UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2013
or
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from to
Commission File Number: 0-23636
HAWTHORN BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
Missouri
43-1626350
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
132 East High Street, Box 688, Jefferson City, Missouri 65102
(Address of principal executive offices) (Zip Code)
(573) 761-6100
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report.)
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. x Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o 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 o
Accelerated filer o
Non-accelerated filer x (Do not check if a smaller reporting company)
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
As of November 14, 2013, the registrant had 5,032,679 shares of common stock, par value $1.00 per share, outstanding
Index to Exhibits located on page 61
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
HAWTHORN BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (unaudited)
(In thousands, except per share data)
September 30,
December 31,
2013
2012
ASSETS
Cash and due from banks
$
24,683
31,020
Federal funds sold and other overnight interest-bearing deposits
1,090
27,857
Cash and cash equivalents
25,773
58,877
Investment in available-for-sale securities, at fair value
213,629
200,246
Loans
823,042
846,984
Allowances for loan losses
(14,254
)
(14,842
Net loans
808,788
832,142
Premises and equipment - net
37,602
37,021
Investments in Federal Home Loan Bank stock and other equity securities, at cost
4,001
3,925
Mortgage servicing rights
3,079
2,549
Other real estate owned and repossessed assets - net
15,868
23,592
Accrued interest receivable
4,956
5,190
Cash surrender value - life insurance
2,192
2,136
Other assets
15,427
15,928
Total assets
1,131,315
1,181,606
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Non-interest bearing demand
179,959
192,271
Savings, interest checking and money market
412,887
405,702
Time deposits $100,000 and over
115,370
120,777
Other time deposits
243,262
272,525
Total deposits
951,478
991,275
Federal funds purchased and securities sold under agreements to repurchase
25,007
21,058
Subordinated notes
49,486
Federal Home Loan Bank advances
24,013
20,126
Accrued interest payable
456
909
Other liabilities
9,048
6,532
Total liabilities
1,059,488
1,089,386
Stockholders’ equity:
Preferred stock, $0.01 par value per share, 1,000,000 shares authorized; Issued 0 shares and 18,255 shares, respectively, $1,000 per share liquidation value, net of discount
0
17,977
Common stock, $1 par value, authorized 15,000,000 shares; Issued 5,194,537 and 5,000,972 shares, respectively
5,195
5,001
Surplus
33,380
31,816
Retained earnings
38,609
39,118
Accumulated other comprehensive (loss) income, net of tax
(1,840
1,825
Treasury stock; 161,858 shares, at cost
(3,517
Total stockholders’ equity
71,827
92,220
Total liabilities and stockholders’ equity
See accompanying notes to the unaudited consolidated financial statements.
2
Consolidated Statements of Operations (unaudited)
Three Months Ended
Nine Months Ended
(In thousands, except per share amounts)
INTEREST INCOME
Interest and fees on loans
10,186
10,881
31,009
33,068
Interest on debt securities:
Taxable
873
1,016
2,689
3,216
Nontaxable
212
225
641
688
6
35
43
Dividends on other securities
21
23
62
79
Total interest income
11,298
12,151
34,436
37,094
INTEREST EXPENSE
Interest on deposits:
238
265
752
919
Time deposit accounts $100,000 and over
224
297
705
1,316
535
979
2,275
2,286
Interest on federal funds purchased and securities sold under agreements to repurchase
7
17
Interest on subordinated notes
323
346
963
1,045
Interest on Federal Home Loan Bank advances
106
135
315
403
Total interest expense
1,433
2,029
5,027
5,986
Net interest income
9,865
10,122
29,409
31,108
Provision for loan losses
4,700
2,000
7,900
Net interest income after provision for loan losses
5,422
27,409
23,208
NON-INTEREST INCOME
Service charges on deposit accounts
1,463
1,360
4,213
4,067
Trust department income
179
234
598
670
Real estate servicing fees, net
338
(62
760
(348
Gain on sale of mortgage loans, net
175
779
1,515
1,773
Gain on sale of investment securities
26
554
Other
292
343
903
905
Total non-interest income
2,447
2,680
8,543
7,093
NON-INTEREST EXPENSE
Salaries and employee benefits
4,863
4,761
14,596
14,465
Occupancy expense, net
695
666
1,973
1,953
Furniture and equipment expense
474
431
1,438
1,403
FDIC insurance assessment
253
249
753
Legal, examination, and professional fees
207
284
727
880
Advertising and promotion
310
288
907
750
Postage, printing, and supplies
308
274
854
817
Processing expense
749
888
2,758
2,667
Other real estate expense, net
1,265
1,725
4,437
3,174
848
812
2,745
3,094
Total non-interest expense
9,972
10,378
31,188
29,955
Income (loss) before income taxes
2,340
(2,276
4,764
Income tax expense (benefit)
771
(704
1,519
(273
Net income (loss)
1,569
(1,572
3,245
619
Preferred stock dividends
228
337
894
Accretion of discount on preferred stock
72
278
587
Total preferred stock dividends and accretion of discount on preferred stock
300
615
1,481
Net income (loss) available to common shareholders
(1,872
2,630
(862
Basic earnings (loss) per share
0.31
(0.37
0.52
(0.17
Diluted earnings (loss) per share
3
Consolidated Statements of Comprehensive Income (loss) (unaudited)
(In thousands)
Other comprehensive (loss) income, net of tax
Securities available for sale:
Unrealized (loss) gain on investment securities available-for-sale, net of tax
(109
(3,372
369
Adjustment for gain on sales of investment securities, net of tax
(16
(343
Defined benefit pension plans:
Amortization of prior service cost included in net periodic pension cost, net of tax
16
50
78
Total other comprehensive (loss) income
(93
325
(3,665
Total comprehensive income (loss)
1,476
(1,247
(420
1,050
4
Consolidated Statements of Stockholders’ Equity (unaudited)
Accumulated
Total
Comprehensive
Stock -
Preferred
Common
Retained
Income
Treasury
holders’
Stock
Earnings
(Loss)
Equity
Balance, December 31, 2011
29,318
4,815
30,266
40,354
1,340
102,576
Cumulative effect of change in accounting principle
460
Balance, January 1, 2012
40,814
103,036
Net income
Other comprehensive income
Stock based compensation expense
27
Accretion of preferred stock discount
(587
Redemption of 12,000 shares of preferred stock
(12,000
Stock dividend
186
1,521
(1,707
Cash dividends declared, preferred stock
(975
Cash dividends declared, common stock
(707
Balance, September 30, 2012
17,905
31,814
37,457
1,771
90,431
Balance, December 31, 2012
Other comprehensive loss
14
(278
Redemption of 18,255 shares of preferred stock
(18,255
Redemption of common stock warrant
(540
194
2,090
(2,284
(456
(736
Balance, September 30, 2013
5
Consolidated Statements of Cash Flows (unaudited)
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation expense
1,204
1,447
Net amortization of investment securities, premiums, and discounts
981
851
Amortization of intangible assets
307
Change in fair value of mortgage servicing rights
(86
985
(554
(26
Loss (gain) on sales and dispositions of premises and equipment
(82
Loss (gain) on sales and dispositions of other real estate owned and repossessed assets
390
(220
Provision for other real estate owned
3,031
1,821
Decrease (increase) in accrued interest receivable
(126
Increase in cash surrender value -life insurance
(56
(55
Decrease in other assets
1,729
679
Decrease (increase) in income tax receivable
(1,714
Increase in income tax payable
424
Decrease in accrued interest payable
(453
(370
Increase in other liabilities
2,083
823
Origination of mortgage loans for sale
(61,297
(67,089
Proceeds from the sale of mortgage loans
63,452
68,506
(1,515
(1,773
Other, net
(362
44
Net cash provided by operating activities
15,564
12,554
Cash flows from investing activities:
Net decrease (increase) in loans
17,436
(20,929
Purchase of available-for-sale debt securities
(76,479
(69,305
Proceeds from maturities of available-for-sale debt securities
28,221
32,192
Proceeds from calls of available-for-sale debt securities
6,255
33,095
Proceeds from sales of available-for-sale debt securities
22,115
790
Proceeds from sales of FHLB stock
100
Purchases of FHLB stock
(612
Purchases of premises and equipment
(1,787
(1,155
Proceeds from sales of premises and equipment
269
Proceeds from sales of other real estate owned and repossessed assets
7,586
5,553
Net cash provided (used) by investing activities
3,270
(19,390
Cash flows from financing activities:
Net (decrease) increase in demand deposits
(12,312
5,944
Net increase in interest-bearing transaction accounts
7,185
5,034
Net decrease in time deposits
(34,670
(12,792
Net increase (decrease) in federal funds purchased and securities sold under agreements to repurchase
3,949
(407
Repayment of FHLB advances
(15,113
(194
FHLB advances
19,000
Redemption of 18,255 and 12,000 shares, respectively, of preferred stock
Warrant redemption
Cash dividends paid - preferred stock
Cash dividends paid - common stock
(726
(698
Net cash used by financing activities
(51,938
(16,088
Net decrease in cash and cash equivalents
(33,104
(22,924
Cash and cash equivalents, beginning of period
43,210
Cash and cash equivalents, end of period
20,286
Consolidated Statements of Cash Flows (continued) (unaudited)
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest
5,479
6,724
Income taxes
131
1,575
Supplemental schedule of noncash investing and financing activities:
Other real estate and repossessions acquired in settlement of loans
3,278
16,328
Notes to the Consolidated Financial Statements
(Unaudited)
(1) Summary of Significant Accounting Policies
Hawthorn Bancshares, Inc. (the Company) through its subsidiary, Hawthorn Bank (the Bank), provides a broad range of banking services to individual and corporate customers located within the communities in and surrounding Jefferson City, Clinton, Warsaw, Springfield, Branson, and Lee’s Summit, Missouri. The Company is subject to competition from other financial and nonfinancial institutions providing financial products. Additionally, the Company and its subsidiaries are subject to the regulations of certain regulatory agencies and undergo periodic examinations by those regulatory agencies.
The accompanying unaudited consolidated financial statements of the Company have been prepared in conformity with U.S. generally accepted accounting principles (U.S. GAAP) for interim financial information and with the instructions to Form 10-Q, and Rule 10-01 of Regulation S-X. Accordingly, the unaudited consolidated financial statements do not include all of the information and disclosures required by U.S. GAAP for complete financial statements and should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.
The accompanying unaudited consolidated financial statements include all adjustments that, in the opinion of management, are necessary in order to make those statements not misleading. Management is required to make estimates and assumptions, including the determination of the allowance for loan losses, real estate acquired in connection with foreclosure or in satisfaction of loans, fair values of investment securities available-for-sale, and the valuation of mortgage servicing rights that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company’s management has evaluated and did not identify any subsequent events or transactions requiring recognition or disclosure in the consolidated financial statements.
Stock Dividend On July 1, 2013, the Company paid a special stock dividend of four percent to common shareholders of record at the close of business on June 15, 2013. For all periods presented, share information, including basic and diluted earnings per share, has been adjusted retroactively to reflect this change.
The following represents significant new accounting principles adopted in 2013:
Balance Sheet In December 2011, the FASB issued ASU 2011-11, Disclosures about Offsetting Assets and Liabilities. The ASU is a joint requirement by the FASB and International Accounting Standards Board to enhance current disclosures and increase comparability of U.S. GAAP and International Financial Reporting Standards (IFRS) financial statements. Under the ASU, an entity will be required to disclose both gross and net information about instruments and transactions eligible for offset in the balance sheet, as well as instruments and transactions subject to an agreement similar to a master netting agreement. ASU 2013-01, Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities, was issued in January 2013, and amended ASU 2011-11 to specifically include only derivatives accounted for under Topic 815, repurchase and reverse purchase agreements, and securities and borrowing and lending transactions that are either offset or subject to an enforceable master netting arrangement. Both ASUs are effective for annual and interim periods beginning January 1, 2013. The adoption of these ASUs had no effect on the Company’s financial statements.
Other Comprehensive Income In February 2013, the FASB issued ASU No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (AOCI). The amendments of ASU No. 2013-02 require an entity to present, either in the income statement or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income, but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety, an entity is required to cross-reference to other disclosures that provide additional detail about those amounts. This ASU is effective for annual and interim periods beginning January 1, 2013. As a result of the adoption of the ASU, the disclosure of AOCI included in Note 7 contains information regarding reclassifications out of AOCI and into net income.
8
(2) Loans and Allowance for Loan Losses
A summary of loans, by major class within the Company’s loan portfolio, at September 30, 2013 and December 31, 2012 is as follows:
(in thousands)
Commercial, financial, and agricultural
132,923
130,040
Real estate construction - residential
23,664
22,177
Real estate construction - commercial
48,489
43,486
Real estate mortgage - residential
220,174
221,223
Real estate mortgage - commercial
375,876
405,092
Installment and other consumer
21,916
24,966
Total loans
The Bank grants real estate, commercial, installment, and other consumer loans to customers located within the communities surrounding Jefferson City, Clinton, Warsaw, Springfield, Branson and Lee’s Summit, Missouri. As such, the Bank is susceptible to changes in the economic environment in these communities. The Bank does not have a concentration of credit in any one economic sector. Installment and other consumer loans consist primarily of the financing of vehicles. At September 30, 2013, loans with a carrying value of $383.4 million were pledged to the Federal Home Loan Bank as collateral for borrowings and letters of credit.
Allowance for loan losses
The following is a summary of the allowance for loan losses for the three and nine months ended September 30, 2013, and 2012:
Three Months Ended September 30, 2013
Commercial,
Real Estate
Installment
Financial, &
Construction -
Mortgage -
Loans to
Un-
Agricultural
Residential
Commercial
Individuals
allocated
Balance at beginning of period
2,119
932
2,202
2,456
7,415
233
1
15,358
Additions:
444
32
(216
(294
25
Deductions:
Loans charged off
654
368
178
91
1,426
Less recoveries on loans
(201
(39
(34
(48
(322
Net loans charged off
453
329
144
1,104
Balance at end of period
2,110
964
1,851
2,131
6,977
215
14,254
Nine Months Ended September 30, 2013
1,937
732
1,711
3,387
6,834
239
14,842
725
351
273
(586
1,142
119
754
1,205
271
3,301
(265
(2
(84
(206
(156
(713
552
133
999
115
2,588
9
Three Months Ended September 30, 2012
3,045
709
1,644
3,560
6,107
232
15,314
1,239
(68
90
118
3,241
(11
742
41
2,366
154
3,303
(18
(19
(96
(76
(209
724
22
2,270
1,734
3,656
7,078
245
16,920
Nine Months Ended September 30, 2012
1,804
1,188
1,562
3,251
5,734
267
13,809
2,469
(614
149
913
4,793
187
846
618
3,666
425
5,555
(133
(67
(23
(110
(217
(766
713
508
3,449
209
4,789
10
Loans, or portions of loans, are charged off to the extent deemed uncollectible or a loss is confirmed. Loan charge-offs reduce the allowance for loan losses, and recoveries of loans previously charged off are added back to the allowance. If management determines that it is probable that all amounts due on a loan will not be collected under the original terms of the loan agreement, the loan is considered to be impaired. These loans are evaluated individually for impairment, and in conjunction with current economic conditions and loss experience, specific reserves are estimated as further discussed below. Loans not individually evaluated are aggregated by risk characteristics and reserves are recorded using a consistent methodology that considers historical loan loss experience by loan type, delinquencies, current economic conditions, loan risk ratings and industry concentration. Although the allowance for loan losses are comprised of specific and general allocations, the entire allowance is available to absorb credit losses.
The following table provides the balance in the allowance for loan losses at September 30, 2013 and December 31, 2012, and the related loan balance by impairment methodology.
Financial, and
Un -
September 30, 2013
Allowance for loan losses:
Individually evaluated for impairment
576
248
250
719
2,782
4,581
Collectively evaluated for impairment
1,534
716
1,601
1,412
4,195
9,673
Loans outstanding:
4,392
2,254
7,101
5,217
16,948
35,956
128,531
21,410
41,388
214,957
358,928
21,872
787,086
December 31, 2012
213
125
542
1,069
2,071
4,020
1,724
607
1,169
2,318
4,763
10,822
4,157
2,496
7,762
5,771
18,959
39,189
125,883
19,681
35,724
215,452
386,133
24,922
807,795
Impaired loans
Loans evaluated under ASC 310-10-35 include loans which are individually evaluated for impairment. All other loans are collectively evaluated for impairment under ASC 450-20. Impaired loans totaled $36.2 million and $39.4 million at September 30, 2013 and December 31, 2012, respectively, and are comprised of loans on non-accrual status and loans which have been classified as troubled debt restructurings. Total impaired loans of $36.2 million at September 30, 2013, includes $36.0 million of impaired loans individually evaluated for impairment and $220,000 of non-accrual consumer loans that were collectively evaluated for impairment. Total impaired loans of $39.4 million at December 31, 2012, includes $39.2 million of impaired loans individually evaluated for impairment and $174,000 of non-accrual consumer loans that were collectively evaluated for impairment.
The specific reserve component applies to loans evaluated individually for impairment. The net carrying value of impaired loans is generally based on the fair values of collateral obtained through independent appraisals or internal evaluations, or by discounting the total expected future cash flows. At September 30, 2013 and December 31, 2012, $32.4 million and $36.1 million, respectively, of impaired loans were evaluated based on the fair value of the loan’s collateral. Once the impairment
11
amount is calculated, a specific reserve allocation is recorded. At September 30, 2013, $4.6 million of the Company’s allowance for loan losses was allocated to impaired loans totaling $36.2 million compared to $4.0 million of the Company’s allowance for loan losses allocated to impaired loans totaling approximately $39.4 million at December 31, 2012. Management determined that $12.2 million, or 34%, of total impaired loans required no reserve allocation at September 30, 2013 compared to $14.7 million, or 37%, at December 31, 2012 primarily due to adequate collateral values, acceptable payment history and adequate cash flow ability.
The incurred loss component of the general reserve, or loans collectively evaluated for impairment, is determined by applying percentages to pools of loans by asset type. Loans not individually evaluated are aggregated based on similar risk characteristics. Historical loss rates for each risk group, which are updated quarterly, are quantified using all recorded loan charge-offs. Management determined that the previous twelve quarters were reflective of the loss characteristics of the Company’s loan portfolio during the recent economic environment. These historical loss rates for each risk group are used as the starting point to determine allowance provisions. The Company’s methodology includes factors that allow management to adjust its estimates of losses based on the most recent information available. The rates are then adjusted to reflect actual changes and anticipated changes such as changes in specific allowances on loans and real estate acquired through foreclosure, any gains and losses on final disposition of real estate acquired through foreclosure, changes in national and local economic conditions and developments, including general economic and business conditions affecting the Company’s key lending areas, credit quality trends, specific industry conditions within portfolio segments, bank regulatory examination results, and findings of the internal loan review department. These risk factors are generally reviewed and updated quarterly, as appropriate.
The categories of impaired loans at September 30, 2013 and December 31, 2012 are as follows:
Non-accrual loans
28,610
31,081
Troubled debt restructurings continuing to accrue interest
7,566
8,282
Total impaired loans
36,176
39,363
The following tables provide additional information about impaired loans at September 30, 2013 and December 31, 2012, respectively, segregated between loans for which an allowance has been provided and loans for which no allowance has been provided.
Unpaid
Recorded
Principal
Specific
Investment
Balance
Reserves
With no related allowance recorded:
Commercial, financial and agricultural
2,501
2,581
Real estate - construction residential
104
139
Real estate - construction commercial
2,861
3,459
Real estate - residential
2,419
3,214
Real estate - commercial
4,084
4,344
Consumer
220
12,189
13,975
With an allowance recorded:
1,891
1,984
2,150
2,272
4,240
2,798
2,931
12,864
13,772
23,987
25,243
39,218
12
3,272
4,009
2,307
2,339
1,879
2,102
1,939
2,393
5,162
5,565
174
14,733
16,594
885
898
189
5,883
6,011
3,832
3,999
13,797
14,167
24,630
25,308
41,902
The following table presents by class, information related to the average recorded investment and interest income recognized on impaired loans for the three and nine months ended September 30, 2013 and 2012.
Recognized
Average
For the
Period
Ended
2,598
3,074
2,643
71
3,315
66
1,589
242
737
3,803
1,653
3,168
2,299
3,179
3,333
47
4,346
29
3,598
28
4,348
86
10,582
87
202
181
162
13,912
61
12,620
56
14,427
168
19,782
208
1,996
2,890
2,031
34
2,615
2,273
6,192
6,180
2,920
3,037
2,947
38
2,566
13,210
15,072
13,524
14,209
24,682
27,380
13
25,059
25,759
33
38,594
105
40,000
69
39,486
45,541
241
The recorded investment varies from the unpaid principal balance primarily due to partial charge-offs taken resulting from current appraisals received. The amount recognized as interest income on impaired loans continuing to accrue interest, primarily related to troubled debt restructurings, was $105,000 and $346,000, and $69,000 and $241,000, for the three and nine months ended September 30, 2013 and 2012, respectively. The average recorded investment on impaired loans is calculated on a monthly basis during the periods reported. Contractual interest lost on loans in non-accrual status was $929,000 at September 30, 2013 compared to $966,000 at September 30, 2012. During the three and nine months ended September 30, 2013, $1,000 and $93,000, respectively, in interest was recognized on loans in non-accrual status on a cash basis. During the three and nine months ended September 30, 2012, there was no significant interest recognized on loans in non-accrual status.
Delinquent and Non-Accrual Loans
The delinquency status of loans is determined based on the contractual terms of the notes. Borrowers are generally classified as delinquent once payments become 30 days or more past due.
The following table provides aging information for the Company’s past due and non-accrual loans at September 30, 2013 and December 31, 2012.
Current or
90 Days
Less Than
Past Due
30 Days
30 - 89 Days
And Still
Accruing
Non-Accrual
Commercial, Financial, and Agricultural
130,695
185
15
2,028
Real Estate Construction - Residential
21,249
160
2,255
Real Estate Construction - Commercial
Real Estate Mortgage - Residential
213,627
1,798
377
4,372
Real Estate Mortgage - Commercial
362,293
992
12,591
Installment and Other Consumer
21,378
261
263
790,630
3,396
406
126,884
1,335
19,390
290
2,497
35,117
213,694
2,199
5,330
390,032
1,122
13,938
24,221
520
219
809,338
6,559
Credit Quality
The Company categorizes loans into risk categories based upon an internal rating system reflecting management’s risk assessment. Loans are placed on watch status when (1) one or more weaknesses that could jeopardize timely liquidation exits; or (2) the margin or liquidity of an asset is sufficiently tenuous that adverse trends could result in a collection problem. Loans classified as substandard are inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged, if any. Loans so classified may have a well defined weakness or weaknesses that jeopardize the repayment of the debt. Such loans are characterized by the distinct possibility that the Company may sustain some loss if the deficiencies are not corrected. It is the Company’s policy to discontinue the accrual of interest income on loans when management believes that the collection of interest or principal is doubtful. Loans are placed on non-accrual status when (1) deterioration in the financial condition of the borrower exists for which payment of full principal and interest is not expected, or (2) payment of principal or interest has been in default for a period of 90 days or more and the asset is not both well secured and in the process of collection. Subsequent interest payments received on such loans are applied to principal if any doubt exists as to the collectability of such principal; otherwise, such receipts are recorded as interest income on a cash basis.
The following table presents the risk categories by class at September 30, 2013 and December 31, 2012.
Commercial, Financial, & Agricultural
Installment and other Consumer
At September 30, 2013
Watch
14,825
933
3,763
23,272
24,985
399
68,177
Substandard
8,506
2,564
1,082
7,794
13,885
416
34,247
Non-accrual
25,359
5,752
11,946
35,438
51,461
1,078
131,034
At December 31, 2012
14,814
4,580
6,459
26,063
29,753
672
82,341
6,485
396
2,035
5,472
11,027
423
25,838
22,634
7,473
16,256
36,865
54,718
1,314
139,260
Troubled Debt Restructurings
At September 30, 2013, loans classified as troubled debt restructurings (TDRs) totaled $19.3 million, of which $11.7 million was on non-accrual status and $7.6 million was on accrual status. At December 31, 2012, loans classified as TDRs totaled $22.4 million, of which $14.1 million was on non-accrual status and $8.3 million was on accrual status. When an individual loan is determined to be a TDR, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the underlying collateral less applicable selling costs. Accordingly, specific reserves of $1.3 million and $1.5 million related to TDRs were allocated to the allowance for loan losses at September 30, 2013 and December 31, 2012, respectively.
The following table summarizes loans that were modified as TDRs during the three and nine months ended September 30, 2013 and 2012:
Three Months Ended September 30,
Recorded Investment (1)
Number of Contracts
Pre- Modification
Post- Modification
644
744
Nine Months Ended September 30,
280
42
481
984
966
(1) The amounts reported post-modification are inclusive of all partial pay-downs and charge-offs, and no portion of the debt was forgiven. Loans modified as a TDR that were fully paid down, charged-off or foreclosed upon during the period ended are not reported.
The Company’s portfolio of loans classified as TDRs include concessions such as interest rates below the current market rate, deferring principal payments, and extending maturity dates. Once a loan becomes a TDR, it will continue to be reported as a TDR until it is ultimately repaid in full, charged-off, or the collateral for the loan is foreclosed and sold. The Company considers a loan in TDR status in default when the borrower’s payment according to the modified terms is at least 90 days past due or has defaulted due to expiration of the loan’s maturity date. During the nine months ended September 30, 2013, one loan meeting the TDR criteria was modified compared to six loans during the nine months ended September 30, 2012. During the three months ended September 30, 2013 there were no new loans modified as TDRs and four loans modified as TDRs during the three months ended September 30, 2012. There were no loans modified as a TDR that defaulted during the three and nine months ended September 30, 2013, and within twelve months of their modification date. No loans modified as a TDR during the three and nine months ended September 30, 2012 defaulted.
(3) Real Estate and Other Assets Acquired in Settlement of Loans
126
112
10,028
13,392
908
1,227
9,354
14,201
Repossessed assets
204
468
20,620
29,729
Less valuation allowance for other real estate owned
(4,752
(6,137
Total other real estate owned and foreclosed assets
Changes in the net carrying amount of other real estate owned and repossessed assets for the three and nine months ended September 30, 2013 and 2012 were as follows:
21,977
29,057
22,997
Additions
7,018
16,329
Proceeds from sales
(1,348
(2,469
(7,581
(5,553
Charge-offs against the valuation allowance for other real estate owned, net
(1,075
(4,416
(1,318
Repossessed assets impairment write-downs
(239
Net (loss) gain on sales
(185
(151
Total other real estate owned and repossessed assets
32,675
(7,480
25,195
Activity in the valuation allowance for other real estate owned in settlement of loans for the three and nine months ended September 30, 2013 and 2012, respectively, is summarized as follows:
Balance, beginning of year
7,474
6,137
1,081
Charge-offs
Balance, end of year
4,752
7,480
The increase in the expense provision for other real estate owned during 2013 primarily related to commercial property located in the Branson area that sold at auction during the second quarter of 2013. These amounts are reflected in other real estate expense in the consolidated statements of operations.
(4) Investment Securities
The amortized cost and fair value of debt securities classified as available-for-sale at September 30, 2013 and December 31, 2012 are as follows:
Gross
Amortized
unrealized
cost
gains
losses
Fair value
U.S. Treasury
1,000
1,006
Government sponsored enterprises
64,089
674
63,838
Asset-backed securities
114,966
1,402
2,289
114,079
Obligations of states and political subdivisions
34,299
627
34,706
Total available for sale securities
214,354
2,458
3,183
30
2,030
54,327
853
55,180
104,607
3,276
107,872
33,959
1,222
35,164
194,893
5,381
All of the Company’s investment securities are classified as available for sale. Agency bonds and notes, agency mortgage-backed securities and agency collateralized mortgage obligations (CMO) include securities issued by the Government National Mortgage Association (GNMA), a U.S. government agency, and the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC) and the Federal Home Loan Bank (FHLB), which are U.S. government-sponsored enterprises.
Investment securities that are classified as restricted equity securities primarily consist of Federal Home Loan Bank stock and the Company’s interest in statutory trusts. These securities are reported at cost in other assets in the amount of $4.0 million and $3.9 million as of September 30, 2013 and December 31, 2012, respectively.
Debt securities with carrying values aggregating approximately $154.5 million and $146.4 million at September 30, 2013 and December 31, 2012, respectively, were pledged to secure public funds, securities sold under agreements to repurchase, and for other purposes as required or permitted by law.
The amortized cost and fair value of debt securities classified as available-for-sale at September 30, 2013 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without prepayment penalties.
Fair
value
Due in one year or less
6,432
6,482
Due after one year through five years
59,976
60,495
Due after five years through ten years
31,843
31,488
Due after ten years
1,137
1,085
99,388
99,550
Gross unrealized losses on debt securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2013 and December 31, 2012 were as follows:
Less than 12 months
12 months or more
Unrealized
Value
Losses
27,876
(674
68,464
(2,281
(8
69,254
(2,289
9,636
105,976
(3,175
106,766
(3,183
1,044
4,729
2,114
(17
150
2,264
7,887
(28
8,037
The total available for sale portfolio consisted of approximately 350 securities at September 30, 2013. The portfolio included 100 securities having an aggregate fair value of $106.8 million that were in a loss position at September 30, 2013. Securities identified as temporarily impaired which have been in a loss position for 12 months or longer totaled $790,000 at fair value. The $3.2 million aggregate unrealized loss included in accumulated other comprehensive income (loss) at September 30, 2013 was caused by interest rate fluctuations. The total available for sale portfolio consisted of approximately 380 securities at December 31, 2012. The portfolio included 14 securities having an aggregate fair value of $8.0 million that were in a loss position at December 31, 2012. Securities identified as temporarily impaired which have been in a loss position for 12 months or longer totaled $150,000 at fair value. The $28,000 aggregate unrealized loss included in other comprehensive income at December 31, 2012 was caused by interest rate fluctuations. Because the decline in fair value is attributable to changes in interest rates and not credit quality these investments were not considered other-than-temporarily impaired at September 30, 2013 and December 31, 2012, respectively.
18
The following table presents the components of investment securities gains and losses which have been recognized in earnings.
Gross gains realized on sales
Gross losses realized on sales
Other-than-temporary impairment recognized
Net realized gains
(5) Intangible Assets
Core Deposit Intangible Asset
A summary of amortizable intangible assets at September 30, 2013 and December 31, 2012 is as follows:
Carrying
Net
Amount
Amortization
Core deposit intangible
4,795
(4,795
(4,660
Changes in the net carrying amount of core deposit intangible assets for the three and nine months ended September 30, 2013 and 2012 were as follows:
543
(101
(135
(307
236
Mortgage Servicing Rights
On January 1, 2012, the Company opted to measure mortgage servicing rights at fair value as permitted by Accounting Standards Codification (ASC) Topic 860-50, Accounting for Servicing Financial Assets. The election of this option resulted in the recognition of a cumulative effect of change in accounting principle of $459,890, which was recorded as an increase to beginning retained earnings. As such, effective January 1, 2012, changes in the fair value of mortgage servicing rights have been recognized in earnings in non-interest income in the period in which the change occurred.
At September 30, 2013 and December 31, 2012, respectively, the Company serviced mortgage loans for others totaling $323.0 million and $310.6 million, respectively. Mortgage loan servicing fees, reported as non-interest income, earned on loans sold were $214,000 and $674,000, and $211,000 and $637,000, for the three and nine months ended September 30, 2013 and 2012, respectively.
19
The table below presents changes in mortgage servicing rights (MSRs) for the three and nine months ended September 30, 2013 and 2012 as follows:
2,873
2,666
2,308
Re-measurement to fair value upon election to measure servicing rights at fair value
Originated mortgage servicing rights
83
231
559
Changes in fair value:
Due to change in model inputs and assumptions (1)
296
96
677
372
Other changes in fair value (2)
(173
(369
(591
(1,357
2,624
(1) The change in fair value resulting from changes in valuation inputs or assumptions used in the valuation model reflects the change in discount rates and prepayment speed assumptions primarily due to changes in interest rates.
(2) Other changes in fair value reflect changes due to customer payments and passage of time. This also includes a one time adjustment of a $538,000 correction of an immaterial prior period error in 2012 due to changing from the straight-line amortization method to an accelerated amortization method of accounting for amortizing MSRs in prior years. If the aforementioned was corrected as of December 31, 2011, the balance at the beginning of the nine month period ending September 30, 2012 would have been $1.8 million.
The following key data and assumptions were used in estimating the fair value of the Company’s mortgage servicing rights for the nine months ended September 30, 2013 and 2012:
Weighted-Average Constant Prepayment Rate
10.94
%
16.32
Weighted-Average Note Rate
4.02
4.38
Weighted-Average Discount Rate
8.56
8.01
Weighted-Average Expected Life (in years)
5.70
3.90
(6) Income Taxes
Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 33.0% for the three months ended September 30, 2013 compared to 30.9% for the three months ended September 30, 2012. Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 31.9% for the nine months ended September 30, 2013 compared to (78.9)% for the nine months ended September 30, 2012. Excluding an immaterial correction of a prior period error of $371,000 and prior year return to provision adjustments, income taxes as a percentage of earnings before income taxes would have been 18.9% for the nine months ended September 30, 2012.
The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not the Company will realize the benefits of these temporary differences at September 30, 2013 and, therefore, did not establish a valuation reserve.
20
(7) Stockholders’ Equity
Accumulated Other Comprehensive (Loss) Income
The following details the change in the components of the Company’s accumulated other comprehensive (loss) income for the nine months ended September 30, 2013:
Unrecognized Net
Pension and
Unrealized Gain
Postretirement
on Securities
Costs
3,265
(1,440
Reclassification adjustments to net income:
Realized gain on sale of securities, net of tax
Other comprehensive (loss) income, net of reclassification and tax
(3,322
(450
(1,390
(8) Employee Benefit Plans
Employee Benefits
Employee benefits charged to operating expenses are summarized in the table below.
Payroll taxes
266
832
857
Medical plans
483
448
1,443
1,346
401k match and profit-sharing
97
(30
287
276
Pension plan
286
330
858
990
73
153
Total employee benefits
1,095
3,573
3,711
The Company’s profit-sharing plan includes a matching 401k portion, in which the Company matches the first 3% of eligible employee contributions. The Company made annual contributions in an amount up to 6% of income before income taxes and before contributions to the profit-sharing and pension plans for all participants, limited to the maximum amount deductible for federal income tax purposes, for each of the periods shown. In addition, employees were able to make additional tax-deferred contributions.
Pension
The Company provides a noncontributory defined benefit pension plan for all full-time employees. An employer is required to recognize the funded status of a defined benefit postretirement plan as an asset or liability in its balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. Under the Company’s funding policy for the defined benefit pension plan, contributions are made to a trust as necessary to provide for current service and for any unfunded accrued actuarial liabilities over a reasonable period. To the extent that these requirements are fully covered by assets in the trust, a contribution might not be made in a particular year. The Company has not made any contributions to the defined benefit plan for the current plan year through November 14, 2013. The minimum required contribution for the 2013 plan year is estimated to be $665,000. The Company has not determined whether it will make any contributions other than the minimum required funding contribution for 2013.
Components of Net Pension Cost and Other Amounts Recognized in Accumulated Other Comprehensive (Loss) Income
The following items are components of net pension cost for the periods indicated:
Estimated
Actual
Service cost—benefits earned during the year
1,211
1,168
Interest costs on projected benefit obligations
645
668
Expected return on plan assets
(820
(776
Expected administrative expenses
40
Amortization of prior service cost
Amortization of unrecognized net loss
46
Net periodic pension expense
1,144
1,224
Pension expense - three months ended September 30, (actual)
Pension expense - nine months ended September 30, (actual)
(9) Stock Compensation
The Company’s stock option plan provides for the grant of options to purchase up to 547,492 shares of the Company’s common stock to officers and other key employees of the Company and its subsidiaries. All options have been granted at exercise prices equal to fair value and vest over periods ranging from four to five years, except options issued in 2008 to acquire 11,578 shares that vested immediately.
The following table summarizes the Company’s stock option activity:
Weighted
Aggregate
Number
Contractual
Intrinsic
of
Exercise
Term
Shares
Price
(in years)
(000)
Outstanding at beginning of period *
223,951
23.74
Granted
0.00
Exercised
Forfeited
Expired
(36,181
21.67
Outstanding at September 30, 2013
187,770
24.13
2.8
Exercisable at September 30, 2013
173,253
24.31
2.6
* Options have been adjusted to reflect a 4% stock dividend paid on July 1, 2013.
Total stock-based compensation expense for the three months ended September 30, 2013 and 2012 was $5,000 and $7,000, respectively, and for the nine months ended September 30, 2013 and 2012 was $14,000 and $27,000, respectively. As of September 30, 2013, the total unrecognized compensation expense related to non-vested stock awards was $55,000 and the related weighted average period over which it is expected to be recognized is approximately 2 years.
(10) Preferred Stock
On December 19, 2008, the Company announced its participation in the U.S. Treasury Department’s Capital Purchase Program (CPP), a voluntary program that provides capital to financially healthy banks. This program was designed to attract broad participation by banking institutions to help stabilize the financial system by encouraging lending.
Participating in this program included the Company’s issuance of 30,255 shares of senior preferred stock (with a par value of $1,000 per share) and a ten year warrant to purchase approximately 287,133 shares of common stock (see below for additional information) to the U.S. Department of Treasury in exchange for $30.3 million. On May 9, 2012, the Company redeemed 12,000 shares of preferred stock from the U.S. Department of Treasury by repaying $12.0 million of the $30.3 million CPP funds along with $140,000 of accrued and unpaid dividends on the shares redeemed. Related to these shares was an additional $300,000 of accretion that was recognized at the time of the redemption. On May 15, 2013, the Company redeemed the remaining 18,255 shares of preferred stock from the U.S. Department of Treasury by repaying the $18.3 million of the CPP funds along with $228,187 of accrued and unpaid dividends on the shares redeemed. Related to these shares was an additional $182,209 of accretion that was recognized at the time of the redemption.
The common stock warrant was repurchased by the Company on June 11, 2013 pursuant to a letter agreement between the Treasury and the Company for a total repurchase price of $540,000, or $1.88 per warrant share. The repurchase price was based on the fair market value of the warrant as agreed upon by the Company and the Treasury. The repurchase of the warrant ends the Company’s participation in the U.S Treasury Department’s CPP. For the nine months ended September 30, 2013, the Company had declared and paid $456,000 of dividends and recognized $278,000 of accretion of the discount on preferred stock.
(11) Earnings per Share
Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the year. Diluted earnings per share gives effect to all dilutive potential common shares that were outstanding during the year. The calculations of basic and diluted earnings per share are as follows for the periods indicated:
(dollars in thousands, except per share data)
Basic earnings per common share:
Less:
Net income available to common shareholders
Basic earnings per share
Diluted earnings per common share:
Average shares outstanding
5,032,679
Effect of dilutive stock options
Average shares outstanding including dilutive stock options
Diluted earnings per share
Under the treasury stock method, outstanding stock options are dilutive when the average market price of the Company’s common stock, when combined with the effect of any unamortized compensation expense, exceeds the option price during the period, except when the Company has a loss from continuing operations available to common shareholders. In addition, proceeds from the assumed exercise of dilutive options along with the related tax benefit are assumed to be used to repurchase common shares at the average market price of such stock during the period.
The following options to purchase shares during the three and nine months ended September 30, 2013 and 2012 were not included in the respective computations of diluted earnings per share because the exercise price of the option, when combined with the effect of the unamortized compensation expense, was greater than the average market price of the common shares and were considered anti-dilutive. The warrant to purchase common stock was repurchased by the Company on June 11, 2013. See Note 10 for additional information.
Anti-dilutive shares - option shares
Anti-dilutive shares - warrant shares
298,618
Total anti-dilutive shares
522,569
24
(12) Fair Value Measurements
The Company uses fair value measurements to record fair value adjustments to certain financial and nonfinancial assets and liabilities. The FASB ASC Topic 820, Fair Value Measurements, defines fair value, establishes a framework for the measurement of fair value, and enhances disclosures about fair value measurements. The standard applies whenever other standards require (permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. In this standard, FASB clarified the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, the standard establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. As of September 30, 2013 and December 31, 2012, respectively, there were no transfers into or out of Levels 1, Level 2, or Level 3.
The fair value hierarchy is as follows:
Level 1 — Inputs are unadjusted quoted prices for identical assets or liabilities in active markets.
Level 2 — Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets and liabilities in active markets, such as interest rates and yield curves that are observable at commonly quoted intervals.
Level 3 — Inputs are unobservable inputs for the asset or liability and significant to the fair value. These may be internally developed using the Company’s best information and assumptions that a market participant would consider.
ASC Topic 820 also provides guidance on determining fair value when the volume and level of activity for the asset or liability have significantly decreased and on identifying circumstances when a transaction may not be considered orderly.
The Company is required to disclose assets and liabilities measured at fair value on a recurring basis separate from those measured at fair value on a nonrecurring basis. Nonfinancial assets measured at fair value on a nonrecurring basis would include foreclosed real estate, long-lived assets, and core deposit intangible assets, which are reviewed when circumstances or other events indicate that impairment may have occurred.
Valuation methods for instruments measured at fair value on a recurring basis
Following is a description of the Company’s valuation methodologies used for assets and liabilities recorded at fair value on a recurring basis:
Available-for-sale securities
The fair value measurements of the Company’s investment securities are determined by a third party pricing service which considers observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. The fair value measurements are subject to independent verification to another pricing source by management each quarter for reasonableness. Securities classified as available-for-sale are reported at fair value utilizing Level 2 inputs, except U.S. Treasury securities which are reported as Level 1.
The fair value of mortgage servicing rights is based on the discounted value of estimated future cash flows utilizing contractual cash flows, servicing rate, constant prepayment rate, servicing cost, and discount rate factors. Accordingly, the fair value is estimated based on a valuation model that calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds, market discount rates, cost to service, float earnings rates, and other ancillary income, including late fees. The valuation models estimate the present value of estimated future net servicing income. The Company classifies its servicing rights as Level 3.
Fair Value Measurements
Quoted Prices
in Active
Markets for
Significant
Identical
Observable
Unobservable
Assets
Inputs
Fair Value
(Level 1)
(Level 2)
(Level 3)
Assets:
U.S. treasury
216,708
212,623
202,795
198,216
The changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the three and nine months ended September 30, 2013 and 2012 are summarized as follows:
Fair Value Measurements Using
Significant Unobservable Inputs
Transfer into level 3
3,050
Total gains or losses (realized/unrealized):
Included in earnings
123
(985
Included in other comprehensive income
Purchases
Sales
Issued
Settlements
Total gains included in earnings attributable to the change in unrealized gains or losses related to assets still held were $296,000 and $677,000 and $96,000 and $372,000 for the three and nine months ended September 30, 2013 and 2012, respectively.
Input Value
Quantitative Information about Level 3 Fair Value Measurements
Valuation Technique
Unobservable Inputs
Discounted cash flows
Weighted average constant prepayment rate
Weighted average discount rate
Valuation methods for instruments measured at fair value on a nonrecurring basis
Following is a description of the Company’s valuation methodologies used for assets and liabilities recorded at fair value on a nonrecurring basis:
Impaired Loans
The Company does not record loans at fair value on a recurring basis other than loans that are considered impaired. The net carrying value of impaired loans is generally based on fair values of the underlying collateral obtained through independent appraisals or internal evaluations, or by discounting the total expected future cash flows. Once the fair value of the collateral has been determined and any impairment amount calculated, a specific reserve allocation is made. Because many of these inputs are not observable, the measurements are classified as Level 3. As of September 30, 2013, the Company identified $24.0 million of impaired loans that had specific allowances for losses aggregating $4.6 million.
Other Real Estate Owned and Repossessed Assets
Other real estate owned and repossessed assets consists of loan collateral that has been repossessed through foreclosure. This collateral is comprised of commercial and residential real estate and other non-real estate property, including autos, manufactured homes, and construction equipment. Other real estate owned assets are recorded as held for sale initially at the lower of the loan balance or fair value of the collateral less estimated selling costs. The Company relies on external appraisals and assessment of property values by internal staff. In the case of non-real estate collateral, reliance is placed on a variety of sources, including external estimates of value and judgment based on experience and expertise of internal specialists. Subsequent to foreclosure, valuations are updated periodically, and the assets may be written down to reflect a new cost basis. Because many of these inputs are not observable, the measurements are classified as Level 3.
For assets measured at fair value on a nonrecurring basis during the first nine months of 2013 and 2012, and still held as of September 30, 2013 and 2012, the following table provides the adjustments to fair value recognized during the respective periods, the level of valuation inputs used to determine each adjustment, and the carrying value of the related individual assets or portfolios at September 30, 2013 and 2012.
Three
Nine
Months Ended
Total Gains
(Losses)*
Impaired loans:
Commercial, financial, & agricultural
1,315
(607
(692
1,902
(119
3,990
2,079
(81
(327
10,082
(376
(1,363
19,406
(1,064
(2,501
Other real estate owned and repossessed assets
(320
(5,006
September 30, 2012
876
(742
(791
130
5,458
2,311
(564
14,607
(524
(1,547
23,382
(1,285
(2,902
(2,778
(3,186
* Total gains (losses) reported for other real estate owned and repossessed assets includes charge-offs, valuation write downs, and net losses taken during the periods reported.
(13) Fair Value of Financial Instruments
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 such value:
The fair values of loans are estimated by discounting the expected future cash flows using the current rates at which similar loans could be made to borrowers with similar credit ratings and for the same remaining maturities. The net carrying amount of impaired loans is generally based on the fair values of collateral obtained through independent appraisals or internal evaluations, or by discounting the total expected future cash flows. This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by ASC Topic 820.
Investment in available-for-sale securities
A detailed description of the fair value measurement of the debt instruments in the available-for-sale sections of the investment security portfolio is provided in the Fair Value Measurement section above. A schedule of investment securities by category and maturity is provided in the notes on Investment Securities.
Federal Home Loan Bank (FHLB) Stock
Ownership of equity securities of FHLB is restricted and there is no established market for their resale. The carrying amount is a reasonable estimate of fair value as this stock can only be sold to FHLB or other member banks at their par value per share.
Federal Funds Sold and Other Overnight Interest-Bearing Deposits
The carrying amounts of short-term federal funds sold and securities purchased under agreements to resell, interest earning deposits with banks, and cash and due from banks approximate fair value. Federal funds sold and securities purchased under agreements to resell classified as short-term generally mature in 90 days or less.
The fair value of mortgage servicing rights is based on the discounted value of estimated future cash flows utilizing contractual cash flows, servicing rate, constant prepayment rate, servicing cost, and discount rate factors. Accordingly, the fair value is estimated based on a valuation model that calculates the present value of estimated future net servicing income. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds, market discount rates, cost to service, float earnings rates, and other ancillary income, including late fees.
Cash Surrender Value – Life Insurance
The fair value of Bank owned life insurance (BOLI) approximates the carrying amount. Upon liquidation of these investments, the Company would receive the cash surrender value which equals the carrying amount.
Accrued Interest Receivable and Payable
For accrued interest receivable and payable, the carrying amount is a reasonable estimate of fair value because of the short maturity for these financial instruments.
The fair value of deposits with no stated maturity, such as noninterest-bearing demand, NOW accounts, savings, and money market, is equal to the amount payable on demand. The fair value of time deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.
Securities Sold under Agreements to Repurchase and Interest-bearing Demand Notes to U.S. Treasury
For securities sold under agreements to repurchase and interest-bearing demand notes to U.S. Treasury, the carrying amount is a reasonable estimate of fair value, as such instruments reprice in a short time period.
Subordinated Notes and Other Borrowings
The fair value of subordinated notes and other borrowings is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for other borrowed money of similar remaining maturities.
A summary of the carrying amounts and fair values of the Company’s financial instruments at September 30, 2013 and December 31, 2012 is as follows:
amount
Financial Assets:
Federal fund sold and overnight interest-bearing deposits
Loans, net
818,360
Investment in FHLB stock
2,355
1,060,772
1,070,344
31,735
217,170
821,439
Financial Liabilities:
Deposits:
Time deposits
358,632
360,968
30,975
25,456
1,050,440
1,035,708
618,309
56,431
834,824
2,278
1,103,418
1,106,100
66,097
202,630
837,373
Savings, interest checking, and money market
393,302
397,986
13,154
20,651
1,082,854
1,051,731
619,940
33,805
Off-Balance Sheet Financial Instruments
The fair value of commitments to extend credit and standby letters of credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the likelihood of the counterparties drawing on such financial instruments, and the present creditworthiness of such counterparties. The Company believes such commitments have been made on terms that are competitive in the markets in which it operates.
Limitations
The fair value estimates provided are made at a point in time based on market information and information about the financial instruments. Because no market exists for a portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the fair value estimates.
(14) Repurchase Reserve Liability
During the third quarter of 2013, the Company increased its repurchase reserve liability by $150,000 for estimated losses incurred on sold loans that is included in gain on sales of mortgage loans. This liability represents management’s estimate of the potential repurchase or make-whole liability for residential mortgage loans originated for sale that may arise from representation and warranty claims that could relate to a variety of issues, including but not limited to, misrepresentation of facts, appraisal issues, or program requirements that may not meet investor guidelines. The Company has not experienced any historical repurchase losses although it was notified during the third quarter of 2013 by one of its two investors that fifteen loans which were foreclosed from 2007 to the present are being reviewed for quality control purposes and may result in payments to the investor as reimbursement for losses. The balance of these loans at foreclosure date totaled $1.5 million and because the investor completes the foreclosure process without notifying the Company of the ultimate loss, if any, upon selling the property, the total potential exposure has been estimated based upon reasonable assumptions of the property values at the time of foreclosure and considering private mortgage insurance reimbursements. At September 30, 2013, the Company was servicing approximately 3,100 loans sold to the secondary market with a balance of approximately $323.0 million compared to $310.0 million at December 31, 2012, and $307.0 million at September 30, 2012.
(15) Commitments and Contingencies
The Company issues financial instruments with off-balance-sheet risk in the normal course of business of meeting the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments may involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets.
The Company’s extent of involvement and maximum potential exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for financial instruments included on its consolidated balance sheets. At September 30, 2013, no amounts have been accrued for any estimated losses for these financial instruments.
The contractual amount of off-balance-sheet financial instruments as of September 30, 2013 and December 31, 2012 is as follows:
Commitments to extend credit
137,277
118,412
Commitments to originate residential first and second mortgage loans
4,252
5,171
Standby letters of credit
2,223
2,995
31
Commitments
Commitments to extend credit are agreements to lend to a customer as 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 certain of the commitments and letters of credit are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, furniture and equipment, and real estate.
Commitments to originate residential loans are made following the Company’s usual underwriting guidelines and do not represent more than a normal amount of risk.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These standby letters of credit are primarily issued to support contractual obligations of the Company’s customers. The approximate remaining term of standby letters of credit range from one month to five years at September 30, 2013.
(16) Pending Litigation
The Company and its subsidiaries are defendants in various legal actions incidental to the Company’s past and current business activities. Based on the Company’s analysis, and considering the inherent uncertainties associated with litigation, management does not believe that it is reasonably possible that these legal actions will materially adversely affect the Company’s consolidated financial condition or results of operations in the near term. The Company records a loss accrual for all legal matters for which it deems a loss is probable and can be reasonably estimated. Some legal matters, which are at early stages in the legal process, have not yet progressed to the point where a loss amount can be estimated.
Item 2 - Management’s Discussion and Analysis of Financial Condition And Results of Operations
Forward-Looking Statements
This report contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company and its subsidiaries, including, without limitation:
· statements that are not historical in nature, and
· statements preceded by, followed by or that include the words believes, expects, may, will, should, could, anticipates, estimates, intends or similar expressions.
Forward-looking statements are not guarantees of future performance or results. They involve risks, uncertainties and assumptions. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:
· competitive pressures among financial services companies may increase significantly,
· changes in the interest rate environment may reduce interest margins,
· general economic conditions, either nationally or in Missouri, may be less favorable than expected and may adversely affect the quality of our loans and other assets,
· increases in non-performing assets in the loan portfolios and adverse economic conditions may necessitate increases to our provisions for loan losses,
· costs or difficulties related to the integration of the business of the Company and its acquisition targets may be greater than expected,
· legislative or regulatory changes may adversely affect the business in which the Company and its subsidiaries are engaged, and
· changes may occur in the securities markets.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, or the Dodd-Frank Act, was enacted on July 21, 2010. Provisions of the Act address many issues including, but not limited to, capital, interchange fees, compliance and risk management, debit card overdraft fees, the establishment of a new consumer regulator, healthcare, incentive compensation, expanded disclosures and corporate governance. While many of the new regulations under the Act are expected to primarily impact financial institutions with assets greater than $10 billion, the Company expects these new regulations could reduce revenues and increase expenses in the future. Management is currently assessing the impact of the Act and of the regulations anticipated to be promulgated under the Act.
The Company has described under the caption Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2012 and in other reports filed with the SEC from time to time, additional factors that could cause actual results to be materially different from those described in the forward-looking statements. Other factors that have not been identified in this report could also have this effect. You are cautioned not to put undue reliance on any forward-looking statement, which speak only as of the date they were made.
Overview
Through the branch network of its subsidiary bank, the Company, with $1.1 billion in assets at September 30, 2013, provides a broad range of commercial and personal banking services, including certificates of deposit, individual retirement and other time deposit accounts, checking and other demand deposit accounts, interest checking accounts, savings accounts, and money market accounts. The Company also provides a wide range of lending services, including real estate, commercial, installment, and other consumer loans. Other financial services that the Company provides include automated teller machines, trust services, credit-related insurance, and safe-deposit boxes. The geographic areas in which the Company provides products and services include the communities in and surrounding Jefferson City, Clinton, Warsaw, Springfield, Branson and Lee’s Summit, Missouri.
The Company’s primary source of revenue is net interest income derived primarily from lending and deposit taking activities. A secondary source of revenue is investment income. The Company also derives income from trust, brokerage, credit card and mortgage banking activities and service charge income.
Much of the Company’s business is commercial, commercial real estate development, and mortgage lending. The Company has experienced soft loan demand in the communities within which we operate during the current economic slowdown. The Company’s income from mortgage brokerage activities is directly dependent on mortgage rates and the level of home purchases and refinancings.
The success of the Company’s growth strategy depends primarily on the ability of the banking subsidiary to generate an increasing level of loans and deposits at acceptable risk levels and on acceptable terms without significant increases in non-interest expenses relative to revenues generated. The Company’s financial performance also depends, in part, on the ability to manage various portfolios and to successfully introduce additional financial products and services by expanding new and existing customer relationships, utilizing improved technology, and enhancing customer satisfaction. Furthermore, the success of the Company’s growth strategy depends on the ability to maintain sufficient regulatory capital levels during periods in which general economic conditions are unfavorable and despite economic conditions being beyond its control.
Hawthorn Bank (the Bank), the Company’s subsidiary bank, is a full-service bank conducting a general banking business, offering its customers checking and savings accounts, debit cards, certificates of deposit, safety deposit boxes and a wide range of lending services, including commercial and industrial loans, residential real estate loans, single payment personal loans, installment loans and credit card accounts. In addition, the Bank provides trust services.
The deposit accounts of the Bank are insured by the Federal Deposit Insurance Corporation (FDIC) to the extent provided by law. The operations of the Bank are supervised and regulated by the FDIC and the Missouri Division of Finance. Periodic examinations of the Bank are conducted by representatives of the FDIC and the Missouri Division of Finance. Such regulations, supervision and examinations are principally for the benefit of depositors, rather than for the benefit of shareholders. The Company is subject to supervision and examination by the Federal Reserve Board.
CRITICAL ACCOUNTING POLICIES
The following accounting policies are considered most critical to the understanding of the Company’s financial condition and results of operations. These critical accounting policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. Because these estimates and judgments are based on current circumstances, they may change over time or prove to be inaccurate based on actual experiences. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition and/or results of operations could reasonably be expected. The impact and any associated risks related to the critical accounting policies on the business operations are discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations, where such policies affect the reported and expected financial results.
Allowance for Loan Losses
Management has identified the accounting policy related to the allowance for loan losses as critical to the understanding of the Company’s results of operations, since the application of this policy requires significant management assumptions and estimates that could result in materially different amounts to be reported if conditions or underlying circumstances were to change. Further discussion of the methodology used in establishing the allowance and the impact of any associated risks related to these policies on the business operations is provided in Note 1 to the Company’s consolidated financial statements and is also discussed in the Lending and Credit Management section below. Many of the loans are deemed collateral dependent for purposes of the measurement of the impairment loss, thus the fair value of the underlying collateral and sensitivity of such fair values due to changing market conditions, supply and demand, condition of the collateral and other factors can be volatile over periods of time. Such volatility can have an impact on the financial performance of the Company.
Income Taxes
Income taxes are accounted for under the asset / liability method by recognizing the amount of taxes payable or refundable for the current period and deferred tax assets and liabilities for future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. Judgment is required in addressing the Company’s future tax consequences of events that have been recognized in the consolidated financial statements or tax returns such as realization of the effects of temporary differences, net operating loss carry forwards and changes in tax laws or interpretations thereof. A valuation allowance is established when in the judgment of management, it is more likely than not that such deferred tax assets will not become realizable. In this case, the Company would adjust the recorded value of the deferred tax asset, which would result in a direct charge to income tax expense in the period that the determination was made. Likewise, the Company would reverse the valuation allowance when it is expected to realize the deferred tax asset. In addition, the Company is subject to the continuous examination of its tax returns by the Internal Revenue Service and other taxing authorities. The Company accrues for penalties and interest related to income taxes in income tax expense. As of September 30, 2013, the Company has not recognized any tax liabilities or any interest or penalties in income tax expense related to uncertain tax positions.
Other real estate owned and repossessed assets consist of loan collateral that has been repossessed through foreclosure. This collateral is comprised of commercial and residential real estate and other non-real estate property, including autos, manufactured homes, and construction equipment. Other real estate owned assets are initially recorded as held for sale at the fair value of the collateral less estimated selling costs. Any adjustment is recorded as a charge-off against the allowance for loan losses. The Company relies on external appraisals and assessment of property values by internal staff. In the case of non-real estate collateral, reliance is placed on a variety of sources, including external estimates of value and judgment based on experience and expertise of internal specialists. Subsequent to foreclosure, valuations are updated periodically, and the assets may be written down to reflect a new cost basis. The write-downs are recorded as other real estate expense. The Company establishes a valuation allowance related to other real estate owned on an asset-by-asset basis. The valuation allowance is created during the holding period when the fair value less cost to sell is lower than the cost of the property.
SELECTED CONSOLIDATED FINANCIAL DATA
The following table presents selected consolidated financial information for the Company as of and for each of the three and nine months ended September 30, 2013 and 2012, respectively. The selected consolidated financial data should be read in conjunction with the consolidated financial statements of the Company, including the accompanying notes, presented elsewhere herein.
Selected Financial Data
Per Share Data
Basic earnings per common share
Diluted earnings per common share
Dividends paid on preferred stock
—
229
975
Dividends paid on common stock
726
698
Book value per common share
14.27
14.41
Market price per common share
13.61
8.50
Selected Ratios
(Based on average balance sheets)
Return on total assets
0.54
(0.54
)%
0.37
0.07
Return on common stockholders’ equity
8.68
(9.95
4.79
(1.54
Common stockholders’ equity to total assets
6.26
6.41
7.04
6.31
Efficiency ratio (1)
80.99
81.07
82.18
78.41
(Based on end-of-period data)
Common stockholders’ equity to assets
6.35
6.27
Stockholders’ equity to assets
7.81
Total risk-based capital ratio
15.36
16.71
Tier 1 risk-based capital ratio
11.39
13.36
Leverage ratio
10.09
(1) Efficiency ratio is calculated as non-interest expense as a percent of total revenue. Total revenue includes net interest and non-interest income.
36
RESULTS OF OPERATIONS ANALYSIS
The Company has prepared all of the consolidated financial information in this report in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). In preparing the consolidated financial statements in accordance with U.S. GAAP, the Company makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurances that actual results will not differ from those estimates.
$ Change
% Change
(257
(2.5
(1,699
(5.5
(4,700
(100.0
(5,900
(74.7
Noninterest income
2,654
(207
(7.8
7,989
7,067
922
13.0
Investment securities gains, net
NM
528
Total noninterest income
(233
(8.7
1,450
20.4
Noninterest expense
(406
(3.9
1,233
4.1
Income before income taxes
4,616
202.8
4,418
Income tax expense
1,475
209.5
1,792
656.4
3,141
(199.8
2,626
424.2
Less: preferred dividends
(228
(557
(62.3
and accretion of discount
(72
(309
(52.6
(300
(866
(58.5
3,441
(183.8
3,492
(405.1
Consolidated net income of $1.6 million for the quarter ended September 30, 2013 increased $3.1 million compared to a consolidated net loss of $1.6 million for the quarter ended September 30, 2012. Net income available to common shareholders for the quarter ended September 30, 2013 was $1.6 million, or $0.31 per diluted common share, compared to a net loss available to common shareholders of $1.9 million, or $(0.37) per diluted common share for the quarter ended September 30, 2012. For the quarter ended September 30, 2013, the return on average assets was 0.54%, the return on average common stockholders’ equity was 8.68%, and the efficiency ratio was 80.99%.
For the nine months ended September 30, 2013, consolidated net income was $3.2 million compared to $619,000 for the nine months ended September 30, 2012. For the nine months ended September 30, 2013, net income available to common shareholders was $2.6 million, or $0.52 per diluted common share, compared to a net loss available to common shareholders of $862,000, or $(0.17) per diluted common share, for the nine months ended September 30, 2012. The lower level of dividends and accretion for the three and nine months ended September 30, 2013 resulted from the Company’s redemption of the remaining 18,255 shares of preferred stock issued under the U.S. Treasury’s CPP program on May 15, 2013. For the nine months ended September 30, 2013, the return on average assets was 0.37%, the return on average common stockholders’ equity was 4.79%, and the efficiency ratio was 82.18%.
Net interest income, on a tax equivalent basis, decreased 2.6% to $10.0 million for the quarter ended September 30, 2013 compared to $10.3 million for the quarter ended September 30, 2012. For the nine months ended September 30, 2013, net interest income decreased 5.5% to $29.8 million compared to $31.5 million for the nine months ended September 30, 2012. These decreases were primarily a result of a decrease in the net interest margin due to a decrease in the Company’s average earning assets partially offset by a decrease in average cost of deposits. The net interest margin decreased to 3.74% and 3.68% for the three and nine months ended September 30, 2013 respectively, compared to 3.80% and 3.85% for the three and nine months ended September 30, 2012, respectively.
The lower provision for loan losses for the three and nine months ended September 30, 2013 compared to the three and nine months ended September 30, 2012 was primarily a result of the improving credit quality in the Company’s historical loss analysis and reduced levels of nonperforming loans. Net charge-offs for the quarter ended September 30,
37
2013, were $1.1 million, or 0.17% of average loans compared to $3.1 million, or 0.37% of average loans for the quarter ended September 30, 2012. Net charge-offs for the nine months ended September 30, 2013, were $2.6 million, or 0.40% of average loans compared to $4.8 million, or 0.57% of average loans for the nine months ended September 30, 2012. Non-performing assets were 4.67% of total assets at September 30, 2013 compared to 5.33% at December 31, 2012, and 5.82% at September 30, 2012.
Noninterest income decreased $233,000, or 8.7%, for the quarter ended September 30, 2013 and increased $1.4 million, or 20.4%, for the nine months ended September 30, 2013, compared to the nine months ended September 30, 2012. These changes are discussed in greater detail below under Noninterest Income.
Noninterest expense decreased $406,000, or 3.9 percent, for the quarter ended September 30, 2013, and increased $1.2 million, or 4.1%, for the nine months ended September 30, 2013, compared to the nine months ended September 30, 2012. These increases are discussed in greater detail below under Noninterest Expense.
Business Events
On June 11, 2013 the common stock warrant issued under the U.S Treasury Department’s CPP program was repurchased by the Company pursuant to a letter agreement between the Treasury and the Company for a total repurchase price of $540,000, or $1.88 per warrant share. The repurchase price was based on the fair market value of the warrant as agreed upon by the Company and the Treasury. The repurchase of the warrant ends the Company’s participation in the U.S Treasury Department’s CPP.
On July 1, 2013, the Company distributed a four percent stock dividend for the fifth consecutive year to common shareholders of record at the close of business on June 15, 2013. For all periods presented, share information, including basic and diluted earnings per share, has been adjusted retroactively to reflect the stock dividend.
Average Balance Sheets
Net interest income is the largest source of revenue resulting from the Company’s lending, investing, borrowing, and deposit gathering activities. It is affected by both changes in the level of interest rates and changes in the amounts and mix of interest earning assets and interest bearing liabilities. The following table presents average balance sheets, net interest income, average yields of earning assets, average costs of interest bearing liabilities, net interest spread and net interest margin on a fully taxable equivalent basis for each of the three month and nine month periods ended September 30, 2013 and September 30, 2012, respectively.
Rate
Income/
Earned/
Expense(1)
Paid(1)
Loans: (2) (4)
135,428
1,641
4.81
126,092
1,620
5.11
23,679
4.41
21,087
4.24
47,691
529
4.40
43,697
463
4.22
218,365
2,746
4.99
221,191
2,842
383,975
4,661
4.82
401,649
5,311
5.26
22,061
370
6.65
27,474
6.49
831,199
10,210
4.87
841,190
10,909
5.16
Investment securities: (3)
1,009
1.18
2,041
1.56
64,455
199
1.22
69,656
1.32
Asset backed securities
116,223
660
2.25
118,773
765
2.56
State and municipal
34,905
328
3.73
34,790
3.96
Total investment securities
216,592
1,190
2.18
225,260
1,350
2.38
Restricted investments
4,074
2.05
4,287
2.13
8,117
0.29
4,112
0.58
Total interest earning assets
1,059,982
11,427
4.28
1,074,849
12,288
4.55
All other assets
100,452
108,898
(15,423
(15,471
1,145,011
1,168,276
NOW accounts
184,912
0.25
176,904
136
Savings
76,849
0.11
67,162
Money market
160,865
99
0.24
152,488
111
Time deposits of $100,000 and over
117,945
0.75
127,565
0.93
247,349
0.86
278,305
980
1.40
Total time deposits
787,920
997
0.50
802,424
1,542
0.76
22,335
0.12
24,170
2.59
2.78
24,837
1.69
28,258
134
1.89
Total borrowings
96,658
436
1.79
101,914
487
1.90
Total interest bearing liabilities
884,578
0.64
904,338
0.89
Demand deposits
180,497
163,538
8,209
7,697
1,073,284
1,075,573
Stockholders’ equity
71,727
92,703
Net interest income (FTE)
9,994
10,259
Net interest spread
3.64
3.66
Net interest margin
3.74
3.80
39
(1) Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate of 34%, net of nondeductible interest expense. Such adjustments totaled $129,000 and $137,000 for the three months ended September 30, 2013 and 2012, respectively.
(2) Non-accruing loans are included in the average amounts outstanding.
(3) Average balances are based on amortized cost.
(4) Fees and costs on loans are included in interest income.
131,525
4,846
4.93
127,634
4,913
5.14
23,467
4.50
928
5.89
46,173
42,967
1,382
4.30
218,226
8,274
5.07
217,919
8,841
5.42
392,609
14,401
4.90
404,826
15,709
5.18
23,579
1,118
6.34
28,176
1,374
6.51
835,579
31,082
4.97
842,580
33,147
5.25
1,503
1.51
2,053
68,147
613
1.20
73,771
796
1.44
119,349
2,026
2.27
115,227
2,363
2.74
35,168
989
3.76
34,092
1,058
4.15
224,167
3,645
2.17
225,143
4,241
2.52
4,036
4,308
2.45
17,388
0.27
20,294
0.28
1,081,170
34,824
4.31
1,092,325
37,509
4.59
102,849
104,223
(15,229
(14,707
1,168,790
1,181,841
195,178
186,933
0.38
74,751
59
65,862
159,602
152,090
334
118,515
706
0.80
130,887
833
0.85
261,701
2,274
1.16
2,769
1.33
809,747
3,732
0.62
814,077
4,521
0.74
19,997
23,271
0.10
2.60
2.82
23,003
1.83
28,323
402
92,486
1,295
1.87
101,080
1,464
1.93
902,233
915,157
5,985
0.87
176,861
160,765
7,424
8,086
1,086,518
1,084,008
82,272
97,833
29,797
31,524
3.57
3.72
3.68
3.85
(1) Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate of 34%, net of nondeductible interest expense. Such adjustments totaled $388,000 and $416,000 for the nine months ended September 30, 2013 and 2012, respectively.
Rate and volume analysis
The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest earning assets and interest bearing liabilities, identifying changes related to volumes and rates for the three and nine months ended September 30, 2013 compared to September 30, 2012. The change in interest due to the combined rate/volume variance has been allocated to rate and volume changes in proportion to the absolute dollar amounts of change in each.
2013 vs. 2012
Change due to
Change
Volume
Interest income on a fully taxable equivalent basis: (1)
116
(95
147
(214
(138
98
(236
108
163
(36
(60
(567
(579
(650
(227
(423
(1,308
(465
(843
(78
(90
(256
(219
(37
(5
(3
(7
(6
(1
Government sponsored entities
(32
(183
(58
(125
(105
(89
(337
82
(419
(69
(12
Federal funds sold and other over-night Interest bearing deposits
(4
(861
(196
(665
(2,685
(280
(2,405
Interest expense:
(24
(148
(44
(59
(73
(21
(52
(127
(51
(445
(100
(345
(495
(158
(15
(13
(87
(74
(596
(122
(474
(958
(693
Net interest income on a fully taxable equivalent basis
(191
(1,727
(1,712
(1) Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate of 34%, net of nondeductible interest expense. Such adjustments totaled $129,000 and $137,000 for the three months ended September 30, 2013 and 2012, respectively, and $388,000 and $416,000 for the nine months ended September 30, 2013 and 2012, respectively.
Financial results for the three and nine months ended September 30, 2013 compared to the three and nine months ended September 30, 2012 reflected a decrease in net interest income, on a tax equivalent basis, of $265,000, or 2.6%, and $1.7 million, or 5.5%, respectively. The decreases in net interest income are primarily due to lower average earning asset levels and continued contraction of the net interest margin resulting from the prolonged low interest rate environment. Measured as a percentage of average earning assets, the net interest margin (expressed on a fully taxable equivalent basis)
decreased to 3.74% and 3.68% for the three and nine months ended September 30, 2013, respectively, compared to 3.80% and 3.85% for the three and nine months ended September 30, 2012, respectively.
Average interest-earning assets decreased $14.8 million, or 1.3%, to $1.06 billion for the quarter ended September 30, 2013 compared to $1.07 billion for the quarter ended September 30, 2012, and average interest bearing liabilities decreased $19.7 million, or 2.2%, to $884.6 million for the quarter ended September 30, 2013 compared to $904.3 million for the quarter ended September 30, 2012.
Average interest-earning assets decreased $11.1 million, or 1.0%, to $1.08 billion for the nine months ended September 30, 2013 compared to $1.09 billion for the nine months ended September 30, 2012, and average interest bearing liabilities decreased $12.9 million, or 1.4%, to $902.2 million for the nine months ended September 30, 2013 compared to $915.1 million for the nine months ended September 30, 2012.
Total interest income decreased to $11.4 million and $34.8 million for the three and nine months ended September 30, 2013, respectively, compared to $12.3 million and $37.5 million for the three and nine months ended September 30, 2012, respectively. The Company’s rates earned on interest earning assets wer 4.28% and 4.31% for the three and nine months ended September 30, 2013, respectively, compared to 4.55% and 4.59% for the three and nine months ended September 30, 2012, respectively.
Interest income on loans decreased 6.4% to $10.2 million for the quarter ended September 30, 2013 compared to $10.9 million for the quarter ended September 30, 2012. Average loans outstanding decreased $10.0 million, or 1.2%, to $831.2 million for the quarter ended September 30, 2013 compared to $841.1 million for the quarter ended September 30, 2012. The average yield on loans receivable decreased to 4.87% during the quarter ended September 30, 2013 compared to 5.16% for the quarter ended September 30, 2012 primarily as a result of decreasing market interest rates.
For the nine months ended September 30, 2013, interest income on loans decreased 6.2% to $31.1 million compared to $33.1 million for the nine months ended September 30, 2012. Average loans outstanding decreased $7.0 million, or 0.8%, to $835.6 million for the nine months ended September 30, 2013 compared to $842.6 million for the nine months ended September 30, 2012. The average yield on loans decreased to 4.97% for the nine months ended September 30, 2013 compared to 5.25% for the nine months ended September 30, 2012. See the Lending and Credit Management section for further discussion of changes in the composition of the lending portfolio.
Total interest expense decreased to $1.4 million and $5.0 million for the three and nine months ended September 30, 2013, respectively, compared to $2.0 million and $6.0 million for the three and nine months ended September 30, 2012, respectively. The Company’s rates paid on interest bearing liabilities was 0.64% and 0.74% for the three and nine months ended September 30, 2013, respectively, compared to 0.89% and 0.87% for the three and nine months ended September 30, 2012, respectively. On January 1, 2012, the Company recorded a $368,000 credit to interest expense on time deposits for imputed capitalized interest not accounted for during the time period of 2004 through 2011 on the construction of the Company’s new bank buildings. This is considered a correction of an immaterial prior period error. Without this credit to interest expense, rates paid on interest bearing liabilities would have been approximately 0.92% for the nine months ended September 30, 2012. See the Liquidity Management section for further discussion.
Interest expense on deposits decreased to $997,000 for the quarter ended September 30, 2013 compared to $1.5 million for the quarter ended September 30, 2012. Average time deposits decreased $14.5 million, or 1.8%, to $787.9 million for the quarter ended September 30, 2013 compared to $802.4 million for the quarter ended September 30, 2012. The average cost of deposits decreased to 0.50% during the quarter ended September 30, 2013 compared to 0.76% for the quarter ended September 30, 2012 primarily as a result of lower market interest rates, and approximately $23.0 million from a 58 month 6.05% certificate of deposit special that matured during the third quarter of 2013.
For the nine months ended September 30, 2013, interest expense on deposits decreased to $3.7 million compared to $4.5 million for the nine months ended September 30, 2012. Average time deposits decreased $4.3 million, or 0.5%, to $809.7 million for the nine months ended September 30, 2013 compared to $814.1 million for the nine months ended September 30, 2012. The cost of deposits decreased to 0.62% for the nine months ended September 30, 2012 to 0.74% for the nine months ended September 30, 2013.
Interest expense on borrowings decreased to $436,000 and $1.3 million for the three and nine months ended September 30, 2013, respectively, compared to $487,000 and $1.5 million for the three and nine months ended September 30, 2012, respectively. Average borrowings decreased $5.2 million to $96.6 million for the three months ended September 30, 2013 compared to $101.9 million for the three months ended September 30, 2012, and decreased $8.6 million to $92.5 million
for the nine months ended September 30, 2013 compared to $101.1 million for the nine months ended September 30, 2012. See the Liquidity Management section for further discussion.
Non-interest Income and Expense
Non-interest income for the three and nine months ended September 30, 2013 and 2012 was as follows:
(Dollars in thousands)
Non-interest Income
103
7.6
146
3.6
(23.5
(10.7
400
(645.2
1,108
(318.4
Gain on sales of mortgage loans
(604
(77.5
(258
(14.6
Gain on sales of investment securities
(14.9
(0.2
Non-interest income as a % of total revenue *
19.9
20.9
22.5
18.6
Total revenue per full time equivalent employee
35.6
36.6
109.7
109.1
* Total revenue is calculated as net interest income plus non-interest income.
Total non-interest income decreased $233,000, or 8.7%, to $2.4 million for the quarter ended September 30, 2013 compared to $2.7 million for the quarter ended September 30, 2012, and increased $1.4 million, or 20.4%, to $8.5 million for the nine months ended September 30, 2013 compared to $7.1 million for the nine months ended September 30, 2012. On January 1, 2012, the Company opted to measure mortgage servicing rights (MSRs) at fair value as permitted by Accounting Standards Codification (ASC) Topic 860-50 Accounting for Servicing Financial Assets. The election of this option resulted in the recognition of a cumulative effect of change in accounting principle of $459,890, which was recorded as an increase to beginning retained earnings, as further described in Note 5 to the consolidated financial statements. As such, effective January 1, 2012, the change in the fair value of mortgage servicing rights is recognized in earnings as other noninterest income for the period in which the change occurs.
Real estate servicing fees, net increased $400,000 to $338,000 for the quarter ended September 30, 2013 compared to the quarter ended September 30, 2012, and increased $1.1 million to $760,000 for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. Net real estate servicing fees include mortgage loan servicing fees and the gains or losses due to the change in fair value of MSRs arising from inputs and assumptions. Mortgage loan servicing fees earned on loans sold were $214,000 and $674,000 for the three months and nine months ended September 30, 2013, respectively, compared to $211,000 and $637,000 for the comparable 2012 periods, respectively. Total gains or losses recognized were $123,000 and $86,000 for the three and nine months ended September 30, 2013, respectively, compared to ($273,000) and ($985,000) for the comparable 2012 periods. The net losses recognized in 2012 included a one time adjustment of $538,000 correction of an immaterial prior period error due to changing from the straight-line amortization method to an accelerated amortization method of accounting for amortizing MSRs in prior years.
Gain on sales of mortgage loans decreased $604,000 to $175,000 for the quarter ended September 30, 2013 compared to the quarter ended September 30, 2012, and decreased $258,000 to $1.5 million for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. The Company’s loans sold decreased from $27.3 million for the quarter ended September 30, 2012 to $12.6 million for the quarter ended September 30, 2013, and decreased from $68.5 million for the nine months ended September 30, 2012 to $63.4 million for the nine months ended September 30, 2013. Refinancing activity impacting both the volume of loans sold and gains recognized began to slow down during the third quarter of 2013 due to rising interest rates. During the third quarter of 2013, the Company increased its repurchase reserve liability by $150,000 for estimated losses incurred on sold loans that is included in total gain on sales of mortgage loans. The Company was servicing $323.0 million of mortgage loans at September 30, 2013 compared to $306.5 million at September 30, 2012.
45
Gain on sale of investment securities During the nine months ended September 30, 2013, the Company received $22,115,000 from proceeds on sales of available-for-sale debt securities and recognized gains of $554,000. These transactions were the result of bond sales and purchases to replace several smaller holdings with fewer, larger investments without materially changing the duration or yield of the investment portfolio.
Non-interest expense for the three and nine months ended September 30, 2013 and 2012 was as follows:
Non-interest Expense
Salaries
3,658
11,023
10,754
2.5
Employee benefits
110
10.0
(3.7
4.4
1.0
1.6
0.1
(77
(27.1
(153
(17.4
157
12.4
4.5
(139
(15.7
3.4
Other real estate expense
(460
(26.7
1,263
39.8
(349
(11.3
Efficiency ratio
81.0
81.1
82.2
78.4
Salaries and benefits as a % of total non-interest expense
48.8
45.9
46.8
48.3
Number of full-time equivalents employees
350
Total non-interest expense decreased $406,000, or 3.9%, to $10.0 million for the quarter ended September 30, 2013 compared to the quarter September 30, 2012, and increased $1.2 million, or 4.1%, to $31.2 million for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012.
Employee benefits increased $110,000, or 10.0%, for the quarter ended September 30, 2013 compared to the quarter ended September 30, 2012, and decreased $138,000, or 3.7%, for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. The increase in the current quarter over the prior year quarter primarily resulted from an $83,000 increase in estimated profit sharing and pension expense accruals and a $35,000 increase in medical insurance premiums. The decrease in the nine months ended September 30, 2013 over the nine months ended September 30, 2012 primarily resulted from a $121,000 decrease in estimated profit sharing and pension expense accruals and an $89,000 decrease in other employee benefits, partially offset by a $97,000 increase in medical insurance premiums.
Legal, examination, and professional fees decreased $77,000, or 27.1%, for the quarter ended September 30, 2013 compared to the quarter ended September 30, 2012, and decreased $153,000, or 17.4%, for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. The decrease for the quarter ended September 30, 2013 over the quarter ended September 30, 2012 primarily consisted of a $22,000 decrease in legal fees and a $27,000 decrease in consulting fees, and a $30,000 decrease in audit fees. The decrease for the nine months ended September 30, 2013 over the nine months ended September 30, 2012 primarily consisted of an $85,000 decrease in legal fees and a $72,000 decrease in audit fees that was partially offset by a $7,000 increase in consulting fees. The decrease in legal fees for the three and nine months ended September 30, 2013 over the comparable periods 2012, was primarily a result of a decrease in litigation fees related to two legal suits incurred during the first nine months of 2012. The decrease in auditing fees was primarily due to nonrecurring fees incurred in 2012 for tax and fair value analysis. The increase in consulting fees during the nine months ended September 30, 2013 was primarily due to a deposit product review project and various additional new consulting projects.
Advertising and promotion increased $22,000, or 7.6%, for the quarter ended September 30, 2013 compared to the quarter ended September 30, 2012, and increased $157,000, or 20.9%, for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. The increase for both the three and nine months ended September 30, 2013 was primarily due to additional advertising projects and payment for several sponsorships and promotional items that were not incurred during 2012.
Processing expense decreased $139,000, or 15.7%, for the quarter ended September 30, 2013 compared to the quarter ended September 30, 2012, and increased $91,000, or 3.4% for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. The decrease quarter over quarter was primarily due to contract savings resulting in lower core processing expenses. The increase in processing expense during the nine months ended September 30, 2013 was primarily due to a one time consulting fee incurred to negotiate reduced future core processing expenses. A portion of this fee is being amortized over the new contract period with the Company’s core processing vendor.
Other real estate (ORE) expense decreased $460,000, or 26.7%, to $1.3 million for the quarter ended September 30, 2013 compared to the quarter ended September 30, 2012, and increased $1.3 million, or 39.8%, to $4.4 million for the nine months ended September 30, 2013 compared to September 30, 2012. The expense provision for valuation write-downs taken on ORE was $847,000 and $3.1 million for the three and nine months ended September 30, 2013, respectively, compared to $1.1 million and $1.8 million for the three and nine months ended September 30, 2012, respectively. The significant increase in the expense provision during 2013 primarily related to two hotels located in the Branson area that were sold at auction during the second quarter of 2013. Expenses incurred to maintain foreclosed properties were $260,000 and $1.3 million for the three months and nine months ended September 30, 2013, respectively, compared to $786,000 and $1.6 million for the same periods in 2012. The Company began to see a decrease in operating costs during the third quarter of 2013 due to the sale of the hotels.
Other non-interest expense increased $36,000, or 4.4%, for the quarter ended September 30, 2013 compared to the quarter ended September 30, 2012, and decreased $349,000, or 11.3%, for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012. The increase for the quarter ended September 30, 2013 was primarily due to a $54,000 increase in debit card charge-offs, an $80,000 increase in repossessed asset and loan expenses, partially offset by a $100,000 decrease in CDI amortization. The decrease for the nine months ended September 30, 2013 was primarily due to two property donations totaling $309,000 to charitable organizations during the first and second quarter of 2012 that were both in other real estate owned, and $179,000 decrease in CDI amortization. These decreases were partially offset by $239,000 impairment write-downs on repossessed assets taken in the second and third quarter of 2013.
Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 33.0% for the quarter ended September 30, 2013 compared to 30.9% for the quarter ended September 30, 2012. Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 31.9% for the nine months ended September 30, 2013 compared to (78.9)% for the nine months ended September 30, 2012. Excluding an immaterial correction of a prior period error of $371,000, income taxes as a percentage of earnings before income taxes would have been 18.9% for the nine months ended September 30, 2012. The Company had not recognized any tax liabilities or any interest or penalties in income tax expense related to uncertain tax positions as of September 30, 2013 and 2012.
Lending and Credit Management
Interest earned on the loan portfolio is a primary source of interest income for the Company. Net loans represented 71.5% of total assets as of September 30, 2013 compared to 70.4% as of December 31, 2012.
Lending activities are conducted pursuant to an established loan policy approved by the Bank’s Board of Directors. The Bank’s credit review process is overseen by regional loan committees with established loan approval limits. In addition, a senior loan committee reviews all credit relationships in aggregate over an established dollar amount. The senior loan committee meets weekly and are comprised of senior managers of the Bank.
A summary of loans, by major class within the Company’s loan portfolio as of the dates indicated is as follows:
16.2
15.4
2.9
5.9
5.1
26.8
26.1
45.7
47.8
Installment loans to individuals
3.0
100.0
The Company’s loan portfolio decreased $23.4 million, or 2.8%, from December 31, 2012 to September 30, 2013. During the nine months ended September 30, 2013 there were no significant increases in loan demand.
The Company extends credit to its local community market through traditional real estate mortgage products. The Company does not participate in extending credit to sub-prime residential real estate markets. The Company does not lend funds for the type of transactions defined as “highly leveraged” by bank regulatory authorities or for foreign loans. Additionally, the Company does not have any concentrations of loans exceeding 10% of total loans that are not otherwise disclosed in the loan portfolio composition table. The Company does not have any interest-earning assets that would have been included in nonaccrual, past due, or restructured loans if such assets were loans.
The Company generally does not retain long-term fixed rate residential mortgage loans in its portfolio. Fixed rate loans conforming to standards required by the secondary market are offered to qualified borrowers, but are not funded until the Company has a non-recourse purchase commitment from the secondary market at a predetermined price. For the nine months ended September 30, 2013, the Company sold approximately $63.4 million of loans to investors compared to $68.5 million for the nine months ended September 30, 2012. At September 30, 2013, the Company was servicing approximately $323.0 million of loans sold to the secondary market compared to $310.0 million at December 31, 2012, and $307.0 million at September 30, 2012.
Real estate mortgage loans retained in the Company’s portfolio generally include provisions for rate adjustments at one to five year intervals. Commercial loans and real estate construction loans generally have maturities of less than one year. Installment loans to individuals are primarily fixed rate loans with maturities from one to five years.
Risk Elements of the Loan Portfolio
Management, the senior loan committee, and internal loan review, formally review all loans in excess of certain dollar amounts (periodically established) at least annually. Currently, loans in excess of $2.0 million in aggregate and all adversely classified credits identified by management are reviewed. In addition, all other loans are reviewed on a sample basis. The senior loan committee reviews and reports to the board of directors, on a monthly basis, past due, classified, and watch list loans in order to classify or reclassify loans as loans requiring attention, substandard, doubtful, or loss. During this review, management also determines which loans should be considered impaired. Management follows the guidance provided in the FASB’s ASC Topic 310, Accounting by Creditors for Impairment of a Loan, in identifying and measuring loan impairment. If management determines that it is probable that all amounts due on a loan will not be collected under the original terms of the loan agreement, the loan is considered to be impaired. These loans are evaluated individually for impairment, and in conjunction with current economic conditions and loss experience, specific reserves are estimated as further discussed below. Loans not individually evaluated are aggregated and reserves are recorded using a consistent methodology that considers historical loan loss experience by loan type, delinquencies, current economic conditions, loan risk ratings and industry concentration. Management believes, but there can be no assurance, that these procedures keep management informed of potential problem loans. Based upon these procedures, both the allowance and provision for loan losses are adjusted to maintain the allowance at a level considered necessary by management to provide for probable losses inherent in the loan portfolio.
48
Nonperforming Assets
The following table summarizes nonperforming assets at the dates indicated:
Nonaccrual loans:
Loans contractually past - due 90 days or more and still accruing:
Troubled debt restructurings - accruing
Total nonperforming loans
36,582
39,369
Other real estate owned
15,664
23,124
Foreclosed assets
Total nonperforming assets
52,450
62,961
Allowance for loan losses to loans
1.73
1.75
Nonperforming loans to loans
4.44
4.65
Allowance for loan losses to nonperforming loans
38.96
37.70
Nonperforming assets to loans, other real estate owned and foreclosed assets
6.25
7.23
Total nonperforming assets decreased $10.5 million, or 16.7%, from December 30, 2012 to September 30, 2013. As detailed below, this decrease includes a decrease of $7.7 million, or 32.7%, due to sales and impairment write-downs of other real estate owned and repossessed assets, a $2.5 million, or 7.9%, decrease in nonaccrual loans, and a $716,000, or 8.6%, decrease in accruing troubled debt restructurings (TDRs).
Nonperforming loans, defined as loans on nonaccrual status, loans 90 days or more past due and still accruing, and TDRs totaled $36.6 million, or 4.44%, of total loans at September 30, 2013 compared to $39.3 million, or 4.65%, of total loans at December 31, 2012.
It is the Company’s policy to discontinue the accrual of interest income on loans when management believes that the borrower’s financial condition, after consideration of business conditions and collection efforts, is such that the collection of interest is doubtful, or upon which principal or interest due has been in default for a period of 90 days or more and the asset is not both well secured and in the process of collection. Subsequent interest payments received on such loans are applied to principal if any doubt exists as to the collectability of such principal; otherwise, such receipts are recorded as interest income on a cash basis. Interest on nonaccrual loans, which would have been recorded under the original terms of the loans, was approximately $660,000 and $966,000 for the nine months ended September 30, 2013 and 2012, respectively.
As of September 30, 2013 and December 31, 2012, approximately $26.7 million and $17.6 million, respectively, of loans classified as substandard, not included in the nonperforming asset table, were identified as potential problem loans having more than normal risk which raised doubts as to the ability of the borrower to comply with present loan repayment terms. Even though borrowers are experiencing moderate cash flow problems as well as some deterioration in collateral value, management believes the general allowance was sufficient to cover the risks and probable losses related to such loans at September 30, 2013 and December 31, 2012, respectively.
49
Total non-accrual loans at September 30, 2013 decreased $2.5 million to $28.6 million from December 31, 2012. This decrease primarily consisted of a $2.3 million decrease in real estate mortgage non-accrual loans and a net decrease of $661,000 in real estate construction loans. This decrease was partially offset by a $693,000 increase in commercial, financial, and agricultural loans. At September 30, 2013 and December 31, 2012, real estate mortgage — commercial non-accrual loans made up 45% of total non-accrual loans.
Loans past due 90 days and still accruing interest at September 30, 2013 increased $400,000 to $406,000 from December 31, 2012. Other real estate owned and repossessed assets at September 30, 2013 decreased $7.7 million to $15.9 million from December 31, 2012 primarily due to the sale of two hotels located in the Branson area and land held in foreclosed property in the Company’s real-estate subsidiary. During the nine months ended September 30, 2013, $3.3 million of nonaccrual loans, net of charge-offs taken, moved to other real estate owned and repossessed assets, and a net $3.0 million additional provision to the valuation allowance was recorded to reflect current fair values compared to a $1.8 million provision during the nine months ended September 30, 2012.
The following table summarizes the Company’s TDRs at the dates indicated:
Number of contracts
Recorded Investment
Specific Reserves
TDRs - Accrual
2,364
2,820
844
440
94
4,358
211
5,022
Total TDRs - Accrual
380
309
TDRs - Non-accrual
201
4,555
5,693
643
1,177
142
6,349
604
6,966
611
Total TDRs - Non-accrual
11,706
960
14,081
1,235
Total TDRs
19,272
51
22,363
1,544
At September 30, 2013, loans classified as TDRs totaled $19.3 million, of which $11.7 million were on non-accrual status and $7.6 million were on accrual status. At December 31, 2012, loans classified as TDRs totaled $22.4 million, of which $14.1 million were on non-accrual status and $8.3 million were on accrual status. The $3.1 million net decrease in total TDRs from December 31, 2012 was a primarily due to $504,000 charged off and approximately $2.7 million of payments received. The increase in TDRs classified as real estate mortgage - residential accruing loans primarily related to one new loan relationship modified to interest only payments. The decrease in TDRs classified as real estate mortgage - commercial accruing loans consisted of one loan relationship that transferred from accruing TDRs to non-accrual TDRs. The decrease in real estate construction and real estate mortgage non-accrual TDRs is primarily related to $1.8 million in payoffs due to property sales.
Provision and Allowance for Loan Losses
As mentioned above, the Company is continuing to recover from the deterioration of collateral values during the prior and current economic conditions. Current appraisals are being obtained and management has adjusted the provision to reflect the amounts determined necessary to maintain the allowance for loan losses at a level necessary to cover probable losses in the loan portfolio. The allowance for loan losses was $14.2 million, or 1.73%, of loans outstanding at September 30, 2013 compared to $14.8 million, or 1.75%, of loans outstanding at December 31, 2012, and $16.9 million, or 2.01%, of loans outstanding at September 30, 2012.
The following table summarizes loan loss experience for the periods ended as indicated:
Analysis of allowance for loan losses:
Balance beginning of period
Net charge-offs (recoveries):
Net charge-offs
Balance end of period
Net Loan Charge-offs
The Company’s net loan charge-offs were $1.1 million, or 0.17% of average loans, for the quarter ended September 30, 2013 compared to net loan charge-offs of $3.1 million, or 0.37% of average loans, for the quarter ended September 30, 2012. Real estate mortgage — residential net charge-offs represented 35% of total net charge-offs during the three months ended September 30, 2013 compared to 46% of total net charge-offs during the three months ended September 30, 2012. Commercial, financial, and agricultural net charge-offs increased to 42% of total net charge-offs during the three months ended September 30, 2013 compared to 5% of net charge-offs during the three months ended September 30, 2012, and real estate mortgage - commercial net charge-offs decreased to 9% of total net charge-offs during the three months ended September 30, 2013 compared to 48% of total net charge-offs during the three months ended September 30, 2012.
The Company’s net loan charge-offs were $2.6 million, or 0.40% of average loans, for the nine months ended September 30, 2013 compared to net loan charge-offs of $4.8 million, or 0.57% of average loans, for the nine months ended September 30, 2012. Real estate mortgage - commercial net charge-offs represented 58% of total net charge-offs during the nine months ended September 30, 2013 compared to 70% of total net charge-offs during the nine months ended September 30, 2012. Real estate mortgage — residential net charge-offs remained consistent at 23% of total net charge-offs during the nine months ended September 30, 2013 compared to 29% of total net charge-offs during the nine months ended September 30, 2012.
Provision
The provision for loan losses decreased to $2.0 million for the nine months ended September 30, 2013, respectively, compared to $4.7 million and $7.9 million for the three and nine months ended September 30, 2012, respectively. The Company did not record a provision during the quarter ended September 30, 2013. Due to decreases in historical loss rates based on the Company’s last thirty-six months of charge-off experience, decreases in average loans and reduced levels of nonperforming loans, the Company’s required provision during the period has begun to decrease.
The following table is a summary of the allocation of the allowance for loan losses:
Allocation of allowance for loan losses at end of period:
Unallocated
The Company’s allowance for loan losses decreased to $14.2 million at September 30, 2013 compared to $14.8 million at December 31, 2012, and $16.9 million at September 30, 2012. The decrease from December 31, 2012 primarily consisted of a $1.3 million decrease in the allocation for real estate mortgage — residential loans, partially offset by a $372,000 increase in real estate construction loans, a $143,000 increase in real estate mortgage — commercial loans, and a $173,000 increase to commercial, financial, and agricultural loans. The ratio of the allowance for loan losses to nonperforming loans was 38.9% at September 30, 2013, compared to 37.7% at December 31, 2012, and 40.1% at September 30, 2012.
The following table is a summary of the general and specific allocations of the allowance for loan losses:
Allocation of allowance for loan losses:
Individually evaluated for impairment - specific reserves
Collectively evaluated for impairment - general reserves
The specific reserve component applies to loans evaluated individually for impairment. The net carrying value of impaired loans is generally based on the fair values of collateral obtained through independent appraisals and/or internal evaluations, or by discounting the total expected future cash flows. Once the impairment amount is calculated, a specific reserve allocation is recorded. At September 30, 2013, $4.6 million of the Company’s allowance for loan losses was allocated to impaired loans totaling approximately $36.2 million compared to $4.0 million of the Company’s allowance for loan losses allocated to impaired loans totaling approximately $39.4 million at December 31, 2012. Management determined that $12.2 million, or 34%, of total impaired loans required no reserve allocation at September 30, 2013 compared to $14.7 million, or 37%, at December 31, 2012 primarily due to adequate collateral values, acceptable payment history and adequate cash flow ability.
The incurred loss component of the general reserve, or loans collectively evaluated for impairment, is determined by applying percentages to pools of loans by asset type. Loans not individually evaluated are aggregated based on similar risk characteristics. Historical loss rates for each risk group, which is updated quarterly, are quantified using all recorded loan charge-offs. Management determined that the previous twelve quarters were reflective of the loss characteristics of the Company’s loan portfolio during the recent economic environment. These historical loss rates for each risk group are used as the starting point to determine allowance provisions. The Company’s methodology includes factors that allow management to adjust its estimates of losses based on the most recent information available. The rates are then adjusted to reflect actual changes and anticipated changes such as changes in specific allowances on loans and real estate acquired through foreclosure, any gains and losses on final disposition of real estate acquired through foreclosure, changes in national and local economic conditions and developments, including general economic and business conditions affecting the Company’s key lending areas, credit quality trends, specific industry conditions within portfolio segments, bank regulatory examination results, and findings of the internal loan review department. These risk factors are generally reviewed and updated quarterly, as appropriate.
52
The specific and general reserve allocations represent management’s best estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses.
Liquidity and Capital Resources
Liquidity Management
The role of liquidity management is to ensure funds are available to meet depositors’ withdrawal and borrowers’ credit demands while at the same time maximizing profitability. This is accomplished by balancing changes in demand for funds with changes in the supply of those funds. Liquidity to meet the demands is provided by maturing assets, short-term liquid assets that can be converted to cash and the ability to attract funds from external sources, principally depositors. Due to the nature of services offered by the Company, management prefers to focus on transaction accounts and full service relationships with customers. Management believes it has the ability to increase deposits at any time by offering rates slightly higher than the market rate.
The Company’s Asset/Liability Committee (ALCO), primarily made up of senior management, has direct oversight responsibility for the Company’s liquidity position and profile. A combination of daily, weekly, and monthly reports provided to management detail the following: internal liquidity metrics, composition and level of the liquid asset portfolio, timing differences in short-term cash flow obligations, available pricing and market access to the financial markets for capital, and exposure to contingent draws on the Company’s liquidity.
The Company has a number of sources of funds to meet liquidity needs on a daily basis. The Company’s most liquid assets are comprised of available for sale investment securities, federal funds sold, and excess reserves held at the Federal Reserve.
Available for sale investment securities
214,719
228,103
Federal funds sold and resale agreements normally have overnight maturities and are used for general daily liquidity purposes. The fair value of the available for sale investment portfolio was $213.6 million at September 30, 2013 and included an unrealized net loss of $548,000. The portfolio includes projected maturities and mortgage backed securities pay-downs of approximately $8.8 million over the next twelve months, which offer resources to meet either new loan demand or reductions in the Company’s deposit base.
The Company pledges portions of its investment securities portfolio to secure public fund deposits, federal funds purchase lines, securities sold under agreements to repurchase, borrowing capacity at the Federal Reserve Bank, and for other purposes required by law. At September 30, 2013 and December 31, 2012, respectively, the Company’s unpledged securities in the available for sale portfolio totaled approximately $59.2 million and $53.8 million, respectively.
Total investment securities pledged for these purposes were as follows:
Investment securities pledged for the purpose of securing:
Federal Reserve Bank borrowings
3,365
3,436
30,745
31,278
Other deposits
120,348
111,728
Total pledged, at fair value
154,458
146,442
Liquidity is available from the Company’s base of core customer deposits, defined as demand, interest checking, savings, and money market deposit accounts. At September 30, 2013, such deposits totaled $592.8 million and represented 62.3% of the Company’s total deposits. These core deposits are normally less volatile and are often tied to other products of the Company through long lasting relationships. Time deposits and certificates of deposit of $100,000 and over totaled $358.6 million at September 30, 2013. These accounts are normally considered more volatile and higher costing representing 37.7% of total deposits at September 30, 2013.
53
Core deposits at September 30, 2013 and December 31, 2012 were as follows:
Core deposit base:
Interest checking
177,771
178,121
Savings and money market
235,116
227,581
592,846
597,973
Other components of liquidity are the level of borrowings from third party sources and the availability of future credit. The Company’s outside borrowings are comprised of securities sold under agreements to repurchase, Federal Home Loan Bank advances, and subordinated notes. Federal funds purchased are overnight borrowings obtained mainly from upstream correspondent banks with which the Company maintains approved credit lines. As of September 30, 2013, under agreements with these unaffiliated banks, the Bank may borrow up to $40.0 million in federal funds on an unsecured basis and $4.5 million on a secured basis. There was no federal funds purchased outstanding at September 30, 2013. Securities sold under agreements to repurchase are generally borrowed overnight and are secured by a portion of the Company’s investment portfolio. At September 30, 2013, there was $25.0 million in repurchase agreements. The Company may periodically borrow additional short-term funds from the Federal Reserve Bank through the discount window; although no such borrowings were outstanding at September 30, 2013.
The Bank is a member of the Federal Home Loan Bank of Des Moines (FHLB). As a member of the FHLB, the Bank has access to credit products of the FHLB. As of September 30, 2013, the Bank had $24.0 million in outstanding borrowings with the FHLB. In addition, the Company has $49.5 million in outstanding subordinated notes issued to wholly-owned grantor trusts, funded by preferred securities issued by the trusts.
Borrowings outstanding at September 30, 2013 and December 31, 2012 were as follows:
Borrowings:
Securities sold under agreements to repurchase
98,506
90,670
The Company pledges certain assets, including loans and investment securities to the Federal Reserve Bank, FHLB, and other correspondent banks as security to establish lines of credit and borrow from these entities. Based on the type and value of collateral pledged, the Company may draw advances against this collateral.
The following table reflects the advance equivalent of the assets pledged, borrowings, and letters of credit outstanding, in addition to the estimated future funding capacity available to the Company as follows:
FHLB
Federal Reserve Bank
Federal Funds Purchased Lines
Advance equivalent
256,111
3,275
41,250
300,636
290,084
3,344
16,790
310,218
Advances outstanding
(24,013
(20,126
Total available
232,098
276,623
269,958
290,092
At September 30, 2013, loans with a market value of $377.1 million were pledged at the Federal Home Loan Bank as collateral for borrowings and letters of credit. At September 30, 2013, investments with a market value of $5.0 million were pledged to secure federal funds purchase lines and borrowing capacity at the Federal Reserve Bank.
54
Sources and Uses of Funds
Cash and cash equivalents were $25.8 million at September 30, 2013 compared to $58.9 million at December 31, 2012. The $33.1 million decrease resulted from changes in the various cash flows produced by operating, investing, and financing activities of the Company, as shown in the accompanying consolidated statement of cash flows for the nine months ended September 30, 2013. Cash flow provided from operating activities consists mainly of net income adjusted for certain non-cash items. Operating activities provided cash flow of $15.6 million for the nine months ended September 30, 2013.
Investing activities consisting mainly of purchases, sales and maturities of available for sale securities, and changes in the level of the loan portfolio, provided total cash of $3.3 million. Cash was provided by $34.5 million in proceeds from investment maturities, calls, and pay-downs, $22.1 million in proceeds from sales of investment securities, $17.4 million net decrease in the loan portfolio, and $7.6 million in proceeds received from sales of other real estate owned and repossessed assets, partially offset by $76.5 million in purchases of investment securities.
Financing activities used cash of $51.9 million, resulting primarily from a $12.3 million decrease in demand deposits, a $34.7 million decrease in time deposits, $18.2 million to redeem the remaining shares of preferred stock, and $540,000 to redeem the common stock warrant. These decreases were partially offset by a $7.1 million increase in interest-bearing transaction accounts and a $3.9 million net advance from Federal Home Loan Bank. Future short-term liquidity needs arising from daily operations are not expected to vary significantly during 2013.
In the normal course of business, the Company enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit. These transactions are managed through the Company’s various risk management processes. Management considers both on-balance sheet and off-balance sheet transactions in its evaluation of the Company’s liquidity. The Company had $143.7 million in unused loan commitments and standby letters of credit as of September 30, 2013. Although the Company’s current liquidity resources are adequate to fund this commitment level the nature of these commitments is such that the likelihood of such a funding demand is very low.
The Company is a legal entity, separate and distinct from the Bank, which must provide its own liquidity to meet its operating needs. The Company’s ongoing liquidity needs primarily include funding its operating expenses and paying cash dividends to its common and preferred shareholders. The Company paid cash dividends to its common and preferred shareholders totaling approximately $1.2 million for both the nine months ended September 30, 2013 and 2012, respectively. A large portion of the Company’s liquidity is obtained from the Bank in the form of dividends. The Bank declared and paid $15.0 million and $3.0 million in dividends to the Company during each of the nine months ended September 30, 2013 and 2012, respectively. At September 30, 2013 and December 31, 2012, the Company had cash and cash equivalents totaling $952,000 and $1.9 million, respectively.
Capital Management
The Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification of the Company and the Bank are subject to qualitative judgments by the regulators about components, risk-weightings, and other factors.
Quantitative measures established by regulations to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital to risk-weighted assets, and of Tier I capital to adjusted-average assets. Management believes, as of September 30, 2013 and December 31, 2012, the Company and the Bank each met all capital adequacy requirements.
In July 2013, the federal banking agencies issued final rules to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. The phase-in period for community banking organizations begins January 1, 2015, while larger institutions (generally those with assets of $250 billion or more) must begin compliance on January 1, 2014. The final rules call for the following capital requirements:
·A minimum ratio of common tier 1 capital to risk-weighted assets of 4.5%.
·A minimum ratio of tier 1 capital to risk-weighted assets of 6%.
·A minimum leverage ratio of 4%.
55
In addition, the final rules establish a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets applicable to all banking organizations. If a banking organization fails to hold capital above the minimum capital ratios and the capital conservation buffer, it will be subject to certain restrictions on capital distributions and discretionary bonus payments. The phase-in period for the capital conservation and countercyclical capital buffers for all banking organizations will begin on January 1, 2016.
Under the proposed rules previously issued by the federal banking agencies, accumulated other comprehensive income (AOCI) would have been included in a banking organization’s common equity tier 1 capital. The final rules allow community banks to make a one-time election not to include these new AOCI components in regulatory capital and instead use the existing treatment under the general risk-based capital rules that excludes most AOCI components from regulatory capital. The opt-out election must be made in the first call report or FR Y-9 series report that is filed after the financial institution becomes subject to the final rule.
The final rules permanently grandfather non-qualifying capital instruments (such as trust preferred securities and cumulative perpetual preferred stock) issued before May 19, 2010 for inclusion in the tier 1 capital of banking organizations with total consolidated assets less than $15 billion as of December 31, 2009 and banking organizations that were mutual holding companies as of May 19, 2010.
The Company is in the process of assessing the impact of these changes in the regulatory ratios on the capital, operations, liquidity and earnings of the Company and Bank.
The table below represents actual and required amounts and ratios for the Company and the Bank as of September 30, 2013 and December 31, 2012 as follows:
Minimum
Well-Capitalized
Capital Requirements
Ratio
Total capital (to risk-weighted assets):
Company
132,002
68,762
8.00
N.A.
Bank
120,511
14.21
67,862
84,828
10.00
Tier I capital (to risk-weighted assets):
97,914
34,381
4.00
109,868
12.95
33,931
50,897
6.00
Tier I capital (to adjusted average assets):
34,312
3.00
9.71
33,944
56,573
5.00
148,889
16.83
70,759
131,126
15.12
69,375
86,715
120,138
13.58
35,380
120,243
13.87
34,686
52,029
10.37
34,762
10.60
34,037
56,729
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Sensitivity
Market risk arises from exposure to changes in interest rates and other relevant market rate or price risk. The Company faces market risk in the form of interest rate risk through transactions other than trading activities. The Company uses financial modeling techniques to measure interest rate risk. These techniques measure the sensitivity of future earnings due to changing interest rate environments. Guidelines established by the Company’s Asset/Liability Committee and approved by the board of directors are used to monitor exposure of earnings at risk. General interest rate movements are used to develop sensitivity as the Company feels it has no primary exposure to specific points on the yield curve. For the three and nine
months ended September 30, 2013 our Company utilized a 400 basis point immediate and gradual move in interest rates (both upward and downward) applied to both a parallel and proportional yield curve.
The following table represents estimated interest rate sensitivity and periodic and cumulative gap positions calculated as of September 30, 2013. Significant assumptions used for this table included: loans will repay at historic repayment rates; certain interest-bearing demand accounts are interest sensitive due to immediate repricing, and fixed maturity deposits will not be withdrawn prior to maturity. A significant variance in actual results from one or more of these assumptions could materially affect the results reflected in the table.
Over
5 Years or
No stated
Year 1
Year 2
Year 3
Year 4
Year 5
Maturity
Investment securities
17,412
26,892
41,093
16,312
12,375
99,545
Federal funds sold and other over-night interest-bearing deposits
Other restricted investments
362,560
123,511
114,578
95,051
95,497
31,845
385,063
150,403
155,671
111,363
131,390
1,041,762
LIABILITIES
Savings, interest checking, and money market deposits
238,457
174,430
239,132
61,883
28,037
12,454
17,126
10,013
3,000
8,000
562,095
205,467
15,454
25,126
870,025
Interest-sensitivity GAP
Periodic GAP
(177,032
88,520
(49,796
95,909
82,746
171,737
Cumulative GAP
(88,512
(138,308
(42,399
40,347
Ratio of interest-earning assets to interest-bearing liabilities
0.69
2.43
7.21
4.29
0.83
0.95
1.05
Effects of Inflation
The effects of inflation on financial institutions are different from the effects on other commercial enterprises since financial institutions make few significant capital or inventory expenditures, which are directly affected by changing prices. Because bank assets and liabilities are virtually all monetary in nature, inflation does not affect a financial institution as much as do changes in interest rates. The general level of inflation does underlie the general level of most interest rates, but interest rates do not increase at the rate of inflation as do prices of goods and services. Rather, interest rates react more to changes in the expected rate of inflation and to changes in monetary and fiscal policy.
Inflation does have an impact on the growth of total assets in the banking industry, often resulting in a need to increase capital at higher than normal rates to maintain an appropriate capital to asset ratio. In the opinion of management, inflation did not have a significant effect on the Company’s operations for the nine months ended September 30, 2013.
57
Item 4. Controls and Procedures
Our Company’s management has evaluated, with the participation of our principal executive and principal financial officers, the effectiveness of our disclosure controls and procedures as defined in Rules 13a — 15(e) or 15d — 15(e) of the Securities Exchange Act of 1934 as of September 30, 2013. Based upon and as of the date of that evaluation, our principal executive and principal financial officers concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports we file and submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported as and when required. It should be noted that any system of disclosure controls and procedures, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the design of any system of disclosure controls and procedures is based in part upon assumptions about the likelihood of future events. Because of these and other inherent limitations of any such system, there can be no assurance that any design will always succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
There has been no change in our Company’s internal control over financial reporting that occurred during the three months ended September 30, 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Impact of New Accounting Standards
No new accounting pronouncements issued during the three months ended September 30, 2013, have had or are expected to have a significant impact on the Company’s consolidated financial statements.
58
PART II - OTHER INFORMATION
Item 1.
Legal Proceedings
The information required by this Item is set forth in Note 16, Pending Litigation, in our
Company’s Notes to Consolidated Financial Statements (unaudited).
Item 1A.
Risk Factors
None
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.
Defaults Upon Senior Securities
Item 4.
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
Exhibit No.
Description
3.1
Restated Articles of Incorporation of our Company (filed as Exhibit 3.1 to our Company’s current report on Form 8-K on August 9, 2007 and incorporated herein by reference).
3.2
Amended and Restated Bylaws of our Company (filed as Exhibit 3.1 to our Company’s current report on Form 8-K on June 8, 2009 and incorporated herein by reference).
Specimen certificate representing shares of our Company’s $1.00 par value common stock (filed as Exhibit 4.1 to our Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1999 (Commission file number 0-23636) and incorporated herein by reference).
31.1
Certificate of the Chief Executive Officer of our Company pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certificate of the Chief Financial Officer of our Company pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certificate of the Chief Executive Officer of our Company pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certificate of the Chief Financial Officer of our Company pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Changes in Equity, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to Consolidated Financial Statements, tagged as blocks of text and in detail (XBRL)
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 thereunto duly authorized.
Date
/s/ David T. Turner
November 14, 2013
David T. Turner, Chairman of the Board and Chief Executive Officer (Principal Executive Officer)
/s/ W. Bruce Phelps
W. Bruce Phelps, Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)
60
INDEX TO EXHIBITS
September 30, 2013 Form 10-Q
Page No.
**
63
64
65
*
*As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933, as amended, and Section 18 of the Securities Exchange Act of 1934, as amended.
**Incorporated by reference.