Table Of Contents

  

---

---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 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

 

OR

 

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

 

For the transition period from                      to                     .

 

Commission file number: 001-36878

---

NATIONAL COMMERCE CORPORATION

(Exact name of registrant as specified in its charter)

---

 

Delaware	20-8627710
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
813 Shades Creek Parkway, Suite 100 Birmingham, Alabama	35209
(Address of principal executive offices)	(Zip Code)

 (205) 313-8100

(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  ☒    No  ☐

 

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

 

        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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer	☐	Accelerated filer	☒
Non-accelerated filer	☐	Smaller reporting company	☐

 

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

Yes  ☐

No   ☒

                 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

	Class of Common Stock		Outstanding at May 5, 2016
	Common stock, $0.01 par value		10,864,579 shares

 

---

---

  

NATIONAL COMMERCE CORPORATION

FORM 10-Q

INDEX

 

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited):	1
	Consolidated Balance Sheets as of March 31, 2016 and December 31, 2015	1
	Consolidated Statements of Earnings for the Three Months Ended March 31, 2016 and 2015	2
	Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2016 and 2015	3
	Consolidated Statements of Changes in Shareholders’ Equity for the Three Months Ended March 31, 2016	4
	Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2016 and 2015	5
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	39
Item 4.	Controls and Procedures	39
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	39
Item 1A.	Risk Factors	39
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	39
Item 3.	Defaults Upon Senior Securities	39
Item 4.	Mine Safety Disclosure	39
Item 5.	Other Information	39
Item 6.	Exhibits	40
	Signatures	41

  

 

 

GENERAL

 

Unless the context otherwise indicates or requires, references in this Quarterly Report on Form 10-Q to “National Commerce Corporation,” “NCC,” the “Company,” “we,” “us” and “our” refer to National Commerce Corporation and its consolidated affiliates as of March 31, 2016.

 

FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q contains forward-looking statements that reflect our current views with respect to, among other things, future events and financial performance, which involve substantial risks and uncertainties. Certain statements made in this Quarterly Report on Form 10-Q are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements include any statement that, without limitation, may predict, forecast, indicate or imply future results, performance or achievements instead of historical or current facts and may contain words like “anticipates,” “approximately,” “believes,” “budget,” “can,” “could,” “continues,” “contemplates,” “estimates,” “expects,” “forecast,” “intends,” “may,” “might,” “objective,” “outlook,” “predicts,” “probably,” “plans,” “potential,” “project,” “seeks,” “shall,” “should,” “target,” “will,” or the negative of these terms and other words, phrases, or expressions with similar meaning.

 

Any forward-looking statements contained in this Quarterly Report on Form 10-Q are based on our historical performance and on our current plans, estimates and expectations in light of information currently available to us. The inclusion of forward-looking information should not be regarded as a representation by us that the future plans, estimates or expectations will be achieved. Such forward-looking statements are subject to various risks and uncertainties and assumptions relating to our operations, financial results, financial condition, business, prospects, growth strategy and liquidity. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those projected in the forward-looking statements, and the Company cannot give assurances that such statements will prove to be correct. Except as required by law, we undertake no obligation to update any forward-looking statement, whether as a result of new information or otherwise. Given these uncertainties, the reader should not place undue reliance on forward-looking statements as a prediction of actual results. Factors that could cause actual results to differ materially from those projected or estimated by us include those that are discussed in this Quarterly Report on Form 10-Q under Part II, “Item 1A. Risk Factors” and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015 under Part I, “Item 1A. Risk Factors.”

 

 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements  

 

NATIONAL COMMERCE CORPORATION

Unaudited Consolidated Balance Sheets

(In thousands, except share and per share data)

 

		March 31, 2016				December 31, 2015
Assets
Cash and due from banks		$	15,018				27,173
Interest-bearing deposits with banks			108,835				185,284
Cash and cash equivalents			123,853				212,457
Investment securities held-to-maturity (fair value of $27,910 and $27,843 at March 31, 2016 and December 31, 2015, respectively)			27,284				27,458
Investment securities available-for-sale			55,670				53,405
Other investments			6,106				6,235
Mortgage loans held-for-sale			12,529				15,020
Loans, net of unearned income			1,383,539				1,319,414
Less: allowance for loan losses			10,927				9,842
Loans, net			1,372,612				1,309,572
Premises and equipment, net			31,897				31,432
Accrued interest receivable			3,637				3,510
Bank-owned life insurance			27,426				27,223
Other real estate			2,884				3,965
Deferred tax assets, net			13,937				14,190
Goodwill			50,715				50,686
Core deposit intangible, net			2,597				2,788
Other assets			4,793				5,428
Total assets		$	1,735,940				1,763,369
Liabilities and Shareholders’ Equity
Deposits:
Noninterest-bearing demand		$	382,642				382,946
Interest-bearing demand			222,271				202,649
Savings and money market			597,179				611,887
Time			296,105				316,976
Total deposits			1,498,197				1,514,458
Federal Home Loan Bank advances			7,000				22,000
Accrued interest payable			644				627
Other liabilities			8,999				9,648
Total liabilities			1,514,840				1,546,733
Commitments and contingencies
Shareholders’ equity:
Preferred stock, 250,000 shares authorized, no shares issued or outstanding			-				-
Common stock, $0.01 par value, 30,000,000 shares authorized, 10,861,487 and 10,824,969 shares issued and outstanding at March 31, 2016 and December 31, 2015, respectively			109				108
Additional paid-in capital			202,971				202,456
Retained earnings			9,931				6,152
Accumulated other comprehensive income			814				548
Total shareholders' equity attributable to National Commerce Corporation			213,825				209,264
Noncontrolling interest			7,275				7,372
Total shareholders' equity			221,100				216,636
Total liabilities and shareholders' equity		$	1,735,940				1,763,369

 

See accompanying notes to unaudited consolidated financial statements.

  

 

NATIONAL COMMERCE CORPORATION

Unaudited Consolidated Statements of Earnings

(In thousands, except per share data)

 

		For the Three Months Ended March 31,
		2016				2015
Interest and dividend income:
Interest and fees on loans		$	17,483				11,792
Interest and dividends on taxable investment securities			412				256
Interest on non-taxable investment securities			200				42
Interest on interest-bearing deposits and federal funds sold			218				103
Total interest income			18,313				12,193
Interest expense:
Interest on deposits			1,569				918
Interest on borrowings			81				109
Total interest expense			1,650				1,027
Net interest income			16,663				11,166
Provision for loan losses			1,533				161
Net interest income after provision for loan losses			15,130				11,005
Other income:
Service charges and fees on deposit accounts			480				267
Mortgage origination and fee income			1,392				1,271
Merchant sponsorship revenue			522				-
Income from bank-owned life insurance			204				79
Wealth management fees			13				19
Gain (loss) on other real estate			156				(13	)
Other			358				141
Total other income			3,125				1,764
Other expense:
Salaries and employee benefits			6,945				4,987
Commission-based compensation			875				796
Occupancy and equipment			1,135				836
Core deposit intangible amortization			191				111
Other			2,907				2,560
Total other expense			12,053				9,290
Earnings before income taxes			6,202				3,479
Income tax expense			2,083				1,092
Net earnings			4,119				2,387
Less: Net earnings attributable to noncontrolling interest			340				466
Net earnings attributable to National Commerce Corporation		$	3,779				1,921
Basic earnings per common share		$	0.35				0.25
Diluted earnings per common share		$	0.34				0.25

 

See accompanying notes to unaudited consolidated financial statements.

  

 

NATIONAL COMMERCE CORPORATION

Unaudited Consolidated Statements of Comprehensive Income

(In thousands)

 

		For the Three Months Ended March 31,
		2016				2015
Net earnings		$	3,779			$	1,921
Other comprehensive income, net of tax:
Unrealized gains on investment securities available-for-sale:
Unrealized gains arising during the period, net of tax of $143 and $20, respectively			266				38
Other comprehensive income			266				38
Comprehensive income		$	4,045			$	1,959

 

See accompanying notes to unaudited consolidated financial statements.

  

 

NATIONAL COMMERCE CORPORATION

Unaudited Consolidated Statements of Changes in Shareholders’ Equity

(In thousands)

 

		Common Stock				Additional Paid-in Capital				Retained Earnings				Accumulated Other Comprehensive Income				Noncontrolling Interest				Total
Balance, December 31, 2015		$	108				202,456				6,152				548				7,372				216,636
Share-based compensation expense			-				263				-				-				-				263
Net earnings attributable to National Commerce Corporation			-				-				3,779				-				-				3,779
Exercise of stock options and issuance of performance shares			1				200				-				-				-				201
Tax benefit resulting from exercise of stock options, net of adjustment			-				52				-				-				-				52
Net earnings attributable to noncontrolling interest			-				-				-				-				340				340
Distributions paid to noncontrolling interest			-				-				-				-				(437	)			(437	)
Change in unrealized gain/loss on securities available-for-sale, net of tax			-				-				-				266				-				266
Balance, March 31, 2016		$	109				202,971				9,931				814				7,275				221,100

 

See accompanying notes to unaudited consolidated financial statements.

  

 

NATIONAL COMMERCE CORPORATION

Unaudited Consolidated Statements of Cash Flows

(In thousands)

 

		For the Three Months Ended March 31,
		2016				2015
Cash flows from operating activities:
Net earnings		$	3,779				1,921
Adjustments to reconcile net earnings to net cash provided (used) by operating activities:
Provision for loan losses			1,533				161
Net earnings attributable to noncontrolling interest			340				466
Depreciation, amortization, and accretion			138				571
(Gain) loss on ineffective portion of fair value hedge derivative			(28	)			23
Change in mortgage loan derivative			(97	)			(181	)
Loss on trade or sale of premises and equipment			-				5
Share-based compensation expense			263				234
Income from bank-owned life insurance			(204	)			(79	)
(Gain) loss on other real estate			(156	)			13
Change in:
Mortgage loans held-for-sale			2,491				(4,475	)
Other assets and accrued interest receivable			784				24
Other liabilities and accrued interest payable			(998	)			(1,902	)
Net cash provided (used) by operating activities			7,845				(3,219	)
Cash flows from investing activities:
Proceeds from calls, maturities, and paydowns of securities available-for-sale and held-to-maturity			1,973				5,577
Proceeds from sale of securities available-for-sale			-				(2,500	)
Purchases of securities available-for-sale			(3,766	)			-
Purchases of securities held-to-maturity			-				(1,046	)
Proceeds from sale of other investments			693				703
Purchases of other investments			(564	)			(1,126	)
Net change in loans			(63,698	)			(33,111	)
Proceeds from sale of other real estate			1,237				10
Investment in bank-owned life insurance			-				(1,042	)
Proceeds from the sale of premises and equipment			-				49
Purchases of premises and equipment			(872	)			(332	)
Net cash used by investing activities			(64,997	)			(32,818	)
Cash flows from financing activities:
Net change in deposits			(16,216	)			29,157
Repayment of Federal Home Loan Bank advances			(15,000	)			-
Cash distribution paid to noncontrolling interests			(437	)			(539	)
Proceeds from stock offering			-				34,495
Stock offering expenses			-				(604	)
Proceeds from exercise of options and warrants			201				-
Net cash (used) provided by financing activities			(31,452	)			62,509
Net change in cash and cash equivalents			(88,604	)			26,472
Cash and cash equivalents at beginning of the period			212,457				123,435
Cash and cash equivalents at end of the period		$	123,853				149,907

 

See accompanying notes to unaudited consolidated financial statements.

  

 

NATIONAL COMMERCE CORPORATION

Unaudited Consolidated Statements of Cash Flows, continued

(In thousands)

 

		For the Three Months Ended March 31,
		2016				2015
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest		$	1,633				962
Income taxes		$	-				15
Non-cash investing and financing activities:
Change in unrealized (losses) gains on securities available-for-sale, net of tax		$	(266	)			(38	)
Transfer of loans to other real estate		$	-				694

 

See accompanying notes to unaudited consolidated financial statements.

 

 

  

NATIONAL COMMERCE CORPORATION

 

Notes to Unaudited Consolidated Financial Statements

 

(amounts in tables in thousands, except per share data)

 

 

 

Note 1 – Basis of Presentation

 

General

 

The unaudited consolidated financial statements include the accounts of National Commerce Corporation (“NCC,” and, including its subsidiaries, the “Company”) and its wholly owned subsidiaries, National Bank of Commerce (“NBC” or the “Bank”) and National Commerce Risk Management, Inc. The unaudited consolidated financial statements also include the accounts of NBC’s majority-owned subsidiary, CBI Holding Company, LLC, which owns Corporate Billing, LLC (“Corporate Billing”), a transaction–based finance company headquartered in Decatur, Alabama that provides factoring, invoicing, collection, and accounts receivable management services to transportation companies and automotive parts and service providers nationwide. The Bank provides a full range of commercial and consumer banking services throughout Alabama and in central and northeast Florida. NBC is primarily regulated by the Office of the Comptroller of Currency (“OCC”) and is subject to periodic examinations by the OCC. The Company is regulated by the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and is subject to periodic examinations by the Federal Reserve.

 

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly the Company’s consolidated balance sheets, statements of earnings, comprehensive income, changes in shareholders’ equity and cash flows for the periods presented, and all such adjustments are of a normal recurring nature. All material intercompany transactions have been eliminated. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the entire year.

 

These interim consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission and, therefore, certain information and footnote disclosures normally presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been omitted or abbreviated. These financial statements should be read in conjunction with the Company’s audited consolidated financial statements and footnotes as of December 31, 2015, which are contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

 

Preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. These estimates are based on management’s knowledge and best estimates of the impact of current events and actions that the Company may undertake in the future. Estimates are used in accounting for, among other items, the allowance for loan losses, useful lives for depreciation and amortization, fair value of financial instruments, deferred taxes and contingencies. Estimates that are particularly susceptible to significant change and therefore are critical accounting estimates for the Company include the determination of the allowance for loan losses and the assessment of deferred tax assets and liabilities. Management does not anticipate any material changes to its estimates in the near term. Factors that may affect such estimates include, but are not limited to, external market factors, such as market interest rates and employment rates; changes to operating policies and procedures; economic conditions in the Company’s markets; and changes in applicable banking regulations. Actual results may ultimately differ from estimates, although management does not generally believe that such differences would materially affect the consolidated financial statements in any individual reporting period presented.

 

 

Note 2 – Reclassifications

 

Certain prior period amounts have been reclassified to conform to the presentation used in 2016. These reclassifications had no material effect on the operations, financial condition or cash flows of the Company.

 

Note 3 – Net Earnings per Common Share

 

Basic earnings per common share are computed by dividing net income by the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per common share are computed by dividing net income by the effect of the issuance of potential common shares that are dilutive and by the sum of the weighted-average number of shares of common stock outstanding. Anti-dilutive potential common shares (options) are excluded from the diluted earnings per share computation and totaled 102,297 for the three months ended March 31, 2016 and 2015.

 

The reconciliation of the components of the basic and diluted earnings per share is as follows.

 

		For the Three Months Ended March 31,
		2016				2015
Net earnings available to common shareholders		$	3,779				1,921
Weighted average common shares outstanding			10,855,871				7,701,663
Dilutive effect of stock options			94,614				33,078
Dilutive effect of directors' deferred shares			12,326				3,147
Dilutive effect of performance share awards			76,397				63,689
Diluted common shares			11,039,208				7,801,577
Basic earnings per common share		$	0.35				0.25
Diluted earnings per common share		$	0.34				0.25

 

Note 4 – Securities

 

The amortized cost and fair value of held-to-maturity and available-for-sale debt securities at March 31, 2016 and December 31, 2015 were as follows.

 

		Held-to-Maturity Securities
March 31, 2016		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Estimated Fair Value
Mortgage-backed securities		$	5,936				38				-				5,974
Municipal securities			21,348				609				21				21,936
Total held-to-maturity securities		$	27,284				647				21				27,910

 

December 31, 2015		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Estimated Fair Value
Mortgage-backed securities		$	6,097				-				16				6,081
Municipal securities			21,361				439				38				21,762
Total held-to-maturity securities		$	27,458				439				54				27,843

 

		Available-for-Sale Securities
March 31, 2016		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Estimated Fair Value
U.S. Government agency obligations		$	3,755				-				36				3,719
Mortgage-backed securities			46,255				1,012				1				47,266
Municipal securities			4,407				278				-				4,685
Total available-for-sale securities		$	54,417				1,290				37				55,670

 

December 31, 2015		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Estimated Fair Value
Mortgage-backed securities		$	48,155				758				187				48,726
Municipal securities			4,407				273				1				4,679
Total available-for-sale securities		$	52,562				1,031				188				53,405

 

 

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

 

Details concerning the Company’s debt securities with unrealized losses as of March 31, 2016 and December 31, 2015 are as follows.

 

		Held-to-Maturity Securities
		Less than 12 Months								12 Months or More								Total
March 31, 2016		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
Mortgage-backed securities		$	-				-				-				-				-				-
Municipal securities			1,241				21				-				-				1,241				21
Total held-to-maturity securities		$	1,241				21				-				-				1,241				21

 

		Less than 12 Months								12 Months or More								Total
December 31, 2015		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
Mortgage-backed securities		$	3,960				16				-				-				3,960				16
Municipal securities			1,996				38				-				-				1,996				38
Total held-to-maturity securities		$	5,956				54				-				-				5,956				54

 

		Available-for-Sale Securities
		Less than 12 Months								12 Months or More								Total
March 31, 2016		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
U.S. Government agency obligations		$	3,719				36				-				-				3,719				36
Mortgage-backed securities			2,045				1				-				-				2,045				1
Municipal securities			-				-				-				-				-				-
Total available-for-sale securities		$	5,764				37				-				-				5,764				37

 

		Less than 12 Months								12 Months or More								Total
December 31, 2015		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
Mortgage-backed securities		$	28,606				128				3,654				59				32,260				187
Municipal securities			498				1				-				-				498				1
Total available-for-sale securities		$	29,104				129				3,654				59				32,758				188

  

 

As of March 31, 2016, the Company did not consider securities with unrealized losses to be other-than-temporarily impaired. The unrealized losses in each category have occurred as a result of changes in interest rates, market spreads and market conditions subsequent to purchase. The Company has the ability and intent to hold its securities for a period of time sufficient to allow for a recovery in fair value. There were no other-than-temporary impairments charged to earnings during the three-month periods ended March 31, 2016 and 2015.

 

During the three-month periods ended March 31, 2016 and 2015, the Company did not sell any debt securities.

 

The amortized cost and estimated fair value of debt securities at March 31, 2015, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

 

		Available-for-Sale Securities								Held-to-Maturity Securities
		Amortized Cost				Fair Value				Amortized Cost				Fair Value
Municipal securities:
0 to 5 years		$	-				-			$	-				-
5 to 10 years			1,046				1,087				-				-
Over 10 years			3,361				3,598				21,348				21,936
Mortgage-backed securities and
U.S. Government agency obligations			50,010				50,985				5,936				5,974
Total		$	54,417				55,670			$	27,284				27,910

 

Note 5 – Loans, Allowance for Loan Losses and Credit Quality

 

Major classifications of loans at March 31, 2016 and December 31, 2015 are summarized as follows.

 

		March 31, 2016				December 31, 2015
Commercial, financial, and agricultural		$	192,407				196,732
Factored commercial receivables			74,248				67,628
Real estate - mortgage			931,021				881,556
Real estate - construction			166,714				152,862
Consumer			19,666				21,116
			1,384,056				1,319,894
Less: Unearned fees			517				480
Total loans			1,383,539				1,319,414
Allowance for loan losses			(10,927	)			(9,842	)
Total net loans		$	1,372,612				1,309,572

 

The Company makes loans and extensions of credit to individuals and a variety of businesses located in its market areas throughout Alabama and in central and northeast Florida. Through Corporate Billing, the Company also purchases receivables from transportation companies and automotive parts and service providers nationwide. Although the Company has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by improved and unimproved real estate and is dependent upon prevailing conditions in the real estate market. Portfolio segments utilized by the Company are identified below. Relevant risk characteristics for these portfolio segments generally include (i) debt service coverage, loan-to-value ratios, and financial performance (for non-consumer loans) and (ii) credit scores, debt-to-income ratios, collateral type, and loan-to-value ratios (for consumer loans).

 

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method for the periods indicated. Acquired loans are not included in the allowance for loan losses calculation, as these loans are recorded at fair value, and there has been no further indication of credit deterioration that would require an additional provision.

 

Balance, March 31, 2016		Commercial, financial, and agricultural				Factored commercial receivables				Real estate - mortgage				Real estate - construction				Consumer				Unallocated				Total
Balance, beginning of year		$	1,345				500				5,525				1,412				236				824				9,842
Provisions charged to operating expense			443				488				923				549				(46	)			(824	)			1,533
Loans charged off			(1	)			(888	)			-				-				(27	)			-				(916	)
Recoveries			14				400				47				3				4				-				468
Balance, March 31, 2016		$	1,801				500				6,495				1,964				167				-				10,927
Ending balance, individually evaluated for impairment		$	-				-				-				-				-				-				-
Ending balance, collectively evaluated for impairment		$	1,801				500				6,495				1,964				167				-				10,927
Loans:
Individually evaluated for impairment		$	-				-				196				162				56				-				414
Collectively evaluated for impairment		$	192,096				74,248				921,609				166,120				19,364				-				1,373,437
Acquired loans with deteriorated credit quality		$	311				-				9,216				432				246				-				10,205

 

Balance, March 31, 2015		Commercial, financial, and agricultural				Factored commercial receivables				Real estate - mortgage				Real estate - construction				Consumer				Unallocated				Total
Balance, beginning of year		$	1,523				955				5,047				647				562				1,068				9,802
Provisions charged to operating expense			(43	)			161				453				122				(245	)			(287	)			161
Loans charged off			(1	)			(566	)			(332	)			-				-				-				(899	)
Recoveries			20				406				24				8				-				-				458
Balance, March 31, 2015		$	1,499				956				5,192				777				317				781				9,522
Ending balance, individually evaluated for impairment		$	-				678				-				100				-				-				778
Ending balance, collectively evaluated for impairment		$	1,499				278				5,192				677				317				781				8,744
Loans:
Individually evaluated for impairment		$	-				820				430				187				-				-				1,437
Collectively evaluated for impairment		$	140,226				68,721				596,432				89,733				15,885				-				910,997
Acquired loans with deteriorated credit quality		$	983				-				7,194				343				332				-				8,852

 

 

The Company individually evaluates for impairment all loans that are on nonaccrual status. Additionally, all troubled debt restructurings are individually evaluated for impairment. A loan is considered impaired when, based on current events and circumstances, it is probable that all amounts due according to the contractual terms of the loan will not be collected. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, at the loan’s observable market price or at the fair value of the collateral if the loan is collateral-dependent. Management may also elect to apply an additional collective reserve to groups of impaired loans based on current economic or market factors. Interest payments received on impaired loans are generally applied as a reduction of the outstanding principal balance. During the three months ended March 31, 2016 and 2015, the Company did not modify any loans in a manner that would be considered a troubled debt restructuring.

 

The following tables present impaired loans by class of loans as of March 31, 2016 and December 31, 2015. The purchased credit-impaired loans are not included in these tables because they are carried at fair value and accordingly have no related associated allowance.

 

March 31, 2016		Recorded Investment				Unpaid Principal Balance				Related Allowance				Average Recorded Investment
Impaired loans without related allowance:
Commercial, financial, and agricultural		$	-				-				-				-
Factored commercial receivables			-				-				-				-
Real estate - mortgage			196				237				-				108
Real estate - construction			162				176				-				166
Consumer			56				127				-				28
Total		$	414				540				-				302
Impaired loans with related allowance:
Commercial, financial, and agricultural		$	-				-				-				-
Factored commercial receivables			-				-				-				-
Real estate - mortgage			-				-				-				-
Real estate - construction			-				-				-				-
Consumer			-				-				-				-
Total		$	-				-				-				-
Total impaired loans:
Commercial, financial, and agricultural		$	-				-				-				-
Factored commercial receivables			-				-				-				-
Real estate - mortgage			196				237				-				108
Real estate - construction			162				176				-				166
Consumer			56				127				-				28
Total		$	414				540				-				302

 

December 31, 2015		Recorded Investment				Unpaid Principal Balance				Related Allowance				Average Recorded Investment
Impaired loans without related allowance:
Commercial, financial, and agricultural		$	-				-				-				-
Factored commercial receivables			-				-				-				-
Real estate - mortgage			19				55				-				1,523
Real estate - construction			169				178				-				105
Consumer			-				-				-				39
Total		$	188				233				-				1,667
Impaired loans with related allowance:
Commercial, financial, and agricultural		$	-				-				-				-
Factored commercial receivables			-				-				-				653
Real estate - mortgage			-				-				-				250
Real estate - construction			-				-				-				77
Consumer			-				-				-				-
Total		$	-				-				-				980
Total impaired loans:
Commercial, financial, and agricultural		$	-				-				-				-
Factored commercial receivables			-				-				-				653
Real estate - mortgage			19				55				-				1,773
Real estate - construction			169				178				-				182
Consumer			-				-				-				39
Total		$	188				233				-				2,647

 

 

For the three months ended March 31, 2016 and 2015, the Company did not recognize a material amount of interest income on impaired loans.

 

The following tables present the aging of the recorded investment in past due loans and non-accrual loan balances as of March 31, 2016 and December 31, 2015, by class of loans. All loans greater than 90 days past due are placed on non-accrual status, excluding factored receivables. For Corporate Billing's factored receivables, which are commercial trade credits rather than promissory notes, our practice is to charge off unpaid recourse receivables when they become 90 days past due from the invoice due date and the non-recourse receivables when they become 120 days past due from the statement billing date. For the recourse receivables, the invoice is charged against the client reserve account established for such purposes, unless the client reserve is insufficient, in which case the invoice is charged against the allowance for loan losses.

 

March 31, 2016		30-59 Days Past Due				60-89 Days Past Due				> 90 Days Past Due				Total Past Due				Current				Total				Non-accrual
Commercial, financial, and agricultural		$	64				-				-				64				192,343				192,407				-
Factored commercial receivables			5,624				1,087				452				7,163				67,085				74,248				-
Real estate - mortgage			637				-				1,085				1,722				929,299				931,021				3,392
Real estate - construction			-				-				-				-				166,714				166,714				276
Consumer			313				-				31				344				19,322				19,666				133
Total		$	6,638				1,087				1,568				9,293				1,374,763				1,384,056				3,801

 

December 31, 2015		30-59 Days Past Due				60-89 Days Past Due				> 90 Days Past Due				Total Past Due				Current				Total				Non-accrual
Commercial, financial, and agricultural		$	21				-				-				21				196,711				196,732				-
Factored commercial receivables			5,762				1,595				252				7,609				60,019				67,628				-
Real estate - mortgage			1,707				760				911				3,378				878,178				881,556				3,300
Real estate - construction			59				88				-				147				152,715				152,862				283
Consumer			114				-				34				148				20,968				21,116				112
Total		$	7,663				2,443				1,197				11,303				1,308,591				1,319,894				3,695

 

The Bank groups loans into risk categories based on relevant information about the ability of borrowers to service their debt, such as current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. Loans are analyzed individually and classified according to credit risk. This analysis is performed on a continuous basis. The Bank uses the following definitions for its risk ratings:

 

Other Assets Especially Mentioned (“OAEM”): Weakness exists that could cause future impairment, including the deterioration of financial ratios, past due status and questionable management capabilities. Collateral values generally afford adequate coverage but may not be immediately marketable.

 

Substandard: Specific and well-defined weaknesses exist that may include poor liquidity and deterioration of financial ratios. The loan may be past due and related deposit accounts may be experiencing overdrafts. Immediate corrective action is necessary.

 

Doubtful: Specific weaknesses characterized as Substandard that are severe enough to make collection in full unlikely. There is no reliable secondary source of full repayment. Loans classified as Doubtful will usually be placed on non-accrual, analyzed and fully or partially charged off based on a review of the related collateral and other relevant factors.

 

 

Loss: Specific weaknesses characterized as Doubtful that are severe enough to be considered uncollectible and of such minimal value that its continuance as an asset is not warranted.

 

Loans not meeting the criteria above that are analyzed individually as part of the above-described process are considered to be Pass-rated loans. As of March 31, 2016 and December 31, 2015, and based on the most recent analysis performed, the risk category of loans by class of loans was as follows.

 

March 31, 2016		Pass				OAEM				Substandard				Doubtful				Total
Commercial, financial, and agricultural		$	189,505				1,036				1,866				-				192,407
Factored commercial receivables			74,248				-				-				-				74,248
Real estate - mortgage			920,697				2,426				4,505				3,393				931,021
Real estate - construction			164,196				-				2,242				276				166,714
Consumer			18,802				32				700				132				19,666
Total		$	1,367,448				3,494				9,313				3,801				1,384,056

 

December 31, 2015		Pass				OAEM				Substandard				Doubtful				Total
Commercial, financial, and agricultural		$	193,176				1,509				2,047				-				196,732
Factored commercial receivables			67,628				-				-				-				67,628
Real estate - mortgage			870,617				2,756				4,882				3,301				881,556
Real estate - construction			152,255				-				324				283				152,862
Consumer			20,260				33				712				111				21,116
Total		$	1,303,936				4,298				7,965				3,695				1,319,894

 

Note 6 – Fair Value Measurements and Disclosures

 

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures.  Securities available-for-sale and derivative financial instruments are recorded at fair value on a recurring basis.  Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans and other real estate and repossessed assets. These nonrecurring fair value adjustments typically involve application of the lower of cost or market accounting or write-downs of individual assets.

 

Fair Value Hierarchy

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

 

Level 1 – Valuation is based on quoted prices for identical instruments traded in active markets.

 

Level 2 – Valuation is based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

 

Level 3 – Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability.  Valuation techniques include the use of option pricing models, discounted cash flow models and similar techniques.

 

 

The following is a description of valuation methodologies used for assets and liabilities recorded or disclosed at fair value.

 

Cash and Cash Equivalents

For disclosure purposes, the carrying amount for cash, due from banks, interest-bearing deposits and federal funds sold is a reasonable estimate of fair value.

 

Investment Securities

Securities available-for-sale and held-to-maturity securities are recorded at fair value on a recurring basis.  Fair value measurements are based on quoted prices, if available.  If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques, such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions, and other factors, such as credit assumptions.  Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange or Nasdaq, and U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter market funds.  Level 2 securities include mortgage-backed securities issued by government-sponsored enterprises and municipal bonds.  Securities classified as Level 3 include asset-backed securities in less liquid markets.

 

Other Investments

For disclosure purposes, the carrying amount of other investments approximates their fair value.

 

Loans and Mortgage Loans Held-for-Sale

The Company does not record loans at fair value on a recurring basis.  However, from time to time, a loan is considered impaired, and an allowance for loan losses is established.  Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired.  Once a loan is identified as individually impaired, management measures impairment using one of three methods, including collateral value, market value of similar debt, and discounted cash flows.  Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans.  At March 31, 2016 and December 31, 2015, impaired loans were evaluated based on the fair value of the collateral.  Impaired loans for which an allowance is established based on the fair value of collateral, or loans that are charged down according to the fair value of collateral, require classification in the fair value hierarchy.  When the fair value of the collateral is based on an observable market price, the Company records the impaired loan as nonrecurring Level 2.  When the fair value is based on an appraised value, the Company records the impaired loan as nonrecurring Level 3.

 

For disclosure purposes, the fair value of fixed-rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings. For variable-rate loans, the carrying amount is a reasonable estimate of fair value. Mortgage loans held-for-sale are carried at cost, which is a reasonable estimate of fair value.

 

Bank-Owned Life Insurance

For disclosure purposes, the fair value of the cash surrender value of life insurance policies is equivalent to the carrying value.

 

 

Other Real Estate

Other real estate properties are adjusted to fair value upon the transfer of the loans to other real estate.  Subsequently, other real estate assets are carried at the lower of carrying value or fair value.  Fair value is based on independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral.  When the fair value of the collateral is based on an observable market price, the Company records the other real estate as nonrecurring Level 2.  When fair value is based on an appraised value or management’s estimate of value, the Company records the other real estate or repossessed asset as nonrecurring Level 3.

 

Deposits

For disclosure purposes, the fair value of demand deposits, NOW and money market accounts and savings accounts is the amount payable on demand at the reporting date. The fair value of fixed-rate maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.

 

 

Federal Home Loan Bank Advances

For disclosure purposes, the fair value of Federal Home Loan Bank (“FHLB”) advances is based on the quoted value for similar remaining maturities provided by the FHLB.

 

Derivative Financial Instruments

Derivative financial instruments are recorded at fair value on a recurring basis.  The value of the Company’s derivative financial instruments is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of the derivative. This analysis reflects the contractual terms of the derivative, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The fair values of the interest rate swaps are determined by using the market standard methodology of netting the discounted future fixed cash receipts and the discounted expected variable cash payments. The variable cash payments are based on an expectation of future interest rates (forward curves derived from observable market interest rate curves).

 

The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company considers the impact of netting any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.

 

Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by the Company or the counterparty. However, as of March 31, 2016 and December 31, 2015, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustment is not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuations are classified in Level 2 of the fair value hierarchy.

 

 

Commitments to Extend Credit and Standby Letters of Credit

Because commitments to extend credit and standby letters of credit are generally short-term and made using variable rates, the carrying value and estimated fair value associated with these instruments are immaterial.

 

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis as of March 31, 2016 and December 31, 2015.

 

March 31, 2016		Level 1				Level 2				Level 3				Total
U.S. Government agency obligations		$	-				3,719				-				3,719
Mortgage-backed securities			-				47,266				-				47,266
Municipal securities			-				4,685				-				4,685
Total investment securities available-for-sale		$	-				55,670				-				55,670
Derivative assets		$	-				569				-				569
Derivative liabilities		$	-				1,016				-				1,016

 

December 31, 2015		Level 1				Level 2				Level 3				Total
Mortgage-backed securities		$	-				48,726				-				48,726
Municipal securities			-				4,679				-				4,679
Total investment securities available-for-sale		$	-				53,405				-				53,405
Derivative assets		$	-				258				-				258
Derivative liabilities		$	-				518				-				518

 

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

From time to time, the Company may be required to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. GAAP. These include assets that are measured at the lower of cost or market value that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the table below as of March 31, 2016 and December 31, 2015.

 

March 31, 2016		Level 1				Level 2				Level 3				Total
Other real estate and repossessed assets		$	-				-				2,884				2,884
Impaired loans			-				-				3,801				3,801

 

December 31, 2015		Level 1				Level 2				Level 3				Total
Other real estate and repossessed assets		$	-				-				3,965				3,965
Impaired loans			-				-				3,695				3,695

 

The carrying amounts and estimated fair values of the Company’s financial instruments at March 31, 2016 and December 31, 2015 were as follows:

 

March 31, 2016		Carrying Amount				Level 1				Estimated Fair Value Level 2				Level 3
Assets:
Cash and cash equivalents		$	123,853				123,853				-				-
Investment securities held-to-maturity			27,284				-				27,910				-
Investment securities available-for-sale			55,670				-				55,670				-
Other investments			6,106				-				6,106				-
Loans, net			1,372,612				-				1,380,509				3,801
Mortgage loans held-for-sale			12,529				-				12,529				-
Bank-owned life insurance			27,426				-				27,426				-
Derivative assets			569				-				569				-
Liabilities:
Deposits			1,498,197				-				1,479,070				-
Federal Home Loan Bank advances			7,000				-				7,450				-
Derivative liabilities			1,016				-				1,016				-

 

December 31, 2015		Carrying Amount				Level 1				Estimated Fair Value Level 2				Level 3
Assets:
Cash and cash equivalents		$	212,457				212,457				-				-
Investment securities held-to-maturity			27,458				-				27,843				-
Investment securities available-for-sale			53,405				-				53,405				-
Other investments			6,235				-				6,235				-
Loans, net			1,309,572				-				1,309,547				3,695
Mortgage loans held-for-sale			15,020				-				15,020				-
Bank-owned life insurance			27,223				-				27,223				-
Derivative assets			258				-				258				-
Liabilities:
Deposits			1,514,458				-				1,479,746				-
Federal Home Loan Bank advances			22,000				-				22,405				-
Derivative liabilities			518				-				518				-

 

 

Limitations

Fair value estimates are made at a specific point in 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 at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

 

Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial instruments include mortgage banking operations, deferred income taxes, and premises and equipment. 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 the estimates.

 

Note 7 – Segment Reporting

 

The Company’s three reportable segments represent distinct product lines and are viewed separately for strategic planning purposes and internal reporting. The following table is a reconciliation of the reportable segment revenues, expenses and profit to the Company’s consolidated totals.

 

		Retail and Commercial Banking				Mortgage Division (1)				Receivables Factoring				Elimination Entries (2)				Total
For the Three Months Ended March 31, 2016
Interest income		$	15,699				115				2,999				(500	)			18,313
Interest expense			1,606				44				500				(500	)			1,650
Net interest income			14,093				71				2,499				-				16,663
Provision for loan and lease losses			1,045				-				488				-				1,533
Noninterest income			1,632				1,453				40				-				3,125
Noninterest expense			9,412				1,349				1,292				-				12,053
Net earnings before tax and noncontrolling interest			5,268				175				759				-				6,202
Income tax expense			1,857				67				159				-				2,083
Noncontrolling interest			-				-				(340	)			-				(340	)
Net earnings attributable to National Commerce Corporation		$	3,411				108				260				-				3,779
Total assets as of March 31, 2016		$	1,694,223				12,529				95,262				(66,074	)			1,735,940
For the Three Months Ended March 31, 2015
Interest income		$	9,516				84				3,113				(520	)			12,193
Interest expense			999				28				520				(520	)			1,027
Net interest income			8,517				56				2,593				-				11,166
Provision for loan and lease losses			-				-				161				-				161
Noninterest income			547				1,187				30				-				1,764
Noninterest expense			6,916				1,040				1,334				-				9,290
Net earnings before tax and noncontrolling interest			2,148				203				1,128				-				3,479
Income tax expense			763				77				252				-				1,092
Noncontrolling interest			-				-				(466	)			-				(466	)
Net earnings attributable to National Commerce Corporation		$	1,385				126				410				-				1,921
Total assets as of March 31, 2015		$	1,164,877				13,804				93,923				(65,937	)			1,206,667

 

(1)	Noninterest income for the mortgage division segment includes intercompany income allocation.

(2)	Entry to remove intercompany interest allocated to the receivables factoring segment. For segment reporting purposes, we  allocate funding costs to the receivables factoring segment at the federal funds rate plus 2.50%.

 

 

Note 8 – Goodwill and Intangible Assets

 

Changes to the carrying amount of goodwill for the three months ended March 31, 2016 is provided in the following table.

 

Balance, December 31, 2015		$	50,686
Adjustments to goodwill			29
Balance, March 31, 2016		$	50,715

 

The adjustments to goodwill made during the three months ended March 31, 2016 resulted from the recognition of liabilities that existed as of the acquisition date but were not recorded. The adjustments were made following the Company’s review of additional information that existed at the time of acquisition that affected the recorded fair value of certain liabilities. Net of deferred taxes, the adjustment resulted in a $29,000 increase to goodwill recorded in our acquisition of Reunion Bank of Florida. The adjustment to goodwill had no impact on net income or shareholders’ equity of the Company for the first three months of 2016.

 

A summary of core deposit intangible assets as of March 31, 2016 and December 31, 2015 is as follows.

 

			March 31, 2016				December 31, 2015
Gross carrying amount		$	3,315			$	3,315
Less: accumulated amortization			(718	)			(527	)
Net carrying amount		$	2,597			$	2,788

 

Note 9 – Cash and Cash Equivalents

 

Cash equivalents include amounts due from banks, interest-bearing deposits with the Federal Reserve Bank of Atlanta (“FRB”), the FHLB and correspondent banks, and federal funds sold. Generally, federal funds are sold for one-day periods. The Company is required to maintain average reserve balances with the FRB or in cash. At March 31, 2016 and December 31, 2015, the Company’s reserve requirements were approximately $1,899,000 and $12,218,000, respectively.

 

Note 10 – Recently Issued Accounting Pronouncements

 

In January 2016, the FASB issued ASU 2016-1, Financial Instruments Overall (Topic 825): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in ASU 2016-1: (a) require equity investments (except for those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value, with changes in fair value recognized in net income; (b) simplify the impairment assessment of equity securities without readily determinable fair values by requiring a qualitative assessment to identify impairment; (c) eliminate the requirement for public business entities to disclose the method and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (d) require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (e) require an entity to present separately, in other comprehensive income, the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (f) require separate presentation of financial assets and financial liabilities by measurement category and form of financial assets on the balance sheet or the notes to the financial statements; and (g) clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The amendments in this ASU are effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company will evaluate the provisions of this ASU to determine the potential impact that the new standard will have on the Company’s consolidated financial statements.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The guidance in this update supersedes the requirements in ASC Topic 840, Leases. The update will require business entities to recognize lease assets and liabilities on the balance sheet and to disclose key information about leasing arrangements. A lessee would recognize a liability to make lease payments and a right-of-use asset representing its right to use the leased asset for the lease term. For public companies, this update will be effective for interim and annual periods beginning after December 15, 2018, and is to be applied on a modified retrospective basis. The Company is currently assessing the impact that this guidance will have on its consolidated financial statements. Adoption of this guidance will increase the assets and liabilities of the Company.

  

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis of our financial condition and results of operations should be read together with our condensed consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q, as well as our audited consolidated financial statements and related notes thereto for the year ended December 31, 2015, which are contained in our Annual Report on Form 10-K for the year ended December 31, 2015. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results could differ materially from those contained in forward-looking statements as a result of many factors, including those discussed in our 2015 Annual Report on Form 10-K under “Part I, Item 1A. – Risk Factors,” as well as other unknown risks and uncertainties.

 

All dollar amounts in the tables in this section are in thousands of dollars, except per share data, yields, percentages and rates, or when specifically identified. The words “we,” “us,” “our,” the “Company,” “NCC” and similar terms when used in this section refer to National Commerce Corporation and its consolidated affiliates, unless the context indicates otherwise.

 

Our Business

 

NCC is a financial holding company headquartered in Birmingham, Alabama. We engage in the business of banking through our wholly owned banking subsidiary, National Bank of Commerce, which we may refer to as the “Bank” or “NBC.”

 

Through the Bank, we provide a broad array of financial services to businesses, business owners and professionals through seven full-service banking offices in Alabama (in Birmingham, Huntsville, Auburn-Opelika, and Baldwin County) and ten full-service banking offices in central and northeast Florida (in Vero Beach through National Bank of Commerce; in Longwood, Winter Park, Orlando, and Oviedo through United Legacy Bank, a division of National Bank of Commerce; and in Tavares, Port Orange, St. Augustine, and Ormond Beach through Reunion Bank of Florida, a division of National Bank of Commerce), as well as a loan production office in Atlanta, Georgia. We also own a 70% equity interest in CBI Holding Company, LLC (”CBI”), which owns Corporate Billing, LLC (“Corporate Billing”), a transaction-based finance company headquartered in Decatur, Alabama that provides factoring, invoicing, collection and accounts receivable management services to transportation companies and automotive parts and service providers throughout the United States and parts of Canada.

 

 

Overview of First Quarter 2016 Results

 

Net income was $3.8 million in the first quarter ended March 31, 2016, compared with $1.9 million during the first quarter of 2015. Several important measures from the 2016 first quarter include:

 

●

Net interest margin (taxable equivalent) of 4.21%, compared with 4.25% for the first quarter of 2015.

●

Return on average assets of 0.86%, compared with 0.67% for the first quarter of 2015.

●

First quarter 2016 loan growth (excluding mortgage loans held for sale) of $64.1 million, representing a 19.5% annualized growth rate. Excluding factoring receivables, loans grew $57.5 million, representing an 18.5% annualized growth rate.

●

Decrease in deposits of $16.3 million, reflecting a withdrawal of a significant amount of temporary year-end deposits, including deposits from tax-collecting authorities.

●

$63.8 million in mortgage production, compared with $55.7 million for the first quarter of 2015.

●

$178.8 million in purchased volume in the factoring division, compared to $175.1 million for the first quarter of 2015.

●

Reduction in non-acquired non-performing assets to $3.4 million, from $4.3 million at December 31, 2015.

●

Annualized net charge-offs of 0.13%, compared to 0.20% for the first quarter of 2015.

●

Ending book value per share of $20.36.

●

The successful completion of the system conversion at Reunion Bank, a division of National Bank of Commerce, in March 2016.

 

Critical Accounting Policies and Estimates

 

Our consolidated financial statements are prepared based on the application of certain accounting policies, the most significant of which are described in the notes to NCC’s audited consolidated financial statements for the year ended December 31, 2015, which are contained in our Annual Report on Form 10-K. Certain of these policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or subject to variation and may significantly affect our reported results and financial position for the current period or future periods. The use of estimates, assumptions and judgments is necessary when financial assets and liabilities are required to be recorded at, or adjusted to reflect, fair value. Assets carried at fair value inherently result in more financial statement volatility. Fair values and information used to record valuation adjustments for certain assets and liabilities are either based on quoted market prices or provided by other independent third-party sources, when available. When such information is not available, management estimates valuation adjustments. Changes in underlying factors, assumptions or estimates in any of these areas could have a material impact on our future financial condition and results of operations.

 

The following briefly describes the more complex policies involving a significant degree of judgment about valuation and the application of complex accounting standards and interpretations.

 

 

Allowance for Loan Losses

 

We record estimated probable inherent credit losses in the loan portfolio as an allowance for loan losses. The methodologies and assumptions for determining the adequacy of the overall allowance for loan losses involve significant judgments to be made by management. Some of the more critical judgments supporting our allowance for loan losses include judgments about the creditworthiness of borrowers and the estimated value of underlying collateral, assumptions about cash flow, determinations of loss factors for estimating credit losses, and judgments regarding the impact of current events, conditions and other factors affecting the level of inherent losses. Under different conditions or using different assumptions, the actual or estimated credit losses that we ultimately realize may be different from our estimates. In determining the allowance, we estimate losses on individual impaired loans, or groups of loans that are not impaired, where the probable loss can be identified and reasonably estimated. On a quarterly basis, we assess the risk inherent in our loan portfolio based on qualitative and quantitative trends in the portfolio, including the internal risk classification of loans, historical loss rates, changes in the nature and volume of the loan portfolio, industry or borrower concentrations, delinquency trends, detailed reviews of significant loans with identified weaknesses and the impacts of local, regional and national economic factors on the quality of the loan portfolio. Based on this analysis, we may record a provision for loan losses in order to maintain the allowance at appropriate levels. For a more complete discussion of the methodology employed to calculate the allowance for loan losses, see Note 1 to NCC’s consolidated financial statements for the year ended December 31, 2015, which are contained in our Annual Report on Form 10-K.

 

Investment Securities Impairment

 

We assess on a quarterly basis whether there have been any events or economic circumstances to indicate that a security with respect to which there is an unrealized loss is impaired on an other-than-temporary basis. We consider many factors in this assessment, including the severity and duration of the impairment, our intent and ability to hold the security for a period of time sufficient for a recovery in value, recent events specific to the issuer or industry, and, for debt securities, external credit ratings and recent downgrades. Securities with respect to which there is an unrealized loss that is deemed to be other-than-temporary are written down to fair value. The credit portion of the impairment, if any, is recognized as a realized loss in current earnings.

 

Income Taxes

 

Deferred income tax assets and liabilities are computed using the asset and liability method, which recognizes an asset or liability representing the tax effects, based on current tax law, of future deductible or taxable amounts attributable to events recognized in the financial statements. A valuation allowance may be established to the extent necessary to reduce the deferred tax asset to a level at which it is “more likely than not” that the tax asset or benefit will be realized. The ultimate realization of tax benefits depends on many factors, including the sufficiency of taxable income, the availability of tax loss carrybacks or credits, the reversal of taxable temporary differences and tax planning strategies within the reversal period and the state of applicable tax laws with respect to the realization of recorded tax benefits.

 

Business Combinations

 

Assets purchased and liabilities assumed in a business combination are recorded at their respective fair values. The fair value of a loan portfolio acquired in a business combination requires greater levels of management estimates and judgment than the remainder of the purchased assets or assumed liabilities. On the date of acquisition, when the loans exhibit evidence of credit deterioration since origination and it is probable that we will not collect all contractually required principal and interest payments, the difference between contractually required payments at acquisition and the cash flows expected to be collected is referred to as non-accretable difference. We must estimate expected cash flows at each reporting date. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows will generally result in a reversal of the provision for loan losses to the extent of prior charges and adjusted accretable yield, which will have a positive impact on interest income. Purchased loans without evidence of credit deterioration are recorded in the same manner.

 

 

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

 

The following is a narrative discussion and analysis of significant changes in our results of operations for the three months ended March 31, 2016 compared to the three months ended March 31, 2015.

 

Net Income

 

During the three months ended March 31, 2016, our net income was $3.8 million, compared to $1.9 million for the three months ended March 31, 2015, an increase of 96.7%. Our results of operations for the three months ended March 31, 2016 included the results Reunion Bank of Florida (“RBF”). We acquired RBF on October 31, 2015, and, therefore, its results are not included in our results of operations for three months ended March 31, 2015.

 

The primary reason for the increase in net income for the three months ended March 31, 2016 compared to the same period of 2015 was an increase in net interest income. During the three months ended March 31, 2016, net interest income was $16.7 million, an increase of $5.5 million, or 49.2%, compared to the three months ended March 31, 2015. This increase was a result of higher levels of loan volume and other earning assets from organic growth and the acquisition of RBF. Total noninterest income during the three months ended March 31, 2016 was $3.1 million, an increase of $1.4 million compared to the three months ended March 31, 2015. The largest increases in noninterest income during the first quarter of 2016 were in revenue from the mortgage division, income from bank-owned life insurance, gain from sales of other real estate and merchant sponsorship revenue. During the three months ended March 31, 2016, mortgage origination and fee income increased $121 thousand, and income from bank-owned life insurance increased $125 thousand. In addition, we recorded a gain of $156 thousand on the sale of other real estate, compared to a loss of $13 thousand during the three months ended March 31, 2015. Merchant sponsorship revenue totaled $522 thousand during the three months ended March 31, 2016. We entered this business line during the second quarter of 2015, so there was no revenue attributable to this business line for the three months ended March 31, 2015.

 

 The increased net interest income and noninterest income was partially offset by an increase in other noninterest expense and provision for loan losses during the three months ended March 31, 2016. Total noninterest expense during the three months ended March 31, 2016 was $12.1 million, an increase of $2.8 million, or 29.7%, compared to the three months ended March 31, 2015. This increase was primarily a result of the addition of the operating expenses of RBF and costs associated with the growth of the Company. RBF was not included in our results of operations for the three months ended March 31, 2015. The provision for loan losses during the three months ended March 31, 2016 was $1.5 million, compared to $161 thousand during the three months ended March 31, 2015.

 

 

Most of the changes in our net interest income, noninterest income and noninterest expense for the three months ended March 31, 2016 compared to the same period of 2015 were due to the additional revenues and expenses of RBF, which we acquired on October 31, 2015. During the three months ended March 31, 2016, RBF’s net interest income, noninterest income and noninterest expense were approximately $3.6 million, $251 thousand and $1.8 million, respectively.

 

Net Interest Income and Net Interest Margin Analysis

 

The largest component of our net income is net interest income – the difference between the income earned on interest-earning assets and the interest paid on deposits and borrowed funds used to support our assets. Net interest income divided by average earning assets represents our net interest margin. The major factors that affect net interest income and net interest margin are changes in volume, the yield on interest-earning assets and the cost of interest-bearing liabilities. Our net interest margin can also be affected by economic conditions, the competitive environment, loan demand and deposit flow. Our ability to respond to changes in these factors by using effective asset-liability management techniques is critical to maintaining the stability of the net interest margin as our primary source of earnings.

 

The following table shows, for the periods indicated, the average balances of each principal category of our assets, liabilities and shareholders’ equity and the average yields on assets and average costs of liabilities. Such yields and costs are calculated by dividing annualized income or expense by the average daily balances of the associated assets or liabilities.

 

AVERAGE BALANCE SHEETS AND NET INTEREST ANALYSIS

 

		For the Three Months Ended
(Dollars in thousands)		March 31, 2016												March 31, 2015
Assets		Average Balance				Interest Income/ Expense				Average Yield/ Rate				Average Balance				Interest Income/ Expense				Average Yield/ Rate
Loans		$	1,352,737			$	17,373				5.17	%		$	903,563			$	11,709				5.26	%
Mortgage loans held for sale			10,503				115				4.40				9,487				85				3.63
Securities:
Taxable securities			61,764				412				2.68				35,540				256				2.92
Tax-exempt securities			26,041				317				4.90				4,750				67				5.72
Cash balances in other banks			151,318				217				0.58				114,579				103				0.36
Total interest-earning assets			1,602,363			$	18,434				4.63				1,067,919			$	12,220				4.64
Noninterest-earning assets			156,260												94,118
Total assets		$	1,758,623											$	1,162,037
Liabilities and shareholders' equity
Interest-bearing transactions accounts		$	204,339			$	123				0.24	%		$	159,706			$	99				0.25	%
Savings and money market deposits			620,429				762				0.49				391,321				377				0.39
Time deposits			306,106				684				0.90				209,016				442				0.86
Federal Home Loan Bank and other borrowed money			10,959				81				2.97				22,000				109				2.01
Total interest-bearing liabilities			1,141,833			$	1,650				0.58				782,043			$	1,027				0.53
Noninterest-bearing deposits			386,674												232,497
Total funding sources			1,528,507												1,014,540
Noninterest-bearing liabilities			11,386												7,879
Shareholders' equity			218,730												139,618
		$	1,758,623											$	1,162,037
Net interest rate spread											4.05	%											4.11	%
Net interest income/margin (taxable equivalent)							16,784				4.21	%							11,193				4.25	%
Tax equivalent adjustment							121												27
Net interest income/margin						$	16,663				4.18	%						$	11,166				4.24	%

 

Net interest income increased by $5.5 million, or 49.2%, to $16.7 million for the three months ended March 31, 2016, compared to $11.2 million for the same period of 2015. The increase was due to an increase in interest income of $6.1 million, resulting from higher levels of loan volume from organic growth and the acquisition of RBF. This increase in interest income was partially offset by a $623 thousand increase in interest expense. The increase in interest income was primarily due to a 49.7% increase in average loans outstanding for the three months ended March 31, 2016 compared to the three months ended March 31, 2015. The resulting net interest margin for the three months ended March 31, 2016 was 4.18%, compared to 4.24% for the three months ended March 31, 2015.

 

Interest-earning assets averaged $1.6 billion for the three months ended March 31, 2016, compared to $1.1 billion for the three months ended March 31, 2015, an increase of $534.4 million, or 50.0%. Additional information on growth in our loan portfolio for these periods is presented below. The yield on average interest-earning assets decreased 1 basis point, to 4.63% for the three months ended March 31, 2016, compared to 4.64% for the three months ended March 31, 2015. During the three months ended March 31, 2016, the loan yield was 5.17%, compared to 5.26% during the three months ended March 31, 2015. The decrease in loan yield was primarily attributable to the fact that rates on maturing loans are generally higher than rates on new or renewed loans and that factored receivables, which earn a higher yield than traditional loans, represent a lower proportion of our total loans. RBF contributed average loan balances of $287.1 million during the three months ended March 31, 2016.

 

 

Interest-bearing liabilities averaged $1.1 billion for the three months ended March 31, 2016, compared to $782.0 million for the three months ended March 31, 2015, an increase of $359.8 million, or 46.0%. The rate on total interest-bearing liabilities was 58 basis points for the three months ended March 31, 2016, compared to 53 basis points for the three months ended March 31, 2015. The increase in average deposits was due to organic deposit production and the inclusion of RBF’s deposits in our results for the three months ended March 31, 2016.

 

Average noninterest-bearing deposits increased to $386.7 million during the three months ended March 31, 2016, representing an increase of $154.2 million compared to the three months ended March 31, 2015.

 

The following table reflects, for the periods indicated, the changes in our net interest income due to changes in the volume of interest-earning assets and interest-bearing liabilities and the associated rates paid or earned on these assets and liabilities.

 

ANALYSIS OF CHANGES IN NET INTEREST INCOME

 

		For the Three Months Ended
(Dollars in thousands)		March 31, 2016 vs. 2015
		Variance due to
Interest-earning assets		Volume				Yield/Rate				Total
Loans		$	5,866			$	(202	)		$	5,664
Mortgage loans held for sale			10				20				30
Securities:
Taxable securities			178				(22	)			156
Tax-exempt securities			261				(11	)			250
Cash balances in other banks			41				73				114
Funds sold			-				-				-
Total interest-earning assets		$	6,356			$	(142	)		$	6,214
Interest-bearing liabilities
Interest-bearing transactions accounts		$	28			$	(4	)		$	24
Savings and money market deposits			266				119				385
Time deposits			220				22				242
Federal Home Loan Bank and other borrowed money			(69	)			41				(28	)
Total interest-bearing liabilities		$	445			$	178			$	623
Net interest income
Net interest income (taxable equivalent)			5,911				(320	)			5,591
Taxable equivalent adjustment			85				9				94
Net interest income		$	5,826			$	(329	)		$	5,497

 

Provision for Loan Losses

 

During the three months ended March 31, 2016, we recorded a provision for loan losses of $1.5 million, compared to $161 thousand during the three months ended March 31, 2015. The additional provision for loan losses during the three months ended March 31, 2016 was due to charge-offs of approximately $488 thousand at Corporate Billing, loan growth and uncertainty in the national economy. Our policy is to maintain an allowance for loan losses at a level sufficient to absorb probable incurred losses inherent in the loan portfolio. The allowance is increased by a provision for loan losses, which is a charge to earnings, and is decreased by charge-offs and increased by loan recoveries. In determining the proper level of the allowance for loan losses, we consider our historical loan loss experience, the general economic environment, our overall portfolio composition and other relevant information. As these factors change, the level of loan loss provision changes. When individual loans are evaluated for impairment and an impairment is deemed necessary, the impaired portion of the loan amount is charged off. As of March 31, 2016, none of our recorded allowance was related to impaired loans.

 

 

Noninterest Income

 

In addition to net interest margin, we generate other types of recurring noninterest income from our operations. Our banking operations generate revenue from service charges and fees on deposit accounts. Our mortgage division generates revenue from originating and selling mortgages, and we have a revenue-sharing relationship with a registered broker-dealer. In addition to these types of recurring noninterest income, NBC owns life insurance on several key employees and records income on the increase in the cash surrender value of these policies.

  

 

Additionally, during the 2015 second quarter, we began earning revenue as a sponsor bank for a provider of electronic transaction processing services for retail merchants and the consumer finance industry. This sponsorship into the VISA and MasterCard networks allows the processor to accept debit and credit card transactions, and we earn a fee on each such transactions.

 

The following table sets forth the principal components of noninterest income for the periods indicated.

 

NONINTEREST INCOME

 

		For the Three Months Ended
(Dollars in thousands)		March 31, 2016				March 31, 2015
Service charges and fees on deposit accounts		$	480			$	267
Mortgage origination and fee income			1,392				1,271
Merchant sponsorship revenue			522				-
Income from bank-owned life insurance			204				79
Wealth management fees			13				19
Gain (loss) on sale of other real estate			156				(13	)
Other noninterest income			358				141
Total noninterest income		$	3,125			$	1,764

 

Noninterest income for the three months ended March 31, 2016 and 2015 was $3.1 million and $1.8 million, respectively. The inclusion of RBF in our results of operations for the three months ended March 31, 2016 accounted for approximately $251 thousand of the $1.4 million increase recorded in noninterest income during the three months ended March 31, 2016.

 

All categories of noninterest income experienced an increase. The mortgage division income increased $121 thousand during the three months ended March 31, 2016 and totaled $1.4 million for this period, compared to $1.3 million during the three months ended March 31, 2015. Increased production led to higher mortgage division income. During the three months ended March 31, 2016, total production was $63.8 million, compared to $55.7 million during the three months ended March 31, 2015. During the three months ended March 31, 2016, refinance activity accounted for 18.2% of production volume, compared to 26.9% during the same period in 2015. The addition of RBF did not have an impact on the higher mortgage division income during the three months ended March 31, 2016. We are expanding this business line in several markets in Florida, but the increased mortgage division income during the first quarter of 2016 resulted primarily from activity in our existing markets.

 

Service charges and fees on deposit accounts increased $213 thousand, to $480 thousand for the three months ended March 31, 2016. The addition of RBF contributed $108 thousand to this increase, and the remaining portion of this increase was the result of an increase in the number of deposit accounts as we continue to increase market share and accounts in our markets. Income from bank-owned life insurance increased $125 thousand to $204 thousand for the three months ended March 31, 2016. The addition of RBF contributed $25 thousand of this increase, and the remaining increase was due to additional investment in bank-owned life insurance made during 2015.

 

During the three months ended March 31, 2016, we recorded merchant sponsorship revenue of $522 thousand. There was no corresponding income for the three months ended March 31, 2015, since we entered this business line during the second quarter of 2015.

 

Noninterest expense

 

The increase in our total noninterest expense during the three months ended March 31, 2016 reflects the continued growth of the Company (organic growth and growth through acquisitions), as well as the expansion of our operational framework, employee base and facilities infrastructure as we build the foundation to support our growth strategies. We believe that some of our overhead costs will decrease as a percentage of our revenue as we grow and gain operating leverage by spreading these costs over a larger revenue base.

 

 

The following table presents the primary components of noninterest expense for the periods indicated.

 

NONINTEREST EXPENSE

 

		For the Three Months Ended
(Dollars in thousands)		March 31, 2016				March 31, 2015
Salaries and employee benefits		$	6,945			$	4,987
Commission-based compensation			875				796
Occupancy and equipment expense			1,135				836
Data processing expenses			667				425
Advertising and marketing expenses			160				173
Legal fees			122				167
FDIC insurance assessments			263				206
Accounting and audit expenses			250				223
Consulting and other professional expenses			243				105
Telecommunications expenses			159				128
Other real estate owned, repossessed asset and other collection expenses			59				122
Core deposit intangible amortization			191				111
Other noninterest expense			984				1,011
Total noninterest expense		$	12,053			$	9,290

 

Noninterest expense for the three months ended March 31, 2016 and 2015 was $12.1 million and $9.3 million, respectively. The inclusion of RBF in our results of operations for the three months ended March 31, 2016 accounted for approximately $1.8 million of the $2.8 million increase in noninterest expense recorded during the three months ended March 31, 2016.

 

Two of the largest components of noninterest expense are related to employee costs shown in the table above as salaries and employee benefits and commission-based compensation. Salaries continue to increase as we expand our presence in our markets. Higher incentive compensation accruals during the three months ended March 31, 2016 contributed to the increase in salaries and employee benefits. Commission-based compensation expense is directly related to mortgage loan origination activity and certain production activity at Corporate Billing. The higher levels of revenue for the mortgage division contributed to the increased commission-based compensation during the three months ended March 31, 2016.   Additionally, salaries and benefits for RBF’s employees contributed approximately $1.0 million of the $2.0 million increase in salaries and employee benefits and commission-based compensation expense recorded during the three months ended March 31, 2016.

 

Many categories of noninterest expense increased during the three months ended March 31, 2016, compared to the three months ended March 31, 2015. This was largely a result of the additional expenses associated with the operations of RBF. Other noninterest expense for the three months ended March 31, 2016 includes a recovery of $270 thousand related to the settlement of a lawsuit. Without this recovery, other noninterest expense would have been $1.3 million for the three months ended March 31, 2016.

 

Income Tax Provision

 

We recognized income tax expense of $2.1 million during the three months ended March 31, 2016, compared to $1.1 million during the three months ended March 31, 2015. The increase in income tax expense during the first three months of 2016 was due to the increase in pre-tax income. The effective tax rate for the first three months of 2016 was 33.6% (35.5% including the minority interest in CBI), compared to 31.4% (36.2% including the minority interest in CBI) during the first three months of 2015. The effective tax rate is affected by items of income and expense that are not subject to federal and state taxation.

 

 

Comparison of Balance Sheets at March 31, 2016 and December 31, 2015

 

Overview

 

Our total assets decreased $27.4 million, or 1.6%, from $1.8 billion at December 31, 2015 to $1.7 billion at March 31, 2016. Cash and cash equivalents decreased by $88.6 million during the first three months of 2016. Loans increased by $64.1 million, or 4.9%, during the first three months of 2016. Total assets and cash and cash equivalents decreased due to temporary year-end deposits that were withdrawn during the first of quarter of 2016 and our investment of some of our excess cash in loans and securities.

 

During the first three months of 2016, deposits decreased $16.2 million and totaled $1.5 billion at March 31, 2016. Our deposits were higher at year end 2015 due to the existence of temporary deposits that were withdrawn during the first three months of 2016. Our deposits actually increased when normalized for the temporary deposits. Deposit production is one of our primary focuses, and a component of our account officers’ bonus calculations is tied to deposit production during 2016.

 

Investment Securities

 

We use our securities portfolio primarily to enhance our overall yield on interest-earning assets and as a source of liquidity, as a tool to manage our balance sheet sensitivity and regulatory capital ratios, and as a base from which to pledge assets for public deposits. When our liquidity position exceeds current needs and our expected loan demand, other investments are considered as a secondary earnings alternative. As investments mature, they are used to meet current cash needs, or they are reinvested to maintain our desired liquidity position. We have designated a majority of our securities as available-for-sale to provide flexibility in case an immediate need for liquidity arises, and we believe that the composition of the portfolio offers needed flexibility in managing our liquidity position and interest rate sensitivity without adversely impacting our regulatory capital levels. Securities available-for-sale are reported at fair value, with unrealized gains or losses reported as a separate component of other comprehensive income, net of related deferred taxes. Purchase premiums and discounts are recognized in income using the interest method over the terms of the securities. Securities classified as held-to-maturity are carried at amortized cost on our balance sheet.

 

During the three months ended March 31, 2016, we elected to use a portion of our balance sheet liquidity and invested $3.8 million in a United States Government agency obligation. We intend to continue to invest excess liquidity in securities when the yield, liquidity and interest rate risk are appropriate.

 

The following table summarizes the amortized cost and fair value of securities available-for-sale and securities held-to-maturity at March 31, 2016 and December 31, 2015.

 

INVESTMENT SECURITIES AVAILABLE-FOR-SALE

 

		As of
(Dollars in thousands)		March 31, 2016								December 31, 2015
		Cost				Market				Cost				Market
U.S. Government agency obligations (excluding MBS)		$	3,755			$	3,719			$	-			$	-
Securities issued by states and political subdivisions			4,407				4,685				4,407				4,679
Residential mortgage pass-through securities			46,255				47,266				48,155				48,726
Total investment securities available-for-sale		$	54,417			$	55,670			$	52,562			$	53,405

 

INVESTMENT SECURITIES HELD-TO-MATURITY

 

		As of
(Dollars in thousands)		March 31, 2016								December 31, 2015
		Cost				Market				Cost				Market
Securities issued by states and political subdivisions		$	21,348			$	21,936			$	21,361			$	21,762
Residential mortgage pass-through securities			5,936				5,974				6,097				6,081
Total investment securities held-to-maturity		$	27,284			$	27,910			$	27,458			$	27,843

 

We invest primarily in mortgage-backed securities, municipal securities and obligations of government-sponsored entities and agencies of the United States, though we may in some situations also invest in direct obligations of the United States or obligations guaranteed as to the principal and interest by the United States. All of our mortgage-backed securities are residential securities issued by the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC) or the Government National Mortgage Association (GNMA).

 

 

Loans

 

Loans are our largest category of earning assets and typically provide higher yields than other types of earning assets. Associated with the higher loan yields are the inherent credit and liquidity risks that management attempts to control and counterbalance. Total loans averaged $1.4 billion during the three months ended March 31, 2016, or 84.4% of average earning assets, compared to $903.6 million, or 84.6% of average earning assets, for the three months ended March 31, 2015. At March 31, 2016, total loans, net of unearned income, were $1.4 billion, compared to $1.3 billion at December 31, 2015, an increase of $64.1 million, or 4.9%.

 

The organic, or non-acquired, growth in the Bank’s loan portfolio is attributable to the Bank’s ability to attract new customers from other financial institutions. We have also been successful in building banking relationships with new customers in all of the markets that we serve. We have hired several new bankers in our markets, and these employees have been successful in transitioning their former clients and new clients to the Bank. Our bankers are expected to be involved in their communities and to maintain business development efforts to develop relationships with clients, and our philosophy is to be responsive to customer needs by providing decisions in a timely manner. In addition to our business development efforts, many of the markets in which we operate have shown signs of economic recovery over the last few years, which has increased demand for the services that we provide.

 

The table below provides a summary of the loan portfolio composition as of the periods indicated.

 

COMPOSITION OF LOAN PORTFOLIO

 

		As of
(Dollars in thousands)		March 31, 2016								December 31, 2015
		Amount				Percent of Total				Amount				Percent of Total
Construction, land development, and other land loans		$	166,714				12.05	%		$	152,862				11.58	%
Secured by farmland			7,262				0.52				7,455				0.56
Secured by 1-4 family residential properties			340,291				24.59				333,761				25.29
Secured by multifamily (5 or more) residential properties			41,880				3.03				31,128				2.36
Secured by nonfarm nonresidential properties			541,588				39.13				509,212				38.58
Loans secured by real estate			1,097,735				79.32				1,034,418				78.37
Commercial and industrial loans			170,207				12.30				171,160				12.97
Factored commercial receivables			74,248				5.36				67,628				5.12
Consumer loans			19,666				1.42				21,116				1.60
Other loans			22,200				1.60				25,572				1.94
Total gross loans			1,384,056				100.00	%			1,319,894				100.00	%
Unearned income			(517	)							(480	)
Total loans, net of unearned income			1,383,539								1,319,414
Allowance for loan losses			(10,927	)							(9,842	)
Total net loans		$	1,372,612							$	1,309,572

 

In the context of this discussion, a "real estate mortgage loan" is defined as any loan secured by real estate, other than a loan for construction purposes, regardless of the purpose of the loan. It is common practice for financial institutions in our market areas, and for us in particular, to obtain a security interest in or lien on real estate whenever possible, in addition to any other available collateral. This collateral is taken to increase the likelihood of the ultimate repayment of the loan. This practice tends to increase the magnitude of the real estate loan portfolio. In many cases, we prefer real estate collateral to many other potential collateral sources, such as accounts receivable, inventory and equipment.

 

The principal component of our loan portfolio is loans secured by real estate. At March 31, 2016, this category totaled $1.1 billion and represented 79.3% of our total loan portfolio, compared to $1.0 billion, or 78.4% of the total loan portfolio, at December 31, 2015. Each category of real estate mortgage loans increased during the first three months of 2016.

 

Loans secured by nonfarm nonresidential properties (“commercial mortgage loans”) increased by $32.4 million, or 6.4%, to $541.6 million at March 31, 2016, compared to $509.2 million at December 31, 2015. Commercial mortgage loans comprise the single largest category of our loans, and at March 31, 2016, accounted for 39.1% of our entire loan portfolio. Our management team has a great deal of experience and expertise in commercial mortgages, and this loan type has traditionally comprised a large portion of our loan portfolio. Of the $541.6 million in total commercial mortgage loans at March 31, 2016, approximately $229.1 million were loans secured by owner-occupied properties.

 

 

Residential mortgage loans increased by $6.5 million, or 2.0%, to $340.3 million at March 31, 2016, compared to $333.8 million at December 31, 2015. At March 31, 2016, residential mortgages accounted for 24.6% of our entire loan portfolio.

 

Real estate construction loans totaled $166.7 million at March 31, 2016, an increase of 9.1% from $152.9 million at December 31, 2015. At March 31, 2016, this loan type accounted for 12.1% of our total loan portfolio.

 

Factored commercial receivables totaled $74.2 million at March 31, 2016, compared to $67.6 million at December 31, 2015. This balance fluctuates based on several variables, such as when receivables are purchased and when and how quickly payments are received.

 

Allowance for Loan Losses, Provision for Loan Losses and Asset Quality

 

Allowance for Loan Losses and Provision for Loan Losses

 

The allowance for loan losses represents our estimate of probable inherent credit losses in our loan portfolio. We determine the allowance based on an ongoing evaluation of risk as it correlates to potential losses within the portfolio. Increases to the allowance are made by charges to the provision for loan losses. Loans deemed to be uncollectible are charged against the allowance. Recoveries of previously charged-off amounts are credited to the allowance for loan losses.

 

In determining the amount of the allowance, we utilize our risk department’s independent analysis of the minimum required loan loss reserve for the Bank. In this analysis, problem loans are reviewed for impairment or for loss exposure based on their payment performance and probability of default and the value of any collateral securing the loan. These totals are specifically allocated to the reserve. The loan portfolio is then divided into various homogeneous risk pools utilizing a combination of collateral codes and/or loan purpose codes and internal risk ratings. Historical losses are used to estimate the probable loss in the current portfolio based on both an average loss methodology and a migration loss methodology. The methodologies and the time periods considered are subjective and vary for each risk pool based on systematic risk relative to our ability to estimate losses for that risk pool. Because every loan has a risk of loss, the calculation begins with a minimum loss allocation for each loan pool. The minimum loss is estimated based on long-term trends for the Bank, the banking industry and the economy. A minimum loss allocation is similarly applied to letters of credit and unused lines of credit. Loss allocations are adjusted for changes in the economy, problem loans, payment performance, loan policy, management, credit administration systems, credit concentrations, loan growth and other elements over the time periods utilized in the methodology. The adjusted loss allocations are then applied to the current balances in their respective loan pools. Loss allocations are totaled, yielding the required allowance for loan losses.

 

 

We incorporate the data from the allowance calculation with interim changes to that data in our ongoing determination of the allowance for loan losses. We then take into consideration other factors that may support an allowance in excess of required minimums. These factors include systems changes, historically high loan growth, changes in the economy and company management and lending practices at the time at which the loans were made. We believe that the data that we use in determining the allowance for loan losses is sufficient to estimate the potential losses in the loan portfolio; however, actual results could differ from management’s estimates.

 

The following table presents a summary of changes in the allowance for loan losses for the periods indicated.

 

ALLOWANCE FOR LOAN LOSSES

 

		For the Three Months Ended
		March 31,
(Dollars in thousands)		2016				2015
Total loans oustanding, net of unearned income		$	1,383,539			$	920,740
Average loans oustanding, net of unearned income		$	1,352,737			$	903,563
Allowance for loan losses at beginning of period		$	9,842			$	9,802
Charge-offs:
Loans secured by real estate			-				332
Commercial and industrial loans			-				-
Factored receivables			888				566
Consumer loans			27				-
All other loans			1				1
Total charge-offs			916				899
Recoveries:
Loans secured by real estate			50				32
Commercial and industrial loans			6				7
Factored receivables			400				406
Consumer loans			4				-
All other loans			8				13
Total recoveries			468				458
Net charge-offs			448				441
Provision for loan losses			1,533				161
Allowance for loan losses at period end		$	10,927			$	9,522
Allowance for loan losses to period end loans			0.79	%			1.03	%
Net charge-offs to average loans			0.13	%			0.20	%

 

The table above does not include the allowances of United Legacy Bank (”United”) or RBF that were established prior the banks’ respective dates of acquisition. In accordance with ASC Topic 805, Business Combinations, United’s and RBF’s allowances for loan losses were not brought forward at acquisition; instead, the acquired loans were recorded at fair value, and any discount to fair value was recorded against the loans rather than as an allowance for loan losses. The portion of the discount deemed related to credit quality was recorded as a non-accretable difference, and the remaining discount was recorded as an accretable discount and accreted into interest income over the estimated average life of the loans using the level yield method. At March 31, 2016, United’s and RBF’s acquired loan portfolios totaled $366.5 million and had an aggregate related non-accretable difference of $5.8 million and accretable discount of $3.7 million.

 

For the acquired loan portfolio, the allowance is determined for each loan pool and compared to the remaining discount for that pool. If the allowance amount calculated under the Company’s methodology is greater than the Company’s remaining discount, this amount is added to the reported allowance through a provision for loan losses. If the allowance amount calculated under the Company’s methodology is less than the Company’s recorded discount, no additional allowance or provision is recognized. Our analysis indicates that no additional allowance is necessary on our acquired loan portfolio.

 

Overall, asset quality indicators have remained steady, and, as a result, provision expense has been minimal. However, during the three months ended March 31, 2016, we recorded a provision expense of $1.5 million due to charge-offs of $488 thousand at Corporate Billing, strong loan growth during the first three months of 2016, and uncertainty in the national economy and the resulting impact on our local markets.     

 

Allocation of the Allowance for Loan Losses

 

While no portion of the allowance is in any way restricted to any individual loan or group of loans and the entire allowance is available to absorb losses from any and all loans, the following table represents management’s allocation of the allowance for loan losses to specific loan categories as of the dates indicated.

 

 

ALLOCATION OF ALLOWANCE FOR LOAN LOSSES

 

		As of
(Dollars in thousands)		March 31, 2016								December 31, 2015
		Amount				Percent of Loans in each Category to Total Loans				Amount				Percent of Loans in each Category to Total Loans
Commercial, financial and agricultural		$	1,801				13.90	%		$	1,345				14.91	%
Factored receivables			500				5.36				500				5.12
Real estate - mortgage			6,495				67.27				5,525				66.79
Real estate - construction			1,964				12.05				1,412				11.58
Consumer			167				1.42				236				1.60
Unallocated			-				-				824				-
		$	10,927				100.00	%		$	9,842				100.00	%

 

Our allowance for loan losses is composed of general reserves and specific reserves. General reserves are determined by applying loss percentages to each segment of our portfolio based on that segment’s historical loss experience and adjustment factors derived from internal and external environmental conditions. All loans considered to be impaired are evaluated on an individual basis to determine specific reserve allocations in accordance with U.S. GAAP. Loans for which specific reserves are provided are excluded from the calculation of general reserves.

 

Nonperforming Assets

 

The following table presents our nonperforming assets as of the dates indicated.

 

NONPERFORMING ASSETS

 

		As of
		March 31,								December 31,
(Dollars in thousands)		2016				2015				2015
Nonaccrual loans		$	3,801			$	3,194			$	3,695
Loans past due 90 days or more and still accruing			452				168				252
Total nonperforming loans			4,253				3,362				3,947
Other real estate and repossessed assets			2,884				2,036				3,965
Total nonperforming assets		$	7,137			$	5,398			$	7,912
Allowance for loan losses to period-end loans			0.79	%			1.03	%			0.75	%
Allowance for loan losses to period-end non performing loans			256.92				283.22				249.35
Net charge-offs to average loans			0.13				0.20				0.11
Nonperforming assets to period-end loans and foreclosed property and repossessed assets			0.51				0.58				0.60
Nonperforming loans to period-end loans			0.31				0.37				0.30

 

Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that the collection of interest is doubtful. In addition to a consideration of these factors, we have a consistent and continuing policy of placing all loans on nonaccrual status if they become 90 days or more past due, excluding factored receivables. For Corporate Billing's factored receivables, which are trade credits rather than promissory notes, our practice is to charge off unpaid recourse receivables when they become 90 days past due from the invoice due date and to charge off unpaid non-recourse receivables when they become 120 days past due from the statement billing date. For the recourse receivables, the amount of the invoice is charged against the client reserve account established for such purposes, unless the client reserve and the client’s financial resources are insufficient, in which case either the amount of the invoice is charged against loans or the balance is considered impaired and the client is responsible for repaying the unpaid obligation of the account debtor. When a loan is placed on nonaccrual status, all accrued interest on the loan is reversed and deducted from earnings as a reduction of reported interest income. No additional interest is accrued on the loan balance until collection of both principal and interest becomes reasonably certain. Payments received while a loan is on nonaccrual status will be applied to the loan’s outstanding principal balance. When a problem loan is resolved, there may ultimately be an actual write-down or charge-off of the principal balance of the loan that would necessitate additional charges to the allowance for loan losses.

 

Total nonperforming assets decreased by $775 thousand to $7.1 million at March 31, 2016, from $7.9 million at December 31, 2015. Asset quality has been and will continue to be a primary focus of management.

 

 

Deposits

 

Deposits, which include noninterest-bearing demand deposits, interest-bearing demand deposits, money market accounts and savings and time deposits, are the primary funding source for the Bank. We offer a variety of products designed to attract and retain customers, with a primary focus on building and expanding client relationships. We continually focus on establishing a comprehensive relationship with consumer and business borrowers, seeking deposits as well as lending relationships.

 

The following table details the composition of our deposit portfolio as of the dates indicated.

 

COMPOSITION OF DEPOSITS

 

		As of
(Dollars in thousands)		March 31, 2016								December 31, 2015
		Amount				Percent of Total				Amount				Percent of Total
Noninterest-bearing demand		$	382,642				25.54	%		$	382,946				25.29	%
Interest-bearing demand			222,271				14.84				202,649				13.38
Savings and money market			597,179				39.86				611,887				40.40
Time less than $100k			78,463				5.24				87,069				5.75
Time equal to or greater than $100k and less than $250k			73,382				4.90				85,151				5.62
Time equal to or greater than $250k			144,260				9.62				144,756				9.56
Total deposits		$	1,498,197				100.00	%		$	1,514,458				100.00	%

 

Total deposits were $1.5 billion at March 31, 2016, a decrease of $16.3 million from December 31, 2015. This decrease was primarily due to an expected withdrawal of year-end temporary deposits during the first three months of 2016, as discussed above. Deposit growth has been a point of emphasis, and additionally we have benefited from uncertainty in the financial markets, which has increased the liquidity of many banks as consumers and businesses look for safe places for liquidity, thereby increasing bank deposits.

 

Other Funding Sources

 

We supplement our deposit funding with wholesale funding when needed for balance sheet planning or when the terms are attractive and will not disrupt our offering rates in our markets. One of our primary sources of wholesale funding is the Federal Home Loan Bank of Atlanta (“FHLB”). We had FHLB borrowings of $7.0 million and $22.0 million at March 31, 2016 and December 31, 2015, respectively. During the first three months of 2016, a $15.0 million advance matured. We have not initiated any additional borrowings from the FHLB since 2012. During 2014, we issued $48.9 million of brokered deposits to fund a portion of the assets acquired in the CBI transaction. Several of these brokered deposits have matured, and as of March 31, 2016, we had $34.4 million of brokered deposits outstanding. Another funding source that we have used to supplement our local funding is internet certificates of deposit. We have used this source to book certificates of deposit that mature in three to five years at rates that are lower than we would offer in our local markets, typically below the rates indicated on the LIBOR swap curve for similar maturities. We had internet certificates of deposit balances of $5.7 million and $12.3 million at March 31, 2016 and December 31, 2015, respectively. The decrease during the first three months of 2016 was primarily due to maturities.

 

Liquidity

 

Market and public confidence in our financial strength and in financial institutions generally affects our access to appropriate levels of liquidity. This confidence is significantly dependent on our ability to maintain sound asset quality and appropriate levels of capital reserves.

 

Liquidity is defined as the ability to meet anticipated customer demands for funds under credit commitments and deposit withdrawals at a reasonable cost and on a timely basis. We measure our liquidity position by giving consideration to both on-and off-balance sheet sources of and demands for funds on a daily, weekly and monthly basis.

 

 

Liquidity risk involves the risk of being unable to fund assets with the appropriate duration and rate-based liabilities, as well as the risk of not being able to meet our cash needs as they arise. Liquidity planning and management are necessary to ensure the ability to fund operations in a cost-effective manner and to meet current and future potential obligations, such as loan commitments, lease obligations and deposit outflows. In this process, we focus on both assets and liabilities and on the manner in which they collectively contribute to provide adequate liquidity to meet our needs.

 

Funds are available from a number of basic banking activity sources, including our core deposit base, the repayment and maturity of loans and investment security cash flows. Other funding sources include federal funds purchased, brokered certificates of deposit and borrowings from the FHLB.

 

Cash and cash equivalents at March 31, 2016 and December 31, 2015 were $123.9 million and $212.5 million, respectively. Based on the balance of cash and cash equivalents, we believe that our liquidity resources were sufficient at March 31, 2016 to fund loans and meet our other cash needs as necessary.

 

Contractual Obligations

 

While our liquidity monitoring and management considers both present and future demands for and sources of liquidity, the following table of contractual commitments focuses only on future obligations.

 

CONTRACTUAL OBLIGATIONS
As of March 31, 2016
(Dollars in thousands)		Due in 1 year or less				Due after 1 through 3 years				Due after 3 through 5 years				Due after 5 years				Total
Federal Home Loan Bank advances		$	-			$	5,000			$	2,000			$	-			$	7,000
Certificates of deposit of less than $100k			45,652				27,626				5,185				-				78,463
Certificates of deposit of $100k or more			136,839				48,441				32,362				-				217,642
Operating leases			1,007				1,488				952				2,820				6,267
Total contractual obligations		$	183,498			$	82,555			$	40,499			$	2,820			$	309,372

 

Off-Balance Sheet Arrangements

 

We are a party to credit-related financial instruments with off-balance sheet risks in the normal course of business in order to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of amounts recorded on our balance sheet. Our exposure to credit loss is represented by the contractual amounts of these commitments. We follow the same credit policies in making these types of commitments as we do for on-balance sheet instruments.

 

Our off-balance sheet arrangements are summarized in the following table as of the dates indicated.

 

CREDIT EXTENSION COMMITMENTS
		As of
		March 31, 2016				December 31, 2015
(Dollars in thousands)		Amount				Amount
Unfunded lines		$	307,743			$	311,424
Letters of credit			10,525				10,206
Total credit extension commitments		$	318,268				321,630

 

 

Interest Sensitivity and Market Risk

 

Interest Sensitivity

 

We monitor and manage the pricing and maturity of our assets and liabilities in order to diminish the potential adverse impact that changes in interest rates could have on our net interest income. The principal monitoring technique that we employ is simulation analysis, as augmented by a “gap” analysis.

 

In simulation analysis, we review each individual asset and liability category and its projected behavior in various interest rate environments. These projected behaviors are based on our past experiences and on current competitive environments in the markets in which we compete. Using this projected behavior and differing rate scenarios as inputs, the simulation analysis generates projections of net interest income. We also periodically verify the validity of this approach by comparing actual results with those that were projected in previous models.

 

Another technique used in interest rate management, but to a lesser degree than simulation analysis, is the measurement of the interest sensitivity "gap," which is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time. Interest rate sensitivity can be managed by repricing assets and liabilities, selling securities available for sale or trading securities, replacing an asset or liability at maturity or adjusting the interest rate during the life of an asset or liability.

 

We evaluate interest rate sensitivity risk and then formulate guidelines regarding asset generation and repricing and sources and prices of off-balance sheet commitments in order to decrease interest sensitivity risk. We use computer simulations to measure the net income effect of various interest rate scenarios. The modeling reflects interest rate changes and the related impact on net income over specified periods of time.

 

The following table illustrates our interest rate sensitivity at March 31, 2016, assuming that the relevant assets and liabilities are collected and paid, respectively, based on historical experience rather than their stated maturities.

 

INTEREST SENSITIVITY ANALYSIS
As of March 31, 2016
(Dollars in thousands)
Interest-earning assets		0-1 Mos				1-3 Mos				3-12 Mos				1-3 Yrs				3-5 Yrs				> 5 Yrs				Total
Loans (1)		$	691,237				36,871				122,457				244,126				228,985				72,392				1,396,068
Securities			4,394				3,027				4,927				16,056				11,016				43,534				82,954
Cash balances in other banks			107,685				-				-				-				-				-				107,685
Funds sold			-				-				-				-				-				-				-
Total interest-earning assets		$	803,316				39,898				127,384				260,182				240,001				115,926				1,586,707
Interest-bearing liabilities
Interest-bearing transactions accounts		$	91,828				5,934				26,700				46,581				21,960				29,268				222,271
Savings and money market deposits			354,343				7,494				33,720				85,165				2,570				113,887				597,179
Time deposits			7,975				63,155				111,116				76,066				37,548				245				296,105
Federal Home Loan Bank and other borrowed money			-				-				-				7,000				-				-				7,000
Total interest-bearing liabilities		$	454,146				76,583				171,536				214,812				62,078				143,400				1,122,555
Interest sensitivity gap
Period gap		$	349,170				(36,685	)			(44,152	)			45,370				177,923				(27,474	)			464,152
Cumulative gap			349,170				312,485				268,333				313,703				491,626				464,152
Cumulative gap - Rate-Sensitive Assets/Rate-Sensitive Liabilities			22.01	%			19.69				16.91				19.77				30.98				29.25

 

(1)	Includes mortgage loans held-for-sale

 

We generally benefit from an increase in market rates of interest when we have an asset-sensitive gap (a positive number) and from a decrease in market interest rates when we have a liability-sensitive gap (a negative number). As shown in the table above, we are asset-sensitive on a cumulative basis throughout all timeframes presented. The interest sensitivity analysis presents only a static view of the timing and repricing opportunities, without taking into consideration the fact that changes in interest rates do not affect all assets and liabilities equally. For example, rates paid on a substantial portion of core deposits may change contractually within a relatively short timeframe, but those are viewed by management as significantly less interest-sensitive than market-based rates, such as those paid on non-core deposits. For this and other reasons, we rely more on the simulation analysis (as described above) in managing interest rate risk. Net interest income may be impacted by other significant factors in a given interest rate environment, including changes in the volume and mix of earning assets and interest-bearing liabilities.

 

 

Market Risk

 

Our earnings are dependent, to a large degree, on our net interest income, which is the difference between interest income earned on all earning assets, primarily consisting of loans and securities, and interest paid on all interest-bearing liabilities, primarily consisting of deposits. Market risk is the risk of loss from adverse changes in market prices and interest rates. Our market risk arises primarily from inherent interest rate risk in our lending, investing and deposit-gathering activities. We seek to reduce our exposure to market risk through actively monitoring and managing interest rate risk. Management relies on static “gap” analysis to determine the degree of mismatch in the maturity and repricing distribution of interest-earning assets and interest-bearing liabilities, which quantifies, to a large extent, the degree of market risk inherent in our balance sheet. Gap analysis is further augmented by simulation analysis to evaluate the impact of varying levels of prevailing interest rates and the sensitivity of specific earning assets and interest-bearing liabilities to changes in those prevailing rates. Simulation analysis consists of evaluating the impact on net interest income given changes from 400 basis points below the current prevailing rates to 400 basis points above the current prevailing rates. We make certain assumptions regarding the effect that varying levels of interest rates have on certain earning assets and interest-bearing liabilities, based on both historical experience and consensus estimates of outside sources.

 

The following table illustrates the results of our simulation analysis to determine the extent to which market risk would affect net interest margin for the next twelve months if prevailing interest rates increased or decreased by the specified amounts from current rates. As described above, this model uses estimates and assumptions regarding the manner in which asset and liability accounts will react to changes in prevailing interest rates. However, to isolate the market risk inherent in the balance sheet, the model assumes that no growth in the balance sheet occurs during the projection period. The model also assumes an immediate and parallel shift in interest rates, which would result in no change in the shape or slope of the interest rate yield curve. Because of the inherent use of these estimates and assumptions in the simulation model to derive this market risk information, the actual results of the future impact of market risk on our net interest margin may (and likely will) differ from those set forth in the table.

 

		MARKET RISK
		Impact on Net Interest Income
Change in prevailing interest rates		As of March 31, 2016				As of December 31, 2015
+400 basis points			19.69	%			21.26	%
+300 basis points			14.79				15.89
+200 basis points			9.81				10.48
+100 basis points			4.79				5.08
0 basis points			-				-
-100 basis points			(3.54	)			(3.85	)
-200 basis points			(9.16	)			(8.95	)
-300 basis points			(13.71	)			(13.17	)
-400 basis points			(17.07	)			(16.96	)

 

Capital Resources

 

Total shareholders’ equity attributable to NCC at March 31, 2016 was $213.8 million, or 12.3% of total assets. At December 31, 2015, total shareholders’ equity attributable to NCC was $209.3 million, or 11.9% of total assets. The increase in shareholders’ equity during the first quarter of 2016 was primarily attributable to net income of $3.8 million and an increase in accumulated other comprehensive income of $266 thousand.

 

 

In July 2013, the Federal Reserve and the OCC issued final rules implementing the Basel III regulatory capital framework, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The final rules took effect for the Company and the Bank on January 1, 2015, subject to a transition period for certain parts of the rules. Among other things, the rules (i) revised the minimum capital requirements and adjusted the prompt corrective action thresholds applicable to financial institutions under the agencies’ jurisdiction, (ii) revised the regulatory capital elements, (iii) added a new common equity Tier 1 capital ratio, (iv) increased the minimum Tier 1 capital ratio requirements and (v) implemented a new capital conservation buffer. The rules also permit certain banking organizations to retain, through a one-time election, the existing treatment for accumulated other comprehensive income. The Company and Bank have made the election to retain the existing treatment for accumulated other comprehensive income.

 

The rules are intended to provide an additional measure of a bank’s capital adequacy by assigning weighted levels of risk to asset categories. Banks are also required to systematically maintain capital against such “off-balance sheet” activities as loans sold with recourse, loan commitments, guarantees and standby letters of credit. These guidelines are intended to strengthen the quality of capital by increasing the emphasis on common equity and restricting the amount of loan loss reserves and other forms of equity, such as preferred stock, that may be included in capital. Certain items, such as goodwill and other intangible assets, are deducted from total capital in arriving at the various regulatory capital measures, such as common equity Tier 1 capital, Tier 1 capital and total risk-based capital. Our objective is to maintain our current status as a “well−capitalized” institution, as that term is defined by the Bank’s regulators. As of March 31, 2016, the Bank was “well-capitalized” under the regulatory framework for prompt corrective action.

 

Under the current regulatory guidelines, banks must meet minimum capital adequacy levels based on both total assets and risk-adjusted assets. All banks are required to maintain a minimum ratio of total capital to risk-weighted assets of 8%, a minimum ratio of Tier 1 capital to risk-weighted assets of 6%, a minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% and a minimum ratio of Tier 1 capital to average assets (“leverage ratio”) of 4%. Adherence to these guidelines has not had an adverse impact on us.

 

The table below calculates and presents regulatory capital based on the regulatory capital ratio requirements under Basel III. As of January 1, 2016, an additional capital conservation buffer has been added to the minimum requirements for capital adequacy purposes and is subject to a three-year phase-in period. The capital conservation buffer will be fully phased-in on January 1, 2019 at 2.5%. A banking organization with a conservation buffer of less than 2.5% (or the required phase-in amount in years prior to 2019) will be subject to limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. The ratios for the Company and Bank are currently sufficient to satisfy the fully phased-in conservation buffer.

 

The following table sets forth selected consolidated capital ratios at March 31, 2016 and December 31, 2015 for both NBC and NCC.

 

CAPITAL ADEQUACY ANALYSIS

 

(Dollars in thousands)		Actual								For Capital Adequacy Purposes								To Be Well-Capitalized Under Prompt Corrective Action Provisions
As of March 31, 2016		Amount				Ratio				Amount				Ratio				Amount				Ratio
Total Capital
(to Risk-Weighted Assets)
NCC		$	166,419				11.97%			$	111,221				8.00%				N/A				N/A
NBC		$	156,456				11.26%				111,124				8.00%			$	138,905				10.00%
Tier 1 Capital
(to Risk-Weighted Assets)
NCC		$	155,492				11.18%			$	83,416				6.00%				N/A				N/A
NBC		$	145,529				10.48%			$	83,343				6.00%			$	111,124				8.00%
Common Equity Tier 1 Capital
(to Risk-Weighted Assets)
NCC		$	155,492				11.18%			$	62,562				4.50%				N/A				N/A
NBC		$	145,529				10.48%			$	62,507				4.50%			$	90,288				6.50%
Tier 1 Capital
(to Average Assets)
NCC		$	155,492				9.13%			$	68,107				4.00%				N/A				N/A
NBC		$	145,529				8.56%			$	67,995				4.00%			$	84,993				5.00%
As of December 31, 2015		Amount				Ratio				Amount				Ratio				Amount				Ratio
Total Capital
(to Risk-Weighted Assets)
NCC		$	161,023				11.91%			$	108,178				8.00%				N/A				N/A
NBC		$	151,386				11.21%				108,085				8.00%			$	135,106				10.00%
Tier 1 Capital
(to Risk-Weighted Assets)
NCC		$	151,181				11.18%			$	81,134				6.00%				N/A				N/A
NBC		$	141,544				10.48%			$	81,064				6.00%			$	108,085				8.00%
Common Equity Tier 1 Capital
(to Risk-Weighted Assets)
NCC		$	151,181				11.18%			$	60,850				4.50%				N/A				N/A
NBC		$	141,544				10.48%			$	60,798				4.50%			$	87,819				6.50%
Tier 1 Capital
(to Average Assets)
NCC		$	151,181				9.68%			$	62,501				4.00%				N/A				N/A
NBC		$	141,544				9.05%			$	62,575				4.00%			$	78,219				5.00%

 

 

Banking regulations limit the amount of dividends that a bank can pay without the prior approval of its regulatory authorities. These restrictions are based on levels of regulatory classified assets, prior years’ net earnings and the ratio of equity capital to assets. The Bank is currently permitted to pay dividends to NCC, subject to safety and soundness requirements and other limitations imposed by law and federal regulatory authorities.

 

  

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

The information required by this item is contained in Part I, Item 2 herein under the heading “Interest Sensitivity and Market Risk.”

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

The Company has carried out an evaluation under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2016, the Company’s disclosure controls and procedures are effective in ensuring that material information relating to the Company that is required to be disclosed in reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the requisite time periods and is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure.

 

Changes in Internal Control Over Financial Reporting

 

There has been no change in the Company’s internal control over financial reporting during the Company’s quarter ended March 31, 2016 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings

 

The Company and its subsidiaries may be involved from time to time in various routine legal proceedings incidental to our respective businesses. Neither the Company nor any of its subsidiaries is currently engaged in any legal proceedings that are expected to have a material adverse effect on our results of operations or financial position.

 

Item 1A. Risk Factors

 

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A, “Risk Factors,” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 that could materially affect the Company’s business, financial condition or future results. The risks described in the Company’s Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known to the Company or that the Company currently deems to be immaterial also may materially adversely affect the Company’s business, financial condition or operating results.

 

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

 

None.

 

Item 3. Defaults Upon Senior Securities

 

None.

 

 

Item 4. Mine Safety Disclosure

 

Not applicable.

 

Item 5. Other Information

 

None.

 

 

Item 6. Exhibits

 

Exhibit Number		Exhibit Description
3.1		Certificate of Incorporation of National Commerce Corporation (incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-4 (File No. 333-198219), filed with the Securities and Exchange Commission on August 18, 2014)
3.1A		Amendment to Certificate of Incorporation of National Commerce Corporation (incorporated by reference to Exhibit 3.1A to the Company’s Annual Report on Form 10-K (File No. 000-55336), filed with the Securities and Exchange Commission on February 20, 2015)
3.2		By-Laws of National Commerce Corporation (incorporated by reference to Exhibit 3.2 to the Company’s Registration Statement on Form S-4 (File No. 333-198219), filed with the Securities and Exchange Commission on August 18, 2014)
31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 and Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 and Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification by Chief Executive Officer pursuant to 18 USC. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101		Interactive Data Files for the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2016

 

 

 

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.

 

			NATIONAL COMMERCE CORPORATION
			(Registrant)
Date: May 6, 2016			/s/ John H. Holcomb, III
			John H. Holcomb, III
			Chief Executive Officer and Chairman of the Board
Date: May 6, 2016			/s/ William E. Matthews, V
			William E. Matthews, V
			Chief Financial Officer and Vice Chairman of the Board

 

 

41