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EX-32.2 - EXHIBIT 32.2 - DCB FINANCIAL CORPv452565_ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - DCB FINANCIAL CORPv452565_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - DCB FINANCIAL CORPv452565_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - DCB FINANCIAL CORPv452565_ex31-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

xQUARTERLY 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

 

Commission file number: 0-22387

 

DCB Financial Corp    
(Exact name of registrant as specified in its charter)    

 

Ohio   31-1469837
(State or other jurisdiction of   (I.R.S. Employer Identification No.)
incorporation or organization)    

 

110 Riverbend Avenue, Lewis Center, Ohio  43035
(Address of principal executive offices) (Zip code)

 

(740) 657-7000

 

(Registrant’s telephone number including area code)

 

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

 

Yes x         No   ¨

 

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

 

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer (Do not check if a smaller reporting company) ¨ Smaller reporting company x

 

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

Yes ¨         No x

 

As of November 10, 2016, the latest practicable date, 7,339,232 of the registrant’s common shares, no par value, were issued and outstanding.

 

 

 

  

DCB Financial Corp

 

 

Table of Contents

 

  Page
Part I – Financial Information 3
   
Item 1 – Financial Statements 3
   
Consolidated Balance Sheets as of September 30, 2016 (unaudited) and December 31, 2015 3
   
Consolidated Statements of Operations (unaudited) for the three and nine month periods ended September 30, 2016 and 2015 4
   
Consolidated Statements of Comprehensive Operations (unaudited) for the three and nine month periods ended September 30, 2016 and 2015 5
   
Consolidated Statements of Shareholders’ Equity (unaudited) for the nine month periods ended September 30, 2016 and 2015 6
   
Consolidated Statements of Cash Flows (unaudited) for the nine month periods ended September 30, 2016 and 2015 7
   
Notes to the Consolidated Financial Statements 8
   
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations 27
   
Item 3 – Quantitative and Qualitative Disclosures about Market Risk 37
   
Item 4 – Controls and Procedures 37
   
Part II – Other Information 38
   
Item 1 – Legal Proceedings 38
   
Item 1A – Risk Factors 38
   
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds 40
   
Item 3 – Defaults Upon Senior Securities 40
   
Item 4 – Mine Safety Disclosures 40
   
Item 5 – Other Information 40
   
Item 6 – Exhibits 41
   
Signatures 42

   

 

 

  

Part I – Financial Information

Item 1. Financial Statements

DCB Financial Corp

Consolidated Balance Sheets

 

   September 30, 2016   December 31, 2015 
   (unaudited)     
   (Dollars in thousands, except share and per share data) 
Assets:          
Cash and due from financial institutions  $6,092   $6,929 
Interest-bearing deposits   25,190    24,963 
Total cash and cash equivalents   31,282    31,892 
           
Securities available-for-sale   95,676    87,797 
           
Loans   390,750    378,513 
Less allowance for loan losses   (4,592)   (4,333)
Net loans   386,158    374,180 
           
Loans held for sale   755    - 
Real estate owned   68    68 
Investment in FHLB stock   3,250    3,250 
Premises and equipment, net   9,810    5,091 
Premises and equipment held-for-sale   -    4,771 
Bank-owned life insurance   21,329    20,760 
Deferred tax asset, net   10,467    10,440 
Accrued interest receivable and other assets   6,622    3,015 
Total assets  $565,417   $541,264 
           
Liabilities and shareholders’ equity          
Liabilities:          
Deposits:          
Non-interest bearing  $123,353   $124,023 
Interest bearing   366,195    350,514 
Total deposits   489,548    474,537 
           
Borrowings   4,293    4,520 
Obligations under capital lease   8,016    - 
Accrued interest payable and other liabilities   4,167    3,360 
Total liabilities   506,024    482,417 
           
Shareholders’ equity:          
Preferred shares, no par value, 2,000,000 shares authorized, none issued and outstanding   -    - 
Common shares, no par value, 17,500,000 shares authorized, 7,661,632 and 7,588,887 shares issued, and 7,339,232 and 7,281,237 shares outstanding for September 30, 2016 and December 31, 2015, respectively   16,907    16,410 
Retained earnings   49,820    49,799 
Treasury stock, at cost, 322,400 and 307,650 shares at September 30, 2016 and December 31, 2015, respectively   (7,520)   (7,416)
Accumulated other comprehensive income   994    436 
Deferred stock-based compensation   (808)   (382)
Total shareholders’ equity   59,393    58,847 
Total liabilities and shareholders’ equity  $565,417   $541,264 
           
Common shares outstanding   7,339,232    7,281,237 
Book value per common share  $8.09   $8.08 

 

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

 

  3.

 

 

DCB Financial Corp

Consolidated Statements of Income (Loss) (Unaudited)

 

   Three months ended
September 30,
   Nine months ended
September 30,
 
   2016   2015   2016   2015 
   (Dollars in thousands, except share and per share data) 
Interest income:                    
Loans  $4,157   $3,979   $12,154   $11,884 
Securities   494    473    1,508    1,460 
Federal funds sold and interest bearing deposits   28    17    80    46 
Total interest income   4,679    4,469    13,742    13,390 
                     
Interest expense:                    
Deposits:                    
Savings and money market accounts   202    153    560    445 
Time accounts   81    88    229    272 
NOW accounts   20    16    56    49 
Total   303    257    845    766 
                     
Obligation under capital lease   81    -    215    - 
FHLB advances   41    35    126    106 
Total interest expense   425    292    1,186    872 
                     
Net interest income   4,254    4,177    12,556    12,518 
Provision for loan losses   -    (150)   -    - 
Net interest income after provision for loan losses   4,254    4,327    12,556    12,518 
                     
Non-interest income:                    
Service charges   560    523    1,596    1,475 
Wealth management fees   463    438    1,355    1,217 
Treasury management fees   134    81    348    203 
Income from bank-owned life insurance   163    163    569    571 
Gain on sales of loans   351    -    829    - 
Net losses on sales of REO   -    (19)   -    (20)
Other non-interest income   47    37    144    115 
Total non-interest income   1,718    1,223    4,841    3,561 
                     
Non-interest expense:                    
Salaries and employee benefits   3,186    2,771    9,356    8,302 
Occupancy and equipment   1,016    1,000    2,963    2,965 
Professional services   218    405    905    1,042 
Merger related expenses   987    -    987    - 
Advertising   108    169    506    418 
Office supplies, postage and courier   87    81    250    232 
FDIC insurance premium   60    95    238    302 
State franchise taxes   118    75    352    225 
Other non-interest expense   808    554    2,052    1,810 
Total non-interest expense   6,588    5,150    17,609    15,296 
                     
Income (loss) before income tax expense (benefit)   (616)   400    (212)   783 
Income tax benefit   (190)   (10,688)   (233)   (10,688)
Net income (loss)  $(426)  $11,088   $21   $11,471 
                     
Share and Per Share Data                    
Basic average common shares outstanding   7,339,710    7,282,365    7,332,482    7,269,222 
Diluted average common shares outstanding   7,339,710    7,302,174    7,355,709    7,288,237 
Basic and diluted earnings (loss) per common share  $(0.06)  $1.52   $0.00   $1.58 

 

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

 

  4.

 

  

DCB Financial Corp

Consolidated Statements of Comprehensive Income (Loss) (Unaudited)

 

   Three months ended
September 30,
   Nine months ended
September 30,
 
   2016   2015   2016   2015 
   (In thousands) 
Net income (loss)  $(426)  $11,088   $21   $11,471 
                     
Other comprehensive income (loss):                    
                     
Net unrealized gains (losses) on securities available-for-sale, net of taxes of $(24) and $287 for the three and nine months ended September 30, 2016, respectively, and $60 and $(10) for the three and nine months ended September 30, 2015, respectively.   (47)   116    558    (45)
                     
Total other comprehensive income (loss)   (47)   116    558    (45)
                     
Comprehensive income (loss)  $(473)  $11,204   $579   $11,426 

 

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

 

  5.

 

  

DCB Financial Corp

Consolidated Statements of Shareholders’ Equity (Unaudited)

  

   Issued and
Outstanding
Common
Shares
   Preferred
Stock
   Common
Stock
   Retained
Earnings
   Treasury
Stock
   Accumulated
Other
Comprehensive
Income (Loss)
   Deferred
Stock-Based
Compensation
   Total 
   (Dollars in thousands) 
Balance at January 1, 2015   7,233,797   $-   $16,064   $38,055   $(7,416)  $654   $(146)  $47,211 
Net income   -    -    -    11,471    -    -    -    11,471 
Other comprehensive
income, net of taxes
   -    -    -    -    -    (45)   -    (45)
Issuance of restricted stock   55,785    -    407    -    -    -    (407)   - 
Forfeiture of restricted stock   (9,290)   -    (59)   -    -    -    59    - 
Amortization of restricted stock   -    -    -    -    -    -    59    59 
Balance at September 30, 2015   7,280,292   $-   $16,412   $49,526   $(7,416)  $609   $(435)  $58,696 
                                         
Balance at January 1, 2016   7,281,237   $-   $16,410   $49,799   $(7,416)  $436   $(382)  $58,847 
Net income   -    -    -    21    -    -    -    21 
Other comprehensive income, net of taxes   -    -    -    -    -    558    -    558 
Issuance of restricted stock   78,036    -    532    -    -    -    (532)   - 
Repurchase of common shares   (14,750)   -    -    -    (104)   -    -    (104)
Restricted stock withheld upon vesting for payment of taxes   (1,857)   -    (12)   -    -    -    -    (12)
Forfeiture of restricted stock   (3,434)   -    (23)   -    -    -    23    - 
Amortization of restricted stock   -    -    -    -    -    -    83    83 
Balance at September 30, 2016   7,339,232   $-   $16,907   $49,820   $(7,520)  $994   $(808)  $59,393 

 

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

  

  6.

 

  

DCB Financial Corp

Consolidated Statements of Cash Flows (Unaudited)

   

   Nine months ended September 30, 
   2016   2015 
   (In thousands) 
Cash flows from operating activities          
Net income  $21   $11,471 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation   677    729 
Provision for loan losses   -    - 
Deferred taxes   (233)   (10,688)
Net loss on sale of real estate owned   -    20 
Net gain on sale of loans   (829)   - 
Gain on calls of securities   (18)   - 
Net stock-based compensation expense   57    132 
Premium amortization on securities, net   712    790 
Originations of mortgage loans held for sale   (10,997)   - 
Proceeds from sale of mortgage loans   10,466    - 
Proceeds from sale of guaranteed portion of SBA loans   6,975    - 
Earnings on bank owned life insurance   (569)   (571)
Net changes in other assets and other liabilities   (2,948)   (545)
Net cash provided by operating activities   3,314    1,338 
           
Cash flows from investing activities          
Purchases of securities available-for-sale   (30,042)   (25,696)
Proceeds from maturities, principal payments and calls of securities available-for-sale   22,296    18,728 
Net change in loans   (12,581)   5,124 
Net proceeds from sale of premises and equipment   2,347    - 
Proceeds from sale of real estate owned   -    307 
Premises and equipment expenditures   (410)   (662)
Net cash used in investing activities   (18,390)   (2,199)
           
Cash flows from financing activities          
Net change in deposits   15,011    21,715 
Proceeds from short-term borrowings   4,293    - 
Repayment of capital lease   (214)   - 
Repayment of borrowings   (4,520)   (7,097)
Repurchase of common stock   (104)   - 
Net cash provided by financing activities   14,466    14,618 
           
Net change in cash and cash equivalents   (610)   13,757 
Cash and cash equivalents at beginning of period   31,892    21,274 
Cash and cash equivalents at end of period  $31,282   $35,031 
           
Supplemental disclosures of cash flow information          
Cash paid during the period for interest on deposits and borrowings  $1,195   $834 
Transfer from portfolio loans to loans held for sale   6,132    - 
Transfer from loans held for sale to portfolio loans   2,540    - 
Non-cash investing and financing activities:          
Loan to finance sale of premises and equipment   5,530    - 
Capital lease obligation   8,230    - 

   

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

  

  7.

 

  

Note 1 – Summary of Significant Accounting Policies

 

Unless the context indicates otherwise, all references in this report to “Delaware,” “DCB,” “we,” “us,” “our company,” “corporation” and “our” refer to DCB Financial Corp and its direct and indirect subsidiaries The Delaware County Bank and Trust Company, our wholly owned bank subsidiary (the “Bank”), DCB Title Services, LLC, DCB Insurance Services, LLC, DataTasx LLC, ORECO, Inc., and 110 Riverbend, LLC.

 

DCB Financial Corp is a financial holding company headquartered in Lewis Center, Ohio, and was incorporated under the laws of the State of Ohio in 1997, as a bank holding company under the Bank Holding Company Act of 1956, as amended. DCB is the holding company for The Delaware County Bank and Trust Company, a commercial bank organized in 1950 and chartered under the laws of the State of Ohio (the “Bank”).

 

We also have two wholly-owned, non-bank subsidiaries, DCB Title Services, LLC, an Ohio limited liability company (“DCB Title”), and DCB Insurance Services, LLC, an Ohio limited liability company (“DCB Insurance”). DCB Title provides standard real estate title services, while DCB Insurance provides a variety of insurance products. The activities of each of these subsidiaries are not material to our operations. The Bank has two wholly-owned subsidiaries, ORECO, Inc., an Ohio corporation, which is used to hold the Bank’s foreclosed real estate, and 110 Riverbend, LLC, which was used to hold real estate owned by the Bank prior to the sale of such real estate in January 2016.

 

The accompanying unaudited financial statements were prepared in accordance with the instructions for Form 10-Q and Regulation S-X and, therefore, do not include information for footnotes necessary for a complete presentation of financial condition, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The material under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is written with the presumption that the users of the interim financial statements have read, or have access to, the latest audited financial statements and notes thereto of the Company, together with Management’s Discussion and Analysis of Financial Condition and Results of Operations as of December 31, 2015, and for the two-year period then ended, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015. Accordingly, only material changes in the results of operations and financial condition are discussed in the remainder of Part I. Certain amounts from prior year periods are reclassified, when necessary, to conform to the current period presentation.

 

All adjustments, consisting of only normal recurring items, that in the opinion of management are necessary for a fair presentation of the financial statements have been included in the results of operations for the three and nine months ended September 30, 2016 and 2015. The results of operations are not necessarily indicative of the results anticipated for the year.

 

To prepare financial statements in conformity with U.S. GAAP, management makes estimates and assumptions based on available information. These estimates and assumptions affect amounts reported in the financial statements and disclosures provided, and future results could differ. The allowance for loan losses, fair values of financial instruments and status of contingencies are particularly subject to change.

 

Earnings per Common Share

 

Earnings per common share is computed using the two-class method. Basic earnings per common share is computed by dividing net income allocated to common shares by the weighted average number of common shares outstanding during the period which excludes the participating securities. All outstanding unvested restricted stock awards containing rights to non-forfeitable dividends are considered participating securities for this calculation. Diluted earnings per common share includes the dilutive effect of additional potential common shares from stock compensation awards, but excludes awards considered participating securities.

 

Stock-Based Compensation

 

Compensation cost is recognized for restricted stock awards issued to employees and directors based on the fair value of these awards at the date of grant. The market price of the Company’s common shares at the date of grant is used to determine the fair value for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.

 

The Company’s outstanding stock options may be settled for cash at the recipient’s discretion; therefore, liability accounting applies to the Company’s 2004 Long-Term Stock Incentive Plan under which such stock options were granted. Compensation expense is recognized based on the fair value of these awards at the reporting date. A Black Scholes model is utilized to estimate the fair value of stock options at the date of grant and subsequent re-measurement dates. Compensation cost is recognized over the required service period, generally defined as the vesting period. The Company’s stock option awards contain terms that provide for a graded vesting schedule whereby portions of the award vest in increments over the requisite service period.  Changes in fair value of the options between the vesting date and option expiration date are also recognized in the Consolidated Statement of Operations.

 

  8.

 

  

Significant Accounting Estimates

 

The Company’s consolidated financial statements are prepared in accordance with U.S. GAAP and follow general practices within the financial services industry. The 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; as this information changes, the financial statements could reflect different estimates, assumptions, and judgments.

 

The procedures for assessing the adequacy of the allowance for loan losses reflect the Company’s evaluation of credit risk after careful consideration of all information available to the Company. In developing this assessment, the Company must rely on estimates and exercise judgment regarding matters where the ultimate outcome is unknown, such as economic factors, developments affecting companies in specific industries and issues with respect to single borrowers. Depending on changes in circumstances, future assessments of credit risk may yield materially different results, which may require an increase or a decrease in the allowance for loan losses.

 

The valuation of other assets requires that management utilize a variety of estimates and analysis to determine whether an asset is impaired or other-than-temporarily impaired (“OTTI”). After determining the appropriate methodology for fair value measurement, management then evaluates whether or not declines in fair value below book value are temporary or other-than-temporary impairments. When the Company does not intend to sell a debt security, and it is more likely than not that the Company will not have to sell the security before recovery of its cost basis, it recognizes the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income.

 

Loans

 

Loans are classified as held for investment when management has both the intent and ability to hold the loan for the foreseeable future, or until maturity or payoff. Management’s intent and view of the foreseeable future may change based on changes in business strategies, the economic environment, market conditions and the availability of government programs. Loans that are held for investment are reported at the principal balance outstanding, net of unearned interest, unamortized deferred loan fees and costs and the allowance for loan losses. Loans held for sale are carried at the lower of amortized cost or estimated fair value, determined on an aggregate basis for each type of loan. Net unrealized losses are recognized by charges to income.

 

Interest income is accrued based on the unpaid principal balance and includes amortization of net deferred loan fees and costs over the loan term. Interest income on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in process of collection. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not received for loans placed on non-accrual status is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

When loans are transferred from held for investment to held for sale, specific reserves and allocated pooled reserves included in the allowance for loan and losses are reclassified to reduce the basis of the loans to the lower of cost or estimated fair value less cost to sell.

 

Allowance for Loan Losses

 

The allowance for loan losses is a valuation allowance for probable but unconfirmed credit losses, increased by the provision for loan losses and decreased by charge-offs net of recoveries. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the required allowance balance based on past loan loss experience, augmented by additional estimates related to the nature and volume of the portfolio, information about specific borrower situations, estimated collateral values, economic conditions and other factors.

 

The allowance consists of both specific and general components. The specific component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the collateral value or value of expected discounted cash flows of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical charge-off experience and expected loss given default derived from the Bank’s internal risk rating process. Management utilizes an average of a three year historical loss period. Management has the ability to adjust these loss rates by utilizing risk ratings based on current period trends. If current period trends differ either positively or negatively from the given weighted historical loss rates, adjustments can be made. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risking rating data.

 

  9.

 

  

Management also utilizes its assessment of general economic conditions, and other localized economic data to more fully support its loan loss estimates. General economic data may include: inflation rates, savings rates and national unemployment rates. Local data may include: unemployment rates, housing starts, real estate valuations, and other economic data specific to the Company’s market area. Though not specific to individual loans, these economic trends can have an impact on portfolio performance as a whole.

 

Uncollectibility is usually determined based on a pre-determined number of days delinquent in the case of consumer loans, or, in the case of commercial loans, is based on a combination of factors including delinquency, collateral and other legal considerations. Consumer loans are charged-off prior to 120 days of delinquency, but could be charged off earlier, depending on the individual circumstances. Mortgage loans are charged down prior to 180 days of delinquency, but could be charged off sooner, again, depending upon individual circumstance. Typically, loans collateralized by residential real estate are partially charged down to the estimated liquidation value, which is generally based on appraisal less costs to hold and liquidate. Commercial and commercial real estate loans are evaluated for impairment and typically reserved based on the results of the analysis, then subsequently charged down to a recoverable value when loan repayment is deemed to be collateral dependent. Loans can be partially charged down depending on a number of factors including: the remaining strength of the borrower and guarantor; the type and value of the collateral, and the ease of liquidating collateral; and whether or not collateral is brought onto the bank’s balance sheet via repossession. In the case of commercial and commercial real estate loans, charge-offs, partial or whole, take place when management determines that full collectability of principal balance is unlikely to occur. Subsequent recoveries, if any, are credited to the allowance. Management’s policies for determining impairment, reserves and charge-offs are reviewed and approved by the Board of Directors on an annual basis.

 

Troubled debt restructuring of loans is undertaken to improve the likelihood that the loan will be repaid in full under the modified terms in accordance with a reasonable repayment schedule.  All modified loans are evaluated to determine whether the loans should be reported as a Troubled Debt Restructuring (“TDR”).  A loan is a TDR when the Company, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower by modifying or renewing a loan that the Company would not otherwise consider. To make this determination, the Company must determine whether (a) the borrower is experiencing financial difficulties and (b) the Company granted the borrower a concession. This determination requires consideration of all of the facts and circumstances surrounding the modification.  An overall general decline in the economy or some deterioration in a borrower’s financial condition does not automatically mean the borrower is experiencing financial difficulties.

 

Income Taxes

 

The Company accounts for income taxes in accordance with income tax accounting guidance (ASC 740, Income Taxes). 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 based on the tax effects of the differences between the book and tax basis of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur. 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 a deferred tax asset will not be realized.

 

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 percent; 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 percent 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. The Company recognizes interest and penalties on income taxes, if applicable, as a component of income tax expense. The Company files consolidated income tax returns with its subsidiaries.

 

  10.

 

 

New Accounting Pronouncements

 

Recently Issued Accounting Standards

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 was issued to provide financial statement users with information about expected credit losses on financial instruments and other commitments to extend credit rather than the current “incurred loss” model. For public business entities, the new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the effect the guidance will have on the Company’s consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). Among other things, in the amendments in ASU 2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date:

 

- 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.

 

Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. For public business entities, the amendments in this update are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted. The Company is currently evaluating the effect the guidance will have on the Company’s consolidated financial statements.

 

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in ASU 2016-01 supersede the guidance to classify equity securities with readily determinable fair values into different categories (that is, trading or available-for-sale) and require equity securities (including other ownership interests, such as partnerships, unincorporated joint ventures, and limited liability companies) to be measured at fair value with changes in the fair value recognized through net income. The amendments allow equity investments that do not have readily determinable fair values to be re-measured at fair value either upon the occurrence of an observable price change or upon identification of an impairment. The amendments also require enhanced disclosures about those investments. The amendments improve financial reporting by providing relevant information about an entity’s equity investments and reducing the number of items that are recognized in other comprehensive income. For public business entities, the amendments in this update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The amendments should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The adoption of this guidance is not expected to have a material effect on the Company’s financial position or results of operations.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). This new guidance supersedes the revenue recognition requirements in ASC 605, Revenue Recognition, and is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects consideration to which the entity expects to be entitled in exchange for those goods and services. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. In April 2015, the FASB approved deferral of the effective date of this guidance, which is now effective prospectively for the Company for annual and interim periods beginning after December 15, 2017. The Company is currently evaluating the effect the guidance will have on the Company’s consolidated financial statements.

 

  11.

 

  

Note 2 – Securities

 

The amortized cost and estimated fair values of securities available-for-sale were as follows at the dates indicated (in thousands):

 

   September 30, 2016 
   Amortized
 Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
U.S. Government and agency obligations  $27,282   $34   $19   $27,297 
Corporate bonds   2,800    68    2    2,866 
States and municipal obligations   20,501    738    13    21,226 
Collateralized mortgage obligations   27,577    161    28    27,710 
Mortgage-backed securities   15,510    570    -    16,080 
Other equity securities   500    -    3    497 
Total  $94,170   $1,571   $65   $95,676 

 

   December 31, 2015 
   Amortized
Cost
   Gross
 Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
                 
U.S. Government and agency obligations  $20,904   $26   $88   $20,842 
Corporate bonds   3,714    26    13    3,727 
States and municipal obligations   21,954    388    81    22,261 
Collateralized mortgage obligations   22,862    46    107    22,801 
Mortgage-backed securities   17,702    505    41    18,166 
Total  $87,136   $991   $330   $87,797 

 

Securities with unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at the dates indicated are as follows (dollars in thousands):

 

   September 30, 2016 
   (Less than 12 months)   (12 months or longer)   Total 
Description of securities  Number of
investments
   Fair
value
   Unrealized
losses
   Number of
investments
   Fair
 value
   Unrealized
losses
   Number of
 investments
   Fair
value
   Unrealized
 losses
 
U.S. Government and agency
obligations
   11   $15,225   $19    -   $-   $-    11   $15,225   $19 
Corporate bonds   -    -    -    1    499    2    1    499    2 
State and municipal obligations   3    1,158    13    -    -    -    3    1,158    13 
Collateralized mortgage obligations   10    7,654    14    6    2,323    14    16    9,977    28 
Mortgage-backed  securities   1    1,234    -    -    -    -    1    1,234    - 
Other equity securities   1    497    3    -    -    -    1    497    3 
Total temporarily impaired securities   26   $25,768   $49    7   $2,822   $16    33   $28,590   $65 

 

   December 31, 2015 
   (Less than 12 months)   (12 months or longer)   Total 
Description of securities  Number of
 investments
   Fair
value
   Unrealized
losses
   Number of
investments
   Fair
 value
   Unrealized
losses
   Number of
investments
   Fair
value
   Unrealized
losses
 
U.S. Government and agency
obligations
   14   $15,333   $55    2   $1,964   $33    16   $17,297   $88 
Corporate bonds   2    759    5    3    1,400    8    5    2,159    13 
State and municipal obligations   9    3,902    48    4    1,355    33    13    5,257    81 
Collateralized mortgage obligations   13    11,298    63    6    2,551    44    19    13,849    107 
Mortgage-backed securities   5    5,176    41    -    -    -    5    5,176    41 
Total temporarily impaired securities   43   $36,468   $212    15   $7,270   $118    58   $43,738   $330 

 

The unrealized losses on the Company’s securities were caused primarily by changes in interest rates. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments and it is not more likely than not the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be OTTI at September 30, 2016 or December 31, 2015.

 

  12.

 

  

Substantially all mortgage-backed securities are backed by pools of mortgages that are insured or guaranteed by the Federal National Mortgage Association (“FNMA”), the Government National Mortgage Association (“GNMA”) or the Federal Home Loan Mortgage Corporation (“FHLMC”).

 

There were no sales of securities in the nine months ended September 30, 2016 and 2015.

 

At September 30, 2016, there were no holdings of securities of any one issuer, other than the U.S. government and its agencies, in an amount greater than 10% of shareholders’ equity.

 

The amortized cost and estimated fair value of all debt securities at September 30, 2016, by contractual maturity, are shown below (in thousands). Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Mortgage-backed securities are shown separately since they are not due at a single maturity date.

  

   Amortized Cost   Fair Value 
Due in one year or less  $3,726   $3,730 
Due after one to five years   32,422    32,674 
Due after five to ten years   10,835    11,214 
Due after ten years   3,600    3,771 
Mortgage-backed and related securities   43,587    44,287 
Total  $94,170   $95,676 

 

Securities with a fair value of $75.6 million at September 30, 2016 were pledged to secure public deposits and other obligations.

 

Note 3 – Loans

 

Loans were comprised of the following at the dates indicated (in thousands):

 

   September 30,
2016
   December 31,
2015
 
         
Consumer and credit card  $36,158   $40,587 
Residential real estate and home equity   150,362    137,645 
Commercial and industrial   104,108    99,213 
Commercial real estate   99,505    100,743 
    390,133    378,188 
           
Net deferred loan costs   617    325 
Loans  $390,750   $378,513 
Allowance for loan losses   (4,592)   (4,333)
Net loans  $386,158   $374,180 

 

Note 4 – Credit Quality

 

Allowance for Loan Losses

 

The Company’s methodology for estimating probable future losses on loans utilizes a combination of probability of loss by loan grade and loss given defaults for its portfolios. The probability of default is based on both market data from a third-party independent source and actual historical default rates within the Company’s portfolio. A loan is impaired when full payment of interest and principal under the original contractual loan terms is not expected. Commercial and industrial loans, commercial real estate, including construction and land development, and multi-family real estate loans are individually evaluated for impairment. If a loan is impaired, the loan amount exceeding fair value, based on the most current information available is reserved. Management has developed a process by which commercial and commercial real estate loan relationships with balances of $250,000 or greater are assigned an internal risk grade 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. Borrower’s receiving an internal risk grade of substandard or doubtful are individually evaluated for impairment through a loan quality review (LQR). The LQR details the various attributes of the relationship and collateral and determines based on the most recent available information if a specific reserve needs to be applied and at what level. The LQR process for all loans meeting the specific review criteria is completed on a quarterly basis. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, such loans are not separately identified for impairment disclosures. This methodology recognizes portfolio behavior while allowing for reasonable loss ratios on which to estimate allowance calculations.

 

  13.

 

 

Further, the process for estimating probable loan losses is divided into reviewing impaired loans on an individual basis for probable losses and, as noted above, calculating probable losses based on historical and market data for homogenous loan portfolios. As the Company’s troubled loan portfolios have been reduced through paydowns, payoffs, credit improvement and charge-offs, the remaining loan portfolios possess better overall credit characteristics, and based on the Company’s methodology require lower rates of reserving than historical levels.

 

The tables below summarize activity in the allowance for loan losses for the periods indicated (in thousands).

 

   Three months ended September 30, 2016 
   Consumer
and
Credit
Card
   Residential
Real Estate
and Home
Equity
   Commercial
and
Industrial
   Commercial
Real Estate
   Unallocated   Total 
Beginning balance  $122   $544   $1,521   $2,140   $263   $4,590 
Charge-offs   (63)   (3)   (2)   -    -    (68)
Recoveries   23    12    23    12    -    70 
Net (charge-offs) recoveries   (40)   9    21    12    -    2 
                               
Provision   38    (24)   (26)   (71)   83    - 
Ending balance  $120   $529   $1,516   $2,081   $346   $4,592 

 

   Nine months ended September 30, 2016 
   Consumer
and
Credit
Card
   Residential
Real Estate
and Home
Equity
   Commercial
and
Industrial
   Commercial
Real Estate
   Unallocated   Total 
Beginning balance  $144   $561   $1,321   $1,999   $308   $4,333 
Charge-offs   (142)   (12)   (2)   -    -    (156)
Recoveries   56    35    240    84    -    415 
Net (charge-offs) recoveries   (86)   23    238    84    -    259 
                               
Provision   62    (55)   (43)   (2)   38    - 
Ending balance  $120   $529   $1,516   $2,081   $346   $4,592 

 

 

   Three months ended September 30, 2015 
   Consumer
and
Credit
Card
   Residential
Real Estate
and Home
Equity
   Commercial
and
Industrial
   Commercial
Real Estate
   Unallocated   Total 
Beginning balance  $172   $315   $1,035   $2,195   $447   $4,164 
Charge-offs   (63)   -    -    -    -    (63)
Recoveries   50    30    157    18    -    255 
Net (charge-offs) recoveries   (13)   30    157    18    -    192 
                               
Provision   -    156    (63)   (217)   (26)   (150)
Ending balance  $159   $501   $1,129   $1,996   $421   $4,206 

 

   Nine months ended September 30, 2015 
   Consumer
and
Credit
Card
   Residential
Real Estate
and Home
Equity
   Commercial
and
Industrial
   Commercial
Real Estate
   Unallocated   Total 
Beginning balance  $190   $268   $1,132   $2,376   $270   $4,236 
Charge-offs   (122)   (73)   (311)   (64)   -    (570)
Recoveries   109    97    297    37    -    540 
Net charge-offs   (13)   24    (14)   (27)   -    (30)
                               
Provision   (18)   209    11    (353)   151    - 
                               
Ending balance  $159   $501   $1,129   $1,996   $421   $4,206 

 

  14.

 

 

Impaired Loans

 

A loan is considered impaired when based on current information and events it is probable the Bank will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include non-performing commercial loans but also include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.

 

The following presents by class, information related to the Company’s impaired loans as of the dates indicated (in thousands).

 

   At September 30, 2016   Period ended September 30, 2016 
   Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Three months
Average
Recorded
Investment
   Three months
Interest Income
Recognized
   Nine months
Average
Recorded
Investment
   Nine months
Interest Income
Recognized
 
With no related allowance recorded:                                   
Consumer and credit card  $282   $282    -   $283   $5   $376   $14 
Residential real estate and home equity   668    668    -    672    -    660    1 
Commercial and industrial   572    572    -    579    5    862    16 
Commercial real estate   2,284    2,284    -    2,292    19    842    19 
    3,806    3,806    -    3,826    29    2,740    50 

With an allowance recorded:

                                   
Commercial and industrial  $1,545   $1,623   $344   $1,407   $17   $1,263   $46 
Commercial real estate   4,831    4,831    581    4,841    56    4,751    168 
    6,376    6,454    925    6,248    73    6,014    214 

Total:

                                   
Consumer and credit card  $282   $282   $-   $283   $5   $376   $14 
Residential real estate and home equity   668    668    -    672    -    660    1 
Commercial and industrial   2,117    2,195    344    1,986    22    2,125    62 
Commercial real estate   7,115    7,115    581    7,133    75    5,593    187 
Total  $10,182   $10,260   $925   $10,074   $102   $8,754   $264 

 

   At December 31, 2015   Period ended September 30, 2015 
   Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Three months
Average
Recorded
Investment
   Three months
Interest Income
Recognized
   Nine months
Average
Recorded
Investment
   Nine months
Interest Income
Recognized
 
With no related allowance recorded:                                   
Consumer and credit card  $548   $548    -   $469   $7   $469   $19 
Residential real estate and home equity   668    668    -    733    -    552    8 
Commercial and industrial   926    926    -    914    5    1,106    21 
Commercial real estate   126    126    -    451    2    468    2 
    2,268    2,268    -    2,567    14    2,595    50 
With an allowance recorded:                                   
Commercial and industrial  $944   $1,021   $144   $1,134   $13   $1,016   $43 
Commercial real estate   4,579    4,579    435    6,706    53    7,727    163 
    5,523    5,600    579    7,840    66    8,743    206 
Total:                                   
Consumer and credit card  $548   $548   $-   $469   $7   $469   $19 
Residential real estate and home equity   668    668    -    733    -    552    8 
Commercial and industrial   1,870    1,947    144    2,048    18    2,122    64 
Commercial real estate   4,705    4,705    435    7,157    55    8,195    165 
Total  $7,791   $7,868   $579   $10,407   $80   $11,338   $256 

 

  15.

 

 

The allocation of the allowance for loan losses summarized on the basis of the Company’s impairment methodology was as follows at the dates indicated (in thousands):

 

   Consumer
and Credit
Card
   Residential
Real Estate
and Home
Equity
   Commercial
and
Industrial
   Commercial
Real Estate
   Total 
September 30, 2016                         
Individually evaluated for impairment  $-   $-   $344   $581   $925 
Collectively evaluated for impairment   120    529    1,172    1,500    3,321 
Allocated  $120   $529   $1,516   $2,081    4,246 
Unallocated                       346 
                       $4,592 
                          
December 31, 2015                         
Individually evaluated for impairment  $-   $-   $144   $435   $579 
Collectively evaluated for impairment   144    561    1,177    1,564    3,446 
Allocated  $144   $561   $1,321   $1,999    4,025 
Unallocated                       308 
                       $4,333 

 

The recorded investment in loans summarized on the basis of the Company’s impairment methodology at the dates indicated was as follows (in thousands):

 

   Consumer
and Credit
Card
   Residential
Real Estate
and Home
Equity
   Commercial
and
Industrial
   Commercial
Real Estate
   Total 
September 30, 2016                         
Individually evaluated for impairment  $282   $668   $2,117   $7,115   $10,182 
Collectively evaluated for impairment   35,876    149,694    101,991    92,390    379,951 
Ending balance  $36,158   $150,362   $104,108   $99,505   $390,133 

 

   Consumer
and Credit
Card
   Residential
Real Estate
and Home
Equity
   Commercial
and
Industrial
   Commercial
Real Estate
   Total 
December 31, 2015                         
Individually evaluated for impairment  $548   $668   $1,870   $4,705   $7,791 
Collectively evaluated for impairment   40,039    136,977    97,343    96,038    370,397 
Ending balance  $40,587   $137,645   $99,213   $100,743   $378,188 

 

Loans on non-accrual status were as follows at the dates indicated (in thousands):

 

   September 30,   December 31, 
   2016   2015 
Consumer and credit card  $-   $- 
Residential real estate and home equity   816    668 
Commercial and industrial   236    554 
Commercial real estate   2,315    - 
Total  $3,367   $1,222 

 

Credit Quality Indicators

 

The Company uses the following definitions for criticized and classified commercial loans and commercial real estate loans which are consistent with regulatory guidelines:

 

Special Mention

 

Loans which possess some credit deficiency or potential weakness which deserves close attention, but which do not yet warrant substandard classification. Such loans pose unwarranted financial risk that, if not corrected, could weaken the loan and increase risk in the future. The key distinctions of a Special Mention classification are that (1) it is indicative of an unwarranted level of risk, and (2) weaknesses are considered “potential,” versus “well-defined,” impairments to the primary source of loan repayment.

 

  16.

 

 

Substandard

 

Loans that are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

 

Doubtful

 

Loans that have all the weaknesses inherent in a Substandard loan 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 and improbable. Specific pending factors may strengthen the credit, therefore deferring a Loss classification.

 

Loss

 

Loans are considered uncollectible and of such little value that continuing to carry them as assets on the institution’s financial statements is not feasible. Loans will be classified Loss when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.

 

As of the dates indicated and based on the most recent analysis performed, the recorded investment by risk category and class of loans is as of the dates indicated (in thousands):

 

   September 30, 2016   December 31, 2015 
   Commercial
and Industrial
   Commercial
Real Estate
   Commercial
and Industrial
   Commercial
Real Estate
 
                 
Pass  $101,331   $92,499   $96,225   $91,132 
Special mention   1,200    4,374    925    4,592 
Substandard   1,577    2,632    2,063    5,019 
Total  $104,108   $99,505   $99,213   $100,743 

 

For residential real estate and consumer loan classes, the Company evaluates credit quality primarily based upon the aging status of the loan and by payment activity.

 

The following table presents the recorded investment in residential real estate and consumer loans based on payment activity as of the dates indicated (in thousands):

 

   September 30, 2016   December 31, 2015 
   Consumer and
Credit Card
   Residential
Real Estate and
Home Equity
   Consumer and
Credit Card
   Residential
Real Estate and
Home Equity
 
                 
Performing  $36,158   $149,546   $40,587   $136,975 
Non-performing   -    816    -    670 
Total  $36,158   $150,362   $40,587   $137,645 

 

  17.

 

 

Age Analysis of Past Due Loans

 

The following tables present past due loans aged as of the dates indicated (in thousands).

 

   September 30, 2016 
   30-59 Days
Past Due
   60-89
Days
Past
Due
   90 Days or
more Past
Due
   Total 
Past Due
   Loans
Not Past
Due
   Total Loans 
Consumer and credit card  $103   $34   $-   $137   $36,021   $36,158 
Residential real estate and home equity   72    89    434    595    149,767    150,362 
Commercial and industrial   99    -    168    267    103,841    104,108 
Commercial real estate   -    -    2,315    2,315    97,190    99,505 
Total  $274   $123   $2,917   $3,314   $386,819   $390,133 

 

   December 31, 2015 
   30-59 Days
Past Due
   60-89
Days
Past
Due
   90 Days or
more Past
Due
   Total 
Past Due
   Loans
Not Past
Due
   Total Loans 
Consumer and credit card  $48   $13   $-   $61   $40,526   $40,587 
Residential real estate and home equity   160    98    401    659    136,986    137,645 
Commercial and industrial   236    -    -    236    98,977    99,213 
Commercial real estate   -    -    -    -    100,743    100,743 
Total  $444   $111   $401   $956   $377,232   $378,188 

 

Troubled Debt Restructurings

 

The following table summarizes troubled debt restructurings that occurred during the periods indicated (dollars in thousands):

 

   For the three months ended September 30, 
   2016   2015 
   Number of
Contracts
   Recorded Investment
(as of period end)
   Number of
Contracts
   Recorded Investment
(as of period end)
 
Consumer and credit card   -   $-    1   $188 
                     
Total   -   $-    1   $188 

 

   For the nine months ended September 30, 
   2016   2015 
   Number of
Contracts
   Recorded Investment
(as of period end)
   Number of
Contracts
   Recorded Investment
(as of period end)
 
Consumer and credit card   -   $-    7   $279 
Commercial real estate   4    392    -    - 
                     
Total   4   $392    7   $279 

 

There were no loans modified in a TDR that subsequently defaulted within twelve months of the modification (i.e. 60 days or more past due) during the three and nine months ended September 30, 2016 and 2015.

 

A modification of a loan constitutes a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Company offers various types of concessions when modifying a loan; however, forgiveness of principal is rarely granted. Depending on the financial condition of the borrower, the purpose of the loan and the type of collateral supporting the loan structure; modifications can be either short-term (12 months of less) or long term (greater than one year). Commercial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral, a co-borrower, or a guarantor may be requested. Commercial mortgage and construction loans modified in a TDR often involve reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, or substituting or adding a new borrower or guarantor. Construction loans modified in a TDR may also involve extending the interest-only payment period.

 

  18.

 

 

 

Land loans are also included in the class of commercial real estate loans. Land loans are typically structured as interest-only monthly payments with a balloon payment due at maturity. Land loans modified in a TDR typically involve extending the balloon payment by one to three years, changing the monthly payments from interest-only to principal and interest, while leaving the interest rate unchanged.

 

Loans modified in a TDR are typically already on non-accrual status and partial charge-offs have in some cases already been taken against the outstanding loan balance. As a result, loans modified in a TDR for the Company may have the financial effect of increasing the specific allowance associated with the loan. The allowance for impaired loans that have been modified in a TDR is measured based on the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent or on the present value of expected future cash flows discounted at the loan’s effective interest rate. Management exercises significant judgment in developing these estimates.

 

As mentioned above, an individual loan is placed on a non-accruing status if, in the judgment of management, it is unlikely that all principal and interest will be received according to the terms of the note. Loans on non-accrual may be eligible to be returned to an accruing status after six months of compliance with the modified terms. However, there are number of factors that could prevent a loan from returning to accruing status, even after remaining in compliance with loan terms for the aforementioned six month period. For example: deteriorating collateral, negative cash flow changes and inability to reduce debt to income ratios.

 

Note 5 – Fair Value Measurements

 

The Company accounts for fair value measurements in accordance with FASB ASC 820, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. FASB ASC 820 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 at the measurement date. FASB ASC 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.

 

The standard describes three levels of inputs that may be used to measure fair value:

 

  Level 1 Quoted prices in active markets for identical assets or liabilities
     
  Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities
     
  Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

 

The carrying value of certain financial assets and liabilities is impacted by the application of fair value measurements, either directly or indirectly. In certain cases, an asset or liability is measured and reported at fair value on a recurring basis, such as available-for-sale investment securities. In other cases, management must rely on estimates or judgments to determine if an asset or liability not measured at fair value warrants an impairment write-down or whether a valuation reserve should be established. Given the inherent volatility, the use of fair value measurements may have a significant impact on the carrying value of assets or liabilities, or result in material changes to the financial statements, from period to period.

 

Fair value is defined as the price that would be received to sell an asset or transfer a liability between market participants at the balance sheet date. When possible, the Company looks to active and observable markets to price identical assets or liabilities. When identical assets and liabilities are not traded in active markets, the Company looks to observable market data for similar assets and liabilities. However, certain assets and liabilities are not traded in observable markets and the Company must use other valuation methods to develop a fair value.

 

The following methods, assumptions, and valuation techniques were used by the Company to measure different financial assets and liabilities at fair value and in estimating its fair value disclosures for financial instruments.

 

Cash and Cash Equivalents: The carrying amounts reported in the consolidated statements of financial condition for cash and cash equivalents is deemed to approximate fair value and are classified as Level 1 of the fair value hierarchy.

 

  19.

 

 

Available for Sale Investment Securities: Fair values for investment securities are determined by quoted market prices if available (Level 1). For securities where quoted prices are not available, fair values are estimated based on market prices of similar securities. For securities where quoted prices or market prices of similar securities are not available, fair values are estimated using matrix pricing, which is a mathematical technique widely used in the industry to value investment securities without relying exclusively on quoted prices for the specific investment securities but rather relying on the investment securities’ relationship to other benchmark quoted investment securities (Level 2). Any investment securities not valued based upon the methods above is considered Level 3.

 

The Company utilizes information provided by a third-party investment securities portfolio manager in analyzing the investment securities portfolio in accordance with the fair value hierarchy of the Fair Value Topic. The portfolio manager’s evaluation of investment security portfolio pricing is performed using a combination of prices and data from other sources, along with internally developed matrix pricing models. The third-party’s month-end pricing process includes a series of quality assurance activities where prices are compared to recent market conditions, previous evaluation prices, and between the various pricing services. These processes produce a series of quality assurance reports on which price exceptions are identified, reviewed and where appropriate, securities are re-priced. In the event of a materially different price, the third party will report the variance and review the pricing methodology in detail. The results of the quality assurance process are incorporated into the selection of pricing providers by the third party.

 

Loans Held for Sale: The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in Level 2 classification.

 

Loans: For fixed rate loans and for variable rate loans with infrequent re-pricing or re-pricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. For loans held on balance sheet, the discounted fair value is further reduced by the amount of reserves held against the loan portfolios. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price and due to the significant judgment involved in evaluating credit quality, loans are classified within Level 3 classification.

 

Federal Home Loan Bank Stock: The carrying amount presented in the consolidated statements of financial condition is deemed to approximate fair value, and is classified as a Level 2 instrument.

 

Accrued Interest Receivable and Payable: The fair value for accrued interest approximates its carrying amounts due to the short duration before collection. The valuation is a Level 3 classification which is consistent with its underlying asset or liability.

 

Deposits: The fair values of deposits with no stated maturity, such as money market demand deposits, savings and NOW accounts have been analyzed by management and assigned estimated maturities and cash flows which are then discounted to derive a value. The fair value of fixed-rate certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The Company classifies the estimated fair value of deposit liabilities as Level 2 in the fair value hierarchy.

 

Advances from the Federal Home Loan Bank: The fair value of these advances is estimated using the rates currently offered for similar advances of similar remaining maturities (Level 2).

 

Commitments to Extend Credit: For fixed-rate and adjustable-rate loan commitments, the fair value estimate considers the difference between current levels of interest rates and committed rates. At September 30, 2016 and December 31, 2015, the fair value of loan commitments was not material.

 

  20.

 

 

Based on the foregoing methods and assumptions, the carrying value and fair value of the Company’s financial instruments are as follows at the dates indicated (in thousands):

 

   September 30, 2016 
   Carrying Amount   Fair Value   Level 1   Level 2   Level 3 
Financial assets                         
Cash and cash equivalents  $31,282   $31,282   $31,282   $-   $- 
Securities available-for-sale   95,676    95,676    -    95,179    497 
Loans held for sale   755    755    -    755    - 
Loans (net of allowance)   386,158    382,919    -    -    382,919 
FHLB stock   3,250    3,250    -    3,250    - 
Accrued interest receivable   1,383    1,383    -    -    1,383 
                          
Financial liabilities                         
Non-interest-bearing deposits  $123,353   $123,353   $-   $123,353   $- 
Interest-bearing deposits   366,195    366,187    -    366,187    - 
Borrowings   4,293    4,293    -    4,293    - 
Accrued interest payable   65    65    -    -    65 

  

   December 31, 2015 
   Carrying
Amount
   Fair
Value
   Level 1   Level 2   Level 3 
Financial assets                         
Cash and cash equivalents  $31,892   $31,892   $31,892   $-   $- 
Securities available-for-sale   87,797    87,797    -    87,797    - 
Loans (net of allowance)   374,180    371,930    -    -    371,930 
FHLB stock   3,250    3,250    -    3,250    - 
Accrued interest receivable   1,307    1,307    -    -    1,307 
                          
Financial liabilities                         
Non-interest-bearing deposits  $124,023   $124,023   $-   $124,023   $- 
Interest-bearing deposits   350,514    350,957    -    350,957    - 
Borrowings   4,520    4,520    -    4,520    - 
Accrued interest payable   74    74    -    -    74 

 

  21.

 

 

The following table presents the fair value measurements of assets recognized in the accompanying balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at the dates indicated (in thousands):

 

   September 30, 2016 
       Fair Value Measurements Using 
   Fair Value   Quoted Prices in Active Markets for Identical Assets
(Level 1)
   Significant Other Observable Inputs
(Level 2)
   Significant Unobservable Inputs
(Level 3)
 
U.S. Government and agency obligations  $27,297   $-   $27,297   $- 
Corporate bonds   2,866    -    2,866    - 
State and municipal obligations   21,226    -    21,226    - 
Collateralized mortgage obligations   27,710    -    27,710    - 
Mortgage-backed securities   16,080    -    16,080    - 
Other equity securities   497    -    -    497 
Total  $95,676   $-   $95,179   $497 

  

   December 31, 2015 
       Fair Value Measurements Using 
   Fair Value   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
U.S. Government and agency obligations  $20,842   $-   $20,842   $- 
Corporate bonds   3,727    -    3,727    - 
State and municipal obligations   22,261    -    22,261    - 
Collateralized mortgage obligations   22,801    -    22,801    - 
Mortgage-backed securities   18,166    -    18,166    - 
Total  $87,797   $-   $87,797   $- 

 

The following is a description of the valuation methodologies used for instruments measured at fair value on a non-recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such instruments pursuant to the valuation hierarchy.

 

Impaired loans

 

At September 30, 2016 and December 31, 2015, impaired loans consisted primarily of loans secured by commercial real estate. Management has determined fair value measurements on impaired loans primarily through evaluations of appraisals performed.

 

Real Estate Owned

 

Real estate acquired through, or in lieu of, loan foreclosure is held for sale and initially recorded at fair value (based on current appraised value) at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less estimated costs to sell. Management has determined fair value measurements on real estate owned primarily through evaluations of appraisals performed.

 

  22.

 

 

The following table presents the fair value measurements of assets measured at fair value on a non-recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at the dates indicated (in thousands).

 

   September 30, 2016 
   Fair Value Measurements Using 
   Fair Value   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant Other
Observable
Inputs
(Level 2 )
   Significant
Unobservable
Inputs
(Level 3)
 
Impaired loans  $10,182   $-   $-   $10,182 
Real estate owned   68    -    -    68 

 

   December 31, 2015 
   Fair Value Measurements Using 
   Fair Value   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant Other
Observable
Inputs
(Level 2 )
   Significant
Unobservable
Inputs
(Level 3)
 
Impaired loans  $7,791   $-   $-   $7,791 
Real estate owned   68    -    -    68 

 

Note 6 – Sale-Leaseback and Capital Lease Obligation

 

In January 2016, the Company entered into a sale-leaseback of its corporate headquarters building. Under the arrangement, the Company sold and leased the building back for a period of fifteen years, with options to extend the term of the lease for two additional periods of ten years each. The gain of $3.1 million realized in the transaction has been netted against the right of use asset and will result in a reduction of depreciation expense over the term of the lease.

 

The lease has been accounted for as a capital lease, and the building is included in property and equipment. The present value of the net minimum lease payments has been capitalized and is being amortized over the life of the lease. Under the terms of the lease agreements, minimum payments of $54,000 are due monthly, increasing 2% annually thereafter, through January 2031. The lease has been imputed with interest at an annual rate of 3.91%.

 

At September 30, 2016, property under capital leases consists of the corporate headquarters with a cost, net of the deferred gain, of $5.0 million. Accumulated depreciation on the property under capital leases was $274,000 at September 30, 2016.

 

Depreciation expense on property under capital leases was $51,000 and $136,000 for the three and nine months ended September 30, 2016, respectively.

  

The future minimum lease payments under capital leases are as follows (in thousands):

 

2016  $161 
2017   655 
2018   668 
2019   682 
2020   695 
Thereafter   7,798 
Total minimum lease payments   10,659 
Less amounts representing interest   2,643 
Present value of net minimum lease payments  $8,016 

 

  23.

 

 

 

Note 7 – Federal Income Taxes

 

The Company files income tax returns in the U.S. federal jurisdiction and franchise tax returns in Ohio. Income tax benefit for the dates indicated include the following components (in thousands):

 

   Three months ended   Nine months ended 
   September 30,   September 30, 
   2016   2015   2016   2015 
Current  $(11)  $-   $73   $- 
Deferred   (179)   96    (306)   96 
Valuation allowance   -    (10,784)   -    (10,784)
Total  $(190)  $(10,688)  $(233)  $(10,688)

 

The difference between the financial statement tax provision and amounts computed by applying the statutory federal income tax rate to income before income taxes was as follows (in thousands):

 

   Three months ended   Nine months ended 
   September 30,   September 30, 
   2016   2015   2016   2015 
Federal income taxes calculated at the expected statutory rate  $(209)  $136   $(72)  $266 
Increase (decrease) in taxes resulting from:                    
Nontaxable dividend and interest income   (30)   (29)   (71)   (70)
Increase in cash surrender value of life insurance - net   (55)   (56)   (193)   (194)
Nondeductible acquisition costs   98    -    98    - 
Other   6    45    5    94 
Valuation allowance   -    (10,784)   -    (10,784)
Income tax benefit per financial statements  $(190)  $(10,688)  $(233)  $(10,688)

 

Deferred tax assets and liabilities were comprised of the following at the dates indicated (in thousands):

 

   September 30, 2016   December 31, 2015 
Deferred tax assets:          
Allowance for loan losses  $1,561   $1,473 
Deferred compensation   308    300 
Alternative minimum tax carry forward   212    155 
Expenses on foreclosed property   -    14 
Deferred gain on sale of building   1,009    - 
NOL carry forward   8,258    9,020 
Other   307    98 
Subtotal   11,655    11,060 
Deferred tax liabilities:          
FHLB stock dividends   (307)   (307)
Unrealized gains on available-for-sale securities   (512)   (225)
Depreciation   (55)   (55)
Other   (314)   (33)
Subtotal   (1,188)   (620)
Net deferred tax asset   10,467    10,440 
Less: valuation allowance   -    - 
Total  $10,467   $10,440 

 

At September 30, 2016, the Company had a $24.3 million net operating loss carryforward that begins to expire in 2030.

 

  24.

 

 

Note 8 - Earnings per Common Share

 

The Company issued restricted stock awards with non-forfeitable dividend rights, which are considered participating securities. As such, earnings per share is computed using the two-class method as required by Accounting Standard Codification (“ASC”) 206-10-45. Basic earnings per common share is computed by dividing net income allocated to common stock by the weighted average number of common shares outstanding during the period which excludes the participating securities. Diluted earnings per common share includes the dilutive effect of additional potential common shares from stock compensation awards and warrants, but excludes awards considered participating securities.

 

Basic and diluted net income per common share calculations for the three and nine months ended September 30 are as follows (in thousands, except share and per share amounts):

 

follows (in thousands, except share and per share amounts):

 

   Three months ended September 30,   Nine months ended September 30, 
   2016   2015   2016   2015 
Basic                    
Net income (loss)  $(426)  $11,088   $21   $11,471 
Less: undistributed earnings allocated to unvested restricted shares   (8)   137    -    121 
Net earnings (losses) allocated to common shareholders  $(418)  $10,951   $21   $11,350 
                     
Weighted average common shares outstanding including shares considered
participating securities
   7,339,710    7,282,365    7,332,482    7,269,222 
Less: average participating securities   (140,205)   (90,015)   (132,977)   (76,872)
Weighted average shares   7,199,505    7,192,350    7,199,505    7,192,350 
                     
Basic earnings (loss) per common share  $(0.06)  $1.52   $0.00   $1.58 
                     
Diluted                    
Net earnings (losses) allocated to common shareholders  $(418)  $10,951   $21   $11,350 
                     
Weighted average common shares outstanding for basic earnings per common share   7,199,505    7,192,350    7,199,505    7,192,350 
Dilutive effect of assumed exercise of average participating securities   -    19,809    23,227    19,015 
Average participating securities   140,205    90,015    132,977    76,872 
Average common shares outstanding – diluted   7,339,710    7,302,174    7,355,709    7,288,237 
                     
Diluted earnings (loss) per common share  $(0.06)  $1.52   $0.00   $1.58 
                     

  

At September 30, 2016, 51,578 stock options were excluded from the diluted weighted average common share calculation for the three months ended September 30, 2016, due to the net loss for the quarter.

 

There were 14,985 of anti-dilutive stock options excluded from the diluted weighted average common share calculation for the three months ended September 30, 2016. At September 30, 2015, 19,324 of anti-dilutive stock options were excluded from the diluted weighted average common share calculations.

  

  25.

 

 

Note 9 – Stock Based Compensation

 

Compensation cost is recognized for restricted stock awards issued to employees and directors based on the fair value of these awards at the date of grant. The market price of the Company’s common shares at the date of grant is used to determine the fair value for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.

 

Awards for 78,036 and 53,640 restricted shares were granted under the Company’s 2014 Restricted Stock Plan during the nine months ended September 30, 2016 and 2015, respectively. The awards vest ratably over a five-year period. There were 1,429 shares and 3,434 restricted shares forfeited in the three months and nine months ended September 30, 2016, respectively. There were 9,290 restricted shares forfeited in the three months and nine months ended September 30, 2015. There were 146,411 and 81,732 unvested restricted shares at September 30, 2016 and December 31, 2015, respectively. Compensation expense associated with amortization of restricted stock was $22,000 and $25,000 for the three months ended September 30, 2016 and 2015, respectively. Compensation expense associated with the amortization of restricted stock was $83,000 and $59,000 in the nine months ended September 30, 2016 and 2015, respectively.

 

The Company’s outstanding stock options may be settled for cash at the recipient’s discretion; therefore, liability accounting applies to the Company’s 2004 Long-Term Stock Incentive Plan under which such stock options were granted. Compensation expense is recognized based on the fair value of these awards at the reporting date. A Black Scholes model is utilized to estimate the fair value of stock options at the date of grant and subsequent re-measurement dates. Compensation cost is recognized over the required service period, generally defined as the vesting period. The Company’s stock option awards contain terms that provide for a graded vesting schedule whereby portions of the award vest in increments over the requisite service period.  Changes in fair value of the options between the vesting date and option expiration date are also recognized in the Consolidated Statement of Income.

 

Note 10 – Subsequent Event

 

On October 3, 2016, First Commonwealth Financial Corporation (“First Commonwealth”) and the Company announced that they had entered into a definitive merger agreement which provides for the merger of the Company with and into First Commonwealth following the satisfaction of certain closing conditions, including approval by the Company’s shareholders and approval by appropriate bank regulatory authorities (the “Merger”). Under the terms of the definitive merger agreement, which has been unanimously approved by the board of directors of both companies, the Company’s shareholders will be entitled to receive either 1.427 shares of First Commonwealth common stock or $14.50 in cash for each common share of the Company, subject to proration provisions set forth in the definitive merger agreement. Aggregate cash consideration to Company shareholders is fixed at $21,283,773, which is approximately 20% of the Merger consideration, and the remaining Merger consideration will be in the form of stock consideration. The Merger is expected to be completed in the second quarter of 2017.

 

  26.

 

 

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

 

Introduction

 

DCB Financial Corp is a financial holding company headquartered in Lewis Center, Ohio, and was incorporated under the laws of the State of Ohio in 1997, as a bank holding company under the Bank Holding Company Act of 1956, as amended. DCB is the holding company for The Delaware County Bank and Trust Company, a commercial bank organized in 1950 and chartered under the laws of the State of Ohio (the “Bank”).

 

We also have two wholly-owned, non-bank subsidiaries, DCB Title Services, LLC, an Ohio limited liability company (“DCB Title”) and DCB Insurance Services, LLC, an Ohio limited liability company (“DCB Insurance”). DCB Title provides standard real estate title services, while DCB Insurance provides a variety of insurance products. The activities of each of these subsidiaries are not material to our operations. The Bank has two wholly-owned subsidiaries, ORECO, Inc., an Ohio corporation, which is used to hold the Bank’s foreclosed real estate, and 110 Riverbend, LLC, which was used to hold real estate owned by the Bank prior to the sale of such real estate in January 2016.

 

We offer full-service banking with a broad range of financial products to meet the needs of our commercial, retail, government, and investment management customers located primarily in Delaware, Franklin and Union Counties in Ohio. Depository account services include interest and non-interest-bearing checking accounts, money market accounts, savings accounts, time deposit accounts, and individual retirement accounts. Our lending activities include the making of residential and commercial mortgage loans, business lines of credit, working capital facilities and business term loans, as well as installment loans, home equity loans, and personal lines of credit to individuals. Investment management and trust services include personal trust, employee benefit trust, investment management, custodial, and financial planning. Through Raymond James Financial Services, Inc., member FINRA/SIPC, we provide financial counseling and brokerage services. We also offer safe deposit boxes, wire transfers, collection services, drive-up banking facilities, 24-hour night depositories, automated teller machines, 24-hour telephone banking, and internet banking.

 

Forward-Looking Statements

 

Certain statements in this report constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, such as statements relating to the financial condition and prospects, lending risks, plans for future business development and marketing activities, capital spending and financing sources, capital structure, the effects of regulation and competition, and the prospective business of both the Company and the Bank. Where used in this report, the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” and similar words and expressions, related to the Company or the Bank or their respective management, identify forward-looking statements. Such forward-looking statements reflect the current views of the Company and are based on information currently available to the management of the Company and the Bank and upon current expectations, estimates, and projections about the Company and its industry, management’s belief with respect thereto, and certain assumptions made by management. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements. 

 

Potential risks and uncertainties include, but are not limited to: (i) significant increases in competitive pressure in the banking and financial services industries; (ii) changes in the interest rate environment which could reduce anticipated or actual margins; (iii) changes in political conditions or the legislative or regulatory environment; (iv) general economic conditions, either nationally or regionally (especially in central Ohio), becoming less favorable than expected resulting in, among other things, a deterioration in credit quality of assets; (v) changes occurring in business conditions and inflation; (vi) changes in technology; (vii) changes in monetary and tax policies; (viii) changes in the securities markets; (ix) other risks and uncertainties detailed from time to time in the filings of the Company with the Securities and Exchange Commission; (x) ability to obtain regulatory approvals for the Merger in a timely manner and without significant expense or other burdens; (xi) ability to meet other closing conditions to the Merger, including approval by our shareholders; (xii) delay in closing the Merger; (xiii) difficulties and delays in integrating the businesses of our Company and First Commonwealth or fully realizing cost savings and other benefits; and (xiv) business disruption following the Merger.

 

The Company does not undertake, and specifically disclaims any obligation, to publicly revise any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

 

  27.

 

 

Overview of the third quarter of 2016

 

·Total assets were $565.4 million at September 30, 2016, compared with $541.3 million at December 31, 2015.

 

·Total loans were $391.5 million at September 30, 2016, compared with $378.5 million at December 31, 2015.

 

·Total deposits were $489.5 million at September 30, 2016, compared with $474.5 million at December 31, 2015.

 

·Net loss was $426,000 for the three months ended September 30, 2016, compared with net income of $11.1 million for the year-ago quarter and $331,000 for the second quarter of 2016. For the nine months ended September 30, 2016, net income was $21,000, compared with $11.5 million for the first nine months of 2015.

 

·Net income (loss) per diluted share was $(0.06) for the three months ended September 30, 2016, compared with $1.52 per diluted share for the year-ago quarter and $0.04 per diluted share for the second quarter of 2016. Net income per diluted share was $0.00 for the nine months ended September 30, 2016 compared with $1.58 per diluted share for the same period in 2015.

 

·Third quarter results for 2016 included after-tax costs associated with the recently announced acquisition of the Company by First Commonwealth Financial Corporation ("First Commonwealth") of $651,000 or $0.09 per diluted share. In the third quarter of 2015, the Company reversed a valuation allowance that had previously been recorded against its net deferred tax assets, resulting in a one-time tax benefit in the third quarter of 2015 of $10.7 million or $1.46 per diluted share.

 

·A pre-tax loss of $616,000 or $0.08 per diluted share was recorded for the third quarter of 2016, compared with pre-tax income of $400,000 or $0.06 per diluted share in the year-ago quarter. A pre-tax loss of $212,000 or $0.03 per diluted share was recorded for the nine months ended September 30, 2016, compared with pre-tax income of $783,000 or $0.11 per diluted share for the nine months ended September 30, 2015.

 

·Net interest income was $4.2 million for each of the three months ended September 30, 2016, September 30, 2015 and June 30, 2016. Net interest income was $12.6 million for the nine months ended September 30, 2016 and $12.5 million for the year ago period.

 

·The net interest margin was 3.31% for the three months ended September 30, 2016, compared with 3.35% in the year-ago quarter and 3.41% in the second quarter of 2016. The net interest margin was 3.33% in the first nine months of 2016, compared with 3.41% in the year-ago period.

 

·There was no provision for loan losses recorded in the three months ended September 30, 2016, compared to a negative provision for loan losses in the year ago quarter. There was no provision for loan losses recorded in the nine months ended September 30, 2016 and 2015..

 

·Non-interest income was 28.8% of total revenue in the quarter ended September 30, 2016, compared to 22.0% in the year-ago quarter and 29.8% in the second quarter of 2016.

 

·Our efficiency ratio was 110.3% for the three months ended September 30, 2016, compared to 95.0% in the year-ago quarter and 93.7% in the second quarter of 2016.

 

·Income tax benefit was $190,000 in the third quarter of 2016. An income tax benefit of $233,000 was recorded for the nine months ended September 30, 2016. There was a $10.7 million income tax benefit recorded in the third quarter and first nine months of 2015.

 

·Total non-performing assets (including troubled debt restructurings ”TDR’s”) were $9.9 million or 1.37% of total assets at September 30, 2016, compared to $8.0 million or 1.43% of total assets at June 30, 2016 and $7.3 million or 1.35% of total assets at December 31, 2015.

 

·Total non-performing assets (excluding TDR’s) were $3.4 million or 0.23% of total assets at September 30, 2016, compared to $1.5 million or 0.27% of total assets at June 30, 2016 and $1.3 million or 0.24% at December 31, 2015.

 

  28.

 

 

Pending Merger

 

On October 3, 2016, we announced that we entered into a definitive merger agreement which provides for the merger of the Company with and into First Commonwealth following the satisfaction of certain closing conditions, including approval by the Company’s shareholders and approval by appropriate bank regulatory authorities (the “Merger”). Under the terms of the definitive merger agreement, which has been unanimously approved by the board of directors of both companies, the Company’s shareholders will be entitled to receive either 1.427 shares of First Commonwealth common stock or $14.50 in cash for each common share of the Company, subject to proration provisions set forth in the definitive merger agreement. Aggregate cash consideration to Company shareholders is fixed at $21,283,773, which is approximately 20% of the Merger consideration, and the remaining Merger consideration will be in the form of stock consideration. The Merger is expected to be completed in the second quarter of 2017.

 

Comparison of Results of Operations

 

General

 

A net loss of $426,000 or $0.06 per diluted share was recorded for the three months ended September 30, 2016, compared to net income of $11.1 million or $1.52 per diluted share for the same period in 2015 and to net income of $331,000 or $0.04 per diluted share for the second quarter of 2016.

 

Net income was $21,000 or $0.00 per diluted share for the nine months ended September 30, 2016, compared to net income of $11.5 million or $1.58 per diluted share for the same period in 2015.

 

Third quarter results for 2016 included after-tax costs associated with the recently announced acquisition of the Company by First Commonwealth of $651,000 or $0.09 per share. In the third quarter of 2015, we reversed a valuation allowance that had previously been recorded against our net deferred tax assets, resulting in a one-time tax benefit in the third quarter of 2015 of $10.7 million or $1.46 per diluted share. A pre-tax loss of $616,000 or $0.08 per diluted share was recorded for the third quarter of 2016, compared with pre-tax income of $400,000 or $0.06 per diluted share in the year-ago quarter.

 

Net income was $21,000 or $0.00 per diluted share for the nine months ended September 30, 2016, compared to net income of $11.5 million or $1.58 per diluted share for the same period in 2015. A pre-tax loss of $212,000 or $0.03 per diluted share was recorded for the nine months ended September 30, 2016, compared with pre-tax income of $783,000 or $0.11 per diluted share for the nine months ended September 30, 2015.

 

Net Interest Income

 

Net interest income totaled $4.3 million in the quarter ended September 30, 2016, compared to $4.2 million in third quarter of 2015 and $4.2 million in the second quarter of 2016. The net interest margin was 3.31% in the third quarter of 2016, compared to 3.35% in the year-ago quarter and 3.41% in the second quarter of 2016. The decline in the net interest margin compared to the second quarter of 2016 was attributable to growth in interest-earning assets being concentrated in lower yielding securities and cash.

 

Average interest-earning assets were $509.6 million in the third quarter of 2016, compared to $496.5 million in the year-ago quarter and $499.1 million in the second quarter of 2016. Average loans outstanding in the third quarter of 2016 were $394.4 million or 69.2% of total average interest-earning assets, compared with $383.3 million or 71.5% in the year-ago quarter and $395.7 million or 79.3% of total average interest-earning assets in the second quarter of 2016.

 

Average interest-bearing deposit balances were $356.8 million in the third quarter of 2016, compared to $350.4 million in the year-ago quarter and $342.6 million in the second quarter of 2016. The average balances of interest-bearing demand, savings and money market accounts (transaction accounts) increased $24.2 million to $301.4 million in the third quarter of 2016 compared to the year-ago quarter, partially offsetting a decrease in the average balance of time deposits of $17.7 million compared to the year-ago quarter. Transaction accounts comprised 84.5% of total interest-bearing deposits in the third quarter of 2016, compared to 79.1% in the year-ago quarter and 84.7% of total interest-bearing deposits in the second quarter of 2016.

 

Net interest income totaled $12.6 million in the nine months ended September 30, 2016 and $12.5 million in the year-ago period. The net interest margin was 3.33% for the nine months ended September 30, 2016, compared with 3.41% in the year-ago period.

 

Average interest-earning assets were $501.5 million in the first nine months of 2016, which was an increase of $9.8 million or 2.0% from the year-ago period. Average loans outstanding in the first nine months of 2016 increased $9.8 million compared to the year-ago period, and totaled 77.9% of total interest-earning assets in the nine months ended September 30, 2016, compared with 77.4% in the year-ago period.

 

  29.

 

 

The average balance in time deposits decreased $18.5 million in the first nine months of 2016 compared with the year-ago period, while the average balances in lower-costing transaction accounts increased $13.4 million. Transaction accounts comprised 83.8% of total interest-bearing deposits in the first nine months of 2016, compared to 78.9% in the first nine months of 2015. The changes in the composition of average deposit balances in the three and nine months ended September 30, 2016 was primarily the result of the movement of large municipal time deposit maturities into money market accounts and overnight sweep accounts.

 

The following table presents certain information from the Company’s average balance sheet and reflects the average yield on interest-earning assets and the average cost of interest-bearing liabilities (dollars in thousands). Such yields and costs are derived by dividing income or expense by the average balance of interest-earning assets or interest-bearing liabilities. Average balances are derived from daily balances. Interest on tax-exempt securities is reported on a historical basis without tax-equivalent adjustment. Average loan balances include non-accruing loans and loans held for sale. Loan income includes cash received on non-accruing loans.

 

   Three months ended September 30, 
   2016   2015 
   Outstanding
balance
   Interest
Earned/paid
   Yield/rate   Outstanding
balance
   Interest
Earned/paid
   Yield/rate 
Assets                              
Interest earning assets:                              
Interest bearing deposits   21,473    28    0.51%   27,563    17    0.26%
                               
Investment securities   93,711    494    2.11%   85,648    473    2.16%
                               
Consumer loans and credit cards   37,494    494    5.23%   39,972    530    5.26%
Residential real estate loans and home equity   151,217    1,477    3.88%   135,455    1,285    3.76%
Commercial and industrial   104,682    1,070    4.00%   100,732    1,003    3.90%
Commercial real estate   100,999    1,116    4.33%   107,164    1,161    4.30%
Total loans   394,392    4,157    4.16%   383,323    3,979    4.10%
Total interest-earning assets   509,576    4,679    3.63%   496,534    4,469    3. 55% 
                               
Non-interest-earning assets:                              
Other assets   63,080              42,822           
Allowance for loan losses   (4,601)             (4,254)          
Net unrealized gains on securities AFS   1,586              864           
Total assets   569,641              535,966           
                               
Liabilities and shareholders’ equity                              
Interest-bearing liabilities:                              
Interest-bearing demand   88,129    60    0.27%   80,287    26    0.13%
Savings   50,777    15    0.11%   43,628    12    0.10%
Money market   162,468    147    0.36%   153,318    131    0.34%
Time accounts   55,406    81    0.57%   73,151    88    0.48%
Total interest-bearing deposits   356,780    303    0.34%   350,384    257    0.29%
Borrowed funds   9,690    41    1.66%   7,759    35    1.81%
Obligations under capital lease   8,069    81    3.97%   -    -    - 
Total interest-bearing liabilities   374,539    425    0.45%   358,143    292    0.32%
                               
                               
Non-interest-bearing liabilities and shareholders’ equity:                              
Demand deposits   123,214              126,128           
Other liabilities   12,731              4,927           
Shareholders’ equity   59,157              46,768           
                               
Total liabilities and shareholders’ equity   569,641              535,966           
                               
Net interest income; interest rate spread        4,254    3.18%        4,177    3.23%
                               
Net interest margin (net interest income as a percent of average interest-earning assets)             3.31%             3.35%
                               
Average interest-earning assets to average interest-bearing liabilities   136.05%             138.64%          

 

  30.

 

 

   Nine months ended September 30, 
   2016   2015 
   Outstanding
balance
   Interest
Earned/paid
   Yield/rate   Outstanding
balance
   Interest
Earned/paid
   Yield/rate 
Assets                              
Interest earning assets:                              
Interest bearing deposits   20,658    80    0.51%   26,167    46    0.24%
                               
Investment securities   90,273    1,508    2.23%   84,756    1,460    2.27%
                               
Consumer loans and credit cards   39,059    1,513    5.16%   39,210    1,598    5.45%
Residential real estate loans and home equity   145,654    4,214    3.91%   133,544    3,792    3.80%
Commercial and industrial   102,624    3,037    3.89%   102,350    3,036    3.91%
Commercial real estate   103,276    3,390    4.31%   105,720    3,458    4.91%
Total loans   390,613    12,154    4.12%   380,824    11,884    4.30%
Total interest-earning assets   501,544    13,742    3.63%   491,747    13,390    3.74%
                               
Non-interest-earning assets:                              
Other assets   56,757              43,175           
Allowance for loan losses   (4,471)             (4, 209)           
Net unrealized gains on securities AFS   1,327              1,094           
Total assets   555,157              531,807           
                               
Liabilities and shareholders’ equity                              
Interest-bearing liabilities:                              
Interest-bearing demand   84,861    157    0.25%   80,583    71    0.12%
Savings   49,396    41    0.11%   43,425    33    0.10%
Money market   158,822    418    0.35%   155,706    390    0.34%
Time accounts   56,513    229    0.54%   74,972    272    0.49%
Total interest-bearing deposits   349,592    845    0.32%   354,686    766    0.29%
Borrowed funds   10,717    126    1.56%   6,304    106    2.25%
Obligations under capital lease   8,121    215    3.49%   -    -    - 
Total interest-bearing liabilities   368,430    1,186    0.43%   360,990    872    0.32%
                               
Non-interest-bearing liabilities and shareholders’ equity:                              
Demand deposits   123,364              119,593           
Other liabilities   4,775              4,491           
Shareholders’ equity   58,588              46,733           
                               
Total liabilities and shareholders’ equity   555,157              531,807           
                               
Net interest income; interest rate spread        12,556    3.20%        12,518    3.42%
                               
Net interest margin (net interest income as a percent of average interest-earning assets)             3.33%             3.41%
                               
Average interest-earning assets to average interest-bearing liabilities   136.11%             134.22%          

 

  31.

 

 

Asset Quality and Allowance for Loan Losses

 

Delinquent loans (including non-accrual loans) totaled $3.7 million or 0.94% of total loans at September 30, 2016, compared to $1.6 million or 0.41% of total loans at June 30, 2016 and $1.5 million or 0.41% of total loans at December 31, 2015. Non-accrual loans totaled $3.4 million or 0.86% of total loans at September 30, 2016, compared to $1.4 million or 0.36% of total loans at June 30, 2016 and $1.2 million or 0.32% of total loans at December 31, 2015. The increase in non-accrual loans resulted from a commercial real estate mortgage with a balance of $2.1 million that was moved to non-accrual status in the third quarter of 2016.

 

The following tables present past due loans aged as of the dates indicated (dollars in thousands).

 

Delinquent loans  September 30, 2016   June 30, 2016   December 31, 2015 
   $   %(1)   $   %(1)   $   %(1) 
                         
30 days past due  $202    0.05%  $158    0.04%  $191    0.05%
60 days past due   123    0.03%   56    0.01%   111    0.03%
90 days past due and still accruing   -    0.00%   -    0.00%   2    0.01%
Non-accrual   3,367    0.86%   1,423    0.36%   1,222    0.32%
Total  $3,692    0.94%  $1,637    0.41%  $1,526    0.41%

 

(1) As a percentage of total loans, excluding deferred costs

 

Non-performing assets were $9.9 million or 1.43% of total assets at September 30, 2016, compared to $8.0 million or 1.43% of total assets at June 30, 2016 and $7.3 million or 1.35% of total assets at December 31, 2015. Troubled debt restructurings (“TDR’s”), which are performing in accordance with the restructured terms and accruing interest, but are included in non-performing assets, were $6.5 million at September 30, 2016, compared to $6.5 million at June 30, 2016 and $6.0 million at December 31, 2015.

 

The following table represents information concerning the aggregate amount of non-performing assets (in thousands):

 

Non-performing assets  September 30, 2016   June 30, 2016   December 31, 2015 
Non-accruing loans:               
Consumer loans and credit cards  $-   $-   $- 
Residential real estate loans and home equity   816    742    668 
Commercial and industrial   236    539    554 
Commercial real estate   2,315    142    - 
Total non-accruing loans   3,367    1,423    1,222 
Accruing loans delinquent 90 days or more   -    -    2 
Total non-performing loans (excluding TDR’s)   3,367    1,423    1,224 
                
Other real estate and repossessed assets   68    68    68 
Total non-performing assets (excluding TDR’s)  $3,435   $1,491   $1,292 
                
Restructured loans not included above(1)  $6,431   $6,486   $6,040 
Total non-performing loans (including TDR’s)  $9,798   $7,909   $7,264 
Total non-performing assets (including TDR’s)  $9,866   $7,977   $7,332 

 

(1) TDR’s that are in compliance with their modified terms and accruing interest.

 

Net recoveries of $2,000 were recorded in the third quarter of 2016, compared to net recoveries of $255,000 in the second quarter of 2016 and net recoveries of $192,000 in the year ago quarter. There was no provision for loan losses recorded in the three months and nine months ended September 30, 2016. We recorded a negative provision for loan losses of $150,000 in the third quarter of 2015, due primarily to the net recoveries recorded in that quarter and to the favorable impact on the allowance for loan losses of the reduction in non-performing loans during that quarter. The negative provision for loan losses recorded in the third quarter of 2015 had the effect of offsetting the provision for loan losses of $150,000 that was recorded in the first quarter of 2015, resulting in no provision for loan losses for the nine months ended September 30, 2015. The allowance for loan losses was $4.6 million at both September 30, 2016 and at June 30, 2016 and was $4.3 million at December 31, 2015. The ratio of the allowance for loan losses to total loans was 1.18% at September 30, 2016, compared to 1.17% at June 30, 2016 and 1.14% at December 31, 2015.

 

The ratio of the allowance for loan losses to non-performing loans (including TDR’s) was 46.9% at September 30, 2016, compared to 58.0% at June 30, 2016 and 59.7% at December 31, 2015. The ratio of the allowance for loan losses to non-accrual loans was 136% at September 30, 2016, compared to 323% at June 30, 2016 and 355% at December 31, 2015.

 

  32.

 

 

We assess a number of quantitative and qualitative factors at the individual portfolio level in determining the adequacy of the allowance for loan losses and the required provision expense each quarter. In addition, we analyze certain broader, non-portfolio specific factors in assessing the adequacy of the allowance for loan losses, such as the allowance as a percentage of total loans, the allowance as a percentage of non-performing loans and the provision expense as a percentage of net charge-offs. This portion of the allowance has been considered “unallocated,” which means it is not based on either quantitative or qualitative factors. At September 30, 2016, $346,000 or 7.5% of the allowance for loan losses was considered to be “unallocated,” compared to $263,000 or 5.7% of the allowance for loan losses at June 30, 2016 and $308,000 or 7.1% of the allowance for loan losses at December 31, 2015.

 

The following table summarizes changes in the allowance for loan losses arising from loans charged off, recoveries on loans previously charged off and additions to the allowance, which have been charged to expense (in thousands).

 

   Three months ended
September 30,
   Nine months ended
September 30,
 
   2016   2015   2016   2015 
Allowance for loan losses, beginning of period  $4,590   $4,164   $4,333   $4,236 
                     
Loans charged-off   (68)   (63)   (156)   (570)
Recoveries of loans previously charged-off   70    255    415    540 
Net recoveries (charge-offs)   2    192    259    (30)
Provision for loan losses   -    (150)   -    - 
Allowance for loan losses, end of period  $4,592   $4,206   $4,592   $4,206 

 

Non-interest Income

 

The following table sets forth certain information on non-interest income for the periods indicated (dollars in thousands):

 

   Three months ended September 30,   Nine months ended September 30, 
   2016   2015   $ Change   % Change   2016   2015   $ Change   % Change 
Service charges  $560   $523   $37    7.07%  $1,596   $1,475   $121    8.20%
Wealth management fees   463    438    25    5.71%   1,355    1,217    138    11.34%
Treasury management fees   134    81    53    65.43%   348    203    145    71.34%
Income from Bank-owned life insurance   163    163    -    0.00%   569    571    (2)   (0.35)%
Net gain on sale of loans   351    -    351    100.00%   829    -    829    100.00%
Net losses on sale of REO   -    (19)   19    100.00%   -    (20)   20    100.00%
Other non-interest income   47    37    10    27.03%   144    115    29    25.22%
Total non-interest income  $1,718   $1,223   $495    40.47%  $4,841   $3,561   $1,280    35.94%

 

Non-interest income was $1.7 million in the third quarter of 2016, compared to $1.2 million in the year-ago quarter and $1.8 million in the second quarter of 2016. Gains on sales of loans totaled $351,000 in the third quarter of 2016, and $829,000 in the first nine months of 2016, reflecting the launch since the second quarter of secondary market sales of SBA and residential mortgage loans. The total principal amount of loan sales in the third quarter was $9.6 million, of which $2.1 million were the 75% guaranteed portion of SBA loans and $7.5 million were residential mortgages. Gains on sales of SBA loans and residential mortgages in the third quarter totaled $191,000 and $160,000, respectively, compared to $414,000 and $64,000 in the second quarter. The Company did not sell any loans in 2015 or in the second quarter of 2016. Service charges, wealth management fees and treasury management fees increased an aggregate $115,000 or 11.0% in the third quarter of 2016 compared with the year-ago quarter, primarily from the impact of changes to certain of the Bank’s fees and service charges and from business development activities.

 

Non-interest income was $4.8 million in the first nine months of 2016, compared to $3.6 million in the first nine months of 2015. Gains on sales of loans accounted for approximately 65% of the increase in non-interest income, with the balance of the increase being driven by changes to certain of the Bank’s fees and service charges and from business development activities.

 

Non-interest income accounted for 28.8% of total revenue in the third quarter of 2016, compared to 22.0% in the year-ago quarter and 29.8% in the second quarter of 2016. Non-interest income accounted for 27.8% of total revenue in the first nine months of 2016, compared with 22.1% in the year-ago period.

 

  33.

 

 

Non-interest Expense

 

The following table sets forth certain information on non-interest expenses for the periods indicated (dollars in thousands):

 

   Three months ended September 30,   Nine months ended September 30, 
   2016   2015   $ Change   % Change   2016   2015   $ Change   % Change 
Salaries and benefits  $3,186   $2,771   $415    14.98%  $9,356   $8,302   $1,054    12.70%
Occupancy and equipment   1,016    1,000    16    1.60%   2,963    2,965    (2)   (0.07)%
Professional services   218    405    (187)   (46.17)%   905    1,042    (137)   (13.15)%
Merger related expenses   987    -    987    -%    987    -    987    0.00%
Advertising   108    169    (61)   (36.09)%   506    418    88    21.05%
Office supplies, postage and courier   87    81    6    7.41%   250    232    18    7.76%
FDIC insurance premium   60    95    (35)   (36.84)%   238    302    (64)   (21.19)%
State franchise taxes   118    75    43    57.33%   352    225    127    56.44%
Other non-interest expense   808    554    254    45.85%   2,052    1,810    242    13.37%
Total non-interest expenses  $6,588   $5,150   $1,438    27.92%  $17,609   $15,296   $2,313    15.12%

 

Non-interest expenses were $6.6 million for the third quarter of 2016, compared with $5.2 million in the year-ago quarter and $5.7 million for the second quarter of 2016. Merger related expenses accounted for approximately 69% of the increase in non-interest expenses compared to the year-ago quarter. Salaries and benefits increased $415,000 in the third quarter of 2016 compared to the year-ago quarter due primarily to the previously-announced hiring of the small business lending team and residential mortgage originators in the fourth quarter of 2015.

 

Non-interest expenses were $17.6 million in the first nine months of 2016, compared to $15.3 million in the first nine months of 2015. Merger related expenses accounted for $987,000, or 43% of the increase in non-interest expenses compared to the year-ago period. Salaries and benefits increased $1.1 million due primarily to the hiring of the small business lending team and residential mortgage originators.

 

The Company’s efficiency ratio was 110.3% in the third quarter of 2016, compared with 95.0% in the year-ago quarter and 93.7% in the second quarter of 2016. The efficiency ratio was 101.2% for the first nine months of 2016, compared to 95.0% in the year-ago period.

 

Income Taxes

 

We had net deferred tax assets totaling $10.5 million at September 30, 2016, compared with $10.4 million at December 31, 2015, of which the majority are attributable to net operating loss carry-forwards and timing differences between provision for loan losses and the charge-off of loans.

 

Income tax benefit was $190,000 in the third quarter of 2016. An income tax benefit of $233,000 was recorded for the nine months ended September 30, 2016. The amount of income tax expense or benefit recognized in each of the three quarters of 2016 was impacted by the overall amount of pre-tax income and the amount of pre-tax income that is not subject to federal income taxes, which is comprised primarily of income from bank-owned life insurance that was partially offset by non-deductible merger related expenses.

 

Comparison of Financial Condition at September 30, 2016 and December 31, 2015

 

Total assets were $565.4 million at September 30, 2016, compared with $556.1 million at June 30, 2016 and $541.3 million at December 31, 2015. Much of the increase in assets in the first nine months of 2016 was in the Company’s loan portfolio (including held for sale), which increased $13.0 million or 3.4%, to $391.5 million at September 30, 2016.

 

Securities

 

Investment securities totaled $95.7 million at September 30, 2016, compared with $87.8 million at December 31, 2015. Our portfolio was comprised primarily of investment grade securities. The breakdown of the securities portfolio at September 30, 2016 was 26.7% collateralized mortgage obligations, 20.5% government-sponsored entity guaranteed mortgage-backed securities, 26.1% municipal securities, 22.8% obligations of U.S. government agencies and 3.9% corporate bonds.

 

  34.

 

 

Loans

 

The following table sets forth the composition of our loan portfolio, excluding deferred loan costs and including loans held for sale at the dates indicated (dollars in thousands):

 

   September 30, 2016   June 30, 2016   December 31, 2015 
   Amount   Percent   Amount   Percent   Amount   Percent 
Loan portfolio composition                              
Consumer and credit card  $36,158    9.2%  $37,615    9.5%  $40,587    10.7%
Real estate and home equity   151,117    38.7%   149,383    37.7%   137,645    36.4%
Commercial and industrial   104,108    26.6%   105,530    26.7%   99,213    26.2%
Commercial real estate   99,505    25.5%   103,408    26.1%   100,743    26.7%
Total loans  $390,888    100.0%  $395,936    100.0%  $378,188    100.0%
                               
Net deferred loan costs   617         617         325      
Loans   391,505         396,553         378,513      
Allowance for loan losses   (4,592)        (4,590)        (4,333)     
Net loans  $386,913        $391,963        $374,180      

 

Total loans were $391.5 million at September 30, 2016, compared with $378.5 million at December 31, 2015. At September 30, 2016, total loans included $755,000 in residential mortgages held for sale.

 

Deposits

 

The following table sets forth the composition of our deposit accounts, at the dates indicated (dollars in thousands):

 

   September 30, 2016   June 30, 2016   December 31, 2015 
   Amount   Percent   Amount   Percent   Amount   Percent 
Non-interest bearing demand  $123,353    25.2%  $119,808    25.6%  $124,023    26.1%
Interest bearing demand   86,239    17.6%   87,873    18.8%   77,616    16.4%
Total demand   209,594    42.8%   207,681    44.4%   201,639    42.5%
                               
Savings   52,026    10.6%   49,722    10.6%   47,333    10.0%
Money market   171,817    35.1%   157,136    33.6%   154,119    32.5%
Time deposits   56,113    11.5%   53,053    11.4%   71,446    15.0%
Total deposits  $489,548    100.0%  $467,592    100.0%  $474,537    100.0%

 

Deposits totaled $489.6 million at September 30, 2016, compared with $467.6 million at June 30, 2016 and $474.5 million at December 31, 2015. Most of the increase during the quarter was the result of an increase in municipal deposit balances of $19.5 million during the quarter.

 

Liquidity

 

Liquidity is the ability of the Company to fund loan originations and customers’ needs for borrowing and deposit withdrawals. The purpose of liquidity management is to assure sufficient cash flow to meet all of the financial commitments and to capitalize on opportunities for business expansion. This ability depends on the financial strength, asset quality and types of deposit and investment instruments offered by the Company to its customers. The Company’s principal sources of funds are deposits, loan and security repayments, maturities of securities, sales of securities available for sale and other funds provided by operations. The Bank also has the ability to borrow from the FHLB. While scheduled loan repayments and maturing investments are relatively predictable, deposit flows and early loan and mortgage-backed security prepayments are more influenced by interest rates, general economic conditions, and competition. The Company maintains investments in liquid assets based upon management’s assessment of (1) need for funds, (2) expected deposit flows, (3) yields available on short-term liquid assets and (4) objectives of the asset/liability management program.

 

Cash and cash equivalents totaled $31.3 million at September 30, 2016, compared to $31.9 million at December 31, 2015. Cash and cash equivalents represented 5.5% of total assets at September 30, 2016 and 5.9% of total assets at December 31, 2015. The Company has the ability to borrow funds from the FHLB and the Federal Reserve Bank should the Company need to supplement its future liquidity. Management believes the Company’s liquidity position is adequate based on its current level of cash, cash equivalents, core deposits, the stability of its other funding sources, and the support provided by its capital base.

 

  35.

 

 

Capital Resources

 

Shareholders’ equity was $59.4 million at September 30, 2016, compared with $58.8 million at December 31, 2015. The increase in shareholders’ equity in the first nine months of 2016 was attributable primarily to net income of $21,000 and to an increase in accumulated other comprehensive income of $558,000 due to higher unrealized gains on securities available-for-sale. Treasury stock increased $104,000 during the second quarter of 2016 as the result of repurchases of 14,750 of the Company’s common shares under the stock repurchase program announced in May 2016. The Company’s tangible common equity to tangible assets ratio was 10.5% at September 30, 2016, compared with 10.9% at December 31, 2015.

 

Regulatory Capital Requirements

 

The Bank’s common equity tier 1 capital ratio was 12.26% and its total risk-based capital ratio was 13.44% at September 30, 2016, both of which were well above the regulatory thresholds required to be classified as a “well-capitalized” institution, which are 6.5% and 10.0%, respectively.

 

Beginning on January 1, 2015, the capital requirements for our Company and the Bank increased as a result of the phase-in of certain changes to capital requirements for U.S. banking organizations. Consistent with the international Basel III framework, the capital requirements include a new minimum ratio of common equity tier 1 capital to risk-weighted assets and a Tier 1 common capital conservation buffer of 2.5% of risk-weighted assets that applies to all supervised financial institutions. The rule also raises the minimum ratio of tier 1 capital to risk-weighted assets to 6.0% and includes a minimum leverage ratio of 4.0% for all banking organizations. These new minimum capital ratios became effective for us on January 1, 2015, and will be fully phased-in on January 1, 2019.

 

The following table compares our actual capital amounts for the Bank and ratios with those needed to qualify for the “well-capitalized” category, which is the highest capital category as defined in the regulations, dollars in thousands:

 

   Actual   For Capital Adequacy
Purposes
   To be well-capitalized
under Prompt Corrective
Action Provisions 
 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
As of September 30, 2016                              
Total risk-based capital  $52,393    13.44%  $31,186    8.0%  $38,983    10.0%
Tier 1 capital  $47,801    12.26%  $23,394    6.0%  $31,192    8.0%
Common equity tier 1 capital  $47,801    12.26%  $17,545    4.5%  $25,343    6.5%
Leverage  $47,801    8.84%  $21,629    4.0%  $27,037    5.0%
                               
As of December 31, 2015                              
Total risk-based capital  $52,500    14.29%  $29,391    8.0%  $36,739    10.0%
Tier-1 capital  $48,167    13.11%  $22,044    6.0%  $29,393    8.0%
Common equity tier 1 capital  $48,167    13.11%  $16,533    4.5%  $23,881    6.5%
Leverage  $48,167    9.11%  $21,149    4.0%  $26,436    5.0%

 

  36.

 

 

Share Repurchase Program

 

On April 28, 2016, the Board of Directors of Directors of the Company approved a share repurchase program of up to three percent of the Company’s outstanding common shares, or approximately 220,000 shares, up to $1.7 million.  The share repurchase program is authorized for up to one year. As of September 30, 2016, the Company has repurchased 14,750 shares under this program for a total amount of $104,000. The share repurchase program was suspended in June 2016.

 

Item 3. Quantitative and Qualitative Disclosure about Market Risk

 

Not required.

 

Item 4. Controls and Procedures

 

The Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of September 30, 2016, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of September 30, 2016.

 

There was no change in the Company’s 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 Company’s fiscal quarter ended September 30, 2016, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting

 

  37.

 

 

Part IIOther Information

 

Item 1.Legal Proceedings.

There are no matters required to be reported under this item.

 

Item 1A.Risk Factors.
Our operations involve various risks that could have adverse consequences, including those described below and in Part I, Item 1A, “Risk Factors” in our 2015 Annual Report on Form 10-K.

 

Risks Related to the Merger with First Commonwealth Financial Corporation

 

The Merger cannot be completed unless a number of conditions in the merger agreement are satisfied or waived.

 

The merger agreement contains a number of conditions that must be satisfied or waived in order to complete the Merger. Those conditions include: approval of the Merger by our shareholders, receipt of all required regulatory approvals, absence of any law, statute or regulation, or any order, injunction or other legal restraint or prohibition preventing the completion of the Merger, effectiveness of the registration statement filed in connection with the Merger, the accuracy of the representations and warranties of both parties to the merger agreement, the performance by both parties to the merger agreement of their respective covenants and agreements, and the receipt by both parties of legal opinions from their respective tax counsels. There can be no assurance that the conditions to closing of the Merger will be fulfilled or that the Merger will be completed.

 

Regulatory approvals may not be received, may take longer than expected or may impose conditions that are not presently anticipated or cannot be met.

 

Before the Merger may be completed, various approvals must be obtained from bank regulatory agencies and other governmental authorities. These governmental entities may not grant approval of the Merger, or may impose conditions on the granting of their approvals. The conditions or changes they impose, as well as the process of obtaining regulatory approvals, could have the effect of delaying completion of the Merger or of imposing additional costs or limitations on First Commonwealth following the Merger. First Commonwealth may elect not to consummate the Merger if, in connection with any regulatory approval needed for the Merger, any governmental or regulatory entity imposes a restriction, requirement or condition on First Commonwealth that, individually or in the aggregate, would be reasonably likely to have a material and adverse effect on First Commonwealth and its subsidiaries, taken as a whole, after giving effect to the Merger. As a result, there can be no assurance that the desired regulatory approvals for the Merger will be obtained or that the Merger will be completed.

 

Termination of the merger agreement could negatively affect our businesses and the market price of our common shares.

 

If the merger agreement is terminated, there may be various consequences, including:

 

  our businesses may have been adversely impacted by the failure to pursue other beneficial opportunities due to the focus of management on the Merger, without realizing any of the anticipated benefits of completing the Merger; and
     
  the market price of our common shares may decline to the extent that the current market price reflects a market assumption that the Merger will be completed.

 

If the merger agreement is terminated and our board of directors seeks another merger or business combination, our shareholders cannot be certain that we will be able to find a party willing to offer equivalent or more attractive consideration than the consideration First Commonwealth has agreed to pay in the Merger.

 

If the merger agreement is terminated under certain circumstances, we may be required to pay First Commonwealth a termination fee of $5.3 million.

 

If the Merger is not completed, we will have incurred substantial expenses without our shareholders realizing the expected benefits of the Merger.

 

We have already incurred, and will continue to incur, substantial expenses in connection with the Merger and the transactions contemplated thereby, which are charged to earnings as incurred. If the Merger is not completed, these expenses will have a material adverse impact on our operating results even though we will not have realized the expected benefits of the Merger. There can be no assurance that the Merger will be completed.

 

  38.

 

 

The merger agreement limits our ability to pursue alternatives to the Merger with First Commonwealth

 

The merger agreement contains provisions that restrict our ability to discuss, facilitate or enter into agreements with third parties to acquire us. We are not required to comply with this restriction if compliance would reasonably be expected to cause our board of directors to breach its fiduciary duties. Even if we were to avail ourselves of that limited exception, we could be obligated to pay First Commonwealth a termination fee of $5.3 million if either we or First Commonwealth terminates the merger agreement under specified circumstances. In any event, the presence of those restrictions in the merger agreement could discourage a potential competing acquiror that may have an interest in acquiring us from proposing or considering an acquisition even if that potential acquiror were prepared to pay a higher price to our shareholders than the Merger consideration offered by First Commonwealth.

 

We will be subject to business uncertainties and contractual restrictions while the Merger is pending.

 

Uncertainties about the effect of the Merger on employees and customers may have an adverse effect on us. These uncertainties may impair our ability to attract, retain and motivate key personnel until the Merger is completed, and could cause customers and others who deal with us to consider changing existing business relationships with us. Retention of certain employees may be challenging during the pendency of the Merger, as certain employees may experience uncertainty about their future roles with the combined company. If key employees depart because of issues relating to the uncertainty and difficulty of integration or a desire not to remain with the business, our business prior to the Merger.

 

The pursuit of the Merger and the preparation for the integration may place a significant burden on management and internal resources. Any significant diversion of management attention away from the ongoing business and any difficulties encountered in the transition and integration process could affect our financial results.

 

In addition, the merger agreement restricts us from taking specified actions relative to our business without the prior consent of First Commonwealth. These restrictions may prevent us from pursuing attractive business opportunities that may arise prior to the completion of the Merger.

 

Some of our directors and executive officers have interests in the Merger that may differ from the interests of our shareholders including, if the Merger is completed, the receipt of financial and other benefits.

 

Our directors and executive officers may have economic interests in the Merger that are different from, or in addition to, the interests of our shareholders generally. For example, once the Merger is completed, it is expected that each of our executive officers will be entitled to change-in-control payments and accelerated vesting of equity-based compensation under our compensation programs. In addition, the executive officers may receive “stay bonuses” if they remain employed by us through the closing date of the Merger.

 

Our directors will receive, once the Merger is completed, accelerated vesting of equity-based compensation. Additionally, following completion of the Merger, the First Commonwealth and First Commonwealth Bank boards of directors will each be enlarged by one seat, and one of our directors, as mutually agreed upon by First Commonwealth and us, will be appointed to serve on the First Commonwealth and First Commonwealth Bank boards of directors. The merger agreement also provides for the continued indemnification of our current and former directors and executive officers following the Merger and for the continuation of directors’ and officers’ insurance for these individuals for six years after the Merger.

 

Our shareholders will have a reduced ownership and voting interest after the Merger and will exercise less influence over management.

 

Following the Merger, our shareholders are expected to hold approximately 9% of the outstanding shares of First Commonwealth common stock. As a result, our shareholders will have only limited ability to influence First Commonwealth’s business. Our shareholders will not have separate approval rights with respect to any actions or decisions of First Commonwealth or have separate representation on First Commonwealth’s or First Commonwealth Bank’s board of directors.

 

The shares of First Commonwealth common stock to be received by our shareholders as consideration in the Merger will have different rights from our common shares.

 

The rights associated with our common shares are different from the rights associated with First Commonwealth common stock in certain significant respects. Upon completion of the Merger, our shareholders who receive shares of First Commonwealth common stock as consideration in the Merger will become First Commonwealth shareholders and their rights as shareholders will be governed by the articles of incorporation and by-laws of First Commonwealth and provisions of Pennsylvania law applicable to companies formed in Pennsylvania, like First Commonwealth.

 

  39.

 

 

Item 2.Unregistered Sales of Equity Securities and Use of Proceeds.
a) Not applicable

 

b) Not applicable

 

c) On May 2, 2016, the Company announced that its Board of Directors had authorized the repurchase of up to 3% of the Company’s outstanding common stock, or approximately 220,683 shares, over a 12-month period. The share repurchase program was suspended in June 2016. The table below sets forth the information with respect to purchases made by the Company of its common stock during the quarter ended September 30, 2016:

 

Period  Total
Number of
Shares
Purchased
   Average
Price Paid
Per Share
   Total
Number of
Shares
Purchased as
Part of
Publicly
Announced
Plan
   Maximum
Number of
Shares that
May Yet be
Purchased
Under the
Plan
 
7/1/2016 – 7/31/2016   -   $-    -    205,933 
8/1/2016 – 8/31/2016   -   $-    -    205,933 
9/1/2016 – 9/30/2016   -   $-    -    205,933 
Total   -   $-    -      

 

Item 3.Defaults upon Senior Securities.
There are no matters required to be reported under this item.

 

Item 4.Mine Safety Disclosures.
There are no matters required to be reported under this item.

 

Item 5.Other Information.

There are no matters required to be reported under this item.

 

  40.

 

 

Item 6.Exhibits.

 

Exhibits – The following exhibits are filed as a part of this report:

 

Exhibit No. Exhibit
   
2.1 Agreement and Plan of Merger by and between First Commonwealth Financial Corporation and DCB Financial Corp, dated October 2, 2016 (incorporated herein by reference to Exhibit 2.1 to DCB Financial Corp’s Current Report on Form 8-K filed with the SEC on October 3, 2016)
   
3.1 Amended and Restated Articles of Incorporation of DCB Financial Corp as amended, incorporated by reference to the Company’s Registration Statement on Form S-8 filed with the Commission on November 7, 2014 (File No. 000-22387).
   
3.2 Second Amended and Restated Code of Regulations of DCB Financial Corp, incorporated by reference to the Company’s  Registration Statement on Form S-8 filed with the Commission on November 7, 2014 (File No. 000-22387).
   
31.1* Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002.
   
31.2* Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002.
   
32.1** Certification pursuant to 18 U.S.C. 1350, as enacted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
   
32.2** Certification pursuant to 18 U.S.C. 1350, as enacted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
   
101* The following information from DCB Financial Corp.’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2016 formatted in XBRL (eXtensible Business Reporting Language) pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets as of September 30, 2016 (unaudited) and December 31, 2015;  (ii) the Consolidated Statements of Income (Loss) (unaudited) for the three and nine months ended September 30, 2016 and 2015;  (iii) the Consolidated Statements of Comprehensive Income (Loss) (unaudited) for the three and nine months ended September 30, 2016 and 2015;  (iv) the Condensed Consolidated Statements of Shareholders’ Equity (unaudited) for the nine month periods ended September 30, 2016 and 2015; (v) the Consolidated Statements of Cash Flows (unaudited) for the nine month periods ended September 30, 2016 and 2015; and (vi) the Notes to Consolidated Financial Statements.

 

* Filed herewith. ** Furnished herewith.

 

  41.

 

 

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.

 

  DCB FINANCIAL CORP
  (Registrant)
   
Dated:  November 14 , 2016 /s/ Ronald J. Seiffert
  Ronald J. Seiffert
  Chairman, President and Chief Executive Officer
  (Principal Executive Officer)
   
Dated:  November 14, 2016 /s/ J. Daniel Mohr
  J. Daniel Mohr
  Executive Vice President and Chief Financial Officer
  (Principal Financial and Accounting Officer)

 

  42.