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, 2016
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, or a smaller reporting company.
Large accelerated filer ¨ | Accelerated filer þ |
Non-accelerated filer ¨ (Do not check if a smaller reporting company) | Smaller Reporting Company ¨ |
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, 13,884,794 shares outstanding as of July 29, 2016
FORM 10-Q
Table of Contents
PART I - FINANCIAL INFORMATION
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
June 30, 2016 | December 31, 2015 | |||||||
(unaudited) | (audited) | |||||||
ASSETS | ||||||||
Cash and due from banks | $ | 51,576 | $ | 46,627 | ||||
Interest-bearing deposits in banks | 1,465 | 1,996 | ||||||
Total cash & cash equivalents | 53,041 | 48,623 | ||||||
Securities available for sale | 528,539 | 507,582 | ||||||
Loans and leases: | ||||||||
Gross loans and leases | 1,155,262 | 1,132,856 | ||||||
Allowance for loan and lease losses | (10,042 | ) | (10,423 | ) | ||||
Deferred loan and lease fees, net | 2,651 | 2,169 | ||||||
Net loans and leases | 1,147,871 | 1,124,602 | ||||||
Premises and equipment, net | 22,449 | 21,990 | ||||||
Foreclosed assets | 2,897 | 3,193 | ||||||
Company owned life insurance | 43,829 | 44,140 | ||||||
Goodwill | 6,908 | 6,908 | ||||||
Other intangible assets, net | 1,170 | 930 | ||||||
Other assets | 36,584 | 38,569 | ||||||
$ | 1,843,288 | $ | 1,796,537 | |||||
LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||||
Deposits: | ||||||||
Non-interest bearing | $ | 433,328 | $ | 432,251 | ||||
Interest bearing | 1,052,746 | 1,032,377 | ||||||
Total deposits | 1,486,074 | 1,464,628 | ||||||
Repurchase agreements | 10,194 | 9,405 | ||||||
Federal funds purchased | 4,100 | - | ||||||
Short-term borrowings | 93,700 | 75,300 | ||||||
Long-term borrowings | - | 2,000 | ||||||
Junior subordinated debentures | 30,928 | 30,928 | ||||||
Other liabilities | 19,977 | 23,936 | ||||||
Total Liabilities | 1,644,973 | 1,606,197 | ||||||
Commitments and contingent liabilities (Note 8) | ||||||||
Shareholders' equity | ||||||||
Common stock, no par value; 24,000,000 shares authorized; 13,285,568 and 13,254,088 shares issued and outstanding at June 30, 2016 and December 31, 2015, respectively | 62,825 | 62,404 | ||||||
Additional paid in capital | 2,755 | 2,689 | ||||||
Retained earnings | 127,638 | 122,701 | ||||||
Accumulated other comprehensive income | 5,097 | 2,546 | ||||||
Total shareholders' equity | 198,315 | 190,340 | ||||||
$ | 1,843,288 | $ | 1,796,537 |
The accompanying notes are an integral part of these consolidated financial statements
1 |
CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands, except per share data, unaudited)
Three months ended June 30, | Six months ended June 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Interest and dividend income | ||||||||||||||||
Loans and leases, including fees | $ | 13,147 | $ | 12,880 | $ | 26,240 | $ | 25,200 | ||||||||
Taxable securities | 2,052 | 2,003 | 4,199 | 4,251 | ||||||||||||
Tax-exempt securities | 730 | 732 | 1,460 | 1,457 | ||||||||||||
Dividend income on securities | - | 48 | 36 | 93 | ||||||||||||
Federal funds sold and other | 5 | 6 | 32 | 18 | ||||||||||||
Total interest income | 15,934 | 15,669 | 31,967 | 31,019 | ||||||||||||
Interest expense | ||||||||||||||||
Deposits | 508 | 449 | 999 | 893 | ||||||||||||
Short-term borrowings | 31 | 21 | 56 | 31 | ||||||||||||
Long-term borrowings | - | 3 | - | 7 | ||||||||||||
Subordinated debentures | 200 | 178 | 402 | 352 | ||||||||||||
Total interest expense | 739 | 651 | 1,457 | 1,283 | ||||||||||||
Net Interest Income | 15,195 | 15,018 | 30,510 | 29,736 | ||||||||||||
Provision for loan losses | - | - | - | - | ||||||||||||
Net interest income after provision for loan losses | 15,195 | 15,018 | 30,510 | 29,736 | ||||||||||||
Non-interest income | ||||||||||||||||
Service charges on deposits | 2,478 | 2,278 | 4,848 | 4,269 | ||||||||||||
Net gains on sale of securities available-for-sale | 146 | 307 | 122 | 323 | ||||||||||||
Other income | 1,950 | 2,069 | 3,898 | 4,069 | ||||||||||||
Total non-interest income | 4,574 | 4,654 | 8,868 | 8,661 | ||||||||||||
Other operating expense | ||||||||||||||||
Salaries and employee benefits | 6,624 | 6,125 | 13,490 | 13,020 | ||||||||||||
Occupancy and equipment | 1,866 | 1,666 | 3,617 | 3,326 | ||||||||||||
Other | 5,225 | 4,960 | 10,087 | 9,865 | ||||||||||||
Total other operating expense | 13,715 | 12,751 | 27,194 | 26,211 | ||||||||||||
Income before taxes | 6,054 | 6,921 | 12,184 | 12,186 | ||||||||||||
Provision for income taxes | 1,968 | 2,364 | 4,062 | 3,891 | ||||||||||||
Net income | $ | 4,086 | $ | 4,557 | $ | 8,122 | $ | 8,295 | ||||||||
PER SHARE DATA | ||||||||||||||||
Book value | $ | 14.93 | $ | 13.88 | $ | 14.93 | $ | 13.88 | ||||||||
Cash dividends | $ | 0.12 | $ | 0.10 | $ | 0.24 | $ | 0.20 | ||||||||
Earnings per share basic | $ | 0.31 | $ | 0.34 | $ | 0.61 | $ | 0.61 | ||||||||
Earnings per share diluted | $ | 0.31 | $ | 0.33 | $ | 0.61 | $ | 0.60 | ||||||||
Average shares outstanding, basic | 13,280,443 | 13,560,091 | 13,272,903 | 13,619,050 | ||||||||||||
Average shares outstanding, diluted | 13,393,448 | 13,686,206 | 13,388,664 | 13,745,467 | ||||||||||||
Total shareholder equity (in thousands) | $ | 198,315 | $ | 186,106 | $ | 198,315 | $ | 186,106 | ||||||||
Shares outstanding | 13,285,568 | 13,404,812 | 13,285,568 | 13,404,812 | ||||||||||||
Dividends Paid | $ | 1,593,395 | $ | 1,361,581 | $ | 3,184,711 | $ | 2,730,579 |
The accompanying notes are an integral part of these consolidated financial statements
2 |
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in thousands, unaudited)
Three months ended June 30, | Six months ended June 30, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Net Income | $ | 4,086 | $ | 4,557 | $ | 8,122 | $ | 8,295 | ||||||||
Other comprehensive income, before tax: | ||||||||||||||||
Unrealized gains on securities: | ||||||||||||||||
Unrealized holding (losses) gains arising during period | 2,486 | (2,805 | ) | 4,487 | (2,509 | ) | ||||||||||
Less: reclassification adjustment for gains (1) included in net income | (146 | ) | (307 | ) | (122 | ) | (323 | ) | ||||||||
Other comprehensive (loss) income, before tax | 2,340 | (3,112 | ) | 4,365 | (2,832 | ) | ||||||||||
Income tax expense (benefit) related to items of other comprehensive income (loss), net of tax | (984 | ) | 1,309 | (1,814 | ) | 1,126 | ||||||||||
Other comprehensive income (loss) gain | 1,356 | (1,803 | ) | 2,551 | (1,706 | ) | ||||||||||
Comprehensive Income | $ | 5,442 | $ | 2,754 | $ | 10,673 | $ | 6,589 |
(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, 2016 and 2015 was $61 thousand and $129 thousand respectively. Income tax expense associated with the reclassification adjustment for the six months ended June 30, 2016 and 2015 was $51 thousand and $136 thousand respectively.
The accompanying notes are an integral part of these consolidated financial statements
3 |
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands, unaudited)
Six months ended June 30, | ||||||||
2016 | 2015 | |||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 8,122 | $ | 8,295 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Gain on sales of securities | (122 | ) | (323 | ) | ||||
Gain on sales of loans | - | - | ||||||
Loss on disposal of fixed assets | 2 | 55 | ||||||
Loss (gain) on sale on foreclosed assets | 1 | (78 | ) | |||||
Writedowns on foreclosed assets | 262 | 173 | ||||||
Share-based compensation expense | 169 | 18 | ||||||
Provision for loan losses | - | - | ||||||
Depreciation | 1,209 | 1,119 | ||||||
Net accretion on purchased loans | (70 | ) | (526 | ) | ||||
Net amortization on securities premiums and discounts | 3,312 | 3,384 | ||||||
Decrease in unearned net loan fees | 482 | 247 | ||||||
Decrease (increase) in cash surrender value of life insurance policies | 311 | (731 | ) | |||||
Loss from sale of loans | - | - | ||||||
Decrease in interest receivable and other assets | 67 | 246 | ||||||
Increase in other liabilites | (3,959 | ) | (640 | ) | ||||
Deferred income tax provision | 310 | 470 | ||||||
Excess tax benefit from equity based compensation | 85 | 40 | ||||||
Net cash provided by operating activities | 10,181 | 11,749 | ||||||
Cash flows from investing activities: | ||||||||
Maturities of securities available for sale | 30 | 290 | ||||||
Proceeds from sales/calls of securities available for sale | 5,365 | 22,538 | ||||||
Purchases of securities available for sale | (70,675 | ) | (67,813 | ) | ||||
Principal pay downs on securities available for sale | 45,536 | 44,056 | ||||||
Purchases of FHLB stock | (399 | ) | (504 | ) | ||||
Net increase in loans receivable, net | (24,377 | ) | (103,829 | ) | ||||
Purchases of premises and equipment, net | (1,901 | ) | (1,672 | ) | ||||
Proceeds from sale premises and equipment | 231 | 55 | ||||||
Proceeds from sales of foreclosed assets | 729 | 981 | ||||||
Net cash used in investing activities | (45,461 | ) | (105,898 | ) | ||||
Cash flows from financing activities: | ||||||||
Increase in deposits | 21,446 | 104,895 | ||||||
Increase (decrease) in borrowed funds | 16,400 | (10,500 | ) | |||||
Increase in Fed funds purchased | 4,100 | - | ||||||
Increase in repurchase agreements | 789 | 4,021 | ||||||
Cash dividends paid | (3,185 | ) | (2,730 | ) | ||||
Repurchases of common stock | - | (5,251 | ) | |||||
Stock options exercised | 233 | 349 | ||||||
Excess tax benefit from equity based compensation | (85 | ) | (40 | ) | ||||
Net cash provided by financing activities | 39,698 | 90,744 | ||||||
Increase (decrease) in cash and due from banks | 4,418 | (3,405 | ) | |||||
Cash and cash equivalents | ||||||||
Beginning of period | 48,623 | 50,095 | ||||||
End of period | $ | 53,041 | $ | 46,690 |
The accompanying notes are an integral part of these consolidated financial statements
4 |
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2016
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, 2016, the Company’s only other subsidiaries were Sierra Statutory Trust II and Sierra Capital Trust III, which were formed in March 2004 and June 2006, respectively, 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.
The Bank is a California state-chartered bank headquartered in Porterville, California. Bank of the Sierra was incorporated in September 1977, and opened for business in January 1978 as a one-branch bank with $1.5 million in capital and eleven employees. Our growth in the ensuing years has primarily been organic, but includes three whole-bank acquisitions: Sierra National Bank in the year 2000, Santa Clara Valley Bank in 2014, and Coast National Bank in July of 2016 (see Note 13 to the financial statements, Recent Developments, for details on the Coast acquisition). With our latest acquisition the Bank now operates 33 full-service branches and a loan production office, and offers a full range of retail and commercial banking services in California's South Central Valley and neighboring communities, the Central Coast, and select Southern California locations including Ventura County and the Santa Clarita Valley. Our most recent branching activity occurred in the second quarter of 2016, with the opening of a de novo branch in Sanger, California and the purchase of a competitor bank’s Porterville branch which was consolidated into our main office (see Note 13 to the financial statements, Recent Developments, for details on the branch acquisition). We have also received regulatory approvals for another branch in Bakersfield, California, which is under construction and should be ready to commence operations by the first quarter of 2017. 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 also have ATMs at all branch locations and offsite ATMs at six different non-branch locations. We were well over $1.8 billion in assets as of June 30, 2016, even without consideration of the assets gained via the Coast National Bank acquisition, 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 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 period. 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 2015 have been reclassified to be consistent with the reporting for 2016. 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, 2015, as filed with the Securities and Exchange Commission.
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 does not expect to adopt this guidance early and is currently evaluating the potential effects of the guidance on its financial statements and disclosures.
In June 2014 the FASB issued ASU 2014-12, Compensation–Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. These amendments to existing guidance require that a performance target be treated as a “performance condition” if it affects vesting and can be achieved after the requisite service period. To account for such awards, a reporting entity should apply existing guidance in Topic 718 as it relates to awards with performance conditions that affect vesting. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest, and should be adjusted to reflect those awards that ultimately vest. The requisite period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. ASU 2014-12 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. It was adopted by the Company for the first quarter of 2016, and because our stock compensation practices do not currently utilize performance-based criteria there was no impact upon our financial statements or operations upon adoption.
In April 2015 the FASB issued ASU 2015-03, Interest–Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, to simplify the presentation of debt issuance costs related to a recognized debt liability by reflecting those costs as a direct deduction from the carrying amount of debt liability, consistent with debt discounts. ASU 2015-15 was subsequently issued in August 2015 to clarify the SEC staff’s position on presenting and measuring debt issuance costs incurred in connection with line-of-credit arrangements. ASU 2015-03, as modified by ASU 2015-15, became effective for interim and annual periods beginning after December 15, 2015, and we adopted this guidance for the first quarter of 2016 without any material effect 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. We are evaluating the potential effects of this guidance on our financial statements and disclosures, but do not currently expect it to have a material impact upon adoption.
In February 2016 the FASB issued ASU 2016-02, Leases (Topic 842). This new standard is being issued 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 is currently evaluating the potential impact of this guidance on its financial statements and disclosures.
6 |
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. Currently, as they relate to share-based payments, tax benefits in excess of compensation costs (“windfalls”) are recorded in equity, and tax deficiencies (“shortfalls”) are recorded in equity to the extent of previous windfalls, and then to the income statement. ASU 2016-09 will reduce some of the administrative complexities by eliminating the need to track a windfall “pool,” but could increase the volatility of income tax expense. This change is required to be applied prospectively to all excess tax benefits and tax deficiencies resulting from settlements after the date of adoption. ASU 2016-09 also removes the requirement to delay recognition of a windfall tax benefit until it reduces current taxes payable. Under the new guidance, the benefit will be recorded when it arises, subject to normal valuation allowance considerations. This change is required to be applied on a modified retrospective basis, with a cumulative-effect adjustment to opening retained earnings. Furthermore, all tax-related cash flows resulting from share-based payments are to be reported as operating activities on the statement of cash flows, a change from the current 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 should be classified as a financing activity. Under the new guidance, entities are also 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 today, or recognized as they occur. Estimates will still be 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 needs to be adopted using a modified retrospective approach, with a cumulative effect adjustment recorded to opening retained earnings. ASU 2016-09 is effective for public business entities for annual reporting periods beginning after December 15, 2016, and interim periods within that reporting period. Early adoption will be permitted in any interim or annual period, with any adjustments reflected as of the beginning of the fiscal year of adoption. We are currently evaluating the potential impact of this guidance on our financial statements and disclosures.
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. We are currently evaluating the potential impact of this guidance on our financial statements and disclosures, and in general expect an increase in our allowance for loan and lease losses upon adoption.
Note 4 – Supplemental Disclosure of Cash Flow Information
During the six months ended June 30, 2016 and 2015, cash paid for interest due on interest-bearing liabilities was $1.423 million and $1.318 million, respectively. There was $2.500 million in cash paid for income taxes during the six months ended June 30, 2016, and $4.550 million in cash paid for income taxes for the six months ended June 30, 2015. Assets totaling $694,000 and $501,000 were acquired in settlement of loans for the six months ended June 30, 2016 and June 30, 2015, respectively. We received $729,000 in cash from the sale of foreclosed assets during the first six months of 2016 relative to $981,000 during the first six months of 2015, which represents sales proceeds less loans (if any) extended to finance such sales.
7 |
Note 5 – Share Based Compensation
The 2007 Stock Incentive Plan (the “2007 Plan”) was adopted by the Company in 2007. Our 1998 Stock Option Plan was concurrently terminated, although options to purchase 43,500 shares that were granted under that plan were still outstanding as of June 30, 2016 and remain unaffected by the plan’s termination. The 2007 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 of the Company. The 2007 Plan also provides for the issuance of restricted stock awards to these same classes of eligible participants, on such terms and conditions as are established at the discretion of the Board of Directors or the Compensation Committee, although no restricted stock awards have 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 2007 Plan was initially 1,500,000 shares, although due to awards granted since the inception of the plan the number remaining available for grant had declined to 741,940 at June 30, 2016. No equity awards can be issued under the 2007 Plan after February 15, 2017, when the plan expires, but any award granted under the plan prior to February 15, 2017 had an original life of 10 years and thus may extend beyond that date. 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 amortizing the value over the vesting period for options with graded vesting, or by expensing it as of the grant date for immediately vested options. 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 $12,000 was reflected in the Company’s income statement during the second quarter of 2016 and $11,000 was charged during the second quarter of 2015, as expense related to stock options. For the first half, the charges totaled $169,000 in 2016 and $18,000 in 2015.
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 13,280,433 weighted average shares outstanding during the second quarter of 2016, and 13,560,091 during the second quarter of 2015. There were 13,272,903 weighted average shares outstanding during the first six months of 2016, and 13,619,050 during the first six months of 2015.
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 2016, calculations under the treasury stock method resulted in the equivalent of 113,015 shares being added to basic weighted average shares outstanding for purposes of determining diluted earnings per share, while a weighted average of 162,700 stock options were excluded from the calculation because they were underwater and thus anti-dilutive. For the second quarter of 2015 the equivalent of 126,115 shares were added in calculating diluted earnings per share while 169,300 anti-dilutive stock options were excluded. Likewise, for the first half of 2016 the equivalent of 115,761 shares were added to basic weighted average shares outstanding in calculating diluted earnings per share and a weighted average of 212,700 stock options that were anti-dilutive for the period were excluded, compared to the inclusion of the equivalent of 126,417 shares and exclusion of 171,700 anti-dilutive options in calculating diluted earnings per share for first half of 2015.
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.
8 |
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, 2016 | December 31, 2015 | |||||||
Commitments to extend credit | $ | 325,357 | $ | 354,890 | ||||
Standby letters of credit | $ | 8,990 | $ | 16,654 |
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, 2016, the Company was also utilizing a letter of credit in the amount of $97 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 fair values. 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. |
9 |
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, 2016 and December 31, 2015:
· | Cash and cash equivalents and fed funds sold: The carrying amount is estimated to be fair value. |
· | 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 change in credit risk or interest rate spread, 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. |
· | Investments in, and capital commitments to, limited partnerships: The fair values of our limited partner investments in low-income housing tax credit funds and other limited partnership investments are estimated using quarterly indications of value provided by the general partners. The fair values of undisbursed capital commitments are assumed to be the same as their book values. |
· | 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. |
10 |
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, 2016 | ||||||||||||||||||||
Estimated Fair Value | ||||||||||||||||||||
Carrying Amount | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Observable (Level 2) | Significant Unobservable (Level 3) | Total | ||||||||||||||||
Financial assets: | ||||||||||||||||||||
Cash and cash equivalents | $ | 53,041 | $ | 53,041 | $ | - | $ | - | $ | 53,041 | ||||||||||
Investment securities available for sale | 528,539 | 1,127 | 527,412 | - | 528,539 | |||||||||||||||
Loans and leases, net held for investment | 1,145,888 | - | 1,172,194 | - | 1,172,194 | |||||||||||||||
Collateral dependent impaired loans | 1,983 | - | 1,983 | - | 1,983 | |||||||||||||||
Loans held-for-sale | - | - | - | - | - | |||||||||||||||
Cash surrender value of life insurance policies | 43,829 | - | 43,829 | - | 43,829 | |||||||||||||||
Other investments | 7,945 | - | 7,945 | - | 7,945 | |||||||||||||||
Investment in limited partnership | 8,568 | - | 8,568 | - | 8,568 | |||||||||||||||
Accrued interest receivable | 5,697 | - | 5,697 | - | 5,697 | |||||||||||||||
Financial liabilities: | ||||||||||||||||||||
Deposits: | ||||||||||||||||||||
Noninterest-bearing | $ | 433,328 | $ | 433,328 | $ | - | $ | - | $ | 433,328 | ||||||||||
Interest-bearing | 1,052,746 | - | 929,491 | - | 929,491 | |||||||||||||||
Fed funds purchased and repurchase agreements | 14,294 | - | 14,294 | - | 14,294 | |||||||||||||||
Short-term borrowings | 93,700 | - | 93,700 | - | 93,700 | |||||||||||||||
Long-term borrowings | - | - | - | - | - | |||||||||||||||
Subordinated debentures | 30,928 | - | 8,847 | - | 8,847 | |||||||||||||||
Limited partnership capital commitment | 3,070 | - | 3,070 | - | 3,070 | |||||||||||||||
Accrued interest payable | 128 | - | 128 | - | 128 |
Notional Amount | ||||
Off-balance-sheet financial instruments: | ||||
Commitments to extend credit | $ | 325,357 | ||
Standby letters of credit | 8,990 |
December 31, 2015 | ||||||||||||||||||||
Estimated Fair Value | ||||||||||||||||||||
Carrying Amount | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Observable (Level 2) | Significant Unobservable (Level 3) | Total | ||||||||||||||||
Financial assets: | ||||||||||||||||||||
Cash and cash equivalents | $ | 48,623 | $ | 48,623 | $ | - | $ | - | $ | 48,623 | ||||||||||
Investment securities available for sale | 507,582 | 1,296 | 506,286 | - | 507,582 | |||||||||||||||
Loans and leases, net held for investment | 1,120,773 | - | 1,136,386 | - | 1,136,386 | |||||||||||||||
Collateral dependent impaired loans | 3,829 | - | 3,829 | - | 3,829 | |||||||||||||||
Cash surrender value of life insurance policies | 44,140 | - | 44,140 | - | 44,140 | |||||||||||||||
Other Investments | 7,546 | - | 7,546 | - | 7,546 | |||||||||||||||
Investment in limited partnership | 6,217 | - | 6,217 | - | 6,217 | |||||||||||||||
Accrued interest receivable | 5,808 | - | 5,808 | - | 5,808 | |||||||||||||||
Financial liabilities: | ||||||||||||||||||||
Deposits: | ||||||||||||||||||||
Noninterest-bearing | $ | 432,251 | $ | 432,251 | $ | - | $ | - | $ | 432,251 | ||||||||||
Interest-bearing | 1,032,377 | - | 1,032,547 | - | 1,032,547 | |||||||||||||||
Fed funds purchased and repurchase agreements | 9,405 | - | 9,405 | - | 9,405 | |||||||||||||||
Short-term borrowings | 75,300 | - | 75,300 | - | 75,300 | |||||||||||||||
Long-term borrowings | 2,000 | - | 2,001 | - | 2,001 | |||||||||||||||
Subordinated debentures | 30,928 | - | 7,383 | - | 7,383 | |||||||||||||||
Limited partnership capital commitment | 795 | - | 795 | - | 795 | |||||||||||||||
Accrued interest payable | 116 | - | 116 | - | 116 |
Notional Amount | ||||
Off-balance-sheet financial instruments: | ||||
Commitments to extend credit | $ | 354,890 | ||
Standby letters of credit | 16,654 |
11 |
For financial asset categories that were actually reported at fair value as of June 30, 2016 and December 31, 2015, 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, 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) | ||||||||||||||||
Investment securities | ||||||||||||||||||||
US Government agencies | $ | - | $ | 24,872 | $ | - | $ | 24,872 | $ | - | ||||||||||
Mortgage-backed securities | - | 394,614 | - | 394,614 | - | |||||||||||||||
State and poltical subdivisions | - | 107,926 | - | 107,926 | - | |||||||||||||||
Other securities | 1,127 | - | - | 1,127 | - | |||||||||||||||
Total available-for-sale securities | $ | 1,127 | $ | 527,412 | $ | - | $ | 528,539 | $ | - |
Fair Value Measurements at December 31, 2015, 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) | ||||||||||||||||
Investment securities | ||||||||||||||||||||
US Government agencies | $ | - | $ | 29,042 | $ | - | $ | 29,042 | $ | - | ||||||||||
Mortgage-backed securities | - | 375,061 | - | 375,061 | - | |||||||||||||||
State and poltical subdivisions | - | 102,183 | - | 102,183 | - | |||||||||||||||
Other securities | 1,296 | - | - | 1,296 | - | |||||||||||||||
Total available-for-sale securities | $ | 1,296 | $ | 506,286 | $ | - | $ | 507,582 | $ | - |
12 |
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, 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 | - | 75 | - | 75 | ||||||||||||
1-4 family - closed-end | - | - | - | - | ||||||||||||
Equity lines | - | - | - | - | ||||||||||||
Multi-family residential | - | - | - | - | ||||||||||||
Commercial real estate - owner occupied | - | 20 | - | 20 | ||||||||||||
Commercial real estate-non-owner occupied | - | 1,845 | - | 1,845 | ||||||||||||
Farmland | - | - | - | - | ||||||||||||
Total real estate | - | 1,940 | - | 1,940 | ||||||||||||
Agriculture | - | - | - | - | ||||||||||||
Commercial and industrial | - | - | - | - | ||||||||||||
Consumer loans | - | 43 | - | 43 | ||||||||||||
Total impaired loans | - | 1,983 | - | 1,983 | ||||||||||||
Foreclosed assets | $ | - | $ | 2,897 | $ | - | $ | 2,897 | ||||||||
Total assets measured on a norecurring basis | $ | - | $ | 4,880 | $ | - | $ | 4,880 |
Fair Value Measurements at December 31, 2015, 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 | - | 179 | - | 179 | ||||||||||||
1-4 family - closed-end | - | 499 | - | 499 | ||||||||||||
Equity lines | - | 30 | - | 30 | ||||||||||||
Multi-family residential | - | - | - | - | ||||||||||||
Commercial real estate - owner occupied | - | 26 | - | 26 | ||||||||||||
Commercial real estate-non-owner occupied | - | 3,053 | - | 3,053 | ||||||||||||
Farmland | - | - | - | |||||||||||||
Total real estate | - | 3,787 | - | 3,787 | ||||||||||||
Agriculture | - | - | - | |||||||||||||
Commercial and industrial | - | - | - | |||||||||||||
Consumer loans | - | 42 | 42 | |||||||||||||
Total impaired loans | - | 3,829 | - | 3,829 | ||||||||||||
Foreclosed assets | $ | - | $ | 3,193 | $ | - | $ | 3,193 | ||||||||
Total assets measured on a norecurring basis | $ | - | $ | 7,022 | $ | - | $ | 7,022 |
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. Increases or decreases in 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.
13 |
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.
Amortized Cost And Estimated Fair Value
(dollars in thousands, unaudited):
The amortized cost and estimated fair value of investment securities available-for-sale are as follows
June 30, 2016 | ||||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | |||||||||||||
US Government agencies | $ | 24,466 | $ | 409 | $ | (3 | ) | $ | 24,872 | |||||||
Mortgage-backed securities | 391,345 | 3,951 | (682 | ) | 394,614 | |||||||||||
State and poltical subdivisions | 103,433 | 4,503 | (10 | ) | 107,926 | |||||||||||
Other securities | 500 | 627 | - | 1,127 | ||||||||||||
Total investment securities | $ | 519,744 | $ | 9,490 | $ | (695 | ) | $ | 528,539 |
December 31, 2015 | ||||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | |||||||||||||
US Government agencies | $ | 28,801 | $ | 303 | $ | (62 | ) | $ | 29,042 | |||||||
Mortgage-backed securities | 374,683 | 2,440 | (2,062 | ) | 375,061 | |||||||||||
State and political subdivisons | 99,093 | 3,146 | (56 | ) | 102,183 | |||||||||||
Other securities | 575 | 721 | - | 1,296 | ||||||||||||
Total investment securities | $ | 503,152 | $ | 6,610 | $ | (2,180 | ) | $ | 507,582 |
14 |
At June 30, 2016 and December 31, 2015, the Company had 90 securities and 175 securities, respectively, with 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, 2016 | ||||||||||||||||
Less than twelve months | Twelve months or more | |||||||||||||||
Gross Unrealized | Gross Unrealized | |||||||||||||||
Losses | Fair Value | Losses | Fair Value | |||||||||||||
US Government agencies | $ | (3 | ) | $ | 3,301 | $ | - | $ | - | |||||||
Mortgage-backed securities | (323 | ) | 67,579 | (359 | ) | 51,187 | ||||||||||
State and political subdivisions | (10 | ) | 1,583 | - | - | |||||||||||
Total | $ | (336 | ) | $ | 72,463 | $ | (359 | ) | $ | 51,187 |
December 31, 2015 | ||||||||||||||||
Less than twelve months | Twelve months or more | |||||||||||||||
Gross Unrealized | Gross Unrealized | |||||||||||||||
Losses | Fair Value | Losses | Fair Value | |||||||||||||
US Government agencies | $ | (62 | ) | $ | 10,329 | $ | - | $ | - | |||||||
Mortgage-backed securities | (1,608 | ) | 187,734 | (454 | ) | 35,511 | ||||||||||
State and political subdivisions | (17 | ) | 3,409 | (39 | ) | 3,847 | ||||||||||
Total | $ | (1,687 | ) | $ | 201,472 | $ | (493 | ) | $ | 39,358 |
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, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Proceeds from sales, calls and maturities of securities available for sale | $ | 2,790 | $ | 2,963 | $ | 5,395 | $ | 22,828 | ||||||||
Gross gains on sales, calls and maturities of securities available for sale | $ | 146 | $ | 307 | $ | 160 | $ | 522 | ||||||||
Gross losses on sales, calls and maturities of securities available for sale | - | - | (38 | ) | (199 | ) | ||||||||||
Net gains on sale of securities available for sale | $ | 146 | $ | 307 | $ | 122 | $ | 323 |
15 |
The amortized cost and estimated fair value of investment securities available-for-sale at June 30, 2016 and December 31, 2015 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 could have the right to call or prepay obligations with or without penalties.
Estimated Fair Value of Contractual Maturities
(dollars in thousands, unaudited)
June 30, 2016 | ||||||||
Amortized Cost | Fair Value | |||||||
Maturing within one year | $ | 6,164 | $ | 6,370 | ||||
Maturing after one year through five years | 250,424 | 253,919 | ||||||
Maturing after five years through ten years | 47,068 | 48,674 | ||||||
Maturing after ten years | 47,348 | 49,287 | ||||||
Investment securities not due at a single maturity date: | ||||||||
U.S Government agencies collateralized by mortgage obligations | 168,240 | 169,162 | ||||||
Other securities | 500 | 1,127 | ||||||
$ | 519,744 | $ | 528,539 |
December 31, 2015 | ||||||||
Amortized Cost | Fair Value | |||||||
Maturing within one year | $ | 3,657 | $ | 3,706 | ||||
Maturing after one year through five years | 242,719 | 244,733 | ||||||
Maturing after five years through ten years | 50,144 | 51,308 | ||||||
Maturing after ten years | 50,413 | 51,671 | ||||||
Investment securities not due at a single maturity date: | ||||||||
U.S Government agencies collateralized by mortgage obligations | 155,644 | 154,868 | ||||||
Other securities | 575 | 1,296 | ||||||
$ | 503,152 | $ | 507,582 |
At June 30, 2016, the Company’s investment portfolio included securities issued by 292 different government municipalities and agencies located within 27 states with a fair value of $107.9 million. The largest exposure to any single municipality or agency was a $934,000 (fair value) bond issued by the Thurston School District in Washington, to be repaid by property taxes.
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.
16 |
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, 2016 | December 31, 2015 | |||||||||||||||
Amortized | Fair Market | Amortized | Fair Market | |||||||||||||
General obligation bonds | Cost | Value | Cost | Value | ||||||||||||
State of issuance | ||||||||||||||||
California | $ | 23,250 | $ | 24,690 | $ | 20,473 | $ | 21,642 | ||||||||
Texas | 17,656 | 18,326 | 16,575 | 16,954 | ||||||||||||
Illinois | 10,234 | 10,545 | 9,997 | 10,191 | ||||||||||||
Ohio | 9,059 | 9,305 | 7,610 | 7,748 | ||||||||||||
Washington | 5,873 | 6,090 | 5,905 | 6,081 | ||||||||||||
Arizona | 2,023 | 2,103 | 2,039 | 2,108 | ||||||||||||
Utah | 951 | 1,013 | 953 | 990 | ||||||||||||
Other states | 18,518 | 19,298 | 20,334 | 20,848 | ||||||||||||
Total General Obligation Bonds | 87,564 | 91,370 | 83,886 | 86,562 | ||||||||||||
Revenue bonds | ||||||||||||||||
State of issuance | ||||||||||||||||
Texas | 4,969 | 5,153 | 3,732 | 3,863 | ||||||||||||
Utah | 4,426 | 4,631 | 4,434 | 4,519 | ||||||||||||
Washington | 1,306 | 1,387 | 1,791 | 1,827 | ||||||||||||
California | 1,002 | 1,030 | 1,002 | 1,028 | ||||||||||||
Ohio | 318 | 319 | 318 | 319 | ||||||||||||
Other states | 3,848 | 4,036 | 3,930 | 4,065 | ||||||||||||
Total Revenue Bonds | 15,869 | 16,556 | 15,207 | 15,621 | ||||||||||||
Total Obligations of States and Political Subdivisions | $ | 103,433 | $ | 107,926 | $ | 99,093 | $ | 102,183 |
17 |
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, 2016 | December 31, 2015 | |||||||||||||||
Amortized | Fair Market | Amortized | Fair Market | |||||||||||||
Revenue bonds | Cost | Value | Cost | Value | ||||||||||||
Revenue source: | ||||||||||||||||
Water | $ | 4,402 | $ | 4,516 | $ | 3,942 | $ | 4,052 | ||||||||
College & University | 2,706 | 2,876 | 2,975 | 3,103 | ||||||||||||
Sales Tax | 2,256 | 2,373 | 2,630 | 2,663 | ||||||||||||
Lease | 2,299 | 2,403 | 2,040 | 2,100 | ||||||||||||
Port, Airport & Marina | 1,302 | 1,374 | - | - | ||||||||||||
Electric & Power | 729 | 753 | 679 | 691 | ||||||||||||
Other sources | 2,175 | 2,261 | 2,941 | 3,012 | ||||||||||||
Total Revenue Bonds | $ | 15,869 | $ | 16,556 | $ | 15,207 | $ | 15,621 |
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, augmenting 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 seven LIHTC fund limited partnerships from 2001 through 2007, and in the second quarter of 2016 we committed $3 million to another such fund. Our investments to date have all been in California-focused funds which help the Company meet its obligations under the Community Reinvestment Act. We utilize the equity method of accounting for our LIHTC fund investments. Under the equity method, our balance sheet initially reflects 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 treatment under the equity method reflects tax credits received by the Company “below the line” within the income tax provision, while fund operating results are included “above the line” in non-interest income. As noted above, operating results are typically losses that are netted against non-interest income.
As of June 30, 2016 our total LIHTC investment balance was $7.4 million, which includes $2.4 million in remaining commitments for additional capital contributions to the limited partnerships. There were $343,000 in tax credits derived from our LIHTC investments which were recognized during the six months ended June 30, 2016, and a pass-through operating loss of $519,000 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.
18 |
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 risk classifications utilized:
· | Pass: Larger non-homogeneous loans not meeting the risk rating definitions below, and smaller homogeneous loans that are not assessed on an individual basis. |
· | 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, restructured troubled debt (“TDRs”), and certain other loans that are still being maintained on accrual status. 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). |
19 |
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, 2016 | ||||||||||||||||||||
Pass | Special Mention | Substandard | Impaired | Total | ||||||||||||||||
Real Estate: | ||||||||||||||||||||
1-4 family residential construction | $ | 16,939 | $ | - | $ | - | $ | - | $ | 16,939 | ||||||||||
Other construction/land | 32,065 | 5,356 | - | 969 | 38,390 | |||||||||||||||
1-4 family - closed end | 127,637 | 774 | 935 | 6,112 | 135,458 | |||||||||||||||
Equity lines | 34,599 | 1,700 | 748 | 3,777 | 40,824 | |||||||||||||||
Multi-family residential | 31,017 | - | - | 417 | 31,434 | |||||||||||||||
Commercial real estate - owner occupied | 201,868 | 3,984 | 3,045 | 3,302 | 212,199 | |||||||||||||||
Commercial real estate - non-owner occupied | 164,128 | 5,378 | 167 | 5,103 | 174,776 | |||||||||||||||
Farmland | 129,053 | 560 | 2,484 | 43 | 132,140 | |||||||||||||||
Total real estate | 737,306 | 17,752 | 7,379 | 19,723 | 782,160 | |||||||||||||||
Agricultural | 49,775 | 159 | 24 | 65 | 50,023 | |||||||||||||||
Commercial and industrial | 86,649 | 22,143 | 661 | 2,293 | 111,746 | |||||||||||||||
Mortgage Warehouse | 197,715 | - | - | - | 197,715 | |||||||||||||||
Consumer loans | 11,485 | 148 | 23 | 1,962 | 13,618 | |||||||||||||||
Total gross loans and leases | $ | 1,082,930 | $ | 40,202 | $ | 8,087 | $ | 24,043 | $ | 1,155,262 |
December 31, 2015 | ||||||||||||||||||||
Pass | Special Mention | Substandard | Impaired | Total | ||||||||||||||||
Real Estate: | ||||||||||||||||||||
1-4 family residential construction | $ | 13,784 | $ | 1,157 | $ | - | $ | - | $ | 14,941 | ||||||||||
Other construction/land | 35,901 | 135 | - | 1,323 | 37,359 | |||||||||||||||
1-4 family - closed end | 127,972 | 2,498 | 387 | 6,499 | 137,356 | |||||||||||||||
Equity lines | 39,966 | 199 | 957 | 3,111 | 44,233 | |||||||||||||||
Multi-family residential | 26,178 | - | - | 1,044 | 27,222 | |||||||||||||||
Commercial real estate - owner occupied | 196,211 | 12,075 | 7,322 | 3,100 | 218,708 | |||||||||||||||
Commercial real estate - non-owner occupied | 155,223 | 4,505 | 170 | 5,209 | 165,107 | |||||||||||||||
Farmland | 130,285 | 1,563 | 724 | 610 | 133,182 | |||||||||||||||
Total real estate | 725,520 | 22,132 | 9,560 | 20,896 | 778,108 | |||||||||||||||
Agricultural | 46,197 | 40 | - | - | 46,237 | |||||||||||||||
Commercial and industrial | 108,931 | 933 | 755 | 2,588 | 113,207 | |||||||||||||||
Mortgage Warehouse | 180,355 | - | - | - | 180,355 | |||||||||||||||
Consumer loans | 12,718 | 178 | 16 | 2,037 | 14,949 | |||||||||||||||
Total gross loans and leases | $ | 1,073,721 | $ | 23,283 | $ | 10,331 | $ | 25,521 | $ | 1,132,856 |
20 |
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, 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 | $ | - | $ | - | $ | - | $ | - | $ | 16,939 | $ | 16,939 | $ | - | ||||||||||||||
Other construction/land | - | - | - | - | 38,390 | 38,390 | 257 | |||||||||||||||||||||
1-4 family - closed end | 75 | - | - | 75 | 135,383 | 135,458 | 446 | |||||||||||||||||||||
Equity lines | 298 | 78 | 197 | 573 | 40,251 | 40,824 | 1,630 | |||||||||||||||||||||
Multi-family residential | - | - | - | - | 31,434 | 31,434 | - | |||||||||||||||||||||
Commercial real estate - owner occupied | 198 | - | 358 | 556 | 211,643 | 212,199 | 2,276 | |||||||||||||||||||||
Commercial real estate - non-owner occupied | - | - | - | - | 174,776 | 174,776 | 235 | |||||||||||||||||||||
Farmland | - | 43 | - | 43 | 132,097 | 132,140 | 43 | |||||||||||||||||||||
Total real estate | 571 | 121 | 555 | 1,247 | 780,913 | 782,160 | 4,887 | |||||||||||||||||||||
Agricultural | - | - | 64 | 64 | 49,959 | 50,023 | 65 | |||||||||||||||||||||
Commercial and industrial | 32 | 1 | 112 | 145 | 111,601 | 111,746 | 529 | |||||||||||||||||||||
Mortgage warehouse lines | - | - | - | - | 197,715 | 197,715 | - | |||||||||||||||||||||
Consumer | 99 | 13 | - | 112 | 13,506 | 13,618 | 463 | |||||||||||||||||||||
Total gross loans and leases | $ | 702 | $ | 135 | $ | 731 | $ | 1,568 | $ | 1,153,694 | $ | 1,155,262 | $ | 5,944 |
(1) As of June 30, 2016 there were no loans over 90 days past due and still acrruing.
(2) Included in total financing receivables
December 31, 2015 | ||||||||||||||||||||||||||||
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 | $ | 612 | $ | 545 | $ | - | $ | 1,157 | $ | 13,784 | $ | 14,941 | $ | - | ||||||||||||||
Other construction/land | 18 | 129 | 63 | 210 | 37,149 | 37,359 | 457 | |||||||||||||||||||||
1-4 family - closed end | 1,065 | 917 | 566 | 2,548 | 134,808 | 137,356 | 2,298 | |||||||||||||||||||||
Equity lines | 199 | 247 | 484 | 930 | 43,303 | 44,233 | 1,770 | |||||||||||||||||||||
Multi-family residential | - | 630 | - | 630 | 26,592 | 27,222 | 630 | |||||||||||||||||||||
Commercial real estate - owner occupied | 232 | 129 | 260 | 621 | 218,087 | 218,708 | 2,325 | |||||||||||||||||||||
Commercial real estate - non-owner occupied | - | - | - | - | 165,107 | 165,107 | 262 | |||||||||||||||||||||
Farmland | - | - | - | - | 133,182 | 133,182 | 610 | |||||||||||||||||||||
Total real estate | 2,126 | 2,597 | 1,373 | 6,096 | 772,012 | 778,108 | 8,352 | |||||||||||||||||||||
Agricultural | - | - | - | - | 46,237 | 46,237 | - | |||||||||||||||||||||
Commercial and industrial | 127 | 153 | 86 | 366 | 112,841 | 113,207 | 710 | |||||||||||||||||||||
Mortgage warehouse lines | - | - | - | - | 180,355 | 180,355 | - | |||||||||||||||||||||
Consumer | 98 | 9 | 45 | 152 | 14,797 | 14,949 | 572 | |||||||||||||||||||||
Total gross loans and leases | $ | 2,351 | $ | 2,759 | $ | 1,504 | $ | 6,614 | $ | 1,126,242 | $ | 1,132,856 | $ | 9,634 |
(1) As of December 31, 2015 there were no loans over 90 days past due and still accruing.
(2) Included in total financing receivables
21 |
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, 2016, the Company had a total of $17.2 million in TDRs, including $2.5 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, 2016 | ||||||||||||||||||||
Rate Modification | 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 |
Three months ended June 30, 2015 | ||||||||||||||||||||
Rate Modification | Term Modification | Interest Only Modification | Rate & Term Modification | Total | ||||||||||||||||
Real Estate: | ||||||||||||||||||||
Other construction/land | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||
1-4 family - closed-end | - | - | - | 226 | 226 | |||||||||||||||
Equity lines | - | 146 | - | 290 | 436 | |||||||||||||||
Multi-family residential | - | 418 | - | - | 418 | |||||||||||||||
Commercial real estate - owner occupied | - | - | - | - | - | |||||||||||||||
Total real estate loans | - | 564 | - | 516 | 1,080 | |||||||||||||||
Commercial and industrial | - | 25 | - | - | 25 | |||||||||||||||
Consumer loans | - | - | - | - | - | |||||||||||||||
$ | - | $ | 589 | $ | - | $ | 516 | $ | 1,105 |
22 |
Troubled Debt Restructurings, by Type of Loan Modification | |
(dollars in thousands, unaudited) |
Six months ended June 30, 2016 | ||||||||||||||||||||
Rate Modification | Term Modification | Interest Only Modification | Rate & Term Modification | Total | ||||||||||||||||
Real estate: | ||||||||||||||||||||
Other construction/land | $ | - | $ | 17 | $ | - | $ | - | $ | 17 | ||||||||||
1-4 family - closed-end | - | - | 547 | 259 | 806 | |||||||||||||||
Equity lines | - | 1,280 | - | - | 1,280 | |||||||||||||||
Multi-family residential | - | - | 132 | 132 | ||||||||||||||||
Commercial real estate - owner occupied | - | - | - | 266 | 266 | |||||||||||||||
Total real estate loans | - | 1,297 | 547 | 657 | 2,501 | |||||||||||||||
Commercial and industrial | - | - | - | - | - | |||||||||||||||
Consumer loans | - | 20 | - | 60 | 80 | |||||||||||||||
$ | - | $ | 1,317 | $ | 547 | $ | 717 | $ | 2,581 |
Six months ended June 30, 2015 | ||||||||||||||||||||
Rate Modification | Term Modification | Interest Only Modification | Rate & Term Modification | Total | ||||||||||||||||
Real Estate: | ||||||||||||||||||||
Other construction/land | $ | - | $ | 111 | $ | - | $ | - | $ | 111 | ||||||||||
1-4 family - closed-end | - | - | - | 226 | 226 | |||||||||||||||
Equity lines | - | 351 | - | 290 | 641 | |||||||||||||||
Multi-family residential | - | 418 | - | - | 418 | |||||||||||||||
Commercial real estate - owner occupied | - | - | - | - | - | |||||||||||||||
Total real estate loans | - | 880 | - | 516 | 1,396 | |||||||||||||||
Commercial and industrial | - | 68 | - | - | 68 | |||||||||||||||
Consumer loans | - | - | - | - | - | |||||||||||||||
$ | - | $ | 948 | $ | - | $ | 516 | $ | 1,464 |
23 |
The following tables present, by class, additional details related to loans classified as TDRs during the referenced periods, including the recorded investment in the loan both before and after modification and balances that were modified during the period:
Troubled Debt Restructurings
(dollars in thousands, unaudited)
Three months ended June 30, 2016 | ||||||||||||||||||||
Pre- Modification | Post- Modification | |||||||||||||||||||
Number of Loans | Outstanding Recorded Investment | Outstanding Recorded Investment | Reserve Difference(¹) | Reserve | ||||||||||||||||
Real Estate: | ||||||||||||||||||||
Other Construction/Land | 0 | $ | - | $ | - | $ | - | $ | - | |||||||||||
1-4 family - closed-end | 5 | 806 | 806 | 75 | 139 | |||||||||||||||
Equity Lines | 8 | 1,051 | 1,051 | 1 | 22 | |||||||||||||||
Multi-family residential | 1 | 132 | 132 | - | 7 | |||||||||||||||
Commercial RE- owner occupied | 0 | - | - | - | - | |||||||||||||||
Total Real Estate Loans | 1,989 | 1,989 | 76 | 168 | ||||||||||||||||
Commercial and Industrial | 0 | - | - | - | - | |||||||||||||||
Consumer loans | 1 | 10 | 10 | - | 1 | |||||||||||||||
$ | 1,999 | $ | 1,999 | $ | 76 | $ | 169 |
(1) This represents the change in the ALLL reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan loss methodology.
Three months ended June 30, 2015 | ||||||||||||||||||||
Pre- Modification | Post- Modification | |||||||||||||||||||
Number of Loans | Outstanding Recorded Investment | Outstanding Recorded Investment | Reserve Difference(¹) | Reserve | ||||||||||||||||
Real Estate: | ||||||||||||||||||||
Other Construction/Land | 0 | $ | - | $ | - | $ | - | $ | - | |||||||||||
1-4 family - closed-end | 2 | 226 | 226 | 6 | 7 | |||||||||||||||
Equity Lines | 5 | 436 | 436 | 142 | 157 | |||||||||||||||
Multi-family residential | 1 | 418 | 418 | - | 1 | |||||||||||||||
Commercial RE- owner occupied | 0 | - | - | - | - | |||||||||||||||
Total Real Estate Loans | 1,080 | 1,080 | 148 | 165 | ||||||||||||||||
Commercial and Industrial | 1 | 25 | 25 | - | 11 | |||||||||||||||
Consumer loans | 0 | - | - | - | - | |||||||||||||||
$ | 1,105 | $ | 1,105 | $ | 148 | $ | 176 |
(1) This represents the change in the ALLL reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan loss methodology.
24 |
Six months ended June 30, 2016 | ||||||||||||||||||||
Pre- Modification | Post- Modification | |||||||||||||||||||
Number of Loans | Outstanding Recorded Investment | Outstanding Recorded Investment | Reserve Difference(¹) | Reserve | ||||||||||||||||
Real Estate: | ||||||||||||||||||||
Other Construction/Land | 1 | $ | 17 | $ | 17 | $ | - | $ | 2 | |||||||||||
1-4 family - closed-end | 5 | 806 | 806 | 75 | 139 | |||||||||||||||
Equity Lines | 10 | 1,280 | 1,280 | - | 30 | |||||||||||||||
Multi-family residential | 1 | 132 | 132 | - | 7 | |||||||||||||||
Commercial RE- owner occupied | 1 | 266 | 266 | - | 4 | |||||||||||||||
Total Real Estate Loans | 2,501 | 2,501 | 75 | 182 | ||||||||||||||||
Commercial and Industrial | 0 | - | - | - | - | |||||||||||||||
Consumer loans | 3 | 80 | 80 | - | 6 | |||||||||||||||
$ | 2,581 | $ | 2,581 | $ | 75 | $ | 188 |
(1) This represents the change in the ALLL reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan loss methodology.
Six months ended June 30, 2015 | ||||||||||||||||||||
Pre- Modification | Post- Modification | |||||||||||||||||||
Number of Loans | Outstanding Recorded Investment | Outstanding Recorded Investment | Reserve Difference(¹) | Reserve | ||||||||||||||||
Real Estate: | ||||||||||||||||||||
Other Construction/Land | 2 | $ | 111 | $ | 111 | $ | 4 | $ | 2 | |||||||||||
1-4 family - closed-end | 2 | 226 | 226 | 6 | 7 | |||||||||||||||
Equity Lines | 7 | 641 | 641 | 142 | 218 | |||||||||||||||
Multi-family residential | 1 | 418 | 418 | - | 1 | |||||||||||||||
Commercial RE- owner occupied | 0 | - | - | - | - | |||||||||||||||
Total Real Estate Loans | 1,396 | 1,396 | 152 | 228 | ||||||||||||||||
Commercial and Industrial | 3 | 68 | 68 | (19 | ) | 23 | ||||||||||||||
Consumer loans | 0 | - | - | - | - | |||||||||||||||
$ | 1,464 | $ | 1,464 | $ | 133 | $ | 251 |
(1) This represents the change in the ALLL reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan loss methodology.
The company had no finance receivables modified as TDRs within the previous twelve months that defaulted or were charged off during the three month or six month periods ended June 30, 2016 and 2015 respectively.
Purchased Credit Impaired Loans
The Company may acquire loans which show evidence of credit deterioration since origination. These purchased credit impaired (“PCI”) loans are recorded at the amount paid, since there is no carryover of the seller’s allowance for loan losses. Potential losses on PCI loans subsequent to acquisition are recognized by an increase in the allowance for loan losses. PCI loans are accounted for individually or are aggregated into pools of loans based on common risk characteristics. The Company estimates the amount and timing of expected cash flows, and expected cash receipts in excess of the amount paid for the loan(s) are recorded as interest income over the remaining life of the loan or pool of loans (accretable yield). The excess of contractual principal and interest over expected cash flows is not recorded (nonaccretable difference). Expected cash flows are periodically re-evaluated throughout the life of the loan or pool of loans. If the present value of the expected cash flows is determined at any time to be less than the carrying amount, a reserve is recorded. If the present value of the expected cash flows is greater than the carrying amount, it is recognized as part of future interest income.
25 |
Our acquisition of Santa Clara Valley Bank in the fourth quarter of 2014 included a portfolio of loans, some of which have shown evidence of credit deterioration since origination and for which it was probable at acquisition that all contractually required payments would not be collected. The carrying amount and unpaid principal balance of those PCI loans was as follows, as of the dates indicated (dollars in thousands):
Purchased Credit Impaired Loans:
(dollars in thousands, unaudited)
June 30, 2016 | ||||||||
Unpaid Principal Balance | Carrying Value | |||||||
Real estate secured | $ | 1,124 | $ | 171 | ||||
Commercial and industrial | 19 | - | ||||||
Consumer | - | - | ||||||
Total purchased credit impaired loans | $ | 1,143 | $ | 171 |
December 31, 2015 | ||||||||
Unpaid Principal Balance | Carrying Value | |||||||
Real estate secured | $ | 1,158 | $ | 188 | ||||
Commercial and industrial | 38 | - | ||||||
Consumer | 1 | - | ||||||
Total purchased credit impaired loans | $ | 1,197 | $ | 188 |
An allowance for loan losses totaling $117,000 was allocated for PCI loans as of June 30, 2016, as compared to $121,000 at December 31, 2015. We also recorded approximately $70,000 in discount accretion on PCI loans during the six months ended June 30, 2016.
Note 12 – Allowance for Loan and Lease Losses
The Company’s allowance for loan and lease losses, a contra-asset, is established through a provision for loan and lease losses. The allowance is maintained at a level that is considered adequate to absorb probable losses on certain specifically identified loans, as well as probable incurred losses inherent in the remaining loan portfolio. Specifically identifiable and quantifiable losses are immediately charged off against the allowance; recoveries are generally recorded only when cash payments are received subsequent to the charge off. We employ a systematic methodology, consistent with FASB guidelines on loss contingencies and impaired loans, for determining the appropriate level of the allowance for loan and lease losses and adjusting it at least quarterly. Pursuant to that methodology, impaired loans and leases are individually analyzed and a criticized asset action plan is completed specifying the financial status of the borrower and, if applicable, the characteristics and condition of collateral and any associated liquidation plan. A specific loss allowance is created for each impaired loan, if necessary.
26 |
The following tables disclose the unpaid principal balance, recorded investment, average recorded investment, and interest income recognized for impaired loans on our books as of the dates indicated. Balances are shown by loan type, and are further broken out by those that required an allowance and those that did not, with the associated allowance disclosed for those that required such. Included in the valuation allowance for impaired loans shown in the tables below are specific reserves allocated to TDRs, totaling $1.619 million at June 30, 2016 and $1.486 million at December 31, 2015.
Impaired Loans
(dollars in thousands, unaudited)
June 30, 2016 | ||||||||||||||||||||
Unpaid Principal Balance(1) | Recorded Investment(2) | Related Allowance | Average Recorded Investment | Interest Income Recognized(3) | ||||||||||||||||
With an allowance recorded | ||||||||||||||||||||
Real Estate: | ||||||||||||||||||||
Other construction/land | $ | 558 | $ | 521 | $ | 42 | $ | 581 | $ | 15 | ||||||||||
1-4 Family - closed-end | 7,989 | 6,042 | 325 | 8,118 | 233 | |||||||||||||||
Equity lines | 3,337 | 3,284 | 164 | 3,426 | 32 | |||||||||||||||
Multi-family residential | 417 | 417 | 7 | 421 | 27 | |||||||||||||||
Commercial real estate- owner occupied | 1,375 | 1,352 | 537 | 1,431 | 125 | |||||||||||||||
Commercial real estate- non-owner occupied | 5,096 | 4,940 | 1,359 | 5,185 | 173 | |||||||||||||||
Farmland | - | - | - | - | - | |||||||||||||||
Total real estate | 18,772 | 16,556 | 2,434 | 19,162 | 605 | |||||||||||||||
Agriculture | - | - | - | - | - | |||||||||||||||
Commercial and industrial | 2,254 | 2,254 | 591 | 2,435 | 48 | |||||||||||||||
Consumer loans | 1,931 | 1,927 | 302 | 2,084 | 57 | |||||||||||||||
22,957 | 20,737 | 3,327 | 23,681 | 710 | ||||||||||||||||
With no related allowance recorded | ||||||||||||||||||||
Real estate: | ||||||||||||||||||||
Other construction/land | 567 | 448 | - | 599 | 12 | |||||||||||||||
1-4 family - closed-end | 321 | 70 | - | 667 | 1 | |||||||||||||||
Equity lines | 522 | 493 | - | 537 | - | |||||||||||||||
Multi-family residential | - | - | - | - | - | |||||||||||||||
Commercial real estate- owner occupied | 2,036 | 1,950 | - | 2,340 | - | |||||||||||||||
Commercial real estate- non-owner occupied | 163 | 163 | - | 194 | - | |||||||||||||||
Farmland | 43 | 43 | - | 50 | - | |||||||||||||||
Total real estate | 3,652 | 3,167 | - | 4,387 | 13 | |||||||||||||||
Agriculture | 65 | 65 | - | 66 | - | |||||||||||||||
Commercial and industrial | 107 | 39 | - | 292 | 1 | |||||||||||||||
Consumer loans | 196 | 35 | - | 304 | - | |||||||||||||||
4,020 | 3,306 | - | 5,049 | 14 | ||||||||||||||||
Total | $ | 26,977 | $ | 24,043 | $ | 3,327 | $ | 28,730 | $ | 724 |
(1)Contractual principal balance due from customer.
(2)Principal balance on Company's books, less any direct charge offs, including interest applied to principal and unaccreted discount or premium.
(3)Interest income is recognized on performing balances on a regular accrual basis.
27 |
December 31, 2015 | ||||||||||||||||||||
Unpaid Principal Balance(1) | Recorded Investment(2) | Related Allowance | Average Recorded Investment | Interest Income Recognized(3) | ||||||||||||||||
With an allowance recorded | ||||||||||||||||||||
Real estate: | ||||||||||||||||||||
Other construction/land | $ | 919 | $ | 769 | $ | 83 | $ | 967 | $ | 42 | ||||||||||
1-4 family - closed-end | 8,085 | 6,137 | 290 | 6,157 | 255 | |||||||||||||||
Equity lines | 2,339 | 2,269 | 214 | 2,374 | 17 | |||||||||||||||
Multifamily residential | 414 | 414 | 1 | 417 | 5 | |||||||||||||||
Commercial real estate- owner occupied | 1,272 | 1,272 | 589 | 1,405 | 139 | |||||||||||||||
Commercial real estate- non-owner occupied | 3,350 | 3,350 | 1,712 | 3,390 | 164 | |||||||||||||||
Farmland | - | - | - | - | - | |||||||||||||||
Total real estate | 16,379 | 14,211 | 2,889 | 14,710 | 622 | |||||||||||||||
Commercial and industrial | 2,572 | 2,559 | 683 | 2,857 | 97 | |||||||||||||||
Consumer loans | 2,023 | 2,022 | 343 | 2,298 | 112 | |||||||||||||||
20,974 | 18,792 | 3,915 | 19,865 | 831 | ||||||||||||||||
With no related allowance recorded | ||||||||||||||||||||
Real estate: | ||||||||||||||||||||
Other construction/land | 554 | 554 | - | 566 | 34 | |||||||||||||||
1-4 family - closed-end | 585 | 362 | - | 602 | - | |||||||||||||||
Equity lines | 843 | 842 | - | 840 | - | |||||||||||||||
Multifamily residential | 630 | 630 | - | 633 | - | |||||||||||||||
Commercial real estate- owner occupied | 1,828 | 1,828 | - | 2,251 | - | |||||||||||||||
Commercial real estate- non-owner occupied | 2,006 | 1,859 | - | 2,102 | 118 | |||||||||||||||
Farmland | 610 | 610 | - | 629 | - | |||||||||||||||
Total real estate | 7,056 | 6,685 | - | 7,623 | 152 | |||||||||||||||
Commercial and industrial | 45 | 29 | - | 77 | - | |||||||||||||||
Consumer loans | 160 | 15 | - | 256 | - | |||||||||||||||
7,261 | 6,729 | - | 7,956 | 152 | ||||||||||||||||
Total | $ | 28,235 | $ | 25,521 | $ | 3,915 | $ | 27,821 | $ | 983 |
(1)Contractual principal balance due from customer.
(2)Principal balance on Company's books, less any direct charge offs, including interest applied to principal and unaccreted discount or premium.
(3)Interest income is recognized on performing balances on a regular accrual basis.
The specific loss allowance for an impaired loan generally represents the difference between the book value of the loan and either the fair value of underlying collateral less estimated disposition costs, or the loan’s net present value as determined by a discounted cash flow analysis. The discounted cash flow approach is typically used to measure impairment on loans for which it is anticipated that repayment will be provided from cash flows other than those generated solely by the disposition or operation of underlying collateral. However, historical loss rates may be used to determine a specific loss allowance if they indicate a higher potential reserve need than the discounted cash flow analysis. Any change in impairment attributable to the passage of time is accommodated by adjusting the loss allowance accordingly.
28 |
For loans where repayment is expected to be provided by the disposition or operation of the underlying collateral, impairment is measured using the fair value of the collateral. If the collateral value, net of the expected costs of disposition where applicable, is less than the loan balance, then a specific loss reserve is established for the shortfall in collateral coverage. If the discounted collateral value is greater than or equal to the loan balance, no specific loss reserve is required. At the time a collateral-dependent loan is designated as nonperforming, a new appraisal is ordered and typically received within 30 to 60 days if a recent appraisal is not already available. We generally use external appraisals to determine the fair value of the underlying collateral for nonperforming real estate loans, although the Company’s licensed staff appraisers may update older appraisals based on current market conditions and property value trends. Until an updated appraisal is received, the Company uses the existing appraisal to determine the amount of the specific loss allowance that may be required. The specific loss allowance is adjusted, as necessary, once a new appraisal is received. Updated appraisals are generally ordered at least annually for collateral-dependent loans that remain impaired. Current appraisals were available or in process for 96% of the Company’s impaired real estate loan balances at June 30, 2016. Furthermore, the Company analyzes collateral-dependent loans on at least a quarterly basis, to determine if any portion of the recorded investment in such loans can be identified as uncollectible and would therefore constitute a confirmed loss. All amounts deemed to be uncollectible are promptly charged off against the Company’s allowance for loan and lease losses, with the loan then carried at the fair value of the collateral, as appraised, less estimated costs of disposition if applicable. Once a charge-off or write-down is recorded, it will not be restored to the loan balance on the Company’s accounting books.
Our methodology also provides for the establishment of a “general” allowance for probable incurred losses inherent in loans and leases that are not impaired. Unimpaired loan balances are segregated by credit quality, and are then evaluated in pools with common characteristics. At the present time, pools are based on the same segmentation of loan types presented in our regulatory filings. While this methodology utilizes historical loss data and other measurable information, the classification of loans and the establishment of the allowance for loan and lease losses are both to some extent based on Management’s judgment and experience. Our methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan and lease losses that Management believes is appropriate at each reporting date. Quantitative information includes our historical loss experience, delinquency and charge-off trends, and current collateral values. Qualitative factors include the general economic environment in our markets and, in particular, the condition of the agricultural industry and other key industries. Lending policies and procedures (including underwriting standards), the experience and abilities of lending staff, the quality of loan review, credit concentrations (by geography, loan type, industry and collateral type), the rate of loan portfolio growth, and changes in legal or regulatory requirements are additional factors that are considered. The total general reserve established for probable incurred losses on unimpaired loans was $6.715 million at June 30, 2016.
There were no material changes to the methodology used to determine our allowance for loan and lease losses during the three months ended June 30, 2016. We continue to consider the estimated impact of drought conditions and lower oil prices on credit quality, in evaluating the adequacy of our allowance. As we add new products and expand our geographic coverage, and as the economic environment changes, we expect to enhance our methodology to keep pace with the size and complexity of the loan and lease portfolio and respond to pressures created by external forces. We engage outside firms on a regular basis to assess our methodology and perform independent credit reviews of our loan and lease portfolio. In addition, the Company’s external auditors, the FDIC, and the California DBO review the allowance for loan and lease losses as an integral part of their audit and examination processes. Management believes that the current methodology is appropriate given our size and level of complexity.
29 |
The tables that follow detail the activity in the allowance for loan and lease losses for the periods noted:
Allowance for Credit Losses and Recorded Investment in Financing Receivables
(dollars in thousands, unaudited)
Three months ended June 30, 2016 | ||||||||||||||||||||||||
Real Estate | Agricultural Production | Commercial and Industrial | Consumer | Unallocated | Total | |||||||||||||||||||
Allowance for credit losses: | ||||||||||||||||||||||||
Beginning Balance | $ | 4,713 | $ | 567 | $ | 2,503 | $ | 1,119 | $ | 1,128 | $ | 10,030 | ||||||||||||
Charge-offs | (71 | ) | - | (66 | ) | (494 | ) | - | (631 | ) | ||||||||||||||
Recoveries | 336 | 2 | 39 | 266 | - | 643 | ||||||||||||||||||
Provision | (496 | ) | (153 | ) | 1,265 | 353 | (969 | ) | - | |||||||||||||||
Ending Balance | $ | 4,482 | $ | 416 | $ | 3,741 | $ | 1,244 | $ | 159 | $ | 10,042 |
Six months ended June 30, 2016 | ||||||||||||||||||||||||
Real Estate | Agricultural Production | Commercial and Industrial | Consumer | Unallocated | Total | |||||||||||||||||||
Allowance for credit losses: | ||||||||||||||||||||||||
Beginning Balance | $ | 4,783 | $ | 722 | $ | 2,533 | $ | 1,263 | $ | 1,122 | $ | 10,423 | ||||||||||||
Charge-offs | (280 | ) | - | (174 | ) | (985 | ) | - | (1,439 | ) | ||||||||||||||
Recoveries | 397 | 4 | 160 | 497 | - | 1,058 | ||||||||||||||||||
Provision | (418 | ) | (310 | ) | 1,222 | 469 | (963 | ) | - | |||||||||||||||
Ending Balance | $ | 4,482 | $ | 416 | $ | 3,741 | $ | 1,244 | $ | 159 | $ | 10,042 | ||||||||||||
Reserves: | ||||||||||||||||||||||||
Specific | $ | 2,434 | $ | - | $ | 591 | $ | 302 | $ | - | $ | 3,327 | ||||||||||||
General | 2,048 | 416 | 3,150 | 942 | 159 | 6,715 | ||||||||||||||||||
Ending Balance | $ | 4,482 | $ | 416 | $ | 3,741 | $ | 1,244 | $ | 159 | $ | 10,042 | ||||||||||||
Loans evaluated for impairment: | ||||||||||||||||||||||||
Individually | $ | 19,723 | $ | 65 | $ | 2,293 | $ | 1,962 | $ | - | $ | 24,043 | ||||||||||||
Collectively | 762,437 | 49,958 | 307,168 | 11,656 | - | 1,131,219 | ||||||||||||||||||
Ending Balance | $ | 782,160 | $ | 50,023 | $ | 309,461 | $ | 13,618 | $ | - | $ | 1,155,262 |
Year ended December 31, 2015 | ||||||||||||||||||||||||
Real Estate | Agricultural Production | Commercial and Industrial | Consumer | Unallocated | Total | |||||||||||||||||||
Allowance for credit losses: | ||||||||||||||||||||||||
Beginning Balance | $ | 6,243 | $ | 986 | $ | 1,944 | $ | 1,765 | $ | 310 | $ | 11,248 | ||||||||||||
Charge-offs | (706 | ) | - | (395 | ) | (1,739 | ) | - | (2,840 | ) | ||||||||||||||
Recoveries | 751 | 81 | 225 | 958 | - | 2,015 | ||||||||||||||||||
Provision | (1,505 | ) | (345 | ) | 759 | 279 | 812 | - | ||||||||||||||||
Ending Balance | $ | 4,783 | $ | 722 | $ | 2,533 | $ | 1,263 | $ | 1,122 | $ | 10,423 | ||||||||||||
Reserves: | ||||||||||||||||||||||||
Specific | $ | 2,889 | $ | - | $ | 683 | $ | 343 | $ | - | $ | 3,915 | ||||||||||||
General | 1,894 | 722 | 1,850 | 920 | 1,122 | 6,508 | ||||||||||||||||||
Ending Balance | $ | 4,783 | $ | 722 | $ | 2,533 | $ | 1,263 | $ | 1,122 | $ | 10,423 | ||||||||||||
Loans evaluated for impairment: | ||||||||||||||||||||||||
Individually | $ | 20,896 | $ | - | $ | 2,588 | $ | 2,037 | $ | - | $ | 25,521 | ||||||||||||
Collectively | 757,212 | 46,237 | 290,974 | 12,912 | - | 1,107,335 | ||||||||||||||||||
Ending Balance | $ | 778,108 | $ | 46,237 | $ | 293,562 | $ | 14,949 | $ | - | $ | 1,132,856 |
30 |
Note 13 – Recent Developments
On May 13, 2016, the Company acquired certain loans and deposits from Citizens Business Bank concurrent with the closure of that bank’s Porterville branch. At the time of acquisition there were a total of $10 million in deposits and $1 million in loans, which we consolidated into our Porterville Main office.
In January 2016 the Company entered into a definitive agreement to acquire Coast Bancorp, the holding company for Coast National Bank. The transaction closed on July 8, 2016, subsequent to the receipt of requisite regulatory and shareholder approvals, and immediately following that acquisition, Coast National Bank was merged with and into Bank of the Sierra. Coast National Bank was a community bank with branch offices in San Luis Obispo, Paso Robles, and Arroyo Grande, and a loan production office in Atascadero, California. Shortly after transaction closing, the Atascadero location was converted into a full-service branch office. The transaction also involved Sierra Bancorp’s acquisition of 100% of the voting equity of Coast Bancorp Statutory Trust II and Sierra Bancorp’s assumption of $7 million in associated junior subordinated debentures. The aggregate consideration tendered by the Company in its acquisition of Coast Bancorp consisted of 599,242 shares of Sierra Bancorp common stock and $3.3 million in cash, and one-time acquisition costs are expected to add roughly $3.2 million to the Company’s pre-tax non-interest expense in 2016. At the merger date the Coast acquisition contributed approximately $95 million to the Company’s outstanding loan balances, $31 million to investments, and $129 million to total deposits. In accordance with GAAP, assets and liabilities will be reflected on the Company’s books at their estimated fair values and there was no carryover of the allowance for loan losses that had previously been recorded by Coast. The Company will also record a deferred income tax asset, goodwill, and a core deposit intangible in conjunction with the acquisition, although those amounts have not yet been definitively determined. Goodwill represents the excess of consideration transferred over the fair values of the identifiable net assets acquired. The core deposit intangible will be amortized on a straight line basis over eight years, commencing at the date of acquisition. Goodwill and core deposit intangibles are not deductible for income tax purposes.
31 |
PART I - FINANCIAL INFORMATION
MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This Form 10-Q includes forward-looking statements that involve inherent risks and uncertainties. Words such as “expects”, “anticipates”, “believes”, “projects”, and “estimates” or variations of such words and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed, forecast in, or implied by such forward-looking statements.
A variety of factors could have a material adverse impact on the Company’s financial condition or results of operations, and should be considered when evaluating the Company’s potential future financial performance. They include, but are not limited to, the potential impact of extreme drought conditions on businesses and consumers located in the Company’s market areas; unfavorable economic conditions in the Company’s service areas; risks associated with fluctuations in interest rates; liquidity risks; increases in nonperforming assets and credit losses that could occur, particularly in times of weak economic conditions or rising interest rates; reductions in the market value of available-for-sale securities that could result if interest rates increase substantially or an issuer has real or perceived financial difficulties; the Company’s ability to attract and retain skilled employees; the Company’s ability to successfully deploy new technology; the success of acquisitions or branch expansion; and risks associated with the multitude of current and prospective laws and regulations to which the Company is and will be subject. Risk factors that could cause actual results to differ materially from results that might be implied by forward-looking statements include the risk factors disclosed in the Company’s Form 10-K for the fiscal year ended December 31, 2015.
The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States. The financial information and disclosures contained within those statements are significantly impacted by Management’s estimates and judgments, which are based on historical experience and incorporate various assumptions that are believed to be reasonable under current circumstances. Actual results may differ from those estimates under divergent conditions.
Critical accounting policies are those that involve the most complex and subjective decisions and assessments, and have the greatest potential impact on the Company’s stated results of operations. In Management’s opinion, the Company’s critical accounting policies deal with the following areas: the establishment of the allowance for loan and lease losses, as explained in detail in Note 12 to the consolidated financial statements and in the “Provision for Loan and Lease Losses” and “Allowance for Loan and Lease Losses” sections of this discussion and analysis; the valuation of impaired loans and foreclosed assets, as discussed in Note 11 to the consolidated financial statements; income taxes and deferred tax assets and liabilities, especially with regard to the ability of the Company to recover deferred tax assets as discussed in the “Provision for Income Taxes” and “Other Assets” sections of this discussion and analysis; and goodwill and other intangible assets, which are evaluated annually for impairment and for which we have determined that no impairment exists, as discussed in the “Other Assets” section of this discussion and analysis. Critical accounting areas are evaluated on an ongoing basis to ensure that the Company’s financial statements incorporate our most recent expectations with regard to those areas.
32 |
OVERVIEW OF THE RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
results of operations Summary
Second quarter 2016 compared to Second quarter 2015
Net income for the quarter ended June 30, 2016 was $4.086 million, representing a decline of $471,000, or 10%, relative to net income of $4.557 million for the quarter ended June 30, 2015. Basic and diluted earnings per share for the second quarter of 2016 were both $0.31, compared to $0.34 basic earnings per share and $0.33 diluted earnings per share for the second quarter of 2015. The Company’s annualized return on average equity was 8.38% and annualized return on average assets was 0.93% for the quarter ended June 30, 2016, compared to 9.67% and 1.07%, respectively, for the quarter ended June 30, 2015. The primary drivers behind the variance in net income are as follows:
· | Net interest income was up by $177,000, or 1%, due to growth in average interest-earning assets totaling $45 million, or 3%, that was partially offset by the impact of a five basis point drop in our net interest margin. There was no loan loss provision recorded in either quarter. |
· | Total non-interest income fell by $80,000, or 2%, due to a drop in investment gains and the impact of the special dividend received on our Federal Home Loan Bank (“FHLB”) stock in the second quarter of 2015, partially offset by fees earned from increased activity on commercial deposit accounts, higher overdraft income, and rising debit card interchange income. |
· | Total non-interest expense reflects an increase of $964,000, or 8%, due to non-recurring acquisition costs totaling $128,000 that were recognized in the second quarter of 2016 as well as increases in personnel costs, occupancy expense, debit card processing costs, and foreclosed assets expense (including write-downs). Lower telecommunications expense helped offset some of the expense increases. |
· | The Company’s provision for income taxes was 33% of pre-tax income in the second quarter of 2016 relative to 34% in the second quarter of 2015. The tax provisioning rate fell in 2016 due to lower pre-tax income and a slightly higher level of tax credits. |
First Half 2016 compared to First Half 2015
Net income for the first half of 2016 was $8.122 million, representing a decline of $173,000, or 2%, relative to net income of $8.295 million for the first half of 2015. Basic and diluted earnings per share for the first half of 2016 were both $0.61, compared to $0.61 basic earnings per share and $0.60 diluted earnings per share for the first half of 2015. The Company’s annualized return on average equity was 8.39% and annualized return on average assets was 0.93% for the six months ended June 30, 2016, compared to a return on equity of 8.87% and return on assets of 1.00% for the six months ended June 30, 2015. The primary drivers behind the variance in year-to-date net income are as follows:
· | Net interest income increased $774,000, or 3%, due to the positive impact of a $75 million increase in average interest-earning assets that was partially offset by an 11 basis point drop in our net interest margin. There was no loan loss provision recorded in either period. |
· | Total non-interest income was up $207,000, or 2%, due to fees earned from increased activity on commercial deposit accounts, higher overdraft income, and higher debit card interchange income, offset in part by lower gains from the sale of investments and lower dividends on our FHLB stock. |
· | Total non-interest expense increased by $983,000, or 4%, due to non-recurring acquisition costs of $342,000 in the first half of 2016 relative to $101,000 in the first half of 2015, in addition to relatively large increases in personnel costs, occupancy expense, debit card processing costs, foreclosed assets expense, and legal/accounting costs. The expense increases were offset in part by a non-recurring reversal of certain director retirement plan accruals in the first quarter of 2016, and lower telecommunications costs. |
· | The Company’s provision for income taxes was 33% of pre-tax income for the first half of 2016, relative to 32% for the first half of 2015. Since pre-tax income was almost the same in the first half of 2016 as in the first half of 2015, the higher tax provisioning for the first half comparison is the result of a lower level of available tax credits and lower non-taxable BOLI income. |
33 |
Financial Condition Summary
June 30, 2016 relative to December 31, 2015
The Company’s assets totaled $1.843 billion at June 30, 2016, relative to total assets of $1.797 billion at December 31, 2015. Total liabilities were $1.645 billion at June 30, 2016 compared to $1.606 billion at the end of 2015, and shareholders’ equity totaled $198 million at June 30, 2016 compared to $190 million at December 31, 2015. The following is a summary of key balance sheet changes during the first six months of 2016:
· | The Company’s assets were up $47 million, or 3%, due primarily to higher loan, investment, and cash balances. |
· | Gross loans increased by $22 million, or 2%, as the result of a $17 million increase in mortgage warehouse loans stemming from higher line utilization, as well as increases in non-farm real estate loans and agricultural production loans. The remaining growth in net loan balances was facilitated by loan participations purchased during the period. |
· | Total nonperforming assets, including non-accrual loans and foreclosed assets, were reduced by $4 million, or 31%, during the first six months of 2016, including the return to accrual status of our single largest remaining nonperforming loan. The Company’s ratio of nonperforming assets to total loans plus foreclosed assets was 0.76% at June 30, 2016, compared to 1.13% at December 31, 2015. |
· | Deposit balances reflect net growth of $21 million, or 1%, due to growth in core non-maturity deposits that was partially offset by an $8 million reduction in time deposits. |
· | Junior subordinated debentures remain the same, but other borrowings were increased by $21 million during the first half of 2016 to support growth in loans and investments. |
· | Total capital reflects an increase of $8 million, or 4%, for the first six months of the year due to the rising level of retained earnings, the impact of stock options exercised, and an increase in accumulated other comprehensive income. There were no shares repurchased during the first half of 2016. Due to the growth in capital relative to a very minor increase in risk-weighted assets, our consolidated total risk-based capital ratio increased to 17.51% at June 30, 2016 from 17.01% at year-end 2015. |
The Company earns income from two primary sources. The first is net interest income, which is interest income generated by earning assets less interest expense on deposits and other borrowed money. The second is non-interest income, which primarily consists of customer service charges and fees but also comes from non-customer sources such as bank-owned life insurance. The majority of the Company’s non-interest expense is comprised of operating costs that facilitate offering a full range of banking services to our customers.
Net interest income AND NET INTEREST MARGIN
Net interest income increased by $177,000, or 1%, for the second quarter of 2016 relative to the second quarter of 2015, and by $774,000, or 3%, for the first half of 2016 compared to the first half of 2015. The level of net interest income we recognize in any given period depends on a combination of factors including the average volume and yield for interest-earning assets, the average volume and cost of interest-bearing liabilities, and the mix of products which comprise the Company’s earning assets, deposits, and other interest-bearing liabilities. Net interest income is also impacted by the reversal of interest for loans placed on non-accrual status during the reporting period, and the recovery of interest on loans that had been on non-accrual and were paid off, sold or returned to accrual status.
The following tables show average balances for significant balance sheet categories and the amount of interest income or interest expense associated with each category for the noted periods. The tables also display the calculated yields on each major component of the Company’s investment and loan portfolios, the average rates paid on each key segment of the Company’s interest-bearing liabilities, and our net interest margin for the noted periods.
34 |
Average Balances and Rates | For the three months ended | For the three months ended | ||||||||||||||||||||||
(dollars in thousands, except per share data) | Ended June 30, 2016 | Ended June 30, 2015 | ||||||||||||||||||||||
Assets | Average Balance (1) | Income/ Expense | Average Rate/Yield (2)(3) | Average Balance (1) | Income/ Expense | Average Rate/Yield (2)(3) | ||||||||||||||||||
Investments: | ||||||||||||||||||||||||
Federal funds sold/due from time | $ | 4,830 | $ | 5 | 0.41 | % | $ | 8,193 | $ | 6 | 0.29 | % | ||||||||||||
Taxable | 417,881 | 2,052 | 1.94 | % | 405,951 | 2,003 | 1.95 | % | ||||||||||||||||
Non-taxable | 104,548 | 730 | 4.25 | % | 99,092 | 732 | 4.50 | % | ||||||||||||||||
Equity | 1,177 | - | 0.00 | % | 2,005 | 48 | 9.47 | % | ||||||||||||||||
Total investments | 528,436 | 2,787 | 2.38 | % | 515,241 | 2,789 | 2.44 | % | ||||||||||||||||
Loans and Leases:(4) | ||||||||||||||||||||||||
Real estate | 776,172 | 9,703 | 5.03 | % | 713,966 | 9,253 | 5.20 | % | ||||||||||||||||
Agricultural | 47,184 | 520 | 4.43 | % | 29,447 | 306 | 4.17 | % | ||||||||||||||||
Commercial | 105,750 | 1,251 | 4.76 | % | 107,245 | 1,218 | 4.56 | % | ||||||||||||||||
Consumer | 14,152 | 270 | 7.67 | % | 17,387 | 409 | 9.44 | % | ||||||||||||||||
Mortgage warehouse lines | 137,937 | 1,353 | 3.95 | % | 181,001 | 1,639 | 3.63 | % | ||||||||||||||||
Direct financing leases | 1,592 | 21 | 5.31 | % | 1,950 | 26 | 5.35 | % | ||||||||||||||||
Other | 1,951 | 29 | 5.98 | % | 1,962 | 29 | 5.93 | % | ||||||||||||||||
Total loans and leases | 1,084,738 | 13,147 | 4.87 | % | 1,052,958 | 12,880 | 4.91 | % | ||||||||||||||||
Total interest earning assets (5) | 1,613,174 | 15,934 | 4.07 | % | 1,568,199 | 15,669 | 4.11 | % | ||||||||||||||||
Other earning assets | 7,853 | 7,397 | ||||||||||||||||||||||
Non-earning assets | 137,025 | 138,752 | ||||||||||||||||||||||
Total assets | $ | 1,758,052 | $ | 1,714,348 | ||||||||||||||||||||
Liabilities and shareholders' equity | ||||||||||||||||||||||||
Interest bearing deposits: | ||||||||||||||||||||||||
Demand deposits | $ | 146,686 | $ | 110 | 0.30 | % | $ | 127,176 | $ | 94 | 0.30 | % | ||||||||||||
NOW | 314,556 | 78 | 0.10 | % | 293,263 | 87 | 0.12 | % | ||||||||||||||||
Savings accounts | 202,011 | 56 | 0.11 | % | 186,265 | 52 | 0.11 | % | ||||||||||||||||
Money market | 97,971 | 16 | 0.07 | % | 114,540 | 21 | 0.07 | % | ||||||||||||||||
CDAR's | 2,074 | - | 0.00 | % | 11,285 | 2 | 0.07 | % | ||||||||||||||||
Certificates of deposit<$100,000 | 73,913 | 57 | 0.31 | % | 77,749 | 62 | 0.32 | % | ||||||||||||||||
Certificates of deposit>$100,000 | 222,547 | 191 | 0.35 | % | 220,273 | 131 | 0.24 | % | ||||||||||||||||
Total interest bearing deposits | 1,059,758 | 508 | 0.19 | % | 1,030,551 | 449 | 0.17 | % | ||||||||||||||||
Borrowed Funds: | ||||||||||||||||||||||||
Federal funds purchased | 1,399 | 3 | 0.86 | % | 5 | - | - | |||||||||||||||||
Repurchase agreements | 9,989 | 10 | 0.40 | % | 8,544 | 9 | 0.42 | % | ||||||||||||||||
Short term borrowings | 17,273 | 18 | 0.42 | % | 27,689 | 12 | 0.17 | % | ||||||||||||||||
Long term borrowings | - | - | 0.00 | % | 2,000 | 3 | 0.60 | % | ||||||||||||||||
TRUPS | 30,928 | 200 | 2.60 | % | 30,928 | 178 | 2.31 | % | ||||||||||||||||
Total borrowed funds | 59,589 | 231 | 1.56 | % | 69,166 | 202 | 1.17 | % | ||||||||||||||||
Total interest bearing liabilities | 1,119,347 | 739 | 0.27 | % | 1,099,717 | 651 | 0.24 | % | ||||||||||||||||
Demand deposits - non-interest bearing | 427,581 | 412,874 | ||||||||||||||||||||||
Other liabilities | 14,918 | 12,745 | ||||||||||||||||||||||
Shareholders' equity | 196,206 | 189,012 | ||||||||||||||||||||||
Total liabilities and shareholders' equity | $ | 1,758,052 | $ | 1,714,348 | ||||||||||||||||||||
Interest income/interest earning assets | 4.07 | % | 4.11 | % | ||||||||||||||||||||
Interest expense/interest earning assets | 0.18 | % | 0.17 | % | ||||||||||||||||||||
Net interest income and margin(6) | $ | 15,195 | 3.89 | % | $ | 15,018 | 3.94 | % |
(1) Average balances are obtained from the best available daily or monthly data and are net of deferred fees and related direct costs.
(2) Yields and net interest margin have been computed on a tax equivalent basis utilizing a 35% effective tax rate.
(3) Annualized
(4) Loan costs have been included in the calculation of interest income. Loan costs were approximately $109 thousand and $10 thousand for the quarters ended June 30, 2016 and 2015. Loans are gross of the allowance for possible loan losses.
(5) Non-accrual loans have been included in total loans for purposes of total earning assets.
(6) Net interest margin represents net interest income as a percentage of average interest-earning assets.
35 |
Average Balances and Rates | For the six months ended | For the six months ended | ||||||||||||||||||||||
(dollars in thousands, except per share data) | June 30, 2016 | June 30, 2015 | ||||||||||||||||||||||
Assets | Average Balance (1) | Income/ Expense | Average Rate/Yield (2)(3) | Average Balance (1) | Income/ Expense | Average Rate/Yield (2)(3) | ||||||||||||||||||
Investments: | ||||||||||||||||||||||||
Federal funds sold/Due from time | $ | 12,389 | $ | 32 | 0.51 | % | $ | 13,758 | $ | 18 | 0.26 | % | ||||||||||||
Taxable | 413,424 | 4,199 | 2.01 | % | 407,912 | 4,251 | 2.07 | % | ||||||||||||||||
Non-taxable | 103,261 | 1,460 | 4.30 | % | 98,648 | 1,457 | 4.52 | % | ||||||||||||||||
Equity | 1,215 | 36 | 5.86 | % | 2,118 | 93 | 8.73 | % | ||||||||||||||||
Total Investments | 530,289 | 5,727 | 2.43 | % | 522,436 | 5,819 | 2.51 | % | ||||||||||||||||
Loans and Leases:(4) | ||||||||||||||||||||||||
Real Estate | 775,248 | 19,492 | 5.06 | % | 702,957 | 18,439 | 5.29 | % | ||||||||||||||||
Agricultural | 46,504 | 1,022 | 4.42 | % | 28,093 | 569 | 4.08 | % | ||||||||||||||||
Commercial | 106,293 | 2,477 | 4.69 | % | 108,015 | 2,539 | 4.74 | % | ||||||||||||||||
Consumer | 14,486 | 672 | 9.33 | % | 17,834 | 843 | 9.53 | % | ||||||||||||||||
Mortgage Warehouse Lines | 127,502 | 2,471 | 3.90 | % | 144,954 | 2,694 | 3.75 | % | ||||||||||||||||
Direct Financing Leases | 1,605 | 42 | 5.26 | % | 1,984 | 53 | 5.39 | % | ||||||||||||||||
Other | 1,989 | 64 | 6.47 | % | 2,149 | 63 | 5.91 | % | ||||||||||||||||
Total Loans and Leases | 1,073,627 | 26,240 | 4.91 | % | 1,005,986 | 25,200 | 5.05 | % | ||||||||||||||||
Total Interest Earning Assets (5) | 1,603,916 | 31,967 | 4.11 | % | 1,528,422 | 31,019 | 4.20 | % | ||||||||||||||||
Other Earning Assets | 7,700 | 7,220 | ||||||||||||||||||||||
Non-Earning Assets | 135,831 | 138,073 | ||||||||||||||||||||||
Total Assets | $ | 1,747,447 | $ | 1,673,715 | ||||||||||||||||||||
Liabilities and Shareholders' Equity | ||||||||||||||||||||||||
Interest Bearing Deposits: | ||||||||||||||||||||||||
Demand Deposits | $ | 136,829 | $ | 205 | 0.30 | % | $ | 117,956 | $ | 173 | 0.30 | % | ||||||||||||
NOW | 311,085 | 166 | 0.11 | % | 288,337 | 172 | 0.12 | % | ||||||||||||||||
Savings Accounts | 199,463 | 109 | 0.11 | % | 180,505 | 100 | 0.11 | % | ||||||||||||||||
Money Market | 98,600 | 32 | 0.07 | % | 114,733 | 42 | 0.07 | % | ||||||||||||||||
CDAR's | 7,072 | 2 | 0.06 | % | 11,284 | 4 | 0.07 | % | ||||||||||||||||
Certificates of Deposit<$100,000 | 74,246 | 114 | 0.31 | % | 78,589 | 127 | 0.33 | % | ||||||||||||||||
Certificates of Deposit>$100,000 | 220,985 | 371 | 0.34 | % | 213,093 | 264 | 0.25 | % | ||||||||||||||||
Brokered Deposits | - | - | 0.00 | % | 1,298 | 11 | 1.71 | % | ||||||||||||||||
Total Interest Bearing Deposits | 1,048,280 | 999 | 0.19 | % | 1,005,795 | 893 | 0.18 | % | ||||||||||||||||
Borrowed Funds: | ||||||||||||||||||||||||
Federal Funds Purchased | 700 | 3 | 0.86 | % | 3 | - | - | |||||||||||||||||
Repurchase Agreements | 9,463 | 19 | 0.40 | % | 7,688 | 15 | 0.39 | % | ||||||||||||||||
Short Term Borrowings | 16,640 | 34 | 0.41 | % | 18,008 | 16 | 0.18 | % | ||||||||||||||||
Long Term Borrowings | 615 | - | 0.00 | % | 3,017 | 7 | 0.47 | % | ||||||||||||||||
TRUPS | 30,928 | 402 | 2.61 | % | 30,928 | 352 | 2.30 | % | ||||||||||||||||
Total Borrowed Funds | 58,346 | 458 | 1.58 | % | 59,644 | 390 | 1.32 | % | ||||||||||||||||
Total Interest Bearing Liabilities | 1,106,626 | 1,457 | 0.26 | % | 1,065,439 | 1,283 | 0.24 | % | ||||||||||||||||
Demand deposits- non interest bearing | 431,572 | 404,431 | ||||||||||||||||||||||
Other liabilities | 14,659 | 15,261 | ||||||||||||||||||||||
Shareholders' equity | 194,590 | 188,584 | ||||||||||||||||||||||
Total liabilities and shareholders' equity | $ | 1,747,447 | $ | 1,673,715 | ||||||||||||||||||||
Interest Income/Interest Earning Assets | 4.11 | % | 4.20 | % | ||||||||||||||||||||
Interest Expense/Interest Earning Assets | 0.19 | % | 0.17 | % | ||||||||||||||||||||
Net Interest Income and Margin(6) | $ | 30,510 | 3.92 | % | $ | 29,736 | 4.03 | % |
(1) Average balances are obtained from the best available daily or monthly data and are net of deferred fees and related direct costs.
(2) Yields and net interest margin have been computed on a tax equivalent basis utilizing a 35% effective tax rate.
(3) Annualized
(4) Loan costs have been included in the calculation of interest income. Loan costs were approximately $164 thousand and $360 thousand for the six months ended June 30, 2016 and 2015. Loans are gross of the allowance for possible loan losses.
(5) Non-accrual loans have been included in total loans for purposes of total earning assets.
(6) Net interest margin represents net interest income as a percentage of average interest-earning assets.
36 |
The Volume and Rate Variances table below sets forth the dollar difference for the comparative periods in interest earned or paid for each major category of interest-earning assets and interest-bearing liabilities, and the amount of such change attributable to fluctuations in average balances (volume) or differences in average interest rates. Volume variances are equal to the increase or decrease in average balances multiplied by prior period rates, and rate variances are equal to the change in rates multiplied by prior period average balances. Variances attributable to both rate and volume changes, calculated by multiplying the change in rates by the change in average balances, have been allocated to the rate variance.
Volume & Rate Variances | Three months ended June 30, | Six months ended June 30, | ||||||||||||||||||||||
(dollars in thousands) | 2016 over 2015 | 2016 over 2015 | ||||||||||||||||||||||
Increase(decrease) due to | Increase(decrease) due to | |||||||||||||||||||||||
Assets: | Volume | Rate | Net | Volume | Rate | Net | ||||||||||||||||||
Investments: | ||||||||||||||||||||||||
Federal funds sold / Due from time | $ | (2 | ) | $ | 1 | $ | (1 | ) | $ | (2 | ) | $ | 16 | $ | 14 | |||||||||
Taxable | 59 | (10 | ) | 49 | 57 | (109 | ) | (52 | ) | |||||||||||||||
Non-taxable(1) | 40 | (42 | ) | (2 | ) | 68 | (65 | ) | 3 | |||||||||||||||
Equity | (20 | ) | (28 | ) | (48 | ) | (40 | ) | (17 | ) | (57 | ) | ||||||||||||
Total Investments | 77 | (79 | ) | (2 | ) | 83 | (175 | ) | (92 | ) | ||||||||||||||
Loans and Leases: | ||||||||||||||||||||||||
Real Estate | 806 | (356 | ) | 450 | 1,896 | (843 | ) | 1,053 | ||||||||||||||||
Agricultural | 184 | 30 | 214 | 373 | 80 | 453 | ||||||||||||||||||
Commercial | (17 | ) | 50 | 33 | (40 | ) | (22 | ) | (62 | ) | ||||||||||||||
Consumer | (76 | ) | (63 | ) | (139 | ) | (158 | ) | (13 | ) | (171 | ) | ||||||||||||
Mortgage Warehouse | (390 | ) | 104 | (286 | ) | (324 | ) | 101 | (223 | ) | ||||||||||||||
Direct Financing Leases | (5 | ) | - | (5 | ) | (10 | ) | (1 | ) | (11 | ) | |||||||||||||
Other | - | - | - | (5 | ) | 6 | 1 | |||||||||||||||||
Total Loans and Leases | 502 | (235 | ) | 267 | 1,732 | (692 | ) | 1,040 | ||||||||||||||||
Total Interest Earning Assets | $ | 579 | $ | (314 | ) | $ | 265 | $ | 1,815 | $ | (867 | ) | $ | 948 | ||||||||||
Liabilities | ||||||||||||||||||||||||
Interest Bearing Deposits: | ||||||||||||||||||||||||
Demand Deposits | $ | 14 | $ | 2 | $ | 16 | $ | 28 | $ | 4 | $ | 32 | ||||||||||||
NOW | 6 | (15 | ) | (9 | ) | 14 | (20 | ) | (6 | ) | ||||||||||||||
Savings Accounts | 4 | - | 4 | 11 | (2 | ) | 9 | |||||||||||||||||
Money Market | (3 | ) | (2 | ) | (5 | ) | (6 | ) | (4 | ) | (10 | ) | ||||||||||||
CDAR's | (2 | ) | - | (2 | ) | (1 | ) | (1 | ) | (2 | ) | |||||||||||||
Certificates of Deposit < $100,000 | (3 | ) | (2 | ) | (5 | ) | (7 | ) | (6 | ) | (13 | ) | ||||||||||||
Certificates of Deposit > $100,000 | 1 | 59 | 60 | 10 | 97 | 107 | ||||||||||||||||||
Brokered Deposits | - | - | - | (11 | ) | - | (11 | ) | ||||||||||||||||
Total Interest Bearing Deposits | 17 | 42 | 59 | 38 | 68 | 106 | ||||||||||||||||||
Borrowed Funds: | ||||||||||||||||||||||||
Federal Funds Purchased | - | 3 | 3 | - | 3 | 3 | ||||||||||||||||||
Repurchase Agreements | 2 | (1 | ) | 1 | 3 | 1 | 4 | |||||||||||||||||
Short Term Borrowings | (5 | ) | 11 | 6 | (1 | ) | 19 | 18 | ||||||||||||||||
Long Term Borrowings | (3 | ) | - | (3 | ) | (6 | ) | (1 | ) | (7 | ) | |||||||||||||
TRUPS | - | 22 | 22 | - | 50 | 50 | ||||||||||||||||||
Total Borrowed Funds | (6 | ) | 35 | 29 | (4 | ) | 72 | 68 | ||||||||||||||||
Total Interest Bearing Liabilities | 11 | 77 | 88 | 34 | 140 | 174 | ||||||||||||||||||
Net Interest Margin/Income | $ | 568 | $ | (391 | ) | $ | 177 | $ | 1,781 | $ | (1,007 | ) | $ | 774 |
(1) Yields on tax exempt income have not been computed on a tax equivalent basis.
37 |
The volume variance calculated for the second quarter of 2016 relative to the second quarter of 2015 was a favorable $568,000, due to an increase of $45 million, or 3%, in the average balance of interest-earning assets resulting from growth in loans and investments. The rate variance for the second quarter comparison was an unfavorable $391,000, due to a drop of four basis points in our yield on earning assets relative to a three basis point increase in the cost of interest-bearing liabilities. Our yield on interest-earning assets is down because investment yields have dropped due to the reinvestment of portfolio cash flows in a historically low interest rate environment, and the weighted average yield on loans is lower due to the impact of continued competition on loan rates and a small drop in non-recurring interest income. Nonrecurring interest income, primarily in the form of interest recovered on non-accrual loans net of interest reversed on loans placed on non-accrual status, totaled $22,000 in the second quarter of 2016 relative to $45,000 in the second quarter of 2015. Our weighted average cost of interest-bearing liabilities increased slightly because of higher interest rates paid on trust-preferred securities (“TRUPS”) and large time deposits. The unfavorable rate variance was exacerbated by the allocation of the variance attributable to both rate and volume changes (as per the calculations noted above), and also by the volume differential between our interest-earning assets and interest-bearing liabilities. That differential averaged $468 million for the second quarter of 2015, the base period for the rate variance calculation, thus the decrease in our earning asset yield was applied to a much higher balance than rate changes for interest-bearing liabilities and had a greater impact on net interest income.
The Company’s net interest margin, which is tax-equivalent net interest income as a percentage of average interest-earning assets, was affected by the same factors discussed above relative to rate and volume variances. Our net interest margin was 3.89% in the second quarter of 2016, a drop of five basis points relative to the second quarter of 2015. The principal development affecting our net interest margin in the second quarter of 2016 was lower yields on loans and investments.
For net interest income in the first half of 2016 relative to the first half of 2015, a favorable variance of $1.781 million attributable to volume changes was partially offset by an unfavorable rate variance of $1.007 million. The volume variance for the half was due primarily to an increase of $75 million, or 5%, in average interest-earning assets, which was enhanced by strong growth in the average balance of loans relative to lower-yielding investments. As with the quarter, the negative rate variance for the half is the result of declining yields on earning assets relative to a slightly higher weighted average rate on interest-bearing liabilities. In addition to competitive pressures on loan rates, the year-to-date rate variance was impacted by nonrecurring interest income, with totaled only $65,000 for the first six months of 2016 but added $411,000 to interest income for the first six months of 2015. The unfavorable rate variance was also intensified by the allocation of variances attributable to both rate and volume changes, and the fact that the decrease in our yield on earning assets was applied to a much higher balance than the rate change for interest-bearing liabilities. The Company’s net interest margin for the first half of 2016 was 3.92%, a drop of 11 basis points relative to our net interest margin for the first half of 2015.
Provision for loan and LEASE losses
Credit risk is inherent in the business of making loans. The Company sets aside an allowance for loan and lease losses, a contra-asset account, through periodic charges to earnings which are reflected in the income statement as the provision for loan and lease losses. A loan loss provision has not been necessary thus far in 2016, nor was a provision recorded in 2015.
The Company’s loan loss provision has been sufficient to maintain our allowance for loan and lease losses at a level that, in Management’s judgment, is adequate to absorb probable loan losses related to specifically-identified impaired loans as well as probable incurred losses in the remaining loan portfolio. Specifically identifiable and quantifiable loan losses are immediately charged off against the allowance. The Company had $12,000 in net recoveries on charged off balances in the second quarter of 2016 relative to $169,000 in net loans charged off in the second quarter of 2015, and net charge-offs were $381,000 in the first six months of 2016 relative to $699,000 in the first six months of 2015. A loan loss provision has not been recorded in recent periods due to the following factors: we had net recoveries on charged off loans in the second quarter of 2016, which went back into the allowance for loan and lease losses; loan charge-offs for several preceding periods were primarily recorded against pre-established reserves, which alleviated what otherwise might have been a need for reserve replenishment; growth in our performing loan portfolio has been concentrated in loan types with low historical loss rates, thus having a positive impact on general reserves for performing loans; and, new loans booked since the great recession have been underwritten using tighter credit standards than was the case for many legacy loans. Partially offsetting these favorable factors in the second quarter of 2016 was the transfer of certain energy-related credits into a higher-risk credit quality classification, with elevated historical loss rates applied in calculating loss reserves.
38 |
The Company’s policies for monitoring the adequacy of the allowance and determining loan amounts that should be charged off, and other detailed information with regard to changes in the allowance, are discussed in note 12 to the consolidated financial statements and below under “Allowance for Loan and Lease Losses.” The process utilized to establish an appropriate allowance for loan and lease losses can result in a high degree of variability in the Company’s loan loss provision, and consequently in our net earnings.
NON-INTEREST INCOME and NON-INTEREST expense
The following table provides details on the Company’s non-interest income and non-interest expense for the three-month and six-month periods ended June 30, 2016 and 2015:
Non Interest Income/Expense
(dollars in thousands, unaudited)
For the three months ended June 30, | For the six months ended June 30, | |||||||||||||||||||||||||||||||
2016 | % of Total | 2015 | % of Total | 2016 | % of Total | 2015 | % of Total | |||||||||||||||||||||||||
NON-INTEREST INCOME: | ||||||||||||||||||||||||||||||||
Service charges on deposit accounts | $ | 2,478 | 54.18 | % | $ | 2,278 | 48.95 | % | $ | 4,848 | 54.66 | % | $ | 4,269 | 49.29 | % | ||||||||||||||||
Other service charges, commissions & fees | 1,783 | 38.98 | % | 1,750 | 37.60 | % | 3,593 | 40.52 | % | 3,472 | 40.09 | % | ||||||||||||||||||||
Gains on securities | 146 | 3.19 | % | 307 | 6.60 | % | 122 | 1.38 | % | 323 | 3.73 | % | ||||||||||||||||||||
Bank owned life insurance | 229 | 5.01 | % | 231 | 4.96 | % | 439 | 4.95 | % | 588 | 6.79 | % | ||||||||||||||||||||
Other | (62 | ) | -1.36 | % | 88 | 1.89 | % | (134 | ) | -1.51 | % | 9 | 0.10 | % | ||||||||||||||||||
Total non-interest income | $ | 4,574 | 100.00 | % | $ | 4,654 | 100.00 | % | $ | 8,868 | 100.00 | % | $ | 8,661 | 100.00 | % | ||||||||||||||||
As a % of average interest-earning assets (1) | 1.14 | % | 1.19 | % | 1.12 | % | 1.14 | % | ||||||||||||||||||||||||
OTHER OPERATING EXPENSE: | ||||||||||||||||||||||||||||||||
Salaries and employee benefits | $ | 6,624 | 48.28 | % | $ | 6,125 | 48.04 | % | $ | 13,490 | 49.61 | % | $ | 13,020 | 49.67 | % | ||||||||||||||||
Occupancy costs | ||||||||||||||||||||||||||||||||
Furniture & equipment | 596 | 4.35 | % | 504 | 3.95 | % | 1,163 | 4.28 | % | 1,011 | 3.86 | % | ||||||||||||||||||||
Premises | 1,270 | 9.26 | % | 1,162 | 9.11 | % | 2,454 | 9.02 | % | 2,315 | 8.83 | % | ||||||||||||||||||||
Advertising and marketing costs | 695 | 5.07 | % | 681 | 5.34 | % | 1,184 | 4.35 | % | 1,245 | 4.75 | % | ||||||||||||||||||||
Data processing costs | 861 | 6.28 | % | 858 | 6.73 | % | 1,627 | 5.98 | % | 1,697 | 6.47 | % | ||||||||||||||||||||
Deposit services costs | 861 | 6.28 | % | 759 | 5.95 | % | 1,722 | 6.33 | % | 1,549 | 5.91 | % | ||||||||||||||||||||
Loan services costs | ||||||||||||||||||||||||||||||||
Loan processing | 192 | 1.40 | % | 227 | 1.78 | % | 359 | 1.32 | % | 484 | 1.85 | % | ||||||||||||||||||||
Foreclosed assets | 319 | 2.33 | % | 92 | 0.72 | % | 450 | 1.65 | % | 237 | 0.90 | % | ||||||||||||||||||||
Other operating costs | ||||||||||||||||||||||||||||||||
Telephone & data communications | 366 | 2.67 | % | 510 | 4.00 | % | 749 | 2.75 | % | 979 | 3.74 | % | ||||||||||||||||||||
Postage & mail | 226 | 1.65 | % | 252 | 1.98 | % | 453 | 1.67 | % | 452 | 1.72 | % | ||||||||||||||||||||
Other | 230 | 1.68 | % | 212 | 1.66 | % | 386 | 1.42 | % | 379 | 1.45 | % | ||||||||||||||||||||
Professional services costs | ||||||||||||||||||||||||||||||||
Legal & accounting | 425 | 3.10 | % | 376 | 2.95 | % | 850 | 3.13 | % | 709 | 2.70 | % | ||||||||||||||||||||
Acquistion Cost | 128 | 0.93 | % | (11 | ) | -0.09 | % | 342 | 1.26 | % | 101 | 0.39 | % | |||||||||||||||||||
Other professional service | 487 | 3.55 | % | 508 | 3.98 | % | 868 | 3.19 | % | 943 | 3.60 | % | ||||||||||||||||||||
Stationery & supply costs | 231 | 1.68 | % | 325 | 2.55 | % | 650 | 2.39 | % | 661 | 2.52 | % | ||||||||||||||||||||
Sundry & tellers | 204 | 1.49 | % | 171 | 1.35 | % | 447 | 1.65 | % | 429 | 1.64 | % | ||||||||||||||||||||
Total non-interest expense | $ | 13,715 | 100.00 | % | $ | 12,751 | 100.00 | % | $ | 27,194 | 100.00 | % | $ | 26,211 | 100.00 | % | ||||||||||||||||
As a % of average interest-earning assets (1) | 3.42 | % | 3.26 | % | 3.43 | % | 3.46 | % | ||||||||||||||||||||||||
Efficiency Ratio (2) | 68.10 | % | 64.13 | % | 67.51 | % | 66.91 | % |
(1) Annualized
(2) Tax Equivalent
Total non-interest income declined by $80,000, or 2%, for the quarterly comparison, but increased by $207,000, or 2%, for the comparative year-to-date periods. Both the second quarter and the first six months of 2016 saw a higher level of customer activity that generated additional fee income, but experienced lower gains on the sale of investment securities and a drop in dividends on our FHLB stock. For the year-to-date comparison, income on bank-owned life insurance (“BOLI”) also declined. Total non-interest income was an annualized 1.14% of average interest-earning assets in the second quarter of 2016 relative to 1.19% in the second quarter of 2015, and was 1.12% for the first six months of 2016 relative to 1.14% for the first six months of 2015. The ratio fell slightly due primarily to a higher level of average interest-earning assets.
39 |
Service charge income on deposits increased by $200,000, or 9%, for the quarterly comparison and by $579,000, or 14%, for the year-to-date comparison, due primarily to fees earned from increased activity on commercial accounts and higher overdraft income. Other service charges, commissions, and fees also increased by $33,000, or 2%, for the second quarter and $121,000, or 3%, for the first six months, largely as a result of higher debit card interchange income. Gains realized on the sale of investment securities totaled $146,000 in the second quarter of 2016 relative to $307,000 in the second quarter of 2015, for a decline of $161,000, or 52%. For the first half, investment gains totaled $122,000 in 2016 compared to $323,000 in 2015, representing a drop of $201,000, or 62%.
BOLI income was down only $2,000 in the second quarter of 2016 relative to the second quarter of 2015, but dropped by $149,000, or 25%, for the year-to-date comparison due to lower crediting rates, a drop in net cash surrender values, and fluctuations in income on BOLI associated with deferred compensation plans. The Company owns and derives income from two basic types of BOLI: “general account” and “separate account.” At June 30, 2016 the Company had $38.7 million invested in single-premium general account BOLI, down from $39.3 million at the end of 2015 due to certain policies that were paid out in the first quarter of 2016. General account BOLI generates income that is used to fund expenses associated with executive salary continuation plans, director retirement plans and other employee benefits. Interest credit rates on general account BOLI do not change frequently and the income is typically fairly consistent, but rate reductions have led to slightly lower income in recent periods. In addition to general account BOLI, at June 30, 2016 the Company had $5.1 million invested in separate account BOLI, which produces income that helps offset expense accruals for deferred compensation accounts the Company maintains for certain directors and senior officers. Those accounts have returns pegged to participant-directed investment allocations that can include equity, bond, or real estate indices, and are thus subject to gains or losses which often contribute to significant fluctuations in income (and associated expense accruals). There was a gain on separate account BOLI totaling $36,000 in the second quarter of 2016 relative to a loss of $15,000 in the second quarter of 2015, for an absolute difference of $51,000. For the first half, there was an $11,000 gain in 2016 compared to a gain of $109,000 in 2015, resulting in a decline in income of $98,000. As noted, gains and losses on separate account BOLI are related to expense accruals or reversals associated with participant gains and losses on deferred compensation balances, thus their impact on taxable income tends to be minimal.
The “Other” category under non-interest income reflects reductions of $150,000 for the quarter and $143,000 for the year-to-date period. This line item includes gains and losses on the disposition of assets other than OREO, rent on bank-owned property other than OREO, dividends on restricted stock, and other miscellaneous income. Pass-through expenses associated with our investments in low-income housing tax credit funds are netted against this category. The largest unfavorable impact on 2016 over 2015 variances in “Other” non-interest income was the result of a $245,000 special dividend received on our FHLB stock in the second quarter of 2015 and not repeated in 2016, although that reduction was partially offset by higher debit card interchange income and dividends received on other non-listed stock in 2016.
Total non-interest expense increased by $964,000, or 8%, in the second quarter of 2016 relative to the second quarter of 2015, and by $983,000, or 4%, for the first half of 2016 compared to the first half of 2015. As detailed below there were several significant fluctuations within non-interest expense, including items of a non-recurring nature. Because of the increase in total non-interest expense, it rose to an annualized 3.42% of average interest-earning assets in the second quarter of 2016 relative to 3.26% in the second quarter of 2015. However, due to a sizeable increase in the denominator, non-interest expense fell slightly as an annualized percentage of average interest earning assets for the six-month comparison despite the 4% increase in total expense.
The largest component of non-interest expense, salaries and employee benefits, increased by $499,000, or 8%, for the second quarter of 2016 over the second quarter of 2015, and by $470,000, or 4%, for the first six months of 2016 compared to the first six months of 2015. The higher level of salaries and benefits was the result of salary increases in the normal course of business, higher staffing levels as vacant positions were filled, and temporary salaries and overtime costs incurred in preparation for our recent acquisition (totaling roughly $80,000 for the quarter and $120,000 for the year-to-date period), partially offset by lower group health insurance costs. For the second quarter comparison, personnel expense was also adversely impacted by a $98,000 drop in the level of deferred salaries directly related to successful loan originations (which increases current period expense), as well as an increase of $55,000 in deferred compensation expense accruals associated with the aforementioned increase in separate account BOLI income. The first half comparison was impacted by a $50,000 increase in equity incentive compensation costs due to stock options issued to Company officers during the first quarter of 2016. Total salaries and benefits increased slightly as a percentage of total non-interest expense for the comparative quarters, but dropped slightly for the year-to-date comparison.
40 |
Occupancy expense was up $200,000, or 12%, for the quarter, and $291,000, or 9%, for the first six months due primarily to rent escalations in the normal course of business, office renovations in recent periods, and our loan production office which opened in May 2015. Marketing costs were up slightly for the second quarter of 2016 but down slightly for the first six months, due to the timing of payments. Data processing costs did not change materially for the second quarter, but were down $70,000, or 4%, for the first six months due to ongoing efforts to manage network and other information technology costs. Total deposit services costs increased by $102,000, or 13%, for the quarterly comparison and by $173,000, or 11%, for the first six months due primarily to activity-related increases in debit card processing costs.
Loan processing costs were reduced by $35,000, or 15%, for the comparative quarters and $125,000, or 26%, for the first six months. The reduction for the quarter is due mainly to lower inspection costs, while the year-to-date decrease also reflects declining collection and foreclosure costs. Net costs associated with foreclosed assets, on the other hand, increased by $227,000, or 247%, in the second quarter of 2016 relative to the second quarter of 2015, and by $213,000, or 90%, in the first half of 2016 as compared to the first half of 2015, due in large part to higher OREO write-downs and operating expense.
Telecommunications expense was reduced by $144,000, or 28%, in the second quarter of 2016 relative to the second quarter of 2015 and by $230,000, or 23%, for the year-to-date period due to focused efforts to increase efficiencies in this area, although a portion of the reduction represents non-recurring credits received from prior period overbillings. Postage costs fell by by $26,000, or 10%, for the quarterly comparison due to a reduced number of compliance mailings, but year-to-date postage expense was roughly the same in 2016 as in 2015. The “Other” category under other operating costs increased slightly for both the second quarter and first half.
Under professional services costs, legal and accounting costs increased by $49,000, or 13%, in the second quarter of 2016 and by $141,000, or 20%, for the first six months due to rising costs for both internal and independent audits as well as higher legal expense. Non-recurring acquisition costs totaled $128,000 in the second quarter of 2016 relative to a credit of $11,000 in the second quarter of 2015, and they were $342,000 for the first half of 2016 as compared to $101,000 in the first half of 2015. The cost of other professional services fell by $21,000, or 4%, for the second quarter and by $75,000, or 8%, for the first half. The drop for the quarter was primarily due to a lower FDIC assessment. The reduction for the first half includes a non-recurring expense reversal of $173,000 in director retirement plan accruals in the first quarter of 2016, subsequent to the death of a former director and the payment of split-dollar life insurance proceeds to his beneficiary, and an $83,000 drop in deferred compensation costs for directors related to the aforementioned year-to-date drop in separate account BOLI income. The favorable variances for the year-to-date comparison were partially offset by $101,000 in equity incentive compensation costs for stock options issued to our directors during the first quarter of 2016.
Stationery and supply costs fell by $94,000, or 29%, for the second quarter and by $11,000, or 2%, for the first six months, with the reduction for the quarter stemming from the timing of payments as well as from costs incurred in previous periods for the rollout of chipped debit cards incorporating EMV technology. Sundry and teller losses were up $33,000, or 19%, for the second quarter of 2016 relative to the second quarter of 2015, and increased by $18,000, or 4%, for the first half of 2016 in comparison to the first half of 2015. The increase for the quarter was due to higher debit card losses and higher operations-related losses in our branch system, and the increase for the year-to-date comparison came from higher operations-related losses that were partially offset by a reduction in debit card losses.
Due to the increase in overhead expense, the Company’s tax-equivalent overhead efficiency ratio increased to 68.10% in the second quarter of 2016 from 64.13% in the second quarter of 2015, and to 67.51% for the first six months of 2016 from 66.91% for the first six months of 2015. The overhead efficiency ratio represents total non-interest expense divided by the sum of fully tax-equivalent net interest and non-interest income, with the provision for loan losses and investment gains/losses excluded from the equation.
The Company sets aside a provision for income taxes on a monthly basis. The amount of that provision is determined by first applying the Company’s statutory income tax rates to estimated taxable income, which is pre-tax book income adjusted for permanent differences, and then subtracting available tax credits. Permanent differences include but are not limited to tax-exempt interest income, BOLI income, and certain book expenses that are not allowed as tax deductions. Our tax credits consist primarily of those generated by investments in low-income housing tax credit funds, and California state employment tax credits.
41 |
The Company’s provision for income taxes was 33% of pre-tax income in the second quarter of 2016 relative to 34% in the second quarter of 2015, and 33% in the first half of 2016 as compared to 32% in the first half of 2015. The tax accrual rate fell for the second quarter comparison due to lower pre-tax income and a slightly higher level of tax credits. Since pre-tax income was almost the same in the first half of 2016 as in the first half of 2015, the higher tax provisioning for the first half comparison is the result of a lower level of available tax credits and lower non-taxable BOLI income.
The Company’s interest-earning assets are comprised of investments and loans, and the composition, growth characteristics, and credit quality of both are significant determinants of the Company’s financial condition. Investments are analyzed in the section immediately below, while the loan and lease portfolio and other factors affecting earning assets are discussed in the sections following investments.
The Company’s investments can at any given time consist of debt securities and marketable equity securities (together, the “investment portfolio”), investments in the time deposits of other banks, surplus interest-earning balances in our Federal Reserve Bank (“FRB”) account, and overnight fed funds sold. Surplus FRB balances and fed funds sold to correspondent banks represent the temporary investment of excess liquidity. The Company’s investments serve several purposes: 1) they provide liquidity to even out cash flows from the loan and deposit activities of customers; 2) they provide a source of pledged assets for securing public deposits, bankruptcy deposits and certain borrowed funds which require collateral; 3) they constitute a large base of assets with maturity and interest rate characteristics that can be changed more readily than the loan portfolio, to better match changes in the deposit base and other funding sources of the Company; 4) they are another interest-earning option for surplus funds when loan demand is light; and 5) they can provide partially tax exempt income. Aggregate investments totaled $530 million, or 29% of total assets at June 30, 2016, compared to $510 million, or 28% of total assets at December 31, 2015.
We had no fed funds sold at June 30, 2016 or December 31, 2015, and interest-bearing balances at other banks dropped to $1 million at June 30, 2016 from $2 million at December 31, 2015 due to the timing of cash flows in and out of our FRB account. The Company’s investment portfolio had a book balance of $529 million at June 30, 2016, reflecting an increase of $21 million, or 4%, for the first half of 2016 due to the investment of excess liquidity. The Company carries investments at their fair market values. Although we currently have the intent and ability to hold our investment securities 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. The expected average life for all bonds in our investment portfolio was 3.6 years and their average effective duration was 2.2 as of June 30, 2016, both down slightly relative to year-end 2015.
The following table sets forth the amortized cost and fair market value of Company’s investment portfolio by investment type as of the dates noted:
Investment Portfolio | ||||||||||||||||
(dollars in thousands, unaudited) | June 30, 2016 | December 31, 2015 | ||||||||||||||
Amortized | Fair Market | Amortized | Fair Market | |||||||||||||
Cost | Value | Cost | Value | |||||||||||||
Available for Sale | ||||||||||||||||
US Government agencies & corporations | $ | 24,466 | $ | 24,872 | $ | 28,801 | $ | 29,042 | ||||||||
Mortgage-backed securities | 391,345 | 394,614 | 374,683 | 375,061 | ||||||||||||
State & political subdivisions | 103,433 | 107,926 | 99,093 | 102,183 | ||||||||||||
Other securities | 500 | 1,127 | 575 | 1,296 | ||||||||||||
Total investment securities | $ | 519,744 | $ | 528,539 | $ | 503,152 | $ | 507,582 |
42 |
The net unrealized gain on our investment portfolio, or the difference between the fair market value and amortized cost, was $8.8 million at June 30, 2016, up from $4.4 million at December 31, 2015 due to lower long-term interest rates. The balance of US Government agency securities declined $4 million, or 14%, during the first six months due to bond maturities. Mortgage-backed securities increased by almost $20 million, or 5%, as bond purchases and increases in market value exceeded prepayments. Municipal bond balances were also up by almost $6 million, or 6%, due again to bond purchases and increases in market value. It should be noted that municipal bonds purchased in recent periods have strong underlying ratings, and all municipal bonds in our portfolio are evaluated quarterly for potential impairment. The balance of other securities fell by $169,000, or 13%, due primarily to the liquidation of one of our equity positions at a gain during the second quarter of 2016.
Investment portfolio securities that were pledged as collateral for Federal Home Loan Bank borrowings, repurchase agreements, public deposits and other purposes as required or permitted by law totaled $179 million at June 30, 2016 and $180 million at December 31, 2015, leaving $348 million in unpledged debt securities at June 30, 2016 and $326 million at December 31, 2015. Securities that were pledged in excess of actual pledging needs and were thus available for liquidity purposes, if needed, totaled $55 million at June 30, 2016 and $57 million at December 31, 2015.
The Company’s loans and leases, gross of the associated allowance for losses and deferred fees and origination costs, totaled $1.155 billion at June 30, 2016, an increase of $22 million, or 2%, since December 31, 2015. The increase came primarily in the latter part of the second quarter, more than offsetting the decline experienced in the first quarter of 2016 from lower utilization on mortgage warehouse lines and a relatively high level of prepayments.
A distribution of the Company’s loans showing the balance and percentage of loans by type is presented for the noted periods in the table below. The balances shown are before deferred or unamortized loan origination, extension, or commitment fees, and deferred origination costs. While not reflected in the loan totals and not currently comprising a material segment of our lending activities, the Company also occasionally originates and sells, or participates out portions of, loans to non-affiliated investors.
43 |
Loan and Lease Distribution | ||||||||
(dollars in thousands, unaudited) | June 30, 2016 | December 31, 2015 | ||||||
Real Estate: | ||||||||
1-4 family residential construction | $ | 16,939 | $ | 14,941 | ||||
Other construction/land | 38,390 | 37,359 | ||||||
1-4 family - closed-end | 135,458 | 137,356 | ||||||
Equity lines | 40,824 | 44,233 | ||||||
Multi-family residential | 31,434 | 27,222 | ||||||
Commercial real estate- owner occupied | 212,199 | 218,708 | ||||||
Commercial real estate- non-owner occupied | 174,776 | 165,107 | ||||||
Farmland | 132,140 | 133,182 | ||||||
Total real estate | 782,160 |