SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|
|
|
|
For the quarterly period ended March 31, 2014 |
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|
|
|
| |
|
|
|
| |
For the transition period from |
|
to |
| |
| ||||
Commission File Number: 0-11595 | ||||
| ||||
Merchants Bancshares, Inc. | ||||
(Exact name of registrant as specified in its charter) | ||||
| ||||
Delaware |
| 03-0287342 | ||
(State or other jurisdiction of incorporation or organization) |
| (I.R.S. Employer Identification No.) | ||
| ||||
275 Kennedy Drive, South Burlington, VT |
|
05403 | ||
(Address of principal executive offices) |
| (Zip Code) | ||
| ||||
802-658-3400 | ||||
(Registrant’s telephone number, including area code) | ||||
| ||||
Not Applicable | ||||
(Former name, former address and former fiscal year, if changed since last report) |
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [ X ] Yes [ ] No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). [X] Yes[ ] No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a nonaccelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer [ ]Accelerated Filer [ X ]Nonaccelerated Filer [ ] Smaller Reporting Company [ ]
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).
[ ] Yes [ X ] No
As of April 29, 2014, there were 6,322,599 shares of the registrant’s common stock, par value $0.01 per share, outstanding.
MERCHANTS BANCSHARES, INC. AND SUBSIDIARIES
FORM 10-Q
TABLE OF CONTENTS
|
|
|
| ||
PART I – FINANCIAL INFORMATION | Page Reference | |
Item 1 | Financial Statements |
|
|
|
|
|
| |
| As of March 31, 2014 and December 31, 2013 | 3 |
|
|
|
|
| |
| Three months ended March 31, 2014 and 2013 | 4 |
|
|
|
| Consolidated Statements of Comprehensive Income (Loss) (Unaudited) |
|
| Three months ended March 31, 2014 and 2013 | 5 |
|
|
|
|
| |
| Three months ended March 31, 2014 and 2013 | 6 |
|
|
|
| Notes to Interim Unaudited Consolidated Financial Statements | 7 |
|
|
|
Item 2 | Management's Discussion and Analysis of Financial Condition and Results of Operations | 25 |
Item 3 | 38 | |
Item 4 | 40 | |
|
|
|
PART II - OTHER INFORMATION |
| |
Item 1 | 41 | |
Item 1A | 41 | |
Item 2 | 41 | |
Item 3 | 41 | |
Item 4 | 41 | |
Item 5 | 41 | |
Item 6 | 41 | |
| 42 | |
|
|
|
|
|
|
|
2
ITEM 1 – FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Consolidated Balance Sheets
(Unaudited)
|
|
|
|
|
|
|
|
|
|
| March 31, | December 31, | ||
(In thousands except share and per share data) | 2014 | 2013 | ||
ASSETS |
|
|
|
|
Cash and due from banks | $ | 31,130 | $ | 30,434 |
Interest earning deposits with banks and other short-term investments |
| 45,354 |
| 85,037 |
Total cash and cash equivalents |
| 76,484 |
| 115,471 |
Investments: |
|
|
|
|
Securities available for sale, at fair value |
| 214,957 |
| 252,513 |
Securities held to maturity (fair value of $147,480 and $137,087) |
| 150,382 |
| 140,826 |
Total investments |
| 365,339 |
| 393,339 |
Loans |
| 1,171,737 |
| 1,166,233 |
Less: Allowance for loan losses |
| 12,174 |
| 12,042 |
Net loans |
| 1,159,563 |
| 1,154,191 |
Federal Home Loan Bank stock |
| 7,496 |
| 7,496 |
Bank premises and equipment, net |
| 15,188 |
| 15,572 |
Investment in real estate limited partnerships |
| 4,342 |
| 4,631 |
Bank owned life insurance |
| 10,080 |
| 10,000 |
Other assets |
| 23,553 |
| 24,769 |
Total assets | $ | 1,662,045 | $ | 1,725,469 |
LIABILITIES |
|
|
|
|
Deposits: |
|
|
|
|
Demand (noninterest bearing) | $ | 271,704 | $ | 266,299 |
Savings, interest bearing checking and money market accounts |
| 770,980 |
| 752,171 |
Time deposits $100 thousand and greater |
| 103,246 |
| 115,204 |
Other time deposits |
| 180,127 |
| 189,902 |
Total deposits |
| 1,326,057 |
| 1,323,576 |
Securities sold under agreements to repurchase |
| 182,647 |
| 250,314 |
Other long-term debt |
| 2,382 |
| 2,403 |
Junior subordinated debentures issued to unconsolidated subsidiary trust |
| 20,619 |
| 20,619 |
Other liabilities |
| 8,102 |
| 8,946 |
Total liabilities |
| 1,539,807 |
| 1,605,858 |
Commitments and contingencies (Note 9) |
|
|
|
|
SHAREHOLDERS' EQUITY |
|
|
|
|
Preferred stock |
|
|
|
|
Preferred stock |
| - |
| - |
Class A non-voting shares authorized - 200,000, none outstanding |
| - |
| - |
Common stock, $.01 par value |
| 67 |
| 67 |
Authorized: 10,000,000 shares; Issued: 6,651,760 at March 31, 2014 and December 31, 2013 |
|
|
|
|
Outstanding: 6,320,531 at March 31, 2014 and 6,318,708 at December 31, 2013 |
|
|
|
|
Capital in excess of par value |
| 37,132 |
| 37,129 |
Retained earnings |
| 97,290 |
| 95,657 |
Treasury stock, at cost: 331,229 shares at March 31, 2014 and 333,052 shares at December 31, 2013 |
| (13,572) |
| (14,043) |
Deferred compensation arrangements: 294,673 shares at March 31, 2014 and 319,854 at December 31, 2013 |
| 6,156 |
| 6,521 |
Accumulated other comprehensive loss |
| (4,835) |
| (5,720) |
Total shareholders' equity |
| 122,238 |
| 119,611 |
Total liabilities and shareholders' equity | $ | 1,662,045 | $ | 1,725,469 |
|
|
|
|
|
See accompanying notes to unaudited consolidated financial statements |
3
Merchants Bancshares, Inc.
Consolidated Statements of Income
(Unaudited)
|
|
|
|
|
|
|
|
|
|
| Three Months Ended | |||
| March 31, | |||
(In thousands except per share data) | 2014 | 2013 | ||
INTEREST AND DIVIDEND INCOME |
|
|
|
|
Interest and fees on loans | $ | 10,762 | $ | 10,750 |
Investment income: |
|
|
|
|
Interest and dividends on investment securities |
| 2,214 |
| 2,785 |
Interest on interest earning deposits with banks and other short-term investments |
| 39 |
| 12 |
Total interest and dividend income |
| 13,015 |
| 13,547 |
INTEREST EXPENSE |
|
|
|
|
Savings, interest bearing checking and money market accounts |
| 430 |
| 167 |
Time deposits $100 thousand and greater |
| 181 |
| 235 |
Other time deposits |
| 291 |
| 344 |
Securities sold under agreement to repurchase and other short-term debt |
| 92 |
| 357 |
Long-term debt |
| 197 |
| 196 |
Total interest expense |
| 1,191 |
| 1,299 |
Net interest income |
| 11,824 |
| 12,248 |
Provision for credit losses |
| 100 |
| 250 |
Net interest income after provision for credit losses |
| 11,724 |
| 11,998 |
NONINTEREST INCOME |
|
|
|
|
Net gains on investment securities |
| 126 |
| - |
Trust division income |
| 852 |
| 758 |
Service charges on deposits |
| 944 |
| 985 |
Net debit card income |
| 621 |
| 654 |
Other |
| 367 |
| 250 |
Total noninterest income |
| 2,910 |
| 2,647 |
NONINTEREST EXPENSE |
|
|
|
|
Compensation and benefits |
| 4,923 |
| 4,795 |
Occupancy expense |
| 1,168 |
| 1,064 |
Equipment expense |
| 1,083 |
| 946 |
Legal and professional fees |
| 698 |
| 687 |
Marketing |
| 319 |
| 280 |
State franchise taxes |
| 377 |
| 357 |
FDIC insurance |
| 216 |
| 220 |
Other Real Estate Owned ("OREO") expenses |
| 16 |
| 13 |
Other |
| 1,354 |
| 1,387 |
Total noninterest expense |
| 10,154 |
| 9,749 |
Income before provision for income taxes |
| 4,480 |
| 4,896 |
Provision for income taxes |
| 1,077 |
| 1,287 |
NET INCOME | $ | 3,403 | $ | 3,609 |
|
|
|
|
|
Basic earnings per common share | $ | 0.54 | $ | 0.57 |
Diluted earnings per common share | $ | 0.54 | $ | 0.57 |
See accompanying notes to unaudited consolidated financial statements
4
Consolidated Statements of Comprehensive Income (Loss)
(Unaudited)
|
|
|
|
|
| Three Months Ended | |||
| March 31, | |||
(In thousands) | 2014 | 2013 | ||
Net income | $ | 3,403 | $ | 3,609 |
Other comprehensive income (loss), net of tax: |
|
|
|
|
Change in net unrealized gain (loss) on securities available for sale, |
| 784 |
| (1,285) |
Unrealized holding gain arising during the period for securities transferred |
| 8 |
| 0 |
Accretion of unrealized holding losses of securities transferred from |
| 113 |
| 0 |
Reclassification adjustments for net securities gains included in net income, |
| (82) |
| 0 |
Change in net unrealized loss on interest rate swaps, |
| 41 |
| 48 |
Pension liability adjustment, net of taxes of $11 and $32 |
| 21 |
| 60 |
Other comprehensive income (loss) |
| 885 |
| (1,177) |
Comprehensive income | $ | 4,288 | $ | 2,432 |
See accompanying notes to unaudited consolidated financial statements
5
Merchants Bancshares, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
|
|
|
|
|
| Three Months Ended March 31, | |||
(In thousands) | 2014 | 2013 | ||
CASH FLOWS FROM OPERATING ACTIVITIES: |
|
|
|
|
Net income | $ | 3,403 | $ | 3,609 |
Adjustments to reconcile net income to net cash provided by operating activities: |
|
|
|
|
Provision for loan losses |
| 100 |
| 250 |
Depreciation and amortization |
| 632 |
| 512 |
Amortization of investment security premiums and accretion of discounts, net |
| 136 |
| 402 |
Stock based compensation |
| 46 |
| 46 |
Net gain on sales of investment securities |
| (126) |
| - |
Accretion of deferred gain on sale of premises |
| (129) |
| - |
Gains on sale of other real estate owned |
| (12) |
| - |
Equity in losses of real estate limited partnerships, net |
| 327 |
| 270 |
Increase in cash surrender value of bank owned life insurance |
| (80) |
| - |
Changes in assets and liabilities: |
|
|
|
|
Net change in interest receivable |
| (335) |
| (912) |
Net change in other assets |
| 1,069 |
| 707 |
Net change in interest payable |
| (29) |
| (3) |
Net change in other liabilities |
| (593) |
| (2,111) |
Net cash provided by operating activities |
| 4,409 |
| 2,770 |
CASH FLOWS FROM INVESTING ACTIVITIES: |
|
|
|
|
Proceeds from sales of investment securities available for sale |
| 26,641 |
| - |
Proceeds from maturities of investment securities available for sale |
| 9,556 |
| 39,112 |
Proceeds from maturities of investment securities held to maturity |
| 3,195 |
| 41 |
Proceeds from redemption of Federal Home Loan Bank stock |
| - |
| 649 |
Purchases of investment securities available for sale |
| (10,135) |
| (40,804) |
Loan originations in excess of principal payments |
| (5,503) |
| (18,764) |
Proceeds from sale of premises and equipment |
| - |
| 1 |
Proceeds from sales of other real estate owned |
| 36 |
| - |
Real estate limited partnership investments |
| (25) |
| (46) |
Purchases of bank premises and equipment |
| (247) |
| (879) |
Net cash provided by (used in) investing activities |
| 23,518 |
| (20,690) |
CASH FLOWS FROM FINANCING ACTIVITIES: |
|
|
|
|
Net increase (decrease) in deposits |
| 2,481 |
| (1,303) |
Net increase in short-term borrowings |
| - |
| 30,900 |
Net decrease in securities sold under agreement to repurchase, short-term |
| (67,667) |
| (44,316) |
Principal payments on long-term debt |
| (21) |
| (20) |
Cash dividends paid |
| (1,770) |
| (1,606) |
Sale of treasury stock |
| - |
| 7 |
Increase in deferred compensation arrangements |
| 63 |
| 53 |
Net cash used in financing activities |
| (66,914) |
| (16,285) |
Decrease in cash and cash equivalents |
| (38,987) | - | (34,205) |
Cash and cash equivalents beginning of period |
| 115,471 |
| 77,228 |
Cash and cash equivalents end of period | $ | 76,484 | $ | 43,023 |
|
|
|
|
|
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: |
|
|
|
|
Total interest payments | $ | 1,220 | $ | 1,302 |
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES |
|
|
|
|
Distribution of stock under deferred compensation arrangements | $ | 553 | $ | 446 |
Distribution of treasury stock in lieu of cash dividend under dividend reinvestment plan |
| - |
| 154 |
Transfer of securities from available for sale to held to maturity |
| 12,626 |
| - |
|
|
|
|
|
See accompanying notes to consolidated financial statements |
6
Notes To Interim Unaudited Consolidated Financial Statements
For additional information, see the Merchants Bancshares, Inc. (“Merchants,” “we,” “us,” “our”) Annual Report on Form 10-K for the fiscal year ended December 31, 2013, filed with the Securities and Exchange Commission (the “SEC”) on March 10, 2014.
NOTE 1: FINANCIAL STATEMENT PRESENTATION
Principles of Consolidation
The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to the Quarterly Report on Form 10-Q and Rule 10-01 of Regulation S-X promulgated under the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements. All adjustments necessary for a fair presentation of our interim consolidated financial statements as of March 31, 2014 and December 31, 2013 and for the three months ended March 31, 2014 and 2013 have been included. The information was prepared from our unaudited financial statements and the unaudited financial statements of our subsidiaries, Merchants Bank and MBVT Statutory Trust I. Amounts reported for prior periods are reclassified, where necessary, to be consistent with the current period presentation.
Management’s Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in conformity with U.S. Generally Accepted Accounting Principles (“GAAP”) requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of income and expenses during the reporting periods. The most significant estimates include those used in determining the allowance for credit losses, income taxes, interest income recognition on loans and investments and analysis of other-than-temporary impairment of our investment securities portfolio. Operating results in the future may vary from the amounts derived from Management's estimates and assumptions.
NOTE 2: RECENT ACCOUNTING PRONOUNCEMENTS
In January 2014, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2014-01, “Investments – Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects.” The amendments in this ASU modify the conditions that a reporting entity must meet to be eligible to use a method other than the equity or cost methods to account for qualified affordable housing project investments. If the modified conditions are met, the amendments permit an entity to amortize the initial cost of the investment in proportion to the amount of tax credits and other tax benefits received and recognize the net investment performance in the income statement as a component of income tax expense (benefit). Additionally, the amendments introduce new recurring disclosures about all investments in qualified affordable housing projects irrespective of the method used to account for the investments. The amendments in this ASU are effective for public entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. In the first quarter of 2014, we early adopted this ASU for the reporting of our equity investments in qualified affordable housing projects. The investments are recorded using the proportional amortization method whereby an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The application of this standard reduced total noninterest expense by $327 and $270 thousand for the quarters ended March 31, 2014 and March 31, 2013, respectively, and increased income tax expense by an equivalent amount. The application of the standard also increased our effective tax rate to 24% and 26% from 18% and 22% for the same periods. This ASU was applied retrospectively and prior periods have been reclassified accordingly.
7
NOTE 3: INVESTMENT SECURITIES
Investments in securities are classified as available for sale or held to maturity as of March 31, 2014 and December 31, 2013. The amortized cost and fair values of the securities classified as available for sale and held to maturity as of March 31, 2014 are as follows:
|
|
|
|
|
|
| Gross | Gross |
|
| Amortized | Unrealized | Unrealized | Fair |
(In thousands) | Cost | Gains | Losses | Value |
Available for Sale: |
|
|
|
|
U.S. Treasury Obligations | $ 100 | $ - | $ - | $ 100 |
Residential Real Estate Mortgage-backed Securities ("Agency MBSs") | 96,952 | 2,715 | 1,010 | 98,657 |
Agency Commercial Mortgage Backed Securities ("Agency CMBSs") | 18,261 | - | 635 | 17,626 |
Agency Collateralized Mortgage Obligations ("Agency CMOs") | 78,738 | 241 | 518 | 78,461 |
Collateralized Loan Obligations ("CLOs") | 19,688 | 34 | - | 19,722 |
Asset Backed Securities ("ABSs") | 357 | 34 | - | 391 |
Total Available for Sale | $ 214,096 | $ 3,024 | $ 2,163 | $ 214,957 |
|
| Gross | Gross |
|
| Amortized | Unrecognized | Unrecognized | Fair |
(In thousands) | Cost | Gains | Losses | Value |
Held to Maturity: |
|
|
|
|
U.S. Agency Obligations | $ 23,104 | $ 23 | $ 335 | 22,792 |
U.S. Government Sponsored Enterprises ("U.S. GSEs") | 9,456 | - | 319 | 9,137 |
Federal Home Loan Bank ("FHLB") Obligations | 4,693 | - | 75 | 4,618 |
Agency Collateralized Mortgage Obligations | 104,321 | 4 | 2,147 | 102,178 |
Agency MBSs | 8,808 | 24 | 77 | 8,755 |
Total Held to Maturity | $ 150,382 | $ 51 | $ 2,953 | $ 147,480 |
The amortized cost and fair values of the securities classified as available for sale and held to maturity as of December 31, 2013 are as follows:
|
|
|
|
|
|
| Gross | Gross |
|
| Amortized | Unrealized | Unrealized | Fair |
(In thousands) | Cost | Gains | Losses | Value |
Available for Sale: |
|
|
|
|
U.S. Treasury Obligations | $ 100 | $ - | $ - | $ 100 |
Agency MBSs | 97,882 | 2,876 | 1,487 | 99,271 |
Agency CMBSs | 18,398 | - | 760 | 17,638 |
Agency CMOs | 98,162 | 254 | 1,207 | 97,209 |
CLOs | 37,834 | 73 | - | 37,907 |
ABSs | 357 | 31 | - | 388 |
Total Available for Sale | $ 252,733 | $ 3,234 | $ 3,454 | $ 252,513 |
|
| Gross | Gross |
|
| Amortized | Unrecognized | Unrecognized | Fair |
(In thousands) | Cost | Gains | Losses | Value |
Held to Maturity: |
|
|
|
|
U.S. Agency Obligations | $ 23,580 | $ - | $ 458 | $ 23,122 |
U.S. GSEs | 9,442 | - | 512 | 8,930 |
FHLB Obligations | 4,684 | - | 191 | 4,493 |
Agency Collateralized Mortgage Obligations | 94,105 | - | 2,426 | 91,679 |
Agency MBSs | 9,015 | 25 | 177 | 8,863 |
Total Held to Maturity | $ 140,826 | $ 25 | $ 3,764 | $ 137,087 |
8
The contractual final maturity distribution of the debt securities classified as available for sale as of March 31, 2014, are as follows:
|
|
|
|
|
|
|
| After One | After Five |
|
|
| Within | But Within | But Within | After Ten |
|
(In thousands) | One Year | Five Years | Ten Years | Years | Total |
Available for Sale (at fair value): |
|
|
|
|
|
U.S. Treasury Obligations | $ 100 | $ - | $ - | $ - | $ 100 |
Agency MBSs | 50 | 3,842 | 18,853 | 75,912 | 98,657 |
Agency CMBSs | - | - | 13,258 | 4,368 | 17,626 |
Agency CMOs | - | - | 2,881 | 75,580 | 78,461 |
CLOs | - | - | 9,834 | 9,888 | 19,722 |
ABSs | - | - | - | 391 | 391 |
Total Available for Sale | $ 150 | $ 3,842 | $ 44,826 | $ 166,139 | $ 214,957 |
Available for Sale (at amortized cost): |
|
|
|
|
|
U.S. Treasury Obligations | $ 100 | $ - | $ - | $ - | $ 100 |
Agency MBSs | 47 | 3,616 | 18,125 | 75,164 | 96,952 |
Agency CMBSs | - | - | 13,696 | 4,565 | 18,261 |
Agency CMOs | - | - | 2,877 | 75,861 | 78,738 |
CLOs | - | - | 9,800 | 9,888 | 19,688 |
ABSs | - | - | - | 357 | 357 |
Total Available for Sale | $ 147 | $ 3,616 | $ 44,498 | $ 165,835 | $ 214,096 |
The contractual final maturity distribution of the debt securities classified as held to maturity as of March 31, 2014, are as follows:
|
|
|
|
|
|
|
| After One | After Five |
|
|
| Within | But Within | But Within | After Ten |
|
(In thousands) | One Year | Five Years | Ten Years | Years | Total |
Held to Maturity (at fair value): |
|
|
|
|
|
U.S. Agency Obligations | $ - | $ - | $ - | $ 22,792 | $ 22,792 |
U.S. GSEs | - | - | 9,137 | - | 9,137 |
FHLB Obligations | - | - | 4,618 | - | 4,618 |
Agency MBSs | 3 | 23 | 59 | 8,670 | 8,755 |
Agency CMOs | - | - | - | 102,178 | 102,178 |
Total Held to Maturity | $ 3 | $ 23 | $ 13,814 | $ 133,640 | $ 147,480 |
Held to Maturity (at amortized cost): |
|
|
|
|
|
U.S. Agency Obligations | $ - | $ - | $ - | $ 23,104 | $ 23,104 |
U.S. GSEs | - | - | 9,456 | - | 9,456 |
FHLB Obligations | - | - | 4,693 | - | 4,693 |
Agency MBSs | 3 | 22 | 52 | 8,731 | 8,808 |
Agency CMOs | - | - | - | 104,321 | 104,321 |
Total Held to Maturity | $ 3 | $ 22 | $ 14,201 | $ 136,156 | $ 150,382 |
Actual maturities will differ from contractual maturities because borrowers may have rights to call or prepay obligations. Maturities of Agency MBSs and Agency CMOs in the tables above are based on final contractual maturities.
The following table presents the proceeds, gross gains and gross losses on available for sale securities for the three months ended March 31, 2014 and 2013.
|
|
|
(In thousands) | 2014 | 2013 |
Proceeds | $ 26,641 | $ - |
Gross gains | 225 | - |
Gross losses | (99) | - |
Net gains | $ 126 | $ - |
Securities with a carrying amount of $265.55 million and $315.53 million at March 31, 2014 and December 31, 2013, respectively, were pledged to secure U.S. Treasury borrowings, public deposits, securities sold under agreements to repurchase, and for other purposes required by law.
9
Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in continuous unrealized loss position, at March 31, 2014, were as follows:
|
|
|
|
|
|
|
| Less Than 12 Months | 12 Months or More | Total | |||
| Fair |
| Fair |
| Fair |
|
(In thousands) | Value | Loss | Value | Loss | Value | Loss |
Available for Sale: |
|
|
|
|
|
|
Agency MBSs | $ 44,760 | $ 1,010 | $ - | $ - | $ 44,760 | $ 1,010 |
Agency CMBSs | 12,758 | 487 | 4,868 | 148 | 17,626 | 635 |
Agency CMOs | 47,233 | 518 | - | - | 47,233 | 518 |
Total Available for Sale | $ 104,751 | $ 2,015 | $ 4,868 | $ 148 | $ 109,619 | $ 2,163 |
Held to Maturity: |
|
|
|
|
|
|
U.S. Agency Obligations | $ 4,468 | $ 37 | $ 15,172 | $ 298 | $ 19,640 | $ 335 |
U.S. GSEs | 9,137 | 319 | - | - | 9,137 | 319 |
FHLB Obligations | 4,618 | 75 | - | - | 4,618 | 75 |
Agency CMOs | 65,161 | 1,160 | 33,904 | 987 | 99,065 | 2,147 |
Agency MBSs | 8,522 | 77 | - | - | 8,522 | 77 |
Total Held to Maturity | $ 91,906 | $ 1,668 | $ 49,076 | $ 1,285 | $ 140,982 | $ 2,953 |
Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in continuous unrealized loss position over our entire holding period, at December 31, 2013, were as follows:
|
|
|
|
|
|
|
| Less Than 12 Months | 12 Months or More | Total | |||
| Fair |
| Fair |
| Fair |
|
(In thousands) | Value | Loss | Value | Loss | Value | Loss |
Available for Sale: |
|
|
|
|
|
|
Agency MBSs | $ 46,547 | $ 1,487 | $ - | $ - | $ 46,547 | $ 1,487 |
Agency CMBSs | 12,778 | 578 | 4,860 | 182 | 17,638 | 760 |
Agency CMOs | 57,904 | 977 | 3,557 | 230 | 61,461 | 1,207 |
Total Available for Sale | $ 117,229 | $ 3,042 | $ 8,417 | $ 412 | $ 125,646 | $ 3,454 |
Held to Maturity: |
|
|
|
|
|
|
U.S. Agency Obligations | $ 13,722 | $ 307 | $ 9,400 | $ 151 | $ 23,122 | $ 458 |
U.S. GSEs | 8,930 | 512 | - | - | 8,930 | 512 |
FHLB Obligations | 4,493 | 191 | - | - | 4,493 | 191 |
Agency CMOs | 66,203 | 1,410 | 25,476 | 1,016 | 91,679 | 2,426 |
Agency MBSs | 8,569 | 177 | - | - | 8,569 | 177 |
Total Held to Maturity | $ 101,917 | $ 2,597 | $ 34,876 | $ 1,167 | $ 136,793 | $ 3,764 |
There were no securities classified as trading at March 31, 2014 and December 31, 2013.
Unrealized losses on investment securities result from the cost basis of the security being higher than its current fair value. These discrepancies generally occur because of changes in interest rates since the time of purchase, or because the credit quality of the issuer has deteriorated. We perform a quarterly analysis of each security in our portfolio to determine if impairment exists, and if it does, whether that impairment is other-than-temporary.
At March 31, 2014, all of our MBSs and CMOs held were issued by U.S. government-sponsored entities and agencies, primarily Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corp (“FHLMC”), institutions which the government has affirmed its commitment to support. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because we do not have the intent to sell these securities and it is not likely that we will be required to sell the securities before their anticipated recovery, we do not consider these securities to be other-than-temporarily impaired at March 31, 2014.
Under the Volcker Rule, we may be required to divest some or all of our CLOs by July of 2017. We took an impairment charge totaling $166 thousand related to our CLO portfolio during 2013 and have sold $17.52 million of our CLOs for a small gain during the first quarter of 2014.
10
Agency MBSs and Agency CMOs consist of pools of residential mortgages which are guaranteed by FNMA, FHLMC, or Government National Mortgage Association (“GNMA”) with various origination dates and maturities. Agency CMBS consists of bonds backed by commercial real estate which are guaranteed by FNMA and GNMA. CLOs are floating rate securities that consist primarily of pools of senior secured commercial loans structured to provide very strong over collateralization and subordination. All of our CLOs are the senior AAA tranche and are the first bond to get paid down. Additionally, we monitor individual bonds that experience greater levels prepayment or market volatility.
We use external pricing services to obtain fair market values for our investment portfolio. We have obtained and reviewed the service providers’ pricing and reference data documentation. Evaluations are based on market data and vary by asset class and incorporate available trade, bid and other market information. Because many fixed income securities do not trade on a daily basis, the service provider’s evaluated pricing applications apply available information as applicable through processes such as benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing, to prepare evaluations. In addition, model processes, such as the Option Adjusted Spread model are used to assess interest rate impact and develop prepayment scenarios, with inputs determined based on knowledge of the market. For CLOs, the issuer, structure, collateral type, performance and deal and class triggers are also reviewed. We periodically test the values provided to us by the pricing service through a combination of back testing on actual sales of securities and by obtaining prices on all bonds from an alternative pricing source.
We do not intend to sell the investment securities that are in an unrealized loss position, and it is unlikely that we will be required to sell the investment securities before recovery of their amortized cost bases, which may be maturity.
During the first quarter of 2014, we transferred securities with a total amortized cost of $12.63 million with a corresponding fair value of $12.64 million from available for sale to held to maturity. The net unrealized gain, net of taxes, on these securities at the dates of the transfers was $8.31 thousand. The unrealized holding gain at the time of transfer continues to be reported in accumulated other comprehensive income, net of tax and is amortized over the remaining lives of the securities as an adjustment of the yield. The amortization of the unamortized holding loss reported in accumulated other comprehensive income will offset the effect on interest income of the discount for the transferred securities. The remaining unamortized balance of the losses for the securities transferred from available for sale to held to maturity during 2013 and 2014 was $4.88 million, or $3.18 million, net of tax, at March 31, 2014.
NOTE 4: LOANS AND THE ALLOWANCE FOR CREDIT LOSSES
The composition of our loan portfolio at March 31, 2014 and December 31, 2013 was as follows:
|
|
|
|
|
(In thousands) |
| March 31, 2014 |
| December 31, 2013 |
Commercial, financial and agricultural | $ | 190,840 | $ | 172,810 |
Municipal loans |
| 93,176 |
| 94,007 |
Real estate loans – residential |
| 482,775 |
| 489,706 |
Real estate loans – commercial |
| 372,155 |
| 371,319 |
Real estate loans – construction |
| 27,567 |
| 31,841 |
Installment loans |
| 4,993 |
| 5,655 |
All other loans |
| 231 |
| 895 |
Total loans | $ | 1,171,737 | $ | 1,166,233 |
We primarily originate residential real estate, commercial, commercial real estate, municipal obligations and installment loans to customers throughout the state of Vermont. There are no significant industry concentrations in the loan portfolio. Total loans in the table above included $587 thousand and $618 thousand of net deferred loan origination cost at March 31, 2014 and December 31, 2013, respectively. The aggregate amount of overdrawn deposit balances classified as loan balances was $231 thousand and $895 thousand at March 31, 2014 and December 31, 2013, respectively.
11
The following table reflects our loan loss experience and activity in the allowance for credit losses by portfolio segment for the three months ended March 31, 2014:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Commercial, |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| financial and |
|
|
| Real estate- |
| Real estate- |
| Real estate- |
|
|
|
|
|
|
(In thousands) |
| agricultural |
| Municipal |
| residential |
| commercial |
| construction |
| Installment |
| All Other |
| Total |
Allowance for credit losses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning balance | $ | 3,354 | $ | 768 | $ | 3,081 | $ | 5,085 | $ | 512 | $ | 18 | $ | 10 | $ | 12,828 |
Charge-offs |
| - |
| - |
| (2) |
| - |
| - |
| - |
| (20) |
| (22) |
Recoveries |
| 2 |
| - |
| 18 |
| - |
| - |
| - |
| 3 |
| 23 |
Provision (credit) |
| 22 |
| (75) |
| 255 |
| 34 |
| (152) |
| - |
| 16 |
| 100 |
Ending balance | $ | 3,378 | $ | 693 | $ | 3,352 | $ | 5,119 | $ | 360 | $ | 18 | $ | 9 | $ | 12,929 |
The following table reflects our loan loss experience and activity in the allowance for credit losses by portfolio segment for the three months ended March 31, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Commercial, |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| financial and |
|
|
| Real estate- |
| Real estate- |
| Real estate- |
|
|
|
|
|
|
(In thousands) |
| agricultural |
| Municipal |
| residential |
| commercial |
| construction |
| Installment |
| All Other |
| Total |
Allowance for credit losses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning balance | $ | 3,447 | $ | 522 | $ | 3,582 | $ | 4,499 | $ | 234 | $ | 17 | $ | 11 | $ | 12,312 |
Charge-offs |
| - |
| - |
| (7) |
| (1) |
| - |
| - |
| (20) |
| (28) |
Recoveries |
| 9 |
| - |
| 3 |
| 40 |
| 1 |
| - |
| 1 |
| 54 |
Provision (credit) |
| (45) |
| 133 |
| 130 |
| (27) |
| 40 |
| (1) |
| 20 |
| 250 |
Ending balance | $ | 3,411 | $ | 655 | $ | 3,708 | $ | 4,511 | $ | 275 | $ | 16 | $ | 12 | $ | 12,588 |
The allowance for credit losses consists of the allowance for loan losses and the reserve for undisbursed lines of credit. The reserve for undisbursed lines of credit is included in other liabilities on the balance sheet. The following presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based upon impairment method at March 31, 2014:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Commercial, |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| financial and |
|
|
| Real estate- |
| Real estate- |
| Real estate- |
|
|
|
|
|
|
(In thousands) |
| agricultural |
| Municipal |
| residential |
| commercial |
| construction |
| Installment |
| All Other |
| Total |
Allowance for credit losses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending balance individually | $ | 1 | $ | - | $ | 63 | $ | 68 | $ | - | $ | - | $ | - | $ | 132 |
Ending balance collectively |
| 3,377 |
| 693 |
| 3,289 |
| 5,051 |
| 360 |
| 18 |
| 9 |
| 12,797 |
Totals | $ | 3,378 | $ | 693 | $ | 3,352 | $ | 5,119 | $ | 360 | $ | 18 | $ | 9 | $ | 12,929 |
Financing receivables: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending balance individually | $ | 120 | $ | - | $ | 724 | $ | 162 | $ | - | $ | - | $ | - | $ | 1,006 |
Ending balance collectively |
| 190,720 |
| 93,176 |
| 482,051 |
| 371,993 |
| 27,567 |
| 4,993 |
| 231 |
| 1,170,731 |
Totals | $ | 190,840 | $ | 93,176 | $ | 482,775 | $ | 372,155 | $ | 27,567 | $ | 4,993 | $ | 231 | $ | 1,171,737 |
Components: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for loan losses | $ | 2,792 | $ | 681 | $ | 3,260 | $ | 5,077 | $ | 340 | $ | 15 | $ | 9 | $ | 12,174 |
Reserve for undisbursed |
| 586 |
| 12 |
| 92 |
| 42 |
| 20 |
| 3 |
| - |
| 755 |
Total allowance for | $ | 3,378 | $ | 693 | $ | 3,352 | $ | 5,119 | $ | 360 | $ | 18 | $ | 9 | $ | 12,929 |
12
The following presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based upon impairment method at December 31, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Commercial, |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| financial and |
|
|
| Real estate- |
| Real estate- |
| Real estate- |
|
|
|
|
|
|
(In thousands) |
| agricultural |
| Municipal |
| residential |
| commercial |
| construction |
| Installment |
| All Other |
| Total |
Allowance for credit losses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending balance individually | $ | 2 | $ | - | $ | 41 | $ | 69 | $ | - | $ | - | $ | - | $ | 112 |
Ending balance collectively |
| 3,352 |
| 768 |
| 3,040 |
| 5,016 |
| 512 |
| 18 |
| 10 |
| 12,716 |
Totals | $ | 3,354 | $ | 768 | $ | 3,081 | $ | 5,085 | $ | 512 | $ | 18 | $ | 10 | $ | 12,828 |
Financing receivables: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending balance individually | $ | 20 | $ | - | $ | 722 | $ | 164 | $ | - | $ | - | $ | - | $ | 906 |
Ending balance collectively |
| 172,790 |
| 94,007 |
| 488,984 |
| 371,155 |
| 31,841 |
| 5,655 |
| 895 |
| 1,165,327 |
Totals | $ | 172,810 | $ | 94,007 | $ | 489,706 | $ | 371,319 | $ | 31,841 | $ | 5,655 | $ | 895 | $ | 1,166,233 |
Components: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for loan losses | $ | 2,740 | $ | 758 | $ | 2,995 | $ | 5,040 | $ | 481 | $ | 18 | $ | 10 | $ | 12,042 |
Reserve for undisbursed |
| 614 |
| 10 |
| 86 |
| 45 |
| 31 |
| - |
| - |
| 786 |
Total allowance for credit losses | $ | 3,354 | $ | 768 | $ | 3,081 | $ | 5,085 | $ | 512 | $ | 18 | $ | 10 | $ | 12,828 |
The table below presents the recorded investment of loans, including nonaccrual and restructured loans, segregated by class, with delinquency aging as of March 31, 2014:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Greater |
|
| 30-59 |
| 60-89 |
| 90 Days |
|
|
|
|
|
|
| Than 90 |
|
| Days |
| Days |
| or More |
| Total Past |
|
|
|
|
| Days and |
(In thousands) |
| Past Due |
| Past Due |
| Past Due |
| Due |
| Current |
| Total |
| Accruing |
Commercial, financial and agricultural | $ | 146 | $ | - | $ | 19 | $ | 165 | $ | 190,675 | $ | 190,840 | $ | - |
Municipal |
| - |
| - |
| - |
| - |
| 93,176 |
| 93,176 |
| - |
Real estate-residential: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First mortgage |
| 511 |
| 133 |
| 233 |
| 877 |
| 445,029 |
| 445,906 |
| - |
Second mortgage |
| 72 |
| - |
| 168 |
| 240 |
| 36,629 |
| 36,869 |
| 79 |
Real estate-commercial: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Owner occupied |
| 734 |
| 231 |
| - |
| 965 |
| 224,967 |
| 225,932 |
| - |
Non-owner occupied |
| 522 |
| - |
| - |
| 522 |
| 145,701 |
| 146,223 |
| - |
Real estate-construction: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential |
| - |
| - |
| - |
| - |
| 2,603 |
| 2,603 |
| - |
Commercial |
| - |
| - |
| - |
| - |
| 24,964 |
| 24,964 |
| - |
Installment |
| - |
| - |
| - |
| - |
| 4,993 |
| 4,993 |
| - |
Other |
| - |
| - |
| - |
| - |
| 231 |
| 231 |
| - |
Total | $ | 1,985 | $ | 364 | $ | 420 | $ | 2,769 | $ | 1,168,968 | $ | 1,171,737 | $ | 79 |
Of the total past due loans in the aging table above, $709 thousand are non-performing of which $162 thousand are restructured loans and $79 thousand were greater than 90 days past due and accruing. There were $2.06 million past due performing loans at March 31, 2014.
13
The table below presents the recorded investment of loans, including nonaccrual and restructured loans, segregated by class, with delinquency aging as of December 31, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Greater |
|
| 30-59 |
| 60-89 |
| 90 Days |
|
|
|
|
|
|
| Than 90 |
|
| Days |
| Days |
| or More |
| Total Past |
|
|
|
|
| Days and |
(In thousands) |
| Past Due |
| Past Due |
| Past Due |
| Due |
| Current |
| Total |
| Accruing |
Commercial, financial and agricultural | $ | - | $ | - | $ | 20 | $ | 20 | $ | 172,790 | $ | 172,810 | $ | - |
Municipal |
| - |
| - |
| - |
| - |
| 94,007 |
| 94,007 |
| - |
Real estate-residential: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First mortgage |
| 4 |
| 294 |
| 341 |
| 639 |
| 452,440 |
| 453,079 |
| - |
Second mortgage |
| - |
| 4 |
| 181 |
| 185 |
| 36,442 |
| 36,627 |
| 75 |
Real estate-commercial: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Owner occupied |
| - |
| - |
| - |
| - |
| 224,416 |
| 224,416 |
| - |
Non-owner occupied |
| 72 |
| - |
| - |
| 72 |
| 146,831 |
| 146,903 |
| - |
Real estate-construction: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential |
| - |
| - |
| - |
| - |
| 2,495 |
| 2,495 |
| - |
Commercial |
| - |
| - |
| - |
| - |
| 29,346 |
| 29,346 |
| - |
Installment |
| - |
| - |
| - |
| - |
| 5,655 |
| 5,655 |
| - |
Other |
| - |
| - |
| - |
| - |
| 895 |
| 895 |
| - |
Total | $ | 76 | $ | 298 | $ | 542 | $ | 916 | $ | 1,165,317 | $ | 1,166,233 | $ | 75 |
Of the total past due loans in the aging table above, $542 thousand are non-performing of which $42 thousand are restructured loans and $75 thousand were greater than 90 days past due and accruing. There were $374 thousand past due performing loans at December 31, 2013.
Impaired loans by class at March 31, 2014 and for the three months ended March 31, 2014 are as follows:
|
|
|
|
|
|
|
|
|
| Three Months Ended | |
|
|
|
| March 31, 2014 | |
|
| Unpaid |
| Average | Interest |
| Recorded | Principal | Related | Recorded | Income |
(In thousands) | Investment | Balance | Allowance | Investment | Recognized |
With no related allowance recorded |
|
|
|
|
|
Commercial, financial and agricultural | $ 101 | $ 101 | $ - | $ 34 | $ - |
Real estate – residential: |
|
|
|
|
|
First mortgage | 325 | 440 | - | 264 | 2 |
Second mortgage | 168 | 169 | - | 174 | - |
With related allowance recorded |
|
|
|
|
|
Commercial, financial and agricultural | 19 | 19 | 1 | 19 | - |
Real estate – residential: |
|
|
|
|
|
First mortgage | 231 | 236 | 63 | 164 | - |
Real estate – commercial: |
|
|
|
|
|
Owner occupied | 162 | 175 | 68 | 162 | - |
Total |
|
|
|
|
|
Commercial, financial and agricultural | 120 | 120 | 1 | 53 | - |
Real estate – residential | 724 | 845 | 63 | 602 | 2 |
Real estate – commercial | 162 | 175 | 68 | 162 | - |
Total | $ 1,006 | $ 1,140 | $ 132 | $ 817 | $ 2 |
14
Impaired loans by class at December 31, 2013 and for the three months ended March 31, 2013 are as follows:
|
|
|
|
|
|
|
|
|
| Three Months Ended | |
|
|
|
| March 31, 2013 | |
|
| Unpaid |
| Average | Interest |
| Recorded | Principal | Related | Recorded | Income |
(In thousands) | Investment | Balance | Allowance | Investment | Recognized |
With no related allowance recorded |
|
|
|
|
|
Commercial, financial and agricultural | $ - | $ - | $ - | $ 107 | $ 8 |
Real estate – residential: |
|
|
|
|
|
First mortgage | 410 | 629 | - | 841 | 33 |
Second mortgage | 181 | 218 | - | 67 | - |
Real estate – commercial: |
|
|
|
|
|
Owner occupied | - | - | - | 36 | 15 |
Installment | - | - | - | 3 | - |
With related allowance recorded |
|
|
|
|
|
Commercial, financial and agricultural | 20 | 21 | 2 | 414 | - |
Real estate – residential: |
|
|
|
|
|
First mortgage | 131 | 135 | 41 | 677 | - |
Second mortgage | - | - | - | 700 | - |
Real estate – commercial: |
|
|
|
|
|
Owner occupied | 164 | 175 | 69 | 174 | - |
Installment | - | - | - | 3 | - |
Total |
|
|
|
|
|
Commercial, financial and agricultural | 20 | 21 | 2 | 521 | 8 |
Real estate – residential | 722 | 982 | 41 | 2,285 | 33 |
Real estate – commercial | 164 | 175 | 69 | 210 | 15 |
Installment | - | - | - | 6 | - |
Total | $ 906 | $ 1,178 | $ 112 | $ 3,022 | $ 56 |
Residential and commercial loans serviced for others at March 31, 2014 and December 31, 2013 amounted to approximately $13.21 million and $13.83 million, respectively.
Nonperforming loans at March 31, 2014 and December 31, 2013 are as follows:
|
|
|
|
|
(In thousands) |
| March 31, 2014 |
| December 31, 2013 |
Nonaccrual loans | $ | 473 | $ | 425 |
Loans greater than 90 days and accruing |
| 79 |
| 75 |
Troubled debt restructurings ("TDRs") |
| 454 | $ | 406 |
Total nonperforming loans | $ | 1,006 |
| 906 |
Of the total TDRs in the table above, $187 thousand at March 31, 2014 and $235 thousand at December 31, 2013, are nonaccruing. We have reviewed all restructurings that occurred on or after January 1, 2014 for identification as TDRs. There was one TDR that was restructured during 2014. We did not identify as a TDR any loan for which the allowance for credit losses had been measured under a general allowance for credit losses methodology.
TDRs represent balances where the existing loan was modified involving a concession in rate, term or payment amount due to the distressed financial condition of the borrower. There were six restructured residential mortgages at March 31, 2014 with balances totaling $191 thousand. There were two restructured commercial loans at March 31, 2014 with balances totaling $263 thousand. With the exception of one TDR showing delinquency related to a renewal, all TDRs at March 31, 2014 continue to pay as agreed according to the modified terms and all but two of these loans are considered well-secured. At March 31, 2014, there were no commitments to lend additional funds to borrowers whose loans have been modified in a TDR. We had no commitments to lend additional funds to borrowers whose loans were in nonaccrual status or to borrowers whose loans were 90 days past due and still accruing at March 31, 2014. Interest income on restructured loans during the three months ended March 31, 2014 and 2013 was insignificant.
15
Nonaccrual loans by class as of March 31, 2014 and December 31, 2013 are as follows:
|
|
|
|
|
(In thousands) |
| March 31, 2014 |
| December 31, 2013 |
Commercial, financial and agricultural | $ | 19 | $ | 20 |
Real estate - residential: |
|
|
|
|
First mortgage |
| 365 |
| 299 |
Second mortgage |
| 89 |
| 106 |
Total nonaccruing non-TDR loans |
| 473 |
| 425 |
Nonaccruing TDR’s |
|
|
|
|
Real estate – residential: |
|
|
|
|
First mortgage |
| 26 |
| 71 |
Real estate - commercial: |
|
|
|
|
Owner occupied |
| 162 |
| 164 |
Total nonaccrual loans including TDRs | $ | 661 | $ | 660 |
Commercial Grading System
We use risk rating definitions for our commercial loan portfolios and certain residential loans which are generally consistent with regulatory and banking industry norms. Loans are assigned a credit quality grade which is based upon management’s on-going assessment of risk based upon an evaluation of the quantitative and qualitative aspects of each credit. This assessment is a dynamic process and risk ratings are adjusted as each borrower’s financial situation changes. This process is designed to provide timely recognition of a borrower’s financial condition and appropriately focus management resources.
Pass rated loans exhibit acceptable risk to the bank in terms of financial capacity to repay their loans as well as possessing acceptable fallback repayment sources, typically collateral and personal guarantees. Pass rated commercial loan relationships with a total exposure of $1 million or greater are subject to a formal annual review process; additionally, management reviews the risk rating at the time of any late payments, overdrafts or other sign of deterioration in the interim.
Loans rated Pass-Watch require more than usual attention and monitoring by the account officer, though not to the extent that a formal remediation plan is warranted. Borrowers can be rated Pass-Watch based upon a weakened capital structure, marginally adequate cash flow and/or collateral coverage or early-stage declining trends in operations or financial condition.
Loans rated Special Mention possess potential weakness that may expose the bank to some risk of loss in the future. These loans require more frequent monitoring and formal reporting to Management.
Substandard loans reflect well-defined weaknesses in the current repayment capacity, collateral or net worth of the borrower with the possibility of some loss to the bank if these weaknesses are not corrected. Action plans are required for these loans to address the inherent weakness in the credit and are formally reviewed.
Residential real estate and consumer loans
We do not use a grading system for our performing residential real estate and consumer loans. Credit quality for these loans is based on performance and payment status.
16
Below is a summary of loans by credit quality indicator as of March 31, 2014:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Pass- |
| Special |
| Sub- |
|
|
(In thousands) |
| Unrated |
| Pass |
| Watch |
| Mention |
| Standard |
| Total |
Commercial, financial and agricultural | $ | 229 | $ | 169,830 | $ | 12,200 | $ | 7,136 | $ | 1,445 | $ | 190,840 |
Municipal |
| 18 |
| 64,667 |
| 26,534 |
| 1,957 |
| - |
| 93,176 |
Real estate – residential: |
|
|
|
|
|
|
|
|
|
|
|
|
First mortgage |
| 443,059 |
| 2,417 |
| - |
| 64 |
| 366 |
| 445,906 |
Second mortgage |
| 36,859 |
| - |
| - |
| - |
| 10 |
| 36,869 |
Real estate – commercial: |
|
|
|
|
|
|
|
|
|
|
|
|
Owner occupied |
| 177 |
| 187,602 |
| 15,469 |
| 5,592 |
| 17,092 |
| 225,932 |
Non-owner occupied |
| 143 |
| 132,489 |
| 10,887 |
| 240 |
| 2,464 |
| 146,223 |
Real estate – construction: |
|
|
|
|
|
|
|
|
|
|
|
|
Residential |
| 790 |
| 473 |
| 1,340 |
| - |
| - |
| 2,603 |
Commercial |
| 201 |
| 24,296 |
| 467 |
| - |
| - |
| 24,964 |
Installment |
| 4,953 |
| 40 |
| - |
| - |
| - |
| 4,993 |
All other loans |
| 231 |
| - |
| - |
| - |
| - |
| 231 |
Total | $ | 486,660 | $ | 581,814 | $ | 66,897 | $ | 14,989 | $ | 21,377 | $ | 1,171,737 |
Below is a summary of loans by credit quality indicator as of December 31, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Pass- |
| Special |
| Sub- |
|
|
(In thousands) |
| Unrated Residential and |
| Pass |
| Watch |
| Mention |
| Standard |
| Total |
Commercial, financial and agricultural | $ | 242 | $ | 152,466 | $ | 14,092 | $ | 96 | $ | 5,914 | $ | 172,810 |
Municipal |
| 28 |
| 65,474 |
| 26,548 |
| 1,957 |
| - |
| 94,007 |
Real estate – residential: |
|
|
|
|
|
|
|
|
|
|
|
|
First mortgage |
| 449,951 |
| 2,520 |
| - |
| 65 |
| 543 |
| 453,079 |
Second mortgage |
| 36,599 |
| - |
| - |
| - |
| 28 |
| 36,627 |
Real estate – commercial: |
|
|
|
|
|
|
|
|
|
|
|
|
Owner occupied |
| 165 |
| 187,779 |
| 17,236 |
| 2,342 |
| 16,894 |
| 224,416 |
Non-owner occupied |
| 171 |
| 134,222 |
| 9,841 |
| 270 |
| 2,399 |
| 146,903 |
Real estate – construction: |
|
|
|
|
|
|
|
|
|
|
|
|
Residential |
| 904 |
| 1,591 |
| - |
| - |
| - |
| 2,495 |
Commercial |
| 738 |
| 28,127 |
| 481 |
| - |
| - |
| 29,346 |
Installment |
| 5,655 |
| - |
| - |
| - |
| - |
| 5,655 |
All other loans |
| 895 |
| - |
| - |
| - |
| - |
| 895 |
Total | $ | 495,348 | $ | 572,179 | $ | 68,198 | $ | 4,730 | $ | 25,778 | $ | 1,166,233 |
The amount of interest which was not earned, but which would have been earned had our nonaccrual and restructured loans performed in accordance with their original terms and conditions, was approximately $7 thousand and $38 thousand for the three months ended March 31, 2014 and March 31, 2013, respectively.
It is our policy to make loans to directors, executive officers, and associates of such persons on substantially the same terms, including interest rates and collateral, as those prevailing for comparable lending transactions with other persons.
17
NOTE 5: FAIR VALUE OF FINANCIAL INSTRUMENTS
We record certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are also utilized to determine the initial value of certain assets and liabilities, to perform impairment assessments, and for disclosure purposes. We use quoted market prices and observable inputs to the maximum extent possible when measuring fair value. In the absence of quoted market prices, various valuation techniques are utilized to measure fair value. When possible, observable market data for identical or similar financial instruments are used in the valuation. When market data is not available, fair value is determined using valuation models that incorporate Management’s estimates of the assumptions a market participant would use in pricing the asset or liability.
Our valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While Management believes our valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein. A more detailed description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
Ø | Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. |
Ø | Level 2 - Quoted prices for similar assets or liabilities in active markets, quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability. |
Ø | Level 3 - Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported by little or no market activity). |
A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
The types of instruments valued based on quoted market prices in active markets include most U.S. government and Agency securities, liquid mortgage products, active listed equities and most money market securities. Such instruments are generally classified within Level 1 or Level 2 of the fair value hierarchy. We do not adjust the quoted price for such instruments.
The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include most investment-grade and high-yield corporate bonds, less liquid mortgage products, less liquid Agency securities, less liquid listed equities, state, municipal and provincial obligations, and certain physical commodities. Such instruments are generally classified within Level 2 of the fair value hierarchy.
Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions; valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, Management’s best estimate will be used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Subsequent to inception, Management only changes Level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows.
18
Financial instruments on a recurring basis
The table below presents the balance of financial assets and liabilities at March 31, 2014 measured at fair value on a recurring basis:
|
|
|
|
|
|
| Fair Value Measurements at Reporting Date Using | ||
|
| Quoted Prices in | Signficant |
|
|
| Active Markets | Other | Signficant |
|
| for Idential | Observable | Unobservable |
|
| Assets | Inputs | Inputs |
(In thousands) | Total | (Level 1) | (Level 2) | (Level 3) |
Assets |
|
|
|
|
U.S. Treasury Obligations | $ 100 | $ - | $ 100 | $ - |
Agency MBSs | 98,657 | - | 98,657 | - |
Agency CMBSs | 17,626 | - | 17,626 | - |
Agency CMOs | 78,461 | - | 78,461 | - |
CLOs | 19,722 | - | 19,722 | - |
ABSs | 391 | - | 391 | - |
Interest rate swap agreements | 371 | - | 371 | - |
Total assets | $ 215,328 | $ - | $ 215,328 | $ - |
Liabilities |
|
|
|
|
Interest rate swap agreements | 1,034 | - | 1,034 | - |
Total liabilities | $ 1,034 | $ - | $ 1,034 | $ - |
The table below presents the balance of financial assets and liabilities at December 31, 2013 measured at fair value on a recurring basis:
|
|
|
|
|
|
| Fair Value Measurements at Reporting Date Using | ||
|
| Quoted Prices in | Signficant |
|
|
| Active Markets | Other | Signficant |
|
| for Idential | Observable | Unobservable |
|
| Assets | Inputs | Inputs |
(In thousands) | Total | (Level 1) | (Level 2) | (Level 3) |
Assets |
|
|
|
|
U.S. Treasury Obligations | $ 100 | $ - | $ 100 | $ - |
Agency MBSs | 99,271 | - | 99,271 | - |
Agency CMBSs | 17,638 | - | 17,638 | - |
Agency CMOs | 97,209 | - | 97,209 | - |
CLOs | 37,907 | - | 37,907 | - |
ABSs | 388 | - | 388 | - |
Interest rate swap agreements | 803 | - | 803 | - |
Total assets | $ 253,316 | $ - | $ 253,316 | $ - |
Liabilities |
|
|
|
|
Interest rate swap agreements | 1,529 | - | 1,529 | - |
Total liabilities | $ 1,529 | $ - | $ 1,529 | $ - |
Investment securities are reported at fair value utilizing Level 2 inputs. The prices for these instruments are obtained through an independent pricing service or dealer market participant with whom we have historically transacted both purchases and sales of investment securities. Prices obtained from these sources include market quotations and matrix pricing. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. More information regarding our investment securities can be found in Note 3 to these consolidated financial statements.
The interest rate swaps are reported at their fair value utilizing Level 2 inputs from third parties. The fair value of our interest rate swaps are determined using prices obtained from a third party advisor. The fair value measurement of the interest rate swap is determined by netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on the expectation of future interest rates derived from observed market interest rate curves.
19
There were no transfers between Level 1 and Level 2 for the three months ended March 31, 2014. There were no Level 3 assets measured at fair value on a recurring basis during the three months ended March 31, 2014.
Financial instruments on a non-recurring basis
Certain financial assets are also measured at fair value on a non-recurring basis, however they were not material at March 31, 2014 or December 31, 2013. These financial assets include impaired loans and OREO.
The table below presents the balance of financial assets by class at March 31, 2014 measured at fair value on a nonrecurring basis:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Carrying |
|
|
|
|
(In thousands) | Amount | Fair Value | Level 1 | Level 2 | Level 3 |
Cash and cash equivalents | $ 76,484 | $ 76,484 | $ 76,484 | $ - | $ - |
Securities available for sale | 214,957 | 214,957 | - | 214,957 | - |
Securities held to maturity | 150,382 | 147,480 | - | 147,480 | - |
FHLB stock | 7,496 | N/A | N/A | N/A | N/A |
Loans, net of allowance for loan losses | 1,159,563 | 1,162,339 | - | - | 1,162,339 |
Interest rate contract-cash flow hedge | 371 | 371 | - | 371 | - |
Accrued interest receivable | 4,317 | 4,317 | - | 866 | 3,451 |
Total assets | $ 1,613,570 | $ 1,605,948 | $ 76,484 | $ 363,674 | $ 1,165,790 |
Deposits | $ 1,326,057 | $ 1,326,947 | $ 1,042,684 | $ 284,263 | $ - |
Securities sold under agreement to repurchase | 182,647 | 182,628 | - | 182,628 | - |
Other long-term debt | 2,382 | 2,298 | - | 2,298 | - |
Junior subordinated debentures issued to unconsolidated subsidiary trust | 20,619 | 14,244 | - | 14,244 | - |
Interest rate contract-cash flow hedge | 1,034 | 1,034 | - | 1,034 | - |
Accrued interest payable | 185 | 185 | 15 | 170 | - |
Total liabilities | $ 1,532,924 | $ 1,527,336 | $ 1,042,699 | $ 484,637 | $ - |
The table below presents the balance of financial assets by class at December 31, 2013 measured at fair value on a nonrecurring basis:
|
|
|
|
|
|
| Carrying |
|
|
|
|
(In thousands) | Amount | Fair Value | Level 1 | Level 2 | Level 3 |
Cash and cash equivalents | $ 115,471 | $ 115,471 | $ 115,471 | $ - | $ - |
Securities available for sale | 252,513 | 252,513 | - | 252,513 | - |
Securities held to maturity | 140,826 | 137,087 | - | 137,087 | - |
FHLB stock | 7,496 | N/A | N/A | N/A | N/A |
Loans, net of allowance for loan losses | 1,154,191 | 1,155,348 | - | - | 1,155,348 |
Interest rate swap agreement | 803 | 803 | - | 803 | - |
Accrued interest receivable | 3,982 | 3,982 | - | 958 | 3,024 |
Total assets | $ 1,675,282 | $ 1,665,204 | $ 115,471 | $ 391,361 | $ 1,158,372 |
Deposits | $ 1,323,576 | $ 1,324,634 | $ 1,018,472 | $ 306,162 | $ - |
Securities sold under agreement to repurchase | 250,314 | 250,290 | - | 250,290 | - |
Other long-term debt | 2,403 | 2,287 | - | 2,287 | - |
Junior subordinated debentures issued to unconsolidated subsidiary trust | 20,619 | 14,189 | - | 14,189 | - |
Interest rate swap agreement | 1,529 | 1,529 | - | 1,529 | - |
Accrued interest payable | 214 | 214 | 15 | 199 | - |
Total liabilities | $ 1,598,655 | $ 1,593,143 | $ 1,018,487 | $ 574,656 | $ - |
The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, accrued interest receivable and accrued interest payable approximate fair value. It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.
20
The methodologies for other financial assets and financial liabilities are discussed below.
Loans - The fair value for loans is estimated using discounted cash flow analyses, using interest rates and spreads currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.
Deposits - The fair value of deposits with no stated maturity, which includes demand, savings, interest bearing checking and money market accounts, is equal to the amount payable on demand resulting in a Level 1 classification. The fair value of variable rate, fixed term certificates of deposit also approximates the carrying amount reported in the consolidated balance sheets. The fair value of fixed rate and fixed term certificates of deposit is estimated using a discounted cash flow method which applies interest rates currently being offered for deposits of similar remaining maturities resulting in a Level 2 classification.
Debt - The fair value of debt is estimated using current market rates for borrowings of similar remaining maturity resulting in a Level 2 classification.
Commitments to Extend Credit and Standby Letters of Credit - The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of financial standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties. The fair value of commitments to extend credit and standby letters of credit is approximately $46 thousand at March 31, 2014 and $47 thousand as of December 31, 2013, respectively.
Limitations ‑ Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instruments. Because no market exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other such factors.
These estimates do not reflect any premium or discount that could result from offering for sale at one time our entire holdings of a particular financial instrument. These estimates are subjective in nature and require considerable judgment to interpret market data. Accordingly, the estimates presented herein are not necessarily indicative of the amounts we could realize in a current market exchange, nor are they intended to represent the fair value of us as a whole. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The fair value estimates presented herein are based on pertinent information available to Management as of the respective balance sheet date. Although we are not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein.
Other significant assets, such as premises and equipment, other assets, and liabilities not defined as financial instruments, are not included in the above disclosures. Also, the fair value estimates for deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market.
|
|
|
|
|
|
NOTE 6: EMPLOYEE BENEFIT PLANS
Pension Plan
Prior to January 1995, we maintained a noncontributory defined benefit plan (the “Pension Plan”) covering all eligible employees. During 1995, the Pension Plan was curtailed. Accordingly, all accrued benefits were fully vested and no additional years of service or age will be accrued.
The following tables summarize the components of net periodic benefit cost and other changes in Pension Plan assets and benefit obligations recognized for the three months ended March 31, 2014 and 2013, respectively:
|
|
|
(In thousands) | 2014 | 2013 |
Interest cost | $ 116 | $ 104 |
Expected return on plan assets | (265) | (247) |
Service costs | 10 | 15 |
Net loss amortization | 32 | 92 |
Net periodic pension cost | $ (107) | $ (36) |
21
We have no minimum required contribution for 2014.
Our Pension Investment Policy Statement sets for the investment objectives and constraints of the Pension Plan. The purpose of the policy is to assist and our Retirement Plan Committee in effectively supervising, monitoring, and evaluating the Pension Plan.
NOTE 7: EARNINGS PER SHARE
The following table presents reconciliations of the calculations of basic and diluted earnings per share for the three months ended March 31, 2014 and 2013:
|
|
|
(In thousands except per share data) | 2014 | 2013 |
Net income | $ 3,403 | $ 3,609 |
Weighted average common shares outstanding | 6,320 | 6,287 |
Dilutive effect of common stock equivalents | 22 | 12 |
Weighted average common and common equivalent |
|
|
shares outstanding | 6,342 | 6,299 |
Basic earnings per common share | $ 0.54 | $ 0.57 |
Diluted earnings per common share | $ 0.54 | $ 0.57 |
Basic earnings per common share were computed by dividing net income by the weighted average number of shares of common stock outstanding for the three months ended March 31, 2014 and 2013. The computation of diluted earnings per share excludes the effect of assuming the exercise of certain outstanding stock options because the effect would be anti-dilutive. There were no anti-dilutive options outstanding for the three months ended March 31, 2014 or 2013.
NOTE 8: STOCK REPURCHASE PROGRAM
We extended our stock buyback program through January 2015. Under the program, which was originally adopted in January 2007, we may repurchase up to 200,000 shares of our common stock on the open market from time to time, and have purchased 143,475 shares at an average price per share of $22.94 since the program’s adoption. We did not repurchase any of our shares during 2013 or during the first three months of 2014, and do not expect to repurchase shares in the near future.
NOTE 9: COMMITMENTS AND CONTINGENCIES
Financial Instruments with Off-Balance Sheet Risk
We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments primarily include commitments to extend credit and financial guarantees. Such instruments involve, to varying degrees, elements of credit and interest rate risk that are not recognized in the accompanying consolidated balance sheets.
Disclosures are required regarding liability-recognition for the fair value at issuance of certain guarantees. We do not issue any guarantees that would require liability-recognition or disclosure, other than our standby letters of credit. We have issued conditional commitments in the form of standby letters of credit to guarantee payment on behalf of a customer and guarantee the performance of a customer to a third party. Standby letters of credit generally arise in connection with lending relationships. The credit risk involved in issuing these instruments is essentially the same as that involved in extending loans to customers. Contingent obligations under standby letters of credit totaled approximately $4.57 million and $4.73 million at March 31, 2014 and December 31, 2013, respectively, and represent the maximum potential future payments we could be required to make. Typically, these instruments have terms of 12 months or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements. Each customer is evaluated individually for creditworthiness under the same underwriting standards used for commitments to extend credit and on-balance sheet instruments. Our policies governing loan collateral apply to standby letters of credit at the time of credit extension. Loan-to-value ratios are generally consistent with loan-to-value requirements for other commercial loans secured by similar types of collateral.
We may enter into commitments to sell loans, which involve market and interest rate risk. There were no such commitments at March 31, 2014 or December 31, 2013.
Legal Proceedings
We have been named as defendants in various legal proceedings arising from our normal business activities. Although the amount of any ultimate liability with respect to such proceedings cannot be determined, in the opinion of Management, based upon input from counsel on the outcome of such proceedings, any such liability will not have a material effect on our financial condition and results of operations.
22
NOTE 10: COMPREHENSIVE INCOME
The accumulated balances for each classification of other comprehensive income at March 31, 2014 are as follows:
|
|
|
|
|
|
|
| Unrealized |
|
|
|
|
| (Gains) |
|
|
|
|
| Losses on |
|
|
|
|
| Securities |
|
|
|
| Unrealized | Transferred |
|
|
|
| (Gains) Losses | From |
|
| Accumulated |
| on Securities | Available-For- |
|
| Other |
| Available-For- | Sale to Held- | Pension | Interest Rate | Comprehensive |
(In thousands) | Sale | To-Maturity | Plan | Swaps | Income (Loss) |
Beginning Balance December 31, 2013 | $ (162) | $ (3,296) | $ (1,790) | $ (472) | $ (5,720) |
Other comprehensive income before reclassifications | 792 | - | - | 41 | 833 |
Transfer of securities from available-for-sale to held-to-maturity | (8) | 8 | - | - | - |
Accretion of unrealized losses of securities transferred from available-for-sale to held-to-maturity recognized in other comprehensive income | - | 113 | - | - | 113 |
Reclassification adjustments for (gains) losses reclassified into income | (82) | - | 21 | - | (61) |
Net current period other comprehensive income | 702 | 121 | 21 | 41 | 885 |
Balance March 31, 2014 | $ 540 | $ (3,175) | $ (1,769) | $ (431) | $ (4,835) |
The accumulated balances for each classification of other comprehensive income at March 31, 2013 are as follows:
|
|
|
|
|
| Unrealized |
|
|
|
| (Gains) Losses |
|
| Accumulated |
| on Securities |
|
| Other |
| Available-For- | Pension | Interest Rate | Comprehensive |
(In thousands) | Sale | Plan | Swaps | Income (Loss) |
Beginning Balance December 31, 2012 | $ 6,033 | $ (3,130) | $ (688) | $ 2,215 |
Other comprehensive income before reclassifications | (1,285) | - | 48 | (1,237) |
Reclassification adjustments for (gains) losses reclassified into income | - | 60 | - | 60 |
Net current period other comprehensive income | (1,285) | 60 | 48 | (1,177) |
Balance March 31, 2013 | $ 4,748 | $ (3,070) | $ (640) | $ 1,038 |
All amounts in the tables above are net of tax. Amounts in parentheses indicate debits.
23
Details of amounts reclassified from accumulated comprehensive income for the three months ended March 31, 2014 and March 31, 2013 are presented below:
|
|
|
|
|
|
Details about Accumulated Other |
|
|
|
| |
Comprehensive Income Components | March 31, | March 31, | Affected Line Item in the Statement | ||
(In thousands) | 2014 | 2013 | Where Net Income is Presented | ||
Unrealized gains on securities | $ | (126) | $ | - | Net gains on investment securities |
|
| (126) |
| - | Total before tax |
|
| 44 |
| - | Provision for income taxes |
| $ | (82) | $ | - | Net of tax |
|
|
|
|
|
|
Pension and postretirement benefit plans | $ | 32 | $ | 92 | Compensation and benefits |
|
| 32 |
| 92 | Total before tax |
|
| (11) |
| (32) | Provision for income taxes |
| $ | 21 | $ | 60 | Net of tax |
|
|
|
|
|
|
Total reclassification adjustments | $ | (61) | $ | 60 |
|
NOTE 11: DERIVATIVE FINANCIAL INSTRUMENTS
At March 31, 2014 and December 31, 2013, we had an interest rate swap with a notional amount of $10 million that was designated as a cash flow hedge. The swap was used to convert a portion of the floating rate interest on our trust preferred issuance to a fixed rate of interest. Each quarter we assess the effectiveness of the hedging relationships by comparing the changes in cash flows of the derivative hedging instruments with the changes in cash flows of the designated hedged item. There was no ineffective portion recognized in earnings during the three months ended March 31, 2014 or March 31, 2013. The fair value of $(663) thousand and $(726) thousand was reflected in other comprehensive income in the accompanying consolidated balance sheets at March 31, 2014 and December 31, 2013, respectively.
We are party to interest rate swaps with a notional amount of $41.5 million with certain of our commercial customers. In order to minimize our risk, these customer derivatives (pay floating/receive fixed swaps) have been offset with essentially matching interest rate swaps with our counterparty totaling $41.5 million (pay fixed/receive floating swaps). At March 31, 2014, the weighted average receive rate of these interest rate swaps was 1.83%, the weighted average pay rate was 3.63% and the weighted average maturity was 12.8 years. The fair values of $371 thousand and $371 thousand were reflected in other assets and other liabilities, respectively, in the accompanying consolidated balance sheets at March 31, 2014. The fair values of $803 thousand and $803 thousand were reflected in other assets and other liabilities, respectively, in the accompanying consolidated balance sheets at December 31, 2013. Hedge accounting has not been applied for these derivatives. Because the terms of the swaps with our customer and the other financial institution offset each other, with the only difference being counterparty credit risk, changes in the fair value of the underlying derivative contracts are not materially different and do not significantly impact our results of operations.
We are party to interest rate swaps with notional amounts totaling $8.80 million that were designated as fair value hedges of certain fixed rate loans with municipalities. At March 31, 2014, the weighted average receive rate of these interest rate swaps was 1.47%, the weighted average pay rate was 3.11% and the weighted average maturity was 19.3 years. The amounts recognized in earnings and other assets for the ineffective portion of the interest swaps was immaterial.
We assessed our counterparty risk at March 31, 2014 and determined any credit risk inherent in our derivative contracts was insignificant. Information about the fair value of derivative financial instruments can be found in Note 5 to these consolidated financial statements.
24
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Quarterly Report on Form 10-Q that are not historical facts may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve risks and uncertainties. These statements, which are based on certain assumptions and describe Merchants’ future plans, strategies and expectations, can generally be identified by the use of the words “may,” “will,” “should,” “could,” “would,” “plan,” “potential,” “estimate,” “project,” “believe,” “intend,” “anticipate,” “expect,” “target” and similar expressions. Forward-looking statements are based on the current assumptions and beliefs of management and are only expectations of future results. Our actual results could differ materially from those projected in the forward-looking statements as a result of, among others, continued weakness in general, national, regional or local economic conditions, the performance of our investment portfolio, quality of credits or the overall demand for services; changes in loan default and charge-off rates which could affect the allowance for credit losses; declines in the equity and financial markets; reductions in deposit levels which could necessitate increased and/or higher cost borrowing to fund loans and investments; declines in mortgage loan refinancing, equity loan and line of credit activity which could reduce net interest and non-interest income; changes in the domestic interest rate environment and inflation; changes in the carrying value of investment securities and other assets; misalignment of our interest-bearing assets and liabilities; increases in loan repayment rates affecting interest income and the value of mortgage servicing rights; changing business, banking, or regulatory conditions or policies, or new legislation affecting the financial services industry that could lead to changes in the competitive balance among financial institutions, restrictions on bank activities, changes in costs (including deposit insurance premiums), increased regulatory scrutiny, declines in consumer confidence in depository institutions, or changes in the secondary market for bank loan and other products; and changes in accounting rules, federal and state laws, IRS regulations, and other regulations and policies governing financial holding companies and their subsidiaries which may impact our ability to take appropriate action to protect our financial interests in certain loan situations.
Investors should not place undue reliance on our forward-looking statements, and are cautioned that forward-looking statements are inherently uncertain. Actual performance and results of operations may differ materially from those projected or suggested in the forward-looking statements due to certain risks and uncertainties, which are included in more detail in our Annual Report on Form 10-K, as updated by our Quarterly Reports on Form 10-Q and other filings submitted to the Securities and Exchange Commission. We do not undertake any obligation to update any forward-looking statement to reflect circumstances or events that occur after the date the forward-looking statements are made.
USE OF NON-GAAP FINANCIAL MEASURES
Certain information in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains financial information determined by methods other than in accordance with accounting principles generally accepted in the United States of America (“GAAP”). We use these “non-GAAP” measures in our analysis of our performance and believe that these non-GAAP financial measures provide a greater understanding of ongoing operations and enhance comparability of results with prior periods as well as demonstrating the effects of significant gains and charges in the current period. We believe that a meaningful analysis of our financial performance requires an understanding of the factors underlying that performance. We believe that investors may use these non-GAAP financial measures to analyze financial performance without the impact of unusual items that may obscure trends in our underlying performance. These disclosures should not be viewed as a substitute for operating results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.
In several places net interest income is presented on a fully taxable equivalent basis. Specifically included in interest income is tax-exempt interest income from certain tax-exempt loans. An amount equal to the tax benefit derived from this tax exempt income is added back to the interest income total, to produce net interest income on a fully taxable equivalent basis. We believe the disclosure of taxable equivalent net interest income information improves the clarity of financial analysis, and is particularly useful to investors in understanding and evaluating the changes and trends in our results of operations. Other financial institutions commonly present net interest income on a taxable equivalent basis. This adjustment is considered helpful in the comparison of one financial institution’s net interest income to that of another, as each will have a different proportion of taxable exempt interest from its earning assets. Moreover, net interest income is a component of a second financial measure commonly used by financial institutions, net interest margin, which is the ratio of net interest income to average earning assets. For purposes of this measure as well, other financial institutions generally use taxable equivalent net interest income to provide a better basis of comparison from institution to institution. We follow these practices. A reconciliation of taxable equivalent financial information to our consolidated financial statements prepared in accordance with GAAP appears at the bottom of the table entitled “Distribution of Assets, Liabilities and Shareholders Equity; Interest Rates and Net Interest Margin.” A 35.0% tax rate was used in both 2014 and 2013. An additional non-GAAP financial measure we use is the tangible capital ratio. Because we have no intangible assets, our tangible shareholder’s equity is the same as our shareholder’s equity.
25
GENERAL
The following discussion and analysis of financial condition as of March 31, 2014 and December 31, 2013 and results of operations of Merchants and its subsidiaries for the three months ended March 31, 2014 and 2013 should be read in conjunction with the consolidated financial statements and Notes thereto and selected statistical information appearing elsewhere in this Quarterly Report on Form 10-Q. The financial condition and results of operations of Merchants essentially reflect the operations of its principal subsidiary, Merchants Bank.
RESULTS OF OPERATIONS
Overview
We realized net income of $3.40 million for the three months ended March 31, 2014, compared to $3.61 million for the three months ended March 31, 2013. Basic and diluted earnings per share were $0.54 for the three months ended March 31, 2014 and were $0.57 per share for the three months ended March 31, 2013.
We declared and distributed dividends of $0.28 per share during the three months ended March 31, 2014. On April 17, 2014, we declared a dividend of $0.28 per share, which will be paid on May 15, 2014 to shareholders of record as of May 1, 2014. Total assets were $1.66 billion at March 31, 2014. Total shareholders’ equity was $122.24 million at March 31, 2014.
Our return on average equity was 11.31% for the three months ended March 31, 2014 compared to 12.31% for the three months ended March 31, 2013. Our return on average assets was 0.81% for the three months ended March 31, 2014 compared to 0.86% for the three months ended March 31, 2013. Our capital ratios remain strong, with a Tier 1 leverage ratio of 8.57%, a total risk-based capital ratio of 16.40% and a tangible capital ratio of 7.35%.
Ø | Net interest income - Our taxable equivalent net interest income was $12.36 million for the three months ended March 31, 2014 compared to $12.73 million for the same period in 2013. Our taxable equivalent net interest margin decreased by nine basis points to 3.10% for the three months ended March 31, 2014 from 3.19% for the same period in 2013. |
Ø | Provision for Credit Losses – The provision for credit losses was $100 thousand and $250 thousand for the quarter ended March 31, 2014 and March 31, 2013, respectively. The decrease in the provision was primarily a result of slower loan growth during the first quarter of 2014 compared to 2013. |
Ø | Loans - Ending loan balances at March 31, 2014 were $1.17 billion, an increase of $5.50 million from balances at December 31, 2013 and an increase of $70.02 million from March 31, 2013. Year over year loans have grown by 6.4%. |
Ø | Investments - Our investment portfolio totaled $365.34 million at March 31, 2014, a decrease of $28.00 million from the December 31, 2013 ending balance of $393.34 million, and a decrease of $143.02 million from the balance at March 31, 2013. |
Ø | Deposits – Deposit balances at March 31, 2014 were $1.33 billion, an increase of $2.48 million from December 31, 2013 and an increase of $56.28 million from March 31, 2013. |
Ø | Shareholders’ equity - Shareholder’s equity ended the quarter at $122.24 million compared to $119.15 million at March 31, 2013. Our book value per share was $19.34 at March 31, 2014, compared to $18.94 at March 31, 2013. |
Ø | Non-interest expense – Total noninterest expense increased $405 thousand to $10.15 million for the first quarter of 2014 compared to the same period in 2013. We incurred $171 thousand in expenses related to the conversion of our core banking computer systems during the first quarter of 2014. The conversion is scheduled to occur during the fourth quarter of this year. In total we expect to incur approximately $1.21 million in expenses related to the core conversion during 2014 and expect to realize annual cost savings and additional revenue opportunities of approximately $800 thousand starting in November of this year. |
Net Interest Income
As shown on the tables on pages 27 and 28, our taxable equivalent net interest income was $12.36 million for the three months ended March 31, 2014 compared to $12.73 million for the same period in 2013. Our taxable equivalent net interest margin was 3.10% for the three months ended March 31, 2014, unchanged from the fourth quarter of 2013 and a decrease of nine basis points from 3.19% for the three months ended March 31, 2013. Though margin compression has slowed, it continues to be a challenge. Asset yields were flat from the fourth quarter of 2013 to the first quarter of 2014, and were 12 basis points lower for the first quarter of 2014 compared to the first quarter of 2013. Investment yields were 11 basis points higher quarter over quarter while loan yields were 26 basis points lower. One of the factors influencing our loan yields is an increase in variable rate loans. Average variable-rate loans for the first quarter of 2014 were $314.24 million, an increase of $50.39 million over average balances for the first quarter of 2013. These loans have a lower current yield than fixed-rate loans, but will have higher yields when rates start to rise. They also help reduce exposure to rising rates for our largely fixed rate balance sheet. Our average cost of interest bearing liabilities has remained fairly steady over the last year at 0.38% for the quarter ended March 31, 2014, compared to 0.37% for the quarter ended December 31, 2013 and 0.40% for the quarter ended March 31, 2013.
26
The following tables present an analysis of net interest income and illustrate interest income earned and interest expense charged for each major component of interest earning assets and interest bearing liabilities. Yields/rates are computed on a fully taxable-equivalent basis, using a 35% rate. Nonaccrual loans are included in the average loan balance outstanding.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Three Months Ended | ||||||
| March 31, 2014 |
| March 31, 2013 | ||||
|
| Interest |
|
|
| Interest |
|
| Average | Income/ | Average |
| Average | Income/ | Average |
(In thousands, fully taxable equivalent) | Balance | Expense | Rate |
| Balance | Expense | Rate |
ASSETS: |
|
|
|
|
|
|
|
Loans, including fees on loans | $ 1,167,067 | $ 11,295 | 3.93% |
| $ 1,086,289 | $ 11,232 | 4.19% |
Investments | 387,326 | 2,214 | 2.32% |
| 511,842 | 2,785 | 2.21% |
Interest-earning deposits with banks and other short-term | 59,516 | 39 | 0.26% |
| 18,442 | 12 | 0.26% |
Total interest earning assets | 1,613,909 | $ 13,548 | 3.40% |
| 1,616,573 | $ 14,029 | 3.52% |
Allowance for loan losses | (12,117) |
|
|
| (11,689) |
|
|
Cash and due from banks | 28,164 |
|
|
| 25,469 |
|
|
Bank premises and equipment, net | 15,426 |
|
|
| 16,286 |
|
|
Bank owned life insurance | 10,029 |
|
|
| - |
|
|
Other assets | 22,996 |
|
|
| 34,491 |
|
|
Total assets | $ 1,678,407 |
|
|
| $ 1,681,130 |
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS' EQUITY: |
|
|
|
|
|
|
|
Interest-bearing deposits: |
|
|
|
|
|
|
|
Savings, interest bearing checking and money market accounts | $ 759,068 | $ 430 | 0.23% |
| $ 696,160 | $ 167 | 0.10% |
Time deposits | 294,753 | 472 | 0.65% |
| 334,373 | 579 | 0.70% |
Total interest bearing deposits | 1,053,821 | 902 | 0.35% |
| 1,030,533 | 746 | 0.29% |
Short-term borrowings | - | - | - |
| 13,873 | 9 | 0.28% |
Securities sold under agreements to repurchase, short-term | 209,589 | 92 | 0.18% |
| 264,884 | 348 | 0.53% |
Other long-term debt | 2,389 | 12 | 2.02% |
| 2,470 | 12 | 2.02% |
Junior subordinated debentures issued to unconsolidated subsidiary trust | 20,619 | 185 | 3.60% |
| 20,619 | 184 | 3.74% |
Total borrowed funds | 232,597 | 289 | 0.51% |
| 301,846 | 553 | 0.74% |
Total interest bearing liabilities | 1,286,418 | $ 1,191 | 0.37% |
| 1,332,379 | $ 1,299 | 0.40% |
Noninterest bearing deposits | 263,120 |
|
|
| 223,245 |
|
|
Other liabilities | 8,564 |
|
|
| 8,241 |
|
|
Shareholders' equity | 120,305 |
|
|
| 117,265 |
|
|
Total liabilities and shareholders' equity | $ 1,678,407 |
|
|
| $ 1,681,130 |
|
|
|
|
|
|
|
|
|
|
Net interest earning assets | $ 327,491 |
|
|
| $ 284,194 |
|
|
|
|
|
|
|
|
|
|
Net interest income (fully taxable equivalent) |
| $ 12,357 |
|
|
| $ 12,730 |
|
Tax equivalent adjustment |
| (533) |
|
|
| (482) |
|
Net interest income |
| $ 11,824 |
|
|
| $ 12,248 |
|
|
|
|
|
|
|
|
|
Net interest rate spread |
|
| 3.03% |
|
|
| 3.12% |
|
|
|
|
|
|
|
|
Net interest margin |
|
| 3.10% |
|
|
| 3.19% |
|
|
|
|
|
|
|
|
27
The following tables present the extent to which changes in interest rates and changes in the volume of earning assets and interest bearing liabilities have affected interest income and interest expense during the periods indicated. Information is presented in each category with respect to: (i) changes attributable to changes in volume (changes in volume multiplied by prior rate), (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume) and (iii) changes in volume/rate (change in volume multiplied by change in rate).
Analysis of Changes in Fully Taxable Equivalent Net Interest Income
|
|
|
|
|
|
|
| Three Months Ended |
|
|
|
| |
| March 31, | Increase | Due to | |||
(In thousands) | 2014 | 2013 | (Decrease) | Volume | Rate | Volume/Rate |
Fully taxable equivalent interest income: |
|
|
|
|
|
|
Loans | $ 11,295 | $ 11,232 | $ 63 | $ 835 | $ (718) | $ (54) |
Investments | 2,214 | 2,785 | (571) | (678) | 140 | (33) |
Interest earning deposits with banks and other short-term investments | 39 | 12 | 27 | 27 | - | (0) |
Total interest income | 13,548 | 14,029 | (481) | 184 | (578) | (87) |
Less interest expense: |
|
|
|
|
|
|
Savings, interest bearing checking and money market accounts | 430 | 167 | 263 | 15 | 227 | 21 |
Time deposits | 472 | 579 | (107) | (69) | (43) | 6 |
FHLB and other short-term borrowings | - | 9 | (9) | (10) | (10) | 11 |
Securities sold under agreements to repurchase, short-term | 92 | 348 | (256) | (73) | (232) | 49 |
Other long-term debt | 12 | 12 | - | - | - | - |
Junior subordinated debentures issued to unconsolidated subsidiary trust | 185 | 184 | 1 | - | (7) | 8 |
Total interest expense | 1,191 | 1,299 | (108) | (137) | (65) | 95 |
Net interest income | $ 12,357 | $ 12,730 | $ (373) | $ 321 | $ (513) | $ (182) |
28
Provision for Credit Losses
The allowance for loan losses at March 31, 2014 was $12.17 million, or 1.04% of total loans and 1,210% of non-performing loans, compared to the December 31, 2013 balance of $12.04 million, or 1.03% of total loans and 1,329% of non-performing loans. We recorded a $100 thousand provision for credit losses during the three months ended March 31, 2014 compared to $250 thousand for the same period in 2013. Asset quality remains very strong and continues to be a core strength for our company. Loan growth during the quarter was the primary factor for the provision to date in 2014. Performing loans past due 30-89 days were 0.17% of total loans at March 31, 2014 compared to 0.03% at December 31, 2013. Nonperforming loans as a percent of total loans were 0.09% at March 31, 2014 compared to 0.08% at December 31, 2013. Accruing substandard loans decreased to 1.79% of total loans at March 31, 2014 compared to 2.16% at December 31, 2013. Net recoveries year to date for 2014 total $1 thousand. Our other real estate owned (“OREO”) balance was $85 thousand at March 31, 2014 and was $108 thousand at December 31, 2013. All of these factors are taken into consideration during Management’s quarterly review of the Allowance. For a more detailed discussion of our allowance for credit losses (“Allowance”) and nonperforming assets, see “Credit Quality and Allowance for Credit Losses” beginning on page 34.
NONINTEREST INCOME AND EXPENSES
Noninterest income
Total noninterest income increased $263 thousand to $2.91 million for the first quarter of 2014 compared to the first quarter of 2013. Excluding a gain on the sale of investments of $126 thousand, total noninterest income increased $137 thousand for the first quarter of 2014 compared to the same period in 2013. Trust Division Income increased $94 thousand to $852 thousand for the quarter ended March 31, 2014, compared to the quarter ended March 31, 2013, as the trust assets under management have demonstrated strong growth and now total $616 million from $577 million at March 31, 2013. Service charges on deposits decreased $41 thousand for the first quarter of 2014 compared to 2013, a result of reduced overdraft fee income, which was partially offset by increases in cash management fees and business checking service charges. Other noninterest income has increased since the first quarter of 2013, as a result of increased income generated by check cashing fees and income related to our recent investment in bank owned life insurance.
Noninterest expense
Total noninterest expense increased $405 thousand to $10.15 million for the first quarter of 2014 compared to the same period in 2013. We incurred $171 thousand in expenses related to the conversion of our core banking computer systems. The conversion is scheduled to occur during the fourth quarter of this year. In total we expect to incur approximately $1.21 million in expenses related to the core conversion during 2014 and expect to realize annual cost savings and additional revenue opportunities of approximately $800 thousand starting in November of this year. Compensation and benefits increased by $128 thousand for the first quarter of 2014 compared to the first quarter of 2013. Salaries and wages were $179 thousand higher for the first quarter of 2014 compared to 2013, a result of lower credits related to loan originations because of lower loan volumes, and additional personnel investments in the Finance and Risk areas. Employee benefits were $51 thousand lower for the first quarter of 2014 compared to 2013, a result of a reduction in the cost for health and group insurance, and a credit from our overfunded pension plan. Occupancy and equipment costs were $241 thousand higher for the first quarter of 2014 compared to 2013, a result of expenses related to the core conversion of $111 thousand, combined with the cost of amortization of the investments we have made recently to update, and in some cases combine, our facilities. Legal and professional fees were $698 thousand for the first quarter of 2014, an $11 thousand increase over the first quarter of 2013. Included in legal and professional fees for the first quarter of 2014 were $60 thousand in core conversion costs.
Income Taxes
During the first quarter of 2014 we adopted, and applied retrospectively, Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2014-01, “Accounting for Investments in Qualified Affordable Housing Projects,” which allows investors in low income housing tax credit entities that meet certain conditions to account for the investments entirely in income tax expense, which we believe more accurately reflects the economics of the investment. The application of this standard reduced total noninterest expense by $327 and $270 thousand for the quarters ended March 31, 2014 and March 31, 2013 respectively, and increased income tax expense by an equivalent amount. The application of the standard also increased our effective tax rate to 24% and 26%, from 18% and 22% for the same periods.
BALANCE SHEET ANALYSIS
Loans
Ending loan balances at March 31, 2014 increased to $1.17 billion, an increase of $5.50 million over ending loan balances at December 31, 2013. Year over year loans have grown by 6.4%.
29
The composition of our loan portfolio is shown in the following table as of the dates indicated:
|
|
|
|
(In thousands) | March 31, 2014 | December 31, 2013 | March 31, 2013 |
Commercial, financial and agricultural | $ 190,840 | $ 172,810 | $ 168,500 |
Municipal loans | 93,176 | 94,007 | 85,211 |
Real estate loans – residential | 482,775 | 489,706 | 473,795 |
Real estate loans – commercial | 372,155 | 371,319 | 354,639 |
Real estate loans – construction | 27,567 | 31,841 | 14,115 |
Installment loans | 4,993 | 5,655 | 5,192 |
All other loans | 231 | 895 | 261 |
Total loans | $ 1,171,737 | $ 1,166,233 | $ 1,101,713 |
Totals above are shown net of deferred loan fees of $587 thousand, $618 thousand and $272 thousand for March 31, 2014, December 31, 2013 and March 31, 2013, respectively. Ending loan balances at March 31, 2013 reflect the reclassification of $30.43 million, in non-owner occupied residential real estate loans from the residential real estate category to the commercial real estate category. This presentation more accurately presents the risk profile of these loans.
Growth in our commercial loan portfolio was driven by new customer acquisition and increased line of credit utilization, offset by increased prepayment activity. Mortgage refinance activity has slowed considerably, leading to reduced residential real estate balances. We expect this trend to continue in our residential real estate portfolio.
Investments
The investment portfolio is used to generate interest income, manage liquidity and mitigate interest rate sensitivity. The average investment portfolio for the first quarter of 2014 was $380 million, a reduction of $124 million compared to the first quarter of 2013. The ending balance in the investment portfolio at March 31, 2014 was $365 million, compared to $508 million at March 31, 2013. We have allowed the investment portfolio to run off during the past year to fund loan growth, as well as to control asset growth, and strengthen our capital ratios.
Under the Volcker Rule, we may be required to divest some or all of our CLOs by July of 2017. We took an impairment charge totaling $166 thousand related to our CLO portfolio during 2013 and have sold $17.52 million of our CLOs for a small gain during the first quarter of 2014.
The composition of our investment portfolio as of March 31, 2014, including both available for sale and held to maturity securities, consisted of the following:
|
|
|
| Amortized | Fair |
(In thousands) | Cost | Value |
Available for Sale: |
|
|
U.S. Treasury Obligations | $ 100 | $ 100 |
Residential Real Estate Mortgage-backed Securities ("Agency MBSs") | 96,952 | 98,657 |
Agency Commercial Mortgage Backed Securities ("Agency CMBSs") | 18,261 | 17,626 |
Non-agency Collateralized Mortgage Obligations ("Non-agency CMOs") | 78,738 | 78,461 |
Collateralized Loan Obligations ("CLOs") | 19,688 | 19,722 |
Asset Backed Securities ("ABSs") | 357 | 391 |
Total Available for Sale | 214,096 | 214,957 |
Held to Maturity: |
|
|
U.S. Agency Obligations | $ 23,104 | $ 22,792 |
U.S. Government Sponsored Enterprises ("U.S. GSEs") | 9,456 | 9,137 |
Federal Home Loan Bank ("FHLB") Obligations | 4,693 | 4,618 |
Agency Collateralized Mortgage Obligations | 104,321 | 102,178 |
Agency MBSs | 8,808 | 8,755 |
Total Held to Maturity | $ 150,382 | $ 147,480 |
Total Securities | $ 364,478 | $ 362,437 |
30
Agency MBSs and Agency CMOs consist of pools of residential mortgages which are guaranteed by the FNMA, FHLMC, or Government National Mortgage Association (“GNMA”) with various origination dates and maturities. Agency CMBSs consist of bonds backed by commercial real estate which are guaranteed by FNMA. CLOs are floating rate securities that consist of pools of commercial loans structured to provide very strong over collateralization and subordination. All of our CLOs are the senior AAA tranche and are the first bond to get paid down.
We use an external pricing service to obtain fair market values for our investment portfolio. We have obtained and reviewed the service provider’s pricing and reference data document. Evaluations are based on market data and vary by asset class and incorporate available trade, bid and other market information. Because many fixed income securities do not trade on a daily basis, the service provider’s evaluated pricing applications apply available information as applicable through processes such as benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing, to prepare evaluations. In addition, model processes, such as the Option Adjusted Spread model are used to assess interest rate impact and develop prepayment scenarios. We periodically test the values provided to us by the pricing service through a combination of back testing on actual sales of securities and by obtaining prices on bonds from an alternative pricing source.
We do not intend to sell the investment securities that are in an unrealized loss position, and it is unlikely that we will be required to sell the investment securities before recovery of their amortized cost bases, which may be maturity.
Deposits and Other Liabilities
Total deposits at March 31, 2014 were $1.33 billion, an increase of $2.48 million from balances at December 31, 2013 and $56.28 million higher than balances at March 31, 2013. Quarterly average balances increased by $63.16 million to $1.32 billion, a 5% increase over quarterly averages for the first quarter of 2013. Securities sold under agreement to repurchase, which represent collateralized customer accounts, were $182.65 million at March 31, 2014, a reduction of $67.67 million from $250.31 million at December 31, 2013, and a reduction of $60.56 million from balances at March 31, 2013. The decreases are a result of seasonal municipal cash flows combined with migration of some balances to deposit products.
CREDIT QUALITY AND ALLOWANCE FOR CREDIT LOSSES
The United States economy continues to show improvement into 2014; however, high unemployment and foreclosure rates continue in certain parts of the country. Although Vermont, our primary market, has not been immune to this economic turmoil, the state has one of the lowest foreclosure rates in the country, home price depreciation has been muted, and the unemployment rate is lower than the national average.
Credit quality
Credit quality is a major strategic focus and strength of our company. Although we actively manage current nonperforming and classified loans, there is no assurance that we will not have increased levels of problem assets in the future. The pool of nonperforming loans is dynamic with accounts moving in and out of this category over time.
The following table summarizes our nonperforming loans and nonperforming assets as of the dates indicated:
|
|
|
|
(In thousands) | March 31, 2014 | December 31, 2013 | March 31, 2013 |
Nonaccrual loans | $ 473 | $ 425 | $ 2,876 |
Loans past due 90 days or more and still accruing | 79 | 75 | - |
Troubled debt restructurings ("TDR") | 454 | 406 | 539 |
Total nonperforming loans ("NPL") | 1,006 | 906 | 3,415 |
OREO | 85 | 108 | - |
Total non performing assets ("NPA") | $ 1,091 | $ 1,014 | $ 3,415 |
Non-performing loans at March 31, 2014 were $1.01 million, 0.09% of total loans. Of the $1.01 million in nonperforming loans in the table above, $282 thousand are commercial and commercial real estate loans and $724 thousand are residential mortgages and home equity loans.
We originate traditional mortgage and home equity products that are fully documented and underwritten. We take a proactive risk management approach by conducting periodic stress-testing of the existing residential loan portfolio and adjusting underwriting requirements, if necessary, based upon the results of the analysis. The assumptions used in the stress testing include: credit score migration; calculation of possible losses using conservative assumptions of market decline; review of life-of-loan delinquency levels relative to loan size and credit score; analysis of the portfolio by loan size, and distribution within the portfolio by loan-to-value ratios. Based upon the results of assessments of the residential loan portfolio, Management concluded that current reserve levels were adequate.
Our analysis indicates that, through a combination of estimated collateral value and, where needed, an appropriately allocated reserve, any additional loss exposure on current non-accruing loans is minimal.
TDRs represent balances where the existing loan was modified involving a concession in rate, term or payment amount due to the distressed financial condition of the borrower. At March 31, 2014, $187 thousand of TDRs were in nonaccrual status and $267
31
thousand were accruing interest.
Excluded from the nonperforming balances discussed above are loans that are 30 to 89 days past due, which are not necessarily considered classified or impaired. Accruing loans 30 to 89 days past due as a percentage of total loans as of the periods indicated are presented in the following table:
|
|
Period Ended | 30-89 Days |
March 31, 2014 | 0.17% |
December 31, 2013 | 0.03% |
March 31, 2013 | 0.09% |
December 31, 2012 | 0.00% |
Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days. If a loan or a portion of a loan is internally classified as impaired or is partially charged-off, the loan is generally classified as nonaccrual. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt. Income accruals are suspended on all nonaccruing loans, and all previously accrued and uncollected interest is charged against current income.
Loans may be returned to accrual status when there is a sustained period of repayment performance (generally a minimum of six months) by the borrower, in accordance with the contractual terms of the loans and all principal and interest amounts contractually due, including arrearages, are reasonably assured of repayment within an acceptable period of time.
While a loan is classified as nonaccrual and the future collectability of the recorded loan balance is uncertain, any payments received are generally applied to reduce the principal balance. When the future collectability of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan has been partially charged-off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Interest collections in excess of that amount are recorded as a reduction of principal.
A loan remains in nonaccruing status until the factors which suggest doubtful collectability no longer exist, the loan is liquidated, or when the loan is determined to be uncollectible, and is charged off against the allowance for loan losses. In those cases where a nonaccruing loan is secured by real estate, we can, and may, initiate foreclosure proceedings. The result of such action will either be to cause repayment of the loan with the proceeds of a foreclosure sale or to give us possession of the collateral in order to manage a future resale of the real estate. Foreclosed property is recorded at the lower of its cost or estimated fair value, less any estimated costs to sell and is actively marketed. Any cost in excess of the estimated fair value on the transfer date is charged to the allowance for loan losses, while further declines in market values are recorded as OREO expense in the consolidated statements of income. Impaired loans, which primarily consist of non-accruing residential mortgage and commercial real estate loans and TDRs, totaled $1.01 million and $906 thousand at March 31, 2014 and December 31, 2013, respectively. At March 31, 2014, $412 thousand of impaired loans had specific reserve allocations totaling $132 thousand.
Substandard loans at March 31, 2014 totaled $21.38 million, of which $21.00 million in loans continue to accrue interest. Loans identified as substandard have well-defined weaknesses that, if not addressed, could result in a loss. These accruing substandard loans have generally continued to pay promptly and Management conducts regularly scheduled comprehensive reviews of the borrowers’ financial condition, payment performance, accrual status and collateral. These reviews also ensure that these troubled accounts are properly administered with a focus on loss mitigation and that any potential loss exposures are appropriately quantified, and reserved for. The findings of this review process are a key component in assessing the adequacy of our loan loss reserve.
Accruing substandard loans at March 31, 2014 reflect a $4.2 million decrease in balances since December 31, 2013. At March 31, 2014, accruing substandard loans related to owner-occupied commercial real estate totaled $15.99 million, investor commercial real estate loans totaled $1.58 million, residential mortgage loans totaled $181 thousand, residential investment real estate loans totaled $1.83 million, and $1.43 million in substandard loans are outstanding to corporate borrowers in a variety of different industries. Nine borrowers in a variety of industries account for 77% of the total accruing substandard loans, and approximately $787 thousand of the total accruing substandard loans carry some form of government guarantee.
To date, with very few exceptions, payments due from accruing substandard borrowers have been made as agreed and Management’s ongoing evaluation of these borrowers’ financial condition and collateral indicates a reasonable certainty that these exposures are adequately secured.
Management monitors asset quality closely and continuously performs detailed and extensive reviews on larger credits and problematic credits identified on the watched asset list, nonperforming asset listings and internal credit rating reports. In addition to frequent financial analysis and review of well-rated and adversely graded loans, Management incorporates active monitoring of key credit and non-credit risks for each customer, assessing risk through the daily reviews of overdrafts, delinquencies and usage of electronic banking products and tracking for timely receipt of all required financial statements.
32
Allowance for Credit Losses
The Allowance is made up of two components: the allowance for loan losses (“ALL”) and the reserve for undisbursed lines. The ALL is based on Management's estimate of the amount required to reflect the probable incurred losses in the loan portfolio, based on circumstances and conditions known at each reporting date. We review the adequacy of the ALL quarterly. Factors considered in evaluating the adequacy of the ALL include previous loss experience, the size and composition of the portfolio, risk rating composition, current economic and real estate market conditions and their effect on the borrowers, the performance of individual loans in relation to contractual terms and estimated fair values of properties that secure impaired loans.
The adequacy of the ALL is determined using a consistent, systematic methodology, consisting of a review of both specific reserves for loans identified as impaired and general reserves for the various loan portfolio classifications. When a loan is impaired, we determine its impairment loss by comparing the excess, if any, of the loan’s carrying amount over (1) the present value of expected future cash flows discounted at the loan’s original effective interest rate, (2) the observable market price of the impaired loan, or (3) the fair value of the collateral securing a collateral-dependent loan. When a loan is deemed to have an impairment loss, the loan is either charged down to its estimated net realizable value, or a specific reserve is established as part of the overall allowance for loan losses if Management needs more time to evaluate all of the facts and circumstances relevant to that particular loan.
The general allowance for loan losses is a percentage-based reflection of historical loss experience adjusted for qualitative factors and assigns a required allocation by loan classification based on a fixed percentage of all outstanding loan balances. The general allowance for loan losses employs a risk-rating model that grades loans based on their general characteristics of credit quality and relative risk. Appropriate reserve levels are estimated based on Management’s judgments regarding the historical loss experience, current economic trends, trends in the portfolio mix, volume and trends in delinquencies and non-accrual loans.
Losses are charged against the ALL when Management believes that the collectability of principal is doubtful. To the extent Management determines the level of anticipated losses in the portfolio has increased or decreased, the ALL is adjusted through current earnings. Overall, Management believes that the ALL is maintained at an adequate level, in light of historical and current factors, to reflect the level of credit risk in the loan portfolio. Loan loss experience and nonperforming asset data are presented and discussed in relation to their impact on the adequacy of the ALL.
33
The following table reflects our loan loss experience and activity in the Allowance for the periods indicated:
|
|
|
|
| Three Months | Twelve Months | Three Months |
| Ended | Ended | Ended |
(In thousands) | March 31, 2014 | December 31, 2013 | March 31, 2013 |
Average loans during the period | $ 1,167,067 | $ 1,133,637 | $ 1,086,289 |
Allowance beginning of the year | 12,828 | 12,312 | 12,312 |
Charge-offs: |
|
|
|
Commercial, financial & agricultural | - | (20) | - |
Real estate - residential | (2) | (289) | (7) |
Real estate - commercial | - | (1) | (1) |
Real estate - construction | - | - | - |
Other | (20) | (102) | (20) |
Total charge-offs | (22) | (412) | (28) |
Recoveries: |
|
|
|
Commercial, financial & agricultural | 2 | 62 | 9 |
Real estate - residential | 18 | 6 | 3 |
Real estate - commercial | - | 40 | 40 |
Real estate - construction | - | 1 | 1 |
Other | 3 | 19 | 1 |
Total recoveries | 23 | 128 | 54 |
Net recoveries (charge-offs) | 1 | (284) | 26 |
Provision for credit losses | 100 | 800 | 250 |
Allowance end of year | $ 12,929 | $ 12,828 | $ 12,588 |
Ratio of net (charge-offs) recoveries to average loans outstanding | 0.00% | (0.02)% | 0.00% |
|
|
|
|
Components: |
|
|
|
Allowance for loan losses | $ 12,174 | $ 12,042 | $ 11,796 |
Reserve for undisbursed lines of credit | 755 | 786 | 792 |
Allowance for credit losses | $ 12,929 | $ 12,828 | $ 12,588 |
The provision for 2014 was primarily a result of our loan growth.
The following table reflects our nonperforming asset and coverage ratios as of the dates indicated:
|
|
|
|
| March 31, 2014 | December 31, 2013 | March 31, 2013 |
NPL to total loans | 0.09% | 0.08% | 0.31% |
NPA to total assets | 0.07% | 0.06% | 0.20% |
Allowance for loan losses to total loans | 1.04% | 1.03% | 1.07% |
Allowance for loan losses to NPL | 1210% | 1329% | 345% |
We will continue to take all appropriate measures to restore nonperforming assets to performing status or otherwise liquidate these assets in an orderly fashion so as to maximize their value. There can be no assurances that we will be able to complete the disposition of nonperforming assets without incurring further losses.
Loan Portfolio Monitoring
Our Board of Directors grants each loan officer the authority to originate loans on our behalf, subject to certain limitations. The Board of Directors also establishes restrictions regarding the types of loans that may be granted and the distribution of loan types within our portfolio, and sets loan authority limits for each lender. These authorized lending limits are reviewed at least annually and are based upon the lender's experience. Loan requests that exceed a lender's authority require the signature of our Senior Lender, the Senior Credit Officer, and/or our President. With the exception of certain municipal loans, all extensions of credit of $5.0 million or greater to any one borrower, or related party interest, are reviewed and approved by the Loan Committee of Merchants Bank’s Board of Directors. Short-term revenue anticipation and tax anticipation extensions of credit of $8.0 million or greater to a municipality are reviewed and approved by the Loan Committee of Merchants Bank’s Board of Directors.
34
The Loan Committee and the credit department regularly monitor our loan portfolio. The entire loan portfolio, as well as individual loans, is reviewed for loan performance, compliance with internal policy requirements and banking regulations, creditworthiness, and strength of documentation. We monitor loan concentrations by individual borrowers, industries and loan types. As part of the annual credit policy review process, targets are set by loan type for the total portfolio. Credit risk ratings assessing inherent risk in individual loans are assigned to commercial loans at origination and are routinely reviewed by lenders and Management on a periodic basis according to total exposure and risk rating. These internal reviews assess the adequacy of all aspects of credit administration, additionally, we maintain an on-going active monitoring process of loan performance during the year. We have also hired external loan review firms to assist in monitoring the commercial, municipal and residential loan portfolios. The commercial loan review firm annually reviews, at a minimum, 60% in dollar volume of our commercial loan portfolio and certain transactions based on amount and maturity date for our municipal loan portfolio. These comprehensive reviews assessed the accuracy of our risk rating system as well as the effectiveness of credit administration in managing overall credit risks.
All loan officers are required to service their loan portfolios and account relationships. Loan officers, a commercial workout officer, or collection personnel take remedial actions to assure full and timely payment of loan balances as necessary, with the supervision of the Senior Lender and the Senior Credit Officer.
Liquidity and Capital Resource Management
General
Liquid assets are maintained at levels considered adequate to meet our liquidity needs. Liquidity is adjusted as appropriate to meet asset and liability management objectives. Liquidity is monitored by the Asset and Liability Committee (“ALCO”) of Merchants Bank’s Board of Directors, based upon Merchants Bank’s policies. Our primary sources of liquidity are deposits, amortization and prepayment of loans, maturities of investment securities and other short-term investments, periodic principal repayments on mortgage-backed and other amortizing securities, advances from the FHLBB, and earnings and funds provided from operations. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan and investment prepayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competition. Interest rates on deposits are priced to maintain a desired level of total deposits.
As of March 31, 2014, we could borrow up to $65 million in overnight funds through unsecured borrowing lines established with correspondent banks. We have established both overnight and longer term lines of credit with the FHLBB. FHLBB borrowings are secured by residential mortgage loans. The total amount of loans pledged to the FHLBB for both short- and long-term borrowing arrangements totaled $274.27 million at March 31, 2014. We have additional borrowing capacity with the FHLBB of $246.8 million as of March 31, 2014. We have also established a borrowing facility with the Board of Governors of the Federal Reserve System (“FRB”) which will enable us to borrow at the discount window. Additionally, we have the ability to borrow through the use of repurchase agreements, collateralized by Agency MBSs and Agency CMOs, with certain approved counterparties. Our investment portfolio, which is managed by the ALCO, has a cost basis of $364.48 million at March 31, 2014, of which $265.55 million was pledged. The portfolio is a reliable source of cash flow for us. We closely monitor our short term cash position. Any excess funds are either left on deposit at the FRB, or are in a fully insured account with one of our correspondent banks.
The following table presents information regarding our short-term borrowings as of the dates indicated:
|
|
|
| Three Months |
|
| Ended | Year Ended |
(In thousands) | March 31, 2014 | December 31, 2013 |
FHLBB and other short-term borrowings |
|
|
Amount outstanding at end of period | $ - | $ - |
Maximum during the period amount outstanding | - | 72,500 |
Average amount outstanding | - | 17,259 |
Weighted-average rate during the period | 0% | 0.30% |
Weighted-average rate at period end | 0% | 0% |
Securities sold under agreement to repurchase, short-term |
|
|
Amount outstanding at end of period | $ 182,647 | $ 250,314 |
Maximum during the period amount outstanding | 247,153 | 284,297 |
Average amount outstanding | 209,589 | 212,644 |
Weighted-average rate during the period | 0.18% | 0.41% |
Weighted-average rate at period end | 0.18% | 0.18% |
35
Commitments and Off-Balance Sheet Risk
We are a party to financial instruments with off‑balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments primarily include commitments to extend credit and financial guarantees. Contingent obligations under standby letters of credit totaled approximately $4.57 million and $4.71 million at March 31, 2014 and March 31, 2013 and represent the maximum potential future payments we could be required to make. Typically, these instruments have terms of 12 months or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements. The fair value of our standby letters of credit at March 31, 2014 and 2013 was insignificant.
Capital Resources
We are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements results in certain mandatory, and the possibility of additional discretionary, actions by regulators that could have a direct material effect on our financial statements. Under capital adequacy guidelines, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. It is the policy of the FRB that banks and bank holding companies should pay dividends only out of current earnings and only if, after paying such dividends, the bank or bank holding company would remain adequately capitalized. We are also subject to the regulatory framework for prompt corrective action that requires it to meet specific capital guidelines to be considered well capitalized. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require us to maintain minimum ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of March 31, 2014, that Merchants met all capital adequacy requirements to which it is subject.
As of March 31, 2014, the most recent notification from the FDIC categorized Merchants Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that Management believes have changed Merchants Bank’s category. To be considered well capitalized under the regulatory framework for prompt corrective action, Merchants Bank must maintain minimum Tier 1 Leverage, Tier 1 Risk-Based, and Total Risk-Based Capital ratios. As of March 31, 2014, we exceeded all current applicable regulatory capital requirements. We continue to be considered well capitalized under current applicable regulations.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) required the federal banking agencies to establish minimum leverage and risk-based capital requirements for insured banks and their holding companies. The federal banking agencies issued a joint final rule, or the “Final Capital Rule,” that implements the Basel III capital standards and establishes the minimum capital levels required under the Dodd-Frank Act. We must comply with the Final Capital Rule by January 1, 2015. The Final Capital Rule establishes a minimum common equity Tier 1 capital ratio of 6.5% of risk-weighted assets for a “well capitalized” institution and increases the minimum Tier 1 capital ratio for a “well capitalized” institution from 6% to 8%. Additionally, the Final Capital Rule requires an institution to maintain a 2.5% common equity Tier 1 capital conservation buffer over the 6.5% minimum risk-based capital requirement to avoid restrictions on the ability to pay dividends, discretionary bonuses, and engage in share repurchases. The Final Capital Rule permanently grandfathers trust preferred securities issued before May 19, 2010, subject to a limit of 25% of Tier 1 capital. As of March 31, 2014, our capital ratios exceed all Basel III minimums, including the capital conservation buffer.
36
The following table represents our actual capital ratios and capital adequacy requirements as of March 31, 2014.
|
|
|
|
|
|
|
|
|
|
|
| To Be Well- | |
|
|
|
|
| Capitalized Under | |
|
|
| For Capital | Prompt Corrective | ||
| Actual | Adequacy Purposes | Action Provisions | |||
(In thousands) | Amount | Percent | Amount | Percent | Amount | Percent |
Merchants Bancshares, Inc.: |
|
|
|
|
|
|
Tier 1 Leverage Capital | $ 143,898 | 8.57% | $ 67,136 | 4.00% | N/A | N/A |
Tier 1 Risk-Based Capital | 143,898 | 15.15% | 37,990 | 4.00% | N/A | N/A |
Total Risk-Based Capital | 155,782 | 16.40% | 75,980 | 8.00% | N/A | N/A |
Tangible Capital | 122,238 | 7.35% | N/A | N/A | N/A | N/A |
Merchants Bank: |
|
|
|
|
|
|
Tier 1 Leverage Capital | $ 141,146 | 8.39% | $ 67,264 | 4.00% | $ 84,080 | 5.00% |
Tier 1 Risk-Based Capital | 141,146 | 14.77% | 38,227 | 4.00% | 57,341 | 6.00% |
Total Risk-Based Capital | 153,103 | 16.02% | 76,455 | 8.00% | 95,568 | 10.00% |
Tangible Capital | 139,917 | 8.43% | N/A | N/A | N/A | N/A |
Capital amounts for Merchants Bancshares, Inc. include $20 million in trust preferred securities issued in December 2004. These hybrid securities qualify as regulatory capital up to certain regulatory limits.
37
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
General
Our Management and Board of Directors are committed to sound risk management practices throughout the organization. We have developed and implemented a centralized risk management monitoring program. Risks associated with our business activities and products are identified and measured as to probability of occurrence and impact on us (low, moderate, or high), and the control or other activities in place to manage those risks are identified and assessed. Periodically, department-level and senior managers re-evaluate and report on the risk management processes for which they are responsible. This documented program provides Management with a comprehensive framework for monitoring our risk profile from a macro perspective; it also serves as a tool for assessing internal controls over financial reporting as required under the Federal Deposit Insurance Corporation Improvement Act and the Sarbanes-Oxley Act of 2002.
Liquidity Risk
Our liquidity is measured by our ability to raise cash when needed at a reasonable cost. We must be capable of meeting expected and unexpected obligations to customers at any time. Given the uncertain nature of customer demands as well as the need to maximize earnings, we must have available reasonably priced sources of funds that can be accessed quickly in time of need. As discussed previously under “Liquidity and Capital Resources,” we have several sources of readily available funds, including the ability to borrow using our investment portfolio as collateral. We also monitor our liquidity on a quarterly basis in compliance with our Liquidity Contingency Plan.
Market Risk – Interest Rate Risk
Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices, and equity prices. Our primary market risk exposure is interest rate risk. An important component of our asset and liability management process is the ongoing monitoring and management of this risk, which is governed by established policies that are reviewed and approved annually by our Bank’s Board of Directors. Our investment policy details the types of securities that may be purchased, and establishes portfolio limits and maturity limits for the various sectors. Our investment policy also establishes specific investment quality limits. Our Bank’s Board of Directors has established a Board-level Asset and Liability Committee (“ALCO”), which delegates responsibility for carrying out the asset/liability management policies to the Management-level Asset and Liability Committee (“Management ALCO”). The Management ALCO, chaired by the Chief Financial Officer and composed of members of senior management, develops guidelines and strategies impacting our asset and liability management-related activities based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends. The Management ALCO manages the investment portfolio. Our goal is to maximize net interest income while mitigating market and interest rate risk. We accomplish this through careful monitoring of the overall duration and average life of the portfolio, thorough analysis of securities we are considering for purchase, monitoring of individual securities, occasional repositioning of the investment portfolio, as well as selective sales of specific securities.
The Management ALCO is responsible for evaluating and managing the interest rate risk which arises naturally from imbalances in repricing, maturity and cash flow characteristics of our assets and liabilities. Techniques used by the Management ALCO take into consideration the cash flow and repricing attributes of balance sheet and off-balance sheet items and their relation to possible changes in interest rates. The Management ALCO manages interest rate exposure primarily by using on-balance sheet strategies, generally accomplished through the management of the duration, rate sensitivity and average lives of our various investments, and by extending or shortening maturities of borrowed funds, as well as carefully managing and monitoring the pricing of loans and deposits. The Management ALCO also considers the use of off-balance sheet strategies, such as interest rate caps and floors and interest rate swaps, to help minimize our exposure to changes in interest rates. By using derivative financial instruments to hedge exposures to changes in interest rates we expose ourselves to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes us, which creates credit risk for us. We minimize the credit risk in derivative instruments by entering into transactions only with high-quality counterparties. The market risk associated with interest rate contracts is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken.
The ALCO is responsible for ensuring that our Bank’s Board of Directors receives accurate information regarding our interest rate risk position at least quarterly. The ALCO uses an outside consultant to perform rate shocks of our balance sheet, and to perform a variety of other analyses. The ALCO consultant meets with the Board and Management-level ALCOs on a quarterly basis. During these meetings, the ALCO consultant reviews our current position and discusses future strategies, as well as reviewing the result of rate shocks of our balance sheet and a variety of other analyses. The consultant’s most recent review was as of March 31, 2014. The consultant ran a base simulation assuming no changes in rates as well as a 200 basis point rising and, because rates are quite low, a 100 basis point falling interest rate scenario which assumes a parallel and pro rata shift of the yield curve over a one-year period, and no growth assumptions. The consultant also ran shock simulations in a 100 basis point decreasing scenario as well as 100, 200, 300 and 400 basis points rising scenarios. Additionally the consultant ran simulations with changes in the yield curve and with prepayment speed changes. A summary of the results is as follows:
Current/Flat Rates: Net interest income levels are projected to trend downward throughout the simulation as the sustained low rate environment causes continued margin pressure as assets reprice and are replaced at lower rates than the existing portfolio, while funding costs provide little or no relief.
38
Falling Rates: If rates fall 100 basis points, our net interest income is projected to trend in line with the base case over the first year as we bring funding costs down to near zero. Thereafter margins contract as asset yields continue to reprice lower while funding rates have reached their floors.
Rising Rates: Our interest rate risk profile is structurally asset sensitive due to our strong core funding base. Higher rates are better for us under all scenarios as our low cost deposits are worth more to us when they can be invested at higher rates. If rates rise in a parallel fashion net interest income is projected to increase throughout the simulation as asset yields will reset into the higher rate environment and funding costs lag. This assets sensitivity holds true even if the yield curve were to flatten as rates rise.
We have established a target range for the change in net interest income in year one of zero to 7.5%. The net interest income simulation as of March 31, 2014 showed that the change in net interest income for the next 12 months from our expected or “most likely” forecast was as follows:
|
| |
Rate Change | Percent Change in Net Interest Income | |
Up 200 basis points | 2.7% |
|
Down 100 basis points | (0.1)% |
|
The change in net interest income in the second year of the simulation shows a much more pronounced downward trend in the flat and down 100 basis points scenarios, the projected change is (2.8)% and (7.3)%, respectively, while the up 200 basis points simulation produces an increase of 6.3%. The degree to which this exposure materializes will depend, in part, on our ability to manage our balance sheet as interest rates rise or fall. We have intentionally increased our variable rate assets, through purchases and originations of variable rate investment and through the use of loan level swaps.
The preceding sensitivity analysis does not represent our forecast and should not be relied upon as being indicative of expected operating results. These estimates are based upon numerous assumptions including among others, the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, deposit run-off rates, pricing decisions on loans and deposits and reinvestment/replacement of asset and liability cash flows. While assumptions are developed based upon current economic and local market conditions, we cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.
The model used to perform the base case balance sheet simulation assumes a parallel shift of the yield curve over twelve months and reprices every interest earning asset and interest bearing liability on our balance sheet. Prepayment assumptions for all residential mortgage products take into account prepayment assumptions most recently published by Applied Financial Technologies. Prepayment assumptions for commercial loan and commercial mortgage products are derived through an analysis of historical prepayment patterns combined with analysis of the current characteristics of the portfolio. Investment securities with call provisions are examined on an individual basis in each rate environment to estimate the likelihood of a call. The model uses product-specific assumptions for deposits which are subject to repricing based on current market conditions
The most significant ongoing factor affecting market risk exposure of net interest income during the quarter ended March 31, 2014 was the sustained low interest rate environment. Net interest income exposure is also significantly affected by the shape and level of the U.S. Government securities and interest rate swap yield curves, and changes in the size and composition of the loan, investment and deposit portfolios.
As market conditions vary from those assumed in the sensitivity analysis, actual results will likely differ due to: the varying impact of changes in the balances and mix of loans and deposits differing from those assumed, the impact of possible off balance sheet hedging strategies, and other internal/external variables. Furthermore, the sensitivity analysis does not reflect all actions that the ALCO might take in responding to or anticipating changes in interest rates.
Credit Risk
The Board of Directors reviews and approves our loan policy on an annual basis. Among other things, the loan policy establishes restrictions regarding the types of loans that may be granted, and the distribution of loan types within our portfolio. Our Board of Directors grants each loan officer the authority to originate loans on our behalf, subject to certain limitations. These authorized lending limits are reviewed at least annually and are based upon the lender’s experience. Loan requests that exceed a lender’s authority require the signature of our Credit Division Manager, Senior Loan Officer, and/or President. With the exception of certain municipal loans, all extensions of credit of $5.0 million or greater to any one borrower, or related party interest, are reviewed and approved by the Loan Committee of Merchants Bank’s Board of Directors. Short-term revenue anticipation and tax anticipation extensions of credit of $8.0 million or greater to a municipality are reviewed and approved by the Loan Committee of Merchants Bank’s Board of Directors. Our loan portfolio is continuously monitored for performance, creditworthiness and strength of documentation through the use of a variety of management reports and the assistance of an external loan review firm. Credit ratings are assigned to commercial loans and are routinely reviewed. Loan officers, under the supervision of the Senior Lender and Senior Credit Officer, take remedial actions to assure full and timely payment of loan balances when necessary. Our policy is to discontinue the accrual of interest on loans when scheduled payments become contractually past due 90 or more days and the ultimate collectability of principal or interest become doubtful. In certain instances the accrual of interest is discontinued prior to 90 days past due if Management determines that the borrower will not be able to continue making timely payments.
39
Item 4. Controls and Procedures
Our principal executive officer, principal financial officer, and other members of our senior management have evaluated our disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on this evaluation, our principal executive officer and principal financial officer have concluded that the disclosure controls and procedures effectively ensure that information required to be disclosed in our filings and submissions with the SEC under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to our management (including the principal executive officer and principal financial officer), and is recorded, processed, summarized and reported within the time periods specified by the SEC. In addition, we have reviewed our internal control over financial reporting and there have been no changes in our internal control over financial reporting during the quarter ended March 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
40
MERCHANTS BANCSHARES, INC.
PART II – OTHER INFORMATION
None.
In addition to the other information set forth in this report, please read the factors discussed in Part I – Item 1A, "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 filed with the SEC on March 10, 2014, which could materially adversely affect our business, financial condition and operating results. These risks are not the only ones facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and operating results.
General economic and market conditions in the United States of America and abroad may materially and adversely affect the market price of shares of our common stock. Because of these and other factors, past financial performance should not be considered an indicator of future performance. The forward-looking statements contained herein represent our judgments as of the date of this Quarterly Report on Form 10-Q and we undertake no duty to update these forward-looking statements. We caution readers not to place undue reliance on such statements.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosure
Not applicable.
None.
31.1* Certification of Chief Executive Officer Pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as amended
31.2* Certification of Chief Financial Officer Pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as amended
32.1** Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2** Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101** The following materials from Merchants Bancshares, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2014 formatted in XBRL: (i) Consolidated Balance Sheets at March 31, 2014 and December 31, 2013; (ii) Consolidated Statements of Income for the three months ended March 31, 2014 and 2013; (iii) Consolidated Statements of Comprehensive Income for the three months ended March 31, 2014 and 2013; (iv) Consolidated Statements of Cash Flows for the three months ended March 31, 2014 and 2013; and (v) Notes to Interim Unaudited Consolidated Financial Statements.
_______________________________
* Filed herewith
** Furnished herewith
41
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.
Merchants Bancshares, Inc.
/s/ Michael R. Tuttle
Michael R. Tuttle
President & Chief Executive Officer
/s/ Janet P. Spitler
Janet P. Spitler
Chief Financial Officer & Treasurer
Principal Accounting Officer
May 9, 2014
Date
42