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SouthState Corp - Quarter Report: 2019 June (Form 10-Q)

Table of Contents 

G3

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, 2019

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 001-12669

Graphic

SOUTH STATE CORPORATION

(Exact name of registrant as specified in its charter)

South Carolina

57-0799315

(State or other jurisdiction of incorporation)

(IRS Employer Identification No.)

520 Gervais Street

Columbia, South Carolina

29201

(Address of principal executive offices)

(Zip Code)

(800) 277-2175

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes    No  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data file required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes    No  

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

Emerging Growth Company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

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

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

Title of each class:

    

Trading Symbol

    

Name of each exchange on which registered:

Common Stock, $2.50 par value

SSB

Nasdaq Global Select Market

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

Class

Outstanding as of July 31, 2019

Common Stock, $2.50 par value

34,147,790

Table of Contents 

South State Corporation and Subsidiary

June 30, 2019 Form 10-Q

INDEX

Page

PART I — FINANCIAL INFORMATION

Item 1.

Financial Statements

Condensed Consolidated Balance Sheets at June 30, 2019, December 31, 2018 and June 30, 2018

3

Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30, 2019 and 2018

4

Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2019 and 2018

5

Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Six Months Ended June 30, 2019 and 2018

6

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2019 and 2018

7

Notes to Condensed Consolidated Financial Statements

8

Item 2.

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

55

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

82

Item 4.

Controls and Procedures

82

PART II — OTHER INFORMATION

Item 1.

Legal Proceedings

82

Item 1A.

Risk Factors

82

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

83

Item 3.

Defaults Upon Senior Securities

83

Item 4.

Mine Safety Disclosures

83

Item 5.

Other Information

84

Item 6.

Exhibits

84

2

Table of Contents 

PART I — FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

South State Corporation and Subsidiary

Condensed Consolidated Balance Sheets

(Dollars in thousands, except par value)

June 30,

December 31,

June 30,

 

    

2019

    

2018

    

2018

 

(Unaudited)

(Unaudited)

ASSETS

    

    

    

    

    

Cash and cash equivalents:

Cash and due from banks

$

251,631

$

251,411

$

250,106

Interest-bearing deposits with banks

 

500,340

 

124,895

 

73,013

Federal funds sold and securities purchased under agreements to resell

 

100,000

 

32,677

 

73,730

Total cash and cash equivalents

 

851,971

 

408,983

 

396,849

Investment securities:

Securities held to maturity (fair value of $0, $0 and $503, respectively)

 

 

 

499

Securities available for sale, at fair value

 

1,717,276

 

1,517,067

 

1,577,999

Other investments

 

49,124

 

25,604

 

19,229

Total investment securities

 

1,766,400

 

1,542,671

 

1,597,727

Loans held for sale

 

47,796

 

22,925

 

36,968

Loans:

Acquired credit impaired, net of allowance for loan losses

 

419,961

 

485,119

 

551,979

Acquired non-credit impaired

 

2,180,281

 

2,594,826

 

3,076,424

Non-acquired

 

8,621,327

 

7,933,286

 

7,197,539

Less allowance for non-acquired loan losses

 

(53,590)

 

(51,194)

 

(47,874)

Loans, net

 

11,167,979

 

10,962,037

 

10,778,068

Other real estate owned

 

14,506

 

11,410

 

17,222

Premises and equipment, net

321,348

241,076

245,288

Bank owned life insurance

231,708

230,105

227,588

Deferred tax assets

28,240

37,128

48,853

Mortgage servicing rights

30,332

34,727

35,107

Core deposit and other intangibles

 

56,351

 

62,900

 

69,975

Goodwill

1,002,900

1,002,900

1,002,722

Other assets

 

163,806

 

119,466

 

110,121

Total assets

$

15,683,337

$

14,676,328

$

14,566,488

LIABILITIES AND SHAREHOLDERS’ EQUITY

Deposits:

Noninterest-bearing

$

3,255,906

$

3,061,769

$

3,152,828

Interest-bearing

 

8,666,374

 

8,585,164

 

8,485,461

Total deposits

 

11,922,280

 

11,646,933

 

11,638,289

Federal funds purchased and securities sold under agreements to repurchase

 

298,029

 

270,649

 

331,969

Other borrowings

 

816,414

 

266,084

 

115,754

Other liabilities

 

272,636

 

126,366

 

132,109

Total liabilities

 

13,309,359

 

12,310,032

 

12,218,121

Shareholders’ equity:

Common stock - $2.50 par value; authorized 80,000,000 shares; 34,735,587, 35,829,549 and 36,825,556 shares issued and outstanding, respectively

 

86,839

 

89,574

 

92,064

Surplus

 

1,676,229

 

1,750,495

 

1,811,446

Retained earnings

 

609,444

 

551,108

 

480,928

Accumulated other comprehensive income (loss)

 

1,466

 

(24,881)

 

(36,071)

Total shareholders’ equity

 

2,373,978

 

2,366,296

 

2,348,367

Total liabilities and shareholders’ equity

$

15,683,337

$

14,676,328

$

14,566,488

The Accompanying Notes are an Integral Part of the Financial Statements.

3

Table of Contents 

South State Corporation and Subsidiary

Condensed Consolidated Statements of Income (unaudited)

(Dollars in thousands, except per share data)

Three Months Ended

Six Months Ended

June 30,

June 30,

 

    

2019

    

2018

    

2019

    

2018

 

Interest income:

Loans, including fees

$

135,388

$

129,852

$

267,222

$

256,893

Investment securities:

Taxable

 

9,551

 

9,048

 

18,148

 

17,836

Tax-exempt

 

1,617

 

1,614

 

3,113

 

3,173

Federal funds sold and securities purchased under agreements to resell

 

3,426

 

1,218

 

4,889

 

1,878

Total interest income

 

149,982

 

141,732

 

293,372

 

279,780

Interest expense:

Deposits

 

17,393

 

10,009

 

34,038

 

16,922

Federal funds purchased and securities sold under agreements to repurchase

 

673

 

642

 

1,426

 

1,096

Other borrowings

 

4,737

 

1,519

 

7,462

 

3,227

Total interest expense

 

22,803

 

12,170

 

42,926

 

21,245

Net interest income

 

127,179

 

129,562

 

250,446

 

258,535

Provision for loan losses

 

3,704

 

4,478

 

5,192

 

6,932

Net interest income after provision for loan losses

 

123,475

 

125,084

 

245,254

 

251,603

Noninterest income:

Fees on deposit accounts

 

18,741

 

22,612

 

36,549

 

45,155

Mortgage banking income

 

5,307

 

3,317

 

7,692

 

8,265

Trust and investment services income

 

7,720

 

7,567

 

14,989

 

15,081

Securities gains (losses), net

 

1,709

 

(641)

 

2,250

 

(641)

Recoveries on acquired loans

1,347

2,167

3,214

5,142

Other

 

2,794

 

2,503

 

4,982

 

5,078

Total noninterest income

 

37,618

 

37,525

 

69,676

 

78,080

Noninterest expense:

Salaries and employee benefits

 

58,547

 

55,026

 

116,978

 

117,491

Net occupancy expense

 

7,616

 

7,815

 

14,815

 

15,981

Information services expense

 

8,671

 

8,903

 

17,680

 

18,641

Furniture and equipment expense

4,233

4,519

8,646

9,145

OREO expense and loan related

 

881

 

1,037

 

1,632

 

2,698

Pension plan termination expense

 

9,526

 

 

9,526

 

Amortization of intangibles

 

3,268

 

3,722

 

6,549

 

7,135

Supplies, printing and postage expense

1,495

1,406

2,999

2,798

Professional fees

 

2,781

 

1,898

 

5,021

 

3,597

FDIC assessment and other regulatory charges

 

1,455

 

3,277

 

2,990

 

4,540

Advertising and marketing

 

959

 

1,163

 

1,766

 

1,899

Merger and branch consolidation related expense

 

2,078

 

14,096

 

3,058

 

25,392

Other

 

7,897

 

7,644

 

15,986

 

14,652

Total noninterest expense

 

109,407

 

110,506

 

207,646

 

223,969

Earnings:

Income before provision for income taxes

 

51,686

 

52,103

 

107,284

 

105,714

Provision for income taxes

 

10,226

 

11,644

 

21,457

 

22,929

Net income

$

41,460

$

40,459

$

85,827

$

82,785

Earnings per common share:

Basic

$

1.18

$

1.10

$

2.43

$

2.25

Diluted

$

1.17

$

1.09

$

2.42

$

2.24

Weighted average common shares outstanding:

Basic

 

35,089

 

36,677

 

35,268

 

36,657

Diluted

 

35,300

 

36,929

 

35,461

 

36,910

The Accompanying Notes are an Integral Part of the Financial Statements.

4

Table of Contents 

South State Corporation and Subsidiary

Condensed Consolidated Statements of Comprehensive Income (unaudited)

(Dollars in thousands)

Three Months Ended

Six Months Ended

June 30,

June 30,

    

2019

    

2018

    

2019

    

2018

 

Net income

    

$

41,460

    

$

40,459

    

$

85,827

    

$

82,785

Other comprehensive income:

Unrealized gains (losses) on securities:

Unrealized holding gains (losses) arising during period

 

24,593

 

(8,216)

 

42,426

 

(30,298)

Tax effect

 

(5,410)

 

1,807

 

(9,334)

 

6,697

Reclassification adjustment for gains included in net income

 

(1,709)

 

641

 

(2,250)

 

641

Tax effect

 

376

 

(141)

 

496

 

(141)

Net of tax amount

 

17,850

 

(5,909)

 

31,338

 

(23,101)

Unrealized gains (losses) on derivative financial instruments qualifying as cash flow hedges:

Unrealized holding gains (losses) arising during period

 

(11,275)

 

8

 

(13,943)

 

44

Tax effect

 

2,480

 

(2)

 

3,067

 

(10)

Reclassification adjustment for gains (losses) included in interest expense

 

(350)

 

39

 

(343)

 

87

Tax effect

 

77

 

(8)

 

75

 

(19)

Net of tax amount

 

(9,068)

 

37

 

(11,144)

 

102

Change in pension plan obligation:

Change in pension and retiree medical plan obligation during period

 

 

 

 

Tax effect

 

 

 

 

Reclassification adjustment for changes included in net income

 

7,767

 

194

 

7,888

 

387

Tax effect

 

(1,709)

 

(43)

 

(1,735)

 

(85)

Net of tax amount

 

6,058

 

151

 

6,153

 

302

Other comprehensive income (loss), net of tax

 

14,840

 

(5,721)

 

26,347

 

(22,697)

Comprehensive income

$

56,300

$

34,738

$

112,174

$

60,088

The Accompanying Notes are an Integral Part of the Financial Statements.

5

Table of Contents 

South State Corporation and Subsidiary

Condensed Consolidated Statements of Changes in Shareholders’ Equity (unaudited)

Six months ended June 30, 2019 and 2018

(Dollars in thousands, except for share data)

Accumulated Other

Common Stock

Retained

Comprehensive

 

    

Shares

    

Amount

    

Surplus

    

Earnings

    

Income (Loss)

    

Total

 

Balance, December 31, 2017

    

36,759,656

$

91,899

$

1,807,601

$

419,847

$

(10,427)

$

2,308,920

Comprehensive income

 

 

82,785

(22,697)

60,088

Cash dividends declared on common stock at $0.67 per share

 

 

 

(24,651)

 

 

(24,651)

AOCI reclassification to retained earnings from adoption of ASU 2018-02

 

 

2,947

(2,947)

Employee stock purchases

4,338

 

11

 

341

 

352

Stock options exercised

33,424

 

83

 

948

 

 

 

1,031

Restricted stock awards

7,836

 

20

 

(20)

 

 

 

Stock issued pursuant to restricted stock units

39,541

99

(99)

Common stock repurchased

(19,239)

 

(48)

 

(1,678)

 

 

 

(1,726)

Share-based compensation expense

 

 

4,353

 

 

 

4,353

Balance, June 30, 2018

36,825,556

$

92,064

$

1,811,446

$

480,928

$

(36,071)

$

2,348,367

Balance, December 31, 2018

35,829,549

$

89,574

$

1,750,495

$

551,108

$

(24,881)

$

2,366,296

Comprehensive income

 

 

85,827

26,347

112,174

Cash dividends declared on common stock at $0.78 per share

 

 

 

(27,491)

 

 

(27,491)

Employee stock purchases

5,950

15

328

 

343

Stock options exercised

12,722

 

32

 

370

 

 

 

402

Restricted stock awards

6,602

 

17

 

(17)

 

 

 

Common stock repurchased - buyback plan

(1,141,200)

 

(2,853)

 

(77,287)

(80,140)

Common stock repurchased

(29,001)

 

(73)

 

(1,890)

 

 

 

(1,963)

Stock issued pursuant to restricted stock units

50,965

127

(127)

 

Share-based compensation expense

 

 

4,357

 

 

 

4,357

Balance, June 30, 2019

34,735,587

$

86,839

$

1,676,229

$

609,444

$

1,466

$

2,373,978

The Accompanying Notes are an Integral Part of the Financial Statements.

6

Table of Contents 

South State Corporation and Subsidiary

Condensed Consolidated Statements of Cash Flows (unaudited)

(Dollars in thousands)

Six Months Ended

June 30,

    

2019

    

2018

 

Cash flows from operating activities:

Net income

$

85,827

$

82,785

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

Depreciation and amortization

 

16,837

 

18,025

Provision for loan losses

 

5,192

 

6,932

Deferred income taxes

 

1,457

 

5,517

(Gains) losses on sale of securities, net

 

(2,250)

 

641

Share-based compensation expense

 

4,357

 

4,353

Accretion of discount related to performing acquired loans

 

(6,518)

 

(17,251)

Loss on disposal of premises and equipment

 

3,723

 

1,266

Gain on sale of OREO

 

(380)

 

(204)

Net amortization of premiums on investment securities

 

3,325

 

3,843

OREO write downs

 

487

 

932

Fair value adjustment for loans held for sale

 

730

 

(208)

Originations and purchases of loans held for sale

 

(331,662)

 

(324,803)

Proceeds from sales of loans

 

306,062

 

358,929

Net change in:

Accrued interest receivable

 

(2,653)

 

(1,023)

Prepaid assets

 

(2,025)

 

(52)

Operating Leases

 

504

 

Miscellaneous other assets

 

(38,129)

 

8,819

Accrued interest payable

 

1,449

 

1,093

Accrued income taxes

 

470

 

6,404

Miscellaneous other liabilities

 

53,454

 

4,188

Net cash provided by operating activities

 

100,257

 

160,186

Cash flows from investing activities:

Proceeds from sales of investment securities available for sale

 

189,327

 

51,822

Proceeds from maturities and calls of investment securities held to maturity

 

 

2,030

Proceeds from maturities and calls of investment securities available for sale

 

113,039

 

114,825

Proceeds from sales of other investment securities

 

45

 

13,175

Purchases of investment securities available for sale

 

(463,473)

 

(130,378)

Purchases of other investment securities

 

(23,566)

 

(9,356)

Net increase in loans

 

(214,785)

 

(207,909)

Recoveries of loans previously charged off

1,949

2,104

Purchases of premises and equipment

 

(8,116)

 

(7,268)

Proceeds from sale of OREO

 

4,428

 

3,722

Proceeds from sale of premises and equipment

 

8

 

18

Net cash used in investing activities

 

(401,144)

 

(167,215)

Cash flows from financing activities:

Net increase in deposits

 

275,346

 

106,135

Net increase in federal funds purchased and securities sold under agreements to repurchase and other short-term borrowings

 

27,381

 

45,112

Proceeds from FHLB advances

700,001

260,001

Repayment of other borrowings

 

(150,004)

 

(360,003)

Common stock issuance

343

352

Common stock repurchase

 

(82,103)

 

(1,726)

Dividends paid on common stock

 

(27,491)

 

(24,651)

Stock options exercised

 

402

 

1,031

Net cash provided by financing activities

 

743,875

 

26,251

Net increase in cash and cash equivalents

 

442,988

 

19,222

Cash and cash equivalents at beginning of period

 

408,983

 

377,627

Cash and cash equivalents at end of period

$

851,971

$

396,849

Supplemental Disclosures:

Cash Flow Information:

Cash paid for:

Interest

$

41,476

$

20,152

Income taxes

$

20,903

$

11,796

Initial measurement and recognition of operating lease assets in exchange for lease liabilities per ASU 2016-02

$

82,160

$

Recognition of operating lease assets in exchange for lease liabilities

$

4,950

$

Schedule of Noncash Investing Transactions:

Acquisitions:

Fair value of tangible assets acquired

$

$

(7,068)

Other intangible assets acquired

 

 

3,321

Liabilities assumed

 

 

(612)

Net identifiable assets acquired over liabilities assumed

 

 

(3,135)

Real estate acquired in full or in partial settlement of loans

$

7,632

$

10,259

The Accompanying Notes are an Integral Part of the Financial Statements.

7

Table of Contents 

South State Corporation and Subsidiary

Notes to Condensed Consolidated Financial Statements (unaudited)

Note 1 — Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required 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. Certain prior period information has been reclassified to conform to the current period presentation, and these reclassifications had no impact on net income or equity as previously reported. Operating results for the three and six months ended June 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019.

The condensed consolidated balance sheet at December 31, 2018 has been derived from the audited financial statements at that date but does not include all of the information and disclosures required by GAAP for complete financial statements.

Note 2 — Summary of Significant Accounting Policies

The information contained in the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the Securities and Exchange Commission (the “SEC”) on February 22, 2019, should be referenced when reading these unaudited condensed consolidated financial statements. Unless otherwise mentioned or unless the context requires otherwise, references herein to “South State,” the “Company” “we,” “us,” “our” or similar references mean South State Corporation and its consolidated subsidiary. References to the “Bank” means South State Corporation’s wholly owned subsidiary, South State Bank, a South Carolina banking corporation.

Leases (Topic 842) and Method of Adoption

On January 1, 2019, we adopted the requirements of Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842). Topic 842 was subsequently amended by ASU No. 2018-01, Land Easement Practical Expedient for Transition to Topic 842; ASU No. 2018-10, Codification Improvements to Topic 842, Leases; ASU No. 2018-11, Targeted Improvements; and ASU No. 2019-01, Codification Improvements to Topic 842 Leases. The purpose of the update was to increase transparency and comparability between organizations that enter into lease agreements. The key difference between the previous guidance and the update is the recognition of a right-of-use asset (ROU) and lease liability on the statement of financial position for those leases previously classified as operating leases under the old guidance. Accounting Standards Codification (“ASC”) Topic 842 defines a lease as a contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration. In applying this standard, we reviewed our material contracts to determine if they included a lease by this new definition and did not identify any new leases. Our lease agreements in which ASC Topic 842 has been applied are primarily for real estate properties, including retail branch locations, operations and administration locations and stand-alone ATM locations. These leases have lease terms from greater than 12 months to leases with options of more than 24 years. Related to lease payment terms, some are fixed payments or based on a fixed annual increases while others are variable and the annual increases are based on market rates. We performed an analysis on equipment leases for the implementation of ASC Topic 842 and determined the number and dollar amount of our equipment leases was not material.

A modified retrospective transition approach is required, applying the new standard to all leases existing at the date of initial application. An entity may choose to use either (1) its effective date or (2) the beginning of the earliest comparative period presented in the financial statements as its date of initial application. We chose the transition method of adoption provided by ASU 2018-11, Leases (Topic 842) – Targeted Improvements, where we initially apply the new lease standard at the effective date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption if applicable. Therefore, we applied this standard to all existing leases as of the adoption date of January 1, 2019, recording a ROU asset and a lease liability in an equal amount. We did not have a

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cumulative-effect adjustment to the opening balance of retained earnings. With this transition method, we did not have to restate comparative prior periods presented in the financial statements related to ASC Topic 842, but will present comparative prior periods disclosures using the previous accounting guidance for leases. This adoption method is considered a change in accounting principle requiring additional disclosure of the nature of and reason for the change, which is solely a result of the adoption of the required standard.

ASC Topic 842 provides a package of practical expedients in applying the lease standard that had to be chosen at the date of adoption. We chose to elect this package of practical expedients. With this election, we do not have to reassess whether any expired or existing contracts are or contain a lease, do not have to reassess the classification of any expired or existing leases, do not have to separate lease and non-lease components and can account for both as a single lease component, and do not have to reassess initial direct costs or cash incentives for any existing leases due to immateriality. In addition, we chose not to apply ASC Topic 842 to short-term leases (leases with terms of 12 months or less) and not to record an underlying ROU asset or lease liability based on the uncertainty around the renewal of these leases. We will recognize lease expense for such leases on a straight-line basis over the lease term.

ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. We determined that we do not have any leases classified as finance leases and that all of our leases are operating leases. ROU assets and liabilities for operating leases are recognized at commencement date based on present value of lease payments not yet paid, discounted using the discount rate for the lease at the lease commencement date over the lease term. For operating leases, lease expense is determined by the sum of the lease payments to be recognized on a straight-line basis over the lease term. Based on the transition method that we chose to follow, the commencement date of the lease term for all existing leases is January 1, 2019. The lease term used for the calculation of the initial ROU asset and lease liability will include the initial lease term in addition to any renewal options or termination costs in the lease that we think are reasonably certain to be exercised or incurred. We received input from several levels of management and our corporate real estate department in determining which options were reasonably certain to be exercised. A discount rate is also needed in the calculation of the initial ROU assets and lease liability. ASC Topic 842 requires that the implicit rate within the lease agreement be used if available. If not available, we should use its incremental borrowing rate in effect at the time of the lease commencement date. We looked at the incremental borrowing rate from several of our borrowing sources to determine an average rate to be used in the calculation of the initial ROU asset and lease liability. We also considered the term of the borrowings as they relate to the terms of the leases.

The adoption of the new standard had a material impact on our consolidated balance sheet, with the recording of ROU asset and lease liability of $82.2 million at the commencement date of January 1, 2019. We did not have a cumulative-effect adjustment to the opening balance of retained earnings at commencement. As of June 30, 2019, we had ROU assets of $84.5 million recorded within premises and equipment on the balance sheet and a lease liability of $85.0 million recorded within other liabilities on the balance sheet. The adoption of ASC Topic 842 did not have a material impact on our consolidated income statement.

Revenue from Contracts with Customers (Topic 606) and Method of Adoption

On January 1, 2018, we adopted the requirements of ASU 2014-09, Revenue from Contracts with Customers (“Topic 606”). The majority of our revenue is derived primarily from interest income from receivables (loans) and securities. Other revenues are derived from fees received in connection with deposit accounts, mortgage banking activities including gains from the sale of loans and loan origination fees, and trust and investment advisory services. The core principle of the new standard is that a company 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.

We adopted Topic 606 using the retrospective transition approach which requires restatement of prior periods. We selected this method even though there were no material changes in the timing of revenue recognition due to the fact that Topic 606 requires us to report network costs associated with debit card and ATM transactions netted against the related fees from such transactions. Previously, such network costs were reported as a component of other noninterest expense. We did restate prior periods through March 31, 2018 for this reclassification. This adoption method is considered a change in accounting principle requiring additional disclosure of the nature of and reason for the change, which is solely a result of the adoption of the required standard. When applying the retrospective approach under Topic 606, we elected, as a practical expedient, to apply the revenue standard only to contracts that are not completed as of

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January 1, 2018. A completed contract is considered to be a contract for which all (or substantially all) of the revenue was recognized in accordance with revenue guidance that was in effect before January 1, 2018. There were no uncompleted contracts as of January 1, 2018 for which application of the new standard required an adjustment to retained earnings.

The following disclosures related to Topic 606 involve income derived from contracts with customers. Within the scope of Topic 606, we maintain contracts to provide services, primarily for investment advisory and/or custody of assets. Through our wholly-owned subsidiaries, the Bank and South State Advisory, Inc., we contract with our customers to perform IRA, Trust, and/or Custody and Agency advisory services. Total revenue recognized from these contracts with customers was $7.7 million and $7.6 million, respectively, for the three months ended June 30, 2019 and 2018, and $15.0 million and $15.1 million, respectively, for the six months ended June 30, 2019 and 2018. The Bank contracts with our customers to perform deposit account services. Total revenue recognized from these contracts with customers is $19.0 million and $22.9 million, respectively, for the three months ended June 30, 2019 and 2018, and $37.0 million and $45.7 million, respectively, for the six months ended June 30, 2019 and 2018. Due to the nature of our relationship with the customers that we provide services, we do not incur costs to obtain contracts and there are no material incremental costs to fulfill these contracts that should be capitalized.

Disaggregation of Revenue - Our portfolio of services provided to our customers which generates revenue in which the revenue recognition standard applies consists of approximately 779,000 active contracts at June 30, 2019 compared to approximately 803,000 at June 30, 2018. We have disaggregated revenue according to timing of the transfer of service. Total revenue derived from contracts in which services are transferred at a point in time was $25.6 million and $29.9 million, respectively, for the three months ended June 30, 2019 and 2018, and $49.7 million and $60.7 million, respectively, for the six months ended June 30, 2019 and 2018. Total revenue derived from contracts in which services are transferred over time was $5.0 million and $4.9 million, respectively, for the three months ended June 30, 2019 and 2018, and $10.0 million and $9.8 million, respectively, for the six months ended June 30, 2019 and 2018. Revenue is recognized as the services are provided to the customers. Economic factors impacting the customers could affect the nature, amount, and timing of these cash flows, as unfavorable economic conditions could impair the customers’ ability to provide payment for services. This risk is mitigated as we generally deduct payments from customers’ accounts as services are rendered.

Contract Balances - The timing of revenue recognition, billings, and cash collections results in billed accounts receivable on our balance sheet. Most contracts call for payment by a charge or deduction to the respective customer account but there are some that require a receipt of payment from the customer. For fee per transaction contracts, the customers are billed as the transactions are processed. For hourly rate and monthly service contracts related to trust and some investment revenues, the customers are billed monthly (generally as a percentage basis point of the market value of the investment account). In some cases, specific to South State Advisory, Inc., customers are billed in advance for quarterly services to be performed based on the past quarter’s average account balance. These do create contract liabilities or deferred revenue, as the customers pay in advance for service. Neither the contract liabilities nor the accounts receivables balances are material to our balance sheet.

Performance Obligations - A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in Topic 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The performance obligations for these contracts are satisfied as the service is provided to the customer (either over time or at a point in time). The payment terms of the contracts are typically based on a basis point percentage of the investment account market value, fee per hour of service, or fee for service incurred. There are no significant financing components in the contracts. Excluding deposit services revenues which are mostly billed at a point in time as a fee for services incurred, all other contracts within the scope of Topic 606 contain variable consideration in that fees earned are derived from market values of accounts or from hours worked for services performed which determines the amount of consideration to which we are entitled. The variability is resolved when the hours are incurred or services are provided. The contracts do not include obligations for returns, refunds, or warranties. The contracts are specific to the amounts owed to the Company for services performed during a period should the contracts be terminated.

Significant Judgments - All of the contracts create performance obligations that are satisfied at a point in time excluding the contracts billed in advance through South State Advisory, Inc. and some immaterial deposit revenues. Revenue is recognized as services are billed to the customers. Variable consideration does exist for contracts related to our trust and investment services as revenues are based on market values and services performed. We have adopted the

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right-to-invoice practical expedient for trust management contracts through the Bank which we contract with our customers to perform IRA, trust, and/or custody services.

Note 3 — Recent Accounting and Regulatory Pronouncements

Accounting Standards Adopted in 2019

In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASC Topic 842 related to leases. ASC Topic 842 applies a right-of-use, which we refer to herein as ROU, model that requires a lessee to record, for all leases with a lease term of more than 12 months, an asset representing its right to use the underlying asset and a liability to make lease payments. For leases with a term of 12 months or less, a practical expedient is available whereby a lessee may elect, by class of underlying asset, not to recognize an ROU asset or lease liability. At inception, lessees must classify all leases as either finance or operating based on five criteria. Balance sheet recognition of finance and operating leases is similar, but the pattern of expense recognition in the income statement, as well as the effect on the statement of cash flows, differs depending on the lease classification. In July 2018, ASU 2018-11 - Targeted Improvements - Leases (Topic 842) (“ASU 2018-11”) was issued which provided targeted improvements related to ASC Topic 842. ASU 2018-11 updates the new lease standard ASC Topic 842 by providing another transition method in addition to the existing transition method by allowing entities to initially apply the new leases standard at the adoption date instead of at the beginning of the earliest period presented in the financial statements as required in the original pronouncement. ASU 2018-11 also provides updated guidance for lessors related to separating lease and nonlease components in a contract and allocating the consideration in the contract to the separate components. In December 2018, the FASB issued ASU No. 2018-20, Leases (Topic 842): Narrow-Scope Improvements for Lessors (“ASU 2018-20”). ASU 2018-20 updates the new lease standard ASC Topic 842 by addressing several issues related to lessors which should reduce lessors’ implementation and ongoing costs related to the new lease standard. In March 2019, the FASB issued ASU No. 2019-01, Leases (Topic 842): Codification Improvements (“ASU 2019-01”). ASU 2019-01 provides clarification on several issues related to ASC Topic 842. None of these issues had a material effect on our financial statements. For public business entities, the amendments in ASU 2016-02, ASU 2018-11, ASU 2018-20 and ASU 2019-01 are effective for interim and annual periods beginning after December 15, 2018. In transition, lessees and lessors have the choice to recognize and measure leases at the beginning of the earliest period presented in financials using a modified retrospective approach or to allow the entity to recognize and measure leases as of the adoption date and not in comparative periods. We chose the option to recognize and measure leases as of the adoption date and not in comparative periods. See Note 2 – Summary of Significant Accounting Policies and Note 7 – Leases for further discussion around the adoption of these standards related to leases. On January 1, 2019, we recorded a ROU asset and a lease liability of approximately $82.2 million. The guidance did not have a material impact on our statement of operations.

In October 2018, the FASB issued ASU No. 2018-16, Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes (Derivatives and Hedging - Topic 815) (“ASU 2018-16”). The amendments in this ASU permit the OIS rate based on SOFR as a U.S. benchmark interest rate. Including the OIS rate based on SOFR as an eligible benchmark interest rate during the early stages of the marketplace transition provides sufficient lead time for entities to prepare for changes to interest rate risk hedging strategies for both risk management and hedge accounting purposes. The guidance is effective for public companies for annual periods beginning on or after December 15, 2018 and interim periods within those fiscal years. Early adoption is permitted. All transition requirements and elections should be applied to hedging relationships existing on the date of adoption. This guidance became effective on January 1, 2019 and did not have a material impact to our consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (Subtopic 350-40) (“ASU 2018-15”). This ASU clarifies certain aspects of ASU 2015-05, Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, which was issued in April 2015. Specifically, ASU 2018-15 “align[s] the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license).” This ASU does not affect the accounting for the service element of a hosting arrangement that is a service contract. An entity would expense the capitalized implementation costs related to a hosting arrangement that is a service contract over the hosting arrangement’s term, which comprises the arrangement’s

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noncancelable term and any renewal options whose exercise is reasonably certain. The expense would be presented in the same line item in the statement of income as that in which the fee associated with the hosting arrangement is presented. For public business entities, the amendments in ASU 2018-15 are effective for interim and annual periods beginning after December 15, 2019 and an entity has the option of using either a retrospective or prospective transition method. Early adoption is permitted. We early adopted this standard as of January 1, 2019, but it did not have a material impact on our consolidated financial statements. There were $35,614 in capitalized implementation costs in the second quarter of 2019 related to internal use software for a front capture software product for running customer banking transactions at branch locations. These costs are being held in a suspense account classified as premises and equipment on the balance sheet until the project is complete when they will then begin to be depreciated.

In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities (“ASU 2017-12”). ASU 2017-12 amends ASU 2018-16 to better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. These amendments will improve the transparency of information about an entity’s risk management activities and simplify the application of hedge accounting. The guidance is effective for public companies for annual periods beginning on or after December 15, 2018 and interim periods within those fiscal years. All transition requirements and elections should be applied to hedging relationships existing on the date of adoption. This guidance became effective on January 1, 2019 and we determined that the implementation of this standard did not have a material impact to our consolidated financial statements.

In March 2017, the FASB issued ASU No. 2017-08, Receivables-Nonrefundable Fees and Other Cost (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities; (“ASU 2017-08”). ASU 2017-08 shortens the amortization period of the premium for certain callable debt securities, from the contractual maturity date to the earliest call date. The amendments do not require an accounting change for securities held at a discount; an entity will continue to amortize to the contractual maturity date the discount related to callable debt securities. The amendments apply to the amortization of premiums on callable debt securities with explicit, noncontingent call features that are callable at fixed prices on preset dates. For public business entities, ASU 2017-08 is effective in fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. For entities other than public business entities, the amendments are effective in fiscal years beginning after December 15, 2019 and in interim periods in fiscal years beginning after December 15, 2020. Early adoption is permitted for all entities, including in an interim period. The amendments should be applied on a modified retrospective basis, with a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the amendments are adopted. This guidance became effective on January 1, 2019 and we determined that the implementation of this standard did not have a material impact to our consolidated financial statements.

Accounting Standards Adopted in 2018

In February 2018, the FASB issued ASU No. 2018-03, Technical Corrections and Improvements to Financial Instruments-Overall (Subtopic 825-10) (“ASU 2018-03”). ASU 2018-03 updates the new financial instruments standard by clarifying issues that arose from ASU 2016-01, but does not change the core principle of the new standard. The issues addressed in this ASU include: (1) Equity securities without a readily determinable fair value-discontinuation, (2) Equity securities without a readily determinable fair value-adjustments, (3) Forward contracts and purchased options, (4) Presentation requirements for certain fair value option liabilities, (5) Fair value option liabilities denominated in a foreign currency, (6) Transition guidance for equity securities without a readily determinable fair value, and (7) Transition and open effective date information. For public business entities, the amendments in ASU 2018-03 and ASU 2016-01 are effective for interim and annual periods beginning after December 15, 2017. An entity should apply the amendments by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values (including disclosure requirements) should be applied prospectively to equity investments that exist as of the date of adoption of ASU 2018-03 and ASU 2016-01. This guidance became effective on January 1, 2018 and we determined that the implementation of this standard did not have a material impact to our consolidated financial statements.

In February 2018, the FASB issued ASU No. 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (“ASU 2018-02”). ASU 2018-02 amends ASC Topic 220 and allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017 (the “Tax Reform

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Act”). Consequently, this amendment eliminates the stranded tax effects resulting from the Tax Reform Act and will improve the usefulness of information reported to financial statement users. However, because the amendments only relate to the reclassification of the income tax effects of the Tax Reform Act, the underlying guidance that requires that the effects of the change in tax laws or rates be included in income from continuing operations is not affected. The guidance is effective for public companies for annual periods beginning on or after December 15, 2018 and interim periods within those fiscal years. Early adoption was permitted, including adoption in any interim period, (1) for public business entities for reporting periods for which financial statements have not yet been issued and (2) for all other entities for reporting periods for which financial statements have not yet been made available for issuance. This amendment should be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in U.S. federal corporate income tax rate in the Tax Reform Act is recognized. We early adopted this amendment in the first quarter of 2018 and reclassified $2.9 million from accumulated other comprehensive income to retained earnings for the stranded tax effects resulting from the Tax Reform Act.

In May 2017, the FASB issued ASU No. 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting (“ASU 2017-09”). ASU 2017-09 provides clarity by offering guidance on the scope of modification accounting for share-based payment awards and gives direction on which changes to the terms or conditions of these awards require an entity to apply modification accounting. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or a liability) changes as a result of the change in terms or conditions. The guidance is effective prospectively for all companies for annual periods beginning on or after December 15, 2017. We adopted this standard in the first quarter of 2018 and determined that this guidance did not have a material impact on our consolidated financial statements.

In March 2017, the FASB issued ASU No. 2017-07, Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (“ASU 2017-07”). ASU 2017-07 applies to any employer that sponsors a defined benefit pension plan, other postretirement benefit plan, or other types of benefits accounted for under Topic 715. The amendments require that an employer disaggregate the service cost component from the other components of net benefit cost, as follows (1) service cost must be presented in the same line item(s) as other employee compensation costs, which costs are generally included within income from continuing operations, but in some cases may be eligible for capitalization, (2) all other components of net benefit cost must be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented, and (3) the amendments permit capitalizing only the service cost component of net benefit cost, assuming such costs meet the criteria required for capitalization by other GAAP , rather than total net benefit cost which has been permitted under prior GAAP. The guidance is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those years. The amendments should be adopted prospectively and allows a practical expedient that permits an employer to use the amounts disclosed in its pension and other postretirement benefit plan note for the prior periods to apply the retrospective presentation requirements. We adopted this standard in the first quarter of 2018 and determined that this guidance did not have a material impact on our consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (“ASU 2017-01”). These amendments are intended to clarify the definition of a business to assist companies and other reporting entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 requires an entity to evaluate if substantially all of the fair value of the gross assets acquired are concentrated in a single identifiable asset or a group of similar identifiable assets; if so, the set of transferred assets and activities is not a business. The guidance also requires a business to include at least one substantive process and narrows the definition of outputs by more closely aligning it with how outputs are described in ASC Topic 606. The guidance is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those years. We adopted this standard in the first quarter of 2018 and determined that this guidance did not have a material impact on our consolidated financial statements.

In December 2016, the FASB issued ASU No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers (“ASU 2016-20”). ASU 2016-20 updates the new revenue standard by clarifying issues that arose from ASU 2014-09, but does not change the core principle of the new standard. The issues addressed in this ASU include: (1) Loan guarantee fees, (2) Impairment testing of contract costs, (3) Interaction of impairment testing with guidance in other topics, (4) Provisions for losses on construction-type and production-type contracts, (5) Scope of topic 606, (6) Disclosure of remaining performance obligations, (7) Disclosure of prior-period performance obligations, (8) Contract modifications, (9) Contract asset vs. receivable, (10) Refund liability, (11)

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Advertising costs, (12) Fixed-odds wagering contracts in the casino industry, (13) Cost capitalization for advisors to private funds and public funds. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2017. The amendments can be applied retrospectively to each prior reporting period or retrospectively with the cumulative effect of initially applying this new guidance recognized at the date of initial application. Our revenue includes net interest income on financial assets and financial liabilities, which is explicitly excluded from the scope of ASU 2014-09, and noninterest income. ASU 2016-20, ASU 2016-08 and ASU 2014-09 became effective on January 1, 2018 and we refined our disclosures around the standard in the first quarter of 2018. See Note 2 – Summary of Significant Accounting Policies for additional information. We determined that there is no material change on how we recognize our revenue streams and the adoption of these standards did not have a material impact on our consolidated financial statements.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). ASU 2016-15 addresses eight classification issues related to the statement of cash flows: Debt prepayment or debt extinguishment costs; Settlement of zero-coupon bonds; Contingent consideration payments made after a business combination; Proceeds from the settlement of insurance claims; Proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; Distributions received from equity method investees; Beneficial interests in securitization transactions; and Separately identifiable cash flows and application of the predominance principle. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. Entities will apply the standard’s provisions using a retrospective transition method to each period presented.  We adopted this standard in the first quarter of 2018 and determined that this guidance did not have a material impact on our consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent considerations (Reporting Revenue Gross versus Net) (“ASU 2016-08”). ASU 2016-08 updates the new revenue standard by clarifying the principal versus agent implementation guidance, but does not change the core principle of the new standard. The updates to the principal versus agent guidance: (i) require an entity to determine whether it is a principal or an agent for each distinct good or service (or a distinct bundle of goods or services) to be provided to the customer; (ii) illustrate how an entity that is a principal might apply the control principle to goods, services, or rights to services, when another party is involved in providing goods or services to a customer and (iii) Clarify that the purpose of certain specific control indicators is to support or assist in the assessment of whether an entity controls a good or service before it is transferred to the customer, provide more specific guidance on how the indicators should be considered, and clarify that their relevance will vary depending on the facts and circumstances. For public business entities, the effective date and transition requirements for these amendments are the same as the effective date and transition requirements of ASU 2014-09 which is effective for interim and annual periods beginning after December 15, 2017. The amendments can be applied retrospectively to each prior reporting period or retrospectively with the cumulative effect of initially applying this new guidance recognized at the date of initial application. Our revenue includes net interest income on financial assets and financial liabilities, which is explicitly excluded from the scope of ASU 2014-09, and noninterest income. ASU 2016-20, ASU 2016-08 and ASU 2014-09 became effective on January 1, 2018 and we refined its disclosures around the standard in the first quarter of 2018. We determined that there is no material change on how we recognize our revenue streams and the adoption of these standards did not have a material impact on our consolidated financial statements, other than the required disclosures and the reclassification of interchange costs from noninterest expense to noninterest income on the Consolidated Statement of Income which we applied retrospectively to each prior reporting period. See further discussion in Note 2 – Summary of Significant Accounting Policies.

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10); Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). This update is intended to improve the recognition and measurement of financial instruments and it requires an entity to: (i) measure equity investments at fair value through net income, with certain exceptions; (ii) present in other comprehensive income the changes in instrument-specific credit risk for financial liabilities measured using the fair value option; (iii) present financial assets and financial liabilities by measurement category and form of financial asset; (iv) calculate the fair value of financial instruments for disclosure purposes based on an exit price; and (v) assess a valuation allowance on deferred tax assets related to unrealized losses of AFS debt securities in combination with other deferred tax assets. ASU 2016-01 also provides an election to subsequently measure certain nonmarketable equity investments at cost less any impairment and adjusted for certain observable price changes and requires a qualitative impairment assessment of such equity investments and amends certain fair value disclosure requirements. For public business entities, the amendments in

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ASU 2016-01 are effective for interim and annual periods beginning after December 15, 2017. An entity should apply the amendments by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values (including disclosure requirements) should be applied prospectively to equity investments that exist as of the date of adoption of the ASU 2016-01. This guidance became effective on January 1, 2018 and we determined that the implementation of this standard did not have a material impact to our consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, Topic 606 (“ASU 2014-09”). The new standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under existing guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. In August of 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers, Topic 606: Deferral of the Effective Date, deferring the effective date of ASU 2014-09 until annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The amendments can be applied retrospectively to each prior reporting period or retrospectively with the cumulative effect of initially applying this new guidance recognized at the date of initial application. Our revenue includes net interest income on financial assets and financial liabilities, which is explicitly excluded from the scope of ASU 2014-09, and noninterest income. ASU 2016-20, ASU 2016-08 and ASU 2014-09 became effective on January 1, 2018 and we refined our disclosures around the standard in the first quarter of 2018. See Note 2 – Summary of Significant Accounting Policies for additional information. We determined that there is no material change on how we recognize our revenue streams, other than the required disclosures and the reclassification of interchange costs from noninterest expense to noninterest income on the Consolidated Statement of Income which we applied retrospectively to each prior reporting period.

Issued But Not Yet Adopted Accounting Standards

In April 2019, the FASB issued ASU No. 2019-05, Targeted Transition Relief (Topic 326 – Financial Instruments-Credit Losses). This update provides entities that have certain instruments within the scope of Subtopic 326-20, Financial Instruments—Credit Losses— Measured at Amortized Cost, with an option to irrevocably elect the fair value option in Subtopic 825-10 applied on an instrument-by-instrument basis for eligible instruments, upon adoption of Topic 326. The fair value option election does not apply to held-to-maturity debt securities. An entity that elects the fair value option should subsequently apply the guidance in Subtopics 820-10, Fair Value Measurement—Overall, and 825-10. This guidance is effective for interim and annual reporting periods beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the overall guidance is adopted.

In April 2019, the FASB issued ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments-Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments. This update related to ASU 2016-01, ASU 2017-12 and ASU 2016-13 clarifies certain aspects brought to the Account Standards Board attention by stakeholders related to these ASUs, but does not change the core principles of these standards. The clarifications related to ASU 2016-01 and 2017-12 will be adopted this quarter since these standards have already been adopted. The clarifications related to ASU 2016-13 will be adopted in the first quarter of 2020 when the overall standard will be adopted. The clarification related to ASU 2016-01 and ASU 2017-12 did not have a material impact on our consolidated financial statements. The clarification related to ASU 2016-13 are still being evaluated as are the effects of the overall standard on our consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-14, Disclosure Framework-Changes to the Disclosure Requirements for Defined Benefit Plans (Subtopic 715-20) (“ASU 2018-14”). ASU 2018-14 amends ASC 715-20 to add, remove, and clarify disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. For public business entities, ASU 2018-14 is effective for fiscal years ending after December 15, 2020 and requires entities to apply the amendment on a retrospective basis. Early adoption is permitted. At this point in time, we do not expect that this guidance will have a material impact on our consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-13, Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement (Topic 820) (“ASU 2018-13”). ASU 2018-13 removes, modifies, and adds

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certain disclosure requirements in ASC 820 related to Fair Value Measurement on the basis of the concepts in the FASB Concepts Statement Conceptual Framework for Financial Reporting — Chapter 8: Notes to Financial Statements. ASU 2018-13 is effective for all entities for fiscal years beginning after December 15, 2019, including interim periods therein. Early adoption is permitted upon issuance of this ASU, including in any interim period for which financial statements have not yet been issued or made available for issuance. Entities making this election are permitted to early adopt the eliminated or modified disclosure requirements and delay the adoption of all the new disclosure requirements until their effective date. The ASU requires application of the prospective method of transition (for only the most recent interim or annual period presented in the initial fiscal year of adoption) to the new disclosure requirement additions. The ASU also requires prospective application to any modifications to disclosures made because of the change to the requirements for the narrative description of measurement uncertainty. The effects of all other amendments made by the ASU must be applied retrospectively to all periods presented. The Company is still assessing the impact of this new guidance, but does not believe it will have a material impact on the Company’s consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-04, Intangible-Goodwill and other (Topic 350): Simplifying the Test for Goodwill Impairment (“ASU 2017-04”). ASU 2017-04 simplifies the accounting for goodwill impairment for all entities by requiring impairment charges to be based on the first step in today’s two-step impairment test under ASC Topic 350 and eliminating Step 2 from the goodwill impairment test. As amended, the goodwill impairment test will consist of one step comparing the fair value of a reporting unit with its carrying amount. An entity should recognize a goodwill impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. The guidance is effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those years. The amendments should be adopted prospectively and early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. We are still assessing the impact of this new guidance, but at this point in time, do not believe it will have a material impact on our consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 requires an entity to utilize a new impairment model known as the current expected credit loss (“CECL”) model to estimate its lifetime “expected credit loss” and record an allowance that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset. The CECL model is expected to result in earlier recognition of credit losses for loans, investment securities portfolio, and purchased financial assets with credit deterioration. ASU 2016-13 also will require enhanced disclosures.  The new guidance is effective for interim and annual reporting periods beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. A cross-functional working group comprised of individuals from credit administration, risk management, accounting and finance, information technology, among others are in place implementing and developing the data, forecast, processes, and portfolio segmentation that will be used in the models that will estimate the expected credit loss for nine loan segments. We have determined a preliminary baseline model result for each loan segment based upon our 10 years of historical losses. These credit models are currently being validated by Model Risk Management. We are currently determining the qualitative framework that will be applied to the nine loan segments which will allow for a reasonable estimate upon adoption of ASU 2016-13. We have also contracted with a third party vendor solution to assist us in the application and analysis of ASU 2016-13 in aggregating the results of the models and provide macroeconomic forecast for the markets served relative to the nine loan segments. We are currently unable to reasonably estimate the full impact of adopting ASU 2016-13, and it will be influenced by the composition, characteristics and quality of our loan and securities portfolio, as well as the economic conditions and forecasts as of each reporting period. These economic conditions and forecasts could be significantly different in future periods.

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Note 4 — Investment Securities

The following is the amortized cost and fair value of investment securities held to maturity:

Gross

    

Gross

 

Amortized

Unrealized

Unrealized

Fair

 

(Dollars in thousands)

    

Cost

    

Gains

    

Losses

    

Value

 

June 30, 2019:

State and municipal obligations

$

$

$

$

December 31, 2018:

State and municipal obligations

$

$

$

$

June 30, 2018:

State and municipal obligations

$

499

$

4

$

$

503

The following is the amortized cost and fair value of investment securities available for sale:

Gross

Gross

Amortized

Unrealized

Unrealized

Fair

 

(Dollars in thousands)

    

Cost

    

Gains

    

Losses

    

Value

 

June 30, 2019:

Government-sponsored entities debt*

$

65,604

$

933

$

(8)

$

66,529

State and municipal obligations

 

177,533

 

4,614

 

(1)

 

182,146

Mortgage-backed securities**

 

1,457,544

 

13,983

 

(2,926)

 

1,468,601

$

1,700,681

$

19,530

$

(2,935)

$

1,717,276

December 31, 2018:

Government-sponsored entities debt*

$

48,982

$

21

$

(752)

$

48,251

State and municipal obligations

 

200,184

 

1,709

 

(1,125)

 

200,768

Mortgage-backed securities**

 

1,291,484

 

697

 

(24,133)

 

1,268,048

$

1,540,650

$

2,427

$

(26,010)

$

1,517,067

June 30, 2018:

Government-sponsored entities debt*

$

48,933

$

$

(1,320)

$

47,613

State and municipal obligations

 

223,533

 

1,932

 

(1,649)

 

223,816

Mortgage-backed securities**

 

1,342,105

 

110

 

(35,645)

 

1,306,570

$

1,614,571

$

2,042

$

(38,614)

$

1,577,999

* -  Our government-sponsored entities holdings are comprised of debt securities offered by Federal Home Loan Mortgage Corporation (“FHLMC”) or Freddie Mac, Federal National Mortgage Association (“FNMA”) or Fannie Mae, Federal Home Loan Bank (“FHLB”), and Federal Farm Credit Banks (“FFCB”).

** - All of the mortgage-backed securities are issued by government-sponsored entities; there are no private-label holdings. Also, included in our mortgage-backed securities are debt securities offered by the Small Business Administration (“SBA”), which have the full faith and credit backing of the United States Government.

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The following is the amortized cost and carrying value of other investment securities:

Carrying

 

(Dollars in thousands)

    

Value

 

June 30, 2019:

Federal Home Loan Bank stock

$

43,044

Investment in unconsolidated subsidiaries

 

3,563

Other nonmarketable investment securities

 

2,517

$

49,124

December 31, 2018:

Federal Home Loan Bank stock

$

19,524

Investment in unconsolidated subsidiaries

 

3,563

Other nonmarketable investment securities

 

2,517

$

25,604

June 30, 2018:

Federal Home Loan Bank stock

$

13,149

Investment in unconsolidated subsidiaries

 

3,563

Other nonmarketable investment securities

 

2,517

$

19,229

Our other investment securities consist of non-marketable equity securities that have no readily determinable market value. Accordingly, when evaluating these securities for impairment, management considers the ultimate recoverability of the par value rather than recognizing temporary declines in value. As of June 30, 2019, we determined that there was no impairment on its other investment securities.

The amortized cost and fair value of debt and equity securities at June 30, 2019 by contractual maturity are detailed below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.

Securities

Securities

 

Held to Maturity

Available for Sale

 

Amortized

Fair

Amortized

Fair

 

(Dollars in thousands)

    

Cost

    

Value

    

Cost

    

Value

 

Due in one year or less

    

$

$

    

$

11,037

    

$

11,038

Due after one year through five years

 

 

 

52,053

 

52,764

Due after five years through ten years

 

 

 

402,345

 

408,027

Due after ten years

 

 

 

1,235,246

 

1,245,447

$

$

$

1,700,681

$

1,717,276

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Information pertaining to our securities with gross unrealized losses at June 30, 2019, December 31, 2018 and June 30, 2018, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position is as follows:

Less Than

Twelve Months

 

Twelve Months

or More

 

Gross

Gross

 

Unrealized

Fair

Unrealized

Fair

 

(Dollars in thousands)

    

Losses

    

Value

    

Losses

    

Value

 

June 30, 2019:

Securities Available for Sale

Government-sponsored entities debt

$

$

$

8

$

5,742

State and municipal obligations

 

 

1,490

 

1

 

1,153

Mortgage-backed securities

 

324

 

64,960

 

2,602

 

330,213

$

324

$

66,450

$

2,611

$

337,108

December 31, 2018:

Securities Available for Sale

Government-sponsored entities debt

$

100

$

10,571

$

652

$

32,959

State and municipal obligations

 

760

 

40,387

 

365

 

14,231

Mortgage-backed securities

 

5,182

 

405,055

 

18,951

 

755,223

$

6,042

$

456,013

$

19,968

$

802,413

June 30, 2018:

Securities Available for Sale

Government-sponsored entities debt

$

1,179

$

39,145

$

141

$

8,468

State and municipal obligations

 

1,617

 

77,373

 

32

 

1,348

Mortgage-backed securities

 

21,494

 

946,142

 

14,151

 

331,871

$

24,290

$

1,062,660

$

14,324

$

341,687

Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the financial condition and near-term prospects of the issuer, (2) the outlook for receiving the contractual cash flows of the investments, (3) the length of time and the extent to which the fair value has been less than cost, (4) our intent and ability to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value or for a debt security whether it is more-likely-than-not that we will be required to sell the debt security prior to recovering its fair value, and (5) the anticipated outlook for changes in the general level of interest rates. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the results of reviews of the issuer’s financial condition, and the issuer’s anticipated ability to pay the contractual cash flows of the investments. All debt securities available for sale in an unrealized loss position as of June 30, 2019 continue to perform as scheduled. As part of our evaluation of its intent and ability to hold investments for a period of time sufficient to allow for any anticipated recovery in the market, we consider our investment strategy, cash flow needs, liquidity position, capital adequacy and interest rate risk position. We do not currently intend to sell the securities within the portfolio and it is not more-likely-than-not that we will be required to sell the debt securities; therefore, management does not consider these investments to be other-than-temporarily impaired at June 30, 2019.

Management continues to monitor all of our securities with a high degree of scrutiny. There can be no assurance that we will not conclude in future periods that conditions existing at that time indicate some or all of its securities may be sold or are other than temporarily impaired, which would require a charge to earnings in such periods.

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Note 5 — Loans and Allowance for Loan Losses

The following is a summary of non-acquired loans:

June 30,

December 31,

June 30,

(Dollars in thousands)

    

2019

    

2018

    

2018

 

Non-acquired loans:

    

    

    

Commercial non-owner occupied real estate:

Construction and land development

$

879,724

$

841,445

$

906,890

Commercial non-owner occupied

 

1,723,640

 

1,415,551

 

1,135,235

Total commercial non-owner occupied real estate

 

2,603,364

 

2,256,996

 

2,042,125

Consumer real estate:

Consumer owner occupied

 

2,079,949

 

1,936,265

 

1,733,924

Home equity loans

 

514,242

 

495,148

 

456,946

Total consumer real estate

 

2,594,191

 

2,431,413

 

2,190,870

Commercial owner occupied real estate

 

1,589,987

 

1,517,551

 

1,372,453

Commercial and industrial

 

1,114,513

 

1,054,952

 

941,067

Other income producing property

 

214,203

 

214,353

 

205,507

Consumer

 

503,468

 

448,664

 

416,650

Other loans

 

1,601

 

9,357

 

28,867

Total non-acquired loans

 

8,621,327

 

7,933,286

 

7,197,539

Less allowance for loan losses

 

(53,590)

 

(51,194)

 

(47,874)

Non-acquired loans, net

$

8,567,737

$

7,882,092

$

7,149,665

The following is a summary of acquired non-credit impaired loans accounted for under FASB ASC Topic 310-20, net of related discount:

June 30,

December 31,

June 30,

(Dollars in thousands)

2019

2018

2018

Acquired non-credit impaired loans:

    

    

    

    

    

    

 

Commercial non-owner occupied real estate:

Construction and land development

$

60,391

$

165,070

$

281,282

Commercial non-owner occupied

 

595,367

 

679,253

 

752,465

Total commercial non-owner occupied real estate

 

655,758

 

844,323

 

1,033,747

Consumer real estate:

Consumer owner occupied

 

577,284

 

628,813

 

676,596

Home equity loans

 

208,777

 

242,425

 

278,906

Total consumer real estate

 

786,061

 

871,238

 

955,502

Commercial owner occupied real estate

 

376,187

 

421,841

 

486,254

Commercial and industrial

 

151,579

 

212,537

 

304,864

Other income producing property

 

111,006

 

133,110

 

169,392

Consumer

 

99,690

 

111,777

 

126,665

Acquired non-credit impaired loans

$

2,180,281

$

2,594,826

$

3,076,424

The unamortized discount related to the acquired non-credit impaired loans totaled $26.9 million, $33.4 million, and $43.6 million at June 30, 2019, December 31, 2018, and June 30, 2018, respectively.

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In accordance with FASB ASC Topic 310-30, we aggregated acquired loans that have common risk characteristics into pools of loan categories as described in the table below. The following is a summary of acquired credit impaired loans accounted for under FASB ASC Topic 310-30 (identified as credit impaired at the time of acquisition), net of related discount:

June 30,

December 31,

June 30,

(Dollars in thousands)

    

2019

    

2018

    

2018

 

Acquired credit impaired loans:

    

    

    

Commercial real estate

$

164,540

$

196,764

$

227,739

Commercial real estate—construction and development

 

27,014

 

32,942

 

40,951

Residential real estate

 

184,208

 

207,482

 

229,502

Consumer

 

38,624

 

42,492

 

45,633

Commercial and industrial

 

10,198

 

10,043

 

12,580

Acquired credit impaired loans

 

424,584

 

489,723

 

556,405

Less allowance for loan losses

 

(4,623)

 

(4,604)

 

(4,426)

Acquired credit impaired loans, net

$

419,961

$

485,119

$

551,979

Contractual loan payments receivable, estimates of amounts not expected to be collected, other fair value adjustments and the resulting carrying values of acquired credit impaired loans as of June 30, 2019, December 31, 2018 and June 30, 2018 are as follows:

June 30,

December 31,

June 30,

(Dollars in thousands)

    

2019

    

2018

    

2018

 

Contractual principal and interest

$

538,730

$

626,691

$

717,180

Non-accretable difference

 

(18,156)

 

(24,818)

 

(43,397)

Cash flows expected to be collected

 

520,574

 

601,873

 

673,783

Accretable yield

 

(100,613)

 

(116,754)

 

(121,804)

Carrying value

$

419,961

$

485,119

$

551,979

Income on acquired credit impaired loans that are not impaired at the acquisition date is recognized in the same manner as loans impaired at the acquisition date. A portion of the fair value discount on acquired non-impaired loans has been ascribed as an accretable yield that is accreted into interest income over the estimated remaining life of the loans. The remaining nonaccretable difference represents cash flows not expected to be collected.

The following are changes in the carrying value of acquired credit impaired loans:

Six Months Ended June 30,

(Dollars in thousands)

    

2019

    

2018

Balance at beginning of period

$

485,119

$

618,803

Net reductions for payments, foreclosures, and accretion

 

(65,139)

 

(67,025)

Change in the allowance for loan losses on acquired loans

 

(19)

 

201

Balance at end of period, net of allowance for loan losses on acquired credit impaired loans

$

419,961

$

551,979

The table below reflects refined accretable yield balance for acquired credit impaired loans:

Six Months Ended June 30,

(Dollars in thousands)

    

2019

    

2018

Balance at beginning of period

$

116,754

$

133,096

PSC acquisition Day 1 adjustment

(1,460)

Contractual interest income

 

(14,189)

 

(17,050)

Accretion on acquired credit impaired loans

(10,287)

(9,013)

Reclass of nonaccretable difference due to improvement in expected cash flows

 

8,468

 

16,453

Other changes, net

 

(133)

 

(222)

Balance at end of period

$

100,613

$

121,804

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The table above reflects the changes in the carrying amount of accretable yield for the acquired credit impaired loans and shows both the contractual interest income and incremental accretion for the six months ended June 30, 2019 and 2018. In the first six months of 2019, the accretable yield balance declined by $16.1 million as total contractual interest and accretion income of $24.5 million was recognized. This was partially offset by improved expected cash flows of $8.5 million. The improved cash flows for the prior year was adjusted to accurately reflect the split between income types.

As of June 30, 2019, the table above excludes $2.2 billion ($2.2 billion in contractual principal less a $26.9 million discount) in acquired loans which are accounted for under FASB ASC Topic 310-20. These loans were identified as either performing with no discount related to the credit or as a revolving lines of credit (commercial or consumer) at acquisition. As of June 30, 2018, the balance of these acquired loans totaled $3.1 billion ($3.1 billion in contractual principal less a $43.6 million remaining discount).

Our loan loss policy adheres to GAAP as well as interagency guidance. The allowance for loan losses, which we sometimes refer to herein as ALLL, is based upon estimates made by management. We maintain an allowance for loan losses at a level that we believe is appropriate to cover estimated credit losses on individually evaluated loans that are determined to be impaired as well as estimated credit losses inherent in the remainder of our loan portfolio. Arriving at the allowance involves a high degree of management judgment and results in a range of estimated losses. We regularly evaluate the adequacy of the allowance through our internal risk rating system, outside credit review, and regulatory agency examinations to assess the quality of the loan portfolio and identify problem loans. The evaluation process also includes our analysis of current economic conditions, composition of the loan portfolio, past due and nonaccrual loans, concentrations of credit, lending policies and procedures, and historical loan loss experience. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on, among other factors, changes in economic conditions in our markets. In addition, regulatory agencies, as an integral part of their examination process, periodically review our allowances for losses on loans. These agencies may require management to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. Because of these and other factors, it is possible that the allowances for losses on loans may change. The provision for loan losses is charged to expense in an amount necessary to maintain the allowance at an appropriate level.

The allowance for loan losses on non-acquired loans consists of general and specific reserves. The general reserves are determined by applying loss percentages to the portfolio that are based on historical loss experience for each class of loans and management’s evaluation and “risk grading” of the loan portfolio. Additionally, the general economic and business conditions affecting key lending areas, credit quality trends, collateral values, loan volumes and concentrations, seasoning of the loan portfolio, the findings of internal and external credit reviews and results from external bank regulatory examinations are included in this evaluation. Currently, these adjustments are applied to the non-acquired loan portfolio when estimating the level of reserve required. The specific reserves are determined on a loan-by-loan basis based on management’s evaluation of our exposure for each credit, given the current payment status of the loan and the value of any underlying collateral. These are loans classified by management as doubtful or substandard. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. Generally, the need for specific reserve is evaluated on impaired loans, and once a specific reserve is established for a loan, a charge off of that amount occurs in the quarter subsequent to the establishment of the specific reserve. Loans that are determined to be impaired are provided a specific reserve, if necessary, and are excluded from the calculation of the general reserves.

Beginning with the First Financial Holdings, Inc. acquisition, we segregated the loan portfolio into performing loans (“non-credit impaired) and purchased credit impaired loans. The performing loans and revolving type loans are accounted for under FASB ASC 310-20, with each loan being accounted for individually. The allowance for loan losses on these loans will be measured and recorded consistent with non-acquired loans. The acquired credit impaired loans will follow the description in the next paragraph.

In determining the acquisition date fair value of purchased loans, and in subsequent accounting, we generally aggregate purchased loans into pools of loans with common risk characteristics. Expected cash flows at the acquisition date in excess of the fair value of loans are recorded as interest income over the life of the loans using a level yield method if the timing and amount of the future cash flows of the pool is reasonably estimable. Subsequent to the acquisition date, increases in cash flows over those expected at the acquisition date are reclassified from the

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non-accretable difference to accretable yield and recognized as interest income prospectively. Decreases in expected cash flows after the acquisition date are recognized by recording an allowance for loan losses. Management analyzes the acquired loan pools using various assessments of risk to determine an expected loss. The expected loss is derived based upon a loss given default based upon the collateral type and/or detailed review by loan officers and the probability of default that is determined based upon historical data at the loan level. All acquired loans managed by Special Asset Management are reviewed quarterly and assigned a loss given default.  Acquired loans not managed by Special Asset Management are reviewed twice a year in a similar method to our originated portfolio of loans which follow review thresholds based on risk rating categories. In the fourth quarter of 2015, we modified its methodology to a more granular approach in determining loss given default on substandard loans with a net book balance between $100,000 and $500,000 by adjusting the loss given default to 90% of the most current collateral valuation based on appraised value.  Substandard loans greater than $500,000 were individually assigned loss given defaults each quarter. Trends are reviewed in terms of accrual status, past due status, and weighted-average grade of the loans within each of the accounting pools. In addition, the relationship between the change in the unpaid principal balance and change in the mark is assessed to correlate the directional consistency of the expected loss for each pool.

An aggregated analysis of the changes in allowance for loan losses is as follows:

   

Non-acquired

   

Acquired Non-Credit

   

Acquired Credit

   

 

(Dollars in thousands)

Loans

Impaired Loans

Impaired Loans

Total

 

Three Months Ended June 30, 2019:

Balance at beginning of period

$

52,008

$

$

4,514

$

56,522

Loans charged-off

 

(1,327)

(1,535)

 

 

(2,862)

Recoveries of loans previously charged off (1)

 

875

116

 

 

991

Net charge-offs

 

(452)

(1,419)

 

 

(1,871)

Provision for loan losses charged to operations

 

2,034

1,419

 

251

 

3,704

Reduction due to loan removals

 

 

(142)

 

(142)

Balance at end of period

$

53,590

$

$

4,623

$

58,213

Three Months Ended June 30, 2018:

Balance at beginning of period

$

45,203

$

$

4,084

$

49,287

Loans charged-off

 

(1,240)

(1,183)

 

 

(2,423)

Recoveries of loans previously charged off (1)

 

1,051

87

 

 

1,138

Net charge-offs

 

(189)

(1,096)

 

 

(1,285)

Provision for loan losses charged to operations

 

2,860

1,096

 

522

 

4,478

Reduction due to loan removals

 

 

(180)

 

(180)

Balance at end of period

$

47,874

$

$

4,426

$

52,300

    

Non-acquired

    

Acquired Non-Credit

    

Acquired Credit

    

 

(Dollars in thousands)

Loans

Impaired Loans

Impaired Loans

Total

 

Six Months Ended June 30, 2019:

Balance at beginning of period

$

51,194

$

$

4,604

$

55,798

Loans charged-off

 

(2,572)

(1,909)

 

 

(4,481)

Recoveries of loans previously charged off (1)

 

1,627

322

 

 

1,949

Net charge-offs

 

(945)

(1,587)

 

 

(2,532)

Provision for loan losses charged to operations

 

3,341

1,587

 

264

 

5,192

Reduction due to loan removals

 

 

(245)

 

(245)

Balance at end of period

$

53,590

$

$

4,623

$

58,213

Six Months Ended June 30, 2018:

Balance at beginning of period

$

43,448

$

$

4,627

$

48,075

Loans charged-off

 

(2,409)

(1,517)

 

 

(3,926)

Recoveries of loans previously charged off (1)

 

1,853

252

 

 

2,105

Net charge-offs

 

(556)

(1,265)

 

 

(1,821)

Provision for losses charged to operations

 

4,982

1,265

 

685

 

6,932

Reduction due to loan removals

 

 

(886)

 

(886)

Balance at end of period

$

47,874

$

$

4,426

$

52,300

(1)– Recoveries related to acquired credit impaired loans are recorded through other noninterest income on the consolidated statement of income and do not run through the ALLL.

23

Table of Contents 

The following tables present a disaggregated analysis of activity in the allowance for loan losses and loan balances for non-acquired loans:

   

Construction

   

Commercial

   

Commercial

   

Consumer

   

   

   

Other Income

   

   

   

& Land

Non-owner

Owner

Owner

Home

Commercial

Producing

Other

(Dollars in thousands)

Development

Occupied

Occupied

Occupied

Equity

& Industrial

Property

Consumer

Loans

Total

Three Months Ended June 30, 2019

Allowance for loan losses:

Balance, March 31, 2019

$

5,371

$

9,740

$

9,629

$

12,058

$

3,273

$

7,249

$

1,387

$

3,195

$

106

$

52,008

Charge-offs

 

(9)

 

(3)

 

 

(48)

 

 

(90)

 

(31)

 

(1,146)

 

 

(1,327)

Recoveries

 

326

 

23

 

41

 

30

 

98

 

138

 

13

 

206

 

 

875

Provision (benefit)

 

30

 

551

 

(144)

 

392

 

(194)

 

198

 

(10)

 

1,317

 

(106)

 

2,034

Balance, June 30, 2019

$

5,718

$

10,311

$

9,526

$

12,432

$

3,177

$

7,495

$

1,359

$

3,572

$

$

53,590

Loans individually evaluated for impairment

$

715

$

1

$

33

$

35

$

125

$

394

$

78

$

3

$

$

1,384

Loans collectively evaluated for impairment

$

5,003

$

10,310

$

9,493

$

12,397

$

3,052

$

7,101

$

1,281

$

3,569

$

$

52,206

Loans:

Loans individually evaluated for impairment

$

36,130

$

101

$

5,440

$

5,566

$

2,436

$

2,674

$

2,064

$

98

$

$

54,509

Loans collectively evaluated for impairment

 

843,594

 

1,723,539

 

1,584,547

 

2,074,383

 

511,806

 

1,111,839

 

212,139

 

503,370

 

1,601

 

8,566,818

Total non-acquired loans

$

879,724

$

1,723,640

$

1,589,987

$

2,079,949

$

514,242

$

1,114,513

$

214,203

$

503,468

$

1,601

$

8,621,327

Three Months Ended June 30, 2018

Allowance for loan losses:

Balance, March 31, 2018

$

5,847

$

6,798

$

8,346

$

10,193

$

3,237

$

6,333

$

1,393

$

2,899

$

157

$

45,203

Charge-offs

 

 

 

(81)

 

 

(5)

 

(59)

 

 

(1,095)

 

 

(1,240)

Recoveries

 

547

 

2

 

25

 

41

 

27

 

199

 

3

 

207

 

 

1,051

Provision (benefit)

 

(207)

 

409

 

317

 

711

 

109

 

238

 

17

 

1,060

 

206

 

2,860

Balance, June 30, 2018

$

6,187

$

7,209

$

8,607

$

10,945

$

3,368

$

6,711

$

1,413

$

3,071

$

363

$

47,874

Loans individually evaluated for impairment

$

846

$

93

$

44

$

30

$

180

$

485

$

144

$

7

$

$

1,829

Loans collectively evaluated for impairment

$

5,341

$

7,116

$

8,563

$

10,915

$

3,188

$

6,226

$

1,269

$

3,064

$

363

$

46,045

Loans:

Loans individually evaluated for impairment

$

42,392

$

1,348

$

4,750

$

5,628

$

3,144

$

1,834

$

3,240

$

257

$

$

62,593

Loans collectively evaluated for impairment

 

864,498

 

1,133,887

 

1,367,703

 

1,728,296

 

453,802

 

939,233

 

202,267

 

416,393

 

28,867

 

7,134,946

Total non-acquired loans

$

906,890

$

1,135,235

$

1,372,453

$

1,733,924

$

456,946

$

941,067

$

205,507

$

416,650

$

28,867

$

7,197,539

    

Construction

    

Commercial

    

Commercial

    

Consumer

    

    

    

Other Income

    

    

    

& Land

Non-owner

Owner

Owner

Home

Commercial

Producing

Other

(Dollars in thousands)

Development

Occupied

Occupied

Occupied

Equity

& Industrial

Property

Consumer

Loans

Total

Six Months Ended June 30, 2019

Allowance for loan losses:

Balance, December 31, 2018

$

5,682

$

8,754

$

9,369

$

11,913

$

3,434

$

7,454

$

1,446

$

3,101

$

41

$

51,194

Charge-offs

 

(9)

 

(3)

 

(12)

 

(85)

 

(15)

 

(109)

 

(31)

 

(2,308)

 

 

(2,572)

Recoveries

 

625

 

45

 

66

 

32

 

134

 

209

 

58

 

458

 

 

1,627

Provision (benefit)

 

(580)

 

1,515

 

103

 

572

 

(376)

 

(59)

 

(114)

 

2,321

 

(41)

 

3,341

Balance, June 30, 2019

$

5,718

$

10,311

$

9,526

$

12,432

$

3,177

$

7,495

$

1,359

$

3,572

$

$

53,590

Six Months Ended June 30, 2018

Allowance for loan losses:

Balance, December 31, 2017

$

5,921

$

6,525

$

8,128

$

9,668

$

3,250

$

5,488

$

1,375

$

2,788

$

305

$

43,448

Charge-offs

 

(35)

 

 

(81)

 

(4)

 

(71)

 

(144)

 

 

(2,074)

 

 

(2,409)

Recoveries

 

989

 

4

 

33

 

64

 

128

 

214

 

11

 

410

 

 

1,853

Provision (benefit)

 

(688)

 

680

 

527

 

1,217

 

61

 

1,153

 

27

 

1,947

 

58

 

4,982

Balance, June 30, 2018

$

6,187

$

7,209

$

8,607

$

10,945

$

3,368

$

6,711

$

1,413

$

3,071

$

363

$

47,874

24

Table of Contents 

The following tables present a disaggregated analysis of activity in the allowance for loan losses and loan balances for acquired non-credit impaired loans:

    

Construction

    

Commercial

    

Commercial

    

Consumer

    

    

    

Other Income

    

    

 

& Land

Non-owner

Owner

Owner

Home

Commercial

Producing

 

(Dollars in thousands)

Development

Occupied

Occupied

Occupied

Equity

& Industrial

Property

Consumer

Total

 

Three Months Ended June 30, 2019

Allowance for loan losses:

Balance at beginning of period

$

$

$

$

$

$

$

$

$

Charge-offs

 

 

 

(786)

 

(6)

 

(168)

 

(506)

 

 

(69)

 

(1,535)

Recoveries

 

1

 

 

 

3

 

24

 

6

 

71

 

11

 

116

Provision (benefit)

 

(1)

 

 

786

 

3

 

144

 

500

 

(71)

 

58

 

1,419

Balance, June 30, 2019

$

$

$

$

$

$

$

$

$

Loans individually evaluated for impairment

$

$

$

$

$

$

$

$

$

Loans collectively evaluated for impairment

$

$

$

$

$

$

$

$

$

Loans:

Loans individually evaluated for impairment

$

$

$

$

$

$

$

$

$

Loans collectively evaluated for impairment

 

60,391

 

595,367

 

376,187

 

577,284

 

208,777

 

151,579

 

111,006

 

99,690

 

2,180,281

Total acquired non-credit impaired loans

$

60,391

$

595,367

$

376,187

$

577,284

$

208,777

$

151,579

$

111,006

$

99,690

$

2,180,281

Three Months Ended June 30, 2018

Allowance for loan losses:

Balance at beginning of period

$

$

$

$

$

$

$

$

$

Charge-offs

 

(106)

 

 

(28)

 

 

(158)

 

(764)

 

 

(127)

 

(1,183)

Recoveries

 

6

 

 

 

5

 

28

 

2

 

 

46

 

87

Provision (benefit)

 

100

 

 

28

 

(5)

 

130

 

762

 

 

81

 

1,096

Balance, June 30, 2018

$

$

$

$

$

$

$

$

$

Loans individually evaluated for impairment

$

$

$

$

$

$

$

$

$

Loans collectively evaluated for impairment

$

$

$

$

$

$

$

$

$

Loans:

Loans individually evaluated for impairment

$

$

$

$

$

$

$

$

$

Loans collectively evaluated for impairment

 

281,282

 

752,465

 

486,254

 

676,596

 

278,906

 

304,864

 

169,392

 

126,665

 

3,076,424

Total acquired non-credit impaired loans

$

281,282

$

752,465

$

486,254

$

676,596

$

278,906

$

304,864

$

169,392

$

126,665

$

3,076,424

    

Construction

    

Commercial

    

Commercial

    

Consumer

    

    

    

    

    

Other Income

    

    

    

    

 

& Land

Non-owner

Owner

Owner

Home

Commercial

Producing

 

(Dollars in thousands)

Development

Occupied

Occupied

Occupied

Equity

& Industrial

Property

Consumer

Total

 

Six Months Ended June 30, 2019

Allowance for loan losses:

Balance, December 31, 2018

$

$

$

$

$

$

$

$

$

Charge-offs

 

(6)

 

 

(786)

 

(6)

 

(240)

 

(640)

 

(26)

 

(205)

 

(1,909)

Recoveries

 

2

 

 

 

5

 

46

 

171

 

71

 

27

 

322

Provision (benefit)

 

4

 

 

786

 

1

 

194

 

469

 

(45)

 

178

 

1,587

Balance, June 30, 2019

$

$

$

$

$

$

$

$

$

Six Months Ended June 30, 2018

Allowance for loan losses:

Balance, December 31, 2017

$

$

$

$

$

$

$

$

$

Charge-offs

 

(107)

 

 

(28)

 

(70)

 

(240)

 

(807)

 

 

(265)

 

(1,517)

Recoveries

 

7

 

 

 

62

 

79

 

55

 

 

49

 

252

Provision (benefit)

 

100

 

 

28

 

8

 

161

 

752

 

 

216

 

1,265

Balance, June 30, 2018

$

$

$

$

$

$

$

$

$

25

Table of Contents 

The following tables present a disaggregated analysis of activity in the allowance for loan losses and loan balances for acquired credit impaired loans:

   

   

Commercial

   

   

   

   

Real Estate-

Commercial

Construction and

Residential

Commercial

(Dollars in thousands)

Real Estate

Development

Real Estate

Consumer

and Industrial

Total

Three Months Ended June 30, 2019

Allowance for loan losses:

Balance, March 31, 2019

$

847

$

717

$

2,164

$

707

$

79

$

4,514

Provision (benefit) for loan losses

 

162

 

81

 

279

 

(237)

 

(34)

 

251

Reduction due to loan removals

 

 

 

(97)

 

 

(45)

 

(142)

Balance, June 30, 2019

$

1,009

$

798

$

2,346

$

470

$

$

4,623

Loans individually evaluated for impairment

$

$

$

$

$

$

Loans collectively evaluated for impairment

$

1,009

$

798

$

2,346

$

470

$

$

4,623

Loans:*

Loans individually evaluated for impairment

$

$

$

$

$

$

Loans collectively evaluated for impairment

 

164,540

 

27,014

 

184,208

 

38,624

 

10,198

 

424,584

Total acquired credit impaired loans

$

164,540

$

27,014

$

184,208

$

38,624

$

10,198

$

424,584

Three Months Ended June 30, 2018

Allowance for loan losses:

Balance , March 31, 2018

$

261

$

215

$

2,509

$

594

$

505

$

4,084

Provision (benefit) for loan losses

 

375

 

390

 

137

 

(19)

 

(361)

 

522

Reduction due to loan removals

 

 

(29)

 

(132)

 

(3)

 

(16)

 

(180)

Balance, June 30, 2018

$

636

$

576

$

2,514

$

572

$

128

$

4,426

Loans individually evaluated for impairment

$

$

$

$

$

$

Loans collectively evaluated for impairment

$

636

$

576

$

2,514

$

572

$

128

$

4,426

Loans:*

Loans individually evaluated for impairment

$

$

$

$

$

$

Loans collectively evaluated for impairment

 

227,739

 

40,951

 

229,502

 

45,633

 

12,580

 

556,405

Total acquired credit impaired loans

$

227,739

$

40,951

$

229,502

$

45,633

$

12,580

$

556,405

    

    

Commercial

    

    

    

    

Real Estate-

Commercial

Construction and

Residential

Commercial

(Dollars in thousands)

Real Estate

Development

Real Estate

Consumer

and Industrial

Total

Six Months Ended June 30, 2019

Allowance for loan losses:

Balance, December 31, 2018

$

801

$

717

$

2,246

$

761

$

79

$

4,604

Provision (benefit) for loan losses

 

213

 

81

 

295

 

(291)

 

(34)

 

264

Reduction due to loan removals

 

(5)

 

 

(195)

 

 

(45)

 

(245)

Balance, June 30, 2019

$

1,009

$

798

$

2,346

$

470

$

$

4,623

Six Months Ended June 30, 2018

Allowance for loan losses:

Balance, December 31, 2017

$

288

$

180

$

3,553

$

461

$

145

$

4,627

Provision (benefit) for loan losses

 

361

 

478

 

(807)

 

114

 

539

 

685

Reduction due to loan removals

 

(13)

 

(82)

 

(232)

 

(3)

 

(556)

 

(886)

Balance, June 30, 2018

$

636

$

576

$

2,514

$

572

$

128

$

4,426

*— The carrying value of acquired credit impaired loans includes a non-accretable difference which is primarily associated with the assessment of credit quality of acquired loans.

As part of the ongoing monitoring of the credit quality of our loan portfolio, management tracks certain credit quality indicators, including trends related to (i) the level of classified loans, (ii) net charge-offs, (iii) non-performing loans (see details below), and (iv) the general economic conditions of the markets that we serve.

We utilize a risk grading matrix to assign a risk grade to each of its loans. A description of the general characteristics of the risk grades is as follows:

Pass—These loans range from minimal credit risk to average, however, still acceptable credit risk.
Special mention—A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or the institution’s credit position at some future date.
Substandard—A substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness, or weaknesses, that may jeopardize the liquidation of the debt. A substandard loan is characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
Doubtful—A doubtful loan has all of the weaknesses inherent in one classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of the currently existing facts, conditions and values, highly questionable and improbable.

26

Table of Contents 

The following table presents the credit risk profile by risk grade of commercial loans for non-acquired loans:

Construction & Development

Commercial Non-owner Occupied

Commercial Owner Occupied

 

June 30,

December 31,

June 30,

June 30,

December 31,

June 30,

June 30,

December 31,

June 30,

 

(Dollars in thousands)

    

2019

    

2018

    

2018

    

2019

    

2018

    

2018

    

2019

    

2018

    

2018

 

Pass

$

871,393

$

832,612

$

895,887

$

1,714,606

$

1,407,744

$

1,126,099

$

1,561,594

$

1,480,267

$

1,343,624

Special mention

 

5,948

 

6,015

 

7,858

 

7,557

 

6,427

 

7,378

 

16,310

 

24,576

 

18,808

Substandard

 

2,383

 

2,818

 

3,145

 

1,477

 

1,380

 

1,758

 

12,083

 

12,708

 

10,021

Doubtful

 

 

 

 

 

 

 

 

 

$

879,724

$

841,445

$

906,890

$

1,723,640

$

1,415,551

$

1,135,235

$

1,589,987

$

1,517,551

$

1,372,453

Commercial & Industrial

Other Income Producing Property

Commercial Total

 

June 30,

December 31,

June 30,

June 30,

December 31,

June 30,

June 30,

December 31,

June 30,

 

    

2019

    

2018

    

2018

    

2019

    

2018

    

2018

    

2019

    

2018

    

2018

 

Pass

$

1,090,519

$

1,037,915

$

923,995

$

208,598

$

208,186

$

198,899

$

5,446,710

$

4,966,724

$

4,488,504

Special mention

 

16,279

 

5,887

 

8,522

 

4,376

 

4,706

 

4,828

 

50,470

 

47,611

 

47,394

Substandard

 

7,715

 

11,150

 

8,550

 

1,229

 

1,461

 

1,780

 

24,887

 

29,517

 

25,254

Doubtful

 

 

 

 

 

 

 

 

 

$

1,114,513

$

1,054,952

$

941,067

$

214,203

$

214,353

$

205,507

$

5,522,067

$

5,043,852

$

4,561,152

The following table presents the credit risk profile by risk grade of consumer loans for non-acquired loans:

Consumer Owner Occupied

Home Equity

Consumer

 

June 30,

December 31,

June 30,

June 30,

December 31,

June 30,

June 30,

December 31,

June 30,

 

(Dollars in thousands)

    

2019

    

2018

    

2018

    

2019

    

2018

    

2018

    

2019

    

2018

    

2018

 

Pass

$

2,052,808

$

1,909,427

$

1,706,574

$

502,305

$

481,607

$

443,953

$

501,474

$

446,823

$

415,053

Special mention

 

9,936

 

11,304

 

12,566

 

5,731

 

7,293

 

6,805

 

443

 

437

 

623

Substandard

 

17,205

 

15,534

 

14,784

 

6,206

 

6,248

 

6,188

 

1,551

 

1,404

 

974

Doubtful

 

 

 

 

 

 

 

 

 

$

2,079,949

$

1,936,265

$

1,733,924

$

514,242

$

495,148

$

456,946

$

503,468

$

448,664

$

416,650

Other

Consumer Total

 

    

June 30, 2019

    

December 31, 2018

    

June 30, 2018

    

June 30, 2019

    

December 31, 2018

    

June 30, 2018

 

Pass

$

1,601

$

9,357

$

28,867

$

3,058,188

$

2,847,214

$

2,594,447

Special mention

 

 

 

 

16,110

 

19,034

 

19,994

Substandard

 

 

 

 

24,962

 

23,186

 

21,946

Doubtful

 

 

 

 

 

 

$

1,601

$

9,357

$

28,867

$

3,099,260

$

2,889,434

$

2,636,387

The following table presents the credit risk profile by risk grade of total non-acquired loans:

Total Non-acquired Loans

 

June 30,

December 31,

June 30,

 

(Dollars in thousands)

    

2019

    

2018

    

2018

 

Pass

$

8,504,898

$

7,813,938

$

7,082,951

Special mention

 

66,580

 

66,645

 

67,388

Substandard

 

49,849

 

52,703

 

47,200

Doubtful

 

 

 

$

8,621,327

$

7,933,286

$

7,197,539

The following table presents the credit risk profile by risk grade of commercial loans for acquired non-credit impaired loans:

Commercial Non-owner

 

Construction & Development

Occupied

Commercial Owner Occupied

 

June 30,

December 31,

June 30,

June 30,

December 31,

June 30,

June 30,

December 31,

June 30,

 

(Dollars in thousands)

    

2019

    

2018

    

2018

    

2019

    

2018

    

2018

    

2019

    

2018

    

2018

 

Pass

$

58,165

$

163,777

$

279,239

$

583,416

$

665,913

$

738,293

$

359,783

$

411,783

$

479,399

Special mention

 

821

 

838

 

1,449

 

5,753

 

13,018

 

14,164

 

12,841

 

5,664

 

5,871

Substandard

 

1,405

 

455

 

594

 

6,198

 

322

 

8

 

3,563

 

4,394

 

984

Doubtful

 

 

 

 

 

 

 

 

 

$

60,391

$

165,070

$

281,282

$

595,367

$

679,253

$

752,465

$

376,187

$

421,841

$

486,254

27

Table of Contents 

Other Income Producing

Commercial & Industrial

Property

Commercial Total

June 30,

December 31,

June 30,

June 30,

December 31,

June 30,

June 30,

December 31,

June 30,

    

2019

    

2018

    

2018

    

2019

    

2018

    

2018

    

2019

    

2018

    

2018

 

Pass

$

145,733

$

202,399

$

291,755

$

103,325

$

125,399

$

165,188

$

1,250,422

$

1,569,271

$

1,953,874

Special mention

 

2,616

 

6,523

 

5,248

 

6,140

 

6,419

 

3,381

 

28,171

 

32,462

 

30,113

Substandard

 

3,230

 

3,615

 

7,861

 

1,541

 

1,292

 

823

 

15,937

 

10,078

 

10,270

Doubtful

 

 

 

 

 

 

 

 

 

$

151,579

$

212,537

$

304,864

$

111,006

$

133,110

$

169,392

$

1,294,530

$

1,611,811

$

1,994,257

The following table presents the credit risk profile by risk grade of consumer loans for acquired non-credit impaired loans:

Consumer Owner Occupied

Home Equity

Consumer

June 30,

December 31,

June 30,

June 30,

December 31,

June 30,

June 30,

December 31,

June 30,

(Dollars in thousands)

    

2019

    

2018

    

2018

    

2019

    

2018

    

2018

    

2019

    

2018

    

2018

 

Pass

$

566,433

$

617,391

$

664,594

$

196,254

$

227,515

$

263,994

$

96,766

$

108,833

$

123,807

Special mention

 

6,749

 

7,868

 

7,495

 

5,459

 

7,688

 

8,319

 

637

 

698

 

723

Substandard

 

4,102

 

3,554

 

4,507

 

7,064

 

7,222

 

6,593

 

2,287

 

2,246

 

2,135

Doubtful

 

 

 

 

 

 

 

 

 

$

577,284

$

628,813

$

676,596

$

208,777

$

242,425

$

278,906

$

99,690

$

111,777

$

126,665

Consumer Total

June 30,

December 31,

June 30,

2019

    

2018

    

2018

 

Pass

$

859,453

$

953,739

$

1,052,395

Special mention

 

12,845

 

16,254

 

16,537

Substandard

 

13,453

 

13,022

 

13,235

Doubtful

 

 

 

$

885,751

$

983,015

$

1,082,167

The following table presents the credit risk profile by risk grade of total acquired non-credit impaired loans:

Total Acquired

Non-credit Impaired Loans

June 30,

December 31,

June 30,

(Dollars in thousands)

    

2019

    

2018

    

2018

 

Pass

$

2,109,875

$

2,523,010

$

3,006,269

Special mention

 

41,016

 

48,716

 

46,650

Substandard

 

29,390

 

23,100

 

23,505

Doubtful

 

 

 

$

2,180,281

$

2,594,826

$

3,076,424

The following table presents the credit risk profile by risk grade of acquired credit impaired loans (identified as credit-impaired at the time of acquisition), net of the related discount (this table should be read in conjunction with the allowance for acquired credit impaired loan losses table found on page 26):

Commercial Real Estate—

 

Construction and

 

Commercial Real Estate

Development

 

    

June 30,

December 31,

June 30,

June 30,

December 31,

June 30,

 

(Dollars in thousands)

    

2019

    

2018

    

2018

    

2019

    

2018

    

2018

 

Pass

$

132,852

$

160,788

$

177,996

$

18,665

$

20,293

$

25,243

Special mention

 

13,811

 

14,393

 

22,568

 

3,181

 

3,001

 

4,884

Substandard

 

17,877

 

21,583

 

27,175

 

5,168

 

9,648

 

10,824

Doubtful

 

 

 

 

 

 

$

164,540

$

196,764

$

227,739

$

27,014

$

32,942

$

40,951

Residential Real Estate

Consumer

Commercial & Industrial

 

June 30,

December 31,

June 30,

June 30,

December 31,

June 30,

June 30,

December 31,

June 30,

 

    

2019

    

2018

    

2018

    

2019

    

2018

    

2018

    

2019

    

2018

    

2018

 

Pass

$

93,303

$

104,181

$

116,461

$

4,896

$

5,751

$

6,144

$

6,389

$

5,093

$

6,161

Special mention

 

39,020

 

41,964

 

46,089

 

13,250

 

14,484

 

15,613

 

508

 

546

 

1,139

Substandard

 

51,885

 

61,337

 

66,952

 

20,478

 

22,257

 

23,876

 

3,301

 

4,404

 

5,280

Doubtful

 

 

 

 

 

 

 

 

 

$

184,208

$

207,482

$

229,502

$

38,624

$

42,492

$

45,633

$

10,198

$

10,043

$

12,580

28

Table of Contents 

Total Acquired

Credit Impaired Loans

June 30,

December 31,

June 30,

    

2019

    

2018

    

2018

 

Pass

$

256,105

$

296,106

$

332,005

Special mention

 

69,770

 

74,388

 

90,293

Substandard

 

98,709

 

119,229

 

134,107

Doubtful

 

 

 

$

424,584

$

489,723

$

556,405

The risk grading of acquired credit impaired loans is determined utilizing a loan’s contractual balance, while the amount recorded in the financial statements and reflected above is the carrying value.

The following table presents an aging analysis of past due loans (includes nonaccrual loans), segregated by class for non-acquired loans:

    

30 - 59 Days

    

60 - 89 Days

    

90+ Days

    

Total

    

    

Total

(Dollars in thousands)

Past Due

Past Due

Past Due

Past Due

Current

Loans

June 30, 2019

Commercial real estate:

Construction and land development

$

630

$

54

$

498

$

1,182

$

878,542

$

879,724

Commercial non-owner occupied

 

 

 

 

 

1,723,640

 

1,723,640

Commercial owner occupied

 

1,474

 

4,514

 

1,161

 

7,149

 

1,582,838

 

1,589,987

Consumer real estate:

Consumer owner occupied

 

669

 

215

 

2,953

 

3,837

 

2,076,112

 

2,079,949

Home equity loans

 

424

 

136

 

592

 

1,152

 

513,090

 

514,242

Commercial and industrial

 

1,007

 

369

 

107

 

1,483

 

1,113,030

 

1,114,513

Other income producing property

 

674

 

514

 

110

 

1,298

 

212,905

 

214,203

Consumer

 

676

 

415

 

746

 

1,837

 

501,631

 

503,468

Other loans

 

 

 

 

 

1,601

 

1,601

$

5,554

$

6,217

$

6,167

$

17,938

$

8,603,389

$

8,621,327

December 31, 2018

Commercial real estate:

Construction and land development

$

693

$

305

$

452

$

1,450

$

839,995

$

841,445

Commercial non-owner occupied

 

68

 

18

 

396

 

482

 

1,415,069

 

1,415,551

Commercial owner occupied

 

1,639

 

1,495

 

904

 

4,038

 

1,513,513

 

1,517,551

Consumer real estate:

Consumer owner occupied

 

1,460

 

789

 

943

 

3,192

 

1,933,073

 

1,936,265

Home equity loans

 

744

 

532

 

713

 

1,989

 

493,159

 

495,148

Commercial and industrial

 

898

 

120

 

573

 

1,591

 

1,053,361

 

1,054,952

Other income producing property

 

169

 

26

 

289

 

484

 

213,869

 

214,353

Consumer

 

437

 

174

 

718

 

1,329

 

447,335

 

448,664

Other loans

 

 

 

 

 

9,357

 

9,357

$

6,108

$

3,459

$

4,988

$

14,555

$

7,918,731

$

7,933,286

June 30, 2018

Commercial real estate:

Construction and land development

$

1,222

$

$

344

$

1,566

$

905,324

$

906,890

Commercial non-owner occupied

 

354

 

19

 

659

 

1,032

 

1,134,203

 

1,135,235

Commercial owner occupied

 

1,578

 

1,599

 

1,314

 

4,491

 

1,367,962

 

1,372,453

Consumer real estate:

Consumer owner occupied

 

479

 

387

 

900

 

1,766

 

1,732,158

 

1,733,924

Home equity loans

 

913

 

473

 

1,114

 

2,500

 

454,446

 

456,946

Commercial and industrial

 

762

 

94

 

815

 

1,671

 

939,396

 

941,067

Other income producing property

 

157

 

5

 

259

 

421

 

205,086

 

205,507

Consumer

 

475

 

202

 

557

 

1,234

 

415,416

 

416,650

Other loans

 

 

 

 

 

28,867

 

28,867

$

5,940

$

2,779

$

5,962

$

14,681

$

7,182,858

$

7,197,539

29

Table of Contents 

The following table presents an aging analysis of past due loans (includes nonaccrual loans), segregated by class for acquired non-credit impaired loans:

    

30 - 59 Days

    

60 - 89 Days

    

90+ Days

    

Total

    

    

Total

(Dollars in thousands)

Past Due

Past Due

Past Due

Past Due

Current

Loans

June 30, 2019

Commercial real estate:

Construction and land development

$

169

$

169

$

317

$

655

$

59,736

$

60,391

Commercial non-owner occupied

 

640

 

 

265

 

905

 

594,462

 

595,367

Commercial owner occupied

 

933

 

366

 

891

 

2,190

 

373,997

 

376,187

Consumer real estate:

Consumer owner occupied

 

970

 

 

413

 

1,383

 

575,901

 

577,284

Home equity loans

 

1,107

 

322

 

587

 

2,016

 

206,761

 

208,777

Commercial and industrial

 

1,266

 

1,543

 

323

 

3,132

 

148,447

 

151,579

Other income producing property

 

897

 

10

 

109

 

1,016

 

109,990

 

111,006

Consumer

 

424

 

194

 

323

 

941

 

98,749

 

99,690

$

6,406

$

2,604

$

3,228

$

12,238

$

2,168,043

$

2,180,281

December 31, 2018

Commercial real estate:

Construction and land development

$

647

$

45

$

365

$

1,057

$

164,013

$

165,070

Commercial non-owner occupied

 

607

 

21

 

283

 

911

 

678,342

 

679,253

Commercial owner occupied

 

964

 

1,006

 

 

1,970

 

419,871

 

421,841

Consumer real estate:

Consumer owner occupied

 

1,127

 

621

 

789

 

2,537

 

626,276

 

628,813

Home equity loans

 

1,286

 

442

 

2,209

 

3,937

 

238,488

 

242,425

Commercial and industrial

 

2,648

 

130

 

19

 

2,797

 

209,740

 

212,537

Other income producing property

 

603

 

276

 

129

 

1,008

 

132,102

 

133,110

Consumer

 

574

 

209

 

532

 

1,315

 

110,462

 

111,777

$

8,456

$

2,750

$

4,326

$

15,532

$

2,579,294

$

2,594,826

June 30, 2018

Commercial real estate:

Construction and land development

$

666

$

66

$

309

$

1,041

$

280,241

$

281,282

Commercial non-owner occupied

 

2,936

 

 

157

 

3,093

 

749,372

 

752,465

Commercial owner occupied

 

1,121

 

11

 

737

 

1,869

 

484,385

 

486,254

Consumer real estate:

Consumer owner occupied

 

1,434

 

207

 

860

 

2,501

 

674,095

 

676,596

Home equity loans

 

1,656

 

326

 

2,197

 

4,179

 

274,727

 

278,906

Commercial and industrial

 

115

 

118

 

21

 

254

 

304,610

 

304,864

Other income producing property

 

544

 

14

 

145

 

703

 

168,689

 

169,392

Consumer

 

436

 

717

 

296

 

1,449

 

125,216

 

126,665

$

8,908

$

1,459

$

4,722

$

15,089

$

3,061,335

$

3,076,424

30

Table of Contents 

The following table presents an aging analysis of past due loans (includes nonaccrual loans), segregated by class for acquired credit impaired loans:

    

30 - 59 Days

    

60 - 89 Days

    

90+ Days

    

Total

    

    

Total

(Dollars in thousands)

Past Due

Past Due

Past Due

Past Due

Current

Loans

June 30, 2019

Commercial real estate

$

883

$

244

$

4,263

$

5,390

$

159,150

$

164,540

Commercial real estate—construction and development

 

126

 

 

152

 

278

 

26,736

 

27,014

Residential real estate

 

3,011

 

2,101

 

4,302

 

9,414

 

174,794

 

184,208

Consumer

 

567

 

174

 

664

 

1,405

 

37,219

 

38,624

Commercial and industrial

 

49

 

 

80

 

129

 

10,069

 

10,198

$

4,636

$

2,519

$

9,461

$

16,616

$

407,968

$

424,584

December 31, 2018

Commercial real estate

$

876

$

112

$

4,533

$

5,521

$

191,243

$

196,764

Commercial real estate—construction and development

 

115

 

12

 

2,816

 

2,943

 

29,999

 

32,942

Residential real estate

 

4,620

 

1,251

 

8,487

 

14,358

 

193,124

 

207,482

Consumer

 

722

 

90

 

839

 

1,651

 

40,841

 

42,492

Commercial and industrial

 

2,437

 

 

88

 

2,525

 

7,518

 

10,043

$

8,770

$

1,465

$

16,763

$

26,998

$

462,725

$

489,723

June 30, 2018

Commercial real estate

$

621

$

553

$

7,637

$

8,811

$

218,928

$

227,739

Commercial real estate—construction and development

 

175

 

 

3,212

 

3,387

 

37,564

 

40,951

Residential real estate

 

5,279

 

3,989

 

6,948

 

16,216

 

213,286

 

229,502

Consumer

 

767

 

174

 

763

 

1,704

 

43,929

 

45,633

Commercial and industrial

 

125

 

386

 

465

 

976

 

11,604

 

12,580

$

6,967

$

5,102

$

19,025

$

31,094

$

525,311

$

556,405

31

Table of Contents 

The following is a summary of certain information pertaining to impaired non-acquired loans:

    

Unpaid

    

Recorded

    

Gross

    

    

Contractual

Investment

Recorded

Total

Principal

With No

Investment

Recorded

Related

(Dollars in thousands)

Balance

Allowance

With Allowance

Investment

Allowance

June 30, 2019

Commercial real estate:

Construction and land development

$

36,539

$

321

$

35,809

$

36,130

$

715

Commercial non-owner occupied

 

187

 

85

 

16

 

101

 

1

Commercial owner occupied

 

6,673

 

3,833

 

1,607

 

5,440

 

33

Consumer real estate:

Consumer owner occupied

 

5,989

 

3,983

 

1,583

 

5,566

 

35

Home equity loans

 

2,566

 

1,084

 

1,352

 

2,436

 

125

Commercial and industrial

 

2,708

 

509

 

2,165

 

2,674

 

394

Other income producing property

 

2,333

 

129

 

1,935

 

2,064

 

78

Consumer

 

158

 

 

98

 

98

 

3

Total

$

57,153

$

9,944

$

44,565

$

54,509

$

1,384

December 31, 2018

Commercial real estate:

Construction and land development

$

38,314

$

339

$

37,574

$

37,913

$

788

Commercial non-owner occupied

 

1,157

 

536

 

489

 

1,025

 

70

Commercial owner occupied

 

5,085

 

3,101

 

1,041

 

4,142

 

27

Consumer real estate:

Consumer owner occupied

 

7,291

 

4,992

 

1,769

 

6,761

 

41

Home equity loans

 

2,953

 

1,129

 

1,697

 

2,826

 

142

Commercial and industrial

 

1,332

 

467

 

824

 

1,291

 

416

Other income producing property

 

3,117

 

150

 

2,722

 

2,872

 

142

Consumer

 

211

 

 

188

 

188

 

2

Total

$

59,460

$

10,714

$

46,304

$

57,018

$

1,628

June 30, 2018

Commercial real estate:

Construction and land development

$

42,955

$

600

$

41,792

$

42,392

$

846

Commercial non-owner occupied

 

1,505

 

831

 

517

 

1,348

 

93

Commercial owner occupied

 

5,733

 

3,031

 

1,719

 

4,750

 

44

Consumer real estate:

Consumer owner occupied

 

6,085

 

4,631

 

997

 

5,628

 

30

Home equity loans

 

3,256

 

1,146

 

1,998

 

3,144

 

180

Commercial and industrial

 

1,876

 

724

 

1,110

 

1,834

 

485

Other income producing property

 

3,473

 

234

 

3,006

 

3,240

 

144

Consumer

325

 

 

257

257

7

Total

$

65,208

$

11,197

$

51,396

$

62,593

$

1,829

Acquired credit impaired loans are accounted for in pools as shown on page 21 rather than being individually evaluated for impairment; therefore, the table above excludes acquired credit impaired loans.

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The following summarizes the average investment in impaired non-acquired loans, and interest income recognized on these loans:

Three Months Ended June 30,

2019

2018

Average

Average

Investment in

Interest Income

Investment in

Interest Income

(Dollars in thousands)

    

Impaired Loans

    

Recognized

    

Impaired Loans

    

Recognized

Commercial real estate:

    

    

    

    

Construction and land development

$

37,194

$

310

$

44,295

$

298

Commercial non-owner occupied

 

238

 

2

 

1,265

 

9

Commercial owner occupied

 

4,830

 

94

 

5,164

 

72

Consumer real estate:

Consumer owner occupied

 

6,226

 

44

 

5,561

 

44

Home equity loans

 

2,595

 

32

 

3,156

 

36

Commercial and industrial

 

1,994

 

66

 

1,756

 

19

Other income producing property

 

2,210

 

24

 

3,163

 

42

Consumer

 

104

 

 

285

 

Total Impaired Loans

$

55,391

$

572

$

64,645

$

520

Six Months Ended June 30,

2019

2018

Average

Average

Investment in

Interest Income

Investment in

Interest Income

(Dollars in thousands)

    

Impaired Loans

    

Recognized

    

Impaired Loans

    

Recognized

Commercial real estate:

    

    

    

    

Construction and land development

$

37,021

$

791

$

42,811

$

810

Commercial non-owner occupied

 

563

 

4

 

1,362

 

15

Commercial owner occupied

 

4,791

 

161

 

5,196

 

147

Consumer real estate:

Consumer owner occupied

 

6,164

 

93

 

5,630

 

87

Home equity loans

 

2,631

 

64

 

3,077

 

65

Commercial and industrial

 

1,982

 

86

 

1,495

 

36

Other income producing property

 

2,468

 

54

 

3,189

 

88

Consumer

 

144

 

 

248

 

Other loans

 

 

 

 

Total Impaired Loans

$

55,764

$

1,253

$

63,008

$

1,248

The following is a summary of information pertaining to non-acquired nonaccrual loans by class, including restructured loans:

June 30,

December 31,

June 30,

(Dollars in thousands)

    

2019

    

2018

    

2018

 

Commercial non-owner occupied real estate:

    

    

    

Construction and land development

$

299

$

424

$

423

Commercial non-owner occupied

 

481

 

831

 

1,109

Total commercial non-owner occupied real estate

 

780

 

1,255

 

1,532

Consumer real estate:

Consumer owner occupied

 

6,688

 

7,109

 

6,465

Home equity loans

 

1,740

 

2,333

 

2,308

Total consumer real estate

 

8,428

 

9,442

 

8,773

Commercial owner occupied real estate

 

3,459

 

1,068

 

1,526

Commercial and industrial

 

285

 

647

 

811

Other income producing property

 

351

 

500

 

323

Consumer

 

1,351

 

1,267

 

893

Restructured loans

 

671

 

648

 

902

Total loans on nonaccrual status

$

15,325

$

14,827

$

14,760

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The following is a summary of information pertaining to acquired non-credit impaired nonaccrual loans by class, including restructured loans:

June 30,

December 31,

June 30,

(Dollars in thousands)

    

2019

    

2018

    

2018

Commercial non-owner occupied real estate:

Construction and land development

$

1,207

$

252

$

369

Commercial non-owner occupied

277

283

Total commercial non-owner occupied real estate

1,484

535

369

Consumer real estate:

Consumer owner occupied

1,699

3,864

2,136

Home equity loans

3,023

4,512

4,234

Total consumer real estate

4,722

8,376

6,370

Commercial owner occupied real estate

1,108

1,470

885

Commercial and industrial

964

1,296

101

Other income producing property

228

244

254

Consumer

1,442

1,568

1,394

Total loans on nonaccrual status

$

9,948

$

13,489

$

9,373

In the course of resolving delinquent loans, the Bank may choose to restructure the contractual terms of certain loans. Any loans that are modified are reviewed by the Bank to determine if a troubled debt restructuring (“TDR” or “restructured loan”) has occurred. The Bank designates loan modifications as TDRs when it grants a concession to a borrower that it would not otherwise consider due to the borrower experiencing financial difficulty (FASB ASC Topic 310-40). The concessions granted on TDRs generally include terms to reduce the interest rate, extend the term of the debt obligation, or modify the payment structure on the debt obligation.

Loans on nonaccrual status at the date of modification are initially classified as nonaccrual TDRs. Loans on accruing status at the date of concession are initially classified as accruing TDRs if the note is reasonably assured of repayment and performance is expected in accordance with its modified terms. Such loans may be designated as nonaccrual loans subsequent to the concession date if reasonable doubt exists as to the collection of interest or principal under the restructuring agreement. Nonaccrual TDRs are returned to accruing status when there is economic substance to the restructuring, there is documented credit evaluation of the borrower’s financial condition, the remaining balance is reasonably assured of repayment in accordance with its modified terms, and the borrower has demonstrated sustained repayment performance in accordance with the modified terms for a reasonable period of time (generally a minimum of six months). For the six months ended June 30, 2019 and 2018, our TDRs were not material.

Note 6—Other Real Estate Owned

The following is a summary of information pertaining to OREO:

Six Months Ended June 30,

(Dollars in thousands)

2019

2018

Beginning balance

$

11,410

$

11,203

Acquired in PSC acquisition

 

 

210

Additions

 

7,632

 

10,259

Writedowns

 

(487)

 

(932)

Sold

 

(4,049)

 

(3,518)

Ending Balance

$

14,506

$

17,222

At June 30, 2019, there were a total of 69 properties included in OREO compared to 86 properties at June 30, 2018. At June 30, 2019, we had $2.5 million in residential real estate included in OREO and $6.3 million in residential real estate consumer mortgage loans in the process of foreclosure.

Note 7 — Leases

As of June 30, 2019, we had operating ROU assets of $84.5 million and operating lease liabilities of $85.0 million. We maintain operating leases on land and buildings for our operating centers, branch facilities and ATM locations. Most leases include one or more options to renew, with renewal terms extending up to 25 years. The exercise of renewal options is based on the sole judgment of management and what they consider to be reasonably certain given the environment today. Factors in determining whether an option is reasonably certain of exercise include, but are not

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limited to, the value of leasehold improvements, the value of renewal rate compared to market rates, and the presence of factors that would cause a significant economic penalty to us if the option is not exercised. Leases with an initial term of 12 months or less are not recorded on the balance sheet and instead are recognized in lease expense on a straight-line basis over the lease term. We do not sublease any portion of these locations to third parties.

Three Months Ended

Six Months Ended

(Dollars in thousands)

June 30,

June 30,

    

2019

    

2019

 

Lease Expense Components:

Operating lease expense

$

2,173

$

4,319

Short-term lease expense

132

276

Variable lease expense

 

117

 

186

Total lease expense

$

2,422

$

4,781

Supplemental Cash Flow and Other Information Related to Leases:

Cash paid for amounts included in the measurement of lease liabilities - operating leases

$

1,918

$

3,808

Initial ROU assets recorded in exchange for new lease liabilities - operating leases

$

2,994

$

4,950

Weighted - average remaining lease term (years) - operating leases

 

14.40

Weighted - average discount rate - operating leases

 

 

4.0%

 

 

June 30,

2019

Supplemental Balance Sheet Information Related to Leases

Operating lease ROU assets (premises and equipment)

$

84,464

Operating lease liabilities (other liabilities)

$

84,968

Maturity Analysis of Lease Liabilities:

Year Ending December 31,

2019 (excluding the six months ended June 30, 2019)

$

3,796

2020

7,531

2021

7,989

2022

8,007

2023

8,021

Thereafter

78,176

Total

113,520

Less: Imputed Interest

(28,552)

Lease Liability

$

84,968

As of June 30, 2019, we did not maintain any finance leases, leases with related parties, and we determined that the number and dollar amount of our equipment leases was immaterial. As of June 30, 2019, we have additional operating leases that have not yet commenced of $4.9 million. These operating leases will commence in fiscal year 2019 with lease terms of 15 years. Disclosures for prior periods under the previous accounting guidance were on an annual basis only, therefore are not included for the June 30, 2019 interim reporting period.

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Note 8 — Deposits

Our total deposits are comprised of the following:

June 30,

December 31,

June 30,

(Dollars in thousands)

    

2019

    

2018

    

2018

Certificates of deposit

$

1,732,554

$

1,775,095

$

1,804,657

Interest-bearing demand deposits

 

5,588,061

 

5,407,175

 

5,216,942

Non-interest bearing demand deposits

 

3,255,906

 

3,061,769

 

3,152,828

Savings deposits

 

1,339,293

 

1,399,815

 

1,458,208

Other time deposits

 

6,466

 

3,079

 

5,654

Total deposits

$

11,922,280

$

11,646,933

$

11,638,289

At June 30, 2019, December 31, 2018, and June 30, 2018, we had $310.2 million, $320.0 million, and $336.9 million in certificates of deposits of $250,000 and greater, respectively. At June 30, 2019, December 31, 2018, and June 30, 2018, we had $3.9 million, $7.6 million and $19.8 million, in traditional, out-of-market brokered deposits, respectively.

Note 9 — Retirement Plans

The Company and the Bank provide certain retirement benefits to their employees in the form of a non-contributory defined benefit pension plan and an employees’ savings plan. The non-contributory defined benefit pension plan covers all employees hired on or before December 31, 2005, who have attained age 21, and who have completed a year of eligible service. Employees hired on or after January 1, 2006 are not eligible to participate in the non-contributory defined benefit pension plan, but are eligible to participate in the employees’ savings plan. On this date, a new benefit formula applies only to participants who have not attained age 45 or who do not have five years of service.

Effective July 1, 2009, we suspended the accrual of benefits for pension plan participants under the non-contributory defined benefit plan. The pension plan remained suspended as of June 30, 2019.

During 2018, we made the decision to terminate the non-contributory defined benefit pension plan. We received approval from the IRS through a determination letter in the fourth quarter of 2018 to proceed with the termination. The termination of the pension plan was recorded during the second quarter of 2019 and distributions of assets from the plan will be fully paid out by the third quarter of 2019. During the second quarter of 2019, the Company recorded a charge of $9.5 million related to the termination of the pension plan in the consolidated statement of income. This cost was the result of the recognition of the pre-tax losses from the pension plan that were recorded and held in accumulated other comprehensive income of $7.7 and the write-off of the pension plan asset of $1.8 million. Participants have the option to be fully paid out in a lump sum or be paid through an annuity over time. If the participant chooses the annuity, the funds will be placed in an annuity product with a third party.

Under the provisions of Internal Revenue Code Section 401(k), electing employees are eligible to participate in the employees’ savings plan after attaining age 21. Plan participants elect to contribute portions of their annual base compensation as a before tax contribution. Employer contributions may be made from current or accumulated net profits. Participants may elect to contribute 1% to 50% of annual base compensation as a before tax contribution. In 2018, employees participating in the plan received a 100% match of their 401(k) plan contribution from the Company, up to 4% of their salary. The employees were also eligible for an additional 2% discretionary matching contribution contingent upon certain of our annual financial goals which would be paid in the first quarter of the following year. Based on our financial performance in 2018, we paid a 0.75% discretionary matching contribution in the first quarter of 2019. Currently, we expect the same terms in the employees’ savings plan for 2019. We expensed $1.7 million and $3.0 million for the 401(k) plan during the three and six months ended June 30, 2019 compared to $896,000 and $3.3 million for the three and six months ended June 30, 2018, respectively.

Employees can enter the savings plan on or after the first day of each month. The employee may enter into a salary deferral agreement at any time to select an alternative deferral amount or to elect not to defer in the plan. If the employee does not elect an investment allocation, the plan administrator will select a retirement-based portfolio

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according to the employee’s number of years until normal retirement age. The plan’s investment valuations are generally provided on a daily basis.

Note 10 — Earnings Per Share

Basic earnings per share are calculated by dividing net income by the weighted-average shares of common stock outstanding during each period, excluding non-vested shares. Our diluted earnings per share are based on the weighted-average shares of common stock outstanding during each period plus the maximum dilutive effect of common stock issuable upon exercise of stock options or vesting of restricted shares. The weighted-average number of shares and equivalents are determined after giving retroactive effect to stock dividends and stock splits.

The following table sets forth the computation of basic and diluted earnings per share:

Three Months Ended

Six Months Ended

June 30,

June 30,

(Dollars and shares in thousands, except for per share amounts)

    

2019

    

2018

    

2019

    

2018

 

Basic earnings per common share:

    

    

    

    

Net income

$

41,460

$

40,459

$

85,827

$

82,785

Weighted-average basic common shares

35,089

36,677

35,268

36,657

Basic earnings per common share

$

1.18

$

1.10

$

2.43

$

2.25

Diluted earnings per share:

Net income

$

41,460

$

40,459

$

85,827

$

82,785

Weighted-average basic common shares

35,089

36,677

35,268

36,657

Effect of dilutive securities

211

252

193

253

Weighted-average dilutive shares

35,300

36,929

35,461

36,910

Diluted earnings per common share

$

1.17

$

1.09

$

2.42

$

2.24

The calculation of diluted earnings per common share excludes outstanding stock options for which the results would have been anti-dilutive under the treasury stock method as follows:

Three Months Ended June 30,

Six Months Ended June 30,

(Dollars in thousands)

    

2019

    

2018

    

2019

    

2018

 

Number of shares

63,313

61,272

    

63,313

61,272

Range of exercise prices

$

69.48

to

$

91.35

$

91.05

to

$

91.35

$

69.48

to

$

91.35

$

91.05

to

$

91.35

Note 11 — Share-Based Compensation

Our 2004, 2012 and 2019 share-based compensation plans are long-term retention plans intended to attract, retain, and provide incentives for key employees and non-employee directors in the form of incentive and non-qualified stock options, restricted stock, and restricted stock units (“RSUs”).

Stock Options

With the exception of non-qualified stock options granted to directors under the 2004 and 2012 plans, which in some cases may be exercised at any time prior to expiration and in some other cases may be exercised at intervals less than a year following the grant date, incentive stock options granted under our 2004, 2012 and 2019 plans may not be exercised in whole or in part within a year following the date of the grant, as these incentive stock options become exercisable in 25% increments pro ratably over the four-year period following the grant date. The options are granted at an exercise price at least equal to the fair value of the common stock at the date of grant and expire ten years from the date of grant. No options were granted under the 2004 plan after January 26, 2012, and the 2004 plan is closed other than for any options still unexercised and outstanding. No options were granted under the 2012 plan after February 1, 2019, and the 2012 plan is closed other than for any options still unexercised and outstanding. The 2019 plan is the only plan from which new share-based compensation grants may be issued. It is our policy to grant options out of the 1,000,000 share registered under the 2019 plan.

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Activity in our stock option plans for 2004 and 2012 is summarized in the following table. Our 2019 plan was adopted by our shareholders at our annual meeting on April 25, 2019. All information has been retroactively adjusted for stock dividends and stock splits.

Weighted

Weighted

Average

Aggregate

Average

Remaining

Intrinsic

    

Shares

    

Price

    

(Yrs.)

    

(000's)

 

Outstanding at January 1, 2019

213,866

$

61.28

Granted

 

 

Exercised

(12,722)

 

31.62

 

Outstanding at June 30, 2019

201,144

 

63.16

5.39

$

3,201

Exercisable at June 30, 2019

155,472

56.07

4.63

$

3,137

Weighted-average fair value of options granted during the year

$0.00

The fair value of options is estimated at the date of grant using the Black-Scholes option pricing model and expensed over the options’ vesting periods. The following weighted-average assumptions were used in valuing options issued (There have been no stock options issued in 2019):

Six months ended June 30,

    

2019

    

2018

Dividend yield

 %  

1.46

%  

Expected life

 

years  

8.5

years  

Expected volatility

 

%  

  

28.0

%  

Risk-free interest rate

 

%  

  

2.54

%  

As of June 30, 2019, there was $1.0 million of total unrecognized compensation cost related to nonvested stock option grants under the plans. The cost is expected to be recognized over a weighted-average period of 1.26 years as of June 30, 2019.  The total fair value of shares vested during the six months ended June 30, 2019 was $799,000.

Restricted Stock

We from time-to-time also grants shares of restricted stock to key employees and non-employee directors. These awards help align the interests of these employees and directors with the interests of our shareholders by providing economic value directly related to increases in the value of our stock. The value of the stock awarded is established as the fair market value of the stock at the time of the grant. We recognize expenses, equal to the total value of such awards, ratably over the vesting period of the stock grants. Restricted stock grants to employees typically “cliff vest” after four years. Grants to non-employee directors typically vest within a 12-month period.

All restricted stock agreements are conditioned upon continued employment and service in the case of directors. Termination of employment prior to a vesting date, as described below, would terminate any interest in non-vested shares. Prior to vesting of the shares, as long as employed by the Company, the key employees and non-employee directors will have the right to vote such shares and to receive dividends paid with respect to such shares. All restricted shares will fully vest in the event of change in control of the Company or upon the death of the recipient.

Nonvested restricted stock for the six months ended June 30, 2019 is summarized in the following table. All information has been retroactively adjusted for stock dividends and stock splits.

    

    

Weighted-

 

Average

 

Grant-Date

 

Restricted Stock

Shares

Fair Value

 

Nonvested at January 1, 2019

 

104,419

$

62.45

Granted

 

8,934

 

73.34

Vested

 

(26,514)

 

74.29

Forfeited

 

(2,332)

 

73.89

Nonvested at June 30, 2019

 

84,507

 

59.57

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As of June 30, 2019, there was $2.0 million of total unrecognized compensation cost related to nonvested restricted stock granted under the plans. This cost is expected to be recognized over a weighted-average period of 1.51 years as of June 30, 2019. The total fair value of shares vested during the six months ended June 30, 2019 was $2.1 million.

Restricted Stock Units

We from time-to-time also grants performance RSUs to key employees. These awards help align the interests of these employees with the interests of our shareholders by providing economic value directly related to our performance. Some performance RSU grants contain a three-year performance period while others contain a one-year performance period and a time vested requirement (generally four years from grant date). We communicate threshold, target, and maximum performance RSU awards and performance targets to the applicable key employees at the beginning of a performance period. Dividends are not paid in respect to the awards during the performance period. The value of the RSUs awarded is established as the fair market value of the stock at the time of the grant. We recognize expenses on a straight-line basis typically over the performance and vesting periods based upon the probable performance target that will be met. For the six months ended June 30, 2019, we accrued for 88.1% of the RSUs granted, based on Management’s expectations of performance.

Nonvested RSUs for the six months ended June 30, 2019 is summarized in the following table.

    

    

Weighted-

 

Average

 

Grant-Date

 

Restricted Stock Units

Shares

Fair Value

 

Nonvested at January 1, 2019

 

200,540

$

85.10

Granted

 

152,564

 

67.83

Forfeited

(1,651)

89.43

Nonvested at June 30, 2019

 

351,453

 

77.58

As of June 30, 2019, there was $13.4 million of total unrecognized compensation cost related to nonvested RSUs granted under the plan. This cost is expected to be recognized over a weighted-average period of 2.06 years as of June 30, 2019. The total fair value of RSUs vested during the six months ended June 30, 2019 was $2.9 million. During the six months ended June 30, 2019, 44,599 vested restricted stock units were issued to the participants in the 2016 Long-Term Incentive Plan.

Note 12 — Commitments and Contingent Liabilities

In the normal course of business, we make various commitments and incur certain contingent liabilities, which are not reflected in the accompanying financial statements. The commitments and contingent liabilities include guarantees, commitments to extend credit, and standby letters of credit. At June 30, 2019, commitments to extend credit and standby letters of credit totaled $2.8 billion. We do not anticipate any material losses as a result of these transactions.

We have been named as defendant in various legal actions, arising from its normal business activities, in which damages in various amounts are claimed. We are also exposed to litigation risk related to the prior business activities of banks acquired through whole bank acquisitions as well as banks from which assets were acquired and liabilities assumed in FDIC-assisted transactions. Although the amount of any ultimate liability with respect to such matters cannot be determined, in the opinion of management, any such liability is not expected to have a material effect on our consolidated financial statements.

The Company and the Bank are involved at times in certain litigation arising in the normal course of business. In the opinion of management as of June 30, 2019, there is no pending or threatened litigation that will have a material effect on our consolidated financial position or results of operations.

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Note 13 — Fair Value

FASB ASC Topic 820, Fair Value Measurements and Disclosures, defines fair value, establishes a framework for measuring fair value under GAAP, and enhances disclosures about fair value measurements. FASB ASC Topic 820 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions.

We utilize fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Available for sale securities, derivative contracts, and mortgage servicing rights (“MSRs”) are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans, OREO, and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

FASB ASC Topic 820 establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:

Level 1

Observable inputs such as quoted prices in active markets;

Level 2

Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and

Level 3

Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

The following is a description of valuation methodologies used for assets recorded at fair value.

Investment Securities

Securities available for sale are valued on a recurring basis at quoted market prices where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable securities. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange and The NASDAQ Stock Market, or U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities and debentures issued by government sponsored entities, municipal bonds and corporate debt securities. Securities held to maturity are valued at quoted market prices or dealer quotes similar to securities available for sale. The carrying value of FHLB stock approximates fair value based on the redemption provisions.

Mortgage Loans Held for Sale

Mortgage loans held for sale are carried at fair value. The fair values of mortgage loans held for sale are based on commitments on hand from investors within the secondary market for loans with similar characteristics. As such, the fair value adjustments for mortgage loans held for sale are recurring Level 2.

Loans

We do not record loans at fair value on a recurring basis. However, from time to time, a loan may be considered impaired and an ALLL may be established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using estimated fair value methodologies. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At June 30, 2019, substantially all of the impaired loans were evaluated based on the fair value of the collateral because such loans were considered collateral dependent. Impaired loans, where an allowance is established based on the fair value of collateral; require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, we consider the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, we consider the impaired loan as nonrecurring Level 3.

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Other Real Estate Owned

Typically OREO, consisting of properties obtained through foreclosure or in satisfaction of loans, is reported at fair value, determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources, adjusted for estimated selling costs (Level 2). However, OREO is considered Level 3 in the fair value hierarchy because management has qualitatively applied a discount due to the size, supply of inventory, and the incremental discounts applied to the appraisals. Management also considers other factors, including changes in absorption rates, length of time the property has been on the market and anticipated sales values, which have resulted in adjustments to the collateral value estimates indicated in certain appraisals. At the time of foreclosure, any excess of the loan balance over the fair value of the real estate held as collateral is treated as a charge against the ALLL. Gains or losses on sale and generally any subsequent adjustments to the value are recorded as a component of OREO expense.

Derivative Financial Instruments

Fair value is estimated using pricing models of derivatives with similar characteristics or discounted cash flow models where future floating cash flows are projected and discounted back; and accordingly, these derivatives are classified within Level 2 of the fair value hierarchy. (See Note 15—Derivative Financial Instruments for additional information).

Mortgage servicing rights

The estimated fair value of MSRs is obtained through an independent derivatives dealer analysis of future cash flows. The evaluation utilizes assumptions market participants would use in determining fair value including market discount rates, prepayment speeds, servicing income, servicing costs, default rates and other market driven data, as well as the market’s perception of future interest rate movements. MSRs are classified as Level 3.

41

Table of Contents 

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The tables below present the recorded amount of assets and liabilities measured at fair value on a recurring basis.

 

    

    

Quoted Prices

    

    

In Active

Significant

Markets

Other

Significant

for Identical

Observable

Unobservable

Assets

Inputs

Inputs

(Dollars in thousands)

Fair Value

(Level 1)

(Level 2)

(Level 3)

June 30, 2019:

Assets

Derivative financial instruments

$

17,587

$

$

17,587

$

Loans held for sale

 

47,796

 

 

47,796

 

Securities available for sale:

Government-sponsored entities debt

66,529

66,529

State and municipal obligations

 

182,146

 

 

182,146

 

Mortgage-backed securities

 

1,468,601

 

 

1,468,601

 

Total securities available for sale

 

1,717,276

 

 

1,717,276

 

Mortgage servicing rights

 

30,332

 

 

 

30,332

$

1,812,991

$

$

1,782,659

$

30,332

Liabilities

Derivative financial instruments

$

30,286

$

$

30,286

$

December 31, 2018:

Assets

Derivative financial instruments

$

5,090

$

$

5,090

$

Loans held for sale

 

22,925

 

 

22,925

 

Securities available for sale:

Government-sponsored entities debt

48,251

48,251

State and municipal obligations

 

200,768

 

 

200,768

 

Mortgage-backed securities

 

1,268,048

 

 

1,268,048

 

Total securities available for sale

 

1,517,067

 

 

1,517,067

 

Mortgage servicing rights

 

34,727

 

 

 

34,727

$

1,579,809

$

$

1,545,082

$

34,727

Liabilities

Derivative financial instruments

$

4,421

$

$

4,421

$

June 30, 2018:

Assets

Derivative financial instruments

$

8,848

$

$

8,848

$

Loans held for sale

 

36,968

 

 

36,968

 

Securities available for sale:

Government-sponsored entities debt

47,613

47,613

State and municipal obligations

 

223,816

 

 

223,816

 

Mortgage-backed securities

 

1,306,570

 

 

1,306,570

 

Total securities available for sale

 

1,577,999

 

 

1,577,999

 

Mortgage servicing rights

 

35,107

 

 

 

35,107

$

1,658,922

$

$

1,623,815

$

35,107

Liabilities

Derivative financial instruments

$

8,097

$

$

8,097

$

Changes in Level 1, 2 and 3 Fair Value Measurements

When a determination is made to classify a financial instrument within Level 3 of the valuation hierarchy, the determination is based upon the significance of the unobservable factors to the overall fair value measurement.

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However, since Level 3 financial instruments typically include, in addition to the unobservable or Level 3 components, observable components (that is, components that are actively quoted and can be validated to external sources), the gains and losses below include changes in fair value due in part to observable factors that are part of the valuation methodology.

There were no changes in hierarchy classifications of Level 3 assets or liabilities for the six months ended June 30, 2019. A reconciliation of the beginning and ending balances of Level 3 assets and liabilities recorded at fair value on a recurring basis for the six months ended June 30, 2019 and 2018 is as follows:

(Dollars in thousands)

    

Assets

    

Liabilities

 

Fair value, January 1, 2019

$

34,727

$

Servicing assets that resulted from transfers of financial assets

 

2,558

 

Changes in fair value due to valuation inputs or assumptions

 

(4,924)

 

Changes in fair value due to decay

 

(2,029)

 

Fair value , June 30, 2019

$

30,332

$

Fair value, January 1, 2018

$

31,119

$

Servicing assets that resulted from transfers of financial assets

 

3,112

 

Changes in fair value due to valuation inputs or assumptions

2,945

Changes in fair value due to decay

 

(2,069)

 

Fair value, June 30, 2018

$

35,107

$

There were no unrealized losses included in accumulated other comprehensive income related to Level 3 financial assets and liabilities at June 30, 2019 or 2018.

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The tables below present the recorded amount of assets and liabilities measured at fair value on a nonrecurring basis:

    

    

Quoted Prices

    

    

 

In Active

Significant

 

Markets

Other

Significant

 

for Identical

Observable

Unobservable

 

Assets

Inputs

Inputs

 

(Dollars in thousands)

Fair Value

(Level 1)

(Level 2)

(Level 3)

 

June 30, 2019:

OREO

$

14,506

$

$

$

14,506

Non-acquired impaired loans

 

4,946

 

 

 

4,946

December 31, 2018:

OREO

$

11,410

$

$

$

11,410

Non-acquired impaired loans

 

13,164

 

 

 

13,164

June 30, 2018:

OREO

$

17,222

$

$

$

17,222

Non-acquired impaired loans

 

5,909

 

 

 

5,909

Quantitative Information about Level 3 Fair Value Measurement

Weighted Average

June 30,

December 31,

June 30,

    

Valuation Technique

    

Unobservable Input

    

2019

    

2018

2018

 

Nonrecurring measurements:

Non-acquired impaired loans

 

Discounted appraisals

 

Collateral discounts

3

%

3

%

3

%

OREO

 

Discounted appraisals

 

Collateral discounts and estimated costs to sell

22

%

23

%

17

%

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Table of Contents 

Fair Value of Financial Instruments

We used the following methods and assumptions in estimating our fair value disclosures for financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those models are significantly affected by the assumptions used, including the discount rates and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. The use of different methodologies may have a material effect on the estimated fair value amounts. The fair value estimates presented herein are based on pertinent information available to management as of June 30, 2019, December 31, 2018 and June 30, 2018. Such amounts have not been revalued for purposes of these consolidated financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and Cash Equivalents — The carrying amount is a reasonable estimate of fair value.

Investment Securities — Securities held to maturity are valued at quoted market prices or dealer quotes. The carrying value of FHLB stock approximates fair value based on the redemption provisions. The carrying value of our investment in unconsolidated subsidiaries approximates fair value. See Note 4—Investment Securities for additional information, as well as page 40 regarding fair value.

Loans held for sale — The fair values disclosed for loans held for sale are based on commitments from investors for loans with similar characteristics.

Loans — ASU 2016-01 - Financial Instruments – Overall – Recognition and Measurement of Financial Assets and Financial Liabilities became effective for us on January 1, 2018. This accounting standard requires us to calculate the fair value of our loans for disclosure purposes based on an estimated exit price. With ASU 2016-01, to estimate an exit price, all loans (fixed and variable) are being valued with a discounted cash flow analyses for loans that includes our estimate of future credit losses expected to be incurred over the life of the loans. Fair values for certain mortgage loans (e.g., one-to-four family residential) and other consumer loans are estimated using discounted cash flow analyses based on our current rates offered for new loans of the same type, structure and credit quality. Fair values for other loans (e.g., commercial real estate and investment property mortgage loans, commercial and industrial loans) are estimated using discounted cash flow analyses-using interest rates we currently offer for loans with similar terms to borrowers of similar credit quality. Fair values for non-performing loans are estimated using a discounted cash flow analyses.

Deposit Liabilities — The fair values disclosed for demand deposits (e.g., interest and noninterest bearing checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts, and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Federal Funds Purchased and Securities Sold Under Agreements to Repurchase — The carrying amount of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within ninety days approximate their fair values.

Other Borrowings — The fair value of other borrowings is estimated using discounted cash flow analysis on our current incremental borrowing rates for similar types of instruments.

Accrued Interest — The carrying amounts of accrued interest approximate fair value.

Derivative Financial Instruments — The fair value of derivative financial instruments (including interest rate swaps) is estimated using pricing models of derivatives with similar characteristics or discounted cash flow models where future floating cash flows are projected and discounted back.

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Table of Contents 

Commitments to Extend Credit, Standby Letters of Credit and Financial Guarantees — The fair values of commitments to extend credit are estimated taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair values of guarantees and letters of credit are based on fees currently charged for similar agreements or on the estimated costs to terminate them or otherwise settle the obligations with the counterparties at the reporting date.

The estimated fair value, and related carrying amount, of our financial instruments are as follows:

    

Carrying

    

Fair

    

    

    

 

(Dollars in thousands)

Amount

Value

Level 1

Level 2

Level 3

 

June 30, 2019

Financial assets:

Cash and cash equivalents

$

851,971

$

851,971

$

851,971

$

$

Investment securities

 

1,766,400

 

1,766,400

 

49,124

 

1,717,276

 

Loans held for sale

47,796

47,796

47,796

Loans, net of allowance for loan losses

 

11,167,979

 

11,278,624

 

 

 

11,278,624

Accrued interest receivable

 

38,650

 

38,650

 

 

7,880

 

30,770

Mortgage servicing rights

 

30,332

 

30,332

 

 

 

30,332

Interest rate swap - non-designated hedge

 

14,561

 

14,561

 

 

14,561

 

Other derivative financial instruments (mortgage banking related)

 

3,026

 

3,026

 

 

3,026

 

Financial liabilities:

Deposits

 

11,922,280

 

11,124,796

 

 

11,124,796

 

Federal funds purchased and securities sold under agreements to repurchase

 

298,029

 

298,029

 

 

298,029

 

Other borrowings

 

816,414

 

819,306

 

 

819,306

 

Accrued interest payable

 

6,168

 

6,168

 

 

6,168

 

Interest rate swap - non-designated hedge

 

15,952

 

15,952

 

 

15,952

 

Interest rate swap - cash flow hedge

 

14,334

 

14,334

 

 

14,334

 

Other derivative financial instruments (mortgage banking related)

 

 

 

 

 

Off balance sheet financial instruments:

Commitments to extend credit

 

 

27,579

 

 

27,579

 

December 31, 2018

Financial assets:

Cash and cash equivalents

$

408,983

$

408,983

$

408,983

$

$

Investment securities

 

1,542,671

 

1,542,671

 

25,604

 

1,517,067

 

Loans held for sale

22,925

22,925

22,925

Loans, net of allowance for loan losses

 

10,962,037

 

10,613,571

 

 

 

10,613,571

Accrued interest receivable

 

35,997

 

35,997

 

 

6,908

 

29,089

Mortgage servicing rights

 

34,727

 

34,727

 

 

 

34,727

Interest rate swap - non-designated hedge

 

3,824

 

3,824

 

 

3,824

 

Other derivative financial instruments (mortgage banking related)

 

1,267

 

1,267

 

 

1,267

 

Financial liabilities:

Deposits

 

11,646,933

 

10,561,394

 

 

10,561,394

 

Federal funds purchased and securities sold under agreements to repurchase

 

270,649

 

270,649

 

 

270,649

 

Other borrowings

 

266,084

 

269,134

 

 

269,134

 

Accrued interest payable

 

4,719

 

4,719

 

 

4,719

 

Interest rate swap - non-designated hedge

 

4,373

 

4,373

 

 

4,373

 

Interest rate swap - cash flow hedge

 

48

 

48

 

 

48

 

Off balance sheet financial instruments:

 

 

Commitments to extend credit

 

(88,424)

 

 

(88,424)

 

June 30, 2018

Financial assets:

Cash and cash equivalents

$

396,849

$

396,849

$

396,849

$

$

Investment securities

 

1,597,727

 

1,597,731

 

19,229

 

1,578,502

 

Loans held for sale

36,968

36,968

36,968

Loans, net of allowance for loan losses

 

10,778,068

 

10,547,778

 

 

 

10,547,778

Accrued interest receivable

 

33,751

 

33,751

 

 

7,333

 

26,418

Mortgage servicing rights

 

35,107

 

35,107

 

 

 

35,107

Interest rate swap - non-designated hedge

 

7,750

 

7,750

 

 

7,750

 

Other derivative financial instruments (mortgage banking related)

 

1,098

 

1,098

 

 

1,098

 

Financial liabilities:

Deposits

 

11,638,289

 

10,675,705

 

 

10,675,705

 

Federal funds purchased and securities sold under agreements to repurchase

 

331,969

 

331,969

 

 

331,969

 

Other borrowings

 

115,754

 

119,221

 

 

119,221

 

Accrued interest payable

 

3,882

 

3,882

 

 

3,882

 

Interest rate swap - cash flow hedge

 

116

 

116

 

 

116

 

Interest rate swap - non-designated hedge

 

7,981

 

7,981

 

 

7,981

 

Off balance sheet financial instruments:

 

 

 

 

Commitments to extend credit

 

(62,060)

 

 

(62,060)

 

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Table of Contents 

Note 14 — Accumulated Other Comprehensive Income (Loss)

The changes in each components of accumulated other comprehensive income (loss), net of tax, were as follows:

    

    

Unrealized Gains

    

    

and Losses

Gains and

on Securities

Losses on

Benefit

Available

Cash Flow

(Dollars in thousands)

Plans

for Sale

Hedges

Total

Three Months Ended June 30, 2019

Balance at March 31, 2019

$

(6,355)

$

(4,906)

$

(2,113)

$

(13,374)

Other comprehensive gain (loss) before reclassifications

 

 

19,183

 

(8,795)

 

10,388

Amounts reclassified from accumulated other comprehensive income (loss)

 

6,058

 

(1,333)

 

(273)

 

4,452

Net comprehensive income (loss)

 

6,058

 

17,850

 

(9,068)

 

14,840

Balance at June 30, 2019

$

(297)

$

12,944

$

(11,181)

$

1,466

Three Months Ended June 30, 2018

Balance at March 31, 2018

$

(7,607)

$

(22,617)

$

(126)

$

(30,350)

Other comprehensive income (loss) before reclassifications

 

 

(6,409)

 

6

(6,403)

Amounts reclassified from accumulated other comprehensive income

 

151

 

500

 

31

 

682

Net comprehensive income (loss)

 

151

 

(5,909)

 

37

 

(5,721)

Balance at June 30, 2018

$

(7,456)

$

(28,526)

$

(89)

$

(36,071)

Six Months Ended June 30, 2019

Balance at December 31, 2018

$

(6,450)

$

(18,394)

$

(37)

$

(24,881)

Other comprehensive income (loss) before reclassifications

33,092

(10,876)

22,216

Amounts reclassified from accumulated other comprehensive income (loss)

 

6,153

 

(1,754)

 

(268)

 

4,131

Net comprehensive income (loss)

 

6,153

 

31,338

 

(11,144)

 

26,347

Balance at June 30, 2019

$

(297)

$

12,944

$

(11,181)

$

1,466

Six Months Ended June 30, 2018

Balance at December 31, 2017

$

(5,998)

$

(4,278)

$

(151)

$

(10,427)

Other comprehensive income (loss) before reclassifications

 

 

(23,601)

 

34

 

(23,567)

Amounts reclassified from accumulated other comprehensive income

 

302

 

500

 

68

 

870

Net comprehensive income (loss)

 

302

 

(23,101)

 

102

 

(22,697)

AOCI reclassification to retained earnings from the adoption of ASU 2018-02

(1,760)

 

(1,147)

 

(40)

 

(2,947)

Balance at June 30, 2018

$

(7,456)

$

(28,526)

$

(89)

$

(36,071)

See the Capital Resources section of Management Discussion and Analysis on page 76 for discussion of changes in accumulated other comprehensive income (loss) during 2019.

46

Table of Contents 

The table below presents the reclassifications out of accumulated other comprehensive income (loss), net of tax:

Amount Reclassified from Accumulated Other Comprehensive Income (Loss)

(Dollars in thousands)

For the Three Months Ended June 30,

For the Six Months Ended June 30,

Accumulated Other Comprehensive Income (Loss) Component

    

2019

    

2018

    

2019

    

2018

    

Income Statement
Line Item Affected

Gains (losses) on cash flow hedges:

Interest rate contracts

$

(350)

$

39

$

(343)

$

87

Interest expense

77

(8)

 

75

(19)

Provision for income taxes

(273)

31

 

(268)

68

Net income

(Gains) losses on sales of available for sale securities:

$

(1,709)

$

641

$

(2,250)

$

641

Securities gains (losses), net

376

(141)

496

(141)

Provision for income taxes

(1,333)

500

(1,754)

500

Net income

Losses and amortization of defined benefit pension:

Actuarial losses

$

7,767

$

194

$

7,888

$

387

Salaries and employee benefits

(1,709)

(43)

 

(1,735)

(85)

Provision for income taxes

6,058

151

 

6,153

302

Net income

Total reclassifications for the period

$

4,452

$

682

$

4,131

$

870

Note 15 — Derivative Financial Instruments

We use certain derivative instruments to meet the needs of its customers as well as to manage the interest rate risk associated with certain transactions. The following table summarizes the derivative financial instruments utilized by the Company:

June 30, 2019

June 30, 2018

Balance Sheet

Notional

Estimated Fair Value

Notional

Estimated Fair Value

(Dollars in thousands)

  

Location

  

Amount

  

Gain

  

Loss

  

Amount

  

Gain

  

Loss

Cash flow hedges of interest rate risk on Junior Subordinated Debt:

Pay fixed rate swap with counterparty

Other Liabilities

$

$

$

$

8,000

$

$

116

Cash flow hedges of interest rate risk on FHLB Advances:

Pay fixed rate swap with counterparty

Other Liabilities

$

700,000

$

$

14,334

$

$

$

Fair value hedge of interest rate risk:

Pay fixed rate swap with counterparty

Other Assets

$

2,784

$

$

197

$

2,824

$

8

$

Not designated hedges of interest rate risk:

Customer related interest rate contracts:

Matched interest rate swaps with borrowers

Other Assets and Other Liabilities

$

432,963

$

14,561

$

478

$

327,027

$

437

$

7,947

Matched interest rate swaps with counterparty

Other Assets and Other Liabilities

$

432,963

$

$

15,277

$

327,027

$

7,271

$

Not designated hedges of interest rate risk: Foreign Exchange

Matched foreign exchange swaps with borrower

Other Assets

$

$

$

$

2,521

$

$

34

Matched foreign exchange swaps with counterparty

Other Liabilities

$

$

$

$

2,521

$

34

$

Not designated hedges of interest rate risk - mortgage banking activities:

Contracts used to hedge mortgage servicing rights

Other Assets

$

139,500

$

1,834

$

$

63,500

$

291

$

Forward sales commitments used to hedge mortgage pipeline

Other Assets

$

93,949

$

1,192

$

$

92,584

807

$

Total derivatives

$

1,802,159

$

17,587

$

30,286

$

826,004

$

8,848

$

8,097

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Table of Contents 

Cash Flow Hedge of Interest Rate Risk

The Company is exposed to interest rate risk in the course of its business operations and manages a portion of this risk through the use of derivative financial instruments, in the form of interest rate swaps. We account for interest rate swaps that are classified as cash flow hedges in accordance with FASB ASC 815, Derivatives and Hedging, which requires that all derivatives be recognized as assets or liabilities on the balance sheet at fair value. We have three cash flow hedges as of June 30, 2019. We had one cash flow hedge mature during the second quarter of 2019. For more information regarding the fair value of our derivative financial instruments, see Note 13 to these financial statements.

Our cash flow hedge, in which we utilized an interest rate swap agreement to essentially convert a portion of its variable-rate debt to a fixed rate (cash flow hedge), matured June 15, 2019 and was no longer in existence at June 30, 2019. During 2009, we entered into a forward starting interest rate swap agreement with a notional amount of $8.0 million to manage interest rate risk due to periodic rate resets on its junior subordinated debt issued by SCBT Capital Trust II, an unconsolidated subsidiary of the Company established for the purpose of issuing trust preferred securities. We hedged the variable rate cash flows of subordinated debt against future interest rate increases by using an interest rate swap that effectively fixed the rate on the debt beginning on June 15, 2010, at which time the debt contractually converted from a fixed interest rate to a variable interest rate. The notional amount on which the interest payments were based was not be exchanged. This derivatives contract called for us to pay a fixed rate of 4.06% on the $8.0 million notional amount and receive a variable rate of three-month LIBOR on the $8.0 million notional amount.

For the three remaining cash flow hedges, we utilize interest rate swap agreements to manage interest rate risk related to funding through short term FHLB advances. In March 2019, we entered into three-month FHLB advances for $350 million and $150 million for which at this time we plan to continuously renew. At the same time, we entered into interest rate swap agreements with a notional amount of $350 million and $150 million to manage the interest rate risk related to these FHLB advances. In June 2019, we entered into a three-month FHLB advance for $200 million for which at this time we plan to continuously renew. At the same time, we entered into an interest rate swap agreement with a notional amount of $200 million to manage the interest rate risk related to this FHLB advance. With our plan to continually renew and reprice the FHLB advances every three months, we are treating this funding as variable rate funding. We are hedging the cash flows from these FHLB advances against future interest rate increases by using an interest rate swap that effectively fixed the rate on the debt. The notional amount on which the interest payments are based will not be exchanged related to these interest rate swaps. The derivative contract on the $350 million notional amount calls for us to pay a fixed rate of 2.44% and receive a variable rate of three-month LIBOR (2.39% at June 30, 2019). The derivative contract on the $150 million notional amount calls for us to pay a fixed rate of 2.21% and receive a variable rate of three-month LIBOR (2.33% at June 30, 2019). The derivative contract on the $200 million notational amount calls for us to pay a fixed rate of 1.89% and receive a variable rate of three-month LIBOR (2.52% at June 30, 2019). The hedge for $350 million expires on March 23, 2023, the hedge for $150 million expires on March 29, 2024, and the hedge for the $200 million expires on June 3, 2024.

For derivatives designated as hedging exposure to variable cash flows of a forecasted transaction (cash flow hedge), the derivative’s entire gain or loss is initially reported as a component of other comprehensive income and subsequently reclassified into earnings when the forecasted transaction affects earnings or when the hedge is terminated. For derivatives that are not designated as hedging instruments, changes in the fair value of the derivatives are recognized in earnings immediately.

For designated hedging relationships, we have a third party perform retrospective and prospective effectiveness testing on a quarterly basis using quantitative methods to determine if the hedge is still highly effective. Hedge accounting ceases on transactions that are no longer deemed highly effective, or for which the derivative has been terminated or de-designated.

We recognized an after-tax unrealized loss on our cash flow hedges in other comprehensive income of $9.1 million and $11.1 million for the three and six months ended months ended June 30, 2019, respectively. This compares to an unrealized gain of $37,000 and $102,000 for the three and six months ended June 30, 2018. We recognized a $14.3 million cash flow hedge liability in other liabilities on the balance sheet at June 30, 2019, as compared to a $116,000 liability at June 30, 2018. There was no ineffectiveness in the cash flow hedge during the three and six months ended

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June 30, 2019 and 2018. (See Note 14 – Accumulated Other Comprehensive Income (Loss) for activity in accumulated comprehensive income (loss) and the amounts reclassified into earnings related the cash flow hedges.)

Credit risk related to the derivative arises when amounts receivable from the counterparty (derivatives dealer) exceed those payable. We control the risk of loss by only transacting with derivatives dealers that are national market makers whose credit ratings are strong. Each party to the interest rate swap is required to provide collateral in the form of cash or securities to the counterparty when the counterparty’s exposure to a mark-to-market replacement value exceeds certain negotiated limits. These limits are typically based on current credit ratings and vary with ratings changes. As of both June 30, 2019 and 2018, we provided $0 and $300,000 of collateral, respectively, on the cash flow hedge on the junior subordinated debt which is included in cash and cash equivalents on the balance sheet as interest-bearing deposits with banks. As of June 30, 2019, the Company provided $22.8 million of collateral on the cash flow hedges on the FHLB advances which is also included in cash and cash equivalents on the balance sheet as interest-bearing deposits with banks. Also, we have a netting agreement with the counterparties.

Balance Sheet Fair Value Hedge

We maintain one loan swap, with an aggregate notional amount of $2.8 million at June 30, 2019, accounted for as fair value hedges in accordance with ASC 815, Derivatives and Hedging. This derivative protects us from interest rate risk caused by changes in the LIBOR curve in relation to a certain designated fixed rate loan. The derivative converts the fixed rate loan to a floating rate. Settlement occurs in any given period where there is a difference in the stated fixed rate and variable rate. The fair value of this hedge is recorded in either other assets or in other liabilities depending on the position of the hedge. All changes in fair value are recorded through earnings as noninterest income. There was no gain or loss recorded on this derivative for the three and six months ended June 30, 2019 or 2018.

Non-designated Hedges of Interest Rate Risk

Customer Swap

We maintain interest rate swap contracts with customers that are classified as non-designated hedges and are not speculative in nature. These agreements are designed to convert customer’s variable rate loans with the Company to fixed rate. These interest rate swaps are executed with loan customers to facilitate a respective risk management strategy and allow the customer to pay a fixed rate of interest to the Company. These interest rate swaps are simultaneously hedged by executing offsetting interest rate swaps with unrelated market counterparties to minimize the net risk exposure to the Company resulting from the transactions and allow the Company to receive a variable rate of interest. The interest rate swaps pay and receive interest based on a floating rate based on one month LIBOR plus credit spread, with payments being calculated on the notional amount. The interest rate swaps are settled monthly with varying maturities.

As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. As of June 30, 2019, the interest rate swaps had an aggregate notional amount of approximately $865.9 million and the fair value of the interest rate swap derivatives are recorded in other assets at $14.6 million and in other liabilities at $15.8 million for a net liability position of $1.2 million, which was recorded through earnings. As of June 30, 2018, the interest rate swaps had an aggregate notional amount of approximately $654.1 million and the fair value of the interest rate swap derivative with the derivatives dealer was in a net liability position of $240,000. As of June 30, 2019, the Company provided $43.3 million of collateral on the customer swaps which is also included in cash and cash equivalents on the balance sheet as interest-bearing deposits with banks.

Foreign Exchange

We also enter into foreign exchange contracts with customers to accommodate their need to convert certain foreign currencies into to U.S. Dollars. To offset the foreign exchange risk, we have entered into substantially identical agreements with an unrelated market counterparty to hedge these foreign exchange contracts. At June 30, 2019, there were no outstanding contracts or agreements related to foreign currency. At June 30, 2019, there were foreign exchange contracts of a notional amount of $2.5 million, representing the amount of contracts outstanding in U.S. dollars. If there were foreign currency contracts outstanding June 30, 2019, the fair value of these contracts would be included in other

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assets and other liabilities in the accompanying balance sheet. All changes in fair value are recorded as other noninterest income. There was no gain or loss recorded related to the foreign exchange derivative for the three and six months ended June 30, 2019 or 2018.

Mortgage Banking

We also have derivatives contracts that are classified as non-designated hedges. These derivatives contracts are a part of our risk management strategy for its mortgage banking activities. These instruments may include financial forwards, futures contracts, and options written and purchased, which are used to hedge MSRs; while forward sales commitments are typically used to hedge the mortgage pipeline. Such instruments derive their cash flows, and therefore their values, by reference to an underlying instrument, index or referenced interest rate. We do not elect hedge accounting treatment for any of these derivative instruments and as a result, changes in fair value of the instruments (both gains and losses) are recorded in our consolidated statements of income in mortgage banking income.

Mortgage Servicing Rights

Derivatives contracts related to MSRs are used to help offset changes in fair value and are written in amounts referred to as notional amounts. Notional amounts provide a basis for calculating payments between counterparties but do not represent amounts to be exchanged between the parties, and are not a measure of financial risk. On June 30, 2019, we had derivative financial instruments outstanding with notional amounts totaling $139.5 million related to MSRs, compared to $63.5 million on June 30, 2018. The estimated net fair value of the open contracts related to the MSRs was recorded as a gain of $1.8 million at June 30, 2019, compared to a gain of $291,000 at June 30, 2018.

Mortgage Pipeline

The following table presents our notional value of forward sale commitments and the fair value of those obligations along with the fair value of the mortgage pipeline.

(Dollars in thousands)

    

June 30, 2019

    

December 31, 2018

    

June 30, 2018

Mortgage loan pipeline

$

117,144

$

50,442

$

89,085

Expected closures

 

87,858

 

37,832

 

66,813

Fair value of mortgage loan pipeline commitments

 

1,878

 

705

 

1,159

Forward sales commitments

 

93,949

 

54,533

 

92,584

Fair value of forward commitments

 

(686)

 

(621)

 

(352)

Note 16 — Capital Ratios

We are subject to regulations with respect to certain risk-based capital ratios. These risk-based capital ratios measure the relationship of capital to a combination of balance sheet and off-balance sheet risks. The values of both balance sheet and off-balance sheet items are adjusted based on the rules to reflect categorical credit risk. In addition to the risk-based capital ratios, the regulatory agencies have also established a leverage ratio for assessing capital adequacy. The leverage ratio is equal to Tier 1 capital divided by total consolidated on-balance sheet assets (minus amounts deducted from Tier 1 capital). The leverage ratio does not involve assigning risk weights to assets.

In July 2013, the Federal Reserve announced its approval of a final rule to implement the regulatory capital reforms developed by the Basel Committee on Banking Supervision (“Basel III”), among other changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The new rules became effective January 1, 2015, subject to a phase-in period for certain aspects of the new rules.

As applied to the Company and the Bank, the new rules include a new minimum ratio of common equity Tier 1 capital (“CET1”) to risk-weighted assets of 4.5%. The new rules also raised the minimum required ratio of Tier 1 capital to risk-weighted assets from 4% to 6%. The minimum required leverage ratio under the new rules is 4%. The minimum required total capital to risk-weighted assets ratio remains at 8% under the new rules.

In order to avoid restrictions on capital distributions and discretionary bonus payments to executives, under the new rules a covered banking organization is also required to maintain a “capital conservation buffer” in addition to its minimum risk-based capital requirements. This buffer is required to consist solely of CET1, and the buffer applies to all

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three risk-based measurements (CET1, Tier 1 capital and total capital). The capital conservation buffer was phased in incrementally over time, beginning January 1, 2016 and become fully effective on January 1, 2019. The fully phased-in capital conservation buffer consists of an additional amount of Tier 1 common equity equal to 2.5% of risk-weighted assets.

The Bank is also subject to the regulatory framework for prompt corrective action, which identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized) and is based on specified thresholds for each of the three risk-based regulatory capital ratios (CET1, Tier 1 capital and total capital) and for the leverage ratio.

The following table presents actual and required capital ratios as of June 30, 2019, December 31, 2018 and June 30, 2018 for the Company and the Bank under the Basel III capital rules. The minimum required capital amounts presented below include the minimum required capital levels based on the phase-in provisions of the Basel III Capital Rules. The minimum required capital levels plus the capital conservation buffer under the Basel III capital rules became fully phased-in as of January 1, 2019. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules.

Minimum Capital

Minimum Capital

 

Required to be

 

Required - Basel III

Required - Basel III

 

Considered Well

 

Actual

Phase-In Schedule

Fully Phased In

Capitalized

(Dollars in thousands)

    

Amount

    

Ratio

    

Capital Amount

    

Ratio

    

Capital Amount

    

Ratio

    

Capital Amount

    

Ratio

 

June 30, 2019

    

    

    

    

    

    

    

    

Common equity Tier 1 to risk-weighted assets:

Consolidated

$

1,323,535

 

11.58

%  

$

800,109

 

7.00

%  

$

800,109

7.00

%  

$

742,959

 

6.50

%  

South State Bank (the Bank)

 

1,419,395

 

12.42

%  

 

800,123

 

7.00

%  

 

800,123

7.00

%  

 

742,971

 

6.50

%  

Tier 1 capital to risk-weighted assets:

Consolidated

 

1,435,471

 

12.56

%  

 

971,561

 

8.50

%  

 

971,561

8.50

%  

 

914,411

 

8.00

%  

South State Bank (the Bank)

 

1,419,395

 

12.42

%  

 

971,578

 

8.50

%  

 

971,578

8.50

%  

 

914,426

 

8.00

%  

Total capital to risk-weighted assets:

Consolidated

 

1,494,019

 

13.07

%  

 

1,200,164

 

10.50

%  

 

1,200,164

10.50

%  

 

1,143,013

 

10.00

%  

South State Bank (the Bank)

 

1,477,943

 

12.93

%  

 

1,200,184

 

10.50

%  

 

1,200,184

10.50

%  

 

1,143,033

 

10.00

%  

Tier 1 capital to average assets (leverage ratio):

Consolidated

 

1,435,471

 

9.99

%  

 

574,940

 

4.00

%  

 

574,940

4.00

%  

 

718,675

 

5.00

%  

South State Bank (the Bank)

 

1,419,395

 

9.88

%  

 

574,780

 

4.00

%  

 

574,780

4.00

%  

 

718,475

 

5.00

%  

December 31, 2018:

    

    

    

    

    

    

    

    

Common equity Tier 1 to risk-weighted assets:

Consolidated

$

1,335,826

 

12.05

%  

$

706,981

 

6.38

%  

$

776,293

7.00

%  

$

720,844

 

6.50

%  

South State Bank (the Bank)

 

1,427,764

 

12.87

%  

 

707,039

 

6.38

%  

 

776,356

7.00

%  

 

720,902

 

6.50

%  

Tier 1 capital to risk-weighted assets:

Consolidated

 

1,447,428

 

13.05

%  

 

873,330

 

7.88

%  

 

942,642

8.50

%  

 

887,192

 

8.00

%  

South State Bank (the Bank)

 

1,427,764

 

12.87

%  

 

873,401

 

7.88

%  

 

942,718

8.50

%  

 

887,264

 

8.00

%  

Total capital to risk-weighted assets:

Consolidated

 

1,503,561

 

13.56

%  

 

1,095,128

 

9.88

%  

 

1,164,440

10.50

%  

 

1,108,990

 

10.00

%  

South State Bank (the Bank)

 

1,483,897

 

13.38

%  

 

1,095,217

 

9.88

%  

 

1,164,534

10.50

%  

 

1,109,080

 

10.00

%  

Tier 1 capital to average assets (leverage ratio):

Consolidated

 

1,447,428

 

10.65

%  

 

543,506

 

4.00

%  

 

543,506

4.00

%  

 

679,383

 

5.00

%  

South State Bank (the Bank)

 

1,427,764

 

10.51

%  

 

543,387

 

4.00

%  

 

543,387

4.00

%  

 

679,234

 

5.00

%  

June 30, 2018:

    

    

    

    

    

    

    

    

Common equity Tier 1 to risk-weighted assets:

Consolidated

$

1,324,901

 

12.00

%  

$

704,261

 

6.38

%  

$

773,306

7.00

%  

$

718,070

 

6.50

%  

South State Bank (the Bank)

 

1,413,812

 

12.80

%  

 

704,275

 

6.38

%  

 

773,321

7.00

%  

 

718,084

 

6.50

%  

Tier 1 capital to risk-weighted assets:

Consolidated

 

1,436,170

 

13.00

%  

 

869,970

 

7.88

%  

 

939,015

8.50

%  

 

883,779

 

8.00

%  

South State Bank (the Bank)

 

1,413,812

 

12.80

%  

 

869,986

 

7.88

%  

 

939,033

8.50

%  

 

883,796

 

8.00

%  

Total capital to risk-weighted assets:

Consolidated

 

1,488,805

 

13.48

%  

 

1,090,914

 

9.88

%  

 

1,159,960

10.50

%  

 

1,104,723

 

10.00

%  

South State Bank (the Bank)

 

1,466,447

 

13.27

%  

 

1,090,935

 

9.88

%  

 

1,159,982

10.50

%  

 

1,104,745

 

10.00

%  

Tier 1 capital to average assets (leverage ratio):

Consolidated

 

1,436,170

 

10.62

%  

 

540,869

 

4.00

%  

 

540,869

4.00

%  

 

676,086

 

5.00

%  

South State Bank (the Bank)

 

1,413,812

 

10.46

%  

 

540,726

 

4.00

%  

 

540,726

4.00

%  

 

675,907

 

5.00

%  

As of June 30, 2019, December 31, 2018, and June 30, 2018, the capital ratios of the Company and the Bank were well in excess of the minimum regulatory requirements and exceeded the thresholds for the “well capitalized” regulatory classification.

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Note 17—Goodwill and Other Intangible Assets

The carrying amount of goodwill was $1.0 billion at June 30, 2019. Our other intangible assets, consisting of core deposit intangibles, noncompete intangibles, and client list intangibles are included on the face of the balance sheet. The following is a summary of gross carrying amounts and accumulated amortization of other intangible assets:

June 30,

December 31,

June 30,

(Dollars in thousands)

    

2019

    

2018

    

2018

 

Gross carrying amount

$

119,501

$

121,736

$

121,736

Accumulated amortization

 

(63,150)

 

(58,836)

 

(51,761)

$

56,351

$

62,900

$

69,975

Amortization expense totaled $3.3 million and $6.5 million for the three and six months ended June 30, 2019, respectively, compared to $3.7 million and $7.1 million for the three and six months ended June 30, 2018, respectively.  Other intangibles are amortized using either the straight-line method or an accelerated basis over their estimated useful lives, with lives generally between two and 15 years.  Estimated amortization expense for other intangibles for each of the next five quarters is as follows:

(Dollars in thousands)

Quarter ending:

    

    

 

September 30, 2019

$

3,268

December 31, 2019

 

3,267

March 31, 2020

 

3,007

June 30, 2020

 

2,995

September 30, 2020

2,945

Thereafter

 

40,869

$

56,351

Note 18 — Loan Servicing, Mortgage Origination, and Loans Held for Sale

As of June 30, 2019, December 31, 2018, and June 30, 2018, the portfolio of residential mortgages serviced for others, which is not included in the accompanying balance sheets, was $3.1 billion, $3.1 billion, and $3.0 billion, respectively. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts and disbursing payments to investors. The amount of contractually specified servicing fees we earned during both the three and six months ended June 30, 2019 and June 30, 2018 was $2.0 million and $3.9 million, and $1.9 million and $3.8 million, respectively. Servicing fees are recorded in mortgage banking income in our consolidated statements of income.

At June 30, 2019, December 31, 2018, and June 30, 2018, MSRs were $32.3 million, $34.7 million, and $35.1 million on our consolidated balance sheets, respectively. MSRs are recorded at fair value with changes in fair value recorded as a component of mortgage banking income in the consolidated statements of income. The market value adjustments related to MSRs recorded in mortgage banking income for the three and six months ended June 30, 2019 and June 30, 2018 were losses of $2.6 million and $4.9 million, compared with gains of $429,000 and $2.9 million, respectively. We used various free-standing derivative instruments to mitigate the income statement effect of changes in fair value due to changes in market value adjustments and to changes in valuation inputs and assumptions related to MSRs.

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See Note 13 — Fair Value for the changes in fair value of MSRs. The following table presents the changes in the fair value of the offsetting hedge.

Three Months Ended

    

Six Months Ended

(Dollars in thousands)

    

June 30, 2019

    

June 30, 2018

    

June 30, 2019

    

June 30, 2018

 

Increase (decrease) in fair value of MSRs

$

(2,568)

$

429

$

(4,924)

$

2,945

Decay of MSRs

 

(1,143)

 

(1,141)

 

(2,029)

 

(2,069)

Gain (loss) related to derivatives

2,659

(339)

3,940

(1,893)

Net effect on statements of income

$

(1,052)

$

(1,051)

$

(3,013)

$

(1,017)

The fair value of MSRs is highly sensitive to changes in assumptions and fair value is determined by estimating the present value of the asset’s future cash flows utilizing market-based prepayment rates, discount rates and other assumptions validated through comparison to trade information, industry surveys and with the use of independent third-party appraisals. Changes in prepayment speed assumptions have the most significant impact on the fair value of MSRs. Generally, as interest rates increase, mortgage loan prepayments decelerate due to decreased refinance activity, which results in an increase in the fair value of the MSRs. Measurement of fair value is limited to the conditions existing and the assumptions utilized as of a particular point in time, and those assumptions may not be appropriate if they are applied at a different time. See Note 13 — Fair Value for additional information regarding fair value.

The characteristics and sensitivity analysis of the MSRs are included in the following table.

June 30,

December 31,

June 30,

 

(Dollars in thousands)

    

2019

   

    

2018

   

    

2018

Composition of residential loans serviced for others

Fixed-rate mortgage loans

99.8

%  

99.8

%  

99.7

%

Adjustable-rate mortgage loans

0.2

%  

0.2

%  

0.3

%

Total

100.0

%  

100.0

%  

100.0

%

Weighted average life

6.54

years

7.88

years  

8.56

years

Constant Prepayment rate (CPR)

10.1

%  

7.3

%  

6.1

%

Weighted average discount rate

9.4

%  

9.4

%  

9.4

%

Effect on fair value due to change in interest rates

25 basis point increase

$

2,517

$

1,504

$

934

50 basis point increase

4,621

2,740

 

1,626

25 basis point decrease

(2,575)

(1,981)

 

(1,379)

50 basis point decrease

(5,540)

(4,421)

 

(3,112)

The sensitivity calculations in the previous table are hypothetical and should not be considered to be predictive of future performance. Changes in fair value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the changes in assumptions to fair value may not be linear. Also, the effects of an adverse variation in a particular assumption on the fair value of the MSRs is calculated without changing any other assumptions, while in reality, changes in one factor may result in changing another, which may magnify or contract the effect of the change.

Custodial escrow balances maintained in connection with the loan servicing were $27.7 million and $26.0 million at June 30, 2019 and June 30, 2018, respectively.

Whole loan sales were $186.5 million and $301.7 million for the three and six months ended June 30, 2019, respectively, compared to $173.7 million and $328.5 million for the three and six months ended June 30, 2018, respectively. For the three and six months ended June 30, 2019, $147.3 million and $236.5 million, or 79.0% and 78.4%, respectively, were sold with the servicing rights retained by the company, compared to $134.6 million and $253.0 million, or 77.5% and 77.0%, for the three and six months ended June 30, 2018, respectively

Loans held for sale have historically been comprised of residential mortgage loans awaiting sale in the secondary market, which generally settle in 15 to 45 days. Loans held for sale were $47.8 million, $22.9 million and $37.0 million at June 30, 2019, December 31, 2018 and June 30, 2018, respectively.

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Note 19 – Investments in Qualified Affordable Housing Projects

We have investments in qualified affordable housing projects (“QAHPs”) that provide low income housing tax credits and operating loss benefits over an extended period. The tax credits and the operating loss tax benefits that are generated by each of the properties are expected to exceed the total value of the investment made by the Company. For the six months ended June 30, 2019, tax credits and other tax benefits of $3.1 million and amortization of $3.2 million were recorded. For the six months ended June 30, 2018, tax credits and other tax benefits of $2.4 million and amortization of $2.0 million were recorded. At June 30, 2019 and 2018, our carrying value of QAHPs was $72.2 million and $37.6 million, respectively, with an original investment of $89.2 million. We have $39.7 million and $16.9 million in remaining funding obligations related to these QAHPs recorded in liabilities at June 30, 2019 and 2018, respectively. None of the original investment will be repaid. The investment in QAHPs is being accounted for using the equity method.

Note 20 – Repurchase Agreements

Securities sold under agreements to repurchase (“repurchase agreements”) represent funds received from customers, generally on an overnight or continuous basis, which are collateralized by investment securities owned or, at times, borrowed and re-hypothecated by the Company. Repurchase agreements are subject to terms and conditions of the master repurchase agreements between the Company and the client and are accounted for as secured borrowings. Repurchase agreements are included in federal funds purchased and securities sold under agreements to repurchase on the condensed consolidated balance sheets.

At June 30, 2019, December 31, 2018 and June 30, 2018, our repurchase agreements totaled $260.4 million, $205.3 million, and $243.1 million, respectively. All of our repurchase agreements were overnight or continuous (until-further-notice) agreements at June 30, 2019, December 31, 2018 and June 30, 2018. These borrowings were collateralized with government, government-sponsored enterprise, or state and political subdivision-issued securities with a carrying value of $260.4 million, $205.3 million and $243.1 million at June 30, 2019, December 31, 2018 and June 30, 2018, respectively. Declines in the value of the collateral would require us to increase the amounts of securities pledged.

Note 21 – Subsequent Events

In June 2019, the Board of Directors approved and reset the number of shares available to be repurchased to 2,000,000 common shares under the 2019 Stock Repurchase Program (“Repurchase Program”). In July 2019, we repurchased an additional 594,400 shares at an average price of $75.05 a share for a total of $44.6 million in common stock. We may repurchase up to an additional 1,264,400 shares of common stock under the Repurchase Program. We are not obligated to repurchase any additional shares under the Repurchase Program, and any repurchases under the Repurchase Program after June 6, 2020 would require additional Federal Reserve approval.

We have evaluated subsequent events for accounting and disclosure purposes through the date the financial statements are issued and have determined that there is no additional disclosure necessary.

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) relates to the financial statements contained in this Quarterly Report beginning on page 3. For further information, refer to the MD&A appearing in the Annual Report on Form 10-K for the year ended December 31, 2018. Results for the six months ended June 30, 2019 are not necessarily indicative of the results for the year ending December 31, 2019 or any future period.

Unless otherwise mentioned or unless the context requires otherwise, references herein to “South State,” the “Company” “we,” “us,” “our” or similar references mean South State Corporation and its consolidated subsidiary. References to the “Bank” means South State Corporation’s wholly owned subsidiary, South State Bank, a South Carolina banking corporation.

Overview

South State Corporation is a bank holding company headquartered in Columbia, South Carolina, and was incorporated under the laws of South Carolina in 1985. We provide a wide range of banking services and products to our customers through our wholly owned bank subsidiary, South State Bank, a South Carolina-chartered commercial bank that opened for business in 1934. The Bank also operates South State Advisory, Inc. (formerly First Southeast 401K Fiduciaries), a wholly owned registered investment advisor. We merged Minis & Co., Inc., another registered investment advisor that was wholly-owned by the Bank, with and into South State Advisory effective January 1, 2019. We do not engage in any significant operations other than the ownership of our banking subsidiary.

At June 30, 2019, we had approximately $15.7 billion in assets and 2,544 full-time equivalent employees.  Through the Bank, we provide our customers with checking accounts, NOW accounts, savings and time deposits of various types, brokerage services and alternative investment products such as annuities and mutual funds, trust and asset management services, business loans, agriculture loans, real estate loans, personal use loans, home improvement loans, manufactured housing loans, automobile loans, credit cards, letters of credit, home equity lines of credit, safe deposit boxes, bank money orders, wire transfer services, correspondent banking services, and use of ATM facilities.

We have pursued, and continue to pursue, a growth strategy that focuses on organic growth, supplemented by acquisitions of select financial institutions, or branches in certain market areas.

The following discussion describes our results of operations for the three and six months ended June 30, 2019 as compared to the three and six months ended June 30, 2018 and also analyzes our financial condition as of June 30, 2019 as compared to December 31, 2018 and June 30, 2018. Like most financial institutions, we derive most of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we may pay interest. Consequently, one of the key measures of our success is the amount of our net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.

Of course, there are risks inherent in all loans, so we maintain an ALLL to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the following section, we have included a detailed discussion of this process.

In addition to earning interest on our loans and investments, we earn income through fees and other services we charge to our customers. We incur costs in addition to interest expense on deposits and other borrowings, the largest of which is salaries and employee benefits. We describe the various components of this noninterest income and noninterest expense in the following discussion.

The following sections also identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information also included in this report.

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Recent Events

Branch consolidation and other cost initiatives - 2019

In mid-January 2019, the Company scheduled the closure of 13 branch locations during 2019. All but one of those locations was closed during the second quarter of 2019. In addition, certain cost reduction initiatives began during the first quarter of 2019. The cost incurred with these closures and cost initiatives totals $3.1 million for the first six months, with $2.1 million in the second quarter of 2019. The annual savings of these closures and cost initiatives is expected to be $13.0 million, and the net impact on 2019 anticipated to be approximately $10.0 million. In the second quarter of 2019, the Company recognized approximately $2.5 million in cost saves, and expect to realize another $6.4 million in the third and fourth quarter of 2019.

Pension plan termination – 2nd Quarter 2019

During the second quarter of 2019, the Company recorded the impact of the termination of the pension plan. The pre-tax, non-cash charge totaled $9.5 million and comprised of $7.7 million that was reclassified from accumulated other comprehensive income and a charge of $1.8 million for the net pension plan asset. This action supports the Company’s long-term focus on managing noninterest expense to 0% to 3% growth annually.

Critical Accounting Policies

We have established various accounting policies that govern the application of GAAP in the preparation of our financial statements. Significant accounting policies are described in Note 1 to the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2018. These policies may involve significant judgments and estimates that have a material impact on the carrying value of certain assets and liabilities. Different assumptions made in the application of these policies could result in material changes in our financial position and results of operations.

Allowance for Loan Losses

The ALLL reflects the estimated losses that will result from the inability of our bank’s borrowers to make required loan payments. In determining an appropriate level for the allowance, we identify portions applicable to specific loans as well as providing amounts that are not identified with any specific loan but are derived with reference to actual loss experience, loan types, loan volumes, economic conditions, and industry standards. Changes in these factors may cause our estimate of the allowance to increase or decrease and result in adjustments to the provision for loan losses. See Note 5 — Loans and Allowance for Loan Losses in this Quarterly Report on Form 10-Q, “Provision for Loan Losses and Nonperforming Assets” in this MD&A and “Allowance for Loan Losses” in Note 1 to the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2018 for further detailed descriptions of our estimation process and methodology related to the allowance for loan losses.

Goodwill and Other Intangible Assets

Goodwill represents the excess of the purchase price over the sum of the estimated fair values of the tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed in a business combination. As of June 30, 2019, December 31, 2018 and June 30, 2018, the balance of goodwill was $1.0 billion for all periods. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. The goodwill impairment analysis is a two-step test. The first step, used to identify potential impairment, involves comparing each reporting unit’s estimated fair value to its carrying value, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying value, goodwill is not considered to be impaired. If the carrying value exceeds estimated fair value, there is an indication of potential impairment and the second step is performed to measure the amount of impairment, if any.

If required, the second step involves calculating an implied fair value of goodwill for each reporting unit for which the first step indicated impairment. The implied fair value of goodwill is determined in a manner similar to the amount of goodwill calculated in a business combination, by measuring the excess of the estimated fair value of the

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reporting unit, as determined in the first step, over the aggregate estimated fair values of the individual assets, liabilities and identifiable intangibles as if the reporting unit was being acquired in a business combination. If the implied fair value of goodwill exceeds the carrying value of goodwill assigned to the reporting unit, there is no impairment. If the carrying value of goodwill assigned to a reporting unit exceeds the implied fair value of the goodwill, an impairment charge is recorded for the excess. An impairment loss cannot exceed the carrying value of goodwill assigned to a reporting unit, and the loss establishes a new basis in the goodwill. Subsequent reversal of goodwill impairment losses is not permitted.

In January 2017, the FASB issued ASU No. 2017-04, which simplifies the accounting for goodwill impairment for all entities by requiring impairment charges to be based on the first step in today’s two-step impairment test under ASC Topic 350 and eliminating Step 2 from the goodwill impairment test. This guidance is effective for the Company for fiscal years beginning after December 15, 2019, and interim periods within those years.

We evaluated the carrying value of goodwill as of April 30, 2019, our annual test date, and determined that no impairment charge was necessary. Our stock price has historically traded above its book value and tangible book value. At June 30, 2019, our stock price was $73.67 which was above book value of $68.34 and tangible book value of $37.85. Based on the updated analysis of goodwill as of April 30, 2019 and the fact that our stock price has traded above book value for most of the quarter and at the end of the quarter, we believe there is no impairment of goodwill as of June 30, 2019. Should our future earnings and cash flows decline, discount rates increase, and/or the market value of our stock decreases, an impairment charge to goodwill and other intangible assets may be required.

Core deposit intangibles, client list intangibles, and noncompetition (“noncompete”) intangibles consist primarily of amortizing assets established during the acquisition of other banks. This includes whole bank acquisitions and the acquisition of certain assets and liabilities from other financial institutions. Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in these transactions. Client list intangibles represent the value of long-term client relationships for the wealth and trust management business. Noncompete intangibles represent the value of key personnel relative to various competitive factors such as ability to compete, willingness or likelihood to compete, and feasibility based upon the competitive environment, and what the Bank could lose from competition. These costs are amortized over the estimated useful lives, such as deposit accounts in the case of core deposit intangible, on a method that we believe reasonably approximates the anticipated benefit stream from this intangible. The estimated useful lives are periodically reviewed for reasonableness.

Income Taxes and Deferred Tax Assets

Income taxes are provided for the tax effects of the transactions reported in our condensed consolidated financial statements and consist of taxes currently due plus deferred taxes related to differences between the tax basis and accounting basis of certain assets and liabilities, including available-for-sale securities, allowance for loan losses, write downs of OREO properties, accumulated depreciation, net operating loss carry forwards, accretion income, deferred compensation, intangible assets, mortgage servicing rights, and post-retirement benefits. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. A valuation allowance is recorded in situations where it is “more likely than not” that a deferred tax asset is not realizable. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The Company and its subsidiaries file a consolidated federal income tax return. Additionally, income tax returns are filed by the Company or its subsidiaries in the state of South Carolina, Georgia, North Carolina, Florida, Virginia, Alabama, and Mississippi. We evaluate the need for income tax reserves related to uncertain income tax positions but had no material reserves at June 30, 2019 or 2018.

Other Real Estate Owned

OREO, consisting of properties obtained through foreclosure or through a deed in lieu of foreclosure in satisfaction of loans or through reclassification of former branch sites, is reported at the lower of cost or fair value, determined on the basis of current valuations obtained principally from independent sources, adjusted for estimated selling costs. At the time of foreclosure or initial possession of collateral, any excess of the loan balance over the fair value of the real estate held as collateral is treated as a charge against the ALLL. Subsequent adjustments to this value are described below.

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Subsequent declines in the fair value of OREO below the new cost basis are recorded through valuation adjustments. Significant judgments and complex estimates are required in estimating the fair value of OREO, and the period of time within which such estimates can be considered current is significantly shortened during periods of market volatility. In response to market conditions and other economic factors, management may utilize liquidation sales as part of its problem asset disposition strategy. As a result of the significant judgments required in estimating fair value and the variables involved in different methods of disposition, the net proceeds realized from sales transactions could differ significantly from the current valuations used to determine the fair value of OREO. Management reviews the value of OREO periodically and adjusts the values as appropriate. Revenue and expenses from OREO operations as well as gains or losses on sales and any subsequent adjustments to the value are recorded as OREO expense and loan related expense, a component of non-interest expense.

Business Combinations and Method of Accounting for Loans Acquired

We account for acquisitions under FASB ASC Topic 805, Business Combinations, which requires the use of the acquisition method of accounting. All identifiable assets acquired, including loans, are recorded at fair value. No ALLL related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk.

Acquired credit-impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality, found in FASB ASC Topic 310-30, Receivables—Loans and Debt Securities Acquired with Deteriorated Credit Quality, formerly American Institute of Certified Public Accountants Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer, and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loans. Loans acquired in business combinations with evidence of credit deterioration are considered impaired. Loans acquired through business combinations that do not meet the specific criteria of FASB ASC Topic 310-30, but for which a discount is attributable, at least in part to credit quality, are also accounted for under this guidance. Certain acquired loans, including performing loans and revolving lines of credit (consumer and commercial), are accounted for in accordance with FASB ASC Topic 310-20, where the discount is accreted through earnings based on estimated cash flows over the estimated life of the loan.

For further discussion of our loan accounting and acquisitions, see “Business Combinations and Method of Accounting for Loans Acquired” in our Annual Report on Form 10-K for the year ended December 31, 2018 and Note 5—Loans and Allowance for Loan Losses in this Quarterly Report on Form 10-Q.

Results of Operations

We reported consolidated net income of $41.5 million, or diluted earnings per share (“EPS”) of $1.17, for the second quarter of 2019 as compared to consolidated net income of $40.5 million, or diluted EPS of $1.09, in the comparable period of 2018, a 2.5% increase. The $1.0 million increase in consolidated net income was primarily the net result of the following items:

An $8.3 million increase in interest income, resulting primarily from a $5.5 million increase in interest income from loans and a $2.2 million increase in interest income from federal funds sold and securities purchased under agreements to resell. Non-acquired loan interest income increased $20.4 million due to both a $1.5 billion increase in average balance and a 26 basis point increase in yield. This increase was offset by a $14.9 million decline in interest income from the acquired loan portfolio due to a $1.0 billion decline in the average loan balance;
A $10.6 million increase in interest expense, resulting primarily from a 40 basis points increase in the cost of funds on interest-bearing liabilities due to both the higher rate environment and the competition for deposits in our markets. The interest expense on interest-bearing deposits increased $7.4 million mainly driven by a 33 basis points increase in average cost while interest expense on other borrowings increased $3.2 million driven by a $511.9 million or 308.5% increase in average balance;
A $774,000 decrease in the provision for loan losses, which primarily resulted from an $826,000 decrease in the provision for loan losses within the non-acquired loan portfolio and from a $271,000 decrease in the provision for loan losses within the acquired credit impaired loan portfolio. The provision for loan losses for the acquired non-credit impaired loan portfolio increased by $323,000 during the second quarter of 2019 compared to the same period in 2018. The decrease in the provision for the non-acquired loan portfolio was due to the continued low amount of

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net charge-offs excluding overdrafts and ready reserves and the continued strength in the asset quality of the portfolio. The decrease in the provision in the acquired credit impaired loan portfolio was due to us having a lower impairment in the valuation allowance of $251,000 in the second quarter of 2019 compared to an impairment of $522,000 in the second quarter of 2018;
A $93,000 increase in noninterest income, which resulted primarily from a $2.0 million increase in mortgage banking income and a $2.4 million increase in gains (loss) on sale of securities. These increases were mostly offset by a $3.9 million decline in fees on deposit accounts. (See Noninterest Income section on page 74 for further discussion);
A $1.1 million decrease in noninterest expense, which resulted primarily from a $12.0 million decrease in merger and branch consolidation related expense and a $1.8 million decrease in FDIC assessment and other regulatory charges. These decreases were mostly offset by $9.5 million charge related to the termination of the pension plan during the second quarter of 2019 and an increase in salaries and employee benefits of $3.5 million. (See Noninterest Expense section on page 75 for further discussion); and
A $1.4 million decrease in the provision for income taxes. This decrease was due to a lower effective tax rate that was attributable to an increase in federal tax credits available and the absence of the tax expense related to the revaluation of deferred taxes.

Our asset quality related to non-acquired loans continued to remain strong at the end of the second quarter of 2019. Non-acquired nonperforming assets decreased from $23.0 million at June 30, 2018 to $20.0 million at June 30, 2019, a decrease of $3.1 million, which resulted from a $3.7 million decrease in OREO and a $735,000 increase in non-acquired nonperforming loans. The decrease in OREO was primarily the result of a higher balance in OREO at June 30, 2018 from the closing of branches during the first half of 2018 due to the merger with PSC. The Company moved $5.3 million in properties related to closed branches to OREO during the second quarter of 2018, most of which have now been sold. Non-acquired nonperforming assets remained flat at $20.0 million at June 30, 2019 compared to the previous quarter at March 31, 2019. Annualized net charge-offs for the second quarter of 2019 were 0.02%, or $452,000, compared to net charge-offs in the second quarter of 2018 of 0.01%, or $189,000, and net charge-offs in the first quarter of 2019 of 0.02%, or $493,000.

The ALLL declined to 0.62% of total non-acquired loans at June 30, 2019 compared to 0.65% at December 31, 2018 and 0.67% at June 30, 2018. The allowance provides 3.43 times coverage of non-acquired nonperforming loans at June 30, 2019, an increase from 3.41 times at December 31, 2018, and an increase from 3.22 times at June 30, 2018. We continue to show solid and stable asset quality numbers and ratios.

Nonperforming acquired non-credit impaired loans increased $395,000 from $9.6 million at June 30, 2018 and decreased $3.7 million from $13.7 million at December 31, 2018 to $10.0 million at June 30, 2019. The decrease from December 31, 2018 was mainly due to payoffs and pay downs on several nonperforming loans during the second quarter of 2019. During the second quarter of 2019, we had net charge-offs related to acquired non-credit impaired loans of $1.4 million, or 0.25% annualized, and accordingly, recorded a provision for loan losses equal to the net charge-off for the same amount. The net charge-offs in the second quarter of 2019 were mainly related to two loan relationships. We had a net charge-off of $1.1 million in the second quarter of 2018 and net charge-offs of $168,000 in the first quarter of 2019 related to acquired non-credit impaired loans.

During the second quarter of 2019, the valuation allowance on acquired credit impaired loans increased $109,000, or 2.4%. This was due to impairments recorded through the provision for loan losses of $251,000 offset by loan removals from loans being paid off, fully charged off or transferred to OREO of $142,000. From June 30, 2018, the valuation allowance on acquired credit impaired loans increased $197,000, or 4.5%. This was due to impairments recorded through the provision for loan losses of $690,000 offset by loan removals form loans being paid off, fully charged off or transferred to OREO of $493,000.

We perform ongoing assessments of the estimated cash flows of our acquired credit impaired loan portfolios. In general, increases in cash flow expectations result in a favorable adjustment to interest income over the remaining life of the related loans, and decreases in cash flow expectations result in an immediate recognition of a provision for loans losses. When a provision for loan losses (impairments) has been recognized in earlier periods, subsequent improvement in cash flows will result in reversals of those impairments.

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During the second quarter of 2019, acquired loan interest income declined $2.2 million due to lower average acquired loan balance from payoffs and paydowns compared to the first quarter of 2019. Below is additional detail of the second quarter of 2019 changes within the acquired loan portfolio:

Acquired credit impaired period-end loan balances decreased by $32.2 million, and acquired non-credit impaired period-end loan balances decreased by $198.5 million, from March 31, 2019. The yield on acquired loans was up to 6.54% from 6.34% at March 31, 2019. The increase in the yield, in the second quarter of 2019, was primarily the result of the receipt of $1.0 million on an acquired credit impaired loan. As mentioned above, the average balance of acquired loans decreased by $252.2 million compared to the first quarter of 2019.
Net impairments of acquired credit impaired loans in the second quarter of 2019 totaled $251,000 compared to $13,000 of impairment in the first quarter of 2019. In the second quarter of 2018, impairment of $522,000 was recorded.

The table below provides an analysis of the yield on our total loan portfolio, excluding loans held for sale, including both non-acquired and acquired loans (credit impaired and non-credit impaired loans). The acquired loan yield increased from the second quarter of 2018 due to acquired credit impaired loans being renewed and the cash flow from these assets being extended out, along with the $1.0 million unexpected receipt discussed above.

Three Months Ended

Six Months Ended

 

    

June 30,

    

June 30,

    

June 30,

    

June 30,

 

(Dollars in thousands)

2019

2018

2019

2018

 

Average balances:

Acquired loans, net of allowance for loan losses

$

2,694,862

$

3,742,517

$

2,820,243

$

3,874,405

Non-acquired loans

 

8,463,080

 

6,980,883

 

8,270,602

 

6,789,877

Total loans, excluding held for sale

$

11,157,942

$

10,723,400

$

11,090,845

$

10,664,282

Interest income:

Noncash interest income on acquired performing loans

$

3,156

$

7,570

$

6,313

$

17,155

Acquired loan interest income

 

40,767

 

51,207

 

83,693

 

103,164

Total acquired loans

 

43,923

 

58,777

 

90,006

 

120,319

Non-acquired loans

 

91,128

 

70,738

 

176,665

 

135,930

Total loans, excluding held for sale

$

135,051

$

129,515

$

266,671

$

256,249

Non-taxable equivalent yield:

Acquired loans

 

6.54

%  

 

6.30

%

 

6.44

%  

 

6.26

%

Non-acquired loans

 

4.32

%  

 

4.06

%

 

4.31

%  

 

4.04

%

Total loans, excluding held for sale

 

4.85

%  

 

4.84

%

 

4.85

%  

 

4.85

%

Compared to the balance at March 31, 2019, our non-acquired loan portfolio has increased $310.7 million, or 15.0% annualized, to $8.6 billion, driven by increases in almost all categories: consumer real estate lending by $80.6 million, or 12.9% annualized; consumer non real estate lending by $38.4 million, or 33.1% annualized; commercial and industrial by $42.2 million, or 15.9% annualized and commercial non-owner occupied by $177.4 million, or 29.3% annualized. The acquired loan portfolio decreased by $230.6 million to $2.6 billion in the second quarter of 2019 compared to $2.8 billion at March 31, 2019. This decrease was due to continued payoffs, charge-offs, transfers to OREO, and renewals of acquired loans moved to the non-acquired loan portfolio. Since June 30, 2018, the non-acquired loan portfolio has grown by $1.4 billion, or 19.8%, driven by increases in all loan categories. Consumer real estate loans, commercial non-owner occupied real estate loans, commercial owner occupied real estate loans and commercial and industrial loans have accounted for the largest increases contributing $403.3 million, or 18.4%, $561.2 million, or 27.5%, $217.5 million, or 15.9%, and $173.4 million, or 18.4% of growth, respectively. Since June 30, 2018, the acquired loan portfolio decreased by $1.0 billion, or 28.3% due to continued payoffs, charge-offs, transfers to OREO, and renewals of acquired loans moved to the non-acquired loan portfolio. Consumer real estate loans, commercial non-owner occupied real estate loans, commercial owner occupied real estate loans and commercial and industrial loans have accounted for the largest decreases in the acquired loan portfolio contributing $204.9 million, or 17.8%, $412.3 million, or 35.4%, $139.4 million, or 23.3%, and $161.0 million, or 50.6% of reduction, respectively.

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Compared to the first quarter of 2019, non-taxable equivalent net interest income increased $3.9 million or 12.7% annualized. The increase in net interest income during the second quarter of 2019 was mainly due to the increase in interest income on the non-acquired loan portfolio of $5.6 million, an increase in interest income from federal funds sold and reverse repos of $2.0 million and an increase in interest income from investment securities of $1.1 million. The increase in interest income on the non-acquired loan portfolio was due an increase in average balance of the non-acquired loan portfolio of $387.1 million through organic loan growth and due to an increase in yield of 2 basis points due to the higher rate environment with the Federal Reserve increasing the federal funds target rate 100 basis points since December 2017. The increase in interest income from federal funds sold and reverse repos was from an increase in the average balance of federal funds sold and reverse repos of $353.7 million due to the Company having more funds to invest through increases in the average balances of deposits of $199.6 million and other borrowings of $376.2 million. The increase in interest income from investment securities was due to an increase in the average balance of $106.0 million and due to an increase in the yield of 9 basis points. The increase in average balance of investment securities was due to the Company making the strategic decision in the increase the size of the portfolio with the excess funds from deposit growth and the increase in other borrowings. The increase in yield on investment securities was due to the higher interest rate environment with the Federal Reserve increasing the federal funds target rate 100 basis point since December 2017. The positive effects on net interest income were partially offset by a decline in interest income on the acquired loan portfolio of $2.2 million, an increase in interest expense on other borrowings of $2.0 million and an increase in interest expense on interest-bearing deposits of $748,000. The decrease in interest income on the acquired loan portfolio was due to a decrease in the average balance of $252.2 million due to continued payoffs, charge-offs, transfers to OREO, and renewals of acquired loans moved to the non-acquired loan portfolio. The increase in interest expense on other borrowings was due to the increase in the average balance of other borrowings of $376.2 million from the Bank making the strategic decision to use a longer term FHLB funding strategy to fund balance sheet growth as the average balance of FHLB advances increased $376.0 million. The Bank has borrowed $700 million in FHLB borrowings since March 2019 to lock in longer term low cost funding. The increase in interest expense on interest-bearing deposits was due to the higher interest rate environment with the Federal Reserve increasing the federal funds target rate 100 basis points since December 2017 and due to the increase in competition for deposits in our markets. The non-taxable equivalent net interest margin declined during the second quarter of 2019 compare the first quarter of 2019 by 10 basis points from 3.90% to 3.80%. The decrease in the net interest margin was due to both the increase in the cost of interest-bearing liabilities of 6 basis points to 0.95% from 0.89% and due to decline in the yield on interest-earning assets of 6 basis points to 4.48% from 4.54%. The increase in cost of interest-bearing liabilities was mainly due to the higher cost on certificate of deposits which increased 11 basis points during the quarter from the higher interest rate environment and increased competition for deposits in our markets. The overall increase in the cost of interest-bearing liabilities was also due to the increase in the average balance of other borrowings of $376.2 million which is the bank’s highest costing interest-bearing liability at 2.80% during the quarter. The decline in yield on interest-earning assets was mainly due to a change in asset mix as the average balance on the acquired loan portfolio declined $252.2 million which is the Bank’s highest yielding asset at 6.54% during the quarter while the average balance of federal funds sold and reverse repos increased $353.7 million which was the Bank’s lowest yielding asset at 2.28% during the quarter.

Comparing the second quarter of 2019 to the same period in 2018, non-taxable equivalent net interest income decreased $2.4 million, or 1.8%, and the non-taxable equivalent net interest margin decreased to 3.80% from 4.12%. The decrease in net interest income was due to an increase in the average cost on interest-bearing liabilities of 40 basis points, an increase in the average balance of other borrowings of $511.9 million and a decline in the average balance on the acquired loan portfolio of $1.0 billion. The cost on all categories of interest-bearing liabilities except other borrowings increased from the second quarter in 2018 as the interest rate environment rose during 2018 with the Federal Reserve increasing the federal funds target rate 100 basis points since December 2017. The cost on interest-bearing deposits was also affected by the increased competition for deposits in our markets. The cost of interest-bearing deposits and the cost of federal funds purchased and repurchase agreements increased 33 basis points and 20 basis points, respectively, during the second quarter of 2019 compared to the second quarter of 2018. The increase in the average balance of other borrowing was due to the Bank making the strategic decision to use a longer term FHLB funding strategy to fund balance sheet growth as the average balance of FHLB advances increased $511.3 million. The Bank has borrowed $700 million in FHLB borrowings since March 2019 to lock in longer term low cost funds. The decrease in the average balance on the acquired loan portfolio was due to continued payoffs, charge-offs, transfers to OREO, and renewals of acquired loans moved to the non-acquired loan portfolio causing interest income from acquired loans to decline. The decrease in the net interest margin was due to both the increase in the average cost of interest-bearing liabilities of 40 basis points for the reasons stated above and a decline in the yield on interest-earning assets of 3 basis points. The decline in yield on interest-earning assets was mainly due to a change in asset mix as the average balance on the acquired loan portfolio declined $1.0 billion which is the Bank’s highest yielding asset at 6.54% during the quarter

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while the average balance of federal funds sold and reverse repos increased $399.2 million which was the Bank’s lowest yielding asset at 2.28% during the quarter.

Our quarterly efficiency ratio increased to 66.9% in the second quarter of 2019 compared to 63.2% in the first quarter of 2019 and 65.6% in the second quarter of 2018. The increase in the efficiency ratio compared to the first quarter of 2019 was the result of an $11.2 million, or 11.4% increase in noninterest expense partially offset by a $9.5 million or 6.1% increase in net interest income and noninterest income. The increase in noninterest expense from the first quarter of 2019 was mainly due to the $9.5 million charge for the termination of the pension plan in the second quarter of 2019 and a $1.1 million increase in merger and branch consolidation related expense. The increase in merger and branch consolidation related expense was due to increased branch consolidation expenses in the second quarter of 2019 as the Company closed 12 branches. Net interest income increased $3.9 million which was mainly due to the increase in the average balance of interest-earning assets of $609.2 million. Noninterest income increased $5.6 million which was mainly due to an increase in mortgage banking income of $2.9 million, an increase in securities gains on sales of $1.2 million and an increase in fees on deposit accounts of $933,000. The increase in mortgage banking income was due to a $1.9 million increase in secondary market income due to due to higher activity and sales volume and due to higher MSR related income of $1.0 million due to higher gains on the MSR hedge. The increase in fees of deposit accounts was due to higher bankcard service income. The main reason for the increase in the efficiency ratio compared to the second quarter of 2018 was due to the decrease in net interest income of $2.4 million. The decrease in net interest income was due to the increase in interest expense $10.6 million due to higher cost of funds partially offset by higher interest income of $8.3 million mainly due to an $803.2 million increase in the average balance of interest-earning assets.

Diluted EPS and basic EPS increased to $1.17 and $1.18, respectively for the second quarter of 2019, from the second quarter 2018 amounts of $1.09 and $1.10, respectively. This was the result of the 2.5% increase in net income and a 5.7% decrease in outstanding common shares. The decrease in outstanding shares from June 30, 2018 was due to the Company repurchasing 2,141,200 common shares through its share repurchase programs.

Selected Figures and Ratios

Three Months Ended

Six Months Ended

 

June 30,

June 30,

 

(Dollars in thousands)

    

2019

    

2018

2019

    

2018

 

Return on average assets (annualized)

 

1.08

%  

1.12

%

1.14

%  

1.15

%

Return on average equity (annualized)

 

6.98

%  

6.96

%

7.29

%  

7.18

%

Return on average tangible equity (annualized)*

 

13.38

%  

13.79

%

14.01

%  

14.23

%

Dividend payout ratio **

 

33.89

%  

30.93

%

32.03

%  

29.78

%

Equity to assets ratio

 

15.14

%  

16.12

%

15.14

%  

16.12

%

Average shareholders’ equity

$

2,382,742

$

2,332,439

$

2,373,572

$

2,323,943

* -   Denotes a non-GAAP financial measure.  The section titled “Reconciliation of GAAP to non-GAAP” below provides a table that reconciles GAAP measures to non-GAAP measures.

** - See explanation of the dividend payout ratio below.

For the three months ended June 30, 2019, return on average tangible equity decreased slightly to 13.38% compared to 13.79% for the same period in 2018. This decrease was the result of the higher percentage increase in average tangible equity of 4.7% as compared to a 1.5% increase in net income excluding amortization of intangibles.
For the three months ended June 30, 2019, return on average assets decreased to 1.08%, compared to 1.12% for the three months ended June 30, 2018, due to a 6.0% increase in average assets partially offset by the effects of a 2.5% increase in net income.
Dividend payout ratio increased to 33.89% for the three months ended June 30, 2019 compared with 30.93% for the three months ended June 30, 2018. The increase from the comparable period in 2018 primarily reflects the increase of 12.3% in cash dividends declared per common share being higher than the 2.5% increase in net income. The dividend payout ratio is calculated by dividing total dividends paid during the quarter by the total net income reported for the same period. The dividend payout range for shareholders was adjusted to 30% to 35% annually, from our historical range of 25% to 30% during the first quarter of 2019.
Equity to assets ratio decreased to 15.14% for the three months ended June 30, 2019 compared with 16.12% for the three months ended June 30, 2018. The decrease from the comparable period in 2018 primarily reflects the higher percentage increase in assets of 7.7% as compared to a 1.1% increase in equity. The reason for the lower increase in equity was due to the Company repurchasing 2,141,200 common shares for $148.5 million since June 30, 2018.

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Reconciliation of GAAP to Non-GAAP

Three Months Ended

Six Months Ended

 

June 30,

June 30,

 

(Dollars in thousands)

    

2019

    

2018

2019

    

2018

 

Return on average equity (GAAP)

 

6.98

%  

6.96

%

7.29

%  

7.18

%

Effect to adjust for intangible assets

 

6.40

%  

6.83

%

6.72

%  

7.05

%

Return on average tangible equity (non-GAAP)

 

13.38

%  

13.79

%

14.01

%  

14.23

%

Average shareholders’ equity (GAAP)

$

2,382,742

$

2,332,439

$

2,373,572

$

2,323,943

Average intangible assets

 

(1,061,130)

 

(1,070,520)

 

(1,062,781)

 

(1,071,369)

Adjusted average shareholders’ equity (non-GAAP)

$

1,321,612

$

1,261,919

$

1,310,791

$

1,252,574

Net income (GAAP)

$

41,460

$

40,459

$

85,827

$

82,785

Amortization of intangibles

 

3,268

 

3,722

 

6,549

 

7,135

Tax effect

 

(646)

 

(788)

 

(1,310)

 

(1,506)

Net income excluding the after-tax effect of amortization of intangibles (non-GAAP)

$

44,082

$

43,393

$

91,066

$

88,414

The return on average tangible equity is a non-GAAP financial measure. It excludes the effect of the average balance of intangible assets and adds back the after-tax amortization of intangibles to GAAP basis net income. Management believes that this non-GAAP measure provides additional useful information, particularly since this measure is widely used by industry analysts following companies with prior merger and acquisition activities. Non-GAAP measures should not be considered as an alternative to any measure of performance or financial condition as promulgated under GAAP, and investors should consider our performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the company. Non-GAAP measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of our results of financial condition as reported under GAAP.

Net Interest Income and Margin

Summary

Our taxable equivalent (“TE”) net interest margin for the second quarter of 2019 decreased by 32 basis points from 4.14% in the second quarter of 2018 to 3.82%. This decrease was due to an increase in the cost of interest-bearing liabilities of 40 basis points as well as a 3 basis points decline in the yield on interest-earning assets.

Non-TE net interest margin decreased by 32 basis points from the second quarter of 2018, which was the result of both the cost on interest-bearing liabilities increasing by 40 basis points and the yield on interest-earning assets decreasing by 3 basis points. The increase in average cost on interest-bearing liabilities was due to both the increase in the cost of interest-bearing deposits of 33 basis points and federal funds purchased of 20 basis points during the second quarter of 2019 compared to the second quarter of 2018. The overall increase in the average cost of interest-bearing liabilities was also due to the increase in the average balance of other borrowings of $511.9 million which is the bank’s highest costing interest-bearing liability at 2.80% during the quarter. The increase in the cost of interest-bearing deposits and federal funds purchased was due to the rising interest rate environment during 2018 as the Federal Reserve increased the federal funds target rate 100 basis points since December 2017. The cost on interest-bearing deposits was also negatively affected by the increased competition for deposits in our markets. The increase in the average balance of other borrowing was due to the Bank making the strategic decision to use longer term FHLB funding strategy to fund its balance sheet growth as the average balance of FHLB advances increased $511.3 million. The Bank has borrowed $700 million in FHLB borrowings since March 2019 to lock in longer term low cost funds. The decline in yield on interest-earning assets was mainly due to a change in asset mix as the average balance on the acquired loan portfolio declined $1.0 billion which is the Bank’s highest yielding asset at 6.54% during the quarter while the average balance of federal funds sold and reverse repos increased $399.2 million which was the Bank’s lowest yielding asset at 2.28% during the quarter. The decrease in the average balance on the acquired loan portfolio was due to continued payoffs, charge-offs, transfers to OREO, and renewals of acquired loans moved to the non-acquired loan portfolio. The increase in the average balance of federal funds sold and reverse repos was from due to the Company having more funds to invest through increases in the average balances of total deposits of $272.5 million and other borrowings of $511.9 million. The

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negative effects on the net interest margin discussed above were partially offset by an increase in the yield on the non-acquired loan portfolio of 26 basis points, the acquired loan portfolio of 24 basis points and investment securities of 17 basis points. The yield on the non-acquired loan portfolio increased mainly due to the Federal Reserve increasing the federal funds target rate 100 basis points since December 2017 which effectively increased the Prime Rate, the rate used in pricing a majority of our new originated loans. The yield on the acquired loan portfolio increased mainly due to improvements in the projected cash flows, acquired credit impaired loans being renewed and the cash flow form these assets being extended out, and the unexpected receipt of $1.0 million on an acquired credit impaired loans during the second quarter of 2019. The yield on investment securities increased mainly due to the rising rate environment as new securities purchased during 2018 and 2019 were at higher rates.

Three Months Ended

Six Months Ended

 

June 30,

June 30,

 

(Dollars in thousands)

    

2019

    

2018

2019

    

2018

 

Non-TE net interest income

$

127,179

$

129,562

$

250,446

$

258,535

Non-TE yield on interest-earning assets

 

4.48

%  

 

5.51

 

4.51

%  

 

4.50

%

Non-TE rate on interest-bearing liabilities

 

0.95

%  

 

0.55

 

0.92

%  

 

0.48

%

Non-TE net interest margin

 

3.80

%  

 

4.12

 

3.85

%  

 

4.16

%

TE net interest margin

 

3.82

%  

 

4.14

 

3.87

%  

 

4.18

%

Non-TE net interest income decreased $2.4 million, or 1.8%, in the second quarter of 2019 compared to the same period in 2018. Some key highlights are outlined below:

Higher interest income of $8.3 million with non-acquired loan interest income increasing by $20.4 million due to higher average balances through organic loan growth and due to higher yields due to the rising rate environment and with federal funds sold and reverse repo interest income increasing $2.2 million due to higher average balances from the Bank having more funds to invest through the increase in total deposit and other borrowings. The increases in interest income were partially offset by a $14.9 million decline in acquired loan interest income due to the decline in average balances of the acquired loan portfolio due to continued payoffs, charge-offs, transfers to OREO, and renewals of acquired loans moved to the non-acquired loan portfolio.
Higher interest expense of $10.6 million with deposit interest expense increasing $7.4 million and other borrowing interest expense increasing $3.2 million. These increases were due to higher average balances in interest-bearing deposits of $172.3 million and in other borrowings of $511.9 million and due to higher average cost on interest-bearing deposits of 33 basis points due to the rising rate environment and increased competition for deposits in our markets.
Average interest-earning assets increased $803.2 million, or 6.4% to $13.4 billion in the second quarter of 2019 compared to the same period in 2018 due to the increase in the average balance of the non-acquired loan portfolio of $1.5 billion through organic growth and due to the increase in the average balance of federal funds sold and reverse repos of $399.2 million due to the Bank having more funds to invest through the increases in total deposits and other borrowings. These increases were partially offset by a decline in the average balance of the acquired loan portfolio of $1.0 billion due to continued payoffs, charge-offs, transfers to OREO, and renewals of acquired loans moved to the non-acquired loan portfolio
Non-TE yield on interest-earning assets for the second quarter of 2019 decreased 3 basis points from the comparable period in 2018. The decline in yield on interest-earning assets was due to a change in asset mix as the average balance on the acquired loan portfolio declined $1.0 billion which is the Bank’s highest yielding asset at 6.54% during the quarter while the average balance of federal funds sold and reverse repos increased $399.2 million which was the Bank’s lowest yielding asset at 2.28% during the quarter. Even though the yields on the non-acquired loan portfolio, acquired loan portfolio and investment securities increased 26 basis points, 24 basis points, and 17 basis points, respectively, the decline in the average balance of the higher yielding acquired loan portfolio and the increase in the average balance of the lower yielding federal funds sold and reverse repos offset the effects from the increase in the yields during the quarter. The loan portfolio continues to remix with 77% of the portfolio being comprised of non-acquired loans and 23% being acquired loans. This compares to 66% and 34%, respectively, one year ago. The decrease in the acquired loan portfolio as a percentage of the total portfolio was due to continued payoffs, charge-offs, transfers to OREO, and renewals of acquired loans moved to the non-acquired loan portfolio. The percentage of the non-acquired loan portfolio of the total loan portfolio increased from December 31, 2018 with 72% being non-acquired loans and 28% being acquired loans at that time.
The average cost of interest-bearing liabilities for the second quarter of 2019 increased 40 basis points from the same period in 2018. This increase compared to the second quarter of 2018 was primarily the result of an increase in the cost of interest-bearing deposits of 33 basis points and the increase in the average balance of

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other borrowings of $511.9 million which is the bank’s highest costing interest-bearing liability at 2.80%. The average cost of deposits increased from 0.48% during the second quarter of 2018 to 0.81% in the same period in 2019. The increase in the cost of interest-bearing deposits was due to the rising rate environment with the Federal Reserve increasing the federal funds target rate 100 basis points since December 2017 and due to increased competition for deposits in our markets. The increase in the average balance of other borrowing was due to the Bank making the strategic decision to use a longer term FHLB funding strategy to fund balance sheet growth as the average balance of FHLB advances increased $511.3 million. The Bank has borrowed $700 million in FHLB borrowings since March 2019 to lock in longer term low cost funds.
The Non-TE net interest margin decreased by 32 basis points and the TE net interest margin decreased by 32 basis points in the second quarter of 2019 compared to the first quarter of 2018 due mainly to the increase in the cost of interest-bearing liabilities of 40 basis points, the decline in the average balance of acquired loans of $1.0 billion which is the Company’s highest yield asset and the increase in the average balance of federal funds sold and reverse repos of $399.2 million which is the Company’s lowest yielding asset.

Loans

The following table presents a summary of the loan portfolio by category (excludes loans held for sale):

LOAN PORTFOLIO (ENDING BALANCE)

June 30,

% of

December 31,

% of

June 30,

% of

(Dollars in thousands)

2019

    

Total

2018

    

Total

2018

    

Total

Acquired loans:

Acquired non-credit impaired loans:

Commercial non-owner occupied real estate:

Construction and land development

$

60,391

0.5

%  

$

165,070

1.5

%  

$

281,282

2.6

%  

Commercial non-owner occupied

595,367

5.3

%  

679,253

6.2

%  

752,465

6.9

%  

Total commercial non-owner occupied real estate

655,758

5.8

%  

844,323

7.7

%  

1,033,747

9.5

%  

Consumer real estate:

Consumer owner occupied

577,284

5.1

%  

628,813

5.7

%  

676,596

6.2

%  

Home equity loans

208,777

1.9

%  

242,425

2.2

%  

278,906

2.6

%  

Total consumer real estate

786,061

7.0

%  

871,238

7.9

%  

955,502

8.8

%  

Commercial owner occupied real estate

376,187

3.4

%  

421,841

3.8

%  

486,254

4.5

%  

Commercial and industrial

151,579

1.4

%  

212,537

1.9

%  

304,864

2.8

%  

Other income producing property

111,006

1.0

%  

133,110

1.2

%  

169,392

1.6

%  

Consumer non real estate

99,690

0.9

%  

111,777

1.0

%  

126,665

1.2

%  

Other

-

-

%  

-

-

%  

-

-

%  

Total acquired non-credit impaired loans

2,180,281

19.5

%  

2,594,826

23.5

%  

3,076,424

28.4

%  

Acquired credit impaired loans:

Commercial non-owner occupied real estate:

Construction and land development

17,231

0.2

%  

30,893

0.3

%  

36,606

0.3

%  

Commercial non-owner occupied

79,242

0.7

%  

82,183

0.7

%  

94,192

0.9

%  

Total commercial non-owner occupied real estate

96,473

0.9

%  

113,076

1.0

%  

130,798

1.2

%  

Consumer real estate:

Consumer owner occupied

105,033

0.9

%  

119,288

1.1

%  

132,234

1.2

%  

Home equity loans

55,215

0.5

%  

59,978

0.5

%  

63,501

0.6

%  

Total consumer real estate

160,248

1.4

%  

179,266

1.6

%  

195,735

1.8

%  

Commercial owner occupied real estate

81,759

0.7

%  

95,861

0.9

%  

111,127

1.0

%  

Commercial and industrial

5,372

-

%  

8,230

0.1

%  

13,128

0.1

%  

Other income producing property

42,144

0.4

%  

50,808

0.5

%  

59,997

0.6

%  

Consumer non real estate

38,588

0.3

%  

42,482

0.4

%  

45,620

0.4

%  

Other

-

-

%  

-

-

%  

-

-

%  

Total acquired credit impaired loans

424,584

3.7

%  

489,723

4.5

%  

556,405

5.1

%  

Total acquired loans

2,604,865

23.2

%  

3,084,549

28.0

%  

3,632,829

33.5

%  

Non-acquired loans:

Commercial non-owner occupied real estate:

Construction and land development

879,724

7.8

%  

841,445

7.6

%  

906,890

8.4

%  

Commercial non-owner occupied

1,723,640

15.4

%  

1,415,551

12.8

%  

1,135,235

10.5

%  

Total commercial non-owner occupied real estate

2,603,364

23.2

%  

2,256,996

20.4

%  

2,042,125

18.9

%  

Consumer real estate:

Consumer owner occupied

2,079,949

18.5

%  

1,936,265

17.6

%  

1,733,924

16.0

%  

Home equity loans

514,242

4.6

%  

495,148

4.5

%  

456,946

4.2

%  

Total consumer real estate

2,594,191

23.1

%  

2,431,413

22.1

%  

2,190,870

20.2

%  

Commercial owner occupied real estate

1,589,987

14.2

%  

1,517,551

13.8

%  

1,372,453

12.7

%  

Commercial and industrial

1,114,513

9.9

%  

1,054,952

9.6

%  

941,067

8.7

%  

Other income producing property

214,203

1.9

%  

214,353

1.9

%  

205,507

1.9

%  

Consumer non real estate

503,468

4.5

%  

448,664

4.1

%  

416,650

3.8

%  

Other

1,601

-

%  

9,357

0.1

%  

28,867

0.3

%  

Total non-acquired loans

8,621,327

76.8

%  

7,933,286

72.0

%  

7,197,539

66.5

%  

Total loans (net of unearned income)

$

11,226,192

100.0

%  

$

11,017,835

100.0

%  

$

10,830,368

100.0

%  

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Total loans, net of deferred loan costs and fees (excluding mortgage loans held for sale), increased by $395.8 million, or 3.7%, to $11.2 billion at June 30, 2019 as compared to the same period in 2018. Non-acquired loans or legacy loans increased by $1.4 billion, or 19.8%, from June 30, 2018 to June 30, 2019 through organic loan growth. Acquired non-credit impaired loans decreased by $896.1 million, or 29.1% and acquired credit impaired loans decreased by $131.8 million, or 23.7% as compared to the same period in 2018. The overall decrease in acquired loans was the result of principal payments, charge-offs, foreclosures and renewals of acquired loans. Acquired loans as a percentage of total loans decreased to 23.2% at June 30, 2019 compared to 33.5% at June 30, 2018. As of June 30, 2019, non-acquired loans as a percentage of the overall portfolio were 76.8% compared to 66.5% at June 30, 2018.

Three Months Ended June 30,

Six Months Ended June 30,

 

(Dollars in thousands)

    

2019

    

2018

    

2019

    

2018

 

Average total loans

$

11,157,942

$

10,723,400

$

11,090,845

$

10,664,282

Interest income on total loans

 

135,051

 

129,515

 

266,671

 

256,249

Non-TE yield

 

4.85

%  

 

4.84

%

 

4.85

%  

 

4.85

%

Interest earned on loans increased $5.5 million in the second quarter of 2019 compared to the second quarter of 2018. Some key highlights for the quarter ended June 30, 2019 are outlined below:

Our non-TE yield on total loans increased one basis point in the second quarter of 2019 compared to the same period in 2018 and average total loans increased $434.5 million or 4.0%, in the second quarter of 2019, as compared to the same period in 2018. The increase in average total loans was the result of 21.2% growth in the average non-acquired loan portfolio, offset by a 28.0% decline in the average acquired loan portfolio during period. The growth in the non-acquired loan portfolio was due to normal organic growth while the decline in the acquired loan portfolio was due to principal payments, charge-offs, foreclosures and renewals of acquired loans. The yield on the non-acquired loan portfolio increased from 4.06% in the second quarter of 2018 to 4.32% in the same period in 2019 and the yield on the acquired loan portfolio increased from 6.30% in the second quarter of 2018 to 6.54% in the same period in 2019. The yield on the non-acquired loan portfolio increased mainly due to the Federal Reserve increasing the federal funds target rate 100 basis points since December 2017 which effectively increased the Prime Rate, the rate used in pricing a majority of our variable rate loans and new originated loans. The yield on the acquired loan portfolio increased mainly due to improvements in the projected cash flows and due to the Company reevaluating loans acquired in the PSC merger and adjusting the fair value of these assets as well as the increase in interest rates. Even though the yields on non-acquired loans increased 26 basis points and acquired loans increased 24 basis points, the overall yield on the loan portfolio increased 1 basis point. This was due to the decline of $1.0 billion in the average balance of the acquired loan portfolio which earns a higher yield than on the non-acquired loan portfolio. For the three months ended June 30, 2019, the non-acquired loan portfolio yield was 4.32% while the yield on the acquired loan portfolio was 6.54%. Therefore, the reduction in the average balance of the higher yielding acquired loan portfolio caused the overall yield on loans to decline.

The balance of mortgage loans held for sale increased $24.9 million from December 31, 2018 to $47.8 million at June 30, 2019, and increased $10.8 million from a balance of $37.0 million at June 30, 2018.

Investment Securities

We use investment securities, our second largest category of earning assets, to generate interest income through the deployment of excess funds, to provide liquidity, to fund loan demand or deposit liquidation, and to pledge as collateral for public funds deposits and repurchase agreements.  At June 30, 2019, investment securities totaled $1.8 billion, compared to $1.5 billion and $1.6 billion at December 31, 2018 and June 30, 2018, respectively. Our investment portfolio increased $223.7 million from December 31, 2018 and $168.7 million from June 30, 2018. Related to the increase in investment securities from December 31, 2018, we had purchases of $487.0 million during the first six months of 2019 along with a $40.2 million positive impact to the unrealized gain (loss) position in the available for sale securities. These increases were partially offset by maturities, calls and paydowns of investment securities totaling $113.0 million and sales totaling $189.4 million. In the first and second quarters of 2019, we sold some lower yielding legacy securities (mostly mortgage-backed securities) at a loss and reinvested the funds in higher yielding current market securities that also mostly consisted of mortgage-backed securities. The losses on the sales of securities of

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approximately $3.1 million in this restructuring were offset by gains of $5.4 million that we recorded on the sale of VISA Class B shares.

Three Months Ended

Six Months Ended

 

June 30,

June 30,

 

(Dollars in thousands)

    

2019

    

2018

    

2019

    

2018

 

Average investment securities

$

1,621,064

$

1,653,046

$

1,568,359

$

1,659,586

Interest income on investment securities

 

11,168

 

10,662

 

21,261

 

21,009

Non-TE yield

 

2.76

%  

 

2.59

%

 

2.73

%  

 

2.55

%

Interest earned on investment securities was higher in the second quarter of 2019 compared to the second quarter of 2018, as result of the bank selling some lower yielding securities during the first and second quarters of 2019 and reinvesting in higher yielding securities. The increase in interest earned on investment securities came from the increase in the yield on securities and was slightly offset by a decrease in the average securities balance compared to the second quarter of 2018.

    

    

    

    

    

Unrealized

    

    

    

    

    

    

    

    

 

Amortized

Fair

Gain

BB or

 

(Dollars in thousands)

Cost

Value

(Loss)

AAA - A

BBB

Lower

Not Rated

 

June 30, 2019

Government-sponsored entities debt

$

65,604

$

66,529

$

925

$

65,604

$

$

$

State and municipal obligations

 

177,533

 

182,146

 

4,613

 

174,528

 

 

 

3,005

Mortgage-backed securities *

 

1,457,544

 

1,468,601

 

11,057

 

 

 

 

1,457,544

$

1,700,681

$

1,717,276

$

16,595

$

240,132

$

$

$

1,460,549

* - Agency mortgage-backed securities (“MBS”) are guaranteed by the issuing government-sponsored enterprise (“GSE”) as to the timely payments of principal and interest. Except for Government National Mortgage Association securities, which have the full faith and credit backing of the United States Government, the GSE alone is responsible for making payments on this guaranty. While the rating agencies have not rated any of the MBS issued, senior debt securities issued by GSEs are rated consistently as “Triple-A.” Most market participants consider agency MBS as carrying an implied Aaa rating (S&P rating of AA+) because of the guarantees of timely payments and selection criteria of mortgages backing the securities. We do not own any private label mortgage-backed securities.

At June 30, 2019, we had 98 securities available for sale in an unrealized loss position, which totaled $2.9 million. At December 31, 2018, we had 384 securities available for sale in an unrealized loss position, which totaled $26.0 million. At June 30, 2018, we had 412 securities available for sale in an unrealized loss position, which totaled $38.6 million.

As of June 30, 2019 as compared to December 31, 2018 and June 30, 2018, the total number of available for sale securities with an unrealized loss position decreased by 286 and 314 securities, respectively, while the total dollar amount of the unrealized loss decreased by $23.1 million and $35.7 million, respectively. This decrease in number and the amount of the unrealized loss was mainly due to the drop in both short and long term interest rates during the second quarter of 2019. It was also due to the restructuring of the investment portfolio completed in the first and second quarters of 2019 where we sold many of the securities that were in a loss position.

All debt securities available for sale in an unrealized loss position as of June 30, 2019 continue to perform as scheduled. We have evaluated the cash flows and determined that all contractual cash flows should be received; therefore impairment is temporary because we have the ability to hold these securities within the portfolio until the maturity or until the value recovers, and we believe that it is not likely that we will be required to sell these securities prior to recovery. We continue to monitor all of our securities with a high degree of scrutiny. There can be no assurance that we will not conclude in future periods that conditions existing at that time indicate some or all of these securities are other than temporarily impaired, which would require a charge to earnings in such periods. Any charges for OTTI related to securities available-for-sale would not impact cash flow, tangible capital or liquidity.

As securities are purchased, they are designated as held to maturity or available for sale based upon our intent, which incorporates liquidity needs, interest rate expectations, asset/liability management strategies, and capital requirements. We do not currently hold, nor have we ever held, any securities that are designated as trading securities.

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Although securities classified as available for sale may be sold from time to time to meet liquidity or other needs, it is not our normal practice to trade this segment of the investment securities portfolio. While management generally holds these assets on a long-term basis or until maturity, any short-term investments or securities available for sale could be converted at an earlier point, depending partly on changes in interest rates and alternative investment opportunities.

Other Investments

Other investment securities include primarily our investments in FHLB stock with no readily determinable market value. Accordingly, when evaluating these securities for impairment, management considers the ultimate recoverability of the par value rather than recognizing temporary declines in value. As of June 30, 2019, we determined that there was no impairment on its other investment securities. As of June 30, 2019, other investment securities represented approximately $49.1 million, or 0.31% of total assets and primarily consists of FHLB stock which totals $43.0 million, or 0.27% of total assets.

Interest-Bearing Liabilities

Interest-bearing liabilities include interest-bearing transaction accounts, savings deposits, CDs, other time deposits, federal funds purchased, and other borrowings. Interest-bearing transaction accounts include NOW, HSA, IOLTA, and Market Rate checking accounts.

Three Months Ended

Six Months Ended

June 30,

June 30,

(Dollars in thousands)

2019

    

2018

    

    

2019

    

2018

    

Average interest-bearing liabilities

$

9,578,699

$

8,953,242

$

9,374,719

$

8,973,276

Interest expense

 

22,803

 

12,170

 

42,926

 

21,245

Average rate

 

0.95

%  

 

0.55

%

 

0.92

%  

 

0.48

%

The average balance of interest-bearing liabilities increased $625.5 million in the second quarter of 2019 compared to the same period in 2018 due to increases in interest-bearing deposits of $172.3 million and in other borrowings of $511.9 million. The increase in average interest-bearing deposits is due to our continued focus on increasing core deposits (excluding certificates of deposits and other time deposits), which increased $206.8 million during the second quarter of 2019 compared to the same period in 2018. These funds are normally lower cost funds. The increase in other borrowings was due to the Company executing two 90-day FHLB advances of $350.0 million and $150.0 million in March 2019 and another 90-day FHLB advance of $200.0 million in June 2019, each with a cash flow hedge. These advances with these hedges are effectively locking in four and five years fixed rate funding. The $350.0 million advance is four year funding at a rate of 2.44%, the $150.0 million advance is five year funding at a rate of 2.21% and the $200.0 million advance is five year funding at a rate of 1.89%. We paid off a $150.0 million FHLB advance in March 2019 that was executed in the fourth quarter of 2018. The increase in interest expense of $10.6 million in the second quarter of 2019 compared to the same period in 2018 was driven by higher deposit interest expense of $7.4 million and by higher other borrowings interest expense of $3.2 million. These increases were due to higher average balances in interest-bearing deposits of $172.3 million and in other borrowings of $511.9 million and due to higher average cost on interest-bearing deposits due to the rising rate environment as the Federal Reserve has increased the federal funds target rate 100 basis points since December 2017 and increased competition for deposits in our markets. Overall, this resulted in a 40 basis point increase in the average rate on all interest-bearing liabilities from the three months ended June 30, 2018. Some key highlights are outlined below:

Average interest-bearing deposits for the three months ended June 30, 2019 increased 2.0% from the same period in 2018.
Interest-bearing deposits increased $180.9 million to $8.7 billion at June 30, 2019 from the period end balance at June 30, 2018 of $8.5 billion. The increase from June 30, 2018 was driven by an increase in money market accounts of $347.7 million and interest-bearing transaction accounts of $23.4 million partially offset by a decline in savings of $118.9 million and in certificate of deposits of $71.3 million. We continue to monitor and adjust rates paid on deposit products as part of our strategy to manage our net interest margin.
Average transaction and money market accounts balances increased $311.8 million, or 6.0% to $5.5 billion from the average balance in the second quarter of 2018. Interest expense on transaction and money market accounts increased $4.9 million as a result of a 34 basis point increase in the average cost of funds to 70 basis points for the three months ended June 30, 2019 as compared to the same period in 2018. The increase in the

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cost of funds on the transaction and money market account is due to both the rising rate environment during 2018 and the competitive marketplace for deposits at this time.
Average savings account balances decreased 7.2%, or $105.0 million to $1.4 billion from the average balance in the second quarter of 2018. Even with the decline in average balance, interest expense on savings accounts increased $92,000 as a result of a 5 basis point increase in the average rate to 37 basis points for the three months ended June 30, 2019 as compared to the same period in 2018. The increase in the cost of funds on savings accounts is due to both the rising rate environment during 2018 and the competitive marketplace for deposits at this time.
The average rate on certificates of deposit and other time deposits for the three months ended June 30, 2019 increased 56 basis points to 149 basis points from the comparable period in 2018. Average balances on certificates of deposits and other time deposits for the three months ended June 30, 2019 decreased $34.5 million from the comparable period in 2018. The increase in the cost of funds on certificate of deposit is due to both the rising rate environment during 2018 and the competitive marketplace for deposits at this time.
In the second quarter of 2019, average other borrowings increased $511.9 million compared to the second quarter of 2018. The average rate on other borrowings experienced an 87 basis point decrease to 2.80% for the three months ended June 30, 2019 compared to 3.67% for the same period in 2018. The increase in average balance was the result of the Company executing $500.0 million in FHLB advances in March 2019 and an additional $200 million June 2019 to provide funding for growth in the investment and loan portfolios in 2019. We use cash flow hedges to lock in the funding costs of these advances for four and five years, and we believe this will provide lower funding costs than trying to increase deposits in our competitive markets. The decrease in the average cost of other borrowings is due to the $700.0 million in FHLB advances added in March 2019 and June 2019 which have an average effective rate with the hedges of 2.23%. These borrowings are at a lower cost than our remaining other borrowings which mainly consist of our long term trust preferred borrowings which reprice quarterly and are tied to 3 month LIBOR. For the second quarter of 2019, the average rate for our long term trust preferred borrowing was 5.13%. The new FHLB borrowings have driven down the average cost of our other borrowings.

Noninterest-Bearing Deposits

Noninterest-bearing deposits are transaction accounts that provide our Bank with “interest-free” sources of funds. Average noninterest-bearing deposits increased $100.2 million, or 3.2%, to $3.2 billion in the second quarter of 2019 compared to $3.1 billion during the same period in 2018. At June 30, 2019, the period end balance of noninterest-bearing deposits was $3.3 billion, exceeding the June 30, 2018 balance by $103.1 million. We continue to focus on increasing the noninterest-bearing deposits to try and limit our funding costs. Our overall cost of funds including noninterest-bearing deposits was 0.71% for the three months ended June 30, 2019 compared to 0.40% for the three months ended June 30, 2018.

Provision for Loan Losses and Nonperforming Assets

The ALLL is based upon estimates made by management. We maintain an ALLL at a level that we believe is appropriate to cover estimated credit losses on individually evaluated loans that are determined to be impaired as well as estimated credit losses inherent in the remainder of our loan portfolio. Arriving at the allowance involves a high degree of management judgment and results in a range of estimated losses. We regularly evaluate the adequacy of the allowance through our internal risk rating system, outside and internal credit review, and regulatory agency examinations to assess the quality of the loan portfolio and identify problem loans. The evaluation process also includes our analysis of current economic conditions, composition of the loan portfolio, past due and nonaccrual loans, concentrations of credit, lending policies and procedures, and historical loan loss experience. The provision for loan losses is charged to expense in an amount necessary to maintain the allowance at an appropriate level.

The ALLL on non-acquired loans consists of general and specific reserves. The general reserves are determined by applying loss percentages to the portfolio that are based on historical loss experience for each class of loans and management’s evaluation and “risk grading” of the loan portfolio. Additionally, the general economic and business conditions affecting key lending areas, credit quality trends, collateral values, loan volumes and concentrations, seasoning of the loan portfolio, the findings of internal and external credit reviews and results from external bank regulatory examinations are included in this evaluation. Currently, these adjustments are applied to the non-acquired loan portfolio when estimating the level of reserve required. The specific reserves are determined on a loan-by-loan basis

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based on management’s evaluation of our exposure for each credit, given the current payment status of the loan and the value of any underlying collateral. These are loans classified by management as doubtful or substandard. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. Generally, the need for a specific reserve is evaluated on impaired loans, and once a specific reserve is established for a loan, a charge-off of that amount occurs in the quarter subsequent to the establishment of the specific reserve. Loans that are determined to be impaired are provided a specific reserve, if necessary, and are excluded from the calculation of the general reserves.

We segregate the acquired loan portfolio into performing loans (“non-credit impaired”) and credit impaired loans. The acquired non-credit impaired loans and acquired revolving type loans are accounted for under FASB ASC 310-20, with each loan being accounted for individually. Acquired credit impaired loans are recorded net of any acquisition accounting discounts and have no ALLL associated with them at acquisition date. The related discount, if applicable, is accreted into interest income over the remaining contractual life of the loan using the level yield method. Subsequent deterioration in the credit quality of these loans is recognized by recording a provision for loan losses through the income statement, increasing the non-acquired and acquired non-credit impaired ALLL. The acquired credit impaired loans will follow the description in the next paragraph.

In determining the acquisition date fair value of acquired credit impaired loans, and in subsequent accounting, we generally aggregate purchased loans into pools of loans with common risk characteristics. Expected cash flows at the acquisition date in excess of the fair value of loans are recorded as interest income over the life of the loans using a level yield method if the timing and amount of the future cash flows of the pool is reasonably estimable. Subsequent to the acquisition date, increases in cash flows over those expected at the acquisition date are recognized as interest income prospectively. Decreases in expected cash flows after the acquisition date are recognized by recording an ALLL. Evidence of credit quality deterioration for the loan pools may include information such as increased past-due and nonaccrual levels and migration in the pools to lower loan grades. For further discussion of our ALLL on acquired loans, see Note 5—Loans and Allowance for Loan Losses.

During the second quarter of 2019, the valuation allowance on acquired credit impaired loans increased by $109,000. This was the result of impairments of $251,000 which were recorded through the provision for loan losses, being offset by removals of $142,000 from loans being paid off, fully charged off or transferred to OREO. During the second quarter of 2018, we recorded impairments totaling $522,000, offset by loan removals of $180,000. Impairments are recognized immediately and releases are generally spread over time.

Net charge offs related to “acquired non-credit impaired loans” were $1.4 million, or 0.25% annualized, in the second quarter of 2019; and we recorded a provision for loan losses, accordingly. This charge off level was primarily the result of two specific relationships, and was not representative of a particular trend within any of our markets. Net charge-offs in the first quarter of 2019 totaled $168,000, or 0.03% annualized, and net charge offs of $1.1 million, or 0.14% annualized, in the second quarter of 2018, also the result of a specific relationship in that quarter.

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The following table presents a summary of the changes in the ALLL for the three and six months ended June 30, 2019 and 2018:

Three Months Ended June 30,

 

2019

2018

 

Acquired

Acquired

Acquired

Acquired

Non-credit

Credit

Non-credit

Credit

    

Non-acquired

    

Impaired

    

Impaired

    

    

Non-acquired

    

Impaired

    

Impaired

    

 

(Dollars in thousands)

    

Loans

    

Loans

    

Loans

    

Total

    

Loans

    

Loans

    

Loans

    

Total

 

Balance at beginning of period

$

52,008

$

$

4,514

$

56,522

$

45,203

$

$

4,084

$

49,287

Loans charged-off

 

(1,327)

 

(1,535)

 

 

(2,862)

 

(1,240)

 

(1,183)

 

 

(2,423)

Recoveries of loans previously charged off

 

875

 

116

 

 

991

 

1,051

 

87

 

 

1,138

Net charge-offs

 

(452)

 

(1,419)

 

 

(1,871)

 

(189)

 

(1,096)

 

 

(1,285)

Provision for loan losses

 

2,034

 

1,419

 

251

 

3,704

 

2,860

 

1,096

 

522

 

4,478

Reductions due to loan removals

 

 

 

(142)

 

(142)

 

 

 

(180)

 

(180)

Balance at end of period

$

53,590

$

$

4,623

$

58,213

$

47,874

$

$

4,426

$

52,300

Total non-acquired loans:

At period end

$

8,621,327

$

7,197,539

Average

 

8,463,080

 

6,980,883

Net charge-offs as a percentage of average non-acquired loans (annualized)

 

0.02

%  

 

0.01

%  

Allowance for loan losses as a percentage of period end non-acquired loans

 

0.62

%  

 

0.67

%  

Allowance for loan losses as a percentage of period end non-performing non-acquired loans (“NPLs”)

 

343.42

%  

 

321.95

%  

Six Months Ended June 30,

2019

2018

Acquired

Acquired

Acquired

Acquired

Non-credit

Credit

Non-credit

Credit

    

Non-acquired

    

Impaired

    

Impaired

    

    

Non-acquired

    

Impaired

    

Impaired

    

(Dollars in thousands)

    

Loans

    

Loans

    

Loans

    

Total

    

Loans

    

Loans

    

Loans

    

Total

Balance at beginning of period

$

51,194

$

$

4,604

$

55,798

$

43,448

$

$

4,627

$

48,075

Loans charged-off

 

(2,572)

 

(1,909)

 

 

(4,481)

 

(2,409)

 

(1,517)

 

 

(3,926)

Recoveries of loans previously charged off

 

1,627

 

322

 

 

1,949

 

1,853

 

252

 

 

2,105

Net charge-offs

 

(945)

 

(1,587)

 

 

(2,532)

 

(556)

 

(1,265)

 

 

(1,821)

Provision for loan losses

 

3,341

 

1,587

 

264

 

5,192

 

4,982

 

1,265

 

685

 

6,932

Total provision for loan losses charged to operations

 

3,341

 

1,587

 

264

 

5,192

 

4,982

 

1,265

 

685

 

6,932

Reductions due to loan removals

 

 

 

(245)

 

(245)

 

 

 

(886)

 

(886)

Balance at end of period

$

53,590

$

$

4,623

$

58,213

$

47,874

$

$

4,426

$

52,300

Total non-acquired loans:

At period end

$

8,621,327

$

7,197,539

Average

 

8,270,602

 

6,789,877

Net charge-offs as a percentage of average non-acquired loans (annualized)

 

0.02

%  

 

0.02

%  

Allowance for loan losses as a percentage of period end non-acquired loans

 

0.62

%  

 

0.67

%  

Allowance for loan losses as a percentage of period end non-performing non-acquired loans (“NPLs”)

 

343.42

%  

 

321.95

%  

The ALLL as a percent of non-acquired loans continues to reflect our solid and stable credit quality over the last year as our credit quality indicators have remained strong. Total nonperforming loans did increase by $735,000 to $15.6 million in the second quarter of 2019, compared to the same quarter in 2018, however, as a percentage of total non-acquired loans, declined by 3 basis points to 0.18%. Total past due loans increased by $1.3 million to $9.6 million in the second quarter of 2019, compared to the same quarter in 2018, but, as a percentage of total non-acquired loans, remained flat at 11 basis points. Bankruptcies and foreclosures increased by $2.6 million, compared to the same quarter in 2018, however increased by only 1 basis point to 0.12% as a percentage of total non-acquired loans. As compared to the first quarter of 2019, nonperforming loans declined by $305,000 during the second quarter of 2019. Total past due loans decreased by $4.6 million from $14.2 million, compared to the first quarter of 2019, and as a percentage of total non-acquired loans, declined 6 basis points from 0.17% at March 31, 2019. Bankruptcies and foreclosures increased by $3.5 million in the second quarter of 2019, when compared to the first quarter of 2019. The ratio of the ALLL to cover total nonperforming non-acquired loans increased from 321.95% at June 30, 2018 and 326.89% at March 31, 2019, to 343.42% at June 30, 2019. Overall net charge offs for the quarter on non-acquired loans was 2 basis points annualized, or $452,000, compared to 1 basis points annualized, or $189,000, a year ago, and 2 basis points, or $493,000 in the first quarter of 2019. Net charge-offs related to the non-acquired loan portfolio were primarily from overdraft and ready reserve accounts over the past several quarters. During the second quarter of 2019, net charge-offs related to the non-acquired loan portfolio excluding overdraft and ready reserve accounts was in a net recovery position of $292,000.

We increased the ALLL compared to the second quarter of 2018, as well as compared to the first quarter of 2019, due primarily to loan growth and increased risk and uncertainty in new and expanded markets from our mergers in

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2017. From a general perspective, we generally consider a three-year historical loss rate on all loan portfolios, unless circumstances within a portfolio loan type require the use of an alternate historical loss rate to better capture the risk within the portfolio. We also consider qualitative factors such as economic risk, model risk and operational risk when determining the ALLL. We adjust our qualitative factors to account for uncertainty and certain risk inherent in the portfolio that cannot be measured with historical loss rates. All of these factors are reviewed and adjusted each reporting period to account for management’s assessment of loss within the loan portfolio. Overall, the general reserve increased by $6.2 million compared to the balance at June 30, 2018, and $1.8 million compared to the balance at March 31, 2019.

On a specific reserve basis, the ALLL decreased $215,000 from March 31, 2019 to $1.4 million, with loan balances being evaluated for specific reserves decreasing $1.8 million during the second quarter of 2019, to $54.5 million. Specific reserves decreased $445,000 from $1.8 million at June 30, 2018 with the loan balances being evaluated for specific reserves decreasing $8.1 million from $62.6 million at June 30, 2018. The decrease in loans being evaluated for specific reserves during the second quarter of 2019 compared to both the same period in 2018, as well as the previous quarter, is primarily due to the maturity or roll off of builder loans for which greater scrutiny was provided. These builder loans for which greater scrutiny was provided were all performing under their contractual terms.

During the three months ended June 30, 2019, qualitative factors remained consistent, which is reflective of stability in the unemployment rates and economy as a whole within the markets that we serve. We continue to work our nonperforming assets out through collections, transfers to OREO and disposals of OREO.

The following table summarizes our nonperforming assets for the past five quarters:

    

June 30,

 

March 31,

    

December 30,

    

September 30,

    

June 30,

    

(Dollars in thousands)

2019

 

2019

2018

2018

2018

Non-acquired:

Nonaccrual loans

$

14,654

$

14,584

$

14,179

$

14,214

$

13,858

Accruing loans past due 90 days or more

 

280

 

496

 

191

 

36

 

110

Restructured loans - nonaccrual

 

671

 

830

 

648

 

1,065

 

902

Total nonperforming loans

 

15,605

 

15,910

 

15,018

 

15,315

 

14,870

Other real estate owned (2)

 

4,345

 

3,918

 

3,902

 

3,154

 

8,042

Other nonperforming assets (3)

 

29

 

152

 

135

 

75

 

137

Total non-acquired nonperforming assets

 

19,979

 

19,980

 

19,055

 

18,544

 

23,049

Acquired non-credit impaired:

Nonaccrual loans

 

9,948

 

14,294

 

13,489

 

10,798

 

9,373

Accruing loans past due 90 days or more

 

37

 

264

 

162

 

2

 

217

Total acquired nonperforming loans (1)

 

9,985

 

14,558

 

13,651

 

10,800

 

9,590

Acquired OREO and other nonperforming assets:

Acquired OREO (2)

 

10,161

 

7,379

 

7,508

 

8,965

 

9,180

Other acquired nonperforming assets (3)

 

251

 

403

 

247

 

337

 

347

Total acquired OREO and other nonperforming assets

 

10,412

 

7,782

 

7,755

 

9,302

 

9,527

Total nonperforming assets

$

40,376

$

42,320

$

40,461

$

38,646

$

42,166

Excluding Acquired Assets

Total NPAs as a percentage of total loans and repossessed assets (4)

 

0.23

%

 

0.24

%  

 

0.24

%  

 

0.24

%  

 

0.32

%  

Total NPAs as a percentage of total assets (5)

 

0.13

%

 

0.13

%  

 

0.13

%  

 

0.13

%  

 

0.16

%  

Total NPLs as a percentage of total loans (4)

 

0.18

%

 

0.19

%  

 

0.19

%  

 

0.20

%  

 

0.21

%  

Including Acquired Assets

Total NPAs as a percentage of total loans and repossessed assets (4)

 

0.36

%

 

0.38

%  

 

0.37

%  

 

0.35

%  

 

0.39

%  

Total NPAs as a percentage of total assets

 

0.26

%

 

0.27

%  

 

0.28

%  

 

0.27

%  

 

0.29

%  

Total NPLs as a percentage of total loans (4)

 

0.23

%

 

0.27

%  

 

0.26

%  

 

0.24

%  

 

0.23

%  

(1)Excludes the acquired credit impaired loans that are contractually past due 90 days or more totaling $9.5 million, $15.9 million, $16.8 million, $17.9 million, and $19.0 million as of June 30, 2019, March 31, 2019, December 31,

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2018, September 30, 2018, and June 30, 2018, respectively, including the valuation discount. Acquired credit impaired loans are considered to be performing due to the application of the accretion method under FASB ASC Topic 310-30. (For further discussion of our application of the accretion method, see “Business Combinations and Method of Accounting for Loans Acquired” in our Annual Report on Form 10-K for the year ended December 31, 2018).
(2)Includes certain real estate acquired as a result of foreclosure and property not intended for bank use.
(3)Consists of non-real estate foreclosed assets, such as repossessed vehicles.
(4)Loan data excludes mortgage loans held for sale.
(5)For purposes of this calculation, total assets include all assets (both acquired and non-acquired).

Nonperforming non-acquired loans, including restructured loans, were $15.6 million, or 0.18% of non-acquired loans, at June 30, 2019, an increase of $735,000, or 4.9%, from June 30, 2018. The increase in nonperforming loans was driven primarily by an increase in commercial nonaccrual loans of $684,000, consumer nonaccrual loans of $112,000, and past due 90 day loans still accruing of $170,000, offset by a decline in restructured loan nonaccruals of $231,000. Nonperforming non-acquired loans overall, including restructured loans, decreased by $305,000 during the second quarter of 2019 from the level at March 31, 2019. This decrease was primarily driven by a decrease in consumer nonaccrual loans of $1.9 million, restructured nonaccrual loans of $159,000 and past due 90 day loans still accruing of $216,000, offset by an increase in commercial nonaccrual loans of $2.0 million. Non-acquired nonperforming loans still remain at historically low levels at June 30, 2019.

Nonperforming acquired non-credit impaired loans were $10.0 million at June 30, 2019, an increase of $395,000, or 4.1%, from June 30, 2018. The increase in nonperforming loans was driven by an increase in commercial nonaccrual loans of $2.1 million, offset by a decline in consumer nonaccrual loans of $1.5 million and in past due 90 day loans still accruing of $180,000. As a percentage of the acquired non-credit impaired loan portfolio, nonperforming loans increased by 15 basis points to 0.46% at June 30, 2019 from 0.31% at June 30, 2018. Nonperforming acquired non-credit impaired loans decreased by $4.6 million during the second quarter of 2019 from $14.6 million at March 31, 2019. The decrease in nonperforming loans was driven by a decrease in consumer nonaccrual loans of $3.8 million, in commercial nonaccrual loans of $515,000 and in past due 90 day loans still accruing of $227,000. As a percentage of the acquired non-credit impaired loan portfolio, nonperforming loans decreased by 15 basis points to 0.46% from 0.61% at March 31, 2019.

At June 30, 2019, OREO totaled $14.5 million which included $4.3 million in non-acquired OREO and $10.2 million in acquired OREO. Total OREO increased $3.2 million from March 31, 2019. At June 30, 2019, non-acquired OREO consisted of 21 properties with an average value of $207,000. This compared to 20 properties with an average value of $196,000 at March 31, 2019. At June 30, 2019, acquired OREO consisted of 48 properties with an average value of $212,000. This compared to 54 properties with an average value of $137,000 at March 31, 2019. In the second quarter of 2019, we added six properties with an aggregate value of $1.8 million into non-acquired OREO, and we sold five properties with a basis of $1.4 million. Of the six properties added related to non-acquired OREO, five were related to closed branch properties totaling $1.7 million. We added ten properties with an aggregate value of $4.8 million into acquired OREO, and we sold sixteen properties with a basis of $1.7 million in the second quarter of 2019. Of the ten properties added related to acquired OREO, two of the properties total $3.7 million of which one was a residential home for $1.3 million and another was commercial land for $2.4 million.

Potential Problem Loans

Potential problem loans (excluding all acquired loans) totaled $8.2 million, or 0.09% of total non-acquired loans outstanding, at June 30, 2019, compared to $8.0 million, or 0.10% of total non-acquired loans outstanding, at March 31, 2019, and compared to $6.1 million, or 0.08% of total non-acquired loans outstanding, at June 30, 2018. Potential problem loans related to acquired non-credit impaired loans totaled $7.1 million, or 0.32% of total acquired non-credit impaired loans, at June 30, 2019, compared to $4.3 million, or 0.18% of total acquired non-credit impaired loans outstanding, at March 31, 2019, and compared to $5.0 million, or 0.16% of total acquired non-credit impaired loans outstanding, at June 30, 2018. All potential problem loans represent those loans where information about possible credit problems of the borrowers has caused management to have serious concern about the borrower’s ability to comply with present repayment terms.

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Noninterest Income

Three Months Ended

Six Months Ended

June 30,

June 30,

(Dollars in thousands)

    

2019

    

2018

    

2019

    

2018

 

Fees on deposit accounts

$

18,741

$

22,612

$

36,549

$

45,155

Mortgage banking income

 

5,307

 

3,317

 

7,692

 

8,265

Trust and investment services income

 

7,720

 

7,567

 

14,989

 

15,081

Securities gains, net

 

1,709

 

(641)

 

2,250

 

(641)

Recoveries on acquired loans

 

1,347

 

2,167

 

3,214

 

5,142

Other

 

2,794

 

2,503

 

4,982

 

5,078

Total noninterest income

$

37,618

$

37,525

$

69,676

$

78,080

Note that “Fees on deposit accounts” include service charges on deposit accounts and bankcard income

Noninterest income increased by $93,000, or 0.2%, during the second quarter of 2019 compared to the same period in 2018. The quarterly change in total noninterest income primarily resulted from the following:

Fees on deposit accounts decreased $3.9 million, or 17.1%, which resulted primarily from lower bankcard service income of $4.9 million due to the cap on fees charged related to the Durbin amendment that became effective as of July 1, 2018 (The Durbin amendment is a provision of federal law that requires the Federal Reserve to limit fees charged to retailers for debit card processing). This decrease was partially offset by an increase in deposit account service charges of $539,000 and an increase in NSF and AOP income of $398,000;
Mortgage banking income increased by $2.0 million, or 60.0%, which was a result of higher income from the secondary market of $1.9 million due to higher activity and sales volume and by an increase of $113,000 in income from mortgage servicing rights, net of the hedge which was mainly the result of an increase in servicing fee income on loans sold;
Securities gains, net of $1.7 million during the second quarter of 2019 compared to securities losses, net of $641,000 during the second quarter of 2018. The securities gains were a result of the Company selling VISA Class B shares at a gain of $1.8 million partially offset by net realized losses of $118,000 on lower yielding securities that were sold during the quarter; and
Recoveries on acquired loans declined $820,000 million, or 37.8%;

Noninterest income decreased by $8.4 million, or 10.8%, during the first six months of 2019 compared to the same period in 2018. The quarterly decrease in total noninterest income primarily resulted from the following:

Fees on deposit accounts decreased $8.6 million, or 19.1%, which resulted primarily from lower bankcard service income of $9.5 million due to the cap on fees charged related to the Durbin amendment that became effective as of July 1, 2018 (The Durbin amendment is a provision of federal law that requires the Federal Reserve to limit fees charged to retailers for debit card processing). This decrease was partially offset by an increase in deposit account service charges of $571,000 and an increase in NSF and AOP income of $313,000;
Mortgage banking income decreased by $573,000, or 6.9%, which was a result of a decrease of $1.9 million in income from mortgage servicing rights, net of the hedge which was the result of a decrease in the fair value due to the decline in interest rates. This decrease was partially offset by higher income from the secondary market of $1.3 million due to higher activity and sales volume;
Securities gains, net of $2.2 million during the first six months of 2019 compared to securities losses, net of $641,000 during the first six months of 2018.  The securities gains in the first half of 2019 were a result of the Company selling VISA Class B shares at a gain of $5.3 million partially offset by net realized losses of $3.1 million on lower yielding securities that were sold during the year; and
Recoveries on acquired loans declined $1.9 million, or 37.5%;

Bankcard Services Income

We exceeded $10 billion in total consolidated assets upon consummation of our merger with SBFC on January 3, 2017. Banks with over $10 billion in total assets are no longer exempt from the requirements of the Federal Reserve’s rules on interchange transaction fees for debit cards. This means that, beginning on July 1, 2018 as a result of the Durbin amendment, the Bank was limited to receiving only a “reasonable” interchange transaction fee for any debit card

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transactions processed using debit cards issued by the Bank to our customers. The Federal Reserve has determined that it is unreasonable for a bank with more than $10 billion in total assets to receive more than $0.21 plus 5 basis points of the transaction plus a $0.01 fraud adjustment for an interchange transaction fee for debit card transactions. This reduction in the amount of interchange fees we receive for electronic debit interchange began reducing our revenues in the third quarter of 2018. As noted above, bankcard income including interchange transaction fees is included in “Fees on deposit accounts”. In the three and six months ended June 30, 2019, we earned approximately $6.1 million and $11.6 million, respectively, in interchange transaction fees for debit cards. We estimate that bankcard service income was reduced by approximately $5.8 million and $11.1 million, respectively during the three and six months ended June 30, 2019 compared to the same period in 2018 due to the Durbin amendment, which became effective with respect to us on July 1, 2018.

Noninterest Expense

Three Months Ended

Six Months Ended

 

June 30,

June 30,

(Dollars in thousands)

    

2019

    

2018

    

2019

    

2018

 

Salaries and employee benefits

$

58,547

$

55,026

$

116,978

$

117,491

Net occupancy expense

 

7,616

 

7,815

 

14,815

 

15,981

Information services expense

 

8,671

 

8,903

 

17,680

 

18,641

Furniture and equipment expense

 

4,233

 

4,519

 

8,646

 

9,145

OREO expense and loan related

 

881

 

1,037

 

1,632

 

2,698

Pension plan termination expense

 

9,526

 

 

9,526

 

Amortization of intangibles

 

3,268

 

3,722

 

6,549

 

7,135

Supplies, printing and postage expense

 

1,495

 

1,406

 

2,999

 

2,798

Professional fees

 

2,781

 

1,898

 

5,021

 

3,597

FDIC assessment and other regulatory charges

 

1,455

 

3,277

 

2,990

 

4,540

Advertising and marketing

 

959

 

1,163

 

1,766

 

1,899

Merger and branch consolidation related expense

 

2,078

 

14,096

 

3,058

 

25,392

Other

 

7,897

 

7,644

 

15,986

 

14,652

Total noninterest expense

$

109,407

$

110,506

$

207,646

$

223,969

Noninterest expense decreased by $1.1 million, or 1.0%, in the second quarter of 2019 as compared to the same period in 2018. The quarterly decrease in total noninterest expense primarily resulted from the following:

A decrease in merger and branch consolidation related expense of $12.0 million, or 85.3%, compared to the second quarter of 2018. This decrease in costs was related to costs in the second quarter of 2018 associated with the merger with PSC which occurred in the fourth quarter of 2017;
FDIC assessment and other regulatory charges decreased by $1.8 million, or 55.6% in the second quarter of 2019 compared to the same period in 2018. The Company exceeded $10.0 billion in assets for four consecutive quarters in the first quarter of 2018 which changed the assessment calculation by the FDIC for the Company. An adjustment to the accrual for the FDIC assessment was made in the second quarter of 2018 for both the first and second quarter 2018 assessments based on the new calculation which increased the expense during the second quarter of 2018. This decrease was also related to the elimination of the surcharge assessment which occurred in the fourth quarter of 2018 and the change in risk related to certain acquired loans, which resulted in a lower assessments beginning in the fourth quarter of 2018 ; partially offset by
Pension plan termination expense of $9.5 million in the second quarter of 2019. During the second quarter of 2019, the Company recorded the termination of its pension plan which resulted in the recognition of the losses from the pension plan that were being held in accumulated other comprehensive income of $7.7 million and the write-off of the pension plan asset of $1.8 million.
Salaries and employee benefits expense increased by $3.5 million, or 6.4%, in the second quarter of 2019 compared to the same period in 2018. This increase was mainly attributable to an increases in medical insurance costs, 401K match expense and incentive plan accruals;

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Noninterest expense decreased by $16.3 million, or 7.3%, in the first six months of 2019 as compared to the same period in 2018. The decrease in total noninterest expense primarily resulted from the following:

A decrease in merger and branch consolidation related expense of $22.3 million, or 88.0%, compared to the first six months of 2018. This decrease in costs was related to costs in 2018 associated with the merger with PSC which occurred in the fourth quarter of 2017;
FDIC assessment and other regulatory charges decreased by $1.6 million, or 34.1% in the first six months of 2019 compared to the same period in 2018. This decrease was primarily related to the elimination of the surcharge assessment which occurred in the fourth quarter of 2018 and the change in risk related to certain acquired loans, which resulted in a lower assessments beginning in the fourth quarter of 2018;
Net occupancy expense and furniture and equipment expense decreased by $1.7 million, or 6.6% during the first six months of 2019 compared to the same period in 2018. This decrease was related to the cost savings related to the merger with PSC and branch consolidations that occurred during 2019. The number of branches decreased by 13 or 7.1%, from 169 at June 30, 2018 to 156 at June 30, 2019; partially offset by
Pension plan termination expense of $9.5 million in the second quarter of 2019. During the second quarter of 2019, the Company recorded the termination of its pension plan which resulted in the recognition of the losses from the pension plan that were being held in accumulated other comprehensive income of $7.7 million and the write-off of the pension plan asset of $1.8 million.

See in Note 2 – Summary of Significant Accounting Policies and in the Noninterest Income section above a discussion on the reclassification of our interchange network costs to net against interchange network fees included in Fees of Deposit Accounts in Noninterest income.

Income Tax Expense

Our effective income tax rate was 19.78% and 20.00% for the three and six months ended June 30, 2019. This compares to 22.35% and 21.69% for the three and six months ended June 30, 2018. The decline in the effective tax rate for the quarter, and year to date, is primarily due to an increase in federal income tax credits available in 2019 and the absence of tax expense related to the revaluation of deferred taxes that was recorded in the second quarter of 2018.

Capital Resources

Our ongoing capital requirements have been met primarily through retained earnings, less the payment of cash dividends. As of June 30, 2019, shareholders’ equity was $2.4 billion, an increase of $7.7 million, or 0.3%, from December 31, 2018, and an increase of $25.6 million, or 1.1%, from $2.3 billion at June 30, 2018. The change from year-end was attributable to net income of $85.8 million and a decline in the accumulated other comprehensive loss of $26.3 million, which was partially offset by the common stock dividend paid of $27.5 million and a reduction in capital of $80.1 million from the repurchase of 1,141,200 shares of common stock through our stock buyback plan in the first half of 2019. At June 30, 2019, we had accumulated other comprehensive gain of $1.5 million compared to an accumulated other comprehensive loss of $24.9 million at December 31, 2018. This change was attributable to a $31.3 million, net of tax, improvement in the unrealized gain (loss) position in the available for sale securities portfolio, a $6.1 million, net of tax, improvement in the unrealized gain (loss) position related to pension plans and a $11.1 million, net of tax, decline in the unrealized gain (loss) position related to the cash flow hedges. The change in the unrealized gain (loss) position in the available for sale securities portfolio and the cash flow hedges are due to the decline in interest rates during 2019. The change in the unrealized gain (loss) position in the pension plan is due to the Company terminating the pension plan in the second quarter of 2019 and the unrealized loss position was recognized into net income. The increase in shareholders’ equity from June 30, 2018 was primarily attributable to net income of $181.9 million and a decline in the accumulated other comprehensive loss of $37.5 million, which was partially offset by dividends paid to common shareholders of $53.4 million and a reduction in capital of $148.5 million from the repurchase of common stock through our share buyback plan. Our common equity-to-assets ratio was 15.14% at June 30, 2019, down from 16.12% at both December 31, 2018 and June 30, 2018. The decrease from December 31, 2018 is due to the percentage increase in equity of 0.3% being less than the percentage increase in total assets of 6.9%. This was mainly due to the reduction in equity during the first half of 2019 from our repurchase of 1,141,200 shares of common stock at a cost of $80.1 million.

In March 2017, our board of directors approved and reset the number of shares available to be repurchased under the 2004 Stock Repurchase Program to 1,000,000 of which all the shares were repurchased in the third and fourth

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quarters of 2018. On January 25, 2019, our board of directors approved a new program to repurchase up to 1,000,000 of our common stock (“2019 Stock repurchase Program”). All 1,000,000 shares from this new program were repurchased in the first and second quarter of 2019 at an average price of $69.89 a share for a total of $69.9 million in common stock. In June 2019, the Board of Directors authorized an additional 2,000,000 of our common shares to be repurchased under the 2019 stock repurchase program. We made this determination after considering the liquidity needs and capital resources as well as the estimated current value of our net assets. The number of shares to be purchased and the timing of the purchases are based on a variety of factors, including, but not limited to, the level of cash balances, general business conditions, regulatory requirements, the market price of our common stock, and the availability of alternative investment opportunities. We repurchased 141,200 shares at an average price of $72.56 a share for a total of $10.2 million in common stock since the reset of the number of shares available in June 2019. We may repurchase up to an additional 1,858,800 shares of common stock under the 2019 Stock Repurchase Program. We are not obligated to repurchase any additional shares under the 2019 Stock Repurchase Program, and any repurchases under the 2019 Stock Repurchase Program after June 6, 2020 would require additional Federal Reserve approval.

We are subject to regulations with respect to certain risk-based capital ratios. These risk-based capital ratios measure the relationship of capital to a combination of balance sheet and off-balance sheet risks. The values of both balance sheet and off-balance sheet items are adjusted based on the rules to reflect categorical credit risk. In addition to the risk-based capital ratios, the regulatory agencies have also established a leverage ratio for assessing capital adequacy. The leverage ratio is equal to Tier 1 capital divided by total consolidated on-balance sheet assets (minus amounts deducted from Tier 1 capital). The leverage ratio does not involve assigning risk weights to assets.

As disclosed in our Annual Report on Form 10-K for the year ended December 31, 2018, in July 2013, the Federal Reserve announced its approval of a final rule to implement the regulatory capital reforms developed by the Basel Committee on Banking Supervision, otherwise referred to as Basel III, among other changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. Basel III became effective January 1, 2015, subject to a phase-in period for certain aspects of the new rules.

The Basel III capital rules framework requires banking organizations to hold more and higher quality capital, which acts as a financial cushion to absorb losses, taking into account the impact of risk. As applied to the Company and the Bank, the rules include a minimum ratio of CET1 to risk-weighted assets of 4.5%. The rules also require a ratio of Tier 1 capital to risk-weighted assets of 6%. Our minimum required leverage ratio under Basel III is 4% (the rules eliminated a previous exemption that permitted a minimum leverage ratio of 3% for certain institutions). Our minimum required total capital to risk-weighted assets ratio remains at 8% under Basel III.

In order to avoid restrictions on capital distributions and discretionary bonus payments to executives, under the rules a covered banking organization is also required to maintain a “capital conservation buffer” in addition to its minimum risk-based capital requirements. This buffer is required to consist solely of CET1, and the buffer applies to all three risk-based measurements (CET1, Tier 1 capital and total capital). The capital conservation buffer was phased in over a four-year period at 0.625% per annual, beginning January 1, 2016. The capital conservation buffer became fully effective on January 1, 2019, and now consists of an additional amount of Tier 1 common equity equal to 2.5% of risk-weighted assets.

In terms of quality of capital, the rule emphasizes CET1 capital and implements strict eligibility criteria for regulatory capital instruments. When implemented, the Basel III rules also changed the methodology for calculating risk-weighted assets to enhance risk sensitivity.

Under the Basel III rules, accumulated other comprehensive income (“AOCI”) is presumptively included in CET1 capital and can operate to reduce this category of capital. When implemented, the final rule provided a one-time opportunity at the end of the first quarter of 2015 for covered banking organizations to opt out of much of this treatment of AOCI, which election the Bank and the Company have made. As a result, the Company and the Bank retain the pre-existing treatment for AOCI.

The Bank is also subject to the regulatory framework for prompt corrective action, which identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized) and is based on specified thresholds for each of the three risk-based regulatory capital ratios (CET1, Tier 1 capital and total capital) and for the leverage ratio.

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The Company’s and the Bank’s regulatory capital ratios for the following periods are reflected below:

    

June 30,

    

December 31,

    

June 30,

  

2019

2018

2018

 

South State Corporation:

Common equity Tier 1 risk-based capital

 

11.58

%  

12.05

%  

12.00

%

Tier 1 risk-based capital

 

12.56

%  

13.05

%  

13.00

%

Total risk-based capital

 

13.07

%  

13.56

%  

13.48

%

Tier 1 leverage

 

9.99

%  

10.65

%  

10.62

%

South State Bank:

Common equity Tier 1 risk-based capital

 

12.42

%  

12.87

%  

12.80

%

Tier 1 risk-based capital

 

12.42

%  

12.87

%  

12.80

%

Total risk-based capital

 

12.93

%  

13.38

%  

13.27

%

Tier 1 leverage

 

9.88

%  

10.51

%  

10.46

%

The Tier 1 leverage ratio decreased compared to December 31, 2018 due to the increase in our average assets outpacing the increase in our equity. The CET1 risk-based capital, Tier 1 risk-based capital and total risk-based capital ratios all decreased compared to December 31, 2018 due to our risk-based assets increase outpacing the increase in our equity. The main reason for the lower increase in equity was due our repurchase of 1,141,200 shares of common stock at a cost of $80.1 million through our stock buyback plan in the first half of 2019. The main drivers for the increase in both average and risk-weighted assets was due to loan growth, growth in interest-bearing deposits and in premises equipment from the recording of right of use asset related to the new lease standard. Our capital ratios are currently well in excess of the minimum standards and continue to be in the “well capitalized” regulatory classification.

Liquidity

Liquidity refers to our ability to generate sufficient cash to meet our financial obligations, which arise primarily from the withdrawal of deposits, extension of credit and payment of operating expenses. Our Asset/Liability Management Committee (“ALCO”) is charged with monitoring liquidity management policies, which are designed to ensure acceptable composition of asset/liability mix. Two critical areas of focus for ALCO are interest rate sensitivity and liquidity risk management. We have employed our funds in a manner to provide liquidity from both assets and liabilities sufficient to meet our cash needs.

Asset liquidity is maintained by the maturity structure of loans, investment securities and other short-term investments. Management has policies and procedures governing the length of time to maturity on loans and investments. Normally, changes in the earning asset mix are of a longer-term nature and are not utilized for day-to-day corporate liquidity needs.

Our liabilities provide liquidity on a day-to-day basis. Daily liquidity needs are met from deposit levels or from our use of federal funds purchased, securities sold under agreements to repurchase and other short-term borrowings. We engage in routine activities to retain deposits intended to enhance our liquidity position. These routine activities include various measures, such as the following:

Emphasizing relationship banking to new and existing customers, where borrowers are encouraged and normally expected to maintain deposit accounts with our Bank;
Pricing deposits, including certificates of deposit, at rate levels that will attract and/or retain balances of deposits that will enhance our Bank’s asset/liability management and net interest margin requirements; and
Continually working to identify and introduce new products that will attract customers or enhance our Bank’s appeal as a primary provider of financial services.

Our non-acquired loan portfolio increased by approximately $1.4 billion, or approximately 19.8%, compared to the balance at June 30, 2018, and by $688.0 million, or 17.5% annualized, compared to the balance at December 31, 2018. The acquired loan portfolio decreased by $1.0 billion, or 28.3%, from the balance at June 30, 2018 and by $479.7 million, or 31.4%, annualized, from the balance at December 31, 2018 through principal paydowns, charge-offs, foreclosures and renewals of acquired loans.

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Our investment securities portfolio increased $223.7 million, or 29.2%, annualized, compared to the balance at December 31, 2018, and increased by $168.7 million, or 10.6% compared to the balance at June 30, 2018. Related to the increase in investment securities from December 31, 2018, we had purchases of $487.0 million as well as improvements in the market value of the portfolio of $40.2 million which were partially offset by maturities, calls and paydowns of investment securities totaling $113.0 million and sales totaling $189.4 million during the six months ended June 30, 2019. The increase in investment securities was due to the Company making the strategic decision to increase the size of the portfolio with the excess funds from deposit growth and the increase in other borrowings. In the first and second quarter of 2019, we also sold certain lower yielding legacy securities (mostly mortgage-backed securities) at a loss and reinvested the funds in higher yielding current market securities which also mostly consisted of mortgage-backed securities. The losses on the sales of securities of approximately $3.1 million taken in this restructuring were offset by a gain of $5.4 million that we recorded on the sale of VISA Class B shares. Total cash and cash equivalents were $852.0 million at June 30, 2019 as compared to $409.0 million at December 31, 2018 and $396.8 million at June 30, 2018. We borrowed an additional $550.0 million in FHLB advances in the first half of 2019 as well as total deposits increased $275.3 million which improved liquidity in 2019.

At June 30, 2019, December 31, 2018 and June 30, 2018, we had $3.9 million, $7.6 million and $19.8 million, respectively, in traditional, out-of-market brokered deposits and $56.4 million, $72.2 million, and $64.1 million, respectively, of reciprocal brokered deposits. Total deposits were $11.9 billion at June 30, 2019, up $275.3 million or 4.8% annualized from $11.6 billion at December 31, 2018 and up $284.0 million or 2.4%, from $11.6 billion at June 30, 2018. Our deposit growth since December 31, 2018 included an increase in demand deposit accounts of $194.1 million, in savings and money market accounts of $124.5 million partially offset by declines in interest-bearing transaction accounts of $4.2 million and in certificates of deposit of $39.2 million. Other borrowings increased $550.3 million and $700.7 million, respectively, from December 31, 2018 and June 30, 2018 to $816.4 million. Other borrowings at June 30, 2019 included $700.1 million in FHLB advances compared to $150.1 million at December 31, 2018 and $115,000 at June 30, 2018. We had approximately $115 million in junior subordinated debt at June 30, 2019, December 31, 2018 and March 31, 2018. During the first quarter of 2019, we paid-off early the FHLB advance of $150.0 million that was outstanding at December 31, 2018 that would have matured in December 2019. We then borrowed $500 million in March 2019 and $200 million in June 2019 in 90-day fixed rate FHLB advances for which at this time we plan to continuously renew. At the same time, we entered into interest rate swap agreements with a notional amount of $350 million (4 year agreement) and $350 million (5 year agreement) to manage the interest rate risk related to these 90-day FHLB advances. We borrowed these FHLB advances to provide liquidity for operations, loan growth and investment growth. To the extent that we employ other types of non-deposit funding sources, typically to accommodate retail and correspondent customers, we continue to take in some shorter maturities of such funds.  Our current approach may provide an opportunity to sustain a low funding rate or possibly lower our cost of funds but could also increase our cost of funds if interest rates rise.

Our ongoing philosophy is to remain in a liquid position taking into account our current composition of earning assets, asset quality, capital position, and operating results. Our liquid earning assets include federal funds sold, balances at the Federal Reserve Bank, reverse repurchase agreements, and/or other short-term investments. Cyclical and other economic trends and conditions can disrupt our Bank’s desired liquidity position at any time.  We expect that these conditions would generally be of a short-term nature.  Under such circumstances, our Bank’s federal funds sold position and any balances at the Federal Reserve Bank serve as the primary sources of immediate liquidity.  At June 30, 2019, our Bank had total federal funds credit lines of $606.0 million with no balance outstanding.  If additional liquidity were needed, the Bank would turn to short-term borrowings as an alternative immediate funding source and would consider other appropriate actions such as promotions to increase core deposits or the sale of a portion of our investment portfolio.  At June 30, 2019, our Bank had $391.0 million of credit available at the Federal Reserve Bank’s Discount Window, but had no outstanding advances as of the end of the quarter. In addition, we could draw on additional alternative immediate funding sources from lines of credit extended to us from our correspondent banks and/or the FHLB.  At June 30, 2019, our Bank had a total FHLB credit facility of $1.7 billion with total outstanding FHLB letters of credit consuming $231.1 million, $700.1 million in outstanding advances and $73,000 in credit enhancements from participation in the FHLB’s Mortgage Partnership Finance Program, leaving $723.3 million in availability on the FHLB credit facility. The Company has a $10.0 million unsecured line of credit with U.S. Bank National Association with no outstanding advances. We believe that our liquidity position continues to be adequate and readily available.

Our contingency funding plans incorporate several potential stages based on liquidity levels. Also, we review on at least an annual basis our liquidity position and our contingency funding plans with our principal banking regulator. We maintain various wholesale sources of funding. If our deposit retention efforts were to be unsuccessful, we would

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utilize these alternative sources of funding. Under such circumstances, depending on the external source of funds, our interest cost would vary based on the range of interest rates we are charged. This could increase our cost of funds, impacting net interest margins and net interest spreads.

Deposit and Loan Concentrations

We have no material concentration of deposits from any single customer or group of customers. We have no significant portion of our loans concentrated within a single industry or group of related industries. Furthermore, we attempt to avoid making loans that, in an aggregate amount, exceed 10% of total loans to a multiple number of borrowers engaged in similar business activities. As of June 30, 2019, there were no aggregated loan concentrations of this type. We do not believe there are any material seasonal factors that would have a material adverse effect on us. We do not have foreign loans or deposits.

Concentration of Credit Risk

We consider concentrations of credit to exist when, pursuant to regulatory guidelines, the amounts loaned to a multiple number of borrowers engaged in similar business activities which would cause them to be similarly impacted by general economic conditions represents 25 percent of total risk-based capital, or $373.5 million at June 30, 2019. Based on these criteria, we had three such credit concentrations at June 30, 2019, including loans on hotels and motels of $554.3 million, loans to lessors of nonresidential buildings (except mini-warehouses) of $1.3 billion and loans to lessors of residential buildings (investment properties and multi-family) of $586.5 million. The risk for these loans and for all loans is managed collectively through the use of credit underwriting practices developed and updated over time. The loss estimate for these loans is determined using our standard ALLL methodology.

Banking regulators have established guidelines for the construction, land development and other land loans to total less than 100% of total risk-based capital and for total commercial real estate loans to total less than 300% of total risk-based capital. Both ratios are calculated by dividing certain types of loan balances for each of the two categories by the Bank’s total risk-based capital. At June 30, 2019 , December 31, 2018, and June 30, 2018 the Bank’s construction, land development and other land loans as a percentage of total risk-based capital were 64.7%, 69.5%, and 83.3%, respectively. Commercial real estate loans (which includes construction, land development and other land loans along with other non-owner occupied commercial real estate and multifamily loans) as a percentage of total risk-based capital were 227.4%, 216.0% and 218.5% as of June 30, 2019, December 31, 2018 and June 30, 2018, respectively. As of June 30, 2019, December 31, 2018 and June 30, 2018, the Bank was below the established regulatory guidelines. When a bank’s ratios are in excess of one or both of these commercial real estate loan ratio guidelines, banking regulators generally require an increased level of monitoring in these lending areas by bank management. Therefore, we monitor these two ratios as part of our concentration management processes.

Cautionary Note Regarding Any Forward-Looking Statements

Statements included in this report, which are not historical in nature are intended to be, and are hereby identified as, forward-looking statements for purposes of the safe harbor provided by Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward looking statements are based on, among other things, management’s beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy and South State. Words and phrases such as “may,” “approximately,” “continue,” “should,” “expects,” “projects,” “anticipates,” “is likely,” “look ahead,” “look forward,” “believes,” “will,” “intends,” “estimates,” “strategy,” “plan,” “could,” “potential,” “possible” and variations of such words and similar expressions are intended to identify such forward-looking statements. We caution readers that forward looking statements are subject to certain risks, uncertainties and assumptions that are difficult to predict with regard to, among other things, timing, extent, likelihood and degree of occurrence, which could cause actual results to differ materially from anticipated results. Such risks, uncertainties and assumptions, include, among others, the matters described in Item 1A. Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2018, and the following:

Economic downturn risk, potentially resulting in deterioration in the credit markets, greater than expected noninterest expenses, excessive loan losses and other negative consequences, which risks could be exacerbated by potential negative economic developments resulting from federal spending cuts and/or one or more federal budget-related impasses or actions;
Increased expenses, loss of revenues, and increased regulatory scrutiny associated with our total assets having

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exceeded $10.0 billion;
Controls and procedures risk, including the potential failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures;
Ownership dilution risk associated with potential acquisitions in which South State’s stock may be issued as consideration for an acquired company;
Potential deterioration in real estate values;
The impact of competition with other financial institutions, including pricing pressures (including those resulting from the Tax Cuts and Jobs Act) and the resulting impact, including as a result of compression to net interest margin;
Credit risks associated with an obligor’s failure to meet the terms of any contract with the bank or otherwise fail to perform as agreed under the terms of any loan-related document;
Interest risk involving the effect of a change in interest rates on the bank’s earnings, the market value of the bank’s loan and securities portfolios, and the market value of South State’s equity;
Liquidity risk affecting the bank’s ability to meet its obligations when they come due;
Risks associated with an anticipated increase in South State’s investment securities portfolio, including risks associated with acquiring and holding investment securities or potentially determining that the amount of investment securities South State desires to acquire are not available on terms acceptable to South State;
Price risk focusing on changes in market factors that may affect the value of traded instruments in “mark-to-market” portfolios;
Transaction risk arising from problems with service or product delivery;
Compliance risk involving risk to earnings or capital resulting from violations of or nonconformance with laws, rules, regulations, prescribed practices, or ethical standards;
Risks associated with actual or potential litigation or investigations by customers, regulatory agencies or others;
Regulatory change risk resulting from new laws, rules, regulations, accounting principles, proscribed practices or ethical standards, including, without limitation, the possibility that regulatory agencies may require higher levels of capital above the current regulatory-mandated minimums and including the impact of the recently enacted Tax Cuts and Jobs Act, the Consumer Financial Protection Bureau rules and regulations, and the possibility of changes in accounting standards, policies, principles and practices, including changes in accounting principles relating to loan loss recognition (CECL);
Strategic risk resulting from adverse business decisions or improper implementation of business decisions;
Reputation risk that adversely affects earnings or capital arising from negative public opinion;
Terrorist activities risk that results in loss of consumer confidence and economic disruptions;
Cybersecurity risk related to the dependence of South State on internal computer systems and the technology of outside service providers, as well as the potential impacts of third-party security breaches, subjects each company to potential business disruptions or financial losses resulting from deliberate attacks or unintentional events;
Greater than expected noninterest expenses;
Noninterest income risk resulting from the effect of regulations that prohibit or restrict the charging of fees on paying overdrafts on ATM and one-time debit card transactions;
Excessive loan losses;
Failure to realize synergies and other financial benefits from, and to limit liabilities associated with, mergers and acquisitions within the expected time frame;
Potential deposit attrition, higher than expected costs, customer loss and business disruption associated with merger and acquisition integration, including, without limitation, and potential difficulties in maintaining relationships with key personnel;
The risks of fluctuations in market prices for South State common stock that may or may not reflect economic condition or performance of South State;
The payment of dividends on South State common stock is subject to regulatory supervision as well as the discretion of the board of directors of South State, South State’s performance and other factors;
Operational, technological, cultural, regulatory, legal, credit and other risks associated with the exploration, consummation and integration of potential future acquisition, whether involving stock or cash consideration; and
Other risks and uncertainties disclosed in South State’s most recent Annual Report on Form 10-K filed with the SEC or disclosed in documents filed or furnished by South State with or to the SEC after the filing of such Annual Reports on Form 10-K, and of which could cause actual results to differ materially from future results expressed, implied or otherwise anticipated by such forward-looking statements.

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Additional information with respect to factors that may cause actual results to differ materially from those contemplated by our forward-looking statements may also be included in other reports that we file with the SEC. We caution that the foregoing list of risk factors is not exclusive and not to place undue reliance on forward-looking statements.

For any forward-looking statements made in this Quarterly Report on Form 10-Q or in any documents incorporated by reference into this Quarterly Report on Form 10-Q, we claim the protection of the safe harbor for forward looking statements contained in the Private Securities Litigation Reform Act of 1995. Such forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q or the date of any document incorporated by reference in Quarterly Report on Form 10-Q. We do not undertake to update forward looking statements to reflect facts, circumstances, assumptions or events that occur after the date the forward-looking statements are made. All subsequent written and oral forward looking statements by us or any person acting on its behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this Quarterly Report on Form 10-Q.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes in our quantitative and qualitative disclosures about market risk as of June 30, 2019 from those disclosures presented in our Annual Report on Form 10-K for the year ended December 31, 2018.

Item 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance regarding our control objective that information required to be disclosed in the reports we file and submit under the Exchange Act is (i) recorded, processed, summarized and reported as and when required and (ii) accumulated and communicated to our management, including our Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

Changes in Internal Control over Financial Reporting

There has been no change in our internal control over financial reporting during the three months ended June 30, 2019, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

As of June 30, 2019 and the date of this Quarterly Report on Form 10-Q, we believe that we are not party to, nor is any or our property the subject of, any pending material legal proceeding other than those that may occur in the ordinary course of our business.

Item 1A. RISK FACTORS

Investing in shares of our common stock involves certain risks, including those identified and described in Item 1A. of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, as well as cautionary statements contained in this Quarterly Report on Form 10-Q, including those under the caption “Cautionary Note Regarding Any

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Forward-Looking Statements” set forth in Part I, Item 2 of this Quarterly Report on Form 10-Q, risks and matters described elsewhere in this Quarterly Report on Form 10-Q and in our other filings with the SEC.

There have been no material changes to the risk factors disclosed in Item 1A. of Part I in our Annual Report on Form 10-K for the year ended December 31, 2018.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(a)Not applicable
(b)Not applicable
(c)Issuer Purchases of Registered Equity Securities:

In February 2004, we announced a program with no formal expiration date to repurchase up to 250,000 of our common shares. In March 2017, the Board of Directors approved and reset the number of shares available to be repurchased under the 2004 stock repurchase program to 1,000,000, all of which had been repurchased as of December 31, 2018. In January 2019, the Board of Directors approved a new program (“2019 stock repurchase program”) to repurchase up to an additional 1,000,000 of our common shares, all of which had been repurchased as of June 30, 2019. In June 2019, the Board of Directors authorized an additional 2,000,000 of our common shares to be repurchased under the 2019 repurchase program. We are not obligated to repurchase any additional shares under the 2019 repurchase program, and any repurchases under the 2019 stock repurchase program after June 6, 2020 would require additional Federal Reserve approval. As of the date of this filing, we have repurchased 141,200 shares of the 2,000,000 approved in June 2019 at an average price per share of $72.56. The following table reflects share repurchase activity during the second quarter of 2019:

    

    

    

    

(d) Maximum

 

(c) Total

Number (or

 

Number of

Approximate

 

Shares (or

Dollar Value) of

 

Units)

Shares (or

 

(a) Total

Purchased as

Units) that May

 

Number of

Part of Publicly

Yet Be

 

Shares (or

(b) Average

Announced

Purchased

 

Units)

Price Paid per

Plans or

Under the Plans

 

Period

Purchased

Share (or Unit)

Programs

or Programs

 

April 1 - April 30

 

5,629

*

$

74.46

 

 

500,000

**

May 1 - May 31

 

250,181

*

 

75.15

 

250,000

 

250,000

**

June 1 - June 30

 

391,381

*

 

71.29

 

391,200

 

1,858,800

**

Total

 

647,191

 

641,200

 

1,858,800

**

*

For the months ended April 30, 2019, May 31, 2019 and June 30, 2019, total includes 5,629 shares, 181 shares and 181 shares, respectively, that were repurchased under arrangements, authorized by our stock-based compensation plans and Board of Directors, whereby officers or directors may sell previously owned shares to the Company in order to pay for the exercises of stock options or for income taxes owed on vesting shares of restricted stock. These shares were not purchased under the 2004 or 2019 stock repurchase programs to repurchase shares.

**

In June 2019, the Company completed the repurchase of all 1,000,000 of our common shares that had been approved under the 2019 stock repurchase program in January 2019. In June 2019 the Board of Directors authorized another 2,000,000 to be repurchased under the 2019 stock repurchase program of which 141,200 shares had been purchased as of June 30, 2019.

Item 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

Item 4. MINE SAFETY DISCLOSURES

Not applicable.

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Item 5. OTHER INFORMATION

Not applicable.

Item 6. EXHIBITS

The exhibits required to be filed as part of this Quarterly Report on Form 10-Q are listed in the Exhibit Index attached hereto and are incorporated by reference.

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Exhibit Index

Exhibit No.

    

Description

Exhibit 31.1

Rule 13a-14(a) Certification of Principal Executive Officer

Exhibit 31.2

Rule 13a-14(a) Certification of Principal Financial Officer

Exhibit 32

Section 1350 Certifications of Principal Executive Officer and Principal Financial Officer

Exhibit 101

The following financial statements from the Quarterly Report on Form 10-Q of South State Corporation for the quarter ended June 30, 2019, formatted in iXBRL (Inline eXtensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Income, (iii) Condensed Consolidated Statements of Comprehensive Income, (iv) Condensed Consolidated Statements of Changes in Shareholders’ Equity, (v) Condensed Consolidated Statement of Cash Flows and (vi) Notes to Condensed Consolidated Financial Statements.

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

SOUTH STATE CORPORATION

(Registrant)

Date: August 2, 2019

/s/ Robert R. Hill, Jr.

Robert R. Hill, Jr.

Chief Executive Officer

(Principal Executive Officer)

Date: August 2, 2019

/s/ John C. Pollok

John C. Pollok

Senior Executive Vice President,

Chief Financial Officer

(Principal Financial Officer)

Date: August 2, 2019

/s/ Keith S. Rainwater

Keith S. Rainwater

Executive Vice President and

Principal Accounting Officer

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