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EX-32 - EXHIBIT 32 - COMMUNITY FINANCIAL CORP /MD/v465845_ex32.htm
EX-31 - EXHIBIT 31 - COMMUNITY FINANCIAL CORP /MD/v465845_ex31.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

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

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended March 31, 2017

 

OR

 

¨     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ______ to ______

 

Commission File Number 001-36094

 

The Community Financial Corporation

(Exact name of registrant as specified in its charter)

 

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

 

 

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

 

(301) 645-5601

(Registrant's telephone number, including area code)

Not applicable

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

 

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

Yes x     No ¨

 

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

Yes x      No ¨

 

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

 

Large Accelerated Filer  ¨ Accelerated Filer x
Non-accelerated Filer  ¨ Smaller Reporting Company  ¨
(Do not check if a smaller reporting company)  
   
Emerging growth company  ¨  

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

 

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

Yes ¨      No x

 

As of May 1, 2017, the registrant had 4,642,119 shares of common stock outstanding.

 

 

 

 

THE COMMUNITY FINANCIAL CORPORATION

FORM 10-Q

INDEX

 

   Page
PART I - FINANCIAL INFORMATION   
    
Item 1 – Financial Statements (Unaudited)   
    
Consolidated Balance Sheets – March 31, 2017
and December 31, 2016
  1
    
Consolidated Statements of Income -
Three Months Ended March 31, 2017 and 2016
  2
    
Consolidated Statements of Comprehensive Income -
Three Months Ended March 31, 2017 and 2016
  3
    
Consolidated Statements of Cash Flows -
Three Months Ended March 31, 2017 and 2016
  4
    
Notes to Consolidated Financial Statements  6
    
Item 2 – Management’s Discussion and Analysis of Financial Condition
and Results of Operations
  38
    
Item 3 – Quantitative and Qualitative Disclosures about Market Risk  59
    
Item 4 – Controls and Procedures  60
    
PART II - OTHER INFORMATION   
    
Item 1 –    Legal Proceedings  61
    
Item 1A – Risk Factors   61
    
Item 2 –    Unregistered Sales of Equity Securities and Use of Proceeds  61
    
Item 3 –    Defaults Upon Senior Securities  61
    
Item 4 –    Mine Safety Disclosures  61
    
Item 5 –    Other Information  61
    
Item 6 –    Exhibits  61
    
SIGNATURES  62

 

 

 

 

 

PART 1 - FINANCIAL INFORMATION
ITEM 1 – FINANCIAL STATEMENTS

 

CONSOLIDATED BALANCE SHEETS

 

   March 31, 2017     
(dollars in thousands)  (Unaudited)   December 31, 2016 
Assets          
Cash and due from banks  $9,301   $9,948 
Interest-bearing deposits with banks   1,487    1,315 
Securities available for sale (AFS), at fair value   57,042    53,033 
Securities held to maturity (HTM), at amortized cost   104,965    109,247 
Federal Home Loan Bank (FHLB) and Federal Reserve Bank (FRB) stock - at cost   7,703    7,235 
Loans receivable - net of allowance for loan losses of $10,109 and $9,860   1,104,369    1,079,519 
Premises and equipment, net   22,246    22,205 
Premises and equipment held for sale   345    345 
Other real estate owned (OREO)   6,747    7,763 
Accrued interest receivable   4,023    3,979 
Investment in bank owned life insurance   28,817    28,625 
Other assets   9,028    11,043 
Total Assets  $1,356,073   $1,334,257 
           
Liabilities and Stockholders' Equity          
Liabilities          
Deposits          
Non-interest-bearing deposits  $149,410   $144,877 
Interest-bearing deposits   902,379    893,948 
Total deposits   1,051,789    1,038,825 
Short-term borrowings   97,500    79,000 
Long-term debt   55,544    65,559 
Guaranteed preferred beneficial interest in
junior subordinated debentures (TRUPs)
   12,000    12,000 
Subordinated notes - 6.25%   23,000    23,000 
Accrued expenses and other liabilities   9,674    11,447 
Total Liabilities   1,249,507    1,229,831 
           
Stockholders' Equity          
Common stock - par value $.01; authorized - 15,000,000 shares;
issued 4,641,342 and 4,633,868 shares, respectively
   46    46 
Additional paid in capital   47,511    47,377 
Retained earnings   59,979    58,100 
Accumulated other comprehensive loss   (801)   (928)
Unearned ESOP shares   (169)   (169)
Total Stockholders' Equity   106,566    104,426 
Total Liabilities and Stockholders' Equity  $1,356,073   $1,334,257 

 

See notes to Consolidated Financial Statements

 

 1 

 

 

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

 

   Three Months Ended March 31, 
(dollars in thousands, except per share amounts )  2017   2016 
Interest and Dividend Income          
Loans, including fees  $11,970   $10,545 
Interest and dividends on investment securities   946    763 
Interest on deposits with banks   6    4 
Total Interest and Dividend Income   12,922    11,312 
           
Interest Expense          
Deposits   1,269    1,095 
Short-term borrowings   147    38 
Long-term debt   832    786 
Total Interest Expense   2,248    1,919 
           
Net Interest Income   10,674    9,393 
Provision for loan losses   380    427 
Net Interest Income After Provision For Loan Losses   10,294    8,966 
           
Noninterest Income          
Loan appraisal, credit, and miscellaneous charges   47    61 
Net gains on sale of OREO   27    5 
Income from bank owned life insurance   191    196 
Service charges   610    588 
Total Noninterest Income   875    850 
           
Noninterest Expense          
Salary and employee benefits   4,313    4,152 
Occupancy expense   653    589 
Advertising   108    63 
Data processing expense   577    554 
Professional fees   337    425 
Depreciation of furniture, fixtures, and equipment   199    196 
Telephone communications   51    44 
Office supplies   32    43 
FDIC Insurance   166    243 
OREO valuation allowance and expenses   195    301 
Other   748    630 
Total Noninterest Expense   7,379    7,240 
           
Income before income taxes   3,790    2,576 
Income tax expense   1,448    968 
Net Income  $2,342   $1,608 
           
Earnings Per Common Share          
Basic  $0.51   $0.35 
Diluted  $0.51   $0.35 
Cash dividends paid per common share  $0.10   $0.10 

 

See notes to Consolidated Financial Statements

 

 2 

 

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

 

   Three Months Ended March 31, 
(dollars in thousands)  2017   2016 
         
Net Income  $2,342   $1,608 
Net unrealized holding gains arising during period,
net of tax expense of $83 and $155, respectively
   127    239 
Comprehensive Income  $2,469   $1,847 

 

See notes to Consolidated Financial Statements

 

 3 

 

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

 

   Three Months Ended March 31, 
(dollars in thousands)  2017   2016 
         
Cash Flows from Operating Activities          
Net income  $2,342   $1,608 
Adjustments to reconcile net income to net cash
provided by operating activities
          
Provision for loan losses   380    427 
Depreciation and amortization   394    354 
Net gains on the sale of OREO   (27)   (5)
Net amortization of premium/discount on investment securities   94    128 
Increase in OREO valuation allowance   196    255 
Increase in cash surrender of bank owned life insurance   (192)   (196)
(Increase) decrease in deferred income tax benefit   (382)   82 
Increase in accrued interest receivable   (44)   (164)
Stock based compensation   113    80 
Increase (decrease) in net deferred loan premiums   337    (100)
Decrease in accrued expenses and other liabilities   (1,773)   (763)
Decrease (increase) in other assets   2,322    (84)
Net Cash Provided by Operating Activities   3,760    1,622 
           
Cash Flows from Investing Activities          
Purchase of AFS investment securities   (5,559)   (2,512)
Proceeds from redemption or principal payments of AFS investment securities   1,732    1,361 
Purchase of HTM investment securities   (997)   (9,962)
Proceeds from maturities or principal payments of HTM investment securities   5,214    4,824 
Net (decrease) increase of FHLB and FRB stock   (469)   391 
Loans originated or acquired   (84,772)   (79,948)
Principal collected on loans   59,406    50,806 
Purchase of premises and equipment   (435)   (2,648)
Proceeds from sale of OREO   646    676 
Proceeds from disposal of asset   -    2,000 
           
Net Cash Used in Investing Activities   (25,234)   (35,012)

 

 

 4 

 

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(continued)

 

 

   Three Months Ended March 31, 
(dollars in thousands)  2017   2016 
         
Cash Flows from Financing Activities          
Net increase in deposits  $12,964   $43,700 
Payments of long-term debt   (10,015)   (5,015)
Net increase (decrease) in short term borrowings   18,500    (5,500)
Dividends paid   (450)   (453)
Repurchase of common stock   -    (323)
Net Cash Provided by Financing Activities   20,999    32,409 
Decrease in Cash and Cash Equivalents  $(475)  $(981)
           
Cash and Cash Equivalents - January 1   11,263    11,139 
Cash and Cash Equivalents - March 31  $10,788   $10,158 
           
Supplemental Disclosures of Cash Flow Information          
Cash paid during the period for          
Interest  $2,602   $2,244 
Income taxes  $-   $300 
           
Supplemental Schedule of Non-Cash Operating Activities          
Issuance of common stock for payment of compensation  $203   $464 
Transfer from loans to OREO  $-   $2,515 
Financed amount of sale of OREO  $200   $- 

 

See notes to Consolidated Financial Statements

 

 5 

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

NOTE 1 – BASIS OF PRESENTATION 

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

 

The consolidated financial statements reflect all adjustments consisting only of normal recurring accruals that, in the opinion of management, are necessary to present fairly the Company’s financial condition, results of operations, and cash flows for the periods presented. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The Company believes that the disclosures are adequate to make the information presented not misleading. The balances as of December 31, 2016 have been derived from audited financial statements. There have been no significant changes to the Company’s accounting policies as disclosed in the 2016 Annual Report. The results of operations for the three months ended March 31, 2017 are not necessarily indicative of the results of operations to be expected for the remainder of the year or any other period. Certain previously reported amounts have been restated to conform to the 2017 presentation.

 

These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s 2016 Annual Report.

 

 

NOTE 2 – NATURE OF BUSINESS

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

 

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

 

 

NOTE 3 – INCOME TAXES

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

 

 6 

 

 

NOTE 4 – ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following tables present the components of comprehensive income for the three months ended March 31, 2017 and 2016. The Company’s “other comprehensive” income was solely related to securities for the three months ended March 31, 2017 and 2016.

 

 

 

   Three Months Ended March 31, 2017   Three Months Ended March 31, 2016 
(dollars in thousands)  Before Tax   Tax Effect   Net of Tax   Before Tax   Tax Effect   Net of Tax 
Net unrealized holding gains
arising during period
  $210   $83   $127   $394   $155   $239 
Reclassification adjustments   -    -    -    -    -    - 
Other comprehensive income  $210   $83   $127   $394   $155   $239 

 

The following table presents the changes in each component of accumulated other comprehensive loss, net of tax, for the three months ended March 31, 2017 and 2016.

 

 

  

Three Months Ended
March 31, 2017

  

Three Months Ended
March 31, 2016

 
(dollars in thousands)  Net Unrealized
Gains And Losses
   Net Unrealized
Gains And Losses
 
         
Beginning of period  $(928)  $(251)
Other comprehensive gains, net
of tax before reclassifications
   127    239 
Amounts reclassified from accumulated
other comprehensive loss
   -    - 
Net other comprehensive income   127    239 
End of period  $(801)  $(12)

 

 

NOTE 5 – EARNINGS PER SHARE (“EPS”)

Basic earnings per common share represent income available to common shareholders, divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate to outstanding stock options and are determined using the treasury stock method. At March 31, 2017 and 2016, there were 0 and 21,111 options, respectively, which were excluded from the calculation as their effect would be anti-dilutive, because the exercise price of the options were greater than the average market price of the common shares.

 

 7 

 

 

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

 

   Three Months Ended 
   March 31, 
(dollars in thousands)  2017   2016 
Net Income  $2,342   $1,608 
           
Average number of common shares outstanding   4,628,357    4,594,683 
Dilutive effect of common stock equivalents   2,041    29,920 
Average number of shares used to calculate diluted EPS   4,630,398    4,624,603 
           
Earnings Per Common Share          
Basic  $0.51   $0.35 
Diluted   0.51    0.35 

 

 

NOTE 6 – STOCK-BASED COMPENSATION

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

 

Stock-based compensation expense totaled $113,000 and $80,000 for the three months ended March 31, 2017 and 2016, respectively. Stock-based compensation expense consisted of the vesting of grants of restricted stock.

 

All outstanding options are fully vested and the Company has not granted any stock options since 2007. All outstanding options as of March 31, 2017 expire on July 17, 2017. The fair value of the Company’s outstanding employee stock options is estimated on the date of grant using the Black-Scholes option pricing model. The Company estimates expected market price volatility and expected term of the options based on historical data and other factors.

 

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

 

The following tables below summarize outstanding and exercisable options at March 31, 2017 and December 31, 2016.

 

 

       Weighted       Weighted-Average 
       Average   Aggregate   Contractual Life 
       Exercise   Intrinsic   Remaining In 
(dollars in thousands, except per share amounts)  Shares   Price   Value   Years 
                 
Outstanding at January 1, 2017   15,081   $27.70   $-      
Exercised   (1,865)   27.70    5      
                     
Outstanding at March 31, 2017   13,216   $27.70   $110    0.3 
                     
Exercisable at March 31, 2017   13,216   $27.70   $110    0.3 

 

 8 

 

 

       Weighted       Weighted-Average 
       Average   Aggregate   Contractual Life 
       Exercise   Intrinsic   Remaining In 
(dollars in thousands, except per share amounts)  Shares   Price   Value   Years 
                 
Outstanding at January 1, 2016   21,211   $27.70   $-      
Forfeited   (6,130)   27.70           
                     
Outstanding at December 31, 2016   15,081   $27.70   $20    0.5 
                     
Exercisable at December 31, 2016   15,081   $27.70   $20    0.5 

 

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

 

Shares Outstanding  Weighted Average  Weighted Average 
March 31, 2017  Remaining Contractual Life  Exercise Price 
13,216  less than 1 year  $27.70 
         

  

The aggregate intrinsic value of outstanding stock options and exercisable stock options was $110,000 at March 31, 2017 and $20,000 at December 31, 2016. Aggregate intrinsic value represents the difference between the Company’s closing stock price on the last trading day of the period, which was $36.00 and $29.00 per share at March 31, 2017 and December 31, 2016, respectively, and the exercise price multiplied by the number of options outstanding.

 

The Company granted restricted stock and stock units in accordance with the Plan. The vesting period for outstanding granted restricted stock is between three and five years. As of March 31, 2017 and December 31, 2016, unrecognized stock compensation expense was $897,000 and $810,000, respectively. The following tables summarize the unvested restricted stock awards outstanding at March 31, 2017 and December 31, 2016, respectively.

 

   Restricted Stock 
   Number of Shares   Weighted
Average Grant
Date Fair Value
 
         
Nonvested at January 1, 2017   47,881   $20.41 
Granted   6,752    30.20 
Vested   (18,423)   20.04 
Cancelled   (86)   20.75 
           
Nonvested at March 31, 2017   36,124   $22.43 

 

 

   Restricted Stock 
   Number of Shares   Weighted
Average Grant
Date Fair Value
 
         
Nonvested at January 1, 2016   37,048   $19.83 
Granted   27,403    21.00 
Vested   (15,912)   20.09 
Cancelled   (658)   20.31 
           
Nonvested at December 31, 2016   47,881   $20.41 

 

 9 

 

  

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

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

 

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

 

 

NOTE 8 – SUBORDINATED NOTES

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

 

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

 

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

 

 10 

 

 

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

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

 

   Three Months Ended March 31,   Years Ended
December 31,
 
(dollars in thousands)  2017   2016   2016 
Balance at beginning of year  $7,763   $9,449   $9,449 
Additions of underlying property   -    2,515    3,120 
Disposals of underlying property   (820)   (671)   (3,860)
Transfers to premises and equipment   -    -    (372)
Valuation allowance   (196)   (255)   (574)
Balance at end of period  $6,747   $11,038   $7,763 

 

During the three months ended March 31, 2017, there were no additions to OREO. The Company disposed of three residential properties and three residential lots for proceeds of $846,000 and a gain of $27,000 for the three months ended March 31, 2017. The Bank provided $200,000 in financing for one residential property and the three residential lots which were transferred from OREO to loans during the first quarter of 2017. The transaction qualified for full accrual sales treatment under ASC Topic 360-20-40 “Property Plant and Equipment – Derecognition”.

 

During the three months ended March 31, 2016, additions of $2.5 million consisted of $400,000 for a residential property and $2.1 million for a deed in lieu of foreclosure on an improved commercial office building with multiple tenants. The Company disposed of one residential property and two commercial properties for proceeds of $676,000 and a gain of $5,000 for the three months ended March 31, 2016.

 

The Company had $314,000 and $353,000 of impaired loans secured by residential real estate for which formal foreclosure proceedings were in process as of March 31, 2017 and December 31, 2016, respectively.

 

Additions to the valuation allowances of $196,000 and $255,000 were taken to adjust properties to current appraised values for the three months ended March 31, 2017 and 2016, respectively. OREO carrying amounts reflect management’s estimate of the realizable value of these properties incorporating current appraised values, local real estate market conditions and related costs. Expenses applicable to OREO assets included the following.

 

   Three Months Ended March 31, 
(dollars in thousands)  2017   2016 
Valuation allowance  $196   $255 
Operating expenses   (1)   46 
   $195   $301 

 

 

 11 

 

 

 

NOTE 10 – SECURITIES

 

   March 31, 2017 
   Amortized   Gross Unrealized   Gross Unrealized   Estimated 
(dollars in thousands)  Cost   Gains   Losses   Fair Value 
Securities available for sale (AFS)                    
Asset-backed securities issued by GSEs and
U.S. Agencies
                    
Residential Mortgage Backed Securities ("MBS")  $5,777   $-   $145   $5,632 
Residential Collateralized Mortgage
Obligations ("CMOs")
   37,771    25    916    36,880 
U.S. Agency   10,371    -    314    10,057 
Corporate equity securities   37    -    -    37 
Bond mutual funds   4,408    28    -    4,436 
Total securities available for sale  $58,364   $53   $1,375   $57,042 
                     
Securities held to maturity (HTM)                    
Asset-backed securities issued by GSEs and
U.S. Agencies
                    
Residential MBS  $33,503   $374   $315   $33,562 
Residential CMOs   60,073    183    714    59,542 
U.S. Agency   6,599    -    169    6,430 
Asset-backed securities issued by Others:                    
Residential CMOs   792    -    71    721 
Callable GSE Agency Bonds   3,000    -    17    2,983 
U.S. government obligations   998    -    -    998 
Total securities held to maturity  $104,965   $557   $1,286   $104,236 

 

 

   December 31, 2016 
   Amortized   Gross Unrealized   Gross Unrealized   Estimated 
(dollars in thousands)  Cost   Gains   Losses   Fair Value 
Securities available for sale (AFS)                    
Asset-backed securities issued by GSEs and
U.S. Agencies
                    
Residential MBS  $4,377   $-   $194   $4,183 
Residential CMOs   35,176    18    966    34,228 
U.S. Agency   10,589    -    417    10,172 
Corporate equity securities   37    -    -    37 
Bond mutual funds   4,386    27    -    4,413 
Total securities available for sale  $54,565   $45   $1,577   $53,033 
                     
Securities held to maturity (HTM)                    
Asset-backed securities issued by GSEs and
U.S. Agencies
                    
Residential MBS  $34,735   $367   $569   $34,533 
Residential CMOs   63,060    135    802    62,393 
U.S. Agency   6,717    -    253    6,464 
Asset-backed securities issued by Others:                    
Residential CMOs   884    -    81    803 
Callable GSE Agency Bonds   3,001    -    10    2,991 
U.S. government obligations   850    -    -    850 
Total securities held to maturity  $109,247   $502   $1,715   $108,034 
 12 

 

 

At March 31, 2017, securities with an amortized cost of $25.1 million were pledged to secure certain customer deposits. At March 31, 2017, securities with an amortized cost of $1.5 million were pledged as collateral for advances from the Federal Home Loan Bank (“FHLB”) of Atlanta.

 

At March 31, 2017, 99% of the asset-backed securities and agency bond portfolio was rated AAA by Standard & Poor’s or the equivalent credit rating from another major rating agency. AFS asset-backed securities issued by GSEs and U.S. Agencies had an average life of 5.01 years and average duration of 4.47 years and are guaranteed by their issuer as to credit risk. HTM asset-backed securities issued by GSEs and U.S. Agencies had an average life of 5.14 years and average duration of 4.57 years and are guaranteed by their issuer as to credit risk.

 

At December 31, 2016, securities with an amortized cost of $21.5 million were pledged to secure certain deposits. At December 31, 2016, securities with an amortized cost of $1.6 million were pledged as collateral for advances from the Federal Home Loan Bank (“FHLB”) of Atlanta.

 

At December 31, 2016, 99% of the asset-backed securities and agency bond portfolio was rated AAA by Standard & Poor’s or the equivalent credit rating from another major rating agency. AFS asset-backed securities issued by GSEs and U.S. Agencies had an average life of 4.96 years and average duration of 4.43 years and are guaranteed by their issuer as to credit risk. HTM asset-backed securities issued by GSEs and U.S. Agencies had an average life of 5.30 years and average duration of 4.71 years and are guaranteed by their issuer as to credit risk.

 

Management believes that AFS securities with unrealized losses will either recover in market value or be paid off as agreed. The Company intends to, and has the ability to, hold these securities to maturity. Because our intention is not to sell the investments and it is not more likely than not that the Company will be required to sell the investments, management considers the unrealized losses in the AFS portfolio to be temporary. We believe that the losses are the result of general perceptions of safety and creditworthiness of the entire sector and a general disruption of orderly markets in the asset class.

 

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

 

No charges related to other-than-temporary impairment were made during for the three months ended March 31, 2017 and the year ended December 31, 2016.

 

During the three months ended March 31, 2017 and 2016, respectively, there were no securities sold. During the year ended December 31, 2016 the Company recognized net gains on the sale of securities of $31,000. The Company sold five AFS securities with aggregate carrying values of $6.5 million and one HTM security with a carrying value of $698,000, recognizing gains of $23,000 and $8,000, respectively.

 

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

 

AFS Securities

Gross unrealized losses and estimated fair value by length of time that the individual AFS securities have been in a continuous unrealized loss position at March 31, 2017 were as follows:

 

March 31, 2017  Less Than 12   More Than 12         
   Months   Months   Total 
(dollars in thousands)  Fair Value   Unrealized
Loss
   Fair Value   Unrealized
Loss
   Fair Value   Unrealized
Losses
 
Asset-backed securities issued by
GSEs and U.S. Agencies
  $35,765   $891   $13,698   $484   $49,463   $1,375 

 

 

 13 

 

 

At March 31, 2017, the AFS investment portfolio had an estimated fair value of $57.0 million, of which $49.5 million of the securities had some unrealized losses from their amortized cost.

 

AFS asset-backed securities issued by GSEs are guaranteed by the issuer and AFS U.S. government agency securities and bonds are guaranteed by the full faith and credit of the U.S. government. Total unrealized losses on the portfolio were $1.4 million of the portfolio amortized cost of $53.9 million. AFS asset-backed securities issued by GSEs and U.S. Agencies with unrealized losses had an average life of 4.93 years and an average duration of 4.40 years. Management believes that the securities will either recover in market value or be paid off as agreed.

 

Gross unrealized losses and estimated fair value by length of time that the individual AFS securities have been in a continuous unrealized loss position at December 31, 2016 were as follows:

 

December 31, 2016  Less Than 12   More Than 12         
   Months   Months   Total 
(dollars in thousands)  Fair Value   Unrealized
Loss
   Fair Value   Unrealized
Loss
   Fair Value   Unrealized
Losses
 
Asset-backed securities issued by
GSEs and U.S. Agencies
  $34,262   $1,110   $11,846   $467   $46,108   $1,577 

 

At December 31, 2016, the AFS investment portfolio had an estimated fair value of $53.0 million, of which $46.1 million of the securities had some unrealized losses from their amortized cost.

 

AFS asset-backed securities issued by GSEs are guaranteed by the issuer and AFS U.S. government agency securities and bonds are guaranteed by the full faith and credit of the U.S. government. Total unrealized losses on the portfolio were $1.6 million of the portfolio amortized cost of $50.1 million. AFS asset-backed securities issued by GSEs and U.S. Agencies with unrealized losses had an average life of 4.91 years and an average duration of 4.37 years. Management believes that the securities will either recover in market value or be paid off as agreed.

 

HTM Securities

Gross unrealized losses and estimated fair value by length of time that the individual HTM securities have been in a continuous unrealized loss position at March 31, 2017 were as follows:

 

March 31, 2017  Less Than 12   More Than 12         
   Months   Months   Total 
(dollars in thousands)  Fair Value   Unrealized
Loss
   Fair Value   Unrealized
Loss
   Fair Value   Unrealized
Losses
 
Asset-backed securities issued by
GSEs and U.S. Agencies
   68,205    1,033    5,978    165    74,183    1,198 
Callable GSE Agency Bonds   2,983    17    -    -    2,983    17 
Asset-backed securities issued by
Others
   -    -    721    71    721    71 
   $71,188   $1,050   $6,699   $236   $77,887   $1,286 

 

At March 31, 2017, the HTM investment portfolio had an estimated fair value of $104.2 million, of which $77.9 million of the securities had some unrealized losses from their amortized cost. Of these securities, $74.2 million were asset-backed securities issued by GSEs and U.S. Agencies and $3.0 million of callable GSE Agency Bonds. The remaining $721,000 were asset-backed securities issued by others.

 

HTM asset-backed securities issued by GSEs and GSE agency bonds are guaranteed by the issuer and HTM U.S. government agency securities and bonds are guaranteed by the full faith and credit of the U.S. government. Total unrealized losses on the portfolio were $1.2 million of the portfolio amortized cost of $104.2 million. The securities with unrealized losses had an average life of 5.26 years and an average duration of 4.66 years. Management believes that the securities will either recover in market value or be paid off as agreed. The Company intends to, and has the ability to, hold these securities to maturity.

 

 14 

 

 

HTM asset-backed securities issued by others are collateralized mortgage obligation securities. The securities have credit support tranches that absorb losses prior to the tranches that the Company owns. The Company reviews credit support positions on its securities regularly. Total unrealized losses on the asset-backed securities issued by others were $71,000 of the portfolio amortized cost of $792,000. HTM asset-backed securities issued by others with unrealized losses had an average life of 3.30 years and an average duration of 2.74 years.

 

Gross unrealized losses and estimated fair value by length of time that the individual HTM securities have been in a continuous unrealized loss position at December 31, 2016 were as follows:

 

December 31, 2016  Less Than 12   More Than 12         
   Months   Months   Total 
(dollars in thousands)  Fair Value   Unrealized
Loss
   Fair Value   Unrealized
Loss
   Fair Value   Unrealized
Losses
 
Asset-backed securities issued by
GSEs and U.S. Agencies
  $77,879   $1,452   $6,340   $182   $84,219   $1,634 
Asset-backed securities issued by
Others
   -    -    803    81    803    81 
   $77,879   $1,452   $7,143   $263   $85,022   $1,715 

 

At December 31, 2016, the HTM investment portfolio had an estimated fair value of $108.0 million, of which $85.0 million of the securities had some unrealized losses from their amortized cost. Of these securities, $84.2 million were asset-backed securities issued by GSEs and U.S. Agencies. The remaining $803,000 were asset-backed securities issued by others.

 

HTM asset-backed securities issued by GSEs are guaranteed by the issuer and HTM U.S. government agency securities and bonds are guaranteed by the full faith and credit of the U.S. government. Total unrealized losses on the portfolio were $1.6 million of the portfolio amortized cost of $108.4 million. The securities with unrealized losses had an average life of 5.06 years and an average duration of 4.49 years. Management believes that the securities will either recover in market value or be paid off as agreed. The Company intends to, and has the ability to, hold these securities to maturity.

 

HTM asset-backed securities issued by others are collateralized mortgage obligation securities. The securities have credit support tranches that absorb losses prior to the tranches that the Company owns. The Company reviews credit support positions on its securities regularly. Total unrealized losses on the asset-backed securities issued by others were $81,000 of the portfolio amortized cost of $884,000. HTM asset-backed securities issued by others with unrealized losses had an average life of 4.15 years and an average duration of 3.29 years.

 

Credit Quality of Asset-Backed Securities and Agency Bonds

The tables below present the Standard & Poor’s (“S&P”) or equivalent credit rating from other major rating agencies for AFS and HTM asset-backed securities issued by GSEs and U.S. Agencies and others or bonds issued by GSEs or U.S. government agencies at March 31, 2017 and December 31, 2016 by carrying value. The Company considers noninvestment grade securities rated BB+ or lower as classified assets for regulatory and financial reporting. GSE asset-backed securities and GSE agency bonds with S&P AA+ ratings were treated as AAA based on regulatory guidance.

 

March 31, 2017  December 31, 2016
Credit Rating  Amount   Credit Rating  Amount 
(dollars in thousands)
AAA  $156,742   AAA  $156,947 
BB   364   BB   411 
B+   428   B+   472 
Total  $157,534   Total  $157,830 

 

 

 15 

 

 

NOTE 11 – LOANS

Loans consist of the following:

 

(dollars in thousands)  March 31, 2017   %   December 31, 2016   % 
                 
Commercial real estate  $677,205    60.79%  $667,105    61.25%
Residential first mortgages   178,903    16.06%   171,004    15.70%
Residential rentals   100,891    9.06%   101,897    9.36%
Construction and land development   37,761    3.39%   36,934    3.39%
Home equity and second mortgages   21,392    1.92%   21,399    1.97%
Commercial loans   55,091    4.95%   50,484    4.64%
Consumer loans   439    0.04%   422    0.04%
Commercial equipment   42,060    3.78%   39,737    3.65%
    1,113,742    100.00%   1,088,982    100.00%
Less:                    
Deferred loan fees and premiums   (736)   -0.07%   (397)   -0.04%
Allowance for loan losses   10,109    0.91%   9,860    0.91%
    9,373         9,463      
   $1,104,369        $1,079,519      

 

At March 31, 2017 and December 31, 2016, the Bank’s allowance for loan losses totaled $10.1 million and $9.9 million, or 0.91% and 0.91%, respectively, of loan balances. Management’s determination of the adequacy of the allowance is based on a periodic evaluation of the portfolio with consideration given to the overall loss experience, current economic conditions, size, growth and composition of the loan portfolio, financial condition of the borrowers and other relevant factors that, in management’s judgment, warrant recognition in providing an adequate allowance.

 

Deferred loan fees and premiums include net deferred fees paid by customers of $2.7 million and $2.7 million at March 31, 2017 and December 31, 2016, respectively. These were offset by net deferred premiums for the purchase of residential first mortgages and deferred costs of $3.4 million and $3.1 million, respectively, at March 31, 2017 and December 31, 2016, respectively.

 

Prior to April 1, 2016, loans secured by residential rental property were included in the residential first mortgage and commercial real estate loan portfolios. Beginning in the second quarter of 2016, the Company segregated loans secured by residential rental property into a new loan portfolio segment. Residential rental property includes income producing properties comprising 1-4 family units and apartment buildings. The Company’s decision to segregate the residential rental property portfolio for financial reporting was based on the growth and size of the portfolio and risk characteristics unique to residential rental properties. Comparative financial information was reclassified to conform to the classification presented.

 

 16 

 

 

Risk Characteristics of Portfolio Segments

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

 

Commercial Real Estate (“CRE”)

Commercial and other real estate projects include office buildings, retail locations, churches, other special purpose buildings and commercial construction. Commercial construction balances were 7.2% and 9.3% of the CRE portfolio at March 31, 2017 and December 31, 2016, respectively. The Bank offers both fixed-rate and adjustable-rate loans under these product lines. The primary security on a commercial real estate loan is the real property and the leases that produce income for the real property. Loans secured by commercial real estate are generally limited to 80% of the lower of the appraised value or sales price at origination and have an initial contractual loan payment period ranging from three to 20 years.

 

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

 

Residential First Mortgages

Residential first mortgage loans are generally long-term loans, amortized on a monthly basis, with principal and interest due each month. The contractual loan payment period for residential loans typically ranges from ten to 30 years. The Bank’s experience indicates that real estate loans remain outstanding for significantly shorter time periods than their contractual terms. Borrowers may refinance or prepay loans at their option, without penalty. The Bank’s residential portfolio has both fixed-rate and adjustable-rate residential first mortgages. During the three months ended March 31, 2017 and the years ended December 31, 2016, the Bank purchased residential first mortgages of $11.6 million and $64.2 million, respectively.

  

The annual and lifetime limitations on interest rate adjustments may limit the increases in interest rates on these loans. There are also credit risks resulting from potential increased costs to the borrower as a result of repricing of adjustable-rate mortgage loans. During periods of rising interest rates, the risk of default on adjustable-rate mortgage loans may increase due to the upward adjustment of interest cost to the borrower. The Bank’s adjustable rate residential first mortgage portfolio was $55.5 million or 5.0% of total gross loans of $1.11 billion at March 31, 2017 compared to $45.6 million or 4.2% of total gross loans of $1.09 billion at December 31, 2016.

 

Residential Rentals

Residential rental mortgage loans are amortizing, with principal and interest due each month. The loans are secured by income-producing 1-4 family units and apartments. As of March 31, 2017 and December 31, 2016, $84.0 million and $84.9 million, respectively, were 1-4 family units and $16.9 million and $17.0 million, respectively, were apartment buildings. Loans secured by residential rental properties are generally limited to 80% of the lower of the appraised value or sales price at origination and have an initial contractual loan payment period ranging from three to 20 years. The primary security on a residential rental loan is the property and the leases that produce income. During periods of rising interest rates, the risk of default on adjustable-rate mortgage loans may increase due to the upward adjustment of interest cost to the borrower. The Bank’s adjustable rate residential rental portfolio was $83.3 million or 7.5% of total gross loans of $1.11 billion at March 31, 2017 compared to $84.0 million or 7.7% of total gross loans of $1.09 billion at December 31, 2016.

 

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

 

Construction and Land Development

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

 

 17 

 

 

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

 

Home Equity and Second Mortgage Loans

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

 

Commercial Loans

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

 

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

 

Consumer Loans

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

 

Commercial Equipment Loans

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

  

 18 

 

 

Non-accrual and Past Due Loans

Non-accrual loans as of March 31, 2017 and December 31, 2016 were as follows: 

 

   March 31, 2017 
(dollars in thousands)  90 or Greater
Days
Delinquent
   Number
of Loans
   Non-accrual
Only Loans
   Number
of Loans
   Total
Non-accrual
Loans
   Total
Number
of Loans
 
                         
Commercial real estate  $1,710    6   $-    -   $1,710    6 
Residential first mortgages   488    3    -    -    488    3 
Residential rentals   899    4    -    -    899    4 
Construction and land development   3,048    2    -    -    3,048    2 
Home equity and second mortgages   172    3    -    -    172    3 
Commercial loans   376    3    662    2    1,038    5 
Commercial equipment   475    4    -    -    475    4 
   $7,168    25   $662    2   $7,830    27 

 

 

   December 31, 2016 
(dollars in thousands)  90 or Greater
Days
Delinquent
   Number
of Loans
   Non-accrual
Only Loans
   Number
of Loans
   Total
Non-accrual
Loans
   Total
Number
of Loans
 
                         
Commercial real estate  $2,371    7   $-    -   $2,371    7 
Residential first mortgages   623    4    -    -    623    4 
Residential rentals   577    4    -    -    577    4 
Construction and land development   3,048    2    -    -    3,048    2 
Home equity and second mortgages   61    2    -    -    61    2 
Commercial loans   375    3    669    2    1,044    5 
Commercial equipment   650    5    -    -    650    5 
   $7,705    27   $669    2   $8,374    29 

 

Non-accrual loans (90 days or greater delinquent and non-accrual only loans) decreased $544,000 from $8.4 million or 0.77% of total loans at December 31, 2016 to $7.8 million or 0.70% of total loans at March 31, 2017. Non-accrual only loans are loans classified as non-accrual due to customer operating results or payment history. In accordance with the Company’s policy, interest income is recognized on a cash basis for these loans.

 

Non-accrual loans at March 31, 2017 included $6.2 million, or 79% of non-accrual loans, attributed to 11 loans representing six customer relationships. Non-accrual loans at December 31, 2016 included $6.4 million, or 77% of non-accrual loans, attributed to 15 loans representing six customer relationships. Non-accrual loans included five troubled debt restructures (“TDRs”) totaling $4.6 million at March 31, 2017 and six troubled debt restructures (“TDRs”) totaling $4.7 million at December 31, 2016. These loans are classified solely as non-accrual loans for the calculation of financial ratios.

 

Non-accrual loans on which the recognition of interest has been discontinued, which did not have a specific allowance for impairment, amounted to $6.7 million and $7.8 million at March 31, 2017 and December 31, 2016, respectively. Interest due but not recognized on these balances at March 31, 2017 and December 31, 2016 was $844,000 and $947,000, respectively. Non-accrual loans with a specific allowance for impairment on which the recognition of interest has been discontinued amounted to $1.1 million and $575,000 at March 31, 2017 and December 31, 2016, respectively. Interest due but not recognized on these balances at March 31, 2017 and December 31, 2016 was $218,000 and $156,000, respectively.

 

 19 

 

 

Past due loans as of March 31, 2017 and December 31, 2016 were as follows:

 

   March 31, 2017 
(dollars in thousands)  Current   31-60
Days
   61-89
Days
   90 or Greater
Days
   Total
Past Due
   Total
Loan
Receivables
   Loans > 90 Days
and Accruing
 
Commercial real estate  $675,345   $150   $-   $1,710   $1,860   $677,205   $- 
Residential first mortgages   178,415    -    -    488    488    178,903    - 
Residential rentals   99,992    -    -    899    899    100,891    - 
Construction and land dev.   34,713    -    -    3,048    3,048    37,761    - 
Home equity and second mtg.   21,181    39    -    172    211    21,392    - 
Commercial loans   54,715    -    -    376    376    55,091    - 
Consumer loans   437    1    1    -    2    439    - 
Commercial equipment   41,545    40    -    475    515    42,060    - 
Total  $1,106,343   $230   $1   $7,168   $7,399   $1,113,742   $- 

 

  

   December 31, 2016 
(dollars in thousands)  Current   31-60
Days
   61-89
Days
   90 or Greater
Days
   Total
Past Due
   Total
Loan
Receivables
   Loans > 90 Days
and Accruing
 
Commercial real estate  $664,250   $-   $484   $2,371   $2,855   $667,105   $- 
Residential first mortgages   170,381    -    -    623    623    171,004    - 
Residential rentals   101,309    -    11    577    588    101,897    - 
Construction and land dev.   33,886    -    -    3,048    3,048    36,934    - 
Home equity and second mtg.   21,175    130    33    61    224    21,399    - 
Commercial loans   49,778    331    -    375    706    50,484    - 
Consumer loans   420    -    2    -    2    422    - 
Commercial equipment   39,044    42    1    650    693    39,737    - 
Total  $1,080,243   $503   $531   $7,705   $8,739   $1,088,982   $- 

 

 20 

 

 

Impaired Loans and Troubled Debt Restructures (“TDRs”)

Impaired loans, including TDRs, at March 31, 2017 and 2016 and at December 31, 2016 were as follows:

 

   March 31, 2017 
(dollars in thousands)  Unpaid
Contractual
Principal Balance
   Recorded
Investment With No
Allowance
   Recorded
Investment
With Allowance
   Total
Recorded
Investment
   Related
Allowance
   Quarter
Average Recorded
Investment
   Quarter
Interest Income
Recognized
 
                             
Commercial real estate  $20,300   $15,543   $4,564   $20,107   $795   $20,213   $225 
Residential first mortgages   2,534    2,035    472    2,507    17    2,523    28 
Residential rentals   3,320    2,750    570    3,320    71    3,379    30 
Construction and land dev.   4,304    2,926    851    3,777    188    3,777    3 
Home equity and second mtg.   232    232    -    232    -    233    1 
Commercial loans   3,088    2,832    169    3,001    169    3,029    28 
Commercial equipment   648    112    500    612    425    633    8 
Total  $34,426   $26,430   $7,126   $33,556   $1,665   $33,787   $323 

 

 

   December 31, 2016 
(dollars in thousands)  Unpaid
Contractual
Principal Balance
   Recorded
Investment With No
Allowance
   Recorded
Investment With
Allowance
   Total
Recorded
Investment
   Related
Allowance
   Average Recorded
Investment
   Interest Income
Recognized
 
                             
Commercial real estate  $22,195   $14,896   $7,081   $21,977   $806   $22,303   $908 
Residential first mortgages   2,436    1,938    475    2,413    7    2,445    90 
Residential rentals   3,440    2,850    178    3,028    36    3,486    134 
Construction and land dev.   4,304    2,926    851    3,777    178    3,867    16 
Home equity and second mtg.   170    170    -    170    -    176    7 
Commercial loans   3,285    3,004    200    3,204    123    3,442    137 
Commercial equipment   855    652    139    791    139    815    17 
Total  $36,685   $26,436   $8,924   $35,360   $1,289   $36,534   $1,309 

 

 21 

 

 

   March 31, 2016 
(dollars in thousands)  Unpaid
Contractual
Principal Balance
   Recorded
Investment With No
Allowance
   Recorded
Investment
With Allowance
   Total
Recorded
Investment
   Related
Allowance
   Quarter
Average Recorded
Investment
   Quarter
Interest Income
Recognized
 
                             
Commercial real estate  $23,104   $20,723   $2,352   $23,075   $598   $23,203   $208 
Residential first mortgages   2,838    2,346    491    2,837    27    2,865    25 
Residential rentals   4,414    3,777    239    4,016    53    4,026    34 
Construction and land dev.   4,284    3,780    431    4,211    398    4,210    4 
Home equity and second mtg.   130    130    -    130    -    128    1 
Commercial loans   4,857    4,179    192    4,371    74    4,376    33 
Commercial equipment   848    687    138    825    138    845    5 
Total  $40,475   $35,622   $3,843   $39,465   $1,288   $39,653   $310 

 

 22 

 

 

TDRs, included in the impaired loan schedules above, as of March 31, 2017 and December 31, 2016 were as follows:

 

   March 31, 2017   December 31, 2016 
(dollars in thousands)  Dollars   Number
of Loans
   Dollars   Number
of Loans
 
                 
Commercial real estate  $9,520    9   $9,587    8 
Residential first mortgages   542    2    545    2 
Residential rentals   225    1    227    1 
Construction and land development   3,777    4    3,777    4 
Commercial loans   668    3    872    5 
Commercial equipment   111    2    113    2 
Total TDRs  $14,843    21   $15,121    22 
Less: TDRs included in non-accrual loans   (4,579)   (5)   (4,673)   (6)
Total accrual TDR loans  $10,264    16   $10,448    16 

 

TDRs decreased $278,000 from $15.1 million at December 31, 2016 to $14.8 million at March 31, 2017. TDRs that are included in non-accrual are classified solely as non-accrual loans for the calculation of financial ratios. The Company had specific reserves of $848,000 on 10 TDRs totaling $5.9 million at March 31, 2017 and $844,000 on nine TDRs totaling $5.7 million at December 31, 2016. Interest income in the amount of $114,000 and $357,000 was recognized on outstanding TDR loans for the three months ended March 31, 2017 and the year ended December 31, 2016, respectively.

 

During the three months ended March 31, 2017, TDR disposals, which included payoffs and refinancing decreased by one loan of $167,000 and TDR loan principal curtailment was $111,000. There were no TDRs added during the three months ended March 31, 2017. During the year ended December 31, 2016 the Company added one TDR loan totaling $196,000. TDR disposals, which included payoffs and refinancing for the year ended December 31, 2016 decreased by nine loans or $2.1 million. TDR loan principal curtailment was $1.6 million for the year ended December 31, 2016.

 

 23 

 

 

Allowance for Loan Losses

The following tables detail activity in the allowance for loan losses at and for the three months ended March 31, 2017 and 2016, respectively. An allocation of the allowance to one category of loans does not prevent the Company from using that allowance to absorb losses in a different category.

 

   March 31, 2017 
(dollars in thousands)  Beginning Balance   Charge-offs   Recoveries   Provisions   Ending
Balance
 
Three Months Ended                    
Commercial real estate  $5,212   $-   $5   $(38)  $5,179 
Residential first mortgages   1,406    -    -    22    1,428 
Residential rentals   362    -    -    (8)   354 
Construction and land development   941    -    -    (50)   891 
Home equity and second mortgages   138    -    -    (62)   76 
Commercial loans   794    -    1    (6)   789 
Consumer loans   3    (2)   -    4    5 
Commercial equipment   1,004    (146)   11    518    1,387 
   $9,860   $(148)  $17   $380   $10,109 

 

 

   March 31, 2016 
(dollars in thousands)  Beginning Balance   Charge-offs   Recoveries   Provisions   Ending
Balance
 
Three Months Ended                    
Commercial real estate  $3,465   $-   $2   $371   $3,838 
Residential first mortgages   584    -    -    7    591 
Residential rentals   538    -    -    52    590 
Construction and land development   1,103    (73)   1    98    1,129 
Home equity and second mortgages   142    -    5    (13)   134 
Commercial loans   1,477    (325)   3    (109)   1,046 
Consumer loans   2    (1)   -    -    1 
Commercial equipment   1,229    -    12    21    1,262 
   $8,540   $(399)  $23   $427   $8,591 

 

 24 

 

 

The following tables detail loan receivable and allowance balances disaggregated on the basis of the Company’s impairment methodology at March 31, 2017 and 2016 and December 31, 2016.

 

   March 31, 2017   December 31, 2016   March 31, 2016 
(dollars in thousands)  Ending balance:
individually
evaluated for
impairment
   Ending balance:
collectively
evaluated for
impairment
   Total   Ending balance:
individually
evaluated for
impairment
   Ending balance:
collectively
evaluated for
impairment
   Total   Ending balance:
individually
evaluated for
impairment
   Ending balance:
collectively
evaluated for
impairment
   Total 
Loan Receivables:                                             
Commercial real estate  $20,107   $657,098   $677,205   $21,977   $645,128   $667,105   $23,075   $547,340   $570,415 
Residential first mortgages   2,507    176,396    178,903    2,413    168,591    171,004    2,837    131,452    134,289 
Residential rentals   3,320    97,571    100,891    3,028    98,869    101,897    4,016    90,789    94,805 
Construction and land development   3,777    33,984    37,761    3,777    33,157    36,934    4,211    34,476    38,687 
Home equity and second mortgages   232    21,160    21,392    170    21,229    21,399    130    20,889    21,019 
Commercial loans   3,001    52,090    55,091    3,204    47,280    50,484    4,371    49,849    54,220 
Consumer loans   -    439    439    -    422    422    -    330    330 
Commercial equipment   612    41,448    42,060    791    38,946    39,737    825    30,554    31,379 
   $33,556   $1,080,186   $1,113,742   $35,360   $1,053,622   $1,088,982   $39,465   $905,679   $945,144 
                                              
Allowance for loan losses:                                             
Commercial real estate  $795   $4,384   $5,179   $806   $4,406   $5,212   $598   $3,240   $3,838 
Residential first mortgages   17    1,411    1,428    7    1,399    1,406    27    564    591 
Residential rentals   71    283    354    36    326    362    53    537    590 
Construction and land development   188    703    891    178    763    941    398    731    1,129 
Home equity and second mortgages   -    76    76    -    138    138    -    134    134 
Commercial loans   169    620    789    123    671    794    74    972    1,046 
Consumer loans   -    5    5    -    3    3    -    1    1 
Commercial equipment   425    962    1,387    139    865    1,004    138    1,124    1,262 
   $1,665   $8,444   $10,109   $1,289   $8,571   $9,860   $1,288   $7,303   $8,591 

 

During the fourth quarter of 2016, the Company expanded its factor scoring categories from three levels to five levels to capture additional movements in qualitative factors used to calculate the general allowance of each portfolio segment. No additional qualitative factors were added to the Company’s methodology as part of this change. There were no material changes to the existing allowance for loan losses by portfolio segment or in the aggregate as a result of the change. 

 

 25 

 

 

Credit Quality Indicators

Credit quality indicators as of March 31, 2017 and December 31, 2016 were as follows:

 

Credit Risk Profile by Internally Assigned Grade

 

   Commercial Real Estate   Construction and Land Dev.   Residential Rentals 
(dollars in thousands)  3/31/2017   12/31/2016   3/31/2017   12/31/2016   3/31/2017   12/31/2016 
                         
Unrated  $51,002   $51,503   $1,446   $1,632   $24,919   $25,563 
Pass   605,610    594,768    32,537    31,525    74,755    74,989 
Special mention   1,031    -    -    -    -    - 
Substandard   19,562    20,834    3,778    3,777    1,217    1,345 
Doubtful   -    -    -    -    -    - 
Loss   -    -    -    -    -    - 
Total  $677,205   $667,105   $37,761   $36,934   $100,891   $101,897 

 

 

   Commercial Loans   Commercial Equipment   Total  Commercial Portfolios 
(dollars in thousands)  3/31/2017   12/31/2016   3/31/2017   12/31/2016   3/31/2017   12/31/2016 
                         
Unrated  $11,674   $11,266   $11,590   $11,769   $100,631   $101,733 
Pass   40,456    36,221    29,970    27,290    783,328    764,793 
Special mention   -    -    -    -    1,031    - 
Substandard   2,961    2,997    500    541    28,018    29,494 
Doubtful   -    -    -    137    -    137 
Loss   -    -    -    -    -    - 
Total  $55,091   $50,484   $42,060   $39,737   $913,008   $896,157 

 

 

Credit Risk Profile Based on Payment Activity

 

   Residential First Mortgages   Home Equity and Second Mtg.   Consumer Loans 
(dollars in thousands)  3/31/2017   12/31/2016   3/31/2017   12/31/2016   3/31/2017   12/31/2016 
                         
Performing  $178,415   $170,381   $21,220   $21,338   $439   $422 
Nonperforming   488    623    172    61    -    - 
Total  $178,903   $171,004   $21,392   $21,399   $439   $422 

 

A risk grading scale is used to assign grades to commercial relationships, which include commercial real estate, residential rentals, construction and land development, commercial loans and commercial equipment loans. Loans are graded at inception, annually thereafter when financial statements are received and at other times when there is an indication that a credit may have weakened or improved. Only commercial loan relationships with an aggregate exposure to the Bank of $750,000 or greater are subject to being risk rated.

 

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

 

 26 

 

 

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

 

Ratings 1 thru 6 - Pass

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

 

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

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

 

Rating 8 - Substandard

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

  

Rating 9 - Doubtful

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

 

Rating 10 – Loss

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

 

 27 

 

 

NOTE 12 – REGULATORY

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

 

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

 

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

 

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

 

As of March 31, 2017 and December 31, 2016, the Company and Bank were well-capitalized under the regulatory framework for prompt corrective action under the new Basel III Capital Rules. Management believes, as of March 31, 2017 and December 31, 2016, that the Company and the Bank met all capital adequacy requirements to which they were subject.

 

 28 

 

 

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

 

                 
Regulatory Capital and Ratios  The Company   The Bank 
(dollars in thousands)  March 31, 2017   December 31, 2016   March 31, 2017   December 31, 2016 
                 
Common Equity  $106,566   $104,426   $137,769   $136,109 
Preferred Stock -SBLF   -    -    -    - 
Total Stockholders' Equity   106,566    104,426    137,769    136,109 
AOCI Losses   801    928    801    928 
Common Equity Tier 1 Capital   107,367    105,354    138,570    137,037 
TRUPs   12,000    12,000    -    - 
Tier 1 Capital   119,367    117,354    138,570    137,037 
Allowable Reserve for Credit Losses and Other Tier 2 Adjustments   10,129    9,860    10,129    9,860 
Subordinated Notes   23,000    23,000    -    - 
Tier 2 Capital  $152,496   $150,214   $148,699   $146,897 
                     
Risk-Weighted Assets ("RWA")  $1,116,421   $1,104,505   $1,113,482   $1,102,116 
                     
Average Assets ("AA")  $1,340,046   $1,300,445   $1,337,326   $1,298,145 

 

   2019 Regulatory
 Min. Ratio + CCB (1)
             
Common Tier 1 Capital to RWA   7.00%   9.62%   9.54%   12.44%   12.43%
Tier 1 Capital to RWA   8.50    10.69    10.62    12.44    12.43 
Tier 2 Capital to RWA   10.50    13.66    13.60    13.35    13.33 
Tier 1 Capital to AA (Leverage)   n/a    8.91    9.02    10.36    10.56 

 

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

 

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NOTE 13 – FAIR VALUE MEASUREMENTS

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

 

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

 

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

 

Under FASB ASC Topic 820, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine the fair value. These hierarchy levels are:

 

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

 

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

 

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

 

Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’s quarterly valuation process. Transfers in and out of level 3 during a quarter are disclosed. There was one transfer from Level 2 to Level 3 in the fair value hierarchy for the three months ended March 31, 2017. There were no transfers between Level 1, 2 or 3 in the fair value hierarchy for the year ended December 31, 2016. The Company changed its presentation during the year ended December 31, 2016, for loans and OREO from Level 2 to Level 3. No changes were made to the Company’s valuation methodologies as a result of these changes. Comparative financial information was reclassified to conform to the classification presented in 2016.

 

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

 

Securities Available for Sale

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

 

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Loans Receivable

The Company does not record loans at fair value on a recurring basis, however, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan are considered impaired. Management estimates the fair value of impaired loans using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Impaired loans not requiring a specific allowance represent loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. At December 31, 2016 and 2015, substantially all of the impaired loans were evaluated based upon the fair value of the collateral.

 

In accordance with FASB ASC 820, impaired loans where an allowance is established based on the fair value of collateral (loans with impairment) require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price (e.g., contracted sales price), the Company records the loan as nonrecurring Level 2. When the fair value of the impaired loan is derived from an appraisal, the Company records the loan as nonrecurring Level 3. Fair value is re-assessed at least quarterly or more frequently when circumstances occur that indicate a change in the fair value. The fair values of impaired loans that are not measured based on collateral values are measured using discounted cash flows and considered to be Level 3 inputs.

 

Premises and Equipment Held For Sale

Premises and equipment are adjusted to fair value upon transfer of the assets to premises and equipment held for sale. Subsequently, premises and equipment held for sale are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised value of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price (e.g., contracted sales price), the Company records the asset as nonrecurring Level 2. When the fair value of premises and equipment is derived from an appraisal or a cash flow analysis, the Company records the asset at nonrecurring Level 3.

 

As of December 31, 2016, the Company had a small office condo under contract held for sale with a fair value of $345,000 that was recorded as a non-recurring Level 2 asset at December 31, 2016. The contract on the property was cancelled during the three months ended March 31, 2017, and the asset was transferred and recorded as a non-recurring Level 3 asset. No changes to the fair value recorded were deemed necessary based on evaluation of the market value of the property.

 

Other Real Estate Owned (“OREO”)

OREO is adjusted for fair value upon transfer of the loans to foreclosed assets. Subsequently, OREO is carried at the lower of carrying value and fair value. Fair value is based upon independent market prices, appraised value of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price (e.g., contracted sales price), the Company records the foreclosed asset as nonrecurring Level 2. When the fair value is derived from an appraisal, the Company records the foreclosed asset at nonrecurring Level 3.

 

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The tables below present the recorded amount of assets as of March 31, 2017 and December 31, 2016 measured at fair value on a recurring basis.

 

(dollars in thousands)  March 31, 2017 
Description of Asset  Fair Value   Level 1   Level 2   Level 3 
Available for sale securities                    
Asset-backed securities issued by GSEs
and U.S. Agencies
                    
CMOs  $36,880   $-   $36,880   $- 
MBS   5,632    -    5,632    - 
U.S. Agency   10,057    -    10,057    - 
Corporate equity securities   37    -    37    - 
Bond mutual funds   4,436    -    4,436    - 
Total available for sale securities  $57,042   $-   $57,042   $- 

 

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(dollars in thousands)  December 31, 2016 
Description of Asset  Fair Value   Level 1   Level 2   Level 3 
                 
Available for sale securities                    
Asset-backed securities issued by GSEs 
and U.S. Agencies
                    
CMOs  $34,228   $-   $34,228   $- 
MBS   4,183    -    4,183    - 
U.S. Agency   10,172    -    10,172    - 
Corporate equity securities   37    -    37    - 
Bond mutual funds   4,413    -    4,413    - 
Total available for sale securities  $53,033   $-   $53,033   $- 

 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The Company may be required to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. GAAP. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis as of March 31, 2017 and December 31, 2016 were included in the tables below.

 

(dollars in thousands)  March 31, 2017 
Description of Asset  Fair Value   Level 1   Level 2   Level 3 
Loans with impairment                    
Commercial real estate  $3,769   $-   $-   $3,769 
Residential first mortgages   455    -    -    455 
Residential rentals   499    -    -    499 
Construction and land development   663    -    -    663 
Commercial equipment   75    -    -    75 
Total loans with impairment  $5,461   $-   $-   $5,461 
Premises and equipment held for sale  $345   $-   $-   $345 
Other real estate owned  $6,747   $-   $-   $6,747 

 

(dollars in thousands)  December 31, 2016 
Description of Asset  Fair Value   Level 1   Level 2   Level 3 
Loans with impairment                    
Commercial real estate  $6,275   $-   $-   $6,275 
Residential first mortgages   468    -    -    468 
Residential rentals   142    -    -    142 
Construction and land development   673    -    -    673 
Commercial loans   77    -    -    77 
Total loans with impairment  $7,635   $-   $-   $7,635 
Premises and equipment held for sale  $345   $-   $345   $- 
Other real estate owned  $7,763   $-   $-   $7,763 

 

Loans with impairment had unpaid principal balances of $7.7 million and $8.9 million at March 31, 2017 and December 31, 2016, respectively, and include impaired loans with a specific allowance.

 

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The following tables provide information describing the unobservable inputs used in Level 3 fair value measurements at March 31, 2017 and December 31, 2016.

 

March 31, 2017         
(dollars in thousands)          
Description of Asset  Fair Value   Valuation Technique  Unobservable Inputs