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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT

Pursuant to Section 13 OR 15(d) of

The Securities Exchange Act of 1934

 

For the quarterly period ended June 30, 2017

 

Farmers Capital Bank Corporation

(Exact name of registrant as specified in its charter)

 

Kentucky

 

000-14412

 

61-1017851

(State or other jurisdiction of incorporation or organization)

 

(Commission

File Number)

 

(IRS Employer

Identification No.)

 

P.O. Box 309

202 West Main St.

Frankfort, KY

 

40601

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code – (502) 227-1668

 

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   ☒     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 (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

Yes  ☒     No  ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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.

 

Large accelerated filer  ☐

 Accelerated filer  ☒

 

 

Non-accelerated filer  ☐ (Do not check if a smaller reporting company)

 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  ☒

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Common stock, par value $0.125 per share

7,513,964 shares outstanding at August 1, 2017

 

 
1

 

 

TABLE OF CONTENTS

 

 

PART I – FINANCIAL INFORMATION

 
   

Item 1. Condensed Consolidated Financial Statements

 

Unaudited Condensed Consolidated Balance Sheets

3

Unaudited Condensed Consolidated Statements of Income

4

Unaudited Condensed Consolidated Statements of Comprehensive Income

5

Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity

6

Unaudited Condensed Consolidated Statements of Cash Flows

7

Notes to Unaudited Condensed Consolidated Financial Statements

9

   

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

33

   

Item 3. Quantitative and Qualitative Disclosures About Market Risk

54

   

Item 4. Controls and Procedures

55

   

PART II - OTHER INFORMATION

 
   

Item 1. Legal Proceedings

55

   

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

55

   

Item 6. Exhibits

55

   

SIGNATURES

58

 

 
2

 

 

PART I – FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

Unaudited Condensed Consolidated Balance Sheets


   

June 30,

   

December 31,

 

(In thousands, except share data)

 

2017

   

2016

 

Assets

               

Cash and cash equivalents:

               

Cash and due from banks

  $ 27,391     $ 25,666  

Interest bearing deposits in other banks

    42,926       62,696  

Federal funds sold and securities purchased under agreements to resell

    -       6,622  

Money market mutual funds

    27,697       18,550  

Total cash and cash equivalents

    98,014       113,534  

Investment securities:

               

Available for sale, amortized cost of $465,281 (2017) and $486,038 (2016)

    463,620       480,864  

Held to maturity, fair value of $3,617 (2017) and $3,597 (2016)

    3,461       3,488  

Total investment securities

    467,081       484,352  

Loans, net of unearned income

    989,049       970,975  

Allowance for loan losses

    (9,222 )     (9,344 )

Loans, net

    979,827       961,631  

Premises and equipment, net

    31,684       31,900  

Company-owned life insurance

    31,351       30,914  

Other real estate owned

    6,187       10,673  

Other assets

    38,196       38,026  

Total assets

  $ 1,652,340     $ 1,671,030  

Liabilities

               

Deposits:

               

Noninterest bearing

  $ 349,572     $ 334,676  

Interest bearing

    1,003,266       1,035,231  

Total deposits

    1,352,838       1,369,907  

Securities sold under agreements to repurchase

    32,569       36,370  

Federal Home Loan Bank advances

    13,562       18,646  

Subordinated notes payable to unconsolidated trusts

    33,506       33,506  

Dividends payable, common stock

    751       751  

Other liabilities

    26,238       27,784  

Total liabilities

    1,459,464       1,486,964  

Shareholders’ Equity

               

Common stock, par value $.125 per share; 14,608,000 shares authorized; 7,513,209 and 7,509,444 shares issued and outstanding at June 30, 2017 and December 31, 2016, respectively

    939       939  

Capital surplus

    52,034       51,885  

Retained earnings

    140,959       134,650  

Accumulated other comprehensive loss

    (1,056 )     (3,408 )

Total shareholders’ equity

    192,876       184,066  

Total liabilities and shareholders’ equity

  $ 1,652,340     $ 1,671,030  

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 
3

 

 

Unaudited Condensed Consolidated Statements of Income


   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 

(In thousands, except per share data)

 

2017

   

2016

   

2017

   

2016

 

Interest Income

                               

Interest and fees on loans

  $ 12,106     $ 11,836     $ 23,828     $ 23,926  

Interest on investment securities:

                               

Taxable

    1,984       2,429       3,884       4,936  

Nontaxable

    579       606       1,170       1,236  

Interest on deposits in other banks

    128       93       270       188  

Interest on federal funds sold, securities purchased under agreements to resell, and money market mutual funds

    33       9       57       17  

Total interest income

    14,830       14,973       29,209       30,303  

Interest Expense

                               

Interest on deposits

    523       599       1,056       1,245  

Interest on securities sold under agreements to repurchase

    16       1,021       41       2,045  

Interest on Federal Home Loan Bank advances

    129       185       289       371  

Interest on subordinated notes payable to unconsolidated trusts

    213       170       411       357  

Total interest expense

    881       1,975       1,797       4,018  

Net interest income

    13,949       12,998       27,412       26,285  

Provision for loan losses

    (499 )     (156 )     81       (629 )

Net interest income after provision for loan losses

    14,448       13,154       27,331       26,914  

Noninterest Income

                               

Service charges and fees on deposits

    2,012       1,927       3,970       3,794  

Allotment processing fees

    651       820       1,366       1,694  

Other service charges, commissions, and fees

    1,328       1,432       2,700       2,714  

Trust income

    626       665       1,330       1,319  

Investment securities (losses) gains, net

    (1 )     131       (10 )     214  

Gains on sale of mortgage loans, net

    189       222       343       422  

Income from company-owned life insurance

    221       231       456       556  

Gain on debt extinguishment

    -       -       -       4,050  

Other

    76       93       198       300  

Total noninterest income

    5,102       5,521       10,353       15,063  

Noninterest Expense

                               

Salaries and employee benefits

    7,646       7,655       15,263       15,634  

Occupancy expenses, net

    1,135       1,179       2,349       2,369  

Equipment expenses

    599       639       1,152       1,171  

Data processing and communication expenses

    1,093       1,212       2,386       2,326  

Bank franchise tax

    609       611       1,166       1,210  

Deposit insurance expense

    130       280       267       578  

Other real estate expenses, net

    326       373       400       1,012  

Legal expenses

    118       102       203       269  

Other

    1,690       1,833       3,689       3,722  

Total noninterest expense

    13,346       13,884       26,875       28,291  

Income before income taxes

    6,204       4,791       10,809       13,686  

Income tax expense

    1,722       1,235       2,998       3,950  

Net income

  $ 4,482     $ 3,556     $ 7,811     $ 9,736  

Per Common Share

                               

Net income – basic and diluted

  $ .60     $ .47     $ 1.04     $ 1.30  

Cash dividends declared

    .10       .07       .20       .14  

Weighted Average Common Shares Outstanding

                               

Basic and diluted

    7,512       7,502       7,511       7,501  

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 
4

 

 

Unaudited Condensed Consolidated Statements of Comprehensive Income


   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 

(In thousands)

 

2017

   

2016

   

2017

   

2016

 

Net Income

  $ 4,482     $ 3,556     $ 7,811     $ 9,736  

Other comprehensive income:

                               

Unrealized holding gain on available for sale securities arising during the period, net of tax of $716, $941, $1,226 and $2,387, respectively

    1,329       1,749       2,277       4,436  
                                 

Reclassification adjustment for net realized loss (gain) included in net income, net of tax of $-, $46, $(3) and $75, respectively

    1       (85 )     7       (139 )
                                 

Change in unfunded portion of postretirement benefit obligation, net of tax of $5, $5, $36 and $10, respectively

    9       9       68       18  

Other comprehensive income

    1,339       1,673       2,352       4,315  

Comprehensive income

  $ 5,821     $ 5,229     $ 10,163     $ 14,051  

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 
5

 

 

Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity


(In thousands, except per share data)

                                 

Accumulated

         
                                   

Other

   

Total

 

Six months ended

 

Common Stock

   

Capital

   

Retained

   

Comprehensive

   

Shareholders’

 

June 30, 2017 and 2016

 

Shares

   

Amount

   

Surplus

   

Earnings

   

(Loss) Income

   

Equity

 

Balance at January 1, 2017

    7,509     $ 939     $ 51,885     $ 134,650     $ (3,408 )   $ 184,066  

Net income

    -       -       -       7,811       -       7,811  

Other comprehensive income

    -       -       -       -       2,352       2,352  

Cash dividends declared – common, $.20 per share

    -       -       -       (1,502 )     -       (1,502 )

Shares issued under director compensation plan

    1       -       46       -       -       46  

Shares issued pursuant to employee stock purchase plan

    3       -       87       -       -       87  

Expense related to employee stock purchase plan

    -       -       16       -       -       16  

Balance at June 30, 2017

    7,513     $ 939     $ 52,034     $ 140,959     $ (1,056 )   $ 192,876  
                                                 
                                                 
                                                 

Balance at January 1, 2016

    7,500     $ 937     $ 51,608     $ 120,371     $ 2,782     $ 175,698  

Net income

    -       -       -       9,736       -       9,736  

Other comprehensive income

    -       -       -       -       4,315       4,315  

Cash dividends declared – common, $.14 per share

    -       -       -       (1,050 )     -       (1,050 )

Shares issued under director compensation plan

    1       -       36       -       -       36  

Shares issued pursuant to employee stock purchase plan

    3       1       73       -       -       74  

Expense related to employee stock purchase plan

    -       -       17       -       -       17  

Balance at June 30, 2016

    7,504     $ 938     $ 51,734     $ 129,057     $ 7,097     $ 188,826  

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 
6

 

 

Unaudited Condensed Consolidated Statements of Cash Flows


Six months ended June 30, (In thousands)

 

2017

   

2016

 

Cash Flows from Operating Activities

               

Net income

  $ 7,811     $ 9,736  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Depreciation and amortization

    1,740       1,800  

Net premium amortization of investment securities:

               

Available for sale

    1,694       1,958  

Held to maturity

    27       26  

Provision for loan losses

    81       (629 )

Deferred income tax expense (benefit)

    18       (209 )

Noncash employee stock purchase plan expense

    16       17  

Noncash director fee compensation

    46       36  

Mortgage loans originated for sale

    (12,088 )     (16,522 )

Proceeds from sale of mortgage loans

    13,793       17,078  

Gain on sale of mortgage loans, net

    (343 )     (422 )

Loss on disposal of premises and equipment, net

    50       2  

Net loss on sale and write downs of other real estate

    278       857  

Gain on extinguishment of subordinated notes payable to unconsolidated trusts

    -       (4,050 )

Net loss (gain) on sale of available for sale investment securities

    10       (214 )

Curtailment gain on postretirement benefits plan liability

    (351 )     -  

Increase in cash surrender value of company-owned life insurance

    (437 )     (452 )

Death benefits in excess of cash surrender value on company-owned life insurance

    -       (81 )

Decrease in accrued interest receivable

    312       422  

Decrease in other assets

    1,816       1,290  

Decrease in accrued interest payable

    (42 )     (48 )

Decrease in other liabilities

    (1,049 )     (277 )

Net cash provided by operating activities

    13,382       10,318  

Cash Flows from Investing Activities

               

Proceeds from maturities and calls of available for sale investment securities

    60,210       76,407  

Proceeds from sale of available for sale investment securities

    -       51,184  

Purchase of available for sale investment securities

    (41,286 )     (120,970 )

Purchase of restricted stock investments, net

    (3,570 )     (472 )

Loans originated for investment (greater) less than principal collected, net

    (16,711 )     2,723  

Purchase of loans held for investment

    (1,804 )     (1,244 )

Principal collected on purchased loans

    1,329       1,755  

Proceeds from death benefits of company-owned life insurance

    -       341  

Purchase of premises and equipment

    (1,462 )     (1,005 )

Proceeds from sale of other real estate

    1,761       2,477  

Net cash (used in) provided by investing activities

    (1,533 )     11,196  

Cash Flows from Financing Activities

               

Net decrease in deposits

    (17,069 )     (15,549 )

Net decrease in short-term securities sold under agreements to repurchase

    (3,548 )     (2,772 )

Proceeds from long-term securities sold under agreements to repurchase

    5       6  

Repayments of long-term securities sold under agreements to repurchase

    (258 )     (200 )

Repayments of Federal Home Loan Bank advances

    (5,084 )     (80 )

Cash paid to extinguish subordinated notes payable to unconsolidated trust

    -       (10,950 )

Dividends paid, common stock

    (1,502 )     (525 )

Shares issued under employee stock purchase plan

    87       74  

Net cash used in financing activities

    (27,369 )     (29,996 )

Net decrease in cash and cash equivalents

    (15,520 )     (8,482 )

Cash and cash equivalents at beginning of year

    113,534       120,493  

Cash and cash equivalents at end of period

  $ 98,014     $ 112,011  

 

 
7

 

 

Unaudited Condensed Consolidated Statements of Cash Flows—(Continued)


Six months ended June 30, (In thousands)

 

2017

   

2016

 

Supplemental Disclosures

               

Cash paid during the period for:

               

Interest

  $ 1,839     $ 4,066  

Income Taxes

    1,835       1,750  

Transfers from loans to other real estate

    339       1,330  

Sale and financing of other real estate

    2,792       3,050  

Cash dividends payable, common

    751       525  

Cancelation of investment in Farmers Capital Bank Trust II

    -       464  

Extinguishment of subordinated notes payable to Farmers Capital Bank Trust II

    -       15,464  

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 
8

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

1. Basis of Presentation and Nature of Operations

 

The condensed consolidated financial statements include the accounts of Farmers Capital Bank Corporation (the “Company” or “Parent Company”), a bank holding company, and its wholly owned subsidiaries. The Company has one bank subsidiary, United Bank & Capital Trust Company (“United Bank”), and one nonbank subsidiary, FFKT Insurance Services, Inc. (“FFKT Insurance”). In February 2017, the Company merged three of its subsidiary banks (United Bank & Trust Company in Versailles, KY; First Citizens Bank, Inc. in Elizabethtown, KY; and Citizens Bank of Northern Kentucky, Inc. in Newport, KY) and its data processing subsidiary (FCB Services, Inc. in Frankfort, KY) into its subsidiary bank Farmers Bank & Capital Trust Company in Frankfort, KY, the name of which was immediately changed under the merger to United Bank & Capital Trust Company. The Company accounted for the transfer of assets and liabilities of the merged subsidiaries at their respective historical cost amounts as of the date of the merger.

 

FFKT Insurance is a captive insurance company that provides property and casualty coverage to the Parent Company and its subsidiaries for risk management purposes or where insurance may not be available or economically feasible. The Company has two subsidiaries organized as Delaware statutory trusts that are not consolidated into its financial statements. These trusts were formed for the purpose of issuing trust preferred securities.

 

United Bank’s significant subsidiaries include EG Properties, Inc. and Farmers Capital Insurance Corporation (“Farmers Insurance”). EG Properties, Inc. is involved in real estate management and liquidation for certain repossessed properties of United Bank. Farmers Insurance is an insurance agency in Frankfort, KY.

 

The Company provides financial services at its 34 locations in 21 communities throughout Central and Northern Kentucky to individual, business, agricultural, governmental, and educational customers. Its primary deposit products are checking, savings, and term certificate accounts. Its primary lending products are residential mortgage, commercial lending, and consumer installment loans. Substantially all loans are secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. Other services include, but are not limited to, cash management services, issuing letters of credit, safe deposit box rental, and providing funds transfer services. Other financial instruments, which potentially represent concentrations of credit risk, include deposit accounts in other financial institutions and federal funds sold.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates used in the preparation of the condensed financial statements are based on various factors including the current interest rate environment and the general strength of the local and state economy. Changes in the overall interest rate environment can significantly affect the Company’s net interest income and the value of its recorded assets and liabilities. Actual results could differ from those estimates used in the preparation of the condensed financial statements. The allowance for loan losses, carrying value of other real estate owned, actuarial assumptions used to calculate postretirement benefits, and the fair values of financial instruments are estimates that are particularly subject to change.

 

The consolidated balance sheet as of December 31, 2016 has been derived from the audited financial statements of the Company as of that date. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2016 included in the Company’s annual report on Form 10-K. The accompanying condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X and do not include all of the information and the footnotes required by U.S. GAAP for complete statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of such condensed financial statements, have been included. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. All significant intercompany transactions and balances are eliminated in consolidation.

 

 
9

 

 

2. Reclassifications

 

Certain reclassifications have been made to the condensed consolidated financial statements of prior periods to conform to the current period presentation. These reclassifications do not affect net income or total shareholders’ equity as previously reported.

 

3. Accumulated Other Comprehensive Income

 

The following table presents changes in accumulated other comprehensive income by component, net of tax, for the periods indicated.

 


Three Months Ended June 30,

 

2017

   

2016

 

(In thousands)

 

Unrealized

Gains (Losses)

on Available

for Sale

Investment

Securities

   

Postretirement

Benefit

Obligation

   

Total

   

Unrealized

Gains (Losses)

on Available

for Sale

Investment

Securities

   

Postretirement

Benefit

Obligation

   

Total

 

Beginning balance

  $ (2,409 )   $ 14     $ (2,395 )   $ 5,852     $ (428 )   $ 5,424  

Other comprehensive income before reclassifications

    1,329       8       1,337       1,749       -       1,749  

Amounts reclassified from accumulated other comprehensive income

    1       1       2       (85 )     9       (76 )

Net current-period other comprehensive income

    1,330       9       1,339       1,664       9       1,673  

Ending balance

  $ (1,079 )   $ 23     $ (1,056 )   $ 7,516     $ (419 )   $ 7,097  

 


Six Months Ended June 30,

 

2017

   

2016

 

(In thousands)

 

Unrealized

Gains (Losses)

on Available

for Sale

Investment

Securities

   

Postretirement

Benefit

Obligation

   

Total

   

Unrealized

Gains (Losses)

on Available

for Sale

Investment

Securities

   

Postretirement

Benefit

Obligation

   

Total

 

Beginning balance

  $ (3,363 )   $ (45 )   $ (3,408 )   $ 3,219     $ (437 )   $ 2,782  

Other comprehensive income before reclassifications

    2,277       17       2,294       4,436       -       4,436  

Amounts reclassified from accumulated other comprehensive income

    7       51       58       (139 )     18       (121 )

Net current-period other comprehensive income

    2,284       68       2,352       4,297       18       4,315  

Ending balance

  $ (1,079 )   $ 23     $ (1,056 )   $ 7,516     $ (419 )   $ 7,097  

 

 
10

 

 

The following table presents amounts reclassified out of accumulated other comprehensive income by component for the periods indicated. Line items in the statement of income affected by the reclassification are also presented.

 

   

Amount Reclassified from Accumulated Other

Comprehensive Income

   

Affected Line Item in the

Statement Where Net Income is

Presented

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

     

(In thousands)

 

2017

   

2016

   

2017

   

2016

     

Unrealized gains (losses) on available for sale investment securities

  $ (1 )   $ 131     $ (10 )   $ 214    

Investment securities (losses) gains, net

      -       (46 )     3       (75 )  

Income tax expense

    $ (1 )   $ 85     $ (7 )   $ 139    

Net of tax

                                     

Amortization related to postretirement benefits

                                   

Prior service costs

  $ -     $ (12 )   $ (75 )   $ (25 )  

Salaries and employee benefits

Actuarial losses

    (2 )     (2 )     (3 )     (3 )  

Salaries and employee benefits

      (2 )     (14 )     (78 )     (28 )  

Total before tax

      1       5       27       10    

Income tax expense

    $ (1 )   $ (9 )   $ (51 )   $ (18 )  

Net of tax

                                     

Total reclassifications for the period

  $ (2 )   $ 76     $ (58 )   $ 121    

Net of tax

 

4. Accounting Policy

 

Loans and Interest Income

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their unpaid principal amount outstanding adjusted for any charge-offs and deferred fees or costs on originated loans. Interest income on loans is recognized using the interest method based on loan principal amounts outstanding during the period. Interest income also includes amortization and accretion of any premiums or discounts over the expected life of acquired loans at the time of purchase or business acquisition. Loan origination fees, net of certain direct origination costs, are deferred and amortized as yield adjustments over the contractual term of the loans.

 

The Company disaggregates certain disclosure information related to loans, the related allowance for loan losses, and credit quality measures by either portfolio segment or by loan class. The Company segregates its loan portfolio segments based on similar risk characteristics as follows: real estate loans, commercial loans, and consumer loans. Portfolio segments are further disaggregated into classes for certain required disclosures as follows:

 

Portfolio Segment

Class

   

Real estate loans

Real estate mortgage – construction and land development

Real estate mortgage – residential

Real estate mortgage – farmland and other commercial enterprises

Commercial loans

Commercial and industrial

Depository institutions

Agriculture production and other loans to farmers

States and political subdivisions

Other

Consumer loans

Secured

Unsecured

 

 
11

 

 

The Company has a loan policy in place that is amended and approved from time to time as needed to reflect current economic conditions and product offerings in its markets. The policy establishes written procedures concerning areas such as the lending authorities of loan officers, committee review and approval of certain credit requests, underwriting criteria, policy exceptions, appraisal requirements, and loan review. Credit is extended to borrowers based primarily on their ability to repay as demonstrated by income and cash flow analysis.

 

Loans secured by real estate make up the largest segment of the Company’s loan portfolio. If a borrower fails to repay a loan secured by real estate, the Company may liquidate the collateral in order to satisfy the amount owed. Determining the value of real estate is a key component to the lending process for real estate backed loans. If the fair value of real estate (less estimated cost to sell) securing a collateral dependent loan declines below the outstanding loan amount, the Company will write down the carrying value of the loan and thereby incur a loss. The Company uses independent third party state certified or licensed appraisers in accordance with its loan policy to mitigate risk when underwriting real estate loans. Cash flow analysis of the borrower, loan to value limits as adopted by loan policy, and other customary underwriting standards are also in place which are designed to maximize credit quality and mitigate risks associated with real estate lending.

 

Commercial loans are made to businesses and are secured mainly by assets such as inventory, accounts receivable, machinery, fixtures and equipment, or other business assets. Commercial lending involves significant risk, as loan repayments are more dependent on the successful operation or management of the business and its cash flows. Consumer lending includes loans to individuals mainly for personal autos, boats, or a variety of other personal uses and may be secured or unsecured. Loan repayment associated with consumer loans is highly dependent upon the borrower’s continuing financial stability, which is heavily influenced by local unemployment rates. The Company mitigates its risk exposure to each of its loan segments by analyzing the borrower’s repayment capacity, imposing restrictions on the amount it will loan compared to estimated collateral values, limiting the payback periods, and following other customary underwriting practices as adopted in its loan policy.

 

The accrual of interest on loans is discontinued when it is determined that the collection of interest or principal is doubtful, or when a default of interest or principal has existed for 90 days or more, unless such loan is well secured and in the process of collection. Past due status is based on the contractual terms of the loan. Interest accrued but not received for a loan placed on nonaccrual status is reversed against interest income. Cash payments received on nonaccrual loans generally are applied to principal until qualifying for return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. The Company’s policy for placing a loan on nonaccrual status or subsequently returning a loan to accrual status does not differ based on its portfolio class or segment.

 

Commercial and real estate loans delinquent in excess of 120 days and consumer loans delinquent in excess of 180 days are charged off, unless the collateral securing the debt is of such value that any loss appears to be unlikely. In all cases, loans are charged off at an earlier date if classified as loss under the Company’s loan grading process or as a result of regulatory examination. The Company’s charge-off policy for impaired loans does not differ from the charge-off policy for loans outside the definition of impaired.

 

Provision and Allowance for Loan Losses

The provision for loan losses represents charges or credits made to earnings to maintain an allowance for loan losses at a level considered adequate to provide for probable incurred credit losses at the balance sheet date. The allowance for loan losses is a valuation allowance increased by the provision for loan losses and decreased by net charge-offs. Loan losses are charged against the allowance when management believes the uncollectibility of a loan is confirmed. Subsequent recoveries, if any, are credited to the allowance.

 

The Company estimates the adequacy of the allowance using a risk-rated methodology which is based on the Company’s past loan loss experience, known and inherent risks in the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral securing loans, composition of the loan portfolio, current economic conditions, and other relevant factors. This evaluation is inherently subjective as it requires significant judgment and the use of estimates that may be susceptible to change.

 

The allowance for loan losses consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component covers non-impaired loans and is based on historical loss experience adjusted for current risk factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off. Actual loan losses could differ significantly from the amounts estimated by management.

 

 
12

 

 

The general portion of the Company’s loan portfolio is segregated into portfolio segments having similar risk characteristics identified as follows: real estate loans, commercial loans, and consumer loans. Each of these portfolio segments is assigned a loss percentage based on their respective rolling historical loss rates, adjusted for the qualitative risk factors summarized below. During the first quarter of 2017, the Company shortened the look-back period it uses to determine historical loss rates to the previous twelve quarters from sixteen quarters. The change in the look-back period is the result of the Company’s ongoing monitoring and evaluation of the adequacy of its allowance for loan losses. The shorter look-back period better reflects the Company’s loss estimates based on current market conditions. Shortening the look-back period increased the allowance for loan losses by $49 thousand compared to the previous sixteen quarter look-back period.

 

The qualitative risk factors used in the methodology are consistent with the guidance in the most recent Interagency Policy Statement on the Allowance for Loan Losses issued. Each factor is supported by a detailed analysis and is both measurable and supportable. Some factors include a minimum allocation in instances where loss levels are extremely low and it is determined to be prudent from a safety and soundness perspective. Qualitative risk factors that are used in the methodology include the following for each loan portfolio segment:

 

 

Delinquency trends

 

Trends in net charge-offs

 

Trends in loan volume

 

Lending philosophy risk

 

Management experience risk

 

Concentration of credit risk

 

Economic conditions risk

 

A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

 

The Company accounts for impaired loans in accordance with Accounting Standards Codification (“ASC”) Topic 310, “Receivables. ASC Topic 310 requires that impaired loans be measured at the present value of expected future cash flows, discounted at the loan’s effective interest rate, at the loan’s observable market price, or at the fair value of the collateral if the loan is collateral dependent. Impaired loans may also be classified as nonaccrual. In many circumstances, however, the Company continues to accrue interest on an impaired loan. Cash receipts on accruing impaired loans are applied to the recorded investment in the loan, including any accrued interest receivable. Cash payments received on nonaccrual impaired loans generally are applied to principal until qualifying for return to accrual status. Loans that are part of a large group of smaller-balance homogeneous loans, such as residential mortgage, consumer, and smaller-balance commercial loans, are collectively evaluated for impairment. Troubled debt restructurings are measured at the present value of estimated future cash flows using the loan’s effective interest rate at inception, or at the fair value of collateral. The Company determines the amount of reserve for troubled debt restructurings that subsequently default in accordance with its accounting policy for the allowance for loan losses.

 

Recently Issued Accounting Standards

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606), and subsequently issued several amendments to the standard during 2015 and 2016. The primary principle of ASU No. 2014-09 is that entities should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU also requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

 

 
13

 

 

As amended, ASU No. 2014-09 is effective for the Company in annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Earlier application is permitted, but only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within those reporting periods. Entities are permitted to apply the amendments either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying this ASU recognized at the date of initial application. The Company expects to adopt ASU No. 2014-09 in the first quarter of 2018. The Company is still assessing the impact this ASU will have on its consolidated financial statements as well as the most appropriate transition method of application. Based on this evaluation to date, the Company has determined that the majority of its revenues earned are excluded from the scope of ASU No. 2014-09. The Company believes that for most revenue streams within the scope of ASU No. 2014-09, the amendments will not change the timing of when the revenue is recognized. The Company will continue to evaluate the impact the adoption of this ASU will have on its consolidated financial statements, focusing on noninterest income sources within the scope of the ASU as well as the new disclosures required; however, the adoption of ASU No. 2014-09 is not expected to have a material impact on the Company’s consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842),” to improve financial reporting about leasing transactions. This ASU will require organizations that lease assets (“lessees”) to recognize a lease liability and a right-of-use asset on its balance sheet for all leases with terms of more than twelve months. A lease liability is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis and a right-of-use asset represents the lessee’s right to use, or control use of, a specified asset for the lease term. The amendments in this ASU simplify the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. This ASU leaves the accounting for the organizations that own the assets leased to the lessee (“lessor”) largely unchanged except for targeted improvements to align it with the lessee accounting model and Topic 606, Revenue from Contracts with Customers.

 

For public companies, ASU No. 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company has identified a project team to review its leases and to assess the impact of ASU No. 2016-02 on its consolidated financial position, results of operations, and cash flows.

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. The ASU requires enhanced disclosures, including qualitative and quantitative requirements, which provide additional information about the amounts recorded in the financial statements. Additionally, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.

 

ASU No. 2016-13 is effective for the Company in annual and interim reporting periods beginning after December 15, 2019. Although early adoption is permitted for fiscal years beginning after December 15, 2018, the Company does not plan to early adopt. The Company has been preserving certain historical loan information from its core processing system in anticipation of adopting the standard. The Company has identified a project team to assess the impact of this ASU on its consolidated financial position, results of operations, and cash flows. The project team is in the process of identifying resources needed and has developed a timeline for implementing the standard.

 

 
14

 

 

In March 2017, the FASB issued ASU NO. 2017-07, “CompensationRetirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost,” which requires that employers offering benefit plans accounted for under Topic 715 report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component. If a separate line item or items are not used, the line item or items used in the income statement to present the other components of net benefit cost must be disclosed. This ASU is effective for the Company in annual and interim reporting periods beginning after December 15, 2017. The Company is currently evaluating the impact of ASU No. 2017-07 on its consolidated financial position, results of operations, or cash flows upon adoption.

 

In March 2017, the FASB issued ASU No. 2017-08, ReceivablesNonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities.” This ASU shortens the amortization period for certain callable debt securities held at a premium and requires the premium to be amortized to the earliest call date. The ASU does not change the accounting for securities held at a discount; the discount will continue to be amortized to maturity. This ASU is effective for the Company in annual and interim reporting periods beginning after December 15, 2018, with early adoption permitted. Entities are required to apply the amendments on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company is considering early adoption and is in the process of determining the impact on its consolidated financial position, results of operations, or cash flows upon adoption.

 

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

 

5. Net Income Per Common Share

 

Basic net income per common share is determined by dividing net income by the weighted average total number of common shares issued and outstanding. There were no dilutive instruments at June 30, 2017 and 2016.

 

Net income per common share computations were as follows for the periods indicated:

 

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 

(In thousands, except per share data)

 

2017

   

2016

   

2017

   

2016

 
                                 

Net income, basic and diluted

  $ 4,482     $ 3,556     $ 7,811     $ 9,736  
                                 
                                 

Average common shares issued and outstanding, basic and diluted

    7,512       7,502       7,511       7,501  
                                 

Net income per common share, basic and diluted

  $ .60     $ .47     $ 1.04     $ 1.30  

 

 
15

 

 

6. Investment Securities

 

The following tables summarize the amortized costs and estimated fair value of the securities portfolio at June 30, 2017 and December 31, 2016.

 

June 30, 2017 (In thousands)

 

Amortized
Cost

   

Gross Unrealized
Gains

   

Gross Unrealized
Losses

   

Estimated
Fair Value

 

Available For Sale

                               

Obligations of U.S. government-sponsored entities

  $ 79,734     $ 160     $ 377     $ 79,517  

Obligations of states and political subdivisions

    126,308       1,128       863       126,573  

Mortgage-backed securities – residential

    202,825       1,339       2,001       202,163  

Mortgage-backed securities – commercial

    48,003       9       1,186       46,826  

Corporate debt securities

    7,575       94       3       7,666  

Mutual funds and equity securities

    836       42       3       875  

Total securities – available for sale

  $ 465,281     $ 2,772     $ 4,433     $ 463,620  

Held To Maturity

                               

Obligations of states and political subdivisions

  $ 3,461     $ 156     $ -     $ 3,617  

 

 

December 31, 2016 (In thousands)

 

Amortized
Cost

   

Gross Unrealized
Gains

   

Gross Unrealized
Losses

   

Estimated
Fair Value

 

Available For Sale

                               

Obligations of U.S. government-sponsored entities

  $ 71,941     $ 213     $ 460     $ 71,694  

Obligations of states and political subdivisions

    134,055       773       2,536       132,292  

Mortgage-backed securities – residential

    225,489       1,505       2,687       224,307  

Mortgage-backed securities – commercial

    47,164       6       1,557       45,613  

Corporate debt securities

    6,565       1       441       6,125  

Mutual funds and equity securities

    824       20       11       833  

Total securities – available for sale

  $ 486,038     $ 2,518     $ 7,692     $ 480,864  

Held To Maturity

                               

Obligations of states and political subdivisions

  $ 3,488     $ 109     $ -     $ 3,597  

 

Investment securities with a carrying value of $193 million and $191 million at June 30, 2017 and December 31, 2016, respectively, were pledged to secure public and trust deposits, repurchase agreements, and for other purposes.

 

The amortized cost and estimated fair value of the debt securities portfolio at June 30, 2017, by contractual maturity, are detailed below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Mutual funds and equity securities in the available for sale portfolio consist of investments attributed to the Company’s captive insurance subsidiary. These securities have no stated maturity and are not included in the maturity schedule that follows.

 

Mortgage-backed securities are stated separately due to the nature of payment and prepayment characteristics of these securities, as principal is not due at a single date.

 

   

Available For Sale

   

Held To Maturity

 
   

Amortized

   

Estimated

   

Amortized

   

Estimated

 

June 30, 2017 (In thousands)

 

Cost

   

Fair Value

   

Cost

   

Fair Value

 

Due in one year or less

  $ 32,117     $ 32,149     $ -     $ -  

Due after one year through five years

    72,712       73,016       -       -  

Due after five years through ten years

    84,313       84,005       1,302       1,407  

Due after ten years

    24,475       24,586       2,159       2,210  

Mortgage-backed securities

    250,828       248,989       -       -  

Total

  $ 464,445     $ 462,745     $ 3,461     $ 3,617  

 

 
16

 

 

Gross realized gains and losses on the sale of available for sale investment securities were as follows:

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 

(In thousands)

 

2017

   

2016

   

2017

   

2016

 
                                 

Gross realized gains

  $ -     $ 190     $ -     $ 352  

Gross realized losses

    1       59       10       138  

Net realized (loss) gain

  $ (1 )   $ 131     $ (10 )   $ 214  

 

Investment securities with unrealized losses at June 30, 2017 and December 31, 2016 not recognized in income are presented in the tables below. The tables segregate investment securities that have been in a continuous unrealized loss position for less than twelve months from those that have been in a continuous unrealized loss position for twelve months or more. The tables also include the fair value of the related securities.

 

   

Less than 12 Months

   

12 Months or More

   

Total

 

June 30, 2017 (In thousands)

 

Fair

Value

   

Unrealized

Losses

   

Fair

Value

   

Unrealized

Losses

   

Fair

Value

   

Unrealized

Losses

 

Obligations of U.S. government-sponsored entities

  $ 57,666     $ 369     $ 1,992     $ 8     $ 59,658     $ 377  

Obligations of states and political subdivisions

    57,732       765       4,838       98       62,570       863  

Mortgage-backed securities – residential

    142,716       1,783       8,567       218       151,283       2,001  

Mortgage-backed securities – commercial

    42,997       1,186       -       -       42,997       1,186  

Corporate debt securities

    1,311       3       -       -       1,311       3  

Mutual funds and equity securities

    -       -       120       3       120       3  

Total

  $ 302,422     $ 4,106     $ 15,517     $ 327     $ 317,939     $ 4,433  

 

    Less than 12 Months     12 Months or More     Total  

December 31, 2016 (In thousands)

 

Fair

Value

   

Unrealized

Losses

   

Fair

Value

   

Unrealized

Losses

   

Fair

Value

   

Unrealized

Losses

 

Obligations of U.S. government-sponsored entities

  $ 51,657     $ 460     $ -     $ -     $ 51,657     $ 460  

Obligations of states and political subdivisions

    91,728       2,526       1,999       10       93,727       2,536  

Mortgage-backed securities – residential

    154,397       2,485       5,841       202       160,238       2,687  

Mortgage-backed securities – commercial

    43,309       1,557       -       -       43,309       1,557  

Corporate debt securities

    536       6       5,476       435       6,012       441  

Mutual funds and equity securities

    128       2       113       9       241       11  

Total

  $ 341,755     $ 7,036     $ 13,429     $ 656     $ 355,184     $ 7,692  

 

Unrealized losses included in the tables above have not been recognized in income since they have been identified as temporary. The Company evaluates investment securities for other-than-temporary impairment (“OTTI”) at least quarterly, and more frequently when economic or market conditions warrant. Many factors are considered, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was effected by macroeconomic conditions, and (4) whether the Company has the intent to sell the security or more likely than not will be required to sell the security before its anticipated recovery. The assessment of whether an OTTI charge exists involves a high degree of subjectivity and judgment and is based on the information available to the Company at a point in time.

 

The Company attributes the unrealized losses in its investment securities portfolio to changes in market interest rates and volatility. Investment securities with unrealized losses at June 30, 2017 are performing according to their contractual terms, and the Company does not expect to incur a loss on these securities unless they are sold prior to maturity. The Company does not have the intent to sell these securities nor does it believe it is likely that it will be required to sell these securities prior to their anticipated recovery. The Company does not consider any of the securities to be impaired due to reasons of credit quality or other factors.

 

 
17

 

 

7. Loans and Allowance for Loan Losses

 

Major classifications of loans outstanding are summarized as follows:

 

(In thousands)

 

June 30,
2017

   

December 31,
2016

 
                 

Real Estate

               

Real estate mortgage – construction and land development

  $ 103,884     $ 120,230  

Real estate mortgage – residential

    340,213       350,295  

Real estate mortgage – farmland and other commercial enterprises

    438,945       400,367  

Commercial

               

Commercial and industrial

    58,604       48,607  

States and political subdivisions

    18,612       18,933  

Other

    20,565       23,308  

Consumer

               

Secured

    4,184       4,554  

Unsecured

    4,042       4,681  

Total loans

    989,049       970,975  

Less unearned income

    -       -  

Total loans, net of unearned income

  $ 989,049     $ 970,975  

 

 
18

 

 

Activity in the allowance for loan losses by portfolio segment was as follows for the periods indicated:

 

(In thousands)

 

Real Estate

   

Commercial

   

Consumer

   

Total

 

Three months ended June 30, 2017

                               

Balance, beginning of period

  $ 8,184     $ 864     $ 459     $ 9,507  

Provision for loan losses

    (546 )     135       (88 )     (499 )

Recoveries

    398       17       8       423  

Loans charged off

    (75 )     (116 )     (18 )     (209 )

Balance, end of period

  $ 7,961     $ 900     $ 361     $ 9,222  
                                 

Six months ended June 30, 2017

                               

Balance, beginning of period

  $ 8,205     $ 854     $ 285     $ 9,344  

Provision for loan losses

    (150 )     128       103       81  

Recoveries

    415       66       19       500  

Loans charged off

    (509 )     (148 )     (46 )     (703 )

Balance, end of period

  $ 7,961     $ 900     $ 361     $ 9,222  

 

 

(In thousands)

 

Real Estate

   

Commercial

   

Consumer

   

Total

 

Three months ended June 30, 2016

                               

Balance, beginning of period

  $ 8,709     $ 839     $ 280     $ 9,828  

Provision for loan losses

    (147 )     (4 )     (5 )     (156 )

Recoveries

    50       19       11       80  

Loans charged off

    (208 )     (48 )     (11 )     (267 )

Balance, end of period

  $ 8,404     $ 806     $ 275     $ 9,485  
                                 

Six months ended June 30, 2016

                               

Balance, beginning period

  $ 9,173     $ 820     $ 322     $ 10,315  

Provision for loan losses

    (600 )     (10 )     (19 )     (629 )

Recoveries

    102       55       43       200  

Loans charged off

    (271 )     (59 )     (71 )     (401 )

Balance, end of period

  $ 8,404     $ 806     $ 275     $ 9,485  

 

The following tables present individually impaired loans by class of loans for the dates indicated.

 


June 30, 2017 (In thousands)

 

Unpaid
Principal

Balance

   

Recorded
Investment

With No

Allowance

   

Recorded
Investment

With

Allowance

   

Total

Recorded

Investment

   

Allowance

for
Loan Losses
Allocated

 

Real Estate

                                       

Real estate mortgage – construction and land development

  $ 4,859     $ 2,188     $ 2,043     $ 4,231     $ 406  

Real estate mortgage – residential

    11,077       3,890       7,211       11,101       1,720  

Real estate mortgage – farmland and other commercial enterprises

    23,223       8,504       14,600       23,104       280  

Commercial

                                       

Commercial and industrial

    405       -       406       406       225  

Other

    25       -       25       25       13  

Consumer

                                       

Unsecured

    329       -       329       329       236  

Total

  $ 39,918     $ 14,582     $ 24,614     $ 39,196     $ 2,880  

 

 
19

 

 


December 31, 2016 (In thousands)

 

Unpaid
Principal

Balance

   

Recorded
Investment

With No

Allowance

   

Recorded
Investment

With

Allowance

   

Total

Recorded

Investment

   

Allowance

for
Loan Losses
Allocated

 

Real Estate

                                       

Real estate mortgage – construction and land development

  $ 9,076     $ 2,599     $ 3,800     $ 6,399     $ 759  

Real estate mortgage – residential

    9,930       4,388       5,590       9,978       1,503  

Real estate mortgage – farmland and other commercial enterprises

    25,045       9,699       15,235       24,934       304  

Commercial

                                       

Commercial and industrial

    435       20       418       438       236  

Consumer

                                       

Unsecured

    146       -       146       146       146  

Total

  $ 44,632     $ 16,706     $ 25,189     $ 41,895     $ 2,948  

 

 

Three Months Ended June 30,

 

2017

   

2016

 

(In thousands)

 

Average

   

Interest

Income

Recognized

   

Cash Basis

Interest

Recognized

   

Average

   

Interest

Income

Recognized

   

Cash Basis

Interest

Recognized

 

Real Estate

                                               

Real estate mortgage – construction and land development

  $ 4,216     $ 58     $ 58     $ 8,832     $ 108     $ 96  

Real estate mortgage – residential

    11,080       136       134       8,619       109       88  

Real estate mortgage – farmland and other commercial enterprises

    24,108       296       296       26,985       368       353  

Commercial

                                               

Commercial and industrial

    409       4       4       410       7       7  

Other

    26       -       -       -       -       -  

Consumer

                                               

Unsecured

    325       4       4       150       1       1  

Total

  $ 40,164     $ 498     $ 496     $ 44,996     $ 593     $ 545  

 

 

Six Months Ended June 30,

 

2017

   

2016

 

(In thousands)

 

Average

   

Interest

Income

Recognized

   

Cash Basis

Interest

Recognized

   

Average

   

Interest

Income

Recognized

   

Cash Basis

Interest

Recognized

 

Real Estate

                                               

Real estate mortgage – construction and land development

  $ 5,226     $ 134     $ 133     $ 8,562     $ 155     $ 143  

Real estate mortgage – residential

    10,395       254       251       8,827       212       187  

Real estate mortgage – farmland and other commercial enterprises

    24,098       598       592       25,388       637       616  

Commercial

                                               

Commercial and industrial

    454       11       11       415       11       11  

Other

    13       -       -       -       -       -  

Consumer

                                               

Unsecured

    330       9       8       153       3       2  

Total

  $ 40,516     $ 1,006     $ 995     $ 43,345     $ 1,018     $ 959  

 

 
20

 

  

The following tables present the balance of the allowance for loan losses and the recorded investment in loans by portfolio segment based on impairment method as of June 30, 2017 and December 31, 2016.

 

June 30, 2017 (In thousands)

 

Real Estate

   

Commercial

   

Consumer

   

Total

 

Allowance for Loan Losses

                               

Ending allowance balance attributable to loans:

                               

Individually evaluated for impairment

  $ 2,406     $ 238     $ 236     $ 2,880  

Collectively evaluated for impairment

    5,555       662       125       6,342  

Total ending allowance balance

  $ 7,961     $ 900     $ 361     $ 9,222  
                                 

Loans

                               

Loans individually evaluated for impairment

  $ 38,436     $ 431     $ 329     $ 39,196  

Loans collectively evaluated for impairment

    844,606       97,350       7,897       949,853  

Total ending loan balance, net of unearned income

  $ 883,042     $ 97,781     $ 8,226     $ 989,049  

 

 

December 31, 2016 (In thousands)

 

Real Estate

   

Commercial

   

Consumer

   

Total

 

Allowance for Loan Losses

                               

Ending allowance balance attributable to loans:

                               

Individually evaluated for impairment

  $ 2,566     $ 236     $ 146     $ 2,948  

Collectively evaluated for impairment

    5,639       618       139       6,396  

Total ending allowance balance

  $ 8,205     $ 854     $ 285     $ 9,344  
                                 

Loans

                               

Loans individually evaluated for impairment

  $ 41,311     $ 438     $ 146     $ 41,895  

Loans collectively evaluated for impairment

    829,581       90,410       9,089       929,080  

Total ending loan balance, net of unearned income

  $ 870,892     $ 90,848     $ 9,235     $ 970,975  

 

The following tables present the recorded investment in nonperforming loans by class of loans as of June 30, 2017 and December 31, 2016.

 

June 30, 2017 (In thousands)

 

Nonaccrual

   

Restructured

Loans

   

Loans Past

Due 90 Days

or More and

Still Accruing

 

Real Estate

                       

Real estate mortgage – construction and land development

  $ 381     $ 1,961     $ -  

Real estate mortgage – residential

    1,913       5,402       -  

Real estate mortgage – farmland and other commercial enterprises

    1,924       14,546       -  

Commercial

                       

Commercial and industrial

    -       374       -  

Other

    25       -       -  

Consumer

                       

Secured

    11       -       -  

Unsecured

    173       132       2  

Total

  $ 4,427     $ 22,415     $ 2  

 

 
21

 

 

December 31, 2016 (In thousands)

 

Nonaccrual

   

Restructured

Loans

   

Loans Past

Due 90 Days

or More and

Still Accruing

 

Real Estate

                       

Real estate mortgage – construction and land development

  $ 712     $ 3,637     $ -  

Real estate mortgage – residential

    2,316       4,006       -  

Real estate mortgage – farmland and other commercial enterprises

    3,383       14,787       -  

Commercial

                       

Commercial and industrial

    -       377       -  

Consumer

                       

Secured

    4       -       -  

Unsecured

    8       135       -  

Total

  $ 6,423     $ 22,942     $ -  

 

The Company has allocated $1.8 million and $2.0 million of specific reserves as of June 30, 2017 and December 31, 2016, respectively, to customers whose loan terms have been modified in troubled debt restructurings and that are in compliance with those terms. The Company had no commitments to lend additional amounts to customers with outstanding loans that are classified as troubled debt restructurings at June 30, 2017 and December 31, 2016. The Company had no credits during the first six months of 2017 or 2016 that were modified as troubled debt restructurings.

 

The tables below present an age analysis of past due loans 30 days or more by class of loans as of the dates indicated. Past due loans that are also classified as nonaccrual are included in their respective past due category.

 

June 30, 2017 (In thousands)

 

30-89

Days

Past Due

   

90 Days

or More

Past Due

   

Total

   

Current

   

Total

Loans

 

Real Estate

                                       

Real estate mortgage – construction and land development

  $ 515     $ 314     $ 829     $ 103,055     $ 103,884  

Real estate mortgage – residential

    1,088       767       1,855       338,358       340,213  

Real estate mortgage – farmland and other commercial enterprises

    145       1,090       1,235       437,710       438,945  

Commercial

                                       

Commercial and industrial

    29       -       29       58,575       58,604  

States and political subdivisions

    -       -       -       18,612       18,612  

Other

    2       25       27       20,538       20,565  

Consumer

                                       

Secured

    11       -       11       4,173       4,184  

Unsecured

    33       2       35       4,007       4,042  

Total

  $ 1,823     $ 2,198     $ 4,021     $ 985,028     $ 989,049  

 

 
22

 

 

December 31, 2016 (In thousands)

 

30-89

Days

Past Due

   

90 Days

or More

Past Due

   

Total

   

Current

   

Total

Loans

 

Real Estate

                                       

Real estate mortgage – construction and land development

  $ 393     $ 227     $ 620     $ 119,610     $ 120,230  

Real estate mortgage – residential

    1,935       798       2,733       347,562       350,295  

Real estate mortgage – farmland and other commercial enterprises

    -       2,483       2,483       397,884       400,367  

Commercial

                                       

Commercial and industrial

    -       -       -       48,607       48,607  

States and political subdivisions

    -       -       -       18,933       18,933  

Other

    24       -       24       23,284       23,308  

Consumer

                                       

Secured

    13       -       13       4,541       4,554  

Unsecured

    30       8       38       4,643       4,681  

Total

  $ 2,395     $ 3,516     $ 5,911     $ 965,064     $ 970,975  

 

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends and conditions. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes large-balance loans and non-homogeneous loans, such as commercial real estate and certain residential real estate loans. Loan rating grades, as described further below, are assigned based on a continuous process. The amount and adequacy of the allowance for loan loss is determined on a quarterly basis. The Company uses the following definitions for its risk ratings:

 

Special Mention. Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the borrower’s repayment ability, weaken the collateral or inadequately protect the Company’s credit position at some future date. These credits pose elevated risk, but their weaknesses do not yet justify a substandard classification.

 

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

 

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

 

 
23

 

 

Loans not meeting the criteria above which are analyzed individually as part of the above described process are considered to be pass rated loans and are considered to have a low risk of loss. Based on the most recent analysis performed, the risk category of loans by class of loans is as follows for the dates indicated. Each of the following tables excludes immaterial amounts attributed to accrued interest receivable.

 

   

Real Estate

   

Commercial

 

June 30, 2017
(In thousands)

 

Real Estate

Mortgage –

Construction

and Land

Development

   

Real Estate

Mortgage –

Residential

   

Real Estate

Mortgage –

Farmland and

Other Commercial

Enterprises

   

Commercial

and

Industrial

   

States and

Political

Subdivisions

   

Other

 

Credit risk profile by internally assigned rating grades

                                               

Pass

  $ 99,119     $ 314,632     $ 405,637     $ 57,349     $ 18,612     $ 20,518  

Special Mention

    511       9,794       18,579       725       -       22  

Substandard

    4,254       15,787       14,729       530       -       25  

Doubtful

    -       -       -       -       -       -  

Total

  $ 103,884     $ 340,213     $ 438,945     $ 58,604     $ 18,612     $ 20,565  

 

 

   

Real Estate

   

Commercial

 

December 31, 2016
(In thousands)

 

Real Estate

Mortgage –

Construction

and Land

Development

   

Real Estate

Mortgage –

Residential

   

Real Estate

Mortgage –

Farmland and

Other Commercial

Enterprises

   

Commercial

and

Industrial

   

States and

Political

Subdivisions

   

Other

 

Credit risk profile by internally assigned rating grades

                                               

Pass

  $ 112,435     $ 323,300     $ 363,448     $ 47,254     $ 18,933     $ 23,308  

Special Mention

    1,413       12,147       21,088       764       -       -  

Substandard

    6,382       14,806       15,831       589       -       -  

Doubtful

    -       42       -       -       -       -  

Total

  $ 120,230     $ 350,295     $ 400,367     $ 48,607     $ 18,933     $ 23,308  

 

The Company considers the performance of the loan portfolio and its impact on the allowance for loan losses. For consumer loan classes, the Company evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the consumer loans outstanding based on payment activity as of June 30, 2017 and December 31, 2016.

 

   

June 30, 2017

   

December 31, 2016

 
   

Consumer

   

Consumer

 

(In thousands)

 

Secured

   

Unsecured

   

Secured

   

Unsecured

 

Credit risk profile based on payment activity

                               

Performing

  $ 4,173     $ 3,735     $ 4,550     $ 4,538  

Nonperforming

    11       307       4       143  

Total

  $ 4,184     $ 4,042     $ 4,554     $ 4,681  

 

The Company evaluates the loan risk grading system definitions and allowance for loan loss methodology on an ongoing basis. During the first quarter of 2017, the Company shortened the look-back period it uses to determine historical loss rates to the previous twelve quarters from sixteen quarters. No other significant changes were made to the loan risk grading system definitions and allowance for loan loss methodology during the past year.

 

 
24

 

 

8. Other Real Estate Owned

 

Other real estate owned (“OREO”) was as follows for the dates indicated:

 

(In thousands)

 

June 30,

2017

   

December 31,

2016

 

Construction and land development

  $ 4,808     $ 7,996  

Residential real estate

    460       871  

Farmland and other commercial enterprises

    919       1,806  

Total

  $ 6,187     $ 10,673  

 

OREO activity for the six months ended June 30, 2017 and 2016 was as follows:

 

Six months ended June 30, (In thousands)

 

2017

   

2016

 

Beginning balance

  $ 10,673     $ 21,843  

Transfers from loans and other increases

    345       1,474  

Proceeds from sales

    (4,553 )     (5,527 )

Gain (loss) on sales, net

    72       (125 )

Write downs and other decreases, net

    (350 )     (732 )

Ending balance

  $ 6,187     $ 16,933  

 

At June 30, 2017, the Company had a total of $1.2 million of loans secured by residential real estate mortgages that were in the process of foreclosure.

 

9. Securities Sold under Agreements to Repurchase

 

Securities sold under agreements to repurchase represent transactions where the Company sells certain of its investment securities and agrees to repurchase them at a specific date in the future. Securities sold under agreements to repurchase are accounted for as secured borrowing and reflect the amount of cash received in connection with the transaction.

 

Securities sold under agreements to repurchase are collateralized by U.S. government agency securities, primarily mortgage-backed securities. The Company may be required to provide additional collateral securing the borrowings in the event of principal pay downs or a decrease in the market value of the pledged securities. The Company mitigates this risk by monitoring the market value and liquidity of the collateral and ensuring that it holds a sufficient level of eligible securities to cover potential increases in collateral requirements.

 

The following tables represent the remaining maturity of repurchase agreements disaggregated by the class of securities pledged as of the dates indicated.

 

   

Remaining Contractual Maturity of the Agreements

 

June 30, 2017 (In thousands)

 

Overnight/
Continuous

   

Less

Than 30

Days

   

30-89
Days

   

90 Days

to One

Year

   

Over One

Year to

Three Years

   

Total

 

Obligations of U.S. government-sponsored entities

  $ -     $ 501     $ -     $ -     $ 1,032     $ 1,533  

Mortgage-backed securities – residential

    30,134       702       200       -       -       31,036  

Total

  $ 30,134     $ 1,203     $ 200     $ -     $ 1,032     $ 32,569  

 

 
25

 

 

   

Remaining Contractual Maturity of the Agreements

 

December 31, 2016 (In thousands)

 

Overnight/
Continuous

   

Less

Than 30

Days

   

30-89
Days

   

90 Days

to One

Year

   

Over One

Year to

Three Years

   

Total

 

Obligations of U.S. government-sponsored entities

  $ 5,596     $ 301     $ -     $ 258     $ 1,027     $ 7,182  

Mortgage-backed securities – residential

    28,086       902       -       200       -       29,188  

Total

  $ 33,682     $ 1,203     $ -     $ 458     $ 1,027     $ 36,370  

 

10. Postretirement Medical Benefits

 

The Company provides lifetime medical and dental benefits upon retirement for certain employees meeting the eligibility requirements as of December 31, 1989 (“Plan 1”). Additional participants are not eligible to be included in Plan 1 unless they met the requirements on this date. During 2003, the Company implemented an additional postretirement health insurance program (“Plan 2”). Under Plan 2, any employee meeting the service requirement of 20 years of full time service to the Company and is at least age 55 upon retirement is eligible to continue their health insurance coverage. Under both plans, retirees not yet eligible for Medicare have coverage identical to the coverage offered to active employees. Under both plans, Medicare-eligible retirees are provided with a Medicare Advantage plan. The Company pays 100% of the cost of Plan 1. The Company and the retirees each pay 50% of the cost under Plan 2. Both plans are unfunded. Employees hired on or after January 1, 2016 are not eligible for benefits under Plan 2.

 

The following disclosures of the net periodic benefit cost components of Plan 1 and Plan 2 were measured at January 1, 2017 and 2016.

 

   

Three months ended

   

Six months ended

 
   

June 30,

   

June 30,

 

(In thousands)

 

2017

   

2016

   

2017

   

2016

 

Service cost

  $ 137     $ 159     $ 283     $ 318  

Interest cost

    164       171       332       342  

Curtailment gain recognized

    -       -       (351 )     -  

Recognized prior service cost

    -       12       8       25  

Net periodic benefit cost

  $ 301     $ 342     $ 272     $ 685  

 

In connection with the merger of certain of its subsidiaries in February 2017, the Company recognized a curtailment gain of $351 thousand during the first quarter of 2017 as a result of revaluing its postretirement medical benefits plan liability due to a reduction in workforce. The gain is net of $67 thousand of prior service costs recognized due to the curtailment.

 

The Company expects benefit payments of $468 thousand for 2017, of which $172 thousand have been made during the first six months of 2017.

 

11. Regulatory Matters

 

The Company and its subsidiary bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements will initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, banks must meet specific capital guidelines that involve quantitative measures of the bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and its subsidiary bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

 

 
26

 

 

The regulatory ratios of the consolidated Company and its subsidiary bank were as follows for the dates indicated:

 

   

June 30, 2017

   

December 31, 2016

 
   

Common

Equity Tier

1 Risk-based

Capital1

   

Tier 1
Risk-based
Capital1

   

Total
Risk-based
Capital1

   

Tier 1
Leverage2

   

Common

Equity Tier

1 Risk-based

Capital1

   

Tier 1
Risk-

based
Capital1

   

Total
Risk-

based
Capital1

   

Tier 1
Leverage2

 

Consolidated

    16.60 %     19.39 %     20.18 %     13.64 %     16.43 %     19.28 %     20.10 %     13.20 %

United Bank & Capital Trust Company

    14.76       14.76       15.55       10.49       *       *       *       *  

Farmers Bank & Capital Trust Company

    *       *       *       *       16.53       16.53       17.23       9.80  

United Bank & Trust Company

    *       *       *       *       15.54       15.54       16.47       12.38  

First Citizens Bank

    *       *       *       *       13.56       13.56       14.16       9.76  

Citizens Bank of Northern Kentucky, Inc.

    *       *       *       *       15.24       15.24       16.40       10.68  
                                                                 

Regulatory minimum

    4.50       6.00       8.00       4.00       4.50       6.00       8.00       4.00  

Well-capitalized status

    6.50       8.00       10.00       5.00       6.50       8.00       10.00       5.00  

 

1Common Equity Tier 1 Risked-based, Tier 1 Risk-based, and Total Risk-based Capital ratios are computed by dividing a bank’s Common Equity Tier 1, Tier 1 or Total Capital, as defined by regulation, by a risk-weighted sum of the bank’s assets, with the risk weighting determined by general standards established by regulation.

2Tier 1 Leverage ratio is computed by dividing a bank’s Tier 1 Capital by its total quarterly average assets, as defined by regulation.

*In February 2017, the Company merged United Bank & Trust Company, First Citizens Bank, Inc., and Citizens Bank of Northern Kentucky, Inc. into Farmers Bank & Capital Trust Company in Frankfort, KY, the name of which was immediately changed to United Bank & Capital Trust Company.

 

12. Fair Value Measurements

 

ASC Topic 820, “Fair Value Measurements and Disclosures, defines fair value, establishes a framework for measuring fair value, and sets forth disclosures about fair value measurements. ASC Topic 825, “Financial Instruments, allows entities to choose to measure certain financial assets and liabilities at fair value. The Company has not elected the fair value option for any of its financial assets or liabilities.

 

ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. It 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. This Topic describes three levels of inputs that may be used to measure fair value:

 

 

Level 1:

Quoted prices for identical assets or liabilities in active markets that the entity has the ability to access at the measurement date.

 

 

Level 2:

Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

 

Level 3:

Significant unobservable inputs that reflect a reporting entity’s own assumptions supported by little or no market activity, about the assumptions that market participants would use in pricing the asset or liability.

 

Following is a description of the valuation method used for financial instruments measured at fair value on a recurring basis. For this disclosure, the Company only has available for sale investment securities and money market mutual funds classified as cash equivalents that meet the requirement. The carrying value of the $27.7 million in money market mutual funds is equivalent to its fair value and based on Level 1 inputs.

 

 
27

 

 

Available for sale investment securities

Valued primarily by independent third party pricing services under the market valuation approach that include, but are not limited to, the following inputs:

 

 

Mutual funds and equity securities are priced utilizing real-time data feeds from active market exchanges for identical securities and are considered Level 1 inputs.

 

Government-sponsored agency debt securities, obligations of states and political subdivisions, mortgage-backed securities, corporate bonds, and other similar investment securities are priced with available market information through processes using benchmark yields, matrix pricing, prepayment speeds, cash flows, live trading data, and market spreads sourced from new issues, dealer quotes, and trade prices, among others sources and are considered Level 2 inputs.

 

Fair value disclosure for available for sale investment securities as of June 30, 2017 and December 31, 2016 are as follows:

 

           

Fair Value Measurements Using

 

(In thousands)


Available For Sale Investment Securities

 

Fair Value

   

Quoted Prices in

Active Markets

for Identical

Assets
(Level 1)

   

Significant Other

Observable

Inputs
(Level 2)

   

Significant

Unobservable

Inputs
(Level 3)

 
                                 

June 30, 2017

                               

Obligations of U.S. government-sponsored entities

  $ 79,517     $ -     $ 79,517     $ -  

Obligations of states and political subdivisions

    126,573       -       126,573       -  

Mortgage-backed securities – residential

    202,163       -       202,163       -  

Mortgage-backed securities – commercial

    46,826       -       46,826       -  

Corporate debt securities

    7,666       -       7,666       -  

Mutual funds and equity securities

    875       875       -       -  

Total

  $ 463,620     $ 875     $ 462,745     $ -  

 

 

           

Fair Value Measurements Using

 

(In thousands)


Available For Sale Investment Securities

 

Fair Value

   

Quoted Prices in

Active Markets

for Identical

Assets
(Level 1)

   

Significant Other

Observable

Inputs
(Level 2)

   

Significant

Unobservable

Inputs
(Level 3)

 
                                 

December 31, 2016

                               

Obligations of U.S. government-sponsored entities

  $ 71,694     $ -     $ 71,694     $ -  

Obligations of states and political subdivisions

    132,292       -       132,292       -  

Mortgage-backed securities – residential

    224,307       -       224,307       -  

Mortgage-backed securities – commercial

    45,613       -       45,613       -  

Corporate debt securities

    6,125       -       6,125       -  

Mutual funds and equity securities

    833       833       -       -  

Total

  $ 480,864     $ 833     $ 480,031     $ -  

 

The Company is required to measure and disclose certain other assets and liabilities at fair value on a nonrecurring basis in periods following their initial recognition. The Company’s disclosure about assets and liabilities measured at fair value on a nonrecurring basis consists of collateral-dependent impaired loans and OREO. The carrying value of these assets are adjusted to fair value on a nonrecurring basis through impairment charges as described more fully below.

 

 
28

 

 

Impairment charges on collateral-dependent loans are recorded by either an increase to the provision for loan losses and related allowance or by direct loan charge-offs. The fair value of collateral-dependent impaired loans with specific allocations of the allowance for loan losses is measured based on recent appraisals of the underlying collateral. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraisers take absorption rates into consideration and adjustments are routinely made in the appraisal process to identify differences between the comparable sales and income data available. Such adjustments consist mainly of estimated costs to sell that are not included in certain appraisals or to update appraised collateral values as a result of market declines of similar properties for which a newer appraisal is available. These adjustments can be significant and typically result in a Level 3 classification of the inputs for determining fair value.

 

OREO includes properties acquired by the Company through, or in lieu of, actual loan foreclosures and is carried at fair value less estimated costs to sell. Fair value of OREO at acquisition is generally based on third party appraisals of the property that includes comparable sales data and is considered as Level 3 inputs. The carrying value of each OREO property is updated at least annually and more frequently when market conditions significantly impact the value of the property. If the carrying amount of the OREO exceeds fair value less estimated costs to sell, an impairment loss is recorded through noninterest expense.

 

The following table represents the carrying amount of assets measured at fair value on a nonrecurring basis and still held by the Company as of the dates indicated. The amounts in the table only represent assets whose carrying amount has been adjusted by impairment charges during the period in a manner as described above; therefore, these amounts will differ from the total amounts outstanding. With the exception of those calculated using the collateral valuation method, collateral-dependent impaired loan amounts in the tables below exclude restructured loans that are measured based on present value techniques, which are outside the scope of the fair value reporting framework.

 

 

           

Fair Value Measurements Using

 

(In thousands)


Description

 

Fair Value

   

Quoted Prices in

Active Markets

for Identical

Assets
(Level 1)

   

Significant

Other

Observable

Inputs
(Level 2)

   

Significant

Unobservable

Inputs
(Level 3)

 
                                 

June 30, 2017

                               

Collateral-dependent Impaired Loans

                               

Real estate mortgage – construction and land development

  $ 1,315     $ -     $ -     $ 1,315  

Real estate mortgage – residential

    395       -       -       395  

Commercial, financial, and agriculture

    13       -       -       13  

Total

  $ 1,723     $ -     $ -     $ 1,723  
                                 

OREO

                               

Construction and land development

  $ 2,588     $ -     $ -     $ 2,588  

Residential real estate

    90       -       -       90  

Farmland and other commercial enterprises

    729       -       -       729  

Total

  $ 3,407     $ -     $ -     $ 3,407  

 

 
29

 

 

           

Fair Value Measurements Using

 

(In thousands)



Description

 

Fair Value

   

Quoted Prices in

Active Markets

for Identical

Assets
(Level 1)

   

Significant

Other

Observable

Inputs
(Level 2)

   

Significant

Unobservable

Inputs
(Level 3)

 

December 31, 2016

                               

Collateral-dependent Impaired Loans

                               

Real estate mortgage – construction and land development

  $ 2,909     $ -     $ -     $ 2,909  

Real estate mortgage – residential

    3,137       -       -       3,137  

Real estate mortgage – farmland and other commercial enterprises

    351       -       -       351  

Total

  $ 6,397     $ -     $ -     $ 6,397  
                                 

OREO

                               

Construction and land development

  $ 4,883     $ -     $ -     $ 4,883  

Residential real estate

    234       -       -       234  

Farmland and other commercial enterprises

    1,070       -       -       1,070  

Total

  $ 6,187     $ -     $ -     $ 6,187  

 

The following table represents impairment charges recorded in earnings for the periods indicated on assets measured at fair value on a nonrecurring basis. 

 

   

Three months ended

   

Six months ended

 
   

June 30,

   

June 30,

 

(In thousands)

 

2017

   

2016

   

2017

   

2016

 

Impairment charges:

                               

Collateral-dependent impaired loans

  $ 25     $ 494     $ 27     $ 524  

OREO

    138       116       202       566  

Total

  $ 163     $ 610     $ 229     $ 1,090  

 

The following table presents quantitative information about unobservable inputs for assets measured on a nonrecurring basis using Level 3 measurements. As described above, the fair value of real estate securing collateral-dependent impaired loans and OREO are based on current third party appraisals. It is sometimes necessary, however, for the Company to discount the appraisal amounts supporting its impaired loans and OREO. These discounts relate primarily to marketing and other holding costs that are not included in certain appraisals or to update values as a result of market declines of similar properties for which newer appraisals are available. Discounts may also result from contracts to sell properties entered into during the period. The range of discounts is presented in the table below for 2017 and 2016.

 

(In thousands)

 

Fair Value

 

Valuation Technique

 

Unobservable Inputs

 

Range

   

Average

 

June 30, 2017

                                 

Collateral-dependent impaired loans

  $ 1,723  

Discounted appraisals

 

Marketability discount

    0% - 10.7%       4.1 %

OREO

  $ 3,407  

Discounted appraisals

 

Marketability discount

    0% - 40.5%       20.2 %

December 31, 2016

                                 

Collateral-dependent impaired loans

  $ 6,397  

Discounted appraisals

 

Marketability discount

    0% - 67.8%       3.5 %

OREO

  $ 6,187  

Discounted appraisals

 

Marketability discount

    0% - 50.0%       11.2 %

 

 
30

 

 

Fair Value of Financial Instruments

 

The table that follows represents the estimated fair values of the Company’s financial instruments made in accordance with the requirements of ASC Topic 825, “Financial Instruments. ASC Topic 825 requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet for which it is practicable to estimate that value. The estimated fair value amounts have been determined by the Company using available market information and present value or other valuation techniques. These derived fair values are subjective in nature, involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. ASC Topic 825 excludes certain financial instruments and all nonfinancial instruments from the disclosure requirements. Accordingly, the aggregate fair value amounts presented are not intended to represent the underlying value of the Company.

 

The following methods and assumptions were used to estimate the fair value of each class of financial instruments not presented elsewhere for which it is practicable to estimate that value.

 

Cash and Cash Equivalents, Accrued Interest Receivable, and Accrued Interest Payable

The carrying amount is a reasonable estimate of fair value due to the relatively short time between the origination of the instrument and its expected realization or settlement.

 

Investment Securities Held to Maturity

Fair value is based on quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities or with available market information through processes using benchmark yields, matrix pricing, prepayment speeds, cash flows, live trading data, and market spreads sourced from new issues, dealer quotes, and trade prices, among other sources.

 

Loans

The fair value of loans is estimated by discounting expected future cash flows using current discount rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Expected future cash flows are projected based on contractual cash flows adjusted for estimated prepayments.

 

Federal Home Loan Bank and Federal Reserve Bank Stock

The fair value of Federal Home Loan Bank and Federal Reserve Bank stock is estimated at book value due to restrictions that limit the sale or transfer of such securities.

 

Deposit Liabilities

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date and fair value approximates carrying value. The fair value of fixed maturity certificates of deposit is estimated by discounting the expected future cash flows using the rates currently offered for certificates of deposit with similar remaining maturities.

 

Federal Funds Purchased and Short-term Securities Sold Under Agreements to Repurchase

The carrying amount is the estimated fair value for these borrowings which reprice frequently in the near term.

 

Securities Sold Under Agreements to Repurchase, Subordinated Notes Payable, and Other Long-term Borrowings

The fair value of these borrowings is estimated by discounting the expected future cash flows using rates currently available for debt with similar terms and remaining maturities. For subordinated notes payable, the Company uses its best estimate to determine an appropriate discount rate since active markets for similar debt transactions are very limited.

 

 
31

 

 

Commitments to Extend Credit and Standby Letters of Credit

Pricing of these financial instruments is based on the credit quality and relationship, fees, interest rates, probability of funding, compensating balance, and other covenants or requirements. Loan commitments generally have fixed expiration dates, variable interest rates and contain termination and other clauses that provide for relief from funding in the event there is a significant deterioration in the credit quality of the customer. Many loan commitments are expected to, and typically do, expire without being drawn upon. The rates and terms of the Company’s commitments to lend and standby letters of credit are competitive with others in the various markets in which the Company operates. There are no unamortized fees relating to these financial instruments, as such the carrying value and fair value are both zero.

 

The following table presents the estimated fair values of the Company’s financial instruments and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2017 and December 31, 2016. Information for available for sale investment securities is presented within this footnote in greater detail above.

 

                   

Fair Value Measurements Using

 

(In thousands)

 

Carrying
Amount

   

Fair
Value

   

Quoted Prices

in Active

Markets for

Identical Assets
(Level 1)

   

Significant

Other

Observable

Inputs
(Level 2)

   

Significant

Unobservable

Inputs
(Level 3)

 

June 30, 2017

                                       

Assets

                                       

Cash and cash equivalents

  $ 98,014     $ 98,014     $ 98,014     $ -     $ -  

Held to maturity investment securities

    3,461       3,617       -       3,617       -  

Loans, net

    979,827       973,781       -       -       973,781  

Accrued interest receivable

    4,707       4,707       -       4,707       -  

Federal Home Loan Bank and Federal Reserve Bank Stock

    13,410       13,410       -       -       13,410  
                                         

Liabilities

                                       

Deposits

    1,352,838       1,352,783       1,109,354       -       243,429  

Securities sold under agreements to repurchase

    32,569       32,576       -       32,576       -  

Federal Home Loan Bank advances

    13,562       13,855       -       13,855       -  

Subordinated notes payable to unconsolidated trusts

    33,506       21,110       -       -       21,110  

Accrued interest payable

    279       279       -       279       -  
                                         

December 31, 2016

                                       

Assets

                                       

Cash and cash equivalents

  $ 113,534     $ 113,534     $ 113,534     $ -     $ -  

Held to maturity investment securities

    3,488       3,597       -       3,597       -  

Loans, net

    961,631       962,437       -       -       962,437  

Accrued interest receivable

    5,019       5,019       -       5,019       -  

Federal Home Loan Bank and Federal Reserve Bank Stock

    9,840       9,840       -       -       9,840  
                                         

Liabilities

                                       

Deposits

    1,369,907       1,369,567       1,099,211       -       270,356  

Securities sold under agreements to repurchase

    36,370       36,381       -       36,381       -  

Federal Home Loan Bank advances

    18,646       19,114       -       19,114       -  

Subordinated notes payable to unconsolidated trusts

    33,506       21,234       -       -       21,234  

Accrued interest payable

    321       321       -       321       -  

 

 
32

 

 

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

 

FORWARD-LOOKING STATEMENTS

 

This report contains forward-looking statements with the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Statements in this report that are not statements of historical fact are forward-looking statements. In general, forward-looking statements relate to a discussion of future financial results or projections, future economic performance, future operational plans and objectives, and statements regarding the underlying assumptions of such statements. Although management of Farmers Capital Bank Corporation (the “Company” or “Parent Company”) believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore, there can be no assurance that the forward-looking statements included herein will prove to be accurate.

 

Various risks and uncertainties may cause actual results to differ materially from those indicated by the Company’s forward-looking statements. In addition to the risks described under Part 1, Item 1A “Risk Factors” in the Company’s most recent annual report on Form 10-K, factors that could cause actual results to differ from the results discussed in the forward-looking statements include, but are not limited to: economic conditions (both generally and more specifically in the markets in which the Company and its subsidiaries operate) and lower interest margins; competition for the Company’s customers from other providers of financial services; deposit outflows or reduced demand for financial services and loan products; government legislation, regulation, and changes in monetary and fiscal policies (which changes from time to time and over which the Company has no control); changes in interest rates; changes in prepayment speeds of loans or investment securities; inflation; material unforeseen changes in the liquidity, results of operations, or financial condition of the Company’s customers; changes in the level of non-performing assets and charge-offs; changes in the number of common shares outstanding; the capability of the Company to successfully enter into a definitive agreement for, close, and realize the benefits of anticipated transactions; unexpected claims or litigation against the Company; expected insurance or other recoveries; technological or operational difficulties; the impact of new accounting pronouncements and changes in policies and practices that may be adopted by regulatory agencies; acts of war or terrorism; the ability of the Parent Company to receive dividends from its subsidiaries; the impact of larger or similar financial institutions encountering difficulties, which may adversely affect the banking industry or the Company; the Company or its subsidiary bank’s ability to maintain required capital levels and adequate funding sources and liquidity; and other risks or uncertainties detailed in the Company’s filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of the Company.

 

The Company’s forward-looking statements are based on information available at the time such statements are made. The Company expressly disclaims any intent or obligation to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events, or other changes.

 

 
33

 

 

RESULTS OF OPERATIONS

 

Second Quarter 2017 Compared to Second Quarter 2016

 

The Company reported net income of $4.5 million or $.60 per common share and $3.6 million or $.47 per common share for the quarters ended June 30, 2017 and 2016, respectively. This represents an increase of $926 thousand or 26.0%, and $.13 on a per common share basis in the comparison.

 

(In thousands except per share data)

                       

Three Months Ended June 30,

 

2017

   

2016

   

Increase
(Decrease)

 

Interest income

  $ 14,830     $ 14,973     $ (143 )

Interest expense

    881       1,975       (1,094 )

Net interest income

    13,949       12,998       951  

Provision for loan losses

    (499 )     (156 )     (343 )

Net interest income after provision for loan losses

    14,448       13,154       1,294  

Noninterest income

    5,102       5,521       (419 )

Noninterest expenses

    13,346       13,884       (538 )

Income before income taxes

    6,204       4,791       1,413  

Income tax expense

    1,722       1,235       487  

Net income

  $ 4,482     $ 3,556     $ 926  
                         

Basic and diluted net income per common share

  $ .60     $ .47     $ .13  

Cash dividends declared per common share

    .10       .07       .03  
                         

Weighted average common shares outstanding – basic and diluted

    7,512       7,502       10  

Return on average assets

    1.09 %     .81 %  

28 bp

 

Return on average equity

    9.45 %     7.73 %  

172 bp

 

bp – basis points.

                       

 

The increase in net income is attributed primarily to higher net interest income of $951 thousand or 7.3% and a higher credit to the provision for loan losses of $343 thousand. Noninterest income declined $419 thousand or 7.6%, which was more than offset by a decrease in noninterest expense of $538 thousand or 3.9%. Further information related to the more significant components making up the decline in net income follows.

 

Net Interest Income

 

The overall interest rate environment at June 30, 2017, as measured by the Treasury yield curve, remained at very low levels when compared with historical trends. During the quarter, the shape of the yield curve flattened as a result of a decrease in yields on longer-term maturities and higher yields on shorter-term maturities. Yields for the ten and thirty-year maturity periods declined 8 and 17 basis points, respectively, while the three-month and two-year maturities were up 26 and 13 basis points, respectively. During June 2017, the Federal Reserve Board (“Federal Reserve”) raised the short-term federal funds target interest rate to a range between 1.00% and 1.25%. This marks the second increase during 2017, up from a target range of 0.50% to 0.75% established in December 2016 and a range of 0.25% to 0.50% targeted in December 2015. The Federal Reserve has indicated that it will continue to assess realized and expected economic conditions relative to its objectives of maximum employment and two percent inflation when determining the timing and size of future adjustments to the target rate. At June 30, 2017, the national and Kentucky unemployment rates were 4.4% and 5.1%, respectively. The national inflation rate at June 30, 2017 was 1.6% based on the Consumer Price Index published by the Bureau of Labor Statistics, down from 2.1% at year-end 2016.

 

Net interest income was $13.9 million for the current quarter, an increase of $951 thousand or 7.3% compared to $13.0 million a year earlier. The increase in net interest income was driven by a decline in interest expense of $1.1 million or 55.4% partially offset by a decrease in interest income of $143 thousand or 1.0%. Interest expense on deposits and borrowed funds were down $76 thousand or 12.7% and $1.0 million or 74.0%, respectively. Interest income on loans was up $270 thousand or 2.3%. Interest on loans in the current quarter include the collection of a $73 thousand prepayment fee and the collection of $38 thousand related to a nonaccrual residential real estate loan that fully paid off during the quarter. Interest income on investments decreased $472 thousand or 15.6%.

 

 
34

 

 

The increase in interest income on loans was driven by a higher average loan balance outstanding, partially offset by a lower average rate earned of three basis points. For the current quarter, the prepayment fee and collection of interest on the nonaccrual loan identified above aided the average rate earned on loans by three basis points. Average loans for the current quarter increased $24.6 million or 2.6% compared to the prior-year quarter.

 

Interest income on investment securities is down primarily due to lower volume. Average investment securities for the quarter decreased $99.6 million or 16.9% from a year ago. Volume declines are mainly the result of the balance sheet deleverage transaction that was announced during the third quarter of 2016, which is more fully described below.

 

The decrease in interest expense on deposits was driven by rate declines and lower average outstanding balances related to time deposits. Interest expense on borrowed funds was down primarily due to the early repayment of $100 million of high fixed-rate borrowings during the third quarter of 2016 related to the deleveraging transaction discussed below.

 

Overall declines in the average rate earned from interest income on loans and average interest rate paid on deposits are the result of a slow growing economy and related low interest rate environment, competitive pressures, and the Company’s ongoing strategy of being more selective in pricing its loans and deposits. The goal of this strategy is to improve credit quality, net interest income, overall profitability, and capital position.

 

The Company is generally earning and paying less interest from its earning assets and funding sources as the average rates earned and paid have decreased. This includes repricing of variable and floating rate assets and liabilities that have reset to overall lower amounts since their previous repricing date, as well as activity related to new earning assets and funding sources in a low interest rate environment. The Company continues to reprice its higher-rate maturing time deposits downward to lower market rates or to allow them to mature without renewal, as liquidity has been adequate.

 

To offset the overall decline in average rates earned and paid, the Company has improved its mix of earning assets and interest bearing liabilities through growth in the loan portfolio over the past year combined with a significant decrease in lower-yielding investment securities and higher-rate borrowings. On an average basis, loans represented 63.2% of earning assets for the second quarter of 2017, an increase of 481 basis points compared to 58.4% for the second quarter of 2016. Loans typically involve an increase in credit risk and higher yields when compared to investment securities.

 

As part of its strategy to improve net interest income and net interest margin, the Company completed a series of transactions during the last half of 2016 to deleverage its balance sheet and reposition its investment securities portfolio. The Company used a mixture of $10.4 million of excess cash and $93.4 million of proceeds from the sale of investment securities to prepay $100 million of high fixed-rate borrowings due to mature in November 2017. The Company incurred a prepayment fee of $3.8 million, which was offset by a gain in the same amount from the sale of investment securities. The average yield on the mix of cash and investment securities sold to fund the debt prepayment was 2.97%. The average cost of the fixed rate borrowings that were repaid was 3.95%. The Company also took action to reposition its investment securities portfolio by replacing approximately $78 million of certain lower-yielding, short-term investments with longer-term, higher-yielding investments consistent with a more normalized strategy and maturity periods. The lower-yielding, short-term investments were built up in anticipation of the November 2017 debt repayment. The average yield on the investments identified for the repositioning strategy was 0.85% compared to a targeted reinvestment yield of 1.85%. As a result, the average life of the securities portfolio at the time of the transaction increased to 4.0 years from 3.5 years.

 

The net interest margin on a taxable equivalent basis was 3.69% for the current quarter, an increase of 41 basis points compared with 3.28% a year earlier. Net interest spread increased 49 basis points to 3.60%, up from 3.11% a year ago. Net interest margin and spread for the current quarter were positively impacted three basis points from the prepayment fee and collection of interest on the nonaccrual residential real estate loan identified above. The Company expects its net interest margin to stay relatively flat in the near term according to internal modeling using expectations about future market interest rates, the maturity structure of the Company’s earning assets and liabilities, and other factors. Future results could be significantly different than current expectations.

 

 
35

 

 

The following tables present an analysis of net interest income for the quarterly periods ended June 30.

 

Distribution of Assets, Liabilities and Shareholders’ Equity: Interest Rates and Interest Differential

Three Months Ended June 30,

 

2017

   

2016

 

(In thousands)

 

Average

Balance

   

Interest

   

Average

Rate

   

Average

Balance

   

Interest

   

Average

Rate

 

Earning Assets

                                               

Investment securities1

                                               

Taxable

  $ 370,020     $ 1,984       2.15 %   $ 469,793     $ 2,429       2.08 %

Nontaxable2

    119,640       871       2.92       119,483       903       3.04  

Interest bearing deposits in banks, federal funds sold and securities purchased under agreements to resell, and money market mutual funds

    81,734       161       .79       92,618       102       .44  

Loans2,3,4

    983,139       12,179       4.97       958,542       11,912       5.00  

Total earning assets

    1,554,533     $ 15,195       3.92 %     1,640,436     $ 15,346       3.76 %

Allowance for loan losses

    (9,499 )                     (9,674 )                

Total earning assets, net of allowance for loan losses

    1,545,034                       1,630,762                  

Nonearning Assets

                                               

Cash and due from banks

    21,005                       22,170                  

Premises and equipment, net

    31,923                       32,403                  

Other assets

    62,245                       81,628                  

Total assets

  $ 1,660,207                     $ 1,766,963                  

Interest Bearing Liabilities

                                               

Deposits

                                               

Interest bearing demand

  $ 345,206     $ 110       .13 %   $ 335,841     $ 65       .08 %

Savings

    424,297       132       .12       405,986       130       .13  

Time

    251,141       281       .45       302,807       404       .54  

Federal funds purchased

    4       -       -       1       -       -  

Short-term securities sold under agreements to repurchase

    31,712       14       .18       32,579       21       .26  

Long-term securities sold under agreements to repurchase

    1,048       2       .77       101,280       1,000       3.97  

Federal Home Loan Bank advances

    13,579       129       3.81       18,751       185       3.97  

Subordinated notes payable to unconsolidated trusts

    33,506       213       2.55       33,506       170       2.04  

Total interest bearing liabilities

    1,100,493     $ 881       .32 %     1,230,751     $ 1,975       .65 %

Noninterest Bearing Liabilities

                                               

Demand deposits

    341,535                       322,817                  

Other liabilities

    27,421                       28,299                  

Total liabilities

    1,469,449                       1,581,867                  

Shareholders’ equity

    190,758                       185,096                  

Total liabilities and shareholders’ equity

  $ 1,660,207                     $ 1,766,963                  

Net interest income

            14,314                       13,371          

TE basis adjustment

            (365 )                     (373 )        

Net interest income

          $ 13,949                     $ 12,998          

Net interest spread

                    3.60 %                     3.11 %

Impact of noninterest bearing sources of funds

                    .09                       .17  

Net interest margin

                    3.69 %                     3.28 %

 

1Average yields on securities available for sale have been calculated based on amortized cost.

2Income and yield stated at a fully tax equivalent basis using the marginal corporate Federal tax rate of 35%.

3Loan balances include principal balances on nonaccrual loans.

4Loan fees included in interest income amounted to $429 thousand and $364 thousand in 2017 and 2016, respectively.

 

 
36

 

 

Analysis of Changes in Net Interest Income (tax equivalent basis)

(In thousands)

 

Variance

   

Variance Attributed to

 

Three Months Ended June 30,

 

2017/20161

   

Volume

   

Rate

 
                         

Interest Income

                       

Taxable investment securities

  $ (445 )   $ (952 )   $ 507  

Nontaxable investment securities2

    (32 )     9       (41 )

Interest bearing deposits in banks, federal funds sold and securities purchased under agreements to resell, and money market mutual funds

    59       (76 )     135  

Loans2

    267       683       (416 )

Total interest income

    (151 )     (336 )     185  

Interest Expense

                       

Interest bearing demand deposits

    45       2       43  

Savings deposits

    2       31       (29 )

Time deposits

    (123 )     (62 )     (61 )

Federal funds purchased

    -       -       -  

Short-term securities sold under agreements to repurchase

    (7 )     -       (7 )

Long-term securities sold under agreements to repurchase

    (998 )     (550 )     (448 )

Federal Home Loan Bank advances

    (56 )     (49 )     (7 )

Subordinated notes payable to unconsolidated trusts

    43       -       43  

Total interest expense

    (1,094 )     (628 )     (466 )

Net interest income

  $ 943     $ 292     $ 651  

Percentage change

    100.0 %     31.0 %     69.0 %

 

1The changes that are not solely due to rate or volume are allocated on a percentage basis using the absolute values of rate and volume variances as a basis for allocation.

2Income stated at fully tax equivalent basis using the marginal corporate Federal tax rate of 35%.

 

Provision for Loan Losses

 

The provision for loan losses represents charges or credits to earnings that are necessary to maintain an allowance for loan losses at an adequate level to cover credit losses specifically identified in the loan portfolio, as well as management’s best estimate of incurred probable loan losses in the remainder of the portfolio at the balance sheet date. The credit quality of the Company’s loan portfolio continued recent trends of improvement during the current quarter, as certain credit quality metrics are at or near recent quarterly bests.

 

The Company recorded a credit to the provision for loan losses in the amount of $499 thousand and $156 thousand for the current and year-ago quarters, respectively. The allowance for loan losses as a percentage of outstanding loans was 0.93% at June 30, 2017 compared to 0.96% and 0.99% at year-end 2016 and June 30, 2016, respectively. The credit to the provision for the current quarter was driven by net recoveries of $214 thousand combined with a decline in specific reserves on impaired loans of $273 thousand. Net recoveries during the quarter include $371 thousand from a real estate development project. The Company recorded a total of $1.4 million in charge-offs between 2010 and 2012 related to the real estate development project and anticipates it could receive an additional $340 thousand in recoveries related to this credit during the remainder of 2017.

 

While historical loss rates continued to be low, the effect of the improvement in loss rates on the allowance for loan losses has diminished now that the higher levels experienced during 2008 through the first quarter of 2014 have already rolled out of the three year look-back period used when evaluating the allowance for loan losses. Overall credit quality metrics of the loan portfolio has continued to improve. Nonperforming loans, impaired loans, loans graded as substandard or below, and watch list loans have each declined when compared with a year earlier. For further information about improvements in the Company’s overall credit quality, please refer to the discussion under the captions “Allowance for Loan Losses” and “Nonperforming Loans” that follows.

 

 
37

 

 

Noninterest Income

 

The components of noninterest income are as follows for the periods indicated:

 

Three Months Ended June 30, (In thousands)

 

2017

   

2016

   

Increase
(Decrease)

   

%

 

Service charges and fees on deposits

  $ 2,012     $ 1,927     $ 85       4.4 %

Allotment processing fees

    651       820       (169 )     (20.6 )

Other service charges, commissions, and fees

    1,328       1,432       (104 )     (7.3 )

Trust income

    626       665       (39 )     (5.9 )

Investment securities (losses) gains, net

    (1 )     131       (132 )     (100.8 )

Gain on sale of mortgage loans, net

    189       222       (33 )     (14.9 )

Income from company-owned life insurance

    221       231       (10 )     (4.3 )

Other

    76       93       (17 )     (18.3 )

Total noninterest income

  $ 5,102     $ 5,521     $ (419 )     (7.6 )%

 

The decline in noninterest income is primarily attributable to lower allotment processing fees, a net loss on the sale of investment securities compared to a net gain a year-ago, and lower nondeposit charges, commissions, and fees.

 

Service charges and fees on deposits increased primarily due to higher service charges on savings accounts of $28 thousand or 125% and higher overdraft fees of $18 thousand or 1.9%. Contributing to the overall increase in service charges are higher average balances of demand deposits and savings account compared to the prior year. Additionally, during the second quarter of 2016, the Company standardized and reduced the number of its deposit account product offerings throughout the corporation, which has contributed to an overall increase in service charges since completion.

 

The decline in allotment processing fees is primarily a result of lower processing volume stemming from the U.S. Department of Defense policy that went into effect on January 1, 2015 which restricts the types of purchases that active duty service members are able to make using the military allotment system for payment. The Company is continuing its effort to mitigate these declines by diversifying its customer base beyond the historically strong level of military participants and by expanding its payment processing options.

 

The decrease in nondeposit service charges, commissions, and fees was driven by declines across multiple line items. Net losses on the sale of investment securities compared to net gains in the prior year is attributed to normal asset/liability management strategies, as the Company periodically sells investment securities to lock in gains, increase yield, restructure expected future cash flows, improve risk exposures, and/or enhance its capital position.

 

 
38

 

 

Noninterest Expense

 

The components of noninterest expense are as follows for the periods indicated:

 

Three Months Ended June 30, (In thousands)

 

2017

   

2016

   

Increase
(Decrease)

   

%

 

Salaries and employee benefits

  $ 7,646     $ 7,655     $ (9 )     (0.1 )%

Occupancy expenses, net

    1,135       1,179       (44 )     (3.7 )

Equipment expenses

    599       639       (40 )     (6.3 )

Data processing and communication expenses

    1,093       1,212       (119 )     (9.8 )

Bank franchise tax

    609       611       (2 )     (0.3 )

Deposit insurance expenses

    130       280       (150 )     (53.6 )

Other real estate expenses, net

    326       373       (47 )     (12.6 )

Legal expenses

    118       102       16       15.7  

Other

    1,690       1,833       (143 )     (7.8 )

Total noninterest expense

  $ 13,346     $ 13,884     $ (538 )     (3.9 )%

 

The decline in noninterest expense in the comparison was driven by lower deposit insurance expenses and a decrease in data processing and communications expenses.

 

Salaries and employee benefits was relatively unchanged compared to the prior-year second quarter. Salaries and related payroll taxes increased $131 thousand or 2.1% in the comparison, partially offset by a decline in employee benefits of $130 thousand or 9.9%. Salaries and related payroll taxes in the current quarter includes incentive pay accruals of $359 thousand related to the Company’s Board-approved incentive payment plans put in place for 2017. These plans include the Company’s executive management team and certain other designated officers throughout the corporation. Salary expense also includes Board-approved retention payments during the second quarter of 2017 in the amount of $201 thousand to certain members of management. There were no such incentive accruals or retention payments in the comparable period. The decline in employee benefits was mainly due to lower claims activity related to the Company’s self-funded health insurance plan of $138 thousand due to the reduced workforce. The Company had 433 full time equivalent employees at quarter-end, down from 489 a year ago.

 

Data processing and communication expense was down primarily due to a one-time accrual adjustment of $137 thousand included in the prior-year quarter related to a change in card vendor. The reduction in deposit insurance expense is due to a combination of further improvement in the risk rating at the Company’s subsidiary bank and lower assessment rates. The decline in other expenses was across multiple line items, led by lower directors’ fees of $63 thousand or 38.1%, mainly attributable to having fewer boards of directors due to the consolidation of subsidiaries during the first quarter of 2017.

 

Income Taxes

 

Income tax expense was $1.7 million for the current quarter, an increase of $487 thousand or 39.4% compared to $1.2 million for the same quarter of 2016. The effective income tax rates were 27.8% and 25.8% for the current and year-ago quarters, respectively.

 

 
39

 

 

First Six Months of 2017 Compared to First Six Months 2016

 

The Company reported net income of $7.8 million or $1.04 per common share and $9.7 million or $1.30 per common share for the six months ended June 30, 2017 and 2016, respectively. This represents a decrease of $1.9 million or 19.8%, and $.26 on a per common share basis in the comparison. The current six-months includes pre-tax expenses of $472 thousand ($307 thousand after tax) or $.04 per common share related to the Company’s consolidation of its four bank subsidiaries and data processing subsidiary into one bank. This consolidation was completed in February 2017. Selected income statement amounts and related data are summarized in the table below.

 

(In thousands except per share data)

                       

Six Months Ended June 30,

 

2017

   

2016

   

Increase
(Decrease)

 

Interest income

  $ 29,209     $ 30,303     $ (1,094 )

Interest expense

    1,797       4,018       (2,221 )

Net interest income

    27,412       26,285       1,127  

Provision for loan losses

    81       (629 )     710  

Net interest income after provision for loan losses

    27,331       26,914       417  

Noninterest income

    10,353       15,063       (4,710 )

Noninterest expenses

    26,875       28,291       (1,416 )

Income before income taxes

    10,809       13,686       (2,877 )

Income tax expense

    2,998       3,950       (952 )

Net income

  $ 7,811     $ 9,736     $ (1,925 )
                         

Basic and diluted net income per common share

  $ 1.04     $ 1.30     $ (.26 )

Cash dividends declared per common share

    .20       .14       .06  
                         

Weighted average common shares outstanding – basic and diluted

    7,511       7,501       10  

Return on average assets

    .95 %     1.11 %  

(16

)bp

Return on average equity

    8.37 %     10.69 %  

(232

)bp

bp – basis points.

                       

 

The $1.9 million decline in net income is attributed primarily to a pretax gain during the first quarter of 2016 of $4.1 million related to the early extinguishment of $15.5 million of debt. Net interest income and the provision for loan losses increased $1.1 million or 4.3% and $710 thousand, respectively. Salaries and employee benefits and expenses related to repossessed real estate decreased $371 thousand and $612 thousand, respectively. Further information related to the more significant components making up the decline in net income follows.

 

Net Interest Income

 

Net interest income was $27.4 million for the first six months of 2017, an increase of $1.1 million or 4.3% compared to $26.3 million for the first six months of 2016. The increase in net interest income was driven by reductions of interest expense of $2.2 million or 55.3% partially offset by a decrease in interest income of $1.1 million or 3.6%. Interest expense on deposits and borrowed funds were down $189 thousand or 15.2% and $2.0 million or 73.3%, respectively. Interest income on loans declined $98 thousand or 0.4%. Interest on loans in the current six months includes a $73 thousand prepayment fee and the collection of $38 thousand related to a nonaccrual residential real estate loan that fully paid off during the period. The prior year was positively impacted by the collection of $236 thousand related to a nonaccrual commercial real estate loan that fully paid off during the year-ago first quarter. Interest income on investments decreased $1.1 million or 18.1%.

 

The decline in interest income on loans was driven by a lower average rate earned of 11 basis points, partially offset by a higher average loan balance outstanding. The average rate earned on loans during the current period was positively impacted two basis points from the prepayment fee and collection of interest on the nonaccrual loan identified above. For the first six months of 2016, the average rate earned on loans was boosted five basis points by the collection of interest on the nonaccrual loan identified above. Average loans increased $20.3 million or 2.1% from the year-ago comparable period.

 

 
40

 

 

Interest income on investment securities is down mainly due to lower volume. Average investment securities for the period decreased $93.9 million or 16.1% compared to the first six months of 2016. Volume declines are mainly the result of the balance sheet deleverage transaction that was announced during the third quarter of 2016, which is more fully described below.

 

The decrease in interest expense on deposits was driven by rate declines and lower average outstanding balances of time deposits. Interest expense on borrowed funds was down primarily due to the early repayment of $100 million of high fixed-rate borrowings during the third quarter of 2016 related to the deleveraging transaction discussed below.

 

Overall declines in the average rate earned from interest income on loans and average interest rate paid on deposits are the result of a slow growing economy and related low interest rate environment, competitive pressures, and the Company’s ongoing strategy of being more selective in pricing its loans and deposits. The goal of this strategy is to improve credit quality, net interest income, overall profitability, and capital position.

 

The Company is generally earning and paying less interest from its earning assets and funding sources as the average rates earned and paid have decreased. This includes repricing of variable and floating rate assets and liabilities that have reset to overall lower amounts since their previous repricing date, as well as activity related to new earning assets and funding sources in a low interest rate environment. The Company continues to reprice its higher-rate maturing time deposits downward to lower market rates or to allow them to mature without renewal, as liquidity has been adequate.

 

To offset the overall decline in average rates earned and paid, the Company has improved its mix of earning assets and interest bearing liabilities through growth in the loan portfolio over the past year combined with a significant decrease in lower-yielding investment securities and higher-rate borrowings. On an average basis, loans represented 62.9% of earning assets for the first six months of 2017, an increase of 412 basis points compared to 58.7% for the first six months of 2016. Loans typically involve an increase in credit risk and higher yields when compared to investment securities.

 

As part of its strategy to improve net interest income and net interest margin, the Company completed a series of transactions during the second half of 2016 to deleverage its balance sheet and reposition its investment securities portfolio. The Company used a mixture of $10.4 million of excess cash and $93.4 million of proceeds from the sale of investment securities to prepay $100 million of high fixed-rate borrowings due to mature in November 2017. The Company incurred a prepayment fee of $3.8 million, which was offset by a gain in the same amount on the sale of investment securities. The average yield on the mix of cash and investment securities sold to fund the debt prepayment was 2.97%. The average cost of the fixed rate borrowings that were repaid was 3.95%. The Company also took action to reposition its investment securities portfolio by replacing approximately $78 million of certain lower-yielding, short-term investments with longer-term, higher-yielding investments consistent with a more normalized strategy and maturity periods. The lower-yielding, short-term investments were built up in anticipation of the November 2017 debt repayment. The average yield on the investments identified for the repositioning strategy was 0.85% compared to a targeted reinvestment yield of 1.85%. As a result, the average life of the securities portfolio at the time of the transaction increased to 4.0 years from 3.5 years.

 

The net interest margin on a taxable equivalent basis was 3.64% for the first six months of 2017, an increase of 31 basis points compared with 3.33% a year earlier. Net interest spread increased 37 basis points to 3.55%, up from 3.18% a year ago. The Company expects its net interest margin to remain relatively flat in the near term according to internal modeling using expectations about future market interest rates, the maturity structure of the Company’s earning assets and liabilities, and other factors. Future results could be significantly different than current expectations.

 

 
41

 

 

The following tables present an analysis of net interest income for the six months ended June 30.

 

Distribution of Assets, Liabilities and Shareholders’ Equity: Interest Rates and Interest Differential

Six Months Ended June 30,

 

2017

   

2016

 

(In thousands)

 

Average

Balance

   

Interest

   

Average

Rate

   

Average

Balance

   

Interest

   

Average

Rate

 

Earning Assets

                                               

Investment securities1

                                               

Taxable

  $ 369,820     $ 3,884       2.12 %   $ 463,110     $ 4,936       2.14 %

Nontaxable2

    121,407       1,758       2.92       122,045       1,842       3.04  

Interest bearing deposits in banks, federal funds sold and securities purchased under agreements to resell, and money market mutual funds

    87,174       327       .76       88,277       205       .47  

Loans2,3,4

    979,063       23,975       4.94       958,795       24,069       5.05  

Total earning assets

    1,557,464     $ 29,944       3.88 %     1,632,227     $ 31,052       3.83 %

Allowance for loan losses

    (9,473 )                     (9,940 )                

Total earning assets, net of allowance for loan losses

    1,547,991                       1,622,287                  

Nonearning Assets

                                               

Cash and due from banks

    23,234                       22,538                  

Premises and equipment, net

    31,888                       32,654                  

Other assets

    60,448                       88,350                  

Total assets

  $ 1,663,561                     $ 1,765,829                  

Interest Bearing Liabilities

                                               

Deposits

                                               

Interest bearing demand

  $ 347,209     $ 201       .12 %   $ 333,011     $ 131       .08 %

Savings

    422,763       256       .12       404,852       261       .13  

Time

    257,863       599       .47       310,206       853       .55  

Federal funds purchased

    22       -       -       230       -       -  

Short-term securities sold under agreements to repurchase

    32,717       37       .23       33,739       45       .27  

Long-term securities sold under agreements to repurchase

    1,168       4       .69       101,308       2,000       3.97  

Federal Home Loan Bank advances

    14,789       289       3.94       18,766       371       3.98  

Subordinated notes payable to unconsolidated trusts

    33,506       411       2.47       35,585       357       2.02  

Total interest bearing liabilities

    1,110,037     $ 1,797       .33 %     1,237,697     $ 4,018       .65 %

Noninterest Bearing Liabilities

                                               

Demand deposits

    339,276                       317,135                  

Other liabilities

    25,981                       27,914                  

Total liabilities

    1,475,294                       1,582,746                  

Shareholders’ equity

    188,267                       183,083                  

Total liabilities and shareholders’ equity

  $ 1,663,561                     $ 1,765,829                  

Net interest income

            28,147                       27,034          

TE basis adjustment

            (735 )                     (749 )        

Net interest income

          $ 27,412                     $ 26,285          

Net interest spread

                    3.55 %                     3.18 %

Impact of noninterest bearing sources of funds

                    .09                       .15  

Net interest margin

                    3.64 %                     3.33 %

 

1Average yields on securities available for sale have been calculated based on amortized cost.

2Income and yield stated at a fully tax equivalent basis using the marginal corporate Federal tax rate of 35%.

3Loan balances include principal balances on nonaccrual loans.

4Loan fees included in interest income amounted to $755 thousand and $682 thousand in 2017 and 2016, respectively.

 

 
42

 

 

Analysis of Changes in Net Interest Income (tax equivalent basis)

(In thousands)

 

Variance

   

Variance Attributed to

 

Six Months Ended June 30,

 

2017/20161

   

Volume

   

Rate

 
                         

Interest Income

                       

Taxable investment securities

  $ (1,052 )   $ (1,005 )   $ (47 )

Nontaxable investment securities2

    (84 )     (10 )     (74 )

Interest bearing deposits in banks, federal funds sold and securities purchased under agreements to resell, and money market mutual funds

    122       (7 )     129  

Loans2

    (94 )     993       (1,087 )

Total interest income

    (1,108 )     (29 )     (1,079 )

Interest Expense

                       

Interest bearing demand deposits

    70       5       65  

Savings deposits

    (5 )     27       (32 )

Time deposits

    (254 )     (136 )     (118 )

Federal funds purchased

    -       -       -  

Short-term securities sold under agreements to repurchase

    (8 )     (1 )     (7 )

Long-term securities sold under agreements to repurchase

    (1,996 )     (1,087 )     (909 )

Federal Home Loan Bank advances

    (82 )     (78 )     (4 )

Subordinated notes payable to unconsolidated trusts

    54       (55 )     109  

Total interest expense

    (2,221 )     (1,325 )     (896 )

Net interest income

  $ 1,113     $ 1,296     $ (183 )

Percentage change

    100.0 %     116.4 %     (16.4 )%

 

The changes that are not solely due to rate or volume are allocated on a percentage basis using the absolute values of rate and volume variances as a basis for allocation.

Income stated at fully tax equivalent basis using the marginal corporate Federal tax rate of 35%.

 

Provision for Loan Losses

 

The Company recorded a provision for loan losses in the amount of $81 thousand and a credit to the provision of $629 thousand for the first six months of 2017 and 2016, respectively. The allowance for loan losses as a percentage of outstanding loans was 0.93% at June 30, 2017 compared to 0.96% and 0.99% at year-end 2016 and June 30, 2016, respectively. The provision for loan losses was driven by net charge-offs of $203 thousand for the current quarter.

 

Nonperforming loans, impaired loans, loans graded as substandard or below, and watch list loans have each declined when compared with a year earlier. While historical loss rates continued to improve, the rate of improvement has declined as the elevated levels of charge-offs experienced in prior years have already rolled out of the three year look-back period used when evaluating the allowance for loan losses. For further information about improvements in the Company’s overall credit quality, please refer to the discussion under the captions “Allowance for Loan Losses” and “Nonperforming Loans” that follows.

 

 
43

 

 

Noninterest Income

 

The components of noninterest income are as follows for the periods indicated:

 

Six Months Ended June 30, (In thousands)

 

2017

   

2016

   

Increase
(Decrease)

   

%

 

Service charges and fees on deposits

  $ 3,970     $ 3,794     $ 176       4.6 %

Allotment processing fees

    1,366       1,694       (328 )     (19.4 )

Other service charges, commissions, and fees

    2,700       2,714       (14 )     (0.5 )

Trust income

    1,330       1,319       11       0.8  

Investment securities (losses) gains, net

    (10 )     214       (224 )     (104.7 )

Gain on sale of mortgage loans, net

    343       422       (79 )     (18.7 )

Income from company-owned life insurance

    456       556       (100 )     (18.0 )

Gain on debt extinguishment

    -       4,050       (4,050 )     NM  

Other

    198       300       (102 )     (34.0 )

Total noninterest income

  $ 10,353     $ 15,063     $ (4,710 )     (31.3 )%

NM – not meaningful.

 

The decline in noninterest income is mainly attributed to the $4.1 million pre-tax gain during the first quarter of 2016 related to the early extinguishment of debt. Noninterest income in the first six months of 2016 also includes a $100 thousand payment received related to a litigation settlement.

 

Service charges and fees on deposits increased primarily due to higher service charges related to demand deposits and savings accounts of $117 thousand or 28.6% and $35 thousand or 81.7%, respectively. Contributing to the overall increase in service charges are higher average balances of demand deposits and savings account compared to the prior year. Additionally, during the second quarter of 2016, the Company standardized and reduced the number of its deposit account product offerings throughout the corporation, which has contributed to an overall increase in service charges since completion.

 

The decrease in allotment processing fees is a result of lower processing volume resulting from the U.S. Department of Defense policy that went into effect on January 1, 2015 restricting the types of purchases that active duty service members are able to make using the military allotment system for payment. The Company continues its efforts to mitigate these declines by diversifying its customer base beyond the historically strong level of military participants and by expanding its payment processing options.

 

Net losses on the sale of investment securities compared to net gains in the prior year is attributed to normal asset/liability management strategies, as the Company periodically sells investment securities to lock in gains, increase yield, restructure expected future cash flows, improve risk exposures, and/or enhance its capital position. Net gains on the sale of mortgage loans were down mainly due to lower sales volume of $3.2 million or 19.2% compared to the prior year. The decline in income from company-owned life insurance is primarily due to a tax-free death benefit received in excess of the cash surrender value during the first quarter of 2016 of $81 thousand.

 

 
44

 

 

Noninterest Expense

 

The components of noninterest expense are as follows for the periods indicated:

 

Six Months Ended June 30, (In thousands)

 

2017

   

2016

   

Increase
(Decrease)

   

%

 

Salaries and employee benefits

  $ 15,263     $ 15,634     $ (371 )     (2.4 )%

Occupancy expenses, net

    2,349       2,369       (20 )     (0.8 )

Equipment expenses

    1,152       1,171       (19 )     (1.6 )

Data processing and communication expenses

    2,386       2,326       60       2.6  

Bank franchise tax

    1,166       1,210       (44 )     (3.6 )

Deposit insurance expenses

    267       578       (311 )     (53.8 )

Other real estate expenses, net

    400       1,012       (612 )     (60.5 )

Legal expenses

    203       269       (66 )     (24.5 )

Other

    3,689       3,722       (33 )     (0.9 )

Total noninterest expense

  $ 26,875     $ 28,291     $ (1,416 )     (5.0 )%

 

Noninterest expense for the current six months includes $472 thousand related to the consolidation of the Company’s subsidiaries during the first quarter of 2017. The decline in noninterest expense in the comparison was led by lower expenses related to repossessed real estate. Write-downs on repossessed real estate were down $382 thousand or 52.2%, which include a write-down in the prior-year period of $352 thousand related to one larger-balance commercial real estate property resulting from an updated appraisal. Net gains on the sale of property in the current period were $72 thousand compared to a net loss of $125 thousand in the prior year. Maintenance and operating costs were down $33 thousand or 21.3% in the comparison.

 

The decrease in salaries and employee benefits is attributed to lower employee benefits of $734 thousand or 27.4% primarily related to a curtailment gain of $351 thousand in the first quarter. The curtailment gain resulted from revaluing the Company’s postretirement medical benefits plan liability due to a reduction in workforce related to the subsidiary consolidation plan that was completed in the first quarter. Also contributing to the decline in employee benefits was lower claims activity related to the Company’s self-funded health insurance plan of $338 thousand, also due to the reduced workforce. Salaries and related payroll taxes increased $74 thousand or 0.6%. Salaries and related payroll taxes for the current year include incentive pay accruals of $574 thousand, severance pay expense of $301 thousand, and retention payments to certain members of management of $201 thousand. There were no similar accruals or payments during the prior year period. The Company had 433 full time equivalent employees at June 30, 2017, down from 489 a year ago.

 

Data processing and communication expense during the current year includes $127 thousand related to the consolidation of subsidiaries. The reduction in deposit insurance expense is due to a combination of further improvement in the risk rating at the Company’s subsidiary bank and lower assessment rates.

 

Income Taxes

 

Income tax expense was $3.0 million for the first six months of 2017, a decrease of $952 thousand or 24.1% compared to $4.0 million for 2016. The effective income tax rates were 27.7% and 28.9% for the current and year-ago periods, respectively. Income tax expense and the effective tax rate are down in the current period as a result of lower pretax income, made up by a higher mix of tax-exempt versus taxable sources of revenue that was driven by the $4.1 million pretax gain on extinguishment of debt in 2016.

 

 
45

 

 

FINANCIAL CONDITION

 

Total assets were $1.7 billion at June 30, 2017, a decrease of $18.7 million or 1.1% from year-end 2016, led by a decline in investment securities of $17.3 million. Liabilities were down $27.5 million or 1.8% and equity increased $8.8 million or 4.8% in the comparison. Selected balance sheet amounts and related data are presented in the table below and discussion that follows.

 

(Dollars in thousands, except per share data)

 

June 30,
2017

   

December 31,
2016

   

Increase
(Decrease)

   

%

 

Cash and cash equivalents

  $ 98,014     $ 113,534     $ (15,520 )     (13.7 )%

Investment securities

    467,081       484,352       (17,271 )     (3.6 )

Loans, net of allowance of $9,222 and $9,344

    979,827       961,631       18,196       1.9  

Other real estate owned

    6,187       10,673       (4,486 )     (42.0 )

Other assets

    101,231       100,840       391       0.4  

Total assets

  $ 1,652,340     $ 1,671,030     $ (18,690 )     (1.1 )%
                                 

Deposits

  $ 1,352,838     $ 1,369,907     $ (17,069 )     (1.2 )%

Securities sold under agreements to repurchase

    32,569       36,370       (3,801 )     (10.5 )

Other borrowings

    47,068       52,152       (5,084 )     (9.7 )

Other liabilities

    26,989       28,535       (1,546 )     (5.4 )

Total liabilities

    1,459,464       1,486,964       (27,500 )     (1.8 )
                                 

Common stock

    939       939       -       -  

Capital surplus

    52,034       51,885       149       0.3  

Retained earnings

    140,959       134,650       6,309       4.7  

Accumulated other comprehensive loss

    (1,056 )     (3,408 )     2,352       69.0  

Total shareholders’ equity

    192,876       184,066       8,810       4.8  

Total liabilities and shareholders’ equity

  $ 1,652,340     $ 1,671,030     $ (18,690 )     (1.1 )%
                                 

End of period tangible book value per common share1

  $ 25.67     $ 24.51     $ 1.16       4.7 %

End of period per common share closing price

    38.55       42.05       (3.50 )     (8.3 )

 

1Represents total common equity less intangible assets divided by the number of common shares outstanding at the end of the period.

 

Cash and cash equivalents are down mainly as a result of funding new loans and the outflow of deposits. The increase in loans was driven mainly by loans secured by real estate, primarily commercial related lending, partially offset by lower construction and residential real estate lending. OREO decreased primarily due to property sales and impairment charges to adjust carrying amounts to their estimated fair value less cost to sell.

 

The decline in total liabilities was driven by lower deposits and a reduction in both securities sold under agreements to repurchase and other borrowings. Deposits were down primarily from lower time deposits and interest bearing demand deposits. The trend over the last several years has been for deposits in the first quarter of the year to exceed the prior year-end amount, then experiencing a decline in the second and third quarters before trending back up during the fourth quarter. These trends indicate a certain amount of seasonality in our customer deposit base particularly related to public funds. The decrease in other borrowings was driven by principal payments of $5.1 million related to Federal Home Loan Bank (“FHLB”) advances during the period.

 

Shareholders’ equity was up primarily due to net income of $7.8 million and other comprehensive income of $2.4 million, partially offset by dividends declared on common stock of $1.5 million. Other comprehensive income was driven by an increase in the after-tax unrealized gain of $2.3 million related to the available for sale investment securities portfolio.

 

 
46

 

 

Temporary Investments

 

Temporary investments consist of interest bearing deposits in other banks, federal funds sold and securities purchased under agreements to resell, and money market mutual funds. The Company uses these funds in the management of liquidity and interest rate sensitivity, as a short-term holding prior to subsequent movement into other investments with higher yields, or for other purposes. At June 30, 2017, temporary investments were $70.6 million, a decrease of $17.2 million or 19.6% from year-end 2016.

 

Investment Securities

 

The investment securities portfolio is comprised primarily of residential mortgage-backed securities, tax-exempt securities of states and political subdivisions, and debt securities issued by U.S. government-sponsored agencies. Substantially all of the Company’s investment securities are designated as available for sale. Proceeds received from maturing or called investment securities not needed to fund higher-earning loans are either reinvested in similar investments or used to manage liquidity, such as for deposit outflows or other payment obligations. Total investment securities had a carrying amount of $467 million at June 30, 2017, a decrease of $17.3 million or 3.6% compared to $484 million at year-end 2016.

 

The decline in investment securities was driven by net maturities, calls, and sales totaling $18.9 million and net premium amortization of $1.7 million, partially offset by higher pre-tax market values related to the available for sale portfolio of $3.5 million.

 

Loans

 

Loans were $989 million at June 30, 2017, an increase of $18.1 million or 1.9% compared to year-end 2016. While recent loan demand and near term prospects are encouraging, the Company continues a conservative approach to loan originations as it strives to further reduce its level of nonperforming assets. The loan portfolio grew during the first quarter of 2017, then held relatively steady during the second quarter despite several early payoffs of larger-balance commercial real estate loans totaling $7.3 million in the aggregate.

 

From time to time the Company may purchase a limited amount of loans originated by otherwise nonaffiliated third parties. The Company performs its own risk assessment and makes the credit decision on each loan prior to purchase. The Company purchased smaller balance commercial loans totaling $1.8 million and $1.2 million in the aggregate during the first six months of 2017 and 2016, respectively. The average amount of the purchased loans was $150 thousand for 2017 and $124 thousand for 2016.

 

The composition of the loan portfolio is summarized in the table below.

 

   

June 30, 2017

   

December 31, 2016

 

(Dollars in thousands)

 

Amount

   

%

   

Amount

   

%

 
                                 

Real estate mortgage – construction and land development

  $ 103,884       10.5 %   $ 120,230       12.4 %

Real estate mortgage – residential

    340,213       34.4       350,295       36.1  

Real estate mortgage – farmland and other commercial enterprises

    438,945       44.4       400,367       41.2  

Commercial, financial, and agriculture

    97,781       9.9       90,848       9.4  

Installment

    8,226       .8       9,235       .9  

Total

  $ 989,049       100.0 %   $ 970,975       100.0 %

 

On an average basis, loans represented 62.9% of earning assets for the first six months of 2017, an increase of 357 basis points compared to 59.3% for the full year of 2016. The increase in the level of loans as a percentage of earning assets reflects the overall growth in the loan portfolio over the past year combined with a significant decrease in investment securities as a result of unwinding the balance sheet leverage transaction. The increase in loans in recent periods has been funded by cash flows from investment securities and temporary investments. Loans typically involve an increase in credit risk and higher yields when compared to investment securities and temporary investment alternatives.

 

 
47

 

 

Allowance for Loan Losses

 

The allowance for loan losses is maintained at a level management believes is adequate to cover probable losses in the loan portfolio. The determination of the appropriate level of allowance for loan losses requires significant judgment in order to reflect credit losses specifically identified in the Company’s loan portfolio as well as management's best estimate of probable incurred credit losses in the loan portfolio at the balance sheet date. The allowance for loan losses is a valuation allowance increased by the provision for loan losses and decreased by net charge-offs. Loan losses are charged against the allowance when management believes the uncollectibility of a loan is confirmed. Subsequent recoveries, if any, are credited to the allowance.

 

The allowance for loan losses and the related provision for loan losses generally fluctuate as the relative level of nonperforming and impaired loans vary. However, other factors impact the amount of the allowance such as the Company’s historical loss experience, the financial condition of its borrowers, general economic conditions, and other qualitative risk factors as described in greater detail in the Company’s most recent annual report on Form 10-K.

 

The allowance for loan losses was $9.2 million or 0.93% of outstanding loans at June 30, 2017. This compares to $9.3 million or 0.96% of net loans outstanding at year-end 2016. The decrease in the allowance as a percentage of net loans outstanding from the prior year-end is a result of net charge-offs of $203 thousand combined loan growth for the current six-month period, partially offset by a provision for loan losses of $81 thousand. As a percentage of nonperforming loans, the allowance for loan losses was 34.4% at June 30, 2017 compared to 31.8% at year-end 2016. The relatively low amount of the allowance for loan losses as a percentage of nonperforming loans is due mainly to the makeup of nonperforming loans as discussed further below.

 

Nonperforming loans include $22.4 million of accruing restructured loans, which represents 83.5% of total nonperforming loans at June 30, 2017. At year-end 2016, this amount was $22.9 million or 78.1%. The allowance attributed to credits that are restructured with lower interest rates generally represents the difference in the present value of future cash flows calculated at the loan’s original effective interest rate and the new lower rate resulting from the restructuring. This typically results in a reserve for loan losses that is less severe than for other loans that are collateral dependent. The allowance specifically allocated to impaired loans, which includes restructured loans, was $2.9 million or 7.3% and $2.9 million or 7.0% of such loans at June 30, 2017 and year-end 2016, respectively. As a percentage of nonaccrual loans and loans past due 90 days or more and still accruing, the allowance for loan losses was 208% and 145% for the current quarter-end and year-end 2016, respectively.

 

The overall improvement in the credit quality of the loan portfolio experienced during 2016 continued during the first six months of 2017. While the specific reserve on total impaired loans was relatively unchanged from year-end 2016, total impaired loans declined $2.7 million or 6.4%. This is due to the characteristics of the individual loans that are classified as impaired.

 

Certain credit quality measures are summarized in the table that follows for the periods indicated. Several of these measures are at or near the best level in the last three years.

 

(In thousands)

 

June 30,

2017

   

December 31,

2016

   

June 30,

2016

   

Three-year
High1

   

Three-year
Low1

 

Nonperforming loans

  $ 26,844     $ 29,365     $ 29,843     $ 40,819     $ 26,844  

Nonaccrual loans

    4,427       6,423       6,397       15,530       4,427  

Loans past due 30-89 days and still accruing

    1,218       2,259       2,719       3,016       588  

Loans graded substandard or below

    35,325       37,650       39,826       66,185       35,325  

Impaired loans

    39,196       41,895       43,298       48,881       37,182  

Loans, net of unearned income

    989,049       970,975       957,426       989,833       927,389  

 

1Based on quarter-end balances over the previous three years.

 

 
48

 

 

Nonperforming Loans

 

Nonperforming loans consist of nonaccrual loans, accruing restructured loans, and loans 90 days or more past due and still accruing interest. The accrual of interest on loans is discontinued when it is determined that the collection of interest or principal is doubtful, or when a default of interest or principal has existed for 90 days or more, unless such loan is well secured and in the process of collection.

 

Restructured loans occur when a lender, because of economic or legal reasons related to a borrower’s financial difficulty, grants a concession to the borrower that it would not otherwise consider. Restructured loans typically include a reduction of the stated interest rate or an extension of the maturity date, among other possible concessions. The Company gives careful consideration to identifying which of its challenged credits merit a restructuring of terms that it believes will result in maximum loan repayments and mitigation of possible losses. Cash flow projections are carefully scrutinized prior to restructuring any credits; past due credits are typically not granted concessions.

 

Nonperforming loans were $26.8 million at June 30, 2017, a decrease of $2.5 million or 8.6% compared to $29.4 million at year-end 2016. Nonaccrual loans and accruing restructured loans decreased $2.0 million or 31.1% and $527 thousand or 2.3%, respectively. Loan payments include $1.5 million related to nonaccrual loans during the first six months of 2017, which include two larger-balance credits totaling $712 thousand in the aggregate. One of these larger-balance credits also had a charge-off totaling $405 thousand and the remaining collateral securing the loan was repossessed and subsequently sold at a small gain. There are no further balances outstanding related to this credit. One larger-balance nonaccrual credit in the amount of $428 thousand secured by commercial real estate was upgraded to performing status during the second quarter of 2017. The credit was upgraded based on a detailed review and current expectation of full repayment during the third quarter.

 

Accruing restructured loans make up $22.4 million or 83.5% of the Company’s nonperforming loans at June 30, 2017 compared with $4.4 million or 16.5% related to nonaccrual loans. Additionally, three larger balance credits account for $21.2 million or 94.7% of total restructured loans. Nonaccrual loans have decreased to the lowest level since the second quarter of 2007.

 

 
49

 

 

Nonperforming loans, presented by class, were as follows for the periods indicated:

 

Nonperforming Loans

(In thousands)

 

June 30,
2017

   

December 31,
2016

 

Nonaccrual Loans

               

Real Estate

               

Real estate mortgage – construction and land development

  $ 381     $ 712  

Real estate mortgage – residential

    1,913       2,316  

Real estate mortgage – farmland and other commercial enterprises

    1,924       3,383  

Commercial

               

Other

    25       -  

Consumer

               

Secured

    11       4  

Unsecured

    173       8  

Total nonaccrual loans

  $ 4,427     $ 6,423  
                 

Restructured Loans

               

Real Estate

               

Real estate mortgage – construction and land development

  $ 1,961     $ 3,637  

Real estate mortgage – residential

    5,402       4,006  

Real estate mortgage – farmland and other commercial enterprises

    14,546       14,787  

Commercial

               

Commercial and industrial

    374       377  

Consumer

               

Unsecured

    132       135  

Total restructured loans

  $ 22,415     $ 22,942  
                 

Past Due 90 Days or More and Still Accruing

               

Consumer

               

Unsecured

  $ 2     $ -  

Total past due 90 days or more and still accruing

  $ 2     $ -  
                 

Total nonperforming loans

  $ 26,844     $ 29,365  
                 

Ratio of total nonperforming loans to total loans

    2.7 %     3.0 %

 

The most significant components of nonperforming loans include nonaccrual and restructured loans. Activity during 2017 related to these two components was as follows:

 

(In thousands)

 

Nonaccrual
Loans

   

Restructured
Loans

 

Balance at December 31, 2016

  $ 6,423     $ 22,942  

Additions

    742       -  

Principal paydowns

    (1,542 )     (527 )

Transfers to performing status

    (428 )     -  

Transfers to other real estate owned

    (187 )     -  

Charge-offs

    (581 )     -  

Balance at June 30, 2017

  $ 4,427     $ 22,415  

 

 
50

 

 

The Company’s comprehensive risk-grading and loan review program includes a review of loans to assess risk and assign a grade to those loans, a review of delinquencies, and an assessment of loans for needed charge-offs or placement on nonaccrual status. The Company had loans in the amount of $38.5 million and $44.0 million at June 30, 2017 and year-end 2016, respectively, which were performing but considered potential problem loans and are not included in the nonperforming loan totals in the table above. These loans, however, are considered in establishing an appropriate allowance for loan losses. The balance outstanding for potential problem credits is partially attributed to lingering strain from the recession on certain of the Company’s customers. Potential problem loans include a variety of borrowers and are secured primarily by various types of real estate including commercial, construction properties, and residential real estate developments. At June 30, 2017, the five largest potential problem credits were $11.3 million in the aggregate compared to $11.5 million at year-end 2016.

 

Potential problem loans are identified on the Company’s watch list and consist of loans that require close monitoring by management. Credits may be considered as a potential problem loan for reasons that are temporary or correctable, such as for a deficiency in loan documentation or absence of current financial statements of the borrower. Potential problem loans may also include credits where adverse circumstances are identified that may affect the borrower’s ability to comply with the contractual terms of the loan. Other factors which might indicate the existence of a potential problem loan include the delinquency of a scheduled loan payment, deterioration in a borrower’s financial condition identified in a review of periodic financial statements, a decrease in the value of the collateral securing the loan, or a change in the economic environment in which the borrower operates. Certain loans on the Company’s watch list are also considered impaired and specific allowances related to these loans are established in accordance with the appropriate accounting guidance.

 

Other Real Estate

 

OREO includes real estate properties acquired by the Company through, or in lieu of, actual foreclosure. At June 30, 2017, OREO was $6.2 million, a decrease of $4.5 million or 42.0% compared to $10.7 million at year-end 2016. The decrease was driven by sales activity, including the sale of a residential real estate development property that sold for $2.0 million with a related gain of $147 thousand and three larger-balance commercial real estate development properties sold for $1.4 million with a related net loss of $62 thousand in the aggregate. OREO has declined $46.4 million or 88.2% from its peak of $52.6 million, which occurred at year-end 2012. A summary of OREO activity for 2017 follows.

 

(In thousands)

 

Amount

 

Balance at December 31, 2016

  $ 10,673  

Transfers from loans and other increases

    345  

Proceeds from sales

    (4,553 )

Gain on sales, net

    72  

Write-downs

    (350 )

Balance at June 30, 2017

  $ 6,187  

 

Deposits

 

A summary of the Company’s deposits are as follows for the periods indicated:

 

   

End of Period

   

Average

 

(In thousands)

 

June 30,
2017

   

December 31,
2016

   

Increase
(Decrease)

   

Six Months
June 30,
2017

   

Twelve Months
December 31,
2016

   

Increase
(Decrease)

 

Noninterest Bearing

  $ 349,572     $ 334,676     $ 14,896     $ 339,276     $ 324,596     $ 14,680  
                                                 

Interest Bearing

                                               

Demand

    337,688       348,197       (10,509 )     347,209       334,818       12,391  

Savings

    422,094       416,611       5,483       422,763       407,353       15,410  

Time

    243,484       270,423       (26,939 )     257,863       296,258       (38,395 )

Total interest bearing

    1,003,266       1,035,231       (31,965 )     1,027,835       1,038,429       (10,594 )
                                                 

Total Deposits

  $ 1,352,838     $ 1,369,907     $ (17,069 )   $ 1,367,111     $ 1,363,025     $ 4,086  

 

 
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The decline in total end of period deposits was driven by lower time deposits and interest bearing demand deposits of $26.9 million or 10.0% and $10.5 million or 3.0%, respectively. Noninterest bearing demand deposits and savings deposits increased $14.9 million or 4.5% and $5.5 million or 1.3%. The decrease in time deposits is a result of the Company’s overall high liquidity position and a strategy to lower overall funding costs, mainly by allowing higher-rate certificates of deposit to roll off or reprice at lower interest rates. Many of those balances have been rolled into interest and noninterest bearing demand accounts or savings accounts by the customer. As rates have generally decreased throughout the deposit portfolio, many customers have opted to transfer funds from maturing time deposits or investments from other sources into short-term demand or savings accounts. The Company has not sought out or accepted brokered deposits in the past nor does it have plans to do so in the future.

 

Borrowed Funds

 

Total borrowed funds were $79.6 million at June 30, 2017, down $8.9 million or 10.0% from year-end 2016. The decline in borrowed funds was driven by a principal payment to the FHLB of $5.0 million for borrowings that matured in February which carried a fixed interest rate of 4.45%. The Company has $10.0 million of FHLB debt outstanding with a fixed interest rate of 3.95% that matures during the third quarter of 2017.

 

Securities sold under agreements to repurchase were $32.6 million at quarter-end, down $3.8 million or 10.5% from year-end 2016. Securities sold under agreements to repurchase represent funds that have been swept out of the deposit accounts to facilitate the needs of certain qualifying customers, primarily commercial, into repurchase agreements. Such transactions are accounted for as secured borrowings by the Company.

 

LIQUIDITY

 

The primary source of funds for the Parent Company is the receipt of dividends from its subsidiary bank, United Bank & Capital Trust Company (“United Bank” or the “Bank”), balances of cash and cash equivalents maintained, and borrowings from nonaffiliated sources. Primary uses of cash include the payment of dividends to its shareholders, paying interest expense on borrowings, and payments to fund general operating expenses.

 

Payments of dividends to the Parent Company by the Bank are subject to certain regulatory restrictions as set forth in national and state banking laws and regulations. A depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it is already undercapitalized. The federal banking agencies may prevent the payment of a dividend if they determine that the payment would be an unsafe and unsound banking practice. Moreover, the federal agencies have issued policy statements which provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings. Capital ratios at the Bank exceed regulatory established “well-capitalized” status at June 30, 2017 under the prompt corrective action regulatory framework.

 

The Parent Company had cash and cash equivalents of $52.4 million and $44.3 million at June 30, 2017 and year-end 2016, respectively. Significant cash receipts for 2017 include dividend payments from United Bank of $13 million and management fees from subsidiaries of $551 thousand. Significant cash payments include $1.5 million for the payment of dividends on common stock; $1.5 million to the Bank in connection with the transfer of Parent Company personnel and related liabilities resulting from the consolidation of its subsidiaries; $1.4 million for salaries, payroll taxes, and employee benefits incurred prior to the consolidation of subsidiaries; and $400 thousand for the payment of interest on subordinated notes payable.

 

The Company's objective as it relates to liquidity is to ensure that the Bank has funds available to meet deposit withdrawals and credit demands without unduly penalizing profitability. In order to maintain a proper level of liquidity, the Bank has several sources of funds available on a daily basis. For assets, those sources of funds include liquid assets that are readily marketable or that can be pledged, or which mature in the near future. These assets primarily include cash and due from banks, federal funds sold, investment securities, and cash flow generated by the repayment of principal and interest on loans and investment securities. For liabilities, sources of funds primarily include the Bank’s core deposits, FHLB and other borrowings, and federal funds purchased and securities sold under agreements to repurchase. While maturities and scheduled amortization of loans and investment securities are generally a predictable source of funds, deposit outflows and mortgage prepayments are influenced significantly by general interest rates, economic conditions, and competition in our local markets.

 

 
52

 

 

As of June 30, 2017, the Company had $424 million of additional borrowing capacity under various FHLB, federal funds, and other borrowing agreements. However, there is no guarantee that these sources of funds will continue to be available to the Company, or that current borrowings can be refinanced upon maturity, although the Company is not aware of any events or uncertainties that are likely to cause a decrease in the Company’s liquidity from these sources. The Company’s borrowing capacity was $275 million at year-end 2016.

 

For the longer term, the liquidity position is managed by balancing the maturity structure of the balance sheet. This process allows for an orderly flow of funds over an extended period of time. The Company’s Asset and Liability Management Committee meets regularly and monitors the composition of the balance sheet to ensure comprehensive management of interest rate risk and liquidity.

 

Liquid assets consist of cash and cash equivalents and available for sale investment securities. At June 30, 2017, consolidated liquid assets were $562 million, down $32.8 million or 5.5% compared to $594 million at year-end 2016. Although liquid assets decreased in the comparison, the Company’s liquidity position remains elevated mainly as a result of the Company’s overall net funding position. The overall funding position of the Company changes as loan demand, deposit levels, and other sources and uses of funds fluctuate.

 

Net cash provided by operating activities was $13.4 million and $10.3 million for the first six months of 2017 and 2016, respectively. This represents an increase of $3.1 million or 29.7%. Net cash used in investing activities was $1.5 million for the first six months of 2017 compared to net cash provided by investing activities of $11.2 million in the comparable period. The change was primarily driven by loan activity, investment securities activity and, to a lesser extent, purchases of restricted stock investments. For loans, the Company had cash outflow representing overall net principal advances of $17.2 million for 2017 compared to net principal collections of $3.2 million a year earlier. The Company had net cash proceeds of $18.9 million related to investment securities for 2017, up $12.3 million compared with the year-ago period. Net cash inflows represent proceeds from the sale, maturity, and call of investment securities in excess of purchases. In the six months of 2017, the Company purchased $3.6 million of restricted stock investments consisting of Federal Reserve Bank (“FRB”) stock compared to purchases of $472 thousand in 2016. The Company purchased the additional FRB stock in 2017 as a result of the merger of its subsidiaries. Two of the merged banks were previously not members of a regional FRB.

 

Net cash used in financing activities was $27.4 million and $30.0 million for the first six months of 2017 and 2016, respectively. This represents a decrease of $2.6 million or 8.8%, driven primarily by cash paid in the prior year to extinguish subordinated notes payable to unconsolidated trusts, partially offset by net repayments of FHLB advances. During 2016, the Company paid $11.0 million to purchase the trust preferred securities issued by Trust II and subsequently extinguished the subordinated debt issued to the trust. There was no similar transaction in the current year. For 2017, the Company had net repayments of FHLB advances of $5.1 million, up $5.0 million from $80 thousand in 2016.

 

Commitments to extend credit are entered into with customers in the ordinary course of providing traditional banking services and are considered in addressing the Company’s liquidity management. The Company does not expect these commitments to significantly affect the liquidity position in future periods. The Company has not entered into any contracts for financial derivative instruments such as futures, swaps, options, or similar instruments.

 

CAPITAL RESOURCES

 

Shareholders’ equity was $193 million at June 30, 2017, an increase of $8.8 million or 4.8% compared to $184 million at year-end 2016. The increase in shareholders’ equity was driven by net income of $7.8 million and higher accumulated other comprehensive income of $2.4 million, partially offset by dividends declared on common stock of $1.5 million. The increase in accumulated other comprehensive income is primarily due to a $2.3 million after-tax increase in the market value of the available for sale investment securities portfolio, which correlates with a general decline in long term market interest rates during the quarter. As market interest rates fall, the value of fixed rate investments generally increase.

 

At June 30, 2017, the Company’s tangible common equity ratio was 11.67%, an increase of 65 basis points compared to 11.02% at year-end 2016. The tangible common equity ratio represents tangible common equity as a percentage of tangible assets, which excludes intangible assets.

 

 
53

 

 

In July 2013, U.S. banking regulators adopted final rules related to standards on bank capital adequacy and liquidity (commonly referred to as “Basel III”). The new rules were effective for the Company beginning on January 1, 2015, subject to a phase-in period for certain provisions extending through January 1, 2019. The rules include a new common equity Tier 1 capital ratio, an increase to the minimum Tier 1 capital ratio, an increase to risk-weightings of certain assets, implementation of a new capital conservation buffer in excess of the required minimum (which began being phased in during 2016), and changes to how regulatory capital is defined. At June 30, 2017, the Company and the Bank met the minimum capital ratios and a fully phased-in capital conservation buffer under the new rules.

 

Consistent with the objective of operating a sound financial organization, the Company’s goal is to maintain capital ratios well above the regulatory minimum requirements. The capital ratios of the Company and its subsidiary bank are presented in the following table for the dates indicated.

 

   

June 30, 2017

   

December 31, 2016

 
   

Common Equity Tier 1 Risk-based Capital1

   

Tier 1
Risk-based
Capital1

   

Total
Risk-based
Capital1

   

Tier 1
Leverage2

   

Common Equity Tier 1 Risk-based Capital1

   

Tier 1
Risk-based
Capital1

   

Total
Risk-based
Capital1

   

Tier 1
Leverage2

 

Consolidated

    16.60 %     19.39 %     20.18 %     13.64 %     16.43 %     19.28 %     20.10 %     13.20 %

United Bank & Capital Trust Company

    14.76       14.76       15.55       10.49       *       *       *       *  

Farmers Bank & Capital Trust Company

    *       *       *       *       16.53       16.53       17.23       9.80  

United Bank & Trust Company

    *       *       *       *       15.54       15.54       16.47       12.38  

First Citizens Bank

    *       *       *       *       13.56       13.56       14.16       9.76  

Citizens Bank of Northern Kentucky, Inc.

    *       *       *       *       15.24       15.24       16.40       10.68  
                                                                 

Regulatory minimum

    4.50       6.00       8.00       4.00       4.50       6.00       8.00       4.00  

Well-capitalized status

    6.50       8.00       10.00       5.00       6.50       8.00       10.00       5.00  

 

1Common Equity Tier 1 Risked-based, Tier 1 Risk-based, and Total Risk-based Capital ratios are computed by dividing a bank’s Common Equity Tier 1, Tier 1 or Total Capital, as defined by regulation, by a risk-weighted sum of the bank’s assets, with the risk weighting determined by general standards established by regulation.

2Tier 1 Leverage ratio is computed by dividing a bank’s Tier 1 Capital by its total quarterly average assets, as defined by regulation.

*In February 2017, the Company merged United Bank & Trust Company, First Citizens Bank, Inc., and Citizens Bank of Northern Kentucky, Inc. into Farmers Bank & Capital Trust Company in Frankfort, KY, the name of which was immediately changed to United Bank & Capital Trust Company.

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

The Company uses a simulation model as a tool to monitor and evaluate interest rate risk exposure. The model is designed to measure the sensitivity of net interest income and net income to changing interest rates over future time periods. Forecasting net interest income and its sensitivity to changes in interest rates requires the Company to make assumptions about the volume and characteristics of many attributes, including assumptions relating to the replacement of maturing earning assets and liabilities. Other assumptions include, but are not limited to, projected prepayments, projected new volume, and the predicted relationship between changes in market interest rates and changes in customer account balances. These effects are combined with the Company’s estimate of the most likely rate environment to produce a forecast of net interest income and net income. The forecasted results are then adjusted for the effect of a gradual increase and decrease in market interest rates on the Company’s net interest income and net income. Because assumptions are inherently uncertain, the model cannot precisely estimate net interest income and net income or the effect of interest rate changes on net interest income and net income. Actual results could differ significantly from simulated results.

 

At June 30, 2017, the model indicated that if rates were to gradually increase by 150 basis points during the remainder of the calendar year, then net interest income and net income would increase 0.26% and 0.64%, respectively for the year ending December 31, 2017 when compared to the forecasted results for the most likely rate environment. The model indicated that if rates were to gradually decrease by 150 basis points over the same period, then net interest income and net income would decrease 0.78% and 1.85%, respectively.

 

In the current low interest rate environment, it is not practical or possible to reduce certain deposit rates by the same magnitude as rates on earning assets. The average rate paid on the Company’s deposits is presently below 1.5%. This situation magnifies the model’s predicted results when modeling a decrease in interest rates, as earning assets with higher yields have more of an opportunity to reprice at lower rates than lower-rate deposits.

 

 
54

 

 

Item 4. Controls and Procedures

 

The Company’s Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report, and have concluded that the Company’s disclosure controls and procedures were adequate and effective to ensure that all material information required to be disclosed in this report has been made known to them in a timely fashion.

 

The Company’s Chief Executive Officer and Chief Financial Officer have also concluded that there were no significant changes during the quarter ended June 30, 2017 in the Company’s internal control over financial reporting or in other factors that have materially affected, or are reasonably likely to materially affect, the registrant’s internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings

 

As of June 30, 2017, there were various pending legal actions and proceedings against the Company arising from the normal course of business and in which claims for damages are asserted. It is the opinion of management, after discussion with legal counsel, that the disposition or ultimate resolution of such claims and legal actions will not have a material effect upon the consolidated financial statements of the Company.

 

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

 

During 2014, the Company changed the form of payment to its directors for board meeting and quarterly fees from 100% cash to 50% in cash and 50% in Company common stock. The shares are issued as part of a plan adopted by the Board of Directors. Each director has elected to participate by entering into an agreement with the Company to accept common stock in lieu of cash for 50% of the director’s board meeting and quarterly fees. As the shares are only issued to directors as part of a plan approved by the Board, the shares are exempt from the registration requirements of the Securities Act of 1933, as amended (the “1933 Act”), as a sale not involving any public offering under Section 4(2) of the 1933 Act. Attendance for committee meetings continues to be paid completely in cash. As employee directors are not paid director’s fees, only non-employee directors receive stock under this plan.

 

The Company issued a total of 448 shares and 1,194 shares of common stock to its non-employee directors under this plan in the three and six months ended June 30, 2017, respectively, as compensation for director fees of $18 thousand and $46 thousand for those respective periods. The cash retained by the Company by issuing common stock in lieu of paying cash is used for general corporate purposes. There are no brokers involved in the issuance of stock to directors and no commissions or other broker fees are paid.

 

At various times, the Company’s Board of Directors has authorized the purchase of shares of the Company’s outstanding common stock. No stated expiration dates have been established under any of the previous authorizations. There were no shares of common stock repurchased by the Company during the quarter ended June 30, 2017. There are 84,971 shares that may still be purchased under the various authorizations, although no shares have been purchased since 2008.

 

Item 6. Exhibits

 

List of Exhibits

 

3.1

Second Amended and Restated Articles of Incorporation of Farmers Capital Bank Corporation (incorporated by reference to the Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2006 (File No. 000-14412)).

     
 

3.2

Articles of Amendment to Second Amended and Restated Articles of Incorporation of Farmers Capital Bank Corporation dated January 6, 2009 (incorporated by reference to the Current Report on Form 8-K dated January 13, 2009 (File No. 000-14412)).

 

 
55

 

 

 

3.3

Articles of Amendment to Second Amended and Restated Articles of Incorporation of Farmers Capital Bank Corporation dated November 16, 2009 (incorporated by reference to the Current Report on Form 8-K dated November 17, 2009 (File No. 000-14412)).

     
 

3.4

Amended and Restated Bylaws of Farmers Capital Bank Corporation (incorporated by reference to the Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2015 (File No. 000-14412)).

     
 

4.1*

Junior Subordinated Indenture, dated as of July 21, 2005, between Farmers Capital Bank Corporation and Wilmington Trust Company, as Trustee, relating to unsecured junior subordinated deferrable interest notes that mature in 2035.

     
 

4.2*

Amended and Restated Trust Agreement, dated as of July 21, 2005, among Farmers Capital Bank Corporation, as Depositor, Wilmington Trust Company, as Property and Delaware Trustee, the Administrative Trustees (as named therein), and the Holders (as defined therein).

     
 

4.3*

Guarantee Agreement, dated as of July 21, 2005, between Farmers Capital Bank Corporation, as Guarantor, and Wilmington Trust Company, as Guarantee Trustee.

     
 

4.4*

Junior Subordinated Indenture, dated as of July 26, 2005, between Farmers Capital Bank Corporation and Wilmington Trust Company, as Trustee, relating to unsecured junior subordinated deferrable interest notes that mature in 2035.

     
 

4.5*

Amended and Restated Trust Agreement, dated as of July 26, 2005, among Farmers Capital Bank Corporation, as Depositor, Wilmington Trust Company, as Property and Delaware Trustee, the Administrative Trustees (as named therein), and the Holders (as defined therein).

     
 

4.6*

Guarantee Agreement, dated as of July 26, 2005, between Farmers Capital Bank Corporation, as Guarantor, and Wilmington Trust Company, as Guarantee Trustee.

     
 

4.7*

Indenture, dated as of August 14, 2007 between Farmers Capital Bank Corporation, as Issuer, and Wilmington Trust Company, as Trustee, relating to fixed/floating rate junior subordinated debt due 2037.

     
 

4.8*

Amended and Restated Declaration of Trust, dated as of August 14, 2007, by Farmers Capital Bank Corporation, as Sponsor, Wilmington Trust Company, as Delaware and Institutional Trustee, the Administrative Trustees (as named therein), and the Holders (as defined therein).

     
 

4.9*

Guarantee Agreement, dated as of August 14, 2007, between Farmers Capital Bank Corporation, as Guarantor, and Wilmington Trust Company, as Guarantee Trustee.

     
 

10.1

Employee Stock Purchase Plan of Farmers Capital Bank Corporation (incorporated by reference to Form S-8 effective June 24, 2004 (File No. 333-116801)).

     
 

10.2

Nonqualified Stock Option Plan of Farmers Capital Bank Corporation (incorporated by reference to Form S-8 effective September 8, 1998 (File No. 333-63037)).

     
 

10.3

Employment agreement dated December 10, 2012 between Farmers Capital Bank Corporation and Lloyd C. Hillard, Jr. (incorporated by reference to Exhibit 10.1 to Form 8-K/A filed December 26, 2012 (File No. 000-14412)).

     
 

10.4

Amendment No. 1 to Employment agreement dated December 10, 2012 between Farmers Capital Bank Corporation and Lloyd C. Hillard, Jr. (incorporated by reference to Exhibit 10.1 to Form 8-K filed December 30, 2013 (File No. 000-14412)).

     
 

10.5

Amendment No. 2 to Employment agreement dated December 10, 2012 between Farmers Capital Bank Corporation and Lloyd C. Hillard, Jr. (incorporated by reference to Exhibit 10.1 to Form 8-K filed December 8, 2014 (File No. 000-14412)).

 

 
56

 

 

 

10.6

Amendment No. 3 to Employment agreement dated December 10, 2012 between Farmers Capital Bank Corporation and Lloyd C. Hillard, Jr. (incorporated by reference to Exhibit 10.1 to Form 8-K filed December 9, 2015 (File No. 000-14412)).

     
 

10.7

Amendment No. 4 to Employment agreement dated December 10, 2012 between Farmers Capital Bank Corporation and Lloyd C. Hillard, Jr. (incorporated by reference to Exhibit 10.1 to Form 8-K filed January 4, 2017).

     
 

10.8

Employment agreement dated December 17, 2013 between Farmers Capital Bank Corporation and Rickey D. Harp (incorporated by reference to Exhibit 10.1 to Form 8-K filed December 30, 2013 (File No. 000-14412)).

     
 

10.9

Employment agreement dated October 28, 2014 between Farmers Capital Bank Corporation and Mark A. Hampton (incorporated by reference to Exhibit 10.1 to Form 8-K filed October 28, 2014 (File No. 000-14412)).

     
 

10.10

Employment agreement dated November 18, 2015 between Farmers Capital Bank Corporation and J. David Smith, Jr. (incorporated by reference to Exhibit 10.1 to Form 8-K filed November 19, 2015 (File No. 000-14412)).

     
 

10.11

Executive Short-Term Incentive Plan January 1, 2017 (incorporated by reference to Exhibit 10.1 to Form 8-K filed January 24, 2017).

     
 

31.1**

CEO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

     
 

31.2**

CFO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

     
 

32**

CEO & CFO Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

     
 

101**

Interactive Data Files

 

* Exhibit not included pursuant to Item 601(b)(4)(iii) and (v) of Regulation S-K. The Company will provide a copy of such exhibit to the Securities and Exchange Commission upon request.

 

** Filed with this Quarterly Report on Form 10-Q.

 

 
57

 

 

SIGNATURES

 

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

 

 

 

 

Date:

August 7, 2017

 

/s/ Lloyd C. Hillard, Jr.

     

Lloyd C. Hillard, Jr.

     

President and CEO

     

(Principal Executive Officer)

       

Date:

August 7, 2017

 

/s/ Mark A. Hampton

     

Mark A. Hampton

     

Executive Vice President, CFO, and Secretary

     

(Principal Financial and Accounting Officer)

 

 

58