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Table of Contents

 

UNITED STATES

 

SECURITIES AND EXCHANGE COMMISSION

 

Washington, DC 20549

 

Form 10-K

 

 

XANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2015

 

__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____ to _____

 

Commission File Number 001-33126

 

 

CITIZENS FIRST CORPORATION

 

(Exact name of registrant as specified in its charter)

 

Kentucky

 

61-0912615

(State or other jurisdiction of

 

(I.R.S. Employer Identification No.)

incorporation or organization)

 

 

 

1065 Ashley Street, Bowling Green, Kentucky

 

42103

(Address of Principal Executive Offices)

 

(Zip Code)

 

Issuer’s Telephone Number, Including Area Code: (270) 393-0700

 

Securities registered under Section 12(b) of the Exchange Act:

Title of each class

 

Name of each exchange on which registered

 

Common stock, no par value

 

 

The NASDAQ Stock Market, LLC

 

Securities registered under Section 12(g) of the Exchange Act:  None

 

Indicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes__ NoX

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes__ No X

 

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

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K(Section229.405) is not contained herein, and will not be contained to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X

 

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

 

 

 

Large accelerated filer__

Accelerated filer__

 

 

Non-accelerated filer _ (Do not check if a smaller reporting company)

Smaller reporting company X

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.

Yes__ No X

 

State the aggregate market value of the voting and non-voting common equity held by non-affiliates (for purposes of this calculation, “affiliates” are considered to be the directors and executive officers of the issuer) computed by reference to the price at which the common equity was last sold, or the average bid and asked prices of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.   $22,826,325 as of June 30, 2015

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date:  1,998,352 shares of common stock as of March 23, 2016

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s proxy statement for the Annual Meeting of Shareholders to be held May 18, 2016 are incorporated by reference into Part III.

 



Table of Contents

 

Citizens First Corporation

Table of Contents

 

 

 

 

 

Part I:

 

 

 

 

 

Item 1

Business

7

 

 

 

Item 1A

Risk Factors

23

 

 

 

Item 1B

Unresolved Staff Comments

37

 

 

 

Item 2

Properties

37

 

 

 

Item 3

Legal Proceedings

38

 

 

 

Item 4

Mine Safety and Disclosures

38

 

 

 

Part II:

 

 

 

 

 

Item 5

Market for Registrant’s Common Equity, Related Stockholder Matters and Issued Purchases of Equity Securities

39

 

 

 

Item 6

Selected Financial Data

40

 

 

 

Item 7

Management’s Discussion and Analysis of Financial Condition and Results of Operation

41

 

 

 

Item 7A

Quantitative and Qualitative Disclosures About Market Risk

60

 

 

 

Item 8

Financial Statements and Supplementary Data

62

 

 

 

Item 9

Changes In and Disagreements with Accountants on Accounting and Financial Disclosure

108

 

 

 

Item 9A

Controls and Procedures

108

 

 

 

Item 9B

Other Information

109

 

 

 

Part III:

 

 

 

 

 

Item 10

Directors, Executive Officers and Corporate Governance

110

 

 

 

Item 11

Executive Compensation

111

 

 

 

Item 12

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

111

 

 

 

Item 13

Certain Relationships and Related Transactions and Director Independence

111

 

 

 

Item 14

Principal Accounting Fees and Services

111

 

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Part IV:

 

 

 

 

 

Item 15

Exhibits, Financial Statement Schedules

112

 

 

 

 

Signatures

114

 

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Part I

 

Forward-Looking Statements

 

Citizens First Corporation (the “Company”) may from time to time make written or oral statements, including statements contained in this report, which may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). The words “may”, “expect”, “anticipate”, “intend”, “consider”, “plan”, “believe”, “seek”, “should”, “estimate”, and similar expressions are intended to identify such forward-looking statements, but other statements may constitute forward-looking statements. These statements should be considered subject to various risks and uncertainties. Such forward-looking statements are based on many assumptions and estimates and are not guarantees of future performance.  Such statements are made pursuant to “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.

 

Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. Factors that could cause actual results and performance to differ from those expressed in our forward-looking statements we make or incorporate by reference in this Annual Report on Form 10-K include, but are not limited to those described below under Item 1A – “Risk Factors” and the following:

 

}

current and future economic and business conditions, including, without limitation, the deterioration of real estate values, the subprime mortgage, credit and liquidity markets, as well as the Federal Reserve’s actions with respect to interest rates, may lead to a deterioration in credit quality, thereby requiring increases in our provision for credit losses, a reduced demand for credit, which would reduce earning assets, and/or a decline in real estate values;

 

 

}

possible changes in trade, monetary and fiscal policies, as well as legislative and regulatory changes, including changes in accounting standards and banking, securities and tax laws, and our ability to maintain appropriate levels of capital;

 

 

}

changes in the interest rate environment and our ability to effectively manage interest rate risk and other market risk, credit risk and operational risk;

 

 

}

changes in the quality or composition of our loan or investment portfolios, including adverse developments in the real estate markets, the borrowers’ industries or in the repayment ability of individual borrowers or issuers;

 

 

}

increases in our nonperforming assets, or our inability to recover or absorb losses created by such nonperforming assets;

 

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}

our ability to manage fluctuations in the value of assets and liabilities and off-balance sheet exposure so as to maintain sufficient capital and liquidity to support our business;

 

 

}

the failure of our assumptions underlying the establishment of allowances for loan losses and other estimates, or dramatic changes in those underlying assumptions or judgments in future periods, that, in either case, render the allowance for loan losses inadequate or require that further provisions for loan losses be made;

 

 

}

laws and regulations affecting financial institutions in general;

 

 

}

government intervention in the U.S. financial system;

 

 

}

the cost and other effects of material contingencies;

 

 

}

our ability to keep pace with technological changes;

 

 

}

our ability to develop competitive new products and services in a timely manner and the acceptance of such products and services by our customers and potential customers;

 

 

}

the threat or occurrence of war or acts of terrorism and the existence or exacerbation of general geopolitical instability and uncertainty;

 

 

}

management’s ability to develop and execute plans to effectively respond to unexpected changes; and

 

 

}

other factors and information contained in this Annual Report on Form 10-K and other reports that we file with the Securities and Exchange Commission (SEC) under the Exchange Act.

 

The cautionary statements in this Annual Report on Form 10-K also identify important factors and possible events that involve risk and uncertainties that could cause our actual results to differ materially from those contained in the forward-looking statements. These forward-looking statements speak only as of the date on which the statements were made. We do not intend and undertake no obligation to update or revise any forward-looking statements, whether as a result of differences in actual results, changes in assumptions, future events or otherwise.

 

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Item 1.  Business

 

Overview

 

We are a Kentucky corporation organized in 1975 for the purpose of conducting business as an investment club. We are headquartered in Bowling Green, Kentucky.  In late 1998 and early 1999 we received regulatory approval to serve as the bank holding company for Citizens First Bank, Inc. (the “Bank”), a Kentucky state chartered bank that commenced operations on February 19, 1999. The Bank currently conducts full-service community banking operations from ten locations in the Kentucky counties of Barren, Hart, Simpson and Warren.

 

We are primarily engaged in the business of accepting demand, savings and time deposits insured by the FDIC and providing commercial, consumer and mortgage loans to the general public. We primarily market our products and services to small and medium-sized businesses and to retail consumers. Our strategy is to provide outstanding service through our employees, who are relationship-oriented and committed to customer service. Through this strategy, we intend to grow our business, expand our customer base and improve our profitability.

 

As of December 31, 2015, we had total assets of $432.2 million, total loans of $330.8 million, deposits of $370.4 million and stockholders’ equity of $39.5 million.

 

Lending Activities

 

General. We offer a variety of loans, including commercial and residential real estate mortgage loans, construction loans, commercial loans and consumer loans to individuals and small to mid-size businesses that are located in or conduct a substantial portion of their business in our market area.  Our underwriting standards vary for each type of loan, as described below. At December 31, 2015, we had total loans of $330.8 million, representing 76.5% of our total assets.

 

Commercial Loans.  We make commercial loans primarily to small and medium-sized businesses. These loans are secured and unsecured and are made available for general operating inventory and accounts receivables, as well as any other purposes considered appropriate. We will generally look to a borrower’s business operations as the principal source of repayment, but will also require, when appropriate, security interests in personal property and personal guarantees. In addition, the majority of commercial loans that are not mortgage loans are secured by a lien on equipment, inventory and other assets of the commercial borrower. These loans are generally considered to have greater risk than first and second mortgages on real estate because these loans may be unsecured or, if they are secured, the value of the collateral may be difficult to assess and more likely to decrease than real estate.  At December 31, 2015, commercial loans amounted to $53.5 million, or 16.2% of our total loan portfolio, excluding for these purposes commercial loans secured by real estate which are included in the commercial real estate category.  At December 31, 2015, our commercial loans had an average size of $96,000 and the largest loan was $4.6 million.

 

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Commercial Real Estate Loans.  We originate and maintain a significant amount of commercial real estate loans. This lending involves loans secured by multi-family residential units, income-producing properties and owner-occupied commercial properties. Loan amounts generally conform to the regulatory loan-to-value guidelines and amortizations match the economic life of the collateral, with a maximum amortization schedule of 20 years. Loans secured by commercial real estate are generally subject to a maximum term of 20 years. At December 31, 2015, total commercial real estate loans amounted to $193.5 million, or 58.5% of our loan portfolio. At December 31, 2015, our commercial real estate loans had an average size of $392,000 and the largest loan was $5.6 million.

 

Residential Real Estate Mortgage Loans.  We originate residential real estate mortgage loans with either fixed or variable interest rates to borrowers to purchase and refinance one-to-four family properties. We also offer home equity loans and home equity lines of credit.  Real estate mortgage loans are subject to the same general risks as other loans and are particularly sensitive to fluctuations in the value of real estate, which could negatively affect a borrower’s cash flow, creditworthiness and ability to repay the loan.  Except for home equity loans and lines of credit, substantially all of our residential real estate loans are secured by a first lien on the real estate.  Loans secured by residential real estate with variable interest rates will have a maximum term and amortization schedule of 30 years.  We sell to the secondary market the majority of our residential fixed-rate mortgage loans, thereby reducing our interest rate risk and credit risk. Loans secured by vacant land are generally subject to a maximum term of five years and a maximum amortization schedule of five years. At December 31, 2015, total residential real estate loans amounted to $79.7 million, or 24.1% of our loan portfolio. At December 31, 2015, our residential real estate mortgage loans had an average size of $68,000 and the largest loan was $1.9 million.

 

We provide customers access to long-term conventional real estate loans through our mortgage loan division, which underwrites loans that are purchased by unaffiliated third party brokers in the secondary market.  We receive fees in connection with the sale of mortgage loans, with these fees aggregating $233,000 and $190,000 for the years ending December 31, 2015 and 2014, respectively.  We do not retain servicing rights with respect to the secondary market residential mortgage loans that we originate.

 

Consumer.  We make personal loans and lines of credit available to consumers for various purposes, such as the purchase of automobiles, boats and other recreational vehicles, and the making of home improvements and personal investments. Consumer loans generally have shorter terms and higher interest rates than residential mortgage loans and usually involve more credit risk than mortgage loans because of the type and nature of the collateral. Consumer lending collections are dependent on a borrower’s continuing financial stability and are thus likely to be adversely affected by job loss, illness or personal bankruptcy. In many cases, repossessed collateral for a defaulted consumer loan will not provide an adequate source of repayment of the outstanding loan balance because of depreciation of the underlying collateral. We emphasize the amount of the down payment, credit quality and history, employment stability and monthly income. These loans are expected generally to be repaid on a monthly repayment schedule with the payment amount tied to the borrower’s periodic income.

 

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We believe that the generally higher yields earned on consumer loans help compensate for the increased credit risk associated with such loans and that consumer loans are important to our efforts to serve the credit needs of our customer base.  At December 31, 2015, total consumer loans amounted to $4.1 million, or 1.2% of our loan portfolio. At December 31, 2015, our consumer loans had an average size of $5,000, and the largest loan was $261,000.

 

Loan Underwriting and Approval.  We seek to make sound, high quality loans while recognizing that lending money involves a degree of business risk.  Our loan policies are designed to assist us in managing this business risk.  These policies provide a general framework for our loan operations while recognizing that not all risk activities and procedures can be anticipated.  Our loan policies instruct lending personnel to use care and prudent decision making and to seek the guidance of our Chief Credit Officer, our Vice President Credit Risk Officer, our Senior Vice President Credit Administration or our President and Chief Executive Officer where appropriate.

 

Deposit Products

 

Our principal source of funds is core deposits.  We offer a range of deposit products and services including checking accounts, savings accounts, NOW accounts, money market accounts, sweep accounts, fixed and variable rate IRA accounts, Christmas Club accounts and certificate of deposit accounts.  We solicit accounts from a wide variety of customers, including individuals and small to medium-sized businesses.  We actively pursue business checking accounts by offering competitive rates and other convenient services to our business customers.  In some cases, we require business customers to maintain minimum balances.  We offer a deposit pick-up service to our commercial customers that enable these customers to make daily cash deposits through one of our couriers.  At December 31, 2015, we had total deposits of $370.4 million.

 

Other Banking Services

 

Our retail banking strategy is to offer basic banking products and services that are attractively priced and easily understood by the customer.  We focus on making our products and services convenient and readily accessible to the customer.  In addition to banking during normal business hours, we offer extended drive-through hours, ATMs, and banking by telephone, mail and personal appointment.  We have twelve ATMs located within our markets. We also provide debit cards, credit cards, safekeeping and safe deposit boxes, ACH and other direct deposit services, savings bond redemptions, cashier’s checks, travelers’ checks and letters of credit.  We have also established relationships with correspondent banks and other independent financial institutions to provide other services requested by customers, including cash management services, wire transfer services, and loan participations where the requested loan amount exceeds the lending limits imposed by law or by our policies.  We maintain an internet banking website at www.citizensfirstbank.com, which allows customers to obtain account balances and transfer funds among accounts.  The website also provides online bill payment and electronic delivery of customer statements.

 

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We provide title insurance services to mortgage loan customers for a fee and, through third party providers, we offer other insurance services and trust services and receive a fee for referrals.  We offer non-deposit investment services and products through an agreement with a broker-dealer.  We earn advisory fees and commissions from the sale of these services and products.  The objective of offering these products and services is to generate fee income and strengthen relationships with our customers.

 

Competition and Market Area

 

The banking business is highly competitive, and we experience competition in our market from many other financial institutions. Our profitability depends upon our ability to compete in the market area in which our bank offices are located.  We compete for deposits, loans and other banking services generally on the basis of convenient office locations, interest rates offered on deposit accounts and charged on loans, fees and the range of services offered. We compete with existing area financial institutions other than commercial banks and savings banks, including commercial bank loan production offices, mortgage companies, insurance companies, consumer finance companies, securities brokerage firms, credit unions, money market funds and other business entities which have recently entered traditional banking markets.

 

Along with its headquarters in Bowling Green, the Bank currently operates eight (8) full-service banking facilities in the counties of Warren, Simpson, Barren and Hart in south central Kentucky, as well as a loan production office in Williamson County, Tennessee. Our market area consists primarily of a ten county region located in south central Kentucky known as the Barren River Area Development District.  This region consists of Allen, Barren, Butler, Edmonson, Hart, Logan, Metcalfe, Monroe, Simpson, and Warren Counties in Kentucky. As of June 30, 2015, there were 20 financial institutions operating a total of 53 offices in the Bowling Green MSA. In addition, there are six financial institutions operating a total of seven offices in Simpson County, four institutions operating a total of six offices in Hart County and eight financial institutions operating 19 offices in Barren County.

 

Employees

 

At December 31, 2015, we had 98 full-time equivalent employees.  Management considers its relations with its employees to be good. Neither we nor the Bank are a party to any collective bargaining agreement.

 

Supervision and Regulation

 

We are subject to the extensive regulatory framework applicable to bank holding companies and their subsidiaries. This framework is intended primarily for the protection of depositors, the FDIC’s Deposit Insurance Fund and the banking system as a whole, and generally is not intended for the protection of stockholders or other investors. Described below are the material elements of selected laws and regulations applicable to us and the Bank. These descriptions are not intended to be complete and are qualified in their entirety by reference to the full text of the statutes and regulations described. Changes in applicable law or regulation, and in their interpretation and

 

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application by regulatory agencies and other governmental authorities, cannot be predicted, but may have a material effect on our business, financial condition or results of operations.

 

Applicable laws and regulations restrict our permissible activities and investments and impose conditions and requirements on the products and services we offer and the manner in which they are offered and sold. They also restrict our ability to repurchase stock or pay dividends, or to receive dividends from our banking subsidiary, and impose capital adequacy requirements on us and our banking subsidiary. The consequences of noncompliance with these laws and regulations can include substantial monetary and nonmonetary sanctions.

 

As described in more detail below, comprehensive reform of the legislative and regulatory landscape occurred with the passage of the Dodd-Frank Act in 2010. Implementation of the Dodd-Frank Act and related rulemaking activities continued in 2015. In addition to banking laws, regulations and regulatory agencies, we are subject to various other laws, regulations, supervision and examination by other regulatory agencies, all of which directly or indirectly affect our operations and management.

 

Overview

 

We are a bank holding company under the Bank Holding Company Act of 1956 (BHC Act). As such, we are subject to the supervision, examination and reporting requirements of the Board of Governors of the Federal Reserve (Federal Reserve) under the BHC Act and the regulations promulgated thereunder. We are required to file periodic reports of our operations and any additional information the Federal Reserve may require.

 

The Bank is a member of the FDIC and, as such, its deposits are insured by the FDIC to the extent provided by law. The Bank is a state bank chartered under the banking laws of the Commonwealth of Kentucky. As a result, it is subject to the supervision, examination and reporting requirements of both the Kentucky Department of Financial Institutions (KDFI) and the FDIC.

 

We are subject to numerous state and federal statutes and regulations that affect our business activities and operations, including restrictions on loan limits, interest rates, “insider” loans to officers, directors, and principal shareholders, tie-in arrangements and transactions with affiliates, among other things.  Federal and state regulators also have authority to impose substantial sanctions on the Bank and its directors and its directors and officers if we engage in unsafe or unsound practices, or otherwise fail to comply with regulatory standards. Supervisory agreements, such as memoranda of understanding entered into with federal and state bank regulators, may also impose requirements and reporting obligations.

 

Financial Regulatory Reform

 

The recent financial crisis led to the adoption and revision of numerous laws and regulations applicable to financial institutions operating in the U.S. In particular, the Dodd-Frank Act and the rules that followed have significantly restructured the financial

 

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regulatory regime in the U.S. The Dodd-Frank Act is extensive, complicated and comprehensive legislation that impacts practically all aspects of a banking organization, representing a significant overhaul of many aspects of the regulation of the financial services industry.

 

The Dodd-Frank Act imposed regulatory requirements and oversight over banks and other financial institutions in a number of ways, among which were: (i) created the Consumer Financial Protection Bureau (CFPB) to regulate consumer financial products and services; (ii) granted orderly liquidation authority to the FDIC for the liquidation of financial corporations that pose a risk to the financial system of the U.S.; (iii) limited debit card interchange fees; (iv) adopted certain changes to stockholder rights and responsibilities, including a stockholder “say on pay” vote on executive compensation; (v) strengthened the SEC’s powers to regulate securities markets; (vi) restricted variable-rate lending by requiring the ability to repay to be determined for variable-rate loans by using the maximum rate that will apply during the first five years of a variable-rate loan term, and making more loans subject to provisions for higher cost loans, new disclosures, and certain other revisions; (vii) changed the base upon which the deposit insurance assessment is assessed from deposits to, substantially, average consolidated assets minus equity; and (viii) amended the Truth in Lending Act with respect to mortgage originations, including originator compensation, minimum repayment standards, and prepayment considerations.

 

Most recently, federal regulators have finalized rules for new capital requirements for financial institutions that include several changes to the way capital is calculated and how assets are risk-weighted, informed in part by the Basel II revised international capital framework published by the Basel Committee. The Basel III Rules, summarized briefly below, will have an effect on our level of capital, and may influence the types of business we may pursue and how we pursue business opportunities. Among other things, the Basel III Rules raise the required minimums for certain capital ratios, add a new common equity ratio, include capital buffers, and restrict what constitutes capital. The new capital and risk weighting requirements became effective for us on January 1, 2015.

 

Many of the provisions of the Dodd-Frank Act and other laws are subject to further rulemaking, guidance and interpretation by the applicable federal regulators. We will continue to evaluate the impact of any new regulations so promulgated.

 

Acquisitions

 

A bank holding company must obtain Federal Reserve Board approval before acquiring, directly or indirectly, ownership or control of more than 5% of the voting stock or all or substantially all of the assets of a bank, merging or consolidating with any other bank holding company and before engaging, or acquiring a company that is not a bank but is engaged in certain non-banking activities. Federal law also prohibits a person or group of persons from acquiring “control” of a bank holding company without notifying the Federal Reserve Board in advance and then only if the Federal Reserve Board does not object to the proposed transaction. The Federal Reserve Board has established a rebuttable presumptive standard that the acquisition of 10% or more of the voting stock

 

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of a bank holding company with a class of securities registered under the Securities Exchange Act of 1934 would constitute an acquisition of control of the bank holding company. In addition, any company is required to obtain the approval of the Federal Reserve Board before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of any class of a bank holding company’s voting securities, or otherwise obtaining control or a “controlling influence” over a bank holding company.

 

Permissible Activities under the BHC Act

 

A bank holding company is generally permitted under the BHC Act to engage in or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in banking or managing or controlling banks, furnishing services to or performing services for our subsidiaries and any activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.

 

As a bank holding company, we may elect to become a financial holding company, which enables the holding company to conduct activities that are “financial in nature.” Activities that are “financial in nature” include securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; and activities that the Federal Reserve has determined to be closely related to banking. We have not sought financial holding company status. If we were to elect in writing for financial holding company status, each insured depository institution we controlled would have to be well capitalized, well managed and have at least a satisfactory CRA rating.

 

Capital Requirements

 

We are required to comply with the capital adequacy standards established by the Federal Reserve at the holding company level, and the FDIC at the bank level. In July 2013, the Federal Reserve Board and the FDIC approved final rules that substantially amend the regulatory capital rules applicable to the Company and the Bank. The final rules, parts of which are currently in the process of being phased in, implement the regulatory capital reforms of the Basel Committee on Banking Supervision reflected in “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (Basel III) and changes required by the Dodd-Frank Act.

 

The Basel III rules substantially revised the risk-based capital requirements applicable to bank holding companies and their depository institution subsidiaries, including the Company and the Bank, as compared to the general risk-based capital rules. The final rules implementing the Basel III regulatory capital reforms became effective as to the Company and the Bank on January 1, 2015 (subject to a phase-in period for certain provisions).

 

The Basel III rules, among other things, (i) introduce a new capital measure called common equity Tier 1 (CET1), (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting certain revised requirements, (iii) define CET1 narrowly by requiring that most deductions/adjustments to regulatory capital

 

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measures be made to CET1 and not to the other components of capital, and (iv) expand the scope of the deductions/adjustments to capital as compared to existing regulations.

 

The new minimum capital level requirements applicable to bank holding companies and banks subject to the rules are: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 risk-based capital ratio of 6% (increased from 4%); (iii) a total risk-based capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions.

 

The rules also establish a “capital conservation buffer” of 2.5% (to be phased in over three years) above the new regulatory minimum risk-based capital ratios, and result in the following minimum ratios once the capital conservation buffer is fully phased in: (i) a common equity Tier 1 risk-based capital ratio of 7%, (ii) a Tier 1 risk-based capital ratio of 8.5%, and (iii) a total risk-based capital ratio of 10.5%. The capital conservation buffer requirement is to be phased in beginning in January 2016 at 0.625% of risk-weighted assets and would increase each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if capital levels fall below minimum plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

 

Under these new rules, Tier 1 capital will generally consist of common stock (plus related surplus) and retained earnings, limited amounts of minority interest in the form of additional Tier 1 capital instruments, and non-cumulative preferred stock and related surplus, subject to certain eligibility standards, less goodwill and other specified intangible assets and other regulatory deductions. Cumulative preferred stock and trust preferred securities issued after May 19, 2010, will no longer qualify as Tier 1 capital, but such securities issued prior to May 19, 2010, including in the case of bank holding companies with less than $15.0 billion in total assets, trust preferred securities issued prior to that date, will continue to count as Tier 1 capital subject to certain limitations. The definition of Tier 2 capital is generally unchanged for most banking organizations, subject to certain new eligibility criteria.

 

Common equity Tier 1 capital will generally consist of common stock (plus related surplus) and retained earnings plus limited amounts of minority interest in the form of common stock, less goodwill and other specified intangible assets and other regulatory deductions.

 

The final rules allow banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. The Company has elected to opt-out of this requirement.

 

Bank holding companies and banks are also required to comply with minimum leverage ratio requirements. These requirements provide for a minimum ratio of Tier 1 capital to total consolidated quarterly average assets (as defined for regulatory purposes), net of the loan loss reserve, goodwill and certain other intangible assets (the “leverage ratio”), of 4.0% for all bank holding companies.

 

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Safety and Soundness Standards

 

Guidelines adopted by the federal bank regulatory agencies pursuant to the Federal Deposit Insurance Act (FDIA), establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. In general, these guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines. Additionally, the agencies adopted regulations that authorize, but do not require, an agency to order an institution that has been given notice by an agency that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the FDIA. If an institution fails to comply with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties.

 

Prompt Corrective Action

 

The FDIA establishes a system of prompt corrective action to resolve the problems of undercapitalized institutions. Under this system, the federal banking regulators established five capital categories (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized), into one of which each institution is placed. With respect to institutions in the three undercapitalized categories, the regulators must take prescribed supervisory actions and are authorized to take other discretionary actions. The severity of the action depends upon the capital category into which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized. The federal banking agencies have specified by regulation the relevant capital level for each category.  As of December 31, 2015, the Bank was well-capitalized.

 

An institution that is classified as well-capitalized based on its capital levels may be treated as adequately capitalized, and an institution that is adequately capitalized or undercapitalized based upon its capital levels may be treated as though it were undercapitalized or significantly undercapitalized, respectively, if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment.

 

If a bank is not well capitalized, it cannot accept brokered deposits without prior FDIC approval. Even if approved, rate restrictions apply governing the rate the bank may be permitted to pay on the brokered deposits. In addition, a bank that is undercapitalized cannot offer an effective yield in excess of 75 basis points over the “national rate” paid on deposits (including brokered deposits, if approval is granted for the bank to accept them) of comparable size and maturity. The “national rate” is defined as a simple average of rates paid by insured depository institution and branches for which data are available and is published weekly by the FDIC. Institutions subject to the restrictions

 

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that believe they are operating in an area where the rates paid on deposits are higher than the “national rate” can use the local market to determine the prevailing rate if they seek and receive a determination from the FDIC that it is operating in a high-rate area. Regardless of the determination, institutions must use the national rate to determine conformance for all deposits outside their market area.

 

An institution that is categorized as undercapitalized, significantly undercapitalized, or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. A bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to limitations. The controlling bank holding company’s obligation to fund a capital restoration plan is limited to the lesser of 5% of an undercapitalized subsidiary’s assets or the amount required to meet regulatory capital requirements. An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except in accordance with an accepted capital restoration plan or with FDIC approval. The regulations also establish procedures for downgrading an institution and a lower capital category based on supervisory factors other than capital.

 

An insured depository institution may not pay a management fee to a bank holding company controlling that institution or any other person having control of the institution if, after making the payment, the institution would be undercapitalized. In addition, an institution cannot make a capital distribution, such as a dividend or other distribution that is in substance a distribution of capital to the owners of the institution if following such a distribution the institution would be undercapitalized. Thus, if payment of such a management fee or the making of such capital distribution would cause the bank to become undercapitalized, it could not pay a management fee or dividend to us.

 

Dividends

 

We are a legal entity separate and distinct from the Bank. The principal source of our cash flow is dividends paid to us by the Bank. Statutory and regulatory limitations apply to the Bank’s ability to pay dividends to us as well as to our ability to pay dividends to our shareholders.  Under Kentucky law, the Company is not permitted to pay dividends to the extent they result in the insolvency of the corporation from a balance sheet perspective or in the corporation becoming unable to pay debts as they come due.

 

In addition to state law limitations on the Company’s ability to pay dividends, the Federal Reserve imposes limitations on the Company’s ability to pay dividends.  As noted above, effective January 1, 2016, Federal Reserve limitations limit dividends, stock repurchases and discretionary bonuses to executive officers if the Company’s regulatory capital is below the level of regulatory minimums plus the applicable capital conservation buffer which will increase each year until January 1, 2019.

 

Statutory limitations also apply to the Bank’s payment of dividends to the Company.  Under Kentucky law, dividends by Kentucky banks may be paid only from current or retained net profits. The Kentucky Department of Financial Institutions must approve the declaration of dividends if the total dividends to be declared by a bank for any calendar

 

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year would exceed the bank’s total net profits for such year combined with its retained net profits for the preceding two years, less any required transfers to surplus or a fund for the retirement of preferred stock or debt.

 

The payment of dividends by the Bank may also be affected by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. The federal agencies have issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.  Under the FDIA, an insured institution may not pay a dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the Federal Reserve and the FDIC have issued policy statements stating that BHCs and insured banks should generally pay dividends only out of current operating earnings, and the new capital rules prohibit the payment of dividends when a holding company or insured depository institution is not in compliance with the capital conservation buffer described elsewhere in this report.

 

The amount and timing of all future dividend payments, if any, is subject to Board discretion and will depend on our earnings, capital position, financial condition and other factors, including new regulatory capital requirements, as they become known to us.

 

Transactions with Affiliates

 

Both the Company and the Bank are subject to the provisions of Section 23A and Section 23B of the Federal Reserve Act. Section 23A places limits on the amount of a bank’s loans or extensions of credit to affiliates, a bank’s investment in an affiliate, assets a bank may purchase from affiliates, except for real and personal property exempted by the obligations of affiliates, the amount of loans or extensions of credit to third parties collateralized by the securities or obligations of affiliates, transactions involving the borrowing or lending of securities and any derivative transaction that results in credit exposure to an affiliate, and a bank’s guarantee, acceptance or letter of credit issued on behalf of an affiliate.

 

The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. The Bank must also comply with other provisions designed to avoid the taking of low-quality assets. Section 23B prohibits an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

 

Source of Strength

 

Under the Dodd-Frank Act, and previously under Federal Reserve policy, we are required to act as a source of financial strength for and to commit resources to support

 

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the Bank in circumstances in which might not otherwise do so. This support may be required at times when, absent such Federal Reserve policy, we may not be inclined to provide it. If the Bank were to become undercapitalized, we would be required to provide a guarantee of the Bank’s plan to return to capital adequacy. In addition, any loans by a bank holding company to any of its banking subsidiaries are subordinate in right of payment to deposits and to other indebtedness of such banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a banking subsidiary will be assumed by the bankruptcy trustee and entitled to a priority of payment.

 

Branching

 

With prior regulatory approval and/or notices, as applicable, Kentucky law permits banks based in the state to either establish new or acquire existing branch offices throughout Kentucky. As a result of the Dodd Frank Act, the Bank and any other national or state chartered bank may branch across state lines to the same extent as banks chartered in the state of the branch.

 

FDIC Insurance

 

Deposits in the Bank are insured by the FDIC subject to applicable limitations. To offset the cost of this issuance, the FDIC has adopted a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities and the size of the institutions. Under the Dodd-Frank Act, the FDIC has adopted regulations that base deposit insurance assessments on total assets less capital rather than deposit liabilities and include off-balance sheet liabilities of institutions and their affiliates in risk-based assessments.

 

The Dodd-Frank Act increased the basic limit on federal deposit insurance coverage to $250,000 per depositor. The Dodd-Frank Act also repealed the prohibition on paying interest on demand transaction accounts.

 

The FDIC may terminate its insurance of an institution’s deposits if it finds that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.

 

Community Reinvestment

 

The Community Reinvestment Act (CRA) requires that the FDIC in connection with examinations of financial institutions within their respective jurisdictions, a financial institution’s primary regulator, which is the FDIC for the Bank, shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate-income neighborhoods. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank. At our last regulatory examination, the Bank received a “satisfactory” CRA rating.

 

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Consumer Protection Laws

 

The Bank is subject to consumer laws and regulations that are designed to protect consumers. Interest and other charges collected or contracted for by the bank are subject to state usury laws and federal laws concerning interest rates. The Bank’s loan operations are also subject to federal laws applicable to credit transactions such as the:

 

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Federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

 

 

 

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Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

 

 

 

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Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

 

 

 

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Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies;

 

 

 

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Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;

 

 

 

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Bank Secrecy Act, governing how banks and other firms report certain currency transactions and maintain appropriate safeguards against “money laundering” activities;

 

 

 

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Soldiers’ and Sailors’ Civil Relief Act of 1940, governing the repayment terms of, and property rights underlying, secured obligations of persons in active military service; and

 

 

 

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Rules and regulations of the various federal agencies charged with the responsibility of implementing the federal laws.

 

 

 

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The Bank’s deposit operations are subject to the:

 

 

 

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Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and

 

 

 

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Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve to implement that act, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities (including with respect to the permissibility of overdraft charges) arising from the use of automated teller machines and other electronic banking services.

 

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Consumer Financial Protection Bureau

 

Dodd-Frank created a new, independent federal agency called the Consumer Financial Protection Bureau (CFPB) which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions are subject to rules promulgated by the CFPB but are examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB has authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. Dodd-Frank permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.

 

Financial Privacy and Cybersecurity

 

The federal banking regulators have adopted rules that limit the ability of banks and other financial institutions to disclose non-public information about consumers to non-affiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a non-affiliated third party. These regulations affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors. In addition, consumers may also prevent disclosure of certain information among affiliated companies that is assembled or used to determine eligibility for a product or service, such as that shown on consumer credit reports and asset and income information from applications. Consumers also have the option to direct banks and other financial institutions not to share information about transactions and experiences with affiliated companies for the purpose of marketing products or services.

 

In March 2015, federal regulators issued two related statements regarding cybersecurity. One statement indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing Internet-based services of the financial institution. The other statement indicates that a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber attack involving destructive malware. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber attack. If we fail to observe the regulatory guidance, we could be subject to various regulatory sanctions, including financial penalties.

 

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Anti-Money Laundering; USA Patriot Act

 

Financial institutions must maintain anti-money laundering programs that include established internal policies, procedures, and controls; a designated compliance officer; an ongoing employee training program; and testing of the program by an independent audit function. We are prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence in dealings with foreign financial institutions and foreign customers. We also must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions. Recent laws provide law enforcement authorities with increased access to financial information maintained by banks. Anti-money laundering obligations have been substantially strengthened as a result of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA Patriot Act), enacted in 2001, renewed in 2006 and extended, in part, in 2011. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.

 

The USA Patriot Act amended, in part, the Bank Secrecy Act and provides for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering. The statute also creates enhanced information collection tools and enforcement mechanics for the U.S. government, including: (1) requiring standards for verifying customer identification at account opening; (2) promulgating rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (3) requiring reports by nonfinancial trades and businesses filed with the Treasury’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and (4) mandating the filing of suspicious activities reports if a bank believes a customer may be violating U.S. laws and regulations. The statute also requires enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons.

 

The Federal Bureau of Investigation may send bank regulatory agencies lists of the names of persons suspected of involvement in terrorist activities. The Bank may be subject to a request for a search of its records for any relationships or transactions with persons on those lists and may be required to report any identified relationships or transactions. Furthermore, the Office of Foreign Assets Control (OFAC) is responsible for helping to ensure that U.S. entities do not engage in transactions with certain prohibited parties, as defined by various Executive Orders and Acts of Congress. OFAC has sent, and will send, bank regulatory agencies lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts, known as Specially Designated Nationals and Blocked Persons. If we find a name on any transaction, account or wire transfer that is on an OFAC list, we must freeze such account, file a suspicious activity report and notify the appropriate authorities.

 

Proposed Legislation and Regulatory Action

 

Congress may enact further legislation that affects the regulation of the financial services industry, and state legislatures may enact further legislation affecting the

 

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regulation of financial institutions chartered by or operation in these states.  Federal and state regulatory agencies also periodically propose and adopt changes to their regulations or change the manner in which existing regulations are applied.  We cannot predict the substance or impact of pending or future legislation or regulations, or the application thereof, although enactment of the proposed legislation could impact the regulatory structure under which the Company operates and may significantly increase costs, impede the efficiency of internal business processes, require an increase in regulatory capital, may require modifications of the Company’s business strategy, and limit the Company’s ability to pursue business opportunities in an efficient manner.  A change in statutes, regulations or regulatory policies applicate to the Company or the Bank could have a material effect on our business.

 

Effects of Governmental Policies and Economic Conditions

 

Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government, and its agencies. The Federal Reserve’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through the Federal Reserve’s statutory power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The Federal Reserve, through its monetary and fiscal policies, affects the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature and impact of future changes in monetary or fiscal policies.

 

Available Information

 

We file reports with the SEC including our annual report on Form 10-K, quarterly reports on Form 10-Q, current event reports on Form 8-K and proxy statements, as well as any amendments to those reports. The public may read and copy any materials the Registrant files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at http://www.sec.gov. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Exchange Act are accessible at no cost on our web site at http://www.citizensfirstbank.com, under the Investors Relations section, once they are electronically filed with or furnished to the SEC. A shareholder may also request a copy of our Annual Report or Form 10-K free of charge upon written request to: Chief Financial Officer, Citizens First Corporation, 1065 Ashley Street, Suite 150, Bowling Green, Kentucky 42103.

 

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Item 1A. Risk Factors

 

Our business, financial condition, and results of operation could be harmed by any of the following risks, or other risks that have not been identified or which we believe are immaterial or unlikely. Shareholders should carefully consider the risks described below in conjunction with other information in this Form 10-K and the information incorporated by reference in this Form 10-K, including our consolidated financial statements and related notes.

 

Risks Related to the Operation of Our Business

 

General economic conditions in the U.S. and in our local economy could adversely affect us.

 

We provide traditional commercial, retail and mortgage banking services, as well as other financial services including asset management, wealth management, securities brokerage, insurance, merger-and-acquisition advisory services and other specialty financing. All of our businesses are materially affected by conditions in the financial markets and economic conditions generally or specifically in the Southeastern U.S., the principal markets in which we conduct business. A worsening of business and economic conditions generally or specifically in the principal markets in which we conduct business could have adverse effects on our business, including the following:

 

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A decrease in the demand for, or the availability of, loans and other products and services offered by us;

 

 

 

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A decrease in the value of our loans held for sale or other assets secured by consumer or commercial real estate;

 

 

 

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An impairment of certain intangible assets, such as goodwill;

 

 

 

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A decrease in interest income from variable rate loans, due to declines in interest rates; and

 

 

 

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An increase in the number of clients and counterparties who become delinquent, file for protection under bankruptcy laws or default on their loans or other obligations to us, which could result in a higher level of nonperforming assets, net charge-offs, provisions for loan losses, and valuation adjustments on loans held for sale.

 

Overall, during the past several years, the general business environment has had an adverse effect on our business. Although the general business environment has shown some improvement, there can be no assurance that it will continue to improve. Since 2008, the federal government and the Federal Reserve have intervened in an unprecedented manner in an effort to provide stability and liquidity to the financial markets, including by implementing monetary policy measures designed to stabilize and stimulate the U.S. economy. There can be no assurance that the federal government and the Federal Reserve will continue to intervene or that the measures undertaken by

 

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the federal government and the Federal Reserve will result in continued improvement in the general business environment or in the business environments in the principal markets in which we do business. Additionally, the improvement of certain economic indicators, such as real estate asset values and rents and unemployment, may vary between geographic markets and in our principal markets may continue to lag behind improvement in the overall economy. These economic indicators typically affect certain industries, such as real estate and financial services, more significantly than other economic sectors. Furthermore, financial services companies with a substantial lending business, like ours, are dependent upon the ability of their borrowers to make debt service payments on loans. If economic conditions worsen or remain volatile, our business, financial condition and results of operations could be materially adversely affected.

 

We may be adversely affected by interest rate changes.

 

Our earnings are largely dependent upon our net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies, in particular, the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, and (iii) the average duration of our loan and mortgage-backed securities portfolios. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.

 

We generally seek to maintain a neutral position in terms of the volume of assets and liabilities that mature or re-price during any period. As such, we have adopted asset and liability management strategies to attempt to minimize the potential adverse effects of changes in interest rates on net interest income, primarily by altering the mix and maturity of loans, investments and funding sources, so that it may reasonably maintain its net interest income and net interest margin. However, interest rate fluctuations, the level and shape of the interest rate yield curve, loan prepayments, loan production and deposit flows are constantly changing and influence the ability to maintain a neutral position. Accordingly, we may not be successful in maintaining a neutral position and, as a result, our net interest margin may be adversely impacted.

 

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Our loan portfolio exposes us to credit risk.

 

There are inherent risks associated with our lending activities and we seek to mitigate these risks by adhering to conservative underwriting practices.  Although we believe that our underwriting practices are appropriate for the various kinds of loans we make, we may nevertheless incur losses on loans that meet our underwriting criteria, and these losses may exceed the amounts set aside as reserves in our allowance for loan losses.  Increased credit risk may result from several factors, including adverse changes in local, U.S. and global economic and industry conditions, declines in the value of collateral, concentrations of credit associated with specific loan categories, industries or collateral types and risks related to individual borrowers.  We rely heavily on information provided by third parties when originating and monitoring loans.  If this information is intentionally or negligently misrepresented and we do not detect such misrepresentations, the credit risk associated with the transaction may be increased.  Although we attempt to manage our credit risk by carefully monitoring the concentration of our loans within specific loan categories and industries and through prudent loan approval and monitoring practices in all categories of our lending, we cannot assure you that our approval and monitoring procedures will reduce these lending risks.  If our credit administration personnel, policies and procedures are not able to adequately adapt to changes in economic or other conditions that affect customers and the quality of the loan portfolio, we may incur increased losses that could adversely affect our financial results.

 

We are exposed to higher credit risk by commercial real estate, commercial and agricultural loans.

 

Commercial real estate and commercial and agricultural lending usually involve higher credit risks than that of single-family residential lending. As of December 31, 2015, commercial real estate loans accounted for 58.5% of our loan portfolio and commercial and agricultural loans accounted for 16.2% of our loan portfolio. These types of loans involve larger loan balances to a single borrower or groups of related borrowers. Commercial real estate loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because commercial real estate borrowers’ ability to repay their loans depends on successful development of their properties, in addition to the factors affecting residential real estate borrowers. These loans also involve greater risk because they generally are not fully amortizing over the loan period, but have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or sell the underlying property in a timely manner.

 

Commercial loans are typically based on the borrowers’ ability to repay the loans from the cash flow of their businesses. These loans may involve greater risk because the availability of funds to repay each loan depends substantially on the success of the business itself. In addition, the collateral securing the loans have the following characteristics: (a) they depreciate over time, (b) they are difficult to appraise and liquidate, and (c) they fluctuate in value based on the success of the business.

 

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Risk of loss on a construction loan depends largely upon whether our initial estimate of the property’s value at completion of construction equals or exceeds the cost of the property construction (including interest), the availability of permanent take-out financing, and the builder’s ability to ultimately sell the property. During the construction phase, a number of factors can result in delays and cost overruns. If estimates of value are inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan or by seizure of collateral.

 

Commercial real estate and commercial and agricultural loans are more susceptible to a risk of loss during a downturn in the business cycle. Our underwriting, review and monitoring cannot eliminate all of the risks related to these loans.

 

The banking regulators are giving commercial real estate lending greater scrutiny, and may require banks with higher levels of commercial real estate loans to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for losses and capital levels as a result of commercial real estate lending growth and exposures.

 

Our loan portfolio possesses increased risk due to our relatively high concentration of loans collateralized by real estate.

 

Approximately 86% of our loan portfolio as of December 31, 2015 was comprised of loans collateralized by real estate. Further adverse changes in the economy affecting values of real estate generally or in our primary market specifically could significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure. The real estate collateral provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If real estate values decline, it is also more likely that we would be required to increase our allowance for loan losses. If during a period of reduced real estate values we are required to liquidate the collateral securing a loan to satisfy the debt or to increase our allowance for loan losses, it could materially reduce our profitability and adversely affect our financial condition.

 

Weakness in the residential real estate markets could adversely affect our performance.

 

As of December 31, 2015, consumer residential real estate loans represented approximately 24% of our total loan portfolio. Declines in home values would adversely affect the value of collateral securing the residential real estate that we hold, as well as the volume of loan originations and the amount we realize on the sale of real estate loans. These factors could result in higher delinquencies and greater charge-offs in future periods, which could materially adversely affect our business, financial condition or results of operations.

 

If our allowance for loan losses proves to be insufficient to absorb probable incurred losses in our loan portfolio, our earnings will decrease.

 

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If loan customers with significant loan balances fail to repay their loans, our earnings and capital levels will suffer. We maintain an allowance for loan losses that we believe is a reasonable estimate of probable incurred losses within the loan portfolio. We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of any collateral securing the loans. Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of customers relative to their financial obligations with us. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and these losses may exceed current estimates. We cannot fully predict the amount or timing of losses or whether the loss allowance will be adequate in the future and our current and future allowances for loan losses may not be adequate to cover future loan losses given current and future market conditions. Excessive loan losses and significant additions to our allowance for loan losses could have a material adverse impact on our financial condition and results of operations.

 

In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those of our management. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities may have a material adverse effect on our financial condition and results of operations.

 

Recently adopted changes to capital requirements for bank holding companies and depository institutions may negatively impact our results of operations.

 

In July 2013, the Federal Reserve Board and the FDIC approved final rules that substantially amend the regulatory risk-based capital rules applicable to the Company and the Bank. The final rules implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act.

 

Under these rules, the leverage and risk-based capital ratios of bank holding companies may not be lower than the leverage and risk-based capital ratios for insured depository institutions. The final rules implementing the Basel III regulatory capital reforms were effective as to the Company and the Bank on January 1, 2015, and include new minimum risk-based capital and leverage ratios. Moreover, these rules refine the definition of what constitutes “capital” for purposes of calculating those ratios, including the definitions of Tier 1 capital and Tier 2 capital. The new minimum capital level requirements applicable to bank holding companies and banks subject to the rules are: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 risk-based capital ratio of 6% (increased from 4%); (iii) a total risk-based capital ratio of 8% (unchanged from current rules); (iv) a Tier 1 leverage ratio of 4% for all institutions. The rules also establish a “capital conservation buffer” of 2.5% (to be phased in over three years) above the new regulatory minimum risk-based capital ratios, and result in the following minimum ratios once the capital conservation buffer is fully phased in: (i) a common equity Tier 1 risk-based capital ratio of 7%, (ii) a Tier 1 risk-based capital ratio of 8.5%, and (iii) a total risk-based capital ratio of 10.5%. The capital conservation buffer

 

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requirement is to be phased in beginning in January 2016 at 0.625% of risk-weighted assets and would increase each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if capital levels fall below minimum plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

 

Under these new rules, Tier 1 capital will generally consist of common stock (plus related surplus) and retained earnings, limited amounts of minority interest in the form of additional Tier 1 capital instruments, and non-cumulative preferred stock and related surplus, subject to certain eligibility standards, less goodwill and other specified intangible assets and other regulatory deductions. Cumulative preferred stock and trust preferred securities issued after May 19, 2010, will no longer qualify as Tier 1 capital, but such securities issued prior to May 19, 2010, including in the case of bank holding companies with less than $15.0 billion in total assets, trust preferred securities issued prior to that date, will continue to count as Tier 1 capital subject to certain limitations. The definition of Tier 2 capital is generally unchanged for most banking organizations, subject to certain new eligibility criteria. Common equity Tier 1 capital will generally consist of common stock (plus related surplus) and retained earnings plus limited amounts of minority interest in the form of common stock, less goodwill and other specified intangible assets and other regulatory deductions.

 

The final rules allow banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. We have opted out of this requirement.

 

The application of more stringent capital requirements for the Company and the Bank, like those adopted to implement the Basel III reforms, could, among other things, result in lower returns on invested capital, require the raising of additional capital, and result in regulatory actions if we were to be unable to comply with such requirements. Implementation of changes to asset risk weightings for risk based capital calculations, items included or deducted in calculating regulatory capital and/or additional capital conservation buffers could result in management modifying its business strategy and could limit our ability to make distributions, including paying dividends or buying back shares.

 

Our ability to maintain required capital levels and adequate sources of funding and liquidity could be impacted by changes in the capital markets and deteriorating economic and market conditions.

 

We, and the Bank, are required to maintain certain capital levels established by banking regulations or specified by bank regulators, including those capital maintenance standards imposed on us as a result of the Dodd-Frank Act, and we are required to serve as a source of strength to the Bank. We must also maintain adequate funding sources in the normal course of business to support our operations and fund outstanding liabilities. Our ability to maintain capital levels, sources of funding and liquidity could be impacted by changes in the capital markets in which we operate and

 

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deteriorating economic and market conditions. The Bank will be required to obtain regulatory approval in order to pay dividends to us unless the amount of such dividends does not exceed its retained net profits for that year plus the preceding two years. Failure by the Bank to meet applicable capital guidelines or to satisfy certain other regulatory requirements could subject our bank subsidiary to a variety of enforcement remedies available to the federal regulatory authorities.

 

Certain of our deposits and other funding sources may be volatile and impact our liquidity.

 

In addition to traditional core deposits, such as demand deposit accounts, interest checking, money market savings and certificates of deposits, we utilize or in the past have utilized several noncore funding sources, such as brokered certificates of deposit, Federal Home Loan Bank (FHLB) of Cincinnati advances, federal funds purchased and other sources. We utilize these noncore funding sources to fund the ongoing operations and growth of the Bank. The availability of these noncore funding sources is subject to broad economic conditions and to investor assessment of our financial strength and, as such, the cost of funds may fluctuate significantly and/or be restricted, thus impacting our net inters income, our immediate liquidity and/or our access to additional liquidity.

 

Impairment of goodwill and/or intangible assets could require charges to earnings, which could result in a negative impact on our results of operations.

 

A significant and sustained decline in our stock price and market capitalization, a significant decline in our expected future cash flows, a significant adverse change in the business climate, slower growth rates or other factors could result in future impairment of goodwill or other intangible assets. At December 31, 2015, our goodwill and other identifiable intangible assets totaled approximately $4.4 million. If we were to conclude that a future write-down of our goodwill or intangible assets is necessary, then we would record the appropriate charge to earnings, which could be materially adverse to our results of operations and financial position.

 

Our internal operations are subject to a number of risks.

 

Our internal operations are subject to certain risks, including but not limited to, data processing system failures and errors, customer or employee fraud and catastrophic failures resulting from terrorist acts or natural disasters. Operational risk resulting inadequate or failed internal processes, people and systems includes the risk of fraud by employees or persons outside of our company, the execution of unauthorized transactions by employees, errors relating to transaction processing and systems, and breaches of the internal control system and compliance requirements. This risk of loss also includes potential legal actions that could arise as a result of the operational deficiency or as a result of noncompliance with applicable regulatory standards.

 

We are dependent on our information technology and telecommunications systems and third-party servicers, and systems failures, interruptions or breaches of security could have an adverse effect on our financial condition and results of operations.

 

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Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify these systems as circumstances warrant, the security of our computer systems, software and networks may be vulnerable to breaches, unauthorized access, misuse, computer viruses or other malicious code and other events that could have a security impact. We outsource many of our major systems, such as data processing. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. If sustained or repeated, a system failure or service denial could result in a deterioration of our ability to process new and renewal loans, gather deposits and provide customer service, compromise our ability to operate effectively, damage our reputation, result in a loss of customer business and/or subject us to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

 

In addition, we provide our customers the ability to bank remotely, including online over the Internet. The secure transmission of confidential information is a critical element of remote banking. Our network could be vulnerable to unauthorized access, computer viruses, phishing schemes, spam attacks, human error, natural disasters, power loss and other security breaches. We may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, or to alleviate problems caused by security breaches or viruses. To the extent that our activities or the activities of our customers involve the storage and transmission of confidential information, security breaches and viruses could expose us to claims, litigation and other possible liabilities. Any inability to prevent security breaches or computer viruses could also cause existing customers to lose confidence in our systems and could adversely affect our reputation, results of operations and ability to attract and maintain customers and businesses. In addition, a security breach could also subject us to additional regulatory scrutiny, expose us to civil litigation and possible financial liability and cause reputational damage.

 

We continually encounter technological change, and we may have fewer resources than many of our competitors to continue to invest in technological improvements.

 

The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology will increase efficiency and will enable financial institutions to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our clients by using technology to provide products and services that will satisfy client demands for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our clients.

 

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Our securities portfolio performance in difficult market conditions could have adverse effects on our results of operations.

 

Under U.S. generally accepted accounting principles, we are required to review our investment portfolio periodically for the presence of other-than-temporary impairment of its securities, taking into consideration current market conditions, the extent and nature of change in fair value, issuer rating changes and trends, volatility of earnings, current analysts’ evaluations, our intent to sell or determination that we will not be required to sell investments until a recovery of fair value, as well as other factors. Adverse developments with respect to one or more of the foregoing factors may require us to deem particular securities to be other-than-temporarily impaired, with the credit loss recognized as a charge to earnings. Subsequent valuations, in light of factors prevailing at that time, may result in significant changes in the values of these securities in future periods. Any of these factors could require us to recognize further impairments in the value of our securities portfolio, which may have an adverse effect on our results of operations.

 

We are subject to environmental liability risk associated with our lending activities.

 

A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our business, results of operations and financial condition.

 

Our businesses may be adversely affected if we are unable to hire and retain qualified employees

 

Our success depends, in part, on our executive officers and other key personnel. The market for qualified individuals is highly competitive, and we may not be able to attract and retain qualified personnel or candidates to replace or succeed members of our senior management team or other key personnel. Our compensation practices are subject to review and oversight by the Federal Reserve, the FDIC and other regulators. As a banking institution, we may be subject to limitations on compensation practices, which may or may not affect our competitors, by the Federal Reserve, the FDIC or other regulators. These limitations could further affect our ability to attract and retain our executive officers and other key personnel.

 

Our future success is dependent on our ability to compete effectively in the highly competitive banking industry.

 

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We face substantial competition in all phases of our operations from a variety of different competitors. Our future growth and success will depend on our ability to compete effectively in this highly competitive environment. To date, we have grown our business by focusing on our geographic market and emphasizing the high level of service and responsiveness desired by our customers. We compete for loans, deposits and other financial services with other commercial banks, thrifts, credit unions, consumer finance companies, insurance companies and brokerage firms. Many of our competitors offer products and services which we do not offer, and many have substantially greater resources, name recognition and market presence that benefit them in attracting business. In addition, larger competitors may be able to price loans and deposits more aggressively than we do, and smaller and newer competitors may also be more aggressive in terms of pricing loan and deposit products than us in order to obtain a larger share of the market. Some of the financial institutions and financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on bank holding companies, federally insured state-chartered banks and national banks and federal savings banks. As a result, these non-bank competitors have certain advantages over us in accessing funding and in providing various services.

 

We also experience competition from a variety of institutions outside of our market area. Some of these institutions conduct business primarily over the Internet and may thus be able to realize certain cost savings and offer products and services at more favorable rates and with greater convenience to the customer.

 

Our accounting policies and methods impact how we report our financial condition and results of operations. Application of these policies and methods may require management to make estimates about matters that are uncertain.

 

Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with U.S. generally accepted accounting principles and reflect management’s judgment of the most appropriate manner to report our financial condition and results of operations. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances yet might result in our reporting materially different amounts than would have been reported under a different alternative. For a description of our significant accounting policies, see Note 1 of the Notes to Consolidated Financial Statements. These accounting policies are critical to presenting our financial condition and results of operations. They may require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions.

 

Changes in accounting standards could materially impact our consolidated financial statements.

 

The accounting standard setters, including the Financial Accounting Standards Board, SEC and other regulatory bodies, from time to time may change the financial accounting

 

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and reporting standards that govern the preparation of our consolidated financial statements. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in changes to previously reported financial results, or a cumulative charge to retained earnings.

 

Our internal controls may be ineffective.

 

We regularly review and update our internal controls, disclosure controls and procedures and corporate governance policies and procedures. As a result, we may incur increased costs to maintain and improve our controls and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls or procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations or financial condition.

 

Risks Arising From the Legal and Regulatory Framework in which Our Business Operates

 

Recent legislative and regulatory initiatives to support the financial services industry have been coupled with numerous restrictions and requirements that could detrimentally affect our business.

 

The Dodd-Frank Act and the rules and regulations promulgated thereunder significantly impacted the United States bank regulatory structure and affected the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies.  The scope and impact of many of the Dodd-Frank Act provisions, including the authority provided to the CFPB, will continue to be determined over time as rules and regulations are issued and become effective. As a result, we cannot predict the ultimate impact of the Dodd-Frank Act on us at this time, including the extent to which it could increase costs or limit our ability to pursue business opportunities in an efficient manner, or otherwise adversely affect our business, financial condition, results of operations and our ability to pay dividends. However, it is expected that at a minimum they will increase our operating and compliance costs. Compliance with these requirements may necessitate that we hire additional compliance or other personnel, design and implement additional internal controls, or incur other significant expenses, any of which could have a material adverse effect on our business, financial condition or results of operations.

 

National or state legislation or regulation may increase our expenses and reduce earnings.

 

Federal bank regulators are increasing regulatory scrutiny, and additional restrictions (including those originating from the Dodd-Frank Act) on financial institutions have been proposed or adopted by regulators and by Congress. Changes in tax law, federal legislation, regulation or policies, such as bankruptcy laws, deposit insurance, consumer

 

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protection laws, and capital requirements, among others, can result in significant increases in our expenses and/or charge-offs, which may adversely affect our earnings. Changes in state or federal tax laws or regulations can have a similar impact. Many state and municipal governments, including the Commonwealth of Kentucky, are under financial stress due to the economy. As a result, these governments could seek to increase their tax revenues through increased tax levies which could have a meaningful impact on our results of operations. Furthermore, financial institution regulatory agencies are expected to continue to be very aggressive in responding to concerns and trends identified in examinations, including the continued issuance of additional formal or informal enforcement or supervisory actions. These actions, whether formal or informal, could result in our agreeing to limitations or to take actions that limit our operational flexibility, restrict our growth or increase our capital or liquidity levels. Failure to comply with any formal or informal regulatory restrictions, including informal supervisory actions, could lead to further regulatory enforcement actions. Negative developments in the financial services industry and the impact of recently enacted or new legislation in response to those developments could negatively impact our operations by restricting our business operations, including our ability to originate or sell loans, and adversely impact our financial performance. In addition, industry, legislative or regulatory developments may cause us to materially change our existing strategic direction, capital strategies, compensation or operating plans.

 

We may be adversely affected by further increases in FDIC insurance or special assessments.

 

The FDIC insures deposits at FDIC-insured depository institutions, such as the Bank, up to applicable limits. The amount of a particular institution’s deposit insurance assessment is based on that institution’s risk classification under an FDIC risk-based assessment system. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to its regulators. Market developments have significantly depleted the Deposit Insurance Fund (DIF) of the FDIC and reduced the ratio of reserves to insured deposits. As a result of recent economic conditions and the enactment of the Dodd-Frank Act, the FDIC has increased the deposit insurance assessment rates and thus raised deposit insurance premiums for insured depository institutions. If these increases are insufficient for the DIF to meet its funding requirements, there may need to be further special assessments or increases in deposit insurance premiums. We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures, we may be required to pay even higher premiums than the recently increased levels. Any future additional assessments, increases or required prepayments in FDIC insurance premiums may materially and adversely affect us, including by reducing our profitability or limiting our ability to pursue certain business opportunities.

 

Risks Related to Our Capital Stock

 

Even though our common stock is currently traded on the NASDAQ Stock Market, it has less liquidity than many other stocks quoted on a national securities exchange.

 

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The trading volume in our common stock has been relatively low when compared with larger companies listed on NASDAQ or other stock exchanges. We cannot say with any certainty that an active and liquid trading market for our common stock will develop. Because of this, it may be more difficult for stockholders to sell a substantial number of shares for the same price at which stockholders could sell a smaller number of shares. We cannot predict the effect, if any, that future sales of our common stock in the market, or the availability of shares of common stock for sale in the market, will have on the market price of our common stock. We can give no assurance that sales of substantial amounts of common stock in the market, or the potential for large amounts of sales in the market, would not cause the price of our common stock to decline or impair our future ability to raise capital through sales of our common stock.

 

The market price of our common stock has fluctuated significantly, and may fluctuate in the future. These fluctuations may be unrelated to our performance. General market or industry price declines or overall market volatility in the future could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices.

 

Our capital stock is subordinate to our existing and future indebtedness.

 

Our capital stock ranks junior to all of our existing and future indebtedness and other non-equity claims with respect to assets available to satisfy claims against us, including claims in the event of our liquidation. As of December 31, 2015, our total liabilities were approximately $393 million, and we may incur additional indebtedness in the future to increase our capital resources. Additionally, if our capital ratios or the capital ratios of the Bank fall below the required minimums, we or the Bank could be forced to raise additional capital by making additional offerings of debt securities.

 

We are a holding company and depend on our subsidiary bank for dividends, distributions and other payments.

 

We are a legal entity separate and distinct from our bank subsidiary. Our principal source of cash flow, including cash flow to pay dividends to our stockholders and principal and interest on our outstanding debt, is dividends from the Bank. There are statutory and regulatory limitations on the payment of dividends by the Bank to us, as well as by us to our stockholders. Regulations of both the Federal Reserve and the State of Kentucky affect the ability of the Bank to pay dividends and other distributions to us and to make loans to us. If the Bank is unable to make dividend payments to us and sufficient cash or liquidity is not otherwise available, we may not be able to make dividend payments to our common and preferred stockholders or principal and interest payments on our outstanding debt. In addition, our right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of creditors of that subsidiary, except to the extent that any of our claims as a creditor of such subsidiary may be recognized. As a result, shares of our capital stock are effectively subordinated to all existing and future liabilities and obligations of our subsidiaries.

 

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We may not pay dividends on shares of our capital stock.

 

Holders of shares of our capital stock are only entitled to receive such dividends as our board of directors may declare out of funds legally available for such payments. We have declared cash dividends on our common stock sporadically; we are not required to do so. Furthermore, the terms of our outstanding preferred stock prohibit us from declaring or paying any dividends on any junior series of our capital stock, including our common stock, or from repurchasing, redeeming or acquiring such junior stock, unless we have declared and paid full dividends on our outstanding preferred stock for the most recently completed dividend period.

 

We are also subject to statutory and regulatory limitations on our ability to pay dividends on our capital stock. For example, it is the policy of the Federal Reserve that BHCs should generally pay dividends on common stock only out of earnings, and only if prospective earnings retention is consistent with the organization’s expected future needs, asset quality and financial condition. Further, if we are unable to satisfy the capital requirements applicable to us for any reason, we may be limited in our ability to declare and pay dividends on our capital stock.

 

We may need to raise additional debt or equity capital in the future, but may be unable to do so.

 

We may need to raise additional capital in the future to provide us with sufficient capital resources and liquidity to meet our commitments and other business purposes. Our ability to raise additional capital, if needed, will depend on, among other things, prevailing conditions in the capital markets, which are outside of our control, and our financial performance. The economic slowdown and loss of confidence in financial institutions over the past several years may increase our cost of funding and limit our access to some of our customary sources of capital, including inter-bank borrowings, repurchase agreements and borrowings from the discount window of the Federal Reserve. We cannot assure you that capital will be available to us on acceptable terms or at all.  An inability to raise additional capital on acceptable terms when needed could have a materially adverse effect on our business, financial condition or results of operations.

 

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Item 1B. Unresolved Staff Comments None.

 

Item 2. Properties

 

We currently operate in Warren, Simpson, Barren and Hart Counties in Kentucky, as well as Williamson County, Tennessee.

 

 

 

 

Type of Office

Location

Leased or Owned

 

 

 

 

 

 

Corporate Office

1065 Ashley Street
Bowling Green, Kentucky

Owned

 

 

 

Main Office

1805 Campbell Lane
Bowling Green, Kentucky

Leased(1)

 

 

 

Branch

987 Lehman Avenue
Bowling Green, Kentucky

Owned

 

 

 

Branch

1200 S. Main Street
Franklin, Kentucky

Owned

 

 

 

Branch

204 East Main Street
Horse Cave, Kentucky

Owned

 

 

 

Branch

760 West Cherry
Glasgow, Kentucky

Owned

 

 

 

Branch

607 S L Rogers Well Blvd
Glasgow, Kentucky

Leased

 

 

 

Branch

656 North Main Street
Munfordville, Kentucky

Leased

 

 

 

Branch

1700 Scottsville Road

Owned

 

Bowling Green, Kentucky

 

 

 

 

 

 

 

Loan Production Office

3301 Aspen Grove Drive, Ste.200
Franklin, Tennessee

Leased

 

 

 

__________

 

(1)         We sold this branch in the fourth quarter of 2006 to an unrelated party and leased it back.

 

We also own properties located at 2900 Louisville Road and on Gator Drive in Bowling

 

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Green which may be used for future branch expansion.  We also own property at 705 N. Main Street in Franklin, KY where an ATM is located.

 

Item 3. Legal Proceedings

 

In the opinion of management, there is no proceeding pending or, to the knowledge of management, threatened, in which an adverse decision could result in a material adverse change in the consolidated financial condition or results of operations of the Company.

 

Item 4.  Mine Safety Disclosures. Not Applicable.

 

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Part II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

 

The common stock of the Company is traded in the NASDAQ Global Market under the symbol “CZFC.” Trading volume in the Company’s common stock is light. As of March 22, 2016, there were approximately 737 beneficial owners of the Company’s common stock, including 119 shareholders of record and, to the best knowledge of the Company,  approximately 618 beneficial owners whose shares are held by securities brokers-dealers or other nominees.

 

The following table shows the reported high and low closing sales price information for our common stock for the periods indicated:

 

 

2015

 

 

High

 

 

Low

 

 

 

 

 

 

 

 

Fourth Quarter

 

$14.35

 

 

$12.66

 

 

 

 

 

 

 

 

 

 

Third Quarter

 

13.20

 

 

12.51

 

 

 

 

 

 

 

 

 

 

Second Quarter

 

12.85

 

 

12.00

 

 

 

 

 

 

 

 

 

 

First Quarter

 

12.69

 

 

11.90

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2014

 

 

High

 

 

Low

 

 

 

 

 

 

 

 

Fourth Quarter

 

$12.49

 

 

$11.11

 

 

 

 

 

 

 

 

 

 

Third Quarter

 

12.10

 

 

10.35

 

 

 

 

 

 

 

 

 

 

Second Quarter

 

11.00

 

 

10.11

 

 

 

 

 

 

 

 

 

 

First Quarter

 

10.50

 

 

9.00

 

 

 

 

 

 

 

 

 

 

 

We paid a cash dividend of $0.08 per share on our common stock in November, 2015, which marks the first common dividend paid by the Company since December, 2008. Dividends on common stock will be payable in the future at the discretion of the Board of Directors, subject to certain restrictions discussed below and in our financial statements. Quarterly dividends are payable on our cumulative perpetual preferred stock, prior and in preference to the payment of dividends on our common stock, at an annual fixed rate of 6.5%.  See Item 1, “Business — Supervision and Regulation” for

 

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additional information on dividend restrictions applicable to the Company and Citizens First Bank.

 

The following table sets forth certain information as of December 31, 2015, regarding Company compensation plans under which equity securities of the Company are authorized for issuance.

 

 

 

Equity Compensation Plan Information

Plan Category

 

Number of
Securities

To be Issued Upon

Exercise of

Outstanding
Options,

Warrants and Rights

(a)

Weighted-average

Exercise Price of

Outstanding

Options, Warrants

and Rights

(b)

Number of Securities

Remaining Available
for

Future Issuance under

equity compensation

plans

(excluding securities

reflected in Column a)

(c) 

Equity compensation plans approved by security holders

 

26,571

$

18.36

-

Equity compensation plans not approved by security holders

 

-

-

-

Total

 

26,571

$

18.36

-

 

 

 

Item 6. Selected Financial Data. Not Applicable.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with Item 8 “Financial Statements” as well as other information included in this Form 10-K.

 

Overview of 2015

 

Significant developments for the year ended December 31, 2015 were:

 

}

Net income increased $366,000, or $0.11 per diluted common share, from a net income of $3.24 million in 2014 to $3.61 million in 2015.  Net income increased primarily due to an increase in net interest income of $651,000.

 

 

}

Net interest margin increased to 3.86% for 2015 compared to 3.85% for 2014 as interest income increased coupled with a reduction of interest expense.  The rates we earned on loans and investments declined slightly but an increase in the volume of earning assets contributed to the improvement in interest income.

 

 

}

Nonperforming assets decreased to $637,000, or 0.15% of total assets at December 31, 2015, compared to $1.4 million, or 0.33% of total assets at December 31, 2014.  Net charge-offs for 2015 totaled $104,000 compared to $43,000 in 2014.

 

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Application of Critical Accounting Policies

 

Our consolidated financial statements are prepared in accordance with United States generally accepted accounting principles and follow general practices within the financial services industry. The most significant accounting policies followed by the Company are presented in Note 1 to the Consolidated Financial Statements. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses, the evaluation of our goodwill and other intangible assets, and our valuation of deferred tax assets to be the accounting areas that require the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.

 

Allowance for Loan Losses

 

The allowance for loan losses represents management’s estimate of probable credit losses incurred in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows or underlying collateral values on impaired loans, estimated losses on loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheet. Note 1 to the Consolidated Financial Statements describes the methodology used to determine the allowance for loan losses, and a discussion of the factors driving changes in the amount of the allowance for loan losses is included under “Credit Quality and the Allowance for Loan Losses” below.

 

Goodwill and Other Intangibles

 

Management is required to assess goodwill and other intangible assets annually for impairment or more often if certain factors are identified which could imply potential impairment. This assessment involves preparing analyses of market multiples for similar operations, and estimating the fair value of the reporting unit to which the goodwill is allocated. If the analysis results in an estimate of fair value materially less than the carrying value we would be required to take a charge against earnings to write down the asset to the lower fair value. Based on management’s assessment completed with the help of an outside valuation firm, we believe our goodwill of $4.1 million and other identifiable intangibles of $265,000 are not impaired and are properly recorded in the consolidated financial statements as of December 31, 2015.

 

Valuation of Deferred Tax Asset

 

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We evaluate deferred tax assets quarterly. We will realize this asset to the extent we are profitable or able to carry back tax losses to periods in which we paid income taxes. Our determination of the realization of the deferred tax asset will be based upon management’s judgment of various future events and uncertainties, including the timing and amount of future income we will earn and the implementation of various tax planning strategies to maximize realization of the deferred tax assets.  Management believes we will generate sufficient operating earnings to realize the deferred tax asset.  Examinations of our income tax returns or changes in tax law may impact the tax liabilities and resulting provisions for income taxes.

 

Results of Operations

 

Net Interest Income

 

Net interest income, our principal source of earnings, is the difference between the interest income generated by earning assets, such as loans and securities, and the total interest cost of the deposits and borrowings obtained to fund these assets. Factors that influence the level of net interest income include the volume of earning assets and interest bearing liabilities, yields earned and rates paid, the level of non-performing loans and non-earning assets, and the amount of non-interest bearing deposits supporting earning assets.

 

For the year ended December 31, 2015, net interest income was $15.1 million, an increase of $651,000, or 4.5%, from net interest income of $14.4 million in 2014.  The net interest margin in 2015 was 3.86%, compared to 3.85% in 2014.  The increase of one basis point in the net interest margin resulted primarily from an increase in the volume of earning assets and a decrease in interest expense.  The prime rate remained stable throughout most of 2015 and all of 2014 at 3.25%, but increased to 3.50% in December, 2015.

 

Net Interest Analysis Summary

 

 

 

2015

 

2014

 

 

 

 

 

Average yield on interest earning assets

 

4.52%

 

4.56%

Average rate on interest bearing liabilities

 

0.76%

 

0.81%

Net interest spread

 

3.76%

 

3.75%

Net interest margin

 

3.86%

 

3.85%

 

 

Our average interest-earning assets were $399.4 million for 2015, compared with $383.6 million for 2014, a $15.8 million, or 4.1% increase primarily attributable to an increase in loans.  Average loans were $322.3 million for 2015, compared with $307.3 million for 2014, an increase of $15.0 million, or 4.9%.  Our total interest income on a tax-equivalent basis increased 2.9% to $18.0 million for 2015, compared with $17.5 million for 2014.  The change was due primarily to the increased volume of interest-earning assets.

 

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Our average interest-bearing liabilities increased $9.5 million, or 2.8%, to $344.0 million for 2015, compared with $334.5 million for 2014.  Our total interest expense decreased $102,000, or 3.8%, to $2.6 million for 2015, compared with $2.7 million during 2014.  The change was due primarily to a decrease in the rates on FHLB borrowings which matured during the year.

 

The following table sets forth for the years ended December 31, 2015 and 2014 information regarding average balances of assets and liabilities as well as the amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities and average yields and costs.  We have calculated the yields and costs for the periods indicated by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented.

 

Average Consolidated Balance Sheets and Net Interest Analysis (Dollars in thousands)      Year Ended December 31,

 

 

 

2015

 

2014

 

 

 

Average

 

Income/

 

Average

 

Average

 

Income/

 

Average

 

 

 

Balance

 

Expense

 

Rate

 

Balance

 

Expense

 

Rate

 

Earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal funds sold

 

$   15,258

 

$         36

 

0.24%

 

$  17,688

 

$        38

 

0.21%

 

Interest-bearing deposits in other financial institutions

 

1,100

 

17

 

1.55%

 

-    

 

-    

 

0.00%

 

Available-for-sale securities (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

34,718

 

632

 

1.82%

 

35,273

 

615

 

1.74%

 

Nontaxable

 

24,063

 

1,039

 

4.32%

 

21,374

 

1,009

 

4.72%

 

Federal Home Loan Bank stock

 

2,025

 

81

 

4.00%

 

2,025

 

81

 

4.00%

 

Loans receivable (2)

 

322,256

 

16,230

 

5.04%

 

307,256

 

15,732

 

5.12%

 

Total interest earning assets

 

399,420

 

18,035

 

4.52%

 

383,616

 

17,475

 

4.56%

 

Non-interest earning assets

 

30,760

 

 

 

 

 

31,711

 

 

 

 

 

Total Assets

 

$ 430,180

 

 

 

 

 

$415,327

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing transaction accounts

 

$ 112,505

 

$       409

 

0.36%

 

$104,207

 

$      405

 

0.39%

 

Savings accounts

 

45,792

 

134

 

0.29%

 

40,515

 

116

 

0.29%

 

Time deposits

 

162,254

 

1,686

 

1.04%

 

158,887

 

1,613

 

1.02%

 

Total interest-bearing deposits

 

320,551

 

2,229

 

0.70%

 

303,609

 

2,134

 

0.70%

 

Borrowings

 

18,448

 

279

 

1.51%

 

25,895

 

479

 

1.85%

 

Subordinated debentures

 

5,000

 

99

 

1.98%

 

5,000

 

96

 

1.92%

 

Total interest-bearing liabilities

 

343,999

 

2,607

 

0.76%

 

334,504

 

2,709

 

0.81%

 

Non-interest bearing deposits

 

45,237

 

 

 

 

 

41,734

 

 

 

 

 

Other liabilities

 

2,218

 

 

 

 

 

2,010

 

 

 

 

 

Total liabilities

 

391,454

 

 

 

 

 

378,248

 

 

 

 

 

Stockholders’ equity

 

38,726

 

 

 

 

 

37,079

 

 

 

 

 

Total Liabilities and Stockholders’ Equity

 

$ 430,180

 

 

 

 

 

$415,327

 

 

 

 

 

Net interest income

 

 

 

$15,428

 

 

 

 

 

$14,766

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest spread (1)

 

 

 

 

 

3.76%

 

 

 

 

 

3.75%

 

Net interest margin (1) (3)

 

 

 

 

 

3.86%

 

 

 

 

 

3.85%

 

Return on average assets ratio

 

 

 

 

 

0.84%

 

 

 

 

 

0.78%

 

Return on average equity ratio

 

 

 

 

 

9.32%

 

 

 

 

 

8.74%

 

 

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(1)          Income and yield stated at a tax equivalent basis for nontaxable securities using  the marginal corporate Federal tax rate of 34.0%.

 

(2)          Average loans include nonperforming loans. Interest income includes interest and fees on loans, but does not include interest on loans 90 days or more past due.

 

(3)          Net interest income as a percentage of average interest-earning assets.

 

 

Rate/Volume Analysis

 

Net interest income can be analyzed in terms of the impact of changing interest rates and changing volumes.  The following table sets forth the effect which the varying levels of interest earning assets and interest bearing liabilities and the applicable rates have had on changes in net interest income for the periods presented. Changes in rate-volume are proportionately allocated between rate and volume variances.

 

 

 

(Dollars in Thousands)

 

 

 

Twelve Months Ended December 31, 2015
Vs. 2014

 

 

 

Increase (Decrease) Due to

Interest-earning assets:

 

Rate

 

Volume

 

Net

 

Federal funds sold

 

3

 

(5

)

(2

)

Interest-bearing deposits in other financial institutions

 

-    

 

17

 

17

 

Available-for-sale securities

 

 

 

 

 

 

 

Taxable

 

27

 

(10

)

17

 

Nontaxable (1)

 

(97

)

127

 

30

 

Federal Home Loan Bank stock

 

-    

 

-    

 

-    

 

Loans, net

 

(270

)

768

 

498

 

Total Net Change in income on interest-earning assets

 

(337

)

897

 

560

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

Interest-bearing transaction accounts

 

(28

)

32

 

4

 

Savings accounts

 

3

 

15

 

18

 

Time deposits

 

39

 

34

 

73

 

 

 

 

 

 

 

 

 

FHLB and other borrowings

 

(62

)

(138

)

(200

)

Subordinated debentures

 

3

 

-    

 

3

 

Total Net Change in expense on interest-earning liabilities

 

(45

)

(57

)

(102

)

Net change in net interest income

 

(292

)

954

 

662

 

 

(1)     Income stated at a fully tax equivalent basis using the marginal corporate Federal  tax rate of 34.0%.

 

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Provision for Loan Losses

 

The provision for loan losses for 2015 was $135,000, or 0.04% of average loans, compared to a provision of $275,000, or 0.09% of average loans during 2014.  We had net charge-offs totaling $104,000 during 2015, compared to $43,000 during 2014.  We consider the size, volume and credit quality of the loan portfolio as well as recent economic and other external influences to record the allowance for loan losses and provision for loan losses that is directionally consistent with our loan portfolio.

 

Non-interest Income

 

Non-interest income increased 13.6%, or $392,000, from $2.9 million in 2014 to $3.3 million in 2015. Service charges on deposit accounts increased $225,000 during 2015 as a result of a new consumer deposit checking account introduced in late 2014.  Other non-interest income increased $128,000 of which $95,000 was related to the gain on the sale of a loan. The following table shows the detailed components of non-interest income:

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

Increase

 

 

 

2015

 

2014

 

(Decrease)

 

Service charges on deposit accounts

 

$        1,421 

 

$        1,196 

 

$            225 

Other non-interest income

 

758 

 

630 

 

128  

Gain on sale of mortgage loans held for sale

 

233 

 

190 

 

43  

Bank owned life insurance

 

181 

 

188 

 

(7) 

Non-deposit brokerage fees

 

364 

 

301 

 

63  

Gain on the sale of available-for-sale securities

 

78 

 

95 

 

(17) 

Lease income

 

245 

 

288 

 

(43) 

 

 

$        3,280 

 

$        2,888 

 

$            392 

 

Non-interest Expense

 

Non-interest expense increased 5.1%, or $640,000, from $12.6 million in 2014 to $13.2 million in 2015.  Salaries and benefits increased $397,000, while $262,000 is related to a loss on the disposal of a former branch facility.

 

The increases and decreases in expense in 2015 by major categories are as follows:

 

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(Dollars in Thousands)

 

 

 

 

 

 

Increase

 

 

2015

 

2014

 

(Decrease)

Salaries and employee benefits

 

   $

6,535

 

   $

6,138

 

   $

397

Net occupancy expense

 

2,019

 

1,945

 

74

Advertising and public relations

 

330

 

323

 

7

Professional and legal

 

710

 

581

 

129

Data processing services

 

1,001

 

973

 

28

FDIC insurance

 

244

 

287

 

(43)

Franchise shares and deposit tax

 

533

 

594

 

(61)

Postage and office supplies

 

190

 

207

 

(17)

Telephone and other communication

 

326

 

295

 

31

Other real estate owned expenses

 

94

 

92

 

2

Core deposit intangible amortization

 

71

 

329

 

(258)

Loss on branch disposal

 

262

 

0

 

262

Other

 

883

 

794

 

89

 

 

   $

13,198

 

$12,558

 

   $

640

 

Income Taxes

 

Income tax expense was calculated using the Company’s expected effective rate for 2015 and 2014.  We have recognized deferred tax liabilities and assets to show the tax effects of differences between the financial statement and tax bases of assets and liabilities. Our statutory federal tax rate was 34.0% in both 2015 and 2014.  The effective tax rate for 2015 was 28.2%, compared to 27.7% for 2014.  The difference between the statutory and effective rates are impacted by such factors as income from tax-exempt loans, tax-exempt income on state and municipal securities, and income on bank owned life insurance.

 

Balance Sheet Review

 

Our assets at December 31, 2015 totaled $432.2 million, compared with $412.8 million at December 31, 2014, an increase of $19.4 million, or 4.7%.  Average assets increased 3.6% or $14.9 million, from $415.3 million in 2014 to $430.2 million in 2015.

 

Loans

 

Total loans averaged $322.3 million in 2015, compared to $307.3 million in 2014.  At year-end 2015, loans totaled $330.8 million, compared to $318.5 million at year-end 2014, an increase of $12.3 million, or 3.9%.  We experienced increases in all segments of our loan portfolio except consumer loans.  The following table presents a summary of the loan portfolio by category:

 

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(Dollars in Thousands)

 

 

December 31, 2015

 

December 31, 2014

 

 

 

% of Total

 

 

% of Total

 

 

 

Loans

 

 

Loans

Commercial and agricultural

 

$53,516

16.18%

 

$43,439

13.64%

Commercial real estate

 

193,457

58.48%

 

192,096

60.32%

Residential real estate

 

79,680

24.09%

 

78,270

24.57%

Consumer

 

4,129

1.25%

 

4,672

1.47%

 

 

  $

330,782

100%

 

  $

318,477

100%

 

Our commercial real estate loans include financing for industrial developments, residential developments, retail shopping centers, industrial buildings, restaurants, and hotels.  The percentage distribution of our loans by industry as of December 31, 2015 and 2014 is shown in the following table:

 

 

 

 

2015

 

2014

 

 

 

 

 

Agriculture, forestry, and fishing

 

8.06%

 

9.98%

Construction

 

5.90%

 

5.55%

Manufacturing

 

3.75%

 

4.90%

Transportation, communication, electric, gas, and sanitary services

 

4.84%

 

2.18%

Wholesale trade

 

2.79%

 

2.93%

Retail trade

 

5.48%

 

6.31%

Finance, insurance, and real estate

 

34.05%

 

29.15%

Services

 

19.71%

 

21.50%

Public administration

 

0.39%

 

0.35%

Total commercial and commercial real estate

 

84.97%

 

82.85%

Residential real estate loans

 

14.01%

 

15.87%

Other consumer loans

 

1.02%

 

1.28%

Total loans

 

100.00%

 

100.00%

 

The majority of our loans are to customers located in south central Kentucky and central Tennessee.  As of December 31, 2015, the Company’s 20 largest credit relationships consisted of loans and loan commitments ranging from $3.8 million to $6.6 million.  The aggregate amount of these credit relationships was $84.8 million, with total commitments of $95.9 million.

 

Our lending activities are subject to a variety of lending limits imposed by state and federal law. Citizens First Bank’s secured legal lending limit to a single borrower was approximately $12.5 million at December 31, 2015.

 

As of December 31, 2015, we had $21.1 million of participations in loans purchased from, and $21.8 million of participations in loans sold to, other banks. As of December 31, 2014, we had $18.1 million of participations in loans purchased from, and $19.9 million of participations in loans sold to, other banks.

 

The following table sets forth the maturity distribution of our loan portfolio as of December 31, 2015.  Maturities are based upon contractual terms.  Our policy is to

 

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specifically review and approve all loans renewed; loans are not automatically rolled over.

 

 

 

(Dollars in Thousands)

 

Loan Maturities
as of December 31, 2015

 

Within One
Year

 

After One but
Within Five
Years

 

After Five
Years

 

Total

 

Commercial and agricultural

 

  $

20,063

 

  $

21,013

 

  $

12,440

 

  $

53,516

 

Commercial real estate

 

32,538

 

114,841

 

46,078

 

193,457

 

Residential real estate

 

7,663

 

40,869

 

31,148

 

79,680

 

Consumer

 

834

 

3,252

 

43

 

4,129

 

Total

 

  $

61,098

 

  $

179,975

 

  $

89,709

 

  $

330,782

 

 

 

The table below presents loans outstanding as of December 31, 2015 with maturities greater than one year categorized by fixed and variable interest rates:

 

As of December 31, 2015

 

(Dollars in
Thousands)

 

Fixed Rate

 

  $

195,308

 

Variable Rate

 

74,376

 

Total maturities greater than one year

 

  $

269,684

 

 

Asset and Liability Management

 

We manage our assets and liabilities to provide a consistent level of liquidity to accommodate normal fluctuations in loans and deposits. The yield on approximately 26.5% of our earning assets as of December 31, 2015, adjusts simultaneously with changes in an external index, primarily the highest prime rate as quoted in the Wall Street Journal.  A majority of our interest bearing liabilities have been issued with fixed terms and can only be repriced at maturity. The prime rate remained stable at 3.25% during most of 2015 and all of 2014.  The prime rate increased to 3.50% in December, 2015.  The yield on our earning assets declined during 2015 as we were not able to reinvest at the yields previously earned on loans and called and matured investments.  The cost of our interest bearing liabilities continued to decline in 2015, which allowed the net interest margin to increase 1 basis point from the prior year end.  If interest rates stabilize for a period of time, the difference between interest earning assets and interest bearing liabilities will tend to stabilize. In a stable rate environment, our net interest margin will be impacted by, among other factors, a change in the mix of earning assets, with our deposit growth being invested in federal funds sold, investment securities or loans.

 

Credit Quality and the Allowance for Loan Losses

 

We consider credit quality to be of primary importance. We contract with a third party CPA firm for loan review services. The scope of the engagement calls for annual review of large loan relationships (in excess of $1 million), problem credits, unsecured loans,

 

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insider relationships, and a random sample of smaller commercial credits with annual coverage of at least 50% of the outstanding loan portfolio. The focus of the reviews is centered in the commercial and commercial real estate portfolios, as they comprise the majority of the Bank’s loan portfolio. Management addresses any findings raised during the review process and takes appropriate actions as warranted.

 

The allowance for loan losses represents management’s estimate of probable credit losses incurred in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change.

 

The allowance for loan losses is established through a provision for loan losses charged to expense.  At December 31, 2015, the allowance was $4.9 million, compared to $4.9 million at the end of 2014. The ratio of the allowance for loan losses to total loans at December 31, 2015 was 1.49%, compared to 1.53% at December 31, 2014. The following table sets forth an analysis of our allowance for loan losses for the years ended December 31, 2015 and 2014.

 

 

 

(Dollars in Thousands)

 

 

 

2015

 

2014

 

Balance at beginning of year

 

$

4,885

 

$

4,653

 

Provision for loan losses

 

135

 

275

 

Amounts charged off:

 

 

 

 

 

Commercial

 

154

 

3

 

Commercial real estate

 

17

 

57

 

Residential real estate

 

57

 

177

 

Consumer

 

24

 

25

 

Total loans charged off

 

252

 

262

 

 

 

 

 

 

 

Recoveries of amounts previously charged off:

 

 

 

 

 

Commercial

 

124

 

124

 

Commercial real estate

 

2

 

74

 

Residential real estate

 

13

 

16

 

Consumer

 

9

 

5

 

Total recoveries

 

148

 

219

 

Net charge-offs

 

104

 

43

 

Balance at end of year

 

$

4,916

 

$

4,885

 

 

 

 

 

 

 

Total loans, net of unearned income:

 

 

 

 

 

Average

 

$

322,256

 

$

307,256

 

At December 31

 

$

330,782

 

$

318,477

 

As a percentage of average loans:

 

 

 

 

 

Net charge-offs

 

0.03%

 

0.01%

 

Provision for loan losses

 

0.04%

 

0.09%

 

 

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The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated.  This allocation is not intended to suggest how actual losses may occur.

 

 

 

(Dollars in Thousands)

 

 

 

December 31, 2015

 

 

 

December 31, 2014

 

 

 

Amount

 

% of Loans
in Each
Category to
Toal Loans

 

Amount

 

% of Loans

in Each
Category to

Toal Loans

 

 

 

 

 

 

 

 

 

Residential real estate loans

 

$

524

 

24.09%

 

$

582

 

24.57%

Consumer and other loans

 

28

 

1.25%

 

45

 

1.47%

Commercial and agricultural

 

812

 

16.18%

 

1,029

 

13.64%

Commercial real estate

 

3,431

 

58.48%

 

3,088

 

60.32%

Unallocated

 

121

 

0.00%

 

141

 

0.00%

Total allowance for loan losses

 

$

4,916

 

100.00%

 

$

4,885

 

100.00%

 

We maintain a modest unallocated amount in the allowance to recognize the imprecision in estimating and measuring losses when evaluating allocations for individual loans or pools of loans. Allocations on individual loans and historical loss rates are reviewed quarterly and adjusted as necessary based on changing borrower and/or collateral conditions and actual collection and charge-off experience.  The unallocated portion of the allowance decreased from $141,000 at December 31, 2014 to $121,000 at December 31, 2015.

 

The following table sets forth selected asset quality amounts and ratios for the periods indicated:

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

 

2015

 

2014

 

 

 

 

 

 

Non-accrual loans

 

$

537

 

$

446

Loans 90+ days past due/accruing

 

-

 

-

Restructured loans on non-accrual

 

-

 

721

Total non-performing loans

 

537

 

1,167

Other real estate owned

 

100

 

198

Total non-performing assets

 

$

637

 

$

1,365

 

 

 

 

 

Non-performing loans to total loans

 

0.16%

 

0.37%

Non-performing assets to total assets

 

0.15%

 

0.33%

Net-charge-offs YTD

 

$

104

 

$

43

Net charge-offs YTD to average YTD total loans

 

0.03%

 

0.01%

Allowance for loan losses to non-performing loans

 

915.46%

 

418.60%

Allowance for loan losses to total loans

 

1.49%

 

1.53%

 

Non-performing assets totaled $637,000 at December 31, 2015, compared to $1.4 million at December 31, 2014, a decrease of $728,000. Payoffs and paydowns of $1.3 million included the disposition of one other real estate owned property sold for $25,000, and five loans totaling $149,000 that were charged off, but these decreases were offset by the addition of $405,000 in commercial real estate loans, and $98,000 in residential real estate loans.

 

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Non-performing loans are defined as non-accrual loans, loans accruing but past due 90 days or more, and non-current restructured loans. Non-performing assets are defined as non-performing loans, other real estate owned, and repossessed assets. The non-performing loan total at year-end 2015 consisted of four non-accrual loans totaling $537,000 and no loans over 90 days past due that are still accruing.  Non-performing assets also includes other real estate owned of two commercial real estate properties totaling $100,000.

 

Management classifies commercial and commercial real estate loans as non-accrual when principal or interest is past due 90 days or more and the loan is not adequately collateralized and is in the process of collection, or when, in the opinion of management, principal or interest is not likely to be paid in accordance with the terms of the obligation.  We charge off consumer loans after 120 days of delinquency unless they are adequately secured and in the process of collection. Non-accrual loans are not reclassified as accruing until principal and interest payments are brought current and future payments appear reasonably certain. Generally, we do not include loans that are current as to principal and interest in our non-performing assets categories. However, we will still classify a current loan as a potential problem loan if we develop doubts about the borrower’s future performance under the terms of the loan contract.

 

Troubled debt restructurings (TDRs) are modified loans in which a concession is provided to a borrower experiencing financial difficulties. Loan modifications are considered TDRs when the concession provided is not available to the borrower through either normal channels or other sources. However, not all loan modifications are TDRs. Our standards relating to loan modifications consider, among other factors, minimum verified income requirements, cash flow analysis, and collateral valuations. However, each potential loan modification is reviewed individually and the terms of the loan are modified to meet a borrower’s specific circumstances at a point in time. TDRs can be classified as either accrual or nonaccrual loans. Non-accrual TDRs are included in non-accrual loans whereas accruing TDRs are excluded because the borrower remains contractually current.

 

Loans that exhibit probable or observed credit weaknesses are subject to individual review. Where appropriate, allocations for individual loans are included in the allowance calculation based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Company. Included in the review of individual loans are those that are impaired as provided in ASC Topic 310 “Receivables”. We evaluate the collectability of both principal and interest when assessing the need for a loss accrual. Historical loss rates are applied to other loans not subject to individual allocations. These historical loss rates may be adjusted for significant factors that, in management’s judgment, reflect the impact of any current conditions on loss recognition. Factors which management considers in the analysis include the effects of the national and local economies, trends in the nature and volume of loans (delinquencies, charge-offs and nonaccrual loans), changes in mix, asset quality trends, risk management and loan administration, changes in internal lending policies and credit standards, and examination results from bank regulatory agencies and loan review.

 

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

 

We believe that the allowance for loan losses at December 31, 2015, provides for probable incurred credit losses in the loan portfolio as of that date.  That determination is based on the best information available to management, but necessarily involves uncertainties and matters of judgment and, therefore, cannot be determined with precision and could be susceptible to significant change in the future.  In addition, bank regulatory authorities, as a part of their periodic examinations, may reach different conclusions regarding the quality of the loan portfolio and the level of the allowance, which could require us to make additional provisions in the future.

 

Securities

 

Our securities portfolio serves as a source of liquidity and earnings and contributes to the management of interest rate risk.  Our portfolio also provides us with securities to pledge as required collateral for certain governmental deposits and borrowed funds.

 

The investment securities portfolio is comprised primarily of U.S. Government agency securities, mortgage-backed securities, and tax-exempt securities of state and political subdivisions.  Securities are all classified as available-for-sale. The investment portfolio increased by $1.2 million, or 2.0%, to $60.2 million at December 31, 2015, compared with $59.0 million at December 31, 2014.

 

The tables below present the maturities and yield characteristics of securities as of December 31, 2015 and 2014. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

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December 31, 2015

 

(Dollars in Thousands)

 

 

 

 

Over

 

Over

 

 

 

 

 

 

 

 

 

 

 

One Year

 

Five Years

 

 

 

 

 

 

 

 

 

One Year or

 

Through

 

Through

 

Over Ten

 

Total

 

 

 

 

 

Less

 

Five Years

 

Ten Years

 

Years

 

Maturities

 

Fair Value

 

U.S. Government agencies

 

$

-

 

$

2,998

 

$

-

 

$

-

 

$

2,998

 

$

2,994

 

Agency mortgage-backed securities: (1)

 

315

 

24,389

 

4,742

 

-

 

29,446

 

29,657

 

Municipal securities

 

1,126

 

10,838

 

8,086

 

4,591

 

24,641

 

25,222

 

Trust preferred security

 

-

 

-

 

-

 

1,880

 

1,880

 

1,340

 

Corporate bond

 

-

 

-

 

1,000

 

-

 

1,000

 

987

 

Total available-for-sale securities

 

$

1,441

 

$

38,225

 

$

13,828

 

$

6,471

 

$

59,965

 

$

60,200

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Percent of total

 

2.40%

 

63.75%

 

23.06%

 

10.79%

 

100.00%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average yield(2)

 

4.31%

 

2.45%

 

3.43%

 

4.07%

 

2.88%

 

 

 

 

 

(1)  Agency mortgage backed securities (residential) are grouped into average lives based on December 2015 prepayment projections.

 

(2)  The weighted average yields are based on amortized cost and municipal securities are calculated on a full tax-equivalent basis.

 

December 31, 2014

 

(Dollars in Thousands)

 

 

 

 

Over

 

Over

 

 

 

 

 

 

 

 

 

 

 

One Year

 

Five Years

 

 

 

 

 

 

 

 

 

One Year or

 

Through

 

Through

 

Over Ten

 

Total

 

 

 

 

 

Less

 

Five Years

 

Ten Years

 

Years

 

Maturities

 

Fair Value

 

U.S. Government agencies

 

$

-

 

$

1,999

 

$

1,000

 

$

-

 

$

2,999

 

$

2,948

 

Agency mortgage-backed securities: (1)

 

4

 

24,231

 

3,006

 

-

 

27,241

 

27,519

 

Municipal securities

 

535

 

7,802

 

11,466

 

5,547

 

25,350

 

26,039

 

Trust preferred security

 

-

 

-

 

-

 

1,876

 

1,876

 

1,480

 

Corporate bond

 

-

 

-

 

1,000

 

-

 

1,000

 

1,000

 

Total available-for-sale securities

 

$

539

 

$

34,032

 

$

16,472

 

$

7,423

 

$

58,466

 

$

58,986

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Percent of total

 

0.92%

 

58.21%

 

28.17%

 

12.70%

 

100.00%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average yield(2)

 

5.27%

 

2.40%

 

3.44%

 

4.31%

 

2.96%

 

 

 

 

 

(1)  Agency mortgage backed securities (residential) are grouped into average lives based on December 2014 prepayment projections.

 

(2)  The weighted average yields are based on amortized cost and municipal securities are calculated on a full tax-equivalent basis.

 

 

The Trust preferred security category consist of one single issue trust preferred security which has experienced a decline in fair value due to inactivity in the market. No impairment charge is being taken as no loss of principal is anticipated and all principal and interest payments are being received as scheduled. All rated securities are investment grade.  For those that are not rated, the financial condition has been evaluated and no adverse conditions were identified related to repayment. Declines in fair value are a function of rate changes in the market and market illiquidity. The Company does not intend to sell these securities and does not believe it will be required to sell these securities.

 

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Deferred Tax Assets

 

We have a net deferred tax asset of $1.3 million at December 31, 2015.  We evaluate this asset on a quarterly basis.  To the extent we believe it is more likely than not that it will not be utilized, we will establish a valuation allowance to reduce its carrying amount to the amount it expects to be realized.  At December 31, 2015, no valuation allowance has been established against the outstanding deferred tax asset.  The deferred tax asset will be utilized as taxable income is generated in future years.

 

Deposits

 

We offer traditional deposit products, including non-interest-bearing and interest-bearing checking (or NOW accounts), commercial checking, money market accounts, savings accounts and certificates of depositWe compete for deposits through our branch network with competitive pricing and advertising.

 

Total deposits averaged $365.8 million during 2015, an increase of $20.5 million, or 5.9%, compared to $345.3 million during 2014.  Average deposits increased during the year, but the cost of funds declined as higher cost deposits matured and were renewed at lower rates.  Deposits at December 31, 2015 totaled $370.4 million, an increase of $28.6 million, or 8.4%, from $341.8 million at December 31, 2014.

 

We utilize brokered certificates of deposit and will continue to utilize these sources for deposits when they can be cost-effective.  We have also implemented the use of a deposit listing service and have utilized this service to replace brokered deposits. There were $1,766,000 brokered deposits at December 31, 2015 and none at December 31, 2014.

 

Time deposits of $100,000 or more totaled $73.4 million at December 31, 2015, compared to $63.4 million at December 31, 2014.  Interest expense on time deposits of $100,000 or more was $808,000 in 2015, compared to $669,000 in 2014.  A summary of average balances and rates paid on deposits for the years ended December 31, 2015 and 2014 follows.

 

 

 

(Dollars in Thousands)

 

 

2015

 

2014

 

 

Average

 

Average

 

Average

 

Average

 

 

 

 

 

 

 

 

 

 

 

Balance

 

Rate

 

Balance

 

Rate

Noninterest bearing demand

 

$

45,237

 

0.00%

 

$

41,734

 

0.00%

Interest bearing demand

 

112,505

 

0.36%

 

104,207

 

0.39%

Savings

 

45,792

 

0.29%

 

40,515

 

0.29%

Time

 

162,254

 

1.04%

 

158,887

 

1.02%

 

 

$

365,788

 

0.70%

 

$

345,343

 

0.71%

 

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Liquidity, Other Borrowings, and Capital Resources

 

 

 

Borrowings

 

FHLB Advances. We obtain advances from the Federal Home Bank of Cincinnati (FHLB) for funding and liability management.  These advances are collateralized by a blanket agreement of eligible 1-4 family residential mortgage loans and eligible commercial real estate.  Rates vary based on the term to repayment. Total advances as of December 31, 2015 were $13.0 million.

 

At December 31, 2015, we had established Federal Funds lines of credit totaling $18.8 million with three correspondent banks.  No amounts were drawn as of December 31, 2015 or 2014.

 

In 2015, we renewed a line of credit agreement with a community bank to be used for operating capital and general corporate purposes.  The line has a total availability of $3.0 million and matures November 21, 2016. The line has a floor rate of 4.5% and is secured by the Bank’s common stock.  As of December 31, 2015, the line had a balance of $2.0 million.

 

We issued $5.0 million in subordinated debentures in October, 2006.  These subordinated debentures bear an interest rate, which reprices each calendar quarter, of 165 basis points over 3-month LIBOR (London Inter Bank Offering Rate).  Our interest rate was as of December 31, 2015 was 1.98%, and at December 31, 2014 was 1.89%.

 

Information regarding our borrowings as of December 31, 2015 and 2014 is presented below:

 

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(Dollars in Thousands)

 

 

2015

 

2014

 

Borrowed funds:

 

 

 

 

Balance at year end

 

$15,000

 

$25,500

Weighted average rate at year end

 

1.54%

 

1.22%

Average balance during the year

 

$18,448

 

$25,895

Weighted average rate during the year

 

1.51%

 

1.85%

Maximum month-end balance

 

$21,500

 

$30,000

 

Subordinated debentures:

 

 

 

 

Balance at year end

 

$5,000

 

$5,000

Weighted average rate at year end

 

1.98%

 

1.89%

Average balance during the year

 

$5,000

 

$5,000

Weighted average rate during the year

 

1.98%

 

1.90%

Maximum month-end balance

 

$5,000

 

$5,000

 

Total borrowings:

 

 

 

 

Balance at year end

 

$20,000

 

$30,500

Weighted average rate at year end

 

1.65%

 

1.33%

Average balance during the year

 

$23,448

 

$30,895

Weighted average rate during the year

 

1.61%

 

1.86%

Maximum month-end balance

 

$26,500

 

$35,000

 

 

 

Capital

 

Stockholders’ equity was $39.5 million on December 31, 2015, an increase of $1.1 million, or 2.8%, from $38.4 million on December 31, 2014.  A common dividend of $0.08 per share was paid during the fourth quarter of 2015, which marks the first common dividend paid since 2008.  During 2015, we repurchased the 254,218 warrants issued in 2008 to the US Treasury as part of its participation in the US Treasury’s Capital Purchase Program for $1.7 million.

 

The Company previously issued 250 shares of Cumulative Convertible Preferred Stock, (Preferred Stock), for an aggregate purchase price of $8.0 million. The Preferred Stock was sold for $31,992 per share, is entitled to quarterly cumulative dividends at an annual fixed rate of 6.5% and is currently convertible into shares of common stock of the Company at an initial conversion price per share of $15.50 (currently $14.06, adjusted for stock dividends).  During the fourth quarter of 2015, our share price closed above $14.06 for several business days. Approximately 5% of preferred shareholders (holding 13 shares of Preferred Stock) have converted their shares into 29,575 shares of common stock as of March 23, 2016.

 

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We are subject to regulatory capital requirements administered by federal banking agencies.  Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices.  Capital amounts and classifications are also subject to qualitative judgments by regulators.  Failure to meet capital requirements can initiate regulatory action.  The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. banks, (Basel III rules) became effective for the Bank on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule, and fully phased in by January 1, 2019. The net unrealized gain or loss on available for sale securities is not included in computing regulatory capital. Capital amounts and ratios for December 31, 2014 are calculated using Basel I rules. We believe as of December 31, 2015, the Company and the Bank met all capital adequacy requirements to which it is subject.

 

Capital ratios as of December 31, 2015, and 2014 (calculated in accordance with regulatory guidelines) were as follows:

 

 

 

 

 

 

December 31, 2015

 

December 31, 2014

 

 

Tier 1
Risk-
based
Capital

 

Total
Risk-
based
Capital

 

Common
Equity
Tier 1
Capital

 

Tier 1
Leverage

 

Tier 1
Risk-
based
Capital

 

Total
Risk-
based
Capital

 

Tier 1
Leverage

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

11.33%

 

12.58%

 

7.77%

 

9.46%

 

11.49%

 

12.74%

 

9.42%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Citizens First Bank, Inc.

 

11.78%

 

13.03%

 

11.78%

 

9.83%

 

11.83%

 

13.09%

 

9.78%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Regulatory minimum

 

4.00%

 

8.00%

 

4.50%

 

4.00%

 

4.00%

 

8.00%

 

4.00%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Well-capitalized minimum

 

6.00%

 

10.00%

 

6.50%

 

5.00%

 

6.00%

 

10.00%

 

5.00%

 

(1)Calculated in accordance with regulatory guidelines. The well-capitalized minimum is for bank only.

 

 

 

Contractual Obligations

 

The following table summarizes our contractual obligations and other commitments to make future payments as of December 31, 2015:

 

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(Dollars in Thousands)

 

 

 

 

 

 

 

 

 

 

 

December 31, 2015

 

One Year or
Less

 

More Than
One Year but
Less Than
Three Years

 

More Than
Three Years
but Less Than
Five Years

 

Five Years or
More

 

Total

Time deposits

 

$

93,122

 

$

53,152

 

$

7,253

 

$

4

 

$

153,531

FHLB advances

 

10,000

 

-

 

3,000

 

-

 

$

13,000

Subordinated debentures

 

-

 

-

 

-

 

5,000

 

$

5,000

Lease commitments

 

404

 

832

 

762

 

1,028

 

$

3,026

 

 

$

103,526

 

$

53,984

 

$

11,015

 

$

6,032

 

$

174,557

 

 

 

FHLB advances include arrangements under various FHLB credit programs. Long-term FHLB debt is more fully described under the caption “Federal Home Loan Bank Advances and Letter of Credit” in Note 9 of our Consolidated Financial Statements.  Lease commitments include the leases in place for certain branch sites.

 

Liquidity

 

Our objective for liquidity management is to ensure that we have funds available to meet deposit withdrawals and credit demands without unduly penalizing profitability.  In order to maintain a proper level of liquidity, the Bank has several sources of funds available on a daily basis that can be used for liquidity purposes.  Those sources of funds include the Bank’s core deposits, cash flow generated by repayment of principal and interest on loans and investment securities, FHLB borrowings and federal funds purchased. While maturities and scheduled amortization of loans and investment securities are generally a predictable source of funds, deposit outflows and mortgage prepayments are influenced significantly by general interest rates, economic conditions, and competition in our local markets.

 

Our asset and liability management committee meets monthly and monitors the composition of the balance sheet to ensure comprehensive management of interest rate risk and liquidity. We prepare a monthly cash flow report which forecasts funding needs and availability for the coming months, based on forecasts of loan closings and payoffs, potentially callable securities, and other factors.

 

Off-Balance Sheet Risk

 

We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Commitments to extend credit are agreements to lend to a client as long as the client has not violated any material condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee.

 

At December 31, 2015, unfunded commitments to extend credit and unused lines of credit totaled $46.3 million, of which $13.0 million were at fixed rates and $33.3 million were at variable rates.  At December 31, 2014, unfunded commitments to extend credit

 

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and unused lines of credit totaled $42.2 million, of which $8.3 million were at fixed rates and $33.9 million were at variable rates. We evaluate each client’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. The type of collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate.

 

We had letters of credit totaling $333,000 and $1.3 million at December 31, 2015 and 2014, respectively. The credit risk and collateral involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to clients. Since most of the letters of credit are expected to expire without being drawn upon, they do not necessarily represent future cash requirements.

 

Except as otherwise disclosed, we are not involved in off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements, or transactions that could result in liquidity needs or other commitments that significantly impact earnings.

 

Impact of Inflation and Changing Prices

 

The consolidated financial statements and related financial data presented in this filing have been prepared in accordance with U.S. generally accepted accounting principles, 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 due to inflation.  The impact of inflation is reflected in the increased cost of the Company’s operations.  Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature.  As a result, interest rates generally have a more significant impact on a financial institution’s performance than do general levels of inflation.  Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk.

 

Our principal financial objective is to achieve long-term profitability while reducing exposure to fluctuating market interest rates.  The Company has sought to reduce the exposure of its earnings to changes in market interest rates by attempting to manage the mismatch between asset and liability maturities and interest rates.  In order to reduce the exposure to interest rate fluctuations, the Company has developed strategies to manage its liquidity and shorten its effective maturities of certain interest-earning assets.  We do not maintain a trading account for any class of financial instrument nor do we engage in hedging activities or purchase high-risk derivative instruments, and we are not subject to foreign exchange rate risk or commodity price risk.

 

We monitor interest rate sensitivity and interest rate risk with an earnings simulation model generated by First National Bankers Bank of Louisiana who employs the Sungard Ambit ALM4 model.  This model uses rate risk measurement techniques to produce a reasonable estimate of interest margin risks.  The system provides several

 

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methods for measuring interest rate risk, including rate sensitivity gap analysis to show cash flow and repricing information, and margin simulation, or rate shocking, to quantify the actual income risk, by modeling the Company’s sensitivity to changes in cash flows over a variety of interest rate scenarios.  The program performs a full simulation of each balance sheet category under various rate change conditions and calculates the net interest income change for each.  Each category’s interest change is calculated as rates ramp up and down.  In addition, the prepayment speeds and repricing speeds are changed.

 

The following illustrates the effects on net interest income of an immediate shift in market interest rates from the earnings simulation model as of December 31, 2015:

 

 

 

Projected

 

 

Net Interest Income

 

 

Interest Rate
Change

 

Estimated Value

$ Change From
Base

% Change From
Base

 

+400

 

$18,628,476

$2,891,406

18.37%

 

+300

 

17,877,289

2,140,219

13.60%

 

+200

 

17,111,755

1,374,686

8.74%

 

Base

 

15,737,070

0

0.00%

 

-200

 

15,324,159

(412,910)

(2.62)%

 

 

As of December 31, 2015, our balance sheet was in an asset-sensitive position and remains in an asset sensitive position for the next four years.  During the asset-sensitive time frame, an increase in interest rates would have a positive effect on earnings and a decrease in interest rates would have a negative effect on earnings.  The Company’s interest rate risk position is also impacted by the activation of floors on variable rate loans subject to repricing during the time frame.

 

In preparing the preceding table, we used certain assumptions relating to interest rates, loan prepayment rates, deposit decay rates, and the market values of certain assets under differing interest rate scenarios, among others.

 

As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table.  For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates.  Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates.  Additionally, certain assets, such as ARM loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset.  Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates could deviate significantly from those assumed in calculating the table.

 

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Item 8. Financial Statements and Supplementary Data

 

The following consolidated financial statements of the Company and report of independent accountants are included herein:

 

       Report of Independent Registered Public Accounting Firm, Crowe Horwath LLP

 

       Consolidated Balance Sheets - December 31, 2015 and 2014

 

       Consolidated Statements of Comprehensive Income - Years ended December 31, 2015 and 2014

 

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

 

       Consolidated Statements of Cash Flows - Years ended December 31, 2015 and 2014

 

       Notes to Consolidated Financial Statements

 

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Report of Independent Registered Public Accounting Firm

 

 

 

Stockholders and Board of Directors
Citizens First Corporation

Bowling Green, Kentucky

 

We have audited the accompanying consolidated balance sheets of Citizens First Corporation as of December 31, 2015 and 2014, and the related consolidated statements of comprehensive income, changes in stockholders’ equity and cash flows for the years then ended.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes 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 Citizens First Corporation as of December 31, 2015 and 2014, and the results of its operations and its cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.

 

 

 

 

/s/ Crowe Horwath LLP

 

 

 

Louisville, Kentucky

March 24, 2016

 

Page 63



Table of Contents

 

Citizens First Corporation

 

Consolidated Balance Sheets

 

December 31

 

 

 

(In Thousands, Except Share Data)

 

 

 

 

2015

 

 

2014