Exhibit 13
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Middlefield Banc Corp.
We have audited the accompanying consolidated balance sheet of Middlefield Banc Corp. and subsidiaries (the “Company”) as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income (loss), changes in stockholders’ equity, and cash flows for the three years in the period ended December 31, 2015. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Middlefield Banc Corp. and subsidiaries as of December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the three years in the period ending December 31, 2015, in conformity with U.S. Generally Accepted Accounting Principles.
/s/ S.R. Snodgrass P.C. |
Wexford, Pennsylvania
March 9, 2016
MIDDLEFIELD BANC CORP.
CONSOLIDATED BALANCE SHEET
(Dollar amounts in thousands, except shares)
December 31, | ||||||||
2015 | 2014 | |||||||
ASSETS | ||||||||
Cash and due from banks | $ | 22,421 | $ | 20,846 | ||||
Federal funds sold | 1,329 | 4,793 | ||||||
Cash and cash equivalents | 23,750 | 25,639 | ||||||
Investment securities available for sale, at fair value | 146,520 | 154,334 | ||||||
Loans held for sale | 1,107 | 438 | ||||||
Loans | 533,710 | 470,584 | ||||||
Less allowance for loan and lease losses | 6,385 | 6,846 | ||||||
Net loans | 527,325 | 463,738 | ||||||
Premises and equipment, net | 9,772 | 9,980 | ||||||
Goodwill | 4,559 | 4,559 | ||||||
Core deposit intangibles | 76 | 116 | ||||||
Bank-owned life insurance | 13,141 | 9,092 | ||||||
Other real estate owned | 1,412 | 2,590 | ||||||
Accrued interest and other assets | 7,477 | 7,045 | ||||||
TOTAL ASSETS | $ | 735,139 | $ | 677,531 | ||||
LIABILITIES | ||||||||
Deposits: | ||||||||
Noninterest-bearing demand | $ | 116,498 | $ | 105,512 | ||||
Interest-bearing demand | 57,219 | 56,377 | ||||||
Money market | 78,856 | 75,895 | ||||||
Savings | 180,653 | 178,470 | ||||||
Time | 191,221 | 169,858 | ||||||
Total deposits | 624,447 | 586,112 | ||||||
Short-term borrowings | 35,825 | 14,808 | ||||||
Other borrowings | 9,939 | 10,624 | ||||||
Accrued interest and other liabilities | 2,624 | 2,120 | ||||||
TOTAL LIABILITIES | 672,835 | 613,664 | ||||||
STOCKHOLDERS' EQUITY | ||||||||
Common stock, no par value; 10,000,000 shares authorized, 2,263,403 and 2,242,025 shares issued; 1,877,238 and 2,052,495 shares outstanding | 36,191 | 35,529 | ||||||
Retained earnings | 37,236 | 32,524 | ||||||
Accumulated other comprehensive income | 2,395 | 2,548 | ||||||
Treasury stock, at cost; 386,165 and 189,530 shares | (13,518 | ) | (6,734 | ) | ||||
TOTAL STOCKHOLDERS' EQUITY | 62,304 | 63,867 | ||||||
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY | $ | 735,139 | $ | 677,531 | ||||
See accompanying notes to the consolidated financial statements.
MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF INCOME
(Dollar amounts in thousands, except per share data)
Year Ended December 31, | ||||||||||||
2015 | 2014 | 2013 | ||||||||||
INTEREST INCOME | ||||||||||||
Interest and fees on loans | $ | 23,824 | $ | 22,726 | $ | 22,496 | ||||||
Interest-bearing deposits in other institutions | 33 | 24 | 30 | |||||||||
Federal funds sold | 13 | 14 | 15 | |||||||||
Investment securities: | ||||||||||||
Taxable interest | 1,467 | 1,896 | 2,514 | |||||||||
Tax-exempt interest | 3,160 | 3,127 | 3,044 | |||||||||
Dividends on stock | 98 | 87 | 79 | |||||||||
Total interest income | 28,595 | 27,874 | 28,178 | |||||||||
INTEREST EXPENSE | ||||||||||||
Deposits | 3,426 | 3,633 | 4,709 | |||||||||
Short-term borrowings | 194 | 148 | 178 | |||||||||
Federal funds purchased | - | - | 7 | |||||||||
Other borrowings | 83 | 118 | 166 | |||||||||
Trust preferred securities | 117 | 171 | 190 | |||||||||
Total interest expense | 3,820 | 4,070 | 5,250 | |||||||||
NET INTEREST INCOME | 24,775 | 23,804 | 22,928 | |||||||||
Provision for loan losses | 315 | 370 | 196 | |||||||||
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES | 24,460 | 23,434 | 22,732 | |||||||||
NONINTEREST INCOME | ||||||||||||
Service charges on deposit accounts | 1,874 | 1,876 | 1,956 | |||||||||
Investment securities gains, net | 323 | 248 | 11 | |||||||||
Earnings on bank-owned life insurance | 624 | 276 | 280 | |||||||||
Gains on sale of loans | 329 | 237 | - | |||||||||
Other income | 894 | 951 | 898 | |||||||||
Total noninterest income | 4,044 | 3,588 | 3,145 | |||||||||
NONINTEREST EXPENSE | ||||||||||||
Salaries and employee benefits | 9,751 | 8,817 | 7,913 | |||||||||
Occupancy expense | 1,253 | 1,108 | 1,231 | |||||||||
Equipment expense | 944 | 963 | 950 | |||||||||
Data processing costs | 1,071 | 917 | 854 | |||||||||
Ohio state franchise tax | 300 | 342 | 618 | |||||||||
Federal deposit insurance expense | 472 | 449 | 516 | |||||||||
Professional fees | 1,247 | 1,086 | 1,174 | |||||||||
(Gain) loss on other real estate owned | (48 | ) | 183 | 18 | ||||||||
Advertising expenses | 721 | 488 | 445 | |||||||||
Other real estate expenses | 611 | 387 | 410 | |||||||||
Directors fees | 451 | 403 | 403 | |||||||||
Core deposit intangible amortization | 40 | 40 | 40 | |||||||||
Other expense | 3,264 | 2,667 | 2,298 | |||||||||
Total noninterest expense | 20,077 | 17,850 | 16,870 | |||||||||
Income before income taxes | 8,427 | 9,172 | 9,007 | |||||||||
Income taxes | 1,562 | 1,992 | 1,979 | |||||||||
NET INCOME | $ | 6,865 | $ | 7,180 | $ | 7,028 | ||||||
EARNINGS PER SHARE | ||||||||||||
Basic | $ | 3.41 | $ | 3.52 | $ | 3.48 | ||||||
Diluted | 3.39 | 3.50 | 3.47 | |||||||||
DIVIDENDS DECLARED PER SHARE | $ | 1.07 | $ | 1.04 | $ | 1.04 | ||||||
See accompanying notes to the consolidated financial statements.
MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Dollar amounts in thousands)
Year Ended December 31, | ||||||||||||
2015 | 2014 | 2013 | ||||||||||
Net income | $ | 6,865 | $ | 7,180 | $ | 7,028 | ||||||
Other comprehensive income (loss): | ||||||||||||
Net unrealized holding gain (loss) on available-for-sale investment securities | 91 | 7,498 | (11,545 | ) | ||||||||
Tax effect | (31 | ) | (2,549 | ) | 3,925 | |||||||
Reclassification adjustment for investment securities gains included in net income | (323 | ) | (248 | ) | (11 | ) | ||||||
Tax effect | 110 | 84 | 3 | |||||||||
Total other comprehensive (loss) income | (153 | ) | 4,785 | (7,628 | ) | |||||||
Comprehensive income (loss) | $ | 6,712 | $ | 11,965 | $ | (600 | ) | |||||
See accompanying notes to the consolidated financial statements.
MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollar amounts in thousands, except shares and dividend per share amount)
Common Stock | Retained | Accumulated Other Comprehensive | Treasury | Total Stockholders' | ||||||||||||||||||||
Shares | Amount | Earnings | Income (Loss) | Stock | Equity | |||||||||||||||||||
Balance, December 31, 2012 | 2,181,763 | $ | 34,295 | $ | 22,485 | $ | 5,391 | $ | (6,734 | ) | $ | 55,437 | ||||||||||||
Net income | 7,028 | 7,028 | ||||||||||||||||||||||
Other comprehensive loss | (7,628 | ) | (7,628 | ) | ||||||||||||||||||||
Common stock issuance, net of issuance cost ($139) | 13,320 | 74 | 74 | |||||||||||||||||||||
Dividend reinvestment and purchase plan | 25,751 | 736 | 736 | |||||||||||||||||||||
Stock options exercised | 1,000 | (126 | ) | 49 | (77 | ) | ||||||||||||||||||
Cash dividends ($1.04 per share) | (2,097 | ) | (2,097 | ) | ||||||||||||||||||||
Balance, December 31, 2013 | 2,221,834 | $ | 34,979 | $ | 27,465 | $ | (2,237 | ) | $ | (6,734 | ) | $ | 53,473 | |||||||||||
Net income | 7,180 | 7,180 | ||||||||||||||||||||||
Other comprehensive income | 4,785 | 4,785 | ||||||||||||||||||||||
Dividend reinvestment and purchase plan | 19,791 | 590 | 590 | |||||||||||||||||||||
Stock options exercised | (50 | ) | (50 | ) | ||||||||||||||||||||
Stock-based compensation | 400 | 10 | 10 | |||||||||||||||||||||
Cash dividends ($1.04 per share) | (2,121 | ) | (2,121 | ) | ||||||||||||||||||||
Balance, December 31, 2014 | 2,242,025 | $ | 35,529 | $ | 32,524 | $ | 2,548 | $ | (6,734 | ) | $ | 63,867 | ||||||||||||
Net income | 6,865 | 6,865 | ||||||||||||||||||||||
Other comprehensive loss | (153 | ) | (153 | ) | ||||||||||||||||||||
Purchase of treasury stock (196,635 shares) | (6,784 | ) | (6,784 | ) | ||||||||||||||||||||
Dividend reinvestment and purchase plan | 20,393 | 651 | 651 | |||||||||||||||||||||
Stock options exercised | 400 | (7 | ) | (7 | ) | |||||||||||||||||||
Stock-based compensation | 585 | 18 | 18 | |||||||||||||||||||||
Cash dividends ($1.07 per share) | (2,153 | ) | (2,153 | ) | ||||||||||||||||||||
Balance, December 31, 2015 | 2,263,403 | $ | 36,191 | $ | 37,236 | $ | 2,395 | $ | (13,518 | ) | $ | 62,304 | ||||||||||||
See accompanying notes to the consolidated financial statements.
MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollar amounts in thousands)
Year Ended December 31, | ||||||||||||
2015 | 2014 | 2013 | ||||||||||
OPERATING ACTIVITIES | ||||||||||||
Net income | $ | 6,865 | $ | 7,180 | $ | 7,028 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
Provision for loan losses | 315 | 370 | 196 | |||||||||
Investment securities gains, net | (323 | ) | (248 | ) | (11 | ) | ||||||
Depreciation and amortization | 1,013 | 1,049 | 891 | |||||||||
Amortization of premium and discount on investment securities | 669 | 737 | 1,100 | |||||||||
Accretion of deferred loan fees, net | (603 | ) | (237 | ) | (245 | ) | ||||||
Origination of loans held for sale | (17,889 | ) | (6,223 | ) | - | |||||||
Proceeds from sale of loans held for sale | 17,549 | 6,022 | - | |||||||||
Gains on sale of loans | (329 | ) | (237 | ) | - | |||||||
Earnings on bank-owned life insurance | (624 | ) | (276 | ) | (280 | ) | ||||||
Deferred income taxes | 558 | (154 | ) | 423 | ||||||||
Stock-based compensation expense | 18 | 10 | - | |||||||||
(Gain) loss on other real estate owned | (48 | ) | 183 | 18 | ||||||||
Other real estate owned writedowns | 102 | 123 | 101 | |||||||||
(Increase) decrease in accrued interest receivable | (292 | ) | 40 | 28 | ||||||||
Increase (decrease) in accrued interest payable | 80 | (49 | ) | (128 | ) | |||||||
Decrease in prepaid federal deposit insurance | - | - | 513 | |||||||||
Other, net | 121 | (831 | ) | 263 | ||||||||
Net cash provided by operating activities | 7,182 | 7,459 | 9,897 | |||||||||
INVESTING ACTIVITIES | ||||||||||||
Investment securities available for sale: | ||||||||||||
Proceeds from repayments and maturities | 13,497 | 13,474 | 25,411 | |||||||||
Proceeds from sale of securities | 15,686 | 8,383 | 25,088 | |||||||||
Purchases | (21,946 | ) | (12,287 | ) | (25,815 | ) | ||||||
Increase in loans, net | (63,937 | ) | (36,222 | ) | (29,829 | ) | ||||||
Proceeds from the sale of other real estate owned | 1,762 | 832 | 882 | |||||||||
Purchase of bank-owned life insurance | (4,000 | ) | - | - | ||||||||
Purchase of premises and equipment | (507 | ) | (902 | ) | (1,834 | ) | ||||||
Net cash used for investing activities | (59,445 | ) | (26,722 | ) | (6,097 | ) | ||||||
FINANCING ACTIVITIES | ||||||||||||
Net increase (decrease) in deposits | 38,335 | 17,276 | (24,499 | ) | ||||||||
Increase in short-term borrowings, net | 21,017 | 3,999 | 4,271 | |||||||||
Repayment of other borrowings | (685 | ) | (985 | ) | (1,361 | ) | ||||||
Common stock issued | - | - | 74 | |||||||||
Stock options exercised | (7 | ) | (50 | ) | (77 | ) | ||||||
Proceeds from dividend reinvestment and purchase plan | 651 | 590 | 736 | |||||||||
Purchase of treasury stock | (6,784 | ) | - | - | ||||||||
Cash dividends | (2,153 | ) | (2,121 | ) | (2,097 | ) | ||||||
Net cash provided by (used for) financing activities | 50,374 | 18,709 | (22,953 | ) | ||||||||
Decrease in cash and cash equivalents | (1,889 | ) | (554 | ) | (19,153 | ) | ||||||
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR | 25,639 | 26,193 | 45,346 | |||||||||
CASH AND CASH EQUIVALENTS AT END OF YEAR | $ | 23,750 | $ | 25,639 | $ | 26,193 | ||||||
SUPPLEMENTAL INFORMATION | ||||||||||||
Cash paid during the year for: | ||||||||||||
Interest on deposits and borrowings | $ | 3,740 | $ | 4,119 | $ | 5,378 | ||||||
Income taxes | 800 | 2,260 | 1,620 | |||||||||
Non-cash investing transactions: | ||||||||||||
Transfers from loans to other real estate owned | $ | 638 | $ | 1,030 | $ | 2,113 | ||||||
Loans to facilitate the sale of other real estate owned | - | - | (260 | ) | ||||||||
Death benefit proceeds not yet received from insurance company | 575 | - | - | |||||||||
See accompanying notes to the consolidated financial statements.
MIDDLEFIELD BANC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
A summary of the significant accounting and reporting policies applied in the presentation of the accompanying financial statements follows:
Nature of Operations and Basis of Presentation
Middlefield Banc Corp. (the “Company”) is an Ohio corporation organized to become the holding company of The Middlefield Banking Company (“MBC”). MBC is a state-chartered bank located in Ohio. On April 19, 2007, Middlefield Banc Corp. acquired Emerald Bank (“EB”), an Ohio-chartered commercial bank headquartered in Dublin, Ohio. EB merged into MBC on January 20, 2014. On October 23, 2009, the Company established an asset resolution subsidiary named EMORECO, Inc. The Company and its subsidiaries derive substantially all of their income from banking and bank-related services, which includes interest earnings on residential real estate, commercial mortgage, commercial and consumer financings as well as interest earnings on investment securities and deposit services to its customers through ten locations. The Company is supervised by the Board of Governors of the Federal Reserve System, while MBC is subject to regulation and supervision by the Federal Deposit Insurance Corporation and the Ohio Division of Financial Institutions.
The consolidated financial statements of the Company include its wholly owned subsidiaries, MBC and EMORECO, Inc. Significant intercompany items have been eliminated in preparing the consolidated financial statements.
The financial statements have been prepared in conformity with U.S. Generally Accepted Accounting Principles. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the balance sheet date and revenues and expenses for the period. Actual results could differ from those estimates.
Investment Securities
Investment securities are classified at the time of purchase, based on management’s intention and ability, as securities held to maturity or securities available for sale. Debt securities acquired with the intent and ability to hold to maturity are stated at cost adjusted for amortization of premium and accretion of discount, which are computed using a level yield method and recognized as adjustments of interest income. Certain other debt securities have been classified as available for sale to serve principally as a source of liquidity. Unrealized holding gains and losses for available-for-sale securities are reported as a separate component of stockholders’ equity, net of tax, until realized. Realized security gains and losses are computed using the specific identification method. Interest and dividends on investment securities are recognized as income when earned.
Securities are evaluated on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether a decline in their value is other than temporary. For debt securities, management considers whether the present value of cash flows expected to be collected are less than the security’s amortized cost basis (the difference defined as the credit loss), the magnitude and duration of the decline, the reasons underlying the decline and the Bank’s intent to sell the security or whether it is more likely than not that the Bank would be required to sell the security before its anticipated recovery in market value, to determine whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, if the Bank does not intend to sell the security, and it is more likely than not that it will not be required to sell the security, before recovery of the security’s amortized cost basis, the charge to earnings is limited to the amount of credit loss. Any remaining difference between fair value and amortized cost (the difference defined as the non-credit portion) is recognized in other comprehensive income, net of applicable taxes. Otherwise, the entire difference between fair value and amortized cost is charged to earnings. For equity securities where the fair value has been significantly below cost for one year, the Bank’s policy is to recognize an impairment loss unless sufficient evidence is available that the decline is not other than temporary and a recovery period can be predicted.
Restricted Stock
Common stock of the Federal Home Loan Bank (“FHLB”) represents ownership in an institution that is wholly owned by other financial institutions. This equity security is accounted for at cost and classified with other assets. The FHLB of Cincinnati has reported profits for 2015 and 2014, remains in compliance with regulatory capital and liquidity requirements, and continues to pay dividends on the stock and make redemptions at the par value. With consideration given to these factors, management concluded that the stock was not impaired at December 31, 2015 or 2014.
Mortgage Banking Activities Mortgage loans originated and intended for sale in the secondary market are carried at fair value. The Bank sells the loans on a servicing retained basis. Servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. The Bank measures servicing assets using the amortization method. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. Loan servicing rights are amortized in proportion to and over the period of estimated net future servicing revenue. The expected period of the estimated net servicing income is based in part on the expected prepayment of the underlying mortgages. The unamortized balance of mortgage servicing rights is included in accrued interest and other assets on the Consolidated Balance Sheet.
Mortgage servicing rights will be periodically evaluated for impairment, beginning in 2016. Impairment represents the excess of amortized cost over its estimated fair value. Impairment is determined by stratifying rights into tranches based on predominant risk characteristics, such as interest rate and original time to maturity. Any impairment is reported as a valuation allowance for an individual tranche. If the Company later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the allowance will be recorded as an increase to income.
Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of outstanding principal and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income. Late fees and ancillary fees related to loan servicing are not material.
The Company is exposed to interest rate risk on loans held for sale and rate-lock loan commitments (“IRLCs”). As market interest rates increase or decrease, the fair value of loans held for sale and rate-lock commitments will decrease or increase. The Company enters into derivative transactions principally to protect against the risk of adverse interest movements affecting the value of the Company’s committed loan sales pipeline. In order to mitigate the risk that a change in interest rates will result in a decrease in value of the Company’s IRLCs in the committed mortgage pipeline or its loans held for sale, the Company enters into mandatory forward loan sales contracts with secondary market participants. Mandatory forward sales contracts and committed loans intended to be held for sale are considered free-standing derivative instruments and changes in fair value are recorded in current period earnings. For committed loans, fair value is measured using current market rates for the associated mortgage loans. For mandatory forward sales contracts, fair value is measured using secondary market pricing.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff generally are reported at their outstanding unpaid principal balances net of the allowance for loan and lease losses. Interest income is recognized as income when earned on the accrual method. The accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower’s financial condition is such that collection of interest is doubtful. Interest received on nonaccrual loans is recorded as income or applied against principal according to management’s judgment as to the collectability of such principal.
Loan origination fees and certain direct loan origination costs are being deferred and the net amount amortized as an adjustment of the related loan’s yield. Management is amortizing these amounts over the contractual life of the related loans.
Allowance for Loan and Lease Losses
The allowance for loan and lease losses represents the amount which management estimates is adequate to provide for probable loan losses inherent in the loan portfolio. The allowance method is used in providing for loan losses. Accordingly, all loan losses are charged to the allowance, and all recoveries are credited to it. The allowance for loan and lease losses is established through a provision for loan losses which is charged to operations. The provision is based on management’s periodic evaluation of the adequacy of the allowance for loan and lease losses, which encompasses the overall risk characteristics of the various portfolio segments, past experience with losses, the impact of economic conditions on borrowers, and other relevant factors. The estimates used in determining the adequacy of the allowance for loan and lease losses, including the amounts and timing of future cash flows expected on impaired loans, are particularly susceptible to significant change in the near term.
A loan is considered impaired when it is probable the borrower will not repay the loan according to the original contractual terms of the loan agreement. Management has determined that first mortgage loans on one-to-four family properties and all consumer loans represent large groups of smaller-balance homogeneous loans that are to be collectively evaluated. Loans that experience insignificant payment delays, which are defined as 90 days or less, generally are not classified as impaired. A loan is not impaired during a period of delay in payment if the Company expects to collect all amounts due, including interest accrued, at the contractual interest rate for the period of delay. All loans identified as impaired are evaluated independently by management. The Company estimates credit losses on impaired loans based on the present value of expected cash flows or the fair value of the underlying collateral if the loan repayment is expected to come from the sale or operation of such collateral. Impaired loans, or portions thereof, are charged off when it is determined a realized loss has occurred. Until such time, an allowance for loan and lease losses is maintained for estimated losses. Cash receipts on impaired loans are applied first to accrued interest receivable unless otherwise required by the loan terms, except when an impaired loan is also a nonaccrual loan, in which case the portion of the payment related to interest is recognized as income.
Mortgage loans secured by one-to-four family properties and all consumer loans are large groups of smaller-balance homogeneous loans and are measured for impairment collectively. Management determines the significance of payment delays on a case-by-case basis, taking into consideration all circumstances concerning the loan, the creditworthiness and payment history of the borrower, the length of the payment delay, and the amount of shortfall in relation to the principal and interest owed.
Premises and Equipment
Land is carried at cost. Premises and equipment are stated at cost net of accumulated depreciation. Depreciation is computed on the straight-line method over the estimated useful lives of the assets, which range from 3 to 20 years for furniture, fixtures, and equipment and 3 to 40 years for buildings and leasehold improvements. Expenditures for maintenance and repairs are charged against income as incurred. Costs of major additions and improvements are capitalized.
Goodwill
The Company accounts for goodwill using a three-step process for testing the impairment of goodwill on at least an annual basis. This approach could cause more volatility in the Company’s reported net income because impairment losses, if any, could occur irregularly and in varying amounts. No impairment of goodwill was recognized in any of the periods presented.
Intangible Assets
Intangible assets include core deposit intangibles, which are a measure of the value of consumer demand and savings deposits acquired in business combinations accounted for as purchases. The core deposit intangibles are being amortized to expense over a 10 year life on a straight-line basis. The recoverability of the carrying value of intangible assets is evaluated on an ongoing basis, and permanent declines in value, if any, are charged to expense.
Bank-Owned Life Insurance (“BOLI”)
The Company owns insurance on the lives of a certain group of key employees. The policies were purchased to help offset the increase in the costs of various fringe benefit plans including healthcare. The cash surrender value of these policies is included as an asset on the Consolidated Balance Sheet and any increases in the cash surrender value are recorded as noninterest income on the Consolidated Statement of Income. In the event of the death of an insured individual under these policies, the Company would receive a death benefit, which would be recorded as noninterest income.
Other Real Estate Owned
Real estate properties acquired through foreclosure are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. After foreclosure, management periodically performs valuations and the real estate is carried at the lower of cost or fair value less estimated cost to sell. Revenue and expenses from operations of the properties, gains or losses on sales and additions to the valuation allowance are included in operating results.
Income Taxes
The Company and its subsidiaries file a consolidated federal income tax return. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.
Earnings Per Share
The Company provides dual presentation of basic and diluted earnings per share. Basic earnings per share are calculated utilizing net income as reported in the numerator and average shares outstanding in the denominator. The computation of diluted earnings per share differs in that the dilutive effects of any stock options, warrants, and convertible securities are adjusted in the denominator.
Stock-Based Compensation
The Company accounts for stock compensation based on the grant date fair value of all share-based payment awards that are expected to vest, including employee share options to be recognized as employee compensation expense over the requisite service period.
For each of the years ended December 31, 2015, 2014, and 2013, the Company recorded no compensation cost related to vested stock options. As of December 31, 2015, there was no unrecognized compensation cost related to unvested stock options.
At year ended December 31, 2015, 585 shares of restricted stock were awarded and immediately vested. There were no shares of restricted stock issued in 2014 or 2013.
For the years ended December 31, 2015 and 2014, 2,175 and 11,223 options were exercised resulting in net proceeds to the participant of $7,000 and $50,000, respectively.
Cash Flow Information
The Company has defined cash and cash equivalents as those amounts included in the Consolidated Balance Sheet captions as “Cash and due from banks” and “Federal funds sold” with original maturities of less than 90 days.
Advertising Costs
Advertising costs are expensed as incurred.
Reclassification of Comparative Amounts
Certain comparative amounts for prior years have been reclassified to conform to current-year presentations. Such reclassifications did not affect net income or retained earnings.
Recent Accounting Pronouncements:
In January 2014, the Financial Accounting Standards Board (“FASB”) 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 Update permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, 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 amendments in this Update should be applied retrospectively to all periods presented. A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those preexisting investments. The amendments in this Update are effective for public business entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. This Update did not have a significant impact on the Company’s financial statements.
In January 2014, the FASB issued ASU 2014-04,Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.The amendments in this Update clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this Update are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. An entity can elect to adopt the amendments in this Update using either a modified retrospective transition method or a prospective transition method. This Update did not have a significant impact on the Company’s financial statements.
In May 2014, the FASB issued ASU 2014-09,Revenue from Contracts with Customers (a new revenue recognition standard). The Update’s core principle is that a company will recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, this update specifies the accounting for certain costs to obtain or fulfill a contract with a customer and expands disclosure requirements for revenue recognition. This Update is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. The Company is evaluating the effect of adopting this new accounting Update.
In June 2014, the FASB issued ASU 2014-11,Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. The amendments in this Update change the accounting for repurchase-to-maturity transactions to secured borrowing accounting. For repurchase financing arrangements, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which will result in secured borrowing accounting for the repurchase agreement. The amendments also require enhanced disclosures. The accounting changes in this Update are effective for the first interim or annual period beginning after December 15, 2014. An entity is required to present changes in accounting for transactions outstanding on the effective date as a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. Earlier application is prohibited. The disclosure for certain transactions accounted for as a sale is required to be presented for interim and annual periods beginning after December 15, 2014, and the disclosure for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and for interim periods beginning after March 15, 2015. The disclosures are not required to be presented for comparative periods before the effective date. This Update did not have a significant impact on the Company’s financial statements.
In June 2014, the FASB issued ASU 2014-12,Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments when the Terms of an Award Provide that a Performance Target Could Be Achieved After the Requisite Service Period. The amendments require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition.The amendments in this Update are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. Entities may apply the amendments in this Update either (a) prospectively to all awards granted or modified after the effective date or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. If retrospective transition is adopted, the cumulative effect of applying this Update as of the beginning of the earliest annual period presented in the financial statements should be recognized as an adjustment to the opening retained earnings balance at that date. Additionally, if retrospective transition is adopted, an entity may use hindsight in measuring and recognizing the compensation cost. This Update is not expected to have a significant impact on the Company’s financial statements.
In August 2014, the FASB issued ASU 2014-14,Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40). The amendments in this Update require that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met: (1) the loan has a government guarantee that is not separable from the loan before foreclosure, (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim, and (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. The amendments in this Update are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. This Update did not have a significant impact on the Company’s financial statements.
In November 2014, the FASB issued ASU 2014-17,Business Combinations (Topic 805): Pushdown Accounting.The amendments in this Update apply to the separate financial statements of an acquired entity and its subsidiaries that are a business or nonprofit activity (either public or nonpublic) upon the occurrence of an event in which an acquirer (an individual or an entity) obtains control of the acquired entity. An acquired entity may elect the option to apply pushdown accounting in the reporting period in which the change-in-control event occurs. If pushdown accounting is not applied in the reporting period in which the change-in-control event occurs, an acquired entity will have the option to elect to apply pushdown accounting in a subsequent reporting period to the acquired entity's most recent change-in-control event. The amendments in this Update are effective on November 18, 2014. After the effective date, an acquired entity can make an election to apply the guidance to future change-in-control events or to its most recent change-in-control event. This Update is not expected to have a significant impact on the Company’s financial statements.
In February 2015, the FASB issued ASU 2015-02,Consolidation (Topic 810). The amendments in this Update affect reporting entities that are required to evaluate whether they should consolidate certain legal entities. All legal entities are subject to reevaluation under the revised consolidation model. Specifically, the amendments (1) modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities (“VIEs”) or voting interest entities; (2) eliminate the presumption that a general partner should consolidate a limited partnership; (3) affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related-party relationships; and (4) provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. The amendments in this Update are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. For all other entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2016, and for interim periods within fiscal years beginning after December 15, 2017. This Update is not expected to have a significant impact on the Company’s financial statements.
In April 2015, the FASB issued ASU 2015-05,Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40), as part of its initiative to reduce complexity in accounting standards. This guidance will help entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement. The amendments in this Update provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. For public business entities, the FASB decided that the amendments will be effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2015. For all other entities, the amendments will be effective for annual periods beginning after December 15, 2015, and interim periods in annual periods beginning after December 15, 2016. Early adoption is permitted for all entities. This Update is not expected to have a significant impact on the Company’s financial statements.
In May 2015, the FASB issued ASU 2015-08, Business Combinations – Pushdown Accounting – Amendment to SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 115. This Update was issued to amend various SEC paragraphs pursuant to the issuance of Staff Accounting Bulletin No. 115. This Update is not expected to have a significant impact on the Company’s financial statements.
In June 2015, the FASB issued ASU 2015-10,Technical Corrections and Improvements. The amendments in this Update represent changes to clarify the FASB Accounting Standards Codification (“Codification”), correct unintended application of guidance, or make minor improvements to the Codification that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. Transition guidance varies based on the amendments in this Update. The amendments in this Update that require transition guidance are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. All other amendments will be effective upon the issuance of this Update. This Update is not expected to have a significant impact on the Company’s financial statements.
In August 2015, the FASB issued ASU 2015-14,Revenue from Contract with Customers (Topic 606). The amendments in this Update defer the effective date of ASU 2014-09 for all entities by one year. Public business entities, certain not-for-profit entities, and certain employee benefit plans should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. All other entities should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019. The Company is evaluating the effect of adopting this new accounting Update.
In September 2015, the FASB issued ASU 2015-16,Business Combinations (Topic 805). The amendments in this Update require that an acquirer recognizes adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments in this Update require that the acquirer record, in the same period's financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The amendments in this Update require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. For all other entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017. This Update is not expected to have a significant impact on the Company’s financial statements.
In November 2015, the FASB issued ASU 2015-17,Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. The amendments in this Update require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments in this Update apply to all entities that present a classified statement of financial position. For public business entities, the amendments in this Update are effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. For all other entities, the amendments in this Update are effective for financial statements issued for annual periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. Earlier application is permitted for all entities as of the beginning of an interim or annual reporting period. The amendments in this Update may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. This Update is not expected to have a significant impact on the Company’s financial statements.
In January 2016, the FASB issued ASU 2016-01,Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This Update applies to all entities that hold financial assets or owe financial liabilities and is intended to provide more useful information on the recognition, measurement, presentation, and disclosure of financial instruments. Among other things, this Update (a) requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (b) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (c) eliminates the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (d) eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (e) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (f) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (g) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (h) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. For all other entities including not-for-profit entities and employee benefit plans within the scope of Topics 960 through 965 on plan accounting, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. All entities that are not public business entities may adopt the amendments in this Update earlier as of the fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.
2. | EARNINGS PER SHARE |
There are no convertible securities that would affect the numerator in calculating basic and diluted earnings per share; therefore, net income as presented on the Consolidated Statement of Income will be used as the numerator. The following table sets forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings per share computation for the year ended December 31.
2015 | 2014 | 2013 | ||||||||||
| Weighted-average common sharesoutstanding | 2,251,365 | 2,231,165 | 2,206,392 | |||||||||
Average treasury stock shares | (236,399 | ) | (189,530 | ) | (189,530 | ) | ||||||
| Weighted-average common shares andcommon stock equivalents used to calculate basic earnings per share | 2,014,966 | 2,041,635 | 2,016,862 | |||||||||
| Additional common stock equivalentsused to calculate diluted earnings per share | 9,154 | 7,871 | 7,178 | |||||||||
| Weighted-average common shares andcommon stock equivalents used to calculate diluted earnings per share | 2,024,120 | 2,049,506 | 2,024,040 | |||||||||
Options to purchase 31,949 shares of common stock at prices ranging from $17.55 to $40.24 were outstanding during the year ended December 31, 2015. Of those options, 27,250were considered dilutive based on the average market price exceeding the strike price for the year ended December 31, 2015. The remaining options had no dilutive effect on the earnings per share.
Options to purchase 46,451 shares of common stock at prices ranging from $17.55 to $40.24 were outstanding during the year ended December 31, 2014. Of those options, 28,282were considered dilutive based on the average market price exceeding the strike price for the year ended December 31, 2014. The remaining options had no dilutive effect on the earnings per share.
Options to purchase 58,581 shares of common stock at prices ranging from $17.55 to $40.24 were outstanding during the year ended December 31, 2013. Of those options, 39,808were considered dilutive based on the average market price exceeding the strike price for the year ended December 31, 2013. The remaining options had no dilutive effect on the earnings per share.
3. | INVESTMENT SECURITIES AVAILABLE FOR SALE |
The amortized cost and fair values of securities available for sale are as follows:
December 31, 2015 | ||||||||||||||||
| (Dollar amounts in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||
U.S. government agency securities | $ | 21,655 | $ | 245 | $ | (271 | ) | $ | 21,629 | |||||||
Obligations of states and political subdivisions: | ||||||||||||||||
Taxable | 1,989 | 134 | - | 2,123 | ||||||||||||
Tax-exempt | 91,940 | 3,402 | (175 | ) | 95,167 | |||||||||||
Mortgage-backed securities in government-sponsored entities | 24,480 | 316 | (272 | ) | 24,524 | |||||||||||
Private-label mortgage-backed securities | 2,079 | 184 | - | 2,263 | ||||||||||||
Total debt securities | 142,143 | 4,281 | (718 | ) | 145,706 | |||||||||||
Equity securities in financial institutions | 750 | 64 | - | 814 | ||||||||||||
Total | $ | 142,893 | $ | 4,345 | $ | (718 | ) | $ | 146,520 | |||||||
December 31, 2014 | ||||||||||||||||
| (Dollar amounts in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||
U.S. government agency securities | $ | 23,035 | $ | 311 | $ | (450 | ) | $ | 22,896 | |||||||
Obligations of states and political subdivisions: | ||||||||||||||||
Taxable | 2,953 | 226 | - | 3,179 | ||||||||||||
Tax-exempt | 91,916 | 3,803 | (553 | ) | 95,166 | |||||||||||
Mortgage-backed securities in government-sponsored entities | 29,150 | 475 | (234 | ) | 29,391 | |||||||||||
Private-label mortgage-backed securities | 2,672 | 247 | - | 2,919 | ||||||||||||
Total debt securities | 149,726 | 5,062 | (1,237 | ) | 153,551 | |||||||||||
Equity securities in financial institutions | 750 | 33 | - | 783 | ||||||||||||
Total | $ | 150,476 | $ | 5,095 | $ | (1,237 | ) | $ | 154,334 | |||||||
The amortized cost and fair value of debt securities at December 31, 2015, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
| (Dollar amounts in thousands) | Amortized Cost | Fair Value | ||||||
Due in one year or less | $ | 1,139 | $ | 1,153 | ||||
Due after one year through five years | 10,790 | 10,890 | ||||||
Due after five years through ten years | 19,172 | 19,830 | ||||||
Due after ten years | 111,042 | 113,833 | ||||||
Total | $ | 142,143 | $ | 145,706 | ||||
Investment securities with an approximate carrying value of $68.8 millionand $61.9 million at December 31, 2015 and 2014, respectively, were pledged to secure deposits and other purposes as required by law.
Proceeds from the sales of securities available for sale and the gross realized gains and losses for the yearsended December, 31 are as follows (in thousands):
2015 | 2014 | 2013 | ||||||||||
Proceeds from sales | $ | 15,686 | $ | 8,383 | $ | 25,088 | ||||||
Gross realized gains | 440 | 306 | 186 | |||||||||
Gross realized losses | (117 | ) | (58 | ) | (175 | ) | ||||||
The following tables show the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.
December 31, 2015 | ||||||||||||||||||||||||
Less than Twelve Months | Twelve Months or Greater | Total | ||||||||||||||||||||||
| (Dollar amounts in thousands) | Fair Value | Gross Unrealized Losses | Fair Value | Gross Unrealized Losses | Fair Value | Gross Unrealized Losses | ||||||||||||||||||
U.S. government agency securities | $ | 3,818 | $ | (57 | ) | $ | 10,872 | $ | (214 | ) | $ | 14,690 | $ | (271 | ) | |||||||||
Obligations of states and political subdivisions | ||||||||||||||||||||||||
Tax-exempt | 1,268 | (9 | ) | 9,394 | (166 | ) | 10,662 | (175 | ) | |||||||||||||||
Mortgage-backed securities in government-sponsored entities | 8,725 | (86 | ) | 6,685 | (186 | ) | 15,410 | (272 | ) | |||||||||||||||
| Total | $ | 13,811 | $ | (152 | ) | $ | 26,951 | $ | (566 | ) | $ | 40,762 | $ | (718 | ) | |||||||||
December 31, 2014 | ||||||||||||||||||||||||
Less than Twelve Months | Twelve Months or Greater | Total | ||||||||||||||||||||||
| (Dollar amounts in thousands) | Fair Value | Gross Unrealized Losses | Fair Value | Gross Unrealized Losses | Fair Value | Gross Unrealized Losses | ||||||||||||||||||
U.S. government agency securities | $ | - | $ | - | $ | 15,734 | $ | (450 | ) | $ | 15,734 | $ | (450 | ) | ||||||||||
Obligations of states and political subdivisions | ||||||||||||||||||||||||
Tax-exempt | 2,406 | (10 | ) | 18,232 | (543 | ) | 20,638 | (553 | ) | |||||||||||||||
Mortgage-backed securities in government-sponsored entities | - | - | 16,774 | (234 | ) | 16,774 | (234 | ) | ||||||||||||||||
| Total | $ | 2,406 | $ | (10 | ) | $ | 50,740 | $ | (1,227 | ) | $ | 53,146 | $ | (1,237 | ) | |||||||||
There were 46 securities that were considered temporarily impaired at December 31, 2015.
On a quarterly basis, the Company performs an assessment to determine whether there have been any events or economic circumstances indicating that a security with an unrealized loss has suffered other-than-temporary impairment (“OTTI”). A debt security is considered impaired if the fair value is less than its amortized cost basis at the reporting date. The accounting literature requires the Company to assess whether the unrealized loss is other than temporary. For equity securities where the fair value has been significantly below cost for one year, the Company’s policy is to recognize an impairment loss unless sufficient evidence is available that the decline is not other than temporary and a recovery period can be predicted.
The Company has asserted that at December 31, 2015 and 2014, the declines outlined in the above table represent temporary declines and the Company does not intend to sell and does not believe it will be required to sell these securities before recovery of their cost basis, which may be at maturity. The Company has concluded that any impairment of its investment securities portfolio outlined in the above table is not other than temporary and is the result of interest rate changes, sector credit rating changes, or company-specific rating changes that are not expected to result in the non-collection of principal and interest during the period.
Debt securities issued by U.S. government agencies, U.S. government-sponsored enterprises, and state and political subdivisions accounted for more than 97.9% of the total available-for-sale portfolio as of December 31, 2015, and no credit losses are expected, given the explicit and implicit guarantees provided by the U.S. federal government and the lack of significant unrealized loss positions within the obligations of state and political subdivisions security portfolio. The Company evaluates credit losses on a quarterly basis. The Company considered the following factors in determining whether a credit loss exists and the period over which the debt security is expected to recover:
● | The length of time and the extent to which the fair value has been less than the amortized cost basis. |
● | Changes in the near term prospects of the underlying collateral of a security such as changes in default rates, loss severity given default and significant changes in prepayment assumptions. |
● | The level of cash flows generated from the underlying collateral supporting the principal and interest payments of the debt securities. |
● | Any adverse change to the credit conditions and liquidity of the issuer, taking into consideration the latest information available about the overall financial condition of the issuer, credit ratings, recent legislation, and government actions affecting the issuer’s industry and actions taken by the issuer to deal with the present economic climate. |
4. | LOANS AND RELATEDALLOWANCE FOR LOAN LOSSES |
Major classifications of loans at December 31 are summarized as follows (in thousands):
2015 | 2014 | |||||||
Commercial and industrial | $ | 42,536 | $ | 34,928 | ||||
Real estate - construction | 22,137 | 30,296 | ||||||
Real estate - mortgage: | ||||||||
Residential | 232,478 | 210,096 | ||||||
Commercial | 231,701 | 190,685 | ||||||
Consumer installment | 4,858 | 4,579 | ||||||
| 533,710 | 470,584 | |||||||
Less allowance for loan and lease losses | (6,385 | ) | (6,846 | ) | ||||
Net loans | $ | 527,325 | $ | 463,738 | ||||
The Company’s primary business activity is with customers located within its local trade area, eastern Geauga County, and contiguous counties to the north, east, and south. The Company also serves the central Ohio market with offices in Dublin and Westerville, Ohio. Commercial, residential, consumer, and agricultural loans are granted. Although the Company has a diversified loan portfolio at December 31, 2015 and 2014, loans outstanding to individuals and businesses are dependent upon the local economic conditions in its immediate trade area.
The following tables summarize the primary segments of the loan portfolio and the allowance for loan and lease losses as of December 31, 2015 and 2014 (in thousands):
Real Estate- Mortgage | ||||||||||||||||||||||||
| December 31, 2015 | Commercial and industrial | Real estate- construction | Residential | Commercial | Consumer installment | Total | ||||||||||||||||||
Loans: | ||||||||||||||||||||||||
Individually evaluated for impairment | $ | 1,808 | $ | 1,787 | $ | 3,881 | $ | 6,199 | $ | 6 | $ | 13,681 | ||||||||||||
Collectively evaluated for impairment | 40,728 | 20,350 | 228,597 | 225,502 | 4,852 | 520,029 | ||||||||||||||||||
Total loans | $ | 42,536 | $ | 22,137 | $ | 232,478 | $ | 231,701 | $ | 4,858 | $ | 533,710 | ||||||||||||
Real estate- Mortgage | ||||||||||||||||||||||||
| December 31, 2014 | Commercial and industrial | Real estate- construction | Residential | Commercial | Consumer installment | Total | ||||||||||||||||||
Loans: | ||||||||||||||||||||||||
Individually evaluated for impairment | $ | 1,393 | $ | 3,296 | $ | 5,183 | $ | 4,490 | $ | 6 | $ | 14,368 | ||||||||||||
Collectively evaluated for impairment | 33,535 | 27,000 | 204,913 | 186,195 | 4,573 | 456,216 | ||||||||||||||||||
Total loans | $ | 34,928 | $ | 30,296 | $ | 210,096 | $ | 190,685 | $ | 4,579 | $ | 470,584 | ||||||||||||
Real Estate- Mortgage | ||||||||||||||||||||||||
| December 31, 2015 | Commercial and industrial | Real estate- construction | Residential | Commercial | Consumer installment | Total | ||||||||||||||||||
Allowance for loan and lease losses: | ||||||||||||||||||||||||
Ending allowance balance attributable to loans: | ||||||||||||||||||||||||
| Individually evaluated for impairment | $ | 388 | $ | 130 | $ | 276 | $ | 39 | $ | - | $ | 833 | ||||||||||||
| Collectively evaluated for impairment | 479 | 146 | 2,863 | 2,039 | 25 | 5,552 | ||||||||||||||||||
| Total ending allowance balance | $ | 867 | $ | 276 | $ | 3,139 | $ | 2,078 | $ | 25 | $ | 6,385 | ||||||||||||
Real Estate- Mortgage | ||||||||||||||||||||||||
| December 31, 2014 | Commercial and industrial | Real estate- construction | Residential | Commercial | Consumer installment | Total | ||||||||||||||||||
Allowance for loan and lease losses: | ||||||||||||||||||||||||
Ending allowance balance attributable to loans: | ||||||||||||||||||||||||
| Individually evaluated for impairment | $ | 83 | $ | 589 | $ | 892 | $ | 30 | $ | 2 | $ | 1,596 | ||||||||||||
| Collectively evaluated for impairment | 559 | 279 | 2,811 | 1,546 | 55 | 5,250 | ||||||||||||||||||
| Total ending allowance balance | $ | 642 | $ | 868 | $ | 3,703 | $ | 1,576 | $ | 57 | $ | 6,846 | ||||||||||||
The Company’s loan portfolio is segmented to a level that allows management to monitor risk and performance. The portfolio is segmented into Commercial and Industrial (“C&I”), Real Estate Construction, Real Estate - Mortgage which is further segmented into Residential and Commercial real estate, and Consumer Installment Loans. The C&I loan segment consists of loans made for the purpose of financing the activities of commercial customers. The residential mortgage loan segment consists of loans made for the purpose of financing the activities of residential homeowners. The commercial mortgage loan segment consists of loans made for the purpose of financing the activities of commercial real estate owners and operators. The consumer loan segment consists primarily of installment loans and overdraft lines of credit connected with customer deposit accounts.
Management evaluates individual loans in all of the commercial segments for possible impairment if the loan is greater than $150,000 and if the loan either is in nonaccrual status, or is risk rated Substandard or Doubtful and is greater than 90 days past due. Loans are considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in evaluating impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. The Company does not separately evaluate individual consumer and residential mortgage loans for impairment, unless such loans are part of a larger relationship that is impaired.
Once the determination has been made that a loan is impaired, the determination of whether a specific allocation of the allowance is necessary is measured by comparing the recorded investment in the loan to the fair value of the loan using one of three methods: (a) the present value of expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observable market price; or (c) the fair value of the collateral less selling costs. The method is selected on a loan-by-loan basis, with management primarily utilizing the fair value of collateral method. The evaluation of the need and amount of a specific allocation of the allowance and whether a loan can be removed from impairment status is made on a quarterly basis. The Company’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition.
The following tables present impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary (in thousands):
| December 31, 2015 | ||||||||||||
| Impaired Loans | ||||||||||||
Recorded Investment |
Unpaid Principal Balance |
Related Allowance | ||||||||||
With no related allowance recorded: | ||||||||||||
| Commercial and industrial | $ | 1,027 | $ | 1,025 | $ | - | ||||||
| Real estate - construction | 1,657 | 1,651 | - | |||||||||
| Real estate - mortgage: | ||||||||||||
| Residential | 2,445 | 2,443 | - | |||||||||
| Commercial | 2,337 | 2,335 | - | |||||||||
| Total | $ | 7,466 | $ | 7,454 | $ | - | ||||||
With an allowance recorded: | ||||||||||||
| Commercial and industrial | $ | 781 | $ | 781 | $ | 388 | ||||||
| Real estate - construction | 130 | 130 | 130 | |||||||||
| Real estate - mortgage: | ||||||||||||
| Residential | 1,436 | 1,436 | 276 | |||||||||
| Commercial | 3,862 | 3,846 | 39 | |||||||||
| Consumer installment | 6 | 6 | - | |||||||||
| Total | $ | 6,215 | $ | 6,199 | $ | 833 | ||||||
Total: | ||||||||||||
| Commercial and industrial | $ | 1,808 | $ | 1,806 | $ | 388 | ||||||
| Real estate - construction | 1,787 | 1,781 | 130 | |||||||||
| Real estate - mortgage: | ||||||||||||
| Residential | 3,881 | 3,879 | 276 | |||||||||
| Commercial | 6,199 | 6,181 | 39 | |||||||||
| Consumer installment | 6 | 6 | - | |||||||||
| Total | $ | 13,681 | $ | 13,653 | $ | 833 | ||||||
| December 31, 2014 | ||||||||||||
| Impaired Loans | ||||||||||||
Recorded Investment |
Unpaid Principal Balance |
Related Allowance | ||||||||||
With no related allowance recorded: | ||||||||||||
| Commercial and industrial | $ | 1,146 | $ | 1,145 | $ | - | ||||||
| Real estate - construction | 2,707 | 2,705 | - | |||||||||
| Real estate - mortgage: | ||||||||||||
| Residential | 2,202 | 2,197 | - | |||||||||
| Commercial | 4,064 | 4,060 | - | |||||||||
| Total | $ | 10,119 | $ | 10,107 | $ | - | ||||||
With an allowance recorded: | ||||||||||||
| Commercial and industrial | $ | 247 | $ | 247 | $ | 83 | ||||||
| Real estate - construction | 589 | 589 | 589 | |||||||||
| Real estate - mortgage: | ||||||||||||
| Residential | 2,981 | 2,978 | 892 | |||||||||
| Commercial | 426 | 426 | 30 | |||||||||
| Consumer installment | 6 | 6 | 2 | |||||||||
| Total | $ | 4,249 | $ | 4,246 | $ | 1,596 | ||||||
Total: | ||||||||||||
| Commercial and industrial | $ | 1,393 | $ | 1,392 | $ | 83 | ||||||
| Real estate - construction | 3,296 | 3,294 | 589 | |||||||||
| Real estate - mortgage: | ||||||||||||
| Residential | 5,183 | 5,175 | 892 | |||||||||
| Commercial | 4,490 | 4,486 | 30 | |||||||||
| Consumer installment | 6 | 6 | 2 | |||||||||
| Total | $ | 14,368 | $ | 14,353 | $ | 1,596 | ||||||
The tables above include troubled debt restructuring totaling $3.1 million and $2.9 million as of December 31, 2015 and 2014, respectively.
The following table presents interest income by class, recognized on impaired loans (in thousands):
As of December 31, 2015 | As of December 31, 2014 | As of December 31, 2013 | ||||||||||||||||||||||
Average Recorded Investment | Interest Income Recognized | Average Recorded Investment | Interest Income Recognized | Average Recorded Investment | Interest Income Recognized | |||||||||||||||||||
Commercial and industrial | $ | 1,468 | $ | 100 | $ | 1,989 | $ | 85 | $ | 2,187 | $ | 119 | ||||||||||||
Real estate - construction | 2,407 | 115 | 3,631 | 154 | 3,743 | 183 | ||||||||||||||||||
Real estate - mortgage: | ||||||||||||||||||||||||
Residential | 4,356 | 160 | 5,331 | 171 | 5,380 | 293 | ||||||||||||||||||
Commercial | 5,203 | 350 | 5,998 | 229 | 6,500 | 493 | ||||||||||||||||||
Consumer installment | 6 | - | 11 | 1 | 13 | 1 | ||||||||||||||||||
Total | $ | 13,440 | $ | 725 | $ | 16,960 | $ | 640 | $ | 17,824 | $ | 1,090 | ||||||||||||
Troubled Debt Restructuring (TDR) describes loans on which the bank has granted concessions for reasons related to the customer’s financial difficulties. Such concessions may include one or more of the following:
● | reduction in the interest rate to below market rates |
● | extension of repayment requirements beyond normal terms |
● | reduction of the principal amount owed |
● | reduction of accrued interest due |
● | acceptance of other assets in full or partial payment of a debt |
In each case the concession is made due to deterioration in the borrower’s financial condition, and the new terms are less stringent than those required on a new loan with similar risk.
The following tables present the number of loan modifications by class, the corresponding recorded investment, and the subsequently defaulted modifications (in thousands):
December 31, 2015 | ||||||||||||||||||||
Number of Contracts | Pre-Modification | Post-Modification | ||||||||||||||||||
Troubled Debt Restructurings | Term Modification | Other | Total | Outstanding Recorded Investment | Outstanding Recorded Investment | |||||||||||||||
| Commercial and industrial | 6 | - | 6 | $ | 434 | $ | 434 | |||||||||||||
| Real estate construction | 1 | - | 1 | 181 | 181 | |||||||||||||||
| Residential real estate | 5 | 1 | 6 | 515 | 535 | |||||||||||||||
| Commercial real estate | 1 | - | 1 | 270 | 270 | |||||||||||||||
December 31, 2015 | ||||||||
Troubled Debt Restructurings subsequently defaulted | Number of Contracts | Recorded Investment | ||||||
| Commercial and industrial | 2 | $ | 14 | |||||
| Real estate construction | 1 | 130 | ||||||
December 31, 2014 | ||||||||||||||||||||
Number of Contracts | Pre-Modification | Post-Modification | ||||||||||||||||||
| Troubled Debt Restructurings | Term Modification | Other | Total | Outstanding Recorded Investment | Outstanding Recorded Investment | |||||||||||||||
Residential real estate | 3 | - | 3 | $ | 140 | $ | 140 | |||||||||||||
Commercial real estate | 1 | - | 1 | 48 | 48 | |||||||||||||||
Consumer | 1 | - | 1 | 6 | 6 | |||||||||||||||
December 31, 2014 | ||||||||
Troubled Debt Restructurings subsequently defaulted | Number of Contracts | Recorded Investment | ||||||
| Residential real estate | 1 | $ | 15 | |||||
December 31, 2013 | ||||||||||||||||||||
Number of Contracts | Pre-Modification | Post-Modification | ||||||||||||||||||
| Troubled Debt Restructurings | Term Modification | Other | Total | Outstanding Recorded Investment | Outstanding Recorded Investment | |||||||||||||||
| Commercial and industrial | 6 | 1 | 7 | $ | 1,264 | $ | 1,264 | |||||||||||||
| Residential real estate | 7 | - | 7 | 784 | 784 | |||||||||||||||
| Commercial real estate | 2 | - | 2 | 834 | 834 | |||||||||||||||
December 31, 2013 | ||||||||
Troubled Debt Restructurings subsequently defaulted | Number of Contracts | Recorded Investment | ||||||
| Commercial and industrial | 5 | $ | 574 | |||||
| Commercial real estate | 1 | 190 | ||||||
Management uses a nine-point internal risk-rating system to monitor the credit quality of the overall loan portfolio. The first five categories are considered not criticized and are aggregated as Pass-rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are considered Substandard. Any portion of a loan that has been charged off is placed in the Loss category.
To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Company has a structured loan-rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as bankruptcy, repossession, or death, occurs to raise awareness of a possible credit event. The Company’s Commercial Loan Officers are responsible for the timely and accurate risk rating of the loans in their portfolios at origination and on an ongoing basis with the Chief Credit Officer ultimately responsible for accurate and timely risk ratings. The Credit Department performs an annual review of all commercial relationships $1,000,000 or greater. Confirmation of the appropriate risk grade is included in the review on an ongoing basis. The Company engages an external consultant to conduct loan reviews on a semiannual basis. Generally, the external consultant reviews commercial relationships greater than $250,000 and/or criticized relationships greater than $125,000. Detailed reviews, including plans for resolution, are performed on loans classified as Substandard on a quarterly basis. Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.
The following tables present the classes of the loan portfolio summarized by the aggregate Pass rating and the criticized categories of Special Mention, Substandard, and Doubtful within the internal risk rating system as of December 31, 2015 and 2014 (in thousands):
Pass | Special Mention | Substandard | Doubtful | Total Loans | ||||||||||||||||
| December 31, 2015 | ||||||||||||||||||||
Commercial and industrial | $ | 40,560 | $ | 242 | $ | 1,734 | $ | - | $ | 42,536 | ||||||||||
Real estate - construction | 22,007 | - | - | 130 | 22,137 | |||||||||||||||
Real estate - mortgage: | ||||||||||||||||||||
Residential | 225,945 | 728 | 5,805 | - | 232,478 | |||||||||||||||
Commercial | 219,331 | 4,327 | 8,043 | - | 231,701 | |||||||||||||||
Consumer installment | 4,854 | - | 4 | - | 4,858 | |||||||||||||||
Total | $ | 512,697 | $ | 5,297 | $ | 15,586 | $ | 130 | $ | 533,710 | ||||||||||
Pass | Special Mention | Substandard | Doubtful | Total Loans | ||||||||||||||||
| December 31, 2014 | ||||||||||||||||||||
Commercial and industrial | $ | 33,160 | $ | - | $ | 1,730 | $ | 38 | $ | 34,928 | ||||||||||
Real estate - construction | 29,212 | 495 | - | 589 | 30,296 | |||||||||||||||
Real estate - mortgage: | ||||||||||||||||||||
Residential | 200,928 | 584 | 8,584 | - | 210,096 | |||||||||||||||
Commercial | 180,899 | 3,908 | 5,878 | - | 190,685 | |||||||||||||||
Consumer installment | 4,572 | - | 7 | - | 4,579 | |||||||||||||||
Total | $ | 448,759 | $ | 4,987 | $ | 16,211 | $ | 627 | $ | 470,584 | ||||||||||
Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following tables present the classes of the loan portfolio summarized by the aging categories of loans and nonaccrual loans as of December 31, 2015 and 2014 (in thousands):
Current | 30-59 Days Past Due | 60-89 Days Past Due | 90 Days+ Past Due | Total Past Due | Total Loans | |||||||||||||||||||
December 31, 2015 | ||||||||||||||||||||||||
| Commercial and industrial | $ | 41,544 | $ | 225 | $ | 26 | $ | 741 | $ | 992 | $ | 42,536 | ||||||||||||
| Real estate - construction | 22,137 | - | - | - | - | 22,137 | ||||||||||||||||||
| Real estate - mortgage: | ||||||||||||||||||||||||
| Residential | 229,725 | 1,482 | 92 | 1,179 | 2,753 | 232,478 | ||||||||||||||||||
| Commercial | 230,903 | 189 | - | 609 | 798 | 231,701 | ||||||||||||||||||
| Consumer installment | 4,837 | 16 | 3 | 2 | 21 | 4,858 | ||||||||||||||||||
| Total | $ | 529,146 | $ | 1,912 | $ | 121 | $ | 2,531 | $ | 4,564 | $ | 533,710 | ||||||||||||
Current | 30-59 Days Past Due | 60-89 Days Past Due | 90 Days+ Past Due | Total Past Due | Total Loans | |||||||||||||||||||
| December 31, 2014 | ||||||||||||||||||||||||
Commercial and industrial | $ | 34,480 | $ | 349 | $ | 68 | $ | 31 | $ | 448 | $ | 34,928 | ||||||||||||
Real estate - construction | 30,296 | - | - | - | - | 30,296 | ||||||||||||||||||
Real estate - mortgage: | ||||||||||||||||||||||||
Residential | 205,753 | 2,065 | 363 | 1,915 | 4,343 | 210,096 | ||||||||||||||||||
Commercial | 190,088 | 30 | - | 567 | 597 | 190,685 | ||||||||||||||||||
Consumer installment | 4,547 | 27 | 3 | 2 | 32 | 4,579 | ||||||||||||||||||
Total | $ | 465,164 | $ | 2,471 | $ | 434 | $ | 2,515 | $ | 5,420 | $ | 470,584 | ||||||||||||
The following tables present the classes of the loan portfolio summarized by nonaccrual loans and loans 90 days or more past due and still accruing as of December 31, 2015 and 2014 (in thousands):
Nonaccrual | 90+ Days Past Due and Accruing | |||||||
December 31, 2015 | ||||||||
| Commercial and industrial | $ | 1,450 | $ | - | ||||
| Real estate - construction | 130 | - | ||||||
| Real estate - mortgage: | ||||||||
| Residential | 4,122 | - | ||||||
| Commercial | 1,842 | - | ||||||
| Consumer installment | 1 | 2 | ||||||
| Total | $ | 7,545 | $ | 2 | ||||
Nonaccrual |
90+ Days Past Due and Accruing | |||||||
December 31, 2014 | ||||||||
| Commercial and industrial | $ | 365 | $ | - | ||||
| Real estate - construction | 587 | - | ||||||
| Real estate - mortgage: | ||||||||
| Residential | 5,310 | 165 | ||||||
| Commercial | 1,083 | - | ||||||
| Consumer installment | 2 | - | ||||||
| Total | $ | 7,347 | $ | 165 | ||||
Interest income that would have been recorded had these loans not been placed on nonaccrual status was $259,000 in 2015, $207,000 in 2014, and $439,000 in 2013.
An allowance for loan and lease losses (“ALLL”) is maintained to absorb losses from the loan portfolio. The ALLL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of nonperforming loans.
The Company’s methodology for determining the ALLL is based on the requirements of ASC Section 310-10-35 for loans individually evaluated for impairment (discussed above) and ASC Subtopic 450-20 for loans collectively evaluated for impairment, as well as the Interagency Policy Statement on the Allowance for Loan and Lease Losses and other bank regulatory guidance. The total of the two components represents the Company’s ALLL.
Loans that are collectively evaluated for impairment are analyzed, with general allowances being made as appropriate. For general allowances, historical loss trends are used in the estimation of losses in the current portfolio. These historical loss amounts are modified by other qualitative factors.
The classes described above, which are based on the purpose code assigned to each loan, provide the starting point for the ALLL analysis. Management tracks the historical net charge-off activity at the purpose code level. A historical charge-off factor is calculated utilizing the last twelve consecutive quarters.
Management has identified a number of additional qualitative factors which it uses to supplement the historical charge-off factor, because these factors are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience. The additional factors that are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources are: national and local economic trends and conditions; levels of and trends in delinquency rates and nonaccrual loans; trends in volumes and terms of loans; effects of changes in lending policies; experience, ability, and depth of lending staff; value of underlying collateral; and concentrations of credit from a loan type, industry, and/or geographic standpoint.
Management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the ALLL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALLL.
The following tables summarize the primary segments of the loan portfolio (in thousands):
Commercial and industrial | Real estate- construction | Real estate- residential mortgage | Real estate- commercial mortgage | Consumer installment | Total | |||||||||||||||||||
ALLL balance at December 31, 2014 | $ | 642 | $ | 868 | $ | 3,703 | $ | 1,576 | $ | 57 | $ | 6,846 | ||||||||||||
Charge-offs | (280 | ) | (385 | ) | (425 | ) | (92 | ) | (15 | ) | (1,197 | ) | ||||||||||||
Recoveries | 207 | - | 186 | 5 | 23 | 421 | ||||||||||||||||||
Provision | 298 | (207 | ) | (325 | ) | 589 | (40 | ) | 315 | |||||||||||||||
ALLL balance at December 31, 2015 | $ | 867 | $ | 276 | $ | 3,139 | $ | 2,078 | $ | 25 | $ | 6,385 | ||||||||||||
Commercial and industrial | Real estate- construction | Real estate- residential mortgage | Real estate- commercial mortgage | Consumer installment | Total | |||||||||||||||||||
ALLL balance at December 31, 2013 | $ | 614 | $ | 576 | $ | 3,664 | $ | 2,170 | $ | 22 | $ | 7,046 | ||||||||||||
Charge-offs | (237 | ) | - | (671 | ) | (260 | ) | (44 | ) | (1,212 | ) | |||||||||||||
Recoveries | 121 | 60 | 267 | 40 | 154 | 642 | ||||||||||||||||||
Provision | 144 | 232 | 443 | (374 | ) | (75 | ) | 370 | ||||||||||||||||
ALLL balance at December 31, 2014 | $ | 642 | $ | 868 | $ | 3,703 | $ | 1,576 | $ | 57 | $ | 6,846 | ||||||||||||
Commercial and industrial | Real estate- construction | Real estate- residential mortgage | Real estate- commercial mortgage | Consumer installment | Total | |||||||||||||||||||
ALLL balance at December 31, 2012 | $ | 1,732 | $ | 1,123 | $ | 2,872 | $ | 1,991 | $ | 61 | $ | 7,779 | ||||||||||||
Charge-offs | (419 | ) | (191 | ) | (675 | ) | - | (45 | ) | (1,330 | ) | |||||||||||||
Recoveries | 191 | 33 | 107 | 46 | 24 | 401 | ||||||||||||||||||
Provision | (890 | ) | (389 | ) | 1,360 | 133 | (18 | ) | 196 | |||||||||||||||
ALLL balance at December 31, 2013 | $ | 614 | $ | 576 | $ | 3,664 | $ | 2,170 | $ | 22 | $ | 7,046 | ||||||||||||
The decrease in the ALLL balance for real estate construction was largely due to a $0.4 million charge off. The decrease in the ALLL balance for residential real estate was largely due to aggregate charge offs of $0.3 million of loans secured by first liens. The increase in the ALLL balance for commercial real estate is mostly due to the 21.5% growth in the portfolio.
5. | OTHER REAL ESTATE OWNED (“OREO”) |
OREO comprises foreclosed assets acquired in settlement of loans and is carried at fair value less estimated cost to sell and is included in other assets on the Consolidated Balance Sheet. As of December 31, 2015 and December 31, 2014, there were $1.4 million and $2.6 million, respectively, of OREO. As of December 31, 2015, the Company has initiated formal foreclosure proceedings on $1.1 million of real estate.
6. | PREMISES AND EQUIPMENT |
Major classifications of premises and equipment at December 31:
(Dollar amounts in thousands) | 2015 | 2014 | ||||||
Land and land improvements | $ | 1,943 | $ | 1,943 | ||||
Building and leasehold improvements | 11,414 | 11,133 | ||||||
Furniture, fixtures, and equipment | 4,853 | 4,637 | ||||||
| 18,210 | 17,713 | |||||||
Less accumulated depreciation and amortization | 8,438 | 7,733 | ||||||
Total | $ | 9,772 | $ | 9,980 | ||||
Depreciation and amortization charged to operations was $715,000 in 2015, $750,000 in 2014, and $676,000 in 2013.
7. | GOODWILL AND INTANGIBLE ASSETS |
Goodwill totaled $4,559,000 at the years ended December 31, 2015, and 2014. Core deposit intangible carrying amount was $76,000 and $116,000 for the years ended December 31, 2015, and 2014. Core deposit accumulated amortization was $320,000 and $280,000 for the years ended December 31, 2015, and 2014.
Core deposit intangible assets are amortized on a straight-line basis over their estimated lives of ten years. Amortization expense totaled $40,000 in 2015, 2014, and 2013, respectively. The estimated aggregate future amortization expense for core deposit intangible assets as of December 31, 2015, is $40,000 in 2017 and $36,000 in 2018.
8. | OTHER ASSETS |
The components of other assets at the years ended December 3:
| (Dollar amounts in thousands) | 2015 | 2014 | ||||||
FHLB stock | $ | 1,887 | $ | 1,887 | ||||
Accrued interest on investment securities | 1,010 | 1,005 | ||||||
Accrued interest on loans | 1,377 | 1,090 | ||||||
Deferred tax asset, net | 959 | 1,484 | ||||||
Other | 2,244 | 1,579 | ||||||
Total | $ | 7,477 | $ | 7,045 | ||||
9. | DEPOSITS |
Time deposits at December 31, 2015, mature $92.9 million, $30.2 million, $11.0 million, $9.0 million, and $48.2 million during 2016, 2017, 2018, 2019, and 2020, respectively.
The aggregate of all time deposit accounts of $250,000 or more amounted to $29.0 million and $54.6 million at December 31, 2015 and 2014, respectively.
10. | SHORT-TERM BORROWINGS |
The year ended December 31 outstanding balances and related information of short-term borrowings, which includes securities sold under agreements to repurchase and short-term borrowings from other banks, are summarized as follows:
(Dollar amounts in thousands) | 2015 | 2014 | ||||||
Balance at year-end | $ | 35,825 | $ | 14,808 | ||||
Average balance outstanding | 11,768 | 8,379 | ||||||
Maximum month-end balance | 35,825 | 19,970 | ||||||
Weighted-average rate at year-end | 1.37 | % | 0.98 | % | ||||
Weighted-average rate during the year | 1.65 | % | 1.77 | % | ||||
Average balances outstanding during the year represent daily average balances, and average interest rates represent interest expense divided by the related average balance.
The Company maintains a $4.0 million line of credit at an adjustable rate, currently 3.92%, a $3.0 million line of credit at an adjustable rate, currently at 4.00%, and a $2.5 million line of credit at an adjustable rate, currently 3.75%. At December 31, 2015, 2014, and 2013, outstanding borrowings under these lines were $9.5 million, $3.1 million, and $3.9 million, respectively.
The following table provides additional detail regarding short-term borrowed funds.
Repurchase Agreements (Sweep) Accounted for as Secured Borrowings (in thousands) Overnight and Continuous | ||||||||
December 31, 2015 | December 31, 2014 | |||||||
Repurchase agreements: | ||||||||
U.S. Government agency securities | $ | 1,052 | $ | 1,090 | ||||
Mortgage-backed securities in government-sponsored entities | 1,877 | 2,091 | ||||||
| $ | 2,929 | $ | 3,181 | |||||
11. | OTHER BORROWINGS |
Other borrowings consist of advances from the FHLB and subordinated debt as follows:
(Dollar amounts in thousands) | Maturity range | Weighted- average | Stated interest rate range | ||||||||||||||||||||||||
Description | from | to | interest rate | from | to | 2015 | 2014 | ||||||||||||||||||||
Fixed-rate amortizing | 07/01/17 | 10/01/28 | 4.02 | % | 2.99 | % | 4.47 | % | $ | 1,691 | $ | 2,376 | |||||||||||||||
Junior subordinated debt | 12/21/37 | 12/21/37 | 1.95 | % | 1.90 | 1.99 | 8,248 | 8,248 | |||||||||||||||||||
Total | $ | 9,939 | $ | 10,624 | |||||||||||||||||||||||
The scheduled maturities of other borrowings are as follows:
(Dollar amounts in thousands) | ||||||||
Year Ending December 31, | Amount | Weighted- Average Rate | ||||||
2016 | 502 | 4.00 | % | |||||
2017 | 373 | 4.00 | % | |||||
2018 | 252 | 4.02 | % | |||||
2019 | 155 | 4.04 | % | |||||
| 2020 | 116 | 4.04 | % | |||||
Beyond 2020 | 8,542 | 1.51 | % | |||||
Total | $ | 9,939 | 1.84 | % | ||||
Fixed-rate amortizing advances from the FHLB require monthly principal and interest payments and an annual 20 percent paydown of outstanding principal. Monthly principal and interest payments are adjusted after each 20 percent paydown. Under the terms of a blanket agreement, FHLB borrowings are secured by certain qualifying assets of the Company which consist principally of first mortgage loans or mortgage-backed securities. Under this credit arrangement, the Company has a remaining borrowing capacity of approximately $80.0 million at December 31, 2015.
The Company formed a special purpose entity (“Entity”) to issue $8,000,000 of floating rate, obligated mandatorily redeemable securities, and $248,000 in common securities as part of a pooled offering. The rate adjusts quarterly, equal to LIBOR plus 1.67%. The Entity may redeem them, in whole or in part, at face value. The Company borrowed the proceeds of the issuance from the Entity in December 2006 in the form of an $8,248,000 note payable, which is included in the other borrowings on the Company’s Consolidated Balance Sheet.
12. | OTHER LIABILITIES |
The components of other liabilities are as follows:
2015 | 2014 | |||||||
| (Dollar amounts in thousands) | ||||||||
Accrued interest payable | $ | 395 | $ | 315 | ||||
Supplemental Executive Retirement Plan | 1,091 | 828 | ||||||
Accrued salary expense | 689 | 609 | ||||||
Other | 449 | 368 | ||||||
Total | $ | 2,624 | $ | 2,120 | ||||
13. | INCOME TAXES |
The provision for federal income taxes consists of:
(Dollar amounts in thousands) | 2015 | 2014 | 2013 | |||||||||
Current payable | $ | 1,004 | $ | 2,146 | $ | 1,556 | ||||||
Deferred | 558 | (154 | ) | 423 | ||||||||
Total provision | $ | 1,562 | $ | 1,992 | $ | 1,979 | ||||||
The tax effects of deductible and taxable temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows:
| (Dollar amounts in thousands) | 2015 | 2014 | ||||||
| Deferred tax assets: | ||||||||
Allowance for loan and lease losses | $ | 2,171 | $ | 2,328 | ||||
Supplemental retirement plan | 371 | 282 | ||||||
Investment security basis adjustment | 66 | 66 | ||||||
Nonaccrual interest income | 415 | 444 | ||||||
Deferred origination fees, net | 12 | 295 | ||||||
OREO adjustments | 92 | 94 | ||||||
Accrued compensation | 234 | 207 | ||||||
Other | 23 | 14 | ||||||
Gross deferred tax assets | 3,384 | 3,730 | ||||||
| Deferred tax liabilities: | ||||||||
Premises and equipment | 514 | 385 | ||||||
Net unrealized gain on securities | 1,233 | 1,311 | ||||||
FHLB stock dividends | 225 | 225 | ||||||
Intangibles | 401 | 353 | ||||||
Mortgage servicing rights | 68 | - | ||||||
Other | 44 | 77 | ||||||
Gross deferred tax liabilities | 2,485 | 2,351 | ||||||
Net deferred tax assets | $ | 899 | $ | 1,379 | ||||
No valuation allowance was established at December 31, 2015 and 2014, in view of the Company’s ability to carry back to taxes paid in previous years and certain tax strategies, coupled with the anticipated future taxable income as evidenced by the Company's earnings potential.
The reconciliation between the federal statutory rate and the Company’s effective consolidated income tax rate is as follows:
| (Dollar amounts in thousands) | 2015 | 2014 | 2013 | |||||||||||||||||||||
Amount | % of Pretax Income | Amount | % of Pretax Income | Amount | % of Pretax Income | |||||||||||||||||||
Provision at statutory rate | $ | 2,866 | 34.0 | % $ | 3,119 | 34.0 | % $ | 3,062 | 34.0 | % | ||||||||||||||
Tax-free income | (1,347 | ) | (15.9 | ) | (1,187 | ) | (12.9 | ) | (1,138 | ) | (12.6 | ) | ||||||||||||
Nondeductible interest expense | 34 | 0.4 | 37 | 0.4 | 45 | 0.5 | ||||||||||||||||||
Other | 9 | 0.0 | 23 | 0.2 | 10 | 0.1 | ||||||||||||||||||
Actual tax expense and effective rate | $ | 1,562 | 18.5 | % $ | 1,992 | 21.7 | % $ | 1,979 | 22.0 | % | ||||||||||||||
ASC 740‐10 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Benefits from tax positions should be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more‐likely‐than‐not recognition threshold is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more‐likely‐than‐not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more‐likely‐than‐not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met.
At December 31, 2015 and December 31, 2014, the Company had no unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase within the next 12 months. The Company recognizes interest and penalties on unrecognized tax benefits as a component of income tax expense.
The Company and the Bank are subject to U.S. federal income tax as well as an income tax in the state of Ohio, and the Bank is subject to a capital‐based franchise tax in the state of Ohio. The Company and the Bank are no longer subject to examination by taxing authorities for years before December 31, 2012.
14. | EMPLOYEE BENEFITS |
Retirement Plan
The Bank maintains section 401(k) employee savings and investment plans for all full-time employees and officers of the Bank with more than one year of service. The Bank’s contributions to the plans are based on 50 percent matching of voluntary contributions up to 6 percent of compensation. An eligible employee can contribute up to 100 percent of salary. Employee contributions are vested at all times, and MBC contributions are fully vested after six years beginning at the second year in 20 percent increments. Contributions for 2015, 2014, and 2013 to these plans amounted to $156,000,$143,000, and $155,000, respectively.
Supplemental Retirement Plan
Until 2001, MBC maintained a Directors’ Retirement Plan to provide postretirement payments over a ten-year period to members of the Board of Directors who had completed five or more years of service. The plan required payment of 25 percent of the final average annual board fees paid to a director in the three years preceding the director’s retirement.
The following table illustrates the components of the projected payments for the Directors’ Retirement Plan for the years ended:
Projected Payments | |||||
2016 | $ | 29,000 | |||
2017 | 23,000 | ||||
2018 | 18,000 | ||||
2019 | 12,000 | ||||
2020 | 10,000 | ||||
2021 | 2,000 | ||||
Total | $ | 94,000 | |||
The retirement plan is available solely for nonemployee directors of The Middlefield Banking Company, but the Bank has not entered into any additional retirement arrangements for nonemployee directors since 2001. All director participants have retired.
Executive Deferred Compensation Plan
The Company maintains an Executive Deferred Compensation Plan (the “Plan”) to provide post-retirement payments to members of senior management. The Plan agreements are noncontributory, defined contribution arrangements that provide supplemental retirement income benefits to several officers, with contributions made solely by the Bank. During 2015, 2014, and 2013, the Company contributed $65,000, $115,000, and $120,000, respectively, to the Plan.
Stock Option and Restricted Stock Plan
The Company maintains a stock option and restricted stock plan (“the Plan”) for granting incentive stock options, nonqualified stock options, and restricted stock to key officers and employees and nonemployee directors of the Company. A total of 160,000 shares of authorized and unissued or issued common stock were reserved for issuance under the Plan, which expires ten years from the date of stockholder ratification. The per share exercise price of an option granted will not be less than the fair value of a share of common stock on the date the option is granted.
The following table presents share data related to the outstanding options:
2015 | Weighted- average Exercise Price | 2014 | Weighted- average Exercise Price | |||||||||||||
Outstanding, January 1 | $ | 46,451 | $ | 27.90 | $ | 58,581 | $ | 28.38 | ||||||||
Expired | (10,802 | ) | 36.93 | - | - | |||||||||||
Exercised | (2,175 | ) | 21.31 | (11,223 | ) | 30.45 | ||||||||||
Forfeited | (1,525 | ) | 33.53 | (907 | ) | 27.35 | ||||||||||
Outstanding, December 31 | $ | 31,949 | $ | 25.03 | $ | 46,451 | $ | 27.90 | ||||||||
Exercisable, December 31 | $ | 31,949 | $ | 25.03 | $ | 46,451 | $ | 27.90 | ||||||||
The following table summarizes the characteristics of stock options at December 31, 2015:
Outstanding | Exercisable | |||||||||||||||||||||||
Grant Date | Exercise Price | Shares | Contractual Average Life | Average Exercise Price | Shares | Average Exercise Price | ||||||||||||||||||
December 10, 2006 | 40.24 | 2,625 | 0.94 | 40.24 | 2,625 | 40.24 | ||||||||||||||||||
May 16, 2007 | 37.48 | 1,337 | 1.37 | 37.48 | 1,337 | 37.48 | ||||||||||||||||||
December 10, 2007 | 37.00 | 1,950 | 1.94 | 37.00 | 1,950 | 37.00 | ||||||||||||||||||
January 2, 2008 | 36.25 | 1,337 | 2.00 | 36.25 | 1,337 | 36.25 | ||||||||||||||||||
November 10, 2008 | 23.00 | 16,500 | 2.86 | 23.00 | 16,500 | 23.00 | ||||||||||||||||||
May 9, 2011 | 17.55 | 8,200 | 5.35 | 17.55 | 8,200 | 17.55 | ||||||||||||||||||
| 31,949 | 31,949 | |||||||||||||||||||||||
No options were granted for the years ended December 31, 2015 and 2014. The Company recognizes compensation expense in the amount of fair value of the common stock at the grant date and as an addition to stockholders’ equity.
15. | COMMITMENTS |
In the normal course of business, there are various outstanding commitments and certain contingent liabilities which are not reflected in the accompanying consolidated financial statements. These commitments and contingent liabilities represent financial instruments with off-balance sheet risk. The contract or notional amounts of those instruments reflect the extent of involvement in particular types of financial instruments which were composed of the following:
(Dollar amounts in thousands) | 2015 | 2014 | ||||||
Commitments to extend credit | $ | 112,134 | $ | 97,947 | ||||
Standby letters of credit | 4,404 | 4,514 | ||||||
Total | $ | 116,538 | $ | 102,461 | ||||
These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Balance Sheet. The Company’s exposure to credit loss, in the event of nonperformance by the other parties to the financial instruments, is represented by the contractual amounts as disclosed. The Company minimizes its exposure to credit loss under these commitments by subjecting them to credit approval and review procedures and collateral requirements as deemed necessary. Commitments generally have fixed expiration dates within one year of their origination.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Performance letters of credit represent conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These instruments are issued primarily to support bid or performance-related contracts. The coverage period for these instruments is typically a one-year period with an annual renewal option subject to prior approval by management. Fees earned from the issuance of these letters are recognized over the coverage period. For secured letters of credit, the collateral is typically bank deposit instruments or customer business assets.
Commitments to fund certain mortgage loans (interest rate locks) to be sold into the secondary market and forward contracts for the future delivery of these mortgage loans are considered derivatives. It is the Company’s practice to enter into the forward contracts for the future purchase of mortgage-backed securities when interest rate lock commitments are entered into in order to economically hedge the effect of changes in interest rates resulting from its commitments to fund the loans. These mortgage banking derivatives are not formally designated as hedge relationships. The derivative assets and liabilities are considered immaterial as of December 31, 2015. Associated income and expense is reported in gains on sale of loans.
Leasing Arrangements
The Company leases certain of its banking facilities under operating leases which contain certain renewal options. As of December 31, 2015, approximate future minimum rental payments, including the renewal options under these leases, are as follows (in thousands):
2016 | $ | 285 | ||
2017 | 293 | |||
2018 | 294 | |||
2019 | 289 | |||
2020 | 301 | |||
Thereafter | 2,055 | |||
| $ | 3,517 |
The above amounts represent minimum rentals not adjusted for possible future increases due to escalation provisions and assume that all renewal option periods will be exercised by the Company. Rent expense approximated $288,000, $269,000, and $301,000 for the years ended December 31, 2015, 2014, and 2013, respectively.
16. | REGULATORY RESTRICTIONS |
The Company is subject to the regulatory requirements of the Federal Reserve System as a bank holding company. The bank is subject to regulations of the Federal Deposit Insurance Corporation (“FDIC”) and the State of Ohio, Division of Financial Institutions.
Since the establishment in the fourth quarter of 2009 of Middlefield Banc Corp.’s nonbank-asset resolution subsidiary, EMORECO, Inc., the Bank has sold $5.8 millionof nonperforming assets to this subsidiary.
Cash Requirements
The Cleveland district Federal Reserve Bank requires the Company tomaintain certain average reserve balances. As of December 31, 2015 and 2014, the Bank had required reserves of $6.9 million and $6.8 million comprising vault cash and a depository amount held with the Federal Reserve Bank.
Loans
Federal law prevents the Company from borrowing from the Bank unless the loans are secured by specific obligations. Further, such secured loans are limited in amount of 10 percent of the Bank’s common stock and capital surplus.
Dividends
MBC is subject to dividend restrictions that generally limit the amount of dividends that can be paid by an Ohio state-chartered bank. Under the Ohio Banking Code, cash dividends may not exceed net profits as defined for that year combined with retained net profits for the two preceding years less any required transfers to surplus. Under this formula the amount available for payment of dividends for 2015 approximates $8.5 millionplus 2016 profits retained up to the date of the dividend declaration. As a condition to the ODFI's approval of the merger of Emerald Bank into MBC, until the third anniversary of the merger, that is until January 20, 2017, MBC will have to obtain the ODFI's advance approval for dividend payments to the Company.
17. | REGULATORY CAPITAL |
The Bank and Company are subject to regulatory capital requirements administered by banking agencies. Capital adequacy guidelines and prompt corrective-action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements. Management believes as of December 31, 2015, the Bank and Company have met all capital adequacy requirements to which it is subject.
The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, under-capitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required.
The Basel III Capital Rules became effective for the Bank on January 1, 2015 and certain provisions are subject to a phase-in period. The implementation of the capital conservation buffer will begin on January 1, 2016 at the 0.625% level and be phased in over a four -year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019). The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and does not have any current applicability to the Bank. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of Common Equity Tier 1 capital to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.
The following tables present actual and required capital ratios as of December 31, 2015 under the Basel III Capital Rules. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules.
As of December 31, 2015 | ||||||||||||||||
Leverage | Tier 1 Risk Based | Common Equity Tier 1 | Total Risk Based | |||||||||||||
The Middlefield Banking Company | 9.23 | % | 12.52 | % | 12.52 | % | 13.73 | % | ||||||||
Middlefield Banc Corp. | 8.69 | % | 12.00 | % | 12.00 | % | 13.20 | % | ||||||||
Adequately capitalized ratio | 4.00 | % | 6.00 | % | 4.50 | % | 8.00 | % | ||||||||
Adequately capitalized ratio plus capital conservation buffer | 4.00 | % | 8.50 | % | 7.00 | % | 10.50 | % | ||||||||
Well-capitalized ratio (Bank only) | 5.00 | % | 8.00 | % | 6.50 | % | 10.00 | % | ||||||||
See Note 15 foradditional information concerning regulatory capital requirements
The Company’s and its subsidiary’s actual capital ratios are presented in the following table that shows that all regulatory capital requirements were met as of December 31, 2014.
| As of December 31, 2014 | |||||||||||
Leverage | Tier 1 Risk Based | Total Risk Based | ||||||||||
The Middlefield Banking Company | 9.25 | % | 12.95 | % | 14.19 | % | ||||||
Middlefield Banc Corp. | 9.60 | % | 13.38 | % | 14.64 | % | ||||||
Adequately capitalized ratio | 4.00 | % | 4.00 | % | 8.00 | % | ||||||
Well-capitalized ratio (Bank only) | 5.00 | % | 6.00 | % | 10.00 | % | ||||||
18. | FAIR VALUE DISCLOSURE MEASUREMENTS |
The following disclosures show the hierarchal disclosure framework associated with the level of pricing observations utilized in measuring assets and liabilities at fair value. The three broad levels defined by U.S. generally accepted accounting principles are as follows:
Level I: | Quoted prices are available in active markets for identical assets or liabilities as of the reported date. |
Level II: | Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair-valued using other financial instruments, the parameters of which can be directly observed. |
Level III: | Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable. |
This hierarchy requires the use of observable market data when available.
The following tables present the assets measured on a recurring basis on the Consolidated Balance Sheet at their fair value as of December 31, 2015 and 2014, by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
December 31, 2015 | ||||||||||||||||
| (Dollar amounts in thousands) | Level I | Level II | Level III | Total | ||||||||||||
Assets measured on a recurring basis: | ||||||||||||||||
U.S. government agency securities | $ | - | $ | 21,629 | $ | - | $ | 21,629 | ||||||||
Obligations of states and political subdivisions | - | 97,290 | - | 97,290 | ||||||||||||
Mortgage-backed securities in government-sponsored entities | - | 24,524 | - | 24,524 | ||||||||||||
Private-label mortgage-backed securities | - | 2,263 | - | 2,263 | ||||||||||||
Total debt securities | - | 145,706 | - | 145,706 | ||||||||||||
Equity securities in financial institutions | - | 814 | - | 814 | ||||||||||||
Total | $ | - | $ | 146,520 | $ | - | $ | 146,520 | ||||||||
December 31, 2014 | ||||||||||||||||
Level I | Level II | Level III | Total | |||||||||||||
Assets measured on a recurring basis: | ||||||||||||||||
U.S. government agency securities | $ | - | $ | 22,896 | $ | - | $ | 22,896 | ||||||||
Obligations of states and political subdivisions | - | 98,345 | - | 98,345 | ||||||||||||
Mortgage-backed securities in government-sponsored entities | - | 29,391 | - | 29,391 | ||||||||||||
Private-label mortgage-backed securities | - | 2,919 | - | 2,919 | ||||||||||||
Total debt securities | - | 153,551 | - | 153,551 | ||||||||||||
Equity securities in financial institutions | - | 783 | - | 783 | ||||||||||||
Total | $ | - | $ | 154,334 | $ | - | $ | 154,334 | ||||||||
Financial instruments are considered Level III when their values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable. In addition to these unobservable inputs, the valuation models for Level III financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly. Level III financial instruments also include those for which the determination of fair value requires significant management judgment or estimation.
The following tables present the assets measured on a non-recurring basis on the Consolidated Balance Sheet at their fair value by level within the fair value hierarchy. Impaired loans that are collateral dependent are written down to fair value through the establishment of specific reserves. Techniques used to value the collateral that secure the impaired loan include quoted market prices for identical assets classified as Level I inputs and observable inputs, employed by certified appraisers, for similar assets classified as Level II inputs. In cases where valuation techniques included inputs that are unobservable and are based on estimates and assumptions developed by management based on the best information available under each circumstance, the asset valuation is classified as Level III inputs.
December 31, 2015 | ||||||||||||||||
(Dollar amounts in thousands) | Level I | Level II | Level III | Total | ||||||||||||
Assets measured on a non-recurring basis: | ||||||||||||||||
Impaired loans | $ | - | $ | - | $ | 12,848 | $ | 12,848 | ||||||||
Other real estate owned | - | - | 1,412 | 1,412 | ||||||||||||
December 31, 2014 | ||||||||||||||||
Level I | Level II | Level III | Total | |||||||||||||
Assets measured on a non-recurring basis: | ||||||||||||||||
Impaired loans | $ | - | $ | - | $ | 12,772 | $ | 12,772 | ||||||||
Other real estate owned | - | - | 2,590 | 2,590 | ||||||||||||
The following tables present additional quantitative information about assets measured at fair value on a non-recurring basis and for which the Company uses Level III inputs to determine fair value:
Quantitative Information about Level III Fair Value Measurements | ||||||||||||
| (Dollar amounts in thousands) | Fair Value Estimate | Valuation Techniques | Unobservable Input | Range (Weighted Average) | ||||||||
December 31, 2015 | ||||||||||||
Impaired loans | $ | 6,867 | Discounted cash flow | Discount rate | 3.1% | to | 7.9% | (5.0%) | ||||
| 5,981 | Appraisal of collateral (1) | Appraisal adjustments (2) | 0.0% | to | 87.1% | (23.3%) | ||||||
Other real estate owned | $ | 1,412 | Appraisal of collateral (1) | Appraisaladjustments (2) | 0.0% | to | 10.0% | (7.3%) | ||||
Quantitative Information about Level III Fair Value Measurements | ||||||||||||
(Dollar amounts in thousands) | Fair Value Estimate | Valuation Techniques | Unobservable Input | Range (Weighted Average) | ||||||||
December 31, 2014 | ||||||||||||
Impaired loans | $ | 12,772 | Appraisal of collateral (1) | Appraisal adjustments (2) | 0% | to | 84.6% | (25.5%) | ||||
Other real estate owned | $ | 2,590 | Appraisal of collateral (1) | Appraisal adjustments (2) | 0% | to | 10.0% | (7.5%) | ||||
(1) | Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level 3 inputs which are not identifiable. |
(2) | Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal. |
The estimated fair value of the Company’s financial instruments is as follows:
December 31, 2015 | ||||||||||||||||||||
Carrying Value | Level I | Level II | Level III | Total Fair Value | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
| Financial assets: | ||||||||||||||||||||
Cash and cash equivalents | $ | 23,750 | $ | 23,750 | $ | - | $ | - | $ | 23,750 | ||||||||||
Investment securities available for sale | 146,520 | - | 146,520 | - | 146,520 | |||||||||||||||
Loans held for sale | 1,107 | - | 1,107 | - | 1,107 | |||||||||||||||
Net loans | 527,325 | - | - | 534,021 | 534,021 | |||||||||||||||
Bank-owned life insurance | 13,141 | 13,141 | - | - | 13,141 | |||||||||||||||
Federal Home Loan Bank stock | 1,887 | 1,887 | - | - | 1,887 | |||||||||||||||
Accrued interest receivable | 2,387 | 2,387 | - | - | 2,387 | |||||||||||||||
| Financial liabilities: | ||||||||||||||||||||
Deposits | $ | 624,447 | $ | 433,226 | $ | - | $ | 191,747 | $ | 624,973 | ||||||||||
Short-term borrowings | 35,825 | 35,825 | - | - | 35,825 | |||||||||||||||
Other borrowings | 9,939 | - | 10,063 | 10,063 | ||||||||||||||||
Accrued interest payable | 395 | 395 | - | - | 395 | |||||||||||||||
December 31, 2014 | ||||||||||||||||||||
Carrying Value | Level I | Level II | Level III | Total Fair Value | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
| Financial assets: | ||||||||||||||||||||
Cash and cash equivalents | $ | 25,639 | $ | 25,639 | $ | - | $ | - | $ | 25,639 | ||||||||||
Investment securities available for sale | 154,334 | - | 154,334 | - | 154,334 | |||||||||||||||
Loans held for sale | 438 | - | 438 | - | 438 | |||||||||||||||
Net loans | 463,738 | - | - | 475,019 | 475,019 | |||||||||||||||
Bank-owned life insurance | 9,092 | 9,092 | - | - | 9,092 | |||||||||||||||
Federal Home Loan Bank stock | 1,887 | 1,887 | - | - | 1,887 | |||||||||||||||
Accrued interest receivable | 2,095 | 2,095 | - | - | 2,095 | |||||||||||||||
| Financial liabilities: | ||||||||||||||||||||
Deposits | $ | 586,112 | $ | 416,254 | $ | - | $ | 170,542 | $ | 586,796 | ||||||||||
Short-term borrowings | 14,808 | 14,808 | - | - | 14,808 | |||||||||||||||
Other borrowings | 10,624 | - | 10,822 | 10,822 | ||||||||||||||||
Accrued interest payable | 315 | 315 | - | - | 315 | |||||||||||||||
Financial instruments are defined as cash, evidence of ownership interest in an entity, or a contract which creates an obligation or right to receive or deliver cash or another financial instrument from/to a second entity on potentially favorable or unfavorable terms.
Fair value is defined as the amount at which a financial instrument could be exchanged in a current transaction between willing parties other than in a forced liquidation sale. If a quoted market price is available for a financial instrument, the estimated fair value would be calculated based upon the market price per trading unit of the instrument.
If no readily available market exists, the fair value estimates for financial instruments should be based upon management’s judgment regarding current economic conditions, interest rate risk, expected cash flows, future estimated losses, and other factors as determined through various option pricing formulas or simulation modeling. Since many of these assumptions result from judgments made by management based upon estimates which are inherently uncertain, the resulting estimated fair values may not be indicative of the amount realizable in the sale of a particular financial instrument. In addition, changes in assumptions on which the estimated fair values are based may have a significant impact on the resulting estimated fair values.
As certain assets such as deferred tax assets and premises and equipment are not considered financial instruments, the estimated fair value of financial instruments would not represent the full value of the Company.
The Company employed simulation modeling in determining the estimated fair value of financial instruments for which quoted market prices were not available based upon the following assumptions.
Cash and Cash Equivalents, Federal Home Loan Bank Stock, Accrued Interest Receivable, Accrued Interest Payable, and Short-Term Borrowings
The fair value is equal to the current carrying value.
Bank-Owned Life Insurance
The fair value is equal to the cash surrender value of the life insurance policies.
Investment Securities Available for Sale
The fair value of investment securities is equal to the available quoted market price. If no quoted market price is available, fair value is estimated using the quoted market price for similar securities.
Loans
The fair value is estimated by discounting future cash flows using current market inputs at which loans with similar terms and qualities would be made to borrowers of similar credit quality. Where quoted market prices were available, primarily for certain residential mortgage loans, such market rates were utilized as estimates for fair value.
Mortgage loans held for sale
Mortgage loans held for sale are carried at their fair value. Mortgage loans held for sale are estimated using security prices for similar product types and, therefore, are classified in Level II.
Deposits and Other Borrowed Funds
The fair values of certificates of deposit and other borrowed funds are based on the discounted value of contractual cash flows. The discount rates are estimated using rates currently offered for similar instruments with similar remaining maturities. Demand, savings, and money market deposits are valued at the amount payable on demand as of year-end.
Commitments to Extend Credit
These financial instruments are generally not subject to sale, and estimated fair values are not readily available. The carrying value, represented by the net deferred fee arising from the unrecognized commitment or letter of credit, and the fair value, determined by discounting the remaining contractual fee over the term of the commitment using fees currently charged to enter into similar agreements with similar credit risk, are not considered material for disclosure. The contractual amounts of unfunded commitments and letters of credit are presented in Note 14.
19. | ACCUMULATED OTHER COMPREHENSIVE INCOME |
The following table presents the changes in accumulated other comprehensive income (loss) by component net of tax:
(Dollars in thousands) | Unrealized gains on available-for-sale securities (a) | |||
Balance as of December 31, 2014 | $ | 2,548 | ||
Other comprehensive income before reclassification | 60 | |||
Amount reclassified from accumulated other comprehensive income | (213 | ) | ||
Period change | (153 | ) | ||
Balance at December 31, 2015 | $ | 2,395 | ||
(Dollars in thousands) | Unrealized gains on available for sale securities (a) | |||
Balance as of December 31, 2013 | $ | (2,237 | ) | |
Other comprehensive income before reclassification | 4,949 | |||
Amount reclassified from accumulated other comprehensive income | (164 | ) | ||
Period change | 4,785 | |||
Balance at December 31, 2014 | $ | 2,548 | ||
(a) | All amounts are net of tax. Amounts in parentheses indicate debits. |
The following tables present significant amounts reclassified out of each component of accumulated other comprehensive income (loss):
Amount Reclassified from Accumulated Other | Affected Line Item in the Statement Where | ||||
(Dollars in thousands) | Comprehensive Income (a) | Net Income is | |||
Details about other comprehensive income | December 31, 2015 | Presented | |||
Unrealized gains on available-for-sale securities | |||||
| $ | 323 | Investment securities gains, net | |||
| (110 | ) | Income taxes | |||
| $ | 213 | Net of tax | |||
Amount Reclassified from Accumulated Other | Affected Line Item in the Statement Where | ||||
(Dollars in thousands) | Comprehensive Income (a) | Net Income is | |||
Details about other comprehensive income | December 31, 2014 | Presented | |||
Unrealized gains on available-for-sale securities | |||||
| $ | 248 | Investment securities gains, net | |||
| (84 | ) | Income taxes | |||
| $ | 164 | Net of tax | |||
(a) | Amounts in parentheses indicate debits to net income |
20. | PARENT COMPANY |
Following are condensed financial statements for the Company.
CONDENSED BALANCE SHEET
(Dollar amounts in thousands) | December 31, | |||||||
2015 | 2014 | |||||||
ASSETS | ||||||||
Cash and due from banks | $ | 1,329 | $ | 466 | ||||
Investment securities available for sale | 814 | 783 | ||||||
Investment in nonbank subsidiary | 2,418 | 2,534 | ||||||
Investment in subsidiary bank | 73,061 | 69,514 | ||||||
Other assets | 2,475 | 1,981 | ||||||
TOTAL ASSETS | $ | 80,097 | $ | 75,278 | ||||
LIABILITIES | ||||||||
Trust preferred securities | $ | 8,248 | $ | 8,248 | ||||
Short-term borrowings | 9,499 | 3,136 | ||||||
Other liabilities | 43 | 27 | ||||||
TOTAL LIABILITIES | 17,790 | 11,411 | ||||||
STOCKHOLDERS' EQUITY | 62,307 | 63,867 | ||||||
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY | $ | 80,097 | $ | 75,278 | ||||
CONDENSED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
Year Ended December 31, | ||||||||||||
(Dollar amounts in thousands) | 2015 | 2014 | 2013 | |||||||||
INCOME | ||||||||||||
Dividends from subsidiary bank | $ | 4,023 | $ | 3,142 | $ | 2,198 | ||||||
Other | 19 | 8 | 5 | |||||||||
Total income | 4,042 | 3,150 | 2,203 | |||||||||
EXPENSES | ||||||||||||
Interest expense | 290 | 304 | 361 | |||||||||
Other | 860 | 816 | 475 | |||||||||
Total expenses | 1,150 | 1,120 | 836 | |||||||||
Income before income tax benefit | 2,892 | 2,030 | 1,367 | |||||||||
Income tax benefit | (386 | ) | (378 | ) | (283 | ) | ||||||
Income before equity in undistributednet income of subsidiaries | 3,278 | 2,408 | 1,650 | |||||||||
Equity in undistributed net incomeof subsidiaries | 3,587 | 4,772 | 5,378 | |||||||||
NET INCOME | $ | 6,865 | $ | 7,180 | $ | 7,028 | ||||||
Comprehensive Income (Loss) | $ | 6,712 | $ | 11,965 | $ | (600 | ) | |||||
CONDENSED STATEMENT OF CASH FLOWS
Year Ended December 31, | ||||||||||||
(Dollar amounts in thousands) | 2015 | 2014 | 2013 | |||||||||
OPERATING ACTIVITIES | ||||||||||||
Net income | $ | 6,865 | $ | 7,180 | $ | 7,028 | ||||||
Adjustments to reconcile net income tonet cash provided by operating activities:Equity in undistributed netincome of Middlefield Banking Company | (3,703 | ) | (4,798 | ) | (4,884 | ) | ||||||
Equity in undistributed netincome of Emerald Bank | - | - | (598 | ) | ||||||||
Equity in undistributed netloss of EMORECO | 116 | 26 | 104 | |||||||||
Stock-based compensation expense | 18 | 10 | - | |||||||||
Other | (503 | ) | (409 | ) | (253 | ) | ||||||
Net cash provided byoperating activities | 2,793 | 2,009 | 1,397 | |||||||||
FINANCING ACTIVITIES | ||||||||||||
Net increase (decrease) in short-term borrowings | 6,363 | (759 | ) | (976 | ) | |||||||
Purchase of treasury stock | (6,784 | ) | - | - | ||||||||
Common stock issued | - | - | 74 | |||||||||
Stock options exercised | (7 | ) | (50 | ) | (77 | ) | ||||||
Proceeds from dividend reinvestment plan | 651 | 590 | 736 | |||||||||
Cash dividends | (2,153 | ) | (2,121 | ) | (2,097 | ) | ||||||
Net cash used for financing activities | (1,930 | ) | (2,340 | ) | (2,340 | ) | ||||||
Increase (decrease) in cash | 863 | (331 | ) | (943 | ) | |||||||
CASH AT BEGINNING OF YEAR | 466 | 797 | 1,740 | |||||||||
CASH AT END OF YEAR | $ | 1,329 | $ | 466 | $ | 797 | ||||||
21. | SELECTED QUARTERLY FINANCIAL DATA (Unaudited) |
(Dollar amounts in thousands) | Three Months Ended | |||||||||||||||
March 31, 2015 | June 30, 2015 | September 30, 2015 | December 31, 2015 | |||||||||||||
Total interest income | $ | 7,035 | $ | 7,066 | $ | 7,151 | $ | 7,343 | ||||||||
Total interest expense | 883 | 990 | 959 | 988 | ||||||||||||
Net interest income | 6,152 | 6,076 | 6,192 | 6,355 | ||||||||||||
Provision for loan losses | 105 | - | 105 | 105 | ||||||||||||
Net interest income afterprovision for loan losses | 6,047 | 6,076 | 6,087 | 6,250 | ||||||||||||
Total noninterest income | 796 | 962 | 1,108 | 1,178 | ||||||||||||
Total noninterest expense | 4,811 | 5,217 | 4,669 | 5,380 | ||||||||||||
Income before income taxes | 2,032 | 1,821 | 2,526 | 2,048 | ||||||||||||
Income taxes | 404 | 316 | 544 | 298 | ||||||||||||
Net income | $ | 1,628 | $ | 1,505 | $ | 1,982 | $ | 1,750 | ||||||||
Per share data: | ||||||||||||||||
Net income | ||||||||||||||||
Basic | $ | 0.79 | $ | 0.73 | $ | 0.96 | $ | 0.93 | ||||||||
Diluted | 0.78 | 0.73 | 0.96 | 0.92 | ||||||||||||
Average shares outstanding: | ||||||||||||||||
Basic | 2,053,660 | 2,058,986 | 2,064,054 | 1,884,484 | ||||||||||||
Diluted | 2,062,867 | 2,068,313 | 2,072,639 | 1,893,345 | ||||||||||||
(Dollar amounts in thousands) | Three Months Ended | |||||||||||||||
March 31, 2014 | June 30, 2014 | September 30, 2014 | December 31, 2014 | |||||||||||||
Total interest income | $ | 6,989 | $ | 6,919 | $ | 6,911 | $ | 7,055 | ||||||||
Total interest expense | 1,033 | 1,033 | 999 | 1,005 | ||||||||||||
Net interest income | 5,956 | 5,886 | 5,912 | 6,050 | ||||||||||||
Provision for loan losses | 180 | 120 | 70 | - | ||||||||||||
Net interest income afterprovision for loan losses | 5,776 | 5,766 | 5,842 | 6,050 | ||||||||||||
Total noninterest income | 715 | 857 | 990 | 1,026 | ||||||||||||
Total noninterest expense | 4,229 | 4,598 | 4,385 | 4,638 | ||||||||||||
Income before income taxes | 2,262 | 2,025 | 2,447 | 2,438 | ||||||||||||
Income taxes | 499 | 414 | 529 | 550 | ||||||||||||
Net income | $ | 1,763 | $ | 1,611 | $ | 1,918 | $ | 1,888 | ||||||||
Per share data: | ||||||||||||||||
Net income | ||||||||||||||||
Basic | $ | 0.87 | $ | 0.79 | $ | 0.94 | $ | 0.92 | ||||||||
Diluted | 0.86 | 0.79 | 0.93 | 0.92 | ||||||||||||
Average shares outstanding: | ||||||||||||||||
Basic | 2,033,480 | 2,038,026 | 2,044,124 | 2,049,536 | ||||||||||||
Diluted | 2,039,515 | 2,044,564 | 2,052,012 | 2,059,561 | ||||||||||||
Management’s Discussion and Analysis ofFinancial Condition and Results of Operations
This information should be read in conjunction with the consolidated financial statements and accompanying notes to the financial statements.
This Management’s Discussion and Analysis section of the Annual Report contains forward-looking statements. Forward-looking statements are based upon a variety of estimates and assumptions. The estimates and assumptions involve judgments about a number of things, including future economic, competitive, and financial market conditions and future business decisions. These matters are inherently subject to significant business, economic, and competitive uncertainties, all of which are difficult to predict and many of which are beyond the Company's control. Although the Company believes its estimates and assumptions are reasonable, actual results could vary materially from those shown. Inclusion of forward-looking information does not constitute a representation by the Company or any other person that the indicated results will be achieved. Investors are cautioned not to place undue reliance on forward-looking information.
These forward-looking statements may involve significant risks and uncertainties. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from the results in these forward-looking statements.
Significant Factors Affecting Financial Results
Capital maintenance is a priority. The Company’s Tier 1 leverage capital was 8.69% as of December 31, 2015, with total risk-based capital of 13.20%. MBC’s Tier 1 leverage capital was 9.23% as of December 31, 2015, with total risk-based capital of 13.73%. In 2015 MBC grew the balance sheet as a result of increasing loan volume. We also benefitted from strong income and stockholders’ equity experienced growth. The goal of the elevated capital levels is to account for potential economic stress in the markets in which the Company operates and to account for the levels of substandard and other nonperforming assets.
Longer-term prospects for growth. Continued reduction of nonperforming assets continues to be a higher priority than growth. The Company does not anticipate significant deposit growth. An increase in loan demand and the availability of high-quality lending opportunities continues to be the driver of growth potential and depends on a broad range of economic factors in the markets in which the Company operates, including the condition of real estate markets in northeastern Ohio and in central Ohio.
Nonperforming and classified assets held by the banking industry have decreased from previous elevated levels. Because of ncertainty about economic sustainability and the potential for other factors to have an adverse impact on the prospects for the banking industry, such as national and global economic and political factors, the bank regulatory agencies have insisted that banks increase the size of the buffer that protects a bank from unknown potential adverse events and circumstances: regulatory capital.
The total number of banks and savings associations as of the end of 2015 is less than half the number at the end of 1990. Nevertheless, a large percentage of the institutions that remain are small, community-oriented institutions, although the share of total banking assets that they control continues to decline. As an increasing share of the banking universe is occupied by the largest institutions, and taking into account economic, demographic, and technological changes and a greatly expanding regulatory burden, the future of banking favors larger institutions. We believe these factors create a strong incentive for growth through industry consolidation, meaning acquisition of smaller institutions by larger institutions and mergers of smaller institutions as a defense to competitive pressure from larger institutions. We therefore believe that industry consolidation is likely to continue and that the pace of consolidation could actually accelerate.
The trend toward consolidation would be most advantageous for financial institution organizations that have a surplus of capital, a strategy for growth, a strong financial profile, and few if any regulatory supervisory concerns, the ingredients of prompt regulatory approval that could be a significant competitive advantage in the market for financial institution mergers and acquisitions. Our goal is to acquire that advantage, although we give no assurance that our efforts to do so will succeed. We continue to commit significant resources to increase operational effectiveness in The Middlefield Banking Company. We continue to invest resources both to resolve existing nonperforming and substandard assets and to prevent growth in those asset classes.
Although we are not currently exploring acquisition opportunities, we are seeking to make Middlefield Banc Corp. eligible to grow by acquisition if a suitable opportunity arises. We give no assurance that a suitable acquisition opportunity will arise.
Critical Accounting Policies
Allowance for loan and lease losses. Arriving at an appropriate level of allowance for loan and lease losses involves a high degree of judgment. The Company’s allowance for loan and lease losses provides for probable losses based upon evaluations of known and inherent risks in the loan portfolio.
Management uses historical information to assess the adequacy of the allowance for loan and lease losses as well as the prevailing business environment, which is affected by changing economic conditions and various external factors and which may impact the portfolio in ways currently unforeseen. The allowance is increased by provisions for loan losses and by recoveries of loans previously charged-off and reduced by loans charged-off. For a full discussion of the Company’s methodology of assessing the adequacy of the reserve for loan losses, refer to Note 1 of “Notes to Consolidated Financial Statements” of this Annual Report.
Valuation of Securities. Securities are classified as held to maturity or available for sale on the date of purchase. Only those securities classified as held to maturity are reported at amortized cost. Available-for-sale and trading securities are reported at fair value with unrealized gains and losses included in accumulated other comprehensive income, net of related deferred income taxes, on the Consolidated Balance Sheet. The majority of all of the Company’s securities are valued based on prices compiled by third party vendors using observable market data. However, certain securities are less actively traded and do not always have quoted market prices. The determination of their fair value, therefore, requires judgment, as this determination may require benchmarking to similar instruments or analyzing default and recovery rates. Examples include certain collateralized mortgage and debt obligations and high-yield debt securities. Realized securities gains or losses are reported within noninterest income in the Consolidated Statement of Income. The cost of securities sold is based on the specific identification method.
Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. Investment securities are generally evaluated for OTTI under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 320, Investments — Debt and Equity Securities. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, whether the market decline was affected by macroeconomic conditions and whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, or U.S. government-sponsored enterprises, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.
When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income or loss. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.
Debt securities issued by U.S. government agencies, U.S. government-sponsored enterprises, and state and political subdivisions accounted for more than 97.9% of the total available-for-sale portfolio as of December 31, 2015, and no credit losses are expected, given the explicit and implicit guarantees provided by the U.S. federal government and the lack of significant unrealized loss positions within the obligations of state and political subdivisions security portfolio. The Company considered the following factors in determining whether a credit loss exists and the period over which the debt security is expected to recover:
● | The length of time and the extent to which the fair value has been less than the amortized cost basis. |
● | Changes in the near term prospects of the underlying collateral of a security such as changes in default rates, loss severity given default and significant changes in prepayment assumptions. |
● | The level of cash flows generated from the underlying collateral supporting the principal and interest payments of the debt securities. |
● | Any adverse change to the credit conditions and liquidity of the issuer, taking into consideration the latest information available about the overall financial condition of the issuer, credit ratings, recent legislation and government actions affecting the issuer’s industry and actions taken by the issuer to deal with the present economic climate. |
Refer to Note 3 in the consolidated financial statements.
Income Taxes
The Company estimates income tax expense based on amounts expected to be owed to the various tax jurisdictions in which the Company conducts business. On a quarterly basis, management assesses the reasonableness of the Company’s effective tax rate based upon management’s current estimate of the amount and components of net income, tax credits and the applicable statutory tax rates expected for the full year. The estimated income tax expense is recorded in the Consolidated Statement of Income.
Deferred income tax assets and liabilities are determined using the balance sheet method and are reported in accrued taxes, interest and expenses in the Consolidated Balance Sheet. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax basis of assets and liabilities and recognizes enacted changes in tax rates and laws. Deferred tax assets are recognized to the extent they exist and are subject to a valuation allowance based on management’s judgment that realization is more likely than not.
Accrued taxes represent the net estimated amount due to taxing jurisdictions and are reported in accrued taxes, interest and expenses in the Consolidated Balance Sheet. The Company evaluates and assesses the relative risks and appropriate tax treatment of transactions and filing positions after considering statutes, regulations, judicial precedent and other information and maintains tax accruals consistent with management’s evaluation of these relative risks and merits. Changes to the estimate of accrued taxes occur periodically due to changes in tax rates, interpretations of tax laws, the status of examinations being conducted by taxing authorities and changes to statutory, judicial and regulatory guidance that impact the relative risks of tax positions. These changes, when they occur, can affect deferred taxes and accrued taxes as well as the current period’s income tax expense and can be significant to the operating results of the Company.
Goodwill and Other Intangible Assets
Goodwill is the excess of the purchase price over the fair value of the assets acquired in connection with business acquisitions accounted for as purchases. Other intangible assets consist of branch acquisition core deposit premiums.Initially, an assessment of qualitative factors (Step 0) is performed to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, we determine it is not more likely than not that the fair value of a reporting unit is less than its carrying value, then performing the two-step impairment test is unnecessary. However, if we conclude otherwise, then we are required to perform the first step (Step 1) of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. If the fair value is less than the carrying value, an expense may be required on our books to write down the goodwill to the proper carrying value. Step 2 of impairment testing, which is necessary only if Step 1 fails, compares the implied fair value of the goodwill with the carrying amount of the goodwill.
The Company must assess goodwill and other intangible assets each year for impairment. The gross carrying amount of goodwill and intangible assets is tested for impairment in the fourth quarter, after the annual forecasting process.
Fair Value of Financial Instruments
The disclosure of the fair value of financial instruments is based on available market prices or management’s estimates of the fair value of such instruments.
Management consults with a third party for available market prices as well as performs calculations of the present value of contractual cash flows discounted at current comparative market inputs. Prepayment estimates are utilized when appropriate.
Changes in Financial Condition
GeneralThe Company’s total assets increased $57.6 million or 8.5% to $735.1 million at December 31, 2015 from $677.5 million at December 31, 2014. This was due to an increase in net loans of $63.6 million, which was partially offset by a decrease in investments of $7.8 million.
The increase in the Company’s total assets reflects a related increase in total liabilities of $59.2 million or 9.6% to a total balance of $672.8 million at December 31, 2015 from $613.7 million at December 31, 2014. The Company experienced a decrease in total stockholders’ equity of $1.6 million.
The increase in total liabilities was due to growth in deposits and short-term borrowings for the year. Total deposits increased $38.3 million or 6.5% to $624.4 million at December 31, 2015 from $586.1 million as of December 31, 2014. Short-term borrowings increased $21.0 million or 141.9% to $35.8 million at December 31, 2015 from $14.8 million as of December 31, 2014. The net decrease in total stockholders’ equity can be attributed to a $6.8 million increase in treasury stock, partially offset by an increase in retained earnings and common stock of $4.7 million and of $0.7 million, respectively.
Cash on hand and Federal funds soldCash and due from banks and federal funds sold represent cash and cash equivalents which decreased $1.9 million or 7.4% to $23.7 million at December 31, 2015 from $25.6 million at December 31, 2014. Deposits from customers into savings and checking accounts, loan and security repayments and proceeds from borrowed funds typically increase these accounts. Decreases result from customer withdrawals, new loan originations, security purchases and repayments of borrowed funds.
SecuritiesManagement's objective in structuring the portfolio is to maintain a prudent level of liquidity while providing an acceptable rate of return without sacrificing asset quality. Maturing securities have historically provided sufficient liquidity. The balance of total securities decreased $7.8 million, or 5.1%, as compared to 2014, with the ratio of securities to total assets decreasing to 19.9% at December 31, 2015, compared to 22.8% at December 31, 2014.
The Company benefits from owning mortgage-backed securities, which totaled $26.6 million or 18.6% of the Company's total investment portfolio at December 31, 2015. The primary difference of mortgage-backed securities is the amortization of principal as compared to other types of investment securities, which deliver proceeds upon maturity or call date. The weighted-average federal tax equivalent (FTE) yield on all debt securities at year-end 2015 was 4.11%, as compared to 4.18% at year-end 2014. While the Company's focus is to generate interest revenue primarily through loan growth, management will continue to invest excess funds in securities when opportunities arise.
Loans receivableThe loans receivable category consists primarily of single-family mortgage loans used to purchase or refinance personal residences located within the Company’s market area and commercial real estate loans used to finance properties that are used in the borrowers’ businesses or to finance investor-owned rental properties and commercial loans to finance the business operations and to a lesser extent construction and consumer loans. Net loans receivable increased $63.6 million or 13.7% to $527.3 million at December 31, 2015 from $463.7 million at December 31, 2014. Included in this growth were increases in real estate mortgages and C&I loans of $63.4 million and $7.6 million, respectively, but partially offset by an $8.2 million decrease in real estate construction loans.
The product mix in the loan portfolio is commercial and industrial loans equaling 8.0%, construction loans 4.1%, residential real estate loans 43.6%, commercial real estate loans 43.4% and consumer loans 0.9% at December 31, 2015 compared with 7.4%, 6.4%, 44.6%, 40.5% and 1.0%, respectively, at December 31, 2014.
Loans contributed 83.3% of total interest income in 2015 and 81.5% in 2014. The loan portfolio yield of 4.81% in 2015 was 30 basis points higher than the average yield for total interest-earning assets. Management recognizes that while the loan portfolio holds some of the Company’s highest yielding assets, it is inherently the most risky portfolio. Accordingly, management attempts to balance credit risk versus return with conservative credit standards. Management has developed and maintains comprehensive underwriting guidelines and a loan review function that monitors credits during and after the approval process. Management follows additional procedures to obtain current borrower financial information annually throughout the life of the loan obligation.
To minimize risks associated with changes in the borrower’s future repayment capacity, the Company generally requires scheduled periodic principal and interest payments on all types of loans and normally requires collateral.
The Company will continue to monitor the size of its loan portfolio growth. The Company's lending markets have rebounded from the suppressed levels of loan originations in previous years. The Company anticipates total loan growth to be steady, with volume to continue at a moderate pace. The Company remains committed to sound underwriting practices without sacrificing asset quality and avoiding exposure to unnecessary risk that could weaken the credit quality of the portfolio.
FHLB stock.FHLB stock remained unchanged at $1.9 million at December 31, 2015 when compared to the prior year.
Goodwill. Goodwill results from prior business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed annually for impairment and any such impairment is recognized in the period identified by a charge to earnings. Goodwill is the excess of the purchase price over the fair value of the assets acquired in connection with business acquisitions accounted for as purchases. Other intangible assets consist of branch acquisition core deposit premiums.Initially, an assessment of qualitative factors (Step 0) is performed to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, we determine it is not more likely than not that the fair value of a reporting unit is less than its carrying value, then performing the two-step impairment test is unnecessary. However, if we conclude otherwise, then we are required to perform the first step (Step 1) of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. If the fair value is less than the carrying value, an expense may be required on our books to write down the goodwill to the proper carrying value. Step 2 of impairment testing, which is necessary only if Step 1 fails, compares the implied fair value of the goodwill with the carrying amount of the goodwill.
The process of evaluating goodwill for impairment requires management to make significant estimates and judgments. The use of different estimates, judgments or approaches to estimate fair value could result in a different conclusion regarding impairment of goodwill. Based on the analysis, management has determined that there is no goodwill impairment.
The Company values core deposits and monitors the ongoing value of core deposit intangibles and goodwill on an annual basis. Goodwill balances were unchanged in 2015.
Bank owned life insurance.Bank owned life insurance (BOLI) is universal life insurance, purchased by the Company, on the lives of the Company’s officers. The beneficial aspects of these universal life insurance policies are tax-free earnings and a tax-free death benefit, which are realized by the Company as the owner of the policies. BOLI increased by $4.0 million to $13.1 million as of December 31, 2015 from $9.1 million at the end of 2014 as a result of the additional insurance purchases and increases in cash surrender value.
Deposits.Interest-earning assets are funded generally by both interest-bearing and noninterest-bearing core deposits. Deposits are influenced by changes in interest rates, economic conditions and competition from other banks. The Company considers various sources when evaluating funding needs, including but not limited to deposits, which represented 93.2% of the Company’s total funding sources at December 31, 2015. The deposit base consists of demand deposits, savings, money market accounts and time deposits. Total deposits increased $38.3 million or 6.5% to $624.4 million at December 31, 2015 from $586.1 million at December 31, 2014.
Savings and time deposits are the largest sources of funding for the Company's earning assets, making up a combined 59.6% of total deposits. During 2015, time deposits increased $21.4 million, or 12.6% while savings increased $2.2 million, or 1.2%, from year-end 2014. The time deposit increase is primarily due to growth in out-of-market time deposits.
Demand deposit balances increased in 2015 by $11.8 million, or 7.3%, to finish at $173.7 million at year-end 2015 as compared to $161.9 million at year-end 2014. The Company will continue to experience increased competition for deposits in its market areas, which could challenge net growth in its deposit balances. The Company will continue to evaluate its deposit portfolio mix to properly employ both retail and wholesale funds to support earning assets and minimize interest costs.
Borrowed funds.The Company uses short and long-term borrowings as another source of funding to benefit asset growth and liquidity needs. These borrowings primarily include FHLB advances, junior subordinated debt, lines of credit from other banks and repurchase agreement borrowings. Borrowed funds increased $20.4 million or 79.9% to $45.8 million at December 31, 2015 from $25.4 million at December 31, 2014. Short-term borrowings increased $21.0 million in order to fund loan growth and purchase treasury shares.
Stockholders’ equity.The Company maintains a capital level that exceeds regulatory requirements as a margin of safety for its depositors and shareholders. All of the capital ratios exceeded the regulatory well-capitalized guidelines.
Stockholders’ equity totaled $62.3 million at December 31, 2015, compared to $63.9 million at December 31, 2014, which represents a decrease of 2.4%. Treasury stock increased $6.8 million, or 100.7%, from $6.7 million at December 31, 2014. Retained earnings increased $4.7 million resulting from net income, less cash dividends paid of $2.2 million, or $1.07 per share, year-to-date. Common stock increased $0.7 million or 1.9% to $36.2 million at December 31, 2015 from $35.5 million at December 31, 2014. The Company maintains a dividend reinvestment and stock purchase plan. The plan allows shareholders to purchase additional shares of Company stock. A benefit of the plan is to permit the shareholders to reinvest cash dividends as well as make supplemental purchases without the usual payment of brokerage commissions. During 2015, shareholders invested $0.7 million through the dividend reinvestment and stock purchase plan. These proceeds resulted in the issuance of 20,393new shares at an average price of $32.17.
Average Balance Sheet and Yield/Rate Analysis.The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resultant average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resultant average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average balances are calculated using monthly averages and the average loan balances include nonaccrual loans and exclude the allowance for loan and lease losses, and interest income includes accretion of net deferred loan fees. Yields on tax-exempt securities (tax-exempt for federal income tax purposes) are shown on a fully tax equivalent basis utilizing a federal tax rate of 34%.
For the Twelve Months Ended December 31, | ||||||||||||||||||||||||||||||||||||
2015 | 2014 | 2013 | ||||||||||||||||||||||||||||||||||
(Dollars in thousands) |
Average Balance | Interest |
Average Yield/Cost |
Average Balance |
Interest |
Average Yield/Cost |
Average Balance |
Interest |
Average Yield/Cost | |||||||||||||||||||||||||||
Interest-earning assets: | ||||||||||||||||||||||||||||||||||||
Loans receivable | $ | 494,931 | $ | 23,824 | 4.81 | % | $ | 455,035 | $ | 22,726 | 4.99 | % | $ | 415,610 | $ | 22,496 | 5.41 | % | ||||||||||||||||||
Investment securities (3) | 152,015 | 4,627 | 4.11 | % | 158,585 | 5,023 | 4.18 | % | 182,942 | 5,558 | 3.90 | % | ||||||||||||||||||||||||
Interest-bearing deposits with other banks | 23,855 | 144 | 0.60 | % | 33,119 | 125 | 0.38 | % | 38,117 | 124 | 0.33 | % | ||||||||||||||||||||||||
Total interest-earning assets | 670,801 | 28,595 | 4.51 | % | 646,739 | 27,874 | 4.56 | % | 636,669 | 28,178 | 4.67 | % | ||||||||||||||||||||||||
Noninterest-earning assets | 39,470 | 24,845 | 24,278 | |||||||||||||||||||||||||||||||||
Total assets | $ | 710,271 | $ | 671,584 | $ | 660,947 | ||||||||||||||||||||||||||||||
Interest-bearing liabilities: | ||||||||||||||||||||||||||||||||||||
Interest-bearing demand deposits | $ | 62,064 | 191 | 0.31 | % | $ | 59,484 | 193 | 0.32 | % | $ | 81,941 | 215 | 0.26 | % | |||||||||||||||||||||
Money market deposits | 76,034 | 312 | 0.41 | % | 75,443 | 300 | 0.40 | % | 77,991 | 303 | 0.39 | % | ||||||||||||||||||||||||
Savings deposits | 179,095 | 542 | 0.30 | % | 177,958 | 560 | 0.31 | % | 178,678 | 608 | 0.34 | % | ||||||||||||||||||||||||
Certificates of deposit | 190,097 | 2,381 | 1.25 | % | 180,634 | 2,580 | 1.43 | % | 184,539 | 3,583 | 1.94 | % | ||||||||||||||||||||||||
Borrowings | 22,108 | 394 | 1.78 | % | 19,567 | 437 | 2.23 | % | 20,451 | 541 | 2.65 | % | ||||||||||||||||||||||||
Total interest-bearing liabilities | 529,398 | 3,820 | 0.72 | % | 513,086 | 4,070 | 0.79 | % | 543,600 | 5,250 | 0.97 | % | ||||||||||||||||||||||||
Noninterest-bearing liabilities: | ||||||||||||||||||||||||||||||||||||
Other liabilities | 116,218 | 99,511 | 63,971 | |||||||||||||||||||||||||||||||||
Stockholders' equity | 64,655 | 58,987 | 53,376 | |||||||||||||||||||||||||||||||||
Total liabilities and stockholders' equity | $ | 710,271 | $ | 671,584 | $ | 660,947 | ||||||||||||||||||||||||||||||
Net interest income | $ | 24,775 | $ | 23,804 | $ | 22,928 | ||||||||||||||||||||||||||||||
Interest rate spread (1) | 3.78 | % | 3.77 | % | 3.71 | % | ||||||||||||||||||||||||||||||
Net interest margin (2) | 3.94 | % | 3.93 | % | 3.85 | % | ||||||||||||||||||||||||||||||
Ratio of average interest-earning assets toaverage interest-bearing liabilities | 126.71 | % | 126.05 | % | 117.12 | % | ||||||||||||||||||||||||||||||
(1) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities
(2) Net interest margin represents net interest income as a percentage of average interest-earning assets.
(3) Tax-equivalent adjustments to interest income for tax-exempt securities were $1,628, $1,611, and $1,568 for 2015, 2014, and 2013, respectively.
Interest Rates and Interest Differential
2015 versus 2014 | 2014 versus 2013 | |||||||||||||||||||||||
Increase (decrease) due to | Increase (decrease) due to | |||||||||||||||||||||||
(Dollars in thousands) | Volume | Rate | Total | Volume | Rate | Total | ||||||||||||||||||
Interest-earning assets: | ||||||||||||||||||||||||
Loans receivable | $ | 1,956 | $ | (858 | ) | $ | 1,098 | $ | 2,052 | $ | (1,822 | ) | $ | 230 | ||||||||||
Investment securities | (273 | ) | (123 | ) | (396 | ) | (984 | ) | 449 | (535 | ) | |||||||||||||
Interest-bearing deposits with other banks | (45 | ) | 64 | 19 | (18 | ) | 19 | 1 | ||||||||||||||||
Total interest-earning assets | 1,638 | (917 | ) | 721 | 1,050 | (1,354 | ) | (304 | ) | |||||||||||||||
Interest-bearing liabilities: | ||||||||||||||||||||||||
Interest-bearing demand deposits | 8 | (10 | ) | (2 | ) | (66 | ) | 44 | (22 | ) | ||||||||||||||
Money market deposits | 2 | 10 | 12 | (10 | ) | 7 | (3 | ) | ||||||||||||||||
Savings deposits | 4 | (22 | ) | (18 | ) | (2 | ) | (46 | ) | (48 | ) | |||||||||||||
Certificates of deposit | 127 | (326 | ) | (199 | ) | (66 | ) | (937 | ) | (1,003 | ) | |||||||||||||
Borrowings | 51 | (94 | ) | (43 | ) | (22 | ) | (82 | ) | (104 | ) | |||||||||||||
Total interest-bearing liabilities | 192 | (442 | ) | (250 | ) | (166 | ) | (1,014 | ) | (1,180 | ) | |||||||||||||
Net interest income | $ | 1,446 | $ | (475 | ) | $ | 971 | $ | 1,216 | $ | (340 | ) | $ | 876 | ||||||||||
Allowance for Loan and Lease Losses. The allowance for loan and lease losses (“ALLL”) represents the amount management estimates is adequate to provide for probable losses inherent in the loan portfolio as of the balance sheet date. Accordingly, all loan losses are charged to the allowance, and all recoveries credited to it. The ALLL is established through a provision for loan losses, which is charged to operations. The provision is based on management's periodic evaluation of the adequacy of the ALLL, taking into account the overall risk characteristics of the various portfolio segments, the Company's loan loss experience, the impact of economic conditions on borrowers, and other relevant factors. The estimates used to determine the adequacy of the ALLL, including the amounts and timing of future cash flows expected on impaired loans, are particularly susceptible to significant change in the near term. The total ALLL is a combination of a specific allowance for identified problem loans and a general allowance for homogeneous loan pools.
The allowance for loan and lease loss balance as of December 31, 2015 totaled $6.4 million representing a $0.4 million decrease from the end of 2014. For the year of 2015, the provision for loan losses was $0.3 million which represented a decrease of $0.1 million from the $0.4 million provided during 2014. Asset quality is a high priority in our overall business plan as it relates to long-term asset growth projections. During 2015, net charge-offs increased by $0.2 million to $0.8 million compared to $0.6 million in 2014. Two key ratios to monitor asset quality performance are net charge-offs/average loans and the allowance for loan and lease losses/nonperforming loans. At year-end 2015, these ratios were 0.16% and 62.2%, respectively, compared to 0.13% and 75.7% in 2014.
The specific allowance incorporates the results of measuring impaired loans. The formula allowance is calculated by applying loss factors to outstanding loans by type, excluding loans for which a specific allowance has been determined. Loss factors are based on management's determination of the amounts necessary for concentrations and changes in mix and volume of the loan portfolio, and consideration of historical loss experience.
The non-specific allowance is determined based upon management's evaluation of existing economic and business conditions affecting the key lending areas of the Company and other conditions, such as new loan products, credit quality trends, collateral values, unique industry conditions within portfolio segments that existed as of the balance sheet date, and the impact of those conditions on the collectability of the loan portfolio. Management reviews these conditions quarterly. The non-specific allowance is subject to a higher degree of uncertainty because it considers risk factors that may not be reflected in the historical loss factors.
Although management uses the best information available to make the determination of the adequacy of the ALLL at December 31, 2015, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making the initial determinations. A downturn in the local economy could result in increased levels of nonperforming assets and charge-offs, increased loan loss provisions, and reductions in income. Additionally, as an integral part of the examination process, bank regulatory agencies periodically review a Bank’s ALLL. The banking agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination.
The following table sets forth information concerning the Company's ALLL at the dates and for the periods presented.
For the Years Ended December 31, | ||||||||||||
(Dollars in thousands) | 2015 | 2014 | 2013 | |||||||||
Allowance balance at beginning of period | $ | 6,846 | $ | 7,046 | $ | 7,779 | ||||||
Loans charged off: | ||||||||||||
Commercial and industrial | (280 | ) | (237 | ) | (419 | ) | ||||||
Real estate-construction | (385 | ) | - | (191 | ) | |||||||
Real estate-mortgage: | ||||||||||||
Residential | (425 | ) | (671 | ) | (675 | ) | ||||||
Commercial | (92 | ) | (260 | ) | - | |||||||
Consumer installment | (15 | ) | (44 | ) | (45 | ) | ||||||
Total loans charged off | (1,197 | ) | (1,212 | ) | (1,330 | ) | ||||||
Recoveries of loans previously charged-off: | ||||||||||||
Commercial and industrial | 207 | 121 | 191 | |||||||||
Real estate-construction | - | 60 | 33 | |||||||||
Real estate-mortgage: | ||||||||||||
Residential | 186 | 267 | 107 | |||||||||
Commercial | 5 | 40 | 46 | |||||||||
Consumer installment | 23 | 154 | 24 | |||||||||
Total recoveries | 421 | 642 | 401 | |||||||||
Net loans charged off | (776 | ) | (570 | ) | (929 | ) | ||||||
Provision for loan losses | 315 | 370 | 196 | |||||||||
Allowance balance at end of period | $ | 6,385 | $ | 6,846 | $ | 7,046 | ||||||
Loans outstanding: | ||||||||||||
Average | $ | 494,931 | $ | 455,035 | $ | 415,610 | ||||||
End of period | 533,710 | 470,584 | 435,725 | |||||||||
Ratio of allowance for loan and lease losses to loansoutstanding at end of period | 1.20 | % | 1.45 | % | 1.62 | % | ||||||
Net charge-offs to average loans | 0.16 | % | 0.13 | % | 0.22 | % | ||||||
The following table illustrates the allocation of the Company's allowance for probable loan losses for each category of loan for each reported period. The allocation of the allowance to each category is not necessarily indicative of future loss in a particular category and does not restrict our use of the allowance to absorb losses in other loan categories.
At December 31, | ||||||||||||||||||||||||
2015 | 2014 | 2013 | ||||||||||||||||||||||
Amount | Percent of Loans in Each Category to Total Loans | Amount | Percent of Loans in Each Category to Total Loans | Amount | Percent of Loans in Each Category to Total Loans | |||||||||||||||||||
(Dollars in Thousands) | ||||||||||||||||||||||||
Type of Loans: | ||||||||||||||||||||||||
Commercial and industrial | $ | 867 | 8.0 | % | $ | 642 | 12.9 | % | $ | 614 | 12.5 | % | ||||||||||||
Real estate construction | 276 | 4.2 | 868 | 6.4 | 576 | 5.9 | ||||||||||||||||||
Mortgage: | ||||||||||||||||||||||||
Residential | 3,139 | 43.6 | 3,703 | 48.4 | 3,664 | 48.3 | ||||||||||||||||||
Commercial | 2,078 | 43.4 | 1,576 | 31.3 | 2,170 | 32.4 | ||||||||||||||||||
Consumer installment | 25 | 0.9 | 57 | 1.0 | 22 | 0.9 | ||||||||||||||||||
Total | $ | 6,385 | 100.0 | % | $ | 6,846 | 100.0 | % | $ | 7,046 | 100.0 | % | ||||||||||||
Nonperforming assets.Nonperforming assets includes nonaccrual loans, troubled debt restructurings (TDRs), loans 90 days or more past due, assets purchased by EMORECO, OREO, and repossessed assets. A loan is classified as nonaccrual when, in the opinion of management, there are serious doubts about collectability of interest and principal. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower’s financial condition is such that collection of principal and interest is doubtful. Payments received on nonaccrual loans are applied against principal.
TDRs are those loans which the Company, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower that the Company would not otherwise consider. The Company has 30 TDRs with a total balance of $3.1 million as of December 31, 2015 compared to 25 TDRs totaling $2.9 million as of December 31, 2014. Nonperforming loans amounted to $10.3 million or 1.9% of total loans and $9.0 million or 1.9% of total loans at December 31, 2015 and December 31, 2014, respectively. Of the nonperforming loans, 80.9% are secured by real estate as of December 31, 2015 as compared to 92.8% at December 31, 2014.
A major factor in determining the appropriateness of the ALLL is the type of collateral which secures the loans. Although this does not insure against all losses, the real estate provides substantial recovery, even in a distressed-sale and declining-value environment. The Bank’s objective is to work with the borrower to minimize the burden of the debt service and to minimize the future loss exposure to the Company.
The following table summarizes nonperforming assets by category.
At December 31, | ||||||||||||
2015 | 2014 | 2013 | ||||||||||
| (Dollars in Thousands) | ||||||||||||
Loans accounted for on a nonaccrual basis: | ||||||||||||
Commercial and industrial | $ | 1,450 | $ | 365 | $ | 214 | ||||||
Real estate - construction | 130 | 587 | - | |||||||||
Real estate-mortgage: | ||||||||||||
Residential | 4,122 | 5,438 | 7,566 | |||||||||
Commercial | 1,842 | 955 | 743 | |||||||||
Consumer installment | 1 | 2 | 8 | |||||||||
Total nonaccrual loans | 7,545 | 7,347 | 8,531 | |||||||||
Troubled debt restructuring: | ||||||||||||
Commercial and industrial | 509 | 250 | 1,352 | |||||||||
Real estate - construction | 129 | - | - | |||||||||
Real estate-mortgage: | ||||||||||||
Residential | 1,398 | 1,015 | 987 | |||||||||
Commercial | 680 | 265 | 1,420 | |||||||||
Consumer installment | - | 6 | - | |||||||||
Total troubled debt restructuring | 2,716 | 1,536 | 3,759 | |||||||||
Accruing loans which are contractually pastdue 90 days or more: | ||||||||||||
Commercial and industrial | - | - | 38 | |||||||||
Real estate - construction | - | - | - | |||||||||
Real estate-mortgage: | ||||||||||||
Residential | 2 | 165 | 143 | |||||||||
Commercial | - | - | - | |||||||||
Consumer installment | - | - | - | |||||||||
Total accruing loans which are contractually pastdue 90 days or more | 2 | 165 | 181 | |||||||||
Total nonperforming loans | 10,263 | 9,048 | 12,471 | |||||||||
Other real estate owned | 1,412 | 2,590 | 2,698 | |||||||||
Total nonperforming assets | $ | 11,675 | $ | 11,638 | $ | 15,169 | ||||||
Total nonperforming loans to total loans | 1.92 | % | 1.92 | % | 2.82 | % | ||||||
Total nonperforming loans to total assets | 1.40 | % | 1.34 | % | 1.90 | % | ||||||
Total nonperforming assets to total assets | 1.59 | % | 1.72 | % | 2.32 | % | ||||||
Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower's financial condition is such that collection of interest is doubtful. Payments received on nonaccrual loans are recorded as income or applied against principal according to management's judgment as to the collectability of principal.
A loan is considered impaired when it is probable the borrower will not repay the loan according to the original contractual terms of the loan agreement, including all troubled debt restructurings. Management has determined that first mortgage loans on one-to-four family properties and all consumer loans represent large groups of smaller-balance homogeneous loans that are to be collectively evaluated. Loans that experience insignificant payment delays, which are defined as 90 days or less, generally are not classified as impaired. A loan is not impaired during a period of delay in payment if the Company expects to collect all amounts due, including interest accrued at the contractual interest rate for the period of delay. Management evaluates all loans identified as impaired individually. The Company estimates credit losses on impaired loans based on the present value of expected cash flows, or the fair value of the underlying collateral if loan repayment is expected to come from the sale or operation of the collateral. Impaired loans, or portions thereof, are charged off when it is determined a realized loss has occurred. Until that time, an allowance for loan and lease loss is maintained for estimated losses.
Interest income that would have been recorded had these loans not been placed on nonaccrual status was $259,000 in 2015; $207,000 in 2014; and $439,000 in 2013. Management is not aware of any trends or uncertainties related to any loans classified as doubtful or substandard that might have a material effect on earnings, liquidity, or capital resources.
Changes in Results of Operations
2015 Results Compared to 2014 Results
GeneralThe Company posted net income of $6.9 million, compared to $7.2 million for the year ended December 31, 2014. On a per share basis, 2015 earnings were $3.39 per diluted share, representing a decrease from the $3.50 per diluted share for the year ended December 31, 2014. The return on average equity for the year ended December 31, 2015, was 10.62% and the Company’s return on average assets was 0.97%.
Net interest incomeNet interest income, which is the Company’s largest revenue source, is the difference between interest income on earning assets and interest expense paid on liabilities. Net interest income is affected by the changes in interest rates and the composition of interest-earning assets and interest-bearing liabilities. Net interest income increased by $1.0 million in 2015 to $24.8 million compared to $23.8 million for 2014. This increase is the result of a $0.7 million increase in interest income and $0.3 million decrease in interest expense. Interest-earning assets averaged $670.8 million during 2015, a year-over-year increase of $24.1 million from $646.7 million for 2014. The Company’s average interest-bearing liabilities increased from $513.1 million in 2014 to $529.4 million in 2015.
The profit margin, or spread, on invested funds is a key performance indicator. The Company monitors two key performance indicators — net interest spread and net interest margin. The net interest spread represents the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. The net interest margin represents the overall profit margin: net interest income as a percentage of total interest-earning assets. This performance indicator gives effect to interest earned for all investable funds including the substantial volume of interest-free funds. For 2015 the net interest margin, measured on a fully taxable equivalent basis, increased to 3.94%, compared to 3.93% in 2014.
Interest incomeInterest income increased $0.7 million to $28.6 million for 2015 which is attributable to a $1.1 million increase in interest and fees on loans. This change was the result of an increase in the average balance of loans receivable, partially offset by a lower yield on the portfolio. The average balance of loans receivable increased by $39.9 million or 8.8% to $494.9 million for the year ended December 31, 2015 as compared to $455.0 million for the year ended December 31, 2014. The loans receivable yield decreased to 4.81% for 2015, from 4.99% in 2014.
Interest on investment securities decreased $0.4 million to $4.6 million for 2015, compared to $5.0 million for 2014. The average balance of investment securities decreased $6.6 million to $152.0 million for the year ended December 31, 2015 as compared to $158.6 million for the year ended December 31, 2014. The investment securities yield slipped 7 basis points to 4.11% for 2015, compared to 4.18% for 2014.
Interest expenseInterest expense decreased $0.3 million or 6.1% to $3.8 million for 2015, compared with $4.1 million for 2014. This change in interest expense can be attributed to a 7 basis point decline in the rate paid on these liabilities, partially offset by an increase in the average balance of interest-bearing liabilities. For the year ended December 31, 2015 the average balance of interest-bearing liabilities increased by $16.3 million to $529.4 million as compared to $513.1 million for the year ended December 31, 2014. Interest incurred on deposits declined by $0.2 million for the year from $3.6 million in 2014 to $3.4 million for year-end 2015. The change in deposit expense was due to the declining average balance as well as a 6 basis point decline during the year. Interest expense incurred on FHLB advances, repurchase agreements, junior subordinated debt and other borrowings declined 9.8% from 2014. The decline was due to a 45 basis point decrease in the rate paid on these borrowings during the year.
Loan Loss Provision The provision for loan losses is an operating expense recorded to maintain the related balance sheet allowance for loan and lease losses at an amount considered adequate to cover probable losses incurred in the normal course of lending. The provision for loan losses for the year ended December 31, 2015 was $0.3 million compared to $0.4 million in 2014. The loan loss provision is based upon management's assessment of a variety of factors, including types and amounts of nonperforming loans, historical loss experience, collectability of collateral values and guaranties, pending legal action for collection of loans and related guaranties, and current economic conditions. The loan loss provision reflects management's judgment of the current period cost-of-credit risk inherent in the loan portfolio. Although management believes the loan loss provision has been sufficient to maintain an adequate allowance for loan and lease losses, actual loan losses could exceed the amounts that have been charged to operations. The ratio of the allowance for loan and lease losses to total loans decreased to 1.20% of total loans at December 31, 2015 compared to the 1.45% at December 31, 2014.
During the fourth quarter of 2009, the Company created a new entity, EMORECO, Inc., which is designed to aid in troubled asset resolution. Since its inception, EMORECO has purchased $5.8 million of nonperforming assets.
Noninterest incomeNoninterest income increased $0.4 million or 12.7% to $4.0 million for 2015 compared to $3.6 million for 2014. The increase is due to increase an increase in earnings on bank-owned life insurance.
Noninterest expenseOperating expenses increased $2.2 million, or 12.5% to $20.1 million for 2015 compared to $17.9 million for 2014. Salaries and benefits, other expense, and advertising expense increased $0.9 million, $0.6 million, and $0.2 million, or 10.6%, 22.1%, and 47.7%, respectively. The salaries increased as a result of the addition of key people and pay increases. The primary driver of increase in other expense was an increase in miscellaneous loan expense. Advertising expense increased as a result of strategic branding efforts. These were partially offset by a decrease in loss on other real estate owned of $0.2 million.
Provision for Income Taxes The provision for income taxes decreased by $0.4 million, or 21.6%, to $1.6 million for 2015 from $2.0 million for 2014. The Company’s effective federal income tax rate in 2015 was 18.5% compared to 21.7% in 2014.
2014 Results Compared to 2013 Results
GeneralThe Company posted net income of $7.2 million, compared to $7.0 million for the year ended December 31, 2013. On a per share basis, 2014 earnings were $3.50 per diluted share, representing an increase from the $3.47 per diluted share for the year ended December 31, 2013. The return on average equity for the year ended December 31, 2014, was 12.17% and the Company’s return on average assets was 1.07%.
Net interest incomeNet interest income, which is the Company’s largest revenue source, is the difference between interest income on earning assets and interest expense paid on liabilities. Net interest income is affected by the changes in interest rates and the composition of interest-earning assets and interest-bearing liabilities. Net interest income increased by $0.9 million in 2014 to $23.8 million compared to $22.9 million for 2013. This increase is the net result of a $1.2 million decrease in interest expense which was partially offset by a decrease in interest income of $0.3 million. Interest-earning assets averaged $644.9 million during 2014, a year-over-year increase of $8.2 million from $636.7 million for 2013. The Company’s average interest-bearing liabilities decreased from $543.6 million in 2013 to $513.1 million in 2014.
The profit margin, or spread, on invested funds is a key performance indicator. The Company monitors two key performance indicators — net interest spread and net interest margin. The net interest spread represents the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. The net interest margin represents the overall profit margin: net interest income as a percentage of total interest-earning assets. This performance indicator gives effect to interest earned for all investable funds including the substantial volume of interest-free funds. For 2014 the net interest margin, measured on a fully taxable equivalent basis, increased to 3.93%, compared to 3.85% in 2013.
Interest incomeInterest income decreased $0.3 million to $27.9 million for 2014 which is attributable to a $0.6 million decrease in taxable interest on investment securities. The change in interest income on securities was the result of a decrease in the average balance of investment securities, partially offset by a higher yield on the portfolio. The average balance of investment securities decreased by $24.4 million or 13.3% to $158.6 million for the year ended December 31, 2014 as compared to $182.9 million for the year ended December 31, 2013. The investment security yield increased to 4.18% for 2014, from 3.90% in 2013.
Interest and fees on loans increased $0.2 million to $22.7 million for 2014, compared to $22.5 million for 2013. The average balance of loans increased $39.4 million to $455.0 million for the year ended December 31, 2014 as compared to $415.6 million for the year ended December 31, 2013 which was offset by a decline in the loan yield to 4.99% for 2014, compared to 5.41% for 2013.
Interest expenseInterest expense decreased $1.2 million or 22.5% to $4.1 million for 2014, compared with $5.3 million for 2013. This change in interest expense can be attributed to an 18 basis point decline in the rate paid on these liabilities, as well as a decrease in the average balance of interest-bearing liabilities. For the year ended December 31, 2014 the average balance of interest-bearing liabilities decreased by $30.5 million to $513.1 million as compared to $543.6 million for the year ended December 31, 2013. Interest incurred on deposits declined by $1.1 million for the year from $4.7 million in 2013 to $3.6 million for year-end 2014. The change in deposit expense was due to the declining average balance as well as a 16 basis point decline during the year. Interest expense incurred on FHLB advances, repurchase agreements, junior subordinated debt and other borrowings declined $0.1 million or 19.2% to $0.4 million for 2014, compared to $0.5 million for 2013. The decline was compounded by a 42 basis point decrease in the rate paid on these borrowings during the year.
Loan Loss Provision The provision for loan losses is an operating expense recorded to maintain the related balance sheet allowance for loan and lease losses at an amount considered adequate to cover probable losses incurred in the normal course of lending. The provision for loan losses for the year ended December 31, 2014 was $0.4 million compared to $0.2 million in 2013. The loan loss provision is based upon management's assessment of a variety of factors, including types and amounts of nonperforming loans, historical loss experience, collectability of collateral values and guaranties, pending legal action for collection of loans and related guaranties, and current economic conditions. The loan loss provision reflects management's judgment of the current period cost-of-credit risk inherent in the loan portfolio. Although management believes the loan loss provision has been sufficient to maintain an adequate allowance for loan and lease losses, actual loan losses could exceed the amounts that have been charged to operations. The ratio of the allowance for loan and lease losses to total loans decreased to 1.45% of total loans at December 31, 2014 compared to the 1.62% at December 31, 2013.
During the fourth quarter of 2009, the Company created a new entity, EMORECO, Inc., which is designed to aid in troubled asset resolution. Since its inception, EMORECO has purchased $5.8 million of nonperforming assets.
Noninterest incomeNoninterest income increased $0.4 million or 14.13% to $3.6 million for 2014 compared to $3.1 million for 2013. The increase is largely due to increases in investment security gains and gains on sale of loans of $0.2 million each. This amount was partially offset by a decrease to service charges on deposit accounts of $0.1 million.
Noninterest expenseOperating expenses increased $1.0 million, or 5.8% to $17.9 million for 2014 compared to $16.9 million for 2013. Salaries and benefits, other expense, and losses on other real estate owned increased $0.9 million, $0.4 million, and $0.2 million, or 11.4%, 15.8%, and 916.7%, respectively. These were partially offset by a decrease in Ohio state franchise tax of $0.3 million, or 44.7%.
Provision for Income Taxes The provision for income taxes was essentially unchanged at $2.0 million for 2014. The Company’s effective federal income tax rate in 2014 was 21.7% compared to 22.0% in 2013.
Asset and Liability Management
The primary objective of the Company’s asset and liability management function is to maximize the Company’s net interest income while simultaneously maintaining an acceptable level of interest rate risk given the Company’s operating environment, capital and liquidity requirements, performance objectives and overall business focus. The principal determinant of the exposure of the Company’s earnings to interest rate risk is the timing difference between the re-pricing or maturity of interest-earning assets and the re-pricing or maturity of its interest-bearing liabilities. The Company’s asset and liability management policies are designed to decrease interest rate sensitivity primarily by shortening the maturities of interest-earning assets while at the same time extending the maturities of interest-bearing liabilities. The Board of Directors of the Company continues to believe in a strong asset/liability management process in order to insulate the Company from material and prolonged increases in interest rates. Mortgage-backed securities generally increase the quality of the Company’s assets by virtue of the insurance or guarantees that back them, are more liquid than individual mortgage loans and may be used to collateralize borrowings or other obligations of the Company.
The Company’s Board of Directors has established an Asset and Liability Management Committee consisting of outside directors and senior management. This committee, which meets quarterly, generally monitors various asset and liability management policies and strategies.
Interest Rate Sensitivity Simulation Analysis
The Company utilizes income simulation modeling in measuring its interest rate risk and managing its interest rate sensitivity. The Asset and Liability Management Committee of the Company believes the various rate scenarios of the simulation modeling enables the Company to more accurately evaluate and manage the exposure of interest rate fluctuations on net interest income, the yield curve, various loan and mortgage-backed security prepayments, and deposit decay assumptions.
Earnings simulation modeling and assumptions about the timing and volatility of cash flows are critical in net portfolio equity valuation analysis. Particularly important are the assumptions driving mortgage prepayments and expected attrition of the core deposit portfolios. These assumptions are based on the Company’s historical experience and industry standards and are applied consistently across all rate risk measures.
The Company has established the following guidelines for assessing interest rate risk:
Net interest income simulation- Given a 200 basis point parallel gradual increase or decrease in market interest rates, net interest income may not change by more than 10% for a one-year period. Given a 100 basis point parallel gradual decrease in market interest rates, net interest income may not change by more than 8% for a one-year period.
Portfolio equity simulation- Portfolio equity is the net present value of the Company’s existing assets and liabilities. Given a 200 basis point immediate and permanent increase in market interest rates, portfolio equity may not correspondingly decrease or increase by more than 20% of stockholders’ equity. Given a 100 basis point immediate and permanent decrease in market interest rates, portfolio equity may not correspondingly decrease or increase by more than 10% of stockholders’ equity.
The following table presents the simulated impact of a 200 basis point upward or 100 basis point downward shift of market interest rates on net interest income, and the change in portfolio equity. This analysis was done assuming the interest-earning asset and interest-bearing liability levels at December 31, 2015 remained constant. The impact of the market rate movements was developed by simulating the effects of rates changing gradually from the December 31, 2015 levels for net interest income, and portfolio equity. The impact of market rate movements was developed by simulating the effects of an immediate and permanent change in rates at December 31, 2015 for portfolio equity:
Increase 200 Basis Points | Decrease 100 Basis Points | |||||||
Net interest income - decrease | (2.8 | )% | (1.7 | )% | ||||
Portfolio equity - decrease | 0.7 | % | (14.5 | )% | ||||
Liquidity and Capital Resources
Liquidity. Liquidity management involves monitoring the ability to meet the cash flow needs of bank customers, such as borrowings or deposit withdrawals, as well as the Company’s own financial commitments. The principal sources of liquidity are net income, loan payments, maturing and principal reductions on securities and sales of securities available for sale, federal funds sold and cash and deposits with banks. Along with its liquid assets, the Company has additional sources of liquidity available to ensure adequate funds are available as needed. These include, but are not limited to, the purchase of federal funds, the ability to borrow funds under line of credit agreements with correspondent banks, a borrowing agreement with the Federal Home Loan Bank of Cincinnati, Ohio and the adjustment of interest rates to obtain deposits. Management believes the Company has the capital adequacy, profitability and reputation to meet the current and projected needs of its customers.
Liquidity is managed based on factors including core deposits as a percentage of total deposits, the level of funding source diversification, the allocation and amount of deposits among deposit types, the short-term funding sources used to fund assets, the amount of non-deposit funding used to fund assets, the availability of unused funding sources, off-balance sheet obligations, the availability of assets readily converted to cash without undue loss, the amount of cash and liquid securities we hold, and the re-pricing characteristics and maturities of our assets when compared to the re-pricing characteristics of our liabilities and other factors.
The Company's liquid assets consist of cash and cash equivalents, which include investments in very short-term investments (i.e., federal funds sold), and investment securities classified as available for sale. The level of these assets is dependent on the Company's operating, investing, and financing activities during any given period. At December 31, 2015, cash and cash equivalents totaled $23.8 million or 3.2% of total assets while investment securities classified as available for sale totaled $146.5 million or 19.9% of total assets. Management believes that the liquidity needs of the Company are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources, FHLB advances, junior subordinated debt, and the portion of the investment and loan portfolios that mature within one year. These sources of funds will enable the Company to meet cash obligations and off-balance sheet commitments as they come due.
Operating activities provided net cash of $7.2 million, $7.5 million, and $9.9 million for 2015, 2014, and 2013, respectively, generated principally from net income of $6.9 million, $7.2 million, and $7.0 million in each of these respective periods.
Investing activities used $59.4 million which consisted primarily of investment activity and loan originations. The cash usages primarily consisted of loan increases of $63.9 million and investment purchases of $21.9 million. Partially offsetting the usage are proceeds from repayments and maturities and proceeds from sale of securities of $13.5 million and $15.7 million, respectively. For the same period ended 2014, investing activities used $26.7 million which consisted primarily of investment activity and loan originations. The cash usages primarily consisted of investment purchases of $12.3 million and loan increases of $36.2 million. Partially offsetting the usage are proceeds from repayments and maturities and proceeds from sale of securities of $13.5 million and $8.4 million, respectively. For the same period ended 2013, investing activities used $6.1 million which consisted primarily of investment activity and loan originations. The cash usages primarily consisted of investment purchases of $25.8 million and loan increases of $29.8 million. Partially offsetting the usage are proceeds from repayments and maturities and proceeds from sale of securities of $25.4 million and $25.1 million, respectively.
Financing activities consist of the solicitation and repayment of customer deposits, borrowings and repayments, treasury stock activity, and the payment of dividends. During 2015, net cash provided by financing activities totaled $50.4 million, principally derived from increases in deposit accounts and short-term borrowings of $38.3 million and $21.0 million, respectively, and partially offset by treasury stock purchase of $6.8 million and $2.2 million in cash dividends. During 2014, net cash provided by financing activities totaled $18.7 million, principally derived from increases in deposit accounts and short-term borrowings of $17.3 million and $4.0 million, respectively, and partially offset by $2.1 million in cash dividends. During 2013, net cash used for financing activities totaled $23.0 million, principally derived from a decrease in deposit accounts of $24.5 million and partially offset by $4.3 million increase in short-term borrowings.
Liquidity may be adversely affected by many circumstances, including unexpected deposit outflows and increased draws on lines of credit. Management monitors projected liquidity needs and determines the desirable level based in part on the Company's commitment to make loans and management's assessment of the Company's ability to generate funds. The Company anticipates having sufficient liquidity to satisfy estimated short and long-term funding needs.
Capital Resources. The Company's primary source of capital is retained earnings. Historically, the Company has generated net retained income to support normal growth and expansion. Management has developed a capital planning policy to not only ensure regulatory compliance but capital adequacy for future expansion.
Market Price of and Dividends on the Registrant's Common Equity and Related Stockholder Matters
The Company had approximately 1,057 stockholders of record as of December 31, 2015. The Company’s common stock is traded and authorized for quotation on NASDAQ under the symbol “MBCN.”
The following table shows the high and low bid prices of and cash dividends paid on the Company’s common stock in 2015 and 2014, adjusted for stock splits and stock dividends. This information does not reflect retail mark-up, markdown or commissions, and does not necessarily represent actual transactions.
High Bid | Low Bid | Cash Dividends per share | ||||||||||
2015 | ||||||||||||
First Quarter | $ | 34.82 | $ | 31.50 | $ | 0.26 | ||||||
Second Quarter | $ | 33.65 | $ | 31.60 | $ | 0.27 | ||||||
Third Quarter | $ | 34.00 | $ | 30.20 | $ | 0.27 | ||||||
Fourth Quarter | $ | 34.75 | $ | 28.90 | $ | 0.27 | ||||||
2014 | ||||||||||||
First Quarter | $ | 28.00 | $ | 26.00 | $ | 0.26 | ||||||
Second Quarter | $ | 30.50 | $ | 27.05 | $ | 0.26 | ||||||
Third Quarter | $ | 35.70 | $ | 28.55 | $ | 0.26 | ||||||
Fourth Quarter | $ | 34.50 | $ | 33.00 | $ | 0.26 | ||||||
MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a significant deficiency (as defined in Public Company Accounting Oversight Board Auditing Standard No. 5), or a combination of significant deficiencies, that results in there being more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis by management or employees in the normal course by management or employees in the normal course of performing their assigned functions.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2015. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013). Based on this assessment, management believes that, as of December 31, 2015, the Company’s internal control over financial reporting was effective.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm because section 989G of the Dodd Frank Act exempts smaller reporting companies from the requirement of an attestation by registered public accountants concerning internal controls over financial reporting.
/s/ Thomas G. Caldwell
By: Thomas G. Caldwell
President and Chief Executive Officer
(Principal Executive Officer)
Date: March 9, 2016
/s/ Donald L. Stacy
By: Donald L. Stacy
Treasurer
(Principal Financial & Accounting Officer)
Date: March 9, 2016