FIRST US BANCSHARES, INC. - Quarter Report: 2018 September (Form 10-Q)

 

 

 

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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FORM 10-Q

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☒	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

 

For the transition period from                         to                        

 

Commission File Number: 0-14549

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First US Bancshares, Inc.

(Exact Name of Registrant as Specified in Its Charter)

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Delaware	63-0843362
(State or Other Jurisdiction of Incorporation or Organization)	(IRS Employer Identification No.)

 

3291 U.S. Highway 280 Birmingham, AL	35243
(Address of Principal Executive Offices)	(Zip Code)

 

(205) 582-1200

(Registrant’s Telephone Number, Including Area Code)

 

N/A

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

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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 pursuant to Rule 405 of Regulations 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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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. (Check one):

 

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☒
Emerging growth company	☐

 

If an emerging growth company, indicate by check mark of 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    ☒

 

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

 

Class	Outstanding at November 8, 2018
Common Stock, $0.01 par value	6,296,712 shares

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FIRST US BANCSHARES, INC. AND SUBSIDIARIES

 

		PAGE
	PART I. FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS
Interim Condensed Consolidated Balance Sheets at September 30, 2018 (Unaudited) and December 31, 2017		4
Interim Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2018 and 2017 (Unaudited)		5
Interim Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2018 and 2017 (Unaudited)		6
Interim Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2018 and 2017 (Unaudited)		7
Notes to Interim Condensed Consolidated Financial Statements (Unaudited)		8
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	40
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	51
ITEM 4.	CONTROLS AND PROCEDURES	52
	PART II. OTHER INFORMATION	53
ITEM 1.	LEGAL PROCEEDINGS	53
ITEM 1A.	RISK FACTORS	53
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	53
ITEM 6.	EXHIBITS	53
Signature Page		54

 

 

 

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		September 30,				December 31,
		2018				2017
		(Unaudited)
ASSETS
Cash and due from banks		$	11,809			$	7,577
Interest-bearing deposits in banks			38,274				19,547
Total cash and cash equivalents			50,083				27,124
Federal funds sold			8,561				15,000
Investment securities available-for-sale, at fair value			137,258				153,871
Investment securities held-to-maturity, at amortized cost			22,238				26,279
Federal Home Loan Bank stock, at cost			703				1,609
Loans and leases, net of allowance for loan and lease losses of $5,116 and $4,774, respectively			519,822				346,121
Premises and equipment, net			27,120				26,433
Cash surrender value of bank-owned life insurance			15,158				14,923
Accrued interest receivable			2,444				2,057
Goodwill and core deposit intangible, net			9,557				—
Other real estate owned			1,489				3,792
Other assets			8,162				8,372
Total assets		$	802,595			$	625,581
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits		$	715,761			$	517,079
Accrued interest payable			355				381
Other liabilities			8,817				6,319
Short-term borrowings			192				15,594
Long-term debt			—				10,000
Total liabilities			725,125				549,373
Commitments and contingencies
Shareholders’ equity:
Common stock, par value $0.01 per share, 10,000,000 shares authorized; 7,560,914 and 7,345,946 shares issued, respectively; 6,296,712 and 6,081,744 shares outstanding, respectively			75				73
Surplus			13,385				10,755
Accumulated other comprehensive loss, net of tax			(2,882	)			(868	)
Retained earnings			87,317				86,673
Less treasury stock: 1,264,202 shares at cost			(20,414	)			(20,414	)
Noncontrolling interest			(11	)			(11	)
Total shareholders’ equity			77,470				76,208
Total liabilities and shareholders’ equity		$	802,595			$	625,581

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		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2018				2017				2018				2017
		(Unaudited)								(Unaudited)
Interest income:
Interest and fees on loans		$	8,395			$	6,802			$	22,815			$	19,928
Interest on investment securities			1,057				1,018				3,146				3,085
Total interest income			9,452				7,820				25,961				23,013
Interest expense:
Interest on deposits			1,120				617				2,619				1,713
Interest on borrowings			4				68				198				189
Total interest expense			1,124				685				2,817				1,902
Net interest income			8,328				7,135				23,144				21,111
Provision for loan and lease losses			789				373				2,149				1,464
Net interest income after provision for loan and lease losses			7,539				6,762				20,995				19,647
Non-interest income:
Service and other charges on deposit accounts			489				481				1,400				1,406
Credit insurance income			198				160				516				459
Net gain on sales and prepayments of investment securities			—				178				105				228
Net gain on settlement of derivative contracts			981				—				981				—
Mortgage fees from secondary market			128				89				389				147
Other income, net			316				328				993				1,093
Total non-interest income			2,112				1,236				4,384				3,333
Non-interest expense:
Salaries and employee benefits			4,643				4,370				13,743				13,048
Net occupancy and equipment			983				806				2,745				2,276
Computer services			328				337				937				1,036
Fees for professional services			242				187				781				650
Acquisition expenses			1,492				—				1,492				—
Other expense			1,454				1,490				4,237				4,080
Total non-interest expense			9,142				7,190				23,935				21,090
Income before income taxes			509				808				1,444				1,890
Provision for income taxes			269				173				431				435
Net income		$	240			$	635			$	1,013			$	1,455
Basic net income per share		$	0.04			$	0.10			$	0.17			$	0.24
Diluted net income per share		$	0.03			$	0.10			$	0.15			$	0.22
Dividends per share		$	0.02			$	0.02			$	0.06			$	0.06

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		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2018				2017				2018				2017
		(Unaudited)								(Unaudited)
Net income		$	240			$	635			$	1,013			$	1,455
Other comprehensive income (loss):
Unrealized holding gains (losses) on securities available-for-sale arising during period, net of tax expense (benefit) of $13, $(7), $(533) and $864, respectively			39				(12	)			(1,602	)			1,481
Reclassification adjustment for net gains on securities available-for-sale realized in net income, net of tax expense of $0, $66, $26 and $84, respectively			—				(113	)			(79	)			(144	)
Unrealized holding gains (losses) arising during the period on effective cash flow hedge derivatives, net of tax expense (benefit) of $0, $(1), $133 and $(20), respectively			(3	)			(1	)			398				(35	)
Reclassification adjustment for net gains on cash flow hedge derivatives realized in net income, net of tax expense of $243, $0, $243 and $0, respectively			(731	)			—				(731	)			—
Other comprehensive income (loss)			(695	)			(126	)			(2,014	)			1,302
Total comprehensive income (loss)		$	(455	)		$	509			$	(1,001	)		$	2,757

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		Nine Months Ended
		September 30,
		2018				2017
		(Unaudited)
Cash flows from operating activities:
Net income		$	1,013			$	1,455
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization			1,078				781
Provision for loan and lease losses			2,149				1,464
Deferred income tax provision			821				231
Net gain on sale and prepayment of investment securities			(105	)			(228	)
Stock-based compensation expense			333				262
Net amortization of securities			618				869
Amortization of intangible assets			43				—
Net loss on premises and equipment and other real estate			330				453
Changes in assets and liabilities:
Decrease in accrued interest receivable			148				110
Decrease (increase) in other assets			(900	)			57
Increase (decrease) in accrued interest expense			(26	)			40
Increase (decrease) in other liabilities			2,061				(114	)
Net cash provided by operating activities			7,563				5,380
Cash flows from investing activities:
Net decrease in federal funds sold			6,439				—
Purchases of investment securities, available-for-sale			(15,224	)			(15,254	)
Purchases of investment securities, held-to-maturity			—				(4,696	)
Proceeds from sales of investment securities, available-for-sale			4,221				1,749
Proceeds from maturities and prepayments of investment securities, available-for-sale			30,909				38,570
Proceeds from maturities and prepayments of investment securities, held-to-maturity			3,950				3,119
Net decrease in Federal Home Loan Bank stock			1,471				185
Net cash paid for acquisition			(21,313	)			—
Proceeds from the sale of premises and equipment and other real estate			2,883				1,215
Net increase in loans			(22,122	)			(17,326	)
Purchases of premises and equipment			(653	)			(9,858	)
Net cash used in investing activities			(9,439	)			(2,296	)
Cash flows from financing activities:
Net increase in deposits			58,307				10,829
Net increase (decrease) in short-term borrowings			(25,402	)			516
Payments on long-term Federal Home Loan Bank advances			(10,000	)			(5,000	)
Net share-based compensation transactions			—				(41	)
Issuance of common stock			2,299				—
Dividends paid			(369	)			(364	)
Net cash provided by financing activities			24,835				5,940
Net increase in cash and cash equivalents			22,959				9,024
Cash and cash equivalents, beginning of period			27,124				23,530
Cash and cash equivalents, end of period		$	50,083			$	32,554
Supplemental disclosures:
Cash paid for:
Interest		$	2,843			$	1,862
Income taxes			137				77
Non-cash transactions:
Assets acquired in settlement of loans			649				608
Reissuance of treasury stock as compensation		$	—			$	350

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1.

GENERAL

 

The accompanying unaudited interim condensed consolidated financial statements include the accounts of First US Bancshares, Inc. (“Bancshares”) and its subsidiaries (collectively, the “Company”). Bancshares is the parent holding company of First US Bank (the “Bank”). The Bank operates a finance company subsidiary, Acceptance Loan Company, Inc. (“ALC”). Management has determined that the Bank and ALC comprise Bancshares’ two reportable operating segments. All significant intercompany transactions and accounts have been eliminated.

 

The unaudited interim condensed consolidated financial statements, in the opinion of management, reflect all adjustments necessary for a fair presentation of the Company’s consolidated financial position, results of operations and cash flows for the periods presented. Such adjustments are of a normal, recurring nature. The results of operations for any interim period are not necessarily indicative of results expected for the fiscal year ending December 31, 2018. While certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), management believes that the disclosures herein are adequate to make the information presented not misleading. These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2017.

 

 

2.	BASIS OF PRESENTATION

 

Summary of Significant Accounting Policies

 

Certain significant accounting policies followed by the Company are set forth in Note 2, “Summary of Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2017.

 

Net Income Per Share

 

Basic net income per share is computed by dividing net income by the weighted average number of shares of common stock outstanding (basic shares). Included in basic shares are certain shares that have been accrued as of the balance sheet date as deferred compensation for members of Bancshares’ Board of Directors. Diluted net income per share is computed by dividing net income by the weighted average number of shares of common stock outstanding, adjusted for the effect of potentially dilutive stock awards outstanding during the period (dilutive shares). The dilutive shares consist of nonqualified stock option grants issued to employees and members of Bancshares’ Board of Directors pursuant to Bancshares’ 2013 Incentive Plan (the “2013 Incentive Plan”) previously approved by Bancshares’ shareholders. The following table reflects weighted average shares used to calculate basic and diluted net income per share for the periods presented.

 

 

 

Comprehensive Income

 

Comprehensive income consists of net income, as well as unrealized holding gains and losses that arise during the period associated with the Company’s available-for-sale securities portfolio and the effective portion of cash flow hedge derivatives. In the calculation of comprehensive income, reclassification adjustments are made for gains or losses realized in the statement of operations associated with the sale of available-for-sale securities, settlement of derivative contracts or changes in the fair value of cash flow derivatives.

 

 

 

 

Accounting Policies Recently Adopted and Pending Accounting Pronouncements

 

Accounting Standards Update (“ASU”) 2017-12, “Targeted Improvements to Accounting for Hedging Activities.” This ASU simplifies and expands the eligible hedging strategies for financial and nonfinancial risks by more closely aligning hedge accounting with a company’s risk management activities, and also simplifies the application of Accounting Standards Codification (“ASC”) Topic 815, Derivatives and Hedging, through targeted improvements in key practice areas. This includes expanding the list of items eligible to be hedged and amending the methods used to measure the effectiveness of hedging relationships. In addition, the ASU prescribes how hedging results should be presented and requires incremental disclosures. These changes are intended to allow preparers more flexibility and to enhance the transparency of how hedging results are presented and disclosed. Further, the ASU provides partial relief on the timing of certain aspects of hedge documentation and eliminates the requirement to recognize hedge ineffectiveness separately in earnings in the current period. The ASU is effective for years beginning after December 15, 2018, and interim periods within those years. The Company does not expect the adoption of ASU 2017-12 to have a material impact on the Company's consolidated financial statements.

 

ASU 2017-04, “Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.”  Issued in January 2017, ASU 2017-04 simplifies the manner in which an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. In computing the implied fair value of goodwill under Step 2, an entity, prior to the amendments in ASU 2017-04, had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities, including unrecognized assets and liabilities, in accordance with the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. However, under the amendments in ASU 2017-04, an entity should (1) perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and (2) recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, with the understanding that the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, ASU 2017-04 removes the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails such qualitative test, to perform Step 2 of the goodwill impairment test. ASU 2017-04 is effective prospectively for annual, or any interim, goodwill impairment tests in fiscal years beginning after December 15, 2019. Management is currently evaluating the impact that this ASU will have on the Company’s consolidated financial statements.

 

ASU 2016-13, "Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments.” Issued in June 2016, ASU 2016-13 removes the thresholds that companies apply to measure credit losses on financial instruments measured at amortized cost, such as loans, receivables and held-to-maturity debt securities. Under current U.S. GAAP, companies generally recognize credit losses when it is probable that the loss has been incurred. The revised guidance will remove all current recognition thresholds and will require companies to recognize an allowance for lifetime expected credit losses. Credit losses will be immediately recognized through net income; the amount recognized will be based on the current estimate of contractual cash flows not expected to be collected over the financial asset’s contractual term. ASU 2016-13 also amends the credit loss measurement guidance for available-for-sale debt securities. For public business entities, ASU 2016-13 is effective for financial statements issued for fiscal years beginning after December 15, 2019, and interim periods within those years. Institutions will be required to apply the changes through a cumulative-effect adjustment to their retained earnings as of the beginning of the first reporting period in which the guidance is effective. Management is currently evaluating the impact that this ASU will have on the Company’s consolidated financial statements.

 

ASU 2016-02, “Leases (Topic 842).” Issued in February 2016, ASU 2016-02 was issued by the Financial Accounting Standards Board (“FASB”) to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and by disclosing key information about leasing arrangements. ASU 2016-02 will require organizations that lease assets (lessees) to recognize on the balance sheet the assets and liabilities for the rights and obligations created by the lease for all operating leases under current U.S. GAAP with a term of more than 12 months. The recognition, measurement and presentation of expenses and cash flows arising from a lease are not significantly changed under ASU 2016-02, and there will continue to be differentiation between finance leases and operating leases. The accounting applied by the lessor in a lease transaction remains largely unchanged from previous U.S. GAAP. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, and interim periods within those years. Management is currently evaluating the impact that this ASU will have on the Company’s consolidated financial statements; however, because the Company has several leases, assets and liabilities are expected to increase upon adoption for right-of-use assets and lease liabilities.

 

ASU 2016-01, “Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (An Amendment of FASB ASC 825).” Issued in January 2016, ASU 2016-01 was intended to enhance the reporting model for financial instruments to provide users of financial statements with improved decision-making information. The amendments of ASU 2016-01 include: (i) requiring equity investments, except those accounted for under the equity method of accounting or those that result in the consolidation of an investee, to be measured at fair value, with changes in fair value recognized in net income; (ii) requiring a qualitative assessment to identify impairment of equity investments without readily determinable fair values; and (iii) clarifying that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. ASU 2016-01 became effective for the Company on January 1, 2018. The adoption of ASU 2016-01 did not have a material impact on the Company's consolidated financial statements.

 

ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).” Issued in May 2014, ASU 2014-09 added FASB ASC Topic 606, Revenue from Contracts with Customers, and superseded revenue recognition requirements in ASC 605, Revenue Recognition and certain cost guidance in ASC 605-35, Revenue Recognition – Construction-Type and Production-Type Contracts. ASU 2014-09 requires an entity to recognize revenue when (or as) an entity transfers control of goods or services to a customer at the amount to which the entity expects to be entitled. Depending on whether certain criteria are met, revenue should be recognized either over time, in a manner that depicts the entity’s performance, or at a point in time, when control of the goods or services is transferred to the customer. ASU 2014-09 became effective for the Company on January 1, 2018. The adoption of ASU 2014-09 did not have a material impact on the Company's consolidated financial statements.

 

Revenue

 

On January 1, 2018, the Company implemented ASU 2014-09, Revenue from Contracts with Customers, codified at ASC 606. The Company adopted ASC 606 using the modified retrospective transition method. As of December 31, 2017, the Company had no uncompleted customer contracts and, as a result, no cumulative transition adjustment was made to the Company’s accumulated deficit during the nine-month period ended September 30, 2018. Results for reporting periods beginning January 1, 2018 are presented under ASC 606, while prior period amounts continue to be reported under legacy U.S. GAAP.

 

The majority of the Company’s revenue is generated through interest earned on financial instruments, including loans and investment securities, which falls outside the scope of ASC 606. The Company also generates revenue from insurance- and lease-related contracts that also fall outside the scope of ASC 606.

 

 

All of the Company’s revenue that is subject to ASC 606 is included in non-interest income; however, not all non-interest income is subject to ASC 606. Revenue earned by the Company subject to ASC 606 primarily consists of service and other charges on deposit accounts, mortgage fees from secondary market transactions at the Bank, ATM fee income and other non-interest income. Revenue generated from these sources for the nine months ended September 30, 2018 and 2017 was $2.4 million and $2.2 million, respectively, and for the three months ended September 30, 2018 and 2017 was $0.8 million and $0.7 million, respectively. All sources of the Company’s revenue subject to ASC 606 are transaction-based, and revenue is recognized at the time the transaction is executed, which is the same time the Company’s performance obligation is satisfied. The Company had no contract liabilities or unsatisfied performance obligations with customers as of September 30, 2018.

 

 

3.	ACQUISITION ACTIVITY

 

On August 31, 2018, the Company completed the acquisition of The Peoples Bank (“TPB”) and then merged TPB with and into its wholly owned subsidiary, First US Bank (the “Bank”). As of the acquisition date, TPB’s assets totaled $166.5 million, consisting primarily of pre-discounted gross loans totaling $156.8 million. Total deposits were $140.0 million.  Preliminary purchase accounting adjustments were recorded as of the acquisition date, resulting in goodwill of $7.6 million. 

 

The acquisition of TPB was accounted for using the purchase method of accounting in accordance with ASC 805, Business Combinations. Assets acquired, liabilities assumed and consideration exchanged were recorded at their respective acquisition date fair values. Determining the fair value of assets and liabilities is a complicated process involving significant judgment regarding the methods and assumptions to be used. Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition as additional information regarding the closing date fair values becomes available.

 

In accordance with the transaction agreement, the Company acquired 100% of the capital stock of TPB for the purchase price of $23.4 million calculated on the net book value of TPB as of December 31, 2017 and a mutually agreed upon multiple of 1.62, less certain mutually agreed upon deductions that are described in the transaction agreement. Approximately 90% of the purchase price was paid in cash, which totaled approximately $20.7 million, and approximately 10% was paid in the form of unregistered shares of the Company’s common stock, which consisted of 204,355 shares of FUSB common stock. The aggregate purchase price was subject to adjustment following the closing date of the transaction based on determination of TPB’s final net book value as of the date of closing, which resulted in the payment by the Company of an additional cash amount of approximately $1.4 million.

 

A summary, at fair value, of the assets acquired and liabilities assumed in the TPB transaction, as of the acquisition date, is as follows:

 

FIRST US BANCSHARES, INC. AND SUBSIDIARIES

NET ASSETS ACQUIRED FROM THE PEOPLES BANK

AUGUST 31, 2018

(Dollars in Thousands)

 

 

 

The following is a description of the methods used to determine the fair values of significant assets and liabilities presented in the acquisition above.

 

Cash and cash equivalents — The carrying amount of these assets is a reasonable estimate of fair value based on the short-term nature of the assets.

 

 

Investment securities — Prior to acquisition, the investment securities acquired were classified as available-for-sale and, accordingly, were recorded at fair value on a recurring basis. Fair value for most of the securities was based upon quoted prices of like or similar securities and determined using observable data including, among other things, dealer quotes, market spreads, cash flow, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus, prepayment speeds, credit information and the securities’ terms and conditions. 

 

Federal Home Loan Bank stock, at cost — Prior to acquisition, TPB maintained a required investment in the Federal Home Loan Bank (FHLB) of Atlanta which was, in part, based on TPB’s amount of borrowings with the FHLB. The investment was carried at cost as it is not readily marketable and, accordingly, there is no established market price for the investment. Upon acquisition, the Bank was able to absorb the investment into its own holdings of stock with the FHLB of Atlanta. The Bank has the ability to be reimbursed by the FHLB of Atlanta at cost for stock holdings as borrowings with the FHLB are paid down.  Accordingly, the carrying amount of the assets is considered a reasonable estimate of fair value. 

 

Loans — Fair values for performing loans were determined based on a discounted cash flow methodology that aggregated model inputs and loan information into selected pools and calculated the loan level cash flows used to value the pools.  The model calculated the contractual cash flows and expected cash flows, and then discounted the expected cash flows to present value in order to determine fair value.  The assumptions used to estimate the fair value of the loans included unpaid principal balance, maturity date, coupon, prepayment speed, expected credit losses, and discount rates.  Purchased credit impaired loans were valued using the cost recovery method. 

 

Allowance for loan losses — In accordance with U.S. GAAP, the fair value of the acquired loans were adjusted to fair value and the pre-acquisition allowance for loan losses on TPB’s balance sheet was reversed.

 

Premises and equipment — The fair value of acquired land and buildings was determined based on independent appraisals performed by a third-party appraiser. The fair value adjustment represents the difference between fair value and the carrying value at the date of acquisition. For furniture and fixtures, carrying value was considered to be a reasonable estimate of fair value.

 

Other real estate owned — These assets are presented at the estimated net realizable value that management expects to receive when the properties are sold, net of related costs of disposal.

 

Other assets — The fair value adjustment was due primarily to changes in deferred tax assets related to the transaction, as well as adjustment of certain prepaid assets associated with the TPB’s core processing vendor. Otherwise, the carrying amount of these assets was deemed to be a reasonable estimate of fair value.

 

Core deposit intangible — This intangible asset represents the value of the relationships that TPB had with its deposit customers. The fair value of the core deposit intangible was estimated using a discounted cash flow methodology that gave consideration to expected customer attrition rates, cost of the deposit base and the net maintenance cost attributable to customer deposits.

 

Deposits — The fair values used for the demand and savings deposits that comprise the transaction accounts acquired equal the amount payable on demand at the acquisition date.  The fair value of certificates of deposit was determined using a discounted cash flow methodology whereby an estimate of the present value of contractual payments over the remaining life of the time deposit was determined.  Future cash flows were discounted using market interest rates estimated based on the median offering rates of peer institutions at the time of the acquisition.

 

Short-term borrowings — TPB’s short-term borrowings were comprised of daily renewable FHLB advances.  Based on the short-term nature of the borrowings, the carrying amount of the liability was determined to be a reasonable approximation of fair value.

 

Other liabilities — The carrying amount of these other liabilities was deemed to be a reasonable estimate of fair value.

 

Pro Forma Financial Information

 

The results of operations of TPB have been included in the Company’s consolidated financial statements since the acquisition date. The following schedule includes pro forma results (unaudited) for the three and nine months ended September 30, 2018 and 2017, as if the TPB acquisition occurred as of the beginning of the reporting periods presented. Non-recurring acquisition-related expenses totaling approximately $1.5 million are included in non-interest expense for both the three and nine months ended September 30, 2018.

 

 

 

 

The pro forma information is presented for information purposes only and is not indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results.

 

 

 

4.	INVESTMENT SECURITIES

 

Details of investment securities available-for-sale and held-to-maturity as of September 30, 2018 and December 31, 2017 were as follows:

 

 

 

 

 

The scheduled maturities of investment securities available-for-sale and held-to-maturity as of September 30, 2018 are presented in the following table:

 

 

 

For purposes of the maturity table, mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on the weighted-average contractual maturities of underlying collateral. The mortgage-backed securities generally mature earlier than their weighted-average contractual maturities because of principal prepayments.

 

The following table reflects gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of September 30, 2018 and December 31, 2017.

 

 

 

 

 

Management evaluates securities for other-than-temporary impairment no less frequently than quarterly, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to: (i) the length of time and the extent to which fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, (iii) whether the Company intends to sell securities, and (iv) whether it is more likely than not that the Company will be required to sell the securities before recovery of their amortized cost bases.

 

 

As of September 30, 2018, 123 debt securities had been in a loss position for more than 12 months, and 56 debt securities had been in a loss position for less than 12 months. As of December 31, 2017, 72 debt securities had been in a loss position for more than 12 months, and 83 debt securities had been in a loss position for less than 12 months. As of both September 30, 2018 and December 31, 2017, the losses for all securities were considered to be a direct result of the effect that the prevailing interest rate environment had on the value of debt securities and were not related to the creditworthiness of the issuers. Further, the Company has the current intent and ability to retain its investments in the issuers for a period of time that management believes to be sufficient to allow for any anticipated recovery in fair value. Therefore, the Company did not recognize any other-than-temporary impairments as of September 30, 2018 or December 31, 2017.

 

Investment securities with a carrying value of $55.9 million and $86.8 million as of September 30, 2018 and December 31, 2017, respectively, were pledged to secure public deposits and for other purposes.

 

 

5.	LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES

 

Portfolio Segments

 

The Company has divided the loan and lease portfolio into eight portfolio segments, each with different risk characteristics described as follows:

 

Construction, land development and other land loans – Commercial construction, land and land development loans include the development of residential housing projects, loans for the development of commercial and industrial use property and loans for the purchase and improvement of raw land. These loans are secured in whole or in part by the underlying real estate collateral and are generally guaranteed by the principals of the borrowing entity.

 

Secured by 1-4 family residential properties – These loans include conventional mortgage loans on one-to-four family residential properties. These properties may serve as the borrower’s primary residence, vacation home or investment property. Also included in this portfolio are home equity loans and lines of credit. This type of lending, which is secured by a first or second mortgage on the borrower’s residence, allows customers to borrow against the equity in their home.

 

Secured by multi-family residential properties – This portfolio segment includes mortgage loans secured by apartment buildings.

 

Secured by non-farm, non-residential properties – This portfolio segment includes real estate loans secured by commercial and industrial properties, office or mixed-use facilities, strip shopping centers or other commercial property. These loans are generally guaranteed by the principals of the borrowing entity.

 

Other real estate loans – Other real estate loans are loans primarily for agricultural production, secured by mortgages on farmland.

 

Commercial and industrial loans and leases – This portfolio segment includes loans and leases to commercial customers for use in the normal course of business. These credits may be loans, lines of credit and leases to financially strong borrowers, secured by inventories, equipment or receivables, and are generally guaranteed by the principals of the borrowing entity.

 

Consumer loans – This portfolio segment includes a variety of secured and unsecured personal loans, including automobile loans, loans for household and personal purposes, and all other direct consumer installment loans.

 

Indirect sales – This portfolio segment includes loans secured by collateral that is purchased by consumers at retail stores with whom ALC has an established relationship to provide financing for the retail products sold if applicable underwriting standards are met.

 

 

As of September 30, 2018 and December 31, 2017, the composition of the loan and lease portfolio by reporting segment and portfolio segment was as follows:

 

 

⁽¹⁾ Includes equipment financing leases.

 

 

 

The Company makes commercial, real estate and installment loans to its customers. Although the Company has a diversified loan portfolio, 63.6% and 54.0% of the portfolio was concentrated in loans secured by real estate as of September 30, 2018 and December 31, 2017, respectively.

 

Loans with a carrying value of $27.0 million were pledged as collateral to secure FHLB borrowings as of September 30, 2018. No loans were pledged as collateral as of December 31, 2017.

 

Related Party Loans

 

In the ordinary course of business, the Bank makes loans to certain officers and directors of the Company, including companies with which they are associated. These loans are made on the same terms as those prevailing for comparable transactions with unrelated parties. Management believes that such loans do not represent more than a normal risk of collectability, nor do they present other unfavorable features. The aggregate balances of such related party loans and commitments as of September 30, 2018 and December 31, 2017 were $0.8 million and $0.5 million, respectively. During the nine months ended September 30, 2018, there were $0.5 million of new loans to these parties, and repayments by active related parties were $0.2 million. During the year ended December 31, 2017, there were no new loans to these related parties, and repayments by active related parties were $11 thousand.

 

 

Acquired Loans

 

The Company acquired loans during the quarter ended September 30, 2018. At acquisition, certain acquired loans evidenced deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected.

 

Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired. Evidence of credit quality deterioration as of the purchase date may include information such as past-due and nonaccrual status, borrower credit scores and recent loan to value percentages. Purchased credit impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality (ASC 310-30) and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for credit losses related to these loans is not carried over and recorded at the acquisition date.

 

The carrying amount of these loans is included in the balance sheet amount of loans receivable at September 30, 2018. The amount of these loans is shown below:

 

 

 

The Company did not recognize any accretable yield, or income expected to be collected, associated with these loans. Additionally, during the three months ended September 30, 2018, the Company did not increase or reverse the allowance for loan losses related to these purchased credit impaired loans.

 

 

Allowance for Loan Losses

 

The following tables present changes in the allowance for loan losses during the nine months ended September 30, 2018 and the year ended December 31, 2017 and the related loan balances by loan portfolio segment and loan type as of September 30, 2018 and December 31, 2017:

 

 

 

 

 

 

 

 

 

 

 

Credit Quality Indicators

 

The Bank utilizes a credit grading system that provides a uniform framework for establishing and monitoring credit risk in the loan portfolio. Under this system, each loan is graded based on pre-determined risk metrics and categorized into one of nine risk grades. These risk grades can be summarized into categories described as pass, special mention, substandard, doubtful and loss, as described in further detail below.

 

●

Pass (Risk Grades 1-5): Loans in this category include obligations in which the probability of default is considered low.

 

●

Special Mention (Risk Grade 6): Loans in this category exhibit potential credit weaknesses or downward trends deserving Bank management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. Special mention loans are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. Although a special mention asset has a higher probability of default than pass-rated categories, its default is not imminent.

 

 

●

Substandard (Risk Grade 7): Loans in this category have defined weaknesses that jeopardize the orderly liquidation of debt. A substandard loan is inadequately protected by the current worth and paying capacity of the obligor or by the collateral pledged, if any. Normal repayment from the borrower is in jeopardy, although no loss of principal is envisioned. There is a distinct possibility that a partial loss of interest and/or principal will occur if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified as substandard.

 

●

Doubtful (Risk Grade 8): Loans classified as doubtful have all of the weaknesses found in substandard loans, with the added characteristic that the weaknesses make collection of debt in full, based on currently existing facts, conditions and values, highly questionable or improbable. Serious problems exist such that partial loss of principal is likely; however, because of certain important, reasonably specific pending factors that may work to strengthen the assets, the loans’ classification as estimated losses is deferred until a more exact status may be determined. Such pending factors may include proposed merger, acquisition or liquidation procedures, capital injection, perfection of liens on additional collateral and refinancing plans. Loans classified as doubtful may include loans to borrowers that have demonstrated a history of failing to live up to agreements.

 

●

Loss (Risk Grade 9): Loans are classified in this category when borrowers are deemed incapable of repayment of unsecured debt. Loans to such borrowers are considered uncollectable and of such little value that continuance as active assets of the Bank is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not prudent to defer writing off these assets, even though partial recovery may be affected in the future.

 

At ALC, because the loan portfolio is more uniform in nature, each loan is categorized into one of two risk grades, depending on whether the loan is considered to be performing or nonperforming. Performing loans are loans that are paying principal and interest in accordance with a contractual agreement. Nonperforming loans are loans that have demonstrated characteristics that indicate a probability of loss.

 

The tables below illustrate the carrying amount of loans by credit quality indicator as of September 30, 2018:

 

 

The above amounts include purchased credit impaired loans. As of September 30, 2018, $2.2 million of purchased credit impaired loans were rated “Substandard.”

 

 

 

The tables below illustrate the carrying amount of loans by credit quality indicator as of December 31, 2017:

 

 

 

The following tables provide an aging analysis of past due loans by class as of September 30, 2018:

 

 

The above amounts include purchased credit impaired loans. As of September 30, 2018, $0.2 million of purchased credit impaired loans were 30-59 days past due and $2.0 million were 90 or more days past due.

 

 

 

The following tables provide an aging analysis of past due loans by class as of December 31, 2017:

 

 

 

 

The following table provides an analysis of non-accruing loans by class as of September 30, 2018 and December 31, 2017:

 

 

As of September 30, 2018, purchased credit impaired loans comprised $2.2 million of nonaccrual loans.

 

Impaired Loans

 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the related loan agreement. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the liquidation of the collateral at the Bank. All loans of $0.5 million or more that have a credit quality risk grade of seven or above are identified for impairment analysis. At management’s discretion, additional loans may be impaired based on homogeneous factors such as changes in the nature and volume of the portfolio, portfolio quality, adequacy of the underlying collateral value, loan concentrations, historical charge-off trends and economic conditions that may affect the borrower’s ability to pay. At ALC, all real estate loans of $0.1 million or more are identified for impairment analysis. There are currently no loans at ALC that meet that criteria. Impaired loans, or portions thereof, are charged off when deemed uncollectable.

 

 

As of September 30, 2018, the carrying amount of impaired loans at the Bank consisted of the following:

 

 

The above amounts include purchased credit impaired loans. As of September 30, 2018, purchased credit impaired loans comprised $2.2 million of impaired loans without a related allowance recorded.

 

 

As of December 31, 2017, the carrying amount of impaired loans at the Bank consisted of the following:  

 

 

The average net investment in impaired loans and interest income recognized and received on impaired loans during the nine months ended September 30, 2018 and the year ended December 31, 2017 were as follows:

 

 

 

 

Loans on which the accrual of interest has been discontinued amounted to $3.8 million and $2.1 million as of September 30, 2018 and December 31, 2017, respectively. If interest on those loans had been accrued, there would have been $26 thousand and $19 thousand of interest accrued for the periods ended September 30, 2018 and December 31, 2017, respectively. Interest income related to these loans as of both September 30, 2018 and December 31, 2017 was $3 thousand.

 

Troubled Debt Restructurings

 

Troubled debt restructurings include loans with respect to which concessions have been granted to borrowers that generally would not have otherwise been considered had the borrowers not been experiencing financial difficulty. The concessions granted may include payment schedule modifications, interest rate reductions, maturity date extensions, modifications of note structure, principal balance reductions or some combination of these concessions. There were no loans modified with concessions granted during the nine-month period ended September 30, 2018. Restructured loans may involve loans remaining on non-accrual, moving to non-accrual or continuing on accrual status, depending on the individual facts and circumstances of the borrower. Non-accrual restructured loans are included with all other non-accrual loans. In addition, all accruing restructured loans are reported as troubled debt restructurings. Generally, restructured loans remain on non-accrual until the customer has attained a sustained period of repayment performance under the modified loan terms (generally a minimum of six months). However, performance prior to the restructuring, or significant events that coincide with the restructuring, are considered in assessing whether the borrower can meet the new terms and whether the loan should be returned to or maintained on non-accrual status. If the borrower’s ability to meet the revised payment schedule is not reasonably assured, then the loan remains on non-accrual. As of both September 30, 2018 and December 31, 2017, the Company had $0.1 million of non-accruing loans that were previously restructured and that remained on non-accrual status. For both the nine months ended September 30, 2018 and the year ended December 31, 2017, the Company had no loans that were restored to accrual status based on a sustained period of repayment performance.

 

The following table provides the number of loans remaining in each loan category, as of September 30, 2018 and December 31, 2017, that the Bank had previously modified in a troubled debt restructuring, as well as the pre- and post-modification principal balance as of each date.

 

 

 

As of September 30, 2018 and December 31, 2017, no loans that previously had been modified in a troubled debt restructuring had defaulted subsequent to modification.

 

Restructured loan modifications primarily included maturity date extensions and payment schedule modifications. There were no modifications to principal balances of the loans that were restructured. Accordingly, there was no impact on the Company’s allowance for loan losses resulting from the modifications.

 

All loans with a principal balance of $0.5 million or more that have been modified in a troubled debt restructuring are considered impaired and evaluated individually for impairment. The nature and extent of impairment of restructured loans, including those that have experienced a subsequent payment default, are considered in the determination of an appropriate level of allowance for loan losses. This evaluation resulted in an allowance for loan losses attributable to such restructured loans of $2 thousand as of both September 30, 2018 and December 31, 2017.