UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2016
or
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 001-36522
Investar Holding Corporation
(Exact name of registrant as specified in its charter)
Louisiana
27-1560715
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
7244 Perkins Road, Baton Rouge, Louisiana 70808
(Address of principal executive offices, including zip code)
(225) 227-2222
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
Accelerated filer
Non-accelerated filer
☐ (Do not check if a smaller reporting company)
Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date, is as follows: Common stock, $1.00 par value, 7,115,186 shares outstanding as of November 1, 2016.
TABLE OF CONTENTS
Special Note Regarding Forward-Looking Statements
3
Part I. Financial Information
Item 1.
Financial Statements (Unaudited)
4
Consolidated Balance Sheets as of September 30, 2016 and December 31, 2015
Consolidated Statements of Operations for the three and nine months ended September 30, 2016 and 2015
5
Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2016 and 2015
6
Consolidated Statements of Changes in Stockholders’ Equity
7
Consolidated Statements of Cash Flows for the nine months ended September 30, 2016 and 2015
8
Notes to the Consolidated Financial Statements
9
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
30
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
49
Item 4.
Controls and Procedures
Part II. Other Information
50
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.
Exhibits
51
Signatures
52
Exhibit Index
53
2
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
When included in this Quarterly Report on Form 10-Q, or in other documents that Investar Holding Corporation (the “Company”) files with the Securities and Exchange Commission (“SEC”) or in statements made by or on behalf of the Company, words like “may,” “should,” “could,” “predict,” “potential,” “believe,” “think,” “will likely result,” “expect,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “would,” “outlook” and similar expressions or the negative version of those words are intended to identify forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a variety of risks and uncertainties that could cause actual results to differ materially from those described therein. The Company’s forward-looking statements are based on assumptions and estimates that management believes to be reasonable in light of the information available at the time such statements are made. However, many of the matters addressed by these statements are inherently uncertain and could be affected by many factors beyond management’s control. A number of important factors could cause actual results to differ materially from those indicated by the forward-looking statements. These factors include, but are not limited to, the following, any one or more of which could materially affect the outcome of future events:
•
business and economic conditions generally and in the financial services industry in particular, whether nationally, regionally or in the markets in which we operate;
our ability to achieve organic loan and deposit growth, and the composition of that growth;
changes (or the lack of changes) in interest rates, yield curves and interest rate spread relationships that affect our loan and deposit pricing;
the extent of continuing client demand for the high level of personalized service that is a key element of our banking approach as well as our ability to execute our strategy generally;
our dependence on our management team, and our ability to attract and retain qualified personnel;
changes in the quality or composition of our loan or investment portfolios, including adverse developments in borrower industries or in the repayment ability of individual borrowers and including the potential impact on our borrowers of the August 2016 flooding in Baton Rouge and surrounding areas;
inaccuracy of the assumptions and estimates we make in establishing reserves for probable loan losses and other estimates;
the concentration of our business within our geographic areas of operation in Louisiana; and
concentration of credit exposure.
These factors should not be construed as exhaustive. Additional information on these and other risk factors can be found in Item 1A. “Risk Factors” and Item 7. “Special Note Regarding Forward-Looking Statements” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, filed with the Securities and Exchange Commission.
Because forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified, you should not rely on any forward-looking statement as a prediction of future events. We expressly disclaim any obligation or undertaking to update our forward-looking statements, and we do not intend to release publicly any updates or changes in our expectations concerning the forward-looking statements or any changes in events, conditions or circumstances upon which any forward-looking statement may be based, except as required by law.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INVESTAR HOLDING CORPORATION
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
September 30, 2016
December 31, 2015
(Unaudited)
ASSETS
Cash and due from banks
$
10,172
6,313
Interest-bearing balances due from other banks
35,811
14,472
Federal funds sold
172
181
Cash and cash equivalents
46,155
20,966
Available for sale securities at fair value (amortized cost
of $147,609, and $113,828, respectively)
148,981
113,371
Held to maturity securities at amortized cost (estimated
fair value of $21,625 and $26,271, respectively)
21,454
26,408
Loans held for sale
40,553
80,509
Loans, net of allowance for loan losses of $7,383 and
$6,128, respectively
839,445
739,313
Other equity securities
7,388
5,835
Bank premises and equipment, net of accumulated
depreciation of $6,380 and $5,368, respectively
31,835
30,630
Other real estate owned, net
279
725
Accrued interest receivable
3,081
2,831
Deferred tax asset
1,384
1,915
Goodwill and other intangible assets, net
3,244
3,175
Bank owned life insurance
7,150
3,512
Other assets
3,256
2,365
Total assets
1,154,205
1,031,555
LIABILITIES
Deposits:
Noninterest-bearing
112,414
90,447
Interest-bearing
794,637
646,959
Total deposits
907,051
737,406
Advances from Federal Home Loan Bank
88,943
127,497
Repurchase agreements
23,554
39,099
Junior subordinated debt
3,609
Accrued taxes and other liabilities
17,472
14,594
Total liabilities
1,040,629
922,205
STOCKHOLDERS’ EQUITY
Preferred stock, no par value per share; 5,000,000 shares
authorized
-
Common stock, $1.00 par value per share; 40,000,000 shares authorized;
7,359,665 and 7,305,213 shares issued, and 7,131,186, and 7,264,282
shares outstanding, respectively
7,360
7,305
Treasury stock
(3,526
)
(634
Surplus
85,124
84,692
Retained earnings
24,465
18,650
Accumulated other comprehensive income (loss)
153
(663
Total stockholders’ equity
113,576
109,350
Total liabilities and stockholders’ equity
See accompanying notes to the consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
Three months ended
Nine months ended
September 30,
2016
2015
INTEREST INCOME
Interest and fees on loans
10,011
8,912
29,277
25,856
Interest on investment securities
920
550
2,667
1,558
Other interest income
62
18
146
Total interest income
10,993
9,480
32,090
27,467
INTEREST EXPENSE
Interest on deposits
1,934
1,358
5,212
3,849
Interest on borrowings
306
170
387
Total interest expense
2,240
1,528
6,132
4,236
Net interest income
8,753
7,952
25,958
23,231
Provision for loan losses
450
400
1,704
1,500
Net interest income after provision for loan losses
8,303
7,552
24,254
21,731
NONINTEREST INCOME
Service charges on deposit accounts
79
95
264
286
Gain on sale of investment securities, net
204
334
428
468
Gain on sale of fixed assets, net
1,252
Gain (loss) on sale of other real estate owned, net
(147
11
(141
Gain on sale of loans, net
1,023
313
3,831
Fee income on loans held for sale, net
118
261
347
771
Servicing fees
392
429
1,291
1,082
Other operating income
236
666
476
Total noninterest income
1,029
2,167
4,572
6,773
Income before noninterest expense
9,332
9,719
28,826
28,504
NONINTEREST EXPENSE
Depreciation and amortization
371
362
1,110
1,081
Salaries and employee benefits
3,945
4,161
11,708
12,040
Occupancy
265
217
743
655
Data processing
374
389
1,115
1,099
Marketing
102
35
316
155
Professional fees
312
271
966
770
Customer reimbursements
584
Other operating expenses
1,179
1,578
3,494
4,319
Total noninterest expense
6,548
7,013
20,036
20,119
Income before income tax expense
2,784
2,706
8,790
8,385
Income tax expense
747
850
2,758
2,766
Net income
2,037
1,856
6,032
5,619
EARNINGS PER SHARE
Basic earnings per share
0.29
0.26
0.85
0.78
Diluted earnings per share
0.84
Cash dividends declared per common share
0.01
0.03
0.02
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)
Other comprehensive income (loss):
Unrealized gain (loss) on investment securities:
Unrealized (loss) gain, available for sale, net of tax
(benefit) expense of ($98), $173, $790 and $122, respectively
(182
323
1,466
227
Reclassification of realized gain, net of tax expense of
$71, $117, $150 and $164, respectively
(133
(218
(278
(305
Unrealized loss, transfer from available for sale to held to maturity,
net of tax benefit of $0, $0, $1, and $1, respectively
(1
(2
(3
Fair value of derivative financial instruments:
Change in fair value of interest rate swap designated as a cash flow
hedge, net of tax expense (benefit) of $151, ($151), ($199) and
($233), respectively
281
(281
(370
(432
Total other comprehensive income
(34
(177
816
(513
Total comprehensive income
2,003
1,679
6,848
5,106
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Accumulated
Other
Total
Common
Treasury
Retained
Comprehensive
Stockholders’
Stock
Earnings
Income (Loss)
Equity
Balance, December 31, 2014
7,264
(23
84,213
11,809
121
103,384
Surrendered shares
(39
Shares repurchased
(572
Options exercised
10
125
135
Dividends declared, $0.02 per share
(232
Stock-based compensation
31
354
385
7,073
Other comprehensive loss, net
(784
Balance, December 31, 2015
(60
(2,832
28
Dividends declared, $0.03 per share
(217
404
457
Other comprehensive income, net
Balance, September 30, 2016 (Unaudited)
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of purchase accounting adjustments
(36
(160
Provision for other real estate owned
54
Net amortization of securities
893
797
Gain on sale of securities, net
(428
(468
(1,252
(Gain) loss on sale of other real estate owned, net
(11
141
FHLB stock dividend
(48
(10
Deferred taxes
92
(433
Net change in value of bank owned life insurance
(137
Loans held for sale:
Originations
(495
(287,512
Proceeds from sales
23,837
339,086
Gain on sale of loans
(313
(3,831
Net change in:
(250
(125
(339
(20
2,232
6,148
Net cash provided by operating activities
33,055
62,159
Cash flows from investing activities:
Proceeds from sales of investment securities available for sale
14,416
27,053
Funds invested in securities available for sale
(60,664
(50,255
Proceeds from maturities, prepayments and calls of investment securities available for sale
12,058
8,479
Funds invested in securities held to maturity
(5,623
Proceeds from maturities, prepayments and calls of investment securities held to maturity
4,893
582
Proceeds from redemption of other equity securities
5,356
Purchase of other equity securities
(1,505
(4,679
Net increase in loans
(84,951
(88,272
Proceeds from sales of other real estate owned
480
1,726
Proceeds from the sales of fixed assets
2,649
Purchases of fixed assets
(3,682
(2,429
Acquisition of trademark intangible
(100
Purchase of bank owned life insurance
(3,500
Purchase of other investments
(553
Net cash used in investing activities
(120,459
(108,062
Cash flows from financing activities:
Net increase in customer deposits
169,693
102,395
Net (decrease) increase in repurchase agreements
(15,545
22,356
Net decrease in short-term FHLB advances
(33,780
(70,639
Proceeds from long-term FHLB advances
5,000
3,000
Repayment of long-term FHLB advances
(9,774
(10,246
Cash dividends paid on common stock
(199
(162
Proceeds from stock options exercised
Payments to repurchase common stock
Net cash provided by financing activities
112,593
46,267
Net increase in cash and cash equivalents
25,189
364
Cash and cash equivalents, beginning of period
19,512
Cash and cash equivalents, end of period
19,876
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited consolidated financial statements of Investar Holding Corporation (the “Company”) have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include information or footnotes necessary for a complete presentation of financial position, results of operations, and cash flows in conformity with GAAP. However, in the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the financial statements have been included. The results of operations for the three and nine month periods ended September 30, 2016 are not necessarily indicative of the results that may be expected for the entire fiscal year. These statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2015, including the notes thereto, which were included as part of the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 11, 2016.
Nature of Operations
Investar Holding Corporation, headquartered in Baton Rouge, Louisiana, provides full banking services, excluding trust services, through its wholly-owned banking subsidiary, Investar Bank (the “Bank”), a Louisiana-chartered bank. The Company’s primary market is South Louisiana. The Company currently operates 10 full service banking offices located throughout its market and had 155 employees at September 30, 2016.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank. All significant intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates, and such differences could be material.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the allowance for loan losses may change materially in the near term. However, the amount of the change that is reasonably possible cannot be estimated.
Other estimates that are susceptible to significant change in the near term relate to the determination of other-than-temporary impairments of securities and the fair value of financial instruments.
Reclassifications
Certain reclassifications have been made to the 2015 financial statements to be consistent with the 2016 presentation.
Concentrations of Credit Risk
The Company’s loan portfolio consists of the various types of loans described in Note 4, Loans. Real estate or other assets secure most loans. The majority of loans have been made to individuals and businesses in the Company’s market of South Louisiana. Customers are dependent on the condition of the local economy for their livelihoods and servicing their loan obligations. The Company does not have any significant concentrations in any one industry or individual customer.
Recent Accounting Pronouncements
FASB ASC Topic 230 “Statement of Cash Flows – Classification of Certain Cash Receipts and Cash Payments” Update No. 2016-15. The Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) No. 2016-15 in August 2016. The amendments in the Update address eight specific cash flow issues with the objective of reducing the existing diversity in practice, as the issues are either unclear or do not have specific guidance under current GAAP. ASU 2016-15 will be effective on January 1, 2018. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position.
FASB ASC Topic 326 “Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments” Update No. 2016-13. The Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) No. 2016-13 in June 2016. The revised accounting guidance requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, ASU 2016-13 amends the accounting for credit losses of available-for-sale debt securities and purchased financial assets with credit deterioration. ASU 2016-13 will be effective on January 1, 2020. Management is currently evaluating the potential impact of ASU 2016-13 on the consolidated financial statements.
FASB ASC Topic 718 “Compensation – Stock Compensation” Update No. 2016-09. The Financial Accounting and Standards Board (the “FASB”) issued Update No. 2016-09 in March 2016 as part of its simplification initiative. The areas for simplification in this Update involve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The amendments in the Update are effective for the Company beginning January 1, 2017. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position.
FASB ASC Topic 323 “Investments – Equity Method and Joint Ventures” Update No. 2016-07. The FASB issued Update No. 2016-07 in March 2016 as part of its simplification initiative. The amendments in the Update eliminate the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. The amendments require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. In addition, the amendments in this Update require that an entity that has an equity security classified as available for sale that becomes qualified for the equity method of accounting recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. The amendments in the Update are effective for the Company beginning January 1, 2017. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position.
FASB ASC Topic 825 “Financial Instruments - Overall” Update No. 2016-01. The FASB issued Update No. 2016-01 in January 2016 to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The main provisions require investments in equity securities to be measured at fair value through net income, unless they qualify for a practicability exception, and require fair value changes arising from changes in instrument-specific credit risk for financial liabilities that are measured under the fair value option to be recognized in other comprehensive income. The amendments in the Update are effective for the Company beginning January 1, 2018. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position.
NOTE 2. EARNINGS PER SHARE
The following is a summary of the information used in the computation of basic and diluted earnings per common share for the three and nine months ended September 30, 2016 and 2015 (in thousands, except share data).
Net income available to common shareholders
Weighted average number of common shares outstanding
used in computation of basic earnings per common share
7,059,953
7,217,006
7,137,398
7,218,603
Effect of dilutive securities:
Restricted stock
15,546
9,326
8,991
4,812
Stock options
15,369
13,980
14,920
12,385
Stock warrants
11,575
12,269
11,360
11,284
plus effect of dilutive securities used in computation
of diluted earnings per common share
7,102,443
7,252,581
7,172,669
7,247,084
NOTE 3. INVESTMENT SECURITIES
The amortized cost and approximate fair value of investment securities classified as available for sale are summarized below as of the dates presented (dollars in thousands).
Gross
Amortized
Unrealized
Fair
Cost
Gains
Losses
Value
Obligations of other U.S. government agencies and corporations
24,909
377
(15
25,271
Obligations of state and political subdivisions
29,473
531
(80
29,924
Corporate bonds
16,049
96
(286
15,859
Residential mortgage-backed securities
75,133
838
(54
75,917
Commercial mortgage-backed securities
1,249
26
1,273
Equity securities
796
(59
737
147,609
1,868
(496
26,502
73
(102
26,473
21,365
21,467
15,069
1
(246
14,824
47,703
72
(249
47,526
2,005
(16
1,989
1,184
1,092
113,828
(736
The amortized cost and approximate fair value of investment securities classified as held to maturity are summarized below as of the dates presented (dollars in thousands).
7,718
7,864
13,736
25
13,761
171
21,625
3,987
(64
3,923
8,373
(91
8,287
14,048
(5
14,061
23
26,271
Securities are classified in the consolidated balance sheets according to management’s intent. The Company had no securities classified as trading as of September 30, 2016 or December 31, 2015.
The aggregate fair values and aggregate unrealized losses on securities whose fair values are below book values are summarized in the tables below. Due to the nature of the investment and current market prices, these unrealized losses are considered a temporary impairment of the securities.
The following table presents, by type and number of securities, the age of gross unrealized losses and approximate fair value by investment category for securities available for sale as of the dates presented (dollars in thousands).
Less than 12 Months
12 Months or More
Count
Fair Value
Obligations of other U.S. government
agencies and corporations
(9
548
(6
2,463
Obligations of state and political
subdivisions
10,840
2,700
(65
6,764
(221
9,464
27
10,588
(44
1,556
12,144
233
(17
670
(42
732
68
26,338
9,538
(279
35,876
14,792
(93
592
15,384
14
2,312
1,322
(12
3,634
29
10,888
(222
1,225
(24
12,113
31,836
(245
326
(4
32,162
517
(79
485
(21
1,002
144
62,334
(666
3,950
(70
66,284
12
The following table presents, by type and number of securities, the age of gross unrealized losses and approximate fair value by investment category for securities held to maturity as of December 31, 2015 (dollars in thousands). There were no held to maturity securities with gross unrealized losses at September 30, 2016.
1,958
1,965
(28
6,862
4,469
(37
1,932
6,401
13,289
(78
3,897
(82
17,186
The unrealized losses in the Company’s investment portfolio, caused by interest rate increases, are not credit issues and the Company does not intend to sell the securities. Furthermore, it is not more likely than not that the Company will be required to sell the securities before recovery of their amortized cost bases. The Company does not consider these securities to be other-than-temporarily impaired at September 30, 2016 or December 31, 2015.
The weighted average tax equivalent yield, amortized cost and approximate fair value of debt securities, by contractual maturity (including mortgage-backed securities), are shown below as of the dates presented. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties (dollars in thousands).
Securities Available for Sale
Securities Held to Maturity
Weighted
Average T.E.
Yield
Due within one year
1.31
%
859
858
7.17
657
Due after one year through five years
2.17
10,132
10,154
2,950
2,957
Due after five years through ten years
2.79
25,354
25,447
3,575
3,583
Due after ten years
2.43
110,468
111,785
3.41
14,274
14,428
Total debt securities
146,813
148,244
2.01
9,979
9,984
2,958
2.81
23,662
23,494
3,584
2.63
79,003
78,801
3.17
19,228
19,072
112,644
112,279
13
NOTE 4. LOANS
The Company’s loan portfolio, excluding loans held for sale, consists of the following categories of loans as of the dates presented (dollars in thousands).
Construction and development
92,355
81,863
1-4 Family
175,392
156,300
Multifamily
42,560
29,694
Farmland
8,281
2,955
Commercial real estate
365,222
288,583
Total mortgage loans on real estate
683,810
559,395
Commercial and industrial
77,312
69,961
Consumer
85,706
116,085
Total loans
846,828
745,441
The table below provides an analysis of the aging of loans as of the dates presented (dollars in thousands).
Past Due and Accruing
Total Past
90 or more
Due &
30-59 days
60-89 days
days
Nonaccrual
Current
Total Loans
86
20
586
91,769
148
175,244
4,321
360,901
4,949
5,055
678,755
76
3,063
3,139
74,173
438
106
943
1,488
84,218
600
126
8,955
9,682
837,146
129
1,061
1,190
80,673
222
538
760
155,540
97
288,486
351
1,696
2,047
557,348
1,779
1,805
68,156
292
179
715
1,186
114,899
669
2,411
5,038
740,403
The balance of total loans at September 30, 2016 in the table above includes approximately $30.9 million of loans acquired in acquisitions (“acquired loans”) that were recorded at fair value as of the acquisition dates. Included in the acquired loan balances as of September 30, 2016 were approximately $0.6 million in nonaccrual loans.
The total December 31, 2015 balance in the table above includes approximately $37.0 million of acquired loans that were recorded at fair value as of the acquisition dates. Included in the acquired loan balances as of December 31, 2015 were approximately $0.2 million in loans 30-59 days past due and $1.1 million in nonaccrual loans.
Credit Quality Indicators
Loans are categorized into risk categories based on relevant information about the ability of borrowers to service their debt, such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The following definitions are utilized for risk ratings, which are consistent with the definitions used in supervisory guidance:
Pass – Loans not meeting the criteria below are considered pass. These loans have the highest credit characteristics and financial strength. Borrowers possess characteristics that are highly profitable, with low to negligible leverage, and demonstrate significant net worth and liquidity.
Special Mention – Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date.
Substandard – Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Loss – Loans classified as loss are considered uncollectible and of such little value that their continuance as recorded assets is not warranted. This classification does not mean that the assets have absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off these assets.
The table below presents the Company’s loan portfolio by category and credit quality indicator as of the dates presented (dollars in thousands).
Special
Pass
Mention
Substandard
91,293
524
174,575
817
359,812
572
4,838
676,521
6,179
73,251
970
3,091
84,256
507
834,028
2,587
10,213
80,759
15
1,089
154,741
719
840
287,853
730
556,002
734
2,659
66,694
3,267
114,684
647
754
737,380
1,381
6,680
The Company had no loans that were classified as doubtful or loss as of September 30, 2016 or December 31, 2015.
Loan participations and whole loans sold to and serviced for others are not included in the accompanying consolidated balance sheets. The balances of the participations and whole loans sold were $298.5 million and $383.7 million as of September 30, 2016 and December 31, 2015, respectively. The unpaid principal balances of these loans were approximately $340.6 million and $426.9 million as of September 30, 2016 and December 31, 2015, respectively.
In the ordinary course of business, the Company makes loans to its executive officers, principal stockholders, directors and to companies in which these individuals are principal owners. Loans outstanding to such borrowers (including companies in which they are principal owners) amounted to approximately $20.0 million and $18.0 million as of September 30, 2016 and December 31, 2015, respectively. These loans are all current and performing according to the original terms. These loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with persons not related to the Company or the Bank and did not involve more than normal risk of collectability or present other unfavorable features.
The table below shows the aggregate amount of loans to such related parties as of the dates presented (dollars in thousands).
Balance, beginning of period
17,992
14,631
New loans
4,526
6,600
Repayments and changes in relationship
(2,631
(3,239
Balance, end of period
19,887
Loans Acquired with Deteriorated Credit Quality
The Company elected to account for certain loans acquired as acquired impaired loans under ASC 310-30 due to evidence of credit deterioration at acquisition and the probability that the Company will be unable to collect all contractually required payments.
The following table presents changes in the carrying value, net of allowance for loan losses, of acquired impaired loans, or loans accounted for under ASC 310-30, for the periods presented (dollars in thousands).
Acquired
Impaired
Carrying value, net at December 31, 2014
2,778
Accretion to interest income
140
Net transfers from (to) nonaccretable difference to (from) accretable yield
110
Payments received, net
Charge-offs
(61
Transfers to other real estate owned
(45
Carrying value, net at December 31, 2015
2,690
94
(439
(72
Carrying value, net at September 30, 2016
2,274
16
The table below shows the changes in the accretable yield on acquired impaired loans for the periods presented (dollars in thousands).
Balance, period ended December 31, 2014
425
(140
Balance, period ended December 31, 2015
395
(94
Balance, period ended September 30, 2016
302
NOTE 5. ALLOWANCE FOR LOAN LOSSES
The table below shows a summary of the activity in the allowance for loan losses for the three and nine months ended September 30, 2016 and 2015 (dollars in thousands).
Three months ended September 30,
Nine months ended September 30,
7,091
5,728
6,128
4,630
Loans charged off
(173
(229
(509
(467
Recoveries
60
248
7,383
5,911
The following tables outline the activity in the allowance for loan losses by collateral type for the three and nine months ended September 30, 2016 and 2015, and show both the allowances and portfolio balances for loans individually and collectively evaluated for impairment as of September 30, 2016 and 2015 (dollars in thousands).
Three months ended September 30, 2016
Construction &
1-4
Commercial
Commercial &
Development
Family
Real Estate
Industrial
Allowance for loan losses:
Beginning balance
779
61
1,280
310
2,430
1,028
1,203
Provision
64
43
613
(336
114
Ending balance
735
1,347
353
3,043
692
1,152
Three months ended September 30, 2015
636
21
1,118
180
2,142
1,239
22
138
33
(112
103
215
659
1,198
213
2,030
493
1,296
17
Nine months ended September 30, 2016
644
1,213
246
2,156
513
1,334
39
130
107
886
159
288
(14
(7
(488
Ending allowance balance for loans
individually evaluated for
impairment
331
149
267
collectively evaluated for
2,712
543
885
6,636
acquired with deteriorated credit
quality
Loans receivable:
Balance of loans individually
evaluated for impairment
649
1,975
4,931
942
11,560
Balance of loans collectively
91,706
173,417
360,291
74,249
84,764
835,268
Total period-end balance
Balance of loans acquired with
deteriorated credit quality
677
564
1,033
Nine months ended September 30, 2015
526
909
137
1,571
390
1,079
343
459
528
(58
(335
197
24
1,170
5,785
2,013
960
6,330
78,678
3,009
152,264
23,626
257,593
67,671
121,390
704,231
79,796
154,277
24,484
258,974
122,350
710,561
854
1,069
41
2,707
Impaired Loans
The Company considers a loan to be impaired when, based on current information and events, the Company determines that it will not be able to collect all amounts due according to the loan agreement, including scheduled interest payments. Generally, those loans rated special mention or lower are evaluated for impairment each quarter. Determination of impairment is treated the same across all classes of loans. When the Company identifies a loan as impaired, it measures the impairment based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, except when the sole (remaining) source of repayment for the loans is the operation or liquidation of the collateral. In these cases when foreclosure is probable, the Company uses the current fair value of the collateral, less selling costs, instead of discounted cash flows. If the Company determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), the Company recognizes impairment through an allowance estimate or a charge-off to the allowance for loan losses.
When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on nonaccrual, all payments are applied to principal, under the cost recovery method. When the ultimate collectability of the total principal of an impaired loan is not in doubt and the loan is on nonaccrual, contractual interest is credited to interest income when received, under the cash basis method.
As of September 30, 2016 and December 31, 2015, the Company was not committed to lend additional funds to any customer whose loan was classified as impaired.
The following tables include the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount, if applicable, as of the dates indicated. The Company determined the specific allowance based on the present values of expected future cash flows, discounted at the loan’s effective interest rate, except when the remaining source of repayment for the loan is the operation or liquidation of the collateral. In those cases, the current fair value of the collateral, less estimated selling cost, was used to determine the specific allowance recorded (dollars in thousands).
Unpaid
Recorded
Principal
Related
Investment
Balance
Allowance
With no related allowance recorded:
664
2,020
610
625
3,234
3,309
1,653
1,699
175
186
5,062
5,194
With related allowance recorded:
1,410
1,432
767
777
6,498
6,530
Total loans:
4,946
7,555
7,630
3,131
963
11,724
19
1,242
1,241
1,419
1,416
630
629
3,291
3,286
3,450
3,445
595
220
4,045
4,040
Presented in the tables below is the average recorded investment of the impaired loans and the related amount of interest income recognized during the time within the period that the loans were impaired. The average balances are calculated based on the month-end balances of the loans during the periods reported (dollars in thousands).
Average
Interest
Income
Recognized
1,014
1,259
2,082
2,073
702
1,266
3,798
4,598
1,692
269
199
5,759
4,810
71
1,440
1,126
668
280
5,238
2,818
937
479
8,993
5,090
1,150
80
1,940
1,551
34
680
915
3,770
136
3,850
1,000
88
45
396
223
5,166
145
115
596
466
202
1,542
1,160
4,250
1,596
862
6,708
150
4,363
Troubled Debt Restructurings
In situations where, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession for other than an insignificant period of time to the borrower that the Company would not otherwise consider, the related loan is classified as a troubled debt restructuring (“TDR”). The Company strives to identify borrowers in financial difficulty early and work with them to modify their loans to more affordable terms before such loans reach nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases in which the Company grants the borrower new terms that provide for a reduction of either interest or principal, the Company measures any impairment on the restructuring as previously noted for impaired loans.
Loans classified as TDRs, consisting of twenty credits, totaled approximately $2.7 million at September 30, 2016 compared to eleven credits totaling approximately $2.2 million at December 31, 2015. Eighteen of the twenty TDRs were acquired. Nine of the restructured loans were considered TDRs due to modification of terms through adjustments to maturity, nine restructured loans were considered TDRs due to a reduction in the interest rate to a rate lower than the current market rate, one restructured loan was considered a TDR due to modification of terms through principal payment forbearance, paying interest only for a specified period of time, as well as adjustments to maturity, and one restructured loan was considered a TDR due to modification of terms through principal payment forbearance only for a specified period of time. At September 30, 2016, one of the TDRs was in default of its modified terms and is included in nonaccrual loans. The Company individually evaluates each TDR for allowance purposes, primarily based on collateral value, and excludes these loans from the loan population that is evaluated by applying qualitative factors.
As of September 30, 2016 and December 31, 2015, the Company was not committed to lend additional funds to any customer whose loan was classified as a TDR.
The table below presents the TDR pre- and post-modification outstanding recorded investments by loan categories for loans modified during the nine month periods ended September 30, 2016 and 2015 (dollars in thousands).
September 30, 2015
Pre-
Post-
Modification
Outstanding
Number of
Contracts
632
1,006
533
1,568
There were no loans modified under troubled debt restructurings during the previous twelve month period that subsequently defaulted during the three months ended September 30, 2016 and 2015.
NOTE 6. STOCK-BASED COMPENSATION
Equity Incentive Plan. The Company’s 2014 Long-Term Incentive Compensation Plan (the “Plan”) authorizes the grant of various types of equity grants and awards, such as restricted stock, stock options and stock appreciation rights to eligible participants, which include all of the Company’s employees and non-employee directors. The Plan has reserved 600,000 shares of common stock for grant, award or issuance to directors and employees, including shares underlying granted options. The Plan is administered by the Compensation Committee of the Company’s Board of Directors, which determines, within the provisions of the Plan, those eligible employees to whom, and the times at which, grants and awards will be made. The Compensation Committee, in its discretion, may delegate its authority and duties under the Plan to specified officers; however, only the Compensation Committee may approve the terms of grants and awards to the Company’s executive officers.
Stock Options
The Company uses a Black-Scholes option pricing model to estimate the fair value of share-based awards. The Black-Scholes option pricing model incorporates various and highly subjective assumptions, including expected term and expected volatility. Stock option expense in the accompanying consolidated statement of operations for the three and nine months ended September 30, 2016 was $48,000 and $0.1 million, respectively, and $42,000 and $0.1 million for the three and nine months ended September 30, 2015, respectively.
The assumptions presented below were used for the options granted during the nine months ended September 30, 2016.
Expected dividends
0.22
Expected volatility
19.55
Risk-free interest rate
1.62
Expected term (in years)
7.0
Weighted-average grant date fair value
3.44
At September 30, 2016, there was $0.8 million of unrecognized compensation cost related to stock options that is expected to be recognized over a weighted-average period of 3.8 years.
The table below summarizes stock option activity for the periods presented.
Number
Weighted-Average
of Options
Exercise Price
Outstanding at beginning of period
278,352
14.37
238,811
13.94
Granted
46,512
14.28
64,333
15.74
Forfeited
(14,667
14.00
Exercised
(2,166
(10,125
13.33
Outstanding at end of period
322,698
14.36
Exercisable at end of period
91,383
14.15
47,351
13.82
At September 30, 2016, the shares underlying outstanding stock options and exercisable stock options had aggregate intrinsic values of $0.3 million and $0.1 million, respectively.
Time Vested Restricted Stock Awards
During the nine months ended September 30, 2016 and 2015, the Company issued shares of time vested restricted stock with vesting terms ranging from two to five years. The total share-based compensation expense to be recognized for these awards is determined based on the market price of the Company’s common stock at the grant date applied to the total number of shares awarded and is amortized over the vesting period.
The table below summarizes the time vested restricted stock award activity for the periods presented.
Shares
Weighted Avg Grant Date Fair Value
Balance at beginning of period
60,592
14.85
42,889
13.96
54,837
14.67
33,757
15.40
(2,550
15.25
(2,670
14.19
Earned and issued
(15,255
14.80
(9,638
14.01
Balance at end of period
97,624
14.76
64,338
14.71
At September 30, 2016, there was $1.2 million of unrecognized compensation cost related to time vested restricted stock awards that is expected to be recognized over a weighted average period of 3.5 years.
NOTE 7. DERIVATIVE FINANCIAL INSTRUMENTS
The Company currently holds interest rate swap contracts to manage exposure against the variability in the expected future cash flows (future interest payments) attributable to changes in the 1-month LIBOR associated with the forecasted issuances of 1-month fixed rate debt arising from a rollover strategy. An interest rate swap is an agreement whereby one party agrees to pay a fixed rate of interest on a notional principal amount in exchange for receiving a floating rate of interest on the same notional amount, for a predetermined period of time, from a second party. The amounts relating to the notional principal amount are not actually exchanged. The maximum length of time over which the Company is currently hedging its exposure to the variability in future cash flows for forecasted transactions is approximately 3.9 years. The total notional amount of the derivative contracts is $50.0 million.
For the three and nine months ended September 30, 2016, a gain of $0.3 million and a loss of $0.4 million, respectively, have been recognized in other comprehensive income in the accompanying consolidated statements of comprehensive income for the change in fair value of the interest rate swaps. The swap contracts had an aggregate negative fair value of $1.2 million as of September 30, 2016 and have been recorded in accrued taxes and other liabilities in the accompanying consolidated balance sheets. The total accumulated loss of $0.7 million included in accumulated other comprehensive loss in the accompanying consolidated balance sheet would be reclassified to current earnings if the hedge transactions become probable of not occurring. The Company expects the hedges to remain fully effective during the remaining term of the swap contracts.
NOTE 8. FAIR VALUES OF FINANCIAL INSTRUMENTS
In accordance with FASB ASC Topic 820, Fair Value Measurement and Disclosure (“ASC 820”), disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, is required. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. Fair value is best determined based upon quoted market prices. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows, and the fair value estimates may not be realized in an immediate settlement of the instruments. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.
Fair Value Hierarchy
In accordance with ASC 820, the Company groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
Level 1 – Valuation is based upon quoted prices for identical assets or liabilities traded in active markets.
Level 2 – Valuation is based upon observable inputs other than quoted prices included in level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.
Level 3 – Valuation is based upon unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:
Cash and Due from Banks – For these short-term instruments, fair value is the carrying value. Cash and due from banks is classified in level 1 of the fair value hierarchy.
Federal Funds Sold – The fair value is the carrying value. The Company classifies these assets in level 1 of the fair value hierarchy.
Investment Securities and Other Equity Securities – Where quoted prices are available in an active market, the Company classifies the securities within level 1 of the valuation hierarchy. Securities are defined as both long and short positions. Level 1 securities include highly liquid government bonds and exchange-traded equities.
If quoted market prices are not available, the Company estimates fair values using pricing models and discounted cash flows that consider standard input factors such as observable market data, benchmark yields, interest rate volatilities, broker/dealer quotes, and credit spreads. Examples of such instruments, which would generally be classified within level 2 of the valuation hierarchy, include Government Sponsored Enterprise obligations, corporate bonds and other securities. Mortgage-backed securities are included in level 2 if observable inputs are available. In certain cases where there is limited activity or less transparency around inputs to the valuation, the Company classifies those securities in level 3. Equity securities are valued based on market quoted prices and are classified in level 1 as they are actively traded.
Loans – For variable-rate loans that re-price frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans (for example, one-to-four family residential), credit card loans, and other consumer loans are based on quoted market prices of similar instruments sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. Fair values for other loans (for example, commercial real estate and investment property mortgage loans, commercial and industrial loans) are estimated using discounted cash flow analyses, using market interest rates for comparable loans. Fair values for nonperforming loans, which are loans for which the accrual of interest has stopped or loans that are contractually 90 past due on which interest continues to accrue, are estimated using discounted cash flow analyses or underlying collateral values, where applicable. The Company classifies loans in level 3 of the fair value hierarchy.
Loans held for sale are measured using quoted market prices when available. If quoted market prices are not available, comparable market values or discounted cash flow analyses may be utilized. The Company classifies these assets in level 3 of the fair value hierarchy.
Deposit Liabilities – The fair values disclosed for noninterest-bearing demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). These noninterest-bearing deposits are classified in level 2 of the fair value hierarchy. The carrying amounts of variable-rate (for example interest-bearing checking, savings, and money market accounts), fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies market interest rates on comparable instruments to a schedule of aggregated expected monthly maturities on time deposits. All interest-bearing deposits are classified in level 3 of the fair value hierarchy.
Short-Term Borrowings – The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within 90 days approximate their fair values. The Company classifies these borrowings in level 2 of the fair value hierarchy.
Long-Term Borrowings – The fair values of long-term borrowings are estimated using discounted cash flows analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. The fair value of the Company’s long-term debt is therefore classified in level 3 in the fair value hierarchy.
Commitments – The fair value of commitments to extend credit was not significant.
Derivative Instruments – The fair value for interest rate swap agreements are based upon the amounts required to settle the contracts. These derivative instruments are classified in level 2 of the fair value hierarchy.
Fair Value of Assets and Liabilities Measured on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis are summarized in the table below as of the dates indicated (dollars in thousands).
Quoted Prices in
Significant
Active Markets for
Significant Other
Unobservable
Estimated
Identical Assets
Observable Inputs
Inputs
(Level 1)
(Level 2)
(Level 3)
Assets:
Obligations of other U.S. government agencies
10,145
19,779
15,235
624
127,841
20,403
Liabilities:
Derivative financial instruments
1,151
11,072
10,395
13,688
1,136
100,748
11,531
581
The Company reviews fair value hierarchy classifications on a quarterly basis. Changes in the Company’s ability to observe inputs to the valuation may cause reclassification of certain assets or liabilities within the fair value hierarchy. The table below provides a reconciliation for assets measured at fair value on a recurring basis using significant unobservable inputs, or Level 3 inputs (dollars in thousands).
Obligations of
State and Political
Corporate
Subdivisions
Bonds
Balance at December 31, 2015
Realized gains (losses) included in net income
Unrealized gains (losses) included in other comprehensive income
319
(27
Purchases
9,065
Sales
Transfers into Level 3
Transfers out of Level 3
(485
Balance at September 30, 2016
Fair Value of Assets Measured on a Nonrecurring Basis
Assets measured at fair value on a nonrecurring basis are summarized in the table below as of the dates indicated (dollars in thousands).
Impaired loans
5,678
Other real estate owned
5,687
335
370
There were no liabilities measured on a nonrecurring basis at September 30, 2016 or December 31, 2015.
The estimated fair values of the Company’s financial instruments are summarized in the table below as of the dates indicated (dollars in thousands).
Carrying
Amount
Level 1
Level 2
Level 3
Financial assets:
45,983
Investment securities
170,435
170,606
135,705
34,164
Loans, net of allowance
842,360
Financial liabilities:
Deposits, noninterest-bearing
Deposits, interest-bearing
788,241
FHLB short-term advances and repurchase agreements
103,297
FHLB long-term advances
9,200
9,284
3,020
20,785
139,779
139,642
112,958
25,592
738,614
89,427
630,613
158,236
8,360
8,455
3,217
NOTE 9. INCOME TAXES
The expense for income taxes and the effective tax rate included in the consolidated statements of operations are shown in the table below for the periods presented (dollars in thousands).
Effective tax rate
26.8
31.4
33.0
The effective tax rates differ from the statutory tax rate of 35% largely due to tax exempt interest income earned on certain investment securities.
NOTE 10. COMMITMENTS AND CONTINGENCIES
The Company is a party to financial instruments with off-balance-sheet risk entered into in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit consisting of loan commitments and standby letters of credit, which are not included in the accompanying financial statements.
Commitments to extend credit are agreements to lend money with fixed expiration dates or termination clauses. The Company applies the same credit standards used in the lending process when extending these commitments, and periodically reassesses the customer’s creditworthiness through ongoing credit reviews. Since some commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Collateral is obtained based on the Company’s assessment of the transaction. Essentially all standby letters of credit issued have expiration dates within one year.
The table below shows the approximate amounts of the Company’s commitments to extend credit as of the dates presented (dollars in thousands).
Commitments to extend credit
Loan commitments
162,212
149,561
Standby letters of credit
382
Additionally, at September 30, 2016, the Company had unfunded commitments of $0.9 million for its investment in Small Business Investment Company qualified funds.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This section presents management’s perspective on the consolidated financial condition and results of operations of Investar Holding Corporation (the “Company,” “we,” “our,” or “us”) and its wholly-owned subsidiary, Investar Bank (the “Bank”). The following discussion and analysis should be read in conjunction with our unaudited consolidated financial statements and related notes thereto included herein, and the audited consolidated financial statements for the year ended December 31, 2015, including the notes thereto, and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Annual Report on Form 10-K that the Company filed with the Securities and Exchange Commission (“SEC”) on March 11, 2016.
Overview
Through our wholly-owned subsidiary Investar Bank, we provide full banking services, excluding trust services, tailored primarily to meet the needs of individuals and small to medium-sized businesses in our primary areas of operation in South Louisiana: Baton Rouge, New Orleans, Lafayette, Hammond and their surrounding metropolitan areas. Our Bank commenced operations in 2006 and we completed our initial public offering in July 2014. Our strategy includes organic growth through high quality loans, and growth through acquisitions. We currently operate 10 full service branches. We have completed construction of one new branch in Gonzales, Louisiana in our Baton Rouge market area, expected to open in 2017, and in September 2015, acquired land and a building for an additional branch in our New Orleans market area. We continue to focus on growing our deposit base in our markets. We completed acquisitions in 2011 and 2013 and regularly review acquisition opportunities.
Our principal business is lending to and accepting deposits from individuals and small to medium-sized businesses in our areas of operation. We generate our income principally from interest on loans and, to a lesser extent, our securities investments, as well as from fees charged in connection with our various loan and deposit services and gains on the sale of securities. Our principal expenses are interest expense on interest-bearing customer deposits and borrowings, salaries, employee benefits, occupancy costs, data processing and other operating expenses. We measure our performance through our net interest margin, return on average assets, and return on average equity, among other metrics, while seeking to maintain appropriate regulatory leverage and risk-based capital ratios.
Discussion and Analysis of Financial Condition
For the three months ended September 30, 2016, net income was $2.0 million, or $0.29 per basic and diluted share, compared to net income of $1.8 million, or $0.26 per basic and diluted share for the three months ended September 30, 2015. For the three months ended September 30, 2016, our net interest margin was 3.23%, return on average assets was 0.71%, and return on average equity was 7.15%. From December 31, 2015 to September 30, 2016, total loans increased $101.4 million, or 13.6%, and total deposits increased $169.4 million, or 23.0%. As of September 30, 2016, the Company and Bank each were in compliance with all regulatory capital requirements, and the Bank was considered “well-capitalized” under the FDIC’s prompt corrective action regulations.
Loans
General. Loans, excluding loans held for sale, or total loans, constitute our most significant asset, comprising 73.4% and 72.3% of our total assets at September 30, 2016 and December 31, 2015, respectively. Total loans increased $101.4 million, or 13.6%, to $846.8 million at September 30, 2016 compared to $745.4 million at December 31, 2015 as a result of organic growth in our business.
The table below sets forth the composition of the Company’s loan portfolio as of the dates indicated (dollars in thousands).
Percentage of
10.9
11.0
20.7
21.0
5.0
4.0
1.0
0.4
Owner-occupied
172,952
20.5
137,752
18.5
Nonowner-occupied
192,270
22.7
150,831
20.2
80.8
75.1
9.1
9.4
10.1
15.5
100.0
Total gross loans
887,381
825,950
The following table sets forth loans outstanding at September 30, 2016, which, based on remaining scheduled repayments of principal, are due in the periods indicated. Loans with balloon payments and longer amortizations are often repriced and extended beyond the initial maturity when credit conditions remain satisfactory. Demand loans, loans having no stated schedule of repayments and no stated maturity and overdrafts are reported below as due in one year or less.
(dollars in thousands)
One Year or
Less
After One
Year Through
Five Years
After Five
Years Through
Ten Years
After Ten
Fifteen Years
After Fifteen
Years
74,443
9,023
6,671
1,720
498
23,728
36,811
41,444
32,161
41,248
676
16,947
23,215
122
1,600
3,477
2,800
1,971
13,812
46,019
66,683
36,457
9,981
21,098
92,068
59,856
19,248
137,234
200,901
200,669
91,679
53,327
29,716
31,408
15,599
589
1,853
68,054
15,299
383
117
168,803
300,363
231,567
92,062
54,033
Loans Held for Sale. Loans held for sale consist of consumer loans and decreased $39.9 million, or 49.6%, to $40.6 million at September 30, 2016 from $80.5 million at December 31, 2015. The decrease in loans held for sale is mainly attributable to the sale of approximately $22.0 million of consumer loans held for sale during the first quarter of 2016 and principal payments on consumer loan balances. Since the Bank discontinued accepting indirect auto loan applications at the end of 2015, which was the primary source of its consumer loan portfolio and loans held for sale, the consumer loan portfolio and loans held for sale are expected to decrease over time. There were no gains on the sale of consumer loans recognized for the three months ended September 30, 2016, compared to $0.7 million for the three months ended September 30, 2015. For the nine months ended September 30, 2016, we recognized gains from the sale of consumer loans of $0.3 million, compared to $2.8 million for the nine months ended September 30, 2015. The Bank currently has the intent and ability to sell the balance of the consumer loans classified as held for sale at September 30, 2016; however, if this classification were to change, the loans would be transferred to the consumer loan portfolio. To a lesser extent, the decreases in gains on sale of loans is also due to our decision to significantly reduce our mortgage operations. Originations of mortgage loans in the nine months ended September 30, 2016 were $0.6 million, compared to $40.7 million in the same period in 2015.
Loan Concentrations. Loan concentrations are considered to exist when there are amounts loaned to multiple borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At September 30, 2016 and December 31, 2015, we had no concentrations of loans exceeding 10% of total loans other than loans in the categories listed in the table above.
We continue to monitor our loan portfolio for exposure to potential negative impacts of low oil and gas prices. We consider our exposure to the energy sector not to be significant, at less than one percent of the total loan portfolio at September 30, 2016. However, should the price of oil and gas decline further and/or remain at the current low price for an extended period, the general economic conditions in our South Louisiana markets could be negatively affected and could negatively impact borrowers’ ability to service their debt.
Investment Securities
We purchase investment securities primarily to provide a source for meeting liquidity needs, with return on investment a secondary consideration. We also use investment securities as collateral for certain deposits and other types of borrowing. Investment securities represented 14.8% of our total assets and totaled $170.4 million at September 30, 2016, an increase of $30.6 million, or 21.9%, from $139.8 million at December 31, 2015. The increase in investment securities at September 30, 2016 compared to December 31, 2015 resulted from purchases of various investment types in our current portfolio to manage liquidity.
The following table shows the carrying value of our investment securities portfolio by investment type and the percentage that such investment type comprises of our entire portfolio as of the dates indicated (dollars in thousands).
Portfolio
Obligations of other U.S. government agencies and
corporations
14.8
30,460
21.8
43,660
25.6
35,515
25.4
9.3
10.6
83,635
49.1
55,899
40.0
0.8
1.4
The investment portfolio consists of available for sale and held to maturity securities. We classify debt securities as held to maturity if management has the positive intent and ability to hold the securities to maturity. Held to maturity securities are stated at amortized cost. Securities not classified as held to maturity or trading are classified as available for sale. The carrying values of the Company’s available for sale securities are adjusted for unrealized gains or losses as valuation allowances, and any gains or losses are reported on an after-tax basis as a component of other comprehensive income. Any expected credit loss due to the inability to collect all amounts due according to the security’s contractual terms is recognized as a charge against earnings. Any remaining unrealized loss related to other factors would be recognized in other comprehensive income, net of taxes.
The following table sets forth the stated maturities and weighted average yields of our investment debt securities based on the amortized cost of our investment portfolio as of September 30, 2016 (dollars in thousands).
One Year or Less
After One Year
Through Five Years
After Five Years
Through Ten Years
After Ten Years
Held to maturity:
Obligations of states and political
6,556
4.38
2.58
Available for sale:
1,351
2.61
4,253
2.46
19,305
2.27
3,102
2.07
5,122
2.98
20,390
4.06
5,679
2.12
10,120
3.15
250
4.00
4,610
2.25
70,523
2.00
2.23
1,514
13,082
28,929
124,742
32
The maturity of mortgage-backed securities reflects scheduled repayments based upon the contractual maturities of the securities. Weighted average yields on tax-exempt obligations have been computed on a fully tax equivalent basis assuming a federal tax rate of 35%.
Deposits
The following table sets forth the composition of our deposits and the percentage of each deposit type to total deposits at September 30, 2016 and December 31, 2015 (dollars in thousands).
Noninterest-bearing demand deposits
12.4
12.3
NOW accounts
150,551
16.6
140,503
19.0
Money market deposit accounts
123,487
13.6
96,113
13.0
Savings accounts
51,332
5.7
53,735
7.3
Time deposits
469,267
51.7
356,608
48.4
Total deposits were $907.0 million at September 30, 2016, an increase of $169.6 million, or 23.0%, compared to December 31, 2015. The increase in total deposits was driven by an increase in noninterest-bearing deposits of $22.0 million, or 24.3%, an increase in money market accounts of $27.4 million, or 28.5%, and an increase in time deposits of $112.7 million, or 31.6%, compared to December 31, 2015. The increase in deposits at September 30, 2016 compared to December 31, 2015 resulted from organic growth in all of our markets, and the Company’s focus on relationship banking which continues to positively impact noninterest-bearing demand deposit growth. Growth in time deposits also reflected an increase in time deposit rates, particularly on deposits greater than $100,000, which we began lowering during and after the third quarter of 2016. See “Results of Operations – Net Interest Income and Net Interest Margin.”
The following table shows the contractual maturities of certificates of deposit and other time deposits greater than $100,000 at September 30, 2016 and December 31, 2015 (dollars in thousands).
Certificates of Deposit
Other Time
Time remaining until maturity:
Three months or less
16,452
4,312
363
Over three months through six months
45,895
101
10,039
Over six months through twelve months
35,808
12,809
Over one year through three years
65,045
1,615
5,272
Over three years
9,057
295
1,468
172,257
2,917
33,900
904
Borrowings
Total borrowings include securities sold under agreements to repurchase, advances from the Federal Home Loan Bank (“FHLB”), unsecured lines of credit with First National Bankers Bank (“FNBB”) and The Independent Bankers Bank (“TIB”), and junior subordinated debentures. In addition, in June 2016, we entered into a loan agreement with TIB providing for a $20 million secured revolving line of credit maturing June 27, 2018, as further described under the heading Liquidity and Capital Resources. There was no outstanding balance on this line of credit at September 30, 2016. Securities sold under agreements to repurchase decreased $15.5 million to $23.6 million at September 30, 2016 from $39.1 million at December 31, 2015. Our advances from the FHLB were $88.9 million at September 30, 2016, a decrease of $38.6 million, or 30.2%, from FHLB advances of $127.5 million at December 31, 2015. We had no funds drawn on the lines of credit at September 30, 2016 or December 31, 2015. The $3.6 million in junior subordinated debt at September 30, 2016 and December 31, 2015 represents the junior subordinated debentures that we assumed through acquisition.
The average balances and cost of funds of short-term borrowings for the nine months ended September 30, 2016 and 2015 are summarized in the table below (dollars in thousands).
Average Balances
Cost of Funds
Federal funds purchased and other
short-term borrowings
82,912
38,971
1.07
0.17
Securities sold under agreements
to repurchase
28,506
14,059
0.20
Total short-term borrowings
111,418
53,030
0.18
Results of Operations
Performance Summary
Three months ended September 30, 2016 vs. three months ended September 30, 2015. For the three months ended September 30, 2016, net income was $2.0 million, or $0.29 per basic and diluted share, compared to net income of $1.8 million, or $0.26 per basic and diluted share for the three months ended September 30, 2015. Return on average assets decreased to 0.71% for the three months ended September 30, 2016 compared to 0.78% for the three months ended September 30, 2015 primarily due to a $190.4 million increase in average assets. Return on average equity was 7.15% for the three months ended September 30, 2016 compared to 6.83% for the three months ended September 30, 2015.
Nine months ended September 30, 2016 vs. nine months ended September 30, 2015. For the nine months ended September 30, 2016, net income was $6.0 million, or $0.85 per basic share and $0.84 per diluted share, compared to net income of $5.6 million, or $0.78 per basic and diluted share for the nine months ended September 30, 2015. Return on average assets decreased to 0.74% for the nine months ended September 30, 2016 compared to 0.83% for the nine months ended September 30, 2015 primarily due to a $187.0 million increase in average assets. Return on average equity was 7.17% for the nine months ended September 30, 2016 compared to 7.06% for the nine months ended September 30, 2015.
Net Interest Income and Net Interest Margin
Net interest income, which is the largest component of our earnings, is the difference between interest earned on assets and the cost of interest-bearing liabilities. The primary factors affecting net interest income are the volume, yield and mix of our rate-sensitive assets and liabilities, as well as the amount of our nonperforming loans and the interest rate environment.
The primary factors affecting net interest margin are changes in interest rates, competition and the shape of the interest rate yield curve. The decline in interest rates since 2008 has put significant downward pressure on net interest margin over the past few years. Each rate reduction in interest rate indices (and, in particular, the prime rate, rates paid on U.S. Treasury securities and the London Interbank Offering Rate) resulted in a reduction in the yield on our variable rate loans indexed to one of these indices. However, rates on our deposits and other interest-bearing liabilities did not decline proportionally. To offset the effects on our net interest income and net interest margin from the prevailing interest rate environment, we have attempted to focus our interest-earning assets in loans and shift our interest-bearing liabilities from higher-costing deposits, like certificates of deposit, to noninterest-bearing and other lower cost deposits.
Three months ended September 30, 2016 vs. three months ended September 30, 2015. Net interest income increased 10.1% to $8.8 million for the three months ended September 30, 2016 compared to $8.0 million for the same period in 2015. This increase is due primarily to the $97.2 million and $67.1 million increases in average loans and average investment securities, respectively, when compared to the same period in 2015, resulting in a $1.5 million increase in interest income, discussed in more detail below. Average interest-bearing deposits and short- and long-term borrowings increased approximately $150.4 million and $16.6 million, respectively, for the three months ended September 30, 2016 when compared to the same period in 2015, resulting in a $0.7 million increase in interest expense, also discussed in more detail below. The increases in both average interest-earning assets and interest-bearing liabilities are a result of organic growth of the Company.
Interest income was $11.0 million for the three months ended September 30, 2016 compared to $9.5 million for the same period in 2015. Loan interest income made up substantially all of our interest income for the three months ended September 30, 2016 and 2015. Increases in interest income can be attributed to an increase in the volume of interest-earning assets. The overall yield on interest-earning assets decreased 14 basis points to 4.06% for the three months ended September 30, 2016 compared to 4.20% for the same period in 2015. The reduction in yield on interest-earning assets is the result of a prolonged low interest rate environment, as well as an increase in nonaccrual loans. The loan portfolio yielded 4.54% for the three months ended September 30, 2016 compared to 4.55%
for the three months ended September 30, 2015, while the yield on the investment portfolio was 2.19% for both the three months ended September 30, 2016 and September 30, 2015.
Interest expense was $2.2 million for the three months ended September 30, 2016, an increase of $0.7 million compared to interest expense of $1.5 million for the three months ended September 30, 2015, as a result of an increase of $0.3 million attributed to volume and $0.4 million attributed to the increase in the rate of interest-bearing liabilities. Average interest-bearing liabilities increased approximately $166.9 million for the three months ended September 30, 2016 as compared to the same period in 2015 mainly as a result of our organic deposit growth and an increase in short-term borrowings to fund increased lending activity. The cost of interest-bearing liabilities increased 16 basis points to 0.98% for the three months ended September 30, 2016 compared to 0.82% for the same period in 2015, primarily as a result of an increase in rates offered to our customers for time deposits. During the third quarter of 2016, the Company began lowering its rates on time deposits in an effort to begin reducing the cost of funds. Subsequent to the end of the quarter, time deposit rates have been lowered further as we attempt to improve our funding costs.
Net interest margin was 3.23% for the three months ended September 30, 2016, down 29 basis points from 3.52% for the three months ended September 30, 2015. The decrease in net interest margin is attributable to the decrease in the overall yield on interest-earning assets, partially due to the increase in nonaccrual loans discussed in “Risk Management” below, and the increase in the cost of interest-bearing liabilities discussed above.
Average Balances and Yields. The following table sets forth average balance sheet data, including all major categories of interest-earning assets and interest-bearing liabilities, together with the interest earned or paid and the average yield or rate paid on each such category for the three months ended September 30, 2016 and 2015. Averages presented in the table below are daily averages (dollars in thousands).
Income/
Expense(1)
Yield/ Rate(1)
Assets
Interest-earning assets:
874,272
4.54
777,080
4.55
Securities:
Taxable
136,047
728
82,476
444
2.14
Tax-exempt
30,733
192
2.48
17,234
2.44
Interest-earning balances with banks
34,093
0.72
18,418
0.39
Total interest-earning assets
1,075,145
895,208
4.20
7,138
5,669
Intangible assets
3,248
3,189
56,273
46,061
Allowance for loan losses
(7,213
(5,893
1,134,591
944,234
Liabilities and stockholders’ equity
Interest-bearing liabilities:
Interest-bearing demand
262,841
433
0.65
229,919
369
0.64
Savings deposits
51,924
0.67
53,407
91
0.68
469,826
1,413
1.19
350,906
898
1.02
Total interest-bearing deposits
784,591
0.98
634,232
Short-term borrowings
98,286
237
0.96
68,544
0.19
Long-term debt
22,644
69
1.21
35,836
1.53
Total interest-bearing liabilities
905,521
738,612
0.82
Noninterest-bearing deposits
102,736
87,425
Other liabilities
13,278
10,402
Stockholders’ equity
113,056
107,795
Net interest income/net interest margin
3.23
3.52
(1)
Interest income and net interest margin are expressed as a percentage of average interest-earning assets outstanding for the indicated periods. Interest expense is expressed as a percentage of average interest-bearing liabilities for the indicated periods.
Volume/Rate Analysis. The following table sets forth a summary of the changes in interest earned and interest paid resulting from changes in volume and rates for the three months ended September 30, 2016 compared to the same period in 2015 (dollars in thousands).
Three months ended September 30, 2016 vs.
three months ended September 30, 2015
Volume
Rate
Net(1)
Interest income:
284
83
44
1,501
1,513
Interest expense:
Interest-bearing demand deposits
304
211
515
191
205
(51
(18
(69
317
712
Change in net interest income
(383
801
Changes in interest due to both volume and rate have been allocated on a pro-rata basis using the absolute ratio value of amounts calculated.
Nine months ended September 30, 2016 vs. nine months ended September 30, 2015. Net interest income increased 11.7% to $26.0 million for the nine months ended September 30, 2016 from $23.2 million for the same period in 2015. This increase is due primarily to the $112.5 million and $57.5 million increases in average loans and average investment securities, respectively, when compared to the same period in 2015, resulting in a $4.6 million increase in interest income, discussed in more detail below. Average interest-bearing deposits and short- and long-term borrowings increased approximately $121.6 million and $43.4 million, respectively, for the nine months ended September 30, 2016 when compared to the same period in 2015, resulting in a $1.9 million increase in interest expense, also discussed in more detail below. The increases in both average interest-earning assets and interest-bearing liabilities are a result of organic growth of the Company.
Interest income was $32.1 million for the nine months ended September 30, 2016 compared to $27.5 million for the same period in 2015. Loan interest income made up substantially all of our interest income for the nine months ended September 30, 2016 and 2015. The increase in interest income was a direct result of continued growth of the Company’s loan and investment portfolios with an increase in interest income of $4.9 million due to an increase in volume offset by a $0.3 million decrease related to a reduction in yield. The overall yield on interest-earning assets decreased 16 basis points to 4.15% for the nine months ended September 30, 2016 compared to 4.31% for the same period in 2015. The loan portfolio yielded 4.57% for the nine months ended September 30, 2016 compared to 4.67% for the nine months ended September 30, 2015. The reduction in yield on the loan portfolio is the result of a prolonged interest rate environment, as well as an increase in nonaccrual loans. The yield on the investment portfolio was 2.34% for the nine months ended September 30, 2016 compared to 2.21% for the nine months ended September 30, 2015.
Interest expense was $6.1 million for the nine months ended September 30, 2016, an increase of $1.9 million compared to interest expense of $4.2 million for the nine months ended September 30, 2015, as a result of increases in both the volume and cost of interest-bearing liabilities. Average interest-bearing liabilities increased approximately $165.0 million for the nine months ended September 30, 2016 compared to the same period in 2015 as a result of our organic deposit growth and an increase in short-term borrowings to fund increased lending activity. The cost of interest-bearing liabilities increased 14 basis points to 0.94% for the nine months ended September 30, 2016 compared to 0.80% for the same period in 2015, primarily as a result of the cost of short-term borrowings and an increase in rates offered to our customers for time deposits, as discussed above.
36
Net interest margin was 3.36% for the nine months ended September 30, 2016, down 28 basis points from 3.64% for the nine months ended September 30, 2015. The decrease in net interest margin is attributable to the decrease in the overall yield on interest-earning assets and the increase in the cost of interest-bearing liabilities discussed above.
Average Balances and Yields. The following table sets forth average balance sheet data, including all major categories of interest-earning assets and interest-bearing liabilities, together with the interest earned or paid and the average yield or rate paid on each such category for the nine months ended September 30, 2016 and 2015. Averages presented in the table below are daily averages (dollars in thousands).
853,116
4.57
740,652
4.67
125,982
2,172
2.30
76,069
1,214
2.13
25,920
495
2.54
18,381
344
2.50
25,608
0.76
17,863
0.40
1,030,626
4.15
852,965
4.31
7,335
5,597
3,228
3,199
54,478
45,619
(6,770
(5,497
1,088,897
901,883
249,960
1,205
219,018
1,034
0.63
52,596
54,158
274
431,328
3,742
1.16
339,129
2,541
1.00
733,884
0.95
612,305
710
24,243
210
1.15
39,213
315
869,545
0.94
704,548
0.80
95,225
82,157
12,135
8,736
111,992
106,442
3.36
3.64
37
Volume/Rate Analysis. The following table sets forth a summary of the changes in interest earned and interest paid resulting from changes in volume and rates for the nine months ended September 30, 2016 compared to the same period in 2015 (dollars in thousands).
Nine months ended September 30, 2016 vs.
nine months ended September 30, 2015
3,940
(519
3,421
799
958
142
151
70
93
4,904
4,623
(8
694
1,201
558
638
(121
(105
791
1,105
1,896
4,113
(1,386
2,727
Noninterest Income
Noninterest income includes, among other things, fees generated from our deposit services and loans held for sale, servicing fees, and gain on sale of investment securities, fixed assets, other real estate owned and loans. We expect to continue to develop new products that generate noninterest income, and enhance our existing products, in order to diversify our revenue sources.
Three months ended September 30, 2016 vs. three months ended September 30, 2015. Total noninterest income decreased $1.2 million, or 52.5%, to $1.0 million for the three months ended September 30, 2016 compared to $2.2 million for the three months ended September 30, 2015. The decrease in noninterest income is mainly attributable to the $1.0 million decrease in the gain on sale of loans. As discussed in Loans above, the gain on sale of loans decreased due to the Bank’s decision to exit the indirect auto loan origination business at the end of 2015.
Fee income on loans held for sale decreased to $0.1 million for the three months ended September 30, 2016 compared to $0.3 million for the same period in 2015 due to the decrease in originations of loans held for sale, as discussed in Loans above.
Nine months ended September 30, 2016 vs. nine months ended September 30, 2015. Total noninterest income decreased $2.2 million, or 32.5%, to $4.6 million for the nine months ended September 30, 2016 compared to $6.8 million for the nine months ended September 30, 2015. The decrease in noninterest income is mainly attributable to the $3.5 million decrease in gain on sale of loans when compared to the nine months ended September 30, 2015. The decrease in the gain on sale of loans was offset by a $1.2 million increase in the gain on sale of fixed assets recognized for the sale of the land and building of one of the Bank’s branch locations to a healthcare company when compared to the nine months ended September 30, 2015.
Fee income on loans held for sale decreased to $0.3 million for the nine months ended September 30, 2016 from $0.8 million for the same period in 2015 due to the decrease in originations of consumer loans held for sale, as discussed in Loans above.
38
Servicing fees, which are fees collected for servicing loans which have been sold and are held in our servicing portfolio, increased $0.2 million, or 19.3%, to $1.3 million for the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015. The increase is directly related to the increase in the size of our servicing portfolio, which is comprised of indirect auto loans, since September 30, 2015. Since the Company exited the indirect auto loan origination business at the end of 2015, we expect our servicing portfolio to decrease as borrowers make principal payments on their loans. As a result, our servicing fees will also decrease over time.
Other operating income primarily consists of interchange fees, credit card fees, ATM surcharge income, and the net change in the value of bank owned life insurance, among other items. Other operating income was $0.7 million for the nine months ended September 30, 2016 compared to $0.5 million for the same period in 2015. The increase is mainly a result of a $138,000 increase in the value of bank owned life insurance and a $35,000 increase in credit card fees.
Noninterest Expense
Three months ended September 30, 2016 vs. three months ended September 30, 2015. Total noninterest expense was $6.5 million for the three months ended September 30, 2016, a decrease of $0.5 million, or 6.6%, compared to the same period in 2015. The decrease is primarily due to a $0.2 million decrease in salaries and benefits and a $0.4 million decrease in other operating expenses. Along with its normal operating expenses, during the third quarter of 2016, the Company recorded additional expense in other operating expenses of approximately $31,000 related to employee and community assistance as a result of the August flooding.
Nine months ended September 30, 2016 vs. nine months ended September 30, 2015. Total noninterest expense was $20.0 million for the nine months ended September 30, 2016, a decrease of $0.1 million, or 0.4%, compared to the same period in 2015. Decreases in salaries and benefits and in other operating expenses were offset by increases in professional fees, marketing and $0.6 million in customer reimbursements paid to certain borrowers during the second quarter of 2016.
Although we are focused on growth, both organically and through acquisition, we are committed to managing our costs within the framework of our operating strategy.
Income Tax Expense
Income tax expense for the three months ended September 30, 2016 was $0.7 million, a decrease of $0.1 million, compared to the three months ended September 30, 2015. The effective tax rate for the three months ended September 30, 2016 and 2015 was 26.8% and 31.4%, respectively. The Company recorded a $0.1 million tax benefit during the quarter related to the filing of its 2015 tax return which contributed to the lower effective tax rate during the third quarter of 2016. Management expects the effective income tax rate to approximate 32.5% for the fourth quarter of 2016.
Income tax expense for both the nine months ended September 30, 2016 and 2015 was $2.8 million. The effective tax rate for the nine months ended September 30, 2016 and 2015 was 31.4 % and 33.0%, respectively.
Risk Management
The primary risks associated with our operations are credit, interest rate and liquidity risk. Credit and interest rate risk are discussed below, while liquidity risk is discussed in this section under the heading Liquidity and Capital Resources below.
Credit Risk and the Allowance for Loan Losses
General. The risk of loss should a borrower default on a loan is inherent in any lending activity. Our portfolio and related credit risk are monitored and managed on an ongoing basis by our risk management department, the board of directors’ loan committee and the full board of directors. We utilize a ten point risk-rating system, which assigns a risk grade to each borrower based on a number of quantitative and qualitative factors associated with a loan transaction. The risk grade categorizes the loan into one of five risk categories, based on information about the ability of borrowers to service the debt. The information includes, among other factors, current financial information about the borrower, historical payment experience, credit documentation, public information and current economic trends. These categories assist management in monitoring our credit quality. The following describes each of the risk categories, which are consistent with the definitions used in guidance promulgated by federal banking regulators:
Pass (grades 1-6) – Loans not meeting the criteria below are considered pass. These loans have high credit characteristics and financial strength. The borrowers at least generate profits and cash flow that are in line with peer and industry standards and have debt service coverage ratios above loan covenants and our policy guidelines. For some of these loans,
a guaranty from a financially capable party mitigates characteristics of the borrower that might otherwise result in a lower grade.
Special Mention (grade 7) – Loans classified as special mention possess some credit deficiencies that need to be corrected to avoid a greater risk of default in the future. For example, financial ratios relating to the borrower may have deteriorated. Often, a special mention categorization is temporary while certain factors are analyzed or matters addressed before the loan is re-categorized as either pass or substandard.
Substandard (grade 8) – Loans rated as substandard are inadequately protected by the current net worth and paying capacity of the borrower or the liquidation value of any collateral. If deficiencies are not addressed, it is likely that this category of loan will result in the Bank incurring a loss. Where a borrower has been unable to adjust to industry or general economic conditions, the borrower’s loan is often categorized as substandard.
Doubtful (grade 9) – Doubtful loans are substandard loans with one or more additional negative factors that makes full collection of amounts outstanding, either through repayment or liquidation of collateral, highly questionable and improbable.
Loss (grade 10) – Loans classified as loss have deteriorated to such a point that it is not practicable to defer writing off the loan. For these loans, all efforts to remediate the loan’s negative characteristics have failed and the value of the collateral, if any, has severely deteriorated relative to the amount outstanding. Although some value may be recovered on such a loan, it is not significant in relation to the amount borrowed.
At September 30, 2016 and December 31, 2015, there were no loans classified as doubtful or loss, while there were $10.2 million and $6.7 million, respectively, of loans classified as substandard. At September 30, 2016 and December 31, 2015, $2.6 million and $1.4 million, respectively, of loans were classified as special mention. Of our substandard and special mention loans at September 30, 2016 and December 31, 2015, $1.3 million and $1.6 million, respectively, were acquired and marked to fair value at the time of their acquisition.
An external loan review consultant is engaged annually by the risk management department to review approximately 40% of commercial loans, utilizing a risk-based approach designed to maximize the effectiveness of the review. In addition, credit analysts periodically review smaller dollar commercial loans to identify negative financial trends related to any one borrower, any related groups of borrowers or an industry. All loans not categorized as pass are put on an internal watch list, with quarterly reports to the board of directors. In addition, a written status report is maintained by our special assets division for all commercial loans categorized as substandard or worse. We use this information in connection with our collection efforts.
If our collection efforts are unsuccessful, collateral securing loans may be repossessed and sold or, for loans secured by real estate, foreclosure proceedings initiated. The collateral is sold at public auction for fair market value, with fees associated with the foreclosure being deducted from the sales price. The purchase price is applied to the outstanding loan balance. If the loan balance is greater than the sales proceeds, the deficient balance is charged-off.
Allowance for Loan Losses. The allowance for loan losses is an amount that management believes will be adequate to absorb probable losses inherent in the entire loan portfolio. The appropriate level of the allowance is based on an ongoing analysis of the loan portfolio and represents an amount that management deems adequate to provide for inherent losses, including collective impairment as recognized under ASC 450, Contingencies. Collective impairment is calculated based on loans grouped by grade. Another component of the allowance is losses on loans assessed as impaired under ASC 310, Receivables. The balance of these loans and their related allowance is included in management’s estimation and analysis of the allowance for loan losses. Other considerations in establishing the allowance for loan losses include the nature and volume of the loan portfolio, overall portfolio quality, historical loan loss, review of specific problem loans and current economic conditions that may affect our borrowers’ ability to pay, as well as trends within each of these factors. The allowance for loan losses is established after input from management as well as our risk management department and our special assets committee. We evaluate the adequacy of the allowance for loan losses on a quarterly basis. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance for loan losses was $7.4 million at September 30, 2016, up from $6.1 million at December 31, 2015, as we increased our loan loss provisioning to reflect our nonperforming and organic loan growth.
40
A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Determination of impairment is treated the same across all classes of loans. Impairment is measured on a loan-by-loan basis for, among others, all loans of $500,000 or greater, nonaccrual loans and a sample of loans between $250,000 and $500,000. When we identify a loan as impaired, we measure the extent of the impairment based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, except when the sole (remaining) source of repayment for the loans is the operation or liquidation of the collateral. In these cases when foreclosure is probable, we use the current fair value of the collateral, less selling costs, instead of discounted cash flows. For real estate collateral, the fair value of the collateral is based upon a recent appraisal by a qualified and licensed appraiser. If we determine that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), we recognize impairment through an allowance estimate or a charge-off recorded against the allowance. When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on nonaccrual, all payments are applied to principal, under the cost recovery method. When the ultimate collectability of the total principal of an impaired loan is not in doubt and the loan is on nonaccrual, contractual interest is credited to interest income when received, under the cash basis method.
Impaired loans at September 30, 2016 were $11.6 million, including impaired loans acquired through acquisition in the amount of $2.0 million, compared to $4.0 million, including impaired loans acquired through acquisition in the amount of $1.5 million, at December 31, 2015. The increase in impaired loans, driven by an increase in nonaccrual loans, is mainly due to a $4.7 million owner-occupied commercial real estate loan relationship and a $2.6 million commercial and industrial loan relationship not related to the oil and gas industry that were placed on nonaccrual during the nine months ended September 30, 2016. Management has recorded a specific reserve against the $4.7 million loan of $0.5 million in the allowance for loan losses. The Company has determined that a specific reserve is no longer required on the $2.6 million loan as it believes sufficient collateral exists after receiving additional cash collateral from the borrower. Subsequent to the end of the third quarter, the Company received a $0.5 million principal pay-down on this loan relationship. A bankruptcy plan was accepted by the borrower’s creditors and the Company does not expect a loss on this loan at this time. As a result of the loan remaining currently throughout the bankruptcy process and the additional cash collateral, the Company anticipates the loan to be placed back on accrual during the fourth quarter. At September 30, 2016 and December 31, 2015, $0.7 million and $0.2 million, respectively, of the allowance for loan losses was specifically allocated to impaired loans.
The provision for loan losses is a charge to expense in an amount that management believes is necessary to maintain an adequate allowance for loan losses. The provision is based on management’s regular evaluation of current economic conditions in our specific markets as well as regionally and nationally, changes in the character and size of the loan portfolio, underlying collateral values securing loans, and other factors which deserve recognition in estimating loan losses. For the three months ended September 30, 2016 and 2015, the provision for loan losses was $0.5 million and $0.4 million, respectively. For the nine months ended September 30, 2016 and 2015, the provision for loan losses was $1.7 million and $1.5 million, respectively. The increase over the three-month comparative period can be attributed to the overall growth of the loan portfolio. The increase over the nine-month comparative period is primarily due to the increase in impaired loans mentioned above.
Acquired loans that are accounted for under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”), were marked to market on the date we acquired the loans to values which, in management’s opinion, reflected the estimated future cash flows, based on the facts and circumstances surrounding each respective loan at the date of acquisition. We continually monitor these loans as part of our normal credit review and monitoring procedures for changes in the estimated future cash flows. Because ASC 310-30 does not permit carry over or recognition of an allowance for loan losses, we may be required to reserve for these loans in the allowance for loan losses through future provision for loan losses if future cash flows deteriorate below initial projections.
The following table presents the allocation of the allowance for loan losses by loan category as of the dates indicated (dollars in thousands).
5,539
4,281
As discussed above, the balance in the allowance for loan losses is principally influenced by the provision for loan losses and by net loan loss experience. Additions to the allowance are charged to the provision for loan losses. Losses are charged to the allowance as incurred and recoveries on losses previously charged to the allowance are credited to the allowance at the time recovery is collected. The table below reflects the activity in the allowance for loan losses for the periods indicated (dollars in thousands).
Allowance at beginning of period
Charge-offs:
Mortgage loans on real estate:
Total charge-offs
Total recoveries
Net (charge-offs) recoveries
(158
(449
(219
Net charge-offs to:
Loans - average
0.06
3.67
6.08
3.70
Allowance for loan losses to:
0.87
0.83
Nonperforming loans
82.44
226.43
The allowance for loan losses to total loans ratio increased to 0.87% at September 30, 2016 compared to 0.83% at September 30, 2015. The allowance for loan losses to nonperforming loans ratio decreased to 82.44% at September 30, 2016 from 226.43% at September 30, 2015. The decrease in the allowance for loan losses to nonperforming loans ratio is due to a $6.3 million increase in nonperforming loans. Nonperforming loans were $9.0 million, or 1.06% of total loans, at September 30, 2016, compared to $2.4 million, or 0.32% of total loans at December 31, 2015. The increase in nonperforming loans is mainly due to the $4.7 million owner-occupied commercial real estate loan relationship and the $2.6 million commercial and industrial loan relationship mentioned above.
Charge-offs reflect the realization of losses in the portfolio that were recognized previously through the provision for loan losses. Net charge-offs for the three and nine months ended September 30, 2016 were $0.2 million and $0.4 million, respectively, equal to 0.02% and 0.06%, respectively, of our average loan balance as of that date. Net charge-offs for both the three and nine months ended September 30, 2015 were $0.2 million, equal to 0.03% of our average loan balance as of that date.
The Company has instituted a 90-day loan deferral program for customers who were impacted by the flood and has allocated a portion of its general reserves to the potential impact as a result of the flood. The Company placed approximately $23.5 million, or 2.8% of the total loan portfolio on a 90-day deferral plan. The Company continues to assess the impact the flooding may have on the region and its loan portfolio to determine the need for specific or additional general reserves.
Management believes the allowance for loan losses at September 30, 2016 is sufficient to provide adequate protection against losses in our portfolio. Although the allowance for loan losses is considered adequate by management, there can be no assurance that this allowance will prove to be adequate over time to cover ultimate losses in connection with our loans. This allowance may prove to be inadequate due to unanticipated adverse changes in the economy or discrete events adversely affecting specific customers or industries. Our results of operations and financial condition could be materially adversely affected to the extent that the allowance is insufficient to cover such changes or events.
42
Nonperforming Assets and Restructured Loans. Nonperforming assets consist of nonperforming loans and other real estate owned. Nonperforming loans are those on which the accrual of interest has stopped or loans which are contractually 90 days past due on which interest continues to accrue. Loans are ordinarily placed on nonaccrual when a loan is specifically determined to be impaired or when principal and interest is delinquent for 90 days or more. However, management may elect to continue the accrual when the estimated net available value of collateral is sufficient to cover the principal balance and accrued interest. It is our policy to discontinue the accrual of interest income on any loan for which we have reasonable doubt as to the payment of interest or principal. Nonaccrual loans are returned to accrual status when the financial position of the borrower indicates there is no longer any reasonable doubt as to the payment of principal or interest.
Another category of assets which contributes to our credit risk is troubled debt restructurings (“TDR”), or restructured loans. A restructured loan is a loan for which a concession that is not insignificant has been granted to the borrower due to a deterioration of the borrower’s financial condition and which is performing in accordance with the new terms. Such concessions may include reduction in interest rates, deferral of interest or principal payments, principal forgiveness and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. We strive to identify borrowers in financial difficulty early and work with them to modify their loans to more affordable terms before such loan reaches nonaccrual status. In evaluating whether to restructure a loan, management analyzes the long-term financial condition of the borrower, including guarantor and collateral support, to determine whether the proposed concessions will increase the likelihood of repayment of principal and interest. Restructured loans that are not performing in accordance with their restructured terms that are either contractually 90 days past due or placed on nonaccrual status are reported as nonperforming loans.
There were twenty loans classified as TDRs at September 30, 2016 that totaled approximately $2.7 million, compared to eleven loans totaling approximately $2.2 million at December 31, 2015. Eighteen of the twenty TDRs were acquired through acquisition. Nine restructured loans were considered TDRs due to a modification of terms through adjustments to maturity, nine restructured loans were considered TDRs due to a reduction in the interest rate to a rate lower than the current market rate, one restructured loan was considered a TDR due to modification of terms through principal payment forbearance, paying interest only for a specified period of time, as well as adjustments to maturity, and one restructured loan was considered a TDR due to modification of terms through principal payment forbearance only for a specified period of time. As of September 30, 2016, one of the restructured loans with a balance of $0.1 million was in default of its modified terms and had been placed on nonaccrual. At December 31, 2015, three of the restructured loans with a balance of $0.5 million were in default of their modified terms and had been placed on nonaccrual.
The following table shows the principal amounts of nonperforming and restructured loans as of the dates indicated. All loans where information exists about possible credit problems that would cause us to have serious doubts about the borrower’s ability to comply with the current repayment terms of the loan have been reflected in the table below (dollars in thousands).
Nonaccrual loans
Accruing loans past due 90 days or more
Total nonperforming loans
8,956
Restructured loans
2,605
1,629
Total nonperforming and restructured loans
11,561
Interest income recognized on nonperforming and restructured loans
300
174
Interest income foregone on nonperforming and restructured loans
252
Of the total nonaccrual loans at September 30, 2016 and December 31, 2015, $0.6 million and $1.1 million, respectively, were acquired through acquisition. Nonperforming loans are comprised of accruing loans past due 90 days or more and nonaccrual loans. Nonperforming loans outstanding represented 1.06% and 0.32% of total loans at September 30, 2016 and December 31, 2015, respectively. Nonperforming loans, other than those acquired through an acquisition and nonperforming acquired loans represented 0.98% and 0.08%, respectively, of total loans at September 30, 2016.
Other Real Estate Owned. Other real estate owned consists of properties acquired through foreclosure or acceptance of a deed in lieu of foreclosure. These properties are carried at the lower of cost or fair market value based on appraised value less estimated selling costs. Losses arising at the time of foreclosure of properties are charged to the allowance for loan losses. Other real estate owned with a cost basis of $0.5 million was sold during the nine months ended September 30, 2016, resulting in a net gain of $11,000 for the period. There were no sales of other real estate owned during the three months ended September 30, 2016. For the three and nine months ended September 30, 2015, other real estate owned with a cost basis $1.3 million and $1.9 million, respectively, was sold resulting in a net loss of $0.1 million for both periods. At September 30, 2016 and December 31, 2015, $0.3 million and $0.6 million, respectively of our other real estate owned was related to loans acquired through acquisition.
The following table provides details of our other real estate owned as of the dates indicated (dollars in thousands).
616
109
Total other real estate owned
Changes in our other real estate owned are summarized in the table below for the periods indicated (dollars in thousands).
2,735
Transfers from loans
Transfers from acquired loans
Sales of other real estate owned
(469
(1,867
Write-downs
1,178
Interest Rate Risk
Market risk is the risk of loss from adverse changes in market prices and rates. Since the majority of our assets and liabilities are monetary in nature, our market risk arises primarily from interest rate risk inherent in our lending and deposit activities. A sudden and substantial change in interest rates may adversely impact our earnings and profitability because the interest rates borne by assets and liabilities do not change at the same speed, to the same extent or on the same basis. Accordingly, our ability to proactively structure the volume and mix of our assets and liabilities to address anticipated changes in interest rates, as well as to react quickly to such fluctuations, can significantly impact our financial results. To that end, management actively monitors and manages our interest rate risk exposure.
The Asset Liability Committee (“ALCO”) has been authorized by the board of directors to implement our asset/liability management policy, which establishes guidelines with respect to our exposure to interest rate fluctuations, liquidity, loan limits as a percentage of funding sources, exposure to correspondent banks and brokers and reliance on non-core deposits. The goal of the policy is to enable us to maximize our interest income and maintain our net interest margin without exposing the Bank to excessive interest rate risk, credit risk and liquidity risk. Within that framework, the ALCO monitors our interest rate sensitivity and makes decisions relating to our asset/liability composition.
We monitor the impact of changes in interest rates on our net interest income using gap analysis. The gap represents the net position of our assets and liabilities subject to repricing in specified time periods. During any given time period, if the amount of rate-sensitive liabilities exceeds the amount of rate-sensitive assets, a financial institution would generally be considered to have a negative gap position and would benefit from falling rates over that period of time. Conversely, a financial institution with a positive gap position would generally benefit from rising rates.
Within the gap position that management directs, we attempt to structure our assets and liabilities to minimize the risk of either a rising or falling interest rate environment. We manage our gap position for time horizons of one month, two months, three months, 4-6 months, 7-12 months, 13-24 months, 25-36 months, 37-60 months and more than 60 months. The goal of our asset/liability management is for the Bank to maintain a net interest income at risk in an up or down 100 basis point environment at less than (5)%. At September 30, 2016, the Bank was within the policy guidelines for asset/liability management.
The table below depicts the estimated impact on net interest income of immediate changes in interest rates at the specified levels.
As of September 30, 2016
Changes in Interest Rates
(in basis points)
Increase/Decrease in
Net Interest Income (1)
+300
(3.3
)%
+200
(2.0
+100
(1.0
-100
5.3
-200
-300
The percentage change in this column represents the projected net interest income for 12 months on a flat balance sheet in a stable interest rate environment versus the projected net interest income in the various rate scenarios.
The computation of the prospective effects of hypothetical interest rate changes requires numerous assumptions regarding characteristics of new business and the behavior of existing positions. These business assumptions are based upon our experience, business plans and published industry experience. Key assumptions include asset prepayment speeds, competitive factors, the relative price sensitivity of certain assets and liabilities and the expected life of non-maturity deposits. However, there are a number of factors that influence the effect of interest rate fluctuations on us which are difficult to measure and predict. For example, a rapid drop in interest rates might cause our loans to repay at a more rapid pace and certain mortgage-related investments to prepay more quickly than projected. This could mitigate some of the benefits of falling rates as are expected when we are in a negatively-gapped position. Conversely, a rapid rise in rates could give us an opportunity to increase our margins and stifle the rate of repayment on our mortgage-related loans which would increase our returns. As a result, because these assumptions are inherently uncertain, actual results will differ from simulated results.
Liquidity and Capital Resources
Liquidity. Liquidity is a measure of the ability to fund loan commitments and meet deposit maturities and withdrawals in a timely and cost-effective way. Cash flow requirements can be met by generating net income, attracting new deposits, converting assets to cash or borrowing funds. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit outflows, loan prepayments, loan sales and borrowings are greatly influenced by general interest rates, economic conditions and the competitive environment in which we operate. To minimize funding risks, we closely monitor our liquidity position through periodic reviews of maturity profiles, yield and rate behaviors, and loan and deposit forecasts. Excess short-term liquidity is usually invested in overnight federal funds sold.
Our core deposits, which are deposits excluding time deposits greater than $250,000 and deposits of municipalities and other political entities, are our most stable source of liquidity to meet our cash flow needs due to the nature of the long-term relationships generally established with our customers. Maintaining the ability to acquire these funds as needed in a variety of markets, and within ALCO compliance targets, is essential to ensuring our liquidity. At September 30, 2016 and December 31, 2015, 76% and 69% of our total assets, respectively, were funded by core deposits.
Our investment portfolio is another alternative for meeting our cash flow requirements. Investment securities generate cash flow through principal payments and maturities, and they generally have readily available markets that allow for their conversion to cash. Some securities are pledged to secure certain deposit types or short-term borrowings, such as FHLB advances, which impacts their liquidity. At September 30, 2016, securities with a carrying value of $59.9 million were pledged to secure certain deposits, borrowings, and other liabilities, compared to $58.8 million in pledged securities as of December 31, 2015.
Other sources available for meeting liquidity needs include advances from the FHLB, repurchase agreements and other borrowings. FHLB advances are primarily used to match-fund fixed rate loans in order to minimize interest rate risk and also may be used to meet day to day liquidity needs, particularly if the prevailing interest rate on an FHLB advance compares favorably to the rates that we would be required to pay to attract deposits. At September 30, 2016, the balance of our outstanding advances with the FHLB was $88.9 million, a decrease from $127.5 million at December 31, 2015. The total amount of the remaining credit available to us from the FHLB at September 30, 2016 was $355.2 million. Repurchase agreements are contracts for the sale of securities which we own with a corresponding agreement to repurchase those securities at an agreed upon price and date. Our policies limit the use of repurchase agreements to those collateralized by U.S. Treasury and agency securities. We had $23.6 million of repurchase agreements outstanding as of September 30, 2016, compared to $39.1 million of outstanding repurchase agreements as of December 31, 2015. We maintain unsecured lines of credit with other commercial banks totaling $55.0 million. The lines of credit mature at various times within the next nine months. There were no amounts outstanding under these lines of credit at September 30, 2016 or December 31, 2015.
In addition, on June 27, 2016, we entered into a loan agreement (“Agreement”) with TIB providing for a $20 million revolving line of credit maturing June 27, 2018. Borrowings bear interest, payable quarterly, at a fixed rate per annum equal to the U.S. prime rate on June 27, 2016 (3.5%); provided, however, that on June 27, 2017, the rate will be adjusted to a fixed rate of interest equal to the prime rate on such date. The revolving line of credit is secured by a first priority security interest in all of the capital stock of Investar Bank and a security interest in all property of Investar Bank held by the lender. There were no amounts outstanding under the revolving line of credit at September 30, 2016.
The loan agreement for the revolving line of credit contains customary representations, warranties, affirmative covenants and events of default, and also contains a number of negative covenants, including, but not limited to, restrictions on mergers and similar transactions, restrictions on liens, and a prohibition on the payment of dividends or repurchase of stock during an event of default. The agreement also contains financial covenants, including requiring that Investar Bank maintain (i) a Tier 1 Leverage Ratio and a Common Equity Tier 1 Ratio not less than 7.5% at all times, (ii) a Tier 1 Capital Ratio and a Total Capital Ratio not less than 9.5% at all times, (iii) a return on average assets of no less than 0.70% as of the end of each fiscal quarter, annualized on a year-to-date basis, (iv) Classified Assets (as defined in the Agreement) at no more than 35% of Investar Bank’s Tier 1 Capital plus allowance for loan and lease losses, and (v) a total loans to total assets ratio of no more than 85% at all times.
Our liquidity strategy is focused on using the least costly funds available to us in the context of our balance sheet composition and interest rate risk position. Accordingly, we target growth of noninterest-bearing deposits. Although we cannot directly control the types of deposit instruments our customers choose, we can influence those choices with the interest rates and deposit specials we offer. We do not hold any brokered deposits, as defined for federal regulatory purposes, although we do hold QwikRate® deposits, included in our time deposit balances, which we obtain via the internet to address liquidity needs when rates on such deposits compare favorably with deposit rates in our markets. At September 30, 2016, we held $131.4 million of QwikRate® deposits, up from $79.3 million at December 31, 2015.
The following table presents, by type, our funding sources, which consist of total average deposits and borrowed funds, as a percentage of total funds and the total cost of each funding source for the three and nine months ended September 30, 2016 and 2015.
Percentage of Total
47
Long-term borrowed funds
Total deposits and borrowed funds
100
0.88
0.73
46
Capital Management. Our primary sources of capital include retained earnings, capital obtained through acquisitions and proceeds from the sale of our capital stock. We are subject to various regulatory capital requirements administered by the Federal Reserve and the FDIC which specify capital tiers, including the following classifications.
Capital Tiers
Tier 1 Leverage Ratio
Common Equity Tier 1 Capital Ratio
Tier 1 Capital
Ratio
Total Capital Ratio
Well capitalized
5% or above
6.5% or above
8% or above
10% or above
Adequately capitalized
4% or above
4.5% or above
6% or above
Undercapitalized
Less than 4%
Less than 4.5%
Less than 6%
Less than 8%
Significantly undercapitalized
Less than 3%
Critically undercapitalized
2% or less
The Company and the Bank each were in compliance with all regulatory capital requirements as of September 30, 2016 and December 31, 2015. The Bank also was considered “well-capitalized” under the FDIC’s prompt corrective action regulations as of these dates. The following table presents the actual capital amounts and regulatory capital ratios for the Company and the Bank as of the dates presented (dollars in thousands).
Actual
Minimum Capital
Requirement to be
Well Capitalized
Investar Holding Corporation:
Tier 1 leverage capital
113,864
10.10
Common equity tier 1 capital
110,364
11.02
Tier 1 capital
11.37
Total capital
121,247
12.11
Investar Bank:
111,937
9.94
56,311
5.00
11.19
64,981
6.50
79,977
8.00
119,320
11.93
99,971
10.00
110,574
11.39
107,074
11.67
12.05
116,702
12.72
107,209
11.07
48,436
11.71
59,511
73,244
113,337
12.38
91,555
Off-Balance Sheet Transactions
The Bank entered into interest rate swap contracts to manage exposure against the variability in the expected future cash flows (future interest payments) attributable to changes in the 1-month LIBOR associated with the forecasted issuances of 1-month fixed rate debt arising from a rollover strategy. An interest rate swap is an agreement whereby one party agrees to pay a fixed rate of interest on a notional principal amount in exchange for receiving a floating rate of interest on the same notional amount for a predetermined period of time, from a second party. The maximum length of time over which the Bank is currently hedging its exposure to the variability in future cash flows for forecasted transactions is approximately 4 years. The total notional amount of the derivative contracts is $50.0 million.
The Bank enters into loan commitments and standby letters of credit in the normal course of its business. Loan commitments are made to meet the financing needs of our customers, while standby letters of credit commit the Bank to make payments on behalf of customers when certain specified future events occur. The credit risks associated with loan commitments and standby letters of credit are essentially the same as those involved in making loans to our customers. Accordingly, our normal credit policies apply to these arrangements. Collateral (e.g., securities, receivables, inventory, equipment, etc.) is obtained based on management’s credit assessment of the customer.
Loan commitments and standby letters of credit do not necessarily represent future cash requirements, in that while the customer typically has the ability to draw upon these commitments at any time, these commitments often expire without being drawn upon in full or at all. Virtually all of our standby letters of credit expire within one year. Our unfunded loan commitments and standby letters of credit outstanding are summarized below as of the dates indicated (dollars in thousands):
Commitments to extend credit:
The Company closely monitors the amount of remaining future commitments to borrowers in light of prevailing economic conditions and adjusts these commitments as necessary. The Company intends to continue this process as new commitments are entered into or existing commitments are renewed.
For the three months ended September 30, 2016 and for the year ended December 31, 2015, except as disclosed herein and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, we engaged in no off-balance sheet transactions that we believe are reasonably likely to have a material effect on our financial condition, results of operations or cash flows.
Contractual Obligations
There have been no material changes outside the ordinary course of business in the contractual obligations set forth in the table of contractual obligations as of December 31, 2015 contained in our Annual Report on Form 10-K for the year ended December 31, 2015.
48
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Quantitative and qualitative disclosures about market risk as of December 31, 2015 are set forth in the Company’s Annual Report on Form 10-K filed with the SEC on March 11, 2016 in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management.” There have been no material changes in the Company’s market risk since December 31, 2015. Please refer to the information in Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, under the heading “Risk Management” in this report for additional information about the Company’s market risk for the nine months ended September 30, 2016.
Item 4. Controls and Procedures
Based on their evaluation as of the end of the period covered by this quarterly report on Form 10-Q, the Company’s Principal Executive Officer and Principal Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) are effective for ensuring that information the Company is required to disclose in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
There were no changes in the Company’s internal control over financial reporting during the fiscal quarter covered by this quarterly report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1A. Risk Factors
There have been no material changes from the risk factors previously disclosed in the Annual Report on Form 10-K for the year ended December 31, 2015 filed by Investar Holding Corporation (the “Company”) with the SEC on March 11, 2016.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Issuer Purchases of Equity Securities
The table below provides the information with respect to purchases made by the Company of shares of its common stock during each of the months during the three month period ended September 30, 2016.
Period
(a) Total Number of
Shares (or Units)
Purchased(1)
(b) Average Price
Paid per Share
(or Unit)
(c ) Total Number
of Shares (or Units)
Purchased as Part
of Publicly
Announced Plans
or Programs(2)
(d) Maximum Number
(or Approximate Dollar
Value) of Shares
(or Units) That May Be
Purchased Under the
Plans or Programs(2)
July 1, 2016 to July 31, 2016
58,389
15.38
56,118
54,209
August 1, 2016 to August 31, 2016
19,491
15.23
19,391
34,818
September 1, 2016 to September 30, 2016
5,358
15.39
5,264
29,554
83,238
15.35
80,773
Includes 2,465 shares surrendered to cover the payroll taxes due upon the vesting of restricted stock.
(2)
On February 19, 2015, the Company announced that its board of directors had authorized the repurchase of up to 250,000 shares of the Company’s common stock in open market transactions from time to time or through privately negotiated transactions in accordance with federal securities laws. In addition, on October 19, 2016, the Company announced that its board of directors authorized an additional 250,000 shares for repurchase.
The Company’s ability to pay dividends to its shareholders may be limited on account of the junior subordinated debentures that the Company assumed in connection with its acquisition of First Community Bank, which are senior to shares of the Company’s common stock. The Company must make payments on the junior subordinated debentures before any dividends can be paid on its common stock.
In addition, the Company’s status as a bank holding company affects its ability to pay dividends, in two ways:
As a holding company with no material business activities, the Company’s ability to pay dividends is substantially dependent upon the ability of Investar Bank to transfer funds to the Company in the form of dividends, loans and advances. Investar Bank’s ability to pay dividends and make other distributions and payments is itself subject to various legal, regulatory and other restrictions.
As a holding company of a bank, the Company’s payment of dividends must comply with the policies and enforcement powers of the Federal Reserve. Under Federal Reserve policies, in general a bank holding company should pay dividends only when (1) its net income available to shareholders over the last four quarters (net of dividends paid) has been sufficient to fully fund the dividends, (2) the prospective rate of earnings retention appears to be consistent with the capital needs and overall current and prospective financial condition of the bank holding company and its subsidiaries, and (3) the bank holding company will continue to meet minimum regulatory capital adequacy ratios.
Item 6. Exhibits
Exhibit No.
Description of Exhibit
3.1
Restated Articles of Incorporation of Investar Holding Corporation(1)
3.2
By-laws of Investar Holding Corporation, as amended(2)
4.1
Specimen Common Stock Certificate(3)
31.1
Certification of the Principal Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of the Principal Financial Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of the Principal Executive Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of the Principal Financial Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
Filed as exhibit 3.1 to the Registration Statement on Form S-1 of the Company filed with the SEC on May 16, 2014 and incorporated herein by reference.
Filed as exhibit 3.2 to the Pre-Effective Amendment No. 1 to Registration Statement on Form S-1 of the Company filed with the SEC on June 4, 2014 and incorporated herein by reference.
(3)
Filed as exhibit 4.1 to the Registration Statement on Form S-1 of the Company filed with the SEC on May 16, 2014 and incorporated herein by reference.
The Company does not have any long-term debt instruments under which securities are authorized exceeding 10% of the total assets of the Company and its subsidiaries on a consolidated basis. The Company will furnish to the Securities and Exchange Commission, upon its request, a copy of all long-term debt instruments.
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: November 4, 2016
/s/ John J. D’Angelo
John J. D’Angelo
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Christopher L. Hufft
Christopher L. Hufft
Chief Financial Officer
(Principal Financial Officer)
EXHIBIT INDEX