Bank maintained a servicing portfolio of one to four family real estate loans of approximately $22.8 million. For the years ended December 31, 2015, December 31, 2014, and December 31, 2013, the Bank has reviewed the value of the servicing asset as well as the operational cost associated with servicing the portfolio. The Bank has determined that the values of its servicing rights are not material to the Company’s consolidated financial statements.

Real Estate and Other Assets Owned

Assets acquired through, or in lieu of, loan foreclosure or repossession carried at the lower of cost or fair value less selling expenses. Costs of improving the assets are capitalized, whereas costs relating to holding the property are expensed. Management conducts periodic valuations (no less than annually) and any adjustments to value are recognized in the current period’s operations.

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

 

(1) Summary of Significant Accounting Policies: (Continued)

 

Brokered Deposits

The Company may choose to attract deposits from several sources, including using outside brokers to assist in obtaining time deposits using national distribution channels. Brokered deposits offer the Company an alternative to Federal Home Loan Bank advances and local retail time deposits

Repurchase Agreements

The Company sells investments from its portfolio to business and municipal customers with a written agreement to repurchase those investments on the next business day. The repurchase product gives business customers the opportunity to earn income on liquid cash reserves. These funds are overnight borrowings of the Company secured by Company assets and are not FDIC insured.

Treasury Stock

The Company may occasional purchase its own common stock either in open market transactions or privately negotiated transactions. The value of the Company’s common stock held in treasury is listed at cost.

Unearned ESOP Shares

The Company offers an Employee Stock Ownership Plan (“ESOP”) to the employees of the Company. The unearned portion of common stock of the Company held in the ESOP Trust is recorded on the balance sheet at cost. Common stock is released from the ESOP Trust to the Company’s employees as the Bank makes payments on the loan to the Corporation on behalf of the ESOP Trust.

Comprehensive Income

Comprehensive income consists of net income and other comprehensive income, net of applicable income taxes. Other comprehensive income includes unrealized appreciation (depreciation) on available-for-sale securities and unrealized appreciation (depreciation) on available-for-sale securities for which a portion of an other than temporary impairment has been recognized in income.

Revenue Recognition

Mortgage loans held for sale are generally delivered to secondary market investors under best efforts sales commitments entered into prior to the closing of the individual loan. Loan sales and related gains or losses are recognized at settlement. Loan fees earned for the servicing of secondary market loans are recognized as earned.

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

 

(1) Summary of Significant Accounting Policies: (Continued)

 

Revenue Recognition (Continued)

 

Interest income on loans receivable is reported on the interest method. Interest income is not reported when full loan repayment is in doubt, typically when the loan is impaired, placed in non-accrual status, or payments are past due more than 90 days. Interest earned as reported as income is reversed on any loans classified as non-accrual or past due more than 90 days. Interest may continue to accrue on loans over 90 days past due if they are well secured and in the process of collection.

Income Taxes

Income taxes are accounted for through the use of the asset and liability method. Under the asset and liability method, deferred taxes are recognized for the tax consequences of temporary differences by applying enacted statutory rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred taxes of a change in tax rates would be recognized in income in the period that includes the enactment date. The Company files its federal and Kentucky income tax returns as well as its Kentucky and Tennessee franchise and excise tax returns on a consolidated basis with its subsidiaries. All taxes are accrued on a separate entity basis.

Operating Segments

The Company’s continuing operations include one primary segment, retail banking. The retail banking segment involves the origination of commercial, residential and consumer loans as well as the collections of deposits in eighteen branch offices.

Premises and Equipment

Land, land improvements, buildings, and furniture and equipment are carried at cost, less accumulated depreciation and amortization. Buildings and land improvements are depreciated generally by the straight-line method, and furniture and equipment are depreciated under various methods over the estimated useful lives of the assets. The Company capitalizes interest expense on construction in process at a rate equal to the Company’s cost of funds. The estimated useful lives used to compute depreciation are as follows:

 

Land improvements

     5-15 years   

Buildings

     40 years   

Furniture and equipment

     5-15 years   

Intangible Assets

The core deposit intangible asset related to the middle Tennessee acquisition of June 2006 is amortized using the sum of the year’s digits method over an estimated period of nine years. At December 31, 2015, the core deposit intangible was fully amortized.

Bank Owned Life Insurance

Bank owned life insurance policies (BOLI) are recorded at the cash surrender value or the amount to be realized upon current redemption. The realization of the redemption value is evaluated for each insuring entity that holds insurance contracts annually by management.

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

 

(1) Summary of Significant Accounting Policies: (Continued)

 

Advertising

The Company expenses the production cost of advertising as incurred.

Financial Instruments

The Company has entered into off-balance-sheet financial instruments consisting of commitments to extend credit and commercial letters of credit. Such financial instruments are recorded in the consolidated financial statements when they are funded or related fees are incurred or received.

Derivative Instruments

Under guidelines ASC 815, Accounting for Derivative Instruments and Hedging Activities, as amended, all derivative instruments are required to be carried at fair value on the consolidated balance sheet. ASC 815 provides special hedge accounting provisions, which permit the change in fair value of the hedge item related to the risk being hedged to be recognized in earnings in the same period and in the same income statement line as the change in the fair value of the derivative.

A derivative instrument designated in a hedge relationship to mitigate exposure to changes in the fair value of an asset, liability or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges under ASC 815. Derivative instruments designated in a hedge relationship to mitigate exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Cash value hedges are accounted for by recording the fair value of the derivative instrument and the fair value related to the risk being hedged of the hedged asset or liability on the consolidated balance sheet with corresponding offsets recorded in the consolidated balance sheet. The adjustment to the hedged asset or liability is included in the basis of the hedged item, while the fair value of the derivative is recorded as a freestanding asset or liability. Actual cash receipts or payments and related amounts accrued during the period on derivatives included in a fair value hedge relationship are recorded as adjustments to the income or expense recorded on the hedged asset or liability.

Under both the fair value and cash flow hedge methods, derivative gains and losses not effective in hedging the change in fair value or expected cash flows of the hedged item are recognized immediately in the income statement. At the hedge’s inception and at least quarterly thereafter, a formal assessment is performed to determine whether changes in the fair values or cash flows of the derivative instrument has been highly effective in offsetting changes in the fair values or cash flows of the hedged items and whether they are expected to be highly effective in the future. If it is determined a derivative instrument has not been, or will not continue to be highly effective as a hedge, hedged accounting is discontinued. ASC 815 basis adjustments recorded on hedged assets and liabilities are amortized over the remaining life of the hedged item beginning no later than when hedge accounting ceases. There were no fair value hedging gains or losses, as a result of hedge ineffectiveness, recognized for the years ended December 31, 2015, December 31, 2014, and December 31, 2013, respectively.

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

 

(1) Summary of Significant Accounting Policies: (Continued)

 

Fair Values of Financial Instruments

ASC 825, Disclosures about Fair Value of Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized in the consolidated balance sheets for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Fair value estimates are made at a point in time, based on relevant market information and information about the financial instrument. Accordingly, such estimates involve uncertainties and matters of judgment and therefore cannot be determined with precision. ASC 825 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

The following are the more significant methods and assumptions used by the Company in estimating its fair value disclosures for financial instruments:

Cash and cash equivalents

The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents approximate those assets’ fair values, because they mature within 90 days or less and do not present credit risk concerns.

Interest earning deposits

The carrying amounts reported in the consolidated balance sheets for interest earning deposits approximate those assets’ fair values, because they are considered overnight deposits and may be withdrawn at any time without penalty and do not present credit risk concerns.

Available-for-sale securities

Fair values for investment securities available-for-sale are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments provided by a third party pricing service. The Company reviews all securities in which the book value is greater than the market value for impairment that is other than temporary. For securities deemed to be other than temporarily impaired, the Company reduces the book value of the security to its market value by recognizing an impairment charge on its income statement.

Loans held for sale

Mortgage loans originated and intended to be sold are carried at the lower of cost or estimated fair value as determined on a loan by loan basis. Gains or losses are recognized at the time of ownership transfer. Net unrealized losses, if any, are recognized through a valuation allowance and charged to income.

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

 

(1) Summary of Significant Accounting Policies: (Continued)

 

Fair Values of Financial Instruments, (Continued)

 

Loans receivable

The fair values for of fixed-rate loans and variable rate loans that re-price on an infrequent basis is estimated using discounted cash flow analysis which considers future re-pricing dates and estimated repayment dates, and further using interest rates currently being offered for loans of similar type, terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics. The estimated fair value of variable-rate loans that re-price frequently and with have no significant change in credit risk is approximately the carrying value of the loan.

Letters of credit

The fair value of standby letters of credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the likelihood of the counter parties drawing on such financial instruments and the present creditworthiness of such counter parties. Such commitments have been made on terms which are competitive in the markets in which the Company operates, thus, the fair value of standby letters of credit equals the carrying value for the purposes of this disclosure.

Accrued interest receivable

Fair value is estimated to approximate the carrying amount because such amounts are expected to be received within 90 days or less and any credit concerns have been previously considered in the carrying value.

Repurchase agreements

Overnight repurchase agreements have a fair value at book, given that they mature overnight. The fair values for of longer date repurchase agreements is estimated using discounted cash flow analysis which considers the current market pricing for repurchase agreements of similar final maturities and collateral requirements.

Bank owned life insurance

The fair value of bank owned life insurance is the cash surrender value of the policy less redemption charges. By surrendering the policy, the Company is also subject to federal income taxes on all earnings previously recognized.

Deposits

The fair values disclosed for deposits with no stated maturity such as demand deposits, interest-bearing checking accounts and savings accounts are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The fair values for certificates of deposit and other fixed maturity time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on such type accounts or similar accounts to a schedule of aggregated contractual maturities or similar maturities on such time deposits.

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

 

(1) Summary of Significant Accounting Policies: (Continued)

 

Fair Values of Financial Instruments, (Continued)

 

Advances from the Federal Home Loan Bank (FHLB)

The fair value of these advances is estimated by discounting the future cash flows of these advances using the current rates at which similar advances or similar financial instruments could be obtained.

FHLB stock

The fair value of FHLB stock is recognized at cost.

Subordinated debentures

The book value of subordinated debentures is cost. The subordinated debentures re-price quarterly at a rate equal to three month libor plus 3.10%.

Treasury Stock

The book value of treasury stock is cost and includes acquisition fees, if any.

Unearned ESOP Shares

The book value of unearned ESOP shares is cost.

Off-Balance-Sheet Instruments

Off-balance-sheet lending commitments approximate their fair values due to the short period of time before the commitment expires.

Dividend Restrictions

The Company is not permitted to pay a dividend to common shareholders if it fails to make a quarterly interest payment to the holders of the Company’s subordinated debentures. Furthermore, the Bank may be restricted in the payment of dividends to the Corporation by the KDFI or FDIC. Any restrictions imposed by either regulator would effectively limit the Company’s ability to pay a dividend to its common stockholders as discussed in Note 17. At December 31, 2015, there were no such restrictions. At December 31, 2015, the Corporation has approximately $2.1 million in cash on hand available to pay common dividends and repurchase treasury stock as outlined in Note 20. At December 31, 2015, the Bank may not pay an additional cash dividend to the Company without regulatory approval.

Earnings Per Share

Earnings per share (EPS) consists of two separate components, basic EPS and diluted EPS. Basic EPS is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for each period presented. Diluted EPS is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding plus dilutive common stock equivalents (CSE). CSE consists of dilutive stock options granted through the Company’s stock option plan. Restricted stock awards represent future compensation expense and are dilutive. Common stock equivalents which are considered anti-dilutive are not included for the purposes of this calculation. Common stock warrants issued in December 2008 and all stock options outstanding are currently anti-dilutive and are not included for the purposes of this calculation.

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

 

(1) Summary of Significant Accounting Policies: (Continued)

 

Fair Values of Financial Instruments, (Continued)

 

Stock Compensation

The Company utilized the Black-Sholes valuation model to determine the fair value of stock options on the date of grant. The model derives the fair value of stock options based on certain assumptions related to the expected stock prices volatility, expected option life, risk-free rate of return and the dividend yield of the stock. The expected life of options granted is estimated based on historical employee exercise behavior. The risk free rate of return coincides with the expected life of the options and is based on the ten year Treasury note rate at the time the options are issued. The historical volatility levels of the Company’s common stock are used to estimate the expected stock price volatility. The set dividend yield is used to estimate the expected dividend yield of the stock.

Effect of New Accounting Pronouncements

ASU 2015-01, “Income Statement - Extraordinary and Unusual Items (Subtopic 225-20) – Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.” ASU 2015-01 eliminates from U.S. GAAP the concept of extraordinary items, which, among other things, required an entity to segregate extraordinary items considered to be unusual and infrequent from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations. ASU 2015-01 is effective for the Company beginning January 1, 2016, though early adoption is permitted. The Company does not anticipate that the implementation of ASU 2015-01 will have a significant impact on the Company’s Consolidated Financial Statements.

ASU No. 2015-02, “Amendments to the Consolidation Analysis.”This ASU affects reporting entities that are required to evaluate whether they should consolidate certain legal entities. Specifically, the amendments: (1) Modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities (“VIEs”) or voting interest entities; (2) Eliminate the presumption that a general partner should consolidate a limited partnership; (3) Affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships; and (4) 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. ASU No. 2015-02 is effective for interim and annual reporting periods beginning after December 15, 2015. The Company does not anticipate that the provisions of ASU No. 2015-02 will have a material impact on the Company’s Consolidated Financial Statements.

 

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Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

 

(1) Summary of Significant Accounting Policies: (Continued)

 

Effect of New Accounting Pronouncements (Continued

 

In May 2014, the FASB issued new guidance related to Revenue from Contracts with Customers. This guidance supersedes the revenue recognition requirements in Accounting Standards Codification Topic 605, Revenue Recognition, and most industry-specific guidance throughout the Accounting Standards Codification. The guidance requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. This guidance is effective for interim and annual reporting periods beginning after December 15, 2016; however, the FASB has agreed to a one year deferral of the effective date to December 15, 2017. The Company is currently evaluating this guidance to determine the impact on its consolidated financial statements.

On June 12, 2014, the FASB issued ASU 2014-11, which makes limited amendments to the guidance in ASC 860 on accounting for certain repurchase agreements (“repos”). ASU 2014-11 requires entities to account for repurchase-to-maturity transactions as secured borrowings (rather than as sales with forward repurchase agreements), (2) eliminates accounting guidance on linked repurchase financing transactions, and (3) expands disclosure requirements related to certain transfers of financial assets that are accounted for as sales and certain transfers (specifically, repos, securities lending transactions, and repurchase-to-maturity transactions) accounted for as secured borrowings. ASU 2014-11 also amends ASC 860 to clarify that repos and securities lending transactions that do not meet all of the de-recognition criteria in ASC 860-10-40-5 should be accounted for as secured borrowings. In addition, the ASU provides examples of repurchase and securities lending arrangements that illustrate whether a transferor has maintained effective control over the transferred financial assets. For public business entities, the accounting changes were effective beginning after January 1, 2015. The implementation of ASU 2014-11 did not have a material impact on the Company’s Consolidated Financial Statements.

In September 2015, the FASB issued Accounting Standards Update No. 2015-16, Simplifying the Accounting for Measurement-Period Adjustments. The guidance in this update eliminates the requirement to restate prior period financial statements for measurement period adjustments. The new guidance requires that the cumulative impact of a measurement period adjustment (including the impact on prior periods) be recognized in the reporting period in which the adjustment is identified. The new guidance is intended to reduce complexity in financial reporting. The elimination of the restatement requirement should simplify financial reporting for many entities. However, recognizing the entire impact of a measurement period adjustment in a single reporting period may introduce earnings volatility and reduce comparability between periods when the adjustments are material. The accounting changes in this update are effective for public companies for annual periods, and the interim periods within those annual periods, beginning after December 15, 2015. Early application is permitted for financial statements that have not been issued. The Company does not anticipate that the implementation of ASU 2015-16 will have a material impact on the Company’s Consolidated Financial Statements.

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

 

(1) Summary of Significant Accounting Policies: (Continued)

 

Effect of New Accounting Pronouncements (Continued)

 

In January 2014, the FASB issued ASU No. 2014-04, Receivables-Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. These amendments are intended to clarify when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan should be derecognized and the real estate recognized. The amendments clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either: (1) the creditor obtaining legal title to the residential real estate property upon completion of residential foreclosure, or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additional disclosures about such activities are required by these amendments. The amendments in this ASU became effective for public companies for annual periods and interim periods within those annual periods beginning after December 15, 2014. The Company’s implementation of ASU 2014-04 did not have a material impact on the Company’s Consolidated Financial Statements.

ASU 2015-02, “Consolidation (Topic 810) – Amendments to the Consolidation Analysis.” ASU 2015-02 implements changes to both the variable interest consolidation model and the voting interest consolidation model. ASU 2015-02 (i) eliminates certain criteria that must be met when determining when fees paid to a decision maker or service provider do not represent a variable interest, (ii) amends the criteria for determining whether a limited partnership is a variable interest entity and (iii) eliminates the presumption that a general partner controls a limited partnership in the voting model. ASU 2015-02 will be effective on January 1, 2016 and is not expected to have a significant impact on the Company’s financial statements.

ASU 2015-03, “Interest – Imputation of Interest (Subtopic 835-30) – Simplifying the Presentation of Debt Issuance Costs. ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in ASU 2015-03. ASU 2015-03 will be effective on January 1, 2016, though early adoption is permitted. ASU 2015-03 is not expected to have a significant impact on the Company’s financial statements.

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

 

(1) Summary of Significant Accounting Policies: (Continued)

 

Effect of New Accounting Pronouncements (Continued)

 

ASU 2015-15, “Interest – Imputation of Interest (Subtopic 835-30) – Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements. Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting.” ASU 2015-15 adds SEC paragraphs pursuant to an SEC Staff Announcement that given the absence of authoritative guidance within ASU 2015-03 for debt issuance costs related to line-of-credit arrangements, the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. ASU 2015-15 is not expected to have a significant impact on the Company’s financial statements.

ASU 2016-1, “No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-1, among other things, (i) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (iv) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (vi) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (viii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale. ASU 2016-1 will be effective on January 1, 2018, and is not expected to have a significant impact on the Company’s financial statements.

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

 

(1) Summary of Significant Accounting Policies: (Continued)

 

Effect of New Accounting Pronouncements (Continued)

 

ASU 2015-05, “Intangibles – Goodwill and Other—Internal-Use Software (Subtopic 350-40) – Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement.” ASU 2015-05 addresses accounting for fees paid by a customer in cloud computing arrangements such as (i) software as a service, (ii) platform as a service, (iii) infrastructure as a service and (iv) other similar hosting arrangements. ASU 2015-05 provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. ASU 2015-05 will be effective on January 1, 2016 and is not expected to have a significant impact on the Company’s financial statements.

Other accounting standards that have been issued or proposed by the FASB or other standards- bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

Reclassifications

Certain items in prior financial statements have been reclassified to conform to the current presentation.

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

(Table Amounts in Thousands)

 

(2) Securities:

Securities, which consist of debt and equity investments, have been classified in the consolidated balance sheets according to management’s intent. The carrying amount of securities and their estimated fair values follow:

 

     December 31, 2015  
            Gross      Gross      Estimated  
     Amortized      Unrealized      Unrealized      Fair  
     Cost      Gains      Losses      Value  

Restricted:

           

FHLB stock

   $ 4,428         —           —           4,428   
  

 

 

    

 

 

    

 

 

    

 

 

 

Available for Sale:

           

U.S. Treasury securities

   $ 2,001         —           (1      2,000   

U.S. Agency securities

     91,694         1,727         (488      92,933   

Tax free municipal bonds

     42,237         2,481         (59      44,659   

Taxable municipal bonds

     6,190         52         (65      6,177   

Trust preferred securities

     1,617         248         —           1,865   

Mortgage-backed securities:

           

GNMA

     29,990         239         (239      29,990   

FNMA

     28,189         266         (152      28,303   

FHLMC

     8,113         24         (51      8,086   

Non- Agency CMOs

     3,828         —           (174      3,654   

AGENCY CMOs

     19,570         71         (131      19,510   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 233,429         5,108         (1,360      237,177   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

(Table Amounts in Thousands)

 

(2) Securities: (Continued)

 

     December 31, 2014  
            Gross      Gross      Estimated  
     Amortized      Unrealized      Unrealized      Fair  
     Cost      Gains      Losses      Value  

Restricted:

           

FHLB stock

   $ 4,428         —           —           4,428   
  

 

 

    

 

 

    

 

 

    

 

 

 

Available for Sale:

           

U.S. Treasury Securities

     3,977         3         —           3,980   

U.S. Agency Securities

   $ 105,631         2,128         (527      107,232   

Tax free municipal bonds

     57,399         3,814         (166      61,047   

Taxable municipal bonds

     11,871         235         (63      12,043   

Trust preferred securities

     1,600         —           (111      1,489   

Commercial bonds

     2,000         7         —           2,007   

Mortgage-backed securities:

           

GNMA

     27,535         670         (122      28,083   

FNMA

     50,617         694         (536      50,775   

FHLMC

     3,276         38         —           3,314   

Non-Agency CMOs

     9,895         —           (252      9,643   

AGENCY CMOs

     28,024         176         (205      27,995   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 297,848         7,762         (1,982      303,628   
  

 

 

    

 

 

    

 

 

    

 

 

 

The scheduled maturities of debt securities available for sale at December 31, 2015, were as follows:

 

            Estimated  
     Amortized      Fair  
     Cost      Value  

Due within one year

   $ —           —     

Due in one to five years

     17,939         18,304   

Due in five to ten years

     42,151         42,793   

Due after ten years

     22,702         24,088   
  

 

 

    

 

 

 
     82,792         85,185   

Amortizing agency bonds

     60,947         62,449   

Mortgage-backed securities

     89,690         89,543   
  

 

 

    

 

 

 

Total unrestricted securities available for sale

   $ 233,429         237,177   
  

 

 

    

 

 

 

 

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Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

(Table Amounts in Thousands)

 

(2) Securities: (Continued)

 

The scheduled maturities of debt securities available for sale at December 31, 2014, were as follows:

 

            Estimated  
     Amortized      Fair  
     Cost      Value  

Due within one year

   $ 4,830         4,927   

Due in one to five years

     21,564         21,818   

Due in five to ten years

     41,683         42,613   

Due after ten years

     33,119         35,380   
  

 

 

    

 

 

 
     101,196         104,738   

Amortizing agency bonds

     77,305         79,080   

Mortgage-backed securities

     119,347         119,810   
  

 

 

    

 

 

 

Total unrestricted securities available for sale

   $ 297,848         303,628   
  

 

 

    

 

 

 

The FHLB stock is an equity interest in the Federal Home Loan Bank. FHLB stock does not have a readily determinable fair value because ownership is restricted and a market is lacking. FHLB stock is classified as a restricted investment security, carried at cost and evaluated for impairment.

The estimated fair value and unrealized loss amounts of temporarily impaired investments as of December 31, 2015, are as follows:

 

     Less than 12 months     12 months or longer     Total  
     Estimated      Unrealized     Estimated      Unrealized     Estimated      Unrealized  
     Fair Value      Losses     Fair Value      Losses     Fair Value      Losses  

Available for sale

               

U.S. Treasury securities

   $ 2,000         (1     —           —          2,000         (1

U.S. Agency debt securities

     26,499         (203     16,224         (285     42,723         (488

Taxable municipals

     2,159         (32     1,887         (33     4,046         (65

Tax free municipals

     —           —          3,878         (59     3,878         (59

Mortgage-backed securities:

               

GNMA

     10,840         (105     11,508         (134     22,348         (239

FNMA

     11,484         (87     3,036         (65     14,520         (152

FHLMC

     7,336         (51     —           —          7,336         (51

Non-Agency CMOs

     —           —          3,654         (174     3,654         (174

AGENCY CMOs

     9,781         (90     1,991         (41     11,772         (131
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total Available for Sale

   $ 70,099         (569     42,178         (791     112,277         (1,360
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

(Table Amounts in Thousands)

 

(2) Securities: (Continued)

 

The estimated fair value and unrealized loss amounts of temporarily impaired investments as of December 31, 2014, are as follows:

 

     Less than 12 months     12 months or longer     Total  
     Estimated      Unrealized     Estimated      Unrealized     Estimated      Unrealized  
     Fair Value      Losses     Fair Value      Losses     Fair Value      Losses  

Available for sale

               

U.S. Agency debt securities

   $ 14,021         (20     29,156         (507     43,177         (527

Taxable municipals

     —           —          4,785         (63     4,785         (63

Tax free municipals

     —           —          6,647         (166     6,647         (166

Trust preferred securities

     —           —          1,489         (111     1,489         (111

Mortgage-backed securities:

               

GNMA

     12,568         (108     2,895         (14     15,463         (122

FNMA

     —           —          18,927         (536     18,927         (536

NON-AGENCY CMOs

     1,923         (14     7,720         (238     9,643         (252

AGENCY CMOs

     9,545         (91     7,685         (114     17,230         (205
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total Available for Sale

   $ 38,057         (233     79,304         (1,749     117,361         (1,982
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

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

At December 31, 2015, the Company has 71 securities with unrealized losses. Management believes these unrealized losses relate to changes in interest rates and not credit quality. Management also believes the Company has the ability to hold these securities until maturity or for the foreseeable future and therefore no declines are deemed to be other than temporary.

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

 

(2) Securities: (Continued)

 

The carrying value of the Company’s investment securities may decline in the future if the financial condition of issuers deteriorates and management determines it is probable that the Company will not recover the entire amortized cost bases of the securities. As a result, there is a risk that other-than-temporary impairment charges may occur in the future.

In June of 2008, the Company purchased $2.0 million par value of a private placement subordinated debenture issued by First Financial Services Corporation (“FFKY”), the holding Company for First Federal Savings Bank (“First Fed”). The debenture is a thirty year security with a coupon rate of 8.00%. FFKY is a NASDAQ listed commercial bank holding company located in Elizabethtown, Kentucky. In October of 2010, FFKY informed the owners of its subordinated trust, including the Company, that it was deferring the dividend payments for up to five years as prescribed by the trust agreement.

At September 30, 2013, the Company recognized a $400,000 impairment charge due against this security. The impairment charge was recognized due to management’s financial analysis of the issuing institution and our opinion that it would be unable to make dividend payments after the five year extension expired. In January 2015, FFKY was sold to Your Community Bankshares (“YCB”). YCB assumed the debt of FFKY and paid all interest current. The Company is currently accreting the $400,000 impairment charge back into income at a rate of $4,200 per quarter.

During 2015, the Company sold investment securities classified as available for sale for proceeds of $84.9 million resulting in gross gains of $1,274,000 and gross losses of $583,000. During 2014, the Company sold investment securities classified as available for sale for proceeds of $75.3 million resulting in gross gains of $788,000 and gross losses of $210,000. During 2013, the Company sold investment securities classified as available for sale for proceeds of $68.5 million resulting in gross gains of $1.7 million and gross losses of $33,000.

As part of its normal course of business, the Bank holds significant balances of municipal and other deposits that require the Bank to pledge investment instruments as collateral. At December 31, 2015, the Bank pledged investments with a book value of $135.9 million and a market value of approximately $140.3 million to various municipal entities as required by law. In addition, the Bank has provided $32.5 million of letters of credit issued by the Federal Home Loan Bank of Cincinnati to collateralize municipal deposits. The collateral for these letters of credit are the Bank’s one to four family loan portfolio.

 

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Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

(Table Amounts in Thousands, Except Percentages)

 

(3) Loans Receivable, Net:

The components of loans receivable in the consolidated balance sheets as of December 31, 2015, and December 31, 2014, were as follows:

 

     December 31, 2015     December 31, 2014  
     Amount      Percent     Amount      Percent  

Real estate loans:

          

One-to-four family (closed end) first mortgages

   $ 145,999         26.0   $ 150,551         27.6

Second mortgages (closed end)

     1,771         0.3     2,102         0.4

Home equity lines of credit

     33,644         6.0     34,238         6.3

Multi-family

     24,725         4.4     25,991         4.8

Construction

     34,878         6.2     24,241         4.4

Land

     22,453         4.0     26,654         4.9

Farmland

     42,246         7.5     42,874         7.8

Non-residential real estate

     149,711         26.6     150,596         27.6
  

 

 

    

 

 

   

 

 

    

 

 

 

Total mortgage loans

     455,427         81.0     457,247         83.8

Consumer loans

     20,324         3.6     14,438         2.6

Commercial loans

     86,743         15.4     74,154         13.6
  

 

 

    

 

 

   

 

 

    

 

 

 

Total other loans

     107,067         19.0     88,592         16.2
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loans, gross

     562,494         100.0     545,839         100.0
     

 

 

      

 

 

 

Deferred loan cost, net of fees

     (445        (286   

Less allowance for loan losses

     (5,700        (6,289   
  

 

 

      

 

 

    

Total loans

   $ 556,349         $ 539,264      
  

 

 

      

 

 

    

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

(3) Loans Receivable, Net: (Continued)

 

Loans serviced for the benefit of others totaled approximately $36.9 million, $30.4 million and $32.6 million at December 31, 2015, 2014 and 2013, respectively. At December 31, 2015, approximately $22.8 million of the $36.9 million in loans serviced by the Company are serviced for the benefit of Freddie Mac. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow amounts, disbursing payments to investors and foreclosure processing. The servicing rights associated with these loans are not material to the Company’s consolidated financial statements. Qualified one-to-four family first mortgage loans, non-residential real estate loans, multi-family loans and commercial real estate loans are pledged to the Federal Home Loan Bank of Cincinnati as discussed in Note 7.

The Company originates most fixed rate loans for immediate sale to FHLMC or other investors. Generally, the sale of such loans is arranged shortly after the loan application is tentatively approved through commitments.

The Company conducts annual reviews on all loan relationships above $1.0 million to ascertain the borrowers continued ability to service their debt as agreed. In addition to the credit relationships mentioned above, management may classify any credit relationship once it becomes aware of adverse credit trends for that customer. Typically, the annual review consists of updated financial statements for borrowers and any guarantors, a review of the borrower’s credit history with the Company and other creditors, and current income tax information. As a result of this review, management will classify loans based on their credit risk.

The Company uses the following risk definitions for commercial loan risk grades:

Excellent - Loans in this category are to persons or entities of unquestioned financial strength, a highly liquid financial position, with collateral that is liquid and well margined. These borrowers have performed without question on past obligations, and the bank expects their performance to continue. Internally generated cash flow covers current maturities of long-term debt by a substantial margin. Loans secured by bank certificates of deposit and savings accounts, with appropriate holds placed on the accounts, are to be rated in this category.

Very Good - These are loans to persons or entities with strong financial condition and above- average liquidity who have previously satisfactorily handled their obligations with the bank. Collateral securing the bank’s debt is margined in accordance with policy guidelines. Internally generated cash flow covers current maturities of long-term debt more than adequately. Unsecured loans to individuals supported by strong financial statements and on which repayment is satisfactory may be included in this classification.

Satisfactory - Assets of this grade conform to substantially all the Bank’s underwriting criteria and evidence an average level of credit risk; however, such assets display more susceptibility to economic, technological or political changes since they lack the above average financial strength of credits rated Very Good. Borrower’s repayment capacity is considered to be adequate. Credit is appropriately structured and serviced; payment history is satisfactory.

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

(3) Loans Receivable, Net: (Continued)

 

Acceptable - Assets of this grade conform to most of the Bank’s underwriting criteria and evidence an acceptable, though higher than average, level of credit risk; however, these loans have certain risk characteristics which could adversely affect the borrower’s ability to repay given material adverse trends. Loans in this category require an above average level of servicing and show more reliance on collateral and guaranties to preclude a loss to the Bank should material adverse trends develop. If the borrower is a company, its earnings, liquidity and capitalization are slightly below average when compared to its peers.

Watch - These loans are characterized by borrowers who have marginal cash flow, marginal profitability, or have experienced an unprofitable year and a declining financial condition. The borrower has in the past satisfactorily handled debts with the bank, but in recent months has either been late, delinquent in making payments, or made sporadic payments. While the bank continues to be adequately secured, margins have decreased or are decreasing, despite the borrower’s continued satisfactory condition. Other characteristics of borrowers in this class include inadequate credit information, weakness of financial statement and repayment capacity, but with collateral that appears to limit exposure. This classification includes loans to established borrowers that are reasonably margined by collateral, but where potential for improvement in financial capacity appears limited.

Special Mention - Loans in this category have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deteriorating prospects for the asset or in the institution’s credit position at some future date. Borrowers may be experiencing adverse operating trends or market conditions. Non- financial reasons for rating a credit exposure Special Mention include, but are not limited to: management problems, pending litigations, ineffective loan agreement and/or inadequate loan documentation, structural weaknesses and/or lack of control over collateral.

Substandard - A substandard asset is inadequately protected by the current sound worth or paying capacity of the debtor or the collateral pledged. There exists one or more well defined weaknesses that jeopardize the liquidation of the debt. There is a distinct possibility the Bank will experience some loss if the deficiencies are not corrected. Generally, the asset is considered collectible as to both principal and interest primarily because of collateral coverage or enterprise value. Generally, the asset is current and marginally secured.

Doubtful - A loan classified as doubtful has all the weaknesses inherent in a loan classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. These are poor quality loans in which neither the collateral, if any, nor the financial condition of the borrower presently ensure collectability in full in a reasonable period of time; in fact, there is permanent impairment in the collateral securing the bank’s loan. These loans are in a work-out status and have a defined work-out strategy.

 

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HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

(3) Loans Receivable, Net: (Continued)

 

Loss - Loans classified as loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. The bank takes losses in the period in which they become uncollectible.

The following credit risk standards are assigned to consumer loans.

Satisfactory - All consumer open-end and closed-end retail loans shall have an initial risk grade assigned of 3 - Satisfactory.

Substandard Assets -All consumer open-end and closed-end retail loans past due 90 cumulative days from the contractual date will be classified as 7 - Substandard. If a consumer/retail loan customer files bankruptcy, the loan will be classified as 7 - Substandard regardless of payment history.

Loss Assets - All closed-end retail loans that become past due 120 cumulative days and open-end retail loans that become past due 180 cumulative days from the contractual due date will be charged off as loss assets. The charge off will be taken by the end of the month in which the 120-day or 180-day time period elapses. All losses in retail credit will be recognized when the affiliate becomes aware of the loss, but in no case should the charge off exceed the time frames stated within this policy.

A loan is considered to be impaired when management determines that it is probable that the Company will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. The value of individually impaired loans is measured based on the present value of expected payments or using the fair value of the collateral if the loan is collateral dependent. Currently, it is management’s practice to classify all substandard or doubtful loans as impaired.

 

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Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

 

(3) Loans Receivable, Net: (Continued)

 

Loan Origination/Risk Management

The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Company’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. This diversity helps reduce the Company’s exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single-purpose projects unless other underwriting factors are present to help mitigate risk. The Company also utilizes third-party experts to provide insight and guidance about economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At December 31, 2015, approximately $82.3 million of the outstanding principal balance of the Company’s non-residential real estate loans were secured by owner-occupied properties, approximately $67.4 million was secured by non-owner occupied properties.

 

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Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

 

(3) Loans Receivable, Net: (Continued)

 

Loan Origination/Risk Management (Continued)

 

With respect to loans to developers and builders that are secured by non-owner occupied properties that the Company may originate from time to time, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the completed project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

The Company maintains an independent loan review function that is typically outsourced to firms that specialize in conducting loan reviews. Results of these reviews are presented to management. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company policies and procedures.

Most of the Company’s lending activity occurs in Western Kentucky and middle and western Tennessee. The majority of the Company’s loan portfolio consists of non-residential real estate loans and one-to-four family residential real estate loans.

 

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Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

(Table Amounts in Thousands)

 

(3) Loans Receivable, Net: (Continued)

 

Loans by classification type and the related valuation allowance amounts at December 31, 2015, were as follows:

 

            Special      Impaired Loans             Specific
Allowance for
     Allowance for
Loans not
 
     Pass      Mention      Substandard      Doubtful      Total      Impairment      Impaired  

One-to-four family mortgages

   $ 142,729         41         3,229         —           145,999         60         970   

Home equity line of credit

     33,475         —           169         —           33,644         —           201   

Junior lien

     1,720         35         16         —           1,771         —           8   

Multi-family

     21,644         —           3,081         —           24,725         138         89   

Construction

     34,878         —           —           —           34,878         —           377   

Land

     11,794         41         10,618         —           22,453         69         1,310   

Non-residential real estate

     138,865         2,489         8,357         —           149,711         134         1,005   

Farmland

     41,917         —           329         —           42,246         —           358   

Consumer loans

     20,123         —           201         —           20,324         49         309   

Commercial loans

     84,317         352         2,074         —           86,743         180         443   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 531,462         2,958         28,074         —           562,494         630         5,070   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans by classification type and the related valuation allowance amounts at December 31, 2014, were as follows:

 

            Special      Impaired Loans      Specific
Allowance for
     Allowance for
Loans not
 
     Pass      Mention      Substandard      Doubtful      Total      Impairment      Impaired  

One-to-four family mortgages

   $ 146,129         203         4,219         —           150,551         51         1,147   

Home equity line of credit

     33,481         —           757         —           34,238         —           181   

Junior lien

     2,025         40         37         —           2,102         —           14   

Multi-family

     20,066         2,904         3,021         —           25,991         —           85   

Construction

     24,241         —           —           —           24,241         —           146   

Land

     15,328         362         10,964         —           26,654         663         460   

Non-residential real estate

     131,854         5,492         13,250         —           150,596         738         1,345   

Farmland

     40,121         516         2,237         —           42,874         —           461   

Consumer loans

     14,118         21         299         —           14,438         62         432   

Commercial loans

     71,246         325         2,583         —           74,154         —           504   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 498,609         9,863         37,367         —           545,839         1,514         4,775   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

(Table Amounts in Thousands)

 

(3) Loans Receivable, Net: (Continued)

 

Impaired loans by classification type and the related valuation allowance amounts at December 31, 2015, were as follows:

 

     At December 31, 2015      For the year ended
December 31, 2015
 
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

Impaired loans with no specific allowance

              

One-to-four family mortgages

   $ 2,526         2,526         —           2,389         80   

Home equity line of credit

     169         169         —           457         7   

Junior liens

     16         16         —           17         1   

Multi-family

     2,128         2,128         —           2,797         126   

Construction

     —           —           —           —           —     

Land

     10,038         10,998         —           8,520         671   

Non-residential real estate

     7,640         7,640         —           283         404   

Farmland

     329         329         —           7,774         19   

Consumer loans

     5         5         —           3         —     

Commercial loans

     1,274         1,274         —           1,599         73   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     24,125         25,085         —           23,839         1,381   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Impaired loans with a specific allowance

              

One-to-four family mortgages

   $ 703         703         60         709         40   

Home equity line of credit

     —           —           —           —           —     

Junior liens

     —           —           —           —           —     

Multi-family

     953         953         138         318         17   

Construction

     —           —           —           —           —     

Land

     580         580         69         1,707         46   

Non-residential real estate

     717         717         134         836         28   

Farmland

     —           —           —           —           —     

Consumer loans

     196         196         49         194         —     

Commercial loans

     800         800         180         514         15   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     3,949         3,949         630         4,278         146   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans

   $ 28,074         29,034         630         28,117         1,527   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

(Table Amounts in Thousands)

 

(3) Loans Receivable, Net: (Continued)

 

Impaired loans by classification type and the related valuation allowance amounts at December 31, 2014, were as follows:

 

     At December 31, 2014      For the year ended
December 31, 2014
 
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

Impaired loans with no specific allowance

              

One-to-four family mortgages

   $ 3,501         3,501         —           2,972         176   

Home equity line of credit

     757         757         —           690         35   

Junior liens

     37         37         —           39         2   

Multi-family

     3,021         3,021         —           1,342         190   

Construction

     —           —           —           29         —     

Land

     7,740         7,740         —           8,978         339   

Non-residential real estate

     12,057         12,057         —           8,672         669   

Farmland

     2,237         2,237         —           3,968         125   

Consumer loans

     51         51         —           36         3   

Commercial loans

     2,583         2,583         —           2,246         154   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     31,984         31,984         —           28,972         1,693   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Impaired loans with a specific allowance

           

One-to-four family mortgages

   $ 718         718         51         1,434         44   

Home equity line of credit

     —           —           —           —           —     

Junior liens

     —           —           —           —           —     

Multi-family

     —           —           —           —           —     

Construction

     —           —           —           —           —     

Land

     3,224         4,737         663         3,418         160   

Non-residential real estate

     1,193         1,258         738         3,617         69   

Farmland

     —           —           —           619         —     

Consumer loans

     248         248         62         355         —     

Commercial loans

     —           —           —           100         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     5,383         6,961         1,514         9,543         273   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans

   $ 37,367         38,945         1,514         38,515         1,966   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

(Table Amounts in Thousands)

 

(3) Loans Receivable, Net: (Continued)

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans as of December 31, 2015, and December 31, 2014, by portfolio segment and based on the impairment method as of December 31, 2015, and December 31, 2014.

 

     Commercial      Land
Development /
Construction
     Commercial
Real Estate
     Residential
Real Estate
     Consumer      Total  

December 31, 2015:

                 

Allowance for loan losses:

                 

Ending allowance balance attributable to loans:

                 

Individually evaluated for impairment

   $ 180         69         272         60         49         630   

Collectively evaluated for impairment

     443         1,687         1,452         1,179         309         5,070   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending allowance balance

   $ 623         1,756         1,724         1,239         358         5,700   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

                 

Loans individually evaluated for impairment

   $ 2,074         10,618         11,767         3,414         201         28,074   

Loans collectively evaluated for impairment

     84,669         46,713         204,915         178,000         20,123         534,420   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending loans balance

   $ 86,743         57,331         216,682         181,414         20,324         562,494   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Commercial      Land
Development /
Construction
     Commercial
Real Estate
     Residential
Real Estate
     Consumer      Total  

December 31, 2014:

                 

Allowance for loan losses:

                 

Ending allowance balance attributable to loans:

                 

Individually evaluated for impairment

   $ —           663         738         51         62         1,514   

Collectively evaluated for impairment

     504         606         1,891         1,342         432         4,775   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending allowance balance

   $ 504         1,269         2,629         1,393         494         6,289   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

                 

Loans individually evaluated for impairment

   $ 2,583         10,964         18,508         5,013         299         37,367   

Loans collectively evaluated for impairment

     71,571         39,931         200,953         181,878         14,139         508,472   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending loans balance

   $ 74,154         50,895         219,461         186,891         14,438         545,839   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

67


Table of Contents

HopFed Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements, Continued

December 31, 2015, 2014 and 2013

(Table Amounts in Thousands)

 

(3) Loans Receivable, Net: (Continued)

 

The average recorded investment in impaired loans for the years ended December 31, 2015, 2014 and 2013 was $28.1 million, $38.5 million and $43.1 million, respectively. Interest income recognized on impaired loans for the years ended December 31, 2015 and December 31, 2014 and December 31, 2013, was $1.5 million, $2.0 million and $859,000, respectively. The following table provides a detail of the Company’s activity in the allowance for loan loss account allocated by loan type for the year ended December 31, 2015:

 

     Balance
12/31/2014
     Charge
off
2015
    Recovery
2015
     General
Provision
2015
    Specific
Provision
2015
    Ending
Balance
12/31/2015
 

One-to-four family mortgages

   $ 1,198         (143     39         (176     112        1,030   

Home equity line of credit

     181         (92     10         20        82        201   

Junior liens

     14         —          4         (6     (4     8   

Multi-family

     85         —          —           4        138        227   

Construction

     146         —          —           231        —          377   

Land

     1,123         (911     —           850        317        1,379   

Non-residential real estate

     2,083         (222     2         (944     220        1,139   

Farmland

     461         —          —           500        (603     358   

Consumer loans

     494         (298     118         (123     167        358   

Commercial loans

     504         (201     54         (61     327        623   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 
   $ 6,289         (1,867     227         295        756        5,700   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

The following table provides a detail of the Company’s activity in the allowance for loan loss account allocated by loan type for the year ended December 30, 2014:

 

     Balance
12/31/2013
     Charge
off
2014
    Recovery
2014
     General
Provision
2014
    Specific
Provision
2014
    Ending
Balance
12/31/2014
 

One-to-four family mortgages

   $ 2,048         (233     24         (304     (337     1,198   

Home equity line of credit

     218         (83     3         (37     80        181   

Junior liens

     39         —          9         (25     (9     14   

Multi-family

     466         —          —           (381     —          85   

Construction

     88         (139     9         58        130        146   

Land

     1,305         —          —           (74     (108     1,123   

Non-residential real estate

     2,719         (66     864         (1,368