GREAT SOUTHERN BANCORP, INC. AND SUBSIDIARIES
GREAT SOUTHERN BANCORP, INC. AND SUBSIDIARIES
The accompanying unaudited interim consolidated financial statements of Great Southern Bancorp, Inc. (the "Company" or "Great Southern") have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. The financial statements presented herein reflect all adjustments which are, in the opinion of management, necessary to fairly present the financial condition, results of operations, changes in stockholders’ equity and cash flows of the Company as of the dates and for the periods presented. Those adjustments consist only of normal recurring adjustments. Operating results for the three and six months ended June 30, 2019 are not necessarily indicative of the results that may be expected for the full year. The consolidated statement of financial condition of the Company as of December 31, 2018, has been derived from the audited consolidated statement of financial condition of the Company as of that date. Certain prior period amounts have been reclassified to conform to the current period presentation. These reclassifications had no effect on net income.
The Company operates as a one-bank holding company. The Company’s business primarily consists of the operations of Great Southern Bank (the “Bank”), which provides a full range of financial services to customers primarily located in Missouri, Iowa, Kansas, Minnesota, Nebraska and Arkansas. The Bank also originates commercial loans from lending offices in Dallas, Texas, Tulsa, Okla., Chicago, Ill., Atlanta, Ga., Denver, Colo. and Omaha, Neb. The Company and the Bank are subject to regulation by certain federal and state agencies and undergo periodic examinations by those regulatory agencies.
The Company’s banking operation is its only reportable segment. The banking operation is principally engaged in the business of originating residential and commercial real estate loans, construction loans, commercial business loans and consumer loans and funding these loans by attracting deposits from the general public, accepting brokered deposits and borrowing from the Federal Home Loan Bank and others. The operating results of this segment are regularly reviewed by management to make decisions about resource allocations and to assess performance. Selected information is not presented separately for the Company’s reportable segment, as there is no material difference between that information and the corresponding information in the consolidated financial statements.
Options outstanding at June 30, 2019 and 2018, to purchase 309,000 and 161,400 shares of common stock, respectively, were not included in the computation of diluted earnings per common share for each of the three and six month periods because the exercise prices of such options were greater than the average market prices of the common stock for the three and six months ended June 30, 2019 and 2018, respectively.
The amortized cost and fair values of securities classified as available-for-sale were as follows:
The amortized cost and fair value of available-for-sale securities at June 30, 2019, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at June 30, 2019 and December 31, 2018, was approximately $61.6 million and $95.7 million, respectively, which is approximately 20.1% and 39.2% of the Company’s available-for-sale investment portfolio, respectively.
Based on an evaluation of available evidence, including recent changes in market interest rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these debt securities are temporary.
The following table shows the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2019 and December 31, 2018:
There were no sales of available-for-sale securities during the three months ended June 30, 2019. Gross gains of $226,000 and gross losses of $216,000 resulting from sales of available-for-sale securities were realized during the six months ended June 30, 2019. There were no sales of available-for-sale securities during the three and six months ended June 30, 2018. Gains and losses on sales of securities are determined on the specific-identification method.
The accounting guidance for beneficial interests in securitized financial assets provides incremental impairment guidance for a subset of the debt securities within the scope of the guidance for investments in debt and equity securities. For securities where the security is a beneficial interest in securitized financial assets, the Company uses the beneficial interests in securitized financial asset impairment model. For securities where the security is not a beneficial interest in securitized financial assets, the Company uses the debt and equity securities impairment model. The Company does not currently have securities within the scope of this guidance for beneficial interests in securitized financial assets.
The Company routinely conducts periodic reviews to identify and evaluate each investment security to determine whether an other-than-temporary impairment has occurred. The Company considers the length of time a security has been in an unrealized loss position, the relative amount of the unrealized loss compared to the carrying value of the security, the type of security and other factors. If certain criteria are met, the Company performs additional review and evaluation using observable market values or various inputs in economic models to determine if an unrealized loss is other-than-temporary. The Company uses quoted market prices for marketable equity securities and uses broker pricing quotes based on observable inputs for equity investments that are not traded on a stock exchange. For non-agency collateralized mortgage obligations, to determine if the unrealized loss is other than temporary, the Company projects total estimated defaults of the underlying assets (mortgages) and multiplies that calculated amount by an estimate of realizable value upon sale in the marketplace (severity) in order to determine the projected collateral loss. The Company also evaluates any current credit enhancement underlying these securities to determine the impact on cash flows. If the Company determines that a given security position will be subject to a write-down or loss, the Company records the expected credit loss as a charge to earnings.
During the three and six months ended June 30, 2019 and 2018, respectively, no securities were determined to have impairment that had become other-than-temporary.
Nonaccruing loans (excluding FDIC-assisted acquired loans, net of discount) are summarized as follows:
The following table presents the activity in the allowance for loan losses by portfolio segment for the three and six months ended June 30, 2019. Also presented are the balance in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method as of June 30, 2019:
The following table presents the activity in the allowance for loan losses by portfolio segment for the three and six months ended June 30, 2018:
The following table presents the balance in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method as of December 31, 2018:
The portfolio segments used in the preceding three tables correspond to the loan classes used in all other tables in Note 6 as follows:
A loan is considered impaired, in accordance with the impairment accounting guidance (FASB ASC 310-10-35-16), when based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include not only nonperforming loans but also include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties.
Impaired loans (excluding FDIC-assisted loans, net of discount), are summarized as follows:
Included in certain loan categories in the impaired loans are troubled debt restructurings that were classified as impaired. Troubled debt restructurings are loans that are modified by granting concessions to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. The types of concessions made are factored into the estimation of the allowance for loan losses for troubled debt restructurings primarily using a discounted cash flow or collateral adequacy approach.
The following tables present newly restructured loans during the three and six months ended June 30, 2019 and 2018, respectively, by type of modification:
On March 20, 2009, Great Southern Bank entered into a purchase and assumption agreement with loss share with the Federal Deposit Insurance Corporation (FDIC) to assume all of the deposits (excluding brokered deposits) and acquire certain assets of TeamBank, N.A., a full service commercial bank headquartered in Paola, Kansas.
The loans, commitments and foreclosed assets purchased in the TeamBank transaction were covered by a loss sharing agreement between the FDIC and Great Southern Bank. This agreement originally was to extend for ten years for 1-4 family real estate loans and for five years for other loans. The five-year period ended March 31, 2014 and the ten-year period was terminated early, effective April 26, 2016, by mutual agreement of Great Southern Bank and the FDIC. Based upon the acquisition date fair values of the net assets acquired, no goodwill was recorded.
On September 4, 2009, Great Southern Bank entered into a purchase and assumption agreement with loss share with the FDIC to assume all of the deposits and acquire certain assets of Vantus Bank, a full service thrift headquartered in Sioux City, Iowa.
The loans, commitments and foreclosed assets purchased in the Vantus Bank transaction were covered by a loss sharing agreement between the FDIC and Great Southern Bank. This agreement originally was to extend for ten years for 1-4 family real estate loans and for five years for other loans. The five year period ended September 30, 2014 and the ten-year period was terminated early, effective April 26, 2016, by mutual agreement of Great Southern Bank and the FDIC. Based upon the acquisition date fair values of the net assets acquired, no goodwill was recorded.
On October 7, 2011, Great Southern Bank entered into a purchase and assumption agreement with loss share with the FDIC to assume all of the deposits and acquire certain assets of Sun Security Bank, a full service bank headquartered in Ellington, Missouri.
The loans and foreclosed assets purchased in the Sun Security Bank transaction were covered by a loss sharing agreement between the FDIC and Great Southern Bank. This agreement originally was to extend for ten years for 1-4 family real estate loans and for five years for other loans but was terminated early, effective April 26, 2016, by mutual agreement of Great Southern Bank and the FDIC. Based upon the acquisition date fair values of the net assets acquired, no goodwill was recorded.
On April 27, 2012, Great Southern Bank entered into a purchase and assumption agreement with loss share with the FDIC to assume all of the deposits and acquire certain assets of Inter Savings Bank, FSB (“InterBank”), a full service bank headquartered in Maple Grove, Minnesota.
The loans and foreclosed assets purchased in the InterBank transaction were covered by a loss sharing agreement between the FDIC and Great Southern Bank. This agreement originally was to extend for ten years for 1-4 family real estate loans and for five years for other loans but was terminated early, effective June 9, 2017, by mutual agreement of Great Southern Bank and the FDIC. Based upon the acquisition date fair values of the net assets acquired, no goodwill was recorded.
On June 20, 2014, Great Southern Bank entered into a purchase and assumption agreement with the FDIC to purchase a substantial portion of the loans and investment securities, as well as certain other assets, and assume all of the deposits, as well as certain other liabilities, of Valley Bank, a full-service bank headquartered in Moline, Illinois, with significant operations in Iowa. This transaction did not include a loss sharing agreement. Based upon the acquisition date fair values of the net assets acquired, no goodwill was recorded.
The following table presents the balances of the acquired loans related to the various FDIC-assisted transactions at June 30, 2019 and December 31, 2018.
The amount of the estimated cash flows expected to be received from the acquired loan pools in excess of the fair values recorded for the loan pools is referred to as the accretable yield. The accretable yield is recognized as interest income over the estimated lives of the loans. The Company continues to evaluate the fair value of the loans including cash flows expected to be collected. Increases in the Company’s cash flow expectations are recognized as increases to the accretable yield while decreases are recognized as impairments through the allowance for loan losses. During the three months ended June 30, 2019 and 2018, improvements in expected cash flows (reclassification of discounts from non-accretable to accretable) related to the acquired loan portfolios resulted in adjustments of $3.7 million and $725,000, respectively, to the accretable yield to be spread over the estimated remaining lives of the loans on a level-yield basis. During the six months ended June 30, 2019 and 2018, improvements in expected cash flows (reclassification of discounts from non-accretable to accretable) related to the acquired loan portfolios resulted in adjustments of $5.3 million and $2.5 million, respectively, to the accretable yield to be spread over the estimated remaining lives of the loans on a level-yield basis.
The impact to income of adjustments on the Company’s financial results is shown below:
Changes in the accretable yield for acquired loan pools were as follows for the three and six months ended June 30, 2019 and 2018:
At June 30, 2019, other real estate owned not acquired through foreclosure included eight properties, seven of which were branch locations that were closed and are held for sale, and one of which is land acquired for a potential branch location.
At December 31, 2018, other real estate owned not acquired through foreclosure included nine properties, eight of which were branch locations that were closed and are held for sale, and one of which is land acquired for a potential branch location.
At June 30, 2019, residential mortgage loans totaling $511,000 were in the process of foreclosure, $501,000 of which were acquired loans. Of the $501,000 of acquired loans, $243,000 were previously covered by loss sharing agreements and $258,000 were acquired in the Valley Bank transaction.
At December 31, 2018, residential mortgage loans totaling $1.3 million were in the process of foreclosure, $1.0 million of which were acquired loans. Of the $1.0 million of acquired loans, $873,000 were previously covered by loss sharing agreements and $171,000 were acquired in the Valley Bank transaction.
Expenses applicable to other real estate owned and repossessions included the following:
Major classifications of premises and equipment, stated at cost, were as follows:
All of our leases are classified as operating leases (as they were prior to January 1, 2019), and therefore were previously not recognized on the Company’s consolidated statements of financial condition. With the adoption of ASU 2016-02, these operating leases are now included as a right of use asset in the premises and equipment line item on the Company’s consolidated statements of financial condition. The corresponding lease liability is included in the accrued expenses and other liabilities line item on the Company’s consolidated statements of financial condition. Because these leases are classified as operating leases, the adoption of the new standard did not have a material effect on lease expense on the Company’s consolidated statements of income.
ASU 2016-02 provides a number of optional practical expedients in transition. The Company has elected the “package of practical expedients,” which permits the Company not to reassess under the new standard the prior conclusions about lease identification, lease classification and initial direct costs. The Company also elected the use of the hindsight, a practical expedient which permits the use of information available after lease inception to determine the lease term via the knowledge of renewal options exercised not available as of the lease’s inception. The practical expedient pertaining to land easements is not applicable to the Company.
ASU 2016-02 also requires certain other accounting elections. The Company elected the short-term lease recognition exemption for all leases that qualify, meaning those with terms under twelve months. Right of use assets or lease liabilities are not to be recognized for short-term leases. The Company also elected the practical expedient to not separate lease and non-lease components for all leases. The Company’s short-term leases related to offsite ATMs have both fixed and variable lease payment components, based on the number of transactions at the various ATMs. The variable portion of these lease payments is not material and the total lease expense related to ATMs for the three and six months ended June 30, 2019, was $76,000 and $149,000, respectively.
The calculated amounts of the right of use assets and lease liabilities in the table below are impacted by the length of the lease term and the discount rate used to present value the minimum lease payments. The Company’s lease agreements often include one or more options to renew at the Company’s discretion. If at lease inception, the Company considers the exercising of a renewal option to be reasonably certain, the Company will include the extended term in the calculation of the right of use asset and lease liability. Regarding the discount rate, the ASU requires the use of the rate implicit in the lease whenever this rate is readily determinable. As this rate is rarely determinable, the Company utilizes its incremental borrowing rate at lease inception over a similar term. The discount rate utilized was the FHLBank borrowing rate for the term corresponding to the expected term of the lease. The expected lease terms range from 3.3 years to 19.9 years with a weighted-average lease term of 11.1 years. The weighted-average discount rate was 3.40%.
For the three months ended June 30, 2019 and 2018, lease expense was $371,000 and $323,000, respectively. For the six months ended June 30, 2019 and 2018, lease expense was $747,000 and $654,000, respectively. At June 30, 2019, future expected lease payments for leases with terms exceeding one year were as follows (in thousands):
The Company does not sublease any of its leased facilities; however, it does lease to other third parties portions of facilities that it owns. In terms of being the lessor in these circumstances, all of these lease agreements are classified as operating leases. In the three and six months ended June 30, 2019, income recognized from these lessor agreements was $285,000 and $561,000, respectively, and was included in occupancy and equipment expense.
At June 30, 2019 and December 31, 2018, there were no outstanding term advances from the Federal Home Loan Bank of Des Moines (FHLBank advances). There were overnight borrowings from the Federal Home Loan Bank of Des Moines, which are included below in Note 12.
NOTE 12: SECURITIES SOLD UNDER REVERSE REPURCHASE AGREEMENTS AND SHORT-TERM BORROWINGS
The Bank enters into sales of securities under agreements to repurchase (reverse repurchase agreements). Reverse repurchase agreements are treated as financings, and the obligations to repurchase securities sold are reflected as a liability in the statements of financial condition. The dollar amount of securities underlying the agreements remains in the asset accounts. Securities underlying the agreements are being held by the Bank during the agreement period. All agreements are written on a term of one month or less.
At both June 30, 2019 and December 31, 2018, other interest-bearing liabilities consisted of cash collateral held by the Company to satisfy minimum collateral posting thresholds with its derivative dealer counterparties representing the termination value of derivatives, which at such time were in a net asset position. Under the collateral agreements between the parties, either party may choose to provide cash or securities to satisfy its collateral requirements.
On August 8, 2016, the Company completed the public offering and sale of $75.0 million of its subordinated notes. The notes are due August 15, 2026, and have a fixed interest rate of 5.25% until August 15, 2021, at which time the rate becomes floating at a rate equal to three-month LIBOR plus 4.087%. The Company may call the notes at par beginning on August 15, 2021, and on any scheduled interest payment date thereafter. The notes were sold at par, resulting in net proceeds, after underwriting discounts and commissions, legal, accounting and other professional fees, of approximately $73.5 million. Total debt issuance costs of approximately $1.5 million were deferred and are being amortized over the expected life of the notes, which is five years. Amortization of the debt issuance costs during the three months ended June 30, 2019 and 2018, totaled $108,000 and $38,000, respectively, and is included in interest expense on subordinated notes in the consolidated statements of income, resulting in an imputed interest rate of 5.91%. Amortization of the debt issuance costs during the six months ended June 30, 2019 and 2018, totaled $217,000 and $78,000, respectively, and is included in interest expense on subordinated notes in the consolidated statements of income, resulting in an imputed interest rate of 5.91%.
At June 30, 2019 and December 31, 2018, subordinated notes are summarized as follows:
Reconciliations of the Company’s effective tax rates to the statutory corporate tax rates were as follows:
The Company and its consolidated subsidiaries have not been audited recently by the Internal Revenue Service (IRS) and, as such, tax years through December 31, 2005, have been closed without audit. The Company, through one of its subsidiaries, is a partner in two partnerships which have been under Internal Revenue Service examination for 2006 and 2007. As a result, the Company’s 2006 and subsequent tax years remain open for examination. The examinations of these partnerships advanced during 2016, 2017, and 2018. One of the partnerships has advanced to Tax Court and has entered a Motion for Entry of Decision with an agreed upon settlement. The other partnership examination was recently completed by the IRS with no change impacting the Company’s tax positions. The Company does not currently expect significant adjustments to its financial statements from the partnership matter at the Tax Court.
The Company is currently under State of Missouri income and franchise tax examinations for its 2014 through 2015 tax years. The Company does not currently expect significant adjustments to its financial statements from this state examination.
Financial instruments are broken down as follows by recurring or nonrecurring measurement status. Recurring assets are initially measured at fair value and are required to be remeasured at fair value in the financial statements at each reporting date. Assets measured on a nonrecurring basis are assets that, due to an event or circumstance, were required to be remeasured at fair value after initial recognition in the financial statements at some time during the reporting period.
The Company considers transfers between the levels of the hierarchy to be recognized at the end of related reporting periods. From December 31, 2018 to June 30, 2019, no assets for which fair value is measured on a recurring basis transferred between any levels of the hierarchy.
The following table presents the fair value measurements of assets recognized in the accompanying statements of financial condition measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fell at June 30, 2019 and December 31, 2018:
The following tables present the fair value measurements of assets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2019 and December 31, 2018:
The Company records impaired loans as Nonrecurring Level 3. If a loan’s fair value as estimated by the Company is less than its carrying value, the Company either records a charge-off of the portion of the loan that exceeds the fair value or establishes a reserve within the allowance for loan losses specific to the loan. Loans for which such charge-offs or reserves were recorded during the six months ended June 30, 2019 or the year ended December 31, 2018, are shown in the table above (net of reserves).
The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying statements of financial condition at amounts other than fair value.
The following table presents estimated fair values of the Company’s financial instruments not recorded at fair value on the statements of financial condition. The fair values of certain of these instruments were calculated by discounting expected cash flows, which method involves significant judgments by management and uncertainties. Fair value is the estimated amount at which financial assets or liabilities could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Because no market exists for certain of these financial instruments and because management does not intend to sell these financial instruments, the Company does not know whether the fair values shown below represent values at which the respective financial instruments could be sold individually or in the aggregate.
The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity and credit risk, primarily by managing the amount, sources and duration of its assets and liabilities. In the normal course of business, the Company may use derivative financial instruments (primarily interest rate swaps) from time to time to assist in its interest rate risk management. The Company has interest rate derivatives that result from a service provided to certain qualifying loan customers that are not used to manage interest rate risk in the Company’s assets or liabilities and are not designated in a qualifying hedging relationship. The Company manages a matched book with respect to its derivative instruments in order to minimize its net risk exposure resulting from such transactions. In addition, the Company has interest rate derivatives that are designated in a qualified hedging relationship.
The Company has interest rate swaps that are not designated as qualifying hedging relationships. Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain loan customers, which the Company began offering during 2011. The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings.
As part of the Valley Bank FDIC-assisted acquisition, the Company acquired seven loans with related interest rate swaps. Valley’s swap program differed from the Company’s in that Valley did not have back to back swaps with the customer and a counterparty. Five of the seven acquired loans with interest rate swaps have paid off. The aggregate notional amount of the two remaining Valley swaps was $736,000 at June 30, 2019. At June 30, 2019, excluding the Valley Bank swaps, the Company had 18 interest rate swaps totaling $69.6 million in notional amount with commercial customers, and 18 interest rate swaps with the same aggregate notional amount with third parties related to its program. In addition, the Company has three participation loans purchased totaling $30.7 million, in which the lead institution has an interest rate swap with its customer and the economics of the counterparty swap are passed along to the Company through the loan participation. At December 31, 2018, excluding the Valley Bank swaps, the Company had 18 interest rate swaps totaling $78.5 million in notional amount with commercial customers, and 18 interest rate swaps with the same aggregate notional amount with third parties related to its program. During the three months ended June 30, 2019 and 2018, the Company recognized net gains (losses) of $(44,000) and $11,000, respectively, in noninterest income related to changes in the fair value of these swaps. During the six months ended June 30, 2019 and 2018, the Company recognized net gains (losses) of $(68,000) and $48,000, respectively, in noninterest income related to changes in the fair value of these swaps.
The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Consolidated Statements of Financial Condition:
The following table presents the effect of cash flow hedge accounting on the statements of comprehensive income:
The following table presents the effect of cash flow hedge accounting on the statements of operations:
The Company has agreements with its derivative counterparties. If the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations. If the Bank fails to maintain its status as a well-capitalized institution, then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations under the agreements. Similarly, the Company could be required to settle its obligations under certain of its agreements if certain regulatory events occur, such as the issuance of a formal directive, or if the Company’s credit rating is downgraded below a specified level.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-looking Statements
When used in this Quarterly Report on Form 10-Q and other documents filed or furnished by Great Southern Bancorp, Inc. (the “Company”) with the Securities and Exchange Commission (the "SEC"), in the Company's press releases or other public or stockholder communications, and in oral statements made with the approval of an authorized executive officer, the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," "intends" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties, including, among other things, (i) expected revenues, cost savings, earnings accretion, synergies and other benefits from the Company's merger and acquisition activities might not be realized within the anticipated time frames or at all, and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, might be greater than expected; (ii) changes in economic conditions, either nationally or in the Company's market areas; (iii) fluctuations in interest rates; (iv) the risks of lending and investing activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses; (v) the possibility of other-than-temporary impairments of securities held in the Company's securities portfolio; (vi) the Company's ability to access cost-effective funding; (vii) fluctuations in real estate values and both residential and commercial real estate market conditions; (viii) demand for loans and deposits in the Company's market areas; (ix) the ability to adapt successfully to technological changes to meet customers' needs and developments in the marketplace; (x) the possibility that security measures implemented might not be sufficient to mitigate the risk of a cyber attack or cyber theft, and that such security measures might not protect against systems failures or interruptions; (xi) legislative or regulatory changes that adversely affect the Company's business, including, without limitation, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and its implementing regulations, the overdraft protection regulations and customers' responses thereto and the Tax Reform Legislation; (xii) changes in accounting principles, policies or guidelines; (xiii) monetary and fiscal policies of the Federal Reserve Board and the U.S. Government and other governmental initiatives affecting the financial services industry; (xiv) results of examinations of the Company and Great Southern Bank by their regulators, including the possibility that the regulators may, among other things, require the Company to limit its business activities, change its business mix, increase its allowance for loan losses, write-down assets or increase its capital levels, or affect its ability to borrow funds or maintain or increase deposits, which could adversely affect its liquidity and earnings; (xv) costs and effects of litigation, including settlements and judgments; and (xvi) competition. The Company wishes to advise readers that the factors listed above and other risks described from time to time in documents filed or furnished by the Company with the SEC could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.
The Company does not undertake -and specifically declines any obligation- to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
Critical Accounting Policies, Judgments and Estimates
The accounting and reporting policies of the Company conform with accounting principles generally accepted in the United States and general practices within the financial services industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.
Allowance for Loan Losses and Valuation of Foreclosed Assets
The Company believes that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The allowance for loan losses is calculated with the objective of maintaining an allowance level believed by management to be sufficient to absorb estimated loan losses. Management's determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective as it requires material estimates of, among other things, expected default probabilities, loss once loans default, expected commitment usage, the amounts and timing of expected future cash flows on impaired loans, value of collateral, estimated losses, and general amounts for historical loss experience.
The process also considers economic conditions, uncertainties in estimating losses and inherent risks in the loan portfolio. All of these factors may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required, which would adversely impact earnings. In addition, the Bank’s regulators could require additional provisions for loan losses as part of their examination process.
See Note 6 “Loans and Allowance for Loan Losses” included in Item 1 for additional information regarding the allowance for loan losses. Inherent in this process is the evaluation of individual significant credit relationships. From time to time certain credit relationships may deteriorate due to payment performance, cash flow of the borrower, value of the collateral, or other factors. In these instances, management may revise its loss estimates and assumptions for these specific credits due to changing circumstances. In some cases, additional losses may be realized; in other instances, the factors that led to the deterioration may improve or the credit may be refinanced elsewhere and allocated allowances may be released from the particular credit. No significant changes were made to management's overall methodology for evaluating the allowance for loan losses during the periods presented in the financial statements of this report.
In the three months ending March 31, 2020, the Company will adopt ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326), which requires an entity to reflect its current estimate of all expected future credit losses. The Company previously formed a cross-functional committee to oversee the system, data, reporting and other considerations for purposes of meeting the requirements of this standard. Data and system needs were assessed. As a result, third-party software was acquired and implemented to manage the data. We have completed the upload of the necessary historical loan data to the software that will be used in meeting certain requirements of this standard. Our loss data covers multiple credit cycles back to 2003. Parallel testing of the new methodology compared to the current methodology has been performed throughout 2019 and the Company continues to evaluate the impact of adopting the new guidance. The Company engaged a third party to perform validation of the accuracy of inputs into the model. This review is currently in process. The Company expects to recognize a one-time cumulative effect adjustment to the allowance for loan losses upon adoption, but cannot yet determine the exact amount of any such one-time adjustment, or the overall impact of the new guidance on the Company’s consolidated financial statements. Based on the current modeling results, we anticipate that the one-time cumulative effect adjustment will be less than five percent of total stockholders’ equity.
In addition, the Company considers that the determination of the valuations of foreclosed assets held for sale involves a high degree of judgment and complexity. The carrying value of foreclosed assets reflects management’s best estimate of the amount to be realized from the sales of the assets. While the estimate is generally based on a valuation by an independent appraiser or recent sales of similar properties, the amount that the Company realizes from the sales of the assets could differ materially from the carrying value reflected in the financial statements, resulting in losses that could adversely impact earnings in future periods.
Carrying Value of Loans Acquired in FDIC-assisted Transactions
The Company considers that the determination of the carrying value of loans acquired in the FDIC-assisted transactions involves a high degree of judgment and complexity. The carrying value of the acquired loans reflects management’s best ongoing estimates of the amounts to be realized on each of these assets. The Company has now terminated all loss sharing agreements with the FDIC and, accordingly, no longer has an indemnification asset. The Company determined initial fair value accounting estimates of the acquired assets and assumed liabilities in
accordance with FASB ASC 805, Business Combinations. However, the amount that the Company realizes on its acquired loan assets could differ materially from the carrying value reflected in its financial statements, based upon the timing of collections on the acquired loans in future periods. Subsequent to the initial valuation, the Company continues to monitor identified loan pools for changes in estimated cash flows projected for the loan pools, anticipated credit losses and changes in the accretable yield. Analysis of these variables requires significant estimates and a high degree of judgment. See Note 7 “FDIC-Acquired Loans” included in Item 1 for additional information regarding the TeamBank, Vantus Bank, Sun Security Bank, InterBank and Valley Bank FDIC-assisted transactions.
Goodwill and Intangible Assets
Goodwill and intangible assets that have indefinite useful lives are subject to an impairment test at least annually and more frequently if circumstances indicate their value may not be recoverable. Goodwill is tested for impairment using a process that estimates the fair value of each of the Company’s reporting units compared with its carrying value. The Company defines reporting units as a level below each of its operating segments for which there is discrete financial information that is regularly reviewed. As of June 30, 2019, the Company had one reporting unit to which goodwill has been allocated – the Bank. If the fair value of a reporting unit exceeds its carrying value, then no impairment is recorded. If the carrying value exceeds the fair value of a reporting unit, further testing is completed comparing the implied fair value of the reporting unit’s goodwill to its carrying value to measure the amount of impairment. Intangible assets that are not amortized must be tested for impairment at least annually by comparing the fair values of those assets to their carrying values. At June 30, 2019, goodwill consisted of $5.4 million at the Bank reporting unit, which included goodwill of $4.2 million that was recorded during 2016 related to the acquisition of 12 branches from Fifth Third Bank. Other identifiable intangible assets that are subject to amortization are amortized on a straight-line basis over a period of seven years. At June 30, 2019, the amortizable intangible assets consisted of core deposit intangibles of $3.3 million, which are reflected in the table below. These amortizable intangible assets are reviewed for impairment if circumstances indicate their value may not be recoverable based on a comparison of fair value.
While the Company believes no impairment of its goodwill or other intangible assets existed at June 30, 2019, different conditions or assumptions used to measure fair value of reporting units, or changes in cash flows or profitability, if significantly negative or unfavorable, could have a material adverse effect on the outcome of the Company’s impairment evaluation in the future.
A summary of goodwill and intangible assets is as follows:
| | | June 30,
2019 | | | December 31,
2018 | |
| | | (In Thousands) | |
| | | | | | | |
| Goodwill – Branch acquisitions | | $ | 5,396 | | | $ | 5,396 | |
| Deposit intangibles | | | | | | | | |
| InterBank | | | — | | | | 36 | |
| Boulevard Bank | | | 214 | | | | 275 | |
| Valley Bank | | | 800 | | | | 1,000 | |
| Fifth Third Bank | | | 2,265 | | | | 2,581 | |
| | | | 3,279 | | | | 3,892 | |
| | | $ | 8,675 | | | $ | 9,288 | |
Current Economic Conditions
Changes in economic conditions could cause the values of assets and liabilities recorded in the financial statements to change rapidly, resulting in material future adjustments in asset values, the allowance for loan losses, or capital that could negatively impact the Company’s ability to meet regulatory capital requirements and maintain sufficient liquidity.
Following the housing and mortgage crisis and correction beginning in mid-2007, the United States entered a prolonged economic downturn. Unemployment rose from 4.7% in November 2007 to peak at 10.0% in October 2009. The elevated unemployment levels negatively impacted consumer confidence, which had a detrimental impact on industry-wide performance nationally as well as in the Company's Midwest market area. Economic conditions have significantly improved since then, as indicated by consumer confidence levels, increased economic activity and low unemployment levels.
In June 2019, the economy broke the record for the longest period of economic growth in US history. After slower job growth reported in previous months pointed to an economic downturn, the job market increased sharply with 224,000 new jobs added in June. The national unemployment rate remained steady at 3.7% .The rate compares to a 4.0% rate at June 2018 and is still the lowest rate of unemployed Americans recorded since December 1969. Employment increases were primarily in business services and health care. In June 2019, the U.S. labor force participation rate (the share of working-age Americans who were either employed or are actively looking for a job) was 62.9% and the employment population ratio was 60.6%, with both ratios changing little over the past few months. The unemployment rate for the Midwest, where most of the Company’s business is conducted, remained stable and consistent with the national average at 3.7% in June 2019. Unemployment rates for June 2019 were: Missouri at 3.3%, Arkansas at 3.5%, Kansas at 3.4%, Iowa at 2.4%, Minnesota at 3.3%, Illinois at 4.3%, Oklahoma at 3.2%, Texas at 3.4%, Georgia at 3.7% and Colorado at 3.0%. Of the metropolitan areas in which the Company does business, the Chicago area had the highest unemployment level at 3.5% as of May 2019. This rate has improved significantly since the 4.9% rate reported as of December 2017. The unemployment rates for the Springfield and St. Louis market areas were at 2.7% and 3.1%, respectively, well below the national average. Metropolitan areas in Iowa, Missouri, Nebraska and Minnesota continued to boast unemployment levels amongst the lowest in the nation.
Sales of newly built single-family homes for June 2019 were at a seasonally adjusted annual rate of 646,000 according to U.S. Census Bureau and the Department of Housing and Urban Development estimates. This is 7% above the revised May 2019 seasonally adjusted annual rate of 604,000, and is 4.5% above the June 2018 seasonally adjusted annual rate of 618,000. The median sales price of new houses sold in June 2019 was $310,400, up from $302,100 a year earlier. The June 2019 average sales price of $368,600 was down slightly from $370,100 a year ago. The inventory of new homes for sale at the end of June would support 6.3 months’ supply at the current sales pace, down from 6.7 months in May 2019.
Existing-home sales weakened in June, as total sales saw a small decline after a previous month of gains, according to the National Association of Realtors (NAR). Total existing home sales decreased 1.7% from May to a seasonally adjusted rate of 5.27 million in June 2019. Sales as a whole are down 2.2% from a year ago. Total housing inventory at the end of June 2019 increased to 1.93 million, up slightly from 1.91 million existing homes available for sale in May 2019, but unchanged from the level of June 2018. Unsold inventory is at a 4.4-month supply at the current sales pace, up from a 4.3-month supply in both May and June 2018.
The median existing home price for all housing types in June 2019 reached an all-time high of $285,700, up 4.3% from June 2018. June’s price increase marks the 88th straight month of year-over-year gains. The Midwest region existing home median sale price was $230,400, which is up 6.7% from last year. First-time buyers accounted for 35% of sales in June 2019, up slightly from 32% the prior month and 31% a year ago.
According to Freddie Mac, the average commitment rate for a 30-year, conventional, fixed-rate mortgage decreased to 3.80% in June 2019, down from 4.07% in May 2019. The average commitment rate for all of 2018 was 4.54%, up from 3.99% for 2017.
The multi-family sector rebounded in 2017 and 2018, with demand approaching the highest level on record. National vacancy rates were 5.7% at the end of June 2019, while our market areas reflected the following vacancy levels: Springfield, Mo. at 4.6%, St. Louis at 8.3%, Kansas City at 6.6%, Minneapolis at 4.1%, Tulsa, Okla. at 8.9%, Dallas-Fort Worth at 7.7%, Chicago at 5.9%, Atlanta at 8.4% and Denver at 6.6%. Rent growth picked up in recent months and demand has increased at a steady rate supported by the strong economy. Vacancy rates have increased in Tulsa, St. Louis and Dallas due to an increased number of units coming on-line. Developers continue to favor more-expensive submarkets. Transaction volume has slowed, but pricing has remained on an upward trajectory. Cap rates are still at low levels. Continued increase in the homeownership rate is the largest risk to the apartment sector. Despite the decline in affordability and rigid mortgage origination standards, about two-thirds of consumers
still believe now is a good time to buy a home, according to a recent University of Michigan consumer survey. The homeownership rate has risen by more than a percentage point since 2016, to 64.2% in 2019. Per information provided by Integra IRR Viewpoint, all of the Company’s market areas within the multi-family sector are in expansion phase with the exception of Denver and Atlanta, which are both currently in a hyper-supply phase.
Per Integra, nationally, approximately 45% of the suburban office markets are in an expansion market cycle -- characterized by decreasing vacancy rates, moderate/high new construction, high absorption, moderate/high employment growth and medium/high rental rate growth. Signs of late-cycle conditions are spreading in 2019. Both central business district and suburban markets are being categorized as either in recession or in hyper-supply by about one in 10 market respondents. So while most markets are in recovery or expansion, they tilt toward risk in the coming years. The Company’s larger market areas in the suburban office expansion market cycle include Minneapolis, Dallas-Ft. Worth, and St. Louis. Tulsa, Okla. and Kansas City are currently in the recovery/expansion market cycle -- typified by decreasing vacancy rates, low new construction, moderate absorption, low/moderate employment growth and negative/low rental rate growth. Chicago is currently in a recession market cycle typified by increasing vacancies, low absorption and low new construction while Denver is in hyper-supply.
Approximately 70% of the retail sector is in the expansion phase of the market cycle, with another 20% in recovery mode and the remaining 10% in hyper-supply and recession. The Company’s larger market areas included in the retail expansion market segment, are Chicago, Denver, Minneapolis, Kansas City, Dallas-Ft. Worth, and St. Louis, with Chicago and Minneapolis nearing hyper-supply. The Atlanta and Tulsa markets are each in recovery phase.
The industrial segment, once concentrated in manufacturing, is now epitomized by a dense network of warehousing, distribution, logistics, and R&D/Flex properties which is the conduit of the current global e-commerce revolution. All of the Company’s larger industrial market areas are categorized as being in the expansion cycle with prospects of continuing good economic growth. Two market areas, Chicago and Kansas City, are in the latter stages of the expansion cycle.
Occupancy, absorption and rental income levels of commercial real estate properties located throughout the Company’s market areas remain stable according to information provided by real estate services firm CoStar Group. Moderate real estate sales and financing activity is continuing to support loan growth.
While current economic indicators show stability nationally in employment, housing starts and prices, commercial real estate occupancy, absorption and rental rates, our management will continue to closely monitor regional, national and global economic conditions, as these could significantly impact our market areas.
The profitability of the Company and, more specifically, the profitability of its principal subsidiary, the Bank, depends primarily on its net interest income, as well as provisions for loan losses and the level of non-interest income and non-interest expense. Net interest income is the difference between the interest income the Bank earns on its loan and investment portfolios, and the interest it pays on interest-bearing liabilities, which consists mainly of interest paid on deposits and borrowings. Net interest income is affected by the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on these balances. When interest-earning assets approximate or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income.
Great Southern's total assets increased $195.3 million, or 4.2%, from $4.68 billion at December 31, 2018, to $4.87 billion at June 30, 2019. Full details of the current period changes in total assets are provided in the “Comparison of Financial Condition at June 30, 2019 and December 31, 2018” section of this Quarterly Report on Form 10-Q.
Loans. Net outstanding loans increased $123.5 million, or 3.1%, from $3.99 billion at December 31, 2018, to $4.11 billion at June 30, 2019. Included in the net increase in loans were reductions of $16.0 million in the FDIC-acquired loan portfolios. Increases primarily occurred in commercial construction loans, commercial real estate loans, one-to four-family residential mortgage loans and other residential (multi-family) loans. These increases were partially offset by decreases in consumer auto loans. The increases were primarily due to loan growth in our existing banking center network and our commercial loan production offices. Excluding FDIC-assisted acquired loans and mortgage
loans held for sale, total gross loans increased $42.2 million from December 31, 2018 to June 30, 2019. As loan demand is affected by a variety of factors, including general economic conditions, and because of the competition we face and our focus on pricing discipline and credit quality, no assurances can be made regarding our future loan growth. The Company's strategy continues to be focused on maintaining credit risk and interest rate risk at appropriate levels.
Recent loan growth has occurred in several loan types, primarily commercial construction loans, commercial real estate loans, other residential (multi-family) loans and one- to four-family residential mortgage loans and in most of Great Southern’s primary lending locations, including Springfield, St. Louis, Kansas City, Des Moines and Minneapolis, as well as the loan production offices in Chicago, Dallas, Omaha and Tulsa, and offices added recently in Atlanta and Denver. Certain minimum underwriting standards and monitoring help assure the Company’s portfolio quality. Great Southern’s loan committee reviews and approves all new loan originations in excess of lender approval authorities. Generally, the Company considers commercial construction, consumer, and commercial real estate loans to involve a higher degree of risk compared to some other types of loans, such as first mortgage loans on one- to four-family, owner-occupied residential properties. For commercial real estate, commercial business and construction loans, the credits are subject to an analysis of the borrower’s and guarantor’s financial condition, credit history, verification of liquid assets, collateral, market analysis and repayment ability. It has been, and continues to be, Great Southern’s practice to verify information from potential borrowers regarding assets, income or payment ability and credit ratings as applicable and as required by the authority approving the loan. To minimize construction risk, projects are monitored as construction draws are requested by comparison to budget and with progress verified through property inspections. The geographic and product diversity of collateral, equity requirements and limitations on speculative construction projects help to mitigate overall risk in these loans. Underwriting standards for all loans also include loan-to-value ratio limitations, which vary depending on collateral type, debt service coverage ratios or debt payment to income ratio guidelines, where applicable, credit histories, use of guaranties and other recommended terms relating to equity requirements, amortization, and maturity. Consumer loans are primarily secured by new and used motor vehicles and these loans are also subject to certain minimum underwriting standards to assure portfolio quality. While Great Southern’s consumer underwriting and pricing standards have been fairly consistent since 2016, the Company tightened its underwriting guidelines on automobile lending beginning in the latter part of 2016. Management took this step in an effort to improve credit quality in the portfolio and reduce delinquencies and charge-offs. The underwriting standards employed by Great Southern for consumer loans include a determination of the applicant's payment history on other debts, credit scores, employment history and an assessment of ability to meet existing obligations and payments on the proposed loan. In 2019, the Company discontinued indirect auto loan originations. See “Item 1. Business – Lending Activities – General, – Commercial Real Estate and Construction Lending, and – Consumer Lending” in the Company’s December 31, 2018 Annual Report on Form 10-K.
While our policy allows us to lend up to 95% of the appraised value on one-to four-family residential properties, originations of loans with loan-to-value ratios at that level are minimal. Private mortgage insurance is typically required for loan amounts above the 80% level. Few exceptions occur and would be based on analyses which determined minimal transactional risk to be involved. We consider these lending practices to be consistent with or more conservative than what we believe to be the norm for banks our size. At each of June 30, 2019 and December 31, 2018, an estimated 0.1% of total owner occupied one- to four-family residential loans had loan-to-value ratios above 100% at origination. At each of June 30, 2019 and December 31, 2018, an estimated 0.9% of total non-owner occupied one- to four-family residential loans had loan-to-value ratios above 100% at origination.
At June 30, 2019, troubled debt restructurings totaled $2.0 million, or less than 0.1% of total loans, down $4.9 million from $6.9 million, or 0.2% of total loans, at December 31, 2018. Concessions granted to borrowers experiencing financial difficulties may include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. For troubled debt restructurings occurring during the six months ended June 30, 2019, no loans were restructured into multiple new loans. For troubled debt restructurings occurring during the year ended December 31, 2018, five loans totaling $31,000 were restructured into multiple new loans. For further information on troubled debt restructurings, see Note 6 of the Notes to Consolidated Financial Statements contained in this report.
Loans that were acquired through FDIC-assisted transactions, which are accounted for in pools, are currently included in the analysis and estimation of the allowance for loan losses. If expected cash flows to be received on any given pool of loans decreases from previous estimates, then a determination is made as to whether the loan pool should be charged down or the allowance for loan losses should be increased (through a provision for loan losses). Acquired loans are described in Note 7 of the Notes to Consolidated Financial Statements contained in this report. For acquired loan pools, the Company may allocate, and at June 30, 2019, has allocated, a portion of its allowance for loan losses related to these loan pools in a manner similar to how it allocates its allowance for loan losses to those loans which are collectively evaluated for impairment.
The level of non-performing loans and foreclosed assets affects our net interest income and net income. We generally do not accrue interest income on these loans and do not recognize interest income until the loans are repaid or interest payments have been made for a period of time sufficient to provide evidence of performance on the loans. Generally, the higher the level of non-performing assets, the greater the negative impact on interest income and net income.
Available-for-sale Securities. In the six months ended June 30, 2019, available-for-sale securities increased $61.7 million, or 25.3%, from $244.0 million at December 31, 2018, to $305.6 million at June 30, 2019. The increase was primarily due to the purchase of FNMA and GNMA fixed-rate multi-family mortgage-backed securities, partially offset by calls of municipal securities and normal monthly payments received related to the portfolio of mortgage-backed securities. The Company used increased deposits and short-term borrowings to fund this increase in investment securities. The addition of these securities is a component of the Company’s asset/liability management strategy to partially mitigate risk from falling interest rates.
Deposits. The Company attracts deposit accounts through its retail branch network, correspondent banking and corporate services areas, and brokered deposits. The Company then utilizes these deposit funds, along with FHLBank advances and other borrowings, to meet loan demand or otherwise fund its activities. In the six months ended June 30, 2019, total deposit balances increased $163.5 million, or 4.4%. Transaction account balances increased $24.0 million to $2.16 billion at June 30, 2019, while retail certificates of deposit increased $96.5 million, to $1.36 billion at June 30, 2019. The increases in transaction accounts were primarily a result of increases in money market and NOW deposit accounts. Retail certificates of deposit increased due to an increase in certificates opened through the Company’s internet deposit acquisition channels. In addition, at June 30, 2019 and December 31, 2018, customer deposits totaling $30.9 million and $27.9 million, respectively, were part of the CDARS program, which allows customers to maintain balances in an insured manner that would otherwise exceed the FDIC deposit insurance limit. Brokered deposits, including CDARS program purchased funds, were $369.9 million at June 30, 2019, an increase of $43.0 million from $326.9 million at December 31, 2018.
Our deposit balances may fluctuate depending on customer preferences and our relative need for funding. We do not consider our retail certificates of deposit to be guaranteed long-term funding because customers can withdraw their funds at any time with minimal interest penalty. When loan demand trends upward, we can increase rates paid on deposits to increase deposit balances and utilize brokered deposits to provide additional funding. The level of competition for deposits in our markets is high. It is our goal to gain deposit market share, particularly checking accounts, in our branch footprint. To accomplish this goal, increasing rates to attract deposits may be necessary, which could negatively impact the Company’s net interest margin.
Our ability to fund growth in future periods may also depend on our ability to continue to access brokered deposits and FHLBank advances. In times when our loan demand has outpaced our generation of new deposits, we have utilized brokered deposits and FHLBank advances to fund these loans. These funding sources have been attractive to us because we can create either fixed or variable rate funding, as desired, which more closely matches the interest rate nature of much of our loan portfolio. While we do not currently anticipate that our ability to access these sources will be reduced or eliminated in future periods, if this should happen, the limitation on our ability to fund additional loans could have a material adverse effect on our business, financial condition and results of operations.
Federal Home Loan Bank Advances and Short Term Borrowings. The Company’s Federal Home Loan Bank advances totaled $-0- at both June 30, 2019 and December 31, 2018. At both June 30, 2019 and December 31, 2018, there were no borrowings from the FHLBank, other than overnight advances which are included in the short term borrowings category.
Short term borrowings and other interest-bearing liabilities decreased $24.1 million from $192.7 million at December 31, 2018 to $168.6 million at June 30, 2019. The short term borrowings included overnight FHLBank borrowings of $136.5 million and $178.0 million at June 30, 2019 and December 31, 2018, respectively. The Company utilizes both overnight borrowings and short-term FHLBank advances depending on relative interest rates.
Net Interest Income and Interest Rate Risk Management. Our net interest income may be affected positively or negatively by changes in market interest rates. A large portion of our loan portfolio is tied to one-month LIBOR, three-month LIBOR or the "prime rate" and adjusts immediately or shortly after the index rate adjusts (subject to the effect of contractual interest rate floors on some of the loans). We monitor our sensitivity to interest rate changes on an ongoing basis (see "Item 3. Quantitative and Qualitative Disclosures About Market Risk"). In addition, our net interest income may be impacted by changes in the cash flows expected to be received from acquired loan pools. As described in Note 7 of the Notes to the Consolidated Financial Statements contained in this report, the Company’s evaluation of cash flows expected to be received from acquired loan pools is on-going and increases in cash flow expectations are recognized as increases in accretable yield through interest income. Decreases in cash flow expectations are recognized as impairments through the allowance for loan losses.
The current level and shape of the interest rate yield curve poses challenges for interest rate risk management. Prior to its increase of 0.25% on December 16, 2015, the FRB had last changed interest rates on December 16, 2008. This was the first rate increase since September 29, 2006. The FRB has now also implemented rate increases of 0.25% on eight different occasions beginning December 14, 2016, with the Federal Funds rate now at 2.50%. A substantial portion of Great Southern’s loan portfolio ($1.59 billion at June 30, 2019) is tied to the one-month or three-month LIBOR index and will be subject to adjustment at least once within 90 days after June 30, 2019. Of these loans, $1.54 billion had interest rate floors. Great Southern also has a significant portfolio of loans ($241 million at June 30, 2019) tied to a "prime rate" of interest and will adjust immediately with changes to the “prime rate” of interest. But for the interest rate floors, a rate cut by the FRB generally would have an anticipated immediate negative impact on the Company’s net interest income due to the large total balance of loans which generally adjust immediately as the Federal Funds rate adjusts. Loans at their floor rates are, however, subject to the risk that borrowers will seek to refinance elsewhere at the lower market rate. Because the Federal Funds rate is still generally low, there may also be a negative impact on the Company's net interest income due to the Company's inability to significantly lower its funding costs in the current competitive rate environment, although interest rates on assets may decline further. Conversely, interest rate increases would normally result in increased interest rates on our LIBOR-based and prime-based loans. As of June 30, 2019, Great Southern's interest rate risk models indicate that, generally, rising interest rates are expected to have a positive impact on the Company's net interest income, while declining interest rates are expected to have a negative impact on net interest income. We model various interest rate scenarios for rising and falling rates, including both parallel and non-parallel shifts in rates. The results of our modeling indicate that net interest income is not likely to be materially affected either positively or negatively in the first twelve months following a rate change, regardless of any changes in interest rates, because our portfolios are relatively well matched in a twelve-month horizon. The effects of interest rate changes, if any, on net interest income are expected to be greater in the 12 to 36 months following a rate change. For further discussion of the processes used to manage our exposure to interest rate risk, see “Item 3. Quantitative and Qualitative Disclosures About Market Risk – How We Measure the Risks to Us Associated with Interest Rate Changes.”
Non-Interest Income and Non-Interest (Operating) Expenses. The Company's profitability is also affected by the level of its non-interest income and operating expenses. Non-interest income consists primarily of service charges and ATM fees, late charges and prepayment fees on loans, gains on sales of loans and available-for-sale investments and other general operating income. Non-interest income may also be affected by the Company's interest rate derivative activities, if the Company chooses to implement derivatives. See Note 16 “Derivatives and Hedging Activities” in the Notes to Consolidated Financial Statements included in this report.
Operating expenses consist primarily of salaries and employee benefits, occupancy-related expenses, expenses related to foreclosed assets, postage, FDIC deposit insurance, advertising and public relations, telephone, professional fees, office expenses and other general operating expenses. Details of the current period changes in non-interest income and non-interest expense are provided in the “Results of Operations and Comparison for the Three and Six Months Ended June 30, 2019 and 2018” section of this report.
Effect of Federal Laws and Regulations
General. Federal legislation and regulation significantly affect the operations of the Company and the Bank, and have increased competition among commercial banks, savings institutions, mortgage banking enterprises and other financial institutions. In particular, the capital requirements and operations of regulated banking organizations such as the Company and the Bank have been and will be subject to changes in applicable statutes and regulations from time to time, which changes could, under certain circumstances, adversely affect the Company or the Bank.
Dodd-Frank Act. On July 21, 2010, sweeping financial regulatory reform legislation entitled the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act implements far-reaching changes across the financial regulatory landscape, including provisions that, among other things, centralize responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, with broad rulemaking authority for a wide range of consumer protection laws that apply to all banks, require new capital rules (discussed below), change the assessment base for federal deposit insurance, repeal the federal prohibitions on the payment of interest on demand deposits, amend the account balance limit for federal deposit insurance protection, and increase the authority of the FRB to examine the Company and its non-bank subsidiaries.
Certain aspects of the Dodd-Frank Act remain subject to rulemaking and take effect over a number of years. Provisions in the legislation that affect deposit insurance assessments and payment of interest on demand deposits could increase the costs associated with deposits. Provisions in the legislation that require revisions to the capital requirements of the Company and the Bank could require the Company and the Bank to seek additional sources of capital in the future.
A provision of the Dodd-Frank Act, commonly referred to as the “Durbin Amendment,” directed the FRB to analyze the debit card payments system and fix the interchange rates based upon their estimate of actual costs. The FRB has established the interchange rate for all debit transactions for issuers with over $10 billion in assets at $0.21 per transaction. An additional five basis points of the transaction amount and an additional $0.01 may be collected by the issuer for fraud prevention and recovery, provided the issuer performs certain actions. The Bank is currently exempt from the rule on the basis of asset size.
Certain aspects of the Dodd-Frank Act have been affected by the EGRRCP Act, as defined and discussed below under “-EGRRCP Act.”
Capital Rules. The federal banking agencies have adopted regulatory capital rules that substantially amend the risk-based capital rules applicable to the Bank and the Company. The rules implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. “Basel III” refers to various documents released by the Basel Committee on Banking Supervision. For the Company and the Bank, the general effective date of the new rules was January 1, 2015, and, for certain provisions, various phase-in periods and later effective dates apply. The chief features of the new rules are summarized below.
The rules refine the definitions of what constitutes regulatory capital and add a new regulatory capital element, common equity Tier 1 capital. The minimum capital ratios are (i) a common equity Tier 1 (“CET1”) risk-based capital ratio of 4.5%; (ii) a Tier 1 risk-based capital ratio of 6%; (iii) a total risk-based capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. In addition to the minimum capital ratios, the new rules include a capital conservation buffer, under which a banking organization must have CET1 more than 2.5% above each of its minimum risk-based capital ratios in order to avoid restrictions on paying dividends, repurchasing shares, and paying certain discretionary bonuses. The capital conservation buffer requirement began phasing in on January 1, 2016 when a buffer greater than 0.625% of risk-weighted assets was required, which amount increased an equal amount each year until the buffer requirement of greater than 2.5% of risk-weighted assets became fully implemented on January 1, 2019.
Effective January 1, 2015, these rules also revised the prompt corrective action framework, which is designed to place restrictions on insured depository institutions if their capital levels show signs of weakness. Under the prompt corrective action requirements, insured depository institutions are required to meet the following in order to qualify
as “well capitalized:” (i) a common equity Tier 1 risk-based capital ratio of at least 6.5%, (ii) a Tier 1 risk-based capital ratio of at least 8%, (iii) a total risk-based capital ratio of at least 10% and (iv) a Tier 1 leverage ratio of 5%, and must not be subject to an order, agreement or directive mandating a specific capital level.
EGRRCP Act. In May 2018 the Economic Growth, Regulatory Relief and Consumer Protection Act (the “EGRRCCP Act”), was enacted to modify or remove certain financial reform rules and regulations, including some of those implemented under the Dodd-Frank Act. While the EGRRCP Act maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain aspects of the regulatory framework for depository institutions with assets of less than $10 billion and for banks with assets of more than $50 billion. Many of these changes could result in meaningful regulatory relief for community banks such as Great Southern.
The EGRRCP Act, among other matters, expands the definition of qualified mortgages that may be held by a financial institution and simplifies the regulatory capital rules for financial institutions and their holding companies with total consolidated assets of less than $10 billion by instructing the federal banking regulators to establish a single “Community Bank Leverage Ratio” of between 8 and 10 percent. Any qualifying depository institution or its holding company that exceeds the “community bank leverage ratio” will be considered to have met generally applicable leverage and risk-based regulatory capital requirements and any qualifying depository institution that exceeds the new ratio will be considered to be “well capitalized” under the prompt corrective action rules. In addition, the EGRRCP Act includes regulatory relief for community banks regarding regulatory examination cycles, call reports, the Volcker Rule (proprietary trading prohibitions), mortgage disclosures and risk weights for certain high-risk commercial real estate loans.
It is difficult at this time to predict when or how any new standards under the EGRRCP Act will ultimately be applied to the Company and the Bank or what specific impact the EGRRCP Act and the yet-to-be-written implementing rules and regulations will have on community banks.
Business Initiatives
The Company’s retail banking center network continues to evolve. In April 2019, the Company consolidated its Fayetteville, Ark., location into its Rogers, Ark., banking center. The Fayetteville office opened in 2014 and did not meet performance expectations. The Company now operates one banking center in Arkansas.
In addition, the Company announced plans to consolidate its Ames, Iowa, banking center into its North Ankeny, Iowa, office in September 2019. The Company entered the Ames market through an FDIC-assisted acquisition in 2014, and currently operates this one office in the Ames market.
Comparison of Financial Condition at June 30, 2019 and December 31, 2018
During the six months ended June 30, 2019, the Company’s total assets increased by $195.3 million to $4.87 billion. The increase was primarily attributable to an increase in loans receivable and available-for-sale investment securities.
Cash and cash equivalents were $181.4 million at June 30, 2019, a decrease of $21.4 million, or 10.5%, from $202.7 million at December 31, 2018.
The Company's available-for-sale securities increased $61.7 million, or 25.3%, compared to December 31, 2018. The increase was primarily due to the purchase of FNMA and GNMA fixed-rate multi-family mortgage-backed securities, partially offset by calls of municipal securities and normal monthly payments received related to the portfolio of mortgage-backed securities. The available-for-sale securities portfolio was 6.3% and 5.2% of total assets at June 30, 2019 and December 31, 2018, respectively.
Net loans increased $123.5 million from December 31, 2018, to $4.11 billion at June 30, 2019. Excluding FDIC-assisted acquired loans and mortgage loans held for sale, total gross loans (including the undisbursed portion of loans) increased $42.2 million, or 0.9%, from December 31, 2018 to June 30, 2019. Increases in outstanding loan totals primarily occurred in commercial construction loans, commercial real estate loans, other residential (multi-family) loans and one- to four-family residential mortgage loans. Partially offsetting the increases in these loans were reductions of $52 million in consumer auto loans and $16 million in the FDIC-acquired loan portfolios.
Other real estate owned and repossessions were $7.1 million at June 30, 2019, a decrease of $1.3 million, or 15.8%, from $8.4 million at December 31, 2018. Activity in other real estate owned and repossessions during the period is discussed in more detail in the Non-performing Assets section below.
Premises and equipment totaled $143.5 million at June 30, 2019, an increase of $11.0 million, or 8.3%, from $132.4 million at December 31, 2018. This increase is primarily related to the recording of a right-of-use asset for leased premises and assets under the new lease accounting standard adopted January 1, 2019. The right-of-use asset totaled $9.1 million at June 30, 2019.
Total liabilities increased $155.0 million, from $4.14 billion at December 31, 2018 to $4.30 billion at June 30, 2019. The increase was primarily attributable to an increase in deposits, partially offset by a decrease in short-term borrowings and securities sold under reverse repurchase agreements with customers.
Total deposits increased $163.5 million, or 4.4%, to $3.89 billion at June 30, 2019. Transaction account balances increased $24.0 million to $2.16 billion at June 30, 2019, while retail certificates of deposit increased $96.5 million compared to December 31, 2018, to $1.36 billion at June 30, 2019. The increase in transaction accounts was primarily a result of increases in money market and NOW deposit accounts. Retail certificates of deposit increased due to an increase in certificates opened through the Company’s internet deposit acquisition channels. In addition, at June 30, 2019 and December 31, 2018, customer deposits totaling $30.9 million and $27.9 million, respectively, were part of the CDARS program, which allows customers to maintain balances in an insured manner that would otherwise exceed the FDIC deposit insurance limit. Brokered deposits, including CDARS program purchased funds, were $369.9 million at June 30, 2019, an increase of $43.0 million from $326.9 million at December 31, 2018.
The Company’s FHLBank advances totaled $-0- at both June 30, 2019 and December 31, 2018. At both June 30, 2019 and December 31, 2018, there were no borrowings from the FHLBank, other than overnight advances, which are included in the short term borrowings category.
Short term borrowings and other interest-bearing liabilities decreased $24.1 million from $192.7 million at December 31, 2018 to $168.6 million at June 30, 2019. Short term borrowings at June 30, 2019 and December 31, 2018, included overnight FHLBank borrowings of $136.5 million and $178.0 million, respectively. The Company utilizes both overnight borrowings and short-term FHLBank advances depending on relative interest rates.
Securities sold under reverse repurchase agreements with customers decreased $6.7 million from $105.3 million at December 31, 2018 to $98.6 million at June 30, 2019. These balances fluctuate over time based on customer demand for this product.
Total stockholders' equity increased $40.3 million from $532.0 million at December 31, 2018 to $572.3 million at June 30, 2019. The Company recorded net income of $36.0 million for the six months ended June 30, 2019, and dividends declared on common stock were $19.7 million. Accumulated other comprehensive income increased $22.5 million due to increases in the fair value of available-for-sale investment securities and the fair value of cash flow hedges. In addition, total stockholders’ equity increased $2.4 million due to stock option exercises. These increases were partially offset by repurchases of the Company’s common stock totaling $849,000.
Results of Operations and Comparison for the Three and Six Months Ended June 30, 2019 and 2018
General
Net income was $18.4 million for the three months ended June 30, 2019 compared to $13.8 million for the three months ended June 30, 2018. This increase of $4.6 million, or 32.8%, was primarily due to an increase in net interest income of $3.7 million, or 9.0%, a decrease in non-interest expense of $1.5 million, or 5.1%, and a decrease in provision for loan losses of $350,000, or 17.9%, partially offset by an increase in income tax expense of $753,000, or 25.4%, and a decrease in non-interest income of $302,000, or 4.0%.
Net income was $36.0 million for the six months ended June 30, 2019 compared to $27.3 million for the six months ended June 30, 2018. This increase of $8.7 million, or 31.8%, was primarily due to an increase in net interest income of $8.9 million, or 11.0%, a decrease in non-interest expense of $1.4 million, or 2.3%, a decrease in provision for loan losses of $350,000, or 9.0%, and an increase in non-interest income of $213,000, or 1.5%, partially offset by an increase in income tax expense of $2.1 million, or 37.5%.
Total Interest Income
Total interest income increased $8.8 million, or 17.6%, during the three months ended June 30, 2019 compared to the three months ended June 30, 2018. The increase was due to a $7.6 million increase in interest income on loans and a $1.2 million increase in interest income on investments and other interest-earning assets. Interest income on loans increased for the three months ended June 30, 2019 compared to the same period in 2018, due to higher average rates of interest on loans and higher average balances. Interest income from investment securities and other interest-earning assets increased during the three months ended June 30, 2019 compared to the same period in 2018 due to higher average rates of interest and higher average balances of investment securities.
Total interest income increased $19.3 million, or 19.9%, during the six months ended June 30, 2019 compared to the six months ended June 30, 2018. The increase was due to a $16.9 million increase in interest income on loans and a $2.4 million increase in interest income on investments and other interest-earning assets. Interest income on loans increased for the six months ended June 30, 2019 compared to the same period in 2018, due to higher average rates of interest on loans and higher average balances. Interest income from investment securities and other interest-earning assets increased during the six months ended June 30, 2019 compared to the same period in 2018 due to higher average rates of interest and higher average balances of investment securities.
Interest Income – Loans
During the three months ended June 30, 2019 compared to the three months ended June 30, 2018, interest income on loans increased $4.3 million as a result of higher average interest rates on loans. The average yield on loans increased from 4.97% during the three months ended June 30, 2018, to 5.40% during the three months ended June 30, 2019. This increase was primarily due to increased yields in most loan categories as a result of increased LIBOR and Federal Funds interest rates. Interest income on loans increased $3.3 million as the result of higher average loan balances, which increased from $3.89 billion during the three months ended June 30, 2018, to $4.14 billion during the three months ended June 30, 2019. The higher average balances were primarily due to organic loan growth in commercial construction loans, commercial real estate loans, one- to four-family residential loans and other residential (multi-family) loans, partially offset by decreases in consumer loans and commercial business loans.
During the six months ended June 30, 2019 compared to the six months ended June 30, 2018, interest income on loans increased $10.0 million as a result of higher average interest rates on loans. The average yield on loans increased from 4.91% during the six months ended June 30, 2018, to 5.41% during the six months ended June 30, 2019. This increase was primarily due to increased yields in most loan categories as a result of increased LIBOR and Federal Funds interest rates. Interest income on loans increased $6.9 million as the result of higher average loan balances, which increased from $3.84 billion during the six months ended June 30, 2018, to $4.11 billion during the six months ended June 30, 2019. The higher average balances were primarily due to organic loan growth in commercial construction loans, commercial real estate loans, one- to four-family residential loans and other residential (multi-family) loans, partially offset by decreases in consumer loans and commercial business loans.
On an on-going basis, the Company estimates the cash flows expected to be collected from the acquired loan pools. For each of the loan portfolios acquired, the cash flow estimates have increased, based on the payment histories and the collection of certain loans, thereby reducing loss expectations of certain loan pools, resulting in adjustments to be spread on a level-yield basis over the remaining expected lives of the loan pools. For the three months ended June 30, 2019 and 2018, the adjustments increased interest income by $1.4 million and $1.1 million, respectively. For the six months ended June 30, 2019 and 2018, the adjustments increased interest income by $2.9 million and $2.2 million, respectively.
As of June 30, 2019, the remaining accretable yield adjustment that will affect interest income is $5.1 million. Of the remaining adjustments affecting interest income, we expect to recognize $2.0 million of interest income during the remainder of 2019. Additional adjustments may be recorded in future periods from the FDIC-assisted transactions, as the Company continues to estimate expected cash flows from the acquired loan pools. Apart from the yield accretion, the average yield on loans was 5.27% during the three months ended June 30, 2019, compared to 4.86% during the three months ended June 30, 2018, as a result of higher current market rates on adjustable rate loans and new loans originated during the year. Apart from the yield accretion, the average yield on loans was 5.27% during the six months ended June 30, 2019, compared to 4.79% during the six months ended June 30, 2018.
In October 2018, the Company entered into an interest rate swap transaction as part of its ongoing interest rate management strategies to hedge the risk of its floating rate loans. The notional amount of the swap is $400 million with a termination date in October 2025. Under the terms of the swap, the Company receives a fixed rate of interest of 3.018% and pays a floating rate of interest equal to one-month USD-LIBOR. The floating rate resets monthly and net settlements of interest due to/from the counterparty also occur monthly. To the extent that the fixed rate continues to exceed one-month USD-LIBOR, the Company will receive net interest settlements, which will be recorded as loan interest income. If one-month USD-LIBOR exceeds the fixed rate of interest in future periods, the Company will be required to pay net settlements to the counterparty and will record those net payments as a reduction of interest income on loans. The Company recorded loan interest income related to this swap transaction of $568,000 and $1.1 million, respectively, in the three and six months ended June 30, 2019.
Interest Income – Investments and Other Interest-earning Assets
Interest income on investments increased in the three months ended June 30, 2019 compared to the three months ended June 30, 2018. Interest income increased $921,000 as a result of an increase in average balances from $188.6 million during the three months ended June 30, 2018, to $309.2 million during the three months ended June 30, 2019. Average balances of securities increased primarily due to purchases of agency multi-family mortgage-backed securities which have a fixed rate of interest with expected lives of six to ten years. These purchased securities fit with the Company’s current asset/liability management strategies. Interest income increased $203,000 due to an increase in average interest rates from 2.75% during the three months ended June 30, 2018, to 3.13% during the three months ended June 30, 2019, primarily due to higher market rates of interest on investment securities and a decrease in the volume of prepayments on mortgage-backed securities.
Interest income on investments increased in the six months ended June 30, 2019 compared to the six months ended June 30, 2018. Interest income increased $1.6 million as a result of an increase in average balances from $187.8 million during the six months ended June 30, 2018, to $293.9 million during the six months ended June 30, 2019. Average balances of securities increased primarily due to purchases of agency multi-family mortgage-backed securities which have a fixed rate of interest with expected lives of six to ten years. These purchased securities fit with the Company’s current asset/liability management strategies. Interest income increased $424,000 due to an increase in average interest rates from 2.79% during the six months ended June 30, 2018, to 3.20% during the six months ended June 30, 2019, primarily due to higher market rates of interest on investment securities and a decrease in the volume of prepayments on mortgage-backed securities.
Interest income on other interest-earning assets increased in the three months ended June 30, 2019 compared to the three months ended June 30, 2018. Interest income increased $169,000 due to an increase in average interest rates from 1.44% during the three months ended June 30, 2018, to 2.45% during the three months ended June 30, 2019, primarily due to higher market rates of interest on other interest-bearing deposits in financial institutions. Partially offsetting that increase, interest income decreased $65,000 as a result of a decrease in average balances from $120.7 million during the three months ended June 30, 2018, to $88.0 million during the three months ended June 30, 2019, primarily due to lower excess funds maintained in other interest-bearing deposits in financial institutions.
Interest income on other interest-earning assets increased in the six months ended June 30, 2019 compared to the six months ended June 30, 2018. Interest income increased $355,000 due to an increase in average interest rates from 1.54% during the six months ended June 30, 2018, to 2.41% during the six months ended June 30, 2019, primarily due to higher market rates of interest on other interest-bearing deposits in financial institutions. Partially offsetting that increase, interest income decreased $108,000 as a result of a decrease in average balances from $109.9 million during the six months ended June 30, 2018, to $91.2 million during the six months ended June 30, 2019, primarily due to lower excess funds maintained in other interest-bearing deposits in financial institutions .
Total Interest Expense
Total interest expense increased $5.1 million, or 58.1%, during the three months ended June 30, 2019, when compared with the three months ended June 30, 2018, due to an increase in interest expense on deposits of $5.5 million, or 89.2%, an increase in interest expense on short-term borrowing and repurchase agreements of $679,000, or 377.2%, an increase in interest expense on subordinated debentures issued to capital trust of $29,000, or 12.2%, and an increase in interest expense on subordinated notes of $70,000, or 6.8%, partially offset by a decrease in interest expense on FHLBank advances of $1.2 million, or 100.0%.
Total interest expense increased $10.4 million, or 64.2%, during the six months ended June 30, 2019, when compared with the six months ended June 30, 2018, due to an increase in interest expense on deposits of $10.3 million, or 88.4%, an increase in interest expense on short-term borrowing and repurchase agreements of $1.6 million, or 755.8%, an increase in interest expense on subordinated debentures issued to capital trust of $94,000, or 21.4%, and an increase in interest expense on subordinated notes of $140,000, or 6.8%, partially offset by a decrease in interest expense on FHLBank advances of $1.8 million, or 100.0%.
Interest Expense – Deposits
Interest expense on demand deposits increased $560,000 due to average rates of interest that increased from 0.37% in the three months ended June 30, 2018 to 0.52% in the three months ended June 30, 2019. Partially offsetting that increase, interest expense on demand deposits decreased $65,000, due to a decrease in average balances from $1.57 billion during the three months ended June 30, 2018 to $1.50 billion during the three months ended June 30, 2019.
Interest expense on demand deposits increased $1.1 million due to average rates of interest that increased from 0.35% in the six months ended June 30, 2018 to 0.50% in the six months ended June 30, 2019. Partially offsetting that increase, interest expense on demand deposits decreased $137,000, due to a decrease in average balances from $1.57 billion during the six months ended June 30, 2018 to $1.49 billion during the six months ended June 30, 2019.
Interest expense on time deposits increased $3.0 million as a result of an increase in average rates of interest from 1.46% during the three months ended June 30, 2018, to 2.23% during the three months ended June 30, 2019. Interest expense on time deposits increased $2.0 million due to an increase in average balances of time deposits from $1.28 billion during the three months ended June 30, 2018, to $1.73 billion during the three months ended June 30, 2019. A large portion of the Company’s certificate of deposit portfolio matures within six to eighteen months and therefore reprices fairly quickly; this is consistent with the portfolio over the past several years. Older certificates of deposit that renewed or were replaced with new deposits generally resulted in the Company paying a higher rate of interest due to market interest rate increases during 2018 and 2019. The increase in average balances of time deposits was a result of increases in both retail customer time deposits and in brokered deposits added through the CDARS program purchased funds.
Interest expense on time deposits increased $6.2 million as a result of an increase in average rates of interest from 1.38% during the six months ended June 30, 2018, to 2.17% during the six months ended June 30, 2019. Interest expense on time deposits increased $3.2 million due to an increase in average balances of time deposits from $1.31 billion during the six months ended June 30, 2018, to $1.70 billion during the six months ended June 30, 2019. A large portion of the Company’s certificate of deposit portfolio matures within six to eighteen months and therefore reprices fairly quickly; this is consistent with the portfolio over the past several years. Older certificates of deposit that renewed or were replaced with new deposits generally resulted in the Company paying a higher rate of interest due to market interest rate increases during 2018 and 2019. The increase in average balances of time deposits was a result of increases in both retail customer time deposits and in brokered deposits added through the CDARS program purchased funds.
Interest Expense – FHLBank Advances, Short-term Borrowings and Repurchase Agreements, Subordinated Debentures Issued to Capital Trusts and Subordinated Notes
During the three months ended June 30, 2019 compared to the three months ended June 30, 2018, interest expense on FHLBank advances decreased $1.2 million due to a decrease in average balances from $233.4 million during the three months ended June 30, 2018 to $-0- during the three months ended June 30, 2019. This decrease was primarily due to an overall decrease in term borrowings from the FHLBank. Instead, the Company utilized overnight borrowings from the FHLBank, primarily due to slightly lower rates compared to term borrowings. These overnight FHLBank borrowings are included in short-term borrowings and repurchase agreements.
During the six months ended June 30, 2019 compared to the six months ended June 30, 2018, interest expense on FHLBank advances decreased $1.8 million due to a decrease in average balances from $189.7 million during the six months ended June 30, 2018 to $-0- during the six months ended June 30, 2019. This decrease was primarily due to an overall decrease in term borrowings from the FHLBank. Instead, the Company utilized overnight borrowings from the FHLBank, primarily due to slightly lower rates compared to term borrowings. These overnight FHLBank borrowings are included in short-term borrowings and repurchase agreements.
Interest expense on short-term borrowings and repurchase agreements increased $479,000 due to an increase in average rates from 0.51% in the three months ended June 30, 2018 to 1.41% in the three months ended June 30, 2019. The increase was due to an increase in market interest rates during the period and the higher interest rate charged on overnight FHLBank borrowings as compared to customer repurchase agreements. Interest expense on short-term borrowings and repurchase agreements increased $200,000 due to an increase in average balances from $141.3 million during the three months ended June 30, 2018 to $244.6 million during the three months ended June 30, 2019, which was primarily due to changes in the Company’s funding needs and the mix of funding, which can fluctuate. In the three months ended June 30, 2019, more overnight FHLBank borrowings were utilized.
Interest expense on short-term borrowings and repurchase agreements increased $1.2 million due to an increase in average rates from 0.35% in the six months ended June 30, 2018 to 1.43% in the six months ended June 30, 2019. The increase was due to an increase in market interest rates during the period and the higher interest rate charged on overnight FHLBank borrowings as compared to customer repurchase agreements. Interest expense on short-term borrowings and repurchase agreements increased $408,000 due to an increase in average balances from $120.5 million during the six months ended June 30, 2018 to $251.3 million during the six months ended June 30, 2019, which was primarily due to changes in the Company’s funding needs and the mix of funding, which can fluctuate. In the six months ended June 30, 2019, more overnight FHLBank borrowings were utilized.
During the three months ended June 30, 2019, compared to the three months ended June 30, 2018, interest expense on subordinated debentures issued to capital trusts increased $29,000 due to higher average interest rates. The average interest rate was 3.70% in the three months ended June 30, 2018 compared to 4.16% in the three months ended June 30, 2019. The subordinated debentures are variable-rate debentures which bear interest at an average rate of three-month LIBOR plus 1.60%, adjusting quarterly, which was 4.18% at June 30, 2019. There was no change in the average balance of the subordinated debentures between the 2019 and the 2018 periods.
During the six months ended June 30, 2019, compared to the six months ended June 30, 2018, interest expense on subordinated debentures issued to capital trusts increased $94,000 due to higher average interest rates. The average interest rate was 3.44% in the six months ended June 30, 2018 compared to 4.18% in the six months ended June 30, 2019. There was no change in the average balance of the subordinated debentures between the 2019 and the 2018 periods.
In August 2016, the Company issued $75 million of 5.25% fixed-to-floating rate subordinated notes due August 15, 2026. The notes were sold at par, resulting in net proceeds, after underwriting discounts and commissions and other issuance costs, of approximately $73.5 million. Interest expense on the subordinated notes for the three and six months ended June 30, 2019 increased $66,000 and $138,000, respectively, due to deferred issuance cost amortization.
Net Interest Income
Net interest income for the three months ended June 30, 2019 increased $3.7 million to $44.9 million compared to $41.2 million for the three months ended June 30, 2018. Net interest margin was 3.97% in the three months ended June 30, 2019, compared to 3.94% in the three months ended June 30, 2018, an increase of three basis points, or 0.8%. In both three month periods, the Company’s net interest income and margin were positively impacted by the increases in expected cash flows from the FDIC-acquired loan pools and the resulting increase to accretable yield, which were previously discussed in Note 7 of the Notes to Consolidated Financial Statements. The positive impact of these changes in the three months ended June 30, 2019 and 2018 were increases in interest income of $1.4 million and $1.1 million, respectively, and increases in net interest margin of 12 basis points and 10 basis points, respectively. Excluding the positive impact of the additional yield accretion, net interest margin increased one basis point when compared to the year-ago three month period. The increase was primarily due to increased yields in most loan categories and higher overall yields on investments and interest-earning deposits at the Federal Reserve Bank, significantly offset by an increase in the average interest rate on deposits and borrowings.
Net interest income for the six months ended June 30, 2019 increased $8.8 million to $89.5 million compared to $80.7 million for the six months ended June 30, 2018. Net interest margin was 4.02% in the six months ended June 30, 2019, compared to 3.93% in the six months ended June 30, 2018, an increase of nine basis points, or 2.3%. In both six month periods, the Company’s net interest income and margin were positively impacted by the increases in expected cash flows from the FDIC-acquired loan pools and the resulting increase to accretable yield, which were previously discussed in Note 7 of the Notes to Consolidated Financial Statements. The positive impact of these changes in the six months ended June 30, 2019 and 2018 were increases in interest income of $2.9 million and $2.2 million, respectively, and increases in net interest margin of 13 basis points and 11 basis points, respectively. Excluding the positive impact of the additional yield accretion, net interest margin increased seven basis points when compared to the year-ago six month period. The increase was primarily due to increased yields in most loan categories and higher overall yields on investments and interest-earning deposits at the Federal Reserve Bank, partially offset by an increase in the average interest rate on deposits and borrowings.
The Company's overall average interest rate spread decreased eight basis points, or 2.2%, from 3.72% during the three months ended June 30, 2018 to 3.64% during the three months ended June 30, 2019. The decrease was due to a 50 basis point increase in the weighted average rate paid on interest-bearing liabilities, partially offset by a 42 basis point increase in the weighted average yield on interest-earning assets. In comparing the two periods, the yield on loans increased 43 basis points, the yield on investment securities increased 38 basis points and the yield on other interest-earning assets increased 101 basis points. The rate paid on deposits increased 58 basis points, the rate paid on short-term borrowings and repurchase agreements increased 90 basis points, the rate paid on subordinated debentures issued to capital trusts increased 46 basis points, the rate paid on subordinated notes increased 36 basis points and the rate paid on FHLBank advances decreased 200 basis points (due to the average balance of FHLBank advances decreasing to $-0-).
The Company's overall average interest rate spread decreased four basis points, or 1.1%, from 3.73% during the six months ended June 30, 2018 to 3.69% during the six months ended June 30, 2019. The decrease was due to a 53 basis point increase in the weighted average rate paid on interest-bearing liabilities, partially offset by a 49 basis point increase in the weighted average yield on interest-earning assets. In comparing the two periods, the yield on loans increased 50 basis points, the yield on investment securities increased 41 basis points and the yield on other interest-earning assets increased 87 basis points. The rate paid on deposits increased 57 basis points, the rate paid on
short-term borrowings and repurchase agreements increased 108 basis points, the rate paid on subordinated debentures issued to capital trusts increased 74 basis points, the rate paid on subordinated notes increased 37 basis points and the rate paid on FHLBank advances decreased 188 basis points (due to the average balance of FHLBank advances decreasing to $-0-).
For additional information on net interest income components, refer to the "Average Balances, Interest Rates and Yields" tables in this Quarterly Report on Form 10-Q.
Provision for Loan Losses and Allowance for Loan Losses
Management records a provision for loan losses in an amount it believes is sufficient to result in an allowance for loan losses that will cover current net charge-offs as well as risks believed to be inherent in the loan portfolio of the Bank. The amount of provision charged against current income is based on several factors, including, but not limited to, past loss experience, current portfolio mix, actual and potential losses identified in the loan portfolio, economic conditions, and internal as well as external reviews. The levels of non-performing assets, potential problem loans, loan loss provisions and net charge-offs fluctuate from period to period and are difficult to predict.
Weak economic conditions, higher inflation or interest rates, or other factors may lead to increased losses in the portfolio and/or requirements for an increase in loan loss provision expense. Management maintains various controls in an attempt to limit future losses, such as a watch list of possible problem loans, documented loan administration policies and loan review staff to review the quality and anticipated collectability of the portfolio. Additional procedures provide for frequent management review of the loan portfolio based on loan size, loan type, delinquencies, financial analysis, on-going correspondence with borrowers and problem loan work-outs. Management determines which loans are potentially uncollectible, or represent a greater risk of loss, and makes additional provisions to expense, if necessary, to maintain the allowance at a satisfactory level.
The provision for loan losses for the three months ended June 30, 2019 was $1.6 million compared with $2.0 million for the three months ended June 30, 2018. The provision for loan losses for the six months ended June 30, 2019 was $3.6 million compared with $3.9 million for the six months ended June 30, 2018. At June 30, 2019 and December 31, 2018, the allowance for loan losses was $39.3 million and $38.4 million, respectively. Total net charge-offs were $997,000 and $704,000 for the three months ended June 30, 2019 and 2018, respectively. During the three months ended June 30, 2019, $679,000 of the $997,000 of net charge-offs were in the consumer auto category. In addition, one commercial loan relationship was responsible for $189,000 of the total net charge-offs during the three months ended June 30, 2019. Total net charge-offs were $2.7 million and $2.8 million for the six months ended June 30, 2019 and 2018, respectively. During the six months ended June 30, 2019, $1.6 million of the $2.7 million of net charge-offs were in the consumer auto category. In addition, two unrelated commercial loan relationships were responsible for $560,000 of the total net charge-offs during the first six months of 2019.
In response to a more challenging consumer credit environment, the Company tightened its underwriting guidelines on automobile lending in the latter part of 2016. Management took this step in an effort to improve credit quality in the portfolio and lower delinquencies and charge-offs. This action also resulted in a lower level of origination volume and, as such, the outstanding balance of the Company's automobile loans continued to decline in the six months ended June 30, 2019. We expect to see more rapid reductions in the automobile loan outstanding balance as we determined in February 2019 to cease providing indirect lending services to automobile dealerships. At June 30, 2019, indirect automobile loans totaled approximately $157 million. We expect this total balance will be largely paid off in the next two to four years. General market conditions and unique circumstances related to individual borrowers and projects contributed to the level of provisions and charge-offs. Collateral and repayment evaluations of all assets categorized as potential problem loans, non-performing loans or foreclosed assets were completed with corresponding charge-offs or reserve allocations made as appropriate.
All acquired loans were grouped into pools based on common characteristics and were recorded at their estimated fair values, which incorporated estimated credit losses at the acquisition date. These loan pools are systematically reviewed by management to determine the risk of losses that may exceed those identified at the time of the acquisition. Techniques used in determining risk of loss are similar to those used to determine the risk of loss for the legacy Great Southern Bank portfolio, with most focus being placed on those loan pools which include the larger loan relationships and those loan pools which exhibit higher risk characteristics. Review of the acquired loan portfolio also includes monitoring of payment performance, review of financial information and credit scores, collateral valuations and customer interaction to determine if any additional reserves are warranted.
The Bank’s allowance for loan losses as a percentage of total loans, excluding FDIC-acquired loans, was 0.97%, 0.98% and 0.97% at June 30, 2019, December 31, 2018 and March 31, 2019, respectively. Management considers the allowance for loan losses adequate to cover losses inherent in the Bank’s loan portfolio at June 30, 2019, based on recent reviews of the Bank’s loan portfolio and current economic conditions. If economic conditions were to deteriorate or management’s assessment of the loan portfolio were to change, it is possible that additional loan loss provisions would be required, thereby adversely affecting future results of operations and financial condition.
Non-performing Assets
Non-performing assets acquired through FDIC-assisted transactions, including foreclosed assets and potential problem loans, are not included in the totals or in the discussion of non-performing loans, potential problem loans and foreclosed assets below. These assets were initially recorded at their estimated fair values as of their acquisition dates and are accounted for in pools. Therefore, these loan pools are analyzed rather than the individual loans. The overall performance of the loan pools acquired in each of the five FDIC-assisted transactions has been better than original expectations as of the acquisition dates.
As a result of changes in balances and composition of the loan portfolio, changes in economic and market conditions and other factors specific to a borrower’s circumstances, the level of non-performing assets will fluctuate.
Non-performing assets, excluding all FDIC-assisted acquired assets, at June 30, 2019 were $15.9 million, an increase of $4.1 million from $11.8 million at December 31, 2018. Non-performing assets, excluding all FDIC-assisted acquired assets, as a percentage of total assets were 0.33% at June 30, 2019, compared to 0.25% at December 31, 2018.
Compared to December 31, 2018, non-performing loans increased $5.1 million to $11.4 million at June 30, 2019, and foreclosed assets decreased $1.0 million to $4.5 million at June 30, 2019. Non-performing construction and land development loans comprised $3.6 million, or 31.2%, of the total non-performing loans at June 30, 2019, an increase of $3.5 million from December 31, 2018. Non-performing commercial real estate loans comprised $3.7 million, or 32.3%, of the total non-performing loans at June 30, 2019, an increase of $3.3 million from December 31, 2018. Non-performing one- to four-family residential loans comprised $1.5 million, or 13.5%, of the total non-performing loans at June 30, 2019, a decrease of $1.1 million from December 31, 2018. Non-performing commercial business loans comprised $1.4 million, or 11.9%, of the total non-performing loans at June 30, 2019, a decrease of $78,000 from December 31, 2018. Non-performing consumer loans comprised $1.3 million, or 11.1%, of the total non-performing loans at June 30, 2019, a decrease of $550,000 from December 31, 2018.
Non-performing Loans. Activity in the non-performing loans category during the six months ended June 30, 2019 was as follows:
| | | Beginning
Balance,
January 1 | | | Additions
to Non-
Performing | | | Removed
from Non-
Performing | | | Transfers to
Potential
Problem
Loans | | | Transfers to
Foreclosed
Assets and Repossessions | | | Charge-
Offs | | | Payments | | | Ending
Balance,
June 30 | |
| | | (In Thousands) | |
| One- to four-family construction | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
| Subdivision construction | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Land development | | | 49 | | | | 3,727 | | | | — | | | | — | | | | — | | | | (220 | ) | | | — | | | | 3,556 | |
| Commercial construction | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| One- to four-family residential | | | 2,664 | | | | 926 | | | | — | | | | (87 | ) | | | (1,250 | ) | | | (490 | ) | | | (231 | ) | | | 1,532 | |
| Other residential | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Commercial real estate | | | 334 | | | | 4,074 | | | | — | | | | — | | | | — | | | | — | | | | (733 | ) | | | 3,675 | |
| Commercial business | | | 1,437 | | | | 50 | | | | — | | | | — | | | | — | | | | (24 | ) | | | (104 | ) | | | 1,359 | |
| Consumer | | | 1,816 | | | | 1,122 | | | | — | | | | (165 | ) | | | (223 | ) | | | (893 | ) | | | (391 | ) | | | 1,266 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 6,300 | | | $ | 9,899 | | | $ | — | | | $ | (252 | ) | | $ | (1,473 | ) | | $ | (1,627 | ) | | $ | (1,459 | ) | | $ | 11,388 | |
The increase in non-performing loans during the six months ended June 30, 2019, primarily related to one borrower relationship. This relationship totaled approximately $6.7 million, with collateral consisting of commercial development ground and a single-family property in central Missouri and agricultural ground in Iowa. The loans in this relationship were all cross-collateralized. This relationship is represented in the non-performing land development, commercial real estate and one- to four-family categories as described below. During July 2019, the borrower deeded the properties to the Bank in lieu of foreclosure. This relationship and the corresponding development project originated in 2007.
At June 30, 2019, the non-performing land development category included six loans, three of which were added during 2019. The largest relationship in the category (discussed above) totaled $3.5 million, after a charge-off of $189,000, or 98.4% of the total category. This balance is primarily related to the commercial development ground in Missouri. The non-performing commercial real estate category included five loans, two of which were added during 2019. The largest relationship in the category (discussed above), totaled $2.9 million, or 78.9% of the total category. This balance is primarily related to the agricultural ground in Iowa. The non-performing commercial business category included five loans, one of which was added during 2019. The largest relationship in this category, which was added during 2018, totaled $1.1 million, or 79.7% of the total category. This relationship is collateralized by an assignment of an interest in a real estate project. The non-performing one- to four-family residential category included 19 loans, seven of which were added during 2019. The largest relationship in the category (discussed above) totaled $290,000, or 18.9% of the total category. This balance is primarily related to the single-family property in central Missouri. One relationship in this category, which included nine loans that were collateralized by residential rental homes in the Springfield, Mo. area, was charged down $371,000 during 2019 and the remaining balance of $793,000 was transferred to foreclosed assets. The non-performing consumer category included 110 loans, 44 of which were added during 2019, and the majority of which are indirect used automobile loans.
Potential Problem Loans. Compared to December 31, 2018, potential problem loans increased $1.7 million, or 51.5%, to $5.0 million. This increase was due to the addition of $2.2 million of loans to potential problem loans, partially offset by $227,000 in payments, $167,000 in loans transferred to non-performing loans and $124,000 in loans transferred to performing loans. Potential problem loans are loans which management has identified through routine internal review procedures as having possible credit problems that may cause the borrowers difficulty in complying with the current repayment terms. These loans are not reflected in non-performing assets, but are considered in determining the adequacy of the allowance for loan losses.
Activity in the potential problem loans category during the six months ended June 30, 2019, was as follows:
| | | Beginning
Balance,
January 1 | | | Additions
to
Potential
Problem | | | Removed
from
Potential
Problem | | | Transfers to
Non-
Performing | | | Transfers to
Foreclosed
Assets and Repossessions | | | Charge-
Offs | | | Payments | | | Ending
Balance,
June 30 | |
| | | (In Thousands) | |
| One- to four-family construction | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
| Subdivision construction | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Land development | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Commercial construction | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| One- to four-family residential | | | 1,044 | | | | 87 | | | | — | | | | (152 | ) | | | — | | | | — | | | | (139 | ) | | | 840 | |
| Other residential | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Commercial real estate | | | 2,053 | | | | 1,931 | | | | (124 | ) | | | — | | | | — | | | | — | | | | (51 | ) | | | 3,809 | |
| Commercial business | | | — | | | | 37 | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 37 | |
| Consumer | | | 206 | | | | 179 | | | | — | | | | (15 | ) | | | (4 | ) | | | (10 | ) | | | (37 | ) | | | 319 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 3,303 | | | $ | 2,234 | | | $ | (124 | ) | | $ | (167 | ) | | $ | (4 | ) | | $ | (10 | ) | | $ | (227 | ) | | $ | 5,005 | |
At June 30, 2019, the commercial real estate category of potential problem loans included two loans, one of which was added during the current year. The largest relationship in the category (added during the current year), which totaled $1.9 million, or 50.5% of the total category, is collateralized by a commercial retail building. Payments became past due during the three months ended March 31, 2019, but were current at June 30, 2019 and a principal payment of $400,000 was received in July 2019. The second largest relationship in this category (added during 2018), which totaled $1.9 million, or 49.5% of the total category, is collateralized by a mixed use commercial retail building. Payments were current on this relationship at June 30, 2019. The one- to four-family residential category of potential problem loans included 17 loans, two of which were added during the current year. The consumer category of potential problem loans included 33 loans, 20 of which were added during the current year.
Other Real Estate Owned and Repossessions. Of the total $7.1 million of other real estate owned and repossessions at June 30, 2019, $1.3 million represents the fair value of foreclosed and repossessed assets related to loans acquired in FDIC-assisted transactions and $1.3 million represents properties which were not acquired through foreclosure. The foreclosed and other assets acquired in the FDIC-assisted transactions and the properties not acquired through foreclosure are not included in the following table and discussion of other real estate owned and repossessions.
Activity in other real estate owned and repossessions during the three months ended June 30, 2019, was as follows:
| | | Beginning
Balance,
January 1 | | | Additions | | | Sales | | | Capitalized
Costs | | | Write-
Downs | | | Ending
Balance,
June 30 | |
| | | (In Thousands) | |
| One- to four-family construction | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
| Subdivision construction | | | 1,092 | | | | — | | | | (81 | ) | | | — | | | | (93 | ) | | | 918 | |
| Land development | | | 3,191 | | | | — | | | | (300 | ) | | | — | | | | (307 | ) | | | 2,584 | |
| Commercial construction | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| One- to four-family residential | | | 269 | | | | 1,286 | | | | (1,555 | ) | | | — | | | | — | | | | — | |
| Other residential | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Commercial real estate | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Commercial business | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Consumer | | | 928 | | | | 2,318 | | | | (2,247 | ) | | | — | | | | — | | | | 999 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 5,480 | | | $ | 3,604 | | | $ | (4,183 | ) | | $ | — | | | $ | (400 | ) | | $ | 4,501 | |
At June 30, 2019, the land development category of foreclosed assets included five properties, the largest of which was located in the Branson, Mo. area and had a balance of $768,000, or 29.7% of the total category. Of the total dollar amount in the land development category of foreclosed assets, 59.0% was located in the Branson, Mo. area, including the largest property previously mentioned. The subdivision construction category of foreclosed assets included five properties, the largest of which was located in the Branson, Mo. area and had a balance of $350,000, or 38.1% of the total category. Of the total dollar amount in the subdivision construction category of foreclosed assets, 67.6% is located in Branson, Mo., including the largest property previously mentioned. All of the properties in the one- to four-family residential category of foreclosed assets were sold during the three months ended June 30, 2019. The amount of additions and sales in the consumer loans category are due to a higher volume of repossessions of automobiles, which generally are subject to a shorter repossession process. The Company experienced increased levels of delinquencies and repossessions in indirect and used automobile loans throughout 2016 and 2017. The level of delinquencies and repossessions in indirect and used automobile loans generally decreased in 2018 and to date in 2019.
Non-interest Income
For the three months ended June 30, 2019, non-interest income decreased $302,000 to $7.2 million when compared to the three months ended June 30, 2018, primarily as a result of the following items:
Service charges and ATM fees: Service charges and ATM fees decreased $179,000 compared to the prior year period. This decrease was primarily due to a decrease in overdraft and insufficient funds fees on customer accounts.
Net gains on loan sales: Net gains on loan sales decreased $183,000 compared to the prior year period. The decrease was due to a decrease in originations of fixed-rate loans during the 2019 period compared to the 2018 period. Fixed rate single-family mortgage loans originated are generally subsequently sold in the secondary market. In 2019, the Company has originated more fixed-to-variable-rate single-family mortgage loans, most of which have been retained in the Company’s portfolio.
Commissions: Commissions income decreased $149,000 compared to the prior year period. The decrease was due to annuity sales that were approximately 32% lower in the 2019 period compared to the 2018 period.
Other income: Other income increased $293,000 compared to the prior year period. The Company recognized approximately $435,000 more in income from a new debit card contract that became effective at the beginning of 2019.
For the six months ended June 30, 2019, non-interest income increased $213,000 to $14.6 million when compared to the six months ended June 30, 2018, primarily as a result of the following items:
Other income: Other income increased $1.3 million compared to the prior year period. This increase was primarily due to gains totaling $677,000 in the 2019 period from the sale of, or recovery of, receivables and assets that were acquired several years ago in FDIC-assisted transactions. In addition, the Company recognized approximately $769,000 more in income as a result of the new debit card contract discussed previously.
Service charges and ATM fees: Service charges and ATM fees decreased $464,000 compared to the prior year period. This decrease was primarily due to a decrease in overdraft and insufficient funds fees on customer accounts.
Net gains on loan sales: Net gains on loan sales decreased $398,000 compared to the prior year period. The decrease was due to a decrease in originations of fixed-rate loans during the 2019 period compared to the 2018 period. Fixed rate single-family mortgage loans originated are generally subsequently sold in the secondary market. In 2019, the Company has originated more fixed-to-variable-rate single-family mortgage loans, most of which have been retained in the Company’s portfolio.
Non-interest Expense
For the three months ended June 30, 2019, non-interest expense decreased $1.5 million to $28.4 million when compared to the three months ended June 30, 2018, primarily as a result of the following items:
Expense on other real estate owned and repossessions: Expense on other real estate owned and repossessions decreased $2.3 million compared to the prior year period primarily due to higher valuation write-downs of certain foreclosed assets during the 2018 period and higher levels of expense related to consumer repossessions in the 2018 period. During the 2018 period, valuation write-downs of certain foreclosed assets totaled approximately $2.1 million, while valuation write-downs in the 2019 period totaled approximately $197,000.
Acquired deposit intangible asset amortization: Acquired deposit intangible amortization expense decreased $123,000 in the three months ended June 30, 2019 compared to the prior year period. The Company generally amortizes its acquired deposit intangibles over a period of seven years. The amortization of the intangible related to the InterBank acquisition was completed during the first quarter of 2019 and the amortization of the intangible related to the Sun Security Bank acquisition was completed during the third quarter of 2018.
Salaries and employee benefits: Salaries and employee benefits increased $481,000 from the prior year period. The increase was due to staffing additions in the new loan production offices opened in Atlanta and Denver in late 2018, and due to annual employee compensation increases.
Other operating expenses: Other operating expenses increased $192,000 compared to the prior year period. This increase primarily related to a contribution expense totaling $250,000 for the Company’s pledge covering the next ten years related to the $15 million Siouxland Expo Center in Sioux City, Iowa. Currently under construction, the Expo Center is a multi-purpose event venue that is part of Sioux City’s entertainment and cultural reinvestment district.
For the six months ended June 30, 2019, non-interest expense decreased $1.3 million to $56.9 million when compared to the six months ended June 30, 2018, primarily as a result of the following items:
Expense on other real estate owned and repossessions: Expense on other real estate owned and repossessions decreased $2.8 million compared to the prior year period primarily due to higher valuation write-downs of certain foreclosed assets during the prior year period and higher levels of expense related to consumer repossessions in the prior year period. During the 2018 period, valuation write-downs of certain foreclosed assets totaled approximately $2.1 million, while valuation write-downs in the 2019 period totaled approximately $444,000.
Partnership tax credit: Partnership tax credit expense decreased $211,000 in the six months ended June 30, 2019 compared to the prior year period. The Company periodically invests in certain tax credits and amortizes those investments over the period that the tax credits are used. The tax credit period for certain of these credits ended in 2018; therefore, the final amortization of the investment in those credits also ended in 2018.
Acquired deposit intangible asset amortization: Acquired deposit intangible amortization expense decreased $212,000 in the six months ended June 30, 2019 compared to the prior year period. The Company generally amortizes its acquired deposit intangibles over a period of seven years, as described above.
Salaries and employee benefits: Salaries and employee benefits increased $1.5 million from the prior year period. The increase was due to staffing additions in the new loan production offices opened in Atlanta and Denver in late 2018, and due to annual employee compensation increases.
Other operating expenses: Other operating expenses increased $298,000 compared to the prior year period. This increase primarily related to a contribution expense totaling $250,000 for the Company’s pledge covering the next ten years related to the Siouxland Expo Center in Sioux City, Iowa, as described above.
The Company’s efficiency ratio for the three months ended June 30, 2019, was 54.50% compared to 61.46% for the same three month period in 2018. The efficiency ratio for the six months ended June 30, 2019, was 54.62% compared to 61.26% for the same period in 2018. The improvement in the ratio in both 2019 periods was primarily due to an increase in net interest income and a decrease in non-interest expense, primarily related to a decrease in expenses on other real estate owned and repossessions. The Company’s ratio of non-interest expense to average assets was 2.35% and 2.38% for the three and six months ended June 30, 2019, respectively, compared to 2.66% and 2.63% for the three and six months ended June 30, 2018, respectively. The decreases in the current three month and six month period ratios were due to decreases in non-interest expenses as described above. The decreases in the current three month and six month period ratios were also due to an increase in average assets in the 2019 periods compared to the 2018 periods. Average assets for the three months ended June 30, 2019, increased $326.0 million, or 7.3%, from the quarter ended June 30, 2018, primarily due to increases in loans receivable and investment securities. Average assets for the six months ended June 30, 2019, increased $340.0 million, or 7.7%, from the six months ended June 30, 2018, primarily due to increases in loans receivable and investment securities.
Provision for Income Taxes
On December 22, 2017, H.R.1, originally known as the Tax Cuts and Jobs Act (the “TJC Act”), was signed into law. Among other things, the TJC Act permanently lowered the corporate federal income tax rate to 21% from the prior maximum rate of 35%, effective for tax years including or commencing January 1, 2018. The Company currently expects its effective tax rate (combined federal and state) to be approximately 17.0% to 18.5% in 2019 and future years, mainly as a result of the TJC Act.
For the three months ended June 30, 2019 and 2018, the Company's effective tax rate was 16.8% and 17.6%, respectively. For the six months ended June 30, 2019 and 2018, the Company's effective tax rate was 17.7% and 17.0%, respectively. These effective rates were lower than the statutory federal tax rates of 21%, due primarily to the utilization of certain investment tax credits and to tax-exempt investments and tax-exempt loans, which reduced the Company’s effective tax rate. The Company’s effective tax rate may fluctuate in future periods as it is impacted by the level and timing of the Company’s utilization of tax credits and the level of tax-exempt investments and loans and the overall level of pre-tax income. The Company's effective income tax rate is currently expected to continue to be less than the statutory rate due primarily to the factors noted above.
Average Balances, Interest Rates and Yields
The following table presents, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. Average balances of loans receivable include the average balances of non-accrual loans for each period. Interest income on loans includes interest received on non-accrual loans on a cash basis. Interest income on loans includes the amortization of net loan fees which were deferred in accordance with accounting standards. Net fees included in interest income were $1.0 million and $754,000 for the three months ended June 30, 2019 and 2018, respectively. Net fees included in interest income were $2.1 million and $1.6 million for the six months ended June 30, 2019 and 2018, respectively. Tax-exempt income was not calculated on a tax equivalent basis. The table does not reflect any effect of income taxes.
| | | June 30, 2019(2) | | | Three Months Ended
June 30, 2019 | | | Three Months Ended
June 30, 2018 | |
| | | Yield/
Rate | | | Average
Balance | | | Interest | | | Yield/
Rate | | | Average
Balance | | | Interest | | | Yield/
Rate | |
| | | (Dollars in Thousands) | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | | | | |
| Loans receivable: | | | | | | | | | | | | | | | | | | | | | |
| One- to four-family residential | | | 4.27 | % | | $ | 515,749 | | | $ | 6,556 | | | | 5.10 | % | | $ | 437,856 | | | $ | 5,422 | | | | 4.97 | % |
| Other residential | | | 5.21 | | | | 819,577 | | | | 11,270 | | | | 5.52 | | | | 744,809 | | | | 9,347 | | | | 5.03 | |
| Commercial real estate | | | 5.02 | | | | 1,414,009 | | | | 18,304 | | | | 5.19 | | | | 1,332,339 | | | | 15,968 | | | | 4.81 | |
| Construction | | | 5.60 | | | | 713,885 | | | | 10,585 | | | | 5.95 | | | | 553,787 | | | | 7,246 | | | | 5.25 | |
| Commercial business | | | 5.33 | | | | 259,779 | | | | 3,358 | | | | 5.18 | | | | 289,895 | | | | 3,560 | | | | 4.93 | |
| Other loans | | | 5.97 | | | | 403,584 | | | | 5,450 | | | | 5.42 | | | | 508,722 | | | | 6,291 | | | | 4.96 | |
Industrial revenue bonds(1) | | | 4.93 | | | | 14,940 | | | | 248 | | | | 6.67 | | | | 22,667 | | | | 385 | | | | 6.81 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total loans receivable | | | 5.25 | | | | 4,141,523 | | | | 55,771 | | | | 5.40 | | | | 3,890,075 | | | | 48,219 | | | | 4.97 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Investment securities(1) | | | 3.36 | | | | 309,170 | | | | 2,415 | | | | 3.13 | | | | 188,589 | | | | 1,291 | | | | 2.75 | |
| Other interest-earning assets | | | 2.50 | | | | 88,024 | | | | 537 | | | | 2.45 | | | | 120,688 | | | | 433 | | | | 1.44 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest-earning assets | | | 5.07 | | | | 4,538,717 | | | | 58,723 | | | | 5.19 | | | | 4,199,352 | | | | 49,943 | | | | 4.77 | |
| Non-interest-earning assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | | | | | | 92,500 | | | | | | | | | | | | 97,295 | | | | | | | | | |
| Other non-earning assets | | | | | | | 190,416 | | | | | | | | | | | | 199,003 | | | | | | | | | |
| Total assets | | | | | | $ | 4,821,633 | | | | | | | | | | | $ | 4,495,650 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing demand and savings | | | 0.51 | | | $ | 1,498,795 | | | | 1,930 | | | | 0.52 | | | $ | 1,573,936 | | | | 1,435 | | | | 0.37 | |
| Time deposits | | | 2.25 | | | | 1,733,163 | | | | 9,652 | | | | 2.23 | | | | 1,284,414 | | | | 4,688 | | | | 1.46 | |
| Total deposits | | | 1.44 | | | | 3,231,958 | | | | 11,582 | | | | 1.44 | | | | 2,858,350 | | | | 6,123 | | | | 0.86 | |
Short-term borrowings, repurchase agreements and other interest- bearing liabilities | | | 1.51 | | | | 244,586 | | | | 859 | | | | 1.41 | | | | 141,268 | | | | 180 | | | | 0.51 | |
Subordinated debentures issued to
capital trusts | | | 4.18 | | | | 25,774 | | | | 267 | | | | 4.16 | | | | 25,774 | | | | 238 | | | | 3.70 | |
| Subordinated notes | | | 5.91 | | | | 74,015 | | | | 1,094 | | | | 5.93 | | | | 73,752 | | | | 1,024 | | | | 5.57 | |
| FHLBank advances | | | — | | | | — | | | | — | | | | — | | | | 233,363 | | | | 1,166 | | | | 2.00 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest-bearing liabilities | | | 1.56 | | | | 3,576,333 | | | | 13,802 | | | | 1.55 | | | | 3,332,507 | | | | 8,731 | | | | 1.05 | |
| Non-interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand deposits | | | | | | | 655,642 | | | | | | | | | | | | 653,281 | | | | | | | | | |
| Other liabilities | | | | | | | 34,504 | | | | | | | | | | | | 20,744 | | | | | | | | | |
| Total liabilities | | | | | | | 4,266,479 | | | | | | | | | | | | 4,006,532 | | | | | | | | | |
| Stockholders’ equity | | | | | | | 555,154 | | | | | | | | | | | | 489,118 | | | | | | | | | |
| Total liabilities and stockholders’ equity | | | | | | $ | 4,821,633 | | | | | | | | | | | $ | 4,495,650 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest rate spread | | | 3.51 | % | | | | | | $ | 44,921 | | | | 3.64 | % | | | | | | $ | 41,212 | | | | 3.72 | % |
| Net interest margin* | | | | | | | | | | | | | | | 3.97 | % | | | | | | | | | | | 3.94 | % |
Average interest-earning assets to
average interest-bearing liabilities | | | | | | | 126.9 | % | | | | | | | | | | | 126.0 | % | | | | | | | | |
| _______________________ |
| * | Defined as the Company’s net interest income divided by total average interest-earning assets. |
| (1) | Of the total average balances of investment securities, average tax-exempt investment securities were $43.5 million and $53.7 million for the three months ended June 30, 2019 and 2018, respectively. In addition, average tax-exempt loans and industrial revenue bonds were $21.0 million and $25.2 million for the three months ended June 30, 2019 and 2018, respectively. Interest income on tax-exempt assets included in this table was $614,000 and $693,000 for the three months ended June 30, 2019 and 2018, respectively. Interest income net of disallowed interest expense related to tax-exempt assets was $553,000 and $656,000 for the three months ended June 30, 2019 and 2018, respectively. |
| (2) | The yield on loans at June 30, 2019 does not include the impact of the accretable yield (income) on loans acquired in the FDIC-assisted transactions. See “Net Interest Income” for a discussion of the effect on results of operations for the three months ended June 30, 2019. |
| | | June 30, 2019(2) | | | Six Months Ended
June 30, 2019 | | | Six Months Ended
June 30, 2018 | |
| | | Yield/
Rate | | | Average
Balance | | | Interest | | | Yield/
Rate | | | Average
Balance | | | Interest | | | Yield/
Rate | |
| | | (Dollars in Thousands) | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | | | | |
| Loans receivable: | | | | | | | | | | | | | | | | | | | | | |
| One- to four-family residential | | | 4.27 | % | | $ | 506,490 | | | $ | 12,944 | | | | 5.15 | % | | $ | 434,507 | | | $ | 10,605 | | | | 4.92 | % |
| Other residential | | | 5.21 | | | | 815,354 | | | | 22,260 | | | | 5.51 | | | | 741,782 | | | | 18,186 | | | | 4.94 | |
| Commercial real estate | | | 5.02 | | | | 1,400,789 | | | | 36,000 | | | | 5.18 | | | | 1,289,141 | | | | 30,326 | | | | 4.74 | |
| Construction | | | 5.60 | | | | 690,883 | | | | 20,758 | | | | 6.06 | | | | 536,478 | | | | 13,734 | | | | 5.16 | |
| Commercial business | | | 5.33 | | | | 261,967 | | | | 6,750 | | | | 5.20 | | | | 287,329 | | | | 6,904 | | | | 4.85 | |
| Other loans | | | 5.97 | | | | 420,190 | | | | 11,154 | | | | 5.35 | | | | 524,995 | | | | 12,887 | | | | 4.95 | |
Industrial revenue bonds(1) | | | 4.93 | | | | 15,072 | | | | 461 | | | | 6.17 | | | | 23,188 | | | | 742 | | | | 6.45 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total loans receivable | | | 5.25 | | | | 4,110,745 | | | | 110,327 | | | | 5.41 | | | | 3,837,420 | | | | 93,384 | | | | 4.91 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Investment securities(1) | | | 3.36 | | | | 293,937 | | | | 4,666 | | | | 3.20 | | | | 187,803 | | | | 2,601 | | | | 2.79 | |
| Other interest-earning assets | | | 2.50 | | | | 91,182 | | | | 1,088 | | | | 2.41 | | | | 109,944 | | | | 841 | | | | 1.54 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest-earning assets | | | 5.07 | | | | 4,495,864 | | | | 116,081 | | | | 5.21 | | | | 4,135,167 | | | | 96,826 | | | | 4.72 | |
| Non-interest-earning assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | | | | | | 91,657 | | | | | | | | | | | | 99,818 | | | | | | | | | |
| Other non-earning assets | | | | | | | 185,672 | | | | | | | | | | | | 198,226 | | | | | | | | | |
| Total assets | | | | | | $ | 4,773,193 | | | | | | | | | | | $ | 4,433,211 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing demand and savings | | | 0.51 | | | $ | 1,485,948 | | | | 3,693 | | | | 0.50 | | | $ | 1,569,299 | | | | 2,745 | | | | 0.35 | |
| Time deposits | | | 2.25 | | | | 1,703,087 | | | | 18,359 | | | | 2.17 | | | | 1,307,814 | | | | 8,961 | | | | 1.38 | |
| Total deposits | | | 1.44 | | | | 3,189,035 | | | | 22,052 | | | | 1.39 | | | | 2,877,113 | | | | 11,706 | | | | 0.82 | |
Short-term borrowings, repurchase agreements and other interest- bearing liabilities | | | 1.51 | | | | 251,347 | | | | 1,780 | | | | 1.43 | | | | 120,494 | | | | 208 | | | | 0.35 | |
Subordinated debentures issued to
capital trusts | | | 4.18 | | | | 25,774 | | | | 534 | | | | 4.18 | | | | 25,774 | | | | 440 | | | | 3.44 | |
| Subordinated notes | | | 5.91 | | | | 73,958 | | | | 2,189 | | | | 5.97 | | | | 73,733 | | | | 2,049 | | | | 5.60 | |
| FHLBank advances | | | — | | | | — | | | | — | | | | — | | | | 189,682 | | | | 1,772 | | | | 1.88 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest-bearing liabilities | | | 1.56 | | | | 3,540,114 | | | | 26,555 | | | | 1.52 | | | | 3,286,796 | | | | 16,175 | | | | 0.99 | |
| Non-interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand deposits | | | | | | | 657,018 | | | | | | | | | | | | 641,969 | | | | | | | | | |
| Other liabilities | | | | | | | 30,011 | | | | | | | | | | | | 19,788 | | | | | | | | | |
| Total liabilities | | | | | | | 4,227,143 | | | | | | | | | | | | 3,948,553 | | | | | | | | | |
| Stockholders’ equity | | | | | | | 546,050 | | | | | | | | | | | | 484,658 | | | | | | | | | |
| Total liabilities and stockholders’ equity | | | | | | $ | 4,773,193 | | | | | | | | | | | $ | 4,433,211 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest rate spread | | | 3.51 | % | | | | | | $ | 89,526 | | | | 3.69 | % | | | | | | $ | 80,651 | | | | 3.73 | % |
| Net interest margin* | | | | | | | | | | | | | | | 4.02 | % | | | | | | | | | | | 3.93 | % |
Average interest-earning assets to
average interest-bearing liabilities | | | | | | | 127.0 | % | | | | | | | | | | | 125.8 | % | | | | | | | | |
| _______________________ |
| * | Defined as the Company’s net interest income divided by total average interest-earning assets. |
| (1) | Of the total average balances of investment securities, average tax-exempt investment securities were $45.7 million and $54.6 million for the six months ended June 30, 2019 and 2018, respectively. In addition, average tax-exempt loans and industrial revenue bonds were $21.4 million and $26.2 million for the six months ended June 30, 2019 and 2018, respectively. Interest income on tax-exempt assets included in this table was $1.2 million and $1.6 million for the six months ended June 30, 2019 and 2018, respectively. Interest income net of disallowed interest expense related to tax-exempt assets was $1.1 million and $1.5 million for the six months ended June 30, 2019 and 2018, respectively. |
| (2) | The yield on loans at June 30, 2019 does not include the impact of the accretable yield (income) on loans acquired in the FDIC-assisted transactions. See “Net Interest Income” for a discussion of the effect on results of operations for the six months ended June 30, 2019. |
Rate/Volume Analysis
The following tables present the dollar amounts of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities for the periods shown. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in rate (i.e., changes in rate multiplied by old volume) and (ii) changes in volume (i.e., changes in volume multiplied by old rate). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to volume and rate. Tax-exempt income was not calculated on a tax equivalent basis.
| | | Three Months Ended June 30, | |
| | | 2019 vs. 2018 | |
| | | Increase | | | | |
| | | (Decrease) | | | Total | |
| | | Due to | | | Increase | |
| | | Rate | | | Volume | | | (Decrease) | |
| | | (Dollars in Thousands) | |
| Interest-earning assets: | | | | | | | | | |
| Loans receivable | | $ | 4,320 | | | $ | 3,232 | | | $ | 7,552 | |
| Investment securities | | | 203 | | | | 921 | | | | 1,124 | |
| Other interest-earning assets | | | 169 | | | | (65 | ) | | | 104 | |
| Total interest-earning assets | | | 4,692 | | | | 4,088 | | | | 8,780 | |
| Interest-bearing liabilities: | | | | | | | | | | | | |
| Demand deposits | | | 560 | | | | (65 | ) | | | 495 | |
| Time deposits | | | 2,983 | | | | 1,981 | | | | 4,964 | |
| Total deposits | | | 3,543 | | | | 1,916 | | | | 5,459 | |
| Short-term borrowings | | | 479 | | | | 200 | | | | 679 | |
| Subordinated debentures issued to capital trust | | | 29 | | | | — | | | | 29 | |
| Subordinated notes | | | 66 | | | | 4 | | | | 70 | |
| FHLBank advances | | | — | | | | (1,166 | ) | | | (1,166 | ) |
| Total interest-bearing liabilities | | | 4,117 | | | | 954 | | | | 5,071 | |
| Net interest income | | $ | 575 | | | $ | 3,134 | | | $ | 3,709 | |
| | | Six Months Ended June 30, | |
| | | 2019 vs. 2018 | |
| | | Increase | | | | |
| | | (Decrease) | | | Total | |
| | | Due to | | | Increase | |
| | | Rate | | | Volume | | | (Decrease) | |
| | | (Dollars in Thousands) | |
| Interest-earning assets: | | | | | | | | | |
| Loans receivable | | $ | 10,012 | | | $ | 6,931 | | | $ | 16,943 | |
| Investment securities | | | 424 | | | | 1,641 | | | | 2,065 | |
| Other interest-earning assets | | | 355 | | | | (108 | ) | | | 247 | |
| Total interest-earning assets | | | 10,791 | | | | 8,464 | | | | 19,255 | |
| Interest-bearing liabilities: | | | | | | | | | | | | |
| Demand deposits | | | 1,085 | | | | (137 | ) | | | 948 | |
| Time deposits | | | 6,153 | | | | 3,245 | | | | 9,398 | |
| Total deposits | | | 7,238 | | | | 3,108 | | | | 10,346 | |
| Short-term borrowings | | | 1,164 | | | | 408 | | | | 1,572 | |
| Subordinated debentures issued to capital trust | | | 94 | | | | — | | | | 94 | |
| Subordinated notes | | | 138 | | | | 2 | | | | 140 | |
| FHLBank advances | | | — | | | | (1,772 | ) | | | (1,772 | ) |
| Total interest-bearing liabilities | | | 8,634 | | | | 1,746 | | | | 10,380 | |
| Net interest income | | $ | 2,157 | | | $ | 6,718 | | | $ | 8,875 | |
Liquidity is a measure of the Company's ability to generate sufficient cash to meet present and future financial obligations in a timely manner through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. These obligations include the credit needs of customers, funding deposit withdrawals, and the day-to-day operations of the Company. Liquid assets include cash, interest-bearing deposits with financial institutions and certain investment securities and loans. As a result of the Company’s management of the ability to generate liquidity primarily through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors' requirements and meet its customers’ credit needs. At June 30, 2019, the Company had commitments of approximately $164.9 million to fund loan originations, $1.14 billion of unused lines of credit and unadvanced loans, and $27.0 million of outstanding letters of credit.
Loan commitments and the unfunded portion of loans at the dates indicated were as follows (in thousands):
| | | June 30, 2019 | | | March 31, 2019 | | | December 31, 2018 | | | December 31, 2017 | | | December 31, 2016 | |
| Closed loans with unused available lines | | | | | | | | | | | | | | | |
| Secured by real estate (one- to four-family) | | $ | 153,871 | | | $ | 154,400 | | | $ | 150,948 | | | $ | 133,587 | | | $ | 123,433 | |
| Secured by real estate (not one- to four-family) | | | 13,237 | | | | 10,450 | | | | 11,063 | | | | 10,836 | | | | 26,062 | |
| Not secured by real estate - commercial business | | | 80,887 | | | | 83,520 | | | | 87,480 | | | | 113,317 | | | | 79,937 | |
| | | | | | | | | | | | | | | | | | | | | |
Closed construction loans with unused available lines | | | | | | | | | | | | | | | | | | | | |
| Secured by real estate (one-to four-family) | | | 28,023 | | | | 33,818 | | | | 37,162 | | | | 20,919 | | | | 10,047 | |
| Secured by real estate (not one-to four-family) | | | 818,047 | | | | 831,155 | | | | 906,006 | | | | 718,277 | | | | 542,326 | |
| | | | | | | | | | | | | | | | | | | | | |
| Loan Commitments not closed | | | | | | | | | | | | | | | | | | | | |
| Secured by real estate (one-to four-family) | | | 49,694 | | | | 36,945 | | | | 24,253 | | | | 23,340 | | | | 15,884 | |
| Secured by real estate (not one-to four-family) | | | 110,647 | | | | 134,607 | | | | 104,871 | | | | 156,658 | | | | 119,126 | |
| Not secured by real estate - commercial business | | | 4,535 | | | | — | | | | 405 | | | | 4,870 | | | | 7,022 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | $ | 1,258,941 | | | $ | 1,284,895 | | | $ | 1,322,188 | | | $ | 1,181,804 | | | $ | 923,837 | |
The Company's primary sources of funds are customer deposits, FHLBank advances, other borrowings, loan repayments, unpledged securities, proceeds from sales of loans and available-for-sale securities and funds provided from operations. The Company utilizes particular sources of funds based on the comparative costs and availability at the time. The Company has from time to time chosen not to pay rates on deposits as high as the rates paid by certain of its competitors and, when believed to be appropriate, supplements deposits with less expensive alternative sources of funds.
At June 30, 2019, the Company had these available secured lines and on-balance sheet liquidity:
| Federal Home Loan Bank line | $868.6 million | |
| Federal Reserve Bank line | $407.4 million | |
| Cash and cash equivalents | $181.4 million | |
| Unpledged securities | $141.2 million | |
Statements of Cash Flows. During both the six months ended June 30, 2019 and 2018, the Company had positive cash flows from operating activities. The Company experienced negative cash flows from investing activities during both the six months ended June 30, 2019 and 2018. The Company experienced positive cash flows from financing activities during both the six months ended June 30, 2019 and 2018.
Cash flows from operating activities for the periods covered by the Statements of Cash Flows have been primarily related to changes in accrued and deferred assets, credits and other liabilities, the provision for loan losses, depreciation and amortization, realized gains on sales of loans and the amortization of deferred loan origination fees and discounts (premiums) on loans and investments, all of which are non-cash or non-operating adjustments to operating cash flows. Net income adjusted for non-cash and non-operating items and the origination and sale of loans held for sale were the primary source of cash flows from operating activities. Operating activities provided cash flows of $39.2 million and $50.4 million during the six months ended June 30, 2019 and 2018, respectively.
During the six months ended June 30, 2019, investing activities used cash of $180.3 million, primarily due to the purchase of loans and the net origination of loans, the purchase of investment securities and the purchase of equipment, partially offset by the sale of other real estate owned, the sale of investment securities and payments received on investment securities. Investing activities in the 2018 period used cash of $139.9 million, primarily due to the purchase of loans, the net origination of loans and the purchase of equipment, partially offset by the sale of other real estate owned and payments received on investment securities.
Changes in cash flows from financing activities during the periods covered by the Statements of Cash Flows are due to changes in deposits after interest credited, changes in FHLBank advances and changes in short-term borrowings, as well as dividend payments to stockholders, purchases of the Company’s common stock and the exercise of common stock options. Financing activities provided cash of $119.7 million and $127.7 million during the six months ended June 30, 2019 and 2018, respectively. In the 2019 three-month period, financing activities provided cash primarily as a result of net increases in checking account balances and certificates of deposit, partially offset by decreases in short-term borrowings. Net cash provided during the 2018 six-month period was due primarily to the net increase in FHLBank advances. Financing activities in the future are expected to primarily include changes in deposits, changes in FHLBank advances, changes in short-term borrowings and dividend payments to stockholders.
Capital Resources
Management continuously reviews the capital position of the Company and the Bank to ensure compliance with minimum regulatory requirements, as well as to explore ways to increase capital either by retained earnings or other means.
At June 30, 2019, the Company's total stockholders' equity and common stockholders’ equity were each $572.3 million, or 11.7% of total assets, equivalent to a book value of $40.30 per common share. At December 31, 2018, total stockholders' equity and common stockholders’ equity were each $532.0 million, or 11.4% of total assets, equivalent to a book value of $37.59 per common share. At June 30, 2019, the Company’s tangible common equity to tangible assets ratio was 11.6%, compared to 11.2% at December 31, 2018. (See Non-GAAP Financial Measures below). Included in stockholders’ equity at June 30, 2019 and December 31, 2018, were unrealized gains (net of taxes) on the Company’s available-for-sale investment securities and cash flow hedges (interest rate swap) totaling $32.1 million and $9.6 million, respectively.
Banks are required to maintain minimum risk-based capital ratios. These ratios compare capital, as defined by the risk-based regulations, to assets adjusted for their relative risk as defined by the regulations. Under current guidelines banks must have a minimum common equity Tier 1 capital ratio of 4.50%, a minimum Tier 1 risk-based capital ratio of 6.00%, a minimum total risk-based capital ratio of 8.00%, and a minimum Tier 1 leverage ratio of 4.00%. To be considered "well capitalized," banks must have a minimum common equity Tier 1 capital ratio of 6.50%, a minimum Tier 1 risk-based capital ratio of 8.00%, a minimum total risk-based capital ratio of 10.00%, and a minimum Tier 1 leverage ratio of 5.00%. On June 30, 2019, the Bank's common equity Tier 1 capital ratio was 12.6%, its Tier 1 capital ratio was 12.6%, its total capital ratio was 13.5% and its Tier 1 leverage ratio was 12.2%. As a result, as of June 30, 2019, the Bank was well capitalized, with capital ratios in excess of those required to qualify as such. On December 31, 2018, the Bank's common equity Tier 1 capital ratio was 12.4%, its Tier 1 capital ratio was 12.4%, its total capital ratio was 13.3% and its Tier 1 leverage ratio was 12.2%. As a result, as of December 31, 2018, the Bank was well capitalized, with capital ratios in excess of those required to qualify as such.
The FRB has established capital regulations for bank holding companies that generally parallel the capital regulations for banks. On June 30, 2019, the Company's common equity Tier 1 capital ratio was 11.5%, its Tier 1 capital ratio was 12.0%, its total capital ratio was 14.5% and its Tier 1 leverage ratio was 11.5%. To be considered
well capitalized, a bank holding company must have a Tier 1 risk-based capital ratio of at least 6.00% and a total risk-based capital ratio of at least 10.00%. As of June 30, 2019, the Company was considered well capitalized, with capital ratios in excess of those required to qualify as such. On December 31, 2018, the Company's common equity Tier 1 capital ratio was 11.4%, its Tier 1 capital ratio was 11.9%, its total capital ratio was 14.4% and its Tier 1 leverage ratio was 11.7%. As of December 31, 2018, the Company was considered well capitalized, with capital ratios in excess of those required to qualify as such.
In addition to the minimum common equity Tier 1 capital ratio, Tier 1 risk-based capital ratio and total risk-based capital ratio, the Company and the Bank have to maintain a capital conservation buffer consisting of additional common equity Tier 1 capital greater than 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations on paying dividends, repurchasing shares, and paying discretionary bonuses. This capital conservation buffer requirement began phasing in beginning on January 1, 2016 when a buffer greater than 0.625% of risk-weighted assets was required, which amount increased by an additional 0.625% each year until the buffer requirement of greater than 2.5% of risk-weighted assets was fully implemented on January 1, 2019.
For additional information, see “Item 1. Business--Government Supervision and Regulation-Capital” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.
Dividends. During the three months ended June 30, 2019, the Company declared a common stock cash dividend of $0.32 per share, or 25% of net income per diluted common share for that three month period, and paid a common stock cash dividend of $0.32 per share (which was declared in March 2019). During the three months ended June 30, 2018, the Company declared a common stock cash dividend of $0.28 per share, or 29% of net income per diluted common share for that three month period, and paid a common stock cash dividend of $0.28 per share (which was declared in March 2018). During the six months ended June 30, 2019, the Company declared common stock cash dividends of $1.39 per share, or 55% of net income per diluted common share for that six month period, and paid a common stock cash dividend of $1.39 per share. During the six months ended June 30, 2018, the Company declared a common stock cash dividend of $0.56 per share, or 29% of net income per diluted common share for that six month period, and paid a common stock cash dividend of $0.52 per share. The total dividends declared during the six months ended June 30, 2019, consisted of regular cash dividends of $0.64 per share and a special cash dividend of $0.75 per share. The Board of Directors meets regularly to consider the level and the timing of dividend payments. The $0.32 per share dividend declared but unpaid as of June 30, 2019, was paid to stockholders in July 2019.
Common Stock Repurchases and Issuances. The Company has been in various buy-back programs since May 1990. During the three months ended June 30, 2019, the Company issued 30,858 shares of stock at an average price of $28.50 per share to cover stock option exercises and did not repurchase any shares of its common stock. During the three months ended June 30, 2018, the Company issued 22,681 shares of stock at an average price of $27.75 per share to cover stock option exercises and did not repurchase any shares of its common stock. During the six months ended June 30, 2019, the Company issued 66,458 shares of stock at an average price of $29.06 per share to cover stock option exercises and repurchased 16,040 shares of its common stock at an average price of $52.93 per share. During the six months ended June 30, 2018, the Company issued 46,290 shares of stock at an average price of $25.38 per share to cover stock option exercises and did not repurchase any shares of its common stock.
On April 18, 2018, the Company's Board of Directors authorized management to repurchase up to 500,000 shares of the Company's outstanding common stock, under a program of open market purchases or privately negotiated transactions. The plan does not have an expiration date. Management has historically utilized stock buy-back programs from time to time as long as management believed that repurchasing the stock would contribute to the overall growth of shareholder value. The number of shares of stock that will be repurchased at any particular time and the prices that will be paid are subject to many factors, several of which are outside of the control of the Company. The primary factors, however, are the number of shares available in the market from sellers at any given time, the price of the stock within the market as determined by the market and the projected impact on the Company’s earnings per share and capital.
Non-GAAP Financial Measures
This document contains certain financial information determined by methods other than in accordance with accounting principles generally accepted in the United States (“GAAP”), consisting of the tangible common equity to tangible assets ratio.
In calculating the ratio of tangible common equity to tangible assets, we subtract period-end intangible assets from common equity and from total assets. Management believes that the presentation of this measure excluding the impact of intangible assets provides useful supplemental information that is helpful in understanding our financial condition and results of operations, as it provides a method to assess management’s success in utilizing our tangible capital as well as our capital strength. Management also believes that providing a measure that excludes balances of intangible assets, which are subjective components of valuation, facilitates the comparison of our performance with the performance of our peers. In addition, management believes that this is a standard financial measure used in the banking industry to evaluate performance.
This non-GAAP financial measure is supplemental and is not a substitute for any analysis based on GAAP financial measures. Because not all companies use the same calculation of non-GAAP measures, this presentation may not be comparable to similarly titled measures as calculated by other companies.
Non-GAAP Reconciliation: Ratio of Tangible Common Equity to Tangible Assets
| | | June 30, | | | December 31, | |
| | | 2019 | | | 2018 | |
| | | (Dollars in Thousands) | |
| | | | | | | |
| Common equity at period end | | $ | 572,309 | | | $ | 531,977 | |
| Less: Intangible assets at period end | | | 8,675 | | | | 9,288 | |
| Tangible common equity at period end (a) | | $ | 563,634 | | | $ | 522,689 | |
| | | | | | | | | |
| Total assets at period end | | $ | 4,871,522 | | | $ | 4,676,200 | |
| Less: Intangible assets at period end | | | 8,675 | | | | 9,288 | |
| Tangible assets at period end (b) | | $ | 4,862,847 | | | $ | 4,666,912 | |
| | | | | | | | | |
| Tangible common equity to tangible assets (a) / (b) | | | 11.59 | % | | | 11.20 | % |
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Asset and Liability Management and Market Risk
A principal operating objective of the Company is to produce stable earnings by achieving a favorable interest rate spread that can be sustained during fluctuations in prevailing interest rates. The Company has sought to reduce its exposure to adverse changes in interest rates by attempting to achieve a closer match between the periods in which its interest-bearing liabilities and interest-earning assets can be expected to reprice through the origination of adjustable-rate mortgages and loans with shorter terms to maturity and the purchase of other shorter term interest-earning assets.
Our Risk When Interest Rates Change
The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time. Market interest rates change over time. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.
How We Measure the Risk to Us Associated with Interest Rate Changes
In an attempt to manage our exposure to changes in interest rates and comply with applicable regulations, we monitor Great Southern's interest rate risk. In monitoring interest rate risk we regularly analyze and manage assets and liabilities based on their payment streams and interest rates, the timing of their maturities and their sensitivity to actual or potential changes in market interest rates.
The ability to maximize net interest income is largely dependent upon the achievement of a positive interest rate spread that can be sustained despite fluctuations in prevailing interest rates. Interest rate sensitivity is a measure of the difference between amounts of interest-earning assets and interest-bearing liabilities which either reprice or mature within a given period of time. The difference, or the interest rate repricing "gap," provides an indication of the extent to which an institution's interest rate spread will be affected by changes in interest rates. A gap is considered positive when the amount of interest-rate sensitive assets exceeds the amount of interest-rate sensitive liabilities repricing during the same period, and is considered negative when the amount of interest-rate sensitive liabilities exceeds the amount of interest-rate sensitive assets during the same period. Generally, during a period of rising interest rates, a negative gap within shorter repricing periods would adversely affect net interest income, while a positive gap within shorter repricing periods would result in an increase in net interest income. During a period of falling interest rates, the opposite would be true. As of June 30, 2019, Great Southern's interest rate risk models indicate that, generally, rising interest rates are expected to have a positive impact on the Company's net interest income, while declining interest rates are expected to have a negative impact on net interest income. We model various interest rate scenarios for rising and falling rates, including both parallel and non-parallel shifts in rates. The results of our modeling indicate that net interest income is not likely to be materially affected either positively or negatively in the first twelve months following a rate change, regardless of any changes in interest rates, because our portfolios are relatively well matched in a twelve-month horizon. The effects of interest rate changes, if any, on net interest income are expected to be greater in the 12 to 36 months following a rate change.
The current level and shape of the interest rate yield curve poses challenges for interest rate risk management. Prior to its increase of 0.25% on December 16, 2015, the FRB had last changed interest rates on December 16, 2008. This was the first rate increase since June 29, 2006. The FRB has now also implemented rate increases of 0.25% on eight different occasions beginning December 14, 2016, with the Federal Funds rate now at 2.50%. A substantial portion of Great Southern's loan portfolio ($1.59 billion at June 30, 2019) is tied to the one-month or three-month LIBOR index and will be subject to adjustment at least once within 90 days after June 30, 2019. Of these loans, $1.54 billion as of June 30, 2019 had interest rate floors. Great Southern also has a portfolio of loans ($241 million at June 30, 2019) tied to a "prime rate" of interest and will adjust immediately with changes to the "prime rate" of interest.
Interest rate risk exposure estimates (the sensitivity gap) are not exact measures of an institution's actual interest rate risk. They are only indicators of interest rate risk exposure produced in a simplified modeling environment designed to allow management to gauge the Bank's sensitivity to changes in interest rates. They do not necessarily indicate the impact of general interest rate movements on the Bank's net interest income because the repricing of certain categories of assets and liabilities is subject to competitive and other factors beyond the Bank's control. As a result, certain assets and liabilities indicated as maturing or otherwise repricing within a stated period may in fact mature or reprice at different times and in different amounts and cause a change, which potentially could be material, in the Bank's interest rate risk.
In order to minimize the potential for adverse effects of material and prolonged increases and decreases in interest rates on Great Southern's results of operations, Great Southern has adopted asset and liability management policies to better match the maturities and repricing terms of Great Southern's interest-earning assets and interest-bearing liabilities. Management recommends and the Board of Directors sets the asset and liability policies of Great Southern which are implemented by the Asset and Liability Committee. The Asset and Liability Committee is chaired by the Chief Financial Officer and is comprised of members of Great Southern's senior management. The purpose of the Asset and Liability Committee is to communicate, coordinate and control asset/liability management consistent with Great Southern's business plan and board-approved policies. The Asset and Liability Committee establishes and monitors the volume and mix of assets and funding sources taking into account relative costs and spreads, interest rate sensitivity and liquidity needs. The objectives are to manage assets and funding sources to produce results that are consistent with liquidity, capital adequacy, growth, risk and profitability goals. The Asset and Liability Committee meets on a monthly basis to review, among other things, economic conditions and interest rate outlook, current and projected liquidity needs and capital positions and anticipated changes in the volume and mix of assets and liabilities. At each meeting, the Asset and Liability Committee recommends appropriate strategy changes based on this review. The Chief Financial Officer or his designee is responsible for reviewing and reporting on the effects of the policy implementations and strategies to the Board of Directors at their monthly meetings.
In order to manage its assets and liabilities and achieve the desired liquidity, credit quality, interest rate risk, profitability and capital targets, Great Southern has focused its strategies on originating adjustable rate loans or loans with fixed rates that mature in less than five years, and managing its deposits and borrowings to establish stable relationships with both retail customers and wholesale funding sources.
At times, depending on the level of general interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, we may determine to increase our interest rate risk position somewhat in order to maintain or increase our net interest margin.
The Asset and Liability Committee regularly reviews interest rate risk by forecasting the impact of alternative interest rate environments on net interest income and market value of portfolio equity, which is defined as the net present value of an institution's existing assets, liabilities and off-balance sheet instruments, and evaluating such impacts against the maximum potential changes in net interest income and market value of portfolio equity that are authorized by the Board of Directors of Great Southern.
In the normal course of business, the Company may use derivative financial instruments (primarily interest rate swaps) from time to time to assist in its interest rate risk management. In 2011, the Company began executing interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. Because the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. These interest rate derivatives result from a service provided to certain qualifying customers and, therefore, are not used to manage interest rate risk in the Company’s assets or liabilities. The Company manages a matched book with respect to its derivative instruments in order to minimize its net risk exposure resulting from such transactions.
In October 2018, the Company entered into an interest rate swap transaction as part of its ongoing interest rate management strategies to hedge the risk of its floating rate loans. The notional amount of the swap is $400 million with a termination date of October 6, 2025. Under the terms of the swap, the Company receives a fixed rate of interest of 3.018% and pays a floating rate of interest equal to one-month USD-LIBOR. The floating rate will be
reset monthly and net settlements of interest due to/from the counterparty will also occur monthly. The floating rate of interest was 2.4185% as of June 30, 2019. The Company receives net interest settlements which will be recorded as loan interest income to the extent that the fixed rate of interest continues to exceed one-month USD-LIBOR. If USD-LIBOR exceeds the fixed rate of interest in future periods, the Company is required to pay net settlements to the counterparty and record those net payments as a reduction of interest income on loans. The effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affected earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.
The Company’s interest rate derivatives and hedging activities are discussed further in Note 16 of the Notes to Consolidated Financial Statements contained in this report.
ITEM 4. CONTROLS AND PROCEDURES
We maintain a system of disclosure controls and procedures (as defined in Rule 13(a)-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")) that is designed to provide reasonable assurance that information required to be disclosed by us in the reports that we file under the Exchange Act is recorded, processed, summarized and reported accurately and within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate. An evaluation of our disclosure controls and procedures was carried out as of June 30, 2019, under the supervision and with the participation of our principal executive officer, principal financial officer and several other members of our senior management. Our principal executive officer and principal financial officer concluded that, as of June 30, 2019, our disclosure controls and procedures were effective in ensuring that the information we are required to disclose in the reports we file or submit under the Act is (i) accumulated and communicated to our management (including the principal executive officer and principal financial officer) to allow timely decisions regarding required disclosure, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms.
There were no changes in our internal control over financial reporting (as defined in Rule 13(a)-15(f) under the Act) that occurred during the quarter ended June 30, 2019, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
We do not expect that our internal control over financial reporting will prevent all errors and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns in controls or procedures can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In the normal course of business, the Company and its subsidiaries are subject to pending and threatened legal actions, some of which seek substantial relief or damages. While the ultimate outcome of such legal proceedings cannot be predicted with certainty, after reviewing pending and threatened litigation with counsel, management believes at this time that, except as noted below, the outcome of such litigation will not have a material adverse effect on the Company’s business, financial condition or results of operations.
Item 1A. Risk Factors
On April 18, 2018, the Company's Board of Directors authorized management to repurchase up to 500,000 shares of the Company's outstanding common stock, under a program of open market purchases or privately negotiated transactions. The plan does not have an expiration date. The authorization of this new plan terminated the previous repurchase plan which was approved in November 2006, with an authorization to repurchase up to 700,000 shares of the Company's outstanding common stock.
As indicated below, the Company repurchased the following shares of its common stock during the three months ended June 30, 2019.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Item 5. Other Information
None.
