FIRST COMMUNITY BANKSHARES INC /VA/ - Quarter Report: 2018 September (Form 10-Q)

 

 

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

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

For the quarterly period ended September 30, 2018

or

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

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)					(IRS Employer Identification No.)
P.O. Box 989 Bluefield, Virginia					24605-0989
(Address of principal executive offices)					(Zip Code)

 

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
☑ Yes ☐ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
☑ Yes ☐ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See 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 ☐ (Do not check if a smaller reporting company)					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 Exchange Act).

☐ Yes ☑ No

As of October 26, 2018, there were 16,285,370 shares outstanding of the registrant’s Common Stock, $1.00 par value.

 

 

 

FIRST COMMUNITY BANKSHARES, INC.

FORM 10-Q

INDEX

 

PART I.	FINANCIAL INFORMATION		Page
Item 1.	Financial Statements
		Condensed Consolidated Balance Sheets as of September 30, 2018 (Unaudited) and December 31, 2017	4
		Condensed Consolidated Statements of Income for the Three and Nine months Ended September 30, 2018 and 2017 (Unaudited)	5
		Condensed Consolidated Statements of Comprehensive Income for the Three and Nine months Ended September 30, 2018 and 2017 (Unaudited)	6
		Condensed Consolidated Statements of Changes in Stockholders’ Equity for the Nine months Ended September 30, 2018 and 2017 (Unaudited)	7
		Condensed Consolidated Statements of Cash Flows for the Nine months Ended September 30, 2018 and 2017 (Unaudited)	8
		Notes to Condensed Consolidated Financial Statements (Unaudited)	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		38
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		53
Item 4.	Controls and Procedures		54
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings		54
Item 1A.	Risk Factors		54
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		54
Item 3.	Defaults Upon Senior Securities		55
Item 4.	Mine Safety Disclosures		55
Item 5.	Other Information		55
Item 6.	Exhibits		55
Signatures			57

 

 

 

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		September 30,				December 31,
		2018				2017(1)
(Amounts in thousands, except share and per share data)		(Unaudited)
Assets
Cash and due from banks		$	44,719			$	37,115
Federal funds sold			27,965				119,891
Interest-bearing deposits in banks			995				945
Total cash and cash equivalents			73,679				157,951
Debt securities available for sale			163,593				165,525
Debt securities held to maturity			25,047				25,149
Loans held for investment, net of unearned income (including covered loans of $20,483 and $27,948)			1,790,909				1,817,184
Allowance for loan losses			(18,256	)			(19,276	)
Loans held for investment, net			1,772,653				1,797,908
FDIC indemnification asset			5,653				7,161
Premises and equipment, net			45,537				48,126
Other real estate owned (including covered OREO of $44 and $105)			4,798				2,514
Interest receivable			5,374				5,778
Goodwill			94,287				95,779
Other intangible assets			5,366				6,151
Other assets			73,701				76,418
Total assets		$	2,269,688			$	2,388,460
Liabilities
Deposits
Noninterest-bearing		$	463,945			$	454,143
Interest-bearing			1,411,906				1,475,748
Total deposits			1,875,851				1,929,891
Securities sold under agreements to repurchase			30,151				30,086
FHLB borrowings			-				50,000
Interest, taxes, and other liabilities			25,284				27,769
Total liabilities			1,931,286				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; 21,381,779 shares issued at September 30, 2018, and December 31, 2017; 4,991,277 and 4,383,553 shares in treasury at September 30, 2018, and December 31, 2017, respectively			21,382				21,382
Additional paid-in capital			229,182				228,750
Retained earnings			189,902				180,543
Treasury stock, at cost			(99,247	)			(79,121	)
Accumulated other comprehensive loss			(2,817	)			(840	)
Total stockholders' equity			338,402				350,714
Total liabilities and stockholders' equity		$	2,269,688			$	2,388,460

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		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(Amounts in thousands, except share and per share data)		2018				2017				2018				2017
Interest income
Interest and fees on loans		$	22,556			$	22,694			$	67,733			$	67,435
Interest on securities -- taxable			666				341				1,704				1,157
Interest on securities -- tax-exempt			706				739				2,133				2,299
Interest on deposits in banks			358				275				1,343				655
Total interest income			24,286				24,049				72,913				71,546
Interest expense
Interest on deposits			1,269				1,275				3,847				3,674
Interest on short-term borrowings			204				213				606				634
Interest on long-term debt			488				511				1,494				1,753
Total interest expense			1,961				1,999				5,947				6,061
Net interest income			22,325				22,050				66,966				65,485
Provision for loan losses			495				730				1,485				2,156
Net interest income after provision for loan losses			21,830				21,320				65,481				63,329
Noninterest income
Wealth management			791				758				2,408				2,339
Service charges on deposits			3,803				3,605				10,883				10,078
Other service charges and fees			1,925				1,709				5,716				5,156
Insurance commissions			299				306				966				1,004
Net loss on sale of securities			(618	)			-				(618	)			(657	)
Net FDIC indemnification asset amortization			(645	)			(268	)			(1,602	)			(3,186	)
Other operating income			964				593				2,393				2,336
Total noninterest income			6,519				6,703				20,146				17,070
Noninterest expense
Salaries and employee benefits			8,983				9,001				27,417				26,771
Occupancy expense			1,075				1,082				3,408				3,671
Furniture and equipment expense			985				1,133				2,976				3,311
Service fees			1,134				705				2,813				2,645
Advertising and public relations			478				551				1,461				1,700
Professional fees			337				339				1,074				1,978
Amortization of intangibles			261				266				785				790
FDIC premiums and assessments			234				227				697				698
Loss on extinguishment of debt			1,096				-				1,096				-
Goodwill impairment			1,492				-				1,492				-
Other operating expense			2,056				3,173				9,188				8,655
Total noninterest expense			18,131				16,477				52,407				50,219
Income before income taxes			10,218				11,546				33,220				30,180
Income tax expense			1,118				3,894				6,186				9,908
Net income			9,100				7,652				27,034				20,272
Earnings per common share
Basic		$	0.55			$	0.45			$	1.62			$	1.19
Diluted			0.55				0.45				1.61				1.19
Cash dividends per common share			0.21				0.18				1.05				0.50
Weighted average shares outstanding
Basic			16,512,823				17,005,654				16,717,704				17,005,350
Diluted			16,612,416				17,082,729				16,810,425				17,076,958

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		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2018				2017				2018				2017
(Amounts in thousands)
Net income		$	9,100			$	7,652			$	27,034			$	20,272
Other comprehensive income, before tax
Available-for-sale debt securities:
Change in net unrealized (losses) gains on debt securities without other-than-temporary impairment			(983	)			(169	)			(3,426	)			2,127
Reclassification adjustment for net losses recognized in net income			618				-				618				657
Net unrealized (losses) gains on available-for-sale debt securities			(365	)			(169	)			(2,808	)			2,784
Employee benefit plans:
Net actuarial (loss) gain			(1	)			(1	)			91				133
Reclassification adjustment for amortization of prior service cost and net actuarial loss recognized in net income			72				65				214				194
Net unrealized gains on employee benefit plans			71				64				305				327
Other comprehensive (loss) income, before tax			(294	)			(105	)			(2,503	)			3,111
Income tax (benefit) expense			(62	)			(39	)			(526	)			1,167
Other comprehensive (loss) income, net of tax			(232	)			(66	)			(1,977	)			1,944
Total comprehensive income		$	8,868			$	7,586			$	25,057			$	22,216

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																						Accumulated
										Additional												Other
		Preferred				Common				Paid-in				Retained				Treasury				Comprehensive
		Stock				Stock				Capital				Earnings				Stock				Income (Loss)				Total
(Amounts in thousands, except share and per share data)
Balance January 1, 2017		$	-			$	21,382			$	228,142			$	170,377			$	(78,833	)		$	(2,011	)		$	339,057
Net income			-				-				-				20,272				-				-				20,272
Other comprehensive income			-				-				-				-				-				1,944				1,944
Common dividends declared -- $0.50 per share			-				-				-				(8,504	)			-				-				(8,504	)
Equity-based compensation expense			-				-				250				-				387				-				637
Common stock options exercised -- 8,036 shares			-				-				6				-				145				-				151
Issuance of treasury stock to 401(k) plan -- 12,834 shares			-				-				112				-				231				-				343
Purchase of treasury shares -- 50,118 shares at $25.20 per share			-				-				-				-				(1,263	)			-				(1,263	)
Balance September 30, 2017		$	-			$	21,382			$	228,510			$	182,145			$	(79,333	)		$	(67	)		$	352,637
Balance January 1, 2018		$	-			$	21,382			$	228,750			$	180,543			$	(79,121	)		$	(840	)		$	350,714
Net income			-				-				-				27,034				-				-				27,034
Other comprehensive loss			-				-				-				-				-				(1,977	)			(1,977	)
Common dividends declared -- $0.57 per share			-				-				-				(9,541	)			-				-				(9,541	)
Special common dividend declared -- $0.48 per share			-				-				-				(8,134	)			-				-				(8,134	)
Equity-based compensation expense			-				-				345				-				602				-				947
Common stock options exercised -- 18,979 shares			-				-				(41	)			-				362				-				321
Issuance of treasury stock to 401(k) plan -- 10,543 shares			-				-				128				-				197				-				325
Purchase of treasury shares -- 670,016 shares at $31.77 per share			-				-				-				-				(21,287	)			-				(21,287	)
Balance September 30, 2018		$	-			$	21,382			$	229,182			$	189,902			$	(99,247	)		$	(2,817	)		$	338,402

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		Nine Months Ended
		September 30,
(Amounts in thousands)		2018				2017
Operating activities
Net income		$	27,034			$	20,272
Adjustments to reconcile net income to net cash provided by operating activities
Provision for loan losses			1,485				2,156
Depreciation and amortization of premises and equipment			2,221				2,688
Amortization (accretion) of premiums on investments, net			26				63
Amortization of FDIC indemnification asset, net			1,602				3,186
Amortization of intangible assets			785				790
Goodwill impairment			1,492				-
Accretion on acquired loans			(4,257	)			(4,257	)
Equity-based compensation expense			947				637
Issuance of treasury stock to 401(k) plan			325				343
(Gain) loss on sale of premises and equipment, net			(8	)			13
Loss on sale of other real estate owned			833				940
Loss on sale of securities			618				657
Loss on extinguishment of debt			1,096				-
Decrease in accrued interest receivable			404				397
Decrease (increase) in other operating activities			2,543				(4,647	)
Net cash provided by operating activities			37,146				23,238
Investing activities
Proceeds from sale of securities available for sale			8,937				12,273
Proceeds from maturities, prepayments, and calls of securities available for sale			57,056				18,022
Proceeds from maturities and calls of securities held to maturity			-				21,840
Payments to acquire securities available for sale			(67,355	)			(36,966	)
Proceeds from loans, net			23,929				17,304
Proceeds from bank owned life insurance			458				2,639
(Redemption of) proceeds from FHLB stock, net			(2,122	)			694
(Payments to) proceeds from the FDIC			(117	)			1,701
Proceeds from sale of premises and equipment			507				29
Payments to acquire premises and equipment			(1,076	)			(2,028	)
Proceeds from sale of other real estate owned			981				2,130
Net cash provided by investing activities			21,198				37,638
Financing activities
Increase in noninterest-bearing deposits, net			9,802				25,235
Decrease in interest-bearing deposits, net			(63,842	)			(2,753	)
Proceeds from (repayments of) securities sold under agreements to repurchase, net			65				(14,222	)
Repayments of FHLB and other borrowings, net			(50,000	)			(30,708	)
Proceeds from stock options exercised			321				151
Payments for repurchase of treasury stock			(21,287	)			(1,263	)
Payments of common dividends			(17,675	)			(8,504	)
Net cash used in financing activities			(142,616	)			(32,064	)
Net (decrease) increase in cash and cash equivalents			(84,272	)			28,812
Cash and cash equivalents at beginning of period			157,951				76,307
Cash and cash equivalents at end of period		$	73,679			$	105,119
Supplemental disclosure -- cash flow information
Cash paid for interest		$	6,447			$	6,257
Cash paid for income taxes			4,800				12,942
Supplemental transactions -- noncash items
Transfer of loans to other real estate owned			4,135				1,282
Loans originated to finance other real estate owned			92				-
(Increase) decrease in accumulated other comprehensive loss			(1,977	)			1,944

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Note 1. Basis of Presentation

 

General

 

First Community Bankshares, Inc. (the “Company”), a financial holding company, was 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 provides insurance services through its wholly owned subsidiary First Community Insurance Services (“FCIS”) and 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.

 

On September 17, 2018, the Company announced its intention to sell its remaining insurance agency assets to Bankers Insurance, LLC (“BI”) of Glen Allen, Virginia in exchange for an equity interest in BI. The sale, which closed October 1, 2018, strategically allows the Company to continue offering insurance products to its customers through a larger, more diversified insurance agency. In connection with the decision to divest the insurance agency assets, 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.

 

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, wealth management, and insurance services. Operating results for interim periods are not necessarily indicative of results that may be expected for other interim periods or for the full year. In management’s opinion, the accompanying unaudited interim condensed consolidated financial statements contain all necessary adjustments, including normal recurring accruals, and disclosures for a fair presentation.

 

These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 (the “2017 Form 10-K”), as filed with the Securities and Exchange Commission (the “SEC”) on March 5, 2018. The condensed consolidated balance sheet as of December 31, 2017, has been derived from the audited consolidated financial statements.

 

Reclassifications

 

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.

 

Use of Estimates

 

Preparation of the condensed 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, investment securities, the allowance for loan losses, goodwill and other intangible assets, and income taxes. A discussion of the Company’s application of critical accounting estimates is included in “Critical Accounting Estimates” in Item 2 of this report.

 

 

Significant Accounting Policies

 

A complete and detailed description of the Company’s significant accounting policies is included in Note 1, “Basis of Presentation,” of the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2018, and in Note 1, “Basis of Presentation and Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in Part II, Item 8 of the Company’s 2017 Form 10-K.

 

Recent Accounting Standards

 

Standards Adopted in 2018

 

In May 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Updated (“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 $136 thousand for the three months ended September 30, 2017, and $407 thousand for the nine months ended September 30, 2017.

 

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 for the nine months ended September 30, 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 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 measured 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 Condensed Consolidated Financial Statements of this report.

 

 

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.

 

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 as consideration for managing 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.

 

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. In accordance with the adoption of ASC 606, the Company reclassified interchange expense, which was previously a component of noninterest expense, to net against interchange income on a retrospective basis, which totaled $432 thousand for the three months ended September 30, 2017, and $1.23 million for the nine months ended September 30, 2017.

 

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.

 

Standards Not Yet Adopted

 

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 expects to adopt ASU 2018-09 in the first quarter of 2019. The Company is evaluating the impact of the standard and does not expect the guidance to have a material effect on its 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 expects to adopt ASU 2017-12 in the first quarter of 2019. The Company is evaluating the impact of the standard and does not expect the guidance to have a material effect on its financial statements.

 

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 is evaluating the impact of the standard.

 

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 expects to adopt ASU 2016-02 in the first quarter of 2019. The Company leases certain banking offices under lease agreements it classifies as operating leases. The Company is evaluating the impact of the standard and expects an increase in assets and liabilities; however, the Company does not expect the guidance to have a material effect on its financial statements or resulting operations.

 

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.

 

 

Note 2. 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:

 

 

 

 

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:

 

 

 

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

 

 

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:

 

 

 

 

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:

 

 

 

There were 116 individual debt securities in an unrealized loss position as of September 30, 2018, and their combined depreciation in value represented 1.29% of the debt securities portfolio. 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.

 

The Company reviews its investment portfolio quarterly for indications of other-than-temporary impairment (“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 other comprehensive income (“OCI”). During the three and nine months ended September 30, 2018 and 2017, the Company incurred no OTTI charges on debt securities. 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 gross realized gains and losses from the sale of available-for-sale debt securities for the periods indicated:

 

 

The carrying amount of securities pledged for various purposes totaled $37.79 million as of September 30, 2018, and $51.34 million as of December 31, 2017.

 

 

 

Note 3. 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 Federal Deposit Insurance Corporation (“FDIC”) assisted transactions that are covered by loss share agreements. Customer overdrafts reclassified as loans totaled $1.83 million as of September 30, 2018, and $1.71 million as of December 31, 2017. Deferred loan fees, net of loan costs, totaled $4.64 million as of September 30, 2018, and $4.44 million as of December 31, 2017. For information about off-balance sheet financing, see Note 14, “Litigation, Commitments, and Contingencies,” to the Condensed Consolidated Financial Statements of this report.

 

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

 

 

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

 

 

The Company identifies certain purchased loans as impaired when fair values are established at acquisition and groups those purchased credit impaired (“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:

 

 

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

 

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(1) Represents changes attributable to expected loss assumptions

 

 

Note 4. 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.

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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.

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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.

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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.

 

 

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.

 

 

 

 

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.

 

 

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:

 

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(1)

Total impaired loans include loans totaling $25.42 million as of September 30, 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.

 

 

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

 

 

There were no impaired PCI loan pools as of September 30, 2018, or December 31, 2017. The following table provides information on impaired PCI loan pools for the dates indicated:

 

 

 

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:

 

 

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 $46 thousand as of September 30, 2018, compared to $1 thousand as of December 31, 2017.

 

 

 

 

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 September 30, 2018, or December 31, 2017.

 

The following table presents loans modified as TDRs, by loan class and accrual status, as of the dates indicated:

 

 

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

 

 

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

 

 

The following tables present loans modified as TDRs, by type of concession made and loan class, that were restructured during the periods indicated:

 

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(1) Represents the loan balance immediately following modification

 

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(1) Represents the loan balance immediately following modification

 

There were no payment defaults on loans modified as TDRs that were restructured within the previous 12 months as of September 30, 2018 or 2017.

 

The following table provides information about other real estate owned (“OREO”), which consists of properties acquired through foreclosure, as of the dates indicated:

 

(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