UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

[X]Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the quarterly period ended JuneSeptember 30, 2016

 

[]Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the transition period                    to                    

Commission File Number: 0-26486

 

 

Auburn National Bancorporation, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

  Delaware  63-0885779  
  

(State or other jurisdiction of

incorporation or organization)

  

(I.R.S. Employer

Identification No.)

  

100 N. Gay Street

Auburn, Alabama 36830

(334) 821-9200

(Address and telephone number of principal executive offices)

(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.

Yesx                                             No¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, 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).

Yesx                                             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. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated filer ¨  Accelerated filer ¨  Non-accelerated filer ¨    Smaller reporting company x
  (Do not check if a smaller reporting company)

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

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

 

Class   Outstanding at July 28,October 27, 2016
Common Stock, $0.01 par value per share   3,643,5033,643,523 shares


AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

INDEX

 

PART I.  FINANCIAL INFORMATION

     PAGE 

 

 

Item 1

 Financial Statements    
  

Consolidated Balance Sheets (Unaudited)
as of JuneSeptember 30, 2016 and December 31, 2015

       3  
  

Consolidated Statements of Earnings (Unaudited)
for the quarter and sixnine months ended JuneSeptember 30, 2016 and 2015

       4  
  

Consolidated Statements of Comprehensive Income (Unaudited)
for the quarter and sixnine months ended JuneSeptember 30, 2016 and 2015

       5  
  

Consolidated Statements of Stockholders’ Equity (Unaudited)
for the sixnine months ended JuneSeptember 30, 2016 and 2015

       6  
  

Consolidated Statements of Cash Flows (Unaudited)
for the sixnine months ended JuneSeptember 30, 2016 and 2015

       7  
  

Notes to Consolidated Financial Statements (Unaudited)

       8  

Item 2

 Management’s Discussion and Analysis of Financial Condition and Results of Operations     2931  
  Table 1 – Explanation of Non-GAAP Financial Measures     4750  
  Table 2 – Selected Quarterly Financial Data     4851  
  Table 3 – Selected Financial Data     4952  
  Table 4 – Average Balances and Net Interest Income Analysis – for the quarter ended JuneSeptember 30, 2016 and 2015     5053  
  Table 5 – Average Balances and Net Interest Income Analysis – for the sixnine months ended JuneSeptember 30, 2016 and 2015     5154  
  Table 6 – Loan Portfolio Composition     5255  
  Table 7 – Allowance for Loan Losses and Nonperforming Assets     5356  
  Table 8 – Allocation of Allowance for Loan Losses     5457  
  Table 9 – CDs and Other Time Deposits of $100,000 or more     5558  

Item 3

 Quantitative and Qualitative Disclosures About Market Risk     5659  

Item 4

 Controls and Procedures     5659  

PART II.  OTHER INFORMATION

    

Item 1

 Legal Proceedings     5659  

Item 1A

 Risk Factors     5659  

Item 2

 Unregistered Sales of Equity Securities and Use of Proceeds     5659  

Item 3

 Defaults Upon Senior Securities     5659  

Item 4

 Mine Safety Disclosures     5659  

Item 5

 Other Information     5659  

Item 6

 Exhibits     5760  


PART 1. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(Unaudited)

 

(Dollars in thousands, except share data)  

June 30,

2016

 

December 31,

2015

   September 30,
2016
 

December 31,

2015

 

 

 

Assets:

      

Cash and due from banks

  $11,872   $9,806      $14,171   $9,806    

Federal funds sold

   48,571   57,395       33,047   57,395    

Interest bearing bank deposits

   103,977   46,729       94,061   46,729    

 

 

Cash and cash equivalents

   164,420   113,930       141,279   113,930   

 

 

Securities available-for-sale

   217,002   241,687       249,556   241,687    

Loans held for sale

   1,567   1,540       701   1,540    

Loans, net of unearned income

   430,694   426,410       427,203   426,410    

Allowance for loan losses

   (4,528 (4,289)      (4,578 (4,289)   

 

 

Loans, net

   426,166   422,121       422,625   422,121    

 

 

Premises and equipment, net

   11,710   11,866       12,697   11,866    

Bank-owned life insurance

   17,658   17,433       17,772   17,433    

Other real estate owned

   300   252       37   252    

Other assets

   7,233   8,360       7,005   8,360    

 

 

Total assets

  $846,056   $817,189      $851,672   $817,189    

 

 

Liabilities:

      

Deposits:

      

Noninterest-bearing

  $167,741   $156,817      $179,576   $156,817    

Interest-bearing

   579,798   566,810       572,339   566,810    

 

 

Total deposits

   747,539   723,627       751,915   723,627    

Federal funds purchased and securities sold under agreements to repurchase

   2,578   2,951       3,507   2,951    

Long-term debt

   7,217   7,217       7,217   7,217    

Accrued expenses and other liabilities

   3,914   3,445       3,978   3,445    

 

 

Total liabilities

   761,248   737,240       766,617   737,240    

 

 

Stockholders’ equity:

      

Preferred stock of $.01 par value; authorized 200,000 shares; no issued shares

   —      —         —      —      

Common stock of $.01 par value; authorized 8,500,000 shares; issued 3,957,135 shares

   39   39       39   39    

Additional paid-in capital

   3,767   3,766       3,767   3,766    

Retained earnings

   83,327   80,845       84,459   80,845    

Accumulated other comprehensive income, net

   4,313   1,937       3,428   1,937    

Less treasury stock, at cost - 313,632 shares and 313,657 shares at June 30, 2016 and December 31, 2015, respectively

   (6,638 (6,638)   

Less treasury stock, at cost - 313,612 shares and 313,657 shares at September 30, 2016 and December 31, 2015, respectively

   (6,638 (6,638)   

 

 

Total stockholders’ equity

   84,808   79,949       85,055   79,949    

 

 

Total liabilities and stockholders’ equity

  $          846,056   $          817,189      $          851,672   $          817,189    

 

 

See accompanying notes to consolidated financial statements

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Statements of Earnings

(Unaudited)

 

 Quarter ended June 30, Six Months Ended June 30,  Quarter ended September 30, Nine months ended September 30, 
(In thousands, except share and per share data) 2016 2015 2016 2015  2016 2015 2016 2015 

 

 

Interest income:

            

Loans, including fees

 

$

 5,172   $5,217   $ 10,268   $10,223    

$

 5,105   $5,090   $ 15,373   $15,313   

Securities:

            

Taxable

  775   949    1,673   1,989     747   939    2,420   2,928   

Tax-exempt

  623   654    1,248   1,305     616   664    1,864   1,969   

Federal funds sold and interest bearing bank deposits

  156   51    282   90     191   57    473   147   

 

 

Total interest income

  6,726   6,871    13,471   13,607     6,659   6,750    20,130   20,357   

 

 

Interest expense:

            

Deposits

  967   1,020    1,948   2,122     984   1,017    2,932   3,139   

Short-term borrowings

  3   4    7   10     4   4    11   14   

Long-term debt

  64   59    127   164     63   59    190   223   

 

 

Total interest expense

  1,034   1,083    2,082   2,296     1,051   1,080    3,133   3,376   

 

 

Net interest income

  5,692   5,788    11,389   11,311     5,608   5,670    16,997   16,981   

Provision for loan losses

   —      —      (600  —        —     200    (600 200   

 

 

Net interest income after provision for loan losses

  5,692   5,788    11,989   11,311     5,608   5,470    17,597   16,781   

 

 

Noninterest income:

            

Service charges on deposit accounts

  193   209    391   415     197   209    588   624   

Mortgage lending

  315   457    494   791     246   362    740   1,153   

Bank-owned life insurance

  113   112    225   513     114   116    339   629   

Other

  372   389    717   766     358   358    1,075   1,124   

Securities gains, net

   —      —       —         148   11    148   14   

 

 

Total noninterest income

  993   1,167    1,827   2,488     1,063   1,056    2,890   3,544   

 

 

Noninterest expense:

            

Salaries and benefits

  2,446   2,291    4,851   4,559     2,471   2,255    7,322   6,814   

Net occupancy and equipment

  358   362    718   720     389   405    1,107   1,125   

Professional fees

  194   218    405   419     220   191    625   610   

FDIC and other regulatory assessments

  122   118    244   243     76   120    320   363   

Other real estate owned, net

  (43 1    (23 18     (194 1    (217 19   

Prepayment penalties on long-term debt

   —      —       —     362      —      —       —     362   

Other

  944   1,039    1,935   2,022     1,018   920    2,953   2,942   

 

 

Total noninterest expense

  4,021   4,029    8,130   8,343     3,980   3,892    12,110   12,235   

 

 

Earnings before income taxes

  2,664   2,926    5,686   5,456     2,691   2,634    8,377   8,090   

Income tax expense

  733   776    1,564   1,444     740   724    2,304   2,168   

 

 

Net earnings

 

$

 1,931   $2,150   $ 4,122   $4,012    

$

 1,951   $1,910   $ 6,073   $5,922   

 

 

Net earnings per share:

            

Basic and diluted

 

$

 0.53   $0.59   $ 1.13   $1.10    

$

 0.54   $0.52   $ 1.67   $1.63   

 

 

Weighted average shares outstanding:

            

Basic and diluted

  3,643,503       3,643,413    3,643,493       3,643,389     3,643,506   3,643,455    3,643,498   3,643,411   

 

 

See accompanying notes to consolidated financial statements

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Unaudited)

 

         Quarter ended June 30,             Six Months Ended June 30,                Quarter ended September 30,             Nine months ended September 30,       
(Dollars in thousands)   2016 2015 2016 2015    2016 2015 2016 2015 

 

 

Net earnings

 $   1,931   $2,150   $ 4,122   $4,012     $   1,951   $1,910   $ 6,073   $5,922   

Other comprehensive income (loss), net of tax:

       

Unrealized net holding gain (loss) on securities

    810   (1,842  2,376   (1,156)   

Other comprehensive (loss) income, net of tax:

       

Unrealized net holding (loss) gain on securities

    (792 1,444    1,584   288   

Reclassification adjustment for net gain on securities recognized in net earnings

    —      —       —     (2)       (93 (7  (93 (9)  

 

 

Other comprehensive income (loss)

    810   (1,842  2,376   (1,158)   

Other comprehensive (loss) income

    (885 1,437    1,491   279   

 

 

Comprehensive income

 $   2,741   $308   $ 6,498   $2,854     $   1,066   $3,347   $ 7,564   $6,201   

 

 

See accompanying notes to consolidated financial statements

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

(Unaudited)

 

         Accumulated              Accumulated     
     Additional   other          Additional   other     
 Common Stock paid-in Retained comprehensive Treasury    Common Stock paid-in Retained comprehensive Treasury   
(Dollars in thousands, except share data) Shares Amount capital earnings income stock Total  Shares Amount capital earnings income stock Total 

 

 

Balance, December 31, 2014

 3,957,135   $39    $          3,763   $          76,193   $        2,443   $(6,639 $          75,799     3,957,135   $39   $          3,763   $          76,193   $        2,443   $(6,639 $          75,799    

Net earnings

  —                 —        —      4,012    —                     —      4,012      —                 —       —      5,922    —                     —      5,922    

Other comprehensive loss

  —       —        —       —      (1,158  —      (1,158)     —       —       —       —      279    —      279    

Cash dividends paid ($0.44 per share)

  —       —        —      (1,603  —       —      (1,603)   

Sale of treasury stock (100 shares)

  —       —       2    —       —      1   3    

Cash dividends paid ($0.66 per share)

  —       —       —      (2,405  —       —      (2,405)   

Sale of treasury stock (150 shares)

  —       —      3    —       —      1   4    

 

 

Balance, June 30, 2015

 3,957,135   $39   $3,765   $78,602   $1,285   $(6,638 $77,053    

Balance, September 30, 2015

 3,957,135   $39   $3,766   $79,710   $2,722   $(6,638 $79,599    

 

 

Balance, December 31, 2015

 3,957,135   $39   $3,766   $80,845   $1,937   $(6,638 $79,949     3,957,135   $39   $3,766   $80,845   $1,937   $(6,638 $79,949    

Net earnings

  —       —        —      4,122    —       —      4,122      —       —       —      6,073    —       —      6,073    

Other comprehensive income

  —       —        —       —      2,376    —      2,376      —       —       —       —      1,491    —      1,491    

Cash dividends paid ($0.45 per share)

  —       —        —      (1,640  —       —      (1,640)   

Sale of treasury stock (25 shares)

  —       —       1    —       —       —      1    

Cash dividends paid ($0.675 per share)

  —       —       —      (2,459  —       —      (2,459)   

Sale of treasury stock (45 shares)

  —       —      1    —       —       —      1    

 

 

Balance, June 30, 2016

 3,957,135   $39   $3,767   $83,327   $4,313   $(6,638 $84,808    

Balance, September 30, 2016

 3,957,135   $39   $3,767   $84,459   $3,428   $(6,638 $85,055    

 

 

See accompanying notes to consolidated financial statements

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)

 

     Six Months Ended June 30,          Nine months ended September 30,     
(In thousands) 2016 2015  2016 2015 

 

 

Cash flows from operating activities:

      

Net earnings

 

$

 4,122   $4,012     

$

 6,073   $5,922    

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

      

Provision for loan losses

  (600  —        (600 200    

Depreciation and amortization

  544   545      876   863    

Premium amortization and discount accretion, net

  692   804      1,137   1,186    

Net gain on securities available-for-sale

   —     (3)     (148 (14)   

Net gain on sale of loans held for sale

  (367 (644)     (609 (942)   

Increase (decrease) in MSR valuation allowance

  1   (39)     21   (52)   

Net (gain) loss on other real estate owned

  (43 5      (238 6    

Loss on prepayment of long-term debt

   —     362       —     362    

Loans originated for sale

  (20,327 (38,404)     (33,331 (55,956)   

Proceeds from sale of loans

  20,523   36,883      34,537   54,882    

Increase in cash surrender value of bank-owned life insurance

  (225 (237)     (339 (353)   

Income recognized from death benefit on bank-owned life insurance

   —     (276)      —     (276)   

Net (increase) decrease in other assets

  (425 237    

Net increase (decrease) in accrued expenses and other liabilities

  510   (84)   

Net decrease in other assets

  196   293    

Net increase in accrued expenses and other liabilities

  577   280    

 

 

Net cash provided by operating activities

  4,405   3,161      8,152   6,401    

 

 

Cash flows from investing activities:

      

Proceeds from sales of securities available-for-sale

  5,126    —      

Proceeds from maturities of securities available-for-sale

  30,922   16,698      50,934   23,981    

Purchase of securities available-for-sale

  (3,164 (4,637)     (62,556 (7,249)   

Increase in loans, net

  (3,693 (5,491)     (189 (19,527)   

Net purchases of premises and equipment

  (57 (415)     (1,173 (1,189)   

Proceeds from bank-owned life insurance death benefit

   —     1,319       —     1,319    

(Increase) decrease in FHLB stock

  (25 191      (25 191    

Proceeds from sale of other real estate owned

  203   30      695   250    

 

 

Net cash provided by investing activities

  24,186   7,695    

Net cash used in investing activities

  (7,188 (2,224)   

 

 

Cash flows from financing activities:

      

Net increase in noninterest-bearing deposits

  10,924   19,576      22,759   25,454    

Net increase in interest-bearing deposits

  12,988   3,028      5,529   5,467    

Net decrease in federal funds purchased and securities sold under agreements to repurchase

  (373 (1,769)   

Net increase (decrease) in federal funds purchased and securities sold under agreements to repurchase

  556   (1,234)   

Repayments or retirement of long-term debt

   —     (5,362)      —     (5,362)   

Dividends paid

  (1,640 (1,603)     (2,459 (2,405)   

 

 

Net cash provided by financing activities

  21,899   13,870      26,385   21,920    

 

 

Net change in cash and cash equivalents

  50,490   24,726      27,349   26,097    

Cash and cash equivalents at beginning of period

  113,930   83,503      113,930   83,503    

 

 

Cash and cash equivalents at end of period

 

$

 164,420   $108,229     

$

 141,279   $109,600    

 

 
      

 

 

Supplemental disclosures of cash flow information:

      

Cash paid during the period for:

      

Interest

 

$

 2,062   $2,366     

$

 3,193   $3,503    

Income taxes

  1,403   1,241      1,703   1,803    

Supplemental disclosure of non-cash transactions:

      

Real estate acquired through foreclosure

  248    —        285    —      

 

 

See accompanying notes to consolidated financial statements

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

General

Auburn National Bancorporation, Inc. (the “Company”) provides a full range of banking services to individual and corporate customers in Lee County, Alabama and surrounding counties through its wholly owned subsidiary, AuburnBank (the “Bank”). The Company does not have any segments other than banking that are considered material.

Basis of Presentation and Use of Estimates

The unaudited consolidated financial statements in this report have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information. Accordingly, these financial statements do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The unaudited consolidated financial statements include, in the opinion of management, all adjustments necessary to present a fair statement of the financial position and the results of operations for all periods presented. All such adjustments are of a normal recurring nature. The results of operations in the interim statements are not necessarily indicative of the results of operations that the Company and its subsidiaries may achieve for future interim periods or the entire year. For further information, refer to the consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

The unaudited consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Auburn National Bancorporation Capital Trust I is an affiliate of the Company and was included in these unaudited consolidated financial statements pursuant to the equity method of accounting. Significant intercompany transactions and accounts are eliminated in consolidation.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term include other-than-temporary impairment on investment securities, the determination of the allowance for loan losses, fair value of financial instruments, and the valuation of deferred tax assets and other real estate owned.

Subsequent Events

The Company has evaluated the effects of events and transactions through the date of this filing that have occurred subsequent to JuneSeptember 30, 2016. The Company does not believe there were any material subsequent events during this period that would have required further recognition or disclosure in the unaudited consolidated financial statements included in this report.report except as reported in Note 9, Subsequent Events.

Accounting Developments

In the first quarter of 2016, the Company adopted new guidance related to the following Accounting Standards Updates (“Updates” or “ASUs”):

 

  ASU 2015-02,Amendments to the Consolidation Analysis;

 

  ASU 2015-03,Simplifying the Presentation of Debt Issuance Costs; and

 

  ASU 2015-05,Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement.

Information about these pronouncements is described in more detail below.

ASU 2015-02,Amendments to the Consolidation Analysis,, affects reporting entities that are required to evaluate whether they should consolidate certain legal entities. Specifically, the amendments: (1) Modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities (“VIEs”) or voting interest entities; (2) Eliminate the presumption that a general partner should consolidate a limited partnership; (3) Affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships; and (4) Provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. Adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

ASU 2015-03,Simplifying the Presentation of Debt Issuance Costs, requires that debt issuance costs related to a recognized debt liability be presented on the balance sheet as a direct deduction from the debt liability, rather than as an asset. Adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

ASU 2015-05,Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The new guidance does not change the accounting for a customer’s accounting for service contracts. Adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

NOTE 2: BASIC AND DILUTED NET EARNINGS PER SHARE

Basic net earnings per share is computed by dividing net earnings by the weighted average common shares outstanding for the respective period. Diluted net earnings per share reflect the potential dilution that could occur upon exercise of securities or other rights for, or convertible into, shares of the Company’s common stock. At JuneSeptember 30, 2016 and 2015, respectively, the Company had no such securities or rights issued or outstanding, and therefore, no dilutive effect to consider for the diluted earnings per share calculation.

The basic and diluted net earnings per share computations for the respective periods are presented below.

 

  Quarter ended June 30,   Six Months Ended June 30,   Quarter ended September 30,   Nine months ended September 30, 
(In thousands, except share and per share data)  2016   2015   2016   2015   2016   2015   2016   2015 

 

 

Basic and diluted:

                

Net earnings

  $1,931    $2,150    $4,122    $4,012    $1,951    $1,910    $6,073    $5,922  

Weighted average common shares outstanding

       3,643,503         3,643,413         3,643,493         3,643,389         3,643,506         3,643,455         3,643,498         3,643,411  

 

 

Net earnings per share

  $0.53    $0.59    $1.13    $1.10    $0.54    $0.52    $1.67    $1.63  

 

 

NOTE 3: VARIABLE INTEREST ENTITIES

Generally, a variable interest entity (“VIE”) is a corporation, partnership, trust, or other legal structure that does not have equity investors with substantive or proportional voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities.

At JuneSeptember 30, 2016, the Company did not have any consolidated VIEs to disclose but did have one nonconsolidated VIE, discussed below.

Trust Preferred Securities

The Company owns the common stock of a subsidiary business trust, Auburn National Bancorporation Capital Trust I, which issued mandatorily redeemable preferred capital securities (“trust preferred securities”) in the aggregate of approximately $7.0 million at the time of issuance. This trust meets the definition of a VIE of which the Company is not the primary beneficiary; the trust’s only assets are junior subordinated debentures issued by the Company, which were acquired by the trust using the proceeds from the issuance of the trust preferred securities and common stock. The junior subordinated debentures of approximately $7.2 million are included in long-term debt and the Company’s equity interest of $0.2 million in the business trust is included in other assets. Interest expense on the junior subordinated debentures is included in interest expense on long-term debt.

The following table summarizes VIEs that are not consolidated by the Company as of JuneSeptember 30, 2016.

 

(Dollars in thousands)  

Maximum

 

Loss Exposure

   

Liability

 

Recognized

                       Classification                      

 

 

Type:

      

Trust preferred issuances

   N/A     $7,217     Long-term debt  

 

 

NOTE 4: SECURITIES

At JuneSeptember 30, 2016 and December 31, 2015, respectively, all securities within the scope of Accounting Standards Codification (“ASC”) 320,Investments – Debt and Equity Securities,were classified as available-for-sale. The fair value and amortized cost for securities available-for-sale by contractual maturity at JuneSeptember 30, 2016 and December 31, 2015, respectively, are presented below.

 

 

 

 

 
  1 year  1 to 5  5 to 10  After 10  Fair  Gross Unrealized  Amortized 
(Dollars in thousands) or less  years  years  years  Value  Gains  Losses  Cost 

 

 

June 30, 2016

        

Agency obligations (a)

 $        3,113          23,136        16,390        —           42,639            943              —      $    41,696    

Agency RMBS (a)

  —       1,265    20,223    81,391    102,879    2,132      —       100,747    

State and political subdivisions

  —       2,004    11,440    58,040    71,484    3,759      —       67,725    

 

 

Total available-for-sale

 $3,113      26,405    48,053    139,431    217,002    6,834      —      $210,168    

 

 

December 31, 2015

        

Agency obligations (a)

 $5,000    25,852    19,463    9,770    60,085    384      518     $60,219    

Agency RMBS (a)

  —       1,623    13,511    95,820    110,954    968      780      110,766    

State and political subdivisions

  —       497    12,094    58,057    70,648    3,022      7      67,633    

 

 

Total available-for-sale

 $5,000    27,972    45,068    163,647    241,687    4,374      1,305     $238,618    

 

 

(a) Includes securities issued by U.S. government agencies or government sponsored entities.

 

 

 

 
  1 year  1 to 5  5 to 10  After 10  Fair  Gross Unrealized  Amortized 
(Dollars in thousands) or less  years  years  years  Value  Gains  Losses  Cost 

 

 

September 30, 2016

        

Agency obligations (a)

 $        3,080           17,889        20,856        —          41,825            634              40     $    41,231    

Agency RMBS (a)

  —         1,109    18,820    113,336    133,265    1,967      75      131,373    

State and political subdivisions

  —         1,990    11,788    60,688    74,466    2,990      45      71,521    

 

 

Total available-for-sale

 $3,080       20,988    51,464    174,024    249,556    5,591      160     $244,125    

 

 

December 31, 2015

        

Agency obligations (a)

 $5,000       25,852    19,463    9,770    60,085    384      518     $60,219    

Agency RMBS (a)

  —         1,623    13,511    95,820    110,954    968      780      110,766    

State and political subdivisions

  —         497    12,094    58,057    70,648    3,022      7      67,633    

 

 

Total available-for-sale

 $5,000       27,972    45,068    163,647    241,687    4,374      1,305     $238,618    

 

 

(a) Includes securities issued by U.S. government agencies or government sponsored entities.

  

Securities with aggregate fair values of $155.2$143.6 million and $133.3 million at JuneSeptember 30, 2016 and December 31, 2015, respectively, were pledged to secure public deposits, securities sold under agreements to repurchase, Federal Home Loan Bank (“FHLB”) advances, and for other purposes required or permitted by law.

Included in other assets are cost-method investments. The carrying amounts of cost-method investments were $1.4 million at JuneSeptember 30, 2016 and December 31, 2015, respectively. Cost-method investments primarily include non-marketable equity investments, such as FHLB of Atlanta stock and Federal Reserve Bank (“FRB”) stock.

Gross Unrealized Losses and Fair Value

The Company had no gross unrealized losses at June 30, 2016. The fair values and gross unrealized losses on securities at September 30, 2016 and December 31, 2015, respectively, segregated by those securities that have been in an unrealized loss position for less than 12 months and 12 months or longer, are presented below.

 

   Less than 12 Months   12 Months or Longer   Total    Less than 12 Months   12 Months or Longer   Total 
(Dollars in thousands)   

 

Fair

 

Value

   

Unrealized  

 

Losses

   

Fair

 

Value

   

Unrealized  

 

Losses

   

Fair

 

Value

   

Unrealized  

 

Losses

    

 

Fair

 

Value

   

Unrealized  

 

Losses

   

Fair

 

Value

   

Unrealized  

 

Losses

   

Fair

 

Value

   

Unrealized  

 

Losses

 

 

September 30, 2016:

              

Agency obligations

 

$

   10,747     40     —       —     $   10,747     40  

Agency RMBS

    31,374     75     —       —        31,374     75  

State and political subdivisions

    6,155     45     —       —        6,155     45  

 

Total

 

$

       48,276         160         —           —     $       48,276         160  

 

 

December 31, 2015:

                            

Agency obligations

 

$

   8,157     2     24,444     516   $   32,601     518   

$

   8,157     2     24,444     516   $   32,601     518  

Agency RMBS

    42,345     367     18,184     413      60,529     780      42,345     367     18,184     413      60,529     780  

State and political subdivisions

    267     1     969     6      1,236     7      267     1     969     6      1,236     7  

 

 

Total

 

$

       50,769         370         43,597         935   $       94,366         1,305   

$

   50,769     370     43,597     935   $   94,366     1,305  

 

 

For the securities in the previous table, the Company does not have the intent to sell and has determined it is not more likely than not that the Company will be required to sell the security before recovery of the amortized cost basis, which may be maturity. On a quarterly basis, the Company assesses each security for credit impairment. For debt securities, the Company evaluates, where necessary, whether credit impairment exists by comparing the present value of the expected cash flows to the securities’ amortized cost basis. For cost-method investments, the Company evaluates whether an event or change in circumstances has occurred during the reporting period that may have a significant adverse effect on the fair value of the investment.

In determining whether a loss is temporary, the Company considers all relevant information including:

the length of time and the extent to which the fair value has been less than the amortized cost basis;

adverse conditions specifically related to the security, an industry, or a geographic area (for example, changes in the financial condition of the issuer of the security, or in the case of an asset-backed debt security, in the financial condition of the underlying loan obligors, including changes in technology or the discontinuance of a segment of the business that may affect the future earnings potential of the issuer or underlying loan obligors of the security or changes in the quality of the credit enhancement);

the historical and implied volatility of the fair value of the security;

the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future;

failure of the issuer of the security to make scheduled interest or principal payments;

any changes to the rating of the security by a rating agency; and

recoveries or additional declines in fair value subsequent to the balance sheet date.

Agency obligations

The unrealized losses associated with agency obligations were primarily driven by changes in interest rates and not due to the credit quality of the securities. These securities were issued by U.S. government agencies or government-sponsored entities and did not have any credit losses given the explicit government guarantee or other government support.

Agency RMBS

The unrealized losses associated with agency residential mortgage-backed securities (“RMBS”) were primarily driven by changes in interest rates and not due to the credit quality of the securities. These securities were issued by U.S. government agencies or government-sponsored entities and did not have any credit losses given the explicit government guarantee or other government support.

Securities of U.S. states and political subdivisions

The unrealized losses associated with securities of U.S. states and political subdivisions were primarily driven by changes in interest rates and were not due to the credit quality of the securities. Some of these securities are guaranteed by a bond insurer, but management did not rely on the guarantee in making its investment decision. These securities will continue to be monitored as part of the Company’s quarterly impairment analysis, but are expected to perform even if the rating agencies reduce the credit rating of the bond insurers. As a result, the Company expects to recover the entire amortized cost basis of these securities.

Cost-method investments

At JuneSeptember 30, 2016, cost-method investments with an aggregate cost of $1.4 million were not evaluated for impairment because the Company did not identify any events or changes in circumstances that may have a significant adverse effect on the fair value of these cost-method investments.

The carrying values of the Company’s investment securities could decline in the future if the financial condition of an issuer deteriorates and the Company determines it is probable that it will not recover the entire amortized cost basis for the security. As a result, there is a risk that other-than-temporary impairment charges may occur in the future.

Other-Than-Temporarily Impaired Securities

Credit-impaired debt securities are debt securities where the Company has written down the amortized cost basis of a security for other-than-temporary impairment and the credit component of the loss is recognized in earnings. At JuneSeptember 30, 2016 and December 31, 2015, the Company had no credit-impaired debt securities and there were no additions or reductions in the credit loss component of credit-impaired debt securities during the sixnine months ended JuneSeptember 30, 2016 and 2015, respectively.

Realized Gains and Losses

The following table presents the gross realized gains and losses on sales of securities.

 

         Quarter ended June 30,               Six Months Ended June 30,              Quarter ended September 30,               Nine months ended September 30,       
(Dollars in thousands) 2016   2015   2016   2015  2016   2015   2016    2015 

 

 

Gross realized gains

 

$

   —       —           —      $      3     

$

 148     11     148    $ 14  

 

 

Realized gains, net

 

$

   —       —           —      $      3     

$

 148     11     148    $ 14  

 

 

NOTE 5: LOANS AND ALLOWANCE FOR LOAN LOSSES

 

(In thousands)  

June 30,

 

2016

   

December 31,

 

2015

   

September 30,

 

2016

   

December 31,

 

2015

 

 

 

Commercial and industrial

  $50,190     $52,479     $50,881     $52,479   

Construction and land development

   49,346      43,694      44,004      43,694   

Commercial real estate:

        

Owner occupied

   47,600      46,602      46,427      46,602   

Multi-family

   43,279      45,264      45,799      45,264   

Other

   117,946      111,987      119,332      111,987   

 

 

Total commercial real estate

   208,825      203,853      211,558      203,853   

Residential real estate:

        

Consumer mortgage

   68,077      70,009      67,238      70,009   

Investment property

   45,686      46,664      45,065      46,664   

 

 

Total residential real estate

   113,763      116,673      112,303      116,673   

Consumer installment

   9,125      10,220      8,996      10,220   

 

 

Total loans

   431,249      426,919      427,742      426,919   

Less: unearned income

   (555)     (509)     (539)     (509)  

 

 

Loans, net of unearned income

  $        430,694     $        426,410     $        427,203     $        426,410   

 

 

Loans secured by real estate were approximately 86.2%86.0% of the Company’s total loan portfolio at JuneSeptember 30, 2016. At JuneSeptember 30, 2016, the Company’s geographic loan distribution was concentrated primarily in Lee County, Alabama, and surrounding areas.

In accordance with ASC 310, a portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for loan losses. As part of the Company’s quarterly assessment of the allowance, the loan portfolio is disaggregated into the following portfolio segments: commercial and industrial, construction and land development, commercial real estate, residential real estate, and consumer installment. Where appropriate, the Company’s loan portfolio segments are further disaggregated into classes. A class is generally determined based on the initial measurement attribute, risk characteristics of the loan, and an entity’s method for monitoring and determining credit risk.

The following describe the risk characteristics relevant to each of the portfolio segments and classes.

Commercial and industrial (“C&I”) —includes loans to finance business operations, equipment purchases, or other needs for small and medium-sized commercial customers. Also included in this category are loans to finance agricultural production. Generally, the primary source of repayment is the cash flow from business operations and activities of the borrower.

Construction and land development (“C&D”) —includes both loans and credit lines for the purpose of purchasing, carrying, and developing land into commercial developments or residential subdivisions. Also included are loans and credit lines for construction of residential, multi-family, and commercial buildings. Generally, the primary source of repayment is dependent upon the sale or refinance of the real estate collateral.

Commercial real estate (CRE)includes loans disaggregated into three classes: (1) owner occupied, (2) multifamily and (3) other.

 

  Owner occupied – includes loans secured by business facilities to finance business operations, equipment and owner-occupied facilities primarily for small and medium-sized commercial customers. Generally, the primary source of repayment is the cash flow from business operations and activities of the borrower, who owns the property.

 

  Multi-family – primarily includes loans to finance income-producing multi-family properties. Loans in this class include loans for 5 or more unit residential property and apartments leased to residents. Generally, the primary source of repayment is dependent upon income generated from the real estate collateral. The underwriting of these loans takes into consideration the occupancy and rental rates, as well as the financial health of the borrower.

 

  Other – primarily includes loans to finance income-producing commercial properties that are not owner occupied. Loans in this class include loans for neighborhood retail centers, hotels, medical and professional offices, single retail stores, industrial buildings, and warehouses leased to local businesses. Generally, the primary source of repayment is dependent upon income generated from the real estate collateral. The underwriting of these loans takes into consideration the occupancy and rental rates, as well as the financial health of the borrower.

Residential real estate (“RRE”) —includes loans disaggregated into two classes: (1) consumer mortgage and (2) investment property.

 

  Consumer mortgage – primarily includes first or second lien mortgages and home equity lines of credit to consumers that are secured by a primary residence or second home. These loans are underwritten in accordance with the Bank’s general loan policies and procedures which require, among other things, proper documentation of each borrower’s financial condition, satisfactory credit history, and property value.

 

  Investment property – primarily includes loans to finance income-producing 1-4 family residential properties. Generally, the primary source of repayment is dependent upon income generated from leasing the property securing the loan. The underwriting of these loans takes into consideration the rental rates and property value, as well as the financial health of the borrower.

Consumer installment —includes loans to individuals both secured by personal property and unsecured. Loans include personal lines of credit, automobile loans, and other retail loans. These loans are underwritten in accordance with the Bank’s general loan policies and procedures which require, among other things, proper documentation of each borrower’s financial condition, satisfactory credit history, and, if applicable, property value.

The following is a summary of current, accruing past due, and nonaccrual loans by portfolio segment and class as of JuneSeptember 30, 2016 and December 31, 2015.

 

(In thousands)  Current   

Accruing

 

30-89 Days

 

Past Due

   

Accruing

 

Greater than

 

90 days

   

Total

 

Accruing

 

Loans

   

Non-

 

Accrual

   

Total

 

Loans

   Current   

Accruing

 

30-89 Days

 

Past Due

   

Accruing

 

Greater than

 

90 days

   

Total

 

Accruing

 

Loans

   

Non-

 

Accrual

   

Total

 

Loans

 

    

    

June 30, 2016:

             

September 30, 2016:

             

Commercial and industrial

  $50,125     25     —       50,150     40    $   50,190     $50,840     3     —       50,843     38   $   50,881  

Construction and land development

   49,291     —       —       49,291     55       49,346      43,959     —       —       43,959     45      44,004  

Commercial real estate:

                          

Owner occupied

   47,600     —       —       47,600     —         47,600      46,427     —       —       46,427     —        46,427  

Multi-family

   43,279     —       —       43,279     —         43,279      45,799     —       —       45,799     —        45,799  

Other

   116,382     —       —       116,382     1,564       117,946      117,811     —       —       117,811     1,521      119,332  

 

 

Total commercial real estate

   207,261     —       —       207,261     1,564       208,825      210,037     —       —       210,037     1,521      211,558  

Residential real estate:

                          

Consumer mortgage

   67,510     557     —       68,067     10       68,077      66,705     312     211     67,228     10      67,238  

Investment property

   45,598     88     —       45,686     —         45,686      45,008     57     —       45,065     —        45,065  

 

 

Total residential real estate

   113,108     645     —       113,753     10       113,763      111,713     369     211     112,293     10      112,303  

Consumer installment

   9,074     51     —       9,125     —         9,125      8,956     40     —       8,996     —        8,996  

 

 

Total

  $428,859     721     —       429,580     1,669    $   431,249     $425,505     412     211     426,128     1,614   $   427,742  

 

 

December 31, 2015:

                          

Commercial and industrial

  $52,387     49     —       52,436     43    $   52,479     $52,387     49     —       52,436     43   $   52,479  

Construction and land development

   43,111     —       —       43,111     583       43,694      43,111     —       —       43,111     583      43,694  

Commercial real estate:

                          

Owner occupied

   46,372     —       —       46,372     230       46,602      46,372     —       —       46,372     230      46,602  

Multi-family

   45,264     —       —       45,264     —         45,264      45,264     —       —       45,264     —        45,264  

Other

   110,467     —       —       110,467     1,520       111,987      110,467     —       —       110,467     1,520      111,987  

 

 

Total commercial real estate

   202,103     —       —       202,103     1,750       203,853      202,103     —       —       202,103     1,750      203,853  

Residential real estate:

                          

Consumer mortgage

   68,579     1,105     —       69,684     325       70,009      68,579     1,105     —       69,684     325      70,009  

Investment property

   46,435     229     —       46,664     —         46,664      46,435     229     —       46,664     —        46,664  

 

 

Total residential real estate

   115,014     1,334     —       116,348     325       116,673      115,014     1,334     —       116,348     325      116,673  

Consumer installment

   10,179     28     —       10,207     13       10,220      10,179     28     —       10,207     13      10,220  

 

 

Total

  $        422,794     1,411     —       424,205     2,714    $       426,919     $        422,794     1,411     —       424,205     2,714   $       426,919  

 

 

Allowance for Loan Losses

The Company assesses the adequacy of its allowance for loan losses prior to the end of each calendar quarter. The level of the allowance is based upon management’s evaluation of the loan portfolio, past loan loss experience, current asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect a borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan loss rates, and other pertinent factors, including regulatory recommendations. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Loans are charged off, in whole or in part, when management believes that the full collectability of the loan is unlikely. A loan may be partially charged-off after a “confirming event” has occurred, which serves to validate that full repayment pursuant to the terms of the loan is unlikely.

The Company deems loans 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. Collection of all amounts due according to the contractual terms means that both the interest and principal payments of a loan will be collected as scheduled in the loan agreement.

An impairment allowance is recognized if the fair value of the loan is less than the recorded investment in the loan. The impairment is recognized through the allowance. Loans that are impaired are recorded at the present value of expected future cash flows discounted at the loan’s effective interest rate, or if the loan is collateral dependent, the impairment measurement is based on the fair value of the collateral, less estimated disposal costs.

The level of allowance maintained is believed by management to be adequate to absorb probable losses inherent in the portfolio at the balance sheet date. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries of amounts previously charged-off.

In assessing the adequacy of the allowance, the Company also considers the results of its ongoing internal and independent loan review processes. The Company’s loan review process assists in determining whether there are loans in the portfolio whose credit quality has weakened over time and evaluating the risk characteristics of the entire loan portfolio. The Company’s loan review process includes the judgment of management, the input from our independent loan reviewers, and reviews that may have been conducted by bank regulatory agencies as part of their examination process. The Company incorporates loan review results in the determination of whether or not it is probable that it will be able to collect all amounts due according to the contractual terms of a loan.

As part of the Company’s quarterly assessment of the allowance, management divides the loan portfolio into five segments: commercial and industrial, construction and land development, commercial real estate, residential real estate, and consumer installment. The Company analyzes each segment and estimates an allowance allocation for each loan segment.

The allocation of the allowance for loan losses begins with a process of estimating the probable losses inherent for each loan segment. The estimates for these loans are established by category and based on the Company’s internal system of credit risk ratings and historical loss data. The Company calculates average losses for all loan segments using a rolling 20 quarter historical period. The estimated loan loss allocation rate for the Company’s internal system of credit risk grades is based on its experience with similarly graded loans. For loan segments where the Company believes it does not have sufficient historical loss data, the Company may make adjustments based, in part, on loss rates of peer bank groups. At JuneSeptember 30, 2016 and December 31, 2015, and for the periods then ended, the Company adjusted its historical loss rates for the commercial real estate portfolio segment based, in part, on loss rates of peer bank groups.

The estimated loan loss allocation for all five loan portfolio segments is then adjusted for management’s estimate of probable losses for several “qualitative and environmental” factors. The allocation for qualitative and environmental factors is particularly subjective and does not lend itself to exact mathematical calculation. This amount represents estimated probable inherent credit losses which exist, but have not yet been identified, as of the balance sheet date, and are based upon quarterly trend assessments in delinquent and nonaccrual loans, credit concentration changes, prevailing economic conditions, changes in lending personnel experience, changes in lending policies or procedures, and other influencing factors. These qualitative and environmental factors are considered for each of the five loan segments and the allowance allocation, as determined by the processes noted above, is increased or decreased based on the incremental assessment of these factors.

The following table details the changes in the allowance for loan losses by portfolio segment for the respective periods.

 

  June 30, 2016   September 30, 2016 
  

 

 

   

 

 

 
(In thousands)  Commercial and
industrial
 Construction
and land
development
 Commercial
real estate
  Residential 
real estate
 Consumer
   installment   
   Total   Commercial and
industrial
 Construction
and land
development
 Commercial
real estate
 Residential
real estate
 Consumer
   installment   
   Total 

 

 

Quarter ended:

          

Beginning balance

  $517   695   2,403   1,026   133       $4,774     $506   744   2,092   1,061   125       $4,528   

Charge-offs

   (83  —     (194 (37 (2 (316)     —      —      —     (7 (1 (8)  

Recoveries

   3   5    —     58   4   70      3   5    —     49   1   58   

 

 

Net (charge-offs) recoveries

   (80 5   (194 21   2   (246)  

Net recoveries

   3   5    —     42    —     50   

Provision for loan losses

   69   44   (117 14   (10  —         6   (76 140   (83 13    —     

 

 

Ending balance

  $506   744   2,092   1,061   125       $4,528     $515   673   2,232   1,020   138       $4,578   

 

 

Six months ended:

     

Nine months ended:

     

Beginning balance

  $523   669   1,879   1,059   159       $4,289     $523   669   1,879   1,059   159       $4,289   

Charge-offs

   (83  —     (194 (155 (28 (460)     (83  —     (194 (162 (29 (468)  

Recoveries

   23   1,203    —     65   8   1,299      26   1,207    —     115   9   1,357   

 

 

Net (charge-offs) recoveries

   (60 1,203   (194 (90 (20 839      (57 1,207   (194 (47 (20 889   

Provision for loan losses

   43   (1,128 407   92   (14 (600)     49   (1,203 547   8   (1 (600)  

 

 

Ending balance

  $506   744   2,092   1,061   125       $            4,528     $515   673   2,232   1,020   138       $            4,578  

 

 
  June 30, 2015   September 30, 2015 
  

 

 

   

 

 

 
(In thousands)  Commercial and
industrial
 Construction
and land
development
 Commercial
real estate
 Residential
real estate
 Consumer
installment
   Total   Commercial and
industrial
 Construction
and land
development
 Commercial
real estate
 Residential
real estate
 Consumer
installment
 Total 

 

 

Quarter ended:

          

Beginning balance

  $644   830   1,888   1,153   207       $4,722     $681   640   2,146   1,180   239       $4,886   

Charge-offs

   —      —      —      —     (5 (5)     —      —      —     (26 (23 (49)  

Recoveries

   3   4    —     151   11   169      13   4    —     71   2   90   

 

 

Net recoveries (charge-offs)

   3   4    —     151   6   164      13   4    —     45   (21 41   

Provision for loan losses

   34   (194 258   (124 26    —        (190 (17 533   (122 (4 200   

 

 

Ending balance

  $681   640   2,146   1,180   239       $4,886     $504   627   2,679   1,103   214       $5,127   

 

 

Six months ended:

     

Nine months ended:

     

Beginning balance

  $639   974   1,928   1,119   176       $4,836     $639   974   1,928   1,119   176       $4,836   

Charge-offs

   (58  —     —    (59 (23 (140)     (58  —     —    (86 (45 (189)  

Recoveries

   4   9    —    165   12   190      17   13    —    236   14   280   

 

 

Net (charge-offs) recoveries

   (54 9    —    106   (11 50      (41 13    —    150   (31 91   

Provision for loan losses

   96   (343 218   (45 74    —       (94 (360 751   (166 69   200   

 

 

Ending balance

  $681   640   2,146   1,180   239       $4,886     $504   627   2,679   1,103   214       $5,127   

 

 

The following table presents an analysis of the allowance for loan losses and recorded investment in loans by portfolio segment and impairment methodology as of JuneSeptember 30, 2016 and 2015.

 

 Collectively evaluated (1) Individually evaluated (2) Total  Collectively evaluated (1) Individually evaluated (2) Total 
 

 

  Allowance  

 

 

Recorded

 

 

   Allowance   

 

 

Recorded

 

 

   Allowance   

 

 

Recorded

 

  

 

  Allowance  

 Recorded    Allowance    Recorded    Allowance    Recorded 
 

for loan

 

 

   investment   

 

 

for loan

 

 

   investment   

 

 

for loan

 

 

    investment    

 

  

 

for loan

 

 

   investment   

 

 

for loan

 

 

   investment   

 

 

for loan

 

 

    investment    

 
(In thousands) losses in loans losses in loans losses in loans  

 

losses

 

 

in loans

 

 

losses

 

 

in loans

 

 

losses

 

 

in loans

 

 

 

June 30, 2016:

       

September 30, 2016:

       

Commercial and industrial

 $ 506   50,159     —     31    506   50,190    $ 515   50,858     —     23   515   50,881   

Construction and land development

  744   49,291     —     55    744   49,346     673   43,959     —     45   673   44,004   

Commercial real estate

  1,995   206,258    97   2,567    2,092   208,825     2,196   209,840    36   1,718   2,232   211,558   

Residential real estate

  1,061   113,763     —      —      1,061   113,763     1,020   112,303     —      —     1,020   112,303   

Consumer installment

  125   9,125     —      —      125   9,125     138   8,996     —      —     138   8,996   

 

 

Total

 $ 4,431   428,596    97   2,653    4,528   431,249    $ 4,542   425,956    36   1,786   4,578   427,742   

 

 

June 30, 2015:

       

September 30, 2015:

       

Commercial and industrial

 $ 681   57,246     —     64    681   57,310    $ 504   47,869     —     56   504   47,925   

Construction and land development

  640   38,252     —     602    640   38,854     627   40,999     —     593   627  �� 41,592   

Commercial real estate

  1,672   182,465    474   1,659    2,146   184,124     1,719   197,693    960   3,756   2,679   201,449   

Residential real estate

  1,180   115,039     —      —      1,180   115,039     1,103   117,863     —      —     1,103   117,863   

Consumer installment

  239   13,632     —      —      239   13,632     214   14,362     —      —     214   14,362   

 

 

Total

 $ 4,412   406,634    474   2,325    4,886   408,959    $ 4,167   418,786    960   4,405   5,127   423,191   

 

 

 

(1)Represents loans collectively evaluated for impairment in accordance with ASC 450-20,Loss Contingencies (formerly FAS 5), and pursuant to amendments by ASU 2010-20 regarding allowance for non-impaired loans. 
(2)Represents loans individually evaluated for impairment in accordance with ASC 310-30,Receivables (formerly FAS 114), and pursuant to amendments by ASU 2010-20 regarding allowance for impaired loans. 

Credit Quality Indicators

The credit quality of the loan portfolio is summarized no less frequently than quarterly using categories similar to the standard asset classification system used by the federal banking agencies. The following table presents credit quality indicators for the loan portfolio segments and classes. These categories are utilized to develop the associated allowance for loan losses using historical losses adjusted for qualitative and environmental factors and are defined as follows:

 

Pass – loans which are well protected by the current net worth and paying capacity of the obligor (or guarantors, if any) or by the fair value, less cost to acquire and sell, of any underlying collateral.

 

Special Mention – loans with potential weakness that may, if not reversed or corrected, weaken the credit or inadequately protect the Company’s position at some future date. These loans are not adversely classified and do not expose an institution to sufficient risk to warrant an adverse classification.

 

Substandard Accruing – loans that exhibit a well-defined weakness which presently jeopardizes debt repayment, even though they are currently performing. These loans are characterized by the distinct possibility that the Company may incur a loss in the future if these weaknesses are not corrected.

 

Nonaccrual – includes loans where management has determined that full payment of principal and interest is not expected.

(In thousands)  Pass         Special        
Mention        
 Substandard
Accruing
     Nonaccrual       Total loans       Pass         Special        
Mention        
 Substandard
Accruing
     Nonaccrual       Total loans     

 

 

June 30, 2016:

       

September 30, 2016:

       

Commercial and industrial

  $46,015    3,850    285   40     $50,190     $46,784    3,703    356   38     $50,881   

Construction and land development

   48,873    53    365   55      49,346      43,554    53    352   45      44,004   

Commercial real estate:

              

Owner occupied

   46,874    275    451    —        47,600      45,456    528    443    —        46,427   

Multi-family

   43,279     —       —      —        43,279      45,799     —       —      —        45,799   

Other

   115,568    354    460   1,564      117,946      117,006    64    741   1,521      119,332   

 

 

Total commercial real estate

   205,721    629    911   1,564      208,825      208,261    592    1,184   1,521      211,558   

Residential real estate:

              

Consumer mortgage

   62,702    2,501    2,864   10      68,077      61,379    2,579    3,270   10      67,238   

Investment property

   44,588    107    991    —        45,686      43,806    106    1,153    —        45,065   

 

 

Total residential real estate

   107,290    2,608    3,855   10      113,763      105,185    2,685    4,423   10      112,303   

Consumer installment

   9,010    31    84    —        9,125      8,849    58    89    —        8,996   

 

 

Total

  $416,909    7,171    5,500   1,669     $431,249     $412,633    7,091    6,404   1,614     $427,742   

 

 

December 31, 2015:

              

Commercial and industrial

  $48,038    4,075    323   43     $52,479     $48,038    4,075    323   43     $52,479   

Construction and land development

   42,458    60    593   583      43,694      42,458    60    593   583      43,694   

Commercial real estate:

              

Owner occupied

   45,772    381    219   230      46,602      45,772    381    219   230      46,602   

Multi-family

   45,264     —       —      —        45,264      45,264     —       —      —        45,264   

Other

   110,159    36    272   1,520      111,987      110,159    36    272   1,520      111,987   

 

 

Total commercial real estate

   201,195    417    491   1,750      203,853      201,195    417    491   1,750      203,853   

Residential real estate:

              

Consumer mortgage

   64,502    1,964    3,218   325      70,009      64,502    1,964    3,218   325      70,009   

Investment property

   45,399    112    1,153    —        46,664      45,399    112    1,153    —        46,664  

 

 

Total residential real estate

   109,901    2,076    4,371   325      116,673      109,901    2,076    4,371   325      116,673   

Consumer installment

   10,038    55    114   13      10,220      10,038    55    114   13      10,220   

 

 

Total

  $     411,630                6,683    5,892   2,714     $      426,919     $     411,630                6,683    5,892   2,714     $      426,919   

 

 

Impaired loans

The following tables present details related to the Company’s impaired loans. Loans that have been fully charged-off do not appear in the following tables. The related allowance generally represents the following components that correspond to impaired loans:

 

Individually evaluated impaired loans equal to or greater than $500,000 secured by real estate (nonaccrual construction and land development, commercial real estate, and residential real estate loans).

 

Individually evaluated impaired loans equal to or greater than $250,000 not secured by real estate (nonaccrual commercial and industrial and consumer installment loans).

The following tables set forth certain information regarding the Company’s impaired loans that were individually evaluated for impairment at JuneSeptember 30, 2016 and December 31, 2015.

 

 June 30, 2016  September 30, 2016 
(In thousands)  Unpaid principal 
balance (1)
   

 

Charge-offs and
payments applied
(2)

 Recorded
  investment (3)  
     Related allowance   Unpaid principal
balance (1)
   

 

Charge-offs and
payments applied

(2)

 Recorded
investment (3)
    Related allowance 

    

 

 

    

 

 

With no allowance recorded:

                

Commercial and industrial

 $ 31      —     31       $ 23     —     23      

Construction and land development

  159      (104 55        151     (106 45      

Commercial real estate:

                

Other

  2,478      (914 1,564        2,472     (952 1,520      

    

    

Total commercial real estate

  2,478      (914 1,564        2,472     (952 1,520      

    

    

Total

 $ 2,668      (1,018 1,650       $ 2,646     (1,058 1,588      

    

    

With allowance recorded:

                

Commercial real estate:

                

Owner occupied

  1,003      —     1,003      97     198     —     198      36   

    

 

 

    

 

 

Total commercial real estate

  1,003      —     1,003      97     198     —     198      36   

    

 

 

    

 

 

Total

 $ 1,003      —     1,003     $ 97    $ 198     —     198     $ 36   

    

 

 

    

 

 

Total impaired loans

 $ 3,671      (1,018 2,653     $ 97    $ 2,844     (1,058 1,786     $ 36   

    

 

 

    

 

 

 

(1)Unpaid principal balance represents the contractual obligation due from the customer.
(2)Charge-offs and payments applied represents cumulative charge-offs taken, as well as interest payments that have been applied against the outstanding principal balance subsequent to the loans being placed on nonaccrual status.
(3)Recorded investment represents the unpaid principal balance less charge-offs and payments applied; it is shown before any related allowance for loan losses.

 

 December 31, 2015  December 31, 2015 
(In thousands)  Unpaid principal 
balance (1)
   

 

Charge-offs and
payments applied
(2)

 Recorded
  investment (3)  
     Related allowance   Unpaid principal
balance (1)
   

 

Charge-offs and
payments applied

(2)

 Recorded
investment (3)
    Related allowance 

    

 

 

    

 

 

With no allowance recorded:

                

Commercial and industrial

  $ 48      —     48       $ 48     —     48      

Construction and land development

  2,582      (1,999 583        2,582     (1,999 583      

Commercial real estate:

                

Owner occupied

  308      (78 230        308     (78 230      

Other

  2,136      (617 1,519        2,136     (617 1,519      

    

    

Total commercial real estate

  2,444      (695 1,749        2,444     (695 1,749      

    

    

Total

  $ 5,074      (2,694 2,380       $ 5,074     (2,694 2,380      

    

    

With allowance recorded:

                

Commercial real estate:

                

Owner occupied

  1,027      —     1,027      121     1,027     —     1,027      121   

    

 

 

    

 

 

Total commercial real estate

  1,027      —     1,027      121     1,027     —     1,027      121   

    

 

 

    

 

 

Total

  $ 1,027      —     1,027     $ 121    $ 1,027     —     1,027     $ 121   

    

 

 

    

 

 

Total impaired loans

  $ 6,101      (2,694 3,407     $ 121    $ 6,101     (2,694 3,407     $ 121   

    

 

 

    

 

 

 

(1)Unpaid principal balance represents the contractual obligation due from the customer.
(2)Charge-offs and payments applied represents cumulative charge-offs taken, as well as interest payments that have been applied against the outstanding principal balance subsequent to the loans being placed on nonaccrual status.
(3)Recorded investment represents the unpaid principal balance less charge-offs and payments applied; it is shown before any related allowance for loan losses.

The following table provides the average recorded investment in impaired loans and the amount of interest income recognized on impaired loans after impairment by portfolio segment and class during the respective periods.

 

 Quarter ended June 30, 2016 Six months ended June 30, 2016  Quarter ended September 30, 2016 Nine months ended September 30, 2016 
 

 

Average

 

 

Total interest

 

 

Average

 

 

Total interest

 

  Average Total interest Average Total interest 
 

recorded

 

 

income

 

 

recorded

 

 

income

 

  

 

recorded

 

 

income

 

 

recorded

 

 

income

 
(In thousands)       investment            recognized            investment            recognized       

 

        investment        

 

 

        recognized        

 

 

        investment        

 

 

        recognized        

 

 

 

Impaired loans:

Impaired loans:

  

Impaired loans:

  

Commercial and industrial

 

$

 36   1   40      

$

 26    —     36   2  

Construction and land development

  60    —     138    —       48    —     111    —    

Commercial real estate:

          

Owner occupied

  1,009   11   1,015   26     465   3   850   29  

Other

  1,699    —     1,718    —        1,532    —     1,662    —    

 

 

Total commercial real estate

  2,708   11   2,733   26    1,997   3   2,512   29  

 

 

Total

 $ 2,804   12   2,911   28   $ 2,071   3   2,659   31  

 

 
 Quarter ended June 30, 2015 Six months ended June 30, 2015  Quarter ended September 30, 2015 Nine months ended September 30, 2015 
 

 

Average

 

 

Total interest

 

 

Average

 

 

Total interest

 

  Average Total interest Average Total interest 
 

recorded

 

 

income

 

 

recorded

 

 

income

 

  

 

recorded

 

 

income

 

 

recorded

 

 

income

 
(In thousands)       investment            recognized            investment            recognized       

 

investment

 

 

recognized

 

 

investment

 

 

recognized

 

 

 

Impaired loans:

          

Commercial and industrial

 

$

 64      66      

$

 58   1   63   3  

Construction and land development

  608    —      613    —       596    —     608    —    

Commercial real estate:

          

Owner occupied

  1,202      1,143   21     1,433   11   1,273   32  

Other

  466      538   18     921    —     610   18  

 

 

Total commercial real estate

  1,668   17    1,681   39     2,354   11   1,883   50  

Residential real estate:

          

Consumer mortgages

  512   158    648   173      —      —     454   173  

Investment property

  100   76    130   76      —      —     91   76  

 

 

Total residential real estate

  612   234    778   249      —      —     545   249  

 

 

Total

 

$

 2,952   252    3,138   290    

$

 3,008   12   3,099   302  

 

 

Interest income recognized for the quarter and sixnine months ended JuneSeptember 30, 2015 included non-routine interest recoveries of $225 thousand related to two impaired residential real estate loans that paid off in June 2015. Excluding the interest recoveries on these two loans, interest income recognized on impaired loans for the quarter and sixnine months ended JuneSeptember 30, 2015 would have been $27 thousand and $65 thousand, respectively.$77 thousand.

Troubled Debt Restructurings

Impaired loans also include troubled debt restructurings (“TDRs”). In the normal course of business, management may grant concessions to borrowers that are experiencing financial difficulty. A concession may include, but is not limited to, delays in required payments of principal and interest for a specified period, reduction of the stated interest rate of the loan, reduction of accrued interest, extension of the maturity date, or reduction of the face amount or maturity amount of the debt. A concession has been granted when, as a result of the restructuring, the Bank does not expect to collect all amounts due, including interest at the original stated rate. A concession may have also been granted if the debtor is not able to access funds elsewhere at a market rate for debt with similar risk characteristics as the restructured debt. In making the determination of whether a loan modification is a TDR, the Company considers the individual facts and circumstances surrounding each modification. As part of the credit approval process, the restructured loans are evaluated for adequate collateral protection in determining the appropriate accrual status at the time of restructure.

Similar to other impaired loans, TDRs are measured for impairment based on the present value of expected payments using the loan’s original effective interest rate as the discount rate, or the fair value of the collateral, less selling costs if the loan is collateral dependent. If the recorded investment in the loan exceeds the measure of fair value, impairment is recognized by establishing a valuation allowance as part of the allowance for loan losses or a charge-off to the allowance for loan losses. In periods subsequent to the modification, all TDRs are individually evaluated for possible impairment.

The following is a summary of accruing and nonaccrual TDRs, which are included in the impaired loan totals, and the related allowance for loan losses, by portfolio segment and class as of JuneSeptember 30, 2016 and December 31, 2015.

 

 TDRs      TDRs     
       Related        Related 
(In thousands)         Accruing             Nonaccrual                 Total               Allowance                Accruing             Nonaccrual                 Total               Allowance       

   

 

 

   

 

 

June 30, 2016

      

September 30, 2016

      

Commercial and industrial

 

$

 31     —      31    $  —      

$

 23     —      23    $  —     

Construction and land development

   —      55    55      —        —      45    45      —     

Commercial real estate:

            

Owner occupied

  1,003     —      1,003     97     198     —      198     36   

Other

   —      1,564    1,564      —        —      1,520    1,520      —     

   

 

 

   

 

 

Total commercial real estate

  1,003    1,564    2,567     97     198    1,520    1,718     36   

   

 

 

   

 

 

Total

 $ 1,034    1,619    2,653        $ 97    $ 221    1,565    1,786        $ 36   

   

 

 

   

 

 

December 31, 2015

    

Commercial and industrial

 

$

 48     —      48    $  —      

$

 48     —      48    $  —     

Construction and land development

   —      582    582      —        —      582    582      —     

Commercial real estate:

            

Owner occupied

  1,027    230    1,257     121     1,027    230    1,257     121   

   

 

 

   

 

 

Total commercial real estate

  1,027    230    1,257     121     1,027    230    1,257     121   

   

 

 

   

 

 

Total

 $ 1,075    812    1,887    $ 121    $ 1,075    812    1,887    $ 121   

   

 

 

   

 

 

The following table summarizes loans modified in a TDR during the respective periods both before and after their modification.

 

  Quarter ended June 30,   Six months June 30,   Quarter ended September 30,   Nine months ended September 30, 
      

 

      Pre-

 

   

 

  Post -

 

       

 

      Pre-

 

   

 

  Post -

 

       

 

      Pre-

 

   

 

  Post -

 

       

 

      Pre-

 

   

 

  Post -

 

 
      

      modification

 

   

  modification

 

       

      modification

 

   

  modification

 

       

      modification

 

   

  modification

 

       

      modification

 

   

  modification

 

 
      Number   

      outstanding

 

   

  outstanding

 

   

    Number

 

   

      outstanding

 

   

  outstanding

 

       Number   

      outstanding

 

   

  outstanding

 

   

    Number

 

   

      outstanding

 

   

  outstanding

 

 
      of   

      recorded

 

   

  recorded

 

   

    of

 

   

      recorded

 

   

  recorded

 

       of   

      recorded

 

   

  recorded

 

   

    of

 

   

      recorded

 

   

  recorded

 

 
(Dollars in thousands)      contracts         investment     investment       contracts         investment     investment       contracts         investment     investment       contracts         investment     investment 

 

 

2016:

                        

Commercial real estate:

                        

Other

   1    $1,509     1,509     1    $1,509     1,509      —      $—       —       1    $1,509     1,509   

 

 

Total commercial real estate

   1     1,509     1,509     1     1,509     1,509      —       —       —       1     1,509     1,509   

 

 

Total

   1    $1,509     1,509     1    $1,509     1,509      —      $—       —       1    $1,509     1,509   

 

 

2015:

                        

Commercial and industrial

   1    $61     66     1    $61     66      —      $—       —       1    $61     66   

Construction and land development

   —       —       —       1     116     113      —       —       —       1     116     113   

Commercial real estate:

                        

Owner occupied

   1     216     218     1     216     218   

Other

   —       —       —       1     592     592      —       —       —       1     592     592   

 

 

Total commercial real estate

   —       —       —       1     592     592      1     216     218     2     808     810   

 

 

Total

   1    $61     66     3    $769     771      1    $216     218     4    $985     989   

 

 

The majority of the loans modified in a TDR during the quarter and six monthsnine month ended JuneSeptember 30, 2016 and 2015, included permitting delays in required payments of principal and/or interest or where the only concession granted by the Company was that the interest rate at renewal was considered to be less than a market rate.

There were no TDRs with default payments during the quarter and sixnine months ended JuneSeptember 30, 2016. The following table summarizes the recorded investment in loans modified in a TDR within the previous 12 months for which there was a payment default (defined as 90 days or more past due) during the respective periods.

 

                  Quarter ended June 30,                   Six months Ended June 30,                  Quarter ended September 30,                   Nine months ended September 30,
  Number of   Recorded   Number of   Recorded   Number of   Recorded   Number of Recorded 
(Dollars in thousands)  Contracts   investment(1)      Contracts   investment(1)     

 

Contracts

   investment(1)      Contracts investment(1)   

2015:

                     

Commercial real estate:

                  ��  

Owner occupied

   —      $—          1    $261       —      $—          1   $261    

     

 

 

  

     

 

 

  

Total commercial real estate

   —       —          1     261       —       —          1   261    

Residential real estate:

                     

Investment property

   —       —          1     150       —       —          1   150    

     

 

 

  

     

 

 

  

Total residential real estate

   —       —          1     150       —       —          1   150    

     

 

 

  

     

 

 

  

Total

   —      $—          2    $411       —      $—          2   $411    

     

 

 

  

     

 

 

  

(1) Amount as of applicable month end during the respective period for which there was a payment default.

NOTE 6: MORTGAGE SERVICING RIGHTS, NET

Mortgage servicing rights (“MSRs”) are recognized based on the fair value of the servicing rights on the date the corresponding mortgage loans are sold. An estimate of the fair value of the Company’s MSRs is determined using assumptions that market participants would use in estimating future net servicing income, including estimates of prepayment speeds, discount rates, default rates, costs to service, escrow account earnings, contractual servicing fee income, ancillary income, and late fees. Subsequent to the date of transfer, the Company has elected to measure its MSRs under the amortization method. Under the amortization method, MSRs are amortized in proportion to, and over the period of, estimated net servicing income.

The Company has recorded MSRs related to loans sold without recourse to Fannie Mae. The Company generally sells conforming, fixed-rate, closed-end, residential mortgages to Fannie Mae. MSRs are included in other assets on the accompanying consolidated balance sheets.

The Company evaluates MSRs for impairment on a quarterly basis. Impairment is determined by stratifying MSRs into groupings based on predominant risk characteristics, such as interest rate and loan type. If, by individual stratum, the carrying amount of the MSRs exceeds fair value, a valuation allowance is established. The valuation allowance is adjusted as the fair value changes. Changes in the valuation allowance are recognized in earnings as a component of mortgage lending income.

The following table details the changes in amortized MSRs and the related valuation allowance for the respective periods.

 

               Quarter ended June 30,               Six Months Ended June 30,     
(Dollars in thousands)  2016   2015   2016   2015 

 

 

MSRs, net:

        

Beginning balance

  $2,235    $2,355    $2,316    $2,388  

Additions, net

   88     154     145     265  

Amortization expense

   (176)     (199)     (314)     (333)  

(Increase) decrease in valuation allowance

   (1)     49     (1)     39  

 

 

Ending balance

  $2,146    $2,359    $2,146    $2,359  

 

 

Valuation allowance included in MSRs, net:

  

    

Beginning of period

  $—         $63    $—         $53  

End of period

   1     14     1     14  

 

 

Fair value of amortized MSRs:

        

Beginning of period

  $2,906    $3,066    $3,086    $3,238  

End of period

   2,539     3,014     2,539     3,014  

 

 

        Quarter ended September 30,             Nine months ended September 30,     
(Dollars in thousands)   2016   2015     2016   2015 

 

 

MSRs, net:

         

Beginning balance

 $  2,146    $2,359   $   2,316    $2,388  

Additions, net

   97     174      242     440  

Amortization expense

   (192)     (171)      (506)     (505)  

(Increase) decrease in valuation allowance

   (20)     13      (21)     52  

 

 

Ending balance

 $  2,031    $2,375   $   2,031    $2,375  

 

 

Valuation allowance included in MSRs, net:

  

     

Beginning of period

 $  1    $14   $   —      $53  

End of period

   21     1      21     1  

 

 

Fair value of amortized MSRs:

         

Beginning of period

 $  2,539    $3,014   $   3,086    $3,238  

End of period

   2,455     3,052      2,455     3,052  

 

 

NOTE 7: DERIVATIVE INSTRUMENTS

Financial derivatives are reported at fair value in other assets or other liabilities on the accompanying Consolidated Balance Sheets. The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship. For derivatives not designated as part of a hedging relationship, the gain or loss is recognized in current earnings within other noninterest income on the accompanying consolidated statements of earnings. From time to time, the Company may enter into interest rate swaps (“swaps”) to facilitate customer transactions and meet their financing needs. Upon entering into these swaps, the Company enters into offsetting positions in order to minimize the risk to the Company. These swaps qualify as derivatives, but are not designated as hedging instruments.

Interest rate swap agreements involve the risk of dealing with counterparties and their ability to meet contractual terms. When the fair value of a derivative instrument is positive, this generally indicates that the counterparty or customer owes the Company, and results in credit risk to the Company. When the fair value of a derivative instrument is negative, the Company owes the customer or counterparty and therefore, has no credit risk.

A summary of the Company’s interest rate swap agreements at JuneSeptember 30, 2016 and December 31, 2015 is presented below.

 

      Other   Other        Other   Other 
      Assets   Liabilities        Assets   Liabilities 
      Estimated   Estimated        Estimated   Estimated 
(Dollars in thousands)  Notional         Fair Value               Fair Value          Notional         Fair Value               Fair Value       

 

 

June 30, 2016:

      

September 30, 2016:

       

Pay fixed / receive variable

  $             4,142     —         375    

$

   4,054     —         309   

Pay variable / receive fixed

   4,142     375       —          4,054     309       —      

 

 

Total interest rate swap agreements

  $8,284     375       375    

$

               8,108     309       309   

 

 

December 31, 2015:

             

Pay fixed / receive variable

  $4,317     —         440    

$

   4,317     —         440   

Pay variable / receive fixed

   4,317     440       —          4,317     440       —      

 

 

Total interest rate swap agreements

  $8,634     440       440    

$

   8,634     440       440   

 

 

NOTE 8: FAIR VALUE

Fair Value Hierarchy

“Fair value” is defined by ASC 820,Fair Value Measurements and Disclosures, as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for an asset or liability at the measurement date. GAAP establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

Level 1—inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets.

 

Level 2—inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs that are observable for the asset or liability, either directly or indirectly.

 

Level 3—inputs to the valuation methodology are unobservable and reflect the Company’s own assumptions about the inputs market participants would use in pricing the asset or liability.

Level changes in fair value measurements

Transfers between levels of the fair value hierarchy are generally recognized at the end of the reporting period. The Company monitors the valuation techniques utilized for each category of financial assets and liabilities to ascertain when transfers between levels have been affected. The nature of the Company’s financial assets and liabilities generally is such that transfers in and out of any level are expected to be infrequent. For the sixnine months ended JuneSeptember 30, 2016, there were no transfers between levels and no changes in valuation techniques for the Company’s financial assets and liabilities.

Assets and liabilities measured at fair value on a recurring basis

Securities available-for-sale

Fair values of securities available for sale were primarily measured using Level 2 inputs. For these securities, the Company obtains pricing from third party pricing services. These third party pricing services consider observable data that may include broker/dealer quotes, market spreads, cash flows, benchmark yields, reported trades for similar securities, market consensus prepayment speeds, credit information, and the securities’ terms and conditions. On a quarterly basis, management reviews the pricing received from the third party pricing services for reasonableness given current market conditions. As part of its review, management may obtain non-binding third party broker quotes to validate the fair value measurements. In addition, management will periodically submit pricing provided by the third party pricing services to another independent valuation firm on a sample basis. This independent valuation firm will compare the price provided by the third party pricing service with its own price and will review the significant assumptions and valuation methodologies used with management.

Interest rate swap agreements

The carrying amount of interest rate swap agreements was included in other assets and accrued expenses and other liabilities on the accompanying consolidated balance sheets. The fair value measurements for our interest rate swap agreements were based on information obtained from a third party bank. This information is periodically tested by the Company and validated against other third party valuations. If needed, other third party market participants may be utilized to corroborate the fair value measurements for our interest rate swap agreements. The Company classified these derivative assets and liabilities within Level 2 of the valuation hierarchy. These swaps qualify as derivatives, but are not designated as hedging instruments.

The following table presents the balances of the assets and liabilities measured at fair value on a recurring basis as of JuneSeptember 30, 2016 and December 31, 2015, respectively, by caption, on the accompanying consolidated balance sheets by ASC 820 valuation hierarchy (as described above).

 

      

Quoted Prices in

 

   

      Significant      

 

           

Quoted Prices in

 

   

      Significant      

 

     
      

Active Markets

 

   

      Other      

 

   

Significant    

 

       

Active Markets

 

   

      Other      

 

   

Significant    

 

 
      

for

 

   

      Observable      

 

   

Unobservable    

 

       

for

 

   

      Observable      

 

   

Unobservable    

 

 
      

Identical Assets

 

   

      Inputs      

 

   

Inputs    

 

       

Identical Assets

 

   

      Inputs      

 

   

Inputs    

 

 
(Dollars in thousands)  Amount   (Level 1)         (Level 2)         (Level 3)       Amount   (Level 1)         (Level 2)         (Level 3)     

 

 

June 30, 2016:

        

September 30, 2016:

        

Securities available-for-sale:

                

Agency obligations

  $42,639          42,639     —       $41,825          41,825     —     

Agency RMBS

   102,879          102,879     —        133,265          133,265     —     

State and political subdivisions

   71,484          71,484     —        74,466          74,466     —     

 

 

Total securities available-for-sale

   217,002          217,002     —        249,556          249,556     —     

Other assets(1)

   375          375     —        309          309     —     

 

 

Total assets at fair value

  $         217,377          217,377     —       $         249,865          249,865     —     

 

 

Other liabilities(1)

  $375          375     —       $309          309     —     

 

 

Total liabilities at fair value

  $375          375     —       $309          309     —     

 

 

December 31, 2015:

                

Securities available-for-sale:

                

Agency obligations

  $60,085          60,085     —       $60,085          60,085     —     

Agency RMBS

   110,954          110,954     —        110,954          110,954     —     

State and political subdivisions

   70,648          70,648     —        70,648          70,648     —     

 

 

Total securities available-for-sale

   241,687          241,687     —        241,687          241,687     —     

Other assets(1)

   440          440     —        440          440     —     

 

 

Total assets at fair value

  $242,127          242,127     —       $242,127          242,127     —     

 

 

Other liabilities(1)

  $440          440     —       $440          440     —     

 

 

Total liabilities at fair value

  $440          440     —       $440          440     —     

 

 

(1)Represents the fair value of interest rate swap agreements.

Assets and liabilities measured at fair value on a nonrecurring basis

Loans held for sale

Loans held for sale are carried at the lower of cost or fair value. Fair values of loans held for sale are determined using quoted market secondary market prices for similar loans. Loans held for sale are classified within Level 2 of the fair value hierarchy.

Impaired Loans

Loans considered impaired under ASC 310-10-35,Receivables, are loans for which, based on current information and events, it is probable that the Company will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. Impaired loans can be measured based on the present value of expected payments using the loan’s original effective rate as the discount rate, the loan’s observable market price, or the fair value of the collateral less selling costs if the loan is collateral dependent.

The fair value of impaired loans were primarily measured based on the value of the collateral securing these loans. Impaired loans are classified within Level 3 of the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory, and/or accounts receivable. The Company determines the value of the collateral based on independent appraisals performed by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraised values are discounted for costs to sell and may be discounted further based on management’s historical knowledge, changes in market conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the customer’s business. Such discounts by management are subjective and are typically significant unobservable inputs for determining fair value. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors discussed above.

Other real estate owned

Other real estate owned, consisting of properties obtained through foreclosure or in satisfaction of loans, are initially recorded at the lower of the loan’s carrying amount or the fair value less costs to sell upon transfer of the loans to other real estate. Subsequently, other real estate is carried at the lower of carrying value or fair value less costs to sell. Fair values are generally based on third party appraisals of the property and are classified within Level 3 of the fair value hierarchy. The appraisals are sometimes further discounted based on management’s historical knowledge, and/or changes in market conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the customer’s business. Such discounts are typically significant unobservable inputs for determining fair value. In cases where the carrying amount exceeds the fair value, less costs to sell, a loss is recognized in noninterest expense.

Mortgage servicing rights, net

Mortgage servicing rights, net, included in other assets on the accompanying consolidated balance sheets, are carried at the lower of cost or estimated fair value. MSRs do not trade in an active market with readily observable prices. To determine the fair value of MSRs, the Company engages an independent third party. The independent third party’s valuation model calculates the present value of estimated future net servicing income using assumptions that market participants would use in estimating future net servicing income, including estimates of prepayment speeds, discount rates, default rates, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, and late fees. Periodically, the Company will review broker surveys and other market research to validate significant assumptions used in the model. The significant unobservable inputs include prepayment speeds or the constant prepayment rate (“CPR”) and the weighted average discount rate. Because the valuation of MSRs requires the use of significant unobservable inputs, all of the Company’s MSRs are classified within Level 3 of the valuation hierarchy.

The following table presents the balances of the assets and liabilities measured at fair value on a nonrecurring basis as of JuneSeptember 30, 2016 and December 31, 2015, respectively, by caption, on the accompanying consolidated balance sheets and by FASB ASC 820 valuation hierarchy (as described above):

 

      Quoted Prices in               Quoted Prices in         
      Active Markets       Other         Significant         Active Markets       Other         Significant   
      for       Observable         Unobservable         for       Observable         Unobservable   
  Carrying   Identical Assets       Inputs         Inputs     Carrying   Identical Assets       Inputs         Inputs   
(Dollars in thousands)  Amount   (Level 1)       (Level 2)         (Level 3)     Amount   (Level 1)       (Level 2)         (Level 3)   

 

 

June 30, 2016:

        

September 30, 2016:

        

Loans held for sale

  $1,567     —       1,567     —       $701     —       701     —     

Loans, net(1)

   2,556     —       —       2,556      1,750     —       —       1,750   

Other real estate owned

   300     —       —       300      37     —       —       37   

Other assets(2)

   2,146     —       —       2,146      2,031     —       —       2,031   

 

 

Total assets at fair value

  $             6,569     —       1,567     5,002     $             4,519     —       701     3,818   

 

 

December 31, 2015:

                

Loans held for sale

  $1,540     —       1,540     —       $1,540     —       1,540     —     

Loans, net(1)

   3,286     —       —       3,286      3,286     —       —       3,286   

Other real estate owned

   252     —       —       252      252     —       —       252   

Other assets(2)

   2,316     —       —       2,316      2,316     —       —       2,316   

 

 

Total assets at fair value

  $7,394     —       1,540     5,854     $7,394     —       1,540     5,854   

 

 

(1)Loans considered impaired under ASC 310-10-35,Receivables. This amount reflects the recorded investment in

impaired loans, net of any related allowance for loan losses.

(2)Represents MSRs, net, carried at lower of cost or estimated fair value.

Quantitative Disclosures for Level 3 Fair Value Measurements

At JuneSeptember 30, 2016, the Company had no Level 3 assets measured at fair value on a recurring basis. For Level 3 assets measured at fair value on a non-recurring basis at JuneSeptember 30, 2016, the significant unobservable inputs used in the fair value measurements are presented below.

 

                Weighted                   Weighted     
     Carrying                Average         Carrying                Average     
(Dollars in thousands)     Amount           Valuation Technique             Significant Unobservable Input            of Input         Amount           Valuation Technique             Significant Unobservable Input            of Input     

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

Nonrecurring:

                

Impaired loans

  $       2,556   

Appraisal

  

Appraisal discounts (%)

  50.2%    $        1,750   

Appraisal

  

Appraisal discounts (%)

  50.2%   

Other real estate owned

  300   

Appraisal

  

Appraisal discounts (%)

  6.6%     37   

Appraisal

  

Appraisal discounts (%)

  61.5%   

Mortgage servicing rights, net

  2,146   

Discounted cash flow

  

Prepayment speed or CPR (%)

  12.7%     2,031   

Discounted cash flow

  

Prepayment speed or CPR (%)

  13.3%   
      

Discount rate (%)

  10.0%         

Discount rate (%)

  10.0%   

Fair Value of Financial Instruments

ASC 825,Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of the Company’s financial instruments are explained below. Where quoted market prices are not available, fair values are based on estimates using discounted cash flow analyses. Discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following fair value estimates cannot be substantiated by comparison to independent markets and should not be considered representative of the liquidation value of the Company’s financial instruments, but rather are a good-faith estimate of the fair value of financial instruments held by the Company. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements.

The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:

Loans, net

Fair values for loans were calculated using discounted cash flows. The discount rates reflected current rates at which similar loans would be made for the same remaining maturities. This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by ASC 820 and generally produces a higher value than an exit-price approach. Expected future cash flows were projected based on contractual cash flows, adjusted for estimated prepayments.

Loans held for sale

Fair values of loans held for sale are determined using quoted secondary market prices for similar loans.

Time Deposits

Fair values for time deposits were estimated using discounted cash flows. The discount rates were based on rates currently offered for deposits with similar remaining maturities.

Long-term debt

The fair value of the Company’s fixed rate long-term debt is estimated using discounted cash flows based on estimated current market rates for similar types of borrowing arrangements. The carrying amount of the Company’s variable rate long-term debt approximates its fair value.

The carrying value, related estimated fair value, and placement in the fair value hierarchy of the Company’s financial instruments at JuneSeptember 30, 2016 and December 31, 2015 are presented below. This table excludes financial instruments for which the carrying amount approximates fair value. Financial assets for which fair value approximates carrying value included cash and cash equivalents. Financial liabilities for which fair value approximates carrying value included noninterest-bearing demand deposits, interest-bearing demand deposits, and savings deposits due to these products having no stated maturity. In addition, financial liabilities for which fair value approximates carrying value included overnight borrowings such as federal funds purchased and securities sold under agreements to repurchase.

 

          Fair Value Hierarchy            Fair Value Hierarchy 
  

 

Carrying

   

 

Estimated

   

 

Level 1

   

 

Level 2

   

 

Level 3

   

 

Carrying

   

 

Estimated

    

 

Level 1

   

 

Level 2

   

 

Level 3

 
(Dollars in thousands)  amount   fair value   inputs   inputs   Inputs   amount   fair value    inputs   inputs   Inputs 

 

 

June 30, 2016:

          

September 30, 2016:

           

Financial Assets:

                     

Loans, net (1)

  $       426,166     $        439,452     $                —       $—       $         439,452     $       422,625     $        434,053     $                  —       $—       $         434,053   

Loans held for sale

   1,567      1,600      —        1,600      —        701      717       —        717      —     

Financial Liabilities:

                     

Time Deposits

  $210,846     $212,291     $—       $         212,291     $—       $210,239     $211,129     $  —       $         211,129     $—     

Long-term debt

   7,217      7,217      —        7,217      —        7,217      7,217       —        7,217      —     

 

 

December 31, 2015:

                     

Financial Assets:

                     

Loans, net (1)

  $422,121     $427,340     $—       $—       $427,340     $422,121     $427,340     $  —       $—       $427,340   

Loans held for sale

   1,540      1,574      —        1,574      —        1,540      1,574       —        1,574      —     

Financial Liabilities:

                     

Time Deposits

  $219,598     $220,093     $—       $220,093     $—       $219,598     $220,093     $  —       $220,093     $—     

Long-term debt

   7,217      7,217      —        7,217      —        7,217      7,217       —        7,217      —     

 

 

(1) Represents loans, net of unearned income and the allowance for loan losses.

NOTE 9: SUBSEQUENT EVENTS

In October 2016, the Company purchased $4.0 million par amount of outstanding trust preferred securities issued by a trust affiliate of the Company. These securities were sold by the FDIC, as receiver of a failed bank. The Company used dividends from the Bank to purchase, retire and cancel these trust preferred securities and an equivalent amount of the related junior subordinated debentures issued by the Company. The Company realized a pre-tax gain of $0.8 million on the early extinguishment of debt in this transaction. Following the transaction, the Company had $3.2 million in junior subordinated debentures related to $3.0 million of trust preferred securities outstanding. The amount related to the trust preferred securities remains included in the Company’s Tier 1 capital for regulatory purposes.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

The following discussion and analysis is designed to provide a better understanding of various factors related to the results of operations and financial condition of Auburn National Bancorporation, Inc. (the “Company”) and its wholly owned subsidiary, AuburnBank (the “Bank”). This discussion is intended to supplement and highlight information contained in the accompanying unaudited condensed consolidated financial statements and related notes for the quarters and sixnine months ended JuneSeptember 30, 2016 and 2015, as well as the information contained in our Annual Reportannual report on Form 10-K for the year ended December 31, 2015 and our Quarterly Reportquarterly reports on Form 10-Q for the quarterquarters ended March 31, 2016 and June 30, 2016.

Special Notice Regarding Forward-Looking Statements

Certain of the statements made in this discussion and analysis and elsewhere, including information incorporated herein by reference to other documents, are “forward-looking statements” within the meaning of, and subject to, the protections of Section 27A of the Securities Act of 1933, as amended, (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause the actual results, performance, achievements, or financial condition of the Company to be materially different from future results, performance, achievements, or financial condition expressed or implied by such forward-looking statements. You should not expect us to update any forward-looking statements.

All statements other than statements of historical fact are statements that could be forward-looking statements. You can identify these forward-looking statements through our use of words such as “may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “plan,” “point to,” “project,” “could,” “intend,” “target” and other similar words and expressions of the future. These forward-looking statements may not be realized due to a variety of factors, including, without limitation:

 

the effects of future economic, business, and market conditions and changes, domestic and foreign, including seasonality;

 

governmental monetary and fiscal policies;

 

legislative and regulatory changes, including changes in banking, securities, and tax laws, regulations and rules and their application by our regulators, including capital and liquidity requirements, and changes in the scope and cost of FDIC insurance;

 

changes in accounting policies, rules, and practices;

 

the risks of changes in interest rates on the levels, composition, and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities, and the risks and uncertainty of the amounts realizable and the timing of dispositions of assets by the FDIC where we may have a participation or other interest;

 

changes in borrower credit risks and payment behaviors;

 

changes in the availability and cost of credit and capital in the financial markets, and the types of instruments that may be included as capital for regulatory purposes;

 

changes in the prices, values, and sales volumes of residential and commercial real estate;

 

the effects of competition from a wide variety of local, regional, national, and other providers of financial, investment, and insurance services;

the failure of assumptions and estimates underlying the establishment of allowances for possible loan and other asset impairments, losses, and other estimates;

changes in technology or products that may be more difficult, costly, or less effective than anticipated;

 

the effects of war, or other conflicts, acts of terrorism, or other catastrophic events that may affect general economic conditions;

 

cyber attacks and data breaches that may compromise our systems or customers’ information;

 

the failure of assumptions and estimates, as well as differences in, and changes to, economic, market, and credit conditions, including changes in borrowers’ credit risks and payment behaviors from those used in our loan portfolio stress tests and other evaluations;

 

the risk that our deferred tax assets could be reduced if estimates of future taxable income from our operations and tax planning strategies are less than currently estimated, and sales of our capital stock could trigger a reduction in the amount of net operating loss carry-forwards that we may be able to utilize for income tax purposes; and

 

the other factors and information in this report and other filings that we make with the SEC under the Exchange Act, including our Annual Report on Form 10-K for the year ended December 31, 2015 and subsequent quarterly and current reports. See Part II, Item 1A. “RISK FACTORS”.

All written or oral forward-looking statements that are made by or attributable to us are expressly qualified in their entirety by this cautionary notice. We have no obligation and do not undertake to update, revise or correct any of the forward-looking statements after the date of this report, or after the respective dates on which such statements otherwise are made.

Business

The Company was incorporated in 1990 under the laws of the State of Delaware and became a bank holding company after it acquired its Alabama predecessor, which was a bank holding company established in 1984. The Bank, the Company’s principal subsidiary, is an Alabama state-chartered bank that is a member of the Federal Reserve System and has operated continuously since 1907. Both the Company and the Bank are headquartered in Auburn, Alabama. The Bank conducts its business primarily in East Alabama, including Lee County and surrounding areas. The Bank operates full-service branches in Auburn, Opelika, Notasulga, and Valley, Alabama. In-store branches are located in the Kroger and Wal-Mart SuperCenter in Opelika. The Bank also operates a commercial loan production office in Phenix City, Alabama.

Summary of Results of Operations

 

           Quarter ended June 30,                 Six Months Ended June 30,                  Quarter ended September 30,               Nine months ended September 30,     
(Dollars in thousands, except per share amounts)   2016   2015 2016   2015    2016   2015     2016 2015 

 

 

Net interest income (a)

 $   6,014    $6,126       $ 12,033    $11,984   $    5,924    $6,011        $    17,957   $17,995  

Less: tax-equivalent adjustment

    322     338    644     673    316     341     960   1,014  

 

 

Net interest income (GAAP)

    5,692     5,788    11,389     11,311    5,608     5,670     16,997   16,981  

Noninterest income

    993     1,167    1,827     2,488    1,063     1,056     2,890   3,544  

 

 

Total revenue

    6,685     6,955    13,216     13,799    6,671     6,726     19,887   20,525  

Provision for loan losses

    —        —       (600)     —        —        200     (600 200  

Noninterest expense

    4,021     4,029    8,130     8,343    3,980     3,892     12,110   12,235  

Income tax expense

    733     776    1,564     1,444    740     724     2,304   2,168  

 

 

Net earnings

 $   1,931    $2,150   $ 4,122    $4,012   $    1,951    $1,910        $    6,073   $5,922  

 

 

Basic and diluted earnings per share

 $   0.53    $0.59   $ 1.13    $1.10   $    0.54    $0.52        $    1.67   $1.63  

 

 

(a) Tax-equivalent. See “Table 1 - Explanation of Non-GAAP Financial Measures.”

Financial Summary

The Company’s net earnings were $4.1$6.1 million for the first sixnine months of 2016, compared to $4.0$5.9 million for the first sixnine months of 2015. Basic and diluted earnings per share were $1.13$1.67 per share for the first sixnine months of 2016, compared to $1.10$1.63 per share for the first sixnine months of 2015.

Net interest income (tax-equivalent) was $12.0$18.0 million for the first sixnine months of 2016 and 2015. Net interest income (tax-equivalent) for the first sixnine months of 2015 included $0.2 million in recoveries of interest related to payoffs received on two loans that were previously impaired. Excluding the impact of these interest recoveries, net interest income (tax-equivalent) increased 2%1% in the first sixnine months of 2016 compared to the first sixnine months of 2015. This increase was primarily due to a reduction in interest expense as the company lowered its deposit costs and repaid higher-cost wholesale funding sources. Average loans were $432.2$431.2 million in the first sixnine months of 2016, an increase of $30.9$24.9 million or 8%6%, from the first sixnine months of 2015. Average deposits were $727.2$734.2 million in the first sixnine months of 2016, an increase of $24.6$27.5 million or 3%4%, from the first sixnine months of 2015.

The Company recorded a negative provision for loan losses of $0.6 million for the first sixnine months of 2016, compared to noa $0.2 million provision for loan losses for the first sixnine months of 2015. Annualized net recoveries as a percent of average loans were 0.39%0.27% for the first sixnine months of 2016 compared to 0.02%0.03% for the first sixnine months of 2015. The Company recognized a recovery of $1.2 million from the payoff of one nonperforming construction and land development loan during the first sixnine months of 2016.

Noninterest income was $1.8$2.9 million for the first sixnine months of 2016, compared to $2.5$3.5 million in the first sixnine months of 2015. The decrease was primarily due to $0.3 million in non-taxable death benefits from bank-owned life insurance that were received in the first sixnine months of 2015, compared to none in the first sixnine months of 2016, and a decrease in mortgage lending income of $0.3$0.4 million as mortgage loan production declined. These decreases were partially offset by $0.1 million increase in securities gains, net.

Noninterest expense was $8.1$12.1 million in the first sixnine months of 2016, compared to $8.3$12.2 million in the first sixnine months of 2015. The decrease was primarily due to no prepayment penalties on long-term debt incurred in the first sixnine months of 2016 compared to $0.4 million incurred in the first sixnine months of 2015 when the Company repaid $5.0 million of long-term debt with an interest rate of 3.59%. This decrease wasIn addition, other real estate owned expense decreased $0.2 million primarily due to realized holding gains on the sale of OREO. These decreases were partially offset by a $0.3$0.5 million increase in salaries and benefits due to routine annual increases.

Income tax expense was $1.6$2.3 million for the first sixnine months of 2016, compared to $1.4$2.2 million for the first sixnine months of 2015. The Company’s income tax expense for the first sixnine months of 2016 reflects an effective income tax rate of 27.51%27.50%, compared to 26.47%26.80% for the first sixnine months of 2015. The increase in the effective tax rate iswas primarily due to a decrease in tax preference items such as income from bank-owned life insurance. The Company’s effective income tax rate is principally impacted by tax-exempt earnings from the Company’s investments in municipal securities and bank-owned life insurance.

In the first sixnine months of 2016, the Company paid cash dividends of $1.6$2.5 million, or $0.45$0.675 per share. The Company’s balance sheet remains “well capitalized” under current regulatory guidelines with a total risk-based capital ratio of 17.77%17.97% and a Tier 1 leverage ratio of 10.56%10.36% at JuneSeptember 30, 2016.

In the secondthird quarter of 2016, net earnings were $1.9$2.0 million, or $0.53$0.54 per share, compared to $2.2$1.9 million, or $0.59$0.52 per share, for the secondthird quarter of 2015. Net interest income (tax-equivalent) was $6.0$5.9 million for the secondthird quarter of 2016, a decrease of 1% compared to the third quarter of 2015. Although net interest income (tax-equivalent) declined slightly, management continues to seek to increase earnings by growing the Company’s loan portfolio (in total and as a percentage of our earning assets), focusing on deposit pricing, and repaying higher-cost wholesale funding sources. These efforts to increase earnings were offset by declining yields in the securities portfolio due to maturities and calls and management’s decision to carry higher levels of short-term interest earning assets (e.g. interest bearing bank deposits). As a result, the Company’s net interest margin (tax-equivalent) declined to 2.94% in the third quarter of 2016, compared to $6.1 million3.13% for the second quarter of 2015. Net interest income (tax-equivalent) for the second quarter of 2015 included $0.2 million in recoveries of interest related to payoffs received on two loans that were previously impaired. Excluding the impact of these interest recoveries, net interest income (tax-equivalent) increased 2% in the second quarter of 2016 compared to the secondthird quarter of 2015. The Company recorded no provision for loan losses in the secondthird quarter of 2016 and $0.2 million in provision for loan losses in the third quarter of 2015. Noninterest income was $1.1 million in the third quarter of 2016 and 2015. Noninterest income was $1.0 million in the second quarter of 2016, compared to $1.2 million in the second quarter of 2015. The decrease was primarily due to aA decrease in mortgage lending income of $0.1 million as mortgage loan production declined.was offset by securities gains of $0.1 million. Noninterest expense was $4.0 million in the second quarter of 2016, unchanged compared to second quarter 2015. Income tax expense was approximately $0.7 million for the secondthird quarter of 2016, compared to $0.8$3.9 million in the third quarter of 2015. Increases in salaries and benefits expense and other noninterest expense of $0.2 million and $0.1 million, respectively, were offset by a decrease in other real estate owned expense of $0.2 million. Income tax expense was $0.7 million for the secondthird quarter of 2016 unchanged from the third quarter of 2015. The Company’s effective tax rate for the secondthird quarter of 2016 was 27.57%27.50%, compared to 26.52%27.49% in the secondthird quarter of 2015. Despite the increase in the effective tax rate, income tax expense decreased due to a decrease in earnings before taxes.

CRITICAL ACCOUNTING POLICIES

The accounting and financial reporting policies of the Company conform with U.S. generally accepted accounting principles and with general practices within the banking industry. In connection with the application of those principles, we have made judgments and estimates which, in the case of the determination of our allowance for loan losses, our assessment of other-than-temporary impairment, recurring and non-recurring fair value measurements, the valuation of other real estate owned, and the valuation of deferred tax assets, were critical to the determination of our financial position and results of operations. Other policies also require subjective judgment and assumptions and may accordingly impact our financial position and results of operations.

Allowance for Loan Losses

The Company assesses the adequacy of its allowance for loan losses prior to the end of each calendar quarter. The level of the allowance is based upon management’s evaluation of the loan portfolio, past loan loss experience, current asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect a borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan loss rates, and other pertinent factors, including regulatory recommendations. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Loans are charged off, in whole or in part, when management believes that the full collectability of the loan is unlikely. A loan may be partially charged-off after a “confirming event” has occurred, which serves to validate that full repayment pursuant to the terms of the loan is unlikely.

The Company deems loans 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. Collection of all amounts due according to the contractual terms means that both the interest and principal payments of a loan will be collected as scheduled in the loan agreement.

An impairment allowance is recognized if the fair value of the loan is less than the recorded investment in the loan. The impairment is recognized through the allowance. Loans that are impaired are recorded at the present value of expected future cash flows discounted at the loan’s effective interest rate, or if the loan is collateral dependent, the impairment measurement is based on the fair value of the collateral, less estimated disposal costs.

The level of allowance maintained is believed by management to be adequate to absorb probable losses inherent in the portfolio at the balance sheet date. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries of amounts previously charged-off.

In assessing the adequacy of the allowance, the Company also considers the results of its ongoing internal and independent loan review processes. The Company’s loan review process assists in determining whether there are loans in the portfolio whose credit quality has weakened over time and evaluating the risk characteristics of the entire loan portfolio. The Company’s loan review process includes the judgment of management, the input from our independent loan reviewers, and reviews that may have been conducted by bank regulatory agencies as part of their examination process. The Company incorporates loan review results in the determination of whether or not it is probable that it will be able to collect all amounts due according to the contractual terms of a loan.

As part of the Company’s quarterly assessment of the allowance, management divides the loan portfolio into five segments: commercial and industrial, construction and land development, commercial real estate, residential real estate, and consumer installment. The Company analyzes each segment and estimates an allowance allocation for each loan segment.

The allocation of the allowance for loan losses begins with a process of estimating the probable losses inherent for each loan segment. The estimates for these loans are established by category and based on the Company’s internal system of credit risk ratings and historical loss data. The Company calculates average losses for all loan segments using a rolling 20 quarter historical period. The estimated loan loss allocation rate for the Company’s internal system of credit risk grades is based on its experience with similarly graded loans. For loan segments where the Company believes it does not have sufficient historical loss data, the Company may make adjustments based, in part, on loss rates of peer bank groups. At JuneSeptember 30, 2016 and December 31, 2015, and for the periods then ended, the Company adjusted its historical loss rates for the commercial real estate portfolio segment based, in part, on loss rates of peer bank groups.

The estimated loan loss allocation for all five loan portfolio segments is then adjusted for management’s estimate of probable losses for several “qualitative and environmental” factors. The allocation for qualitative and environmental factors is particularly subjective and does not lend itself to exact mathematical calculation. This amount represents estimated probable inherent credit losses which exist, but have not yet been identified, as of the balance sheet date, and are based upon quarterly trend assessments in delinquent and nonaccrual loans, credit concentration changes, prevailing economic conditions, changes in lending personnel experience, changes in lending policies or procedures, and other influencing factors. These qualitative and environmental factors are considered for each of the five loan segments and the allowance allocation, as determined by the processes noted above, is increased or decreased based on the incremental assessment of these factors.

Assessment for Other-Than-Temporary Impairment of Securities

On a quarterly basis, management makes an assessment to determine whether there have been events or economic circumstances to indicate that a security on which there is an unrealized loss is other-than-temporarily impaired. For equity securities with an unrealized loss, the Company considers many factors including the severity and duration of the impairment; the intent and ability of the Company to hold the security for a period of time sufficient for a recovery in value; and recent events specific to the issuer or industry. Equity securities for which there is an unrealized loss that is deemed to be other-than-temporary are written down to fair value with the write-down recorded as a realized loss in securities gains (losses).

For debt securities with an unrealized loss, an other-than-temporary impairment write-down is triggered when (1) the Company has the intent to sell a debt security, (2) it is more likely than not that the Company will be required to sell the debt security before recovery of its amortized cost basis, or (3) the Company does not expect to recover the entire amortized cost basis of the debt security. If the Company has the intent to sell a debt security or if it is more likely than not that it will be required to sell the debt security before recovery, the other-than-temporary write-down is equal to the entire difference between the debt security’s amortized cost and its fair value. If the Company does not intend to sell the security or it is not more likely than not that it will be required to sell the security before recovery, the other-than-temporary impairment write-down is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income, net of applicable taxes.

Fair Value Determination

U.S. GAAP requires management to value and disclose certain of the Company’s assets and liabilities at fair value, including investments classified as available-for-sale and derivatives. ASC 820,Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value in accordance with U.S. GAAP and expands disclosures about fair value measurements. For more information regarding fair value measurements and disclosures, please refer to Note 8, Fair Value, of the consolidated financial statements that accompany this report.

Fair values are based on active market prices of identical assets or liabilities when available. Comparable assets or liabilities or a composite of comparable assets in active markets are used when identical assets or liabilities do not have readily available active market pricing. However, some of the Company’s assets or liabilities lack an available or comparable trading market characterized by frequent transactions between willing buyers and sellers. In these cases, fair value is estimated using pricing models that use discounted cash flows and other pricing techniques. Pricing models and their underlying assumptions are based upon management’s best estimates for appropriate discount rates, default rates, prepayments, market volatility, and other factors, taking into account current observable market data and experience.

These assumptions may have a significant effect on the reported fair values of assets and liabilities and the related income and expense. As such, the use of different models and assumptions, as well as changes in market conditions, could result in materially different net earnings and retained earnings results.

Other Real Estate Owned

Other real estate owned (“OREO”), consists of properties obtained through foreclosure or in satisfaction of loans and is reported at the lower of cost or fair value, less estimated costs to sell at the date acquired, with any loss recognized as a charge-off through the allowance for loan losses. Additional OREO losses for subsequent valuation adjustments are determined on a specific property basis and are included as a component of other noninterest expense along with holding costs. Any gains or losses on disposal of OREO are also reflected in noninterest expense. Significant judgments and complex estimates are required in estimating the fair value of OREO, and the period of time within which such estimates can be considered current is significantly shortened during periods of market volatility. As a result, the net proceeds realized from sales transactions could differ significantly from appraisals, comparable sales, and other estimates used to determine the fair value of other OREO.

Deferred Tax Asset Valuation

A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more-likely-than-not that some portion or the entire deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of taxable income over the last three years and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that we will realize the benefits of these deductible differences at JuneSeptember 30, 2016. The amount of the deferred tax assets considered realizable, however, could be reduced if estimates of future taxable income are reduced.

RESULTS OF OPERATIONS

Average Balance Sheet and Interest Rates

 

   Six Months Ended June 30, 
   2016   2015 
(Dollars in thousands)  

 

Average

 

Balance

   

 

Yield/      

 

Rate      

   

 

Average

 

Balance

   

 

Yield/      

 

Rate      

 

 

  

 

 

   

 

 

 

Loans and loans held for sale

    $    433,504     4.76%      $    404,106     5.10%  

Securities - taxable

   162,980     2.06%     193,694     2.07%  

Securities - tax-exempt

   67,271     5.66%     68,115     5.86%  

 

  

 

 

   

 

 

 

 Total securities

   230,251     3.11%     261,809     3.06%  

Federal funds sold

   57,702     0.50%     60,789     0.21%  

Interest bearing bank deposits

   57,023     0.49%     24,449     0.23%  

 

  

 

 

   

 

 

 

 Total interest-earning assets

   778,480     3.65%     751,153     3.83%  

 

  

 

 

   

 

 

 

Deposits:

        

NOW

   123,831     0.31%     114,739     0.31%  

Savings and money market

   227,772     0.38%     207,027     0.40%  

Certificates of deposits less than $100,000

   82,794     0.97%     93,933     1.06%  

Certificates of deposits and other time deposits of $100,000 or more

   132,336     1.41%     145,124     1.45%  

 

  

 

 

   

 

 

 

 Total interest-bearing deposits

   566,733     0.69%     560,823     0.76%  

Short-term borrowings

   2,836     0.50%     4,167     0.48%  

Long-term debt

   7,217     3.54%     9,372     3.53%  

 

  

 

 

   

 

 

 

 Total interest-bearing liabilities

   576,786     0.73%     574,362     0.81%  

 

  

 

 

   

 

 

 

Net interest income and margin (tax-equivalent)

    $      12,033     3.11%      $      11,984     3.22%  

 

  

 

 

   

 

 

 

   Nine months ended September 30, 
   2016   2015 
(Dollars in thousands)  

 

Average

 

Balance

   

 

Yield/      

 

Rate      

   

 

Average

 

Balance

   

 

Yield/      

 

Rate      

 

 

  

 

 

   

 

 

 

Loans and loans held for sale

    $    432,628     4.75%      $    408,954     5.01%  

Securities - taxable

   161,484     2.00%     189,750     2.06%  

Securities - tax-exempt

   67,701     5.57%     68,549     5.82%  

 

  

 

 

   

 

 

 

 Total securities

   229,185     3.06%     258,299     3.06%  

Federal funds sold

   53,420     0.50%     59,639     0.22%  

Interest bearing bank deposits

   71,384     0.51%     27,589     0.23%  

 

  

 

 

   

 

 

 

 Total interest-earning assets

   786,617     3.58%     754,481     3.79%  

 

  

 

 

   

 

 

 

Deposits:

        

NOW

   123,049     0.31%     114,973     0.30%  

Savings and money market

   232,893     0.38%     212,300     0.39%  

Certificates of deposits less than $100,000

   81,626     0.97%     92,510     1.04%  

Certificates of deposits and other time deposits of $100,000 or more

   132,033     1.40%     142,575     1.44%  

 

  

 

 

   

 

 

 

 Total interest-bearing deposits

   569,601     0.69%     562,358     0.75%  

Short-term borrowings

   2,872     0.51%     3,758     0.50%  

Long-term debt

   7,217     3.52%     8,645     3.45%  

 

  

 

 

   

 

 

 

 Total interest-bearing liabilities

   579,690     0.72%     574,761     0.79%  

 

  

 

 

   

 

 

 

Net interest income and margin (tax-equivalent)

    $      17,957     3.05%      $      17,995     3.19%  

 

  

 

 

   

 

 

 

Net Interest Income and Margin

Net interest income (tax-equivalent) was $12.0$18.0 million for the first sixnine months of 2016 and 2015. Net interest income (tax-equivalent) for the first sixnine months of 2015 included $0.2 million in recoveries of interest related to payoffs received on two loans that were previously impaired. Excluding the impact of these interest recoveries, net interest income (tax-equivalent) increased 2%1% in the first sixnine months of 2016 compared to the first sixnine months of 2015. This increase reflects management’s ongoing efforts to increase earnings by shifting the Company’s asset mix through loan growth, focusing on deposit pricing, and repaying higher-cost wholesale funding.

The tax-equivalent yield on total interest-earning assets decreased by 1821 basis points in the first sixnine months of 2016 from the first sixnine months of 2015 to 3.65%3.58%. This decrease was primarily due to declining yields on loans and increased pricing competition for quality loan opportunities in our markets, which has limited the Company’s ability to increase yields on new and renewed loans.

The cost of total interest-bearing liabilities decreased 87 basis points in the first sixnine months of 2016 from the first sixnine months of 2015 to 0.73%0.72%. The net decrease was largely a result of the continued shift in our funding mix, as we increased our lower-cost interest bearing demand deposits (NOW accounts), and savings and money market accounts and concurrently reduced balances of higher-cost certificates of deposits and long-term debt.

The Company continues to deploy various asset liability management strategies to manage its risk to interest rate fluctuations. The Company’s net interest margin could experience pressure due to lower reinvestment yields in the securities portfolio given the current interest rate environment, increased competition for quality loan opportunities, and fewer opportunities to reduce our cost of funds due to the low level of deposit rates currently.

Provision for Loan Losses

The provision for loan losses represents a charge to earnings necessary to provide an allowance for loan losses that management believes, based on its processes and estimates, should be adequate to provide for the probable losses on outstanding loans. The Company recorded a negative provision for loan losses of $0.6 million infor the first sixnine months of 2016, compared to $0.2 million provision for loan losses for the first nine months of 2015. Annualized net recoveries as a resultpercent of average loans were 0.27% for the first nine months of 2016 compared to 0.03% for the first nine months of 2015. The Company recognized a recovery of $1.2 million recovery from the payoff of a non-performingone nonperforming construction and land development loan. No provision for loan losses was made forduring the first sixnine months of 2015.2016. Provision expense reflects the absolute level of loans, loan growth, the credit quality of the loan portfolio, and the amount of net charge-offs or recoveries.

Based upon its assessment of the loan portfolio, management adjusts the allowance for loan losses to an amount it believes should be appropriate to adequately cover its estimate of probable losses in the loan portfolio. The Company’s allowance for loan losses as a percentage of total loans was 1.05%1.07% at JuneSeptember 30, 2016, compared to 1.01% at December 31, 2015. While the policies and procedures used to estimate the allowance for loan losses, as well as the resulting provision for loan losses charged to operations, are considered adequate by management and are reviewed from time to time by our regulators, they are based on estimates and judgments and are therefore approximate and imprecise. Factors beyond our control (such as conditions in the local and national economy, local real estate markets, or industry) may have a material adverse effect on our asset quality and the adequacy of our allowance for loan losses resulting in significant increases in the provision for loan losses.

Noninterest Income

 

             Quarter ended June 30,               Six Months Ended June 30,         Quarter ended September 30,             Nine months ended September 30,     
(Dollars in thousands)  

 

2016

   

 

2015

   

 

2016

   

 

2015

   

 

2016

   

 

2015

   

 

2016

   

 

2015

 

 

 

Service charges on deposit accounts

   $193    $209      $391    $415      $197    $209      $588    $624   

Mortgage lending income

   315     457      494     791      246     362      740     1,153   

Bank-owned life insurance

   113     112      225     513      114     116      339     629   

Securities gains, net

   —      —       —            148     11      148     14   

Other

   372     389      717     766      358     358      1,075     1,124   

 

 

Total noninterest income

   $            993    $          1,167      $          1,827    $          2,488      $        1,063    $          1,056      $          2,890    $          3,544   

 

 

Service charges on deposit accounts decreased primarily due to a decline in insufficient funds charges, reflecting changes in customer behavior and spending patterns.

The Company’s income from mortgage lending was primarily attributable to the (1) origination and sale of new mortgage loans and (2) servicing of mortgage loans. Origination income, net, is comprised of gains or losses from the sale of the mortgage loans originated, origination fees, underwriting fees, and other fees associated with the origination of loans, which are netted against the commission expense associated with these originations. The Company’s normal practice is to originate mortgage loans for sale in the secondary market and to either sell or retain the associated mortgage servicing rights (“MSRs”) when the loan is sold.

MSRs are recognized based on the fair value of the servicing right on the date the corresponding mortgage loan is sold. Subsequent to the date of transfer, the Company has elected to measure its MSRs under the amortization method. Servicing fee income is reported net of any related amortization expense.

MSRs are also evaluated for impairment on a quarterly basis. Impairment is determined by grouping MSRs by common predominant characteristics, such as interest rate and loan type. If the aggregate carrying amount of a particular group of MSRs exceeds the group’s aggregate fair value, a valuation allowance for that group is established. The valuation allowance is adjusted as the fair value changes. An increase in mortgage interest rates typically results in an increase in the fair value of the MSRs while a decrease in mortgage interest rates typically results in a decrease in the fair value of MSRs.

The following table presents a breakdown of the Company’s mortgage lending income.

 

                Quarter ended June 30,                              Six Months Ended June 30,                      Quarter ended September 30,             Nine months ended September 30,     
(Dollars in thousands)  

 

2016

   

 

2015

   

 

2016

   

 

2015

   

 

2016

 

 

2015

   

 

2016

 

 

2015

 

 

 

Origination income

    $270     $386     $367     $644       $242   $298    $609   $942   

Servicing fees, net

   46      22      128      108      24   51     152   159   

(Increase) decrease in MSR valuation allowance

   (1)     49      (1)     39      (20 13     (21 52   

 

 

Total mortgage lending income

    $      315     $      457     $      494     $      791       $      246   $      362    $      740   $      1,153   

 

 

The decrease in mortgage lending income was primarily due to a decrease in the volume of mortgage loans originated and sold. The decrease in volume is due to various factors, including the Company’s efforts to comply with the new TILA-RESPA Integrated Disclosure (TRID) rules and a reduction in the number of mortgage originators. Until the Company’s new loan origination system is fully implemented and operational, management expects mortgage lending income and volume will decrease compared to prior periods. The Company is in the implementation phase of this new system.

Income from bank-owned life insurance decreased in the first sixnine months of 2016, compared to the first sixnine months of 2015 due to non-taxable death benefits received in the prior year. The assets that support these policies are administered by the life insurance carriers and the income we receive (i.e. increases or decreases in the cash surrender value of the policies) on these policies is dependent upon the returns the insurance carriers are able to earn on the underlying investments that support these policies. Earnings on these policies are generally not taxable.

Securities gains, net consisted of realized gains and losses on the sale of securities. Gross realized gains were $148,000 for the third quarter and first nine months of 2016, compared to $11,000 and $14,000, respectively, for the third quarter and first nine months of 2015.

Noninterest Expense

                Quarter ended June 30,                              Six Months Ended June 30,                      Quarter ended September 30,             Nine months ended September 30,     
(Dollars in thousands)  

 

2016

   

 

2015

   

 

2016

   

 

2015

   

 

2016

   

 

2015

   

 

2016

   

 

2015

 

 

 

Salaries and benefits

    $2,446     $2,291       $4,851       $4,559       $2,471     $2,255       $7,322       $6,814   

Net occupancy and equipment

   358      362      718      720      389      405      1,107      1,125   

Professional fees

   194      218      405      419      220      191      625      610   

FDIC and other regulatory assessments

   122      118      244      243      76      120      320      363   

Other real estate owned, net

   (43)          (23)     18      (194)          (217)     19   

Prepayment penalty on long-term debt

   —        —        —        362      —        —        —        362   

Other

   944      1,039      1,935      2,022      1,018      920      2,953      2,942   

 

 

Total noninterest expense

    $    4,021     $    4,029       $    8,130       $    8,343       $    3,980     $    3,892       $    12,110       $    12,235   

 

 

The increase in salaries and benefits expense reflected routine annual increases.

The decrease in FDIC and other regulatory assessments expense was primarily due to a decrease in the Bank’s initial assessment rate during the third quarter of 2016. In addition to changes in the FDIC assessment rate formula for banks with less than $10 billion in assets, the initial assessment rate for all banks decreased effective July 1, 2016 due to the Deposit Insurance Reserve Fund ratio exceeding 1.15% at June 30, 2016.

The decrease in other real estate owned expense was primarily due to a gain realized on the sale of OREO.

During the first sixnine months of 2015, the Company repaid $5.0 million of long-term debt with an interest rate of 3.59% and incurred prepayment penalties of $0.4 million.

Income Tax Expense

Income tax expense was $1.6$2.3 million for the first sixnine months of 2016, compared to $1.4$2.2 million for the first sixnine months of 2015. The Company’s income tax expense for the first sixnine months of 2016 reflects an effective income tax rate of 27.51%27.50%, compared to 26.47%26.80% for the first sixnine months of 2015. The increase in the effective tax rate is primarily due to a decrease in tax preference items such as income from bank-owned life insurance. The Company’s income tax expense is principally affected by tax exempt earnings on municipal securities investments and bank-owned life insurance.

BALANCE SHEET ANALYSIS

Securities

Securities available-for-sale were $217.0$249.6 million at JuneSeptember 30, 2016, a decreasean increase of $24.7$7.9 million, or 10%3%, compared to $241.7 million at December 31, 2015. This declineincrease was primarily due to a decreasean increase of $30.9$5.5 million in the amortized cost basis of securities available-for-sale from purchases, net of principal repayments, maturities and calls. This decrease was offset by securities purchasescalls, and an increase of $3.2$2.4 million and a $3.8 million change in net unrealized gains on securities available-for-sale, reflecting an increase in prices as long-term interest rates declined during the first sixnine months of 2016.

The average tax-equivalent yields earned on total securities were 3.11% in the first six months of 2016 and 3.06% in the first sixnine months of 2016 unchanged from the first nine months of 2015.

Loans

 

   

                           2016                          

                                          2015                                           

2016

   2015 
(In thousands)   

 

Second

 

Quarter

  

 

First

 

Quarter

   

 

Fourth

 

Quarter

 

 

Third

 

Quarter

 

 

Second

 

Quarter

    

 

Third

 

      Quarter      

  

 

Second

 

      Quarter      

 

 

First

 

      Quarter      

   

 

Fourth

 

      Quarter      

 

 

    Third    

 

      Quarter      

 

 

 

Commercial and industrial

    50,190   50,192    52,479    47,925    57,310    $    50,881   50,190  50,192     52,479    47,925   

Construction and land development

  49,346   45,953    43,694    41,592    38,854     44,004   49,346  45,953     43,694    41,592   

Commercial real estate

  208,825   209,320    203,853    201,449    184,124     211,558   208,825  209,320     203,853    201,449   

Residential real estate

  113,763   117,046    116,673    117,863    115,039     112,303   113,763  117,046     116,673    117,863   

Consumer installment

  9,125   9,769    10,220    14,362    13,632     8,996   9,125  9,769     10,220    14,362   

 

 

Total loans

  431,249   432,280    426,919    423,191    408,959     427,742   431,249  432,280     426,919    423,191   

Less: unearned income

  (555)  (517)   (509)   (619)   (464)    (539)  (555) (517)    (509)   (619)  

 

 

Loans, net of unearned income

  $   430,694   431,763    426,410    422,572    408,495    $    427,203   430,694  431,763     426,410    ��422,572   

 

 

Total loans, net of unearned income, were $430.7$427.2 million at JuneSeptember 30, 2016, compared to $426.4 million at December 31, 2015. Four loan categories represented the majority of the loan portfolio at JuneSeptember 30, 2016: commercial real estate (49%), residential real estate (26%), construction and land development (11%(10%) and commercial and industrial (12%). Approximately 23%22% of the Company’s commercial real estate loans were classified as owner-occupied at JuneSeptember 30, 2016.

Within the residential real estate portfolio segment, the Company had junior lien mortgages of approximately $14.7 million, or 3% of total loans, at JuneSeptember 30, 2016, compared to $16.4 million, or 4% of total loans, at December 31, 2015. For residential real estate mortgage loans with a consumer purpose, $1.6$1.3 million required interest-only payments at JuneSeptember 30, 2016, compared to $0.9 million at December 31, 2015. The Company’s residential real estate mortgage portfolio does not include any option ARM loans, subprime loans, or any material amount of other high-risk consumer mortgage products.

The average yield earned on loans and loans held for sale was 4.76%4.75% in the first sixnine months of 2016 and 5.10%5.01% in the first sixnine months of 2015.

The specific economic and credit risks associated with our loan portfolio include, but are not limited to, the effects of current economic conditions on our borrowers’ cash flows, real estate market sales volumes, valuations, availability and cost of financing properties, real estate industry concentrations, deterioration in certain credits, interest rate fluctuations, reduced collateral values or non-existent collateral, title defects, inaccurate appraisals, financial deterioration of borrowers, fraud, and any violation of applicable laws and regulations.

The Company attempts to reduce these economic and credit risks by adhering to loan to value guidelines for collateralized loans, investigating the creditworthiness of borrowers and monitoring borrowers’ financial position. Also, we have established and periodically review, lending policies and procedures. Banking regulations limit a bank’s credit exposure by prohibiting unsecured loan relationships that exceed 10% of its capital; or 20% of capital, if loans in excess of 10% of capital are fully secured. Under these regulations, we are prohibited from having secured loan relationships in excess of approximately $18.1$18.3 million. Furthermore, we have an internal limit for aggregate credit exposure (loans outstanding plus unfunded commitments) to a single borrower of $16.3$16.5 million. Our loan policy requires that the Loan Committee of the Board of Directors approve any loan relationships that exceed this internal limit. At JuneSeptember 30, 2016, the Bank had no loan relationships exceeding these limits.

We periodically analyze our commercial loan portfolio to determine if a concentration of credit risk exists in any one or more industries. We use classification systems broadly accepted by the financial services industry in order to categorize our commercial borrowers. Loan concentrations to borrowers in the following classes exceeded 25% of the Bank’s total risk-based capital at JuneSeptember 30, 2016 (and related balances at December 31, 2015).

 

      June 30,    December 31,       September 30,    December 31, 
(In thousands)  

 

    2016

    2015   

 

    2016

    2015 

 

 

Lessors of 1 to 4 family residential properties

  $             45,686    $             46,664     $             45,065    $             46,664  

Multi-family residential properties

   43,279     45,264      45,799     45,264  

Shopping centers

   38,190     38,116      38,779     38,116  

 

 

Allowance for Loan Losses

The Company maintains the allowance for loan losses at a level that management believes appropriate to adequately cover the Company’s estimate of probable losses inherent in the loan portfolio. At JuneSeptember 30, 2016 and December 31, 2015, the allowance for loan losses was $4.5$4.6 million and $4.3 million, respectively, which management believed to be adequate at each of the respective dates. The judgments and estimates associated with the determination of the allowance for loan losses are described under “Critical Accounting Policies.”

A summary of the changes in the allowance for loan losses and certain asset quality ratios for the secondthird quarter of 2016 and the previous four quarters is presented below.

 

   2016 2015    2016   2015 
(Dollars in thousands)   

 

    Second

 

    Quarter

 

 

First    

 

Quarter    

 

 

    Fourth

 

    Quarter

   

 

Third

 

Quarter

   

 

Second    

 

Quarter    

    

 

Third

 

    Quarter    

 

 

Second

 

    Quarter    

 

 

First

 

    Quarter    

   

 

Fourth

 

    Quarter    

   

 

    Third    

 

    Quarter    

 

 

 

Balance at beginning of period

  $ 4,774   4,289    5,127     4,886     4,722     $ 4,528   4,774   4,289     5,127     4,886   

Charge-offs:

                  

Commercial and industrial

   (83  —      (42   —       —         —     (83  —       (42   —     

Commercial real estate

   (194  —      (866   —       —         —     (194  —       (866   —     

Residential real estate

   (37 (118)   (3   (26   —        (7 (37 (118   (3   (26)  

Consumer installment

   (2 (26)   (14   (23   (5)     (1 (2 (26   (14   (23)  

 

 

Total charge-offs

   (316 (144)   (925   (49   (5)     (8 (316 (144   (925   (49)  

Recoveries

   70   1,229    87     90     169      58   70   1,229     87     90   

 

 

Net (charge-offs) recoveries

   (246 1,085    (838   41     164   

Net recoveries (charge-offs)

   50   (246 1,085     (838   41   

Provision for loan losses

    —     (600)    —       200     —         —      —     (600   —       200   

 

 

Ending balance

  $ 4,528   4,774    4,289     5,127     4,886     $ 4,578   4,528   4,774     4,289     5,127   

 

 

as a % of loans

   1.05 %  1.11    1.01     1.21     1.20      1.07 %  1.05   1.11     1.01     1.21   

as a % of nonperforming loans

   271 %  246    158     140     360      284 %  271   246     158     140   

Net charge-offs (recoveries) as % of average loans (a)

   0.23 %  (1.01)   0.79     (0.04   (0.16)  

Net (recoveries) charge-offs as % of average loans (a)

   (0.05)%  0.23   (1.01   0.79     (0.04)  

 

 

(a) Net (recoveries) charge-offs (recoveries) are annualized.

As described under “Critical Accounting Policies,” management assesses the adequacy of the allowance prior to the end of each calendar quarter. The level of the allowance is based upon management’s evaluation of the loan portfolios, past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan loss rates, and other pertinent factors. This evaluation is inherently subjective as it requires various material estimates and judgments, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The ratio of our allowance for loan losses to total loans outstanding was 1.05%1.07% at JuneSeptember 30, 2016, compared to 1.01% at December 31, 2015. In the future, the allowance to total loans outstanding ratio will increase or decrease to the extent the factors that influence our quarterly allowance assessment in their entirety either improve or weaken. In addition, our regulators, as an integral part of their examination process, will periodically review the Company’s allowance for loan losses, and may require the Company to make additional provisions to the allowance for loan losses based on their judgementjudgment about information available to them at the time of their examinations.

Net recoveries were $839$889 thousand, or 0.39%0.27% of average loans in the first sixnine months of 2016, compared to net recoveries of $50,000,$91,000, or 0.02%0.03% of average loans in the first sixnine months of 2015. In the first sixnine months of 2016, the Company recognized a recovery of $1.2 million from the payoff of one nonperforming construction and land development loan.

At JuneSeptember 30, 2016, the ratio of our allowance for loan losses as a percentage of nonperforming loans was 271%284%, compared to 158% at December 31, 2015. The increase was primarily due to a decrease in nonperforming loans of $1.0$1.1 million.

At JuneSeptember 30, 2016 and December 31, 2015, the Company’s recorded investment in loans considered impaired was $2.7 million$1,786,000 and $3.4 million,$3,407,000, respectively, with corresponding valuation allowances (included in the allowance for loan losses) of $0.1 million$36,000 and $121,000 at each respective date.

Nonperforming Assets

At JuneSeptember 30, 2016 and December 31, 2015, respectively, the Company had $2.0$1.7 million and $3.0 million in nonperforming assets. The decrease was primarily due to the payoff of one nonperforming construction and land development loan with a recorded investment of $0.5 million at December 31, 2015.2015 and partial charge-offs of approximately $0.5 million on several impaired loans.    

The table below provides information concerning total nonperforming assets and certain asset quality ratios for the secondthird quarter of 2016 and the previous four quarters.

 

     

2016

       2015
     

 

Second  

  First       Fourth   Third      Second  
(Dollars in thousands)    

 

    Quarter      

        Quarter                 Quarter             Quarter              Quarter    

 

Nonperforming assets:

              

Nonaccrual loans

 $  1,669      1,938       2,714    3,650    1,359 

Other real estate owned

   300      397       252    278    499 

 

Total nonperforming assets

 $  1,969      2,335       2,966    3,928    1,858 

 

as a % of loans and other real estate owned

   0.46 %  0.54       0.70    0.93    0.45 

as a % of total assets

   0.23 %  0.28       0.36    0.48    0.23 

Nonperforming loans as a % of total loans

   0.39 %  0.45       0.64    0.86    0.33 

Accruing loans 90 days or more past due

 $  —        —         —       112    442 

 

     

2016

         

2015

     

 

Third

  Second First         Fourth  Third
(Dollars in thousands)    

 

      Quarter      

        Quarter             Quarter                     Quarter              Quarter      

 

Nonperforming assets:

              

Nonaccrual loans

 $  1,614      1,669   1,938        2,714    3,650 

Other real estate owned

   37      300   397        252    278 

 

Total nonperforming assets

 $  1,651      1,969   2,335        2,966    3,928 

 

as a % of loans and other real estate owned

   0.39 %  0.46   0.54        0.70    0.93 

as a % of total assets

   0.19 %  0.23   0.28        0.36    0.48 

Nonperforming loans as a % of total loans

   0.38 %  0.39   0.45        0.64    0.86 

Accruing loans 90 days or more past due

 $  211      —     —           —      112 

 

The table below provides information concerning the composition of nonaccrual loans for the secondthird quarter of 2016 and the previous four quarters.

 

     

2016

   2015   

2016

         

2015

     

 

Second    

  First   

 

Fourth

   Third  Second   

 

Third

  Second First         Fourth  Third
(In thousands)     

 

      Quarter          

        Quarter         

 

      Quarter      

         Quarter              Quarter         

 

      Quarter      

        Quarter             Quarter                     Quarter              Quarter      

Nonaccrual loans:

                           

Commercial and industrial

  $  40      42     43    81  46  $  38      40 42        43  81 

Construction and land development

    55      66     583    594  602    45      55 66        583  594 

Commercial real estate

    1,564      1,734     1,750    2,790  684    1,521      1,564 1,734        1,750  2,790 

Residential real estate

    10      96     325    185  27    10      10 96        325  185 

Consumer installment

    —        —       13    —    —       —        —    —          13  —   

Total nonaccrual loans

  $  1,669      1,938     2,714    3,650  1,359  $  1,614      1,669 1,938        2,714  3,650 

The Company discontinues the accrual of interest income when (1) there is a significant deterioration in the financial condition of the borrower and full repayment of principal and interest is not expected or (2) the principal or interest is 90 days or more past due, unless the loan is both well-secured and in the process of collection. At JuneSeptember 30, 2016 and December 31, 2015, respectively, the Company had $1.7$1.6 million and $2.7 million in loans on nonaccrual.

At JuneSeptember 30, 2016 and December 31, 2015, there were no$0.2 million in loans 90 days or more past due and still accruing.accruing compared to none at December 31, 2015.

The table below provides information concerning the composition of other real estate owned for the secondthird quarter of 2016 and the previous four quarters.

 

   

2016

   2015   2016   2015 
   

 

Second    

  

 

First

   Fourth   Third      Second   

 

Third

   Second   First   Fourth   Third 
(In thousands)   

 

      Quarter          

        Quarter               Quarter               Quarter                Quarter         

 

    Quarter    

       Quarter           Quarter           Quarter           Quarter     

 

Other real estate owned:

                       

Commercial:

                       

Developed lots

 $  252      252     252    252    252  $   —       252     252     252     252   

Residential

   48      145     —      26    247     37     48     145     —       26   

 

Total other real estate owned

 $      300          397     252    278    499  $   37     300     397     252     278   

 

At JuneSeptember 30, 2016 and December 31, 2015, respectively, the Company held $0.3 million,$37,000 and $252,000, respectively, in OREO, which we acquired from borrowers.

Potential Problem Loans

Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of a borrower havehas caused management to have serious doubts about the borrower’s ability to comply with present repayment terms. This definition is believed to be substantially consistent with the standards established by the Federal Reserve, the Company’s primary regulator, for loans classified as substandard, excluding nonaccrual loans. Potential problem loans, which are not included in nonperforming assets, amounted to $5.5$6.4 million, or 1.3%1.5% of total loans at JuneSeptember 30, 2016, compared to $5.9 million, or 1.4% of total loans at December 31, 2015.

The table below provides information concerning the composition of potential problem loans for the secondthird quarter of 2016 and the previous four quarters.

 

   

2016

      

2015

   2016   2015 
   

 

      Second      

  First        Fourth    Third    Second       

 

Third

   Second   First   Fourth   Third 
(In thousands)   

 

 

      Quarter      

        Quarter                    Quarter                Quarter                Quarter             

 

    Quarter    

       Quarter           Quarter           Quarter           Quarter     

 

Potential problem loans:

                        

Commercial and industrial

 $  285   309    323      329    383  $   356     285     309     323     329   

Construction and land development

   365     477    593      578    627     352     365     477     593     578   

Commercial real estate

   911   783    491      501    503     1,184     911     783     491     501   

Residential real estate

   3,855   3,938    4,371      4,964    4,898     4,423     3,855     3,938     4,371     4,964   

Consumer installment

   84   110    114      128    167     89     84     110     114     128   

 

Total potential problem loans

 $  5,500   5,617    5,892      6,500    6,578  $   6,404     5,500     5,617     5,892     6,500   

 

At JuneSeptember 30, 2016, approximately $0.1$0.2 million, or 2.0%3.7%, of total potential problem loans were past due at least 30 days, but less than 90 days. At June 30, 2016, the remaining balance of potential problem loans were current or past due less than 30 days.

The following table is a summary of the Company’s performing loans that were past due at least 30 days, but less than 90 days, for the secondthird quarter of 2016 and the previous four quarters.

 

   

2016

      

2015

   2016   2015 
   

 

      Second      

        First              Fourth      Third    Second       

 

Third

   Second   First   Fourth   Third 
(In thousands)   

 

 

      Quarter      

        Quarter                    Quarter                  Quarter                Quarter             

 

    Quarter    

       Quarter           Quarter           Quarter           Quarter     

 

Performing loans past due 30 to 89 days:

                        

Commercial and industrial

 $  25    14     49      37     $   3     25     14     49     37   

Construction and land development

   —      129     —        —      12     —       —       129     —       —     

Commercial real estate

   —      —       —        182    —        —       —       —       —       182   

Residential real estate

   645    623     1,334      335    415     369     645     623     1,334     335   

Consumer installment

   51    28     28      20    23     40     51     28     28     20   

 

Total

 $  721    794     1,411      574    456  $   412     721     794     1,411     574   

 

Deposits

Total deposits were $747.5$751.9 million at JuneSeptember 30, 2016, compared to $723.6 million at December 31, 2015. Noninterest bearing deposits were $167.7$179.6 million, or 22.4%23.9% of total deposits, at JuneSeptember 30, 2016, compared to $156.8 million, or 21.7% of total deposits at December 31, 2015.

The average rate paid on total interest-bearing deposits was 0.69% in the first sixnine months of 2016 and 0.76%0.75% in the first sixnine months of 2015.

Other Borrowings

Other borrowings consist of short-term borrowings and long-term debt. Short-term borrowings generally consist of federal funds purchased and securities sold under agreements to repurchase with an original maturity less than one year. The Bank had available federal funds lines totaling $41.0 million with none outstanding at JuneSeptember 30, 2016, and at December 31, 2015, respectively. Securities sold under agreements to repurchase totaled $2.6$3.5 million and $3.0 million at JuneSeptember 30, 2016 and December 31, 2015, respectively.

The average rate paid on short-term borrowings was 0.51% in the first nine months of 2016 and 0.50% in the first six months of 2016 and 0.48% in the first sixnine months of 2015.

Long-term debt includes FHLB advances with an original maturity greater than one year and subordinated debentures related to trust preferred securities. The BankCompany had no long-term FHLB advances outstanding and $7.2 million in junior subordinated debentures related to trust preferred securities outstanding at JuneSeptember 30, 2016 and December 31, 2015, respectively. The debentures mature on December 31, 2033 and have been redeemable since December 31, 2008.

The average rate paid on long-term debt was 3.54%3.52% in the first sixnine months of 2016 and 3.53%3.45% in the first sixnine months of 2015.

CAPITAL ADEQUACY

The Company’s consolidated stockholders’ equity was $84.8$85.1 million and $79.9 million as of JuneSeptember 30, 2016 and December 31, 2015, respectively. The change from December 31, 2015 was primarily driven by net earnings of $4.1$6.1 million and other comprehensive income due to the change in unrealized gains (losses) on securities available-for-sale, net-of-tax, of $2.4$1.5 million, partially offset by cash dividends paid of $1.6$2.5 million.

On January 1, 2015, the Company and Bank became subject to the rules of the Basel III regulatory capital framework and related Dodd-Frank Wall Street Reform and Consumer Protection Act changes. The new rules included the implementation of a new capital conservation buffer that is added to the minimum requirements for capital adequacy purposes. The capital conservation buffer is subject to a three year phase-in period that began on January 1, 2016 and will be fully phased-in on January 1, 2019 at 2.5%. The required phase-in capital conservation buffer during 2016 is 0.625%. A banking organization with a conservation buffer of less than the required amount will be subject to limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. At JuneSeptember 30, 2016, the ratios for the Company and Bank were sufficient to meet the fully phased-in conservation buffer.

The Company’s tier 1 leverage ratio was 10.56%10.36%, common equity tier 1 (“CET1”) risk-based capital ratio was 15.54%15.74%, tier 1 risk-based capital ratio was 16.87%17.07%, and total risk-based capital ratio was 17.77%17.97% at JuneSeptember 30, 2016. These ratios exceed the minimum regulatory capital percentages of 5.0% for tier 1 leverage ratio, 6.5% for CET1 risk-based capital ratio, 8.0% for tier 1 risk-based capital ratio, and 10.0% for total risk-based capital ratio to be considered “well capitalized.” The Company’s capital conservation buffer was 9.77%9.97% at JuneSeptember 30, 2016.

MARKET AND LIQUIDITY RISK MANAGEMENT

Management’s objective is to manage assets and liabilities to provide a satisfactory, consistent level of profitability within the framework of established liquidity, loan, investment, borrowing, and capital policies. The Bank’s Asset Liability Management Committee (“ALCO”) is charged with the responsibility of monitoring these policies, which are designed to ensure an acceptable asset/liability composition. Two critical areas of focus for ALCO are interest rate risk and liquidity risk management.

Interest Rate Risk Management

In the normal course of business, the Company is exposed to market risk arising from fluctuations in interest rates. ALCO measures and evaluates interest rate risk so that the Bank can meet customer demands for various types of loans and deposits. Measurements used to help manage interest rate sensitivity include an earnings simulation model and an economic value of equity (“EVE”) model.

Earnings simulation. Management believes that interest rate risk is best estimated by our earnings simulation modeling. Forecasted levels of earning assets, interest-bearing liabilities, and off-balance sheet financial instruments are combined with ALCO forecasts of market interest rates for the next 12 months and other factors in order to produce various earnings simulations and estimates. To help limit interest rate risk, we have guidelines for earnings at risk which seek to limit the variance of net interest income from gradual changes in interest rates. For changes up or down in rates from management’s flat interest rate forecast over the next 12 months, policy limits for net interest income variances are as follows:

 

  +/- 20% for a gradual change of 400 basis points
  +/- 15% for a gradual change of 300 basis points
  +/- 10% for a gradual change of 200 basis points
  +/- 5% for a gradual change of 100 basis points

At JuneSeptember 30, 2016, our earnings simulation model indicated that we were in compliance with the policy guidelines noted above.

Economic Value of Equity. EVE measures the extent that the estimated economic values of our assets, liabilities, and off-balance sheet items will change as a result of interest rate changes. Economic values are estimated by discounting expected cash flows from assets, liabilities, and off-balance sheet items, which establishes a base case EVE. In contrast with our earnings simulation model, which evaluates interest rate risk over a 12 month timeframe, EVE uses a terminal horizon which allows for the re-pricing of all assets, liabilities, and off-balance sheet items. Further, EVE is measured using values as of a point in time and does not reflect any actions that ALCO might take in responding to or anticipating changes in interest rates, or market and competitive conditions. To help limit interest rate risk, we have stated policy guidelines for an instantaneous basis point change in interest rates, such that our EVE should not decrease from our base case by more than the following:

 

  45% for an instantaneous change of +/- 400 basis points
  35% for an instantaneous change of +/- 300 basis points
  25% for an instantaneous change of +/- 200 basis points
  15% for an instantaneous change of +/- 100 basis points

At JuneSeptember 30, 2016, our EVE model indicated that we were in compliance with the policy guidelines noted above.

Each of the above analyses may not, on its own, be an accurate indicator of how our net interest income will be affected by changes in interest rates. Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by changes in interest rates. In addition, the magnitude and duration of changes in interest rates may have a significant impact on net interest income. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates, and other economic and market factors, including market perceptions. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types of assets and liabilities may lag behind changes in general market rates. In addition, certain assets, such as adjustable rate mortgage loans, have features (generally referred to as “interest rate caps and floors”) which limit changes in interest rates. Prepayment and early withdrawal levels also could deviate significantly from those assumed in calculating the maturity of certain instruments. The ability of many borrowers to service their debts also may decrease during periods of rising interest rates or economic stress, which may differ across industries and economic sectors. ALCO reviews each of the above interest rate sensitivity analyses along with several different interest rate scenarios in seeking satisfactory, consistent levels of profitability within the framework of the Company’s established liquidity, loan, investment, borrowing, and capital policies.

The Company may also use derivative financial instruments to improve the balance between interest-sensitive assets and interest-sensitive liabilities, and as a tool to manage interest rate sensitivity while continuing to meet the credit and deposit needs of our customers. From time to time, the Company may enter into interest rate swaps (“swaps”) to facilitate customer transactions and meet their financing needs. These swaps qualify as derivatives, but are not designated as hedging instruments. At JuneSeptember 30, 2016 and December 31, 2015, the Company had no derivative contracts designated as part of a hedging relationship to assist in managing its interest rate sensitivity.

Liquidity Risk Management

Liquidity is the Company’s ability to convert assets into cash equivalents in order to meet daily cash flow requirements, primarily for deposit withdrawals, loan demand and maturing obligations. Without proper management of its liquidity, the Company could experience higher costs of obtaining funds due to insufficient liquidity, while excessive liquidity can lead to a decline in earnings due to the cost of foregoing alternative higher-yielding investment opportunities.

Liquidity is managed at two levels. The first is the liquidity of the Company. The second is the liquidity of the Bank. The management of liquidity at both levels is essential, because the Company and the Bank are separate legal entities with different funding needs and sources, and each are subject to regulatory guidelines and requirements.

The primary source of funding and the primary source of liquidity for the Company include dividends received from the Bank, and secondarily proceeds from the possible issuance of common stock or other securities. Primary uses of funds by the Company include dividends paid to stockholders, stock repurchases, and interest payments on junior subordinated debentures issued by the Company in connection with trust preferred securities. The junior subordinated debentures are presented as long-term debt in the accompanying consolidated balance sheets and the related trust preferred securities are currently includible in Tier 1 Capital for regulatory capital purposes.

Primary sources of funding for the Bank include customer deposits, other borrowings, repayment and maturity of securities, sales of securities, and the sale and repayment of loans. The Bank has access to federal funds lines from various banks and borrowings from the Federal Reserve discount window. In addition to these sources, the Bank may participate in the FHLB’s advance program to obtain funding for its growth. Advances include both fixed and variable terms and may be taken out with varying maturities. At JuneSeptember 30, 2016, the Bank had a remaining available line of credit with the FHLB of $245.9$249.7 million. At JuneSeptember 30, 2016, the Bank also had $41.0 million of available federal funds lines with none outstanding. Primary uses of funds include repayment of maturing obligations and growing the loan portfolio.

Management believes that the Company and the Bank have adequate sources of liquidity to meet all known contractual obligations and unfunded commitments, including loan commitments and reasonable borrower, depositor, and creditor requirements over the next twelve months.

Off-Balance Sheet Arrangements, Commitments and Contingencies

At JuneSeptember 30, 2016, the Bank had outstanding standby letters of credit of $7.0 million and unfunded loan commitments outstanding of $53.0$51.5 million. Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements. If needed to fund these outstanding commitments, the Bank could liquidate federal funds sold or a portion of securities available-for-sale, or draw on its available credit facilities.

Mortgage lending activities

Since 2009, we have primarily sold residential mortgage loans in the secondary market to Fannie Mae while retaining the servicing of these loans. The sale agreements for these residential mortgage loans with Fannie Mae and other investors include various representations and warranties regarding the origination and characteristics of the residential mortgage loans. Although the representations and warranties vary among investors, they typically cover ownership of the loan, validity of the lien securing the loan, the absence of delinquent taxes or liens against the property securing the loan, compliance with loan criteria set forth in the applicable agreement, compliance with applicable federal, state, and local laws, among other matters.

As of JuneSeptember 30, 2016, the unpaid principal balance of residential mortgage loans, which we have originated and sold, but retained the servicing rights was $349.6$343.4 million. Although these loans are generally sold on a non-recourse basis, we may be obligated to repurchase residential mortgage loans or reimburse investors for losses incurred (make whole requests) if a loan review reveals a potential breach of seller representations and warranties. Upon receipt of a repurchase or make whole request, we work with investors to arrive at a mutually agreeable resolution. Repurchase and make whole requests are typically reviewed on an individual loan by loan basis to validate the claims made by the investor and to determine if a contractually required repurchase or make whole event has occurred. We seek to reduce and manage the risks of potential repurchases, make whole requests, or other claims by mortgage loan investors through our underwriting and quality assurance practices and by servicing mortgage loans to meet investor and secondary market standards.

In the first sixnine months of 2016, as a result of the representation and warranty provisions contained in the Company’s sale agreements with Fannie Mae, the Company was required to repurchase one loan with a principal balance of $198,000 that was current as to principal and interest at the time of repurchase. At JuneSeptember 30, 2016, the Company had no pending repurchase or make whole requests.

We service all residential mortgage loans originated and sold by us to Fannie Mae. As servicer, our primary duties are to: (1) collect payments due from borrowers; (2) advance certain delinquent payments of principal and interest; (3) maintain and administer any hazard, title, or primary mortgage insurance policies relating to the mortgage loans; (4) maintain any required escrow accounts for payment of taxes and insurance and administer escrow payments; and (5) foreclose on defaulted mortgage loans or take other actions to mitigate the potential losses to investors consistent with the agreements governing our rights and duties as servicer.

The agreement under which we act as servicer generally specifies a standard of responsibility for actions taken by us in such capacity and provides protection against expenses and liabilities incurred by us when acting in compliance with the respective servicing agreements. However, if we commit a material breach of our obligations as servicer, we may be subject to termination if the breach is not cured within a specified period following notice. The standards governing servicing and the possible remedies for violations of such standards are determined by servicing guides issued by Fannie Mae as well as the contract provisions established between Fannie Mae and the Bank. Remedies could include repurchase of an affected loan.

Although repurchase and make whole requests related to representation and warranty provisions and servicing activities have been limited to date, it is possible that requests to repurchase mortgage loans or reimburse investors for losses incurred (make whole requests) may increase in frequency if investors more aggressively pursue all means of recovering losses on their purchased loans. As of JuneSeptember 30, 2016, we do not believe that this exposure is material due to the historical level of repurchase requests and loss trends, in addition to the fact that 99% of our residential mortgage loans serviced for Fannie Mae were current as of such date. We maintain ongoing communications with our investors and will continue to evaluate this exposure by monitoring the level and number of repurchase requests as well as the delinquency rates in our investor portfolios.

Effects of Inflation and Changing Prices

The Consolidated Financial Statements and related consolidated financial data presented herein have been prepared in accordance with U.S. generally accepted accounting principles and practices within the banking industry which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation.

CURRENT ACCOUNTING DEVELOPMENTS

The following Accounting Standards Updates (“Updates” or “ASUs”) have been issued by the FASB but are not yet effective.

 

 ASU 2014-09,Revenue from Contracts with Customers;

 ASU 2015-14,Revenue from Contracts with Customers – Deferral of the Effective Date;

 ASU 2016-01,Financial Instruments – Overall:Recognition and Measurement of Financial Assets and Financial LiabilitiesLiabilities;;

 ASU 2016-02,Leases; and

 ASU 2016-13,Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.Instruments; and

ASU 2016-15,Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments

Information about these pronouncements is described in more detail below.

ASU 2014-09,Revenue from Contracts with Customers, provides a comprehensive and converged standard on revenue recognition. The new guidance is intended to improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects consideration to which the entity expects to be entitled in exchange for those goods and services. This guidance also requires new qualitative and quantitative disclosures related to revenue from contracts with customers. In August 2015, FASB issued ASU 2015-14,Revenue from Contracts with Customers – Deferral of the Effective Date,which defers the effective date by one year. With the deferral, these changes are effective for the Company in the first quarter of 2018 with retrospective application to each prior reporting period or with the cumulative effect of initially applying this Update at the date of initial application. Early adoption is not permitted. The Company is currently evaluating the impact this ASU will have on its consolidated financial statements.

ASU 2016-01,Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities, enhances the reporting model for financial instruments to provide users of financial statements with more decision-useful information. The ASU addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Some of the amendments include the following: 1) Require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; 2) Simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; 3) Require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; 4) Require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value; among others. For public business entities, the amendments of this ASU are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact of this ASU will have on its consolidated financial statements.

ASU 2016-02,Leases, requires lessees to recognize the assets and liabilities that arise from leases on the balance sheet. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for lease term. The new guidance is effective for annual and interim reporting periods beginning after December 15, 2018. The amendment should be applied at the beginning of the earliest period presented using a modified retrospective approach with earlier application permitted as of the beginning of an interim or annual reporting period. The Company is currently evaluating the impact of the new guidance on its consolidated financial statements.

ASU 2016-13,Financial Instruments - Credit Losses (Topic 326): - Measurement of Credit Losses on Financial Instruments, amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. For assets held at amortized cost basis, the new standard eliminates the probable initial recognition threshold in current GAAP and, instead, requires an entity to reflect its current estimate of all expected credit losses using a broader range of information regarding past events, current conditions and forecasts assessing the collectability of cash flows. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial assets to present the net amount expected to be collected. For available for sale debt securities, credit losses should be measured in a manner similar to current GAAP, however the new standard will require that credit losses be presented as an allowance rather than as a write-down. The new guidance affects entities holding financial assets and net investment in leases that are not accounted for at fair value through net income. The amendments affect loans, debt securities, trade receivables, net investments in leases, off balance sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. For public business entities that are SEC filers, the new guidance is effective for annual and interim periods in fiscal years beginning after December 15, 2019 early adoption is permitted beginning in 2019. The Company is currently evaluating the impact of the new guidance on its consolidated financial statements.

ASU 2016-15,Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, provides guidance on eight specific cash flow issues where current GAAP is either unclear or does not include specific guidance on classification in the statement of cash flows. The new guidance is effective for annual and interim reporting periods in fiscal years beginning after December 15, 2017. The Company is currently evaluating the impact of the new guidance on its consolidated financial statements.

Table 1 – Explanation of Non-GAAP Financial Measures

In addition to results presented in accordance with U.S. generally accepted accounting principles (GAAP), this quarterly report on Form 10-Q includes certain designated net interest income amounts presented on a tax-equivalent basis, a non-GAAP financial measure, including the presentation and calculation of the efficiency ratio.

The Company believes the presentation of net interest income on a tax-equivalent basis provides comparability of net interest income from both taxable and tax-exempt sources and facilitates comparability within the industry. Although the Company believes these non-GAAP financial measures enhance investors’ understanding of its business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP. The reconciliations of these non-GAAP financial measures to their most directly comparable GAAP financial measures are presented below.

 

 

2016

 2015    2016   2015 
 

 

Second

  First Fourth Third   Second    

 

Third

   Second   First   Fourth   Third 
(In thousands) 

 

        Quarter        

          Quarter                 Quarter                 Quarter                   Quarter         
(in thousands)   

 

      Quarter      

         Quarter               Quarter               Quarter               Quarter       

 

   

 

 

 

Net interest income (GAAP)

 

$

 5,692   5,697     5,737     5,670     5,788   $   5,608     5,692     5,697     5,737     5,670   

Tax-equivalent adjustment

  322   322    328    341     338      316     322     322     328     341   

 

   

 

 

 

Net interest income (Tax-equivalent)

 

$

       6,014             6,019               6,065               6,011               6,126   $   5,924     6,014     6,019     6,065     6,011   

 

   

 

 

 
             Six Months Ended June 30,       
(In thousands)       2016   2015 

 

Net interest income (GAAP)

       $  11,389     11,311  

Tax-equivalent adjustment

        644     673  

 

Net interest income (Tax-equivalent)

       

$

          12,033             11,984  

 

      Nine months ended September 30, 
(In thousands)     2016   2015 

 

 

Net interest income (GAAP)

  $     16,997     16,981  

Tax-equivalent adjustment

    960     1,014  

 

 

Net interest income (Tax-equivalent)

  $     17,957     17,995  

 

 

Table 2 - Selected Quarterly Financial Data

 

  2016   2015   2016 2015 
        Second           First           Fourth           Third           Second       Third Second   First Fourth   Third 
(Dollars in thousands, except per share amounts)  

 

      Quarter      

     Quarter           Quarter           Quarter           Quarter       Quarter Quarter   Quarter Quarter   Quarter 

 

 

Results of Operations

                 

Net interest income (a)

  $6,014   6,019     6,065     6,011     6,126    $5,924   6,014     6,019   6,065     6,011  

Less: tax-equivalent adjustment

   322   322     328     341     338     316   322     322   328     341  

 

 

Net interest income (GAAP)

   5,692   5,697     5,737     5,670     5,788     5,608   5,692     5,697   5,737     5,670  

Noninterest income

   993   834     988     1,056     1,167     1,063   993     834   988     1,056  

 

 

Total revenue

   6,685   6,531     6,725     6,726     6,955     6,671   6,685     6,531   6,725     6,726  

Provision for loan losses

   —      (600)     —        200     —        —      —       (600  —       200  

Noninterest expense

   4,021   4,109     4,137     3,892     4,029     3,980   4,021     4,109   4,137     3,892  

Income tax expense

   733   831     652     724     776     740   733     831   652     724  

 

 

Net earnings

  $1,931   2,191     1,936     1,910     2,150    $1,951   1,931     2,191   1,936     1,910  

 

 

Per share data:

                 

Basic and diluted net earnings

  $0.53   0.60     0.53     0.52     0.59    $0.54   0.53     0.60   0.53     0.52  

Cash dividends declared

   0.225   0.225     0.22     0.22     0.22     0.225   0.225     0.225   0.22     0.22  

Weighted average shares outstanding:

                 

Basic and diluted

   3,643,503   3,643,484     3,643,478     3,643,455     3,643,413     3,643,506   3,643,503     3,643,484   3,643,478     3,643,455  

Shares outstanding

   3,643,503   3,643,503     3,643,478     3,643,478     3,643,428  

Shares outstanding, at period end

         3,643,523         3,643,503           3,643,503         3,643,478           3,643,478  

Book value

  $23.28   22.75     21.94     21.85     21.15    $23.34   23.28     22.75   21.94     21.85  

Common stock price

                 

High

  $29.85   30.49     30.39     27.80     25.75    $28.91   29.85     30.49   30.39     27.80  

Low

   26.81   24.56     26.14     25.78     24.51     27.45   26.81     24.56   26.14     25.78  

Period end

   28.49   28.25     29.62     26.47     25.73  

Period end:

   27.45   28.49     28.25   29.62     26.47  

To earnings ratio

   13.07 12.61     13.78     12.37     12.08     12.48 13.07     12.61   13.78     12.37  

To book value

   122 124     135     121     122     118 122     124   135     121  

Performance ratios:

                 

Return on average equity

   9.18 10.82     9.59     9.75     10.91     9.06 9.18     10.82   9.59     9.75  

Return on average assets

   0.93 1.07     0.95     0.95     1.09     0.92 0.93     1.07   0.95     0.95  

Dividend payout ratio

   42.45 37.50     41.51     42.31     37.29     41.67 42.45     37.50   41.51     42.31  

Asset Quality:

                 

Allowance for loan losses as a % of:

                 

Loans

   1.05 1.11     1.01     1.21     1.20     1.07 1.05     1.11   1.01     1.21  

Nonperforming loans

   271 246     158     140     360     284 271     246   158     140  

Nonperforming assets as a % of:

                 

Loans and other real estate owned

   0.46 0.54     0.70     0.93     0.45  

Loans and foreclosed properties

   0.39 0.46     0.54   0.70     0.93  

Total assets

   0.23 0.28     0.36     0.48     0.23     0.19 0.23     0.28   0.36     0.48  

Nonperforming loans as a % of total loans

   0.39 0.45     0.64     0.86     0.33     0.38 0.39     0.45   0.64     0.86  

Net charge-offs (recoveries) as a % of average loans (c)

   0.23 (1.01)     0.79     (0.04)     (0.16)  

Annualized net (recoveries) charge-offs as a % of average loans

   (0.05)%  0.23     (1.01)   0.79     (0.04)  

Capital Adequacy:

                 

CET 1 risk-based capital ratio

   15.54 15.36     15.28     15.01     15.42     15.74 15.54     15.36   15.28     15.01  

Tier 1 risk-based capital ratio

   16.87 16.69     16.57     16.29     16.76     17.07 16.87     16.69   16.57     16.29  

Total risk-based capital ratio

   17.77 17.64     17.44     17.33     17.78     17.97 17.77     17.64   17.44     17.33  

Tier 1 Leverage Ratio

   10.56 10.47     10.35     10.37     10.39  

Tier 1 leverage ratio

   10.36 10.56     10.47   10.35     10.37  

Other financial data:

                 

Net interest margin (a)

   3.10 3.12     3.12     3.13     3.29     2.94 3.10     3.12   3.12     3.13  

Effective income tax rate

   27.52 27.50     25.19     27.49     26.52     27.50 27.52     27.50   25.19     27.49  

Efficiency ratio (b)

   57.39 59.96     58.66     55.07     55.24     56.96 57.39     59.96   58.66     55.07  

Selected average balances:

                 

Securities

  $223,414   237,087     246,130     251,393     259,376    $227,076   223,414     237,087   246,130     251,393  

Loans, net of unearned income

   434,934   429,528     426,192     416,210     402,482     429,201   434,934     429,528   426,192     416,210  

Total assets

   828,106   821,382     815,616     806,764     791,889     851,409   828,106     821,382   815,616     806,764  

Total deposits

   727,989   726,354     720,854     714,960     699,453     748,229   727,989     726,354   720,854     714,960  

Long-term debt

   7,217   7,217     7,217     7,217     7,217     7,217   7,217     7,217   7,217     7,217  

Total stockholders’ equity

   84,124   80,965     80,764     78,387     78,791     86,103   84,124     80,965   80,764     78,387  

Selected period end balances:

                 

Securities

  $217,002   234,109     241,687     250,142     252,906    $249,556   217,002     234,109   241,687     250,142  

Loans, net of unearned income

   430,694   431,763     426,410     422,572     408,495     427,203   430,694     431,763   426,410     422,572  

Allowance for loan losses

   4,528   4,774     4,289     5,127     4,886     4,578   4,528     4,774   4,289     5,127  

Total assets

   846,056   833,328     817,189     817,994     806,233     851,672   846,056     833,328   817,189     817,994  

Total deposits

   747,539   737,361     723,627     724,311     715,994     751,915   747,539     737,361   723,627     724,311  

Long-term debt

   7,217   7,217     7,217     7,217     7,217     7,217   7,217     7,217   7,217     7,217  

Total stockholders’ equity

   84,808   82,887     79,949     79,599     77,053     85,055   84,808     82,887   79,949     79,599  

 

 

(a) Tax-equivalent. See “Table 1 - Explanation of Non-GAAP Financial Measures.”

(b) Efficiency ratio is the result of noninterest expense divided by the sum of noninterest income and tax-equivalent net interest income.

(c) Net charge-offs (recoveries) are annualized.

Table 3 - SelectedFinancialSelected Financial Data

 

         Six Months Ended June 30,            Nine months ended September 30, 
(Dollars in thousands, except per share amounts)   2016            2015             2016 2015 

 

Results of Operations

          

Net interest income (a)

 $  12,033     11,984  $      17,957   17,995  

Less: tax-equivalent adjustment

    644     673     960   1,014  

 

Net interest income (GAAP)

   11,389     11,311     16,997   16,981  

Noninterest income

    1,827     2,488     2,890   3,544  

 

Total revenue

   13,216     13,799     19,887   20,525  

Provision for loan losses

   (600)     —         (600 200  

Noninterest expense

   8,130     8,343     12,110   12,235  

Income tax expense

    1,564     1,444     2,304   2,168  

 

Net earnings

 $  4,122     4,012  $      6,073   5,922  

 

Per share data:

          

Basic and diluted net earnings

 $  1.13     1.10  $      1.67   1.63  

Cash dividends declared

   0.45     0.44     0.675   0.66  

Weighted average shares outstanding:

          

Basic and diluted

   3,643,493     3,643,389     3,643,498   3,643,411  

Shares outstanding, at period end

   3,643,503     3,643,428     3,643,523   3,643,478  

Book value

 $  23.28     21.15  $      23.34   21.85  

Common stock price

          

High

 $  30.49     25.75  $      30.49   27.80  

Low

   24.56     23.15     24.56   23.15  

Period end

   28.49     25.73     27.45   26.47  

To earnings ratio

   13.07x   12.08     12.48 12.37  

To book value

   122%  122     118 121  

Performance ratios:

          

Return on average equity

   9.99%  10.31     9.67 10.12  

Return on average assets

   1.00%  1.01     0.97 0.99  

Dividend payout ratio

   39.82%  40.00     40.42 40.49  

Asset Quality:

          

Allowance for loan losses as a % of:

          

Loans

   1.05%  1.20     1.07 1.21  

Nonperforming loans

   271%  360     284 140  

Nonperforming assets as a % of:

          

Loans and other real estate owned

   0.46%  0.45     0.39 0.93  

Total assets

   0.23%  0.23     0.19 0.48  

Nonperforming loans as a % of total loans

   0.39%  0.33     0.38 0.86  

Annualized net recoveries as a % of average loans

   (0.39)%  (0.02)     (0.27)%  (0.03

Capital Adequacy:

          

CET 1 risk-based capital ratio

   15.54%  15.42     15.74 15.01  

Tier 1 risk-based capital ratio

   16.87%  16.76     17.07 16.29  

Total risk-based capital ratio

   17.77%  17.78     17.97 17.33  

Tier 1 Leverage Ratio

   10.56%  10.39

Tier 1 leverage ratio

     10.36 10.37  

Other financial data:

          

Net interest margin (a)

   3.11%  3.22     3.05 3.19  

Effective income tax rate

   27.51%  26.47     27.50 26.80  

Efficiency ratio (b)

   58.66%  57.65     58.09 56.80  

Selected average balances:

          

Securities

 $  230,251     261,809  $      229,185   258,299  

Loans, net of unearned income

   432,231     401,327     431,213   406,343  

Total assets

   823,054     796,947     834,721   800,255  

Total deposits

   727,171     702,582     734,241   706,754  

Long-term debt

   7,217     9,372     7,217   8,645  

Total stockholders’ equity

   82,545     77,858     83,740   78,037  

Selected period end balances:

          

Securities

 $  217,002     252,906  $      249,556   250,142  

Loans, net of unearned income

   430,694     408,495     427,203   422,572  

Allowance for loan losses

   4,528     4,886     4,578   5,127  

Total assets

   846,056     806,233     851,672   817,994  

Total deposits

   747,539     715,994     751,915   724,311  

Long-term debt

   7,217     7,217     7,217   7,217  

Total stockholders’ equity

    84,808     77,053     85,055   79,599  

 

(a) Tax-equivalent. See “Table 1 - Explanation of Non-GAAP Financial Measures.”

(b) Efficiency ratio is the result of noninterest expense divided by the sum of noninterest income and tax-equivalent net interest income.

Table 4 - Average Balances and Net Interest Income Analysis

 

 Quarter ended June 30,    Quarter ended September 30, 
 

 

     2016

      2015    

 

2016

   

 

2015

 
   

 

    Interest

         Interest          

 

Interest

           Interest     
     Average     

 

    Income/

   Yield/ Average     Income/   Yield/    Average   

 

Income/

   Yield/   Average   Income/   Yield/ 
(Dollars in thousands) Balance 

 

    Expense

   Rate Balance     Expense   Rate    Balance   

 

Expense

   Rate   Balance   Expense   Rate 

   

 

 

    

 

 

    

 

 

    

 

 

 

Interest-earning assets:

                        

Loans and loans held for sale (1)

  

$

 436,462      $5,172   4.77%    $ 405,093      $5,217   5.17%   $   430,896     $5,105     4.71%   $   418,491     $5,090     4.83%  

Securities - taxable

   155,835    775   2.00%     191,181    949   1.99%      158,525      747     1.87%      181,991      939     2.05%  

Securities - tax-exempt (2)

   67,580    945   5.62%     68,195    992   5.83%      68,551      932     5.41%      69,402      1,005     5.75%  

   

 

 

    

 

 

    

 

 

    

 

 

 

Total securities

   223,415    1,720   3.10%     259,376    1,941   3.00%      227,076      1,679     2.94%      251,393      1,944     3.07%  

Federal funds sold

   56,989    72   0.51%     47,215    28   0.24%      44,949      56     0.50%      57,375      37     0.26%  

Interest bearing bank deposits

   64,062    84   0.53%     35,370    23   0.26%      99,794      135     0.54%      33,766      20     0.23%  

   

 

 

    

 

 

    

 

 

    

 

 

 

Total interest-earning assets

   780,928      $7,048   3.63%     747,054      $7,209   3.87%      802,715     $    6,975     3.46%      761,025     $    7,091     3.70%  

Cash and due from banks

   12,614        13,083         13,515           12,971       

Other assets

   34,564        31,752         35,179           32,768       

   

 

      

 

      

 

        

 

     

Total assets

  $   828,106       $ 791,889      $   851,409        $   806,764       

   

 

      

 

      

 

        

 

     

Interest-bearing liabilities:

                        

Deposits:

                        

NOW

  $ 125,512      $97   0.31%    $ 114,803      $88   0.31%   $   121,501     $91     0.30%   $   115,433     $88     0.30%  

Savings and money market

   225,678    212   0.38%     202,309    183   0.36%      243,024      240     0.39%      222,675      211     0.38%  

Certificates of deposits less than $100,000

   81,582    201   0.99%     92,423    238   1.03%      79,317      192     0.96%      89,711      227     1.00%  

Certificates of deposits and other time deposits of $100,000 or more

   131,252    457   1.40%     142,526    511   1.44%      131,434      461     1.40%      137,557      491     1.42%  

   

 

 

    

 

 

    

 

 

    

 

 

 

Total interest-bearing deposits

   564,024    967   0.69%     552,061    1,020   0.74%      575,276      984     0.68%      565,376      1,017     0.71%  

Short-term borrowings

   2,517    3   0.48%     3,678    4   0.44%      2,943      4     0.54%      2,955      4     0.54%  

Long-term debt

   7,217    64   3.57%     7,217    59   3.28%      7,217      63     3.47%      7,217      59     3.24%  

   

 

 

    

 

 

    

 

 

    

 

 

 

Total interest-bearing liabilities

   573,758      $1,034   0.72%     562,956      $1,083   0.77%      585,436     $1,051     0.71%      575,548     $1,080     0.74%  

Noninterest-bearing deposits

   163,965        147,392         172,953           149,584       

Other liabilities

   6,259        2,750         6,917           3,245       

Stockholders’ equity

   84,124        78,791         86,103           78,387       

   

 

      

 

      

 

        

 

     

Total liabilities and stockholders’ equity

  $ 828,106       $   791,889      $   851,409        $   806,764       

   

 

      

 

      

 

        

 

     

Net interest income and margin (tax-equivalent)

      $        6,014       3.10%        $        6,126       3.29%       $5,924     2.94%       $6,011     3.13%  

    

 

 

     

 

 

      

 

 

      

 

 

 

(1) Average loan balances are shown net of unearned income and loans on nonaccrual status have been included in the computation of average balances.

(2) Yields on tax-exempt securities have been computed on a tax-equivalent basis using an income tax rate of 34%.

Table 5 - Average Balances and Net Interest Income Analysis

 

 Six Months Ended June 30, 
      2016      2015 
       Interest         Interest      Nine months ended September 30, 
   

 

2016

   

 

2015

 
     Average         Income/   Yield/ Average     Income/   Yield/        

 

Interest

           Interest     
   Average   

 

Income/

   Yield/   Average   Income/   Yield/ 
(Dollars in thousands) Balance     Expense   Rate Balance     Expense   Rate    Balance   

 

Expense

   Rate   Balance   Expense   Rate 

   

 

 

    

 

 

    

 

 

    

 

 

 

Interest-earning assets:

                        

Loans and loans held for sale (1)

  

$

 433,504      $10,268   4.76%    $ 404,106      $10,223   5.10%   $   432,628     $15,373     4.75%   $   408,954     $15,313     5.01%  

Securities - taxable

   162,980    1,673   2.06%     193,694    1,989   2.07%      161,484      2,420     2.00%      189,750      2,928     2.06%  

Securities - tax-exempt (2)

   67,271    1,892   5.66%     68,115    1,978   5.86%      67,701      2,824     5.57%      68,549      2,983     5.82%  

   

 

 

    

 

 

    

 

 

    

 

 

 

Total securities

   230,251    3,565   3.11%     261,809    3,967   3.06%      229,185      5,244     3.06%      258,299      5,911     3.06%  

Federal funds sold

   57,702    143   0.50%     60,789    62   0.21%      53,420      199     0.50%      59,639      99     0.22%  

Interest bearing bank deposits

   57,023    139   0.49%     24,449    28   0.23%      71,384      274     0.51%      27,589      48     0.23%  

   

 

 

    

 

 

    

 

 

    

 

 

 

Total interest-earning assets

   778,480      $14,115   3.65%     751,153      $14,280   3.83%      786,617     $  21,090     3.58%      754,481     $  21,371     3.79%  

Cash and due from banks

   12,867        13,439         13,085          13,281       

Other assets

   31,707        32,355         35,019           32,493       

   

 

      

 

      

 

        

 

     

Total assets

  $   823,054       $   796,947      $   834,721        $   800,255       

   

 

      

 

      

 

        

 

     

Interest-bearing liabilities:

                        

Deposits:

                        

NOW

  $ 123,831      $191   0.31%    $ 114,739      $174   0.31%   $   123,049     $282     0.31%   $   114,973     $262     0.30%  

Savings and money market

   227,772    431   0.38%     207,027    409   0.40%      232,893      671     0.38%      212,300      620     0.39%  

Certificates of deposits less than $100,000

   82,794    401   0.97%     93,933    492   1.06%      81,626      593     0.97%      92,510      719     1.04%  

Certificates of deposits and other time deposits of $100,000 or more

   132,336    925   1.41%     145,124    1,047   1.45%      
 
 
132,033 
  
  
   1,386     1.40%      142,575      1,538     1.44%  

   

 

 

    

 

 

    

 

 

    

 

 

 

Total interest-bearing deposits

   566,733    1,948   0.69%     560,823    2,122   0.76%      569,601      2,932     0.69%      562,358      3,139     0.75%  

Short-term borrowings

   2,836    7   0.50%     4,167    10   0.48%      2,872      11     0.51%      3,758      14     0.50%  

Long-term debt

   7,217    127   3.54%     9,372    164   3.53%      7,217      190     3.52%      8,645      223     3.45%  

   

 

 

    

 

 

    

 

 

    

 

 

 

Total interest-bearing liabilities

   576,786      $2,082   0.73%     574,362      $2,296   0.81%      579,690     $3,133     0.72%      574,761     $3,376     0.79%  

Noninterest-bearing deposits

   160,438        141,759         164,640           144,396       

Other liabilities

   3,285        2,968         6,651           3,061       

Stockholders’ equity

   82,545        77,858         83,740           78,037       

   

 

      

 

      

 

        

 

     

Total liabilities and stockholders’ equity

  $ 823,054       $ 796,947      $   834,721        $   800,255       

   

 

      

 

      

 

        

 

     

Net interest income and margin (tax-equivalent)

      $        12,033       3.11%        $        11,984       3.22%       $17,957     3.05%       $17,995     3.19%  

    

 

 

     

 

 

      

 

 

      

 

 

 

(1) Average loan balances are shown net of unearned income and loans on nonaccrual status have been included in the computation of average balances.

(1)Average loan balances are shown net of unearned income and loans on nonaccrual status have been included in the computation of average balances.
(2)Yields on tax-exempt securities have been computed on a tax-equivalent basis using an income tax rate of 34%.

(2) Yields on tax-exempt securities have been computed on a tax-equivalent basis using an income tax rate of 34%.

Table 6 - Loan Portfolio Composition

 

  2016   2015   2016   2015 
 

 

Second

   First   Fourth   Third   Second  

 

Third

   Second   First   Fourth   Third 
(In thousands) 

 

Quarter

   Quarter   Quarter   Quarter   Quarter  

 

Quarter

   Quarter   Quarter   Quarter   Quarter 

 

 

Commercial and industrial

 

$

 50,190      50,192      52,479      47,925      57,310    

$

 50,881      50,190      50,192      52,479      47,925   

Construction and land development

  49,346      45,953      43,694      41,592      38,854     44,004      49,346      45,953      43,694      41,592   

Commercial real estate

  208,825      209,320      203,853      201,449      184,124     211,558      208,825      209,320      203,853      201,449   

Residential real estate

  113,763      117,046      116,673      117,863      115,039     112,303      113,763      117,046      116,673      117,863   

Consumer installment

  9,125      9,769      10,220      14,362      13,632     8,996      9,125      9,769      10,220      14,362   

 

 

Total loans

  431,249      432,280      426,919      423,191      408,959     427,742      431,249      432,280      426,919      423,191   

Less: unearned income

  (555)     (517)     (509)     (619)     (464)    (539)     (555)     (517)     (509)     (619)  

 

 

Loans, net of unearned income

  430,694      431,763      426,410      422,572      408,495     427,203      430,694      431,763      426,410      422,572   

Less: allowance for loan losses

  (4,528)     (4,774)     (4,289)     (5,127)     (4,886)    (4,578)     (4,528)     (4,774)     (4,289)     (5,127)  

 

 

Loans, net

 $       426,166          426,989          422,121          417,445          403,609    $       422,625          426,166          426,989          422,121          417,445   

 

 

Table 7 - Allowance for Loan Losses and Nonperforming Assets

 

 2016 2015  2016   2015 
 

 

Second

 First Fourth   Third     Second  

 

Third

 Second   First   Fourth Third 
(Dollars in thousands) 

 

Quarter

 Quarter Quarter   Quarter     Quarter  

 

Quarter

 Quarter   Quarter   Quarter Quarter 

 

 

Allowance for loan losses:

                  

Balance at beginning of period

 $ 4,774    4,289     5,127      4,886      4,722    $ 4,528    4,774      4,289      5,127   4,886   

Charge-offs:

                  

Commercial and industrial

  (83)    —        (42)     —         —         —    (83)     —       (42  —   

Commercial real estate

  (194)    —        (866)     —         —         —    (194)     —       (866  —   

Residential real estate

  (37)   (118)    (3)     (26)     —        (7)   (37)     (118    (3 (26)  

Consumer installment

  (2)   (26)    (14)     (23)     (5)    (1)   (2)     (26    (14 (23)  

 

 

Total charge-offs

  (316)   (144)    (925)     (49)     (5)    (8)   (316)     (144)      (925 (49)  

Recoveries

  70    1,229     87      90      169     58    70     1,229      87   90   

 

 

Net (charge-offs) recoveries

  (246)   1,085     (838)     41      164   

Net recoveries (charge-offs)

  50    (246)     1,085      (838 41   

Provision for loan losses

   —       (600)     —         200      —        —      —      (600    —    200   

 

 

Ending balance

 

$

 4,528    4,774     4,289      5,127      4,886    $         4,578          4,528             4,774              4,289           5,127   

 

 

as a % of loans

  1.05  1.11     1.01      1.21      1.20     1.07  1.05     1.11      1.01   1.21   

as a % of nonperforming loans

  271  246     158      140      360     284  271     246      158   140   

Net charge-offs (recoveries) as % of avg. loans (a)

  0.23  (1.01)    0.79      (0.04)     (0.16)  

Net (recoveries) charge-offs as % of average loans (a)

  (0.05) %  0.23     (1.01    0.79   (0.04)  

 

 

Nonperforming assets:

                  

Nonaccrual loans

 

$

 1,669    1,938     2,714      3,650      1,359    

$

 1,614    1,669     1,938      2,714   3,650   

Other real estate owned

  300    397     252      278      499     37    300     397      252   278   

 

 

Total nonperforming assets

 

$

         1,969          2,335             2,966              3,928              1,858    

$

 1,651    1,969     2,335      2,966   3,928   

 

 

as a % of loans and other real estate owned

  0.46  0.54     0.70      0.93      0.45   

as a % of loans and foreclosed properties

  0.39  0.46     0.54      0.70   0.93   

as a % of total assets

  0.23  0.28     0.36      0.48      0.23     0.19  0.23     0.28      0.36   0.48   

Nonperforming loans as a % of total loans

  0.39  0.45     0.64      0.86      0.33     0.38  0.39     0.45      0.64   0.86   

Accruing loans 90 days or more past due

 

$

  —        —         —         112      442    

$

 211      —      —       —    112   

 

 

(a) Net (recoveries) charge-offs (recoveries) are annualized.

Table 8 - Allocation of Allowance for Loan Losses

 

 2016 2015  2016 2015 
 Second Quarter First Quarter Fourth Quarter Third Quarter Second Quarter  Third Quarter Second Quarter First Quarter Fourth Quarter Third Quarter 
(Dollars in thousands)  Amount   %*  Amount   %*  Amount   %*  Amount   %*  Amount   %*   Amount   %*  Amount   %*  Amount   %*  Amount   %*  Amount   %* 

 

 

Commercial and industrial

 $ 506     11.6    $ 517     11.6    $ 523     12.3    $ 504     11.3    $ 681     14.0    $ 515     11.9    $ 506     11.6    $ 517     11.6    $ 523     12.3    $ 504     11.3   

Construction and land development

  744     11.4     695     10.6     669     10.2     627     9.8     640     9.5     673     10.3     744     11.4     695     10.6     669     10.2     627     9.8   

Commercial real estate

  2,092     48.5     2,403     48.4     1,879     47.8     2,679     47.6     2,146     45.1     2,232     49.4     2,092     48.5     2,403     48.4     1,879     47.8     2,679     47.6   

Residential real estate

  1,061     26.4     1,026     27.1     1,059     27.3     1,103     27.9     1,180     28.1     1,020     26.3     1,061     26.4     1,026     27.1     1,059     27.3     1,103     27.9   

Consumer installment

  125     2.1     133     2.3     159     2.4     214     3.4     239     3.3     138     2.1     125     2.1     133     2.3     159     2.4     214     3.4   

 

 

Total allowance for loan losses

 $     4,528     $     4,774     $     4,289     $     5,127     $     4,886     $ 4,578     $   4,528     $   4,774     $   4,289     $   5,127    

 

 

* Loan balance in each category expressed as a percentage of total loans.

Table 9 - CDs and Other Time Deposits of $100,000 or More

 

(Dollars in thousands)  JuneSeptember 30, 2016 

 

 

Maturity of:

  

3 months or less

  $            13,18222,117   

Over 3 months through 6 months

   22,38114,238   

Over 6 months through 12 months

   23,44636,860   

Over 12 months

   71,54958,754   

 

 

Total CDs and other time deposits of $100,000 or more

  $130,558131,969   

 

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information called for by ITEM 3 is set forth in ITEM 2 under the caption “MARKET AND LIQUIDITY RISK MANAGEMENT” and is incorporated herein by reference.

ITEM 4. CONTROLS ANDPROCEDURESAND PROCEDURES

The Company, with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based upon that evaluation and as of the end of the period covered by this report, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective to allow timely decisions regarding disclosure in its reports that the Company files or submits to the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended. There have been no changes in the Company’s internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In the normal course of its business, the Company and the Bank are, from time to time, involved in legal proceedings. The Company’s and Bank’s management believe there are no pending or threatened legal, governmental, or regulatory proceedings that, upon resolution, are expected to have a material adverse effect upon the Company’s or the Bank’s financial condition or results of operations. See also, Part I, Item  3 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

ITEM 1A. RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A. “RISK FACTORS” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, which could materially affect our business, financial condition or future results. The risks described in our annual report on Form 10-K are not the only the risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, and/or operating results in the future.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

ITEM 6. EXHIBITS

 

Exhibit    

Number    

                                           Description
3.1  Certificate of Incorporation of Auburn National Bancorporation, Inc. and all amendments thereto.*
3.2  Amended and Restated Bylaws of Auburn National Bancorporation, Inc., adopted as of November 13, 2007. **
31.1  Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, As Adopted Pursuant To Section 302 of the Sarbanes-Oxley Act of 2002, by E.L. Spencer, Jr., President, Chief Executive Officer and Chairman of the Board.
31.2  Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, As Adopted Pursuant To Section 302 of the Sarbanes-Oxley Act of 2002, by David A. Hedges, Executive Vice President, Chief Financial Officer.
32.1  

Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the

Sarbanes-Oxley Act of 2002, by E.L. Spencer, Jr., President, Chief Executive Officer and

Chairman of the Board.***

32.2  

Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley Act of 2002, by David A. Hedges, Executive Vice President, Chief

Financial Officer.***

101.INS  XBRL Instance Document
101.SCH  XBRL Taxonomy Extension Schema Document
101.CAL  XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB  XBRL Taxonomy Extension Label Linkbase Document
101.PRE  XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF  XBRL Taxonomy Extension Definition Linkbase Document

 

 

*Incorporated by reference from Registrant’s Form 10-Q dated September 30, 2002.

 

**    Incorporated by reference from Registrant’s Form 10-K dated March 31, 2008.

 

***The certifications attached as exhibits 32.1 and 32.2 to this quarterly report on Form 10-Q are “furnished” to the Securities and Exchange Commission pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed “filed” by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.

SIGNATURES

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

 

 AUBURN NATIONAL BANCORPORATION, INC. 
 

(Registrant)

 
Date:            July 29,October 28, 2016                              By:          /s/ E. L. Spencer, Jr.                         
 E. L. Spencer, Jr. 
 President, Chief Executive Officer and 
 Chairman of the Board 
Date:            July 29,October 28, 2016                              By:          /s/ David A. Hedges                         
 David A. Hedges 
 EVP, Chief Financial Officer