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EX-32.1 - EXHIBIT 32.1 - Business First Bancshares, Inc.ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - Business First Bancshares, Inc.ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - Business First Bancshares, Inc.ex31-1.htm
EX-21.1 - EXHIBIT 21.1 - Business First Bancshares, Inc.ex21-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K

 



 

ANNUAL REPORT PURSUANT TO 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

 

 

For the fiscal year ended December 31, 2016

Commission file number: 333-200112

 


 

BUSINESS FIRST BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

 


 

Louisiana

 

20-5340628

(State of incorporation or organization)

 

(I.R.S. Employer Identification Number)

     

500 Laurel Street, Suite 101
Baton Rouge, Louisiana

 

70801

(Address of principal executive offices)

 

(Zip code)

     

Registrant’s telephone number, including area code: (225) 248-7600

 



 

Securities registered under Section 12(b) of the Exchange Act:     None

Securities registered under Section 12(g) of the Exchange Act:     None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes ☐       No ☒

   

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes ☐       No ☒

   

Indicate by check mark whether the registrant: (i) 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, and (ii) has been subject to such filing requirements for the past 90 days.

Yes ☒       No ☐

   

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

Yes ☒       No ☐

   

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in part III of this Form 10-K or any amendment to this Form 10-K.

 

   

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

 

Large accelerated filer

Accelerated filer ☐

Non-accelerated filer  ☐

Smaller reporting company  ☒ 

                                                                                                    (Do not check if a smaller reporting company)

 
   

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

Yes ☐       No ☒

   

There is no established public trading market for the registrants common stock. As of March 10, 2017, there were 6,914,179 outstanding shares of the registrants common stock, $1.00 par value per share.

 

 

 

 

table of contents

 

 

PART I

 

 

     

ITEM 1.

Business

3

ITEM 1A.

Risk Factors

16

ITEM 1B.

Unresolved Staff Comments

28

ITEM 2.

Properties

29

ITEM 3.

Legal Proceedings

30

ITEM 4.

Mine Safety Disclosures

30

     

PART II

 

 

     

ITEM 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

31

ITEM 6.

Selected Financial Data

32

ITEM 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

33

ITEM 7A.

Quantitative and Qualitative Disclosures About Market Risk

59

ITEM 8.

Financial Statements and Supplementary Data

60

ITEM 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosures

110

ITEM 9A.

Controls and Procedures

110

ITEM 9B.

Other Information

110

     

PART III

 

 

     

ITEM 10.

Directors, Executive Officers and Corporate Governance

111

ITEM 11.

Executive Compensation

116

ITEM 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

121

ITEM 13.

Certain Relationships and Related Transactions, and Director Independence

121

ITEM 14.

Principal Accounting Fees and Services

122

     

PART IV

 

 

     

ITEM 15.

Exhibits and Financial Statement Schedules

123

     
Signatures    

 

 

 

 

NOTE: When we refer in this Report to “we,” “our,” “us,” “Business First” and the “Company,” we are referring to Business First Bancshares, Inc., unless the context indicates otherwise.

 

FORWARD LOOKING STATEMENTS

 

This Annual Report on Form 10-K, or the “Report,” contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 (the “Securities Act”) and 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). These forward-looking statements include statements that reflect the current views of our senior management with respect to our financial performance and future events with respect to our business and the banking industry in general. These statements are often, but not always, made through the use of words or phrases such as “may,” “should,” “could,” “predict,” “potential,” “believe,” “will likely result,” “expect,” “will continue,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “would” and “outlook,” and similar expressions of a future or forward-looking nature. These statements involve estimates, assumptions and risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements.

 

We believe these factors include, but are not limited to, the following:

 

 

changes in the strength of the United States economy in general and the local economy in our local market areas adversely affecting our customers and their ability to transact profitable business with us, including the ability of our borrowers to repay their loans according to their terms or a change in the value of the related collateral;

 

 

market declines in industries to which we have exposure, such as the decline in crude oil prices that impact certain of our borrowers and investments that operate within, or are backed by collateral associated with, the oil and gas industry;

 

 

changes in interest rates and market prices, which could reduce our net interest margins, asset valuations and expense expectations;

 

 

changes in the levels of loan prepayments and the resulting effects on the value of our loan portfolio;

 

 

increased competition for deposits and loans adversely affecting rates and terms;

 

 

increased credit risk in our assets and increased operating risk caused by a material change in commercial, consumer and/or real estate loans as a percentage of the total loan portfolio;

 

 

the failure of assumptions underlying the establishment of and provisions made to our allowance for credit losses;

 

 

changes in the availability of funds resulting in increased costs or reduced liquidity;

 

 

a determination or downgrade in the credit quality and credit agency ratings of the securities in our securities portfolio;

 

 

increased asset levels and changes in the composition of assets and the resulting impact on our capital levels and regulatory capital ratios;

 

 

the loss of senior management or operating personnel and the potential inability to hire qualified personnel at reasonable compensation levels;

 

 

legislative or regulatory developments, including changes in laws and regulations concerning taxes, banking, securities, insurance and other aspects of the financial securities industry, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), and the extensive rule making required to be undertaken by various regulatory agencies under the Dodd-Frank Act;

 

 

further government intervention in the U.S. financial system;

 

 

changes in statutes and government regulations or their interpretations applicable to us, including changes in tax requirements and tax rates;

 

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acts of terrorism, an outbreak of hostilities or other international or domestic calamities, weather, including the Historic Louisiana Flood of 2016, or other acts of God and other matters beyond our control; and

 

 

and other risks and uncertainties listed from time to time in our reports and documents filed with the SEC.

 

The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this Report. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Accordingly, you should not place undue reliance on any such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made and we do not undertake any obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

 

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PART I

 

ITEM 1. Business.

 

General

 

We are a registered bank holding company headquartered in Baton Rouge, Louisiana. We were incorporated on July 20, 2006 to serve as a bank holding company under the Bank Holding Company Act of 1956 (the “BHC Act”) for our wholly-owned subsidiary, Business First Bank. We became the parent company of Business First Bank on April 1, 2007, and we currently own all of the outstanding shares of the capital stock of Business First Bank. As of December 31, 2016, on a consolidated basis, we had total assets of $1.1 billion, total loans of $811.1 million, total deposits of $932.8 million and shareholders’ equity of $113.6 million.

 

Business First Bank is a Louisiana state non-member bank that was established in February of 2006. Business First Bank serves the state of Louisiana with sixteen banking centers, with offices located in the Louisiana cities of Baton Rouge, Brusly, Covington, Denham Springs, Erwinville, Gonzales, Houma, Lafayette, Lake Charles, Port Allen, Shreveport and Zachary. Business First Bank also has a Loan Production Office in the New Orleans Metro area and a Wealth Solutions Office in Thibodaux. Business First is organized into eight markets, each of which is led by an experienced market president and bankers who are all involved in the community and industry. Business First Bank’s principal office is located in Baton Rouge, Louisiana.

 

Business First Bank offers a full range of banking services, including commercial and consumer banking. As of December 31, 2016, Business First Bank had total assets of $1.1 billion, total loans of $811.1 million, total deposits of $932.8 million and shareholders’ equity of $116.0 million.

 

Our principal executive office is located at Business First Bank, 500 Laurel Street, Suite 101, Baton Rouge, Louisiana 70801. Our telephone number is (225) 248-7600 and our website address is www.b1bank.com.

 

Our Business Strategy

 

Our mission is to be the financial institution of choice for Louisiana enterprises and their owners and employees. To achieve this mission, we concentrate our resources on two fronts: convenience-enhancing technology and products, and recruitment, retention and empowerment of world class employees. We believe a bank should be measured by the value it adds to its customer’s business processes.

 

The focus of our strategy has been, and continues to be, the establishment and enhancement of an attractive commercial banking franchise by maximizing long-term shareholder value through growth in our loans, investments, deposits and net income in a manner consistent with safe, sound and prudent banking practices while providing personalized customer service consistent with the needs of small- and mid-sized businesses, their owners and employees. To accomplish this goal, we utilize the following business strategy:

 

 

Offering competitive products and services at fair prices to expand loan and deposit market share and increase interest and non-interest income;

 

 

Providing high quality personal service delivered by skilled and experienced professionals who have a long-term commitment to the communities in which we conduct business;

 

 

Enhancing the banking options available to customers by offering a wide array of financial products with the latest technology; and

 

 

Maintaining asset quality and control operating expense.

 

We focus on providing private banking services primarily to small businesses and professionals. Rather than attempt to compete for customers with larger financial institutions on a transaction-by-transaction basis, we work to build robust, lasting partnerships with our customers.

 

By locating in eight metropolitan areas and decentralizing as much decision-making authority as sound banking practices will permit, we endeavor to capture both the stability of geographic diversification within Louisiana and the loyalties of a customer base that only a locally-owned community bank can provide. Each market we serve has a local president and our director’s loan committee is comprised of community leaders who have a stake in the institution. We believe that one of our greatest competitive advantages is the depth of our statewide network of entrepreneurial directors.

 

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Consistent with our focus on service, we have invested heavily in people and technology, not just brick and mortar infrastructure. We operate with a limited number of more experienced personnel, while also limiting the number of our offices, providing universal ATM and internet account access, digital deposits, and personalized, flexible, name-recognizing service.

 

We also endeavor to serve our constituent communities in unique ways—hosting non-profit board meetings, for example, or encouraging our employees to participate in financially-centered volunteer efforts, whether that be serving as board members themselves or participating in school-based educational activities. Through these activities, we strive to foster relationships with community leaders and a reputation of positive involvement in our communities.

 

Expansion

 

With the exception of our March 31, 2015 acquisition of American Gateway Financial Corporation (“AGFC”) and its subsidiary, American Gateway Bank, we have historically grown organically by targeting markets in Louisiana that we believe provide attractive banking opportunities. Within these markets, we engage a local advisory board and hire local management. The purpose of these advisors and management is to build our banking franchise within their respective markets. We believe this structure provides many of the benefits of smaller, locally-owned banks while permitting us to serve multiple markets.

 

While we continue to prioritize organic growth, we also seek to capitalize upon other opportunities as they arise. In particular, we will consider opportunities such as the 2015 acquisition of AGFC, which has enhanced our core deposits and provided cost savings through economies of scale. Although we do not currently have any definitive expansion plans, we routinely explore various acquisition and expansion opportunities as they may arise from time to time. We will continue to evaluate growth opportunities and may add other markets to our geographic footprint as opportunities arise.

 

Products and Services

 

We are a full-service financial services company with a focus on small- to mid-sized businesses, their officers and employees. We satisfy our commercial and retail customers’ banking needs with an encompassing range of financial services.

 

Business First Bank is an independent financial institution that is engaged in substantially all of the business operations customarily conducted by financial institutions in Louisiana. We offer, among other products, checking, savings and money market accounts, certificates of deposit, commercial and consumer loans, mortgage loans, real estate loans, and other installment and term loans. In addition, Business First Bank offers our customers wealth management products, drive-through banking facilities, automated teller machines, night depository, personalized checks, credit cards, debit cards, internet banking, electronic funds transfers through ACH services, domestic and foreign wire transfers, traveler’s checks, cash management, vault services, loan and deposit sweep accounts, and lock box services.

 

Subsidiaries

 

We have three wholly-owned subsidiaries. Business First Bank is a direct, wholly-owned subsidiary of Business First. Business First Insurance, LLC and American Gateway Insurance Agency, LLC are wholly-owned subsidiaries of Business First Bank, and are, therefore, indirect wholly-owned subsidiaries of Business First. Business First Insurance, LLC and American Gateway Insurance Agency, LLC are currently inactive, and do not engage in any material business activities.

 

Competition

 

We compete with several local and regional commercial banks, thrifts, credit unions and mortgage companies for deposits, loans, and other banking-related financial services. There is intense competition in our market areas from other financial institutions as well as other “non-bank” companies that engage in similar activities. Some of our competitors are not subject to the degree of regulatory review and restrictions that apply to us. In addition, we must compete with much larger financial institutions that have greater financial resources than we do, and that compete aggressively for market share. These competitors attempt to gain market share through their financial product mix, pricing strategies and banking center locations. We also compete with insurance companies, savings banks, consumer finance companies, investment banking firms, brokerage houses, mutual fund managers, investment advisors, and credit unions. Retail establishments compete for loans by offering credit cards and retail installment contracts for the purchase of goods and merchandise.

 

We anticipate that competition from both bank and non-bank entities will continue to grow. Accordingly, we build and implement strategic plans to address competitive factors in the various markets we serve. We have been able to compete effectively with other financial institutions by emphasizing customer service and local office decision-making, by establishing long-term customer relationships and building customer loyalty, and by providing products and services designed to address the specific needs of our customers.

 

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Employees

 

As of December 31, 2016, we had 208 full-time equivalent employees, 80 of whom are officers of Business First Bank. We are committed to hiring and retaining high quality employees to execute our strategic plan, and we consider our relations with employees to be very good.

 

Supervision and Regulation

 

General

 

The U.S. banking industry is highly regulated under federal and state law. Banking laws, regulations and policies affect our operations and those of our subsidiaries.

 

As a bank holding company, we are subject to inspection, examination, supervision and regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). Business First Bank is subject to extensive regulation and examination by the Louisiana Office of Financial Institutions (the “Louisiana OFI”) and the Federal Deposit Insurance Corporation (“FDIC”).

 

Statutes, regulations and policies limit the activities in which we may engage and how we conduct certain permitted activities. The system of supervision and regulation applicable to us and our subsidiaries establishes a comprehensive framework for our respective operations and is intended primarily for the protection of the FDIC’s Deposit Insurance Fund, Business First Bank’s depositors and the public, rather than our shareholders or creditors. Further, the bank regulatory system imposes reporting and information collection obligations. We incur significant costs relating to compliance with these laws and regulations. Banking statutes, regulations and policies are continually under review by Congress and state legislatures and regulatory agencies, and a change in them, including changes in how they are interpreted or implemented, could have a material adverse effect on our business, financial condition and results of operations.

 

The material statutory and regulatory requirements that are applicable to us and to Business First Bank are summarized below. This description is not intended to describe all laws and regulations applicable to us and our subsidiaries, and the description is qualified in its entirety by reference to the full text of the statutes, regulations, policies, interpretive letters and other written guidance that are described herein.

 

Business First Bancshares, Inc.

 

We are a bank holding company registered under the BHC Act, and we are subject to supervision, regulation and examination by the Federal Reserve. The BHC Act and other federal laws subject bank holding companies to particular restrictions on the types of activities in which they may engage and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations.

 

Banking statutes, regulations and policies could restrict our ability to diversify into other areas of financial services, acquire depository institutions and make distributions or pay dividends on our equity securities. They may also require us to provide financial support to any bank that we control, maintain capital balances in excess of those desired by management and pay higher deposit insurance premiums as a result of a general deterioration in the financial condition of Business First Bank.

 

Business First Bank

 

Business First Bank is a commercial bank chartered under the laws of the State of Louisiana and it is not a member of the Federal Reserve. In addition, its deposits are insured to the maximum extent permitted by law by the FDIC. As such, Business First Bank is subject to extensive regulation and examination by the Louisiana OFI and the FDIC. The federal and state laws and regulations which are applicable to Business First Bank regulate, among other things, the scope of its business, its investments, its reserves against deposits, the timing of the availability of deposited funds and the nature and amount of and collateral for certain loans. In addition to the impact of such regulations, commercial banks are affected significantly by the actions of the Federal Reserve in connection with its economic policy.

 

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Broad Supervision and Enforcement Powers

 

A principal objective of the U.S. bank regulatory system is to protect depositors by ensuring the financial safety and soundness of banking organizations. To that end, the banking regulators have broad regulatory, examination and enforcement authority. The regulators regularly examine the operations of banking organizations. In addition, banking organizations are subject to periodic reporting requirements.

 

The regulators have various remedies available if they determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of a banking organization’s operations are unsatisfactory. The regulators may also take action if they determine that the banking organization or its management is violating or has violated any law or regulation. The regulators have the power to, among other things:

 

 

enjoin “unsafe or unsound” practices;

 

 

require affirmative actions to correct any violation or practice;

 

 

issue administrative orders that can be judicially enforced;

 

 

direct increases in capital;

 

 

direct the sale of subsidiaries or other assets;

 

 

limit dividends and distributions;

 

 

restrict growth;

 

 

assess civil monetary penalties;

 

 

remove officers and directors; and

 

 

terminate deposit insurance.

 

The FDIC may terminate a depository institution’s deposit insurance upon a finding that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the institution’s regulatory agency. Engaging in unsafe or unsound practices or failing to comply with applicable laws, regulations and supervisory agreements could subject us and our subsidiaries or their officers, directors and institution-affiliated parties to the remedies described above and other sanctions.

 

The Dodd-Frank Act

 

On July 21, 2010, the Dodd-Frank Act became law. The Dodd-Frank Act is having a broad impact on the financial services industry, and imposes significant regulatory and compliance requirements, including the designation of certain financial companies as systemically important financial companies, the changing roles of credit rating agencies, the imposition of increased capital, leverage, and liquidity requirements, and numerous other provisions designed to improve supervision and oversight of, and strengthen safety and soundness within, the financial services sector. Additionally, the Dodd-Frank Act establishes a new framework of authority to conduct systemic risk oversight within the financial system to be distributed among new and existing federal regulatory agencies.

 

The following items provide a brief description of certain provisions of the Dodd-Frank Act that are most relevant to us and to Business First Bank.

 

 

Source of strength. Under Federal Reserve policy, bank holding companies have historically been required to act as a source of financial and managerial strength to each of their banking subsidiaries. The Dodd-Frank Act codified this policy as a statutory requirement. The Dodd-Frank Act requires all companies, including bank holding companies that directly or indirectly control an insured depository institution, to serve as a source of strength for the institution. Under this requirement, in the future we could be required to provide financial assistance to Business First Bank should it experience financial distress.

 

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Consumer Financial Protection Bureau. The Dodd-Frank Act created the Consumer Financial Protection Bureau (“CFPB”) as a new, independent regulatory agency. The CFPB is tasked with establishing and implementing rules and regulations under certain federal consumer protection laws governing the conduct of providers of certain consumer financial products and services. The CFPB has rulemaking authority over many of the statutes governing products and services offered to bank and thrift consumers. For banking organizations with assets of $10 billion or more, the CFPB has exclusive rule making and examination, and primary enforcement authority under federal consumer financial laws. In addition, the Dodd-Frank Act permits states to adopt consumer protection laws and regulations that are stricter than those regulations promulgated by the CFPB. Compliance with any such new regulations would increase our cost of operations.

 

 

Mortgage loan origination rules. The Dodd-Frank Act authorized the CFPB to establish certain minimum standards for the origination of residential mortgages, including requirements for lenders to affirmatively determine that their borrowers have the ability to repay their mortgage loans. Under the Dodd-Frank Act, financial institutions may not make a residential mortgage loan unless they make a “reasonable and good faith determination” that the consumer has a “reasonable ability” to repay the loan. The Dodd-Frank Act allows borrowers to bring civil claims and raise certain defenses to foreclosure if the lender does not make an appropriate ability-to-repay determination. The CFPB’s rules, however, provide a full or partial safe harbor from such liability and defenses for loans that are “qualified mortgages.” The ability-to-repay rule is just one among many of the CFPB’s new rules that will affect origination, disclosure and servicing in connection with consumer mortgages. Many of the CFPB’s new rules governing mortgage loan origination became effective in January of 2014. Additional regulations revising disclosure and timing requirements in connection with mortgage loan origination became effective in October of 2015. Compliance with all of the CFPB’s new mortgage rules will increase our cost of operations.

 

 

Deposit insurance. The Dodd-Frank Act made permanent the increased $250,000 deposit insurance limit for insured deposits. Amendments to the Federal Deposit Insurance Act (“FDI Act”) also revised the assessment base against which an insured depository institution’s deposit insurance premiums paid to the Deposit Insurance Fund of the FDIC will be calculated. Under the amendments, the assessment base is no longer the institution’s deposit base, but rather its average consolidated total assets less its average tangible equity. Additionally, the Dodd-Frank Act made changes to the minimum designated reserve ratio of the Deposit Insurance Fund, increasing the minimum from 1.15% to 1.35% of the estimated amount of total insured deposits, and eliminating the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain thresholds. Several of these provisions may impact the FDIC deposit insurance premiums paid by Business First Bank.

 

 

Transactions with affiliates and insiders. The Dodd-Frank Act generally enhanced the restrictions on transactions with affiliates under Section 23A and 23B of the Federal Reserve Act, including an expansion of the definition of “covered transactions” and clarification regarding the amount of time for which collateral requirements regarding covered credit transactions must be satisfied. Insider transaction limitations are expanded through the strengthening of loan restrictions to insiders and the expansion of the types of transactions subject to the various limits, including derivatives transactions, repurchase agreements, reverse repurchase agreements and securities lending or borrowing transactions. Restrictions are also placed on certain asset sales to and from an insider to an institution, including requirements that such sales be on market terms and, in certain circumstances, approved by the institution’s board of directors.

 

 

Corporate governance. The Dodd-Frank Act addresses many investor protection, corporate governance and executive compensation matters that will affect most U.S. publicly traded companies. The Dodd-Frank Act (1) grants shareholders of U.S. publicly traded companies an advisory vote on executive compensation; (2) enhances independence requirements for compensation committee members; (3) requires companies listed on national securities exchanges to adopt incentive-based compensation clawback policies for executive officers and (4) provides the SEC with authority to adopt proxy access rules that would allow shareholders of publicly traded companies to nominate candidates for election as a director and have those nominees included in a company’s proxy materials. For so long as we are an emerging growth company, we may take advantage of the provisions of the JOBS Act allowing us to not seek a non-binding advisory vote on executive compensation or golden parachute arrangements, but we will remain subject to many of the other provisions of the Dodd-Frank Act relating to investor protection and corporate governance.

 

7

 

 

The requirements of the Dodd-Frank Act are in the process of being implemented over time and most will be subject to regulations implemented over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on our operations is unclear. Further, the Trump administration issued an executive order on February 3, 2017, outlining a number of “Core Principles” of regulation of the industry and directing the Secretary of the Treasury to submit a report by June 3, 2017, identifying any laws, rules or regulations (including those promulgated under the auspices of the Dodd-Frank Act) that are determined to be inconsistent with those principles. Changes resulting from further implementation of, changes to, or repeal of the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make any changes necessary to comply with new statutory and regulatory requirements. Failure to comply with the new requirements could have a material adverse effect on our business, financial condition and results of operations.

 

Regulatory Notice and Approval Requirements Related to Control

 

Banking laws impose notice, approval and ongoing regulatory requirements on any shareholder or other party that seeks to acquire direct or indirect “control” of an FDIC-insured depository institution. These laws include the BHC Act and the Change in Bank Control Act. Among other things, these laws require regulatory filings by a shareholder or other party that seeks to acquire direct or indirect “control” of an FDIC-insured depository institution. The determination whether an investor “controls” a depository institution is based on all of the facts and circumstances surrounding the investment. As a general matter, a party is deemed to control a depository institution or other company if the party owns or controls 25% or more of any class of voting stock. Subject to rebuttal, a party may be presumed to control a depository institution or other company if the investor owns or controls 10% or more of any class of voting stock. Ownership by affiliated parties, or parties acting in concert, is typically aggregated for these purposes. If a party’s ownership of Business First were to exceed certain thresholds, the investor could be deemed to “control” Business First for regulatory purposes. This could subject the investor to regulatory filings or other regulatory consequences.

 

In addition, except under limited circumstances, bank holding companies are prohibited from acquiring, without prior approval, (1) control of any other bank or bank holding company or all or substantially all the assets thereof or (2) more than 5% of the voting shares of a bank or bank holding company which is not already a subsidiary.

 

Branching

 

Louisiana law provides that a Louisiana state bank can establish a branch anywhere in Louisiana provided that the branch is approved in advance by the Louisiana OFI. The branch also must be approved by the FDIC. When considering whether to approve the establishment of a branch, the Louisiana OFI and the FDIC consider a number of factors, including financial history, capital adequacy, earnings prospects, character of management, needs of the community and consistency with corporate powers. The Dodd-Frank Act permits insured state banks to engage in de novo interstate branching if the laws of the state where the new branch is to be established would permit the establishment of the branch if the branching bank were chartered by such state.

 

Limits on Transactions with Affiliates

 

Federal law restricts the amount and the terms of both credit and noncredit transactions (generally referred to as “covered transactions”) between a bank and its nonbank affiliates. Covered transactions with any single affiliate may not exceed 10% of the capital stock and surplus of a bank, and covered transactions with all affiliates may not exceed, in the aggregate, 20% of a bank’s capital stock and surplus. For a bank, capital stock and surplus refers to the bank’s Tier 1 and Tier 2 capital, as calculated under the risk-based capital guidelines, plus the balance of the allowance for credit losses excluded from Tier 2 capital. A bank’s transactions with all of its affiliates in the aggregate are limited to 20% of the foregoing capital. In addition, in connection with covered transactions that are extensions of credit, a bank may be required to hold collateral to provide added security to the bank and the types of permissible collateral may be limited. The Dodd-Frank Act generally enhances the restrictions on transactions with affiliates, including an expansion of what types of transactions are covered transactions to include credit exposures related to derivatives, repurchase agreements and securities lending arrangements and an increase in the amount of time for which collateral requirements regarding covered transactions must be satisfied.

 

Loans to Insiders

 

Sections 22(g) and (h) of the Federal Reserve Act and its implementing regulation, Regulation O, place restrictions on loans by a bank to executive officers, directors and principal shareholders. Under Section 22(h), loans to a director, an executive officer and to a greater than 10.0% shareholder of a bank and certain of their related interests or insiders and insiders of affiliates, may not exceed, together with all other outstanding loans to such person and related interests, a bank’s loans-to-one-borrower limit (generally equal to 15.0% of the institution’s unimpaired capital and surplus). Section 22(h) also requires that loans to insiders and to insiders of affiliates be made on terms substantially the same as offered in comparable transactions to other persons, unless the loans are made pursuant to a benefit or compensation program that (1) is widely available to employees of the bank and (2) does not give preference to insiders over other employees of the bank. Section 22(h) also requires prior board of directors’ approval for certain loans and the aggregate amount of extensions of credit by a bank to all insiders cannot exceed the institution’s unimpaired capital and surplus. Furthermore, Section 22(g) places additional restrictions on loans to executive officers.

 

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Depositor Preference

 

The FDI Act provides that, in the event of the “liquidation or other resolution” of an insured depository institution, the claims of depositors of the institution (including the claims of the FDIC as subrogee of insured depositors) and certain claims for administrative expenses of the FDIC as a receiver will have priority over other general unsecured claims against the institution. Therefore, if an insured depository institution like Business First Bank fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, nondeposit creditors, including us, with respect to any extensions of credit they have made to such insured depository institution.

 

Dividend Restrictions

 

In 2016, our board of directors made the decision to commence payment of regular quarterly dividends; however, we are not required to pay dividends. Our shareholders are entitled to receive dividends out of legally available funds as and when declared by our board of directors, in their sole discretion.

 

As a Louisiana corporation, we are subject to certain restrictions on dividends under the Louisiana Business Corporation Act. Generally, under Louisiana law, we may not pay a dividend if (i) after giving effect to the dividend, we would not be able to pay our debts as they become due in the usual course of business, (ii) after giving effect to the dividend, our total assets would be less than the sum of our total liabilities plus the amount that would be needed, if we were to be dissolved at the time of the distribution, to satisfy any preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution, or (iii) the declaration or payment thereof would be contrary to any restrictions contained in our articles of incorporation. Also, as a bank holding company, we are required by the Federal Reserve to serve as a source of financial strength for Business First Bank. The Federal Reserve has stated that, as a matter of prudent banking, a bank holding company generally should not maintain a rate of dividends to shareholders unless its net income available has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears consistent with the bank holding company’s capital needs, asset quality and overall financial condition.

 

We do not engage in separate business activities of a material nature. As a result, our ability to pay dividends depends upon the dividends received from Business First Bank. As a Louisiana state bank, Business First Bank’s ability to pay dividends is restricted by certain laws and regulations. Under the Louisiana Banking Law, Business First Bank may not declare or pay cash or property dividends unless it has unimpaired surplus that equals or exceeds 50% of its outstanding capital stock. Business First Bank’s unimpaired surplus may not be reduced below 50% as a result of the payment of any combination of cash or property dividends, or the purchase or redemption of any shares of its capital stock. In addition, Business First Bank must obtain the prior approval of the Louisiana Banking Commissioner to pay dividends to us if the total of all year-to-date cash or property dividends declared and paid by Business First Bank, when added to any amounts used by Business First Bank to redeem or purchase shares of its capital stock, would exceed the total of its year-to-date net income combined with its net income from the immediately preceding year, after deducting all of the following: (i) amounts paid or accrued for the payments of cash dividends, (ii) the value of all property paid in dividends, and (iii) amounts paid or accrued to redeem or purchase shares of Business First Bank’s capital stock over the calculation period.

 

In addition to Louisiana law restrictions on Business First Bank’s ability to pay dividends, under FDICIA, Business First Bank may not pay any dividend if the payment of the dividend would cause Business First Bank to become undercapitalized or if Business First Bank is “undercapitalized.” The FDIC may further restrict the payment of dividends by requiring that Business First Bank maintain a higher level of capital than would otherwise be required to be “adequately capitalized” for regulatory purposes. Moreover, if, in the opinion of the FDIC, Business First Bank is engaged in an unsound practice (which could include the payment of dividends), the FDIC may require, generally after notice and hearing, that Business First Bank cease such practice. The FDIC has indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe banking practice. Moreover, the FDIC has also issued policy statements providing that insured depository institutions generally should pay dividends only out of current operating earnings. Under regulatory capital guidelines, Business First Bank must maintain a Tier 1 capital to adjusted average total assets ratio of at least 4.0%, a Tier 1 capital to risk weighted assets ratio of at least 6.0%, and a total risk based capital to risk weighted assets ratio of at least 8.0%. As of December 31, 2016, Business First Bank had a ratio of Tier 1 capital to adjusted average total assets of 9.91%, a ratio of Tier 1 capital to risk weighted assets of 11.07% and a ratio of total risk based capital to risk weighted assets of 11.89%.

 

The Dodd-Frank Act and Basel III (described below) impose additional restrictions on the ability of banking institutions to pay dividends.

 

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Regulatory Capital Requirements

 

The Federal Reserve monitors our capital adequacy, on a consolidated basis, and the FDIC and the Louisiana OFI monitor the capital adequacy of Business First Bank. The bank regulators use a combination of risk-based guidelines and a leverage ratio to evaluate capital adequacy. The risk-based capital guidelines applicable to us and our bank are based on the Basel Committee’s December 2010 final capital framework, known as Basel III, as implemented by the federal bank regulators. The risk-based guidelines are intended to make regulatory capital requirements sensitive to differences in credit and market risk profiles among banks and bank holding companies, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to weighted risk categories, and capital is classified in one of the following tiers depending on its characteristic:

 

Common Equity Tier 1 (CET1) Capital. CET1 capital generally includes common equity, surplus and retained earnings less goodwill, most intangible assets and certain other assets. The capital rules require bank holding companies and banks to include Accumulated Other Comprehensive Income (“AOCI”) into CET1 unless the bank and bank holding company use a one-time election to exclude AOCI from its regulatory capital metrics on January 1, 2015. We elected to exclude AOCI from CET1.

 

Tier 1 (Core) Capital. Tier 1 capital generally includes CET1 and qualifying trust preferred securities at the holding company level, less goodwill, most intangible assets and certain other assets.

 

Tier 2 (Supplementary) Capital. Tier 2 capital generally includes qualifying subordinated debt and a limited amount of allowances for loan and lease losses.

 

Bank holding companies and banks are also currently required to comply with minimum leverage requirements, measured based on the ratio of a bank holding company’s or a bank’s, as applicable, Tier 1 capital to adjusted quarterly average total assets (as defined for regulatory purposes). These requirements generally necessitate a minimum Tier 1 leverage ratio of 4% for all bank holding companies and banks. To be considered “well capitalized” under the regulatory framework for prompt corrective action, Business First Bank must maintain minimum Tier 1 leverage ratios of at least 5%. See —Prompt Corrective Action Framework.

 

Basel III and the Capital Rules. In July 2013, the federal bank regulators approved final rules, or the Capital Rules, implementing the Basel Committee’s December 2010 final capital framework for strengthening international capital standards, known as Basel III, and various provisions of the Dodd-Frank Act. The Capital Rules substantially revise the risk-based capital requirements applicable to bank holding companies and banks, including us and Business First Bank, compared to the previous risk-based capital rules. The Capital Rules revise the components of capital and address other issues affecting the numerator in regulatory capital ratio calculations. The Capital Rules also address risk weights and other issues affecting the denominator in regulatory capital ratio calculations, including by replacing the existing risk-weighting approach derived from Basel I with a more risk-sensitive approach based, in part, on the standardized approach adopted by the Basel Committee in its 2004 capital accords, known as Basel II. The Capital Rules also implement the requirements of Section 939A of the Dodd-Frank Act to remove references to credit ratings from the federal bank regulators’ rules. Subject to a phase-in period for various provisions, the Capital Rules became effective for us and for Business First Bank beginning on January 1, 2015.

 

Under the Basel III Capital Rules, the minimum capital ratios are (i) 4.5% CET1 to risk-weighted assets, (ii) 6% Tier 1 capital (that is, CET1 plus Additional Tier 1 capital) to risk-weighted assets and (iii) 8% total capital (that is, Tier 1 capital plus Tier 2 capital) to risk-weighted assets.

 

The current capital rules also include a capital conservation buffer designed to absorb losses during periods of economic stress. The capital conservation buffer is composed entirely of CET1, on top of these minimum risk-weighted asset ratios. In addition, the Capital Rules provide for a countercyclical capital buffer applicable only to certain covered institutions. We do not expect the countercyclical capital buffer to be applicable to us or to Business First Bank. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the capital conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.

 

The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and will be phased in over a three-year period (increasing by 0.625% on each subsequent January 1, until it reaches 2.5% on January 1, 2019). When fully phased-in, the Capital Rules will require us, and Business First Bank, to maintain an additional capital conservation buffer of 2.5% of CET1, effectively resulting in minimum ratios of: (i) 7.0% CET1 to risk-weighted assets, (ii) 8.5% Tier 1 capital to risk-weighted assets, and (iii) 10.5% total capital to risk-weighted assets.

 

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The Capital Rules provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, certain deferred tax assets and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1. Implementation of the deductions and other adjustments to CET1 began on January 1, 2015, and will be phased in over a four-year period (beginning at 40% on January 1, 2015 and an additional 20% per year thereafter). The Capital Rules also generally preclude certain hybrid securities, such as trust preferred securities, from being counted as Tier 1 capital for most bank holding companies. However, bank holding companies such as us who had less than $15 billion in assets as of December 31, 2009 (and who continue to have less than $15 billion in assets) are permitted to include trust preferred securities issued prior to May 19, 2010 as Additional Tier 1 capital under the Capital Rules.

 

The Capital Rules also prescribed a new standardized approach for risk weightings that expanded the risk-weighting categories from the current four Basel I-derived categories (0%, 20%, 50% and 100%) to a much larger and more risk-sensitive number of categories, depending on the nature of the assets, generally ranging from 0%, for U.S. government and agency securities, to 600%, for certain equity exposures, and resulting in higher risk weights for a variety of asset categories.

 

With respect to Business First Bank, the Capital Rules also revised the prompt corrective action regulations pursuant to Section 38 of the FDI Act. See —Prompt Corrective Action Framework.

 

We believe that, as of December 31, 2016, we and Business First Bank would meet all capital adequacy requirements under the Capital Rules on a fully phased-in basis as if such requirements were then in effect.

 

Liquidity Requirements

 

Historically, the regulation and monitoring of bank and bank holding company liquidity has been addressed as a supervisory matter, without required formulaic measures. The Basel III final framework requires banks and bank holding companies to measure their liquidity against specific liquidity tests that, although similar in some respects to liquidity measures historically applied by banks and regulators for management and supervisory purposes, going forward would be required by regulation. One test, referred to as the liquidity coverage ratio, or LCR, is designed to ensure that the banking entity maintains an adequate level of unencumbered high-quality liquid assets equal to the entity’s expected net cash outflow for a 30-day time horizon (or, if greater, 25% of its expected total cash outflow) under an acute liquidity stress scenario. The other test, referred to as the net stable funding ratio, or NSFR, is designed to promote more medium- and long-term funding of the assets and activities of banking entities over a one-year time horizon. These requirements will incentivize banking entities to increase their holdings of U.S. Treasury securities and other sovereign debt as a component of assets and increase the use of long-term debt as a funding source.

 

In September 2015, the federal bank regulators approved final rules implementing the LCR for advanced approaches banking organizations (i.e., banking organizations with $250 billion or more in total consolidated assets or $10 billion or more in total on-balance sheet foreign exposure) and a modified version of the LCR for bank holding companies with at least $50 billion in total consolidated assets that are not advanced approach banking organizations, neither of which would apply to us or Business First Bank. The Federal Reserve and other federal bank regulatory agencies proposed rules to implement the NSFR in 2016, but those have not yet become final.

 

Prompt Corrective Action Framework

 

The FDI Act requires the federal bank regulators to take prompt corrective action in respect of depository institutions that fail to meet specified capital requirements. The FDI Act establishes five capital categories (“well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized”), and the federal bank regulators are required to take certain mandatory supervisory actions, and are authorized to take other discretionary actions, with respect to institutions that are undercapitalized, significantly undercapitalized or critically undercapitalized. The severity of these mandatory and discretionary supervisory actions depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the FDI Act requires the regulator to appoint a receiver or conservator for an institution that is critically undercapitalized.

 

An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. A bank’s capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the bank’s overall financial condition or prospects for other purposes.

 

The Capital Rules revised the current prompt corrective action requirements effective January 1, 2015 by (i) introducing a CET1 ratio requirement at each level (other than critically undercapitalized), with the required CET1 ratio being 6.5% for well-capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category (other than critically undercapitalized), with the minimum Tier 1 capital ratio for well-capitalized status being 8% (as compared to the previous 6%); and (iii) eliminating the provision that provided that a bank with a composite supervisory rating of 1 may have a 3% leverage ratio and still be adequately capitalized. The Capital Rules do not change the total risk-based capital requirement for any prompt corrective action category.

 

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As of December 31, 2016, we and Business First Bank were well capitalized with Tier 1 capital ratios of 10.81% and 11.07%, respectively, total capital ratios of 11.63% and 11.89%, respectively, Tier 1 leverage ratios of 9.67% and 9.91%, respectively, and a CET1 ratio of 10.81% and 11.07%, respectively, as calculated under Basel III which went into effect on January 1, 2015. For more information on these financial measures, including reconciliations to our and Business First Bank’s Tier 1 capital ratio, see Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations.

 

An institution that is categorized as undercapitalized, significantly undercapitalized or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal bank regulator. Under the FDI Act, in order for the capital restoration plan to be accepted by the appropriate federal banking agency, a bank holding company must guarantee that a subsidiary depository institution will comply with its capital restoration plan, subject to certain limitations. The bank holding company must also provide appropriate assurances of performance. The obligation of a controlling bank holding company under the FDI Act to fund a capital restoration plan is limited to the lesser of 5.0% of an undercapitalized subsidiary’s assets or the amount required to meet regulatory capital requirements. An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions and capital distributions, establishing any branches or engaging in any new line of business, except in accordance with an accepted capital restoration plan or with the approval of the FDIC. Institutions that are undercapitalized or significantly undercapitalized and either fail to submit an acceptable capital restoration plan or fail to implement an approved capital restoration plan may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets and cessation of receipt of deposits from correspondent banks. Critically undercapitalized depository institutions failing to submit or implement an acceptable capital restoration plan are subject to appointment of a receiver or conservator.

 

Reserve Requirements

 

Pursuant to regulations of the Federal Reserve, all banks are required to maintain average daily reserves at mandated ratios against their transaction accounts. In addition, reserves must be maintained on certain nonpersonal time deposits. These reserves must be maintained in the form of vault cash or in an account at a Federal Reserve Bank.

 

Brokered Deposits

 

The FDI Act restricts the use of brokered deposits by certain depository institutions. Under the applicable regulations, (i) a well-capitalized insured depository institution may solicit and accept, renew or roll over any brokered deposit without restriction, (ii) an adequately capitalized insured depository institution may not accept, renew or roll over any brokered deposit unless it has applied for and been granted a waiver of this prohibition by the FDIC, and (iii) an undercapitalized insured depository institution may not accept, renew or roll over any brokered deposit. The FDIC may, on a case-by-case basis and upon application by an adequately capitalized insured depository institution, waive the restriction on brokered deposits upon a finding that the acceptance of brokered deposits does not constitute an unsafe or unsound practice with respect to such institution. A depository institution that is adequately capitalized and accepts brokered deposits under a waiver from the FDIC may not pay an interest rate on any deposit in excess of 75 basis points over certain prevailing market rates.

 

Concentrated Commercial Real Estate Lending Guidance

 

The federal banking agencies, including the FDIC, have promulgated guidance governing financial institutions with concentrations in commercial real estate lending. The guidance provides that a bank has a concentration in commercial real estate lending if (1) total reported loans for construction, land development and other land represent 100% or more of total capital or (2) total reported loans secured by multifamily and nonfarm nonresidential properties and loans for construction, land development and other land represent 300% or more of total capital and the bank’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months. Owner occupied commercial real estate loans are excluded from this second category. If a concentration is present, management must employ heightened risk management practices that address the following key elements including: board and management oversight and strategic planning, portfolio management, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, and maintenance of increased capital levels as needed to support the level of commercial real estate lending.

 

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Examination and Examination Fees

 

The FDIC periodically examines and evaluates state non-member banks. Based on such an evaluation, Business First Bank, among other things, may be required to revalue its assets and establish specific reserves to compensate for the difference between Business First Bank’s assessment and that of the FDIC. The Louisiana OFI also conducts examinations of state banks but may accept the results of a federal examination in lieu of conducting an independent examination. In addition, the FDIC and Louisiana OFI may elect to conduct a joint examination. The Louisiana OFI charges fees to recover the costs of examining Louisiana chartered banks. The FDIC assesses fees in the form of deposit insurance premiums (discussed below). The Dodd-Frank Act provides various agencies with the authority to assess additional supervision fees.

 

Deposit Insurance Assessments

 

As an FDIC-insured bank, Business First Bank must pay deposit insurance assessments to the FDIC based on its average total assets minus its average tangible equity. As an institution with less than $10 billion in assets, Business First Bank’s assessment rates are based on its risk classification (i.e., the level of risk it poses to the FDIC’s deposit insurance fund). Institutions classified as higher risk pay assessments at higher rates than institutions that pose a lower risk. For institutions with $10 billion or more in assets, the FDIC uses a performance score and a loss-severity score that are used to calculate an initial assessment rate. In calculating these scores, the FDIC uses a bank’s capital level and regulatory supervisory ratings and certain financial measures to assess an institution’s ability to withstand asset-related stress and funding-related stress. The FDIC also has the ability to make discretionary adjustments to the total score based upon significant risk factors that are not adequately captured in the calculations. In addition to ordinary assessments described above, the FDIC has the ability to impose special assessments in certain instances.

 

In recent years, the FDIC’s deposit insurance fund has been underfunded, and the FDIC has raised assessment rates and imposed special assessments on certain institutions during recent years to raise funds. Under the Dodd-Frank Act, the minimum designated reserve ratio for the deposit insurance fund is 1.35% of the estimated total amount of insured deposits. In October 2010, the FDIC adopted a restoration plan to ensure that the fund reserve ratio reaches 1.35% by September 30, 2020, as required by the Dodd-Frank Act. At least semi-annually, the FDIC will update its loss and income projections for the fund and, if needed, will increase or decrease assessment rates, following notice-and-comment rulemaking if required.

 

Under the FDI Act, the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.

 

Continued action by the FDIC to replenish the Deposit Insurance Fund as well as changes contained in the Dodd-Frank Act may result in higher assessment rates. Business First Bank may be able to pass part or all of this cost on to its customers, including in the form of lower interest rates on deposits or fees to some depositors, depending on market conditions.

 

Permitted Activities and Investments by Financial Holding Companies

 

The BHC Act generally prohibits a financial holding company from engaging, directly or indirectly, in activities other than banking or managing or controlling banks, except for activities determined by the Federal Reserve to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.

 

Activities that the Federal Reserve Board has found to be so closely related to banking as to be a proper incident to the business of banking include:

 

 

factoring accounts receivable;

 

 

making, acquiring, brokering or servicing loans and usual related activities;

 

 

leasing personal or real property;

 

 

operating a nonbank depository institution, such as a savings association;

 

 

trust company functions;

 

 

financial and investment advisory activities;

 

 

conducting discount securities brokerage activities;

 

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underwriting and dealing in government obligations and money market instruments;

 

 

providing specified management consulting and counseling activities;

 

 

performing selected data processing services and support services;

 

 

acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and

 

 

performing selected insurance underwriting activities.

 

Provisions of the Gramm-Leach-Bliley Act expanded the permissible activities of a financial holding company that qualifies as and elects to become a financial holding company. Under the regulations implementing the Gramm-Leach-Bliley Act, a financial holding company may engage in additional activities that are “financial in nature” or incidental or complementary to financial activity. Among other things, to qualify as a financial holding company, all of the subsidiary banks controlled by the financial holding company must be and remain at all times “well-capitalized” and “well-managed.” We are not currently a financial holding company.

 

Privacy and Security

 

Federal law establishes a minimum federal standard of financial privacy by, among other provisions, requiring banks to adopt and disclose privacy policies with respect to consumer information and setting forth certain rules with respect to the disclosure to third parties of consumer information. Business First Bank has adopted and disseminated privacy policies pursuant to applicable law. Regulations adopted under federal law set standards for protecting the security, confidentiality and integrity of customer information, and require notice to regulators, and in some cases to customers, in the event of security breaches. A number of states have also adopted statutes concerning financial privacy and requiring notification of security breaches.

 

Anti-Money Laundering Requirements

 

Under federal law, including the Bank Secrecy Act and the PATRIOT Act, certain types of financial institutions, including insured depository institutions, must maintain anti-money laundering programs that include established internal policies, procedures and controls, a designated compliance officer, an ongoing employee training program and testing of the program by an independent audit function. Among other things, these laws are intended to strengthen the ability of U.S. law enforcement agencies and intelligence communities to work together to combat terrorism on a variety of fronts. Financial institutions are prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence, customer identification and recordkeeping, including in their dealings with non-U.S. financial institutions and non-U.S. customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious information maintained by financial institutions. Bank regulators routinely examine institutions for compliance with these obligations and they must consider an institution’s anti-money laundering compliance when considering regulatory applications filed by the institution, including applications for banking mergers and acquisitions. The regulatory authorities have imposed “cease and desist” orders and civil money penalty sanctions against institutions found to be violating these obligations.

 

Office of Foreign Asset Control, or the OFAC, is responsible for helping to insure that U.S. entities do not engage in transactions with certain prohibited parties, as defined by various executive orders by the President of the United States and acts of Congress. OFAC publishes lists of persons, organizations and countries suspected of aiding, harboring or engaging in terrorist acts, known as Specially Designated Nationals and Blocked Persons. If we or Business First Bank finds a name on any transaction, account or wire transfer that is on an OFAC list, we or Business First Bank must freeze or block such account or transaction, file a suspicious activity report and notify the appropriate authorities.

 

Consumer Laws and Regulations

 

Banks and other financial institutions are subject to numerous laws and regulations intended to protect consumers in their transactions with banks. These laws include, among others, laws regarding unfair and deceptive acts and practices and usury laws, as well as the federal consumer protection statutes set forth below. Many states and local jurisdictions have consumer protection laws analogous and in addition, to those listed below. These federal, state and local laws regulate the manner in which financial institutions deal with customers when taking deposits, making loans or conducting other types of transactions. Failure to comply with these laws and regulations could give rise to regulatory sanctions, customer rescission rights, action by state and local attorneys general and civil or criminal liability.

 

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Federal Laws Applicable to Credit Transactions. The loan operations of Business First Bank are also subject to federal laws and regulations applicable to credit transactions, including, among others, the:

 

 

Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

 

 

Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

 

 

Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

 

 

Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies;

 

 

Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;

 

 

the Real Estate Settlement Procedures Act, requiring lenders to give borrowers certain disclosures with respect to the origination and servicing of one-to-four family mortgage loans;

 

 

Service Members Civil Relief Act, which amended the Soldiers’ and Sailors’ Civil Relief Act of 1940, governing the repayment terms of and property rights underlying, secured obligations of persons in military service;

 

 

Military Lending Act, which provides expanded protections to active duty military members and their covered dependents on specific credit transactions; and

 

 

the rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws and regulations, which continue to be extensively amended and revised.

 

Federal Laws Applicable to Deposit Operations. Among other laws and regulations, the deposit operations of Business First Bank are subject to the following federal laws and their related regulations:

 

 

the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

 

 

the Electronic Funds Transfer Act, which governs automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;

 

 

the Expedited Funds Availability Act, which standardizes hold periods for deposits and regulates financial institutions’ use of deposit holds;

 

 

Truth-in-Savings Act, which requires uniform disclosure of terms and conditions regarding interest and fees when giving out information on or opening a new savings account; and

 

 

the rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws, which continue to be extensively amended and revised.

 

The Community Reinvestment Act

 

The Community Reinvestment Act, or the CRA, is intended to encourage banks to help meet the credit needs of their entire communities, including low- and moderate-income neighborhoods, consistent with safe and sound operations. The regulators examine banks and assign each bank a public CRA rating. The CRA then requires bank regulators to take into account the bank’s record in meeting the needs of its community when considering certain applications by a bank, including applications to establish a branch or to conduct certain mergers or acquisitions. The Federal Reserve is required to consider the CRA records of a bank holding company’s controlled banks when considering an application by the bank holding company to acquire a bank or to merge with another bank holding company.

 

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When Business First applies for regulatory approval to make certain investments, the regulators will consider the CRA record of the target institution and Business First Bank. An unsatisfactory CRA record could substantially delay approval or result in denial of an application. The regulatory agency’s assessment of the institution’s record is made available to the public. The FDIC conducted its most recent CRA exam of Business First Bank in April 2014, and Business First Bank received an “Outstanding” rating.

 

In addition, federal law requires the disclosure of agreements reached with community groups that relate to the CRA, and contains various other provisions designed to improve the delivery of financial services to consumers while maintaining an appropriate level of safety in the financial services industry.

 

Federal Home Loan Bank System

 

Business First Bank is a member of the Dallas FHLB, which is one of the 12 regional FHLB’s composing the FHLB system. Each FHLB provides a central credit facility primarily for its member institutions as well as other entities involved in home mortgage lending. Any advances from a FHLB must be secured by specified types of collateral. As a member of the FHLB of Dallas, Business First Bank is required to acquire and hold shares of capital stock in the FHLB of Dallas.

 

Changes in Laws, Regulations or Policies

 

Congress and state legislatures may introduce from time to time measures or take actions that would modify the regulation of banks or bank holding companies. In addition, federal and state regulatory agencies also periodically propose and adopt changes to their regulations or change the manner in which existing regulations are applied. Such changes could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks and other financial institutions, all of which could adversely affect our investment opportunities and our assessment of how attractive such opportunities may be. We cannot predict whether potential legislation will be enacted and, if enacted, the effect that it or any implementing regulations would have on our business, financial condition or results of operations.

 

Effect on Economic Environment

 

The policies of regulatory authorities, including the monetary policy of the Federal Reserve, have a significant effect on the operating results of bank holding companies and their subsidiaries. Among the means available to the Federal Reserve to affect the money supply are open market operations in U.S. government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may affect interest rates charged on loans or paid for deposits. Federal Reserve monetary policies have materially affected the operating results of commercial banks in the past and are expected to continue to do so in the future. We cannot predict the nature of future monetary policies and the effect of such policies on our business, financial condition or results of operations.

 

ITEM 1A. Risk Factors.

 

In evaluating our business, you should consider carefully the factors described below. The occurrence of one or more of these events could significantly and adversely affect our business, prospects, financial condition, results of operations and cash flows. You should also consider the cautionary statement regarding the use of forward-looking statements elsewhere in this Report.

 

Risks Relating to our Business

 

We may not be able to adequately measure and limit our credit risk, which could lead to unexpected losses.

 

The business of lending is inherently risky, including risks that the principal of or interest on any loan will not be repaid timely or at all, or that the value of any collateral supporting the loan will be insufficient to cover our outstanding exposure. These risks may be affected by the strength of the borrower’s business sector and local, regional and national market and economic conditions. Our risk management practices, such as monitoring the concentration of our loans within specific industries and our credit approval practices, may not adequately reduce credit risk, and our credit administration personnel, policies and procedures may not adequately adapt to changes in economic or any other conditions affecting customers and the quality of our loan portfolio. Finally, many of our loans are made to small and midsized businesses that may be less able to withstand competitive, economic and financial pressures than larger borrowers. A failure to effectively measure and limit the credit risk associated with our loan portfolio could have a material adverse effect on our business, financial condition and results of operations.

 

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Our allowance for loan losses may prove to be insufficient to absorb losses inherent in our loan portfolio, which could have a material adverse effect on our financial condition and results of operations.

 

We maintain an allowance for loan losses that represents management’s judgment of probable losses and risks inherent in our loan portfolio. As of December 31, 2016, our allowance for loan losses totaled $8.2 million, which represents approximately 1.01% of our total loans held for investment. The level of the allowance reflects management’s continuing evaluation of general economic conditions, diversification and seasoning of the loan portfolio, historic loss experience, identified credit problems, delinquency levels and adequacy of collateral. The determination of the appropriate level of the allowance for loan losses is inherently highly subjective and requires us to make significant estimates of and assumptions regarding current credit risks and future trends, all of which may undergo material changes. Inaccurate management assumptions, deterioration of economic conditions affecting borrowers, new information regarding existing loans, identification or deterioration of additional problem loans, acquisition of problem loans and other factors, both within and outside of our control, may require us to increase our allowance for loan losses. In addition, our regulators, as an integral part of their periodic examination, review our methodology for calculating, and the adequacy of, our allowance for loan losses and may direct us to make additions to the allowance based on their judgments about information available to them at the time of their examination. Further, if actual charge-offs in future periods exceed the amounts allocated to the allowance for loan losses, we may need additional provisions for loan losses to restore the adequacy of our allowance for loan losses. Finally, the measure of our allowance for loan losses is dependent on the adoption and interpretation of accounting standards. The Financial Accounting Standards Board recently issued a new credit impairment model, the Current Expected Credit Loss, or CECL model, which will become applicable to us on January 1, 2020, though we may choose to adopt CECL on January 1, 2019, or may be encouraged to by our regulators. CECL will require financial institutions to estimate and develop a provision for credit losses at origination for the lifetime of the loan, as opposed to reserving for incurred or probable losses up to the balance sheet date. Under the CECL model, credit deterioration would be reflected in the income statement in the period of origination or acquisition of the loan, with changes in expected credit losses due to further credit deterioration or improvement reflected in the periods in which the expectation changes. Accordingly, the CECL model could require financial institutions like the Bank to increase their allowances for loan losses. Moreover, the CECL model likely would create more volatility in our level of allowance for loan losses. If we are required to materially increase our level of allowance for loan losses for any reason, such increase could adversely affect our business, financial condition and results of operations.

 

We rely heavily on our executive management team and other key employees, and an unexpected loss of their service could have a material adverse effect on our business, financial condition and results of operations.

 

Our success depends in large part on the performance of our key personnel, as well as on our ability to attract, motivate and retain highly qualified senior and middle management and other skilled employees. Competition for employees is intense, and the process of locating key personnel with the combination of skills and attributes required to execute our business plan may be lengthy. We may not be successful in retaining our key employees, and the unexpected loss of services of one or more of our key personnel could have a material adverse effect on our business given their skills, knowledge of the primary markets, years of industry experience and the difficulty of promptly finding qualified replacement personnel. If the services of any of our key personnel should become unavailable for any reason, we may not be able to identify and hire qualified persons on terms acceptable to us, or at all, which could have a material adverse effect on our business, financial condition and results of operations.

 

Our ability to retain bankers and recruit additional successful bankers is critical to the success of our business strategy, and any failure to do so could have a material adverse effect on our business, financial condition and results of operations.

 

Our ability to retain and grow our loans, deposits and fee income depends upon the business generation capabilities, reputation and relationship management skills of our bankers. If we were to lose the services of any of our bankers, including successful bankers employed by banks that we may acquire, to a new or existing competitor or otherwise, we may not be able to retain valuable relationships and some of our customers could choose to use the services of a competitor instead.

 

Our growth strategy also relies on our ability to attract and retain additional profitable bankers. We may face difficulties in recruiting and retaining bankers of our desired caliber, including as a result of competition from other financial institutions. In particular, many of our competitors are significantly larger with greater financial resources, and may be able to offer more attractive compensation packages and broader career opportunities. Additionally, we may incur significant expenses and expend significant time and resources on training, integration and business development before we are able to determine whether a new banker will be profitable or effective. If we are unable to attract and retain successful bankers, or if our bankers fail to meet our expectations in terms of customer relationships and profitability, we may be unable to execute our business strategy, which could have a material adverse effect on our business, financial condition and results of operations.

 

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We may fail to grow or manage our growth effectively, which could have a material adverse effect on our ability to successfully implement our business strategy.

 

We may not be able to sustain our historical rate of growth or continue to grow our business at all. Because of the uncertainty in the general economy and the government intervention in the credit markets, it may be difficult for us to continue our historical earnings growth as we continue to expand. Failure to grow or failure to manage our growth effectively could adversely affect our ability to successfully implement our business strategy, which could have a material adverse effect on our business, financial condition and results of operations.

 

Difficult market conditions and economic trends have adversely affected the banking industry and could have a material adverse effect on our business, financial condition and results of operations.

 

We are operating in a challenging and uncertain economic environment, including generally uncertain conditions nationally and locally in our industry and market. Although economic conditions have improved in recent years, financial institutions continue to be affected by depressed oil prices, volatility in the real estate market in some parts of the country, and uncertain regulatory and interest rate conditions. We retain direct exposure to the oil and gas markets, and also to the residential and commercial real estate market in Louisiana. Consequently, we are affected by related market conditions.

 

Our ability to assess the creditworthiness of customers and to estimate the losses inherent in our loan portfolio is made more complex by uncertain market and economic conditions. Our risk management practices, such as monitoring the concentration of our loans within specific industries and our credit approval practices, may not adequately reduce credit risk, and our credit administration personnel, policies and procedures may not adequately adapt to changes in economic or any other conditions affecting customers and the quality of the loan portfolio. Another national economic recession or deterioration of conditions in our market could drive losses beyond those which are provided for in our allowance for loan losses and result in the following consequences:

 

 

increases in loan delinquencies;

 

 

increases in nonperforming assets and foreclosures;

 

 

decreases in demand for products and services, which could adversely affect our liquidity position; and

 

 

decreases in the value of the collateral securing our loans, especially real estate, which could reduce customers’ borrowing power and repayment ability.

 

While economic conditions in Louisiana and the U.S. continue to show signs of recovery, there can be no assurance that these conditions will continue to improve. A continued decline in oil and gas prices or a resumption of declines in real estate values, volume of home sales and financial stress on borrowers as a result of the uncertain economic environment, including job losses, could have a material adverse effect on our borrowers and/or their customers, which could have a material adverse effect on our business, financial condition and results of operations.

 

A large portion of our loan portfolio is comprised of commercial loans secured by equipment or other collateral, the deterioration in value of which could increase our exposure to future probable losses.

 

As of December 31, 2016, approximately $213.1 million, or approximately 26.3% of our total loans held for investment, was comprised of commercial loans to businesses collateralized by general business assets including, among other things, accounts receivable, inventory and equipment. These commercial and industrial loans are typically larger in amount than loans to individual consumers and, therefore, have the potential for larger losses on an individual loan basis. Additionally, asset-based borrowers are often highly leveraged and have inconsistent historical earnings. Significant adverse changes in various industries could cause rapid declines in values and collectability associated with those business assets resulting in inadequate collateral coverage that may expose us to future losses. An increase in specific reserves and charge-offs related to our commercial and industrial loan portfolio could have a material adverse effect on our business, financial condition and results of operations.

 

The small to medium-sized businesses that we lend to may have fewer resources to weather adverse business developments, which may impair a borrowers ability to repay a loan, and such impairment could have a material adverse effect on our business, financial condition and results of operations.

 

We focus our business development and marketing strategy primarily on small to medium-sized businesses. Small to medium-sized businesses frequently have smaller market shares than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete, and may experience substantial volatility in operating results, any of which may impair a borrower’s ability to repay a loan. In addition, the success of a small and medium-sized business often depends on the management skills, talents and efforts of one or two people or a small group of people, and the death, disability or resignation of one or more of these people could have a material adverse impact on the business and its ability to repay its loan. If general economic conditions negatively impact the markets in which we operate and small to medium-sized businesses are adversely affected or our borrowers are otherwise harmed by adverse business developments, this, in turn, could have a material adverse effect on our business, financial condition and results of operations.

 

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Because a significant portion of our loan portfolio is comprised of real estate loans, negative changes in the economy affecting real estate values and liquidity could impair the value of collateral securing our real estate loans and result in loan and other losses.

 

As of December 31, 2016, $553.5 million, or 68.3% of our total loans held for investment, was comprised of loans with real estate as a primary or secondary component of collateral. As a result, adverse developments affecting real estate values in the state of Louisiana could increase the credit risk associated with our real estate loan portfolio. Real estate values in many Louisiana markets have experienced periods of fluctuation over the last five years. The market value of real estate can fluctuate significantly in a short period of time. Adverse changes affecting real estate values and the liquidity of real estate in one or more of our banking markets could increase the credit risk associated with our loan portfolio, and could result in losses that adversely affect credit quality, financial condition, and results of operations. Negative changes in the economy affecting real estate values and liquidity in our market areas could significantly impair the value of property pledged as collateral on loans and affect our ability to sell the collateral upon foreclosure without a loss or additional losses. Collateral may have to be sold for less than the outstanding balance of the loan, which could result in losses on such loans. Such declines and losses could have an adverse effect on our business, financial condition and results of operations. If real estate values decline, it is also more likely that we would be required to increase our allowance for loan losses, which could have a material adverse effect on our business, financial condition and results of operations.

 

Our commercial real estate portfolio exposes us to credit risks that could be greater than the risks related to other types of loans.

 

As of December 31, 2016, approximately $424.4 million, or 52.3% of our loan portfolio is secured by commercial real estate. Commercial real estate loans typically involve repayment dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service. The availability of such income for repayment may be adversely affected by changes in the economy or local market conditions. These loans expose a lender to greater credit risk than loans secured by other types of collateral because the collateral securing these loans is typically more difficult to liquidate due to the fluctuation of real estate values. Additionally, non-owner occupied commercial real estate loans generally involve relatively large balances to single borrowers or related groups of borrowers. Unexpected deterioration in the credit quality of our non-owner occupied commercial real estate loan portfolio could require us to increase our allowance for loan losses, which would reduce our profitability and could have a material adverse effect on our business, financial condition and results of operations.

 

Our business concentration in the State of Louisiana imposes risks and may magnify the consequences of any regional or local economic downturn affecting Louisiana, including any downturn in the real estate sector.

 

We conduct our operations exclusively in the State of Louisiana. As of December 31, 2016, the substantial majority of the loans in our loan portfolio were made to borrowers who live and/or conduct business in Louisiana and the substantial majority of our secured loans were secured by collateral located in the State of Louisiana. Accordingly, we are exposed to risks associated with a lack of geographic diversification. The economic conditions in Louisiana are highly dependent on the real estate sector as well as the technology, financial services, insurance, transportation, manufacturing and energy sectors. Any downturn or adverse development in these sectors, particularly the real estate and energy sectors in Louisiana, could have a material adverse impact on our business, financial condition and results of operations, and future prospects. Any adverse economic developments, among other things, could negatively affect the volume of loan originations, increase the level of nonperforming assets, increase the rate of foreclosure losses on loans, and reduce the value of our loans. Any regional or local economic downturn that affects Louisiana, our existing or prospective borrowers, or property values in our market area may affect us and our profitability more significantly and more adversely than our competitors whose operations are less geographically focused.

 

Our portfolio contains many large loans, and deterioration in the financial condition of these large loans could have a material adverse impact on our asset quality.

 

Our growth over the past several years has been partially attributable to our ability to originate and retain relatively large loans given our asset size. As of December 31, 2016, our average loan size was approximately $329,000. Further, as of December 31, 2016, our 20 largest borrowing relationships ranged from approximately $9.0 million to $17.6 million (including unfunded commitments) and averaged approximately $11.9 million in total commitments and $8.5 million in principal balance, respectively. Along with other risks inherent in our loans, such as the deterioration of the underlying businesses or property securing these loans, the higher average size of our loans presents a risk to our lending operations. Because we have a large average loan size, if only a few of our largest borrowers become unable to repay their loan obligations as a result of economic or market conditions or personal circumstances, our nonperforming loans and our provision for loan losses could increase significantly, which could have a material adverse effect on our business, financial condition and results of operations.

 

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Our lending limit may restrict our growth and prevent us from effectively implementing our business strategy.

 

We are limited in the amount we can loan to a single borrower by the amount of our capital. Generally, under applicable Louisiana law, we may lend up to 20% of our capital stock and surplus to any one borrower on an unsecured basis and up to 50% of our capital stock and surplus on a secured basis, when aggregated with all unsecured loans to such borrower. Based upon our current capital levels, the amount we may lend is significantly less than that of many of our competitors and may discourage potential borrowers who have credit needs in excess of our lending limit from doing business with us. We accommodate larger loans by selling participations in those loans to other financial institutions, but this strategy may not always be available. If we are unable to compete effectively for loans from our target customers, we may not be able to effectively implement our business strategy, which could have a material adverse effect on our business, financial condition and results of operations.

 

New lines of business or new products and services may subject us to additional risks.

 

From time to time, we may start-up or acquire new lines of business or offer new products and services within existing lines of business. There may be substantial risks and uncertainties associated with these endeavors. In developing and marketing new lines of business and/or new products or services, we may invest significant time and resources. Initial timelines for the introduction and development of new lines of business and/or new products or services may not be achieved, and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on our business, financial condition and results of operations.

 

A lack of liquidity could impair our ability to fund operations, which could have a material adverse effect on our business, financial condition and results of operations.

 

Liquidity is essential to our operations. We rely upon our ability to generate deposits and effectively manage the repayment and maturity schedules of our loans and investment securities, respectively, to ensure we have adequate liquidity to fund our operations. An inability to raise funds through deposits, borrowings, the sale of our investment securities, the sale of loans, and other sources could have a substantial negative effect on our liquidity. Our most important source of funds is deposits. Deposit balances can decrease when customers perceive alternative investments as providing a better risk/return tradeoff. If customers move money out of bank deposits and into other investments such as money market funds, we would lose a relatively low-cost source of funds, increasing our funding costs and reducing our net interest income and net income.

 

Other primary sources of funds for us consist of cash flows from operations, and maturities and sales of investment securities. Additional liquidity is provided by our ability to borrow from the Federal Reserve Bank of Atlanta and the Federal Home Loan Bank of Dallas (“FHLB”). We also may borrow funds from third-party lenders, such as other financial institutions. Our access to funding sources in amounts adequate to finance or capitalize our activities, or on terms that are acceptable to us, could be impaired by factors that affect us directly or the financial services industry or economy in general, such as disruptions in the financial markets or negative views and expectations about the prospects for the financial services industry. Our access to funding sources could also be affected by a decrease in the level of our business activity as a result of a downturn in the economy in our primary market area or by one or more adverse regulatory actions against us.

 

Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, or to fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on our liquidity and could, in turn, have a material adverse effect on our business, financial condition and results of operations.

 

We may face risks with respect to future acquisitions.

 

When we attempt to expand our business in Louisiana or other states through mergers and acquisitions, we seek targets with a similar culture, have experienced management, and possess either significant market presence or have potential for improved profitability through economies of scale or expanded services. Merger and acquisition activity involves various risks, in addition to the general risks associated with our growth plans, including, among other things:

 

 

the time and costs associated with identifying and evaluating potential acquisition and merger targets;

 

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inaccuracies in the judgments and estimates used to evaluate the credit, operations, management and market risks associated with the target institution;

 

our ability to finance an acquisition and possible dilution to our existing shareholders;

 

the diversion of management’s attention to the negotiation of a transaction; and

 

risks associated with integrating the operations and personnel of the target in a manner that enables growth opportunities and does not significantly disrupt existing customer relationships or cause us to lose customers.

 

With respect to the integration of a target institution, it is possible that the business combination could ultimately result in the loss of key employees or disruption of our ongoing business or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with customers and employees or to achieve the expected benefits of the acquisition. As with any merger of banking institutions, there also may be business disruptions that cause us to lose customers or cause customers to take their deposits out of our Bank. The continued success of our combined company will depend in large part on our ability to continue to integrate the two businesses, business models and cultures. If we are not able to fully integrate our operations or if we are unable to do so in a timely manner, the expected benefits of the merger may not be realized.

 

We expect to continue to evaluate merger and acquisition opportunities that are presented to us and conduct due diligence activities related to possible transactions with other financial institutions. As a result, merger or acquisition discussions and, in some cases, negotiations may take place and future mergers or acquisitions involving cash, debt or equity securities may occur at any time. Failure to realize the expected revenue growth, cost savings, increases in geographic or product presence, and/or other projected benefits from an acquisition could have a material adverse effect on our business, financial condition and results of operations.

 

We may need to raise additional capital in the future, and if we fail to maintain sufficient capital, we may not be able to maintain regulatory compliance, which could have a material adverse effect on our business, financial condition and results of operations.

 

We face significant capital and other regulatory requirements as a financial institution. We may need to raise additional capital in the future to provide us with sufficient capital resources and liquidity to meet our commitments and business needs, which could include the possibility of financing acquisitions. In addition, we, on a consolidated basis, and Business First Bank, on a stand-alone basis, must meet certain regulatory capital requirements and maintain sufficient liquidity. Importantly, regulatory capital requirements could increase from current levels, which could require us to raise additional capital or downsize our operations. Our ability to raise additional capital depends on conditions in the capital markets, economic conditions and a number of other factors, including investor perceptions regarding the banking industry, market conditions and governmental activities, and upon our financial condition and performance. Accordingly, we may not be able to raise additional capital if needed or on terms acceptable to us. If we fail to maintain capital to meet regulatory requirements, we could be subject to enforcement actions, which could have a material adverse effect on our business, financial condition and results of operations.

 

Interest rate shifts could reduce net interest income and otherwise have a material adverse effect on our financial condition and results of operations.

 

The majority of our banking assets are monetary in nature and subject to risk from changes in interest rates. Like most financial institutions, our earnings and cash flows depend to a great extent upon the level of our net interest income, or the difference between the interest income we earn on loans, investments and other interest-earning assets, and the interest we pay on interest-bearing liabilities, such as deposits and borrowings. Changes in interest rates can increase or decrease our net interest income, because different types of assets and liabilities may react differently, and at different times, to market interest rate changes. When interest-bearing liabilities mature or reprice more quickly, or to a greater degree than interest-earning assets in a period, an increase in interest rates could reduce net interest income. Similarly, when interest-earning assets mature or reprice more quickly, or to a greater degree than interest-bearing liabilities, falling interest rates could reduce net interest income. As of December 31, 2016, 31.4% of our earning assets and 49.5% of our interest-bearing liabilities are variable rate. Our interest sensitivity profile was asset sensitive as of December 31, 2016, meaning that we estimate our net interest income would increase more from rising interest rates than from falling interest rates.

 

Interest rate increases often result in larger payment requirements for our borrowers, which increases the potential for default and could result in a decrease in the demand for loans. At the same time, the marketability of the property securing a loan may be adversely affected by any reduced demand resulting from higher interest rates. In a declining interest rate environment, there may be an increase in prepayments on loans as borrowers refinance their loans at lower rates. In addition, in a low interest rate environment, loan customers often pursue long-term fixed rate credits, which could adversely affect our earnings and net interest margin if rates increase. Changes in interest rates also can affect the value of loans, securities and other assets. An increase in interest rates that adversely affects the ability of borrowers to pay the principal or interest on loans may lead to an increase in nonperforming assets and a reduction of income recognized, which could have an adverse effect on our results of operations and cash flows. Further, when we place a loan on nonaccrual status, we reverse any accrued but unpaid interest receivable, which decreases interest income. At the same time, we continue to have a cost to fund the loan, which is reflected as interest expense, without any interest income to offset the associated funding expense. Thus, an increase in the amount of nonperforming assets would have an adverse impact on net interest income. Although our asset-liability management strategy is designed to control and mitigate exposure to the risks related to changes in market interest rates, those rates are affected by many factors outside of our control, including governmental monetary policies, inflation, deflation, recession, changes in unemployment, the money supply, international disorder and instability in domestic and foreign financial markets.

 

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We face significant competitive pressures that could impair our growth, decrease our profitability or reduce our market share.

 

We operate in the highly competitive banking industry and face significant competition for customers from bank and non-bank competitors, particularly regional and nationwide institutions, in originating loans, attracting deposits and providing other financial services. Our competitors are generally larger and may have significantly more resources, greater name recognition, and more extensive and established branch networks or geographic footprints than us. Because of their scale, many of these competitors can be more aggressive than we can on loan and deposit pricing. Also, many of our non-bank competitors have fewer regulatory constraints and may have lower cost structures. We expect competition to continue to intensify due to financial institution consolidation; legislative, regulatory and technological changes; and the emergence of alternative banking sources.

 

Our ability to compete successfully will depend on a number of factors, including, among other things:

 

 

our ability to develop, maintain and build long-term customer relationships based on top quality service, high ethical standards and safe, sound assets;

 

 

our scope, relevance and pricing of products and services offered to meet customer needs and demands;

 

 

the rate at which we introduce new products and services relative to our competitors;

 

 

customer satisfaction with our level of service;

 

 

our ability to expand our market position;

 

 

industry and general economic trends; and

 

 

our ability to keep pace with technological advances and to invest in new technology.

 

Increased competition could require us to increase the rates we pay on deposits or lower the rates we offer on loans, which could reduce our profitability. Our failure to compete effectively in our primary markets could cause us to lose market share and could have a material adverse effect on our business, financial condition and results of operations.

 

Our ability to maintain our reputation is critical to the success of our business.

 

Our business plan emphasizes relationship banking. We have benefitted from strong relationships with and among our customers. As a result, we consider our reputation to be one of the most valuable components of our business.

 

Our growth over the past several years has depended on attracting new customers from competing financial institutions and increasing our market share, primarily through involvement in our primary markets and word-of-mouth advertising, rather than on growth in the market for banking services in our primary markets. As such, we strive to enhance our reputation by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve and delivering superior service to our customers. If our reputation is negatively affected by the actions of our employees or otherwise, our existing relationships may be damaged. We could lose some of our existing customers, and we may not be successful in attracting new customers. Any of these developments could have a material adverse effect on our business, financial condition and results of operations.

 

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The fair value of our investment securities can fluctuate due to factors outside of our control.

 

As of December 31, 2016, the fair value of our investment securities portfolio was approximately $198.3 million, which included a net unrealized loss of approximately $3.5 million. Factors beyond our control can significantly influence the fair value of securities in our portfolio and can cause potential adverse changes to the fair value of these securities. These factors include, but are not limited to, rating agency actions in respect of the securities, defaults by the issuer or with respect to the underlying securities, and changes in market interest rates and continued instability in the capital markets. Any of these factors, among others, could cause other-than-temporary impairments and realized or unrealized losses in future periods and declines in other income, which could have a material adverse effect on our business, results of operations, financial condition and future prospects. The process for determining whether impairment of a security is other-than-temporary often requires complex, subjective judgments about whether there has been a significant deterioration in the financial condition of the issuer, whether management has the intent or ability to hold a security for a period of time sufficient to allow for any anticipated recovery in fair value, the future financial performance and liquidity of the issuer and any collateral underlying the security, and other relevant factors.

 

If we fail to maintain an effective system of disclosure controls and procedures and internal controls over financial reporting, we may not be able to accurately report our financial results or prevent fraud.

 

Ensuring that we have adequate disclosure controls and procedures, including internal controls over financial reporting, in place so we can produce accurate financial statements on a timely basis is costly and time-consuming and needs to be reevaluated frequently. As a public company, we are subject to the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”), which require annual management assessments of the effectiveness of our internal controls over financial reporting and, when we cease to be an emerging growth company under the JOBS Act, will require a report by our independent auditors addressing these assessments. Our management may conclude that our internal controls over financial reporting are not effective due to our failure to cure any identified material weakness or otherwise. Moreover, even if our management concludes that our internal controls over financial reporting are effective, our independent registered public accounting firm may not conclude that our internal controls over financial reporting are effective. In the future, our independent registered public accounting firm may not be satisfied with our internal controls over financial reporting or the level at which our controls are documented, designed, operated or reviewed, or we and our accounting firm may have differences in opinion regarding the applicable requirements. In addition, during the course of the evaluation, documentation and testing of our internal controls over financial reporting, we may identify deficiencies that we may not be able to remediate in time to meet the deadline imposed by the Securities and Exchange Commission (“SEC”), for compliance with the requirements of Section 404 of the Sarbanes-Oxley Act. Any such deficiencies may also subject us to adverse regulatory consequences. If we fail to achieve and maintain the adequacy of our internal controls over financial reporting, as these standards are modified, supplemented or amended from time to time, we may be unable to report our financial information on a timely basis, we may not be able to conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with the Sarbanes-Oxley Act, and we may suffer adverse regulatory consequences. There could also be a decline in investor confidence as to the reliability our financial statements, which could result in a decline in the value of our capital stock.

 

Our financial results depend on managements selection of accounting methods and certain assumptions and estimates.

 

Our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with Generally Accounting Principles Accepted in the United States, (“GAAP”), and with general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of certain assets and liabilities, disclosure of contingent assets and liabilities and the reported amount of related revenues and expenses. Certain accounting policies inherently are based to a greater extent on estimates, assumptions and judgments of management and, as such, have a greater possibility of producing results that could be materially different than originally reported. They require management to make subjective or complex judgments, estimates or assumptions, and changes in those estimates or assumptions could have a significant impact on our consolidated financial statements. These critical accounting policies include the allowance for loan losses, accounting for income taxes, the determination of fair value for financial instruments and accounting for stock-based compensation. Because of the uncertainty of estimates involved in these matters, we may be required to significantly increase our allowance for loan losses or sustain loan losses that are significantly higher than the reserve provided, significantly increase our accrued tax liability or otherwise incur charges that could have a material adverse effect on our business, financial condition and results of operations.

 

From time to time, the Financial Accounting Standards Board (“FASB”) and the Securities and Exchange Commission (“SEC”) change the financial accounting and reporting standards or the interpretation of such standards that govern the preparation of our consolidated financial statements which could affect our critical accounting policies and the estimates and assumptions made by management. These changes are beyond our control, can be difficult to predict, and could materially impact how we report our financial condition and results of operations.

 

We have a continuing need for technological change, and we may not have the resources to effectively implement new technology, or we may experience operational challenges when implementing new technology.

 

The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, at least in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations as we continue to grow and expand our products and service offerings. We may experience operational challenges as we implement these new technology enhancements or products, which could result in our not fully realizing the anticipated benefits from such new technology or require us to incur significant costs to remedy any such challenges in a timely manner.

 

23

 

 

Many of our larger competitors have substantially greater resources to invest in technological improvements. As a result, they may be able to offer additional or superior products compared to those that we will be able to provide, which would put us at a competitive disadvantage. Accordingly, we may lose customers seeking new technology-driven products and services to the extent we are unable to provide such products and services.

 

We rely on third parties to provide key components of our business infrastructure, and a failure of these parties to perform for any reason could disrupt our operations.

 

Third parties provide key components of our operational infrastructure such as data processing, internet connections, network access, core application processing, statement production and account analysis. Our operations depend on the successful and uninterrupted functioning of our information technology and telecommunications systems and third-party servicers. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. Replacing vendors or addressing other issues with our third-party service providers could entail significant delay and expense. If we are unable to efficiently replace ineffective service providers, or if we experience a significant, sustained or repeated system failure or service denial, it could compromise our ability to operate effectively, damage our reputation, result in a loss of customer business, and subject us to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on our business, financial condition and results of operations.

 

We could be subject to losses, regulatory action or reputational harm due to fraudulent and negligent acts on the part of loan applicants, our employees and vendors.

 

In deciding whether to extend credit or enter into other transactions with customers and counterparties, we may rely on information furnished by or on behalf of clients and counterparties, including financial statements, property appraisals, title information, employment and income documentation, account information and other financial information. We may also rely on representations of customers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. Any such misrepresentation or incorrect or incomplete information may not be detected prior to funding. In addition, one or more of our employees or vendors could cause a significant operational breakdown or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates our loan documentation, operations or systems. Any of these developments could have a material adverse effect on our business, financial condition and results of operations.

 

Unauthorized access, cyber-crime and other threats to data security may require significant resources, harm our reputation, and otherwise have a material adverse effect on our business, financial condition and results of operations.

 

We necessarily collect, use and hold personal and financial information concerning individuals and businesses with which we have a banking relationship. Threats to data security, including unauthorized access, and cyber-attacks, rapidly emerge and change, exposing us to additional costs for protection or remediation and competing time constraints to secure our data in accordance with customer expectations and statutory and regulatory privacy and other requirements. It is difficult or impossible to defend against every risk being posed by changing technologies, as well as criminal intent on committing cyber-crime. Increasing sophistication of cyber-criminals and terrorists make keeping up with new threats difficult and could result in a breach. Controls employed by our information technology department and our other employees and vendors could prove inadequate. We could also experience a breach due to intentional or negligent conduct on the part of employees or other internal sources, software bugs or other technical malfunctions, or other causes. As a result of any of these threats, our customer accounts may become vulnerable to account takeover schemes or cyber-fraud. Our systems and those of our third-party vendors may also become vulnerable to damage or disruption due to circumstances beyond our or their control, such as from catastrophic events, power anomalies or outages, natural disasters, network failures, and viruses and malware.

 

A breach of our security that results in unauthorized access to our data could expose us to a disruption or challenges relating to our daily operations as well as to data loss, litigation, damages, fines and penalties, significant increases in compliance costs, and reputational damage, any of which could have a material adverse effect on our business, results of operations, financial condition and future prospects.

 

24

 

 

The market in which we operate is susceptible to hurricanes and other natural disasters and adverse weather which could result in a disruption of our operations and increases in loan losses.

 

A significant portion of our business is generated from markets that have, and may continue to be, damaged by major hurricanes, floods, tropical storms and other natural disasters and adverse weather. Natural disasters can disrupt our operations, cause widespread property damage, and severely depress the local economies in which we operate. If the economies in our primary markets experience an overall decline as a result of a natural disaster, adverse weather, or other disaster, demand for loans and our other products and services could be reduced. In addition, the rates of delinquencies, foreclosures, bankruptcies and losses on loan portfolios may increase substantially, as uninsured property losses or sustained job interruption or loss may materially impair the ability of borrowers to repay their loans. Moreover, the value of real estate or other collateral that secures the loans could be materially and adversely affected by such a disaster. Such a disaster could, therefore, result in decreased revenue and loan losses that could have a material adverse effect on our business, financial condition and results of operations.

 

If the goodwill that we recorded in connection with the AGFC merger, or if goodwill that we record in connection with future business acquisitions becomes impaired, it could require charges to earnings, which could have a material adverse effect on our business, financial condition and results of operations.

 

Goodwill represents the amount by which the cost of an acquisition exceeded the fair value of net assets we acquired in connection with the purchase of another financial institution. We review goodwill for impairment at least annually, or more frequently if a triggering event occurs which indicates that the carrying value of the asset might be impaired. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss must be recognized in an amount equal to that excess. Any such adjustments are reflected in our results of operations in the periods in which they become known. There can be no assurance that our future evaluations of our existing goodwill or goodwill we may acquire in the future will not result in findings of impairment and related write-downs, which could have a material adverse effect on our business, financial condition and results of operations.

 

We are subject to environmental liability risk associated with our lending activities.

 

In the course of our business, we may purchase real estate, or we may foreclose on and take title to real estate. As a result, we could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or we may be required to investigate or clean up hazardous or toxic substances or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. Any significant environmental liabilities could cause a material adverse effect on our business, financial condition and results of operations.

 

Risks Associated with our Common Stock

 

Our stock is not listed or traded on any established securities market and is less liquid than most securities traded in those markets.

 

Our stock is not listed or traded on any established securities exchange or market and we have no plans to seek to list our stock on any recognized exchange or qualify it for trading in any market. Accordingly, our stock has substantially fewer trades than the average securities listed on any national securities exchange. Most transactions in our stock are privately negotiated trades and our stock is very thinly traded. There is no dealer for our stock and no “market maker.” Our shares do not have a trading symbol. The lack of a liquid market can produce downward pressure on our stock price and can reduce the marketability of our stock.

 

The obligations associated with being a public company require significant resources and management attention.

 

As a company with stock registered with the SEC, we face increased legal, accounting, administrative and other costs and expenses that we did not previously incur as a private company. These costs will increase after we are no longer an emerging growth company. We are subject to the reporting requirements of the Exchange Act, which require that we file annual, quarterly and current reports with respect to our business and financial condition and proxy and other information statements, and the rules and regulations implemented by the SEC, the Sarbanes-Oxley Act, and the Dodd-Frank Act, each of which imposes additional reporting and other obligations on public companies.

 

25

 

 

We expect these rules and regulations, and changes in these laws, regulations and standards relating to corporate governance and public disclosure, which have created uncertainty for public companies, to increase legal and financial compliance costs and make some activities more time consuming and costly. These laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. Our investment in compliance with existing and evolving regulatory requirements will result in increased administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities, which could have a material adverse effect on our business, financial condition and results of operations. These increased costs could require us to divert a significant amount of money that we could otherwise use to expand our business and achieve our strategic objectives.

 

The rights of our common shareholders are subordinate to the rights of any debt that we may issue and may be subordinate to the holders of any other class of preferred stock that we may issue in the future.

 

Our board of directors has the authority to issue debt, or an aggregate of up to 1,000,000 shares of preferred stock, on the terms it determines without shareholder approval. Accordingly, you should assume that any shares of preferred stock that we may issue in the future will be senior to our common stock. Because our decision to issue debt or equity, or to incur other borrowings in the future will depend on market conditions and other factors beyond our control, the amount, timing, nature or success of our future capital raising efforts is uncertain. Thus, common shareholders bear the risk that our future issuances of debt or equity securities or our incurrence of other borrowings will negatively affect the market price of our common stock.

 

We are an emerging growth company, and the reduced reporting requirements applicable to emerging growth companies may make our common stock less attractive to investors.

 

We are an “emerging growth company,” as defined in the JOBS Act. For as long as we continue to be an emerging growth company we are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies.” These include, without limitation, exemption from the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, reduced financial reporting requirements, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a non-binding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved.

 

We could be an emerging growth company for up to five years following the February 2015 registration of our common stock, but we could lose that status sooner if our gross revenues exceed $1.0 billion, if we issue more than $1.0 billion in non-convertible debt in a three year period, or if the market value of our common stock held by non-affiliates exceeds $700.0 million as of any June 30 before that time, in which case we would no longer be an emerging growth company as of the following December 31. Investors may find our common stock less attractive if we rely on the exemptions, which may decrease the price at which our shareholders may be able to sell their shares.

 

We are dependent upon Business First Bank for cash flow, and the Banks ability to make cash distributions is subject to regulatory and legal restrictions which could impact our ability to satisfy our obligations.

 

Our primary asset is Business First Bank. As such, we depend upon Business First Bank for cash distributions through dividends on its stock to pay our operating expenses and satisfy our obligations, including debt obligations. There are numerous laws and banking regulations that limit Business First Bank’s ability to pay dividends to us. If Business First Bank is unable to pay dividends to us, we will not be able to satisfy our obligations. Federal and state statutes and regulations restrict the Bank’s ability to make cash distributions to us. These statutes and regulations require, among other things, that Business First Bank maintain certain levels of capital in order to pay a dividend. Further, federal and state banking authorities have the ability to restrict the Bank’s payment of dividends through supervisory action.

 

Our dividend policy may change without notice, and our future ability to pay dividends is subject to regulatory limitations.

 

In 2016, our board of directors made the decision to commence payment of regular quarterly dividends; however, there can be no guarantee that we will pay dividends at any time in the future. All future determinations relating to dividend policy will be made at the discretion of our board of directors and will depend on a number of factors, including earnings and financial condition, liquidity and capital requirements, the general economic and regulatory climate, ability to service any equity or debt obligations senior to our common stock and other factors deemed relevant by the board of directors. In addition, as a bank holding company, we are subject to general regulatory restrictions on the payment of cash dividends. Federal bank regulatory agencies have the authority to prohibit bank holding companies from engaging in unsafe or unsound practices in conducting their business, which depending on the financial condition and liquidity of the holding company at the time, could include the payment of dividends.

 

26

 

 

Our corporate governance documents and certain corporate and banking laws applicable to us could make a takeover more difficult.

 

Certain provisions of our articles of incorporation, bylaws and corporate and federal banking laws, could make it more difficult for a third party to acquire control of our organization or conduct a proxy contest, even if those events were perceived by many of our shareholders as beneficial to their interests. These provisions, and the corporate and banking laws and regulations applicable to us:

 

 

empower our board of directors, without shareholder approval, to issue preferred stock, the terms of which, including voting power, are set by our board of directors;

 

 

do not provide for cumulative voting in elections of directors; and

 

 

require prior regulatory application and approval of any transaction involving control of our organization.

 

These provisions may discourage potential acquisition proposals and could delay or prevent a change in control of Business First, including under circumstances in which our shareholders might otherwise receive a premium over the market price of our shares.

 

An investment in Business Firsts common stock is not an insured deposit and is subject to risk of loss.

 

Your investment in our common stock is not a bank deposit and is not insured or guaranteed by the FDIC or any other government agency. Your investment is subject to investment risk, and you must be capable of affording the loss of your entire investment.

 

Risks Relating to the Regulation of our Industry

 

We operate in a highly regulated environment, which could restrain our growth and profitability.

 

We are subject to extensive regulation and supervision that governs almost all aspects of our operations. These laws and regulations, and the supervisory framework that oversees the administration of these laws and regulations, are primarily intended to protect consumers, depositors, the Deposit Insurance Fund and the banking system as a whole, and not shareholders and counterparties. These laws and regulations, among other matters, affect our lending practices, capital structure, investment practices, dividend policy, operations and growth. Compliance with the myriad laws and regulations applicable to our organization can be difficult and costly. In addition, these laws, regulations and policies are subject to continual review by governmental authorities, and changes to these laws, regulations and policies, including changes in interpretation or implementation of these laws, regulations and policies, could affect us in substantial and unpredictable ways and often impose additional compliance costs. Further, any new laws, rules and regulations, such as the Dodd-Frank Act, could make compliance more difficult or expensive. All of these laws and regulations, and the supervisory framework applicable to our industry, could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Federal and state regulators periodically examine our business, and we may be required to remediate adverse examination findings.

 

The Federal Reserve, the FDIC and the Louisiana OFI periodically examine various aspects our business, including our compliance with laws and regulations. If, as a result of an examination, our regulators were to determine that our financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of any of our operations had become unsatisfactory, or that we were in violation of any law or regulation, our regulators may take a number of different remedial actions as they deem appropriate. These actions include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital, to restrict our growth, to assess civil monetary penalties against our officers or directors, to remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate our deposit insurance and place us into receivership or conservatorship. Any regulatory action against us could have a material adverse effect on our business, results of operations, financial condition and prospects.

 

27

 

 

Our FDIC deposit insurance premiums and assessments may increase.

 

Our deposits are insured by the FDIC up to legal limits and, accordingly, we are subject to FDIC deposit insurance assessments. Our regular assessments are determined by our risk classification, which is based on our regulatory capital levels and the level of supervisory concern that we pose. High levels of bank failures since the beginning of the financial crisis and increases in the statutory deposit insurance limits have increased resolution costs to the FDIC and put significant pressure on the Deposit Insurance Fund. In order to maintain a strong funding position and restore the reserve ratios of the Deposit Insurance Fund, the FDIC has increased deposit insurance assessment rates and charged special assessments to all FDIC-insured financial institutions. Further increases in assessment rates or special assessments may occur in the future, especially if there are significant additional financial institution failures. Any future special assessments, increases in assessment rates or required prepayments in FDIC insurance premiums could reduce our profitability or limit our ability to pursue certain business opportunities, which could materially and adversely affect our business, financial condition, results of operations and prospects.

 

We are subject to numerous laws designed to protect consumers, including the Community Reinvestment Act and fair lending laws, and failure to comply with these laws could lead to a wide variety of sanctions.

 

The Community Reinvestment Act, the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations impose nondiscriminatory lending requirements on financial institutions. The Department of Justice and other federal agencies are responsible for enforcing these laws and regulations. A successful regulatory challenge to an institution’s performance under the Community Reinvestment Act or fair lending laws and regulations could result in a wide variety of sanctions, including damages and civil money penalties, injunctive relief, restrictions on mergers and acquisitions activity, restrictions on expansion, and restrictions on entering new business lines. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. Such actions could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations.

 

The Bank Secrecy Act, the USA PATRIOT Act of 2001, and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and file suspicious activity and currency transaction reports as appropriate. The federal Financial Crimes Enforcement Network is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration, and Internal Revenue Service. We are also subject to increased scrutiny of compliance with the rules enforced by the Office of Foreign Assets Control. If our policies, procedures and systems are deemed deficient, we would be subject to liability, including fines and regulatory actions, which may include restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, including our acquisition plans. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us. Any of these results could materially and adversely affect our business, financial condition, results of operations and prospects.

 

ITEM 1B. Unresolved Staff Comments.

 

Not applicable.

 

28

 

 

ITEM 2. Properties.

 

Our current principal offices are located at 500 Laurel Street, Baton Rouge, Louisiana. We relocated our corporate headquarters to downtown Baton Rouge, Louisiana in July 2016. All of our banking offices are located in the State of Louisiana. The following table provides information about all of our banking locations. We believe that our facilities are adequately covered by insurance and that these facilities are adequate to meet our needs.

 

 

Location

 

Date Opened

 

Own/ Lease

 

Square Footage

Principal Executive Office:

           

500 Laurel Street
Baton Rouge, Louisiana

 

7/11/2016

 

Lease

 

24,347

             

Banking Centers:

           

Northwest Louisiana Banking Center

800 Spring Street, Suite 120
Shreveport, Louisiana

 

8/28/2006

 

Lease

 

8,267

             

Northshore Banking Center

1675 N. Highway 190
Covington, Louisiana

 

10/18/2007

 

Lease

 

4,909

             

Lafayette Banking Center

CDT Plaza

900 East St. Mary Boulevard, Suite 100
Lafayette, Louisiana

 

5/22/2008

 

Lease

 

4,723

             

Southwest Louisiana Banking Center

728 Ryan Street
Lake Charles, Louisiana

 

3/9/2009

 

Lease

 

6,065

             

Bayou Region Banking Center

435 Corporate Drive, Suite 102
Houma, Louisiana

 

11/17/2010

 

Lease

 

2,800

             

Gonzales Banking Center
1821 West Highway 30

Gonzales, Louisiana

 

12/18/2008*

 

Own

 

3,360

             

Florida Boulevard Banking Center
4944 Florida Street

Baton Rouge, Louisiana

 

4/6/1992*

 

Own

 

2,167

             

Jefferson Highway Banking Center
7880 Jefferson Highway

Baton Rouge, Louisiana

 

12/7/2004*

 

Lease

 

2,330

             

Perkins Road Banking Center
10725 Perkins Road

Baton Rouge, Louisiana

 

6/9/2003*

 

Lease

 

4,000

             

Coursey Boulevard Banking Center
11307 Coursey Boulevard

Baton Rouge, Louisiana

 

11/18/2004*

 

Own

 

11,092

             

Zachary Banking Center
1858 Church Street

Zachary, Louisiana

 

12/10/2009*

 

Own

 

2,868

 

29

 

 

Location   Date Opened   Own/ Lease   Square Footage

Denham Springs Banking Center
31635 Louisiana Hwy. 16

Denham Springs, Louisiana

 

8/16/2005*

 

Own

 

3,682

             

Brusly Banking Center
729 South Vaughan Street

Brusly, Louisiana

 

3/26/1979*

 

Own

 

1,943

             

Erwinville Banking Center
4610 Poydras Bayou Rd.

Erwinville, Louisiana

 

1/26/1981*

 

Own

 

750

             

Port Allen Banking Center
320 North Alexander Ave

Port Allen, Louisiana

 

1/1/1905*

 

Own

 

21,444

             

New Orleans Loan Production Office
3838 N. Causeway Blvd

Metairie, Louisiana

 

9/1/2015

 

Lease

 

1,867

             

Wealth Solutions Office
602 Green Street

Thibodaux, Louisiana

 

11/1/2015

 

Lease

 

850

             

*Acquired in the merger transaction with AGFC, completed following the close of business on March 31, 2015.

 

ITEM 3. Legal Proceedings.

 

We and our subsidiaries are defendants in various lawsuits arising in the normal course of business. In the opinion of our management, the ultimate resolution of such matters should not have a material adverse effect on our consolidated financial condition or results of operations. Litigation is, however, inherently uncertain, and we cannot make assurances that we will prevail in any of these actions, nor can we estimate with reasonable certainty the amount of damages that we might incur.

 

ITEM 4. Mine Safety Disclosures.

 

Not applicable.

 

30

 

 

 

Part II

 

ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

There is no established public trading market for our common stock, and no market for our common stock is expected to develop. No registered broker/dealer makes a market in our common stock, and our common stock is not listed or quoted on any stock exchange or automated quotation system. American Stock Transfer & Trust Company, LLC acts as register and transfer agent for our shares of common stock.

 

From time to time, we become aware of trades of shares of our common stock. The following table sets forth the high and low sales prices (to the extent known to our management) for trades of our common stock and the cash dividends declared per share for the periods shown:

 

 

By Quarter 2016

 

 

High

   

 

Low

   

Cash Dividend

Per Share

 

First

  $ 15.00     $ 10.00     $  

Second

  $ 16.00     $ 16.00     $ 0.05  

Third

  $ 16.00     $ 9.00     $ 0.05  

Fourth

  $ 16.00     $ 13.75     $ 0.05  

 

 

By Quarter 2015

 

 

High

   

 

Low

   

Cash Dividend

Per Share

 

First

  $ N/A     $ N/A     $  

Second

  $ N/A     $ N/A     $  

Third

  $ 16.50     $ 15.75     $  

Fourth

  $ 16.00     $ 15.00     $  

 

Common Stock

 

As of March 10, 2017, there were 6,914,179 issued and outstanding shares of our common stock held of record by approximately 807 shareholders. In addition, we had outstanding warrants to purchase 87,625 shares of our common stock, which were issued to our organizers in connection with our organization. All outstanding warrants have an exercise price of $10.00 per share and effective February 1, 2016 were extended to expire on February 2, 2019.

 

Dividends

 

In 2016, our board of directors made the determination to begin paying regular quarterly dividends; however, we are not obligated to pay dividends. The payment of future dividends and our dividend policy will depend on our earnings, capital requirements and financial condition, as well as other factors that our board of directors deems relevant. For additional discussion of legal and regulatory restrictions on the payment of dividends, see “PART I - ITEM 1. Business – Supervision and Regulation.

 

Securities Authorized for Issuance under Equity Compensation Plans

 

In 2006, our board of directors adopted the 2006 Stock Option Plan pursuant to which we were permitted to issue stock options to purchase up to 1,500,000 shares of our common stock, all of which could be issued as either incentive stock options under Section 422A of the Internal Revenue Code of 1986, as amended, or non-qualified stock options. Although our 2006 Stock Option Plan expired on December 22, 2016 and we are no longer permitted to issue additional stock options under this plan, as of December 31, 2016, we had 998,480 outstanding and unexercised stock options that have been issued to our executive officers and key personnel and remain subject to the terms and conditions of the 2006 Stock Option Plan until they are exercised or forfeited.

 

31

 

 

The following table summarizes information as of December 31, 2016 relating to the number of securities to be issued upon the exercise of the outstanding options and warrants and their weighted-average exercise price.

 

   

Number of Securities to Be Issued Upon Exercise of Outstanding Options, Warrants and Rights

   

Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights

   

Number of Securities Remaining Available For Future Issuance Under Equity Compensation Plans

 

Equity compensations plans approved by security holders

    998,480     $ 12.82        

Equity compensation plans not approved by security holders

    87,625       10.00        

Total equity compensation plans

    1,086,105     $ 12.59        

 

 

Recent Sales of Unregistered Securities

 

We did not sell any equity securities that were not registered under the Securities Act of 1933 during 2016.

 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

On March 31, 2016, our board of directors approved a resolution authorizing management to repurchase a limited number of shares of our common stock prior to March 31, 2017. The authorization to repurchase shares through privately negotiated transactions in any calendar quarter is subject to a number of conditions and is limited to a number of shares having a maximum aggregate repurchase price equal to $1.0 million. Business First purchased 25,740 shares of our common stock under this delegated authority during the fourth quarter of 2016. In addition, on July 28, 2016, our board of directors authorized the repurchase of 100,000 shares of our common stock in order to facilitate a charitable contribution to the Baton Rouge Area Foundation by one of our shareholders. This transaction was consummated during the fourth quarter 2016. The equity securities repurchased during the fourth quarter 2016 are as follows:

 

 

 

 

 

 

 

Period

 

(a)

Total number of shares purchased

   

(b)

Average price paid per share

   

(c)

Total number of shares purchased as part of publicly announced plans or programs

   

(d)

Maximum number (or approximate dollar value) of shares that may yet be purchased under the plans or programs

 
Month #1:                                

October 1 through October 31, 2016

        $           $  
Month #2:                                

November 1 through November 30, 2016

    10,000     $ 13.75           $  
Month #3:                                

December 1 through December 31, 2016

    115,740     $ 15.01           $  

 

 

ITEM 6. Selected Financial Data.

 

As a smaller reporting company, we are not required to provide the information required by this Item.

 

32

 

 

ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

This discussion presents management’s analysis of our results of operations and financial condition over each of the last two most recent fiscal years. The discussion should be read in conjunction with our Financial Statements and the notes related thereto which appear elsewhere in this Report.

 

The following discussion and analysis is to focus on significant changes in the financial condition of Business First and its subsidiaries from December 31, 2015 to December 31, 2016 and its results of operations for the year ended December 31, 2016. This discussion and analysis is intended to highlight and supplement information presented elsewhere in this report, particularly the consolidated financial statements and related notes appearing in Item 8. This discussion and analysis contains forward-looking statements that are subject to certain risks and uncertainties and are based on certain assumptions that Business First believes are reasonable but may prove to be inaccurate. Certain risks, uncertainties and other factors, including those set forth under “Forward-Looking Statements,” “Risk Factors” and elsewhere in this statement, may cause actual results to differ materially from those projected results discussed in the forward-looking statements appearing in this discussion and analysis. Business First assumes no obligation to update any of these forward-looking statements.

 

Overview

 

We are a registered bank holding company headquartered in Baton Rouge, Louisiana. Through our wholly-owned subsidiary, Business First Bank, a Louisiana state chartered bank, we provide a broad range of financial services tailored to meet the needs of small to medium-sized businesses and professionals. Since our inception in 2006, our priority has been and continues to be creating shareholder value through the establishment of an attractive commercial banking franchise in Louisiana. We consider our primary market to include the State of Louisiana. We currently operate out of eighteen offices, including sixteen banking centers, one loan production office, and one wealth solutions office in eight markets across Louisiana. As of December 31, 2016, we had total assets of $1.1 billion, total loans of $811.1 million, total deposits of $932.8 million, and total stockholders’ equity of $113.6 million.

 

After the close of business on March 31, 2015, we merged with American Gateway Financial Corporation (AGFC), parent bank holding company for American Gateway Bank, pursuant to which the operations of AGFC were merged with us. Our financial condition and results of operations as of and for the year ended December 31, 2015 were impacted as a result of this merger, as 10 former American Gateway branches were added to our branch network. Total assets acquired were $372.0 million, which included loans of $143.2 million, investment securities of $108.4 million, and deposits of $283.3 million. Shareholders of AGFC received merger consideration of $10 in cash and 11.88 shares of our common stock in exchange for each share of AGFC common stock. See Note 3 to the Audited Consolidated Financial Statements for additional information regarding this merger.

 

As a bank holding company operating through one market segment, community banking, we generate most of our revenues from interest income on loans, customer service and loan fees, and interest income from securities. We incur interest expense on deposits and other borrowed funds and noninterest expense, such as salaries and employee benefits and occupancy expenses. We analyze our ability to maximize income generated from interest earning assets and expense of our liabilities through our net interest margin. Net interest margin is a ratio calculated as net interest income divided by average interest-earning assets. Net interest income is the difference between interest income on interest-earning assets, such as loans and securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings, which are used to fund those assets.

 

Changes in the market interest rates and the interest rates we earn on interest-earning assets or pay on interest-bearing liabilities, as well as the volume and types of interest-earning assets, interest-bearing and noninterest-bearing liabilities and stockholders’ equity, are usually the largest drivers of periodic changes in net interest spread, net interest margin and net interest income. Fluctuations in market interest rates are driven by many factors, including governmental monetary policies, inflation, deflation, macroeconomic developments, changes in unemployment, the money supply, political and international conditions, and conditions in domestic and foreign financial markets. Periodic changes in the volume and types of loans in our loan portfolio are affected by, among other factors, economic and competitive conditions in Louisiana, as well as developments affecting the real estate, technology, financial services, insurance, transportation, manufacturing and energy sectors within our target market and throughout the state of Louisiana.

 

 

Financial Highlights

 

The financial highlights for the year ended December 31, 2016 include:

 

 

Total assets of $1.1 billion, a $29.8 million or 2.8% increase from December 31, 2015.

 

 

Total loans of $811.1 million, a $38.7 million or 5.0% increase from December 31, 2015.

 

 

Total deposits of $932.8 million, a $28.6 million or 3.2% increase from December 31, 2015.

 

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Net income for the year ended December 31, 2016 of $5.1 million, a $1.0 million or 24.8% increase from the year ended December 31, 2015.

 

 

Net interest income of $37.6 million for the year ended December 31, 2016, a year-over-year increase of $3.4 million or 10.1%, from the year ended December 31, 2015.

 

 

An allowance for loan and lease losses of 1.01% of total loans held for investment and a ratio of non-performing loans to total loans held for investment of 0.90% as of December 31, 2016.

 

 

Return on average assets of 0.45% for the year ended December 31, 2016.

 

 

Return on average equity of 4.42% for the year ended December 31, 2016.

 

 

Capital ratios for Tier 1 Leverage, Common Equity Tier 1, Tier 1 Risk-based and Total Risk-based Capital of 9.67%, 10.81%, 10.81% and 11.63%, respectively as of December 31, 2016.

 

 

Book value per share of $16.42 as of December 31, 2016, an increase of 2.8% from $15.98 at December 31, 2015.

 

Results of Operations for the Years Ended December 31, 2016 and 2015

 

Performance Summary

 

For the year ended December 31, 2016, net income was $5.1 million, or $0.73 per basic share and $0.70 per diluted share, compared to net income of $4.1 million, or $0.61 per basic share and $0.59 per diluted share, for the year ended December 31, 2015. The increase for the year ended December 31, 2016, compared to the same time period 2015, can mainly be attributed to our year over year growth in earning assets. Return on average assets increased to 0.45% for the year ended December 31, 2016 from 0.41% for the year ended December 31 2015, primarily because of the increase in net income while average assets had nominal growth during the year ended December 31, 2016. Return on average equity was 4.42% for the year ended December 31, 2016, as compared to 3.89% for the year ended December 31, 2015.

 

Net Interest Income

 

Our operating results depend primarily on our net interest income, calculated as the difference between interest income on interest-earning assets, such as loans and securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Fluctuations in market interest rates impact the yield and rates paid on interest sensitive assets and liabilities. Changes in the amount and type of interest-earning assets and interest-bearing liabilities also impact net interest income. The variance driven by the changes in the amount and mix of interest-earning assets and interest-bearing liabilities is referred to as a “volume change.” Changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds are referred to as a “rate change.”

 

To evaluate net interest income, we measure and monitor (1) yields on our loans and other interest-earning assets, (2) the costs of our deposits and other funding sources, (3) our net interest spread and (4) our net interest margin. Net interest spread is the difference between rates earned on interest-earning assets and rates paid on interest-bearing liabilities. Net interest margin is calculated as net interest income divided by average interest-earning assets. Because noninterest-bearing sources of funds, such as noninterest-bearing deposits and stockholders’ equity also fund interest-earning assets, net interest margin includes the benefit of these noninterest-bearing sources. We calculate average assets, liabilities, and capital using a monthly average.

 

For the year ended December 31, 2016, net interest income totaled $37.6 million, and net interest margin and net interest spread were 3.64% and 3.46%, respectively. For the year ended December 31, 2015 net interest income totaled $34.2 million and net interest margin and net interest spread were 3.68% and 3.51%, respectively. The change in net interest margin and net interest spread were primarily attributable to the change in rate environment where the average rate on the loan portfolio decreased seven basis points from 5.03% as of December 31, 2015 to 4.96% as of December 31, 2016. In addition, we experienced an overall increase in cost of funds of nine basis points for the same period. While we experienced significant growth in average loan balances, the market yields on new loan originations were below the average yield of amortizing or paid-off loans. However, this declining yield on new originations was partially offset by the accretion of the purchase discount related to the AGFC loan portfolio which positively impacted average loan yields. Due to the continued impact of new loan growth and the runoff of higher yielding loan balances, we anticipate continued pressure on our net interest margin and net interest spread.

 

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The following table presents, for the periods indicated, an analysis of net interest income by each major category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding and the interest earned or paid on such amounts. The table also sets forth the average rate earned on interest-earning assets, the average rate paid on interest-bearing liabilities, and the net interest margin on average total interest-earning assets for the same periods. Interest earned on loans that are classified as nonaccrual is not recognized in income; however the balances are reflected in average outstanding balances for the period. For the years ended December 31, 2016 and 2015, interest income not recognized on nonaccrual loans was not material. Any nonaccrual loans have been included in the table as loans carrying a zero yield. The average total loans reflected below is net of deferred loan fees and discounts. Acquired loans were recorded at fair value at acquisition and accrete interest income over the remaining lives of the respective loans.

 

   

For the Years Ended December 31,

 
   

2016

   

2015

 
   

Average
Outstanding
Balance

   

Interest
Earned/
Interest
Paid

   

Average
Yield/
Rate

   

Average
Outstanding
Balance

   

Interest
Earned/
Interest
Paid

   

Average
Yield/
Rate

 
   

(Dollars in thousands)

 

Assets

                                               

Interest-earning assets:

                                               

Total loans

  $ 795,625     $ 39,468       4.96 %   $ 700,952     $ 35,244       5.03 %

Securities available for sale

    211,351       3,781       1.79 %     178,915       3,186       1.78 %

Interest-bearing deposits in other banks

    25,642       169       0.66 %     47,617       187       0.39 %

Total interest-earning assets

    1,032,618       43,418       4.20 %     927,484       38,617       4.16 %

Allowance for loan losses

    (7,453 )                     (7,144 )                

Noninterest-earning assets

    102,608                       79,147                  

Total assets

  $ 1,127,773     $ 43,418             $ 999,487     $ 38,617          
                                                 

Liabilities and Stockholders’ Equity

                                               

Interest-bearing liabilities:

                                               

Interest-bearing deposits

  $ 723,996     $ 5,152       0.71 %   $ 632,755     $ 3,858       0.61 %

Advances from FHLB

    53,516       561       1.05 %     54,942       566       1.03 %

Other borrowings

    6,436       113       1.76 %     3,069       43       1.40 %

Total interest-bearing liabilities

    783,948       5,826       0.74 %     690,766       4,467       0.65 %
                                                 

Noninterest-bearing liabilities:

                                               

Noninterest-bearing deposits

    221,047                       188,995                  

Other liabilities

    7,141                       14,423                  

Total noninterest-bearing liabilities

    228,188                       203,418                  

Stockholders’ equity

    115,637                       105,303                  
                                                 

Total liabilities and stockholders’ equity

  $ 1,127,773                     $ 999,487                  
                                                 

Net interest rate spread(1)

                    3.46 %                     3.51 %

Net interest income

          $ 37,592                     $ 34,150          

Net interest margin(2)

                    3.64 %                     3.68 %

(1)

Net interest spread is the average yield on interest-earning assets minus the average rate on interest-bearing liabilities. 

(2)

Net interest margin is equal to net interest income divided by average interest-earning assets.

 

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The following table presents information regarding the dollar amount of changes in interest income and interest expense for the periods indicated for each major component of interest-earning assets and interest-bearing liabilities, and distinguishes between the changes attributable to changes in volume and changes attributable to changes in interest rates. For purposes of these tables, changes attributable to both rate and volume that cannot be segregated have been allocated to rate.

 

   

For the Year Ended December 31, 2016
compared to the Year ended
December 31, 2015

 
   

Increase (Decrease) due to change in

 
   

Volume

   

Rate

   

Total

 
   

(Dollars in thousands)

 

Interest-earning assets:

                       

Total loans

  $ 4,697     $ (473 )   $ 4,224  

Securities available for sale

    580       15       595  

Interest-earning deposits in other banks

    (145 )     127       (18 )

Total increase (decrease) in interest income

  $ 5,132     $ (331 )   $ 4,801  
                         

Interest-bearing liabilities:

                       

Interest-bearing deposits

  $ 649     $ 645     $ 1,294  

Advances from FHLB

    (15 )     10       (5 )

Other borrowings

    59       11       70  

Total increase (decrease) in interest expense

    693       666       1,359  

Increase (decrease) in net interest income

  $ 4,439     $ (997 )   $ 3,442  

 

Provision for Loan Losses 

 

Our provision for loan losses is a charge to income in order to bring our allowance for loan losses to a level deemed appropriate by management. For a description of the factors taken into account by management in determining the allowance for loan losses see “—Financial Condition—Allowance for Loan Losses.” The provision for loan losses was $1.2 million for both of the years ended December 31, 2016 and 2015.

 

Noninterest Income

 

Our primary sources of recurring noninterest income are service charges on deposit accounts, debit card fee income, brokerage commissions, and income from bank-owned life insurance.

 

The following table presents, for the periods indicated, the major categories of noninterest income:

 

   

For the Years Ended
December 31,

   

 Increase

 
   

2016

   

2015

    (Decrease)  
   

(Dollars in thousands)

 

Noninterest income:

                       

Service charges on deposit accounts

  $ 2,033     $ 1,553     $ 480  

Debit card fee income

    619       467       152  

ATM fees

    183       153       30  

Gain on sales of other real estate owned

    168       54       114  

Bank-owned life insurance income

    789       637       152  

Gain (Loss) on sales of investment securities

    232       (15 )     247  

Gain (Loss) on sales / disposal of premises and equipment

    24       (157 )     181  

Brokerage commissions

    657       13       644  

Correspondent bank income

    204             204  

Other

    512       475       37  

Total noninterest income

  $ 5,421     $ 3,180     $ 2,241  

 

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Noninterest income for the year ended December 31, 2016 increased $2.2 million or 70.5% to $5.4 million compared to noninterest income of $3.2 million for the same period in 2015. The primary components of the increase were as follows:

 

Service charges on deposit accounts. We earn fees from our customers for deposit-related services, and these fees constitute a significant and predictable component of our noninterest income. Service charges on deposit accounts were $2.0 million for the year ended December 31, 2016, an increase of $480,000 over the same period in 2015. The increase was primarily due to the continued deposit penetration in our market area and the resulting increase in fee income as well as the increase in the number of deposit accounts as a result of the March 2015 merger with AGFC.

 

Debit card fee income. We earn fees from our customers based upon debit card activity, and these fees constitute a significant recurring component of our noninterest income. Debit card fee income was $619,000 and $467,000 for the years ended December 31, 2016 and 2015, respectively, representing an increase of $152,000 or 32.5%. The increase was primarily due to increased customer volume as a result of the March 2015 merger with AGFC.

 

ATM fees. We earn fee income as a result of noncustomer activity at our ATM machines, and these fees represent a significant and predictable component of our noninterest income. ATM fees were $183,000 and $153,000 for the years ended December 31, 2016 and 2015, respectively. These fees were a new revenue source in 2015 as a result of the AGFC merger, as previously we did not own any ATM machines.

 

Bank-owned life insurance income. We invest in bank-owned life insurance due to its attractive nontaxable return and protection against the loss of our key employees. We record income based on the growth of the cash surrender value of these policies as well as the annual yield. Income from bank-owned life insurance was $789,000 for the year ended December 31, 2016 as compared to $637,000 for the same time period in 2015, an increase of $152,000. The increase was primarily due to receipt of a death benefit related to a former AGFC employee.

 

Gain (Loss) on sales / disposal of premises and equipment. We had a gain of $24,000 and a loss of $157,000 for the years ended December 31, 2016 and 2015, respectively, related to the sale or other disposition of premises and equipment. In the third quarter 2016 we sold a building acquired in the AGFC merger at a gain of $24,000. In conjunction with the AGFC merger and our July 2015 rebranding, we incurred a loss of $157,000 related to the disposition of our outdated signage.

 

Brokerage commissions. We earn commissions from brokerage services provided by our Wealth Solutions Group. We began offering these services to our clients during the first quarter 2015. Brokerage commissions totaled $657,000 and $13,000 for the years ended December 31, 2016 and 2015, respectively. The increases are due to these services being in the start-up phase during the year ended December 31, 2015.

 

Correspondent bank income. In 2016 we renegotiated certain of our correspondent banking relationships and received earnings credit income of $204,000 for the year ended December 31, 2016. There was no correspondent bank income for 2015.

 

Other. This category includes a variety of other income producing activities, including wire transfer fees, mortgage related income, insurance commissions, credit card income, participation fee income and rental income. Other income increased $37,000 or 7.8% for the year ended December 31, 2016, compared to the same period in 2015.

 

Noninterest Expense

 

Generally, noninterest expense is composed of all employee expenses and costs associated with operating our facilities, obtaining and retaining customer relationships and providing bank services. The major component of noninterest expense is salaries and employee benefits. Noninterest expense also includes operational expenses, such as occupancy expenses, depreciation and amortization, professional and regulatory fees, including FDIC assessments, data processing expenses, and advertising and promotion expenses.

 

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The following table presents, for the periods indicated, the major categories of noninterest expense:

 

   

For the Years Ended
December 31,

   

 

Increase

 
   

2016

   

2015

    (Decrease)  
   

(Dollars in thousands)

 

Salaries and employee benefits

  $ 19,471     $ 16,145     $ 3,326  

Non-staff expenses:

                       

Occupancy of bank premises

    2,428       2,097       331  

Depreciation and amortization

    1,577       1,398       179  

Data processing

    1,528       1,141       387  

FDIC assessment fees

    748       790       (42 )

Legal and other professional fees

    1,806       1,980       (174 )

Advertising and promotions

    1,253       805       448  

Utilities and communications

    1,004       575       429  

Ad valorem shares tax

    650       669       (19 )

Other real estate owned expenses and write-downs

    221       111       110  

Other

    4,383       4,798       (415 )

Total noninterest expense

  $ 35,069     $ 30,509     $ 4,560  

 

Noninterest expense for the year ended December 31, 2016 increased $4.6 million or 14.9% to $35.1 million compared to noninterest expense of $30.5 million for the same period in 2015. The most significant components of the increase were as follows:

 

Salaries and employee benefits. Salaries and employee benefits are the largest component of noninterest expense and include payroll expense, the cost of incentive compensation, benefit plans, health insurance and payroll taxes. Salaries and employee benefits were $19.5 million for the year ended December 31, 2016, an increase of $3.3 million or 20.6% compared to the same period in 2015. The increase was primarily attributable to new salaries and benefits for employees acquired in the 2015 AGFC merger, as well as additional hires for new positions. Our salary expense also increased as a result of our merit increase cycle. As of December 31, 2016, we had 208 full-time equivalent employees. Salaries and employee benefits included stock-based compensation expense of $456,000 and $198,000 for the years ended December 31, 2016 and 2015, respectively. The increased stock-based compensation expense incurred during the year ended December 31, 2016, compared to the prior year, was primarily as a result of extending the expiration date for the warrants and options expiring in 2016.

 

Occupancy of bank premises. Expense associated with occupancy of premises was $2.4 million for the year ended December 31, 2016 and $2.1 million for the same period in 2015. The increase of $331,000 can primarily be attributed to the addition of 10 banking centers in conjunction with the March 2015 merger with AGFC. The increase is also in part due to the demolition and cleanup costs incurred for one of our branches impacted by the August 2016 flooding in south Louisiana as well the costs incurred in July 2016 to relocate our corporate offices to downtown Baton Rouge.

 

Depreciation and amortization. Depreciation and amortization costs were $1.6 million and $1.4 million for the years ended December 31, 2016 and 2015, respectively. This category includes leasehold, furniture, fixtures and equipment depreciation totaling $1.3 million and $1.2 million for the years ended December 31, 2016 and 2015, respectively. The amortization of intangible assets was $276,000 and $207,000 for the years ended December 31, 2016 and 2015, respectively.

 

Data processing. Data processing expenses were $1.5 million for the year ended December 31, 2016 and $1.1 million for the same period in 2015. The increase of $387,000 for the year ended December 31, 2016 was attributable to the merger with AGFC as well as organic growth in our loans and deposits.

 

Legal and other professional fees. Other professional fees include audit, loan review, compliance, and other consultants. Legal and other professional fees were $1.8 million and $2.0 million for the years ended December 31, 2016 and 2015, respectively. The decrease of $174,000 for the year ended December 31, 2016 can be attributed to renegotiating certain consulting agreements and the continual reevaluation of consulting products and services. The costs incurred during the year ended December 31, 2015 related to the AGFC merger and registration of our common stock were replaced in 2016 with fees incurred in our defense of the litigation related to the dissenting former AGFC shareholders who exercised their statutory rights of appraisal as well as due diligence costs related to an unsuccessful bid for a potential acquisition.

 

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Other. This category includes operating and administrative expenses including business development expenses (i.e. travel and entertainment, donations and club memberships), directors’ fees, insurance, supplies and printing, equipment rent, and software support and maintenance. Other noninterest expense decreased $415,000 for the year ended December 31, 2016 compared to the same period in 2015. The decrease was primarily due to the nonrecurring conversion and post-merger costs related to the 2015 merger with AGFC which totaled $1.1 million for the year ended December 31, 2015.

 

Income Tax Expense

 

The amount of income tax expense is influenced by the amounts of our pre-tax income, tax-exempt income and other nondeductible expenses. Deferred tax assets and liabilities are reflected at currently enacted income tax rates in effect for the period in which the deferred tax assets and liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

 

For the year ended December 31, 2016, income tax expense totaled $1.6 million, an increase of $88,000 or 5.8% compared to $1.5 million for the same period in 2015. The increase in income tax expense can be attributed primarily to an increase in taxable income. Our effective tax rate for the years ended December 31, 2016 and 2015 was 24.0% and 27.1%, respectively. Our effective tax rate for both years was affected primarily by tax-exempt income generated by municipal securities and bank-owned life insurance and by other nondeductible expenses.

 

Financial Condition

 

Our assets increased $29.8 million or 2.8% from $1.1 billion as of December 31, 2015 to $1.1 billion as of December 31, 2016. Our asset growth was primarily driven by loan and deposit growth.

 

Loan Portfolio 

 

Our primary source of income is interest on loans to individuals, professionals, small to medium-sized businesses and commercial companies located in Louisiana. Our loan portfolio consists primarily of commercial loans and real estate loans secured by commercial real estate properties located in our primary market area. Our loan portfolio represents the highest yielding component of our earning asset base.

 

As of December 31, 2016, total loans, including mortgage loans held for sale, were $811.1 million, an increase of $38.7 million compared to $772.4 million as of December 31, 2015. The increase was primarily due to our continued loan penetration in our primary market area. Of these amounts, $180,000 in loans were classified as held for sale as of December 31, 2016. No loans were classified as held for sale as of December 31, 2015.

 

Total loans as a percentage of deposits were 87.0% and 85.4% as of December 31, 2016 and 2015, respectively. Total loans as a percentage of assets were 73.3% and 71.8% as of December 31, 2016 and 2015, respectively.

 

 

The following table summarizes our loan portfolio by type of loan as of the dates indicated:

 

   

As of December 31, 2016

   

As of December 31, 2015

 
   

Amount

   

Percent

   

Amount

   

Percent

 
   

(Dollars in

thousands)

   

(Dollars in

thousands)

 

Commercial

  $ 213,120       26.3 %   $ 185,276       24.0 %

Real estate:

                               

Construction and land

    94,426       11.6 %     97,872       12.7 %

Farmland

    9,217       1.1 %     8,897       1.1 %

1-4 family residential

    129,052       15.9 %     112,954       14.6 %

Multi-family residential

    22,737       2.8 %     26,058       3.4 %

Nonfarm nonresidential

    298,057       36.8 %     312,207       40.4 %

Consumer

    44,342       5.5 %     29,128       3.8 %

Total loans held for investment

  $ 810,951       100 %   $ 772,392       100 %

 

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Commercial loans. Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and effectively. These loans are primarily made based on the identified cash flows of the borrower and, secondarily, on the underlying collateral provided by the borrower. Most commercial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory, and generally include personal guarantees.

 

Commercial loans increased $27.8 million or 15.0% to $213.1 million as of December 31, 2016 from $185.3 million as of December 31, 2015. The increase in lending activity was due the efforts of our bankers who attracted new clients and leveraged existing bank relationships to fund expansion and growth opportunities.

 

Construction and land. Construction and land development loans are comprised of loans to fund construction, land acquisition and land development construction. The properties securing the portfolio are located throughout Louisiana and are generally diverse in terms of type.

 

Construction and land loans decreased $3.4 million or 3.5% to $94.4 million as of December 31, 2016 from $97.9 million as of December 31, 2015. The decrease may be attributable to the slowdown in the oil and gas sector over the last several years, and the resulting negative effect on new subdivision development in several of our markets.

 

1-4 family residential. Our 1-4 family residential loan portfolio is comprised of loans secured by single family homes, which are both owner-occupied and investor owned. Our 1-4 family residential loans have a relatively small balance spread between many individual borrowers.

 

1-4 family residential loans increased $16.1 million or 14.3% to $129.1 million as of December 31, 2016 from $113.0 million as of December 31, 2015. This increase resulted from both the conversion of residential construction to in-house financed owner-occupied term debt and new financing of existing 1-4 family residential.

 

Nonfarm nonresidential. Nonfarm nonresidential loans are underwritten primarily based on projected cash flows and, secondarily, as loans secured by real estate. These loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the portfolio are located throughout Louisiana and are generally diverse in terms of type. This diversity helps reduce the exposure to adverse economic events that affect any single industry.

 

Nonfarm nonresidential loans decreased $14.2 million or 4.5% to $298.1 million as of December 31, 2016 from $312.2 million as of December 31, 2015. The decrease was primarily driven by two factors: (1) regularly scheduled principal amortization of the portfolio, and (2) loans that were refinanced by borrowers with other financial institutions.

 

Other loan categories. Other categories of loans included in our loan portfolio include farmland and agricultural loans made to farmers and ranchers relating to their operations, multi-family residential loans, and consumer loans. None of these categories of loans represents a significant portion of our total loan portfolio.

 

40

 

 

The contractual maturity ranges of loans in our loan portfolio and the amount of such loans with fixed and floating interest rates in each maturity range as of date indicated are summarized in the following tables:

 

   

As of December 31, 2016

 
   

One Year
or Less

   

One
Through
Five Years

   

After Five
Years

   

Total

 
   

(Dollars in thousands)

 

Commercial

  $ 76,596     $ 98,037     $ 38,487     $ 213,120  

Real estate:

                               

Construction and land

    45,403       39,346       9,677       94,426  

Farmland

    779       5,973       2,465       9,217  

1-4 family residential

    14,509       51,557       62,986       129,052  

Multi-family residential

    12,335       5,268       5,134       22,737  

Nonfarm nonresidential

    30,371       120,082       147,604       298,057  

Consumer

    14,560       23,437       6,345       44,342  

Total loans held for investment

  $ 194,553     $ 343,700     $ 272,698     $ 810,951  

Amounts with fixed rates

  $ 81,929     $ 252,718     $ 176,540     $ 511,187  

Amounts with floating rates

  $ 112,624     $ 90,982     $ 96,158     $ 299,764  

 

   

As of December 31, 2015

 
   

One Year
or Less

   

One
Through
Five Years

   

After Five
Years

   

Total

 
   

(Dollars in thousands)

 

Commercial

  $ 68,158     $ 82,765     $ 34,353     $ 185,276  

Real estate:

                               

Construction and land

    52,242       38,415       7,215       97,872  

Farmland

    2,560       5,470       867       8,897  

1-4 family residential

    13,524       52,639       46,791       112,954  

Multi-family residential

    1,408       12,086       12,564       26,058  

Nonfarm nonresidential

    37,802       128,039       146,366       312,207  

Consumer

    14,600       12,034       2,494       29,128  

Total loans held for investment

  $ 190,294     $ 331,448     $ 250,650     $ 772,392  

Amounts with fixed rates

  $ 85,246     $ 216,675     $ 151,589     $ 453,510  

Amounts with floating rates

  $ 105,048     $ 114,773     $ 99,061     $ 318,882  

 

Nonperforming Assets

 

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on nonaccrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

We have several procedures in place to assist in maintaining the overall quality of our loan portfolio. We have established underwriting guidelines to be followed by our bankers, and we also monitor our delinquency levels for any negative or adverse trends.

 

There can be no assurance, however, that our loan portfolio will not become subject to increasing pressures from deteriorating borrower credit due to general economic conditions.

 

We believe our conservative lending approach and focused management of nonperforming assets has resulted in sound asset quality and timely resolution of problem assets. We had $8.5 million and $10.0 million in nonperforming assets as of December 31, 2016 and 2015, respectively. We had $7.3 million in nonperforming loans as of December 31, 2016 compared to $8.0 million as of December 31, 2015. The decrease in nonperforming assets and nonperforming loans from December 31, 2015 to December 31, 2016 is mainly attributable to our successful workout efforts on several larger clients.

 

41

 

 

 

The following table presents information regarding nonperforming loans at the dates indicated:

 

   

As of December 31,
2016
(Dollars in
thousands)

   

As of December 31,
201
5
(Dollars in
thousands)

 

Nonaccrual loans

  $ 7,126     $ 7,957  

Accruing loans 90 or more days past due

    168        

Total nonperforming loans

    7,294       7,957  

Nonaccrual debt securities

           

Other real estate owned:

               

Commercial real estate, construction, land and land development

    1,187       1,373  

Residential real estate

          660  

Total other real estate owned

    1,187       2,033  

Total nonperforming assets

  $ 8,481     $ 9,990  

Restructured loans-nonaccrual

  $ 816     $ 811  

Restructured loans-accruing

  $ 5,115     $ 5,054  

Ratio of nonperforming loans to total loans held for investment

    0.90 %     1.03 %

Ratio of nonperforming assets to total assets

    0.77 %     0.93 %

 

   

As of December 31,
2016
(Dollars in
thousands)

   

As of December 31,
2015
(Dollars in
thousands)

 

Nonaccrual loans by category:

               

Real estate:

               

Construction and land

  $ 243     $ 1,738  

1-4 family residential

    2,721       3,205  

Multi-family residential

          229  

Nonfarm nonresidential

    1,201       1,806  

Commercial

    2,763       979  

Consumer

    198        

Total

  $ 7,126     $ 7,957  

 

Potential Problem Loans 

 

From a credit risk standpoint, we classify loans in one of four categories: pass, special mention, substandard or doubtful. Loans classified as loss are charged-off. The classifications of loans reflect a judgment about the risks of default and loss associated with the loan. We review the ratings on credits monthly. Ratings are adjusted to reflect the degree of risk and loss that is believed to be inherent in each credit as of each monthly reporting period. Our methodology is structured so that specific allocations are increased in accordance with deterioration in credit quality (and a corresponding increase in risk of loss) or decreased in accordance with improvement in credit quality (and a corresponding decrease in risk of loss).

 

Credits rated special mention show clear signs of financial weaknesses or deterioration in credit worthiness; however, such concerns are not so pronounced that we generally expect to experience significant loss within the short-term. Such credits typically maintain the ability to perform within standard credit terms and credit exposure is not as prominent as credits with a lower rating.

 

Credits rated substandard are those in which the normal repayment of principal and interest may be, or has been, jeopardized by reason of adverse trends or developments of a financial, managerial, economic or political nature, or important weaknesses which exist in collateral. A protracted workout on these credits is a distinct possibility. Prompt corrective action is therefore required to reduce exposure and to assure that adequate remedial measures are taken by the borrower. Credit exposure becomes more likely in such credits and a serious evaluation of the secondary support to the credit is performed.

 

42

 

 

The following table summarizes our internal ratings of our loans held for investment as of the dates indicated.

 

   

As of December 31, 2016

 
   

Pass

   

Special Mention

   

Substandard

   

Doubtful

   

Total

 
   

(Dollars in thousands)

 

Real estate:

                                       

Construction and land

  $ 92,951     $ 932     $ 300     $ 243     $ 94,426  

Farmland

    9,217                         9,217  

1-4 family residential

    118,891       4,782       2,658       2,721       129,052  

Multi-family residential

    22,685             52             22,737  

Nonfarm nonresidential

    280,398       14,531       1,927       1,201       298,057  

Commercial

    186,197       16,783       7,377       2,763       213,120  

Consumer

    43,414       505       225       198       44,342  

Total

  $ 753,753     $ 37,533     $ 12,539     $ 7,126     $ 810,951  

 

   

As of December 31, 2015

 
   

Pass

   

Special Mention

   

Substandard

   

Doubtful

   

Total

 
   

(Dollars in thousands)

 

Real estate:

                                       

Construction and land

  $ 93,740     $ 1,300     $ 1,094     $ 1,738     $ 97,872  

Farmland

    8,897                         8,897  

1-4 family residential

    104,720       1,824       3,205       3,205       112,954  

Multi-family residential

    24,884       945             229       26,058  

Nonfarm nonresidential

    281,503       12,727       16,171       1,806       312,207  

Commercial

    157,734       22,222       4,341       979       185,276  

Consumer

    28,702       396       30             29,128  

Total

  $ 700,180     $ 39,414     $ 24,841     $ 7,957     $ 772,392  

 

Allowance for loan losses

 

We maintain an allowance for loan losses that represents management’s best estimate of the loan losses and risks inherent in the loan portfolio. In determining the allowance for loan losses, we estimate losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. The balance of the allowance for loan losses is based on internally assigned risk classifications of loans, historical loan loss rates, changes in the nature of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, current economic factors and the estimated impact of current economic conditions on certain historical loan loss rates. For additional discussion of our methodology, please refer to “—Critical Accounting Policies—Allowance for loan losses.”

 

In connection with our review of the loan portfolio, we consider risk elements attributable to particular loan types or categories in assessing the quality of individual loans. Some of the risk elements we consider include:

 

 

for commercial and industrial loans, the operating results of the commercial, industrial or professional enterprise, the borrower’s business, professional and financial ability and expertise, the specific risks and volatility of income and operating results typical for businesses in that category, and the value, nature and marketability of collateral;

 

 

for commercial mortgage loans and multifamily residential loans, the debt service coverage ratio (income from the property in excess of operating expenses compared to loan payment requirements), operating results of the owner in the case of owner occupied properties, the loan to value ratio, the age and condition of the collateral, and the volatility of income, property value and future operating results typical for properties of that type;

 

 

for 1-4 family residential mortgage loans, the borrower’s ability to repay the loan, including a consideration of the debt to income ratio and employment and income stability, the loan to value ratio, and the age, condition and marketability of the collateral; and

 

 

for construction, land development and other land loans, the perceived feasibility of the project including the ability to sell developed lots or improvements constructed for resale or the ability to lease property constructed for lease, the quality and nature of contracts for presale or prelease, if any, the experience and ability of the developer, and the loan to value ratio.

 

43

 

 

 

As of December 31, 2016, the allowance for loan losses totaled $8.2 million or 1.01% of total loans held for investment. As of December 31, 2015, the allowance for loan losses totaled $7.2 million or 0.94% of total loans held for investment.

 

The following table presents, as of and for the periods indicated, an analysis of the allowance for loan losses and other related data:

 

   

As of December 31, 2016
(Dollars in thousands)

   

As of December 31, 2015
(Dollars in thousands)

 

Average loans outstanding(1)

  $ 795,625     $ 700,952  
                 

Gross loans held for investment outstanding at end of period(1)

  $ 810,951     $ 772,392  
                 

Allowance for loan losses at beginning of period

    7,244       6,632  

Provision for loan losses

    1,220       1,200  

Charge-offs:

               

Real estate:

               

Construction, land and farmland

    484       102  

Residential

    162       144  

Nonfarm non-residential

    473       44  

Commercial

    667       695  

Consumer

    3        

Total charge-offs

    1,789       985  

Recoveries:

               

Real estate:

               

Construction, land and farmland

    10       34  

Residential

    140       94  

Nonfarm non-residential

    1,258       13  

Commercial

    33       164  

Consumer

    46       92  

Total recoveries

    1,487       397  

Net charge-offs

    302       588  

Allowance for loan losses at end of period

  $ 8,162     $ 7,244  

Ratio of allowance to end of period loans held for investment

    1.01 %     0.94 %

Ratio of net charge-offs to average loans

    0.04 %     0.08 %

                                                                                           

(1)

Excluding loans held for sale.

 

Although we believe that we have established our allowance for loan losses in accordance with accounting principles generally accepted in the United States and that the allowance for loan losses was adequate to provide for known and inherent losses in the portfolio at all times shown above, future provisions will be subject to ongoing evaluations of the risks in our loan portfolio. If we experience economic declines or if asset quality deteriorates, material additional provisions could be required.

 

44

 

 

The following table shows the allocation of the allowance for loan losses among loan categories and certain other information as of the dates indicated. The allocation of the allowance for loan losses as shown in the table should neither be interpreted as an indication of future charge-offs, nor as an indication that charge-offs in future periods will necessarily occur in these amounts or in the indicated proportions. The total allowance is available to absorb losses from any loan category.

 

   

As of December 31,
2016

   

As of December 31,
2015

 
   

Amount

   

Percent
to Total

   

Amount

   

Percent
to Total

 
   

(Dollars in
thousands)

   

(Dollars in
thousands)

 

Real estate:

                               

Construction and land

  $ 933       11.4 %   $ 600       8.3 %

Farmland

    75       0.9 %     30       0.4 %

1-4 family residential

    1,228       15.1 %     1,021       14.1 %

Multi-family residential

    172       2.1 %     101       1.4 %

Nonfarm nonresidential

    2,314       28.4 %     1,416       19.6 %

Total real estate

    4,722       57.9 %     3,168       43.8 %

Commercial

    3,039       37.2 %     3,618       49.9 %

Consumer

    401       4.9 %     458       6.3 %

Total allowance for loan losses

  $ 8,162       100 %   $ 7,244       100 %

 

Securities 

 

We use our securities portfolio to provide a source of liquidity, an appropriate return on funds invested, manage interest rate risk, meet collateral requirements, and meet regulatory capital requirements. As of December 31, 2016, the carrying amount of investment securities totaled $198.3 million, a decrease of $12.5 million or 5.9% compared to $210.9 million as of December 31, 2015. Securities represented 17.9%, and 19.6% of total assets as of December 31, 2016 and 2015, respectively.

 

Our investment portfolio consists entirely of securities classified as available for sale. As a result, the carrying values of our investment securities are adjusted for unrealized gain or loss, and any gain or loss is reported on an after-tax basis as a component of other comprehensive income in stockholders’ equity. The following table summarizes the amortized cost and estimated fair value of investment securities as of the dates shown:

 

   

As of December 31, 2016

 
   

Amortized
Cost

   

Gross
Unrealized
Gains

   

Gross
Unrealized
Losses

   

Fair Value

 
   

(Dollars in thousands)

 

U.S. government agencies

  $ 7,580     $ 36     $ 50     $ 7,566  

Corporate bonds

    11,148       31       52       11,127  

Municipal securities

    80,559       210