UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended September 30, 2016

OR

For the transition period from _________ to __________

Commission File Number: 001-36808

 

COUNTY BANCORP, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

Registrant’s telephone number, including area code: (920) 686-9998

 

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

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

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

 

 

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

As of November 10, 2016, the registrant had 6,560,135 shares of common stock, $0.01 par value per share, outstanding.

 

 

 

 

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Table of Contents

 

 

 

 

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

COUNTY BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

September 30, 2016 and December 31, 2015

(Unaudited)

 

See accompanying notes to unaudited consolidated financial statements

 

 

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COUNTY BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

For the Three and Nine Months Ended September 30, 2016 and 2015

(Unaudited)

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

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COUNTY BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

For the Three and Nine Months Ended September 30, 2016 and 2015

(Unaudited)

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

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COUNTY BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

For the Nine Months Ended September 30, 2016 and 2015

(Unaudited)

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

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COUNTY BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Nine Months Ended September 30, 2016 and 2015

(Unaudited)

 

See accompanying notes to unaudited consolidated financial statements

 

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County Bancorp, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

NOTE 1 – BASIS OF PRESENTATION

The unaudited consolidated financial statements of County Bancorp, Inc. (“we,” “us,” ”our,” or the “Company”) and its subsidiaries have been prepared, in the opinion of management, to reflect all adjustments necessary for a fair presentation of the financial position, results of operations, and cash flows for the interim period.  The results of operations for the three and nine months ended September 30, 2016 may not necessarily be indicative of the results to be expected for the year ending December 31, 2016, or for any other period.

Management of the Company is required to make estimates and assumptions which affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements, as well as the reported amounts of income and expenses during the reported periods.  Actual results could differ significantly from those estimates.

These unaudited interim financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”).  Certain information in footnote disclosure normally included in financial statements prepared in accordance with GAAP has been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

The Company qualifies as an “emerging growth company” under the Jumpstart Our Business Startups Act (the “JOBS Act”). Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended (the “Securities Act”), for complying with new or revised accounting standards. As an emerging growth company, the Company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. The Company elected to take advantage of the benefits of this extended transition period.

Significant Accounting Policies

In addition to the assumptions and methodologies that the Company used to apply significant accounting policies and develop significant estimates as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, the following policies have been added:

Business Combinations and Valuation of Loans Acquired in Business Combinations:  We account for acquisitions under Financial Accounting Standards Board (“FASB”) ASC Topic 805, Business Combinations, which requires the use of the acquisition method of accounting. Assets acquired and liabilities assumed in a business combination are recorded at estimated fair value on their purchase date. As provided for under GAAP, management has up to 12 months following the date of the acquisition to finalize the fair values of acquired assets and assumed liabilities, where it was not possible to estimate the acquisition date fair value upon consummation.

 

In particular, the valuation of acquired loans involves significant estimates, assumptions and judgments based on information available as of the acquisition date. Substantially all loans acquired in the transaction are evaluated either individually or in pools of loans with similar characteristics; since the estimated fair value of acquired loans includes a credit consideration, no carryover of any previously recorded allowance for loan losses is recorded at acquisition. A number of factors are considered in determining the estimated fair value of purchased loans including, among other things, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, estimated holding periods, contractual interest rates compared to market interest rates, and net present value of cash flows expected to be received.

 

In determining the fair value of acquired loans, management calculates a nonaccretable difference (the credit mark component of the acquired loans) and an accretable difference (the market rate or yield component of the acquired loans). The nonaccretable difference is the difference between the undiscounted contractually required payments and the undiscounted cash flows expected to be collected in accordance with management’s determination of the fair value. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows will result in a reversal of the provision for loan losses to the extent of prior charges and then an adjustment to accretable yield, and nonaccretable difference which would have a positive impact on interest income.

 

The accretable yield on acquired loans is the difference between the expected cash flows and the initial investment in the acquired loans. The accretable yield is recognized into earnings using the effective yield method over the term of the loans.

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Management separately monitors the acquired loan portfolio and periodically reviews loans contained within this portfolio against the factors and assumptions used in determining the fair value.

 

Goodwill and Core Deposit Intangible:  Goodwill represents the excess of the purchase price over the fair value of the net identifiable assets acquired and is included as an asset on the consolidated balance sheets. Goodwill is not amortized but is subject to impairment tests on at least an annual basis. Core deposit intangible represents the value of the acquired customer core deposit bases and is included in as an asset on the consolidated balance sheets. The core deposit intangible has an estimated finite life, is amortized on an accelerated basis over a 66-month period, and is subject to periodic impairment evaluation.

 

Management will periodically review the carrying value of its long-lived and intangible assets to determine if any impairment has occurred or whether changes in circumstances have occurred that would require a revision to the remaining useful life, in which case an impairment charge would be recorded as an expense in the period of impairment. In making such determination, management evaluates whether there are any adverse qualitative factors indicating that an impairment may exist, as well as the performance, on an undiscounted basis, of the underlying operations or assets which give rise to the intangible. Given that the acquisition of Fox River Valley Bancorp. (“Fox River Valley”) took place during the second quarter of 2016, there was no impairment charge to goodwill or core deposit intangible at September 30, 2016.  The net book value of core deposit intangible was $1.6 million and $0 at September 30, 2016 and December 31, 2015, respectively and is included on the consolidated balance sheets.

 

New Accounting Pronouncements

In June 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments – Credit Losses, to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date.  The amendment replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates.  This amendment is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years with early adoption permitted for the fiscal year beginning after December 15, 2018, including interim periods within those fiscal years.  Entities should apply this amendment a modified-retrospective approach, through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective.  The Company is currently evaluating the effects this ASU will have on its consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments, to reduce the existing diversity in practice in how certain cash receipts and payments are presented and classified on the statement of cash flows.  The amendment is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years with early adoption permitted including adoption in an interim period.  Entities should apply this amendment as of the beginning of the first reporting period in which the guidance is effective.  The Company is currently evaluating the effects this ASU will have on its consolidated financial statements.

NOTE 2—ACQUISITION

On May 13, 2016, the Company completed its acquisition of Fox River Valley, a Wisconsin corporation, pursuant to the Agreement and Plan of Merger dated November 19, 2015 (the “Merger Agreement”) by and among the Company, County Acquisition LLC, a wholly-owned subsidiary of the Company, and Fox River Valley, whereby the Company acquired Fox River Valley and its wholly-owned bank subsidiary, The Business Bank, through the merger of Fox River Valley into County Acquisition LLC (which subsequently dissolved) and the merger of The Business Bank into Investors Community Bank (the “Bank”).  Under the terms of the Merger Agreement, the Company acquired Fox River Valley for aggregate consideration of approximately $14.45 million in cash and 712,830 shares of the Company’s common stock.    The system integration was completed, and the two branches of The Business Bank opened on May 16, 2016 as branches of Investors Community Bank.

 

The Company accounted for the transaction under the acquisition method of accounting under FASB Accounting Standards Codification (“ASC”) Topic 805, Business Combinations, and thus, the financial position and results of operations of Fox River Valley prior to the closing date were not included in the accompanying consolidated financial statements.  The accounting required assets purchased and liabilities assumed to be recorded at their respective fair values at the date of acquisition. The Company determined the fair value with the assistance of third party valuations, appraisals, and third party advisors.  The estimated fair values will be subject to refinement as additional information relative to the closing date fair values becomes available through the measurement period of approximately one year from consummation.

The fair value of the assets acquired and liabilities assumed on May 13, 2016 were as follows:

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Supplemental Pro Forma Information

The table below presents supplemental pro forma information as if the Fox River Valley merger had occurred at the beginning of the earliest period presented, which was January 1, 2015.  Pro forma results include adjustments for amortization and accretion of fair value adjustments and do not include any projected cost savings or other anticipated benefits of the merger.  These unaudited pro forma results are presented for illustrative purposes and are not intended to represent or be indicative of the results of operations that would have occurred had the transaction been effected on the assumed date.

 

 

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NOTE 3 – EARNINGS PER SHARE

Earnings per common share is computed using the two-class method.  Basic earnings per common share is computed by dividing net income by the weighted-average number of common shares outstanding during the applicable period.  Diluted earnings per share is computed using the weighted-average number of shares determined for the basic earnings per common share plus the dilutive effect of share-based compensation using the treasury stock method.

 

 

 

NOTE 4 – SECURITIES AVAILABLE-FOR-SALE

The amortized cost and fair value of securities available-for-sale as of September 30, 2016 and December 31, 2015 are as follows:

 

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The amortized cost and fair value of securities at September 30, 2016 and December 31, 2015, by contractual maturity, are shown below.  Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

There were no security sales for the nine months ended September 30, 2016 and 2015, respectively.  

The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temorarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2016 and December 31, 2015:

 

The unrealized loss on the investments at September 30, 2016 and December 31, 2015 was due to normal fluctuations and pricing inefficiencies.  The contractual terms of the investments do not permit the issuers to settle the securities at a price less than the amortized cost basis of the investment.  Because the Company does not intend 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 the amortized cost basis, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at September 30, 2016 and December 31, 2015.

 

 

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NOTE 5 – LOANS

The components of loans were as follows:  

 

Changes in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2016 and 2015 were as follows: 

 

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The following tables present the balances in the allowance for loan losses and the recorded balance in loans by portfolio segment and based on impairment method as of September 30, 2016 and December 31, 2015: 

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The following table presents the aging of the recorded investment in past due loans at September 30, 2016 and December 31, 2015:

 

The following table lists information on nonaccrual, restructured, and certain past due loans at September 30, 2016 and December 31, 2015:

 

 

The following table presents the recorded investment in nonaccrual loans and loans past due 90 days or more at September 30, 2016 and December 31, 2015:

 

The average recorded investment in total impaired loans for the nine months ended September 30, 2016 and for the year ended December 31, 2015 amounted to approximately $29.3 million and $27.6 million, respectively.  Interest income recognized on total impaired loans for the nine months ended September 30, 2016 and for the year ended December 31, 2015 amounted to approximately $0.4 million and $1.7 million, respectively.  For nonaccrual loans included in impaired loans, the interest income that would have been recognized had those loans been performing in accordance with their original terms would have been approximately $1.2 million and $1.7 million for the nine months ended September 30, 2016 and for the year ended December 31, 2015, respectively.  

 

Troubled Debt Restructurings

 

The Company has allocated approximately $0.5 million and $0.7 million of specific reserves to customers whose loan terms have been modified in troubled debt restructurings (“TDR”) at September 30, 2016 and December 31, 2015, respectively.  The

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Company has no additional lending commitments at September 30, 2016 and December 31, 2015 to customers with outstanding loans that are classified as TDRs.

A TDR on nonaccrual status is classified as a nonaccrual loan until evaluation supports reasonable assurance of repayment and of performance according to the modified terms of the loan.  Once this assurance is reached, the TDR is classified as a restructured loan.  There were no unfunded commitments on these loans at September 30, 2016, and December 31, 2015.  The following table presents the TDRs by loan class at September 30, 2016 and December 31, 2015:

The following table provides the number of loans modified in a troubled debt restructuring investment by class for the nine months ended September 30, 2016 and 2015:

The following table provides the troubled debt restructurings for the nine months ended September 30, 2016 and 2015 grouped by type of concession:

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Credit Quality Indicators

The Company categorizes loans into risk categories based on relevant information about the ability of the borrowers to service their debt, such as current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. Beginning in the third quarter of 2016, the substandard category was separated in to performing and impaired subcategories to provide more detailed analysis of this category of loans. The Company analyzes agricultural, commercial, and commercial real estate loans individually by classifying the credits as to credit risk. The process of analyzing loans for changes in risk rating is ongoing through routine monitoring of the portfolio and annual internal credit reviews for credits with total exposure in excess of $300,000. The Company uses the following definitions for credit risk ratings:

Sound. Credits classified as sound show very good probability of ongoing ability to meet and/or exceed obligations.

Acceptable. Credits classified as acceptable show a good probability of ongoing ability to meet and/or exceed obligations.

Satisfactory. Credits classified as satisfactory show fair probability of ongoing ability to meet and/or exceed obligations.

Low Satisfactory.  Credits classified as low satisfactory show fair probability of ongoing ability to meet and/or exceed obligations.  Low satisfactory credits may be newer or have a less established track record of financial performance, inconsistent earnings, or may be going through an expansion.

Watch. Credits classified as watch show some questionable probability of ongoing ability to meet and/or exceed obligations.

Special Mention. Credits classified as special mention show potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loans or of the institution’s credit position at some future date.

Substandard – Performing.  Credits classified as substandard – performing generally have well-defined weaknesses. Collateral coverage is adequate and the loans are not considered impaired.  Payments are being made and the loans are on accrual status. 

Substandard - Impaired. Credits classified as substandard generally have well-defined weaknesses that jeopardize the repayment of the debt. They have a distinct possibility that a loss will be sustained if the deficiencies are not corrected.  Loans are considered impaired.  Loans are either exhibiting signs of delinquency, are on non-accrual or are identified as a TDR. 

Doubtful. Credits classified as doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable.

The Company categorizes residential real estate, installment and consumer other loans as satisfactory at the time of origination based on information obtained as to the ability of the borrower(s) to service their debt, such as current financial information, employment status and history, historical payment experience, credit scores and type and amount of collateral among other factors.

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The Company updates relevant information on these types of loans at the time of refinance, troubled debt restructuring or other indications of financial difficulty, downgrading as needed using the same category descriptions as for agricultural, commercial, and commercial real estate loans. In addition, the Company further considers current payment status as an indicator of which risk category to assign the borrower.

The greater the level of deteriorated risk as indicated by a loan’s assigned risk category, the greater the likelihood a loss will occur in the future. If the loan is substandard - impaired, then the loan loss reserves for the loan are recorded at the loss level of impairment. If the loan is not impaired, then its loan loss reserves are determined by the application of a loss rate that increases with risk in accordance with the allowance for loan loss analysis.

Based on the most recent analysis performed by management, the risk category of loans by class of loans is as follows as of September 30, 2016 and December 31, 2015: 

 

NOTE 6 – LOAN SERVICING RIGHTS

Loans serviced for others are not included in the accompanying consolidated balance sheets.  The risks inherent in servicing assets relate primarily to changes in prepayments that result from shifts in interest rates.  The unpaid principal balances of mortgage and other loans serviced for others were approximately $569.2 million and $495.9 million at September 30, 2016 and December 31, 2015, respectively.  The fair value of these rights were approximately $12.0 million and $10.7 million at September 30, 2016 and December 31, 2015, respectively.  The fair value of servicing rights was determined using an assumed discount rate of 10 percent and prepayment speeds primarily ranging from 4 percent to 9 percent, depending upon the stratification of the specific right, and nominal credit losses.

The following summarizes servicing rights capitalized and amortized, along with the aggregate activity in related valuation allowances:

 

 

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NOTE 7 – GOODWILL AND CORE DEPOSIT INTANGIBLE

The excess of the purchase price in an acquisition over the fair value of net assets acquired consists primarily of goodwill and the core deposit intangible. Goodwill is not amortized but is instead subject to impairment tests on at least an annual basis. Core deposit intangible, which arose from value ascribed to the deposit base of a bank acquired, has estimated finite lives and is amortized on an accelerated basis to expense over a 66-month period.

 

Management will periodically review the carrying value of its long-lived and intangible assets to determine if any impairment has occurred, in which case an impairment charge would be recorded as an expense in the period of impairment, or whether changes in circumstances have occurred that would require a revision to the remaining useful life which would impact expense prospectively. In making such determination, management evaluates whether there are any adverse qualitative factors indicating that an impairment may exist, as well as the performance, on an undiscounted basis, of the underlying operations or assets which give rise to the intangible. There was no impairment charge to goodwill or core deposit intangible at September 30, 2016.  

 

Goodwill:  Goodwill resulted from the acquisition of Fox River Valley on May 13, 2016.  The carrying amount of goodwill was $5.0 million at September 30, 2016 and $0 million at December 31, 2015. See Note 2 for additional information on the acquisition.

 

Core deposit intangible:  Core deposit intangible, primarily related to acquired customer relationships, is amortized over their estimated finite lives.  The core deposit intangible related to the Fox River Valley acquisition had a gross carrying amount of $1.8 million. Amortization on core deposit intangible was $157 thousand and $211 thousand for the three and nine months ended September 30, 2016.  There was no core deposit intangible and no amortization recorded on the balance sheet and statement of operations for the year ended December 31, 2015.  See Note 2 for additional information on the acquisition.

 

 

NOTE 8 – DEPOSITS

Deposits are summarized as follows at September 30, 2016 and December 31, 2015:

At September 30, 2016 and December 31, 2015, brokered deposits amounted to $190.4 million and $164.6 million, respectively, and are included in savings and certificates of deposit categories.

 

 

 

NOTE 9 – SUBORDINATED DEBENTURES

In connection with the merger with Fox River Valley, the Company also acquired Fox River Valley’s wholly-owned subsidiary Fox River Valley Capital Trust I, a Delaware statutory trust (the “Trust”), which issued capital securities that qualify for Tier II capital of the Company.  The Company assumed the $3.6 million of floating rate, junior subordinated debentures, of which the Company owns $0.1 million. The debentures are non-voting, mandatorily redeemable in 2033 and guaranteed by the Company.

The distribution rate payable on the debentures is cumulative and payable quarterly in arrears. The Company has the right, subject to events of default, to defer payments of interest on the debentures at any time by extending the interest payment period not exceeding 20 consecutive quarters with respect to each deferral period, provided that no extension period may extend beyond the redemption or maturity date of the debentures. Interest is current through the most recent due date of May 30, 2016.

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The Trust may redeem some or all of the capital securities, at par, with 30 days advance notice, on or after November 30, 2008, but only on May 30 or November 30 of any given year, and only in a minimum amount of $500,000 and in increments of $10,000 thereafter, or the full amount of the capital securities. The Trust may redeem all of the capital securities at any time upon the occurrence and during the continuation of a Tax Event, an Investment Company Event or a Capital Treatment Event (each as defined in the trust agreement for the Trust), at any time within 90 days following such event.

The Trust debentures carry an interest rate equal to 5-year LIBOR plus 3.40%, which resets every five years. The current rate is equal to 4.855% through November 30, 2018. Interest payments are due quarterly.

 

 

NOTE 10 – EQUITY INCENTIVE PLAN

On June 21, 2016 the shareholders approved the 2016 Long Term Incentive Plan (the “2016 Plan”), replacing the Company’s 2012 Equity Incentive Compensation Plan (the “2012 Plan”).  In accordance with the 2016 Plan and the 2012 Plan, the Company may grant options to purchase shares of common stock and issue restricted stock to its directors, officers, and employees.  Both qualified and non-qualified stock options and restricted stock may be granted and issued, respectively, under the 2016 Plan and 2012 Plan.  As of September 30, 2016, 3,587 options or shares of restricted stock have been granted under the 2016 Plan.

The exercise price of each option equals the market price of the Company’s stock on the date of grant and an option’s maximum term is ten years. Vesting periods range from one to five years from the date of grant. The restricted stock vesting periods range from one to five years from the date of issuance.

The status of the Company’s 2012 Plan and 2016 Plan as of September 30, 2016, and changes in the 2012 Plan and 2016 Plan during the nine months ended September 30, 2016 are as follows:

 

Activity in restricted stock awards (“RSA”) for the nine months ended September 30, 2016 is as follows:

For the nine months ended September 30, 2016 and 2015, share-based compensation expense, including options and restricted stock awards, applicable to the 2016 Plan and 2012 Plan was $295 thousand and $266 thousand, respectively.

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As of September 30, 2016, unrecognized share-based compensation expense related to nonvested options and restricted stock awards amounted to $0.7 million and is expected to be recognized over a weighted average period of 2.4 years.

 

 

NOTE 11 – REGULATORY MATTERS

The Company (on a consolidated basis) and the Bank are each subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total, Tier 1 and Tier 1 Common Equity capital to risk-weighted assets, and of Tier 1 capital to average assets, as such terms are defined in the regulations. Management believed, 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.

As of September 30, 2016, the Bank’s capital ratios met those required to be considered as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based, Tier 1 Common Equity risk-based, and Tier 1 leverage ratios as set forth in the following tables.

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

The rules of the Basel III regulatory capital framework (the “Basel III Capital Rules”), which became effective January 1, 2015, revised the prompt corrective action requirements by, among other things: (i) introducing a Common Equity Tier 1 ratio requirement at each level (other than critically undercapitalized), with the required Common Equity Tier 1 ratio being 6.5% for “well-capitalized” status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category (other than critically undercapitalized), with the minimum Tier 1 capital ratio for “well-capitalized” status being 8% (compared to the prior ratio of 6%); and (iii) eliminating the former provision that provided that a bank with a composite supervisory rating of 1 may have a 3% Leverage Ratio and still be adequately capitalized. The Basel III Capital Rules do not change the total risk based capital requirement for any prompt corrective action category.  The Basel III Capital Rules also implemented a new capital conservation buffer that is added to the minimum requirements for capital adequacy purposes.  The capital conservation buffer is subject to a three year phase-in period that began on January 1, 2016 and will be fully phased in on January 1, 2019 at 2.5%.  The required phase-in capital conservation buffer during 2016 is 0.625%.  At the present time, the ratios for the Company and the Bank are sufficient to meet the fully phased-in conservation buffer.

 

 

NOTE 12 – FAIR VALUE MEASUREMENTS

ASC 820-10 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the

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asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are independent, knowledgeable, and both able and willing to transact.

ASC 820-10 requires the use of valuation techniques that are consistent with the market approach, the income approach, and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable or unobservable. Observable inputs reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources. Unobservable inputs reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, ASC 820-10 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1—Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2—Valuation is based on inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

Level 3—Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.

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

The following methods and assumptions were used by the Company in estimating the fair value disclosures for financial instruments:

Cash and Cash Equivalents and Interest-Bearing Deposits in Banks

The carrying amounts of cash and short-term instruments approximate fair values based on the short-term nature of the assets.

Fair values of other interest-bearing deposits are estimated using discounted cash flow analyses based on current rates for similar types of deposits.

Securities Available for Sale

Where quoted prices are available in an active market, the Company classifies the securities within Level 1 of the valuation hierarchy. Securities are defined as both long and short positions. Level 1 securities include highly liquid government bonds and exchange-traded equities.

If quoted market prices are not available, the Company estimates fair values using pricing models and discounted cash flows that consider standard input factors such as observable market data, benchmark yields, interest rate volatilities, broker/dealer quotes and credit spreads.

Examples of such instruments, which would generally be classified within Level 2 of the valuation hierarchy, include U.S. government and agency securities, corporate bonds and other securities. Mortgage-backed securities are included in Level 2 if

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observable inputs are available. In certain cases where there is limited activity or less transparency around inputs to the valuation, the Company classifies those securities in Level 3.

Loans

For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans (e.g., one-to-four family residential), credit card loans, and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. Fair values for other loans (e.g., commercial and agricultural loans) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

Loans Held for Sale

The carrying value of loans held for sale generally approximates fair value based on the short-term nature of the assets. If management identifies a loan held for sale that will ultimately sell at a value less than its carrying value, it is recorded at the estimated value. 

Loan Servicing Rights

Fair value is based on market prices for comparable loan servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income.

Other Real Estate Owned

Loans on which the underlying collateral has been repossessed are adjusted to fair value upon transfer to other real estate owned. Subsequently, other real estate owned is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral. Due to the significance of the unobservable inputs, all other real estate owned is classified as Level 3.

Deposits

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, statement savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Other Borrowings

The carrying amounts of federal funds purchased, other borrowings, and other short-term borrowings maturing within 90 days approximate their fair values.

Advances from the Federal Home Loan Bank

Current market rates for debt with similar terms and remaining maturities are used to estimate fair value of advances from the Federal Home Loan Bank (the “FHLB”). Fair values are estimated using discounted cash flow analyses based on current market rates for similar types of borrowing arrangements.

Subordinated Debentures

The fair values of these debt instruments utilize a discounted cash flow analysis based on an estimate of current interest rates being offered by instruments with similar terms and credit quality.  Since the market for these instruments is limited, the internal evaluation represents a Level 3 measurement and approximates fair value.

Accrued Interest

The carrying amounts approximate fair value.

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Commitments to Extend Credit and Standby Letters of Credit

As of September 30, 2016 and December 31, 2015, the carrying and fair values of the commitments to extend credit and standby letters of credit are not considered significant.

Assets measured at fair value on a recurring basis are summarized below:

 

Certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, they are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following table presents the financial instruments carried on the consolidated balance sheet by caption and by level in the fair value hierarchy for which a nonrecurring change in fair value has been recorded:

 

 

The significant inputs used in the fair value measurements for Level 3 assets measured at fair value on a nonrecurring basis are as follows:

 

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The estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments are as follows:

 

 

NOTE 13 – OTHER REAL ESTATE OWNED

Changes in other real estate owned are as follows:

 

Expenses applicable to other real estate owned include the following:

 

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NOTE 14 – SUBSEQUENT EVENTS

Management evaluated subsequent events through the date the financial statements were issued. There were no significant events or transactions occurring after September 30, 2016, but prior to November 10, 2016, that provided additional evidence about conditions that existed at September 30, 2016. There were no other significant events or transactions that provided evidence about conditions that did not exist at September 30, 2016.

 

 

 

 

  

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

The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes thereto included elsewhere in this Form 10-Q. This report contains “forward-looking statements” within the meaning of such term in the Private Securities Litigation Reform Act of 1995 that reflect our plans, estimates and beliefs. These statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results to differ materially from those discussed in the forward-looking statements. Factors that could cause such differences are discussed in the sections titled “Forward-Looking Statements” and “Risk Factors” and other sections of the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.  Forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “plan,” “seek,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” or “continue” or the negative thereof or variations thereon or similar terminology.  Furthermore, forward-looking statements speak only as of the date they are made. Except as required under the federal securities laws or the rules and regulations of the SEC, we do not undertake any obligation to update or review any forward-looking information, whether as a result of new information, future events or otherwise.

Overview

County Bancorp, Inc. is a Wisconsin corporation founded in May 1996 and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. Our primary activities consist of operating through our wholly-owned subsidiary bank, Investors Community Bank, headquartered in Manitowoc, Wisconsin, and providing a wide range of banking and related business services through the Bank and our other subsidiaries.

In addition to the Bank, we have three wholly-owned subsidiaries, County Bancorp Statutory Trust II, County Bancorp Statutory Trust III, and Fox River Valley Capital Trust I, which are Delaware statutory trusts.  The Bank is the sole shareholder of ICB Investments Corp., a Nevada corporation, and is the sole member of Investors Insurance Services, LLC and ABS 1, LLC, which are both Wisconsin limited liability companies.  

Our results of operations depend primarily on our net interest income. Net interest income is the difference between the interest income we earn on our interest-earning assets, such as loans, and the interest we pay on interest-bearing liabilities, such as deposits. We generate most of our revenue from interest on loans and investments, and loan- and deposit-related fees. Our loan portfolio consists of a mix of agricultural, commercial real estate, commercial, residential real estate, and installment and consumer loans. Our primary source of funding is deposits. Our largest expenses are interest on these deposits and salaries and related employee benefits. We measure our performance through various metrics, including our pre-tax net income, net interest margin, net overhead ratio, return on average assets,  earnings per share, and ratio of non-performing assets to total assets; we utilize non-GAAP metrics such as efficiency ratio, return on average common shareholders’ equity, income before provision for loan losses, merger expense, and income tax expense.  We are also required to maintain appropriate regulatory leverage and risk-based capital ratios.

Merger Transaction

On May 13, 2016, the Company completed its acquisition of Fox River Valley and its wholly-owned bank subsidiary, The Business Bank, through the merger of Fox River Valley into a wholly-owned subsidiary of the Company (which subsequently dissolved) and the merger of The Business Bank into the Bank.  In connection with the merger, County paid aggregate merger consideration of approximately $14.45 million in cash and 712,830 shares of the Company’s common stock.    

The purpose of the acquisition was for strategic reasons beneficial to the Company. The acquisition is consistent with its growth plans to expand into the markets of Appleton and Green Bay, Wisconsin and diversify its loan portfolio and agricultural concentration.  The Company believes it is well-positioned to achieve stronger financial performance and enhance shareholder value through synergies of the combined operations.

For additional information on this merger, see Note 2. “Acquisition” to our consolidated financial statements.

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Initial Public Offering

On January 22, 2015, we closed our initial public offering (“IPO”), in which we offered 1,357,000 shares of common stock for gross proceeds of $21.4 million.  Of the 1,357,000 shares sold, 1,210,750 shares were sold by the Company and 146,250 shares were sold by certain selling shareholders.  The Company did not receive any proceeds from the sale of shares by the selling shareholders.  The offer and sale of all shares of the IPO were registered under the Securities Act pursuant to a registration statement on Form S-1, which was declared effective by the SEC on January 15, 2015.

The net proceeds from our IPO were $16.9 million after deducting underwriting discounts and commissions of $1.2 million and other offering expenses of $1.0 million for total expenses of $2.2 million.

Operational Overview

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Selected Financial Data

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Non-GAAP Financial Measures

“Efficiency ratio” is defined as non-interest expenses, excluding gains and losses on sales and write-downs of other real estate owned, divided by operating revenue, which is equal to net interest income plus non-interest income excluding gains and losses on sales of securities.  In our judgment, the adjustments made to non-interest expense allow investors to better assess our operating expenses in relation to our core operating revenue by removing the volatility that is associated with certain one-time items and other discrete items that are unrelated to our core business.

 

 

Return on average common shareholders’ equity is a non-GAAP based financial measure calculated using non-GAAP based amounts.  The most directly comparable GAAP based measure is return on average shareholders’ equity.  We calculate return on average common shareholders’ equity by excluding the average preferred shareholders’ equity and the related dividends.  Management uses the return on average common shareholders’ equity in order to review our core operating results and our performance.  

 

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Income before provision for loan losses, merger expense, and income tax expense is a non-GAAP financial measure based on GAAP amounts.  In our judgment, the adjustments made to net income allow investors to better assess our operating results by removing the volatility that is associated with certain nonrecurring items related to our acquisition and other discrete items that are unrelated to our core business.

Results of Operations

Our operating revenue is comprised of interest income and non-interest income.  Net interest income increased by 48.1% to $10.2 million for the three months ended September 30, 2016 compared to the three months ended September 30, 2015; the increase is primarily attributable to loan growth of 41.0% between the same periods mainly due to the merger.  Interest income increased to $12.8 million for the third quarter of 2016 compared to $8.8 million for the third quarter of 2015.  The $4.0 million increase was partially offset by an increase in interest expense from $1.9 million for the third quarter of 2015 to $2.6 million for the third quarter of 2016 which was the result of an increase in the volume of deposits between the two periods.  Non-interest income increased 16.9% to $2.0 million and non-interest expense increased 47.6% to $6.1 million for the three months ended September 30, 2016 compared to the same period in 2015.  The increase in non-interest expense is primarily due to increased operating costs associated with two additional branches acquired through the merger and a 31.0% increase in employee headcount since September 30, 2015.

For the nine months ended September 30, 2016, net interest income was $25.4 million, an increase of $6.1 million, or 32.0% from the nine months ended September 30, 2015.  Interest income increased $7.8 million to $32.6 million for the first nine months of 2016 compared to $24.8 million for the same period of 2015 due primarily to increased loan volume.  Interest expense was $7.2 million for the first nine months of 2016, an increase of $1.7 million from the same period of 2015 primarily the result of increased volume of time deposits.  Non-interest income increased to $6.7 million for the first three quarters of 2016 which represents a 26.3% increase compared to the nine months ended September 30, 2015, mainly due to an increase in loan servicing fees.  Non-interest expense increased to $18.1 million for the nine months ended September 30, 2016, an increase of $5.2 million, or 39.8%, from the nine months ended September 30, 2015, primarily due to $2.6 million in nonrecurring merger expenses that were paid during the nine months ended September 30, 2016 in connection with the Fox River Valley acquisition and the resulting increased operating and employee expenses.

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Analysis of Net Interest Income

Net interest income is the largest component of our income and is dependent on the amounts of and yields on interest-earning assets as compared to the amounts of and rates paid on interest-bearing liabilities.  The following tables reflect the components of net interest income for the three and nine months ended September 30, 2016 and 2015:

 

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Rate/Volume Analysis

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

 

 

Provision for Loan Losses

Based on our analysis of the components of the allowance for loan losses, management recorded a provision for loan losses of $1.1 million for the three months ended September 30, 2016 compared to a credit provision of $867 thousand for the three months ended September 30, 2015.  The increase in the provision between these two periods is the result of a $1.6 million non-recurring loan recovery that took place during the third quarter of 2015, organic loan growth, and increased loan loss factors applied to the watch and special mention categories.  The loans that we acquired from Fox River Valley were recorded at fair market value at the time of acquisition and are excluded from the allowance calculation until they are renewed, rewritten, or exhibit deterioration in credit quality in excess of the existing credit mark on the loan. During the third quarter of 2016, we charged-off $327 thousand in loans and recovered $28 thousand in loans that had previously been written-off.

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For the nine months ended September 30, 2016, the provision for loan losses was $2.4 million compared to a credit provision of $1.3 million for the nine months ended September 30, 2015.  Despite the increase in provision, overall credit quality remains consistent with management’s expectations.  The specific reserve related to impaired loans increased slightly from $2.3 million at September 30, 2015 to $2.4 million at September 30, 2016.

There have been no substantive changes to our methodology for estimating the appropriate level of allowance for loan losses from what was previously outlined in our 2015 Annual Report on Form 10-K. Based upon this methodology, which includes actively monitoring the asset quality and inherent risks within the loan and lease portfolio, management concluded that an allowance for loan losses of $11.6 million, or 1.17% of total loans, was appropriate as of September 30, 2016.  This is compared to an allowance for loan losses of $9.8 million, or 1.40% of total loans, at September 30, 2015, and $10.4 million, or 1.39% of total loans, at December 31, 2015.  Beginning in the third quarter of 2016, the substandard category was separated in to performing and impaired subcategories to provide more detailed analysis of this category of loans.  This addition did not have a material impact on the provision.

Non-Interest Income

Non-interest income for the three months ended September 30, 2016 increased by 16.9% from the three months ended September 30, 2015 of $1.7 million to $2.0 million.  The increase was primarily the result of increases in loan servicing fees, due to an increase in loans sold.

For the nine months ended September 30, 2016, non-interest income increased 26.3% to $6.7 million from $5.3 million for the nine months ended September 30, 2015.  The following table reflects the components of non-interest income for the three months and nine months ended September 30, 2016 and 2015:

 

 

Non-Interest Expense

Non-interest expense increased 47.6% to $6.1 million for the three months ended September 30, 2016 compared to $4.1 million for the three months ended September 30, 2015.  The increase is primarily due to increased operating costs associated with the two additional branches acquired through the merger and a 31.0% increase in employee headcount since September 30, 2015.

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For the nine months ended September 30, 2016, non-interest expense increased 39.8% to $18.1 million from $13.0 million for the nine months ended September 30, 2015.  The increase is predominantly the result of $2.6 million in nonrecurring merger expenses related to our acquisition of Fox River Valley on May 13, 2016, of which $1.2 million is attributable to expenses relating to the conversion of The Business Bank’s core processor, $0.4 million is attributable to professional fees, and $1.0 million was paid to Fox River Valley executives in accordance with the terms of their employment agreements.  The remaining $2.5 million increase in non-interest expense is the result of increased operations of the expanded entity.

The following table reflects the components of our non-interest expense for the three and nine ended September 30, 2016 and 2015:

 

 

Income taxes

The Company accounts for income taxes in accordance with income tax accounting guidance, which sets out a consistent framework to determine the appropriate level of tax reserves to maintain for uncertain tax positions.

The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes 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 assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur. 

Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term “more likely than not” means a likelihood of more than 50%; the terms “examined” and “upon examination” also include resolution of the related appeals or litigation processes, if any. A tax position that meets the “more likely than not” recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the “more likely than not” recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of the deferred tax asset will not be realized.

The Company files income tax returns in the U.S. federal jurisdiction and in the state of Wisconsin. The Company is no longer subject to U.S. federal or state income tax examinations by tax authorities for years before 2012.

The Company recognizes interest and penalties on income taxes as a component of other non-interest expense.

Income tax expense for the three months ended September 30, 2016 and 2015 was $1.8 million and $2.0 million, which represents an effective tax rate of 37.3% and 37.5%, respectively.  For the nine months ended September 30, 2016 and 2015, income tax expense was $4.3 million and $4.8 million, respectively.  This represents an effective tax rate of 37.5% for both nine months ended September 30, 2016 and 2015.

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Financial Condition

Total assets increased $332.3 million, or 37.5%, from $884.9 million at December 31, 2015 to $1.2 billion at September 30, 2016.  $223.6 million of the increase is due to the acquisition of Fox River Valley.  The remaining $108.7 million is primarily due to organic loan growth.

Total liabilities increased $325.5 million, or 42.7%, from $762.9 million at December 31, 2015 to $1.1 billion at September 30, 2016.  This increase is primarily attributed to $206.0 million of liabilities assumed in the Fox River Valley acquisition, with the remaining due to increased borrowings associated with our increased loan demand.  

On February 23, 2016, we redeemed all 15,000 shares of SBLF Preferred Stock at its liquidation value of $1,000 per share plus accrued dividends, for a total redemption amount of $15.0 million.  

Shareholders’ equity increased $21.8 million, or 20.3%, to $128.8 million at September 30, 2016 from $107.0 million at December 31, 2015.  This increase was due primarily to the 712,830 shares of common stock that were recorded at a fair value of $20.00 per share in connection with the Fox River Valley acquisition and the net income for the nine months ended September 30, 2016 of $7.2 million.

Net Loans

Total net loans increased by $243.1 million, or 32.9%, from $737.8 million at December 31, 2015 to $980.9 million at September 30, 2016. The acquired loans accounted for $135.6 million of the increase, with the remaining $107.5 million increase from organic loan growth, primarily in the agricultural sector.  Agricultural loans grew 17.2% from December 31, 2015 to $585.3 million at September 30, 2016.

The following table sets forth the composition of our loan portfolio at the dates indicated:

 

 

Allowance for Loan Losses

The allowance for loan losses is established through a provision for loan losses charged to expense, which affects our earnings directly. Loans are charged against the allowance for loan losses when management believes that the collectability of all or some of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that reflects management’s estimate of the level of probable incurred losses in the loan portfolio. Factors considered by management in determining the adequacy of the allowance include, but are not limited to, detailed reviews of individual loans, historical and current trends in loan charge-offs for the various portfolio segments evaluated, the level of the allowance in relation to total loans and to historical loss levels, levels and trends in non-performing and past due loans, volume and migratory direction of adversely graded loans, external factors including regulation, reputation, and competition, and management’s assessment of economic conditions. Our board of directors reviews the recommendations of management regarding the appropriate level for the allowance for loan losses based upon these factors.

The provision for loan losses is the charge to operating earnings necessary to maintain an adequate allowance for loan losses. We have developed policies and procedures for evaluating the overall quality of our loan portfolio and the timely identification of problem credits. Management continuously reviews these policies and procedures and makes further improvements as needed. The adequacy of our allowance for loan losses and the effectiveness of our internal policies and procedures are also reviewed periodically by our regulators, our auditors, and external loan review personnel. Our regulators may advise us to recognize additions to the allowance based upon their judgments about information available to them at the time of their examination. Such regulatory guidance is taken under consideration by management, and we may recognize additions to the allowance as a result.

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We continually refine our methodology for determining the allowance for loan losses by comparing historical loss ratios utilized to actual experience and by classifying loans for analysis based on similar risk characteristics. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreements; however, cash receipts on impaired and nonaccrual loans for which the accrual of interest has been discontinued are applied to principal and interest income depending upon the overall risk of principal loss to us.

At September 30, 2016 and December 31, 2015, the allowance for loan losses was $11.6 million and $10.4 million, respectively, which resulted in a ratio to total loans of 1.17% and 1.39%, respectively.  The decrease in ratio of the allowance to total loans is due to the acquired loans; at the completion of the merger, the acquired loans were recorded at fair market value and, as a result, are excluded from the allowance calculation until they are renewed or rewritten.  The overall increase in the allowance for loan losses, is the result of organic loan growth, partially offset by slightly lower loan loss factors resulting from improved dairy prices that impact our agricultural customers.  Also during the first three quarters of 2015, we experienced $2.4 million of loan recoveries that are not recurring.  

Charge-offs and recoveries by loan category for the three and nine months ended September 30, 2016 and 2015 are as follows:

 

 

 

Loan Servicing Rights

As part of our growth and risk management strategy, we have actively developed a loan participation and loan sales network. Our ability to sell loan participations and whole loans benefits us by freeing up capital and funding to lend to new customers as well as to increase non-interest income through the recognition of loan sale and servicing revenue. Because we continue to service these loans, we are able to maintain a relationship with the customer. Additionally, we receive a servicing fee that offsets some of the cost of administering the loan, while maintaining the customer relationship.  

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Servicing assets are recognized as separate assets when rights are acquired through the sale of financial assets. Servicing rights resulting from the sale or securitization of loans originated by the Company are initially measured at fair value at the date of transfer. The Company subsequently measures each class of servicing asset using the amortization method. Under the amortization method, servicing rights are amortized in proportion to and over the period of estimated net servicing income. The amortized assets are assessed for impairment or increased obligation based on fair value at each reporting date.

Fair value is based on market prices for comparable servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. These variables may have an adverse impact on the value of the servicing right and may result in a reduction to non-interest income.

Servicing assets measured using the amortization method are evaluated and measured for impairment. Impairment is determined by stratifying rights into tranches based on predominant characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the carrying amount of the servicing assets for that tranche. The valuation allowance is adjusted to reflect changes in the measurement of impairment after the initial measure of the impairment.

Changes in the valuation allowances are reported with loan servicing fees on the income statement. Fair value in excess of the carrying amount of servicing assets for that stratum is not recognized.

Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. The amortization of loan servicing rights is netted against loan servicing fee income.

Information about the loan servicing portfolio is shown below:

 

Securities

Our securities portfolio is predominately composed of municipal securities, investment grade mortgage-backed securities, U.S. Government and agency securities, and asset-backed securities. We classify substantially all of our securities as available for sale. We do not engage in active securities trading in carrying out our investment strategies.

Securities increased to $124.4 million at September 30, 2016 from $83.3 million at December 31, 2015.  During the nine months ended September 30, 2016, we recognized unrealized holding gains of $1.2 million before income taxes through other comprehensive income.

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The following table sets forth the amortized cost and fair values of our securities portfolio at September 30, 2016 and December 31, 2015:

 

 

Deposits

Deposits are the major source of our funds for lending and other investment purposes. Deposits are attracted principally from within our primary market area through the offering of a broad variety of deposit instruments including checking accounts, noninterest-bearing demand accounts, money market accounts, savings accounts, time deposit accounts (including “jumbo” certificates in denominations of $100,000 or more) and retirement savings plans.  We also obtain brokered deposits on an as-needed basis.

Deposit growth was 38.3% to $929.4 million at September 30, 2016 from $672.2 million at December 31, 2015.  The increase in deposits was primarily the result of a $203.3 million in deposits acquired from Fox River Valley.  Organic deposit growth has been slow in recent years in a market with compressed interest rates, but our recent acquisition expanded our geographical footprint into two new markets in which we can attract core deposits.  As of September 30, 2016 and December 31, 2015, the distribution by type of deposit accounts was as follows:

 

 

Liquidity Management and Capital Resources

Liquidity is the ability to meet current and future financial obligations of a short-term and long-term nature including, but not limited to, funding loans and depositor withdrawals. Our primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of securities and borrowings from the FHLB. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows, calls of investment securities and borrowed funds and prepayments on loans are greatly influenced by general interest rates, economic conditions and competition.

At September 30, 2016, advances from the FHLB were $132.9 million compared to $66.4 million at December 31, 2015.  This increase is directly related to the $108.7 million of organic loan growth between these dates.

Management adjusts our investments in liquid assets based upon an assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities, (4) the objectives of our interest-rate risk and investment policies and (5) the risk tolerance of management and our board of directors.

Our cash flows are composed of three primary classifications: cash flows from operating activities, investing activities, and financing activities.  Net cash provided by operating activities was $19.2 million for the nine months ended September 30, 2016, compared to net cash used in operating activities of $0.4 million for the nine months ended September 30, 2015. Net cash used in investing activities, which consists primarily of purchases of and proceeds from the sale, maturities, calls, and principal repayments of securities available for sale, as well as loan originations, net of repayments, was $84.5 million and $60.1 million for the nine months ended September 30, 2016 and 2015, respectively.  Net cash provided by financing activities, consisting primarily of the activity in

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deposit accounts, FHLB advances, and the redemption of the SBLF Preferred Stock, was $103.3 million and $63.1 million for the nine months ended September 30, 2016 and 2015, respectively.

At September 30, 2016, the Bank exceeded all of its regulatory capital requirements with Tier 1 leverage capital of $132.6 million, or 11.19% of adjusted average total assets, which is above the minimum level to be well-capitalized of $59.2 million, or 5.0% of adjusted average assets, and total risk-based capital of $144.7 million, or 13.31% of risk-weighted assets, which is above the minimum level to be well-capitalized of $108.7 million, or 10.0% of risk-weighted assets.

At the holding company level, our primary sources of liquidity are dividends from the Bank, investment income and net proceeds from investment sales, borrowings and capital offerings. The main uses of liquidity are the payment of interest to holders of our junior subordinated debentures and the payment of interest or dividends to common and preferred shareholders.  The Bank is subject to certain regulatory limitations regarding its ability to pay dividends to the Company; however, we do not believe that the Company will be adversely affected by these dividend limitations.  At September 30, 2016, there were $66.8 million of retained earnings available for the payment of dividends by the Bank to us.

Off-Balance Sheet Arrangements

As of September 30, 2016, there were no significant changes to our contractual obligations and off-balance sheet arrangements disclosed in our Annual Report on Form 10-K for the year ended December 31, 2015.  We continue to believe that we have adequate capital and liquidity available from various sources to fund projected obligations and commitments.

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Not required.

 

 

Item 4. Controls and Procedures.

Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of September 30, 2016. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2016, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act.

There are inherent limitations in the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and circumvention or overriding of controls. Accordingly, even an effective system of disclosure controls and procedures can provide only reasonable assurance with respect to financial statement preparation. Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended September 30, 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

 

 

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

We and our subsidiaries may be involved from time to time in ordinary routine litigation incidental to our respective businesses.  Neither we nor any of our subsidiaries are currently engaged in, nor is any of our property the subject of, any legal proceedings, other than ordinary routine litigation incidental to the business, that are expected to have a material adverse effect on our results of operations or financial position.  

Item 1A. Risk Factors.

There are no material changes to the risk factors set forth in “Risk Factors” in Item 1A to Part I of our Annual Report on Form 10-K for the year ended December 31, 2015.  

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

The Company did not issue any unregistered equity securities or repurchase any shares of its common stock during the quarter ended September 30, 2016.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None.

 

 

 

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Item 6. Exhibits.

 

 

 

 

 

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SIGNATURES

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

 

 

 

 

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Exhibit Index

 

 

 

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