UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended:
March 31, 2019
Commission File Number: 001-35302
Entegra Financial Corp.
(Exact name of registrant as specified in its charter)
| |
North Carolina | 45-2460660 |
(State of Incorporation) | (I.R.S. Employer Identification No.) |
| |
14 One Center Court, | |
Franklin, North Carolina | 28734 |
(Address of principal executive offices) | (Zip Code) |
(828) 524-7000
(Registrant’s telephone number, including area code)
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 Noo
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 Noo
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,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filero | Accelerated filerx | Non-accelerated filero | Smaller reporting companyo | Emerging growth companyx |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yeso Nox
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading symbol(s) | Name of each exchange on which registered |
Common Stock, no par value | ENFC | The NASDAQ Stock Market LLC |
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: On May 7, 2019, 6,919,212 shares of the issuer’s common stock (no par value), were issued and outstanding.
ENTEGRA FINANCIAL CORP. AND SUBSIDIARY
FORM 10-Q
TABLE OF CONTENTS
Item 1. Financial Statements
ENTEGRA FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
| | March 31, | | | December 31, | |
| | 2019 | | | 2018 | |
| | (Unaudited) | | | (Audited) | |
Assets | | | | | | | | |
Cash and due from banks | | $ | 15,494 | | | $ | 15,409 | |
Interest-earning deposits | | | 82,791 | | | | 53,710 | |
Cash and cash equivalents | | | 98,285 | | | | 69,119 | |
| | | | | | | | |
Investments - equity securities | | | 6,812 | | | | 6,178 | |
Investments - available for sale | | | 357,132 | | | | 359,738 | |
Other investments, at cost | | | 12,092 | | | | 12,039 | |
Loans held for sale (includes $3,270 and $2,431 at fair value) | | | 9,208 | | | | 7,570 | |
Loans receivable, net | | | 1,079,837 | | | | 1,076,069 | |
Allowance for loan losses | | | (12,043 | ) | | | (11,985 | ) |
Fixed assets, net | | | 26,093 | | | | 26,385 | |
Real estate owned | | | 2,256 | | | | 2,493 | |
Accrued interest receivable | | | 6,669 | | | | 6,443 | |
Bank owned life insurance | | | 32,087 | | | | 32,886 | |
Small Business Investment Company holdings, at cost | | | 4,306 | | | | 3,839 | |
Net deferred tax asset | | | 5,265 | | | | 7,551 | |
Loan servicing rights | | | 2,753 | | | | 2,837 | |
Goodwill | | | 23,903 | | | | 23,903 | |
Core deposit intangible | | | 3,404 | | | | 3,577 | |
Other assets | | | 11,092 | | | | 7,799 | |
| | | | | | | | |
Total assets | | $ | 1,669,151 | | | $ | 1,636,441 | |
| | | | | | | | |
Liabilities and Shareholders’ Equity | | | | | | | | |
| | | | | | | | |
Liabilities: | | | | | | | | |
Core deposits | | $ | 828,850 | | | $ | 795,261 | |
Retail certificates of deposit | | | 340,047 | | | | 349,971 | |
Wholesale deposits | | | 77,322 | | | | 76,008 | |
Federal Home Loan Bank advances | | | 213,500 | | | | 213,500 | |
Junior subordinated notes | | | 14,433 | | | | 14,433 | |
Other borrowings | | | 9,385 | | | | 9,299 | |
Post employment benefits | | | 9,410 | | | | 9,305 | |
Accrued interest payable | | | 1,173 | | | | 1,647 | |
Other liabilities | | | 4,106 | | | | 4,145 | |
Total liabilities | | | 1,498,226 | | | | 1,473,569 | |
| | | | | | | | |
Commitments and contingencies (Notes 7 and 12) | | | | | | | | |
| | | | | | | | |
Shareholders’ Equity: | | | | | | | | |
Preferred stock - no par value, 10,000,000 shares authorized; none issued and outstanding | | | — | | | | — | |
Common stock - no par value, 50,000,000 shares authorized; 6,919,212 and 6,917,703 shares issued and outstanding as of March 31, 2019 and December 31, 2018, respectively | | | — | | | | — | |
Common stock held by Rabbi Trust, at cost; 17,672 shares at both March 31, 2019 and December 31, 2018 | | | (379 | ) | | | (379 | ) |
Additional paid in capital | | | 74,320 | | | | 74,051 | |
Retained earnings | | | 96,439 | | | | 92,624 | |
Accumulated other comprehensive income (loss) | | | 545 | | | | (3,424 | ) |
Total shareholders’ equity | | | 170,925 | | | | 162,872 | |
| | | | | | | | |
Total liabilities and shareholders’ equity | | $ | 1,669,151 | | | $ | 1,636,441 | |
The accompanying notes are an integral part of the consolidated financial statements.
ENTEGRA FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
| | Three Months Ended March 31, | |
| | 2019 | | | 2018 | |
| | (Unaudited) | | | (Unaudited) | |
Interest income: | | | | | | | | |
Interest and fees on loans | | $ | 12,916 | | | $ | 11,892 | |
Interest on tax exempt loans | | | 108 | | | | 92 | |
Taxable securities | | | 2,081 | | | | 1,789 | |
Tax-exempt securities | | | 760 | | | | 550 | |
Interest-earning deposits | | | 472 | | | | 349 | |
Other | | | 205 | | | | 170 | |
Total interest income | | | 16,542 | | | | 14,842 | |
| | | | | | | | |
Interest expense: | | | | | | | | |
Deposits | | | 2,926 | | | | 1,382 | |
Federal Home Loan Bank advances | | | 1,396 | | | | 820 | |
Junior subordinated notes | | | 139 | | | | 138 | |
Other borrowings | | | 128 | | | | 109 | |
Total interest expense | | | 4,589 | | | | 2,449 | |
| | | | | | | | |
Net interest income | | | 11,953 | | | | 12,393 | |
| | | | | | | | |
Provision for loan losses | | | 116 | | | | 361 | |
Net interest income after provision for loan losses | | | 11,837 | | | | 12,032 | |
| | | | | | | | |
Noninterest income: | | | | | | | | |
Servicing income, net | | | 89 | | | | 94 | |
Mortgage banking | | | 263 | | | | 239 | |
Gain on sale of SBA loans | | | 80 | | | | 61 | |
Loss on sale of investments, net | | | — | | | | (12 | ) |
Equity securities gains (losses) | | | 418 | | | | (53 | ) |
Service charges on deposit accounts | | | 398 | | | | 431 | |
Interchange fees, net | | | 246 | | | | 248 | |
Bank owned life insurance | | | 180 | | | | 200 | |
Legal settlement income | | | 1,750 | | | | — | |
Other | | | 278 | | | | 208 | |
Total noninterest income | | | 3,702 | | | | 1,416 | |
| | | | | | | | |
Noninterest expenses: | | | | | | | | |
Compensation and employee benefits | | | 6,020 | | | | 5,617 | |
Net occupancy | | | 1,120 | | | | 1,092 | |
Federal deposit insurance | | | 142 | | | | 279 | |
Professional and advisory | | | 325 | | | | 277 | |
Data processing | | | 493 | | | | 509 | |
Marketing and advertising | | | 279 | | | | 209 | |
Merger-related expenses | | | 1,350 | | | | 196 | |
Net cost of operation of real estate owned | | | 7 | | | | 50 | |
Other | | | 1,002 | | | | 894 | |
Total noninterest expenses | | | 10,738 | | | | 9,123 | |
| | | | | | | | |
Income before taxes | | | 4,801 | | | | 4,325 | |
| | | | | | | | |
Income tax expense | | | 986 | | | | 743 | |
| | | | | | | | |
Net income | | $ | 3,815 | | | $ | 3,582 | |
| | | | | | | | |
Earnings per common share: | | | | | | | | |
Basic | | $ | 0.55 | | | $ | 0.52 | |
Diluted | | $ | 0.55 | | | $ | 0.51 | |
| | | | | | | | |
Weighted average common shares outstanding: | | | | | | | | |
Basic | | | 6,918,769 | | | | 6,885,911 | |
Diluted | | | 6,943,267 | | | | 7,027,884 | |
The accompanying notes are an integral part of the consolidated financial statements.
ENTEGRA FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Dollars in thousands)
| | Three Months Ended March 31, | |
| | 2019 | | | 2018 | |
| | | | | | |
Net income | | $ | 3,815 | | | $ | 3,582 | |
| | | | | | | | |
Other comprehensive income (loss): | | | | | | | | |
Change in unrealized holding gains and (losses) on securities available for sale | | | 5,390 | | | | (4,505 | ) |
Reclassification adjustment for securities (gains) losses realized in net income | | | — | | | | 12 | |
Change in unrealized holding gains and losses on cash flow hedge | | | (159 | ) | | | 202 | |
Reclassification adjustment for cash flow hedge effectiveness | | | (65 | ) | | | (56 | ) |
Other comprehensive income (loss), before tax | | | 5,166 | | | | (4,347 | ) |
Income tax effect related to items of other comprehensive income (loss) | | | (1,197 | ) | | | 965 | |
Other comprehensive income (loss), after tax | | | 3,969 | | | | (3,382 | ) |
| | | | | | | | |
Comprehensive income | | $ | 7,784 | | | $ | 200 | |
The accompanying notes are an integral part of the consolidated financial statements.
ENTEGRA FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)
Three Months Ended March 31, 2019 and 2018
(Dollars in thousands)
| | Common Stock | | | | | | | | | | | | | | | | |
| | Shares | | | Additional Paid in Capital | | | Retained Earnings | | | Accumulated Other Comprehensive Income (loss) | | | Common Stock held by Rabbi Trust | | | Total | |
Balances at December 31, 2018 | | | 6,917,703 | | | $ | 74,051 | | | $ | 92,624 | | | $ | (3,424 | ) | | $ | (379 | ) | | $ | 162,872 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net income | | | — | | | | — | | | | 3,815 | | | | — | | | | — | | | | 3,815 | |
Other comprehensive income, net of tax | | | — | | | | — | | | | — | | | | 3,969 | | | | — | | | | 3,969 | |
Stock compensation expense | | | — | | | | 290 | | | | — | | | | — | | | | — | | | | 290 | |
Vesting of restricted stock units, net of 931 shares surrendered | | | 1,509 | | | | (21 | ) | | | — | | | | — | | | | — | | | | (21 | ) |
Balances at March 31, 2019 | | | 6,919,212 | | | $ | 74,320 | | | $ | 96,439 | | | $ | 545 | | | $ | (379 | ) | | $ | 170,925 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Balance, December 31, 2017 | | | 6,879,191 | | | $ | 72,997 | | | $ | 78,718 | | | $ | (23 | ) | | $ | (379 | ) | | $ | 151,313 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net income | | | — | | | | — | | | | 3,582 | | | | — | | | | — | | | | 3,582 | |
Other comprehensive loss, net of tax | | | — | | | | — | | | | — | | | | (3,382 | ) | | | — | | | | (3,382 | ) |
Stock compensation expense | | | — | | | | 257 | | | | — | | | | — | | | | — | | | | 257 | |
Stock options exercised | | | 8,081 | | | | 117 | | | | — | | | | — | | | | — | | | | 117 | |
Vesting of restricted stock units, net of 397 shares surrendered | | | 1,143 | | | | (11 | ) | | | — | | | | — | | | | — | | | | (11 | ) |
Cumulative effect of change in accounting principle | | | — | | | | — | | | | (9 | ) | | | 9 | | | | — | | | | — | |
Balance, March 31, 2018 | | | 6,888,415 | | | $ | 73,360 | | | $ | 82,291 | | | $ | (3,396 | ) | | $ | (379 | ) | | $ | 151,876 | |
The accompanying notes are an integral part of the consolidated financial statements
ENTEGRA FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
| | For the Three Months Ended March 31, | |
| | 2019 | | | 2018 | |
Cash flows from operating activities: | | | | | | | | |
Net income | | $ | 3,815 | | | $ | 3,582 | |
Adjustments to reconcile net income to net cash (used in) provided by operating activities: | | | | | | | | |
Depreciation, amortization and accretion | | | 220 | | | | 173 | |
Investment amortization, net | | | 820 | | | | 813 | |
Equity securities (income) loss | | | (418 | ) | | | 53 | |
Provision for loan losses | | | 116 | | | | 361 | |
Provision for real estate owned | | | — | | | | 18 | |
Share-based compensation expense | | | 290 | | | | 257 | |
Deferred tax expense | | | 1,045 | | | | 895 | |
Loss on sales of investments | | | — | | | | 12 | |
Income on bank owned life insurance, net | | | (180 | ) | | | (200 | ) |
Mortgage banking income, net | | | (263 | ) | | | (239 | ) |
Gain on sales of SBA loans | | | (80 | ) | | | (61 | ) |
Net realized (gain) loss on sale of real estate owned | | | (6 | ) | | | 16 | |
Loans originated for sale | | | (9,510 | ) | | | (9,745 | ) |
Proceeds from sale of loans originated for sale | | | 8,215 | | | | 9,866 | |
Net change in operating assets and liabilities: | | | | | | | | |
Accrued interest receivable | | | (226 | ) | | | (134 | ) |
Loan servicing rights | | | 84 | | | | 30 | |
Other assets | | | (3,711 | ) | | | (1,135 | ) |
Postemployment benefits | | | 105 | | | | (163 | ) |
Accrued interest payable | | | (474 | ) | | | (170 | ) |
Other liabilities | | | (170 | ) | | | (428 | ) |
Net cash (used in) provided by operating activities | | | (328 | ) | | | 3,801 | |
| | | | | | | | |
Cash flows from investing activities: | | | | | | | | |
Activity for investment securities available for sale: | | | | | | | | |
Purchases | | | — | | | | (21,758 | ) |
Maturities/calls and principal repayments | | | 7,177 | | | | 8,858 | |
Sales | | | — | | | | 10,009 | |
Net increase in loans | | | (3,474 | ) | | | (31,241 | ) |
Proceeds from sale of real estate owned | | | 34 | | | | 355 | |
Proceeds from settlement of BOLI policies | | | 1,115 | | | | — | |
Purchase of fixed assets | | | (39 | ) | | | (345 | ) |
Purchase of Small Business Investment Company Holdings, at cost | | | (467 | ) | | | (68 | ) |
Purchase of other investments, at cost | | | (53 | ) | | | (78 | ) |
Net cash provided by (used in) investing activities | | | 4,293 | | | | (34,268 | ) |
| | | | | | | | |
Cash flows from financing activities: | | | | | | | | |
Net increase in deposits | | | 24,366 | | | | 43,375 | |
Net increase in escrow deposits | | | 770 | | | | 653 | |
Net increase in other borrowings | | | 86 | | | | 463 | |
Proceeds from FHLB advances | | | 50,000 | | | | 40,000 | |
Repayment of FHLB advances | | | (50,000 | ) | | | (40,000 | ) |
Cash received upon exercise of stock options | | | — | | | | 117 | |
Cash paid for shares surrendered upon vesting of restricted stock | | | (21 | ) | | | (11 | ) |
Net cash provided by financing activities | | | 25,201 | | | | 44,597 | |
| | | | | | | | |
Increase in cash and cash equivalents | | | 29,166 | | | | 14,130 | |
| | | | | | | | |
Cash and cash equivalents, beginning of period | | | 69,119 | | | | 109,467 | |
| | | | | | | | |
Cash and cash equivalents, end of period | | $ | 98,285 | | | $ | 123,597 | |
| | | | | | | | |
Supplemental disclosures of cash flow information: | | | | | | | | |
Cash paid during the year for: | | | | | | | | |
Interest on deposits and other borrowings | | $ | 5,220 | | | $ | 2,619 | |
Income taxes | | | 554 | | | | — | |
| | | | | | | | |
Noncash investing and financing activities: | | | | | | | | |
Real estate acquired in satisfaction of mortgage loans | | $ | — | | | $ | 749 | |
Loans originated for the disposition of real estate owned | | | 209 | | | | 54 | |
The accompanying notes are an integral part of the consolidated financial statements
ENTEGRA FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION
Organization
Entegra Financial Corp. (“we,” “us,” “our,” or the “Company”) was incorporated on May 31, 2011 and became the holding company for Entegra Bank (the “Bank”) on September 30, 2014 upon the completion of Macon Bancorp’s merger with and into the Company, pursuant to which Macon Bancorp converted from a mutual to stock form of organization. The Company’s primary operation is its investment in the Bank. The Company also owns 100% of the common stock of Macon Capital Trust I (the “Trust”), a Delaware statutory trust formed in 2003 to facilitate the issuance of trust preferred securities. The Bank is a North Carolina state-chartered commercial bank and has a wholly owned subsidiary, Entegra Services, Inc. (“Entegra Services”), which holds investment securities. The consolidated financials are presented in these financial statements.
The Bank operates as a community-focused retail bank, originating primarily real estate-based mortgage, consumer and commercial loans and accepting deposits from consumers and small businesses.
Estimates
The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change, in the near term, relate to the determination of the allowance for loan losses, the valuation of acquired loans, separately identifiable intangible assets associated with mergers and acquisitions, the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, and the valuation of deferred tax assets.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company, the Bank, and Entegra Services. The accounts of the Trust are not consolidated with the Company. In consolidation, all significant intercompany accounts and transactions have been eliminated.
Reclassification
Certain amounts in the prior year’s financial statements may have been reclassified to conform to the current year’s presentation. The reclassifications had no effect on our results of operations or financial condition as previously reported.
Basis of Presentation
The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP, for interim financial information and with the Securities and Exchange Commission’s (the “SEC”) instructions for Quarterly Reports on Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on March 14, 2019 (the “2018 Form 10-K”). In the opinion of management, these interim financial statements present fairly, in all material respects, the Company’s consolidated financial position and results of operations for each of the interim periods presented. Results of operations for interim periods are not necessarily indicative of the results of operations that may be expected for a full year or any future period.
Business Combinations
The Company accounts for business combinations under the acquisition method of accounting. Assets acquired and liabilities assumed are measured and recorded at fair value at the date of acquisition, including identifiable intangible assets. If the fair value of net assets purchased exceeds the fair value of consideration paid, a bargain purchase gain is recognized at the date of acquisition. Conversely, if the consideration paid exceeds the fair value of the net assets acquired, goodwill is recognized at the acquisition date. Fair values are subject to refinement for a period not to exceed one year after the closing date of an acquisition as information relative to closing date fair values becomes available.
The determination of the fair value of loans acquired takes into account credit quality deterioration and probability of loss; therefore, the related allowance for loan losses is not carried forward.
All identifiable intangible assets that are acquired in a business combination are recognized at fair value on the acquisition date. Identifiable intangible assets are recognized separately if they arise from contractual or other legal rights or if they are separable (i.e., capable of being sold, transferred, licensed, rented, or exchanged separately from the entity). Deposit liabilities and the related depositor relationship intangible assets may be exchanged in observable exchange transactions. As a result, the depositor relationship intangible asset is considered identifiable, because the separability criterion has been met.
In addition, acquisition-related costs and restructuring costs are recognized as period expenses as incurred.
Recent Accounting Standards Updates
Accounting Standards Update (“ASU”) 2016-02, “Leases (Topic 842).” ASU 2016-02, among other things, requires lessees to recognize a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. We adopted ASU 2016-02, along with several other subsequent codification updates related to lease accounting, as of January 1, 2019. See Note 14 for additional information.
In June 2016, the FASB issued amendments to ASU 2016-13Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.The amendments in the update require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected thereby providing financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by the reporting entity. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. The Company has formed a cross-functional committee to provide corporate governance over the implementation of this update, has evaluated data sources and made process updates to capture additional relevant data, has identified a service provider to perform the calculation, and continues to attend seminars and forums specific to this update. The Company also engaged the service provider to assist with the implementation of the standard. The preliminary measurement of life of loan credit losses was completed in the first quarter of 2019 using December 31, 2018 data. While we continue to evaluate the impact the new guidance will have on our financial position and results of operations, we currently expect the new guidance may result in an increase to our allowance for credit losses given the change to estimated losses over the contractual life of the loan portfolio. The amount of any change to our allowance will depend, in part, upon the composition of our loan portfolio at the adoption date as well as economic conditions and loss forecasts at that date.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
NOTE 2. INVESTMENT SECURITIES
The following table presents the holdings of our equity securities as of March 31, 2019 and December 31, 2018:
| | March 31, | | | December 31, | |
| | 2019 | | | 2018 | |
| | (Dollars in thousands) | |
| | | | | | |
Mutual funds | | $ | 6,812 | | | $ | 6,178 | |
Equity securities with a fair value of $6.2 million as of March 31, 2019 are held in a Rabbi Trust and seek to generate returns that will fund the cost of certain deferred compensation agreements. Equity securities with a fair value of $0.6 million as of March 31, 2019 are in a mutual fund that qualifies under the Community Reinvestment Act (“CRA”) as CRA activity. There were gains on equity securities of $0.4 million for the three months ended March 31, 2019, and losses of $0.1 million for the three months ended March 31, 2018.
The amortized cost and estimated fair values of available-for-sale (“AFS”) securities as of March 31, 2019 and December 31, 2018 are summarized as follows:
| | March 31, 2019 | |
| | | | | Gross | | | Gross | | | Estimated | |
| | Amortized | | | Unrealized | | | Unrealized | | | Fair | |
| | Cost | | | Gains | | | Losses | | | Value | |
| | (Dollars in thousands) | |
| | | | | | | | | | | | |
U.S. Treasury & Government Agencies | | $ | 33,918 | | | $ | 112 | | | $ | (208 | ) | | $ | 33,822 | |
Municipal Securities | | | 115,467 | | | | 2,194 | | | | (182 | ) | | | 117,479 | |
Mortgage-backed Securities - Guaranteed | | | 82,467 | | | | 196 | | | | (1,137 | ) | | | 81,526 | |
Collateralized Mortgage Obligation - Guaranteed | | | 22,194 | | | | 99 | | | | (388 | ) | | | 21,905 | |
Collateralized Mortgage Obligation - Non Guaranteed | | | 66,842 | | | | 491 | | | | (194 | ) | | | 67,139 | |
Collateralized Loan Obligations | | | 15,524 | | | | — | | | | (312 | ) | | | 15,212 | |
Corporate bonds | | | 19,920 | | | | 237 | | | | (108 | ) | | | 20,049 | |
| | $ | 356,332 | | | $ | 3,329 | | | $ | (2,529 | ) | | $ | 357,132 | |
| | December 31, 2018 | |
| | | | | Gross | | | Gross | | | Estimated | |
| | Amortized | | | Unrealized | | | Unrealized | | | Fair | |
| | Cost | | | Gains | | | Losses | | | Value | |
| | (Dollars in thousands) | |
| | | | | | | | | | | | |
U.S. Treasury & Government Agencies | | $ | 34,068 | | | $ | 74 | | | $ | (152 | ) | | $ | 33,990 | |
Municipal Securities | | | 115,860 | | | | 209 | | | | (1,667 | ) | | | 114,402 | |
Mortgage-backed Securities - Guaranteed | | | 86,664 | | | | 98 | | | | (1,578 | ) | | | 85,184 | |
Collateralized Mortgage Obligation - Guaranteed | | | 22,492 | | | | 47 | | | | (650 | ) | | | 21,889 | |
Collateralized Mortgage Obligation - Non Guaranteed | | | 69,774 | | | | 125 | | | | (728 | ) | | | 69,171 | |
Collateralized Loan Obligations | | | 15,534 | | | | 1 | | | | (458 | ) | | | 15,077 | |
Corporate bonds | | | 19,936 | | | | 232 | | | | (143 | ) | | | 20,025 | |
| | $ | 364,328 | | | $ | 786 | | | $ | (5,376 | ) | | $ | 359,738 | |
Information pertaining to securities with gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
| | March 31, 2019 | |
| | Less Than 12 Months | | | More Than 12 Months | | | Total | |
| | Fair Value | | | Unrealized Losses | | | Fair Value | | | Unrealized Losses | | | Fair Value | | | Unrealized Losses | |
| | (Dollars in thousands) | |
| | | | | | | | | | | | | | | | | | |
U.S. Treasury & Government Agencies | | $ | 22,738 | | | $ | 179 | | | $ | 2,032 | | | $ | 29 | | | $ | 24,770 | | | $ | 208 | |
Municipal Securities | | | — | | | | — | | | | 20,277 | | | | 182 | | | | 20,277 | | | | 182 | |
Mortgage-backed Securities - Guaranteed | | | 5,987 | | | | 60 | | | | 54,578 | | | | 1,077 | | | | 60,565 | | | | 1,137 | |
Collateralized Mortgage Obligations - Guaranteed | | | — | | | | — | | | | 15,433 | | | | 388 | | | | 15,433 | | | | 388 | |
Collateralized Mortgage Obligations - Non Guaranteed | | | 2,908 | | | | 25 | | | | 17,739 | | | | 169 | | | | 20,647 | | | | 194 | |
Collateralized loan obligations | | | 11,750 | | | | 269 | | | | 3,462 | | | | 43 | | | | 15,212 | | | | 312 | |
Corporate bonds | | | 3,125 | | | | 25 | | | | 3,350 | | | | 83 | | | | 6,475 | | | | 108 | |
| | $ | 46,508 | | | $ | 558 | | | $ | 116,871 | | | $ | 1,971 | | | $ | 163,379 | | | $ | 2,529 | |
| | December 31, 2018 | |
| | Less Than 12 Months | | | More Than 12 Months | | | Total | |
| | Fair Value | | | Unrealized Losses | | | Fair Value | | | Unrealized Losses | | | Fair Value | | | Unrealized Losses | |
| | (Dollars in thousands) | |
| | | | | | | | | | | | | | | | | | |
U.S. Treasury & Government Agencies | | $ | 23,423 | | | $ | 152 | | | $ | — | | | $ | — | | | $ | 23,423 | | | $ | 152 | |
Municipal Securities | | | 33,028 | | | | 421 | | | | 56,153 | | | | 1,246 | | | | 89,181 | | | | 1,667 | |
Mortgage-backed Securities - Guaranteed | | | 27,692 | | | | 370 | | | | 45,619 | | | | 1,208 | | | | 73,311 | | | | 1,578 | |
Collateralized Mortgage Obligations - Guaranteed | | | 2,042 | | | | 19 | | | | 15,294 | | | | 631 | | | | 17,336 | | | | 650 | |
Collateralized Mortgage Obligations - Non Guaranteed | | | 22,383 | | | | 185 | | | | 30,471 | | | | 543 | | | | 52,854 | | | | 728 | |
Collateralized loan obligations | | | 11,618 | | | | 404 | | | | 1,449 | | | | 54 | | | | 13,067 | | | | 458 | |
Corporate bonds | | | 2,492 | | | | 45 | | | | 3,345 | | | | 98 | | | | 5,837 | | | | 143 | |
| | $ | 122,678 | | | $ | 1,596 | | | $ | 152,331 | | | $ | 3,780 | | | $ | 275,009 | | | $ | 5,376 | |
Information pertaining to the number of securities with gross unrealized losses is detailed in the table below. Management of the Company believes all unrealized losses as of March 31, 2019 and December 31, 2018 represent temporary impairment. The unrealized losses have resulted from temporary changes in the interest rate market and not as a result of credit deterioration. We do not intend to sell and it is not likely that we will be required to sell any of the securities referenced in the table below before recovery of their amortized cost.
| | March 31, 2019 | |
| | Less Than 12 Months | | | More Than 12 Months | | | Total | |
U.S. Treasury & Government Agencies | | | 15 | | | | 1 | | | | 16 | |
Municipal Securities | | | — | | | | 18 | | | | 18 | |
Mortgage-backed Securities - Guaranteed | | | 5 | | | | 52 | | | | 57 | |
Collateralized Mortgage Obligations - Guaranteed | | | — | | | | 8 | | | | 8 | |
Collateralized Mortgage Obligations - Non Guaranteed | | | 2 | | | | 13 | | | | 15 | |
Collateralized Loan Obligations | | | 6 | | | | 2 | | | | 8 | |
Corporate bonds | | | 4 | | | | 4 | | | | 8 | |
| | | 32 | | | | 98 | | | | 130 | |
| | December 31, 2018 | |
| | Less Than 12 Months | | | More Than 12 Months | | | Total | |
U.S. Treasury & Government Agencies | | | 14 | | | | — | | | | 14 | |
Municipal Securities | | | 31 | | | | 52 | | | | 83 | |
Mortgage-backed Securities - Guaranteed | | | 21 | | | | 43 | | | | 64 | |
Collateralized Mortgage Obligations - Guaranteed | | | 1 | | | | 8 | | | | 9 | |
Collateralized Mortgage Obligations - Non Guaranteed | | | 12 | | | | 22 | | | | 34 | |
Collateralized Loan Obligations | | | 6 | | | | 1 | | | | 7 | |
Corporate bonds | | | 3 | | | | 4 | | | | 7 | |
| | | 88 | | | | 130 | | | | 218 | |
The Company received proceeds from sales of securities classified as AFS and corresponding gross realized gains and losses as follows for the three months ended March 31, 2018:
(Dollars in thousands) | |
Gross proceeds | | $ | 10,009 | |
Gross realized gains | | | 21 | |
Gross realized losses | | | 33 | |
There were no investment security sales for the three months ended March 31, 2019.
The Company had securities pledged against deposits and borrowings of approximately $159.8 million at March 31, 2019 and $155.8 million at December 31, 2018.
The amortized cost and estimated fair value of investments in debt securities at March 31, 2019, by contractual maturity, is shown below. Mortgage-backed securities have not been scheduled because expected maturities will differ from contractual maturities when borrowers have the right to prepay the obligations.
| | Available-for-Sale | |
| | Amortized Cost | | | Fair Value | |
| | (Dollars in thousands) | |
| | | | | | |
Less than 1 year | | $ | 1,979 | | | $ | 1,981 | |
Over 1 year through 5 years | | | 4,570 | | | | 3,207 | |
After 5 years through 10 years | | | 30,973 | | | | 32,307 | |
Over 10 years | | | 147,307 | | | | 149,067 | |
| | | 184,829 | | | | 186,562 | |
Mortgage-backed securities | | | 171,503 | | | | 170,570 | |
| | | | | | | | |
Total | | $ | 356,332 | | | $ | 357,132 | |
NOTE 3. LOANS RECEIVABLE
Loans receivable as of March 31, 2019 and December 31, 2018 are summarized as follows:
| | March 31, | | | December 31, | |
| | 2019 | | | 2018 | |
| | (Dollars in thousands) | |
| | | | | | |
Real estate mortgage loans: | | | | | | | | |
One-to four-family residential | | $ | 328,779 | | | $ | 325,560 | |
Commercial real estate | | | 500,600 | | | | 498,106 | |
Home equity loans and lines of credit | | | 47,665 | | | | 48,679 | |
Residential construction | | | 46,622 | | | | 39,533 | |
Other construction and land | | | 99,462 | | | | 104,645 | |
Total real estate loans | | | 1,023,128 | | | | 1,016,523 | |
| | | | | | | | |
Commercial and industrial | | | 51,562 | | | | 54,410 | |
Consumer | | | 6,494 | | | | 6,842 | |
Total commercial and consumer | | | 58,056 | | | | 61,252 | |
| | | | | | | | |
Loans receivable, gross | | | 1,081,184 | | | | 1,077,775 | |
| | | | | | | | |
Less: Net deferred loan fees | | | (1,046 | ) | | | (1,000 | ) |
Fair value discount | | | (915 | ) | | | (1,048 | ) |
Hedged loans basis adjustment (See Note 8) | | | 503 | | | | 245 | |
Unamortized premium | | | 319 | | | | 333 | |
Unamortized discount | | | (208 | ) | | | (236 | ) |
| | | | | | | | |
Loans receivable, net of deferred fees | | $ | 1,079,837 | | | $ | 1,076,069 | |
The Bank had $267.2 million and $256.1 million of loans pledged as collateral to secure funding with the Federal Home Loan Bank of Atlanta (“FHLB”) at March 31, 2019 and December 31, 2018, respectively. The Bank also had $115.2 million and $114.4 million of loans pledged as collateral to secure funding availability with the Federal Reserve Bank (“FRB”) Discount Window at March 31, 2019 and December 31, 2018, respectively.
Included in loans receivable and other borrowings at March 31, 2019 are $4.4 million in participated loans that did not qualify for sale accounting. Interest expense on the other borrowings accrues at the same rate as the interest income recognized on the loans receivable, resulting in no effect to net income.
The following tables present the activity related to the discount on individually purchased loans for the three months ended March 31, 2019 and 2018:
| | For the Three Months Ended | |
| | March 31, | |
(Dollars in thousands) | | 2019 | | | 2018 | |
| | | | | | |
Discount on purchased loans, beginning of period | | $ | 236 | | | $ | 710 | |
Accretion | | | (28 | ) | | | (29 | ) |
Discount on purchased loans, end of period | | $ | 208 | | | $ | 681 | |
The following table presents the activity related to the fair value discount on loans from business combinations for the three months ended March 31 2019, and 2018:
| | For the Three Months Ended | |
| | March 31, | |
(Dollars in thousands) | | 2019 | | | 2018 | |
| | | | | | |
Fair value discount, beginning of period | | $ | 1,048 | | | $ | 2,012 | |
Accretion | | | (133 | ) | | | (266 | ) |
Fair value discount, end of period | | $ | 915 | | | $ | 1,746 | |
NOTE 4. ALLOWANCE FOR LOAN LOSSES
The following tables present, by portfolio segment, the changes in the allowance for loan losses for the periods indicated:
| | Three Months Ended March 31, 2019 | |
| | One-to four Family Residential | | | Commercial Real Estate | | | Home Equity and Lines of Credit | | | Residential Construction | | | Other Construction and Land | | | Commercial | | | Consumer | | | Total | |
| | (Dollars in thousands) | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Beginning balance | | $ | 3,909 | | | $ | 5,130 | | | $ | 560 | | | $ | 452 | | | $ | 1,250 | | | $ | 608 | | | $ | 76 | | | $ | 11,985 | |
Provision | | | 34 | | | | (112 | ) | | | 255 | | | | 68 | | | | (42 | ) | | | 43 | | | | (130 | ) | | | 116 | |
Charge-offs | | | (4 | ) | | | — | | | | (209 | ) | | | — | | | | — | | | | (59 | ) | | | (26 | ) | | | (298 | ) |
Recoveries | | | 20 | | | | 56 | | | | — | | | | — | | | | 8 | | | | 4 | | | | 152 | | | | 240 | |
Ending balance | | $ | 3,959 | | | $ | 5,074 | | | $ | 606 | | | $ | 520 | | | $ | 1,216 | | | $ | 596 | | | $ | 72 | | | $ | 12,043 | |
| | Three Months Ended March 31, 2018 | |
| | One-to four Family Residential | | | Commercial Real Estate | | | Home Equity and Lines of Credit | | | Residential Construction | | | Other Construction and Land | | | Commercial | | | Consumer | | | Total | |
| | (Dollars in thousands) | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Beginning balance | | $ | 4,018 | | | $ | 4,364 | | | $ | 616 | | | $ | 303 | | | $ | 1,025 | | | $ | 503 | | | $ | 58 | | | $ | 10,887 | |
Provision | | | (151 | ) | | | 229 | | | | (21 | ) | | | 150 | | | | 63 | | | | 128 | | | | (37 | ) | | | 361 | |
Charge-offs | | | (110 | ) | | | (35 | ) | | | (41 | ) | | | — | | | | — | | | | — | | | | (29 | ) | | | (215 | ) |
Recoveries | | | 13 | | | | 3 | | | | 21 | | | | — | | | | 20 | | | | 5 | | | | 72 | | | | 134 | |
Ending balance | | $ | 3,770 | | | $ | 4,561 | | | $ | 575 | | | $ | 453 | | | $ | 1,108 | | | $ | 636 | | | $ | 64 | | | $ | 11,167 | |
The following tables present, by portfolio segment and reserving methodology, the allocation of the allowance for loan losses and the net investment in loans for the periods indicated:
| | March 31, 2019 | |
| | One-to four Family Residential | | | Commercial Real Estate | | | Home Equity and Lines of Credit | | | Residential Construction | | | Other Construction and Land | | | Commercial | | | Consumer | | | Total | |
| | (Dollars in thousands) | |
Allowance for loan losses | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Individually evaluated for impairment | | $ | 148 | | | $ | 80 | | | $ | 74 | | | $ | — | | | $ | 46 | | | $ | 5 | | | $ | — | | | $ | 353 | |
Collectively evaluated for impairment | | | 3,811 | | | | 4,994 | | | | 532 | | | | 520 | | | | 1,170 | | | | 591 | | | | 72 | | | | 11,690 | |
| | $ | 3,959 | | | $ | 5,074 | | | $ | 606 | | | $ | 520 | | | $ | 1,216 | | | $ | 596 | | | $ | 72 | | | $ | 12,043 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Loans Receivable | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Individually evaluated for impairment | | $ | 3,262 | | | $ | 5,994 | | | $ | 312 | | | $ | — | | | $ | 1,358 | | | $ | 271 | | | $ | — | | | $ | 11,197 | |
Collectively evaluated for impairment | | | 325,414 | | | | 493,085 | | | | 47,500 | | | | 46,566 | | | | 97,918 | | | | 51,563 | | | | 6,594 | | | | 1,068,640 | |
| | $ | 328,676 | | | $ | 499,079 | | | $ | 47,812 | | | $ | 46,566 | | | $ | 99,276 | | | $ | 51,834 | | | $ | 6,594 | | | $ | 1,079,837 | |
| | December 31, 2018 | |
| | One-to four Family Residential | | | Commercial Real Estate | | | Home Equity and Lines of Credit | | | Residential Construction | | | Other Construction and Land | | | Commercial | | | Consumer | | | Total | |
| | (Dollars in thousands) | |
Allowance for loan losses | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Individually evaluated for impairment | | $ | 79 | | | $ | 27 | | | $ | — | | | $ | — | | | $ | 54 | | | $ | 7 | | | $ | — | | | $ | 167 | |
Collectively evaluated for impairment | | | 3,830 | | | | 5,103 | | | | 560 | | | | 452 | | | | 1,196 | | | | 601 | | | | 76 | | | | 11,818 | |
| | $ | 3,909 | | | $ | 5,130 | | | $ | 560 | | | $ | 452 | | | $ | 1,250 | | | $ | 608 | | | $ | 76 | | | $ | 11,985 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Loans Receivable | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Individually evaluated for impairment | | $ | 2,900 | | | $ | 6,019 | | | $ | 313 | | | $ | — | | | $ | 1,377 | | | $ | 276 | | | $ | — | | | $ | 10,885 | |
Collectively evaluated for impairment | | | 322,255 | | | | 490,530 | | | | 48,512 | | | | 39,488 | | | | 103,087 | | | | 54,367 | | | | 6,945 | | | | 1,065,184 | |
| | $ | 325,155 | | | $ | 496,549 | | | $ | 48,825 | | | $ | 39,488 | | | $ | 104,464 | | | $ | 54,643 | | | $ | 6,945 | | | $ | 1,076,069 | |
Portfolio Quality Indicators
The Company’s loan portfolio grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled. The Company’s internal credit risk grading system is based on experiences with similarly graded loans, industry best practices, and regulatory guidance. Credit risk grades are refreshed each quarter, at which time management analyzes the resulting information, as well as other external statistics and factors, to track loan performance.
The Company’s internally assigned grades pursuant to the Board-approved lending policy are as follows:
| · | Pass (1-5) – Acceptable loans with any identifiable weaknesses appropriately mitigated. |
| · | Special Mention (6) – Potential weakness or identifiable weakness present without appropriate mitigating factors; however, loan continues to perform satisfactorily with no material delinquency noted. This may include some deterioration in repayment capacity and/or loan-to-value of securing collateral. |
| · | Substandard (7) – Significant weakness that remains unmitigated, most likely due to diminished repayment capacity, serious delinquency, and/or marginal performance based upon restructured loan terms. |
| · | Doubtful (8) – Significant weakness that remains unmitigated and collection in full is highly questionable or improbable. |
| · | Loss (9) – Collectability is unlikely resulting in immediate charge-off. |
Description of Segment and Class Risks
Each of our portfolio segments and the classes within those segments are subject to risks that could have an adverse impact on the credit quality of our loan portfolio. Management has identified the most significant risks as described below which are generally similar among our segments and classes. While the list is not exhaustive, it provides a description of the risks that management has determined are the most significant.
One-to-four family residential
We centrally underwrite each of our one-to-four family residential loans using credit scoring and analytical tools consistent with the Board-approved lending policy and internal procedures based upon industry best practices and regulatory directives. Loans to be sold to secondary market investors must also adhere to investor guidelines. We also evaluate the value and marketability of that collateral. Common risks to each class of non-commercial loans, including one-to-four family residential, include risks that are not specific to individual transactions such as general economic conditions within our markets, particularly unemployment and potential declines in real estate values. Personal events such as death, disability or change in marital status also add risk to non-commercial loans.
Commercial real estate
Commercial mortgage loans are primarily dependent on the ability of our customers to achieve business results consistent with those projected at loan origination resulting in cash flow sufficient to service the debt. To the extent that a customer’s business results are significantly unfavorable versus the original projections, the ability for our loan to be serviced on a basis consistent with the contractual terms may be at risk. While these loans are secured by real property and possibly other business assets such as inventory or accounts receivable, it is possible that the liquidation of the collateral will not fully satisfy the obligation. Other commercial real estate loans consist primarily of loans secured by multifamily housing and agricultural loans. The primary risk associated with multifamily loans is the ability of the income-producing property that collateralizes the loan to produce adequate cash flow to service the debt. High unemployment or generally weak economic conditions may result in our customer having to provide rental rate concessions to achieve adequate occupancy rates. The performance of agricultural loans are highly dependent on favorable weather, reasonable costs for seed and fertilizer, and the ability to successfully market the product at a profitable margin. The demand for these products is also dependent on macroeconomic conditions that are beyond the control of the borrower.
Home equity and lines of credit
Home equity loans are often secured by first or second liens on residential real estate, thereby making such loans particularly susceptible to declining collateral values. A substantial decline in collateral value could render our second lien position to be effectively unsecured. Additional risks include lien perfection inaccuracies and disputes with first lienholders that may further weaken our collateral position. Further, the open-end structure of these loans creates the risk that customers may draw on the lines of credit in excess of the collateral value if there have been significant declines since origination.
Residential construction and other construction and land
Residential mortgage construction loans are typically secured by undeveloped or partially developed land with funds to be disbursed as home construction is completed contingent upon receipt and satisfactory review of invoices and inspections. Declines in real estate values can result in residential mortgage loan borrowers having debt levels in excess of the collateral’s current market value. Non-commercial construction and land development loans can experience delays in completion and/or cost overruns that exceed the borrower’s financial ability to complete the project. Cost overruns can result in foreclosure of partially completed collateral with unrealized value and diminished marketability.Commercial construction and land development loans are dependent on the supply and demand for commercial real estate in the markets we serve as well as the demand for newly constructed residential homes and building lots. Deterioration in demand could result in significant decreases in the underlying collateral values and make repayment of the outstanding loans more difficult for our customers.
Commercial
We centrally underwrite each of our commercial loans based primarily upon the customer’s ability to generate the required cash flow to service the debt in accordance with the contractual terms and conditions of the loan agreement. We strive to gain a complete understanding of our borrower’s businesses, including the experience and background of the principals of such businesses. To the extent that the loan is secured by collateral, which is a predominant feature of the majority of our commercial loans, or other assets including accounts receivable and inventory, we gain an understanding of the likely value of the collateral and what level of strength it brings to the loan transaction. To the extent that the principals or other parties are obligated under the note or guaranty agreements, we analyze the relative financial strength and liquidity of each guarantor. Common risks to each class of commercial loans include risks that are not specific to individual transactions such as general economic conditions within our markets, as well as risks that are specific to each transaction including volatility or seasonality of cash flows, changing demand for products and services, personal events such as death, disability or change in marital status, and reductions in the value of our collateral.
Consumer
The consumer loan portfolio includes loans secured by personal property such as automobiles, marketable securities, other titled recreational vehicles including boats and motorcycles, as well as unsecured consumer debt. The value of underlying collateral within this class is especially volatile due to potential rapid depreciation in values since the date of loan origination in excess of principal repayment.
The following tables present the recorded investment in gross loans by loan grade as of the dates indicated:
March 31, 2019 |
Loan Grade | | One-to-Four Family Residential | | | Commercial Real Estate | | | Home Equity and Lines of Credit | | | Residential Construction | | | Other Construction and Land | | | Commercial | | | Consumer | | | Total | |
| | (Dollars in thousands) | |
| | | | | | | | | | | | | | | | | | | | | | | | |
1 | | $ | — | | | $ | 7,449 | | | $ | — | | | $ | — | | | $ | — | | | $ | 1,191 | | | $ | 6 | | | $ | 8,646 | |
2 | | | — | | | | 10,444 | | | | — | | | | — | | | | — | | | | 904 | | | | — | | | | 11,348 | |
3 | | | 31,789 | | | | 89,877 | | | | 4,839 | | | | 9,562 | | | | 12,292 | | | | 14,717 | | | | 17 | | | | 163,093 | |
4 | | | 124,622 | | | | 281,883 | | | | 3,719 | | | | 24,186 | | | | 55,743 | | | | 22,044 | | | | 215 | | | | 512,412 | |
5 | | | 25,610 | | | | 88,755 | | | | 392 | | | | 2,443 | | | | 17,947 | | | | 12,105 | | | | 4 | | | | 147,256 | |
6 | | | 318 | | | | 8,185 | | | | — | | | | 1 | | | | 1,280 | | | | 478 | | | | — | | | | 10,262 | |
7 | | | 646 | | | | 5,491 | | | | — | | | | — | | | | 187 | | | | 383 | | | | — | | | | 6,707 | |
| | $ | 182,985 | | | $ | 492,084 | | | $ | 8,950 | | | $ | 36,192 | | | $ | 87,449 | | | $ | 51,822 | | | $ | 242 | | | $ | 859,724 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Ungraded Loan Exposure: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Performing | | $ | 144,670 | | | $ | 6,976 | | | $ | 38,519 | | | $ | 10,374 | | | $ | 11,763 | | | $ | 12 | | | $ | 6,351 | | | $ | 218,665 | |
Nonperforming | | | 1,021 | | | | 19 | | | | 343 | | | | — | | | | 64 | | | | — | | | | 1 | | | | 1,448 | |
Subtotal | | $ | 145,691 | | | $ | 6,995 | | | $ | 38,862 | | | $ | 10,374 | | | $ | 11,827 | | | $ | 12 | | | $ | 6,352 | | | $ | 220,113 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 328,676 | | | $ | 499,079 | | | $ | 47,812 | | | $ | 46,566 | | | $ | 99,276 | | | $ | 51,834 | | | $ | 6,594 | | | $ | 1,079,837 | |
December 31, 2018 |
Loan Grade | | One-to-Four Family Residential | | | Commercial Real Estate | | | Home Equity and Lines of Credit | | | Residential Construction | | | Other Construction and Land | | | Commercial | | | Consumer | | | Total | |
| | (Dollars in thousands) | |
| | | | | | | | | | | | | | | | | | | | | | | | |
1 | | $ | — | | | $ | 7,569 | | | $ | — | | | $ | — | | | $ | — | | | $ | 1,264 | | | $ | 7 | | | $ | 8,840 | |
2 | | | — | | | | 7,860 | | | | — | | | | — | | | | — | | | | 20 | | | | — | | | | 7,880 | |
3 | | | 31,623 | | | | 87,756 | | | | 5,212 | | | | 9,365 | | | | 12,111 | | | | 15,685 | | | | 264 | | | | 162,016 | |
4 | | | 121,688 | | | | 280,630 | | | | 4,014 | | | | 18,358 | | | | 61,646 | | | | 22,374 | | | | 245 | | | | 508,955 | |
5 | | | 24,738 | | | | 88,698 | | | | 615 | | | | 3,404 | | | | 17,630 | | | | 12,307 | | | | 5 | | | | 147,397 | |
6 | | | 321 | | | | 7,867 | | | | — | | | | 1 | | | | 1,303 | | | | 495 | | | | — | | | | 9,987 | |
7 | | | 674 | | | | 5,725 | | | | — | | | | — | | | | 376 | | | | 487 | | | | — | | | | 7,262 | |
| | $ | 179,044 | | | $ | 486,105 | | | $ | 9,841 | | | $ | 31,128 | | | $ | 93,066 | | | $ | 52,632 | | | $ | 521 | | | $ | 852,337 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Ungraded Loan Exposure: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Performing | | $ | 145,470 | | | $ | 10,420 | | | $ | 38,806 | | | $ | 8,360 | | | $ | 11,334 | | | $ | 2,011 | | | $ | 6,424 | | | $ | 222,825 | |
Nonperforming | | | 641 | | | | 24 | | | | 178 | | | | — | | | | 64 | | | | — | | | | — | | | | 907 | |
Subtotal | | $ | 146,111 | | | $ | 10,444 | | | $ | 38,984 | | | $ | 8,360 | | | $ | 11,398 | | | $ | 2,011 | | | $ | 6,424 | | | $ | 223,732 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 325,155 | | | $ | 496,549 | | | $ | 48,825 | | | $ | 39,488 | | | $ | 104,464 | | | $ | 54,643 | | | $ | 6,945 | | | $ | 1,076,069 | |
Delinquency Analysis of Loans by Class
The following tables include an aging analysis of the recorded investment of past-due financing receivables by class. The Company does not accrue interest on loans greater than 90 days past due.
| | March 31, 2019 | |
| | 30-59 Days Past Due | | | 60-89 Days Past Due | | | 90 Days and Over Past Due | | | Total Past Due | | | Current | | | Total Loans Receivable | |
| | (Dollars in thousands) | |
| | | | | | | | | | | | | | | | | | |
One-to-four family residential | | $ | 4,364 | | | $ | — | | | $ | 251 | | | $ | 4,615 | | | $ | 324,061 | | | $ | 328,676 | |
Commercial real estate | | | 4,291 | | | | 119 | | | | 1,515 | | | | 5,925 | | | | 493,154 | | | | 499,079 | |
Home equity and lines of credit | | | 159 | | | | — | | | | 343 | | | | 502 | | | | 47,310 | | | | 47,812 | |
Residential construction | | | 350 | | | | — | | | | 1 | | | | 351 | | | | 46,215 | | | | 46,566 | |
Other construction and land | | | 129 | | | | — | | | | 64 | | | | 193 | | | | 99,083 | | | | 99,276 | |
Commercial | | | 283 | | | | — | | | | 62 | | | | 345 | | | | 51,489 | | | | 51,834 | |
Consumer | | | 35 | | | | 3 | | | | 1 | | | | 39 | | | | 6,555 | | | | 6,594 | |
Total | | $ | 9,611 | | | $ | 122 | | | $ | 2,237 | | | $ | 11,970 | | | $ | 1,067,867 | | | $ | 1,079,837 | |
| | December 31, 2018 | |
| | 30-59 Days Past Due | | | 60-89 Days Past Due | | | 90 Days and Over Past Due | | | Total Past Due | | | Current | | | Total Loans Receivable | |
| | (Dollars in thousands) | |
| | | | | | | | | | | | | | | | | | |
One-to-four family residential | | $ | 3,562 | | | $ | 1,317 | | | $ | 84 | | | $ | 4,963 | | | $ | 320,192 | | | $ | 325,155 | |
Commercial real estate | | | 2,615 | | | | — | | | | 1,782 | | | | 4,397 | | | | 492,152 | | | | 496,549 | |
Home equity and lines of credit | | | 400 | | | | 457 | | | | 73 | | | | 930 | | | | 47,895 | | | | 48,825 | |
Residential construction | | | — | | | | — | | | | 1 | | | | 1 | | | | 39,487 | | | | 39,488 | |
Other construction and land | | | 613 | | | | 32 | | | | 64 | | | | 709 | | | | 103,755 | | | | 104,464 | |
Commercial | | | 307 | | | | 25 | | | | 121 | | | | 453 | | | | 54,190 | | | | 54,643 | |
Consumer | | | 27 | | | | 4 | | | | — | | | | 31 | | | | 6,914 | | | | 6,945 | |
Total | | $ | 7,524 | | | $ | 1,835 | | | $ | 2,125 | | | $ | 11,484 | | | $ | 1,064,585 | | | $ | 1,076,069 | |
Impaired Loans
The following table presents investments in loans considered to be impaired and related information on those impaired loans as of March 31, 2019 and December 31, 2018.
| | March 31, 2019 | | | December 31, 2018 | |
| | Recorded Balance | | | Unpaid Principal Balance | | | Specific Allowance | | | Recorded Balance | | | Unpaid Principal Balance | | | Specific Allowance | |
| | (Dollars in thousands) | |
Loans without a valuation allowance | | | | | | | | | | | | | | | | | | | | | | | | |
One-to-four family residential | | $ | 2,324 | | | $ | 2,475 | | | $ | — | | | $ | 845 | | | $ | 923 | | | $ | — | |
Commercial real estate | | | 3,925 | | | | 6,271 | | | | — | | | | 3,835 | | | | 6,207 | | | | — | |
Home equity and lines of credit | | | 213 | | | | 328 | | | | — | | | | 283 | | | | 283 | | | | — | |
Other construction and land | | | 549 | | | | 683 | | | | — | | | | 365 | | | | 366 | | | | — | |
| | $ | 7,011 | | | $ | 9,757 | | | $ | — | | | $ | 5,328 | | | $ | 7,779 | | | $ | — | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Loans with a valuation allowance | | | | | | | | | | | | | | | | | | | | | | | | |
One-to-four family residential | | $ | 938 | | | $ | 938 | | | $ | 148 | | | $ | 2,055 | | | $ | 2,055 | | | $ | 79 | |
Commercial real estate | | | 2,069 | | | | 2,069 | | | | 80 | | | | 2,184 | | | | 2,184 | | | | 27 | |
Home equity and lines of credit | | | 99 | | | | 99 | | | | 74 | | | | 30 | | | | 30 | | | | — | |
Other construction and land | | | 809 | | | | 809 | | | | 46 | | | | 1,012 | | | | 1,012 | | | | 54 | |
Commercial | | | 271 | | | | 271 | | | | 5 | | | | 276 | | | | 276 | | | | 7 | |
| | $ | 4,186 | | | $ | 4,186 | | | $ | 353 | | | $ | 5,557 | | | $ | 5,557 | | | $ | 167 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total | | | | | | | | | | | | | | | | | | | | | | | | |
One-to-four family residential | | $ | 3,262 | | | $ | 3,413 | | | $ | 148 | | | $ | 2,900 | | | $ | 2,978 | | | $ | 79 | |
Commercial real estate | | | 5,994 | | | | 8,340 | | | | 80 | | | | 6,019 | | | | 8,391 | | | | 27 | |
Home equity and lines of credit | | | 312 | | | | 427 | | | | 74 | | | | 313 | | | | 313 | | | | — | |
Other construction and land | | | 1,358 | | | | 1,492 | | | | 46 | | | | 1,377 | | | | 1,378 | | | | 54 | |
Commercial | | | 271 | | | | 271 | | | | 5 | | | | 276 | | | | 276 | | | | 7 | |
| | $ | 11,197 | | | $ | 13,943 | | | $ | 353 | | | $ | 10,885 | | | $ | 13,336 | | | $ | 167 | |
The following table presents average impaired loans and interest income recognized on those impaired loans, by class segment, for the periods indicated:
| | Three Months Ended March 31, | |
| | 2019 | | | 2018 | |
| | Average Investment in Impaired Loans | | | Interest Income Recognized | | | Average Investment in Impaired Loans | | | Interest Income Recognized | |
| | (Dollars in thousands) | |
Loans without a valuation allowance | | | | | | | | | | | | | | | | |
One-to four-family residential | | $ | 2,483 | | | $ | 29 | | | $ | 1,877 | | | $ | 29 | |
Commercial real estate | | | 6,272 | | | | 37 | | | | 5,613 | | | | 31 | |
Home equity and lines of credit | | | 328 | | | | 15 | | | | 427 | | | | 14 | |
Other construction and land | | | 685 | | | | 5 | | | | 699 | | | | 5 | |
| | $ | 9,768 | | | $ | 86 | | | $ | 8,616 | | | $ | 79 | |
| | | | | | | | | | | | | | | | |
Loans with a valuation allowance | | | | | | | | | | | | | | | | |
One-to four-family residential | | $ | 937 | | | $ | 8 | | | $ | 1,621 | | | $ | 16 | |
Commercial real estate | | | 2,155 | | | | 23 | | | | 1,693 | | | | 23 | |
Home equity and lines of credit | | | 99 | | | | 2 | | | | — | | | | — | |
Other construction and land | | | 819 | | | | 12 | | | | 1,724 | | | | 9 | |
Commercial | | | 274 | | | | 6 | | | | 290 | | | | 5 | |
| | $ | 4,284 | | | $ | 51 | | | $ | 5,328 | | | $ | 53 | |
| | | | | | | | | | | | | | | | |
Total | | | | | | | | | | | | | | | | |
One-to four-family residential | | $ | 3,420 | | | $ | 37 | | | $ | 3,498 | | | $ | 45 | |
Commercial real estate | | | 8,427 | | | | 60 | | | | 7,306 | | | | 54 | |
Home equity and lines of credit | | | 427 | | | | 17 | | | | 427 | | | | 14 | |
Other construction and land | | | 1,504 | | | | 17 | | | | 2,423 | | | | 14 | |
Commercial | | | 274 | | | | 6 | | | | 290 | | | | 5 | |
| | $ | 14,052 | | | $ | 137 | | | $ | 13,944 | | | $ | 132 | |
Nonperforming Loans
The following table summarizes the balances of nonperforming loans as of March 31, 2019 and December 31, 2018. Certain loans classified as Troubled Debt Restructurings (“TDRs”) and impaired loans may be on non-accrual status even though they are not contractually delinquent.
| | March 31, 2019 | | | December 31, 2018 | |
| | (Dollars in thousands) | |
| | | | | | |
One-to-four family residential | | $ | 1,394 | | | $ | 1,037 | |
Commercial real estate | | | 2,854 | | | | 3,266 | |
Home equity loans and lines of credit | | | 343 | | | | 178 | |
Residential construction | | | 1 | | | | — | |
Other construction and land | | | 251 | | | | 256 | |
Commercial | | | 62 | | | | 120 | |
Consumer | | | 1 | | | | — | |
Non-performing loans | | $ | 4,906 | | | $ | 4,857 | |
TDRs
The following tables summarize TDR loans as of the dates indicated:
| | March 31, 2019 | |
| | Performing | | | Nonperforming | | | Total | |
| | TDRs | | | TDRs | | | TDRs | |
| | (Dollars in thousands) | |
| | | | | | | | | |
One-to-four family residential | | $ | 2,138 | | | $ | 358 | | | $ | 2,496 | |
Commercial real estate | | | 3,912 | | | | 1,212 | | | | 5,124 | |
Home equity and lines of credit | | | 313 | | | | — | | | | 313 | |
Other construction and land | | | 1,170 | | | | 187 | | | | 1,357 | |
Commercial | | | 271 | | | | — | | | | 271 | |
| | | | | | | | | | | | |
| | $ | 7,804 | | | $ | 1,757 | | | $ | 9,561 | |
| | December 31, 2018 | |
| | Performing | | | Nonperforming | | | Total | |
| | TDRs | | | TDRs | | | TDRs | |
| | (Dollars in thousands) | |
| | | | | | | | | |
One-to-four family residential | | $ | 2,154 | | | $ | 361 | | | $ | 2,515 | |
Commercial real estate | | | 3,690 | | | | 1,462 | | | | 5,152 | |
Home equity and lines of credit | | | 283 | | | | 30 | | | | 313 | |
Other construction and land | | | 1,185 | | | | 192 | | | | 1,377 | |
Commercial | | | 276 | | | | — | | | | 276 | |
| | | | | | | | | | | | |
| | $ | 7,588 | | | $ | 2,045 | | | $ | 9,633 | |
There were no loan modifications that were deemed TDRs at the time of the modification during the three months ended March 31, 2019 or 2018.
There were no TDRs that defaulted during the three months ending March 31, 2019 or 2018 and which were modified as TDRs within the previous 12 months.
NOTE 5. GOODWILL AND OTHER INTANGIBLES
The Company had $23.9 million of goodwill as of March 31, 2019 and December 31, 2018.
The Company had $3.4 million and $3.6 million of core deposit intangibles as of March 31, 2019 and December 31, 2018, respectively. The following is a summary of gross carrying amounts and accumulated amortization of core deposit intangibles:
| | As of and for the Three Months Ending | | | As of and for the Year Ending | |
| | March 31, | | | December 31, | |
| | 2019 | | | 2018 | |
| | Dollars in thousands | |
Gross balance at beginning of period | | $ | 4,840 | | | $ | 4,840 | |
Additions from acquisitions | | | — | | | | — | |
Gross balance at end of period | | | 4,840 | | | | 4,840 | |
Less accumulated amortization | | | (1,436 | ) | | | (1,263 | ) |
Core deposit intangible, net | | $ | 3,404 | | | $ | 3,577 | |
Core deposit intangibles are amortized using the straight-line method over their estimated useful lives of seven years. Estimated amortization expense for core deposit intangibles is $0.7 million for 2019 and each of the next three years, $0.6 million in the fifth year, and $0.3 million in the final year.
NOTE 6. DEPOSITS
The following table summarizes deposit balances and interest expense by type of deposit as of and for the three months ended March 31, 2019 and 2018 and the year ended December 31, 2018.
| | As of and for the | | | As of and for the Year Ended | |
| | Three Months Ended March 31, | | | December 31, | |
| | 2019 | | | 2018 | | | 2018 | |
(Dollars in thousands) | | Balance | | | Interest Expense | | | Balance | | | Interest Expense | | | Balance | | | Interest Expense | |
Noninterest-bearing demand | | $ | 194,562 | | | $ | — | | | $ | 192,916 | | | $ | — | | | $ | 184,404 | | | $ | — | |
Interest-bearing demand | | | 198,516 | | | | 98 | | | | 206,530 | | | | 87 | | | | 209,085 | | | | 374 | |
Money Market | | | 390,839 | | | | 1,138 | | | | 336,625 | | | | 366 | | | | 356,086 | | | | 2,637 | |
Savings | | | 49,996 | | | | 14 | | | | 52,162 | | | | 15 | | | | 50,716 | | | | 59 | |
Time Deposits | | | 412,306 | | | | 1,676 | | | | 417,675 | | | | 914 | | | | 420,949 | | | | 5,048 | |
| | $ | 1,246,219 | | | $ | 2,926 | | | $ | 1,205,908 | | | $ | 1,382 | | | $ | 1,221,240 | | | $ | 8,118 | |
The following table indicates wholesale deposits included in the money market and time deposits amounts above:
| | As of March 31, | | | As of December 31, | |
| | 2019 | | | 2018 | | | 2018 | |
(Dollars in thousands) | | Balance | | | Balance | | | Balance | |
Wholesale money market | | $ | 5,063 | | | $ | 25,026 | | | $ | 5,030 | |
Wholesale time deposits | | | 72,259 | | | | 56,232 | | | | 70,978 | |
| | $ | 77,322 | | | $ | 81,258 | | | $ | 76,008 | |
NOTE 7. BORROWINGS
The scheduled maturities and respective weighted average rates of outstanding FHLB advances are as follows for the dates indicated:
| | March 31, 2019 | | | December 31, 2018 | |
Year of Maturity | | Balance | | | Weighted Average Rate | | | Balance | | | Weighted Average Rate | |
| | (Dollars in thousands) | |
2019 | | | 163,500 | | | | 2.59 | % | | | 168,500 | | | | 2.52 | % |
2020 | | | 45,000 | | | | 2.80 | % | | | 45,000 | | | | 2.80 | % |
2024 | | | 5,000 | | | | 2.81 | % | | | — | | | | — | |
| | $ | 213,500 | | | | 2.64 | % | | $ | 213,500 | | | | 2.58 | % |
The Company has a $15.0 million revolving credit loan facility with NexBank SSB. The loan facility, which is secured by Entegra Bank stock, bears interest at LIBOR plus 350 basis points and is intended to be used for general corporate purposes. The Company had drawn $5.0 million on the revolving credit loan facility as of March 31, 2019 and December 31, 2018.
The Company also had other borrowings of $4.4 million and $4.3 million at March 31, 2019 and December 31, 2018, respectively, which is comprised of participated loans that did not qualify for sale accounting. Interest expense on these other borrowings accrues at the same rate as the interest income recognized on the loans receivable, resulting in no effect to net income.
NOTE 8. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
Interest Rate Swaps
Risk Management Objective of Interest Rate Swaps
The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity and credit risk, primarily by managing the amount, sources and duration of certain balance sheet assets and liabilities. In the normal course of business, the Company also uses derivative financial instruments to add stability to interest income or expense and to manage its exposure to movements in interest rates. The Company does not use derivatives for trading or speculative purposes and only enters into transactions that have a qualifying hedging relationship. The Company's hedging strategies involving interest rate derivatives are classified as either “Fair Value Hedges” or “Cash Flow Hedges,” depending upon the rate characteristic of the hedged item.
Fair Value Hedge:As a result of interest rate fluctuations, fixed-rate assets and liabilities will appreciate or depreciate in fair value. When effectively hedged, this appreciation or depreciation will generally be offset by fluctuations in the fair value of the derivative instruments that are linked to the hedged assets and liabilities. This strategy is referred to as a fair value hedge.
Cash Flow Hedge: Cash flows related to floating-rate assets and liabilities will fluctuate with changes in an underlying rate index. When effectively hedged, the increases or decreases in cash flows related to the floating rate asset or liability will generally be offset by changes in cash flows of the derivative instrument designated as a hedge. This strategy is referred to as a cash flow hedge.
Credit and Collateral Risks for Interest Rate Swaps
The Company manages credit exposure on interest rate swap transactions by entering into a bilateral credit support agreement with each counterparty. The credit support agreements allow for collateralization of exposures beyond specified minimum threshold amounts.
The Company’s agreements with its interest rate swap counterparties contain a provision where if either party defaults on any of its indebtedness, then it could also be declared in default on its derivative obligations. The agreements with derivative counterparties also include provisions that if not met, could result in the Company being declared in default. If the Company were to be declared in default, the counterparty could terminate the derivative positions and the Company and the counterparty would be required to settle their obligations under the agreements. At March 31, 2019, the Company had two derivatives in net liability positions of $0.6 million under these agreements and recognized the right to reclaim cash collateral of $0.6 million which was included in the consolidated balance sheets in Other assets. The Company had one derivative in a net liability position of $0.2 million at December 31, 2018.
Mortgage Derivatives
Risk Management Objective of Mortgage Lending Activities
The Company also maintains a risk management program to manage interest rate risk and pricing risk associated with its mortgage lending activities. The risk management program includes the use of forward contracts and other derivatives that are recorded in the financial statements at fair value and are used to offset changes in value of the mortgage inventory due to changes in market interest rates. As a normal part of our operations, we enter into derivative contracts to economically hedge risks associated with overall price risk related to interest rate lock commitments (”IRLCs”) and mortgage loans held-for-sale for which the fair value option has been elected. Fair value changes occur as a result of interest rate movements as well as changes in the value of the associated servicing. Derivative instruments used include forward sales commitments and IRLCs.
Credit and Collateral Risks for Mortgage Lending Activities
The Company’s underlying risks are primarily related to interest rates and forward sales commitments entered into as part of its mortgage banking activities. Forward sales commitments are contracts for the delayed delivery or net settlement of an underlying instrument, such as a mortgage loan, in which the seller agrees to deliver on a specified future date, either a specified instrument at a specified price or yield or the net cash equivalent of an underlying instrument. These hedges are used to preserve the Company’s position relative to future sales of mortgage loans to third parties in an effort to minimize the volatility of the expected gain on sale from changes in interest rate and the associated pricing changes.
The table below presents the fair value of the Company’s derivative financial instruments as of the dates indicated as well as their classification on the consolidated balance sheets (in thousands).
| | Derivative Assets(1) | | | Derivative Liabilities(1) | |
| | March 31, | | | December 31, | | | March 31, | | | December 31, | |
| | 2019 | | | 2018 | | | 2019 | | | 2018 | |
Derivatives designated as hedging instruments: | | | | | | | | | | | | | | | | |
Interest rate swaps | | $ | 260 | | | $ | 354 | | | $ | 861 | | | $ | 462 | |
Total | | $ | 260 | | | $ | 354 | | | $ | 861 | | | $ | 462 | |
| | | | | | | | | | | | | | | | |
Derivatives not designated as hedging instruments: | | | | | | | | | | | | | | | | |
Mortgage derivatives | | $ | 45 | | | $ | 34 | | | $ | 21 | | | $ | 22 | |
Total | | $ | 45 | | | $ | 34 | | | $ | 21 | | | $ | 22 | |
(1)All derivative assets are located in “Other assets” on the consolidated balance sheets and all derivative liabilities are located in “Other liabilities” on the consolidated balance sheets.
The table below presents the effect of fair value and cash flow hedge accounting on the consolidated statements of income:
Derivatives Designated as Hedging Instruments
| | Three Months Ended March 31, | |
| | 2019 | | | 2018 | |
(dollars in thousands) | | Interest income | | | Interest expense | | | Interest income | | | Interest expense | |
Total amounts of income and expense line items presented in the consolidated statements of income | | $ | 16,542 | | | $ | 4,589 | | | $ | 14,842 | | | $ | 2,449 | |
| | | | | | | | | | | | | | | | |
Amounts related to fair value hedging relationships | | | | | | | | | | | | | | | | |
Interest rate swaps: | | | | | | | | | | | | | | | | |
Hedged items | | | 259 | | | | — | | | | — | | | | — | |
Derivatives designated as hedging instruments | | | (274 | ) | | | — | | | | — | | | | — | |
| | | | | | | | | | | | | | | | |
Amounts related to cash flow hedging relationships | | | | | | | | | | | | | | | | |
Interest rate swaps: | | | | | | | | | | | | | | | | |
Amount reclassified from accumulated other comprehensive loss into income | | | — | | | | (65 | ) | | | — | | | | (56 | ) |
Fair Value Hedges
The Company uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps, designated as fair value hedges, involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed payments over the life of the agreements without the exchange of the underlying notional amount. The gain or loss on the derivative as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in earnings. The Company entered into a pay-fixed/receive-variable interest rate swap with a notional amount of $25.0 million which was designated as a fair value hedge associated with the Company’s fixed rate loan program.
As of March 31, 2019, the following amounts were recorded on the balance sheet related to cumulative basis adjustments for fair value hedges:
(dollars in thousands) | | Carrying amount of the hedged assets | | | Cumulative amount of fair value hedging adjustment included in the carrying amount of the hedged assets | |
Line item in the balance sheet in which the hedged item is included | | March 31, 2019 | | | March 31, 2019 | |
Loans receivable(1) | | $ | 97,891 | | | $ | 503 | |
(1)These amounts include the amortized cost basis of the closed portfolio used to designate the hedging relationship in which the hedged item is the last layer expected to be remaining at the end of the hedging relationship. At March 31, 2019, the amortized cost basis of the closed portfolio used in the the hedging relationship was $97.9 million, the cumulative basis adjustment associated with the hedging relationship was $0.5 million, and the amount of the designated hedged item was $25.0 million.
Cash Flow Hedges
Interest rate swap contracts, designated as cash flow hedges, involve the payment of fixed-rate amounts to a counterparty in exchange for the Company receiving variable-rate payments without exchange of the underlying notional amounts. The forward starting interest rate swap begins exchanging cash flows in 2020 when the current interest rate swap agreement expires.
The structures of the swap agreements designated as cash flow hedges are described in the table below (dollars in thousands):
Underlyings | | Designation | | Notional | | Payment Provision | | Life of Swap Contract |
Junior Subordinated Debt | | Cash Flow Hedge | | $ 14,000 | | Pay 0.958%/Receive 3 month LIBOR | | 4 yrs |
Junior Subordinated Debt | | Cash Flow Hedge | | $ 14,000 | | Pay 3.02%/Receive 3 month LIBOR | | 3 yrs |
The table below presents the effect of the Company's derivatives in cash flow hedging relationships for the periods presented (dollars in thousands):
| | | | As of and for the Three Months Ended March 31, | | | As of and for the Year Ended December 31, | |
Interest rate swaps | | Location | | 2019 | | | 2018 | | | 2018 | |
Amounts recognized in AOCI on derivatives | | OCI | | $ | (159 | ) | | $ | 202 | | | $ | 2 | |
Amounts reclassified from AOCI into income | | Interest expense | | | (65 | ) | | | (56 | ) | | | (431 | ) |
Amounts recognized in consolidated statement of comprehensive income | | | | $ | (224 | ) | | $ | 146 | | | $ | (429 | ) |
Derivatives Not Designated as Hedging Instruments
Mortgage Derivatives
Mortgage derivative fair value assets and liabilities are described above. At March 31, 2019 and December 31, 2018, the Company had the following IRLCs and forward commitments for the future delivery of residential mortgage loans.
| | As of March 31, | | | As of December 31, | |
(Dollars in thousands) | | 2019 | | | 2018 | |
Mortgage derivatives | | | | | | | | |
Interest rate lock commitments | | $ | 2,736 | | | $ | 1,627 | |
Forward sales commitment | | | 4,250 | | | | 3,500 | |
The table below presents the effect of the Company's derivatives not designated as hedging instruments for the periods presented:
| | | | Three Months Ended March 31, | |
Interest rate products | | Location | | 2019 | | | 2018 | |
| | | | (Dollars in thousands) | |
Amount of (loss) gain recognized in income on forward commitments | | Noninterest income | | $ | (38 | ) | | $ | 10 | |
Amount of gain recognized in income on interest rate lock commitments | | Noninterest income | | | 11 | | | | 17 | |
Amount of gain (loss) recognized in income on derivatives not designated as hedging instruments | | | | $ | (27 | ) | | $ | 27 | |
NOTE 9. INCOME TAXES
The components of net deferred taxes as of March 31, 2019 and December 31, 2018 are summarized as follows:
| | As of March 31, | | | As of December 31, | |
| | 2019 | | | 2018 | |
| | (Dollars in thousands) | |
Deferred tax assets: | | | | | | | | |
Allowance for loan losses | | $ | 2,729 | | | $ | 2,703 | |
Deferred compensation and post-employment benefits | | | 1,874 | | | | 1,854 | |
Non-accrual interest | | | 251 | | | | 245 | |
Valuation reserve for other real estate | | | 198 | | | | 191 | |
North Carolina NOL carryover | | | 233 | | | | 293 | |
Federal NOL carryover | | | 554 | | | | 1,231 | |
AMT credit carryover | | | — | | | | 316 | |
General federal business credit carryover | | | 826 | | | | 691 | |
Unrealized losses on securities | | | 581 | | | | 1,061 | |
Loan basis differences | | | 46 | | | | 50 | |
Fixed assets | | | 131 | | | | 123 | |
Core deposit intangible | | | 148 | | | | 129 | |
Derivative instruments | | | 21 | | | | — | |
Other | | | 1,122 | | | | 1,207 | |
Total deferred tax assets | | | 8,714 | | | | 10,094 | |
| | | | | | | | |
Deferred tax liabilities: | | | | | | | | |
Loan servicing rights | | | 633 | | | | 653 | |
Goodwill | | | 581 | | | | 495 | |
Core deposit intangible | | | 70 | | | | 74 | |
Deferred loan costs | | | 1,014 | | | | 1,001 | |
Prepaid expenses | | | 14 | | | | 14 | |
Unrealized gains on securities | | | 961 | | | | 105 | |
Derivative instruments | | | 6 | | | | 29 | |
Investment in partnerships | | | 170 | | | | 155 | |
Other | | | — | | | | 17 | |
Total deferred tax liabilities | | | 3,449 | | | | 2,543 | |
| | | | | | | | |
Net deferred tax asset | | $ | 5,265 | | | $ | 7,551 | |
The following table summarizes the amount and expiration dates of the Company’s unused net operating losses and other carryforwards as of March 31, 2019:
| | As of September, 2017 |
(Dollars in thousands) | | Amount | | | Expiration Dates |
Federal | | $ | 2,803 | | | 2032-2037 |
North Carolina | | $ | 13,708 | | | 2026-2029 |
Federal General Business Carryforwards | | $ | 826 | | | 2037-2039 |
NOTE 10. EARNINGS PER SHARE
The following is a reconciliation of the numerator and denominator of basic and diluted net income per share of common stock as of the dates indicated:
| | Three Months Ended March 31, | |
(Dollars in thousands, except per share amounts) | | 2019 | | | 2018 | |
Numerator: | | | | | | | | |
Net income | | $ | 3,815 | | | $ | 3,582 | |
Denominator: | | | | | | | | |
Weighted-average common shares outstanding - basic | | | 6,918,769 | | | | 6,885,911 | |
Effect of dilutive securities: | | | | | | | | |
Stock options | | | 6,960 | | | | 96,871 | |
Restricted stock units | | | 17,538 | | | | 45,102 | |
Weighted-average common shares outstanding - diluted | | | 6,943,267 | | | | 7,027,884 | |
| | | | | | | | |
Earnings per share - basic | | $ | 0.55 | | | $ | 0.52 | |
Earnings per share - diluted | | $ | 0.55 | | | $ | 0.51 | |
The average market price used in calculating the assumed number of dilutive shares issued related to stock options for the three months ended March 31, 2019 and 2018 was $23.12 and $28.56, respectively. The average stock price was less than the exercise price for 91,977 options in the three months ended March 31, 2019 and 19,592 options in the three months ended March 31, 2018. As a result, these stock options are not deemed dilutive in calculating diluted earnings per share for the respective periods in the table above.
NOTE 11. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The following table summarizes the components of accumulated other comprehensive income (loss) and changes in those components as of and for the three months ended March 31, 2019 and 2018.
| | Three Months Ended March 31, 2019 | |
| | (Dollars in thousands) | |
| | Available for Sale Securities | | | Cash Flow Hedge | | | Total | |
| | | | | | | | | |
Balance, beginning of period | | $ | (3,528 | ) | | $ | 104 | | | $ | (3,424 | ) |
| | | | | | | | | | | | |
Change in deferred tax valuation allowance attributable to net unrealized losses on investment securities available for sale | | | — | | | | — | | | | — | |
Change in net unrealized holding losses on securities available for sale | | | 5,390 | | | | — | | | | 5,390 | |
Reclassification adjustment for net securities losses realized in net income | | | — | | | | — | | | | — | |
Change in unrealized holding gains on cash flow hedge | | | — | | | | (159 | ) | | | (159 | ) |
Reclassification adjustment for cash flow hedge effectiveness | | | — | | | | (65 | ) | | | (65 | ) |
Income tax effect | | | (1,244 | ) | | | 47 | | | | (1,197 | ) |
| | | | | | | | | | | | |
Balance, end of period | | $ | 618 | | | $ | (73 | ) | | $ | 545 | |
| | | | | | | | | |
| | Three Months Ended March 31, 2018 | |
| | (Dollars in thousands) | |
Balance, beginning of period | | $ | (455 | ) | | $ | 432 | | | $ | (23 | ) |
| | | | | | | | | | | | |
Change in deferred tax valuation allowance attributable to net unrealized losses on investment securities available for sale | | | — | | | | — | | | | — | |
Change in net unrealized holding losses on securities available for sale | | | (4,505 | ) | | | — | | | | (4,505 | ) |
Reclassification adjustment for net securities losses realized in net income | | | 12 | | | | — | | | | 12 | |
Change in unrealized holding gains on cash flow hedge | | | — | | | | 202 | | | | 202 | |
Reclassification adjustment for cash flow hedge effectiveness | | | — | | | | (56 | ) | | | (56 | ) |
Cumulative effect of change in accounting principle | | | 9 | | | | — | | | | 9 | |
Income tax effect | | | 996 | | | | (31 | ) | | | 965 | |
| | | | | | | | | | | | |
Balance, end of period | | $ | (3,943 | ) | | $ | 547 | | | $ | (3,396 | ) |
The following table shows the line items in the Consolidated Statements of Income affected by amounts reclassified from accumulated other comprehensive income as of the dates indicated:
| | Three Months Ended March 31, | | | |
(Dollars in thousands) | | 2019 | | | 2018 | | | Income Statement Line Item Affected |
Available-for-sale securities | | | | | | | | | | |
Losses recognized | | $ | — | | | $ | (12 | ) | | Loss on sale of investments, net |
Income tax effect | | | — | | | | 3 | | | Income tax expense |
Reclassified out of AOCI, net of tax | | | — | | | | (9 | ) | | Net income |
| | | | | | | | | | |
Cash flow hedge | | | | | | | | | | |
Interest expense - effective portion | | | — | | | | 30 | | | Interest expense - FHLB advances |
Interest expense - effective portion | | | 65 | | | | 26 | | | Interest expense - Junior subordinated notes |
Income tax effect | | | (15 | ) | | | (13 | ) | | Income tax expense |
Reclassified out of AOCI, net of tax | | | 50 | | | | 43 | | | Net income |
| | | | | | | | | | |
Total reclassified out of AOCI, net of tax | | $ | 50 | | | $ | 34 | | | Net income |
NOTE 12. COMMITMENTS AND CONTINGENCIES
To accommodate the financial needs of its customers, the Company makes commitments under various terms to lend funds. These commitments include revolving credit agreements, term loan commitments and short-term borrowing agreements. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness. The amount of collateral obtained, if it is deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held includes first and second mortgages on one-to-four family dwellings, accounts receivable, inventory, and commercial real estate. Certain lines of credit are unsecured.
The following summarizes the Company’s approximate commitments to extend credit:
| | March 31, 2019 | |
| | (Dollars in thousands) | |
Lines of credit | | $ | 175,353 | |
Standby letters of credit | | | 1,011 | |
| | $ | 176,364 | |
The Company had outstanding commitments to originate loans as follows:
| | March 31, 2019 | |
| | Amount | | | Range of Rates | |
| | (Dollar in thousands) | |
| | | | | | |
Fixed | | $ | 24,709 | | | | 4.25% to 12.00% | |
Variable | | | 9,323 | | | | 3.38% to 8.00% | |
| | $ | 34,032 | | | | | |
The allowance for unfunded commitments was $0.1 million at March 31, 2019 and December 31, 2018.
The Company is exposed to loss as a result of its obligation for representations and warranties on loans sold to
Fannie Mae and maintained a reserve of $0.3 million as of March 31, 2019 and December 31, 2018.
In the normal course of business, the Company is periodically involved in litigation. In the opinion of the Company’s management, none of this litigation is expected to have a material adverse effect on the accompanying consolidated financial statements.
NOTE 13. FAIR VALUE DISCLOSURES
Overview
Fair value measurements are determined based on the assumptions that market participants would use in pricing an asset or liability. As a basis for considering market participant assumptions in fair value measurements, ASC Topic 820 (“ASC 820”),Fair Value Measurements and Disclosures establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity's own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs classified within Level 3 of the hierarchy).
Fair Value Hierarchy
Level 1
Valuation is based on inputs that are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.
Level 2
Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, such as interest rates, yield curves observable at commonly quoted intervals, and other market-corroborated inputs.
Level 3
Valuation is generated from techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models and similar techniques.
In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon models that primarily use, as inputs, observable market-based parameters. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. The Company evaluates fair value measurement inputs on an ongoing basis in order to determine if there is a change of sufficient significance to warrant a transfer between levels. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company's valuation process.
Fair Value Option
ASC 820 allows companies to report selected financial assets and liabilities at fair value using the fair value option. The changes in fair value are recognized in earnings and the assets and liabilities measured under this methodology are required to be displayed separately on the balance sheet. The Company made the election in June 2018, to record mortgage loans held-for-sale at fair value under the fair value option, which allows for a more effective offset of the changes in fair values of the loans and the derivative instruments used to hedge them without the burden of complying with the requirements for hedge accounting.
Financial Assets and Financial Liabilities Measured on a Recurring Basis
The Company uses the following methods and assumptions in estimating the fair value of its financial assets and financial liabilities on a recurring basis:
Investment Securities Available-for-Sale
We obtain fair values for debt securities from a third-party pricing service, which utilizes several sources for valuing fixed-income securities. The market evaluation sources for debt securities include observable inputs rather than significant unobservable inputs and are classified as Level 2. The service provider utilizes pricing models that vary by asset class and include available trade, bid and other market information. Generally, the methodologies include broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs.
Included in securities are investments in an exchange traded bond fund and U.S. Treasury bonds which are valued by reference to quoted market prices and considered a Level 1 security.
Also included in securities are corporate bonds which are valued using significant unobservable inputs and are classified as Level 2 or Level 3 based on market information available during the period.
Equity Securities
Equity securities represent investments in exchange traded mutual funds which are valued by reference to quoted market prices and considered a Level 1 security.
Mortgage Loans Held-for-Sale
Mortgage loans held-for-sale are recorded at fair value on a recurring basis. The estimated fair value is determined using Level 3 inputs based on observable data such as the existing forward commitment terms or the current market value of similar loans.
Loan Servicing Rights
Loan servicing rights are carried at fair value as determined by a third party valuation firm. The valuation model utilizes a discounted cash flow analysis using discount rates and prepayment speed assumptions used by market participants. The Company classifies loan servicing rights fair value measurements as Level 3.
Derivative Instruments
Derivative instruments include IRLCs, forward sale commitments, and interest rate swaps. IRLCs and forward sale commitments are valued based on the change in the value of the underlying loan between the commitment date and the end of the period. The Company classifies these instruments as Level 3.
Interest rate swaps are valued by a third party using significant assumptions that are observable in the market and can be corroborated by market data. The Company classifies interest rate swaps as Level 2.
The following tables present financial assets and financial liabilities measured at fair value on a recurring basis at the dates indicated, segregated by the level of valuation inputs within the fair value hierarchy utilized to measure fair value:
| | March 31, 2019 | |
| | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
| | (Dollars in thousands) | |
Assets: | | | | | | | | | | | | | | | | |
Equity securities | | $ | 6,812 | | | $ | — | | | $ | — | | | $ | 6,812 | |
Securities available for sale: | | | | | | | | | | | | | | | | |
U.S. Treasury & Government Agencies | | | 4,991 | | | | 28,831 | | | | — | | | | 33,822 | |
Municipal Securities | | | — | | | | 117,479 | | | | — | | | | 117,479 | |
Mortgage-backed Securities - Guaranteed | | | — | | | | 81,526 | | | | — | | | | 81,526 | |
Collateralized Mortgage Obligations - Guaranteed | | | — | | | | 21,905 | | | | — | | | | 21,905 | |
Collateralized Mortgage Obligations - Non Guaranteed | | | — | | | | 67,139 | | | | — | | | | 67,139 | |
Collateralized Loan Obligations | | | — | | | | 15,212 | | | | | | | | 15,212 | |
Corporate bonds | | | — | | | | 19,556 | | | | 493 | | | | 20,049 | |
Total securities available for sale | | | 4,991 | | | | 351,648 | | | | 493 | | | | 357,132 | |
| | | | | | | | | | | | | | | | |
Mortgage loans held for sale | | | — | | | | — | | | | 3,270 | | | | 3,270 | |
Loan servicing rights | | | — | | | | — | | | | 2,753 | | | | 2,753 | |
Interest rate swaps | | | — | | | | 260 | | | | — | | | | 260 | |
Mortgage derivatives | | | — | | | | — | | | | 45 | | | | 45 | |
| | | | | | | | | | | | | | | | |
Total recurring assets at fair value | | $ | 11,803 | | | $ | 351,908 | | | $ | 6,561 | | | $ | 370,272 | |
| | | | | | | | | | | | | | | | |
Liabilities: | | | | | | | | | | | | | | | | |
Interest rate swaps | | $ | — | | | $ | 861 | | | $ | — | | | $ | 861 | |
Mortgage derivatives | | | — | | | | — | | | | 21 | | | | 21 | |
| | | | | | | | | | | | | | | | |
Total recurring liabilities at fair value | | $ | — | | | $ | 861 | | | $ | 21 | | | $ | 882 | |
| | December 31, 2018 | |
| | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
| | (Dollars in thousands) | |
Assets: | | | | | | | | | | | | | | | | |
Equity securities | | $ | 6,178 | | | $ | — | | | $ | — | | | $ | 6,178 | |
Securities available for sale: | | | | | | | | | | | | | | | | |
U.S. Treasury & Government Agencies | | | 4,949 | | | | 29,041 | | | | — | | | | 33,990 | |
Municipal Securities | | | — | | | | 114,402 | | | | — | | | | 114,402 | |
Mortgage-backed Securities - Guaranteed | | | — | | | | 85,184 | | | | — | | | | 85,184 | |
Collateralized Mortgage Obligations - Guaranteed | | | — | | | | 21,889 | | | | — | | | | 21,889 | |
Collateralized Mortgage Obligations - Non Guaranteed | | | — | | | | 69,171 | | | | — | | | | 69,171 | |
Collateralized Loan Obligations | | | — | | | | 15,077 | | | | | | | | 15,077 | |
Corporate bonds | | | — | | | | 19,532 | | | | 493 | | | | 20,025 | |
Total securities available for sale | | | 4,949 | | | | 354,296 | | | | 493 | | | | 359,738 | |
| | | | | | | | | | | | | | | | |
Mortgage loans held for sale | | | — | | | | — | | | | 2,431 | | | | 2,431 | |
Loan servicing rights | | | — | | | | — | | | | 2,837 | | | | 2,837 | |
Interest rate swaps | | | — | | | | 354 | | | | — | | | | 354 | |
Mortgage derivatives | | | — | | | | — | | | | 34 | | | | 34 | |
| | | | | | | | | | | | | | | | |
Total recurring assets at fair value | | $ | 11,127 | | | $ | 354,650 | | | $ | 5,795 | | | $ | 371,572 | |
| | | | | | | | | | | | | | | | |
Liabilities: | | | | | | | | | | | | | | | | |
Interest rate swaps | | $ | — | | | $ | 462 | | | $ | — | | | $ | 462 | |
Mortgage derivatives | | | — | | | | — | | | | 22 | | | | 22 | |
| | | | | | | | | | | | | | | | |
Total recurring liabilities at fair value | | $ | — | | | $ | 462 | | | $ | 22 | | | $ | 484 | |
The following table presents the changes in assets and liabilities measured at fair value on a recurring basis for which we have utilized Level 3 inputs to determine fair value:
| | Three Months Ended March 31, | |
| | 2019 | | | 2018 | |
| | (Dollars in thousands) | |
Balance at beginning of period | | $ | 5,773 | | | $ | 3,321 | |
| | | | | | | | |
AFS securities | | | | | | | | |
Transfer to Level 2 | | | — | | | | 1,331 | |
| | | | | | | | |
Mortgage loans held for sale | | | 839 | | | | — | |
| | | | | | | | |
Loan servicing right activity, included in servicing income, net | | | | | | | | |
Capitalization from loans sold | | | 47 | | | | 100 | |
Fair value adjustment | | | (131 | ) | | | (130 | ) |
| | | | | | | | |
Mortgage derivative gains (losses) included in other income | | | 12 | | | | 27 | |
| | | | | | | | |
Balance at end of period | | $ | 6,540 | | | $ | 4,649 | |
Financial Assets Measured on a Nonrecurring Basis
The Company uses the following methods and assumptions in estimating the fair value of its financial assets on a nonrecurring basis:
SBA Loans Held for Sale
SBA loans held for sale are carried at the lower of cost or fair value. The fair value of SBA loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics and are classified as Level 2.
Impaired Loans
Impaired loans are carried at the lower of recorded investment or fair value. The fair value of collateral dependent impaired loans is estimated using the value of the collateral less selling costs if repayment is expected from liquidation of the collateral. Appraisals may be discounted based on our historical knowledge, changes in market conditions from the time of appraisal or our knowledge of the borrower and the borrower’s business. Impaired loans carried at fair value are classified as Level 3. Impaired loans measured using the present value of expected future cash flows are not deemed to be measured at fair value.
REO
REO obtained in partial or total satisfaction of a loan is recorded at the lower of recorded investment in the loan or fair value less cost to sell. Subsequent to foreclosure, these assets are carried at the lower of the amount recorded at acquisition date or fair value less cost to sell. Accordingly, it may be necessary to record nonrecurring fair value adjustments. Fair value, when recorded, is generally based upon appraisals by approved, independent, state certified appraisers. Like impaired loans, appraisals may be discounted based on our historical knowledge, changes in market conditions from the time of appraisal or other information available to us. REO carried at fair value is classified as Level 3.
Small Business Investment Company (“SBIC) Holdings
SBIC holdings are carried at the lower of cost or cost less a valuation allowance. From time to time, impairment of SBIC is evident as a result of underlying financial review and a valuation allowance is established. SBIC carried at cost less a valuation allowance is classified as Level 3.
The following table presents nonfinancial assets measured at fair value on a nonrecurring basis at the dates indicated, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
| | March 31, 2019 | |
| | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
| | (Dollars in thousands) | |
Collateral dependent impaired loans: | | | | | | | | | | | | | | | | |
One-to four family residential | | $ | — | | | $ | — | | | $ | 2,324 | | | $ | 2,324 | |
Commercial real estate | | | — | | | | — | | | | 3,925 | | | | 3,925 | |
Home equity loans and lines of credit | | | — | | | | — | | | | 213 | | | | 213 | |
Other construction and land | | | — | | | | — | | | | 549 | | | | 549 | |
| | | | | | | | | | | | | | | | |
Real estate owned: | | | | | | | | | | | | | | | | |
Commercial real estate | | | — | | | | — | | | | 949 | | | | 949 | |
Other construction and land | | | — | | | | — | | | | 1,307 | | | | 1,307 | |
| | | | | | | | | | | | | | | | |
Total assets | | $ | — | | | $ | — | | | $ | 9,267 | | | $ | 9,267 | |
| | December 31, 2018 | |
| | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
| | (Dollars in thousands) | |
Collateral dependent impaired loans: | | | | | | | | | | | | | | | | |
One-to-four family residential | | $ | — | | | $ | — | | | $ | 845 | | | $ | 845 | |
Commercial real estate | | | — | | | | — | | | | 3,835 | | | | 3,835 | |
Home equity loans and lines of credit | | | — | | | | — | | | | 283 | | | | 283 | |
Other construction and land | | | — | | | | — | | | | 365 | | | | 365 | |
| | | | | | | | | | | | | | | | |
Real estate owned: | | | | | | | | | | | | | | | | |
One-to-four family residential | | | — | | | | — | | | | 228 | | | | 228 | |
Commercial real estate | | | — | | | | — | | | | 949 | | | | 949 | |
Other construction and land | | | — | | | | — | | | | 1,316 | | | | 1,316 | |
| | | | | | | | | | | | | | | | |
Total assets | | $ | — | | | $ | — | | | $ | 7,821 | | | $ | 7,821 | |
There were no liabilities measured at fair value on a nonrecurring basis as of March 31, 2019, or December 31, 2018.
Impaired loans totaling $4.2 million at March 31, 2019 and $5.6 million at December 31, 2018 were measured using the present value of expected future cash flows. These impaired loans were not deemed to be measured at fair value on a nonrecurring basis.
The following table provides information describing the unobservable inputs used in Level 3 fair value measurements at March 31, 2019.
| | Valuation Technique | | Unobservable Input | | General Range |
| | | | | | |
Impaired loans | | Discounted Appraisals | | Collateral discounts and estimated selling cost | | 0% - 30% |
Real estate owned | | Discounted Appraisals | | Collateral discounts and estimated selling cost | | 0% - 30% |
Corporate bonds | | Discounted Cash Flows | | Recent trade pricing | | 0% -10% |
Loan servicing rights | | Discounted Cash Flows | | Prepayment speed | | 9% - 20% |
| | | | Discount rate | | 10% - 14% |
Mortgage loans held for sale | | External pricing model | | Recent trade pricing | | 101% - 103% |
Mortgage derivatives | | External pricing model | | Pull-through rate | | 78%-100% |
SBIC | | Indicative value provided by fund | | Current operations and financial condition | | N/A |
Fair Value of Financial Assets and Financial Liabilities
The following table includes the estimated fair value of the Company's financial assets and financial liabilities at the dates indicated:
| | | | | Fair Value Measurements at March 31, 2019 | |
| | Carrying | | | | | | | | | | | | | |
(Dollars in thousands) | | Amount | | | Total | | | Level 1 | | | Level 2 | | | Level 3 | |
Assets: | | | | | | | | | | | | | | | | | | | | |
Cash and equivalents | | $ | 98,285 | | | $ | 98,285 | | | $ | 98,285 | | | $ | — | | | $ | — | |
Equity securities | | | 6,812 | | | | 6,812 | | | | 6,812 | | | | — | | | | — | |
Securities available for sale | | | 357,132 | | | | 357,132 | | | | 4,991 | | | | 351,648 | | | | 493 | |
Loans held for sale | | | 9,208 | | | | 9,885 | | | | — | | | | 6,615 | | | | 3,270 | |
Loans receivable, net | | | 1,079,837 | | | | 1,046,136 | | | | — | | | | — | | | | 1,046,552 | |
Other investments, at cost | | | 12,092 | | | | 12,092 | | | | — | | | | 12,092 | | | | — | |
Accrued interest receivable | | | 6,669 | | | | 6,669 | | | | — | | | | 6,669 | | | | — | |
BOLI | | | 32,087 | | | | 32,087 | | | | — | | | | 32,087 | | | | — | |
Loan servicing rights | | | 2,753 | | | | 2,753 | | | | — | | | | — | | | | 2,753 | |
Mortgage derivatives | | | 45 | | | | 45 | | | | — | | | | — | | | | 45 | |
Interest rate swaps | | | 260 | | | | 260 | | | | — | | | | 260 | | | | — | |
SBIC investments | | | 4,306 | | | | 4,306 | | | | — | | | | — | | | | 4,306 | |
| | | | | | | | | | | | | | | | | | | | |
Liabilities: | | | | | | | | | | | | | | | | | | | | |
Demand deposits | | $ | 833,913 | | | $ | 833,913 | | | $ | — | | | $ | 833,913 | | | $ | — | |
Time deposits | | | 412,306 | | | | 416,631 | | | | — | | | | — | | | | 416,631 | |
Federal Home Loan Bank advances | | | 213,500 | | | | 213,249 | | | | — | | | | 213,249 | | | | — | |
Junior subordinated debentures | | | 14,433 | | | | 13,720 | | | | — | | | | 13,720 | | | | — | |
Other borrowings | | | 9,385 | | | | 9,572 | | | | — | | | | 9,572 | | | | — | |
Accrued interest payable | | | 1,173 | | | | 1,173 | | | | — | | | | 1,173 | | | | — | |
Mortgage derivatives | | | 21 | | | | 21 | | | | — | | | | — | | | | 21 | |
Interest rate swaps | | | 861 | | | | 861 | | | | — | | | | 861 | | | | — | |
| | | | | Fair Value Measurements at December 31, 2018 | |
| | Carrying | | | | | | | | | | | | | |
(Dollars in thousands) | | Amount | | | Total | | | Level 1 | | | Level 2 | | | Level 3 | |
Assets: | | | | | | | | | | | | | | | | | | | | |
Cash and equivalents | | $ | 69,119 | | | $ | 69,119 | | | $ | 69,119 | | | $ | — | | | $ | — | |
Equity securities | | | 6,178 | | | | 6,178 | | | | 6,178 | | | | — | | | | — | |
Securities available for sale | | | 359,739 | | | | 359,739 | | | | 4,949 | | | | 354,297 | | | | 493 | |
Loans held for sale | | | 7,570 | | | | 8,114 | | | | — | | | | 5,683 | | | | 2,431 | |
Loans receivable, net | | | 1,076,069 | | | | 1,046,136 | | | | — | | | | — | | | | 1,046,136 | |
Other investments, at cost | | | 12,039 | | | | 12,039 | | | | — | | | | 12,039 | | | | — | |
Accrued interest receivable | | | 6,443 | | | | 6,443 | | | | — | | | | 6,443 | | | | — | |
BOLI | | | 32,886 | | | | 32,886 | | | | — | | | | 32,886 | | | | — | |
Loan servicing rights | | | 2,837 | | | | 2,837 | | | | — | | | | — | | | | 2,837 | |
Mortgage derivatives | | | 34 | | | | 34 | | | | — | | | | — | | | | 34 | |
Interest rate swaps | | | 354 | | | | 354 | | | | — | | | | 354 | | | | — | |
SBIC investments | | | 3,839 | | | | 3,839 | | | | — | | | | — | | | | 3,839 | |
| | | | | | | | | | | | | | | | | | | | |
Liabilities: | | | | | | | | | | | | | | | | | | | | |
Demand deposits | | $ | 800,291 | | | $ | 800,291 | | | $ | — | | | $ | 800,291 | | | $ | — | |
Time deposits | | | 420,949 | | | | 424,054 | | | | — | | | | — | | | | 424,054 | |
Federal Home Loan Bank advances | | | 213,500 | | | | 213,513 | | | | — | | | | 213,513 | | | | — | |
Junior subordinated debentures | | | 14,433 | | | | 12,440 | | | | — | | | | 12,440 | | | | — | |
Other borrowings | | | 9,299 | | | | 9,253 | | | | — | | | | 9,253 | | | | — | |
Accrued interest payable | | | 1,647 | | | | 1,647 | | | | — | | | | 1,647 | | | | — | |
Mortgage derivatives | | | 22 | | | | 22 | | | | — | | | | — | | | | 22 | |
Interest rate swaps | | | 462 | | | | 462 | | | | — | | | | 462 | | | | — | |
NOTE 14. Leases
As of January 1, 2019, we adopted certain accounting standard updates related to accounting for leases (Topic 842 -Leases), primarily ASU 2016-02 and subsequent updates. These updates require lessees to recognize a lease liability, measured on a discounted basis, related to the lessee's obligation to make lease payments arising under a lease contract; and a right-of-use asset related to the lessee’s right to use, or control the use of, a specified asset for the lease term. We adopted the updates using a modified-retrospective transition approach and recognized a right-of-use lease asset and related lease liabilities totaling $0.5 million as of January 1, 2019. At adoption, we elected to apply certain practical adoption expedients provided under the updates whereby we did not reassess (i) whether any expired or existing contracts are or contain leases, (ii) the lease classification for any expired or existing leases and (iii) initial direct costs for any existing leases. As of March 31, 2019, the right-of-use lease asset, included in other assets, and related lease liabilities, included in other liabilities, totaled $0.4 million.
We lease certain office facilities and office equipment under operating leases. The lease agreements have maturity dates ranging from March 2020 to May 2027, one of which includes an option for a five-year extension. The weighted average remaining life of the lease term for these leases was 6.82 years as of March 31, 2019. We do not apply the recognition requirements of Topic 842 -Leasesto short-term operating leases. A short-term operating lease has an original term of 12 months or less and does not have a purchase option that is likely to be exercised. For non-short-term operating leases, we recognized lease right-of-use assets and related lease liabilities on our balance sheet upon commencement of the lease in accordance with Topic 842 -Leases. In recognizing lease right-of-use assets and related lease liabilities, we account for lease and non-lease components (such as taxes, insurance, and common area maintenance costs) separately as such amounts are generally readily determinable under our lease contracts. Lease payments over the expected term are discounted using our incremental borrowing rate referenced to the Federal Home Loan Bank Secure Connect advance rates for borrowings of similar term. The weighted average discount rate for leases was 3.04% as of March 31, 2019. We also consider renewal and termination options in the determination of the term of the lease. If it is reasonably certain that a renewal or termination option will be exercised, the effects of such options are included in the determination of the expected lease term. Generally, we cannot be reasonably certain about whether or not we will renew a lease until such time the lease is within the last two years of the existing lease term. When we are reasonably certain that a renewal option will be exercised, we measure/remeasure the right-of-use asset and related lease liability using the lease payments specified for the renewal period.
Maturities of lease liabilities as of March 31, 2019 were as follows:
(Dollard in thousands) | | Operating Leases | |
2019 | | $ | 107 | |
2020 | | | 69 | |
2021 | | | 53 | |
2022 | | | 53 | |
2023 | | | 53 | |
Thereafter | | | 177 | |
Total undiscounted lease payments | | | 512 | |
Discount effect of cash flows | | | (68 | ) |
Total lease liability | | $ | 444 | |
The total operating lease costs were $56,000 for the three months ended March 31, 2019.
NOTE 15. Subsequent Events
On April 23, 2019, Entegra entered into a definitive agreement (the “Merger Agreement”) to merge with and into First Citizens BancShares, Inc., a North Carolina corporation (“BancShares”). Under the terms of the Merger Agreement, each outstanding share of Entegra common stock would be converted into the right to receive $30.18 in cash.
Previously on January 15, 2019, Entegra had entered into a definitive agreement to merge with and into SmartFinancial, Inc. (“SmartFinancial”), a Tennessee corporation. Under the terms of the SmartFinancial definitive agreement, each outstanding share of Entegra common stock would be converted into the right to receive 1.215 shares of SmartFinancial common stock.
On April 18, 2019, Entegra notified SmartFinancial that it had received a proposal from BancShares and certain affiliates containing the Merger Agreement described above and that the Entegra board of directors had concluded that such proposal constituted a Superior Proposal (as defined in the SmartFinancial definitive agreement). On April 23, 2019, SmartFinancial delivered a notice to Entegra waiving its rights to renegotiate its agreement with Entegra, subject to Entegra’s compliance with the SmartFinancial Merger Agreement and the payment of the termination fee due to SmartFinancial simultaneously with the termination of the SmartFinancial definitive agreement.
On April 23, 2019, in connection with the termination by Entegra of the SmartFinancial definitive agreement, BancShares, on behalf of Entegra, paid SmartFinancial a termination fee of $6.4 million as required by the terms of the SmartFinancial definitive agreement, and the SmartFinancial definitive agreement was terminated.
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q (this “Form 10-Q”) contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may” and words of similar meaning. These forward-looking statements include, but are not limited to:
| · | statements of our goals, intentions and expectations; |
| · | statements regarding our business plans, prospects, growth and operating strategies; |
| · | statements regarding the asset quality of our loan and investment portfolios; and |
| · | estimates of our risks and future costs and benefits. |
These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. The Company is under no duty to and does not undertake any obligation to update any forward-looking statements after the date of this Form 10-Q except as required by law.
The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:
| · | The proposed merger with First Citizens BancShares, Inc. (“BancShares”) may distract the management of the Company from its other responsibilities; |
| · | We may not be able to implement aspects of our growth strategy; |
| · | Failure to complete the merger with BancShares could negatively impact our stock prices, future business and financial results; |
| · | The Company will be subject to business uncertainties and contractual restrictions while the merger is pending; |
| · | Future expansion involves risks; |
| · | New bank office facilities and other facilities may not be profitable; |
| · | Acquisition of assets and assumption of liabilities may expose us to intangible asset risk, which could impact our results of operations and financial condition; |
| · | The success of our growth strategy depends on our ability to identify and retain individuals with experience and relationships in the markets in which we intend to expand; |
| · | We may not be able to utilize all of our deferred tax asset; |
| · | We may need additional access to capital, which we may be unable to obtain on attractive terms or at all; |
| · | Our estimate for losses in our loan portfolio may be inadequate, which would cause our results of operations and financial condition to be adversely affected; |
| · | Our commercial real estate loans generally carry greater credit risk than one-to-four family residential mortgage loans; |
| · | Our concentration of construction financing may expose us to a greater risk of loss and impair our earnings and profitability; |
| · | Repayment of our commercial business loans is primarily dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value; |
| · | Our level of home equity loans and lines of credit lending may expose us to increased credit risk; |
| · | We continue to hold and acquire other real estate, which has led to operating expenses and vulnerability to additional declines in real property values; |
| · | A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate market could adversely affect business, results of operations, financial condition and the value of our common stock; |
| · | Concentration of collateral in our primary market area may increase the risk of increased non-performing assets; |
| · | Income from secondary mortgage market operations is volatile, and we may incur losses with respect to our secondary mortgage market operations that could negatively affect our earnings; |
| · | We rely on the mortgage secondary market for some of our liquidity; |
| · | Future changes in interest rates could reduce our profits; |
| · | Strong competition within our market areas may limit our growth and profitability; |
| · | We may not be able to compete with larger competitors for larger customers because our lending limits are lower than our competitors; |
| · | We depend on our executive management team to implement our business strategy and execute successful operations and we could be harmed by the loss of their services; |
| · | The fair value of our investments could decline; |
| · | Liquidity risk could impair our ability to fund operations and jeopardize our financial condition, results of operations and cash flows; |
| · | Changes in accounting standards could affect reported earnings; |
| · | We are subject to environmental liability risk associated with our lending activities; |
| · | A failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers or other third parties, including as a result of cyber-attacks, could disrupt our businesses, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs, and cause losses; |
| · | We are party to various lawsuits incidental to our business. Litigation is subject to many uncertainties such that the expenses and ultimate exposure with respect to many of these matters cannot be ascertained; |
| · | Our stock-based benefit plan will increase our costs, which will reduce our income; |
| · | Negative public opinion surrounding the Company and the financial institutions industry generally could damage our reputation and adversely impact our earnings; |
| · | Severe weather, natural disasters, acts of war or terrorism, and other external events could significantly impact our business; |
| · | We are subject to extensive regulation and oversight, and, depending upon the findings and determinations of our regulatory authorities, we may be required to make adjustments to our business, operations or financial position and could become subject to formal or informal regulatory action; |
| · | Financial reform legislation enacted by Congress and resulting regulations have increased and are expected to continue to increase our costs of operations; |
| · | We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations; |
| · | As a regulated entity, we and the Bank must maintain certain required levels of regulatory capital that may limit our and the Bank’s operations and potential growth; |
| · | Many of our new activities and expansion plans require regulatory approvals, and failure to obtain them may restrict our growth; |
| · | The Federal Reserve may require the Company to commit capital resources to support the Bank; |
| · | Our stock price may be volatile, which could result in losses to our shareholders and litigation against us; |
| · | The trading volume in our common stock is lower than that of other larger companies; future sales of our stock by our shareholders or the perception that those sales could occur may cause our stock price to decline; |
| · | There may be future sales of our common stock or preferredstock or other dilution of our equity, which may adversely affect the market price of our common stock; |
| · | The implementation of stock-based benefit plans may dilute your ownership interest; and |
| · | We may issue additional debt and equity securities or securities convertible into equity securities, any of which may be senior to our common stock as to distributions and in the event of liquidation, which could negatively affect the value of our common stock. |
For additional information with respect to factors that could cause actual results to differ from the expectations stated in the forward-looking statements, see “Risk Factors” under Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the Securities and Exchange Commission (the “SEC”) on March 14, 2019 (the “2018 Form 10-K”).
Critical Accounting Policies and Estimates
Our critical accounting policies involving significant judgments and assumptions used in the preparation of the Consolidated Financial Statements as of March 31, 2019 have remained unchanged from the disclosures presented in our 2018 Form 10-K. Refer to Note 1 of this Form 10-Q for more information about our accounting policies and recent accounting updates.
Overview
Entegra Financial Corp. was incorporated on May 31, 2011 to be the holding company for Entegra Bank (the “Bank”) upon the completion of Macon Bancorp’s merger with and into Entegra Financial Corp., pursuant to which Macon Bancorp converted from a mutual to stock form of organization. Prior to the completion of the conversion, Entegra Financial Corp. did not engage in any significant activities other than organizational activities. On September 30, 2014, the mutual to stock conversion was completed and the Bank became the wholly owned subsidiary of Entegra Financial Corp. Also on September 30, 2014, Entegra Financial Corp. completed the initial public offering of its common stock. In this Management’s Discussion and Analysis of Financial Condition and Results of Operations section (the “MD&A”), terms such as “we,” “us,” “our” and the “Company” refer to Entegra Financial Corp.
We provide a full range of financial services through offices located throughout the western North Carolina counties of Buncombe, Cherokee, Haywood, Henderson, Jackson, Macon, Polk, and Transylvania, the Upstate South Carolina counties of Anderson, Greenville, Pickens, and Spartanburg and the northern Georgia counties of Gwinnett, Hall and Pickens. We provide full service retail and commercial banking products, as well as wealth management services through a third party.
We earn revenue primarily from interest on loans and securities and fees charged for financial services provided to our customers. Offsetting these revenues are the cost of deposits and other funding sources, provisions for loan losses and other operating costs such as salaries and employee benefits, data processing, occupancy and tax expense.
Our results of operations are significantly affected by general economic and competitive conditions in our market areas and nationally, as well as changes in interest rates, sources of funding, government policies and actions of regulatory authorities. Future changes in applicable laws, regulations or government policies may materially affect our financial condition and results of operations.
The following discussion and analysis is presented on a consolidated basis and focuses on the major components of the Company’s operations and significant changes in its results of operations for the periods presented. We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information included in this Form 10-Q and in our 2018 Form 10-K.
Recent Developments
On April 23, 2019, Entegra entered into a definitive agreement to merge with and into BancShares (the “Merger Agreement”). Under the terms of the Merger Agreement, each outstanding share of Entegra common stock would be converted into the right to receive $30.18 in cash.
Previously on January 15, 2019, Entegra had entered into a definitive agreement to merge with and into SmartFinancial, Inc. (“SmartFinancial”), a Tennessee corporation. Under the terms of the SmartFinancial definitive agreement, each outstanding share of Entegra common stock would be converted into the right to receive 1.215 shares of SmartFinancial common stock.
On April 18, 2019, Entegra notified SmartFinancial that it had received a proposal from BancShares and certain affiliates containing the Merger Agreement described above and that the Entegra board of directors had concluded that such proposal constituted a Superior Proposal (as defined in the SmartFinancial definitive agreement). On April 23, 2019, SmartFinancial delivered a notice to Entegra waiving its rights to renegotiate its agreement with Entegra, subject to Entegra’s compliance with the SmartFinancial definitive agreement and the payment of the termination fee due to SmartFinancial simultaneously with the termination of the SmartFinancial definitive agreement.
On April 23, 2019, in connection with the termination by Entegra of the SmartFinancial definitive agreement, BancShares, on behalf of Entegra, paid SmartFinancial a termination fee of $6.4 million as required by the terms of the SmartFinancial definitive agreement, and the SmartFinancial definitive agreement was terminated.
Earnings Summary
Net income for the three months ended March 31, 2019 was $3.8 million compared to $3.6 million for the same period in 2018. The increase in net income for the three months ended March 31, 2019 was primarily the result of increases in noninterest income of $2.3 million, partially offset by a decrease in net interest income of $0.4 million and an increase in noninterest expense of $1.6 million.
Net interest income decreased $0.4 million, or 3.59%, to $12.0 million for the three months ended March 31, 2019 compared to $12.4 million for the same period in 2018. The decrease in net interest income was primarily due to increased costs of deposits and borrowings, partially offset by higher volumes in the loan portfolio as well as an increase in the yields earned on cash and taxable investments. Net interest margin on a tax-equivalent basis was 3.23% for the three months ended March 31, 2019 compared to 3.49% for the same period in 2018.
Noninterest income increased $2.3 million, or 161.4%, to $3.74 million for the three months ended March 31, 2019 compared to $1.4 million for the same period in 2018, primarily as the result of a definitive agreement to settle an acquisition-related dispute for $1.75 million and an increase of $0.5 million in equity security gains.
Noninterest expense increased $1.6 million, or 17.7%, to $10.7 million for the three months ended March 31, 2019 compared to $9.1 million for the same period in 2018. The increase was primarily related to increased compensation and employee benefits and merger-related expenses, partially offset by reduced Federal deposit insurance premiums.
Non-GAAP Financial Measures
Statements included in this MD&A include financial measures that do not conform to U.S. generally accepted accounting principles (“GAAP”) and should be read along with the accompanying tables, which provide a reconciliation of non-GAAP financial measures to GAAP financial measures. This MD&A and the accompanying tables discuss non-GAAP financial measures, such as core noninterest expense, core net income, core return on average assets, core return on tangible average equity, and core efficiency ratio. We believe that such non-GAAP measures are useful because they enhance the ability of investors and management to evaluate and compare the Company’s operating results from period to period in a meaningful manner. Non-GAAP measures should not be considered as an alternative to any measure of performance as promulgated under GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. Investors should consider the Company’s performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the Company. Non-GAAP measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of the Company’s results or financial condition as reported under GAAP.
We analyze our noninterest expense and net income on a non-GAAP basis as detailed and as of the periods indicated in the table below:
| | Three Months Ended March 31, | |
(Dollars in thousands, except per share data) | | 2019 | | | 2018 | |
| | | | | | | | |
Adjusted Noninterest Expense | | | | | | | | |
Noninterest expense (GAAP) | | $ | 10,738 | | | $ | 9,123 | |
Merger-related expenses | | | (1,350 | ) | | | (196 | ) |
Adjusted noninterest expense (Non-GAAP) | | $ | 9,388 | | | $ | 8,927 | |
| | | | | | | | |
Adjusted Net Income | | | | | | | | |
Net income (GAAP) | | $ | 3,815 | | | $ | 3,582 | |
Loss (gain) on sale of investments | | | — | | | | 9 | |
Equity securities (gains) losses | | | (330 | ) | | | 42 | |
Legal settlement | | | (1,383 | ) | | | — | |
Merger-related expenses | | | 1,067 | | | | 155 | |
Adjusted net income (Non-GAAP) | | $ | 3,169 | | | $ | 3,788 | |
| | | | | | | | |
Adjusted Diluted Earnings Per Share | | | | | | | | |
Diluted earnings per share (GAAP) | | $ | 0.55 | | | $ | 0.51 | |
Loss (gain) on sale of investments | | | — | | | | — | |
Equity securities (gains) losses | | | (0.05 | ) | | | 0.01 | |
Legal settlement | | | (0.20 | ) | | | — | |
Merger-related expenses | | | 0.16 | | | | 0.02 | |
Adjusted diluted earnings per share (Non-GAAP) | | $ | 0.46 | | | $ | 0.54 | |
| | | | | | | | |
Adjusted Return on Average Assets | | | | | | | | |
Return on Average Assets (GAAP) | | | 0.92 | % | | | 0.90 | % |
Loss (gain) on sale of investments | | | 0.00 | % | | | 0.00 | % |
Equity securities (gains) losses | | | -0.08 | % | | | 0.01 | % |
Legal settlement | | | -0.33 | % | | | 0.00 | % |
Merger-related expenses | | | 0.26 | % | | | 0.04 | % |
Adjusted Return on Average Assets (Non-GAAP) | | | 0.77 | % | | | 0.95 | % |
| | | | | | | | |
Adjusted Return on Tangible Average Equity | | | | | | | | |
Return on Average Equity (GAAP) | | | 9.26 | % | | | 9.48 | % |
Loss (gain) on sale of investments | | | 0.00 | % | | | 0.03 | % |
Equity securities (gains) losses | | | -0.80 | % | | | 0.11 | % |
Legal settlement | | | -3.36 | % | | | 0.00 | % |
Merger-related expenses | | | 2.59 | % | | | 0.41 | % |
Effect of goodwill and intangibles | | | 1.54 | % | | | 2.26 | % |
Adjusted Return on Average Tangible Equity (Non-GAAP) | | | 9.23 | % | | | 12.29 | % |
| | | | | | | | |
Adjusted Efficiency Ratio | | | | | | | | |
Efficiency ratio (GAAP) | | | 68.59 | % | | | 66.07 | % |
Gain (loss) on sale of investments | | | 0.00 | % | | | -0.06 | % |
Equity securities gains (losses) | | | 1.88 | % | | | -0.25 | % |
Legal settlement | | | 8.63 | % | | | 0.00 | % |
Merger-related expenses | | | -9.49 | % | | | -1.40 | % |
Adjusted Efficiency Ratio (Non-GAAP) | | | 69.61 | % | | | 64.36 | % |
| | | |
| | As Of | |
| | March 31, 2019 | | | December 31, 2018 | |
| | (Dollars in thousands, except share data) | |
Tangible Assets | | | | | | | | |
Total Assets | | $ | 1,669,151 | | | $ | 1,636,441 | |
Goodwill and Intangibles | | | (27,307 | ) | | | (27,480 | ) |
Tangible Assets | | $ | 1,641,844 | | | $ | 1,608,961 | |
| | | | | | | | |
Tangible Book Value Per Share | | | | | | | | |
Book Value (GAAP) | | $ | 170,925 | | | $ | 162,872 | |
Goodwill and intangibles | | | (27,307 | ) | | | (27,480 | ) |
Book Value (Tangible) | | $ | 143,618 | | | $ | 135,392 | |
Outstanding shares | | | 6,919,212 | | | | 6,917,703 | |
Tangible Book Value Per Share | | $ | 20.76 | | | $ | 19.57 | |
Financial Condition at March 31, 2019 and December 31, 2018
Total assets increased $32.7 million, or 2.0%, to $1.67 billion at March 31, 2019 from $1.64 billion at December 31, 2018. This increase in assets was primarily due to increases in cash and cash equivalents of $29.2 million, from $69.1 million at December 31, 2018 to $98.3 million at March 31, 2019, and loans, which increased $3.8 million for the three months ended March 31, 2019, or an annualized rate or 1.4%. Core deposits increased $33.6 million, or 4.2%, to $828.9 million at March 31, 2019 from $795.3 million at December 31, 2018. Core deposits represented 67% of the Company’s deposit portfolio at March 31, 2019 compared to 65% at December 31, 2018.
Total liabilities increased $24.7 million, or 1.7%, to $1.49 billion at March 31, 2019 from $1.47 billion at December 31, 2018, due primarily to the $25.0 million increase in total deposits, partially offset by the $0.5 million decrease in accrued interest payable.
Total shareholders’ equity increased $8.0 million to $170.9 million at March 31, 2019 compared to $162.9 million at December 31, 2018. This increase was primarily attributable to $3.8 million of net income and $4.0 million of after-tax increase in market value of investment securities available for sale. Tangible book value per share, a non-GAAP measure, increased $1.19 to $20.76 at March 31, 2019 from $19.57 at December 31, 2018.
Cash and Cash Equivalents
Total cash and cash equivalents increased $29.2 million to $98.3 million at March 31, 2019 from $69.1 million at December 31, 2018, primarily as a result of proposed merger-related restrictions which limited the use of excess cash.
Investment Securities
The following table presents the holdings of our equity securities as of March 31, 2019 and December 31, 2018:
| | March 31, 2019 | | | December 31, 2018 | |
| | (Dollars in thousands) | |
| | | | | | |
Mutual funds | | $ | 6,812 | | | $ | 6,178 | |
Equity securities with a fair value of $6.2 million as of March 31, 2019 and $5.6 million as of December 31, 2018 are held in a Rabbi Trust and seek to generate returns that will fund the cost of certain deferred compensation agreements.
Equity securities with a fair value of $0.6 million as of both March 31, 2019 and December 31, 2018 are in a mutual fund that qualifies under the Community Reinvestment Act (“CRA”) as CRA activity.
The remainder of our investment securities portfolio is classified as available-for-sale (“AFS”) and is carried at fair value. The following table shows the amortized cost and fair value for our AFS investment portfolio as of the dates indicated.
| | March 31, 2019 | | | December 31, 2018 | |
| | | | | Estimated | | | | | | Estimated | |
| | Amortized | | | Fair | | | Amortized | | | Fair | |
(Dollars in thousands) | | Cost | | | Value | | | Cost | | | Value | |
| | | | | | | | | | | | |
U.S. Treasury & Government Agencies | | $ | 33,918 | | | $ | 33,822 | | | $ | 34,068 | | | $ | 33,990 | |
Municipal Securities | | | 115,467 | | | | 117,479 | | | | 115,860 | | | | 114,402 | |
Mortgage-backed Securities - Guaranteed | | | 82,467 | | | | 81,526 | | | | 86,664 | | | | 85,184 | |
Collateralized Mortgage Obligations - Guaranteed | | | 22,194 | | | | 21,905 | | | | 22,492 | | | | 21,889 | |
Collateralized Mortgage Obligations - Non Guaranteed | | | 66,842 | | | | 67,139 | | | | 69,774 | | | | 69,171 | |
Collateralized Loan Obligations | | | 15,524 | | | | 15,212 | | | | 15,534 | | | | 15,077 | |
Corporate bonds | | | 19,920 | | | | 20,049 | | | | 19,936 | | | | 20,025 | |
| | $ | 356,332 | | | $ | 357,132 | | | $ | 364,328 | | | $ | 359,738 | |
AFS investment securities decreased $2.6 million to $357.1 million at March 31, 2019 from $359.7 million at December 31, 2018. We continue to monitor and decrease our investment portfolio as we continue to build our loan portfolio.
Loans
The following table presents our loan portfolio composition and the corresponding percentage of total loans as of the dates indicated. Other construction and land loans include residential acquisition and development loans, commercial undeveloped land and one-to-four family improved and unimproved lots. Commercial real estate includes non-residential owner occupied and non-owner occupied real estate, multi-family, and owner-occupied investment property. Commercial business loans include unsecured commercial loans and commercial loans secured by business assets.
| | March 31, | | | December 31, | |
| | 2019 | | | 2018 | |
| | Amount | | | Percent | | | Amount | | | Percent | |
| | (Dollars in thousands) | |
Real estate loans: | | | | | | | | | | | | | | | | |
One-to-four family residential | | $ | 328,779 | | | | 30.4 | % | | $ | 325,560 | | | | 30.2 | % |
Commercial | | | 500,600 | | | | 46.3 | | | | 498,106 | | | | 46.2 | |
Home equity loans and lines of credit | | | 47,665 | | | | 4.4 | | | | 48,679 | | | | 4.5 | |
Residential construction | | | 46,622 | | | | 4.3 | | | | 39,533 | | | | 3.7 | |
Other construction and land | | | 99,462 | | | | 9.2 | | | | 104,645 | | | | 9.7 | |
Commercial | | | 51,562 | | | | 4.8 | | | | 54,410 | | | | 5.1 | |
Consumer | | | 6,494 | | | | 0.6 | | | | 6,842 | | | | 0.6 | |
Total loans, gross | | $ | 1,081,184 | | | | 100.0 | % | | $ | 1,077,775 | | | | 100.0 | % |
| | | | | | | | | | | | | | | | |
Less: | | | | | | | | | | | | | | | | |
Deferred loan fees, net | | | (1,046 | ) | | | | | | | (1,000 | ) | | | | |
Fair value discount | | | (915 | ) | | | | | | | (1,048 | ) | | | | |
Hedged loans basis adjustment | | | 503 | | | | | | | | 245 | | | | | |
Unamortized premium | | | 319 | | | | | | | | 333 | | | | | |
Unamortized discount | | | (208 | ) | | | | | | | (236 | ) | | | | |
| | | | | | | | | | | | | | | | |
Total loans, net | | $ | 1,079,837 | | | | | | | $ | 1,076,069 | | | | | |
| | | | | | | | | | | | | | | | |
Percentage of total assets | | | 64.7 | % | | | | | | | 65.8 | % | | | | |
Netloans increased $3.8 million, or an annualized rate of 1.4%, to $1.08 billion at March 31, 2019. Most of our loan growth is concentrated in one-to-four family residential and commercial real estate with increases of $3.2 million, or 1.0%, and $2.5 million, or 0.5%, respectively, as compared to relative balances at December 31, 2018. We believe that economic conditions in our primary market areas are favorable and present opportunities for continued growth.
Delinquent Loans
When a loan becomes 15 days past due, we contact the borrower to inquire as to the status of the loan payment. When a loan becomes 30 days or more past due, we increase collection efforts to include all available forms of communication. Once a loan becomes 45 days past due, we generally issue a demand letter and further explore the reasons for non-repayment, discuss repayment options, and inspect the collateral. In the event the loan officer or collections staff has reason to believe restructuring will be mutually beneficial to the borrower and the Bank, the borrower will be referred to the Bank’s Credit Administration staff to explore restructuring alternatives to foreclosure. Once the demand period has expired and it has been determined that restructuring is not a viable option, the Bank’s counsel is instructed to pursue foreclosure.
The accrual of interest on loans is discontinued at the time a loan becomes 90 days delinquent or when it becomes impaired, whichever occurs first, unless the loan is well secured and in the process of collection. All interest accrued but not collected for loans that are placed on nonaccrual is reversed. Interest payments received on nonaccrual loans are generally applied as a direct reduction to the principal outstanding until the loan is returned to accrual status. Interest payments received on nonaccrual loans may be recognized as income on a cash basis if recovery of the remaining principal is reasonably assured. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Interest payments applied to principal while the loan was on nonaccrual may be recognized in income over the remaining life of the loan after the loan is returned to accrual status.
If a loan is modified in a troubled debt restructuring (“TDR”), the loan is generally placed on non-accrual until there is a period of satisfactory payment performance by the borrower (either immediately before or after the restructuring), generally six consecutive months, and the ultimate collectability of all amounts contractually due is not in doubt.
The following table sets forth certain information with respect to our loan portfolio carrying balances of delinquencies at the dates indicated. We have no loans past due 90 days and over that are still accruing interest as of March 31, 2019 or December 31, 2018.
| | Delinquent loans | |
| | 30-59 Days | | | 60-89 Days | | | 90 Days and over | | | Total | |
| | (Dollars in thousands) | |
March 31, 2019 | | | | | | | | | | | | | | | | |
Real estate loans: | | | | | | | | | | | | | | | | |
One-to-four family residential | | $ | 4,364 | | | $ | — | | | $ | 251 | | | $ | 4,615 | |
Commercial | | | 4,291 | | | | 119 | | | | 1,515 | | | | 5,925 | |
Home equity loans and lines of credit | | | 159 | | | | — | | | | 343 | | | | 502 | |
Residential construction | | | 350 | | | | — | | | | 1 | | | | 351 | |
Other construction and land | | | 129 | | | | — | | | | 64 | | | | 193 | |
Commercial | | | 283 | | | | — | | | | 62 | | | | 345 | |
Consumer | | | 35 | | | | 3 | | | | 1 | | | | 39 | |
Total delinquent loans | | $ | 9,611 | | | $ | 122 | | | $ | 2,237 | | | $ | 11,970 | |
% of total loans, net | | | 0.89 | % | | | 0.01 | % | | | 0.21 | % | | | 1.11 | % |
| | | | | | | | | | | | | | | | |
December 31, 2018 | | | | | | | | | | | | | | | | |
Real estate loans: | | | | | | | | | | | | | | | | |
One-to-four family residential | | $ | 3,562 | | | $ | 1,317 | | | $ | 84 | | | $ | 4,963 | |
Commercial | | | 2,615 | | | | — | | | | 1,782 | | | | 4,397 | |
Home equity loans and lines of credit | | | 400 | | | | 457 | | | | 73 | | | | 930 | |
One- to four-family residential construction | | | — | | | | — | | | | 1 | | | | 1 | |
Other construction and land | | | 613 | | | | 32 | | | | 64 | | | | 709 | |
Commercial | | | 307 | | | | 25 | | | | 121 | | | | 453 | |
Consumer | | | 27 | | | | 4 | | | | — | | | | 31 | |
Total delinquent loans | | $ | 7,524 | | | $ | 1,835 | | | $ | 2,125 | | | $ | 11,484 | |
% of total loans, net | | | 0.70 | % | | | 0.17 | % | | | 0.20 | % | | | 1.07 | % |
Delinquent loans increased $0.5 million to $12.0 million at March 31, 2019 from $11.5 million at December 31, 2018. The increase in 30-59 days delinquencies of $2.1 million, or 27.7%, from December 31, 2018 is concentrated primarily in one-to-four residential and commercial real estate loans. We continue to focus on collection efforts and favorable resolutions.
Non-Performing Assets
Non-performing loans include all loans past due 90 days and over, certain impaired loans (some of which may be contractually current), and TDR loans that have not yet established a satisfactory period of payment performance (some of which may be contractually current). Non-performing assets include non-performing loans and real estate owned (“REO”). The table below sets forth the amounts and categories of our non-performing assets at the dates indicated.
| | March 31 | | | December 31, | |
| | 2019 | | | 2018 | |
| | (Dollars in thousands) | |
Non-accrual loans: | | | | | | | | |
Real estate loans: | | | | | | | | |
One-to-four family residential | | $ | 1,394 | | | $ | 1,037 | |
Commercial | | | 2,854 | | | | 3,266 | |
Home equity loans and lines of credit | | | 343 | | | | 178 | |
Residential construction | | | 1 | | | | — | |
Other construction and land | | | 251 | | | | 256 | |
Commercial | | | 62 | | | | 120 | |
Consumer | | | 1 | | | | — | |
| | | | | | | | |
Total non-performing loans | | | 4,906 | | | | 4,857 | |
| | | | | | | | |
REO: | | | | | | | | |
One-to-four family residential | | | — | | | | 228 | |
Commercial real estate | | | 949 | | | | 949 | |
Other construction and land | | | 1,307 | | | | 1,316 | |
| | | | | | | | |
Total foreclosed real estate | | | 2,256 | | | | 2,493 | |
| | | | | | | | |
Total non-performing assets | | $ | 7,162 | | | $ | 7,350 | |
| | | | | | | | |
Troubled debt restructurings still accruing | | $ | 7,804 | | | $ | 7,588 | |
| | | | | | | | |
Ratios: | | | | | | | | |
Non-performing loans to total loans | | | 0.45 | % | | | 0.45 | % |
Non-performing assets to total assets | | | 0.43 | % | | | 0.45 | % |
Non-performing loans to total loans was 0.45% at both March 31, 2019 and December 31, 2018. Non-performing assets to total assets declined to 0.43% at March 31, 2019 from 0.45% at December 31, 2018.
REO decreased $0.2 million, or 9.5%, to $2.3 million at March 31, 2019 from $2.5 million at December 31, 2018 due to the sale of the remaining one-to-four residential property.
Classification of Loans
The following table sets forth amounts of classified and criticized loans at the dates indicated. As indicated in the table, loans classified as “doubtful” or “loss” are charged off immediately.
| | March 31, | | | December 31, | |
| | 2019 | | | 2018 | |
| | (Dollars in thousands) | |
| | | | | | |
Classified loans: | | | | | | | | |
Substandard | | $ | 8,155 | | | $ | 8,169 | |
Doubtful | | | — | | | | — | |
Loss | | | — | | | | — | |
| | | | | | | | |
Total classified loans: | | | 8,155 | | | | 8,169 | |
As a % of total loans, net | | | 0.76 | % | | | 0.76 | % |
| | | | | | | | |
Special mention | | | 10,262 | | | | 9,987 | |
| | | | | | | | |
Total criticized loans | | $ | 18,417 | | | $ | 18,156 | |
As a % of total loans, net | | | 1.71 | % | | | 1.68 | % |
Total classified loans to total loans was 0.76% at both March 31, 2019 and December 31, 2018. Total criticized loans to total loans increased slightly to 1.71% at March 31, 2019 from 1.68% at December 31, 2018. Management continues to dedicate resources to monitoring and resolving classified and criticized loans.
Allowance for Loan Losses
The allowance for loan losses reflects our estimates of probable losses inherent in our loan portfolio at the balance sheet date. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of our loans in light of historical experience, the nature and volume of our loan portfolio, adverse situations that may affect our borrowers’ abilities to repay, the estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The methodology for determining the allowance for loan losses has two main components: the evaluation of individual loans for impairment and the evaluation of certain groups of homogeneous loans with similar risk characteristics.
A loan is considered impaired when it is probable that we will be unable to collect all principal and interest payments due according to the original contractual terms of the loan. We individually evaluate loans classified as “substandard” or nonaccrual and greater than $350,000 for impairment. If the impaired loan is considered collateral dependent, a charge-off is taken based upon the appraised value of the property less an estimate of selling costs if foreclosure or sale of the property is anticipated. If the impaired loan is not collateral dependent, a specific reserve is established based upon an estimate of the future discounted cash flows after consideration of modifications and the likelihood of future default and prepayment.
The allowance for homogenous loans consists of a base loss reserve and a qualitative reserve. The base loss reserve utilizes an average loss rate for the last 16 quarters. The loss rates for the base loss reserve are segmented into 13 loan categories and contain loss rates ranging from approximately 0.50% to 1.36%.
The qualitative reserve adjusts the weighted average loss rates utilized in the base loss reserve for trends in the following internal and external factors:
| · | | non-accrual and classified loans; |
| · | | economic conditions – including unemployment rates, home sales and prices, and a regional economic index; and |
| · | | lender risk – personnel changes. |
Qualitative reserve adjustment factors are decreased for favorable trends and increased for unfavorable trends. These factors are subject to further adjustment as economic and other conditions change.
The following table sets forth activity in our allowance for loan losses at the dates and for the periods indicated.
| | As of or for the Three Months Ended March 31, | |
| | 2019 | | | 2018 | |
| | (Dollars in thousands) | |
Balance at beginning of period | | $ | 11,985 | | | $ | 10,887 | |
| | | | | | | | |
Charge-offs: | | | | | | | | |
Real Estate: | | | | | | | | |
One- to four-family residential | | | 4 | | | | 110 | |
Commercial | | | — | | | | 35 | |
Home equity loans and lines of credit | | | 209 | | | | 41 | |
Residential construction | | | — | | | | — | |
Other construction and land | | | — | | | | — | |
Commercial | | | 59 | | | | — | |
Consumer | | | 26 | | | | 29 | |
Total charge-offs | | | 298 | | | | 215 | |
| | | | | | | | |
Recoveries: | | | | | | | | |
Real Estate: | | | | | | | | |
One- to four-family residential | | | 20 | | | | 13 | |
Commercial | | | 56 | | | | 3 | |
Home equity loans and lines of credit | | | — | | | | 21 | |
Residential construction | | | — | | | | — | |
Other construction and land | | | 8 | | | | 20 | |
Commercial | | | 4 | | | | 5 | |
Consumer | | | 152 | | | | 72 | |
Total recoveries | | | 240 | | | | 134 | |
| | | | | | | | |
Net chargeoffs | | | 58 | | | | 81 | |
| | | | | | | | |
Provision for loan losses | | | 116 | | | | 361 | |
| | | | | | | | |
Balance at end of period | | $ | 12,043 | | | $ | 11,167 | |
| | | | | | | | |
Ratios: | | | | | | | | |
Net charge-offs to average loans outstanding | | | 0.02 | % | | | 0.03 | % |
Allowance to non-performing loans at period end | | | 245.47 | % | | | 257.54 | % |
Allowance to total loans at period end | | | 1.12 | % | | | 1.08 | % |
Our allowance as a percentage of total loans increased to 1.12% at March 31, 2019 from 1.08% at March 31, 2018 primarily as the result of loan growth and provision related to acquired loans. The remaining fair value discount on acquired loans was $0.9 million as of March 31, 2019.
We have continued to experience limited charge-off amounts and stable collections of amounts previously charged-off. The overall historical loss rate used in our allowance for loan losses calculation continues to decline as previous quarters with larger loss rates are eliminated from the calculation as time passes. Our coverage ratio of non-performing loans decreased slightly to 245.47% at March 31, 2019 from 246.76% at December 31, 2018 and 257.54% at March 31, 2018.
REO
The table below summarizes the balances and activity in REO at the dates and for the periods indicated.
| | March 31, | | | December 31, | |
| | 2019 | | | 2018 | |
| | (Dollars in thousands) | |
| | | | | | |
One- to four-family residential | | $ | — | | | $ | 228 | |
Commercial real estate | | | 949 | | | | 949 | |
Other construction and land | | | 1,307 | | | | 1,316 | |
Total | | $ | 2,256 | | | $ | 2,493 | |
| | Three Months Ended March 31, | |
| | 2019 | | | 2018 | |
| | (Dollars in thousands) | |
Balance, beginning of period | | $ | 2,493 | | | $ | 2,568 | |
Additions | | | — | | | | 749 | |
Disposals | | | (228 | ) | | | (425 | ) |
Writedowns | | | — | | | | (18 | ) |
Balance, end of period | | $ | 2,265 | | | $ | 2,874 | |
Real estate owned decreased $0.2 million, or 9.5%, to $2.3 million at March 31, 2019 from $2.5 million at December 31, 2018. We have experienced a significant decrease in the number and dollar amount of additions to REO, and have had success in liquidating REO. Our policy continues to be to aggressively market REO for sale, including recording write-downs when necessary.
Net Deferred Tax Assets
Deferred tax assets and liabilities are determined using the asset and liability method and are reported net in the consolidated balance sheets of this Form 10-Q. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax basis of assets and liabilities and recognizes enacted changes in tax rate and laws. When deferred tax assets are recognized, they are subject to a valuation allowance based on management’s judgment as to whether realization is more likely than not. In determining the need for a valuation allowance, we considered the following sources of taxable income:
| · | future reversals of existing taxable temporary differences; |
| · | future taxable income exclusive of reversing temporary differences and carry forwards; |
| · | taxable income in prior carryback years; and |
| · | tax planning strategies that would, if necessary, be implemented. |
Net deferred tax assets decreased $2.3 million to $5.3 million at March 31, 2019 from $7.6 million at December 31, 2018. The decrease in net deferred tax assets is mainly attributable to decreases in the net unrealized holding losses on our investment securities and reductions in our federal and state net operating losses.
Deposits
The following table presents deposits by category and percentage of total deposits as of the dates indicated.
| | March 31, 2019 | | | December 31, 2018 | |
| | Balance | | | Percent | | | Balance | | | Percent | |
| | (Dollars in thousands) | |
Deposit type: | | | | | | | | | | | | | | | | |
Noninterest-bearing demand accounts | | $ | 194,562 | | | | 15.6 | % | | $ | 184,404 | | | | 15.1 | % |
Interest-bearing demand accounts | | | 198,516 | | | | 15.9 | | | | 209,085 | | | | 17.1 | |
Money market accounts - retail | | | 385,776 | | | | 31.0 | | | | 351,056 | | | | 28.7 | |
Money market accounts - wholesale | | | 5,063 | | | | 0.4 | | | | 5,030 | | | | 0.4 | |
Savings accounts | | | 49,996 | | | | 4.0 | | | | 50,716 | | | | 4.2 | |
Time deposits - retail | | | 340,047 | | | | 27.3 | | | | 349,971 | | | | 28.7 | |
Time deposits - wholesale | | | 72,259 | | | | 5.8 | | | | 70,978 | | | | 5.8 | |
| | | | | | | | | | | | | | | | |
Total deposits | | $ | 1,246,219 | | | | 100.0 | % | | $ | 1,221,240 | | | | 100.0 | % |
Core deposits increased $33.6 million to $828.9 million at March 31, 2019 from $795.3 million at December 31, 2018. Retail certificates of deposit decreased $9.9 million to $340.0 million at March 31, 2019 from $349.9 million at December 31, 2018. Wholesale deposits increased $1.3 million to $77.3 million at March 31, 2019 from $76.0 million at December 31, 2018. We continue to focus on gathering core deposits, which increased to 67% of the Company’s deposit portfolio at March 31, 2019 compared to 65% at December 31, 2018.
FHLB Advances
FHLB advances were $213.5 million at March 31, 2019 and December 31, 2018. FHLB advances are secured by qualifying one-to-four family permanent and commercial loans, by investment securities, and by a blanket collateral agreement with the FHLB.
Other Borrowings
On September 15, 2017, the Company established a $15.0 million revolving credit loan facility with NexBank SSB. The loan facility, which is secured by Entegra Bank stock, bears interest at LIBOR plus 350 basis points and is intended to be used for general corporate purposes. Unless extended, the loan will mature on September 15, 2020. The Company had drawn $5.0 million on the revolving credit loan facility as of March 31, 2019.
The Company also had other borrowings at March 31, 2019 of $4.4 million which is comprised of participated loans that did not qualify for sale accounting. Interest expense on the other borrowings accrues at the same rate as the interest income recognized on the loans receivable, resulting in no effect to net income.
Junior Subordinated Notes
We had $14.4 million in junior subordinated notes outstanding at March 31, 2019 and December 31, 2018 payable to an unconsolidated subsidiary. These notes accrue interest at 2.80% above the 90-day LIBOR, adjusted quarterly. To add stability to net interest income and manage our exposure to interest rate movement, we entered into an interest rate swap in September 2016 on the junior subordinated notes. We also entered into a forward starting interest rate swap on our junior subordinated date in June 2018 to begin in 2020 after the current interest rate swap terminates. The swap contracts involve the payment of fixed-rate amounts to a counterparty in exchange for our receipt of variable-rate payments over the four year life of the current contract and three additional years under the forward starting contract. The effective interest rate on the swapped notes was 3.76% at March 31, 2019 and December 31, 2018.
Equity
Total shareholders’ equity increased $8.0 million to $170.9 million at March 31, 2019 compared to $162.9 million at December 31, 2018. This increase was primarily attributable to $3.8 million of net income and $4.0 million of after-tax increase in the market value of investment securities available for sale.
Comparison of Operating Results for the Three Months Ended March 31, 2019 and March 31, 2018.
General.Net income for the three months ended March 31, 2019 was $3.8 million compared to $3.6 million for the same period in 2018. The increase in net income for the recent quarter was primarily the result of an increase in noninterest income of $2.3 million partially offset by a decrease in net interest income of $0.4 million and increases in noninterest expense of $1.6 million.
Net Interest Income.Net interest income decreased $0.4 million, or 3.5%, to $12.0 million for the three months ended March 31, 2019, compared to $12.4 million for the same period in 2018. The decrease in net interest income was primarily due to increased costs of deposits and borrowings, partially offset by higher volumes in the loan portfolio, as well as an increase in the yields earned on cash and taxable investments. The tax-equivalent net interest margin decreased to 3.23% for the three months ended March 31, 2019 compared to 3.49% for the same period in 2018.
The following table sets forth the average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets on a tax-equivalent basis, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average tax-equivalent yields and cost for the periods indicated. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.
| | For the Three Months Ended March 31, | |
| | 2019 | | | 2018 | |
| | Average Outstanding Balance | | | Interest | | | Yield/ Rate | | | Average Outstanding Balance | | | Interest | | | Yield/ Rate | |
| | (Dollars in thousands) | |
Interest-earning assets: | | | | | | | | | | | | | | | | | | | | | | | | |
Loans, including loans held for sale | | $ | 1,069,700 | | | $ | 12,916 | | | | 4.90 | % | | $ | 1,008,074 | | | $ | 11,892 | | | | 4.78 | % |
Loans, tax exempt(1) | | | 17,246 | | | | 137 | | | | 3.21 | % | | | 15,792 | | | | 116 | | | | 2.99 | % |
Investments - taxable | | | 255,539 | | | | 2,082 | | | | 3.26 | % | | | 261,970 | | | | 1,789 | | | | 2.73 | % |
Investment tax exempt(1) | | | 102,427 | | | | 962 | | | | 3.76 | % | | | 76,129 | | | | 696 | | | | 3.66 | % |
Interest earning deposits | | | 72,538 | | | | 472 | | | | 2.64 | % | | | 86,644 | | | | 349 | | | | 1.63 | % |
Other investments, at cost | | | 12,045 | | | | 204 | | | | 6.87 | % | | | 12,391 | | | | 171 | | | | 5.60 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-earning assets | | | 1,529,495 | | | | 16,773 | | | | 4.45 | % | | | 1,461,000 | | | | 15,013 | | | | 4.17 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Noninterest-earning assets | | | 122,582 | | | | | | | | | | | | 124,753 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 1,652,077 | | | | | | | | | | | $ | 1,585,753 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
Savings accounts | | $ | 50,522 | | | $ | 14 | | | | 0.11 | % | | $ | 51,123 | | | $ | 15 | | | | 0.12 | % |
Time deposits | | | 419,097 | | | | 1,676 | | | | 1.62 | % | | | 403,284 | | | | 914 | | | | 0.92 | % |
Money market accounts | | | 375,676 | | | | 1,138 | | | | 1.23 | % | | | 319,351 | | | | 366 | | | | 0.46 | % |
Interest bearing transaction accounts | | | 200,654 | | | | 98 | | | | 0.20 | % | | | 212,366 | | | | 87 | | | | 0.17 | % |
Total interest bearing deposits | | | 1,045,949 | | | | 2,926 | | | | 1.13 | % | | | 986,124 | | | | 1,382 | | | | 0.57 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
FHLB advances | | | 213,500 | | | | 1,396 | | | | 2.62 | % | | | 223,500 | | | | 820 | | | | 1.47 | % |
Junior subordinated debentures | | | 14,433 | | | | 139 | | | | 3.85 | % | | | 14,433 | | | | 138 | | | | 3.82 | % |
Other borrowings | | | 9,368 | | | | 128 | | | | 5.54 | % | | | 8,763 | | | | 109 | | | | 5.04 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-bearing liabilities | | | 1,283,250 | | | | 4,589 | | | | 1.45 | % | | | 1,232,820 | | | | 2,449 | | | | 0.81 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
Noninterest-bearing deposits | | | 189,511 | | | | | | | | | | | | 183,071 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Other non interest bearing liabilities | | | 14,526 | | | | | | | | | | | | 18,773 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total liabilities | | | 1,487,287 | | | | | | | | | | | | 1,434,664 | | | | | | | | | |
Total equity | | | 164,790 | | | | | | | | | | | | 151,089 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total liabilities and equity | | $ | 1,652,077 | | | | | | | | | | | $ | 1,585,753 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Tax-equivalent net interest income | | | | | | $ | 12,184 | | | | | | | | | | | $ | 12,565 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net interest-earning assets(2) | | $ | 246,245 | | | | | | | | | | | $ | 228,180 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Average interest-earning assets to interest-bearing liabilities | | | 119.19 | % | | | | | | | | | | | 118.51 | % | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Tax-equivalent net interest rate spread(3) | | | | | | | | | | | 3.00 | % | | | | | | | | | | | 3.36 | % |
Tax-equivalent net interest margin(4) | | | | | | | | | | | 3.23 | % | | | | | | | | | | | 3.49 | % |
(1) Tax exempt loans and investments are calculated giving effect to a 21% federal tax rate.
(2) Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.
(3) Tax-equivalent net interest rate spread represents the difference between the tax equivalent yield on average interest-earning assets and the cost of average interest-bearing liabilities.
(4) Tax-equivalent net interest margin represents tax equivalent net interest income divided by average total interest-earning assets.
The following table presents the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to change in volume (changes in volume multiplied by prior rate). The total column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, based on changes due to rate and the changes due to volume.
| | For the Three Months Ended March 31, 2019 | |
| | Compared to the Three Months Ended March 31, 2018 | |
| | Increase (decrease) due to: | |
| | Volume | | | Rate | | | Total | |
| | (Dollars in thousands) | |
Interest-earning assets: | | | | | | | | | | | | |
Loans, including loans held for sale(1) | | $ | 739 | | | $ | 285 | | | $ | 1,024 | |
Loans, tax exempt(2) | | | 12 | | | | 9 | | | | 21 | |
Investment - taxable | | | (44 | ) | | | 337 | | | | 293 | |
Investments - tax exempt(2) | | | 247 | | | | 19 | | | | 266 | |
Interest-earning deposits | | | (64 | ) | | | 187 | | | | 123 | |
Other investments, at cost | | | (6 | ) | | | 38 | | | | 32 | |
| | | | | | | | | | | | |
Total interest-earning assets | | | 884 | | | | 875 | | | | 1,759 | |
| | | | | | | | | | | | |
Interest-bearing liabilities: | | | | | | | | | | | | |
Savings accounts | | | — | | | | (1 | ) | | | (1 | ) |
Time deposits | | | 37 | | | | 725 | | | | 762 | |
Money market accounts | | | 75 | | | | 697 | | | | 772 | |
Interest bearing transaction accounts | | | (5 | ) | | | 16 | | | | 11 | |
FHLB advances | | | (37 | ) | | | 614 | | | | 577 | |
Junior subordinated debentures | | | — | | | | — | | | | — | |
Other borrowings | | | 8 | | | | 11 | | | | 19 | |
| | | | | | | | | | | | |
Total interest-bearing liabilities | | | 79 | | | | 2,062 | | | | 2,140 | |
| | | | | | | | | | | | |
Change in tax-equivalent net interest income | | $ | 805 | | | $ | (1,187 | ) | | $ | (381 | ) |
(1) Non-accrual loans are included in the above analysis.
(2) Interest income on tax exempt loans and investments are adjusted for based on a 21% federal tax rate.
Net interest income before provision for loan losses decreased to $12.0 million for the three months ended March 31, 2019, compared to $12.4 million for the same period in 2018. As indicated in the table above, a decrease in tax-equivalent net interest income of $1.2 million attributable to an unfavorable movement in rates was partially offset by a $0.8 million improvement in volume.
The increase in tax-equivalent net interest income of $0.8 million related to volume was primarily the result of higher average loan and tax exempt investment balances which increased $63.1 million and $26.3 million, respectively, and lower average FHLB advances which decreased $10.0 million for the three months ended March 31, 2019 as compared to the same period in 2018. The increase in average loan balances and decrease in FHLB advances was partially offset by decreases in average taxable investments and interest-earning deposit balances of $6.4 million and $0.3 million, respectively, and increases in time deposit and money market balances of $15.8 million and $56.3 over the same periods.
The decrease in tax-equivalent net interest income of $1.2 million related to rate was primarily the result of increased rates on time deposits, money markets and FHLB advances, partially off by yields loans, taxable investments, and interest-earning deposits.
Our tax-equivalent net interest rate spread decreased to 3.00% for the three months ended March 31, 2019 compared to 3.36% for the three months ended March 31, 2018. Our tax-equivalent net interest margin decreased to 3.23% for the three months ended March 31, 2019, compared to 3.49% for the three months ended March 31, 2018.
Provision for Loan Losses.We recorded a provision for loan losses for the three months ended March 31, 2019 of $0.1 million due to organic loan growth and acquired loans compared to a $0.4 million provision for loan losses for the same period in 2018. We are experiencing continued stabilization in asset quality, low charge-off amounts, and a continued decline in the historical loss rates used in our allowance for loan losses model.
Noninterest Income.The following table summarizes the components of noninterest income and the corresponding change between the three month periods ended March 31, 2019 and 2018:
| | Three Months Ended March 31, | |
| | 2019 | | | 2018 | | | Change | |
| | (Dollars in thousands) | |
Servicing income, net | | $ | 89 | | | $ | 94 | | | $ | (5 | ) |
Mortgage banking | | | 263 | | | | 239 | | | | 24 | |
Gain on sale of SBA loans | | | 80 | | | | 61 | | | | 19 | |
Loss on sale of investments, net | | | — | | | | (12 | ) | | | 12 | |
Equity securities gains (losses) | | | 418 | | | | (53 | ) | | | 471 | |
Service charges on deposit accounts | | | 398 | | | | 431 | | | | (33 | ) |
Interchange fees, net | | | 246 | | | | 248 | | | | (2 | ) |
Bank owned life insurance | | | 180 | | | | 200 | | | | (20 | ) |
Legal settlement income | | | 1,750 | | | | — | | | | 1,750 | |
Other | | | 278 | | | | 208 | | | | 70 | |
| | | | | | | | | | | | |
Total | | $ | 3,702 | | | $ | 1,416 | | | $ | 2,286 | |
Gains on equity securities in the three months ended March 31, 2019 compared to losses in the same period in 2018 relate to increases in market value of the equity securities.
The legal settlement income in the three months ended March 31, 2019 relates to a definitive settlement agreement with one of our former advisors.
Noninterest Expense.The following table summarizes the components of noninterest expense and the corresponding change between the three months ended March 31, 2019 and 2018:
| | Three Months Ended March 31, | |
| | 2019 | | | 2018 | | | Change | |
| | (Dollars in thousands) | |
| | | | | | | | | |
Compensation and employee benefits | | $ | 6,020 | | | $ | 5,617 | | | $ | 403 | |
Net occupancy | | | 1,120 | | | | 1,092 | | | | 28 | |
Federal deposit insurance | | | 142 | | | | 279 | | | | (137 | ) |
Professional and advisory | | | 325 | | | | 277 | | | | 48 | |
Data processing | | | 493 | | | | 509 | | | | (16 | ) |
Marketing and advertising | | | 279 | | | | 209 | | | | 70 | |
Merger-related expenses | | | 1,350 | | | | 196 | | | | 1,154 | |
Net cost of operation of REO | | | 7 | | | | 50 | | | | (43 | ) |
Other | | | 1,002 | | | | 894 | | | | 108 | |
| | | | | | | | | | | | |
Total noninterest expenses | | $ | 10,738 | | | $ | 9,123 | | | $ | 1,615 | |
Compensation and employee benefits increased $0.4 million, or 7.2%, for the three months ended March 31, 2019 as compared to the same period in 2018. This additional expense is related to annual raises, employee benefits, incentives and commissions.
Federal deposit insurance premiums decreased $0.1 million for the three months ended March 31, 2019 compared to the same period in 2018 due to an increase in premium credits based on an increase in certain regulatory ratios.
Merger-related expenses increased $1.2 million in the three months ended March 31, 2019 compared to the same period in 2018 due to expenses related primarily to the previously proposed merger with SmartFinancial.
Other noninterest expense increased $0.1 million for the three months ended March 31, 2019 compared to the same period in 2018, primarily as the result of increased franchise tax expense.
Income Taxes.We recorded $1.0 million of income tax expense for the three months ended March 31, 2019 compared to $0.7 million for the same period in 2018. Income tax expense for the three months ending March 31, 2019 and 2018 benefitted from tax-exempt income related to municipal bond investment and BOLI income resulting in effective tax rates of 20.5% and 17.2%, respectively. The increase in the effective tax rate is primarily attributable to higher disallowed interest expense deductions and state income taxes.
We continue to have unutilized net operating losses for federal and state income tax purposes and do not have a material current tax receivable or liability.
Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations. Our primary sources of funds consist of deposit inflows, loan repayments, advances from the FHLB, proceeds from the sale of loans originated for sale, and principal repayments and the sale of available-for-sale securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. Our Asset/Liability Management Committee, under the direction of our Chief Financial Officer, is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we have enough sources of liquidity to satisfy our short- and long-term liquidity needs as of March 31, 2019.
We regularly monitor and adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows and borrowing maturities, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program. Excess liquid assets are invested generally in FHLB and Federal Reserve Bank of Richmond (“FRB”) interest-earning deposits and investment securities and are also used to pay off short-term borrowings. At March 31, 2019, cash and cash equivalents totaled $98.3 million. Included in this total was $49.2 million held at the FRB, $2.7 million held at the FHLB, and $30.9 million held at correspondent banks in interest-earning accounts.
Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statements of Cash Flows included in our Consolidated Financial Statements of this Form 10-Q. The following summarizes the most significant sources and uses of liquidity during the three months ended March 31, 2019 and 2018:
| | Three Months Ended March 31, | |
| | 2019 | | | 2018 | |
| | (Dollars in thousands) | |
Operating activities: | | | | | | | | |
Loans originated for sale | | $ | (9,510 | ) | | $ | (9,745 | ) |
Proceeds from loans originated for sale | | | 8,215 | | | | 9,866 | |
| | | | | | | | |
Investing activities: | | | | | | | | |
Purchases of investments | | $ | — | | | $ | (21,758 | ) |
Maturities and principal repayments of investments | | | 7,177 | | | | 8,858 | |
Sales of investments | | | — | | | | 10,009 | |
Net increase in loans | | | (3,474 | ) | | | (31,241 | ) |
Proceeds from settlement of BOLI policies | | | 1,115 | | | | — | |
| | | | | | | | |
Financing activities: | | | | | | | | |
Net increase in deposits | | $ | 24,366 | | | $ | 43,375 | |
Proceeds from FHLB advances | | | 50,000 | | | | 40,000 | |
Repayment of FHLB advances | | | (50,000 | ) | | | (40,000 | ) |
At March 31, 2019, we had $34.0 million in outstanding commitments to originate loans. In addition to commitments to originate loans, we had $175.4 million in unused lines of credit.
Depending on market conditions, we may be required to pay higher rates on our deposits or other borrowings than we currently pay on certificates of deposit. Based on historical experience and current market interest rates, we anticipate that following their maturity we will retain a large portion of our retail certificates of deposit with maturities of one year or less as of March 31, 2019.
In addition to loans, we invest in securities that provide a source of liquidity, both through repayments and as collateral for borrowings. Our securities portfolio includes both callable securities (which allow the issuer to exercise call options) and mortgage-backed securities (which allow borrowers to prepay loans). Accordingly, a decline in interest rates would likely prompt issuers to exercise call options and borrowers to prepay higher-rate loans, producing higher than otherwise scheduled cash flows.
Liquidity management is both a daily and long-term function of management. If we require more funds than we are able to generate locally, we have borrowing agreements with the FHLB and the FRB discount window, and a revolving credit loan facility with NexBank SSB. The following summarizes our borrowing capacity as of March 31, 2019:
| | Total | | | Used | | | Unused | |
(Dollars in thousands) | | Capacity | | | Capacity | | | Capacity | |
| | | | | | | | | |
FHLB | | | | | | | | | | | | |
Loan collateral capacity | | $ | 208,734 | | | | | | | | | |
Pledgeable marketable securities | | | 96,795 | | | | | | | | | |
FHLB totals | | | 305,529 | | | $ | 213,500 | | | $ | 92,029 | |
FRB | | | 48,268 | | | | — | | | | 48,268 | |
Fed funds lines | | | 15,000 | | | | — | | | | 15,000 | |
Holding Company revolving line of credit | | | 15,000 | | | | 5,000 | | | | 10,000 | |
| | $ | 383,797 | | | $ | 218,500 | | | $ | 165,297 | |
In July 2013, the Board of Governors of the Federal Reserve System and the FDIC issued final rules to revise their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act (“Basel III”). On January 1, 2015, the Basel III rules became effective and include transition provisions which implement certain portions of the rules through January 1, 2019.
The Basel III also includes changes in what constitutes regulatory capital, some of which are subject to a transition period. These changes include the phasing-out of certain instruments as qualifying capital. In addition, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital. Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock are required to be deducted from capital, subject to a transition period. Finally, common equity Tier 1 capital includes accumulated other comprehensive income (which includes all unrealized gains and losses on available-for-sale debt and equity securities), subject to a transition period and a one-time opt-out election. The Bank elected to opt-out of this provision. As such, accumulated comprehensive income is not included in the Bank’s Tier 1 capital.
The Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based guidelines and framework under prompt corrective action provisions include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories.
Basel III was fully phased in on January 1, 2019. The Company and the Bank are now required to maintain a 2.5% capital conservation buffer which is designed to absorb losses during periods of economic distress. This capital conservation buffer is comprised entirely of Common Equity Tier 1 Capital and is in addition to minimum risk-weighted asset ratios.
The tables below summarize capital ratios and related information in accordance with Basel III as measured at March 31, 2019 and December 31, 2018.
The following table summarizes the required and actual capital ratios of the Bank as of the dates indicated:
| | Actual | | | For Capital Adequacy Purposes(1) | | | To Be Well- Capitalized Under Prompt Corrective Action Provisions | |
(Dollars in thousands) | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
As of March 31, 2019: | | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 Leverage Capital | | $ | 157,179 | | | | 9.67 | % | | $ | 65,040 | | | | >4 | % | | $ | 81,300 | | | | >5 | % |
Common Equity Tier 1 Capital | | $ | 157,179 | | | | 13.32 | % | | $ | 82,590 | | | | >7.0 | % | | $ | 76,691 | | | | >6.5 | % |
Tier 1 Risk-based Capital | | $ | 157,179 | | | | 13.32 | % | | $ | 94,388 | | | | >8.5 | % | | $ | 94,388 | | | | >8 | % |
Total Risk-based Capital | | $ | 169,322 | | | | 14.35 | % | | $ | 123,885 | | | | >10.5 | % | | $ | 117,985 | | | | >10 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
As of December 31, 2018: | | | | | | | | | | | | | | | | | | | | | | | | |
Tier 1 Leverage Capital | | $ | 152,137 | | | | 9.42 | % | | $ | 64,589 | | | | >4 | % | | $ | 80,737 | | | | >5 | % |
Common Equity Tier 1 Capital | | $ | 152,137 | | | | 12.92 | % | | $ | 75,046 | | | | >6.375 | % | | $ | 76,517 | | | | >6.5 | % |
Tier 1 Risk-based Capital | | $ | 152,137 | | | | 12.92 | % | | $ | 92,703 | | | | >7.875 | % | | $ | 94,175 | | | | >8 | % |
Total Risk-based Capital | | $ | 164,222 | | | | 13.95 | % | | $ | 116,247 | | | | >9.875 | % | | $ | 117,719 | | | | >10 | % |
(1)As of December 31, 2018, includes capital conservation buffer of 1.875%.
The following table summarizes the required and actual consolidated capital ratios of the Company as of the dates indicated:
| | Actual | | | For Capital Adequacy Purposes(1) | |
(Dollars in thousands) | | Amount | | | Ratio | | | Amount | | | Ratio | |
As of March 31, 2019: | | | | | | | | | | | | |
Tier I Leverage Capital | | $ | 156,786 | | | | 9.64 | % | | $ | 65,077 | | | | >4 | % |
Common Equity Tier 1 Capital | | $ | 142,353 | | | | 12.05 | % | | $ | 82,662 | | | | >7.0 | % |
Tier I Risk-based Capital | | $ | 156,786 | | | | 13.28 | % | | $ | 100,375 | | | | >8.5 | % |
Total Risk Based Capital | | $ | 168,929 | | | | 14.31 | % | | $ | 123,993 | | | | >10.5 | % |
| | | | | | | | | | | | | | | | |
As of December 31, 2018: | | | | | | | | | | | | | | | | |
Tier I Leverage Capital | | $ | 151,629 | | | | 9.38 | % | | $ | 64,629 | | | | >4 | % |
Common Equity Tier 1 Capital | | $ | 137,196 | | | | 11.65 | % | | $ | 75,106 | | | | >6.375 | % |
Tier I Risk-based Capital | | $ | 151,629 | | | | 12.87 | % | | $ | 92,777 | | | | >7.875 | % |
Total Risk Based Capital | | $ | 163,714 | | | | 13.90 | % | | $ | 116,340 | | | | >9.875 | % |
(1) As of December 31, 2018, includes capital conservation buffer of 1.875%.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
One of the most significant forms of market risk is interest rate risk because, as a financial institution, the majority of our assets and liabilities are sensitive to changes in interest rates. Interest rate fluctuations affect earnings by changing net interest income and other interest-sensitive income and expense levels. Interest rate changes affect economic value of equity (“EVE”) by changing the net present value of a bank’s future cash flows, and the cash flows themselves as rates change. Accepting this risk is a normal part of banking and can be an important source of profitability and shareholder value. However, excessive risk can threaten a bank’s earnings, capital, liquidity and solvency. Therefore, a principal part of our operations is to manage interest rate risk and limit the exposure of our net interest income to changes in market interest rates. The Board of Directors of the Bank has established an ALCO, which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board. Our ALCO monitors and manages market risk through rate shock analyses, economic value of equity, or EVE, analyses and simulations in order to avoid unacceptable earnings and market value fluctuations due to changes in interest rates.
One of the primary ways we manage interest rate risk is by selling the majority of our long-term fixed rate mortgages into the secondary markets, and obtaining commitments to sell at locked-in interest rates prior to issuing a loan commitment. From a funding perspective, we expect to satisfy the majority of our future requirements with retail deposit growth, including checking and savings accounts, money market accounts and certificates of deposit generated within our primary markets. If our funding needs exceed our deposits, we will utilize our excess funding capacity with the FHLB and the FRB.
We have taken the following steps to reduce our interest rate risk:
| · | increased our personal and business checking accounts and our money market accounts, which are less rate-sensitive than certificates of deposit and which provide us with a stable, low-cost source of funds; |
| · | limited the fixed rate period on loans within our portfolio; |
| · | utilized our securities portfolio for positioning based on projected interest rate environments; |
| · | priced certificates of deposit to encourage customers to extend to longer terms; |
| · | engaged in interest rate swap agreements; and |
| · | utilized FHLB advances for positioning. |
We have not conducted speculative hedging activities, such as engaging in futures or options.
Economic Value of Equity (EVE)
EVE is the difference between the present value of an institution’s assets and liabilities that would change in the event of a range of assumed changes in market interest rates. EVE is used to monitor interest rate risk beyond the 12 month time horizon of income simulations. The simulation model uses a discounted cash flow analysis and an option-based pricing approach to measure the interest rate sensitivity of EVE. The model estimates the economic value of each type of asset, liability and off-balance sheet contract using the current interest rate yield curve with instantaneous increases or decreases of 100 to 400 basis points in 100 basis point increments. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below. Given the current relatively low level of market interest rates, an EVE calculation for an interest rate decrease of greater than 100 basis points has not been prepared.
Certain shortcomings are inherent in the methodologies used in determining interest rate risk through changes in EVE. Modeling changes in EVE require making certain assumptions that may or may not reflect the manner in which actual yields and costs, or loan repayments and deposit decay, respond to changes in market interest rates. In this regard, the EVE information presented assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the EVE information provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.
Net Interest Income
In addition to an EVE analysis, we analyze the impact of changing rates on our net interest income. Using our balance sheet as of a given date, we analyze the repricing components of individual assets, and adjusting for changes in interest rates at 100 basis point increments, we analyze the impact on our net interest income. Changes to our net interest income are shown in the following table based on immediate changes to interest rates in 100 basis point increments.
The table below reflects the impact of an immediate increase in interest rates in 100 basis point increments on Pretax Net Interest Income (“NII”) and EVE.
| | | March 31, 2019 | | | December 31, 2018 | |
Change in Interest Rates (basis points) | | | % Change in Pretax Net Interest Income | | | % Change in Economic Value of Equity | | | % Change in Pretax Net Interest Income | | | % Change in Economic Value of Equity | |
| +400 | | | | (2.7 | ) | | | (5.1 | ) | | | 0.9 | | | | 3.9 | |
| +300 | | | | (1.6 | ) | | | (2.6 | ) | | | 0.9 | | | | 2.9 | |
| +200 | | | | (0.7 | ) | | | (2.0 | ) | | | 0.8 | | | | 1.8 | |
| +100 | | | | (0.2 | ) | | | (1.5 | ) | | | 0.7 | | | | 0.2 | |
| — | | | | — | | | | — | | | | — | | | | — | |
| -100 | | | | (3.0 | ) | | | 2.0 | | | | (2.5 | ) | | | 2.7 | |
The results from the rate shock analysis on NII are consistent with having a liability sensitive balance sheet. Having a liability sensitive balance sheet means liabilities will reprice at a faster pace than assets during the short-term horizon. The implications of a liability sensitive balance sheet will differ depending upon the change in market rates. For example, with a liability sensitive balance sheet in a declining interest rate environment, the interest rate on liabilities will decrease at a faster pace than assets. This situation generally results in an increase in NII and operating income. Conversely, with a liability sensitive balance sheet in a rising interest rate environment, the interest rate on liaiblities will increase at a faster pace than assets. This situation generally results in a decrease in NII and operating income. As indicated in the table above, a 200 basis point increase in rates would result in a 0.72% decrease in NII as of March 31, 2019 as compared to a 0.8% increase in NII as of December 31, 2018, suggesting that there is no benefit for the Company to net interest income in rising interest rates The Company generally seeks to remain neutral to the impact brof changes in interest rates by maximizing current earnings while balancing the risk of changes in interest rates.
The results from the rate shock analysis on EVE are consistent with a balance sheet whose assets have a longer maturity than its liabilities. Like most financial institutions, we generally invest in longer maturity assets as compared to our liabilities in order to earn a higher return on our assets than we pay on our liabilities. This is because interest rates generally increase as the time to maturity increases, assuming a normal, upward sloping yield curve. In a rising interest rate environment, this results in a negative EVE because higher interest rates will reduce the present value of longer term assets more than it will reduce the present value of shorter term liabilities, resulting in a negative impact on equity. As noted in the table above, our exposure to higher interest rates from an EVE or present value perspective has increased from December 31, 2018 to March 31, 2019. For example, as indicated in the table above, a 200 basis point increase in rates would result in a 2.0% decrease in EVE as of March 31, 2019 as compared to a 1.8% inecrease in EVE as of December 31, 2018.
Item 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company’s management, including its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of March 31, 2019. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer each concluded that as of March 31, 2019, the end of the period covered by this Form 10-Q, the Company maintained effective disclosure controls and procedures.
Changes in Internal Control over Financial Reporting
There have been no changes to the Company’s internal control over financial reporting that occurred during the quarter ended March 31, 2019 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 ordinary course of operations, we are often involved in legal proceedings. In the opinion of management, neither the Company nor the Bank is a party to, nor is their property the subject of, any material pending legal proceedings, other than ordinary routine litigation incidental to their business, nor has any such proceeding been terminated during the quarter ended March 31, 2019.
Item 1A. Risk Factors
There have been no material changes to the risk factors that we have previously disclosed in the “Risk Factors” section in our 2018 Form 10-K as filed with the SEC on March 14, 2019.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Mine Safety Disclosures
Not Applicable
Item 5. Other Information
None
Item 6. Exhibits
Exhibit No. | Description |
2.1 | Agreement and Plan of Merger, dated as of January 15, 2019, by and among Entegra Financial Corp., SmartFinancial, Inc., and CT Merger Sub, Inc. * |
| |
2.2 | Agreement and Plan of Merger, dated as of April 23, 2019, by and among Entegra Financial Corp., First Citizens BancShares, Inc., First-Citizens Bank & Trust Company and FC Merger Subsidiary VII, Inc. * |
| |
3.1 | Articles of Incorporation of Entegra Financial Corp., as amended and restated, incorporated by reference to Exhibit 3.1 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641). |
| |
3.2 | Bylaws of Entegra Financial Corp., as amended and restated, incorporated by reference to Exhibit 3.2 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641). |
| |
3.3 | Articles of Amendment of Entegra Financial Corp., incorporated by reference to Exhibit 3.1 of the Current Report on Form 8-K, filed with the SEC on November 16, 2015 (SEC File No. 001-35302) |
| |
31.1 | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| |
31.2 | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| |
32 | Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| |
101 | Financial Statements filed in XBRL format. |
| |
* | The registrant has omitted schedules and similar attachments to the subject agreement pursuant to Item 601(b)(2) of Regulation S-K. The registrant will furnish a copy of any omitted schedule or similar attachment to the SEC upon request. |
| |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: May 8, 2019 | Entegra Financial Corp. | |
| (Registrant) |
| |
| By: | /s/David A. Bright | |
| Name:David A. Bright |
| Title: Chief Financial Officer |
| (Authorized Officer) |
EXHIBIT INDEX
Exhibit No. | Description |
| |
31.01 | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| |
31.02 | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| |
32.01 | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| |
101 | Financial Statements filed in XBRL format. |