Annual Statements Open main menu

AUBURN NATIONAL BANCORPORATION, INC - Quarter Report: 2014 March (Form 10-Q)

10-Q
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

(Mark One)

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
  For the quarterly period ended March 31, 2014

 

[   ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
  For the transition period                  to                 

Commission File Number: 0-26486

 

 

Auburn National Bancorporation, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Delaware   63-0885779

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

100 N. Gay Street

Auburn, Alabama 36830

(334) 821-9200

(Address and telephone number of principal executive offices)

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x                                         No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data 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 x                                         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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

    Large Accelerated filer ¨

  Accelerated filer ¨   Non-accelerated filer ¨   Smaller reporting company x
  (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 Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

 

Outstanding at April 30, 2014

Common Stock, $0.01 par value per share

 

3,643,283 shares

 

 


Table of Contents

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

INDEX

 

      PAGE  

PART I. FINANCIAL INFORMATION

  

Item 1  Financial Statements

  

Consolidated Balance Sheets (Unaudited) as of March 31, 2014 and December 31, 2013

     3   

Consolidated Statements of Earnings (Unaudited) for the quarters ended March 31, 2014 and 2013

     4   

Consolidated Statements of Comprehensive Income (Unaudited) for the quarters ended March 31, 2014 and 2013

     5   

Consolidated Statements of Stockholders’ Equity (Unaudited) for the quarters ended March 31, 2014 and 2013

     6   

Condensed Consolidated Statements of Cash Flows (Unaudited) for the quarters ended March 31, 2014 and 2013

     7   

Notes to Consolidated Financial Statements (Unaudited)

     8   

Item 2   Management’s Discussion and Analysis of Financial Condition and Results of Operations

     29   

Table 1 – Explanation of Non-GAAP Financial Measures

     45   

Table 2 – Selected Quarterly Financial Data

     46   

Table 3 – Average Balances and Net Interest Income Analysis – for the quarters ended March 31, 2014 and 2013

     47   

Table 4 – Loan Portfolio Composition

     48   

Table 5 – Allowance for Loan Losses and Nonperforming Assets

     49   

Table 6 – Allocation of Allowance for Loan Losses

     50   

Table 7 – CDs and Other Time Deposits of $100,000 or more

     51   

Item 3  Quantitative and Qualitative Disclosures About Market Risk

     52   

Item 4  Controls and Procedures

     52   

PART II. OTHER INFORMATION

  

Item 1  Legal Proceedings

     52   

Item  1A  Risk Factors

     52   

Item 2  Unregistered Sales of Equity Securities and Use of Proceeds

     52   

Item 3  Defaults Upon Senior Securities

     52   

Item 4  Mine Safety Disclosures

     52   

Item 5  Other Information

     53   

Item 6  Exhibits

     53   


Table of Contents

PART 1. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(Unaudited)

 

(Dollars in thousands, except share data)   

March 31,

2014

    

December 31,

2013

 

 

 

Assets:

     

Cash and due from banks

   $ 14,318       $ 13,437   

Federal funds sold

     60,756         26,965   

Interest bearing bank deposits

     1,706         13,820   

 

 

Cash and cash equivalents

     76,780         54,222   

 

 

Securities available-for-sale

     279,989         271,219   

Loans held for sale

     1,250         2,296   

Loans, net of unearned income

     377,350         383,339   

Allowance for loan losses

     (4,711)         (5,268)   

 

 

Loans, net

     372,639         378,071   

 

 

Premises and equipment, net

     10,345         10,442   

Bank-owned life insurance

     17,629         17,503   

Other real estate owned

     3,111         3,884   

Other assets

     11,590         13,706   

 

 

Total assets

   $     773,333       $     751,343   

 

 

Liabilities:

     

Deposits:

     

Noninterest-bearing

   $ 125,627       $ 125,740   

Interest-bearing

     561,461         543,104   

 

 

Total deposits

     687,088         668,844   

Federal funds purchased and securities sold under agreements to repurchase

     3,266         3,363   

Long-term debt

     12,217         12,217   

Accrued expenses and other liabilities

     2,478         2,434   

 

 

Total liabilities

     705,049         686,858   

 

 

Stockholders’ equity:

     

Preferred stock of $.01 par value; authorized 200,000 shares; no issued shares

               

Common stock of $.01 par value; authorized 8,500,000 shares; issued 3,957,135 shares

     39         39   

Additional paid-in capital

     3,760         3,759   

Retained earnings

     72,918         71,879   

Accumulated other comprehensive loss, net

     (1,793)         (4,552)   

Less treasury stock, at cost - 313,962 shares and 314,017 shares at March 31, 2014 and December 31, 2013, respectively

     (6,640)         (6,640)   

 

 

Total stockholders’ equity

     68,284         64,485   

 

 

Total liabilities and stockholders’ equity

   $         773,333       $         751,343   

 

 

See accompanying notes to consolidated financial statements

 

3


Table of Contents

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Statements of Earnings

(Unaudited)

 

     Quarter ended March 31,  
(Dollars in thousands, except share and per share data)    2014      2013  

 

 

Interest income:

     

Loans, including fees

   $ 4,790       $ 5,328   

Securities

     1,803         1,616   

Federal funds sold and interest bearing bank deposits

     42         31   

 

 

Total interest income

     6,635         6,975   

 

 

Interest expense:

     

Deposits

     1,257         1,404   

Short-term borrowings

     4         4   

Long-term debt

     104         426   

 

 

Total interest expense

     1,365         1,834   

 

 

Net interest income

     5,270         5,141   

Provision for loan losses

     (400)         400   

 

 

Net interest income after provision for loan losses

     5,670         4,741   

 

 

Noninterest income:

     

Service charges on deposit accounts

     213         249   

Mortgage lending

     386         810   

Bank-owned life insurance

     126         95   

Other

     338         340   

Securities (losses) gains, net:

     

Realized gains, net

     26         161   

Total other-than-temporary impairments

     (333)         —     

 

 

Total securities (losses) gains, net

     (307)         161   

 

 

Total noninterest income

     756         1,655   

 

 

Noninterest expense:

     

Salaries and benefits

     2,281         2,250   

Net occupancy and equipment

     352         331   

Professional fees

     206         176   

FDIC and other regulatory assessments

     145         194   

Other real estate owned, net

     118         23   

Prepayment penalty on long-term debt

             425   

Other

     846         827   

 

 

Total noninterest expense

     3,948         4,226   

 

 

Earnings before income taxes

     2,478         2,170   

Income tax expense

     657         481   

 

 

Net earnings

   $ 1,821       $ 1,689   

 

 

Net earnings per share:

     

Basic and diluted

   $ 0.50       $ 0.46   

 

 

Weighted average shares outstanding:

     

Basic and diluted

        3,643,161            3,642,918   

 

 

See accompanying notes to consolidated financial statements

 

4


Table of Contents

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Unaudited)

 

         Quarter ended March 31,      
(Dollars in thousands)    2014      2013  

 

 

Net earnings

   $ 1,821       $ 1,689   

Other comprehensive income (loss), net of tax:

     

Unrealized net holding gain (loss) on securities

     2,565         (756)   

Reclassification adjustment for net loss (gain) on securities recognized in net earnings

     194         (101)   

 

 

Other comprehensive income (loss)

     2,759         (857)   

 

 

Comprehensive income

   $ 4,580       $ 832   

 

 

See accompanying notes to consolidated financial statements

 

5


Table of Contents

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

(Unaudited)

 

     Common Stock     

Additional
paid-in

capital

    

Retained

earnings

    

Accumulated
other
comprehensive

income (loss)

    

Treasury

stock

    

Total

 
(Dollars in thousands, except share data)    Shares      Amount                 

 

 

Balance, December 31, 2012

     3,957,135       $ 39       $ 3,756       $ 67,821       $ 5,174       $ (6,641)       $ 70,149   

Net earnings

                             1,689                         1,689   

Other comprehensive loss

                                     (857)                 (857)   

Cash dividends paid ($0.21 per share)

                             (764)                         (764)   

 

 

Balance, March 31, 2013

     3,957,135       $ 39       $ 3,756       $ 68,746       $ 4,317       $ (6,641)       $ 70,217   

 

 

Balance, December 31, 2013

     3,957,135       $ 39       $ 3,759       $ 71,879       $ (4,552)       $ (6,640)       $ 64,485   

Net earnings

                             1,821                         1,821   

Other comprehensive income

                                     2,759                 2,759   

Cash dividends paid ($0.215 per share)

                             (782)                         (782)   

Sale of treasury stock (55 shares)

                     1                                 1   

 

 

Balance, March 31, 2014

     3,957,135       $ 39       $ 3,760       $ 72,918       $ (1,793)       $ (6,640)       $ 68,284   

 

 

See accompanying notes to consolidated financial statements

 

6


Table of Contents

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)

 

     Quarter ended March 31,  
(In thousands)    2014      2013  

 

 

Cash flows from operating activities:

     

Net earnings

   $ 1,821       $ 1,689   

Adjustments to reconcile net earnings to net cash provided by operating activities:

     

Provision for loan losses

     (400)         400   

Depreciation and amortization

     182         233   

Premium amortization and discount accretion, net

     392         602   

Net loss (gain) on securities available-for-sale

     307         (161)   

Net gain on sale of loans held for sale

     (240)         (667)   

Decrease in MSR valuation allowance

             (66)   

Net loss (gain) on other real estate owned

     126         (39)   

Loss on prepayment of long-term debt

             425   

Loans originated for sale

     (8,848)         (33,056)   

Proceeds from sale of loans

     10,037         31,457   

Increase in cash surrender value of bank owned life insurance

     (126)         (95)   

Net decrease in other assets

     281         430   

Net increase in accrued expenses and other liabilities

     44         238   

 

 

Net cash provided by operating activities

     3,576         1,390   

 

 

Cash flows from investing activities:

     

Proceeds from sales of securities available-for-sale

             12,932   

Proceeds from maturities of securities available-for-sale

     10,119         22,821   

Purchase of securities available-for-sale

     (15,217)         (48,297)   

Decrease in loans, net

     5,717         6,652   

Net purchases of premises and equipment

             (437)   

Decrease in FHLB stock

     235         703   

Proceeds from sale of other real estate owned

     762         765   

 

 

Net cash provided by (used in) investing activities

     1,616         (4,861)   

 

 

Cash flows from financing activities:

     

Net (decrease) increase in noninterest-bearing deposits

     (113)         10,006   

Net increase in interest-bearing deposits

     18,357         12,233   

Net decrease in federal funds purchased and securities sold under agreements to repurchase

     (97)         (223)   

Repayments or retirement of long-term debt

             (10,425)   

Proceeds from sale of treasury stock

     1           

Dividends paid

     (782)         (764)   

 

 

Net cash provided by financing activities

     17,366         10,827   

 

 

Net change in cash and cash equivalents

     22,558         7,356   

Cash and cash equivalents at beginning of period

     54,222         61,949   

 

 

Cash and cash equivalents at end of period

   $ 76,780       $ 69,305   

 

 

 

 

Supplemental disclosures of cash flow information:

     

Cash paid during the period for:

     

Interest

   $ 1,418       $ 1,906   

Income taxes

     156         54   

Supplemental disclosure of non-cash transactions:

     

Real estate acquired through foreclosure

     115         617   

 

 

See accompanying notes to consolidated financial statements

 

7


Table of Contents

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

General

Auburn National Bancorporation, Inc. (the “Company”) provides a full range of banking services to individual and corporate customers in Lee County, Alabama and surrounding counties through its wholly owned subsidiary, AuburnBank (the “Bank”). The Company does not have any segments other than banking that are considered material.

Basis of Presentation and Use of Estimates

The unaudited consolidated financial statements in this report have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information. Accordingly, these financial statements do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The unaudited consolidated financial statements include, in the opinion of management, all adjustments necessary to present a fair statement of the financial position and the results of operations for all periods presented. All such adjustments are of a normal recurring nature. The results of operations in the interim statements are not necessarily indicative of the results of operations that the Company and its subsidiaries may achieve for future interim periods or the entire year. For further information, refer to the consolidated financial statements and footnotes included in the Company’s annual report on Form 10-K for the year ended December 31, 2013.

The unaudited consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Auburn National Bancorporation Capital Trust I is an affiliate of the Company and was included in these unaudited consolidated financial statements pursuant to the equity method of accounting. Significant intercompany transactions and accounts are eliminated in consolidation.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term include other-than-temporary impairment on investment securities, the determination of the allowance for loan losses, fair value of financial instruments, and the valuation of deferred tax assets and other real estate owned.

Subsequent Events

The Company has evaluated the effects of events and transactions through the date of this filing that have occurred subsequent to March 31, 2014. The Company does not believe there were any material subsequent events during this period that would have required further recognition or disclosure in the unaudited consolidated financial statements included in this report.

Accounting Developments

In the first quarter of 2014, the Company adopted new guidance related to the following Accounting Standards Update (“Update” or “ASU”):

 

   

ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists;

Information about this pronouncement is described in more detail below.

ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, is expected to eliminate diversity in practice as it provides guidance on financial statement presentation of an unrecognized tax benefit when a net operating loss (NOL) carryforward, a similar tax loss, or a tax credit carryforward exists. The changes were effective for the Company during the first quarter of 2014. Adoption of this ASU had no impact on the financial statements of the Company.

 

8


Table of Contents

NOTE 2: BASIC AND DILUTED EARNINGS PER SHARE

Basic net earnings per share is computed by dividing net earnings by the weighted average common shares outstanding for the quarters ended March 31, 2014 and 2013, respectively. Diluted net earnings per share reflect the potential dilution that could occur upon exercise of securities or other rights for, or convertible into, shares of the Company’s common stock. At March 31, 2014 and 2013, respectively, the Company had no such securities or rights issued or outstanding, and therefore, no dilutive effect to consider for the diluted earnings per share calculation.

The basic and diluted earnings per share computations for the respective periods are presented below.

 

     Quarter ended March 31,  
(Dollars in thousands, except share and per share data)    2014     2013  

 

 

Basic and diluted:

    

Net earnings

   $ 1,821      $ 1,689   

Weighted average common shares outstanding

         3,643,161            3,642,918   

 

 

Earnings per share

   $ 0.50      $ 0.46   

 

 

NOTE 3: VARIABLE INTEREST ENTITIES

Generally, a variable interest entity (“VIE”) is a corporation, partnership, trust or other legal structure that does not have equity investors with substantive or proportional voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities.

At March 31, 2014, the Company did not have any consolidated VIEs to disclose but did have one nonconsolidated VIE, discussed below.

Trust Preferred Securities

The Company owns the common stock of a subsidiary business trust, Auburn National Bancorporation Capital Trust I, which issued mandatorily redeemable preferred capital securities (“trust preferred securities”) in the aggregate of approximately $7.0 million at the time of issuance. This trust meets the definition of a VIE of which the Company is not the primary beneficiary; the trust’s only assets are junior subordinated debentures issued by the Company, which were acquired by the trust using the proceeds from the issuance of the trust preferred securities and common stock. The junior subordinated debentures of approximately $7.2 million are included in long-term debt and the Company’s equity interest of $0.2 million in the business trust is included in other assets. Interest expense on the junior subordinated debentures is included in interest expense on long-term debt.

The following table summarizes VIEs that are not consolidated by the Company as of March 31, 2014.

 

(Dollars in thousands)    Maximum
Loss Exposure
     Liability
        Recognized
    Classification            

 

Type:

       

Trust preferred issuances

     N/A         $   7,217      Long-term debt            

 

 

9


Table of Contents

NOTE 4: SECURITIES

At March 31, 2014 and December 31, 2013, respectively, all securities within the scope of ASC 320, Investments – Debt and Equity Securities, were classified as available-for-sale. The fair value and amortized cost for securities available-for-sale by contractual maturity at March 31, 2014 and December 31, 2013, respectively, are presented below.

 

     1 year      1 to 5      5 to 10      After 10      Fair      Gross Unrealized      Amortized  
(Dollars in thousands)    or less          years              years              years              Value              Gains          Losses      Cost  

 

 

March 31, 2014

                       

Agency obligations (a)

   $          —                 33,920         22,114         56,034         54         3,143       $ 59,123   

Agency RMBS (a)

                     7,954         154,755         162,709         1,138         3,016         164,587   

State and political subdivisions

             679         20,402         40,165         61,246         2,236         111         59,121   

 

 

Total available-for-sale

   $         679         62,276         217,034         279,989         3,428         6,270       $ 282,831   

 

 

December 31, 2013

                       

Agency obligations (a)

   $                 23,247         21,275         44,522                 4,557       $ 49,079   

Agency RMBS (a)

                     8,306         154,052         162,358         976         4,733         166,115   

State and political subdivisions

             1,735         21,366         41,238         64,339         1,560         459         63,238   

 

 

Total available-for-sale

   $         1,735         52,919         216,565         271,219         2,536         9,749       $ 278,432   

 

 

 

(a) Includes securities issued by U.S. government agencies or government sponsored entities.

Securities with aggregate fair values of $140.0 million and $120.5 million at March 31, 2014 and December 31, 2013, respectively, were pledged to secure public deposits, securities sold under agreements to repurchase, Federal Home Loan Bank (“FHLB”) advances, and for other purposes required or permitted by law.

Included in other assets are cost-method investments. The carrying amounts of cost-method investments were $1.6 million and $1.8 million at March 31, 2014 and December 31, 2013, respectively. Cost-method investments primarily include non-marketable equity investments, such as FHLB of Atlanta stock and Federal Reserve Bank (“FRB”) stock.

Gross Unrealized Losses and Fair Value

The fair values and gross unrealized losses on securities at March 31, 2014 and December 31, 2013, respectively, segregated by those securities that have been in an unrealized loss position for less than 12 months and 12 months or longer, are presented below.

 

     Less than 12 Months      12 Months or Longer      Total  
(Dollars in thousands)   

Fair

Value

     Unrealized
Losses
     Fair Value      Unrealized
Losses
     Fair Value      Unrealized
Losses
 

 

 

March 31, 2014:

                 

Agency obligations

   $ 22,827                 1,303                 18,112                 1,840       $ 40,939                 3,143   

Agency RMBS

     88,746         2,778         4,616         238         93,362         3,016   

State and political subdivisions

     4,255         111                         4,255         111   

 

 

Total

   $ 115,828         4,192         22,728         2,078       $ 138,556         6,270   

 

 

December 31, 2013:

                 

Agency obligations

   $ 35,933         3,182         8,590         1,376       $ 44,523         4,558   

Agency RMBS

     109,774         4,393         7,683         339         117,457         4,732   

State and political subdivisions

     9,575         459                         9,575         459   

 

 

Total

   $       155,282         8,034         16,273         1,715       $       171,555         9,749   

 

 

The Company recorded an other-than-temporary impairment charge in the first quarter of 2014 related to securities management intended to sell at March 31, 2014. Subsequent to March 31, 2014, the Company sold these available-for-sale agency residential mortgage-backed securities (“RMBS”) with a fair value of approximately $18.9 million and realized a loss of $0.3 million. Periodically, available-for-sale securities may be sold or the composition of the portfolio realigned to improve yields, quality, or marketability, or to implement changes in investment or asset/liability strategy, including collateral requirements and raising funds for liquidity purposes.

 

10


Table of Contents

For the securities in the previous table, the Company does not have the intent to sell and has determined it is not more likely than not that the Company will be required to sell the security before recovery of the amortized cost basis, which may be maturity. On a quarterly basis, the Company assesses each security for credit impairment. For debt securities, the Company evaluates, where necessary, whether credit impairment exists by comparing the present value of the expected cash flows to the securities’ amortized cost basis. For cost-method investments, the Company evaluates whether an event or change in circumstances has occurred during the reporting period that may have a significant adverse effect on the fair value of the investment.

In determining whether a loss is temporary, the Company considers all relevant information including:

 

   

the length of time and the extent to which the fair value has been less than the amortized cost basis;

 

   

adverse conditions specifically related to the security, an industry, or a geographic area (for example, changes in the financial condition of the issuer of the security, or in the case of an asset-backed debt security, in the financial condition of the underlying loan obligors, including changes in technology or the discontinuance of a segment of the business that may affect the future earnings potential of the issuer or underlying loan obligors of the security or changes in the quality of the credit enhancement);

 

   

the historical and implied volatility of the fair value of the security;

 

   

the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future;

 

   

failure of the issuer of the security to make scheduled interest or principal payments;

 

   

any changes to the rating of the security by a rating agency; and

 

   

recoveries or additional declines in fair value subsequent to the balance sheet date.

Agency obligations

The unrealized losses associated with agency obligations were primarily driven by changes in interest rates and not due to the credit quality of the securities. These securities were issued by U.S. government agencies or government-sponsored entities and did not have any credit losses given the explicit government guarantee or other government support.

Agency RMBS

The unrealized losses associated with agency RMBS were primarily driven by changes in interest rates and not due to the credit quality of the securities. These securities were issued by U.S. government agencies or government-sponsored entities and did not have any credit losses given the explicit government guarantee or other government support.

Securities of U.S. states and political subdivisions

The unrealized losses associated with securities of U.S. states and political subdivisions were primarily driven by changes in interest rates and were not due to the credit quality of the securities. Some of these securities are guaranteed by a bond insurer, but management did not rely on the guarantee in making its investment decision. These securities will continue to be monitored as part of the Company’s quarterly impairment analysis, but are expected to perform even if the rating agencies reduce the credit rating of the bond insurers. As a result, the Company expects to recover the entire amortized cost basis of these securities.

Cost-method investments

At March 31, 2014, cost-method investments with an aggregate cost of $1.6 million were not evaluated for impairment because the Company did not identify any events or changes in circumstances that may have a significant adverse effect on the fair value of these cost-method investments.

The carrying values of the Company’s investment securities could decline in the future if the financial condition of an issuer deteriorates and the Company determines it is probable that it will not recover the entire amortized cost basis for the security. As a result, there is a risk that other-than-temporary impairment charges may occur in the future.

 

11


Table of Contents

Other-Than-Temporarily Impaired Securities

The following table presents a roll-forward of the credit loss component of the amortized cost of debt securities that the Company has written down for other-than-temporary impairment and has recognized the credit component of the loss in earnings (referred to as “credit-impaired” debt securities). Other-than-temporary impairments recognized in earnings for credit-impaired debt securities are presented as additions in two components based upon whether the current period is the first time the debt security was credit-impaired (initial credit impairment) or is not the first time the debt security was credit-impaired (subsequent credit impairments). The credit loss component is reduced if the Company sells, intends to sell, or believes it will be required to sell previously credit-impaired debt securities. Additionally, the credit loss component is reduced if the Company receives cash flows in excess of what it expected to receive over the remaining life of the credit-impaired debt security, the security matures or the security is fully written-down and deemed worthless. Changes in the credit loss component of credit-impaired debt securities for the respective periods are presented below.

 

     Quarter ended March 31,  
(Dollars in thousands)    2014      2013  

 

 

Balance, beginning of period

   $             —       $             1,257   

 

 

Balance, end of period

   $       $ 1,257   

 

 

Other-Than-Temporary Impairment

The following table presents details of the other-than-temporary impairment related to securities.

 

     Quarter ended March 31,  
(Dollars in thousands)    2014      2013  

 

 

Other-than-temporary impairment charges (included in earnings):

     

Debt securities:

     

Agency RMBS

   $             333       $             —   

 

 

Total debt securities

     333           

 

 

Total other-than-temporary impairment charges (included in earnings)

   $ 333       $   

 

 

Other-than-temporary impairment on debt securities:

     

Recorded as part of gross realized losses:

     

Securities with intent to sell

   $ 333       $   

 

 

Total other-than-temporary impairment on debt securities

   $ 333       $   

 

 

Realized Gains and Losses

The following table presents the gross realized gains and losses on sales and other-than-temporary impairment charges related to securities.

 

     Quarter ended March 31,  
(Dollars in thousands)    2014      2013  

 

 

Gross realized gains

   $ 26       $ 161   

Other-than-temporary impairment charges

     (333)         —     

 

 

Realized gains, net

   $         (307)       $           161   

 

 

 

12


Table of Contents

NOTE 5: LOANS AND ALLOWANCE FOR LOAN LOSSES

 

     March 31,      December 31,  
(In thousands)    2014      2013  

Commercial and industrial

   $ 54,632       $ 57,780   

Construction and land development

     31,275         36,479   

Commercial real estate:

     

Owner occupied

     53,973         56,102   

Other

     124,748         118,818   

 

 

Total commercial real estate

     178,721         174,920   

Residential real estate:

     

Consumer mortgage

     58,449         57,871   

Investment property

     42,984         43,835   

 

 

Total residential real estate

     101,433         101,706   

Consumer installment

     11,766         12,893   

 

 

Total loans

     377,827         383,778   

Less: unearned income

     (477)         (439)   

 

 

Loans, net of unearned income

   $         377,350       $         383,339   

 

 

Loans secured by real estate were approximately 82.4% of the Company’s total loan portfolio at March 31, 2014. At March 31, 2014, the Company’s geographic loan distribution was concentrated primarily in Lee County, Alabama and surrounding areas.

In accordance with ASC 310, a portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for loan losses. As part of the Company’s quarterly assessment of the allowance, the loan portfolio is disaggregated into the following portfolio segments: commercial and industrial, construction and land development, commercial real estate, residential real estate and consumer installment. Where appropriate, the Company’s loan portfolio segments are further disaggregated into classes. A class is generally determined based on the initial measurement attribute, risk characteristics of the loan, and an entity’s method for monitoring and determining credit risk.

The following describe the risk characteristics relevant to each of the portfolio segments and classes.

Commercial and industrial (“C&I”) — includes loans to finance business operations, equipment purchases, or other needs for small and medium-sized commercial customers. Also included in this category are loans to finance agricultural production. Generally the primary source of repayment is the cash flow from business operations and activities of the borrower.

Construction and land development (“C&D”) — includes both loans and credit lines for the purpose of purchasing, carrying and developing land into commercial developments or residential subdivisions. Also included are loans and lines for construction of residential, multi-family and commercial buildings. Generally the primary source of repayment is dependent upon the sale or refinance of the real estate collateral.

Commercial real estate (“CRE”) — includes loans disaggregated into two classes: (1) owner occupied and (2) other.

 

   

Owner occupied – includes loans secured by business facilities to finance business operations, equipment and owner-occupied facilities primarily for small and medium-sized commercial customers. Generally the primary source of repayment is the cash flow from business operations and activities of the borrower, who owns the property.

 

   

Other – primarily includes loans to finance income-producing commercial and multi-family properties that are not owner occupied. Loans in this class include loans for neighborhood retail centers, hotels, medical and professional offices, single retail stores, industrial buildings, warehouses and apartments leased generally to local businesses and residents. Generally the primary source of repayment is dependent upon income generated from the real estate collateral. The underwriting of these loans takes into consideration the occupancy and rental rates, as well as the financial health of the borrower.

 

13


Table of Contents

Residential real estate (“RRE”) — includes loans disaggregated into two classes: (1) consumer mortgage and (2) investment property.

 

   

Consumer mortgage – primarily includes first or second lien mortgages and home equity lines of credit to consumers that are secured by a primary residence or second home. These loans are underwritten in accordance with the Bank’s general loan policies and procedures which require, among other things, proper documentation of each borrower’s financial condition, satisfactory credit history and property value.

 

   

Investment property – primarily includes loans to finance income-producing 1-4 family residential properties. Generally the primary source of repayment is dependent upon income generated from leasing the property securing the loan. The underwriting of these loans takes into consideration the rental rates and property value, as well as the financial health of the borrower.

Consumer installment — includes loans to individuals both secured by personal property and unsecured. Loans include personal lines of credit, automobile loans, and other retail loans. These loans are underwritten in accordance with the Bank’s general loan policies and procedures which require, among other things, proper documentation of each borrower’s financial condition, satisfactory credit history, and if applicable, property value.

The following is a summary of current, accruing past due and nonaccrual loans by portfolio segment and class as of March 31, 2014, and December 31, 2013.

 

            Accruing
30-89 Days
     Accruing
Greater than
     Total
Accruing
     Non-      Total  
(In thousands)    Current      Past Due      90 days      Loans      Accrual      Loans  

 

    

 

 

 

March 31, 2014:

                 

Commercial and industrial

   $ 54,270         191         117         54,578         54       $ 54,632   

Construction and land development

     29,747         157                 29,904         1,371         31,275   

Commercial real estate:

                 

Owner occupied

     53,417         275                 53,692         281         53,973   

Other

     124,133         186                 124,319         429         124,748   

Total commercial real estate

     177,550         461                 178,011         710         178,721   

Residential real estate:

                 

Consumer mortgage

     56,358         1,340                 57,698         751         58,449   

Investment property

     42,195         494                 42,689         295         42,984   

Total residential real estate

     98,553         1,834                 100,387         1,046         101,433   

Consumer installment

     11,659         86         14         11,759         7         11,766   

Total

   $ 371,779         2,729         131         374,639         3,188       $ 377,827   
                                                       

December 31, 2013:

                 

Commercial and industrial

   $ 57,558         167                 57,725         55       $ 57,780   

Construction and land development

     34,883         14                 34,897         1,582         36,479   

Commercial real estate:

                 

Owner occupied

     54,214         861                 55,075         1,027         56,102   

Other

     118,389                         118,389         429         118,818   

Total commercial real estate

     172,603         861                 173,464         1,456         174,920   

Residential real estate:

                 

Consumer mortgage

     56,191         745         69         57,005         866         57,871   

Investment property

     42,935         598                 43,533         302         43,835   

Total residential real estate

     99,126         1,343         69         100,538         1,168         101,706   

Consumer installment

     12,789         100         4         12,893                 12,893   

Total

   $     376,959                 2,485                     73         379,517               4,261       $     383,778   
                                                       

 

14


Table of Contents

Allowance for Loan Losses

The Company assesses the adequacy of its allowance for loan losses prior to the end of each calendar quarter. The level of the allowance is based upon management’s evaluation of the loan portfolio, past loan loss experience, current asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect a borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan loss rates and other pertinent factors, including regulatory recommendations. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Loans are charged off, in whole or in part, when management believes that the full collectability of the loan is unlikely. A loan may be partially charged-off after a “confirming event” has occurred which serves to validate that full repayment pursuant to the terms of the loan is unlikely.

The Company deems loans impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Collection of all amounts due according to the contractual terms means that both the interest and principal payments of a loan will be collected as scheduled in the loan agreement.

An impairment allowance is recognized if the fair value of the loan is less than the recorded investment in the loan. The impairment is recognized through the allowance. Loans that are impaired are recorded at the present value of expected future cash flows discounted at the loan’s effective interest rate, or if the loan is collateral dependent, impairment measurement is based on the fair value of the collateral, less estimated disposal costs.

The level of allowance maintained is believed by management to be adequate to absorb probable losses inherent in the portfolio at the balance sheet date. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries of amounts previously charged-off.

In assessing the adequacy of the allowance, the Company also considers the results of its ongoing internal and independent loan review processes. The Company’s loan review process assists in determining whether there are loans in the portfolio whose credit quality has weakened over time and evaluating the risk characteristics of the entire loan portfolio. The Company’s loan review process includes the judgment of management, the input from our independent loan reviewers, and reviews that may have been conducted by bank regulatory agencies as part of their examination process. The Company incorporates loan review results in the determination of whether or not it is probable that it will be able to collect all amounts due according to the contractual terms of a loan.

As part of the Company’s quarterly assessment of the allowance, management divides the loan portfolio into five segments: commercial and industrial, construction and land development, commercial real estate, residential real estate, and consumer installment loans. The Company analyzes each segment and estimates an allowance allocation for each loan segment.

The allocation of the allowance for loan losses begins with a process of estimating the probable losses inherent for these types of loans. The estimates for these loans are established by category and based on the Company’s internal system of credit risk ratings and historical loss data. The estimated loan loss allocation rate for the Company’s internal system of credit risk grades is based on its experience with similarly graded loans. For loan segments where the Company believes it does not have sufficient historical loss data, the Company may make adjustments based, in part, on loss rates of peer bank groups. At March 31, 2014 and December 31, 2013, and for the periods then ended, the Company adjusted its historical loss rates for the commercial real estate portfolio segment based, in part, on loss rates of peer bank groups.

The estimated loan loss allocation for all five loan portfolio segments is then adjusted for management’s estimate of probable losses for several “qualitative and environmental” factors. The allocation for qualitative and environmental factors is particularly subjective and does not lend itself to exact mathematical calculation. This amount represents estimated probable inherent credit losses which exist, but have not yet been identified, as of the balance sheet date, and are based upon quarterly trend assessments in delinquent and nonaccrual loans, credit concentration changes, prevailing economic conditions, changes in lending personnel experience, changes in lending policies or procedures and other influencing factors. These qualitative and environmental factors are considered for each of the five loan segments and the allowance allocation, as determined by the processes noted above, is increased or decreased based on the incremental assessment of these factors.

 

15


Table of Contents

The Company regularly re-evaluates its practices in determining the allowance for loan losses. During 2013, the Company implemented certain refinements to its allowance for loan losses methodology, specifically the way that historical loss factors are calculated. Prior to June 30, 2013, the Company calculated average losses for all loan segments using a rolling 6 quarter historical period. Beginning with the quarter ended June 30, 2013, the Company calculated average losses for all loan segments (except for the commercial real estate loan segment) using a rolling 8 quarter historical period in order to better capture the effects of the current economic cycle on the Company’s loan loss experience, and continued this methodology through March 31, 2014. Based upon management’s review of charge-off trends for each loan segment, the Company continues to calculate average losses for the commercial real estate loan segment using a rolling 6 quarter historical period. Other than the changes discussed above, the Company has not made any changes to its calculation of historical loss periods that would impact the calculation of the allowance for loan losses or provision for loan losses for the periods included in the accompanying consolidated balance sheets and statements of earnings.

The following table details the changes in the allowance for loan losses by portfolio segment for the respective periods.

 

     March 31, 2014  
(In thousands)    Commercial and
industrial
    Construction
and land
development
    Commercial
real estate
    Residential
real estate
    Consumer
installment
    Total  

Quarter ended:

            

Beginning balance

   $ 386        366        3,186        1,114        216      $ 5,268   

Charge-offs

            (236            (31     (36     (303

Recoveries

     4        2        118        16        6        146   

 

 

Net (charge-offs) recoveries

     4        (234     118        (15     (30     (157

Provision

     92        82        (811     157        80        (400

 

 

Ending balance

   $         482                214                2,493                1,256                266      $         4,711   

 

 
     March 31, 2013  
(In thousands)    Commercial and
industrial
    Construction
and land
development
    Commercial
real estate
    Residential
real estate
    Consumer
installment
    Total  

Quarter ended:

            

Beginning balance

   $ 812        1,545        3,137                1,126        103        6,723   

Charge-offs

     (68     (39     —          (266     (17   $ (390

Recoveries

     12        —          5        13        6      $ 36   

 

 

Net (charge-offs) recoveries

     (56     (39     5        (253     (11     (354

Provision

     (187     113        429        12        33      $ 400   

 

 

Ending balance

   $         569                1,619                3,571        885                  125      $         6,769   

 

 

 

16


Table of Contents

The following table presents an analysis of the allowance for loan losses and recorded investment in loans by portfolio segment and impairment methodology as of March 31, 2014 and 2013.

 

             Collectively evaluated (1)                       Individually evaluated (2)               Total  
(In thousands)   

    Allowance

    for loan

    losses

    

    Recorded

    investment

    in loans

    

    Allowance

    for loan

    losses

    

    Recorded

    investment

    in loans

    

    Allowance

    for loan

    losses

    

    Recorded

    investment

    in loans

 

March 31, 2014:

                 

Commercial and industrial

   $ 482         54,520                 112         482         54,632   

Construction and land development

     214         29,904                 1,371         214         31,275   

Commercial real estate

     2,314         176,548         179         2,173         2,493         178,721   

Residential real estate

     1,256         100,529                 904         1,256         101,433   

Consumer installment

     266         11,766                         266         11,766   

 

 

Total

   $ 4,532         373,267         179         4,560         4,711         377,827   

 

 

March 31, 2013:

                 

Commercial and industrial

   $ 569         55,576                 160         569         55,736   

Construction and land development

     1,498         39,489         121         1,615         1,619         41,104   

Commercial real estate

     3,327         176,492         244         2,501         3,571         178,993   

Residential real estate

     801         101,861         84         1,117         885         102,978   

Consumer installment

     125         12,026                         125         12,026   

 

 

Total

   $ 6,320         385,444                 449         5,393         6,769         390,837   

 

 

 

(1) Represents loans collectively evaluated for impairment in accordance with ASC 450-20, Loss Contingencies (formerly FAS 5), and pursuant to amendments by ASU 2010-20 regarding allowance for unimpaired loans.
(2) Represents loans individually evaluated for impairment in accordance with ASC 310-30, Receivables (formerly FAS 114), and pursuant to amendments by ASU 2010-20 regarding allowance for impaired loans.

 

17


Table of Contents

Credit Quality Indicators

The credit quality of the loan portfolio is summarized no less frequently than quarterly using categories similar to the standard asset classification system used by the federal banking agencies. The following table presents credit quality indicators for the loan portfolio segments and classes. These categories are utilized to develop the associated allowance for loan losses using historical losses adjusted for qualitative and environmental factors and are defined as follows:

 

   

Pass—loans which are well protected by the current net worth and paying capacity of the obligor (or guarantors, if any) or by the fair value, less cost to acquire and sell, of any underlying collateral.

 

   

Special Mention—loans with potential weakness that may, if not reversed or corrected, weaken the credit or inadequately protect the Company’s position at some future date. These loans are not adversely classified and do not expose an institution to sufficient risk to warrant an adverse classification.

 

   

Substandard Accruing—loans that exhibit a well-defined weakness which presently jeopardizes debt repayment, even though they are currently performing. These loans are characterized by the distinct possibility that the Company may incur a loss in the future if these weaknesses are not corrected;

 

   

Nonaccrual—includes loans where management has determined that full payment of principal and interest is not expected.

 

(In thousands)    Pass      Special
Mention
     Substandard
Accruing
     Nonaccrual      Total
loans
 

March 31, 2014:

              

Commercial and industrial

   $ 49,947         4,182         449         54       $ 54,632   

Construction and land development

     28,593         633         678         1,371         31,275   

Commercial real estate:

              

Owner occupied

     52,058         1,218         416         281         53,973   

Other

     123,434         90         795         429         124,748   

Total commercial real estate

     175,492         1,308         1,211         710         178,721   

Residential real estate:

              

Consumer mortgage

     50,436         2,724         4,538         751         58,449   

Investment property

     39,971         1,343         1,375         295         42,984   

Total residential real estate

     90,407         4,067         5,913         1,046         101,433   

Consumer installment

     11,621         32         106         7         11,766   

Total

   $         356,060         10,222         8,357         3,188       $ 377,827   

 

 

December 31, 2013:

              

Commercial and industrial

   $ 53,060         4,183         482         55       $ 57,780   

Construction and land development

     33,616         180         1,101         1,582         36,479   

Commercial real estate:

              

Owner occupied

     53,430         770         875         1,027         56,102   

Other

     117,490         91         808         429         118,818   

Total commercial real estate

     170,920         861         1,683         1,456         174,920   

Residential real estate:

              

Consumer mortgage

     50,392         1,137         5,476         866         57,871   

Investment property

     40,517         1,310         1,706         302         43,835   

Total residential real estate

     90,909         2,447         7,182         1,168         101,706   

Consumer installment

     12,713         34         146                 12,893   

Total

   $ 361,218         7,705         10,594         4,261       $ 383,778   

 

 

 

18


Table of Contents

Impaired loans

The following tables present details related to the Company’s impaired loans. Loans which have been fully charged-off do not appear in the following table. The related allowance generally represents the following components which correspond to impaired loans:

 

   

Individually evaluated impaired loans equal to or greater than $500,000 secured by real estate (nonaccrual construction and land development, commercial real estate, and residential real estate loans).

 

   

Individually evaluated impaired loans equal to or greater than $250,000 not secured by real estate (nonaccrual commercial and industrial and consumer installment loans).

The following tables set forth certain information regarding the Company’s impaired loans that were individually evaluated for impairment at March 31, 2014 and December 31, 2013.

 

         March 31, 2014  
(In thousands)        Unpaid principal
balance (1)
     Charge-offs and
payments applied (2)
     Recorded
investment (3)
     Related allowance  

 

    

 

 

 

With no allowance recorded:

  

Commercial and industrial

     $ 112                 112      

Construction and land development

       3,326         (1,955)         1,371      

Commercial real estate:

             

Owner occupied

       340         (59)         281      

Other

       519         (90)         429      

 

    

Total commercial real estate

       859         (149)         710      

Residential real estate:

             

Consumer mortgages

       947         (211)         736      

Investment property

       207         (39)         168      

 

    

Total residential real estate

       1,154         (250)         904      

 

    

Total

     $ 5,451         (2,354)         3,097      

 

    

With allowance recorded:

             

Commercial real estate:

             

Owner occupied

       868                 868         124   

Other

       595                 595         55   

 

    

 

 

 

Total commercial real estate

       1,463                 1,463         179   

 

    

 

 

 

Total

     $ 1,463                 1,463       $ 179   

 

    

 

 

 

Total impaired loans

     $             6,914         (2,354)         4,560       $                 179   

 

    

 

 

 

 

(1) Unpaid principal balance represents the contractual obligation due from the customer.
(2) Charge-offs and payments applied represents cumulative charge-offs taken, as well as interest payments that have been applied against the outstanding principal balance subsequent to the loans being placed on nonaccrual status.
(3) Recorded investment represents the unpaid principal balance less charge-offs and payments applied; it is shown before any related allowance for loan losses.

 

19


Table of Contents
     December 31, 2013  
(In thousands)    Unpaid principal
balance (1)
     Charge-offs and
payments applied
(2)
     Recorded
investment (3)
     Related allowance  

 

 

With no allowance recorded:

  

Commercial and industrial

   $ 124                 124      

Construction and land development

     2,879         (1,682)         1,197      

Commercial real estate:

           

Owner occupied

     1,217         (190)         1,027      

Other

     518         (89)         429      

 

    

Total commercial real estate

     1,735         (279)         1,456      

Residential real estate:

           

Consumer mortgages

     952         (198)         754      

Investment property

     207         (35)         172      

 

    

Total residential real estate

     1,159         (233)         926      

 

    

Total

   $ 5,897         (2,194)         3,703      

 

    

With allowance recorded:

           

Construction and land development

     452         (67)         385         88   

Commercial real estate:

           

Owner occupied

     875                 875         110   

Other

     602                 602         62   

 

    

 

 

 

Total commercial real estate

     1,477                 —         1,477         172   

 

    

 

 

 

Total

   $ 1,929         (67)         1,862       $ 260   

 

    

 

 

 

Total impaired loans

   $             7,826         (2,261)                     5,565       $             260   

 

    

 

 

 

 

(1) Unpaid principal balance represents the contractual obligation due from the customer.
(2) Charge-offs and payments applied represents cumulative charge-offs taken, as well as interest payments that have been applied against the outstanding principal balance subsequent to the loans being placed on nonaccrual status.
(3) Recorded investment represents the unpaid principal balance less charge-offs and payments applied; it is shown before any related allowance for loan losses.

The following table provides the average recorded investment in impaired loans and the amount of interest income recognized on impaired loans after impairment by portfolio segment and class during the respective periods.

 

    Quarter ended March 31, 2014      Quarter ended March 31, 2013  
(In thousands)   Average
recorded
investment
     Total interest
income
recognized
     Average
recorded
investment
     Total interest
income
recognized
 

 

 

Impaired loans:

  

Commercial and industrial

  $ 116       $ 2       $ 164       $ 3   

Construction and land development

    1,508                 1,619           

Commercial real estate:

          

Owner occupied

    1,648         12         2,044         14   

Other

    1,026         9         3,004           

 

 

Total commercial real estate

    2,674         21         5,048         14   

Residential real estate:

          

Consumer mortgages

    742                 811           

Investment property

    170                 305           

 

 

Total residential real estate

    912                 1,116           

 

 

Total

  $             5,210       $             23       $             7,947       $             17   

 

 

 

20


Table of Contents

Troubled Debt Restructurings

Impaired loans also include troubled debt restructurings (“TDRs”). In the normal course of business, management may grant concessions to borrowers that are experiencing financial difficulty. A concession may include, but is not limited to, delays in required payments of principal and interest for a specified period, reduction of the stated interest rate of the loan, reduction of accrued interest, extension of the maturity date or reduction of the face amount or maturity amount of the debt. A concession has been granted when, as a result of the restructuring, the Bank does not expect to collect all amounts due, including interest at the original stated rate. A concession may have also been granted if the debtor is not able to access funds elsewhere at a market rate for debt with similar risk characteristics as the restructured debt. The Company’s determination of whether a loan modification is a TDR, the Company considers the individual facts and circumstances surrounding each modification. As part of the credit approval process, the restructured loans are evaluated for adequate collateral protection in determining the appropriate accrual status at the time of restructure.

Similar to other impaired loans, TDRs are measured for impairment based on the present value of expected payments using the loan’s original effective interest rate as the discount rate, or the fair value of the collateral, less selling costs if the loan is collateral dependent. If the recorded investment in the loan exceeds the measure of fair value, impairment is recognized by establishing a valuation allowance as part of the allowance for loan losses or a charge-off to the allowance for loan losses. In periods subsequent to the modification, all TDRs are individually evaluated, including those that have payment defaults, for possible impairment.

The following is a summary of accruing and nonaccrual TDRs, which are included in impaired loan totals, and the related allowance for loan losses, by portfolio segment and class as of March 31, 2014, and December 31, 2013.

 

     TDRs  
(In thousands)    Accruing      Nonaccrual      Total        Related
Allowance
 

 

      

 

 

 

March 31, 2014

             

Commercial and industrial

   $ 112                 112         $   

Construction and land development

             1,371         1,371             

Commercial real estate:

             

Owner occupied

     868         281         1,149           124   

Other

     595         429         1,024           55   

 

      

 

 

 

Total commercial real estate

     1,463         710         2,173           179   

Residential real estate:

             

Consumer mortgages

             736         736             

Investment property

             168         168             

 

      

 

 

 

Total residential real estate

             904         904             

 

      

 

 

 

Total

   $         1,575         2,985         4,560         $             179   

 

      

 

 

 

December 31, 2013

             

Commercial and industrial

   $ 124                 124         $   

Construction and land development

             1,582         1,582           88   

Commercial real estate:

             

Owner occupied

     875         285         1,160           110   

Other

     602         429         1,031           62   

 

      

 

 

 

Total commercial real estate

     1,477         714         2,191           172   

Residential real estate:

             

Consumer mortgages

             754         754             

Investment property

             172         172             

 

      

 

 

 

Total residential real estate

             926         926             

 

      

 

 

 

Total

   $ 1,601                 3,222                 4,823         $ 260   

 

      

 

 

 

At March 31, 2014, there were no significant outstanding commitments to advance additional funds to customers whose loans had been restructured.

 

21


Table of Contents

The following table summarizes loans modified in a TDR during the respective periods both before and after their modification.

 

     March 31, 2014      March 31, 2013  
(Dollars in thousands)   

Number

of

contracts

    

Pre-

modification

outstanding

recorded

investment

    

Post -

modification

outstanding

recorded

investment

    

Number

of

contracts

    

Pre-

modification

outstanding

recorded

investment

    

Post -

modification

outstanding

recorded

investment

 

 

 

TDRs:

  

              

Commercial real estate:

                 

Other

           $                 1       $ 431         431   

 

 

Total commercial real estate

                             1         431         431   

Residential real estate:

                 

Consumer mortgages

                             1         131         131   

 

 

Total residential real estate

                             1         131         131   

 

 

Total

                 —       $         —                     —                     2       $         562                 562   

 

 

The majority of the loans modified in a TDR during the quarter ended March 31, 2013 included permitting delays in required payments of principal and/or interest or where the only concession granted by the Company was that the interest rate at renewal was considered to be less than a market rate.

The following table summarizes the recorded investment in loans modified in a TDR within the previous 12 months for which there was a payment default (defined as 90 days or more past due) during the respective periods.

 

     Quarter ended March 31, 2014    Quarter ended March 31, 2013
(Dollars in thousands)    Number of
Contracts
    

Recorded

investment(1)

           Number of
Contracts
    

Recorded

investment(1)

       

TDRs:

                 

Construction and land development

                 —       $         —                        1       $         1,197      

 

       

 

 

    

Total

           $            1       $ 1,197      

 

       

 

 

    

 

(1) Amount as of applicable month end during the respective period for which there was a payment default.

NOTE 6: MORTGAGE SERVICING RIGHTS, NET

Mortgage servicing rights (“MSRs”) are recognized based on the fair value of the servicing rights on the date the corresponding mortgage loans are sold. An estimate of the Company’s MSRs is determined using assumptions that market participants would use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, default rates, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, and late fees. Subsequent to the date of transfer, the Company has elected to measure its MSRs under the amortization method. Under the amortization method, MSRs are amortized in proportion to, and over the period of, estimated net servicing income.

The Company has recorded MSRs related to loans sold without recourse to Fannie Mae. The Company generally sells conforming, fixed-rate, closed-end, residential mortgages to Fannie Mae. MSRs are included in other assets on the accompanying Consolidated Balance Sheets.

The Company evaluates MSRs for impairment on a quarterly basis. Impairment is determined by stratifying MSRs into groupings based on predominant risk characteristics, such as interest rate and loan type. If, by individual stratum, the carrying amount of the MSRs exceeds fair value, a valuation reserve is established. The valuation allowance is adjusted as the fair value changes. Changes in the valuation allowance are recognized in earnings as a component of mortgage lending income.

 

22


Table of Contents

The change in amortized MSRs and the related valuation allowance for the quarters ended March 31, 2014 and 2013 are presented below.

 

     Quarter ended March 31,  
(Dollars in thousands)    2014      2013  

 

 

MSRs, net:

     

Beginning balance

   $ 2,350       $ 1,526   

Additions, net

     98         261   

Amortization expense

     (80)         (125)   

Decrease in MSR valuation allowance

             66   

 

 

Ending balance

   $ 2,368       $ 1,728   

 

 

Valuation allowance included in MSRs, net:

     

Beginning of period

   $       $ 386   

End of period

             320   

 

 

Fair value of amortized MSRs:

     

Beginning of period

   $ 3,452       $ 1,526   

End of period

             3,886                 1,994   

 

 

NOTE 7: DERIVATIVE INSTRUMENTS

Financial derivatives are reported at fair value in other assets or other liabilities on the accompanying Consolidated Balance Sheets. The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship. For derivatives not designated as part of a hedging relationship, the gain or loss is recognized in current earnings within other noninterest income on the accompanying Consolidated Statements of Earnings. From time to time, the Company may enter into interest rate swaps (“swaps”) to facilitate customer transactions and meet their financing needs. Upon entering into these swaps, the Company enters into offsetting positions in order to minimize the risk to the Company. These swaps qualify as derivatives, but are not designated as hedging instruments. At March 31, 2014 and December 31, 2013, the Company had no derivative contracts to assist in managing its own interest rate sensitivity.

Interest rate swap agreements involve the risk of dealing with counterparties and their ability to meet contractual terms. When the fair value of a derivative instrument is positive, this generally indicates that the counterparty or customer owes the Company, and results in credit risk to the Company. When the fair value of a derivative instrument is negative, the Company owes the customer or counterparty and therefore, has no credit risk.

A summary of the Company’s interest rate swap agreements at March 31, 2014 and December 31, 2013 is presented below.

 

             Other Assets      Other
Liabilities
 
(Dollars in thousands)    Notional      Estimated
Fair Value
     Estimated
Fair Value
 

 

 

March 31, 2014:

        

Pay fixed / receive variable

   $ 4,929                 788   

Pay variable / receive fixed

     4,929         788           

 

 

Total interest rate swap agreements

   $ 9,858         788         788   

 

 

December 31, 2013:

        

Pay fixed / receive variable

   $ 5,017                 844   

Pay variable / receive fixed

     5,017         844           

 

 

Total interest rate swap agreements

   $               10,034                       844                       844   

 

 

 

23


Table of Contents

NOTE 8: FAIR VALUE

Fair Value Hierarchy

“Fair value” is defined by ASC 820, Fair Value Measurements and Disclosures, as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for an asset or liability at the measurement date. GAAP establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1—inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets.

Level 2—inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs that are observable for the asset or liability, either directly or indirectly.

Level 3—inputs to the valuation methodology are unobservable and reflect the Company’s own assumptions about the inputs market participants would use in pricing the asset or liability.

Level changes in fair value measurements

Transfers between levels of the fair value hierarchy are generally recognized at the end of the reporting period. The Company monitors the valuation techniques utilized for each category of financial assets and liabilities to ascertain when transfers between levels have been affected. The nature of the Company’s financial assets and liabilities generally is such that transfers in and out of any level are expected to be infrequent. For the quarter ended March 31, 2014, there were no transfers between levels and no changes in valuation techniques for the Company’s financial assets and liabilities.

Assets and liabilities measured at fair value on a recurring basis

Securities available-for-sale

Fair values of securities available for sale were primarily measured using Level 2 inputs. For these securities, the Company obtains pricing from third party pricing services. These third party pricing services consider observable data that may include broker/dealer quotes, market spreads, cash flows, market consensus prepayment speeds, benchmark yields, reported trades for similar securities, market consensus prepayment speeds, credit information and the securities’ terms and conditions. On a quarterly basis, management reviews the pricing received from the third party pricing services for reasonableness given current market conditions. As part of its review, management may obtain non-binding third party broker quotes to validate the fair value measurements. In addition, management will periodically submit pricing provided by the third party pricing services to another independent valuation firm on a sample basis. This independent valuation firm will compare the price provided by the third party pricing service with its own price and will review the significant assumptions and valuation methodologies used with management.

Interest rate swap agreements

The carrying amount of interest rate swap agreements was included in other assets and accrued expenses and other liabilities on the accompanying consolidated balance sheets. The fair value measurements for our interest rate swap agreements were based on information obtained from a third party bank. This information is periodically tested by the Company and validated against other third party valuations. If needed, other third party market participants may be utilized to corroborate the fair value measurements for our interest rate swap agreements. The Company classified these derivative assets and liabilities within Level 2 of the valuation hierarchy. These swaps qualify as derivatives, but are not designated as hedging instruments.

 

24


Table of Contents

The following table presents the balances of the assets and liabilities measured at fair value on a recurring basis as of March 31, 2014 and December 31, 2013, respectively, by caption, on the accompanying consolidated balance sheets by ASC 820 valuation hierarchy (as described above).

 

(Dollars in thousands)    Amount         

Quoted Prices in
Active Markets

for

Identical Assets
(Level 1)

    

Significant
Other
Observable
Inputs

(Level 2)

    

Significant
Unobservable
Inputs

        (Level 3)        

 

March 31, 2014:

           

Securities available-for-sale:

           

Agency obligations

   $ 56,034                 56,034           

Agency RMBS

     162,709                 162,709           

State and political subdivisions

     61,246                 61,246           

 

 

Total securities available-for-sale

     279,989                 279,989           

Other assets (1)

     788                 788           

 

 

Total assets at fair value

   $         280,777                 280,777           

 

 

Other liabilities(1)

   $ 788                 788           

 

 

Total liabilities at fair value

   $ 788                 788           

 

 

December 31, 2013:

           

Securities available-for-sale:

           

Agency obligations

   $ 44,522                 44,522           

Agency RMBS

     162,358                 162,358           

State and political subdivisions

     64,339                 64,339           

 

 

Total securities available-for-sale

     271,219                 271,219           

Other assets (1)

     844                 844           

 

 

Total assets at fair value

   $ 272,063                         272,063           

 

 

Other liabilities(1)

   $ 844                 844           

 

 

Total liabilities at fair value

   $ 844                         —         844                     —   

 

 

 

(1) 

Represents the fair value of interest rate swap agreements.

Assets and liabilities measured at fair value on a nonrecurring basis

Loans held for sale

Loans held for sale are carried at the lower of cost or fair value. Fair values of loans held for sale are determined using quoted market secondary market prices for similar loans. Loans held for sale are classified within Level 2 of the fair value hierarchy.

Impaired Loans

Loans considered impaired under ASC 310-10-35, Receivables, are loans for which, based on current information and events, it is probable that the Company will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. Impaired loans can be measured based on the present value of expected payments using the loan’s original effective rate as the discount rate, the loan’s observable market price, or the fair value of the collateral less selling costs if the loan is collateral dependent.

The fair value of impaired loans were primarily measured based on the value of the collateral securing these loans. Impaired loans are classified within Level 3 of the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory, and/or accounts receivable. The Company determines the value of the collateral based on independent appraisals performed by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraised values are discounted for costs to sell and may be discounted further based on management’s historical knowledge, changes in market conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the

 

25


Table of Contents

customer’s business. Such discounts by management are subjective and are typically significant unobservable inputs for determining fair value. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors discussed above.

Other real estate owned

Other real estate owned, consisting of properties obtained through foreclosure or in satisfaction of loans, are initially recorded at the lower of the loan’s carrying amount or the fair value less costs to sell upon transfer of the loans to other real estate. Subsequently, other real estate is carried at the lower of carrying value or fair value less costs to sell. Fair values are generally based on third party appraisals of the property and are classified within Level 3 of the fair value hierarchy. The appraisals are sometimes further discounted based on management’s historical knowledge, and/or changes in market conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the customer’s business. Such discounts are typically significant unobservable inputs for determining fair value. In cases where the carrying amount exceeds the fair value, less costs to sell, a loss is recognized in noninterest expense.

Mortgage servicing rights, net

Mortgage servicing rights, net, included in other assets on the accompanying consolidated balance sheets, are carried at the lower of cost or estimated fair value. MSRs do not trade in an active market with readily observable prices. To determine the fair value of MSRs, the Company engages an independent third party. The independent third party’s valuation model calculates the present value of estimated future net servicing income using assumptions that market participants would use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, default rates, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, and late fees. Periodically, the Company will review broker surveys and other market research to validate significant assumptions used in the model. The significant unobservable inputs include prepayment speeds or the constant prepayment rate (“CPR”) and the weighted average discount rate. Because the valuation of MSRs requires the use of significant unobservable inputs, all of the Company’s MSRs are classified within Level 3 of the valuation hierarchy.

The following table presents the balances of the assets and liabilities measured at fair value on a nonrecurring basis as of March 31, 2014 and December 31, 2013, respectively, by caption, on the accompanying consolidated balance sheets and by FASB ASC 820 valuation hierarchy (as described above):

 

(Dollars in thousands)         Carrying    
Amount    
    

Quoted Prices in
Active Markets
for

Identical Assets
(Level 1)

     Other
Observable
Inputs
(Level 2)
    

Significant
Unobservable
Inputs

(Level 3)

 

March 31, 2014:

             

Loans held for sale

 

$

     1,250                 1,250           

Loans, net(1)

       4,381                         4,381   

Other real estate owned

       3,111                         3,111   

Other assets (2)

         2,368                         2,368   

Total assets at fair value

  $      11,110                 1,250         9,860   
   

December 31, 2013:

             

Loans held for sale

 

$

     2,296                 2,296           

Loans, net(1)

       5,305                         5,305   

Other real estate owned

       3,884                         3,884   

Other assets (2)

         2,350                         2,350   

Total assets at fair value

  $      13,835                 —             2,296             11,539   
   

 

(1) 

Loans considered impaired under ASC 310-10-35 Receivables. This amount reflects the recorded investment in impaired loans, net of any related allowance for loan losses.

(2) 

Represents MSRs, net, carried at lower of cost or estimated fair value.

 

26


Table of Contents

Quantitative Disclosures for Level 3 Fair Value Measurements

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements for trust preferred securities recognized in the accompanying consolidated balance sheets using Level 3 inputs:

 

       Quarter ended March 31,    
(Dollars in thousands)    2014      2013  

Beginning balance

   $       $ 652   

Total realized and unrealized gains and (losses):

     

Included in other comprehensive income

             8   

 

 

Ending balance

   $                 —       $                 660   
   
   

At March 31, 2014, the Company had no Level 3 assets measured at fair value on a recurring basis. For Level 3 assets measured at fair value on a non-recurring basis at March 31, 2014, the significant unobservable inputs used in the fair value measurements are presented below.

 

(Dollars in thousands)

   Carrying
Amount
    

Valuation Technique

  

    Significant Unobservable Input    

  

Weighted
Average
    of Input    

Nonrecurring:

           

Impaired loans

   $             4,381        Appraisal    Appraisal discounts (%)    19.7%  

Other real estate owned

     3,111        Appraisal    Appraisal discounts (%)    15.1%  

Mortgage servicing rights, net

     2,368        Discounted cash flow    Prepayment speed or CPR (%)    8.3%  
         Discount rate (%)    10.0%  

 

Fair Value of Financial Instruments

ASC 825, Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of the Company’s financial instruments are explained below. Where quoted market prices are not available, fair values are based on estimates using discounted cash flow analyses. Discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following fair value estimates cannot be substantiated by comparison to independent markets and should not be considered representative of the liquidation value of the Company’s financial instruments, but rather are a good–faith estimate of the fair value of financial instruments held by the Company. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements.

The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:

Loans, net

Fair values for loans were calculated using discounted cash flows. The discount rates reflected current rates at which similar loans would be made for the same remaining maturities. This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by ASC 820 and generally produces a higher value than an exit-price approach. Expected future cash flows were projected based on contractual cash flows, adjusted for estimated prepayments.

Loans held for sale

Fair values of loans held for sale are determined using quoted market secondary market prices for similar loans.

 

27


Table of Contents

Time Deposits

Fair values for time deposits were estimated using discounted cash flows. The discount rates were based on rates currently offered for deposits with similar remaining maturities.

Long-term debt

The fair value of the Company’s fixed rate long-term debt is estimated using discounted cash flows based on estimated current market rates for similar types of borrowing arrangements. The carrying amount of the Company’s variable rate long-term debt approximates its fair value.

The carrying value, related estimated fair value, and placement in the fair value hierarchy of the Company’s financial instruments at March 31, 2014 and December 31, 2013 are presented below. This table excludes financial instruments for which the carrying amount approximates fair value. Financial assets for which fair value approximates carrying value included cash and cash equivalents. Financial liabilities for which fair value approximates carrying value included noninterest-bearing demand, interest-bearing demand, and savings deposits due to these products having no stated maturity. In addition, financial liabilities for which fair value approximates carrying value included overnight borrowings such as federal funds purchased and securities sold under agreements to repurchase.

 

                   Fair Value Hierarchy  
(Dollars in thousands)   

Carrying

amount

    

Estimated

fair value

    

Level 1

inputs

    

Level 2

inputs

    

Level 3

Inputs

 

March 31, 2014:

              

Financial Assets:

              

Loans, net (1)

   $             372,639       $             372,112       $                 —       $                 —       $             372,112   

Loans held for sale

     1,250       $ 1,265       $       $ 1,265       $   

Financial Liabilities:

              

Time Deposits

   $ 262,209       $ 265,588       $       $ 265,588       $   

Long-term debt

     12,217         12,617                 12,617           

December 31, 2013:

              

Financial Assets:

              

Loans, net (1)

   $ 378,071       $ 387,180       $       $       $ 387,180   

Loans held for sale

     2,296         2,310                 2,310           

Financial Liabilities:

              

Time Deposits

   $ 261,199       $ 263,985       $       $ 263,985       $   

Long-term debt

     12,217         12,569                 12,569           

 

(1) Represents loans, net of unearned income and the allowance for loan losses.

 

 

28


Table of Contents

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis is designed to provide a better understanding of various factors related to the results of operations and financial condition of the Auburn National Bancorporation, Inc. (the “Company”) and its wholly owned subsidiary, AuburnBank (the “Bank”). This discussion is intended to supplement and highlight information contained in the accompanying unaudited condensed consolidated financial statements and related notes for the quarters ended March 31, 2014 and 2013, as well as the information contained in our annual report on Form 10-K for the year ended December 31, 2013.

Special Notice Regarding Forward-Looking Statements

Certain of the statements made in this discussion and analysis and elsewhere, including information incorporated herein by reference to other documents, are “forward-looking statements” within the meaning of, and subject to, the protections of Section 27A of the Securities Act of 1933, as amended, (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause the actual results, performance, achievements, or financial condition of the Company to be materially different from future results, performance, achievements, or financial condition expressed or implied by such forward-looking statements. You should not expect us to update any forward-looking statements.

All statements other than statements of historical fact are statements that could be forward-looking statements. You can identify these forward-looking statements through our use of words such as “may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “plan,” “point to,” “project,” “could,” “intend,” “target” and other similar words and expressions of the future. These forward-looking statements may not be realized due to a variety of factors, including, without limitation:

 

   

the effects of future economic, business and market conditions and changes, domestic and foreign, including seasonality;

 

   

governmental monetary and fiscal policies;

 

   

legislative and regulatory changes, including changes in banking, securities and tax laws, regulations and rules and their application by our regulators, including capital and liquidity requirements, and changes in the scope and cost of FDIC insurance;

 

   

changes in accounting policies, rules and practices;

 

   

the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities, and the risks and uncertainty of the amounts realizable and the timing of dispositions of assets by the FDIC where we may have a participation or other interest;

 

   

changes in borrower credit risks and payment behaviors;

 

   

changes in the availability and cost of credit and capital in the financial markets, and the types of instruments that may be included as capital for regulatory purposes;

 

   

changes in the prices, values and sales volumes of residential and commercial real estate;

 

   

the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;

 

29


Table of Contents
   

the failure of assumptions and estimates underlying the establishment of allowances for possible loan and other asset impairments, losses and other estimates;

 

   

the risks of mergers, acquisitions and divestitures, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and/or expense savings from such transactions;

 

   

changes in technology or products that may be more difficult, costly, or less effective than anticipated;

 

   

the effects of war or other conflicts, acts of terrorism or other catastrophic events that may affect general economic conditions;

 

   

the failure of assumptions and estimates, as well as differences in, and changes to, economic, market and credit conditions, including changes in borrowers’ credit risks and payment behaviors from those used in our loan portfolio stress tests and other evaluations;

 

   

the risks that our deferred tax assets could be reduced if estimates of future taxable income from our operations and tax planning strategies are less than currently estimated, and sales of our capital stock could trigger a reduction in the amount of net operating loss carry-forwards that we may be able to utilize for income tax purposes; and

 

   

the other factors and information in this report and other filings that we make with the SEC under the Exchange Act, including our annual report on Form 10-K for the year ended December 31, 2013 and subsequent quarterly and current reports. See Part II, Item 1A, “RISK FACTORS”.

All written or oral forward-looking statements that are made by or attributable to us are expressly qualified in their entirety by this cautionary notice. We have no obligation and do not undertake to update, revise or correct any of the forward-looking statements after the date of this report, or after the respective dates on which such statements otherwise are made.

Business

The Company was incorporated in 1990 under the laws of the State of Delaware and became a bank holding company after it acquired its Alabama predecessor, which was a bank holding company established in 1984. The Bank, the Company’s principal subsidiary, is an Alabama state-chartered bank that is a member of the Federal Reserve System and has operated continuously since 1907. Both the Company and the Bank are headquartered in Auburn, Alabama. The Bank conducts its business primarily in East Alabama, including Lee County and surrounding areas. The Bank operates full-service branches in Auburn, Opelika, Valley, Hurtsboro, and Notasulga, Alabama. In-store branches are located in the Kroger and Wal-Mart SuperCenter stores in both Auburn and Opelika. The Bank also operates commercial loan production offices in Montgomery and Phenix City, Alabama.

Summary of Results of Operations

 

       Quarter ended March 31,    
(Dollars in thousands, except per share data)      2014      2013    

Net interest income (a)

   $         5,594         $         5,523   

Less: tax-equivalent adjustment

     324         382   

Net interest income (GAAP)

     5,270         5,141   

Noninterest income

     756         1,655   

Total revenue

     6,026         6,796   

Provision for loan losses

     (400)         400   

Noninterest expense

     3,948         4,226   

Income tax expense

     657         481   

Net earnings

   $ 1,821       $ 1,689   

 

 

Basic and diluted earnings per share

   $ 0.50       $ 0.46   

 

 

 

(a) Tax-equivalent. See “Table 1—Explanation of Non-GAAP Financial Measures.”

 

30


Table of Contents

Financial Summary

The Company’s net earnings were $1.8 million for the first quarter of 2014, compared to $1.7 million for the first quarter of 2013. Basic and diluted earnings per share were $0.50 per share for the first quarter of 2014, compared to $0.46 per share for the first quarter of 2013.

Net interest income (tax-equivalent) was $5.6 million for the first quarter of 2014, compared to $5.5 million for the first quarter of 2013. Net interest income (tax-equivalent) increased as net interest margin improvement offset a decline in average interest-earning assets of 2%. The Company’s improved net interest margin reflects management’s efforts to increase earnings by focusing on deposit pricing and repaying higher-cost wholesale borrowings.

The Company recorded a negative provision for loan losses of $0.4 million for the first quarter of 2014 compared to a charge of $0.4 million for the first quarter of 2013. The decrease in the provision for loan losses was primarily due to improvement in the overall credit quality of the loan portfolio, including declining net charge-offs and lower levels of adversely classified and nonperforming loans.

Noninterest income was $0.8 million for the first quarter of 2014, compared to $1.7 million in the first quarter of 2013. The decrease was primarily due to a decrease in mortgage lending income of $0.4 million as higher interest rates for mortgage loans negatively impacted refinance activity and a decrease in net securities gains (losses) of $0.5 million that was primarily due to an other-than-temporary impairment charge on securities management intended to sell at March 31, 2014. Subsequent to March 31, 2014, the Company sold these available-for-sale agency RMBS with a fair value of approximately $18.9 million and realized a loss of $0.3 million.

Noninterest expense was approximately $4.0 million in the first quarter of 2014, compared to $4.2 million in the first quarter of 2013. The decrease was primarily due to a decrease in prepayment penalties on long-term debt. The Company incurred no prepayment penalties during the first quarter of 2014, compared to $0.4 million during the first quarter of 2013 when the Company repaid a $10.0 million FHLB advance with an interest rate of 3.17%. This decrease was partially offset by increases in certain other noninterest expenses, including an increase in net OREO expenses of $0.1 million due to realized holding losses or write-downs on the valuations of certain OREO properties.

Income tax expense was approximately $0.7 million for the first quarter of 2014, compared to $0.5 million in the first quarter of 2013. The Company’s effective tax rate for the first quarter of 2014 was 26.51%, compared to 22.17% in the first quarter of 2013. The increase in the Company’s effective tax rate was primarily due to decreases in tax exempt interest income as our holdings of municipal securities have declined. In addition, as earnings before income taxes increases, the impact of tax preference items, such as tax exempt interest income, on the Company’s effective tax rate is reduced.

In the first quarter of 2014, the Company paid cash dividends of $0.8 million, or $0.215 per share. The Company’s balance sheet remains “well capitalized” under current regulatory guidelines with a total risk-based capital ratio of 18.64% and a Tier 1 leverage ratio of 10.03% at March 31, 2014.

CRITICAL ACCOUNTING POLICIES

The accounting and financial reporting policies of the Company conform with U.S. generally accepted accounting principles and with general practices within the banking industry. In connection with the application of those principles, we have made judgments and estimates which, in the case of the determination of our allowance for loan losses, our assessment of other-than-temporary impairment, recurring and non-recurring fair value measurements, the valuation of other real estate owned, and the valuation of deferred tax assets, were critical to the determination of our financial position and results of operations. Other policies also require subjective judgment and assumptions and may accordingly impact our financial position and results of operations.

Allowance for Loan Losses

The Company assesses the adequacy of its allowance for loan losses prior to the end of each calendar quarter. The level of the allowance is based upon management’s evaluation of the loan portfolio, past loan loss experience, current asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect a borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan loss rates and other pertinent factors, including regulatory recommendations. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Loans are charged off, in whole or in part, when management believes that the full collectability of the loan is unlikely. A loan may be partially charged-off after a “confirming event” has occurred which serves to validate that full repayment pursuant to the terms of the loan is unlikely.

 

31


Table of Contents

The Company deems loans impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Collection of all amounts due according to the contractual terms means that both the interest and principal payments of a loan will be collected as scheduled in the loan agreement.

An impairment allowance is recognized if the fair value of the loan is less than the recorded investment in the loan. The impairment is recognized through the allowance. Loans that are impaired are recorded at the present value of expected future cash flows discounted at the loan’s effective interest rate, or if the loan is collateral dependent, impairment measurement is based on the fair value of the collateral, less estimated disposal costs.

The level of allowance maintained is believed by management to be adequate to absorb probable losses inherent in the portfolio at the balance sheet date. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries of amounts previously charged-off.

In assessing the adequacy of the allowance, the Company also considers the results of its ongoing internal and independent loan review processes. The Company’s loan review process assists in determining whether there are loans in the portfolio whose credit quality has weakened over time and evaluating the risk characteristics of the entire loan portfolio. The Company’s loan review process includes the judgment of management, the input from our independent loan reviewers, and reviews that may have been conducted by bank regulatory agencies as part of their examination process. The Company incorporates loan review results in the determination of whether or not it is probable that it will be able to collect all amounts due according to the contractual terms of a loan.

As part of the Company’s quarterly assessment of the allowance, management divides the loan portfolio into five segments: commercial and industrial, construction and land development, commercial real estate, residential real estate, and consumer installment loans. The Company analyzes each segment and estimates an allowance allocation for each loan segment.

The allocation of the allowance for loan losses begins with a process of estimating the probable losses inherent for these types of loans. The estimates for these loans are established by category and based on the Company’s internal system of credit risk ratings and historical loss data. The estimated loan loss allocation rate for the Company’s internal system of credit risk grades is based on its experience with similarly graded loans. For loan segments where the Company believes it does not have sufficient historical loss data, the Company may make adjustments based, in part, on loss rates of peer bank groups. At March 31, 2014 and December 31, 2013, and for the periods then ended, the Company adjusted its historical loss rates for the commercial real estate portfolio segment based, in part, on loss rates of peer bank groups.

The estimated loan loss allocation for all five loan portfolio segments is then adjusted for management’s estimate of probable losses for several “qualitative and environmental” factors. The allocation for qualitative and environmental factors is particularly subjective and does not lend itself to exact mathematical calculation. This amount represents estimated probable inherent credit losses which exist, but have not yet been identified, as of the balance sheet date, and are based upon quarterly trend assessments in delinquent and nonaccrual loans, credit concentration changes, prevailing economic conditions, changes in lending personnel experience, changes in lending policies or procedures and other influencing factors. These qualitative and environmental factors are considered for each of the five loan segments and the allowance allocation, as determined by the processes noted above, is increased or decreased based on the incremental assessment of these factors.

Assessment for Other-Than-Temporary Impairment of Securities

On a quarterly basis, management makes an assessment to determine whether there have been events or economic circumstances to indicate that a security on which there is an unrealized loss is other-than-temporarily impaired. For equity securities with an unrealized loss, the Company considers many factors including the severity and duration of the impairment; the intent and ability of the Company to hold the security for a period of time sufficient for a recovery in value; and recent events specific to the issuer or industry. Equity securities for which there is an unrealized loss that is deemed to be other-than-temporary are written down to fair value with the write-down recorded as a realized loss in securities gains (losses).

For debt securities with an unrealized loss, an other-than-temporary impairment write-down is triggered when (1) the Company has the intent to sell a debt security, (2) it is more likely than not that the Company will be required to sell the debt security before recovery of its amortized cost basis, or (3) the Company does not expect to recover the entire amortized cost basis of the debt security. If the Company has the intent to sell a debt security or if it is more likely than not that that it

 

32


Table of Contents

will be required to sell the debt security before recovery, the other-than-temporary write-down is equal to the entire difference between the debt security’s amortized cost and its fair value. If the Company does not intend to sell the security or it is not more likely than not that it will be required to sell the security before recovery, the other-than-temporary impairment write-down is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income, net of applicable taxes.

Fair Value Determination

U.S. GAAP requires management to value and disclose certain of the Company’s assets and liabilities at fair value, including investments classified as available-for-sale and derivatives. ASC 820, Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value in accordance with U.S. GAAP and expands disclosures about fair value measurements. For more information regarding fair value measurements and disclosures, please refer to Note 8, Fair Value, of the consolidated financial statements that accompany this report.

Fair values are based on active market prices of identical assets or liabilities when available. Comparable assets or liabilities or a composite of comparable assets in active markets are used when identical assets or liabilities do not have readily available active market pricing. However, some of the Company’s assets or liabilities lack an available or comparable trading market characterized by frequent transactions between willing buyers and sellers. In these cases, fair value is estimated using pricing models that use discounted cash flows and other pricing techniques. Pricing models and their underlying assumptions are based upon management’s best estimates for appropriate discount rates, default rates, prepayments, market volatility and other factors, taking into account current observable market data and experience.

These assumptions may have a significant effect on the reported fair values of assets and liabilities and the related income and expense. As such, the use of different models and assumptions, as well as changes in market conditions, could result in materially different net earnings and retained earnings results.

Other Real Estate Owned

Other real estate owned (“OREO”), consists of properties obtained through foreclosure or in satisfaction of loans and is reported at the lower of cost or fair value, less estimated costs to sell at the date acquired with any loss recognized as a charge-off through the allowance for loan losses. Additional OREO losses for subsequent valuation adjustments are determined on a specific property basis and are included as a component of other noninterest expense along with holding costs. Any gains or losses on disposal of OREO are also reflected in noninterest expense. Significant judgments and complex estimates are required in estimating the fair value of OREO, and the period of time within which such estimates can be considered current is significantly shortened during periods of market volatility. As a result, the net proceeds realized from sales transactions could differ significantly from appraisals, comparable sales, and other estimates used to determine the fair value of other OREO.

Deferred Tax Asset Valuation

A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more-likely-than-not that some portion or the entire deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon the level of taxable income over the last three years and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that we will realize the benefits of these deductible differences at March 31, 2014. The amount of the deferred tax assets considered realizable, however, could be reduced if estimates of future taxable income are reduced.

 

33


Table of Contents

RESULTS OF OPERATIONS

 

Average Balance Sheet and Interest Rates

 

 
     Quarter ended March 31,  
     2014      2013      
(Dollars in thousands)   

Average

Balance

     Yield/    
Rate    
     Average    
Balance    
     Yield/    
Rate    
 

 

  

 

 

    

 

 

 

Loans and loans held for sale

     $         378,780             5.13%         $     400,062             5.40%   

Securities - taxable

     206,630         2.31%         191,211         1.85%   

Securities - tax-exempt

     61,383         6.28%         71,863         6.34%   

 

  

 

 

    

 

 

 

Total securities

     268,013         3.22%         263,074         3.08%   

Federal funds sold

     55,120         0.18%         60,814         0.21%   

Interest bearing bank deposits

     7,700         0.90%         593         —      

 

  

 

 

    

 

 

 

Total interest-earning assets

     709,613         3.98%         724,543         4.12%   

 

  

 

 

    

 

 

 

Deposits:

           

NOW

     106,331         0.32%         105,578         0.31%   

Savings and money market

     189,601         0.51%         167,928         0.52%   

Certificates of deposits less than $100,000

     104,646         1.21%         105,452         1.46%   

Certificates of deposits and other time deposits of $100,000 or more

     157,431         1.60%         155,858         1.89%   

 

  

 

 

    

 

 

 

Total interest-bearing deposits

     558,009         0.91%         534,816         1.06%   

Short-term borrowings

     3,478         0.47%         2,862         0.57%   

Long-term debt

     12,217         3.45%         46,661         3.70%   

 

  

 

 

    

 

 

 

Total interest-bearing liabilities

     573,704         0.96%         584,339         1.27%   

 

  

 

 

    

 

 

 

Net interest income and margin (tax-equivalent)

     $ 5,594         3.20%         $ 5,523         3.09%   

 

  

 

 

    

 

 

 

Net Interest Income and Margin

Net interest income (tax-equivalent) increased as net interest margin improvement offset a decline in average interest-earning assets of 2%. The Company’s improved net interest margin reflects management’s efforts to increase earnings by focusing on deposit pricing and repaying higher-cost wholesale borrowings.

The tax-equivalent yield on total interest-earning assets decreased by 14 basis points in the first quarter of 2014 from the first quarter of 2013 to 3.98%. The decrease was primarily due to a decrease in average loans and loan yields as reduced loan demand and increased pricing competition for quality loan opportunities in our markets has limited the Company’s ability to increase loans generally, as well as a decrease in the yields on new and renewed loans over the last several quarters.

The cost of total interest-bearing liabilities decreased 31 basis points in the first quarter of 2014 from the first quarter of 2013 to 0.96%. The net decrease was largely a result of the continued shift in our funding mix, as we increased our savings and money market accounts and concurrently reduced balances of higher-cost long-term debt (i.e. wholesale borrowings).

The Company continues to deploy various asset liability management strategies to manage its risk to interest rate fluctuations. The Company’s net interest margin could experience pressure due to lower reinvestment yields in the securities portfolio given the current interest rate environment, increased competition for quality loan opportunities, and fewer opportunities to reduce our cost of funds due to the low level of deposit rates currently.

Provision for Loan Losses

The provision for loan losses represents a charge to earnings necessary to provide an allowance for loan losses that management believes, based on its processes and estimates, should be adequate to provide for the probable losses on outstanding loans. The Company recorded a negative provision for loan losses of $0.4 million for the first quarter of 2014 compared to a charge of $0.4 million for the first quarter of 2013. The decrease in the provision for loan losses was primarily due to improvement in the overall credit quality of the loan portfolio, including declining net charge-offs and lower levels of adversely classified and nonperforming loans.

 

34


Table of Contents

Based upon its assessment of the loan portfolio, management adjusts the allowance for loan losses to an amount it believes should be appropriate to adequately cover its estimate of probable losses in the loan portfolio. The Company’s allowance for loan losses as a percentage of total loans was 1.25% at March 31, 2014, compared to 1.37% at December 31, 2013. While the policies and procedures used to estimate the allowance for loan losses, as well as the resulting provision for loan losses charged to operations, are considered adequate by management and are reviewed from time to time by our regulators, they are based on estimates and judgments and are therefore approximate and imprecise. Factors beyond our control (such as conditions in the local and national economy, local real estate markets, or industry conditions) may have a material adverse effect on our asset quality and the adequacy of our allowance for loan losses resulting in significant increases in the provision for loan losses.

Noninterest Income

 

         Quarter ended March 31,      
(Dollars in thousands)    2014      2013  

 

 

Service charges on deposit accounts

   $         213         $ 249   

Mortgage lending income

     386           810   

Bank-owned life insurance

     126           95   

Securities (losses) gains, net

     (307)           161   

Other

     338           340   

 

 

Total noninterest income

   $ 756         $         1,655   

 

 

Service charges on deposit accounts decreased primarily due to a decline in insufficient funds charges, reflecting changes in customer behavior and spending patterns.

The Company’s income from mortgage lending was primarily attributable to the (1) origination and sale of new mortgage loans and (2) servicing of mortgage loans. Origination income, net, is comprised of gains or losses from the sale of the mortgage loans originated, origination fees, underwriting fees and other fees associated with the origination of loans, which are netted against the commission expense associated with these originations. The Company’s normal practice is to originate mortgage loans for sale in the secondary market and to either sell or retain the associated mortgage servicing rights (“MSRs”) when the loan is sold.

MSRs are recognized based on the fair value of the servicing right on the date the corresponding mortgage loan is sold. Subsequent to the date of transfer, the Company has elected to measure its MSRs under the amortization method. Servicing fee income is reported net of any related amortization expense.

MSRs are also evaluated for impairment on a quarterly basis. Impairment is determined by grouping MSRs by common predominant characteristics, such as interest rate and loan type. If the aggregate carrying amount of a particular group of MSRs exceeds the group’s aggregate fair value, a valuation allowance for that group is established. The valuation allowance is adjusted as the fair value changes. An increase in mortgage interest rates typically results in an increase in the fair value of the MSRs while a decrease in mortgage interest rates typically results in a decrease in the fair value of MSRs.

The following table presents a breakdown of the Company’s mortgage lending income.

 

         Quarter ended March 31,      
(Dollars in thousands)    2014      2013  

 

 

Origination income, net

   $ 240       $ 667   

Servicing fees, net

     146         77   

Decrease in MSR valuation allowance

             66   

 

 

Total mortgage lending income

   $         386       $         810   

 

 

The decrease in mortgage lending income was primarily due to a decline in origination income as refinance activity slowed significantly. This decrease was partially offset by an increase in servicing fees, net of related amortization expense. Servicing fees increased due to an increase in the unpaid principal balance of loans serviced and amortization expense decreased as prepayment speeds slowed.

 

35


Table of Contents

The increase in income from bank-owned life insurance was primarily due to improved policy returns. During the fourth quarter of 2013, the Bank exchanged certain bank-owned life insurance policies with a cash surrender value of approximately $5.9 million. These policies were exchanged to two new carriers with better credit ratings and policy returns. The assets that support these policies are administered by the life insurance carriers and the income we receive (i.e. increases or decreases in the cash surrender value of the policies) on these policies is dependent upon the returns the insurance carriers are able to earn on the underlying investments that support these policies. Earnings on these policies are generally not taxable.

Net securities gains (losses) consist of realized gains and losses on the sale of securities and other-than-temporary impairment charges. Net gains realized on the sale of securities were $26,000 for the first quarter of 2014, compared to net gains on the sale of securities of $161,000 for the first quarter of 2013. The Company recorded an other-than-temporary impairment charge in the first quarter of 2014 related to securities management intended to sell at March 31, 2014. Subsequent to March 31, 2014, the Company sold these available-for-sale Agency RMBS securities with a fair value of $18.9 million and realized a loss of approximately $333,000. The Company incurred no other-than-temporary impairment charges in the first quarter of 2013.

Noninterest Expense

 

     Quarter ended March 31,  
(Dollars in thousands)    2014          2013      

 

 

Salaries and benefits

   $ 2,281       $ 2,250   

Net occupancy and equipment

     352         331   

Professional fees

     206         176   

FDIC and other regulatory assessments

     145         194   

Other real estate owned, net

     118         23   

Prepayment penalty on long-term debt

             425   

Other

     846         827   

 

 

Total noninterest expense

   $         3,948       $         4,226   

 

 

The increase in salaries and benefits expense during the first quarter of 2014, compared to the first quarter of 2013 reflected routine annual increases.

The increase in net occupancy and equipment expense was primarily due to a decrease in rental income. During the fourth quarter of 2013, the Company sold an office building in downtown Auburn that was leased to third party tenants.

The decrease in FDIC and other regulatory assessments expense was primarily due to a decrease in the Bank’s quarterly assessment rate as several variables utilized by the FDIC in calculating our deposit insurance assessments improved.

The increase in OREO expense, net was primarily due to realized holding losses or write-downs on the valuations of certain OREO properties. These properties could be subject to future valuation adjustments as a result of updated appraisal information or further deterioration in real estate values, which would cause additional fluctuations in OREO expense, net. Also, the Company will continue to incur expenses for the maintenance costs and property taxes associated with these properties.

During the first quarter of 2013, the Company repaid a $10.0 million FHLB advance with an interest rate of 3.17% and a remaining term of 1.5 years and incurred a prepayment penalty of $0.4 million.

Income Tax Expense

Income tax expense was approximately $0.7 million for the first quarter of 2014, compared to $0.5 million in the first quarter of 2013. The Company’s effective tax rate for the first quarter of 2014 was 26.51%, compared to 22.17% in the first quarter of 2013. The increase in the Company’s effective tax rate was primarily due to decreases in tax exempt interest income as our holdings of municipal securities have declined. In addition, as earnings before income taxes increases, the impact of tax preference items, such as tax exempt interest income, on the Company’s effective tax rate is reduced.

 

36


Table of Contents

 

BALANCE SHEET ANALYSIS

Securities

Securities available-for-sale were $280.0 million at March 31, 2014, an increase of $8.8 million, or 3%, compared to $271.2 million at December 31, 2013. This increase reflects an increase in the amortized cost basis of securities available-for-sale of $4.4 million and a decrease in unrealized net losses on securities available-for-sale of $4.4 million. The increase in the amortized cost basis was primarily attributable to management allocating more funding to the investment portfolio as the loan portfolio declined. The decrease in unrealized net losses on securities available-for-sale was primarily due to a decrease in long-term interest rates during the first quarter of 2014.

The average tax-equivalent yields earned on total securities were 3.22% in the first quarter of 2014 and 3.08% in the first quarter of 2013.

 

Loans  
     2014      2013  
(In thousands)   

First

Quarter

     Fourth
    Quarter    
     Third
    Quarter    
     Second
    Quarter    
     First
    Quarter    
 

 

 

Commercial and industrial

   $ 54,632         57,780         58,766         56,030         55,736   

Construction and land development

     31,275         36,479         37,062         45,886         41,104   

Commercial real estate

     178,721         174,920         170,520         177,291         178,993   

Residential real estate

     101,433         101,706         102,565         99,021         102,978   

Consumer installment

     11,766         12,893         12,170         12,747         12,026   

 

 

Total loans

     377,827         383,778         381,083         390,975         390,837   

Less: unearned income

     (477)         (439)         (378)         (249)         (267)   

 

 

Loans, net of unearned income

   $         377,350         383,339         380,705         390,726         390,570   

 

 

Total loans, net of unearned income, were $377.4 million at March 31, 2014, compared to $383.3 million at December 31, 2013. The decrease in loans over the past several quarters was primarily due to a decline in construction and land development loans. Four loan categories represented the majority of the loan portfolio at March 31, 2014: commercial real estate (47%), residential real estate (27%), construction and land development (8%) and commercial and industrial (14%). Approximately 30% of the Company’s commercial real estate loans were classified as owner-occupied at March 31, 2014.

Within the residential real estate portfolio segment, the Company had junior lien mortgages of approximately $16.3 million, or 4% of total loans, at March 31, 2014, compared to $15.8 million, or 4% of total loans, at December 31, 2013. For residential real estate mortgage loans with a consumer purpose, approximately $0.8 million and $1.2 million required interest-only payments at March 31, 2014 and December 31, 2013, respectively. The Company’s residential real estate mortgage portfolio does not include any option ARM loans, subprime loans, or any material amount of other high-risk consumer mortgage products.

Purchased loan participations included in the Company’s loan portfolio were approximately $1.4 million at both March 31, 2014 and December 31, 2013. All purchased loan participations are underwritten by the Company independent of the selling bank. In addition, all loans, including purchased participations, are evaluated for collectability during the course of the Company’s normal loan review procedures. If the Company deems a participation loan impaired, it applies the same accounting policies and procedures described under “CRITICAL ACCOUNTING POLICIES – Allowance for Loan Losses”.

The average yield earned on loans and loans held for sale was 5.13% in the first quarter of 2014 and 5.40% in the first quarter of 2013.

The specific economic and credit risks associated with our loan portfolio include, but are not limited to, the effects of current economic conditions on our borrowers’ cash flows, real estate market sales volumes, valuations, availability and cost of financing properties, real estate industry concentrations, deterioration in certain credits, interest rate fluctuations, reduced collateral values or non-existent collateral, title defects, inaccurate appraisals, financial deterioration of borrowers, fraud, and any violation of applicable laws and regulations.

 

37


Table of Contents

The Company attempts to reduce these economic and credit risks by adhering to loan to value guidelines for collateralized loans, investigating the creditworthiness of borrowers and monitoring borrowers’ financial position. Also, we establish and periodically review our lending policies and procedures. Banking regulations limit a bank’s credit exposure by prohibiting unsecured loan relationships that exceed 10% of its capital accounts; or 20% of capital accounts if loans in excess of 10% are fully secured. Under these regulations, we are prohibited from having unsecured loan relationships in excess of approximately $16.1 million. Furthermore, we have an internal limit for aggregate credit exposure (loans outstanding plus unfunded commitments) to a single borrower of $14.5 million. Our loan policy requires that the Loan Committee of the Board of Directors approve any loan relationships that exceed this internal limit. At March 31, 2014, the Bank had no loan relationships exceeding these limits.

We periodically analyze our commercial loan portfolio to determine if a concentration of credit risk exists in any one or more industries. We use classification systems broadly accepted by the financial services industry in order to categorize our commercial borrowers. Loan concentrations to borrowers in the following classes exceeded 25% of the Bank’s total risk-based capital at March 31, 2014 (and related balances at December 31, 2013).

 

(In thousands)   

March 31,

2014

    

December 31,

2013

 

 

 

Lessors of 1 to 4 family residential properties

   $                 42,984       $                 43,835   

Multi-family residential properties

     27,245         27,673   

Shopping centers

     29,691         29,953   

 

 

Allowance for Loan Losses

The Company maintains the allowance for loan losses at a level that management believes appropriate to adequately cover the Company’s estimate of probable losses inherent in the loan portfolio. At March 31, 2014 and December 31, 2013, the allowance for loan losses was $4.7 million and $5.3 million, respectively, which management believed to be adequate at each of the respective dates. The judgments and estimates associated with the determination of the allowance for loan losses are described under “CRITICAL ACCOUNTING POLICIES.”

A summary of the changes in the allowance for loan losses and certain asset quality ratios for the first quarter of 2014 and the previous four quarters is presented below.

 

     2014      2013  
     First      Fourth      Third      Second      First  
(Dollars in thousands)    Quarter          Quarter              Quarter              Quarter              Quarter      

 

 

Balance at beginning of period

   $             5,268         5,946         6,457         6,769         6,723   

Charge-offs:

              

Commercial and industrial

     —             (269)         (177)         —             (68)   

Construction and land development

     (236)         —             —             —             (39)   

Commercial real estate

     —             —             (144)         (118)         —       

Residential real estate

     (31)         (250)         (103)         (189)         (266)   

Consumer installment

     (36)         (198)         (137)         (45)         (17)   

 

 

Total charge-offs

     (303)         (717)         (561)         (352)         (390)   

Recoveries

     146         39         50         40         36   

 

 

Net charge-offs

     (157)         (678)         (511)         (312)         (354)   

Provision for loan losses

     (400)         —             —             —             400   

 

 

Ending balance

   $ 4,711         5,268         5,946         6,457         6,769   

 

 

as a % of loans

     1.25%         1.37         1.56         1.65         1.73   

as a % of nonperforming loans

     148%         124         134         138         143   

Annualized net charge-offs as % of average loans

     0.17%         0.71         0.53         0.32         0.36   

 

 

As described under “CRITICAL ACCOUNTING POLICIES,” management assesses the adequacy of the allowance prior to the end of each calendar quarter. The level of the allowance is based upon management’s evaluation of the loan portfolios, past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan loss rates and other pertinent factors. This evaluation is inherently subjective as it requires various material estimates and judgments, including the amounts and

 

38


Table of Contents

timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The ratio of our allowance for loan losses to total loans outstanding was 1.25% at March 31, 2014, compared to 1.37% at December 31, 2013. In the future, the allowance to total loans outstanding ratio will increase or decrease to the extent the factors that influence our quarterly allowance assessment in their entirety either improve or weaken. In addition, our regulators, as an integral part of their examination process, will periodically review the Company’s allowance for loan losses, and may require the Company to make additional provisions to the allowance for losses based on their judgment about information available to them at the time of their examinations.

At March 31, 2014, the ratio of our allowance for loan losses as a percentage of nonperforming loans was 148%, compared to 124% at December 31, 2013. The increase was primarily due to the payoff of one nonperforming commercial real estate loan during the first quarter of 2014 with a total recorded investment of $0.7 million and no related allowance for loan losses at December 31, 2013. Excluding this nonperforming loan, the ratio of our allowance for loan losses as a percentage of nonperforming loans was 150% at December 31, 2013.

At March 31, 2014, the Company’s recorded investment in loans considered impaired was $4.6 million, with a corresponding valuation allowance (included in the allowance for loan losses) of $0.2 million. At December 31, 2013, the Company’s recorded investment in loans considered impaired was $5.6 million, with a corresponding valuation allowance (included in the allowance for loan losses) of $0.3 million.

Nonperforming Assets

At March 31, 2014, the Company had $6.3 million in nonperforming assets, compared to $8.1 million at December 31, 2013. The majority of the balance in nonperforming assets at March 31, 2014 related to deterioration in the commercial real estate and construction and land development loan portfolios.

The table below provides information concerning total nonperforming assets and certain asset quality ratios for the first quarter of 2014 and the previous four quarters.

 

     2014     2013  
     First     Fourth      Third      Second      First  
(Dollars in thousands)    Quarter         Quarter              Quarter              Quarter              Quarter      

 

 

Nonperforming assets:

             

Nonaccrual loans

   $         3,188        4,261         4,425         4,664         4,748   

Other real estate owned

     3,111        3,884         4,585         3,609         4,810   

 

 

Total nonperforming assets

   $ 6,299        8,145         9,010         8,273         9,558   

 

 

as a % of loans and other real estate owned

     1.66     2.10         2.34         2.10         2.42   

as a % of total assets

     0.81     1.08         1.21         1.08         1.24   

Nonperforming loans as a % of total loans

     0.84     1.11         1.16         1.19         1.22   

Accruing loans 90 days or more past due

   $ 131        73         99         —            —      

 

 

The table below provides information concerning the composition of nonaccrual loans for the first quarter of 2014 and the previous four quarters.

 

     2014      2013  
     First      Fourth      Third      Second      First  
(In thousands)    Quarter          Quarter              Quarter              Quarter              Quarter      

 

 

Nonaccrual loans:

              

Commercial and industrial

   $ 54         55         56         57         59   

Construction and land development

     1,371         1,582         1,592         1,601         1,615   

Commercial real estate

     710         1,456         1,467         1,484         1,610   

Residential real estate

     1,046         1,168         1,310         1,520         1,459   

Consumer installment

     7         —            —            2         5   

 

 

Total nonaccrual loans

   $         3,188         4,261         4,425         4,664         4,748   

 

 

 

 

39


Table of Contents

The Company discontinues the accrual of interest income when (1) there is a significant deterioration in the financial condition of the borrower and full repayment of principal and interest is not expected or (2) the principal or interest is 90 days or more past due, unless the loan is both well-secured and in the process of collection. At March 31, 2014, the Company had $3.2 million in loans on nonaccrual, compared to $4.3 million at December 31, 2013.

At March 31, 2014, there were $131,000 in loans 90 days or more past due and still accruing interest compared to $73,000 at December 31, 2013.

The table below provides information concerning the composition of other real estate owned for the first quarter of 2014 and the previous four quarters.

 

     2014      2013  
     First      Fourth      Third      Second      First  
(In thousands)    Quarter          Quarter              Quarter              Quarter              Quarter      

 

 

Other real estate owned:

              

Commercial:

              

Buildings

   $ 1,515         1,772         1,829         535         540   

Developed lots

     1,260         1,260         1,275         1,275         1,275   

Residential:

              

Undeveloped land

     113         113         242         242         1,464   

Other

     223         739         1,239         1,557         1,531   

 

 

Total other real estate owned

   $         3,111         3,884         4,585         3,609         4,810   

 

 

At March 31, 2014 and December 31, 2013, respectively, the Company held $3.1 million and $3.9 million in OREO, which we acquired from borrowers. At March 31, 2014, approximately 89% of the total balance in OREO related to properties acquired from three borrowers with a total carrying value of $2.8 million.

Potential Problem Loans

Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have serious doubts about the borrower’s ability to comply with present repayment terms. This definition is believed to be substantially consistent with the standards established by the Federal Reserve, the Company’s primary regulator, for loans classified as substandard, excluding nonaccrual loans. Potential problem loans, which are not included in nonperforming assets, amounted to $8.4 million, or 2.2% of total loans at March 31, 2014, compared to $10.6 million, or 2.7% of total loans at December 31, 2013.

The table below provides information concerning the composition of performing potential problem loans for the first quarter of 2014 and the previous four quarters.

 

     2014      2013  
     First      Fourth      Third      Second      First  
(In thousands)    Quarter          Quarter              Quarter              Quarter              Quarter      

 

 

Potential problem loans:

              

Commercial and industrial

   $ 449         482         750         884         555   

Construction and land development

     678         1,101         1,118         1,201         1,288   

Commercial real estate

     1,211         1,683         1,700         1,833         2,843   

Residential real estate

     5,913         7,182         7,417         7,772         7,939   

Consumer installment

     106         146         161         146         197   

 

 

Total potential problem loans

   $         8,357         10,594         11,146         11,836         12,822   

 

 

At March 31, 2014, approximately $1.1 million or 13.5% of total potential problem loans were past due at least 30 days but less than 90 days. At March 31, 2014, the remaining balance of potential problem loans were current or past due less than 30 days.

 

40


Table of Contents

The following table is a summary of the Company’s performing loans that were past due at least 30 days but less than 90 days for the first quarter of 2014 and the previous four quarters.

 

     2014      2013  
     First      Fourth      Third      Second      First  
(In thousands)    Quarter          Quarter              Quarter              Quarter              Quarter      

 

 

Performing loans past due 30 to 89 days:

              

Commercial and industrial

   $ 191         167         444         329         47   

Construction and land development

     157         14         —            —            135   

Commercial real estate

     461         861         49         1,498         —       

Residential real estate

     1,834         1,343         489         501         403   

Consumer installment

     86         100         40         147         36   

 

 

Total

   $         2,729         2,485         1,022         2,475         621   

 

 

Deposits

Total deposits were $687.1 million at March 31, 2014, compared to $668.9 million at December 31, 2013. Noninterest bearing deposits were $125.6 million, or 18.3% of total deposits, at March 31, 2014, compared to $125.7 million, or 18.8% of total deposits at December 31, 2013. The increase in total deposits of $18.2 million was primarily due to a $13.1 million increase in public depositor account balances which are generally subject to seasonal fluctuations.

The average rate paid on total interest-bearing deposits was 0.91% in the first quarter of 2014 and 1.06% in the first quarter of 2013.

Other Borrowings

Other borrowings consist of short-term borrowings and long-term debt. Short-term borrowings consist of federal funds purchased and securities sold under agreements to repurchase with an original maturity less than one year. The Bank had available federal funds lines totaling $41.0 million with none outstanding at both March 31, 2014 and December 31, 2013. Securities sold under agreements to repurchase totaled $3.3 million and $3.4 million at March 31, 2014 and December 31, 2013, respectively.

The average rate paid on short-term borrowings was 0.47% in the first quarter of 2014 and 0.57% in the first quarter of 2013.

Long-term debt includes FHLB advances with an original maturity greater than one year and subordinated debentures related to trust preferred securities. The Bank had $5.0 million in long-term FHLB advances at both March 31, 2014 and December 31, 2013. At both March 31, 2014 and December 31, 2013, the Company had $7.2 million in junior subordinated debentures related to trust preferred securities outstanding.

The average rate paid on long-term debt was 3.45% in the first quarter of 2014 and 3.70% in the first quarter of 2013.

CAPITAL ADEQUACY

The Company’s consolidated stockholders’ equity was $68.3 million and $64.5 million as of March 31, 2014 and December 31, 2013, respectively. The change from December 31, 2013 was primarily driven by other comprehensive income due to the change in unrealized gains (losses) on securities available-for-sale of $2.8 million and net earnings of $1.8 million, partially offset by cash dividends paid of $0.8 million.

The Company’s tier 1 leverage ratio was 10.03%, tier 1 risk-based capital ratio was 17.55% and total risk-based capital ratio was 18.64% at March 31, 2014. These ratios exceed the minimum regulatory capital percentages of 5.0% for tier 1 leverage ratio, 6.0% for tier 1 risk-based capital ratio and 10.0% for total risk-based capital ratio to be considered “well-capitalized.” Based on current regulatory standards, the Company is classified as “well capitalized.”

 

41


Table of Contents

MARKET AND LIQUIDITY RISK MANAGEMENT

Management’s objective is to manage assets and liabilities to provide a satisfactory, consistent level of profitability within the framework of established liquidity, loan, investment, borrowing, and capital policies. The Bank’s Asset Liability Management Committee (“ALCO”) is charged with the responsibility of monitoring these policies, which are designed to ensure acceptable composition of asset/liability mix. Two critical areas of focus for ALCO are interest rate sensitivity and liquidity risk management.

Interest Rate Sensitivity Management

In the normal course of business, the Company is exposed to market risk arising from fluctuations in interest rates. ALCO measures and evaluates interest rate risk so that the Bank can meet customer demands for various types of loans and deposits. Measurements used to help manage interest rate sensitivity include an earnings simulation model and an economic value of equity model.

Management uses earnings simulation modeling to estimate and manage interest rate risk. Forecasted levels of earning assets, interest-bearing liabilities, and off-balance sheet financial instruments are combined with ALCO forecasts of market interest rates for the next 12 months and are combined with other factors in order to produce various earnings simulations and estimates. To limit interest rate risk, we have guidelines for earnings at risk which seek to limit the variance of net interest income to less than a 10% decline for a 200 basis point change up or down in rates from management’s flat interest rate forecast over the next twelve months. The results of our current simulation model indicate that we were in compliance with our current guidelines at March 31, 2014.

Economic value of equity measures the extent that estimated economic values of our assets, liabilities and off-balance sheet items will change as a result of interest rate changes. Economic values are estimated by discounting expected cash flows from assets, liabilities and off-balance sheet items, which establishes a base case economic value of equity. To help limit interest rate risk, we have a guideline stating that for a 200 basis point instantaneous change in interest rates up or down, the economic value of equity should not decrease by more than 25%. The results of our current economic value of equity model indicate that we were in compliance with our guidelines at March 31, 2014.

Each of the above analyses may not, on its own, be an accurate indicator of how our net interest income will be affected by changes in interest rates. Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by changes in interest rates. In addition, the magnitude and duration of changes in interest rates may have a significant impact on net interest income. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates, and other economic and market factors, including market perceptions. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types of assets and liabilities may lag behind changes in general market rates. In addition, certain assets, such as adjustable rate mortgage loans, have features (generally referred to as “interest rate caps and floors”) which limit changes in interest rates. Prepayment and early withdrawal levels also could deviate significantly from those assumed in calculating the maturity of certain instruments. The ability of many borrowers to service their debts also may decrease during periods of rising interest rates or economic stress, which may differ across industries and economic sectors. ALCO reviews each of the above interest rate sensitivity analyses along with several different interest rate scenarios in seeking satisfactory, consistent levels of profitability within the framework of the Company’s established liquidity, loan, investment, borrowing, and capital policies.

The Company may also use derivative financial instruments to improve the balance between interest-sensitive assets and interest-sensitive liabilities and as one tool to manage interest rate sensitivity while continuing to meet the credit and deposit needs of our customers. From time to time, the Company may enter into interest rate swaps (“swaps”) to facilitate customer transactions and meet their financing needs. These swaps qualify as derivatives, but are not designated as hedging instruments. At March 31, 2014 and December 31, 2013, the Company had no derivative contracts designated as part of a hedging relationship to assist in managing its interest rate sensitivity.

Liquidity Risk Management

Liquidity is the Company’s ability to convert assets into cash equivalents in order to meet daily cash flow requirements, primarily for deposit withdrawals, loan demand and maturing obligations. Without proper management of its liquidity, the Company could experience higher costs of obtaining funds due to insufficient liquidity, while excessive liquidity can lead to a decline in earnings due to the cost of foregoing alternative higher-yielding investment opportunities.

Liquidity is managed at two levels. The first is the liquidity of the Company. The second is the liquidity of the Bank. The management of liquidity at both levels is essential, because the Company and the Bank are separate legal entities with different funding needs and sources, and each are subject to regulatory guidelines and requirements.

 

42


Table of Contents

The primary source of funding and the primary source of liquidity for the Company include dividends received from the Bank, and secondarily proceeds from the possible issuance of common stock or other securities. Primary uses of funds for the Company include dividends paid to stockholders, stock repurchases, and interest payments on junior subordinated debentures issued by the Company in connection with trust preferred securities. The junior subordinated debentures are presented as long-term debt in the accompanying Consolidated Balance Sheets and the related trust preferred securities are currently includible in Tier 1 Capital for regulatory capital purposes.

Primary sources of funding for the Bank include customer deposits, other borrowings, repayment and maturity of securities, sales of securities, and sale and repayment of loans. The Bank has access to federal funds lines from various banks and borrowings from the Federal Reserve discount window. In addition to these sources, the Bank has participated in the FHLB’s advance program to obtain funding for its growth. Advances include both fixed and variable terms and are taken out with varying maturities. At March 31, 2014, the Bank had a remaining available line of credit with the FHLB totaling $214.5 million. At March 31, 2014, the Bank also had $41.0 million of available federal funds lines with none outstanding. Primary uses of funds include repayment of maturing obligations and growing the loan portfolio.

Management believes that the Company and the Bank have adequate sources of liquidity to meet all known contractual obligations and unfunded commitments, including loan commitments and reasonable borrower, depositor, and creditor requirements over the next twelve months.

Off-Balance Sheet Arrangements, Commitments and Contingencies

At March 31, 2014, the Bank had outstanding standby letters of credit of $8.3 million and unfunded loan commitments outstanding of $38.9 million. Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements. If needed to fund these outstanding commitments, the Bank could liquidate federal funds sold or a portion of securities available-for-sale, or draw on its available credit facilities.

Mortgage lending activities

Since 2009, we have primarily sold residential mortgage loans in the secondary market to Fannie Mae while retaining the servicing of these loans. The sale agreements for these residential mortgage loans with Fannie Mae and other investors include various representations and warranties regarding the origination and characteristics of the residential mortgage loans. Although the representations and warranties vary among investors, they typically cover ownership of the loan, validity of the lien securing the loan, the absence of delinquent taxes or liens against the property securing the loan, compliance with loan criteria set forth in the applicable agreement, compliance with applicable federal, state, and local laws, among other matters.

As of March 31, 2014, the unpaid principal balance of the residential mortgage loans, which we have originated and sold, but retained the servicing rights was $358.4 million. Although these loans are generally sold on a non-recourse basis, except for breaches of customary seller representations and warranties, we may have to repurchase residential mortgage loans in cases where we breach such representations or warranties or the other terms of the sale, such as where we fail to deliver required documents or the documents we deliver are defective. Investors also may require the repurchase of a mortgage loan when an early payment default underwriting review reveals significant underwriting deficiencies, even if the mortgage loan has subsequently been brought current. Repurchase demands are typically reviewed on an individual loan by loan basis to validate the claims made by the investor and to determine if a contractually required repurchase event has occurred. We seek to reduce and manage the risks of potential repurchases or other claims by mortgage loan investors through our underwriting, quality assurance and servicing practices, including good communications with our residential mortgage investors.

We were not required to repurchase any residential mortgage loans in the first quarter of 2014 or during the full year 2013.

We service all residential mortgage loans originated and sold by us to Fannie Mae. As servicer, our primary duties are to: (1) collect payments due from borrowers; (2) advance certain delinquent payments of principal and interest; (3) maintain and administer any hazard, title, or primary mortgage insurance policies relating to the mortgage loans; (4) maintain any required escrow accounts for payment of taxes and insurance and administer escrow payments; and (5) foreclose on defaulted mortgage loans or take other actions to mitigate the potential losses to investors consistent with the agreements governing our rights and duties as servicer.

 

43


Table of Contents

The agreement under which we act as servicer generally specifies a standard of responsibility for actions taken by us in such capacity and provides protection against expenses and liabilities incurred by us when acting in compliance with the respective servicing agreements. However, if we commit a material breach of our obligations as servicer, we may be subject to termination if the breach is not cured within a specified period following notice. The standards governing servicing and the possible remedies for violations of such standards are determined by servicing guides issued by Fannie Mae as well as the contract provisions established between Fannie Mae and the Bank. Remedies could include repurchase of an affected loan.

Although to date repurchase requests related to representation and warranty provisions, and servicing activities have been limited, it is possible that requests to repurchase mortgage loans may increase in frequency if investors more aggressively pursue all means of recovering losses on their purchased loans. As of March 31, 2014, we believe that this exposure is not material due to the historical level of repurchase requests and loss trends, in addition to the fact that 99.6% of our residential mortgage loans serviced for Fannie Mae were current as of such date. We maintain ongoing communications with our investors and will continue to evaluate this exposure by monitoring the level and number of repurchase requests as well as the delinquency rates in our investor portfolios.

Effects of Inflation and Changing Prices

The Condensed Consolidated Financial Statements and related consolidated financial data presented herein have been prepared in accordance with U.S. generally accepted accounting principles and practices within the banking industry which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation.

CURRENT ACCOUNTING DEVELOPMENTS

The following Accounting Standards Updates (“Updates” or “ASUs”) have been issued by the FASB but are not yet effective.

 

   

ASU 2014-01, Accounting for Investments in Qualified Affordable Housing Projects; and

 

   

ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.

Information about these pronouncements is described in more detail below.

ASU 2014-01, Accounting for Investments in Qualified Affordable Housing Projects, amends the criteria a company must meet to elect to account for investments in qualified affordable housing projects using a method other than the cost or equity methods. If the criteria are met, a company is permitted to amortize the initial investment cost in proportion to and over the same period as the total tax benefits the company expects to receive. The amortization of the initial investment cost and tax benefits are to be recorded in the income tax expense line. The Update also requires new disclosures about all investments in qualified affordable housing projects regardless of the accounting method used. These changes are effective for the Company in the first quarter of 2015 with retrospective application. Early adoption is permitted. The Company is evaluating the impact this ASU will have on our consolidated financial statements.

ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure, clarifies the timing of when a creditor is considered to have taken physical possession of residential real estate collateral for a consumer mortgage loan, resulting in the reclassification of the loan receivable to real estate owned. A creditor has taken physical possession of the property when either (1) the creditor obtains legal title through foreclosure, or (2) the borrower transfers all interests in the property to the creditor via a deed in lieu of foreclosure or a similar legal agreement. The Update also requires disclosure of the amount of foreclosed residential real estate property held by the creditor and the recorded investment in residential real estate mortgage loans that are in process of foreclosure. These changes are effective for the Company in the first quarter of 2015 with retrospective application. Early adoption is permitted. Adoption of this ASU will not have a significant impact on the financial statements of the Company.

 

44


Table of Contents

Table 1 – Explanation of Non-GAAP Financial Measures

In addition to results presented in accordance with U.S. generally accepted accounting principles (GAAP), this quarterly report on Form 10-Q includes certain designated net interest income amounts presented on a tax-equivalent basis, a non-GAAP financial measure, including the presentation of total revenue and the calculation of the efficiency ratio.

The Company believes the presentation of net interest income on a tax-equivalent basis provides comparability of net interest income from both taxable and tax-exempt sources and facilitates comparability within the industry. Although the Company believes these non-GAAP financial measures enhance investors’ understanding of its business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP. The reconciliations of these non-GAAP financial measures to their most directly comparable GAAP financial measures are presented below.

 

     2014      2013  
     First      Fourth      Third      Second      First  
(in thousands)    Quarter          Quarter              Quarter              Quarter              Quarter      

 

 

Net interest income (GAAP)

   $ 5,270         5,279         5,270         5,232         5,141   

Tax-equivalent adjustment

     324         342         351         365         382   

 

 

Net interest income (Tax-equivalent)

   $         5,594         5,621         5,621         5,597         5,523   

 

 

 

45


Table of Contents

Table 2—Selected Quarterly Financial Data

 

     2014     2013  
     First     Fourth      Third      Second      First  
(Dollars in thousands, except per share amounts)    Quarter     Quarter      Quarter      Quarter      Quarter  

 

 

Results of Operations

             

Net interest income (a)

   $ 5,594        5,621         5,621         5,597         5,523   

Less: tax-equivalent adjustment

     324        342         351         365         382   

 

 

Net interest income (GAAP)

     5,270        5,279         5,270         5,232         5,141   

Noninterest income

     756        2,140         1,432         2,071         1,655   

 

 

Total revenue

     6,026        7,419         6,702         7,303         6,796   

Provision for loan losses

     (400     —            —            —            400   

Noninterest expense

     3,948        5,188         4,274         4,724         4,226   

Income tax expense

     657        501         636         672         481   

 

 

Net earnings

   $ 1,821        1,730         1,792         1,907         1,689   

 

 

Per share data:

             

Basic and diluted net earnings

   $ 0.50        0.47         0.49         0.52         0.46   

Cash dividends declared

     0.215        0.21         0.21         0.21         0.21   

Weighted average shares outstanding:

             

Basic and diluted

     3,643,161        3,643,110         3,643,028         3,642,955         3,642,918   

Shares outstanding, at period end

     3,643,173        3,643,118         3,643,058         3,642,993         3,642,928   

Book value

   $ 18.74        17.70         18.06         17.90         19.27   

Common stock price

             

High

   $ 25.80        25.75         24.71         22.33         22.60   

Low

     23.20        23.93         22.00         21.54         20.80   

Period end:

     23.20        25.00         24.40         22.00         22.00   

To earnings ratio

     11.72x        12.89         12.64         11.70         11.46   

To book value

     124     141         135         123         114   

Performance ratios:

             

Return on average equity

     11.11     10.33         10.78         10.74         9.47   

Return on average assets

     0.96     0.92         0.95         1.00         0.87   

Dividend payout ratio

     43.00     44.68         42.86         40.38         45.65   

Asset Quality:

             

Allowance for loan losses as a % of:

             

Loans

     1.25     1.37         1.56         1.65         1.73   

Nonperforming loans

     148     124         134         138         143   

Nonperforming assets as a % of:

             

Loans and other real estate owned

     1.66     2.10         2.34         2.10         2.42   

Total assets

     0.81     1.08         1.21         1.08         1.24   

Nonperforming loans as a % of total loans

     0.84     1.11         1.16         1.19         1.22   

Annualized net charge-offs as % of average loans

     0.17     0.71         0.53         0.32         0.36   

Capital Adequacy:

             

Tier 1 risk-based capital ratio

     17.55     17.19         17.29         16.45         16.32   

Total risk-based capital ratio

     18.64     18.40         18.55         17.70         17.57   

Tier 1 Leverage Ratio

     10.03     10.10         9.96         9.76         9.42   

Other financial data:

             

Net interest margin (a)

     3.20     3.20         3.19         3.16         3.09   

Effective income tax rate

     26.51     22.46         26.19         26.06         22.17   

Efficiency ratio (b)

     62.17     66.85         60.60         61.61         58.87   

Selected average balances:

             

Securities

   $ 268,013        260,091         265,380         266,056         263,074   

Loans, net of unearned income

     377,322        379,450         383,460         389,402         396,436   

Total assets

     762,153        748,894         751,311         761,534         777,756   

Total deposits

     678,324        653,825         651,334         652,952         653,802   

Long-term debt

     12,217        21,347         26,782         31,613         46,661   

Total stockholders’ equity

     65,556        67,015         66,485         71,006         71,317   

Selected period end balances:

             

Securities

   $ 279,989        271,219         259,467         270,794         270,219   

Loans, net of unearned income

     377,350        383,339         380,705         390,726         390,570   

Allowance for loan losses

     4,711        5,268         5,946         6,457         6,769   

Total assets

     773,333        751,343         744,602         767,747         772,155   

Total deposits

     687,088        668,844         650,421         666,490         659,056   

Long-term debt

     12,217        12,217         22,217         27,217         37,217   

Total stockholders’ equity

     68,284        64,485         65,807         65,211         70,217   

 

 

 

(a) Tax-equivalent. See “Table 1 - Explanation of Non-GAAP Financial Measures.”
(b) Efficiency ratio is the result of noninterest expense divided by the sum of noninterest income and tax-equivalent net interest income.

 

46


Table of Contents

Table 3—Average Balances and Net Interest Income Analysis

 

     Quarter ended March 31,  
     2014      2013  
            Interest                    Interest         
     Average      Income/      Yield/      Average      Income/      Yield/  
(Dollars in thousands)    Balance      Expense      Rate      Balance      Expense      Rate  

 

  

 

 

    

 

 

 

Interest-earning assets:

                 

Loans and loans held for sale (1)

   $  378,780       $ 4,790         5.13%       $  400,062       $ 5,328         5.40%   

Securities - taxable

     206,630         1,176         2.31%         191,211         874         1.85%   

Securities - tax-exempt (2)

     61,383         951         6.28%         71,863         1,124         6.34%   

 

  

 

 

    

 

 

 

Total securities

     268,013         2,127         3.22%         263,074         1,998         3.08%   

Federal funds sold

     55,120         25         0.18%         60,814         31         0.21%   

Interest bearing bank deposits

     7,700         17         0.90%         593                   

 

  

 

 

    

 

 

 

Total interest-earning assets

     709,613       $ 6,959         3.98%         724,543       $ 7,357         4.12%   

Cash and due from banks

     12,835               16,515         

Other assets

     39,705               36,698         

 

  

 

 

          

 

 

       

Total assets

   $ 762,153             $ 777,756         

 

  

 

 

          

 

 

       

Interest-bearing liabilities:

                 

Deposits:

                 

NOW

   $ 106,331       $ 84         0.32%       $ 105,578       $ 82         0.31%   

Savings and money market

     189,601         237         0.51%         167,928         217         0.52%   

Certificates of deposits less than $100,000

     104,646         313         1.21%         105,452         380         1.46%   

Certificates of deposits and other time
deposits of $100,000 or more

     157,431         623         1.60%         155,858         725         1.89%   

 

  

 

 

    

 

 

 

Total interest-bearing deposits

     558,009         1,257         0.91%         534,816         1,404         1.06%   

Short-term borrowings

     3,478         4         0.47%         2,862         4         0.57%   

Long-term debt

     12,217         104         3.45%         46,661         426         3.70%   

 

  

 

 

    

 

 

 

Total interest-bearing liabilities

     573,704       $ 1,365         0.96%         584,339       $ 1,834         1.27%   

Noninterest-bearing deposits

     120,315               118,986         

Other liabilities

     2,578               3,114         

Stockholders’ equity

     65,556               71,317         

 

  

 

 

          

 

 

       

Total liabilities and stockholders’ equity

   $ 762,153             $ 777,756         

 

  

 

 

          

 

 

       

Net interest income and margin

      $     5,594         3.20%          $     5,523         3.09%   

 

     

 

 

       

 

 

 

 

(1) Average loan balances are shown net of unearned income and loans on nonaccrual status have been included in the computation of average balances.
(2) Yields on tax-exempt securities have been computed on a tax-equivalent basis using an income tax rate of 34%.

 

47


Table of Contents

Table 4—Loan Portfolio Composition

 

     2014      2013  
     First      Fourth      Third      Second      First  
(In thousands)    Quarter      Quarter      Quarter      Quarter      Quarter  

 

 

Commercial and industrial

   $ 54,632         57,780         58,766         56,030         55,736   

Construction and land development

     31,275         36,479         37,062         45,886         41,104   

Commercial real estate

     178,721         174,920         170,520         177,291         178,993   

Residential real estate

     101,433         101,706         102,565         99,021         102,978   

Consumer installment

     11,766         12,893         12,170         12,747         12,026   

 

 

Total loans

     377,827         383,778         381,083         390,975         390,837   

Less: unearned income

     (477)         (439)         (378)         (249)         (267)   

 

 

Loans, net of unearned income

     377,350         383,339         380,705         390,726         390,570   

Less: allowance for loan losses

     (4,711)         (5,268)         (5,946)         (6,457)         (6,769)   

 

 

Loans, net

   $     372,639           378,071           374,759           384,269           383,801     

 

 

 

48


Table of Contents

Table 5—Allowance for Loan Losses and Nonperforming Assets

 

     2014     2013  
     First     Fourth      Third      Second      First  
(Dollars in thousands)        Quarter             Quarter              Quarter              Quarter              Quarter      

 

 

Allowance for loan losses:

             

Balance at beginning of period

   $ 5,268        5,946         6,457         6,769         6,723   

Charge-offs:

             

Commercial and industrial

            (269)         (177)                 (68)   

Construction and land development

     (236)                                (39)   

Commercial real estate

                    (144)         (118)           

Residential real estate

     (31)        (250)         (103)         (189)         (266)   

Consumer installment

     (36)        (198)         (137)         (45)         (17)   

 

 

Total charge-offs

     (303)        (717)         (561)         (352)         (390)   

Recoveries

     146        39         50         40         36   

 

 

Net charge-offs

     (157)        (678)         (511)         (312)         (354)   

Provision for loan losses

     (400)                                400   

 

 

Ending balance

   $ 4,711        5,268         5,946         6,457         6,769   

 

 

as a % of loans

     1.25     1.37         1.56         1.65         1.73   

as a % of nonperforming loans

     148     124         134         138         143   

Annualized net charge-offs as % of average loans

     0.17     0.71         0.53         0.32         0.36   

 

 

Nonperforming assets:

             

Nonaccrual loans

   $ 3,188        4,261         4,425         4,664         4,748   

Other real estate owned

     3,111        3,884         4,585         3,609         4,810   

 

 

Total nonperforming assets

   $ 6,299        8,145         9,010         8,273         9,558   

 

 

as a % of loans and other real estate owned

     1.66     2.10         2.34         2.10         2.42   

as a % of total assets

     0.81     1.08         1.21         1.08         1.24   

Nonperforming loans as a % of total loans

     0.84     1.11         1.16         1.19         1.22   

Accruing loans 90 days or more past due

   $ 131        73         99                   

 

 

 

49


Table of Contents

Table 6—Allocation of Allowance for Loan Losses

 

    2014     2013  
      First Quarter         Fourth Quarter           Third Quarter             Second Quarter             First Quarter      
(Dollars in thousands)   Amount     %*     Amount     %*     Amount     %*     Amount     %*     Amount     %*  

 

 

Commercial and industrial

  $ 482          14.5        $ 386          15.1        $ 546          15.4        $ 675          14.3        $ 569          14.3     

Construction and land
development

    214          8.3          366          9.5          1,189          9.7          1,454          11.7          1,619          10.5     

Commercial real estate

    2,493          47.3          3,186          45.6          3,104          44.7          3,111          45.3          3,571          45.8     

Residential real estate

    1,256          26.8          1,114          26.5          982          26.9          1,125          25.3          885          26.3     

Consumer installment

    266          3.1          216          3.4          125          3.2          92          3.3          125          3.1     

 

 

Total allowance for loan losses

  $     4,711          $     5,268          $     5,946          $       6,457          $       6,769       

 

 

 

* Loan balance in each category expressed as a percentage of total loans.

 

50


Table of Contents

Table 7—CDs and Other Time Deposits of $100,000 or More

 

(Dollars in thousands)            March 31, 2014  

 

 

Maturity of:

  

3 months or less

   $ 15,222   

Over 3 months through 6 months

     16,210   

Over 6 months through 12 months

     44,497   

Over 12 months

     82,122   

 

 

Total CDs and other time deposits of $100,000 or more

   $ 158,051   

 

 

 

51


Table of Contents

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information called for by ITEM 3 is set forth in ITEM 2 under the caption “MARKET AND LIQUIDITY RISK MANAGEMENT” and is incorporated herein by reference.

ITEM 4. CONTROLS AND PROCEDURES

The Company, with the participation of its management, including its Chief Executive Officer and Principal Financial and Accounting Officer, carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based upon that evaluation and as of the end of the period covered by this report, the Company’s Chief Executive Officer and Principal Financial and Accounting Officer concluded that the Company’s disclosure controls and procedures were effective to allow timely decisions regarding disclosure in its reports that the Company files or submits to the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended. There have been no changes in the Company’s internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In the normal course of business, the Company and the Bank from time to time are involved in legal proceedings. The Company and Bank management believe there are no pending or threatened legal, governmental, or regulatory proceedings that upon resolution are expected to have a material adverse effect upon the Company’s or the Bank’s financial condition or results of operations. See also, Part I, Item 3 of the Company’s annual report on Form 10-K for the year ended December 31, 2013.

ITEM 1A. RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I “Item 1A. Risk Factors” in our annual report on Form 10-K for the year ended December 31, 2013, which could materially affect our business, financial condition or future results. The risks described in our annual report on Form 10-K are not the only the risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results in the future. .

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

ISSUER PURCHASES OF EQUITY SECURITIES

 

Period(1)  

Total Number of  
Shares

Purchased  

  Average Price Paid  
per Share  
 

 

Total Number of Shares  
Purchased as Part of  
Publicly Announced  
Plans or Programs  

  Maximum Number of
Shares  that May Yet Be
Purchased Under the Plans
or Programs
January 1 - January 31   ––   ––   ––   ––

February 1 - February 28    

  ––   ––   ––   ––

March 1 - March 31

  ––   ––   ––   ––

Total

  ––   ––   ––   ––

 

(1) Based on trade date, not settlement date.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

 

52


Table of Contents

ITEM 5. OTHER INFORMATION

Not applicable.

ITEM 6. EXHIBITS

 

Exhibit

Number

  

Description

     
3.1    Certificate of Incorporation of Auburn National Bancorporation, Inc. and all amendments thereto.*
3.2    Amended and Restated Bylaws of Auburn National Bancorporation, Inc., adopted as of November 13, 2007. **
31.1    Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, As Adopted Pursuant To Section 302 of the Sarbanes-Oxley Act of 2002, by E.L. Spencer, Jr., President, Chief Executive Officer and Chairman of the Board.
31.2    Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, As Adopted Pursuant To Section 302 of the Sarbanes-Oxley Act of 2002, by David A. Hedges, Vice President, Controller and Chief Financial Officer (Principal Financial and Accounting Officer).
32.1    Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley Act of 2002, by David A. Hedges, Vice President, Controller and Chief Financial Officer (Principal Financial and Accounting Officer).***
32.2    Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley Act of 2002, by E.L. Spencer, Jr., President, Chief Executive Officer and Chairman of the Board.***
101.INS    XBRL Instance Document
101.SCH    XBRL Taxonomy Extension Schema Document
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB    XBRL Taxonomy Extension Label Linkbase Document
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF    XBRL Taxonomy Extension Definition Linkbase Document

 

* Incorporated by reference from Registrant’s Form 10-Q dated September 30, 2002.
** Incorporated by reference from Registrant’s Form 10-K dated March 31, 2008.
*** The certifications attached as exhibits 32.1 and 32.2 to this quarterly report on Form 10-Q are “furnished” to the Securities and Exchange Commission pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed “filed” by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.

 

53


Table of Contents

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.

 

   

AUBURN NATIONAL BANCORPORATION, INC.                 (Registrant)

Date: May 5, 2014     By:   /s/ E. L. Spencer, Jr.
      E. L. Spencer, Jr.
     

President, Chief Executive Officer and

Chairman of the Board

   
Date: May 5, 2014     By:   /s/ David A. Hedges
      David A. Hedges
     

SVP, Controller and Chief Financial Officer

(Principal Financial and Accounting Officer)