CAPITAL CITY BANK GROUP INC - Quarter Report: 2020 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 

FORM 10-Q

 

[x]           QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended March 31, 2020

 

OR

 

[  ]           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ____________ to ____________

 

Commission File Number: 0-13358 

 

Capital City Bank Group, Inc.

(Exact name of Registrant as specified in its charter)

 

 

 

 

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of The Exchange Act.  [  ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

 

At April 30, 2020, 16,811,781 shares of the Registrant's Common Stock, $.01 par value, were outstanding.

 

CAPITAL CITY BANK GROUP, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE PERIOD ENDED MARCH 31, 2020

TABLE OF CONTENTS

 

INTRODUCTORY NOTE

Caution Concerning Forward-Looking Statements

 

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, among others, statements about our beliefs, plans, objectives, goals, expectations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors, many of which are beyond our control.  The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” “target,” “goal,” and similar expressions are intended to identify forward-looking statements.

 

All forward-looking statements, by their nature, are subject to risks and uncertainties.  Our actual future results may differ materially from those set forth in our forward-looking statements.

 

Our ability to achieve our financial objectives could be adversely affected by the factors discussed in detail in Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Part II, Item 1A. “Risk Factors” in this Quarterly Report on Form 10-Q and the following sections of our Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Form 10-K”): (a) “Introductory Note” in Part I, Item 1. “Business” (b) “Risk Factors” in Part I, Item 1A, as updated in our subsequent quarterly reports filed on Form 10-Q; and (c) “Introduction” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in Part II, Item 7, as well as:

 

·          the magnitude and duration of the COVID-19 pandemic and its impact on the global economy and financial market conditions and our business, results of operations and financial condition, including the impact of our participation in government programs related to COVID-19;

·          our ability to successfully manage interest rate risk, liquidity risk, and other risks inherent to our industry;

·          legislative or regulatory changes;

·          changes in monetary and fiscal policies of the U.S. Government;

·          inflation, interest rate, market and monetary fluctuations;

·          the effects of security breaches and computer viruses that may affect our computer systems or fraud related to debit card products;

·          the accuracy of our financial statement estimates and assumptions, including the estimates used for our loan loss reserve, deferred tax asset valuation and pension plan;

·          changes in accounting principles, policies, practices or guidelines;

·          the frequency and magnitude of foreclosure of our loans;

·          the effects of our lack of a diversified loan portfolio, including the risks of geographic and industry concentrations;

·          the strength of the United States economy in general and the strength of the local economies in which we conduct operations;

·          our ability to declare and pay dividends, the payment of which is subject to our capital requirements;

·          changes in the securities and real estate markets;

·          the effect of corporate restructuring, acquisitions or dispositions, including the actual restructuring and other related charges and the failure to achieve the expected gains, revenue growth or expense savings from such corporate restructuring, acquisitions or dispositions;

·          the effects of natural disasters, harsh weather conditions (including hurricanes), widespread health emergencies, military conflict, terrorism or other geopolitical events;

·          our ability to comply with the extensive laws and regulations to which we are subject, including the laws for each jurisdiction where we operate;

·          the willingness of clients to accept third-party products and services rather than our products and services and vice versa;

·          increased competition and its effect on pricing;

·          technological changes;

·          negative publicity and the impact on our reputation;

·          changes in consumer spending and saving habits;

·          growth and profitability of our noninterest income;

·          the limited trading activity of our common stock;

·          the concentration of ownership of our common stock;

·          anti-takeover provisions under federal and state law as well as our Articles of Incorporation and our Bylaws;

·          other risks described from time to time in our filings with the Securities and Exchange Commission; and

·          our ability to manage the risks involved in the foregoing.

 

However, other factors besides those listed in Item 1A Risk Factors or discussed in this Form 10-Q also could adversely affect our results, and you should not consider any such list of factors to be a complete set of all potential risks or uncertainties.  Any forward-looking statements made by us or on our behalf speak only as of the date they are made.  We do not undertake to update any forward-looking statement, except as required by applicable law.

CAPITAL CITY BANK GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 –  BUSINESS AND BASIS OF PRESENTATION

 

Nature of Operations.  Capital City Bank Group, Inc. (“CCBG” or the “Company”) provides a full range of banking and banking-related services to individual and corporate clients through its subsidiary, Capital City Bank, with banking offices located in Florida, Georgia, and Alabama.  The Company is subject to competition from other financial institutions, is subject to regulation by certain government agencies and undergoes periodic examinations by those regulatory authorities.

 

Basis of Presentation.  The consolidated financial statements in this Quarterly Report on Form 10-Q include the accounts of CCBG and its wholly owned subsidiary, Capital City Bank (“CCB” or the “Bank”).  All material inter-company transactions and accounts have been eliminated.  Certain previously reported amounts have been reclassified to conform to the current year’s presentation.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. 

 

The consolidated statement of financial condition at December 31, 2019 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2019.

 

Business Combination.  On March 1, 2020, CCB completed its acquisition of a 51% membership interest in Brand Mortgage Group, LLC (“Brand”) which is now operated as Capital City Home Loans (“CCHL”).  CCHL was consolidated into CCBG’s financial statements effective March 1, 2020.  Assets acquired totaled $52 million (consisting primarily of loans held for sale) and liabilities assumed totaled $42 million (consisting primarily of warehouse line borrowings).  The primary purpose of the acquisition was to gain access to an expanded residential mortgage product line-up and investor base (including a mandatory delivery channel for loan sales) and to generate other operational synergies and cost savings.  CCB made a $7.1 million cash payment for its 51% membership interest and entered into a buyout agreement for the remaining 49% noncontrolling interest resulting in temporary equity with a fair value of $7.4 million.  Goodwill totaling $4.5 million was recorded in connection with this acquisition.  Factors that contributed to the purchase price resulting in goodwill include Brand’s strong management team and expertise in the mortgage industry, historical record of earnings, and operational synergies created as part of the strategic alliance.  At March 31, 2020, temporary equity totaled $7.1 million and reflected a $0.3 net loss for March, 2020 attributable to noncontrolling interest.            

 

Adoption of New Accounting Standard

 

On January 1, 2020, the Company adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (“CECL”) methodology.  The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables and held-to-maturity debt securities.  It also applies to off-balance sheet credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar instruments).  In addition, ASC 326-30 provides a new credit loss model for available-for-sale debt securities.  The most significant change requires credit losses to be presented as an allowance rather than as a write-down on available-for-sale debt securities management does not intend to sell or believes that it is not more likely than not they will be required to sell.  

 

The Company adopted ASC 326 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures.  Results for reporting periods beginning after January 1, 2020 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP.  The adoption of ASC 326 (“CECL”) had an impact of $4.0 million ($3.3 million increase in the allowance for credit losses and $0.7 million increase in the allowance for unfunded loan commitments (liability account)) that was offset by a corresponding decrease in retained earnings of $3.1 million and $0.9 million increase in deferred tax assets.  The increase in the allowance for credit losses required under the ASC 326 generally reflected the impact of reserves calculated over the life of loan, and more specifically higher reserves required for longer duration loan portfolios, and the utilization of a longer historical look-back period in the calculation of loan loss rates (loss given default).  Upon analyzing the debt security portfolios, the Company determined that no allowance was required as these debt securities are government guaranteed treasuries or government agency-backed securities for which the risk of loss was deemed minimal.  Further, certain municipal debt securities held by the Company have been pre-refunded and secured by government guaranteed treasuries.  

The following table illustrates the impact of adopting ASC 326 on January 1, 2020.

 

 

Significant Accounting Policy Changes

 

Upon adoption of ASC 326, the Company revised certain accounting policies for Investment Securities, Loans, and the Allowance for Credit Losses as detailed below. 

 

In addition, certain accounting policies were revised upon the acquisition of Brand on March 1, 2020 and are also discussed in further detail below under the Mortgage Banking Activities section.

 

Investment Securities

 

Investment securities are classified as held-to-maturity and carried at amortized cost when the Company has the positive intent and ability to hold them until maturity.  Investment securities not classified as held-to-maturity or trading securities are classified as available-for-sale and carried at fair value.  The Company determines the appropriate classification of securities at the time of purchase.  For reporting and risk management purposes, we further segment investment securities by the issuer of the security which correlates to its risk profile: U.S. government treasury, U.S. government agency, state and political subdivisions, and mortgage-backed securities.  Certain equity securities with limited marketability, such as stock in the Federal Reserve Bank and the Federal Home Loan Bank, are classified as available-for-sale and carried at cost.   

 

Interest income includes amortization and accretion of purchase premiums and discounts.  Realized gains and losses are derived from the amortized cost of the security sold.  Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.  Securities transferred from available-for-sale to held-to-maturity are recorded at amortized cost plus or minus any unrealized gain or loss at the time of transfer.  Any existing unrecognized gain or loss continues to be reported in accumulated other comprehensive income (net of tax) and amortized as an adjustment to interest income over the remaining life of the security.  Any existing allowance for credit loss is reversed at the time of transfer.  Subsequent to transfer, the allowance for credit losses on the transferred security is evaluated in accordance with the accounting policy for held-to-maturity securities.  Additionally, any allowance amounts reversed or established as part of the transfer are presented on a gross basis in the consolidated statement of income. 

 

The accrual of interest is generally suspended on securities more than 90 days past due with respect to principal or interest.  When a security is placed on nonaccrual status, all previously accrued and uncollected interest is reversed against current income and thus not included in the estimate of credit losses. 

 

Credit losses and changes thereto, are established as an allowance for credit loss through a provision for credit loss expense.  Losses are charged against the allowance when management believes the uncollectibility of an available-for-sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met.

 

Certain debt securities in the Company’s investment portfolio were issued by a U.S. government entity or agency and are either explicitly or implicitly guaranteed by the U.S. government.  The Company considers the long history of no credit losses on these securities indicates that the expectation of nonpayment of the amortized cost basis is zero, even if the U.S. government were to technically default.  Further, certain municipal securities held by the Company have been pre-refunded and secured by government guaranteed treasuries.  Therefore, for the aforementioned securities, the Company does not assess or record expected credit losses due to the zero loss assumption.

 

Impairment - Available-for-Sale Securities.

 

Unrealized gains on available-for-sale securities are excluded from earnings and reported, net of tax, in other comprehensive income (“OCI”).  For available-for-sale securities that are in an unrealized loss position, the Company first assesses whether it intends to sell, or whether it is more likely than not it will be required to sell the security before recovery of its amortized cost basis.  If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income.  For available-for-sale securities that do not meet the aforementioned criteria or have a zero loss assumption, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors.  In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors.  If the assessment indicates that a credit loss exists, the present value of cash flows to be collected from the security are compared to the amortized cost basis of the security.  If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded through a provision for credit loss expense, limited by the amount that fair value is less than the amortized cost basis.  Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income. 

 

Allowance for Credit Losses - Held-to-Maturity Securities.

 

Management measures expected credit losses on each individual held-to-maturity debt security that has not been deemed to have a zero assumption.  Each security that is not deemed to have zero credit losses is individually measured based on net realizable value, or the difference between the discounted value of the expected cash flows, based on the original effective rate, and the recorded amortized basis of the security.  To the extent a shortfall is related to credit loss, an allowance for credit loss is recorded through a provision for credit loss expense.  Any shortfall related to other noncredit-related factors is recognized in other comprehensive income.         

 

Loans

 

Loans are stated at amortized cost which includes the principal amount outstanding, net premiums and discounts, and net deferred loan fees and costs.  Accrued interest receivable on loans is reported in other assets and is not included in the amortized cost basis of loans.  Interest income is accrued on the effective yield method based on outstanding principal balances, and includes loan late fees.  Fees charged to originate loans and direct loan origination costs are deferred and amortized over the life of the loan as a yield adjustment.      

 

The Company defines loans as past due when one full payment is past due or a contractual maturity is over 30 days late.  The accrual of interest is generally suspended on loans more than 90 days past due with respect to principal or interest.  When a loan is placed on nonaccrual status, all previously accrued and uncollected interest is reversed against current income and thus a policy election has been made to not include in the estimate of credit losses.  Interest income on nonaccrual loans is recognized when the ultimate collectability is no longer considered doubtful.  Loans are returned to accrual status when the principal and interest amounts contractually due are brought current or when future payments are reasonably assured. 

 

Loan charge-offs on commercial and investor real estate loans are recorded when the facts and circumstances of the individual loan confirm the loan is not fully collectible and the loss is reasonably quantifiable.  Factors considered in making these determinations are the borrower’s and any guarantor’s ability and willingness to pay, the status of the account in bankruptcy court (if applicable), and collateral value.  Charge-off decisions for consumer loans are dictated by the Federal Financial Institutions Examination Council’s (FFIEC) Uniform Retail Credit Classification and Account Management Policy which establishes standards for the classification and treatment of consumer loans, which generally require charge-off after 120 days of delinquency.

 

The Company has adopted comprehensive lending policies, underwriting standards and loan review procedures designed to maximize loan income within an acceptable level of risk.  Reporting systems are used to monitor loan originations, loan ratings, concentrations, loan delinquencies, nonperforming and potential problem loans, and other credit quality metrics.  The ongoing review of loan portfolio quality and trends by Management and the Credit Risk Oversight Committee support the process for estimating the allowance for credit losses.   

 

Allowance for Credit Losses

 

The allowance for credit losses is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans.  The allowance for credit losses is adjusted by a credit loss provision which is reported in earnings, and reduced by the charge-off of loan amounts, net of recoveries.  Loans are charged off against the allowance when management believes the uncollectibility of a loan balance in confirmed.  Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.  Expected credit loss inherent in non-cancellable off-balance sheet credit exposures is accounted for as a separate liability included in other liabilities.

 

Management estimates the allowance balance using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts.  Historical loan default and loss experience provides the basis for the estimation of expected credit losses.  Adjustments to historical loss information incorporate management’s view of current conditions and forecasts.   

 

The methodology for estimating the amount of credit losses reported in the allowance for credit losses has two basic components: first, an asset-specific component involving loans that do not share risk characteristics and the measurement of expected credit losses for such individual loans; and second, a pooled component for expected credit losses for pools of loans that share similar risk characteristics. 

 

Loans That Do Not Share Risk Characteristics (Individually Analyzed)

 

Loans that do not share similar risk characteristics are evaluated on an individual basis.  Loans deemed to be collateral dependent have differing risk characteristics and are individually analyzed to estimate the expected credit loss.  A loan is collateral dependent when the borrower is experiencing financial difficulty and repayment of the loan is dependent on the liquidation and sale of the underlying collateral.  For collateral dependent loans where foreclosure is probable, the expected credit loss is measured based on the difference between the fair value of the collateral (less selling cost) and the amortized cost basis of the asset.  For collateral dependent loans where foreclosure is not probable, the Company has elected the practical expedient allowed by ASC 326-20 to measure the expected credit loss under the same approach as those loans where foreclosure is probable.  For loans with balances greater than $250,000 the fair value of the collateral is obtained through independent appraisal of the underlying collateral.  For loans with balances less than $250,000, the Company has made a policy election to measure expected loss for these individual loans utilizing loss rates for similar loan types.  The aforementioned measurement criteria are applied for collateral dependent troubled debt restructurings. 

 

Loans That Share Similar Risk Characteristics (Pooled Loans)

 

The general steps in determining expected credit losses for the pooled loan component of the allowance are as follows:

·          Segment loans into pools according to similar risk characteristics

·          Develop historical loss rates for each loan pool segment

·          Incorporate the impact of forecasts

·          Incorporate the impact of other qualitative factors

·          Calculate and review pool specific allowance for credit loss estimate

 

Methodology –

 

A discounted cash flow (“DCF”) methodology is utilized to calculate expected cash flows for the life of each individual loan.  The discounted present value of expected cash flow is then compared to the loan’s amortized cost basis to determine the credit loss estimate.  Individual loan results are aggregated at the pool level in determining total reserves for each loan pool.     

 

The primary inputs used to calculate expected cash flows include historical loss rates which reflect probability of default (“PD”) and loss given default (“LGD”), and prepayment rates.  The historical look-back period is a key factor in the calculation of the PD rate and is based on management’s assessment of current and forecasted conditions and may vary by loan pool.  Loans subject to the Company’s risk rating process are further sub-segmented by risk rating in the calculation of PD rates.  LGD rates generally reflect the historical average net loss rate by loan pool.  Expected cash flows are further adjusted to incorporate the impact of loan prepayments which will vary by loan segment and interest rate conditions.  In general, prepayment rates are based on observed prepayment rates occurring in the loan portfolio and consideration of forecasted interest rates.

   

Forecast Factors –

 

In developing loss rates, adjustments are made to incorporate the impact of forecasted conditions.  Certain assumptions are also applied, including the length of the forecast and reversion periods.  The forecast period is the period within which management is able to make a reasonable and supportable assessment of future conditions.  The reversion period is the period beyond which management believes it can develop a reasonable and supportable forecast, and bridges the gap between the forecast period and the use of historical default and loss rates.  The remainder period reflects the remaining life of the loan.  The length of the forecast and reversion periods are periodically evaluated and based on management’s assessment of current and forecasted conditions and may vary by loan pool.  For purposes of developing a reasonable and supportable assessment of future conditions, management utilizes established industry and economic data points and sources, including the Federal Open Market Committee forecast, with the forecasted unemployment rate being a significant factor.  PD rates for the forecast period will be adjusted accordingly based on management’s assessment of future conditions.  PD rates for the remainder period will reflect the historical mean PD rate.  Reversion period PD rates reflect the difference between forecast and remainder period PD rates closed using a straight-line adjustment over the reversion period.  

 

Qualitative Factors –

 

Loss rates are further adjusted to account for other risk factors that impact loan defaults and losses.  These basis point adjustments are based on management’s assessment of trends and conditions that impact credit risk and resulting loan losses, more specifically internal and external factors that are independent of and not reflected in the quantitative loss rate calculations.  Risk factors management considers in this assessment include trends in underwriting standards, nature/volume/terms of loan originations, past due loans, loan review systems, collateral valuations, concentrations, legal/regulatory/political conditions, and the unforeseen impact of natural disasters.

 

Allowance for Credit Losses on Off-Balance Sheet Credit Exposures

 

The Company estimates expected credit losses over the contractual period in which it is exposed to credit risk through a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company.  The allowance for credit losses on off-balance sheet credit exposures is adjusted as a provision for credit loss expense and is recorded in other liabilities.  The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life and applies the same estimated loss rate as determined for current outstanding loan balances by segment.  Off-balance sheet credit exposures are identified and classified in the same categories as the allowance for credit losses with similar risk characteristics that have been previously mentioned.

 

Mortgage Banking Activities

 

Mortgage Loans Held for Sale and Revenue Recognition

 

Mortgage loans held for sale are carried at fair value under the fair value option with changes in fair value recorded in gain on sale of mortgage loans held for sale on the statement of operations. The fair value of mortgage loans held for sale committed to investors is calculated using observable market information such as the investor commitment, assignment of trade (AOT) or other mandatory delivery commitment prices. The Company bases loans committed to Agency investors based on the Agency’s quoted mortgage backed security (MBS) prices. The fair value of mortgage loans held for sale not committed to investors is based on quoted best execution secondary market prices. If no such quoted price exists, the fair value is determined using quoted prices for a similar asset or assets, such as MBS prices, adjusted for the specific attributes of that loan, which would be used by other market participants.

 

Gains and losses from the sale of mortgage loans held for sale are recognized based upon the difference between the sales proceeds and carrying value of the related loans upon sale and are recorded in gain on sale of mortgage loans held for sale on the statement of operations. Sales proceeds reflect the cash received from investors through the sale of the loan and servicing release premium. If the related mortgage servicing right (MSR) is sold servicing retained, the MSR addition is recorded in gain on sale of mortgage loans held for sale on the statement of operations. Gain on sale of mortgage loans held for sale also includes the unrealized gains and losses associated with the changes in the fair value of mortgage loans held for sale, and the realized and unrealized gains and losses from derivative instruments.

 

Mortgage loans held for sale are considered sold when the Company surrenders control over the financial assets. Control is considered to have been surrendered when the transferred assets have been isolated from the Company, beyond the reach of the Company and its creditors; the purchaser obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets; and the Company does not maintain effective control over the transferred assets through either an agreement that both entitles and obligates the Company to repurchase or redeem the transferred assets before their maturity or the ability to unilaterally cause the holder to return specific assets. The Company typically considers the above criteria to have been met upon acceptance and receipt of sales proceeds from the purchaser.

 

Derivative Instruments

 

The Company holds and issues derivative financial instruments such as interest rate lock commitments (IRLCs) and other forward sale commitments. IRLCs are subject to price risk primarily related to fluctuations in market interest rates. To hedge the interest rate risk on certain IRLCs, the Company uses forward sale commitments, such as to-be-announced securities (TBAs) or mandatory delivery commitments with investors. Management expects these forward sale commitments to experience changes in fair value opposite to the changes in fair value of the IRLCs thereby reducing earnings volatility. Forward sale commitments are also used to hedge the interest rate risk on mortgage loans held for sale that are not committed to investors and still subject to price risk. If the mandatory delivery commitments are not fulfilled, the Company pays a pair-off fee. Best effort forward sale commitments are also executed with investors, whereby certain loans are locked with a borrower and simultaneously committed to an investor at a fixed price. If the best effort IRLC does not fund, there is no obligation to fulfill the investor commitment.

 

The Company considers various factors and strategies in determining what portion of the IRLCs and uncommitted mortgage loans held for sale to economically hedge.  All derivative instruments are recognized as other assets or other liabilities on the balance sheet at their fair value. Changes in the fair value of the derivative instruments are recognized in gain on sale of mortgage loans held for sale on the statement of operations in the period in which they occur. Gains and losses resulting from the pairing-out of forward sale commitments are recognized in gain on sale of mortgage loans held for sale on the statement of operations. The Company accounts for all derivative instruments as free-standing derivative instruments and does not designate any for hedge accounting.

 

Mortgage Servicing Rights (“MSRs”) and Revenue Recognition

 

The Company sells residential mortgage loans in the secondary market and may retain the right to service the loans sold. Upon sale, an MSR asset is capitalized, which represents the then current fair value of future net cash flows expected to be realized for performing servicing activities.  As the Company has not elected to subsequently measure any class of servicing assets under the fair value measurement method, the Company follows the amortization method.  MSRs are amortized to noninterest income (other income) in proportion to and over the period of estimated net servicing income, and assessed for impairment at each reporting date.  MSRs are carried at the lower of the initial capitalized amount, net of accumulated amortization, or estimated fair value, and included in other assets, net, on the consolidated statements of financial condition. 

 

The Company periodically evaluates its MSRs asset for impairment.  Impairment is assessed based on fair value at each reporting date using estimated prepayment speeds of the underlying mortgage loans serviced and stratifications based on the risk characteristics of the underlying loans (predominantly loan type and note interest rate).  As mortgage interest rates fall, prepayment speeds are usually faster and the value of the MSRs asset generally decreases, requiring additional valuation reserve.  Conversely, as mortgage interest rates rise, prepayment speeds are usually slower and the value of the MSRs asset generally increases, requiring less valuation reserve.  A valuation allowance is established, through a charge to earnings, to the extent the amortized cost of the MSRs exceeds the estimated fair value by stratification.  If it is later determined that all or a portion of the temporary impairment no longer exists for a stratification, the valuation is reduced through a recovery to earnings.  An other-than-temporary impairment (i.e., recoverability is considered remote when considering interest rates and loan pay off activity) is recognized as a write-down of the MSRs asset and the related valuation allowance (to the extent a valuation allowance is available) and then against earnings.  A direct write-down permanently reduces the carrying value of the MSRs asset and valuation allowance, precluding subsequent recoveries.

 

Accounting Standards Updates

 

ASU 2019-12, "Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.  ASU 2019-12 simplifies the accounting for income taxes by eliminating certain exceptions to the guidance in ASC 740 related to the approach for intraperiod tax allocation when there is a loss from continuing operations or a gain from other items and the general methodology for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year.   ASU 2019-12 also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill.  ASU 2019-12 is effective for the Company January 1, 2021 and is not expected to have a material impact on the Company’s consolidated financial statements.

 

ASU 2020-01, "Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815).  ASU 2020-01 clarifies the interaction of the accounting for equity securities under Topic 321 and investments accounted for under the equity method of accounting in Topic 323 and the accounting for certain forward contracts and purchased options accounted for under Topic 815.  ASU 2020-01 is effective for the Company on January 1, 2021 and is not expected to have a material impact on the Company’s consolidated financial statements.

 

ASU 2020-02, "Financial Instruments - Credit Losses (Topic 326) and Leases (Topic 842)".  ASU 2020-02 incorporates SEC SAB 119 (updated from SAB 102) into the Accounting Standards Codification (the "Codification") by aligning SEC recommended policies and procedures with ASC 326.  ASU 2020-02 was effective on January 1, 2020 and had no material impact on the Company’s documentation requirements.

 

ASU 2020-03, "Codification Improvements to Financial Instruments".  ASU 2020-03 revised a wide variety of topics in the Codification with the intent to make the Codification easier to understand and apply by eliminating inconsistencies and providing clarifications. ASU 2020-03 was effective immediately upon its release in March 2020 and did not have a material impact on the Company’s consolidated financial statements.

 

ASU 2020-04, "Reference Rate Reform (Topic 848).  ASU 2020-04 provides optional expedients and exceptions for applying GAAP to loan and lease agreements, derivative contracts, and other transactions affected by the anticipated transition away from LIBOR toward new interest rate benchmarks. For transactions that are modified because of reference rate reform and that meet certain scope guidance (i) modifications of loan agreements should be accounted for by prospectively adjusting the effective interest rate and the modification will be considered "minor" so that any existing unamortized origination fees/costs would carry forward and continue to be amortized and (ii) modifications of lease agreements should be accounted for as a continuation of the existing agreement with no reassessments of the lease classification and the discount rate or re-measurements of lease payments that otherwise would be required for modifications not accounted for as separate contracts. ASU 2020-04 also provides numerous optional expedients for derivative accounting. ASU 2020-04 is effective March 12, 2020 through December 31, 2022. An entity may elect to apply ASU 2020-04 for contract modifications as of January 1, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to the date that the financial statements are available to be issued. Once elected for a Topic or an Industry Subtopic within the Codification, the amendments in this ASU must be applied prospectively for all eligible contract modifications for that Topic or Industry Subtopic. We anticipate this ASU will simplify any modifications we execute between the selected start date (yet to be determined) and December 31, 2022 that are directly related to LIBOR transition by allowing prospective recognition of the continuation of the contract, rather than extinguishment of the old contract resulting in writing off unamortized fees/costs. We are evaluating the impacts of this ASU and have not yet determined if the LIBOR transition and this ASU will have material effects on the Company’s business operations and consolidated financial statements.

 

 

⁽¹⁾     Includes Federal Home Loan Bank and Federal Reserve Bank stock, recorded at cost of $3.0 million, $4.8 million, respectively, at March 31, 2020 and includes Federal Home Loan Bank and Federal Reserve Bank stock recorded at cost of $2.9 million and $4.8 million, respectively, at December 31, 2019.

 

Securities with an amortized cost of $295.5 million and $353.8 million at March 31, 2020 and December 31, 2019, respectively, were pledged to secure public deposits and for other purposes.

 

The Bank, as a member of the Federal Home Loan Bank of Atlanta (“FHLB”), is required to own capital stock in the FHLB based generally upon the balances of residential and commercial real estate loans and FHLB advances.  FHLB stock, which is included in equity securities, is pledged to secure FHLB advances.  No ready market exists for this stock, and it has no quoted market value; however, redemption of this stock has historically been at par value.

 

As a member of the Federal Reserve Bank of Atlanta, the Bank is required to maintain stock in the Federal Reserve Bank of Atlanta based on a specified ratio relative to the Bank’s capital.  Federal Reserve Bank stock is carried at cost.