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EX-31 - EXHIBIT 31 - COMMUNITY FINANCIAL CORP /MD/v451016_ex31.htm
EX-32 - EXHIBIT 32 - COMMUNITY FINANCIAL CORP /MD/v451016_ex32.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

x     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended September 30, 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 0-18279

 

The Community Financial Corporation

(Exact name of registrant as specified in its charter)

 

  Maryland 52-1652138  
  (State of other jurisdiction of (I.R.S. Employer  
  incorporation or organization) Identification No.)  

 

  3035 Leonardtown Road, Waldorf, Maryland 20601  
  (Address of principal executive offices) (Zip Code)  

 

(301) 645-5601

(Registrant's telephone number, including area code)

 

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x              No  ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  x              No  ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, 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. (Check one):

 

Large Accelerated Filer  ¨ Accelerated Filer x
Non-accelerated Filer  ¨ Smaller Reporting Company  ¨
(Do not check if a 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  x

 

As of October 27, 2016, the registrant had 4,657,528 shares of common stock outstanding.

 

 

 

 

THE COMMUNITY FINANCIAL CORPORATION

FORM 10-Q

INDEX

 

  Page
PART I - FINANCIAL INFORMATION  
   
Item 1 – Financial Statements (Unaudited)  
   
Consolidated Balance Sheets – September 30, 2016 and December 31, 2015 1
   
Consolidated Statements of Income -  Three and Nine Months Ended September 30, 2016 and 2015 2
   
Consolidated Statements of Comprehensive Income - Three and Nine Months Ended September 30, 2016 and 2015 3
   
Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2016 and 2015 4
   
Notes to Consolidated Financial Statements 6
   
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations 37
   
Item 3 – Quantitative and Qualitative Disclosures about Market Risk 65
   
Item 4 – Controls and Procedures 66
   
PART II - OTHER INFORMATION  
   
Item 1 –    Legal Proceedings 67
   
Item 1A – Risk Factors 67
   
Item 2 –    Unregistered Sales of Equity Securities and Use of Proceeds 67
   
Item 3 –    Defaults Upon Senior Securities 67
   
Item 4 –    Mine Safety Disclosures 67
   
Item 5 –    Other Information 67
   
Item 6 –    Exhibits 67
   
SIGNATURES 68

 

 

 

 

PART 1 - FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS

 

   September 30, 2016   December 31, 2015 
(dollars in thousands)  (Unaudited)     
Assets          
Cash and due from banks  $12,957   $9,059 
Federal funds sold   -    225 
Interest-bearing deposits with banks   1,406    1,855 
Securities available for sale (AFS), at fair value   43,885    35,116 
Securities held to maturity (HTM), at amortized cost   102,956    109,420 
Federal Home Loan Bank (FHLB) and Federal Reserve Bank (FRB) stock - at cost   6,173    6,931 
Loans receivable - net of allowance for loan losses of $9,663 and $8,540   1,041,910    909,200 
Premises and equipment, net   22,758    20,156 
Premises and equipment held for sale   -    2,000 
Other real estate owned (OREO)   8,620    9,449 
Accrued interest receivable   3,604    3,218 
Investment in bank owned life insurance   28,429    27,836 
Other assets   9,176    8,867 
Total Assets  $1,281,874   $1,143,332 
           
Liabilities and Stockholders' Equity          
Liabilities          
Deposits          
Non-interest-bearing deposits  $143,221   $142,771 
Interest-bearing deposits   868,354    764,128 
Total deposits   1,011,575    906,899 
Short-term borrowings   55,500    36,000 
Long-term debt   65,573    55,617 
Guaranteed preferred beneficial interest in junior subordinated debentures (TRUPs)   12,000    12,000 
Subordinated notes - 6.25%   23,000    23,000 
Accrued expenses and other liabilities   10,243    10,033 
Total Liabilities   1,177,891    1,043,549 
           
Stockholders' Equity          
Common stock - par value $.01; authorized - 15,000,000 shares; issued 4,656,989 and 4,645,429 shares, respectively   47    46 
Additional paid in capital   47,107    46,809 
Retained earnings   57,070    53,495 
Accumulated other comprehensive gain (loss)   75    (251)
Unearned ESOP shares   (316)   (316)
Total Stockholders' Equity   103,983    99,783 
Total Liabilities and Stockholders' Equity  $1,281,874   $1,143,332 

 

See notes to Consolidated Financial Statements

 

  1 

 

 

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
(dollars in thousands, except per share amounts )  2016   2015   2016   2015 
Interest and Dividend Income                    
Loans, including fees  $11,460   $10,336   $33,175   $30,886 
Interest and dividends on investment securities   758    661    2,273    1,768 
Interest on deposits with banks   5    5    15    11 
Total Interest and Dividend Income   12,223    11,002    35,463    32,665 
                     
Interest Expense                    
Deposits   1,209    1,068    3,486    3,098 
Short-term borrowings   36    5    123    26 
Long-term debt   834    845    2,422    2,361 
Total Interest Expense   2,079    1,918    6,031    5,485 
                     
Net Interest Income   10,144    9,084    29,432    27,180 
Provision for loan losses   698    501    1,689    1,071 
Net Interest Income After Provision For Loan Losses   9,446    8,583    27,743    26,109 
                     
Noninterest Income                    
Loan appraisal, credit, and miscellaneous charges   60    61    223    209 
Gain on sale of asset   -    -    4    19 
Net gains (losses) on sale of OREO   3    (2)   (440)   (20)
Net gains (losses) on sale of investment securities   -    -    39    (1)
Loss on premises and equipment held for sale   -    (426)   -    (426)
Income from bank owned life insurance   199    206    593    616 
Service charges   580    627    2,050    1,889 
Gain on sale of loans held for sale   -    -    -    104 
Total Noninterest Income   842    466    2,469    2,390 
                     
Noninterest Expense                    
Salary and employee benefits   4,268    4,185    12,617    12,218 
Occupancy expense   597    599    1,822    1,834 
Advertising   290    164    509    450 
Data processing expense   544    475    1,678    1,500 
Professional fees   308    353    1,113    920 
Depreciation of furniture, fixtures, and equipment   206    210    608    615 
Telephone communications   43    56    133    141 
Office supplies   33    38    105    108 
FDIC Insurance   215    197    642    585 
OREO valuation allowance and expenses   203    129    609    682 
Other   604    625    2,007    1,809 
Total Noninterest Expense   7,311    7,031    21,843    20,862 
                     
Income before income taxes   2,977    2,018    8,369    7,637 
Income tax expense   1,014    735    3,060    2,822 
Net Income  $1,963   $1,283   $5,309   $4,815 
Preferred stock dividends   -    -    -    23 
Net Income Available to Common Stockholders  $1,963   $1,283   $5,309   $4,792 
                     
Earnings Per Common Share                    
Basic  $0.43   $0.28   $1.16   $1.03 
Diluted  $0.42   $0.27   $1.15   $1.02 
Cash dividends paid per common share  $0.10   $0.10   $0.30   $0.30 

 

See notes to Consolidated Financial Statements

 

  2 

 

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
(dollars in thousands)  2016   2015   2016   2015 
                 
Net Income  $1,963   $1,283   $5,309   $4,815 
Net unrealized holding gains arising during period, net of tax expense of $13 and $151, and $223 and $201, respectively   21    230    346    308 
Reclassification adjustment for gains included in net income, net of tax expense (benefit) of $0 and $0; $(10) and $0, respectively   -    -    (20)   - 
Comprehensive Income  $1,984   $1,513   $5,635   $5,123 

 

See notes to Consolidated Financial Statements

 

  3 

 

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

 

   Nine Months Ended September 30, 
(dollars in thousands)  2016   2015 
         
Cash Flows from Operating Activities          
Net income  $5,309   $4,815 
Adjustments to reconcile net income to net cash provided by operating activities          
Provision for loan losses   1,689    1,071 
Depreciation and amortization   1,144    1,055 
Provision for loss on premises held for sale   -    426 
Loans originated for resale   -    (4,192)
Proceeds from sale of loans originated for sale   -    4,296 
Gain on sale of loans held for sale   -    (104)
Net loss on the sale of OREO   440    20 
(Gains) losses on sales of  investment securities   (39)   1 
Gain on sale of asset   (4)   (19)
Net amortization of premium/discount on investment securities   395    157 
Increase in OREO valuation allowance   366    447 
Increase in cash surrender of bank owned life insurance   (593)   (617)
Increase in deferred income tax benefit   (417)   (571)
Increase in accrued interest receivable   (386)   (91)
Stock based compensation   240    182 
(Increase) decrease in net deferred loan premiums   1,308    (4)
Increase in accrued expenses and other liabilities   210    1,745 
(Increase) decrease in other assets   (77)   641 
Net Cash Provided by Operating Activities   9,585    9,258 
           
Cash Flows from Investing Activities          
Purchase of AFS investment securities   (15,142)   (2,062)
Proceeds from redemption or principal payments of AFS investment securities   4,404    5,409 
Purchase of HTM investment securities   (12,180)   (23,647)
Proceeds from maturities or principal payments of HTM investment securities   17,618    14,099 
Net decrease (increase) of FHLB and FRB stock   759    (243)
Loans originated or acquired   (298,714)   (180,539)
Principal collected on loans   160,259    150,067 
Purchase of premises and equipment   (3,757)   (2,585)
Proceeds from sale of OREO   2,770    930 
Proceeds from sale of investment securities   3,174    66 
Proceeds from disposal of premises and equipment and other assets   2,015    34 
           
Net Cash Used in Investing Activities   (138,794)   (38,471)

 

  4 

 

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(continued)

 

   Nine Months Ended September 30, 
(dollars in thousands)  2016   2015 
         
Cash Flows from Financing Activities          
Net increase in deposits  $104,676   $12,895 
Proceeds from long-term debt   15,000    - 
Payments of long-term debt   (5,044)   (4,041)
Net increase in short term borrowings   19,500    12,000 
Proceeds from subordinated notes   -    23,000 
Redemption of Small Business Lending Fund Preferred Stock   -    (20,000)
Dividends paid   (1,362)   (1,456)
Net change in unearned ESOP shares   -    (28)
Repurchase of common stock   (337)   (448)
Net Cash Provided by Financing Activities   132,433    21,922 
Increase (Decrease) in Cash and Cash Equivalents  $3,224   $(7,291)
           
Cash and Cash Equivalents - January 1   11,139    21,373 
Cash and Cash Equivalents - September 30  $14,363   $14,082 
           
Supplemental Disclosures of Cash Flow Information          
Cash paid during the period for          
Interest  $6,253   $5,276 
Income taxes  $2,875   $2,518 
           
Supplemental Schedule of Non-Cash Operating Activities          
Issuance of common stock for payment of compensation  $575   $216 
Transfer from loans to OREO  $3,119   $1,947 
Transfer from OREO to loans  $1,830   $- 
Transfer of OREO to premises and equipment  $372   $- 
Transfer from premises and equipment to premises and equipment held for sale  $-   $2,000 

 

See notes to Consolidated Financial Statements

 

  5 

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

NOTE 1 – BASIS OF PRESENTATION

 

The consolidated financial statements of The Community Financial Corporation (the “Company”) and its wholly owned subsidiary, Community Bank of the Chesapeake (the “Bank”), and the Bank’s wholly owned subsidiary, Community Mortgage Corporation of Tri-County, included herein are unaudited.

 

The consolidated financial statements reflect all adjustments consisting only of normal recurring accruals that, in the opinion of management, are necessary to present fairly the Company’s financial condition, results of operations, and cash flows for the periods presented. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The Company believes that the disclosures are adequate to make the information presented not misleading. The balances as of December 31, 2015 have been derived from audited financial statements. There have been no significant changes to the Company’s accounting policies as disclosed in the 2015 Annual Report. The results of operations for the three and nine months ended September 30, 2016 are not necessarily indicative of the results of operations to be expected for the remainder of the year or any other period. Certain previously reported amounts have been restated to conform to the 2016 presentation.

 

These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s 2015 Annual Report.

 

NOTE 2 – NATURE OF BUSINESS

 

The Company provides a variety of financial services to individuals and businesses through its offices in Southern Maryland and Fredericksburg, Virginia. Its primary deposit products are demand, savings and time deposits, and its primary lending products are commercial and residential mortgage loans, commercial loans, construction and land development loans, home equity and second mortgages and commercial equipment loans.

 

The Bank conducts business through its main office in Waldorf, Maryland, and eleven branch offices in Waldorf, Bryans Road, Dunkirk, Leonardtown, La Plata, Charlotte Hall, Prince Frederick, Lusby, California, Maryland; and Fredericksburg, Virginia. The Company maintains five loan production offices (“LPOs”) in Annapolis, La Plata, Prince Frederick and Leonardtown, Maryland; and Fredericksburg, Virginia. The Leonardtown and Fredericksburg LPOs are co-located with branches. The Company’s second branch in Fredericksburg opened in April 2016.

 

The Company sold its King George, Virginia branch building and equipment to a credit union. The Company’s 2015 third quarter operating results reflect the financial impact of the transaction. The Company recorded an impairment of $426,000 during the third quarter of 2015. The transaction closed on January 28, 2016.

 

NOTE 3 – INCOME TAXES

 

The Company files a consolidated federal income tax return with its subsidiaries. Deferred tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws and when it is considered more likely than not that deferred tax assets will be realized. It is the Company’s policy to recognize accrued interest and penalties related to unrecognized tax benefits as a component of tax expense.

 

  6 

 

 

NOTE 4 – ACCUMULATED OTHER COMPREHENSIVE GAIN (LOSS)

 

The following tables present the components of comprehensive gain for the three and nine months ended September 30, 2016 and 2015. The Company’s “other comprehensive” gain was solely related to securities for the three and nine months ended September 30, 2016 and 2015.

 

 

  

Three Months Ended

September 30, 2016

  

Three Months Ended

September 30, 2015

 
(dollars in thousands)  Before Tax   Tax Effect   Net of Tax   Before Tax   Tax Effect   Net of Tax 
Net unrealized holding gains arising during period  $34   $13   $21   $381   $151   $230 
 Reclassification adjustments   -    -    -    -    -    - 
Other comprehensive gain  $34   $13   $21   $381   $151   $230 

 

   Nine Months Ended September 30, 2016   Nine Months Ended September 30, 2015 
(dollars in thousands)  Before Tax   Tax Effect   Net of Tax   Before Tax   Tax Effect   Net of Tax 
Net unrealized holding gains arising during period  $569   $223   $346   $509   $201   $308 
 Reclassification adjustments   (30)   (10)   (20)   -    -    - 
Other comprehensive gain  $539   $213   $326   $509   $201   $308 

 

The following table presents the changes in each component of accumulated other comprehensive gain (loss), net of tax, for the three and nine months ended September 30, 2016 and 2015.

 

   Three Months
Ended
September 30,
2016
   Three Months
Ended
September 30,
2015
   Nine Months
Ended
September 30,
2016
   Nine Months
Ended
September 30,
2015
 
(dollars in thousands)  Net Unrealized
Gains And Losses
   Net Unrealized
Gains And Losses
   Net Unrealized
Gains And Losses
   Net Unrealized
Gains And Losses
 
                 
Beginning of period  $54   $(300)  $(251)  $(378)
Other comprehensive gains (losses), net of tax before reclassifications   21    230    346    308 
Amounts reclassified from accumulated other comprehensive income   -    -    (20)   - 
Net other comprehensive gain (loss)   21    230    326    308 
End of period  $75   $(70)  $75   $(70)

 

NOTE 5 – EARNINGS PER SHARE (“EPS”)

 

Basic earnings per common share represent income available to common shareholders, divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate to outstanding stock options and are determined using the treasury stock method. At September 30, 2016 and 2015, there were 20,911 and 87,436 options, respectively, which were excluded from the calculation as their effect would be anti-dilutive, because the exercise price of the options were greater than the average market price of the common shares. The Company has not granted any stock options since 2007 and all options outstanding at September 30, 2016 were anti-dilutive. Unvested restricted stock is excluded from the calculation of basic earnings per share. At September 30, 2016 and 2015 there were 47,881 and 37,048 unvested shares of restricted stock.

 

  7 

 

 

Basic and diluted earnings per share have been computed based on weighted-average common and common equivalent shares outstanding as follows:

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
(dollars in thousands)  2016   2015   2016   2015 
Net Income  $1,963   $1,283   $5,309   $4,815 
Less: dividends paid and accrued on preferred stock   -    -    -    (23)
Net income available to common shareholders  $1,963   $1,283   $5,309   $4,792 
                     
Average number of common shares outstanding   4,590,664    4,646,702    4,591,926    4,651,383 
Dilutive effect of common stock equivalents   31,915    37,048    29,702    37,048 
Average number of shares used to calculate diluted EPS   4,622,579    4,683,750    4,621,628    4,688,431 

 

NOTE 6 – STOCK-BASED COMPENSATION

 

The Company has stock-based incentive arrangements to attract and retain key personnel. In May 2015, the 2015 Equity Compensation Plan (the “Plan”) was approved by shareholders, which authorizes the issuance of restricted stock, stock appreciation rights, stock units and stock options to the Board of Directors and key employees. Compensation expense for service-based awards is recognized over the vesting period. Performance-based awards are recognized based on a vesting schedule and the probability of achieving goals specified at the time of the grant. The 2015 Plan replaced the 2005 Equity Compensation Plan.

 

Stock-based compensation expense totaled $80,000 and $240,000 for the three and nine months ended September 30, 2016 and $61,000 and $182,000 for the three and nine months ended September 30, 2015. Stock-based compensation expense consisted of the vesting of grants of restricted stock.

 

All outstanding options are fully vested and the Company has not granted any stock options since 2007. All outstanding options as of September 30, 2016 expire on July 17, 2017. The fair value of the Company’s outstanding employee stock options is estimated on the date of grant using the Black-Scholes option pricing model. The Company estimates expected market price volatility and expected term of the options based on historical data and other factors.

 

The exercise price for options granted is set at the discretion of the committee administering the Plan, but is not less than the market value of the shares as of the date of grant. An option’s maximum term is 10 years and the options vest at the discretion of the committee.  

 

The following tables below summarize outstanding and exercisable options at September 30, 2016 and December 31, 2015.

 

       Weighted       Weighted-Average 
       Average   Aggregate   Contractual Life 
       Exercise   Intrinsic   Remaining In 
(dollars in thousands, except per share amounts)  Shares   Price   Value   Years 
                     
Outstanding at January 1, 2016   21,211   $27.70   $-      
Forfeited   (300)   27.70           
                     
Outstanding at September 30, 2016   20,911   $27.70   $-    0.8 
                     
Exercisable at September 30, 2016   20,911   $27.70   $-    0.8 

 

  8 

 

 

       Weighted       Weighted-Average 
       Average   Aggregate   Contractual Life 
       Exercise   Intrinsic   Remaining In 
(dollars in thousands, except per share amounts)  Shares   Price   Value   Years 
                 
Outstanding at January 1, 2015   87,436   $23.60   $-      
Expired   (66,225)   22.29           
                     
Outstanding at December 31, 2015   21,211   $27.70   $-    1.5 
                     
Exercisable at December 31, 2015   21,211   $27.70   $-    1.5 

 

Options outstanding are all currently exercisable and are summarized as follows: 

 

Shares Outstanding   Weighted Average  Weighted Average 
September 30, 2016   Remaining Contractual Life  Exercise Price 
 20,911   less than 1 year  $27.70 

  

The aggregate intrinsic value of outstanding stock options and exercisable stock options was $0 at September 30, 2016 and December 31, 2015, respectively because all options outstanding were anti-dilutive.

 

The Company granted restricted stock and stock units in accordance with the Plan. The vesting period for outstanding granted restricted stock is between three and five years. As of September 30, 2016, unrecognized stock compensation expense was $1.1 million. The following tables summarize the unvested restricted stock awards outstanding at September 30, 2016 and December 31, 2015, respectively.

 

   Restricted Stock 
         
   Number of Shares  

Weighted

Average Grant

Date Fair Value

 
         
Nonvested at January 1, 2016   37,048   $19.83 
Granted   27,403    21.00 
Vested   (15,912)   20.09 
Cancelled   (658)   20.31 
           
Nonvested at September 30, 2016   47,881   $20.41 

 

   Restricted Stock 
   Number of Shares   Weighted
  Average Grant
Date Fair Value
 
         
Nonvested at January 1, 2015  29,472   $20.83 
Granted   28,040    18.63 
Vested   (20,464)   19.62 
           
Nonvested at December 31, 2015   37,048   $19.83 

 

 

  9 

 

 

NOTE 7 – GUARANTEED PREFERRED BENEFICIAL INTEREST IN JUNIOR SUBORDINATED DEBENTURES (“TRUPs”)

 

On June 15, 2005, Tri-County Capital Trust II (“Capital Trust II”), a Delaware business trust formed, funded and wholly owned by the Company, issued $5.0 million of variable-rate capital securities in a private pooled transaction. The variable rate is based on the 90-day LIBOR rate plus 1.70%. The Trust used the proceeds from this issuance, along with the $155,000 for Capital Trust II’s common securities, to purchase $5.2 million of the Company’s junior subordinated debentures. The interest rate on the debentures and the trust preferred securities is variable and adjusts quarterly. These capital securities qualify as Tier I capital and are presented in the Consolidated Balance Sheets as “Guaranteed Preferred Beneficial Interests in Junior Subordinated Debentures.” Both the capital securities of Capital Trust II and the junior subordinated debentures are scheduled to mature on June 15, 2035, unless called by the Company.

 

On July 22, 2004, Tri-County Capital Trust I (“Capital Trust I”), a Delaware business trust formed, funded and wholly owned by the Company, issued $7.0 million of variable-rate capital securities in a private pooled transaction. The variable rate is based on the 90-day LIBOR rate plus 2.60%. The Trust used the proceeds from this issuance, along with the Company’s $217,000 capital contribution for Capital Trust I’s common securities, to purchase $7.2 million of the Company’s junior subordinated debentures. The interest rate on the debentures and the trust preferred securities is variable and adjusts quarterly. These debentures qualify as Tier I capital and are presented in the Consolidated Balance Sheets as “Guaranteed Preferred Beneficial Interests in Junior Subordinated Debentures.” Both the capital securities of Capital Trust I and the junior subordinated debentures are scheduled to mature on July 22, 2034, unless called by the Company.

 

NOTE 8 – SUBORDINATED NOTES

 

On February 6, 2015 the Company issued $23.0 million of unsecured 6.25% fixed to floating rate subordinated notes due February 15, 2025 (“subordinated notes”). On February 13, 2015, the Company used proceeds of the offering to redeem all $20 million of the Company’s outstanding preferred stock issued under the Small Business Lending Fund (“SBLF”) program. The subordinated notes qualify as Tier 2 regulatory capital and replaced SBLF Tier 1 capital. The subordinated notes are not listed on any securities exchange or included in any automated dealer quotation system and there is no market for the notes. The notes are unsecured obligations and are subordinated in right of payment to all existing and future senior debt, whether secured or unsecured. The notes are not guaranteed obligations of any of the Company’s subsidiaries.

 

Interest will accrue at a fixed per annum rate of 6.25% from and including the issue date to but excluding February 15, 2020. From and including February 15, 2020 to but excluding the maturity date interest will accrue at a floating rate equal to the three-month LIBOR plus 479 basis points. Interest is payable on the notes on February 15 and August 15 of each year, commencing August 15, 2015, through February 15, 2020, and thereafter February 15, May 15, August 15 and November 15 of each year through the maturity date or earlier redemption date.

 

The subordinated notes may be redeemed in whole or in part on February 15, 2020 or on any scheduled interest payment date thereafter and upon the occurrence of certain special events. The redemption price is equal to 100% of the principal amount of the subordinated notes to be redeemed plus accrued and unpaid interest to the date of redemption. Any partial redemption will be made pro rata among all holders of the subordinated notes. The subordinated notes are not subject to repayment at the option of the holders. The subordinated notes may be redeemed at any time, if (1) a change or prospective change in law occurs that could prevent the Company from deducting interest payable on the notes for U.S. federal income tax purposes, (2) a subsequent event occurs that precludes the notes from being recognized as Tier 2 Capital for regulatory capital purposes, or (3) the Company is required to register as an investment company under the Investment Company Act of 1940, as amended.

 

  10 

 

 

NOTE 9 – OTHER REAL ESTATE OWNED (“OREO”)

 

OREO assets are presented net of valuation allowances. The Company considers OREO as classified assets for regulatory and financial reporting. An analysis of OREO activity follows.

 

   Nine Months Ended September 30,  

Year Ended

December 31,

 
(dollars in thousands)  2016   2015   2015 
Balance at beginning of year  $9,449   $5,883   $5,883 
Additions of underlying property   3,120    1,946    5,436 
Disposals of underlying property   (3,583)   (951)   (1,206)
Valuation allowance   (366)   (447)   (664)
Balance at end of period  $8,620   $6,431   $9,449 

 

During the nine months ended September 30, 2016, additions of $3.1 million consisted of $977,000 for three residential properties and $2.1 million for a deed in lieu of foreclosure on an improved commercial office building with multiple tenants. The commercial office building was taken into OREO at fair value of the loan during the three months ended March 31, 2016 and had a ratified contract for its sale. That contract was voided during the second quarter of 2016. The Company plans to manage the property until its sale and will recognize miscellaneous rental income during the ownership and management of the property. During the nine months ended September 30, 2015, additions of $1.9 million consisted of $784,000 for five residential properties, $372,000 for three residential lots and $790,000 for commercial buildings.

 

The Company recognized net losses on OREO disposals of $440,000 for the nine months ended September 30, 2016. Disposals for the nine months ended September 30, 2016 consisted of properties with the following carrying values; $106,000 for three residential lots, $166,000 for one residential property, $875,000 for three commercial properties, $138,000 for a commercial lot and $2.2 million for an apartment and condominium property. The Bank provided financing for the apartment and condominium purchase which was transferred from OREO to loans during the second quarter of 2015. The transaction qualified for full accrual sales treatment under ASC Topic 360-20-40 “Property Plant and Equipment – Derecognition”. The Company disposed of three residential properties and three finished residential lots at a loss of $20,000 for the nine months ended September 30, 2015.

 

Additions to the valuation allowances of $366,000 and $447,000 were taken to adjust properties to current appraised values for the nine months ended September 30, 2016 and 2015, respectively. OREO carrying amounts reflect management’s estimate of the realizable value of these properties incorporating current appraised values, local real estate market conditions and related costs. Expenses applicable to OREO assets include the following.

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
(dollars in thousands)  2016   2015   2016   2015 
Valuation allowance  $104   $73   $366   $447 
Operating expenses   99    56    243    235 
   $203   $129   $609   $682 

 

  11 

 

 

NOTE 10 – SECURITIES

 

   September 30, 2016 
   Amortized   Gross Unrealized   Gross Unrealized   Estimated 
(dollars in thousands)  Cost   Gains   Losses   Fair Value 
Securities available for sale (AFS)                    
Asset-backed securities issued by GSEs and U.S. Agencies                    
Residential Mortgage Backed Securities ("MBS")  $2,473   $28   $-   $2,501 
Residential Collateralized Mortgage Obligations ("CMOs")   31,386    98    141    31,343 
U.S. Agency   5,506    -    27    5,479 
Corporate equity securities   37    -    -    37 
Bond mutual funds   4,359    166    -    4,525 
Total securities available for sale  $43,761   $292   $168   $43,885 
                     
Securities held to maturity (HTM)                    
Asset-backed securities issued by GSEs and U.S. Agencies                    
Residential MBS  $34,092   $1,202   $-   $35,294 
Residential CMOs   61,711    561    63    62,209 
U.S. Agency   2,370    3    4    2,369 
Asset-backed securities issued by Others:                    
Residential CMOs   931    -    85    846 
Total debt securities held to maturity   99,104    1,766    152    100,718 
                     
Callable GSE Agency Bonds   3,002    -    -    3,002 
U.S. government obligations   850    -    -    850 
Total securities held to maturity  $102,956   $1,766   $152   $104,570 

 

   December 31, 2015 
   Amortized   Gross Unrealized   Gross Unrealized   Estimated 
(dollars in thousands)  Cost   Gains   Losses   Fair Value 
Securities available for sale (AFS)                    
Asset-backed securities issued by GSEs                    
Residential MBS  $22   $4   $-   $26 
Residential CMOs   31,182    39    557    30,664 
Corporate equity securities   37    2    -    39 
Bond mutual funds   4,289    98    -    4,387 
Total securities available for sale  $35,530   $143   $557   $35,116 
                     
Securities held to maturity (HTM)                    
Asset-backed securities issued by GSEs                    
Residential MBS  $34,085   $552   $242   $34,395 
Residential CMOs   73,492    278    599    73,171 
Asset-backed securities issued by Others:                    
Residential CMOs   1,093    -    100    993 
Total debt securities held to maturity   108,670    830    941    108,559 
                     
U.S. government obligations   750    -    -    750 
Total securities held to maturity  $109,420   $830   $941   $109,309 
  12 

 

 

At September 30, 2016, certain asset-backed securities with an amortized cost of $34.1 million were pledged to secure certain customer deposits. At September 30, 2016, asset-backed securities with an amortized cost of $1.7 million were pledged as collateral for advances from the Federal Home Loan Bank (“FHLB”) of Atlanta.

 

At September 30, 2016, 99% of the asset-backed securities and agency bond portfolio was rated AAA by Standard & Poor’s or the equivalent credit rating from another major rating agency. AFS asset-backed securities issued by GSEs and U.S. Agencies had an average life of 4.14 years and average duration of 3.84 years and are guaranteed by their issuer as to credit risk. HTM asset-backed securities issued by GSEs and U.S. Agencies had an average life of 4.17 years and average duration of 3.84 years and are guaranteed by their issuer as to credit risk.

 

At December 31, 2015, certain asset-backed securities with an amortized cost of $21.4 million were pledged to secure certain deposits. At December 31, 2015, asset-backed securities with an amortized cost of $1.9 million were pledged as collateral for advances from the Federal Home Loan Bank (“FHLB”) of Atlanta.

 

At December 31, 2015, 99% of the asset-backed securities and agency bond portfolio was rated AAA by Standard & Poor’s or the equivalent credit rating from another major rating agency. AFS asset-backed securities issued by GSEs and U.S. Agencies had an average life of 4.39 years and average duration of 4.04 years and are guaranteed by their issuer as to credit risk. HTM asset-backed securities issued by GSEs and U.S. Agencies and U.S. Agencies had an average life of 5.07 years and average duration of 4.58 years and are guaranteed by their issuer as to credit risk.

 

Management believes that AFS securities with unrealized losses will either recover in market value or be paid off as agreed. The Company intends to, and has the ability to, hold these securities to maturity. Management believes that the losses are the result of general perceptions of safety and creditworthiness of the entire sector and a general disruption of orderly markets in the asset class.

 

Management has the ability and intent to hold the HTM securities with unrealized losses until they mature, at which time the Company will receive full value for the securities. Because management’s intention is not to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, management considers the unrealized losses in the held-to-maturity portfolio to be temporary.

 

No charges related to other-than-temporary impairment were made during for the six months ended September 30, 2016 and the year ended December 31, 2015.

 

During the nine months ended September 30, 2016 the Company recognized net gains on the sale of securities of $39,000. The Company sold three AFS securities with aggregate carrying values of $2.4 million and one HTM security with a carrying value of $698,000, recognizing gains of $31,000 and $8,000, respectively. During the nine months ended September 30, 2015, the Company sold one HTM security with a carrying value of $68,000 and recognized a loss of $1,000.

 

The sale of HTM securities was permitted under ASC 320 “Investments - Debt and Equity Securities.” ASC 320 permits the sale of HTM securities for certain changes in circumstances. The Company will dispose of HTM securities using the safe harbor rule that allows for the sale of HTM securities that have principal payments paid down to less than 15% of original purchased par. ASC 320 10-25-15 indicates that a sale of a debt security after a substantial portion of the principal has been collected is equivalent to holding the security to maturity. In addition, the Company may dispose of HTM securities under ASC 320-10-25-6 due to a significant deterioration in the issues’ creditworthiness.

 

AFS Securities

 

Gross unrealized losses and estimated fair value by length of time that the individual AFS securities have been in a continuous unrealized loss position at September 30, 2016 were as follows:

 

September 30, 2016  Less Than 12   More Than 12         
   Months   Months   Total 
(dollars in thousands)  Fair Value   Unrealized
Loss
   Fair Value   Unrealized
Loss
   Fair Value   Unrealized
Losses
 
Asset-backed securities issued by GSEs and U.S. Agencies  $7,406   $43   $12,781   $125   $20,187   $168 

 

  13 

 

 

At September 30, 2016, the AFS investment portfolio had an estimated fair value of $43.9 million, of which $20.2 million of the securities had some unrealized losses from their amortized cost. The securities with unrealized losses were CMOs issued by GSEs and Small Business Administration bonds.

 

AFS asset-backed securities issued by GSEs are guaranteed by the issuer and AFS U.S. government agency securities and bonds are guaranteed by the full faith and credit of the U.S. government. Total unrealized losses on the portfolio were $168,000 of the portfolio amortized cost of $39.4 million. AFS asset-backed securities issued by GSEs and U.S. Agencies with unrealized losses had an average life of 4.19 years and an average duration of 3.87 years. Management believes that the securities will either recover in market value or be paid off as agreed.

 

Gross unrealized losses and estimated fair value by length of time that the individual AFS securities have been in a continuous unrealized loss position at December 31, 2015 were as follows:

 

December 31, 2015  Less Than 12   More Than 12         
   Months   Months   Total 
(dollars in thousands)  Fair Value   Unrealized
Loss
   Fair Value   Unrealized
Loss
   Fair Value   Unrealized
Losses
 
Asset-backed securities issued by GSEs  $4,658   $28   $17,344   $529   $22,002   $557 

 

At December 31, 2015, the AFS investment portfolio had an estimated fair value of $35.1 million, of which $22.0 million of the securities had some unrealized losses from their amortized cost. The securities with unrealized losses were CMOs issued by GSEs.

 

AFS asset-backed securities issued by GSEs are guaranteed by the issuer and AFS U.S. government agency securities and bonds are guaranteed by the full faith and credit of the U.S. government. Total unrealized losses on the asset-backed securities issued by GSEs were $557,000 of the portfolio amortized cost of $31.2 million. AFS asset-backed securities issued by GSEs and U.S. Agencies with unrealized losses had an average life of 4.45 years and an average duration of 4.04 years. Management believes that the securities will either recover in market value or be paid off as agreed.

 

HTM Securities

 

Gross unrealized losses and estimated fair value by length of time that the individual HTM securities have been in a continuous unrealized loss position at September 30, 2016 were as follows:

 

September 30, 2016  Less Than 12   More Than 12         
   Months   Months   Total 
(dollars in thousands)  Fair Value   Unrealized
Loss
   Fair Value   Unrealized
Loss
   Fair Value   Unrealized
Losses
 
Asset-backed securities issued by GSEs and U.S. Agencies   1,363    4    13,435    63    14,798    67 
Asset-backed securities issued by Others   -    -    846    85    846    85 
   $1,363   $4   $14,281   $148   $15,644   $152 

 

At September 30, 2016, the HTM investment portfolio had an estimated fair value of $104.6 million, of which $15.6 million of the securities had some unrealized losses from their amortized cost. Of these securities, $14.8 million were asset-backed securities issued by GSEs and U.S. Agencies. The remaining $846,000 were asset-backed securities issued by others.

 

HTM asset-backed securities issued by GSEs are guaranteed by the issuer and HTM U.S. government agency securities and bonds are guaranteed by the full faith and credit of the U.S. government. Total unrealized losses on the portfolio were $67,000 of the portfolio amortized cost of $102.0 million. The securities with unrealized losses had an average life of 3.67 years and an average duration of 3.49 years. Management believes that the securities will either recover in market value or be paid off as agreed. The Company intends to, and has the ability to, hold these securities to maturity.

 

  14 

 

 

HTM asset-backed securities issued by others are collateralized mortgage obligation securities. The securities have credit support tranches that absorb losses prior to the tranches that the Company owns. The Company reviews credit support positions on its securities regularly. Total unrealized losses on the asset-backed securities issued by others were $85,000 of the portfolio amortized cost of $931,000. HTM asset-backed securities issued by others with unrealized losses have an average life of 3.96 years and an average duration of 3.14 years.

 

Gross unrealized losses and estimated fair value by length of time that the individual HTM securities have been in a continuous unrealized loss position at December 31, 2015 were as follows:

 

December 31, 2015  Less Than 12   More Than 12         
   Months   Months   Total 
(dollars in thousands)  Fair Value   Unrealized
Loss
   Fair Value   Unrealized
Loss
   Fair Value   Unrealized
Losses
 
Asset-backed securities issued by GSEs  $36,337   $346   $16,431   $495   $52,768   $841 
Asset-backed securities issued by Others   -    -    992    100    992    100 
   $36,337   $346   $17,423   $595   $53,760   $941 

 

At December 31, 2015, the HTM investment portfolio had an estimated fair value of $109.3 million, of which $53.8 million of the securities had some unrealized losses from their amortized cost. Of these securities, $52.8 million were asset-backed securities issued by GSEs and the remaining $992,000 were asset-backed securities issued by others.

 

HTM asset-backed securities issued by GSEs are guaranteed by the issuer and HTM U.S. government agency securities and bonds are guaranteed by the full faith and credit of the U.S. government. Total unrealized losses on the asset-backed securities issued by GSEs were $841,000 of the portfolio amortized cost of $107.6 million. HTM asset-backed securities issued by GSEs and U.S. Agencies with unrealized losses had an average life of 5.42 years and an average duration of 4.78 years. Management believes that the securities will either recover in market value or be paid off as agreed. The Company intends to, and has the ability to, hold these securities to maturity.

 

HTM asset-backed securities issued by others are collateralized mortgage obligation securities. The securities have credit support tranches that absorb losses prior to the tranches that the Company owns. The Company reviews credit support positions on its securities regularly. Total unrealized losses on the asset-backed securities issued by others were $100,000 of the portfolio amortized cost of $1.1 million. HTM asset-backed securities issued by others with unrealized losses have an average life of 4.04 years and an average duration of 3.29 years.

 

Credit Quality of Asset-Backed Securities and Agency Bonds

 

The tables below present the Standard & Poor’s (“S&P”) or equivalent credit rating from other major rating agencies for AFS and HTM asset-backed securities issued by GSEs and U.S. Agencies and others or bonds issued by GSEs or U.S. government agencies at September 30, 2016 and December 31, 2015 by carrying value. The Company considers noninvestment grade securities rated BB+ or lower as classified assets for regulatory and financial reporting. GSE asset-backed securities and GSE agency bonds with S&P AA+ ratings were treated as AAA based on regulatory guidance.

 

September 30, 2016  December 31, 2015
Credit Rating  Amount   Credit Rating  Amount 
(dollars in thousands)
AAA  $141,347   AAA  $138,267 
BB   435   BB   518 
B+   497   B+   - 
CCC+   -   CCC+   575 
Total  $142,279   Total  $139,360 

 

  15 

 

 

NOTE 11 – LOANS

 

Loans consist of the following:

 

(dollars in thousands)  September 30, 2016   %   December 31, 2015   % 
                 
Commercial real estate  $625,504    59.51%  $538,888    58.64%
Residential first mortgages   167,306    15.91%   131,401    14.30%
Residential rentals   99,288    9.44%   93,157    10.14%
Construction and land development   35,475    3.37%   36,189    3.94%
Home equity and second mortgages   21,458    2.04%   21,716    2.36%
Commercial loans   67,334    6.40%   67,246    7.32%
Consumer loans   422    0.04%   366    0.04%
Commercial equipment   34,632    3.29%   29,931    3.26%
    1,051,419    100.00%   918,894    100.00%
Less:                    
Deferred loan fees and premiums   (154)   -0.01%   1,154    0.13%
Allowance for loan losses   9,663    0.92%   8,540    0.93%
    9,509         9,694      
   $1,041,910        $909,200      

 

At September 30, 2016 and December 31, 2015, the Bank’s allowance for loan losses totaled $9.7 million and $8.5 million, respectively or 0.92% and 0.93%, respectively, of loan balances. Management’s determination of the adequacy of the allowance is based on a periodic evaluation of the portfolio with consideration given to the overall loss experience, current economic conditions, size, growth and composition of the loan portfolio, financial condition of the borrowers and other relevant factors that, in management’s judgment, warrant recognition in providing an adequate allowance.

 

Deferred loan fees and premiums include net deferred fees paid by customers of $2.6 million and $2.6 million at September 30, 2016 and December 31, 2015, respectively. These were offset by net deferred premiums paid for the purchase of residential first mortgages and deferred costs of $2.8 million and $1.4 million, respectively, at September 30, 2016 and December 31, 2015.

 

The Company separated residential rentals into a new loan portfolio segment beginning in the second quarter of 2016. Residential rentals include income producing properties secured by 1-4 family units and apartment buildings. The Company’s decision to segregate the residential rental portfolio for financial reporting and valuation purposes was based on the growth and size of the portfolio and risk characteristics unique to residential rental properties.

 

Risk Characteristics of Portfolio Segments

 

The Company manages its credit products and exposure to credit losses (credit risk) by the following specific portfolio segments (classes), which are levels at which the Company develops and documents its allowance for loan loss methodology. These segments are:

 

Commercial Real Estate (“CRE”)

 

Commercial and other real estate projects include office buildings, retail locations, churches, other special purpose buildings and commercial construction. Commercial construction balances were 8.6% and 6.1% of the CRE portfolio at September 30, 2016 and December 31, 2015, respectively. The Bank offers both fixed-rate and adjustable-rate loans under these product lines. The primary security on a commercial real estate loan is the real property and the leases that produce income for the real property. Loans secured by commercial real estate are generally limited to 80% of the lower of the appraised value or sales price at origination and have an initial contractual loan payment period ranging from three to 20 years.

 

Loans secured by commercial real estate are larger and involve greater risks than one-to four-family residential mortgage loans. Because payments on loans secured by such properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy.

 

  16 

 

 

Residential First Mortgages

 

Residential first mortgage loans are generally long-term loans, amortized on a monthly basis, with principal and interest due each month. The contractual loan payment period for residential loans typically ranges from ten to 30 years. The Bank’s experience indicates that real estate loans remain outstanding for significantly shorter time periods than their contractual terms. Borrowers may refinance or prepay loans at their option, without penalty. The Bank’s residential portfolio has both fixed-rate and adjustable-rate residential first mortgages.

  

The annual and lifetime limitations on interest rate adjustments may limit the increases in interest rates on these loans. There are also credit risks resulting from potential increased costs to the borrower as a result of repricing of adjustable-rate mortgage loans. During periods of rising interest rates, the risk of default on adjustable-rate mortgage loans may increase due to the upward adjustment of interest cost to the borrower. The Bank’s adjustable rate residential first mortgage portfolio was $41.4 million or 3.9% of total gross loans of $1.1 billion at September 30, 2016 compared to $18.9 million or 2.1% of gross loans of $918.9 million at December 31, 2015.

 

Residential Rentals

 

Residential rental mortgage loans are amortizing, with principal and interest due each month. The loans are secured by income-producing 1-4 family units and apartments. As of September 30, 2016 and December 31, 2015, $83.3 million and $80.8 million, respectively, were 1-4 family units and $16.0 million and $12.4 million, respectively, were apartment buildings. Loans secured by residential rental properties are generally limited to 80% of the lower of the appraised value or sales price at origination and have an initial contractual loan payment period ranging from three to 20 years. The primary security on a residential rental loan is the property and the leases that produce income.

 

Loans secured by residential rental properties involve greater risks than 1-4 family residential mortgage loans. Although, there are similar risk characteristics shared with commercial real estate loans, the balances for the loans secured by residential rental properties are generally smaller. Because payments on loans secured residential rental properties are often dependent on the successful operation or management of the properties, repayment of these loans may be subject to a greater extent to adverse conditions in the rental real estate market or the economy than similar owner occupied properties.

 

Construction and Land Development

 

The Bank offers loans for the construction of one-to-four family dwellings. Generally, these loans are secured by the real estate under construction as well as by guarantees of the principals involved. In addition, the Bank offers loans to acquire and develop land, as well as loans on undeveloped, subdivided lots for home building.

 

A decline in demand for new housing might adversely affect the ability of borrowers to repay these loans. Construction and land development loans are inherently riskier than providing financing on owner-occupied real estate. The Bank’s risk of loss is affected by the accuracy of the initial estimate of the market value of the completed project as well as the accuracy of the cost estimates made to complete the project. In addition, the volatility of the real estate market has made it increasingly difficult to ensure that the valuation of land associated with these loans is accurate. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the development. If the estimate of value proves to be inaccurate, a project’s value might be insufficient to assure full repayment. As a result of these factors, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the project rather than the ability of the borrower or guarantor to repay principal and interest. If the Bank forecloses on a project, there can be no assurance that the Bank will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.

 

Home Equity and Second Mortgage Loans

 

The Bank maintains a portfolio of home equity and second mortgage loans. These products contain a higher risk of default than residential first mortgages as in the event of foreclosure, the first mortgage would need to be paid off prior to collection of the second mortgage. This risk has been heightened as the market value of residential property has declined.

 

  17 

 

 

Commercial Loans

 

The Bank offers commercial loans to its business customers. The Bank offers a variety of commercial loan products including term loans and lines of credit. Such loans are generally made for terms of five years or less. The Bank offers both fixed-rate and adjustable-rate loans under these product lines. When making commercial business loans, the Bank considers the financial condition of the borrower, the borrower’s payment history of both corporate and personal debt, the projected cash flows of the business, the viability of the industry in which the consumer operates, the value of the collateral, and the borrower’s ability to service the debt from income. These loans are primarily secured by equipment, real property, accounts receivable, or other security as determined by the Bank.

 

Commercial loans are made on the basis of the borrower’s ability to make repayment from the cash flows of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself.

 

Consumer Loans

 

Consumer loans consist of loans secured by automobiles, boats, recreational vehicles and trucks. The Bank also makes home improvement loans and offers both secured and unsecured personal lines of credit. Consumer loans entail greater risk from other loan types due to being secured by rapidly depreciating assets or the reliance on the borrower’s continuing financial stability.

 

Commercial Equipment Loans

 

These loans consist primarily of fixed-rate, short-term loans collateralized by a commercial customer’s equipment. When making commercial equipment loans, the Bank considers the same factors it considers when underwriting a commercial business loan. Commercial loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flows of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. In the case of business failure, collateral would need to be liquidated to provide repayment for the loan. In many cases, the highly specialized nature of collateral equipment would make full recovery from the sale of collateral problematic.

 

  18 

 

 

Non-accrual and Past Due Loans

 

Non-accrual loans as of September 30, 2016 and December 31, 2015 were as follows: 

 

   September 30, 2016 
(dollars in thousands)  90 or Greater
Days
Delinquent
   Number
of Loans
   Non-accrual
Only Loans
   Number
of Loans
   Total
Non-accrual
Loans
   Total
Number
of Loans
 
                         
Commercial real estate  $2,113    7   $-    -   $2,113    7 
Residential first mortgages   371    2    -    -    371    2 
Residential rentals   591    4    -    -    591    4 
Construction and land development   3,611    3    -    -    3,611    3 
Home equity and second mortgages   17    1    -    -    17    1 
Commercial loans   391    4    677    2    1,068    6 
Commercial equipment   684    5    -    -    684    5 
   $7,778    26   $677    2   $8,455    28 

 

   December 31, 2015 
(dollars in thousands)  90 or Greater
Days
Delinquent
   Number
of Loans
   Non-accrual
Only Loans
   Number
of Loans
   Total
Non-accrual
Loans
   Total
Number
of Loans
 
                         
Commercial real estate  $2,875    7   $-    -   $2,875    7 
Residential first mortgages   1,948    7    -    -    1,948    7 
Residential rentals   605    4    -    -    605    4 
Construction and land development   3,555    3    -    -    3,555    3 
Home equity and second mortgages   48    3    -    -    48    3 
Commercial loans   1,361    8    693    2    2,054    10 
Commercial equipment   348    4    -    -    348    4 
   $10,740    36   $693    2   $11,433    38 

 

Non-accrual loans (90 days or greater delinquent and non-accrual only loans) decreased $3.0 million from $11.4 million or 1.24% of total loans at December 31, 2015 to $8.5 million or 0.80% of total loans at September 30, 2016. Non-accrual only loans are loans classified as non-accrual due to customer operating results or payment history. In accordance with the Company’s policy, interest income is recognized on a cash basis for these loans.

 

The Company had 28 non-accrual loans at September 30, 2016 compared to 38 non-accrual loans at December 31, 2015. Non-accrual loans at September 30, 2016 included $7.0 million, or 83% of non-accrual loans, attributed to 16 loans representing six customer relationships classified as substandard. Non-accrual loans at December 31, 2015 included $8.1 million, or 71% of non-accrual loans, attributed to 19 loans representing six customer relationships classified as substandard. Of these loans at September 30, 2016 and December 31, 2015, $3.6 million and $3.8 million, respectively, represented a residential development project. During the second quarter of 2014, the Company deferred the collection of principal and interest on this project. The project is currently being continued with the support of non-bank investment, which has been used for vertical construction that has significantly improved the collateral value and the viability of the project. The loans remain classified as troubled debt restructures (“TDRs”) and non-accrual. In addition, at September 30, 2016 and December 31, 2015, the Company had three TDR loans totaling $1.6 million and $1.7 million, respectively, classified as non-accrual. These loans are classified solely as non-accrual loans for the calculation of financial ratios.

 

Non-accrual loans on which the recognition of interest has been discontinued, which did not have a specific allowance for impairment, amounted to $4.5 million and $10.5 million at September 30, 2016 and December 31, 2015, respectively. Interest due but not recognized on these balances September 30, 2016 and December 31, 2015 was $318,000 and $953,000, respectively. Non-accrual loans with a specific allowance for impairment on which the recognition of interest has been discontinued amounted to $4.0 million and $902,000 at September 30, 2016 and December 31, 2015, respectively. Interest due but not recognized on these balances at September 30, 2016 and December 31, 2015 was $683,000 and $34,000, respectively.

 

  19 

 

 

Past due loans as of September 30, 2016 and December 31, 2015 were as follows:

 

   September 30, 2016 
(dollars in thousands)  Current   31-60
Days
   61-89
Days
   90 or Greater
Days
   Total
Past Due
   Total
Loan
Receivables
   Loans > 90 Days
and Accruing
 
Commercial real estate  $623,239   $-   $152   $2,113   $2,265   $625,504   $- 
Residential first mortgages   166,557    -    378    371    749    167,306    - 
Residential rentals   98,622    -    75    591    666    99,288    - 
Construction and land dev.   31,864    -    -    3,611    3,611    35,475    - 
Home equity and second mtg.   21,369    9    63    17    89    21,458    - 
Commercial loans   66,943    -    -    391    391    67,334    - 
Consumer loans   420    2    -    -    2    422    - 
Commercial equipment   33,904    44    -    684    728    34,632    - 
Total  $1,042,918   $55   $668   $7,778   $8,501   $1,051,419   $- 

 

   December 31, 2015 
(dollars in thousands)  Current   31-60
Days
   61-89
Days
   90 or Greater
Days
   Total
Past Due
   Total
Loan
Receivables
   Loans > 90 Days
and Accruing
 
Commercial real estate  $536,013   $-   $-   $2,875   $2,875   $538,888   $- 
Residential first mortgages   129,154    -    299    1,948    2,247    131,401    - 
Residential rentals   92,552    -    -    605    605    93,157      
Construction and land dev.   32,634    -    -    3,555    3,555    36,189    - 
Home equity and second mtg.   21,603    65    -    48    113    21,716    - 
Commercial loans   65,747    -    138    1,361    1,499    67,246    - 
Consumer loans   365    -    1    -    1    366    - 
Commercial equipment   29,138    152    293    348    793    29,931    - 
Total  $907,206   $217   $731   $10,740   $11,688   $918,894   $- 

 

  20 

 

 

Impaired Loans and Troubled Debt Restructures (“TDRs”)

Impaired loans, including TDRs, at September 30, 2016 and 2015 and at December 31, 2015 were as follows:

 

   September 30, 2016 
(dollars in thousands)  Unpaid
Contractual
Principal
Balance
   Recorded
Investment With
No Allowance
   Recorded
Investment
With
Allowance
   Total
Recorded
Investment
   Related
Allowance
   Quarter
Average
Recorded
Investment
   Quarter
Interest
Income
Recognized
   YTD
Average
Recorded
Investment
   YTD
Interest
Income
Recognized
 
                                     
Commercial real estate  $21,956   $19,719   $2,208   $21,927   $456   $21,994   $242   $22,184   $653 
Residential first mortgages   2,246    1,765    481    2,246    13    2,273    22    2,288    66 
Residential rentals   3,858    3,222    237    3,459    50    3,470    35    3,623    102 
Construction and land dev.   4,413    804    3,536    4,340    467    4,469    4    4,332    11 
Home equity and second mtg.   124    124    -    124    -    125    1    126    4 
Commercial loans   3,390    3,157    174    3,331    106    3,349    36    3,355    101 
Commercial equipment   825    611    192    803    164    829    2    831    12 
Total  $36,812   $29,402   $6,828   $36,230   $1,256   $36,509   $342   $36,739   $949 

 

    December 31, 2015 
(dollars in thousands)  Unpaid
Contractual
Principal
Balance
   Recorded
Investment With
No Allowance
   Recorded
Investment
With
Allowance
   Total
Recorded
Investment
   Related
Allowance
   Average
Recorded
Investment
   Interest
Income
Recognized
 
                             
Commercial real estate  $21,477   $19,081   $2,367   $21,448   $601   $21,786   $774 
Residential first mortgages   4,226    3,730    495    4,225    27    4,276    141 
Residential rentals   4,473    3,893    181    4,074    40    4,400    170 
Construction and land dev.   4,283    3,780    504    4,284    471    4,302    13 
Home equity and second mtg.   154    154    -    154    -    163    8 
Commercial loans   4,775    4,195    380    4,575    330    4,524    251 
Commercial equipment   518    338    139    477    139    491    9 
Total  $39,906   $35,171   $4,066   $39,237   $1,608   $39,942   $1,366 

 

  21 

 

  

   September 30, 2015 
(dollars in thousands)  Unpaid
Contractual
Principal
Balance
   Recorded
Investment With
No Allowance
   Recorded
Investment
With
Allowance
   Total
Recorded
Investment
   Related
Allowance
   Quarter
Average
Recorded
Investment
   Quarter
Interest
Income
Recognized
   YTD
Average
Recorded
Investment
   YTD
Interest
Income
Recognized
 
                                     
Commercial real estate  $21,389   $18,837   $2,523   $21,360   $373   $21,453   $203   $21,357   $610 
Residential first mortgages   3,844    3,343    501    3,844    61    3,857    28    3,874    93 
Residential rentals   8,366    7,726    639    8,365    77    8,383    52    8,399    183 
Construction and land dev.   4,329    3,637    691    4,328    471    4,329    4    4,299    10 
Home equity and second mtg.   529    470    -    470    -    475    2    481    9 
Commercial loans   4,233    3,708    282    3,990    232    4,311    38    4,500    124 
Commercial equipment   596    364    146    510    146    512    2    516    8 
Total  $43,286   $38,085   $4,782   $42,867   $1,360   $43,320   $329   $43,426   $1,037 

 

  22 

 

 

TDRs, included in the impaired loan schedules above, as of September 30, 2016 and December 31, 2015 were as follows:

 

   September 30, 2016   December 31, 2015 
(dollars in thousands)  Dollars   Number
of Loans
   Dollars   Number
of Loans
 
                 
Commercial real estate  $9,667    8   $9,839    8 
Residential first mortgages   552    2    881    3 
Residential rentals   228    1    2,058    5 
Construction and land development   4,340    4    4,283    4 
Commercial loans   883    5    1,384    8 
Commercial equipment   116    2    123    2 
Total TDRs  $15,786    22   $18,568    30 
Less: TDRs included in non-accrual loans   (5,191)   (5)   (5,435)   (7)
Total accrual TDR loans  $10,595    17   $13,133    23 

 

At September 30, 2016, the Company had 17 accruing TDRs totaling $10.6 million compared to 23 accruing TDRs totaling $13.1 million as of December 31, 2015. The Company had specific reserves of $929,000 on seven TDRs totaling $6.2 million at September 30, 2016 and specific reserves of $1.3 million on nine TDRs totaling $3.6 million at December 31, 2015. At September 30, 2016, $8.0 million or 76% of accruing TDRs related to one customer relationship. The $8.0 million in TDRs is for eight loans with two construction and land development loans totaling $724,000, one residential rental property of $228,000, and five commercial real estate loans totaling $7.1 million. The loans in this relationship have been classified as TDRs since the fourth quarter of 2014 and have performed according to the terms of their restructured agreements with all required payments made timely. They presently remain classified as TDRs due to below market rates of interest negotiated at the time the loans were restructured to obtain additional collateral. The Company has a strong collateral position in this relationship and as of September 30, 2016 has specific reserves of $426,000 on the relationship.

 

At September 30, 2016 and December 31, 2015, non-accrual TDRs included $3.6 million and $3.8 million, respectively, related to a residential development project. During the second quarter of 2014, the Company deferred the collection of principal and interest on this project. The project is currently being continued with the support of non-bank investment, which has been used for vertical construction that has significantly improved the collateral value and the viability of the project. In addition, at September 30, 2016 and December 31, 2015, the Company had three TDR loans totaling $1.6 million and $1.7 million, respectively, classified as non-accrual. These loans are classified solely as non-accrual loans for the calculation of financial ratios. There was one TDR of $196,000 added during the nine months ended September 30, 2016.

 

Interest income in the amount of $252,000 and $508,000 was recognized on TDR loans for the nine months ended September 30, 2016 and the year ended December 31, 2015, respectively.

 

  23 

 

 

Allowance for Loan Losses

The following tables detail activity in the allowance for loan losses at and for the three and nine months ended September 30, 2016 and 2015, respectively. An allocation of the allowance to one category of loans does not prevent the Company from using that allowance to absorb losses in a different category.

 

   September 30, 2016 
(dollars in thousands)  Beginning Balance   Charge-offs   Recoveries   Provisions   Ending
Balance
 
Three Months Ended                    
Commercial real estate  $4,380   $-   $48   $619   $5,047 
Residential first mortgages   935    -    -    349    1,284 
Residential rentals   613    -    -    (295)   318 
Construction and land development   1,044    -    -    46    1,090 
Home equity and second mortgages   141    -    -    (26)   115 
Commercial loans   709    (200)   1    422    932 
Consumer loans   2    -    -    1    3 
Commercial equipment   1,282    -    10    (418)   874 
   $9,106   $(200)  $59   $698   $9,663 
                          
Nine Months Ended                         
Commercial real estate  $3,465   $-   $53   $1,529   $5,047 
Residential first mortgages   584    -    -    700    1,284 
Residential rentals   538    -    -    (220)   318 
Construction and land development   1,103    (73)   1    59    1,090 
Home equity and second mortgages   142    -    5    (32)   115 
Commercial loans   1,477    (594)   12    37    932 
Consumer loans   2    (1)   -    2    3 
Commercial equipment   1,229    -    31    (386)   874 
   $8,540   $(668)  $102   $1,689   $9,663 

 

   September 30, 2015 
(dollars in thousands)  Beginning Balance   Charge-offs   Recoveries   Provisions   Ending
Balance
 
Three Months Ended                         
Commercial real estate  $3,334   $-   $5   $(250)  $3,089 
Residential first mortgages   849    -    -    (203)   646 
Residential rentals   561    (17)   -    49    593 
Construction and land development   1,205    -    -    402    1,607 
Home equity and second mortgages   206    -    -    (46)   160 
Commercial loans   1,366    (138)   4    25    1,257 
Consumer loans   2    -    -    -    2 
Commercial equipment   1,234    (743)   6    524    1,021 
   $8,757   $(898)  $15   $501   $8,375 
                          
Nine Months Ended                         
Commercial real estate  $3,528   $-   $12   $(451)  $3,089 
Residential first mortgages   1,047    -    1    (402)   646 
Residential rentals   593    (93)   -    93    593 
Construction and land development   1,071    -    32    504    1,607 
Home equity and second mortgages   173    -    -    (13)   160 
Commercial loans   1,677    (353)   11    (78)   1,257 
Consumer loans   3    -    -    (1)   2 
Commercial equipment   389    (797)   10    1,419    1,021 
   $8,481   $(1,243)  $66   $1,071   $8,375 

 

  24 

 

 

The following tables detail loan receivable and allowance balances disaggregated on the basis of the Company’s impairment methodology at September 30, 2016 and 2015 and December 31, 2015.

 

   September 30, 2016   December 31, 2015   September 30, 2015 
(dollars in thousands)  Ending balance:
individually
evaluated for
impairment
  

Ending balance:

collectively
evaluated for
impairment

   Total   Ending balance:
individually
evaluated for
impairment
   Ending balance:
collectively
evaluated for
impairment
   Total   Ending balance:
individually
evaluated for
impairment
   Ending balance:
collectively
evaluated for
impairment
   Total 
Loan Receivables:                                             
Commercial real estate  $21,927   $603,577   $625,504   $21,448   $517,440   $538,888   $21,360   $508,213   $529,573 
Residential first mortgages   2,246    165,060    167,306    4,225    127,176    131,401    3,844    130,542    134,386 
Residential rentals   3,459    95,829    99,288    4,074    89,083    93,157    8,365    87,750    96,115 
Construction and land development   4,340    31,135    35,475    4,284    31,905    36,189    4,328    33,804    38,132 
Home equity and second mortgages   124    21,334    21,458    154    21,562    21,716    470    20,760    21,230 
Commercial loans   3,331    64,003    67,334    4,575    62,671    67,246    3,990    47,894    51,884 
Consumer loans   -    422    422    -    366    366    -    403    403 
Commercial equipment   803    33,829    34,632    477    29,454    29,931    510    27,255    27,765 
   $36,230   $1,015,189   $1,051,419   $39,237   $879,657   $918,894   $42,867   $856,621   $899,488 
                                              
Allowance for loan losses:                                             
Commercial real estate  $456   $4,591   $5,047   $601   $2,864   $3,465   $373   $2,716   $3,089 
Residential first mortgages   13    1,271    1,284    27    557    584    61    585    646 
Residential rentals   50    268    318    40    498    538    77    516    593 
Construction and land development   467    623    1,090    471    632    1,103    471    1,136    1,607 
Home equity and second mortgages   -    115    115    -    142    142    -    160    160 
Commercial loans   106    826    932    330    1,147    1,477    232    1,025    1,257 
Consumer loans   -    3    3    -    2    2    -    2    2 
Commercial equipment   164    710    874    139    1,090    1,229    146    875    1,021 
   $1,256   $8,407   $9,663   $1,608   $6,932   $8,540   $1,360   $7,015   $8,375 

 

  25 

 

 

Credit Quality Indicators

Credit quality indicators as of September 30, 2016 and December 31, 2015 were as follows:

 

Credit Risk Profile by Internally Assigned Grade

 

   Commercial Real Estate   Construction and Land Dev.   Residential Rentals 
(dollars in
thousands)
  9/30/2016   12/31/2015   9/30/2016   12/31/2015   9/30/2016   12/31/2015 
                         
Unrated  $53,873   $51,924   $2,011   $4,399   $22,825   $21,585 
Pass   550,657    466,601    29,125    27,507    75,097    67,926 
Special mention   -    250    -    -    -    845 
Substandard   20,974    20,113    3,974    3,845    1,366    2,801 
Doubtful   -    -    365    438    -    - 
Loss   -    -    -    -    -    - 
Total  $625,504   $538,888   $35,475   $36,189   $99,288   $93,157 

 

   Commercial Loans   Commercial Equipment         
(dollars in
thousands)
  9/30/2016   12/31/2015   9/30/2016   12/31/2015         
                         
Unrated  $10,730   $11,281   $11,654   $10,074         
Pass   53,483    51,569    22,683    19,610           
Special mention   -    -    -    -           
Substandard   3,121    4,110    158    110           
Doubtful   -    286    137    137           
Loss   -    -    -    -           
Total  $67,334   $67,246   $34,632   $29,931           

 

Credit Risk Profile Based on Payment Activity

 

   Residential First Mortgages   Home Equity and Second Mtg.   Consumer Loans 
(dollars in thousands)  9/30/2016   12/31/2015   9/30/2016   12/31/2015   9/30/2016   12/31/2015 
                         
Performing  $166,935   $129,453   $21,441   $21,668   $422   $366 
Nonperforming   371    1,948    17    48    -    - 
Total  $167,306   $131,401   $21,458   $21,716   $422   $366 

 

Summary of Total Classified Loans

 

(dollars in thousands)  9/30/2016   12/31/2015             
By Internally Assigned Grade  $30,095   $31,840             
By Payment Activity   588    964                
Total Classified  $30,683   $32,804                

 

Management uses a risk scale to assign grades to commercial real estate, residential rentals, construction and land development, commercial loans and commercial equipment loans. Commercial loan relationships with an aggregate exposure to the Bank of $750,000 or greater are risk rated. Residential first mortgages, home equity and second mortgages and consumer loans are monitored on an ongoing basis based on borrower payment history. Consumer loans and residential real estate loans are classified as unrated unless they are part of a larger commercial relationship that requires grading or are troubled debt restructures or nonperforming loans with an Other Assets Especially Mentioned or higher risk rating due to a delinquent payment history

 

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Home equity and second mortgages and consumer loans are evaluated for creditworthiness in underwriting and are monitored based on borrower payment history. Residential first mortgages are evaluated for creditworthiness during credit due diligence before being purchased. Residential first mortgages, home equity and second mortgages and consumer loans are classified as unrated unless they are part of a larger commercial relationship that requires grading or are troubled debt restructures or nonperforming loans with an Other Assets Especially Mentioned (“OAEM”) or higher risk rating due to a delinquent payment history.

 

Management regularly reviews credit quality indicators as part of its individual loan reviews and on a monthly and quarterly basis. The overall quality of the Bank’s loan portfolio is assessed using the Bank’s risk grading scale, the level and trends of net charge-offs, nonperforming loans and delinquencies, the performance of troubled debt restructured loans and the general economic conditions in the Company’s geographical market. This review process is assisted by frequent internal reporting of loan production, loan quality, concentrations of credit, loan delinquencies and nonperforming and potential problem loans. Credit quality indicators and allowance factors are adjusted based on management’s judgment during the monthly and quarterly review process. Loans subject to risk ratings are graded on a scale of one to ten. The Company considers loans classified substandard, doubtful and loss as classified assets for regulatory and financial reporting.

 

Ratings 1 thru 6 - Pass

Ratings 1 thru 6 have asset risks ranging from excellent low risk to adequate. The specific rating assigned considers customer history of earnings, cash flows, liquidity, leverage, capitalization, consistency of debt service coverage, the nature and extent of customer relationship and other relevant specific business factors such as the stability of the industry or market area, changes to management, litigation or unexpected events that could have an impact on risks.

 

Rating 7 - OAEM (Other Assets Especially Mentioned) – Special Mention

These credits, while protected by the financial strength of the borrowers, guarantors or collateral, have reduced quality due to economic conditions, less than adequate earnings performance or other factors which require the lending officer to direct more than normal attention to the credit. Financing alternatives may be limited and/or command higher risk interest rates. OAEM loans are the first adversely classified assets on the Bank’s watch list. These relationships will be reviewed at least quarterly.

 

Rating 8 - Substandard

Substandard assets are assets that are inadequately protected by the sound worth or paying capacity of the borrower or of the collateral pledged. These assets have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified substandard. The loans may have a delinquent history or combination of weak collateral, weak guarantor strength or operating losses. When a loan is assigned to this category the Bank may estimate a specific reserve in the loan loss allowance analysis. These assets listed may include assets with histories of repossessions or some that are non-performing bankruptcies. These relationships will be reviewed at least quarterly.

  

Rating 9 - Doubtful

Doubtful assets have many of the same characteristics of Substandard with the exception that the Bank has determined that loss is not only possible but is probable and the risk is close to certain that loss will occur. When a loan is assigned to this category the Bank will identify the probable loss and the loan will receive a specific reserve in the loan loss allowance analysis. These relationships will be reviewed at least quarterly.

 

Rating 10 – Loss

Once an asset is identified as a definite loss to the Bank, it will receive the classification of “loss”. There may be some future potential recovery; however it is more practical to write off the loan at the time of classification. Losses will be taken in the period in which they are determined to be uncollectable.

 

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NOTE 12 – REGULATORY

 

As of December 31, 2015, the Bank was a member of the Federal Reserve System and its primary federal regulator was the Federal Reserve Board. On April 18, 2016, Community Bank of the Chesapeake, cancelled its stock in the Federal Reserve Bank of Richmond. This terminated its status as a member of the Federal Reserve System. As of that date, the Bank’s primary regulator became the Federal Deposit Insurance Corporation (“FDIC”) and is subject to regulation, supervision and regular examination by the Maryland Commissioner of Financial Regulation (the “Commissioner”) and the FDIC.

 

The Company will continue to be subject to regulation, examination and supervision by the Federal Reserve Board under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and the regulations of the Federal Reserve Board.

 

On January 1, 2015, the Company and Bank became subject to the new Basel III Capital Rules with full compliance with all of the final rule's requirements phased in over a multi-year schedule, to be fully phased-in by January 1, 2019. In July 2013, the final rules were published (the “Basel III Capital Rules”) establishing a new comprehensive capital framework for U.S. banking organizations. The rules implement the Basel Committee’s December 2010 framework known as “Basel III” for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act. The Basel III Capital Rules substantially revise the risk-based capital requirements applicable to bank holding companies and depository institutions compared to the previous U.S. risk-based capital rules. The Basel III Capital Rules define the components of capital and address other issues affecting the numerator in banking institutions’ regulatory capital ratios. The Basel III Capital Rules also address risk weights and other issues affecting the denominator in banking institutions’ regulatory capital ratios and replace the existing risk-weighting approach with a more risk-sensitive approach. The Basel III Capital Rules also implement the requirements of Section 939A of the Dodd-Frank Act to remove references to credit ratings from the federal banking agencies’ rules.

 

The rules include a new common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%, require a minimum ratio (“Min. Ratio”) of Total Capital to risk-weighted assets of 8.0%, and require a minimum Tier 1 leverage ratio of 4.0%. A new capital conservation buffer (“CCB”) is also established above the regulatory minimum capital requirements. This capital conservation buffer will be phased-in beginning January 1, 2016 at 0.625% of risk-weighted assets and increase each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019. Strict eligibility criteria for regulatory capital instruments were also implemented under the final rules. The final rules also revise the definition and calculation of Tier 1 capital, Total Capital, and risk-weighted assets.

 

As of September 30, 2016 and December 31, 2015, the Company and Bank were well-capitalized under the regulatory framework for prompt corrective action under the new Basel III Capital Rules. Management believes, as of September 30, 2016 and December 31, 2015, that the Company and the Bank met all capital adequacy requirements to which they were subject.

 

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The Company’s and the Bank’s actual regulatory capital amounts and ratios are presented in the following table.

 

Regulatory Capital and Ratios      The Company   The Bank 
(dollars in thousands)   September 30, 2016   December 31, 2015   September 30, 2016   December 31, 2015 
                     
Common Equity       $103,983   $99,783   $134,395   $132,571 
Preferred Stock -SBLF        -    -    -    - 
Total Stockholders' Equity        103,983    99,783    134,395    132,571 
AOCI Losses (Gains)        (75)   251    (75)   251 
Common Equity Tier 1 Capital        103,908    100,034    134,320    132,822 
TRUPs        12,000    12,000    -    - 
Tier 1 Capital        115,908    112,034    134,320    132,822 
Allowable Reserve for Credit Losses and Other Tier 2 Adjustments    9,663    8,540    9,663    8,540 
Subordinated Notes        23,000    23,000    -    - 
Tier 2 Capital       $148,571   $143,574   $143,983   $141,362 
                          
Risk-Weighted Assets ("RWA")       $1,066,030   $984,614   $1,063,911   $982,347 
                          
Average Assets ("AA")       $1,256,792   $1,118,843   $1,254,292   $1,116,576 
2019 Regulatory
 Min. Ratio + CCB(1)
                

Common Tier 1 Capital to RWA(2)

   7.00%   9.75%   10.16%   12.63%   13.52%
Tier 1 Capital to RWA   8.50    10.87    11.38    12.63    13.52 
Tier 2 Capital to RWA   10.50    13.94    14.58    13.53    14.39 
Tier 1 Capital to AA (Leverage)   n/a    9.22    10.01    10.71    11.90 

 

(1) These are the fully phased-in ratios as of January 1, 2019 that include the minimum capital ratio ("Min. Ratio") + the capital conservation buffer ("CCB"). The phase-in period is more fully described in the footnote above.

 

(2) The Common Tier 1 ratio became effective for regulatory reporting purposes when the Company and the Bank became subject to the new Basel III Capital Rules during the three months ended March 31, 2015.

 

NOTE 13 – FAIR VALUE MEASUREMENTS

 

The Company adopted FASB ASC Topic 820, “Fair Value Measurements” and FASB ASC Topic 825, “The Fair Value Option for Financial Assets and Financial Liabilities”, which provides a framework for measuring and disclosing fair value under generally accepted accounting principles. FASB ASC Topic 820 requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available for sale investment securities) or on a nonrecurring basis (for example, impaired loans).

 

FASB ASC Topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC Topic 820 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

 

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The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available for sale 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 loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

 

Under FASB ASC Topic 820, 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 the fair value. These hierarchy levels are:

 

Level 1 inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.

 

Level 2 inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

 

Level 3 inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

 

Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’s monthly or quarterly valuation process.

  

There were no transfers between levels of the fair value hierarchy and the Company had no Level 3 fair value assets or liabilities for the nine months ended September 30, 2016 and the year ended December 31, 2015, respectively.

 

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

 

Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon 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 loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by GSEs, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

 

Loans Receivable

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 loss 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 are considered impaired. Management estimates the fair value of impaired loans using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Impaired loans not requiring a specific allowance represent loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. At September 30, 2016 and December 31, 2015, substantially all of the impaired loans were evaluated based upon the fair value of the collateral. In accordance with FASB ASC 820, impaired loans where an allowance is established based on the fair value of collateral (loans with impairment) require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan as nonrecurring Level 3.

 

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Premises and Equipment Held For Sale

Premises and equipment are adjusted to fair value upon transfer of the assets to held for sale. Subsequently, premises and equipment held for sale are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised value 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 (e.g., contracted sales price) or a current appraised value, the Company records the assets as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the asset at nonrecurring Level 3.

 

Other Real Estate Owned

OREO is adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, OREO is carried at the lower of carrying value and fair value. Fair value is based upon independent market prices, appraised value 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 or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset at nonrecurring Level 3.

 

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The tables below present the recorded amount of assets as of September 30, 2016 and December 31, 2015 measured at fair value on a recurring basis.

 

(dollars in thousands)  September 30, 2016 
Description of Asset  Fair Value   Level 1   Level 2   Level 3 
Available for sale securities                    
Asset-backed securities issued by GSEs and U.S. Agencies                    
CMOs  $31,343   $-   $31,343   $- 
MBS   2,501    -    2,501    - 
U.S. Agency   5,479    -    5,479    - 
Corporate equity securities   37    -    37    - 
Bond mutual funds   4,525    -    4,525    - 
Total available for sale securities  $43,885   $-   $43,885   $- 

 

(dollars in thousands)  December 31, 2015 
Description of Asset  Fair Value   Level 1   Level 2   Level 3 
Available for sale securities                    
Asset-backed securities issued by GSEs or U.S. Agencies                    
CMOs  $30,664   $-   $30,664   $- 
MBS   26    -    26    - 
Corporate equity securities   39    -    39    - 
Bond mutual funds   4,387    -    4,387    - 
Total available for sale securities  $35,116   $-   $35,116   $- 

 

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Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

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 that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis as of September 30, 2016 and December 31, 2015 were included in the tables below.

 

(dollars in thousands)  September 30, 2016 
Description of Asset  Fair Value   Level 1   Level 2   Level 3 
Loans with impairment                    
Commercial real estate  $1,752   $-   $1,752   $- 
Residential first mortgages   468    -    468    - 
Residential rentals   187         187      
Construction and land development   3,069    -    3,069    - 
Commercial loans   68    -    68    - 
Commercial equipment   28    -    28    - 
Total loans with impairment  $5,572   $-   $5,572   $- 
                     
Other real estate owned  $8,620   $-   $8,620   $- 

 

(dollars in thousands)  December 31, 2015 
Description of Asset  Fair Value   Level 1   Level 2   Level 3 
Loans with impairment                    
Commercial real estate  $1,765   $-   $1,765   $- 
Residential first mortgages   469    -    469    - 
Residential rentals   141    -    141      
Construction and land development   33    -    33    - 
Commercial loans   50    -    50    - 
Total loans with impairment  $2,458   $-   $2,458   $- 
                     
Premises and equipment held for sale  $2,000   $-   $2,000   $- 
                     
Other real estate owned  $9,449   $-   $9,449   $- 

 

Loans with impairment had unpaid principal balances of $7.3 million and $4.0 million at September 30, 2016 and December 31, 2015, respectively, and include impaired loans with a specific allowance.

 

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NOTE 14 – FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. Therefore, any aggregate unrealized gains or losses should not be interpreted as a forecast of future earnings or cash flows. Furthermore, the fair values disclosed should not be interpreted as the aggregate current value of the Company.

 

Valuation Methodology

Investment securities - Fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

 

FHLB and FRB stock - Fair values are at cost, which is the carrying value of the securities.

 

Investment in bank owned life insurance (“BOLI”) – Fair values are at cash surrender value.

 

Loans receivable - For conforming residential first-mortgage loans, the market price for loans with similar coupons and maturities was used. For nonconforming loans with maturities similar to conforming loans, the coupon was adjusted for credit risk. Loans that did not have quoted market prices were priced using the discounted cash flow method. The discount rate used was the rate currently offered on similar products. Loans priced using the discounted cash flow method included residential construction loans, commercial real estate loans and consumer loans.

 

Loans held for sale – Fair values are derived from secondary market quotations for similar instruments or the estimated fair value of loans held for sale based on the terms of the related sale commitments. There were no loans held for sale at September 30, 2016 and December 31, 2015.

 

Savings, NOW and money market deposits - The fair value of checking accounts, saving accounts and money market accounts were the amount payable on demand at the reporting date.

 

Time deposits - The fair value was determined using the discounted cash flow method. The discount rate was equal to the rate currently offered on similar products.

 

Long-term debt and short-term borrowings - These were valued using the discounted cash flow method. The discount rate was equal to the rate currently offered on similar borrowings.

 

Guaranteed preferred beneficial interest in junior subordinated securities (“TRUPs”) - These were valued using discounted cash flows. The discount rate was equal to the rate currently offered on similar borrowings.

 

Subordinated notes - These were valued using discounted cash flows. The discount rate was equal to the rate currently offered on similar borrowings.

 

Off-balance sheet instruments - The Company charges fees for commitments to extend credit. Interest rates on loans for which these commitments are extended are normally committed for periods of less than one month. Fees charged on standby letters of credit and other financial guarantees are deemed to be immaterial and these guarantees are expected to be settled at face amount or expire unused. It is impractical to assign any fair value to these commitments.

 

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The Company’s estimated fair values of financial instruments are presented in the following tables.

 

September 30, 2016          Fair Value Measurements 
Description of Asset (dollars in thousands)  Carrying
Amount
   Fair Value   Level 1   Level 2   Level 3 
Assets                         
Investment securities - AFS  $43,885   $43,885   $-   $43,885   $- 
Investment securities - HTM   102,956    104,570    799    103,771    - 
FHLB Stock   6,173    6,173    -    6,173    - 
Loans Receivable   1,041,910    1,043,832    -    1,043,832    - 
Investment in BOLI   28,429    28,429    -    28,429    - 
                          
Liabilities                         
Savings, NOW and money market accounts  $595,523   $595,523   $-   $595,523   $- 
Time deposits   416,052    417,486    -    417,486    - 
Long-term debt   65,573    68,889    -    68,889    - 
Short term borrowings   55,500    55,478    -    55,478    - 
TRUPs   12,000    8,400    -    8,400    - 
Subordinated notes   23,000    22,821    -    22,821    - 

 

December 31, 2015          Fair Value Measurements 
Description of Asset (dollars in thousands)  Carrying
Amount
   Fair Value   Level 1   Level 2   Level 3 
Assets                         
Investment securities - AFS  $35,116   $35,116   $-   $35,116   $- 
Investment securities - HTM   109,420    109,309    750    108,559    - 
FHLB and FRB Stock   6,931    6,931    -    6,931    - 
Loans Receivable   909,200    913,506    -    913,506    - 
Investment in BOLI   27,836    27,836    -    27,836    - 
                          
Liabilities                         
Savings, NOW and money market accounts  $531,348   $531,348   $-   $531,348   $- 
Time deposits   375,551    375,376    -    375,376    - 
Long-term debt   55,617    56,987    -    56,987    - 
Short term borrowings   36,000    36,000    -    36,000    - 
TRUPs   12,000    8,400    -    8,400    - 
Subordinated notes   23,000    23,000    -    23,000    - 

 

At September 30, 2016 and December 31, 2015, the Company had outstanding loan commitments and standby letters of credit of $85.3 million and $73.5 million, respectively and $19.4 million and $21.4 million, respectively. Additionally, customers had $135.4 million and $128.1 million available and unused on lines of credit at September 30, 2016 and December 31, 2015, respectively. Based on the short-term lives of these instruments, the Company does not believe that the fair value of these instruments differs significantly from their carrying values.

 

The fair value estimates presented herein are based on pertinent information available to management as of September 30, 2016 and December 31, 2015, respectively. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amount presented herein.

 

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NOTE 15 – NEW ACCOUNTING STANDARDS

Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”). ASU 2014-09 - Revenue from Contracts with Customers (Topic 606); ASU 2016-08 - Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net); ASU No. 2016-10 - Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. ASU 2014-09 states that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This update affects entities that enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards. ASU 2016-08 was issued to clarify certain principal versus agent considerations within the implementation guidance of ASC Topic 606. ASU 2016-10 was issued to clarify ASC Topic 606 related to (i) identifying performance obligations; and (ii) the licensing implementation guidance. The effective date for the ASUs is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted, but not before the original effective date of December 15, 2016. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements.

 

ASU 2015-05 - Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement. ASU 2015-05 provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The new guidance does not change the accounting for a customer’s accounting for service contracts. ASU No. 2015-05 is effective for interim and annual reporting periods beginning after December 15, 2015 and did not have a material impact on the Company’s consolidated financial statements.

 

ASU 2015-16 - Business Combinations (Topic 805) – Simplifying the Accounting for Measurement-Period Adjustments. ASU 2015-16 requires that an acquirer recognize adjustments to estimated amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments require that the acquirer record, in the same period's financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the estimated amounts, calculated as if the accounting had been completed at the acquisition date. The amendments also require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the estimated amounts had been recognized as of the acquisition date. The amendments should be applied prospectively to adjustments to provisional amounts that occur after the effective date with earlier application permitted for financial statements that have not been issued. ASU 2015-16 was effective January 1, 2016 and did not have an impact on the Company’s consolidated financial statements.

 

ASU 2016-01 - Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-1, among other things, (i) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (iv) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (vi) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (viii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale. ASU 2016-1 will be effective on January 1, 2018 and the Company is evaluating its impact on the consolidated financial statements and will monitor developments and additional guidance.

 

ASU 2016-02 - Leases (Topic 842). ASU 2016-02 requires lessees to recognize a lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. ASU 2016-02 does not significantly change lease accounting requirements applicable to lessors; however, certain changes were made to align, where necessary, lessor accounting with the lessee accounting model and ASC Topic 606, “Revenue from Contracts with Customers.” ASU 2016-02 will be effective on January 1, 2019 and will require transition using a modified retrospective approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The Company is evaluating the potential impact of ASU 2016-02 on the consolidated financial statements.

 

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ASU 2016-05 - Derivatives and Hedging (Topic 815) Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships. ASU 2016-05 clarifies that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under ASC Topic 815 does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. ASU 2016-05 will be effective on January 1, 2017 and is not expected to have a significant impact on the consolidated financial statements.

 

ASU 2016-09 - Improvements to Employee Share-Based Payment Accounting. ASU 2016-09 is intended to simplify how share-based payments are accounted for and presented in the financial statements. The key provisions include: (i) a company will no longer record excess tax benefits and certain tax deficiencies in additional paid-in capital (“APIC”). Instead all excess tax benefits and tax deficiencies will be reported as income tax expense or benefit in the income statement, and APIC pools will be eliminated. The guidance also eliminates the requirement that excess tax benefits be realized before companies can recognize them. In addition, the guidance requires companies to present excess tax benefits as an operating activity on the statement of cash flows rather than as a financing activity; (ii) a company can increase the amount of withholding to cover income taxes on awards and still qualify for the exception to liability classification for shares used to satisfy the employer’s statutory income tax withholding obligation. The new guidance will also require an employer to classify the cash paid to a tax authority when shares are withheld to satisfy its statutory income tax withholding obligation as a financing activity on its statement of cash flows (current guidance did not specify how these cash flows should be classified); and (iii) a company can elect an accounting policy election for the impact of forfeitures on the recognition of expense for share-based payment awards. Forfeitures can be estimated, as required today, or recognized when they occur. ASU No. 2016-09 is effective for interim and annual reporting periods beginning after December 15, 2016. Early adoption is permitted, but all of the guidance must be adopted in the same period. The Company is evaluating the potential impact of ASU 2016-09 on the consolidated financial statements.

 

ASU 2016-13 - Measurement of Credit Losses on Financial Instruments. ASU No. 2016-13 significantly changes how entities will measure credit losses for most financial assets and certain other instruments that aren’t measured at fair value through net income. The standard will replace today’s “incurred loss” approach with an “expected loss” model. The new model, referred to as the current expected credit loss (“CECL”) model, will apply to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures. This includes, but is not limited to, loans, leases, held-to-maturity securities, loan commitments, and financial guarantees. The CECL model does not apply to available-for-sale (“AFS”) debt securities. For AFS debt securities with unrealized losses, entities will measure credit losses in a manner similar to what they do today, except that the losses will be recognized as allowances rather than reductions in the amortized cost of the securities. As a result, entities will recognize improvements to estimated credit losses immediately in earnings rather than as interest income over time, as they do today. The ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans. ASU 2016-13 also expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance for loan and lease losses. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. ASU No. 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019; early adoption is permitted for interim and annual reporting periods beginning after December 15, 2018. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (i.e., modified retrospective approach). The Company is currently evaluating the provisions of ASU No. 2016-13 to determine the potential impact the new standard will have on the Company's Consolidated Financial Statements.

 

ASU 2016-15 - Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 is intended to reduce diversity in practice in how eight particular transactions are classified in the statement of cash flows. ASU 2016-15 is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted, provided that all of the amendments are adopted in the same period. Entities will be required to apply the guidance retrospectively. If it is impracticable to apply the guidance retrospectively for an issue, the amendments related to that issue would be applied prospectively. As this guidance only affects the classification within the statement of cash flows, ASU 2016-15 is not expected to have a material impact on the Company's Consolidated Financial Statements

 

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Item 2 - Management's Discussion and Analysis (“MD&A”) of Financial Condition and Results of Operations

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements that are based on assumptions and may describe future plans, strategies and expectations of The Community Financial Corporation (the “Company”) and Community Bank of the Chesapeake (the “Bank”). These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions.

 

The Company and the Bank’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors that could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to, changes in interest rates, national and regional economic conditions, legislative and regulatory changes, monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality and composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company and the Bank’s market area, changes in real estate market values in the Company and the Bank’s market area, changes in relevant accounting principles and guidelines and cyber security risks. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, the Company does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.

 

Additional factors that may affect the Company’s results are discussed in Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 (the “Form 10-K”) that was filed with the Securities and Exchange Commission.

 

Critical Accounting Policies

Critical accounting policies are defined as those that involve significant judgments and uncertainties and could potentially result in materially different results under different assumptions and conditions. The Company considers its determination of the allowance for loan losses, the valuation of foreclosed real estate (OREO) and the valuation of deferred tax assets to be critical accounting policies.

 

The Company’s Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States of America and the general practices of the United States banking industry. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements. Accordingly, as this information changes, the financial statements could reflect different estimates, assumptions and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported.

 

Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When these sources are not available, management makes estimates based upon what it considers to be the best available information.

 

Allowance for Loan Losses

The allowance for loan losses is an estimate of the losses that exist in the loan portfolio. The allowance is based on two principles of accounting: (1) Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 450 “Contingencies,” which requires that losses be accrued when they are probable of occurring and are estimable and (2) FASB ASC 310 “Receivables,” which requires that losses be accrued when it is probable that the Company will not collect all principal and interest payments according to the contractual terms of the loan. The loss, if any, is determined by the difference between the loan balance and the value of collateral, the present value of expected future cash flows and values observable in the secondary markets.

 

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The allowance for loan loss balance is an estimate based upon management’s evaluation of the loan portfolio. The allowance is comprised of a specific and a general component. The specific component consists of management’s evaluation of certain classified and non-accrual loans and their underlying collateral. Management assesses the ability of the borrower to repay the loan based upon all information available. Loans are examined to determine a specific allowance based upon the borrower’s payment history, economic conditions specific to the loan or borrower and other factors that would impact the borrower’s ability to repay the loan on its contractual basis. Depending on the assessment of the borrower’s ability to pay and the type, condition and value of collateral, management will establish an allowance amount specific to the loan.

 

Management uses a risk scale to assign grades to commercial real estate, residential rentals, construction and land development, commercial loans and commercial equipment loans. Commercial loan relationships with an aggregate exposure to the Bank of $750,000 or greater are risk rated. Residential first mortgages, home equity and second mortgages and consumer loans are monitored on an ongoing basis based on borrower payment history. Consumer loans and residential real estate loans are classified as unrated unless they are part of a larger commercial relationship that requires grading or are troubled debt restructures or nonperforming loans with an Other Assets Especially Mentioned or higher risk rating due to a delinquent payment history.

 

The Company’s commercial loan portfolio is periodically reviewed by regulators and independent consultants engaged by management.

 

In establishing the general component of the allowance, management analyzes non-impaired loans in the portfolio including changes in the amount and type of loans. This analysis reviews trends by portfolio segment in charge-offs, delinquency, classified loans, loan concentrations and the rate of portfolio segment growth. Qualitative factors also include an assessment of the current regulatory environment, the quality of credit administration and loan portfolio management and national and local economic trends. Based upon this analysis a loss factor is applied to each loan category and the Bank adjusts the loan loss allowance by increasing or decreasing the provision for loan losses.

 

Management has significant discretion in making the judgments inherent in the determination of the allowance for loan losses, including the valuation of collateral, assessing a borrower’s prospects of repayment and in establishing loss factors on the general component of the allowance. Changes in loss factors have a direct impact on the amount of the provision and on net income. Errors in management’s assessment of the global factors and their impact on the portfolio could result in the allowance not being adequate to cover losses in the portfolio, and may result in additional provisions. At September 30, 2016 and December 31, 2015, the allowance for loan losses was $9.7 million and $8.5 million, respectively, or 0.92% and 0.93%, respectively, of total loans. An increase or decrease in the allowance could result in a charge or credit to income before income taxes that materially impacts earnings.

 

For additional information regarding the allowance for loan losses, refer to Notes 1 and 6 of the Consolidated Financial Statements as presented in the Company’s Form 10-K for the year ended December 31, 2015 and the discussion in this MD&A.

 

Other Real Estate Owned (“OREO”)

The Company maintains a valuation allowance on its other real estate owned. As with the allowance for loan losses, the valuation allowance on OREO is based on FASB ASC 450 “Contingencies,” as well as the accounting guidance on impairment of long-lived assets. These statements require that the Company establish a valuation allowance when it has determined that the carrying amount of a foreclosed asset exceeds its fair value. Fair value of a foreclosed asset is measured by the cash flows expected to be realized from its subsequent disposition. These cash flows are reduced for the costs of selling or otherwise disposing of the asset.

 

Management must make significant assumptions in estimating the timing and amount of cash flows from the sale of OREO. For example, in cases where the real estate acquired is undeveloped land, management must gather the best available evidence regarding the market value of the property, including appraisals, cost estimates of development and broker opinions. Due to the highly subjective nature of this evidence, as well as the limited market, long time periods involved and substantial risks, cash flow estimates are subject to change. Errors regarding any aspect of the costs or proceeds of developing, selling or otherwise disposing of foreclosed real estate could result in the allowance being inadequate to reduce carrying costs to fair value and may require an additional provision for valuation allowances.

 

For additional information regarding OREO, refer to Notes 1 and 8 of the Consolidated Financial Statements as presented in the Company’s Form 10-K for the year ended December 31, 2015.

 

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Deferred Tax Assets

The Company accounts for income taxes in accordance with FASB ASC 740, “Income Taxes,” which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. FASB ASC 740 requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or the entire deferred tax asset will not be realized.

 

The Company periodically evaluates the ability of the Company to realize the value of its deferred tax assets.  If the Company were to determine that it was not more likely than not that the Company would realize the full amount of the deferred tax assets, it would establish a valuation allowance to reduce the carrying value of the deferred tax asset to the amount it believes would be realized. The factors used to assess the likelihood of realization are the Company’s forecast of future taxable income and available tax-planning strategies that could be implemented to realize the net deferred tax assets.

 

Failure to achieve forecasted taxable income might affect the ultimate realization of the net deferred tax assets.  Factors that may affect the Company’s ability to achieve sufficient forecasted taxable income include, but are not limited to, the following: increased competition, a decline in net interest margin, a loss of market share, decreased demand for financial services and national and regional economic conditions. 

 

The Company’s provision for income taxes and the determination of the resulting deferred tax assets and liabilities involve a significant amount of management judgment and are based on the best information available at the time. The Company operates within federal and state taxing jurisdictions and is subject to audit in these jurisdictions.

 

For additional information regarding income taxes and deferred tax assets, refer to Notes 1 and 12 in the Consolidated Financial Statements as presented in the Company’s Form 10-K for the year ended December 31, 2015.

 

OVERVIEW

Community Bank of the Chesapeake (the “Bank”) is headquartered in Southern Maryland with branches located in Maryland and Virginia. The Bank is a wholly owned subsidiary of The Community Financial Corporation. The Bank conducts business through its main office in Waldorf, Maryland, and 11 branch offices in Waldorf, Bryans Road, Dunkirk, Leonardtown, La Plata, Charlotte Hall, Prince Frederick, Lusby, California, Maryland; and Central Park and downtown Fredericksburg, Virginia. The Company opened its second branch in downtown Fredericksburg, Virginia in April 2016. In addition, the Company maintains five loan production offices (“LPOs”) in La Plata, Prince Frederick, Leonardtown and Annapolis, Maryland; and Fredericksburg, Virginia. The Leonardtown and Fredericksburg LPOs are co-located with branches.

 

During 2015, the Company made a number of strategic decisions to meet its longer-term objectives of increased profitability and increased shareholder value. The Company continued to execute its plans to improve asset quality and to increase transaction deposits, which consist of savings, money market, interest-bearing demand and noninterest bearing demand accounts. For additional information regarding 2015 strategic initiatives and results see the overview section and the operations discussion in the MD&A as presented in the Company’s Form 10-K for the year ended December 31, 2015.

 

In 2016, the Company’s initiatives are to grow the loan portfolio by at least 10% and control expenses. Due to the low interest rate environment and the effects on net interest margin, the Company continues its restructuring of operations to reduce costs. In the first quarter of 2016, the Company completed a redesign of the entire branch system. This redesign, combined with the closure of the King George facility allowed the Company to reduce branch employees by 15% from 73 at March 31, 2015 to 62 at March 31, 2016. The Company is focused on reducing expenses by streamlining internal processes and FTEs as well as by reviewing vendor relationships. The Company is cautiously optimistic that these cost control efforts and its continued asset growth will create operating leverage and increase both its return on average assets and return on equity over the next year. During the first quarter of 2016, the Company identified annualized savings of $1.2 million, primarily from reductions in staffing due to employee attrition and retirement.

 

The current year initiative to control costs began to pick up momentum during the second quarter of 2016. The Company’s efficiency ratio improved to 68.33% during the second quarter from 70.68% for the first quarter. The rate of expense growth was controlled at 0.7% compared to the prior quarter. During the third quarter of 2016, the Company’s efficiency ratio improved to 66.55% and expense growth was controlled at 0.3% compared to the second quarter of 2016.

 

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In the first nine months of 2016, loan growth was very strong with end of period gross loans increasing $132.5 million, or 19.2% on an annualized basis, from $918.9 million at December 31, 2015 to $1,051.4 million at September 30, 2016. The significant increase in loan volume resulted net interest income growing faster than operating expenses. The Company has a strong pipeline and is optimistic that continued loan growth, paired with the expense control, should continue to increase operating leverage during the fourth quarter of 2016. Net operating expense to average assets has decreased from 2.38% for the three months ended September 30, 2015 to 2.06% for the three months ended September 30, 2016.

 

Economy

The U.S. economy continued to grow slowly throughout 2015 and 2014. Gross domestic product grew at an annual rate of one percent during the fourth quarter of 2015, which was half of the growth posted during the third quarter of 2015. The Federal Reserve had indicated through its survey of the Board of Governors that up to four rate increases were planned for 2016. During the first half of 2016, due to a number of world events and market disruptions, many economists reduced their forecasts for 2016 rate hikes from four down to two. The Federal Reserve signaled during the second quarter that two rate hikes were likely, but as of late October 2016, rthe Federal Funds rate remained at 0.50%.

 

Medium-term interest rates have fallen since the fourth quarter of 2015, with the ten year U.S. Treasury rate as of October 11, 2016 ending at 1.77%. Although the ten year rate has seen some slight increases recently it has been as low as 1.37% (July 8, 2016) in 2016. This is down from 2.27% at December 31, 2015. The five year U.S. Treasury rate as of October 11, 2016 was 1.30%. This is down from 1.76% at December 31, 2015. Assuming treasury rates remain at current rates in the 5 to 10 year range, there will be more negative pressure on the re-pricing of the loan portfolio and the pricing of new loans. The downward trend in treasury rates had a positive impact on local deposit pricing through the second quarter of 2016. The Company is optimistic that interest-earning asset growth will continue to offset the negative impacts of lower asset yields in the current interest rate environment during the fourth quarter of 2016.

 

The impact of slow economic growth on the Southern Maryland, Annapolis, Maryland and Fredericksburg, Virginia areas has been moderated by the presence of federal government agencies and defense facilities. Further, the private sector that supports the Bank’s footprint has continued to grow at a pace faster than other parts of the country. In addition, the Bank’s market expansion has enabled the Company to grow the loan portfolio and has produced sustainable organic growth in deposits during the last several years. Even through the difficult economic environment, the Bank’s capital levels and asset quality have remained strong.

 

For additional information regarding the local economy and its impact on the Company’s business refer to the Business Section in the Company’s Form 10-K for the year ended December 31, 2015 under the caption “Market Area” (Part I. Item 1. Business Section – Market Area).

 

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Selected Financial Information and Ratios

 

   Three Months Ended (Unaudited)   Nine Months Ended (Unaudited) 
   September 30, 2016   September 30, 2015   September 30, 2016   September 30, 2015 
                 
KEY OPERATING RATIOS                    
Return on average assets   0.63%   0.46%   0.59%   0.59%
Return on average common equity   7.48    5.09    6.89    6.42 
Return on average total equity   7.48    5.09    6.89    6.26 
Average total equity to average total assets   8.37    9.12    8.52    9.46 
Interest rate spread   3.34    3.41    3.37    3.48 
Net interest margin   3.47    3.55    3.50    3.60 
Cost of funds   0.73    0.77    0.73    0.75 
Cost of deposits   0.48    0.48    0.48    0.48 
Cost of debt   2.63    3.06    2.67    2.77 
Efficiency ratio   66.55    73.62    68.47    70.55 
Non-interest expense to average assets   2.33    2.55    2.41    2.56 
Net operating expense to average assets   2.06    2.38    2.14    2.27 
Avg. int-earning assets to avg. int-bearing liabilities   117.49    117.61    117.62    117.46 
Net charge-offs to average loans   0.06    0.40    0.08    0.18 
COMMON SHARE DATA                    
Basic net income per common share  $0.43   $0.28   $1.16   $1.03 
Diluted net income per common share   0.42    0.27    1.15    1.02 
Cash dividends paid per common share   0.10    0.10    0.30    0.30 
Weighted average common shares outstanding:                    
Basic   4,590,644    4,646,702    4,591,926    4,651,383 
Diluted   4,622,579    4,683,750    4,621,628    4,688,431 

 

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Selected Financial Information and Ratios (continued)

 

 

   (Unaudited)             
(dollars in thousands, except per share amounts)  September 30, 2016   December 31, 2015   $ Change   % Change 
ASSET QUALITY                    
Total assets  $1,281,874   $1,143,332   $138,542    12.1%
Gross loans   1,051,419    918,894    132,525    14.4 
Classified Assets   40,234    43,346    (3,112)   (7.2)
Allowance for loan losses   9,663    8,540    1,123    13.1 
                     
Past due loans (PDLs) (31 to 89 days)   723    948    (225)   (23.7)
Nonperforming loans (NPLs) (>=90 days)   7,778    10,740    (2,962)   (27.6)
                     
Non-accrual loans (a)   8,455    11,433    (2,978)   (26.0)
Accruing troubled debt restructures (TDRs) (b)   10,595    13,133    (2,538)   (19.3)
Other real estate owned (OREO)   8,620    9,449    (829)   (8.8)
Non-accrual loans, OREO and TDRs   27,670    34,015    (6,345)   (18.7)
ASSET QUALITY RATIOS                    
Classified assets to total assets   3.14%   3.79%          
Classified assets to risk-based capital   27.08    30.19           
Allowance for loan losses to total loans   0.92    0.93           
Allowance for loan losses to nonperforming loans   124.24    79.52           
Past due loans (PDLs) to total loans   0.07    0.10           
Nonperforming loans (NPLs) to total loans   0.74    1.17           
Loan delinquency (PDLs + NPLs) to total loans   0.81    1.27           
Non-accrual loans to total loans   0.80    1.24           
Non-accrual loans and TDRs to total loans   1.81    2.67           
Non-accrual loans and OREO to total assets   1.33    1.83           
Non-accrual loans, OREO and TDRs to total assets   2.16    2.98           

 

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Selected Financial Information and Ratios (continued)

 

 

   (Unaudited)             
(dollars in thousands, except per share amounts)  September 30, 2016   December 31, 2015         
COMMON SHARE DATA                    
Book value per common share  $22.33   $21.48         
Common shares outstanding at end of period   4,656,989    4,645,429           
OTHER DATA                    
Number of:                    
Full-time equivalent employees   166    171           
Branches   12    12           
Loan Production Offices   5    5           
REGULATORY CAPITAL RATIOS                    
Tier 1 capital to average assets   9.22%   10.01%          
Tier 1 common capital to risk-weighted assets   9.75    10.16           
Tier 1 capital to risk-weighted assets   10.87    11.38           
Total risk-based capital to risk-weighted assets   13.94    14.58           

 

 

(a) Non-accrual loans include all loans that are 90 days or more delinquent and loans that are non-accrual due to the operating results or cash flows of a customer. Non-accrual loans can include loans that are current with all loan payments. Interest and principal are recognized on a cash-basis in accordance with the Bank's policy if the loans are not impaired or there is no impairment.

 

(b) At September 30, 2016 and December 31, 2015, the Bank had total TDRs of $15.8 million and $18.6 million, respectively, with three TDR relationships totaling $5.2 million and $5.4 million, respectively, in non-accrual status. These loans are classified as non-accrual loans for the calculation of financial ratios.

 

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COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2016 AND 2015

 

Earnings Summary

Consolidated net income available to common shareholders of $2.0 million for the three months ended September 30, 2016 increased $680,000 compared to the three months ended September 30, 2015. Earnings per common share (diluted) at $0.42 increased $0.15 from $0.27 per common share (diluted) for the three months ended September 30, 2015. Third quarter 2015 operating results reflected a $0.05 impact to earnings per share for the loss on the sale of the Company’s King George branch. The $680,000 increase in earnings was attributable to increased net interest income of $1.1 million and noninterest income of $376,000, partially offset by increases to the provision for loan losses of $197,000, noninterest expense of $280,000 and income tax expense of $279,000.

 

The Company’s return on average assets was 0.63% for the three months ended September 30, 2016 compared to 0.46% for the three months ended September 30, 2015. The Company’s return on average common stockholders' equity was 7.48% compared to 5.09% for the same comparative period.

 

Net Interest Income

The primary component of the Company’s net income is its net interest income, which is the difference between income earned on assets and interest paid on the deposits and borrowings used to fund them. Net interest income is affected by the difference between the yields earned on the Company’s interest-earning assets and the rates paid on interest-bearing liabilities, as well as the relative amounts of such assets and liabilities. Net interest income, divided by average interest-earning assets, represents the Company’s net interest margin.

 

Net interest income increased $1.1 million to $10.1 million for the three months ended September 30, 2016 compared to $9.1 million for the three months ended September 30, 2015. The net interest margin was 3.47% for the three months ended September 30, 2016, an eight basis point decrease from 3.55% for the three months ended September 30, 2015. The decrease in net interest margin was largely the result of lower yields on loans partially offset on a lower cost of funds.

 

The following table shows the components of net interest income and the dollar and percentage changes for the periods presented.

 

   Three Months Ended September 30,         
(dollars in thousands )  2016   2015   $ Change   % Change 
Interest and Dividend Income                    
Loans, including fees  $11,460   $10,336   $1,124    10.9%
Taxable interest and dividends on investment securities   758    661    97    14.7%
Interest on deposits with banks   5    5    -    0.0%
Total Interest and Dividend Income   12,223    11,002    1,221    11.1%
                     
Interest Expenses                    
Deposits   1,209    1,068    141    13.2%
Short-term borrowings   36    5    31    620.0%
Long-term debt   834    845    (11)   (1.3)%
Total Interest Expenses   2,079    1,918    161    8.4%
                     
Net Interest Income (NII)  $10,144   $9,084   $1,060    11.7%

 

Interest and dividend income increased by $1.2 million to $12.2 million for the three months ended September 30, 2016 compared to $11.0 million for the three months ended September 30, 2015, primarily due to increased income from the growth in the average balance of loans. Interest and dividend income also increased due to moderate growth in the average balance of investments and increased investment yields. Interest and dividend income on loans increased $1.5 million due to growth of $136.7 million in the average balance of loans from $879.7 million for the three months ended September 30, 2015 to $1,016.4 million for the three months ended September 30, 2016. Interest and dividend income on investments increased $97,000 during the third quarter of 2016 compared to the same period in the prior year as average interest-earning investment balances increased $8.3 million and average yields increased from 1.84% to 1.99%. Average loan yields declined 19 basis points from 4.70% for the three months ended September 30, 2015 to 4.51% for the three months ended September 30, 2016, which resulted in a decrease in interest and dividend income of $417,000.

 

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Interest expense increased $161,000 to $2.1 million for the three months ended September 30, 2016 compared to $1.9 million for the three months ended September 30, 2015, due to an increase in the average balances of interest-bearing liabilities and a slight change in the composition of interest-bearing liabilities between the comparable periods. During the three months ended September 30, 2016, interest expense increased $153,000 due to larger average balances of interest-bearing transaction deposit accounts, time deposits and short-term borrowings compared to the same quarter of 2015. Additionally, interest expense increased $51,000 due to increased rates on certificates of deposits and debt. These increases to interest expense were partially offset by a reduction in interest expense of $30,000 due to a $5.1 million decrease in average long-term debt balances from the comparable period to $65.6 million for the three months ended September 30, 2016. As a result of the change in the composition of debt, the average rate paid on debt declined from 3.06% for the three months ended September 30, 2015 to 2.63% for the comparable period in 2016.

 

The Company continued to make progress in controlling overall deposit costs by increasing transaction deposits as a percentage of overall deposits. Average transaction accounts as a percentage of average total deposits increased from 57.0% for the three months ended September 30, 2015 to 59.1% for the three months ended September 30, 2016. Deposit costs at 0.48% were the same for the three months ended September 30, 2016 and 2015. Average transaction deposits, which include savings, money market, interest-bearing demand and noninterest bearing demand accounts, for the three months ended September 30, 2016 increased $91.9 million or 18.3% to $595.4 million compared to $503.5 million for the comparable period in 2015. The increase in average transaction deposits included growth in average noninterest bearing demand deposits of $21.7 million from $123.1 million for the three months ended September 30, 2015 to $144.8 million for the three months ended September 30, 2016.

 

The following table presents information on average balances and rates for deposits.

 

   For the Three Months Ended September 30,     
   2016   2015 
   Average   Average   Average   Average 
(dollars in thousands)  Balance   Rate   Balance   Rate 
Savings  $50,363    0.05%  $45,697    0.10%
Interest-bearing demand and money market accounts   400,214    0.30%   334,691    0.30%
Certificates of deposit   412,683    0.88%   379,867    0.84%
Total interest-bearing deposits   863,260    0.56%   760,255    0.56%
Noninterest-bearing demand deposits   144,837         123,118      
   $1,008,097    0.48%  $883,373    0.48%

 

The following table presents information on the average balances of the Company’s interest-earning assets and interest-bearing liabilities and interest earned or paid thereon for the three months ended September 30, 2016 and 2015, respectively. There are no tax equivalency adjustments.

 

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   For the Three Months Ended September 30, 
       2016           2015     
           Average           Average 
   Average       Yield/   Average       Yield/ 
dollars in thousands  Balance   Interest   Cost   Balance   Interest   Cost 
Assets                              
Interest-earning assets:                              
Commercial real estate  $618,213   $6,885    4.45%  $521,657   $5,998    4.60%
Residential first mortgages   158,047    1,592    4.03%   138,488    1,498    4.33%
Residential rentals   99,951    1,156    4.63%   88,348    1,036    4.69%
Construction and land development   35,681    409    4.59%   37,967    473    4.98%
Home equity and second mortgages   22,170    225    4.06%   21,300    216    4.06%
Commercial and equipment loans   91,285    1,185    5.19%   80,048    1,106    5.53%
Consumer loans   405    8    7.90%   396    9    9.09%
Allowance for loan losses   (9,344)   -    0.00%   (8,502)