UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2015
or
[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from ____________ to _____________
Commission File Number: 0-24159
MIDDLEBURG FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Virginia (State or other jurisdiction of incorporation or organization) | 54-1696103 (I.R.S. Employer Identification No.) |
111 West Washington Street Middleburg, Virginia (Address of principal executive offices) | 20117 (Zip Code) |
(703) 777-6327
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ | No o |
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes þ | No o |
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o | Accelerated filer þ | ||
Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o | No þ |
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. 7,163,255 shares of Common Stock as of August 7, 2015.
MIDDLEBURG FINANCIAL CORPORATION
INDEX
Page No. | |||
2
ITEM 1. | FINANCIAL STATEMENTS |
PART I
MIDDLEBURG FINANCIAL CORPORATION AND SUBSIDIARIES | |||||||
CONSOLIDATED BALANCE SHEETS | |||||||
(Dollars in thousands, except for share and per share data) | |||||||
(Unaudited) | |||||||
June 30, | December 31, | ||||||
2015 | 2014 | ||||||
ASSETS | |||||||
Cash and due from banks | $ | 5,001 | $ | 7,396 | |||
Interest bearing deposits with other banks | 44,406 | 47,626 | |||||
Total cash and cash equivalents | 49,407 | 55,022 | |||||
Securities held to maturity, fair value of $1,374 and $1,397, respectively | 1,500 | 1,500 | |||||
Securities available for sale, at fair value | 351,990 | 348,263 | |||||
Restricted securities, at cost | 5,774 | 5,279 | |||||
Loans, net of allowance for loan losses of $11,894 and $11,786, respectively | 761,196 | 743,060 | |||||
Premises and equipment, net | 19,888 | 18,104 | |||||
Goodwill and identified intangibles, net | 3,722 | 3,807 | |||||
Other real estate owned, net of valuation allowance of $663 and $755, respectively | 3,402 | 4,051 | |||||
Bank owned life insurance | 22,940 | 22,617 | |||||
Accrued interest receivable and other assets | 22,166 | 21,154 | |||||
TOTAL ASSETS | $ | 1,241,985 | $ | 1,222,857 | |||
LIABILITIES | |||||||
Deposits: | |||||||
Non-interest bearing demand deposits | $ | 235,246 | $ | 216,912 | |||
Savings and interest bearing demand deposits | 526,985 | 523,230 | |||||
Time deposits | 243,221 | 248,938 | |||||
Total deposits | 1,005,452 | 989,080 | |||||
Securities sold under agreements to repurchase | 24,049 | 38,551 | |||||
Federal Home Loan Bank borrowings | 70,000 | 55,000 | |||||
Subordinated notes | 5,155 | 5,155 | |||||
Accrued interest payable and other liabilities | 12,539 | 13,037 | |||||
TOTAL LIABILITIES | 1,117,195 | 1,100,823 | |||||
Commitments and contingent liabilities | |||||||
SHAREHOLDERS' EQUITY | |||||||
Common stock ($2.50 par value; 20,000,000 shares authorized; 7,163,255 and 7,131,643 issued and outstanding, respectively) | 17,521 | 17,494 | |||||
Capital surplus | 45,063 | 44,892 | |||||
Retained earnings | 59,152 | 55,854 | |||||
Accumulated other comprehensive income | 3,054 | 3,794 | |||||
TOTAL SHAREHOLDERS' EQUITY | 124,790 | 122,034 | |||||
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY | $ | 1,241,985 | $ | 1,222,857 |
See accompanying notes to the consolidated financial statements.
3
MIDDLEBURG FINANCIAL CORPORATION AND SUBSIDIARIES | |||||||||||||||
CONSOLIDATED STATEMENTS OF INCOME | |||||||||||||||
(Dollars in thousands, except for per share data) | |||||||||||||||
(Unaudited) | |||||||||||||||
For the Three Months Ended June 30, | For the Six Months Ended June 30, | ||||||||||||||
2015 | 2014 | 2015 | 2014 | ||||||||||||
INTEREST INCOME | |||||||||||||||
Interest and fees on loans | $ | 8,014 | $ | 8,493 | $ | 16,257 | $ | 17,299 | |||||||
Interest and dividends on securities | |||||||||||||||
Taxable | 1,792 | 1,792 | 3,698 | 3,410 | |||||||||||
Tax-exempt | 449 | 537 | 910 | 1,121 | |||||||||||
Dividends | 66 | 72 | 125 | 145 | |||||||||||
Interest on deposits with other banks and federal funds sold | 31 | 47 | 61 | 73 | |||||||||||
Total interest and dividend income | 10,352 | 10,941 | 21,051 | 22,048 | |||||||||||
INTEREST EXPENSE | |||||||||||||||
Interest on deposits | 848 | 995 | 1,703 | 1,997 | |||||||||||
Interest on securities sold under agreements to repurchase | 17 | 81 | 62 | 161 | |||||||||||
Interest on FHLB borrowings and other debt | 174 | 355 | 342 | 668 | |||||||||||
Total interest expense | 1,039 | 1,431 | 2,107 | 2,826 | |||||||||||
NET INTEREST INCOME | 9,313 | 9,510 | 18,944 | 19,222 | |||||||||||
(Recovery of) provision for loan losses | (425 | ) | 72 | 25 | 960 | ||||||||||
NET INTEREST INCOME AFTER (RECOVERY OF) PROVISION FOR LOAN LOSSES | 9,738 | 9,438 | 18,919 | 18,262 | |||||||||||
NON-INTEREST INCOME | |||||||||||||||
Service charges on deposit accounts | 612 | 622 | 1,170 | 1,180 | |||||||||||
Trust services income | 1,243 | 1,057 | 2,461 | 2,105 | |||||||||||
Gains (losses) on sales of loans held for sale | (6 | ) | 1,916 | (6 | ) | 4,858 | |||||||||
Gains on sales of securities available for sale, net | 37 | 66 | 138 | 129 | |||||||||||
Commissions on investment sales | 154 | 146 | 283 | 286 | |||||||||||
Bank owned life insurance | 163 | 164 | 323 | 326 | |||||||||||
Gain on sale of majority interest in consolidated subsidiary | — | 24 | — | 24 | |||||||||||
Other operating income | 223 | 278 | 1,065 | 1,247 | |||||||||||
Total non-interest income | 2,426 | 4,273 | 5,434 | 10,155 | |||||||||||
NON-INTEREST EXPENSE | |||||||||||||||
Salaries and employee benefits | 4,973 | 5,993 | 9,821 | 13,026 | |||||||||||
Occupancy and equipment | 1,226 | 1,679 | 2,565 | 3,579 | |||||||||||
Advertising | 101 | 131 | 234 | 294 | |||||||||||
Computer operations | 522 | 510 | 1,012 | 969 | |||||||||||
Other real estate owned | 25 | 12 | 92 | 179 | |||||||||||
Other taxes | 231 | 220 | 454 | 417 | |||||||||||
Federal deposit insurance | 184 | 230 | 395 | 468 | |||||||||||
Other operating expenses | 1,807 | 2,356 | 3,396 | 4,335 | |||||||||||
Total non-interest expense | 9,069 | 11,131 | 17,969 | 23,267 | |||||||||||
Income before income taxes | 3,095 | 2,580 | 6,384 | 5,150 | |||||||||||
Income tax expense | 815 | 667 | 1,656 | 1,415 | |||||||||||
NET INCOME | 2,280 | 1,913 | 4,728 | 3,735 | |||||||||||
Net (income) loss attributable to non-controlling interest | — | (58 | ) | — | 98 | ||||||||||
Net income attributable to Middleburg Financial Corporation | $ | 2,280 | $ | 1,855 | $ | 4,728 | $ | 3,833 | |||||||
Earnings per share: | |||||||||||||||
Basic | $ | 0.32 | $ | 0.26 | $ | 0.66 | $ | 0.54 | |||||||
Diluted | $ | 0.32 | $ | 0.26 | $ | 0.66 | $ | 0.54 |
See accompanying notes to the consolidated financial statements.��
4
MIDDLEBURG FINANCIAL CORPORATION AND SUBSIDIARIES | |||||||||||||||
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME | |||||||||||||||
(Dollars in thousands) | |||||||||||||||
(Unaudited) | |||||||||||||||
For the Three Months Ended June 30, | For the Six Months Ended June 30, | ||||||||||||||
2015 | 2014 | 2015 | 2014 | ||||||||||||
Net income | $ | 2,280 | $ | 1,913 | $ | 4,728 | $ | 3,735 | |||||||
Other comprehensive income (loss), net of tax: | |||||||||||||||
Unrealized holding gains (losses) arising during the period, net of tax of $916, ($974), $333 and ($1,822), respectively | (1,780 | ) | 1,890 | (644 | ) | 3,537 | |||||||||
Reclassification adjustment for gains included in net income, net of tax of $13, $22, $47 and $44, respectively | (24 | ) | (44 | ) | (91 | ) | (85 | ) | |||||||
Unrealized gains (losses) on interest rate swaps, net of tax of ($29), $49, $0 and $53, respectively | 56 | (99 | ) | (1 | ) | (108 | ) | ||||||||
Reclassification adjustment for (gain) loss on interest rate swap ineffectiveness included in net income, net of tax of $0, ($3), $2 and ($3), respectively | — | 5 | (4 | ) | 5 | ||||||||||
Total other comprehensive income (loss) | (1,748 | ) | 1,752 | (740 | ) | 3,349 | |||||||||
Total comprehensive income | 532 | 3,665 | 3,988 | 7,084 | |||||||||||
Comprehensive (income) loss attributable to non-controlling interest | — | (58 | ) | — | 98 | ||||||||||
Comprehensive income attributable to Middleburg Financial Corporation | $ | 532 | $ | 3,607 | $ | 3,988 | $ | 7,182 |
See accompanying notes to the consolidated financial statements.
5
MIDDLEBURG FINANCIAL CORPORATION AND SUBSIDIARIES | |||||||||||||||||||||||
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY | |||||||||||||||||||||||
(Dollars in thousands, except for share and per share data) | |||||||||||||||||||||||
(Unaudited) | |||||||||||||||||||||||
For the Six Months Ended June 30, 2015 and 2014 | |||||||||||||||||||||||
Common Stock | Capital Surplus | Retained Earnings | Accumulated Other Comprehensive Income | Non-Controlling Interest | Total | ||||||||||||||||||
Balance December 31, 2013 | $ | 17,403 | $ | 44,251 | $ | 50,689 | $ | 232 | $ | 2,498 | $ | 115,073 | |||||||||||
Net income | — | — | 3,833 | — | (98 | ) | 3,735 | ||||||||||||||||
Other comprehensive income, net of tax | — | — | — | 3,349 | — | 3,349 | |||||||||||||||||
Cash dividends declared ($0.14 per share) | — | — | (994 | ) | — | — | (994 | ) | |||||||||||||||
Sale of majority interest in consolidated subsidiary | — | — | — | — | (2,400 | ) | (2,400 | ) | |||||||||||||||
Exercise of stock options (9,563 shares) | 24 | 132 | — | — | — | 156 | |||||||||||||||||
Restricted stock vesting (15,258 shares) | 38 | (38 | ) | — | — | — | — | ||||||||||||||||
Repurchase of restricted stock (4,693 shares) | (11 | ) | (75 | ) | — | — | — | (86 | ) | ||||||||||||||
Share-based compensation | — | 213 | — | — | — | 213 | |||||||||||||||||
Balance June 30, 2014 | $ | 17,454 | $ | 44,483 | $ | 53,528 | $ | 3,581 | $ | — | $ | 119,046 | |||||||||||
Balance December 31, 2014 | $ | 17,494 | $ | 44,892 | $ | 55,854 | $ | 3,794 | $ | — | $ | 122,034 | |||||||||||
Net income | — | — | 4,728 | — | — | 4,728 | |||||||||||||||||
Other comprehensive loss, net of tax | — | — | — | (740 | ) | — | (740 | ) | |||||||||||||||
Cash dividends ($0.20 per share) | — | — | (1,430 | ) | — | — | (1,430 | ) | |||||||||||||||
Restricted stock vesting (15,525 shares) | 38 | (38 | ) | — | — | — | — | ||||||||||||||||
Repurchase of restricted stock (4,538 shares) | (11 | ) | (71 | ) | — | — | — | (82 | ) | ||||||||||||||
Share-based compensation | — | 280 | — | — | — | 280 | |||||||||||||||||
Balance June 30, 2015 | $ | 17,521 | $ | 45,063 | $ | 59,152 | $ | 3,054 | $ | — | $ | 124,790 |
See accompanying notes to the consolidated financial statements.
6
MIDDLEBURG FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) | |||||||
For the Six Months Ended | |||||||
June 30, | |||||||
(Dollars in thousands) | 2015 | 2014 | |||||
Cash Flows From Operating Activities | |||||||
Net income | $ | 4,728 | $ | 3,735 | |||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||
Depreciation and amortization | 1,171 | 1,040 | |||||
Provision for loan losses | 25 | 960 | |||||
Gain on sales of securities available for sale, net | (138 | ) | (129 | ) | |||
Loss on disposal of assets, net | 9 | — | |||||
Premium amortization on securities, net | 1,927 | 1,389 | |||||
Decrease in loans held for sale, net | — | 19,691 | |||||
Share-based compensation | 280 | 213 | |||||
Gain on sale of majority interest in consolidated subsidiary | — | (24 | ) | ||||
Loss on sale of other real estate owned, net | 35 | (140 | ) | ||||
Valuation adjustment on other real estate owned | 20 | 168 | |||||
Valuation adjustment on property held for sale | — | 200 | |||||
Changes in assets and liabilities: | |||||||
(Increase) decrease in other assets | (1,447 | ) | 611 | ||||
Decrease in other liabilities | (498 | ) | (882 | ) | |||
Net cash provided by operating activities | $ | 6,112 | $ | 26,832 | |||
Cash Flows from Investing Activities | |||||||
Proceeds from maturity, calls principal repayments and sales of securities available for sale | 62,646 | 71,065 | |||||
Purchase of securities available for sale | (69,277 | ) | (68,339 | ) | |||
Redemption (purchase) of restricted stock, net | (495 | ) | 376 | ||||
Purchases of bank premises and equipment, net | (2,471 | ) | (281 | ) | |||
Origination of loans, net | (19,288 | ) | (8,936 | ) | |||
Proceeds from sale of loans | 1,127 | 5,492 | |||||
Proceeds from sale of majority interest in consolidated subsidiary, net | — | 3,618 | |||||
Proceeds from sale of other real estate owned and repossessed assets | 673 | 1,086 | |||||
Net cash (used in) provided by investing activities | $ | (27,085 | ) | $ | 4,081 | ||
Cash Flows from Financing Activities | |||||||
Increase in demand, interest-bearing demand and savings deposits | $ | 22,089 | $ | 34,077 | |||
Decrease in time deposits | (5,717 | ) | (12,978 | ) | |||
Increase (decrease) in securities sold under agreements to repurchase | (14,502 | ) | 792 | ||||
Increase in FHLB borrowings | 15,000 | — | |||||
Payment of dividends on common stock | (1,430 | ) | (994 | ) | |||
Proceeds from issuance of common stock, net | — | 156 | |||||
Repurchase of common stock | (82 | ) | (86 | ) | |||
Net cash provided by financing activities | $ | 15,358 | $ | 20,967 | |||
Increase (decrease) in cash and and cash equivalents | (5,615 | ) | 51,880 | ||||
Cash and cash equivalents at beginning of the period | 55,022 | 67,343 | |||||
Cash and cash equivalents at end of the period | $ | 49,407 | $ | 119,223 | |||
Supplemental Disclosures of Cash Flow Information | |||||||
Interest paid | $ | 2,147 | $ | 2,884 | |||
Income taxes | $ | 1,360 | $ | 425 | |||
Supplemental Disclosure of Non-Cash Transactions | |||||||
Unrealized (loss) gain on securities available for sale | $ | (1,115 | ) | $ | 5,230 | ||
Change in market value of interest rate swap | $ | (7 | ) | $ | (156 | ) | |
Transfer of loans to other real estate owned and repossessed assets | $ | — | $ | 2,046 |
See accompanying notes to the consolidated financial statements.
7
MIDDLEBURG FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Note 1. General
In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position at June 30, 2015 and December 31, 2014, the results of operations, comprehensive income, for the three and six month periods ending June 30, 2015 and 2014 and changes in shareholders' equity and cash flows for the six months ended June 30, 2015 and 2014, in accordance with accounting principles generally accepted in the United States of America. The statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2014 (the “2014 Form 10-K”) of Middleburg Financial Corporation (the “Company”). The results of operations for the three and six months ended June 30, 2015 are not necessarily indicative of the results to be expected for the full year.
In preparing these financial statements, management has evaluated subsequent events and transactions for potential recognition or disclosure through the date these financial statements were issued. Management has concluded there were no additional material subsequent events to be disclosed.
Certain amounts in the 2014 consolidated financial statements have been reclassified to conform to the 2015 presentation. The amounts of these items are not considered to be material variations from the original classifications and presentations.
On May 15, 2014, the Company sold all of its interest in Southern Trust Mortgage to a consortium of banks and the President of Southern Trust Mortgage. While the Company no longer has a direct financial interest in Southern Trust Mortgage, the Company maintains a warehouse participation agreement with Southern Trust Mortgage in the amount of $19.0 million, which is reflected in loans, net of allowance for loan losses, on the Company's consolidated balance sheets.
Note 2. Share-Based Compensation Plan
The Company sponsors one share-based compensation plan, the 2006 Equity Compensation Plan, which provides for the granting of stock options, stock appreciation rights, stock awards, performance share awards, incentive awards, and stock units. The 2006 Equity Compensation Plan was approved by the Company’s shareholders at the Annual Meeting held on April 26, 2006, and has succeeded the Company’s 1997 Stock Incentive Plan. Under the plan, the Company may grant share-based compensation to its directors, officers, employees, and other persons the Company determines have contributed to the profits or growth of the Company. The number of shares reserved for issuance total 430,000 shares.
For the six months ended June 30, 2015, and 2014, the Company recorded $280,000 and $213,000, respectively, in share-based compensation expense. As of June 30, 2015, there was $1.8 million of total unrecognized compensation expense related to non-vested restricted awards under the 2006 Equity Compensation Plan. For the three and six months ended June 30, 2015, the Company recorded no compensation expense related to option awards. As of June 30, 2015 all outstanding option awards were previously vested and, accordingly, there was no unrecognized compensation expense as of June 30, 2015.
The aggregate intrinsic value, noted in the tables below, represents the amount by which the current market value of the underlying stock exceeds the exercise price as of June 30, 2015. Given there is no exercise price for restricted stock, the amount is equal to the current market value of the stock. This amount changes based on changes in the market value of the Company’s common stock.
The following table summarizes restricted stock awarded under the 2006 Equity Compensation Plan:
June 30, 2015 | ||||||||||
Shares | Weighted-Average Grant Date Fair Value | Aggregate Intrinsic Value (in thousands) | ||||||||
Non-vested at December 31, 2014 | 134,108 | $ | 16.66 | |||||||
Granted | 36,150 | 18.50 | ||||||||
Vested | (15,525 | ) | 15.79 | |||||||
Forfeited | — | — | ||||||||
Non-vested at June 30, 2015 | 154,733 | $ | 17.17 | $ | 2,785 |
The weighted-average remaining contractual term for non-vested service award grants at June 30, 2015, was 3.43 years.
8
The following table summarizes options outstanding under the 2006 Equity Compensation Plan and remaining outstanding unexercised options under the 1997 Stock Incentive Plan.
June 30, 2015 | ||||||||||
Shares | Weighted-Average Exercise Price | Aggregate Intrinsic Value (in thousands) | ||||||||
Outstanding at December 31, 2014 | 30,012 | $ | 14.00 | $ | — | |||||
Granted | — | — | — | |||||||
Exercised | — | — | — | |||||||
Forfeited | — | — | — | |||||||
Outstanding at June 30, 2015 | 30,012 | $ | 14.00 | $ | 120 | |||||
Options exercisable at June 30, 2015 | 30,012 | $ | 14.00 | $ | 120 |
As of June 30, 2015, options outstanding and exercisable are summarized as follows:
Exercise Prices | Options Outstanding | Weighted-Average Remaining Contractual Life (years) | Options Exercisable | |||||||
$ | 14.00 | 25,012 | 3.71 | 25,012 | ||||||
$ | 14.00 | 5,000 | 4.34 | 5,000 | ||||||
$ | 14.00 | 30,012 | 3.81 | 30,012 |
Note 3. Securities
Amortized costs and fair values of securities held to maturity are summarized as follows.
June 30, 2015 | |||||||||||||||
(Dollars in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||
Held to Maturity | |||||||||||||||
Obligations of states and political subdivisions | $ | 1,500 | $ | — | $ | (126 | ) | $ | 1,374 | ||||||
Total | $ | 1,500 | $ | — | $ | (126 | ) | $ | 1,374 |
December 31, 2014 | |||||||||||||||
(Dollars in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||
Held to Maturity | |||||||||||||||
Obligations of states and political subdivisions | $ | 1,500 | $ | — | $ | (103 | ) | $ | 1,397 | ||||||
Total | $ | 1,500 | $ | — | $ | (103 | ) | $ | 1,397 |
The amortized cost and fair value of securities held to maturity as of June 30, 2015, by contractual maturity are shown below.
June 30, 2015 | |||||||
(Dollars in thousands) | Amortized Cost | Fair Value | |||||
Held to Maturity | |||||||
Due after ten years | $ | 1,500 | $ | 1,374 | |||
Total | $ | 1,500 | $ | 1,374 |
9
Amortized costs and fair values of securities available for sale are summarized as follows:
June 30, 2015 | |||||||||||||||
(Dollars in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||
Available for Sale | |||||||||||||||
U.S. government agencies | $ | 45,291 | $ | 336 | $ | (156 | ) | $ | 45,471 | ||||||
U.S. Treasury securities | 50 | — | — | 50 | |||||||||||
Obligations of states and political subdivisions | 71,900 | 1,864 | (521 | ) | 73,243 | ||||||||||
Mortgage-backed securities: | |||||||||||||||
Agency | 142,586 | 4,323 | (543 | ) | 146,366 | ||||||||||
Non-agency | 17,892 | 28 | (54 | ) | 17,866 | ||||||||||
Other asset backed securities | 51,803 | 698 | (308 | ) | 52,193 | ||||||||||
Corporate securities | 17,553 | 15 | (767 | ) | 16,801 | ||||||||||
Total | $ | 347,075 | $ | 7,264 | $ | (2,349 | ) | $ | 351,990 |
December 31, 2014 | |||||||||||||||
(Dollars in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||
Available for Sale | |||||||||||||||
U.S. government agencies | $ | 41,317 | $ | 283 | $ | (203 | ) | $ | 41,397 | ||||||
Obligations of states and political subdivisions | 55,541 | 2,408 | (209 | ) | 57,740 | ||||||||||
Mortgage-backed securities: | |||||||||||||||
Agency | 169,257 | 4,698 | (742 | ) | 173,213 | ||||||||||
Non-agency | 28,235 | 115 | (227 | ) | 28,123 | ||||||||||
Other asset backed securities | 31,338 | 433 | (58 | ) | 31,713 | ||||||||||
Corporate securities | 16,545 | 131 | (599 | ) | 16,077 | ||||||||||
Total | $ | 342,233 | $ | 8,068 | $ | (2,038 | ) | $ | 348,263 |
The amortized cost and fair value of securities available for sale as of June 30, 2015, by contractual maturity are shown below. Maturities may differ from contractual maturities in corporate and mortgage-backed securities because the securities and mortgages underlying the securities may be called or repaid without any penalties. Therefore, these securities are not included in the maturity categories in the following maturity summary.
June 30, 2015 | |||||||
(Dollars in thousands) | Amortized Cost | Fair Value | |||||
Due in one year or less | $ | 240 | $ | 242 | |||
Due after one year through five years | 8,983 | 9,253 | |||||
Due after five years through ten years | 28,048 | 27,922 | |||||
Due after ten years | 97,523 | 98,148 | |||||
Mortgage-backed securities | 160,478 | 164,232 | |||||
Other asset backed securities | 51,803 | 52,193 | |||||
Total | $ | 347,075 | $ | 351,990 |
Proceeds from sales of securities during the six months ended June 30, 2015, were $16.0 million. Gross gains of $175,000 and gross losses of $37,000 were realized on those sales, respectively. The tax expense applicable to these net realized gains amounted to $47,000.
The carrying value of securities pledged to qualify for fiduciary powers, to secure public monies and for other purposes as required by law amounted to $94.6 million and $125.7 million at June 30, 2015 and December 31, 2014, respectively.
10
Investments in an unrealized loss position that are temporarily impaired are as follows:
(Dollars in thousands) | Less than Twelve Months | Twelve Months or Greater | Total | |||||||||||||||||||||
June 30, 2015 | Fair Value | Gross Unrealized Losses | Fair Value | Gross Unrealized Losses | Fair Value | Gross Unrealized Losses | ||||||||||||||||||
Held to Maturity | ||||||||||||||||||||||||
Obligations of states and political subdivisions | $ | 1,374 | $ | (126 | ) | $ | — | $ | — | $ | 1,374 | $ | (126 | ) | ||||||||||
Total | $ | 1,374 | $ | (126 | ) | $ | — | $ | — | $ | 1,374 | $ | (126 | ) | ||||||||||
Available for Sale | ||||||||||||||||||||||||
U.S. government agencies | $ | 18,059 | $ | (87 | ) | $ | 2,553 | $ | (69 | ) | $ | 20,612 | $ | (156 | ) | |||||||||
Obligations of states and political subdivisions | 22,972 | (288 | ) | 3,504 | (233 | ) | 26,476 | (521 | ) | |||||||||||||||
Mortgage-backed securities: | ||||||||||||||||||||||||
Agency | 24,994 | (327 | ) | 6,692 | (216 | ) | 31,686 | (543 | ) | |||||||||||||||
Non-agency | 11,879 | (53 | ) | 55 | (1 | ) | 11,934 | (54 | ) | |||||||||||||||
Other asset backed securities | 14,191 | (86 | ) | 10,890 | (222 | ) | 25,081 | (308 | ) | |||||||||||||||
Corporate securities | 12,932 | (442 | ) | 2,675 | (325 | ) | 15,607 | (767 | ) | |||||||||||||||
Total | $ | 105,027 | $ | (1,283 | ) | $ | 26,369 | $ | (1,066 | ) | $ | 131,396 | $ | (2,349 | ) |
(Dollars in thousands) | Less than Twelve Months | Twelve Months or Greater | Total | |||||||||||||||||||||
December 31, 2014 | Fair Value | Gross Unrealized Losses | Fair Value | Gross Unrealized Losses | Fair Value | Gross Unrealized Losses | ||||||||||||||||||
Held to Maturity | ||||||||||||||||||||||||
Obligations of states and political subdivisions | $ | 1,397 | $ | (103 | ) | $ | — | $ | — | $ | 1,397 | $ | (103 | ) | ||||||||||
Total | $ | 1,397 | $ | (103 | ) | $ | — | $ | — | $ | 1,397 | $ | (103 | ) | ||||||||||
Available for Sale | ||||||||||||||||||||||||
U.S. government agencies | $ | 15,331 | $ | (65 | ) | $ | 5,833 | $ | (138 | ) | $ | 21,164 | $ | (203 | ) | |||||||||
Obligations of states and political subdivisions | 2,780 | (14 | ) | 3,456 | (195 | ) | 6,236 | (209 | ) | |||||||||||||||
Mortgage-backed securities: | ||||||||||||||||||||||||
Agency | 28,065 | (327 | ) | 11,027 | (415 | ) | 39,092 | (742 | ) | |||||||||||||||
Non-agency | 15,488 | (167 | ) | 4,730 | (60 | ) | 20,218 | (227 | ) | |||||||||||||||
Other asset backed securities | 6,594 | (45 | ) | 1,077 | (13 | ) | 7,671 | (58 | ) | |||||||||||||||
Corporate securities | 9,192 | (391 | ) | 792 | (208 | ) | 9,984 | (599 | ) | |||||||||||||||
Total | $ | 77,450 | $ | (1,009 | ) | $ | 26,915 | $ | (1,029 | ) | $ | 104,365 | $ | (2,038 | ) |
A total of 156 securities have been identified by the Company as temporarily impaired at June 30, 2015. Of the 156 securities, 154 are investment grade and two are speculative grade. Mortgage-backed securities, municipal securities and corporate securities make up the majority of the gross unrealized losses for temporarily impaired securities at June 30, 2015. Market prices change daily and are affected by conditions beyond the control of the Company. Although the Company has the ability to hold these securities until the temporary loss is recovered, decisions by management may necessitate a sale before the loss is fully recovered. No such sales were anticipated or required as of June 30, 2015. Investment decisions reflect the strategic asset/liability objectives of the Company. The investment portfolio is analyzed frequently by the Company and managed to provide an overall positive impact to the Company’s consolidated income statement and balance sheet.
Other-than-temporary impairment losses
At June 30, 2015, the Company evaluated the investment portfolio for possible other-than-temporary impairment losses and concluded that no adverse change in cash flows occurred and did not consider any portfolio securities to be other-than-temporarily impaired. Based on this analysis and because the Company does not intend to sell securities prior to maturity and it is more likely
11
than not the Company will not be required to sell any securities before recovery of amortized cost basis, which may be at maturity. For debt securities related to corporate securities, the Company determined that there was no other adverse change in the cash flows as viewed by a market participant; therefore, the Company does not consider the investments in these assets to be other-than-temporarily impaired at June 30, 2015. However, there is a risk that the Company’s continuing reviews could result in recognition of other-than-temporary impairment charges in the future. For the three and six months ended June 30, 2015 and the year ended December 31, 2014, no credit related impairment losses were recognized by the Company.
The Company’s investment in FHLB stock totaled $4.1 million and $3.6 million at June 30, 2015 and December 31, 2014, respectively. FHLB stock is generally viewed as a long-term investment and as a restricted security which is carried at cost because there is no market for the stock other than the FHLB or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. The Company does not consider this investment to be other-than-temporarily impaired at June 30, 2015, and no impairment has been recognized. FHLB stock is shown in restricted securities on the consolidated balance sheets.
The Company also has an investment in Federal Reserve Bank (“FRB”) stock which totaled $1.7 million at June 30, 2015 and December 31, 2014, respectively. The investment in FRB stock is a required investment and is carried at cost since there is no ready market. The Company does not consider this investment to be other-than-temporarily impaired at June 30, 2015 and no impairment has been recognized. FRB stock is shown in the restricted securities line item on the consolidated balance sheets.
Note 4. Loans, Net
The Company segregates its loan portfolio into three primary loan segments: Real Estate Loans, Commercial Loans, and Consumer Loans. Real estate loans are further segregated into the following classes: construction loans, loans secured by farmland, loans secured by 1-4 family residential real estate, and other real estate loans. Other real estate loans include commercial real estate loans. The consolidated loan portfolio was composed of the following:
June 30, 2015 | December 31, 2014 | ||||||||||||
(Dollars in thousands) | Outstanding Balance | Percent of Total Portfolio | Outstanding Balance | Percent of Total Portfolio | |||||||||
Real estate loans: | |||||||||||||
Construction | $ | 30,781 | 4.0 | % | $ | 33,050 | 4.4 | % | |||||
Secured by farmland | 19,505 | 2.5 | 19,708 | 2.6 | |||||||||
Secured by 1-4 family residential | 272,198 | 35.2 | 265,216 | 35.1 | |||||||||
Other real estate loans | 265,892 | 34.4 | 255,236 | 33.8 | |||||||||
Commercial loans | 167,542 | 21.7 | 163,269 | 21.6 | |||||||||
Consumer loans | 17,172 | 2.2 | 18,367 | 2.5 | |||||||||
Total Gross Loans (1) | $ | 773,090 | 100.0 | % | $ | 754,846 | 100.0 | % | |||||
Less allowance for loan losses | 11,894 | 11,786 | |||||||||||
Net loans | $ | 761,196 | $ | 743,060 |
(1) | Includes net deferred loan costs and premiums of $3.1 million and $3.0 million, respectively. |
The following tables present a contractual aging of the recorded investment in past due loans by class of loans:
June 30, 2015 | |||||||||||||||||||||||
(Dollars in thousands) | 30-59 Days Past Due | 60-89 Days Past Due | 90 Days Or Greater | Total Past Due | Current | Total Loans | |||||||||||||||||
Real estate loans: | |||||||||||||||||||||||
Construction | $ | — | $ | — | $ | — | $ | — | $ | 30,781 | $ | 30,781 | |||||||||||
Secured by farmland | — | — | — | — | 19,505 | 19,505 | |||||||||||||||||
Secured by 1-4 family residential | 374 | 463 | 623 | 1,460 | 270,738 | 272,198 | |||||||||||||||||
Other real estate loans | 331 | — | 85 | 416 | 265,476 | 265,892 | |||||||||||||||||
Commercial loans | 22 | — | 88 | 110 | 167,432 | 167,542 | |||||||||||||||||
Consumer loans | 93 | — | — | 93 | 17,079 | 17,172 | |||||||||||||||||
Total | $ | 820 | $ | 463 | $ | 796 | $ | 2,079 | $ | 771,011 | $ | 773,090 |
12
December 31, 2014 | |||||||||||||||||||||||
(Dollars in thousands) | 30-59 Days Past Due | 60-89 Days Past Due | 90 Days Or Greater | Total Past Due | Current | Total Loans | |||||||||||||||||
Real estate loans: | |||||||||||||||||||||||
Construction | $ | — | $ | — | $ | — | $ | — | $ | 33,050 | $ | 33,050 | |||||||||||
Secured by farmland | — | — | — | — | 19,708 | 19,708 | |||||||||||||||||
Secured by 1-4 family residential | 819 | — | 548 | 1,367 | 263,849 | 265,216 | |||||||||||||||||
Other real estate loans | — | — | — | — | 255,236 | 255,236 | |||||||||||||||||
Commercial loans | 138 | — | 320 | 458 | 162,811 | 163,269 | |||||||||||||||||
Consumer loans | 16 | 1 | 3,003 | 3,020 | 15,347 | 18,367 | |||||||||||||||||
Total | $ | 973 | $ | 1 | $ | 3,871 | $ | 4,845 | $ | 750,001 | $ | 754,846 |
The following table presents the recorded investment in nonaccrual loans and loans past due 90 days or more and still accruing by class of loans:
June 30, 2015 | December 31, 2014 | ||||||||||||||
(Dollars in thousands) | Nonaccrual | Past due 90 days or more and still accruing | Nonaccrual | Past due 90 days or more and still accruing | |||||||||||
Real estate loans: | |||||||||||||||
Construction | $ | 223 | $ | — | $ | 247 | $ | — | |||||||
Secured by 1-4 family residential | 4,491 | — | 4,932 | — | |||||||||||
Other real estate loans | 1,187 | 85 | 1,472 | — | |||||||||||
Commercial loans | 73 | 88 | 290 | 30 | |||||||||||
Consumer loans | 2,034 | — | 3,003 | — | |||||||||||
Total | $ | 8,008 | $ | 173 | $ | 9,944 | $ | 30 |
If interest on nonaccrual loans had been accrued, such income would have approximated $187,000 and $544,000 for the six months ended June 30, 2015 and the year ended December 31, 2014, respectively.
The Company utilizes an internal asset classification system as a means of measuring and monitoring credit risk in the loan portfolio. Under the Company’s classification system, problem and potential problem loans are classified as “Special Mention”, “Substandard”, and “Doubtful”.
Special Mention: Loans with potential weaknesses that deserve management’s close attention. If left uncorrected, the potential weaknesses may result in the deterioration of the repayment prospects for the credit.
Substandard: Loans with well-defined weakness that jeopardize the liquidation of the debt. Either the paying capacity of the borrower or the value of the collateral may be inadequate to protect the Company from potential losses.
Doubtful: Loans with a very high possibility of loss. However, because of important and reasonably specific pending factors, classification as a loss is deferred until a more exact status may be determined.
Loss: Loans are deemed uncollectible and are charged off immediately.
The following tables present the recorded investment in loans by class of loan that have been classified according to the internal classification system:
June 30, 2015 | |||||||||||||||||||||||||||
(Dollars in thousands) | Real Estate Construction | Real Estate Secured by Farmland | Real Estate Secured by 1-4 Family Residential | Other Real Estate Loans | Commercial | Consumer | Total | ||||||||||||||||||||
Pass | $ | 23,788 | $ | 11,004 | $ | 262,946 | $ | 251,176 | $ | 165,897 | $ | 15,066 | $ | 729,877 | |||||||||||||
Special Mention | 6,433 | — | 1,572 | 6,607 | 1,429 | 34 | 16,075 | ||||||||||||||||||||
Substandard | 560 | 8,501 | 6,782 | 6,922 | 216 | 2,068 | 25,049 | ||||||||||||||||||||
Doubtful | — | — | 898 | 1,187 | — | 4 | 2,089 | ||||||||||||||||||||
Loss | — | — | — | — | — | — | — | ||||||||||||||||||||
Ending Balance | $ | 30,781 | $ | 19,505 | $ | 272,198 | $ | 265,892 | $ | 167,542 | $ | 17,172 | $ | 773,090 |
13
December 31, 2014 | |||||||||||||||||||||||||||
(Dollars in thousands) | Real Estate Construction | Real Estate Secured by Farmland | Real Estate Secured by 1-4 Family Residential | Other Real Estate Loans | Commercial | Consumer | Total | ||||||||||||||||||||
Pass | $ | 25,637 | $ | 11,203 | $ | 255,898 | $ | 232,169 | $ | 159,595 | $ | 15,310 | $ | 699,812 | |||||||||||||
Special Mention | 6,764 | 7,903 | 1,518 | 15,687 | 3,059 | 18 | 34,949 | ||||||||||||||||||||
Substandard | 649 | 602 | 7,348 | 7,380 | 369 | 3,019 | 19,367 | ||||||||||||||||||||
Doubtful | — | — | 452 | — | 246 | 3 | 701 | ||||||||||||||||||||
Loss | — | — | — | — | — | 17 | 17 | ||||||||||||||||||||
Ending Balance | $ | 33,050 | $ | 19,708 | $ | 265,216 | $ | 255,236 | $ | 163,269 | $ | 18,367 | $ | 754,846 |
The following tables present loans individually evaluated for impairment by class of loan:
June 30, 2015 | |||||||||||||||||||
(Dollars in thousands) | Recorded Investment | Unpaid Principal Balance | Related Allowance | Average Recorded Investment | Interest Income Recognized | ||||||||||||||
With no related allowance recorded: | |||||||||||||||||||
Real estate loans: | |||||||||||||||||||
Construction | $ | 114 | $ | 114 | $ | — | $ | 123 | $ | — | |||||||||
Secured by farmland | 7,903 | 7,903 | — | 7,903 | 113 | ||||||||||||||
Secured by 1-4 family residential | 642 | 642 | — | 667 | — | ||||||||||||||
Other real estate loans | — | — | — | — | — | ||||||||||||||
Commercial loans | 468 | 468 | — | 473 | 9 | ||||||||||||||
Consumer loans | — | — | — | — | — | ||||||||||||||
Total with no related allowance | $ | 9,127 | $ | 9,127 | $ | — | $ | 9,166 | $ | 122 | |||||||||
With an allowance recorded: | |||||||||||||||||||
Real estate loans: | |||||||||||||||||||
Construction | $ | 109 | $ | 109 | $ | 60 | $ | 112 | $ | — | |||||||||
Secured by farmland | — | — | — | — | — | ||||||||||||||
Secured by 1-4 family residential | 4,081 | 4,133 | 1,412 | 4,111 | 8 | ||||||||||||||
Other real estate loans | 4,230 | 4,230 | 454 | 4,241 | 78 | ||||||||||||||
Commercial loans | 327 | 327 | 43 | 344 | 8 | ||||||||||||||
Consumer loans | 2,033 | 2,033 | 1,003 | 2,522 | — | ||||||||||||||
Total with a related allowance | $ | 10,780 | $ | 10,832 | $ | 2,972 | $ | 11,330 | $ | 94 | |||||||||
Total | $ | 19,907 | $ | 19,959 | $ | 2,972 | $ | 20,496 | $ | 216 |
14
December 31, 2014 | |||||||||||||||||||
(Dollars in thousands) | Recorded Investment | Unpaid Principal Balance | Related Allowance | Average Recorded Investment | Interest Income Recognized | ||||||||||||||
With no related allowance recorded: | |||||||||||||||||||
Real estate loans: | |||||||||||||||||||
Construction | $ | 131 | $ | 131 | $ | — | $ | 138 | $ | — | |||||||||
Secured by farmland | 7,903 | 7,903 | — | 7,903 | 454 | ||||||||||||||
Secured by 1-4 family residential | 1,919 | 2,047 | — | 2,032 | 16 | ||||||||||||||
Other real estate loans | 3,289 | 3,289 | — | 3,352 | 104 | ||||||||||||||
Commercial loans | 448 | 448 | — | 454 | 18 | ||||||||||||||
Consumer loans | — | — | — | — | — | ||||||||||||||
Total with no related allowance | $ | 13,690 | $ | 13,818 | $ | — | $ | 13,879 | $ | 592 | |||||||||
With an allowance recorded: | |||||||||||||||||||
Real estate loans: | |||||||||||||||||||
Construction | $ | 115 | $ | 115 | $ | 66 | $ | 124 | $ | — | |||||||||
Secured by farmland | — | — | — | — | — | ||||||||||||||
Secured by 1-4 family residential | 3,694 | 3,746 | 1,370 | 3,704 | 11 | ||||||||||||||
Other real estate loans | 1,242 | 1,242 | 294 | 1,260 | 69 | ||||||||||||||
Commercial loans | 398 | 1,248 | 292 | 783 | 7 | ||||||||||||||
Consumer loans | 3,019 | 3,019 | 647 | 3,021 | 2 | ||||||||||||||
Total with a related allowance | $ | 8,468 | $ | 9,370 | $ | 2,669 | $ | 8,892 | $ | 89 | |||||||||
Total | $ | 22,158 | $ | 23,188 | $ | 2,669 | $ | 22,771 | $ | 681 |
The “Recorded Investment” amounts in the table above represent the outstanding principal balance net of charge-offs and nonaccrual payments to interest on each loan represented in the table. The “Unpaid Principal Balance” represents the outstanding principal balance on each loan represented in the table plus any amounts that have been charged-off on each loan and nonaccrual payments applied to principal.
Included in certain loan categories of impaired loans are troubled debt restructurings (“TDRs”). The total balance of TDRs at June 30, 2015 was $15.7 million of which $3.6 million were included in the Company’s nonaccrual loan totals at that date and $12.1 million represented loans performing as agreed according to the restructured terms. This compares with $6.9 million in total restructured loans at December 31, 2014. The amount of the valuation allowance related to TDRs was $1.62 million and $517,000 as of June 30, 2015 and December 31, 2014, respectively.
Loan modifications that were classified as TDRs during the three and six months ended June 30, 2015 and 2014 were as follows:
Loans Modified as TDRs | ||||||||||||||||||||||
For the Three Months Ended June 30, | ||||||||||||||||||||||
(Dollars in thousands) | 2015 | 2014 | ||||||||||||||||||||
Class of Loan | Number of Contracts | Pre-Modification Outstanding Recorded Investment | Post-Modification Outstanding Recorded Investment | Number of Contracts | Pre-Modification Outstanding Recorded Investment | Post-Modification Outstanding Recorded Investment | ||||||||||||||||
Real estate loans: | ||||||||||||||||||||||
Construction | — | $ | — | $ | — | — | $ | — | $ | — | ||||||||||||
Secured by farmland | 1 | 7,903 | 7,903 | — | — | — | ||||||||||||||||
Secured by 1-4 family residential | — | — | — | 1 | 409 | 409 | ||||||||||||||||
Other real estate loans | — | — | — | — | — | — | ||||||||||||||||
Total real estate loans | 1 | $ | 7,903 | $ | 7,903 | 1 | $ | 409 | $ | 409 | ||||||||||||
Commercial loans | — | — | — | — | — | — | ||||||||||||||||
Consumer loans | 1 | 3,000 | 3,000 | — | — | — | ||||||||||||||||
Total | 2 | $ | 10,903 | $ | 10,903 | 1 | $ | 409 | $ | 409 |
15
Loans Modified as TDRs | ||||||||||||||||||||||
For the Six Months Ended June 30, | ||||||||||||||||||||||
(Dollars in thousands) | 2015 | 2014 | ||||||||||||||||||||
Class of Loan | Number of Contracts | Pre-Modification Outstanding Recorded Investment | Post-Modification Outstanding Recorded Investment | Number of Contracts | Pre-Modification Outstanding Recorded Investment | Post-Modification Outstanding Recorded Investment | ||||||||||||||||
Real estate loans: | ||||||||||||||||||||||
Construction | — | $ | — | $ | — | — | $ | — | $ | — | ||||||||||||
Secured by farmland | 1 | 7,903 | 7,903 | — | — | — | ||||||||||||||||
Secured by 1-4 family residential | — | — | — | 4 | 1,190 | 1,142 | ||||||||||||||||
Other real estate loans | — | — | — | 1 | 200 | 173 | ||||||||||||||||
Total real estate loans | 1 | $ | 7,903 | $ | 7,903 | 5 | $ | 1,390 | $ | 1,315 | ||||||||||||
Commercial loans | — | — | — | — | — | — | ||||||||||||||||
Consumer loans | 1 | 3,000 | 3,000 | — | — | — | ||||||||||||||||
Total | 2 | $ | 10,903 | $ | 10,903 | 5 | $ | 1,390 | $ | 1,315 |
There were no outstanding commitments to lend additional amounts to troubled debt restructured borrowers at June 30, 2015.
TDR payment defaults during three and six months ended June 30, 2015 and 2014 were as follows:
For the Three Months Ended June 30, | ||||||||||||||
(Dollars in thousands) | 2015 | 2014 | ||||||||||||
Class of Loan | Number of Loans | Recorded Investment | Number of Loans | Recorded Investment | ||||||||||
Real estate loans: | ||||||||||||||
Construction | — | $ | — | — | $ | — | ||||||||
Secured by farmland | — | — | — | — | ||||||||||
Secured by 1-4 family residential | — | — | 2 | 200 | ||||||||||
Other real estate loans | — | — | 1 | 94 | ||||||||||
Total real estate loans | — | $ | — | 3 | $ | 294 | ||||||||
Commercial loans | — | — | 1 | 49 | ||||||||||
Consumer loans | — | — | — | — | ||||||||||
Total | — | $ | — | 4 | $ | 343 |
For the Six Months Ended June 30, | ||||||||||||||
(Dollars in thousands) | 2015 | 2014 | ||||||||||||
Class of Loan | Number of Loans | Recorded Investment | Number of Loans | Recorded Investment | ||||||||||
Real estate loans: | ||||||||||||||
Construction | — | $ | — | — | $ | — | ||||||||
Secured by farmland | — | — | — | — | ||||||||||
Secured by 1-4 family residential | — | — | 4 | 376 | ||||||||||
Other real estate loans | — | — | 1 | 94 | ||||||||||
Total real estate loans | — | $ | — | 5 | $ | 470 | ||||||||
Commercial loans | — | — | 1 | 49 | ||||||||||
Consumer loans | — | — | — | — | ||||||||||
Total | — | $ | — | 6 | $ | 519 |
For purposes of this disclosure, a TDR payment default occurs when, within 12 months of the original TDR modification, either a full or partial charge-off occurs or a TDR becomes 90 days or more past due.
16
Note 5. Allowance for Loan Losses
The following table presents, the total allowance for loan losses, the allowance by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment), the total loans and loans by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment).
June 30, 2015 | |||||||||||||||||||||||||||
(Dollars in thousands) | Real Estate Construction | Real Estate Secured by Farmland | Real Estate Secured by 1-4 Family Residential | Other Real Estate Loans | Commercial | Consumer | Total | ||||||||||||||||||||
Allowance for loan losses: | |||||||||||||||||||||||||||
Balance at December 31, 2014 | $ | 550 | $ | 179 | $ | 3,966 | $ | 3,916 | $ | 2,354 | $ | 821 | $ | 11,786 | |||||||||||||
Charge-offs | — | — | (12 | ) | (9 | ) | (246 | ) | (40 | ) | (307 | ) | |||||||||||||||
Recoveries | 31 | — | 324 | 21 | 8 | 6 | 390 | ||||||||||||||||||||
Provision | (21 | ) | 11 | (156 | ) | 35 | (272 | ) | 428 | 25 | |||||||||||||||||
Balance at June 30, 2015 | $ | 560 | $ | 190 | $ | 4,122 | $ | 3,963 | $ | 1,844 | $ | 1,215 | $ | 11,894 | |||||||||||||
Ending allowance: | |||||||||||||||||||||||||||
Ending allowance balance attributable to loans: | |||||||||||||||||||||||||||
Individually evaluated for impairment | $ | 60 | $ | — | $ | 1,412 | $ | 454 | $ | 43 | $ | 1,003 | $ | 2,972 | |||||||||||||
Collectively evaluated for impairment | 500 | 190 | 2,710 | 3,509 | 1,801 | 212 | 8,922 | ||||||||||||||||||||
Total ending allowance balance | $ | 560 | $ | 190 | $ | 4,122 | $ | 3,963 | $ | 1,844 | $ | 1,215 | $ | 11,894 | |||||||||||||
Loans: | |||||||||||||||||||||||||||
Individually evaluated for impairment | $ | 223 | $ | 7,903 | $ | 4,723 | $ | 4,230 | $ | 795 | $ | 2,033 | $ | 19,907 | |||||||||||||
Collectively evaluated for impairment | 30,558 | 11,602 | 267,475 | 261,662 | 166,747 | 15,139 | 753,183 | ||||||||||||||||||||
Total ending loans balance | $ | 30,781 | $ | 19,505 | $ | 272,198 | $ | 265,892 | $ | 167,542 | $ | 17,172 | $ | 773,090 |
17
December 31, 2014 | |||||||||||||||||||||||||||
(Dollars in thousands) | Real Estate Construction | Real Estate Secured by Farmland | Real Estate Secured by 1-4 Family Residential | Other Real Estate Loans | Commercial | Consumer | Total | ||||||||||||||||||||
Allowance for loan losses: | |||||||||||||||||||||||||||
Balance at December 31, 2013 | $ | 847 | $ | 166 | $ | 6,734 | $ | 3,506 | $ | 1,890 | $ | 177 | $ | 13,320 | |||||||||||||
Adjustment for the sale of majority interest in consolidated subsidiary | — | — | (95 | ) | — | — | — | (95 | ) | ||||||||||||||||||
Charge-offs | (1,186 | ) | — | (1,380 | ) | (747 | ) | (959 | ) | (36 | ) | (4,308 | ) | ||||||||||||||
Recoveries | 258 | — | 342 | 110 | 104 | 95 | 909 | ||||||||||||||||||||
Provision | 631 | 13 | (1,635 | ) | 1,047 | 1,319 | 585 | 1,960 | |||||||||||||||||||
Balance at December 31, 2014 | $ | 550 | $ | 179 | $ | 3,966 | $ | 3,916 | $ | 2,354 | $ | 821 | $ | 11,786 | |||||||||||||
Ending allowance: | |||||||||||||||||||||||||||
Ending allowance balance attributable to loans: | |||||||||||||||||||||||||||
Individually evaluated for impairment | $ | 66 | $ | — | $ | 1,370 | $ | 294 | $ | 292 | $ | 647 | $ | 2,669 | |||||||||||||
Collectively evaluated for impairment | 484 | 179 | 2,596 | 3,622 | 2,062 | 174 | 9,117 | ||||||||||||||||||||
Total ending allowance balance | $ | 550 | $ | 179 | $ | 3,966 | $ | 3,916 | $ | 2,354 | $ | 821 | $ | 11,786 | |||||||||||||
Loans: | |||||||||||||||||||||||||||
Individually evaluated for impairment | $ | 246 | $ | 7,903 | $ | 5,613 | $ | 4,531 | $ | 846 | $ | 3,019 | $ | 22,158 | |||||||||||||
Collectively evaluated for impairment | 32,804 | 11,805 | 259,603 | 250,705 | 162,423 | 15,348 | 732,688 | ||||||||||||||||||||
Total ending loans balance | $ | 33,050 | $ | 19,708 | $ | 265,216 | $ | 255,236 | $ | 163,269 | $ | 18,367 | $ | 754,846 |
Note 6. Earnings Per Share
The following shows the weighted-average number of shares used in computing earnings per share and the effect on weighted-average number of shares of diluted potential common stock. Nonvested restricted shares are included in basic earnings per share because of dividend participation rights. Potential dilutive common stock had no effect on income available to common stockholders.
For the Three Months Ended June 30, | |||||||||||||
2015 | 2014 | ||||||||||||
Shares | Per Share Amount | Shares | Per Share Amount | ||||||||||
Earnings per share, basic | 7,145,929 | $ | 0.32 | 7,093,788 | $ | 0.26 | |||||||
Effect of dilutive securities: | |||||||||||||
Stock options | 7,102 | 10,604 | |||||||||||
Warrant | 14,134 | 13,434 | |||||||||||
Earnings per share, diluted | 7,167,165 | $ | 0.32 | 7,117,826 | $ | 0.26 |
18
For the Six Months Ended June 30, | |||||||||||||
2015 | 2014 | ||||||||||||
Shares | Per Share Amount | Shares | Per Share Amount | ||||||||||
Earnings per share, basic | 7,140,514 | $ | 0.66 | 7,088,800 | $ | 0.54 | |||||||
Effect of dilutive securities: | |||||||||||||
Stock options | 7,077 | 10,643 | |||||||||||
Warrant | 13,937 | 13,528 | |||||||||||
Earnings per share, diluted | 7,161,528 | $ | 0.66 | 7,112,971 | $ | 0.54 |
The warrant and none of the stock options were considered anti-dilutive as of June 30, 2015 and 2014.
Note 7. Segment Reporting
The Company operates in a decentralized fashion in the following principal business activities: retail banking services; wealth management services; and mortgage banking services.
• | Revenue from retail banking activity consists primarily of interest earned on loans and investment securities and service charges on deposit accounts. |
• | Revenue from the wealth management activities is comprised of fees based upon the market value of the accounts under administration as well as commissions on investment transactions. |
• | Revenue from the mortgage banking activities is comprised of interest earned on loans and fees received as a result of the mortgage origination process. The Company recognized gains on the sale of loans as part of other income. On May 15, 2014, the Company sold all of its majority interest in Southern Trust Mortgage and as a result, any mortgage banking activity for the Company subsequent to the sale date is included with the results of the retail banking segment. Any activity since the sale of Southern Trust Mortgage is considered to be immaterial and incidental to the Company's retail banking activities. The mortgage banking activities will continue to be evaluated and will be separately reported as a distinguishable segment if determined to be of significance to the reader of these financial statements or if the related operating results are believed to meet the quantitative tests for disclosure. Mortgage banking activities for the three and six months ended June 30, 2014 are the result of Southern Trust Mortgage activity that was consolidated with the Company through the date of sale. |
Middleburg Bank and the Company have assets in custody with Middleburg Trust Company and accordingly pay Middleburg Trust Company a monthly fee. Middleburg Bank also pays interest to Middleburg Trust Company on deposit accounts with Middleburg Bank. Middleburg Bank provided a warehouse line, office space, data processing and accounting services to Southern Trust Mortgage for which it received income. Transactions related to these relationships are eliminated to reach consolidated totals.
The following tables represent reportable segment information for the three and six months ended June 30, 2015 and 2014, respectively:
19
For the Three Months Ended | For the Three Months Ended | ||||||||||||||||||||||||||||||
June 30, 2015 | June 30, 2014 | ||||||||||||||||||||||||||||||
(In Thousands) | Retail Banking | Wealth Management | Mortgage Banking | Intercompany Eliminations | Consolidated | Retail Banking | Wealth Management | Mortgage Banking | Intercompany Eliminations | Consolidated | |||||||||||||||||||||
Revenues: | |||||||||||||||||||||||||||||||
Interest income | $ | 10,350 | $ | 2 | $ | — | $ | — | $ | 10,352 | $ | 10,865 | $ | 3 | $ | 163 | $ | (90 | ) | $ | 10,941 | ||||||||||
Trust and investment fee income | 155 | 1,284 | — | (41 | ) | 1,398 | 146 | 1,095 | — | (38 | ) | 1,203 | |||||||||||||||||||
Other income | 1,029 | — | — | — | 1,029 | 1,083 | — | 2,008 | (21 | ) | 3,070 | ||||||||||||||||||||
Total operating income | 11,534 | 1,286 | — | (41 | ) | 12,779 | 12,094 | 1,098 | 2,171 | (149 | ) | 15,214 | |||||||||||||||||||
Expenses: | |||||||||||||||||||||||||||||||
Interest expense | 1,039 | — | — | — | 1,039 | 1,415 | — | 106 | (90 | ) | 1,431 | ||||||||||||||||||||
Salaries and employee benefits | 4,367 | 606 | — | — | 4,973 | 4,168 | 566 | 1,259 | — | 5,993 | |||||||||||||||||||||
Provision for (recovery of) loan losses | (425 | ) | — | — | — | (425 | ) | — | — | 72 | — | 72 | |||||||||||||||||||
Other | 3,850 | 288 | — | (41 | ) | 4,097 | 4,334 | 287 | 576 | (59 | ) | 5,138 | |||||||||||||||||||
Total operating expenses | 8,831 | 894 | — | (41 | ) | 9,684 | 9,917 | 853 | 2,013 | (149 | ) | 12,634 | |||||||||||||||||||
Income before income taxes and non-controlling interest | 2,703 | 392 | — | — | 3,095 | 2,177 | 245 | 158 | — | 2,580 | |||||||||||||||||||||
Income tax expense | 667 | 148 | — | — | 815 | 568 | 99 | — | — | 667 | |||||||||||||||||||||
Net Income | 2,036 | 244 | — | — | 2,280 | 1,609 | 146 | 158 | — | 1,913 | |||||||||||||||||||||
Non-controlling interest in income of consolidated subsidiary | — | — | — | — | — | — | — | (58 | ) | — | (58 | ) | |||||||||||||||||||
Net income attributable to Middleburg Financial Corporation | $ | 2,036 | $ | 244 | $ | — | $ | — | $ | 2,280 | $ | 1,609 | $ | 146 | $ | 100 | $ | — | $ | 1,855 | |||||||||||
Total assets | $ | 1,238,148 | $ | 6,532 | $ | — | $ | (2,695 | ) | $ | 1,241,985 | $ | 1,365,914 | $ | 12,547 | $ | — | $ | (125,726 | ) | $ | 1,252,735 | |||||||||
Capital expenditures | $ | 2,320 | $ | — | $ | — | $ | — | $ | 2,320 | $ | 298 | $ | 2 | $ | 3 | $ | — | $ | 303 | |||||||||||
Goodwill and other intangibles | $ | — | $ | 3,722 | $ | — | $ | — | $ | 3,722 | $ | — | $ | 3,893 | $ | — | $ | — | $ | 3,893 |
20
For the Six Months Ended | For the Six Months Ended | ||||||||||||||||||||||||||||||
June 30, 2015 | June 30, 2014 | ||||||||||||||||||||||||||||||
(In Thousands) | Retail Banking | Wealth Management | Mortgage Banking | Intercompany Eliminations | Consolidated | Retail Banking | Wealth Management | Mortgage Banking | Intercompany Eliminations | Consolidated | |||||||||||||||||||||
Revenues: | |||||||||||||||||||||||||||||||
Interest income | $ | 21,046 | $ | 5 | $ | — | $ | — | $ | 21,051 | $ | 21,879 | $ | 7 | $ | 450 | $ | (288 | ) | $ | 22,048 | ||||||||||
Trust and investment fee income | 284 | 2,543 | — | (82 | ) | 2,745 | 286 | 2,181 | — | (76 | ) | 2,391 | |||||||||||||||||||
Other income | 2,689 | — | — | — | 2,689 | 2,690 | — | 5,121 | (47 | ) | 7,764 | ||||||||||||||||||||
Total operating income | 24,019 | 2,548 | — | (82 | ) | 26,485 | 24,855 | 2,188 | 5,571 | (411 | ) | 32,203 | |||||||||||||||||||
Expenses: | |||||||||||||||||||||||||||||||
Interest expense | 2,107 | — | — | — | 2,107 | 2,810 | — | 304 | (288 | ) | 2,826 | ||||||||||||||||||||
Salaries and employee benefits | 8,681 | 1,140 | — | — | 9,821 | 8,119 | 1,135 | 3,772 | — | 13,026 | |||||||||||||||||||||
Provision for loan losses | 25 | — | — | — | 25 | 926 | — | 34 | — | 960 | |||||||||||||||||||||
Other | 7,661 | 569 | — | (82 | ) | 8,148 | 8,092 | 550 | 1,722 | (123 | ) | 10,241 | |||||||||||||||||||
Total operating expenses | 18,474 | 1,709 | — | (82 | ) | 20,101 | 19,947 | 1,685 | 5,832 | (411 | ) | 27,053 | |||||||||||||||||||
Income before income taxes and non-controlling interest | 5,545 | 839 | — | — | 6,384 | 4,908 | 503 | (261 | ) | — | 5,150 | ||||||||||||||||||||
Income tax expense | 1,341 | 315 | — | — | 1,656 | 1,211 | 204 | — | — | 1,415 | |||||||||||||||||||||
Net Income | 4,204 | 524 | — | — | 4,728 | 3,697 | 299 | (261 | ) | — | 3,735 | ||||||||||||||||||||
Non-controlling interest in income of consolidated subsidiary | — | — | — | — | — | — | — | 98 | — | 98 | |||||||||||||||||||||
Net income attributable to Middleburg Financial Corporation | $ | 4,204 | $ | 524 | $ | — | $ | — | $ | 4,728 | $ | 3,697 | $ | 299 | $ | (163 | ) | $ | — | $ | 3,833 | ||||||||||
Total assets | $ | 1,238,148 | $ | 6,532 | $ | — | $ | (2,695 | ) | $ | 1,241,985 | $ | 1,365,914 | $ | 12,547 | $ | — | $ | (125,726 | ) | $ | 1,252,735 | |||||||||
Capital expenditures | $ | 2,471 | $ | — | $ | — | $ | — | $ | 2,471 | $ | 441 | $ | 10 | $ | 3 | $ | — | $ | 454 | |||||||||||
Goodwill and other intangibles | $ | — | $ | 3,722 | $ | — | $ | — | $ | 3,722 | $ | — | $ | 3,893 | $ | — | $ | — | $ | 3,893 |
Note 8. Capital Purchase Program
On January 30, 2009, as part of the Capital Purchase Program established by the U.S. Department of the Treasury (the “Treasury”) under the Emergency Economic Stabilization Act of 2008, the Company entered into a Letter Agreement and Securities Purchase Agreement—Standard Terms (collectively, the “Purchase Agreement”) with the Treasury, pursuant to which the Company sold (i) 22,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, par value $2.50 per share, having a liquidation preference of $1,000 per share (the “Preferred Stock”) and (ii) a warrant (the “Warrant”) to purchase 208,202 shares of the Company’s common stock, par value $2.50 per share, at an initial exercise price of $15.85 per share. As a result of the completion of a public stock offering in 2009, the number of shares of common stock underlying the Warrant was reduced by one-half to 104,101 and the Company redeemed all 22,000 shares of Preferred Stock pursuant to the Purchase Agreement. During 2011, the Warrant was sold by the U.S. Treasury at public auction and has not been exercised as of June 30, 2015.
Note 9. Fair Value Measurements
The Company follows ASC 820, "Fair Value Measurements" to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. ASC 820 clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.
ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy under ASC 820 based on these two types of inputs are as follows:
Level I. | Quoted prices are available in active markets for identical assets or liabilities as of the reported date. |
21
Level II. | Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair-valued using other financial instruments, the parameters of which can be directly observed. |
Level III. | Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation. |
Measured on a recurring basis
The following describes the valuation techniques and inputs used by the Company in determining the fair value of certain assets recorded at fair value on a recurring basis in the financial statements.
Securities Available for Sale
The Company primarily values its investment portfolio using Level II fair value measurements, but may also use Level I or Level III measurements if required by the composition of the portfolio. If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level II). In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified as Level III of the valuation hierarchy.
Interest Rate Swaps
Interest rate swaps are recorded at fair value based on third party vendors who compile prices from various sources and may determine fair value of identical or similar instruments by using pricing models that consider observable market data (Level II).
The following tables present the balances of assets and liabilities measured at fair value on a recurring basis as of June 30, 2015 and December 31, 2014.
(Dollars in thousands) | June 30, 2015 | |||||||||||||||
Description | Total | Level I | Level II | Level III | ||||||||||||
Assets: | ||||||||||||||||
U.S. government agencies | $ | 45,471 | $ | — | $ | 45,471 | $ | — | ||||||||
U.S. Treasury securities | 50 | — | 50 | — | ||||||||||||
Obligations of states and political subdivisions | 73,243 | — | 73,243 | — | ||||||||||||
Mortgage-backed securities: | ||||||||||||||||
Agency | 146,366 | — | 146,366 | — | ||||||||||||
Non-agency | 17,866 | — | 17,866 | — | ||||||||||||
Other asset backed securities | 52,193 | — | 52,193 | — | ||||||||||||
Corporate securities | 16,801 | — | 16,801 | — | ||||||||||||
Interest rate swaps | 52 | — | 52 | — | ||||||||||||
Liabilities: | ||||||||||||||||
Interest rate swaps | 341 | — | 341 | — |
22
(Dollars in thousands) | December 31, 2014 | |||||||||||||||
Description | Total | Level I | Level II | Level III | ||||||||||||
Assets: | ||||||||||||||||
U.S. government agencies | $ | 41,397 | $ | — | $ | 41,397 | $ | — | ||||||||
Obligations of states and political subdivisions | 57,740 | — | 57,740 | — | ||||||||||||
Mortgage-backed securities: | ||||||||||||||||
Agency | 173,213 | — | 173,213 | — | ||||||||||||
Non-agency | 28,123 | — | 28,123 | — | ||||||||||||
Other asset backed securities | 31,713 | — | 31,713 | — | ||||||||||||
Corporate securities | 16,077 | — | 16,077 | |||||||||||||
Interest rate swaps | 50 | — | 50 | — | ||||||||||||
Liabilities: | ||||||||||||||||
Interest rate swaps | 337 | — | 337 | — |
Measured on nonrecurring basis
The Company may be required, from time to time, to measure and recognize certain other assets at fair value on a nonrecurring basis in accordance with GAAP. The following describes the valuation techniques and inputs used by the Company in determining the fair value of certain assets recorded at fair value on a nonrecurring basis in the financial statements.
Impaired Loans
Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level II). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level III. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable financial statements of the business if not considered significant using observable market data. Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level III). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of income.
When collateral-dependent loans are performing in accordance with the original terms of their contract, the Company continues to use the appraisal that was performed at origination as the basis for the collateral value. When loans become collateral-dependent and considered nonperforming, they are reviewed to determine the next appropriate course of action, either foreclosure or modification with forbearance agreement. The loans would then be reappraised prior to foreclosure or before a forbearance agreement is executed. This process does not vary by loan type.
The Company's procedure to monitor the value of collateral for collateral-dependent impaired loans between receipt of the original appraisal and an updated appraisal is to review annual tax assessment records. At this time, adjustments are made, if necessary. Information considered in the determination not to order an updated appraisal includes the availability and reliability of tax assessment records and significant changes in capitalization rates for income properties. Other facts and circumstances on a case-by-case basis may be considered relative to a decision not to order an updated appraisal. If, in the judgment of management, a reliable collateral value cannot be obtained by an alternative method, an updated appraisal would be obtained.
Circumstances that may warrant a reappraisal for nonperforming loans might include foreclosure proceedings or a material adverse change in the borrower's condition or that of the collateral underlying the loan. In some cases, management may decide that an updated appraisal for a nonperforming loan is not necessary, In such cases, an estimate of the fair value of the collateral would be made by management by reference to current tax assessments, the latest appraised value, and knowledge of collateral value fluctuations in a loan's market area. If, in management's judgment, a reliable collateral value cannot be obtained by an alternative method, an updated appraisal would be obtained.
For the purpose of evaluating the allowance for loan losses, new appraisals are discounted by 10% for estimated selling costs when determining the amount of specific reserves. Thereafter, for collateral-dependent impaired loans, we consider each loan on
23
a case-by-case basis to determine whether or not the recorded values are appropriate given current market conditions. When necessary, new appraisals are obtained. If an appraisal is less than 12 months old, the only adjustment made is the 10% discount for selling costs. If an appraisal is older than 12 months, management will use judgment based on knowledge of current market values and specific facts surrounding any particular property to determine if an additional valuation adjustment may be necessary.
Other Real Estate Owned
The value of other real estate owned (“OREO”) is determined utilizing a market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level II). For OREO properties that may be in construction, the Company’s policy is to obtain “as-is” appraisals on an annual basis as opposed to “as-completed” appraisals. This approach provides current values without regard to completion of any construction or renovation that may be in process. Accordingly, the Company considers the valuations to be Level II valuations even though some properties may be in process of renovation or construction. If the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability or other factors, then the fair value is considered Level III. Any initial fair value adjustment is charged against the Allowance for Loan Losses. Any subsequent fair value adjustments are recorded in the period incurred and included in other non-interest expense on the consolidated statements of income.
For the purpose of OREO valuations, appraisals are discounted 10% for selling costs and it is the policy of the Company to obtain annual appraisals for properties held in accordance with the bank's OREO policy. Any fair value adjustments are recorded in the period incurred as loss on other real estate owned on the consolidated statements of income.
Repossessed Assets
The value of repossessed assets is determined by the Company based on marketability and other factors and is considered Level III.
The following table summarizes the Company’s non-financial assets that were measured at fair value on a nonrecurring basis during the period.
(Dollars in thousands) | June 30, 2015 | |||||||||||||||
Total | Level I | Level II | Level III | |||||||||||||
Assets: | ||||||||||||||||
Impaired loans | $ | 7,808 | $ | — | $ | 3,156 | $ | 4,652 | ||||||||
Other real estate owned | $ | 3,402 | $ | — | $ | 3,402 | $ | — | ||||||||
Repossessed assets (1) | $ | 1,044 | $ | — | $ | — | $ | 1,044 | ||||||||
(Dollars in thousands) | December 31, 2014 | |||||||||||||||
Total | Level I | Level II | Level III | |||||||||||||
Assets: | ||||||||||||||||
Impaired loans | $ | 5,799 | $ | — | $ | 1,289 | $ | 4,510 | ||||||||
Other real estate owned | $ | 4,051 | $ | — | $ | 4,051 | $ | — | ||||||||
Repossessed assets (1) | $ | 1,132 | $ | — | $ | — | $ | 1,132 |
(1) Included in other assets on the consolidated balance sheets.
The following table presents quantitative information as of June 30, 2015 and December 31, 2014 about Level III fair value measurements for assets measured at fair value on a non-recurring basis:
June 30, 2015 | Fair Value (in thousands) | Valuation Technique | Unobservable Inputs | Range (Weighted Average) | ||||||
Impaired loans | $ | 4,652 | Discounted appraised value | Discount for age of appraisals | 0% - 100% (5%) | |||||
Repossessed assets | $ | 1,044 | Market analysis | Historical sales activity | 50% |
24
December 31, 2014 | Fair Value (in thousands) | Valuation Technique | Unobservable Inputs | Range (Weighted Average) | ||||||
Impaired loans | $ | 4,510 | Discounted appraised value | Discount for age of appraisals | 0% - 100% (7%) | |||||
Repossessed assets | $ | 1,132 | Market analysis | Historical sales activity | 50% |
The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. U.S. generally accepted accounting principles excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments (not previously described) for which it is practicable to estimate that value:
Cash and Cash Equivalents
For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value.
Securities held to maturity
Certain debt securities that management has the positive intent and ability to hold until maturity are recorded at amortized cost. Fair values are determined in a manner that is consistent with securities available for sale.
Restricted securities
The restricted security category is comprised of FHLB and Federal Reserve Bank stock. These stocks are classified as restricted securities because their ownership is restricted to certain types of entities and they lack a market. When the FHLB or Federal Reserve Bank repurchases stock, they repurchase at the stock's book value. Therefore, the carrying amounts of restricted securities approximate fair value.
Loans, Net
For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. For fixed rate loans, the fair value is estimated by discounting future cash flows using current market inputs at which loans with similar terms and qualities would be made to borrowers of similar credit quality. Where quoted market prices were available, primarily for certain residential mortgage loans, such market rates were utilized as estimates for fair value. Fair value for impaired loans is described above.
Bank Owned Life Insurance
The carrying amount of bank owned life insurance is a reasonable estimate of fair value.
Accrued Interest Receivable and Payable
The carrying amounts of accrued interest approximate fair values.
Deposits
The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. For all other deposits, the fair value is determined using the discounted cash flow method. The discount rate is equal to the rate currently offered on similar products.
25
Securities Sold Under Agreements to Repurchase
The carrying amounts approximate fair values.
FHLB Borrowings and Subordinated Debt
For variable rate long-term debt, fair values are based on carrying values. For fixed rate debt, fair values are estimated based on observable market prices and discounted cash flow analysis using interest rates for borrowings of similar remaining maturities and characteristics. The fair values of the Company's Subordinated Debentures are estimated using discounted cash flow analysis based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.
Off-Balance Sheet Financial Instruments
The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. At June 30, 2015 and December 31, 2014, the fair values of loan commitments and standby letters of credit were deemed immaterial; therefore, they have not been included in the tables below.
Fair Value of Financial Instruments
The estimated fair values, and related carrying amounts, of the Company's financial instruments are as follows:
(Dollars in thousands) | June 30, 2015 | ||||||||||||||||||
Fair value measurements using: | |||||||||||||||||||
Carrying Amount | Total Fair Value | Level I | Level II | Level III | |||||||||||||||
Financial assets: | |||||||||||||||||||
Cash and cash equivalents | $ | 49,407 | $ | 49,407 | $ | 49,407 | $ | — | $ | — | |||||||||
Securities held to maturity | 1,500 | 1,374 | — | 1,374 | — | ||||||||||||||
Securities available for sale | 351,990 | 351,990 | — | 351,990 | — | ||||||||||||||
Loans, net | 761,196 | 769,114 | — | 3,156 | 765,958 | ||||||||||||||
Bank owned life insurance | 22,940 | 22,940 | — | 22,940 | — | ||||||||||||||
Accrued interest receivable | 4,785 | 4,785 | — | 4,785 | — | ||||||||||||||
Interest rate swaps | 52 | 52 | — | 52 | — | ||||||||||||||
Financial liabilities: | |||||||||||||||||||
Deposits | $ | 1,005,452 | $ | 1,005,476 | $ | — | $ | 1,005,476 | $ | — | |||||||||
Securities sold under agreements to repurchase | 24,049 | 24,049 | — | 24,049 | — | ||||||||||||||
FHLB borrowings | 70,000 | 69,701 | — | 69,701 | — | ||||||||||||||
Subordinated debt | 5,155 | 5,133 | — | 5,133 | — | ||||||||||||||
Accrued interest payable | 363 | 363 | — | 363 | — | ||||||||||||||
Interest rate swaps | 341 | 341 | — | 341 | — |
26
(Dollars in thousands) | December 31, 2014 | ||||||||||||||||||
Fair value measurements using: | |||||||||||||||||||
Carrying Amount | Total Fair Value | Level I | Level II | Level III | |||||||||||||||
Financial assets: | |||||||||||||||||||
Cash and cash equivalents | $ | 55,022 | $ | 55,022 | $ | 55,022 | $ | — | $ | — | |||||||||
Securities held to maturity | 1,500 | 1,397 | — | 1,397 | — | ||||||||||||||
Securities available for sale | 348,263 | 348,263 | — | 348,263 | — | ||||||||||||||
Loans, net | 743,060 | 751,572 | — | 1,289 | 750,283 | ||||||||||||||
Bank-owned life insurance | 22,617 | 22,617 | — | 22,617 | — | ||||||||||||||
Accrued interest receivable | 4,285 | 4,285 | — | 4,285 | — | ||||||||||||||
Interest rate swaps | 50 | 50 | — | 50 | — | ||||||||||||||
Financial liabilities: | |||||||||||||||||||
Deposits | $ | 989,080 | $ | 989,563 | $ | — | $ | 989,563 | $ | — | |||||||||
Securities sold under agreements to repurchase | 38,551 | 38,551 | — | 38,551 | — | ||||||||||||||
FHLB borrowings | 55,000 | 55,042 | — | 55,042 | — | ||||||||||||||
Subordinated debt | 5,155 | 5,159 | — | 5,159 | — | ||||||||||||||
Accrued interest payable | 403 | 403 | — | 403 | — | ||||||||||||||
Interest rate swaps | 337 | 337 | — | 337 | — |
The Company assumes interest rate risk as a result of its normal operations. As a result, the fair values of the Company's financial instruments will change when interest rate levels change, which may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company's overall interest rate risk.
Note 10. Recent Accounting Pronouncements
In June 2014, the FASB issued ASU No. 2014-11, “Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.” This ASU aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements. The new guidance eliminates sale accounting for repurchase-to-maturity transactions and supersedes the guidance under which a transfer of a financial asset and a contemporaneous repurchase financing could be accounted for on a combined basis as a forward agreement. The amendments in the ASU also require a new disclosure for transactions economically similar to repurchase agreements in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction. Additional disclosures will be required for the nature of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings. The amendments in this ASU are effective for the first interim or annual period beginning after December 15, 2014; however, the disclosure for transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and interim periods beginning after March 15, 2015. Early adoption is not permitted. The adoption of the new guidance did not have a material impact on our consolidated financial statements.
In June 2014, the FASB issued ASU No. 2014-12, “Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.” The new guidance applies to reporting entities that grant employees share-based payments in which the terms of the award allow a performance target to be achieved after the requisite service period. The amendments in the ASU require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. Existing guidance in “Compensation - Stock Compensation (Topic 718),” should be applied to account for these types of awards. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted and reporting entities may choose to apply the amendments in the ASU either on a prospective or retrospective basis. The Company is currently assessing the impact that ASU 2014-12 will have on its consolidated financial statements.
In August 2014, the FASB issued ASU No. 2014-15, “Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.” This update is intended to provide guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going
27
concern and to provide related footnote disclosures. Management is required under the new guidance to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date the financial statements are issued when preparing financial statements for each interim and annual reporting period. If conditions or events are identified, the ASU specifies the process that must be followed by management and also clarifies the timing and content of going concern footnote disclosures in order to reduce diversity in practice. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. Early adoption is permitted. The Company does not expect the adoption of ASU 2014-15 to have a material impact on its consolidated financial statements.
In November 2014, the FASB issued ASU No. 2014-16, “Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity.” The amendments in this ASU do not change the current criteria in U.S. GAAP for determining when separation of certain embedded derivative features in a hybrid financial instrument is required. The amendments clarify how current U.S. GAAP should be interpreted in evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. Specifically, the amendments clarify that an entity should consider all relevant terms and features, including the embedded derivative feature being evaluated for bifurcation, in evaluating the nature of the host contract. Furthermore, the amendments clarify that no single term or feature would necessarily determine the economic characteristics and risks of the host contract. Rather, the nature of the host contract depends upon the economic characteristics and risks of the entire hybrid financial instrument. The amendments in this ASU also clarify that, in evaluating the nature of a host contract, an entity should assess the substance of the relevant terms and features (i.e., the relative strength of the debt-like or equity-like terms and features given the facts and circumstances) when considering how to weigh those terms and features. The amendments in this ASU are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption, including adoption in an interim period, is permitted. The Company does not expect the adoption of ASU 2014-16 to have a material impact on its consolidated financial statements.
In January 2015, the FASB issued ASU No. 2015-01, “Income Statement-Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.” The amendments in this ASU eliminate from U.S. GAAP the concept of extraordinary items. Subtopic 225-20, Income Statement - Extraordinary and Unusual Items, required that an entity separately classify, present, and disclose extraordinary events and transactions. Presently, an event or transaction is presumed to be an ordinary and usual activity of the reporting entity unless evidence clearly supports its classification as an extraordinary item. If an event or transaction meets the criteria for extraordinary classification, an entity is required to segregate the extraordinary item from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations. The entity also is required to disclose applicable income taxes and either present or disclose earnings per share data applicable to the extraordinary item. The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The Company does not expect the adoption of ASU 2015-01 to have a material impact on its consolidated financial statements.
In February 2015, the FASB issued ASU No. 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis.” The amendments in this ASU are intended to improve targeted areas of consolidation guidance for legal entities such as limited partnerships, limited liability corporations, and securitization structures (collateralized debt obligations, collateralized loan obligations, and mortgage-backed security transactions). In addition to reducing the number of consolidation models from four to two, the new standard simplifies the FASB Accounting Standards Codification™ and improves current GAAP by placing more emphasis on risk of loss when determining a controlling financial interest, reducing the frequency of the application of related-party guidance when determining a controlling financial interest in a variable interest entity (VIE), and changing consolidation conclusions for public and private companies in several industries that typically make use of limited partnerships or VIEs. The amendments in this ASU are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. ASU 2015-02 may be applied retrospectively in previously issued financial statements for one or more years with a cumulative-effect adjustment to retained earnings as of the beginning of the first year restated. The Company does not expect the adoption of ASU 2015-02 to have a material impact on its consolidated financial statements.
In April 2015, the FASB issued ASU No. 2015-03, “Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” The amendments in this ASU are intended to simplify the presentation of debt issuance costs. These amendments require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. The amendments in this ASU are effective for public business entities for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within
28
those fiscal years. Early adoption is permitted for financial statements that have not been previously issued. The Company does not expect the adoption of ASU 2015-03 to have a material impact on its consolidated financial statements.
In April 2015, the FASB issued ASU No. 2015-05, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement.” The amendments in this ASU provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The amendments do not change the accounting for a customer’s accounting for service contracts. As a result of the amendments, all software licenses within the scope of Subtopic 350-40 will be accounted for consistent with other licenses of intangible assets. The amendments in this ASU are effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2015. Early adoption is permitted. An entity can elect to adopt the amendments either: (1) prospectively to all arrangements entered into or materially modified after the effective date; or (2) retrospectively. The Company is currently assessing the impact that ASU 2015-05 will have on its consolidated financial statements.
In May 2015, the FASB issued ASU No. 2015-08, “Business Combinations (Topic 805): Pushdown Accounting - Amendments to SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 115.” The amendments in ASU 2015-08 amend various SEC paragraphs pursuant to the issuance of Staff Accounting Bulletin No. 115, Topic 5: Miscellaneous Accounting, regarding various pushdown accounting issues, and did not have a material impact on our consolidated financial statements.
Note 11. Accumulated Other Comprehensive Income
Changes in accumulated other comprehensive income for the six months ended June 30, 2015 and 2014 were:
(Dollars in thousands) | Unrealized Gains (Losses) on Securities | Cash Flow Hedges | Accumulated Other Comprehensive Income | ||||||||
Balance December 31, 2013 | $ | 261 | $ | (29 | ) | $ | 232 | ||||
Unrealized holding gains (net of tax, $1,822) | 3,537 | — | 3,537 | ||||||||
Reclassification adjustment (net of tax, $44) | (85 | ) | — | (85 | ) | ||||||
Unrealized loss on interest rate swaps (net of tax, $53) | — | (108 | ) | (108 | ) | ||||||
Reclassification adjustment (net of tax, $3) | — | 5 | 5 | ||||||||
Balance June 30, 2014 | $ | 3,713 | $ | (132 | ) | $ | 3,581 | ||||
Balance December 31, 2014 | $ | 3,979 | $ | (185 | ) | $ | 3,794 | ||||
Unrealized holding losses (net of tax of $333) | (644 | ) | — | (644 | ) | ||||||
Reclassification adjustment (net of tax, $47) | (91 | ) | — | (91 | ) | ||||||
Unrealized loss on interest rate swap (net of tax, $0) | — | (1 | ) | (1 | ) | ||||||
Reclassification adjustment, (net of tax of $2) | — | (4 | ) | (4 | ) | ||||||
Balance June 30, 2015 | $ | 3,244 | $ | (190 | ) | $ | 3,054 |
The following table presents information related to reclassifications from accumulated other comprehensive income:
29
Details about Accumulated Other Comprehensive Income | Amount Reclassified from Accumulated Other Comprehensive Income | Affected Line Item in the Consolidated Statements of Income | |||||||
For the Three Months Ended June 30, | |||||||||
(Dollars in thousands) | 2015 | 2014 | |||||||
Securities available for sale (1): | |||||||||
Net securities gains reclassified into earnings | $ | (37 | ) | $ | (66 | ) | Gain on securities available for sale | ||
Related income tax expense | 13 | 22 | Income tax expense | ||||||
Derivatives (2): | |||||||||
Loss on interest rate swap ineffectiveness | — | 8 | Other operating expenses | ||||||
Related income tax expense | — | (3 | ) | Income tax expense | |||||
Net effect on accumulated other comprehensive income | (24 | ) | (39 | ) | Net of tax | ||||
Total reclassifications | $ | (24 | ) | $ | (39 | ) | Net of tax |
(1) For more information related to unrealized gains on securities available for sale, see Note 3, "Securities".
(2) For more information related to unrealized losses on derivatives, see Note 12, "Derivatives".
Details about Accumulated Other Comprehensive Income | Amount Reclassified from Accumulated Other Comprehensive Income | Affected Line Item in the Consolidated Statements of Income | |||||||
For the Six Months Ended June 30, | |||||||||
(Dollars in thousands) | 2015 | 2014 | |||||||
Securities available for sale (1): | |||||||||
Net securities gains reclassified into earnings | $ | (138 | ) | $ | (129 | ) | Gain on securities available for sale | ||
Related income tax expense | 47 | 44 | Income tax expense | ||||||
Derivatives (2): | |||||||||
(Gain) loss on interest rate swap ineffectiveness | (6 | ) | 8 | Other operating expenses | |||||
Related income tax expense | 2 | (3 | ) | Income tax expense | |||||
Net effect on accumulated other comprehensive income | (95 | ) | (80 | ) | Net of tax | ||||
Total reclassifications | $ | (95 | ) | $ | (80 | ) | Net of tax |
(1) For more information related to unrealized gains on securities available for sale, see Note 3, "Securities".
(2) For more information related to unrealized losses on derivatives, see Note 12, "Derivatives".
Note 12. Derivatives
The Company utilizes derivative instruments as a part of its asset-liability management program to control fluctuation of market values and cash flows to changes in interest rates associated with certain financial instruments. The Company accounts for derivatives in accordance with ASC 815, "Derivatives and Hedging". Under current guidance, derivative transactions are classified as either cash flow hedges or fair value hedges or they are not designated as hedging instruments. The Company designates each derivative instrument at the inception of the derivative transaction in accordance with this guidance. Information concerning each of the Company's categories of derivatives as of June 30, 2015 and December 31, 2014 is presented below.
Derivatives designated as cash flow hedges
During 2010, the Company entered into an interest rate swap agreement as part of the interest rate risk management process. The swap was designated as a cash flow hedge intended to hedge the variability of cash flows associated with the Company’s trust preferred capital securities. The swap hedges the cash flow associated with the trust preferred capital notes wherein the Company receives a floating rate based on LIBOR from a counterparty and pays a fixed rate of 2.59% to the same counterparty. The swap is calculated on a notional amount of $5.2 million. The term of the swap is 10 years and commenced on October 23, 2010. The swap was entered into with a counterparty that met the Company’s credit standards and the agreement contains collateral provisions protecting the at-risk party. The Company believes that the credit risk inherent in the contract is not significant.
30
During 2013, the Company entered into an interest rate swap agreement as part of the interest rate risk management process. The swap has been designated as a cash flow hedge intended to hedge the variability of cash flows associated with the Company’s FHLB borrowings. The swap hedges the cash flows associated with the FHLB borrowings wherein the Company receives a floating rate based on LIBOR from a counterparty and pays a fixed rate of 1.43% to the same counterparty. The swap is calculated on a notional amount of $10.0 million. The term of the swap is 5 years and commenced on November 25, 2013. The swap was entered into with a counterparty that met the Company’s credit standards and the agreement contains collateral provisions protecting the at-risk party. The Company believes that the credit risk inherent in the contract is not significant.
Amounts receivable or payable are recognized as accrued under the terms of the agreement, with the effective portion of the derivative’s unrealized gain or loss recorded as a component of other comprehensive income. The ineffective portion of the unrealized gain or loss, if any, would be recorded in other expense. The Company has assessed the effectiveness of the hedging relationship by comparing the changes in cash flows on the designated hedged item. As a result of this assessment, there was no hedge ineffectiveness identified for the three and six months ended June 30, 2015 and 2014. At December 31, 2014 there was $6,000 of hedge ineffectiveness identified for this interest rate swap.
The amounts included in accumulated other comprehensive income (loss) as unrealized losses (market value net of tax) were $190,000 and $185,000 as of June 30, 2015 and December 31, 2014, respectively.
Information concerning the derivatives designated as a cash flow hedges at June 30, 2015 and December 31, 2014 is presented in the following tables:
June 30, 2015 | |||||||||||||||||||||
Positions (#) | Notional Amount (in thousands) | Asset (in thousands) | Liability (in thousands) | Receive Rate | Pay Rate | Life (Years) | |||||||||||||||
Pay fixed - receive floating interest rate swap | 1 | $ | 5,155 | $ | — | $ | 212 | 0.28 | % | 2.59 | % | 5.2 | |||||||||
Pay fixed - receive floating interest rate swap | 1 | $ | 10,000 | $ | — | $ | 77 | 0.18 | % | 1.43 | % | 3.4 |
December 31, 2014 | |||||||||||||||||||||
Positions (#) | Notional Amount (in thousands) | Asset (in thousands) | Liability (in thousands) | Receive Rate | Pay Rate | Life (Years) | |||||||||||||||
Pay fixed - receive floating interest rate swap | 1 | $ | 5,155 | $ | — | $ | 213 | 0.23 | % | 2.59 | % | 5.8 | |||||||||
Pay fixed - receive floating interest rate swap | 1 | $ | 10,000 | $ | — | $ | 74 | 0.16 | % | 1.43 | % | 4.0 |
Derivatives not designated as hedging instruments
Two-way client loan swaps
During the fourth quarter of 2014 and 2012, the Company entered into certain interest rate swap contracts that are not designated as hedging instruments. These derivative contracts relate to transactions in which we enter into an interest rate swap with a customer while at the same time entering into an offsetting interest rate swap with another financial institution. In connection with each swap transaction, the Company agrees to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on an identical notional amount at a fixed interest rate. At the same time, the Company agrees to pay the counterparty the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows our clients to effectively convert a variable rate loan into a fixed rate loan. Because the Company acts as an intermediary for our customers, changes in the fair value of the underlying derivatives contracts offset each other and do not significantly impact our results of operations. The Company had no undesignated interest rate swaps at June 30, 2015 and December 31, 2014.
Certain additional risks arise from interest rate swap contracts in that the counterparties to the contracts may not be able to meet the terms of the contracts. We do not expect any counterparty to fail to meet its obligations.
31
Information concerning two-way client interest rate swaps not designated as either fair value or cash flow hedges is presented in the following table:
June 30, 2015 | |||||||||||||||||||||
Positions (#) | Notional Amount (in thousands) | Asset (in thousands) | Liability (in thousands) | Receive Rate | Pay Rate | Life (Years) | |||||||||||||||
Pay fixed - receive floating interest rate swap | 1 | $ | 3,882 | $ | 33 | $ | — | 1 month LIBOR plus 200 BP | 3.90 | % | 12.3 | ||||||||||
Pay fixed - receive floating interest rate swap | 1 | 1,726 | — | 19 | 1 month LIBOR plus 180 BP | 4.09 | % | 9.3 | |||||||||||||
Pay floating - receive fixed interest rate swap | 1 | 3,882 | — | 33 | 3.90 | % | 1 month LIBOR plus 200 BP | 12.3 | |||||||||||||
Pay floating - receive fixed interest rate swap | 1 | 1,726 | 19 | — | 4.09 | % | 1 month LIBOR plus 180 BP | 9.3 | |||||||||||||
Total derivatives not designated | $ | 11,216 | $ | 52 | $ | 52 |
December 31, 2014 | ||||||||||||||||||||||
Positions (#) | Notional Amount (in thousands) | Asset (in thousands) | Liability (in thousands) | Receive Rate | Pay Rate | Life (Years) | ||||||||||||||||
Pay fixed - receive floating interest rate swap | 1 | $ | 4,002 | $ | — | $ | 19 | 1 month LIBOR plus 200 BP | 3.90 | % | 12.9 | |||||||||||
Pay fixed - receive floating interest rate swap | 1 | 1,747 | — | 31 | 1 month LIBOR plus 180 BP | 4.09 | % | 9.9 | ||||||||||||||
Pay floating - receive fixed interest rate swap | 1 | 4,002 | 19 | — | 3.90 | % | 1 month LIBOR plus 200 BP | 12.9 | ||||||||||||||
Pay floating - receive fixed interest rate swap | 1 | 1,747 | 31 | — | 4.09 | % | 1 month LIBOR plus 180 BP | 9.9 | ||||||||||||||
Total derivatives not designated | $ | 11,498 | $ | 50 | $ | 50 |
Note 13. Other Real Estate Owned (OREO)
At June 30, 2015 and December 31, 2014, OREO balances were $3.4 million and $4.1 million, respectively. OREO is primarily comprised of residential properties and non-residential properties, and are located primarily in the state of Virginia. Changes in the balance for OREO, net of valuation allowances, are as follows:
32
(Dollars in thousands) | June 30, 2015 | December 31, 2014 | |||||
Balance at the beginning of year, net | $ | 4,051 | $ | 3,424 | |||
Transfers between loans and other real estate owned | — | 3,301 | |||||
Sales proceeds | (594 | ) | (2,663 | ) | |||
Loss on disposition | (35 | ) | (14 | ) | |||
Less valuation adjustments | (20 | ) | 3 | ||||
Balance at the end of year, net | $ | 3,402 | $ | 4,051 |
Expenses applicable to OREO, were $25,000 and $12,000 during the three months ended June 30, 2015 and 2014, respectively and $92,000 and $179,000 during the six months ended June 30, 2015 and 2014, respectively.
The major classifications of OREO in the consolidated balance sheets at June 30, 2015 and December 31, 2014 were as follows:
(Dollars in thousands) | June 30, 2015 | December 31, 2014 | |||||
Real estate loans: | |||||||
Construction | $ | 853 | $ | 871 | |||
Secured by farmland | — | — | |||||
Secured by 1-4 family residential | 1,035 | 1,035 | |||||
Other real estate loans | 1,514 | 2,145 | |||||
Total real estate loans | $ | 3,402 | $ | 4,051 |
At June 30, 2015, the Company had $250,000 in one consumer mortgage loan secured by residential real estate for which foreclosure was in process. At December 31, 2014, there were no consumer mortgage loans secured by residential real estate for which foreclosure was in process.
Note 14. Low Income Housing Tax Credits
The Company has invested in three separate housing equity funds at June 30, 2015. The general purpose of these funds is to encourage and assist participants in investing in low-income residential rental properties located in the Commonwealth of Virginia, develop and implement strategies to maintain projects as low-income housing, deliver Federal Low Income Housing Credits to investors, allocate tax losses and other possible tax benefits to investors, and to preserve and protect project assets. The investments in these funds were recorded as other assets on the consolidated balance sheets and were $6.30 million and $6.36 million at June 30, 2015 and December 31, 2014, respectively. The expected terms of these investments and the related tax benefits run through 2032. Tax credits and other tax benefits recognized during the six months ended June 30, 2015 and the year ended December 31, 2014, were $186,000 and $78,000, respectively, related to these investments. Total projected tax credits to be received for 2015 are $339,000, which is based on the most recent quarterly estimates received from the funds. Additional capital calls expected for the funds totaled $6.77 million and $7.00 million at June 30, 2015 and December 31, 2014, respectively, and are included in other liabilities on the consolidated balance sheets.
ITEM 2. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITON AND RESULTS OF OPERATIONS |
The following discussion and analysis of the financial condition at June 30, 2015 and results of operations of the Company for the three and six months ended June 30, 2015 should be read in conjunction with the Company’s Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements included in this report and in the 2014 Form 10-K. It should also be read in conjunction with the “Caution About Forward Looking Statements” section at the end of this discussion.
Overview
The Company is headquartered in Middleburg, Virginia and conducts its primary operations through two wholly owned subsidiaries, Middleburg Bank and Middleburg Investment Group, Inc. Middleburg Bank is a community bank serving the Virginia counties of Prince William, Loudoun, Fairfax, Fauquier, the Town of Williamsburg and the City of Richmond with twelve financial service centers and one limited service facility. Middleburg Investment Group is a non-bank holding company with one wholly owned subsidiary, Middleburg Trust Company. Middleburg Trust Company is a trust company headquartered in Richmond, Virginia,
33
and maintains offices in Williamsburg, Virginia and in several of Middleburg Bank’s facilities. On May 15, 2014, the Company sold its membership interests in Southern Trust Mortgage to a consortium of banks and the President of Southern Trust Mortgage.
The Company generates a significant amount of its income from the net interest income earned by Middleburg Bank. Net interest income is the difference between interest income and interest expense. Interest income depends on the amount of interest-earning assets outstanding during the period and the interest rates earned thereon. Middleburg Bank’s cost of funds is a function of the average amount of deposits and borrowed money outstanding during the period and the interest rates paid thereon. The quality of the assets further influences the amount of interest income lost on nonaccrual loans and the amount of additions to the allowance for loan losses or potential other-than-temporary impairment of securities. Middleburg Investment Group’s subsidiary, Middleburg Trust Company, generates fee income by providing investment management and trust services to its clients. Investment management and trust fees are generally based upon the value of assets under management, and, therefore can be significantly affected by fluctuations in the values of securities caused by changes in the capital markets.
Net income attributable to Middleburg Financial Corporation for the quarter ended June 30, 2015 increased 22.91% to $2.28 million from $1.86 million over the same period in 2014. Earnings per diluted share for the quarter ended June 30, 2015 were $0.32 per share compared to $0.26 per share for the same period in 2014. Net income attributable to Middleburg Financial Corporation for the six months ended June 30, 2015 increased 23.35% to $4.73 million from $3.83 million over the same period in 2014. Earnings per diluted share for the six months ended June 30, 2015 were $0.66 per share compared to $0.54 per share for the same period in 2014.
Annualized return on average assets for the quarter ended June 30, 2015 was 0.73%, compared to 0.61% for the same period in 2014. Annualized return on average equity of Middleburg Financial Corporation for the quarter ended June 30, 2015 was 7.31%, compared to 6.30% for the same period in 2014. Annualized return on average assets for the six months ended June 30, 2015 was 0.77%, compared to 0.63% for the same period in 2014. Annualized return on average equity of Middleburg Financial Corporation for the six months ended June 30, 2015 was 7.66%, compared to 6.60% for the same period in 2014.
The net interest margin, a non-GAAP measure more fully described in the “Results of Operations” section below, decreased from 3.38% for the quarter ended June 30, 2014 to 3.24% for the quarter ended June 30, 2015. The net interest margin decreased from 3.47% for the six months ended June 30, 2014 to 3.32% for the six months ended June 30, 2015.
The company recorded a recovery of loan losses in the amount of $425,000 for the quarter ended June 30, 2015 compared to a provision of $72,000 for the same period in 2014. The provision for loan losses decreased to $25,000 for the six months ended June 30, 2015 compared to a provision of $960,000 for the same period in 2014.
Non-interest income for the quarter and six months ended June 30, 2015 was lower by 43.22% and 46.49% , respectively, compared to the quarter and six months ended June 30, 2014 primarily due to the decline in gains recorded on the sale of residential mortgage loans in the current period, stemming from the Company's sale of its majority interest in Southern Trust Mortgage during the second quarter of 2014.
Non-interest expense fell by 18.52% compared to the quarter ended June 30, 2014 and declined by 22.77% compared to the six months ended June 30, 2014. Actions taken by the Company to reduce costs as well as the Company's sale of its interest in Southern Trust Mortgage during the second quarter of 2014 were the primary reasons for the decline in non-interest expense.
The Company’s capital ratios remain well above regulatory minimum capital ratios as of June 30, 2015:
• | Tier 1 Leverage ratio was 9.85%, 5.85% over the regulatory minimum of 4.00%. |
• | Common Equity Tier 1 ratio was 16.35%, 9.35% over the regulatory minimum of 7.00%. |
• | Tier 1 Risk-Based Capital Ratio was 17.04%, 8.54% over the regulatory minimum of 8.50% |
• | Total Risk Based Capital Ratio was 18.28%, 7.78% over the regulatory minimum of 10.50%. |
At June 30, 2015, total assets were $1.24 billion, an increase of 1.56% since December 31, 2014. Net loans held-for-investment increased by $18.14 million to $761.20 million, an increase of 2.44% since December 31, 2014. Total deposits were $1.01 billion, an increase of 1.66% since December 31, 2014. Non-maturity deposits, including demand, NOW and savings deposits increased $22.09 million from December 31, 2014 to $762.23 million at June 30, 2015. Time deposits decreased by 2.30% or $5.72 million from December 31, 2014 to $243.22 million at June 30, 2015.
Critical Accounting Policies
General
34
The financial condition and results of operations presented in the Consolidated Financial Statements, the accompanying Notes to the Consolidated Financial Statements and this section are, to some degree, dependent upon the accounting policies of the Company. The selection and application of these accounting policies involve judgments, estimates, and uncertainties that are susceptible to change.
Presented below is discussion of those accounting policies that management believes are the most important (“Critical Accounting Policies”) to the portrayal and understanding of Middleburg Financial Corporation’s financial condition and results of operations. The Critical Accounting Policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood.
Allowance for Loan Losses
Middleburg Bank monitors and maintains an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio. Middleburg Bank maintains policies and procedures that address the systems of controls over the following areas of maintenance of the allowance: the systematic methodology used to determine the appropriate level of the allowance to provide assurance they are maintained in accordance with accounting principles generally accepted in the United States of America; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; and the loan grading system.
Middleburg Bank evaluates various loans individually for impairment as required by applicable accounting standards. Loans evaluated individually for impairment include nonperforming loans, such as loans on nonaccrual, loans past due 90 days or more, troubled debt restructurings and other loans selected by management. The evaluations are based upon discounted cash flows or collateral valuations. If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment. If a loan evaluated individually is not impaired, then the loan is assessed for impairment with a group of loans that have similar characteristics.
For loans without individual measures of impairment, Middleburg Bank makes estimates of losses for groups of loans as required by applicable accounting standards. Loans are grouped by similar characteristics, including the type of loan, the assigned loan grade and the general collateral type. A loss rate reflecting the expected loss inherent in a group of loans is derived based upon estimates of default rates for a given loan grade, the predominant collateral type for the group and the terms of the loan. The resulting estimate of losses for groups of loans are adjusted for relevant environmental factors and other conditions of the portfolio of loans, including: borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.
The amount of estimated impairment for individually evaluated loans and groups of unimpaired loans is added together for a total estimate of loans losses. This estimate of losses is compared to the allowance for loan losses of Middleburg Bank as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made. If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates. If the estimate of losses is below the range of reasonable estimates, the allowance would be reduced by way of a credit to the provision for loan losses. Middleburg Bank recognizes the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high. If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which may be material to the consolidated financial statements.
Goodwill and Intangibles
With the adoption of Accounting Standards Update 2011-08, "Intangible-Goodwill and Other-Testing Goodwill for Impairment", the Company is no longer required to perform a test for impairment unless, based on an assessment of qualitative factors related to goodwill, we determine that it is more likely than not that the fair value of each applicable reporting unit is less than its carrying amount. If the likelihood of impairment is more than 50%, the Company must perform a test for impairment and may be required to record impairment charges. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value with its carrying amount, including goodwill. If the carrying amount is greater than zero and its fair value exceeds its carrying amount, goodwill is considered not impaired; thus, the second step of the impairment test is unnecessary. If the carrying amount exceeds its fair value, the second step of the goodwill impairment test shall be performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test, used to measure the amount of impairment loss, compares
35
the implied fair value with the carrying amount of that goodwill. If the carrying amount exceeds the implied fair value of that goodwill, an impairment loss shall be recognized in an amount equal to that excess. The loss recognized cannot exceed the carrying amount of goodwill. After a goodwill impairment loss is recognized, the adjusted carrying amount of goodwill shall be its new accounting basis. Subsequent reversal of a previously recognized goodwill impairment loss is prohibited once the measurement of that loss is recognized.
Management estimates fair value utilizing multiple methodologies which include discounted cash flows, comparable companies, third-party sale and assets under management analysis. Determining the fair value requires management to make judgments and assumptions related to various items, including estimates of future operating results, allocations of indirect expenses, and discount rates. Management believes its estimates and assumptions are reasonable; however, the fair value could be different in the future if actual results or market conditions differ from the estimates and assumptions used.
The Company’s forecasted cash flows assume a stable economic environment and consistent long-term growth in assets under management over the projected periods. Additionally, expenses are assumed to be consistently correlated with projected asset and revenue growth over the time periods projected. Although we believe the key assumptions underlying the financial forecasts to be reasonable, they are inherently uncertain and involve a number of risks and uncertainties that are beyond the control of the Company. Accordingly, there can be no assurance that the forecasted results will be realized and variations from the forecast may be material. If weak economic conditions continue or worsen for a prolonged period of time, or if the reporting unit loses key personnel, the fair value may be adversely affected which may result in impairment of goodwill or other intangible assets in the future. Any changes in the key management estimates or judgments could result in an impairment charge, and such a charge could have an adverse effect on the Company’s financial condition and results of operations.
Middleburg Investment Group has intangible assets in the form of certain customer relationships that were acquired in 2002. We amortize those intangible assets on a straight line basis over their estimated useful life.
Other-Than-Temporary Impairment (OTTI) for Securities
Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (i) we intend to sell the security or (ii) it is more-likely-than-not that we will be required to sell the security before recovery of its amortized cost basis. If, however, we do not intend to sell the security and it is not more-likely-than-not that we will be required to sell the security before recovery, we must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income. For equity securities, impairment is considered to be other-than-temporary based on our ability and intent to hold the investment until a recovery of fair value. Other-than-temporary impairment of an equity security results in a write-down that must be included in net income. We regularly review each investment security for other-than-temporary impairment based on criteria that includes the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer, our best estimate of the present value of cash flows expected to be collected from debt securities, our intention with regard to holding the security to maturity and the likelihood that we would be required to sell the security before recovery.
Results of Operations
The Company's net income for the second quarter of 2015 was $2.28 million, an increase of $425,000 or 22.91% compared to the second quarter of 2014. For the second quarter of 2015, earnings per diluted share was $0.32 compared to earnings per diluted share of $0.26 for the second quarter of 2014.
The following tables reflect an analysis of the Company’s net interest income for the quarters ended June 30, 2015 and 2014 using the daily average balances of the Company’s assets and liabilities for the periods indicated. Nonaccrual loans are included in the loan balances.
36
Three Months Ended June 30, | |||||||||||||||||||||
2015 | 2014 | ||||||||||||||||||||
Average Balance | Income/ Expense | Yield/ Rate (2) | Average Balance | Income/ Expense | Yield/ Rate (2) | ||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||
Assets: | |||||||||||||||||||||
Securities: | |||||||||||||||||||||
Taxable | $ | 315,874 | $ | 1,858 | 2.36 | % | $ | 276,110 | $ | 1,864 | 2.71 | % | |||||||||
Tax-exempt (1) | 51,199 | 680 | 5.33 | % | 57,394 | 814 | 5.69 | % | |||||||||||||
Total securities | $ | 367,073 | $ | 2,538 | 2.77 | % | $ | 333,504 | $ | 2,678 | 3.22 | % | |||||||||
Loans: | |||||||||||||||||||||
Taxable | $ | 764,101 | $ | 8,009 | 4.20 | % | $ | 744,009 | $ | 8,487 | 4.58 | % | |||||||||
Tax-exempt (1) | 615 | 8 | 5.22 | % | 652 | 9 | 5.54 | % | |||||||||||||
Total loans (3) | $ | 764,716 | $ | 8,017 | 4.20 | % | $ | 744,661 | $ | 8,496 | 4.58 | % | |||||||||
Interest on deposits with other banks and federal funds sold | 50,861 | 31 | 0.24 | % | 81,552 | 47 | 0.23 | % | |||||||||||||
Total earning assets | $ | 1,182,650 | $ | 10,586 | 3.59 | % | $ | 1,159,717 | $ | 11,221 | 3.88 | % | |||||||||
Less: allowances for loan losses | (12,150 | ) | (12,606 | ) | |||||||||||||||||
Total nonearning assets | 76,720 | 78,679 | |||||||||||||||||||
Total assets | $ | 1,247,220 | $ | 1,225,790 | |||||||||||||||||
Liabilities: | |||||||||||||||||||||
Interest-bearing deposits: | |||||||||||||||||||||
Checking | $ | 345,768 | $ | 173 | 0.20 | % | $ | 340,789 | $ | 161 | 0.19 | % | |||||||||
Regular savings | 118,467 | 55 | 0.19 | % | 113,487 | 53 | 0.19 | % | |||||||||||||
Money market savings | 66,300 | 31 | 0.19 | % | 73,308 | 35 | 0.19 | % | |||||||||||||
Time deposits: | |||||||||||||||||||||
$100,000 and over | 129,519 | 286 | 0.89 | % | 123,527 | 317 | 1.03 | % | |||||||||||||
Under $100,000 | 107,352 | 303 | 1.13 | % | 132,002 | 429 | 1.30 | % | |||||||||||||
Total interest-bearing deposits | $ | 767,406 | $ | 848 | 0.44 | % | $ | 783,113 | $ | 995 | 0.51 | % | |||||||||
Securities sold under agreements to repurchase | 29,168 | 17 | 0.25 | % | 35,114 | 81 | 0.93 | % | |||||||||||||
FHLB borrowings and other debt | 74,825 | 174 | 0.93 | % | 85,155 | 355 | 1.60 | % | |||||||||||||
Federal funds purchased | 4 | — | — | % | |||||||||||||||||
Total interest-bearing liabilities | $ | 871,403 | $ | 1,039 | 0.48 | % | $ | 903,386 | $ | 1,431 | 0.63 | % | |||||||||
Non-interest bearing liabilities: | |||||||||||||||||||||
Demand deposits | 237,560 | 194,779 | |||||||||||||||||||
Other liabilities | 13,149 | 9,936 | |||||||||||||||||||
Total liabilities | $ | 1,122,112 | $ | 1,108,101 | |||||||||||||||||
Non-controlling interest | — | — | |||||||||||||||||||
Shareholders' equity | 125,108 | 117,689 | |||||||||||||||||||
Total liabilities and shareholders' equity | $ | 1,247,220 | $ | 1,225,790 | |||||||||||||||||
Net interest income | $ | 9,547 | $ | 9,790 | |||||||||||||||||
Interest rate spread | 3.11 | % | 3.25 | % | |||||||||||||||||
Cost of Funds | 0.38 | % | 0.52 | % | |||||||||||||||||
Interest expense as a percent of average earning assets | 0.35 | % | 0.49 | % | |||||||||||||||||
Net interest margin | 3.24 | % | 3.38 | % |
(1) | Income and yields are reported on a tax equivalent basis assuming a federal tax rate of 34%. |
(2) | All yields and rates have been annualized on a 365 day year. |
(3) | Total average loans include loans on non-accrual status. |
The Company's net income for the six months ended June 30, 2015 was $4.73 million, an increase of $895,000 or 23.35% from the six months ended June 30, 2014. For the six months ended June 30, 2015, earnings per diluted share was $0.66 compared to earnings per diluted share of $0.54 for the six months ended June 30, 2014.
The following tables reflect an analysis of the Company’s net interest income for the six months ended June 30, 2015 and 2014 using the daily average balances of the Company’s assets and liabilities for the periods indicated. Nonaccrual loans are included in the loan balances.
37
Six Months Ended June 30, | |||||||||||||||||||||
2015 | 2014 | ||||||||||||||||||||
Average Balance | Income/ Expense | Yield/ Rate (2) | Average Balance | Income/ Expense | Yield/ Rate (2) | ||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||
Assets: | |||||||||||||||||||||
Securities: | |||||||||||||||||||||
Taxable | $ | 312,875 | $ | 3,823 | 2.46 | % | $ | 276,510 | $ | 3,555 | 2.59 | % | |||||||||
Tax-exempt (1) | 51,899 | 1,379 | 5.36 | % | 59,155 | 1,698 | 5.79 | % | |||||||||||||
Total securities | $ | 364,774 | $ | 5,202 | 2.88 | % | $ | 335,665 | $ | 5,253 | 3.16 | % | |||||||||
Loans: | |||||||||||||||||||||
Taxable | $ | 757,880 | $ | 16,246 | 4.32 | % | $ | 750,666 | $ | 17,288 | 4.64 | % | |||||||||
Tax-exempt (1) | 615 | 16 | 5.25 | % | 652 | 17 | 5.26 | % | |||||||||||||
Total loans (3) | $ | 758,495 | $ | 16,262 | 4.32 | % | $ | 751,318 | $ | 17,305 | 4.66 | % | |||||||||
Interest on deposits with other banks and federal funds sold | 56,003 | 61 | 0.22 | % | 65,268 | 73 | 0.23 | % | |||||||||||||
Total earning assets | $ | 1,179,272 | $ | 21,525 | 3.68 | % | $ | 1,152,251 | $ | 22,631 | 3.96 | % | |||||||||
Less: allowances for loan losses | (11,907 | ) | (13,101 | ) | |||||||||||||||||
Total nonearning assets | 76,473 | 80,133 | |||||||||||||||||||
Total assets | $ | 1,243,838 | $ | 1,219,283 | |||||||||||||||||
Liabilities: | |||||||||||||||||||||
Interest-bearing deposits: | |||||||||||||||||||||
Checking | $ | 341,471 | $ | 339 | 0.20 | % | $ | 336,690 | $ | 322 | 0.19 | % | |||||||||
Regular savings | 116,902 | 108 | 0.19 | % | 113,262 | 105 | 0.19 | % | |||||||||||||
Money market savings | 67,909 | 63 | 0.19 | % | 74,864 | 71 | 0.19 | % | |||||||||||||
Time deposits: | |||||||||||||||||||||
$100,000 and over | 130,872 | 579 | 0.89 | % | 126,948 | 640 | 1.02 | % | |||||||||||||
Under $100,000 | 108,851 | 614 | 1.14 | % | 131,385 | 859 | 1.32 | % | |||||||||||||
Total interest-bearing deposits | $ | 766,005 | $ | 1,703 | 0.45 | % | $ | 783,149 | $ | 1,997 | 0.51 | % | |||||||||
Securities sold under agreements to repurchase | 31,452 | 62 | 0.40 | % | 35,431 | 161 | 0.90 | % | |||||||||||||
FHLB borrowings and other debt | 70,431 | 342 | 0.98 | % | 85,155 | 668 | 1.54 | % | |||||||||||||
Federal funds purchased | 2 | — | — | % | 2 | — | — | % | |||||||||||||
Total interest-bearing liabilities | $ | 867,890 | $ | 2,107 | 0.49 | % | $ | 903,737 | $ | 2,826 | 0.63 | % | |||||||||
Non-interest bearing liabilities: | |||||||||||||||||||||
Demand deposits | 238,169 | 189,807 | |||||||||||||||||||
Other liabilities | 13,283 | 9,549 | |||||||||||||||||||
Total liabilities | $ | 1,119,342 | $ | 1,103,093 | |||||||||||||||||
Non-controlling interest | — | — | |||||||||||||||||||
Shareholders' equity | 124,496 | 116,190 | |||||||||||||||||||
Total liabilities and shareholders' equity | $ | 1,243,838 | $ | 1,219,283 | |||||||||||||||||
Net interest income | $ | 19,418 | $ | 19,805 | |||||||||||||||||
Interest rate spread | 3.19 | % | 3.33 | % | |||||||||||||||||
Cost of Funds | 0.38 | % | 0.52 | % | |||||||||||||||||
Interest expense as a percent of average earning assets | 0.36 | % | 0.49 | % | |||||||||||||||||
Net interest margin | 3.32 | % | 3.47 | % |
Net Interest Income
Net interest income represents the principal source of earnings of the Company. Net interest income is the amount by which interest generated from earning assets exceeds the expense of funding those assets. Changes in volume and mix of interest earning assets and interest bearing liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income.
Net interest income was $9.31 million for the quarter ended June 30, 2015. This is a decrease of 2.07% compared to net interest income for the same period in 2014. The net interest margin for the quarter ended June 30, 2015 was 3.24% compared to 3.38% for the same period in 2014. Net interest income was $18.94 million for the six months ended June 30, 2015. This is a decrease
38
of 1.45% over net interest income reported for the same period for 2014. The net interest margin for the six months ended June 30, 2015 was 3.32% compared to 3.47% for the same period for 2014.
The following factors contributed to the change in the net interest margin:
• | Yields on earning assets during the quarter ended June 30, 2015 declined by 29 bp compared to the same period for 2014. This included a 38 bp decrease in loan yields and a 45 bp decrease in yields on investment securities for the same period. Yields on earning assets during the six month period ended June 30, 2015 declined by 28 bp compared to the same period for 2014. This included a 34 bp decrease in loan yields and a 28 bp decrease in yields on investment securities for the same period. |
• | Cost of funds was 38 bp, 14 bp lower than the three and six months ended June 30, 2014 of 52 bp. |
Yields on investment securities were impacted by higher premium amortization stemming from faster prepayments on mortgage backed securities accompanied by lower book yields for securities that were added to the portfolio during the period. Loan yields declined due to refinancing of existing loans and new loans getting booked at lower rates.
The net interest margin is calculated by dividing tax equivalent net interest income by total average earning assets. Because a portion of interest income earned by the Company is nontaxable, the tax equivalent net interest income is considered in the calculation of this ratio. The tax rate utilized in calculating the tax benefit for each of the reported periods is 34%. The reconciliation of tax equivalent net interest income, which is not a measurement under accounting principles generally accepted in the United States, to net interest income is reflected in the table below.
For the Three Months Ended June 30, | For the Six Months Ended June 30, | ||||||||||||||
(Dollars in thousands) | 2015 | 2014 | 2015 | 2014 | |||||||||||
GAAP measures: | |||||||||||||||
Interest Income - Loans | $ | 8,014 | $ | 8,493 | $ | 16,257 | $ | 17,299 | |||||||
Interest Income - Investments & Other | 2,338 | 2,448 | 4,794 | 4,749 | |||||||||||
Interest Expense - Deposits | 848 | 995 | 1,703 | 1,997 | |||||||||||
Interest Expense - Other Borrowings | 191 | 436 | 404 | 829 | |||||||||||
Total Net Interest Income | $ | 9,313 | $ | 9,510 | $ | 18,944 | $ | 19,222 | |||||||
Non-GAAP measures: | |||||||||||||||
Tax Benefit Realized on: | |||||||||||||||
Non-taxable interest income - municipal securities | 231 | 277 | 469 | 577 | |||||||||||
Non-taxable interest income - loans | 3 | 3 | 5 | 6 | |||||||||||
Total Tax Benefit Realized on Non-Taxable Interest Income | $ | 234 | $ | 280 | $ | 474 | $ | 583 | |||||||
Total Tax Equivalent Net Interest Income | $ | 9,547 | $ | 9,790 | $ | 19,418 | $ | 19,805 |
Based on our internal interest rate risk models and the assumption of a sustained low rate environment, the Company expects net interest income to trend downward throughout the next 12 months as loans and securities reprice lower and the decline in funding costs slows. It is anticipated that targeted growth in earning assets and liability repricing opportunities will help mitigate the impact to the Company’s net interest margin. The Asset/Liability Management Committee continues to focus on various strategies to maintain the net interest margin.
Non-Interest Income
Non-interest income has been and will continue to be an important factor for increasing profitability. Management recognizes this and continues to review and consider areas where non-interest income can be increased. Non-interest income includes fees generated by the commercial and retail banking segment and the wealth management segment. Non-interest income for the quarter and six months ended June 30, 2015 was lower by 43.22% and 46.49% compared to the quarter and six months ended June 30, 2014, respectively. A more detailed discussion of non-interest income follows:
• | The primary reason for the decline in non-interest income compared to the quarter ended June 30, 2014 was due to the decline of gains on the sales of residential mortgage loans in the current period, stemming primarily from the Company's sale of its majority interest in Southern Trust Mortgage during the second quarter of 2014. |
• | Total revenue generated by our wealth management group, Middleburg Investment Group ("MIG") was $1.24 million for the quarter ended June 30, 2015, an increase of 17.60% when compared to the quarter ended June 30, 2014. Total revenue generated by MIG was $2.46 million for the six month period ended June 30, 2015, an increase of 16.91% when |
39
compared to the same period in 2014. Fee income is based primarily upon the market value of the accounts under administration which were $1.97 billion at June 30, 2015 and $1.68 billion at June 30, 2014.
The following table depicts the changes in non-interest income:
(Dollars in thousands) | For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||
2015 | 2014 | 2015 | 2014 | ||||||||||||
Service charges on deposit accounts | $ | 612 | $ | 622 | $ | 1,170 | $ | 1,180 | |||||||
Trust services income | 1,243 | 1,057 | 2,461 | 2,105 | |||||||||||
Gains (losses) on sales of loans held for sale | (6 | ) | 1,916 | (6 | ) | 4,858 | |||||||||
Gains on sales of securities available for sale, net | 37 | 66 | 138 | 129 | |||||||||||
Commissions on investment sales | 154 | 146 | 283 | 286 | |||||||||||
Bank owned life insurance | 163 | 164 | 323 | 326 | |||||||||||
Gain on sale of majority interest in consolidated subsidiary | — | 24 | — | 24 | |||||||||||
Other operating income | 223 | 278 | 1,065 | 1,247 | |||||||||||
Total non-interest income | $ | 2,426 | $ | 4,273 | $ | 5,434 | $ | 10,155 |
Non-Interest Expense
Non-interest expense for the quarter ended June 30, 2015, fell by 18.52% compared to the same period in 2014. Non-interest expense fell by 22.77% compared to the six months ended June 30, 2014. Principal reasons for the improvement in non-interest expenses were the following:
• | Salaries and employee benefit expenses declined by 17.02% and 24.60% when compared to the quarter and six months ended June 30, 2014. The decline in salary and benefit expenses compared to 2014 was primarily due to the sale of the Company's majority interest in Southern Trust Mortgage in the second quarter of 2014. |
• | Occupancy and equipment expense declined by 26.98% and 28.33% compared to the quarter and six month periods ended June 30, 2014. The primary reasons for lower expenses in this category was management's overall expense control initiative and the sale of Southern Trust Mortgage in the second quarter of 2014. |
• | Other expenses decreased by 23.30% and 21.66% compared to the quarter and six month periods ended June 30, 2014. The majority of expenses in this category relate to deposit processing, professional and advisory fees. The primary reason for lower expenses compared to 2014 was the sale of the Company's majority interest in Southern Trust Mortgage in the second quarter of 2014. |
The following table depicts the changes in non-interest expense:
(Dollars in thousands) | For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||
2015 | 2014 | 2015 | 2014 | ||||||||||||
Salaries and employee benefits | $ | 4,973 | $ | 5,993 | $ | 9,821 | $ | 13,026 | |||||||
Occupancy and equipment | 1,226 | 1,679 | 2,565 | 3,579 | |||||||||||
Advertising | 101 | 131 | 234 | 294 | |||||||||||
Computer operations | 522 | 510 | 1,012 | 969 | |||||||||||
Other real estate owned | 25 | 12 | 92 | 179 | |||||||||||
Other taxes | 231 | 220 | 454 | 417 | |||||||||||
Federal deposit insurance | 184 | 230 | 395 | 468 | |||||||||||
Other operating expenses | 1,807 | 2,356 | 3,396 | 4,335 | |||||||||||
Total non-interest expense | $ | 9,069 | $ | 11,131 | $ | 17,969 | $ | 23,267 |
The adjusted efficiency ratio is not a measurement under accounting principles generally accepted in the United States. The Company calculates its efficiency ratio by dividing non-interest expense (adjusted for amortization of intangibles and other real estate expenses) by the sum of tax equivalent net interest income and non-interest income excluding gains and losses on the investment portfolio. The tax rate utilized in calculating tax equivalent amounts is 34%. The Company calculates and reviews this ratio as a means of evaluating operational efficiency. The calculation of the adjusted efficiency ratio for the three and six months ended June 30, 2015 and 2014 is as follows:
40
For the Three Months Ended June 30, | For the Six Months Ended June 30, | ||||||||||||||
(Dollars in thousands) | 2015 | 2014 | 2015 | 2014 | |||||||||||
Summary of Operating Results: | |||||||||||||||
Non-interest expense | $ | 9,069 | $ | 11,131 | $ | 17,969 | $ | 23,267 | |||||||
Less: Amortization expense | 43 | 43 | 85 | 86 | |||||||||||
Less: Other real estate owned expenses, net | 25 | 12 | 92 | 179 | |||||||||||
Adjusted non-interest expense | $ | 9,001 | $ | 11,076 | $ | 17,792 | $ | 23,002 | |||||||
Net interest income | $ | 9,313 | $ | 9,510 | $ | 18,944 | $ | 19,222 | |||||||
Non-interest income | 2,426 | 4,273 | 5,434 | 10,155 | |||||||||||
Less: Gains on securities available for sale, net | 37 | 66 | 138 | 129 | |||||||||||
Adjusted non-interest income | $ | 2,389 | $ | 4,207 | $ | 5,296 | $ | 10,026 | |||||||
Tax equivalent adjustment | 318 | 365 | 640 | 751 | |||||||||||
Total net interest income and non-interest income, adjusted | $ | 12,020 | $ | 14,082 | $ | 24,880 | $ | 29,999 | |||||||
Efficiency ratio, adjusted | 74.88 | % | 78.65 | % | 71.51 | % | 76.68 | % | |||||||
Efficiency ratio, GAAP (1) | 77.26 | % | 80.76 | % | 73.71 | % | 79.20 | % |
(1) Computed by dividing non-interest expense by the sum of net interest income and non-interest income.
Income Taxes
Income taxes on earnings amounted to $815,000, resulting in an effective tax rate of 26.33% for the quarter ended June 30, 2015, compared with $667,000, or 25.85% for the quarter ended June 30, 2014. Income taxes on earnings amounted to $1.66 million, resulting in an effective tax rate of 25.94% for the six months ended June 30, 2015, compared with $1.42 million, or 27.48% for the six months ended June 30, 2014. The primary reason for the decline in the effective tax rate was the benefit from low income housing tax credits. For a further discussion of low income housing tax credits, see “Note 14. Low Income Housing Tax Credits".
Financial Condition
Assets, Liabilities and Shareholders’ Equity
Total consolidated assets at June 30, 2015 were $1.24 billion, an increase of 1.56% from December 31, 2014. Changes in major asset categories were as follows:
• | Cash balances and deposits with other banks decreased by $5.62 million compared to December 31, 2014. |
• | The Company deployed some of its excess liquidity into growing its securities portfolio which increased by $3.73 million compared to December 31, 2014. |
• | Gross loan balances increased by $18.24 million from December 31, 2014. |
Total consolidated liabilities at June 30, 2015 were $1.12 billion, an increase of 1.49% from December 31, 2014. Total deposits increased by $16.37 million from December 31, 2014 to $1.01 billion as of June 30, 2015. Federal Home Loan Bank borrowings increased by $15 million to $70 million.
Shareholders equity at June 30, 2015 was $124.79 million, compared to shareholders equity of $122.03 million at December 31, 2014. Retained earnings at June 30, 2015 were $59.15 million compared to retained earnings of $55.85 million at December 31, 2014. The book value of the Company’s common stock at June 30, 2015 was $17.42 per share versus $17.11 per share at December 31, 2014.
Loans
The Company’s loan portfolio at June 30, 2015 totaled 65.56% of average earning assets with a tax equivalent yield of 4.32% during the six month period ended June 30, 2015.
The following table summarized total loans by category:
41
June 30, | Years Ended December 31, | ||||||||||||||||||
(Dollars in thousands) | 2015 | 2014 | 2013 | 2012 | 2011 | ||||||||||||||
Real estate loans: | |||||||||||||||||||
Construction | $ | 30,781 | $ | 33,050 | $ | 36,025 | $ | 50,218 | $ | 42,208 | |||||||||
Secured by farmland | 19,505 | 19,708 | 16,578 | 11,876 | 10,047 | ||||||||||||||
Secured by 1-4 family residential | 272,198 | 265,216 | 273,384 | 260,620 | 236,760 | ||||||||||||||
Other real estate loans | 265,892 | 255,236 | 260,333 | 254,930 | 275,428 | ||||||||||||||
Commercial loans | 167,542 | 163,269 | 129,554 | 118,573 | 94,427 | ||||||||||||||
Consumer loans | 17,172 | 18,367 | 12,606 | 13,260 | 12,523 | ||||||||||||||
Total gross loans | 773,090 | 754,846 | 728,480 | 709,477 | 671,393 | ||||||||||||||
Less allowance for loan losses | 11,894 | 11,786 | 13,320 | 14,311 | 14,623 | ||||||||||||||
Net loans | $ | 761,196 | $ | 743,060 | $ | 715,160 | $ | 695,166 | $ | 656,770 |
Changes in the loan portfolio at June 30, 2015 compared to December 31, 2014 were as follows.
• | Real estate construction loans consist primarily of pre-sold 1-4 family residential loans along with a marginal amount of commercial construction loans. These loans represented 4.00% of total loans, a decrease of approximately $2.27 million from $33.05 million. |
• | Loans secured by farmland decreased by $203,000 from $19.71 million. |
• | Loans secured by 1-4 family residential real estate represented 35.20% of total loans, an increase of $6.98 million. |
• | Other real estate loans are typically non-farm, non-residential real estate loans which are, in most cases, owner-occupied commercial buildings. Other real estate loans represented 34.40% of total loans, an increase of $10.66 million. |
• | Commercial loans, which consist of secured and unsecured loans to small businesses, increased 2.62%. |
• | Consumer loans decreased by $1.20 million or 6.51%. |
Asset Quality
Delinquencies on loans that were more than 90 days late and still accruing remain low at 0.02% of total loans as of June 30, 2015 and 0.004% as of December 31, 2014, past due loans decreased from $4.85 million at December 31, 2014 to $2.08 million at June 30, 2015, a decrease of 57.09%, and nonaccrual loans declined to $8.01 million as of June 30, 2015 from $9.94 million as of December 31, 2014.
Two loans from a single borrower relationship totaling $9.93 million underwent a restructuring during the second quarter of 2015 and one of the loans was downgraded, which resulted in total nonperforming assets increasing to $24.77 million or 1.99% of total assets compared to $19.45 million or 1.59% of total assets at December 31, 2014, increased troubled debt restructurings to $15.74 million at June 30, 2015 compared to $6.90 million at December 31, 2014, and increased substandard loans by 29.34% to $25.05 million at June 30, 2015 from $19.37 million at December 31, 2014. While this loan was restructured and downgraded during the second quarter 2015, the Company had properly classified this loan as impaired at December 31, 2014.
During the quarter, the Company sold $1.02 million of nonperforming loans and upgraded the risk rating of several loans due to the improved financial condition of the borrowers, resulting in the release of reserves which led to a recovery of provision for loan losses of $425,000 during the second quarter.
The table below summarizes nonperforming assets for the periods indicated.
42
June 30, | December 31, | ||||||||||||||||||
(Dollars in thousands) | 2015 | 2014 | 2013 | 2012 | 2011 | ||||||||||||||
Nonaccrual loans | $ | 8,008 | $ | 9,944 | $ | 19,752 | $ | 21,664 | $ | 25,346 | |||||||||
Restructured loans (1) | 12,138 | 4,295 | 4,674 | 5,132 | 3,853 | ||||||||||||||
Accruing loans greater than 90 days past due | 173 | 30 | 808 | 1,044 | 1,233 | ||||||||||||||
Total nonperforming loans | $ | 20,319 | $ | 14,269 | $ | 25,234 | $ | 27,840 | $ | 30,432 | |||||||||
Other real estate owned | 3,402 | 4,051 | 3,424 | 9,929 | 8,535 | ||||||||||||||
Repossessed assets (2) | 1,044 | 1,132 | — | — | — | ||||||||||||||
Total nonperforming assets | $ | 24,765 | $ | 19,452 | $ | 28,658 | $ | 37,769 | $ | 38,967 | |||||||||
Allowance for loan losses | $ | 11,894 | $ | 11,786 | $ | 13,320 | $ | 14,311 | $ | 14,623 | |||||||||
Nonperforming loans to total loans | 2.63 | % | 1.89 | % | 3.46 | % | 3.92 | % | 4.53 | % | |||||||||
Allowance for loan losses to nonperforming loans | 58.54 | % | 82.60 | % | 52.79 | % | 51.40 | % | 48.05 | % | |||||||||
Nonperforming assets to total assets | 1.99 | % | 1.59 | % | 2.33 | % | 3.05 | % | 3.27 | % |
(1) Amount reflects restructured loans that are not included in nonaccrual loans.
(2) Included in other assets.
Included in nonperforming loans are troubled debt restructurings (“TDRs”). The total balance of TDRs at June 30, 2015 was $15.7 million of which $3.6 million were included in the Company’s nonaccrual loan totals at that date and $12.1 million represented loans performing as agreed to the restructured terms. This compares with $6.9 million in total TDRs at December 31, 2014. The increase in TDRs during the first six months of 2015 is primarily attributed to the restructuring of two loans to a single borrower described above. The amount of the valuation allowance related to TDRs was $1.62 million and $517,000 as of June 30, 2015 and December 31, 2014, respectively.
The Company requires six timely consecutive monthly payments be made and future payments be reasonably assured, before a restructured loan that has been placed on nonaccrual can be returned to accrual status. The Company does not utilize formal modification programs or packages when loans are considered for restructuring. Any loan restructuring is based on the borrower’s circumstances and may include modifications to more than one of the terms and conditions of the loan.
The Company has not performed any commercial real estate or other type of loan workout whereby the existing loan would have been structured into multiple new loans.
Allowance For Loan Losses
For a discussion of the Company’s accounting policies with respect to the allowance for loan losses, see “Critical Accounting Policies – Allowance for Loan Losses”.
The allowance for loans losses was $11.89 million or 1.54% of total loans at June 30, 2015 compared to $11.79 million or 1.56% of total loans at December 31, 2014 and $13.23 million or 1.81% of total loans at June 30, 2014. During the quarter, the Company sold $1.02 million of nonperforming loans and upgraded the risk rating of several loans due to the improved financial condition of the borrowers, resulting in the release of reserves which led to a recovery of provision for loan losses of $425,000 during the second quarter.
The following table depicts the transactions, in summary form, related to the allowance for loan losses.
43
For the Six Months Ended | For the Year Ended | ||||||
(Dollars in thousands) | June 30, 2015 | December 31, 2014 | |||||
Balance, beginning of period | $ | 11,786 | $ | 13,320 | |||
Add: Provision for loan losses | 25 | 1,960 | |||||
Adjustment for the sale of majority interest in consolidated subsidiary | — | (95 | ) | ||||
Less: Charge-offs: | |||||||
Real estate loans: | |||||||
Construction | $ | — | $ | (1,186 | ) | ||
Secured by 1-4 family residential | (12 | ) | (1,380 | ) | |||
Other real estate loans | (9 | ) | (747 | ) | |||
Commercial loans | (246 | ) | (959 | ) | |||
Consumer loans | (40 | ) | (36 | ) | |||
Total charge-offs | $ | (307 | ) | $ | (4,308 | ) | |
Add: Recoveries: | |||||||
Real estate loans: | |||||||
Construction | $ | 31 | $ | 258 | |||
Secured by 1-4 family residential | 324 | 342 | |||||
Other real estate loans | 21 | 110 | |||||
Commercial loans | 8 | 104 | |||||
Consumer loans | 6 | 95 | |||||
Total recoveries | $ | 390 | $ | 909 | |||
Net charge-offs | $ | 83 | $ | (3,399 | ) | ||
Balance, end of period | $ | 11,894 | $ | 11,786 | |||
Allowance for loan losses to total loans | 1.54 | % | 1.56 | % | |||
Net charge-offs (recoveries) to average loans | (0.01 | )% | 0.46 | % |
The allocation of the allowance (dollars in thousands) at June 30, 2015 and December 31, 2014 were:
June 30, 2015 | December 31, 2014 | ||||||
Real Estate Construction | $ | 560 | $ | 550 | |||
Real Estate Secured by Farmland | 190 | 179 | |||||
1-4 Family Residential | 4,122 | 3,966 | |||||
Other Real Estate Loans | 3,963 | 3,916 | |||||
Commercial | 1,844 | 2,354 | |||||
Consumer | 1,215 | 821 | |||||
$ | 11,894 | $ | 11,786 |
The Company has allocated the allowance according to the amount deemed reasonably necessary to provide for the possibility of losses being incurred within each loan category. The allocation of the allowance should not be interpreted as an indication that loan losses in future years will occur in the same proportions that they may have in prior periods or that the allocation indicates future loan loss trends. Additionally, the proportion allocated to each loan category is not the total amount that may be available for future losses that could occur within such categories since the total allowance is available to absorb losses on the total portfolio.
Securities
The carrying value of the securities portfolio was $353.49 million at June 30, 2015, an increase of $3.73 million compared to the carrying value of $349.76 million at December 31, 2014.
Unrealized losses were $2.48 million and $2.14 million at June 30, 2015 and December 31, 2014, respectively. Unrealized gains were $7.26 million and $8.07 million at June 30, 2015 and December 31, 2014, respectively. At June 30, 2015, the Company evaluated the investment portfolio for possible other-than-temporary impairment losses and concluded that no adverse change in cash flows occurred and did not consider any portfolio securities to be other-than-temporarily impaired. Based on this analysis and because the Company does not intend to sell securities prior to maturity and it is more likely than not the Company will not be required to sell any securities before recovery of amortized cost basis, which may be at maturity. For debt securities related to corporate securities, the Company determined that there was no other adverse change in the cash flows as viewed by a market
44
participant; therefore, the Company does not consider the investments in these assets to be other-than-temporarily impaired at June 30, 2015.
The securities portfolio at June 30, 2015 and December 31, 2014 represented approximately 29.8% and 30.4% of the average earning assets of the Company during the six and twelve month periods then ended.
Goodwill and Other Identified Intangibles
Goodwill and other identified intangibles decreased by $85,000 to $3.72 million at June 30, 2015. This decrease is attributable to amortization expense related to intangibles.
Deposits
Total deposits increased by $16.37 million from December 31, 2014 to $1.01 billion as of June 30, 2015, primarily due to strong deposit inflows, specifically in non-interest bearing business checking accounts, during the period.
Time deposits decreased by $5.72 million or 2.30% from December 31, 2014 to $243.22 million at June 30, 2015. Time deposits include brokered certificates of deposit and CDARS deposits. Securities sold under agreements to repurchase (“Repo Accounts”) decreased by $14.50 million from $38.55 million at December 31, 2014 to $24.05 million at June 30, 2015. The Repo Accounts include certain long-term commercial checking accounts with average balances that typically exceed $100,000. All repurchase agreement transactions entered into by the Company are accounted for as collateralized financings and not as sales.
FHLB Borrowings
The Company had no overnight advances from the Federal Home Loan Bank of Atlanta (“FHLB”) outstanding at June 30, 2015. FHLB term advances were $70.00 million at June 30, 2015, higher by $15.00 million compared to December 31, 2014. We raised cash through short term advances maturing in three months or less in part to pay-off longer term wholesale borrowings that matured during the quarter. Additionally, since some of the deposit growth in the second quarter was deemed to be cyclical, the FHLB term advances enabled the Bank to manage liquidity without selling securities, which would have reduced the yield on earning assets.
Capital Resources and Dividends
Shareholders' equity was $124.79 million at June 30, 2015 compared to $122.03 million at December 31, 2014. During the six month period ended June 30, 2015, the Company declared common stock dividends of $0.20 per share, compared to $0.14 per share for the same period in 2014. The book value of common stock was $17.42 per share at June 30, 2015 and $17.11 at December 31, 2014.
The Company's capital ratios remain well above regulatory minimum capital ratios as of June 30, 2015 and December 31, 2014:
• | Total Risk Based Capital ratio of 18.28% and 16.95% at June 30, 2015 and December 31, 2014, respectively. |
• | Common Equity Tier 1 ratio of 16.35% at June 30, 2015. This is a new ratio under Basel III for 2015. |
• | Tier 1 Capital ratio of 17.04% and 15.70% at June 30, 2015 and December 31, 2014, respectively. |
• | Leverage ratio of 9.85% at June 30, 2015 compared to 9.90% at December 31, 2014. |
The Company’s Tier 1 capital and total capital include $5.0 million of trust preferred securities. Under the changes to the regulatory capital framework that were approved on July 9, 2013 by the federal banking agencies (Basel III Final Rule), the Company's trust preferred securities will continue to be included in Tier 1 capital and total capital until they mature, pursuant to a "grandfathering" provision that exempts Middleburg Financial Corporation's securities from the more stringent regulatory capital treatment contained in the Basel III Final Rule for trust preferred securities. In addition to "grandfathering" certain previously outstanding trust preferred securities for community banks, the Basel III Final Rule introduces a new Common Equity Tier 1 capital measure, increases the applicable minimum regulatory capital levels and certain prompt corrective action capital levels, and establishes a capital conservation buffer and new risk weights for certain types of assets. The implementation date of the Basel III capital rules was January 1, 2015 for all US banking organizations not subject to the advanced approaches capital rules and the date for banking organizations to meet the fully phased in Basel III capital ratios is January 1, 2019. The Company is not subject to the advanced approaches capital rules. An advanced approaches banking organization is one that has total assets of $250 billion or more or foreign asset exposure of $10 billion or more (or elects with approval from its primary federal regulator to use the advanced approaches methodology to calculate risk weights).
Liquidity
45
Liquidity represents an institution’s ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with banks, federal funds sold, short-term investments, securities classified as available for sale and loans and securities maturing within one year. As a result of the Company’s management of liquid assets and the ability to generate liquidity through liability funding, management believes the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and meet its customers’ credit needs.
The Company also maintains additional sources of liquidity through a variety of borrowing arrangements. Middleburg Bank maintains federal funds lines with large regional and money-center banking institutions. These available lines total approximately $24.0 million, none of which were outstanding at June 30, 2015. Middleburg Bank is also able to borrow from the discount window of the Federal Reserve Bank of Richmond. At June 30, 2015, available borrowing capacity from this source was $35.90 million. At June 30, 2015, Middleburg Bank had $24.05 million of outstanding borrowings pursuant to securities sold under agreements to repurchase transactions (“Repo Accounts”), with maturities of one day. The Repo Accounts are long-term commercial checking accounts with average balances that typically exceed $100,000.
The Company has a secured line of credit with the Federal Home Loan Bank of Atlanta . The credit available from this line depends on the total assets of the bank. As of June 30, 2015, the remaining credit availability from this line was up to $307.77 million, while the amount of eligible lendable collateral, in the form of qualifying real estate secured loans, was $150.83 million. The bank would have to post additional collateral, in the form of eligible securities, if it sought to borrow more than the amount of eligible lending collateral. The Company had $248.16 million of unencumbered securities as of June 30, 2015.
At June 30, 2015, cash, interest-bearing deposits with other banks, federal funds sold, short-term investments and unencumbered securities available for sale were 26.64% of total deposits and liabilities.
Off-Balance Sheet Arrangements
As of June 30, 2015, there have been no material changes to the off-balance sheet arrangements disclosed in “Management’s Discussion and Analysis” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.
Caution About Forward Looking Statements
Certain information contained in this discussion may include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are generally identified by phrases such as “the Company expects,” “the Company believes” or words of similar import.
Such forward-looking statements involve known and unknown risks including, but not limited to, the following factors:
• | further adverse changes in general economic and business conditions in the Company’s market area; |
• | changes in banking and other laws and regulations applicable to the Company; |
• | maintaining asset qualities; |
• | the ability to properly identify risks in our loan portfolio and calculate an adequate loan loss allowance; |
• | risks inherent in making loans such as repayment risks and fluctuating collateral values; |
• | concentration in loans secured by real estate; |
• | changing trends in customer profiles and behavior; |
• | changes in interest rates and interest rate policies; |
• | maintaining cost controls as the Company opens or acquires new facilities; |
• | competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources; |
• | the ability to continue to attract low cost core deposits to fund asset growth; |
• | the ability to successfully manage the Company’s growth or implement its growth strategies if it is unable to identify attractive markets, locations or opportunities to expand in the future; |
• | reliance on the Company’s management team, including its ability to attract and retain key personnel; |
• | demand, development and acceptance of new products and services; |
• | problems with technology utilized by the Company; |
• | maintaining capital levels adequate to support the Company’s growth; and |
• | other factors described in Item 1A, “Risk Factors,” discussed in more detail in the Company's Annual Report on Form 10-K for the year ended December 31, 2014. |
46
Although the Company believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices and equity prices. The Company’s primary market risk exposure is interest rate risk, though it should be noted that the assets under management by Middleburg Trust Company are affected by equity price risk. The ongoing monitoring and management of this risk is an important component of the Company’s asset/liability management process, which is governed by policies established by its Board of Directors that are reviewed and approved annually. The Board of Directors delegates responsibility for carrying out asset/liability management policies to the Asset/Liability Committee (“ALCO”) of Middleburg Bank. In this capacity, ALCO develops guidelines and strategies that govern the Company’s asset/liability management related activities, based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends.
Interest rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change, the interest income and expense streams associated with the Company’s financial instruments also change, affecting net interest income, the primary component of the Company’s earnings. ALCO uses the results of a detailed and dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. While ALCO routinely monitors simulated net interest income sensitivity over a rolling two-year horizon, it also employs additional tools to monitor potential longer-term interest rate risk.
The simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all assets and liabilities reflected on the Company’s balance sheet. The simulation model is prepared and updated four times during each year. This sensitivity analysis is compared to ALCO policy limits, which specify a maximum tolerance level for net interest income exposure over a one-year horizon, assuming no balance sheet growth, given a 200 basis point (bp) upward shift and a 200 basis point downward shift in interest rates. The following reflects the range of the Company’s net interest income sensitivity analysis as of June 30, 2015 and December 31, 2014.
Estimated Net Interest Income Sensitivity | ||||
Rate Change | June 30, 2015 | December 31, 2014 | ||
+ 200 bps | 4.9% | 4.3% | ||
- 200 bps | (16.3)% | (14.8)% |
At June 30, 2015, the Company’s interest rate risk model indicated that for an immediate 200 basis points increase in interest rates, net interest income was expected to increase by 4.90% over a 12-month period. For the same time period, the interest rate risk model indicated that, for an immediate 200 basis points decrease in interest rates, net interest income was expected to decrease by 16.3% over a 12-month period. While these numbers are subjective based upon the parameters used within the model, management believes the balance sheet is very balanced and is working to minimize risks to rising rates in the future.
The Company’s specific goal is to lower, where possible, the cost of its borrowed funds.
The preceding sensitivity analysis does not represent the Company's forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions, including the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment or replacement of asset and liability cash flows. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances about the predictive nature of these assumptions, including how customer preferences or competitor influences might change.
Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will also differ due to factors such as prepayment and refinancing levels likely deviating from those assumed, the varying impact of interest rate change, caps or floors on adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early withdrawals and product preference changes, and other internal and external variables. Furthermore, the sensitivity analysis does not reflect actions that ALCO might take in response to or anticipation of changes in interest rates.
ITEM 4. CONTROLS AND PROCEDURES
47
As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended.) Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective.
The Company’s management is also responsible for establishing and maintaining adequate internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting identified in connection with the evaluation of it that occurred during the Company’s last fiscal quarter that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.
PART II
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company is a party or of which the property of the Company is subject.
ITEM 1A. RISK FACTORS
Our operations are subject to many risks that could adversely affect our future financial condition and performance and, therefore, the market value of our securities. The risk factors that are applicable to us are outlined in our Annual Report on Form 10-K for the year ended December 31, 2014. There have been no material changes in our risk factors from those disclosed in this report.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4.MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
31.1 | Rule 13a-14(a) Certification of Chief Executive Officer |
31.2 | Rule 13a-14(a) Certification of Chief Financial Officer |
32.1 | Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. § 1350 |
101 | The following materials from the Middleburg Financial Corporation Quarterly Report on Form 10-Q for the quarter ended June 30, 2015 formatted in Extensible Business reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Changes in Shareholders’ Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements. |
48
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
MIDDLEBURG FINANCIAL CORPORATION | |||
Date: | August 7, 2015 | By: | /s/ Gary R. Shook |
Gary R. Shook | |||
Chief Executive Officer | |||
Date: | August 7, 2015 | By: | /s/ Raj Mehra |
Raj Mehra | |||
Chief Financial Officer | |||
49
EXHIBIT INDEX
Exhibits
31.1 | Rule 13a-14(a) Certification of Chief Executive Officer |
31.2 | Rule 13a-14(a) Certification of Chief Financial Officer |
32.1 | Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. § 1350 |
101 | The following materials from the Middleburg Financial Corporation Quarterly Report on Form 10-Q for the quarter ended June 30, 2015 formatted in Extensible Business reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Changes in Shareholders’ Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements. |