UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
OR
Commission File Number: 0-13358
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 x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
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 definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 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 o No x
At April 30, 2014, 17,426,654 shares of the Registrant’s Common Stock, $.01 par value, were outstanding.
CAPITAL CITY BANK GROUP, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2014
TABLE OF CONTENTS
INTRODUCTORY NOTE
Caution Concerning Forward-Looking Statements
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, among others, statements about our beliefs, plans, objectives, goals, expectations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors, many of which are beyond our control. The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” “target,” “goal,” and similar expressions are intended to identify forward-looking statements.
All forward-looking statements, by their nature, are subject to risks and uncertainties. Our actual future results may differ materially from those set forth in our forward-looking statements.
Our ability to achieve our financial objectives could be adversely affected by the factors discussed in detail in Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Part II, Item 1A. “Risk Factors” in this Quarterly Report on Form 10-Q and the following sections of our Annual Report on Form 10-K for the year ended December 31, 2013 (the “2013 Form 10-K”): (a) “Introductory Note” in Part I, Item 1. “Business”; (b) “Risk Factors” in Part I, Item 1A, as updated in our subsequent quarterly reports filed on Form 10-Q; and (c) “Introduction” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in Part II, Item 7, as well as:
However, other factors besides those listed in Item 1A Risk Factorsor discussed in this Form 10-Q also could adversely affect our results, and you should not consider any such list of factors to be a complete set of all potential risks or uncertainties. Any forward-looking statements made by us or on our behalf speak only as of the date they are made. We do not undertake to update any forward-looking statement, except as required by applicable law.
PART I. FINANCIAL INFORMATION
Item 1. CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREOWNERS’ EQUITY
(Dollars In Thousands, Except Share Data)
CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations. Capital City Bank Group, Inc. (“CCBG” or the “Company”) provides a full range of banking and banking-related services to individual and corporate clients through its subsidiary, Capital City Bank, with banking offices located in Florida, Georgia, and Alabama. The Company is subject to competition from other financial institutions, is subject to regulation by certain government agencies and undergoes periodic examinations by those regulatory authorities.
Basis of Presentation. The consolidated financial statements in this Quarterly Report on Form 10-Q include the accounts of CCBG and its wholly-owned subsidiary, Capital City Bank (“CCB” or the “Bank” and together with the Company). All material inter-company transactions and accounts have been eliminated.
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles 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 footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2014 are not necessarily indicative of the results that may be expected for the year ended December 31, 2014.
The consolidated statement of financial condition at December 31, 2013 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.
For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2013.
NOTE 2 – INVESTMENT SECURITIES
Investment Portfolio Composition. The amortized cost and related market value of investment securities available-for-sale were as follows:
Securities with an amortized cost of $252.4 million and $258.5 million at March 31, 2014 and December 31, 2013, respectively, were pledged to secure public deposits and for other purposes.
The Bank, as a member of the Federal Home Loan Bank of Atlanta (“FHLB”), is required to own capital stock in the FHLB based generally upon the balances of residential and commercial real estate loans, and FHLB advances. FHLB stock which is included in other securities is pledged to secure FHLB advances. No ready market exists for this stock, and it has no quoted market value; however, redemption of this stock has historically been at par value.
Maturity Distribution. As of March 31, 2014, the Company’s investment securities had the following maturity distribution based on contractual maturity. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations. Mortgage-backed securities and certain amortizing U.S. government agency securities are shown separately because they are not due at a certain maturity date.
Unrealized Losses on Investment Securities. The following table summarizes the investment securities with unrealized losses at March 31, 2014, aggregated by major security type and length of time in a continuous unrealized loss position:
Management evaluates securities for other than temporary impairment at least quarterly, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to: 1) the length of time and the extent to which the fair value has been less than amortized cost, 2) the financial condition and near-term prospects of the issuer, and 3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in cost. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by rating agencies have occurred, regulatory issues, and analysts’ reports.
Approximately $7.4 million of investment securities, with an unrealized loss of approximately $57,000, have been in a loss position for greater than 12 months. These debt securities are in a loss position because they were acquired when the general level of interest rates was lower than that on March 31, 2014. The Company believes that the unrealized losses in these debt securities are temporary in nature and that the full principal will be collected as anticipated. Because the declines in the market value of these investments are attributable to changes in interest rates and not credit quality and because the Company has the present ability and intent to hold these investments until there is a recovery in fair value, which may be at maturity, the Company does not consider these investments to be other-than-temporarily impaired at March 31, 2014.
NOTE 3 – LOANS, NET
Loan Portfolio Composition. The composition of the loan portfolio was as follows:
Net deferred fees included in loans were $1.5 million at March 31, 2014 and December 31, 2013.
The Company has pledged a blanket floating lien on all 1-4 family residential mortgage loans, commercial real estate mortgage loans, and home equity loans to support available borrowing capacity at the FHLB of Atlanta and has pledged a blanket floating lien on all consumer loans, commercial loans, and construction loans to support available borrowing capacity at the Federal Reserve Bank of Atlanta.
Nonaccrual Loans. Loans are generally placed on nonaccrual status if principal or interest payments become 90 days past due and/or management deems the collectability of the principal and/or interest to be doubtful. Loans are returned to accrual status when the principal and interest amounts contractually due are brought current or when future payments are reasonably assured.
The following table presents the recorded investment in nonaccrual loans and loans past due over 90 days and still on accrual by class of loans.
Loan Portfolio Aging. A loan is defined as a past due loan when one full payment is past due or a contractual maturity is over 30 days past due (“DPD”).
The following table presents the aging of the recorded investment in past due loans by class of loans.
(Dollars in Thousands)
Allowance for Loan Losses. The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses within the existing portfolio of loans. Loans are charged-off to the allowance when losses are deemed to be probable and reasonably quantifiable.
The following table details the activity in the allowance for loan losses by portfolio class. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.
The following table details the amount of the allowance for loan losses by portfolio class disaggregated on the basis of the Company’s impairment methodology.
The Company’s recorded investment in loans related to each balance in the allowance for loan losses by portfolio class and disaggregated on the basis of the Company’s impairment methodology was as follows:
Impaired Loans. Loans are deemed to be impaired when, based on current information and events, it is probable that the Company will not be able to collect all amounts due (principal and interest payments), according to the contractual terms of the loan agreement. Loans, for which the terms have been modified, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.
The following table presents loans individually evaluated for impairment by class of loans.
The following table summarizes the average recorded investment and interest income recognized by class of impaired loans.
Credit Risk Management. The Company has adopted comprehensive lending policies, underwriting standards and loan review procedures designed to maximize loan income within an acceptable level of risk. Management and the Board of Directors review and approve these policies and procedures on a regular basis (at least annually).
Reporting systems have been implemented to monitor loan originations, loan quality, concentrations of credit, loan delinquencies and nonperforming loans and potential problem loans. Management and the Credit Risk Oversight Committee periodically review our lines of business to monitor asset quality trends and the appropriateness of credit policies. In addition, total borrower exposure limits are established and concentration risk is monitored. As part of this process, the overall composition of the portfolio is reviewed to gauge diversification of risk, client concentrations, industry group, loan type, geographic area, or other relevant classifications of loans. Specific segments of the loan portfolio are monitored and reported to the Board on a quarterly basis and have strategic plans in place to supplement Board approved credit policies governing exposure limits and underwriting standards. Detailed below are the types of loans within the Company’s loan portfolio and risk characteristics unique to each.
Commercial, Financial, and Agricultural – Loans in this category are primarily made based on identified cash flows of the borrower with consideration given to underlying collateral and personal or other guarantees. Lending policy establishes debt service coverage ratio limits that require a borrower’s cash flow to be sufficient to cover principal and interest payments on all new and existing debt. The majority of these loans are secured by the assets being financed or other business assets such as accounts receivable, inventory, or equipment. Collateral values are determined based upon third party appraisals and evaluations. Loan to value ratios at origination are governed by established policy guidelines.
Real Estate Construction – Loans in this category consist of short-term construction loans, revolving and non-revolving credit lines and construction/permanent loans made to individuals and investors to finance the acquisition, development, construction or rehabilitation of real property. These loans are primarily made based on identified cash flows of the borrower or project and generally secured by the property being financed, including 1-4 family residential properties and commercial properties that are either owner-occupied or investment in nature. These properties may include either vacant or improved property. Construction loans are generally based upon estimates of costs and value associated with the completed project. Collateral values are determined based upon third party appraisals and evaluations. Loan to value ratios at origination are governed by established policy guidelines. The disbursement of funds for construction loans is made in relation to the progress of the project and as such these loans are closely monitored by on-site inspections.
Real Estate Commercial Mortgage – Loans in this category consists of commercial mortgage loans secured by property that is either owner-occupied or investment in nature. These loans are primarily made based on identified cash flows of the borrower or project with consideration given to underlying real estate collateral and personal guarantees. Lending policy establishes debt service coverage ratios and loan to value ratios specific to the property type. Collateral values are determined based upon third party appraisals and evaluations.
Real Estate Residential – Residential mortgage loans held in the Company’s loan portfolio are made to borrowers that demonstrate the ability to make scheduled payments with full consideration to underwriting factors such as current income, employment status, current assets, and other financial resources, credit history, and the value of the collateral. Collateral consists of mortgage liens on 1-4 family residential properties. Collateral values are determined based upon third party appraisals and evaluations. The Company does not originate sub-prime loans.
Real Estate Home Equity – Home equity loans and lines are made to qualified individuals and are generally secured by senior or junior mortgage liens on owner-occupied 1-4 family homes or vacation homes. Borrower qualifications include favorable credit history combined with supportive income and debt ratio requirements and combined loan to value ratios within established policy guidelines. Collateral values are determined based upon third party appraisals and evaluations.
Consumer Loans – This loan portfolio includes personal installment loans, direct and indirect automobile financing, and overdraft lines of credit. The majority of the consumer loan portfolio consists of indirect and direct automobile loans. Lending policy establishes maximum debt to income ratios, minimum credit scores, and includes guidelines for verification of applicants’ income and receipt of credit reports.
Credit Quality Indicators. As part of the ongoing monitoring of the Company’s loan portfolio quality, management categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment performance, credit documentation, and current economic/market trends, among other factors. Risk ratings are assigned to each loan and revised as needed through established monitoring procedures for individual loan relationships over a predetermined amount and review of smaller balance homogenous loan pools. The Company uses the definitions noted below for categorizing and managing its criticized loans. Loans categorized as “Pass” do not meet the criteria set forth for the Special Mention, Substandard, or Doubtful categories and are not considered criticized.
Special Mention – Loans in this category are presently protected from loss, but weaknesses are apparent which, if not corrected, could cause future problems. Loans in this category may not meet required underwriting criteria and have no mitigating factors. More than the ordinary amount of attention is warranted for these loans.
Substandard – Loans in this category exhibit well-defined weaknesses that would typically bring normal repayment into jeopardy. These loans are no longer adequately protected due to well-defined weaknesses that affect the repayment capacity of the borrower. The possibility of loss is much more evident and above average supervision is required for these loans.
Doubtful – Loans in this category have all the weaknesses inherent in a loan categorized as Substandard, with the characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
The following table presents the risk category of loans by segment.
Troubled Debt Restructurings (“TDRs”). TDRs are loans in which the borrower is experiencing financial difficulty and the Company has granted an economic concession to the borrower that it would not otherwise consider. In these instances, as part of a work-out alternative, the Company will make concessions including the extension of the loan term, a principal moratorium, a reduction in the interest rate, or a combination thereof. The impact of the TDR modifications and defaults are factored into the allowance for loan losses on a loan-by-loan basis as all TDRs are, by definition, impaired loans. Thus, specific reserves are established based upon the results of either a discounted cash flow analysis or the underlying collateral value, if the loan is deemed to be collateral dependent. In the limited circumstances that a loan is removed from TDR classification it is the Company’s policy to also remove it from the impaired loan category, but to continue to individually evaluate loan impairment based on the contractual terms specified by the loan agreement.
The following table presents loans classified as TDRs.
Loans classified as TDRs during the periods indicated are presented in the table below. The modifications made during the reporting period involved either an extension of the loan term or a principal moratorium and the financial impact of these modifications was not material.
Loans modified as TDRs within the previous 12 months that have subsequently defaulted during the periods indicated are presented in the table below.
Recorded
Investment(1)
The following table provides information on how TDRs were modified during the periods indicated.
(1)Recorded investment reflects charge-offs and additional funds advanced at time of restructure, if applicable.
NOTE 4 - INTANGIBLE ASSETS
The Company had net intangible assets of $84.8 million at March 31, 2014 and December 31, 2013, respectively. Intangible assets were as follows:
Goodwill: As of March 31, 2014 and December 31, 2013, the Company had goodwill, net of accumulated amortization, of $84.8 million. Goodwill is tested for impairment on an annual basis, or more often if impairment indicators exist. A goodwill impairment test consists of two steps. Step One compares the estimated fair value of the reporting unit to its carrying amount. If the carrying amount exceeds the estimated fair value, Step Two is performed by comparing the fair value of the reporting unit’s implied goodwill to the carrying value of goodwill. If the carrying value of the reporting unit’s goodwill exceeds the estimated fair value, an impairment charge is recorded equal to the excess.
As of March 31, 2014, the Company’s net book value, including goodwill, exceeded its market capitalization, and as such, the Company performed goodwill impairment testing. The Step One test indicated that the carrying amount (including goodwill) of the Company’s reporting unit was less than its estimated fair value, therefore, no impairment was recorded. The Company will continue to evaluate goodwill for impairment as defined by ASC Topic 350.
NOTE 5 – OTHER REAL ESTATE OWNED
The following table presents other real estate owned activity for the periods indicated.
Net expenses applicable to other real estate owned include the following:
NOTE 6 - DEPOSITS
The composition of the Company’s interest bearing deposits were as follows:
NOTE 7 - EMPLOYEE BENEFIT PLANS
The Company has a defined benefit pension plan covering substantially all full-time and eligible part-time associates and a Supplemental Executive Retirement Plan (“SERP”) covering its executive officers.
The components of the net periodic benefit costs for the Company’s qualified benefit pension plan were as follows:
The components of the net periodic benefit costs for the Company’s SERP were as follows:
NOTE 8 - COMMITMENTS AND CONTINGENCIES
Lending Commitments. The Company is a party to financial instruments with off-balance sheet risks in the normal course of business to meet the financing needs of its clients. These financial instruments consist of commitments to extend credit and standby letters of credit.
The Company’s maximum exposure to credit loss under standby letters of credit and commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in establishing commitments and issuing letters of credit as it does for on-balance sheet instruments. The amounts associated with the Company’s off-balance sheet obligations were as follows:
Commitments to extend credit are agreements to lend to a client so long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a client to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities. In general, management does not anticipate any material losses as a result of participating in these types of transactions. However, any potential losses arising from such transactions are reserved for in the same manner as management reserves for its other credit facilities.
For both on- and off-balance sheet financial instruments, the Company requires collateral to support such instruments when it is deemed necessary. The Company evaluates each client’s creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management’s credit evaluation of the counterparty. Collateral held varies, but may include deposits held in financial institutions; U.S. Treasury securities; other marketable securities; real estate; accounts receivable; property, plant and equipment; and inventory.
Contingencies. The Company is a party to lawsuits and claims arising out of the normal course of business. In management’s opinion, there are no known pending claims or litigation, the outcome of which would, individually or in the aggregate, have a material effect on the consolidated results of operations, financial position, or cash flows of the Company.
Indemnification Obligation. The Company is a member of the Visa U.S.A. network. Visa U.S.A believes that its member banks are required to indemnify it for potential future settlement of certain litigation (the “Covered Litigation”) that relates to several antitrust lawsuits challenging the practices of Visa and MasterCard International. In 2008, the Company, as a member of the Visa U.S.A. network, obtained Class B shares of Visa, Inc. upon its initial public offering. Since its initial public offering, Visa, Inc. has funded a litigation reserve for the Covered Litigation resulting in a reduction in the Class B shares held by the Company. During the first quarter of 2011, the Company sold its remaining Class B shares resulting in a $3.2 million pre-tax gain. Associated with this sale, the Company entered into a swap contract with the purchaser of the shares that requires a payment to the counterparty in the event that Visa, Inc. makes subsequent revisions to the conversion ratio for its Class B shares.
In December 2013, a settlement agreement was approved by the court in resolution of the aforementioned Covered Litigation matter. Visa’s share of the settlement is to be paid from the litigation reserve account. Based on the aforementioned settlement agreement, the Company does not expect to make any additional payments to the counterparty other than certain fixed charges included in the liability, which are payable quarterly until the litigation reserve is fully liquidated and at which time the aforementioned swap contract will be terminated. Quarterly payments average approximately $50,000. Conversion ratio payments and ongoing fixed quarterly charges are reflected in earnings in the period incurred.
NOTE 9 – FAIR VALUE MEASUREMENTS
The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. ASC Topic 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Securities Available for Sale. U.S. Treasury securities and certain U.S. Government Agency securities are reported at fair value utilizing Level 1 inputs. Other securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, credit information and the bond’s terms and conditions, among other things.
In general, the Company does not purchase securities that have a complicated structure. The Company’s entire portfolio consists of traditional investments, nearly all of which are U.S. Treasury obligations, federal agency bullet or mortgage pass-through securities, or general obligation or revenue based municipal bonds. Pricing for such instruments is easily obtained. From time to time, the Company will validate, on a sample basis, prices supplied by the independent pricing service by comparison to prices obtained from third-party sources or derived using internal models.
Fair Value Swap. The Company entered into a stand-alone derivative contract with the purchaser of its Visa Class B shares. The valuation represents an internally developed estimate of the exposure based upon probability-weighted potential Visa litigation losses and related carrying cost obligations required under the contract.
A summary of fair values for assets and liabilities consisted of the following:
Assets Measured at Fair Value on a Non-Recurring Basis
Certain assets are measured at fair value on a non-recurring basis (i.e., the assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances). An example would be assets exhibiting evidence of impairment). The following is a description of valuation methodologies used for assets measured on a non-recurring basis.
Impaired Loans. Impairment for collateral dependent loans is measured using the fair value of the collateral less selling costs. The fair value of collateral is determined by an independent valuation or professional appraisal in conformance with banking regulations. Collateral values are estimated using Level 3 inputs due to the volatility in the real estate market, and the judgment and estimation involved in the real estate appraisal process. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly. Valuation techniques are consistent with those techniques applied in prior periods. Impaired collateral dependent loans had a carrying value of $31.4 million with a valuation allowance of $3.5 million at March 31, 2014 and $31.5 million and $3.1 million, respectively, at December 31, 2013.
Loans Held for Sale. These loans are carried at the lower of cost or fair value and are adjusted to fair value on a non-recurring basis. Fair value is based on observable markets rates for comparable loan products, which is considered a Level 2 fair value measurement.
Other Real Estate Owned. During the first three months of 2014, certain foreclosed assets, upon initial recognition, were measured and reported at fair value through a charge-off to the allowance for loan losses based on the fair value of the foreclosed asset less estimated cost to sell. The fair value of the foreclosed asset is determined by an independent valuation or professional appraisal in conformance with banking regulations. On an ongoing basis, we obtain updated appraisals on foreclosed assets and realize valuation adjustments as necessary. The fair value of foreclosed assets is estimated using Level 3 inputs due to the judgment and estimation involved in the real estate valuation process.
Assets and Liabilities Disclosed at Fair Value
The Company is required to disclose the estimated fair value of financial instruments, both assets and liabilities, for which it is practical to estimate fair value and the following is a description of valuation methodologies used for those assets and liabilities.
Cash and Short-Term Investments. The carrying amount of cash and short-term investments is used to approximate fair value, given the short time frame to maturity and as such assets do not present unanticipated credit concerns.
Securities Held to Maturity. Securities held to maturity are valued in accordance with the methodology previously noted in this footnote under the caption “Assets and Liabilities Measured at Fair Value on a Recurring Basis – Securities Available for Sale”.
Loans. The loan portfolio is segregated into categories and the fair value of each loan category is calculated using present value techniques based upon projected cash flows and estimated discount rates that reflect the credit, interest rate, and liquidity risks inherent in each loan category. The calculated present values are then reduced by an allocation of the allowance for loan losses against each respective loan category.
Deposits. The fair value of Noninterest Bearing Deposits, NOW Accounts, Money Market Accounts and Savings Accounts are the amounts payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using present value techniques and rates currently offered for deposits of similar remaining maturities.
Subordinated Notes Payable. The fair value of each note is calculated using present value techniques, based upon projected cash flows and estimated discount rates as well as rates being offered for similar obligations.
Short-Term and Long-Term Borrowings. The fair value of each note is calculated using present value techniques, based upon projected cash flows and estimated discount rates as well as rates being offered for similar debt.
A summary of estimated fair values of significant financial instruments consisted of the following:
All non-financial instruments are excluded from the above table. The disclosures also do not include certain intangible assets such as client relationships, deposit base intangibles and goodwill. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
NOTE 10 – OTHER COMPREHENSIVE INCOME (LOSS)
The amounts allocated to other comprehensive income (loss) are presented in the table below. Reclassification adjustments related to securities held for sale are included in net gain (loss) on securities transactions in the accompanying consolidated statements of comprehensive income. For the periods presented, reclassifications adjustments related to securities held for sale was not material.
Accumulated other comprehensive loss was comprised of the following components:
NOTE 11 – ACCOUNTING STANDARDS UPDATES
ASU 2014-01 “Investments – Equity Method and Joint Ventures (Topic 323) – Accounting for Investments in Qualified Affordable Housing Projects.”ASU 2014-01 provides guidance related to the accounting for investments in qualified affordable housing projects. The guidance allows the holder of low income housing tax credit (“LIHTC”) investments to apply a proportional amortization method that would recognize the cost of the investment as a part of income tax expense, provided that the investment meets certain criteria. The guidance is silent regarding statement of financial position classification, although it would not be appropriate to classify the investment as a deferred tax asset. The decision to apply the proportional amortization method is an accounting policy election. Entities may also elect to continue to account for these investments using the equity method. The guidance will be applied retrospectively and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014. Early adoption is permitted. The Company does not believe this pronouncement will have a significant impact on its financial statements.
ASU 2014-04 “Receivables – Troubled Debt Restructurings by Creditors (Topic 310-40) – Reclassification of Residential Real Estate Collateralized Consumer Loans Upon Foreclosure.”ASU 2014-04 provides guidance regarding the reclassification of residential real estate collateralized consumer mortgage loans upon foreclosures. The guidance requires reclassification of a consumer mortgage loan to other real estate owned upon obtaining legal title to the residential property, which could occur either through foreclosure or through a deed in lieu of foreclosure or similar legal agreement. The existence of a borrower redemption right will not prevent the lender from reclassifying a loan to real estate once the lender obtains legal title to the property. In addition, entities are required to disclose the amount of foreclosed residential real estate properties and the recorded investment in residential real estate mortgage loans in the process of foreclosure on both an interim and annual basis. The guidance may be applied prospectively or on a modified retrospective basis in fiscal years, and interim periods within those fiscal years, beginning after December 15, 2014. Early adoption is permitted. The Company is in the process of reviewing the potential impact the adoption of this guidance will have to its financial statements.
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s discussion and analysis (“MD&A”) provides supplemental information, which sets forth the major factors that have affected our financial condition and results of operations and should be read in conjunction with the Consolidated Financial Statements and related notes. The following information should provide a better understanding of the major factors and trends that affect our earnings performance and financial condition, and how our performance during 2014 compares with prior years. Throughout this section, Capital City Bank Group, Inc., and subsidiaries, collectively, are referred to as “CCBG,” “Company,” “we,” “us,” or “our.”
The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q.
CAUTION CONCERNING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, including this MD&A section, contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, among others, statements about our beliefs, plans, objectives, goals, expectations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors, many of which are beyond our control. The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” “target,” “goal,” and similar expressions are intended to identify forward-looking statements.
All forward-looking statements, by their nature, are subject to risks and uncertainties. Our actual future results may differ materially from those set forth in our forward-looking statements. Please see the Introductory Note and Item 1A. Risk Factors of our 2013 Report on Form 10-K, as updated in our subsequent quarterly reports filed on Form 10-Q, and in our other filings made from time to time with the SEC after the date of this report.
However, other factors besides those listed in our Quarterly Report or in our Annual Report also could adversely affect our results, and you should not consider any such list of factors to be a complete set of all potential risks or uncertainties. Any forward-looking statements made by us or on our behalf speak only as of the date they are made. We do not undertake to update any forward-looking statement, except as required by applicable law.
BUSINESS OVERVIEW
We are a bank holding company headquartered in Tallahassee, Florida, and we are the parent of our wholly-owned subsidiary, Capital City Bank (the “Bank” or “CCB”). The Bank offers a broad array of products and services through a total of 63 full-service offices located in Florida, Georgia, and Alabama. The Bank offers commercial and retail banking services, as well as trust and asset management, retail securities brokerage and data processing services.
Our profitability, like most financial institutions, is dependent to a large extent upon net interest income, which is the difference between the interest and fees received on earning assets, such as loans and securities, and the interest paid on interest-bearing liabilities, principally deposits and borrowings. Results of operations are also affected by the provision for loan losses, operating expenses such as salaries and employee benefits, occupancy and other operating expenses including income taxes, and noninterest income such as deposit fees, wealth management fees, mortgage banking fees, bank card fees, and data processing fees.
A detailed discussion regarding the economic conditions in our markets and our long-term strategic objectives is included as part of the MD&A section of our 2013 Form 10-K.
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
FINANCIAL OVERVIEW
A summary overview of our financial performance is provided below.
Results of Operations
Financial Condition
RESULTS OF OPERATIONS
Net Income
For the first quarter of 2014, we realized net income of $3.8 million, or $0.22 per diluted share compared to net income of $2.8 million, or $0.16 per diluted share for the fourth quarter of 2013, and net income of $0.8 million, or $0.05 per diluted share for the first quarter of 2013.
Compared to the fourth quarter of 2013, performance reflects lower noninterest expense of $1.3 million and income taxes of $1.4 million, partially offset by lower net interest income of $0.7 million and noninterest income of $1.0 million.
Compared to the first quarter of 2013, the increase in earnings was due to lower noninterest expense of $2.8 million, a lower loan loss provision of $0.7 million, and a reduction in income taxes of $1.8 million, partially offset by lower net interest income of $1.6 million and noninterest income of $0.7 million.
A condensed earnings summary of each major component of our financial performance is provided below:
Net Interest Income
Net interest income represents our single largest source of earnings and is equal to interest income and fees generated by earning assets, less interest expense paid on interest bearing liabilities. This information is provided on a “taxable equivalent” basis to reflect the tax-exempt status of income earned on certain loans and investments, the majority of which are state and local government debt obligations. We provide an analysis of our net interest income including average yields and rates in Table I on page 39.
Tax equivalent net interest income for the first quarter of 2014 was $18.4 million compared to $19.1 million for the fourth quarter of 2013 and $20.1 million for the first quarter of 2013. The decrease in tax equivalent net interest income compared to the prior periods was due to a reduction in loan income primarily attributable to declining loan balances and continued unfavorable asset repricing, partially offset by a reduction in interest expense. The lower interest expense is attributable to favorable repricing on FHLB advances and certificates of deposit, which reflected both lower balances and favorable repricing.
The decline in the loan portfolio, coupled with the low rate environment continues to put downward pressure on our net interest income. The loan portfolio yield has been declining because the average rate on new loans is lower than the loans being paid off and the existing adjustable rate loans are repricing lower. Lowering our cost of funds, to the extent we can, and continuing to shift the mix of our deposits will help to partially mitigate the unfavorable impact of weak loan demand and repricing, although any further impact is expected to be minimal.
The net interest margin for the first quarter of 2014 was 3.29%, a decrease of 16 basis points from the fourth quarter of 2013 and a decline of 35 basis points from the first quarter of 2013. The shift in interest earning asset mix primarily attributable to the declining loan portfolio, coupled with the low rate environment continues to put pressure on our net interest income. Additionally, as compared to the fourth quarter of 2013, 10 of the 16 basis point decline in the margin was attributable to the higher level of earning assets during the first quarter of 2014, which is attributable to the seasonal influx of public funds.
Historically low interest rates (essentially setting a floor on deposit repricing), foregone interest, unfavorable asset repricing without the flexibility to significantly adjust deposit rates and core deposit growth (which has strengthened our liquidity position, but contributed to an unfavorable shift in our earning asset mix), have all placed pressure on our net interest margin. Our current strategy, which is consistent with our historical strategy, is to not accept greater interest rate risk by reaching further out the curve for yield, particularly given the fact that short term rates are at historical lows. We continue to maintain short duration portfolios on both sides of the balance sheet and believe we are well positioned to respond to changing market conditions. Over time, this strategy has historically produced fairly consistent outcomes and a net interest margin that is significantly above peer comparisons. Given the unfavorable asset repricing and low rate environment, we anticipate continued pressure on the margin in 2014.
Provision for Loan Losses
The provision for loan losses for the first quarter of 2014 was $0.4 million compared to $0.4 million for the fourth quarter of 2013 and $1.1 million for the first quarter of 2013. The lower level of provision reflects favorable problem loan migration, lower loan losses, and continued improvement in key credit metrics. Net charge-offs for the first quarter of 2014 totaled $1.3 million, or 0.39% (annualized), of average loans compared to $2.3 million, or 0.65% (annualized), for the fourth quarter of 2012 and $2.4 million, or 0.66% (annualized), for the first quarter of 2013. At March 31, 2014, the allowance for loan losses of $22.1 million was 1.57% of outstanding loans (net of overdrafts) and provided coverage of 64% of nonperforming loans compared to 1.65% and 62%, respectively, at December 31, 2013, and 1.90% and 61%, respectively, at March 31, 2013.
Charge-off activity for the respective periods is set forth below:
Noninterest Income
Noninterest income for the first quarter of 2014 totaled $12.8 million, a decrease of $1.0 million, or 7.5%, from the fourth quarter of 2013 reflective of lower deposit fees of $0.5 million, wealth management fees of $0.3 million, data processing fees of $0.1 million, and other income of $0.1 million. Compared to the first quarter of 2013, noninterest income decreased $0.7 million, or 5.5%, attributable to a $0.4 million reduction in mortgage banking fees and a $0.3 million decline in deposit fees.
Noninterest income represented 42.05% of operating revenues in the first quarter of 2014 compared to 43.85% in the fourth quarter of 2013 and 40.62% in the first quarter of 2013. The increase over the first quarter of 2013 reflects lower net interest income.
The table below reflects the major components of noninterest income.
Significant components of noninterest income are discussed in more detail below.
Deposit Fees. Deposit fees decreased $529,000, or 8.3%, from the fourth quarter of 2013 and $296,000, or 4.8%, from the first quarter of 2013. The decline from the fourth quarter of 2013 was primarily due to an expected lower utilization of our overdraft protection service during the first quarter as clients receive tax refunds, and to a lesser extent, two fewer processing days in the first quarter of 2014. Compared to the first quarter of 2013, the decline was due to a lower level of overdraft fees generally reflective of improved financial management by our clients.
Bank Card Fees. Bank card fees (including interchange fees and ATM/debit card fees) increased $52,000, or 1.9%, over the fourth quarter of 2013 and $47,000, or 1.8%, over the first quarter of 2013. The increase over both prior periods reflects higher card spend volume by our clients.
Wealth Management Fees. Wealth management fees include both trust fees (i.e., managed accounts, trusts/estates, and retirement plans) and retail brokerage fees (i.e., investment and insurance products) and totaled $1.9 million for the first quarter of 2014, a decrease of $315,000, or 14.1%, from the fourth quarter of 2013 and an increase of $3,000, or 0.2%, over the first quarter of 2013. The decrease from the fourth quarter of 2013 reflects lower retail brokerage fees of $197,000 and trust fees of $118,000. Compared to the fourth quarter of 2013, the decrease in retail brokerage fees was primarily attributable to a lower level of account activity by our clients as well as a decline in new retail investment product sales, which were very strong in the prior quarter. The reduction in trust fees was due to higher fee collections during the fourth quarter for accounts that are billed on an annual basis. At March 31, 2014, total assets under management were approximately $1.238 billion compared to $1.259 billion at December 31, 2013 and $1.143 billion at March 31, 2013.
Mortgage Banking Fees. Mortgage banking fees decreased $29,000, or 4.4%, from the fourth quarter of 2013 and $417,000, or 40.0%, from the first quarter of 2013. The decrease compared to the first quarter of 2013 was attributable to a lower level of refinancing activity in our markets attributable to the higher interest rate environment. The mix of new loan production between home purchase and refinance for the first quarter of 2014 was 81%/19% compared to 50%/50% for the first quarter of 2013.
Data Processing Fees. Data processing fees decreased by $148,000, or 21.5%, from the fourth quarter of 2013 and $112,000, or 17.2%, from the first quarter of 2013. The decrease from both prior periods was attributable to lower fees from a government processing contract for which processing activity is gradually declining due to the client’s migration to a new processor in the second quarter of 2014.
Noninterest Expense
Noninterest expense for the first quarter of 2014 totaled $28.4 million, a decrease of $1.3 million, or 4.3%, from the fourth quarter of 2013. The decrease compared to the fourth quarter of 2013 reflects lower compensation expense of $0.8 million, a $0.4 million decrease in other expense and a $0.1 million increase in occupancy expense. Compared to the first quarter of 2013, noninterest expense decreased $2.8 million, or 8.9%, attributable to lower compensation expense of $1.0 million, OREO expense of $1.4 million, occupancy expense of $0.1 million, and other expense (excluding OREO expense) of $0.3 million. Expense management is an important part of our culture and strategic focus and we will continue to review and evaluate opportunities to optimize our operations, reduce operating costs and manage our discretionary expenses.
The table below reflects the major components of noninterest expense.
Significant components of noninterest expense are discussed in more detail below.
Compensation. Compensation expense totaled $15.8 million for the first quarter of 2014, a decrease of $802,000, or 4.8%, from the fourth quarter of 2013 due to lower associate benefit expense of $1.2 million that was partially offset by higher salary expense of $400,000. The decline in associate benefit expense reflects a $1.2 million reduction in pension plan expense attributable to the utilization of a higher discount rate in 2014 for determining plan liabilities which reflects an increase in long-term bond interest rates. The increase in salary expense was due to higher payroll taxes of $0.2 million and unemployment taxes of $0.2 million. The increase in payroll taxes reflects the reset of social security taxes and the increase in unemployment taxes is attributable to timing as a large portion of the annual premium is paid in the first quarter. Compared to the first quarter of 2013, total compensation expense decreased $958,000, or 5.7%, attributable to lower associate benefit expense of $1.1 million that was partially offset by higher salary expense of $186,000. The reduction in associate benefit expense was due to the favorable adjustment in our pension plan discount rate assumption previously noted. Higher performance compensation (cash incentives) drove the slight increase in salary expense.
Occupancy. Occupancy expense (including premises and equipment) totaled $4.3 million for the first quarter of 2014, a decrease of $51,000, or 1.2%, from the fourth quarter of 2013 driven by lower expense for furniture/equipment repairs and maintenance. Compared to the first quarter of 2013, occupancy expense decreased $120,000, or 2.7%, attributable to lower premises expense, primarily lower building maintenance, banking office lease costs, and lower property taxes.
Other. Other noninterest expense decreased $428,000, or 4.9%, from the fourth quarter of 2013 and $271,000, or 2.7%, from the first quarter of 2013. The decrease compared to the fourth quarter of 2013 was primarily due to lower FDIC insurance fees of $306,000 and miscellaneous expense of $148,000. The decline in FDIC insurance fees was attributable to our improved financial condition and the reduction in miscellaneous expense was attributable to a non-recurring impairment adjustment to a security that was recognized in the fourth quarter of 2013. The decrease compared to the first quarter of 2013 was attributable to lower legal fees of $220,000, professional fees of $71,000, and FDIC insurance fees of $309,000, partially offset by higher processing service fees of $345,000. A lower level of legal support needed for problem loan collection drove the reduction in legal fees. The decrease in professional fees was due to lower fees paid for consulting and other professional service engagements. The lower level of FDIC insurance fees was attributable to the aforementioned improvement in our financial condition. The higher level of processing fees reflects the outsourcing of our items processing system during the first quarter of 2013. While increasing the level of expense for processing services, our decision to outsource our items processing system enabled us to reduce expense in other areas such as compensation, printing/supplies, and postage.
Our operating efficiency ratio (expressed as noninterest expense as a percent of the sum of taxable-equivalent net interest income plus noninterest income) was 91.02% for the first quarter of 2014 compared to 90.22% for the fourth quarter of 2013 and 92.67% for the first quarter of 2013. The improvement in this metric compared to the first quarter of 2013 was driven by a decline in operating expenses which outpaced the decrease in operating revenues (net interest income plus noninterest income).
Income Taxes
We realized an income tax benefit of $1.4 million in the first quarter of 2014 compared to income tax expense of $5,000 and $0.4 million for the fourth and first quarters of 2013, respectively. The first quarter was favorably impacted by a $2.2 million state tax benefit attributable to an adjustment in our reserve for uncertain tax positions associated with prior year matters. A similar adjustment in the amount of $0.9 million was realized in the fourth quarter of 2013. During 2014, we do not anticipate any further adjustments of this nature and, therefore, expect our effective income tax rate for the full year to be higher than the effective tax rate for the first quarter of 2014.
FINANCIAL CONDITION
Average assets totaled approximately $2.598 billion for the first quarter of 2014, an increase of $44.7 million, or 1.8%, from the fourth quarter of 2013, and a decrease of $373,000, or 0.01%, from the first quarter of 2013. Average earning assets were $2.268 billion for the first quarter of 2014, an increase of $62.0 million, or 2.8%, from the fourth quarter of 2013, and an increase of $27.4 million, or 1.2%, over the first quarter of 2013. We discuss these variances in more detail below.
Investment Securities
In the first quarter of 2014, our average investment portfolio increased $25.7 million, or 6.8%, from the fourth quarter of 2013 and increased $109.4 million, or 37.0%, from the first quarter of 2013. As a percentage of average earning assets, the investment portfolio represented 17.9% in the first quarter of 2014, compared to 17.2% in the fourth quarter of 2013 and 13.2% in the first quarter of 2013. The increase in the average balance of the investment portfolio when compared to both periods resulted from strategically increasing our purchases to offset a portion of the decline in the loan portfolio. For the remainder of 2014, we will continue to closely monitor liquidity levels and pledging requirements to assess the need to purchase additional investments, as well as look for new investment products that are prudent relative to our risk profile and the Bank’s overall investment strategy.
The investment portfolio is a significant component of our operations and, as such, it functions as a key element of liquidity and asset/liability management. Two types of classifications are approved for investment securities which are Available-for-Sale (“AFS”) and Held-for-Maturity (“HTM”). During the first quarter of 2014, securities were purchased under both the AFS and HTM designations. As of March 31, 2014, $220.8 million, or 53.6% of the investment portfolio was classified as AFS, with the remaining $191.0 million classified as HTM.
At acquisition, the classification of the security will be determined based on how the purchase will affect our asset/liability strategy and future business plans and opportunities. Such decisions will be weighed against multiple factors, including regulatory capital requirements, volatility in earnings or other comprehensive income, and liquidity needs. Securities in the AFS portfolio are recorded at fair value with unrealized gains and losses associated with these securities recorded net of tax, in the accumulated other comprehensive income (loss) component of shareowners’ equity. Securities that are HTM will be acquired or owned with the intent of holding them to maturity (final payment date). HTM investments are measured at amortized cost. It is neither management’s current intent nor practice to participate in the trading of investment securities for the purpose of recognizing gains and therefore we do not maintain a trading portfolio.
At March 31, 2014, the investment portfolio contained a net pre-tax unrealized gain in the AFS portfolio of $0.3 million compared to $0.3 million at December 31, 2013 and $0.9 million March 31, 2013. At March 31, 2014, there were approximately 123 positions (combined AFS and HTM) with unrealized losses totaling $1.17 million. Of the 123 positions, 93 were Ginnie Mae mortgage-backed securities (GNMA), U.S. Treasuries, or SBA securities, all of which carry the full faith and credit guarantee of the U.S. Government. The remaining 30 positions were 20 municipal bonds that are pre-refunded, or rated “AA-“or better, and ten U.S. Government Agency positions. Three of the municipal bond positions have been in an unrealized loss position for longer than 12 months, and have an unrealized loss of $15,000. None of the securities with unrealized losses are considered to be impaired and all are expected to mature at par or better.
The average maturity of the total portfolio at March 31, 2014 was 2.08 years compared to 1.95 years and 1.70 years at December 31, 2013 and March 31, 2013, respectively. Purchases of U.S. Treasuries and government agencies out to three years were added in 2013 and the first quarter of 2014, which extended the average life of the investment portfolio.
Loans
Average loans declined (a portion of which is attributable to problem loan resolutions) by $19.4 million, or 1.4%, from the end of the fourth quarter of 2013 and $100.9 million, or 6.7%, from the end of the first quarter of 2013. Most loan categories have experienced declines with the reduction primarily in the commercial real estate category.
Without compromising our credit standards or taking on inordinate interest rate risk, we have modified several lending programs in our business and commercial real estate areas to try to mitigate the significant impact that consumer and business deleveraging is having on our portfolio. On a linked quarter basis, period-end loans increased $7.4 million, which was the first time since the second quarter of 2009 we have experienced quarter over quarter growth. Loan categories posting growth included commercial and industrial, construction and auto finance. The quarter over quarter growth reflects both an increase in production (which has increased in four of the last five quarters) as well as lower payoffs.
The resolution of problem loans, which includes loan charge-offs and loans transferred to OREO, totaled $3.4 million for the first quarter of 2014, compared to $6.3 million from the fourth quarter of 2013, and $15.9 million from the first quarter of 2013. The problem loan resolutions are based on “as of” balances, not averages.
Nonperforming Assets
Nonperforming assets (nonaccrual loans and other real estate owned “OREO”) totaled $78.6 million at the end of the first quarter of 2014, a decrease of $6.4 million (8%) from the fourth quarter of 2013 and $25.3 million (24%) from the first quarter of 2013. Nonaccrual loans totaled $34.6 million at the end of the first quarter of 2014, a decrease of $2.4 million and $10.9 million, respectively, from the same prior year periods. Nonaccrual loan gross additions in the first quarter of 2014 totaled $7.5 million compared to $14.5 million and $7.7 million for the fourth quarter of 2013 and first quarter of 2013, respectively. The balance of OREO totaled $44.0 million at the end of the first quarter of 2014, a decrease of $4.0 million and $14.4 million, respectively, from the fourth quarter of 2013 and first quarter of 2013. For the first quarter of 2014, we added properties totaling $1.3 million, sold properties totaling $4.6 million, and recorded valuation adjustments totaling $0.7 million. Nonperforming assets represented 2.98% of total assets at March 31, 2014 compared to 3.26% at December 31, 2013 and 3.99% at March 31, 2013.
Activity within our nonperforming asset portfolio is provided in the table below.
Activity within our TDR portfolio is provided in the table below.
Allowance for Loan Losses
We maintain an allowance for loan losses at a level that management believes to be sufficient to provide for probable losses inherent in the loan portfolio as of the balance sheet date. Credit losses arise from borrowers’ inability or unwillingness to repay, and from other risks inherent in the lending process, including collateral risk, operations risk, concentration risk and economic risk. All related risks of lending are considered when assessing the adequacy of the loan loss reserve. The allowance for loan losses is established through a provision charged to expense. Loans are charged against the allowance when management believes collection of the principal is unlikely. The allowance for loan losses is based on management’s judgment of overall loan quality. This is a significant estimate based on a detailed analysis of the loan portfolio. The balance can and will change based on changes in the assessment of the loan portfolio’s overall credit quality.We evaluate the adequacy of the allowance for loan losses on a quarterly basis.
The allowance for loan losses was $22.1 million at March 31, 2014 compared to $23.1 million at December 31, 2013 and $27.8 million at March 31, 2013. The allowance for loan losses was 1.57% of outstanding loans and provided coverage of 64% of nonperforming loans at March 31, 2014 compared to 1.65% and 62%, respectively, at December 31, 2013 and 1.90% and 61%, respectively, at March 31, 2013. The reduction in the allowance from the same prior year period was attributable to a lower level of impaired loan reserves and to a lesser extent a reduction in general reserves. The decrease in impaired loan reserves was driven by a lower level of impaired loans reflecting reduced inflow and successful resolutions as well as lower loss content. The decrease in general reserves reflects slower problem loan migration, lower loan loss experience, as well as continued improvement in credit metrics. It is management’s opinion that the allowance at March 31, 2014 is adequate to absorb losses inherent in the loan portfolio at quarter-end.
Deposits
Average total deposits were $2.125 billion for the first quarter of 2014, an increase of $74.1 million, or 3.6%, over the fourth quarter of 2013 and higher by $22.0 million, or 1.1%, from the first quarter of 2013. The increase in deposits when compared to the fourth quarter of 2013 resulted primarily from the higher level of public funds, partially offset by a reduction in certificates of deposit. When compared to the first quarter of 2013, the increase was a result of higher levels of noninterest bearing and savings accounts, partially offset by lower public funds and certificates of deposit accounts.
Deposit levels remain strong and our mix of deposits continues to improve as higher cost certificates of deposit are replaced with lower rate non-maturity deposits and noninterest bearing demand accounts. On average for the first quarter of 2014, noninterest bearing deposits comprised 30.4% of our total deposits compared to certificates of deposits, which only represented 10.1% of deposits. This compares to 28.5% and 11.3%, respectively, for the first quarter of 2013. Prudent pricing discipline will continue to be the key to managing our mix of deposits. Therefore, we do not attempt to compete with higher rate paying competitors for deposits.
MARKET RISK AND INTEREST RATE SENSITIVITY
Market Risk and Interest Rate Sensitivity
Overview. Market risk management arises from changes in interest rates, exchange rates, commodity prices, and equity prices. We have risk management policies to monitor and limit exposure to market risk and do not participate in activities that give rise to significant market risk involving exchange rates, commodity prices, or equity prices. In asset and liability management activities, our policies are designed to minimize structural interest rate risk.
Interest Rate Risk Management. Our net income is largely dependent on net interest income. Net interest income is susceptible to interest rate risk to the degree that interest-bearing liabilities mature or re-price on a different basis than interest-earning assets. When interest-bearing liabilities mature or re-price more quickly than interest-earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income. Similarly, when interest-earning assets mature or re-price more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net interest income. Net interest income is also affected by changes in the portion of interest-earning assets that are funded by interest-bearing liabilities rather than by other sources of funds, such as noninterest-bearing deposits and shareowners’ equity.
We have established a comprehensive interest rate risk management policy, which is administered by management’s Asset/Liability Management Committee (“ALCO”). The policy establishes limits of risk, which are quantitative measures of the percentage change in net interest income (a measure of net interest income at risk) and the fair value of equity capital (a measure of economic value of equity (“EVE”) at risk) resulting from a hypothetical change in interest rates for maturities from one day to 30 years. We measure the potential adverse impacts that changing interest rates may have on our short-term earnings, long-term value, and liquidity by employing simulation analysis through the use of computer modeling. The simulation model captures optionality factors such as call features and interest rate caps and floors imbedded in investment and loan portfolio contracts. As with any method of gauging interest rate risk, there are certain shortcomings inherent in the interest rate modeling methodology used by us. When interest rates change, actual movements in different categories of interest-earning assets and interest-bearing liabilities, loan prepayments, and withdrawals of time and other deposits, may deviate significantly from assumptions used in the model. Finally, the methodology does not measure or reflect the impact that higher rates may have on adjustable-rate loan clients’ ability to service their debts, or the impact of rate changes on demand for loan and deposit products.
We prepare a current base case and three alternative simulations, at least once per quarter, and report the analysis to the Board of Directors. In addition, more frequent forecasts may be produced when interest rates are particularly uncertain or when other business conditions so dictate.
Our interest rate risk management goal is to avoid unacceptable variations in net interest income and capital levels due to fluctuations in market rates. Management attempts to achieve this goal by balancing, within policy limits, the volume of floating-rate liabilities with a similar volume of floating-rate assets, by keeping the average maturity of fixed-rate asset and liability contracts reasonably matched, by maintaining our core deposits as a significant component of our total funding sources, and by adjusting pricing rates to market conditions on a continuing basis.
The balance sheet is subject to testing for interest rate shock possibilities to indicate the inherent interest rate risk. Average interest rates are shocked by plus or minus 100, 200, and 300 basis points (“bp”), although we may elect not to use particular scenarios that we determined are impractical in a current rate environment. It is management’s goal to structure the balance sheet so that net interest earnings at risk over a 12-month period and the economic value of equity at risk do not exceed policy guidelines at the various interest rate shock levels.
We augment our interest rate shock analysis with alternative external interest rate scenarios on a quarterly basis. These alternative interest rate scenarios may include non-parallel rate ramps.
Analysis. Measures of net interest income at risk produced by simulation analysis are indicators of an institution’s short-term performance in alternative rate environments. These measures are typically based upon a relatively brief period, usually one year. They do not necessarily indicate the long-term prospects or economic value of the institution.
ESTIMATED CHANGES IN NET INTEREST INCOME (1)
The Net Interest Income at Risk position was slightly more favorable at the end of the first quarter of 2014, when compared to the prior quarter-end, for all up rate scenarios. The favorable change from the prior quarter end reflects higher levels of repricing assets, primarily loans and investments, due to an increase in public fund deposits. All measures of net interest income at risk are within our prescribed policy limits.
The measures of equity value at risk indicate our ongoing economic value by considering the effects of changes in interest rates on all of our cash flows, and discounting the cash flows to estimate the present value of assets and liabilities. The difference between these discounted values of the assets and liabilities is the economic value of equity, which, in theory, approximates the fair value of our net assets.
ESTIMATED CHANGES IN ECONOMIC VALUE OF EQUITY (1)
As of March 31, 2014, the improvement in the economic value of equity in all up rate scenarios versus the base case was more favorable than it was as of December 31, 2013. This favorable variance is primarily attributable to the overall change in market interest rates during the first quarter of 2014. In both periods, in the up 300 bp scenario (relative to the up 200 and 100 bp scenarios), the level of improvement in the economic value of equity declined. This is attributable to the varied assumptions on the non-maturity deposits. Based on historical data, interest rates on non-maturity deposits were increased in escalating increments in the rising rate scenarios, with the up 300 bp scenario being the most aggressive. All measures of economic value of equity were within our prescribed policy limits.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
In general terms, liquidity is a measurement of our ability to meet our cash needs. Our objective in managing our liquidity is to maintain our ability to meet loan commitments, purchase securities or repay deposits and other liabilities in accordance with their terms, without an adverse impact on our current or future earnings. Our liquidity strategy is guided by policies that are formulated and monitored by our ALCO and senior management, and which take into account the marketability of assets, the sources and stability of funding and the level of unfunded commitments. We regularly evaluate all of our various funding sources with an emphasis on accessibility, stability, reliability and cost-effectiveness. Our principal source of funding has been our client deposits, supplemented by our short-term and long-term borrowings, primarily from securities sold under repurchase agreements, federal funds purchased and FHLB borrowings. We believe that the cash generated from operations, our borrowing capacity and our access to capital resources are sufficient to meet our future operating capital and funding requirements.
As of March 31, 2014, we had the ability to generate approximately $686.0 million in additional liquidity through all of our available resources. In addition to primary borrowing outlets mentioned above, we also have the ability to generate liquidity by borrowing from the Federal Reserve Discount Window and through brokered deposits. Management recognizes the importance of maintaining liquidity and has developed a Contingency Liquidity Plan, which addresses various liquidity stress levels and our response and action based on the level of severity. We periodically test our credit facilities for access to the funds, but also understand that as the severity of the liquidity level increases that certain credit facilities may no longer be available. A liquidity stress test is completed on a quarterly basis based on events that could potentially occur at the Bank with results reported to ALCO, our Market Risk and Oversight Committee, and the Board of Directors. The liquidity available to us is considered sufficient to meet our ongoing needs.
We view our investment portfolio as a source of liquidity and have the option to pledge the portfolio as collateral for borrowings or deposits, and/or sell selected securities. The portfolio consists of debt issued by the U.S. Treasury, U.S. governmental agencies, and municipal governments. The weighted average life of the portfolio is approximately 2.08 years and as of March 31, 2014 and had a net unrealized pre-tax gain of $0.3 million in the available-for-sale portfolio.
Our average overnight funds sold position (defined as funds sold plus interest bearing deposits with other banks less funds purchased) of $467.3 million during the first quarter of 2014 compared to an average net overnight funds sold position of $411.6 million in the prior quarter and an average overnight funds soldposition of $448.4 million in the first quarter of 2013. The higher balance when compared to the linked quarter reflects higher average public funds deposits and a decrease in the loan portfolio. The higher average balance when compared to the first quarter of 2013 resulted from higher average noninterest bearing and savings accounts, and a decrease in the loan portfolio.
Capital expenditures are expected to approximate $3.0 million over the next 12 months, which consist primarily of office remodeling, office equipment and furniture, and technology purchases. Management believes that these capital expenditures will be funded with existing resources without impairing our ability to meet our on-going obligations.
Borrowings
At March 31, 2014, advances from the FHLB consisted of $35.3 million in outstanding debt consisting of 38 notes. During the first quarter of 2014, the Bank made FHLB advance payments totaling approximately $6.8 million, which includes paying off six advances totaling $5.9 million. No additional FHLB advances were obtained. The FHLB notes are collateralized by a blanket floating lien on all of our 1-4 family residential mortgage loans, commercial real estate mortgage loans, and home equity mortgage loans.
We have issued two junior subordinated deferrable interest notes to our wholly-owned Delaware statutory trusts. The first note for $30.9 million was issued to CCBG Capital Trust I in November 2004. The second note for $32.0 million was issued to CCBG Capital Trust II in May 2005. The interest payment for the CCBG Capital Trust I borrowing is due quarterly and adjusts quarterly to a variable rate of LIBOR plus a margin of 1.90%. This note matures on December 31, 2034. The interest payment for the CCBG Capital Trust II borrowing is due quarterly and adjusts annually to a variable rate of LIBOR plus a margin of 1.80%. This note matures on June 15, 2035. The proceeds of these borrowings were used to partially fund acquisitions.
Under the terms of each trust preferred securities note, in the event of default or if we elect to defer interest on the note, we may not, with certain exceptions, declare or pay dividends or make distributions on our capital stock or purchase or acquire any of our capital stock. During the fourth quarter of 2013, the informal board resolutions, which required us to obtain approval from the Federal Reserve prior to making interest payments on the two securities, were rescinded. All deferred accrued interest was paid and brought current at year-end 2013 and is current as of March 31, 2014.
Capital
Equity capital was $279.9 million as of March 31, 2014, compared to $276.4 million as of December 31, 2013 and $248.6 million as of March 31, 2013. Our leverage ratio was 10.47%, 10.46%, and 9.81%, respectively, and our tangible capital ratio was 7.66%, 7.58%, and 6.49%, respectively, for the same periods. Our risk-adjusted capital ratio of 18.22% at March 31, 2014, exceeds the 10% threshold to be designated as “well-capitalized” under the risk-based regulatory guidelines.
During the first three months of 2014, shareowners’ equity increased $3.5 million, or 5.0%, on an annualized basis. During this same period, shareowners’ equity was positively impacted by net income of $3.8 million and stock compensation accretion of $0.3 million. Shareowners’ equity was reduced by a common stock dividend of $0.3 million and net adjustments totaling $0.3 million related to transactions under our stock compensation plans.
At March 31, 2014, our common stock had a book value of $16.02 per diluted share compared to $15.85 at December 31, 2013 and $14.35 at March 31, 2013. Book value is impacted by changes in the amount of our net unrealized gain or loss on investment securities available-for-sale and changes to the amount of our unfunded pension liability both of which are recorded through other comprehensive income. At March 31, 2014, the net unrealized loss on investment securities available for sale was $0.1 million and the amount of our unfunded pension liability was $8.4 million.
In February 2014, our Board of Directors authorized the repurchase of up to 1,500,000 shares of our outstanding common stock. Repurchases may be made in the open market or in privately negotiated transactions; however, we are not obligated to repurchase any specified number of shares. Under a predecessor plan, we repurchased a total of 2,520,130 shares at an average purchase price of $25.19 per share. We did not repurchase any shares during 2013 or 2014.
OFF-BALANCE SHEET ARRANGEMENTS
We do not currently engage in the use of derivative instruments to hedge interest rate risks. However, we are a party to financial instruments with off-balance sheet risks in the normal course of business to meet the financing needs of our clients.
At March 31, 2014, we had $273.0 million in commitments to extend credit and $10.8 million in standby letters of credit. Commitments to extend credit are agreements to lend to a client so long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued by us to guarantee the performance of a client to a third party. We use the same credit policies in establishing commitments and issuing letters of credit as we do for on-balance sheet instruments.
If commitments arising from these financial instruments continue to require funding at historical levels, management does not anticipate that such funding will adversely impact its ability to meet on-going obligations. In the event these commitments require funding in excess of historical levels, management believes current liquidity, advances available from the FHLB and the Federal Reserve, and investment security maturities provide a sufficient source of funds to meet these commitments.
CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are described in Note 1 to the Consolidated Financial Statements included in our 2013 Form 10-K. The preparation of our Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States (“GAAP”) and reporting practices applicable to the banking industry requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and to disclose contingent assets and liabilities. Actual results could differ from those estimates.
We have identified accounting for (i) the allowance for loan and lease losses, (ii) valuation of goodwill and other intangible assets, and (iii) pension benefits as our most critical accounting policies and estimates in that they are important to the portrayal of our financial condition and results, and they require our subjective and complex judgment as a result of the need to make estimates about the effects of matters that are inherently uncertain. These accounting policies, including the nature of the estimates and types of assumptions used, are described throughout this Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our 2013 Form 10-K.
TABLE I
AVERAGE BALANCES & INTEREST RATES
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See “Market Risk and Interest Rate Sensitivity” in Management’s Discussion and Analysis of Financial Condition and Results of Operations, above, which is incorporated herein by reference. Management has determined that no additional disclosures are necessary to assess changes in information about market risk that have occurred since December 31, 2013.
Item 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of March 31, 2014, the end of the period covered by this Form 10-Q, our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer each concluded that as of March 31, 2014, the end of the period covered by this Form 10-Q, we maintained effective disclosure controls and procedures.
Changes in Internal Control over Financial Reporting
Our management, including the Chief Executive Officer and Chief Financial Officer, has reviewed our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934). There have been no significant changes in our internal control over financial reporting during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are party to lawsuits arising out of the normal course of business. In management’s opinion, there is no known pending litigation, the outcome of which would, individually or in the aggregate, have a material effect on our consolidated results of operations, financial position, or cash flows.
Item 1A. Risk Factors
In addition to the other information set forth in this Quarterly Report, you should carefully consider the factors discussed in Part I, Item 1A. “Risk Factors” in our 2013 Form 10-K, as updated in our subsequent quarterly reports. The risks described in our 2013 Form 10-K are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results. There have been no material changes in our risk factors from those disclosed in our 2013 Form 10-K, except for the following:
Cybersecurity issues, such as security breaches and computer viruses, affecting our online banking service or fraud related to our credit or debit card products could disrupt our business, result in the unintended disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs, and cause losses.
We provide our clients the ability to bank online. The secure transmission of confidential information over the Internet is a critical element of banking online. Our network, or those of our clients, could be vulnerable to unauthorized access, computer viruses, phishing schemes and other security problems. We may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, or to alleviate problems caused by security breaches or viruses. To the extent that our activities or the activities of our clients involve the storage and transmission of confidential information, security breaches and viruses could expose us to claims, litigation and other possible liabilities. Any inability to prevent security breaches or computer viruses could also cause existing clients to lose confidence in our systems and could adversely affect our reputation and our ability to generate deposits.
Additionally, fraud losses related to credit and debit cards have risen in recent years due in large part to growing and evolving schemes to illegally use cards or steal consumer credit card information despite risk management practices employed by the credit and debit card industry. Many issuers of debit and credit cards have suffered significant losses in recent years due to the theft of cardholder data that has been illegally exploited for personal gain.
The potential for credit and debit card fraud against us or our clients and our third party service providers is a serious issue. Credit card fraud is pervasive and the risks of cybercrime are complex and continue to evolve. In view of the recent high-profile retail data breaches involving customer personal and financial information, the potential impact on us and any exposure to consumer losses and the cost of technology investments to improve security could cause losses to us or our clients, damage to our brand, and an increase in our costs.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosure
Item 5. Other Information
Item 6. Exhibits
SIGNATURES
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 Chief Financial Officer hereunto duly authorized.
(Registrant)
Exhibit Index