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FIRST COMMUNITY BANKSHARES INC /VA/ - Annual Report: 2018 (Form 10-K)

fcbc20181231_10k.htm
 

 

 

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

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

 

For the fiscal year ended December 31, 2018

 

Commission file number 000-19297

 

 

FIRST COMMUNITY BANKSHARES, INC.

 
 

(Exact name of registrant as specified in its charter)

 

 

     

Virginia

 

55-0694814

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

P.O. Box 989

Bluefield, Virginia 24605-0989

 

(Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number, including area code: (276) 326-9000

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, $1.00 par value

 

NASDAQ Global Select

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

☐ Yes ☑ No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

☐ Yes ☑ No

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 ☐ No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

☑ Yes ☐ No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐

 

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 the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐

Accelerated filer ☑

Non-accelerated filer ☐

Smaller reporting company ☐

 

Emerging growth company ☐

 

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 provided 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 Act).

☐ Yes ☑ No

As of June 30, 2018, the aggregate market value of the registrant’s voting and non-voting common stock held by non-affiliates was $403.76 million.

 

As of February 26, 2019, there were 15,799,187 shares outstanding of the registrant’s Common Stock, $1.00 par value.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Proxy Statement for the Annual Meeting of Stockholders to be held on May 29, 2019, are incorporated by reference in Part III of this Form 10-K.

 

 

 

FIRST COMMUNITY BANKSHARES, INC.

2018 FORM 10-K

INDEX

 

   

Page

PART I

   
     

Item 1.

Business.

4

Item 1A.

Risk Factors.

11

Item 1B.

Unresolved Staff Comments.

18

Item 2.

Properties.

18

Item 3.

Legal Proceedings.

18

Item 4.

Mine Safety Disclosures.

18

     

PART II

   
     

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

19

Item 6.

Selected Financial Data.

21

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

22

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk.

45

Item 8.

Financial Statements and Supplementary Data.

46

Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

102

Item 9A.

Controls and Procedures.

102

Item 9B.

Other Information.

102

     

PART III

   
     

Item 10.

Directors, Executive Officers and Corporate Governance.

103

Item 11.

Executive Compensation.

104

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

104

Item 13.

Certain Relationships and Related Transactions, and Director Independence.

104

Item 14.

Principal Accounting Fees and Services.

104

     

PART IV

   
     

Item 15.

Exhibits, Financial Statement Schedules.

105

 

Signatures

107

 

 

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

Forward-looking statements in filings with the Securities and Exchange Commission, including this Annual Report on Form 10-K and the accompanying Exhibits, filings incorporated by reference, reports to shareholders, and other communications that represent the Company’s beliefs, plans, objectives, goals, guidelines, expectations, anticipations, estimates, and intentions are made in good faith pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and involve certain risks, uncertainties, and assumptions that are difficult to predict. The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” and other similar expressions identify forward-looking statements. The following factors, among others, could cause financial performance to differ materially from that expressed in such forward-looking statements:

 

 

the strength of the U.S. economy in general and the strength of the local economies in which we conduct operations;

 

the effects of, and changes in, trade, monetary, and fiscal policies and laws, including interest rate policies of the Federal Reserve System;

 

inflation, interest rate, market and monetary fluctuations;

 

timely development of competitive new products and services and the acceptance of these products and services by new and existing customers;

 

the willingness of customers to substitute competitors’ products and services for the Company’s products and services and vice versa;

 

the impact of changes in financial services laws and regulations, including laws about taxes, banking, securities, and insurance, and the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act;

 

the impact of the U.S. Department of the Treasury and federal banking regulators’ continued implementation of programs to address capital and liquidity in the banking system;

 

further, future, and proposed rules, including those that are part of the process outlined in the Basel Committee on Banking Supervision’s “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems,” which require banking institutions to increase levels of capital;

 

technological changes;

 

the effect of acquisitions, including, without limitation, the failure to achieve the expected revenue growth and/or expense savings from such acquisitions;

 

the growth and profitability of noninterest, or fee, income being less than expected;

 

unanticipated regulatory or judicial proceedings;

 

changes in consumer spending and saving habits; and

 

the Company’s success at managing the risks mentioned above.

 

The list of important factors is not exclusive. If one or more of the factors affecting these forward-looking statements proves incorrect, actual results, performance, or achievements could differ materially from those expressed in, or implied by, forward-looking statements contained in this Annual Report on Form 10-K and other reports we file with the Securities and Exchange Commission. Therefore, the Company cautions you not to place undue reliance on forward-looking information and statements. The Company does not intend to update any forward-looking statements, whether written or oral, to reflect changes. These cautionary statements expressly qualify all forward-looking statements that apply to the Company including the risk factors presented in Part I, Item 1A of this report.

 

 

PART I

 

Item 1.

Business.

 

General

 

First Community Bankshares, Inc. (the “Company”), a financial holding company, was founded in 1989 and incorporated under the laws of the Commonwealth of Virginia in 2018. The Company is the successor to First Community Bancshares, Inc., a Nevada corporation, pursuant to an Agreement and Plan of Reincorporation and Merger, the sole purpose of which was to change the Company’s state of incorporation from Nevada to Virginia. The reincorporation was completed on October 2, 2018. The Company’s principal executive office is located at One Community Place, Bluefield, Virginia. The Company provides banking products and services to individual and commercial customers through its wholly owned subsidiary First Community Bank (the “Bank”), a Virginia-chartered banking institution founded in 1874. The Bank operates as First Community Bank in Virginia, West Virginia, and North Carolina and People’s Community Bank, a Division of First Community Bank, in Tennessee. The Bank offers wealth management and investment advice through its Trust Division and wholly owned subsidiary First Community Wealth Management. Unless the context suggests otherwise, the terms “First Community,” “Company,” “we,” “our,” and “us” in this Annual Report on Form 10-K refer to First Community Bankshares, Inc. and its subsidiaries as a consolidated entity.

 

We focus on building financial partnerships and creating enduring and complete relationships with businesses and individuals through a personal and local approach to banking and financial services. We strive to be the bank of choice in the markets we serve by offering impeccable service and a complete line of competitive products that include:

 

 

demand deposit accounts, savings and money market accounts, certificates of deposit, and individual retirement arrangements;

 

commercial, consumer, and real estate mortgage loans and lines of credit;

 

various credit card, debit card, and automated teller machine card services;

 

corporate and personal trust services; and

 

investment management services.

 

Our operations are guided by a strategic plan that focuses on organic growth supplemented by strategic acquisitions of complementary financial institutions. For a summary of our financial performance, see Item 6, “Selected Financial Data,” in Part II of this report.

 

Employees

 

As of December 31, 2018, we had 519 full-time equivalent employees. Our employees are not represented by collective bargaining agreements and we consider employee relations to be excellent.

 

Market Area

 

As of December 31, 2018, we operated 44 branch locations in Virginia, West Virginia, North Carolina, and Tennessee through our sole operating segment, Community Banking. Economic indicators in our market areas show relatively stable employment and business conditions. We serve a diverse base of individuals and businesses across a variety of industries such as education, government, and health services; coal mining and gas extraction; retail trade; construction; manufacturing; tourism; and transportation.

 

Competition

 

The financial services industry is highly competitive and constantly evolving. We encounter strong competition in attracting and retaining deposit, loan, and other financial relationships in our market areas. We compete with other commercial banks, thrifts, savings and loan associations, credit unions, consumer finance companies, mortgage banking firms, commercial finance and leasing companies, securities firms, brokerage firms, and insurance companies. We have positioned ourselves as a regional community bank that provides an alternative to larger banks, which often place less emphasis on personal relationships, and smaller community banks, which lack the capital and resources to efficiently serve customer needs. Factors that influence our ability to remain competitive include the ability to develop, maintain, and build long-term customer relationships; the quality, variety, and pricing of products and services; the convenience of banking locations and office hours; technological developments; and industry and general economic conditions. We seek to mitigate these pressures with our relationship style of banking, competitive pricing, cost efficiencies, and disciplined approach to loan underwriting.

 

 

Supervision and Regulation

 

Overview

 

We are subject to extensive examination, supervision, and regulation under applicable federal and state laws and various regulatory agencies. These regulations are intended to protect consumers, depositors, borrowers, deposit insurance funds, and the stability of the financial system and are not for the protection of stockholders or creditors.

 

Applicable laws and regulations restrict our permissible activities and investments and impose conditions and requirements on the products and services we offer and the manner in which they are offered and sold. They also restrict our ability to repurchase stock or pay dividends, or to receive dividends from our banking subsidiary, and impose capital adequacy requirements on the Company and the Bank. The consequences of noncompliance with these laws and regulations can include substantial monetary and nonmonetary sanctions.

 

The following discussion summarizes significant laws and regulations applicable to the Company and the Bank. These summaries are not intended to be complete and are qualified in their entirety by reference to the applicable statute or regulation. Changes in laws and regulations may have a material effect on our business, financial condition, or results of operations.

 

First Community Bankshares, Inc.

 

The Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, (“BHC Act”) and a financial holding company under the Gramm-Leach-Bliley Act of 1999 (“GLB Act”). The Company elected financial holding company status in December 2006. The Company and its subsidiaries are subject to supervision, regulation, and examination by the Board of Governors of the Federal Reserve System (“Federal Reserve”). The BHC Act generally provides for umbrella regulation of financial holding companies, such as the Company, by the Federal Reserve, as well as functional regulation of financial holding company subsidiaries by applicable regulatory agencies. The Federal Reserve is granted the authority, in certain circumstances, to require reports of, examine, and adopt rules applicable to any bank holding company subsidiary.

 

The Company is also subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, (“Exchange Act”), as administered by the Securities and Exchange Commission (“SEC”). The Company’s common stock is listed on the NASDAQ Global Select Market under the trading symbol FCBC and is subject to NASDAQ’s rules for listed companies.

 

First Community Bank

 

The Bank is a Virginia chartered bank and a member of the Federal Reserve subject to supervision, regulation, and examination by the Virginia Bureau of Financial Institutions and the Federal Reserve Bank (“FRB”) of Richmond. The Bank is a member of the Federal Deposit Insurance Corporation (“FDIC”), and its deposits are insured by the FDIC to the extent provided by law. The regulations of these agencies govern most aspects of the Bank’s business, including requirements concerning the allowance for loan losses, lending and mortgage operations, interest rates received on loans and paid on deposits, the payment of dividends, loans to affiliates, mergers and acquisitions, capital, and the establishment of branches. Various consumer and compliance laws and regulations also affect the Bank’s operations.

 

As a member bank, the Bank is required to hold stock in the FRB of Richmond in an amount equal to 6% of its capital stock and surplus (half paid to acquire the stock with the remainder held as a cash reserve). Member banks do not have any control over the Federal Reserve as a result of owning the stock and the stock cannot be sold or traded.

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) of 2010 significantly restructured the U.S. financial regulatory regime. The Dodd-Frank Act is extensive, complicated, and comprehensive legislation that impacts practically all aspects of a banking organization, including the following provisions:

 

 

centralizes responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau (“CFPB”), responsible for implementing, examining and enforcing compliance with federal consumer financial laws;

 

requires financial holding companies, such as the Company, to be well-capitalized and well-managed (bank holding companies and banks must also be well-capitalized and well-managed to engage in interstate bank acquisitions);

 

 

 

imposes comprehensive regulation of the over-the-counter derivatives market, which would include certain provisions that would effectively prohibit insured depository institutions from conducting certain derivatives businesses in the institutions themselves;

 

implements corporate governance revisions, including executive compensation and proxy access by shareholders;

 

makes permanent the $250 thousand limit for federal deposit insurance;

 

repeals the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts;

 

amends the Electronic Fund Transfer Act to, among other things, give the Federal Reserve the authority to establish rules about interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and enforces a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer; and

 

increases the authority of the Federal Reserve to examine bank holding companies, such as the Company, and their non-bank subsidiaries.

 

Many of the provisions of the Dodd-Frank Act and other laws are subject to further rulemaking, guidance, and interpretation by applicable federal regulators. We continue to evaluate the impact of any new regulations.

 

Permitted Activities under the BHC Act

 

The BHC Act limits the activities of bank holding companies, such as the Company, to the business of banking, managing or controlling banks and other activities the Federal Reserve determines to be closely related to banking. A bank holding company that elects treatment as a financial holding company under the GLB Act, such as the Company, may engage in a broader range of activities that are financial in nature or complementary to a financial activity and do not pose a substantial risk to the safety and soundness of depository institutions or the financial system. These activities include securities underwriting, dealing, and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; and other activities that the Federal Reserve determines to be closely related to banking.

 

In order to maintain financial holding company status, the Company and the Bank must be well-capitalized and well-managed under applicable Federal Reserve regulations and have received at least a satisfactory rating under the Community Reinvestment Act (“CRA”). See “Prompt Corrective Action” and “Community Reinvestment Act” below. If we fail to meet these requirements, the Federal Reserve may impose corrective capital and managerial requirements and place limitations or conditions on our ability to conduct activities permissible for financial holding companies. If the deficiencies persist, the Federal Reserve may require the Company to divest the Bank or divest investments in companies engaged in activities permissible only for financial holding companies.

 

The Company is required to give the Federal Reserve prior notice of any redemption or repurchase of its own equity securities, subject to certain exemptions, if the consideration to be paid, together with the consideration paid for any repurchases or redemptions in the preceding 12 months, is equal to 10% or more of the Company’s consolidated net worth. The Federal Reserve may oppose the transaction if it believes that the transaction would constitute an unsafe or unsound practice or would violate any law or regulation.

 

The BHC Act requires that bank holding companies obtain the Federal Reserve’s approval before acquiring direct or indirect ownership or control of more than 5% of the voting shares or all, or substantially all, of the assets of a bank. The regulatory authorities are required to consider the financial and managerial resources and future prospects of the bank holding company and the target bank, the convenience and needs of the communities to be served, and various competitive factors when approving acquisitions. The BHC Act also prohibits a bank holding company from acquiring direct or indirect control of more than 5% of the outstanding voting stock of any company engaged in a non-banking business unless the Federal Reserve determines it to be closely related to banking.

 

Capital Requirements

 

We are subject to various regulatory capital requirements administered by the Federal Reserve. The current risk-based capital requirements are based on the December 2010 international capital standards of the Basel Committee on Banking Supervision (“Basel Committee”), known as Basel III.

 

On July 2, 2013, the Federal Reserve approved capital rules for U.S. banking organizations implementing Basel III (“Basel III Capital Rules”) and certain requirements of the Dodd-Frank Act to remove references to credit ratings from the federal banking agencies’ rules. Basel III Capital Rules (1) introduced a new Common Equity Tier 1 (“CET1”) capital measure, (2) specified that Tier 1 capital consist of CET1 and additional Tier 1 capital instruments meeting specified requirements, (3) defined CET1 narrowly by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital, and (4) expanded the scope of the deductions/adjustments to capital as compared to prior regulations. The following initial minimum capital ratios became effective, subject to a phase-in period, for the Company and the Bank under Basel III Capital Rules on January 1, 2015:

 

 

4.5% CET1 to risk-weighted assets

 

6.0% Tier 1 capital (CET1 plus additional Tier 1 capital) to risk-weighted assets

 

8.0% Total capital (Tier 1 plus Tier 2 capital) to risk-weighted assets

 

4.0% Tier 1 leverage ratio

 

 

Basel III Capital Rules introduced a capital conservation buffer designed to absorb losses during periods of economic stress. The capital conservation buffer was implemented on January 1, 2016, at 0.625% and was phased in over a four-year period (increased an additional 0.625% each year until it reached 2.5% on January 1, 2019). Basel III Capital Rules also provide for a countercyclical capital buffer that applies to certain covered institutions; however, the buffer does not apply to the Company or the Bank. Banking institutions with a CET1 to risk-weighted assets ratio above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, if applicable) face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.

 

When fully phased in on January 1, 2019, Basel III Capital Rules will require an additional capital conservation buffer of 2.5% of CET1, effectively resulting in the following minimum ratios:

 

 

7.0% CET1 to risk-weighted assets

 

8.5% Tier 1 capital to risk-weighted assets

 

10.5% Total capital to risk-weighted assets

 

4.0% Tier 1 leverage ratio

 

In August 2018, the Federal Reserve issued an interim final rule, which expanded the applicability of the Small Bank Holding Company Policy Statement through an increase in the size limitation for qualifying bank holding companies from $1 billion to $3 billion in total consolidated assets. As a result, the Company qualifies under the Small Bank Holding Company Policy Statement for exemption from the Federal Reserve’s consolidated risk-based capital requirements at the holding company level. Management believes that the Company and the Bank would meet all capital adequacy requirements under Basel III Capital Rules on a fully phased-in basis, if such requirements were in effect, as of December 31, 2018.

 

Basel III Capital Rules provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that certain deferred tax assets and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories, in the aggregate, exceed 15% of CET1. Implementation of the deductions and other adjustments to CET1 began on January 1, 2015, at 40% and were phased in over a four-year period (increasing an additional 20% each year until it reached 100% on January 1, 2018).

 

Basel III Capital Rules prevent certain hybrid securities, such as trust preferred securities, as Tier 1 capital of bank holding companies, subject to phase-out. The rules do not require a phase-out of trust preferred securities issued before May 19, 2010, for holding companies of depository institutions with less than $15 billion in consolidated total assets, as of December 1, 2009.

 

Basel III Capital Rules prescribe a standardized approach for risk weightings that expand the risk-weighting categories from the four Basel I categories (0%, 20%, 50% and 100%) to a larger and more risk-sensitive number of categories, depending on the nature of the assets, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures, and resulting in higher risk weights for a variety of asset categories.

 

Prompt Corrective Action

 

The federal banking regulators are required to take prompt corrective action with respect to capital-deficient institutions. Agency regulations define, for each capital category, the levels at which institutions are well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, or critically undercapitalized. An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if the appropriate federal regulators determine that it is engaging in an unsafe or unsound practice or is in an unsafe or unsound condition. A bank’s capital category is determined solely for applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the bank’s financial condition or prospects for other purposes.

 

 

The Bank was classified as well-capitalized under prompt corrective action regulations as of December 31, 2018. In order to be considered a well-capitalized institution under Basel III Capital Rules, an organization must not be subject to any written agreement, order, capital directive, or prompt corrective action directive and must maintain the following minimum capital ratios:

 

 

6.5% CET1 to risk-weighted assets

 

8.0% Tier 1 capital to risk-weighted assets

 

10.0% Total capital to risk-weighted assets

 

5.0% Tier 1 leverage ratio

 

Undercapitalized institutions are required to submit a capital restoration plan to federal banking regulators. Under the Federal Deposit Insurance Act, as amended (“FDIA”), in order for the capital restoration plan to be accepted by the appropriate federal banking agency, a bank holding company must provide appropriate assurances of performance and guarantee that its subsidiary bank will comply with its capital restoration plan, subject to certain limitations. Agency regulations contain broad restrictions on certain activities of undercapitalized institutions, including asset growth, acquisitions, establishing branches, and engaging in new lines of business. With certain exceptions, a depository institution is prohibited from making capital distributions, including dividends, and is prohibited from paying management fees to its parent holding company if the institution would be undercapitalized after such distribution or payment.

 

A significantly undercapitalized institution is subject to various requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, and ending deposits from correspondent banks. The FDIC has limited discretion in dealing with a critically undercapitalized institution and is generally required to appoint a receiver or conservator.

 

Safety and Soundness Standards

 

Guidelines adopted by federal bank regulatory agencies establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage risks and exposures. If an institution fails to meet safety and soundness standards, the regulatory agencies may require the institution to submit a written compliance plan describing the steps they would take to correct the situation and the time that such steps would be taken. If an institution fails to submit or implement an acceptable compliance plan, after being notified, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions, such as those applicable to undercapitalized institutions under the prompt corrective action provisions of the FDIA. An institution may be subject to judicial proceedings and civil money penalties if it fails to follow such an order.

 

Payment of Dividends

 

The Company is a legal entity that is separate and distinct from its subsidiaries. The Company’s principal source of cash flow is derived from dividends paid by the Bank. There are various restrictions by regulatory agencies related to dividends paid by the Bank to the Company and dividends paid by the Company to its shareholders. The payment of dividends by the Company and the Bank may be limited by certain factors, such as requirements to maintain capital above regulatory guideline minimums.

 

Prior FRB approval is required for the Bank to declare or pay a dividend to the Company if the total of all dividends declared in any given year exceed the total of the Bank’s net profits for that year and its retained profits for the preceding two years, less any required transfers to surplus or to fund the retirement of preferred stock. Dividends paid by the Company to shareholders are subject to oversight by the Federal Reserve. Federal Reserve policy states that bank holding companies generally should pay dividends on common stock only from income available over the past year if prospective earnings retention is consistent with the organization’s expected future needs, asset quality, and financial condition.

 

Regulatory agencies have the authority to limit or prohibit the Company and the Bank from paying dividends if the payments are deemed to constitute an unsafe or unsound practice. The appropriate regulatory authorities have stated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsafe and unsound banking practice and that banking organizations should generally pay dividends only from current operating earnings. In addition, the Bank may not declare or pay a dividend if, after paying the dividend, the Bank would be classified as undercapitalized. In the current financial and economic environment, the FRB has discouraged payout ratios that are at maximum allowable levels, unless both asset quality and capital are very strong, and has noted that bank holding companies should carefully review their dividend policy. Bank holding companies should not maintain dividend levels that undermine their ability to be a source of strength to their banking subsidiaries.

 

 

Source of Strength

 

Federal Reserve policy and federal law requires the Company to act as a source of financial and managerial strength to the Bank. Under this requirement, the Company is expected to commit resources to support the Bank even when it may not be in a financial position to provide such resources. Because the Company is a legal entity separate and distinct from its subsidiaries, any capital loans it makes to the Bank are subordinate in right of payment to depositors and to certain other indebtedness of the Bank. In the event of the Company’s bankruptcy, any commitment by the Company to a federal bank regulatory agency to maintain the capital of the Bank will be assumed by the bankruptcy trustee and entitled to priority of payment.

 

Transactions with Affiliates

 

The Federal Reserve Act (“FRA”) and Federal Reserve Regulation W place restrictions on “covered transactions” between the Bank and its affiliates, including the Company. The term “covered transactions” includes making loans, purchasing assets, issuing guarantees, and other similar transactions. The Dodd-Frank Act expanded the definition of “covered transactions” to include derivative activities, repurchase agreements, and securities lending or borrowing activities. These restrictions limit the amount of transactions with affiliates, require certain levels of collateral for loans to affiliates, and require that all transactions with affiliates be on terms that are consistent with safe and sound banking practices. In addition, these transactions must be on terms that are substantially the same, or at least as favorable to the Bank, as those prevailing at the time for similar transactions with non-affiliates.

 

The FRA and Federal Reserve Regulation O place restrictions on loans between the Company and the Bank and their directors, executive officers, principal shareholders, affiliates, and interests of those directors, executive officers, and principal shareholders. These restrictions limit the amount of loans to one borrower and require that loans are on terms that are substantially the same as, and follow underwriting procedures that are not less stringent than, those prevailing at the time for similar loans with non-insiders. In addition, the aggregate limit of loans to all insiders, as a group, cannot exceed the Bank’s total unimpaired capital and surplus.

 

Deposit Insurance and Assessments

 

Substantially all of the Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and are subject to quarterly deposit insurance assessments to maintain the DIF. Deposit insurance premiums are assessed using a risk-based system that places FDIC-insured institutions into one of four risk categories based on capital, supervisory ratings and other factors. The assessment rate determined by considering such information is then applied to the institution's average assets minus average tangible equity to determine the institution's insurance premium. The FDIC may change assessment rates or revise its risk-based assessment system if deemed necessary to maintain an adequate reserve ratio for the DIF. The Dodd-Frank Act required that the minimum reserve ratio for the DIF increase from 1.15% to 1.35% by September 30, 2020. Under the FDIA, the FDIC may terminate deposit insurance if it determines that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC. The Bank’s FDIC deposit insurance assessments were $840 thousand in 2018, $797 thousand in 2017, and $1.25 million in 2016.

 

In addition, all FDIC-insured institutions must pay annual assessments to fund interest payments on bonds issued by the Financing Corporation (“FICO”). The FICO is a mixed-ownership government corporation that was formed to borrow the money necessary to carry out the closing and ultimate disposition of failed thrift institutions by the Resolution Trust Corporation. The Bank’s FICO assessments, which are set quarterly, were $66 thousand in 2018, $113 thousand in 2017, and $124 thousand in 2016.

 

The Volcker Rule

 

The Dodd-Frank Act amended the BHC Act to prohibit depository institutions and their affiliates from engaging in proprietary trading and from investing in, sponsoring, or having certain relationships with hedge funds or private equity funds, known as the Volcker Rule. These prohibitions are subject to a number of statutory exemptions, restrictions, and definitions. The Volcker Rule became effective on April 1, 2014, but the Federal Reserve extended the conformance period for certain requirements to July 21, 2017. Upon application of a banking entity, the Federal Reserve may provide an additional transition period of up to 5 years to conform investments in a limited class of legacy illiquid funds. The Volcker Rule has not had a material effect on the operations of the Company and subsidiaries, as the Company does not engage in the businesses prohibited by the Volcker Rule. The Company may incur costs to adopt additional policies and systems to ensure compliance with the Volcker Rule, but any such costs are not expected to be material.

 

 

Community Reinvestment Act

 

The CRA of 1977, as amended, requires depository institutions to help meet the credit needs of their market areas, including low- and moderate-income individuals and communities, consistent with safe and sound banking practices. Federal banking regulators periodically examine depository institutions and assign ratings based on CRA compliance. A rating of less than satisfactory may restrict certain operating activities, delay or deny certain transactions, or result in an institution losing its financial holding company status. The Bank received a rating of satisfactory in its most recent CRA examination.

 

Incentive Compensation

 

Federal regulatory agencies have issued comprehensive guidance intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance is based on the key principles that a banking organization’s incentive compensation arrangements should (1) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (2) be compatible with effective internal controls and risk management, and (3) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.

 

Federal banking regulators periodically examine the incentive compensation arrangements of banking organizations and incorporate any deficiencies in the organization’s supervisory ratings, which can affect certain operating activities. The FRB may initiate enforcement actions if the organization’s incentive compensation arrangements or related risk management, control, or governance processes pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies. The scope and content of the U.S. banking regulators’ policies on incentive compensation are continuing to develop. It cannot be determined at this time if or when a final rule will be adopted or if compliance with such a final rule will adversely affect the ability of the Company and its subsidiaries to hire, retain and motivate their key employees.

 

Anti-Tying Restrictions

 

The Bank and its affiliates are prohibited from tying the provision of certain services, such as extensions of credit, to other services offered by the Company.

 

Consumer Protection and Privacy

 

We are subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. These laws and regulations include the Mortgage Reform and Anti-Predatory Lending Act, the Truth in Lending Act, the Truth in Savings Act, the Home Mortgage Disclosure Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Right to Financial Privacy Act, the Fair Housing Act, and various state law counterparts. These laws and regulations contain extensive customer privacy protection provisions that limit the ability of financial institutions to disclose non-public information about consumers to non-affiliated third parties and require financial institutions to disclose certain policies to consumers.

 

The CFPB is a federal agency with broad authority to implement, examine, and enforce compliance with federal consumer protection laws that relate to credit card, deposit, mortgage, and other consumer financial products and services. The CFPB may enforce actions to prevent and remedy unfair, deceptive, or abusive acts and practices related to consumer financial products and services. The agency has authority to impose new disclosure requirements for any consumer financial product or service. The CFPB may impose a civil penalty or injunction against an entity in violation of federal consumer financial laws.

 

Cybersecurity

 

In March 2015, federal regulators issued two related statements about cybersecurity. One statement indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. The other statement indicates that a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption, and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. If the Bank fails to observe the regulatory guidance, the Bank could be subject to various regulatory sanctions, including financial penalties.

 

 

Bank Secrecy Act and Anti-Money Laundering

 

The Bank is subject to the requirements of the Bank Secrecy Act and the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act (“USA PATRIOT Act”) of 2001. The USA PATRIOT Act broadened existing anti-money laundering legislation by imposing new compliance and due diligence obligations focused on detecting and reporting money laundering transactions. These laws and regulations require the Bank to implement policies, procedures, and controls to detect, prevent, and report money laundering and terrorist financing and to verify the identity of our customers. Violations can result in substantial civil and criminal sanctions. In addition, provisions of the USA PATRIOT Act require the federal financial regulatory agencies to consider the effectiveness of a financial institution's anti-money laundering activities when reviewing mergers and acquisitions.

 

Office of Foreign Assets Control Regulation

 

The U.S. Department of the Treasury’s (“Treasury”) Office of Foreign Assets Control (“OFAC”) administers and enforces economic and trade sanctions against targeted foreign countries and regimes, under authority of various laws, including designated foreign countries, nationals, and others. OFAC publishes lists of specially designated targets and countries. We are responsible for, among other things, blocking accounts of, and transactions with, such targets and countries, prohibiting unlicensed trade and financial transactions with them, and reporting blocked transactions after their occurrence. Failure to comply with these sanctions could have serious legal, financial, and reputational consequences, including causing applicable bank regulatory authorities to not approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required.

 

Sarbanes-Oxley Act

 

The Sarbanes-Oxley Act (“SOX Act”) of 2002 addresses a broad range of corporate governance, auditing and accounting, executive compensation, and disclosure requirements for public companies and their directors and officers. The SOX Act requires our Chief Executive Officer and Chief Financial Officer to certify the accuracy of certain information included in our quarterly and annual reports. The rules require these officers to certify that they are responsible for establishing, maintaining, and regularly evaluating the effectiveness of our financial reporting and disclosure controls and procedures; that they have made certain disclosures to the auditors and to the Audit Committee of the Board of Directors about our controls and procedures; and that they have included information in their quarterly and annual filings about their evaluation and whether there have been significant changes to the controls and procedures or other factors which would significantly impact these controls subsequent to their evaluation. Section 404 of the SOX Act requires management to undertake an assessment of the adequacy and effectiveness of our internal controls over financial reporting and requires our auditors to attest to and report on the effectiveness of these controls.

 

Available Information

 

We file annual, quarterly, and current reports; proxy statements; and other information with the SEC. You may read and copy any document we file with the SEC at the SEC’s website at www.sec.gov that contains reports, proxy and information statements, and other information that issuers file electronically with the SEC. We maintain a website at www.firstcommunitybank.com that makes available, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and other information, including any amendments to those reports as soon as reasonably practicable after such reports are filed with, or furnished to, the SEC. You are encouraged to access these reports and other information about our business from the Investor Relations section of our website. The Investor Relations section contains information about our Board of Directors, executive officers, and corporate governance policies and principles, which include the charters of the standing committees of the Board of Directors, the Insider Trading Policy, and the Standards of Conduct governing our directors, officers, and employees. Information on our website is not incorporated by reference in this report.

 

Item 1A.

Risk Factors.

 

The risk factors described below discuss potential events, trends, or other circumstances that could adversely affect our business, financial condition, results of operations, cash flows, liquidity, access to capital resources, and, consequently, cause the market value of our common stock to decline. These risks could cause our future results to differ materially from historical results and expectations of future financial performance. If any of the risks occur and the market price of our common stock declines significantly, individuals may lose all, or part, of their investment in our Company. Individuals should carefully consider our risk factors and information included, or incorporated by reference, in this report before making an investment decision. There may be risks and uncertainties that we have not identified or that we have deemed immaterial that could adversely affect our business; therefore, the following risk factors are not intended to be an exhaustive list of all risks we face.

 

 

Risks Related to Our Business

 

The current economic environment poses significant challenges.

 

Our financial performance is generally highly dependent on the business environment in the markets we operate in and of the U.S. as a whole, which includes the ability of borrowers to pay interest, repay principal on outstanding loans, the value of collateral securing those loans, and demand for loans and other products and services we offer. A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low inflation, low unemployment, high business and investor confidence, and strong business earnings. Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity, and investor or business confidence; limitations on the availability, or increases, in the cost of credit and capital; increases in inflation or interest rates; high unemployment; natural disasters; or a combination of these or other factors.

 

In recent years, economic growth and business activity across a wide range of industries has been slow and uneven. There are continuing concerns related to the level of U.S. government debt, fiscal actions that may be taken to address that debt, energy price volatility, global economic conditions, and significant uncertainty with respect to domestic and international fiscal and monetary policy. Economic pressure on consumers and uncertainty about continuing economic improvement may result in changes in consumer and business spending, borrowing, and savings habits. There can be no assurance that these conditions will improve or that these conditions will not worsen. Such conditions could adversely affect the credit quality of the Bank’s loans and the Company’s business, financial condition, and results of operations.

 

We operate in a highly regulated industry subject to examination, supervision, enforcement, and other legal actions by various federal and state governmental authorities, laws, and judicial and administrative decisions.

 

Congress and federal regulatory agencies continually review banking laws, regulations, and policies. Changes to these statutes, regulations, and regulatory policies, including changes in the interpretation or implementation, may cause substantial and unpredictable effects, require additional costs, limit the types of financial services and products offered, or allow non-banks to offer competing financial services and products. Failure to follow laws, regulations, and policies may result in sanctions by regulatory agencies and civil money penalties, which could have material adverse effects on our reputation, business, financial condition, and results of operations. We have policies and procedures designed to prevent violations; however, there is no assurance that violations will not occur. Existing and future laws, regulations, and policies yet to be adopted may make compliance more difficult or expensive; restrict our ability to originate, broker, or sell loans; further limit or restrict commissions, interest, and other charges earned on loans we originate or sell; and adversely affect our business, financial condition, and results of operations.

 

The Bank’s ability to pay dividends is subject to regulatory limitations that may affect the Company’s ability to pay expenses and dividends to shareholders.

 

The Company is a legal entity that is separate and distinct from its subsidiaries. The Company depends on the Bank and its other subsidiaries for cash, liquidity, and the payment of dividends to the Company to pay operating expenses and dividends to stockholders. There is no assurance that the Bank will have the capacity to pay dividends to the Company in the future or that the Company will not require dividends from the Bank to satisfy obligations. The Bank’s dividend payment is governed by various statutes and regulations. For additional information, see “Payment of Dividends” in Item 1 of this report. The Company may not be able to service obligations as they become due if the Bank is unable to pay dividends sufficient to satisfy the Company’s obligations, including our common stock. Consequently, the inability to receive dividends from the Bank could adversely affect the Company’s financial condition, results of operations, cash flows, and prospects.

 

We face strong competition from other financial institutions, financial service companies, and organizations that offer services similar to our offerings.

 

Our larger competitors may have substantially greater resources and lending limits, name recognition, and market presence that allow them to offer products and services that we do not offer and to price loans and deposits more aggressively than we do. The expansion of non-bank competitors, which may have fewer regulatory constraints and lower cost structures, has intensified competitive pressures on core deposit generation and retention. For additional information, see “Competition” in Item 1 of this report. Our success depends, in part, on our ability to attract and retain customers by adapting our products and services to evolving customer needs and industry and economic conditions. Failure to perform in any of these areas could weaken our competitive position, reduce deposits and loan originations, and adversely affect our financial condition, results of operations, cash flows, and prospects.

 

 

We may require additional capital in the future that may not be available when needed.

 

We may need to raise additional capital to strengthen our capital position, increase our liquidity, satisfy obligations, or pursue growth objectives. Our ability to raise additional capital depends on current conditions in capital markets, which are outside our control, and our financial performance. Certain economic conditions and declining market confidence may increase our cost of funds and limit our access to customary sources of capital, such as borrowings with other financial institutions, repurchase agreements, and availability under the FRB’s Discount Window. Events that limit access to capital markets and the inability to obtain capital may have a materially adverse effect on our business, financial condition, results of operations, and market value of common stock. We cannot provide any assurance that additional capital will be available, on acceptable terms or at all, in the future.

 

Liquidity risk could impair our ability to fund operations.

 

Liquidity is essential to our business and the inability to raise funds through deposits, borrowings, equity and debt offerings, or other sources could have a materially adverse effect on our liquidity. Company specific factors such as a decline in our credit rating, an increase in the cost of capital from financial capital markets, a decrease in business activity due to adverse regulatory action or other company specific event, or a decrease in depositor or investor confidence may impair our access to funding with acceptable terms adequate to finance our activities. General factors related to the financial services industry such as a severe disruption in financial markets, a decrease in industry expectations, or a decrease in business activity due to political or environmental events may impair our access to liquidity.

 

We are subject to interest rate risk.

 

Interest rate risk results principally when interest-earning assets and interest-bearing liabilities reprice at differing times, when underlying rates change at different levels or in varying degrees, when there is an unequal change in the spread between two or more rates for different maturities, and when embedded options, if any, are exercised. Our earnings and cash flows are largely dependent upon net interest income. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies, particularly, the Federal Reserve. Changes in monetary policy and interest rates could influence the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings. Further, such changes could also affect our ability to originate loans and obtain deposits and the fair value of our financial assets and liabilities. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income and earnings could be adversely affected. Conversely, if interest rates received on loans and other investments fall more quickly than interest rates paid on deposits and other borrowings, our net interest income and earnings could also be adversely affected.

 

Our accounting estimates and risk management processes rely on analytical and forecasting models.

The processes we use to estimate probable loan losses and to measure the fair value of financial instruments, as well as the processes used to estimate the effects of changing interest rates and other market measures on our financial condition and results of operations, depend upon analytical and forecasting models. These models reflect assumptions that may not be accurate, particularly in times of market stress or other unforeseen circumstances. Even if these assumptions are adequate, the models may prove to be inadequate or inaccurate because of other flaws in their design or their implementation. If the models we use for interest rate risk and asset/liability management are inadequate, we may incur increased or unexpected losses upon changes in market interest rates or other market measures. If the models used for determining probable loan losses are inadequate, the allowance for loan losses may not be sufficient to cover actual loan losses and an increase in the loan loss provision could materially and adversely affect our operating results. Federal regulatory agencies regularly review our loans and allowance for loan losses as an integral part of the examination process. There is no assurance that we will not, or that regulators will not require us to, increase our allowance in future periods, which could materially and adversely affect our earnings and profitability. If the models we use to measure the fair value of financial instruments are inadequate, the fair value of such financial instruments may fluctuate unexpectedly or may not accurately reflect what we could realize upon the sale or settlement of such financial instruments. Any such failure in our analytical or forecasting models could have a material adverse effect on our business, financial condition, and results of operations. For additional information, see “Fair Value Measurements” and “Allowance for Loan Losses” in the “Critical Accounting Policies” section in Part II, Item 7 and Note 1, “Basis of Presentation and Accounting Policies,” to the Consolidated Financial Statements in Part II, Item 8 of this report.

 

 

Changes in the fair value of our investment securities may reduce stockholders’ equity and net income.

 

A decline in the estimated fair value of the investment portfolio may result in a decline in stockholders’ equity, book value per common share, and tangible book value per common share. Unrealized losses are recorded even though the securities are not sold or held for sale. If a debt security is never sold and no credit impairment exists, the decrease is recovered at the security’s maturity. Equity securities have no stated maturity; therefore, declines in fair value may or may not be recovered over time. We conduct quarterly reviews of our securities portfolio to determine if unrealized losses are temporary or other than temporary. No assurance can be given that we will not need to recognize other-than-temporary impairment (“OTTI”) charges in the future. Additional OTTI charges may materially affect our financial condition and earnings. For additional information, see Note 1, “Basis of Presentation and Accounting Policies,” and Note 3, “Debt Securities,” to the Consolidated Financial Statements in Part II, Item 8 of this report.

 

We are subject to credit risk associated with the financial condition of other financial institutions. 

 

Credit risk is the risk of not collecting payments pursuant to the contractual terms of loans, leases and investment securities. Financial institutions are interrelated as a result of trading, clearing, counterparty, and other relationships. We have exposure to different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, investment companies, and other institutional clients. Our ability to engage in routine funding transactions could be adversely affected by the failure, actions, and commercial soundness of other financial institutions. These transactions may expose us to credit risk if our counterparty or client defaults on their contractual obligation. Our credit risk may increase if the collateral we hold cannot be realized or liquidated at prices sufficient to recover the full amount of the loan or derivative exposure due to us. In the event of default, we may be required to provide collateral to secure the obligation to the counterparties. In the event of a bankruptcy or insolvency proceeding involving one of such counterparties, we may experience delays in recovering the assets posted as collateral or may incur a loss to the extent that the counterparty was holding collateral in excess of the obligation to such counterparty. Losses from routine funding transactions could have a material adverse effect on our financial condition and results of operations.

 

Our commercial loan portfolio may expose us to increased credit risk.

 

Commercial business and real estate loans generally have a higher risk of loss because loan balances are typically larger than residential real estate and consumer loans and repayment is usually dependent on cash flows from the borrower’s business or the property securing the loan. Our commercial business loans are primarily made to small business and middle market customers. As of December 31, 2018, commercial business and real estate loans totaled $994 million, or 55.97%, of our total loan portfolio. As of the same date, our largest outstanding commercial business loan was $8.81 million and largest outstanding commercial real estate loan was $10.60 million. Commercial construction loans generally have a higher risk of loss due to the assumptions used to estimate the value of property at completion and the cost of the project, including interest. If the assumptions and estimates are inaccurate, the value of completed property may fall below the related loan amount. As of December 31, 2018, commercial construction loans totaled $64 million, or 3.58% of our total loan portfolio. As of the same date, our largest outstanding commercial construction loan was $8.25 million. Losses from our commercial loan portfolio could have a material adverse effect on our financial condition and results of operations.

 

We are subject to environmental liability risk associated with lending activities.

 

A significant portion of our loan portfolio is secured by real property. In the ordinary course of business, we foreclose on and take title to properties that secure certain loans. Hazardous or toxic substances could be found on properties we own. If substances are present, we may be liable for remediation costs, personal injury claims, and property damage and our ability to use or sell the property would be limited. We have policies and procedures in place that require environmental reviews before initiating foreclosure actions on real property; however, these reviews may not detect all potential environmental hazards. Environmental laws that require us to incur substantial remediation costs, which could materially reduce the affected property’s value, and other liabilities associated with environmental hazards could have a material adverse effect on our financial condition and results of operations.

 

Potential acquisitions may disrupt our business and dilute stockholder value.

 

We may seek merger or acquisition partners that are culturally similar, have experienced management, and possess either significant market presence or the potential for improved profitability through financial management, economies of scale, or expanded services. Risks inherent in acquiring other banks, businesses, and banking branches may include the following:

 

 

potential exposure to unknown or contingent liabilities of the target company;

 

exposure to potential asset quality issues of the target company;

 

difficulty, expense, and delays of integrating the operations and personnel of the target company;

 

potential disruption to our business;

 

potential diversion of management’s time and attention;

 

loss of key employees and customers of the target company;

 

difficulty in estimating the value of the target company;

 

potential changes in banking or tax laws or regulations that may affect the target company;

 

unexpected costs and delays;

 

the target company’s performance does not meet our growth and profitability expectations;

 

limited experience in new markets or product areas;

 

increased time, expenses, and personnel as a result of strain on our infrastructure, staff, internal controls, and management; and

 

potential short-term decreases in profitability.

 

 

We regularly evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions and financial services companies. As a result, merger or acquisition discussions and, in some cases, negotiations may take place and future mergers or acquisitions involving the payment of cash or the issuance of debt or equity securities may occur at any time. Acquisitions typically involve goodwill, a purchase premium over the acquired company’s book and market values; therefore, dilution of our tangible book value and net income per common share may occur. If we are unable to realize revenue increases, cost savings, geographic or product presence growth, or other projected benefits from acquisitions, our financial condition and results of operations may be adversely affected.

 

Attractive acquisition opportunities may not be available in the future.

 

We expect banking and financial companies, which may have significantly greater resources, to compete for the acquisition of financial service businesses. This competition could increase the price of potential acquisitions that we believe are attractive. If we fail to receive proper regulatory approval, we will not be able to consummate an acquisition. Our regulators consider our capital, liquidity, profitability, regulatory compliance, level of goodwill and intangible assets, and other factors when considering acquisition and expansion proposals. Future acquisitions may be dilutive to our earnings and equity per share of our common stock.

 

We may experience future goodwill impairment.

 

We test goodwill for impairment annually, or more frequently if events or circumstances indicate there may be impairment, using either a quantitative or qualitative assessment. If we determine that the carrying amount of a reporting unit is greater than its fair value, a goodwill impairment charge is recognized for the difference, but limited to the amount of goodwill allocated to that reporting unit. Unfavorable or uncertain economic and market conditions may trigger additional impairment charges that may cause an adverse effect on our earnings and financial position. For additional information, see “Goodwill and Other Intangible Assets” in the “Critical Accounting Policies” section in Part II, Item 7 and Note 1, “Basis of Presentation and Accounting Policies,” and Note 9, “Goodwill and Other Intangible Assets,” to the Consolidated Financial Statements in Part II, Item 8 of this report.

 

We are subject to certain obligations under FDIC loss share agreements that specify how to manage, service, report, and request reimbursement for losses incurred on covered assets.

 

Our ability to receive benefits under FDIC loss share agreements is subject to compliance with certain requirements, oversight and interpretation, and contractual term limitations. Our obligations under loss share agreements are extensive, and failure to follow any obligations could result in a specific asset, or group of assets, losing loss share coverage. Reimbursement requests are subject to FDIC review and may be delayed or disallowed if we do not comply with our obligations. Losses projected to occur during the loss share term may not be realized until after the expiration of the applicable agreement; consequently, those losses may have a material adverse impact on our results of operations. Our current loss estimates only include those projected to occur during the loss share period and for which we expect reimbursement from the FDIC at the applicable reimbursement rate. We are subject to FDIC audits to ensure compliance with the loss share agreements. The loss share agreements are subject to interpretation by the FDIC and us; therefore, disagreements about the coverage of losses, expenses, and contingencies may arise. The realization of benefits to be received from the FDIC ultimately depends on the performance of the underlying covered assets, the passage of time, claims paid by the FDIC, and interpretation; therefore, the amount received could differ materially from the carrying value of expected reimbursements and have a material effect on our financial condition and results of operations. For additional information, see Note 1, “Basis of Presentation and Accounting Policies,” and Note 7, “FDIC Indemnification Asset,” to the Consolidated Financial Statements in Part II, Item 8 of this report.

 

We may be required to pay higher FDIC insurance premiums or special assessments.

 

Our deposits are insured up to applicable limits by the DIF of the FDIC and we are subject to deposit insurance assessments to maintain the DIF. For additional information, see “Deposit Insurance and Assessments” in Item 1 of this report. We are unable to predict future insurance assessment rates; however, deterioration in our risk-based capital ratios or adjustments to base assessment rates may result in higher insurance premiums or special assessments. The deterioration of banking and economic conditions and financial institution failures deplete the FDIC’s DIF and reduce the ratio of reserves to insured deposits. If the DIF is unable to meet funding requirements, increases in deposit insurance premium rates or special assessments may be required. Future assessments, increases, or required prepayments related to FDIC insurance premiums may negatively affect our financial condition and results of operations.

 

 

The repeal of the federal prohibitions on payment of interest on demand deposits could increase our interest expense.

 

All federal prohibitions on the ability of financial institutions to pay interest on demand deposit accounts were repealed as part of the Dodd-Frank Act. We do not know what interest rates other institutions may offer as market interest rates begin to increase. Our interest expense will increase and net interest margin will decrease if we offer interest on demand deposits to attract additional customers or maintain current customers, which could have a material adverse effect on our business, financial condition, and results of operations.

 

We may lose members of our management team and have difficulty attracting skilled personnel.

 

Our success depends, in large part, on our ability to attract and retain key employees. Competition for the best people can be intense. The unexpected loss of key personnel could have a material adverse impact on our business due to the loss of certain skills, market knowledge, and industry experience and the difficulty of promptly finding qualified replacement personnel. Certain existing and proposed regulatory guidance on compensation may also negatively affect our ability to retain and attract skilled personnel.

 

Our internal controls and procedures may fail or be circumvented.

 

We review our internal controls over financial reporting quarterly and enhance controls in response to these assessments, internal and external audit, and regulatory recommendations. A control system, no matter how well conceived and operated, includes certain assumptions and can only provide reasonable assurance that the objectives of the control system are met. These controls may be circumvented by individual acts, collusion, or management override. Any failure or circumvention related to our controls and procedures or failure to follow regulations related to controls and procedures could have a material adverse effect on our business, reputation, results of operations, and financial condition.

 

We continue to encounter technological change and are subject to information security risks associated with technology.

 

The financial services industry continues to experience rapid technological change with the introduction of new, and increasingly complex, technology-driven products and services. The effective use of technology increases operational efficiency that enables financial service institutions to reduce costs. Our future success depends, in part, on our ability to provide products and services that satisfactorily meet the financial needs of our customers, as well as to realize additional efficiencies in our operations. We may fail to use technology-driven products and services effectively to better serve our customers and increase operational efficiency or sufficiently invest in technology solutions and upgrades to ensure systems are operating properly. Further, many of our competitors have substantially greater resources to invest in technology, which may adversely affect our ability to compete.

 

We rely on electronic communications and information systems, including those provided by third-party vendors, to conduct our business operations. Our security risks increase as our reliance on technology increases; consequently, the expectation to safeguard information by monitoring systems for potential failures, disruptions, and breakdowns has also increased. Risks associated with technology include security breaches, operational failures and service interruptions, and reputational damages. These risks also apply to our third-party service providers. Our third-party vendors include large entities with significant market presence in their respective fields; therefore, their services could be difficult to replace quickly if there are operational failures or service interruptions.

 

We rely on our technology-driven systems to conduct daily business and accounting operations that include the collection, processing, and retention of confidential financial and client information. We may be vulnerable to security breaches, such as employee error, cyber-attacks, and viruses, beyond our control. In addition to security breaches, programming errors, vandalism, natural disasters, terrorist attacks, and third-party vendor disruptions may cause operational failures and service interruptions to our communication and information systems. Further, our systems may be temporarily disrupted during implementation or upgrade. Security breaches and service interruptions related to our information systems could damage our reputation, which may cause us to lose customers, subject us to regulatory scrutiny, or expose us to civil litigation and financial liability.

 

Our customers and employees have been, and will continue to be, targeted by parties using fraudulent e-mails and other communications in attempts to misappropriate passwords, bank account information or other personal information, or to introduce viruses or other malware through "Trojan horse" programs to our information systems and/or our customers' computers. Though we endeavor to mitigate these threats through product improvements, use of encryption and authentication technology, and customer and employee education, such cyber-attacks against us or our merchants and our third-party service providers remain a serious issue. The pervasiveness of cybersecurity incidents in general and the risks of cyber-crime are complex and continue to evolve. More generally, publicized information about security and cyber-related problems could inhibit the use or growth of electronic or web-based applications or solutions as a means of conducting commercial transactions.

 

 

While we have not experienced a significant compromise, significant data loss, or any material financial losses related to cybersecurity attacks, our systems and those of our customers and third-party service providers are under constant threat and it is possible that we could experience a significant event in the future. Although we make significant efforts to maintain the security and integrity of our information systems and have implemented various measures to manage the risk of a security breach or disruption, there can be no assurance that our security efforts and measures will be effective or that attempted security breaches or disruptions would not be successful or damaging. Even the most well protected information, networks, systems and facilities remain potentially vulnerable because attempted security breaches, particularly cyber-attacks and intrusions, or disruptions will occur in the future, and because the techniques used in such attempts are constantly evolving and generally are not recognized until launched against a target, and in some cases are designed not to be detected and, in fact, may not be detected. Accordingly, we may be unable to anticipate these techniques or to implement adequate security barriers or other preventative measures, and thus it is virtually impossible for us to entirely mitigate this risk. A security breach or other significant disruption of our information systems or those related to our customers, merchants and our third-party vendors, including as a result of cyber-attacks, could (1) disrupt the proper functioning of our networks and systems and therefore our operations and/or those of our customers; (2) result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of confidential, sensitive or otherwise valuable information of ours or our customers; (3) result in a violation of applicable privacy, data breach and other laws, subjecting us to additional regulatory scrutiny and expose us to civil litigation, governmental fines and possible financial liability; (4) require significant management attention and resources to remedy the damages that result; or (5) harm our reputation or cause a decrease in the number of customers who choose to do business with us. The occurrence of any of the foregoing could have a material adverse effect on our business, financial condition and results of operations.

 

We may be subject to claims and litigation pertaining to intellectual property.

 

Banking and other financial services companies, such as the Company, rely on technology companies to provide information technology products and services necessary to support the Company’s day-to-day operations. Technology companies often enter into litigation based on allegations of patent infringement or other violations of intellectual property rights. In addition, patent holding companies seek to monetize patents they have purchased or otherwise obtained. Competitors of the Company’s vendors, or other individuals or companies, have from time to time claimed to hold intellectual property sold to the Company by its vendors. Such claims may increase in the future as the financial services sector becomes more reliant on information technology vendors. The plaintiffs in these actions often seek injunctions and substantial damages.

 

Regardless of the scope or validity of such patents or other intellectual property rights, or the merits of any claims by potential or actual litigants, the Company may have to engage in protracted litigation. Such litigation is often expensive, time consuming, disruptive to the Company’s operations, and distracting to management. If the Company is found to have infringed on one or more patents or other intellectual property rights, it may be required to pay substantial damages or royalties to a third party. In certain cases, the Company may consider entering into licensing agreements for disputed intellectual property, although no assurance can be given that such licenses can be obtained on acceptable terms or that litigation will not occur. These licenses may also significantly increase the Company’s operating expenses. If legal matters related to intellectual property claims were resolved against the Company or settled, the Company could be required to make payments in amounts that could have a material adverse effect on its business, financial condition, and results of operations.

 

Risks Related to Our Common Stock

 

The market price of our common stock may be volatile.

 

Stock price volatility may make it more difficult for our stockholders to resell their common stock when desired. Our common stock price may fluctuate significantly due to a variety of factors that include the following:

 

 

actual or expected variations in quarterly results of operations;

 

recommendations by securities analysts;

 

operating and stock price performance of comparable companies, as deemed by investors;

 

news reports relating to trends, concerns, and other issues in the financial services industry;

 

perceptions in the marketplace about our Company or competitors;

 

new technology used, or services offered, by competitors;

 

significant acquisitions or business combinations, strategic partnerships, joint ventures, or capital commitments by, or involving, our Company or competitors;

 

failure to integrate acquisitions or realize expected benefits from acquisitions;

 

changes in government regulations; and

 

geopolitical conditions, such as acts or threats of terrorism or military action.

 

 

General market fluctuations; industry factors; political conditions; and general economic conditions and events, such as economic slowdowns, recessions, interest rate changes, or credit loss trends, could also cause our common stock price to decrease regardless of operating results.

 

The trading volume in our common stock is less than that of other larger financial services companies.

 

Although our common stock is listed for trading on the NASDAQ, the trading volume in our common stock is less than that of other, larger financial services companies. A public trading market having the desired characteristics of depth, liquidity, and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the lower trading volume of our common stock, significant sales of our common stock or the expectation of these sales could cause our stock price to fall.

 

We may not continue to pay dividends on our common stock in the future.

 

Our common stockholders are only entitled to receive dividends when declared by our Board of Directors from funds legally available for such payments. Although we have historically declared cash dividends on our common stock, we are not required to do so, and may reduce or eliminate our common stock dividend in the future. This could adversely affect the market price of our common stock. As a financial holding company, the Company’s ability to declare and pay dividends is dependent on certain federal regulatory considerations, including the guidelines of the Federal Reserve about capital adequacy and dividends. For additional information, see “Payment of Dividends” in Item 1 of this report.

 

Item 1B.

Unresolved Staff Comments.

 

None.

 

Item 2.

Properties.

 

We own our corporate headquarters located at One Community Place, Bluefield, Virginia. As of December 31, 2018, the Bank provided financial services through a network of 44 branch locations in West Virginia (18 branches), Virginia (19 branches), North Carolina (5 branches), and Tennessee (2 branches). We own 42 of those branches and lease the remaining 2 branches. We also own our wealth management office and call center location. As of December 31, 2018, there were no mortgages or liens against any properties. We believe that our properties are suitable and adequate to serve as financial services facilities. A list of all branch and ATM locations is available on our website at www.firstcommunitybank.com. Information contained on our website is not part of this report. For additional information, see Note 8, “Premises, Equipment, and Leases,” to the Consolidated Financial Statements in Part II, Item 8 of this report.

 

Item 3.

Legal Proceedings.

 

We are currently a defendant in various legal actions and asserted claims in the normal course of business. Although we are unable to assess the ultimate outcome of each of these matters with certainty, we are of the belief that the resolution of these actions should not have a material adverse effect on our financial position, results of operations, or cash flows.

 

Item 4.

Mine Safety Disclosures.

 

None.

 

 

 

PART II

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

Market Information and Holders

 

Our common stock is traded on the NASDAQ Global Select Market under the symbol FCBC. As of February 26, 2019, there were 2,222 record holders and 15,799,187 outstanding shares of our common stock.

 

Purchases of Equity Securities

 

We repurchased 1,060,312 shares of our common stock in 2018, 50,118 shares of our common stock in 2017, and 1,182,294 shares in 2016.

 

The following table provides information about purchases of our common stock made by us or on our behalf by any affiliated purchaser, as defined in Rule 10b-18(a)(3) under the Exchange Act, during the periods indicated:

 

   

Total Number

of Shares

Purchased

   

Average

Price Paid

per Share

   

Total Number of Shares

Purchased as Part of a

Publicly Announced Plan

   

Maximum Number of Shares

that May Yet be Purchased

Under the Plan(1)

 
                                 

October 1-31, 2018

    124,078     $ 33.76       124,078       1,484,645  

November 1-30, 2018

    137,248       34.42       137,248       1,347,397  

December 1-31, 2018

    128,970       32.62       128,970       1,218,427  

Total

    390,296     $ 33.62       390,296          

                                                                                                       

(1)

On June 27, 2018, our Board of Directors increased the number of shares authorized under the stock repurchase plan by 1,600,000 shares. Our stock repurchase plan, as amended, authorizes the purchase of up to 6,600,000 shares. The plan has no expiration date and is currently in effect. No determination has been made to terminate the plan or to cease making purchases.

 

 

Stock Performance Graph

 

The following graph, compiled by S&P Global Market Intelligence (“S&P Global”), compares the cumulative total shareholder return on our common stock for the five years ended December 31, 2018, with the cumulative total return of the S&P 500 Index, the NASDAQ Composite Index, and S&P Global’s Asset Size & Regional Peer Group. The Asset Size & Regional Peer Group consists of 41 bank holding companies with total assets between $1 billion and $5 billion that are located in the Southeast Region of the United States and traded on NASDAQ, the OTC Bulletin Board, and pink sheets. The cumulative returns assume that $100 was originally invested on December 31, 2013, and that all dividends are reinvested.

 

 

     

Year Ended December 31,

 
     

2013

   

2014

   

2015

   

2016

   

2017

   

2018

 
                                                   

First Community Bankshares, Inc.

    100.00       101.92       118.89       197.95       193.35       220.75  

S&P 500 Index

    100.00       113.69       115.26       129.05       157.22       150.33  

NASDAQ Composite Index

    100.00       114.75       122.74       133.62       173.22       168.30  

S&P Global Asset & Regional Peer Group(1)

    100.00       107.74       122.17       163.81       184.85       171.68  

                                                                              

(1) Includes the following institutions: Access National Corporation; American National Bankshares Inc.; Atlantic Capital Bancshares, Inc.; Burke & Herbert Bank & Trust Company; C&F Financial Corporation; Capital City Bank Group, Inc.; CapStar Financial Holdings, Inc.; Carolina Financial Corporation; Carter Bank & Trust; City Holding Company; CNB Corporation; Colony Bankcorp, Inc.; Community Bankers Trust Corporation; Entegra Financial Corp.; Fidelity Southern Corporation; First Bancshares, Inc.; First Citizens Bancshares, Inc.; First Community Bankshares, Inc.; First Community Corporation; First Farmers and Merchants Corporation; FVCBankcorp, Inc.; HomeTrust Bancshares, Inc.; Live Oak Bancshares, Inc.; MainStreet Bancshares, Inc.; MetroCity Bankshares, Inc.; MVB Financial Corp.; National Bankshares, Inc.; National Commerce Corporation; Old Point Financial Corporation; Peoples Bancorp of North Carolina, Inc.; Premier Financial Bancorp, Inc.; Reliant Bancorp, Inc.; Select Bancorp, Inc.; SmartFinancial, Inc.; Southern BancShares (N.C.), Inc.; Southern First Bancshares, Inc.; Southern National Bancorp of Virginia, Inc.; Summit Financial Group, Inc.; TGR Financial, Inc.; Three Shores Bancorporation, Inc.; and Wilson Bank Holding Co.

 

 

Item 6.

Selected Financial Data.

 

The following table presents selected consolidated financial data, derived from the audited financial statements, as of and for the five years ended December 31, 2018. This information should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, “Financial Statements and Supplementary Data,” of this report.

 

   

Year Ended December 31,

 

(Amounts in thousands, except share and per share data)

 

2018

   

2017

   

2016

   

2015

   

2014

 

Selected Balance Sheet Data

                                       

Investment debt securities

  $ 178,129     $ 190,674     $ 212,639     $ 438,642     $ 383,826  

Loans

    1,775,084       1,817,184       1,852,948       1,706,541       1,691,208  

Allowance for loan losses

    18,267       19,276       17,948       20,233       20,227  

Total assets

    2,244,374       2,388,460       2,386,398       2,462,276       2,607,936  

Average assets

    2,330,611       2,370,321       2,455,458       2,520,934       2,608,570  

Deposits

    1,855,750       1,929,891       1,841,338       1,873,259       2,000,759  

Borrowings

    29,370       80,086       178,713       219,370       229,741  

Total liabilities

    1,911,517       2,037,746       2,047,341       2,119,259       2,256,562  

Preferred stock

    -       -       -       -       15,151  

Total stockholders' equity

    332,857       350,714       339,057       343,017       351,374  

Average stockholders' equity

    341,519       349,701       338,475       348,199       342,619  
                                         

Summary of Operations

                                       

Interest income

  $ 98,294     $ 95,308     $ 94,724     $ 96,102     $ 106,108  

Interest expense

    7,449       8,090       9,844       11,349       15,290  

Net interest income

    90,845       87,218       84,880       84,753       90,818  

Provision for loan losses

    2,393       2,771       1,255       2,191       145  

Noninterest income

    26,443       24,568       25,534       27,981       28,588  

Noninterest expense

    69,773       66,902       71,214       74,622       81,447  

Income tax expense

    8,782       20,628       12,819       11,381       12,324  

Net income

    36,340       21,485       25,126       24,540       25,490  

Dividends on preferred stock

    -       -       -       105       910  

Net income available to common shareholders

    36,340       21,485       25,126       24,435       24,580  
                                         

Selected Share and Per Share Data

                                       

Basic earnings per common share

  $ 2.19     $ 1.26     $ 1.45     $ 1.32     $ 1.34  

Diluted earnings per common share

    2.18       1.26       1.45       1.31       1.31  

Cash dividends per common share

    1.26       0.68       0.60       0.54       0.50  

Book value per common share at year-end(1)

    20.79       20.63       19.95       18.95       18.06  
                                         

Weighted average basic shares outstanding

    16,587,504       17,002,116       17,319,689       18,531,039       18,406,363  

Weighted average diluted shares outstanding

    16,666,385       17,077,842       17,365,524       18,727,464       19,483,054  
                                         

Selected Ratios

                                       

Return on average assets

    1.56 %     0.91 %     1.02 %     0.97 %     0.94 %

Return on average common equity

    10.64 %     6.14 %     7.42 %     7.08 %     7.51 %

Average equity to average assets

    14.65 %     14.75 %     13.78 %     13.81 %     13.13 %

Dividend payout

    57.51 %     53.81 %     41.36 %     40.95 %     37.44 %

Common equity Tier 1 ratio(2)

    13.72 %     13.98 %     13.88 %     14.54 %     N/A  

Tier 1 risk-based capital ratio

    13.72 %     13.98 %     14.74 %     14.73 %     16.43 %

Total risk-based capital ratio

    14.79 %     15.06 %     15.79 %     15.95 %     17.68 %

Tier 1 leverage ratio

    10.95 %     11.06 %     11.07 %     10.62 %     10.12 %

                                                                                                                                                            

(1) Book value per common share is defined as stockholders' equity divided by as-converted common shares outstanding.

(2) The common equity Tier 1 ratio became effective on January 1, 2015.

 

 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand our financial condition, changes in financial condition, and results of operations. MD&A contains forward-looking statements and should be read in conjunction with our consolidated financial statements, accompanying notes, and other financial information included in this report. Unless the context suggests otherwise, the terms “First Community,” “Company,” “we,” “our,” and “us” refer to First Community Bankshares, Inc. and its subsidiaries as a consolidated entity.

 

Executive Overview

 

First Community Bankshares, Inc. (the “Company”) is a financial holding company, headquartered in Bluefield, Virginia, that provides banking products and services through its wholly owned subsidiary First Community Bank (the “Bank”), a Virginia chartered bank institution. As of December 31, 2018, the Bank operated 44 branches as First Community Bank in Virginia, West Virginia, and North Carolina and as People’s Community Bank, a Division of First Community Bank, in Tennessee. Our primary source of earnings is net interest income, the difference between interest earned on assets and interest paid on liabilities, which is supplemented by fees for services, commissions on sales, and various deposit service charges. We fund our lending and investing activities primarily through the retail deposit operations of our branch banking network and, to a lesser extent, retail and wholesale repurchase agreements and Federal Home Loan Bank (“FHLB”) borrowings. We invest our funds primarily in loans to retail and commercial customers and various investment securities.

 

The Bank offers trust management, estate administration, and investment advisory services through its Trust Division and wholly owned subsidiary First Community Wealth Management (“FCWM”). The Trust Division manages inter vivos trusts and trusts under will, develops and administers employee benefit and individual retirement plans, and manages and settles estates. Fiduciary fees for these services are charged on a schedule related to the size, nature, and complexity of the account. Revenues consist primarily of commissions on assets under management and investment advisory fees. As of December 31, 2018, the Trust Division and FCWM managed and administered $975 million in combined assets under various fee-based arrangements as fiduciary or agent.

 

Our acquisition and divestiture activity during the three years ended December 31, 2018, includes the completion of our Agreement and Plan of Reincorporation and Merger changing our corporate domicile from Nevada to Virginia on October 2, 2018; the sale of our remaining insurance agency assets to Bankers Insurance, LLC on October 1, 2018; the sale of Greenpoint Insurance Group, Inc. (“Greenpoint”) to Ascension Insurance Agency, Inc. on October 31, 2016; and the simultaneous sale of six branches to and purchase of seven branches from First Bank on July 15, 2016. For additional information, see Note 2, “Acquisitions and Divestitures,” to the Consolidated Financial Statements in Item 8 of this report.

 

Critical Accounting Policies

 

Our consolidated financial statements are prepared in conformity with generally accepted accounting principles (“GAAP”) in the U.S. and prevailing practices in the banking industry. Our accounting policies, as presented in Note 1, “Basis of Presentation and Accounting Policies,” to the Consolidated Financial Statements in Item 8 of this report are fundamental in understanding MD&A and the disclosures presented in Item 8, “Financial Statements and Supplementary Data,” of this report. Management may be required to make significant estimates and assumptions that have a material impact on our financial condition or operating performance. Due to the level of subjectivity and the susceptibility of such matters to change, actual results could differ significantly from management’s assumptions and estimates. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates used, we have identified fair value measurements, the allowance for loan losses, goodwill and other intangible assets, and income taxes as the accounting areas that require the most subjective or complex judgments or are the most susceptible to change.

 

Fair Value Measurements

 

We use the fair value hierarchy to determine the fair value of certain assets and liabilities. The hierarchy consists of three levels that include valuations based on observable quoted prices in active markets; quoted prices in inactive markets or other observable inputs, such as third-party sources; and unobservable inputs. When quoted prices or third-party information is not available, management estimates valuation adjustments primarily through the use of financial modeling techniques and appraisal estimates. The assumptions and estimates used to determine fair value may be highly subjective in nature, such as cash flow estimates, risk characteristics, credit quality measurements, and interest rates; therefore, valuations may not be precise. The amounts realized or paid on the settlement or maturity of fair value instruments may be significantly different from estimates. While management believes our valuation methodologies are appropriate and consistent with other market participants, different methodologies or assumptions used to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. For additional information, see Note 17, “Fair Value,” to the Consolidated Financial Statements in Item 8 of this report.

 

 

Allowance for Loan Losses

 

We review our allowance for loan losses quarterly to determine if it is sufficient to absorb probable loan losses in the portfolio. This determination requires management to make significant estimates and assumptions. While management uses its best judgment and available information, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond our control, including the performance of our loan portfolio, the economy, changes in interest rates, and the view of regulatory authorities towards loan classifications. These uncertainties may result in material changes to the allowance for loan losses in the near term; however, the amount of the change cannot reasonably be estimated.

 

Our allowance for loan losses consists of reserves assigned to specific loans and credit relationships and general reserves assigned to loans not separately identified that have been segmented into groups with similar risk characteristics using our internal risk grades. General reserve allocations are based on management’s judgments of qualitative and quantitative factors about macro and micro economic conditions reflected within the loan portfolio and the economy. Factors considered in this evaluation include, but are not limited to, probable losses from loan and other credit arrangements, general economic conditions, changes in credit concentrations or pledged collateral, historical loan loss experience, and trends in portfolio volume, maturities, composition, delinquencies, and nonaccruals. Historical loss rates for each risk grade of commercial loans are adjusted by environmental factors to estimate the amount of reserve needed by segment. Individually significant loans require additional analysis that may include the borrower’s underlying cash flow and capacity for debt repayment, specific business conditions, and value of secondary sources of repayment; consequently, this analysis may result in the identification of weakness and a corresponding need for a specific reserve. No allowance for loan losses is carried over or established at acquisition for purchased loans acquired in business combinations. A provision for loan losses is recorded for any credit deterioration in purchased performing loans after the acquisition date. Loans acquired in business combinations that are deemed impaired at acquisition, purchased credit impaired (“PCI”) loans, are grouped into pools and evaluated separately from the non-PCI portfolio. The estimated cash flows to be collected on PCI loans are discounted at a market rate of interest. Management believed the allowance was adequate to absorb probable loan losses inherent in the loan portfolio as of December 31, 2018. For additional information, see Note 6, “Allowance for Loan Losses,” to the Consolidated Financial Statements in Item 8 of this report.

 

Third-party collateral valuations are regularly obtained and evaluated to help management determine changes in cash flows on purchased loans acquired in business combinations, potential credit impairment, and the amount of impairment to record. Internal collateral valuations are generally performed within two to four weeks of identifying the initial potential impairment. The internal evaluation compares the original appraisal to current local real estate market conditions and considers experience and expected liquidation costs. When a third-party evaluation is received, it is reviewed for reasonableness. Once the evaluation is reviewed and accepted, discounts are applied to fair market value, based on, but not limited to, our historical liquidation experience for like collateral, resulting in an estimated net realizable value. The estimated net realizable value is compared to the outstanding loan balance to determine the appropriate amount of specific impairment reserve. Specific reserves are generally recorded for impaired loans while third-party evaluations are in process and for impaired loans that continue to make some form of payment. While waiting for receipt of the third-party appraisal, we regularly review the relationship to identify any potential adverse developments and begin the tasks necessary to gain control of the collateral and prepare it for liquidation, including, but not limited to, engagement of counsel, inspection of collateral, and continued communication with the borrower. Generally, the only difference between current appraised value, adjusted for liquidation costs, and the carrying amount of the loan, less the specific reserve, is any downward adjustment to appraised value that we determine appropriate, such as the costs to sell the property. Impaired loans that do not meet certain criteria and do not have a specific reserve have typically been written down through partial charge-offs to net realizable value. Based on prior experience, the Company rarely returns loans to performing status after they have been partially charged off. Impaired credits move quickly through the process towards ultimate resolution except in cases involving bankruptcy and various state judicial processes, which may extend the time for ultimate resolution.

 

Goodwill and Other Intangible Assets

 

We test goodwill for impairment annually, or more frequently if events or circumstances indicate there may be impairment, using either a qualitative or quantitative assessment to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount. We have one reporting unit, which is consistent with our sole operating segment, Community Banking. If we elect to perform a qualitative assessment, we evaluate factors such as macroeconomic conditions, industry and market considerations, overall financial performance, changes in stock price, and progress towards stated objectives in assessing the fair value of our reporting unit. If we conclude that it is more likely than not that the fair value of our reporting unit is less than its carrying amount, a quantitative test is performed; otherwise, no further testing is required. The quantitative test consists of comparing the fair value of our reporting unit to its carrying amount, including goodwill. If the fair value of our reporting unit is greater than its book value, no goodwill impairment exists. If the carrying amount of our reporting unit is greater than its calculated fair value, a goodwill impairment charge is recognized for the difference, but limited to the amount of goodwill allocated to the reporting unit. Other identifiable intangible assets are evaluated for impairment if events or changes in circumstances indicate a possible impairment. For additional information, see Note 9, “Goodwill and Other Intangible Assets,” to the Consolidated Financial Statements in Item 8 of this report.

 

 

Income Taxes

 

The establishment of provisions for federal and state income taxes is a complex area of accounting that involves judgments and estimates in applying relevant tax statutes. We operate in many state tax jurisdictions, which requires the appropriate allocation of income and expense to each state based on a variety of apportionment or allocation bases. Audits by federal and state tax authorities may reveal liabilities that differ from our estimates and provisions. We continually evaluate our exposure to possible tax assessments arising from audits and record an estimate of possible exposure based on current facts and circumstances.

 

We measure deferred tax assets and liabilities using the enacted tax rates applicable in the periods we expect temporary differences to be realized or settled. As changes in tax laws and rates are enacted, we adjust deferred tax assets and liabilities through the provision for income taxes. When evidence indicates that it is more likely than not that some, or all, of the deferred tax asset is not recoverable, we may record a valuation allowance to reduce the carrying value of the asset. Increases or decreases in the valuation allowance result in increases or decreases to the provision for income taxes.

 

The Tax Cuts and Jobs Act (“Tax Reform Act”) was enacted on December 22, 2017. Among other things, the new law established a new, flat corporate federal statutory income tax rate of 21%; eliminated the corporate alternative minimum tax and allows the use of any such carryforwards to offset regular tax liability for any taxable year; limits the deduction for net interest expense incurred by U.S. corporations; allows businesses to immediately expense the cost of new investments in certain qualified depreciable assets for tax purposes; eliminates or reduces certain deductions related to meals and entertainment expenses; modifies the limitation on excessive employee remuneration to eliminate the exception for performance-based compensation and clarifies the definition of a covered employee; and limits the deductibility of deposit insurance premiums for certain size financial institutions. The Tax Reform Act also significantly changes U.S. tax law related to foreign operations, however, such changes do not currently impact us. For additional information, see Note 15, “Income Taxes,” to the Consolidated Financial Statements in Item 8 of this report.

 

Non-GAAP Financial Measures

 

In addition to financial statements prepared in accordance with GAAP, we use certain non-GAAP financial measures that provide useful information for financial and operational decision making, evaluating trends, and comparing financial results to other financial institutions. The non-GAAP financial measures presented in this report include certain financial measures presented on a fully taxable equivalent (“FTE”) basis. While we believe certain non-GAAP financial measures enhance the understanding of our business and performance, they are supplemental and not a substitute for, or more important than, financial measures prepared in accordance with GAAP and may not be comparable to those reported by other financial institutions. The reconciliations of non-GAAP to GAAP measures are presented below.

 

We believe FTE basis is the preferred industry measurement of net interest income and provides better comparability between taxable and tax exempt amounts. We use this non-GAAP financial measure to monitor net interest income performance and to manage the composition of our balance sheet. FTE basis adjusts for the tax benefits of income from certain tax exempt loans and investments using the federal statutory income tax rate of 21% for periods after January 1, 2018, and 35% for periods prior to January 1, 2018. The following table reconciles net interest income and margin, as presented in our consolidated statements of income, to net interest income on a FTE basis for the periods indicated:

 

     

Year Ended December 31,

 
     

2018

   

2017

   

2016

 

(Amounts in thousands)

                       

Net interest income, GAAP

  $ 90,845     $ 87,218     $ 84,880  

FTE adjustment(1)

    1,822       1,914       2,081  

Net interest income, FTE

  $ 92,667     $ 89,132     $ 86,961  
                           

Net interest margin, GAAP

    4.37 %     4.14 %     3.91 %

FTE adjustment(1)

    0.09 %     0.09 %     0.10 %

Net interest margin, FTE

    4.46 %     4.23 %     4.01 %

                                                                                                      

(1) FTE basis of 21% for 2018 and 35% for 2017 and 2016

 

 

Performance Overview

 

Highlights of our results of operations in 2018, and financial condition as of December 31, 2018, include the following:

 

 

Net income increased $14.86 million to $36.34 million and diluted earnings per share increased $0.92 to $2.18 compared to the prior year. The large increase reflects the deferred tax asset revaluation charge taken in the fourth quarter of 2017.

 

GAAP net interest margin increased 23 basis points to 4.37% and non-GAAP, FTE net interest margin increased 23 basis points to 4.46% compared to the prior year.

 

We repurchased 1,060,312 shares of our common stock for $34.41 million and paid common stock cash dividends of $21.09 million, or $1.26 per share, in 2018. Cash dividends included a one-time special dividend to common shareholders of $0.48 per common share.

 

Book value per common share increased $0.16 to $20.79 compared to the prior year.

 

We finalized the deferred tax asset revaluation charge originally taken in the fourth quarter of 2017, which resulted in a reduction in tax expense of approximately $1.67 million.

 

We sold our remaining insurance agency assets to Bankers Insurance, LLC of Glen Allen, Virginia (“BI”) in exchange for an equity interest in BI, which resulted in a one-time goodwill impairment of $1.49 million.

 

We prepaid our remaining $50 million FHLB convertible advance, which resulted in a loss on the extinguishment of the debt of $1.10 million.

 

We completed our Agreement and Plan of Reincorporation and Merger changing our corporate domicile from Nevada to Virginia.

 

The divestiture of the insurance agency assets and the extinguishment of FHLB debt, in conjunction with the sale of the remaining trust preferred securities, culminate a 5-year plan to return the balance sheet and business model to a traditional, simplified, and de-risked community bank.

 

The Company and its subsidiary bank both significantly exceed regulatory “well-capitalized” targets as of December 31, 2018.

 

Results of Operations

 

Net Income

 

The following table presents the changes in net income and related information for the periods indicated:

 

                           

2018 Compared to 2017

   

2017 Compared to 2016

 
   

Year Ended December 31,

   

Increase

   

%

   

Increase

   

%

 

(Amounts in thousands, except per share data)

 

2018

   

2017

   

2016

    (Decrease)     Change     (Decrease)     Change  

Net income

  $ 36,340     $ 21,485     $ 25,126     $ 14,855       69.14 %   $ (3,641 )     -14.49 %
                                                         

Basic earnings per common share

    2.19       1.26       1.45       0.93       73.81 %     (0.19 )     -13.10 %

Diluted earnings per common share

    2.18       1.26       1.45       0.92       73.02 %     (0.19 )     -13.10 %
                                                         

Return on average assets

    1.56 %     0.91 %     1.02 %     0.65 %     71.43 %     -0.11 %     -10.78 %

Return on average common equity

    10.64 %     6.14 %     7.42 %     4.50 %     73.29 %     -1.28 %     -17.25 %

 

2018 Compared to 2017. Net income increased in 2018 due to a decrease in income tax expense, driven by a lower federal statutory rate and the deferred tax asset revaluation charge taken in 2017, in accordance with the Tax Reform Act. Pre-tax income increased $3.01 million, or 7.15%, due to increases in net interest and noninterest income and a decrease in the provision for loan losses. These changes were offset by an increase in noninterest expense.

 

2017 Compared to 2016. Net income decreased in 2017 due to an increase in income tax expense, driven by the deferred tax asset revaluation charge taken in accordance with the Tax Reform Act. Pre-tax income increased $4.17 million, or 10.98%, due to an increase in net interest income and a decrease in noninterest expense. These changes were offset by an increase in the provision for loan losses and a decrease in noninterest income.

 

 

Net Interest Income

 

Net interest income, our largest contributor to earnings, is analyzed on a fully taxable equivalent (“FTE”) basis, a non-GAAP financial measure. For additional information, see “Non-GAAP Financial Measures” above. The following table presents the consolidated average balance sheets and net interest analysis on a FTE basis for the dates indicated:

 

   

Year Ended December 31,

 
   

2018

   

2017

   

2016

 

(Amounts in thousands)

 

Average

Balance

   

Interest(1)

   

Average

Yield/

Rate(1)

   

Average

Balance

   

Interest(1)

   

Average

Yield/

Rate(1)

   

Average

Balance

   

Interest(1)

   

Average

Yield/

Rate(1)

 

Assets

                                                                       

Earning assets

                                                                       

Loans(2)(3)

  $ 1,795,391     $ 91,971       5.12 %   $ 1,837,092     $ 90,032       4.90 %   $ 1,793,618     $ 87,848       4.90 %

Securities available for sale

    176,766       6,190       3.50 %     164,489       5,695       3.46 %     287,332       8,047       2.80 %

Securities held to maturity

    25,081       418       1.67 %     32,954       487       1.48 %     71,069       757       1.07 %

Interest-bearing deposits

    81,520       1,537       1.89 %     73,405       1,008       1.37 %     18,864       153       0.81 %

Total earning assets

    2,078,758     $ 100,116       4.82 %     2,107,940     $ 97,222       4.61 %     2,170,883     $ 96,805       4.46 %

Other assets

    251,853                       262,381                       284,575                  

Total assets

  $ 2,330,611                     $ 2,370,321                     $ 2,455,458                  
                                                                         

Liabilities and stockholders' equity

                                                                       

Interest-bearing deposits

                                                                       

Demand deposits

  $ 466,403     $ 246       0.05 %   $ 401,092     $ 224       0.06 %   $ 342,169     $ 156       0.05 %

Savings deposits

    508,353       382       0.08 %     520,430       336       0.06 %     531,050       342       0.06 %

Time deposits

    471,335       4,516       0.96 %     510,411       4,427       0.87 %     525,162       3,981       0.76 %

Total interest-bearing deposits

    1,446,091       5,144       0.36 %     1,431,933       4,987       0.35 %     1,398,381       4,479       0.32 %

Borrowings

                                                                       

Federal funds purchased

    -       -       -       1       -       0.00 %     4,058       26       0.64 %

Retail repurchase agreements

    4,010       5       0.12 %     47,716       32       0.07 %     68,701       49       0.07 %

Wholesale repurchase agreements

    25,000       806       3.22 %     25,000       806       3.22 %     49,727       1,874       3.77 %

FHLB advances and other borrowings

    36,849       1,494       4.05 %     55,502       2,265       4.08 %     116,602       3,416       2.93 %

Total borrowings

    65,859       2,305       3.50 %     128,219       3,103       2.42 %     239,088       5,365       2.24 %

Total interest-bearing liabilities

    1,511,950       7,449       0.49 %     1,560,152       8,090       0.52 %     1,637,469       9,844       0.60 %

Noninterest-bearing demand deposits

    448,903                       438,513                       456,474                  

Other liabilities

    28,239                       21,955                       23,040                  

Total liabilities

    1,989,092                       2,020,620                       2,116,983                  

Stockholders' equity

    341,519                       349,701                       338,475                  

Total liabilities and equity

  $ 2,330,611                     $ 2,370,321                     $ 2,455,458                  
                                                                         

Net interest income, FTE(1)

          $ 92,667                     $ 89,132                     $ 86,961          

Net interest rate spread, FTE(1)

                    4.33 %                     4.09 %                     3.86 %

Net interest margin, FTE(1)

                    4.46 %                     4.23 %                     4.01 %

                                                                   

(1)  FTE basis based on the federal statutory rate of 21% for periods after January 1, 2018, and 35% for periods prior to January 1, 2018

(2)  Nonaccrual loans are included in average balances; however, no related interest income is recognized during the period of nonaccrual.

(3)  Interest on loans include non-cash purchase accounting accretion of $6.39 million in 2018, $5.42 million in 2017, and $4.77 million in 2016.

 

 

The following table presents the impact to net interest income on a FTE basis due to changes in volume (average volume times the prior year’s average rate), rate (average rate times the prior year’s average volume), and rate/volume (average volume times the change in average rate), for the periods indicated:

 

   

Year Ended

   

Year Ended

 
   

December 31, 2018 Compared to 2017

   

December 31, 2017 Compared to 2016

 
   

Dollar Increase (Decrease) due to

   

Dollar Increase (Decrease) due to

 
                   

Rate/

                           

Rate/

         

(Amounts in thousands)

 

Volume

   

Rate

   

Volume

   

Total

   

Volume

   

Rate

   

Volume

   

Total

 

Interest earned on(1):

                                                               

Loans

  $ (2,043 )   $ 4,042     $ (60 )   $ 1,939     $ 2,130     $ -     $ 54     $ 2,184  

Securities available for sale

    425       66       4       495       (3,440 )     1,896       (808 )     (2,352 )

Securities held to maturity

    (117 )     63       (15 )     (69 )     (408 )     291       (153 )     (270 )

Interest-bearing deposits with other banks

    111       382       36       529       442       106       307       855  

Total interest-earning assets

    (1,624 )     4,553       (35 )     2,894       (1,276 )     2,293       (600 )     417  
                                                                 

Interest paid on(1):

                                                               

Demand deposits

    39       (40 )     23       22       29       34       5       68  

Savings deposits

    (7 )     104       (51 )     46       (6 )     -       -       (6 )

Time deposits

    (340 )     459       (30 )     89       (112 )     578       (20 )     446  

Federal funds purchased

    -       -       -       -       (26 )     (26 )     26       (26 )

Retail repurchase agreements

    (31 )     24       (20 )     (27 )     (15 )     -       (2 )     (17 )

Wholesale repurchase agreements

    -       -       -       -       (932 )     (273 )     137       (1,068 )

FHLB advances and other borrowings

    (761 )     (17 )     7       (771 )     (1,790 )     1,341       (702 )     (1,151 )

Total interest-bearing liabilities

    (1,100 )     530       (71 )     (641 )     (2,852 )     1,654       (556 )     (1,754 )
                                                                 

Change in net interest income(1)

  $ (524 )   $ 4,023     $ 36     $ 3,535     $ 1,576     $ 639     $ (44 )   $ 2,171  

                                                        

(1)  FTE basis based on the federal statutory rate of 21% for periods after January 1, 2018, and 35% for periods prior to January 1, 2018

 

2018 Compared to 2017. Net interest income comprised 77.45% of total net interest and noninterest income in 2018 compared to 78.02% in 2017. Net interest income increased $3.63 million, or 4.16%, compared to an increase of $3.54 million, or 3.97%, on a FTE basis. The FTE net interest margin increased 23 basis points and the FTE net interest spread increased 24 basis points.

 

Average earning assets decreased $29.18 million, or 1.38%, primarily due to a decrease in average loans offset by an increase in available-for-sale securities and interest-bearing deposits. The yield on earning assets increased 21 basis points as the yields on loans, debt securities, and interest-bearing deposits increased. Average loans decreased $41.70 million, or 2.27%, and the average loan to deposit ratio decreased to 94.74% from 98.22%. Non-cash accretion income related to PCI loans increased $974 thousand, or 17.98%, to $6.39 million due to continued acquired portfolio attrition. The impact of non-cash purchase accounting accretion income on the FTE net interest margin was 31 basis points compared to 26 basis points in the prior year.

 

Average interest-bearing liabilities, which consist of interest-bearing deposits and borrowings, decreased $48.20 million, or 3.09%, primarily due to a decline in average borrowings. The yield on interest-bearing liabilities decreased 3 basis points. Average borrowings decreased $62.36 million, or 48.64%, largely due to a $43.71 million, or 91.60%, decrease in average retail repurchase agreements and an $18.65 million, or 33.61%, decrease in average FHLB advances. Average interest-bearing deposits increased $14.16 million, or 0.99%, which was driven by a $65.31 million, or 16.28%, increase in average interest-bearing demand deposits offset by a $39.08 million, or 7.66%, decrease in average time deposits, and a $12.08 million, or 2.32%, decrease in average savings deposits, which include money market and savings accounts.

 

2017 Compared to 2016. Net interest income comprised 78.02% of total net interest and noninterest income in 2017 compared to 76.87% in 2016. Net interest income increased $2.34 million, or 2.75%, compared to an increase of $2.17 million, or 2.50%, on a FTE basis. The FTE net interest margin increased 22 basis points and the FTE net interest spread increased 23 basis points.

 

Average earning assets decreased $62.94 million, or 2.90%, primarily due to decreases in investment securities offset by an increase in interest-bearing deposits and loan growth. The yield on earning assets increased 15 basis points. Average loans increased $43.47 million, or 2.42%, and the average loan to deposit ratio increased to 98.22% from 96.70%. Non-cash accretion income related to PCI loans increased $651 thousand, or 13.66%, to $5.42 million. The impact of non-cash purchase accounting accretion income on the FTE net interest margin was 26 basis points compared to 22 basis points in the prior year.

 

 

Average interest-bearing liabilities, which consist of interest-bearing deposits and borrowings, decreased $77.32 million, or 4.72%, primarily due to a decline in average borrowings. The yield on interest-bearing liabilities decreased 8 basis points, largely driven by a decrease in the average balance of borrowings. Average borrowings decreased $110.87 million, or 46.37%, largely due to a $61.10 million, or 52.40%, decrease in average FHLB advances and other borrowings, a $24.73 million, or 49.73%, decrease in average wholesale repurchase agreements, a $20.99 million, or 30.55%, decrease in average retail repurchase agreements, and a $4.06 million, or 99.98%, decrease in average federal funds purchased. Average interest-bearing deposits increased $33.55 million, or 2.40%, which was driven by a $58.92 million, or 17.22%, increase in average interest-bearing demand deposits offset by a $14.75 million, or 2.81%, decrease in average time deposits, and a $10.62 million, or 2.00%, decrease in average savings deposits, which include money market and savings accounts.

 

Provision for Loan Losses

 

2018 Compared to 2017. The provision charged to operations decreased $378 thousand, or 13.64%, to $2.39 million, which was largely attributed to a decrease in the loan portfolio and continued good credit quality.

 

2017 Compared to 2016. The provision charged to operations increased $1.52 million to $2.77 million, which included a $1.49 million increase in the non-PCI provision to $2.78 million and a $30 thousand increase in the PCI provision to a recovery of $12 thousand.

 

Noninterest Income

 

The following table presents the components of, and changes in, noninterest income for the periods indicated:

 

                           

2018 Compared to 2017

   

2017 Compared to 2016

 
   

Year Ended December 31,

   

Increase

   

%

   

Increase

   

%

 
   

2018

   

2017

   

2016

    (Decrease)     Change     (Decrease)     Change  

(Amounts in thousands)

                                                       

Wealth management

  $ 3,262     $ 3,150     $ 2,828     $ 112       3.56 %   $ 322       11.39 %

Service charges on deposits

    14,733       13,803       13,588       930       6.74 %     215       1.58 %

Other service charges and fees

    7,733       6,944       6,570       789       11.36 %     374       5.69 %

Insurance commissions

    966       1,347       5,442       (381 )     -28.29 %     (4,095 )     -75.25 %

Net impairment loss

    -       -       (4,646 )     -       -       4,646       -100.00 %

Net (loss) gain on sale of securities

    (618 )     (661 )     335       43       -6.51 %     (996 )     -297.31 %

Net FDIC indemnification asset amortization

    (2,181 )     (3,517 )     (5,474 )     1,336       -37.99 %     1,957       -35.75 %

Net gain on divestitures

    -       -       3,682       -       -       (3,682 )     -100.00 %

Other operating income

    2,548       3,502       3,209       (954 )     -27.24 %     293       9.13 %

Total noninterest income

  $ 26,443     $ 24,568     $ 25,534     $ 1,875       7.63 %   $ (966 )     -3.78 %

 

2018 Compared to 2017. Noninterest income comprised 22.55% of total net interest and noninterest income in 2018 compared to 21.98% in 2017. Noninterest income increased $1.88 million, or 7.63%, primarily due to the decrease in net negative amortization related to the FDIC indemnification asset as loss share coverage expired June 30, 2017, for commercial loans. Service charges on deposits and other service charges and fees increased $1.72 million, or 8.29%, primarily from increases in checking account fees and net interchange income. Other operating income decreased primarily due to a $678 thousand decrease in death proceeds from bank owned life insurance.

 

2017 Compared to 2016. Noninterest income comprised 21.98% of total net interest and noninterest income in 2017 compared to 23.13% in 2016. Noninterest income decreased $966 thousand, or 3.78%, primarily due to a decrease in insurance commissions and the associated net gain related to the Greenpoint divestiture in the fourth quarter of 2016 and divestiture of six bank branches to First Bank in the third quarter of 2016. The decrease was largely offset by the absence of net impairment losses and the decrease in net negative amortization related to the FDIC indemnification asset as loss share coverage on commercial loans expired on June 30, 2017. We recognized a net loss of $661 thousand on the sale of securities related primarily to certain single issue trust preferred securities. See Note 3, “Debt Securities,” to the Consolidated Financial Statements in Item 1 of this report.

 

 

Noninterest Expense

 

The following table presents the components of, and changes in, noninterest expense for the periods indicated:

 

 

                           

2018 Compared to 2017

   

2017 Compared to 2016

 
   

Year Ended December 31,

   

Increase

   

%

   

Increase

   

%

 
   

2018

   

2017

   

2016

    (Decrease)     Change     (Decrease)     Change  

(Amounts in thousands)

                                                       

Salaries and employee benefits

  $ 36,690     $ 35,774     $ 39,389     $ 916       2.56 %   $ (3,615 )     -9.18 %

Occupancy expense

    4,542       4,775       5,297       (233 )     -4.88 %     (522 )     -9.85 %

Furniture and equipment expense

    3,980       4,425       4,341       (445 )     -10.06 %     84       1.94 %

Service fees

    3,860       3,348       3,641       512       15.29 %     (293 )     -8.05 %

Advertising and public relations

    2,011       2,206       1,532       (195 )     -8.84 %     674       43.99 %

Professional fees

    1,430       2,567       1,501       (1,137 )     -44.29 %     1,066       71.02 %

Amortization of intangibles

    1,039       1,056       1,136       (17 )     -1.61 %     (80 )     -7.04 %

FDIC premiums and assessments

    906       910       1,383       (4 )     -0.44 %     (473 )     -34.20 %

Loss on extinguishment of debt

    1,096       -       -       1,096       -       -       -  

Merger, acquisition, and divestiture expense

    -       -       730       -       -       (730 )     -100.00 %

Goodwill impairment

    1,492       -       -       1,492       -       -       -  

Other operating expense

    12,727       11,841       12,264       886       7.48 %     (423 )     -3.45 %

Total noninterest expense

  $ 69,773     $ 66,902     $ 71,214     $ 2,871       4.29 %   $ (4,312 )     -6.05 %

 

2018 Compared to 2017. Noninterest expense increased $2.87 million, or 4.29%, which was largely due to a one-time goodwill impairment charge related to the divestiture of the Company’s remaining insurance agency assets, the loss on extinguishment of the Company’s remaining FHLB debt, and an increase in salaries and employee benefits. These increases were offset by a decrease in professional fees, which were largely due to a reduction in legal fees. The increase in other operating expense included a $330 thousand increase in property write-downs and a $347 thousand increase in the net loss on sales and expenses related to other real estate owned (“OREO”) to $1.55 million in 2018 from $1.20 million in 2017.

 

2017 Compared to 2016. Noninterest expense decreased $4.31 million, or 6.05%, which was largely due to a decrease in salaries and employee benefits coupled with the absence of merger, acquisition, and divestiture expense. Salaries and employee benefits decreased as full-time equivalent employees, calculated using the number of hours worked, decreased to 562 as of December 31, 2017, from 580 as of December 31, 2016, largely due to the divestiture of Greenpoint. The decrease in other operating expense included a $218 thousand decrease in the net loss on sales and expenses related to OREO to $1.20 million in 2017 from $1.42 million in 2016.

 

Income Tax Expense

 

2018 Compared to 2017. The Company’s effective tax rate, income tax as a percent of pre-tax income, may vary significantly from the statutory rate due to permanent differences and available tax credits. Permanent differences are income and expense items excluded by law in the calculation of taxable income. The Company’s most significant permanent differences generally include interest income on municipal securities and increases in the cash surrender value of life insurance policies. The Tax Reform Act enacted on December 22, 2017, reduced our federal statutory income tax rate from 35% to 21% beginning January 1, 2018. Income tax expense decreased $11.85 million, or 57.43%, and the effective tax rate decreased to 19.46% in 2018 compared to 48.98% in 2017 primarily due to the decreased tax rate and deferred tax asset revaluation charge taken in 2017 as a result of the enactment of the Tax Reform Act.

 

2017 Compared to 2016. Income tax expense increased $7.81 million, or 60.92%, and the effective tax rate increased to 48.98% in 2017 compared to 33.78% in 2016. The increase was largely attributed to tax expense of $6.55 million related to the revaluation of our net deferred tax asset in accordance with the Tax Reform Act. Excluding the impact of the revaluation, income tax expense increased $1.26 million, or 9.81%, and the effective rate decreased 36 basis points to 33.42% largely from a decrease in taxable revenues as a percent of operating earnings. For additional information, see Note 15, “Income Taxes,” to the Consolidated Financial Statements in Item 8 of this report.

 

Financial Condition

 

Total assets as of December 31, 2018, decreased $144.09 million, or 6.03%, to $2.24 billion from $2.39 billion as of December 31, 2017. Total liabilities as of December 31, 2018, decreased $126.23 million, or 6.19%, to $1.91 billion from $2.04 billion as of December 31, 2017.

 

 

Investment Securities

 

Our investment securities are used to generate interest income through the employment of excess funds, to provide liquidity, to fund loan demand or deposit liquidation, and to pledge as collateral where required. The composition of our investment portfolio changes from time to time as we consider our liquidity needs, interest rate expectations, asset/liability management strategies, and capital requirements. Available-for-sale debt securities as of December 31, 2018, decreased $12.41 million, or 7.50%, compared to December 31, 2017, and included the sale of our remaining single issue trust preferred securities. Held-to-maturity debt securities as of December 31, 2018, decreased $136 thousand, or 0.54%, compared to December 31, 2017. The following table presents the amortized cost and fair value of debt securities as of the dates indicated:

 

   

December 31,

 
   

2018

   

2017

   

2016

 
   

Amortized

   

Fair

   

Amortized

   

Fair

   

Amortized

   

Fair

 

(Amounts in thousands)

 

Cost

   

Value

   

Cost

   

Value

   

Cost

   

Value

 

Available for Sale

                                               

U.S. Agency securities

  $ 1,108     $ 1,113     $ 11,289     $ 11,296     $ 1,342     $ 1,345  

U.S. Treasury securities

    19,970       19,960       19,987       19,971       -       -  

Municipal securities

    96,886       97,289       101,552       103,648       111,659       113,331  

Single issue trust preferred securites

    -       -       9,367       8,884       22,104       19,939  

Mortgage-backed Agency securities

    35,513       34,754       22,095       21,726       31,290       30,891  

Total securities available for sale

  $ 153,477     $ 153,116     $ 164,290     $ 165,525     $ 166,395     $ 165,506  
                                                 

Fair value to amortized cost

            99.76 %             100.75 %             99.47 %
                                                 

Held to Maturity

                                               

U.S. Agency securities

  $ 17,887     $ 17,867     $ 17,937     $ 17,888     $ 36,741     $ 36,865  

Corporate securities

    7,126       7,123       7,212       7,196       10,392       10,401  

Total securities held to maturity

  $ 25,013     $ 24,990     $ 25,149     $ 25,084     $ 47,133     $ 47,266  
                                                 

Fair value to amortized cost

            99.91 %             99.74 %             100.28 %

 

The following table provides information about our investment portfolio as of the dates indicated:

 

   

December 31,

 
   

2018

   

2017

 
   

Available for

Sale

   

Held to

Maturity

   

Total

   

Available for

Sale

   

Held to

Maturity

   

Total

 

(Amounts in years)

                                               

Average life

    6.61       0.11       5.70       5.44       1.11       4.87  

Average duration

    5.37       0.11       4.64       4.74       1.09       4.26  

 

There were no holdings of any one issuer, other than the U.S. government and its agencies, in an amount greater than 10% of our total consolidated shareholders’ equity as of December 31, 2018 or 2017.

 

 

The following tables present the amortized cost, fair value, and weighted-average yield of available-for-sale and held-to-maturity debt securities, by contractual maturity, as of December 31, 2018. Actual maturities could differ from contractual maturities because issuers may have the right to call or prepay obligations with or without penalties. 

 

   

Available-for-Sale Securities

 

(Amounts in thousands)

 

U.S. Agency

Securities

   

U.S. Treasury

Securities

   

Municipal

Securities

   

Total

   

Tax Equivalent

Purchase Yield(1)

 

Amortized cost maturity:

                                       

One year or less

  $ -     $ 19,970     $ -     $ 19,970       2.17 %

After one year through five years

    -       -       14,447       14,447       3.81 %

After five years through ten years

    1,108       -       82,439       83,547       3.56 %

After ten years

    -       -       -       -       -  

Amortized cost

  $ 1,108     $ 19,970     $ 96,886       117,964          

Mortgage-backed securities

                            35,513       3.17 %

Total amortized cost

                          $ 153,477          

Tax equivalent purchase yield(1)

    4.06 %     2.17 %     3.59 %     3.36 %        

Average contractual maturity (in years)

    8.07       0.17       6.54       5.48          
                                         

Fair value maturity:

                                       

One year or less

  $ -     $ 19,960     $ -     $ 19,960          

After one year through five years

    -       -       14,595       14,595          

After five years through ten years

    1,113       -       82,694       83,807          

After ten years

    -       -       -       -          

Fair value

  $ 1,113     $ 19,960     $ 97,289       118,362          

Mortgage-backed securities

                            34,754          

Total fair value

                          $ 153,116          

                                                                                  

(1)  FTE basis of 21%

 

   

Held-to-Maturity Securities

 

(Amounts in thousands)

 

U.S. Agency

Securities

   

Corporate

Notes

   

Total

   

Tax Equivalent

Purchase Yield(1)

 

Amortized cost maturity:

                               

One year or less

  $ 17,887     $ 7,126     $ 25,013       1.67 %

After one year through five years

    -       -       -       -  

After five years through ten years

    -       -       -       -  

After ten years

    -       -       -       -  

Total amortized cost

  $ 17,887     $ 7,126     $ 25,013          

Tax equivalent purchase yield(1)

    1.59 %     1.84 %     1.67 %        

Average contractual maturity (in years)

    0.14       0.06       0.11          
                                 

Fair value maturity:

                               

One year or less

  $ 17,867     $ 7,123     $ 24,990          

After one year through five years

    -       -       -          

After five years through ten years

    -       -       -          

After ten years

    -       -       -          

Total fair value

  $ 17,867     $ 7,123     $ 24,990          

                                                                                                                    

(1)  FTE basis of 21%

 

Investment securities are reviewed quarterly for indications of other-than-temporary impairment (“OTTI”) charges. We recognized no OTTI charges in earnings associated with debt securities in 2018 or 2017. For additional information, see Note 1, “Basis of Presentation and Accounting Policies,” and Note 3, “Debt Securities,” to the Consolidated Financial Statements in Item 8 of this report.

 

 

Loans Held for Investment

 

Loans held for investment, our largest component of interest income, are grouped into commercial, consumer real estate, and consumer and other loan segments. Each segment is divided into various loan classes based on collateral or purpose. Certain loans acquired in FDIC-assisted transactions are covered under loss share agreements (“covered loans”). The general characteristics of each loan segment are as follows:

 

 

Commercial loans – This segment consists of loans to small and mid-size industrial, commercial, and service companies that include, but are not limited to, natural gas producers, retail merchants, and wholesale merchants. Commercial real estate projects represent a variety of sectors of the commercial real estate market, including single family and apartment lessors, commercial real estate lessors, and hotel/motel operators. Commercial loan underwriting guidelines require that comprehensive reviews and independent evaluations be performed on credits exceeding predefined size limits. Updates to these loan reviews are done periodically or annually depending on the size of the loan relationship.

 

Consumer real estate loans – This segment consists of loans to individuals within our market footprint for home equity loans and lines of credit and for the purchase or construction of owner occupied homes. Residential real estate loan underwriting guidelines require that borrowers meet certain credit, income, and collateral standards at origination.

 

Consumer and other loans – This segment consists of loans to individuals within our market footprint that include, but are not limited to, personal lines of credit, credit cards, and the purchase of automobiles, boats, mobile homes, and other consumer goods. Consumer loan underwriting guidelines require that borrowers meet certain credit, income, and collateral standards at origination.

 

Total loans held for investment, net of unearned income, as of December 31, 2018, decreased $42.10 million, or 2.32%, compared to December 31, 2017, primarily due to a $32.97 million, or 1.84%, decrease in non-covered loans, which was driven by declines in owner occupied construction; multi-family residential; and farmland segments. Covered loans decreased $9.13 million, or 32.68%, as the Waccamaw Bank (“Waccamaw”) covered loan portfolio continues to pay down. We had no foreign loans or loan concentrations to any single borrower or industry, which are not otherwise disclosed as a category of loans, that represented 10% or more of outstanding loans, as of December 31, 2018 or 2017. For additional information, see Note 4, “Loans,” to the Consolidated Financial Statements in Item 8 of this report.

 

 

The following table presents loans, net of unearned income and by loan class, as of the dates indicated:

 

     

December 31,

 

(Amounts in thousands)

 

2018

   

2017

   

2016

   

2015

   

2014

 

Non-covered loans held for investment

                                       

Commercial loans

                                       

Construction, development, and other land

  $ 63,508     $ 60,017     $ 56,948     $ 48,896     $ 41,271  

Commercial and industrial

    104,863       92,188       92,204       88,903       83,099  

Multi-family residential

    107,012       125,202       134,228       95,026       97,480  

Single family non-owner occupied

    140,097       141,670       142,965       149,351       135,171  

Non-farm, non-residential

    613,877       616,633       598,674       485,460       473,906  

Agricultural

    8,545       7,035       6,003       2,911       1,599  

Farmland

    18,905       25,649       31,729       27,540       29,517  

Total commercial loans

    1,056,807       1,068,394       1,062,751       898,087       862,043  

Consumer real estate loans

                                       

Home equity lines

    93,466       103,205       106,361       107,367       110,957  

Single family owner occupied

    510,963       502,686       500,891       495,209       485,475  

Owner occupied construction

    18,171       39,178       44,535       43,505       32,799  

Total consumer real estate loans

    622,600       645,069       651,787       646,081       629,231  

Consumer and other loans

                                       

Consumer loans

    71,552       70,772       77,445       72,000       69,347  

Other

    5,310       5,001       3,971       7,338       6,555  

Total consumer and other loans

    76,862       75,773       81,416       79,338       75,902  

Total non-covered loans

    1,756,269       1,789,236       1,795,954       1,623,506       1,567,176  

Total covered loans

    18,815       27,948       56,994       83,035       122,240  

Total loans held for investment, net of unearned income

    1,775,084       1,817,184       1,852,948       1,706,541       1,689,416  

Less: allowance for loan losses

    18,267       19,276       17,948       20,233       20,227  

Total loans held for investment, net of unearned income and allowance

  $ 1,756,817     $ 1,797,908     $ 1,835,000     $ 1,686,308     $ 1,669,189  
                                           

Loans held for sale

  $ -     $ -     $ -     $ -     $ 1,792  

 

The following table presents covered loans, by loan class, as of the dates indicated:

 

     

December 31,

 

(Amounts in thousands)

 

2018

   

2017

   

2016

   

2015

   

2014

 

Commercial loans

                                       

Construction, development, and other land

  $ 35     $ 39     $ 4,570     $ 6,303     $ 13,100  

Commercial and industrial

    -       -       895       1,170       2,662  

Multi-family residential

    -       -       8       640       1,584  

Single family non-owner occupied

    238       284       962       2,674       5,918  

Non-farm, non-residential

    6       9       7,512       14,065       25,317  

Agricultural

    -       -       25       34       43  

Farmland

    -       -       397       643       716  

Total commercial loans

    279       332       14,369       25,529       49,340  

Consumer real estate loans

                                       

Home equity lines

    15,284       23,720       35,817       48,565       60,391  

Single family owner occupied

    3,252       3,896       6,729       8,595       11,968  

Owner occupied construction

    -       -       -       262       453  

Total consumer real estate loans

    18,536       27,616       42,546       57,422       72,812  

Consumer and other loans

                                       

Consumer loans

    -       -       79       84       88  

Total covered loans

  $ 18,815     $ 27,948     $ 56,994     $ 83,035     $ 122,240  

 

 

The following table presents the percentage of loans to total loans in the non-covered portfolio, by loan class, as of the dates indicated:

 

   

December 31,

 
   

2018

   

2017

   

2016

   

2015

   

2014

 

Commercial loans

                                       

Construction, development, and other land

    3.61 %     3.36 %     3.17 %     3.01 %     2.64 %

Commercial and industrial

    5.97 %     5.15 %     5.13 %     5.48 %     5.30 %

Multi-family residential

    6.09 %     7.00 %     7.47 %     5.85 %     6.22 %

Single family non-owner occupied

    7.98 %     7.92 %     7.96 %     9.20 %     8.63 %

Non-farm, non-residential

    34.95 %     34.46 %     33.34 %     29.90 %     30.24 %

Agricultural

    0.49 %     0.39 %     0.34 %     0.18 %     0.10 %

Farmland

    1.08 %     1.43 %     1.77 %     1.70 %     1.88 %

Total commercial loans

    60.17 %     59.71 %     59.18 %     55.32 %     55.01 %

Consumer real estate loans

                                       

Home equity lines

    5.32 %     5.77 %     5.92 %     6.62 %     7.08 %

Single family owner occupied

    29.09 %     28.09 %     27.89 %     30.50 %     30.98 %

Owner occupied construction

    1.04 %     2.19 %     2.48 %     2.68 %     2.09 %

Total consumer real estate loans

    35.45 %     36.05 %     36.29 %     39.80 %     40.15 %

Consumer and other loans

                                       

Consumer loans

    4.08 %     3.96 %     4.31 %     4.43 %     4.42 %

Other

    0.30 %     0.28 %     0.22 %     0.45 %     0.42 %

Total consumer and other loans

    4.38 %     4.24 %     4.53 %     4.88 %     4.84 %

Total non-covered loans

    100.00 %     100.00 %     100.00 %     100.00 %     100.00 %

 

The following table presents the percentage of loans to total loans in the covered portfolio, by loan class, as of the dates indicated:

 

   

December 31,

 
   

2018

   

2017

   

2016

   

2015

   

2014

 

Commercial loans

                                       

Construction, development, and other land

    0.19 %     0.14 %     8.02 %     7.59 %     10.72 %

Commercial and industrial

    0.00 %     0.00 %     1.57 %     1.41 %     2.18 %

Multi-family residential

    0.00 %     0.00 %     0.01 %     0.77 %     1.30 %

Single family non-owner occupied

    1.26 %     1.02 %     1.69 %     3.22 %     4.84 %

Non-farm, non-residential

    0.03 %     0.03 %     13.18 %     16.94 %     20.71 %

Agricultural

    0.00 %     0.00 %     0.04 %     0.04 %     0.03 %

Farmland

    0.00 %     0.00 %     0.70 %     0.77 %     0.59 %

Total commercial loans

    1.48 %     1.19 %     25.21 %     30.74 %     40.37 %

Consumer real estate loans

                                       

Home equity lines

    81.23 %     84.87 %     62.84 %     58.49 %     49.40 %

Single family owner occupied

    17.29 %     13.94 %     11.81 %     10.35 %     9.79 %

Owner occupied construction

    0.00 %     0.00 %     0.00 %     0.32 %     0.37 %

Total consumer real estate loans

    98.52 %     98.81 %     74.65 %     69.16 %     59.56 %

Consumer and other loans

                                       

Consumer loans

    0.00 %     0.00 %     0.14 %     0.10 %     0.07 %

Total covered loans

    100.00 %     100.00 %     100.00 %     100.00 %     100.00 %

 

 

The following table presents the maturities and rate sensitivities of the non-covered loan portfolio as of December 31, 2018:

 

(Amounts in thousands)  

Due in One

Year or Less

   

Due After One

Year Through

Five Years

   

Due After Five

Years

   

Total

 

Commercial loans

                         

Construction, development, and other land(1)

  $ 9,638     $ 30,519     $ 23,351     $ 63,508  

Commercial and industrial

    24,631       49,157       31,075       104,863  

Multi-family residential

    9,149       13,440       84,423       107,012  

Single family non-owner occupied

    8,627       20,354       111,116       140,097  

Non-farm, non-residential

    59,475       152,601       401,801       613,877  

Agricultural

    853       5,186       2,506       8,545  

Farmland

    3,640       4,687       10,578       18,905  

Total commercial loans

    116,013       275,944       664,850       1,056,807  

Consumer real estate loans

                         

Home equity lines

    4,232       11,999       77,235       93,466  

Single family owner occupied

    3,969       21,263       485,731       510,963  

Owner occupied construction

    2,391       473       15,307       18,171  

Total consumer real estate loans

    10,592       33,735       578,273       622,600  

Consumer and other loans

                         

Consumer loans

    9,455       54,983       7,114       71,552  

Other

    1,695       1,581       2,034       5,310  

Total consumer and other loans

    11,150       56,564       9,148       76,862  

Total non-covered loans

  $ 137,755     $ 366,243     $ 1,252,271     $ 1,756,269  
                                 

Rate sensitivities

                         

Predetermined interest rate

  $ 99,963     $ 322,401     $ 454,648     $ 877,012  

Floating or adjustable interest rate

    37,792       43,842       797,623       879,257  

Total non-covered loans

  $ 137,755     $ 366,243     $ 1,252,271     $ 1,756,269  

                                                                                              

(1)

Construction loans with maturities due after five years include construction to permanent loans that have not converted to principal and interest payments.

 

The following table presents the maturities and rate sensitivities of the covered loan portfolio as of December 31, 2018:

 

(Amounts in thousands)  

Due in One

Year or Less

   

Due After One

Year Through

Five Years

   

Due After Five

Years

   

Total

 

Commercial loans

                               

Construction, development, and other land

  $ -     $ 35     $ -     $ 35  

Single family non-owner occupied

    3       212       23       238  

Non-farm, non-residential

    -       6       -       6  

Total commercial loans

    3       253       23       279  

Consumer real estate loans

                               

Home equity lines

    607       7,810       6,867       15,284  

Single family owner occupied

    43       363       2,846       3,252  

Total consumer real estate loans

    650       8,173       9,713       18,536  

Total covered loans

  $ 653     $ 8,426     $ 9,736     $ 18,815  
                                 

Rate sensitivities

                               

Predetermined interest rate

  $ 46     $ 563     $ 2,786     $ 3,395  

Floating or adjustable interest rate

    607       7,863       6,950       15,420  

Total covered loans

  $ 653     $ 8,426     $ 9,736     $ 18,815  

 

 

Risk Elements

 

We seek to mitigate credit risk by following specific underwriting practices and by ongoing monitoring of our loan portfolio. Our underwriting practices include the analysis of borrowers’ prior credit histories, financial statements, tax returns, and cash flow projections; valuation of collateral based on independent appraisers’ reports; and verification of liquid assets. We believe our underwriting criteria are appropriate for the various loan types we offer; however, losses may occur that exceed the reserves established in our allowance for loan losses. We track certain credit quality indicators that include: trends related to the risk rating of commercial loans, the level of classified commercial loans, net charge-offs, nonperforming loans, and general economic conditions. The Company’s loan review function generally analyzes all commercial loan relationships greater than $4.00 million annually and at various times during the year. Smaller commercial and retail loans are sampled for review during the year.

 

Nonperforming assets consist of nonaccrual loans, accrual loans contractually past due 90 days or more, unseasoned troubled debt restructurings (“TDRs”), and OREO. Ongoing activity in the classification and categories of nonperforming loans include collections on delinquencies, foreclosures, loan restructurings, and movements into or out of the nonperforming classification due to changing economic conditions, borrower financial capacity, or resolution efforts. Loans acquired with credit deterioration, with a discount, continue to accrue interest based on expected cash flows; therefore, PCI loans are not generally considered nonaccrual. For additional information, see Note 5, “Credit Quality,” to the Consolidated Financial Statements in Item 8 of this report.

 

 

The following table presents the components of nonperforming assets and related information as of the periods indicated:

 

   

December 31,

 

(Amounts in thousands)

 

2018

   

2017

   

2016

   

2015

   

2014

 

Non-covered nonperforming

                                       

Nonaccrual loans

  $ 19,583     $ 18,997     $ 15,854     $ 17,847     $ 10,556  

Accruing loans past due 90 days or more

    58       1       -       -       -  

TDRs(1)

    161       120       114       73       2,726  

Total non-covered nonperforming loans

    19,802       19,118       15,968       17,920       13,282  

Non-covered OREO

    3,806       2,409       5,109       4,873       6,638  

Total non-covered nonperforming assets

  $ 23,608     $ 21,527     $ 21,077     $ 22,793     $ 19,920  
                                         

Covered nonperforming

                                       

Nonaccrual loans

  $ 322     $ 342     $ 608     $ 647     $ 2,438  

Total covered nonperforming loans

    322       342       608       647       2,438  

Covered OREO

    32       105       276       4,034       6,324  

Total covered nonperforming assets

  $ 354     $ 447     $ 884     $ 4,681     $ 8,762  
                                         

Total nonperforming

                                       

Nonaccrual loans

  $ 19,905     $ 19,339     $ 16,462     $ 18,494     $ 12,994  

Accruing loans past due 90 days or more

    58       1       -       -       -  

TDRs(1)

    161       120       114       73       2,726  

Total nonperforming loans

    20,124       19,460       16,576       18,567       15,720  

OREO

    3,838       2,514       5,385       8,907       12,962  

Total nonperforming assets

  $ 23,962     $ 21,974     $ 21,961     $ 27,474     $ 28,682  
                                         

Additional Information

                                       

Performing TDRs(2)

  $ 6,266     $ 7,614     $ 12,838     $ 13,889     $ 11,808  

Total TDRs(3)

    6,427       7,734       12,952       13,962       14,534  

Gross interest income that would have been recorded under the original terms of restructured and nonperforming loans

    1,175       1,217       1,414       1,645       1,171  

Actual interest income recorded on restructured and nonperforming loans

    264       222       424       608       597  
                                         

Non-covered ratios

                                       

Nonperforming loans to total loans

    1.13 %     1.07 %     0.89 %     1.10 %     0.85 %

Nonperforming assets to total assets

    1.06 %     0.91 %     0.90 %     0.96 %     0.80 %

Non-PCI allowance to nonperforming loans

    92.25 %     100.83 %     112.32 %     112.61 %     151.85 %

Non-PCI allowance to total loans

    1.04 %     1.08 %     1.00 %     1.24 %     1.29 %
                                         

Total ratios

                                       

Nonperforming loans to total loans

    1.13 %     1.07 %     0.89 %     1.09 %     0.93 %

Nonperforming assets to total assets

    1.07 %     0.92 %     0.92 %     1.12 %     1.10 %

Allowance for loan losses to nonperforming loans

    90.77 %     99.05 %     108.28 %     108.97 %     128.67 %

Allowance for loan losses to total loans

    1.03 %     1.06 %     0.97 %     1.19 %     1.20 %

                                                                                                                

(1)

TDRs restructured within the past six months and nonperforming exclude nonaccrual TDRs of $898 thousand, $169 thousand, $224 thousand, $923 thousand, and $306 thousand for the five years ended December 31, 2018.

(2)

TDRs with six months or more of satisfactory payment performance exclude nonaccrual TDRs of $1.68 million, $1.76 million, $1.06 million, $416 thousand, and $248 thousand for the five years ended December 31, 2018.

(3)

Total TDRs exclude nonaccrual TDRs of $2.58 million, $1.93 million, $1.28 million, $1.34 million, and $554 thousand for the five years ended December 31, 2018.

 

 

Non-covered nonperforming assets as of December 31, 2018, increased $2.08 million, or 9.67%, from December 31, 2017, primarily due to a $1.40 million, or 57.99%, increase in non-covered OREO and a $586 thousand, or 3.08%, increase in non-covered nonaccrual loans. Non-covered OREO, which is carried at the lesser of estimated net realizable value or cost, consisted of 25 properties with an average holding period of 7 months as of December 31, 2018. The net loss on the sale of OREO was $1.33 million in 2018, $937 thousand in 2017, and $1.15 million in 2016. The following table presents the changes in OREO during the periods indicated:

 

   

Year Ended December 31,

 
   

2018

   

2017

 
   

Non-covered

   

Covered

   

Total

   

Non-covered

   

Covered

   

Total

 

(Amounts in thousands)

                                               

Beginning balance

  $ 2,409     $ 105     $ 2,514     $ 5,109     $ 276     $ 5,385  

Additions

    5,686       -       5,686       2,204       79       2,283  

Disposals

    (3,506 )     (69 )     (3,575 )     (4,165 )     (218 )     (4,383 )

Valuation adjustments

    (783 )     (4 )     (787 )     (739 )     (32 )     (771 )

Ending balance

  $ 3,806     $ 32     $ 3,838     $ 2,409     $ 105     $ 2,514  

 

As of December 31, 2018, non-covered nonaccrual loans were largely attributed to single family owner occupied (51.78%) and non-farm, non-residential (20.53%) loans. As of December 31, 2018, approximately $1.53 million, or 7.80%, of non-covered nonaccrual loans were attributed to performing loans acquired in business combinations. Certain loans included in the nonaccrual category have been written down to estimated realizable value or assigned specific reserves in the allowance for loan losses based on management’s estimate of loss at ultimate resolution.

 

Certain TDRs are classified as nonperforming when modified and are returned to performing status after six months of satisfactory payment performance; however, these loans remain identified as impaired until full payment or other satisfaction of the obligation occurs. Total TDRs as of December 31, 2018, decreased $655 thousand, or 6.78%, to $9.01 million from December 31, 2017. Nonperforming accruing TDRs as of December 31, 2018, increased $41 thousand, or 34.17%, to $161 thousand from December 31, 2017. Nonperforming accruing TDRs as a percent of total accruing TDRs totaled 2.51% as of December 31, 2018, compared to 1.55% as of December 31, 2017. Specific reserves on TDRs totaled $568 thousand as of December 31, 2018, compared to $642 thousand as of December 31, 2017. When restructuring loans for borrowers experiencing financial difficulty, we generally make concessions in interest rates, loan terms, or amortization terms.

 

Non-covered delinquent loans, comprised of loans 30 days or more past due and nonaccrual loans, totaled $29.89 million as of December 31, 2018, a decrease of $825 thousand, or 2.69%, compared to $30.71 million as of December 31, 2017. Non-covered delinquent loans as a percent of total non-covered loans totaled 1.70% as of December 31, 2018, which includes past due loans (0.59%) and nonaccrual loans (1.11%), compared to 1.71% as of December 31, 2017.

 

Allowance for Loan Losses

 

The allowance for loan losses is maintained at a level management deems sufficient to absorb probable loan losses inherent in the loan portfolio. The allowance is increased by the provision for loan losses and recoveries of prior loan charge-offs and decreased by loans charged off. The provision for loan losses is calculated and charged to expense to bring the allowance to an appropriate level using a systematic process of measurement that requires significant judgments and estimates. As of December 31, 2018, our qualitative risk factors reflect a stable risk of loan losses due to consistent asset quality metrics and relatively stable business and economic conditions in our primary market areas. The loan portfolio is continually monitored for deterioration in credit, which may result in the need to increase the allowance for loan losses in future periods. Management considered the allowance adequate as of December 31, 2018; however, no assurance can be made that additions to the allowance will not be required in future periods. For additional information, see “Allowance for Loan Losses” in the “Critical Accounting Policies” section above and Note 6, “Allowance for Loan Losses,” to the Consolidated Financial Statements in Item 8 of this report.

 

The allowance for loan losses as of December 31, 2018, decreased $1.01 million, or 5.23%, from December 31, 2017, due to a $1.11 million decrease in specific reserves on impaired loans combined with a $97 thousand increase in general reserves. The non-PCI allowance as a percent of non-covered loans totaled 1.04% as of December 31, 2018, compared to 1.08% as of December 31, 2017. PCI loans were aggregated into five loan pools as of December 31, 2018 and 2017; Waccamaw commercial, Waccamaw serviced home equity lines, Waccamaw residential, Peoples Bank of Virginia (“Peoples”) commercial, and Peoples residential. The cash flow analysis identified no impaired PCI loan pools as of December 31, 2018 or 2017. Net charge-offs increased $1.96 million in 2018 compared to 2017, largely due to the charge off of one impaired loan relationship totaling $1.34 million in the single family owner occupied segment that was fully reserved.

 

 

The following table presents the changes in the allowance for loan losses, by loan class, during the periods indicated:

 

   

Year Ended December 31,

 
   

2018

   

2017

   

2016

   

2015

   

2014

 

(Amounts in thousands)

                                       

Beginning balance

  $ 19,276     $ 17,948     $ 20,233     $ 20,227     $ 24,077  

Removal of loans transferred(1)

    -       -       -       -       (682 )

Provision for loan losses charged to operations, non-PCI loans

    2,393       2,783       1,296       2,166       420  

(Recovery of) provision for loan losses charged to operations, PCI loans

    -       (12 )     (41 )     25       (275 )

Recovery of loan losses recorded through the FDIC indemnification asset

    -       -       (1 )     (29 )     (422 )

Charge-offs

                                       

Commercial loans

                                       

Construction, development, and other land

    100       427       254       256       1,238  

Commercial and industrial

    566       224       144       93       459  

Multi-family residential

    16       9       64       -       35  

Single family non-owner occupied

    88       52       237       87       488  

Non-farm, non-residential

    119       142       1,684       773       832  

Agricultural

    68       -       -       -       -  

Farmland

    279       68       9       73       -  

Consumer real estate loans

                                       

Home equity lines

    285       13       1,073       92       451  

Single family owner occupied

    1,720       675       508       812       988  

Owner occupied construction

    -       11       31       2       305  

Consumer and other loans

                                       

Consumer loans

    1,666       1,322       1,172       1,557       1,685  

Total charge-offs

    4,907       2,943       5,176       3,745       6,481  

Recoveries

                                       

Commercial loans

                                       

Construction, development, and other land

    210       306       282       135       84  

Commercial and industrial(2)

    200       160       484       173       1,736  

Multi-family residential

    17       9       15       -       10  

Single family non-owner occupied

    98       180       79       92       331  

Non-farm, non-residential

    191       146       59       74       239  

Agricultural

    7       -       -       -       -  

Consumer real estate loans

                                       

Home equity lines

    216       201       137       402       514  

Single family owner occupied

    238       108       182       258       76  

Owner occupied construction

    -       105       39       18       -  

Consumer and other

                                       

Consumer loans

    328       285       360       437       600  

Total recoveries

    1,505       1,500       1,637       1,589       3,590  

Net charge-offs

    3,402       1,443       3,539       2,156       2,891  

Ending balance

  $ 18,267     $ 19,276     $ 17,948     $ 20,233     $ 20,227  
                                         

Net charge-offs to average non-covered loans

    0.19 %     0.08 %     0.21 %     0.14 %     0.18 %

Net charge-offs to average total loans

    0.19 %     0.08 %     0.20 %     0.13 %     0.17 %

                                                                                                                             

(1)

Loans transferred in branch divestitures

(2)

Includes a $1.60 million recovery in 2014 related to the positive resolution of a sizable problem credit

 

 

The following table presents the allowance for loan losses, excluding PCI loans, by loan class, as of the dates indicated:

 

   

December 31,

 

(Amounts in thousands)

 

2018

   

2017

   

2016

   

2015

   

2014

 

Commercial loans

                                       

Construction, development, and other land

  $ 417     $ 830     $ 889     $ 1,119     $ 1,151  

Commercial and industrial

    663       762       495       504       689  

Multi-family residential

    1,192       1,094       1,157       1,535       1,917  

Single family non-owner occupied

    1,442       1,976       2,752       3,369       3,228  

Non-farm, non-residential

    6,530       6,597       6,185       6,393       5,805  

Agricultural

    85       51       43       22       13  

Farmland

    170       362       169       190       206  

Consumer real estate loans

                                       

Home equity lines

    748       803       895       1,091       1,330  

Single family owner occupied

    5,853       5,710       4,364       4,969       4,935  

Owner occupied construction

    131       297       228       297       225  

Consumer and other loans

                                       

Consumer loans

    1,036       794       759       690       670  

Total allowance, excluding PCI loans

  $ 18,267     $ 19,276     $ 17,936     $ 20,179     $ 20,169  

 

The following table presents the PCI allowance for loan losses, by loan pool, as of the dates indicated:

 

   

December 31,

 

(Amounts in thousands)

 

2018

   

2017

   

2016

   

2015

   

2014

 

Commercial loans

                                       

Waccamaw commercial

  $ -     $ -     $ -     $ -     $ 37  

Consumer real estate loans

                                       

Waccamaw residential

    -       -       -       1       -  

Peoples residential

    -       -       12       53       21  

Total PCI allowance

  $ -     $ -     $ 12     $ 54     $ 58  

 

Deposits

 

Total deposits as of December 31, 2018, decreased $74.14 million, or 3.84%, compared to December 31, 2017. Time deposits, which consist of certificates of deposit and individual retirement accounts, decreased $51.89 million; savings deposits, which consist of money market accounts and savings accounts, decreased $13.98 million; and interest-bearing demand deposits decreased $13.69 million while noninterest-bearing demand deposits increased $5.41 million as of December 31, 2018, compared to December 31, 2017. We had no material deposit concentrations to any single customer or industry that represented 10% or more of outstanding deposits as of December 31, 2018 or 2017.

 

The following schedule presents the contractual maturities of time deposits of $100 thousand or more as of December 31, 2018:

 

(Amounts in thousands)

       

Three months or less

  $ 10,522  

Over three through six months

    6,242  

Over six through twelve months

    25,318  

Over twelve months

    131,696  
    $ 173,778  

 

Borrowings

 

Total borrowings as of December 31, 2018, decreased $50.72 million, or 63.33%, compared to December 31, 2017, primarily due to the prepayment of our remaining $50.00 million FHLB convertible advance. Short-term borrowings, which consist of retail repurchase agreements, decreased $716 thousand, or 14.08%, and the weighted average rate increased 5 basis points to 0.12% as of December 31, 2018, compared to December 31, 2017.

 

 

The following table presents the balances and weighted average rates paid on short-term borrowings for the periods indicated:

 

   

Year Ended December 31,

 
   

2018

   

2017

   

2016

 
   

Amount

   

Rate

   

Amount

   

Rate

   

Amount

   

Rate

 

(Amounts in thousands)

                                               

Year-end balance

  $ 4,370       0.13 %   $ 5,086       0.11 %   $ 73,005       0.07 %

Average annual balance(1)

    4,010       0.12 %     47,717       0.07 %     108,620       0.21 %

Maximum month-end balance(1)

    29,305               90,968               182,554          

                                                                         

(1)  Includes federal funds purchased and short-term FHLB advances that were repaid prior to year end

 

Long-term borrowings consisted of a wholesale repurchase agreement that totaled $25.00 million with a weighted average rate of 3.18% as of December 31, 2018 and 2017. During 2018, the prepayment of the FHLB advance resulted in a prepayment penalty of $1.10 million. The prepayment was funded with cash and equivalents on hand, as well as proceeds from the sale of single issue trust preferred investment securities, and is anticipated to result in annualized net pre-tax savings of approximately $800 thousand. On January 9, 2017, the Company redeemed all of its trust preferred securities resulting in a decrease in subordinated debt of $15.46 million.

 

Liquidity and Capital Resources

 

Liquidity

 

Liquidity is a measure of our ability to convert assets to cash or raise cash to meet financial obligations. We believe that liquidity management should encompass an overall balance sheet approach that draws together all sources and uses of liquidity. Poor or inadequate liquidity risk management may result in a funding deficit that could have a material impact on our operations. We maintain a liquidity risk management policy and contingency funding policy (“Liquidity Plan”) to detect potential liquidity issues and protect our depositors, creditors, and shareholders. The Liquidity Plan includes various internal and external indicators that are reviewed on a recurring basis by our Asset/Liability Management Committee (“ALCO”) of the Board of Directors. ALCO reviews liquidity risk exposure and policies related to liquidity management; ensures that systems and internal controls are consistent with liquidity policies; and provides accurate reports about liquidity needs, sources, and compliance. The Liquidity Plan involves ongoing monitoring and estimation of potentially credit sensitive liabilities and the sources and amounts of balance sheet and external liquidity available to replace outflows during a funding crisis. The liquidity model incorporates various funding crisis scenarios and a specific action plan is formulated, and activated, when a financial shock that affects our normal funding activities is identified. Generally, the plan will reflect a strategy of replacing liability outflows with alternative liabilities, rather than balance sheet asset liquidity, to the extent that significant premiums can be avoided. If alternative liabilities are not available, outflows will be met through liquidation of balance sheet assets, including unpledged securities.

 

As a financial holding company, the Company’s primary source of liquidity is dividends received from the Bank, which are subject to certain regulatory limitations. Other sources of liquidity include cash, investment securities, and borrowings. As of December 31, 2018, the Company’s cash reserves totaled $13.73 million and availability on an unsecured, committed line of credit with an unrelated financial institution totaled $15.00 million. There was no outstanding balance on the line of credit as of December 31, 2018. The Company’s cash reserves and investments provide adequate working capital to meet obligations, projected dividends to shareholders, and anticipated debt repayments for the next twelve months.

 

In addition to cash on hand and deposits with other financial institutions, we rely on customer deposits, cash flows from loans and investment securities, and lines of credit from the FHLB and the Federal Reserve Bank (“FRB”) Discount Window to meet potential liquidity demands. These sources of liquidity are immediately available to satisfy deposit withdrawals, customer credit needs, and our operations. Secondary sources of liquidity include approved lines of credit with correspondent banks and unpledged available-for-sale securities. As of December 31, 2018, our unencumbered cash totaled $76.87 million, unused borrowing capacity from the FHLB totaled $402.74 million, available credit from the FRB Discount Window totaled $5.99 million, available lines from correspondent banks totaled $90.00 million, and unpledged available-for-sale securities totaled $114.87 million.

 

 

Cash Flows

 

The following table summarizes the components of cash flow for the periods indicated:

 

   

Year Ended December 31,

 
   

2018

   

2017

   

2016

 

(Amounts in thousands)

                       

Net cash provided by operating activities

  $ 49,499     $ 36,370     $ 43,088  

Net cash provided by investing activities

    49,398       67,796       110,210  

Net cash used in financing activities

    (179,975 )     (22,522 )     (128,778 )

Net (decrease) increase in cash and cash equivalents

    (81,078 )     81,644       24,520  

Cash and cash equivalents, beginning balance

    157,951       76,307       51,787  

Cash and cash equivalents, ending balance

  $ 76,873     $ 157,951     $ 76,307  

 

2018 Compared to 2017. Cash and cash equivalents decreased $81.08 million compared to an increase of $81.64 million in the prior year. The decrease was primarily due to a $157.45 million increase in net cash used in financing activities due to a net decrease in deposit accounts, the repayment of FHLB borrowings, an increase in cash dividends, and an increase in the repurchase of treasury stock. Net cash provided by investing activities decreased $18.40 million largely due to the purchase of available for sale securities. Net cash provided by operating activities increased $13.13 million primarily due to an increase in net income.

 

2017 Compared to 2016. Cash and cash equivalents increased $81.64 million compared to an increase of $24.52 million in the prior year. The increase was primarily due to a $106.26 million reduction in net cash used in financing activities as we increased deposit accounts and significantly reduced FHLB and other borrowings. Net cash provided by investing activities decreased $42.41 million largely due to a decrease in proceeds from sales and maturities of investment securities, which were partially offset by less loan origination activity. Net cash provided by operating activities experienced a slight decrease of $6.72 million.

 

Capital Resources

 

We are committed to effectively managing our capital to protect our depositors, creditors, and shareholders. Failure to meet certain capital requirements may result in actions by regulatory agencies that could have a material impact on our operations. Total stockholders’ equity as of December 31, 2018, decreased $17.86 million, or 5.09%, to $332.86 million from $350.71 million as of December 31, 2017. The change in stockholders’ equity was largely due to the repurchase of 1,060,312 shares of our common stock totaling $34.41 million and dividends declared on our common stock of $21.09 million, which included a one-time special dividend totaling $8.13 million, offset by net income of $36.34 million. Accumulated other comprehensive loss increased $589 thousand to $1.43 million as of December 31, 2018, compared to December 31, 2017, primarily due to net unrealized losses on securities. In accordance with current regulatory guidelines, accumulated other comprehensive income/(loss) is largely excluded from stockholders' equity in the calculation of capital ratios. Our book value per common share increased $0.16 to $20.79 as of December 31, 2018, from $20.63 as of December 31, 2017.

 

Capital Adequacy Requirements

 

Risk-based capital guidelines, issued by state and federal banking agencies, include balance sheet assets and off-balance sheet arrangements weighted by the risks inherent in the specific asset type. Our current risk-based capital requirements, based on the international capital standards known as Basel III, became effective on January 1, 2015, subject to a four-year phase-in period. Basel III’s capital conservation buffer became effective on January 1, 2016, at 0.625%, and was phased in over a four-year period (increased an additional 0.625% each year until it reached 2.5% on January 1, 2019). Our current required capital ratios are as follows:

 

 

4.5% Common Equity Tier 1 capital to risk-weighted assets (effectively 6.375% including the capital conservation buffer)

 

6.0% Tier 1 capital to risk-weighted assets (effectively 7.875% including the capital conservation buffer)

 

8.0% Total capital to risk-weighted assets (effectively 9.875% including the capital conservation buffer)

 

4.0% Tier 1 capital to average consolidated assets (“Tier 1 leverage ratio”)

 

 

The following table presents our capital ratios as of the dates indicated:

 

 

December 31,

 

2018

 

2017

 

2016

The Company

         

Common equity Tier 1 ratio

13.72%

 

13.98%

 

13.88%

Tier 1 risk-based capital ratio

13.72%

 

13.98%

 

14.74%

Total risk-based capital ratio

14.79%

 

15.06%

 

15.79%

Tier 1 leverage ratio

10.95%

 

11.06%

 

11.07%

           

The Bank

         

Common equity Tier 1 ratio

12.55%

 

12.47%

 

12.93%

Tier 1 risk-based capital ratio

12.55%

 

12.47%

 

12.93%

Total risk-based capital ratio

13.62%

 

13.55%

 

13.98%

Tier 1 leverage ratio

9.98%

 

9.84%

 

9.71%

 

The Bank’s risk-based capital ratios as of December 31, 2018, remained relatively flat compared to December 31, 2017; however, the Company’s risk-based capital ratios decreased primarily due to the one-time special dividend to common shareholders and repurchase of common stock. Our risk-based capital ratios as of December 31, 2017, decreased from December 31, 2016, primarily due to an increase in risk-weighted assets. As of December 31, 2018, we continued to meet all capital adequacy requirements and were classified as well-capitalized under the regulatory framework for prompt corrective action. Management believes there have been no conditions or events since those notifications that would change the Bank’s classification. Additionally, our capital ratios were in excess of the minimum standards under the Basel III capital rules on a fully phased-in basis, if such requirements were in effect, as of December 31, 2018. For additional information, see “Capital Requirements” in Part I, Item 1 and Note 21, “Regulatory Requirements and Restrictions,” to the Consolidated Financial Statements in Item 8 of this report.

 

Commitments, Contingencies, and Off-Balance Sheet Arrangements

 

Contractual Obligations

 

We enter into certain contractual obligations in the normal course of business that require future cash payments. Management believes we have adequate resources to fund our outstanding commitments and the ability to adjust rates on certificates of deposit, in a changing interest rate environment; attract new deposits; and replace deposits with FHLB advances or other fund providers, if cost effective. The following table presents our contractual cash obligations, by payment date, as of December 31, 2018:

 

   

Less Than

   

One to

   

Three to

   

More than

         
   

One Year

   

Three Years

   

Five Years

   

Five Years

   

Total

 

(Amounts in thousands)

                                       

Deposits without a stated maturity(1)

  $ 1,414,459     $ -     $ -     $ -     $ 1,414,459  

Certificates of deposit(2)(3)

    196,154       184,391       74,002       104       454,651  

Securities sold under agreements to repurchase

    25,122       -       -       -       25,122  

Operating leases

    160       194       194       597       1,145  

Total contractual cash obligations

  $ 1,635,895     $ 184,585     $ 74,196     $ 701     $ 1,895,377  

                                                                                             

(1)

Excludes interest

(2)

Includes interest on fixed and variable rate obligations (changes in market interest rates may materially affect the variable rate obligation to be paid, which is reflected using the rates in effect as of December 31, 2018)

(3)

Excludes unamortized premiums and discounts

 

Off-Balance Sheet Arrangements

 

We extend contractual commitments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. Our exposure to credit loss in the event of nonperformance by other parties to financial instruments is the same as the contractual amount of the instrument.

 

 

The following table presents our off-balance sheet arrangements, by commitment expiration, as of December 31, 2018:

 

   

Less than

   

One to

   

Three to

   

More than

         
   

One Year(1)

   

Three Years

   

Five Years

   

Five Years

   

Total

 

(Amounts in thousands)

                                       

Commitments to extend credit

  $ 83,720     $ 31,622     $ 21,168     $ 78,729     $ 215,239  

Financial letters of credit

    124       230       10       -       364  

Performance letters of credit(2)

    59,270       89,860       -       -       149,130  

Total off-balance sheet risk

  $ 143,114     $ 121,712     $ 21,178     $ 78,729     $ 364,733  

                                                                                                 

(1)

Lines of credit with no stated maturity date are included in the less than one year expiration category.

(2)

Includes FHLB letters of credit

 

The reserve for the risk inherent in unfunded lending commitments totaled $66 thousand as of December 31, 2018 and 2017. For additional information, see Note 20, “Litigation, Commitments, and Contingencies,” to the Consolidated Financial Statements in Item 8 of this report.

 

Market Risk and Interest Rate Sensitivity

 

Market risk represents the risk of loss due to adverse changes in current and future cash flows, fair values, earnings, or capital due to movements in interest rates and other factors. Our profitability is largely dependent upon net interest income, which is subject to variation due to changes in the interest rate environment and unbalanced repricing opportunities. We are subject to interest rate risk when interest-earning assets and interest-bearing liabilities reprice at differing times, when underlying rates change at different levels or in varying degrees, when there is an unequal change in the spread between two or more rates for different maturities, and when embedded options, if any, are exercised. ALCO reviews our mix of assets and liabilities with the goal of limiting exposure to interest rate risk, ensuring adequate liquidity, and coordinating sources and uses of funds while maintaining an acceptable level of net interest income given the current interest rate environment. ALCO is also responsible for overseeing the formulation and implementation of policies and strategies to improve balance sheet positioning and mitigate the effect of interest rate changes.

 

In order to manage our exposure to interest rate risk, we periodically review third-party and internal simulation models that project net interest income at risk, which measures the impact of different interest rate scenarios on net interest income, and the economic value of equity at risk, which measures potential long-term risk in the balance sheet by valuing our assets and liabilities at fair value under different interest rate scenarios. Simulation results show the existence and severity of interest rate risk in each scenario based on our current balance sheet position, assumptions about changes in the volume and mix of interest-earning assets and interest-bearing liabilities, and estimated yields earned on assets and rates paid on liabilities. The simulation model provides the best tool available to us and the industry for managing interest rate risk; however, the model cannot precisely predict the impact of fluctuations in interest rates on net interest income due to the use of significant estimates and assumptions. Actual results will differ from simulated results due to the timing, magnitude, and frequency of interest rate changes; changes in market conditions and customer behavior; and changes in our strategies that management might undertake in response to a sudden and sustained rate shock.

 

During 2018, the Federal Open Market Committee raised the benchmark federal funds rate 100 basis points to a range of 225 to 250 basis points. The following table presents the sensitivity of net interest income from immediate and sustained rate shocks in various interest rate scenarios over a twelve-month period for the periods indicated. Due to the current target rate, we do not reflect a decrease of more than 100 basis points from current rates in our analysis.

 

   

Year Ended December 31,

 
   

2018

   

2017

 
   

Change in

   

Percent

   

Change in

   

Percent

 

Increase (Decrease) in Basis Points

 

Net Interest Income

   

Change

   

Net Interest Income

   

Change

 

(Dollars in thousands)

                               

300

  $ (1,215 )     -1.3 %   $ 3,759       4.3 %
200     (545 )     -0.6 %     2,756       3.2 %
100     (135 )     -0.1 %     1,535       1.8 %

(100)

    (3,322 )     -3.7 %     (4,405 )     -5.1 %

 

We have established policy limits for tolerance of interest rate risk in various interest rate scenarios and exposure limits to changes in the economic value of equity. As of December 31, 2018, exposure to interest rate risk was within our defined policy limits for the scenarios presented.

 

 

The Company primarily uses derivative instruments to manage exposure to market risk and meet customer financing needs. As of December 31, 2018, we maintained interest rate swap agreements with notional amounts totaling $5.48 million to modify our exposure to interest rate risk caused by changes in the LIBOR curve in relation to certain designated fixed rate loans. The fair value of the swap agreements, which are accounted for as fair value hedges, was recorded as a derivative asset totaling $12 thousand as of December 31, 2018, and a derivative liability totaling $90 thousand as of December 31, 2017. For additional information, see Note 12, “Derivative Instruments and Hedging Activities,” to the Consolidated Financial Statements in Item 8 of this report.

 

Inflation and Changing Prices

 

Our consolidated financial statements and related notes are presented in accordance with GAAP, which requires the measurement of results of operations and financial position in historical dollars. Inflation may cause a rise in price levels and changes in the relative purchasing power of money. These inflationary effects are not reflected in historical dollar measurements. The primary effect of inflation on our operations is increased operating costs. In management’s opinion, interest rates have a greater impact on our financial performance than inflation. Interest rates do not necessarily fluctuate in the same direction, or to the same extent, as the price of goods and services; therefore, the effect of inflation on businesses with large investments in property, plant, and inventory is generally more significant than the effect on financial institutions. The U.S. inflation rate continues to be relatively stable, and management believes that any changes in inflation will not be material to our financial performance.

 

Item 7A.

Quantitative and Qualitative Disclosures about Market Risk.

 

The information required in this item is incorporated by reference to “Market Risk and Interest Rate Sensitivity” in Item 7 of this report.

 

 

Item 8.

Financial Statements and Supplementary Data.

 

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX

 
   

Page  

     

Consolidated Balance Sheets as of December 31, 2018 and 2017

47

Consolidated Statements of Income for the years ended December 31, 2018, 2017, and 2016

48

Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2018, 2017, and 2016

49

Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2018, 2017, and 2016

50

Consolidated Statements of Cash Flows for the years ended December 31, 2018, 2017, and 2016

51

Notes to Consolidated Financial Statements

52

Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements

99

Management’s Assessment of Internal Control Over Financial Reporting

100

Report of Independent Registered Public Accounting Firm on Management’s Assessment of Internal Control Over Financial Reporting

101

 

 

 

FIRST COMMUNITY BANKSHARES, INC.

CONSOLIDATED BALANCE SHEETS

 

   

December 31,

 

(Amounts in thousands, except share and per share data)

 

2018

   

2017

 

Assets

               

Cash and due from banks

  $ 40,421     $ 37,115  

Federal funds sold

    35,457       119,891  

Interest-bearing deposits in banks

    995       945  

Total cash and cash equivalents

    76,873       157,951  

Debt securities available for sale

    153,116       165,525  

Debt securities held to maturity

    25,013       25,149  

Loans held for investment, net of unearned income (includes covered loans of $18,815 and $27,948, respectively)

    1,775,084       1,817,184  

Allowance for loan losses

    (18,267 )     (19,276 )

Loans held for investment, net

    1,756,817       1,797,908  

FDIC indemnification asset

    5,108       7,161  

Premises and equipment, net

    45,785       48,126  

Other real estate owned (includes covered OREO of $32 and $105, respectively)

    3,838       2,514  

Interest receivable

    5,481       5,778  

Goodwill

    92,744       95,779  

Other intangible assets

    5,026       6,151  

Other assets

    74,573       76,418  

Total assets

  $ 2,244,374     $ 2,388,460  
                 

Liabilities

               

Noninterest-bearing deposits

  $ 459,550     $ 454,143  

Interest-bearing deposits

    1,396,200       1,475,748  

Total deposits

    1,855,750       1,929,891  

Securities sold under agreements to repurchase

    29,370       30,086  

FHLB borrowings

    -       50,000  

Interest, taxes, and other liabilities

    26,397       27,769  

Total liabilities

    1,911,517       2,037,746  
                 

Stockholders' equity

               

Preferred stock, undesignated par value; 1,000,000 shares authorized; Series A Noncumulative Convertible Preferred Stock, $0.01 par value; 25,000 shares authorized; none outstanding

     -        -  

Common stock, $1 par value; 50,000,000 shares authorized; 16,007,263 shares issued and outstanding at December 31, 2018; 21,381,779 shares issued and 4,383,553 shares in treasury at December 31, 2017

     16,007        21,382  

Additional paid-in capital

    122,486       228,750  

Retained earnings

    195,793       180,543  

Treasury stock

    -       (79,121 )

Accumulated other comprehensive loss

    (1,429 )     (840 )

Total stockholders' equity

    332,857       350,714  

Total liabilities and stockholders' equity

  $ 2,244,374     $ 2,388,460  

 

See Notes to Consolidated Financial Statements.

 

 

 

FIRST COMMUNITY BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME

 

 

Year Ended December 31,

 

(Amounts in thousands, except share and per share data)

2018

 

2017

 

2016

 

Interest income

                 

Interest and fees on loans

$ 91,671   $ 89,749   $ 87,718  

Interest on securities -- taxable

  2,258     1,522     3,229  

Interest on securities -- tax-exempt

  2,828     3,029     3,624  

Interest on deposits in banks

  1,537     1,008     153  

Total interest income

  98,294     95,308     94,724  

Interest expense

                 

Interest on deposits

  5,144     4,987     4,479  

Interest on short-term borrowings

  811     850     2,101  

Interest on long-term debt

  1,494     2,253     3,264  

Total interest expense

  7,449     8,090     9,844  

Net interest income

  90,845     87,218     84,880  

Provision for loan losses

  2,393     2,771     1,255  

Net interest income after provision for loan losses

  88,452     84,447     83,625  

Noninterest income

                 

Wealth management

  3,262     3,150     2,828  

Service charges on deposits

  14,733     13,803     13,588  

Other service charges and fees

  7,733     6,944     6,570  

Insurance commissions

  966     1,347     5,442  

Impairment losses on securities

  -     -     (4,646 )

Portion of loss recognized in other comprehensive income

  -     -     -  

Net impairment losses recognized in earnings

  -     -     (4,646 )

Net (loss) gain on sale of securities

  (618 )   (661 )   335  

Net FDIC indemnification asset amortization

  (2,181 )   (3,517 )   (5,474 )

Net gain on divestitures

  -     -     3,682  

Other operating income

  2,548     3,502     3,209  

Total noninterest income

  26,443     24,568     25,534  

Noninterest expense

                 

Salaries and employee benefits

  36,690     35,774     39,389  

Occupancy expense

  4,542     4,775     5,297  

Furniture and equipment expense

  3,980     4,425     4,341  

Service fees

  3,860     3,348     3,641  

Advertising and public relations

  2,011     2,206     1,532  

Professional fees

  1,430     2,567     1,501  

Amortization of intangibles

  1,039     1,056     1,136  

FDIC premiums and assessments

  906     910     1,383  

Loss on extinguishment of debt

  1,096     -     -  

Goodwill impairment

  1,492     -     -  

Merger, acquisition, and divestiture expense

  -     -     730  

Other operating expense

  12,727     11,841     12,264  

Total noninterest expense

  69,773     66,902     71,214  

Income before income taxes

  45,122     42,113     37,945  

Income tax expense

  8,782     20,628     12,819  

Net income

$ 36,340   $ 21,485   $ 25,126  
                   

Earnings per common share

                 

Basic

$ 2.19   $ 1.26   $ 1.45  

Diluted

  2.18     1.26     1.45  

Cash dividends per common share

  1.26     0.68     0.60  

Weighted average shares outstanding

                 

Basic

  16,587,504     17,002,116     17,319,689  

Diluted

  16,666,385     17,077,842     17,365,524  

 

See Notes to Consolidated Financial Statements.

 

 

 

FIRST COMMUNITY BANKSHARES, INC

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

   

Year Ended December 31,

 
   

2018

   

2017

   

2016

 

(Amounts in thousands)

                       

Net income

  $ 36,340     $ 21,485     $ 25,126  

Other comprehensive income, before tax

                       

Available-for-sale debt securities:

                       

Change in net unrealized (losses) gains on securities without other-than-temporary impairment

    (2,213 )     1,445       1,035  

Reclassification adjustment for net loss (gain) recognized in net income

    618       661       (335 )

Reclassification adjustment for other-than-temporary impairment losses recognized in net income

    -       -       4,646  

Net unrealized (losses) gains on available-for-sale debt securities

    (1,595 )     2,106       5,346  

Employee benefit plans:

                       

Net actuarial (loss) gain

    565       48       (367 )

Plan change

    -       (258 )     (69 )

Reclassification adjustment for amortization of prior service cost and net actuarial loss recognized in net income

    285       259       273  

Net unrealized gains (losses) on employee benefit plans

    850       49       (163 )

Other comprehensive (loss) income, before tax

    (745 )     2,155       5,183  

Income tax expense (benefit)

    156       (740 )     (1,947 )

Other comprehensive (loss) income, net of tax

    (589 )     1,415       3,236  

Total comprehensive income

  $ 35,751     $ 22,900     $ 28,362  

 

See Notes to Consolidated Financial Statements.

 

 

 

FIRST COMMUNITY BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

 

                                           

Accumulated

         
                   

Additional

                   

Other

         
   

Preferred

   

Common

   

Paid-in

   

Retained

   

Treasury

   

Comprehensive

         

(Amounts in thousands,

 

Stock

   

Stock

   

Capital

   

Earnings

   

Stock

   

Income (Loss)

   

Total

 

except share and per share data)

                                                       

Balance January 1, 2016

  $ -     $ 21,382     $ 227,692     $ 155,647     $ (56,457 )   $ (5,247 )   $ 343,017  

Net income

    -       -       -       25,126       -       -       25,126  

Other comprehensive income

    -       -       -       -       -       3,236       3,236  

Common dividends declared -- $0.60 per share

    -       -       -       (10,396 )     -       -       (10,396 )

Equity-based compensation expense

    -       -       241       -       290       -       531  

Common stock options exercised -- 43,463 shares

    -       -       146       -       775       -       921  

Issuance of treasury stock to 401(k) plan -- 18,218 shares

    -       -       63       -       321       -       384  

Purchase of treasury shares -- 1,182,294 shares at $20.06 per share

    -       -       -       -       (23,762 )     -       (23,762 )

Balance December 31, 2016

  $ -     $ 21,382     $ 228,142     $ 170,377     $ (78,833 )   $ (2,011 )   $ 339,057  
                                                         

Balance January 1, 2017

  $ -     $ 21,382     $ 228,142     $ 170,377     $ (78,833 )   $ (2,011 )   $ 339,057  

Net income

    -       -       -       21,485       -       -       21,485  

Other comprehensive income

    -       -       -       -       -       1,415       1,415  

Reclassification of certain tax effects

    -       -       -       244       -       (244 )     -  

Common dividends declared -- $0.68 per share

    -       -       -       (11,563 )     -       -       (11,563 )

Equity-based compensation expense

    -       -       382       -       408       -       790  

Common stock options exercised -- 16,185 shares

    -       -       86       -       292       -       378  

Issuance of treasury stock to 401(k) plan -- 15,254 shares

    -       -       140       -       275       -       415  

Purchase of treasury shares -- 50,118 shares at $25.16 per share

    -       -       -       -       (1,263 )     -       (1,263 )

Balance December 31, 2017

  $ -     $ 21,382     $ 228,750     $ 180,543     $ (79,121 )   $ (840 )   $ 350,714  
                                                         

Balance January 1, 2018

  $ -     $ 21,382     $ 228,750     $ 180,543     $ (79,121 )   $ (840 )   $ 350,714  

Net income

    -       -       -       36,340       -       -       36,340  

Other comprehensive loss

    -       -       -       -       -       (589 )     (589 )

Common dividends declared -- $0.78 per share

    -       -       -       (12,966 )     -       -       (12,966 )

Special common dividend declared -- $0.48 per share

    -       -       -       (8,124 )     -       -       (8,124 )

Equity-based compensation expense

    -       -       535       -       623       -       1,158  

Common stock options exercised -- 24,186 shares

    -       -       (84 )     -       468       -       384  

Issuance of treasury stock to 401(k) plan -- 11,331 shares

    -       -       138       -       214       -       352  

Purchase of treasury shares -- 1,060,312 shares at $32.45 per share

    -       -       -       -       (34,412 )     -       (34,412 )

Reclassification of treasury stock

    -       (5,375 )     (106,853 )     -       112,228       -       -  

Balance December 31, 2018

  $ -     $ 16,007     $ 122,486     $ 195,793     $ -     $ (1,429 )   $ 332,857  

 

See Notes to Consolidated Financial Statements.

 

 

 

FIRST COMMUNITY BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

   

Year Ended December 31,

 

(Amounts in thousands)

 

2018

   

2017

   

2016

 

Operating activities

                       

Net income

  $ 36,340     $ 21,485     $ 25,126  

Adjustments to reconcile net income to net cash provided by operating activities

                       

Provision for loan losses

    2,393       2,771       1,255  

Depreciation and amortization of premises and equipment

    2,912       3,560       3,563  

Amortization of premiums on investments, net

    40       172       1,066  

Amortization of FDIC indemnification asset, net

    2,181       3,517       5,474  

Amortization of intangible assets

    1,039       1,056       1,136  

Goodwill impairment

    1,492       -       -  

Accretion on acquired loans

    (6,391 )     (5,417 )     (4,766 )

Gain on divestiture, net

    -       -       (3,682 )

Equity-based compensation expense

    1,158       790       531  

Issuance of treasury stock to 401(k) plan

    352       415       384  

(Gain) loss on sale of premises and equipment, net

    (25 )     (1 )     238  

Loss on sale of other real estate owned

    1,313       791       1,495  

Loss (gain) on sale of securities

    618       661       (335 )

Net impairment losses recognized in earnings

    -       -       4,646  

Loss on extinguishment of debt

    1,096       -       -  

Decrease in other operating activities

    4,981       6,570       6,957  

Net cash provided by operating activities

    49,499       36,370       43,088  

Investing activities

                       

Proceeds from sale of securities available for sale

    8,937       13,664       104,928  

Proceeds from maturities, prepayments, and calls of securities available for sale

    68,765       37,155       99,906  

Proceeds from maturities and calls of securities held to maturity

    -       21,840       25,190  

Payments to acquire securities available for sale

    (67,355 )     (49,406 )     (1,174 )

Proceeds from (originations of) loans, net

    39,512       37,455       (159,243 )

Proceeds from bank owned life insurance

    458       2,639       -  

(Redemption of) proceeds from FHLB stock, net

    (2,122 )     694       130  

Cash proceeds from mergers, acquisitions, and divestitures, net

    10       -       29,716  

(Payments to) proceeds from the FDIC

    (151 )     1,689       4,403  

Proceeds from sale of premises and equipment

    955       57       1,092  

Payments to acquire premises and equipment

    (2,551 )     (2,354 )     (1,885 )

Proceeds from sale of other real estate owned

    2,940       4,363       7,147  

Net cash provided by investing activities

    49,398       67,796       110,210  

Financing activities

                       

Increase (decrease) in noninterest-bearing deposits, net

    5,407       26,438       (17,482 )

(Decrease) increase in interest-bearing deposits, net

    (79,548 )     62,115       (37,576 )

Repayments of securities sold under agreements to repurchase, net

    (716 )     (67,919 )     (40,609 )

Repayments of FHLB and other borrowings, net

    (50,000 )     (30,708 )     (48 )

Proceeds from stock options exercised

    384       378       921  

Excess tax benefit from equity-based compensation

    -       -       174  

Payments for repurchase of treasury stock

    (34,412 )     (1,263 )     (23,762 )

Payments of common dividends

    (21,090 )     (11,563 )     (10,396 )

Net cash used in financing activities

    (179,975 )     (22,522 )     (128,778 )

Net (decrease) increase in cash and cash equivalents

    (81,078 )     81,644       24,520  

Cash and cash equivalents at beginning of period

    157,951       76,307       51,787  

Cash and cash equivalents at end of period

  $ 76,873     $ 157,951     $ 76,307  
                         

Supplemental disclosure -- cash flow information

                       

Cash paid for interest

  $ 7,935     $ 8,267     $ 9,845  

Cash paid for income taxes

    7,610       15,852       6,588  
                         

Supplemental transactions -- non-cash items

                       

Transfer of loans to other real estate

    5,686       2,283       5,162  

Loans originated to finance other real estate

    164       -       57  

Increase (decrease) in accumulated other comprehensive loss

    589       (1,171 )     (3,236 )

Non-cash sales price related to divestitures

    1,603       -       -  

 

See Notes to Consolidated Financial Statements.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

Note 1. Basis of Presentation and Significant Accounting Policies

 

Basis of Presentation

 

First Community Bankshares, Inc. (the “Company”), a financial holding company, was founded in 1989 and incorporated under the laws of the Commonwealth of Virginia in 2018. The Company is the successor to First Community Bancshares, Inc., a Nevada corporation, pursuant to an Agreement and Plan of Reincorporation and Merger, the sole purpose of which was to change the Company’s state of incorporation from Nevada to Virginia. The Company’s principal executive office is located at One Community Place, Bluefield, Virginia. The Company provides banking products and services to individual and commercial customers through its wholly owned subsidiary First Community Bank (the “Bank”), a Virginia-chartered banking institution founded in 1874. The Bank operates as First Community Bank in Virginia, West Virginia, and North Carolina and People’s Community Bank, a Division of First Community Bank, in Tennessee. The Bank offers wealth management and investment advice through its Trust Division and wholly owned subsidiary First Community Wealth Management (“FCWM”). Unless the context suggests otherwise, the terms “First Community,” “Company,” “we,” “our,” and “us” refer to First Community Bankshares, Inc. and its subsidiaries as a consolidated entity.

 

Principles of Consolidation

 

The Company’s accounting and reporting policies conform with U.S. generally accepted accounting principles (“GAAP”) and prevailing practices in the banking industry. The consolidated financial statements include all accounts of the Company and its wholly owned subsidiaries and eliminate all intercompany balances and transactions. The Company operates in one business segment, Community Banking, which consists of all operations, including commercial and consumer banking, lending activities, and wealth management.

 

The Company maintains investments in variable interest entities (“VIEs”). VIEs are legal entities in which equity investors do not have sufficient equity at risk for the entity to independently finance its activities, or as a group, the holders of the equity investment at risk lack the power through voting or similar rights to direct the activities of the entity that most significantly impact its economic performance, or do not have the obligation to absorb the expected losses of the entity or the right to receive expected residual returns of the entity. Consolidation of a VIE is required if a reporting entity is the primary beneficiary of the VIE. The Company periodically reviews its VIEs and has determined that it is not the primary beneficiary of any VIE; therefore, the assets and liabilities of these entities are not consolidated into the financial statements.

 

Reclassification

 

Certain amounts reported in prior years have been reclassified to conform to the current year’s presentation. These reclassifications had no effect on the Company’s results of operations, financial position, or net cash flow. In accordance with the reincorporation, the Company reclassified cumulative treasury stock resulting in a $5.38 million reduction of common stock at par value and a $106.85 million reduction of additional paid in capital at the excess cost of the treasury stock over par value. Virginia code provides that reacquired shares return to the status of authorized but unissued; therefore, the concept of treasury shares is eliminated.

 

Use of Estimates

 

Preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that require the most subjective or complex judgments relate to fair value measurements, the allowance for loan losses, goodwill and other intangible assets, and income taxes. For additional information, see “Critical Accounting Policies” in Part II, Item 7 of this report.

 

Summary of Significant Accounting Policies

 

Fair Value Measurements

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants. Market participants are buyers and sellers in the principal market that are independent, knowledgeable, able to transact, and willing to transact.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The fair value hierarchy ranks the inputs used in measuring fair value as follows:

 

 

Level 1 – Observable, unadjusted quoted prices in active markets

 

Level 2 – Inputs other than quoted prices included in Level 1 that are directly or indirectly observable for the asset or liability

 

Level 3 – Unobservable inputs with little or no market activity that require the Company to use reasonable inputs and assumptions

 

The Company uses fair value measurements to record adjustments to certain financial assets and liabilities on a recurring basis. The Company may be required to record certain assets at fair value on a nonrecurring basis in specific circumstances, such as evidence of impairment. Methodologies used to determine fair value might be highly subjective and judgmental in nature; therefore, valuations may not be precise. If the Company determines that a valuation technique change is necessary, the change is assumed to have occurred at the end of the respective reporting period.

 

Cash and Cash Equivalents

 

Cash and cash equivalents include cash and due from banks, federal funds sold, and interest-bearing balances on deposit with the Federal Home Loan Bank (“FHLB”), the Federal Reserve Bank (“FRB”), and correspondent banks that are available for immediate withdrawal.

 

Investment Securities

 

Management classifies debt securities as held-to-maturity or available-for-sale based on the intent and ability to hold the securities to maturity. Debt securities that the Company has the intent and ability to hold to maturity are classified as held-to-maturity securities and carried at amortized cost. Debt securities not classified as held to maturity are classified as available-for-sale securities and carried at estimated fair value. Available-for-sale securities consist of securities the Company intends to hold for indefinite periods of time including securities to be used as part of the Company’s asset/liability management strategy and securities that may be sold in response to changes in interest rates, prepayment risk, or other similar factors. Unrealized gains and losses on available-for-sale securities are included in accumulated other comprehensive income (“AOCI”), net of income taxes, in stockholders’ equity. Gains or losses on calls, maturities, or sales of investment securities are recorded based on the specific identification method and included in noninterest income. Premiums and discounts are amortized or accreted over the life of a security into interest income.

 

The Company reviews its investment portfolio quarterly for indications of other-than-temporary impairment (“OTTI”) using inputs from independent third parties to determine the fair value of investment securities, which are reviewed and corroborated by management. Unrealized losses are evaluated to determine whether the impairment is temporary or other-than-temporary in nature. For debt securities, management considers its intent to sell the securities, the evidence available to determine if it is more likely than not that the securities will have to be sold before recovery of amortized cost, and the probable credit losses. Probable credit losses are evaluated using the present value of expected future cash flows; the severity and duration of the impairment; the issuer’s financial condition and near-term prospects to service the debt; the cause of the decline, such as adverse conditions related to the issuer, the industry, or economic environment; the payment structure of the debt; the issuer’s failure to make scheduled interest or principal payments; and any change in the issuer’s credit rating by rating agencies. If the present value of expected future cash flows discounted at the security's effective yield is less than the net book value, the difference is recognized as a credit-related OTTI in noninterest income. If management does not intend to sell and if we are not likely to be required to sell the security, the OTTI is separated into an amount representing the credit loss, which is recognized as a charge to noninterest income, and the amount representing all other factors, which is recognized in other comprehensive income (“OCI”).

 

Other Investments

 

As a condition of membership in the FHLB and the FRB, the Company is required to hold a minimum level of stock in the FHLB of Atlanta and the FRB of Richmond. These securities are carried at cost and periodically reviewed for impairment. The total investment in FHLB and FRB stock, which is included in other assets, was $7.78 million as of December 31, 2018, and $9.90 million as of December 31, 2017.

 

The Company owns certain long-term equity investments without readily determinable fair values, including certain tax credit limited partnerships and various limited liability companies that manage real estate investments, facilitate tax credits, and provide title insurance and other related financial services. These investments are accounted for at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment. The total carrying value in these investments, which is included other assets, totaled $602 thousand as of December 31, 2018, and $823 thousand as of December 31, 2017.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Business Combinations

 

The Company accounts for business combinations using the acquisition method of accounting as outlined in using Topic 805 of the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”). Under this method, all identifiable assets acquired, including purchased loans, and liabilities assumed are recorded at fair value. Any excess of the purchase price over the fair value of net assets acquired is recorded as goodwill. In instances where the price of the acquired business is less than the net assets acquired, a gain on the purchase is recorded. Fair values are assigned based on quoted prices for similar assets, if readily available, or appraisals by qualified independent parties for relevant asset and liability categories. Certain financial assets and liabilities are valued using discount models that apply current discount rates to streams of cash flow. Valuation methods require assumptions, which can result in alternate valuations, varying levels of goodwill or bargain purchase gains, or amortization expense or accretion income. Management must make estimates for the useful or economic lives of certain acquired assets and liabilities that are used to establish the amortization or accretion of some intangible assets and liabilities, such as core deposits. Fair values are subject to refinement for up to one year after the closing date of the acquisition as additional information about the closing date fair values becomes available. Acquisition and divestiture activities are included in the Company’s consolidated results of operations from the closing date of the transaction. Acquisition and divestiture related costs are recognized in noninterest expense as incurred. For additional information, see “Purchased Credit Impaired Loans” and “Intangible Assets” below.

 

Loans Held for Investment

 

Loans classified as held for investment are originated with the intent to hold indefinitely, until maturity, or until pay-off. Loans held for investment are carried at the principal amount outstanding, net of unearned income and any necessary write-downs to reduce individual loans to net realizable value. Interest income on performing loans is recognized as interest income at the contractual rate of interest. Loan origination fees, including loan commitment and underwriting fees, are reduced by direct costs associated with loan processing, including salaries, legal review, and appraisal fees. Net deferred loan fees are deferred and amortized over the life of the related loan or commitment period.

 

Purchased Performing Loans. Purchased loans that are deemed to be performing at the acquisition date are accounted for using the contractual cash flow method of accounting, which results in the loans being recorded at fair value with a credit discount. The fair value discount is accreted as an adjustment to yield over the estimated contractual lives of the loans. No allowance for loan losses is recorded at acquisition for purchased loans because the fair values of the acquired loans incorporate credit risk assumptions.

 

Purchased Credit Impaired (“PCI”) Loans. When purchased loans exhibit evidence of credit deterioration after the acquisition date, and it is probable at acquisition the Company will not collect all contractually required principal and interest payments, the loans are referred to as PCI loans. PCI loans are accounted for using Topic 310-30 of the FASB ASC. PCI loans are initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loans. Per the guidance, the Company groups PCI loans that have common risk characteristics into loan pools. Evidence of credit quality deterioration at acquisition may include measures such as nonaccrual status, credit scores, declines in collateral value, current loan to value percentages, and days past due. The Company considers expected prepayments and estimates the amount and timing of expected principal, interest, and other cash flows for each loan or pool of loans identified as credit impaired. If contractually required payments at acquisition exceed cash flows expected to be collected, the excess is the non-accretable difference, which is available to absorb credit losses on those loans or pools of loans. If the cash flows expected at acquisition exceed the estimated fair values, the excess is the accretable yield, which is recognized in interest income over the remaining lives of those loans or pools of loans when there is a reasonable expectation about the amount and timing of such cash flows.

 

Impaired Loans and Nonperforming Assets. The Company maintains an active and robust problem credit identification system through its ongoing credit review function. When a credit is identified as exhibiting characteristics of weakening, the Company assesses the credit for potential impairment. Loans are considered impaired when, in the opinion of management and based on current information and events, the collection of principal and interest payments due under the contractual terms of the loan agreements are uncertain. The Company conducts quarterly reviews of loans with balances of $500 thousand or greater that are deemed to be impaired. Factors considered in determining impairment include, but are not limited to, the borrower’s cash flow and capacity for debt repayment, the valuation of collateral, historical loss percentages, and economic conditions. Impairment allowances allocated to individual loans, including individual credit relationships and loan pools grouped by similar risk characteristics, are reviewed quarterly by management. Interest income realized on impaired loans in nonaccrual status, if any, is recognized upon receipt. The accrual of interest, which is based on the daily amount of principal outstanding, on impaired loans is generally continued unless the loan becomes delinquent 90 days or more.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Loans are considered past due when either principal or interest payments become contractually delinquent by 30 days or more. The Company’s policy is to discontinue the accrual of interest, if warranted, on loans based on the payment status, evaluation of the related collateral, and the financial strength of the borrower. Loans that are 90 days or more past due are placed on nonaccrual status. Management may elect to continue the accrual of interest when the loan is well secured and in process of collection. When interest accruals are discontinued, interest accrued and not collected in the current year is reversed from income, and interest accrued and not collected from prior years is charged to the allowance for loan losses. Nonaccrual loans may be returned to accrual status when all principal and interest amounts contractually due, including past due payments, are brought current; the ability of the borrower to repay the obligation is reasonably assured; and there is generally a period of at least six months of repayment performance by the borrower in accordance with the contractual terms.

 

Seriously delinquent loans are evaluated for loss mitigation options. Closed-end retail loans are generally charged off against the allowance for loan losses when the loans become 120 days past due. Open-end retail loans and residential real estate secured loans are generally charged off when the loans become 180 days past due. Unsecured loans are generally charged off when the loans become 90 days past due. All other loans are charged off against the allowance for loan losses after collection attempts have been exhausted, which generally is within 120 days. Recoveries of loans previously charged off are credited to the allowance for loan losses in the period received.

 

Loans are considered troubled debt restructurings (“TDRs”) when the Company grants concessions, for legal or economic reasons, to borrowers experiencing financial difficulty that would not otherwise be considered. The Company generally makes concessions in interest rates, loan terms, and/or amortization terms. All TDRs $250 thousand or greater are evaluated for a specific reserve based on either the collateral or net present value method, whichever is most applicable. TDRs under $250 thousand are subject to the reserve calculation for classified loans based primarily on the historical loss rate. At the date of modification, nonaccrual loans are classified as nonaccrual TDRs. TDRs classified as nonperforming at the date of modification are returned to performing status after six months of satisfactory payment performance; however, these loans remain identified as impaired until full payment or other satisfaction of the obligation occurs.

 

Other real estate owned (“OREO”) acquired through foreclosure, or other settlement, is carried at the lower of cost or fair value less estimated selling costs. The fair value is generally based on current third-party appraisals. When a property is transferred into OREO, any excess of the loan balance over the net realizable fair value is charged against the allowance for loan losses. Operating expenses, gains, and losses on the sale of OREO are included in other noninterest expense in the Company’s consolidated statements of income after any fair value write-downs are recorded as valuation adjustments.

 

Allowance for Loan Losses

 

Management performs quarterly assessments of the allowance for loan losses. The allowance is increased by provisions charged to operations and reduced by net charge-offs. The provision is calculated and charged to earnings to bring the allowance to a level that, through a systematic process of measurement, reflects the amount management estimates is needed to absorb probable losses in the portfolio. The Company’s allowance for loan losses is segmented into commercial, consumer real estate, and consumer and other loans with each segment divided into classes with similar characteristics, such as the type of loan and collateral. The allowance for loan losses includes specific allocations related to significant individual loans and credit relationships and general reserves related to loans not individually evaluated. Loans not individually evaluated are grouped into pools based on similar risk characteristics. A loan that becomes adversely classified or graded is moved into a group of adversely classified or graded loans with similar risk characteristics for evaluation. A provision for loan losses is recorded for any credit deterioration in purchased performing loans after the acquisition date.

 

PCI loans are grouped into pools and evaluated separately from the non-PCI portfolio. The Company estimates cash flows to be collected on PCI loans and discounts those cash flows at a market rate of interest. If cash flows for PCI loans are expected to decline, generally a provision for loan losses is charged to earnings, resulting in an increase to the allowance for loan losses. If cash flows for PCI loans are expected to improve, any previously established allowance is first reversed to the extent of prior charges and then interest income is increased using the prospective yield adjustment over the remaining life of the loan, or pool of loans. Any provision established for PCI loans covered under the FDIC loss share agreements is offset by an adjustment to the FDIC indemnification asset to reflect the indemnified portion, 80%, of the post-acquisition exposure. While allocations are made to various portfolio segments, the allowance for loan losses is available for use against any loan loss management deems appropriate, excluding reserves allocated to specific loans and PCI loan pools.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

FDIC Indemnification Asset

 

The FDIC indemnification asset represents the carrying amount of the right to receive payments from the FDIC for losses incurred on certain loans and OREO purchased from the FDIC that are covered by loss share agreements. The FDIC indemnification asset is measured separately from related covered assets because it is not contractually embedded in the assets or transferable should the assets be disposed. Under the acquisition method of accounting, the FDIC indemnification asset is recorded at fair value using projected cash flows based on expected reimbursements and applicable loss share percentages as outlined in the loss share agreements. The expected reimbursements do not include reimbursable amounts related to future covered expenditures. The cash flows are discounted to reflect the timing and receipt of reimbursements from the FDIC. The discount is accreted through noninterest income over future periods. Post-acquisition adjustments to the indemnification asset are measured on the same basis as the underlying covered assets. Increases in the cash flows of covered loans reduce the FDIC indemnification asset balance, which is recognized as amortization through noninterest income over the shorter of the remaining life of the FDIC indemnification asset or the underlying loans. Decreases in the cash flows of covered loans increase the FDIC indemnification asset balance, which is recognized as accretion through noninterest income. Certain expenses related to covered assets are reimbursable from the FDIC through monthly and quarterly claims. Estimated reimbursements from the FDIC are netted against covered expenses in the consolidated statements of income.

 

Premises and Equipment

 

Premises, equipment, and capital leases are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the respective assets. Useful lives range from 5 to 10 years for furniture, fixtures, and equipment; 3 to 5 years for computer software, hardware, and data handling equipment; and 7 to 40 years for buildings and building improvements. Land improvements are amortized over a period of 20 years and leasehold improvements are amortized over the lesser of the term of the respective leases plus the first optional renewal period, when renewal is reasonably assured, or the estimated useful lives of the improvements. The Company leases various properties within its branch network. Leases generally have initial terms of up to 20 years and most contain options to renew with increases in rent. All leases are accounted for as operating leases. Maintenance and repairs are charged to current operations while improvements that extend the economic useful life of the underlying asset are capitalized. Disposition gains and losses are reflected in current operations.

 

Intangible Assets

 

Intangible assets consist of goodwill, core deposit intangible assets, and other identifiable intangible assets that result from business combinations. Goodwill represents the excess of the purchase price over the fair value of net assets acquired that is allocated to the appropriate reporting unit when acquired. Core deposit intangible assets represent the future earnings potential of acquired deposit relationships that are amortized over their estimated remaining useful lives. Other identifiable intangible assets primarily represent the rights arising from contractual arrangements that are amortized using the straight-line method.

 

Goodwill is tested for impairment annually, or more frequently if events or circumstances indicate there may be impairment, using either a qualitative or quantitative assessment to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company elects to perform a qualitative assessment, it evaluates economic, industry, and company-specific factors in assessing the fair value of its reporting unit. If the Company concludes that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative test is performed; otherwise, no further resting is required. The quantitative test consists of comparing the fair value of a reporting unit to its carrying amount, including goodwill. If the fair value of a reporting unit is greater than its book value, no goodwill impairment exists. If the carrying amount of a reporting unit is greater than its fair value, a goodwill impairment charge is recognized for the difference, but limited to the amount of goodwill allocated to that reporting unit. Other identifiable intangible assets are evaluated for impairment if events or changes in circumstances indicate a possible impairment.

 

Securities Sold Under Agreements to Repurchase

 

Securities sold under agreements to repurchase are generally accounted for as collateralized financing transactions and recognized as short-term borrowings in the Company’s consolidated balance sheets. Securities, generally U.S. government and federal agency securities, pledged as collateral under these arrangements can be sold or repledged only if replaced by the secured party. The fair value of the collateral provided to a third party is continually monitored and additional collateral is provided as appropriate.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Derivative Instruments

 

The Company primarily uses derivative instruments to protect against the risk of adverse price or interest rate movements on the value of certain assets and liabilities and on future cash flows. Derivative instruments represent contracts between parties that usually require little or no initial net investment and result in one party delivering cash or another asset to the other party based on a notional amount and an underlying asset as specified in the contract such as interest rates, equity security prices, currencies, commodity prices, or credit spreads. These derivative instruments may consist of interest rate swaps, floors, caps, collars, futures, forward contracts, and written and purchased options. Derivative contracts often involve future commitments to exchange interest payment streams or currencies based on a notional or contractual amount, such as interest rate swaps or currency forwards, or to purchase or sell other financial instruments at specified terms on a specified date, such as options to buy or sell securities or currencies. Derivative instruments are subject to counterparty credit risk due to the possibility that the Company will incur a loss because a counterparty, which may be a bank, a broker-dealer or a customer, fails to meet its contractual obligations. This risk is measured as the expected positive replacement value of contracts. Derivative contracts may be executed only with exchanges or counterparties approved by the Company’s Asset/Liability Management Committee.

 

If certain conditions are met, a derivative may be designated as a hedge related to fair value, cash flow, or foreign exposure risk. The recognition of changes in the fair value of a derivative instrument varies depending on the intended use of the derivative and the resulting designation. The Company accounts for hedges of customer loans as fair value hedges. The change in fair value of the hedging derivative and the change in fair value of the hedged exposure are recorded in earnings. Any hedge ineffectiveness is also reflected in current earnings. Changes in the fair value of derivatives not designated as hedging instruments are recognized as a gain or loss in earnings. The Company formally documents any relationships between hedging instruments and hedged items and the risk management objective and strategy for undertaking each hedged transaction. All derivative instruments are reported at fair value in the consolidated balance sheets.

 

Equity-Based Compensation

 

The cost of employee services received in exchange for equity instruments, including stock options and restricted stock awards, is generally measured at fair value on the grant date. The Black-Scholes-Merton valuation model is used to estimate the fair value of stock options at the grant date while the fair value of restricted stock awards is based on the market price of the Company’s common stock on the grant date. The Black-Scholes-Merton model incorporates the following assumptions: the expected volatility is based on the weekly historical volatility of the Company’s common stock price over the expected term of the option; the expected term is generally calculated using the shortcut method; the risk-free interest rate is based on the U.S. Department of the Treasury’s (“Treasury”) yield curve on the grant date with a term comparable to the grant; and the dividend yield is based on the Company’s dividend yield using the most recent dividend rate paid per share and trading price of the Company’s common stock. Compensation cost is recognized over the required service period, generally defined as the vesting period for stock option awards and as the restriction period for restricted stock awards. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.

 

Revenue Recognition

 

Accounting Standards Codification Topic 606 (“ASC 606”), “Revenue from Contracts with Customers,” establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the Company's contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied. The great majority of the Company’s revenue-generating transactions are not subject to ASC 606, including revenue generated from financial instruments, such as loans, letters of credit, and derivatives and investment securities, as these activities are subject to other GAAP discussed elsewhere within our disclosures. Descriptions of the Company’s revenue-generating activities that are within the scope of ASC 606, which are discussed below, are presented in the Company’s consolidated statements of income as components of noninterest income.

 

Wealth management. Wealth management income represents monthly fees due from wealth management customers in consideration for managing and administrating the customers' assets. Wealth management and trust services include custody of assets, investment management, escrow services, fees for trust services and similar fiduciary activities. Revenue is recognized when the performance obligation is completed each month, which is generally the time that payment is received. Income also includes fees received from a third party broker-dealer as part of a revenue-sharing agreement for fees earned from customers that are referred to the third party. These fees are paid to the Company by the third party on a quarterly basis and recognized ratably throughout the quarter as the performance obligation is satisfied.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Service charges on deposits and other service charges and fees. Service charges on deposits and other service charges and fees represent general service fees for account maintenance and activity and transaction-based fees that consist of transaction-based revenue, time-based revenue (service period), item-based revenue, or some other individual attribute-based revenue. Revenue is recognized when the performance obligation is completed, which is generally monthly for account maintenance services or when a transaction has been completed. Payment for such performance obligations is generally received at the time the performance obligations are satisfied. Other service charges and fees include interchange income from debit and credit card transaction fees.

 

Other operating income. Other operating income consists primarily of third-party incentive payments, income on life insurance contracts, and dividends received, which are not subject to the requirements of ASC 606.

 

Advertising Expenses

 

Advertising costs are generally expensed as incurred. The Company may establish accruals for expected advertising expenses in the course of a fiscal year.

 

Income Taxes

 

Income tax expense is comprised of the current and deferred tax consequences of events and transactions already recognized. The Company includes interest and penalties related to income tax liabilities in income tax expense. The effective tax rate, income tax expense as a percent of pre-tax income, may vary significantly from statutory rates due to tax credits and permanent differences. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. Deferred tax assets and liabilities are adjusted through the provision for income taxes as changes in tax laws or rates are enacted.

 

Per Share Results

 

Basic earnings per common share is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per common share includes the dilutive effect of potential common stock that could be issued by the Company. Under the treasury stock method of accounting, potential common stock may be issued for stock options, non-vested restricted stock awards, performance based stock awards, and convertible preferred stock. Diluted earnings per common share is calculated by dividing net income by the weighted average number of common shares outstanding for the period plus the number of dilutive potential common shares. The calculation of diluted earnings per common share excludes potential common shares that have an exercise price greater than the average market value of the Company’s common stock because the effect would be antidilutive.

 

Recent Accounting Standards

 

Standards to be Adopted in 2019

 

In July 2018, the FASB issued ASU 2018-09, “Codification Improvements.” This ASU makes changes to a variety of topics to clarify, correct errors in, or make minor improvements to the Accounting Standards Codification. The majority of the amendments in ASU 2018-09 will be effective for the Company for fiscal years beginning after December 15, 2018. The Company adopted ASU 2018-09 in the first quarter of 2019. The adoption of the standard did not have a material effect on the Company’s financial statements.

 

In August 2017, the FASB issued ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.” This ASU intends to improve the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements and simplify the application of hedge accounting guidance. ASU 2017-12 will be effective for the Company for fiscal years beginning after December 15, 2018. The Company adopted ASU 2017-12 in the first quarter of 2019. The adoption of the standard did not have a material effect on the Company’s financial statements.

 

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842).” This ASU increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requiring more disclosures related to leasing transactions. In July 2018, the FASB issued ASU 2018-10, “Codification Improvements to Topic 842, Leases,” which updates narrow aspects of the guidance issued in ASU 2016-02. ASU 2016-02 will be effective for the Company for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company adopted ASU 2016-02 in the first quarter of 2019 and elected practical expedients where it would not reassess (1) whether any expired or existing contracts are or contain leases, (2) the lease classification for any expired or existing leases, and (3) initial direct costs for any existing leases. The Company leases certain banking offices under lease agreements classified as operating leases and recognized a right-of-use asset and related lease liability of $915 thousand as of January 1, 2019.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Standards Adopted in 2018

 

In February 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Updated (“ASU”) 2018-02, “Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” This ASU allows a reclassification from AOCI to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act (“Tax Reform Act”) and requires certain new disclosures. The Company elected to early adopt ASU 2018-02 in the first quarter of 2018 on a retrospective basis. The effect of the adoption of the standard was a decrease in AOCI of $244 thousand with the offset to retained earnings as recorded in the Company’s consolidated balance sheet and statement of changes in stockholders’ equity for the year ended December 31, 2017.

 

In May 2017, the FASB issued ASU 2017-09, “Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting.” This ASU clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The Company adopted ASU 2017-09 in the first quarter of 2018. The adoption of the standard did not have a material effect on the Company’s financial statements.

 

In March 2017, the FASB issued ASU 2017-08, “Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Securities.” This ASU amends the amortization period for certain purchased callable debt securities. The Company early adopted ASU 2017-08 in the first quarter of 2018. The adoption of the standard did not have a material effect on the Company’s financial statements since securities held at a premium were already being amortized to the earliest call date.

 

In March 2017, the FASB issued ASU 2017-07, “Compensation – Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.” This ASU intends to improve the presentation of net periodic pension cost and net periodic postretirement benefit costs in the income statement and to narrow the amounts eligible for capitalization in assets. The Company adopted ASU 2017-07 in the first quarter of 2018. The adoption of the standard did not have a material effect on the Company’s financial statements. In accordance with the standard, the Company reclassified the non-service components of the net periodic benefit costs from salaries and employee benefits to other expense on a retrospective basis, which totaled $543 thousand in 2017 and $523 thousand in 2016.

 

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash.” This ASU requires that a statement of cash flows explains the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The Company adopted ASU 2016-18 in the first quarter of 2018. The adoption of the standard did not have a material effect on the Company’s financial statements.

 

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.” This ASU makes eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. The update should be applied on a retrospective basis, if practicable. The Company adopted ASU 2016-15 in the first quarter of 2018. The adoption of the standard did not have a material effect on the Company’s financial statements. In accordance with the standard, the Company reclassified proceeds from bank owned life insurance from operating activities to investing activities on a retrospective basis, which totaled $2.64 million in 2017.

 

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” This ASU significantly revises how entities account for and disclose financial assets and liabilities. The guidance (1) requires most equity investments to be measured at fair value with changes in fair value recognized in net income; (2) simplifies the impairment assessment of equity investments without a readily determinable fair value; (3) eliminates the requirement to disclose the methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost on the balance sheet; (4) requires public business entities to use exit price notion, rather than entry prices, when measuring fair value of financial instruments for disclosure purposes; (5) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial assets on the balance sheet or the accompanying notes to the financial statements; (6) requires separate presentation in other comprehensive income of the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; and (7) states that a valuation allowance on deferred tax assets related to available-for-sale securities should be evaluated in combination with other deferred tax assets. In February 2018, the FASB issued ASU 2018-03, which included technical corrections and improvements to clarify the guidance in ASU 2016-01. The Company adopted ASU 2016-01 in the first quarter of 2018. The adoption of the standard did not have a material effect on the Company’s financial statements. In accordance with the prospective application of the standard, the Company began measuring the fair value of loans using an exit price notion as of March 31, 2018. For additional information, see Note 13, “Fair Value” to the Consolidated Financial Statements of this report.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).” This ASU’s core principle is that an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under existing guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. In August 2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers” deferring the effective date of ASU 2014-09 for the Company until fiscal years beginning after December 15, 2017, with early adoption permitted for fiscal years beginning after December 15, 2016. The Company adopted Topic 606, and related updates, in the first quarter of 2018 using the modified retrospective method. The Company’s primary source of revenue is interest income, which is excluded from the scope of this guidance; however, the Company evaluated the impact on other income; which includes fees for services, commissions on sales, and various deposit service charges; revenue contracts; and disclosures and determined that no cumulative-effect adjustment to retained earnings was necessary. The adoption of the standard did not have a material effect on the Company’s financial statements. In accordance with the standard, the Company reclassified interchange expense, which was previously a component of noninterest expense, to net against interchange income on a retrospective basis, which totaled $1.68 million in 2017 and $1.53 million in 2016.

 

Standards Not Yet Adopted

 

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” This ASU intends to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. This ASU requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, the update amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. ASU 2016-13 will be effective for the Company for fiscal years beginning after December 15, 2019, with early adoption permitted for fiscal years beginning after December 15, 2018. The Company expects to adopt ASU 2016-13 in the first quarter of 2020 and recognize a cumulative adjustment to retained earnings as of the beginning of the year of adoption. The Company has established a working group to prepare for, and implement changes related to, the standard and has engaged a third-party vendor solution to assist in the application of the standard. The Company is currently unable to reasonably estimate the impact of adopting ASU 2016-13, but expects that the impact of adoption could be significantly influenced by the composition, characteristics, and quality of the Company’s loan and securities portfolios as well as the prevailing economic conditions and forecasts as of the adoption date. The adoption of the standard could result in significant changes to the Company’s consolidated financial statements, which may include changes in the level of the allowance for credit losses that will be considered adequate, a reduction in shareholders’ equity and regulatory capital, differences in the timing of recognizing changes to the allowance for credit losses, expanded disclosures about the allowance for credit losses, and the Company’s internal control over financial reporting related to the allowance for credit losses.

 

The Company does not expect other recent accounting standards issued by the FASB or other standards-setting bodies to have a material impact on the consolidated financial statements.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

Note 2. Acquisitions and Divestitures

 

The following table presents the components of net cash received in, or paid for, acquisitions and divestitures, an investing activity in the Company’s consolidated statements of cash flows, for the periods indicated:

 

   

Year Ended December 31,

 

(Amounts in thousands)

 

2018

   

2017

   

2016

 

Acquisitions

                       

Fair value of assets and liabilities acquired:

                       

Loans

  $ -     $ -     $ 149,122  

Premises and equipment

    -       -       4,829  

Other assets

    -       -       448  

Other intangible assets

    -       -       3,842  

Deposits

    -       -       (134,307 )

Other liabilities

    -       -       (75 )

Purchase price in excess of net assets acquired

    -       -       2,446  

Total purchase price

    -       -       26,305  

Non-cash purchase price

    -       -       -  

Cash acquired

    -       -       -  

Net cash paid in acquisitions

    -       -       26,305  

Divestitures

                       

Book value of assets sold

    (1,685 )     -       (165,742 )

Book value of liabilities sold

    37       -       111,198  

Sales price in excess of net liabilities assumed

    -       -       (3,682 )

Total sales price

    (1,648 )     -       (58,226 )

Cash sold

    35       -       -  

Non-cash sales price

    1,603       -       -  

Amount due remaining on books

    -       -       2,205  

Net cash received in divestitures

    (10 )     -       (56,021 )

Net cash received in acquisitions and divestitures

  $ (10 )   $ -     $ (29,716 )

 

Bankers Insurance, LLC

 

On October 1, 2018, the Company completed the sale of its remaining insurance agency assets to Bankers Insurance, LLC (“BI”) of Glen Allen, Virginia, in exchange for an equity interest in BI. The sale strategically allows the Company to continue offering insurance products to its customers through a larger, more diversified insurance agency. In connection with the divestiture, the Company recognized a one-time goodwill impairment charge of $1.49 million during the third quarter of 2018. The Company used the fair value of the equity interest in BI as the basis for determining the goodwill impairment.

 

Ascension Insurance Agency, Inc.

 

On October 1, 2016, the Company completed the sale of Greenpoint Insurance Group, Inc. (“Greenpoint”) to Ascension Insurance Agency, Inc. for $7.11 million, including earn-out payments of $2.21 million to be received over three years if certain operating targets are met. The divestiture consisted of two North Carolina offices operating as Greenpoint and two Virginia offices operating under the trade name Carr & Hyde Insurance. The transaction did not impact the Company’s in-branch insurance offices operating as FCIS in West Virginia and Virginia. The Company recorded a net gain of $617 thousand in connection with the divestiture and eliminated $6.49 million in goodwill and other intangible assets. The Company incurred expenses related to the divestiture of $46 thousand in 2016.

 

First Bank

 

On July 15, 2016, the Company completed a branch exchange with First Bank, North Carolina, pursuant to which the Bank exchanged a portion of its North Carolina branch network for First Bank’s Virginia branch network. Under the agreements, the Bank simultaneously sold six branches in the Winston-Salem and Mooresville areas of North Carolina and acquired seven branches in Southwestern Virginia. The branch acquisition complements the Company’s 2014 acquisition of seven branches from Bank of America by expanding the Company’s existing presence in Southwest Virginia and affords the opportunity to realize certain operating cost savings.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

In connection with the branch exchange, the Company acquired total assets of $160.69 million, including total loans of $149.12 million and goodwill and other intangibles of $6.29 million, and total liabilities of $134.38 million, including total deposits of $134.31 million. The Company did not acquire any PCI loans. The consideration transferred included the net fair value of divested assets and a purchase premium of $3.84 million. The Company divested total assets of $162.17 million, including loans of $155.54 million and goodwill and other intangibles of $2.33 million, and total liabilities of $111.05 million, including deposits of $111.02 million, and received a deposit premium of $4.07 million. In connection with the divestiture, the Company recorded a net gain of $3.07 million. The Company incurred expenses related to the First Bank transaction of $684 thousand in 2016.

 

 

Note 3. Debt Securities

 

The following tables present the amortized cost and fair value of available-for-sale debt securities, including gross unrealized gains and losses, as of the dates indicated:

 

   

December 31, 2018

 
   

Amortized

   

Unrealized

   

Unrealized

   

Fair

 
   

Cost

   

Gains

   

Losses

   

Value

 

(Amounts in thousands)

                               

U.S. Agency securities

  $ 1,108     $ 5     $ -     $ 1,113  

U.S. Treasury securities

    19,970       -       (10 )     19,960  

Municipal securities

    96,886       912       (509 )     97,289  

Mortgage-backed Agency securities

    35,513       14       (773 )     34,754  

Total

  $ 153,477     $ 931     $ (1,292 )   $ 153,116  

 

   

December 31, 2017

 
   

Amortized

   

Unrealized

   

Unrealized

   

Fair

 
   

Cost

   

Gains

   

Losses

   

Value

 

(Amounts in thousands)

                               

U.S. Agency securities

  $ 11,289     $ 17     $ (10 )   $ 11,296  

U.S. Treasury securities

    19,987       -       (16 )     19,971  

Municipal securities

    101,552       2,203       (107 )     103,648  

Single issue trust preferred securities

    9,367       -       (483 )     8,884  

Mortgage-backed Agency securities

    22,095       46       (415 )     21,726  

Total

  $ 164,290     $ 2,266     $ (1,031 )   $ 165,525  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents the amortized cost and fair value of available-for-sale debt securities, by contractual maturity, as of December 31, 2018. Actual maturities could differ from contractual maturities because issuers may have the right to call or prepay obligations with or without penalties.

 

(Amounts in thousands)

 

U.S. Agency Securities

   

U.S. Treasury Securities

   

Municipal Securities

   

Total

 

Amortized cost maturity:

                               

One year or less

  $ -     $ 19,970     $ -     $ 19,970  

After one year through five years

    -       -       14,447       14,447  

After five years through ten years

    1,108       -       82,439       83,547  

After ten years

    -       -       -       -  

Amortized cost

  $ 1,108     $ 19,970     $ 96,886       117,964  

Mortgage-backed securities

                            35,513  

Total amortized cost

                          $ 153,477  
                                 

Fair value maturity:

                               

One year or less

  $ -     $ 19,960     $ -     $ 19,960  

After one year through five years

    -       -       14,595       14,595  

After five years through ten years

    1,113       -       82,694       83,807  

After ten years

    -       -       -       -  

Fair value

  $ 1,113     $ 19,960     $ 97,289       118,362  

Mortgage-backed securities

                            34,754  

Total fair value

                          $ 153,116  

 

The following tables present the amortized cost and fair value of held-to-maturity debt securities, including gross unrealized gains and losses, as of the dates indicated:

 

   

December 31, 2018

 
   

Amortized

   

Unrealized

   

Unrealized

   

Fair

 
   

Cost

   

Gains

   

Losses

   

Value

 

(Amounts in thousands)

                               

U.S. Agency securities

  $ 17,887     $ -     $ (20 )   $ 17,867  

Corporate securities

    7,126       -       (3 )     7,123  

Total

  $ 25,013     $ -     $ (23 )   $ 24,990  

 

   

December 31, 2017

 
   

Amortized

   

Unrealized

   

Unrealized

   

Fair

 
   

Cost

   

Gains

   

Losses

   

Value

 

(Amounts in thousands)

                               

U.S. Agency securities

  $ 17,937     $ -     $ (49 )   $ 17,888  

Corporate securities

    7,212       -       (16 )     7,196  

Total

  $ 25,149     $ -     $ (65 )   $ 25,084  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents the amortized cost and fair value of held-to-maturity debt securities, by contractual maturity, as of December 31, 2018. Actual maturities could differ from contractual maturities because issuers may have the right to call or prepay obligations with or without penalties. 

 

(Amounts in thousands)

 

U.S. Agency

Securities

   

Corporate Notes

   

Total

 

Amortized cost maturity:

                       

One year or less

  $ 17,887     $ 7,126     $ 25,013  

After one year through five years

    -       -       -  

After five years through ten years

    -       -       -  

After ten years

    -       -       -  

Total amortized cost

  $ 17,887     $ 7,126     $ 25,013  
                         

Fair value maturity:

                       

One year or less

  $ 17,867     $ 7,123     $ 24,990  

After one year through five years

    -       -       -  

After five years through ten years

    -       -       -  

After ten years

    -       -       -  

Total fair value

  $ 17,867     $ 7,123     $ 24,990  

 

The following tables present the geographic composition of municipal securities, by state, where the largest volume of these securities are held in the Company’s portfolio. The tables also present the amortized cost and fair value of the municipal securities, including gross unrealized gains and losses, as of the dates indicated.

 

   

December 31, 2018

 
   

Percent of

Municipal Portfolio

   

Amortized Cost

   

Unrealized Gains

   

Unrealized Losses

   

Fair Value

 

(Amounts in thousands)

                                       

Minnesota

    9.93 %   $ 9,586     $ 88     $ (15 )   $ 9,659  

New York

    9.40 %     9,063       78       -       9,141  

Wisconsin

    9.14 %     8,914       36       (53 )     8,897  

Ohio

    8.78 %     8,541       47       (43 )     8,545  

Massachusetts

    8.46 %     8,165       93       (27 )     8,231  

Texas

    7.55 %     7,378       55       (91 )     7,342  

Connecticut

    5.93 %     5,715       53       -       5,768  

Iowa

    5.20 %     5,138       10       (90 )     5,058  

New Jersey

    4.74 %     4,521       87       -       4,608  

Other

    30.88 %     29,865       365       (190 )     30,040  

Total

    100.00 %   $ 96,886     $ 912     $ (509 )   $ 97,289  

 

   

December 31, 2017

 
   

Percent of

Municipal Portfolio

   

Amortized Cost

   

Unrealized Gains

   

Unrealized Losses

   

Fair Value

 

(Amounts in thousands)

                                       

New York

    10.64 %   $ 10,804     $ 223     $ -     $ 11,027  

Minnesota

    10.12 %     10,280       211       (1 )     10,490  

Wisconsin

    8.74 %     8,913       147       -       9,060  

Massachusetts

    8.57 %     8,691       208       (14 )     8,885  

Ohio

    8.36 %     8,551       123       (13 )     8,661  

Texas

    7.22 %     7,388       122       (21 )     7,489  

Connecticut

    6.82 %     6,929       142       -       7,071  

Iowa

    5.27 %     5,463       30       (35 )     5,458  

New Jersey

    4.67 %     4,670       167       -       4,837  

Other

    29.59 %     29,863       830       (23 )     30,670  

Total

    100.00 %   $ 101,552     $ 2,203     $ (107 )   $ 103,648  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following tables present the fair values and unrealized losses for available-for-sale debt securities in a continuous unrealized loss position for less than 12 months and for 12 months or longer as of the dates indicated:

 

   

December 31, 2018

 
   

Less than 12 Months

   

12 Months or Longer

   

Total

 
   

Fair

   

Unrealized

   

Fair

   

Unrealized

   

Fair

   

Unrealized

 
   

Value

   

Losses

   

Value

   

Losses

   

Value

   

Losses

 

(Amounts in thousands)

                                               

U.S. Treasury securities

  $ 19,960     $ (10 )   $ -     $ -     $ 19,960     $ (10 )

Municipal securities

    7,116       (62 )     18,081       (447 )     25,197       (509 )

Mortgage-backed Agency securities

    15,762       (99 )     15,344       (674 )     31,106       (773 )

Total

  $ 42,838     $ (171 )   $ 33,425     $ (1,121 )   $ 76,263     $ (1,292 )

 

   

December 31, 2017

 
   

Less than 12 Months

   

12 Months or Longer

   

Total

 
   

Fair

   

Unrealized

   

Fair

   

Unrealized

   

Fair

   

Unrealized

 
   

Value

   

Losses

   

Value

   

Losses

   

Value

   

Losses

 

(Amounts in thousands)

                                               

U.S. Agency securities

  $ 10,054     $ (10 )   $ -     $ -     $ 10,054     $ (10 )

U.S. Treasury securities

    19,972       (16 )     -       -       19,972       (16 )

Municipal securities

    8,047       (55 )     2,314       (52 )     10,361       (107 )

Single issue trust preferred securities

    -       -       8,884       (483 )     8,884       (483 )

Mortgage-backed Agency securities

    4,276       (25 )     14,069       (390 )     18,345       (415 )

Total

  $ 42,349     $ (106 )   $ 25,267     $ (925 )   $ 67,616     $ (1,031 )

 

The following tables present the fair values and unrealized losses for held-to-maturity debt securities in a continuous unrealized loss position for less than 12 months and for 12 months or longer as of the dates indicated:

 

   

December 31, 2018

 
   

Less than 12 Months

   

12 Months or Longer

   

Total

 
   

Fair

   

Unrealized

   

Fair

   

Unrealized

   

Fair

   

Unrealized

 
   

Value

   

Losses

   

Value

   

Losses

   

Value

   

Losses

 

(Amounts in thousands)

                                               

U.S. Agency securities

  $ -     $ -     $ 17,867     $ (20 )   $ 17,867     $ (20 )

Corporate securities

    -       -       7,123       (3 )     7,123       (3 )

Total

  $ -     $ -     $ 24,990     $ (23 )   $ 24,990     $ (23 )

 

   

December 31, 2017

 
   

Less than 12 Months

   

12 Months or Longer

   

Total

 
   

Fair

   

Unrealized

   

Fair

   

Unrealized

   

Fair

   

Unrealized

 
   

Value

   

Losses

   

Value

   

Losses

   

Value

   

Losses

 

(Amounts in thousands)

                                               

U.S. Agency securities

  $ 17,888     $ (49 )   $ -     $ -     $ 17,888     $ (49 )

Corporate securities

    7,196       (16 )     -       -       7,196       (16 )

Total

  $ 25,084     $ (65 )   $ -     $ -     $ 25,084     $ (65 )

 

There were 90 individual debt securities in an unrealized loss position as of December 31, 2018, and their combined depreciation in value represented 0.74% of the debt securities portfolio. These securities included 61 securities in a continuous unrealized loss position for 12 months or longer that the Company does not intend to sell, and that it has determined is not more likely than not going to be required to sell, prior to maturity or recovery. There were 45 individual debt securities in an unrealized loss position as of December 31, 2017, and their combined depreciation in value represented 0.57% of the debt securities portfolio.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The Company reviews its investment portfolio quarterly for indications of OTTI. The initial indicator of OTTI for debt securities is a decline in fair value below book value and the severity and duration of the decline. The credit-related OTTI is recognized as a charge to noninterest income and the noncredit-related OTTI is recognized in OCI. The Company incurred no credit-related OTTI charges on debt securities in 2018 or 2017. In 2016 the Company incurred credit-related OTTI charges on debt securities of $4.64 million related to the Company’s change in intent to hold certain securities to recovery. The intent was changed to sell specific trust preferred securities in the Company’s investment portfolio primarily to reduce credit concentrations with two issuers. Temporary impairment on debt securities is primarily related to changes in benchmark interest rates, changes in pricing in the credit markets, and other current economic factors. The following table presents the changes in credit-related losses recognized in earnings on debt securities where a portion of the impairment was recognized in OCI during the periods indicated:

 

   

Year Ended December 31,

 
   

2018

   

2017

   

2016

 

(Amounts in thousands)

                       

Beginning balance

  $ -     $ -     $ -  

Additions for credit losses on securities not previously recognized

    -       -       4,646  

Additions for credit losses on securities previously recognized

    -       -       -  

Reduction for securities sold/realized losses

    -       -       (4,646 )

Ending balance

  $ -     $ -     $ -  

 

The following table presents gross realized gains and losses from the sale of available-for-sale debt securities for the periods indicated:

 

   

Year Ended December 31,

 
   

2018

   

2017

   

2016

 

(Amounts in thousands)

                       

Gross realized gains

  $ -     $ -     $ 757  

Gross realized losses

    (618 )     (661 )     (422 )

Net (loss) gain on sale of securities

  $ (618 )   $ (661 )   $ 335  

 

The carrying amount of securities pledged for various purposes totaled $38.25 million as of December 31, 2018, and $51.34 million as of December 31, 2017.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

Note 4. Loans

 

The Company groups loans held for investment into three segments (commercial loans, consumer real estate loans, and consumer and other loans) with each segment divided into various classes. Covered loans are those loans acquired in FDIC assisted transactions that are covered by loss share agreements. Customer overdrafts reclassified as loans totaled $1.79 million as of December 31, 2018, and $1.71 million as of December 31, 2017. Deferred loan fees were $4.60 million as of December 31, 2018, and $4.44 million as of December 31, 2017. For information about off-balance sheet financing, see Note 20, “Litigation, Commitments, and Contingencies,” to the Consolidated Financial Statements of this report.

 

The following table presents loans, net of unearned income with non-covered loans and by loan class, as of the dates indicated:

 

   

December 31,

 
   

2018

   

2017

 

(Amounts in thousands)

 

Amount

   

Percent

   

Amount

   

Percent

 

Non-covered loans held for investment

                               

Commercial loans

                               

Construction, development, and other land

  $ 63,508       3.58 %   $ 60,017       3.30 %

Commercial and industrial

    104,863       5.91 %     92,188       5.07 %

Multi-family residential

    107,012       6.03 %     125,202       6.89 %

Single family non-owner occupied

    140,097       7.89 %     141,670       7.80 %

Non-farm, non-residential

    613,877       34.58 %     616,633       33.93 %

Agricultural

    8,545       0.48 %     7,035       0.39 %

Farmland

    18,905       1.07 %     25,649       1.41 %

Total commercial loans

    1,056,807       59.54 %     1,068,394       58.79 %

Consumer real estate loans

                               

Home equity lines

    93,466       5.27 %     103,205       5.68 %

Single family owner occupied

    510,963       28.78 %     502,686       27.66 %

Owner occupied construction

    18,171       1.02 %     39,178       2.16 %

Total consumer real estate loans

    622,600       35.07 %     645,069       35.50 %

Consumer and other loans

                               

Consumer loans

    71,552       4.03 %     70,772       3.89 %

Other

    5,310       0.30 %     5,001       0.28 %

Total consumer and other loans

    76,862       4.33 %     75,773       4.17 %

Total non-covered loans

    1,756,269       98.94 %     1,789,236       98.46 %

Total covered loans

    18,815       1.06 %     27,948       1.54 %

Total loans held for investment, net of unearned income

  $ 1,775,084       100.00 %   $ 1,817,184       100.00 %

 

The following table presents the covered loan portfolio, by loan class, as of the dates indicated. 

 

   

December 31,

 

(Amounts in thousands)

 

2018

   

2017

 

Covered loans

               

Commercial loans

               

Construction, development, and other land

  $ 35     $ 39  

Single family non-owner occupied

    238       284  

Non-farm, non-residential

    6       9  

Total commercial loans

    279       332  

Consumer real estate loans

               

Home equity lines

    15,284       23,720  

Single family owner occupied

    3,252       3,896  

Total consumer real estate loans

    18,536       27,616  

Total covered loans

  $ 18,815     $ 27,948  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The Company identifies certain purchased loans as impaired when fair values are established at acquisition and groups those PCI loans into loan pools with common risk characteristics. The Company estimates cash flows to be collected on PCI loans and discounts those cash flows at a market rate of interest. The following table presents the recorded investment and contractual unpaid principal balance of PCI loans, by acquisition, as of the dates indicated:

 

   

December 31,

 
   

2018

   

2017

 

(Amounts in thousands)

 

Recorded

Investment

   

Unpaid Principal

Balance

   

Recorded

Investment

   

Unpaid Principal

Balance

 

PCI Loans, by acquisition

                               

Peoples

  $ 5,330     $ 7,272     $ 5,278     $ 8,111  

Waccamaw

    5,805       19,602       12,176       31,335  

Other acquired

    868       894       986       1,012  

Total PCI Loans

  $ 12,003     $ 27,768     $ 18,440     $ 40,458  

 

The following table presents the changes in the accretable yield on PCI loans, by acquisition, during the periods indicated:

 

   

Peoples

   

Waccamaw

   

Total

 

(Amounts in thousands)

                       

Balance January 1, 2016

  $ 3,589     $ 26,109     $ 29,698  

Accretion

    (1,237 )     (5,380 )     (6,617 )

Reclassifications from nonaccretable difference(1)

    287       1,620       1,907  

Other changes, net

    1,753       (515 )     1,238  

Balance December 31, 2016

  $ 4,392     $ 21,834     $ 26,226  
                         

Balance January 1, 2017

  $ 4,392     $ 21,834     $ 26,226  

Accretion

    (1,379 )     (5,664 )     (7,043 )

Reclassifications from nonaccretable difference(1)

    825       3,378       4,203  

Other changes, net

    (450 )     (83 )     (533 )

Balance December 31, 2017

  $ 3,388     $ 19,465     $ 22,853  
                         

Balance January 1, 2018

  $ 3,388     $ 19,465     $ 22,853  

Accretion

    (1,263 )     (6,269 )     (7,532 )

Reclassifications from nonaccretable difference(1)

    8       1,770       1,778  

Other changes, net

    457       (327 )     130  

Balance December 31, 2018

  $ 2,590     $ 14,639     $ 17,229  

                                                                                                                                  

(1)

Respresents changes attributable to expected loss assumptions

         

 

 

Note 5. Credit Quality

 

The Company uses a risk grading matrix to assign a risk grade to each loan in its portfolio. Loan risk ratings may be upgraded or downgraded to reflect current information identified during the loan review process. The general characteristics of each risk grade are as follows:

 

 

Pass -- This grade is assigned to loans with acceptable credit quality and risk. The Company further segments this grade based on borrower characteristics that include capital strength, earnings stability, liquidity, leverage, and industry conditions.

 

Special Mention -- This grade is assigned to loans that require an above average degree of supervision and attention. These loans have the characteristics of an asset with acceptable credit quality and risk; however, adverse economic or financial conditions exist that create potential weaknesses deserving of management’s close attention. If potential weaknesses are not corrected, the prospect of repayment may worsen.

 

Substandard -- This grade is assigned to loans that have well defined weaknesses that may make payment default, or principal exposure, possible. These loans will likely be dependent on collateral liquidation, secondary repayment sources, or events outside the normal course of business to meet repayment terms.

 

Doubtful -- This grade is assigned to loans that have the weaknesses inherent in substandard loans; however, the weaknesses are so severe that collection or liquidation in full is unlikely based on current facts, conditions, and values. Due to certain specific pending factors, the amount of loss cannot yet be determined.

 

Loss -- This grade is assigned to loans that will be charged off or charged down when payments, including the timing and value of payments, are uncertain. This risk grade does not imply that the asset has no recovery or salvage value, but simply means that it is not practical or desirable to defer writing off, either all or a portion of, the loan balance even though partial recovery may be realized in the future.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following tables present the recorded investment of the loan portfolio, by loan class and credit quality, as of the dates indicated. Losses on covered loans are generally reimbursable by the FDIC at the applicable loss share percentage, 80%; therefore, covered loans are disclosed separately.

 

   

December 31, 2018

 
           

Special

                                 

(Amounts in thousands)

 

Pass

   

Mention

   

Substandard

   

Doubtful

   

Loss

   

Total

 

Non-covered loans

                                               

Commercial loans

                                               

Construction, development, and other land

  $ 61,877     $ 661     $ 970     $ -     $ -     $ 63,508  

Commercial and industrial

    102,044       2,166       653       -       -       104,863  

Multi-family residential

    104,183       1,087       1,742       -       -       107,012  

Single family non-owner occupied

    131,443       4,395       4,259       -       -       140,097  

Non-farm, non-residential

    595,659       8,166       9,906       146       -       613,877  

Agricultural

    8,328       131       86       -       -       8,545  

Farmland

    16,898       538       1,469       -       -       18,905  

Consumer real estate loans

                                               

Home equity lines

    91,194       649       1,623       -       -       93,466  

Single family owner occupied

    482,794       4,355       23,814       -       -       510,963  

Owner occupied construction

    17,872       -       299       -       -       18,171  

Consumer and other loans

                                               

Consumer loans

    71,240       4       308       -       -       71,552  

Other

    5,310       -       -       -       -       5,310  

Total non-covered loans

    1,688,842       22,152       45,129       146       -       1,756,269  

Covered loans

                                               

Commercial loans

                                               

Construction, development, and other land

    -       35       -       -       -       35  

Single family non-owner occupied

    223       -       15       -       -       238  

Non-farm, non-residential

    -       -       6       -       -       6  

Consumer real estate loans

                                               

Home equity lines

    9,511       5,244       529       -       -       15,284  

Single family owner occupied

    2,507       355       390       -       -       3,252  

Total covered loans

    12,241       5,634       940       -       -       18,815  

Total loans

  $ 1,701,083     $ 27,786     $ 46,069     $ 146     $ -     $ 1,775,084  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

   

December 31, 2017

 
           

Special

                                 

(Amounts in thousands)

 

Pass

   

Mention

   

Substandard

   

Doubtful

   

Loss

   

Total

 

Non-covered loans

                                               

Commercial loans

                                               

Construction, development, and other land

  $ 57,768     $ 1,367     $ 882     $ -     $ -     $ 60,017  

Commercial and industrial

    87,181       3,721       1,286       -       -       92,188  

Multi-family residential

    118,509       5,663       1,030       -       -       125,202  

Single family non-owner occupied

    130,689       7,271       3,710       -       -       141,670  

Non-farm, non-residential

    596,616       12,493       7,351       173       -       616,633  

Agricultural

    6,639       294       102       -       -       7,035  

Farmland

    22,875       210       2,564       -       -       25,649  

Consumer real estate loans

                                               

Home equity lines

    100,833       618       1,754       -       -       103,205  

Single family owner occupied

    471,382       5,480       25,824       -       -       502,686  

Owner occupied construction

    38,947       -       231       -       -       39,178  

Consumer and other loans

                                               

Consumer loans

    70,448       13       311       -       -       70,772  

Other

    5,001       -       -       -       -       5,001  

Total non-covered loans

    1,706,888       37,130       45,045       173       -       1,789,236  

Covered loans

                                               

Commercial loans

                                               

Construction, development, and other land

    1       38       -       -       -       39  

Single family non-owner occupied

    265       -       19       -       -       284  

Non-farm, non-residential

    -       -       9       -       -       9  

Consumer real estate loans

                                               

Home equity lines

    11,338       11,685       697       -       -       23,720  

Single family owner occupied

    2,996       411       489       -       -       3,896  

Total covered loans

    14,600       12,134       1,214       -       -       27,948  

Total loans

  $ 1,721,488     $ 49,264     $ 46,259     $ 173     $ -     $ 1,817,184  

 

The Company identifies loans for potential impairment through a variety of means, including, but not limited to, ongoing loan review, renewal processes, delinquency data, market communications, and public information. If the Company determines that it is probable all principal and interest amounts contractually due will not be collected, the loan is generally deemed impaired.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents the recorded investment, unpaid principal balance, and related allowance for loan losses for impaired loans, excluding PCI loans, as of the dates indicated:

 

   

December 31, 2018

   

December 31, 2017

 
           

Unpaid

                   

Unpaid

         
   

Recorded

   

Principal

   

Related

   

Recorded

   

Principal

   

Related

 

(Amounts in thousands)

 

Investment

   

Balance

   

Allowance

   

Investment

   

Balance

   

Allowance

 

Impaired loans with no related allowance

                                               

Commercial loans

                                               

Construction, development, and other land

  $ 824     $ 840     $ -     $ 727     $ 988     $ -  

Commercial and industrial

    386       416       -       315       1,142       -  

Multi-family residential

    1,127       1,274       -       499       1,010       -  

Single family non-owner occupied

    2,761       3,095       -       2,042       3,521       -  

Non-farm, non-residential

    4,154       4,494       -       3,022       5,955       -  

Agricultural

    86       96       -       102       107       -  

Farmland

    1,464       1,547       -       395       414       -  

Consumer real estate loans

                                               

Home equity lines

    1,315       1,451       -       1,621       1,770       -  

Single family owner occupied

    15,451       18,390       -       16,633       18,964       -  

Owner occupied construction

    225       225       -       231       231       -  

Consumer and other loans

                                               

Consumer loans

    145       156       -       141       144       -  

Total impaired loans with no allowance

    27,938       31,984       -       25,728       34,246       -  
                                                 

Impaired loans with a related allowance

                                               

Commercial loans

                                               

Commercial and industrial

    -       -       -       343       343       270  

Multi-family residential

    534       536       230       -       -       -  

Single family non-owner occupied

    -       -       -       446       446       62  

Non-farm, non-residential

    840       842       235       262       263       15  

Farmland

    -       -       -       936       974       233  

Consumer real estate loans

                                               

Home equity lines

    65       68       65       -       -       -  

Single family owner occupied

    3,631       3,683       922       5,586       5,606       1,978  

Total impaired loans with an allowance

    5,070       5,129       1,452       7,573       7,632       2,558  

Total impaired loans(1)

  $ 33,008     $ 37,113     $ 1,452     $ 33,301     $ 41,878     $ 2,558  

                                                                                            

(1)

Total impaired loans include loans totaling $25.27 million as of December 31, 2018, and $20.13 million as of December 31, 2017, that do not meet the Company's evaluation threshold for individual impairment and are therefore collectively evaluated for impairment. During the first quarter of 2018, the Company changed the threshold for quarterly reviews of individual loans that are deemed to be impaired from $250 thousand to $500 thousand or greater.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents the average recorded investment and interest income recognized on impaired loans, excluding PCI loans, for the periods indicated:

 

   

Year Ended December 31,

 
   

2018

   

2017

   

2016

 

(Amounts in thousands)

 

Interest

Income

Recognized

   

Average

Recorded

Investment

   

Interest

Income

Recognized

   

Average

Recorded

Investment

   

Interest

Income

Recognized

   

Average

Recorded

Investment

 

Impaired loans with no related allowance:

                                               

Commercial loans

                                               

Construction, development, and other land

  $ 26     $ 921     $ 56     $ 455     $ 22     $ 344  

Commercial and industrial

    19       383       14       556       16       646  

Multi-family residential

    47       910       53       523       21       308  

Single family non-owner occupied

    123       2,652       106       3,214       178       3,076  

Non-farm, non-residential

    133       4,828       122       4,052       307       8,573  

Agricultural

    -       164       5       124       -       -  

Farmland

    64       1,172       17       853       55       437  

Consumer real estate loans

                                               

Home equity lines

    44       1,637       50       1,365       30       1,223  

Single family owner occupied

    503       15,423       488       15,758       343       12,330  

Owner occupied construction

    8       244       8       234       9       497  

Consumer and other loans

                                               

Consumer loans

    9       161       9       75       5       60  

Total impaired loans with no related allowance

    976       28,495       928       27,209       986       27,494  
                                                 

Impaired loans with a related allowance:

                                               

Commercial loans

                                               

Construction, development, and other land

    -       -       -       107       -       -  

Commercial and industrial

    -       -       103       1,376       -       -  

Multi-family residential

    2       270       -       -       -       -  

Single family non-owner occupied

    7       110       27       479       23       518  

Non-farm, non-residential

    2       809       15       789       215       3,831  

Farmland

    -       307       22       442       14       108  

Consumer real estate loans

                                               

Home equity lines

    3       68       -       104       -       -  

Single family owner occupied

    158       5,296       161       4,805       118       4,452  

Owner occupied construction

    -       -       -       -       -       87  

Total impaired loans with a related allowance

    172       6,860       328       8,102       370       8,996  

Total impaired loans

  $ 1,148     $ 35,355     $ 1,256     $ 35,311     $ 1,356     $ 36,490  

 

There were no impaired PCI loan pools as of December 31, 2018 or 2017. The following tables provide information on impaired PCI loan pools for the dates indicated:

 

   

Year Ended December 31,

 
   

2018

   

2017

   

2016

 

(Amounts in thousands)

                       

Interest income recognized

  $ -     $ 20     $ 142  

Average recorded investment

    -       528       1,929  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The Company generally places a loan on nonaccrual status when it is 90 days or more past due. PCI loans are generally not classified as nonaccrual due to the accrual of interest income under the accretion method of accounting. The following table presents nonaccrual loans, by loan class, as of the dates indicated: 

 

   

December 31, 2018

   

December 31, 2017

 

(Amounts in thousands)

 

Non-covered

   

Covered

   

Total

   

Non-covered

   

Covered

   

Total

 

Commercial loans

                                               

Construction, development, and other land

  $ 413     $ -     $ 413     $ -     $ -     $ -  

Commercial and industrial

    428       -       428       211       -       211  

Multi-family residential

    1,395       -       1,395       498       -       498  

Single family non-owner occupied

    1,696       15       1,711       851       19       870  

Non-farm, non-residential

    4,020       -       4,020       2,448       -       2,448  

Agricultural

    86       -       86       102       -       102  

Farmland

    711       -       711       805       -       805  

Consumer real estate loans

                                               

Home equity lines

    614       271       885       882       306       1,188  

Single family owner occupied

    10,141       36       10,177       13,108       17       13,125  

Consumer and other loans

                                               

Consumer loans

    79       -       79       92       -       92  

Total nonaccrual loans

  $ 19,583     $ 322     $ 19,905     $ 18,997     $ 342     $ 19,339  

 

The following tables present the aging of past due loans, by loan class, as of the dates indicated. Nonaccrual loans 30 days or more past due are included in the applicable delinquency category. Loans acquired with credit deterioration, with a discount, continue to accrue interest based on expected cash flows; therefore, PCI loans are not generally considered nonaccrual. Non-covered accruing loans contractually past due 90 days or more totaled $58 thousand as of December 31, 2018, and $1 thousand as of December 31, 2017.

 

   

December 31, 2018

 
   

30 - 59 Days

   

60 - 89 Days

   

90+ Days

   

Total

   

Current

   

Total

 

(Amounts in thousands)

 

Past Due

   

Past Due

   

Past Due

   

Past Due

   

Loans

   

Loans

 

Non-covered loans

                                               

Commercial loans

                                               

Construction, development, and other land

  $ 111     $ -     $ 407     $ 518     $ 62,990     $ 63,508  

Commercial and industrial

    306       -       262       568       104,295       104,863  

Multi-family residential

    113       -       1,274       1,387       105,625       107,012  

Single family non-owner occupied

    514       1,115       992       2,621       137,476       140,097  

Non-farm, non-residential

    1,332       540       2,398       4,270       609,607       613,877  

Agricultural

    109       -       -       109       8,436       8,545  

Farmland

    640       -       392       1,032       17,873       18,905  

Consumer real estate loans

                                               

Home equity lines

    408       209       334       951       92,515       93,466  

Single family owner occupied

    5,006       3,495       4,445       12,946       498,017       510,963  

Owner occupied construction

    -       -       -       -       18,171       18,171  

Consumer and other loans

                                               

Consumer loans

    507       200       59       766       70,786       71,552  

Other

    -       -       -       -       5,310       5,310  

Total non-covered loans

    9,046       5,559       10,563       25,168       1,731,101       1,756,269  

Covered loans

                                               

Commercial loans

                                               

Construction, development, and other land

    -       -       -       -       35       35  

Single family non-owner occupied

    15       -       -       15       223       238  

Non-farm, non-residential

    -       -       -       -       6       6  

Consumer real estate loans

                                               

Home equity lines

    176       38       91       305       14,979       15,284  

Single family owner occupied

    166       -       -       166       3,086       3,252  

Total covered loans

    357       38       91       486       18,329       18,815  

Total loans

  $ 9,403     $ 5,597     $ 10,654     $ 25,654     $ 1,749,430     $ 1,775,084  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

   

December 31, 2017

 
   

30 - 59 Days

   

60 - 89 Days

   

90+ Days

   

Total

   

Current

   

Total

 

(Amounts in thousands)

 

Past Due

   

Past Due

   

Past Due

   

Past Due

   

Loans

   

Loans

 

Non-covered loans

                                               

Commercial loans

                                               

Construction, development, and other land

  $ 20     $ 365     $ -     $ 385     $ 59,632     $ 60,017  

Commercial and industrial

    232       40       142       414       91,774       92,188  

Multi-family residential

    544       -       185       729       124,473       125,202  

Single family non-owner occupied

    223       302       331       856       140,814       141,670  

Non-farm, non-residential

    2,433       383       1,536       4,352       612,281       616,633  

Agricultural

    123       -       -       123       6,912       7,035  

Farmland

    113       -       692       805       24,844       25,649  

Consumer real estate loans

                                               

Home equity lines

    226       198       485       909       102,296       103,205  

Single family owner occupied

    6,959       2,418       8,186       17,563       485,123       502,686  

Owner occupied construction

    326       79       -       405       38,773       39,178  

Consumer and other loans

                                               

Consumer loans

    439       97       17       553       70,219       70,772  

Other

    -       -       -       -       5,001       5,001  

Total non-covered loans

    11,638       3,882       11,574       27,094       1,762,142       1,789,236  

Covered loans

                                               

Commercial loans

                                               

Construction, development, and other land

    -       -       -       -       39       39  

Single family non-owner occupied

    -       -       -       -       284       284  

Non-farm, non-residential

    -       -       -       -       9       9  

Consumer real estate loans

                                               

Home equity lines

    402       -       173       575       23,145       23,720  

Single family owner occupied

    70       -       -       70       3,826       3,896  

Total covered loans

    472       -       173       645       27,303       27,948  

Total loans

  $ 12,110     $ 3,882     $ 11,747     $ 27,739     $ 1,789,445     $ 1,817,184  

 

The Company may make concessions in interest rates, loan terms and/or amortization terms when restructuring loans for borrowers experiencing financial difficulty. Restructured loans in excess of $250 thousand are evaluated for a specific reserve based on either the collateral or net present value method, whichever is most applicable. Restructured loans under $250 thousand are subject to the reserve calculation at the historical loss rate for classified loans. Certain TDRs are classified as nonperforming at the time of restructuring and are returned to performing status after six months of satisfactory payment performance; however, these loans remain identified as impaired until full payment or other satisfaction of the obligation occurs. PCI loans are generally not considered TDRs as long as the loans remain in the assigned loan pool. No covered loans were recorded as TDRs as of December 31, 2018 or 2017. The following table presents loans modified as TDRs, by loan class and accrual status, as of the dates indicated:

 

   

December 31,

 
   

2018

   

2017

 

(Amounts in thousands)

 

Nonaccrual(1)

   

Accruing

   

Total

   

Nonaccrual(1)

   

Accruing

   

Total

 

Commercial loans

                                               

Single family non-owner occupied

  $ 640     $ 309     $ 949     $ 364     $ 528     $ 892  

Non-farm, non-residential

    -       314       314       -       295       295  

Consumer real estate loans

                                               

Home equity lines

    -       127       127       -       145       145  

Single family owner occupied

    1,941       5,417       7,358       1,565       6,496       8,061  

Owner occupied construction

    -       225       225       -       233       233  

Consumer and other loans

                                               

Consumer loans

    -       35       35       -       37       37  

Total TDRs

  $ 2,581     $ 6,427     $ 9,008     $ 1,929     $ 7,734     $ 9,663  

Allowance for loan losses related to TDRs

                  $ 568                     $ 642  

                                                                                       

(1)

Nonaccrual TDRs are included in total nonaccrual loans disclosed in the nonaccrual table above.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents interest income recognized on TDRs for the periods indicated:

 

   

Year Ended December 31,

 
   

2018

   

2017

   

2016

 

(Amounts in thousands)

                       

Interest income recognized

  $ 264     $ 222     $ 424  

 

The following table presents loans modified as TDRs, by type of concession made and loan class, that were restructured during the periods indicated.

 

   

Year Ended December 31,

 
   

2018

   

2017

 

(Amounts in thousands)

 

Total

Contracts

   

Pre-modification

Recorded

Investment

   

Post-modification

Recorded

Investment(1)

   

Total

Contracts

   

Pre-modification

Recorded

Investment

   

Post-modification

Recorded

Investment(1)

 

Below market interest rate

                                               

Single family owner occupied

    1     $ 11     $ 11       -     $ -     $ -  

Below market interest rate and extended payment term

                                               

Single family owner occupied

    1       41       41       5       207       207  

Consumer loans

    -       -       -       1       36       36  

Total

    2     $ 52     $ 52       6     $ 243     $ 243  

                                                               

(1) Represents the loan balance immediately following modification

 

The following table presents loans modified as TDRs, by loan class, that were restructured within the previous 12 months for which there was a payment default during the periods indicated:

 

   

Year Ended December 31,

 
   

2018

   

2017

 
   

Total

   

Recorded

   

Total

   

Recorded

 
   

Contracts

   

Investment

   

Contracts

   

Investment

 

(Amounts in thousands)

                               

Single family owner occupied

    1     $ 521       1     $ 14  

Total

    1     $ 521       1     $ 14  

 

The following table provides information about OREO, which consists of properties acquired through foreclosure, as of the dates indicated:

 

   

December 31, 2018

   

December 31, 2017

 

(Amounts in thousands)

               

Non-covered OREO

  $ 3,806     $ 2,409  

Covered OREO

    32       105  

Total OREO

  $ 3,838     $ 2,514  
                 

Non-covered OREO secured by residential real estate

  $ 2,303     $ 2,209  

Residential real estate loans in the foreclosure process(1)

    6,349       9,921  

                                                                                                                                       

(1)

The recorded investment in consumer mortgage loans collateralized by residential real estate that are in the process of foreclosure according to local requirements of the applicable jurisdiction

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

Note 6. Allowance for Loan Losses

 

The following tables present the changes in the allowance for loan losses, by loan segment, during the periods indicated. There was no allowance related to PCI loans as of December 31, 2018 or 2017.

 

   

Year Ended December 31, 2018

 

(Amounts in thousands)

 

Commercial

   

Consumer Real

Estate

   

Consumer and

Other

   

Total Allowance

 

Beginning balance

  $ 11,672     $ 6,810     $ 794     $ 19,276  

(Recovery of) provision for loan losses charged to operations

    (660 )     1,473       1,580       2,393  

Charge-offs

    (1,236 )     (2,005 )     (1,666 )     (4,907 )

Recoveries

    723       454       328       1,505  

Net charge-offs

    (513 )     (1,551 )     (1,338 )     (3,402 )

Ending balance

  $ 10,499     $ 6,732     $ 1,036     $ 18,267  

 

   

Year Ended December 31, 2017

 

(Amounts in thousands)

 

Commercial

   

Consumer Real

Estate

   

Consumer and

Other

   

Total

Allowance

 

Allowance, excluding PCI

                               

Beginning balance

  $ 11,690     $ 5,487     $ 759     $ 17,936  

Provision for loan losses charged to operations

    103       1,608       1,072       2,783  

Charge-offs

    (922 )     (699 )     (1,322 )     (2,943 )

Recoveries

    801       414       285       1,500  

Net charge-offs

    (121 )     (285 )     (1,037 )     (1,443 )

Ending balance

  $ 11,672     $ 6,810     $ 794     $ 19,276  
                                 

PCI allowance

                               

Beginning balance

  $ -     $ 12     $ -     $ 12  

Recovery of loan losses

    -       (12 )     -       (12 )

Benefit attributable to the FDIC indemnification asset

    -       -       -       -  

Recovery of loan losses charged to operations

    -       (12 )     -       (12 )

Recovery of loan losses recorded through the FDIC indemnification asset

    -       -       -       -  

Ending balance

  $ -     $ -     $ -     $ -  
                                 

Total allowance

                               

Beginning balance

  $ 11,690     $ 5,499     $ 759     $ 17,948  

Provision for loan losses

    103       1,596       1,072       2,771  

Benefit attributable to the FDIC indemnification asset

    -       -       -       -  

Provision for loan losses charged to operations

    103       1,596       1,072       2,771  

Recovery of loan losses recorded through the FDIC indemnification asset

    -       -       -       -  

Charge-offs

    (922 )     (699 )     (1,322 )     (2,943 )

Recoveries

    801       414       285       1,500  

Net charge-offs

    (121 )     (285 )     (1,037 )     (1,443 )

Ending balance

  $ 11,672     $ 6,810     $ 794     $ 19,276  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following tables present the allowance for loan losses and recorded investment in loans evaluated for impairment, excluding PCI loans, by loan class, as of the dates indicated:

 

   

December 31, 2018

 

(Amounts in thousands)

 

Loans Individually

Evaluated for

Impairment

   

Allowance for Loans

Individually

Evaluated

   

Loans Collectively

Evaluated for

Impairment

   

Allowance for Loans

Collectively

Evaluated

 

Commercial loans

                               

Construction, development, and other land

  $ -     $ -     $ 63,039     $ 417  

Commercial and industrial

    -       -       104,863       663  

Multi-family residential

    534       230       106,478       962  

Single family non-owner occupied

    -       -       138,451       1,442  

Non-farm, non-residential

    840       235       609,100       6,295  

Agricultural

    -       -       8,545       85  

Farmland

    -       -       18,905       170  

Total commercial loans

    1,374       465       1,049,381       10,034  

Consumer real estate loans

                               

Home equity lines

    65       65       103,668       683  

Single family owner occupied

    3,631       922       509,929       4,931  

Owner occupied construction

    -       -       18,171       131  

Total consumer real estate loans

    3,696       987       631,768       5,745  

Consumer and other loans

                               

Consumer loans

    -       -       71,552       1,036  

Other

    -       -       5,310       -  

Total consumer and other loans

    -       -       76,862       1,036  

Total loans, excluding PCI loans

  $ 5,070     $ 1,452     $ 1,758,011     $ 16,815  

 

   

December 31, 2017

 

(Amounts in thousands)

 

Loans Individually

Evaluated for

Impairment

   

Allowance for Loans

Individually

Evaluated

   

Loans Collectively

Evaluated for

Impairment

   

Allowance for Loans

Collectively

Evaluated

 

Commercial loans

                               

Construction, development, and other land

  $ -     $ -     $ 59,386     $ 830  

Commercial and industrial

    343       270       91,845       492  

Multi-family residential

    -       -       125,202       1,094  

Single family non-owner occupied

    770       62       139,093       1,914  

Non-farm, non-residential

    1,367       15       611,477       6,582  

Agricultural

    -       -       7,035       51  

Farmland

    1,219       233       24,430       129  

Total commercial loans

    3,699       580       1,058,468       11,092  

Consumer real estate loans

                               

Home equity lines

    -       -       115,807       803  

Single family owner occupied

    9,471       1,978       496,348       3,732  

Owner occupied construction

    -       -       39,178       297  

Total consumer real estate loans

    9,471       1,978       651,333       4,832  

Consumer and other loans

                               

Consumer loans

    -       -       70,772       794  

Other

    -       -       5,001       -  

Total consumer and other loans

    -       -       75,773       794  

Total loans, excluding PCI loans

  $ 13,170     $ 2,558     $ 1,785,574     $ 16,718  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents the allowance for loan losses on PCI loans and recorded investment in PCI loans, by loan pool, as of the dates indicated:

 

   

December 31, 2018

   

December 31, 2017

 

(Amounts in thousands)

 

Recorded

Investment

   

Allowance for

Loan Pools With

Impairment

   

Recorded

Investment

   

Allowance for

Loan Pools With

Impairment

 

Commercial loans

                               

Waccamaw commercial

  $ -     $ -     $ 64     $ -  

Peoples commercial

    4,405       -       4,279       -  

Other

    868       -       986       -  

Total commercial loans

    5,273       -       5,329       -  

Consumer real estate loans

                               

Waccamaw serviced home equity lines

    5,017       -       11,118       -  

Waccamaw residential

    788       -       994       -  

Peoples residential

    925       -       999       -  

Total consumer real estate loans

    6,730       -       13,111       -  

Total PCI loans

  $ 12,003     $ -     $ 18,440     $ -  

 

Management believed the allowance was adequate to absorb probable loan losses inherent in the loan portfolio as of December 31, 2018.

 

 

Note 7. FDIC Indemnification Asset

 

In connection with the FDIC-assisted acquisition of Waccamaw Bank in 2012, the Company entered into loss share agreements with the FDIC in which the FDIC agrees to cover 80% of most loan and foreclosed real estate losses and reimburse certain expenses incurred in relation to those covered assets. Loss share coverage on commercial loans expired June 30, 2017, with recoveries continuing until June 30, 2019. Loss share coverage on single family loans will expire June 30, 2022. The Company’s consolidated statements of income include the expense on covered assets net of estimated reimbursements. The following table presents the changes in the FDIC indemnification asset and total covered loans and OREO for the periods indicated:

 

   

Year Ended December 31,

 
   

2018

   

2017

 

(Amounts in thousands)

               

Beginning balance

  $ 7,161     $ 12,173  

Increase in estimated losses on covered OREO

    -       81  

Reimbursable expenses (to) from the FDIC

    (23 )     112  

Net amortization

    (2,181 )     (3,517 )

Payments to (reimbursements from) the FDIC

    151       (1,688 )

Ending balance

  $ 5,108     $ 7,161  
                 

Covered loans

  $ 18,815     $ 27,948  

Covered OREO

    32       105  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

Note 8. Premises, Equipment, and Leases

 

Premises and Equipment

 

The following table presents the components of premises and equipment as of the dates indicated:

 

     

December 31,

 
     

2018

   

2017

 

(Amounts in thousands)

               

Land

  $ 18,090     $ 18,921  

Buildings and leasehold improvements

    45,079       46,002  

Equipment

    33,551       33,336  

Total premises and equipment

    96,720       98,259  

Accumulated depreciation and amortization

    (50,935 )     (50,133 )

Total premises and equipment, net

  $ 45,785     $ 48,126  

 

Impairment charges related to certain long-term investments in land and buildings totaled $1.01 million in 2018, $677 thousand in 2017, and $364 thousand in 2016. Depreciation and amortization expense for premises and equipment was $2.91 million in 2018, $3.56 million in 2017, and $3.56 million in 2016.

 

Leases

 

The Company has entered into various noncancelable operating leases for premises and equipment. The following schedule presents the future minimum lease payments required under noncancelable operating leases, with initial or remaining terms in excess of one year, by year, as of December 31, 2018:

 

(Amounts in thousands)

       

2019

  $ 160  

2020

    97  

2021

    97  

2022

    97  

2023

    97  

2024 and thereafter

    597  

Total future minimum lease payments

  $ 1,145  

 

Lease expense was $318 thousand in 2018, $582 thousand in 2017, and $784 thousand in 2016. The Company maintained no subleases as of December 31, 2018.

 

 

Note 9. Goodwill and Other Intangible Assets

 

Goodwill

 

The Company has one reporting unit for goodwill impairment testing purposes, Community Banking. Prior to October 2016, the Company maintained two reporting units, Community Banking and Insurance Services. The Insurance Services reporting unit consisted of the Company’s wholly owned subsidiary Greenpoint, which was sold in October 2016. In October 2018, the Company sold its remaining insurance agency assets to BI in exchange for an equity interest in BI. In connection with the divestiture, the Company recognized a one-time goodwill impairment charge of $1.49 million. The Company used the fair value of the equity interest in BI as the basis for determining the goodwill impairment. The Company performed its annual assessment of goodwill during the fourth quarter of 2018 and concluded that the carrying value of goodwill was not impaired. No events have occurred after the analysis to indicate potential impairment.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents the changes in goodwill, by reporting unit, during the periods indicated:

 

     

Community Banking

   

Insurance Services

   

Total

 

(Amounts in thousands)

                       

Balance January 1, 2016

  $ 91,455     $ 9,031     $ 100,486  

Acquisitions and dispositions, net

    1,290       (5,997 )     (4,707 )

Other (1)

    3,034       (3,034 )     -  

Balance December 31, 2016

  $ 95,779     $ -     $ 95,779  
                           

Balance January 1, 2017

  $ 95,779             $ 95,779  

Acquisitions and dispositions, net

    -               -  

Balance December 31, 2017

  $ 95,779             $ 95,779  
                           

Balance January 1, 2018

  $ 95,779             $ 95,779  

Acquisitions and dispositions, net

    (1,543 )             (1,543 )

Impairment charges

    (1,492 )             (1,492 )

Balance December 31, 2018

  $ 92,744             $ 92,744  

                                                                                                    

(1) Represents the transfer of goodwill after the sale of Greenpoint to one reporting unit

   

 

Other Intangible Assets

 

As of December 31, 2018, the remaining lives of core deposit intangibles ranged from 4 years to 7 years with a weighted average remaining life of 5 years. Other identifiable intangibles currently consist primarily of the value assigned to contractual rights arising from FCWM. The following table presents the components of other intangible assets as of the dates indicated:

 

   

December 31,

 
   

2018

   

2017

   

2016

 

(Amounts in thousands)

                       

Core deposit intangibles

  $ 8,184     $ 8,184     $ 11,536  

Accumulated amortization

    (3,158 )     (2,161 )     (4,515 )

Core deposit intangibles, net

    5,026       6,023       7,021  

Other identifiable intangibles

    535       879       3,508  

Accumulated amortization

    (535 )     (751 )     (3,322 )

Other identifiable intangibles, net

    -       128       186  

Total other intangible assets, net

  $ 5,026     $ 6,151     $ 7,207  

 

Amortization expense for other intangible assets was $1.04 million in 2018, $1.06 million in 2017, and $1.14 million in 2016. The following schedule presents the estimated amortization expense for intangible assets, by year, as of December 31, 2018:

 

(Amounts in thousands)

       

2019

  $ 997  

2020

    997  

2021

    997  

2022

    997  

2023

    431  

2024 and thereafter

    607  

Total estimated amortization expense

  $ 5,026  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

Note 10. Deposits

 

The following table presents the components of deposits as of the dates indicated:

 

   

December 31,

 
   

2018

   

2017

 

(Amounts in thousands)

               

Noninterest-bearing demand deposits

  $ 459,550     $ 454,143  

Interest-bearing deposits

               

Interest-bearing demand deposits

    451,721       465,407  

Money market accounts

    153,483       170,731  

Savings deposits

    345,335       342,064  

Certificates of deposit

    330,757       374,373  

Individual retirement accounts

    114,904       123,173  

Total interest-bearing deposits

    1,396,200       1,475,748  

Total deposits

  $ 1,855,750     $ 1,929,891  

 

The following schedule presents the contractual maturities of time deposits, by year, as of December 31, 2018:

 

(Amounts in thousands)

       

2019

  $ 191,900  

2020

    121,264  

2021

    59,213  

2022

    47,480  

2023

    25,721  

2024 and thereafter

    83  

Total contractual maturities

  $ 445,661  

 

Time deposits of $250 thousand or more totaled $43.84 million as of December 31, 2018, and $48.50 million as of December 31, 2017. The following schedule presents the contractual maturities of time deposits of $250 thousand or more as of December 31, 2018:

 

(Amounts in thousands)

       

Three months or less

  $ 3,605  

Over three through six months

    2,291  

Over six through twelve months

    7,527  

Over twelve months

    30,416  

Total contractual maturities

  $ 43,839  

 

 

Note 11. Borrowings

 

The following table presents the components of borrowings as of the dates indicated:

 

   

December 31,

 
   

2018

   

2017

 

(Amounts in thousands)

 

Balance

   

Weighted Average Rate

   

Balance

   

Weighted Average Rate

 

Short-term borrowings

                               

Retail repurchase agreements

  $ 4,370       0.12 %   $ 5,086       0.07 %

Long-term borrowings

                               

Wholesale repurchase agreements

    25,000       3.18 %     25,000       3.18 %

FHLB advances

    -               50,000       4.00 %

Total borrowings

  $ 29,370             $ 80,086          

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Repurchase agreements are secured by certain securities that remain under the Company’s control during the terms of the agreements. The counterparties may redeem callable repurchase agreements, which could substantially shorten the borrowings’ lives. The prepayment or early termination of a repurchase agreement may result in substantial penalties based on market conditions. The following schedule presents the contractual maturities of repurchase agreements, by type of collateral pledged, as of December 31, 2018:

 

   

Overnight and

Continuous

   

Up to 30 Days

   

30 - 90 Days

   

Greater than 90

Days

   

Total

 

(Amounts in thousands)

                                       

U.S. Agency securities

  $ -     $ -     $ -     $ 14,322     $ 14,322  

Municipal securities

    3,047       -       -       833       3,880  

Mortgage-backed Agency securities

    1,323       -       -       9,845       11,168  

Total

  $ 4,370     $ -     $ -     $ 25,000     $ 29,370  

 

As of December 31, 2018, long-term borrowings consisted of a wholesale repurchase agreement that matures in 2019 with a weighted average maturity of 0.15 years. During the third quarter of 2018, the Company prepaid its remaining $50 million FHLB convertible advance and incurred a loss on the extinguishment of the debt of $1.10 million. The prepayment was funded with cash and cash equivalents on hand, as well as the sale of the Company’s remaining single issue trust preferred investment securities.

 

As of December 31, 2018, unused borrowing capacity with the FHLB totaled $402.74 million, net of FHLB letters of credit of $144.38 million, The Company pledged $874.17 million in qualifying loans to secure the FHLB letters of credit, which provide an attractive alternative to pledging securities for public unit deposits.

 

The Company maintains a $15.00 million unsecured, committed line of credit with an unrelated financial institution with an interest rate of one-month LIBOR plus 2.00% that matures in April 2019. There was no outstanding balance on the line as of December 31, 2018 or 2017.

 

 

Note 12. Derivative Instruments and Hedging Activities

 

Generally, derivative instruments help the Company manage exposure to market risk and meet customer financing needs. Market risk represents the possibility that fluctuations in external factors such as interest rates, market-driven loan rates, prices, or other economic factors will adversely affect economic value or net interest income.

 

The Company uses interest rate swap contracts to modify its exposure to interest rate risk caused by changes in the LIBOR curve in relation to certain designated fixed rate loans. These instruments are used to convert these fixed rate loans to an effective floating rate. If the LIBOR rate falls below the loan’s stated fixed rate for a given period, the Company will owe the floating rate payer the notional amount times the difference between LIBOR and the stated fixed rate. If LIBOR is above the stated rate for a given period, the Company will receive payments based on the notional amount times the difference between LIBOR and the stated fixed rate. The Company’s interest rate swaps qualify as fair value hedging instruments; therefore, fair value changes in the derivative and hedged item attributable to the hedged risk are recognized in earnings in the same period. The fair value hedges were effective as of December 31, 2018. The following table presents the notional, or contractual, amounts and fair values of derivative instruments as of the dates indicated:

 

   

December 31,

 
   

2018

   

2017

 

(Amounts in thousands)

 

Notional or

Contractual

Amount

   

Derivative

Assets

   

Derivative

Liabilities

   

Notional or

Contractual

Amount

   

Derivative

Assets

   

Derivative

Liabilities

 

Derivatives designated as hedges

                                               

Interest rate swaps

  $ 5,483     $ 12     $ -     $ 5,813     $ -     $ 90  

Total derivatives

  $ 5,483     $ 12     $ -     $ 5,813     $ -     $ 90  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents the effect of derivative and hedging activity, if applicable, on the consolidated statements of income for the periods indicated:

 

   

Year Ended December 31,

   

(Amounts in thousands)

 

2018

   

2017

   

2016

 

Income Statement Location

Derivatives designated as hedges

                         

Interest rate swaps

  $ 40     $ 78     $ 116  

Interest and fees on loans

Total derivative expense

  $ 40     $ 78     $ 116    

 

 

Note 13. Employee Benefit Plans

 

Defined Benefit Plans

 

The Company maintains two nonqualified domestic, noncontributory defined benefit plans (the “Benefit Plans”) for key members of senior management and non-management directors. The Company’s unfunded Benefit Plans include the Supplemental Executive Retention Plan (“SERP”) and the Directors’ Supplemental Retirement Plan (“Directors’ Plan”). The SERP provides for a defined benefit, at normal retirement age, targeted at 35% of the participant’s projected final average compensation, subject to a defined maximum annual benefit. Benefits under the SERP generally become payable at age 62. The Directors’ Plan provides for a defined benefit, at normal retirement age, up to 100% of the participant’s highest consecutive three-year average compensation. Benefits under the Directors’ Plan generally become payable at age 70. The following table presents the changes in the aggregate actuarial benefit obligation during the periods indicated:

 

   

December 31,

 
   

2018

   

2017

 

(Amounts in thousands)

               

Beginning balance

  $ 9,635     $ 9,181  

Plan change

    -       258  

Service cost

    245       231  

Interest cost

    358       372  

Actuarial gain

    (565 )     (48 )

Benefits paid

    (408 )     (359 )

Ending balance

  $ 9,265     $ 9,635  

 

The following table presents the components of net periodic pension cost, the effect on the consolidated statements of income, and the assumed discount rate for the periods indicated: 

 

   

Year Ended December 31,

   
   

2018

   

2017

   

2016

 

Income Statement Location

(Amounts in thousands)

                         

Service cost

  $ 245     $ 231     $ 184  

Salaries and employee benefits

Interest cost

    358       372       382  

Other expense

Amortization of prior service cost

    228       228       226  

Other expense

Amortization of losses

    57       31       47  

Other expense

Net periodic cost

  $ 888     $ 862     $ 839    
                           

Assumed discount rate

    4.28 %     3.85 %     4.22 %  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following schedule presents the projected benefit payments to be paid under the Benefit Plans, by year, as of December 31, 2018:

 

(Amounts in thousands)

       

2019

  $ 478  

2020

    578  

2021

    635  

2022

    635  

2023

    634  

2024 through 2028

    3,391  

 

Deferred Compensation Plan

 

The Company maintains deferred compensation agreements with certain current and former officers that provide benefit payments, over various periods, commencing at retirement or death. There were no accrued benefits, which are based on the present values of expected payments and estimated life expectancies, as of December 31, 2018 or 2017. There was no deferred compensation plan expense in 2018, compared to $11 thousand in 2017 and $60 thousand in 2016.

 

Employee Welfare Plan

 

The Company provides various medical, dental, vision, life, accidental death and dismemberment, and long-term disability insurance benefits to all full-time employees who elect coverage under this program. A third-party administrator manages the health plan. Monthly employer and employee contributions are made to a tax-exempt employee benefits trust where the third-party administrator processes and pays claims. As of December 31, 2018, stop-loss insurance coverage generally limits the Company’s risk of loss to $150 thousand for individual claims and $4.20 million for aggregate claims. Health plan expenses were $3.72 million in 2018, $3.50 million in 2017, and $3.48 million in 2016.

 

Employee Stock Ownership and Savings Plan

 

The Company maintains the Employee Stock Ownership and Savings Plan (“KSOP”) that consists of a 401(k) savings feature that covers all employees that meet minimum eligibility requirements. The Company matches employee contributions at levels determined by the Board of Directors annually. These contributions are made in the first quarter following each plan year and employees must be employed on the last day of the plan year to be eligible. Matching contributions to qualified deferrals under the 401(k) savings component of the KSOP totaled $1.06 million in 2018, $1.18 million in 2017, and $1.50 million in 2016. The KSOP held 366,969 shares of the Company’s common stock as of December 31, 2018, 387,935 shares as of December 31, 2017, and 410,384 shares as of December 31, 2016.

 

Equity-Based Compensation Plans

 

The Company maintains equity-based compensation plans to promote the long-term success of the Company by encouraging officers, employees, directors, and other individuals performing services for the Company to focus on critical long-range objectives. The Company’s equity-based compensation plans include the 2012 Omnibus Equity Compensation Plan (“2012 Plan”), 2004 Omnibus Stock Option Plan, 2001 Director’s Option Plan, 1999 Stock Option Plan, and various other plans obtained through acquisitions. As of December 31, 2018, the 2012 Plan was the only plan available for the issuance of future grants. All plans issued or obtained before the 2012 Plan are frozen and no new grants may be issued; however, any options or awards unexercised and outstanding under those plans remain in effect per their respective terms. The 2012 Plan authorized 600,000 shares available for potential grants of incentive stock options, nonqualified stock options, performance awards, restricted stock, restricted stock units, stock appreciation rights, bonus stock, and stock awards. Grants issued under the 2012 Plan state the period of time the grant may be exercised, not to exceed more than ten years from the date granted. The Company’s Compensation and Retirement Committee determines the vesting period for each grant; however, if no vesting period is specified the vesting occurs in 25% increments on the first four anniversaries of the grant date.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                

The following table presents the pre-tax compensation expense and excess tax benefit recognized in earnings for all equity-based compensation plans for the periods indicated:

 

     

Year Ended December 31,

 
     

2018

   

2017

   

2016

 

(Amounts in thousands)

                       

Pre-tax compensation expense

  $ 1,158     $ 790     $ 531  

Excess tax benefit

    95       17       174  

 

Stock Options

 

The following table presents stock option activity and related information for the year ended December 31, 2018:

 

           

Weighted Average

   

Weighted Average

   

Aggregate

 
   

Option

   

Exercise Price

   

Remaining Contractual

   

Intrinsic

 

(Amounts in thousands,

 

Shares

   

Per Share

   

Term (Years)

   

Value

 
except share and per share data)                                

Outstanding, January 1, 2018

    200,704     $ 20.14                  

Granted

    -       -                  

Exercised

    (24,186 )     15.89                  

Canceled

    (20,263 )     19.72                  

Outstanding, December 31, 2018

    156,255     $ 20.85       5.6     $ 1,662  

Exercisable, December 31, 2018

    103,090     $ 20.23       4.6     $ 1,160  

 

The following table presents the total options granted and the weighted average assumptions used to estimate the fair value of those options during the periods indicated. There were no options granted in 2018.

 

   

Year Ended December 31,

 
   

2017

   

2016

 
                 

Stock options granted

    22,849       32,768  

Grant-date fair value per share

  $ 5.79     $ 4.01  

Volatility

    27.86 %     25.04 %

Risk-free rate

    2.17 %     1.56 %

Expected dividend yield

    2.99 %     3.09 %

Expected term (in years)

    6.50       6.50  

 

The intrinsic value of options exercised was $423 thousand in 2018, $84 thousand in 2017, and $434 thousand in 2016. As of December 31, 2018, unrecognized compensation cost related to nonvested stock options totaled $65 thousand with an expected weighted average recognition period of 1.08 years. The actual compensation cost recognized might differ from this estimate due to various items, including new grants and changes in estimated forfeitures.

 

Restricted Stock Awards

 

The following table presents restricted stock activity and related information for the year ended December 31, 2018:

 

           

Weighted Average

 
   

Shares

   

Grant-Date Fair Value

 
                 

Nonvested, January 1, 2018

    43,606     $ 23.49  

Granted

    41,339       30.08  

Vested

    (33,832 )     25.69  

Canceled

    -       -  

Nonvested, December 31, 2018

    51,113     $ 27.37  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

As of December 31, 2018, unrecognized compensation cost related to nonvested restricted stock awards totaled $927 thousand with an expected weighted average recognition period of 1.95 years. The actual compensation cost recognized might differ from this estimate due to various items, including new awards granted and changes in estimated forfeitures.

 

 

Note 14. Other Operating Income and Expense

 

The following table presents the components of other operating income and expense for the periods indicated: 

 

   

Year Ended December 31,

 

(Amounts in thousands)

 

2018

   

2017

   

2016

 

Other operating income

                       

Bank owned life insurance

  $ 687     $ 1,365     $ 955  

Other(1)

    1,861       2,137       2,254  

Total other operating income

  $ 2,548     $ 3,502     $ 3,209  
                         

Other operating expense

                       

OREO expense and net loss

    1,549       1,202       1,420  

Telephone and data communications

    1,333       1,554       1,598  

Office supplies

    1,045       1,171       1,220  

Other(1)

    8,800       7,914       8,026  

Total other operating expense

  $ 12,727     $ 11,841     $ 12,264  

                                                                                                                                       

(1)

Components of other operating income or expense that do not exceed 1% of total income

 

 

Note 15. Income Taxes

 

The Tax Reform Act was enacted on December 22, 2017. Among other things, the new law establishes a new, flat corporate federal statutory income tax rate of 21%; eliminates the corporate alternative minimum tax and allows the use of any such carryforwards to offset regular tax liability for any taxable year; limits the deduction for net interest expense incurred by U.S. corporations; allows businesses to immediately expense the cost of new investments in certain qualified depreciable assets for tax purposes; eliminates or reduces certain deductions related to meals and entertainment expenses; modifies the limitation on excessive employee remuneration to eliminate the exception for performance-based compensation and clarifies the definition of a covered employee; and limits the deductibility of deposit insurance premiums. The Tax Reform Act also significantly changes U.S. tax law related to foreign operations, however, such changes do not currently impact the Company. As a result of the Tax Reform Act, the Company recognized additional tax expense totaling $6.55 million during the fourth quarter of 2017 related to the revaluation of our deferred tax balances, which included provisional estimates primarily related to certain purchase accounting, indemnification asset, intangible, and depreciation items. During the third quarter of 2018, the Company completed the deferred tax asset revaluation and recorded a $1.67 million reduction in tax expense.

 

Income tax expense is comprised of current and deferred, federal and state income taxes on the Company’s pre-tax earnings. The following table presents the components of the income tax provision for the periods indicated:

 

   

Year Ended December 31,

 

(Amounts in thousands)

 

2018

   

2017

   

2016

 

Current tax expense (benefit):

                       

Federal

  $ 7,201     $ 14,509     $ 13,634  

State

    1,233       926       675  

Total current tax expense

    8,434       15,435       14,309  
                         

Deferred tax expense (benefit):

                       

Federal

    296       5,205       (1,480 )

State

    52       (12 )     (10 )

Total deferred tax expense (benefit)

    348       5,193       (1,490 )

Total income tax expense

  $ 8,782     $ 20,628     $ 12,819  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The Company’s effective tax rate, income tax as a percent of pre-tax income, may vary significantly from the statutory rate due to permanent differences and available tax credits. Permanent differences are income and expense items excluded by law in the calculation of taxable income. The Company’s most significant permanent differences generally include interest income on municipal securities and increases in the cash surrender value of life insurance policies. The following table reconciles the Company’s income tax expense to the amount computed by applying the federal statutory tax rate to pre-tax income for the periods indicated:

 

   

Year Ended December 31,

 
   

2018

   

2017

   

2016

 
   

Amount

   

Percent

   

Amount

   

Percent

   

Amount

   

Percent

 

(Amounts in thousands)

                                               

Federal income tax at the statutory rate

  $ 9,475       21.00 %   $ 14,739       35.00 %   $ 13,281       35.00 %

State income tax, net of federal benefit

    1,016       2.25 %     692       1.64 %     598       1.58 %
      10,491       23.25 %     15,431       36.64 %     13,879       36.58 %

Increase (decrease) resulting from:

                                               

Tax-exempt interest income

    (702 )     -1.56 %     (1,228 )     -2.92 %     (1,336 )     -3.52 %

Nondeductible goodwill impairment and disposition

    569       1.26 %     -       0.00 %     340       0.89 %

Bank owned life insurance

    (144 )     -0.32 %     (478 )     -1.13 %     (335 )     -0.88 %

Deferred tax revaluation

    (1,669 )     -3.70 %     6,552       15.56 %     -       0.00 %

Other items, net

    237       0.53 %     351       0.83 %     271       0.71 %

Income tax at the effective tax rate

  $ 8,782       19.46 %   $ 20,628       48.98 %   $ 12,819       33.78 %

 

Deferred taxes derived from continuing operations reflect the net effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and amounts used for tax purposes. The following table presents the significant components of the net deferred tax asset as of the dates indicated:

 

   

December 31,

 

(Amounts in thousands)

 

2018

   

2017

 

Deferred tax assets

               

Allowance for loan losses

  $ 4,275     $ 4,511  

Unrealized losses on available-for-sale securities

    87       -  

Unrealized asset losses

    730       722  

Purchase accounting

    24       3,418  

FDIC assisted transactions

    1,510       4,131  

Intangible assets

    2,430       2,616  

Deferred compensation assets

    3,468       3,617  

Deferred loan fees

    1,201       1,221  

Other

    491       450  

Total deferred tax assets

    14,216       20,686  
                 

Deferred tax liabilities

               

FDIC indemnification asset

    1,195       8,525  

Fixed assets

    1,381       1,282  

Unrealized gains on available-for-sale securities

    -       259  

Odd days interest deferral

    1,614       233  

Other

    460       819  

Total deferred tax liabilities

    4,650       11,118  

Net deferred tax asset

  $ 9,566     $ 9,568  

 

The Company had no unrecognized tax benefits or accrued interest or penalties as of December 31, 2018 or 2017. The Company had no deferred tax valuation allowance recorded as of December 31, 2018 or 2017, as management believes it is more likely than not that all of the deferred tax assets will be realized against deferred tax liabilities and projected future taxable income. The Company is currently open to audit under the statute of limitations by the Internal Revenue Service and various state tax departments for the years ended December 31, 2015 through 2017.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

Note 16. Accumulated Other Comprehensive Income

 

The following table presents the changes in AOCI, net of tax and by component, during the periods indicated:

 

   

Unrealized Gains (Losses)

on Available-for-Sale

Securities

   

Employee Benefit

Plans

   

Total

 

(Amounts in thousands)

                       

Balance January 1, 2016

  $ (3,885 )   $ (1,362 )   $ (5,247 )

Other comprehensive income (loss) before reclassifications

    647       (276 )     371  

Reclassified from AOCI

    2,694       171       2,865  

Other comprehensive income (loss), net

    3,341       (105 )     3,236  

Balance December 31, 2016

  $ (544 )   $ (1,467 )   $ (2,011 )
                         

Balance January 1, 2017

  $ (544 )   $ (1,467 )   $ (2,011 )

Other comprehensive income (loss) before reclassifications

    972       (132 )     840  

Reclassified from AOCI

    413       162       575  

Other comprehensive income, net

    1,385       30       1,415  

Reclassification of certain tax effects

    134       (378 )     (244 )

Balance December 31, 2017

  $ 975     $ (1,815 )   $ (840 )
                         

Balance January 1, 2018

  $ 975     $ (1,815 )   $ (840 )

Other comprehensive income (loss) before reclassifications

    (1,748 )     446       (1,302 )

Reclassified from AOCI

    488       225       713  

Other comprehensive income (loss), net

    (1,260 )     671       (589 )

Balance December 31, 2018

  $ (285 )   $ (1,144 )   $ (1,429 )

 

The following table presents reclassifications out of AOCI, by component, during the periods indicated:

 

   

Year Ended December 31,

 

Income Statement

(Amounts in thousands)

 

2018

   

2017

   

2016

 

Line Item Affected

Available-for-sale securities                          

(Gains) losses recognized

  $ 618     $ 661     $ (335 )

Net gain (loss) on sale of securities

OTTI recognized

    -       -       4,646  

Net impairment losses recognized in earnings

Reclassified out of AOCI, before tax

    618       661       4,311  

Income before income taxes

Income tax expense

    (130 )     (248 )     (1,617 )

Income tax expense

Reclassified out of AOCI, net of tax

    488       413       2,694  

Net income

Employee benefit plans

                         

Amortization of prior service cost

    228       228       226  

Other operating expense

Amortization of net actuarial loss

    57       31       47  

Other operating expense

Reclassified out of AOCI, before tax

    285       259       273  

Income before income taxes

Income tax expense

    (60 )     (97 )     (102 )

Income tax expense

Reclassified out of AOCI, net of tax

    225       162       171  

Net income

Total reclassified out of AOCI, net of tax

  $ 713     $ 575     $ 2,865  

Net income

 

 

Note 17. Fair Value

 

Financial Instruments Measured at Fair Value

 

The following discussion describes the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments under the valuation hierarchy.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Assets and Liabilities Reported at Fair Value on a Recurring Basis

 

Available-for-Sale Debt Securities. Debt securities available for sale are reported at fair value on a recurring basis. The fair value of Level 1 securities is based on quoted market prices in active markets, if available. If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are primarily derived from or corroborated by observable market data. Level 2 securities use fair value measurements from independent pricing services obtained by the Company. These fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and bond terms and conditions. The Company’s Level 2 securities include U.S. Agency and Treasury securities, municipal securities, single issue trust preferred securities, and mortgage-backed securities. Securities are based on Level 3 inputs when there is limited activity or less transparency to the valuation inputs. In the absence of observable or corroborated market data, internally developed estimates that incorporate market-based assumptions are used when such information is available.

 

Fair value models may be required when trading activity has declined significantly or does not exist, prices are not current, or pricing variations are significant. For Level 3 securities, the Company obtains the cash flow of specific securities from third parties that use modeling software to determine cash flows based on market participant data and knowledge of the structures of each individual security. The fair values of Level 3 securities are determined by applying proper market observable discount rates to the cash flow derived from third-party models. Discount rates are developed by determining credit spreads above a benchmark rate, such as LIBOR, and adding premiums for illiquidity, which are based on a comparison of initial issuance spread to LIBOR versus a financial sector curve for recently issued debt to LIBOR. Securities with increased uncertainty about the receipt of cash flows are discounted at higher rates due to the addition of a deal specific credit premium based on assumptions about the performance of the underlying collateral. Finally, internal fair value model pricing and external pricing observations are combined by assigning weights to each pricing observation. Pricing is reviewed for reasonableness based on the direction of specific markets and the general economic indicators.

 

Equity Securities. Equity securities are recorded at fair value on a recurring basis and included in other assets in the consolidated balance sheets. The Company uses Level 1 inputs to value equity securities that are traded in active markets. Equity securities that are not actively traded are classified in Level 2.

 

Loans Held for Investment. Loans held for investment are reported at fair value using the exit price notion, which is derived from third-party models. Loans related to fair value hedges are recorded at fair value on a recurring basis.

 

Deferred Compensation Assets and Liabilities. Securities held for trading purposes are recorded at fair value on a recurring basis and included in other assets in the consolidated balance sheets. These securities include assets related to employee deferred compensation plans, which are generally invested in Level 1 equity securities. The liability associated with these deferred compensation plans is carried at the fair value of the obligation to the employee, which corresponds to the fair value of the invested assets.

 

Derivative Assets and Liabilities. Derivatives are recorded at fair value on a recurring basis. The Company obtains dealer quotes, Level 2 inputs, based on observable data to value derivatives.

 

The following tables summarize financial assets and liabilities recorded at fair value on a recurring basis, by the level of valuation inputs in the fair value hierarchy, as of the dates indicated:

 

   

December 31, 2018

 
   

Total

   

Fair Value Measurements Using

 

(Amounts in thousands)

 

Fair Value

   

Level 1

   

Level 2

   

Level 3

 

Available-for-sale debt securities

                               

U.S. Agency securities

  $ 1,113     $ -     $ 1,113     $ -  

U.S. Treasury securities

    19,960       -       19,960       -  

Municipal securities

    97,289       -       97,289       -  

Mortgage-backed Agency securities

    34,754       -       34,754       -  

Total available-for-sale debt securities

    153,116       -       153,116       -  

Equity securities

    55       55       -       -  

Fair value loans

    5,412       -       -       5,412  

Deferred compensation assets

    3,527       3,527       -       -  

Derivative assets

    12       -       12       -  

Deferred compensation liabilities

    3,527       3,527       -       -  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

   

December 31, 2017

 
   

Total

   

Fair Value Measurements Using

 

(Amounts in thousands)

 

Fair Value

   

Level 1

   

Level 2

   

Level 3

 

Available-for-sale securities

                               

U.S. Agency securities

  $ 11,296     $ -     $ 11,296     $ -  

U.S. Treasury securities

    19,971       -       19,971       -  

Municipal securities

    103,648       -       103,648       -  

Single issue trust preferred securities

    8,884       -       8,884       -  

Mortgage-backed Agency securities

    21,726       -       21,726       -  

Equity securities

    55       55       -       -  

Total available-for-sale securities

    165,580       55       165,525       -  

Fair value loans

    5,739       -       5,739       -  

Deferred compensation assets

    4,002       4,002       -       -  

Deferred compensation liabilities

    4,002       4,002       -       -  

Derivative liabilities

    90       -       90       -  

 

Changes in Level 3 Fair Value Measurements

 

The following table presents the changes in Level 3 assets recorded at fair value on a recurring basis during the period indicated:

 

   

Assets

 

(Amounts in thousands)

       

Balance January 1, 2018

  $ -  
Transfer of certain loans into Level 3     5,739  

Changes in fair value

    1  

Changes due to principal reduction

    (328 )

Balance December 31, 2018

  $ 5,412  

 

 

In according with the adoption of ASU 2016-01, the Company began measuring the fair value of loans held for investment using an exit price notion in 2018. Prior to 2018, loans held for investment were reported at fair value using discounted future cash flows that apply current interest rates for loans with similar terms and borrower credit quality. As a result of using the exit price, certain loans were transferred from Level 2 into Level 3 of the fair value hierarchy during the year ended December 31, 2018. No transfers into or out of Level 3 of the fair value hierarchy occurred during the year ended December 31, 2018.

 

Assets Measured at Fair Value on a Nonrecurring Basis

 

Impaired Loans. Impaired loans are recorded at fair value on a nonrecurring basis when repayment is expected solely from the sale of the loan’s collateral. Fair value is based on appraised value adjusted for customized discounting criteria, Level 3 inputs.

 

The Company maintains an active and robust problem credit identification system. The impairment review includes obtaining third-party collateral valuations to help management identify potential credit impairment and determine the amount of impairment to record. The Company’s Special Assets staff manages and monitors all impaired loans. Internal collateral valuations are generally performed within two to four weeks of identifying the initial potential impairment. The internal valuation compares the original appraisal to current local real estate market conditions and considers experience and expected liquidation costs. The Company typically receives a third-party valuation within thirty to forty-five days of completing the internal valuation. When a third-party valuation is received, it is reviewed for reasonableness. Once the valuation is reviewed and accepted, discounts are applied to fair market value, based on, but not limited to, our historical liquidation experience for like collateral, resulting in an estimated net realizable value. The estimated net realizable value is compared to the outstanding loan balance to determine the appropriate amount of specific impairment reserve.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Specific reserves are generally recorded for impaired loans while third-party valuations are in process and for impaired loans that continue to make some form of payment. While waiting to receive the third-party appraisal, the Company regularly reviews the relationship to identify any potential adverse developments and begins the tasks necessary to gain control of the collateral and prepare it for liquidation, including, but not limited to, engagement of counsel, inspection of collateral, and continued communication with the borrower. Generally, the only difference between the current appraised value, less liquidation costs, and the carrying amount of the loan, less the specific reserve, is any downward adjustment to the appraised value that the Company deems appropriate, such as the costs to sell the property. Impaired loans that do not meet certain criteria and do not have a specific reserve have typically been written down through partial charge-offs to net realizable value. Based on prior experience, the Company rarely returns loans to performing status after they have been partially charged off. Credits identified as impaired move quickly through the process towards ultimate resolution, except in cases involving bankruptcy and various state judicial processes that may extend the time for ultimate resolution.

 

OREO. OREO is recorded at fair value on a nonrecurring basis using Level 3 inputs. The Company calculates the fair value of OREO from current or prior appraisals that have been adjusted for valuation declines, estimated selling costs, and other proprietary qualitative adjustments that are deemed necessary.

 

The following tables present assets measured at fair value on a nonrecurring basis, by the level of valuation inputs in the fair value hierarchy, as of the dates indicated:

 

   

December 31, 2018

 
   

Total

   

Fair Value Measurements Using

 
   

Fair Value

   

Level 1

   

Level 2

   

Level 3

 

(Amounts in thousands)

                               

Impaired loans, non-covered

  $ 3,618     $ -     $ -     $ 3,618  

OREO, non-covered

    3,806       -       -       3,806  

OREO, covered

    32       -       -       32  

 

 

   

December 31, 2017

 
   

Total

   

Fair Value Measurements Using

 
   

Fair Value

   

Level 1

   

Level 2

   

Level 3

 

(Amounts in thousands)

                               

Impaired loans, non-covered

  $ 5,015     $ -     $ -     $ 5,015  

OREO, non-covered

    2,359       -       -       2,359  

OREO, covered

    105       -       -       105  

 

Quantitative Information about Level 3 Fair Value Measurements

 

The following table provides quantitative information for assets measured at fair value on a nonrecurring basis using Level 3 valuation inputs as of the dates indicated:

 

 

Valuation

 

Unobservable

 

Discount Range (Weighted Average)

 
 

Technique

 

Input

 

December 31, 2018

 

December 31, 2017

 
                             

Impaired loans, non-covered

Discounted appraisals(1)

 

Appraisal adjustments(2)

  15% to 100% (29%)   6% to 79% (34%)  

OREO, non-covered

Discounted appraisals(1)

 

Appraisal adjustments(2)

  1% to 81% (31%)   8% to 47% (32%)  

OREO, covered

Discounted appraisals(1)

 

Appraisal adjustments(2)

   49% to 49% (49%)   0% to 65% (52%)  

                                                               

(1)

Fair value is generally based on appraisals of the underlying collateral.

(2)

Appraisals may be adjusted by management for customized discounting criteria, estimated sales costs, and proprietary qualitative adjustments.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following tables present the carrying amounts and fair values of financial instruments, by the level of valuation inputs in the fair value hierarchy, as of the dates indicated:

 

   

December 31, 2018

 
   

Carrying

           

Fair Value Measurements Using

 

(Amounts in thousands)

 

Amount

   

Fair Value

   

Level 1

   

Level 2

   

Level 3

 

Assets

                                       

Cash and cash equivalents

  $ 76,873     $ 76,873     $ 76,873     $ -     $ -  

Debt securities available for sale

    153,116       153,116       -       153,116       -  

Debt securities held to maturity

    25,013       24,990       -       24,990       -  

Equity securities

    55       55       55       -       -  

Loans held for investment, net of allowance

    1,756,817       1,720,114       -       -       1,720,114  

FDIC indemnification asset

    5,108       2,565       -       -       2,565  

Interest receivable

    5,481       5,481       -       5,481       -  

Derivative financial assets

    12       12       -       12       -  

Deferred compensation assets

    3,527       3,527       3,527       -       -  
                                         

Liabilities

                                       

Time deposits

    445,661       436,018       -       436,018       -  

Securities sold under agreements to repurchase

    29,370       29,389       -       29,389       -  

Interest payable

    618       618       -       618       -  

Deferred compensation liabilities

    3,527       3,527       3,527       -       -  

 

   

December 31, 2017

 
   

Carrying

           

Fair Value Measurements Using

 

(Amounts in thousands)

 

Amount

   

Fair Value

   

Level 1

   

Level 2

   

Level 3

 

Assets

                                       

Cash and cash equivalents

  $ 157,951     $ 157,951     $ 157,951     $ -     $ -  

Debt securities available for sale

    165,525       165,525       -       165,525       -  

Debt securities held to maturity

    25,149       25,084       -       25,084       -  

Equity securities

    55       55       55       -       -  

Loans held for investment, net of allowance

    1,797,908       1,760,606       -       5,739       1,754,867  

FDIC indemnification asset

    7,161       3,927       -       -       3,927  

Interest receivable

    5,778       5,778       -       5,778       -  

Deferred compensation assets

    4,002       4,002       4,002       -       -  
                                         

Liabilities

                                       

Demand deposits

    454,143       454,143       -       454,143       -  

Interest-bearing demand deposits

    465,407       465,407       -       465,407       -  

Savings deposits

    512,795       512,795       -       512,795       -  

Time deposits

    497,546       490,628       -       490,628       -  

Securities sold under agreements to repurchase

    30,086       30,449       -       30,449       -  

Interest payable

    1,104       1,104       -       1,104       -  

FHLB and other borrowings

    50,000       52,702       -       52,702       -  

Derivative financial liabilities

    90       90       -       90       -  

Deferred compensation liabilities

    4,002       4,002       4,002       -       -  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

Note 18. Earnings per Share

 

The following table presents the calculation of basic and diluted earnings per common share for the periods indicated:

 

   

Year Ended December 31,

 
   

2018

   

2017

   

2016

 

(Amounts in thousands, except share and per share data)

                       

Net income

  $ 36,340     $ 21,485     $ 25,126  
                         

Weighted average common shares outstanding, basic

    16,587,504       17,002,116       17,319,689  

Dilutive effect of potential common shares

                       

Stock options

    62,417       52,205       34,530  

Restricted stock

    16,464       23,521       11,305  

Total dilutive effect of potential common shares

    78,881       75,726       45,835  

Weighted average common shares outstanding, diluted

    16,666,385       17,077,842       17,365,524  
                         

Basic earnings per common share

  $ 2.19     $ 1.26     $ 1.45  

Diluted earnings per common share

    2.18       1.26       1.45  
                         

Antidilutive potential common shares

                       

Stock options

    19       64,081       107,592  

Restricted stock

    2,736       3,620       3,279  

Total potential antidilutive shares

    2,755       67,701       110,871  

 

 

Note 19. Related Party Transactions

 

The Company engages in transactions with related parties in the normal course of business. Related parties include directors, executive officers, and principal shareholders and their immediate family members, business interests, and affiliates. All related party transactions are made on terms that are substantially the same as those prevailing at the time for similar transactions with unrelated parties, including interest rates and collateral. The following table presents the changes in loans with related parties during the periods indicated:

 

   

Year Ended December 31,

 
   

2018

   

2017

 

(Amounts in thousands)

               

Beginning balance

  $ 19,337     $ 18,360  

New loans and advances

    7,142       942  

Loan repayments

    (4,676 )     (1,566 )

Reclassifications(1)

    230       1,601  

Ending balance

  $ 22,033     $ 19,337  

                                                                                                                                                                         

(1)

Changes related to the composition of the Company's directors, executive officers, and related insiders

 

Deposits with related parties totaled $7.30 million as of December 31, 2018, and $7.13 million as of December 31, 2017. Legal fees paid to related parties totaled $67 thousand in 2018, $44 thousand in 2017, and $104 thousand in 2016. There was no lease expense paid to related parties in 2018, compared to $49 thousand in 2017 and $95 thousand in 2016. Other expense paid to related parties totaled $4 thousand in 2018, $63 thousand in 2017, and $34 thousand in 2016. In addition, the Company repurchased 200,000 shares of its common stock from a related party in 2016 for $4.20 million, which represented the stock’s fair market value as of the date of the transaction.

 

 

Note 20. Litigation, Commitments, and Contingencies

 

Litigation

 

In the normal course of business, the Company is a defendant in various legal actions and asserted claims. While the Company and its legal counsel are unable to assess the ultimate outcome of each of these matters with certainty, the Company believes the resolution of these actions, singly or in the aggregate, should not have a material adverse effect on its financial condition, results of operations, or cash flows.

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Commitments and Contingencies

 

The Company is a party to financial instruments with off balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit, and financial guarantees. These instruments involve, to varying degrees, elements of credit and interest rate risk beyond the amount recognized in the consolidated balance sheets. The contractual amounts of these instruments reflect the extent of involvement the Company has in particular classes of financial instruments. If the other party to a financial instrument does not perform, the Company’s credit loss exposure is the same as the contractual amount of the instrument. The Company uses the same credit policies in making commitments and conditional obligations as it does for on balance sheet instruments.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many commitments are expected to expire without being drawn on, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of each customer on a case-by-case basis. Collateral may include accounts receivable, inventory, property, plant and equipment, and income producing commercial properties. The Company maintains a reserve for the risk inherent in unfunded lending commitments, which is included in other liabilities in the consolidated balance sheets.

 

Standby letters of credit and financial guarantees are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending credit to customers. The amount of collateral obtained, if deemed necessary, to secure the customer’s performance under certain letters of credit is based on management’s credit evaluation of the customer.

 

The following table presents the off-balance sheet financial instruments as of the dates indicated:

 

   

December 31,

 
   

2018

   

2017

 

(Amounts in thousands)

               

Commitments to extend credit

  $ 215,239     $ 243,147  

Standby letters of credit and financial guarantees(1)

    149,494       131,587  

Total off-balance sheet risk

    364,733       374,734  
                 

Reserve for unfunded commitments

  $ 66     $ 66  

                                                                                                  

(1) Includes FHLB letters of credit

   

 

 

Note 21. Regulatory Requirements and Restrictions

 

The Company and the Bank are subject to various regulatory capital requirements administered by state and federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under the capital adequacy guidelines and the regulatory framework for prompt corrective action, which applies only to the Bank, the Bank must meet specific capital guidelines that involve quantitative measures of the entity’s balance sheet assets and off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. In addition, the Company and the Bank are subject to various regulatory restrictions related to the payment of dividends, including requirements to maintain capital at or above regulatory minimums.

 

The current risk-based capital requirements, based on the international capital standards known as Basel III, requires the Company and the Bank to maintain minimum amounts and ratios of Common Equity Tier 1 capital, Tier 1 capital, and total capital to risk-weighted assets, and of Tier 1 capital to average consolidated assets (“Tier 1 leverage ratio”), as defined in the regulations. On January 1, 2016, Basel III’s capital conservation buffer, which is intended to absorb losses during periods of economic stress, became effective at 0.625%, and was phased in over a four-year period (increased an additional 0.625% each year until it reached 2.5% on January 1, 2019).

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The following tables present actual and required capital ratios, under Basel III capital rules, as of the dates indicated:

 

   

December 31, 2018

 
   

Actual

   

Minimum Basel III

Requirement

   

Minimum Basel III

Requirement - Fully

Phased-In

   

Well Capitalized

Requirement(1)

 

(Amounts in thousands)

 

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

 

The Company

                                                               

Common equity Tier 1 ratio

  $ 236,544       13.72 %   $ 77,570       4.50 %   $ 120,664       7.00 %     N/A       N/A  

Tier 1 risk-based capital ratio

    236,544       13.72 %     103,427       6.00 %     146,521       8.50 %     N/A       N/A  

Total risk-based capital ratio

    254,877       14.79 %     137,902       8.00 %     180,997       10.50 %     N/A       N/A  

Tier 1 Leverage ratio

    236,544       10.95 %     86,439       4.00 %     86,439       4.00 %     N/A       N/A  
                                                                 

The Bank

                                                               

Common equity Tier 1 ratio

  $ 215,424       12.55 %   $ 77,223       4.50 %   $ 120,124       7.00 %   $ 111,544       6.50 %

Tier 1 risk-based capital ratio

    215,424       12.55 %     102,964       6.00 %     145,865       8.50 %     137,285       8.00 %

Total risk-based capital ratio

    233,757       13.62 %     137,285       8.00 %     180,186       10.50 %     171,606       10.00 %

Tier 1 Leverage ratio

    215,424       9.98 %     86,376       4.00 %     86,376       4.00 %     107,970       5.00 %

                                                                  

(1)

Based on prompt corrective action provisions

 

   

December 31, 2017

 
   

Actual

   

Minimum Basel III

Requirement

   

Minimum Basel III

Requirement - Fully

Phased-In

   

Well Capitalized

Requirement(1)

 

(Amounts in thousands)

 

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

 

The Company

                                                               

Common equity Tier 1 ratio

  $ 251,052       13.98 %   $ 80,816       4.50 %   $ 125,713       7.00 %     N/A       N/A  

Tier 1 risk-based capital ratio

    251,052       13.98 %     107,754       6.00 %     152,652       8.50 %     N/A       N/A  

Total risk-based capital ratio

    270,394       15.06 %     143,672       8.00 %     188,570       10.50 %     N/A       N/A  

Tier 1 Leverage ratio

    251,052       11.06 %     90,822       4.00 %     90,822       4.00 %     N/A       N/A  
                                                                 

The Bank

                                                               

Common equity Tier 1 ratio

  $ 222,856       12.47 %   $ 80,447       4.50 %   $ 125,139       7.00 %   $ 116,201       6.50 %

Tier 1 risk-based capital ratio

    222,856       12.47 %     107,262       6.00 %     151,955       8.50 %     178,771       8.00 %

Total risk-based capital ratio

    242,218       13.55 %     143,016       8.00 %     187,709       10.50 %     143,016       10.00 %

Tier 1 Leverage ratio

    222,856       9.84 %     90,604       4.00 %     90,604       4.00 %     113,255       5.00 %

                                                                    

(1)

Based on prompt corrective action provisions

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

Note 22. Parent Company Financial Information

 

The following tables present condensed financial information for the parent company, First Community Bankshares, Inc., as of and for the dates indicated:

 

   

CONDENSED BALANCE SHEETS

 
   

December 31,

 

(Amounts in thousands)

 

2018

   

2017

 

Assets

               

Cash and due from banks

  $ 13,726     $ 19,216  

Loans to affiliates

    184       184  

Investment in subsidiaries

    311,736       322,595  

Other assets

    7,717       9,010  

Total assets

  $ 333,363     $ 351,005  
                 

Liabilities

               

Other liabilities

  $ 506     $ 291  

Total liabilities

    506       291  
                 

Stockholders' equity

               

Preferred stock

    -       -  

Common stock

    16,007       21,382  

Additional paid-in capital

    122,486       228,750  

Retained earnings

    195,793       180,543  

Treasury stock

    -       (79,121 )

Accumulated other comprehensive loss

    (1,429 )     (840 )

Total stockholders' equity

    332,857       350,714  

Total liabilities and stockholders' equity

  $ 333,363     $ 351,005  

 

   

CONDENSED STATEMENTS OF INCOME

 
   

Year Ended December 31,

 
   

2018

   

2017

   

2016

 

(Amounts in thousands)

                       

Cash dividends received from subsidiary bank

  $ 48,000     $ 22,720     $ 32,000  

Other income (expense)

    306       352       (1,121 )

Other operating expense

    2,293       2,044       2,097  

Income before income taxes and equity in undistributed net income of subsidiaries

    46,013       21,028       28,782  

Income tax benefit

    (595 )     (678 )     (1,287 )

Income before equity in undistributed net income of subsidiaries

    46,608       21,706       30,069  

Dividends in excess of undistributed net income of subsidiaries

    (10,268 )     (221 )     (4,943 )

Net income

  $ 36,340     $ 21,485     $ 25,126  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

   

CONDENSED STATEMENTS OF CASH FLOWS

 
   

Year Ended December 31,

 

(Amounts in thousands)

 

2018

   

2017

   

2016

 

Operating activities

                       

Net income

  $ 36,340     $ 21,485     $ 25,126  

Adjustments to reconcile net income to net cash provided by operating activities

                       

Gain on sale of securities

    -       -       (65 )

Net change in other operating activities

    1,509       656       397  

Net cash provided by operating activities

    37,849       22,141       25,458  

Investing activities

                       

Proceeds from sale of securities available for sale

    -       -       8,660  

Proceeds from divestitures

    -       -       4,900  

Return of capital from subsidiaries

    -       -       3,654  

Dividends in excess of undistributed net income of subsidiaries

    10,268       221       4,943  

Net change in other investing activities

    -       -       (98 )

Net cash provided by investing activities

    10,268       221       22,059  

Financing activities

                       

Repayments of long-term debt

    -       (15,464 )     -  

Proceeds from issuance of common stock

    832       738       1,243  

Payments for repurchase of treasury stock

    (34,412 )     (1,263 )     (23,762 )

Payments of common dividends

    (21,090 )     (11,563 )     (10,396 )

Net change in other financing activities

    1,063       845       592  

Net cash used in financing activities

    (53,607 )     (26,707 )     (32,323 )

Net (decrease) increase in cash and cash equivalents

    (5,490 )     (4,345 )     15,194  

Cash and cash equivalents at beginning of period

    19,216       23,561       8,367  

Cash and cash equivalents at end of period

  $ 13,726     $ 19,216     $ 23,561  

 

 

Note 23. Quarterly Financial Data (Unaudited)

 

The following tables present selected financial data for the periods indicated:

 

   

Year Ended December 31, 2018

 
   

First

   

Second

   

Third

   

Fourth

 
   

Quarter

   

Quarter

   

Quarter

   

Quarter

 

(Amounts in thousands, except share and per share data)

                               

Interest income

  $ 24,330     $ 24,297     $ 24,286     $ 25,381  

Interest expense

    1,951       2,035       1,961       1,502  

Net interest income

    22,379       22,262       22,325       23,879  

Provision for loan losses

    495       495       495       908  

Net interest income after provision

    21,884       21,767       21,830       22,971  

Noninterest income, excluding net loss on sale of securities

    6,668       6,959       7,137       6,297  

Net loss on sale of securities

    -       -       (618 )     -  

Noninterest expense

    17,116       17,160       18,131       17,366  

Income before income taxes

    11,436       11,566       10,218       11,902  

Income tax expense

    2,568       2,500       1,118       2,596  

Net income

  $ 8,868     $ 9,066     $ 9,100     $ 9,306  
                                 

Basic earnings per common share

  $ 0.52     $ 0.54     $ 0.55     $ 0.58  

Diluted earnings per common share

    0.52       0.54       0.55       0.57  

Dividends per common share

    0.66       0.18       0.21       0.21  
                                 

Weighted average basic shares outstanding

    16,955,758       16,689,398       16,512,823       16,201,148  

Weighted average diluted shares outstanding

    17,047,638       16,788,615       16,612,416       16,280,404  

 

 

FIRST COMMUNITY BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

   

Year Ended December 31, 2017

 
   

First

   

Second

   

Third

   

Fourth

 
   

Quarter

   

Quarter

   

Quarter

   

Quarter

 

(Amounts in thousands, except share and per share data)

                               

Interest income

  $ 23,192     $ 24,305     $ 24,049     $ 23,762  

Interest expense

    2,051       2,011       1,999       2,029  

Net interest income

    21,141       22,294       22,050       21,733  

Provision for loan losses

    492       934       730       615  

Net interest income after provision

    20,649       21,360       21,320       21,118  

Noninterest income, excluding net loss on sale of securities

    5,312       5,712       6,703       7,502  

Net loss on sale of securities

    -       (657 )     -       (4 )

Noninterest expense

    16,704       17,038       16,477       16,683  

Income before income taxes

    9,257       9,377       11,546       11,933  

Income tax expense

    3,055       2,959       3,894       10,720  

Net income

  $ 6,202     $ 6,418     $ 7,652     $ 1,213  
                                 

Basic earnings per common share

  $ 0.36     $ 0.38     $ 0.45     $ 0.07  

Diluted earnings per common share

    0.36       0.38       0.45       0.07  

Dividends per common share

    0.16       0.16       0.18       0.18  
                                 

Weighted average basic shares outstanding

    16,998,125       17,012,189       17,005,654       16,992,519  

Weighted average diluted shares outstanding

    17,072,174       17,082,832       17,082,729       17,083,949  

 

 

 

 

- Report of Independent Registered Public Accounting Firm -

 

Board of Directors and the Stockholders

First Community Bankshares, Inc. and Subsidiary

 

Opinion on the Consolidated Financial Statements 

We have audited the accompanying consolidated balance sheets of First Community Bankshares, Inc. and Subsidiary (formerly named First Community Bancshares, Inc. and herein referred to as the “Company”) as of December 31, 2018 and 2017, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2018, and the related notes (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 1, 2019, expressed an unqualified opinion thereon.

 

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. 

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.

 

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

We have served as the Company’s auditor since 2006.

 

 

/s/ Dixon Hughes Goodman LLP

 

Asheville, North Carolina

March 1, 2019

 

 

- Management’s Assessment of Internal Control over Financial Reporting -

 

First Community Bankshares, Inc. (the “Company”) is responsible for the preparation, integrity, and fair presentation of the consolidated financial statements included in this Annual Report on Form 10-K. The consolidated financial statements and notes included in this Annual Report on Form 10-K have been prepared in conformity with U.S. generally accepted accounting principles and necessarily include some amounts that are based on management’s best estimates and judgments.

 

We, as management of the Company, are responsible for establishing and maintaining effective internal control over financial reporting that is designed to produce reliable financial statements in conformity with U.S. generally accepted accounting principles. The system of internal control over financial reporting as it relates to the financial statements is evaluated for effectiveness by management and tested for reliability. Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation.

 

Management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting based on the framework in the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concluded that its system of internal control over financial reporting was effective as of December 31, 2018.

 

Dixon Hughes Goodman LLP, independent registered public accounting firm, has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018. The Report of Independent Registered Public Accounting Firm, which expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018, appears hereafter in Item 8 of this Annual Report on Form 10-K.

 

 

Dated this 1st day of March, 2019.

 

 

/s/ William P. Stafford, II

 

/s/ David D. Brown

     

William P. Stafford, II

 

David D. Brown

Chief Executive Officer

 

Chief Financial Officer

 

 

- Report of Independent Registered Public Accounting Firm -

 

Board of Directors and the Stockholders

First Community Bankshares, Inc. and Subsidiary

 

Opinion on Internal Control Over Financial Reporting

We have audited First Community Bankshares, Inc. and Subsidiary (formerly named First Community Bancshares, Inc. and herein referred to as the “Company”) internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, First Community Bankshares, Inc. and Subsidiary maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements of First Community Bankshares, Inc. and Subsidiary as of December 31, 2018 and 2017 and for each of the three years in the period ended December 31, 2018, and our report dated March 1, 2019, expressed an unqualified opinion on those consolidated financial statements.

 

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Assessment of Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

Definition and Limitations of Internal Control Over Financial Reporting

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

 

/s/ Dixon Hughes Goodman LLP

 

Asheville, North Carolina

March 1, 2019

 

 

Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

 

None.

 

Item 9A.

Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

In connection with this report, we conducted an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures under the Exchange Act Rule 13a-15(b). Based upon that evaluation, the CEO and CFO concluded that, as of December 31, 2018, our disclosure controls and procedures were effective.

 

Disclosure controls and procedures are our Company’s controls and other procedures that are designed to ensure that information we are required to disclose in the reports we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including the CEO and CFO, as appropriate, to allow timely decisions about required disclosure.

 

Management, including the CEO and CFO, does not expect that our disclosure controls and internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, collusion of two or more people, or management’s override of the controls.

 

Changes in Internal Control over Financial Reporting

 

We assess the adequacy of our internal control over financial reporting quarterly and enhance our controls in response to internal control assessments and internal and external audit and regulatory recommendations. There were no changes in our internal control over financial reporting during the quarter ended December 31, 2018, that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

Management's Report on Internal Controls over Financial Reporting

 

For additional information about the Company’s internal controls, see “Management's Assessment of Internal Control over Financial Reporting,” and “Report of Independent Registered Public Accounting Firm,” in Item 8 of this report.

 

Item 9B.

Other Information.

 

None.

 

 

PART III

 

Item 10.

Directors, Executive Officers and Corporate Governance.

 

Board of Directors, First Community Bankshares, Inc.

 

W. C. Blankenship, Jr.

Retired Agent, State Farm Insurance

 

Gary R. Mills

President, First Community Bankshares, Inc.;

Chief Executive Officer and President, First Community Bank

C. William Davis

Attorney at Law, Richardson & Davis, PLLC

 

M. Adam Sarver

 

Samuel L. Elmore

 

Member/Co-Manager, Main Street Builders, LLC, Eastern Door & Glass, LLC,

and Clover Leaf Properties, LLC

Retired Chief Credit Officer and Senior Vice President, First Community Bank;

Past Executive Vice President, Citizens Southern Bank, Inc.; Past President and

Chief Executive Officer, Bank One; Past Vice President, Key Centurion Bancshares;

Past President and Chief Operations Officer, Beckley National Bank;

Director, Raleigh County Commission on Aging

 

 

William P. Stafford, II

Chief Executive Officer, First Community Bankshares, Inc.; Attorney at Law,

Brewster, Morhous, Cameron, Caruth, Moore, Kersey & Stafford, PLLC

 

 

 

Richard S. Johnson

Chairman, President, and Chief Executive Officer, The Wilton Companies;

Director and Past Chairman, City of Richmond Economic Development Authority;

Trustee Emeritus, University of Richmond

   

 


Executive Officers, First Community Bankshares, Inc.

 

William P. Stafford, II

 

David D. Brown

Chief Executive Officer

 

Chief Financial Officer and Secretary

     

Gary R. Mills

 

E. Stephen Lilly

President

 

Chief Operating Officer and Executive Vice President

 


Board of Directors, First Community Bank

 

James H. Atkinson, Jr.

 

T. Vernon Foster

Retired Chief Executive Officer, Peoples Bank of Virginia

 

W. C. Blankenship, Jr.

 

President of J. La’Verne Print Communications; Past Director, TriStone Community

Bank; Executive Director: MBA Programs, Career Management & Public Relations,

University of Louisville, College of Business

See above    

 

 

Richard H. Jarrell

Robert L. Buzzo

Retired Vice President and Secretary, First Community Bankshares, Inc.;

Retired President Emeritus, First Community Bank

 

Chick-fil-A Franchise Owner; Director, Raleigh General Hospital Board of Trustees;

Director, Beckley-Raleigh County Chamber of Commerce; Director, United Way of

Southwest Virginia; Director, Raleigh County Board of Education

     

Samuel D. Campbell

 

Richard S. Johnson

Attorney at Law 

 

(See above)

     

C. William Davis

 

Gary R. Mills

(See above)

 

(See above) 

     

Samuel L. Elmore

 

M. Adam Sarver

(See above)

 

(See above) 

     

S. Michael Feola

 

William P. Stafford, II

Retired Senior Vice President – Regional President, First Community Bank

 

(See above) 

     

Frank C. Tinder

 

 

President, Tinder Enterprises, Inc. and Tinco Leasing Corporation;

Realtor, Premier Realty

 

 

 

 

Additional Information

 

Additional information required in this item is incorporated by reference to our Proxy Statement for the Annual Meeting of Stockholders to be held on May 29, 2019 (“2019 Annual Meeting”) under the headings “Proposal 1: Election of Directors,” “Nominees for the Class of 2022,” “Incumbent Directors,” “Non-Director Named Executive Officers,” “Corporate Governance,” and “Section 16(a) Beneficial Ownership Reporting Compliance.”

 

Our Standards of Conduct apply to all directors and employees, including our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. The Standards of Conduct is available on the Investor Relations section of our website at www.firstcommunitybank.com. There have been no waivers of the Standards of Conduct for any officer.

 

There have been no material changes to the procedures by which stockholders may recommend nominees to our Board of Directors since the disclosure in our Proxy Statement filed with the SEC on March 13, 2018.

 

Item 11.

Executive Compensation.

 

The information required in this item is incorporated by reference to our Proxy Statement for the 2019 Annual Meeting under the headings “Board Committees,” “Compensation Discussion and Analysis,” and “Director Compensation.”

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

 

The following table provides information about compensation plans under which our equity securities are authorized for issuance as of December 31, 2018:

 

                   

Number of securities

 
   

Number of securities

           

remaining available

 
   

to be issued upon

   

Weighted-average

   

for future issuance

 
   

exercise of

   

exercise price of

   

under equity

 
   

outstanding

   

outstanding

   

compensation plans

 
   

options, warrants

   

options, warrants

   

(excluding securities

 

Plan category

 

and rights

   

and rights

   

reflected in column (a))(3)

 
   

(a)

   

(b)

   

(c)

 

Equity compensation plans approved by security holders(1)

    72,193     $ 19.41       347,285  

Equity compensation plans not approved by security holders(2)

    84,062       22.08       -  

Total

    156,255               347,285  

                                                                                                  

(1) Includes the 2012 Omnibus Equity Compensation Plan and 2004 Omnibus Stock Option Plan

(2) Includes the 2001 Directors' Option Plan and 1999 Stock Option Plan

(3) Shares are available for future issuance under the 2012 Omnibus Equity Compensation Plan.

 

Additional information required in this item is incorporated by reference to our Proxy Statement for the 2019 Annual Meeting under the heading “Information on Stock Ownership.”

 

Item 13.

Certain Relationships and Related Transactions, and Director Independence.

 

The information required in this item is incorporated by reference to our Proxy Statement for the 2019 Annual Meeting under the headings “Corporate Governance” and “Related Person/Party Transactions.”

 

Item 14.

Principal Accounting Fees and Services.

 

The information required in this item is incorporated by reference to our Proxy Statement for the 2019 Annual Meeting under the heading “Independent Registered Public Accounting Firm.”

 

 

PART IV

 

Item 15.

Exhibits, Financial Statement Schedules.

 

(a)

Documents Filed as Part of this Report

 

 

(1)

Financial Statements

 

 

The financial statements required in this item are incorporated by reference to Item 8, “Financial Statements and Supplementary Data,” in Part II of this report.

 

 

(2)

Financial Statement Schedules

 

 

The schedules required in this item are omitted because they are not applicable or the required information is included in the consolidated financial statements or related notes.

 

 

(3)

Exhibits

 

Exhibit

No.

 

 

Exhibit

2.1

 

Agreement and Plan of Reincorporation and Merger between First Community Bancshares, Inc. and First Community Bankshares, Inc., incorporated by reference to Appendix A of the Definitive Proxy Statement on Form DEF 14A dated April 24, 2018, filed on March 13, 2018

3.1

 

Articles of Incorporation of First Community Bankshares, Inc., incorporated by reference to Appendix B of the Definitive Proxy Statement on Form DEF 14A dated April 24, 2018, filed on March 13, 2018

3.2

 

Bylaws of First Community Bankshares, Inc., incorporated by reference to Exhibit 3.2 of the Current Report on Form 8-K dated and filed October 2, 2018

4.1

 

Description of First Community Bankshares, Inc. Common Stock, incorporated by reference to Exhibit 4.1 of the Current Report on Form 8-K dated and filed October 2, 2018

4.2

 

Form of First Community Bankshares, Inc. Common Stock Certificate, incorporated by reference to Exhibit 4.2 of the Current Report on Form 8-K dated and filed October 2, 2018

10.1.1**

 

First Community Bancshares, Inc. 1999 Stock Option Plan, incorporated by reference to Exhibit 10.1 of the Annual Report on Form 10-K/A for the period ended December 31, 1999, filed on April 13, 2000

10.1.2**

 

Amendment One to the First Community Bancshares, Inc. 1999 Stock Option Plan, incorporated by reference to Exhibit 10.1.1 of the Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed on May 7, 2004

10.2**

 

First Community Bancshares, Inc. 1999 Stock Option Agreement, incorporated by reference to Exhibit 10.5 of the Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed on August 14, 2002

10.3**

 

First Community Bancshares, Inc. 2001 Nonqualified Director Stock Option Agreement, incorporated by reference to Exhibit 10.4 of the Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed on August 14, 2002

10.4**

 

First Community Bancshares, Inc. 2004 Omnibus Stock Option Plan, incorporated by reference to Annex B of the Definitive Proxy Statement on Form DEF 14A dated April 27, 2004, filed on March 15, 2004

10.5**

 

First Community Bancshares, Inc. 2004 Omnibus Stock Option Plan Stock Award Agreement, incorporated by reference to Exhibit 10.13 of the Quarterly Report on Form 10-Q for the period ended June 30, 2004, filed on August 6, 2004

10.6**

 

First Community Bancshares, Inc. 2012 Omnibus Equity Compensation Plan, incorporated by reference to Appendix B of the Definitive Proxy Statement on Form DEF 14A dated April 24, 2012, filed on March 7, 2012

10.7**

 

First Community Bancshares, Inc. 2012 Omnibus Equity Compensation Plan Restricted Stock Grant Agreement, incorporated by reference to Exhibit 99.1 of the Current Report on Form 8-K dated and filed May 28, 2013

10.8**

 

First Community Bancshares, Inc. Life Insurance Endorsement Method Split Dollar Plan and Agreement, incorporated by reference to Exhibit 10.5 of the Annual Report on Form 10-K/A for the period ended December 31, 1999, filed on April 13, 2000

10.9.1**

 

First Community Bancshares, Inc. and Affiliates Executive Retention Plan, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated December 30, 2008, filed on January 5, 2009; Amendment #1, incorporated by reference to Exhibit 10.3 of the Current Report on Form 8-K dated December 16, 2010, filed on December 17, 2010; Amendment #2, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated February 21, 2013, filed on February 25, 2013; Amendment #3, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated May 24, 2016, filed on May 27, 2016; and Amendment #4, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated and filed on February 28, 2017

10.9.2**

 

Amendment #1 to the First Community Bancshares, Inc. and Affiliates Executive Retention Plan, incorporated by reference to Exhibit 10.3 of the Current Report on Form 8-K dated December 16, 2010, filed on December 17, 2010

 

 

10.9.3**

 

Amendment #2 to the First Community Bancshares, Inc. and Affiliates Executive Retention Plan, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated February 21, 2013, filed on February 25, 2013

10.9.4**

 

Amendment #3 to the First Community Bancshares, Inc. and Affiliates Executive Retention Plan, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated May 24, 2016, filed on May 31, 2016

10.9.5**

 

Amendment #4 to the First Community Bancshares, Inc. and Affiliates Executive Retention Plan, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated and filed on February 28, 2017

10.10**

 

Amended and Restated Deferred Compensation Plan for Directors of First Community Bancshares, Inc. and Affiliates, incorporated by reference to Exhibit 99.2 of the Current Report on Form 8-K dated August 22, 2006, filed on August 23, 2006

10.11.1**

 

First Community Bancshares, Inc. Amended and Restated Nonqualified Supplemental Cash or Deferred Retirement Plan, incorporated by reference to Exhibit 99.1 of the Current Report on Form 8-K dated August 22, 2006, filed on August 23, 2006, and Amendment #2, incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K dated and filed on February 28, 2017

10.11.2**

 

Amendment #2 to the First Community Bancshares, Inc. Amended and Restated Nonqualified Supplemental Cash or Deferred Retirement Plan, incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K dated and filed on February 28, 2017

10.12.1**

 

First Community Bancshares, Inc. Supplemental Directors Retirement Plan, as amended and restated, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated December 16, 2010, filed on December 17, 2010, and Amendment #2, incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K dated May 24, 2016, filed on May 31, 2016

10.12.2**

 

Amendment #2 to the First Community Bancshares, Inc. Supplemental Directors Retirement Plan, as amended and restated, incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K dated May 24, 2016, filed on May 31, 2016

10.13**

 

Employment Agreement between First Community Bancshares, Inc. and David D. Brown, incorporated by reference to Exhibit 10.3 of the Current Report on Form 8-K dated and filed on April 16, 2015

10.14**

 

Employment Agreement between First Community Bancshares, Inc. and E. Stephen Lilly, incorporated by reference to Exhibit 10.5 of the Current Report on Form 8-K dated and filed on April 16, 2015

10.15**

 

Employment Agreement between First Community Bancshares, Inc. and Gary R. Mills, incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K dated and filed on April 16, 2015

10.16**

 

Employment Agreement between First Community Bancshares, Inc. and William P. Stafford, II, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated and filed on April 16, 2015

10.17**

 

Employment Agreement between First Community Bank and Mark R. Evans, incorporated by reference to Exhibit 2.1 of the Current Report on Form 8-K dated April 2, 2009, filed on April 3, 2009

21*

 

Subsidiaries of the Registrant

23*

 

Consent of Independent Public Accounting Firm

31.1*

 

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2*

 

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32*

 

Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101***

 

Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets as of December 31, 2018 and 2017; (ii) Consolidated Statements of Income for the years ended December 31, 2018, 2017, and 2016; (iii) Consolidated Statements of Comprehensive Income for the years ended December 31, 2018, 2017, and 2016; (iv) Consolidated Statements of Stockholders' Equity for the years ended December 31, 2018, 2017, and 2016; (v) Consolidated Statements of Cash Flows for the years ended December 31, 2018, 2017, and 2016; and (vi) Notes to Consolidated Financial Statements

 

*

 

Filed herewith

**

 

Indicates a management contract or compensation plan or agreement. These contracts, plans, or agreements were assumed by First Community Bankshares, Inc. in October 2018 in connection with First Community Bancshares, Inc., a Nevada corporation, merging with and into its wholly-owned subsidiary, First Community Bankshares, Inc., a Virginia corporation, pursuant to an Agreement and Plan of Reincorporation and Merger with First Community Bankshares, Inc. continuing as the surviving corporation.

***

 

Submitted electronically herewith

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) 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 on the 1st day of March, 2019.

 

First Community Bankshares, Inc.

(Registrant)

 

By:

/s/ William P. Stafford, II

 

By:

/s/ David D. Brown

         
 

William P. Stafford, II

   

David D. Brown

 

Chief Executive Officer

(Principal Executive Officer)

   

Chief Financial Officer

(Principal Financial Officer and Principal Accounting Officer)

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Signature

 

Title

 

Date

         

/s/ William P. Stafford, II

 

Chairman and Chief Executive Officer

 

March 1, 2019

William P. Stafford, II

       
         

/s/ David D. Brown

 

Chief Financial Officer

 

March 1, 2019

David D. Brown

       
         

/s/ C. William Davis

 

Director

 

March 1, 2019

C. William Davis

       
         

/s/ Richard S. Johnson

 

Director

 

March 1, 2019

Richard S. Johnson

       
         

/s/ Gary R. Mills

 

President and Director

 

March 1, 2019

Gary R. Mills

       
         

/s/ M. Adam Sarver

 

Director

 

March 1, 2019

M. Adam Sarver

       

 

107