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EX-31.01 - Entegra Financial Corp.e00275_ex31-01.htm
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EX-32.01 - Entegra Financial Corp.e00275_ex32-01.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10-Q

 

 

 

Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

 

For the quarterly period ended:

 

March 31, 2016

 

Commission File Number: 001-35302

 

Entegra Financial Corp.
(Exact name of Registrant as specified in its Charter)

 

   
North Carolina 45-2460660
(State of Incorporation) (I.R.S. Employer Identification No.)
   
14 One Center Court,  
Franklin, North Carolina 28734
(Address of principal executive offices) (Zip Code)

 

(828) 524-7000
(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

Large accelerated filer o Accelerated filer x Non-accelerated filer o Smaller reporting company o

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: On May 9, 2016, 6,466,375 shares of the issuer’s common stock (no par value), were issued and outstanding.

1 

 

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

 

FORM 10-Q
TABLE OF CONTENTS

 

    Page No.
     
PART I. FINANCIAL INFORMATION    
       
Item 1. Financial Statements (Unaudited)   3
  Consolidated Balance Sheets – March 31, 2016 and December 31, 2015   3
  Consolidated Statements of Income – Three Months Ended March 31, 2016 and 2015   4
  Consolidated Statements of Comprehensive Income – Three Months Ended March 31, 2016 and 2015   5
  Consolidated Statements of Changes in Shareholders’ Equity – Three Months Ended March 31, 2016 and 2015   6
  Consolidated Statements of Cash Flows – Three Months Ended March 31, 2016 and 2015   7
  Notes to Consolidated Financial Statements   9
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   40
Item 3. Quantitative and Qualitative Disclosures about Market Risk   62
Item 4. Controls and Procedures   64
       
PART II. OTHER INFORMATION    
       
Item 1. Legal Proceedings   65
Item 1A. Risk Factors   65
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds   65
Item 3. Defaults Upon Senior Securities   65
Item 4. Mine Safety Disclosures   65
Item 5. Other Information   65
Item 6. Exhibits   66
  Signatures   68

2 

 

Item 1. Financial Statements

 

 

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)

 

   March 31,   December 31, 
   2016   2015 
   (Unaudited)   (Audited) 
Assets          
           
Cash and due from banks  $7,279   $8,421 
Interest-earning deposits   38,621    32,229 
Cash and cash equivalents   45,900    40,650 
           
Investments - trading   4,841    4,714 
Investments - available for sale   260,049    238,862 
Investments - held to maturity (fair value of $34,732 and $41,812 at March 31, 2016 and December 31, 2015, respectively)   34,035    41,164 
Other investments, at cost   9,374    8,834 
Loans held for sale   5,182    8,348 
Loans receivable   632,895    624,072 
Allowance for loan losses   (9,498)   (9,461)
Fixed assets, net   17,524    17,673 
Real estate owned   5,430    5,369 
Interest receivable   3,816    3,554 
Bank owned life insurance   20,964    20,858 
Net deferred tax asset   16,839    18,830 
Loan servicing rights   2,398    2,344 
Goodwill   711    711 
Core deposit intangible   569    590 
Other assets   4,017    4,304 
           
Total assets  $1,055,046   $1,031,416 
           
Liabilities and Shareholders’ Equity          
           
Liabilities:          
Deposits  $720,712   $716,617 
Federal Home Loan Bank advances   163,500    153,500 
Junior subordinated notes   14,433    14,433 
Other borrowings   2,547    2,198 
Post employment benefits   10,253    10,224 
Accrued interest payable   250    213 
Other liabilities   9,113    2,762 
Total liabilities   920,808    899,947 
           
Commitments and contingencies (Note 11)          
           
Shareholders’ Equity:          
Preferred stock - no par value, 10,000,000 shares authorized; none issued and outstanding        
Common stock - no par value, 50,000,000 shares authorized; 6,472,372 and 6,546,375 shares issued and outstanding as of March 31, 2016 and December 31, 2015, respectively        
Common stock held by Rabbi Trust, at cost; 14,000 shares at March 31, 2016 and December 31, 2015   (279)   (279)
Additional paid in capital   62,667    63,722 
Retained earnings   71,129    69,762 
Accumulated other comprehensive gain (loss)   721    (1,736)
Total shareholders’ equity   134,238    131,469 
           
Total liabilities and shareholders’ equity  $1,055,046   $1,031,416 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

3 

 

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Dollars in thousands, except per share data)

 

   Three Months Ended March 31, 
   2016   2015 
   (Unaudited)   (Unaudited) 
Interest income:          
Interest and fees on loans  $7,206   $6,470 
Interest on tax exempt loans   45    26 
Taxable securities   1,458    1,236 
Tax-exempt securities   143    70 
Interest-earning deposits   36    24 
Other   105    58 
Total interest income   8,993    7,884 
           
Interest expense:          
Deposits   942    1,209 
Federal Home Loan Bank advances   275    205 
Junior subordinated notes   126    112 
Other borrowings   26    26 
Total interest expense   1,369    1,552 
           
Net interest income   7,624    6,332 
           
Provision for loan losses       (1,500)
Net interest income after provision for loan losses   7,624    7,832 
           
Noninterest income:          
Servicing income, net   116    86 
Mortgage banking   140    255 
Gain on sale of SBA loans   334    211 
Gain on sale of investments, net   269    164 
Service charges on deposit accounts   394    298 
Interchange fees   342    278 
Bank owned life insurance   107    129 
Other   173    118 
Total noninterest income   1,875    1,539 
           
Noninterest expenses:          
Compensation and employee benefits   4,010    3,697 
Net occupancy   817    702 
Federal deposit insurance   176    284 
Professional and advisory   212    250 
Data processing   351    280 
Merger-related expenses   145     
Net cost of operation of real estate owned   286    216 
Other   1,282    1,147 
Total noninterest expenses   7,279    6,576 
           
Income before taxes   2,220    2,795 
           
Income tax expense   854    180 
           
Net income  $1,366   $2,615 
           
Earnings per share - basic and diluted  $0.21   $0.40 
Average shares outstanding - basic   6,517,753    6,546,375 
Average shares outstanding - diluted   6,517,955    6,546,375 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

4 

 

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Dollars in thousands)

 

   Three Months Ended March 31, 
   2016   2015 
         
Net income  $1,366   $2,615 
           
Other comprehensive income:          
Change in unrealized holding gains and losses on securities available for sale   3,455    2,020 
Reclassification adjustment for securities gains realized in net income   (269)   (164)
Amortization of unrealized loss on securities transferred to held to maturity   431    49 
Change in deferred tax valuation allowance attributable to unrealized gains and losses on investment securities available for sale   201    729 
Other comprehensive income, before tax   3,818    2,634 
Income tax effect related to items of other comprehensive income   (1,361)   (729)
Other comprehensive income, after tax   2,457    1,905 
           
Comprehensive income  $3,823   $4,520 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

5 

 

 

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)
Three Months Ended March 31, 2016 and 2015
(Dollars in thousands)

 

   Common Stock                     
   Shares   Amount   Additional Paid
in Capital
   Retained
Earnings
   Accumulated
Other
Comprehensive
Income (Loss)
   Common Stock
held by Rabbi
Trust
   Total 
Balance, December 31, 2014   6,546,375   $   $63,651   $45,937   $(2,269)  $   $107,319 
                                    
Net income               2,615            2,615 
Other comprehensive income, net of tax                   1,905        1,905 
Balance, March 31, 2015   6,546,375   $   $63,651   $48,552   $(364)  $   $111,839 
                                    
Balance, December 31, 2015   6,546,375   $   $63,722   $69,762   $(1,736)  $(279)  $131,469 
                                    
Net income               1,366            1,366 
Other comprehensive income, net of tax                   2,457        2,457 
Stock compensation expense           208                208 
Repurchase of common stock   (74,003)        (1,263)               (1,263)
Balance, March 31, 2016   6,472,372   $   $62,667   $71,129   $721   $(279)  $134,238 

 

The accompanying notes are an integral part of the consolidated financial statements

 

6 

 

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)

 

   For the Three Months Ended March 31, 
   2016   2015 
Cash flows from operating activities:          
Net income  $1,366   $2,615 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and leasehold amortization   293    251 
Security amortization, net   483    400 
Trading account income   (74)    
Provision for loan losses       (1,500)
Provision for real estate owned   342    113 
Amortization of core deposit intangible   21     
Share-based compensation expense   208     
Deferred income tax expense    831    330 
Net increase (decrease) in deferred loan fees   (150)   237 
Gain on sales of securities available for sale   (269)   (164)
Income on bank owned life insurance, net   (107)   (112)
Mortgage banking income, net   (140)   (255)
Gain on sales of SBA loans   (334)   (211)
Net realized (gain) loss on sale of real estate owned   (144)   (24)
Loans originated for sale   (2,932)   (4,703)
Proceeds from sale of loans originated for sale   6,520    8,698 
Net change in operating assets and liabilities:          
Interest receivable   (262)   (219)
Loan servicing rights   (54)   (45)
Other assets   287    (862)
Postemployment benefits   29    132 
Accrued interest payable   37    7 
Other liabilities   (22)   742 
Net cash provided by operating activities  $5,929   $5,430 

 

The accompanying notes are an integral part of the consolidated financial statements

 

7 

 

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited), continued
(Dollars in thousands)

 

   For the Three Months Ended March 31, 
   2016   2015 
Cash flows from investing activities:          
Activity for investment securities:          
Purchases  $(53,998)  $(37,550)
Maturities/calls and principal repayments   15,000    12,132 
Sales   34,717    13,197 
Net increase in loans   (8,795)   (216)
Purchased loans       (13,367)
Proceeds from sale of real estate owned   249    359 
Purchase of fixed assets   (144)   (2,414)
Purchase of other investments, at cost   (540)   (740)
Redemptions of other investments, at cost       150 
Net cash used in investing activities  $(13,511)  $(28,449)
Cash flows from financing activities:          
Net increase (decrease) in deposits  $3,667   $(3,674)
Net increase in escrow deposits   428    340 
Proceeds from FHLB advances   125,000    25,000 
Repayment of FHLB advances   (115,000)   (10,000)
Repurchase of common stock   (1,263)    
Net cash provided by financing activities  $12,832   $11,666 
           
Increase (decrease) in cash and cash equivalents   5,250    (11,353)
           
Cash and cash equivalents, beginning of period  $40,650   $58,982 
           
Cash and cash equivalents, end of period  $45,900   $47,629 
           
Supplemental disclosures of cash flow information:          
Cash paid during the year for:          
Interest on deposits and other borrowings  $1,332   $1,545 
           
Noncash investing and financing activities:          
Real estate acquired in satisfaction of mortgage loans  $508   $1,317 
Loans originated for disposition of real estate owned       422 
Purchased loans and investments to be settled   6,373    3,434 
Participation loans not qualified for sale accounting       2,086 

 

The accompanying notes are an integral part of the consolidated financial statements

 

8 

 

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION

 

 

Organization

 

Entegra Financial Corp. (the “Company”) was incorporated on May 31, 2011 and became the holding company for Entegra Bank (the “Bank”) on September 30, 2014 upon the completion of Macon Bancorp’s merger with and into the Company, pursuant to which Macon Bancorp converted from the mutual to stock form of organization. The Company’s primary operation is its investment in the Bank. The Company also owns 100% of the common stock of Macon Capital Trust I (the “Trust”), a Delaware statutory trust formed in 2003 to facilitate the issuance of trust preferred securities. The Bank is a North Carolina state-chartered savings bank and has a wholly owned subsidiary, Macon Services, Inc., which was inactive as of March 31, 2016. The consolidated financials are presented in these financial statements.

 

The Bank operates as a community-focused retail bank, originating primarily real estate based mortgage, consumer and commercial loans and accepting deposits from consumers and small businesses.

 

Estimates

 

The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Material estimates that are particularly susceptible to significant change, in the near term, relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowance for loan losses and the valuation of foreclosed real estate, management obtains independent appraisals for significant properties.

 

Principles of Consolidation

 

The accompanying consolidated financial statements include the accounts of the Company, the Bank, and its wholly owned subsidiary. The accounts of the Trust are not consolidated with the Company. In consolidation all significant intercompany accounts and transactions have been eliminated.

 

Reclassification

 

Certain amounts in the prior years’ financial statements may have been reclassified to conform to the current year’s presentation. The reclassifications had no significant effect on our results of operations or financial condition as previously reported.

 

Basis of Presentation

 

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP, for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with our Annual Report on Form 10-K, filed with the SEC on March 15, 2016. In the opinion of management, these interim financial statements present fairly, in all material respects, the Company’s consolidated financial position and results of operations for each of the interim periods presented. Results of operations for interim periods are not necessarily indicative of the results of operations that may be expected for a full year or any future period.

 

Subsequent Events

 

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet including the estimates inherent in the process of preparing financial statements. Unrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. The Company has reviewed events occurring through the issuance date of the Consolidated Financial Statements and no subsequent events have occurred requiring accrual or disclosure in these financial statements other than those included in this Quarterly Report on Form 10-Q.

9 

 

Recent Accounting Standards Updates

 

In January 2016, the FASB amended the Financial Instruments topic of the Accounting Standards Codification to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company will apply the guidance by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values will be applied prospectively to equity investments that exist as of the date of adoption of the amendments. The Company does not expect these amendments to have a material effect on its financial statements.

 

In March 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify the implementation guidance on principal versus agent considerations and address how an entity should assess whether it is the principal or the agent in contracts that include three or more parties. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

 

In March 2016, the FASB issued guidance to simplify several aspects of the accounting for share-based payment award transactions including the income tax consequences, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. Additionally, the guidance simplifies two areas specific to entities other than public business entities allowing them to apply a practical expedient to estimate the expected term for all awards with performance or service conditions that have certain characteristics and also allowing them to make a one-time election to switch from measuring all liability-classified awards at fair value to measuring them at intrinsic value. The amendments will be effective for the Company for annual periods beginning after December 15, 2016 and interim periods within those annual periods. The Company does not expect these amendments to have a material effect on its financial statements.

 

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

10 

 

 

NOTE 2. INVESTMENT SECURITIES

 

 

The amortized cost and estimated fair values of securities available for sale as of March 31, 2016 and December 31, 2015 are summarized as follows:

 

   March 31, 2016 
       Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
   (Dollars in thousands) 
                 
U.S. government agencies  $18,027   $231   $   $18,258 
Municipal securities   61,924    1,019    (23)   62,920 
Mortgage-backed securities   175,757    1,422    (466)   176,713 
U.S. Treasury securities   1,500    46        1,546 
Mutual funds   606    6        612 
   $257,814   $2,724   $(489)  $260,049 
                     
   December 31, 2015 
       Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
   (Dollars in thousands) 
                 
U.S. government agencies  $25,633   $123   $(36)  $25,720 
Municipal securities   39,751    311    (204)   39,858 
Mortgage-backed securities   172,327    276    (1,429)   171,174 
U.S. Treasury securities   1,500    10        1,510 
Mutual funds   602        (2)   600 
   $239,813   $720   $(1,671)  $238,862 

11 

 

The amortized cost and estimated fair values of securities held to maturity (“HTM”) as of March 31, 2016 and December 31, 2015 are summarized as follows:

 

   March 31, 2016 
       Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
   (Dollars in thousands) 
                 
U.S. government agencies  $5,629   $412   $   $6,041 
Municipal securities   12,667    325    (35)   12,957 
Mortgage-backed securities   4,709    18    (3)   4,724 
U.S. Treasury securities   1,001    3        1,004 
Corporate debt securities   10,029    44    (67)   10,006 
   $34,035   $802   $(105)  $34,732 

 

   December 31, 2015 
       Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
   (Dollars in thousands) 
                 
U.S. government agencies  $15,877   $645   $(23)  $16,499 
Municipal securities   12,428    199    (93)   12,534 
Mortgage-backed securities   4,834    4    (62)   4,776 
U.S. Treasury securities   1,002        (7)   995 
Corporate debt securities   7,023    25    (40)   7,008 
   $41,164   $873   $(225)  $41,812 

 

Information pertaining to the activity for the three month period ended March 31, 2016 and 2015 of unrealized losses related to HTM securities (before the impact of income taxes) previously recognized in accumulated other comprehensive income (“AOCI”) is summarized below:

 

   For the Three Months Ended 
   March 31, 
(Dollars in thousands)  2016   2015 
Beginning unrealized loss related to
HTM securities previously recognized in AOCI
  $903   $1,887 
Additions for transfers to HTM        
Amortization of unrealized losses on
HTM securities previously recognized in AOCI
   (431)   (49)
Ending unrealized loss related to
HTM securities previously recognized in AOCI
  $472   $1,838 

 

The increase in amortization during the three months ended March 31, 2016 was due to an increase in securites called.

12 

 

Information pertaining to securities with gross unrealized losses at March 31, 2016 and December 31, 2015, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

 

   March 31, 2016 
   Less Than 12 Months   More Than 12 Months   Total 
   Fair Value   Unrealized Losses   Fair Value   Unrealized Losses   Fair Value   Unrealized Losses 
   (Dollars in thousands) 
Held to Maturity:                              
Municipal securities  $272   $7   $2,210   $28   $2,482   $35 
Mortgage-backed securities   2,671    3            2,671    3 
Corporate debt securities   5,440    67            5,440    67 
   $8,383   $77   $2,210   $28   $10,593   $105 
                               
Available for Sale:                              
Municipal securities  $1,464   $8   $1,962   $15   $3,426   $23 
Mortgage-backed securities   29,662    220    27,791    246    57,453    466 
   $31,126   $228   $29,753   $261   $60,879   $489 
                               
   December 31, 2015 
   Less Than 12 Months   More Than 12 Months   Total 
   Fair Value   Unrealized Losses   Fair Value   Unrealized Losses   Fair Value   Unrealized Losses 
   (Dollars in thousands) 
Held to Maturity:                              
U.S. government agencies  $5,705   $23   $   $   $5,705   $23 
Municipal securities   4,365    93            4,365    93 
Mortgage-backed securities   2,693    62            2,693    62 
U.S. Treasury securities   995    7            995    7 
Corporate debt securities   4,911    40            4,911    40 
   $18,669   $225   $   $   $18,669   $225 
                               
Available for Sale:                              
U.S. government agencies  $13,317   $36   $   $   $13,317   $36 
Municipal securities   18,769    176    947    28    19,716    204 
Mortgage-backed securities   102,419    926    20,905    503    123,324    1,429 
Mutual funds   600    2            600    2 
   $135,105   $1,140   $21,852   $531   $156,957   $1,671 

13 

 

Information pertaining to the number of securities with unrealized losses is detailed in the table below. The Company believes all unrealized losses as of March 31, 2016 and December 31, 2015 represent temporary impairment. The unrealized losses have resulted from temporary changes in the interest rate market and not as a result of credit deterioration. We do not intend to sell and it is not likely that we will be required to sell any of the securities referenced in the table below before recovery of their amortized cost.

 

   March 31, 2016 
   Less Than 12 Months   More Than 12 Months   Total 
Municipal securities   5    7    12 
Mortgage-backed securities   16    19    35 
Corporate debt securities   10        10 
    31    26    57 
                
   December 31, 2015 
   Less Than 12 Months   More Than 12 Months   Total 
U.S. government agencies   13        13 
Municipal securities   51    2    53 
Mortgage-backed securities   71    15    86 
U.S. Treasury securities   1        1 
Corporate debt securities   9        9 
Mutual funds   1        1 
    146    17    163 

 

For the three months ended March 31, 2016 and 2015 the Company had proceeds from sales of securities available for sale and their corresponding gross realized gains and losses as detailed below:

 

   Three Months Ended March 31, 
   2016   2015 
   (Dollars in thousands) 
         
Gross proceeds  $34,717   $13,197 
Gross realized gains   287    184 
Gross realized losses   18    20 

 

The Company had securities pledged against deposits and borrowings of approximately $83.6 million and $69.6 million at March 31, 2016 and December 31, 2015, respectively.

 

The amortized cost and estimated fair value of investments in debt securities at March 31, 2016, by contractual maturity, is shown below. Mortgage-backed securities have not been scheduled because expected maturities will differ from contractual maturities when borrowers have the right to prepay the obligations.

14 

 

   Available for Sale 
   Amortized Cost   Fair Value 
   (Dollars in thousands) 
         
Less than 1 year  $1,106   $1,112 
Over 1 year through 5 years   23,463    23,757 
After 5 years through 10 years   13,242    13,525 
Over 10 years   44,246    44,942 
    82,057    83,336 
Mortgage-backed securities   175,757    176,713 
           
Total  $257,814   $260,049 
           
   Held to Maturity 
   Amortized Cost   Fair Value 
   (Dollars in thousands) 
         
Over 1 year through 5 years  $1,002   $1,005 
After 5 years through 10 years   11,542    11,538 
Over 10 years   16,782    17,465 
    29,326    30,008 
Mortgage-backed securities   4,709    4,724 
           
Total  $34,035   $34,732 

15 

 

NOTE 3. LOANS RECEIVABLE

 

 

Loans receivable as of March 31, 2016 and December 31, 2015 are summarized as follows:

 

   March 31, 2016   December 31, 2015 
   (Dollars in thousands) 
         
Real estate mortgage loans:          
One-to four-family residential  $251,214   $248,633 
Commercial real estate   224,495    214,413 
Home equity loans and lines of credit   51,240    53,446 
Residential construction   7,708    7,848 
Other construction and land   52,701    57,316 
Total real estate loans   587,358    581,656 
           
Commercial and industrial   43,496    41,046 
Consumer   4,128    3,639 
Total commercial and consumer   47,624    44,685 
           
Loans receivable, gross   634,982    626,341 
           
Less: Net deferred loan fees   (1,238)   (1,388)
Unamortized premium   512    557 
Unamortized discount   (1,361)   (1,438)
           
Loans receivable, net  $632,895   $624,072 

 

The Bank had $123.8 million and $119.5 million of loans pledged as collateral to secure funding with the Federal Home Loan Bank of Atlanta (“FHLB”) at March 31, 2016 and December 31, 2015, respectively. The Bank also had $89.2 million and $88.4 million of loans pledged as collateral to secure funding with the Federal Reserve Bank (“FRB”) Discount Window at March 31, 2016 and December 31, 2015, respectively.

 

Included in loans receivable and other borrowings at March 31, 2016 are $2.5 million in participated loans that did not qualify for sale accounting. Interest expense on the other borrowings accrues at the same rate as the interest income recognized on the loans receivable, resulting in no effect to net income.

 

The following tables present the activity related to the discount on purchased loans for the three month periods ended March 31, 2016 and 2015:

 

   For the Three Months Ended 
   March 31, 
(Dollars in thousands)  2016   2015 
         
Discount on purchased loans, beginning of period  $1,438   $1,487 
Additional discount for new purchases       492 
Accretion   (77)   (97)
Discount applied to charge-offs       (295)
Discount on purchased loans, end of period  $1,361   $1,587 

16 

 

NOTE 4. ALLOWANCE FOR LOAN LOSSES

 

 

The following tables present, by portfolio segment, the changes in the allowance for loan losses:

 

   Three Months Ended March 31, 2016 
   One-to four
Family
Residential
   Commercial
Real Estate
   Home Equity and
Lines of Credit
   Residential
Construction
   Other
Construction
and Land
   Commercial   Consumer   Total 
   (Dollars in thousands) 
                                 
Beginning balance  $2,455   $3,221   $1,097   $278   $1,400   $603   $407   $9,461 
Provision   293    587    (214)   (135)   17    (185)   (363)    
Charge-offs   (46)       (37)       (317)       (10)   (410)
Recoveries   23        113        77    118    116    447 
Ending balance  $2,725   $3,808   $959   $143   $1,177   $536   $150   $9,498 
     
   Three Months Ended March 31, 2015 
   One-to four
Family
Residential
   Commercial
Real Estate
   Home Equity and
Lines of Credit
   Residential
Construction
   Other
Construction
and Land
   Commercial   Consumer   Total 
   (Dollars in thousands) 
                                 
Beginning balance  $2,983   $2,717   $1,333   $510   $2,936   $308   $285   $11,072 
Provision   (100)   (416)   (79)   (206)   (1,046)   281    66    (1,500)
Charge-offs   (219)   (30)   (109)       (19)       (13)   (390)
Recoveries   109    92    23        119    7    79    429 
Ending balance  $2,773   $2,363   $1,168   $304   $1,990   $596   $417   $9,611 

 

The following tables present, by portfolio segment and reserving methodology, the allocation of the allowance for loan losses and the gross investment in loans:

 

   March 31, 2016 
  

One-to four
Family

Residential

   Commercial
Real Estate
   Home Equity
and Lines of
Credit
   Residential
Construction
   Other
Construction and
Land
   Commercial   Consumer   Total 
   (Dollars in thousands) 
Allowance for loan losses                                        
Individually evaluated for impairment  $366   $546   $6   $   $223   $35   $   $1,176 
Collectively evaluated for impairment   2,359    3,262    953    143    954    501    150    8,322 
   $2,725   $3,808   $959   $143   $1,177   $536   $150   $9,498 
                                         
Loans Receivable                                        
Individually evaluated for impairment  $5,992   $8,729   $313   $   $1,970   $315   $   $17,319 
Collectively evaluated for impairment   245,222    215,766    50,927    7,708    50,731    43,181    4,128    617,663 
   $251,214   $224,495   $51,240   $7,708   $52,701   $43,496   $4,128   $634,982 

17 

 

   December 31, 2015 
   One-to four
Family
Residential
   Commercial
Real Estate
   Home Equity
and Lines of
Credit
   Residential
Construction
   Other
Construction and
Land
   Commercial   Consumer   Total 
   (Dollars in thousands) 
Allowance for loan losses                                        
Individually evaluated for impairment  $344   $61   $6   $   $61   $38   $   $510 
Collectively evaluated for impairment   2,111    3,160    1,091    278    1,339    565    407    8,951 
   $2,455   $3,221   $1,097   $278   $1,400   $603   $407   $9,461 
                                         
Loans Receivable                                        
Individually evaluated for impairment  $6,315   $9,013   $313   $   $1,509   $318   $   $17,468 
Collectively evaluated for impairment   242,318    205,400    53,133    7,848    55,807    40,728    3,639    608,873 
   $248,633   $214,413   $53,446   $7,848   $57,316   $41,046   $3,639   $626,341 

 

Portfolio Quality Indicators

 

The Company’s portfolio grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled. The Company’s internal credit risk grading system is based on experiences with similarly graded loans, industry best practices, and regulatory guidance. Credit risk grades are refreshed each quarter, at which time management analyzes the resulting information, as well as other external statistics and factors, to track loan performance.

 

The Company’s internally assigned grades pursuant to the Board-approved lending policy are as follows:

 

Pass (1-5) – Acceptable loans with any identifiable weaknesses appropriately mitigated.
Special Mention (6) – Potential weakness or identifiable weakness present without appropriate mitigating factors; however, loan continues to perform satisfactorily with no material delinquency noted. This may include some deterioration in repayment capacity and/or loan-to-value of securing collateral.
Substandard (7) – Significant weakness that remains unmitigated, most likely due to diminished repayment capacity, serious delinquency, and/or marginal performance based upon restructured loan terms.
Doubtful (8) – Significant weakness that remains unmitigated and collection in full is highly questionable or improbable.
Loss (9) – Collectability is unlikely resulting in immediate charge-off.

 

Beginning as of March 31, 2015, we no longer risk grade consumer purposed loans within all categories for which the individual loan balance is less than $417,000. These loan types provide limited credit information subsequent to origination and therefore may not be properly risk graded within our standard risk grading system. All of our consumer purposed loans are now considered ungraded and will be analyzed on a performing versus non-performing basis. The non-performing ungraded loans will be deemed substandard when determining our classified assets. Consumer purposed loans may include residential loans, home equity loans and lines of credit, residential lot loans, and other consumer loans. This change in risk grading methodology did not have any material impact on our allowance for loan losses calculation.

 

Description of segment and class risks

 

Each of our portfolio segments and the classes within those segments are subject to risks that could have an adverse impact on the credit quality of our loan portfolio. Management has identified the most significant risks as described below which are generally similar among our segments and classes. While the list in not exhaustive, it provides a description of the risks that management has determined are the most significant.

18 

 

One-to four family residential

 

We centrally underwrite each of our one-to four family residential loans using credit scoring and analytical tools consistent with the Board-approved lending policy and internal procedures based upon industry best practices and regulatory directives. Loans to be sold to secondary market investors must also adhere to investor guidelines. We also evaluate the value and marketability of that collateral. Common risks to each class of non-commercial loans, including one-to-four family residential, include risks that are not specific to individual transactions such as general economic conditions within our markets, particularly unemployment and potential declines in real estate values. Personal events such as death, disability or change in marital status also add risk to non-commercial loans.

 

Commercial real estate

 

Commercial mortgage loans are primarily dependent on the ability of our customers to achieve business results consistent with those projected at loan origination resulting in cash flow sufficient to service the debt. To the extent that a customer’s business results are significantly unfavorable versus the original projections, the ability for our loan to be serviced on a basis consistent with the contractual terms may be at risk. While these loans are secured by real property and possibly other business assets such as inventory or accounts receivable, it is possible that the liquidation of the collateral will not fully satisfy the obligation. Other commercial real estate loans consist primarily of loans secured by multifamily housing and agricultural loans. The primary risk associated with multifamily loans is the ability of the income-producing property that collateralizes the loan to produce adequate cash flow to service the debt. High unemployment or generally weak economic conditions may result in our customer having to provide rental rate concessions to achieve adequate occupancy rates. The performance of agricultural loans are highly dependent on favorable weather, reasonable costs for seed and fertilizer, and the ability to successfully market the product at a profitable margin. The demand for these products is also dependent on macroeconomic conditions that are beyond the control of the borrower.

 

Home equity and lines of credit

 

Home equity loans are often secured by first or second liens on residential real estate, thereby making such loans particularly susceptible to declining collateral values. A substantial decline in collateral value could render our second lien position to be effectively unsecured. Additional risks include lien perfection inaccuracies and disputes with first lienholders that may further weaken our collateral position. Further, the open-end structure of these loans creates the risk that customers may draw on the lines in excess of the collateral value if there have been significant declines since origination.

 

Residential construction and other construction and land

 

Residential mortgage construction loans are typically secured by undeveloped or partially developed land with funds to be disbursed as home construction is completed contingent upon receipt and satisfactory review of invoices and inspections. Declines in real estate values can result in residential mortgage loan borrowers having debt levels in excess of the collateral’s current market value. Non-commercial construction and land development loans can experience delays in completion and/or cost overruns that exceed the borrower’s financial ability to complete the project. Cost overruns can result in foreclosure of partially completed collateral with unrealized value and diminished marketability. Commercial construction and land development loans are dependent on the supply and demand for commercial real estate in the markets we serve as well as the demand for newly constructed residential homes and building lots. Deterioration in demand could result in significant decreases in the underlying collateral values and make repayment of the outstanding loans more difficult for our customers.

 

Commercial

 

We centrally underwrite each of our commercial loans based primarily upon the customer’s ability to generate the required cash flow to service the debt in accordance with the contractual terms and conditions of the loan agreement. We strive to gain a complete understanding of our borrower’s businesses including the experience and background of the principals. To the extent that the loan is secured by collateral, which is a predominant feature of the majority of our commercial loans, or other assets including accounts receivable and inventory, we gain an understanding of the likely value of the collateral and what level of strength it brings to the loan transaction. To the extent that the principals or other parties are obligated under the note or guaranty agreements, we analyze the relative financial strength and liquidity of each guarantor. Common risks to each class of commercial loans include risks that are not specific to individual transactions such as general economic conditions within our markets, as well as risks that are specific to each transaction including volatility or seasonality of cash flows, changing demand for products and services, personal events such as death, disability or change in marital status, and reductions in the value of our collateral.

19 

 

Consumer

 

The consumer loan portfolio includes loans secured by personal property such as automobiles, marketable securities, other titled recreational vehicles including boats and motorcycles, as well as unsecured consumer debt. The value of underlying collateral within this class is especially volatile due to potential rapid depreciation in values since date of loan origination in excess of principal repayment.

 

The following tables present the recorded investment in gross loans by loan grade:

 

March 31, 2016
Loan Grade  One-to
Four-Family
Residential
   Commercial
Real Estate
   Home Equity
and Lines of
Credit
   Residential
Construction
   Other
Construction
and Land
   Commercial   Consumer   Total 
(Dollars in thousands)
                                 
1  $   $64   $   $   $   $10,199   $   $10,263 
2       4,408                1,846        6,254 
3   26,879    12,284    1,267        1,039    1,891        43,360 
4   47,814    90,448    2,200    3,303    7,542    19,085        170,392 
5   27,678    86,925    4,589    942    26,370    9,635    335    156,474 
6   2,938    14,011    466    1,141    1,961    273        20,790 
7   3,218    14,742            575    463        18,998 
   $108,527   $222,882   $8,522   $5,386   $37,487   $43,392   $335   $426,531 
                                         
Ungraded Loan Exposure:                          
                                         
Performing  $141,207   $1,613   $42,502   $2,322   $15,214   $104   $3,793   $206,755 
Nonperforming   1,480        216                    1,696 
Subtotal  $142,687   $1,613   $42,718   $2,322   $15,214   $104   $3,793   $208,451 
                                         
Total  $251,214   $224,495   $51,240   $7,708   $52,701   $43,496   $4,128   $634,982 

20 

 

December 31, 2015
Loan Grade  One-to
Four-Family
Residential
   Commercial
Real Estate
   Home Equity
and Lines of
Credit
   Residential
Construction
   Other
Construction
and Land
   Commercial   Consumer   Total 
(Dollars in thousands)
                                 
1  $   $65   $   $   $   $10,336   $   $10,401 
2       4,446                99        4,545 
3   18,518    11,396    1,358    525    1,479    1,734        35,010 
4   46,942    74,542    1,961    2,036    13,850    18,586    1    157,918 
5   33,886    97,469    6,648    1,347    22,864    9,274    592    172,080 
6   2,903    13,171        1,106    1,718    297        19,195 
7   3,335    13,106            579    458        17,478 
   $105,584   $214,195   $9,967   $5,014   $40,490   $40,784   $593   $416,627 
                                         
Ungraded Loan Exposure:                
                                         
Performing  $141,771   $218   $43,158   $2,834   $16,707   $262   $3,046   $207,996 
Nonperforming   1,278        321        119            1,718 
Subtotal  $143,049   $218   $43,479   $2,834   $16,826   $262   $3,046   $209,714 
                                         
Total  $248,633   $214,413   $53,446   $7,848   $57,316   $41,046   $3,639   $626,341 

21 

 

Delinquency Analysis of Loans by Class

 

The following tables include an aging analysis of the recorded investment of past-due financing receivables by class. The Company does not accrue interest on loans greater than 90 days past due.

 

   March 31, 2016 
   30-59 Days Past
Due
   60-89 Days Past
Due
   90 Days and Over
Past Due
   Total Past Due   Current   Total Loans
Receivable
 
   (Dollars in thousands) 
                         
One-to four-family residential  $3,166   $1,272   $1,178   $5,616   $245,598   $251,214 
Commercial real estate   2,232    1,027    2,300    5,559    218,936    224,495 
Home equity and lines of credit   671    134    216    1,021    50,219    51,240 
Residential construction                   7,708    7,708 
Other construction and land   528    25    227    780    51,921    52,701 
Commercial           10    10    43,486    43,496 
Consumer   15    1        16    4,112    4,128 
Total  $6,612   $2,459   $3,931   $13,002   $621,980   $634,982 
     
   December 31, 2015 
   30-59 Days Past
Due
   60-89 Days Past
Due
   90 Days and Over
Past Due
   Total Past Due   Current   Total Loans
Receivable
 
   (Dollars in thousands) 
                         
One-to four-family residential  $5,610   $1,260   $1,205   $8,075   $240,558   $248,633 
Commercial real estate   1,585        605    2,190    212,223    214,413 
Home equity and lines of credit   369    38    322    729    52,717    53,446 
Residential construction                   7,848    7,848 
Other construction and land   208    397    138    743    56,573    57,316 
Commercial   625            625    40,421    41,046 
Consumer   12    4        16    3,623    3,639 
Total  $8,409   $1,699   $2,270   $12,378   $613,963   $626,341 

22 

 

Impaired Loans

 

The following table presents investments in loans considered to be impaired and related information on those impaired loans as of March 31, 2016 and December 31, 2015.

 

   March 31, 2016   December 31, 2015 
   Recorded Balance   Unpaid Principal
Balance
   Specific Allowance   Recorded Balance   Unpaid Principal
Balance
   Specific
Allowance
 
   (Dollars in thousands) 
Loans without a valuation allowance                              
One-to four-family residential  $3,818   $3,844   $   $4,289   $4,403   $ 
Commercial real estate   5,808    7,174        7,226    8,809     
Home equity and lines of credit   213    328        213    328     
Residential construction                        
Other construction and land   794    876        658    818     
Commercial                        
   $10,633   $12,222   $   $12,386   $14,358   $ 
                               
Loans with a valuation allowance                              
One-to four-family residential  $2,174   $2,174   $366   $2,026   $2,026   $344 
Commercial real estate   2,921    3,139    546    1,787    1,787    61 
Home equity and lines of credit   100    100    6    100    100    6 
Residential construction                        
Other construction and land   1,176    1,254    223    851    851    61 
Commercial   315    314    35    318    318    38 
   $6,686   $6,981   $1,176   $5,082   $5,082   $510 
                               
Total                              
One-to four-family residential  $5,992   $6,018   $366   $6,315   $6,429   $344 
Commercial real estate   8,729    10,313    546    9,013    10,596    61 
Home equity and lines of credit   313    428    6    313    428    6 
Residential construction                        
Other construction and land   1,970    2,130    223    1,509    1,669    61 
Commercial   315    314    35    318    318    38 
   $17,319   $19,203   $1,176   $17,468   $19,440   $510 

23 

 

The following table presents average impaired loans and interest income recognized on those impaired loans, by class segment, for the periods indicated:

 

   Three Months Ended March 31, 
   2016   2015 
   Average
Investment in
Impaired Loans
   Interest Income
Recognized
   Average
Investment in
Impaired Loans
   Interest Income
Recognized
 
   (Dollars in thousands) 
Loans without a valuation allowance                    
One-to four-family residential  $3,832   $36   $5,672   $51 
Commercial real estate   5,811    46    12,953    120 
Home equity and lines of credit   213    2    714    2 
Residential construction                
Other construction and land   797    8    925    7 
Commercial                 
   $10,653   $92   $20,264   $180 
                     
Loans with a valuation allowance                    
One-to four-family residential  $2,182   $24   $3,185   $27 
Commercial real estate   2,927    27    3,640    39 
Home equity and lines of credit   100    1    186    1 
Residential construction                
Other construction and land   1,180    10    1,020    10 
Commercial   316    5    328    5 
   $6,705   $67   $8,359   $82 
                     
Total                    
One-to four-family residential  $6,014   $60   $8,857   $78 
Commercial real estate   8,738    73    16,593    159 
Home equity and lines of credit   313    3    900    3 
Residential construction                
Other construction and land   1,977    18    1,945    17 
Commercial   316    5    328    5 
   $17,358   $159   $28,623   $262 

 

Nonperforming Loans

 

The following table summarizes the balances of nonperforming loans as of March 31, 2016 and December 31, 2015. Certain loans classified as Troubled Debt Restructurings (“TDRs”) and impaired loans may be on non-accrual status even though they are not contractually delinquent.

 

   March 31, 2016     December 31, 2015 
   (Dollars in thousands) 
         
One-to four-family residential  $2,983   $2,893 
Commercial real estate   5,253    3,628 
Home equity loans and lines of credit   214    320 
Residential construction        
Other construction and land   470    384 
Commercial   62    55 
Consumer        
Non-performing loans  $8,982   $7,280 

24 

 

Troubled Debt Restructurings (TDR)

 

The following tables summarize TDR loans as of the dates indicated:

 

   March 31, 2016 
   Performing   Nonperforming   Total 
   TDR’s   TDR’s   TDR’s 
   (Dollars in thousands) 
             
One-to-four family residential  $3,675   $211   $3,886 
Commercial real estate   4,853    2,922    7,775 
Home equity and lines of credit   213        213 
Residential construction            
Other construction and land   1,510    250    1,760 
Commercial   314    11    325 
                
   $10,565   $3,394   $13,959 
     
   December 31, 2015 
   Performing   Nonperforming   Total 
   TDR’s   TDR’s   TDR’s 
   (Dollars in thousands) 
             
One-to-four family residential  $4,182   $211   $4,393 
Commercial real estate   5,134    2,922    8,056 
Home equity and lines of credit   313        313 
Residential construction            
Other construction and land   1,259    250    1,509 
Commercial   318    12    330 
                
   $11,206   $3,395   $14,601 

 

25 

 

 

Loan modifications that were deemed TDRs at the time of the modification during the period presented are summarized in the tables below:

 

   Three Months Ended March 31, 2016 
(Dollars in thousands)  Number of
Loans
   Pre-modification
Outstanding
Recorded Investment
   Post-modification
Outstanding
Recorded Investment
 
                
None      $   $ 
       $   $ 
                
   Three Months Ended March 31, 2015 
(Dollars in thousands)  Number of
Loans
   Pre-modification
Outstanding
Recorded Investment
   Post-modification
Outstanding
Recorded Investment
 
Forgiveness of principal:               
Commercial real estate   1    1,988    1,693 
    1   $1,988   $1,693 

 

There were no TDR’s that defaulted during the three month periods ending March 31, 2016 and 2015 and which were modified as TDR’s within the previous 12 months.

26 

 

NOTE 5. REAL ESTATE OWNED

 

 

The following tables summarize real estate owned and changes in the valuation allowance for real estate owned as of March 31, 2016 and December 31, 2015 and for the three months ended March 31, 2016 and 2015.

 

   March 31,   December 31, 
(Dollars in thousands)  2016   2015 
         
Real estate owned, gross  $7,081   $6,741 
Less:  Valuation allowance   1,651    1,372 
           
Real estate owned, net  $5,430   $5,369 

 

   Three Months Ended March 31, 
(Dollars in thousands)  2016   2015 
Valuation allowance, beginning  $1,372   $1,760 
Provision charged to expense   342    68 
Reduction due to disposal   (63)   (222)
           
Valuation allowance, ending  $1,651   $1,606 

 

As of March 31, 2016 and December 31, 2015, the Company had $1.2 million and $0.7 million, respectively, in loans secured by residential real estate properties for which formal foreclosure proceedings were in process. As of March 31, 2016 and December 31, 2015, the Company had $1.8 million and $1.4 million, respectively, of residential real estate properties included in real estate owned.

 

NOTE 6. DEPOSITS

 

 

The following table summarizes deposit balances and interest expense by type of deposit as of and for the three months ended March 31, 2016 and 2015 and the year ended December 31, 2015.

 

   As of and for the   As of and for the Year Ended 
   Three Months Ended March 31,   December 31, 
   2016   2015   2015 
(Dollars in thousands)  Balance   Interest
Expense
   Balance   Interest
Expense
   Balance   Interest
Expense
 
Noninterest-bearing demand  $118,228   $   $89,012   $   $121,062   $ 
Interest-bearing demand   105,374    27    89,845    36    103,198    136 
Money Market   193,775    148    175,162    154    180,377    558 
Savings   35,915    10    28,278    8    35,838    33 
Time Deposits   267,420    757    317,486    1,011    276,142    3,607 
   $720,712   $942   $699,783   $1,209   $716,617   $4,334 

27

 

NOTE 7. BORROWINGS

 

 

The scheduled maturities and respective weighted average rates of outstanding FHLB advances, are as follows for the dates indicated:

 

   March 31, 2016   December 31, 2015 
Year of Maturity  Balance   Weighted
Average Rate
   Balance   Weighted
Average Rate
 
   (Dollars in thousands) 
2016   135,000    0.60%   130,000    0.49%
2017   13,000    1.06%   8,000    1.23%
2018   2,000    1.25%   2,000    1.25%
2019   12,500    1.82%   12,500    1.82%
2020   1,000    1.78%   1,000    1.78%
   $163,500    0.75%  $153,500    0.65%

 

NOTE 8. INCOME TAXES

 

 

During 2015, the Company completed an analysis of all positive and negative evidence in assessing the need to maintain the valuation allowance against its net deferred tax asset. As a result of this analysis, the Company determined that significant positive evidence existed that would support the reversal of the valuation allowance including the following:

 

A pattern of sustained profitability, excluding non-recurring items, since the first quarter of 2014;
A 3 year cumulative profit;
Forecasted earnings sufficient to utilize all remaining net operating losses prior to expiration beginning in 2025 for North Carolina and 2032 for Federal ;
Significant improvements in asset quality;
Resolution of all remaining regulatory orders; and
A strong capital position enabling future earnings investments.

 

As of March 31, 2016 and December 31, 2015, $0.4 million and $0.6 million in valuation allowance related to net deferred tax assets on investment securities remains in accumulated other comprehensive income. This valuation allowance will be recognized as tax expense on a security-by-security basis upon the sale or maturity of the individual securities. The tax expense is expected to be recognized over the remaining life of the securities of approximately 2.5 years.

28

 

The components of net deferred taxes as of March 31, 2016 and December 31, 2015 are summarized as follows:

 

   March 31,   December 31, 
   2016   2015 
   (Dollars in thousands) 
Deferred tax assets:          
Federal net operating loss  $10,169   $10,750 
Allowance for loan losses   3,571    3,557 
Deferred compensation and post employment benefits   3,492    3,498 
North Carolina net operating loss   921    988 
Valuation reserve for other real estate   621    516 
Non-accrual interest   312    286 
Deferred gains   192    154 
Unrealized losses on securities       697 
Other   639    618 
Gross deferred tax assets   19,917    21,064 
           
Deferred tax liabilities:          
Fixed assets   510    499 
Loan servicing rights   902    881 
Deferred loan costs   820    708 
Prepaid expenses   161    146 
Unrealized gains on securities   664     
Other   21     
Total deferred tax liabilities   3,078    2,234 
           
Net deferred tax asset  $16,839   $18,830 

 

NOTE 9. EARNINGS PER SHARE

 

 

The following is a reconciliation of the numerator and denominator of basic and diluted net income per share of common stock:

 

(Dollars in thousands, except per share amounts)  For the Three Months
Ended March 31, 2016
   For the Three Months
Ended March 31, 2015
 
Numerator:          
Net income  $1,366   $2,615 
Denominator:          
Weighted-average common shares outstanding - basic   6,517,753    6,546,375 
Effect of dilutive shares   202     
Weighted-average common shares outstanding - diluted   6,517,955    6,546,375 
           
Earnings per share - basic  $0.21   $0.40 
Earnings per share - diluted  $0.21   $0.40 

 

For the three months ended March 31, 2016, all of the 371,000 outstanding stock options remain anti-dilutive and have not been included in calculating diluted earnings per share. There were no stock options outstanding during the three months ended March 31, 2015.

29

 

For the three months ended March 31, 2016, 157,100 of the 160,300 outstanding restricted stock units remain anti-dilutive and have not been included in calculating diluted earnings per share. There were no restricted stock units outstanding during the three months ended March 31, 2015.

 

NOTE 10. ACCUMLATED OTHER COMPREHENSIVE INCOME (LOSS)

 

 

The following table summarizes the components of accumulated other comprehensive income and changes in those components as of and for the three months ended March 31, 2016 and 2015.

 

   Three Months Ended March 31, 2016 
   Available
for Sale
Securities
   Held to Maturity
Securities
Transferred
from AFS
   Deferred Tax
Valuation
Allowance on
AFS
   Total 
   (Dollars in thousands) 
Balance, beginning of period  $(594)  $(563)  $(579)  $(1,736)
                     
Change in deferred tax valuation allowance attributable to net unrealized losses on investment securities available for sale           201    201 
Change in net unrealized holding losses on securities available for sale   3,455            3,455 
Reclassification adjustment for net securities gains realized in net income   (269)           (269)
Transfer of net unrealized loss from available for sale to held to maturity                
Amortization of unrealized gains and losses on securities transferred to held to maturity       431        431 
Income tax benefit   (1,198)   (163)       (1,361)
                     
Balance, end of period  $1,394   $(295)  $(378)  $721 
                     
   Three Months Ended March 31, 2015 
    (Dollars in thousands)  
Balance, beginning of period  $(236)  $(1,165)  $(868)  $(2,269)
                     
Change in deferred tax valuation allowance attributable to unrealized gains on investment securities available for sale           729    729 
Change in unrealized holding gains on securities available for sale   2,020            2,020 
Reclassification adjustment for net securities gains realized in net income   (164)           (164)
Transfer of net unrealized loss from available for sale to held to maturity                
Amortization of unrealized gains and losses on securities transferred to held to maturity       49        49 
Income tax benefit   (710)   (19)       (729)
                     
Balance, end of period  $910   $(1,135)  $(139)  $(364)

30

 

The following table shows the line items in the Consolidated Statements of Income affected by amounts reclassified from accumulated other comprehensive income:

 

   Three Months Ended March 31, 
   2016   2015 
   (Dollars in thousands) 
         
Income tax expense  $201   $ 
Tax effect        
Impact, net of tax   201     
           
Gain on sale of investments, net  $269   $164 
Tax effect        
Impact, net of tax   269    164 
           
Interest income - taxable securities   431    49 
Tax effect        
Impact, net of tax   431    49 
           
Total reclassifications, net of tax  $901   $213 

 

NOTE 11. COMMITMENTS AND CONTINGENCIES

 

 

To accommodate the financial needs of its customers, the Company makes commitments under various terms to lend funds. These commitments include revolving credit agreements, term loan commitments and short-term borrowing agreements. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness. The amount of collateral obtained, if it is deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held includes first and second mortgages on one-to-four family dwellings, accounts receivable, inventory, and commercial real estate. Certain lines of credit are unsecured.

 

The following summarizes the Company’s approximate commitments to extend credit:

 

   March 31, 2016 
   (Dollars in thousands) 
Lines of credit  $83,540 
Standby letters of credit   777 
      
   $84,317 

31

 

As of March 31, 2016, the Company had outstanding commitments to originate loans as follows:

 

   March 31, 2016
   Amount   Range of Rates
   (Dollar in thousands)
        
Fixed  $20,079   2.14% to 5.00%
Variable   17,670   3.25% to 6.25%
         
   $37,749    

 

The allowance for unfunded commitments was $0.1 million at March 31, 2016 and December 31, 2015.

 

The Company is exposed to loss as a result of its obligation for representations and warranties on loans sold to Fannie Mae and maintained a reserve of $0.3 million as of March 31, 2016 and December 31, 2015.

 

In the normal course of business, the Company is periodically involved in litigation. In the opinion of the Company’s management, none of this litigation is expected to have a material adverse effect on the accompanying consolidated financial statements.

 

NOTE 12. FAIR VALUE DISCLOSURES

 

 

We use fair value measurements when recording and disclosing certain financial assets and liabilities. Securities available-for-sale, loan servicing rights and mortgage derivatives are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record other assets at fair value on a nonrecurring basis, such as loans held for sale, impaired loans and real estate owned.

 

Fair value is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants at the measurement date. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction. In determining fair value, we use various valuation approaches, including market, income and cost approaches. The fair value standard establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing an asset or liability, which is developed, based on market data we have obtained from independent sources. Unobservable inputs reflect our estimate of assumptions that market participants would use in pricing an asset or liability, which are developed based on the best information available in the circumstances.

 

The fair value hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:

 

Level 1: valuation is based upon unadjusted quoted market prices for identical instruments traded in active markets.
Level 2: valuation is based upon quoted market prices for similar instruments traded in active markets, quoted market prices for identical or similar instruments traded in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by market data.
Level 3: valuation is derived from other valuation methodologies, including discounted cash flow models and similar techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in determining fair value.

32

 

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

 

Fair value estimates are made at a specific point of time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale the Company’s entire holdings of a particular financial instrument. Because no active market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, current interest rates and prepayment trends, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in any of these assumptions used in calculating fair value also would affect significantly the estimates. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.

 

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value on a recurring basis:

 

Securities

We obtain fair values for debt securities from a third-party pricing service, which utilizes several sources for valuing fixed-income securities. The market evaluation sources for debt securities include observable inputs rather than significant unobservable inputs and are classified as Level 2. The service provider utilizes pricing models that vary by asset class and include available trade, bid and other market information. Generally, the methodologies include broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs.

 

Included in securities are investments in an exchange traded bond fund and U.S. Treasury bonds which are valued by reference to quoted market prices and considered a Level 1 security.

 

Trading securites represent investments in exchange traded mutual funds which are valued by reference to quoted market prices and considered a Level 1 security.

 

Loan Servicing Rights

Loan servicing rights are carried at fair value as determined by a third party valuation firm. The valuation model utilizes a discounted cash flow analysis using discount rates and prepayment speed assumptions used by market participants. The Company classifies loan servicing rights fair value measurements as Level 3.

 

Derivative Instruments

Derivative instruments include interest rate lock commitments and forward sale commitments. These instruments are valued based on the change in the value of the underlying loan between the commitment date and the end of the period. The Company classifies these instruments as Level 3.

 

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value on a nonrecurring basis:

 

Loans Held for Sale

Loans held for sale are carried at the lower of cost or fair value. The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. Loans held for sale carried at fair value are classified as Level 2.

 

Impaired Loans

Impaired loans are carried at the lower of recorded investment or fair value. The fair value of collateral dependent impaired loans is estimated using the value of the collateral less selling costs if repayment is expected from liquidation of the collateral. Appraisals may be discounted based on our historical knowledge, changes in market conditions from the time of appraisal or our knowledge of the borrower and the borrower’s business. Impaired loans carried at fair value are classified as Level 3. Impaired loans measured using the present value of expected future cash flows are not deemed to be measured at fair value.

33

 

Real Estate Owned

Real estate owned, obtained in partial or total satisfaction of a loan is recorded at the lower of recorded investment in the loan or fair value less cost to sell. Subsequent to foreclosure, these assets are carried at the lower of the amount recorded at acquisition date or fair value less cost to sell. Accordingly, it may be necessary to record nonrecurring fair value adjustments. Fair value, when recorded, is generally based upon appraisals by approved, independent, state certified appraisers. Like impaired loans, appraisals may be discounted based on our historical knowledge, changes in market conditions from the time of appraisal or other information available to us. Real estate owned carried at fair value is classified as Level 3.

 

In addition to financial instruments recorded at fair value in our financial statements, fair value accounting guidance requires disclosure of the fair value of all of an entity’s assets and liabilities that are considered financial instruments. The majority of our assets and liabilities are considered financial instruments. Many of these instruments lack an available trading market as characterized by a willing buyer and willing seller engaged in an exchange transaction. Also, it is our general practice and intent to hold our financial instruments to maturity and to not engage in trading or sales activities. For fair value disclosure purposes, we substantially utilize the fair value measurement criteria as required and explained above. In cases where quoted fair values are not available, we use present value methods to determine the fair value of our financial instruments.

 

Following is a description of valuation methodologies used for the disclosure of the fair value of financial instruments not carried at fair value:

 

Cash and Cash Equivalents

The carrying amount of such instruments is deemed to be a reasonable estimate of fair value.

 

Loans

The fair value of variable rate performing loans is based on carrying values adjusted for credit risk. The fair value of fixed rate performing loans is estimated using discounted cash flow analyses, utilizing interest rates currently being offered for loans with similar terms, adjusted for credit risk. The fair value of nonperforming loans is based on their carrying values less any specific reserve. A prepayment assumption is used to estimate the portion of loans that will be repaid prior to their scheduled maturity. No adjustment has been made for the illiquidity in the market for loans as there is no active market for many of the Company’s loans on which to reasonably base this estimate.

 

Bank Owned Life Insurance

Fair values approximate net cash surrender values.

 

Other Investments, at cost

No ready market exists for this stock and it has no quoted market value. However, redemption of this stock has historically been at par value. Accordingly, the carrying amount is deemed to be a reasonable estimate of fair value.

 

Deposits

The fair values disclosed for demand deposits are equal to the amounts payable on demand at the reporting date. The fair value of certificates of deposit are estimated by discounting the amounts payable at the certificate rates using the rates currently offered for deposits of similar remaining maturities.

 

Advances from the FHLB

The fair values disclosed for fixed rate long-term borrowings are determined by discounting their contractual cash flows using current interest rates for long-term borrowings of similar remaining maturities. The carrying amounts of variable rate long-term borrowings approximate their fair values.

 

Junior Subordinated Notes

The carrying amount approximates fair value because the debt is variable rate tied to LIBOR.

 

Accrued Interest Receivable and Payable

Since these financial instruments will typically be received or paid within three months, the carrying amounts of such instruments are deemed to be a reasonable estimate of fair value.

34

 

Loan Commitments

Estimates of the fair value of these off-balance sheet items are not made because of the short-term nature of these arrangements and the credit standing of the counterparties.

 

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

Below is a table that presents information about certain assets and liabilities measured at fair value on a recurring basis:

 

   March 31, 2016 
   Level 1   Level 2   Level 3   Total 
   (Dollars in thousands) 
Trading account assets — mutual funds  $4,841   $   $   $4,841 
Securities available for sale:                    
U.S. government agencies       18,258        18,258 
Municipal securities       62,920        62,920 
Mortgage-backed securities       176,713        176,713 
U.S. Treasury securities   1,546            1,546 
Mutual funds   612            612 
    6,999    257,891        264,890 
                     
Loan servicing rights           2,398    2,398 
Forward sales commitments           15    15 
Interest rate lock commitments           65    65 
                     
Total assets  $6,999   $257,891   $2,478   $267,368 

35

 

   December 31, 2015 
   Level 1   Level 2   Level 3   Total 
   (Dollars in thousands) 
Trading account assets  $4,714   $   $   $4,714 
Securities available for sale:                    
U.S. government agencies       25,720        25,720 
Municipal securities       39,858        39,858 
Mortgage-backed securities       171,174        171,174 
U.S. Treasury securities   1,510            1,510 
Mutual funds   600            600 
    6,824    236,752        243,576 
                     
Loan servicing rights           2,344    2,344 
Forward sales commitments           16    16 
Interest rate lock commitments           30    30 
                     
Total assets  $6,824   $236,752   $2,390   $245,966 

 

The following table presents the changes in assets measured at fair value on a recurring basis for which we have utilized Level 3 inputs to determine fair value:

 

   Three Months Ended March 31, 
   2016   2015 
   (Dollars in thousands) 
Balance at beginning of period  $2,390   $2,248 
           
Loan servicing right activity, included in servicing income, net          
Capitalization from loans sold   128    133 
Fair value adjustment   (74)   (88)
           
Mortgage derivative gains included in Other income   34    75 
           
Balance at end of period  $2,478   $2,368 

 

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The table below presents information about certain assets and liabilities measured at fair value on a nonrecurring basis. There were no loans held for sale carried at fair value at either March 31, 2016 or December 31, 2015.

36

 

   March 31, 2016 
   Level 1   Level 2   Level 3   Total 
   (Dollars in thousands) 
Collateral dependent impaired loans:                    
One-to four family residential  $   $   $3,858   $3,858 
Commercial real estate           6,956    6,956 
Home equity loans and lines of credit           213    213 
Other construction and land           1,127    1,127 
                     
Real estate owned:                    
One-to four family residential           1,795    1,795 
Commercial real estate           1,097    1,097 
Other construction and land           2,538    2,538 
                     
Total assets  $   $   $17,584   $17,584 

 

   December 31, 2015 
   Level 1   Level 2   Level 3   Total 
   (Dollars in thousands) 
Collateral dependent impaired loans:                    
One-to four family residential  $   $   $4,163   $4,163 
Commercial real estate           7,226    7,226 
Home equity loans and lines of credit           213    213 
Other construction and land           658    658 
                     
Real estate owned:                    
One-to four family residential           1,384    1,384 
Commercial real estate           1,123    1,123 
Other construction and land           2,862    2,862 
                     
Total assets  $   $   $17,629   $17,629 

 

There were no liabilities measured at fair value on a nonrecurring basis as of March 31, 2016 or December 31, 2015.

 

Impaired loans totaling $5.2 million at March 31, 2016 and December 31, 2015, were measured using the present value of expected future cash flows. These impaired loans were not deemed to be measured at fair value on a nonrecurring basis.

 

The following table provides information describing the unobservable inputs used in Level 3 fair value measurements at March 31, 2016.

37

 

   Valuation Technique  Unobservable Input  General Range
          
Impaired loans  Discounted Appraisals  Collateral discounts and estimated selling cost  0 – 30%
Real estate owned  Discounted Appraisals  Collateral discounts and estimated selling cost  0 – 30%
Loan servicing rights  Discounted Cash Flows  Prepayment speed  5 - 35%
      Discount rate  12% - 14%
Forward sales commitments and interest rate lock commitments  Change in market price of underlying loan  Value of underlying loan  101 - 108%

 

The approximate carrying and estimated fair value of financial instruments are summarized below:

 

       Fair Value Measurements at March 31, 2016 
   Carrying                 
(Dollars in thousands)  Amount   Total   Level 1   Level 2   Level 3 
Assets:                         
Cash and equivalents  $45,900   $45,900   $45,900   $   $ 
Trading securities   4,841    4,841    4,841         
Securities available for sale   260,049    260,049    2,158    257,891     
Securities held to maturity   34,035    34,732    1,004    33,728     
Loans held for sale   5,182    5,609        5,609     
Loans receivable, net   632,895    629,223            629,223 
Other investments, at cost   9,374    9,374        9,374     
Interest receivable   3,816    3,816        3,816     
Bank owned life  insurance   20,964    20,964        20,964     
Loan servicing rights   2,398    2,398            2,398 
Forward sales commitments   15    15            15 
Interest rate lock commitments   65    65            65 
                          
Liabilities:                         
Demand deposits  $453,292    453,292   $   $453,292   $ 
Time deposits   267,420    267,766            267,766 
Federal Home Loan Bank advances   163,500    163,682        163,682     
Junior subordinated debentures   14,433    14,433        14,433     
Accrued interest payable   250    250        250     

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       Fair Value Measurements at December 31, 2015 
   Carrying                 
(Dollars in thousands)  Amount   Total   Level 1   Level 2   Level 3 
Assets:                         
Cash and equivalents  $40,650   $40,650   $40,650   $   $ 
Trading securities   4,714    4,714    4,714         
Securities available for sale   238,862    238,862    2,110    236,752     
Securities held to maturity   41,164    41,812    995    40,817     
Loans held for sale   8,348    8,952        8,952     
Loans receivable, net   624,072    620,516            620,516 
Other investments, at cost   8,834    8,834        8,834     
Interest receivable   3,554    3,554        3,554     
Bank owned life  insurance   20,858    20,858        20,858     
Loan servicing rights   2,344    2,344            2,344 
Forward sales commitments   16    16            16 
Interest rate lock commitments   30    30            30 
                          
Liabilities:                         
Demand deposits  $440,475    440,475   $   $440,475   $ 
Time deposits   276,142    275,403            275,403 
Federal Home Loan Bank advances   153,500    153,441        153,441     
Junior subordinated debentures   14,433    14,433        14,433     
Accrued interest payable   213    213        213     

 

NOTE 13. SHARE REPURCHASES

 

 

On January 28, 2016, the Company announced that the Board of Directors had authorized the repurchase of up to 327,318 shares of the Company’s common stock. The authorization represented approximately 5% of the Company’s shares outstanding as of December 31, 2015.

 

The following table summarizes share repurchase activity through March 31, 2016:

  

Period  Total Number of Shares Purchased  Average Price Paid per Share  Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs  Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
January 1, 2016 to January 31, 2016   —     $—      —      —   
February 1, 2016 to February 29, 2016   40,621   $17.04    40,621    286,697 
March 1, 2016 to March 31, 2016   33,382   $17.10    33,382    253,315 
Total year-to-date 2016   74,003   $17.07    74,003    253,315 

 

NOTE 14. SUBSEQUENT EVENTS

 

 

On April 1, 2016, the Company completed its acquisition of Oldtown Bank (“Oldtown”) of Waynesville, North Carolina, which was merged with and into Entegra Bank. The Company will continue to operate Oldtown’s office under the Oldtown name until a system conversion is completed in August 2016.

 

Shareholders of Oldtown received a cash payment equal to $11.05 in exchange for each share of Oldtown common stock held immediately prior to the effective time of the merger. The aggregate merger consideration paid by the Company was approximately $13.5 million, which included a $0.7 million payment for the cash-out of in-the-money stock options. The Company did not issue any shares of its common stock in connection with the merger.

 

The acquisition added approximately $97.9 million to the Company’s assets, including $64.6 million of loans and $88.7 million of deposits.

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may” and words of similar meaning. These forward-looking statements include, but are not limited to:

    statements of our goals, intentions and expectations;
    statements regarding our business plans, prospects, growth and operating strategies;
    statements regarding the asset quality of our loan and investment portfolios; and
    estimates of our risks and future costs and benefits.

These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. The Company is under no duty to and do not undertake any obligation to update any forward-looking statements after the date of this Quarterly Report on Form 10-Q.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

    the occurrence of an ownership change under applicable tax rules that could limit our ability to utilize losses to offset future taxable income;
    general economic conditions, either nationally or in our market areas, that are worse than expected;
    credit quality deterioration as a result of, among other potential factors, declining real estate values, increasing interest rates, increasing unemployment, or changes in payment behavior or other factors;
    the adequacy of the level of our allowance for loan losses and the amount of loan loss provisions required in future periods;
    weaknesses in the real estate market affect the value of real estate serving as collateral for loans in our portfolio
    competition among depository and other financial institutions;
    inflation and changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments;
    adverse changes in the securities markets;
    changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;
    increased cybersecurity risk, including potential business disruptions or financial losses;
    our ability to enter new markets successfully and capitalize on growth opportunities;
    our ability to successfully integrate acquired entities;
    changes in consumer spending, borrowing and savings habits;
    changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board (“FASB”), the Securities and Exchange Commission (“SEC”) and the Public Company Accounting Oversight Board (“PCAOB”);
    changes in our key personnel, and our compensation and benefit plans;
    changes in our financial condition or results of operations that reduce capital available to pay dividends or buyback shares;
    changes in the financial condition or future prospects of issuers of securities that we own; and
    other risks and uncertainties detailed in this Quarterly Report on Form 10-Q and, from time to time, in our other filings with the SEC.

For additional information with respect to factors that could cause actual results to differ from the expectations stated in the forward-looking statements, see “Risk Factors” under Part I, Item 1A of our Annual Report on Form 10-K.

40

 

Critical Accounting Policies and Estimates

 

Our critical accounting policies involving significant judgments and assumptions used in the preparation of the Consolidated Financial Statements as of March 31, 2016 have remained unchanged from the disclosures presented in our Annual Report on Form 10-K.

 

The Jumpstart Our Business Startups Act (“JOBS Act”) contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an “emerging growth company” we have elected to use the extended transition period to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. Accordingly, our financial statements may not be comparable to the financial statements of public companies that comply with such new or revised accounting standards. As of March 31, 2016 and December 31, 2015, there was not a significant difference in the presentation of our financial statements as compared to other public companies as a result of this transition guidance.

 

Overview

 

Entegra Financial Corp. was incorporated on May 31, 2011 to be the holding company for Entegra Bank (the “Bank”) upon the completion of Macon Bancorp’s merger with and into Entegra Financial Corp., pursuant to which Macon Bancorp converted from the mutual to stock form of organization. Prior to the completion of the conversion, Entegra Financial Corp. did not engage in any significant activities other than organizational activities. On September 30, 2014, the mutual to stock conversion was completed and the Bank became the wholly owned subsidiary of Entegra Financial Corp. Also on September 30, 2014, Entegra Financial Corp. completed the initial public offering of its common stock. In this Discussion and Analysis section, terms such as “we,” “us,” “our” and the “Company” refer to Entegra Financial Corp.

 

We provide a full range of financial services through offices located in Cherokee, Henderson, Jackson, Macon, Polk, Haywood and Transylvania counties in North Carolina and Anderson, Greenville, and Spartanburg counties in South Carolina. We provide full service retail and commercial banking products as well as wealth management services through a third party.

 

We earn revenue primarily from interest on loans and securities, and fees charged for financial services provided to our customers. Offsetting these revenues are the cost of deposits and other funding sources, provisions for loan losses and other operating costs such as salaries and employee benefits, data processing, occupancy and tax expense.

 

Our results of operations are significantly affected by general economic and competitive conditions in our market areas and nationally, as well as changes in interest rates, sources of funding, government policies and actions of regulatory authorities. Future changes in applicable laws, regulations or government policies may materially affect our financial condition and results of operations.

 

Recent Events

 

On April 1, 2016, the Company completed its acquisition of Oldtown Bank (“Oldtown”) of Waynesville, North Carolina, which was merged with and into Entegra Bank. The Company will continue to operate Oldtown’s office under the Oldtown name until a system conversion is completed in August 2016.

 

Shareholders of Oldtown received a cash payment equal to $11.05 in exchange for each share of Oldtown common stock held immediately prior to the effective time of the merger. The aggregate merger consideration paid by the Company was approximately $13.5 million, which included a $0.7 million payment for the cash-out of in-the-money stock options. The Company did not issue any shares of its common stock in connection with the merger.

 

The acquisition added approximately $97.9 million to the Company’s assets, including $64.6 million of loans and $88.7 million of deposits.

41

 

Strategic Plan

 

We continue to execute on our Board of Director approved strategic plan which involves the following key components:

 

Positioning the Company for long-term independence by building a franchise that will provide above average shareholder returns;
Seeking acquisition opportunities that have reasonable earn-back periods and are accretive to return on equity while minimizing book value dilution;
Building long term franchise value by diversifying into high growth markets with geographic contiguity to our current markets;
Maximizing our capital leverage through organic and acquired asset growth; and
Rational use of share repurchases to supplement shareholder returns and return excess capital to shareholders, but not at the expense of building long-term value.

 

The following discussion and analysis is presented on a consolidated basis and focuses on the major components of the Company’s operations and significant changes in its results of operations for the periods presented. We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information included in this report and in our Annual Report on Form 10-K.

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Earnings Summary

 

Net income for the three months ended March 31, 2016 was $1.4 million compared to $2.6 million for the same period in 2015. The decrease in net income for the quarter was primarily the result of a negative provision of $1.5 million during the 2015 period and increases in noninterest expense of $0.7 million and income tax expense of $0.7 million during the 2016 period. These changes were partially offset by a $1.3 million increase in net interest income and an increase of $0.3 million in noninterest income during the 2016 period.

 

Net interest income increased $1.3 million, or 20.4%, to $7.6 million for the three months ended March 31, 2016 compared to the same period in 2015. The increase in net interest income for the period was primarily the result of increases in interest and fee income on loans of $0.7 million and interest on taxable securities of $0.2 million along with a decrease in interest expense on deposits of $0.2 million.

 

Due to continued improvement in asset quality and significantly reduced charge-off amounts, no provision for loan losses was needed during the three months ended March 31, 2016 and a negative provision for loan losses of $1.5 million was recognized for the three months ended March 31, 2015.

 

Non-GAAP Financial Measures

 

Statements included in this Management’s Discussion and Analysis include non-GAAP financial measures and should be read along with the accompanying tables, which provide a reconciliation of non-GAAP financial measures to GAAP financial measures. This Management’s Discussion and Analysis and the accompanying tables discuss financial measures, such core net interest income, core noninterest expense, and core net income, which are non-GAAP measures. We believe that such non-GAAP measures are useful because they enhance the ability of investors and management to evaluate and compare the Company’s operating results from period to period in a meaningful manner. Non-GAAP measures should not be considered as an alternative to any measure of performance as promulgated under GAAP. Investors should consider the Company’s performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the company. Non-GAAP measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of the Company’s results or financial condition as reported under GAAP.

43

 

We analyze our net interest income, noninterest expense, and net income on a non-GAAP basis in order to exclude non-recurring items as detailed in the table below:

 

   Three Months Ended March 31, 
   2016   2015 
   (Dollars in thousands) 
         
Core Noninterest Expense          
Noninterest expense (GAAP)  $7,279   $6,576 
Merger-related expenses   (145)    
Core noninterest expense (Non-GAAP)  $7,134   $6,576 
           
Core Net Income          
Net income (GAAP)  $1,366   $2,615 
Negative provision for loan losses       (1,500)
Merger-related expenses   145     
Adjust actual income tax expense to 35% estimated effective tax rate (1)       (273)
Core net income (Non-GAAP)  $1,511   $842 
           
Core Earnings Per Share          
Earnings per share (GAAP)  $0.21   $0.40 
Negative provision for loan losses       (0.23)
Merger-related expenses   0.02     
Adjust actual income tax expense to 35% estimated effective tax rate (1)       (0.04)
Core earnings per share (Non-GAAP)  $0.23   $0.13 
           
Core Return on Average Assets          
Return on Average Assets (GAAP)   0.53%   1.18%
Negative provision for loan losses       -0.67%
Merger-related expenses   0.06%    
Adjust actual income tax expense to 35% estimated effective tax rate (1)       -0.12%
Core Return on Average Assets (Non-GAAP)   0.58%   0.39%
           
Core Return on Average Equity          
Return on Average Equity (GAAP)   4.10%   9.69%
Negative provision for loan losses       -5.44%
Merger-related expenses   0.44%    
Adjust actual income tax expense to 35% estimated effective tax rate (1)       -0.99%
Core Return on Average Equity (Non-GAAP)   4.53%   3.26%
           
Core Efficiency Ratio          
Efficiency ratio (GAAP)   76.63%   83.55%
Merger-related expenses   -1.53%    
Core Efficiency Ratio (Non-GAAP)   75.10%   83.55%
     
   As Of 
   March 31, 2016   December 31, 2015 
   (Dollars in thousands, except share data) 
Tangible Book Value Per Share        
Book Value (GAAP)  $134,238   $131,469 
Goodwill and intangibles   (1,280)   (1,301)
Book Value (Tangible)   132,958    130,168 
Outstanding shares   6,472,372    6,546,375 
Tangible Book Value Per Share  $20.54   $19.88 

 

(1) - The Company maintained a valuation allowance on a portion of its net deferred tax asset during a portion of 2015 and therefore did not recognize a normal income tax provision. Core results have been adjusted to reflect income tax expense to an estimated 35% effective tax rate after the other adjustments have been applied.

 

Financial Condition At March 31, 2016 and December 31, 2015

 

Total assets increased $23.6 million, or 2.3%, to $1.06 billion at March 31, 2016 from $1.03 billion at December 31, 2015. This increase in assets was comprised primarily of loans, which increased $8.8 million, or 1.4%, and investment securities, which increased $14.2 million, or 5.0%. The increases in loans and investments were funded by deposits which increased $4.1 million, or 0.6%, and FHLB advances which increased $10.0 million.

44

 

Total liabilities increased $20.9 million, or 2.3%, to $920.8 million at March 31, 2016 from $899.9 million at December 31, 2015, due primarily to the $4.1 million increase in deposits and $10.0 million increase in FHLB advances.

 

Total equity increased $2.8 million, or 2.1%, to $134.2 million at March 31, 2016 from $131.5 million at December 31, 2015. This increase was the result of $1.4 million of net income for the period and a $2.5 million improvement in net unrealized holding gains and losses on securities available for sale.

 

Cash and Cash Equivalents

 

Total cash and cash equivalents increased $5.3 million, or 12.9%, to $45.9 million at March 31, 2016 from $40.7 million at December 31, 2015 as a result of general fluctuations in our cash balances.

 

Investment Securities

 

During the fourth quarter of 2015, the Company funded a trading account which is held in a Rabbi trust to generate returns that seek to offset changes in liabilities related to the market risk of certain deferred compensation agreements.

 

The following table presents the holdings of our trading account as of March 31, 2016 and December 31, 2015:

 

   March 31, 2016   December 31, 2015 
   (Dollars in thousands) 
         
Cash  $   $4,714 
Mutual funds   4,841     
   $4,841   $4,714 

 

The remainder of our investment securities portfolio is classified as both “available-for-sale” and “held-to-maturity”. Available-for-sale securities are carried at fair value. The following table shows the amortized cost and fair value for our available for sale investment portfolio at the dates indicated.

 

   At March 31,   At December 31, 
   2016   2015 
   Amortized Cost   Fair value   Amortized Cost   Fair value 
   (Dollars in thousands) 
Investment securities available-for-sale:                    
U.S. Government and agency securities:                    
U.S. Government and agency obligations  $18,027   $18,258   $25,633   $25,720 
U.S. Treasury Notes & Bonds   1,500    1,546    1,500    1,510 
Municipal obligations   61,924    62,920    39,751    39,858 
Mortgage-backed securities:                    
U.S. Government agency   107,932    108,749    112,857    112,010 
SBA securities   52,399    52,527    47,768    47,582 
Collateralized mortgage obligations   15,426    15,437    11,702    11,582 
Mutual funds   606    612    602    600 
                     
Total securities available-for-sale  $257,814   $260,049   $239,813   $238,862 

 

Available-for-sale investment securities increased $21.2 million, or 8.9%, to $260.0 million at March 31, 2016 from $238.9 million at December 31, 2015. We continue to grow our investment portfolio as we seek to better leverage our capital.

 

Held to maturity investment securities are carried at amortized cost. The following table shows the amortized cost and fair value for our held-to-maturity investment portfolio as of the most recent quarter and year end.

45

 

   At March 31,   At December 31, 
   2016   2015 
   Amortized Cost   Fair value   Amortized Cost   Fair value 
   (Dollars in thousands) 
Investment securities held-to-maturity:                    
U.S. Government and agency securities:                    
U.S. Government and agency obligations  $1,047   $1,051   $5,729   $5,706 
U.S. Government structured agency obligations   4,582    4,990    10,148    10,793 
U.S. Treasury Notes & Bonds   1,001    1,004    1,002    995 
Municipal tax exempt   7,906    8,163    7,641    7,825 
Municipal taxable   4,761    4,794    4,787    4,709 
Collateralized mortgage obligations   4,709    4,724    4,834    4,776 
Corporate debt securities   10,029    10,006    7,023    7,008 
                     
Total securities held-to-maturity  $34,035   $34,732   $41,164   $41,812 

 

Held-to-maturity investment securities decreased $7.1 million, or 17.3%, to $34.0 million at March 31, 2016 from $41.8 million at December 31, 2015 as a result of several structured agency securities being called during the quarter.

 

In prior years, the Company reclassified certain municipal securities from available-for-sale to held-to-maturity. The reclassifications will remain in effect until the investments are called or mature. The difference between the book values and fair values at the date of the transfer will continue to be reported in a separate component of accumulated other comprehensive income (loss), and will be amortized into income over the remaining life of the securities as an adjustment of yield in a manner consistent with the amortization of a premium. Concurrently, the revised book values of the transferred securities (represented by the market value on the date of transfer) are being amortized back to their par values over the remaining life of the securities as an adjustment of yield in a manner consistent with the amortization of a discount.

 

Loans

 

The following table presents our loan portfolio composition and the corresponding percentage of total loans as of the dates indicated. Other construction and land loans include residential acquisition and development loans, commercial undeveloped land and one- to four-family improved and unimproved lots. Commercial real estate includes non-residential owner occupied and non-owner occupied real estate, multi-family, and owner-occupied investment property. Commercial business loans include unsecured commercial loans and commercial loans secured by business assets.

46

 

   At March 31,   At December 31, 
   2016   2015 
   Amount   Percent   Amount   Percent 
   (Dollars in thousands) 
Real estate loans:                    
One- to four-family residential  $251,214    39.6%  $248,633    39.7%
Commercial   224,495    35.3    214,413    34.2 
Home equity loans and lines of credit   51,240    8.1    53,446    8.5 
Residential construction   7,708    1.2    7,848    1.3 
Other construction and land   52,701    8.3    57,316    9.1 
Commercial   43,496    6.8    41,046    6.6 
Consumer   4,128    0.7    3,639    0.6 
Total loans, gross  $634,982    100.0%  $626,341    100.0%
                     
Less:                    
Deferred loan fees, net   (1,238)        (1,388)     
Unamortized premium   512         557      
Unamortized discount   (1,361)        (1,438)     
                     
Total loans, net  $632,895        $624,072      
                     
Percentage of total assets   60.0%        60.5%     

 

Net loans increased $8.8 million, or 1.4%, to $632.9 million at March 31, 2016 from $624.1 million at December 31, 2015. During 2016, we have continued to experience an improvement in loan demand and we maintain a strong pipeline going into the second quarter. We believe that economic conditions in our primary market areas are strong and present opportunities for continued growth. The amount of commercial real estate and commercial loans as a percentage of total loans continues to increase as we continue to shift our lending focus to these loan types as we develop stronger commercial relationships in all of our markets.

 

Included in loans receivable and other borrowings at March 31, 2016 are $2.5 million in participated loans that did not qualify for sale accounting. Interest expense on the other borrowings accrues at the same rate as the interest income recognized on the loans receivable, resulting in no effect to net income.

 

Delinquent Loans

 

When a loan becomes 15 days past due, we contact the borrower to inquire as to why the loan is past due. When a loan becomes 30 days or more past due, we increase collection efforts to include all available forms of communication. Once a loan becomes 45 days past due, we generally issue a demand letter and further explore the reasons for non-repayment, discuss repayment options, and inspect the collateral. In the event the loan officer or collections staff has reason to believe restructuring will be mutually beneficial to the borrower and the Bank, the borrower will be referred to the Bank’s Credit Administration staff to explore restructuring alternatives to foreclosure. Once the demand period has expired and it has been determined that restructuring is not a viable option, the Bank’s counsel is instructed to pursue foreclosure.

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The accrual of interest on loans is discontinued at the time a loan becomes 90 days delinquent or when it becomes impaired, whichever occurs first, unless the loan is well secured and in the process of collection. All interest accrued but not collected for loans that are placed on nonaccrual is reversed. Interest payments received on nonaccrual loans are generally applied as a direct reduction to the principal outstanding until the loan is returned to accrual status. Interest payments received on nonaccrual loans may be recognized as income on a cash basis if recovery of the remaining principal is reasonably assured. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Interest payments applied to principal while the loan was on nonaccrual may be recognized in income over the remaining life of the loan after the loan is returned to accrual status.

 

If a loan is modified in a TDR, the loan is generally placed on non-accrual until there is a period of satisfactory payment performance by the borrower (either immediately before or after the restructuring), generally six consecutive months, and the ultimate collectability of all amounts contractually due is not in doubt.

 

The following table sets forth certain information with respect to our loan portfolio delinquencies at the dates indicated. We have no loans past due 90 days and over that are still accruing interest as of March 31, 2016 or December 31, 2015.

 

   Delinquent loans 
   30-59 Days   60-89 Days   90 Days and over   Total 
   (Dollars in thousands) 
At March 31, 2016                
Real estate loans:                    
One- to four-family residential  $3,166   $1,272   $1,178   $5,616 
Commercial   2,232    1,027    2,300    5,559 
Home equity loans and lines of credit   671    134    216    1,021 
Residential construction                
Other construction and land   528    25    227    780 
Commercial           10    10 
Consumer   15    1        16 
Total loans  $6,612   $2,459   $3,931   $13,002 
% of total loans, net   1.06%   0.39%   0.63%   2.08%
                     
At December 31, 2015                    
Real estate loans:                    
One- to four-family residential  $5,610   $1,260   $1,205   $8,075 
Commercial   1,585        605    2,190 
Home equity loans and lines of credit   369    38    322    729 
One- to four-family residential construction                
Other construction and land   208    397    138    743 
Commercial   625            625 
Consumer   12    4        16 
Total loans  $8,409   $1,699   $2,270   $12,378 
% of total loans, net   1.37%   0.27%   0.37%   2.01%

 

Delinquent loans increased $0.6 million, or 5.0%, to $13.0 million at March 31, 2016 from $12.4 million at December 31, 2015. Despite the current quarter increase, our level of delinquent loans has improved significantly in recent periods and remains fairly low.

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Non-Performing Assets

 

Non-performing loans include all loans past due 90 days and over, certain impaired loans (some of which may be contractually current), and TDR loans that have not yet established a satisfactory period of payment performance (some of which may be contractually current). Non-performing assets include non-performing loans and REO. The table below sets forth the amounts and categories of our non-performing assets at the dates indicated.

 

   March 31,   December 31, 
   2016   2015 
   (Dollars in thousands) 
Non-accrual loans:          
Real estate loans:          
One- to four-family residential  $2,983   $2,893 
Commercial   5,253    3,628 
Home equity loans and lines of credit   214    320 
Residential construction        
Other construction and land   470    384 
Commercial   62    55 
Consumer        
           
Total non-performing loans   8,982    7,280 
           
REO:          
One- to four-family residential   1,795    1,384 
Commercial real estate   1,097    1,123 
Residential construction        
Other construction and land   2,538    2,862 
           
Total foreclosed real estate   5,430    5,369 
           
Total non-performing assets  $14,412   $12,649 
           
Troubled debt restructurings still accruing  $10,565   $11,206 
           
Ratios:          
Non-performing loans to total loans   1.42%   1.17%
Non-performing assets to total assets   1.37%   1.23%

 

Non-performing loans increased $1.7 million, or 23.4%, to $9.0 million at March 31, 2016 from $7.3 million at December 31, 2015. The increase in non-performing loans was primarily attributable due to the addition of a single $1.7 million hospitality loan, for which no loss is expected.

 

Real estate owned remained unchanged at $5.4 million at March 31, 2016 compared to December 31, 2015.

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Classification of Loans

 

The following table sets forth amounts of classified and criticized loans at the dates indicated. As indicated in the table, loans classified as “doubtful” or “loss” are charged off immediately.

 

   At March 31,   At December 31, 
   2016   2015 
   (Dollars in thousands) 
           
Classified loans:          
Substandard  $20,694   $19,196 
Doubtful        
Loss        
           
Total classified loans:   20,694    19,196 
As a % of total loans, net   3.27%   3.08%
           
Special mention   20,790    19,195 
           
Total criticized loans  $41,484   $38,391 
As a % of total loans, net   6.55%   6.15%

 

Total classified loans increased $1.5 million, or 7.8%, to $20.7 million at March 31, 2016 from $19.2 million at December 31, 2015. Total criticized loans increased $3.1 million, or 8.1%, to $41.5 million at March 31, 2016 from $38.4 million at December 31, 2015. As mentioned above, these increases were primarily attributable due to the addition of a single $1.7 million hospitality loan, for which no loss is expected. Management continues to dedicate significant resources to monitoring and resolving classified and criticized loans.

 

Allowance for Loan Losses

 

The allowance for loan losses reflects our estimates of probable losses inherent in our loan portfolio at the balance sheet date. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of our loans in light of historical experience, the nature and volume of our loan portfolio, adverse situations that may affect our borrowers’ abilities to repay, the estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The methodology for determining the allowance for loan losses has two main components: the evaluation of individual loans for impairment and the evaluation of certain groups of homogeneous loans with similar risk characteristics.

 

A loan is considered impaired when it is probable that we will be unable to collect all principal and interest payments due according to the original contractual terms of the loan. We individually evaluate loans classified as “substandard” or nonaccrual and greater than $350,000 for impairment. If the impaired loan is considered collateral dependent, a charge-off is taken based upon the appraised value of the property (less an estimate of selling costs if foreclosure or sale of the property is anticipated). If the impaired loan is not collateral dependent, a specific reserve is established based upon an estimate of the future discounted cash flows after consideration of modifications and the likelihood of future default and prepayment.

 

The allowance for homogenous loans consists of a base loss reserve and a qualitative reserve. The base loss reserve utilizes an average loss rate for the last 16 quarters. Prior to the first quarter of 2015, we more heavily weighted the most recent four quarters than the least recent four quarters. Beginning in the first quarter of 2015, we no longer weight any quarters to calculate our average loss rates. This change in weighting did not have a material impact on our allowance for loan losses methodology. The loss rates for the base loss reserve are segmented into 13 loan categories and contain loss rates ranging from approximately 0.5% to 11%.

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The qualitative reserve adjusts the weighted average loss rates utilized in the base loss reserve for trends in the following internal and external factors:

 

    Non-accrual and classified loans
    Collateral values
    Loan concentrations
    Economic conditions – including unemployment rates, building permits, and a regional economic index.

 

Qualitative reserve adjustment factors are decreased for favorable trends and increased for unfavorable trends. These factors are subject to further adjustment as economic and other conditions change.

 

The following table sets forth activity in our allowance for loan losses at the dates and for the periods indicated.

 

   As of or for the Three Months Ended March 31, 
   2016   2015 
   ( Dollars in thousands) 
Balance at beginning of period  $9,461   $11,072 
           
Charge-offs:          
Real Estate:          
One- to four-family residential   46    219 
Commercial       30 
Home equity loans and lines of credit   37    109 
Residential construction        
Other construction and land   317    19 
Commercial        
Consumer   10    13 
Total charge-offs   410    390 
           
Recoveries:          
Real Estate:          
One- to four-family residential   23    109 
Commercial       92 
Home equity loans and lines of credit   113    23 
Residential construction        
Other construction and land   77    119 
Commercial   118    7 
Consumer   116    79 
Total recoveries   447    429 
           
Net charge-offs (recoveries)   (37)   (39)
           
Provision for loan losses       (1,500)
           
Balance at end of period  $9,498   $9,611 
           
Ratios:          
Net charge-offs to average loans outstanding   (0.02)%   (0.03)%
Allowance to non-performing loans at period end   105.74%   73.31%
Allowance to total loans at period end   1.50%   1.75%

 

We have continued to experience limited charge-off amounts and stable collections of amounts previously charged-off. The overall historical loss rate used in our allowance for loan losses calculation continues to decline as previous quarters with larger loss rates are eliminated from the calculation as time passes. Our coverage ratio of non-performing loans remained strong at 105.74% at March 31, 2016 compared to 73.31% at March 31, 2015 and 129.96% at December 31, 2015.

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Real Estate Owned (REO)

 

The table below summarizes the balances and activity in REO at the dates and for the periods indicated.

 

   March 31,   December 31, 
   2016   2015 
   (Dollars in thousands) 
           
One- to four-family residential  $1,795   $1,384 
Commercial real estate   1,097    1,123 
Residential construction        
Other construction and land   2,538    2,862 
Total  $5,430   $5,369 

 

   Three Months Ended March 31, 
   2016   2015 
   (Dollars in thousands) 
Balance, beginning of period  $5,369   $4,425 
Additions   508    1,317 
Disposals   (105)   (757)
Writedowns   (342)   (68)
Balance, end of period  $5,430   $4,917 

 

Real estate owned remained unchanged at $5.4 million at March 31, 2016 compared to December 31, 2015. Most of the transfers to real estate owned during the quarter were 1-4 family residential properties which are normally sold at a faster pace than other property types. We have experienced a significant decrease in the number and dollar amount of additions to REO, and have had moderate success in liquidating REO. Our policy continues to be to aggressively market REO for sale, including recording write-downs when necessary.

 

Net Deferred Tax Assets

 

Deferred income tax assets and liabilities are determined using the asset and liability method and are reported net in the Consolidated Balance Sheets. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax basis of assets and liabilities and recognizes enacted changes in tax rate and laws. When deferred tax assets are recognized, they are subject to a valuation allowance based on management’s judgment as to whether realization is more likely than not. In determining the need for a valuation allowance, we considered the following sources of taxable income:

 

Future reversals of existing taxable temporary differences;
Future taxable income exclusive of reversing temporary differences and carry forwards;
Taxable income in prior carryback years; and
Tax planning strategies that would, if necessary, be implemented.

 

Net deferred tax assets decreased $2.0 million, or 10.6%, to $16.8 million at March 31, 2016 compared to $18.8 million at December 31, 2015. The decrease in net deferred tax assets is mainly attributable to reductions in our federal and state net operating losses and improvement in the net unrealized holding gains/losses on our investment securities.

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Deposits

 

The following table presents deposits by category and percentage of total deposits as of the dates indicated.

 

   As of   As of 
   March 31, 2016   December 31, 2015 
   Balance   Percent   Balance   Percent 
   (Dollars in thousands) 
Deposit type:                    
Savings accounts  $35,915    5.0%  $35,838    5.0%
Time depsosits   267,420    37.1    276,142    38.5 
Money market accounts   193,775    26.9    180,377    25.2 
Interest-bearing demand accounts   105,374    14.6    103,198    14.4 
Noninterest-bearing demand accounts   118,228    16.4    121,062    16.9 
                     
Total deposits  $720,712    100.0%  $716,617    100.0%

 

Total deposits increased $4.1 million, or 0.6%, to $720.7 million at March 31, 2016 from $716.6 million at December 31, 2015. We continue our efforts to reduce our reliance on time deposits and expand our core deposit relationships which is evidenced by the decrease in time deposits as a percentage of total deposits to 37.1% at March 31, 2016 from 38.5% at December 31, 2015.

 

FHLB Advances

 

FHLB advances increased $10.0 million to $163.5 million at March 31, 2016 compared to $153.5 million at December 31, 2015. The additional funds were used to invest in loans and investment securities and to provide funding for future cash needs. The advances had a weighted average rate of 0.75% as of March 31, 2016 compared to 0.65% at December 31, 2015.

 

Junior Subordinated Notes

 

We had $14.4 million in junior subordinated notes outstanding at March 31, 2016 and December 31, 2015 payable to an unconsolidated subsidiary. These notes accrue interest at 2.80% above the 90-day LIBOR, adjusted quarterly. The effective interest rate was 3.43% and 3.34% at March 31, 2016 and December 31, 2015, respectively.

 

Equity

 

Total equity increased $2.8 million, or 2.1%, to $134.2 million at March 31, 2016 from $131.5 million at December 31, 2015. This increase was the result of $1.4 million of net income for the period, and a $2.5 million improvement in net unrealized holding gains and losses on securities available for sale, which were partially offset by $1.3 million in repurchases of common stock.

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Comparison of Operating Results for the Three Months Ended March 31, 2016 and March 31, 2015.

 

General. Net income for the three months ended March 31, 2016 was $1.4 million compared to $2.6 million for the same period in 2015. The decrease in net income for the quarter was primarily the result of a negative provision of $1.5 million during the 2015 period and increases in noninterest expense of $0.7 million and income tax expense of $0.7 million during the 2016 period. These changes were partially offset by a $1.3 million increase in net interest income and an increase of $0.3 million in noninterest income during the 2016 period.

 

Net Interest Income. Net interest income increased $1.3 million, or 20.4%, to $7.6 million for the three months ended March 31, 2016 compared to the same period in 2015. The increase in net interest income for the period was primarily the result of increases in interest and fee income on loans of $0.7 million and interest on taxable securities of $0.2 million along with a decrease in interest expense on deposits of $0.2 million.

 

The tax-equivalent net interest margin increased to 3.22% for the quarter ended March 31, 2016 compared to 3.04% for the same period in 2015. The increase in margin was primarily the result of increased yields on taxable investments and decreased rates on deposits and FHLB advances.

 

The following table sets forth the average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets on a tax-equivalent basis, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average tax-equivalent yields and cost for the periods indicated. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.

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   For the Three Months Ended March 31, 
   2016   2015 
  

Average

Outstanding

Balance

   Interest   Yield/ Rate  

Average

Outstanding

Balance

   Interest   Yield/ Rate 
   (Dollars in thousands) 
Interest-earning assets:                              
Loans, including loans held for sale  $633,048   $7,206    4.57%  $549,862   $6,470    4.72%
Loans, tax exempt (1)   6,543    68    4.18%   3,230    39    4.89%
Investments - taxable   260,619    1,458    2.24%   245,274    1,236    2.02%
Investment tax exempt (1)   17,713    217    4.91%   6,605    106    6.44%
Interest earning deposits   33,468    36    0.43%   42,164    24    0.23%
Other investments, at cost   8,951    105    4.71%   4,906    58    4.74%
                               
Total interest-earning assets   960,342    9,090    3.80%   852,041    7,933    3.78%
                               
Noninterest-earning assets   75,923              48,700           
                               
Total assets  $1,036,265             $900,741           
                               
Interest-bearing liabilities:                              
Savings accounts  $35,619   $10    0.11%  $27,952   $8    0.11%
Time deposits   272,753    757    1.11%   318,553    1,011    1.27%
Money market accounts   189,334    148    0.31%   177,939    154    0.35%
Interest bearing transaction accounts   102,706    27    0.11%   90,612    36    0.16%
Total interest bearing deposits   600,412    942    0.63%   615,056    1,209    0.79%
                               
FHLB advances   156,247    275    0.71%   60,161    205    1.37%
Junior subordinated debentures   14,433    126    3.50%   14,433    112    3.11%
Other borrowings   2,218    26    4.70%   1,801    26    5.79%
                               
Total interest-bearing liabilities   773,310    1,369    0.71%   691,451    1,552    0.91%
                               
Noninterest-bearing deposits   116,440              86,031           
                               
Other non interest bearing liabilities   13,225              13,792           
                               
Total liabilities   902,975              791,274           
Total equity   133,290              109,467           
                               
Total liabilities and equity  $1,036,265             $900,741           
                               
Tax-equivalent net interest income       $7,721             $6,381      
                               
Net interest-earning assets (2)  $187,032             $160,590           
                               
Average interest-earning assets to interest-bearing liabilities   1.24              1.23           
                               
Tax-equivalent net interest rate spread (3)             3.09%             2.87%
Tax-equivalent net interest margin (4)             3.22%             3.04%

 

(1)Tax exempt loans and investments are calculated giving effect to a 34% federal tax rate.
(2)Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.
(3)Tax-equivalent net interest rate spread represents the difference between the tax equivalent yield on average interest-earning assets and the cost of average interest-bearing liabilities.
(4)Tax-equivalent net interest margin represents tax equivalent net interest income divided by average total interest-earning assets.

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The following table presents the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to change in volume (changes in volume multiplied by prior rate). The total column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, based on changes due to rate and the changes due to volume.

 

  

For the Three Months Ended March 31, 2016 Compared to the
Three Months Ended March 31, 2015

 
             
   Volume   Rate   Total 
   (Dollars in thousands) 
Interest-earning assets:               
Loans, including loans held for sale (1)  $1,012   $(276)  $736 
Loans, tax exempt (2)   35    (7)   28 
Investment - taxable   87    136    223 
Investments - tax exempt (2)   142    (32)   110 
Interest-earning deposits   (6)   18    12 
Other investments, at cost   48    (1)   47 
                
Total interest-earning assets   1,318    (162)   1,157 
                
Interest-bearing liabilities:               
Savings accounts  $2   $   $2 
Time deposits   (131)   (123)   (254)
Money market accounts   10    (16)   (6)
Interest bearing transaction accounts   4    (14)   (10)
FHLB advances   209    (139)   70 
Junior subordinated debentures       14    14 
Other borrowings            
                
Total interest-bearing liabilities   94    (278)   (183)
                
Change in tax-equivalent net interest income  $1,224   $116   $1,340 

 

(1)Non-accrual loans are included in the above analysis.
(2)Interest income on tax exempt loans and investments are adjusted for based on a 35% federal tax rate.

 

Net interest income before provision for loan losses increased to $7.6 million for the three months ended March 31, 2016, compared to $6.3 million for the same period in 2015. As indicated in the table above, an increase in net interest income of $1.2 million attributable to an improvement in volume was supplemented by a $0.1 million improvement in net interest earned attributable to a reduction in rates.

 

The increase in tax-equivalent net interest income of $1.2 million related to volume was primarily the result of higher average loan and taxable investment balances which increased $86.5 million and $15.3 million, respectively, for the three months ended March 31, 2016 as compared to the same period in 2015. The increase in average loan and investment balances was partially offset by higher average FHLB advance balances which increased $96.1 million over the same periods.

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The increase in tax-equivalent net interest income of $0.1 million related to rate was primarily the result of decreased deposit and FHLB advance rates partially offset by decreased loan yields. The decrease in average loan yields was mostly offset by the impact of lower average interest bearing deposit yields which decreased 16 basis points to 0.63% in the quarter ended March 31, 2016 as compared to 0.79% in the three months ending March 31, 2015. In addition, a reduction in average rates on FHLB advances from 1.37% during the three months ended March 31, 2015 to 0.71% for the three months ended March 31, 2016 also contributed to the increase in this component of net interest income.

 

Our tax-equivalent net interest rate spread increased by 22 basis points to 3.09% for the three months ended March 31, 2016 compared to 2.87% for the three months ended March 31, 2015, and our tax-equivalent net interest margin increased 18 basis points to 3.22% for the three months ended March 31, 2016, compared to 3.04% for the three months ended March 31, 2015. The increases in our interest rate spread and margin were primarily a result of decreased rates on deposits and FHLB advances.

 

Provision for Loan Losses. For the three months ended March 31, 2016, we did not record a provision for loan losses compared to a negative provision of $1.5 million for the same period in the prior year. Factors contributing to no recorded provision for loan losses were the continued stabilization in asset quality, significantly reduced charge-off amounts, and a continued decline in the overall loss rates used in our allowance for loan losses model.

 

Noninterest Income. The following table summarizes the components of noninterest income and the corresponding change between the three month periods ended March 31, 2016 and 2015:

 

   Three Months Ended March 31, 
   2016   2015   Change 
   (Dollars in thousands) 
Servicing income, net  $116   $86   $30 
Mortgage banking   140    255    (115)
Gain on sale of SBA loans   334    211    123 
Gain on sale of investments, net   269    164    105 
Service charges on deposit accounts   394    298    96 
Interchange fees   342    278    64 
Bank owned life insurance   107    129    (22)
Other   173    118    55 
                
Total  $1,875   $1,539   $336 

 

The $0.1 million decrease in mortgage banking income is primarily due to decreased volume and changes in the valuation of mortgage banking derivatives compared to the prior year.

 

Gains on sales of SBA loans increased $0.1 million as a result of a larger balance of SBA loans being sold during the 2016 period as we continue to increase our SBA lending efforts.

 

Net gains on sales of investments increased $0.1 million for the three months ended March 31, 2016 compared to the three months ended March 31, 2015 due to increased sales of securities.

 

Service charges on deposit accounts and interchange fees both increased $0.1 million as a result of increased core deposit accounts and the acquisition of approximately $39.9 million in deposits from Arthur State Bank that occurred during December 2015.

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Noninterest Expense. The following table summarizes the components of noninterest expense and the corresponding change between the three months ended March 31, 2016 and 2015:

 

   Three Months Ended March 31, 
   2016   2015   Change 
   (Dollars in thousands) 
             
Compensation and employee benefits  $4,010   $3,697   $313 
Net occupancy   817    702    115 
Federal deposit insurance   176    284    (108)
Professional and advisory   212    250    (38)
Data processing   351    280    71 
Merger-related expenses   145        145 
Net cost of operation of real estate owned   286    216    70 
Other   1,282    1,147    135 
                
Total noninterest expenses  $7,279   $6,576   $703 

 

Compensation and employee benefits increased by $0.3 million, or 8.5%, for the three months ended March 31, 2016 compared to the three months ended March 31, 2015. This additional expense is related to increases in our number of employees, annual raises, employee benefits, incentives and commissions. The 2016 period includes the addition of three branches in South Carolina that were added after the first quarter of 2015.

 

Merger-related expenses were $0.1 million for the three months ended March 31, 2016 compared to none during the 2015 period. The expenses during the period related to both the acquisition of two branches in December 2015 and the whole bank acquisition of Oldtown which closed on April 1, 2016.

 

The net cost of operation of real estate owned increased $0.1 million, or 32.4%, for the three months ended March 31, 2016 compared to the three months ended March 31, 2015. The increase primarily relates to the write-down and disposal of one property that had been held for an extended period of time.

 

Income Taxes. We recorded $0.9 million of income tax expense for the three months ended March 31, 2016, primarily reflecting deferred tax expense. Our effective tax rate of 38.5% for the three months ended March 31, 2016 was unusually high as a result of the reduction of $0.2 million of the valuation allowance related to net deferred tax assets on investment securities that remains in accumulated other comprehensive income. Exclusive of this write-off, our effective tax rate would have been approximately 34.7%. We remain focused on reducing our effective tax rate through further investments in tax-free municipal securities, BOLI and affordable housing tax credits.

 

We continue to be in a net operating loss position for federal and state income tax purposes and do not have a material current tax liability or receivable.

 

Liquidity and Capital Resources

 

Liquidity is the ability to meet current and future financial obligations. Our primary sources of funds consist of deposit inflows, loan repayments, advances from the FHLB, proceeds from the sale of loans originated for sale, and principal repayments and the sale of available-for-sale securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. Our Asset/Liability Management Committee, under the direction of our Chief Operating Officer, is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we have enough sources of liquidity to satisfy our short- and long-term liquidity needs as of March 31, 2016.

 

We regularly monitor and adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows and borrowing maturities, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program. Excess liquid assets are invested generally in FHLB and FRB interest-earning deposits and investment securities and are also used to pay off short-term borrowings. At March 31, 2016, cash and cash equivalents totaled $45.9 million. Included in this total was $2.5 million held at FRB and $35.9 million held at the FHLB in interest-earning accounts.

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Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statements of Cash Flows included in our Consolidated Financial Statements. The following summarizes the most significant sources and uses of liquidity during the three months ended March 31, 2016 and 2015:

 

   Three Months Ended March 31, 
   2016   2015 
   (Dollars in thousands) 
Operating activities:          
Loans originated for sale  $(2,932)  $(4,703)
Proceeds from loans originated for sale   6,520    8,698 
           
Investing activities:          
Purchases of investments  $(53,998)  $(37,550)
Maturities and principal repayments of investments   15,000    12,132 
Sales of investments   34,717    13,197 
Net increase in loans   (8,795)   (216)
Purchase of loans       (13,367)
Purchases of fixed assets   (144)   (2,414)
           
Financing activities:          
Net increase (decrease) in deposits  $3,667   $(3,674)
Proceeds from FHLB advances   125,000    25,000 
Repayment of FHLB advances   (115,000)   (10,000)

 

At March 31, 2016, we had $37.7 million in outstanding commitments to originate loans. In addition to commitments to originate loans, we had $84.3 million in unused lines of credit.

 

Depending on market conditions, we may be required to pay higher rates on our deposits or other borrowings than we currently pay on certificates of deposit. Based on historical experience and current market interest rates, we anticipate that following their maturity we will retain a large portion of our retail certificates of deposit with maturities of one year or less as of March 31, 2016.

 

In addition to loans, we invest in securities that provide a source of liquidity, both through repayments and as collateral for borrowings. Our securities portfolio includes both callable securities (which allow the issuer to exercise call options) and mortgage-backed securities (which allow borrowers to prepay loans). Accordingly, a decline in interest rates would likely prompt issuers to exercise call options and borrowers to prepay higher-rate loans, producing higher than otherwise scheduled cash flows.

 

Liquidity management is both a daily and long-term function of management. If we require more funds than we are able to generate locally, we have borrowing agreements with the FHLB and the FRB discount window. The following summarizes our borrowing capacity as of March 31, 2016:

 

   Total   Used   Unused 
(Dollars in thousands)  Capacity   Capacity   Capacity 
             
FHLB  $177,503   $163,500   $14,003 
Unpledged Marketable Securities   294,084    83,294    210,790 
FRB   45,948        45,948 
   $517,535   $246,794   $270,741 

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In addition to the amounts noted in the table above, we have the ability to pledge additional loans and increase our borrowing capacity with the FHLB.

 

In July 2013, federal bank regulatory agencies issued final rules to revise their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act (“Basel III”). On January 1, 2015, the Basel III rules became effective and include transition provisions which implement certain portions of the rules through January 1, 2019.

 

The rule also includes changes in what constitutes regulatory capital, some of which are subject to a transition period. These changes include the phasing-out of certain instruments as qualifying capital. In addition, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital. Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock are required to be deducted from capital, subject to a transition period. Finally, common equity Tier 1 capital includes accumulated other comprehensive income (which includes all unrealized gains and losses on available for sale debt and equity securities), subject to a transition period and a one-time opt-out election. The Bank elected to opt-out of this provision. As such, accumulated comprehensive income is not included in the Bank’s Tier 1 capital.

 

The Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based guidelines and framework under prompt corrective action provisions include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories.

 

Beginning on January 1, 2016, the Company and its subsidiary bank must maintain a capital conservation buffer to avoid restrictions on capital distributions or discretionary bonus payments. This buffer must consist solely of Common Equity Tier 1 Capital, but the buffer applies to all three measurements (Common Equity Tier 1, Tier 1 capital and total capital) in addition to the minimum risk-based capital requirements. The capital conservation buffer required for 2016 is common equity equal to .626% of risk-weighted assets and will increase by .625% per year until reaching 2.5% beginning January 1, 2019. 

 

The tables below summarize capital ratios and related information in accordance with Basel III as measured at March 31, 2016 and pre-existing rules at December 31, 2015.

 

The following table summarizes the required and actual capital ratios of the Bank as of the dates indicated:

 

   Actual  

For Capital
Adequacy
Purposes

 

To Be Well-
Capitalized Under
Prompt Corrective
Action Provisions

(Dollars in thousands)  Amount   Ratio   Amount   Ratio  Amount   Ratio
As of March 31, 2016:                          
Tier 1 Leverage Capital  $120,296    11.74%  $40,988   >4%  $51,234   >5%
Common Equity Tier 1 Capital  $120,296    18.01%  $30,051   >4.5%  $43,408   >6.5%
Tier 1 Risk-based Capital  $120,296    18.01%  $40,069   >6%  $53,425   >8%
Total Risk-based Capital  $128,707    19.27%  $53,425   >8%  $66,781   >10%
                           
As of December 31, 2015:                          
Tier 1 Leverage Capital  $118,251    12.05%  $39,270   >4%  $49,087   >5%
Common Equity Tier 1 Capital  $118,251    18.07%  $29,443   >4.5%  $42,529   >6.5%
Tier 1 Risk-based Capital  $118,251    18.07%  $39,257   >6%  $52,343   >8%
Total Risk-based Capital  $126,524    19.34%  $52,343   >8%  $65,429   >10%

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The Company exceeded its regulatory capital ratios at March 31, 2016 and December 31, 2015, as set forth in the following table:

 

   Actual   For Capital Adequacy Purposes
(Dollars in thousands)  Amount   Ratio   Amount   Ratio
As of March 31, 2016:                  
Tier I Leverage Capital  $137,050    13.38%  $40,977   >4%
Common Equity Tier 1 Capital  $126,556    18.94%  $30,075   >4.5%
Tier I Risk-based Capital  $137,050    20.51%  $40,101   >6%
Total Risk Based Capital  $145,467    21.77%  $53,468   >8%
                   
As of December 31, 2015:                  
Tier I Leverage Capital  $136,063    13.85%  $39,291   >4%
Common Equity Tier 1 Capital  $128,007    19.55%  $29,468   >4.5%
Tier I Risk-based Capital  $136,063    20.78%  $39,291   >6%
Total Risk Based Capital  $144,343    22.04%  $52,388   >8%

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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

 

One of the most significant forms of market risk is interest rate risk because, as a financial institution, the majority of our assets and liabilities are sensitive to changes in interest rates. Interest rate fluctuations affect earnings by changing net interest income and other interest –sensitive income and expense levels. Interest rate changes affect economic value of equity (“EVE”) by changing the net present value of a bank’s future cash flows, and the cash flows themselves as rates change. Accepting this risk is a normal part of banking and can be an important source of profitability and shareholder value. However, excessive risk can threaten a bank’s earnings, capital, liquidity and solvency. Therefore, a principal part of our operations is to manage interest rate risk and limit the exposure of our net interest income to changes in market interest rates. The Board of Directors of the Bank have established an Asset/Liability Management Committee (“ALCO”), which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board. Our ALCO monitors and manages market risk through rate shock analyses, economic value of equity, or EVE, analyses and simulations in order to avoid unacceptable earnings and market value fluctuations due to changes in interest rates.

 

One of the primary ways we manage interest rate risk is by selling the majority of our long-term fixed rate mortgages into the secondary markets, and obtaining commitments to sell at locked-in interest rates prior to issuing a loan commitment. From a funding perspective, we expect to satisfy the majority of our future requirements with retail deposit growth, including checking and savings accounts, money market accounts and certificates of deposit generated within our primary markets. If our funding needs exceed our deposits, we will utilize our excess funding capacity with the FHLB and the FRB.

 

We have taken the following steps to reduce our interest rate risk:

 

increased our personal and business checking accounts and our money market accounts, which are less rate-sensitive than certificates of deposit and which provide us with a stable, low-cost source of funds;

 

limited the fixed rate period on loans within our portfolio;

 

utilized our securities portfolio for positioning based on projected interest rate environments;

 

priced certificates of deposit to encourage customers to extend to longer terms;

 

increased our level of variable-rate investments and loans;

 

utilized FHLB advances for positioning.

 

We have not conducted hedging activities, such as engaging in futures, options or swap transactions.

 

Economic Value of Equity (EVE)

 

EVE is the difference between the present value of an institution’s assets and liabilities (the institution’s EVE) that would change in the event of a range of assumed changes in market interest rates. EVE is used to monitor interest rate risk beyond the 12 month time horizon of income simulations. The simulation model uses a discounted cash flow analysis and an option-based pricing approach to measure the interest rate sensitivity of EVE. The model estimates the economic value of each type of asset, liability and off-balance sheet contract using the current interest rate yield curve with instantaneous increases or decreases of 100 to 400 basis points in 100 basis point increments. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below. Given the current relatively low level of market interest rates, an EVE calculation for an interest rate decrease of greater than 100 basis points has not been prepared.

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Certain shortcomings are inherent in the methodologies used in determining interest rate risk through changes in EVE. Modeling changes in EVE require making certain assumptions that may or may not reflect the manner in which actual yields and costs, or loan repayments and deposit decay, respond to changes in market interest rates. In this regard, the EVE information presented assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the EVE information provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.

 

Net Interest Income

 

In addition to an EVE analysis, we analyze the impact of changing rates on our net interest income. Using our balance sheet as of a given date, we analyze the repricing components of individual assets, and adjusting for changes in interest rates at 100 basis point increments, we analyze the impact on our net interest income. Changes to our net interest income are shown in the following table based on immediate changes to interest rates in 100 basis point increments.

 

The table below reflects the impact of an immediate increase in interest rates in 100 basis point increments on Pretax Net Interest Income (NII) and Economic Value of Equity (EVE).

 

   March 31, 2016  December 31, 2015
Change in Interest Rates
(basis points)
  % Change in Pretax Net
Interest Income
  % Change in Economic
Value of Equity
  % Change in Pretax
Net Interest Income
  % Change in Economic
Value of Equity
+400  4.9  (8.8)  4.9  (14.5)
+300  3.7  (7.5)  3.5  (11.6)
+200  2.4  (5.9)  2.0  (9.1)
+100  1.2  (4.0)  0.8  (5.9)
       
-100  (3.5)  7.1  (2.5)  10.7

 

The results from the rate shock analysis on NII are consistent with having a slightly asset sensitive balance sheet. Having an asset sensitive balance sheet means assets will reprice at a faster pace than liabilities during the short-term horizon. The implications of an asset sensitive balance sheet will differ depending upon the change in market rates. For example, with an asset sensitive balance sheet in a declining interest rate environment, the interest rate on assets will decrease at a faster pace than liabilities. This situation generally results in a decrease in NII and operating income. Conversely, with an asset sensitive balance sheet in a rising interest rate environment, the interest rate on assets will increase at a faster pace than liabilities. This situation generally results in an increase in NII and operating income. As indicated in the table above, a 200 basis point increase in rates would result in a 2.4% increase in NII as of March 31, 2016 as compared to a 2.0% increase in NII as of December 31, 2015, suggesting that the Company’s exposure to the benefit of rising interest rates has increased slightly since December 31, 2015. The Company generally seeks to remain neutral to the impact of changes in interest rates by maximizing current earnings while balancing the risk of changes in interest rates.

 

The results from the rate shock analysis on EVE are consistent with a balance sheet whose assets have a longer maturity than its liabilities. Like most financial institutions, we generally invest in longer maturity assets as compared to our liabilities in order to earn a higher return on our assets than we pay on our liabilities. This is because interest rates generally increase as the time to maturity increases, assuming a normal, upward sloping yield curve. In a rising interest rate environment, this results in a negative EVE because higher interest rates will reduce the present value of longer term assets more than it will reduce the present value of shorter term liabilities, resulting in a negative impact on equity. As noted in the table above, our exposure to higher interest rates from an EVE or present value perspective has decreased slightly from December 31, 2015 to March 31, 2016. For example, as indicated in the table above, a 200 basis point increase in rates would result in a 5.9% decrease in EVE as of March 31, 2016 as compared to a 9.1% decrease in EVE as of December 31, 2015.

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Item 4. CONTROLS AND PROCEDURES

 

 

Evaluation of Disclosure Controls and Procedures

 

The Company’s management, including its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of March 31, 2016. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer each concluded that as of March 31, 2016, the end of the period covered by this Quarterly Report on Form 10-Q, the Company maintained effective disclosure controls and procedures.

 

Changes in Internal Control over Financial Reporting

 

There have been no changes to the Company’s internal controls over financial reporting that occurred during the quarter ended March 31, 2016 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

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PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

We are not involved in any material pending legal proceedings. In the ordinary course of operations, we are often involved in legal proceedings. In the opinion of management, neither the Company nor the Bank is a party to, nor is their property the subject of, any material pending legal proceedings, other than ordinary routine litigation incidental to their business, nor has any such proceeding been terminated during the quarter ended March 31, 2016.

 

Item 1A. Risk Factors

 

There have been no material changes to the risk factors that we have previously disclosed in the “Risk Factors” section in our 2015 Annual Report on Form 10-K as filed with the SEC on March 15, 2016.

 

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

 

On January 28, 2016, the Company announced that the Board of Directors had authorized the repurchase of up to 327,318 shares of the Company’s common stock through January 27, 2017. The authorization represented approximately 5% of the Company’s shares outstanding as of December 31, 2015.

 

The table below sets forth information regarding the Company’s common stock repurchases during the three months ended March 3016:

 

Period  Total Number of Shares Purchased  Average Price Paid per Share  Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs  Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
January 1, 2016 to January 31, 2016   —     $—      —      —   
February 1, 2016 to February 29, 2016   40,621   $17.04    40,621    286,697 
March 1, 2016 to March 31, 2016   33,382   $17.10    33,382    253,315 
Total year-to-date    74,003   $17.07    74,003    253,315 

 

Item 3. Defaults Upon Senior Securities

 

None

 

Item 4. Mine Safety Disclosures

 

Not Applicable

 

Item 5. Other Information

 

None

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Item 6. Exhibits

 

Exhibit
No.
 Description
   
2 Plan of Conversion, incorporated by reference to Exhibit 2 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).
   
3.1 Articles of Incorporation of Entegra Financial Corp., as amended and restated, incorporated by reference to Exhibit 3.1 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).
   
3.2 Bylaws of Entegra Financial Corp., as amended and restated, incorporated by reference to Exhibit 3.2 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).
   
3.3 Articles of Amendment of Entegra Financial Corp., incorporated by reference to Exhibit 3.1 of the Current Report on Form 8-K, filed with the SEC on November 16, 2015 (SEC File No. 001-35302).
   
4 Form of Common Stock Certificate of Entegra Financial Corp., incorporated by reference to Exhibit 4 of the Registration Statement on Form S-1/A, filed with the SEC on June 27, 2014 (SEC File No. 333-194641).
   
10.1 Employment and Change of Control Agreement, dated as of October 9, 2014, by and among Entegra Financial Corp., Macon Bank, Inc., and Roger D. Plemens, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K, filed with the SEC on October 15, 2014 (SEC File No. 001-35302)*
   
10.2 Employment and Change of Control Agreement, dated as of November 1, 2014, by and among Entegra Financial Corp., Macon Bank, Inc., and Ryan M. Scaggs, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K, filed with the SEC on November 6, 2014 (SEC File No. 001-35302)*
   
10.3 Employment and Change of Control Agreement, dated as of November 1, 2014, by and among Entegra Financial Corp., Macon Bank, Inc., and David A. Bright, incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K, filed with the SEC on November 6, 2014 (SEC File No. 001-35302)*
   
10.4 Form of Macon Bank, Inc. Severance and Non-Competition Agreement between Macon Bank, Inc. and each of (i) Carolyn H. Huscusson, (ii) Bobby D. Sanders, II, (iii) Laura W. Clark, and (iv) Marcia J. Ringle, incorporated by reference to Exhibit 10.4 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).*
   
10.5 Amended and Restated Trust Agreement, regarding Trust Preferred Securities, dated as of December 30, 2003 incorporated by reference to Exhibit 10.6 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).
   
10.6 Guarantee Agreement, regarding Trust Preferred Securities, dated as of December 30, 2003 incorporated by reference to Exhibit 10.7 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).
   
10.7 Junior Subordinated Indenture, regarding Trust Preferred Securities, dated as of December 30, 2003 incorporated by reference to Exhibit 10.8 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).
   
10.8 Salary Continuation Agreement between Macon Bank, Inc. and Carolyn H. Huscusson, dated November 6, 2007, incorporated by reference to Exhibit 10.11 of the Registration Statement on Form S-1/A, filed with the SEC on May 14, 2014 (SEC File No. 333-194641).*

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10.9 Salary Continuation Agreement between Macon Bank, Inc. and Roger D. Plemens, dated June 23, 2003, incorporated by reference to Exhibit 10.12 of the Registration Statement on Form S-1/A, filed with the SEC on May 14, 2014 (SEC File No. 333-194641).*
   
10.10 Entegra Financial Corp. 2015 Long-Term Stock Incentive Plan incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K, filed with the SEC on May 21, 2015. (SEC File No. 001-35302)
   
10.11 Tax Benefits Preservation Plan, dated as of November 16, 2015, incorporated by reference to Exhibit 4.1 of the Current Report on Form 8-K, filed with the SEC on November 16, 2015 (SEC File No. 001-35302)
   
10.12 Macon Bank, Inc. Long-Term Capital Appreciation Plan, as amended and restated, dated December 15, 2004, incorporated by reference to Exhibit 10.12 of the Annual Report on Form 10-K, filed with the SEC on March 15, 2016 (SEC File No. 001-35302)
   
10.13 First Amendment to the Macon Bank, Inc. Amended and Restated Long-Term Capital Appreciation Plan, dated December 10, 2008, incorporated by reference to Exhibit 10.13 of the Annual Report on Form 10-K, filed with the SEC on March 15, 2016 (SEC File No. 001-35302)
   
10.14 Second Amendment to the Macon Bank, Inc. Amended and Restated Long-Term Capital Appreciation Plan, dated March 16, 2011, incorporated by reference to Exhibit 10.14 of the Annual Report on Form 10-K, filed with the SEC on March 15, 2016 (SEC File No. 001-35302)
   
10.15 Third Amendment to the Macon Bank, Inc. Amended and Restated Long-Term Capital Appreciation Plan, dated February 26, 2015, incorporated by reference to Exhibit 10.15 of the Annual Report on Form 10-K, filed with the SEC on March 15, 2016 (SEC File No. 001-35302)
   
31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
32 Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   
101 Financial Statements filed in XBRL format.
   
* Management contract or compensatory plan, contract or arrangement.

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Date: May 6, 2016 Entegra Financial Corp.  
       
(Registrant)      
       
  By:  /s/ David A. Bright  
    Name: David A. Bright  
    Title: Chief Financial Officer  
    (Authorized Officer)  

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EXHIBIT INDEX

 

Exhibit No.   Description
    
31.01  Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
    
31.02  Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
    
32.01  Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
    
101  Financial Statements filed in XBRL format.

69