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EX-32 - EXHIBIT 32 - SIERRA BANCORPv471507_ex32.htm
EX-31.2 - EXHIBIT 31.2 - SIERRA BANCORPv471507_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - SIERRA BANCORPv471507_ex31-1.htm

 

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

Commission file number: 000-33063

 

Sierra Bancorp

(Exact name of Registrant as specified in its charter)

  

California   33-0937517
(State of Incorporation)   (IRS Employer Identification No)

 

86 North Main Street, Porterville, California   93257
(Address of principal executive offices)   (Zip Code)

 

(559) 782-4900

(Registrant’s telephone number, including area code)

 

Not Applicable

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

 

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

Yes  þ    No   ¨

 

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

Yes  þ No  ¨

 

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

 

Large accelerated filer  ¨ Accelerated filer  þ
   
Non-accelerated filer  ¨ Smaller reporting company ¨
(Do not check if a smaller reporting company)  
  Emerging Growth Company  ¨

 

If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 17(a)(2)(B) of the Securities Act. ¨ 

 

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

Yes    ¨    No  þ

 

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

 

Common stock, no par value, 13,838,149 shares outstanding as of August 1, 2017

 

  

 

 

FORM 10-Q

 

Table of Contents

  Page
Part I - Financial Information 1
Item 1. Financial Statements (Unaudited) 1
Consolidated Balance Sheets 1
Consolidated Statements of Income 2
Consolidated Statements of Comprehensive Income 3
Consolidated Statements of Cash Flows 4
Notes to Consolidated Financial Statements (Unaudited) 5
   
Item 2. Management’s Discussion & Analysis of Financial Condition & Results of Operations 33
Forward-Looking Statements 33
Critical Accounting Policies 33
Overview of the Results of Operations and Financial Condition 34
Earnings Performance 35
Net Interest Income and Net Interest Margin 35
Provision for Loan and Lease Losses 39
Non-Interest Income and Non-Interest Expense 40
Provision for Income Taxes 42
Balance Sheet Analysis 43
Earning Assets 43
Investments 43
Loan and Lease Portfolio 44
Nonperforming Assets 46
Allowance for Loan and Lease Losses 47
Off-Balance Sheet Arrangements 49
Other Assets 49
Deposits and Interest-Bearing Liabilities 50
Deposits 50
Other Interest-Bearing Liabilities 51
Non-Interest Bearing Liabilities 51
Liquidity and Market Risk Management 51
Capital Resources 54
   
Item 3. Qualitative & Quantitative Disclosures about Market Risk 55
   
Item 4. Controls and Procedures 55
   
Part II - Other Information 56
Item 1. - Legal Proceedings 56
Item 1A. - Risk Factors 56
Item 2. - Unregistered Sales of Equity Securities and Use of Proceeds 56
Item 3. - Defaults upon Senior Securities 56
Item 4. - (Removed and Reserved) 56
Item 5. - Other Information 56
Item 6. - Exhibits 57
   
Signatures 58

 

  

 

 

PART I - FINANCIAL INFORMATION

Item 1 – Financial Statements

 

SIERRA BANCORP

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, unaudited)

 

   June 30, 2017   December 31, 2016 
  (unaudited)   (audited) 
ASSETS        
Cash and due from banks  $64,445   $79,087 
Interest-bearing deposits in banks   12,730    41,355 
Total cash & cash equivalents   77,175    120,442 
Securities available-for-sale   579,581    530,083 
Loans and leases:          
Gross loans and leases   1,299,239    1,262,531 
Allowance for loan and lease losses   (9,230)   (9,701)
Deferred loan and lease fees, net   2,768    2,924 
Net loans and leases   1,292,777    1,255,754 
Foreclosed assets   2,141    2,225 
Premises and equipment, net   28,438    28,893 
Goodwill   8,268    8,268 
Other intangible assets, net   2,589    2,803 
Company owned life insurance   44,815    43,706 
Other assets   42,196    40,699 
   $2,077,980   $2,032,873 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
Deposits:          
Non-interest bearing  $557,617   $524,552 
Interest-bearing   1,234,240    1,170,919 
Total deposits   1,791,857    1,695,471 
Repurchase agreements   11,296    8,094 
Short-term borrowings   -    65,000 
Subordinated debentures, net   34,499    34,410 
Other liabilities   24,205    24,020 
Total Liabilities   1,861,857    1,826,995 
           
Commitments and contingent liabilities (Note 8)          
           
Shareholders’ equity          
Common stock, no par value; 24,000,000 shares authorized; 13,832,549 and 13,776,589 shares issued and outstanding at June 30, 2017 and December 31, 2016, respectively   73,553    72,626 
Additional paid-in capital   2,954    2,832 
Retained earnings   138,066    132,180 
Accumulated other comprehensive income (loss)   1,550    (1,760)
Total shareholders’ equity   216,123    205,878 
   $2,077,980   $2,032,873 

 

The accompanying notes are an integral part of these consolidated financial statements

 

 1 

 

 

SIERRA BANCORP

CONSOLIDATED STATEMENTS OF INCOME

(dollars in thousands, except per share data, unaudited)

 

   Three months ended June 30,   Six months ended June 30, 
  2017   2016   2017   2016 
Interest and dividend income                
Loans and leases, including fees  $15,837   $13,147   $30,806   $26,240 
Taxable securities   2,141    2,052    4,149    4,199 
Tax-exempt securities   932    730    1,737    1,460 
Dividend income on securities   6    -    11    36 
Federal funds sold and other   139    5    255    32 
Total interest income   19,055    15,934    36,958    31,967 
Interest expense                    
Deposits   868    508    1,557    999 
Short-term borrowings   10    31    21    56 
Subordinated debentures   337    200    657    402 
Total interest expense   1,215    739    2,235    1,457 
Net interest income   17,840    15,195    34,723    30,510 
Provision for loan losses   300    -    300    - 
Net interest income after provision for loan losses   17,540    15,195    34,423    30,510 
Non-interest income                    
Service charges on deposits   2,776    2,478    5,348    4,848 
Net gains on sale of securities available-for-sale   58    146    66    122 
Other income   2,530    1,950    5,084    3,898 
Total non-interest income   5,364    4,574    10,498    8,868 
Other operating expense                    
Salaries and employee benefits   7,253    6,624    15,138    13,490 
Occupancy and equipment   2,235    1,866    4,555    3,617 
Other   5,603    5,225    11,099    10,087 
Total non-interest expenses   15,091    13,715    30,792    27,194 
Income before taxes   7,813    6,054    14,129    12,184 
Provision for income taxes   2,611    1,968    4,375    4,062 
Net income  $5,202   $4,086   $9,754   $8,122 
                     
PER SHARE DATA                    
Book value  $15.62   $14.93   $15.62   $14.93 
Cash dividends  $0.14   $0.12   $0.28   $0.24 
Earnings per share basic  $0.38   $0.31   $0.71   $0.61 
Earnings per share diluted  $0.37   $0.31   $0.70   $0.61 
Average shares outstanding, basic   13,831,345    13,280,433    13,816,576    13,272,903 
Average shares outstanding, diluted   14,010,328    13,393,448    14,009,485    13,388,664 
                     
Total shareholder equity (in thousands)  $216,123   $198,315   $216,123   $198,315 
Shares outstanding   13,832,549    13,285,568    13,832,549    13,285,568 
Dividends paid (in thousands)  $1,936   $1,593   $3,867   $3,185 

 

The accompanying notes are an integral part of these consolidated financial statements

 

 2 

 

 

SIERRA BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(dollars in thousands, unaudited)

 

   Three months ended June 30,   Six months ended June 30, 
   2017   2016   2017   2016 
                 
Net Income  $5,202   $4,086   $9,754   $8,122 
Other comprehensive income, before tax:                    
Unrealized gains on securities:                    
Unrealized holding gains arising during period   4,368    2,486    5,778    4,487 
Less: reclassification adjustment for gains included in net income(1)   (58)   (146)   (66)   (122)
Other comprehensive income, before tax   4,310    2,340    5,712    4,365 
Income tax expense related to items of other comprehensive income, net of tax   (1,812)   (984)   (2,402)   (1,814)
Other comprehensive income gain   2,498    1,356   3,310    2,551 
                     
Comprehensive Income  $7,700   $5,442  $13,064   $10,673 

 

(1) Amounts are included in net gains on investment securities available-for-sale on the Consolidated Statements of Income in non-interest revenue. Income tax expense associated with the reclassification adjustment for the three months ended June 30, 2017 and 2016 was $24 thousand and $61 thousand respectively. Income tax expense associated with the reclassification adjustment for the six months ended June 30, 2017 and 2016 was $28 thousand and $51 thousand respectively.

 

The accompanying notes are an integral part of these consolidated financial statements

 

 3 

 

 

SIERRA BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands, unaudited)

 

   Six months ended June 30, 
   2017   2016 
Cash flows from operating activities:          
Net income  $9,754   $8,122 
Adjustments to reconcile net income to net cash provided by operating activities:          
Gain on sale of securities   (66)   (122)
Loss on disposal of fixed assets   2    2 
(Gain) loss on sale on foreclosed assets   (12)   1 
Writedowns on foreclosed assets   75    262 
Share-based compensation expense   441    169 
Provision for loan losses   300    - 
Depreciation and amortization   1,462    1,209 
Net amortization on securities premiums and discounts   3,433    3,312 
(Accretion) amortization of discounts/premiums for loans acquired and deferred loan fees/costs   (80)   164 
(Increase) decrease in cash surrender value of life insurance policies   (1,109)   311 
Amortization of core deposit intangible   213    78 
Increase in interest receivable and other assets   (3,907)   (11)
Decrease (increase) in other liabilities   185    (3,959)
Deferred income tax provision   133    310 
Net cash provided by operating activities   10,824    9,848 
           
Cash flows from investing activities:          
Maturities of securities available for sale   -    30 
Proceeds from sales/calls of securities available for sale   17,625    5,365 
Purchases of securities available for sale   (114,633)   (70,675)
Principal pay downs on securities available for sale   49,856    45,536 
Purchases of FHLB stock   (235)   (399)
Net increase in loans receivable, net   (37,321)   (24,129)
Purchases of premises and equipment, net   (920)   (1,901)
Proceeds from sale premises and equipment   -    231 
Proceeds from sales of foreclosed assets   99    729 
Net cash used in investing activities   (85,529)   (45,213)
           
Cash flows from financing activities:          
Increase in deposits   96,386    21,446 
(Decrease) increase in borrowed funds   (65,000)   16,400 
Increase in fed funds purchased   -    4,100 
Increase in repurchase agreements   3,202    789 
Cash dividends paid   (3,867)   (3,185)
Stock options exercised   717    233 
Net cash provided by financing activities   31,438    39,783 
           
(Decrease) increase in cash and due from banks   (43,267)   4,418 
           
Cash and cash equivalents          
Beginning of period   120,442    48,623 
End of period  $77,175   $53,041 
           

 

The accompanying notes are an integral part of these consolidated financial statements

 

 4 

 

 

Sierra Bancorp

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2017

(Unaudited)

 

Note 1 – The Business of Sierra Bancorp

 

Sierra Bancorp (the “Company”) is a California corporation headquartered in Porterville, California, and is a registered bank holding company under federal banking laws. The Company was formed to serve as the holding company for Bank of the Sierra (the “Bank”), and has been the Bank’s sole shareholder since August 2001. The Company exists primarily for the purpose of holding the stock of the Bank and of such other subsidiaries it may acquire or establish. As of June 30, 2017, the Company’s only other subsidiaries were Sierra Statutory Trust II, Sierra Capital Trust III, and Coast Bancorp Statutory Trust II, which exist solely to facilitate the issuance of capital trust pass-through securities (“TRUPS”). Pursuant to the Financial Accounting Standards Board (“FASB”) standard on the consolidation of variable interest entities, these trusts are not reflected on a consolidated basis in the Company’s financial statements. References herein to the “Company” include Sierra Bancorp and its consolidated subsidiary, the Bank, unless the context indicates otherwise.

 

Bank of the Sierra, a California state-chartered bank headquartered in Porterville, California, offers a full range of retail and commercial banking services in California’s South San Joaquin Valley, the Central Coast, Ventura County, and neighboring communities. The Bank was incorporated in September 1977, and opened for business in January 1978 as a one-branch bank with $1.5 million in capital. Our growth in the ensuing years has largely been organic in nature, but includes three whole-bank acquisitions: Sierra National Bank in 2000, Santa Clara Valley Bank in 2014, and Coast National Bank in July of 2016. The Bank now operates 34 full-service branches, a loan production office, and an online branch, and maintains ATMs at all branch locations and seven non-branch locations. Our most recent branching activity occurred in the first quarter of 2017, with a de novo branch opened on California Avenue in Bakersfield and our Paso Robles branch relocated to a superior site in reasonably close proximity to the previous location. The Company plans to expand even further in the fourth quarter of 2017 with the acquisition of OCB Bancorp, the holding company for Ojai Community Bank, and the purchase of the Woodlake branch of Citizens Business Bank (see Note 13 to the financial statements, Recent Developments, for more details on the proposed acquisitions). We have also received regulatory approvals for a de novo branch in Pismo Beach, California, although the timing for that branch opening remains uncertain, and have plans to relocate our Fresno Herndon branch to a nearby location with easier access and better visibility. In addition to our stand-alone offices the Bank has specialized lending units which include a real estate industries center, an agricultural credit center, and an SBA lending unit. We were close to $2.1 billion in total assets as of June 30, 2017, and for the past several years have claimed the distinction of being the largest bank headquartered in the South San Joaquin Valley. The Bank’s deposit accounts, which totaled almost $1.8 billion at June 30, 2017, are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to maximum insurable amounts.

 

Note 2 – Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in a condensed format, and therefore do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. The information furnished in these interim statements reflects all adjustments that are, in the opinion of Management, necessary for a fair statement of the results for such periods. Such adjustments can generally be considered as normal and recurring unless otherwise disclosed in this Form 10-Q. In preparing the accompanying financial statements, Management has taken subsequent events into consideration and recognized them where appropriate. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for any other quarter, or for the full year. Certain amounts reported for 2016 have been reclassified to be consistent with the reporting for 2017. The interim financial information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the Securities and Exchange Commission (the “SEC”).

 

 5 

 

 

Note 3 – Current Accounting Developments

 

In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU is the result of a joint project initiated by the FASB and the International Accounting Standards Board (IASB) to clarify the principles for recognizing revenue, and to develop common revenue standards and disclosure requirements that would: (1) remove inconsistencies and weaknesses in revenue requirements; (2) provide a more robust framework for addressing revenue issues; (3) improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets; (4) provide more useful information to users of financial statements through improved disclosures; and (5) simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. The guidance affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets. The core principle is that an entity 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. The guidance provides steps to follow to achieve the core principle. An entity should disclose sufficient information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Qualitative and quantitative information is required with regard to contracts with customers, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. This ASU is effective for annual reporting periods beginning after December 15, 2017, including interim periods therein, with early adoption permitted for reporting periods beginning after December 15, 2016. The Company plans to adopt ASU 2014-09 on January 1, 2018 utilizing the modified retrospective approach. Since the guidance does not apply to revenue associated with financial instruments such as loans and investments, which are accounted for under other provisions of GAAP, we do not expect it to impact interest income, our largest component of income. The Company is currently performing an overall assessment of revenue streams potentially affected by the ASU, including certain deposit related fees and interchange fees, to determine the potential impact of this guidance on our consolidated financial statements.

 

In January 2016 the FASB issued ASU 2016-01, Financial Instruments–Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. This guidance primarily affects the accounting for equity securities with readily determinable fair values, by requiring that the changes in fair value for such securities will be reflected in earnings rather than in other comprehensive income. The accounting for other financial instruments such as loans, debt securities, and financial liabilities is largely unchanged. ASU 2016-01 also changes the presentation and disclosure requirements for financial instruments, including a requirement that public business entities use exit pricing when estimating fair values for financial instruments measured at amortized cost for disclosure purposes. ASU 2016-01 is generally effective for public business entities in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Based on Management’s evaluation of the provisions of ASU 2016-01, we have determined that the difference between the amortized cost and fair market value of our equity securities, which constitutes a $993,000 gain at June 30, 2017, would be credited to retained earnings, net of tax as a one-time cumulative-effect adjustment upon our adoption of this ASU on January 1, 2018, with any subsequent changes in fair market value reflected in our income statement. There would likely be no other impact on our consolidated financial statements or disclosures. We are exploring the possibility of selling most of our equity securities during the current fiscal year, in which case there would be no impact on our consolidated financial statements upon adoption of ASU 2016-01.

 

In February 2016 the FASB issued ASU 2016-02, Leases (Topic 842). The intention of this standard is to increase the transparency and comparability around lease obligations. Previously unrecorded off-balance sheet obligations will now be brought more prominently to light by presenting lease liabilities on the face of the balance sheet, accompanied by enhanced qualitative and quantitative disclosures in the notes to the financial statements. ASU 2016-02 is generally effective for public business entities in fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company has leases on 17 branch locations, a loan production office, and an administrative office, which are considered operating leases and are not currently reflected in our financial statements. We expect that these lease agreements will be recognized on our consolidated statements of condition as right-of-use assets and corresponding lease liabilities subsequent to implementing ASU 2016-02, but we are still evaluating the extent to which this will impact our consolidated financial statements.

 

In March 2016 the FASB issued ASU 2016-09, Compensation–Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, as part of its simplification initiative. ASU 2016-09 became effective for public business entities for annual reporting periods beginning after December 15, 2016, and interim periods within that reporting period. The Company adopted ASU 2016-09 effective January 1, 2017. Prior guidance dictated that as they relate to share-based payments, tax benefits in excess of compensation costs (“windfalls”) were to be recorded in equity, and tax deficiencies (“shortfalls”) were to be recorded in equity to the extent of previous windfalls and then to the income statement. ASU 2016-09 reduced some of the administrative complexities by eliminating the need to track a windfall “pool,” but as we have already experienced, it also increases the volatility of income tax expense. ASU 2016-09 also removed the requirement to delay recognition of a windfall tax benefit until such time as it reduces current taxes payable. Under the new guidance, the benefit is recorded when it arises, subject to normal valuation allowance considerations. This change was applied by us on a modified retrospective basis, as required, with a cumulative-effect adjustment to opening retained earnings. Furthermore, all tax-related cash flows resulting from share-based payments are now reported as operating activities on the statement of cash flows, a change from the previous requirement to present windfall tax benefits as an inflow from financing activities and an outflow from operating activities. However, cash paid by an employer when directly withholding shares for tax withholding purposes is classified as a financing activity. Under the new guidance, entities were permitted to make an accounting policy election for the impact of forfeitures on expense recognition for share-based payment awards. Forfeitures can be estimated in advance, as required previously, or recognized as they occur. Estimates are still required in certain circumstances, such as at the time of modification of an award or issuance of a replacement award in a business combination. If elected, the change to recognize forfeitures when they occur would have been adopted using a modified retrospective approach, with a cumulative effect adjustment recorded to opening retained earnings. We did not elect to recognize forfeitures as they occur, and continue to estimate potential forfeitures in advance.

 

 6 

 

 

In June 2016 the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which eliminates the probable initial recognition threshold for credit losses in current U.S. GAAP, and instead requires an organization to record a current estimate of all expected credit losses over the contractual term for financial assets carried at amortized cost. This is commonly referred to as the current expected credit losses (“CECL”) methodology. Expected credit losses for financial assets held at the reporting date will be measured based on historical experience, current conditions, and reasonable and supportable forecasts. Another change from existing U.S. GAAP involves the treatment of purchased credit deteriorated assets, which are more broadly defined than purchased credit impaired assets in current accounting standards. When such assets are purchased, institutions will estimate and record an allowance for credit losses that is added to the purchase price rather than being reported as a credit loss expense. Furthermore, ASU 2016-13 updates the measurement of credit losses on available-for-sale debt securities, by mandating that institutions record credit losses on available-for-sale debt securities through an allowance for credit losses rather than the current practice of writing down securities for other-than-temporary impairment. ASU 2016-13 will also require the enhancement of financial statement disclosures regarding estimates used in calculating credit losses. ASU 2016-13 does not change the existing write-off principle in U.S. GAAP or current nonaccrual practices, nor does it change accounting requirements for loans held for sale or certain other financial assets which are measured at the lower of amortized cost or fair value. As a public business entity that is an SEC filer, ASU 2016-13 becomes effective for the Company on January 1, 2020, although early application is permitted for 2019. On the effective date, institutions will apply the new accounting standard as follows: for financial assets carried at amortized cost, a cumulative-effect adjustment will be recognized on the balance sheet for any change in the related allowance for loan and lease losses generated by the adoption of the new standard; financial assets classified as purchased credit impaired assets prior to the effective date will be reclassified as purchased credit deteriorated assets as of the effective date, and will be grossed up for the related allowance for expected credit losses created as of the effective date; and, debt securities on which other-than-temporary impairment had been recognized prior to the effective date will transition to the new guidance prospectively with no change in their amortized cost basis. The Company has commenced its transition efforts by establishing an implementation team, comprised of the Company’s executive officers and certain other members of our credit administration and finance departments and chaired by our Chief Credit Officer. The Company’s preliminary evaluation indicates that the provisions of ASU 2016-13 will impact our consolidated financial statements, in particular the level of our reserve for credit losses and shareholders’ equity. However, we continue to evaluate the potential extent of that impact.

 

In January 2017 the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. Currently, Topic 805 specifies three elements of a business – inputs, processes, and outputs. While an integrated set of assets and activities (collectively referred to as a “set”) that is a business usually has outputs, outputs are not required. In addition, all the inputs and processes that a seller uses in operating a set are not required if market participants can acquire the set and continue to produce outputs, for example, by integrating the acquired set with their own inputs and processes. This led many transactions to be accounted for as business combinations rather than asset purchases under legacy GAAP. The primary goal of ASU 2017-01 is to narrow the definition of a business, and the guidance in this update provides a screen to determine when a set is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. This screen reduces the number of transactions that need to be further evaluated. The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The amendments in this update should be applied prospectively on or after the effective date. The Company is currently evaluating this ASU to determine the impact on its consolidated financial position, results of operations and cash flows.

 

 7 

 

 

In January 2017 the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment. This guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation, and goodwill impairment will simply be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. All other goodwill impairment guidance will remain largely unchanged. Entities will continue to have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary. The same one-step impairment test will be applied to goodwill at all reporting units, even those with zero or negative carrying amounts. Entities will be required to disclose the amount of goodwill at reporting units with zero or negative carrying amounts. The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2019. We have not been required to record any goodwill impairment to date, and after a preliminary review do not expect that this guidance would require us to do so given current circumstances. Nevertheless, we will continue to evaluate ASU 2017-04 to more definitely determine its potential impact on the Company’s consolidated financial position, results of operations and cash flows.

 

In March 2017 the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The amendments in this update shorten the amortization period for certain callable debt securities held at a premium, by requiring the premium to be amortized to the earliest call date. Under current guidance, the premium on a callable debt security is generally amortized as an adjustment to yield over the contractual life of the instrument, and any unamortized premium is recorded as a loss in earnings upon the debtor’s exercise of a call provision. Under ASU 2017-08, because the premium will be amortized to the earliest call date, entities will no longer recognize a loss in earnings if a debt security is called prior to the contractual maturity date. The amendments do not require an accounting change for securities held at a discount; discounts will continue to be amortized as an adjustment to yield over the contractual life of the debt instrument. ASU 2017-08 is effective for public business entities, including the Company, for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted, including adoption in an interim period. If an entity early adopts in an interim period, any adjustments must be reflected as of the beginning of the fiscal year that includes that interim period. To apply ASU 2017-08, entities must use a modified retrospective approach, with the cumulative-effect adjustment recognized to retained earnings at the beginning of the period of adoption. Entities are also required to provide disclosures about a change in accounting principle in the period of adoption. The Company has evaluated the potential impact of this guidance, and does not expect the adoption of ASU 2017-08 to have a material impact on our financial statements or operations.

 

In May 2017 the FASB issued ASU 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting. This update was issued to provide clarity, reduce diversity in practice, and lower cost and complexity when applying the guidance in Topic 718. Under the updated guidance, an entity will be expected to account for the effects of an equity award modification unless all the following are met: 1) the fair value of the modified award is the same as the fair value of the original award immediately before the original award is modified; 2) the vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified; 3) the classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified. The current disclosure requirements in Topic 718 continue to apply. ASU 2017-09 is effective for public business entities, including the Company, for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period for public business entities for reporting periods for which financial statements have not yet been issued. Since the Company has not modified equity awards in the past and does not expect to do so in the future, we do not anticipate any impact on our financial statements or operations from the adoption of ASU 2017-09.

 

Note 4 – Supplemental Disclosure of Cash Flow Information

 

During the six months ended June 30, 2017 and 2016, cash paid for interest due on interest-bearing liabilities was $2.273 million and $1.423 million, respectively. There was $5.647 million in cash paid for income taxes during the six months ended June 30, 2017, and $2.500 million for the six months ended June 30, 2016. Assets totaling $115,000 and $694,000 were acquired in settlement of loans for the six months ended June 30, 2017 and June 30, 2016, respectively. We received $99,000 in cash from the sale of foreclosed assets during the first six months of 2017 relative to $729,000 during the first six months of 2016, which represents sales proceeds less loans (if any) extended to finance such sales.

 

 8 

 

 

Note 5 – Share Based Compensation

 

On March 16, 2017 the Company’s Board of Directors approved and adopted the 2017 Stock Incentive Plan (the “2017 Plan”), which became effective May 24, 2017 pursuant to the approval of the Company’s shareholders. The 2017 Plan replaced the Company’s 2007 Stock Incentive Plan (the “2007 Plan”), which expired by its own terms on March 15, 2017. Options to purchase 500,120 shares that were granted under the 2007 Plan were still outstanding as of June 30, 2017, and remain unaffected by that plan’s expiration. The 2017 Plan provides for the issuance of both “incentive” and “nonqualified” stock options to officers and employees, and of “nonqualified” stock options to non-employee directors and consultants of the Company. The 2017 Plan also provides for the issuance of restricted stock awards to these same classes of eligible participants, although no restricted stock awards have ever been issued by the Company. The total number of shares of the Company’s authorized but unissued stock reserved for issuance pursuant to awards under the 2017 Plan is 850,000 shares. The dilutive impact of stock options outstanding is discussed below in Note 6, Earnings per Share.

 

Pursuant to FASB’s standards on stock compensation, the value of each stock option granted is reflected in our income statement as employee compensation or directors’ expense by expensing its fair value as of the grant date in the case of immediately vested options, or by amortizing its grant date fair value over the vesting period for options with graded vesting. The Company is utilizing the Black-Scholes model to value stock options, and the “multiple option” approach is used to allocate the resulting valuation to actual expense. Under the multiple option approach an employee’s options for each vesting period are separately valued and amortized, which appears to be the preferred method for option grants with graded vesting. A pre-tax charge of $18,000 was reflected in the Company’s income statement during the second quarter of 2017 and $12,000 was charged during the second quarter of 2016, as expense related to stock options. For the first half, the charges totaled $441,000 in 2017 and $169,000 in 2016.

 

Note 6 – Earnings per Share

 

The computation of earnings per share, as presented in the Consolidated Statements of Income, is based on the weighted average number of shares outstanding during each period. There were 13,831,345 weighted average shares outstanding during the second quarter of 2017, and 13,280,433 during the second quarter of 2016. There were 13,816,576 weighted average shares outstanding during the first six months of 2017, and 13,272,903 during the first six months of 2016.

 

Diluted earnings per share include the effect of the potential issuance of common shares, which for the Company is limited to shares that would be issued on the exercise of “in-the-money” stock options. For the second quarter of 2017, calculations under the treasury stock method resulted in the equivalent of 178,983 shares being added to basic weighted average shares outstanding for purposes of determining diluted earnings per share, while a weighted average of 120,700 stock options were excluded from the calculation because they were underwater and thus anti-dilutive. For the second quarter of 2016 the equivalent of 113,015 shares were added in calculating diluted earnings per share, while 162,700 anti-dilutive stock options were not factored into the computation. Likewise, for the first half of 2017 the equivalent of 192,909 shares were added to basic weighted average shares outstanding in calculating diluted earnings per share and a weighted average of 120,700 stock options that were anti-dilutive for the period were not included, compared to the addition of the equivalent of 115,761 shares and non-inclusion of 212,700 anti-dilutive options in calculating diluted earnings per share for first half of 2016.

 

Note 7 – Comprehensive Income

 

As presented in the Consolidated Statements of Comprehensive Income, comprehensive income includes net income and other comprehensive income. The Company’s only source of other comprehensive income is unrealized gains and losses on available-for-sale investment securities. Gains or losses on investment securities that were realized and reflected in net income of the current period, which had previously been included in other comprehensive income as unrealized holding gains or losses in the period in which they arose, are considered to be reclassification adjustments that are excluded from other comprehensive income in the current period.

 

 9 

 

 

Note 8 – Financial Instruments with Off-Balance-Sheet Risk

 

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business. Those financial instruments currently consist of unused commitments to extend credit and standby letters of credit. They involve, to varying degrees, elements of risk in excess of the amount recognized in the balance sheet. The Company’s exposure to credit loss in the event of nonperformance by counterparties for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and issuing letters of credit as it does for originating loans included on the balance sheet. The following financial instruments represent off-balance-sheet credit risk (dollars in thousands):

 

   June 30, 2017   December 31, 2016 
Commitments to extend credit  $583,562   $463,923 
Standby letters of credit  $8,432   $8,582 

 

Commitments to extend credit consist primarily of the unused or unfunded portions of the following: home equity lines of credit; commercial real estate construction loans, where disbursements are made over the course of construction; commercial revolving lines of credit; mortgage warehouse lines of credit; unsecured personal lines of credit; and formalized (disclosed) deposit account overdraft lines. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many commitments are expected to expire without being drawn upon, the unused portions of committed amounts do not necessarily represent future cash requirements. Standby letters of credit are generally unsecured and are issued by the Company to guarantee the performance of a customer to a third party, and the credit risk involved in issuing letters of credit is essentially the same as the risk involved in extending loans to customers.

 

At June 30, 2017, the Company was also utilizing a letter of credit in the amount of $87 million issued by the Federal Home Loan Bank on the Company’s behalf as security for certain deposits and to facilitate certain credit arrangements with the Company’s customers. That letter of credit is backed by loans which are pledged to the FHLB by the Company.

 

Note 9 – Fair Value Disclosures and Reporting, the Fair Value Option and Fair Value Measurements

 

FASB’s standards on financial instruments, and on fair value measurements and disclosures, require all entities to disclose in their financial statement footnotes the estimated fair values of financial instruments for which it is practicable to estimate such. In addition to disclosure requirements, FASB’s standard on investments requires that our debt securities which are classified as available for sale and our equity securities that have readily determinable fair values be measured and reported at fair value in our statement of financial position. Certain impaired loans are also reported at fair value, as explained in greater detail below, and foreclosed assets are carried at the lower of cost or fair value. FASB’s standard on financial instruments permits companies to report certain other financial assets and liabilities at fair value, but we have not elected the fair value option for any of those financial instruments.

 

Fair value measurement and disclosure standards also establish a framework for measuring fair values. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants on the measurement date. Further, the standards establish a fair value hierarchy that encourages an entity to maximize the use of observable inputs and limit the use of unobservable inputs when measuring fair values. The standards describe three levels of inputs that may be used to measure fair values:

 

·Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

 

·Level 2: Significant observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

 

·Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the factors that market participants would likely consider in pricing an asset or liability.

 

Fair value estimates are made at a specific point in time based on relevant market data and information about the financial instruments. The estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments. In addition, the tax ramifications related to realized gains and losses could have a significant effect on fair value estimates but have not been considered in those estimates. Because no active market exists for a significant portion of our financial instruments, fair value disclosures are based on judgments regarding current economic conditions, risk characteristics of various financial instruments and other factors. The estimates are subjective and involve uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly alter the fair values presented. The following methods and assumptions were used by the Company to estimate its financial instrument fair values disclosed at June 30, 2017 and December 31, 2016:

 

·Cash and cash equivalents and fed funds sold: The carrying amount is estimated to be fair value.

 

 10 

 

 

·Investment securities: Fair values are determined by obtaining quoted prices on nationally recognized securities exchanges or by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities by relying on their relationship to other benchmark quoted securities when quoted prices for specific securities are not readily available.

 

·Loans and leases: For variable-rate loans and leases that re-price frequently with no significant changes in credit risk or interest rate spreads relative to current market pricing, fair values are based on carrying values. Fair values for other loans and leases are estimated by discounting projected cash flows at interest rates being offered at each reporting date for loans and leases with similar terms, to borrowers of comparable creditworthiness. The carrying amount of accrued interest receivable approximates its fair value.

 

·Loans held for sale: Since loans designated by the Company as available-for-sale are typically sold shortly after making the decision to sell them, realized gains or losses are usually recognized within the same period and fluctuations in fair values are not relevant for reporting purposes. If available-for-sale loans are on our books for an extended period of time, the fair value of those loans is determined using quoted secondary-market prices.

 

·Collateral-dependent impaired loans: Collateral-dependent impaired loans are carried at fair value when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the original loan agreement and the loan has been written down to the fair value of its underlying collateral, net of expected disposition costs where applicable.

 

·Cash surrender value of life insurance policies: Fair values are based on net cash surrender values at each reporting date.

 

·Other investments: Certain investments for which no secondary market exists are carried at cost and the carrying amount for those investments typically approximates their estimated fair value, unless an impairment analysis indicates the need for adjustments.

 

·Deposits: Fair values for non-maturity deposits are equal to the amount payable on demand at the reporting date, which is the carrying amount. Fair values for fixed-rate certificates of deposit are estimated using a cash flow analysis, discounted at interest rates being offered at each reporting date by the Bank for certificates with similar remaining maturities. The carrying amount of accrued interest payable approximates its fair value.

 

·Short-term borrowings: Current carrying amounts are used as an approximation of fair values for federal funds purchased, overnight advances from the Federal Home Loan Bank (“FHLB”), borrowings under repurchase agreements, and other short-term borrowings maturing within ninety days of the reporting dates. Fair values of other short-term borrowings are estimated by discounting projected cash flows at the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

 

·Long-term borrowings: Fair values are estimated using projected cash flows discounted at the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

 

·Subordinated debentures: Fair values are determined based on the current market value for like instruments of a similar maturity and structure.

 

·Commitments to extend credit and letters of credit: If funded, the carrying amounts for currently unused commitments would provide an equivalent measure of fair values for the newly created financial assets at the funding date. However, because of the high degree of uncertainty with regard to whether or not those commitments will ultimately be funded, fair values for loan commitments and letters of credit in their current undisbursed state cannot reasonably be estimated, and only notional values are disclosed in the table below.

 

 11 

 

 

Estimated fair values for the Company’s financial instruments are as follows, as of the dates noted:

 

Fair Value of Financial Instruments

(dollars in thousands, unaudited)

 

   June 30, 2017 
           Estimated Fair Value  
   Carrying
Amount
   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   Total 
Financial assets:                         
Cash and cash equivalents  $77,175   $77,175   $-   $-   $77,175 
Investment securities available for sale   579,581    1,487    578,094    -    579,581 
Loans and leases, net held for investment   1,292,777    -    1,304,509    -    1,304,509 
Collateral dependent impaired loans   -    -    -    -    - 
Cash surrender value of life insurance policies   44,815    -    44,815    -    44,815 
Other investments   8,741    -    8,741    -    8,741 
Accrued interest receivable   6,490    -    6,490    -    6,490 
                          
Financial liabilities:                         
Deposits:                         
Noninterest-bearing  $557,617   $557,617   $-   $-   $557,617 
Interest-bearing   1,234,240    -    1,234,690    -    1,234,690 
Fed funds purchased and repurchase agreements   11,296    -    11,296    -    11,296 
Short-term borrowings   -    -    -    -    - 
Subordinated debentures   34,499    -    23,995    -    23,995 
Accrued interest payable   150    -    150    -    150 
                          
    Notional Amount                     
Off-balance-sheet financial instruments:                         
Commitments to extend credit  $583,562                     
Standby letters of credit   8,432                     

 

   December 31, 2016 
         Estimated Fair Value  
   Carrying
Amount
   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   Total 
Financial assets:                         
Cash and cash equivalents  $120,442   $120,442   $-   $-   $120,442 
Investment securities available for sale   530,083    1,546    528,537    -    530,083 
Loans and leases, net held for investment   1,255,348    -    1,266,447    -    1,266,447 
Collateral dependent impaired loans   406    -    406    -    406 
Cash surrender value of life insurance policies   43,706    -    43,706    -    43,706 
Other investments   8,506    -    8,506    -    8,506 
Accrued interest receivable   6,354    -    6,354    -    6,354 
                          
Financial liabilities:                         
Deposits:                         
Noninterest-bearing  $524,552   $524,552   $-   $-   $524,552 
Interest-bearing   1,170,919    -    1,171,188    -    1,171,188 
Fed funds purchased and  repurchase agreements   8,094    -    8,094    -    8,094 
Short-term borrowings   65,000    -    65,000    -    65,000 
Subordinated debentures   34,410    -    22,633    -    22,633 
Accrued interest payable   188    -    188    -    188 
                          
    Notional Amount                     
Off-balance-sheet financial instruments:                         
Commitments to extend credit  $463,923                     
Standby letters of credit   8,582                     

 

 12 

 

 

For financial asset categories that were actually reported at fair value as of June 30, 2017 and December 31, 2016, the Company used the following methods and significant assumptions:

 

·Investment securities: Fair values are determined by obtaining quoted prices on nationally recognized securities exchanges or by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities by relying on their relationship to other benchmark quoted securities.

 

·Collateral-dependent impaired loans: Collateral-dependent impaired loans are carried at fair value when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the original loan agreement and the loan has been written down to the fair value of its underlying collateral, net of expected disposition costs where applicable.

 

·Foreclosed assets: Repossessed real estate (known as other real estate owned, or “OREO”) and other foreclosed assets are carried at the lower of cost or fair value. Fair value is the appraised value less expected selling costs for OREO and some other assets such as mobile homes, and fair values for any other foreclosed assets are represented by estimated sales proceeds as determined using reasonably available sources. Foreclosed assets for which appraisals can be feasibly obtained are periodically measured for impairment using updated appraisals. Fair values for other foreclosed assets are adjusted as necessary, subsequent to a periodic re-evaluation of expected cash flows and the timing of resolution. If impairment is determined to exist, the book value of a foreclosed asset is immediately written down to its estimated impaired value through the income statement, thus the carrying amount is equal to the fair value and there is no valuation allowance.

 

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

 

Fair Value Measurements - Recurring                    
(dollars in thousands, unaudited)                    
   Fair Value Measurements at June 30, 2017, using     
                     
   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   Total   Realized
Gain/(Loss)
 
Securities:                         
US Government agencies  $-   $25,717   $-   $25,717   $- 
Mortgage-backed securities   -    412,745    -    412,745    - 
State and political subdivisions   -    139,632    -    139,632    - 
Equity securities   1,487    -    -    1,487    - 
                          
Total available-for-sale securities  $1,487   $578,094   $-   $579,581   $- 

 

   Fair Value Measurements at December 31, 2016, using     
                     
   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   Total   Realized
Gain/(Loss)
 
Securities:                         
US Government agencies  $-   $26,468   $-   $26,468   $- 
Mortgage-backed securities   -    387,876    -    387,876    - 
State and political subdivisions   -    114,193    -    114,193    - 
Equity securities   1,546    -    -    1,546    - 
                          
Total available-for-sale securities  $1,546   $528,537   $-   $530,083   $- 

 

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Assets reported at fair value on a nonrecurring basis are summarized below:

 

Fair Value Measurements - Nonrecurring                
(dollars in thousands, unaudited)                
   Fair Value Measurements at June 30, 2017, using 
                 
   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   Total 
Impaired loans                    
Real Estate:                    
1-4 family residential construction  $-   $-   $-   $- 
Other construction/land   -    -    -    - 
1-4 family - closed-end   -    13    -    13 
Equity lines   -    17    -    17 
Multi-family residential   -    -    -    - 
Commercial real estate - owner occupied   -    210    -    210 
Commercial real estate-non-owner occupied   -    -    -    - 
Farmland   -    -    -    - 
Total real estate   -    240    -    240 
Agriculture   -    -    -    - 
Commercial and industrial   -    -    -    - 
Consumer loans   -    14    -    14 
Total impaired loans   -    254    -    254 
Foreclosed assets  $-   $2,141   $-   $2,141 
Total assets measured on a norecurring basis  $-   $2,395   $-   $2,395 
                 
   Fair Value Measurements at December 31, 2016, using 
   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   Total 
Impaired loans                    
Real Estate:                    
1-4 family residential construction  $-   $-   $-   $- 
Other construction/land   -    -    -    - 
1-4 family - closed-end   -    -    -    - 
Equity lines   -    -    -    - 
Multi-family residential   -    -    -    - 
Commercial real estate - owner occupied   -    281    -    281 
Commercial real estate-non-owner occupied   -    67    -    67 
Farmland   -    -    -    - 
Total real estate   -    348    -    348 
Agriculture   -    -    -    - 
Commercial and industrial   -    -    -    - 
Consumer loans   -    58    -    58 
Total impaired loans   -    406    -    406 
Foreclosed assets  $-   $2,225   $-   $2,225 
Total assets measured on a norecurring basis  $-   $2,631   $-   $2,631 

 

The table above includes collateral-dependent impaired loan balances for which a specific reserve has been established or on which a write-down has been taken. Information on the Company’s total impaired loan balances and specific loss reserves associated with those balances is included in Note 11 below, and in Management’s Discussion and Analysis of Financial Condition and Results of Operation in the “Nonperforming Assets” and “Allowance for Loan and Lease Losses” sections.

 

The unobservable inputs are based on Management’s best estimates of appropriate discounts in arriving at fair market value. Adjusting any of those inputs could result in a significantly lower or higher fair value measurement. For example, an increase or decrease in actual loss rates would create a directionally opposite change in the fair value of unsecured impaired loans.

 

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Note 10 – Investments

 

Investment Securities

 

Although the Company currently has the intent and the ability to hold the securities in its investment portfolio to maturity, the securities are all marketable and are classified as “available for sale” to allow maximum flexibility with regard to interest rate risk and liquidity management. Pursuant to FASB’s guidance on accounting for debt and equity securities, available for sale securities are carried on the Company’s financial statements at their estimated fair market values, with monthly tax-effected “mark-to-market” adjustments made vis-à-vis accumulated other comprehensive income in shareholders’ equity.

 

The amortized cost and estimated fair value of investment securities available-for-sale are as follows:

 

Amortized Cost And Estimated Fair Value
(dollars in thousands, unaudited):                
                 
   June 30, 2017 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated Fair
Value
 
                 
US Government agencies  $25,793   $162   $(238)  $25,717 
Mortgage-backed securities   414,065    1,641    (2,961)   412,745 
State and political subdivisions   136,554    3,372    (294)   139,632 
Equity securities   494    993    -    1,487 
Total securities  $576,906   $6,168   $(3,493)  $579,581 

 

   December 31, 2016 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated Fair
Value
 
                 
US Government agencies  $26,926   $48   $(506)  $26,468 
Mortgage-backed securities   391,555    1,492    (5,171)   387,876 
State and political subdivisons   114,140    1,519    (1,466)   114,193 
Equity securities   500    1,046    -    1,546 
Total securities  $533,121   $4,105   $(7,143)  $530,083 

 

 15 

 

 

At June 30, 2017 and December 31, 2016, the Company had 296 securities and 431 securities, respectively, with gross unrealized losses. Management has evaluated those securities as of the respective dates, and does not believe that any of the unrealized losses are other than temporary. Gross unrealized losses on our investment securities as of the indicated dates are disclosed in the table below, categorized by investment type and by the duration of time that loss positions on individual securities have continuously existed (over or under twelve months).

 

Investment Portfolio - Unrealized Losses                
(dollars in thousands, unaudited)  June 30, 2017 
   Less than twelve months   Twelve months or more 
   Gross
Unrealized
Losses
   Fair Value   Gross
Unrealized
Losses
   Fair Value 
                 
US Government agencies  $(193)  $11,451   $(45)  $1,454 
Mortgage-backed securities   (2,086)   234,206    (875)   54,646 
State and political subdivisions   (282)   17,465    (12)   696 
Total  $(2,561)  $263,122   $(932)  $56,796 

 

   December 31, 2016 
   Less than twelve months   Twelve months or more 
   Gross
Unrealized
Losses
   Fair Value   Gross
Unrealized
Losses
   Fair Value 
                 
US Government agencies  $(500)  $21,056   $(6)  $711 
Mortgage-backed securities   (4,303)   271,276    (868)   43,570 
State and political subdivisions   (1,466)   49,195    -    - 
Total  $(6,269)  $341,527   $(874)  $44,281 

 

The table below summarizes the Company’s gross realized gains and losses as well as gross proceeds from the sales of securities, for the periods indicated:

 

Investment Portfolio - Realized Gains/(Losses)                
(dollars in thousands, unaudited)                
                 
   Three months ended June 30,   Six months ended June 30, 
   2017   2016   2017   2016 
Proceeds from sales, calls and maturities of securities available for sale  $4,721   $2,790   $17,625   $5,395 
Gross gains on sales, calls and maturities of securities available for sale  $63   $146   $106   $160 
Gross losses on sales, calls and maturities of securities available for sale   (5)   -    (40)   (38)
Net gains on sale of securities available for sale  $58   $146   $66   $122 

 

 16 

 

 

The amortized cost and estimated fair value of investment securities available-for-sale at June 30, 2017 and December 31, 2016 are shown below, grouped by the remaining time to contractual maturity dates. The expected life of investment securities may not be consistent with contractual maturity dates, since the issuers of the securities might have the right to call or prepay obligations with or without penalties.

 

Estimated Fair Value of Contractual Maturities        
(dollars in thousands, unaudited)  June 30, 2017 
   Amortized Cost   Fair Value 
         
Maturing within one year  $8,552   $8,600 
Maturing after one year through five years   258,614    259,441 
Maturing after five years through ten years   40,566    41,538 
Maturing after ten years   74,654    75,778 
           
Securities not due at a single maturity date:          
US Government agencies collateralized by mortgage obligations   194,026    192,737 
Other securities   494    1,487 
   $576,906   $579,581 

 

   December 31, 2016 
   Amortized Cost   Fair Value 
         
Maturing within one year  $8,488   $8,573 
Maturing after one year through five years   260,387    259,535 
Maturing after five years through ten years   50,823    50,687 
Maturing after ten years   47,132    46,190 
           
Securities not due at a single maturity date:          
US Government agencies collateralized by mortgage obligations   165,791    163,552 
Other securities   500    1,546 
   $533,121   $530,083 

 

At June 30, 2017, the Company’s investment portfolio was comprised of 337 bonds issued by government municipalities and agencies located within 32 states, with an aggregate fair value of $139.6 million. The largest exposure to any single municipality or agency was a combined $2.585 million (fair value) in general obligation bonds issued by the Lindsay (CA) Unified School District.

 

The Company’s investments in bonds issued by states, municipalities and political subdivisions are evaluated in accordance with Supervision and Regulation Letter 12-15 issued by the Board of Governors of the Federal Reserve System, “Investing in Securities without Reliance on Nationally Recognized Statistical Rating Organization Ratings,” and other regulatory guidance. Credit ratings are considered in our analysis only as a guide to the historical default rate associated with similarly-rated bonds. There have been no significant differences in our internal analyses compared with the ratings assigned by the third party credit rating agencies.

 

 17 

 

 

The following table summarizes the amortized cost and fair values of general obligation and revenue bonds in the Company’s investment securities portfolio at the indicated dates, identifying the state in which the issuing municipality or agency operates for our largest geographic concentrations:

 

Revenue and General Obligation Bonds by Location            
(dollars in thousands, unaudited)  June 30, 2017   December 31, 2016 
             
   Amortized   Fair Market   Amortized   Fair Market 
General obligation bonds  Cost   Value   Cost   Value 
State of issuance                    
Texas  $29,104   $29,570   $20,170   $19,875 
California   28,399    29,354    25,457    25,799 
Washington   12,524    12,803    5,928    5,970 
Ohio   9,374    9,502    9,412    9,324 
Illinois   8,398    8,589    9,873    9,871 
Utah   948    981    949    957 
Other ( 20 states)   24,310    24,845    21,688    21,741 
Total General Obligation Bonds   113,057    115,644    93,477    93,537 
                     
Revenue bonds                    
State of issuance                    
Texas   6,718    6,825    5,727    5,702 
Utah   5,413    5,510    5,286    5,236 
Washington   2,112    2,184    1,302    1,299 
California   1,029    1,044    1,283    1,298 
Ohio   260    261    261    261 
Other states (12 states)   7,965    8,164    6,804    6,860 
Total Revenue Bonds   23,497    23,988    20,663    20,656 
                     
Total Obligations of States   and Political Subdivisions  $136,554   $139,632   $114,140   $114,193 

 

 18 

 

 

The revenue bonds in the Company’s investment securities portfolios were issued by government municipalities and agencies to fund public services such as utilities (water, sewer, and power), educational facilities, and general public and economic improvements. The primary sources of revenue for these bonds are delineated in the table below, which shows the amortized cost and fair market values for the largest revenue concentrations as of the indicated dates.

 

Revenue Bonds by Type        
(dollars in thousands, unaudited)  June 30, 2017   December 31, 2016 
         
   Amortized   Fair Market   Amortized   Fair Market 
Revenue bonds  Cost   Value   Cost   Value 
Revenue source:                    
Water  $7,409   $7,483   $4,788   $4,722 
Sales Tax   2,969    3,013    2,981    2,927 
College & University   2,626    2,729    3,401    3,472 
Lease   2,324    2,400    3,119    3,123 
Local or GTD Housing   1,541    1,558    167    167 
Other (15 sources)   6,628    6,805    9,326    9,368 
Total Revenue Bonds  $23,497   $23,988   $20,663   $20,656 

 

Low-Income Housing Tax Credit (“LIHTC”) Fund Investments

 

The Company has the ability to invest in limited partnerships which own housing projects that qualify for federal and/or California state tax credits, by mandating a specified percentage of low-income tenants for each project. The tax credits flow through to investors, supplementing any returns that might be derived from an increase in property values. Because rent levels are lower than standard market rents and the projects are generally highly leveraged, each project also typically generates tax-deductible operating losses that are allocated to the limited partners.

 

The Company invested in nine different LIHTC fund limited partnerships from 2001 through 2017, all of which were California-focused funds that help the Company meet its obligations under the Community Reinvestment Act. We utilize the cost method of accounting for our LIHTC fund investments, under which we initially record on our balance sheet an asset that represents the total cash expected to be invested over the life of the partnership. Any commitments or contingent commitments for future investment are reflected as a liability. The income statement reflects tax credits and any other tax benefits from these investments “below the line” within our income tax provision, while the initial book value of the investment is amortized on a straight-line basis as an offset to non-interest income, over the time period in which the tax credits and tax benefits are expected to be received.

 

As of June 30, 2017 our total LIHTC investment book balance was $9.3 million, which includes $4.2 million in remaining commitments for additional capital contributions. There were $343,000 in tax credits derived from our LIHTC investments that were recognized during the six months ended June 30, 2017, and amortization expense of $475,000 associated with those investments was included in pre-tax income for the same time period. Our LIHTC investments are evaluated annually for potential impairment, and we have concluded that the carrying value of the investments is stated fairly and is not impaired.

 

Note 11 – Credit Quality and Nonperforming Assets

 

Credit Quality Classifications

 

The Company monitors the credit quality of loans on a continuous basis using the regulatory and accounting classifications of pass, special mention, substandard and impaired to characterize the associated credit risk. Balances classified as “loss” are immediately charged off. The Company conforms to the following definitions for its risk classifications:

 

·Pass: Larger non-homogeneous loans not meeting the risk rating definitions below, and smaller homogeneous loans that are not assessed on an individual basis.

 

 19 

 

 

·Special mention: Loans which have potential issues that deserve the close attention of Management. If left uncorrected, those potential weaknesses could eventually diminish the prospects for full repayment of principal and interest according to the contractual terms of the loan agreement, or could result in deterioration of the Company’s credit position at some future date.

 

·Substandard: Loans that have at least one clear and well-defined weakness that could jeopardize the ultimate recoverability of all principal and interest, such as a borrower displaying a highly leveraged position, unfavorable financial operating results and/or trends, uncertain repayment sources or a deteriorated financial condition.

 

·Impaired: A loan is considered 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. Impaired loans include all nonperforming loans and restructured troubled debt (“TDRs”). A TDR may be nonperforming or performing, depending on its accrual status and the demonstrated ability of the borrower to comply with restructured terms (see “Troubled Debt Restructurings” section below for additional information on TDRs).

 

 20 

 

 

Credit quality classifications for the Company’s loan balances were as follows, as of the dates indicated:

 

Credit Quality Classifications                    
(dollars in thousands, unaudited)                    
   June 30, 2017 
   Pass   Special
Mention
   Substandard   Impaired   Total 
Real Estate:                         
1-4 family residential construction  $44,248   $-   $-   $-   $44,248 
Other construction/land   46,401    328    56    580    47,365 
1-4 family - closed end   143,814    605    324    5,449    150,192 
Equity lines   33,169    3,370    488    4,680    41,707 
Multi-family residential   30,501    -    -    562    31,063 
Commercial real estate - owner occupied   248,053    4,508    2,812    2,012    257,385 
Commercial real estate - non-owner occupied   270,076    4,531    3,176    1,688    279,471 
Farmland   134,717    1,003    897    310    136,927 
Total real estate   950,979    14,345    7,753    15,281    988,358 
                          
Agricultural   53,277    759    400    -    54,436 
Commercial and industrial   104,571    10,951    708    2,668    118,898 
Mortgage Warehouse   126,633    -    -    -    126,633 
Consumer loans   9,280    225    21    1,388    10,914 
Total gross loans and leases  $1,244,740   $26,280   $8,882   $19,337   $1,299,239 

 

   December 31, 2016 
   Pass   Special
Mention
   Substandard   Impaired   Total 
Real Estate:                         
1-4 family residential construction  $32,417   $-   $-   $-   $32,417 
Other construction/land   38,699    888    -    1,063    40,650 
1-4 family - closed end   129,726    624    403    6,390    137,143 
Equity lines   35,159    3,165    698    4,421    43,443 
Multi-family residential   31,058    -    -    573    31,631 
Commercial real estate - owner occupied   243,366    4,991    2,892    2,286    253,535 
Commercial real estate - non-owner occupied   233,584    5,597    3,220    1,797    244,198 
Farmland   132,613    1,020    808    39    134,480 
Total real estate   876,622    16,285    8,021    16,569    917,497 
                          
Agricultural   45,249    891    -    89    46,229 
Commercial and industrial   107,404    13,186    732    2,273    123,595 
Mortgage Warehouse   163,045    -    -    -    163,045 
Consumer loans   10,303    191    9    1,662    12,165 
Total gross loans and leases  $1,202,623   $30,553   $8,762   $20,593   $1,262,531 

 

 21 

 

 

Past Due and Nonperforming Assets

 

Nonperforming assets are comprised of loans for which the Company is no longer accruing interest, and foreclosed assets, including mobile homes and OREO. OREO consists of real properties acquired by foreclosure or similar means, which the Company is offering or will offer for sale. Nonperforming loans and leases result when reasonable doubt surfaces with regard to the ability of the Company to collect all principal and interest. At that point, we stop accruing interest on the loan or lease in question and reverse any previously-recognized interest to the extent that it is uncollected or associated with interest-reserve loans. Any asset for which principal or interest has been in default for 90 days or more is also placed on non-accrual status even if interest is still being received, unless the asset is both well secured and in the process of collection. An aging of the Company’s loan balances is presented in the following tables, by number of days past due as of the indicated dates:

 

Loan Portfolio Aging                            
(dollars in thousands, unaudited)                            
   June 30, 2017 
   30-59 Days Past
Due
   60-89 Days Past
Due
   90 Days Or More
Past Due(1)
   Total Past Due   Current   Total Financing
Receivables
   Non-Accrual
Loans(2)
 
Real Estate:                                   
1-4 family residential construction  $-   $-   $-   $-   $44,248   $44,248   $- 
Other construction/land   56    -    -    56    47,309    47,365    140 
1-4 family - closed end   -    13    540    553    149,639    150,192    869 
Equity lines   625    -    69    694    41,013    41,707    1,715 
Multi-family residential   -    -    -    -    31,063    31,063    - 
Commercial real estate - owner occupied   944    -    233    1,177    256,208    257,385    1,310 
Commercial real estate - non-owner occupied   -    -    -    -    279,471    279,471    - 
Farmland   -    -    -    -    136,927    136,927    310 
Total real estate   1,625    13    842    2,480    985,878    988,358    4,344 
                                    
Agricultural   -    -    -    -    54,436    54,436    - 
Commercial and industrial   13    -    686    699    118,199    118,898    988 
Mortgage warehouse lines   -    -    -    -    126,633    126,633    - 
Consumer   90    -    -    90    10,824    10,914    320 
Total gross loans and leases  $1,728   $13   $1,528   $3,269   $1,295,970   $1,299,239   $5,652 

 

(1) As of June 30, 2017 there were no loans over 90 days past due and still accruing.

(2) Included in total financing receivables

 

                                                     December 31, 2016 
   30-59 Days Past
Due
   60-89 Days Past
Due
   90 Days Or More
Past Due(1)
   Total Past Due   Current   Total Financing
Receivables
   Non-Accrual
Loans(2)
 
Real Estate:                                   
1-4 family residential construction  $-   $-   $-   $-   $32,417   $32,417   $- 
Other construction/land   -    -    -    -    40,650    40,650    558 
1-4 family - closed end   99    23    575    697    136,446    137,143    963 
Equity lines   397    -    320    717    42,726    43,443    1,926 
Multi-family residential   -    -    -    -    31,631    31,631    - 
Commercial real estate - owner occupied   338    -    28    366    253,169    253,535    1,572 
Commercial real estate - non-owner occupied   -    -    -    -    244,198    244,198    67 
Farmland   -    -    -    -    134,480    134,480    39 
Total real estate   834    23    923    1,780    915,717    917,497    5,125 
                                    
Agricultural   -    -    89    89    46,140    46,229    89 
Commercial and industrial   168    3    292    463    123,132    123,595    692 
Mortgage warehouse lines   -    -    -    -    163,045    163,045    - 
Consumer   94    9    52    155    12,010    12,165    459 
Total gross loans and leases  $1,096   $35   $1,356   $2,487   $1,260,044   $1,262,531   $6,365 

 

(1) As of December 31, 2016 there were no loans over 90 days past due and still accruing.

(2) Included in total financing receivables

 

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Troubled Debt Restructurings

 

A loan that is modified for a borrower who is experiencing financial difficulty is classified as a troubled debt restructuring if the modification constitutes a concession. At June 30, 2017, the Company had a total of $16.1 million in TDRs, including $2.4 million in TDRs that were on non-accrual status. Generally, a non-accrual loan that has been modified as a TDR remains on non-accrual status for a period of at least six months to demonstrate the borrower’s ability to comply with the modified terms. However, performance prior to the modification, or significant events that coincide with the modification, could result in a loan’s return to accrual status after a shorter performance period or even at the time of loan modification. Regardless of the period of time that has elapsed, if the borrower’s ability to meet the revised payment schedule is uncertain then the loan will be kept on non-accrual status. Moreover, a TDR is generally considered to be in default when it appears that the customer will not likely be able to repay all principal and interest pursuant to restructured terms.

 

The Company may agree to different types of concessions when modifying a loan or lease. The tables below summarize TDRs which were modified during the noted periods, by type of concession:

 

Troubled Debt Restructurings, by Type of Loan Modification        
(dollars in thousands, unaudited)                
                 
   Three months ended June 30, 2017 
   Term
Modification
   Interest Only
Modification
   Rate & Term
Modification
   Total 
                 
Real estate:                    
Other construction/land  $-   $-   $-   $- 
1-4 family - closed-end   -    -    43    43 
Equity lines   322    -    -    322 
Multi-family residential   -    -    -    - 
Commercial real estate - owner occupied   -    -    -    - 
Total real estate loans   322    -    43    365 
Commercial and industrial   15    -    -    15 
Consumer loans   -    -    -    - 
   $337   $-   $43   $380 

 

   Three months ended June 30, 2016 
   Term
Modification
   Interest Only
Modification
   Rate & Term
Modification
   Total 
                 
Real Estate:                    
Other construction/land  $-   $-   $-   $- 
1-4 family - closed-end   -    547    259    806 
Equity lines   1,051    -    -    1,051 
Multi-family residential   -    -    132    132 
Commercial real estate - owner occupied   -    -    -    - 
Total real estate loans   1,051    547    391    1,989 
                     
Commercial and industrial   -    -    -    - 
Consumer loans   -    -    10    10 
   $1,051   $547   $401   $1,999 

 

 23 

 

 

Troubled Debt Restructurings, by Type of Loan Modification