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LIMESTONE BANCORP, INC. - Quarter Report: 2014 September (Form 10-Q)

Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x

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

For the Quarterly Period Ended September 30, 2014

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: 001-33033

 

 

PORTER BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Kentucky   61-1142247

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

2500 Eastpoint Parkway, Louisville, Kentucky   40223
(Address of principal executive offices)   (Zip Code)

(502) 499-4800

(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 shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate 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  x    No  ¨

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

 

Large accelerated filer

 

¨

  

Accelerated filer

 

¨

Non-accelerated filer

 

¨

  

Smaller reporting company

 

x

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

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

13,099,400 shares of Common Stock, no par value, were outstanding at October 31, 2014.

 

 

 


Table of Contents

INDEX

 

         Page  

PART I –

 

FINANCIAL INFORMATION

  

ITEM 1.

 

FINANCIAL STATEMENTS

     3   

ITEM 2.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     36   

ITEM 3.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     55   

ITEM 4.

 

CONTROLS AND PROCEDURES

     55   

PART II –

 

OTHER INFORMATION

  

ITEM 1.

 

LEGAL PROCEEDINGS

     56   

ITEM 1A.

 

RISK FACTORS

     56   

ITEM 2.

 

UNREGISTERED SALES ON EQUITY SECURITIES AND USE OF PROCEEDS

     56   

ITEM 3.

 

DEFAULTS UPON SENIOR SECURITIES

     56   

ITEM 4.

 

MINE SAFETY DISCLOSURES

     56   

ITEM 5.

 

OTHER INFORMATION

     56   

ITEM 6.

 

EXHIBITS

     56   

 

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Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

The following consolidated financial statements of Porter Bancorp, Inc. and subsidiary, PBI Bank, Inc. are submitted:

Unaudited Consolidated Balance Sheets for September 30, 2014 and December 31, 2013

Unaudited Consolidated Statements of Operations for the three and nine months ended September 30, 2014 and 2013

Unaudited Consolidated Statements of Comprehensive Loss for the three and nine months ended September 30, 2014 and 2013

Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the nine months ended September 30, 2014

Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013

Notes to Unaudited Consolidated Financial Statements

 

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PORTER BANCORP, INC.

Unaudited Consolidated Balance Sheets

(dollars in thousands except share data)

 

     September 30,
2014
    December 31,
2013
 

Assets

    

Cash and due from financial institutions

   $ 83,870      $ 109,407   

Federal funds sold

     960        1,727   
  

 

 

   

 

 

 

Cash and cash equivalents

     84,830        111,134   

Securities available for sale

     192,146        163,344   

Securities held to maturity (fair value of $44,144 and $42,947, respectively)

     42,386        43,612   

Mortgage loans held for sale

     —          149   

Loans, net of allowance of $24,198 and $28,124, respectively

     614,162        681,202   

Premises and equipment

     19,649        19,983   

Other real estate owned

     54,507        30,892   

Federal Home Loan Bank stock

     7,323        10,072   

Bank owned life insurance

     9,103        8,911   

Accrued interest receivable and other assets

     6,608        6,822   
  

 

 

   

 

 

 

Total assets

   $ 1,030,714      $ 1,076,121   
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Deposits

    

Non-interest bearing

   $ 110,165      $ 107,486   

Interest bearing

     823,367        880,219   
  

 

 

   

 

 

 

Total deposits

     933,532        987,705   

Repurchase agreements

     1,817        2,470   

Federal Home Loan Bank advances

     16,940        4,492   

Accrued interest payable and other liabilities

     18,922        14,673   

Subordinated capital note

     5,175        5,850   

Junior subordinated debentures

     25,000        25,000   
  

 

 

   

 

 

 

Total liabilities

     1,001,386        1,040,190   

Stockholders’ equity

    

Preferred stock, no par, 1,000,000 shares authorized,

    

Series A – 35,000 issued and outstanding;

    

Liquidation preference of $35.0 million at September 30, 2014 and December 31, 2013

     35,000        35,000   

Series C – 317,042 issued and outstanding;

    

Liquidation preference of $3.6 million at September 30, 2014 and December 31, 2013

     3,283        3,283   
  

 

 

   

 

 

 

Total preferred stockholders’ equity

     38,283        38,283   
  

 

 

   

 

 

 

Common stock, no par, 86,000,000 shares authorized, 13,099,400

and 12,840,999 shares issued and outstanding, respectively

     112,236        112,236   

Additional paid-in capital

     21,367        20,887   

Retained deficit

     (139,913     (130,182

Accumulated other comprehensive loss

     (2,645     (5,293
  

 

 

   

 

 

 

Total common stockholders’ deficit

     (8,955     (2,352
  

 

 

   

 

 

 

Total stockholders’ equity

     29,328        35,931   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 1,030,714      $ 1,076,121   
  

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

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PORTER BANCORP, INC.

Unaudited Consolidated Statements of Operations

(dollars in thousands, except per share data)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2014     2013     2014     2013  

Interest income

        

Loans, including fees

   $ 8,201      $ 9,265      $ 25,094      $ 29,252   

Taxable securities

     1,265        900        3,653        2,615   

Tax exempt securities

     231        239        707        691   

Fed funds sold and other

     117        139        423        411   
  

 

 

   

 

 

   

 

 

   

 

 

 
     9,814        10,543        29,877        32,969   
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

      

Deposits

     2,245        2,443        6,925        7,707   

Federal Home Loan Bank advances

     31        38        96        122   

Subordinated capital note

     47        55        144        169   

Junior subordinated debentures

     153        157        458        468   

Federal funds purchased and other

     1        1        3        4   
  

 

 

   

 

 

   

 

 

   

 

 

 
     2,477        2,694        7,626        8,470   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     7,337        7,849        22,251        24,499   

Provision for loan losses

     —          250        6,300        700   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     7,337        7,599        15,951        23,799   

Non-interest income

      

Service charges on deposit accounts

     535        536        1,490        1,535   

Income from fiduciary activities

     —          —          —          517   

Bank card interchange fees

     209        174        575        542   

Other real estate owned rental income

     5        54        30        396   

Net gain on sales of securities

     46        24        92        727   

Income from bank owned life insurance

     69        75        207        459   

Other

     193        304        527        786   
  

 

 

   

 

 

   

 

 

   

 

 

 
     1,057        1,167        2,921        4,962   
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest expense

      

Salaries and employee benefits

     4,041        3,837        11,731        11,975   

Occupancy and equipment

     857        884        2,645        2,728   

Loan collection expense

     858        531        2,646        3,973   

Other real estate owned expense

     560        669        1,996        3,117   

FDIC Insurance

     571        578        1,682        1,867   

State franchise tax

     405        537        1,235        1,611   

Professional fees

     630        503        1,952        1,408   

Communications

     181        177        581        531   

Insurance expense

     157        171        459        482   

Postage and delivery

     97        99        301        314   

Other

     924        482        2,359        1,835   
  

 

 

   

 

 

   

 

 

   

 

 

 
     9,281        8,468        27,587        29,841   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     (887     298        (8,715     (1,080

Income tax benefit

     (38     —          (1,345     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

     (849     298        (7,370     (1,080

Less:

      

Dividends on preferred stock

     786        437        2,361        1,311   

Accretion on Series A preferred stock

     —          45        —          135   

Earnings allocated to participating securities

     (162     (16     (928     (174
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to common shareholders

   $ (1,473   $ (168   $ (8,803   $ (2,352
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted loss per common share

   $ (0.12   $ (0.01   $ (0.73   $ (0.20
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

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PORTER BANCORP, INC.

Unaudited Consolidated Statements of Comprehensive Loss

(in thousands)

 

     Three Months
Ended

September 30,
    Nine Months Ended
September 30,
 
     2014     2013     2014     2013  

Net income (loss)

   $ (849   $ 298      $ (7,370   $ (1,080

Other comprehensive income (loss):

        

Unrealized gain (loss) on securities:

        

Unrealized gain (loss) arising during the period

     145        (1,687     3,901        (8,801

Reclassification of amount realized through sales

     46        24        92        727   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net unrealized gain/(loss) recognized in comprehensive income

     191        (1,663     3,993        (8,074

Tax effect

     (38     —          (1,345     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss)

     153        (1,663     2,648        (8,074
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss

   $ (696   $ (1,365   $ (4,722   $ (9,154
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

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PORTER BANCORP, INC.

Unaudited Consolidated Statement of Changes in Stockholders’ Equity

For Nine Months Ended September 30, 2014

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

 

                                              Additional
Paid-In
Capital
     Retained
Deficit
    Accumulated
Other
Comprehensive
Loss
    Total  
     Shares      Amount            
     Common     Series A
Preferred
     Series C
Preferred
     Common      Series A
Preferred
     Series C
Preferred
           

Balances, January 1, 2014

     12,840,999        35,000         317,042       $ 112,236       $ 35,000       $ 3,283       $ 20,887       $ (130,182   $ (5,293   $ 35,931   

Issuance of unvested stock

     288,888        —           —           —           —           —           —           —          —          —     

Forfeited unvested stock

     (30,487     —           —           —           —           —           —           —          —          —     

Stock-based compensation expense

     —          —           —           —           —           —           480         —          —          480   

Net loss

     —          —           —           —           —           —           —           (7,370     —          (7,370

Net change in accumulated other comprehensive loss, net of taxes

     —          —           —           —           —           —           —           —          2,648        2,648   

Dividends accrued on Series A preferred stock

     —          —           —           —           —           —           —           (2,361     —          (2,361
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balances, September 30, 2014

     13,099,400        35,000         317,042       $ 112,236       $ 35,000       $ 3,283       $ 21,367       $ (139,913   $ (2,645   $ 29,328   
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

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PORTER BANCORP, INC.

Unaudited Consolidated Statements of Cash Flows

For Nine Months Ended September 30, 2014 and 2013

(dollars in thousands)

 

     2014     2013  

Cash flows from operating activities

    

Net loss

   $ (7,370   $ (1,080

Adjustments to reconcile net loss to net cash from operating activities

    

Depreciation and amortization

     1,329        1,506   

Provision for loan losses

     6,300        700   

Net amortization on securities

     1,219        1,709   

Stock-based compensation expense

     480        390   

Tax benefit from OCI components

     (1,345     —     

Net gain on loans originated for sale

     (52     (76

Loans originated for sale

     (2,265     (3,160

Proceeds from sales of loans originated for sale

     2,466        3,609   

Net gain on sales and calls of investment securities

     (92     (727

Net (gain) loss on sales of other real estate owned

     (455     190   

Net write-down of other real estate owned

     1,250        1,584   

Earnings on bank owned life insurance, net of premium expense

     (192     (443

Net change in accrued interest receivable and other assets

     (132     1,144   

Net change in accrued interest payable and other liabilities

     1,888        3,098   
  

 

 

   

 

 

 

Net cash from operating activities

     3,029        8,444   
  

 

 

   

 

 

 

Cash flows from investing activities

    

Purchases of available for sale securities

     (41,156     (50,266

Sales and calls of available for sale securities

     4,151        2,712   

Maturities and prepayments of available for sale securities

     11,295        22,993   

Calls of held to maturity securities

     1,000          

Proceeds from sale of other real estate owned

     7,253        18,567   

Proceeds from mandatory redemption of Federal Home Loan Bank stock

     2,749        —     

Loan originations and payments, net

     28,844        120,453   

Purchases of premises and equipment, net

     (416     (204
  

 

 

   

 

 

 

Net cash from investing activities

     13,720        114,255   
  

 

 

   

 

 

 

Cash flows from financing activities

    

Net change in deposits

     (54,173     (118,163

Net change in repurchase agreements

     (653     1,088   

Advances from Federal Home Loan Bank

     23,025        —     

Repayment of Federal Home Loan Bank advances

     (10,577     (863

Repayment of subordinated capital note

     (675     (900
  

 

 

   

 

 

 

Net cash from financing activities

     (43,053     (118,838
  

 

 

   

 

 

 

Net change in cash and cash equivalents

     (26,304     3,861   

Beginning cash and cash equivalents

     111,134        49,572   
  

 

 

   

 

 

 

Ending cash and cash equivalents

   $ 84,830      $ 53,433   
  

 

 

   

 

 

 

Supplemental cash flow information:

    

Interest paid

   $ 7,241      $ 8,156   

Income taxes paid (refunded)

     —          —     

Supplemental non-cash disclosure:

    

Transfer from loans to other real estate

   $ 31,663      $ 18,542   

Financed sales of other real estate owned

     —          15   

See accompanying notes to unaudited consolidated financial statements.

 

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PORTER BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

Note 1 – Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation – The consolidated financial statements include Porter Bancorp, Inc. (Company or PBI) and its subsidiary, PBI Bank (Bank). The Company owns a 100% interest in the Bank. All significant inter-company transactions and accounts have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the entire year. A description of other significant accounting policies is presented in the notes to the Consolidated Financial Statements for the year ended December 31, 2013 included in the Company’s Annual Report on Form 10-K.

Use of Estimates – To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan losses, fair values of financial instruments, stock compensation, deferred tax assets, other intangibles, and fair values of other real estate owned are particularly subject to change.

Reclassifications – Some items in the prior year financial statements were reclassified to conform to the current presentation. The reclassifications did not impact net income (loss) or stockholders’ equity.

Adoption of New Accounting Standards – In January 2014, FASB issued Accounting Standards Update 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. The amendments in this ASU clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this ASU are effective for the Company beginning January 1, 2015 and are not expected to have a material impact on the Company’s financial statements.

In May 2014, FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606). The ASU creates a new topic, Topic 606, to provide guidance on revenue recognition for entities that enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of nonfinancial assets. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additional disclosures are required to provide quantitative and qualitative information regarding the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new guidance is effective for annual reporting periods, and interim reporting periods within those annual periods, beginning after December 15, 2016. Early adoption is not permitted. Management is currently evaluating the impact of the adoption of this guidance on the Company’s financial statements.

In August 2014, the FASB amended existing guidance related to the disclosures about an entity’s ability to continue as a going concern. These amendments are intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. These amendments provide guidance to an organization’s management, with principles and definitions that are intended to reduce diversity in the timing and content of disclosures that are commonly provided by organizations in the financial statement footnotes. The amendments are effective for annual periods ending after December 15, 2016, and interim periods within annual periods beginning after December 15, 2016. Early application is permitted for annual or interim reporting periods for which the financial statements have not previously been issued. The effect of adopting this standard is not expected to have a material effect on the Company’s operating results or financial condition.

Note 2 – Going Concern Considerations and Future Plans

The consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business for the foreseeable future. However, the events and circumstances described in this Note create substantial doubt about the Company’s ability to continue as a going concern.

During the first nine months of 2014, we reported net loss attributable to common shareholders of $8.8 million, compared with net loss attributable to common shareholders of $2.4 million for the first nine months of 2013. The increase in 2014 compared to 2013 is primarily attributable to an increase in provision for loan losses expense, coupled with a decrease in net interest income and non-interest income.

 

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At September 30, 2014, we continued to be involved in various legal proceedings in which we dispute the material factual allegations. After conferring with our legal advisors, we believe we have meritorious grounds on which to prevail. If we do not prevail, the ultimate outcome of any one of these matters could have a material adverse effect on our financial condition, results of operations, or cash flows. These matters are more fully described in Note 13 – “Contingencies”.

Management determined that a material weakness existed in the Company’s internal control over financial reporting at June 30, 2014. The material weakness resulted in the Company restating its previously filed interim financial statements for the three and six month periods ended June 30, 2014. The restatement had the effect of increasing the Company’s reported net loss attributable to common shareholders from $672,000 to $6.3 million for the three months ended June 30, 2014 and from $1.6 million to $7.3 million for the six months ended June 30, 2014. Basic and diluted loss per common share increased from $(0.06) per share to $(0.53) per share for the three months ended June 30, 2014 and from $(0.14) per share to $(0.61) per share for the six months ended June 30, 2014. This restatement resulted in commercial real estate loan charge-offs of approximately $5.2 million, an increase in the provision for loan losses of $6.3 million, and an increase in loan collection expenses of $860,000 in the three and six month periods ended June 30, 2014.

For the year ended December 31, 2013, we reported a net loss to common shareholders of $3.4 million, compared to a net loss to common shareholders of $33.4 million for the year ended December 31, 2012. This loss coupled with the comprehensive loss for the year reduced shareholders equity to $35.9 million, from $47.2 million at the end of 2012. This reduction was attributable primarily to OREO expense of $4.5 million resulting from fair value write-downs driven by new appraisals and reduced marketing prices, net loss on sales, and ongoing operating expense, along with $4.7 million in loan collection expenses. The reduction was also attributable to a reduction in the fair value of securities of $8.4 million, net, as well as the accrual of dividends and accretion to preferred shareholders of $2.1 million. We also had lower net interest margin due to lower average loans outstanding, loans re-pricing at lower rates, and the level of non-performing loans in our portfolio.

In the fourth quarter of 2011, we began deferring interest payments on our junior subordinated notes, which resulted in a deferral of distributions on our trust preferred securities. If we cannot pay all unpaid deferred distributions on our trust preferred securities for more than twenty consecutive quarters, we will be in default, and the holders of our trust preferred securities would become entitled to payment of the full amount of outstanding principal plus accrued and unpaid interest. At September 30, 2014, cumulative accrued and unpaid interest on our junior subordinated notes totaled $2.0 million. Future cash dividends on our common stock are subject to the prior payment of all deferred distributions on our trust preferred securities.

In June 2011, the Bank agreed to a Consent Order with the FDIC and KDFI in which the Bank agreed, among other things, to improve asset quality, reduce loan concentrations, and maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. The Consent Order was included in our Current Report on 8-K filed on June 30, 2011. In October 2012, the Bank entered into a new Consent Order with the FDIC and KDFI again agreeing to maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. The Bank also agreed that if it should be unable to reach the required capital levels, and if directed in writing by the FDIC, then the Bank would within 30 days develop, adopt and implement a written plan to sell or merge itself into another federally insured financial institution or otherwise immediately obtain a sufficient capital investment into the Bank to fully meet the capital requirements.

We expect to continue to work with our regulators toward capital ratio compliance as outlined in the written capital plan previously submitted by the Bank. The new Consent Order also requires the Bank to continue to adhere to the plans implemented in response to the June 2011 Consent Order, and includes the substantive provisions of the June 2011 Consent Order. The new Consent Order was included in our Current Report on 8-K filed on September 19, 2012. As of September 30, 2014, the capital ratios required by the Consent Order were not met.

In order to meet these capital requirements, the Board of Directors and management are continuing to evaluate strategies to achieve the following objectives:

 

   

Increasing capital through a possible public offering or private placement of common stock to new and existing shareholders. We have engaged a financial advisor to assist our Board in evaluating our options for increasing capital and redeeming our Series A Preferred Stock.

 

   

Continuing to operate the Company and Bank in a safe and sound manner. This strategy may require us to reduce our lending concentrations, remediate non-performing loans, reduce the size of our balance sheet, and reduce other noninterest expense through the disposition of OREO.

 

   

Management succession and adding resources to the management team. John T. Taylor became CEO of PBI Bank in 2012 and CEO of the Company in 2013. In addition, we appointed new executives to lead key functions of our banking operations. John R. Davis became Chief Credit Officer of PBI Bank in 2012, with responsibility for establishing and executing credit quality policies and overseeing credit administration for the organization. We have also augmented our staffing in the commercial lending area, led by Joe C. Seiler.

 

   

Evaluating our internal processes and procedures, distribution of labor, and work-flow to ensure we have adequately and appropriately deployed resources in an efficient manner in the current environment.

 

   

Executing on our commitment to improve credit quality and reduce loan concentrations and balance sheet risk.

 

   

We have reduced the size of our loan portfolio significantly from $1.3 billion at December 31, 2010 to $638.4 million at September 30, 2014.

 

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Our Consent Order calls for us to reduce our construction and development loans to not more than 75% of total risk-based capital. We have now been in compliance for ten quarters. Construction and development loans totaled $33.7 million, or 44% of total risk-based capital, at September 30, 2014, down from $43.3 million, or 52% of total risk-based capital, at December 31, 2013.

 

   

Our Consent Order also requires us to reduce non-owner occupied commercial real estate loans, construction and development loans, and multi-family residential real estate loans as a group, to not more than 250% of total risk-based capital. We were not in compliance with this concentration limit at September 30, 2014. These loans totaled $206.9 million, or 270% of total risk-based capital, at September 30, 2014 and $237.0 million, or 284% of total risk-based capital, at December 31, 2013.

 

   

We have reduced the construction loan portfolio from $199.5 million at December 31, 2010 to $33.7 million at September 30, 2014. Our non-owner occupied commercial real estate loans declined from $293.3 million at December 31, 2010 to $130.3 million at September 30, 2014.

 

   

Executing on our commitment to sell other real estate owned and reinvest in quality income producing assets.

 

   

The remediation process for loans secured by real estate has led the Bank to acquire significant levels of OREO since 2010. The Bank acquired $20.6 million, $33.5 million, $41.9 million, and $90.8 million during 2013, 2012, 2011, and 2010, respectively. For the nine months ended September 30, 2014, we acquired $31.7 million of OREO.

 

   

We have incurred significant losses in disposing of this real estate. We incurred losses totaling $2.6 million, $9.3 million, $42.8 million, and $13.9 million in 2013, 2012, 2011, and 2010, respectively, from sales at less than carrying values and fair value write-downs attributable to declines in appraisal valuations and changes in our pricing strategies. During the nine months ended September 30, 2014, we incurred OREO losses totaling $795,000 comprised of $1.3 million in fair value write-downs from declining values as evidenced by new appraisals and reduced marketing prices in connection with our sales strategies, offset by $455,000 in net gain on sales of OREO.

 

   

To ensure we maximize the value we receive upon the sale of OREO, we continually evaluate sales opportunities. Proceeds from the sale of OREO totaled $7.3 million during the nine months ended September 30, 2014 and $30.8 million, $22.5 million, $26.0 million and $25.0 million during the years ended December 31, 2013, 2012, 2011, and 2010, respectively.

 

   

At December 31, 2013, the OREO portfolio consisted of 62% construction, development, and land assets. At September 30, 2014, this concentration decreased to 37%; however, the balance increased from $19.2 million to $20.6 million. Commercial real estate represents 31% of the OREO portfolio at September 30, 2014 compared with 19% at December 31, 2013. 1-4 family residential properties represent 21% of the OREO portfolio at September 30, 2014 compared with 16% at December 31, 2013, and multi-family properties represent 11% of the OREO portfolio at September 30, 2014, compared to 1% at December 31, 2013.

Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a consent order. Based on individual circumstances, the agencies may issue mandatory directives, impose monetary penalties, initiate changes in management, or take more serious adverse actions.

Note 3 – Securities

The fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:

 

     Amortized
Cost
     Gross
Unrealized

Gains
     Gross
Unrealized

Losses
    Fair Value  
     (in thousands)  

September 30, 2014

          

Available for sale

          

U.S. Government and federal agency

   $ 35,999       $ 218       $ (914   $ 35,303   

Agency mortgage-backed: residential

     123,647         1,361         (705     124,303   

State and municipal

     11,809         772         (8     12,573   

Corporate bonds

     18,066         1,272         (29     19,309   

Other debt securities

     572         86         —          658   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total available for sale

   $ 190,093       $ 3,709       $ (1,656   $ 192,146   
  

 

 

    

 

 

    

 

 

   

 

 

 

Held to maturity

          

State and municipal

   $ 42,386       $ 1,758       $ —        $ 44,144   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total held to maturity

   $ 42,386       $ 1,758       $ —        $ 44,144   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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December 31, 2013

          

Available for sale

          

U.S. Government and federal agency

   $ 31,026       $ 284       $ (1,444   $ 29,866   

Agency mortgage-backed: residential

     102,435         458         (1,950     100,943   

State and municipal

     12,965         608         (28     13,545   

Corporate bonds

     18,002         769         (610     18,161   

Other debt securities

     572         60         —          632   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total debt securities

     165,000         2,179         (4,032     163,147   

Equity

     135         62         —          197   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total available for sale

   $ 165,135       $ 2,241       $ (4,032   $ 163,344   
  

 

 

    

 

 

    

 

 

   

 

 

 

Held to maturity

          

State and municipal

   $ 43,612       $ 3       $ (668   $ 42,947   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total held to maturity

   $ 43,612       $ 3       $ (668   $ 42,947   
  

 

 

    

 

 

    

 

 

   

 

 

 

Sales and calls of available for sale securities were as follows:

 

     Three Months
Ended

September 30,
     Nine Months Ended
September 30,
 
     2014      2013      2014      2013  
     (in thousands)      (in thousands)  

Proceeds

   $ 4,147       $ 804       $ 4,151       $ 2,712   

Gross gains

     86         24         132         728   

Gross losses

     40         —           —           1   

The amortized cost and fair value of the debt investment securities portfolio are shown by contractual maturity. Contractual maturities may differ from actual maturities if issuers have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities not due at a single maturity date are detailed separately.

 

     September 30, 2014  
     Amortized
Cost
     Fair
Value
 
     (in thousands)  

Maturity

     

Available for sale

     

Within one year

   $ 18,789       $ 19,365   

One to five years

     12,695         13,657   

Five to ten years

     34,390         34,163   

Beyond ten years

     572         658   

Agency mortgage-backed: residential

     123,647         124,303   
  

 

 

    

 

 

 

Total

   $ 190,093       $ 192,146   
  

 

 

    

 

 

 

Held to maturity

     

One to five years

   $ 6,871       $ 7,114   

Five to ten years

     31,392         32,718   

Beyond ten years

     4,123         4,312   
  

 

 

    

 

 

 

Total

   $ 42,386       $ 44,144   
  

 

 

    

 

 

 

Securities pledged at September 30, 2014 and December 31, 2013 had carrying values of approximately $63.5 million and $84.2 million, respectively, and were pledged to secure public deposits and repurchase agreements.

 

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Table of Contents

Securities with unrealized losses at September 30, 2014 and December 31, 2013, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position, are as follows:

 

     Less than 12 Months     12 Months or More     Total  

Description of Securities

   Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
 
     (in thousands)  

September 30, 2014

               

Available for sale

               

U.S. Government and federal

agency

   $ 7,879       $ (71   $ 18,517       $ (843   $ 26,396       $ (914

Agency mortgage-backed:

residential

     17,876         (67     32,080         (638     49,956         (705

State and municipal

     92         (3     478         (5     570         (8

Corporate bonds

     —           —          1,760         (29     1,760         (29
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total temporarily impaired

   $ 25,847       $ (141   $ 52,835       $ (1,515   $ 78,682       $ (1,656
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

December 31, 2013

               

Available for sale

               

U.S. Government and federal

agency

   $ 24,129       $ (1,444   $ —         $ —        $ 24,129       $ (1,444

Agency mortgage-backed:

residential

     58,257         (1,672     10,344         (278     68,601         (1,950

State and municipal

     458         (28     —           —          458         (28

Corporate bonds

     11,313         (610     —           —          11,313         (610
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total temporarily impaired

   $ 94,157       $ (3,754   $ 10,344       $ (278   $ 104,501       $ (4,032
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Held to maturity

               

State and municipal

   $ 39,743       $ (654   $ 1,031       $ (14   $ 40,774       $ (668
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total temporarily impaired

   $ 39,743       $ (654   $ 1,031       $ (14   $ 40,774       $ (668
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

There were no held to maturity securities in an unrealized loss position at September 30, 2014.

The Company evaluates securities for other than temporary impairment (OTTI) on a quarterly basis. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, underlying credit quality of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the sector or industry trends and cycles affecting the issuer, and the results of reviews of the issuer’s financial condition. Management currently intends to hold all securities with unrealized losses until recovery, which for fixed income securities may be at maturity. As of September 30, 2014, management does not believe securities within our portfolio with unrealized losses should be classified as other than temporarily impaired.

 

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Table of Contents

Note 4 – Loans

 

Loans were as follows:    September 30,
2014
    December 31,
2013
 
     (in thousands)  

Commercial

   $ 57,509      $ 52,878   

Commercial Real Estate:

    

Construction

     33,700        43,326   

Farmland

     68,357        71,189   

Nonfarm nonresidential

     189,341        232,026   

Residential Real Estate:

    

Multi-family

     42,857        46,858   

1-4 Family

     204,375        228,505   

Consumer

     12,017        14,365   

Agriculture

     29,648        19,199   

Other

     556        980   
  

 

 

   

 

 

 

Subtotal

     638,360        709,326   

Less: Allowance for loan losses

     (24,198     (28,124
  

 

 

   

 

 

 

Loans, net

   $ 614,162      $ 681,202   
  

 

 

   

 

 

 

The following table presents the activity in the allowance for loan losses by portfolio segment for the three months ended September 30, 2014 and 2013:

 

     Commercial     Commercial
Real Estate
    Residential
Real
Estate
    Consumer     Agriculture     Other     Total  
     (in thousands)  

September 30, 2014:

            

Beginning balance

   $ 3,115      $ 14,359      $ 6,873      $ 339      $ 435      $ 12      $ 25,133   

Provision for loan losses

     (471     (336     803        28        (8     (16     —     

Loans charged off

     (216     (742     (806     (59     —          (1 )     (1,824

Recoveries

     108        458        284        23        2        14        889   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 2,536      $ 13,739      $ 7,154      $ 331      $ 429      $ 9      $ 24,198   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

September 30, 2013:

            

Beginning balance

   $ 4,648      $ 21,022      $ 10,790      $ 594      $ 487      $ 18      $ 37,559   

Provision for loan losses

     (539     196        612        61        (67     (13 )     250   

Loans charged off

     (965     (4,726     (1,272     (99     (9     —          (7,071

Recoveries

     443        456        63        44        10        —          1,016   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 3,587      $ 16,948      $ 10,193      $ 600      $ 421      $ 5      $ 31,754   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

The following table presents the activity in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2014 and 2013:

 

     Commercial     Commercial
Real Estate
    Residential
Real
Estate
    Consumer     Agriculture     Other     Total  
     (in thousands)  

September 30, 2014:

            

Beginning balance

   $ 3,221      $ 16,414      $ 7,762      $ 416      $ 305      $ 6      $ 28,124   

Provision for loan losses

     (355     4,611        1,897        19        143        (15 )     6,300   

Loans charged off

     (670     (9,110     (3,162     (238     (30     (19 )     (13,229

Recoveries

     340        1,824        657        134        11        37        3,003   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 2,536      $ 13,739      $ 7,154      $ 331      $ 429      $ 9      $ 24,198   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

September 30, 2013:

            

Beginning balance

   $ 4,402      $ 34,768      $ 16,235      $ 857      $ 403      $ 15      $ 56,680   

Provision for loan losses

     94        72        522        140        (118 )     (10 )     700   

Loans charged off

     (2,073     (18,904     (6,748     (620 )     (92 )     —          (28,437

Recoveries

     1,164        1,012        184        223        228        —          2,811   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 3,587      $ 16,948      $ 10,193      $ 600      $ 421      $ 5      $ 31,754   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of September 30, 2014:

 

     Commercial      Commercial
Real Estate
     Residential
Real
Estate
     Consumer      Agriculture      Other      Total  
     (in thousands)  

Allowance for loan losses:

                    

Ending allowance balance attributable to loans:

                    

Individually evaluated for impairment

   $ 142       $ 1,399       $ 246       $ 1       $ —         $ —         $ 1,788   

Collectively evaluated for impairment

     2,394         12,340         6,908         330         429         9         22,410   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending allowance balance

   $ 2,536       $ 13,739       $ 7,154       $ 331       $ 429       $ 9       $ 24,198   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

                    

Loans individually evaluated for impairment

   $ 2,116       $ 50,420       $ 25,673       $ 51       $ 271       $ 164       $ 78,695   

Loans collectively evaluated for impairment

     55,393         240,978         221,559         11,966         29,377         392         559,665   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending loans balance

   $ 57,509       $ 291,398       $ 247,232       $ 12,017       $ 29,648       $ 556       $ 638,360   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of December 31, 2013:

 

     Commercial      Commercial
Real Estate
     Residential
Real
Estate
     Consumer      Agriculture      Other      Total  
     (in thousands)  

Allowance for loan losses:

                    

Ending allowance balance attributable to loans:

                    

Individually evaluated for impairment

   $ 290       $ 2,345       $ 827       $ 9       $ —         $ —         $ 3,471   

Collectively evaluated for impairment

     2,931         14,069         6,935         407         305         6         24,653   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending allowance balance

   $ 3,221       $ 16,414       $ 7,762       $ 416       $ 305       $ 6       $ 28,124   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

                    

Loans individually evaluated for impairment

   $ 4,995       $ 94,330       $ 49,512       $ 93       $ 322       $ 631       $ 149,883   

Loans collectively evaluated for impairment

     47,883         252,211         225,851         14,272         18,877         349         559,443   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending loans balance

   $ 52,878       $ 346,541       $ 275,363       $ 14,365       $ 19,199       $ 980       $ 709,326   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Impaired Loans

Impaired loans include restructured loans and loans on nonaccrual or classified as doubtful, whereby collection of the total amount is improbable, or loss, whereby all or a portion of the loan has been written off or a specific allowance for loss has been provided.

The following table presents information related to loans individually evaluated for impairment by class of loans as of and for the three and nine months ended September 30, 2014:

 

     Unpaid
Principal
Balance
     Recorded
Investment
     Allowance
For Loan
Losses
Allocated
     Three Months Ended
September 30, 2014
     Nine Months Ended
September 30, 2014
 
              Average
Recorded
Investment
     Interest
Income
Recognized
     Average
Recorded
Investment
     Interest
Income
Recognized
     Cash Basis
Income
Recognized
 
     (in thousands)  

With No Related Allowance Recorded:

                       

Commercial

   $ 1,128       $ 831       $ —         $ 822       $ —         $ 1,162       $ 55       $ 55   

Commercial real estate:

                       

Construction

     100         21         —           21         —           20         —           —     

Farmland

     2,084         1,805         —           2,064         27         2,763         75         48   

Nonfarm nonresidential

     4,534         1,256         —           1,186         1         1,237         128         127   

Residential real estate:

                       

Multi-family

     83         83         —           85         —           163         —           —     

1-4 Family

     10,366         8,093         —           7,836         28        8,534         208         180   

Consumer

     12         12         —           16         —           10         —           —     

Agriculture

     284         271         —           249         —           280         3         3   

Other

     57         57         —           63         3        55         12         9   

With An Allowance Recorded:

                       

Commercial

     1,426         1,285         142         1,312         11         2,353         31         —     

Commercial real estate:

                       

Construction

     4,929         4,446         103         4,466         8         6,499         25         —     

Farmland

     5,454         3,512         —           3,620         —           3,802         —           —     

Nonfarm nonresidential

     48,108         39,380         1,296         39,191         290         56,247         792         —     

Residential real estate:

                          —     

Multi-family

     4,268         4,268         84         4,274         52         6,364         128         —     

1-4 Family

     15,129         13,229         162         13,867         142         17,844         417         —     

Consumer

     40         39         1         41         1         53         2         —     

Agriculture

     —           —           —           —           —           —           —           —     

Other

     351         107         —           106         3         234         3         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 98,353       $ 78,695       $ 1,788       $ 79,219       $ 566       $ 107,620       $ 1,879       $ 422   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

16


Table of Contents

The following table presents loans individually evaluated for impairment by class of loan as of December 31, 2013:

 

     Unpaid
Principal
Balance
     Recorded
Investment
     Allowance
For Loan
Losses
Allocated
     Average
Recorded
Investment
     Interest
Income
Recognized
     Cash
Basis
Income
Recognized
 
     (in thousands)  

With No Related Allowance Recorded:

                 

Commercial

   $ 2,131       $ 1,533       $ —         $ 1,622       $ 30       $ 30   

Commercial real estate:

                 

Construction

     64         38         —           467         164         164   

Farmland

     4,074         3,898         —           4,259         268         268   

Nonfarm nonresidential

     1,568         1,404         —           1,724         367         366   

Residential real estate:

                 

Multi-family

     444         392         —           541         3         3   

1-4 Family

     11,011         10,083         —           11,533         115         116   

Consumer

     9         9         —           21         —           —     

Agriculture

     401         322         —           213         —           —     

Other

     14         13         —           10         11         11   

With An Allowance Recorded:

                 

Commercial

     3,734         3,462         290         3,905         99         —     

Commercial real estate:

                 

Construction

     10,409         9,264         218         20,173         88         —     

Farmland

     6,117         4,238         65         5,579         37         —     

Nonfarm nonresidential

     94,508         75,488         2,062         77,726         1,324         —     

Residential real estate:

                 

Multi-family

     13,883         12,117         393         13,121         208         —     

1-4 Family

     31,327         26,920         434         27,755         557         —     

Consumer

     84         84         9         134         3         —     

Agriculture

     —           —           —           2         —           —     

Other

     861         618         —           539         17         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 180,639       $ 149,883       $ 3,471       $ 169,324       $ 3,291       $ 958   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

17


Table of Contents

Troubled Debt Restructuring

A troubled debt restructuring (TDR) occurs when the Company has agreed to a loan modification in the form of a concession for a borrower who is experiencing financial difficulty. The majority of the Company’s TDRs involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired and the Company has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower.

The following table presents the types of TDR loan modifications by portfolio segment outstanding as of September 30, 2014 and December 31, 2013:

 

     TDRs
Performing to
Modified
Terms
     TDRs Not
Performing to
Modified
Terms
     Total
TDRs
 
     (in thousands)  

September 30, 2014

        

Commercial

        

Rate reduction

   $ 19       $ —         $ 19   

Principal deferral

     —           869         869   

Commercial Real Estate:

        

Construction

        

Rate reduction

     269         3,397         3,666   

Principal deferral

     355         —           355   

Farmland

        

Principal deferral

     —           2,365         2,365   

Nonfarm nonresidential

        

Rate reduction

     12,392         14,784         27,176   

Principal deferral

     675         —           675   

Residential Real Estate:

        

Multi-family

        

Rate reduction

     4,268         —           4,268   

1-4 Family

        

Rate reduction

     10,096         —           10,096   

Consumer

        

Rate reduction

     40         —           40   
  

 

 

    

 

 

    

 

 

 

Total TDRs

   $ 28,114       $ 21,415       $ 49,529   
  

 

 

    

 

 

    

 

 

 

 

18


Table of Contents
     TDRs
Performing to
Modified
Terms
     TDRs Not
Performing to
Modified
Terms
     Total
TDRs
 
     (in thousands)  

December 31, 2013

        

Commercial

        

Rate reduction

   $ 1,933       $ —         $ 1,933   

Principal deferral

     —           869         869   

Commercial Real Estate:

        

Construction

        

Rate reduction

     275         6,345         6,620   

Principal deferral

     499         —           499   

Farmland

        

Rate reduction

     150         —           150   

Principal deferral

     —           2,365         2,365   

Nonfarm nonresidential

        

Rate reduction

     22,457         21,235         43,692   

Principal deferral

     691         —           691   

Interest only payments

     2,439         1,489         3,928   

Residential Real Estate:

        

Multi-family

        

Rate reduction

     4,354         6,655         11,009   

Interest only payments

     641         —           641   

1-4 Family

        

Rate reduction

     10,312         7,958         18,270   

Consumer

        

Rate reduction

     84         —           84   

Other

        

Rate reduction

     511         —           511   
  

 

 

    

 

 

    

 

 

 

Total TDRs

   $ 44,346       $ 46,916       $ 91,262   
  

 

 

    

 

 

    

 

 

 

At September 30, 2014 and December 31, 2013, 57% and 49%, respectively, of the Company’s TDRs were performing according to their modified terms. The Company allocated $990,000 and $2.9 million in reserves to borrowers whose loan terms have been modified in TDRs as of September 30, 2014, and December 31, 2013, respectively. The Company has committed to lend additional amounts totaling $261,000 as of December 31, 2013 to borrowers with outstanding loans classified as TDRs, with no additional commitments to lend as of September 30, 2014.

Management periodically reviews renewals/modifications of previously identified TDRs, for which there was no principal forgiveness, to consider if it is appropriate to remove the TDR classification. If the borrower is no longer experiencing financial difficulty and the renewal/modification did not contain a concessionary interest rate or other concessionary terms, management considers the potential removal of the TDR classification. If deemed appropriate, the TDR classification is removed as the borrower has complied with the terms of the loan at the date of renewal/modification and there was a reasonable expectation that the borrower would continue to comply with the terms of the loan subsequent to the date of the renewal/modification. In this instance, the TDR was originally considered a restructuring in a prior year as a result of a modification with an interest rate that was not commensurate with the risk of the underlying loan. Additionally, TDR classification can be removed in circumstances in which the Company performs a non-concessionary re-modification of the loan at terms that were considered to be at market for loans with comparable risk. Management expects the borrower will continue to perform under the re-modified terms based on the borrower’s past history of performance.

As of June 30, 2014, the TDR classification was removed from two loans that met the requirements as discussed above. These two loans totaled $7.3 million at December 31, 2013. These loans are no longer evaluated individually for impairment.

 

19


Table of Contents

No TDR loan modifications occurred during the three or nine months ended September 30, 2014. The following tables present a summary of the types of TDR loan modifications by portfolio type that occurred during the three months ended September 30, 2013:

 

     TDRs
Performing to
Modified
Terms
     TDRs Not
Performing to
Modified
Terms
     Total
TDRs
 
     (in thousands)  

September 30, 2013

     

Residential Real Estate:

        

1-4 Family

        

Rate reduction

   $ 363       $ —         $ 363   

Consumer

        

Rate reduction

     26         —           26   
  

 

 

    

 

 

    

 

 

 

Total TDRs

   $ 389       $ —         $ 389   
  

 

 

    

 

 

    

 

 

 

As of September 30, 2013, 100% of the Company’s TDRs that occurred during the three months ended September 30, 2013, were performing according to their modified terms. The Company allocated $36,000 in reserves to customers whose loan terms have been modified during the three months ended September 30, 2013. For modifications occurring during the three month period ended September 30, 2013, the post-modification balances approximate the pre-modification balances.

The following tables present a summary of the types of TDR loan modifications by portfolio type that occurred during the nine months ended September 30, 2013:

 

     TDRs
Performing to
Modified
Terms
     TDRs Not
Performing to
Modified
Terms
     Total
TDRs
 
     (in thousands)  

September 30, 2013

        

Commercial:

        

Rate reduction

   $ 39       $ —         $ 39   

Commercial Real Estate:

        

Construction

        

Rate reduction

     —           1,291         1,291   

Principal deferral

     499         —           499   

Nonfarm nonresidential

        

Rate reduction

     388         —           388   

Residential Real Estate:

        

1-4 Family

        

Rate reduction

     1,254         —           1,254   

Consumer:

        

Rate reduction

     64         —           64   
  

 

 

    

 

 

    

 

 

 

Total TDRs

   $ 2,244       $ 1,291       $ 3,535   
  

 

 

    

 

 

    

 

 

 

During the first nine months of 2013, approximately $1.3 million TDRs defaulted on their restructured loan and the default occurred within the 12 month period following the loan modification. These defaults were construction and development loans. A default is considered to have occurred once the TDR is past due 90 days or more or it has been placed on nonaccrual.

Nonperforming Loans

Nonperforming loans include impaired loans not on accrual and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment.

 

20


Table of Contents

The following table presents the recorded investment in nonaccrual and loans past due 90 days and still on accrual by class of loan as of September 30, 2014, and December 31, 2013:

 

     Nonaccrual      Loans Past Due 90 Days
And Over Still Accruing
 
     September 30,
2014
     December 31,
2013
     September 30,
2014
     December 31,
2013
 
     (in thousands)  

Commercial

   $ 1,959       $ 2,886       $ —         $ —     

Commercial Real Estate:

           

Construction

     3,843         8,528         —           —     

Farmland

     5,318         7,844         —           —     

Nonfarm nonresidential

     21,793         48,447         —           —     

Residential Real Estate:

           

Multi-family

     83         7,513         —           —     

1-4 Family

     11,227         26,098         —           230   

Consumer

     12         9         —           2   

Agriculture

     271         322         —           —     

Other

     164         120         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 44,670       $ 101,767       $ —         $ 232   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table presents the aging of the recorded investment in past due loans as of September 30, 2014 and December 31, 2013:

 

     30 – 59
Days
Past Due
     60 – 89
Days
Past Due
     90 Days
And Over
Past Due
     Nonaccrual      Total
Past Due
And
Nonaccrual
 
     (in thousands)  

September 30, 2014

              

Commercial

   $ 201       $ 319       $ —         $ 1,959       $ 2,479   

Commercial Real Estate:

              

Construction

     —           —           —           3,843         3,843   

Farmland

     654         47         —           5,318         6,019   

Nonfarm nonresidential

     83         2,680         —           21,793         24,556   

Residential Real Estate:

              

Multi-family

     —           —           —           83         83   

1-4 Family

     2,479         271         —           11,227         13,977   

Consumer

     87         16         —           12         115   

Agriculture

     3         —           —           271         274   

Other

     —           —           —           164         164   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,507       $ 3,333       $ —         $ 44,670       $ 51,510   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     30 – 59
Days
Past Due
     60 – 89
Days
Past Due
     90 Days
And Over
Past Due
     Nonaccrual      Total
Past Due
And
Nonaccrual
 
     (in thousands)  

December 31, 2013

              

Commercial

   $ 156       $ 123       $ —         $ 2,886       $ 3,165   

Commercial Real Estate:

              

Construction

     261         —           —           8,528         8,789   

Farmland

     484         41         —           7,844         8,369   

Nonfarm nonresidential

     4,375         —           —           48,447         52,822   

Residential Real Estate:

              

Multi-family

     1,181         —           —           7,513         8,694   

1-4 Family

     4,059         577         230         26,098         30,964   

Consumer

     145         34         2         9         190   

Agriculture

     35         —           —           322         357   

Other

     —           —           —           120         120   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 10,696       $ 775       $ 232       $ 101,767       $ 113,470   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

21


Table of Contents

Credit Quality Indicators

We categorize all loans into risk categories at origination based upon original underwriting. Thereafter, we categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends. Additionally, loans are analyzed continuously through our internal and external loan review processes. Borrower relationships in excess of $500,000 are routinely analyzed through our credit administration processes which classify the loans as to credit risk. The following definitions are used for risk ratings:

Watch – Loans classified as watch are those loans which have experienced a potentially adverse development which necessitates increased monitoring.

Special Mention – Loans classified as special mention do not have all of the characteristics of substandard or doubtful loans. They have one or more deficiencies which warrant special attention and which corrective action, such as accelerated collection practices, may remedy.

Substandard – Loans classified as substandard are those loans with clear and defined weaknesses such as a highly leveraged position, unfavorable financial ratios, uncertain repayment sources or poor financial condition which may jeopardize the repayment of the debt as contractually agreed. They are characterized by the distinct possibility we will sustain some losses if the deficiencies are not corrected.

Doubtful – Loans classified as doubtful are those loans which have characteristics similar to substandard loans but with an increased risk that collection or liquidation in full is highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be “Pass” rated loans. As of September 30, 2014, and December 31, 2013, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

 

     Pass      Watch      Special
Mention
     Substandard      Doubtful      Total  
     (in thousands)  

September 30, 2014

              

Commercial

   $ 45,432       $ 4,729       $ —         $ 7,348       $ —         $ 57,509   

Commercial Real Estate:

                 

Construction

     22,194         6,211         —           5,295         —           33,700   

Farmland

     51,795         8,458         —           8,104         —           68,357   

Nonfarm nonresidential

     112,998         28,091         3,798         44,454         —           189,341   

Residential Real Estate:

                 

Multi-family

     30,231         7,124         —           5,502         —           42,857   

1-4 Family

     144,160         27,652         318         32,245         —           204,375   

Consumer

     10,664         551         315         487         —           12,017   

Agriculture

     28,300         895         —           453         —           29,648   

Other

     392         —           —           164         —           556   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 446,166       $ 83,711       $ 4,431       $ 104,052       $ —         $ 638,360   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Pass      Watch      Special
Mention
     Substandard      Doubtful      Total  
     (in thousands)  

December 31, 2013

              

Commercial

   $ 35,438       $ 8,517       $ 329       $ 8,594       $ —         $ 52,878   

Commercial Real Estate:

                 

Construction

     16,706         10,771         2,277         13,572         —           43,326   

Farmland

     46,909         9,121         1,735         13,424         —           71,189   

Nonfarm nonresidential

     93,327         51,522         734         86,443         —           232,026   

Residential Real Estate:

                 

Multi-family

     16,506         17,320         —           13,032         —           46,858   

1-4 Family

     130,833         43,785         784         53,103         —           228,505   

Consumer

     12,718         968         6         673         —           14,365   

Agriculture

     16,742         1,802         —           655         —           19,199   

Other

     350         510         —           120         —           980   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 369,529       $ 144,316       $ 5,865       $ 189,616       $ —         $ 709,326   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

22


Table of Contents

During the first quarter of 2014, management instituted a new risk category within its pass classification. The purpose was to better identify certain loans where the borrower’s sustained satisfactory repayment history was deemed a more relevant predictor of future loss than certain underwriting criteria at origination. The establishment of this new pass risk category helps to ensure the watch risk category remains transitory and event driven in nature. A total of $24.2 million in commercial, $8.5 million in residential, and $2.2 million in agriculture loans were reclassified from watch to the new pass risk category during the first quarter.

Note 5 – Other Real Estate Owned

Other real estate owned (OREO) is real estate acquired as a result of foreclosure or by deed in lieu of foreclosure. It is classified as real estate owned until such time as it is sold. When property is acquired as a result of foreclosure or by deed in lieu of foreclosure, it is recorded at its fair market value less cost to sell. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. Costs incurred in order to perfect the lien prior to foreclosure may be capitalized if the fair value less the cost to sell exceeds the balance of the loan at the time of transfer to OREO. Examples of eligible costs to be capitalized are payments of delinquent property taxes to clear tax liens or payments to contractors and subcontractors to clear mechanics’ liens. Subsequent reductions in fair value are recorded as non-interest expense.

To determine the fair value of OREO for smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. If the internally evaluated market price is below our underlying investment in the property, appropriate write-downs are taken. For larger dollar residential and commercial real estate properties, we obtain a new appraisal of the subject property or have staff from our special assets group or in our centralized appraisal department evaluate the latest in-file appraisal in connection with the transfer to other real estate owned. We typically obtain updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent.

The following table presents the major categories of OREO at the period-ends indicated:

 

     September 30,
2014
    December 31,
2013
 
     (in thousands)  

Commercial Real Estate:

    

Construction, land development, and other land

   $ 20,632      $ 19,199   

Farmland

     1,213        695   

Nonfarm nonresidential

     15,699        6,064   

Residential Real Estate:

    

Multi-family

     5,990        248   

1-4 Family

     11,504        4,916   
  

 

 

   

 

 

 
     55,038        31,122   

Valuation allowance

     (531     (230
  

 

 

   

 

 

 
   $ 54,507      $ 30,892   
  

 

 

   

 

 

 

 

     For the Three
Months Ended
September 30,
    For the Nine
Months Ended
September 30,
 
     2014     2013     2014     2013  
     (in thousands)     (in thousands)  

OREO Valuation Allowance Activity:

        

Beginning balance

   $ 199      $ 747      $ 230      $ 1,154   

Provision to allowance

     600        300        1,250        1,584   

Write-downs

     (268     (450     (949     (2,141
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 531      $ 597      $ 531      $ 597   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

23


Table of Contents

Net activity relating to other real estate owned during the nine months ended September 30, 2014 and 2013 is as follows:

 

     2014     2013  
     (in thousands)  

OREO Activity

    

OREO as of January 1

   $ 30,892      $ 43,671   

Real estate acquired

     31,663        18,542   

Valuation adjustment writedowns

     (1,250     (1,584

Gain/(Loss) on sale

     455        (190

Proceeds from sale of properties

     (7,253     (18,582
  

 

 

   

 

 

 

OREO as of September 30

   $ 54,507      $ 41,857   
  

 

 

   

 

 

 

Expenses related to other real estate owned include:

 

     Three Months
Ended

September 30,
    Nine Months Ended
September 30,
 
     2014     2013     2014     2013  
     (in thousands)     (in thousands)  

Net (gain) loss on sales

   $ (401   $ (169   $ (455   $ 190   

Provision to allowance

     600        300        1,250        1,584   

Operating expense

     361        538        1,201        1,343   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 560      $ 669      $ 1,996      $ 3,117   
  

 

 

   

 

 

   

 

 

   

 

 

 

Note 6 – Deposits

The following table shows deposits by category:

 

     September 30,
2014
     December 31,
2013
 
     (in thousands)  

Non-interest bearing

   $ 110,165       $ 107,486   

Interest checking

     76,431         84,626   

Money market

     100,890         79,349   

Savings

     36,364         36,292   

Certificates of deposit

     609,682         679,952   
  

 

 

    

 

 

 

Total

   $ 933,532       $ 987,705   
  

 

 

    

 

 

 

Time deposits of $100,000 or more were $269.2 million and $295.0 million at September 30, 2014 and December 31, 2013, respectively.

Scheduled maturities of total time deposits at September 30, 2014 are as follows (in thousands):

 

Year 1

   $ 426,770   

Year 2

     135,887   

Year 3

     12,480   

Year 4

     7,013   

Year 5

     27,479   

Thereafter

     53   
  

 

 

 
   $ 609,682   
  

 

 

 

Note 7 – Advances from the Federal Home Loan Bank

Advances from the Federal Home Loan Bank were as follows:

 

    

September 30,

2014

    

December 31,

2013

 
     (in thousands)  

Monthly amortizing advances with fixed rates from 0.00% to 5.25% and maturities ranging from 2014 through 2033, averaging 2.76% for 2014

   $ 16,940       $ 4,492   
  

 

 

    

 

 

 

 

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Each advance is payable based upon the terms on agreement, with a prepayment penalty. The advances are collateralized by first mortgage loans. The borrowing capacity is based on the market value of the underlying pledged loans. At September 30, 2014, our additional borrowing capacity with the FHLB was $10.1 million. The availability of our borrowing capacity could be affected by our financial condition and the FHLB could require additional collateral or, among other things, exercise its right to deny a funding request, at its discretion. Additionally, any new advances are limited to a one year maturity or less.

Note 8 – Fair Values Measurement

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. We use various valuation techniques to determine fair value, including market, income and cost approaches. There are three levels of inputs that may be used to measure fair values:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets an entity has the ability to access as of the measurement date, or observable inputs.

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. When that occurs, we classify the fair value hierarchy on the lowest level of input that is significant to the fair value measurement. We used the following methods and significant assumptions to estimate fair value.

Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges, if available. This valuation method is classified as Level 1 in the fair value hierarchy. For securities where quoted prices are not available, fair values are calculated on market prices of similar securities, or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Matrix pricing relies on the securities’ relationship to similarly traded securities, benchmark curves, and the benchmarking of like securities. Matrix pricing utilizes observable market inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. In instances where broker quotes are used, these quotes are obtained from market makers or broker-dealers recognized to be market participants. This valuation method is classified as Level 2 in the fair value hierarchy. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators. This valuation method is classified as Level 3 in the fair value hierarchy. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

Impaired Loans: An impaired loan is evaluated at the time the loan is identified as impaired and is recorded at fair value less costs to sell. Fair value is measured based on the value of the collateral securing the loan and is classified as Level 3 in the fair value hierarchy. Fair value is determined using several methods. Generally, the fair value of real estate is determined based on appraisals by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.

Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. These routine adjustments are made to adjust the value of a specific property relative to comparable properties for variations in qualities such as location, size, and income production capacity relative to the subject property of the appraisal. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

We routinely apply an internal discount to the value of appraisals used in the fair value evaluation of our impaired loans. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to 25% for real estate that is determined (1) to have a thin trading market or (2) to be specialized collateral. This is in addition to estimated discounts for cost to sell of six to ten percent.

We also apply discounts to the expected fair value of collateral for impaired loans where the likely resolution involves litigation or foreclosure. Resolution of this nature generally results in receiving lower values for real estate collateral in a more aggressive sales environment. We have utilized discounts ranging from 10% to 33% in our impairment evaluations when applicable.

 

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Table of Contents

Impaired loans are evaluated quarterly for additional impairment. We obtain updated appraisals on properties securing our loans when circumstances are warranted such as at the time of renewal or when market conditions have significantly changed. This determination is made on a property-by-property basis in light of circumstances in the broader economic climate and our assessment of deterioration of real estate values in the market in which the property is located. The first stage of our assessment involves management’s inspection of the property in question. Management also engages in conversations with local real estate professionals, investors, and market makers to determine the likely marketing time and value range for the property. The second stage involves an assessment of current trends in the regional market. After thorough consideration of these factors, management will either internally evaluate fair value or order a new appraisal.

Other Real Estate Owned (OREO): OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or internal market evaluation less cost to sell. Our quarterly evaluations of OREO for impairment are driven by property type. For smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. Based on these consultations, we determine asking prices for OREO properties we are marketing for sale. If the internally evaluated fair value is below our recorded investment in the property, appropriate write-downs are taken.

For larger dollar commercial real estate properties, we obtain a new appraisal of the subject property or have staff in our special assets group or centralized appraisal department evaluate the latest in-file appraisal in connection with the transfer to other real estate owned. In some of these circumstances, an appraisal is in process at quarter end, and we must make our best estimate of the fair value of the underlying collateral based on our internal evaluation of the property, review of the most recent appraisal, and discussions with the currently engaged appraiser. We generally obtain updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent.

We routinely apply an internal discount to the value of appraisals used in the fair value evaluation of our OREO. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to 25% for real estate that is determined (1) to have a thin trading market or (2) to be specialized collateral. This is in addition to estimated discounts for cost to sell of six to ten percent.

Financial assets measured at fair value on a recurring basis at September 30, 2014 and December 31, 2013 are summarized below:

 

            Fair Value Measurements at September 30, 2014 Using  
            (in thousands)  

Description

   Carrying
Value
     Quoted Prices In
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable
Inputs

(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Available for sale securities

           

U.S. Government and federal agency

   $ 35,303       $ —         $ 35,303       $ —     

Agency mortgage-backed: residential

     124,303         —           124,303         —     

State and municipal

     12,573         —           12,573         —     

Corporate bonds

     19,309         —           19,309         —     

Other debt securities

     658         —           —           658   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 192,146       $ —         $ 191,488       $ 658   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
            Fair Value Measurements at December 31, 2013 Using  
            (in thousands)  

Description

   Carrying Value      Quoted Prices In
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable
Inputs

(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Available for sale securities

           

U.S. Government and federal agency

   $ 29,866       $ —         $ 29,866       $ —     

Agency mortgage-backed: residential

     100,943         —           100,943         —     

State and municipal

     13,545         —           13,545         —     

Corporate bonds

     18,161         —           18,161         —     

Other debt securities

     632         —           —           632   

Equity securities

     197         197         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 163,344       $ 197       $ 162,515       $ 632   
  

 

 

    

 

 

    

 

 

    

 

 

 

There were no transfers between Level 1 and Level 2 during 2014 or 2013.

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the periods ended September 30, 2014 and 2013:

 

     Other Debt
Securities
 
     2014      2013  
     (in thousands)  

Balances of recurring Level 3 assets at January 1

   $ 632       $ 618   

Total gain (loss) for the period:

     

Included in other comprehensive income (loss)

     26         (12
  

 

 

    

 

 

 

Balance of recurring Level 3 assets at September 30

   $ 658       $ 606   
  

 

 

    

 

 

 

Our other debt security valuation is determined internally by calculating discounted cash flows using the security’s coupon rate of 6.5% and an estimated current market rate of 8.00% based upon the current yield curve plus spreads that adjust for volatility, credit risk, and optionality. We also consider the issuer’s publicly filed financial information as well as assumptions regarding the likelihood of deferrals and defaults.

Financial assets measured at fair value on a non-recurring basis are summarized below:

 

            Fair Value Measurements at September 30, 2014 Using  
            (in thousands)  

Description

   Carrying Value      Quoted Prices In
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable
Inputs

(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Impaired loans:

        

Commercial

   $ 1,143       $ —         $ —         $ 1,143   

Commercial real estate:

           

Construction

     4,343         —           —           4,343   

Farmland

     3,512         —           —           3,512   

Nonfarm nonresidential

     38,084         —           —           38,084   

Residential real estate:

           

Multi-family

     4,184         —           —           4,184   

1-4 Family

     13,067         —           —           13,067   

Consumer

     38         —           —           38   

Other

     107         —           —           107   

Other real estate owned, net:

           

Commercial real estate:

           

Construction

     20,433         —           —           20,433   

Farmland

     1,202         —           —           1,202   

Nonfarm nonresidential

     15,547         —           —           15,547   

Residential real estate:

           

Multi-family

     5,932         —           —           5,932   

1-4 Family

     11,393         —           —           11,393   

 

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Table of Contents
            Fair Value Measurements at December 31, 2013 Using  
            (in thousands)  

Description

   Carrying Value      Quoted Prices In
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable
Inputs

(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Impaired loans:

        

Commercial

   $ 3,172       $ —         $ —         $ 3,172   

Commercial real estate:

           

Construction

     9,046         —           —           9,046   

Farmland

     4,173         —           —           4,173   

Nonfarm nonresidential

     73,426         —           —           73,426   

Residential real estate:

           

Multi-family

     11,724         —           —           11,724   

1-4 Family

     26,486         —           —           26,486   

Consumer

     75         —           —           75   

Agriculture

     —           —           —           —     

Other

     618         —           —           618   

Other real estate owned, net:

           

Commercial real estate:

           

Construction

     19,057         —           —           19,057   

Farmland

     690         —           —           690   

Nonfarm nonresidential

     6,019         —           —           6,019   

Residential real estate:

           

Multi-family

     246         —           —           246   

1-4 Family

     4,880         —           —           4,880   

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $66.3 million at September 30, 2014 with a valuation allowance of $1.8 million, resulting in an additional provision for loan losses of $5.2 million for the nine months ended September 30, 2014. At December 31, 2013, impaired loans had a carrying amount of $132.2 million, with a valuation allowance of $3.5 million.

Other real estate owned, which is measured at the lower of carrying or fair value less estimated costs to sell, had a net carrying amount of $54.5 million as of September 30, 2014, compared with $30.9 million at December 31, 2013. Fair value write-downs of $1.3 million were recorded on other real estate owned for the nine months ended September 30, 2014.

The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 2014:

 

     Fair Value     

Valuation

Technique(s)

  

Unobservable Input(s)

  

Range

(Weighted Average)

     (in thousands)                 

Impaired loans – Commercial

   $ 1,143       Market value approach    Adjustment for receivables and inventory discounts    16% - 32% (24%)

Impaired loans – Commercial real estate

   $ 45,939       Sales comparison approach    Adjustment for differences between the comparable sales    0% - 62% (18%)
      Income approach    Discount or capitalization rate    8% - 10% (9%)

Impaired loans – Residential real estate

   $ 17,251       Sales comparison approach    Adjustment for differences between the comparable sales    0% - 68% (17%)

Other real estate owned – Commercial real estate

   $ 37,182       Sales comparison approach    Adjustment for differences between the comparable sales    3% - 45% (17%)
      Income approach    Discount or capitalization rate    8% - 16% (11%)

Other real estate owned – Residential real estate

   $ 17,325       Sales comparison approach    Adjustment for differences between the comparable sales    2% - 54% (11%)

 

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Table of Contents

The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at December 31, 2013:

 

     Fair Value     

Valuation

Technique(s)

  

Unobservable Input(s)

  

Range

(Weighted Average)

     (in thousands)                 

Impaired loans – Commercial

   $ 3,172       Market value approach    Adjustment for receivables and inventory discounts    16% - 32% (24%)

Impaired loans – Commercial real estate

   $ 86,645       Sales comparison approach    Adjustment for differences between the comparable sales    0% - 69% (20%)

Impaired loans – Residential real estate

   $ 38,210       Sales comparison approach    Adjustment for differences between the comparable sales    0% - 68% (15%)

Other real estate owned – Commercial real estate

   $ 25,766       Sales comparison approach    Adjustment for differences between the comparable sales    3% - 51% (22%)
      Income approach    Discount or capitalization rate    7% - 16% (11%)

Other real estate owned – Residential real estate

   $ 5,126       Sales comparison approach    Adjustment for differences between the comparable sales    2% - 54% (11%)

Carrying amount and estimated fair values of financial instruments were as follows for the periods indicated:

 

     Carrying
Amount
     Fair Value Measurements at
September 30, 2014 Using
 
        Level 1      Level 2      Level 3      Total  
     (in thousands)  

Financial assets

           

Cash and cash equivalents

   $ 84,830       $ 54,974       $ 29,856       $ —         $ 84,830   

Securities available for sale

     192,146         —           191,488         658         192,146   

Securities held to maturity

     42,386         —           44,144         —           44,144   

Federal Home Loan Bank stock

     7,323         N/A         N/A         N/A         N/A   

Mortgage loans held for sale

     —           —           —           —           —     

Loans, net

     614,162         —           —           627,760         627,760   

Accrued interest receivable

     3,593         —           1,307         2,286         3,593   

Financial liabilities

              

Deposits

   $ 933,532       $ 110,165       $ 817,288       $ —         $ 927,453   

Securities sold under agreements to repurchase

     1,817         —           1,817         —           1,817   

Federal Home Loan Bank advances

     16,940         —           16,945         —           16,945   

Subordinated capital notes

     5,175         —           —           4,972         4,972   

Junior subordinated debentures

     25,000         —           —           14,026         14,026   

Accrued interest payable

     2,921         —           970         1,951         2,921   

 

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Table of Contents
     Carrying
Amount
     Fair Value Measurements at
December 31, 2013 Using
 
        Level 1      Level 2      Level 3      Total  
     (in thousands)  

Financial assets

           

Cash and cash equivalents

   $ 111,134       $ 106,885       $ 4,249       $ —         $ 111,134   

Securities available for sale

     163,344         197         162,515         632         163,344   

Securities held to maturity

     43,612         —           42,947         —           42,947   

Federal Home Loan Bank stock

     10,072         N/A         N/A         N/A         N/A   

Mortgage loans held for sale

     149         —           149         —           149   

Loans, net

     681,202         —           —           695,999         695,999   

Accrued interest receivable

     3,891         —           1,343         2,548         3,891   

Financial liabilities

              

Deposits

   $ 987,705       $ 107,486       $ 879,707       $ —         $ 987,193   

Securities sold under agreements to repurchase

     2,470         —           2,470         —           2,470   

Federal Home Loan Bank advances

     4,492         —           4,495         —           4,495   

Subordinated capital notes

     5,850         —           —           5,586         5,586   

Junior subordinated debentures

     25,000         —           —           13,526         13,526   

Accrued interest payable

     2,535         —           1,042         1,493         2,535   

The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

(a) Cash and Cash Equivalents

The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2. Non-interest bearing deposits are Level 1 whereas interest bearing due from bank accounts and fed funds sold are Level 2.

(b) FHLB Stock

It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

(c) Loans, Net

Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

(d) Mortgage Loans Held for Sale

The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

(e) Deposits

The fair values disclosed for non-interest bearing deposits are, by definition, equal to the amount payable on demand at the reporting date resulting in a Level 1 classification. The carrying amounts of variable rate interest bearing deposits approximate their fair values at the reporting date resulting in a Level 2 classification. Fair values for fixed rate interest bearing deposits are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

(f) Securities Sold Under Agreements to Repurchase

The carrying amounts of borrowings under repurchase agreements approximate their fair values resulting in a Level 2 classification.

(g) Other Borrowings

The fair values of the Company’s FHLB advances are estimated using discounted cash flow analyses based on the current borrowing rates resulting in a Level 2 classification.

The fair values of the Company’s subordinated capital notes and junior subordinated debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

(h) Accrued Interest Receivable/Payable

The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification based on the level of the asset or liability with which the accrual is associated.

 

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Table of Contents

Note 9 – Income Taxes

Deferred tax assets and liabilities were due to the following as of:

 

     September 30,
2014
    December 31,
2013
 
     (in thousands)  

Deferred tax assets:

    

Net operating loss carry-forward

   $ 29,578      $ 25,460   

Allowance for loan losses

     8,469        9,843   

Other real estate owned write-down

     9,321        9,478   

Alternative minimum tax credit carry-forward

     692        692   

Net assets from acquisitions

     662        644   

Other than temporary impairment on securities

     46        89   

Net unrealized loss on securities

     —          1,067   

New market tax credit carry-forward

     208        208   

Nonaccrual loan interest

     922        911   

Amortization of non-compete agreements

     15        16   

Other

     2,108        1,640   
  

 

 

   

 

 

 
     52,021        50,048   
  

 

 

   

 

 

 

Deferred tax liabilities:

    

FHLB stock dividends

     928        1,276   

Fixed assets

     272        333   

Net unrealized gain on securities

     719        —     

Originated mortgage servicing rights

     58        75   

Other

     391        570   
  

 

 

   

 

 

 
     2,368        2,254   
  

 

 

   

 

 

 

Net deferred tax assets before valuation allowance

     49,653        47,794   
  

 

 

   

 

 

 

Valuation allowance

     (49,653     (47,794
  

 

 

   

 

 

 

Net deferred tax asset

   $ —        $ —     
  

 

 

   

 

 

 

Our estimate of the realizability of the deferred tax asset depends on our estimate of projected future levels of taxable income as all carryback ability was fully absorbed by our tax loss of approximately $40.1 million for 2011. In analyzing future taxable income levels, we considered all evidence currently available, both positive and negative. Based on our analysis, we continue to maintain a valuation allowance for all deferred tax assets as of September 30, 2014. Our deferred tax assets and the related valuation allowance are analyzed and adjusted on a quarterly basis.

The calculation for the income tax provision or benefit generally does not consider the tax effects of changes in other comprehensive income, or OCI, which is a component of stockholders’ equity on the balance sheet. However, an exception is provided in certain circumstances, such as when there is a full valuation allowance against net deferred tax assets, there is a loss from continuing operations and there is income in other components of the financial statements. In such a case, pre-tax income from other categories, such as changes in OCI, must be considered in determining a tax benefit to be allocated to the loss from continuing operations. For the nine months ended September 30, 2014, this resulted in $1.3 million of income tax benefit allocated to continuing operations. The September 30, 2014 tax benefit is entirely due to gains in other comprehensive income that are presented in current operations in accordance with applicable accounting standards.

The Company does not have any beginning and ending unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. There were no interest and penalties recorded in the income statement or accrued for the nine months ended September 30, 2014 or the year ended December 31, 2013 related to unrecognized tax benefits.

The Company and its subsidiaries are subject to U.S. federal income tax and the Company is subject to income tax in the Commonwealth of Kentucky. The Company is no longer subject to examination by taxing authorities for years before 2010.

 

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Table of Contents

Note 10 – Stock Plans and Stock Based Compensation

The Company has two stock incentive plans. On February 23, 2006, the Company adopted the Porter Bancorp, Inc. 2006 Stock Incentive Plan. In May 2013, shareholders approved an amendment to the plan to increase the number of shares authorized for issuance by 800,000 shares. In May 2014, shareholders approved an amendment to the Plan to increase the number of shares authorized for issuance by 300,000 shares. The 2006 Plan now permits the issuance of up to 1,563,050 shares of the Company’s common stock upon the exercise of stock options or upon the grant of stock awards. As of September 30, 2014, the Company had granted 770,452 unvested shares net of forfeitures and vesting under the stock incentive plan. Shares issued under the plan vest annually on the anniversary date of the grant over three to ten years. The Company has 533,251 shares remaining available for issue under the plan.

On May 15, 2006, the Board of Directors approved the Porter Bancorp, Inc. 2006 Non-Employee Directors Stock Ownership Incentive Plan, which was approved by holders of the Company’s voting common stock on June 8, 2006. On May 16, 2012, holders of the Company’s voting common stock voted to further amend the 2006 Non-Employee Directors Stock Ownership Incentive Plan to award restricted shares having a fair market value of $25,000 annually to each non-employee director, and to increase the number of shares issuable under the Directors’ Plan from 100,000 shares to 400,000 shares. In May 2014, the Plan was further amended to increase the number of shares issuable to 700,000 shares. Unvested shares are granted automatically under the plan at fair market value on the date of grant and vest on December 31 in the year of grant. To date, the Company has issued 181,819 unvested shares, net of forfeitures and vesting, to non-employee directors. At September 30, 2014, 271,211 shares remain available for issuance under this plan.

The fair value of the 2014 unvested shares issued to employees was $113,000, or $0.93 per weighted-average share. The fair value of the 2014 unvested shares issued to directors was $150,000, or $0.90 per weighted-average share. The Company recorded $480,000 and $390,000 of stock-based compensation during the first nine months of 2014 and 2013, respectively, to salaries and employee benefits. There was no significant impact on compensation expense resulting from forfeited or expiring shares. We expect substantially all of the unvested shares outstanding at the end of the period will vest according to the vesting schedule. No deferred tax benefit was recognized related to this expense for either period.

The following table summarizes unvested share activity as of and for the periods indicated for the Stock Incentive Plan:

 

     Nine Months Ended
September 30, 2014
     Twelve Months Ended
December 31, 2013
 
     Shares     Weighted
Average
Grant
Price
     Shares     Weighted
Average
Grant
Price
 

Outstanding, beginning

     787,426      $ 1.56         153,316      $ 5.92   

Granted

     122,220        0.93         693,214        1.18   

Vested

     (133,227     2.20         (22,113     12.19   

Forfeited

     (5,967     4.17         (36,991     6.22   
  

 

 

      

 

 

   

Outstanding, ending

     770,452      $ 1.33         787,426      $ 1.56   
  

 

 

      

 

 

   

The following table summarizes unvested share activity as of and for the periods indicated for the Non-Employee Directors Stock Ownership Incentive Plan:

 

     Nine Months Ended
September 30, 2014
     Twelve Months Ended
December 31, 2013
 
     Shares     Weighted
Average
Grant
Price
     Shares     Weighted
Average
Grant
Price
 

Outstanding, beginning

     47,428      $ 1.69         80,078      $ 1.77   

Granted

     166,668        0.90         182,355        0.85   

Vested

     (7,757     1.74         (215,005     1.01   

Forfeited

     (24,520     1.69         —          —     
  

 

 

      

 

 

   

Outstanding, ending

     181,819      $ 0.96         47,428      $ 1.69   
  

 

 

      

 

 

   

 

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Unrecognized stock based compensation expense related to unvested shares for the remainder of 2014 and beyond is estimated as follows (in thousands):

 

October 2014 – December 2014

   $ 198   

2015

     417   

2016

     273   

2017

     51   

2018 & thereafter

     —     

Note 11 – Earnings (Loss) per Share

The factors used in the basic and diluted earnings per share computations follow:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2014     2013     2014     2013  
     (in thousands, except share and per share data)  

Net income (loss)

   $ (849 )   $ 298      $ (7,370 )   $ (1,080

Less:

        

Preferred stock dividends

     786        437        2,361        1,311   

Accretion of Series A preferred stock discount

     —          45        —          135   

Earnings allocated to unvested shares

     (122     (11     (685     (107

Earnings allocated to Series C preferred

     (40     (5     (243     (67
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to common shareholders, basic and diluted

   $ (1,473   $ (168   $ (8,803   $ (2,352
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic

        

Weighted average common shares including unvested common shares outstanding

     13,435,788        12,702,627        13,314,138        12,569,514   

Less: Weighted average unvested common shares

     1,016,051        776,774        936,386        535,224   

Less: Weighted average Series C preferred

     332,894        332,894        332,894        332,894   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average common shares outstanding

     12,086,843        11,592,959        12,044,858        11,701,396   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic loss per common share

   $ (0.12   $ (0.01   $ (0.73   $ (0.20
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

        

Add: Dilutive effects of assumed exercises of common and Preferred Series C stock warrants

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average common shares and potential common shares

     12,086,843        11,592,959        12,044,858        11,701,396   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted loss per common share

   $ (0.12   $ (0.01   $ (0.73   $ (0.20
  

 

 

   

 

 

   

 

 

   

 

 

 

The Company had no outstanding stock options at September 30, 2014 or 2013. A warrant for the purchase of 330,561 shares of the Company’s common stock at an exercise price of $15.88 was outstanding at September 30, 2014 and 2013 but was not included in the diluted EPS computation as inclusion would have been anti-dilutive. Additionally, warrants for the purchase of 1,449,459 shares of non-voting common stock at an exercise price of $10.95 per share were outstanding at September 30, 2014 and 2013, but were not included in the diluted EPS computation as inclusion would have been anti-dilutive.

Note 12 – Capital Requirements and Restrictions on Retained Earnings

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.

 

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On June 24, 2011, PBI Bank entered into a Consent Order with the FDIC and the Kentucky Department of Financial Institutions. The consent order requires the Bank to complete a management study, to maintain Tier 1 capital as a percentage of total assets of at least 9% and a total risk based capital ratio of at least 12%, to develop a plan to reduce our risk position in each substandard asset in excess of $1 million, to complete board review of the adequacy of the allowance for loan losses prior to quarterly Call Report submissions, to adopt procedures which strengthen the loan review function and ensure timely and accurate grading of credit relationships, to charge-off all assets classified as loss, to develop a plan to reduce concentrations of construction and development loans to not more than 75% of total risk based capital and non-owner occupied commercial real estate loans to not more than 250% of total risk based capital, to limit asset growth to no more than 5% in any quarter or 10% annually, to not extend additional credit to any borrower classified substandard unless the board of directors adopts prior to the extension a detailed statement giving reasons why the extension is in the best interest of the bank, and to not declare or pay any dividend without the prior consent of our regulators. We are also restricted from accepting, renewing, or rolling-over brokered deposits without the prior receipt of a waiver on a case-by-case basis from our regulators.

On September 21, 2011, we entered into a Written Agreement with the Federal Reserve Bank of St. Louis. Pursuant to the Agreement, we made formal commitments to use our financial and management resources to serve as a source of strength for the Bank and to assist the Bank in addressing weaknesses identified by the FDIC and the KDFI, to pay no dividends without prior written approval, to pay no interest or principal on subordinated debentures or trust preferred securities without prior written approval, and to submit an acceptable plan to maintain sufficient capital.

In October 2012, the Bank entered into a new Consent Order with the FDIC and KDFI again agreeing to maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. The Bank cannot be considered well-capitalized while under the Consent Order. The Bank also agreed that if it should be unable to reach the required capital levels, and if directed in writing by the FDIC, then the Bank would within 30 days develop, adopt and implement a written plan to sell or merge itself into another federally insured financial institution or otherwise immediately obtain a sufficient capital investment into the Bank to fully meet the capital requirements. We have not been directed by the FDIC to implement such a plan.

The new Consent Order also requires the Bank to continue to adhere to the plans implemented in response to the June 2011 Consent Order, and includes the substantive provisions of the June 2011 Consent Order. As of September 30, 2014, the capital ratios required by the Consent Order were not met.

The following table shows the ratios and amounts of Tier 1 capital and total capital to risk-adjusted assets and the leverage ratios for Porter Bancorp, Inc. and PBI Bank at the dates indicated (dollars in thousands):

 

     Actual     For Capital
Adequacy
Purposes
 
     Amount      Ratio     Amount      Ratio  

As of September 30, 2014:

          

Total risk-based capital (to risk-weighted assets)

          

Consolidated

   $ 70,176         10.05   $ 55,881         8.00

Bank

     76,739         11.01        55,779         8.00   

Tier I capital (to risk-weighted assets)

          

Consolidated

     41,439         5.93        27,940         4.00   

Bank

     62,657         8.99        27,889         4.00   

Tier I capital (to average assets)

          

Consolidated

     41,439         4.02        41,231         4.00   

Bank

     62,657         6.09        41,181         4.00   

 

     Actual     For Capital
Adequacy
Purposes
 
     Amount      Ratio     Amount      Ratio  

As of December 31, 2013:

          

Total risk-based capital (to risk-weighted assets)

          

Consolidated

   $ 80,203         11.03   $ 58,178         8.00

Bank

     83,055         11.44        58,064         8.00   

Tier I capital (to risk-weighted assets)

          

Consolidated

     53,371         7.34        29,089         4.00   

Bank

     67,897         9.35        29,032         4.00   

Tier I capital (to average assets)

          

Consolidated

     53,371         4.95        43,156         4.00   

Bank

     67,897         6.28        43,221         4.00   

 

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The Consent Order requires the Bank to achieve the minimum capital ratios presented below:

 

     Actual as of
September 30, 2014
    Ratio Required by
Consent Order
 
     Amount      Ratio     Amount      Ratio  

Total capital to risk-weighted assets

   $ 76,739         11.01   $ 83,668         12.00

Tier I capital to average assets

     62,657         6.09        92,656         9.00   

At September 30, 2014, PBI Bank’s Tier 1 leverage ratio was 6.09%, and its total risk-based capital ratio was 11.01%, both of which are below the minimum capital ratios required by the Consent Order. Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a Consent Order. Based on individual circumstances, the agencies may issue mandatory directives, impose monetary penalties, initiate changes in management, or take more serious adverse actions.

Kentucky banking laws limit the amount of dividends that may be paid to a holding company by its subsidiary banks without prior approval. These laws limit the amount of dividends that may be paid in any calendar year to current year’s net income, as defined in the laws, combined with the retained net income of the preceding two years, less any dividends declared during those periods. PBI Bank has agreed with its primary regulators to obtain their written consent prior to declaring or paying any future dividends. As a practical matter, PBI Bank cannot pay dividends to Porter Bancorp for the foreseeable future.

Note 13 – Contingencies

In the normal course of operations, we are defendants in various legal proceedings. Litigation is subject to inherent uncertainties and unfavorable rulings could occur. We record contingent liabilities resulting from claims against us when a loss is assessed to be probable and the amount of the loss is reasonably estimable. Assessing probability of loss and estimating probable losses requires analysis of multiple factors, including in some cases judgments about the potential actions of third party claimants and courts. Recorded contingent liabilities are based on the best information available and actual losses in any future period are inherently uncertain. Currently, we have accrued approximately $2.0 million related to ongoing litigation matters for which we believe liability is probable and reasonably estimable. Accruals are not made in cases where liability is not probable or the amount cannot be reasonably estimated. We provide disclosure of matters where we believe liability is reasonably possible and which may be material to our consolidated financial statements.

Signature Point Litigation. On June 18, 2010, three real estate development companies filed suit in Kentucky state court against PBI Bank and Managed Assets of Kentucky (“MAKY”). Signature Point Condominiums LLC, et al. v. PBI Bank, et al., Jefferson Circuit Court, Case No 10-CI-04295. On July 16, 2013, a jury in Louisville, Kentucky returned a verdict against PBI Bank, awarding the plaintiffs compensatory damages of $1,515,000 and punitive damages of $5,500,000. The case arose from a settlement in which PBI Bank agreed to release the plaintiffs and guarantors from obligations of more than $26 million related to a real estate project in Louisville. The plaintiffs were granted a right of first refusal to repurchase a tract of land within the project. In exchange, the plaintiffs conveyed the real estate securing the loans to PBI Bank. After plaintiffs declined to exercise their right of first refusal, PBI Bank sold the tract to the third party. Plaintiffs alleged the Bank had knowledge of the third party offer before the conveyance of the land by the Plaintiffs to the Bank. Plaintiffs asserted claims of fraud, breach of fiduciary duty, breach of the duty of good faith and fair dealing, tortious interference with prospective business advantage and conspiracy to commit fraud, negligence, and conspiracy against PBI Bank.

After conferring with its legal advisors, PBI Bank believes the findings and damages are excessive and contrary to law, and that it has meritorious grounds on which it has moved to appeal. The Bank’s Notice of Appeal was filed on October 25, 2013. After a number of procedural issues were resolved, the Bank filed its appellate brief on September 30, 2014. Appellee’s brief is due on December 1, 2014. We will continue to defend this matter vigorously. Although we have made provisions in our condensed consolidated financial statements for this self-insured matter, the amount of our legal accrual is less than the original amount of the damages awarded, plus accrued interest. The ultimate outcome of this matter could have a material adverse effect on our financial condition, results of operations or cash flows.

 

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SBAV LP Litigation. On December 17, 2012, SBAV LP filed a lawsuit against Porter Bancorp, PBI Bank, J. Chester Porter and Maria L. Bouvette in New York state court. The proceeding was removed to New York federal district court on January 16, 2013. On July 10, 2013, the New York federal district court granted the defendants’ motion to transfer the case to federal district court in Kentucky. SBAV LP v. Porter Bancorp, et. al., Civ. Action 3:13-CV-710 (W.D.KY). The complaint alleges violation of the Kentucky Securities Act and negligent misrepresentation against all named defendants, and breach of contract against Porter Bancorp alone. The plaintiff seeks damages in an amount in excess of $4,500,000, or the difference between the $5,000,016 purchase price and the value of the securities when sold by the plaintiff, plus interest at the applicable statutory rate, costs and reasonable attorneys’ fees. On September 13, 2013, defendants filed a motion to dismiss all claims in the complaint for pleading failures and for failure to state a claim upon which relief may be granted. On March 25, 2014, the judge ruled that SBAV had failed to state a claim against PBI Bank and dismissed PBI Bank from the case. The claims against Porter Bancorp, the Estate of J. Chester Porter and Ms. Bouvette remain and have proceeded to discovery. On April 21, 2014, Porter Bancorp filed a third-party complaint for contribution against SBAV’s investment adviser, the Clinton Group, Inc. On September 16, 2014, the Court dismissed the Third-Party Complaint, but held that Clinton’s errors in conducting due diligence may lessen any recovery available to SBAV. On September 23, 2014, Porter Bancorp and SBAV each filed motions to compel discovery and the parties await rulings on those motions. We dispute the material factual allegations made in SBAV’s complaint and intend to defend against SBAV’s claims vigorously.

Miller’s Health System Inc. Employee Stock Ownership Plan. On December 26, 2013, the United States Department of Labor (“DOL”) filed a lawsuit against PBI Bank in U.S. District Court for the Northern District of Indiana. Thomas E. Perez, Secretary of the United States Department of Labor v. PBI Bank, Inc. (Civ. Action 3:13-CV-1400-PPS). The complaint alleges that in 2007 PBI Bank, in the capacity of trustee for the Miller’s Health System’s Inc. Employee Stock Ownership Plan, authorized the alleged imprudent and disloyal purchase of the stock of Miller’s Health Systems, Inc. (“Miller’s Health”) in 2007 for $40 million, a price allegedly far in excess of the stock’s fair market value. The suit also alleges, among other things, that PBI Bank approved 100% seller financing for the transaction at an excessive rate of interest. On March 31, 2014, PBI Bank filed its answer, disputing the material factual allegations of the complaint. On April 10, 2014, PBI Bank filed a third-party complaint against Miller’s Health seeking to enforce its indemnity rights, as well as third party claims for contribution against named directors and officers of Miller’s Health. On May 19, 2014, PBI Bank filed a motion to dismiss the complaint on the basis of a statute of limitations defense. The parties have submitted briefs on both motions to dismiss and await a ruling. We dispute the material factual allegations made in the complaint and intend to defend against DOL’s claims vigorously.

AIT Laboratories Employee Stock Ownership Plan. On August 29, 2014, the United States Department of Labor (“DOL”) filed a lawsuit against PBI Bank and Michael A. Evans in the U.S. District Court for the Southern District of Indiana. Thomas E. Perez, Secretary of the United States Department of Labor v. PBI Bank, Inc. and Michael A. Evans (Case No. 1:14-CV-01429-SEB-MJD). The complaint alleges that in 2009, PBI Bank, in the capacity of trustee for the AIT Laboratories Employee Stock Ownership Plan, authorized the alleged imprudent and disloyal purchase of the stock of AIT Holdings, Inc. in 2009 for $90 million, a price allegedly far in excess of the stock’s fair market value. PBI Bank’s responsive pleading was filed on November 4, 2014, disputing the material factual allegations that have been made by the DOL. We intend to defend against DOL’s claims vigorously.

United States Department of Justice Investigation. On October 17, 2014, the United States Department of Justice (the “DOJ”) notified PBI Bank that the Bank was the subject of an investigation into possible violations of federal laws, including, among other things, possible violations related to false bank entries, bank fraud and securities fraud. The investigation concerns allegations that Bank personnel engaged in practices intended to delay or avoid disclosure of the Bank’s asset quality at the time of and following the United States Treasury’s purchase of preferred stock from Porter Bancorp in November 2008. PBI Bank will respond to and cooperate with any requests for information from DOJ. At this time the investigation is ongoing, and DOJ has made no determination whether to pursue any action in the matter.

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

This item analyzes our financial condition, change in financial condition and results of operations. It should be read in conjunction with the unaudited consolidated financial statements and accompanying notes presented in Part I, Item 1 of this report.

Cautionary Note Regarding Forward-Looking Statements

This report contains statements about the future expectations, activities and events that constitute forward-looking statements. Forward-looking statements express our beliefs, assumptions and expectations of our future financial and operating performance and growth plans, taking into account information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify forward-looking statements.

 

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Forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from the expectations of future results we expressed or implied in any forward-looking statements. These risks and uncertainties can be difficult to predict and may be out of our control. Factors that could contribute to differences in our results include, but are not limited to the following:

 

   

Our inability to increase our capital to the levels required by our agreements with bank regulators could have a material adverse effect on our business.

 

   

A significant percentage of our loan portfolio is comprised of non-owner occupied commercial real estate loans, real estate construction and development loans, and multi-family residential real estate loans, all of which carry a higher degree of risk.

 

   

We continue to hold and acquire a significant amount of OREO properties, which could increase operating expenses and result in future losses.

 

   

Our decisions regarding credit risk may not be accurate, and our allowance for loan losses may not be sufficient to cover actual losses.

 

   

Our ability to pay cash dividends on our common and preferred stock and pay interest on the junior subordinated debentures that relate to our trust preferred securities is currently restricted. Our inability to resume paying dividends and interest on these securities may adversely affect our common shareholders.

 

   

While we believe our provision for legal contingencies is adequate, the outcome of legal proceedings is difficult to predict and we may settle legal claims or be subject to judgments for amounts that exceed our estimates.

We also refer you to Part II, Item 1A – Risk Factors in this report and to the risks identified and the cautionary statements discussed in greater detail in our December 31, 2013 Annual Report on Form 10-K.

Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen these assumptions or bases in good faith and they are reasonable. We caution you however, forward looking statements relying upon such assumptions or bases almost always vary from actual results, and the differences between those statements and actual results can be material. The forward-looking statements included in this report speak only as of the date of the report. We have no duty, and do not intend to, update these statements unless applicable laws require us to do so.

Overview

Porter Bancorp, Inc. is a Louisville, Kentucky-based bank holding company which operates 18 banking offices in twelve counties through its wholly-owned subsidiary, PBI Bank. Our markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and Bullitt, and extend south along the Interstate 65 corridor to Tennessee. We serve south central Kentucky and southern Kentucky from banking offices in Butler, Green, Hart, Edmonson, Barren, Warren, Ohio and Daviess Counties. We also have an office in Lexington, the second largest city in Kentucky. The Bank is a community bank with a wide range of commercial and personal banking products.

The Company reported a net loss of $849,000 and $7.4 million for the three and nine months ended September 30, 2014, compared with net income of $298,000 and a net loss of $1.1 million for the same periods of 2013. After deductions for dividends on preferred stock and earnings allocated to participating securities, net loss attributable to common shareholders was $1.5 million and $8.8 million, respectively, for the three and nine months ended September 30, 2014, compared with net loss to common shareholders of $168,000 and $2.4 million for the three and nine months ended September 30, 2013.

Basic and diluted loss per common share were ($0.12) and ($0.73) for the three and nine months ended September 30, 2014 compared with basic and diluted loss per common share of ($0.01) and ($0.20) for the three and nine months ended September 30, 2013.

The following significant events occurred during the nine months ended September 30, 2014:

 

   

Net interest margin decreased nine basis points to 3.06% in the first nine months of 2014 compared with 3.15% in the first nine months of 2013. The decrease in margin between periods was primarily due to a reduction in interest earning assets coupled with lower rates on those assets. Average loans decreased 17.2% to $671.7 million in the first nine months of 2014 compared with $811.4 million in the first nine months of 2013. Net loans decreased 12.4% to $615.3 million at September 30, 2014, compared with $702.5 million at September 30, 2013.

 

   

No provision for loan losses was recorded in the third quarter of 2014, and a total of $6.3 million was recorded in the first nine months of 2014, compared to $250,000 and $700,000 for the same periods in 2013. Net charge-offs of $935,000 were recognized for the third quarter of 2014 and net charge-offs for the nine months ended September 30, 2014 were $10.2 million, compared to $6.1 million and $25.6 million for the three and nine months ended September 30, 2013, respectively.

 

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We continued to execute on our strategy to reduce our commercial real estate and construction and development loans. At September 30, 2014, we were compliant with the terms of our Consent Order with respect to our level of construction and development loans; however, we were not in compliance with the level of non-owner occupied commercial real estate loans required by the Consent Order. Construction and development loans totaled $33.7 million, or 44% of total risk-based capital, at September 30, 2014 compared with $43.3 million, or 52% of total risk-based capital, at December 31, 2013. Non-owner occupied commercial real estate loans, construction and development loans, and multi-family residential real estate loans as a group totaled $206.9 million, or 270% of total risk-based capital, at September 30, 2014 compared with $237.0 million, or 284% of total risk-based capital, at December 31, 2013.

 

   

Loan proceeds received from the repayment of our commercial real estate and construction and development loans were used primarily to redeem maturing certificates of deposit during the quarter. Deposits decreased 5.5% to $933.5 million at September 30, 2014 compared with $987.7 million at December 31, 2013. Certificate of deposit balances declined $70.3 million during the first nine months of 2014 to $609.7 million at September 30, 2014, from $680.0 million at December 31, 2013. Demand deposits increased 2.5% during the first nine months of 2014 compared with December 31, 2013.

 

   

Non-performing loans decreased $57.3 million to $44.7 million at September 30, 2014, compared with $102.0 million at December 31, 2013. The decrease in non-performing loans was due to the migration of non-performing loans to the OREO portfolio, as well as $25.7 million in paydowns. Net charge-offs were $10.2 million for the nine months ended September 30, 2014.

 

   

Loans past due 30-59 days decreased from $10.7 million at December 31, 2013 to $3.5 million at September 30, 2014 and loans past due 60-89 days increased from $775,000 at December 31, 2013 to $3.3 million at September 30, 2014. Total loans past due and nonaccrual loans decreased to $51.5 million at September 30, 2014 from $113.5 million at December 31, 2013.

 

   

Foreclosed properties were $54.5 million at September 30, 2014, compared with $30.9 million at December 31, 2013, and $41.9 million at September 30, 2013. During the first nine months of 2014, the Company acquired $31.7 million and sold $7.3 million of other real estate owned (“OREO”). In addition, we recorded fair value write-downs of $1.3 million during the first nine months of 2014 reflecting declines in appraisal valuations and changes in pricing strategies. Our ratio of non-performing assets to total assets decreased to 9.62% at September 30, 2014, compared with 12.35% at December 31, 2013, and 14.33% at September 30, 2013.

 

   

Long-term interest rates declined from December 31, 2013 to September 30, 2014 resulting in a decrease of $3.8 million in the net unrealized loss in our available for sale securities portfolio between period ends and a similar increase in the shareholders equity component, accumulated other comprehensive loss.

 

   

The U.S. Treasury (UST) purchased our Series A Preferred Stock in November 2008 under UST’s Capital Purchase Program (CPP). Since 2012 UST has been selling its CPP securities in a series of public auctions. On November 13, 2014, UST announced that it intends to include our Series A Preferred Stock in a public auction to be held later in November 2014.

 

   

Management determined that a material weakness existed in the Company’s internal control over financial reporting at June 30, 2014, as more fully described in Item 4, Controls and Procedures. Our management, overseen by the Audit Committee, is working to implement steps to improve this process and remediate this control weakness. The material weakness resulted in the Company restating its previously filed interim financial statements for the three and six month periods ended June 30, 2014. The restatement had the effect of increasing the Company’s reported net loss attributable to common shareholders from $672,000 to $6.3 million for the three months ended June 30, 2014 and from $1.6 million to $7.3 million for the six months ended June 30, 2014. Basic and diluted loss per common share increased from $(0.06) per share to $(0.53) per share for the three months ended June 30, 2014 and from $(0.14) per share to $(0.61) per share for the six months ended June 30, 2014. This restatement resulted in commercial real estate loan charge-offs of approximately $5.2 million, an increase in the provision for loan losses of $6.3 million, and an increase in loan collection expenses of $860,000 in the three and six month periods ended June 30, 2014.

 

   

On October 17, 2014, the United States Department of Justice (the “DOJ”) notified the Bank that it was the subject of an investigation into possible violations of federal laws, including, among other things, possible violations related to false bank entries, bank fraud and securities fraud. The investigation concerns allegations that Bank personnel engaged in practices intended to delay or avoid disclosure of the Bank’s asset quality at the time of and following the United States Treasury’s purchase of preferred stock from the Company in November 2008. The Bank will respond to and cooperate with any requests for information from DOJ. At this time the investigation is ongoing, and DOJ has made no determination whether to pursue any action in the matter.

Regulatory Matters

Since June 2011, the Bank has operated under the terms of a Consent Order with the Federal Deposit Insurance Company (“FDIC”) and the Kentucky Department of Financial Institutions (“KDFI”). The Bank agreed, among other things, to improve asset quality, reduce loan concentrations, and maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. In September 2012, the Bank also agreed if it should be unable to reach the required capital levels, and if directed in writing by the FDIC, then the Bank would within 30 days develop, adopt and implement a written plan to sell or merge itself into another federally insured financial institution or otherwise immediately obtain a sufficient capital investment into the Bank to fully meet the capital requirements. As of September 30, 2014, the Bank had not met the capital ratios required by the Consent Order. Our current Consent Order was included in our Current Reports on 8-K filed on September 25, 2012.

The Board of Directors and management continue to evaluate and implement strategies to meet the obligations of the Consent Order. These include:

 

   

Increasing capital through a possible public offering or private placement of common stock to new and existing shareholders. We have engaged a financial advisor to assist our Board in this evaluation and to assist in evaluating our options for increasing capital and redeeming our Series A Preferred Stock.

 

   

Continuing to operate the Company and Bank in a safe and sound manner. This strategy will require us to reduce our lending concentrations, remediate non-performing loans, reduce the size of our balance sheet, and reduce other noninterest expense through the disposition of OREO.

 

   

Management succession and adding resources to the management team. John T. Taylor became CEO of PBI Bank in 2012 and CEO of the Company in 2013. In addition, we appointed new executives to lead key functions of our banking operations. John R. Davis became Chief Credit Officer of PBI Bank in 2012, with responsibility for establishing and executing credit quality policies and overseeing credit administration for the organization. We have also augmented our staffing in the commercial lending area, now led by Joe C. Seiler.

 

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Evaluating and implementing improvements to our internal processes and procedures, distribution of labor, and work-flow to ensure we have adequately and appropriately deployed resources in an efficient manner in the current environment.

 

   

Executing on our commitment to improve credit quality and reduce loan concentrations and balance sheet risk.

 

   

We have reduced our loan portfolio significantly from $1.3 billion at December 31, 2010 to $638.4 million at September 30, 2014.

 

   

We have reduced our construction and development loans to less than 75% of total risk-based capital at September 30, 2014, and have now been in compliance with the Consent Order for ten quarters.

 

   

We have reduced our non-owner occupied commercial real estate loans, construction and development loans, and multi-family residential real estate loans; however we are not in compliance with the Consent order at September 30, 2014 which requires those loans to represent less than 250% of total risk-based capital. These loans represented 270% of total risk-based capital at September 30, 2014, down from 284% at December 31, 2013.

 

   

Executing on our commitment to sell other real estate owned and reinvest in quality income producing assets.

 

   

Our acquisition of real estate assets through the loan remediation process slowed during 2013, as we acquired $20.6 million of OREO in 2013 compared with $33.5 million during 2012. However, these acquisitions have increased in 2014 as we acquired $31.7 million of OREO in the first nine months of 2014. Additionally, nonaccrual loans totaled $44.7 million at September 30, 2014, and we expect to resolve many of these loans by foreclosure which could result in further additions to our OREO portfolio.

 

   

We incurred OREO losses totaling $795,000 during the first nine months of 2014, comprised of $1.3 million in fair value write-downs to reflect declines in appraisal valuations and changes in our pricing strategies, offset by $455,000 in net gain on sales of OREO.

 

   

We continually evaluate opportunities to maximize the value we receive from the sale of OREO. We pursue multiple sales channels with focus primarily on internal marketing and the use of brokers.

Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a consent order. Based on individual circumstances, the agencies may issue mandatory directives, impose monetary penalties, initiate changes in management, or take more serious adverse actions.

Application of Critical Accounting Policies

We continually review our accounting policies and financial information disclosures. A summary of our more significant accounting policies that require the use of estimates and judgments in preparing the financial statements was provided in “Application of Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operation in our Annual Report on Form 10-K for the calendar year ended December 31, 2013. Management has discussed the development, selection, and application of our critical accounting policies with our Audit Committee. During the first nine months of 2014, there were no material changes in the critical accounting policies and assumptions.

Results of Operations

The following table summarizes components of income and expense and the change in those components for the three months ended September 30, 2014, compared with the same period of 2013:

 

     For the Three Months
Ended September 30,
     Change from
Prior Period
 
     2014     2013      Amount     Percent  
     (dollars in thousands)  

Gross interest income

   $ 9,814      $ 10,543       $ (729     (6.9 )%

Gross interest expense

     2,477        2,694         (217     (8.1 )

Net interest income

     7,337        7,849         (512     (6.5

Provision for loan losses

     —          250         (250     (100.0

Non-interest income

     1,057        1,167         (110     (9.4

Non-interest expense

     9,281        8,468         813        9.6   

Net loss before taxes

     (887     298         (1,185     (397.7

Income tax benefit

     (38     —           (38     100.0   

Net income (loss)

     (849     298         (1,147     (384.9

 

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Net loss before taxes for the three months ended September 30, 2014 totaled $887,000, compared with net income before taxes of $298,000 for the comparable period of 2013. A tax benefit was recognized in the third quarter of 2014 due to gains in other comprehensive income that are presented in current operations. The calculation for the income tax provision or benefit generally does not consider the tax effects of changes in other comprehensive income, or OCI, which is a component of stockholders’ equity on the balance sheet. However, an exception is provided in certain circumstances, such as when there is a full valuation allowance against net deferred tax assets, there is a loss from continuing operations and there is income in other components of the financial statements. In such a case, pre-tax income from other categories, such as changes in OCI, must be considered in determining a tax benefit to be allocated to the loss from continuing operations. For the quarter ended September 30, 2014, this resulted in $38,000 of income tax benefit allocated to continuing operations. The September 30, 2014 tax benefit is entirely due to gains in other comprehensive income that are presented in current operations in accordance with applicable accounting standards. Net loss after recognition of the tax benefit was $849,000 for the third quarter.

Provision expense for the quarter declined by $250,000, primarily attributable to the reduction in the loan portfolio size. Net interest income decreased $512,000 from the 2013 third quarter as a result of a four basis point decline in net interest margin due to lower earning asset levels and lower average rates on earning assets. In addition, net interest income and net interest margin were adversely affected by $616,000 and $1.4 million of interest lost on nonaccrual loans in the third quarters of 2014 and 2013, respectively. Non-interest income decreased by $110,000 to $1.1 million from $1.2 million in the third quarter of 2013, while non-interest expense increased during the period from $8.5 million to $9.3 million for the three months ended September 30, 2013 and 2014, respectively, primarily due to increases in salaries and employee benefits, loan collection expenses and professional fees offset by decreases in state franchise tax and OREO expenses.

The following table summarizes components of income and expense and the change in those components for the nine months ended September 30, 2014, compared with the same period of 2013:

 

     For the Nine Months
Ended September 30,
    Change from
Prior Period
 
     2014     2013     Amount     Percent  
     (dollars in thousands)  

Gross interest income

   $ 29,877      $ 32,969      $ (3,092     (9.4 )%

Gross interest expense

     7,626        8,470        (844     (10.0 )

Net interest income

     22,251        24,499        (2,248     (9.2

Provision for loan losses

     6,300        700        5,600        800.0   

Non-interest income

     2,921        4,962        (2,041     (41.1

Non-interest expense

     27,587        29,841        (2,254     (7.6

Net loss before taxes

     (8,715     (1,080     (7,635     706.9   

Income tax benefit

     (1,345     —          (1,345     100.0   

Net loss

     (7,370     (1,080     (6,290     582.4   

Net loss before taxes for the nine months ended September 30, 2014 totaled $8.7 million, compared with a net loss before taxes of $1.1 million for the comparable period of 2013. After the tax benefit recorded in the third quarter as noted above, net loss for the first nine months 2014 was $7.4 million. Provision for loan losses expense increased $5.6 million for the first nine months of 2014 compared with the same period in 2013. This was primarily driven by net charge-offs which were $10.2 million for the nine months ended September 30, 2014, compared to $25.6 million for the same period in 2013. The charge-offs for 2013 were primarily the result of charging-off specific reserves for loans deemed to be collateral dependent. The $6.3 million provision in 2014 was recorded in the second quarter and was driven primarily by approximately $5.2 million in charge-offs related to commercial real estate loans. The charge-offs were in addition to reserves established prior to that time. Net interest income decreased $2.2 million from the first nine months of 2013 as a result of a nine basis point decline in net interest margin due to lower earning asset levels and lower average rates on earning assets. In addition, net interest income and net interest margin were adversely affected by $2.7 million and $4.3 million of interest lost on nonaccrual loans in the first nine months of 2014 and 2013, respectively. Non-interest income decreased by $2.0 million to $2.9 million from $5.0 million for the first nine months of 2013, primarily due to decreases in net gains on sales of securities, OREO income, and income from fiduciary activities. Non-interest expense decreased during the period from $29.8 million to $27.6 million for the nine months ended September 30, 2013 and 2014, respectively. This decrease was primarily due to an decrease in loan collection expenses of $1.3 million.

Net Interest Income – Our net interest income was $7.3 million for the three months ended September 30, 2014, a decrease of $512,000, or 6.5%, compared with $7.8 million for the same period in 2013. Net interest spread and margin were 3.00% and 3.10%, respectively, for the third quarter of 2014, compared with 3.03% and 3.14%, respectively, for the third quarter of 2013. Net average non-accrual loans were $43.3 million and $109.0 million for the third quarters of 2014 and 2013, respectively. Net interest income was $22.3 million for the nine months ended September 30, 2014, a decrease of $2.2 million, or 9.2%, compared with $24.5 million for the same period of 2013. Net interest spread and margin were 2.95% and 3.06%, respectively, for the first nine months of 2014, compared with 3.02% and 3.15%, respectively, for the first nine months of 2013. Net average non-accrual loans were $68.2 million and $111.0 million in the first nine months of 2014 and 2013, respectively.

 

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Average loans receivable declined approximately $116.1 million for the quarter ended September 30, 2014 compared with the third quarter of 2013. This resulted in a decline in interest revenue of approximately $1.1 million for the quarter ended September 30, 2014 compared with the prior year period. Average loans receivable declined approximately $139.7 million for the nine months ended September 30, 2014 compared with the first nine months of 2013. This resulted in a decline in interest revenue of approximately $4.2 million for the nine months ended September 30, 2014 compared with the prior year period. The decline in loan volume is attributable to our efforts to reduce concentrations in our construction and development loan portfolio and our non-owner occupied commercial real estate loan portfolio, as well as soft loan demand in our markets. Declines in interest revenue for the nine months ended September 30, 2014 were offset by the collection of previously charged-off accrued uncollected interest and late charges of approximately $279,000.

Net interest margin decreased four basis points from our margin of 3.14% in the prior year third quarter. The yield on earning assets declined eight basis points from the third quarter of 2013, compared with a five basis point decline in rates paid on interest-bearing liabilities. This resulted in a net $512,000 reduction in net interest income. Net interest margin for the first nine months of 2014 decreased nine basis points from our margin of 3.15% in the first nine months of 2013 due primarily to lower average earning assets relative to average interest bearing liabilities. The yield on earning assets declined 13 basis points from the first nine months of 2013, compared with a six basis point decline in rates paid on interest-bearing liabilities.

Net interest margin for the third quarter of 2014 decreased three basis points from our margin of 3.13% in the second quarter of 2014, due primarily to lower average loan receivables and lower yield on investment securities, countered by a slight increase in yield on loans and the collection of previously charged-off accrued uncollected interest and late charges of approximately $38,000. Average loan receivables declined $37.6 million from the second quarter of 2014, due to our efforts to reduce concentrations in our construction and development loan portfolio and in our non-owner occupied commercial real estate loan portfolio and soft loan demand. Yield on loans was positively affected by a decrease in foregone interest on non-accrual loans. Interest foregone on non-accrual loans totaled $616,000 in the third quarter of 2014, compared with $948,000 in the second quarter of 2014, and $1.4 million in the third quarter of 2013. The decrease in yield on investment securities was the result of our investment into lower-yielding securities at current market rates. Yield on average earning assets for the third quarter of 2014 decreased three basis points from 4.16% in the second quarter of 2014, compared with a two basis point decrease in rates paid on interest-bearing liabilities from 1.15% in the second quarter of 2014.

 

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Average Balance Sheets

The following table presents the average balance sheets for the three month periods ended September 30, 2014 and 2013, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

 

     Three Months Ended September 30,  
     2014     2013  
     Average
Balance
    Interest
Earned/Paid
     Average
Yield/
Cost
    Average
Balance
    Interest
Earned/
Paid
     Average
Yield/
Cost
 
     (dollars in thousands)  

ASSETS

              

Interest-earning assets:

              

Loan receivables (1)(2)

   $ 640,011      $ 8,201         5.08   $ 756,132      $ 9,265         4.86

Securities

              

Taxable

     199,912        1,265         2.51        153,412        900         2.33   

Tax-exempt (3)

     30,071        231         4.69        31,261        239         4.67   

FHLB stock

     7,323        73         3.95        10,072        107         4.21   

Other equity securities

     1        —           —          195        —           —     

Federal funds sold and other

     76,899        44         0.23        55,766        32         0.23   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-earning assets

     954,217        9,814         4.13     1,006,838        10,543         4.21
    

 

 

        

 

 

    

Less: Allowance for loan losses

     (25,045          (36,419     

Non-interest earning assets

     104,646             85,881        
  

 

 

        

 

 

      

Total assets

   $ 1,033,818           $ 1,056,300        
  

 

 

        

 

 

      

LIABILITIES AND STOCKHOLDERS’ EQUITY

              

Interest-bearing liabilities:

              

Certificates of deposit and other time deposits

   $ 625,808      $ 2,064         1.31   $ 675,726      $ 2,281         1.34

NOW and money market deposits

     173,344        160         0.37        149,856        136         0.36   

Savings accounts

     36,812        21         0.23        38,653        26         0.27   

Repurchase agreements

     2,354        1         0.17        3,249        1         0.12   

FHLB advances

     4,803        31         2.56        4,836        38         3.12   

Junior subordinated debentures

     30,399        200         2.61        31,287        212         2.69   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-bearing liabilities

     873,520        2,477         1.13     903,607        2,694         1.18
    

 

 

        

 

 

    

Non-interest-bearing liabilities:

              

Non-interest-bearing deposits

     112,025             101,266        

Other liabilities

     17,172             13,432        
  

 

 

        

 

 

      

Total liabilities

     1,002,717             1,018,305        

Stockholders’ equity

     31,101             37,995        
  

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 1,033,818           $ 1,056,300        
  

 

 

        

 

 

      

Net interest income

     $ 7,337           $ 7,849      
    

 

 

        

 

 

    

Net interest spread

          3.00          3.03
       

 

 

        

 

 

 

Net interest margin

          3.10          3.14
       

 

 

        

 

 

 

 

 

(1)

Includes loan fees in both interest income and the calculation of yield on loans.

(2)

Calculations include non-accruing loans averaging $43.3 million and $109.0 million, respectively, in average loan amounts outstanding.

(3)

Taxable equivalent yields are calculated assuming a 35% federal income tax rate.

 

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Table of Contents

The following table presents the average balance sheets for the nine month periods ended September 30, 2014 and 2013, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

 

     Nine Months Ended September 30,  
     2014     2013  
     Average
Balance
    Interest
Earned/
Paid
     Average
Yield/
Cost
    Average
Balance
    Interest
Earned/
Paid
     Average
Yield/
Cost
 
     (dollars in thousands)  

ASSETS

              

Interest-earning assets:

              

Loan receivables (1)(2)

   $ 671,733      $ 25,094         4.99   $ 811,433      $ 29,252         4.82

Securities

              

Taxable

     186,481        3,653         2.62        148,194        2,585         2.33   

Tax-exempt (3)

     30,565        707         4.76        29,886        691         4.76   

FHLB stock

     7,907        264         4.46        10,072        320         4.25   

Other equity securities

     29        —           —          949        30         4.23   

Federal funds sold and other

     91,316        159         0.23        55,357        91         0.22   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-earning assets

     988,031        29,877         4.09     1,055,891        32,969         4.22
    

 

 

        

 

 

    

Less: Allowance for loan losses

     (26,058          (43,602     

Non-interest earning assets

     92,619             91,669        
  

 

 

        

 

 

      

Total assets

   $ 1,054,592           $ 1,103,958        
  

 

 

        

 

 

      

LIABILITIES AND STOCKHOLDERS’ EQUITY

              

Interest-bearing liabilities:

              

Certificates of deposit and other time deposits

   $ 646,157      $ 6,388         1.32   $ 712,945      $ 7,218         1.35

NOW and money market deposits

     172,012        470         0.37        149,939        398         0.35   

Savings accounts

     36,997        67         0.24        40,038        91         0.30   

Repurchase agreements

     2,303        3         0.17        2,857        4         0.19   

FHLB advances

     4,648        96         2.76        5,127        122         3.18   

Junior subordinated debentures

     30,621        602         2.63        31,517        637         2.70   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-bearing liabilities

     892,738        7,626         1.14     942,423        8,470         1.20
    

 

 

        

 

 

    

Non-interest-bearing liabilities:

              

Non-interest-bearing deposits

     110,809             105,917        

Other liabilities

     15,832             11,438        
  

 

 

        

 

 

      

Total liabilities

     1,019,379             1,059,778        

Stockholders’ equity

     35,213             44,180        
  

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 1,054,592           $ 1,103,958        
  

 

 

        

 

 

      

Net interest income

     $ 22,251           $ 24,499      
    

 

 

        

 

 

    

Net interest spread

          2.95          3.02
       

 

 

        

 

 

 

Net interest margin

          3.06          3.15
       

 

 

        

 

 

 

 

(1)

Includes loan fees in both interest income and the calculation of yield on loans.

(2)

Calculations include non-accruing loans averaging $68.2 million and $111.0 million, respectively, in average loan amounts outstanding.

(3)

Taxable equivalent yields are calculated assuming a 35% federal income tax rate.

 

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Rate/Volume Analysis

The table below sets forth certain information regarding changes in interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (changes in rate multiplied by old volume); (2) changes in volume (changes in volume multiplied by old rate); and (3) changes in rate-volume (change in rate multiplied by change in volume). Changes in rate-volume are proportionately allocated between rate and volume variance.

 

     Three Months Ended
September 30,

2014 vs. 2013
    Nine Months Ended
September 30

2014 vs. 2013
 
     Increase (decrease)
due to change in
    Increase (decrease)
due to change in
 
     Rate     Volume     Net
Change
    Rate     Volume     Net
Change
 
     (in thousands)  

Interest-earning assets:

            

Loan receivables

   $ 409      $ (1,473   $ (1,064   $ 1,029      $ (5,187   $ (4,158

Securities

     65        291        356        321        763        1,084   

FHLB stock

     (6     (27     (33     15        (71     (56

Other equity securities

     —          —          —          (15     (15     (30

Federal funds sold and other

     —          12        12        5        63        68   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total increase (decrease) in interest income

     468        (1,197     (729     1,355        (4,447     (3,092
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-bearing liabilities:

            

Certificates of deposit and other time deposits

     (51     (166     (217     (167     (663     (830

NOW and money market accounts

     2        22        24        12        60        72   

Savings accounts

     (4     (1     (5     (17     (7     (24

Federal funds purchased and repurchase agreements

     —          —          —          —          (1     (1

FHLB advances

     (7     —          (7     (15     (11     (26

Junior subordinated debentures

     (6     (6     (12     (17     (18     (35
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total increase (decrease) in interest expense

     (66 )     (151     (217     (204     (640     (844
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Increase (decrease) in net interest income

   $ 534      $ (1,046   $ (512   $ 1,559      $ (3,807   $ (2,248
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-Interest Income – The following table presents the major categories of non-interest income for the three and nine months ended September 30, 2014 and 2013:

 

     For the Three Months
Ended September 30,
     For the Nine Months
Ended September 30,
 
     2014      2013      2014      2013  
     (dollars in thousands)  

Service charges on deposit accounts

   $ 535       $ 536       $ 1,490       $ 1,535   

Income from fiduciary activities

     —           —           —           517   

Bank card interchange fees

     209         174         575         542   

Other real estate owned rental income

     5         54         30         396   

Gains on sales of investment securities, net

     46         24         92         727   

Income from bank owned life insurance

     69         75         207         459   

Other

     193         304         527         786   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest income

   $ 1,057       $ 1,167       $ 2,921       $ 4,962   
  

 

 

    

 

 

    

 

 

    

 

 

 

Non-interest income for the third quarter ended September 30, 2014 decreased by $110,000, or 9.4%, compared with the third quarter of 2013. For the nine months ended September 30, 2014, non-interest income decreased by $2.0 million, or 41.1% to $2.9 million compared with $5.0 million for the same period of 2013.

The decrease in non-interest income between the three month comparative periods was primarily due to decreases in other real estate owned rental income and other non-interest income. The decrease in non-interest income between the nine month comparative periods was primarily due to a $635,000 reduction in gains on sales of investment securities, a $366,000 decline in other real estate owned rental income, a $252,000 decline in income from bank owned life insurance, as well as lower income from fiduciary activities due to our efforts to transition away from non-traditional trust services, such as ESOP and employee benefit plan services, throughout our markets.

 

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Non-interest ExpenseThe following table presents the major categories of non-interest expense for the nine months ended September 30, 2014 and 2013:

 

     For the Three Months
Ended September 30,
     For the Nine Months
Ended September 30,
 
     2014      2013      2014      2013  
     (dollars in thousands)  

Salary and employee benefits

   $ 4,041       $ 3,837       $ 11,731       $ 11,975   

Occupancy and equipment

     857         884         2,645         2,728   

Loan collection expense

     858         531         2,646         3,973   

Other real estate owned expense

     560         669         1,996         3,117   

FDIC insurance

     571         578         1,682         1,867   

State franchise tax

     405         537         1,235         1,611   

Professional fees

     630         503         1,952         1,408   

Communications

     181         177         581         531   

Insurance expense

     157         171         459         482   

Postage and delivery

     97         99         301         314   

Advertising

     164         74         295         190   

Other

     760         408         2,064         1,835   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest expense

   $ 9,281       $ 8,468       $ 27,587       $ 1,645   
  

 

 

    

 

 

    

 

 

    

 

 

 

Non-interest expense for the third quarter ended September 30, 2014 increased $813,000, or 9.6%, compared with the third quarter of 2013. This increase was primarily driven by increased loan collection expenses and salary and employee benefits. For the nine months ended September 30, 2014, non-interest expense decreased $2.3 million, or 7.6% to $27.6 million compared with $29.8 million for the first nine months of 2013. The decrease for the nine month period was primarily due to reductions in OREO expense and loan collection expenses. The nine month period ended September 30, 2013 was negatively impacted by increased loan collection expenses due to litigation costs. During the nine months ended September 30, 2014, we incurred OREO losses totaling $795,000 million comprised of $1.3 million in fair value write-downs from declining values as evidenced by new appraisals and reduced marketing prices in connection with our sales strategies, offset by $455,000 in net gain on sales of OREO.

Income Tax Expense – No income tax expense was recorded for the first nine months of 2014; income tax benefits of $38,000 and $1.3 million were recorded for the three and nine months ended September 30, 2014, respectively. Our September 30, 2014 tax benefit is entirely due to gains in other comprehensive income that are presented in current operations in accordance with applicable accounting standards. The income tax effect on net loss before taxes for the nine months ended September 30, 2014, increased our deferred tax assets and related valuation allowance by $3.3 million. See discussion in the results of operations above.

Effective tax rates differ from the federal statutory rate of 35% applied to income before income taxes due to the following:

 

     For the Three Months
Ended September 30,
    For the Nine Months
Ended September 30,
 
     2014     2013     2014     2013  
     (dollars in thousands)  

Federal statutory rate times financial statement income

   $ (311   $ 104      $ (3,050   $ (378

Effect of:

        

Valuation allowance

     378        (6     3,257        672   

Tax-exempt income

     (79     (84     (240     (242

Tax benefit from OCI components

     (38     —          (1,345     —     

Non-taxable life insurance income

     (24 )     (20     (72 )     (72

Other, net

     36        6        105        20   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ (38   $ —        $ (1,345   $ —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Analysis of Financial Condition

Total assets decreased $45.4 million, or 4.2%, to $1.031 billion at September 30, 2014, from $1.076 billion at December 31, 2013. This decrease was primarily attributable to a decrease of $67.0 million in net loans and $26.3 million in cash and cash equivalents, partially offset by increases of $23.6 million in other real estate owned and $27.6 million in investment securities. The decrease in net loans was due to loan payoffs outpacing loan funding and efforts to move impaired loans through the collection, foreclosure, and disposition process. The increase in OREO was due to the continued remediation of problem loans.

 

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Table of Contents

Loans ReceivableLoans receivable decreased $71.0 million, or 10.0%, during the nine months ended September 30, 2014 to $638.4 million. The decline in loans receivable was attributable to net charge-offs of $10.2 million, transfers to OREO of $31.7 million, and loan payoffs outpacing loan funding by approximately $29.1 million.

Loan Portfolio CompositionThe following table presents a summary of the loan portfolio at the dates indicated, net of deferred loan fees, by type. There are no foreign loans in our portfolio. Except for commercial real estate and 1-4 family residential real estate, there is no concentration of loans in any industry exceeding 10% of total loans, with the exception of loans for retail facilities (included in nonfarm nonresidential commercial real estate below). Those loans totaled $72.4 million at September 30, 2014 and $98.5 million at December 31, 2013.

 

     As of September 30,
2014
    As of December 31,
2013
 
     Amount      Percent     Amount      Percent  
     (dollars in thousands)  

Commercial

   $ 57,509         9.01   $ 52,878         7.45

Commercial Real Estate

          

Construction

     33,700         5.28        43,326         6.11   

Farmland

     68,357         10.71        71,189         10.04   

Nonfarm nonresidential

     189,341         29.66        232,026         32.71   

Residential Real Estate

          

Multi-family

     42,857         6.71        46,858         6.61   

1-4 Family

     204,375         32.02        228,505         32.21   

Consumer

     12,017         1.88        14,365         2.03   

Agriculture

     29,648         4.64        19,199         2.71   

Other

     556         0.09        980         0.13   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loans

   $ 638,360         100.00   $ 709,326         100.00
  

 

 

    

 

 

   

 

 

    

 

 

 

Loan Portfolio by Risk Category – The following table presents a summary of the loan portfolio at the dates indicated, by risk category.

 

     September 30, 2014     June 30, 2014     March 31, 2014     December 31, 2013  
     Loans      % to
Total
    Loans      % to
Total
    Loans      % to
Total
    Loans      % to
Total
 
     (in thousands)  

Pass

   $ 446,166         69.9   $ 434,853       $ 67.6   $ 415,144       $ 60.8   $ 369,529         52.1

Watch

     83,711         13.1        91,208         14.2        104,171         15.3        144,316         20.3   

Special Mention

     4,431         0.7        3,223         0.5        4,069         0.6        5,865         0.9   

Substandard

     104,052         16.3        113,746         17.7        159,207         23.3        189,616         26.7   

Doubtful

     —           —          —           —          —           —          —           —     
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 638,360         100.0   $ 643,030       $ 100.0   $ 682,591       $ 100.0   $ 709,326         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Our loans receivable have decreased $71.0 million, or 10.0%, during the nine months ended September 30, 2014. All loan risk categories have decreased since December 31, 2013, with the exception of pass loans. The pass category increased approximately $76.6 million, the watch category declined approximately $60.6 million, the special mention category declined approximately $1.4 million, and the substandard category declined approximately $85.6 million. During the first quarter of 2014, management instituted a new risk category within its pass classification. The purpose was to better identify certain loans where the borrower’s sustained satisfactory repayment history was deemed a more relevant predictor of future loss than certain underwriting criteria at origination. The establishment of this new pass risk category helps to ensure the watch risk category remains transitory and event driven in nature. A total of $24.2 million in commercial, $8.5 million in residential, and $2.2 million in agriculture loans were reclassified from watch to the new pass risk category during the first quarter of 2014.

 

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Table of Contents

Loan Delinquency – The following table presents a summary of loan delinquencies at the dates indicated.

 

     September 30,
2014
     June 30,
2014
     March 31,
2014
     December 31,
2013
 
     (in thousands)  

Past Due Loans:

           

30-59 Days

   $ 3,507       $ 3,057       $ 5,667       $ 10,696   

60-89 Days

     3,333         991         1,232         775   

90 Days and Over

     —           —           —           232   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Loans Past Due 30-90+ Days

     6,840         4,048         6,899         11,703   

Nonaccrual Loans

     44,670         44,375         77,344         101,767   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Past Due and Nonaccrual Loans

   $ 51,510       $ 48,423       $ 84,243       $ 113,470   
  

 

 

    

 

 

    

 

 

    

 

 

 

During the nine months ended September 30, 2014, nonaccrual loans decreased by $57.1 million to $44.7 million. This decrease was due primarily to $25.7 million in paydowns and $31.0 million transferred to OREO, offset by $14.7 million in loans moved to nonaccrual status. During the nine months ended September 30, 2014, loans past due 30-59 days decreased from $10.7 million at December 31, 2013 to $3.5 million at September 30, 2014. Loans past due 60-89 days increased from $775,000 at December 31, 2013 to $3.3 million at September 30, 2014. This represents a $4.6 million decrease from December 31, 2013 to September 30, 2014, in loans past due 30-89 days. We considered this trend in delinquency levels during the evaluation of qualitative trends in the portfolio when establishing the general component of our allowance for loan losses.

Non-Performing AssetsNon-performing assets consist of loans past due 90 days or more still on accrual, loans on which interest is no longer accrued, real estate acquired through foreclosure, and repossessed assets. The following table sets forth information with respect to non-performing assets as of September 30, 2014 and December 31, 2013.

 

     September 30,
2014
    December 31,
2013
 
     (dollars in thousands)  

Loans past due 90 days or more still on accrual

   $ —        $ 232   

Nonaccrual loans

     44,670        101,767   
  

 

 

   

 

 

 

Total non-performing loans

     44,670        101,999   

Real estate acquired through foreclosure

     54,507        30,892   

Other repossessed assets

     —          —     
  

 

 

   

 

 

 

Total non-performing assets

   $ 99,177      $ 132,891   
  

 

 

   

 

 

 

Non-performing loans to total loans

     7.00     14.38

Non-performing assets to total assets

     9.62     12.35

Allowance for non-performing loans

   $ 1,205      $ 2,285   

Allowance for non-performing loans to non-performing loans

     2.70     2.24

Nonperforming loans at September 30, 2014, were $44.7 million, or 7.00% of total loans, compared with $106.9 million, or 14.56% of total loans, at September 30, 2013, and $102.0 million, or 14.38% of total loans at December 31, 2013. Net loan charge-offs in the first nine months of 2014 totaled $10.2 million compared to $25.6 million for the first nine months of 2013, and were primarily the result of charging off specific reserves for loans deemed to be collateral dependent, in accordance with regulatory guidance.

Troubled Debt RestructuringA troubled debt restructuring (TDR) occurs when the Company has agreed to a loan modification in the form of a concession for a borrower who is experiencing financial difficulty. The majority of the Company’s TDRs involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired, and the Company has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower. If the loan is considered collateral dependent, it is reported net of allocated reserves, at the fair value of the collateral less cost to sell.

We do not have a formal loan modification program. Rather, we work with individual borrowers on a case-by-case basis to facilitate the orderly collection of our principal and interest before a loan becomes a non-performing loan. If a borrower is unable to make contractual payments, we review the particular circumstances of the borrower’s situation and negotiate a revised payment stream. In other words, we identify performing borrowers experiencing financial difficulties, and through negotiations, we lower their interest rate, most typically on a short-term basis for three to six months. Our goal when restructuring a credit is to afford the borrower a reasonable period of time to remedy the issue causing cash flow constraints within their business so they can return to performing status over time.

 

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Table of Contents

Our loan modifications have taken the form of reduction in interest rate and/or curtailment of scheduled principal payments for a short-term period, usually three to six months, but in some cases until maturity of the loan. In some circumstances we restructure real estate secured loans in a bifurcated fashion whereby we have a fully amortizing “A” loan at a market interest rate and an interest-only “B” loan at a reduced interest rate. Our restructured loans are all collateral secured loans. If a borrower fails to perform under the modified terms, we place the loan(s) on nonaccrual status and begin the process of working with the borrower to liquidate the underlying collateral to satisfy the debt.

At September 30, 2014, we had 58 restructured loans totaling $49.5 million with borrowers who experienced deterioration in financial condition compared with 98 loans totaling $91.3 million at December 31, 2013. In general, these loans were granted interest rate reductions to provide cash flow relief to borrowers experiencing cash flow difficulties. Of these loans, five loans totaling approximately $4.3 million were also granted principal payment deferrals until maturity. There were no concessions made to forgive principal relative to these loans, although we have recorded partial charge-offs for certain restructured loans. In general, these loans are secured by first liens on 1-4 residential or commercial real estate properties, or farmland. Restructured loans also include $888,000 of commercial loans. At September 30, 2014, $28.1 million of our restructured loans were accruing and $21.4 million were on nonaccrual compared with $44.3 million and $46.9 million, respectively, at December 31, 2013. There were no new TDRs during the first nine months of 2014, compared to $3.5 million during the first nine months of 2013.

The following table sets forth information with respect to TDRs, non-performing loans, real estate acquired through foreclosure, and other repossessed assets.

 

     September 30,
2014
    December 31,
2013
 
     (dollars in thousands)  

Total non-performing loans

   $ 44,670      $ 101,999   

TDRs on accrual

     28,114        44,346   
  

 

 

   

 

 

 

Total non-performing loans and TDRs on accrual

   $ 72,784      $ 146,345   

Real estate acquired through foreclosure

     54,507        30,892   

Other repossessed assets

     —          —     
  

 

 

   

 

 

 

Total non-performing assets and TDRs on accrual

   $ 127,291      $ 177,237   
  

 

 

   

 

 

 

Total non-performing loans and TDRs on accrual to total loans

     11.40     20.63

Total non-performing assets and TDRs on accrual to total assets

     12.35     16.47

We consider any loan that is restructured for a borrower experiencing financial difficulties due to a borrower’s potential inability to pay in accordance with contractual terms to be a troubled debt restructure. Specifically, we consider a concession involving a modification of the loan terms, such as (i) a reduction of the stated interest rate, (ii) reduction or deferral of principal, or (iii) reduction or deferral of accrued interest at a stated interest rate lower than the current market rate for new debt with similar risk all to be troubled debt restructurings. When a modification of terms is made for a competitive reason, we do not consider that to be a troubled debt restructuring. A primary example of a competitive modification would be an interest rate reduction for a performing borrower’s loan to a market rate as the result of a market decline in rates.

Management periodically reviews renewals/modifications of previously identified TDRs for which there was no principal forgiveness, to consider if it is appropriate to remove the TDR classification. If the borrower is no longer experiencing financial difficulty and the renewal/modification did not contain a concessionary interest rate or other concessionary terms, management considers the potential removal of the TDR classification. If deemed appropriate, the TDR classification is removed as the borrower has complied with the terms of the loan at the date of renewal/modification and there was a reasonable expectation that the borrower would continue to comply with the terms of the loan after the date of the renewal/modification. In this instance, the TDR was originally considered a restructuring in a prior year as a result of a modification with an interest rate that was not commensurate with the risk of the underlying loan. Additionally, TDR classification can be removed in circumstances in which the Company performs a non-concessionary re-modification of the loan at terms that were considered to be at market for loans with comparable risk. Management expects the borrower will continue to perform under the re-modified terms based on the borrower’s past history of performance.

At September 30, 2014 and December 31, 2013, TDRs totaled $49.5 million and $91.3 million, respectively. During the nine months ended September 30, 2014, TDRs were reduced as a result of $17.2 million in payments along with the transfer of $17.2 million to OREO. In addition, the TDR classification was removed from two loans that met the requirements discussed above in the second quarter of 2014. These two loans totaled $7.3 million at December 31, 2013. These loans are no longer evaluated individually for impairment.

 

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Table of Contents

If the borrower fails to perform, we place the loan on nonaccrual status and seek to liquidate the underlying collateral for these loans. Our nonaccrual policy for restructured loans is identical to our nonaccrual policy for all loans. Our policy calls for a loan to be reported as nonaccrual if it is maintained on a cash basis because of deterioration in the financial condition of the borrower, payment in full of principal and interest is not expected, or principal or interest has been in default for a period of 90 days or more unless the assets are both well secured and in the process of collection. Changes in value for impairment, including the amount attributed to the passage of time, are recorded entirely within the provision for loan losses. Upon determination that a loan is collateral dependent, the loan is charged down to the fair value of collateral less estimated costs to sell.

See Footnote 4, “Loans,” to the financial statements for additional disclosure related to troubled debt restructuring.

Allowance for Loan LossesThe allowance for loan losses is based on management’s continuing review and evaluation of individual loans, loss experience, current economic conditions, risk characteristics of various categories of loans and such other factors that, in management’s judgment, require consideration in estimating loan losses.

Management has established loan grading procedures that result in specific allowance allocations for any estimated inherent risk of loss. For loans not individually evaluated, a general allowance allocation is computed using factors developed over time based on actual loss experience. The specific and general allocations plus consideration of qualitative factors represent management’s best estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses.

An analysis of changes in the allowance for loan losses and selected ratios for the three and nine month periods ended September 30, 2014 and 2013, and for the year ended December 31, 2013 follows:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
    Year Ended
December 31,
2013
 
     2014     2013     2014     2013    
     (in thousands)  

Balance at beginning of period

   $ 25,133      $ 37,559      $ 28,124      $ 56,680      $ 56,680   

Loans charged-off:

          

Real estate

     1,548        5,998        12,272        25,652        28,879   

Commercial

     216        965        670        2,073        2,828   

Consumer

     59        99        238        620        773   

Agriculture

     —          9        30        92        128   

Other

     1        —          19        —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total charge-offs

     1,824        7,071        13,229        28,437        32,608   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recoveries

          

Real estate

     742        519        2,481        1,196        1,622   

Commercial

     108        443        340        1,164        1,212   

Consumer

     23        44        134        223        266   

Agriculture

     2        10        11        228        252   

Other

     14        —          37        —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total recoveries

     889        1,016        3,003        2,811        3,352   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     935        6,055        10,226        25,626        29,256   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for loan losses

     —          250        6,300        700        700   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 24,198      $ 31,754      $ 24,198      $ 31,754      $ 28,124   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses to period-end loans

     3.79     4.32     3.79     4.32     3.96

Net charge-offs to average loans (annualized)

     0.58     3.20     2.04     4.21     3.71

Allowance for loan losses to non-performing loans

     54.17     29.70     54.17     29.70     27.57

Allowance for loan losses for loans individually evaluated for impairment

   $ 1,788      $ 4,762      $ 1,788      $ 4,762      $ 3,471   

Loans individually evaluated for impairment

     78,695        155,417        78,695        155,417        149,883   

Allowance for loan losses to loans individually evaluated for impairment

     2.27     3.06     2.27     3.06     2.32

Allowance for loan losses for loans collectively evaluated for impairment

   $ 22,410      $ 26,992      $ 22,410      $ 26,992      $ 24,653   

Loans collectively evaluated for impairment

     559,665        578,823        559,665        578,823        559,443   

Allowance for loan losses to loans collectively evaluated for impairment

     4.00     4.66     4.00     4.66     4.41

 

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Table of Contents

Our loan loss reserve, as a percentage of total loans at September 30, 2014, decreased to 3.79% from 4.32% at September 30, 2013, and from 3.96% at December 31, 2013. The change in our loan loss reserve as a percentage of total loans between periods is attributable to the fluctuation in historical loss experience, qualitative factors, fewer loans migrating downward in risk grade classifications, charge-off levels, and provision expense. Our allowance for loan losses to non-performing loans was 54.17% at September 30, 2014, compared with 27.57% at December 31, 2013, and 29.70% at September 30, 2013. Net charge-offs in the first nine months of 2014 totaled $10.2 million of which $9.9 million were the result of charging off the allowance for individually evaluated loans deemed to be collateral dependent during the period. This resulted in the decline in our allowance for loan losses for loans individually evaluated for impairment and our allowance for loan losses to non-performing loans to current levels.

The following table sets forth the net charge-offs (recoveries) for the periods indicated:

 

     Nine Months
Ended

September 30,
2014
    Year Ended
December 31,
2013
    Year Ended
December 31,
2012
 
     (in thousands)  

Commercial

   $ 330      $ 1,616      $ 3,655   

Commercial Real Estate

     7,286        20,045        21,531   

Residential Real Estate

     2,505        7,212        8,866   

Consumer

     104        507        1,005   

Agriculture

     19        (124     1,092   

Other

     (18     —          —     
  

 

 

   

 

 

   

 

 

 

Total net charge-offs

   $ 10,226      $ 29,256      $ 36,149   
  

 

 

   

 

 

   

 

 

 

The majority of our nonperforming loans are secured by real estate collateral and the underlying collateral coverage for nonperforming loans supports the likelihood of collection of our principal. We have assessed these loans for collectability and considered, among other things, the borrower’s ability to repay, the value of the underlying collateral, and other market conditions to ensure the allowance for loan losses is adequate to absorb probable incurred losses. Our allowance for non-performing loans to non-performing loans was 2.70% at September 30, 2014 compared with 2.24% at December 31, 2013, and 3.63% at September 30, 2013. The increase in this ratio from December 31, 2013 to September 30, 2014 was primarily attributable to the significant decrease in non-performing loans during the period.

The following table presents the unpaid principal balance, recorded investment and allocated allowance related to loans individually evaluated for impairment in the commercial real estate and residential real estate portfolios as of September 30, 2014 and December 31, 2013.

 

     September 30, 2014     December 31, 2013  
     Commercial
Real Estate
    Residential
Real
Estate
    Commercial
Real Estate
    Residential
Real
Estate
 
     (in thousands)  

Unpaid principal balance

   $ 65,209      $ 29,846      $ 116,740      $ 56,665   

Prior charge-offs

     (14,789     (4,173     (22,410     (7,153
  

 

 

   

 

 

   

 

 

   

 

 

 

Recorded investment

     50,420        25,673        94,330        49,512   

Allocated allowance

     (1,399     (246     (2,345     (827
  

 

 

   

 

 

   

 

 

   

 

 

 

Recorded investment, less allocated allowance

   $ 49,021      $ 25,427      $ 91,985      $ 48,685   
  

 

 

   

 

 

   

 

 

   

 

 

 

Recorded investment, less allocated allowance/ Unpaid principal balance

     75.18     85.19     78.79     85.92

Based on previous charge-offs, our current recorded investment in the commercial real estate and residential real estate segments is significantly below the unpaid principal balance for these loans. The recorded investment and allocated allowance were 75.18% and 85.19% of the unpaid principal balance in the commercial real estate and residential real estate segments of the portfolio, respectively, at September 30, 2014.

 

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The following table illustrates recent trends in loans collectively evaluated for impairment and the related allowance for loan losses by portfolio segment:

 

     September 30, 2014     June 30, 2014     March 31, 2014     December 31, 2013  
     Loans      Allowance      % of
Total
    Loans      Allowance      % to
Total
    Loans      Allowance      % to
Total
    Loans      Allowance      % to
Total
 

Commercial

   $ 55,393       $ 2,394         4.32   $ 62,881       $ 2,965         4.72   $ 56,889       $ 3,156         5.55   $ 47,883       $ 2,931         6.12

Commercial real estate

     240,978         12,340         5.12        237,889         11,902         5.00        244,228         12,383         5.07        252,211         14,069         5.58   

Residential real estate:

     221,559         6,908         3.12        222,163         6,621         2.98        219,456         6,620         3.02        225,851         6,935         3.07   

Consumer

     11,966         330         2.76        12,607         338         2.68        13,585         379         2.79        14,272         407         2.85   

Agriculture

     29,377         429         1.46        27,248         435         1.60        26,049         415         1.59        18,877         305         1.62   

Other

     392         9         2.30        500         12         2.40        226         9         3.98        349         6         1.72   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 559,665       $ 22,410         4.00   $ 563,288       $ 22,273         3.95   $ 560,433       $ 22,962         4.10   $ 559,443       $ 24,653         4.41
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Our allowance for loan losses for loans collectively evaluated for impairment declined to 4.00% at September 30, 2014 from 4.66% at September 30, 2013 and 4.41% at December 31, 2013. This decline was driven primarily by an improving loan risk category classification mix and volume as well as improving historical loss trends which are key factors for estimating general reserves. Other factors include the consideration of growth, composition and diversification of our loan portfolio, current delinquency levels, the results of recent regulatory communications and general economic conditions.

Provision for Loan LossesNo provision for loan losses was recorded in the third quarter of 2014 and $6.3 million was recorded the first nine months of 2014, compared to $250,000 and $700,000 for the third quarter and nine months ended September 30, 2013, respectively. The $6.3 million provision in 2014 was recorded in the second quarter and was driven primarily by approximately $5.2 million in charge-offs related to commercial real estate loans. The charge-offs were in addition to reserves established prior to that time. All loan risk categories have decreased since December 31, 2013, with the exception of pass loans. The pass category increased approximately $76.6 million, the watch category declined approximately $60.6 million, the special mention category declined approximately $1.4 million, and the substandard category declined approximately $85.6 million. During the first quarter of 2014, management instituted a new risk category within its pass classification. The purpose was to better identify certain loans where the borrower’s sustained satisfactory repayment history was deemed a more relevant predictor of future loss than certain underwriting criteria at origination. The establishment of this new pass risk category helps to ensure the watch risk category remains transitory and event driven in nature. A total of $24.2 million in commercial, $8.5 million in residential, and $2.2 million in agriculture loans were reclassified from watch to the new pass risk category during the first quarter. We consider the size and volume of our portfolio as well as the credit quality of our loan portfolio based upon risk category classification when determining the loan loss provision for each period and the allowance for loan losses at period end.

Foreclosed Properties – Foreclosed properties at September 30, 2014 were $54.5 million compared with $41.9 million at September 30, 2013 and $30.9 million at December 31, 2013. See Footnote 5, “Other Real Estate Owned,” to the financial statements. During the first nine months of 2014, we acquired $31.7 million of OREO properties, and sold properties totaling approximately $7.3 million. We value foreclosed properties at fair value less estimated costs to sell when acquired and expect to liquidate these properties to recover our investment in the due course of business.

Other real estate owned (OREO) is recorded at fair market value less estimated cost to sell at time of acquisition. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. Subsequent reductions in fair value are recorded as non-interest expense. To determine the fair value of OREO for smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. If the internally evaluated market price is below our underlying investment in the property, appropriate write-downs are recorded.

For larger dollar commercial real estate properties, we obtain a new appraisal of the subject property or have staff in our special assets group or centralized appraisal department evaluate the latest in-file appraisal in connection with the transfer to OREO. In some of these circumstances, an appraisal is in process at quarter end and we must make our best estimate of the fair value of the underlying collateral based on our internal evaluation of the property, our review of the most recent appraisal, and discussions with the currently engaged appraiser. We typically obtain updated appraisals on the anniversary date of ownership unless a sale is imminent.

Net gain (loss) on sales, write-downs, and operating expenses for OREO totaled $2.0 million for the nine months ended September 30, 2014, compared with $3.1 million for the same period of 2013. During the nine months ended September 30, 2014, fair value write-downs of $1.3 million were recorded to reflect declining values evidenced by new appraisals and our reduction of marketing prices in connection with our sales strategies compared with $1.6 million for the nine months ended September 30, 2013.

LiabilitiesTotal liabilities at September 30, 2014 were $1.001 billion compared with $1.040 billion at December 31, 2013, a decrease of $38.8 million, or 3.7%. This decrease was primarily attributable to a decrease in deposits of $54.2 million, or 5.5%, to $933.5 million at September 30, 2014 from $987.7 million at December 31, 2013. Certificate of deposit balances declined $70.3 million during the first nine months of 2014 to $609.7 million at September 30, 2014 from $680.0 million at December 31, 2013. The decrease in deposits follows management’s strategy to match liability funding levels with lower loan balances.

 

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Federal Home Loan Bank advances increased by $12.4 million to $16.9 million at September 30, 2014, from $4.5 million at December 31, 2013. These advances are used from time to time to fund asset growth and manage interest rate risk in accordance with our asset/liability management strategies.

Deposits are our primary source of funds. The following table sets forth the average daily balances and weighted average rates paid for our deposits for the periods indicated:

 

     For the Nine Months
Ended September 30,
2014
    For the Year
Ended December 31,
2013
 
     Average
Balance
     Average
Rate
    Average
Balance
     Average
Rate
 
     (dollars in thousands)  

Demand

   $ 110,809         $ 106,153      

Interest checking

     79,594         0.16     84,917         0.23

Money market

     92,418         0.54        69,842         0.50   

Savings

     36,997         0.24        39,158         0.29   

Certificates of deposit

     646,157         1.32        703,982         1.35   
  

 

 

      

 

 

    

Total deposits

   $ 965,975         0.96   $ 1,004,052         1.01
  

 

 

      

 

 

    

The following table sets forth the average daily balances and weighted average rates paid for our certificates of deposit for the periods indicated:

 

     For the Nine Months
Ended September 30,
2014
    For the Year
Ended December 31,
2013
 
     Average
Balance
     Average
Rate
    Average
Balance
     Average
Rate
 
     (dollars in thousands)  

Less than $100,000

   $ 362,353         1.26   $ 405,758         1.28

$100,000 or more

     283,804         1.40     298,224         1.44
  

 

 

      

 

 

    

Total

   $ 646,157         1.32   $ 703,982         1.35
  

 

 

      

 

 

    

The following table shows at September 30, 2014 the amount of our time deposits of $100,000 or more by time remaining until maturity (in thousands):

 

Maturity Period

 

Three months or less

   $ 65,805   

Three months through six months

     54,758   

Six months through twelve months

     64,206   

Over twelve months

     84,441   
  

 

 

 

Total

   $ 269,210   
  

 

 

 

 

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Liquidity

Liquidity risk arises from the possibility we may not be able to satisfy current or future financial commitments, or may become unduly reliant on alternative funding sources. The objective of liquidity risk management is to ensure we meet the cash flow requirements of depositors and borrowers, as well as our operating cash needs, taking into account all on- and off-balance sheet funding demands. Liquidity risk management also involves ensuring we meet our cash flow needs at a reasonable cost. We maintain an investment and funds management policy, which identifies primary sources of liquidity, establishes procedures for monitoring and measuring liquidity, and establishes minimum liquidity requirements in compliance with regulatory guidance. Our Asset Liability Committee regularly monitors and reviews our liquidity position.

Funds are available from a number of sources, including the sale of securities in the available for sale portion of the investment portfolio, principal pay-downs on loans and mortgage-backed securities, customer deposit inflows, and other wholesale funding. Our available for sale investment portfolio totaled $192.1 million at September 30, 2014 and within that portfolio, $78.7 million of our securities currently have an unrealized loss of $1.7 million.

Traditionally, we have borrowed from the FHLB to supplement our funding requirements. The advances are collateralized by first mortgage residential loans. The borrowing capacity is based on the market value of the underlying pledged loans. At September 30, 2014, our additional borrowing capacity with the FHLB was $10.1 million. Any new advances are limited to a one year maturity or less.

We also have federal funds borrowing lines from correspondent banks totaling $5.0 million on a secured basis. Management believes our sources of liquidity are adequate to meet expected cash needs for the foreseeable future. However, the availability of these lines could be affected by our financial position, and our lenders could exercise their right to deny a funding request at their discretion. We are also subject to FDIC interest rate restrictions for deposits. As such, we are permitted to offer up to the “national rate” plus 75 basis points as published weekly by the FDIC.

We use cash to pay dividends on common stock, if and when declared by the Board of Directors, and to service debt. The main sources of funding include dividends paid by PBI Bank and financing obtained in the capital markets. During 2011, Porter Bancorp contributed $13.1 million to its subsidiary, PBI Bank, which substantially decreased its liquid assets. The contribution was made to strengthen the Bank’s capital in an effort to help it comply with its capital ratio requirements under the consent order. Liquid assets decreased from $20.3 million at December 31, 2010, to $2.1 million at September 30, 2014. Since the Bank is unlikely to be in a position to pay dividends to the parent company for the foreseeable future, cash inflows for the parent are limited to earnings on investment securities, sales of investment securities, and interest on deposits with the Bank. These cash inflows along with the liquid assets held at September 30, 2014, totaling $2.1 million, are needed for the ongoing cash operating expenses of the parent company which have been reduced and are expected to be approximately $200,000 for rest of 2014. We have elected to defer payments on our Series A preferred stock and on our trust preferred securities.

 

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Table of Contents

Capital

In the fourth quarter of 2011, we began deferring the payment of regular quarterly cash dividends on our Series A Preferred Stock issued to the U.S. Treasury. At September 30, 2014, cumulative accrued and unpaid dividends on this stock totaled $6.7 million. As a result of our dividend deferral, the holder of our Series A Preferred Stock (currently the U.S. Treasury) has the right to appoint up to two representatives to our Board of Directors. We will continue to accrue deferred dividends, which will be deducted from income to common shareholders for financial statement purposes.

In addition, effective with the fourth quarter of 2011, we began deferring interest payments on our junior subordinated notes which resulted in a deferral of distributions on our trust preferred securities. We have the option to defer interest payments from time-to-time for a period not to exceed 20 consecutive quarters. Thereafter, we must pay all deferred interest and resume quarterly interest payments or we will be in default. Future cash dividends on our common stock are subject to the prior payment of all deferred distributions on our trust preferred securities. At September 30, 2014, cumulative accrued and unpaid interest on our junior subordinated notes totaled $2.0 million.

Stockholders’ equity decreased $6.6 million to $29.3 million at September 30, 2014, compared with $35.9 million at December 31, 2013. The decrease was due to the current year net loss and further reduced by dividends declared (accrued and unpaid) on cumulative preferred stock.

Each of the federal bank regulatory agencies has established risk-based capital requirements for banking organizations. In addition, PBI Bank has agreed with its primary regulators to maintain a ratio of total capital to total risk-weighted assets (“total risk-based capital ratio”) of at least 12.0%, and a ratio of Tier 1 capital to total assets (“leverage ratio”) of 9.0%.

The following table shows the ratios of Tier 1 capital and total capital to risk-adjusted assets and the leverage ratios for Porter Bancorp, Inc. and PBI Bank at the dates indicated:

 

     Regulatory
Minimums
    Well-
Capitalized

Minimums
    Minimum
Capital

Ratios
Under

Consent
Order
    September 30,
2014
    December 31,
2013
 
           Porter
Bancorp
    PBI
Bank
    Porter
Bancorp
    PBI
Bank
 

Tier 1 Capital

     4.0     6.0     N/A        5.93     8.99     7.34     9.35

Total risk-based capital

     8.0        10.0        12.0     10.05        11.01        11.03        11.44   

Tier 1 leverage ratio

     4.0        5.0        9.0        4.02        6.09        4.95        6.28   

At September 30, 2014, PBI Bank’s Tier 1 leverage ratio was 6.09%, and its total risk-based capital ratio was 11.01%, both of which are below the minimum capital ratios required by the Consent Order. Failure to meet minimum capital requirements could result in additional discretionary actions by regulators that, if undertaken, could have a materially adverse effect on our financial condition.

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

The Company’s interest sensitivity profile was liability sensitive at September 30, 2014, and asset sensitive at December 31, 2013. Given a 100 basis point increase in interest rates sustained for one year, base net interest income would decrease by an estimated 3.05% at September 30, 2014, compared with an increase of 2.45% at December 31, 2013, and is within the risk tolerance parameters of our risk management policy. Given a 200 basis point increase in interest rates sustained for one year, base net interest income would decrease by an estimated 5.65% at September 30, 2014, compared with an increase of 4.85% at December 31, 2013, and is within the risk tolerance parameters of our risk management policy.

The following table indicates the estimated impact on net interest income under various interest rate scenarios for the twelve months following September 30, 2014, as calculated using the static shock model approach:

 

     Change in Future
Net Interest Income
 
     Dollar
Change
    Percentage
Change
 
     (dollars in thousands)  

+ 200 basis points

   $ (1,576 )     (5.65 )% 

+ 100 basis points

     (849 )     (3.05 )

We did not run a model simulation for declining interest rates as of September 30, 2014 because the Federal Reserve effectively lowered the federal funds target rate between 0.00% to 0.25% in December 2008. Therefore, no significant further short-term rate reductions can occur.

Item 4. Controls and Procedures

Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. As of June 30, 2014, an evaluation was performed under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures.

Management determined that a material weakness existed in the Company’s internal control over financial reporting at June 30, 2014. The Company utilized information to record the fair value of other real estate owned at June 30, 2014 which was obtained prior to taking possession of commercial real estate through a settlement agreement with a contentious borrower on June 24, 2014, rather than promptly obtaining new information material to the fair value of the properties before the filing of the financial statements as of and for the three and six month periods ended June 30, 2014. We determined, after the filing of those financial statements, that our initial estimate of fair value was significantly higher than the actual fair value as it was not based upon the best information available. Based upon the restatement of the Company’s financial statements as of and for the three and six month periods ended June 30, 2014, the Company determined that our internal controls for recording other real estate owned at estimated fair value less costs to sell did not in this instance establish an accurate initial book value and were not effective. Our management, overseen by the Audit Committee, is working to implement steps to improve this process and remediate this control weakness.

The identified material weakness will not be considered remediated until the new procedures have been in operation for a sufficient period of time to be tested and determined by management to be operating effectively. Based on our evaluation and the reasons described above, management, including our Chief Executive Officer and our Chief Financial Officer, concluded that our disclosure controls and procedures were not effective as of the end of the period covered by this report. There were no other changes in our internal control over financial reporting that occurred during the nine months ended September 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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Table of Contents

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

In the normal course of operations, we are defendants in various legal proceedings. Except as described in Footnote 13, “Contingencies” in the Notes to our consolidated financial statement, in the opinion of management, there is no known legal proceeding pending which an adverse decision would be expected to result in a material adverse change in our business or consolidated financial position. See Footnote 13, “Contingencies” in the Notes to our consolidated financial statements for additional detail regarding ongoing legal proceedings.

Item 1A. Risk Factors

We refer you to the detailed cautionary statements and discussion of risks that affect our Company and its business in “Item 1A – Risk Factors” of our December 31, 2013 Annual Report on Form 10-K. There have been no material changes from the risk factors previously discussed in those reports.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

Item 3. Default Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits

(a) Exhibits

The following exhibits are filed or furnished as part of this report:

 

Exhibit Number

  

Description of Exhibit

  31.1    Certification of Principal Executive Officer, pursuant to Rule 13a – 14(a).
  31.2    Certification of Principal Financial Officer, pursuant to Rule 13a – 14(a).
  32.1    Certification of Principal Executive Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  32.2    Certification of Principal Financial Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  101    The following financial statements from the Company’s Quarterly Report on Form 10Q for the quarter ended September 30, 2014, formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income (Loss), (iv) Consolidated Statement of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, (vi) Notes to Consolidated Financial Statements.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act if 1934, the Registrant had duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

   

PORTER BANCORP, INC.

(Registrant)

November 14, 2014       By:   /s/ John T. Taylor
      John T. Taylor
      Chief Executive Officer
   
November 14, 2014       By:   /s/ Phillip W. Barnhouse
      Phillip W. Barnhouse
      Chief Financial Officer and Chief Accounting Officer

 

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