FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period endedSeptember 30, 2014
OR
☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
Commission file number:0-26480
PSB HOLDINGS, INC.
(Exact name of registrant as specified in charter)
WISCONSIN | 39-1804877 | |
(State of incorporation) | (I.R.S. Employer Identification Number) |
1905 Stewart Avenue
Wausau, Wisconsin 54401
(Address of principal executive office)
Registrant’s telephone number, including area code:715-842-2191
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 report), and (2) has been subject to such filing requirements for the past 90 days.
Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ☐ | Accelerated filer | ☐ | |||
Non-accelerated filer | ☐ | Smaller reporting company | ☒ | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2) of the Exchange Act).
Yes ☐ No ☒
The number of common shares outstanding at November 1, 2014 was 1,638,157.
PSB HOLDINGS, INC.
FORM 10-Q
Quarter Ended September 30, 2014
Page No. | |||
PART I. | FINANCIAL INFORMATION | ||
Item 1. | Financial Statements | ||
Consolidated Balance Sheets | |||
September 30, 2014 (unaudited) and December 31, 2013 | |||
(derived from audited financial statements) | 1 | ||
Consolidated Statements of Income | |||
Three Months and Nine Months Ended September 30, 2014 and 2013 (unaudited) | 2 | ||
Consolidated Statements of Comprehensive Income | |||
Three Months and Nine Months Ended September 30, 2014 and 2013 (unaudited) | 3 | ||
Consolidated Statements of Changes in Stockholders’ Equity | |||
Nine Months Ended September 30, 2014 and 2013 (unaudited) | 4 | ||
Consolidated Statements of Cash Flows | |||
Nine Months Ended September 30, 2014 and 2013 (unaudited) | 5 | ||
Notes to Consolidated Financial Statements | 7 | ||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 30 | |
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 59 | |
Item 4. | Controls and Procedures | 59 | |
PART II. | OTHER INFORMATION | ||
Item 1A. | Risk Factors | 59 | |
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 59 | |
Item 6. | Exhibits | 60 |
-i- |
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
PSB Holdings, Inc.
Consolidated Balance Sheets
September 30, 2014 unaudited, December 31, 2013 derived from audited financial statements
September 30, | December 31, | |||||||
(dollars in thousands, except per share data) | 2014 | 2013 | ||||||
Assets | ||||||||
Cash and due from banks | $ | 9,824 | $ | 13,800 | ||||
Interest-bearing deposits and money market funds | 1,820 | 977 | ||||||
Federal funds sold | 1,173 | 16,745 | ||||||
Cash and cash equivalents | 12,817 | 31,522 | ||||||
Securities available for sale (at fair value) | 73,174 | 61,650 | ||||||
Securities held to maturity (fair value of $71,645 and $71,672 respectively) | 70,402 | 71,629 | ||||||
Bank certificates of deposit | 3,424 | 2,236 | ||||||
Loans held for sale | 999 | 150 | ||||||
Loans receivable, net | 533,088 | 509,880 | ||||||
Accrued interest receivable | 2,165 | 2,076 | ||||||
Foreclosed assets | 1,724 | 1,750 | ||||||
Premises and equipment, net | 10,981 | 9,669 | ||||||
Mortgage servicing rights, net | 1,734 | 1,696 | ||||||
Federal Home Loan Bank stock (at cost) | 2,556 | 2,556 | ||||||
Cash surrender value of bank-owned life insurance | 13,127 | 12,826 | ||||||
Other assets | 4,114 | 3,901 | ||||||
TOTAL ASSETS | $ | 730,305 | $ | 711,541 | ||||
Liabilities | ||||||||
Non-interest-bearing deposits | $ | 109,197 | $ | 102,644 | ||||
Interest-bearing deposits | 492,880 | 474,870 | ||||||
Total deposits | 602,077 | 577,514 | ||||||
Federal Home Loan Bank advances | 31,372 | 38,049 | ||||||
Other borrowings | 18,211 | 20,441 | ||||||
Senior subordinated notes | 4,000 | 4,000 | ||||||
Junior subordinated debentures | 7,732 | 7,732 | ||||||
Accrued expenses and other liabilities | 6,305 | 7,052 | ||||||
Total liabilities | 669,697 | 654,788 | ||||||
Stockholders’ equity | ||||||||
Preferred stock – no par value: | ||||||||
Authorized – 30,000 shares; no shares issued or outstanding | – | – | ||||||
Common stock – no par value with a stated value of $1 per share: | ||||||||
Authorized – 6,000,000 shares; Issued – 1,830,266 shares | ||||||||
Outstanding – 1,648,157 and 1,651,518 shares, respectively | 1,830 | 1,830 | ||||||
Additional paid-in capital | 6,956 | 6,967 | ||||||
Retained earnings | 56,403 | 52,432 | ||||||
Accumulated other comprehensive income, net of tax | 397 | 349 | ||||||
Treasury stock, at cost – 182,109 and 178,748 shares, respectively | (4,978 | ) | (4,825 | ) | ||||
Total stockholders’ equity | 60,608 | 56,753 | ||||||
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | $ | 730,305 | $ | 711,541 |
-1- |
PSB Holdings, Inc.
Consolidated Statements of Income
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
(dollars in thousands, except per share data – unaudited) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
Interest and dividend income: | ||||||||||||||||
Loans, including fees | $ | 5,821 | $ | 5,865 | $ | 16,885 | $ | 17,333 | ||||||||
Securities: | ||||||||||||||||
Taxable | 617 | 509 | 1,779 | 1,566 | ||||||||||||
Tax-exempt | 377 | 383 | 1,132 | 1,133 | ||||||||||||
Other interest and dividends | 18 | 15 | 60 | 56 | ||||||||||||
Total interest and dividend income | 6,833 | 6,772 | 19,856 | 20,088 | ||||||||||||
Interest expense: | ||||||||||||||||
Deposits | 703 | 738 | 2,132 | 2,279 | ||||||||||||
FHLB advances | 118 | 323 | 534 | 977 | ||||||||||||
Other borrowings | 154 | 165 | 464 | 490 | ||||||||||||
Senior subordinated notes | 38 | 38 | 113 | 147 | ||||||||||||
Junior subordinated debentures | 86 | 86 | 255 | 255 | ||||||||||||
Total interest expense | 1,099 | 1,350 | 3,498 | 4,148 | ||||||||||||
Net interest income | 5,734 | 5,422 | 16,358 | 15,940 | ||||||||||||
Provision for loan losses | 140 | 3,340 | 420 | 4,015 | ||||||||||||
Net interest income after provision for loan losses | 5,594 | 2,082 | 15,938 | 11,925 | ||||||||||||
Noninterest income: | ||||||||||||||||
Service fees | 448 | 422 | 1,223 | 1,170 | ||||||||||||
Mortgage banking | 375 | 384 | 965 | 1,338 | ||||||||||||
Investment and insurance sales commissions | 225 | 204 | 718 | 695 | ||||||||||||
Net gain on sale of securities | – | – | – | 12 | ||||||||||||
Increase in cash surrender value of life insurance | 103 | 102 | 302 | 300 | ||||||||||||
Other noninterest income | 330 | 299 | 962 | 834 | ||||||||||||
Total noninterest income | 1,481 | 1,411 | 4,170 | 4,349 | ||||||||||||
Noninterest expense: | ||||||||||||||||
Salaries and employee benefits | 2,489 | 2,031 | 7,282 | 6,609 | ||||||||||||
Occupancy and facilities | 454 | 408 | 1,361 | 1,324 | ||||||||||||
Loss on foreclosed assets | 47 | 144 | 121 | 294 | ||||||||||||
Data processing and other office operations | 503 | 449 | 1,732 | 1,403 | ||||||||||||
Advertising and promotion | 82 | 80 | 257 | 234 | ||||||||||||
FDIC insurance premiums | 145 | 100 | 424 | 311 | ||||||||||||
Other noninterest expenses | 741 | 605 | 2,239 | 1,940 | ||||||||||||
Total noninterest expense | 4,461 | 3,817 | 13,416 | 12,115 | ||||||||||||
Income (loss) before provision for income taxes | 2,614 | (324 | ) | 6,692 | 4,159 | |||||||||||
Provision (credit) for income taxes | 832 | (337 | ) | 2,057 | 976 | |||||||||||
Net income | $ | 1,782 | $ | 13 | $ | 4,635 | $ | 3,183 | ||||||||
Basic earnings per share | $ | 1.08 | $ | 0.01 | $ | 2.80 | $ | 1.93 | ||||||||
Diluted earnings per share | $ | 1.08 | $ | 0.01 | $ | 2.80 | $ | 1.93 |
-2- |
PSB Holdings, Inc.
Consolidated Statements of Comprehensive Income (Loss)
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
(dollars in thousands – unaudited) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
Net income | $ | 1,782 | $ | 13 | $ | 4,635 | $ | 3,183 | ||||||||
Other comprehensive income, net of tax: | ||||||||||||||||
Unrealized gain (loss) on securities available for sale | (165 | ) | (265 | ) | 132 | (780 | ) | |||||||||
Reclassification adjustment for security gain included in net income | – | – | – | (7 | ) | |||||||||||
Accretion (amortization) of unrealized gain included in net income on securities available for sale transferred to securities held to maturity | (50 | ) | 16 | (152 | ) | (175 | ) | |||||||||
Unrealized gain (loss) on interest rate swap | 20 | (39 | ) | (17 | ) | 45 | ||||||||||
Reclassification adjustment of interest rate swap settlements included in earnings | 28 | 28 | 85 | 84 | ||||||||||||
Other comprehensive income (loss) | (167 | ) | (260 | ) | 48 | (833 | ) | |||||||||
Comprehensive income (loss) | $ | 1,615 | $ | (247 | ) | $ | 4,683 | $ | 2,350 |
-3- |
PSB Holdings, Inc.
Consolidated Statements of Changes in Stockholders’ Equity
Nine months ended September 30, 2014 - unaudited
Accumulated | ||||||||||||||||||||||||
Other | ||||||||||||||||||||||||
Additional | Comprehensive | |||||||||||||||||||||||
Common | Paid-in | Retained | Income | Treasury | ||||||||||||||||||||
(dollars in thousands) | Stock | Capital | Earnings | (Loss) | Stock | Totals | ||||||||||||||||||
Balance January 1, 2014 | $ | 1,830 | $ | 6,967 | $ | 52,432 | $ | 349 | $ | (4,825 | ) | $ | 56,753 | |||||||||||
Net income | 4,635 | 4,635 | ||||||||||||||||||||||
Other comprehensive income | 48 | 48 | ||||||||||||||||||||||
Purchase of treasury stock | (332 | ) | (332 | ) | ||||||||||||||||||||
Issuance of new restricted stock grants | (173 | ) | 173 | – | ||||||||||||||||||||
Vesting of existing restricted stock grants | 162 | 162 | ||||||||||||||||||||||
Directors fees paid in grants of stock | – | 6 | 6 | |||||||||||||||||||||
Cash dividends declared $.40 per share | (649 | ) | (649 | ) | ||||||||||||||||||||
Cash dividends declared on unvested restricted stock grants | (15 | ) | (15 | ) | ||||||||||||||||||||
Balance September 30, 2014 | $ | 1,830 | $ | 6,956 | $ | 56,403 | $ | 397 | $ | (4,978 | ) | $ | 60,608 |
Nine months ended September 30, 2013 - unaudited
Accumulated | ||||||||||||||||||||||||
Other | ||||||||||||||||||||||||
Additional | Comprehensive | |||||||||||||||||||||||
Common | Paid-in | Retained | Income | Treasury | ||||||||||||||||||||
(dollars in thousands) | Stock | Capital | Earnings | (Loss) | Stock | Totals | ||||||||||||||||||
Balance January 1, 2013 | $ | 1,830 | $ | 7,020 | $ | 48,977 | $ | 1,394 | $ | (4,774 | ) | $ | 54,447 | |||||||||||
Net income | $ | 3,183 | $ | 3,183 | ||||||||||||||||||||
Other comprehensive loss | (833 | ) | (833 | ) | ||||||||||||||||||||
Purchase of treasury stock | (269 | ) | (269 | ) | ||||||||||||||||||||
Issuance of new restricted stock grants | (218 | ) | 218 | – | ||||||||||||||||||||
Vesting of existing restricted stock grants | 128 | 128 | ||||||||||||||||||||||
Cash dividends declared $.39 per share | (631 | ) | (631 | ) | ||||||||||||||||||||
Cash dividends declared on unvested restricted stock grants | (13 | ) | (13 | ) | ||||||||||||||||||||
Balance September 30, 2013 | $ | 1,830 | $ | 6,930 | $ | 51,516 | $ | 561 | $ | (4,825 | ) | $ | 56,012 |
-4- |
PSB Holdings, Inc.
Consolidated Statements of Cash Flows
Nine months ended September 30, 2014 - unaudited
(dollars in thousands – unaudited) | 2014 | 2013 | ||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 4,635 | $ | 3,183 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Provision for depreciation and net amortization | 1,729 | 1,956 | ||||||
Provision for loan losses | 420 | 4,015 | ||||||
Deferred net loan origination costs | (314 | ) | (387 | ) | ||||
Gain on sale of loans | (688 | ) | (1,152 | ) | ||||
Provision for servicing right valuation allowance | 5 | (240 | ) | |||||
Loss on sale of premises and equipment | 12 | – | ||||||
Loss on sale of foreclosed assets | 19 | 210 | ||||||
Gain on sale of securities | – | (12 | ) | |||||
Increase in cash surrender value of life insurance | (302 | ) | (300 | ) | ||||
Changes in operating assets and liabilities: | ||||||||
Accrued interest receivable | (41 | ) | (100 | ) | ||||
Other assets | 60 | 1,285 | ||||||
Other liabilities | (667 | ) | (841 | ) | ||||
Net cash provided by operating activities | 4,868 | 7,617 |
-5- |
PSB Holdings, Inc.
Consolidated Statements of Cash Flows
Nine months ended September 30, 2014 – unaudited (continued)
(dollars in thousands – unaudited) | 2014 | 2013 | ||||||
Cash flows from investing activities: | ||||||||
Proceeds from sale and maturities of: | ||||||||
Securities available for sale | 12,225 | 39,084 | ||||||
Securities held to maturity | 3,940 | 4,397 | ||||||
Payment for purchase of: | ||||||||
Securities available for sale | (23,762 | ) | (26,909 | ) | ||||
Securities held to maturity | (3,158 | ) | (6,668 | ) | ||||
Cash acquired on branch purchase | 17,741 | – | ||||||
Proceeds from (purchase of) other investments | (1,188 | ) | 1,984 | |||||
Purchase of FHLB stock | – | (1,088 | ) | |||||
Net increase in loans | (3,522 | ) | (42,649 | ) | ||||
Capital expenditures | (501 | ) | (191 | ) | ||||
Proceeds from sale of premises and equipment | 7 | – | ||||||
Proceeds from sale of foreclosed assets | 765 | 698 | ||||||
Purchase of bank-owned life insurance | – | (610 | ) | |||||
Net cash provided by (used in) investing activities | 2,547 | (31,952 | ) | |||||
Cash flows from financing activities: | ||||||||
Net increase in non-interest-bearing deposits | 2,663 | 2,322 | ||||||
Net decrease in interest-bearing deposits | (18,880 | ) | (13,466 | ) | ||||
Net increase (decrease) in FHLB advances | (6,677 | ) | 8,000 | |||||
Net decrease in other borrowings | (2,230 | ) | (375 | ) | ||||
Repayment of senior subordinated notes | – | (3,000 | ) | |||||
Dividends declared | (664 | ) | (644 | ) | ||||
Purchase of treasury stock | (332 | ) | (269 | ) | ||||
Net cash used in financing activities | (26,120 | ) | (7,432 | ) | ||||
Net decrease in cash and cash equivalents | (18,705 | ) | (31,767 | ) | ||||
Cash and cash equivalents at beginning | 31,522 | 48,847 | ||||||
Cash and cash equivalents at end | $ | 12,817 | $ | 17,080 | ||||
Supplemental cash flow information: | ||||||||
Cash paid during the period for: | ||||||||
Interest | $ | 3,564 | $ | 4,304 | ||||
Income taxes | 1,880 | 694 | ||||||
Noncash investing and financing activities: | ||||||||
Loans charged off | $ | 810 | $ | 4,366 | ||||
Loans transferred to foreclosed assets | 801 | 947 | ||||||
Loans originated on sale of foreclosed assets | 43 | 207 | ||||||
Issuance of unvested restricted stock grants at fair value | 200 | 210 | ||||||
Vesting of restricted stock grants | 162 | 128 |
-6- |
PSB Holdings, Inc.
Notes to Consolidated Financial Statements
NOTE 1 – GENERAL
In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly PSB Holdings, Inc.’s (“PSB”) financial position, results of its operations, and cash flows for the periods presented, and all such adjustments are of a normal recurring nature. The consolidated financial statements include the accounts of all subsidiaries. All material intercompany transactions and balances are eliminated. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. Any reference to “PSB” refers to the consolidated or individual operations of PSB Holdings, Inc. and its subsidiary Peoples State Bank. Dollar amounts are in thousands, except per share amounts.
These interim consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission and, therefore, certain information and footnote disclosures normally presented in accordance with generally accepted accounting principles have been omitted or abbreviated. The information contained in the consolidated financial statements and footnotes in PSB’s Annual Report on Form 10-K for the year ended December 31, 2013 should be referred to in connection with the reading of these unaudited interim financial statements.
In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Estimates that are susceptible to significant change include the determination of the allowance for loan losses, mortgage servicing right assets, and the valuation of investment securities.
NOTE 2 – PURCHASE OF NORTHWOODS NATIONAL BANK, RHINELANDER BRANCH, OF THE BARABOO NATIONAL BANK
On April 11, 2014, Peoples State Bank, subsidiary of PSB Holdings, Inc., purchased the following assets and liabilities of the Northwoods National Bank, Rhinelander, Wisconsin branch:
Fair value of assets acquired ($000s): | ||||
Cash and due from banks | $ | 17,741 | ||
Loans receivable, including accrued interest | 21,365 | |||
Premises and equipment | 1,368 | |||
Core deposit intangible | 231 | |||
Goodwill | 113 | |||
Total fair value of assets acquired | $ | 40,818 | ||
Fair value of liabilities assumed ($000s): | ||||
Non-interest bearing deposits | $ | 3,890 | ||
Interest-bearing deposits, including accrued interest | 36,912 | |||
Other liabilities | 16 | |||
Fair value of liabilities assumed | $ | 40,818 |
The core deposit intangible is being amortized over a five year period using a double declining balance method. In the transaction, net cash received by PSB from the seller was reduced by the purchase premium of $654.
-7- |
NOTE 3 – SECURITIES
The amortized cost and estimated fair value of investment securities are as follows:
Gross | Gross | Estimated | ||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
September 30, 2014 | Cost | Gains | Losses | Value | ||||||||||||
Securities available for sale | ||||||||||||||||
U.S. agency issued residential mortgage-backed securities | $ | 41,198 | $ | 562 | $ | 257 | $ | 41,503 | ||||||||
U.S. agency issued residential collateralized mortgage obligations | 30,726 | 342 | 424 | 30,644 | ||||||||||||
Privately issued residential collateralized mortgage obligations | 29 | 1 | 30 | |||||||||||||
Nonrated SBA loan fund | 950 | – | – | 950 | ||||||||||||
Other equity securities | 47 | – | – | 47 | ||||||||||||
Totals | $ | 72,950 | $ | 905 | $ | 681 | $ | 73,174 | ||||||||
Securities held to maturity | ||||||||||||||||
Obligations of states and political subdivisions | $ | 68,464 | $ | 1,572 | $ | 208 | $ | 69,828 | ||||||||
Nonrated trust preferred securities | 1,538 | 29 | 154 | 1,413 | ||||||||||||
Nonrated senior subordinated notes | 400 | 4 | 404 | |||||||||||||
Totals | $ | 70,402 | $ | 1,605 | $ | 362 | $ | 71,645 |
Gross | Gross | Estimated | ||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
December 31, 2013 | Cost | Gains | Losses | Value | ||||||||||||
Securities available for sale | ||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies | $ | 1,001 | $ | – | $ | 2 | $ | 999 | ||||||||
U.S. agency issued residential mortgage-backed securities | 21,388 | 522 | 424 | 21,486 | ||||||||||||
U.S. agency issued residential collateralized mortgage obligations | 37,998 | 482 | 576 | 37,904 | ||||||||||||
Privately issued residential collateralized mortgage obligations | 102 | 3 | – | 105 | ||||||||||||
Obligations of states and political subdivisions | 159 | – | – | 159 | ||||||||||||
Nonrated SBA loan fund | 950 | – | – | 950 | ||||||||||||
Other equity securities | 47 | – | – | 47 | ||||||||||||
Totals | $ | 61,645 | $ | 1,007 | $ | 1,002 | $ | 61,650 | ||||||||
Securities held to maturity | ||||||||||||||||
Obligations of states and political subdivisions | $ | 69,704 | $ | 1,059 | $ | 887 | $ | 69,876 | ||||||||
Nonrated trust preferred securities | 1,524 | 30 | 165 | 1,389 | ||||||||||||
Nonrated senior subordinated notes | 401 | 6 | – | 407 | ||||||||||||
Totals | $ | 71,629 | $ | 1,095 | $ | 1,052 | $ | 71,672 |
Securities with a fair value of $49,500 and $47,593 at September 30, 2014 and December 31, 2013, respectively, were pledged to secure public deposits, other borrowings, and for other purposes required by law.
During the quarter ended March 31, 2014, PSB realized a net gain of $0 from proceeds totaling $262 on the sale of securities available for sale. During the quarter ended March 31, 2013, PSB realized a net gain of $12 ($7 after tax expense) from proceeds totaling $986 on the sale of securities available for sale. There were no other sales of securities during the nine month periods ended September 30, 2014 and 2013.
-8- |
NOTE 4 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
Loans
Loans that management has the intent to hold for the foreseeable future or until maturity or pay-off are generally reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest on loans is credited to income as earned. Interest income is not accrued on loans where management has determined collection of such interest is doubtful or those loans which are past due 90 days or more as to principal or interest payments. When a loan is placed on nonaccrual status, previously accrued but unpaid interest deemed uncollectible is reversed and charged against current income. After being placed on nonaccrual status, additional income is recorded only to the extent that payments are received and the collection of principal becomes reasonably assured. Interest income recognition on loans considered to be impaired is consistent with the recognition on all other loans. Loan origination fees and certain direct loan origination costs are deferred and recognized as an adjustment of the related loan yield using the interest method.
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes the collectability of the principal is unlikely.
Management maintains the allowance for loan losses at a level to cover probable credit losses relating to specifically identified loans, as well as probable credit losses inherent in the balance of the loan portfolio. In accordance with current accounting standards, the allowance is provided for losses that have been incurred based on events that have occurred as of the balance sheet date. The allowance is based on past events and current economic conditions and does not include the effects of expected losses on specific loans or groups of loans that are related to future events or expected changes in economic conditions. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions.
The allowance for loan losses includes specific allowances related to loans which have been judged to be impaired. A loan is impaired when, based on current information, it is probable that PSB will not collect all amounts due in accordance with the contractual terms of the loan agreement. Management has determined that impaired loans include nonaccrual loans, loans identified as restructurings of troubled debt, and loans accruing interest with elevated risk of default in the near term based on a variety of credit factors. Specific allowances on impaired loans are based on discounted cash flows of expected future payments using the loan’s initial effective interest rate or the fair value of the collateral if the loan is collateral dependent.
In addition, various regulatory agencies periodically review the allowance for loan losses. These agencies may require PSB to make additions to the allowance for loan losses based on their judgments of collectability resulting from information available to them at the time of their examination.
-9- |
The composition of loans categorized by the type of the loan, is as follows:
September 30, 2014 | December 31, 2013 | |||||||
Commercial, industrial, and municipal | $ | 138,999 | $ | 130,220 | ||||
Commercial real estate mortgage | 207,477 | 212,850 | ||||||
Commercial construction and development | 31,943 | 13,672 | ||||||
Residential real estate mortgage | 129,286 | 123,980 | ||||||
Residential construction and development | 17,254 | 18,277 | ||||||
Residential real estate home equity | 23,570 | 20,677 | ||||||
Consumer and individual | 3,448 | 3,567 | ||||||
Subtotals – Gross loans | 551,977 | 523,243 | ||||||
Loans in process of disbursement | (12,776 | ) | (6,895 | ) | ||||
Subtotals – Disbursed loans | 539,201 | 516,348 | ||||||
Net deferred loan costs | 311 | 315 | ||||||
Allowance for loan losses | (6,424 | ) | (6,783 | ) | ||||
Net loans receivable | $ | 533,088 | $ | 509,880 |
The following is a summary of information pertaining to impaired loans at period-end:
September 30, 2014 | December 31, 2013 | |||||||
Impaired loans without a valuation allowance | $ | 9,042 | $ | 9,303 | ||||
Impaired loans with a valuation allowance | 10,298 | 6,472 | ||||||
Total impaired loans before valuation allowances | 19,340 | 15,775 | ||||||
Valuation allowance related to impaired loans | 2,283 | 2,108 | ||||||
Net impaired loans | $ | 17,057 | $ | 13,667 |
Activity in the allowance for loans losses during the nine months ended September 30, 2014 follows:
Allowance for loan losses: | Commercial | Commercial Real Estate | Residential Real Estate | Consumer | Unallocated | Total | ||||||||||||||||||
Beginning Balance | $ | 2,828 | $ | 2,653 | $ | 1,223 | $ | 79 | $ | – | $ | 6,783 | ||||||||||||
Provision (credit) | (455 | ) | (241 | ) | 1,116 | – | – | 420 | ||||||||||||||||
Recoveries | 6 | – | 18 | 7 | – | 31 | ||||||||||||||||||
Charge offs | (99 | ) | – | (692 | ) | (19 | ) | – | (810 | ) | ||||||||||||||
Ending balance | $ | 2,280 | $ | 2,412 | $ | 1,665 | $ | 67 | $ | – | $ | 6,424 |
Activity in the allowance for loans losses during the nine months ended September 30, 2013 follows:
Allowance for loan losses: | Commercial | Commercial Real Estate | Residential Real Estate | Consumer | Unallocated | Total | ||||||||||||||||||
Beginning Balance | $ | 3,014 | $ | 2,803 | $ | 1,511 | $ | 103 | $ | – | $ | 7,431 | ||||||||||||
Provision | 3,553 | 226 | 198 | 38 | – | 4,015 | ||||||||||||||||||
Recoveries | 2 | 30 | 3 | 11 | – | 46 | ||||||||||||||||||
Charge offs | (3,568 | ) | (174 | ) | (574 | ) | (50 | ) | – | (4,366 | ) | |||||||||||||
Ending balance | $ | 3,001 | $ | 2,885 | $ | 1,138 | $ | 102 | $ | – | $ | 7,126 |
-10- |
The following tables provide other information regarding the allowance for loan losses and balances by type of allowance methodology.
At September 30, 2014 | ||||||||||||||||||||||||
Commercial | Residential | |||||||||||||||||||||||
Allowance for loan losses: | Commercial | Real Estate | Real Estate | Consumer | Unallocated | Total | ||||||||||||||||||
Individually evaluated for impairment | $ | 1,233 | $ | 519 | $ | 522 | $ | 9 | $ | – | $ | 2,283 | ||||||||||||
Collectively evaluated for impairment | 1,047 | 1,893 | 1,143 | 58 | – | 4,141 | ||||||||||||||||||
Total allowance for loan losses | $ | 2,280 | $ | 2,412 | $ | 1,665 | $ | 67 | $ | – | $ | 6,424 | ||||||||||||
Loans receivable (gross): | ||||||||||||||||||||||||
Individually evaluated for impairment | $ | 10,965 | $ | 5,277 | $ | 3,089 | $ | 9 | $ | – | $ | 19,340 | ||||||||||||
Collectively evaluated for impairment | 128,034 | 234,143 | 167,021 | 3,439 | – | 532,637 | ||||||||||||||||||
Total loans receivable (gross) | $ | 138,999 | $ | 239,420 | $ | 170,110 | $ | 3,448 | $ | – | $ | 551,977 |
At December 31, 2013 | ||||||||||||||||||||||||
Commercial | Residential | |||||||||||||||||||||||
Allowance for loan losses: | Commercial | Real Estate | Real Estate | Consumer | Unallocated | Total | ||||||||||||||||||
Individually evaluated for impairment | $ | 1,167 | $ | 695 | $ | 228 | $ | 18 | $ | – | $ | 2,108 | ||||||||||||
Collectively evaluated for impairment | 1,661 | 1,958 | 995 | 61 | – | 4,675 | ||||||||||||||||||
Total allowance for loan losses | $ | 2,828 | $ | 2,653 | $ | 1,223 | $ | 79 | $ | – | $ | 6,783 | ||||||||||||
Loans receivable (gross): | ||||||||||||||||||||||||
Individually evaluated for impairment | $ | 8,102 | $ | 5,527 | $ | 2,129 | $ | 17 | $ | – | $ | 15,775 | ||||||||||||
Collectively evaluated for impairment | 122,118 | 220,995 | 160,805 | 3,550 | – | 507,468 | ||||||||||||||||||
Total loans receivable (gross) | $ | 130,220 | $ | 226,522 | $ | 162,934 | $ | 3,567 | $ | – | $ | 523,243 |
PSB maintains an independent credit administration staff that continually monitors aggregate commercial loan portfolio and individual borrower credit quality trends. All commercial purpose loans are assigned a credit grade upon origination, and credit grades for nonproblem borrowers with aggregate credit in excess of $500 are reviewed annually. In addition, all past due, restructured, or identified problem loans, both commercial and consumer purpose, are reviewed and assigned an up-to-date credit grade quarterly.
PSB uses a seven point grading scale to estimate credit risk with risk rating 1, representing the high credit quality, and risk rating 7, representing the lowest credit quality. The assigned credit grade takes into account several credit quality components which are assigned a weight and blended into the composite grade. The factors considered and their assigned weight for the final composite grade is as follows:
Cash flow(30% weight) – Considers earnings trends and debt service coverage levels.
Collateral(25% weight) – Considers loan to value and other measures of collateral coverage.
Leverage(15% weight) – Considers balance sheet debt and capital ratios compared to Robert Morris & Associates (RMA) industry medians.
Liquidity(10% weight) – Considers balance sheet current, quick, and other working capital ratios compared to RMA industry medians.
Management(5% weight) – Considers the past performance, character, and depth of borrower management.
-11- |
Guarantor(5% weight) – Considers the existence of a guarantor along with PSB’s past experience with the guarantor and his related liquidity and credit score.
Financial reporting(5% weight) – Considers the relative level of independent financial review obtained by the borrower on its financial statements, from audited financial statements down to existence of only tax returns or potentially unreliable financial information.
Industry(5% weight) – Considers the borrower’s industry and whether it is stable or subject to cyclical or seasonal factors.
Nonclassified loans are assigned a risk rating of 1 to 4 and have credit quality that ranges from well above average to some inherent industry weaknesses that may present higher than average risk due to conditions affecting the borrower, the borrower’s industry, or economic development.
Special mention and watch loans are assigned a risk rating of 5 when potential weaknesses exist that deserve management’s close attention. If left uncorrected, the potential weaknesses may result in deterioration of repayment prospects or in credit position at some future date. Substandard loans are assigned a risk rating of 6 and are inadequately protected by the current worth and borrowing capacity of the borrower. Well-defined weaknesses exist that may jeopardize the liquidation of the debt. There is a possibility of some loss if the deficiencies are not corrected. At this point, the loan may still be performing and accruing interest.
Impaired and other doubtful loans assigned a risk rating of 7 have all of the weaknesses of a substandard credit plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of current facts, conditions, and collateral values highly questionable and improbable. Impaired loans include all nonaccrual loans and all restructured loans including restructured loans performing according to the restructured terms. In special situations, an impaired loan with a risk rating of 7 could still be maintained on accrual status such as in the case of restructured loans performing according to restructured terms.
The commercial credit exposure based on internally assigned credit grade at September 30, 2014, follows:
Commercial | Construction & | |||||||||||||||||||||||
Commercial | Real Estate | Development | Agricultural | Government | Total | |||||||||||||||||||
High quality (risk rating 1) | $ | 197 | $ | – | $ | – | $ | – | $ | – | $ | 197 | ||||||||||||
Minimal risk (2) | 32,034 | 19,535 | 298 | 1,718 | 65 | 53,650 | ||||||||||||||||||
Average risk (3) | 49,742 | 127,406 | 26,888 | 3,100 | 6,526 | 213,662 | ||||||||||||||||||
Acceptable risk (4) | 30,552 | 47,617 | 3,098 | 580 | 301 | 82,148 | ||||||||||||||||||
Watch risk (5) | 2,500 | 7,306 | 1,527 | 11 | – | 11,344 | ||||||||||||||||||
Substandard risk (6) | 708 | 468 | – | – | – | 1,176 | ||||||||||||||||||
Impaired loans (7) | 7,996 | 5,145 | 132 | 124 | 2,845 | 16,242 | ||||||||||||||||||
Total | $ | 123,729 | $ | 207,477 | $ | 31,943 | $ | 5,533 | $ | 9,737 | $ | 378,419 |
The commercial credit exposure based on internally assigned credit grade at December 31, 2013, follows:
Commercial | Construction & | |||||||||||||||||||||||
Commercial | Real Estate | Development | Agricultural | Government | Total | |||||||||||||||||||
High quality (risk rating 1) | $ | 44 | $ | – | $ | – | $ | – | $ | – | $ | 44 | ||||||||||||
Minimal risk (2) | 24,085 | 19,249 | 120 | 1,115 | 78 | 44,647 | ||||||||||||||||||
Average risk (3) | 51,745 | 145,673 | 8,863 | 2,563 | 6,512 | 215,356 | ||||||||||||||||||
Acceptable risk (4) | 26,395 | 34,154 | 2,917 | 424 | 357 | 64,247 | ||||||||||||||||||
Watch risk (5) | 8,146 | 7,572 | 1,632 | – | – | 17,350 | ||||||||||||||||||
Substandard risk (6) | 654 | 815 | – | – | – | 1,469 | ||||||||||||||||||
Impaired loans (7) | 4,860 | 5,387 | 140 | 152 | 3,090 | 13,629 | ||||||||||||||||||
Total | $ | 115,929 | $ | 212,850 | $ | 13,672 | $ | 4,254 | $ | 10,037 | $ | 356,742 |
-12- |
The consumer credit exposure based on payment activity and internally assigned credit grade at September 30, 2014, follows:
Residential- | Construction and | Residential- | ||||||||||||||||||
Prime | Development | HELOC | Consumer | Total | ||||||||||||||||
Performing | $ | 127,076 | $ | 16,756 | $ | 23,189 | $ | 3,439 | $ | 170,460 | ||||||||||
Impaired loans | 2,210 | 498 | 381 | 9 | 3,098 | |||||||||||||||
Total | $ | 129,286 | $ | 17,254 | $ | 23,570 | $ | 3,448 | $ | 173,558 |
The consumer credit exposure based on payment activity and internally assigned credit grade at December 31, 2013, follows:
Residential- | Construction and | Residential- | ||||||||||||||||||
Prime | Development | HELOC | Consumer | Total | ||||||||||||||||
Performing | $ | 122,408 | $ | 18,230 | $ | 20,167 | $ | 3,550 | $ | 164,355 | ||||||||||
Impaired loans | 1,572 | 47 | 510 | 17 | 2,146 | |||||||||||||||
Total | $ | 123,980 | $ | 18,277 | $ | 20,677 | $ | 3,567 | $ | 166,501 |
The payment age analysis of loans receivable disbursed at September 30, 2014, follows:
30-59 | 60-89 | 90+ | Total | Total | 90+ and | |||||||||||||||||||||||
Loan Class | Days | Days | Days | Past Due | Current | Loans | Accruing | |||||||||||||||||||||
Commercial: | ||||||||||||||||||||||||||||
Commercial and industrial | $ | 350 | $ | 67 | $ | 555 | $ | 972 | $ | 122,757 | $ | 123,729 | $ | – | ||||||||||||||
Agricultural | 7 | – | 124 | 131 | 5,402 | 5,533 | – | |||||||||||||||||||||
Government | – | – | – | – | 9,737 | 9,737 | – | |||||||||||||||||||||
Commercial real estate: | ||||||||||||||||||||||||||||
Commercial real estate | 655 | 32 | 625 | 1,312 | 206,165 | 207,477 | – | |||||||||||||||||||||
Commercial construction and development | – | – | 16 | 16 | 20,962 | 20,978 | – | |||||||||||||||||||||
Residential real estate: | ||||||||||||||||||||||||||||
Residential – Prime | 13 | 391 | 962 | 1,366 | 127,920 | 129,286 | – | |||||||||||||||||||||
Residential – HELOC | 218 | 41 | 124 | 383 | 23,187 | 23,570 | – | |||||||||||||||||||||
Residential – construction and development | 114 | 37 | 118 | 269 | 15,174 | 15,443 | – | |||||||||||||||||||||
Consumer | 4 | 5 | 2 | 11 | 3,437 | 3,448 | – | |||||||||||||||||||||
Total | $ | 1,361 | $ | 573 | $ | 2,526 | $ | 4,460 | $ | 534,741 | $ | 539,201 | $ | – |
-13- |
The payment age analysis of loans receivable disbursed at December 31, 2013, follows:
30-59 | 60-89 | 90+ | Total | Total | 90+ and | |||||||||||||||||||||||
Loan Class | Days | Days | Days | Past Due | Current | Loans | Accruing | |||||||||||||||||||||
Commercial: | ||||||||||||||||||||||||||||
Commercial and industrial | $ | 297 | $ | 57 | $ | 610 | $ | 964 | $ | 114,965 | $ | 115,929 | $ | – | ||||||||||||||
Agricultural | – | – | 152 | 152 | 4,102 | 4,254 | – | |||||||||||||||||||||
Government | – | – | – | – | 10,037 | 10,037 | – | |||||||||||||||||||||
Commercial real estate: | ||||||||||||||||||||||||||||
Commercial real estate | 376 | 547 | 1,276 | 2,199 | 210,651 | 212,850 | – | |||||||||||||||||||||
Commercial construction and development | – | – | – | – | 11,434 | 11,434 | – | |||||||||||||||||||||
Residential real estate: | ||||||||||||||||||||||||||||
Residential – prime | 369 | 87 | 335 | 791 | 123,189 | 123,980 | – | |||||||||||||||||||||
Residential – HELOC | 45 | 14 | 314 | 373 | 20,304 | 20,677 | – | |||||||||||||||||||||
Residential – construction and development | 37 | – | – | 37 | 13,583 | 13,620 | – | |||||||||||||||||||||
Consumer | 2 | 10 | 9 | 21 | 3,546 | 3,567 | – | |||||||||||||||||||||
Total | $ | 1,126 | $ | 715 | $ | 2,696 | $ | 4,537 | $ | 511,811 | $ | 516,348 | $ | – |
Impaired loans as of September 30, 2014, and during the year to date period then ended, by loan class, follows:
Unpaid | Average | Interest | ||||||||||||||||||
Principal | Related | Recorded | Recorded | Income | ||||||||||||||||
Balance | Allowance | Investment | Investment | Recognized | ||||||||||||||||
With no related allowance recorded: | ||||||||||||||||||||
Commercial & industrial | $ | 2,505 | $ | – | $ | 2,456 | $ | 2,659 | $ | 164 | ||||||||||
Commercial real estate | 2,615 | – | 2,389 | 2,383 | 55 | |||||||||||||||
Government | 2,845 | – | 2,845 | 2,968 | 72 | |||||||||||||||
Residential – prime | 1,289 | – | 1,197 | 1,032 | 23 | |||||||||||||||
Residential – HELOC | 155 | – | 155 | 133 | 4 | |||||||||||||||
With an allowance recorded: | ||||||||||||||||||||
Commercial & industrial | $ | 5,809 | $ | 1,194 | $ | 5,540 | $ | 3,770 | $ | 128 | ||||||||||
Commercial real estate | 3,058 | 497 | 2,756 | 2,884 | 5 | |||||||||||||||
Commercial construction & development | 135 | 22 | 132 | 136 | 5 | |||||||||||||||
Agricultural | 127 | 39 | 124 | 138 | – | |||||||||||||||
Residential – prime | 1,518 | 232 | 1,013 | 859 | 16 | |||||||||||||||
Residential – HELOC | 250 | 118 | 226 | 313 | – | |||||||||||||||
Residential construction & development | 505 | 172 | 498 | 273 | 1 | |||||||||||||||
Consumer | 10 | 9 | 9 | 14 | – | |||||||||||||||
Totals: | ||||||||||||||||||||
Commercial & industrial | $ | 8,314 | $ | 1,194 | $ | 7,996 | $ | 6,429 | $ | 292 | ||||||||||
Commercial real estate | 5,673 | 497 | 5,145 | 5,267 | 60 | |||||||||||||||
Commercial construction & development | 135 | 22 | 132 | 136 | 5 | |||||||||||||||
Agricultural | 127 | 39 | 124 | 138 | – | |||||||||||||||
Government | 2,845 | – | 2,845 | 2,968 | 72 | |||||||||||||||
Residential – prime | 2,807 | 232 | 2,210 | 1,891 | 39 | |||||||||||||||
Residential – HELOC | 405 | 118 | 381 | 446 | 4 | |||||||||||||||
Residential construction & development | 505 | 172 | 498 | 273 | 1 | |||||||||||||||
Consumer | 10 | 9 | 9 | 14 | – |
-14- |
The impaired loans at December 31, 2013, and during the year then ended, by loan class, follows:
Unpaid | Average | Interest | ||||||||||||||||||
Principal | Related | Recorded | Recorded | Income | ||||||||||||||||
Balance | Allowance | Investment | Investment | Recognized | ||||||||||||||||
With no related allowance recorded: | ||||||||||||||||||||
Commercial and industrial | $ | 2,906 | $ | – | $ | 2,861 | $ | 2,172 | $ | 135 | ||||||||||
Commercial real estate | 2,555 | – | 2,376 | 1,740 | 85 | |||||||||||||||
Commercial construction and development | 1 | – | – | – | – | |||||||||||||||
Government | 3,090 | – | 3,090 | 1,545 | 150 | |||||||||||||||
Residential – Prime | 979 | – | 866 | 845 | 14 | |||||||||||||||
Residential – HELOC | 110 | – | 110 | 55 | 3 | |||||||||||||||
With an allowance recorded: | ||||||||||||||||||||
Commercial and industrial | $ | 2,231 | $ | 1,112 | $ | 1,999 | $ | 2,813 | $ | 43 | ||||||||||
Commercial real estate | 3,143 | 621 | 3,011 | 2,955 | 81 | |||||||||||||||
Commercial construction and development | 142 | 74 | 140 | 171 | 8 | |||||||||||||||
Agricultural | 152 | 55 | 152 | 153 | – | |||||||||||||||
Residential – Prime | 749 | 101 | 706 | 1,085 | 9 | |||||||||||||||
Residential – HELOC | 412 | 119 | 400 | 453 | 5 | |||||||||||||||
Residential construction and development | 49 | 8 | 47 | 100 | 1 | |||||||||||||||
Consumer | 19 | 18 | 17 | 22 | – | |||||||||||||||
Totals: | ||||||||||||||||||||
Commercial and industrial | $ | 5,137 | $ | 1,112 | $ | 4,860 | $ | 4,985 | $ | 178 | ||||||||||
Commercial real estate | 5,698 | 621 | 5,387 | 4,695 | 166 | |||||||||||||||
Commercial construction and development | 143 | 74 | 140 | 171 | 8 | |||||||||||||||
Agricultural | 152 | 55 | 152 | 153 | – | |||||||||||||||
Government | 3,090 | – | 3,090 | 1,545 | 150 | |||||||||||||||
Residential – Prime | 1,728 | 101 | 1,572 | 1,930 | 23 | |||||||||||||||
Residential – HELOC | 522 | 119 | 510 | 508 | 8 | |||||||||||||||
Residential construction and development | 49 | 8 | 47 | 100 | 1 | |||||||||||||||
Consumer | 19 | 18 | 17 | 22 | – |
Loans on nonaccrual status at period-end, follows:
September 30, 2014 | December 31, 2013 | |||||||
Commercial: | ||||||||
Commercial and industrial | $ | 2,737 | $ | 1,575 | ||||
Agricultural | 124 | 152 | ||||||
Commercial real estate: | ||||||||
Commercial real estate | 3,608 | 4,103 | ||||||
Commercial construction and development | 16 | 17 | ||||||
Residential real estate: | ||||||||
Residential – prime | 1,317 | 1,059 | ||||||
Residential – HELOC | 242 | 387 | ||||||
Residential construction and development | 482 | 30 | ||||||
Consumer | 9 | 17 | ||||||
Total | $ | 8,535 | $ | 7,340 |
-15- |
During the quarter and nine months ended September 30, 2014, the contracts identified below were modified to capitalize unpaid property taxes or interest, convert amortizing payments to interest only payments, or to extend payment amortization periods, and were categorized as troubled debt restructurings. During the quarter and nine months ended September 30, 2013, the contracts identified below were modified to capitalize unpaid property taxes, convert amortizing payments to interest only payments, extend the amortization period, or lower the interest rate. Specific loan reserves maintained in connection with loans restructured during the nine months September 30 totaled $546 at September 30, 2014, and $165 at September 30, 2013. All modified or restructured loans are classified as impaired loans. Recorded investment as presented in the tables below concerning modified loans represents principal outstanding before specific reserves.
The following table presents information concerning modifications of troubled debt made during the quarter ended September 30, 2014:
Number of | Pre-modification outstanding recorded | Post-modification outstanding recorded investment at | ||||||||
As of September 30, 2014 ($000s) | contracts | investment | period-end | |||||||
Commercial real estate | 2 | $ | 376 | $ | 339 |
The following table presents information concerning modifications of troubled debt made during the nine months ended September 30, 2014:
Number of | Pre-modification outstanding recorded | Post-modification outstanding recorded investment at | ||||||||
As of September 30, 2014 ($000s) | contracts | investment | period-end | |||||||
Commercial & industrial | 5 | $ | 1,252 | $ | 1,198 | |||||
Commercial real estate | 3 | $ | 866 | $ | 786 | |||||
Residential real estate – prime | 2 | $ | 309 | $ | 183 |
The following table presents information concerning modifications of troubled debt made during the quarter ended September 30, 2013:
Number of | Pre-modification outstanding recorded | Post-modification outstanding recorded investment at | ||||||||
As of September 30, 2013 ($000s) | contracts | investment | period-end | |||||||
Commercial & industrial | 1 | $ | 75 | $ | 75 | |||||
Commercial real estate | 1 | $ | 82 | $ | 81 | |||||
Residential real estate – prime | 4 | $ | 777 | $ | 774 |
The following table presents information concerning modifications of troubled debt made during the nine months ended September 30, 2013:
Number of | Pre-modification outstanding recorded | Post-modification outstanding recorded investment at | ||||||||
As of September 30, 2013 ($000s) | contracts | investment | period-end | |||||||
Commercial & industrial | 4 | $ | 471 | $ | 369 | |||||
Commercial real estate | 3 | $ | 303 | $ | 288 | |||||
Residential real estate – prime | 5 | $ | 867 | $ | 862 |
-16- |
The following table outlines past troubled debt restructurings that subsequently defaulted within twelve months of the last restructuring date. For purposes of this table, default is defined as 90 days or more past due on restructured payments.
Number of | Recorded | |||||
Default during the quarter ended September 30, 2014 ($000s) | contracts | investment | ||||
Commercial and industrial | 2 | $ | 255 | |||
Commercial real estate | 1 | $ | 102 |
Number of | Recorded | |||||
Default during the nine months ended September 30, 2014 ($000s) | contracts | investment | ||||
Commercial and industrial | 3 | $ | 255 | |||
Commercial real estate | 3 | $ | 102 | |||
Residential real estate – prime | 2 | $ | – |
Number of | Recorded | |||||
Default during the quarter ended September 30, 2013 ($000s) | contracts | investment | ||||
Commercial and industrial | 1 | $ | 172 |
Number of | Recorded | |||||
Default during the nine months ended September 30, 2013 ($000s) | contracts | investment | ||||
Commercial and industrial | 1 | $ | 172 | |||
Commercial real estate | 1 | $ | 81 | |||
Residential – prime | 1 | $ | 88 |
NOTE 5 – FORECLOSED ASSETS
Real estate and other property acquired through, or in lieu of, loan foreclosure are initially recorded at fair value (after deducting estimated costs to sell) at the date of foreclosure, establishing a new cost basis. Costs related to development and improvement of property are capitalized, whereas costs related to holding property are expensed. After foreclosure, valuations are periodically performed by management, and the real estate or other property is carried at the lower of carrying amount or fair value less estimated costs to sell. Revenue and expenses from operations of foreclosed assets and changes in any valuation allowance are included in loss on foreclosed assets.
A summary of activity in foreclosed assets is as follows:
Three months ended | Nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Balance at beginning of period | $ | 1,266 | $ | 1,336 | $ | 1,750 | $ | 1,774 | ||||||||
Transfer of loans at net realizable value to foreclosed assets | 516 | 538 | 801 | 947 | ||||||||||||
Sale proceeds | (4 | ) | (47 | ) | (765 | ) | (698 | ) | ||||||||
Loans made on sale of foreclosed assets | (43 | ) | (100 | ) | (43 | ) | (207 | ) | ||||||||
Net gain (loss) from sale of foreclosed assets | 4 | 28 | (4 | ) | 88 | |||||||||||
Provision for write-down charged to operations | (15 | ) | (149 | ) | (15 | ) | (298 | ) | ||||||||
Balance at end of period | $ | 1,724 | $ | 1,606 | $ | 1,724 | $ | 1,606 |
-17- |
NOTE 6 – DEPOSITS
The distribution of deposits at period end is as follows:
September 30, 2014 | December 31, 2013 | |||||||
Non-interest bearing demand | $ | 109,197 | $ | 102,644 | ||||
Interest bearing demand (NOWs) | 115,345 | 118,769 | ||||||
Savings | 62,745 | 57,658 | ||||||
Money market | 137,312 | 136,797 | ||||||
Retail and local time | 123,801 | 104,287 | ||||||
Broker and national time | 53,677 | 57,359 | ||||||
Total deposits | $ | 602,077 | $ | 577,514 |
NOTE 7 – OTHER BORROWINGS
Other borrowings consist of the following obligations at September 30, 2014, and December 31, 2013:
($000s) | September 30, 2014 | December 31, 2013 | ||||||
Federal funds purchased | $ | – | $ | – | ||||
Short-term repurchase agreements | 4,211 | 5,441 | ||||||
Bank stock term loan | 500 | 1,500 | ||||||
Wholesale structured repurchase agreements | 13,500 | 13,500 | ||||||
Total other borrowings | $ | 18,211 | $ | 20,441 |
PSB pledges various securities available for sale as collateral for repurchase agreements. The fair value of securities pledged for repurchase agreements totaled $20,864 at September 30, 2014 and $22,699 at December 31, 2013.
PSB has pledged its common stock ownership of its subsidiary, Peoples State Bank, as collateral for the bank stock term loan. The bank note carries a floating rate of interest with required remaining principal payments of $500 in 2015. In addition, $8,000 of wholesale structured repurchase agreements mature in 2014 with the remaining $5,500 maturing in 2017.
The following information relates to securities sold under repurchase agreements and other borrowings:
Three months ended | Nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
As of end of period – weighted average rate | 3.20 | % | 3.09 | % | 3.20 | % | 3.09 | % | ||||||||
For the period: | ||||||||||||||||
Highest month-end balance | $ | 24,198 | $ | 24,100 | $ | 24,198 | $ | 24,100 | ||||||||
Daily average balance | $ | 19,962 | $ | 22,797 | $ | 20,348 | $ | 22,368 | ||||||||
Weighted average rate | 3.06 | % | 2.87 | % | 3.05 | % | 2.93 | % |
NOTE 8 – SENIOR SUBORDINATED NOTES
During the quarter ended March 31, 2013, PSB elected to prepay $7,000 of its 8% senior subordinated notes with $1,000 of cash and $6,000 in proceeds from an issue of new subordinated debt. The new debt included $4,000 of privately placed notes carrying a 3.75% fixed interest rate with semi-annual interest only payments, due in 2018, and $2,000 in a fully amortizing bank stock term loan with Bankers’ Bank, Madison, Wisconsin, carrying a floating rate of interest based on changes in the 90-day LIBOR plus 3.00% and maturing in 2015. The $4,000 of new fixed rate debt is held by related parties, including directors and a significant shareholder. Total interest expense on senior subordinated notes was $113 and $147 during the nine months ended September 30, 2014 and 2013, respectively.
-18- |
NOTE 9 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
PSB is exposed to certain risks relating to its ongoing business operations. The primary risk managed by using derivative instruments is interest rate risk. Interest rate swaps are entered into to manage interest rate risk associated with PSB’s variable rate junior subordinated debentures. Accounting standards require PSB to recognize all derivative instruments as either assets or liabilities at fair value in the balance sheet. PSB designates its interest rate swap associated with the junior subordinated debentures as a cash flow hedge of variable-rate debt. For derivative financial instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative instrument representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.
From time to time, PSB will also enter into fixed interest rate swaps with customers in connection with their floating rate loans to PSB. When fixed rate swaps are originated with customers, an identical offsetting swap is also entered into by PSB with a correspondent bank. These swap arrangements are intended to offset each other as “back to back” swaps and allow PSB’s loan customer to obtain fixed rate loan financing via the swap while PSB exchanges these fixed payments with a correspondent bank. In these arrangements, PSB’s net cash flows and interest income are equal to the floating rate loan originated in connection with the swap. These customer swaps are not designated as hedging instruments and are accounted for at fair value with changes in fair value recognized in the income statement during the current period.
PSB is exposed to credit-related losses in the event of nonperformance by the counterparties to these agreements. PSB controls the credit risk of its financial contracts through credit approvals, limits, and monitoring procedures, and does not expect any counterparties to fail their obligations. PSB swaps originated with correspondent banks are over-the-counter (OTC) contracts. Negotiated OTC derivative contracts are generally entered into between two counterparties that negotiate specific agreement terms, including the underlying instrument, amounts, exercise prices, and maturity.
At period end, the following interest rate swaps to hedge variable-rate debt were outstanding:
September 30, 2014 | December 31, 2013 | |||||||
Notional amount: | $ | 7,500 | $ | 7,500 | ||||
Pay fixed rate: | 2.72 | % | 2.72 | % | ||||
Receive variable rate: | 0.23 | % | 0.24 | % | ||||
Maturity: | September 2017 | September 2017 | ||||||
Unrealized fair value gain (loss) | $ | (327 | ) | $ | (438 | ) |
This agreement provides for PSB to receive payments at a variable rate determined by the three-month LIBOR in exchange for making payments at a fixed rate. Actual maturities may differ from scheduled maturities due to call options and/or early termination provisions. No interest rate swap agreements were terminated prior to maturity during the nine months ended September 30, 2014 or 2013. Risk management results for the nine months ended September 30, 2014 related to the balance sheet hedging of variable rate debt indicates that the hedge was 100% effective, and no component of the derivative instrument’s gain or loss was excluded from the assessment of hedge effectiveness.
As of September 30, 2014, approximately $181 of losses ($110 after tax impacts) reported in other comprehensive income related to the interest rate swap are expected to be reclassified into interest expense as a yield adjustment of the hedged borrowings during the 12-month period ending September 30, 2015. The interest rate swap agreement was secured by cash and cash equivalents of $570 at September 30, 2014 and December 31, 2013.
PSB maintains outstanding interest rate swaps with customers and correspondent banks associated with its lending activities that are not designated as hedges. At period end, the following floating interest rate swaps were outstanding with customers:
September 30, 2014 | December 31, 2013 | |||||||
Notional amount: | $ | 13,816 | $ | 14,323 | ||||
Receive fixed rate (average): | 2.00 | % | 2.00 | % | ||||
Pay variable rate (average): | 0.16 | % | 0.17 | % | ||||
Maturity: | March 2015 – Oct. 2021 | March 2015 – Oct. 2021 | ||||||
Weighted average remaining term | 2.2 years | 2.9 years | ||||||
Unrealized fair value gain (loss) | $ | 193 | $ | 276 |
-19- |
At period end, the following offsetting fixed interest rate swaps were outstanding with correspondent banks:
September 30, 2014 | December 31, 2013 | |||||||
Notional amount | $ | 13,816 | $ | 14,323 | ||||
Pay fixed rate (average) | 2.00 | % | 2.00 | % | ||||
Receive variable rate (average) | 0.16 | % | 0.17 | % | ||||
Maturity | March 2015 – Oct. 2021 | March 2015 – Oct. 2021 | ||||||
Weighted average remaining term | 2.2 years | 2.9 years | ||||||
Unrealized fair value gain (loss) | $ | (193 | ) | $ | (276 | ) |
NOTE 10 – INCOME TAX EFFECTS ON ITEMS OF COMPREHENSIVE INCOME
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, 2014 | September 30, 2014 | |||||||||||||||
Period ended September 30, 2014 | Pre-tax | Income Tax | Pre-tax | Income Tax | ||||||||||||
(dollars in thousands) | Inc. (Exp.) | Exp. (Credit) | Inc. (Exp.) | Exp. (Credit) | ||||||||||||
Unrealized gain (loss) on securities available for sale | $ | (272 | ) | $ | (107 | ) | $ | 218 | $ | 86 | ||||||
Amortization of unrealized gain on securities available for sale transferred | ||||||||||||||||
to securities held to maturity included in net income | (83 | ) | (33 | ) | (251 | ) | (99 | ) | ||||||||
Unrealized gain (loss) on interest rate swap | 33 | 13 | (28 | ) | (11 | ) | ||||||||||
Reclassification adjustment of interest rate swap settlements included in earnings | 46 | 18 | 140 | 55 | ||||||||||||
Totals | $ | (276 | ) | $ | (109 | ) | $ | 79 | $ | 31 |
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, 2013 | September 30, 2013 | |||||||||||||||
Period ended September 30, 2013 | Pre-tax | Income Tax | Pre-tax | Income Tax | ||||||||||||
(dollars in thousands) | Inc. (Exp.) | Exp. (Credit) | Inc. (Exp.) | Exp. (Credit) | ||||||||||||
Unrealized loss on securities available for sale | $ | (416 | ) | $ | (151 | ) | $ | (1,277 | ) | $ | (497 | ) | ||||
Reclassification adjustment for security gain included in net income | – | – | (12 | ) | (5 | ) | ||||||||||
Accretion (amortization) of unrealized gain on securities available | ||||||||||||||||
for sale transferred to securities held to maturity included in net income | 3 | (13 | ) | (319 | ) | (144 | ) | |||||||||
Unrealized gain (loss) on interest rate swap | (62 | ) | (23 | ) | 75 | 30 | ||||||||||
Reclassification adjustment of interest rate swap settlements included in earnings | 47 | 19 | 139 | 55 | ||||||||||||
Totals | $ | (428 | ) | $ | (168 | ) | $ | (1,394 | ) | $ | (561 | ) |
NOTE 11 – RECLASSIFICATIONS OUT OF ACCUMULATED OTHER COMPREHENSIVE INCOME
During the quarter ended September 30, 2014, PSB reclassified $46 ($28 after tax impacts) of interest rate swap settlements which increased comprehensive income. The increase to comprehensive net income was recognized as an increase to interest expense on junior subordinated debentures on the statement of income during the quarter.
During the nine months ended September 30, 2014, PSB reclassified $140 ($85 after tax impacts) of interest rate swap settlements which increased comprehensive income. The increase to comprehensive net income was recognized as an increase to interest expense on junior subordinated debentures on the statement of income during the period.
During the nine months ended September 30, 2013, PSB reclassified $12 ($7 after tax impacts) to reduce comprehensive net income following a gain on sale of securities available for sale. The reduction to comprehensive net income was recognized as a gain on sale of securities on the statement of income during the period.
During the quarter ended September 30, 2013, PSB reclassified $47 ($28 after tax impacts) of interest rate swap settlements which increased comprehensive income. The increase to comprehensive net income was recognized as an increase to interest expense on junior subordinated debentures on the statement of income during the quarter.
-20- |
During the nine months ended September 30, 2013, PSB reclassified $139 ($84 after tax impacts) of interest rate swap settlements which increased comprehensive income. The increase to comprehensive net income was recognized as a $139 ($84 after tax impacts) increase to interest expense on junior subordinated debentures on the statement of income during the period.
NOTE 12 – STOCK-BASED COMPENSATION
PSB grants restricted stock to certain employees during the first quarter of each year, which had an initial market value of $200 during the nine months ended September 30, 2014 compared to $210 granted during the nine months ended September 30, 2013. Restricted shares vest to employees based on continued PSB service over a six-year period and are recognized as compensation expense over the vesting period. Cash dividends are paid on unvested shares at the same time and amount as paid to PSB common shareholders. Cash dividends paid on unvested restricted stock shares are charged to retained earnings as significantly all restricted shares are expected to vest to employees. Unvested shares are subject to forfeiture upon employee termination. During the nine months ended September 30, compensation expense recorded from amortization of restricted shares expected to vest to employees was $124 and $109 during 2014 and 2013, respectively.
The following tables summarize information regarding restricted stock outstanding at September 30, 2014 and 2013 including activity during the three months then ended.
Weighted | ||||||||
Average | ||||||||
Shares | Grant Price | |||||||
January 1, 2013 | 30,409 | $ | 19.39 | |||||
Restricted stock granted | 8,076 | 26.00 | ||||||
Restricted stock legally vested | (5,883 | ) | (17.85 | ) | ||||
September 30, 2013 | 32,602 | $ | 21.30 | |||||
January 1, 2014 | 32,602 | $ | 21.30 | |||||
Restricted stock granted | 6,400 | 31.25 | ||||||
Restricted stock legally vested | (7,640 | ) | (18.91 | ) | ||||
September 30, 2014 | 31,362 | $ | 23.92 |
Scheduled compensation expense per calendar year assuming all restricted shares eventually vest to employees would be as follows:
2014 | $ | 166 | ||
2015 | 157 | |||
2016 | 162 | |||
2017 | 122 | |||
2018 | 82 | |||
Thereafter | 40 | |||
Totals | $ | 729 |
NOTE 13 – EARNINGS PER SHARE
Basic earnings per share of common stock are based on the weighted average number of common shares outstanding during the period. Unvested but issued restricted shares are considered to be outstanding shares and used to calculate the weighted average number of shares outstanding and determine net book value per share. Diluted earnings per share is calculated by dividing net income by the weighted average number of shares adjusted for the dilutive effect of any outstanding stock options.
-21- |
Presented below are the calculations for basic and diluted earnings per share:
Three months ended | Nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
(dollars in thousands, except per share data – unaudited) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
Net income | $ | 1,782 | $ | 13 | $ | 4,635 | $ | 3,183 | ||||||||
Weighted average shares outstanding | 1,650,716 | 1,651,518 | 1,655,603 | 1,653,098 | ||||||||||||
Effect of dilutive stock options outstanding | - | - | - | - | ||||||||||||
Diluted weighted average shares outstanding | 1,650,716 | 1,651,518 | 1,655,603 | 1,653,098 | ||||||||||||
Basic earnings per share | $ | 1.08 | $ | 0.01 | $ | 2.80 | $ | 1.93 | ||||||||
Diluted earnings per share | $ | 1.08 | $ | 0.01 | $ | 2.80 | $ | 1.93 |
NOTE 14– CONTINGENCIES
In the normal course of business, PSB is involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the consolidated financial statements.
NOTE 15 – FAIR VALUE MEASUREMENTS
Certain assets and liabilities are recorded or disclosed at fair value to provide financial statement users additional insight into PSB’s quality of earnings. Under current accounting guidance, PSB groups assets and liabilities which are recorded at fair value in three levels based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement (with Level 1 considered highest and Level 3 considered lowest). All transfers between levels are recognized as occurring at the end of the reporting period.
Following is a brief description of each level of the fair value hierarchy:
Level 1 – Fair value measurement is based on quoted prices for identical assets or liabilities in active markets.
Level 2 – Fair value measurement is based on (1) quoted prices for similar assets or liabilities in active markets; (2) quoted prices for identical or similar assets or liabilities in markets that are not active; or (3) valuation models and methodologies for which all significant assumptions are or can be corroborated by observable market data.
Level 3 – Fair value measurement is based on valuation models and methodologies that incorporate at least one significant assumption that cannot be corroborated by observable market data. Level 3 measurements reflect PSB’s estimates about assumptions market participants would use in measuring fair value of the asset or liability.
Some assets and liabilities, such as securities available for sale, loans held for sale, mortgage rate lock commitments, and interest rate swaps, are measured at fair value on a recurring basis under GAAP. Other assets and liabilities, such as impaired loans, foreclosed assets, and mortgage servicing rights are measured at fair value on a nonrecurring basis.
Following is a description of the valuation methodology used for each asset and liability measured at fair value on a recurring or nonrecurring basis, as well as the classification of the asset or liability within the fair value hierarchy.
Securities available for sale – Securities available for sale may be classified as Level 1, Level 2, or Level 3 measurements within the fair value hierarchy and are measured on a recurring basis. Level 1 securities include equity securities traded on a national exchange. The fair value measurement of a Level 1 security is based on the quoted price of the security. Level 2 securities include U.S. government and agency securities, obligations of states and political subdivisions, corporate debt securities, and mortgage-related securities. The fair value measurement of a Level 2 security is obtained from an independent pricing service and is based on recent sales of similar securities and other observable market data and represents a market approach to fair value.
At September 30, 2014 and December 31, 2013, Level 3 securities include a common stock investment in Bankers’ Bancorporation, Inc., Madison, Wisconsin, that is not traded on an active market. Historical cost of the common stock is assumed to approximate fair value of this investment.
-22- |
Loans held for sale – Loans held for sale in the secondary market are carried at the lower of aggregate cost or estimated fair value and are measured on a recurring basis. The fair value measurement of a loan held for sale is based on current secondary market prices for similar loans, which is considered a Level 2 measurement and represents a market approach to fair value.
Impaired loans – Loans are not measured at fair value on a recurring basis. Carrying value of impaired loans that are not collateral dependent are based on the present value of expected future cash flows discounted at the applicable effective interest rate and, thus, are not fair value measurements. However, impaired loans considered to be collateral dependent are measured at fair value on a nonrecurring basis. The fair value measurement of an impaired loan that is collateral dependent is based on the fair value of the underlying collateral. Fair value measurements of underlying collateral that utilize observable market data, such as independent appraisals reflecting recent comparable sales, are considered Level 2 measurements. Other fair value measurements that incorporate internal collateral appraisals or broker price opinions, net of selling costs, or estimated assumptions market participants would use to measure fair value, such as discounted cash flow measurements, are considered Level 3 measurements and represent a market approach to fair value.
In the absence of a recent independent appraisal, collateral dependent impaired loans are valued based on a recent broker price opinion generally discounted by 10% plus estimated selling costs. In the absence of a broker price opinion, collateral dependent impaired loans are valued at the lower of last appraisal value or the current real estate tax value discounted by 30%, plus estimated selling costs. Property values are impacted by many macroeconomic factors. In general, a declining economy or rising interest rates would be expected to lower fair value of collateral dependent impaired loans while an improving economy or falling interest rates would be expected to increase fair value of collateral dependent impaired loans.
Foreclosed assets – Real estate and other property acquired through, or in lieu of, loan foreclosure are not measured at fair value on a recurring basis. Initially, foreclosed assets are recorded at fair value less estimated costs to sell at the date of foreclosure. Estimated selling costs typically range from 5% to 15% of the property value. Valuations are periodically performed by management, and the real estate or other property is carried at the lower of carrying amount or fair value less estimated costs to sell. Fair value measurements are based on current formal or informal appraisals of property value compared to recent comparable sales of similar property. Independent appraisals reflecting comparable sales are considered Level 2 measurements, while internal assessments of appraised value based on current market activity, including broker price opinions, are considered Level 3 measurements and represent a market approach to fair value. Property values are impacted by many macroeconomic factors. In general, a declining economy or rising interest rates would be expected to lower fair value of foreclosed assets while an improving economy or falling interest rates would be expected to increase fair value of foreclosed assets.
Mortgage servicing rights – Mortgage servicing rights are not measured at fair value on a recurring basis. However, mortgage servicing rights that are impaired are measured at fair value on a nonrecurring basis. Serviced loan pools are stratified by year of origination and term of the loan, and a valuation model is used to calculate the present value of expected future cash flows for each stratum. When the carrying value of a stratum exceeds its fair value, the stratum is measured at fair value. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as costs to service, a discount rate, custodial earnings rate, ancillary income, default rates and losses, and prepayment speeds. Although some of these assumptions are based on observable market data, other assumptions are based on unobservable estimates of what market participants would use to measure fair value. As a result, the fair value measurement of mortgage servicing rights is considered a Level 3 measurement and represents an income approach to fair value. When market mortgage rates decline, borrowers may have the opportunity to refinance their existing mortgage loans at lower rates, increasing the risk of prepayment of loans on which PSB maintains mortgage servicing rights. Therefore, declining long-term interest rates would decrease the fair value of mortgage servicing rights. Significant unobservable inputs at September 30, 2014, used to measure fair value included:
Direct annual servicing cost per loan | $ | 60 | ||
Direct annual servicing cost per loan in process of foreclosure | $ | 600 | ||
Weighted average prepayment speed: CPR | 23.11 | % | ||
Weighted average prepayment speed: PSA | 478.10 | % | ||
Weighted average cash flow discount rate | 7.91 | % | ||
Asset reinvestment rate | 4.00 | % | ||
Short-term cost of funds | 0.25 | % | ||
Escrow inflation adjustment | 1.00 | % | ||
Servicing cost inflation adjustment | 1.00 | % |
Other intangible assets – The fair value and impairment of other intangible assets, including core deposit intangible assets and goodwill, is measured annually as of December 31 or more frequently if conditions indicate that impairment may have occurred. The evaluation of possible impairment of other intangible assets involves significant judgment based upon short-term and long-term projections of future performance, which is a Level 3 fair value measurement, and represents an income approach to fair value.
-23- |
Mortgage rate lock commitments – The fair value of mortgage rate lock commitments is measured on a recurring basis. Fair value is based on current secondary market pricing for delivery of similar loans and the value of OMSR on loans expected to be delivered, which is considered a Level 2 fair value measurement.
Interest rate swap agreements – Fair values for interest rate swap agreements are based on the amounts required to settle the contracts based on valuations provided by third-party dealers in the contracts, which is considered a Level 2 fair value measurement, and are measured on a recurring basis.
Recurring Fair Value Measurements Using | ||||||||||||||||
Quoted Prices in Active Markets | Significant Other | Significant | ||||||||||||||
for Identical | Observable | Unobservable | ||||||||||||||
Assets | Inputs | Inputs | ||||||||||||||
(dollars in thousands) | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Assets measured at fair value on a recurring basis at September 30, 2014: | ||||||||||||||||
Securities available for sale: | ||||||||||||||||
U.S. agency issued residential MBS and CMO | $ | 72,147 | – | $ | 72,147 | $– | ||||||||||
Privately issued residential MBS and CMO | 30 | – | 30 | – | ||||||||||||
Solomon Hess SBA loan fund (CDFI Fund) | 950 | – | 950 | – | ||||||||||||
Other equity securities | 47 | – | – | 47 | ||||||||||||
Total securities available for sale | 73,174 | – | 73,127 | 47 | ||||||||||||
Loans held for sale | 999 | 999 | ||||||||||||||
Mortgage rate lock commitments | 21 | – | 21 | – | ||||||||||||
Interest rate swap agreements | 193 | – | 193 | – | ||||||||||||
Total assets | $ | 74,387 | – | $ | 74,340 | $ | 47 | |||||||||
Liabilities – Interest rate swap agreements | $ | 520 | $ | – | $ | 520 | $ | – |
Assets measured at fair value on a recurring basis at December 31, 2013: | ||||||||||||||||
Securities available for sale: | ||||||||||||||||
U.S. Treasury and agency debentures | $ | 999 | $ | – | $ | 999 | $ | – | ||||||||
Obligations of states and political subdivisions | 159 | 159 | – | |||||||||||||
U.S. agency issued residential MBS and CMO | 59,390 | – | 59,390 | – | ||||||||||||
Privately issued residential MBS and CMO | 105 | – | 105 | – | ||||||||||||
Solomon Hess SBA loan fund (CDFI Fund) | 950 | 950 | – | |||||||||||||
Other equity securities | 47 | – | – | 47 | ||||||||||||
Total securities available for sale | 61,650 | – | 61,603 | 47 | ||||||||||||
Loans held for sale | 150 | – | 150 | – | ||||||||||||
Mortgage rate lock commitments | 14 | – | 14 | – | ||||||||||||
Interest rate swap agreements | 276 | – | 276 | – | ||||||||||||
Total assets | $ | 62,090 | $ | – | $ | 62,043 | $ | 47 | ||||||||
Liabilities – Interest rate swap agreements | $ | 714 | $ | – | $ | 714 | $ | – |
-24- |
Reconciliation of fair value measurements using significant unobservable inputs:
Securities | ||||
Available | ||||
(dollars in thousands) | For Sale | |||
Balance at January 1, 2013: | $ | 47 | ||
Total realized/unrealized gains and (losses): | ||||
Included in earnings | – | |||
Included in other comprehensive income | – | |||
Purchases, maturities, and sales | – | |||
Transferred from Level 2 to Level 3 | – | |||
Transferred to held to maturity classification | – | |||
Balance at September 30, 2013 | $ | 47 | ||
Total gains or (losses) for the period included in earnings attributable to the | ||||
change in unrealized gains or losses relating to assets still held at September 30, 2013 | $ | – | ||
Balance at January 1, 2014 | $ | 47 | ||
Total realized/unrealized gains and (losses): | ||||
Included in earnings | – | |||
Included in other comprehensive income | – | |||
Purchases, maturities, and sales | – | |||
Transferred from Level 2 to Level 3 | – | |||
Transferred to held to maturity classification | – | |||
Balance at September 30, 2014 | $ | 47 | ||
Total gains or (losses) for the period included in earnings attributable to the | ||||
change in unrealized gains or losses relating to assets still held at September 30, 2014 | $ | – |
Nonrecurring Fair Value Measurements Using | ||||||||||||||||
Quoted Prices | ||||||||||||||||
in Active Markets | Significant Other | Significant | ||||||||||||||
for Identical | Observable | Unobservable | ||||||||||||||
Assets | Inputs | Inputs | ||||||||||||||
($000s) | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Assets measured at fair value on a nonrecurring basis at September 30, 2014: | ||||||||||||||||
Impaired loans | $ | 2,059 | $ | – | $ | 644 | $ | 1,415 | ||||||||
Foreclosed assets | 1,724 | – | 509 | 1,215 | ||||||||||||
Mortgage servicing rights | 1,734 | – | – | 1,734 | ||||||||||||
Other intangible assets | 297 | – | – | 297 | ||||||||||||
Total assets | $ | 5,814 | $ | – | $ | 1,153 | $ | 4,661 | ||||||||
Assets measured at fair value on a nonrecurring basis at December 31, 2013: | ||||||||||||||||
Impaired loans | $ | 1,720 | $ | – | $ | – | $ | 1,720 | ||||||||
Foreclosed assets | 1,750 | – | 792 | 958 | ||||||||||||
Mortgage servicing rights | 1,696 | – | – | 1,696 | ||||||||||||
Total assets | $ | 5,166 | $ | – | $ | 792 | $ | 4,374 |
-25- |
At September 30, 2014, loans with a carrying amount of $2,429 were considered impaired and were written down to their estimated fair value of $2,059 net of a valuation allowance of $370. At December 31, 2013, loans with a carrying amount of $2,119 were considered impaired and were written down to their estimated fair value of $1,720, net of a valuation allowance of $399. Changes in the valuation allowances are reflected through earnings as a component of the provision for loan losses or as a charge-off against the allowance for loan losses.
At September 30, 2014, foreclosed assets with a carrying amount of $2,405 had been written down to a fair value of $1,724, less costs to sell. During the nine months ended September 30, 2014, foreclosed assets with a fair value of $810 were acquired through or in lieu of foreclosure, which is the fair value net of estimated costs to sell. Impairment charges recorded as a reduction to earnings totaled $15 during the nine months ended September 30, 2014.
At December 31, 2013, foreclosed assets with a carrying amount of $2,735 had been written down to a fair value of $1,750, less costs to sell. During the nine months ended September 30, 2013, foreclosed assets with a fair value of $947 were acquired through or in lieu of foreclosure, which is the fair value net of estimated costs to sell. Impairment charges recorded as a reduction to earnings totaled $298 during the nine months ended September 30, 2013.
At September 30, 2014, mortgage servicing rights with a carrying amount of $1,760 were considered impaired and were written down to their estimated fair value of $1,734, resulting in an impairment allowance of $26. At December 31, 2013, mortgage servicing rights with a carrying amount of $1,717 were considered impaired and were written down to their estimated fair value of $1,696, resulting in an impairment allowance of $21. Changes in the impairment allowances are reflected through earnings as a component of mortgage banking income.
PSB estimates fair value of all financial instruments regardless of whether such instruments are measured at fair value. The following methods and assumptions were used by PSB to estimate fair value of financial instruments not previously discussed.
Cash and cash equivalents – Fair value reflects the carrying value of cash, which is a Level 1 measurement.
Securities held to maturity – Fair value of securities held to maturity is based on dealer quotations on similar securities near period-end, which is considered a Level 2 measurement. Certain debt issued by banks or bank holding companies purchased by PSB as securities held to maturity is valued on a cash flow basis discounted using market rates reflecting credit risk of the borrower, which is considered a Level 3 measurement.
Bank certificates of deposit – Fair value of fixed rate certificates of deposit included in other investments is estimated by discounting future cash flows using current rates at which similar certificates could be purchased, which is a Level 3 measurement.
Loans– Fair value of variable rate loans that reprice frequently are based on carrying values. Loans with an active sale market, such as one- to four-family residential mortgage loans, estimate fair value based on sales of loans with similar structure and credit quality. Fair value of other loans is estimated by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings. Fair value of impaired and other nonperforming loans is estimated using discounted expected future cash flows or the fair value of underlying collateral, if applicable. Except for collateral dependent impaired loans valued using an independent appraisal of collateral value, reflecting a Level 2 fair value measurement, fair value of loans is considered to be a Level 3 measurement due to internally developed discounted cash flow measurements.
Federal Home Loan Bank stock – Fair value is the redeemable (carrying) value based on the redemption provisions of the Federal Home Loan Bank, which is considered a Level 3 fair value measurement.
Accrued interest receivable and payable – Fair value approximates the carrying value, which is considered a Level 3 fair value measurement.
-26- |
Cash value of life insurance – Fair value is based on reported values of the assets by the issuer which are redeemable to the insured, which is considered a Level 2 fair value measurement.
Deposits– Fair value of deposits with no stated maturity, such as demand deposits, savings, and money market accounts, by definition, is the amount payable on demand on the reporting date. Fair value of fixed rate time deposits is estimated using discounted cash flows applying interest rates currently offered on issue of similar time deposits. Use of internal discounted cash flows provides a Level 3 fair value measurement.
FHLB advances and other borrowings – Fair value of fixed rate, fixed term borrowings is estimated by discounting future cash flows using the current rates at which similar borrowings would be made as calculated by the lender or correspondent. Fair value of borrowings with variable rates or maturing within 90 days approximates the carrying value of these borrowings. Fair values based on lender provided settlement provisions are considered a Level 2 fair value measurement. Other borrowings with local customers in the form of repurchase agreements are estimated using internal assessments of discounted future cash flows, which is a Level 3 measurement.
Senior subordinated notes and junior subordinated debentures – Fair value of fixed rate, fixed term notes and debentures are estimated internally by discounting future cash flows using the current rates at which similar borrowings would be made, which is a Level 3 fair value measurement.
The carrying amounts and fair values of PSB’s financial instruments consisted of the following at September 30, 2014:
September 30, 2014 | ||||||||||||||||||||
Carrying | Estimated | Fair Value Hierarchy Level | ||||||||||||||||||
Amount | Fair Value | Level 1 | Level 2 | Level 3 | ||||||||||||||||
Financial assets ($000s): | ||||||||||||||||||||
Cash and cash equivalents | $ | 12,817 | $ | 12,817 | $ | 12,817 | $ | – | $ | – | ||||||||||
Securities | 143,576 | 144,819 | – | 142,955 | 1,864 | |||||||||||||||
Bank certificates of deposit | 3,424 | 3,452 | – | – | 3,452 | |||||||||||||||
Net loans receivable and loans held for sale | 534,087 | 536,240 | – | 1,643 | 534,597 | |||||||||||||||
Accrued interest receivable | 2,165 | 2,165 | – | – | 2,165 | |||||||||||||||
Mortgage servicing rights | 1,734 | 1,734 | – | – | 1,734 | |||||||||||||||
Mortgage rate lock commitments | 21 | 21 | – | 21 | – | |||||||||||||||
FHLB stock | 2,556 | 2,556 | – | – | 2,556 | |||||||||||||||
Cash surrender value of life insurance | 13,127 | 13,127 | – | 13,127 | – | |||||||||||||||
Interest rate swap agreements | 193 | 193 | – | 193 | – | |||||||||||||||
Financial liabilities ($000s): | ||||||||||||||||||||
Deposits | $ | 602,077 | $ | 599,665 | $ | – | $ | – | $ | 599,665 | ||||||||||
FHLB advances | 31,372 | 31,421 | – | 31,421 | – | |||||||||||||||
Other borrowings | 18,211 | 18,703 | – | 13,992 | 4,711 | |||||||||||||||
Senior subordinated notes | 4,000 | 3,563 | – | – | 3,563 | |||||||||||||||
Junior subordinated debentures | 7,732 | 7,186 | – | – | 7,186 | |||||||||||||||
Interest rate swap agreements | 520 | 520 | – | 520 | – | |||||||||||||||
Accrued interest payable | 411 | 411 | – | – | 411 |
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The carrying amounts and fair values of PSB’s financial instruments consisted of the following at December 31, 2013:
December 31, 2013 | ||||||||||||||||||||
Carrying | Estimated | Fair Value Hierarchy Level | ||||||||||||||||||
Amount | Fair Value | Level 1 | Level 2 | Level 3 | ||||||||||||||||
Financial assets ($000s): | ||||||||||||||||||||
Cash and cash equivalents | $ | 31,522 | $ | 31,522 | $ | 31,522 | $ | – | $ | – | ||||||||||
Securities | 133,279 | 133,322 | – | 131,479 | 1,843 | |||||||||||||||
Bank certificates of deposit | 2,236 | 2,280 | – | – | 2,280 | |||||||||||||||
Net loans receivable and loans held for sale | 510,030 | 514,309 | – | 150 | 514,159 | |||||||||||||||
Accrued interest receivable | 2,076 | 2,076 | – | – | 2,076 | |||||||||||||||
Mortgage servicing rights | 1,696 | 1,696 | – | – | 1,696 | |||||||||||||||
Mortgage rate lock commitments | 14 | 14 | – | 14 | – | |||||||||||||||
FHLB stock | 2,556 | 2,556 | – | – | 2,556 | |||||||||||||||
Cash surrender value of life insurance | 12,826 | 12,826 | – | 12,826 | – | |||||||||||||||
Interest rate swap agreements | 276 | 276 | – | 276 | – | |||||||||||||||
Financial liabilities ($000s): | ||||||||||||||||||||
Deposits | $ | 577,514 | $ | 578,387 | $ | – | $ | – | $ | 578,387 | ||||||||||
FHLB advances | 38,049 | 38,511 | – | 38,511 | – | |||||||||||||||
Other borrowings | 20,441 | 21,251 | – | 14,364 | 6,887 | |||||||||||||||
Senior subordinated notes | 4,000 | 3,489 | – | – | 3,489 | |||||||||||||||
Junior subordinated debentures | 7,732 | 7,085 | – | – | 7,085 | |||||||||||||||
Interest rate swap agreements | 714 | 714 | – | 714 | – | |||||||||||||||
Accrued interest payable | 477 | 477 | – | – | 477 |
NOTE 16 – CURRENT ACCOUNTING CHANGES
FASB ASC Topic 210,“Balance Sheet.” In January 2013, clarifications were issued of new authoritative accounting guidance first issued in December 2011 concerning disclosure of information about offsetting and related arrangements associated with derivative instruments. The clarifications and originally issued guidance require additional disclosures associated with offsetting and collateral arrangements with derivative instruments to enable users of PSB’s financial statements to understand the effect of those arrangements on its financial position beginning March 31, 2013. These new disclosures were added as necessary during the quarter ended March 31, 2013 and did not have a significant impact to the reporting of PSB’s financial results upon adoption.
FASB ASC Topic 805,Business Combinations.In October 2012, new authoritative accounting guidance was issued that addressed accounting for an indemnification asset acquired as a result of a government-assisted acquisition of a financial institution when a subsequent change in cash flows expected to be collected is identified. After identification of the new cash flows, the reporting entity should subsequently account for the change in the measurement of the indemnification asset on the same basis as accounting for the change in the assets subject to the indemnification. Amortization of these changes in value is limited to the remaining contractual term of the indemnification agreement. These new rules became effective for changes in cash flows identified beginning January 1, 2013. Adoption of this new guidance did not have an impact on PSB’s financial statements.
FASB ASC Topic 220,Comprehensive Income.In February 2013, new authoritative accounting guidance was issued which required PSB to report the effect of significant reclassifications out of accumulated other comprehensive income in a footnote to the financial statements. The disclosure was effective beginning March 31, 2013 on a prospective basis. The change did not have a significant impact on PSB’s financial reporting or results of operations upon adoption.
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NOTE 17 – FUTURE ACCOUNTING CHANGES
FASB ASC Topic 310,Receivables.In January 2014, new authoritative accounting guidance was issued that defined when a lender has obtained physical possession of residential real estate collateral, requiring charge-off of the loan and recognition as foreclosed property. In addition, additional disclosures on the amount of residential real estate included in foreclosed assets as well as the amount of residential loans in the process of foreclosure are required for each period end. These new rules become effective for quarterly periods beginning January 1, 2015. Adoption of this new guidance is not expected to have a significant impact on PSB’s results of operations or financial statements.
FASB ASC Topic 606,Revenue from Contracts with Customers.In May 2014, new authoritative accounting guidance was issued that provides guidance on when it is appropriate to recognize customer sales agreements as revenue. This large standard has limited impact on PSB as loans, deposits, and other financial instruments are excluded from the scope of the standard. However sales of foreclosed property and certain noninterest income from contracts with customers, such as insurance contracts, are subject to new rules applied on an individual transaction basis. The standard is effective for quarterly periods beginning January 1, 2017. Adoption of this new guidance is not expected to have a significant impact on PSB’s results of operations or financial statements.
NOTE 18 – SUBSEQUENT EVENTS
Management has reviewed PSB’s operations for potential disclosure of information or financial statement impacts related to events occurring after September 30, 2014 but prior to the release of these financial statements. Based on the results of this review, no subsequent event disclosures or financial statement impacts to the recently completed quarter are required as of the release date.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s discussion and analysis (“MD&A”) reviews significant factors with respect to our financial condition as of September 30, 2014 compared to December 31, 2013 and results of our operations for the three months and nine months ended September 30, 2014 compared to the results of operations for the three months and nine months ended September 30, 2013. The following MD&A concerning our operations is intended to satisfy three principal objectives:
● | Provide a narrative explanation of our financial statements that enables investors to see the company through the eyes of management. | |
● | Enhance the overall financial disclosure and provide the context within which our financial information should be analyzed. | |
● | Provide information about the quality of, and potential variability of, our earnings and cash flow, so that investors can ascertain the likelihood that past performance is, or is not, indicative of future performance. |
Management’s discussion and analysis, like other portions of this Quarterly Report on Form 10-Q, includes forward-looking statements that are provided to assist in the understanding of anticipated future financial performance. However, our anticipated future financial performance involves risks and uncertainties that may cause actual results to differ materially from those described in our forward-looking statements. A cautionary statement regarding forward-looking statements is set forth under the caption “Forward-Looking Statements” in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2013, and, from time to time, in our other filings with the Securities Exchange Commission. We do not intend to update forward-looking statements. This discussion and analysis should be considered in light of that cautionary statement. Additional risk factors relating to an investment in our common stock are also described under Item 1A of the 2013 Annual Report on Form 10-K.
This discussion should be read in conjunction with the consolidated financial statements, notes, tables, and the selected financial data presented elsewhere in this report. All figures are in thousands, except per share data and per employee data.
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EXECUTIVE OVERVIEW
Results of Operations
September 2014 quarterly earnings were $1.08 per share on net income of $1,782 compared to earnings of $.01 per share on net income of $13 during the September 2013 quarter in which a $3,340 pre-tax credit write-down related to customer loan fraud was recognized. Earnings during the nine months ended September 30, 2014 were $2.80 per share on net income of $4,635 compared to earnings of $1.93 per share on net income of $3,183 during the nine months ended September 30, 2013.
In addition to the large customer fraud credit loss, there were other nonrecurring items that impacted both periods, including merger and conversion related costs incurred on PSB’s purchase of the Northwoods National Bank, Rhinelander, Wisconsin branch of The Baraboo National Bank during 2014. These items are outlined in Table 1 below. As shown in the table, September 2014 quarterly earnings were $1.08 per share on net income of $1,782 compared to 2013 quarterly pro-forma earnings of $1.07 per share on net income of $1,766. September 2014 quarterly earnings were similar to the prior year quarter before the special items as a $312 increase in net interest income offset a $43 increase in credit costs and a $283 increase in operating expense before tax impacts.
Excluding the special items as shown in the table below, earnings for the nine months ended September 30, 2014 would have been $2.94 per share on net income of $4,860 compared to September 2013 year to date earnings of $2.94 per share on net income of $4,863. Compared to the prior year before the special items, a $428 decline in 2014 credit costs, down 44%, and a $418 increase in net interest income and $194 increase in other noninterest income offset a $373 decline in mortgage banking revenue, down 28%, and a $645 increase in operating costs, up 5%, resulting in similar net income levels.
Looking ahead to the December 2014 quarter, earnings are expected to remain similar to those seen during the September 2014 quarter as increasing net interest margin from maturity of high-cost wholesale funding offsets slightly higher operating expenses despite little increase in loans receivable due to low customer loan demand within our markets.
Credit Quality
Total nonperforming assets decreased $523, or 4.3%, during the quarter ended September 2014 to $11,649, compared to $12,172 at June 30, 2014, but increased $1,260, or 12.1%, compared to $10,389 at December 31, 2013. The increase since the beginning of the year was due to placing a $578 single family jumbo residential mortgage (net of a $497 partial charge-off recorded in the September 2014 quarter) and a $944 commercial loan onto nonaccrual status during the nine months ended September 30, 2014. Net charge-offs of loan principal were $645 and $779 during the quarter and nine months ended September 30, 2014, which were .48% and .20% of average loans during the respective periods on an annualized basis.
During the prior year September 2013 quarter, we recorded a $3,340 provision for loan losses due to the write down of a loan to a grain commodities dealer who was discovered to have misrepresented inventory collateral, financial statements, inventory records, and federal warehouse receipts taken as collateral. The entire loan balance was charged-off at that time, and the borrower and its former operation remain under investigation by the authorities. Separate from this loss, there was no provision for loan losses recorded during the September 2013 quarter. We continue to pursue a recovery of this loss through several channels and remains cautiously optimistic concerning potential outcomes. Net charge-offs of loan principal were $514 and $980 during the quarter and nine months ended September 30, 2013 excluding the large grain loss, which represented .40% and .26% of average loans during the respective periods on an annualized basis.
A reduction in total credit costs, including the provision for loan losses and loss on foreclosed assets, has been an important sustainer of income during 2014 offsetting significant declines in mortgage banking revenue. Total credit costs were $541 and $969 (excluding the large grain loss) during the nine months ended September 30, 2014 and 2013, respectively, a reduction of $428, or 44.2% during 2014. At September 30, 2014, the allowance for loan losses was $6,424, or 1.19% of total loans (65% of nonperforming loans), compared to $6,783, or 1.31% of total loans (79% of nonperforming loans) at December 31, 2013.
Despite 2014 recognition of the two new nonperforming credits noted previously, credit conditions represented in the loan portfolio as a whole continue to improve, and credit costs are expected to remain in a similar range during the December 2014 quarter compared to the September 2014 quarter. During the December 2014 quarter, our nonperforming loans may increase $2,845 from the addition of a municipal tax financing district development loan upon restructuring of the debt issue to extend the amortization term. At September 30, 2014, we classified this municipal loan as an impaired but performing loan and maintained no specific reserves applicable to this credit. The credit is expected to remain on accrual status following the restructuring and no principal loss is anticipated.
-31- |
Asset Growth and Liquidity
Total assets were $730,305 at September 30, 2014 compared to $711,541 million at December 31, 2013, up $18,764, or 2.6%, due to an increase in net loans receivable of $23,208, up 4.6%. The loan increase included $18,507 of purchased Northwoods branch loans held at September 30, 2014, plus $4,701 of existing market loan growth year to date, primarily in seasonal usage of commercial lines of credit. In addition to loan growth, a $10,297 increase in investment securities was funded by an $18,705 decline in cash and cash equivalents during the nine months ended September 30, 2014.
Total local deposits increased $28,245 year to date due to $35,341 in purchased Northwoods branch deposits retained at September 30, 2014 (approximately 87% of the original purchased deposits) with other existing market deposits declining $7,096, or 1.4% since December 31, 2013, led by an $11,652 decline in seasonal government tax deposits. In addition to funding loan growth, the increase in total deposits was used to repay $10.4 million of wholesale funding year to date. Wholesale funding (including brokered certificates of deposit, Federal Home Loan Bank advances, and wholesale repurchase agreements) was $98,549 (13.5% of total assets) at September 30, 2014 compared to $108,908 (15.3% of total assets) at December 31, 2013.
During the upcoming December 2014 quarter, total loans receivable are expected to remain stable primarily due to low borrower demand within our markets while seasonal government tax deposits are expected to significantly increase total deposits. However, maturing wholesale funding may be paid down with the increased deposit liquidity, limiting total asset growth during the quarter.
Capital Resources
During the nine months ended September 30, 2014, stockholders’ equity increased $3,855 primarily from $3,971 of retained net income during the period after payment of $664 in shareholder dividends. During the September 2014 quarter, we repurchased 10,000 shares of our common stock at an average cost of $33.23 per share, while no shares were repurchased in the September 2013 quarter. Year to date, 10,000 shares of common stock were repurchased at an average cost of $33.23 per share during 2014 while 10,030 shares were repurchased at an average cost of $26.78 per share during the nine months ended September 30, 2013. We continued our quarterly stock buyback plan during the December 2014 quarter with shares purchased on the open market at prevailing prices as opportunities arise.
Tangible net book value increased to $36.59 per share at September 30, 2014, compared to $34.36 per share at December 31, 2013, an increase of 6.5%. Our stockholders’ equity to assets ratio increased to 8.30% at September 30, 2014 compared to 7.98% at December 31, 2013 due to increased retained earnings with modest asset growth since the beginning of 2014. For regulatory purposes, the $7,732 junior subordinated debentures maturing September 2035 reflected as debt on the Consolidated Balance Sheet are reclassified as Tier 1 regulatory equity capital. We were considered “well capitalized” under banking regulations at September 30, 2014.
New regulatory capital rules applicable to all banks become effective for us beginning January 1, 2015. The new rules expand the number of capital measurements and new minimum ratios over which a bank may pay dividends, repurchase common stock, or pay certain executive compensation. Other changes addressed the amount of capital required on a “risk adjusted” basis for certain assets and other obligations. We expect regulatory capital ratios to be negatively impacted when the changes are fully implemented, but do not expect to issue additional common stock solely to meet the new requirements or that recurring operations or growth potential will be significantly impacted.
We regularly maintain access to wholesale markets to fund loan originations and manage local depositor needs. At September 30, 2014, unused and available wholesale funding was approximately $328,357, or 45% of total assets, compared to $296,590, or 42% of total assets at December 31, 2013. Unused wholesale funding sources include federal funds purchased lines of credit, Federal Reserve Discount Window advances, FHLB advances, brokered and national certificates of deposit, and a holding company correspondent bank line of credit.
Off Balance –Sheet Arrangements and Contractual Obligations
Our largest volume off-balance sheet activity involves our servicing of payments and related collection activities on $276,367 of residential 1 to 4 family mortgages sold to FHLB and FNMA at September 30, 2014 compared to $272,280 at December 31, 2013. At September 30, 2014, we provided a credit enhancement against FHLB loss under five separate “master commitments” associated with 7% of the total serviced principal (down from 9% at December 31, 2013), up to a maximum guarantee of $949 in the aggregate. However, we would incur such loss only if the FHLB first lost $1,456 on this remaining loan pool of $19,652 as part of their “First Loss Account” (discussed here in the aggregate, although the guarantee is applied on an individual master commitment basis). No loans have been sold by us to the FHLB with our credit enhancement since October 2008 and we do not intend to originate future loans with the guarantee.
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All loans sold to FHLB or FNMA in which we retain the loan servicing are subject to underwriting representations and warranties made by us as the originator and we are subject to annual underwriting audits from both entities. Our representations and warranties would allow FHLB or FNMA to require us to repurchase inadequately originated loans for any number of underwriting violations even if we had not provided a credit enhancement on the mortgage. Provision for representation and warranty losses were $23 and $204 during the nine months ended September 30, 2014 and 2013, respectively. We first began to recognize a reserve liability for representation and warranty losses during the quarter ended March 31, 2013 when a provision for representation and warranty losses of $203 was recorded. We maintained a reserve liability for potential future representation and warranty losses of $100 at September 30, 2014 and $108 at December 31, 2013.
We also utilize interest rate swaps to hedge costs associated with certain variable rate debt (notional amount of $7,500 at September 30, 2014) and as a tool for our customers to obtain long-term fixed rate commercial loan financing (offsetting notional amounts of $13,816 at September 30, 2014). These arrangements and related off balance sheet commitments are outlined in Note 9 in the Notes to Consolidated Financial Statements. Aggregate net unrealized losses on fair value of all interest rate swaps determined by offsetting all swap positions were $327 and $438 at September 30, 2014 and December 31, 2013, respectively before tax impacts. Cash held on deposit with swap counterparties against these liabilities totaled $570 at September 30, 2014 and December 31, 2013.
We provide various commitments to extend credit for both commercial and consumer purposes totaling approximately $117 million at September 30, 2014 compared to $119 million at December 31, 2013. These lending commitments are a traditional and customary part of lending operations and many of the commitments are expected to expire without being drawn upon.
RESULTS OF OPERATIONS
Earnings
Quarter ended September 30, 2014 compared to September 30, 2013
September 2014 quarterly earnings were $1.08 per share on net income of $1,782 compared to earnings of $.01 per share on net income of $13 during the September 2013 quarter. Earnings during the September 2013 quarter were reduced a combined $1,753 after tax benefits from the loan provision and subsequent charge-off of a loan to a customer in the grain commodities industry. During the September 2013 quarter, we identified that the customer had misrepresented the amounts and records of collateral securing our loan and the loans of several other unrelated banks, resulting in a large collateral shortfall. Other non-recurring special income and expense items impacted the September 2013 quarter as outlined in Table 1 below. Excluding these special items, September 2014 quarterly net income was $1.08 per share on net income of $1,782 compared to September 2013 pro-forma net income of $1.07 per share on net income of $1,766. Table 2 below outlines key financial performance metrics for five linked quarters ending September 30, 2014.
Looking ahead to the December 2014 quarter, earnings are expected to remain similar to those seen for the September 2013 quarter as increased net interest margin from repayment of high-cost wholesale funding upon maturity will outpace slightly increased operating expense. However, earnings could be challenged by lower mortgage banking income and a decline in loans receivable outstanding due to low borrower demand in our markets.
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Nine months ended September 30, 2014 compared to September 30, 2013
Earnings during the nine months ended September 30, 2014 were $2.80 per share on net income of $4,635 compared to earnings of $1.93 per share on net income of $3,183 during the nine months ended September 30, 2013. Earnings during the year to date periods were impacted by significant non-recurring items as outlined in Table 1 below. Excluding these non-recurring items, pro-forma net income during the nine months ended September 30, 2014 was $2.94 per share on net income of $4,860 compared to pro-forma net income of $2.94 per share on net income of $4,863. Compared to the prior year before the special items, a $428 decline in 2014 credit costs, down 44%, and a $418 increase in net interest income and $194 increase in other noninterest income offset a $373 decline in mortgage banking revenue, down 28%, and a $645 increase in operating costs, up 5%, resulting in similar net income levels.
Table 1: Impact of Special Income and Expense Items on Continuing Operations (a non-GAAP measure)
Three months ended | Nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
($000s, net of income tax effects) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
Net income from recurring operations before credit costs | $ | 1,895 | $ | 1,853 | $ | 5,188 | $ | 5,450 | ||||||||
Less: Credit costs, excluding the grain credit loss | (113 | ) | (87 | ) | (328 | ) | (587 | ) | ||||||||
Net income from recurring operations | 1,782 | 1,766 | 4,860 | 4,863 | ||||||||||||
Less: Grain credit loss | – | (2,031 | ) | – | (2,031 | ) | ||||||||||
Add: Reduced employee benefits related to the grain credit loss | – | 278 | – | 27 8 | ||||||||||||
Add: Benefit from amendment of Marathon tax returns | – | – | – | 73 | ||||||||||||
Less: Merger related expenses and data processing conversion | – | – | (225 | ) | – | |||||||||||
Net income | $ | 1,782 | $ | 13 | $ | 4,635 | $ | 3,183 |
Three months ended | Nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
(per diluted share, net of income tax effects) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
Net income from recurring operations before credit costs | $ | 1.15 | $ | 1.12 | $ | 3.14 | $ | 3.30 | ||||||||
Less: Credit costs, excluding the grain credit loss | (0.07 | ) | (0.05 | ) | (0.20 | ) | (0.36 | ) | ||||||||
Net income from recurring operations | 1.08 | 1.07 | 2.94 | 2.94 | ||||||||||||
Less: Grain credit loss | – | (1.23 | ) | – | (1.23 | ) | ||||||||||
Add: Reduced employee benefits related to grain credit loss | – | 0.17 | – | 0.17 | ||||||||||||
Add: Benefit from amendment of Marathon tax returns | – | – | – | 0.05 | ||||||||||||
Less: Merger related expenses and data processing conversion | – | – | (0.14 | ) | – | |||||||||||
Net income | $ | 1.08 | $ | 0.01 | $ | 2.80 | $ | 1.93 |
Proforma return on average assets and return on average equity from net income from recurring operations after credit costs:
Proforma return on average assets from recurring operations | 0.97 | % | 1.01 | % | 0.91 | % | 0.94 | % | ||||||||
Return on average assets - as reported | 0.97 | % | 0.01 | % | 0.87 | % | 0.62 | % | ||||||||
Proforma return on average equity from recurring operations | 11.77 | % | 12.31 | % | 11.00 | % | 11.52 | % | ||||||||
Return on average equity - as reported | 11.77 | % | 0.09 | % | 10.49 | % | 7.54 | % |
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The following Table 2 presents PSB’s consolidated quarterly summary financial data.
Table 2: Financial Summary
(dollars in thousands, except per share data) | Quarter ended | |||||||||||||||||||
September 30, | June 30 | March 31, | December 31, | September 30, | ||||||||||||||||
Earnings and dividends: | 2014 | 2014 | 2014 | 2013 | 2013 | |||||||||||||||
Net interest income | $ | 5,734 | $ | 5,450 | $ | 5,174 | $ | 5,365 | $ | 5,422 | ||||||||||
Provision for loan losses | $ | 140 | $ | 140 | $ | 140 | $ | – | $ | 3,340 | ||||||||||
Other noninterest income | $ | 1,481 | $ | 1,369 | $ | 1,320 | $ | 1,274 | $ | 1,411 | ||||||||||
Other noninterest expense | $ | 4,461 | $ | 4,666 | $ | 4,289 | $ | 4,391 | $ | 3,817 | ||||||||||
Net income | $ | 1,782 | $ | 1,403 | $ | 1,450 | $ | 1,561 | $ | 13 | ||||||||||
Basic earnings per share(3) | $ | 1.08 | $ | 0.85 | $ | 0.87 | $ | 0.95 | $ | 0.01 | ||||||||||
Diluted earnings per share(3) | $ | 1.08 | $ | 0.85 | $ | 0.87 | $ | 0.95 | $ | 0.01 | ||||||||||
Dividends declared per share(3) | $ | – | $ | 0.40 | $ | – | $ | 0.39 | $ | – | ||||||||||
Tangible net book value per share(4) | $ | 36.59 | $ | 35.56 | $ | 35.15 | $ | 34.36 | $ | 33.92 | ||||||||||
Semi-annual dividend payout ratio | n/a | 23.34 | % | n/a | 40.91 | % | n/a | |||||||||||||
Average common shares outstanding | 1,650,716 | 1,658,157 | 1,658,017 | 1,651,518 | 1,651,518 | |||||||||||||||
Balance sheet – average balances: | ||||||||||||||||||||
Loans receivable, net of allowances for loss | $ | 528,420 | $ | 513,163 | $ | 498,957 | $ | 507,898 | $ | 510,937 | ||||||||||
Assets | $ | 727,738 | $ | 716,477 | $ | 698,127 | $ | 704,559 | $ | 695,344 | ||||||||||
Deposits | $ | 598,845 | $ | 592,377 | $ | 567,500 | $ | 557,639 | $ | 537,836 | ||||||||||
Stockholders’ equity | $ | 60,080 | $ | 59,424 | $ | 57,710 | $ | 57,243 | $ | 56,907 | ||||||||||
Performance ratios: | ||||||||||||||||||||
Return on average assets(1) | 0.97 | % | 0.79 | % | 0.84 | % | 0.88 | % | 0.01 | % | ||||||||||
Return on average stockholders’ equity(1) | 11.77 | % | 9.47 | % | 10.19 | % | 10.82 | % | 0.09 | % | ||||||||||
Average stockholders’ equity less accumulated other comprehensive income (loss) to average assets | 8.20 | % | 8.24 | % | 8.22 | % | 8.07 | % | 8.09 | % | ||||||||||
Net loan charge-offs to average loans(1) | 0.48 | % | 0.07 | % | 0.03 | % | 0.27 | % | 2.97 | % | ||||||||||
Nonperforming loans to gross loans | 1.84 | % | 2.06 | % | 1.75 | % | 1.67 | % | 1.66 | % | ||||||||||
Allowance for loan losses to gross loans | 1.19 | % | 1.31 | % | 1.39 | % | 1.31 | % | 1.36 | % | ||||||||||
Nonperforming assets to tangible equity plus the allowance for loan losses(4) | 17.92 | % | 18.96 | % | 16.27 | % | 16.80 | % | 16.73 | % | ||||||||||
Net interest rate margin(1)(2) | 3.43 | % | 3.34 | % | 3.31 | % | 3.32 | % | 3.40 | % | ||||||||||
Net interest rate spread(1)(2) | 3.28 | % | 3.19 | % | 3.15 | % | 3.14 | % | 3.23 | % | ||||||||||
Service fee revenue as a percent of average demand deposits(1) | 1.72 | % | 1.83 | % | 1.68 | % | 1.76 | % | 2.01 | % | ||||||||||
Noninterest income as a percent of gross revenue | 17.81 | % | 17.14 | % | 17.09 | % | 15.92 | % | 17.24 | % | ||||||||||
Efficiency ratio(2) | 59.91 | % | 66.19 | % | 63.75 | % | 63.87 | % | 53.94 | % | ||||||||||
Noninterest expenses to average assets(1) | 2.43 | % | 2.61 | % | 2.49 | % | 2.47 | % | 2.18 | % | ||||||||||
Stock price information: | ||||||||||||||||||||
High | $ | 34.00 | $ | 33.85 | $ | 34.50 | $ | 31.25 | $ | 31.50 | ||||||||||
Low | $ | 32.25 | $ | 31.75 | $ | 30.10 | $ | 29.75 | $ | 29.40 | ||||||||||
Last trade value at quarter-end | $ | 33.80 | $ | 32.42 | $ | 32.00 | $ | 31.25 | $ | 29.76 |
(1)Annualized
(2)The yield on tax-exempt loans and securities is computed on a tax-equivalent basis using a tax rate of 34%.
(3)Due to rounding, cumulative quarterly per share performance may not equal annual per share totals.
(4)Tangible stockholders’ equity excludes intangible assets and any preferred stock capital elements.
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Net Interest Income
Quarter ended September 30, 2014 compared to September 30, 2013
Net interest income is the most significant component of earnings. Tax adjusted net interest income totaled $5,965 (on net margin of 3.43%) during the September 30, 2014 quarter compared to $5,666 (3.40%) in the September 2013 quarter, an increase of $299, or 5.3%. Net interest income increased over the prior year quarter as average earnings assets increased 4.5% primarily from loans acquired in the purchase of the Northwoods National Bank, Rhinelander, Wisconsin branch during the June 2014 quarter. In addition, maturity of high-cost FHLB advances since the September 2013 quarter has reduced advance interest expense, which declined $205, or 63%, during the September 2014 quarter compared to the prior year quarter. Refer to Table 3 for more information on average balances, rates, and yields by product for the quarters ended September 30, 2014 and 2013.
Looking ahead, net margin is expected to increase slightly during the December 2014 quarter as continued interest expense savings on maturing high-cost wholesale funding outpace a slight decline in loan yield. However, loan growth is expected to slow, resulting in December 2014 quarterly tax adjusted net interest margin similar to that seen during the September 2014 quarter.
During the September 2014 and September 2013 quarters, net interest margin benefited from interest rate floors on certain commercial-related loans and retail residential home equity lines of credit. At September 30, 2014, the coupon rate on approximately $72 million, or 13.3%, of gross disbursed loans at September 30, 2014 was supported by an average interest rate floor approximately 103 basis points greater than the normal adjustable rate. If current interest rate levels were assumed to remain the same, the annualized increase to net interest income and net interest margin was approximately $738 and .11%, respectively, based on those existing loan floors and average total earning assets during the quarter ended September 30, 2014. During a period of rising short-term interest rates, we expect average funding costs (which are not currently subject to contractual caps on the interest rate) to rise while the yield on loans with interest rate floors would remain the same until those loans’ adjustable rate index caused coupon rates to exceed the loan rate floor. For these particular loans, the speed in which short-term interest rates increase is expected to have a significant impact on net interest income from loans with interest rate floors. Quickly rising short-term rates would allow adjustable rate loans with floors to reprice to rates higher than the existing floor more quickly, impacting net interest income less adversely than if short-term rates rose slowly or deliberately.
At September 30, 2013, the coupon rate on approximately $80 million, or 15.2%, of gross loans at September 30, 2013 was supported by an average interest rate floor approximately 117 basis points greater than the normal adjustable rate. The annualized increase to net interest income and net interest margin was approximately $937 and .14%, respectively, based on those existing loan floors and average total earning assets during the quarter ended September 30, 2013.
Nine months ended September 30, 2014 compared to September 30, 2013
Tax adjusted net interest income totaled $17,053 (on net margin of 3.36%) during the nine months ended September 30, 2014 compared to $16,672 (3.39%) in the nine months ended September 30, 2013, an increase of $381, or 2.3%. As in the September 2014 quarter discussed above, maturity of high-cost funding during 2014 has reduced FHLB advance interest expense, supporting the increase in net interest income. FHLB advance interest expense totaled $534 during the nine months ended September 30, 2014 compared to $977 during the prior year period, down $443, or 45%. Net margin has declined slightly from the prior year period as loan yields have declined slightly faster than funding costs, which are already near functional interest rate floors. A 3.2% increase in earning assets increased net interest income by $979 during the 2014 year to date compared to the nine months ended September 30, 2013, but the decline in net interest margin decreased net interest income by $598 during the nine months ended September 30, 2014 compared to the prior year period. Refer to Table 4 for more information on average balances, rates, and yields by product for the nine months ended September 30, 2014 and 2013.
The following Tables present a schedule of yields and costs for the quarter and nine months ended September 30, 2014, compared to the prior year periods ended September 30, 2013, and the interest income and expense volume and rate analysis for the nine months ended September 30, 2014, compared to the nine months ended September 30, 2013.
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Table 3: Net Interest Income Analysis (Quarter)
(dollars in thousands) | Quarter ended September 30, 2014 | Quarter ended September 30, 2013 | ||||||||||||||||||||||
Average | Yield/ | Average | Yield/ | |||||||||||||||||||||
Balance | Interest | Rate | Balance | Interest | Rate | |||||||||||||||||||
Assets | ||||||||||||||||||||||||
Interest-earning assets: | ||||||||||||||||||||||||
Loans(1)(2) | $ | 535,375 | $ | 5,858 | 4.34 | % | $ | 518,504 | $ | 5,912 | 4.52 | % | ||||||||||||
Taxable securities | 90,321 | 617 | 2.71 | % | 77,961 | 509 | 2.59 | % | ||||||||||||||||
Tax-exempt securities(2) | 53,579 | 571 | 4.23 | % | 54,636 | 580 | 4.21 | % | ||||||||||||||||
FHLB stock | 2,556 | 4 | 0.62 | % | 3,594 | 2 | 0.22 | % | ||||||||||||||||
Other | 8,208 | 14 | 0.68 | % | 5,869 | 13 | 0.88 | % | ||||||||||||||||
Total(2) | 690,039 | 7,064 | 4.06 | % | 660,564 | 7,016 | 4.21 | % | ||||||||||||||||
Non-interest-earning assets: | ||||||||||||||||||||||||
Cash and due from banks | 11,098 | 10,912 | ||||||||||||||||||||||
Premises and equipment, net | 11,037 | 9,786 | ||||||||||||||||||||||
Cash surrender value insurance | 13,064 | 12,350 | ||||||||||||||||||||||
Other assets | 9,455 | 9,299 | ||||||||||||||||||||||
Allowance for loan losses | (6,955 | ) | (7,567 | ) | ||||||||||||||||||||
Total | $ | 727,738 | $ | 695,344 | ||||||||||||||||||||
Liabilities and stockholders’ equity | ||||||||||||||||||||||||
Interest-bearing liabilities: | ||||||||||||||||||||||||
Savings and demand deposits | $ | 178,271 | $ | 70 | 0.16 | % | $ | 168,860 | $ | 89 | 0.21 | % | ||||||||||||
Money market deposits | 138,485 | 86 | 0.25 | % | 121,267 | 100 | 0.33 | % | ||||||||||||||||
Time deposits | 178,841 | 547 | 1.21 | % | 164,441 | 549 | 1.32 | % | ||||||||||||||||
FHLB borrowings | 30,529 | 118 | 1.53 | % | 59,537 | 323 | 2.15 | % | ||||||||||||||||
Other borrowings | 19,962 | 154 | 3.06 | % | 22,797 | 165 | 2.87 | % | ||||||||||||||||
Senior subordinated notes | 4,000 | 38 | 3.77 | % | 4,000 | 38 | 3.77 | % | ||||||||||||||||
Junior subordinated debentures | 7,732 | 86 | 4.41 | % | 7,732 | 86 | 4.41 | % | ||||||||||||||||
Total | 557,820 | 1,099 | 0.78 | % | 548,634 | 1,350 | 0.98 | % | ||||||||||||||||
Non-interest-bearing liabilities: | ||||||||||||||||||||||||
Demand deposits | 103,248 | 83,268 | ||||||||||||||||||||||
Other liabilities | 6,590 | 6,535 | ||||||||||||||||||||||
Stockholders’ equity | 60,080 | 56,907 | ||||||||||||||||||||||
Total | $ | 727,738 | $ | 695,344 | ||||||||||||||||||||
Net interest income | $ | 5,965 | $ | 5,666 | ||||||||||||||||||||
Rate spread | 3.28 | % | 3.23 | % | ||||||||||||||||||||
Net yield on interest-earning assets | 3.43 | % | 3.40 | % |
(1)Nonaccrual loans are included in the daily average loan balances outstanding.
(2)The yield on tax-exempt loans and securities is computed on a tax-equivalent basis using a tax rate of 34%.
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Table 4: Net Interest Income Analysis (Nine months)
(dollars in thousands) | Nine months ended September 30, 2014 | Nine months ended September 30, 2013 | ||||||||||||||||||||||
Average | Yield/ | Average | Yield/ | |||||||||||||||||||||
Balance | Interest | Rate | Balance | Interest | Rate | |||||||||||||||||||
Assets | ||||||||||||||||||||||||
Interest-earning assets: | ||||||||||||||||||||||||
Loans(1)(2) | $ | 520,556 | $ | 16,997 | 4.37 | % | $ | 506,241 | $ | 17,481 | 4.62 | % | ||||||||||||
Taxable securities | 87,021 | 1,779 | 2.73 | % | 84,426 | 1,566 | 2.48 | % | ||||||||||||||||
Tax-exempt securities(2) | 53,986 | 1,715 | 4.25 | % | 53,314 | 1,717 | 4.31 | % | ||||||||||||||||
FHLB stock | 2,556 | 10 | 0.52 | % | 3,189 | 6 | 0.25 | % | ||||||||||||||||
Other | 13,982 | 50 | 0.48 | % | 9,631 | 50 | 0.69 | % | ||||||||||||||||
Total(2) | 678,101 | 20,551 | 4.05 | % | 656,801 | 20,820 | 4.24 | % | ||||||||||||||||
Non-interest-earning assets: | ||||||||||||||||||||||||
Cash and due from banks | 10,202 | 10,147 | ||||||||||||||||||||||
Premises and equipment, net | 10,462 | 10,009 | ||||||||||||||||||||||
Cash surrender value insurance | 12,964 | 12,087 | ||||||||||||||||||||||
Other assets | 9,428 | 9,632 | ||||||||||||||||||||||
Allowance for loan losses | (6,935 | ) | (7,529 | ) | ||||||||||||||||||||
Total | $ | 714,222 | $ | 691,147 | ||||||||||||||||||||
Liabilities and stockholders’ equity | ||||||||||||||||||||||||
Interest-bearing liabilities: | ||||||||||||||||||||||||
Savings and demand deposits | $ | 179,884 | $ | 225 | 0.17 | % | $ | 173,931 | $ | 295 | 0.23 | % | ||||||||||||
Money market deposits | 140,185 | 282 | 0.27 | % | 119,489 | 299 | 0.33 | % | ||||||||||||||||
Time deposits | 172,516 | 1,625 | 1.26 | % | 162,314 | 1,685 | 1.39 | % | ||||||||||||||||
FHLB borrowings | 30,358 | 534 | 2.35 | % | 58,923 | 977 | 2.22 | % | ||||||||||||||||
Other borrowings | 20,348 | 464 | 3.05 | % | 22,368 | 490 | 2.93 | % | ||||||||||||||||
Senior subordinated notes | 4,000 | 113 | 3.78 | % | 4,750 | 147 | 4.14 | % | ||||||||||||||||
Junior subordinated debentures | 7,732 | 255 | 4.41 | % | 7,732 | 255 | 4.41 | % | ||||||||||||||||
Total | 555,023 | 3,498 | 0.84 | % | 549,507 | 4,148 | 1.01 | % | ||||||||||||||||
Non-interest-bearing liabilities: | ||||||||||||||||||||||||
Demand deposits | 93,822 | 79,146 | ||||||||||||||||||||||
Other liabilities | 6,321 | 6,042 | ||||||||||||||||||||||
Stockholders’ equity | 59,056 | 56,452 | ||||||||||||||||||||||
Total | $ | 714,222 | $ | 691,147 | ||||||||||||||||||||
Net interest income | $ | 17,053 | $ | 16,672 | ||||||||||||||||||||
Rate spread | 3.21 | % | 3.23 | % | ||||||||||||||||||||
Net yield on interest-earning assets | 3.36 | % | 3.39 | % |
(1) | Nonaccrual loans are included in the daily average loan balances outstanding. |
(2) | The yield on tax-exempt loans and securities is computed on a tax-equivalent basis using a tax rate of 34%. |
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Table 5: Interest Expense and Expense Volume and Rate Analysis (Year to Date)
Nine months ended September 30, 2014
2014 compared to 2013 | ||||||||||||
increase (decrease) due to (1) | ||||||||||||
(dollars in thousands) | Volume | Rate | Net | |||||||||
Interest earned on: | ||||||||||||
Loans(2) | $ | 468 | $ | (952 | ) | $ | (484 | ) | ||||
Taxable securities | 53 | 160 | 213 | |||||||||
Tax-exempt securities(2) | 21 | (23 | ) | (2 | ) | |||||||
FHLB stock | (2 | ) | 6 | 4 | ||||||||
Other interest income | 16 | (16 | ) | – | ||||||||
Total | 556 | (825 | ) | (269 | ) | |||||||
Interest paid on: | ||||||||||||
Savings and demand deposits | 8 | (78 | ) | (70 | ) | |||||||
Money market deposits | 42 | (59 | ) | (17 | ) | |||||||
Time deposits | 96 | (156 | ) | (60 | ) | |||||||
FHLB borrowings | (502 | ) | 59 | (443 | ) | |||||||
Other borrowings | (46 | ) | 20 | (26 | ) | |||||||
Senior subordinated notes | (21 | ) | (13 | ) | (34 | ) | ||||||
Junior subordinated debentures | – | – | – | |||||||||
Total | (423 | ) | (227 | ) | (650 | ) | ||||||
Net interest earnings | $ | 979 | $ | (598 | ) | $ | 381 |
(1) | The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. |
(2) | The yield on tax-exempt loans and investment securities has been adjusted to its fully taxable equivalent using a 34% tax rate. |
Interest Rate Sensitivity
We incur market risk primarily from interest-rate risk inherent in our lending and deposit taking activities. Market risk is the risk of loss from adverse changes in market prices and rates. We actively monitor and manage our interest-rate risk exposure. The measurement of the market risk associated with financial instruments (such as loans and deposits) is meaningful only when all related and offsetting on- and off-balance sheet transactions are aggregated, and the resulting net positions are identified. Disclosures about the fair value of financial instruments that reflect changes in market prices and rates can be found in Note 15 of the Notes to Consolidated Financial Statements.
Our primary objective in managing interest-rate risk is to minimize the adverse impact of changes in interest rates on net interest income and capital, while adjusting the asset-liability structure to obtain the maximum yield-cost spread on that structure. We rely primarily on our asset-liability structure reflected on the Consolidated Balance Sheets to control interest-rate risk. In general, longer-term earning assets are funded by shorter-term funding sources allowing us to earn net interest income on both the credit risk taken on assets and the yield curve of market interest rates. In general, a sudden and substantial change in interest rates could adversely impact earnings, to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis. We do not engage in significant trading activities to enhance earnings or for hedging purposes.
Our overall strategy is to coordinate the volume of rate sensitive assets and liabilities to minimize the impact of interest rate movement on the net interest margin. The following Table represents our earnings sensitivity to changes in interest rates at September 30, 2014. It is a static indicator which does not reflect various repricing characteristics and may not indicate the sensitivity of net interest income in a changing interest rate environment, particularly during periods when the interest yield curve is flattening or steepening. The following repricing methodologies should be noted:
1. | Public or government fund MMDA and NOW accounts are considered fully repriced within 60 days. Higher yielding retail and non-governmental money market and NOW deposit accounts are considered fully repriced within 90 days. Rewards Checking NOW accounts and other money market deposit accounts are considered fully repriced within one year. Other NOW and savings accounts are considered “core” deposits as they are generally insensitive to interest rate changes. These core deposits are generally considered to reprice beyond five years. |
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2. | Nonaccrual loans are considered to reprice beyond 5 years. |
3. | Assets and liabilities with contractual calls or prepayment options are repriced according to the likelihood of the call or prepayment being exercised in the current interest rate environment. |
4. | Measurements taking into account the impact of rising or falling interest rates are based on a parallel yield curve change that is fully implemented within a 12-month time horizon. |
5. | Bank owned life insurance is considered to reprice beyond 5 years. |
The gap analysis reflects a liability sensitive gap position during the next year, with a cumulative negative one-year gap ratio at September 30, 2014 of 93.0% compared to a negative gap of 85.4% at December 31, 2013. In general, a current negative gap would be favorable in a falling interest rate environment but unfavorable in a rising rate environment. However, net interest income is impacted not only by the timing of product repricing, but the extent of the change in pricing which could be severely limited from local competitive pressures. If we held an asset sensitive gap position, the existence of our “in the money” floating rate loan floors discussed previously could also lessen the impact of an asset sensitive gap position in a rising interest rate environment. These factors can result in change to net interest income from changing interest rates different than expected from review of the gap table.
Table 6: Interest Rate Sensitivity Gap Analysis
September 30, 2014 | ||||||||||||||||||||||||||||
(dollars in thousands) | 0-90 Days | 91-180 days | 181-365 days | 1-2 yrs. | 2-5 yrs. | Beyond 5 yrs. | Total | |||||||||||||||||||||
Earning assets: | ||||||||||||||||||||||||||||
Loans | $ | 194,245 | $ | 36,261 | $ | 66,966 | $ | 85,172 | $ | 117,367 | $ | 40,500 | $ | 540,511 | ||||||||||||||
Securities | 7,598 | 5,721 | 9,425 | 21,044 | 52,356 | 47,432 | 143,576 | |||||||||||||||||||||
FHLB stock | 2,556 | 2,556 | ||||||||||||||||||||||||||
CSV bank-owned life insurance | 13,127 | 13,127 | ||||||||||||||||||||||||||
Other earning assets | 2,993 | 1,192 | 2,232 | 6,417 | ||||||||||||||||||||||||
Total | $ | 204,836 | $ | 43,174 | $ | 78,623 | $ | 106,216 | $ | 169,723 | $ | 103,615 | $ | 706,187 | ||||||||||||||
Cumulative rate sensitive assets | $ | 204,836 | $ | 248,010 | $ | 326,633 | $ | 432,849 | $ | 602,572 | $ | 706,187 | ||||||||||||||||
Interest-bearing liabilities | ||||||||||||||||||||||||||||
Interest-bearing deposits | $ | 87,486 | $ | 21,417 | $ | 202,410 | $ | 28,280 | $ | 53,532 | $ | 99,755 | $ | 492,880 | ||||||||||||||
FHLB advances | 26,540 | 4,832 | 31,372 | |||||||||||||||||||||||||
Other borrowings | 12,711 | 5,500 | 18,211 | |||||||||||||||||||||||||
Senior subordinated notes | 500 | 1,000 | 2,500 | 4,000 | ||||||||||||||||||||||||
Junior subordinated debentures | 7,732 | 7,732 | ||||||||||||||||||||||||||
Total | $ | 126,737 | $ | 21,417 | $ | 202,910 | $ | 29,280 | $ | 74,096 | $ | 99,755 | $ | 554,195 | ||||||||||||||
Cumulative interest sensitive liabilities | $ | 126,737 | $ | 148,154 | $ | 351,064 | $ | 380,344 | $ | 454,440 | $ | 554,195 | ||||||||||||||||
Interest sensitivity gap for the individual period | $ | 78,099 | $ | 21,757 | $ | (124,287 | ) | $ | 76,936 | $ | 95,627 | $ | 3,860 | |||||||||||||||
Ratio of rate sensitive assets to rate sensitive liabilities for the individual period | 161.6 | % | 201.6 | % | 38.7 | % | 362.8 | % | 229.1 | % | 103.9 | % | ||||||||||||||||
Cumulative interest sensitivity gap | $ | 78,099 | $ | 99,856 | $ | (24,431 | ) | $ | 52,505 | $ | 148,132 | $ | 151,992 | |||||||||||||||
Cumulative ratio of rate sensitive assets to rate sensitive liabilities | 161.6 | % | 167.4 | % | 93.0 | % | 113.8 | % | 132.6 | % | 127.4 | % |
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We use financial modeling techniques that measure interest rate risk. These policies are intended to limit exposure of earnings to risk. A formal liquidity contingency plan exists that directs management to the least expensive liquidity sources to fund sudden and unanticipated liquidity needs. We also use various policy measures to assess interest rate risk as described below.
We balance the need for liquidity with the opportunity for increased net interest income available from longer term loans held for investment and securities. To measure the impact on net interest income from interest rate changes, we model interest rate simulations on a quarterly basis. Our policy is that projected net interest income over the next 12 months will not be reduced by more than 15% given a change in interest rates of up to 200 basis points. The following table presents the projected impact to net interest income by certain rate change scenarios and the change to the one year cumulative ratio of rate sensitive assets to rate sensitive liabilities.
Table 7: Net Interest Margin Rate Simulation Impacts
Period Ended: | September 2014 | December 2013 | September 2013 | |||||||||
Cumulative 1 year gap ratio | ||||||||||||
Base | 93 | % | 85 | % | 82 | % | ||||||
Up 200 | 89 | % | 82 | % | 78 | % | ||||||
Down 100 | 94 | % | 87 | % | 84 | % | ||||||
Change in Net Interest Income – Year 1 | ||||||||||||
Up 200 during the year | -4.2 | % | -2.8 | % | -2.4 | % | ||||||
Down 100 during the year | -0.4 | % | -0.1 | % | 0.1 | % | ||||||
Change in Net Interest Income – Year 2 | ||||||||||||
No rate change (base case) | -0.8 | % | -0.8 | % | 1.6 | % | ||||||
Following up 200 in year 1 | -3.2 | % | -0.2 | % | 0.1 | % | ||||||
Following down 100 in year 1 | -4.7 | % | -2.4 | % | -1.1 | % |
Note: Simulations since June 2008 reflect net interest income changes from a down 100 basis point scenario, rather than a down 200 basis point scenario as dictated by internal policy due to the currently low level of relative short-term rates.
We completed a non-maturity deposit study following March 31, 2014 and used the current report findings to update certain key assumptions beginning with our June 30, 2014 interest margin simulations. The findings called for slightly higher average rate change (beta) in rising rate simulations (which would increase projected interest rate risk) as well as extending the projected average life of core deposits under normal operations based on historical experience (which would decrease projected interest rate risk). The increase in non-maturity deposit beta rates in a rising rate environment lowered projected net interest income in the up 200 basis point increase simulations as shown in Table 7 above when comparing September 2014 to the prior quarters before the key assumption change made effective June 30, 2014.
To assess whether interest rate sensitivity beyond one year helps mitigate or exacerbate the short-term rate sensitive position, a quarterly measure of core funding utilization is made. Core funding is defined as liabilities with a maturity in excess of 60 months and stockholders’ equity capital. Core deposits including DDA, lower yielding NOW, and non-maturity savings accounts (not including high yield NOW such as Rewards Checking deposits and money market accounts) are also considered core long-term funding sources. The core funding utilization ratio is defined as assets that reprice in excess of 60 months divided by core funding. Our target for the core funding utilization ratio is to remain at 80% or below given the same 200 basis point changes in rates that apply to the guidelines for interest rate risk limits exposure described previously. Our core funding utilization ratio after a projected 200 basis point increase in rates was 50.8% at September 30, 2014 compared to 53.8% at December 31, 2013.
We also measure internal interest rate simulations that project interest rate changes that maintain the current shape of the yield curve (often referred to as “parallel yield curve shifts”) as well as rising rate environments that create a “flattening” yield curve. We also project the potential impacts of extreme periods of interest rate changes such as up 400 basis points during a 24 month period. The impact of various rate simulations on projected “base” net interest income are shown in the Table below. When the yield curve flattens, repriced short-term funding cost, such as for terms of one year or less increases, while maturing fixed rate balloon loans, such as with terms from 3 to 5 years, increase much less. During flattening periods, assets and liabilities may reprice at the same time but to a much different extent. In addition, although market expectations are for interest rates to rise during the next several years, we also have risk to a prolonged period of low or falling rates in the currently low rate environment. If interest rates remain low, loan and security yields continue to decline while funding costs reach effective lows, reducing net interest margin, particularly if average credit spreads were to decline to levels seen prior to 2008 (pre-recessionary levels).
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The table below summarizes the percentage change to current “base case” net interest income as a result of certain alternative interest simulations:
Table 8: Projected Changes to Net Interest Income Under Various Rate Change Simulations
During next 12M | During next 24M Parallel | During next 24M | Yield Curve | |||||||||||||
Down 100 bp | up 400 bp | Flat up 500 bp | Twist* | |||||||||||||
Year 1 | -0.4 | % | -4.0 | % | -5.0 | % | 1.1 | % | ||||||||
Year 2 | -3.9 | % | -5.5 | % | -7.8 | % | 3.4 | % | ||||||||
Year 3 | -7.6 | % | 0.7 | % | -1.4 | % | -3.6 | % | ||||||||
Year 4 | -10.4 | % | 15.6 | % | 14.8 | % | 5.5 | % | ||||||||
Year 5 | -11.9 | % | 31.9 | % | 33.7 | % | 22.0 | % |
*Yield curve steepens over the first 18 months of the simulation (10 year CMT Treasury = 3.75%) and flattens over months 19-36 to the average slope from 2005-2007 (with Fed Funds targeted at 4.00%)
Noninterest Income
Quarter ended September 30, 2014 compared to September 30, 2013
Total noninterest income for the quarter ended September 30, 2014 was $1,481, compared to $1,411 earned during the September 2013 quarter, an increase of $70, or 5.0%. Mortgage banking revenue was $375 during the September 2014 quarter compared to $384 during the September 2013 quarter. Mortgage banking includes the gain on sale of residential mortgage loans to secondary market investors as well as the net loan servicing income associated with those loans. The increase in quarterly noninterest income was led by small increases in service fees and other noninterest income.
Nine months ended September 30, 2014 compared to September 30, 2013
Total noninterest income for the nine months ended September 30, 2014 was $4,170, compared to $4,349 during the comparable year period, down $179, or 4.1%, as residential mortgage banking declined $373, or 27.9%. Gain on sale of mortgage loans has led the decline in mortgage banking revenue on significantly lower residential loan refinance activity due to an increase in long term interest rates in response to expected actions by the Federal Reserve. Offsetting the year to date mortgage banking decline were higher service fees, up $53, and higher debit and credit card interchange income, up $142. During December 2013, PSB sold its credit card loan principal portfolio in exchange for greater interchange fee income on those retained credit card customers, accounting for 62% of the increased interchange income during the nine months ended September 30, 2014. Prior to the sale of the credit card portfolio, card income was categorized as loan interest income.
Noninterest Expense
Quarter ended September 30, 2014 compared to September 30, 2013
Noninterest expenses totaled $4,461 during the September 2014 quarter compared to $3,817 during the September 2013 quarter. However, September 2013 noninterest expense would have been $4,131 before a $458 reduction to employee incentive benefits on recognition of the large grain charge-off and the loss on foreclosed assets. Excluding these items from both quarters, noninterest expenses increased $283, or 6.9%, during the September 2014 quarter compared to the comparable prior year period. The majority of the 2014 cost increase was due to higher direct operating costs allocated to the new Northwoods branch totaling $118, a $54 increase in data processing fees, a $45 increase in FDIC insurance premiums from impacts of the large September 2013 grain loan charge-off and deposit growth, and a $58 increase in audit and exam charges.
Nine months ended September 30, 2014 compared to September 30, 2013
During the nine months ended September 30, 2014, noninterest expense totaled $13,416 compared to $12,115 during the prior year period. However, both periods included special items including $371 of nonrecurring Northwoods Rhinelander merger and conversion costs during 2014 and a $458 reduction in employee incentive costs during 2014 on recognition of the large gain loss. Excluding the proforma impact of these items as well as the loss on foreclosed assets, noninterest expense during the nine months ended September 30, 2014 would have been $12,924 compared to $12,279 during 2013, an increase of $645, or 5.3%. Approximately $207 of the increase was from recurring Northwoods branch wage and other direct operating costs following the acquisition. Separate from Northwoods wage costs, proforma salaries and employee benefits increased an additional $141, or 2.0%. Data processing and office operations costs increased $105 (excluding the Northwoods branch acquisition conversion and operating costs) and FDIC insurance premiums increased $113 related to the grain loan charge-off and increased deposits. All other net operating expense increases totaled $79.
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CREDIT QUALITY AND PROVISION FOR LOAN LOSSES
The loan portfolio is our primary asset subject to credit risk. Our process for monitoring credit risk includes quarterly analysis of loan quality, delinquencies, nonperforming assets, and potential problem loans. Loans are placed on a nonaccrual status when they become contractually past due 90 days or more as to interest or principal payments. All interest accrued but not collected for loans (including applicable impaired loans) that are placed on nonaccrual status or charged off is reversed against interest income. Nonaccrual loans and restructured loans maintained on accrual status remain classified as nonperforming loans until the uncertainty surrounding the credit is eliminated. In general, uncertainty surrounding the credit is eliminated when the borrower has displayed a history of regular loan payments using a market interest rate that is expected to continue as if a typical performing loan. Some borrowers continue to make loan payments while maintained on non-accrual status. We apply all payments received on nonaccrual loans to principal until the loan is returned to accrual status or repaid. Total nonperforming assets as a percentage of total tangible common equity including the allowance for loan losses was 17.92%, 16.80%, and 16.73% at September 30, 2014, December 31, 2013, and September 30, 2013, respectively (refer to Table 25). For the purpose of this measurement, tangible common equity is equal to total common stockholders’ equity less mortgage servicing right assets, goodwill, and core deposit intangible assets.
Nonperforming assets include: (1) loans that are either contractually past due 90 days or more as to interest or principal payments, on a nonaccrual status, or the terms of which have been renegotiated to provide a reduction or deferral of interest or principal (restructured loans), (2) investment securities in default as to principal or interest, and (3) foreclosed assets.
Table 9: Nonperforming Assets
September 30, | December 31, | |||||||||||
(dollars in thousands) | 2014 | 2013 | 2013 | |||||||||
Nonaccrual loans (excluding restructured loans) | $ | 4,192 | $ | 4,063 | $ | 3,704 | ||||||
Nonaccrual restructured loans | 4,343 | 2,973 | 3,636 | |||||||||
Restructured loans not on nonaccrual | 1,390 | 1,643 | 1,299 | |||||||||
Accruing loans past due 90 days or more | – | – | – | |||||||||
Total nonperforming loans | 9,925 | 8,679 | 8,639 | |||||||||
Foreclosed assets | 1,724 | 1,606 | 1,750 | |||||||||
Total nonperforming assets | $ | 11,649 | $ | 10,285 | $ | 10,389 | ||||||
Nonperforming loans as a % of gross loans receivable | 1.84 | % | 1.66 | % | 1.67 | % | ||||||
Total nonperforming assets as a % of total assets | 1.60 | % | 1.46 | % | 1.46 | % | ||||||
Allowance for loan losses as a % of nonperforming loans | 64.73 | % | 82.11 | % | 78.52 | % |
Total nonperforming assets decreased $523, or 4.3%, during the quarter ended September 2014 to $11,649, compared to $12,172 at June 30, 2014, but increased $1,260, or 12.1%, compared to $10,389 at December 31, 2013. The increase since the beginning of the year was due to placing a $1,075 single family jumbo residential mortgage and a $959 commercial loan onto nonaccrual status during the June 2014 quarter. Recognition of the two problem loans also increased allowance for loan loss needs during the nine months ended September 30, 2014 by $909. Offsetting these significant new problem loans was continued improvement in general loan quality and collateral values on certain impaired loans, allowing a portion of the existing allowance for loan losses to be recaptured, offsetting the negative impact of new reserves recognized on the two problem loans. At September 30, 2014, the allowance for loan losses was $6,424, or 1.19% of total loans (65% of nonperforming loans), compared to $6,783, or 1.31% of total loans (79% of nonperforming loans) at December 31, 2013.
The $1,075 single family residential jumbo mortgage loan became 30 to 59 days delinquent during the March 2014 quarter and was classified as an impaired, but performing loan at March 31, 2014. During the June 2014 quarter, the borrower was placed on nonaccrual status due to nonpayment, and the loan continues to be classified as a nonaccrual loan at September 30, 2014. The borrower is disputing a potential change in ownership of the home via divorce proceedings. This mortgage is significantly under collateralized although the borrower continues income levels sufficient to service the required debt payments. During the September 2014 quarter, we recorded a $497 partial charge-off of the loan reflecting the collateral shortfall. Refer to Table 10 below for more information on this loan relationship and specific reserves maintained on this nonaccrual loan. During the nine months ended September 30, 2014, total past due residential - prime loans increased $575, to $1,366, compared to $791 at December 31, 2013, as shown in Note 4 of the Notes to Consolidated Financial Statements. This remaining $578 nonaccrual jumbo mortgage loan, net of the $497 partial charge off, represents virtually all of the increase in delinquent residential –prime mortgage principal during the nine months ended September 30, 2014.
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Separately, a commercial and industrial loan relationship that includes a significant government agency guarantee of principal became past due during the March 2014 quarter but was classified as a performing loan and credit risk rating 5 (“Watch”) as of March 31, 2014. This borrower was negatively impacted by loss of a large customer during 2013 that has resulted in strained cash flow. The full borrower relationship includes loans receivable totaling $3,464 at September 30, 2014, of which $2,520 carries an 80% principal guarantee by the United States Department of Agriculture (“USDA”). During the June 2014 quarter, the unguaranteed portion of this loan was restructured to convert to interest only payments and was reclassified as a nonaccrual loan, which has a balance of $944 at September 30, 2014. The guaranteed portion of the loan totaling $2,520 was not restructured and continues to be classified as an impaired but performing loan at September 30, 2014. Refer to Table 10 below for more information on this loan relationship and specific reserves maintained on this nonaccrual loan.
While the general credit quality of our loan portfolio and identified problem loans continues to improve, improved local economic conditions are slow growing in central and northern Wisconsin, and during the past several years, large local employers in the paper manufacturing, window manufacturing, and insurance claim processing industries announced plant closures, job reductions, or loss of key customer contracts. Our market area has a higher than typical allocation of resources in the manufacturing sector, although the greatest economic growth for many years has been in health and education services. The local paper and wood industries had, and continue to experience, a long-term production decline. The local retail sales environment also declined during 2013 as J.C. Penney Company, Inc., Gap, Inc., and Abercrombie & Fitch, Co. brand Hollister announced store closures within our primary markets.
We expect these conditions to restrain economic growth as some borrowers continue to carefully manage cash flows and debt servicing ability. In addition, the loss of the significant employers mentioned previously may have a significant negative impact on small local municipalities that depended on these closed manufacturing plants for tax assessment base and utility revenue. At September 30, 2014, $2,845 of tax exempt general obligation and tax incremental financing district development loans receivable reflected in Table 12 with a local municipality expected to be significantly negatively impacted due to a plant closure were classified as performing, but impaired loans with no specific reserve. We expect to restructure this loan to extend the life of the tax incremental financing district so that existing property tax collections from real estate located within the district continue for a period long enough to fully pay the original district development costs. This debt restructuring is expected to be classified as a troubled debt restructuring, which would increase non performing loans in Table 9.
Nonperforming loans are reviewed to determine exposure for potential loss within each loan category. The adequacy of the allowance for loan losses is assessed based on credit quality and other pertinent loan portfolio information. The adequacy of the allowance and the provision for loan losses is consistent with the composition of the loan portfolio and recent internal credit quality assessments. We maintain our headquarters and one branch location in the City of Wausau, Wisconsin, and maintain the majority of our deposits (including five of our nine locations), and loan customers in Marathon County, Wisconsin. The significant majority of our customers and borrowers live and work in Marathon, Oneida, and Vilas Counties, Wisconsin, in which we have branch locations. The unemployment rate (not seasonally adjusted) in the Wausau-Marathon County, Wisconsin MSA was 4.9% at August 2014 (the most recent data available) compared to 6.3% at August 2013. The unemployment rate in Oneida County, Wisconsin was 5.7% at August 2014 compared to 6.9% at August 2013. The unemployment rate in Vilas County, Wisconsin was 5.7% at August 2014 compared to 7.1% at August 2013. The unemployment rate for all of Wisconsin (not seasonally adjusted) was 5.1% at August 2014 compared to 6.4% at August 2013. A local economic outlook survey of business owners for our market area published in the December 2013 quarter points to expectations of an improving local economy with some businesses considering a local capital expansion, although an overall economic rebound was considered further out in the future towards the end of 2014.
At September 30, 2014, all nonperforming assets aggregating to $500 or more measured by gross principal outstanding per credit relationship are summarized in the following table and represented 30% of all nonperforming assets compared to 20% of nonperforming assets at December 31, 2013. In the table, loans presented as “Accrual TDR” represent troubled debt restructured loans maintained on accrual status. During the nine months ended September 30, 2014, there were two loans added to the large nonperforming assets table, including the $944 unguaranteed portion of a USDA guaranteed loan and the $578 residential jumbo mortgage loan, discussed previously.
Table 10: Largest Nonperforming Assets at September 30, 2014 ($000s)
Gross | Specific | |||||||||
Collateral Description | Asset Type | Principal | Reserves | |||||||
Timber byproduct processing equipment and receivables | Nonaccrual | $ | 944 | $ | 355 | |||||
Non-owner occupied light manufacturing facility real estate | Nonaccrual | 695 | 195 | |||||||
Owner occupied commercial office and residential rentals | Nonaccrual | 691 | 137 | |||||||
Owner occupied multi-use, multi-tenant professional building | Nonaccrual | 610 | 77 | |||||||
Single family residential home first mortgage | Nonaccrual | 578 | 31 | |||||||
Total listed nonperforming assets | $ | 3,518 | $ | 795 | ||||||
Total bank wide nonperforming assets | $ | 11,649 | $ | 2,074 | ||||||
Listed assets as a % of total nonperforming assets | 30 | % | 38 | % |
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Table 11: Largest Nonperforming Assets at December 31, 2013 ($000s)
Collateral Description | Asset Type | Gross Principal | Specific Reserves | |||||||
Non-owner occupied light manufacturing facility real estate | Nonaccrual | $ | 731 | $ | 304 | |||||
Owner occupied multi use, multi-tenant professional building | Nonaccrual | 658 | 107 | |||||||
Owner occupied commercial office and residential rentals | Nonaccrual | 642 | 51 | |||||||
Total listed nonperforming assets | $ | 2,031 | $ | 462 | ||||||
Total bank wide nonperforming assets | $ | 10,389 | $ | 1,936 | ||||||
Listed assets as a percent of total nonperforming assets | 20 | % | 24 | % |
In addition to nonperforming loans, we have classified certain performing loans as impaired loans under accounting standards due to heightened risk of nonperformance within the next year or other factors. In general, loans not classified as nonaccrual or restructured may be classified as impaired due to elevated potential credit risk but still be considered performing. At September 30, 2014, all impaired but performing loans aggregating to $500 or more measured by gross principal outstanding per credit relationship are summarized in the following table. During the June 2014 quarter, a new $2,520 commercial loan guaranteed by the USDA as discussed previously was added to the large impaired loan list, as shown in the table below.
Table 12: Largest Performing, but Impaired Loans at September 30, 2014 ($000s)
Gross | Specific | |||||||||
Collateral Description | Asset Type | Principal | Reserves | |||||||
Municipal tax incremental financing district (TID) debt issue | Impaired | $ | 2,845 | $ | – | |||||
Timber byproduct processing real estate and transportation equipment | Impaired | 2,520 | 26 | |||||||
Owner occupied light manufacturing facility and equipment | Impaired | 1,688 | – | |||||||
Owner occupied cabinetry contractor real estate and equipment | Impaired | 752 | – | |||||||
Total listed performing, but impaired loans | $ | 7,805 | $ | 26 | ||||||
Total performing, but impaired loans | $ | 9,415 | $ | 209 | ||||||
Listed assets as a % of total performing, but impaired loans | 83 | % | 12 | % |
Table 13: Largest Performing, but Impaired Loans at December 31, 2013 ($000s)
Collateral Description | Asset Type | Gross Principal | Specific Reserves | |||||||
Municipal tax incremental financing district (TID) debt issue | Impaired | $ | 3,090 | $ | – | |||||
Owner occupied light manufacturing facility and equipment | Impaired | 1,725 | – | |||||||
Owner occupied cabinetry contractor real estate and equipment | Impaired | 700 | – | |||||||
Total listed performing, but impaired loans | $ | 5,515 | $ | – | ||||||
Total performing, but impaired loans | $ | 7,136 | $ | 172 | ||||||
Listed assets as a percent of total performing, but impaired loans | 77 | % | 0 | % |
Provision for Loan Losses and Loss of Foreclosed Assets
We determine the adequacy of the provision for loan losses based on past loan loss experience, current economic conditions, and composition of the loan portfolio. Accordingly, the amount charged to expense is based on management’s evaluation of the loan portfolio. It is our policy that when available information confirms that specific loans, or portions thereof, including impaired loans, are uncollectible, these amounts are promptly charged off against the allowance.
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Comparison of the provision for loan losses and loss on foreclosed assets during the quarter and nine months ended September 30, 2014 compared to the prior year periods must recognize that we recorded a $3,340 provision for loan losses during the September 2013 quarter due to the write down of a loan to a grain commodities dealer. This credit loss resulted from an apparent customer fraud associated with pledges of single party grain inventory represented by federal warehouse receipts or other inventory records to multiple parties as collateral and misrepresented inventory records and financial statements. The borrower and its prior operations remain under investigation by the authorities. We continue to pursue all available channels for recovery of a portion of the credit loss and are cautiously optimistic concerning some amount of future recovery, although the timing and amount of such recovery are still uncertain.
We had a lending relationship with the borrower for several years, dating back to 2008. Our monitoring of the loan relationship included weekly debtor’s certificates demonstrating weekly collateral position of the bank’s loans. In addition, as grain was sold and proceeds came to reduce the bank’s loan balance, we normally would re-advance on the revolving lines of credit based on new collateral pledged (federal warehouse receipts and contracts for sale of grain pledged to bank). The loans had performed as required from the origination date until August 2013 when the misrepresentation was uncovered. Three other unrelated banks were also involved in the collateral based financing arrangement. During 2013, we initiated a review to identify other unrelated credits with similar risk characteristics that could lead to similar losses. The review did not identify other credits with similar risk factors and this large grain loss was considered to be an unusual and non-recurring loss not representative of portfolio credit risk a whole.
Due to improving general credit trends within its portfolio and a slowly improving local economy, our provision for loan losses during the quarter and nine months ended September 30, 2014 respectively was $140 and $420, an increase from $0 recorded for the September 2013 quarter but a decline from $675 recorded during the nine months ended September 30, 2013, when the large grain loss is excluded from both prior year periods. A reduction in total credit costs, including the provision for loan losses and loss on foreclosed assets, has been an important sustainer of income during 2014 offsetting significant declines in mortgage banking revenue. Total credit costs were $187 and $144 during the quarters ended September 30, 2014 and 2013 excluding the large grain loss. Likewise, total credit costs were $541 and $969 during the nine months ended September 30, 2014 and 2013, respectively, a reduction of $428, or 44.2% excluding the grain loss At September 30, 2014, the allowance for loan losses was $6,424, or 1.19% of total loans (65% of nonperforming loans), compared to $6,783, or 1.31% of total loans (79% of nonperforming loans) at December 31, 2013.
Provision for loan losses during the December 2014 quarter is expected to remain similar to that recorded for the prior quarters during 2014. Future provisions are also impacted by the actual amount of newly impaired and other problem loans identified by internal procedures or regulatory agencies which are not yet known.
Table 14: Allowance for Loan Losses
Three months ended | Nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
(dollars in thousands) | 2014 | 2013 | 2014 | 2013 | ||||||||||||
Allowance for loan losses at beginning | $ | 6,929 | $ | 7,640 | $ | 6,783 | $ | 7,431 | ||||||||
Provision for loan losses | 140 | 3,340 | 420 | 4,015 | ||||||||||||
Recoveries on loans previously charged-off | 19 | 32 | 31 | 46 | ||||||||||||
Loans charged off | (664 | ) | (3,886 | ) | (810 | ) | (4,366 | ) | ||||||||
Allowance for loan losses at end | $ | 6,424 | $ | 7,126 | $ | 6,424 | $ | 7,126 |
Net loan charge-offs totaled $645 during the September 2014 quarter (.48% of average loans on an annualized basis) compared to $3,854 during the September 2013 quarter (2.97% of average loans). September 2013 quarterly net charge-offs would have been $514, or .40% of average annualized loans if the $3,340 large grain loss charge-off was excluded. Net loan charge-offs totaled $779 during the nine months ended September 30, 2014 (.20% of average loans) compared to $4,320 during the nine months ended September 30, 2013 (1.14% of average loans). Net charge-offs during the nine months ended September 30, 2013 would have been $980, or .26% of average loans had the large grain loss charge-off been excluded.
The largest loan charge-off during the nine months ended September 2014 was the $497 partial charge-off of the residential jumbo mortgage loan recorded in the September 2014 quarter previously discussed, which represented 64% of all 2014 net loan charge-offs. The largest charge-off during the nine months ended September 30, 2013 was the large grain loss charge-off, which was 77% of all charge-offs during the period.
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ASSET GROWTH AND LIQUIDITY
Balance Sheet Changes and Analysis
Total assets were $730,305 at September 30, 2014 compared to $711,541 million at December 31, 2013, up $18,764, or 2.6%, due to an increase in net loans receivable of $23,208, up 4.6%. The loan increase included $18,507 of purchased Northwoods branch loans held at September 30, 2014, plus $4,701 of existing market loan growth year to date, primarily in seasonal usage of commercial lines of credit. In addition to loan growth, a $10,297 increase in investment securities was funded by an $18,705 decline in cash and cash equivalents during the nine months ended September 30, 2014.
Total local deposits increased $28,245 year to date due to $35,341 in purchased Northwoods branch deposits retained at September 30, 2014 (approximately 87% of the original purchased deposits) with other existing market deposits declining $7,096, or 1.4% since December 31, 2013, led by an $11,652 decline in seasonal government tax deposits. In addition to funding loan growth, the increase in total deposits was used to repay $10.4 million of wholesale funding year to date. Wholesale funding (including brokered certificates of deposit, Federal Home Loan Bank advances, and wholesale repurchase agreements) was $98,549 (13.5% of total assets) at September 30, 2014 compared to $108,908 (15.3% of total assets) at December 31, 2013.
During the upcoming December 2014 quarter, total loans receivable are expected to remain stable primarily due to low borrower demand within our markets while seasonal government tax deposits are expected to significantly increase total deposits. However, maturing wholesale funding may be paid down with the increased deposit liquidity, limiting total asset growth during the quarter.
Changes in assets during the three months and nine months ended September 30, 2014 are listed in Table 15 below.
Table 15: Change in Balance Sheet Assets Composition
Three months ended | Nine months ended | |||||||||||||||
Increase (decrease) in assets ($000s) | September 30, 2014 | September 30, 2014 | ||||||||||||||
$ | % | $ | % | |||||||||||||
Commercial, industrial and agricultural loans | $ | 11,006 | 8.6 | % | $ | 8,779 | 6.7 | % | ||||||||
Commercial real estate mortgage loans | 1,162 | 0.5 | % | 4,167 | 1.9 | % | ||||||||||
Other assets (various categories) | 953 | 4.4 | % | 855 | 4.0 | % | ||||||||||
Premises and equipment, net | (60 | ) | -0.5 | % | 1,312 | 13.6 | % | |||||||||
Bank certificates of deposit | (248 | ) | -6.8 | % | 1,188 | 53.1 | % | |||||||||
Residential real estate mortgage and home equity loans | (271 | ) | -0.2 | % | 10,871 | 6.9 | % | |||||||||
Investment securities | (665 | ) | -0.5 | % | 10,297 | 7.7 | % | |||||||||
Cash and cash equivalents | (8,113 | ) | -38.8 | % | (18,705 | ) | -59.3 | % | ||||||||
Total increase (decrease) in assets | $ | 3,764 | 0.5 | % | $ | 18,764 | 2.6 | % |
A significant portion of the increase in loans during the nine months ended September 30, 2014 came from the acquisition of the Northwoods Rhinelander branch, which at September 30, 2014 had increased commercial real estate mortgages by $7,072 (170% of the year to date increase), increased residential real estate mortgages and related loans by $10,304 (95% of the year to date increase), and increased commercial and related loans by $909 (10% of the year to date increase).
During the nine months ended September 30, 2014, the increase in investment securities included an additional $10,357 investment in federal agency issued residential mortgage backed securities purchased at a slight discount to par value with a weighted average purchased yield of 2.80% and an expected average principal life of 5.4 years under current interest rate levels. These securities are subject to extension of principal payments in a rising rate scenario with average principal life increasing up to 7.2 years in connection with a significant increase in interest rates such as the 10 year U.S. Treasury rate. Total remaining net book value of these securities was $9,860 at September 30, 2014. The majority of the purchased mortgage backed securities were represented by fully amortizing 15 year residential mortgage collateral. While the purchase is expected to increase 2014 net income by approximately $40 per quarter, the purchase was made with existing overnight funds and slightly increased our interest rate risk position in future years.
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Changes in net assets during the three months and six months ended September 30, 2014, impacted funding sources as listed in Table 16 below.
Table 16: Change in Balance Sheet Liabilities and Equity Composition
Three months ended | Nine months ended | |||||||||||||||
Increase (decrease) in liabilities and equity ($000s) | September 30, 2014 | September 30, 2014 | ||||||||||||||
$ | % | $ | % | |||||||||||||
Core deposits (including MMDA) | $ | 8,424 | 1.7 | % | $ | 23,357 | 4.9 | % | ||||||||
FHLB advances | 3,493 | 12.5 | % | (6,677 | ) | -17.5 | % | |||||||||
Stockholders’ equity | 1,327 | 2.2 | % | 3,855 | 6.8 | % | ||||||||||
Senior subordinated notes | – | 0.0 | % | – | 0.0 | % | ||||||||||
Other liabilities and debt (various categories) | (445 | ) | -3.1 | % | (747 | ) | -5.1 | % | ||||||||
Wholesale and national deposits | (1,748 | ) | -3.2 | % | (3,682 | ) | -6.4 | % | ||||||||
Retail certificates of deposit > $100 | (2,939 | ) | -5.4 | % | 4,888 | 10.5 | % | |||||||||
Other borrowings | (4,348 | ) | -19.3 | % | (2,230 | ) | -10.9 | % | ||||||||
Total increase (decrease) in liabilities and stockholders’ equity | $ | 3,764 | 0.5 | % | $ | 18,764 | 2.6 | % |
Loans Receivable
Table 17: Period-End Loan Composition
September 30, | September 30, | December 31, 2013 | ||||||||||||||||||||||
Dollars | Dollars | Percentage of total | Percentage | |||||||||||||||||||||
(dollars in thousands) | 2014 | 2013 | 2014 | 2013 | Dollars | of total | ||||||||||||||||||
Commercial, industrial and agricultural | $ | 138,999 | $ | 143,396 | 25.7 | % | 27.3 | % | $ | 130,220 | 25.2 | % | ||||||||||||
Commercial real estate mortgage | 228,766 | 220,592 | 42.3 | % | 42.0 | % | 224,599 | 43.5 | % | |||||||||||||||
Residential real estate mortgage | 144,729 | 135,353 | 26.8 | % | 25.8 | % | 137,600 | 26.6 | % | |||||||||||||||
Residential real estate loans held for sale | 999 | 824 | 0.2 | % | 0.2 | % | 150 | 0.0 | % | |||||||||||||||
Consumer home equity | 23,570 | 20,346 | 4.4 | % | 3.9 | % | 20,677 | 4.0 | % | |||||||||||||||
Consumer and installment | 3,448 | 4,312 | 0.6 | % | 0.8 | % | 3,567 | 0.7 | % | |||||||||||||||
Totals | $ | 540,511 | $ | 524,823 | 100.0 | % | 100.0 | % | $ | 516,813 | 100.0 | % |
Loans held for investment continue to consist primarily of commercial related loans, including commercial and industrial and commercial real estate loans, representing 68% of total loans as shown in the Table above at September 30, 2014 and 69% of total loans at December 31, 2013. Refer to Note 4 of the Notes to Consolidated Financial Statements for more information on the composition of loans at period-end.
Following a March 2014 quarter characterized by a $19,565 decline in commercial related loans receivable, total loans increased $33,530 (6.8%) during the June 2014 quarter, including $21,468 of purchased Northwoods Rhinelander loans and $12,062 of organic market growth. During the linked quarter ended September 30, 2014, total loans increased an additional $11,758 from local organic growth. Factors contributing to the organic loan balance changes during the nine months ended September 30, 2014 are listed below:
● | Commercial real estate loans declined $8,288 during the March 2014 quarter from the refinance of a multi-family housing development loan with a national lender at low long-term fixed interest rates. We continue to serve as the lender for this developer during the construction and development periods and continue to have ongoing lending relationships for this purpose totaling $3,005 at September 30, 2014. | |
● | At September 30, 2014, we had $48.5 million of combined line of credit commitments to our seven largest line of credit customers. Most of these lines are used to manage seasonal business factors and fluctuate in balance during the year. During the March 2014 quarter, these seven customer reduced their lines balances by $4,663, but increased line usage by $1,834 during the June 2014 quarter and by $7,035 during the September 2014 quarter. Year to date, usage of these large lines of credit is up $4,206 since December 31, 2013 and totaled $20,803 at September 30, 2014. We expect these customers to repay their increased line balances during the normal course of business during the coming months, negatively impacting December 2014 quarterly loan growth. |
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● | During the nine months ended September 30, 2014 total participation loans purchased decreased $4,332, from $27,404 at December 31, 2013 to $23,072 at September 30, 2014. At the beginning of 2014, participation purchased loans included $5,547 of purchased loans from a Wisconsin community bank lead lender collateralized by out of state mobile home park real estate. During the March 2014 quarter, this position declined $2,130 when the loan was refinanced with another lender on a long-term basis. During the June and September 2014 quarters, we repurchased a total of $3,176 of similar loans from the same Wisconsin lender. Together, during the nine months ended September 30, 2014, this position in mobile home park purchased real estate loans increased $1,078, to $6,625 held at September 30, 2014. The $5,410 decline in other participations purchased occurred during the September 2014 quarter as we were repaid those balances from various community bank lead lenders. |
● | During the September quarter, we originated a $4,600 commercial real estate loan to an existing borrower for retail sales business expansion into the Madison, Wisconsin market. |
● | Separate from the purchased Northwoods Rhinelander branch loans and the other loan changes discussed above, all other loans increased $6,000 during the nine months ended September 30, 2014 primarily from commercial related lending activity for a variety of factors. |
During the upcoming December 2014 quarter, we expect loan balances to remain flat or decline as seasonal lines of credit are repaid and local loan demand remains weak.
Competition from larger banks in our markets is strong as such banks with higher capital levels and substantial excess deposits look to lending for higher yielding assets as investment security returns remain very low. Banks including BMO Harris Bank (having the largest deposit market share in our markets), U.S. Bank, and Associated Bank aggressively pursue high credit quality borrowers with low lending interest rate spreads in an effort to aggressively increase their loan market share. We expect strong competition to continue during the next several quarters which could impact the pace of future loan growth and could negatively impact net interest margin and net interest income. Certain lenders within our markets appear to have relaxed their credit standards to support loan growth, including not requiring borrower guarantees on commercial purpose loans, and the offering of original principal amortization periods in excess of 20 years. We have not made changes to our credit standards during 2014 to stimulate loan growth, although from time to time we may extend original commercial real estate amortization periods as long as 25 years on a case by case basis. In addition, to support loan growth, we may seek to increase purchased loan participations from other banks in Wisconsin during 2014 and 2015.
Deposits and Wholesale Funding Sources
Liquidity refers to the ability to generate adequate amounts of cash to meet our need for cash at a reasonable cost. We manage our liquidity to provide adequate funds to support borrowing needs and deposit flow of our customers. We also view liquidity as the ability to raise cash at a reasonable cost or with a minimum of loss and as a measure of balance sheet flexibility to react to marketplace, regulatory, and competitive changes. Retail and local deposits and repurchase agreements are the primary source of funding. Retail and local deposits and repurchase agreements were 75.7% of total assets at September 30, 2014, compared to 73.9% of total assets at December 31, 2013 and 70.0% of total assets at September 30, 2013. This percentage increased compared to the prior year periods due to the purchase of the Northwoods Rhinelander branch deposits in April 2014 as well as continued pay down of wholesale funding.
Table 18: Period-end Deposit Composition
September 30, | December 31, | |||||||||||||||||||||||
(dollars in thousands) | 2014 | 2013 | 2013 | |||||||||||||||||||||
$ | % | $ | % | $ | % | |||||||||||||||||||
Non-interest bearing demand | $ | 109,197 | 18.1 | % | $ | 92,141 | 16.6 | % | $ | 102,644 | 17.8 | % | ||||||||||||
Interest-bearing demand and savings | 178,090 | 29.7 | % | 167,631 | 30.2 | % | 176,427 | 30.5 | % | |||||||||||||||
Money market deposits | 137,312 | 22.8 | % | 125,508 | 22.6 | % | 136,797 | 23.7 | % | |||||||||||||||
Retail and local time deposits less than $100 | 72,523 | 12.0 | % | 57,584 | 10.4 | % | 57,897 | 10.0 | % | |||||||||||||||
Total core deposits | 497,122 | 82.6 | % | 442,864 | 79.8 | % | 473,765 | 82.0 | % | |||||||||||||||
Retail and local time deposits $100 and over | 51,278 | 8.5 | % | 45,686 | 8.3 | % | 46,390 | 8.1 | % | |||||||||||||||
Broker and national time deposits less than $100 | 198 | 0.0 | % | 542 | 0.1 | % | 542 | 0.1 | % | |||||||||||||||
Broker and national time deposits $100 and over | 53,479 | 8.9 | % | 65,147 | 11.8 | % | 56,817 | 9.8 | % | |||||||||||||||
Totals | $ | 602,077 | 100.0 | % | $ | 554,239 | 100.0 | % | $ | 577,514 | 100.0 | % |
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Total deposits increased $24,563, or 4.3%, to $602,077 at September 30, 2014 compared to $577,514 at December 31, 2013. The majority of the increase was from the purchase of the Northwoods Rhinelander branch, which included $35,341 of deposits at September 30, 2014. Other deposits declined $10,778, or 1.9% of total deposits at September 30, 2014 compared to December 31, 2013. The decline included a $3,682 reduction in brokered and national certificates of deposit, and a $7,096 decline in local deposits. The local deposit decline was led by a reduction of $11,652 in seasonal municipal tax deposits since December 31, 2013.
Wholesale funding often carries higher interest rates than local core deposit funding, so loan growth supported by wholesale funds can generate lower net interest spreads than loan growth supported by local funds. However, wholesale funds provide us the ability to quickly raise large funding blocks and to match loan terms to minimize interest rate risk and avoid the higher incremental cost to existing deposits from simply increasing retail rates to raise local deposits. Rates paid on local deposits are significantly impacted by competitor interest rates and the local economy’s ability to grow in a way that supports the deposit needs of all local financial institutions. Current brokered certificate of deposit rates available to us are often less costly to us than equivalent local deposits due to very low rates of return available on the most conservative fixed income investments and as national wholesale funds place a premium on FDIC insurance available on their large deposit when placed with brokers. Consequently, local certificate of deposit rates in many markets are priced higher than equivalent wholesale brokered deposits due to a limited supply of retail deposits. We expect this difference in pricing between wholesale and local certificates of deposit to be removed by the wholesale funding market as the banking industry is considered to be well capitalized and regains consistent profits. An improving national economy will likely increase wholesale rates relative to local core deposit rates which could increase the volatility of our interest expense due to a significant portion of our funding coming from wholesale sources.
Our internal policy is to limit broker and national time deposits (not including CDARS) to 20% of total assets. Broker and national deposits as a percentage of total assets were 7.4%, 8.1%, and 9.3% at September 30, 2014, December 31, 2013, and September 30, 2013, respectively. Limited loan growth and the purchase of the Northwoods Rhinelander branch during April 2014 have provided local deposits used to regularly repay maturing brokered deposits and other wholesale funding for the past several quarters, reducing the ratio of brokered deposits to total assets. During the December quarter, increased seasonal municipal tax deposits will likely be used to repay maturing wholesale funds, decreasing wholesale fund as a percent of total assets at December 31, 2014. Beyond the use of brokered and national time deposits, secondary wholesale sources also include federal funds purchased, FHLB advances, Federal Reserve Discount Window advances, and pledging of investment securities against wholesale repurchase agreements.
Table 19: Summary of Balance by Significant Deposit Source
September 30, | December 31, | |||||||||||
(dollars in thousands) | 2014 | 2013 | 2013 | |||||||||
Total time deposits $100 and over | $ | 104,757 | $ | 110,833 | $ | 103,207 | ||||||
Total broker and national deposits | 53,677 | 65,689 | 57,359 | |||||||||
Total retail and local time deposits | 123,801 | 103,270 | 104,287 | |||||||||
Core deposits, including money market deposits | 497,122 | 442,864 | 473,765 |
Table 20: September 30, 2014 Change in Deposit Balance since Period Ended:
September 30, 2013 | December 31, 2013 | |||||||||||||||
(dollars in thousands) | $ | % | $ | % | ||||||||||||
Total time deposits $100 and over | $ | (6,076 | ) | -5.5 | % | $ | 1,550 | 1.5 | % | |||||||
Total broker and national deposits | (12,012 | ) | -18.3 | % | (3,682 | ) | -6.4 | % | ||||||||
Total retail and local time deposits | 20,531 | 19.9 | % | 19,514 | 18.7 | % | ||||||||||
Core deposits, including money market deposits | 54,258 | 12.3 | % | 23,357 | 4.9 | % |
As a supplement to local deposits, we use short-term and long-term funding sources other than retail deposits including federal funds purchased from other correspondent banks, advances from the FHLB, use of wholesale and national time deposits, advances taken from the Federal Reserve’s Discount Window, and repurchase agreements from security pledging. Table 21 below outlines the available and unused portion of these funding sources (based on collateral and/or company policy limitations) as of September 30, 2014 and December 31, 2013. Currently unused but available funding sources at September 30, 2014 are considered sufficient to fund anticipated asset growth and meet contingency funding needs during the next several quarters. We also maintain formal policies to address liquidity contingency needs and to manage a liquidity crisis. The following Table 21 provides a summary of how the wholesale funding sources normally available to us would be impacted by various operating conditions.
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Table 21: Environmental Impacts on Availability of Wholesale Funding Sources:
Normal | Moderately | Highly | ||||
Operating | Stressed | Stressed | ||||
Environment | Environment | Environment | ||||
Repurchase Agreements | Yes | Likely* | Not Likely | |||
FHLB (primary 1-4 REM collateral) | Yes | Yes* | Less Likely* | |||
FHLB (secondary loan collateral) | Yes | Likely* | Not Likely | |||
Brokered CDs | Yes | Likely* | Not Likely | |||
National CDs | Yes | Likely* | Not Likely | |||
Federal Funds Lines | Yes | Less Likely* | Not Likely | |||
FRB (Borrow-In-Custody) | Yes | Yes | Less Likely* | |||
FRB (Discount Window securities) | Yes | Yes | Yes | |||
Holding Company line of credit | Yes | Yes | Less Likely* |
* May be available but subject to restrictions
Table 22 summarizes the availability of various wholesale funding sources at September 30, 2014, and December 31, 2013.
Table 22: Available but Unused Funding Sources other than Retail Deposits
September 30, 2014 | December 31, 2013 | |||||||||||||||
Unused, but | Amount | Unused, but | Amount | |||||||||||||
(dollars in thousands) | Available | Used | Available | Used | ||||||||||||
Overnight federal funds purchased | $ | 28,000 | $ | – | $ | 28,000 | $ | – | ||||||||
Federal Reserve discount window advances | 84,243 | – | 89,875 | – | ||||||||||||
FHLB advances under blanket mortgage lien | 72,012 | 31,372 | 54,944 | 38,049 | ||||||||||||
Repurchase agreements and other FHLB advances | 48,718 | 17,711 | 35,822 | 20,441 | ||||||||||||
Wholesale and national deposits | 92,384 | 53,677 | 84,949 | 57,359 | ||||||||||||
Holding company secured line of credit | 3,000 | – | 3,000 | – | ||||||||||||
Totals | $ | 328,357 | $ | 102,760 | $ | 296,590 | $ | 115,849 | ||||||||
Funding as a percent of total assets | 45.0 | % | 14.1 | % | 41.7 | % | 16.3 | % | ||||||||
Percentage of gross available funding used at period-end | n/a | 23.8 | % | n/a | 28.1 | % |
The following discussion examines each of the available but unused funding sources listed in the table above and the factors that may directly or indirectly influence the timing or the amount ultimately available to us.
September 30, 2014 compared to December 31, 2013
Overnight federal funds purchased
Our maximum federal funds purchased availability totals $28,000 from three correspondent banks. The most significant portion of the total is $15,000 from our primary correspondent bank, Bankers’ Bank located in Madison, Wisconsin. We make regular use of the Bankers’ Bank line as part of our normal daily cash settlement procedures, but rarely have used the lines offered by the other two correspondent banks. Federal funds must be repaid each day and borrowings may be renewed for up to 14 consecutive business days. To unilaterally draw on the existing federal funds line, we need to maintain a “composite ratio” as defined by Bankers’ Bank of 40% or less. Bankers’ Bank defines the composite ratio to be nonaccrual loans and foreclosed assets divided by tangible capital including the allowance for loan losses calculated at our subsidiary bank level. Due to existence of the composite ratio, an increase in nonaccrual loans or foreclosed assets could impact availability of the line or subject us to further review. In addition, a rising composite ratio could cause our other two correspondent banks to reconsider their federal funds line with us since they do not also serve as our primary correspondent bank. Our subsidiary bank’s composite ratio was approximately 14% at September 30, 2014 and 13% at December 31, 2013, and less than the 40% benchmark used by Bankers’ Bank.
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Federal Reserve discount window advances
We have a $100,000 line of credit with the Federal Reserve Discount Window supported by both commercial and commercial real estate collateral provided to the Federal Reserve under their Borrower in Custody (“BIC”) program. At September 30, 2014 and December 31, 2013, the annualized interest rate applicable to Discount Window advances was .75%. Under the BIC program, we provide a monthly listing of detailed loan information on the loans provided as collateral. We are subject to annual review and certification by the Federal Reserve to retain participation in the program. The Discount Window represents the primary source of liquidity on a daily basis following our federal funds purchased lines of credit discussed above. We were limited to a maximum advance of $84,243 at September 30, 2014 compared to $89,875 at December 31, 2013 based on the BIC loan collateral pledged. Discount Window advances must be repaid or renewed each day. No Discount Window advances were used during the nine months ended September 30, 2014 or during 2013.
Only performing loans are permitted as collateral under the BIC and each individual loan is subject to a haircut to collateral value based on the Federal Reserve’s review of the listing each month. In general, approximately 70% to 75% of the loan principal offered as collateral is able to support Discount Window advances. Similar to the federal funds purchased lines of credit, an increase in nonperforming loans would decrease the amount of collateral available for Discount Window advances.
Federal Home Loan Bank (FHLB) advances under blanket mortgage lien and other FHLB advances
We maintain an available line of credit with the FHLB of Chicago based on a pledge of 1 to 4 family mortgage loan collateral, both first and secondary lien positions. We may borrow on the line to the lesser of the blanket mortgage lien collateral provided, or 20 times our existing FHLB capital stock investment. Based on our existing $2,556 capital stock investment, total FHLB advances in excess of $51,124 require us to purchase additional FHLB stock equal to 5% of the advance amount. At September 30, 2014, $19,752 of advances were available from the FHLB on the blanket mortgage lien without the purchase of additional FHLB stock. Further advances of the remaining $52,260 available at September 30, 2014 would have required us to purchase additional FHLB stock totaling $2,613. FHLB stock currently pays an annualized dividend of .50% with expectations of continuing this dividend level. Therefore, additional FHLB advances carry additional cost relative to other wholesale borrowing alternatives due to the requirement to hold relatively low yielding FHLB stock.
Similar to the Discount Window, only performing residential mortgage loans may be pledged to the FHLB under the blanket lien. In addition, we were subject to a haircut of approximately 36% on first mortgage collateral and 60% on secondary lien collateral at both September 30, 2014 and December 31, 2013. The FHLB conducts periodic audits of collateral identification and submission procedures and adjusts the collateral haircuts higher in response to negative exam findings. The FHLB also assigns a credit risk grade to each member based on a quarterly review of the member’s regulatory CALL report. Our current credit risk is within the normal range for a healthy member bank. Negative financial performance trends such as reduced capital levels, increased nonperforming assets, net operating losses, and other factors can increase a member’s credit risk grade. Higher risk grades can require a member to provide detailed loan collateral listings (rather than a blanket lien), physical collateral, and other restrictions on the maximum line usage. FHLB advances are available on a daily basis and along with Discount Window advances represent a primary source of liquidity following our federal funds purchased lines of credit.
FHLB advances carry substantial penalties for early prepayment that are generally not recovered from the lower interest rates in refinancing. The amount of early prepayment penalty is a function of the difference between the current borrowing rate, and the rate currently available for refinancing. Under the collateral and pledging agreement we maintain with the FHLB effective April 12, 2011, we are also permitted to pledge commercial related collateral for advances. However, we did not pledge any commercial loan collateral to the FHLB at September 30, 2014 or December 31, 2013.
Repurchase agreements and FHLB advances collateralized by investment securities
Wholesale repurchase agreements may be available from a correspondent bank counterparty for both overnight and longer terms. Such arrangements typically call for the agreement to be collateralized by us at 110% of the repurchase principal. In the current market, repurchase counterparty providers are extremely limited and would likely require a minimum $10 million transaction. Repurchase agreements could require up to several business days to receive funding. Due to the lack of availability of counterparties offering the product, wholesale repurchase agreements are not a reliable source of liquidity. At September 30, 2014, $13,500 of our repurchase agreements are wholesale agreements with correspondent banks and $4,211 are overnight repurchase agreements with local customers using our treasury management services. At December 31, 2013, $13,500 of our repurchase agreements were wholesale agreements with correspondent banks and $5,441 were overnight repurchase agreements with local customers.
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In addition to availability of FHLB advances under the blanket mortgage lien, we also have the ability to pledge investment securities as collateral against FHLB advances. Advances secured by investments are also subject to the FHLB stock ownership requirement as described previously. Due to the need to purchase additional FHLB member stock, FHLB advances secured by investments are not considered a primary source of liquidity. At September 30, 2014, $48,718 of additional FHLB advances were available based on pledging of securities if an additional $2,436 of member capital stock were purchased. At December 31, 2013, $35,822 of additional FHLB advances were available based on pledging of securities if an additional $1,791 of member capital stock were purchased.
Wholesale market deposits
Due to the strength of our capital position, balance sheet, and ongoing earnings, we enjoy the lowest possible costs when purchasing wholesale certificates of deposit on the brokered market. We have an internal policy that limits use of brokered deposits to 20% of total assets, which gave availability of $92,384 at September 30, 2014 and $84,949 at December 31, 2013. Brokered and national certificates were 7.3% of total assets at September 30, 2014 and 8.1% at December 31, 2013. Due to a limited number of providers of repurchase agreement funding as well as our desire to retain unencumbered securities for liquidity purposes and adverse impacts from holding additional FHLB capital stock, loan growth in past years was often funded with brokered certificate of deposit funding.
Participants in the brokered certificate market must be considered “well capitalized” under current regulatory capital standards to acquire brokered deposits without approval of their primary federal regulator. We regularly acquire brokered deposits from three market providers and maintain relationships with other providers to obtain required funds at the lowest possible cost. Ten business days are typically required between the request for brokered funding and settlement. Therefore, brokered deposits are a reliable, but not daily, source of liquidity. Brokered deposits represent our largest source of wholesale funding and we would see significant negative impacts if capital levels or earnings were to decline to levels not considered to be well capitalized. In addition to the requirement to be considered well-capitalized, banks under regulatory consent orders are not permitted to participate in the brokered deposit market without approval of their primary federal regulator even if they maintain a well-capitalized capital classification.
Holding company line of credit
We maintained a $3,000 line of credit secured by a pledge of our bank subsidiary common stock with Bankers’ Bank in Madison, Wisconsin as a contingency liquidity source at September 30, 2014 and December 31, 2013. No amounts were drawn on the line at September 30, 2014 or December 31, 2013. Although our bank subsidiary has in the past provided the holding company’s liquidity needs through semi-annual upstream cash dividend of profits, losses or other negative performance trends could prevent the bank from providing these dividends as cash flow. Because our bank holding company currently has approximately $1,500 of debt financing payments per year as well as approximately $150 of other expenses (before tax benefits), the holding company line of credit is a critical source of potential liquidity.
We are subject to financial covenants associated with the line which require our bank subsidiary to:
● | Maintain Tier 1 leverage, Tier 1 risk based capital, and Tier 2 risk based capital ratios above 8%, 10%, and 12%, respectively. |
● | Maintain nonperforming assets (excluding accruing troubled debt restructured loans) as a percentage of tangible equity plus the allowance for loan losses to less than 20%. |
● | Maintain an allowance for loan losses no less than 70% of nonperforming loans (excluding accruing troubled debt restructured loans). |
At September 30, 2014 and December 31, 2013, we were not in violation of any of the line of credit covenants. A violation of any covenant could prevent us from utilizing the unused balance of the line of credit. The line of credit expires during December 2014.
If liquidity needs persist after exhausting all available funds from the sources described above, we would consider more drastic methods to raise funds including, but not limited to, sale of investment securities at a loss, cessation of lending to new or existing customers, sale of branch real estate in a sale-leaseback transaction, surrender of bank owned life insurance to obtain the cash surrender value net of taxes due, packaging and sale of residential mortgage loan pools held in our portfolio, sale of foreclosed assets at a loss, and sale of mortgage servicing rights. Such actions could generate undesirable sale losses or income tax impacts. While sale of additional common stock or issuance of other types of capital could provide additional liquidity, the ability to find significant buyers of such capital issues during a liquidity crisis would be difficult making such a source of funding unlikely or unreliable if the liquidity crisis was caused by our deteriorating financial condition.
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Liquidity Measurements and Contingency Plan
Our liquidity management and contingency plan calls for quarterly measurement of key funding, capital, problem loan, and liquidity contingency ratios at our banking subsidiary level. The measurements are compared to various risk levels that direct management to further responses to declining liquidity measurements as outlined below:
Risk Level 1 is defined as circumstances that create the potential for elevated liquidity risk, thus requiring an assessment of possible funding deficiencies. Normal business operations, plans and strategies are not anticipated to be immediately impacted.
Risk Level 2 is defined as circumstances that point to an increased potential for disruptions in the Bank’s funding plans, needs and/or resources. Assessment of the probability of a liquidity crisis is more urgent, and identification and prioritization of pre-emptive alternatives and actions may be both warranted and time sensitive.
Risk Level 3 is defined as circumstances that create a likely funding problem, or are symptomatic of circumstances that are highly correlated with impending funding problems; and, therefore, are expected to require some level of immediate action depending upon the situation.
These risk parameters and other qualitative and environmental factors are considered to determine whether a “Stress Level” response is required. Identification of a risk trigger does not automatically call for a stress level response. The following summarizes our response plans to various degrees of liquidity stress:
Stress Level A – Management provides a written summary evaluating the warning indicators and why it is deemed unlikely that there will be a resulting liquidity challenge.
Stress Level B – Management provides an assessment of the probability of a liquidity crisis and completes a sources and uses of funds report to estimate the impact on pro forma liquidity. Liquidity stress tests will be reviewed to ensure the scenarios being simulated are sufficiently robust and that there is adequate funding to satisfy potential demands for cash. Various pre-emptive actions will be considered and acted on as needed.
Stress Level C – Management has determined a funding crisis is likely and documents detailed assessments of the current liquidity situation and future liquidity needs. The Board approved action plan is carried out with vigor and may call for one or all of the following steps, among others, to mitigate the liquidity concern: sale of loans, intensify local deposit gathering programs, transferring unencumbered securities and loans to the Federal Reserve for Discount Window borrowings, curtail all lending except for specifically approved loans, reduce or suspend stock dividends, and investigate opportunities to raise new capital.
No Risk Level triggers were exceeded at September 30, 2014 or December 31, 2013 and no liquidity stress levels were considered to exist at those dates.
As part of our formal quarterly asset-liability management projections, we also measure basic surplus as the amount of existing net liquid assets (after deducting short-term liabilities and coverage for anticipated deposit funding outflows during the next 30 days) divided by total assets. The basic surplus calculation does not consider unused but available correspondent bank federal funds purchased, as those funds are subject to availability based on the correspondent bank’s own liquidity needs and therefore are not guaranteed contractual funds. However, basic surplus does include unused but available FHLB advances under the open line of credit supported by a blanket lien on mortgage collateral. Basic surplus does not include available brokered certificate of deposit funding as those funds generally may not be obtained within one business day following the request for funding. Our policy is to maintain a basic surplus of at least 5%. Basic surplus was 15.6% and 11.6% at September 30, 2014 and December 31, 2013, respectively. Basic surplus increased since December 31, 2013 as excess cash and cash equivalent funds from loan pay downs were used to repay maturing FHLB advances, increasing FHLB borrowing capacity during the year to date period.
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CAPITAL RESOURCES
During the nine months ended September 30, 2014, stockholders’ equity increased $3,855, or 6.8%, primarily from $3,971 in retained net income net of $664 of cash dividends declared. Tangible net book value per share at September 30, 2014 was $36.59 compared to $34.36 at December 31, 2013, and increase of 6.5%. The stockholders’ equity ratio increased at September 30, 2014 to 8.30% compared to 8.16% at June 30, 2014, and 7.98% at December 31, 2013. On the purchase of the Northwoods Rhinelander, Wisconsin branch, we recorded $344 of core deposit intangible assets and goodwill, which reduced tangible net book value by $.21 per share at the acquisition date. At September 30, 2014, $297 of these intangibles remain as the core deposit intangible to be amortized over five years using a double declining balance method beginning April 2014.
For regulatory purposes, the $7.7 million junior subordinated debentures maturing September 2035 reflected as debt on the Consolidated Balance Sheet are reclassified as Tier 1 regulatory equity capital. The floating rate payments required by the junior subordinated debentures have been hedged with a fixed rate interest rate swap resulting in a total interest cost of 4.42% through September 2017. The adequacy of our capital is regularly reviewed to ensure sufficient capital is available for current and future needs and is in compliance with regulatory guidelines. As of September 30, 2014 and December 31, 2013, the Bank’s Tier 1 risk-weighted capital ratio, total risk-weighted capital, and Tier 1 leverage ratio were in excess of regulatory minimums and were classified as “well-capitalized.” Refer to Table 23 for specific regulatory capital ratios at period-end. Failure to remain well-capitalized could prevent us from obtaining future whole sale brokered time deposits which are an important source of funding.
During the March 2014 quarter, we issued 6,400 shares of restricted stock having a grant date value of $200, or $31.25 per share, to certain key employees as a retention tool and to align employee performance with shareholder interests. The shares vest over the service period using a straight-line method and unvested shares are forfeited if, prior to vesting, the employee is no longer employed with the Bank. Refer to Note 12 of the Notes to Consolidated Financial Statements for more information on the restricted shares.
During the September 2014 quarter, we repurchased 10,000 shares of our common stock at an average cost of $33.23 per share, while no shares were repurchased in the September 2013 quarter. Year to date, 10,000 shares of common stock were repurchased at an average cost of $33.23 per share during 2014 while 10,030 shares were repurchased at an average cost of $26.78 per share during the nine months ended September 30, 2013. For a community bank such as us, the cost of capital remains very high, particularly related to issue of new common stock as our current stock price trades on the open market at less than our net book value per share. In addition, many sources of previously low cost capital such as pooled trust preferred offerings are no longer available. New regulatory capital rules also become effective for us on January 1, 2015 which are expected to decrease existing capital ratios. The priority use of excess capital is to support continued growth through acquisition activities as such opportunities become available. However, we continue to maintain a quarterly program to repurchase up to 10,000 shares of our common stock on the open market at prevailing prices.
During 2013, the banking regulatory agencies finalized new regulatory capital rules that will increase our capital needs beginning January 1, 2015. The minimum capital ratios to be considered well capitalized and to cover the newly required “capital buffer,” phased in during 2015 through 2019, would be 6.50% for the leverage ratio, 8.50% for the Tier 1 to risk adjusted capital ratio, and 10.50% for the total risk adjusted capital ratio, up from 5.00%, 6.00%, and 10.00%, respectively under current capital regulation.
The most significant factors of the rules changes include:
● | Requirement to meet minimum capital ratios for a new regulatory capital ratio defined as the “Common equity Tier 1 capital ratio.” | |
● | Institution of a new “capital conservation buffer” which provides a buffer between the minimum regulatory capital ratios to be considered “adequately capitalized” and capital ratios that allow the bank to pay certain levels of shareholder dividends, purchase treasury stock, or fund certain executive management incentive plans. The capital buffer will be phased in beginning in 2015 and be fully implemented in 2019. | |
● | Potential limitations on mortgage servicing right assets and deferred income tax assets allowed as regulatory capital as well as a greater risk weight applied to the amount allowed for regulatory capital purposes. | |
● | Past due loans would be subject to a 150% risk weighting, up from the 100% risk weighting currently applied. | |
● | Unused lines of credit not unconditionally cancellable by the bank would be subject to a 20% risk weighting, up from the 0% risk weighting current applied. |
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If the new capital rules were applied to our reported consolidated December 31, 2013 regulatory capital position and made effective immediately, the proforma new capital ratios are projected to change as follows:
Actual | Proforma | Targeted minimum | ||||||||||
as of: Dec 31, 2013 | as of: Dec 31, 2013 | with capital buffer | ||||||||||
Tier 1 leverage ratio to average assets | 9.06 | % | 9.06 | % | 6.50 | % | ||||||
Common equity Tier 1 ratio (new) | n/a | 10.62 | % | 7.00 | % | |||||||
Tier 1 risk adjusted capital ratio | 12.63 | % | 12.04 | % | 8.50 | % | ||||||
Tier 2 total risk adjusted capital ratio | 13.88 | % | 13.29 | % | 10.50 | % |
We continue to internally review the timing and extent of the proposed changes on our regulatory capital position and the final capital ratios at January 1, 2015, may be different than the proforma capital ratios shown above. Increased regulatory capital requirements could impact our ability to pay shareholder cash dividends, repurchase shares of treasury stock, or the pace of which we could grow in assets, both organically and via merger and acquisition activities. While we do not expect to be required to raise common stock capital solely to meet these new requirements, the new rules would increase the likelihood we would need capital through the issuance of new common stock if we continued merger and acquisition activity for growth. Because the market price of our stock currently trades at less than our book value, issuance of new common stock shares, such as for an acquisition, could dilute the book value per share of existing shareholders.
Table 23: Capital Ratios – PSB Holdings, Inc. – Consolidated
September 30, | December 31, | |||||||||||
(dollars in thousands) | 2014 | 2013 | 2013 | |||||||||
Stockholders’ equity | $ | 60,608 | $ | 56,012 | $ | 56,753 | ||||||
Junior subordinated debentures, net | 7,500 | 7,500 | 7,500 | |||||||||
Disallowed mortgage servicing right assets | (173 | ) | (166 | ) | (170 | ) | ||||||
Disallowed other intangible assets | (297 | ) | – | – | ||||||||
Accumulated other comprehensive income | (397 | ) | (561 | ) | (349 | ) | ||||||
Tier 1 regulatory capital | 67,241 | 62,785 | 63,734 | |||||||||
Allowance for loan and credit losses | 6,524 | 6,352 | 6,314 | |||||||||
Total regulatory capital | $ | 73,765 | $ | 69,137 | $ | 70,048 | ||||||
Total quarterly average assets (as defined by current regulations) | $ | 727,138 | $ | 695,909 | $ | 704,448 | ||||||
Disallowed mortgage servicing right assets | (173 | ) | (166 | ) | (170 | ) | ||||||
Disallowed other intangible assets | (297 | ) | – | – | ||||||||
Accumulated other comprehensive income | (985 | ) | (1,414 | ) | (1,017 | ) | ||||||
Quarterly average tangible assets (as defined by current regulations) | $ | 725,683 | $ | 694,329 | $ | 703,261 | ||||||
Risk-weighted assets (as defined by current regulations) | $ | 531,862 | $ | 507,648 | $ | 504,561 | ||||||
Tier 1 capital to average tangible assets (leverage ratio) | 9.27 | % | 9.04 | % | 9.06 | % | ||||||
Tier 1 capital to risk-weighted assets | 12.64 | % | 12.37 | % | 12.63 | % | ||||||
Total capital to risk-weighted assets | 13.87 | % | 13.62 | % | 13.88 | % |
Table 24: Capital Ratios – Peoples State Bank – Subsidiary
Tier 1 capital to average tangible assets (leverage ratio) | 9.57 | % | 9.51 | % | 9.39 | % | ||||||
Tier 1 capital to risk-weighted assets | 13.07 | % | 13.03 | % | 13.10 | % | ||||||
Total capital to risk-weighted assets | 14.30 | % | 14.28 | % | 14.35 | % |
As a measurement of the adequacy of a bank’s capital base related to its level of nonperforming assets, many investors use a “non-GAAP” measure commonly referred to as the “Texas Ratio.” We also track changes in our Texas Ratio against our internal capital and liquidity risk parameters to highlight negative capital trends that could impact our ability for future growth, payment of dividends to shareholders, or other factors. As noted previously, correspondent bank providers of our daily federal funds purchased line of credit and the holding company operating line of credit use similar measures that impact our ability to continued use of those lines of credit if our level of nonperforming assets to capital were to rise above prescribed levels. The following Table 25 presents the calculation of our Texas Ratio.
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Table: 25: Calculation of “Texas Ratio” (a non-GAAP measure)
As of Quarter End | ||||||||||||||||||||
September 30, | June 30, | March 31, | December 31, | September 30, | ||||||||||||||||
(dollars in thousands) | 2014 | 2014 | 2014 | 2013 | 2013 | |||||||||||||||
Total nonperforming assets | $ | 11,649 | $ | 12,172 | $ | 10,323 | $ | 10,389 | $ | 10,285 | ||||||||||
Total stockholders’ equity | $ | 60,608 | $ | 59,281 | $ | 58,277 | $ | 56,753 | $ | 56,012 | ||||||||||
Less: Mortgage servicing rights, net | (1,734 | ) | (1,698 | ) | (1,707 | ) | (1,696 | ) | (1,662 | ) | ||||||||||
Less: Goodwill and other intangible assets | (297 | ) | (321 | ) | – | – | – | |||||||||||||
Add: Allowance for loan losses | 6,424 | 6,929 | 6,882 | 6,783 | 7,126 | |||||||||||||||
Total tangible common stockholders’ equity and reserves | $ | 65,001 | $ | 64,191 | $ | 63,452 | $ | 61,840 | $ | 61,476 | ||||||||||
Total nonperforming assets as a percentage of total tangible common stockholders’ equity and reserves | 17.92 | % | 18.96 | % | 16.27 | % | 16.80 | % | 16.73 | % |
OFF BALANCE-SHEET COMMITMENTS AND CONTRACTUAL OBLIGATIONS
Off Balance Sheet Arrangements
We service residential mortgage loans originated by our lenders and sold to the FHLB and FNMA. As a FHLB Mortgage Partnership Finance (“MPF”) loan servicer, we provide a credit enhancement guarantee to reimburse the FHLB for foreclosure losses in excess of 1% of the original loan principal sold to the FHLB prior to 2009. At September 30, 2014, our credit guarantee covered $19,652 of loan principal on which we would incur credit losses up to $949 if the FHLB first loss exceeds $1,456 on foreclosure of loans within this pool. At December 31, 2013, our credit guarantee covered $23,709 of loan principal on which we would incur credit losses up to $949 if the FHLB first loss exceeds $1,593 on foreclosure of loans within this pool. These first mortgage loans are underwritten using standardized criteria we consider to be conservative on residential properties in our local communities. We believe loans serviced for the FHLB will realize minimal foreclosure losses in the future and that we will experience no loan losses related to charge-offs in excess of the FHLB 1% First Loss Account. The north central Wisconsin residential real estate market experiences housing price changes similar to the state of Wisconsin as a whole, and we do not have a significant reliance on vacation homes located in our northern markets. The average residential first mortgage originated by us under the FHLB program which required a credit enhancement was approximately $154 in 2008 and $140 during 2007, the last two years of the program. At September 30, 2014, the average remaining first mortgage principal balance for loans on which we provided the credit enhancement was $60.
Ten years after the original pool master commitment date, the FHLB First Loss Account and our Credit Enhancement Guarantee are reset to current levels based on loans remaining in the pool. These factors are further reset every subsequent five years until the pool is repaid. During 2012, a MPF 125 program pool reached its ten year anniversary and the First Loss Account and Credit Enhancement Guarantee associated with that program were reset to the new level shown in Table 26. The next First Loss Account reset date for any individual master commitment containing our Credit Enhancement Guarantee is scheduled for July 2017.
Under bank regulatory capital rules, this recourse obligation to the FHLB is risk-weighted for the purposes of the total capital to risk-weighted assets capital calculation. Total risk-based capital required to be held for the recourse obligations under the FHLB MPF programs for capital adequacy purposes was $864 at September 30, 2014 and December 31, 2013. During October 2008, we ceased origination and sale of loans to the FHLB that required a credit enhancement and no additional risk-based capital will be required to support such loans. More information on all loans serviced for other investors, including FHLB and FNMA, is outlined in Table 26.
Use of Interest Rate Swap Derivatives
From time to time, we sell interest rate swaps to certain adjustable rate commercial loan customers to fix the interest rate on their floating rate loan. There were $13,816 and $14,323 of interest rate swaps associated with customer floating rate commercial loan principal at September 30, 2014 and December 31, 2013, respectively, under the program. When the fixed rate swap is originated with customer, an identical offsetting swap is also entered into by us with a correspondent bank. Refer to Note 9 of the Notes to Consolidated Financial Statements for more information on the program.
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We also maintain an interest rate swap to convert floating interest payments on our $7.7 million junior subordinated debentures to a fixed rate which matures during September 2017. Refer to Note 9 of the Notes to Consolidated Financial Statements for further information on this swap, which is designated as a cash flow hedge of interest rate payments.
Residential Mortgage Loan Servicing
We serviced $276,367 and $272,280 of residential real estate loans which have been sold to the FHLB and FNMA at September 30, 2014, and December 31, 2013, respectively. Loans sold to FHLB and FNMA are not reflected on our Consolidated Balance Sheets. An annualized servicing fee equal to .25% of outstanding principal is retained from payments collected from the customer as compensation for servicing the loan for the FHLB and FNMA. Mortgage loan servicing fees are an important source of mortgage banking income. We recognize a mortgage servicing right asset due to the substantial volume of loans serviced for the FHLB and FNMA.
All loans sold to FHLB or FNMA in which we retain the loan servicing are subject to underwriting representations and warranties made by us as the originator and we are subject to annual underwriting audits from both entities. Our representations and warranties would allow FHLB or FNMA to require us to repurchase inadequately originated loans for any number of underwriting violations. Provision for mortgage banking losses from required repurchase was $23 and $204 during the nine months ended September 30, 2014 and 2013, respectively and reduced mortgage banking income for those periods. We have provided a liability of $100 at September 30, 2014 compared to $108 at December 31, 2013 for potential future representation and warranty losses. Actual representation and warranty losses were $31 and $126 during the nine months ended September 30, 2014 and 2013, respectively.
The following tables summarize loan principal serviced for the FHLB under various MPF programs and for FNMA as of September 30, 2014 and December 31, 2013.
Table 26: Residential Mortgage Loans Serviced for Others as of September 30, 2014 ($000s)
Weighted | Average Monthly | PSB Credit | Agency | Mortgage | ||||||||||||||||||||||||||||
Agency | Principal | Loan | Average | Payment | Enhancement | Funded First | Servicing Right, net | |||||||||||||||||||||||||
Program | Serviced | Count | Coupon Rate | Seasoning | Guarantee | Loss Account | $ | % | ||||||||||||||||||||||||
FHLB MPF 100 | $ | 6,832 | 160 | 5.38 | % | 137 | $ | 94 | $ | 291 | $ | 14 | 0.20 | % | ||||||||||||||||||
FHLB MPF 125 | 17,001 | 210 | 5.75 | % | 85 | 855 | 1,165 | 67 | 0.39 | % | ||||||||||||||||||||||
FHLB XTRA | 171,561 | 1,402 | 3.75 | % | 36 | n/a | n/a | 1,005 | 0.59 | % | ||||||||||||||||||||||
FNMA | 80,973 | 551 | 3.63 | % | 18 | n/a | n/a | 648 | 0.80 | % | ||||||||||||||||||||||
Totals | $ | 276,367 | 2,323 | 3.88 | % | 36 | $ | 949 | $ | 1,456 | $ | 1,734 | 0.63 | % |
Table 27: Residential Mortgage Loans Serviced for Others as of December 31, 2013 ($000s)
Weighted | Average Monthly | PSB Credit | Agency | Mortgage | ||||||||||||||||||||||||||||
Agency | Principal | Loan | Average | Payment | Enhancement | Funded First | Servicing Right, net | |||||||||||||||||||||||||
Program | Serviced | Count | Coupon Rate | Seasoning | Guarantee | Loss Account | $ | % | ||||||||||||||||||||||||
FHLB MPF 100 | $ | 8,493 | 184 | 5.38 | % | 128 | $ | 94 | $ | 291 | $ | 19 | 0.22 | % | ||||||||||||||||||
FHLB MPF 125 | 18,748 | 226 | 5.75 | % | 81 | 855 | 1,302 | 77 | 0.41 | % | ||||||||||||||||||||||
FHLB XTRA | 185,283 | 1,472 | 3.75 | % | 27 | n/a | n/a | 1,133 | 0.61 | % | ||||||||||||||||||||||
FNMA | 59,756 | 409 | 3.50 | % | 15 | n/a | n/a | 467 | 0.78 | % | ||||||||||||||||||||||
Totals | $ | 272,280 | 2,291 | 3.88 | % | 31 | $ | 949 | $ | 1,593 | $ | 1,696 | 0.62 | % |
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
There has been no material change in the information provided in response to Item 7A of our Form 10-K for the year ended December 31, 2013.
Item 4. Controls and Procedures
As of the end of the period covered by this report, management, under the supervision, and with the participation, of our President and Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) pursuant to Exchange Act Rule 13a 15. Based upon, and as of the date of such evaluation, the President and Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures were effective.
PART II – OTHER INFORMATION
Item 1A. Risk Factors
In addition to the other information set forth in this report, this report should be considered in light of the risk factors referenced in Part I of PSB’s Annual Report on Form 10-K for the year ended December 31, 2013, under the caption “Forward-Looking Statements.” These and other risk factors could materially affect PSB’s business, financial condition, or future results of operations. The risks referenced in PSB’s Annual Report on Form 10-K are not the only risks facing PSB. Additional risks and uncertainties not currently known to PSB or that it currently deems to be immaterial also may materially adversely affect PSB’s business, financial condition, and/or operating results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Purchases of Equity Securities
Total number of shares (or units) purchased | Average price paid per share (or unit) | Total number of shares (or units) purchased as part of publicly announced plans or programs | Maximum number (or approximate dollar value) of shares (or units) that may yet be purchased under the plans or programs | |||||||||||||
Period | (a) | (b) | (c) | (d) | ||||||||||||
July 2014 | 5,600 | $ | 32.88 | – | – | |||||||||||
August 2014 | 4,400 | 33.69 | – | – | ||||||||||||
September 2014 | – | – | – | – | ||||||||||||
Quarterly totals | 10,000 | $ | 33.23 | – | – |
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Item 6. Exhibits
Exhibits required by Item 601 of Regulation S-K.
Exhibit | ||
Number | Description | |
31.1 | Certification of CEO under Section 302 of Sarbanes-Oxley Act of 2002 | |
31.2 | Certification of CFO under Section 302 of Sarbanes-Oxley Act of 2002 | |
32.1 | Certifications under Section 906 of Sarbanes-Oxley Act of 2002 | |
101.INS* | XBRL Instance Document | |
101.SCH* | XBRL Taxonomy Extension Schema Document | |
101.CAL* | XBRL Taxonomy Extension Calculation Linkbase Document | |
101.DEF* | XBRL Taxonomy Definition Linkbase Document | |
101.LAB* | XBRL Taxonomy Extension Label Linkbase Document | |
101.PRE* | XBRL Taxonomy Extension Presentation Linkbase Document |
* XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
PSB HOLDINGS, INC. | |
November 14, 2014 | SCOTT M. CATTANACH |
Scott M. Cattanach | |
Treasurer | |
(On behalf of the Registrant and as Principal Financial Officer) |
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EXHIBIT INDEX
to
FORM 10-Q
of
PSB HOLDINGS, INC.
for the quarterly period ended September 30, 2014
Pursuant to Section 102(d) of Regulation S-T
(17 C.F.R. §232.102(d))
The following exhibits are filed as part this report:
31.1 | Certification of CEO under Section 302 of Sarbanes-Oxley Act of 2002 | |
31.2 | Certification of CFO under Section 302 of Sarbanes-Oxley Act of 2002 | |
32.1 | Certifications under Section 906 of Sarbanes-Oxley Act of 2002 | |
101.INS* | XBRL Instance Document | |
101.SCH* | XBRL Taxonomy Extension Schema Document | |
101.CAL* | XBRL Taxonomy Extension Calculation Linkbase Document | |
101.DEF* | XBRL Taxonomy Definition Linkbase Document | |
101.LAB* | XBRL Taxonomy Extension Label Linkbase Document | |
101.PRE* | XBRL Taxonomy Extension Presentation Linkbase Document |
* XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections. |
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