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LIMESTONE BANCORP, INC. - Quarter Report: 2016 June (Form 10-Q)

pbib20160630_10q.htm Table Of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 FORM 10-Q  

 

(Mark One)

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

 

For the Quarterly Period Ended June 30, 2016

 

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      No  

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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  

 

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

 

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

 

23,156,969 Common Shares and 7,958,000 Non-Voting Common Shares, no par value, were outstanding at July 31, 2016.

 


 

 


 

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

34

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

51

ITEM 4.

CONTROLS AND PROCEDURES

51

  

  

  

PART II –

OTHER INFORMATION

  

ITEM 1.

LEGAL PROCEEDINGS

52

ITEM 1A.

RISK FACTORS

52

ITEM 2.

UNREGISTERED SALES ON EQUITY SECURITIES AND USE OF PROCEEDS

52

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

52

ITEM 4.

MINE SAFETY DISCLOSURES

52

ITEM 5.

OTHER INFORMATION

52

ITEM 6.

EXHIBITS

52

 

 


 

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 June 30, 2016 and December 31, 2015

Unaudited Consolidated Statements of Operations for the three and six months ended June 30, 2016 and 2015

Unaudited Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2016 and 2015

Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the six months ended June 30, 2016

Unaudited Consolidated Statements of Cash Flows for the six months ended June 30, 2016 and 2015

Notes to Unaudited Consolidated Financial Statements

 

 

PORTER BANCORP, INC.

Unaudited Consolidated Balance Sheets

(dollars in thousands except share data)

 

   

June 30,

2016

   

December 31,

2015

 

Assets

               

Cash and due from banks

  $ 8,289     $ 8,006  

Interest bearing deposits in banks

    49,313       85,329  

Cash and cash equivalents

    57,602       93,335  

Securities available for sale

    143,145       144,978  

Securities held to maturity (fair value of $44,955 and $44,253, respectively)

    41,948       42,075  

Loans held for sale

          186  

Loans, net of allowance of $10,104 and $12,041, respectively

    614,032       606,625  

Premises and equipment, net

    18,618       18,812  

Other real estate owned

    12,322       19,214  

Federal Home Loan Bank stock

    7,323       7,323  

Bank owned life insurance

    14,646       9,441  

Accrued interest receivable and other assets

    6,916       6,733  

Total assets

  $ 916,552     $ 948,722  
                 

Liabilities and Stockholders’ Equity

               

Deposits

               

Non-interest bearing

  $ 117,843     $ 120,043  

Interest bearing

    722,248       757,954  

Total deposits

    840,091       877,997  

Federal Home Loan Bank advances

    2,775       3,081  

Accrued interest payable and other liabilities

    7,651       10,577  

Subordinated capital note

    3,600       4,050  

Junior subordinated debentures

    21,000       21,000  

Total liabilities

    875,117       916,705  

Stockholders’ equity

               

Preferred stock, no par

               

Series E - 6,198 issued and outstanding; Liquidation preference of $6.2 million

    1,644       1,644  

Series F - 4,304 issued and outstanding; Liquidation preference of $4.3 million

    1,127       1,127  

Total preferred stockholders’ equity

    2,771       2,771  

Common stock, no par, 86,000,000 shares authorized, 23,160,302 and 20,089,533 voting, and 7,958,000 and 6,858,000 non-voting shares issued and outstanding, respectively

    125,729       120,699  

Additional paid-in capital

    23,821       23,654  

Retained deficit

    (108,316

)

    (110,808

)

Accumulated other comprehensive loss

    (2,570

)

    (4,299

)

Total common stockholders’ equity

    38,664       29,246  

Total stockholders' equity

    41,435       32,017  

Total liabilities and stockholders’ equity

  $ 916,552     $ 948,722  

  

See accompanying notes to unaudited consolidated financial statements.

 

 

PORTER BANCORP, INC.

Unaudited Consolidated Statements of Operations

(dollars in thousands, except per share data)

 

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
   

2016

   

2015

   

2016

   

2015

 
Interest income                                

Loans, including fees

  $ 7,455     $ 7,846     $ 15,337     $ 15,601  

Taxable securities

    950       1,010       1,939       2,136  

Tax exempt securities

    158       190       322       393  

Fed funds sold and other

    142       121       292       240  
      8,705       9,167       17,890       18,370  

Interest expense

                               

Deposits

    1,280       1,607       2,588       3,299  

Federal Home Loan Bank advances

    18       24       37       51  

Subordinated capital note

    38       41       77       83  

Junior subordinated debentures

    173       155       341       307  

Federal funds purchased and other

          1             1  
      1,509       1,828       3,043       3,741  

Net interest income

    7,196       7,339       14,847       14,629  

Provision (negative provision) for loan losses

    (600

)

          (1,150

)

     

Net interest income after provision for loan losses

    7,796       7,339       15,997       14,629  
                                 

Non-interest income

                               

Service charges on deposit accounts

    473       475       902       884  

Bank card interchange fees

    221       229       423       432  

Other real estate owned rental income

    149       372       405       729  

Net gain on sales of securities

          199       203       1,696  

Other

    309       290       610       520  
      1,152       1,565       2,543       4,261  

Non-interest expense

                               

Salaries and employee benefits

    3,857       4,028       7,679       7,875  

Occupancy and equipment

    808       828       1,662       1,698  

Professional fees

    492       714       877       1,693  

FDIC Insurance

    493       564       1,016       1,134  

Data processing expense

    295       278       592       582  

State franchise and deposit tax

    255       285       510       570  

Other real estate owned expense

    294       2,932       962       3,665  

Loan collection expense

    271       291       353       574  

Other

    1,171       1,114       2,376       2,635  
      7,936       11,034       16,027       20,426  

Income (loss) before income taxes

    1,012       (2,130

)

    2,513       (1,536

)

Income tax expense

                21        

Net income (loss)

    1,012       (2,130

)

    2,492       (1,536

)

Less:

                               

Earnings (loss) allocated to participating securities

    33       (91

)

    84       (269

)

Net income (loss) available to common shareholders

  $ 979     $ (2,039

)

  $ 2,408     $ (1,267

)

Basic and diluted income (loss) per common share

  $ 0.03     $ (0.08

)

  $ 0.09     $ (0.06

)

  

See accompanying notes to unaudited consolidated financial statements.

 

 

PORTER BANCORP, INC.

Unaudited Consolidated Statements of Comprehensive Income (Loss)

(in thousands)

 

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
   

2016

   

2015

   

2016

   

2015

 

Net income (loss)

  $ 1,012     $ (2,130

)

  $ 2,492     $ (1,536

)

Other comprehensive income (loss):

                               

Unrealized gain (loss) on securities:

                               

Unrealized gain (loss) arising during the period

    659       (1,762

)

    1,868       (433

)

Amortization during the period of net unrealized loss transferred to held to maturity

    32       32       64       64  

Reclassification adjustment for gains included in net income

          (199

)

    (203

)

    (1,696

)

Net unrealized gain/(loss) recognized in comprehensive income

    691       (1,929

)

    1,729       (2,065

)

Tax effect

                       

Other comprehensive income (loss)

    691       (1,929

)

    1,729       (2,065

)

                                 

Comprehensive income (loss)

  $ 1,703     $ (4,059

)

  $ 4,221     $ (3,601

)

  

See accompanying notes to unaudited consolidated financial statements.

 

 

PORTER BANCORP, INC.

Unaudited Consolidated Statements of Changes in Stockholders’ Equity

For Six Months Ended June 30, 2016

(Dollar amounts in thousands except share and per share data)  

 

    Shares       Amount   
    Common     Preferred           Preferred     Common  
   

Common

   

Non-

Voting

Common

   

Total

Common

    Series E    

Series F

   

Common

and

Non-Voting Common

   

Series E

   

Series F

   

Additional

Paid-In

Capital

   

Retained

Deficit

   

Accumulated

Other

Compre-

hensive

Income

(Loss)

   

Total

 
                                                                                                 

Balances, January 1, 2016

    20,089,533       6,858,000       26,947,533       6,198       4,304     $ 120,699     $ 1,644     $ 1,127     $ 23,654     $ (110,808

)

  $ (4,299

)

  $ 32,017  

Issuance of unvested stock

    177,290             177,290                                                        

Forfeited unvested stock

    (6,521

)

          (6,521

)

                                                     

Stock-based compensation expense

                                                    167                   167  

Net income

                                                          2,492             2,492  

Net change in accumulated other comprehensive income (loss), net of taxes

                                                                1,729       1,729  

Issuance of stock

    2,900,000       1,100,000       4,000,000                   5,030                                     5,030  

Balances, June 30, 2016

    23,160,302       7,958,000       31,118,302       6,198       4,304     $ 125,729     $ 1,644     $ 1,127     $ 23,821     $ (108,316

)

  $ (2,570

)

  $ 41,435  

  

See accompanying notes.

 

 

PORTER BANCORP, INC.

Unaudited Consolidated Statements of Cash Flows

For Six Months Ended June 30, 2016 and 2015

(dollars in thousands)

 

   

2016

   

2015

 

Cash flows from operating activities

               

Net income

  $ 2,492     $ (1,536

)

Adjustments to reconcile net loss to net cash from operating activities

               

Depreciation and amortization

    747       814  

Provision (negative provision) for loan losses

    (1,150

)

     

Net amortization on securities

    643       721  

Stock-based compensation expense

    167       181  

Net loss (gain) on sales of loans held for sale

    (29

)

    232  

Loans originated for sale

    (1,814

)

    (4,146

)

Proceeds from sales of loans held for sale

    2,029       4,075  

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

    (169

)

    (43

)

Net write-down of other real estate owned

    650       2,630  

Net realized gain on sales of available for sale securities

    (203

)

    (1,696

)

Earnings on bank owned life insurance, net of premium expense

    (205

)

    (153

)

Net change in accrued interest receivable and other assets

    (384

)

    742  

Net change in accrued interest payable and other liabilities

    (127

)

    309  

Net cash from operating activities

    2,647       2,130  
                 

Cash flows from investing activities

               

Purchases of available for sale securities

    (11,295

)

    (16,800

)

Sales and calls of available for sale securities

    3,721       44,110  

Maturities and prepayments of available for sale securities

    10,823       10,756  

Proceeds from sale of other real estate owned

    6,987       5,020  

Proceeds from sales of loans not originated for sale

          8,640  

Loan originations and payments, net

    (6,903

)

    (26,974

)

Purchases of premises and equipment, net

    (282

)

    (134

)

Purchase of bank owned life insurance

    (5,000

)

     

Net cash from investing activities

    (1,949

)

    24,618  
                 

Cash flows from financing activities

               

Net change in deposits

    (37,906

)

    (22,690

)

Net change in repurchase agreements

          (76

)

Repayment of Federal Home Loan Bank advances

    (306

)

    (17,322

)

Advances from Federal Home Loan Bank

          5,000  

Repayment of subordinated capital note

    (450

)

    (450

)

Issuance of common stock

    2,231        

Net cash from financing activities

    (36,431

)

    (35,538

)

                 

Net change in cash and cash equivalents

    (35,733

)

    (8,790

)

Beginning cash and cash equivalents

    93,335       80,180  

Ending cash and cash equivalents

  $ 57,602     $ 71,390  
                 

Supplemental cash flow information:

               

Interest paid

  $ 2,627     $ 3,622  

Income taxes paid

    21        

Supplemental non-cash disclosure:

               

Proceeds from common stock issuance directed by investors for junior subordinated debenture interest

  $ 2,799     $  

Transfer from loans to other real estate

    576       955  

  

See accompanying notes to unaudited consolidated financial statements.

 

 

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) 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 six months ended June 30, 2016 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, 2015 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.

 

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

 

Adoption of New Accounting Standards – In August 2015, FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606). This ASU is an update to ASU 2014-09, and delays the effective date of ASU 2014-09. The ASU provides 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, 2017. Early adoption is not permitted. Management is currently evaluating the impact of the adoption of this guidance on the Company’s financial statements.

 

In January 2016, the FASB issued an update ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this update impact public business entities as follows: 1) Require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. 2) Simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value. 3) Eliminate the requirement to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. 4) Require entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. 5) Require an entity to present separately in other comprehensive income the portion of the total change in fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. 6) Require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements. 7) Clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

 

In February 2016, the FASB issued an update ASU No. 2016-02, Leases (Topic 842). Under the new guidance, lessees will be required to recognize the following for all leases, with the exception of short-term leases, at the commencement date: a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting in largely unchanged. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2018. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

 

 

In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Shared-Based Payment Accounting. The amendments are intended to improve the accounting for employee shared-based payments and affects all organizations that issue share-based payment awards to their employees. Several aspects of the accounting for share-based payment award transactions are simplified, including the income tax consequences, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The final standard will change estimates for credit losses related to financial assets measured at amortized cost such as loans, held-to-maturity debt securities, and certain other contracts. For estimating credit losses, the FASB is replacing the incurred loss model with an expected loss model, which is referred to as the current expected credit loss (CECL) model. The largest impact will be on the allowance for loan and lease losses. The standard is effective for public companies for fiscal years beginning after December 15, 2019. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements.

 

Note 2 – Going Concern Considerations and Future Plans

 

Our 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 discussion create substantial doubt about the Company’s ability to continue as a going concern.

 

For the six months ended June 30, 2016, we reported net income of $2.5 million compared with net loss of $3.2 million and $11.2 million for the years ended December 31, 2015 and 2014, respectively. Our financial performance has been negatively impacted by the Bank’s elevated level of non-performing assets, although the impact continues to diminish as we have substantially reduced non-performing assets during recent periods. Non-performing loans were 1.86%, 2.28%, and 7.57% of total loans at June 30, 2016, December 31, 2015, and December 31, 2014, respectively. Non-performing assets were 2.61%, 3.51%, and 9.19% of total assets at June 30, 2016, December 31, 2015, and December 31, 2014, respectively. See “Analysis of Financial Condition,” below.

 

On April 15, 2016, we completed a private placement of 2.9 million common shares and 1.1 million non-voting common shares to accredited investors for a total purchase price of $5.0 million. The investors in the private placement directed a portion of the purchase price to pay all deferred interest payments on our trust preferred securities, bringing our interest payments current through the second quarter of 2016. We had deferred interest payable on the junior subordinated debentures held by our trust subsidiaries since the fourth quarter of 2011, requiring our trust subsidiaries to defer distributions on our trust preferred securities held by investors during that period. The remaining proceeds from the private placement totaled approximately $2.2 million and will be used for general corporate purposes and to support the Bank.

 

On June 29, 2016, we notified the trustees of our election to again defer our interest payments effective with the third quarter 2016 payment. We have the ability to defer distributions on our trust preferred securities for 20 consecutive quarters or through the second quarter of 2021. After 20 consecutive quarters, we must pay all deferred distributions or we will be in default.

 

We continue to be involved in various legal proceedings, which are more fully described in Note 13 – “Contingencies”. We are appealing a judgment against us that we believe, after conferring with our legal advisors, we have meritorious grounds on which to prevail. If we do not prevail, the ultimate outcome of this matter could have a material adverse effect on our financial condition, results of operations, or cash flows.

 

PBI Bank is in compliance with each element of its Consent Order with the FDIC and KDFI other than the requirement for the Bank to maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. As of June 30, 2016, the Bank’s Tier 1 leverage ratio and total risk based capital ratio were 6.65% and 10.87%, respectively, both less than the minimum capital ratios required by the Consent Order, but otherwise compliant with Basel III capital requirements. The Consent Order provides that if the Bank should be unable to reach the required capital levels, and if directed in writing by the FDIC, the Bank would be required to develop, adopt and implement a written plan to sell or merge itself into another federally insured financial institution or otherwise obtain a capital investment into the Bank sufficient to recapitalize the Bank. The Bank has not been directed by the FDIC to implement such a plan.

 

In order to meet the 9.0% Tier 1 leverage ratio and 12.0% total risk based capital ratio requirements of the Consent Order, the Board of Directors and management are continuing to evaluate and implement strategies to achieve the following objectives:

 

 

Continuing to increase capital through the issuance of senior debt, subordinated debt, and equity securities.

 

Continuing to operate the Company and Bank in a safe and sound manner.  We have reduced our lending concentrations and the size of our balance sheet while continuing to remediate non-performing loans.

 

 

 

Executing on the sale of other real estate owned (“OREO”) and reinvesting the sale proceeds in quality income producing assets.

 

Continuing to improve 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.

 

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 such as directing a bank to seek a buyer or taking a bank into receivership.

 

The Consent Order requires the Bank to obtain the written consent of both agencies before declaring or paying any future dividends to the Company, which are its principal source of revenue. Since the Bank is unlikely to be in a position to pay dividends to the Company until the Consent Order is satisfied, cash inflows for the Company are limited to the issuance of new debt or the issuance of capital securities. The Company’s liquid assets were $2.3 million as of June 30, 2016. Ongoing operating expenses of the Company are forecast at approximately $1.0 million for the next twelve months.

 

Our consolidated financial statements do not include any adjustments that may result should the Company be unable to continue as a going concern. 

 

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)

 

June 30, 2016

                               

Available for sale

                               

U.S. Government and federal agency

  $ 34,043     $ 423     $ (13

)

  $ 34,453  

Agency mortgage-backed: residential

    101,596       1,921       (56

)

    103,461  

State and municipal

    3,035       59             3,094  

Corporate bonds

    2,330             (193

)

    2,137  

Total available for sale

  $ 141,004     $ 2,403     $ (262

)

  $ 143,145  

  

   

Amortized

Cost

   

Gross

Unrecognized

Gains

   

Gross

Unrecognized

Losses

   

Fair Value

 

Held to maturity

                               

State and municipal

  $ 41,948     $ 3,007     $     $ 44,955  

Total held to maturity

  $ 41,948     $ 3,007     $     $ 44,955  

  

December 31, 2015

 

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Fair Value

 

Available for sale

                               

U.S. Government and federal agency

  $ 33,491     $ 146     $ (375

)

  $ 33,262  

Agency mortgage-backed: residential

    102,135       907       (380

)

    102,662  

State and municipal

    6,555       306             6,861  

Corporate bonds

    2,321             (128

)

    2,193  

Total available for sale

  $ 144,502     $ 1,359     $ (883

)

  $ 144,978  

  

   

Amortized

Cost

   

Gross

Unrecognized

Gains

   

Gross

Unrecognized

Losses

   

Fair Value

 

Held to maturity

                               

State and municipal

  $ 42,075     $ 2,178     $     $ 44,253  

Total held to maturity

  $ 42,075     $ 2,178     $     $ 44,253  

 

 

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

 

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
   

2016

   

2015

   

2016

   

2015

 
    (in thousands)     (in thousands)  

Proceeds

  $ 235     $ 9,972     $ 3,721     $ 44,110  

Gross gains

          281       203       1,832  

Gross losses

          82             136  

 

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.

 

   

June 30, 2016

 
   

Amortized

Cost

   

Fair

Value

 
   

(in thousands)

 

Maturity

               

Available for sale

               

Within one year

  $ 6,272     $ 6,134  

One to five years

    7,622       7,744  

Five to ten years

    25,514       25,806  

Agency mortgage-backed: residential

    101,596       103,461  

Total

  $ 141,004     $ 143,145  
                 

Held to maturity

               

One to five years

  $ 19,092     $ 20,079  

Five to ten years

    21,808       23,696  

Beyond ten years

    1,048       1,180  

Total

  $ 41,948     $ 44,955  

                                                                                                 

Securities pledged at June 30, 2016 and December 31, 2015 had carrying values of approximately $53.7 million and $68.0 million, respectively, and were pledged to secure public deposits.

 

At June 30, 2016 and December 31, 2015, we held securities issued by the Commonwealth of Kentucky or municipalities in the Commonwealth of Kentucky having a book value of $17.4 million and $17.7 million, respectively. Additionally, at June 30, 2016 and December 31, 2015, we held securities issued by the State of Texas or municipalities in the State of Texas having a book value of $4.3 million at each period end. At June 30, 2016 and December 31, 2015, there were no other holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.

 

 

Securities with unrealized losses at June 30, 2016 and December 31, 2015, 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)

 

June 30, 2016

                                               

Available for sale

                                               

U.S. Government and federal agency

  $ 1,509     $ (1

)

  $ 8,835     $ (12

)

  $ 10,344     $ (13

)

Agency mortgage-backed: residential

    10,229       (44

)

    2,444       (12

)

    12,673       (56

)

Corporate bonds

    743       (25

)

    1,394       (168

)

    2,137       (193

)

Total temporarily impaired

  $ 12,481     $ (70

)

  $ 12,673     $ (192

)

  $ 25,154     $ (262

)

                                                 

December 31, 2015

                                               

Available for sale

                                               

U.S. Government and federal agency

  $ 7,058     $ (44

)

  $ 14,527     $ (331

)

  $ 21,585     $ (375

)

Agency mortgage-backed: residential

    36,325       (271

)

    3,856       (109

)

    40,181       (380

)

Corporate bonds

    747       (18

)

    1,446       (110

)

    2,193       (128

)

Total temporarily impaired

  $ 44,130     $ (333

)

  $ 19,829     $ (550

)

  $ 63,959     $ (883

)

 

There were no held to maturity securities in an unrecognized loss position at June 30, 2016 or December 31, 2015.

 

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 June 30, 2016, management does not believe securities within our portfolio with unrealized losses should be classified as other than temporarily impaired.

 

Note 4 – Loans

 

Loans were as follows:

 

June 30,

   

December 31,

 
   

2016

   

2015

 
   

(in thousands)

 

Commercial

  $ 75,222     $ 86,176  

Commercial Real Estate:

               

Construction

    33,184       33,154  

Farmland

    77,742       76,412  

Nonfarm nonresidential

    147,969       140,570  

Residential Real Estate:

               

Multi-family

    44,652       44,131  

1-4 Family

    196,388       201,478  

Consumer

    9,853       10,010  

Agriculture

    38,710       26,316  

Other

    416       419  

Subtotal

    624,136       618,666  

Less: Allowance for loan losses

    (10,104

)

    (12,041

)

Loans, net

  $ 614,032     $ 606,625  

 

 

The following table presents the activity in the allowance for loan losses by portfolio segment for the three months ended June 30, 2016 and 2015:

 

   

Commercial

   

Commercial

Real Estate

   

Residential

Real Estate

   

Consumer

   

Agriculture

   

Other

   

Total

 
   

(in thousands)

 

June 30, 2016:

                                                       

Beginning balance

  $ 642     $ 6,763     $ 3,683     $ 115     $ 136     $ 1     $ 11,340  

Negative provision for loan losses

    305       (1,213

)

    471       (200

)

    (15

)

    52       (600

)

Loans charged off

    (249

)

    (127

)

    (455

)

    (22

)

    (8

)

    (67

)

    (928

)

Recoveries

    32       6       79       154       6       15       292  

Ending balance

  $ 730     $ 5,429     $ 3,778     $ 47     $ 119     $ 1     $ 10,104  
                                                         
                                                         

June 30, 2015:

                                                       

Beginning balance

  $ 2,046     $ 10,680     $ 5,221     $ 244     $ 391     $ 15     $ 18,597  

Provision for loan losses

    (296

)

    (330

)

    604       10       3       9        

Loans charged off

    (99

)

    (1,224

)

    (809

)

    (62

)

    (37

)

    (33

)

    (2,264

)

Recoveries

    295       87       44       34       2       14       476  

Ending balance

  $ 1,946     $ 9,213     $ 5,060     $ 226     $ 359     $ 5     $ 16,809  

 

The following table presents the activity in the allowance for loan losses by portfolio segment for the six months ended June 30, 2016 and 2015: 

 

   

Commercial

   

Commercial

Real Estate

   

Residential

Real Estate

   

Consumer

   

Agriculture

   

Other

   

Total

 
   

(in thousands)

 

June 30, 2016:

                                                       

Beginning balance

  $ 818     $ 6,993     $ 3,984     $ 122     $ 122     $ 2     $ 12,041  

Negative provision for loan losses

    106       (1,588

)

    600       (233

)

    (80

)

    45       (1,150

)

Loans charged off

    (261

)

    (245

)

    (1,050

)

    (35

)

    (8

)

    (78

)

    (1,677

)

Recoveries

    67       269       244       193       85       32       890  

Ending balance

  $ 730     $ 5,429     $ 3,778     $ 47     $ 119     $ 1     $ 10,104  
                                                         
                                                         

June 30, 2015:

                                                       

Beginning balance

  $ 2,046     $ 10,931     $ 5,787     $ 274     $ 319     $ 7     $ 19,364  

Provision for loan losses

    (27

)

    (323

)

    220       22       107       1        

Loans charged off

    (474

)

    (1,593

)

    (1,291

)

    (130

)

    (70

)

    (33

)

    (3,591

)

Recoveries

    401       198       344       60       3       30       1,036  

Ending balance

  $ 1,946     $ 9,213     $ 5,060     $ 226     $ 359     $ 5     $ 16,809  

 

 

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 June 30, 2016:

 

   

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

  $     $ 45     $ 100     $     $ 1     $     $ 146  

Collectively evaluated for impairment

    730       5,384       3,678       47       118       1       9,958  

Total ending allowance balance

  $ 730     $ 5,429     $ 3,778     $ 47     $ 119     $ 1     $ 10,104  
                                                         
                                                         

Loans:

                                                       

Loans individually evaluated for impairment

  $ 748     $ 12,554     $ 12,088     $ 6     $ 139     $     $ 25,535  

Loans collectively evaluated for impairment

    74,474       246,341       228,952       9,847       38,571       416       598,601  

Total ending loans balance

  $ 75,222     $ 258,895     $ 241,040     $ 9,853     $ 38,710     $ 416     $ 624,136  

 

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, 2015:

 

   

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

  $     $ 43     $ 385     $     $     $     $ 428  

Collectively evaluated for impairment

    818       6,950       3,599       122       122       2       11,613  

Total ending allowance balance

  $ 818     $ 6,993     $ 3,984     $ 122     $ 122     $ 2     $ 12,041  
                                                         
                                                         

Loans:

                                                       

Loans individually evaluated for impairment

  $ 1,112     $ 12,819     $ 17,673     $ 20     $ 152     $     $ 31,776  

Loans collectively evaluated for impairment

    85,064       237,317       227,936       9,990       26,164       419       586,890  

Total ending loans balance

  $ 86,176     $ 250,136     $ 245,609     $ 10,010     $ 26,316     $ 419     $ 618,666  

 

 

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 tables present information related to loans individually evaluated for impairment by class of loans as of June 30, 2016 and December 31, 2015 and for the three and six months ended June 30, 2016 and 2015:

 

                           

Three Months Ended

June 30, 2016

   

Six Months Ended

June 30, 2016

 
   

Unpaid

Principal

Balance

   

Recorded

Investment

   

Allowance

For Loan

Losses

Allocated

   

Average

Recorded

Investment

   

Interest

Income

Recognized

   

Average

Recorded

Investment

   

Interest

Income

Recognized

 
   

(in thousands)

 

With No Related Allowance Recorded:

                                                       

Commercial

  $ 1,061     $ 748     $     $ 806     $     $ 908     $ 1  

Commercial real estate:

                                                       

Construction

    259       259             260       3       261       78  

Farmland

    6,250       4,591             4,358       2       4,327       8  

Nonfarm nonresidential

    10,056       6,692             6,547       58       6,974       306  

Residential real estate:

                                                       

Multi-family

    2,387       2,387             2,393       28       1,606       58  

1-4 Family

    5,882       3,961             4,897       13       7,184       71  

Consumer

    39       6             7       1       11       8  

Agriculture

    97       69             73             99        

Other

                                         

Subtotal

    26,031       18,713             19,341       105       21,370       530  

With An Allowance Recorded:

                                                       

Commercial

                                         

Commercial real estate:

                                                       

Construction

                                         

Farmland

    614       605       8       302             202        

Nonfarm nonresidential

    407       407       37       409       6       427       12  

Residential real estate:

                                                       

Multi-family

    4,159       4,159       25       4,168       51       4,177       101  

1-4 Family

    1,581       1,581       75       1,630       34       1,650       54  

Consumer

                                         

Agriculture

    78       70       1       35             23        

Other

                                         

Subtotal

    6,839       6,822       146       6,544       91       6,479       167  

Total

  $ 32,870     $ 25,535     $ 146     $ 25,885     $ 196     $ 27,849     $ 697  

 

 

   

As of December 31, 2015

   

Three Months Ended

June 30, 2015

   

Six Months Ended

June 30, 2015

 
   

Unpaid

Principal

Balance

   

Recorded

Investment

   

Allowance

For Loan

Losses

Allocated

   

Average

Recorded

Investment

   

Interest

Income

Recognized

   

 

Average

Recorded

Investment

   

 

Interest

Income

Recognized

 
   

(in thousands)

 

With No Related Allowance Recorded:

                                                       

Commercial

  $ 1,558     $ 1,112     $     $ 1,605     $ 5     $ 1,730     $ 5  

Commercial real estate:

                                                       

Construction

    278       262             2,475       4       3,016       8  

Farmland

    6,004       4,263             4,659       3       4,685       26  

Nonfarm nonresidential

    11,256       7,829             20,356       72       21,043       137  

Residential real estate:

                                                       

Multi-family

    32       32             17             38        

1-4 Family

    14,066       11,756             14,235       110       14,579       244  

Consumer

    118       20             22             25        

Agriculture

    260       152             231             241        

Other

                      62       2       82       4  

Subtotal

    33,572       25,426             43,662       196       45,439       424  

With An Allowance Recorded:

                                                       

Commercial

                      10             22        

Commercial real estate:

                                                       

Construction

                                         

Farmland

                                  105        

Nonfarm nonresidential

    574       465       43       2,615       6       7,266       12  

Residential real estate:

                                                       

Multi-family

    4,195       4,195       57       4,235       55       4,246       102  

1-4 Family

    1,690       1,690       328       1,628       14       1,676       39  

Consumer

                      4             13        

Agriculture

                                         

Other

                                         

Subtotal

    6,459       6,350       428       8,492       75       13,328       153  

Total

  $ 40,031     $ 31,776     $ 428     $ 52,154     $ 271     $ 58,767     $ 577  

 

Cash basis income recognized for the three and six months ended June 30, 2016 was $7,000 and $290,000, respectively, and $29,000 and $102,000 for the three and six months ended June 30, 2015, respectively.

 

 

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 June 30, 2016 and December 31, 2015:

 

   

TDRs

Performing to

Modified

Terms

   

TDRs Not

Performing to

Modified

Terms

   

Total

TDRs

 
   

(in thousands)

 

June 30, 2016

                       

Commercial

                       

Rate reduction

  $     $ 68     $ 68  

Principal deferral

          439       439  

Commercial Real Estate:

                       

Construction

                       

Rate reduction

    259             259  

Farmland

                       

Principal deferral

          2,340       2,340  

Nonfarm nonresidential

                       

Rate reduction

    5,550             5,550  

Principal deferral

          606       606  

Residential Real Estate:

                       

Multi-family

                       

Rate reduction

    6,546             6,546  

1-4 Family

                       

Rate reduction

    1,581             1,581  

Total TDRs

  $ 13,936     $ 3,453     $ 17,389  

  

   

TDRs

Performing to

Modified

Terms

   

TDRs Not

Performing to

Modified

Terms

   

Total

TDRs

 
   

(in thousands)

 

December 31, 2015

                       

Commercial

                       

Rate reduction

  $     $ 68     $ 68  

Principal deferral

          439       439  

Commercial Real Estate:

                       

Construction

                       

Rate reduction

    262             262  

Farmland

                       

Principal deferral

          2,365       2,365  

Nonfarm nonresidential

                       

Rate reduction

    5,637       50       5,687  

Principal deferral

          622       622  

Residential Real Estate:

                       

Multi-family

                       

Rate reduction

    4,195             4,195  

1-4 Family

                       

Rate reduction

    7,346             7,346  

Total TDRs

  $ 17,440     $ 3,544     $ 20,984  

 

At June 30, 2016 and December 31, 2015, 80% and 83%, respectively, of the Company’s TDRs were performing according to their modified terms. The Company allocated $137,000 and $179,000 in reserves to borrowers whose loan terms have been modified in TDRs as of June 30, 2016, and December 31, 2015, respectively. The Company has committed to lend no additional amounts as of June 30, 2016 and December 31, 2015 to borrowers with outstanding loans classified as TDRs.

 

 

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.

 

No TDR loan modifications occurred during the three or six months ended June 30, 2016 or June 30, 2015. During the first six months of 2016 and 2015, no TDRs defaulted on their restructured loan within the 12-month period following the loan modification. 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.

 

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 June 30, 2016, and December 31, 2015: 

 

   

Nonaccrual

   

Loans Past Due 90 Days

And Over Still Accruing

 
   

June 30,

2016

   

December 31,

2015

   

June 30,

2016

   

December 31,

2015

 
   

(in thousands)

 
                                 

Commercial

  $ 748     $ 1,112     $     $  

Commercial Real Estate:

                               

Construction

                       

Farmland

    5,196       4,263              

Nonfarm nonresidential

    1,549       2,657              

Residential Real Estate:

                               

Multi-family

          32              

1-4 Family

    3,961       5,851              

Consumer

    6       20              

Agriculture

    139       152              

Other

                       

Total

  $ 11,599     $ 14,087     $     $  

 

The following table presents the aging of the recorded investment in past due loans as of June 30, 2016 and December 31, 2015: 

 

   

30 – 59

Days

Past Due

   

60 – 89

Days

Past Due

   

90 Days

And Over

Past Due

   

Nonaccrual

   

Total

Past Due

And

Nonaccrual

 
   

(in thousands)

 

June 30, 2016

                                       

Commercial

  $ 42     $ 25     $     $ 748     $ 815  

Commercial Real Estate:

                                       

Construction

                             

Farmland

    242                   5,196       5,438  

Nonfarm nonresidential

    110                   1,549       1,659  

Residential Real Estate:

                                       

Multi-family

                             

1-4 Family

    1,918       311             3,961       6,190  

Consumer

    89                   6       95  

Agriculture

                      139       139  

Other

                             

Total

  $ 2,401     $ 336     $     $ 11,599     $ 14,336  

 

 

   

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, 2015

                                       

Commercial

  $ 78     $     $     $ 1,112     $ 1,190  

Commercial Real Estate:

                                       

Construction

                             

Farmland

    456                   4,263       4,719  

Nonfarm nonresidential

    326                   2,657       2,983  

Residential Real Estate:

                                       

Multi-family

                      32       32  

1-4 Family

    2,225       241             5,851       8,317  

Consumer

    41                   20       61  

Agriculture

    7                   152       159  

Other

                             

Total

  $ 3,133     $ 241     $     $ 14,087     $ 17,461  

  

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 regularly 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 June 30, 2016, and December 31, 2015, 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)

 

June 30, 2016

                                               

Commercial

  $ 73,569     $ 400     $     $ 1,253     $     $ 75,222  

Commercial Real Estate:

                                               

Construction

    27,915       5,269                         33,184  

Farmland

    67,422       2,492             7,828             77,742  

Nonfarm nonresidential

    130,191       14,632       538       2,608             147,969  

Residential Real Estate:

                                               

Multi-family

    33,828       6,934             3,890             44,652  

1-4 Family

    172,447       15,036       84       8,821             196,388  

Consumer

    9,339       378             136             9,853  

Agriculture

    32,726       4,883             1,101             38,710  

Other

    416                               416  

Total

  $ 547,853     $ 50,024     $ 622     $ 25,637     $     $ 624,136  

 

   

Pass

   

Watch

   

Special

Mention

   

Substandard

   

Doubtful

   

Total

 
   

(in thousands)

 
                                                 

December 31, 2015

                                               

Commercial

  $ 81,570     $ 2,953     $     $ 1,653     $     $ 86,176  

Commercial Real Estate:

                                               

Construction

    27,603       5,289             262             33,154  

Farmland

    65,476       4,844             6,092             76,412  

Nonfarm nonresidential

    111,901       22,687       1,328       4,654             140,570  

Residential Real Estate:

                                               

Multi-family

    35,300       4,879             3,952             44,131  

1-4 Family

    164,490       17,636       67       19,285             201,478  

Consumer

    9,323       474             213             10,010  

Agriculture

    21,402       4,601             313             26,316  

Other

    419                               419  

Total

  $ 517,484     $ 63,363     $ 1,395     $ 36,424     $     $ 618,666  

 

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:

 

   

June 30,

2016

   

December 31,

2015

 
   

(in thousands)

 

Commercial Real Estate:

               

Construction, land development, and other land

  $ 11,066     $ 12,749  

Nonfarm nonresidential

    1,512       6,967  

Residential Real Estate:

               

1-4 Family

    185       128  
      12,763       19,844  

Valuation allowance

    (441

)

    (630

)

    $ 12,322     $ 19,214  

 

   

For the Three

Months Ended

June 30,

   

For the Six

Months Ended

June 30,

 
   

2016

   

2015

   

2016

   

2015

 
   

(in thousands) (in thousands)

 

OREO Valuation Allowance Activity:

                               

Beginning balance

  $ 888     $ 492     $ 630     $ 1,066  

Provision to allowance

    150       2,330       650       2,630  

Write-downs

    (597

)

    (2,515

)

    (839

)

    (3,389

)

Ending balance

  $ 441     $ 307     $ 441     $ 307  

 

Residential loans secured by 1-4 family residential properties in the process of foreclosure totaled $533,000 and $934,000 at June 30, 2016 and December 31, 2015, respectively.

 

Net activity relating to other real estate owned during the six months ended June 30, 2016 and 2015 is as follows:

 

   

For the Six

Months Ended

June 30,

 
   

2016

   

2015

 
   

(in thousands)

 

OREO Activity

               

OREO as of January 1

  $ 19,214     $ 46,197  

Real estate acquired

    576       955  

Valuation adjustment write-downs

    (650

)

    (2,630

)

Net gain on sales

    169       43  

Proceeds from sales of properties

    (6,987

)

    (5,020

)

OREO as of June 30

  $ 12,322     $ 39,545  

 

OREO rental income totaled $149,000 and $405,000 for the three and six months ended June 30, 2016, respectively, and $372,000 and $729,000 for the three and six months ended June 30, 2015, respectively. 

 

Expenses related to other real estate owned include:

 

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
   

2016

   

2015

   

2016

   

2015

 
   

(in thousands) (in thousands)

 

Net gain on sales

  $ (114

)

  $ (40

)

  $ (169

)

  $ (43

)

Provision to allowance

    150       2,330       650       2,630  

Operating expense

    258       642       481       1,078  

Total

  $ 294     $ 2,932     $ 962     $ 3,665  

 

 

 Note 6 – Deposits

 

The following table shows ending deposit balances by category as of:

 

   

June 30,

2016

   

December 31,

2015

 
   

(in thousands)

 

Non-interest bearing

  $ 117,843     $ 120,043  

Interest checking

    90,806       97,515  

Money market

    135,643       125,935  

Savings

    34,616       34,677  

Certificates of deposit

    461,183       499,827  

Total

  $ 840,091     $ 877,997  

 

Time deposits of $250,000 or more were $26.7 million and $28.4 million at June 30, 2016 and December 31, 2015, respectively.

 

Scheduled maturities of all time deposits at June 30, 2016 were as follows (in thousands):

 

Year 1

  $ 345,900  

Year 2

    41,056  

Year 3

    13,916  

Year 4

    44,484  

Year 5

    15,827  
    $ 461,183  

 

Note 7 – Advances from the Federal Home Loan Bank

 

Advances from the Federal Home Loan Bank were as follows:

 

   

June 30,

   

December 31,

 
   

2016

   

2015

 
   

(in thousands)

 

Monthly amortizing advances with fixed rates from 0.00% to 5.25% and maturities ranging from 2017 through 2033, averaging 2.50% at June 30, 2016 and 2.65% at December 31, 2015

  $ 2,775     $ 3,081  

 

Each advance is payable based upon the terms of agreement, with a prepayment penalty.  New advances are limited to a one-year maturity or less. No prepayment penalties were incurred during 2016 or 2015. The advances are collateralized by first mortgage loans. The borrowing capacity is based on the market value of the underlying pledged loans. At June 30, 2016, our additional borrowing capacity with the FHLB was $29.5 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.

 

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.

 

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 participants 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 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 June 30, 2016 and December 31, 2015 are summarized below:

 

           

Fair Value Measurements at June 30, 2016 Using

 
           

(in thousands)

 
           

Quoted Prices In

           

Significant

 
           

Active Markets for

   

Significant Other

   

Unobservable

 
   

Carrying

   

Identical Assets

   

Observable Inputs

   

Inputs

 

Description

 

Value

   

(Level 1)

   

(Level 2)

   

(Level 3)

 

Available for sale securities

                               

U.S. Government and federal agency

  $ 34,453     $     $ 34,453     $  

Agency mortgage-backed: residential

    103,461             103,461        

State and municipal

    3,094             3,094        

Corporate bonds

    2,137             2,137        

Total

  $ 143,145     $     $ 143,145     $  

 

           

Fair Value Measurements at December 31, 2015 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

  $ 33,262     $     $ 33,262     $  

Agency mortgage-backed: residential

    102,662             102,662        

State and municipal

    6,861             6,861        

Corporate bonds

    2,193             2,193        

Total

  $ 144,978     $     $ 144,978     $  

 

There were no transfers between Level 1 and Level 2 during 2016 or 2015.

 

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 June 30, 2016 and 2015:

 

   

Other Debt

Securities

 
   

2016

   

2015

 
   

(in thousands)

 

Balances of recurring Level 3 assets at January 1

  $     $ 658  

Total gain (loss) for the period:

               

Included in other comprehensive income (loss)

          (7

)

Balance of recurring Level 3 assets at June 30

  $     $ 651  

 

At June 30, 2015, our other debt security valuation was determined internally by calculating discounted cash flows using the security’s coupon rate of 6.5% and an estimated current market rate of 8.25% based upon the current yield curve plus spreads that adjust for volatility, credit risk, and optionality.  We also considered the issuer’s publicly filed financial information as well as assumptions regarding the likelihood of deferrals and defaults. This security was sold in December 2015.

 

 

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

 

           

Fair Value Measurements at June 30, 2016 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

  $     $     $     $  

Commercial real estate:

                               

Construction

                       

Farmland

    597                   597  

Nonfarm nonresidential

    92                   92  

Residential real estate:

                               

Multi-family

                       

1-4 Family

    1,506                   1,506  

Consumer

                       

Agriculture

    69                   69  

Other

                       

Other real estate owned, net:

                               

Commercial real estate:

                               

Construction

    10,684                   10,684  

Farmland

                       

Nonfarm nonresidential

    1,460                   1,460  

Residential real estate:

                               

Multi-family

                       

1-4 Family

    178                   178  

 

           

Fair Value Measurements at December 31, 2015 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

  $     $     $     $  

Commercial real estate:

                               

Construction

                       

Farmland

                       

Nonfarm nonresidential

    139                   139  

Residential real estate:

                               

Multi-family

                       

1-4 Family

    1,362                   1,362  

Consumer

                       

Other

                       

Other real estate owned, net:

                               

Commercial real estate:

                               

Construction

    12,344                   12,344  

Farmland

                       

Nonfarm nonresidential

    6,746                   6,746  

Residential real estate:

                               

Multi-family

                       

1-4 Family

    124                   124  

 

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $2.4 million at June 30, 2016 with a valuation allowance of $89,000, resulting in no additional provision for loan losses for the three and six months ended June 30, 2016. Impaired loans had a carrying amount of $5.9 million with a valuation allowance of $742,000, and no additional provision for the three and six months ended June 30, 2015. At December 31, 2015, impaired loans had a carrying amount of $1.8 million, with a valuation allowance of $337,000.

 

OREO, which is measured at the lower of carrying or fair value less estimated costs to sell, had a net carrying amount of $12.3 million as of June 30, 2016, compared with $39.5 million at June 30, 2015 and $19.2 million at December 31, 2015. Fair value write-downs of $150,000 and $650,000 were recorded on OREO for the three and six months ended June 30, 2016, respectively, and $2.3 million and $2.6 million for the three and six months ended June 30, 2015, respectively.

 

 

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 June 30, 2016:

 

   

Fair Value

 

Valuation

Technique(s)

 

Unobservable Input(s)

 

Range (Weighted

Average)

 
   

(in thousands)

                   
                           

Impaired loans – Residential real estate

  $ 1,506  

Sales comparison approach

 

Adjustment for differences between the comparable sales

  1% - 22% (10%)  
                           

Other real estate owned – Commercial real estate

  $ 12,144  

Sales comparison approach

 

Adjustment for differences between the comparable sales

  0% - 30% (12%)  
                           
          Income approach   Discount or capitalization rate   10% - 20% (17%)  

 

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, 2015:

 

   

Fair Value

 

Valuation

Technique(s)

 

Unobservable Input(s)

 

Range (Weighted

Average)

 
   

(in thousands)

                   
                           

Impaired loans – Residential real estate

  $

1,362

 

Sales comparison approach

 

Adjustment for differences between the comparable sales

  1% - 16% (7%)  
                           

Other real estate owned – Commercial real estate

  $ 19,090  

Sales comparison approach

 

Adjustment for differences between the comparable sales

  0% - 30% (12%)  
                           
          Income approach   Discount or capitalization rate   10% - 20% (17%)  

 

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

 

           

Fair Value Measurements at June 30, 2016 Using

 
   

Carrying

Amount

   

Level 1

   

Level 2

   

Level 3

   

Total

 
   

(in thousands)

 

Financial assets

                                       

Cash and cash equivalents

  $ 57,602     $ 44,391     $ 13,211     $     $ 57,602  

Securities available for sale

    143,145             143,145             143,145  

Securities held to maturity

    41,948             44,955             44,955  

Federal Home Loan Bank stock

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

Loans held for sale

                             

Loans, net

    614,032                   620,542       620,542  

Accrued interest receivable

    3,048             1,076       1,972       3,048  

Financial liabilities

                                       

Deposits

  $ 840,091     $ 117,845     $ 711,563     $     $ 829,408  

Federal Home Loan Bank advances

    2,775             2,852             2,852  

Subordinated capital notes

    3,600                   3,515       3,515  

Junior subordinated debentures

    21,000                   12,973       12,973  

Accrued interest payable

    422             388       34       422  

 

 

           

Fair Value Measurements at December 31, 2015 Using

 
   

Carrying

Amount

   

Level 1

   

Level 2

   

Level 3

   

Total

 
   

(in thousands)

 

Financial assets

                                       

Cash and cash equivalents

  $ 93,335     $ 79,498     $ 13,837     $     $ 93,335  

Securities available for sale

    144,978             144,978             144,978  

Securities held to maturity

    42,075             44,253             44,253  

Federal Home Loan Bank stock

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

Loans held for sale

    186             186             186  

Loans, net

    606,625                   614,162       614,162  

Accrued interest receivable

    3,116             1,111       2,005       3,116  

Financial liabilities

                                       

Deposits

  $ 877,997     $ 120,043     $ 739,152     $     $ 859,195  

Federal Home Loan Bank advances

    3,081             3,076             3,076  

Subordinated capital notes

    4,050                   3,933       3,933  

Junior subordinated debentures

    21,000                   12,810       12,810  

Accrued interest payable

    2,805             422       2,383       2,805  

 

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) Loans Held for Sale

The fair value of loans held for sale is estimated based upon binding contracts and and/or 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) 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.

 

(g) 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.

 

 

Note 9 – Income Taxes

 

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

 

   

June 30,

   

December 31,

 
   

2016

   

2015

 
   

(in thousands)

 

Deferred tax assets:

               

Net operating loss carry-forward

  $ 39,336     $ 38,085  

Allowance for loan losses

    3,536       4,214  

Other real estate owned write-down

    6,327       7,619  

Alternative minimum tax credit carry-forward

    692       692  

Net assets from acquisitions

    673       671  

Net unrealized loss on securities

          166  

New market tax credit carry-forward

    208       208  

Nonaccrual loan interest

    562       549  

Other

    1,854       1,875  
      53,188       54,079  
                 

Deferred tax liabilities:

               

FHLB stock dividends

    928       928  

Fixed assets

    203       176  

Net unrealized gain on securities

    749        

Other

    536       865  
      2,416       1,969  

Net deferred tax assets before valuation allowance

    50,772       52,110  

Valuation allowance

    (50,772

)

    (52,110

)

Net deferred tax asset

  $     $  

 

Our estimate of our ability to realize the deferred tax asset depends on our estimate of projected future levels of taxable income. In analyzing future taxable income levels, we considered all evidence currently available, both positive and negative. Based on our analysis, we established a valuation allowance for all deferred tax assets as of December 31, 2011. The valuation allowance remains in effect as of June 30, 2016.

 

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 three or six months ended June 30, 2016 or June 30, 2015 related to unrecognized tax benefits.

 

Under Section 382 of the Internal Revenue Code, as amended (“Section 382”), the Company’s net operating loss carryforwards (“NOLs”) and other deferred tax assets can generally be used to offset future taxable income and therefore reduce federal income tax obligations. However, the Company's ability to use its NOLs would be limited if there was an “ownership change” as defined by Section 382. This would occur if shareholders owning (or deemed to own under the tax rules) 5% or more of the Company's increase their aggregate ownership of the Company by more than 50 percentage points over a defined period of time.

 

In 2015, the Company took two measures to preserve the value of its NOLs. First, we adopted a tax benefits preservation plan designed to reduce the likelihood of an “ownership change” occurring as a result of purchases and sales of the Company's common shares. Upon adoption of this plan, the Company declared a dividend of one preferred stock purchase right for each common share outstanding as of the close of business on July 10, 2015. Any shareholder or group that acquires beneficial ownership of 5% or more of the Company (an “acquiring person”) could be subject to significant dilution in its holdings if the Company's Board of Directors does not approve such acquisition. Existing shareholders holding 5% or more of the Company will not be considered acquiring persons unless they acquire additional shares, subject to certain exceptions described in the plan. In addition, the Board of Directors has the discretion to exempt certain transactions and certain persons whose acquisition of securities is determined by the Board not to jeopardize the Company's deferred tax assets. The rights will expire upon the earlier of (i) June 29, 2018, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefits may be carried forward, (iii) the repeal or amendment of Section 382 or any successor statute, if the Board of Directors determines that the plan is no longer needed to preserve the tax benefits, and (iv) certain other events as described in the plan.

 

 

On September 23, 2015, our shareholders approved an amendment to the Company’s articles of incorporation to further help protect the long-term value of the Company’s NOLs. The amendment provides a means to block transfers of our common shares that could result in an ownership change under Section 382. The transfer restrictions will expire on the earlier of (i) September 23, 2018, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefit may be carried forward, (iii) the repeal of Section 382 or any successor statute if our Board determines that the transfer restrictions are no longer needed to preserve the tax benefits of our NOLs, or (iv) such date as the Board otherwise determines that the transfer restrictions are no longer necessary.

 

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 2012.

 

Note 10 – Stock Plans and Stock Based Compensation

 

At the annual meeting on May 25, 2016, shareholders approved the Porter Bancorp, Inc. 2016 Stock Option and Incentive Compensation Plan (“2016 Plan”), which replaces the Porter Bancorp, Inc. 2006 Stock Incentive Plan (“2006 Employee Plan”) that had expired earlier in 2016. The shares available for issuance under the 2016 Plan total 229,180 shares which represents the number of shares that had previously been authorized by shareholders for issuance under the 2006 Employee Plan. Shares issued to employees under the plan vest annually on the anniversary date of the grant over three to ten years.

 

The Company also maintains the Porter Bancorp, Inc. 2006 Non-Employee Directors Stock Ownership Incentive Plan (“2006 Director Plan”) pursuant to which 89,622 shares remain available for issuance as annual awards of restricted stock to the Company’s non-employee directors. Shares issued annually to non-employee directors have a fair market value of $25,000 and vest on December 31 in the year of grant.

 

On December 4, 2014, the U.S. Treasury sold our Series A preferred shares at a discount to face amount. As a result, restricted shares previously granted to senior executives became subject to permanent transfer restrictions. On March 25, 2015, the Compensation Committee modified the equity compensation arrangements with our four named executive officers to restore the incentive that was intended by including equity grants in their employment agreements. The Compensation Committee and our four named executive officers mutually agreed to terminate 538,479 restricted shares that were subject to permanent restrictions on transfer. We then awarded 800,000 new service-based restricted shares to those executive officers. The new awards are accounted for as a modification and vest over four years, with one-third of the shares vesting on each of the second, third and fourth anniversaries of the date of grant. The modification resulted in incremental compensation expense of approximately $233,000, which is being amortized in accordance with the vesting schedule.

 

The fair value of the 2016 unvested shares issued was $323,000, or $1.82 per weighted-average share. The Company recorded $73,000 and $167,000 of stock-based compensation to salaries and employee benefits for the three and six months ended June 30, 2016, respectively, and $49,000 and $181,000 for the three and six months ended June 30, 2015, respectively. 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 Plan:

 

   

Six Months Ended

   

Twelve Months Ended

 
   

June 30, 2016

   

December 31, 2015

 
           

Weighted

           

Weighted

 
           

Average

           

Average

 
           

Grant

           

Grant

 
   

Shares

   

Price

   

Shares

   

Price

 

Outstanding, beginning

    922,419     $ 0.96       775,492     $ 1.33  

Granted

    177,290       1.82       915,740       0.91  

Vested

    (18,637

)

    2.79       (285,977

)

    1.33  

Terminated

                (450,994

)

    1.25  

Forfeited

    (6,521

)

    1.25       (31,842

)

    1.13  

Outstanding, ending

    1,074,551     $ 1.07       922,419     $ 0.96  

  

Unrecognized stock based compensation expense related to unvested shares for the remainder of 2016 and beyond is estimated as follows (in thousands):

 

July 2016 – December 2016

  $ 278  

2017

    197  

2018

    190  

2019

    30  

2020 & thereafter

    9  

 

 

Note 11 – Earnings (Loss) per Share

 

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

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 
   

2016

   

2015

   

2016

   

2015

 
   

(in thousands, except share and per share data)

 
                                 

Net income (loss)

  $ 1,012     $ (2,130

)

  $ 2,492     $ (1,536

)

Less:

                               

Earnings (loss) allocated to unvested shares

    33       (91

)

    84       (60

)

Earnings (loss) allocated to participating preferred shares

                      (209

)

Net income (loss) available to common shareholders, basic and diluted

  $ 979     $ (2,039

)

  $ 2,408     $ (1,267

)

                                 

Basic

                               

Weighted average common shares including unvested common shares outstanding

    30,385,850       25,687,579       28,665,579       25,554,292  

Less:

                               

Weighted average unvested common shares

    996,046       1,098,072       971,504       990,545  

Weighted average Series B preferred

                      1,343,735  

Weighted average Series D preferred

                      2,140,774  

Weighted average common shares outstanding

    29,389,804       24,589,507       27,694,075       21,079,238  

Basic income (loss) per common share

  $ 0.03     $ (0.08

)

  $ 0.09     $ (0.06

)

                                 

Diluted

                               

Add: Dilutive effects of assumed exercises of common stock warrants

                       

Weighted average common shares and potential common shares

    29,389,804       24,589,507       27,694,075       21,079,238  

Diluted income (loss) per common share

  $ 0.03     $ (0.08

)

  $ 0.09     $ (0.06

)

 

The Company had no outstanding stock options at June 30, 2016 or 2015. 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 June 30, 2016 and 2015 but was not included in the diluted EPS computation as inclusion would have been anti-dilutive. Additionally, warrants for the purchase of 650,544 shares of non-voting common stock at an exercise price of $10.95 per share were outstanding at June 30, 2015, but were not included in the diluted EPS computation as inclusion would have been anti-dilutive. The 650,544 warrants outstanding as of June 30, 2015 expired in September 2015.

 

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.

 

The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. Banks (Basel III rules) became effective for the Company and Bank on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule, and fully phased in by January 1, 2019. The final rules allowed banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. The Company and the Bank opted out of this requirement. The rules also establish a “capital conservation buffer” of 2.5%, to be phased in over three years, above the regulatory minimum risk-based capital ratios. Once the capital conservation buffer is fully phased in, the minimum ratios are a common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total risk-based capital ratio of 10.5%. The phase-in of the capital conservation buffer requirement begins in January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented in January 2019. An institution is subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.     

 

 

In its Consent Order with the FDIC and the KDFI, the Bank has agreed to maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. The Consent Order is described in greater detail in Note 2 – “Going Concern and Future Plans”. As of June 30, 2016, the Bank’s Tier 1 leverage ratio and total risk based capital ratio were both less than the minimum capital ratios required by the Consent Order. The Bank cannot be considered well-capitalized while subject to the Consent Order. 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. In 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.

 

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

 

   

Actual

   

Regulatory Minimums For Capital

Adequacy Purposes

 
   

Amount

   

Ratio

   

Amount

   

Ratio

 

As of June 30, 2016:

                               

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

                               

Consolidated

  $ 75,959       11.31

%

  $ 53,750       8.00

%

Bank

    72,974       10.87       53,692       8.00  

Total common equity Tier I risk-based capital (to risk- weighted assets)

                               

Consolidated

    41,068       6.11       30,235       4.50  

Bank

    61,863       9.22       30,202       4.50  

Tier I capital (to risk-weighted assets)

                               

Consolidated

    54,799       8.16       40,313       6.00  

Bank

    61,863       9.22       40,269       6.00  

Tier I capital (to average assets)

                               

Consolidated

    54,799       5.87       37,370       4.00  

Bank

    61,863       6.65       37,237       4.00  

  

   

Actual

   

Regulatory Minimums For Capital

Adequacy Purposes

 
   

Amount

   

Ratio

   

Amount

   

Ratio

 

As of December 31, 2015:

                               

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

                               

Consolidated

  $ 68,530       10.46

%

  $ 52,436       8.00

%

Bank

    69,250       10.58       52,347       8.00  

Total common equity Tier I risk-based capital (to risk weighted assets)

                               

Consolidated

    33,368       5.09

%

    29,495       4.50

%

Bank

    57,873       8.84       29,445       4.50  

Tier I capital (to risk-weighted assets)

                               

Consolidated

    45,174       6.89       39,327       6.00  

Bank

    57,873       8.84       39,260       6.00  

Tier I capital (to average assets)

                               

Consolidated

    45,174       4.74       38,131       4.00  

Bank

    57,873       6.08       38,085       4.00  

 

 

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

 

   

Actual as of June 30, 2016

   

Ratios Required by Consent Order

 
   

Amount

   

Ratio

   

Amount

   

Ratio

 
                                 

Total capital to risk-weighted assets

  $ 72,974       10.87

%

  $ 80,538       12.00

%

Tier I capital to average assets

    61,863       6.65       83,783       9.00  

 

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. The Bank has agreed with its primary regulators to obtain their written consent prior to declaring or paying any future dividends. As a practical matter, the Bank cannot pay dividends to the Company until the Consent Order is satisfied.

 

Note 13 – Contingencies

 

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 $2.1 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 disclose legal matters when we believe liability is reasonably possible and 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 the 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 the 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 the 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 the Bank. After plaintiffs declined to exercise their right of first refusal, the 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 the Bank.

 

After conferring with its legal advisors, the 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 was filed on December 1, 2014. The Appellate Court heard oral arguments on November 16, 2015. We await the Appellate Court’s ruling. We will continue to defend this matter vigorously.

 

In accordance with the guidance provided in ASC 450-20-25, and after consultation with its legal counsel engaged for the appeal of the verdict, the Company concluded that it was not probable the full amount of the compensatory damages awarded by the jury would be overturned. Therefore, a liability was accrued for the full $1.5 million of compensatory damages awarded, plus statutory interest. After conferring with its legal counsel for the appeal, the Company concluded that the jury verdict for punitive damages was contrary to law, unsupported, excessive, and otherwise inappropriate. Based on this advice, the Company concluded it was probable that the verdict amount for $5.5 million in punitive damages would be overturned by the appeals court, and therefore it was not probable that the $5.5 million in punitive damages would become an actual liability. The ultimate outcome of this self-insured matter could have a material adverse effect on our financial condition, results of operations or cash flows.

 

AIT Laboratories Employee Stock Ownership Plan. On August 29, 2014, the United States Department of Labor (“DOL”) filed a lawsuit against the 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, the 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. The Bank's responsive pleading was filed on November 4, 2014, disputing the material factual allegations that have been made by the DOL. On November 19, 2015, the parties agreed to settle the litigation and executed a written settlement agreement on May 12, 2016. The Bank agreed to a settlement payment, which, to the extent not paid from insurance proceeds, had been previously reserved for. The court entered an agreed order ending the litigation on May 13, 2016.

 

United States Department of Justice Investigation. On October 17, 2014, the United States Department of Justice (the “DOJ”) notified the 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 shares from the Company in November 2008.  The Bank is responding to and cooperating 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.

 

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 other real estate owned (“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 shares and pay interest on the junior subordinated debentures that relate to our trust preferred securities is currently restricted. Our inability to resume paying interest on our trust preferred securities could adversely affect our common and preferred 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, 2015 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 and 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. (the “Company”) is a bank holding company headquartered in Louisville, Kentucky. Our wholly owned subsidiary PBI Bank (“the Bank”) is the tenth largest bank domiciled in the Commonwealth of Kentucky based on total assets. We operate banking offices in twelve counties in Kentucky. Our markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and Bullitt. 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. As of June 30, 2016, we had total assets of $916.6 million, total loans of $624.1 million, total deposits of $840.1 million and stockholders’ equity of $41.4 million.

 

 

The Company reported net income of $1.0 million and $2.5 million for the three and six months ended June 30, 2016, compared with net loss of $2.1 million and $1.5 million for the same periods of 2015. After deductions for earnings allocated to participating securities, net income attributable to common shareholders was $979,000 and $2.4 million for the three and six months ended June 30, 2016, respectively, compared with net loss attributable to common shareholders of $2.0 million and $1.3 million for the three and six months ended June 30, 2015, respectively.

 

Basic and diluted net income per common share were $0.03 and $0.09 for the three and six months ended June 30, 2016, respectively, compared with basic and diluted net loss per common share of ($0.08) and ($0.06) for the three and six months ended June 30, 2015, respectively.

 

We note the following significant items during the six months ended June 30, 2016:

 

 

On April 15, 2016, we completed the private placement of 2.9 million common shares and 1.1 million non-voting common shares to accredited investors resulting in total proceeds of $5.0 million. The investors in the private placement directed a portion of purchase price to pay all deferred interest payments on junior subordinated debentures, bringing our interest payments current through the second quarter of 2016. The remaining proceeds totaled approximately $2.2 million and will be used for general corporate purposes and to support the Bank.

 

 

We recorded negative provision for loan losses expense of $1.2 million for the six months ended June 30, 2016, compared to no provision for loan losses expense for the six months ended June 30, 2015, because of declining historical loss rates, improvements in loan quality, and management’s assessment of risk in the loan portfolio. Net loan charge-offs were $787,000 for the first six months of 2016, compared to $2.6 million for the first six months of 2015. In the following paragraphs we discuss our improving trends in non-performing loans, past due loans, and loan risk categories during the period, the factors that led to the negative provision expense.

 

 

Non-performing loans decreased $2.5 million to $11.6 million at June 30, 2016, compared with $14.1 million at December 31, 2015. The decrease in non-performing loans was primarily due to $3.4 million in paydowns, $988,000 in charge-offs, and $576,000 in transfers to OREO, which were offset by $2.9 million in loans being placed on nonaccrual.

 

 

Loans past due 30-59 days decreased from $3.1 million at December 31, 2015 to $2.4 million at June 30, 2016, and loans past due 60-89 days increased from $241,000 at December 31, 2015 to $336,000 at June 30, 2016. Total loans past due and nonaccrual loans decreased to $14.3 million at June 30, 2016, from $17.5 million at December 31, 2015.

 

 

All loan risk categories (other than pass loans) have decreased since December 31, 2015. Pass loans represent 87.8% of the portfolio at June 30, 2016, compared to 83.6% at December 31, 2015. During the six months ended June 30, 2016, the pass category increased approximately $30.4 million, the watch category declined approximately $13.3 million, the special mention category declined approximately $773,000, and the substandard category declined approximately $10.8 million. The $10.8 million decrease in loans classified as substandard was primarily driven by $7.1 million in principal payments received and $7.7 million in loans upgraded from substandard, offset by $6.1 million in loans downgraded to substandard during the six months ended June 30, 2016.

 

 

Foreclosed properties were $12.3 million at June 30, 2016, compared with $19.2 million at December 31, 2015, and $39.5 million at June 30, 2015. During the first six months of 2016, the Company acquired $576,000 and sold $7.0 million of OREO. We incurred OREO losses totaling $481,000 during the first six months of 2016 compared to $2.6 million during the first six months of 2015, reflecting gains and losses on sales and fair value write-downs for reductions in listing prices for certain properties and updated appraisals.

 

 

Our ratio of non-performing assets to total assets decreased to 2.61% at June 30, 2016, compared with 3.51% at December 31, 2015, and 7.13% at June 30, 2015.

 

 

Net interest margin increased 23 basis points to 3.44% for the first six months of 2016 compared with 3.21% for the first six months of 2015. The increase in margin between periods was due to an increase in the yield on earning assets from 4.02% for the first six months of 2015 to 4.13% for the first six months of 2016, coupled with a decrease in the cost of interest bearing liabilities from 0.89% for the first six months of 2015 to 0.79% in the first six months of 2016. The yield on earning assets was positively impacted by the collection of previously charged-off accrued uncollected interest of approximately $285,000 along with the full unpaid balance of three nonaccrual loans.

 

 

 

Average loans receivable declined approximately $22.6 million or 3.5% to $619.7 million for the six months ended June 30, 2016 compared with $642.3 million for the six months ended June 30, 2015. This resulted in an interest revenue volume decline of approximately $556,000. The decrease in the cost of interest bearing liabilities was primarily driven by the continued repricing of certificates of deposit at lower rates and the declining volume of certificates of deposit.

 

 

Non-interest income decreased $1.7 million to $2.5 million for the first six months of 2016, compared with $4.3 million for the first six months of 2015. The decrease was driven primarily by gains on the sales of securities totaling $203,000 in the first six months of 2016, compared to $1.7 million in the first six months of 2015. Non-interest expense decreased $4.4 million to $16.0 million for the first six months of 2016 compared with $20.4 million for the first six months of 2015, primarily due to other real estate owned expense totaling $962,000 in the first six months of 2016, compared to $3.7 million in the first six months of 2015 as well as professional fees totaling $877,000 in the first six months of 2016, compared to $1.7 million in the first six months of 2015.

 

 

Deposits decreased 4.3% to $840.1 million at June 30, 2016, compared with $878.0 million at December 31, 2015. Certificate of deposit balances decreased $38.6 million during the first six months of 2016 to $461.2 million at June 30, 2016, from $499.8 million at December 31, 2015. Money market deposits increased 7.7% at June 30, 2016 compared with December 31, 2015.

 

 

Going Concern Considerations and Future Plans

 

As described in Note 2 – “Going Concern Considerations and Future Plans,” our 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.

 

For the six months ended June 30, 2016, we reported net income of $2.5 million compared with net loss of $3.2 million and $11.2 million for the years ended December 31, 2015 and 2014, respectively. Our financial performance has been negatively impacted by the Bank’s elevated level of non-performing assets, although the impact continues to diminish as we have substantially reduced non-performing assets during recent periods. Non-performing loans were 1.86%, 2.28%, and 7.57% of total loans at June 30, 2016, December 31, 2015, and December 31, 2014, respectively. Non-performing assets were 2.61%, 3.51%, and 9.19% of total assets at June 30, 2016, December 31, 2015, and December 31, 2014, respectively. See “Analysis of Financial Condition,” below.

 

On April 15, 2016, we completed a private placement of 2.9 million common shares and 1.1 million non-voting common shares to accredited investors for a total purchase price of $5.0 million. The investors in the private placement directed a portion of the purchase price to pay all deferred interest payments on our trust preferred securities, bringing our interest payments current through the second quarter of 2016. We had deferred interest payable on the junior subordinated debentures held by our trust subsidiaries since the fourth quarter of 2011, requiring our trust subsidiaries to defer distributions on our trust preferred securities held by investors during that period. The remaining proceeds from the private placement totaled approximately $2.2 million and will be used for general corporate purposes and to support the Bank.

 

On June 29, 2016, we notified the trustees of our election to again defer our interest payments effective with the third quarter 2016 payment. We have the ability to defer distributions on our trust preferred securities for 20 consecutive quarters or through the second quarter of 2021. After 20 consecutive quarters, we must pay all deferred distributions or we will be in default.

 

We continue to be involved in various legal proceedings, which are more fully described in Note 13 – “Contingencies”. We are appealing a judgment against us that we believe, after conferring with our legal advisors, we have meritorious grounds on which to prevail. If we do not prevail, the ultimate outcome of this matter could have a material adverse effect on our financial condition, results of operations, or cash flows.

 

PBI Bank is in compliance with each element of its Consent Order with the FDIC and KDFI other than the requirement for the Bank to maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. As of June 30, 2016, the Bank’s Tier 1 leverage ratio and total risk based capital ratio were 6.65% and 10.87%, respectively, both less than the minimum capital ratios required by the Consent Order, but otherwise compliant with Basel III capital requirements. The Consent Order provides that if the Bank should be unable to reach the required capital levels, and if directed in writing by the FDIC, the Bank would be required to develop, adopt and implement a written plan to sell or merge itself into another federally insured financial institution or otherwise obtain a capital investment into the Bank sufficient to recapitalize the Bank. The Bank has not been directed by the FDIC to implement such a plan.

 

In order to meet the 9.0% Tier 1 leverage ratio and 12.0% total risk based capital ratio requirements of the Consent Order, the Board of Directors and management are continuing to evaluate and implement strategies to achieve the following objectives:

 

 

Continuing to increase capital through the issuance of senior debt, subordinated debt, and equity securities.

 

Continuing to operate the Company and Bank in a safe and sound manner.  We have reduced our lending concentrations and the size of our balance sheet while continuing to remediate non-performing loans.

 

Executing on the sale of OREO and reinvesting the sale proceeds in quality income producing assets.

 

Continuing to improve 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.

 

 

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.

 

The Consent Order requires the Bank to obtain the written consent of both agencies before declaring or paying any future dividends to the Company, which are its principal source of revenue. Since the Bank is unlikely to be in a position to pay dividends to the Company until the Consent Order is satisfied, cash inflows for the Company are limited to the issuance of new debt or the issuance of capital securities. The Company’s liquid assets were $2.3 million at June 30, 2016. Ongoing operating expenses of the Company are forecast at approximately $1.0 million for the next twelve months.

 

Our consolidated financial statements do not include any adjustments that may result should the Company be unable to continue as a going concern.

 

Application of Critical Accounting Policies

 

We continually review our accounting policies and financial information disclosures. Our more significant accounting policies that require the use of estimates and judgments in preparing the financial statements are summarized in “Application of Critical Accounting Policies” in Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation of our Annual Report on Form 10-K for the calendar year ended December 31, 2015. Management has discussed the development, selection, and application of our critical accounting policies with our Audit Committee. During the first six months of 2016, 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 June 30, 2016, compared with the same period of 2015:

 

   

For the Three Months

   

Change from

 
   

Ended June 30,

   

Prior Period

 
   

2016

   

2015

   

Amount

   

Percent

 
   

(dollars in thousands)

 
                                 

Gross interest income

  $ 8,705     $ 9,167     $ (462

)

    (5.0

)%

Gross interest expense

    1,509       1,828       (319

)

    (17.5

)

Net interest income

    7,196       7,339       (143

)

    (1.9

)

Provision (negative provision) for loan losses

    (600

)

          (600

)

    100.0  

Non-interest income

    1,152       1,565       (413

)

    (26.4

)

Non-interest expense

    7,936       11,034       (3,098

)

    (28.1

)

Net income (loss) before taxes

    1,012       (2,130

)

    3,142       147.5  

Income tax expense

                       

Net income (loss)

    1,012       (2,130

)

    3,142       147.5  

 

Net income for the three months ended June 30, 2016 totaled $1.0 million, compared with net loss of $2.1 million for the comparable period of 2015. Net interest income decreased $143,000 from the second quarter of 2015 as a result of a decrease in earning assets, offset by an increase in net interest margin. Net interest margin increased 13 basis points to 3.34% in the second quarter of 2016 compared with 3.21% in the second quarter of 2015. The increase in margin between periods was due to an increase in the yield on earning assets from 4.00% for the second quarter of 2015 to 4.03% for the second quarter of 2016, coupled with a decrease in the cost of interest bearing liabilities from 0.87% in the second quarter of 2015 to 0.79% in the second quarter of 2016. Average earning assets decreased from $930.4 million for the second quarter of 2015 to $876.7 for the second quarter of 2016. Non-interest income decreased by $413,000 to $1.2 million from $1.6 million in the second quarter of 2015 primarily due to a decrease in other real estate owned income of $223,000. Non-interest expense decreased from $11.0 million in the second quarter of 2015 to $7.9 million in the second quarter of 2016 primarily due to a decrease in other real estate owned expense of $2.6 million, a $222,000 decline in professional fees, and a decline in salaries and employee benefits of $171,000.

 

 

The following table summarizes components of income and expense and the change in those components for the six months ended June 30, 2016, compared with the same period of 2015:

 

   

For the Six Months

   

Change from

 
   

Ended June 30,

   

Prior Period

 
   

2016

   

2015

   

Amount

   

Percent

 
   

(dollars in thousands)

 
                                 

Gross interest income

  $ 17,890     $ 18,370     $ (480

)

    (2.6

)%

Gross interest expense

    3,043       3,741       (698

)

    (18.7

)

Net interest income

    14,847       14,629       218       1.5  

Provision (negative provision) for loan losses

    (1,150

)

          (1,150

)

    100.0  

Non-interest income

    2,543       4,261       (1,718

)

    (40.3

)

Non-interest expense

    16,027       20,426       (4,399

)

    (21.5

)

Net income (loss) before taxes

    2,513       (1,536

)

    4,049       263.6  

Income tax expense

    21             21       100.0  

Net income (loss)

    2,492       (1,536

)

    4,028       262.2  

 

Net income for the six months ended June 30, 2016 totaled $2.5 million, compared with net loss of $1.5 million for the comparable period of 2015. Net interest income increased $218,000 from the first six months of 2015 as a result of the positive impact during the first quarter of 2016 of the collection of previously charged-off accrued uncollected interest of approximately $285,000, offset by a decrease in earning assets for the first six months of 2016. Net interest margin increased 23 basis points to 3.44% in the first six months of 2016 compared with 3.21% in the first six months of 2015. The increase in margin between periods was due to an increase in the yield on earning assets from 4.02% for the first six months of 2015 to 4.13% for the first six months of 2016, coupled with a decrease in the cost of interest bearing liabilities from 0.89% in the first six months of 2015 to 0.79% in the first six months of 2016. Average earning assets decreased from $933.2 million for the first six months of 2015 to $879.2 for the first six months of 2016. Non-interest income decreased by $1.7 million to $2.5 million from $4.3 million in the first six months of 2015 primarily due to a decrease in net gain on sales of securities of $1.5 million. Non-interest expense decreased from $20.4 million in the first six months of 2015 to $16.0 million in the first six months of 2016 primarily due to a decrease in other real estate owned expense of $2.7 million, an $816,000 decline in professional fees, and a decline in loan collection expense of $221,000.

 

Net Interest Income – Our net interest income was $7.2 million for the three months ended June 30, 2016, a decrease of $143,000, or 1.9%, compared with $7.3 million for the same period in 2015. Net interest spread and margin were 3.24% and 3.34%, respectively, for the second quarter of 2016, compared with 3.13% and 3.21%, respectively, for the second quarter of 2015. Net average non-accrual loans were $11.4 million and $33.4 million for the second quarters of 2016 and 2015, respectively.

 

Average loans receivable declined approximately $22.3 million for the second quarter of 2016 compared with the second quarter of 2015. This resulted in an in interest revenue volume decline of approximately $270,000 as well as a decline in interest recoveries and rate improvements aggregating $121,000 for the quarter ended June 30, 2016 compared with the prior year period. Interest foregone on non-accrual loans totaled $181,000 in the second quarter of 2016, compared with $215,000 in the first quarter of 2016, and $464,000 in the second quarter of 2015.

 

Net interest margin increased 13 basis points from our margin of 3.21% in the prior year second quarter to 3.34% for the second quarter of 2016. The yield on earning assets increased three basis points and rates paid on interest-bearing liabilities declined eight basis points from the second quarter of 2015. The reduction in the cost of interest bearing liabilities was primarily driven by declines in the average rates paid on and volume declines in certificates of deposit between periods.

 

Net interest income was $14.8 million for the six months ended June 30, 2016, an increase of $218,000, or 1.5%, compared with $14.6 million for the same period in 2015. Net interest spread and margin were 3.34% and 3.44%, respectively, for the first six months of 2016, compared with 3.13% and 3.21%, respectively, for the first six months of 2015. Net average non-accrual loans were $12.4 million and $38.8 million for the first six months of 2016 and 2015, respectively. Cost of funds decreased ten basis points from 0.89% for the first six months of 2015 to 0.79% for the first six months of 2016.

 

Average loans receivable declined approximately $22.6 million for the six months ended June 30, 2016 compared with the first six months of 2015. This resulted in a decline in interest revenue of approximately $556,000 for the six months ended June 30, 2016 compared with the prior year period.

 

Net interest margin increased 23 basis points from our margin of 3.21% in the first six months of 2015. The yield on earning assets increased 11 basis points from the first six months of 2015, compared with a 10 basis point decline in rates paid on interest-bearing liabilities. The reduction in the cost of interest bearing liabilities was primarily driven by declines in the average rates paid on and volume declines in and certificates of deposit between periods.

 

 

Average Balance Sheets

 

The following table presents the average balance sheets for the three month periods ended June 30, 2016 and 2015, 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 June 30,

 
   

2016

   

2015

 
   

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)

  $ 619,253     $ 7,455       4.84

%

  $ 641,587     $ 7,846       4.91

%

Securities

                                               

Taxable

    162,119       950       2.36       171,608       1,010       2.36  

Tax-exempt (3)

    21,240       158       4.60       25,187       190       4.65  

FHLB stock

    7,323       73       4.01       7,323       72       3.94  

Federal funds sold and other

    66,786       69       0.42       84,710       49       0.23  

Total interest-earning assets

    876,721       8,705       4.03

%

    930,415       9,167       4.00

%

Less: Allowance for loan losses

    (11,257

)

                    (18,035

)

               

Non-interest earning assets

    70,536                       91,127                  

Total assets

  $ 936,000                     $ 1,003,507                  
                                                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

                                               

Interest-bearing liabilities:

                                               

Certificates of deposit and other time deposits

  $ 470,399     $ 1,030       0.88

%

  $ 581,786     $ 1,410       0.97

%

NOW and money market deposits

    233,808       235       0.40       194,730       176       0.36  

Savings accounts

    34,856       15       0.17       36,217       21       0.23  

Repurchase agreements

                      951       1       0.42  

FHLB advances

    2,827       18       2.56       3,487       24       2.76  

Junior subordinated debentures

    24,822       211       3.42       29,721       196       2.65  

Total interest-bearing liabilities

    766,712       1,509       0.79

%

    846,892       1,828       0.87

%

                                                 

Non-interest-bearing liabilities:

                                               

Non-interest-bearing deposits

    119,786                       112,107                  

Other liabilities

    10,288                       10,738                  

Total liabilities

    896,786                       969,737                  

Stockholders’ equity

    39,214                       33,770                  

Total liabilities and stockholders’ equity

  $ 936,000                     $ 1,003,507                  
                                                 

Net interest income

          $ 7,196                     $ 7,339          
                                                 

Net interest spread

                    3.24

%

                    3.13

%

                                                 

Net interest margin

                    3.34

%

                    3.21

%

  


(1)

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

(2)

Calculations include non-accruing loans averaging $11.4 million and $33.4 million, respectively, in average loan amounts outstanding.

(3)

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

 

 

The following table presents the average balance sheets for the six month periods ended June 30, 2016 and 2015, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

 

   

Six Months Ended June 30,

 
   

2016

   

2015

 
   

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)

  $ 619,665     $ 15,337       4.98

%

  $ 642,269     $ 15,601       4.90

%

Securities

                                               

Taxable

    161,789       1,939       2.41       175,146       2,136       2.46  

Tax-exempt (3)

    21,646       322       4.60       25,967       393       4.70  

FHLB stock

    7,323       147       4.04       7,323       146       4.02  

Federal funds sold and other

    68,755       145       0.42       82,505       94       0.23  

Total interest-earning assets

    879,178       17,890       4.13

%

    933,210       18,370       4.02

%

Less: Allowance for loan losses

    (11,645

)

                    (18,646

)

               

Non-interest earning assets

    69,156                       92,948                  

Total assets

  $ 936,689                     $ 1,007,512                  
                                                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

                                               

Interest-bearing liabilities:

                                               

Certificates of deposit and other time deposits

  $ 479,461     $ 2,099       0.88

%

  $ 585,327     $ 2,906       1.00

%

NOW and money market deposits

    231,017       458       0.40       194,431       352       0.37  

Savings accounts

    34,756       31       0.18       36,336       41       0.23  

Repurchase agreements

                      990       1       0.20  

FHLB advances

    2,906       37       2.56       3,719       51       2.77  

Junior subordinated debentures

    24,935       418       3.37       29,834       390       2.64  

Total interest-bearing liabilities

    773,075       3,043       0.79

%

    850,637       3,741       0.89

%

                                                 

Non-interest-bearing liabilities:

                                               

Non-interest-bearing deposits

    116,753                       112,156                  

Other liabilities

    10,481                       10,849                  

Total liabilities

    900,309                       973,642                  

Stockholders’ equity

    36,380                       33,870                  

Total liabilities and stockholders’ equity

  $ 936,689                     $ 1,007,512                  
                                                 

Net interest income

          $ 14,847                     $ 14,629          
                                                 

Net interest spread

                    3.34

%

                    3.13

%

                                                 

Net interest margin

                    3.44

%

                    3.21

%

  


(1)

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

(2)

Calculations include non-accruing loans averaging $12.4 million and $38.8 million, respectively, in average loan amounts outstanding.

(3)

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

 

 

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 June 30,

2016 vs. 2015

   

Six Months Ended June 30,

2016 vs. 2015

 
   

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

  $ (121

)

  $ (270

)

  $ (391

)

  $ 292     $ (556

)

  $ (264

)

Securities

    (11

)

    (81

)

    (92

)

    (49

)

    (219

)

    (268

)

FHLB stock

    1             1       1             1  

Federal funds sold and other

    32       (12

)

    (20

)

    69       (18

)

    51  

Total increase (decrease) in interest income

    (99

)

    (363

)

    (462

)

    313       (793

)

    (480

)

                                                 

Interest-bearing liabilities:

                                               

Certificates of deposit and other time deposits

    (127

)

    (253

)

    (380

)

    (319

)

    (488

)

    (807

)

NOW and money market accounts

    21       38       59       35       71       106  

Savings accounts

    (5

)

    (1

)

    (6

)

    (8

)

    (2

)

    (10

)

Federal funds purchased and repurchase agreements

          (1

)

    (1

)

          (1

)

    (1

)

FHLB advances

    (2

)

    (4

)

    (6

)

    (4

)

    (10

)

    (14

)

Junior subordinated debentures

    50       (35

)

    15       99       (71

)

    28  

Total increase (decrease) in interest expense

    (63

)

    (256

)

    (319

)

    (197 )     (501

)

    (698

)

Increase (decrease) in net interest income

  $ (36

)

  $ (107

)

  $ (143

)

  $ 510     $ (292

)

  $ 218  

 

Non-Interest Income – The following table presents the major categories of non-interest income for the three and six months ended June 30, 2016 and 2015:

 

   

For the Three Months

   

For the Six Months

 
   

Ended June 30,

   

Ended June 30,

 
   

2016

   

2015

   

2016

   

2015

 
   

(dollars in thousands)

 
                                 

Service charges on deposit accounts

  $ 473     $ 475     $ 902     $ 884  

Bank card interchange fees

    221       229       423       432  

Other real estate owned rental income

    149       372       405       729  

Net gain on sales of securities

          199       203       1,696  

Other

    309       290       610       520  

Total non-interest income

  $ 1,152     $ 1,565     $ 2,543     $ 4,261  

 

Non-interest income for the second quarter of 2016 decreased by $413,000, or 26.4%, compared with the second quarter of 2015. For the six months ended June 30, 2016, non-interest income decreased by $1.7 million, or 40.3% to $2.5 million compared with $4.3 million for the same period of 2015. The decrease in non-interest income between the three month comparative periods was primarily due to a $223,000 decrease in OREO rental income as income producing properties have been sold, as well as a decrease in net gain on sales of securities of $199,000. The decrease in non-interest income between the six month comparative periods was primarily due to a $1.5 million decrease in net gain on sales of investment securities, as well as a decrease in OREO income of $324,000.

 

 

Non-interest ExpenseThe following table presents the major categories of non-interest expense for the three and six months ended June 30, 2016 and 2015:

 

   

For the Three Months

   

For the Six Months

 
   

Ended June 30,

   

Ended June 30,

 
   

2016

   

2015

   

2016

   

2015

 
   

(dollars in thousands)

 
                                 

Salary and employee benefits

  $ 3,857     $ 4,028     $ 7,679     $ 7,875  

Occupancy and equipment

    808       828       1,662       1,698  

Professional fees

    492       714       877       1,693  

FDIC insurance

    493       564       1,016       1,134  

Data processing expense

    295       278       592       582  

State franchise and deposit tax

    255       285       510       570  

Other real estate owned expense

    294       2,932       962       3,665  

Loan collection expense

    271       291       353       574  

Other

    1,171       1,114       2,376       2,635  

Total non-interest expense

  $ 7,936     $ 11,034     $ 16,027     $ 20,426  

 

Non-interest expense for the second quarter ended June 30, 2016 decreased $3.1 million, or 28.1%, compared with the second quarter of 2015. For the six months ended June 30, 2016, non-interest expense decreased $4.4 million, or 21.5% to $16.0 million compared with $20.4 million for the first six months of 2015. The decreases in non-interest expense for the second quarter and six months ended June 30, 2016 were primarily attributable to decreased OREO expenses, as fair value write downs based upon listing process as well as new appraisals declined, and decreased professional fees.

 

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

 

   

For the Three Months

   

For the Six Months

 
   

Ended June 30,

   

Ended June 30,

 
   

2016

   

2015

   

2016

   

2015

 
   

(dollars in thousands)

 
                                 

Federal statutory rate times financial statement income

  $ 354     $ (745

)

  $ 879     $ (537

)

Effect of:

                               

Valuation allowance

    (282

)

    833       (732

)

    539  

Tax-exempt income

    (53

)

    (66

)

    (109

)

    (136

)

Non-taxable life insurance income

    (42

)

    (33

)

    (75

)

    (57

)

Other, net

    23       11       58       191  

Total

  $     $     $ 21     $  

 

Analysis of Financial Condition

 

Total assets decreased $32.2 million, or 3.4%, to $916.6 million at June 30, 2016, from $948.7 million at December 31, 2015. This decrease was primarily attributable to a decrease in interest bearing deposits of $36.0 million and a decrease of OREO of $6.9 million, offset by an increase in net loans of $7.4 million and an increase in bank owned life insurance of $5.2 million.

 

Loans ReceivableLoans receivable increased $5.5 million, or 0.9%, during the six months ended June 30, 2016 to $624.1 million as loan growth outpaced payoffs.

 

 

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 $69.5 million at June 30, 2016 and $59.1 million at December 31, 2015.

 

   

As of June 30,

   

As of December 31,

 
   

2016

   

2015

 
   

Amount

   

Percent

   

Amount

   

Percent

 
           

(dollars in thousands)

         
                                 

Commercial

  $ 75,222       12.04

%

  $ 86,176       13.93

%

Commercial Real Estate

                               

Construction

    33,184       5.32       33,154       5.36  

Farmland

    77,742       12.45       76,412       12.35  

Nonfarm nonresidential

    147,969       23.71       140,570       22.72  

Residential Real Estate

                               

Multi-family

    44,652       7.15       44,131       7.13  

1-4 Family

    196,388       31.47       201,478       32.57  

Consumer

    9,853       1.58       10,010       1.62  

Agriculture

    38,710       6.20       26,316       4.25  

Other

    416       0.07       419       0.07  

Total loans

  $ 624,136       100.00

%

  $ 618,666       100.0

%

 

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

 

    June 30, 2016     March 31, 2016     December 31, 2015  
                                     
   

Loans

   

% to

Total

   

Loans

   

% to

Total

   

Loans

   

% to

Total

 
   

(dollars in thousands)

 
                                                 

Pass

  $ 547,853       87.8

%

  $ 534,451       86.2

%

  $ 517,484       83.7

%

Watch

    50,024       8.0       59,265       9.6       63,363       10.2  

Special Mention

    622       0.1       1,383       0.2       1,395       0.2  

Substandard

    25,637       4.1       24,728       4.0       36,424       5.9  

Doubtful

                                   

Total

  $ 624,136       100.0

%

  $ 619,827       100.0

%

  $ 618,666       100.0

%

 

Our loans receivable have increased $5.5 million, or 0.9%, during the six months ended June 30, 2016. All loan risk categories have decreased since December 31, 2015, with the exception of pass loans. The pass category increased approximately $30.4 million, the watch category decreased approximately $13.3 million, the special mention category declined approximately $773,000, and the substandard category declined approximately $10.8 million. The $10.8 million decrease in loans classified as substandard was primarily driven by $7.7 million in loans upgraded from substandard, $7.1 million in principal payments received, $576,000 in migration to OREO, and $1.5 million in charge-offs, offset by $6.1 million in loans moved to substandard during the period.

 

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

 

   

June 30,

2016

   

March 31,

2016

   

December 31,

2015

 
   

(in thousands)

 

Past Due Loans:

                       

30-59 Days

  $ 2,401     $ 1,829     $ 3,133  

60-89 Days

    336       62       241  

90 Days and Over

                 

Total Loans Past Due 30-90+ Days

    2,737       1,891       3,374  
                         

Nonaccrual Loans

    11,599       11,119       14,087  

Total Past Due and Nonaccrual Loans

  $ 14,336     $ 13,010     $ 17,461  

 

During the six months ended June 30, 2016, nonaccrual loans decreased by $2.5 million to $11.6 million. This decrease was due primarily to $3.4 million in paydowns, $988,000 in charge offs, and $576,000 in loans migrating to OREO, offset by $2.9 in loans moved to nonaccrual during the period. During the six months ended June 30, 2016, loans past due 30-59 days decreased from $3.1 million at December 31, 2015 to $2.4 million at June 30, 2016. Loans past due 60-89 days increased from $241,000 at December 31, 2015 to $336,000 at June 30, 2016. This represents a $637,000 decrease from December 31, 2015 to June 30, 2016, 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 June 30, 2016 and December 31, 2015.

 

   

June 30,

2016

   

December 31,

2015

 
   

(dollars in thousands)

 
                 

Loans past due 90 days or more still on accrual

  $     $  

Nonaccrual loans

    11,599       14,087  

Total non-performing loans

    11,599       14,087  

Real estate acquired through foreclosure

    12,322       19,214  

Other repossessed assets

           

Total non-performing assets

  $ 23,921     $ 33,301  
                 

Non-performing loans to total loans

    1.86

%

    2.28

%

Non-performing assets to total assets

    2.61

%

    3.51

%

Allowance for non-performing loans

  $ 241     $ 295  

Allowance for non-performing loans to non-performing loans

    2.08

%

    2.09

%

 

Nonperforming loans at June 30, 2016, were $11.6 million, or 1.86% of total loans, compared with $14.1 million, or 2.28% of total loans at December 31, 2015, and $30.3 million, or 4.67% of total loans at June 30, 2015.

 

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. 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.

 

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.

 

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.

 

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.

 

At June 30, 2016, we had 29 restructured loans totaling $17.4 million with borrowers who experienced deterioration in financial condition compared with 30 loans totaling $21.0 million at December 31, 2015. In general, these loans were granted interest rate reductions to provide cash flow relief to borrowers experiencing cash flow difficulties. Of these loans, three loans totaling approximately $3.4 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 $507,000 of commercial loans. At June 30, 2016, $13.9 million of our restructured loans were accruing and $3.5 million were on nonaccrual compared with $17.4 million and $3.5 million, respectively, at December 31, 2015. There were no new TDRs during the first six months of 2016 or 2015. During the six months ended June 30, 2016, TDRs were reduced as a result of $3.6 million in payments.

 

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

 

   

June 30,

2016

   

December 31,

2015

 
   

(dollars in thousands)

 
                 

Total non-performing loans

  $ 11,599     $ 14,087  

TDRs on accrual

    13,936       17,440  

Total non-performing loans and TDRs on accrual

  $ 25,535     $ 31,527  

Real estate acquired through foreclosure

    12,322       19,214  

Other repossessed assets

           

Total non-performing assets and TDRs on accrual

  $ 37,857     $ 50,741  
                 

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

    4.09

%

    5.10

%

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

    4.13

%

    5.35

%

  

See “Note 4 - Loans,” of the notes 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 six month periods ended June 30, 2016 and 2015, and for the year ended December 31, 2015 follows: 

 

                                   

Year Ended

 
   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

   

December

31,

 
   

2016

   

2015

   

2016

   

2015

    2015  
   

(in thousands)

 

Balance at beginning of period

  $ 11,340     $ 18,597     $ 12,041     $ 19,364     $ 19,364  
                                         

Loans charged-off:

                                       

Real estate

    582       2,033       1,295       2,884       5,050  

Commercial

    249       99       261       474       696  

Consumer

    22       62       35       130       268  

Agriculture

    8       37       8       70       118  

Other

    67       33       78       33        

Total charge-offs

    928       2,264       1,677       3,591       6,132  
                                         

Recoveries

                                       

Real estate

    85       131       513       542       2,338  

Commercial

    32       295       67       401       723  

Consumer

    154       34       193       60       240  

Agriculture

    6       2       85       3       8  

Other

    15       14       32       30        

Total recoveries

    292       476       890       1,036       3,309  

Net charge-offs

    636       1,788       787       2,555       2,823  

Provision (negative provision) for loan losses

    (600

)

          (1,150

)

          (4,500 )

Balance at end of period

  $ 10,104     $ 16,809     $ 10,104     $ 16,809     $ 12,041  
                                         

Allowance for loan losses to period-end loans

    1.62

%

    2.59

%

    1.62

%

    2.59

%

    1.95

%

Net charge-offs to average loans

    0.41

%

    1.12

%

    0.26

%

    0.80

%

    0.44

%

Allowance for loan losses to non-performing loans

    87.11

%

    55.46

%

    87.11

%

    55.46

%

    85.48

%

                                         

Allowance for loan losses for loans individually evaluated for impairment

  $ 146     $ 842     $ 146     $ 842     $ 428  

Loans individually evaluated for impairment

    25,535       49,011       25,535       49,011       31,776  

Allowance for loan losses to loans individually evaluated for impairment

    0.57

%

    1.72

%

    0.57

%

    1.72

%

    1.35

%

                                         

Allowance for loan losses for loans collectively evaluated for impairment

  $ 9,958     $ 15,967     $ 9,958     $ 15,967     $ 11,613  

Loans collectively evaluated for impairment

    598,601       599,310       598,601       599,310       586,890  

Allowance for loan losses to loans collectively evaluated for impairment

    1.66

%

    2.66

%

    1.66

%

    2.66

%

    1.98

%

 

Our loan loss reserve, as a percentage of total loans at June 30, 2016, decreased to 1.62% from 1.95% at December 31, 2015 and from 2.59% at June 30, 2015. 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, improved charge-off levels, and negative provision expense. Our allowance for loan losses to non-performing loans was 87.11% at June 30, 2016, compared with 85.48% at December 31, 2015, and 55.46% at June 30, 2015. Net charge-offs in the first six months of 2016 totaled $787,000 compared to $2.6 million in the first six months of 2015.   

 

 

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

 

   

Six Months

Ended

June 30,

2016

   

Year Ended

December 31,

2015

   

Year Ended

December 31,

2014

 
   

(in thousands)

 

Commercial

  $ 194     $ (27

)

  $ 485  

Commercial Real Estate

    (24

)

    1,225       11,878  

Residential Real Estate

    806       1,487       3,339  

Consumer

    (158

)

    37       167  

Agriculture

    (77

)

    110       17  

Other

    46       (9

)

    (26

)

Total net charge-offs

  $ 787     $ 2,823     $ 15,860  

 

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 2.08% at June 30, 2016 compared with 2.09% at December 31, 2015, and 3.94% at June 30, 2015.

 

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 June 30, 2016 and December 31, 2015.

 

   

June 30, 2016

   

December 31, 2015

 
   

Commercial

Real Estate

   

Residential

Real Estate

   

Commercial

Real Estate

   

Residential

Real Estate

 
   

(in thousands)

 

Unpaid principal balance

  $ 17,586     $ 14,009     $ 18,112     $ 19,983  

Prior charge-offs

    (5,032

)

    (1,921

)

    (5,293

)

    (2,310

)

                                 

Recorded investment

    12,554       12,088       12,819       17,673  

Allocated allowance

    (45

)

    (100

)

    (43

)

    (385

)

                                 

Recorded investment, less allocated allowance

  $ 12,509     $ 11,988     $ 12,776     $ 17,288  
                                 

Recorded investment, less allocated allowance/ Unpaid principal balance

    71.13

%

    85.57

%

    70.54

%

    86.51

%

 

Based on prior 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 net of the allocated allowance was 71.13% and 85.57% of the unpaid principal balance in the commercial real estate and residential real estate segments of the portfolio, respectively, at June 30, 2016.

 

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

 

   

June 30, 2016

   

March 31, 2016

   

December 31, 2015

 
   

Loans

   

Allowance

   

% to

Total

   

Loans

   

Allowance

   

% to

Total

   

Loans

   

Allowance

   

% to

Total

 
                                                                         

Commercial

  $ 74,474     $ 730       0.98

%

  $ 82,879     $ 642       0.77

%

  $ 85,064     $ 818       0.96

%

Commercial real estate

    246,341       5,384       2.19       240,319       6,724       2.80       237,317       6,950       2.93  

Residential real estate

    228,952       3,678       1.61       227,435       3,258       1.43       227,936       3,599       1.58  

Consumer

    9,847       47       0.48       9,921       115       1.16       9,990       122       1.22  

Agriculture

    38,571       118       0.31       32,654       136       0.42       26,164       122       0.47  

Other

    416       1       0.24       383       1       0.26       419       2       0.48  

Total

  $ 598,601     $ 9,958       1.66

%

  $ 593,591     $ 10,876       1.83

%

  $ 586,890     $ 11,613       1.98

%

 

 

Our allowance for loan losses for loans collectively evaluated for impairment declined to 1.66% at June 30, 2016 from 2.66% at June 30, 2015 and 1.98% at December 31, 2015. This decline was driven primarily by declining historical loss trends, the negative provision for loan losses, and an improving loan risk category classification mix and volume 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 LossesA negative provision for loan losses of $1.2 million was recorded for the six months ended June 30, 2016, compared to no provision for loan losses for the six months ended June 30, 2015. The negative provision for 2016 was driven by declining historical loss rates, improvements in asset quality, and management’s assessment of risk within the portfolio. All loan risk categories have decreased since December 31, 2015, with the exception of pass loans. The pass category increased approximately $30.4 million, the watch category decreased approximately $13.3 million, the special mention category declined approximately $773,000, and the substandard category declined approximately $10.8 million. Net charge-offs were $787,000 for the six months ended June 30, 2016, compared with $2.6 million for June 30, 2015. 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 June 30, 2016 were $12.3 million compared with $39.5 million at June 30, 2015 and $19.2 million at December 31, 2015.  See “Note 5 - Other Real Estate Owned,” of the notes to the financial statements. During the first six months of 2016, we acquired $576,000 of OREO properties, and sold properties totaling approximately $7.0 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.

 

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 $962,000 for the six months ended June 30, 2016, compared with $3.7 million for the same period of 2015. During the six months ended June 30, 2016, fair value write-downs of $650,000 were recorded to reflect declines in fair value driven by reductions in listing prices and new appraisals compared with $2.6 million for the six months ended June 30, 2015.

 

LiabilitiesTotal liabilities at June 30, 2016 were $875.1 million compared with $916.7 million at December 31, 2015, a decrease of $41.6 million, or 4.5%. This decrease was primarily attributable to a decrease in deposits of $37.9 million from $878.0 million at December 31, 2015 to $840.1 million at June 30, 2016.

 

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 Six Months

   

For the Year

 
   

Ended June 30,

   

Ended December 31,

 
   

2016

   

2015

 
   

Average

   

Average

   

Average

   

Average

 
   

Balance

   

Rate

   

Balance

   

Rate

 
   

(dollars in thousands)

 

Demand

  $ 116,753             $ 113,576          

Interest checking

    98,159       0.13

%

    88,814       0.13

%

Money market

    132,858       0.60       112,350       0.57  

Savings

    34,756       0.18       35,604       0.21  

Certificates of deposit

    479,461       0.88       557,441       0.96  

Total deposits

  $ 861,987       0.61

%

  $ 907,785       0.68

%

 

 

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 Six Months

   

For the Year

 
   

Ended March 31,

   

Ended December 31,

 
   

2016

   

2015

 
   

Average

   

Average

   

Average

   

Average

 
   

Balance

   

Rate

   

Balance

   

Rate

 
   

(dollars in thousands)

 

Less than $100,000

  $ 270,904       0.86

%

  $ 306,941       0.93

%

$100,000 or more

    208,557       0.92

%

    250,500       0.99

%

Total

  $ 479,461       0.88

%

  $ 557,441       0.96

%

 

The following table shows at June 30, 2016 the amount of our time deposits of $100,000 or more by time remaining until maturity (in thousands):

  

Maturity Period

 
         

Three months or less

  $ 48,641  

Three months through six months

    32,456  

Six months through twelve months

    73,446  

Over twelve months

    46,930  

Total

  $ 201,473  

 

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 that 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 that we meet our cash flow needs at a reasonable cost. We maintain an investment and funds management policy, which identifies the 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 investment portfolio, principal pay-downs on loans and mortgage-backed securities, customer deposit inflows, and other wholesale funding. Historically, we also utilized brokered and wholesale deposits to supplement our funding strategy. We are currently 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. At June 30, 2016, we had no brokered deposits.

 

Traditionally, we have borrowed from the FHLB to supplement our funding requirements. At June 30, 2016, we had an unused borrowing capacity with the FHLB of $29.5 million. Our borrowing capacity is under a detailed loan listing requirement and is based on the market value of the underlying pledged loans. Any new advances are limited to a one-year maturity or less.

 

We also have available, on a secured basis, federal funds borrowing lines from a correspondent bank totaling $5.0 million. 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. 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.

  

Capital

 

Stockholders’ equity increased $9.4 million to $41.4 million at June 30, 2016, compared with $32.0 million at December 31, 2015 due to the issuance of $5.0 in common stock, current year net income of $2.5 million and an increase in the fair value of our available for sale securities portfolio of $1.7 million.

 

 

The following table shows the ratios of Tier 1 capital and total capital to risk-adjusted assets and the leverage ratios for the Company and the Bank at the dates indicated:

 

                           

June 30, 2016

   

December 31, 2015

 
   

Regulatory

Minimums

   

Well-Capitalized

Minimums

   

Minimum Capital

Ratios Under

Consent Order

   

Porter

Bancorp

   

PBI

Bank

   

Porter

Bancorp

   

PBI

Bank

 
                                                         

Tier 1 Capital

    6.0 %     8.0 %     N/A       8.16 %     9.22 %     6.89 %     8.84 %

Common equity Tier I capital

    4.5       6.5       N/A       6.11       9.22       5.09       8.84  

Total risk-based capital

    8.0       10.0       12.0 %     11.31       10.87       10.46       10.58  

Tier 1 leverage ratio

    4.0       5.0       9.0       5.87       6.65       4.74       6.08  

 

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.

 

Each of the federal bank regulatory agencies has established risk-based capital requirements for banking organizations. The Basel III regulatory capital reforms became effective for the Company and Bank on January 1, 2015, and include new minimum risk-based capital and leverage ratios. These rules refine the definition of what constitutes “capital” for purposes of calculating those ratios, including the definitions of Tier 1 capital and Tier 2 capital. The final rules allow banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. The Company and the Bank opted out of this requirement. The rules also establish a “capital conservation buffer” of 2.5%, to be phased in over three years, above the regulatory minimum risk-based capital ratios. Once the capital conservation buffer is fully phased in, the minimum ratios are a common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total risk-based capital ratio of 10.5%. The phase-in of the capital conservation buffer requirement begins in January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented in January 2019. An institution is subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions. In addition, the 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%.

 

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Given a 100 basis point increase in interest rates sustained for one year, base net interest income would decrease by an estimated 1.42% at June 30, 2016, compared with an increase of 0.6% at December 31, 2015, 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 3.23% at June 30, 2016, compared with an increase of 1.6% at December 31, 2015, 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 June 30, 2016, as calculated using the static shock model approach:

 

   

Change in Future

Net Interest Income

 
   

Dollar

Change

   

Percentage

Change

 
   

(dollars in thousands)

 

+ 200 basis points

  $ (910

)

    (3.23

)%

+ 100 basis points

    (400

)

    (1.42

)

- 100 basis points

    (1,060

)

    (3.77

)

- 200 basis points

    (2,718

)

    (9.67

)

  

Item 4. Controls and Procedures

 

As of the end of the quarterly period covered by this report, an evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”)). Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were, to the best of their knowledge, effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms as of such date.

 

There was no change in the Company’s internal control over financial reporting that occurred during the Company’s fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings

 

We are defendants in various legal proceedings.  Litigation is subject to inherent uncertainties and unfavorable outcomes could occur. 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, 2015 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

  

10.1

Porter Bancorp, Inc. 2016 Incentive Compensation Bonus Plan (incorporated by reference to Exhibit A to definitive proxy statement on Schedule 14A filed April 25, 2016).

   

10.2

Non-Employee Director Stock Incentive Program (incorporated by reference to Exhibit 10.1 to the Form 8-K filed June 22, 2016).

   

10.3

Form of Restricted Stock Award Agreement (incorporated by reference to Exhibit 10.3 to the Form 8-K filed June 22, 2016).

   

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 June 30, 2016, formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (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.

 

 

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)

  

August 4, 2016

By:

/s/ John T. Taylor

  

  

John T. Taylor

  

  

Chief Executive Officer 

  

August 4, 2016

By:

/s/ Phillip W. Barnhouse

 

 

Phillip W. Barnhouse 

  

  

Chief Financial Officer

  

  

 

 

 

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