Item 7. Management
’s Discussion and Analysis of Financial Condition and Results of Operations
Glossary of
Financial Terms
Allowance for loan losses
A valuation allowance to offset credit losses specifically identified in the loan portfolio, as well as management
’s best estimate of probable incurred losses in the remainder of the portfolio at the balance sheet date. Management estimates the allowance balance required using past loan loss experience, an assessment of the financial condition of individual borrowers, a determination of the value and adequacy of underlying collateral, the condition of the local economy, an analysis of the levels and trends of the loan portfolio, and a review of delinquent and classified loans. Actual losses could differ significantly from the amounts estimated by management.
Dividend payout
ratio
Cash dividends
declared on common shares, divided by net income.
Basis points
Each basis point is equal to one hundredth of one percent. Basis points are calculated by multiplying percentage points times 100. For example: 3.7 percentage points equals 370 basis points.
Interest
rate sensitivity
The relationship between interest sensitive earning assets and interest bearing liabilities.
Net charge-offs
The amount of total loans charged off net of recoveries of loans that have been previously charged off.
Net interest income
Total interest income less total interest expense.
Net interest margin
Taxable equivalent net interest income expressed as a percentage of average earning assets.
Net interest spread
The difference between the taxable equivalent yield on earning assets a
nd the rate paid on interest bearing funds.
Other real estate owned
Real estate not used for banking purposes. For example, real estate acquired through foreclosure.
Provision for loan losses
The charge against current income needed to maintain an adequa
te allowance for loan losses.
Return on average assets (ROA)
Net income
(loss) divided by average total assets. Measures the relative profitability of the resources utilized by the Company.
Return on average equity (ROE)
Net income
(loss) divided by average shareholders’ equity. Measures the relative profitability of the shareholders' investment in the Company.
Tax equivalent basis (TE)
Income from tax-exempt loans and investment securities ha
s been increased by an amount equivalent to the taxes that would have been paid if this income were taxable at statutory rates. In order to provide comparisons of yields and margins for all earning assets, the interest income earned on tax-exempt assets is increased to make them fully equivalent to other taxable interest income investments.
Weighted average number of common shares outstanding
The number of shares determined by relating (a) the portion of time within a reporting period that common shares
have been outstanding to (b) the total time in that period.
Management
’s Discussion and Analysis of Financial Condition and Results of Operations
The following pages present management
’s discussion and analysis of the consolidated financial condition and results of operations of Farmers Capital Bank Corporation (the “Company” or “Parent Company”), a financial holding company, its bank subsidiary, United Bank & Capital Trust Company (“United Bank” or the “Bank”) in Frankfort, Kentucky, and nonbank subsidiary, FFKT Insurance Services, Inc. (“FFKT Insurance”). In February 2017, the Company merged three of its subsidiary banks (United Bank & Trust Company [“United Versailles”] in Versailles, KY; First Citizens Bank, Inc. [“First Citizens”] in Elizabethtown, KY; and Citizens Bank of Northern Kentucky, Inc. [“Citizens Northern”] in Newport, KY) and its data processing subsidiary (FCB Services, Inc. [“FCB Services”] in Frankfort, KY) into its subsidiary bank Farmers Bank & Capital Trust Company (“Farmers Bank”) in Frankfort, KY, the name of which was immediately changed under the merger to United Bank & Capital Trust Company.
All significant intercompany transactions and balances are eliminated in consolidation.
At year-end
2017, United Bank had two primary subsidiaries, which include EG Properties, Inc., and Farmers Capital Insurance Corporation (“Farmers Insurance”). EG Properties, Inc. is involved in real estate management and liquidation for certain repossessed properties of United Bank. Farmers Insurance is an insurance agency in Frankfort, KY. In May 2017, the Company merged the nonbank subsidiaries of each of its pre-merger subsidiary banks (EGT Properties, Inc. [“EGT Properties”], HBJ Properties, LLC [“HBJ Properties”], and ENKY Properties, Inc. [“ENKY”]) into EG Properties.
The Company
had one active nonbank subsidiary at year-end 2017, FFKT Insurance
,
a captive insurance company
that provides property and casualty coverage to its subsidiaries for risk management purposes or where insurance may not be available or economically feasible. The Company has two subsidiaries organized as Delaware statutory trusts that were not consolidated into its financial statements. These trusts were formed for the purpose of issuing trust preferred securities.
For a complete list of the Company
’s subsidiaries, please refer to the discussion under the heading
“Organization”
included in Part 1, Item 1 of this Form 10-K. The following discussion should be read in conjunction with the audited consolidated financial statements and related footnotes that follow.
Forward-Looking Statements
This report contains forward-looking statements
with the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Statements in this report that are not statements of historical fact are forward-looking statements. In general, forward-looking statements relate to a discussion of future financial results or projections, future economic performance, the financial impact of the Tax Cuts and Jobs Act (“Tax Act”) on the Company’s results of operations, future operational plans and objectives, and statements regarding the underlying assumptions of such statements. Although management of the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore, there can be no assurance that the forward-looking statements included herein will prove to be accurate.
Various risks and uncertainties may cause actual results to differ materially from those indicated by the Company
’s forward-looking statements. In addition to the risks described under Part 1, Item 1A
“Risk Factors”
in this report, factors that could cause actual results to differ from the results discussed in the forward-looking statements include, but are not limited to: economic conditions (both generally and more specifically in the markets in which the Company and its subsidiaries operate) and lower interest margins; competition for the Company’s customers from other providers of financial services; deposit outflows or reduced demand for financial services and loan products; government legislation, regulation, and changes in monetary and fiscal policies (which changes from time to time and over which the Company has no control); unanticipated effects from the Tax Act may limit its benefits; changes in interest rates; changes in prepayment speeds of loans or investment securities; inflation; material unforeseen changes in the liquidity, results of operations, or financial condition of the Company’s customers; changes in the level of non-performing assets and charge-offs; changes in the number of common shares outstanding; the capability of the Company to successfully enter into a definitive agreement for, close, and realize the benefits of anticipated transactions; unexpected claims or litigation against the Company; expected insurance or other recoveries; technological or operational difficulties; technological changes; changes in the reliability of our vendors, internal control systems or information systems; the impact of new accounting pronouncements and changes in policies and practices that may be adopted by regulatory agencies; political instability; acts of war or terrorism; the ability of the Parent Company to receive dividends from its subsidiaries; the impact of larger or similar financial institutions encountering difficulties, which may adversely affect the banking industry or the Company; the Company or its United Bank’s ability to maintain required capital levels and adequate funding sources and liquidity; and other risks or uncertainties detailed in the Company’s filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of the Company.
The Company
’s forward-looking statements are based on information available at the time such statements are made. The Company expressly disclaims any intent or obligation to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events, or other changes.
Application of Critical Accounting Policies
The Company
’s audited consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices applicable to the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility between reporting periods. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily through the use of internal cash flow modeling techniques.
The most
significant accounting policies followed by the Company are presented in Note 1 of the Company’s 2017 audited consolidated financial statements. These policies, along with the disclosures presented in other financial statement notes and in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses and fair value measurements to be the accounting areas that require the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.
Allowance for Loan Losses
The allowance for loan losses represents credit losses specifically identified in the loan portfolio, as well as management's estimate of probable
incurred credit losses in the loan portfolio at the balance sheet date. Determining the amount of the allowance for loan losses and the related provision for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant changes. The loan portfolio also represents the largest asset group on the consolidated balance sheets. Additional information related to the allowance for loan losses that describes the methodology and risk factors can be found under the captions
“Asset Quality”
and
“Nonperforming Assets”
in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, as well as Notes 1 and 4 of the Company’s 2017 audited consolidated financial statements.
Fair Value Measurements
T
he carrying value of certain financial assets and liabilities of the Company is impacted by the application of fair value measurements, either directly or indirectly. Fair value is the price that would be received to sell an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. In certain cases, an asset or liability is measured and reported at fair value on a recurring basis, such as investment securities classified as available for sale and money market mutual funds. In other cases, management must rely on estimates or judgments to determine if an asset or liability not measured at fair value warrants an impairment write-down or whether a valuation reserve should be established.
The Company
estimates the fair value of a financial instrument using a variety of valuation methods. Where financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value. Active markets are those where transaction volumes are sufficient to provide objective pricing information with reasonably narrow bid/ask spreads and where quoted prices do not vary widely. When the financial instruments are not actively traded, other observable market inputs such as quoted prices of securities with similar characteristics may be used, if available, to determine fair value. Inactive markets are characterized by low transaction volumes, price quotations that vary substantially among market participants, or in which minimal information is released publicly.
When observable market prices do not exist,
the Company estimates fair value primarily by using cash flow and other financial modeling methods. The valuation methods may also consider factors such as liquidity and concentration concerns. Other factors such as model assumptions, market dislocations, and unexpected correlations can affect estimates of fair value. Changes in these underlying factors, assumptions, or estimates in any of these areas could materially impact the amount of revenue or loss recorded.
Additional
information regarding fair value measurements can be found in Notes 1 and 19 of the Company’s 2017 audited consolidated financial statements. The following is a summary of the Company’s more significant assets that may be affected by fair value measurements, as well as a brief description of the current accounting practices and valuation methodologies employed by the Company:
Available For Sale Investment Securities
and Money Market Mutual Funds
Investment securities classified as available
for sale and money market mutual funds are measured and reported at fair value on a recurring basis. These instruments are valued primarily by independent third party pricing services under the market valuation approach that include, but are not limited to, the following inputs:
|
●
|
Mutual funds and
equity securities are priced utilizing real-time data feeds from active market exchanges for identical securities; and
|
|
●
|
Government-sponsored agency debt securities, obligations of states and political subdivisions,
mortgage-backed securities, corporate bonds, and other similar investment securities are priced with available market information through processes using benchmark yields, matrix pricing, prepayment speeds, cash flows, live trading data, and market spreads sourced from new issues, dealer quotes, and trade prices, among others sources.
|
At December 31, 20
17, all of the Company’s available for sale investment securities and money market mutual funds were measured using observable market data.
Other Real Estate Owned
Other real estate owned (“
OREO”) includes properties acquired by the Company through, or in lieu of, actual loan foreclosures and initially carried at fair value less estimated costs to sell. Fair value is generally based on third party appraisals of the property that includes comparable sales data. The carrying value of each OREO property is updated at least annually and more frequently when market conditions significantly impact the value of the property. If the carrying amount exceeds fair value less estimated costs to sell, an impairment loss is recorded through expense. OREO is subsequently accounted for at the lower of carrying amount or fair value less estimated costs to sell. At December 31, 2017
,
OREO was $5.5 million compared to $10.7 million at year-end 2016
.
Impaired
L
oans
Loans are considered impaired when
it is probable that the Company will be unable to collect all amounts due under the contractual terms of the loan agreement. Impaired loans are measured at the present value of expected future cash flows, discounted at the loan’s effective interest rate, at the loan’s observable market price, or at the fair value of the collateral based on recent appraisals if the loan is collateral dependent. If the value of an impaired loan is less than the unpaid balance, the difference is credited to the allowance for loan losses with a corresponding charge to provision for loan losses. Loan losses are charged against the allowance for loan losses when management believes the uncollectibility of a loan is confirmed.
Appraisals used in connection with valuing collateral
-dependent loans may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraisers take absorption rates into consideration and adjustments are routinely made in the appraisal process to identify differences between the comparable sales and income data available. Such adjustments consist mainly of estimated costs to sell that are not included in certain appraisals or to update appraised collateral values as a result of market declines of similar properties for which a newer appraisal is available. These adjustments can be significant. Impaired loans were $23.1 million and $41.9 million at year-end 2017 and 2016, respectively.
EXECUTIVE LEVEL OVERVIEW
The Company offers a variety of financial products and services at its 3
4 banking locations in 21 communities throughout Central and Northern Kentucky. During the first quarter 2017, the Company completed the consolidation of its subsidiary banks and data processing subsidiary into one chartered commercial bank, United Bank. While benefiting from the resources of a large bank, United Bank continues to operate under a community banking philosophy. This philosophy focuses primarily on understanding the banking needs of those in our local and surrounding communities and providing them with competitively priced products and a high level of personalized service. The most significant products and services the Company offers include consumer and business lending, checking, savings, and other deposit accounts, automated teller machines, electronic bill payments, and providing trust services and other traditional banking products and services. The primary goals of the Company are to continually improve profitability and shareholder value, increase and maintain a strong capital position, provide excellent service to our customers through our community banking structure, and to provide a challenging and rewarding work environment for our employees.
During 2017, the Company
focused on increasing productivity and lowering operating costs to increase profitability and value for its shareholders. As a result of the merger of the Company’s subsidiaries, salaries and employee benefits expenses declined $2.0 million, or 6.2%, to $30.3 million for the year. The decline is net of $1.4 million the Company reinvested into incentive plans and related payroll taxes for employees who met the qualifications of their plan.
The Company generates a significant amount of its revenue, cash flows, and net income from interest income and net interest income. The ability to properly manage net interest income under changing market environments is crucial to the success of the Company.
During 2017, the Company took initiatives to improve its interest income and net interest income and build on the positive momentum of the initiatives taken during 2016. The series of transactions to deleverage the balance sheet during the last half of 2016 drove the increase in net interest margin in 2017. Average loans grew $31.4 million during the year and, as a percent of earnings assets, increased 400 basis points to 63.3%. The Company repositioned its investment securities portfolio in the fourth quarter of 2017 which, in addition to repositioning during the last half of 2016, drove an increase in the average yield of 9 basis points.
The Company
’s loan portfolio increased for the third year in a row. Although loan balances increased, the Company continues its commitment to strong credit underwriting standards which has resulted in steady improvement in the overall credit quality of the portfolio and a decrease to the allowance for loan losses as a percent of the portfolio. Nonperforming loans are at the lowest level since the third quarter of 2007 and are down $92.5 million or 85.8% since peaking at $108 million in the first quarter of 2010.
Net income for 2017 declined compared to the prior year
driven by an income tax expense adjustment of $5.9 million recorded during the fourth quarter of 2017 related to the Tax Act signed into law during December. The Tax Act lowered the corporate Federal income tax rate from 35% to 21% effective January 1, 2018.
Accounting principles generally accepted in the United States of America (“GAAP”) require the Company to revalue its net deferred tax assets using the new rate and record the adjustment through income tax expense. While the reduced tax rates resulted in lower net income for the year, the Company expects to benefit from the lower rate in future periods.
For 201
8, the Company will focus on stability and growth to increase profitability and shareholder value. In the coming year, the Company plans to fine tune operations at the newly consolidated subsidiary bank, increasing productivity and lowering operating costs. The overall economic and business environment outlook for 2018 is positive. In 2018, the Company intends to build on its recent loan growth and continue to reduce nonperforming assets.
RESULTS OF OPERATIONS
The Company reported net
income of $11.7 million or $1.56 per common share for 2017, a decrease of $4.9 million or 29.6% compared to $16.6 million or $2.21 per common share for 2016. Non-GAAP adjusted net income was $17.9 million or $2.38 per common share, an increase of $562 thousand or 3.2% compared to non-GAAP adjusted net income of $17.3 million or $2.31 per common share for 2016.
Non-GAAP adjusted net income for the current year excludes an income tax expense adjustment of $5.9 million recorded in the fourth quarter related to the Tax Act.
The adjustment relates to revaluing its net deferred tax assets using the new lower corporate Federal income tax rate of 21% effective January 1, 2018, a reduction from the current rate of 35%. Non-GAAP adjusted net income also excludes pre-tax expenses of $472 thousand ($307 thousand after tax) in 2017 and $1.1 million ($697 thousand after tax) in 2016 related to the Company’s consolidation of its subsidiaries.
Refer to the heading captioned “
Use of Non-GAAP Financial Measures
” for a reconciliation of non-GAAP financial measures.
Selected income statement amounts and related information is presented in the table below
.
|
|
|
|
|
|
|
|
|
|
(In thousands, except per share data)
Years Ended December 31,
|
|
201
7
|
|
|
201
6
|
|
|
Increase
(Decrease)
|
|
Interest income
|
|
$
|
59,286
|
|
|
$
|
59,371
|
|
|
$
|
(85
|
)
|
Interest expense
|
|
|
3,510
|
|
|
|
6,755
|
|
|
|
(3,245
|
)
|
Net interest income
|
|
|
55,776
|
|
|
|
52,616
|
|
|
|
3,160
|
|
Provision for loan losses
|
|
|
(211
|
)
|
|
|
(644
|
)
|
|
|
433
|
|
Net interest income after provision for loan losses
|
|
|
55,987
|
|
|
|
53,260
|
|
|
|
2,727
|
|
Noninterest income
|
|
|
21,165
|
|
|
|
31,186
|
|
|
|
(10,021
|
)
|
Noninterest expenses
|
|
|
52,823
|
|
|
|
61,400
|
|
|
|
(8,577
|
)
|
Income before income taxes
|
|
|
24,329
|
|
|
|
23,046
|
|
|
|
1,283
|
|
Income tax expense
|
|
|
12,641
|
|
|
|
6,441
|
|
|
|
6,200
|
|
Net income
|
|
$
|
11,688
|
|
|
$
|
16,605
|
|
|
$
|
(4,917
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted net income per common share
|
|
$
|
1.56
|
|
|
$
|
2.21
|
|
|
$
|
(.65
|
)
|
Cash dividends declared per common share
|
|
|
.425
|
|
|
|
.31
|
|
|
|
.115
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
– basic and diluted
|
|
|
7,513
|
|
|
|
7,504
|
|
|
|
9
|
|
Return on average assets
|
|
|
.70
|
%
|
|
|
.96
|
%
|
|
|
(26
|
) bp
|
Return on average equity
|
|
|
6.07
|
%
|
|
|
8.94
|
%
|
|
|
(287
|
) bp
|
bp
– basis points.
The more significant components related to the Company
’s results of operations are included below.
Use of Non-GAAP Financial Measures
In addition to disclosing financial results calculated in accordance with GAAP, the financial information in
this Management’s Discussion and Analysis of Financial Condition and Results of Operations
contains non-GAAP financial measures, including adjusted net income and adjusted net income per common share. Adjusted net income and adjusted net income per common share reflect adjustments for expenses incurred in connection with the Company’s consolidation and integration of its subsidiaries announced during the third quarter of 2016. Additionally, adjusted net income and adjusted net income per common share exclude the income tax expense adjustment during the fourth quarter of 2017 of $5.9 million related to the Tax Act that was signed into law during December. Management believes providing these non-GAAP adjusted financial measures, combined with the primary GAAP presentation of net income and net income per common share, to be useful for investors to understand the Company’s results of operations in comparison to prior periods. It also considers them to be important supplemental measures of the Company’s performance. The non-GAAP financial measures should not be considered superior to, or a substitute for, financial measures calculated in accordance with GAAP. A reconciliation of non-GAAP adjusted net income and non-GAAP adjusted net income per common share is included in the tables below.
The Company
’s methods for determining these non-GAAP financial measures may differ from the methods used by other companies for these or similar non-GAAP financial measures. Accordingly, these non-GAAP financial measures may not be comparable to methods used by other companies.
Reconcilement of Non-GAAP Financial Measures
|
|
|
|
|
|
Twelve Months Ended
|
|
(In thousands, except per share data)
|
|
December 31,
2017
|
|
|
December 31,
2016
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
11,688
|
|
|
$
|
16,605
|
|
Adjustments:
|
|
|
|
|
|
|
|
|
Noninterest expense
1
|
|
|
|
|
|
|
|
|
Severance costs
|
|
|
195
|
|
|
|
391
|
|
Data processing and systems integration
|
|
|
95
|
|
|
|
187
|
|
Other
|
|
|
17
|
|
|
|
119
|
|
Income tax expense related to 2017 Tax Act
|
|
|
5,869
|
|
|
|
-
|
|
Adjusted net income
|
|
$
|
17,864
|
|
|
$
|
17,302
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted net income per common share
|
|
$
|
1.56
|
|
|
$
|
2.21
|
|
Adjustments:
|
|
|
|
|
|
|
|
|
Noninterest expense
1
|
|
|
|
|
|
|
|
|
Severance costs
|
|
|
.03
|
|
|
|
.05
|
|
Data processing and systems integration
|
|
|
.01
|
|
|
|
.03
|
|
Other
|
|
|
-
|
|
|
|
.02
|
|
Income tax expense related to 2017 Tax Act
|
|
|
.78
|
|
|
|
-
|
|
Adjusted basic and diluted net income per common share
|
|
$
|
2.38
|
|
|
$
|
2.31
|
|
1
All noninterest expense adjustments are net of tax using the 2017 marginal corporate Federal tax rate of 35%.
Interest Income
Interest income results from interest earned on earning assets, which primarily include
s loans and investment securities. Interest income is affected by volume (average balance), the composition of earning assets, and the related rates earned on those assets. Total interest income for 2017 was $59.3 million, a decrease of $85 thousand or 0.1% compared to $59.4 million for 2016. The decrease in interest income was driven by lower interest from investment securities of $1.4 million or 12.1%, partially offset by an increase in interest income on loans of $813 thousand or 1.7%. While the average rate earned on investment securities was up 9 basis points, the effect on interest income was more than offset by the negative impact of a decline in the average balance of $82.9 million. The increase in interest income on loans was driven by a higher average loan balance outstanding of $31.4 million, partially offset by lower average rate earned of seven basis points to 4.93%.
The overall interest rate environment at year-end 201
7, as measured by the Treasury yield curve, remains at very low levels when compared with historical trends. During the year,
the shape of the yield curve flattened as a result of yields on short-term maturities increasing while yields on longer-term maturities declined. The most significant change was a 92 basis point increase in the yield for the six-month maturity period. The two and three-year maturities increased 70 and 52 basis points, respectively, while yields on the ten and thirty-year maturities decreased 4 and 33 basis points, respectively. At year-end 2017, the short-term federal funds interest rate target range was between 1.25% and 1.50%, which increased 75 basis points during the year (25 basis points in each of March, June, and December) from the target at year-end 2016 of 0.50% to 0.75%. The Federal Reserve Board (“Federal Reserve”) has indicated that it will continue to assess realized and expected economic conditions relative to its objective of maximum employment and two percent inflation when determining the timing and size of future adjustments to the target rate. At December 31, 2017, the national and Kentucky unemployment rates were 4.1% and 4.4%, respectively. While the national inflation rate was 2.1% at both year-end 2017 and 2016, the average inflation rate for 2017 was also 2.1%, up from 1.3% in 2016, based on the Consumer Price Index published by the Bureau of Labor Statistics.
Interest Expense
Interest expense results from interest bearing
liabilities, which are made up of interest bearing deposits, federal funds purchased, securities sold under agreements to repurchase, and other borrowed funds. Interest expense is affected by volume, composition of interest bearing liabilities, and the related rates paid on those liabilities. Total interest expense was $3.5 million for 2017, a decrease of $3.2 million or 48.0% compared to $6.8 million for 2016. The decrease in interest expense is attributed primarily to lower interest on securities sold under agreements to repurchase of $2.9 million or 97.4%, primarily due to the early repayment of $100 million of high fixed-rate borrowings during the third quarter of 2016 and, to a lesser extent, the maturity of $15.0 million of Federal Home Loan Bank advances during the year. Interest expense on deposits declined $219 thousand or 9.3%. Lower volume and rates on time deposits drove the decrease, which was partially offset by an increase in rates paid on interest bearing demand deposits of eight basis points. The Company has continued to aggressively reprice higher-rate maturing time deposits downward to lower market rates or to allow them to mature without renewal.
Net Interest Income
Net interest income is the most significant component of the Company
’s operating earnings. Net interest income is the excess of the interest income earned on earning assets over the interest paid for funds to support those assets. The two most common metrics used to analyze net interest income are net interest spread and net interest margin. Net interest spread represents the difference between the taxable equivalent yields on earning assets and the rates paid on interest bearing liabilities. Net interest margin represents the percentage of taxable equivalent net interest income to average earning assets. Net interest margin will exceed net interest spread because of the existence of noninterest bearing sources of funds, principally demand deposits and shareholders’ equity, which are also available to fund earning assets.
Changes in net interest income and margin result from the interaction between the volume and composition of earning assets, their related yields, and the associated cost and composition of the interest bearing liabilities. Accordingly, portfolio size, composition, and the related yields earned and the average rates paid have a significant impact on net interest spread and margin. The table
following this discussion represents the major components of interest earning assets and interest bearing liabilities on a tax equivalent basis. To compare the tax-exempt asset yields to taxable yields, amounts in the table are adjusted to pretax equivalents based on the 2017 marginal corporate Federal tax rate of 35%.
Tax equivalent net interest income was $
57.2 million for 2017, an increase of $3.1 million or 5.7% compared to $54.1 million for 2016. Net interest margin was 3.67% for 2017, up 31 basis points from 3.36% for the prior year. Net interest spread increased 36 basis point to 3.57% for 2017 from 3.21% for 2016. The increase in net interest margin and spread was due mainly to a 24 basis point decline in cost of funds to 0.32%.
As part of its strategy to improve net interest income and net i
nterest margin, the Company completed a series of transactions during the last half of 2016 to deleverage its balance sheet and reposition its investment securities portfolio. The Company used a mixture of $10.4 million of excess cash and $93.4 million of proceeds from the sale of investment securities to prepay $100 million of high fixed-rate borrowings that were due to mature in November 2017. The Company incurred a prepayment fee of $3.8 million, which was offset by a gain in the same amount on the sale of investment securities. The average yield on the mix of cash and investment securities sold to fund the debt prepayment was 2.97%. The average cost of the fixed rate borrowings that were repaid was 3.95%. The Company also took action during the last half of 2016 to reposition its investment securities portfolio by replacing approximately $78 million of certain lower yielding, short-term investments with longer-term, higher-yielding investments consistent with a more normalized strategy and maturity periods. The lower yielding short-term investments had been built up in anticipation of the November 2017 debt repayment. The average yield on the investments identified for the repositioning strategy was 0.85% compared to a targeted reinvestment yield of 1.85%.
During the fourth quarter of 2017, t
he Company again refined the investment portfolio, replacing $76.5 million of lower-yielding investment securities. The sale of investment securities resulted in a net loss of $3 thousand. However, this increased the yield on the investments portfolio by 11 basis points.
The Company
actively monitors and proactively manages the rate sensitive components of both its assets and liabilities in a continuously changing and difficult market environment. Competition in the Company’s market areas continues to be intense, and market interest rates remain very low by historical measures. During 2017, the Federal Reserve increased the short-term federal funds target rate 75 basis points, compared to a 25 basis point increase during each of 2016 and 2015. The Federal Reserve has indicated that it continues to expect only gradual adjustments in its stance on monetary policy relative to longer term expectations.
Similar to the short-term federal funds target rate, t
he prime interest rate rose 75 basis points during 2017 (25 basis points in each of March, June, and December). The Company uses the prime interest rate as part of its pricing model primarily on variable rate commercial real estate loans. The prime interest rate can have a significant impact on the Company’s interest income from loans that reprice based on changes to this rate. The Company’s variable interest rate loans contain provisions that limit the amount of increase or decrease in the interest rate during the life of a loan. This will limit the increase or decrease in interest income on loans that have interest rates tied to the prime interest rate. For 2017, the average yield earned on loans was 4.93%, which exceeded the prime interest rate of 4.50% at year-end. Predicting the direction and timing of future interest rates is uncertain.
For
2017, the average rate of the Company’s most significant component of interest income, loans, and the most significant component of interest expense, time deposits, both declined. The average rate earned on the Company’s loan portfolio for 2017 declined seven basis points to 4.93% and the average rate paid on time deposits decreased nine basis points to 0.45% compared to 2016. The Company expects its net interest margin to trend slightly upward in 2018 as compared to 2017 according to internal modeling using expectations about future market interest rates, loan volume, the maturity structure of the Company’s earning assets and liabilities, and other factors. Future results, however, could be significantly different than expectations.
Distribution of Assets, Liabilities and Shareholders
’ Equity: Interest Rates and Interest Differential
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
201
7
|
|
|
20
16
|
|
|
20
15
|
|
|
|
Average
|
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
|
|
|
Average
|
|
(In thousands)
|
|
Balance
|
|
|
Interest
|
|
|
Rate
|
|
|
Balance
|
|
|
Interest
|
|
|
Rate
|
|
|
Balance
|
|
|
Interest
|
|
|
Rate
|
|
Earning Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment securities
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
$
|
362,748
|
|
|
$
|
7,787
|
|
|
|
2.15
|
%
|
|
$
|
438,106
|
|
|
$
|
8,969
|
|
|
|
2.05
|
%
|
|
$
|
493,594
|
|
|
$
|
10,468
|
|
|
|
2.12
|
%
|
Nontaxable
2
|
|
|
115,319
|
|
|
|
3,386
|
|
|
|
2.94
|
|
|
|
122,820
|
|
|
|
3,660
|
|
|
|
2.98
|
|
|
|
130,548
|
|
|
|
3,974
|
|
|
|
3.04
|
|
Interest bearing deposits with banks, federal funds sold and securities purchased under agreements to resell,
and money market mutual funds
|
|
|
94,878
|
|
|
|
899
|
|
|
|
.95
|
|
|
|
95,629
|
|
|
|
418
|
|
|
|
.44
|
|
|
|
90,135
|
|
|
|
192
|
|
|
|
.21
|
|
Loans
2,3
,4
|
|
|
987,877
|
|
|
|
48,666
|
|
|
|
4.93
|
|
|
|
956,463
|
|
|
|
47,831
|
|
|
|
5.00
|
|
|
|
933,260
|
|
|
|
48,257
|
|
|
|
5.17
|
|
Total earning assets
|
|
|
1,560,822
|
|
|
$
|
60,738
|
|
|
|
3.89
|
%
|
|
|
1,613,018
|
|
|
$
|
60,878
|
|
|
|
3.77
|
%
|
|
|
1,647,537
|
|
|
$
|
62,891
|
|
|
|
3.82
|
%
|
Allowance for loan losses
|
|
|
(9,389
|
)
|
|
|
|
|
|
|
|
|
|
|
(9,593
|
)
|
|
|
|
|
|
|
|
|
|
|
(12,255
|
)
|
|
|
|
|
|
|
|
|
Total earning assets, net of allowance for loan losses
|
|
|
1,551,433
|
|
|
|
|
|
|
|
|
|
|
|
1,603,425
|
|
|
|
|
|
|
|
|
|
|
|
1,635,282
|
|
|
|
|
|
|
|
|
|
Nonearning Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and due from banks
|
|
|
24,020
|
|
|
|
|
|
|
|
|
|
|
|
23,275
|
|
|
|
|
|
|
|
|
|
|
|
23,639
|
|
|
|
|
|
|
|
|
|
Premises and equipment, net
|
|
|
31,594
|
|
|
|
|
|
|
|
|
|
|
|
32,491
|
|
|
|
|
|
|
|
|
|
|
|
34,145
|
|
|
|
|
|
|
|
|
|
Other assets
|
|
|
59,707
|
|
|
|
|
|
|
|
|
|
|
|
78,616
|
|
|
|
|
|
|
|
|
|
|
|
89,854
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
1,666,754
|
|
|
|
|
|
|
|
|
|
|
$
|
1,737,807
|
|
|
|
|
|
|
|
|
|
|
$
|
1,782,920
|
|
|
|
|
|
|
|
|
|
Interest Bearing
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing demand
|
|
$
|
356,023
|
|
|
$
|
576
|
|
|
|
.16
|
%
|
|
$
|
334,818
|
|
|
$
|
256
|
|
|
|
.08
|
%
|
|
$
|
334,281
|
|
|
$
|
200
|
|
|
|
.06
|
%
|
Savings
|
|
|
418,507
|
|
|
|
467
|
|
|
|
.11
|
|
|
|
407,353
|
|
|
|
506
|
|
|
|
.12
|
|
|
|
385,932
|
|
|
|
496
|
|
|
|
.13
|
|
Time
|
|
|
245,215
|
|
|
|
1,093
|
|
|
|
.45
|
|
|
|
296,258
|
|
|
|
1,593
|
|
|
|
.54
|
|
|
|
356,419
|
|
|
|
2,265
|
|
|
|
.64
|
|
Federal funds
purchased
|
|
|
19
|
|
|
|
-
|
|
|
|
-
|
|
|
|
153
|
|
|
|
1
|
|
|
|
.65
|
|
|
|
24
|
|
|
|
-
|
|
|
|
-
|
|
S
hort-term securities sold under agreements to repurchase
|
|
|
34,180
|
|
|
|
70
|
|
|
|
.20
|
|
|
|
35,328
|
|
|
|
98
|
|
|
|
.28
|
|
|
|
30,380
|
|
|
|
50
|
|
|
|
.16
|
|
Long-term s
ecurities sold under agreements to repurchase
|
|
|
883
|
|
|
|
7
|
|
|
|
.79
|
|
|
|
71,851
|
|
|
|
2,843
|
|
|
|
3.96
|
|
|
|
101,171
|
|
|
|
4,012
|
|
|
|
3.97
|
|
F
ederal Home Loan Bank advances
|
|
|
11,098
|
|
|
|
427
|
|
|
|
3.85
|
|
|
|
18,863
|
|
|
|
735
|
|
|
|
3.90
|
|
|
|
18,883
|
|
|
|
752
|
|
|
|
3.98
|
|
Subordinated notes payable to unconsolidated trusts
|
|
|
33,506
|
|
|
|
870
|
|
|
|
2.60
|
|
|
|
34,545
|
|
|
|
723
|
|
|
|
2.09
|
|
|
|
48,970
|
|
|
|
866
|
|
|
|
1.77
|
|
Total interest bearing liabilities
|
|
|
1,099,431
|
|
|
$
|
3,510
|
|
|
|
.32
|
%
|
|
|
1,199,169
|
|
|
$
|
6,755
|
|
|
|
.56
|
%
|
|
|
1,276,060
|
|
|
$
|
8,641
|
|
|
|
.68
|
%
|
Noninterest Bearing Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Demand deposits
|
|
|
347,355
|
|
|
|
|
|
|
|
|
|
|
|
324,596
|
|
|
|
|
|
|
|
|
|
|
|
304,516
|
|
|
|
|
|
|
|
|
|
Other liabilities
|
|
|
27,343
|
|
|
|
|
|
|
|
|
|
|
|
28,374
|
|
|
|
|
|
|
|
|
|
|
|
28,220
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
1,474,129
|
|
|
|
|
|
|
|
|
|
|
|
1,552,139
|
|
|
|
|
|
|
|
|
|
|
|
1,608,796
|
|
|
|
|
|
|
|
|
|
Shareholders
’ equity
|
|
|
192,625
|
|
|
|
|
|
|
|
|
|
|
|
185,668
|
|
|
|
|
|
|
|
|
|
|
|
174,124
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders
’ equity
|
|
$
|
1,666,754
|
|
|
|
|
|
|
|
|
|
|
$
|
1,737,807
|
|
|
|
|
|
|
|
|
|
|
$
|
1,782,920
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
|
57,228
|
|
|
|
|
|
|
|
|
|
|
|
54,123
|
|
|
|
|
|
|
|
|
|
|
|
54,250
|
|
|
|
|
|
TE basis adjustment
|
|
|
|
|
|
|
(1,452
|
)
|
|
|
|
|
|
|
|
|
|
|
(1,507
|
)
|
|
|
|
|
|
|
|
|
|
|
(1,655
|
)
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
55,776
|
|
|
|
|
|
|
|
|
|
|
$
|
52,616
|
|
|
|
|
|
|
|
|
|
|
$
|
52,595
|
|
|
|
|
|
Net interest spread
|
|
|
|
|
|
|
|
|
|
|
3.57
|
%
|
|
|
|
|
|
|
|
|
|
|
3.21
|
%
|
|
|
|
|
|
|
|
|
|
|
3.14
|
%
|
Impact of noninterest bearing sources of funds
|
|
|
|
|
|
|
|
|
|
|
.10
|
|
|
|
|
|
|
|
|
|
|
|
.15
|
|
|
|
|
|
|
|
|
|
|
|
.15
|
|
Net interest margin
|
|
|
|
|
|
|
|
|
|
|
3.67
|
%
|
|
|
|
|
|
|
|
|
|
|
3.36
|
%
|
|
|
|
|
|
|
|
|
|
|
3.29
|
%
|
1
Average yields on securities available for sale have been calculated based on amortized cost.
2
Income and yield stated at a fully tax equivalent basis using the marginal corporate Federal tax rate of 35%.
3
Loan balances include principal balances on nonaccrual loans.
4
Loan fees included in interest income amounted to $1.3 million, $1.4 million, and $1.3 million for 2017, 2016, and 2015
.
The following table is an analysis of the change in net interest income.
Analysis of Changes in Net Interest Income (tax equivalent basis
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Variance
|
|
|
Variance Attributed to
|
|
|
Variance
|
|
|
Variance Attributed to
|
|
(In thousands)
|
|
201
7/2016
1
|
|
|
Volume
|
|
|
Rate
|
|
|
201
6/2015
1
|
|
|
Volume
|
|
|
Rate
|
|
Interest Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable investment securities
|
|
$
|
(1,182
|
)
|
|
$
|
(1,603
|
)
|
|
$
|
421
|
|
|
$
|
(1,499
|
)
|
|
$
|
(1,158
|
)
|
|
$
|
(341
|
)
|
Nontaxable investment securities
2
|
|
|
(274
|
)
|
|
|
(225
|
)
|
|
|
(49
|
)
|
|
|
(314
|
)
|
|
|
(236
|
)
|
|
|
(78
|
)
|
Interest bearing deposits with banks, federal
funds sold and securities purchased under agreements to resell, and money market mutual funds
|
|
|
481
|
|
|
|
(3
|
)
|
|
|
484
|
|
|
|
226
|
|
|
|
12
|
|
|
|
214
|
|
Loans
2
|
|
|
835
|
|
|
|
1,525
|
|
|
|
(690
|
)
|
|
|
(426
|
)
|
|
|
1,183
|
|
|
|
(1,609
|
)
|
Total interest income
|
|
|
(140
|
)
|
|
|
(306
|
)
|
|
|
166
|
|
|
|
(2,013
|
)
|
|
|
(199
|
)
|
|
|
(1,814
|
)
|
Interest Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing demand deposits
|
|
|
320
|
|
|
|
19
|
|
|
|
301
|
|
|
|
56
|
|
|
|
-
|
|
|
|
56
|
|
Savings deposits
|
|
|
(39
|
)
|
|
|
10
|
|
|
|
(49
|
)
|
|
|
10
|
|
|
|
37
|
|
|
|
(27
|
)
|
Time deposits
|
|
|
(500
|
)
|
|
|
(254
|
)
|
|
|
(246
|
)
|
|
|
(672
|
)
|
|
|
(349
|
)
|
|
|
(323
|
)
|
Federal funds purchased
|
|
|
(1
|
)
|
|
|
-
|
|
|
|
(1
|
)
|
|
|
1
|
|
|
|
-
|
|
|
|
1
|
|
S
hort-term securities sold under agreements to repurchase
|
|
|
(28
|
)
|
|
|
(3
|
)
|
|
|
(25
|
)
|
|
|
48
|
|
|
|
9
|
|
|
|
39
|
|
Long
-term securities sold under agreements to repurchase
|
|
|
(2,836
|
)
|
|
|
(1,566
|
)
|
|
|
(1,270
|
)
|
|
|
(1,169
|
)
|
|
|
(1,159
|
)
|
|
|
(10
|
)
|
F
ederal Home Loan Bank advances
|
|
|
(308
|
)
|
|
|
(299
|
)
|
|
|
(9
|
)
|
|
|
(17
|
)
|
|
|
(1
|
)
|
|
|
(16
|
)
|
Subordinated notes payable to unconsolidated
trusts
|
|
|
147
|
|
|
|
(23
|
)
|
|
|
170
|
|
|
|
(143
|
)
|
|
|
(283
|
)
|
|
|
140
|
|
Total interest expense
|
|
|
(3,245
|
)
|
|
|
(2,116
|
)
|
|
|
(1,129
|
)
|
|
|
(1,886
|
)
|
|
|
(1,746
|
)
|
|
|
(140
|
)
|
Net interest income
|
|
$
|
3,105
|
|
|
$
|
1,810
|
|
|
$
|
1,295
|
|
|
$
|
(127
|
)
|
|
$
|
1,547
|
|
|
$
|
(1,674
|
)
|
Percentage change
|
|
|
100.0
|
%
|
|
|
58.3
|
%
|
|
|
41.7
|
%
|
|
|
100.0
|
%
|
|
|
(1,218.1
|
)%
|
|
|
1,318.1
|
%
|
1
The changes which are not solely due to rate or volume are allocated on a percentage basis using the absolute values of rate and volume variances as a basis for allocation.
2
Income stated at fully tax equivalent basis using the marginal corporate Federal tax rate of 35%.
Provision for Loan Losses
The Company recorded a credit to the provision for loan losses in the amount of
$211 thousand and $644 thousand for 2017 and 2016, respectively. The lower credit is due to greater improvement in historical loss rates in the prior year compared to the current year and the increase in specific reserves allocated to impaired loans during the current year, partially offset by net recoveries. While historical loss rates continued to be low, the effect of the improvement in loss rates on the allowance for loan losses has diminished now that the higher levels experienced during 2008 through the first quarter of 2014 have already rolled out of the three year look-back period used when evaluating the allowance for loan losses. Although impaired loans declined $18.8 million during 2017, the specific reserves on impaired loans increased $234 thousand primarily due to a single credit relationship secured by a combination of real estate development and residential real estate properties.
Net
recoveries were $650 thousand for 2017 compared to net charge-offs of $327 thousand for 2016. Net recoveries were 0.07% of average loans outstanding for 2017 compared to 0.03% for the net charge-offs in the prior year. Net recoveries during 2017, include $1.3 million from a real estate development project. The Company recorded a total of $2.1 million in principal charge-offs between 2010 and 2012 related to this project and anticipates it could receive an additional $575 thousand in recoveries related to this credit. The timing and amount of these possible recoveries are subject to change and are dependent on the price and volume of lots sold by the developer, however, the Company expects to receive the recoveries during the first half of 2018.
The allowance for loan losses as a percentage of outstanding loans was 0.9
4% at December 31, 2017 compared to 0.96% at year-end 2016. Further information about improvements in the Company’s overall credit quality is included under the captions
“Allowance for Loan Losses”
and
“Nonperforming Loans”
that follows.
Noninterest Income
The components of n
oninterest income are as follows for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands)
Years Ended December 31,
|
|
201
7
|
|
|
201
6
|
|
|
Increase
(Decrease)
|
|
|
%
|
|
Service charges and fees on deposits
|
|
$
|
7,987
|
|
|
$
|
7,856
|
|
|
$
|
131
|
|
|
|
1.7
|
%
|
Allotment processing fees
|
|
|
2,716
|
|
|
|
3,232
|
|
|
|
(516
|
)
|
|
|
(16.0
|
)
|
Other service charges, commissions,
and fees
|
|
|
5,347
|
|
|
|
5,558
|
|
|
|
(211
|
)
|
|
|
(3.8
|
)
|
Trust income
|
|
|
2,704
|
|
|
|
2,664
|
|
|
|
40
|
|
|
|
1.5
|
|
Net gain on sales of available for sale i
nvestment securities
|
|
|
20
|
|
|
|
3,998
|
|
|
|
(3,978
|
)
|
|
|
(99.5
|
)
|
Net gain on sales of cost method investment securities
|
|
|
82
|
|
|
|
-
|
|
|
|
82
|
|
|
|
NM
|
|
Gain on sale of
mortgage loans, net
|
|
|
662
|
|
|
|
942
|
|
|
|
(280
|
)
|
|
|
(29.7
|
)
|
Income from company-owned life insurance
|
|
|
1,138
|
|
|
|
1,016
|
|
|
|
122
|
|
|
|
12.0
|
|
Gain on debt extinguishment
|
|
|
-
|
|
|
|
4,050
|
|
|
|
(4,050
|
)
|
|
|
(100.0
|
)
|
Legal settlement
|
|
|
-
|
|
|
|
1,450
|
|
|
|
(1,450
|
)
|
|
|
(100.0
|
)
|
Other
|
|
|
509
|
|
|
|
420
|
|
|
|
89
|
|
|
|
21.2
|
|
Total noninterest income
|
|
$
|
21,165
|
|
|
$
|
31,186
|
|
|
$
|
(10,021
|
)
|
|
|
(32.1
|
)%
|
N
M – not meaningful.
The more significant items
impacting noninterest income in the annual comparison are included below.
|
●
|
Service charges and fees on deposits
increased primarily due to higher service charges related to demand deposits and savings accounts of $126 thousand or 12.9% and $62 thousand or 65.5%, respectively, partially offset by lower dormant account fees of $56 thousand or 2.1%. During the second quarter of 2016, the Company standardized and reduced the number of its deposit account product offerings throughout each of its markets. This has contributed to higher overall service charges since completion.
|
|
●
|
A
llotment processing fees are down 16.0% in the comparison primarily due to lower volume stemming from the U.S. Department of Defense policy that became effective January 1, 2015, restricting the types of purchases active service members are able to make using the military allotment system for payment.
The rate of decline in allotment processing fees began to subside during 2017, as existing contracts for the types of purchases affected by the new policy have steadily decreased and the Company continues its efforts to diversify its customer base and expand its payment processing options.
|
|
●
|
The net
gain on investment securities in the prior year relates primarily to the series of transactions during the last half of 2016 to deleverage and reposition the balance sheet discussed earlier under the caption
“Net Interest Income”
above, which completely offset the related loss during 2016 on the early repayment of long-term borrowings.
|
|
●
|
Net gains on the sale of cost method investment securities during 2017 relates to the sale of stock held in connection with a correspondent banking relationship
that ended during 2017.
|
|
●
|
Net gains on the sale of mortgage loans
were down mainly due to lower sales volume of $12.2 million or 33.3%.
|
|
●
|
The
increase in income from company-owned life insurance was driven by a $245 thousand tax-free death benefit that exceeded the cash surrender value during the current year, partially offset by a similar benefit received during the prior-year first quarter of $81 thousand.
|
|
●
|
T
he gain on debt extinguishment during the prior year relates to the early extinguishment of $15.5 million of debt under favorable market conditions to the Company during the first quarter of 2016.
|
|
●
|
During 2016
, the Company received $1.5 million related to a litigation settlement; no similar transaction occurred in the current year.
|
Noninterest Expense
The components of noninterest expense are as follows for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands)
Years Ended December 31,
|
|
201
7
|
|
|
201
6
|
|
|
Increase
(Decrease)
|
|
|
%
|
|
Salaries and employee benefits
|
|
$
|
30,296
|
|
|
$
|
32,296
|
|
|
$
|
(2,000
|
)
|
|
|
(6.2
|
)%
|
Occupancy expenses, net
|
|
|
4,672
|
|
|
|
4,742
|
|
|
|
(70
|
)
|
|
|
(1.5
|
)
|
Equipment expenses
|
|
|
2,379
|
|
|
|
2,403
|
|
|
|
(24
|
)
|
|
|
(1.0
|
)
|
Data processing and communication expense
s
|
|
|
4,571
|
|
|
|
4,596
|
|
|
|
(25
|
)
|
|
|
(0.5
|
)
|
Bank franchise tax
|
|
|
2,325
|
|
|
|
2,421
|
|
|
|
(96
|
)
|
|
|
(4.0
|
)
|
Deposit insurance expense
|
|
|
520
|
|
|
|
841
|
|
|
|
(321
|
)
|
|
|
(38.2
|
)
|
Other real estate expenses, net
|
|
|
845
|
|
|
|
2,189
|
|
|
|
(1,344
|
)
|
|
|
(61.4
|
)
|
Legal expenses
|
|
|
86
|
|
|
|
474
|
|
|
|
(388
|
)
|
|
|
(81.9
|
)
|
Loss on debt ext
inguishment
|
|
|
-
|
|
|
|
3,776
|
|
|
|
(3,776
|
)
|
|
|
(100.0
|
)
|
Other
|
|
|
7,129
|
|
|
|
7,662
|
|
|
|
(533
|
)
|
|
|
(7.0
|
)
|
Total noninterest expense
|
|
$
|
52,823
|
|
|
$
|
61,400
|
|
|
$
|
(8,577
|
)
|
|
|
(14.0
|
)%
|
The more significant items
impacting noninterest expenses in the annual comparison are included below.
|
●
|
Employee benefits decreased $1.5 million or 26.7%, primarily due to lower claims activity related to the Company
’s self-funded health insurance plan of $951 thousand or 17.9% and a curtailment gain of $351 thousand as a result of revaluing the Company’s postretirement benefits plan liability, each due to a reduction in workforce occurring in the first quarter of 2017. The reduced workforce also drove the decline in salaries and related payroll taxes of $1.6 million or 6.0%. Severance pay accruals related to the consolidation were $301 thousand for 2017, down $301 thousand or 50.0% from 2016. These declines were partially offset by $1.4 million of incentive pay accruals in the current year. The Company had 426 full time equivalent employees at year-end 2017, down from 472 a year earlier.
|
|
●
|
The
decline in occupancy expenses was driven by lower depreciation expense of $70 thousand or 2.7%.
|
|
●
|
Bank franchise tax expense declined due to
a lower assessment base, which is based primarily on the five-year average of the Bank’s capital, net of certain deductions.
|
|
●
|
The decrease to d
eposit insurance expense for 2017 is primarily the result of the Federal Deposit Insurance Corporation (“FDIC”) lowering assessment rates beginning in the third quarter of 2016.
|
|
●
|
O
ther real estate expenses declined as a combination of a net gain on property sales of $208 thousand in 2017 compared to a net loss of $473 thousand in 2016, and lower impairment charges of $658 thousand or 45.3%.
|
|
●
|
The decrease in l
egal expenses was led by the receipt of a $197 thousand insurance payment during the third quarter of 2017 as reimbursement for expenses previously incurred.
|
|
●
|
T
he $3.8 million loss related to the early extinguishment of debt during the third quarter of 2016 was completely offset by the net gain on the sale of investment securities discussed under the
“Noninterest Income”
caption above. No similar transactions occurred in the current year.
|
|
●
|
Included in other noninterest expense is $504 thousand of d
irectors’ fees in 2017, down $183 thousand or 26.7% compared to 2016. The decline is mainly attributable to having fewer boards of directors due to the consolidation of subsidiaries during the first quarter of 2017. Other noninterest expenses include amounts related to the consolidation of the Company’s subsidiaries of $22 thousand for 2017, down $161 thousand or 88.0% from $183 thousand in 2016.
|
Income Tax
es
Income tax expense was $12.6 million for 2017, an increase of $6.2 million compared to $6.4 million for 2016. For 2017, income tax expense includes $5.9 million related to the 2017 Tax Act
, which increased the effective income tax rate by 24.1 percentage points. The effective income tax rate for the current year was 52.0% compared to 27.9% for 2016. The effective income tax rate for 2016 is lower than the U.S. statutory federal rate of 35% primarily as a result of tax-exempt interest income from loans and investment securities, income from life insurance policies, and premium income associated with the Company’s captive insurance subsidiary.
FINANCIAL CONDITION
Total assets
of the Company were $1.7 billion at year-end 2017, up $2.8 million or 0.2% compared with year-end 2016. The Company’s overall financial condition continued to improve in the current year with loan growth of $64.3 million or 6.6% to $1.0 billion at year-end 2017. Total nonperforming assets were $20.9 million and $40.0 million at year-end 2017 and 2016, respectively. Nonperforming assets have declined $114 million or 84.5% from their peak of $135 million in the first quarter of 2010. Loan quality metrics continued to improve throughout 2017, and regulatory capital levels remain significantly above the “well-capitalized” threshold.
Temporary Investments
Temporary investments consist of interest bearing deposits in other banks
, federal funds sold and securities purchased under agreements to resell, and money market mutual funds. The Company uses these funds in the management of liquidity and interest rate sensitivity or as a short-term holding prior to subsequent movement into other investments with higher yields or for other purposes. At December 31, 2017, temporary investments were $94.8 million, an increase of $7.0 million or 7.9% compared to $87.9 million at year-end 2016.
Investment Securities
The investment securities portfolio
is comprised primarily of residential mortgage-backed securities, tax-exempt securities of states and political subdivisions, and debt securities issued by U.S. government-sponsored agencies. Substantially all of the Company’s investment securities are designated as available for sale. Total investment securities had a carrying amount of $428 million at year-end 2017, a decrease of $56.7 million or 11.7% compared to $484 million at year-end 2016.
The
decrease in investment securities was driven by loan demand as net proceeds from maturities, calls, and sales in excess of purchases were used to fund higher-earning loans. Maturities, calls, and sales of $188 million in the aggregate outpaced purchases totaling $134 million. The remainder of the decrease in investment securities was due to $3.4 million of net premium amortization, partially offset by a $732 thousand decline in the net unrealized loss on securities classified as available for sale. The decrease in the amount of net unrealized loss on available for sale securities is attributed to the decline in longer-term market interest rates, which was more impactful than the increase in shorter-term interest rates.
In general, as market interest rates fall, the value of fixed rate investments increase. The smaller portfolio also contributed to the decline in net unrealized loss.
At year-end 2
0
17, the net unrealized loss on investment securities was $4.3 million, an improvement of $737 thousand or 14.6% from $5.1 million at year-end 2016. The Company attributes the unrealized losses in the investment securities portfolio to changes in market interest rates and volatility, and thus identifies them as temporary. As discussed further above, market interest rates generally increased throughout 2017. Investment securities with an unrealized loss at December 31, 2017 are performing according to their contractual terms, and the Company does not expect to incur a loss on these securities unless they are sold prior to maturity. The Company does not have the intent to sell these securities nor does it believe it is likely that it will be required to sell these securities prior to their anticipated recovery. The Company does not consider any of the securities to be impaired due to reasons of credit quality or other factors.
All investment securities in the Company’s portfolio are currently performing.
Proceeds received from maturing or called investment securities are used to fund higher-earning loans, reinvested in similar investments or used to manage liquidity, such as for deposit outflows or other payment obligations. The Company periodically sells investment securities in response to its overall asset/liability management strategy to lock in gains, increase yield, restructure expected future cash flows, and/or enhance its capital position.
The purchase of nontaxable obligations of states and political subdivisions is one of the primary means of managing the Company’s tax position. The Company does not have direct exposure to the subprime mortgage market. The Company does not originate subprime mortgages nor has it invested in bonds that are secured by such mortgages.
The following table summarizes the carrying values of investment securities on December 31, 20
17, 2016, and 2015. Available for sale securities are carried at estimated fair value and held to maturity securities are carried at amortized cost. Corporate debt securities consist primarily of debt issued by a large global financial services firm. Mutual funds and equity securities are attributed to the Company’s captive insurance subsidiary.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
201
7
|
|
|
201
6
|
|
|
201
5
|
|
(In thousands)
|
|
Available
for Sale
|
|
|
Held to
Maturity
|
|
|
Available
for Sale
|
|
|
Held to
Maturity
|
|
|
Available
for Sale
|
|
|
Held to
Maturity
|
|
Obligations
of U.S. government-sponsored entities
|
|
$
|
43,208
|
|
|
$
|
-
|
|
|
$
|
71,694
|
|
|
$
|
-
|
|
|
$
|
106,906
|
|
|
$
|
-
|
|
Obligations of states and political subdivisions
|
|
|
114,249
|
|
|
|
3,364
|
|
|
|
132,292
|
|
|
|
3,488
|
|
|
|
150,266
|
|
|
|
3,611
|
|
Mortgage-backed securities
– residential
|
|
|
193,393
|
|
|
|
-
|
|
|
|
224,307
|
|
|
|
-
|
|
|
|
297,861
|
|
|
|
-
|
|
Mortgage-backed
securities – commercial
|
|
|
49,352
|
|
|
|
-
|
|
|
|
45,613
|
|
|
|
-
|
|
|
|
20,584
|
|
|
|
-
|
|
Asset-backed securities
|
|
|
15,574
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Corporate debt securities
|
|
|
7,542
|
|
|
|
-
|
|
|
|
6,125
|
|
|
|
-
|
|
|
|
5,840
|
|
|
|
-
|
|
Mutual funds and equity securities
|
|
|
935
|
|
|
|
-
|
|
|
|
833
|
|
|
|
-
|
|
|
|
745
|
|
|
|
-
|
|
Total
|
|
$
|
424,253
|
|
|
$
|
3,364
|
|
|
$
|
480,864
|
|
|
$
|
3,488
|
|
|
$
|
582,202
|
|
|
$
|
3,611
|
|
The following table presents an analysis of the contractual maturity and tax equivalent weighted average interest rates of investment securities at December 31, 20
17. Available for sale securities are stated at estimated fair value and held to maturity securities are stated at amortized cost. Mortgage-backed securities are included in maturity categories based on their stated maturity dates. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Mutual funds and equity securities have no stated maturity date and are not included in the table
.
Available for Sale
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Within One Year
|
|
|
After One But
Within Five Years
|
|
|
After Five But
Within Ten Years
|
|
|
After Ten Years
|
|
(In thousands)
|
|
Amount
|
|
|
Rate
|
|
|
Amount
|
|
|
Rate
|
|
|
Amount
|
|
|
Rate
|
|
|
Amount
|
|
|
Rate
|
|
Obligations of U.S. government-sponso
red entities
|
|
$
|
14,081
|
|
|
|
1.1
|
%
|
|
$
|
5,233
|
|
|
|
1.6
|
%
|
|
$
|
22,412
|
|
|
|
2.0
|
%
|
|
$
|
1,482
|
|
|
|
2.2
|
%
|
Obligations of states and political subdivisions
|
|
|
12,194
|
|
|
|
3.3
|
|
|
|
44,955
|
|
|
|
2.8
|
|
|
|
39,509
|
|
|
|
3.0
|
|
|
|
17,591
|
|
|
|
3.5
|
|
Mortgage-backed securities
– residential
|
|
|
-
|
|
|
|
-
|
|
|
|
7,331
|
|
|
|
1.6
|
|
|
|
25,498
|
|
|
|
1.7
|
|
|
|
160,564
|
|
|
|
2.5
|
|
Mortgage-backed securities
– commercial
|
|
|
-
|
|
|
|
-
|
|
|
|
6,241
|
|
|
|
1.4
|
|
|
|
24,333
|
|
|
|
1.9
|
|
|
|
18,778
|
|
|
|
2.8
|
|
Asset-backed securities
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
376
|
|
|
|
1.9
|
|
|
|
15,198
|
|
|
|
2.1
|
|
Corporate debt securities
|
|
|
1,001
|
|
|
|
1.2
|
|
|
|
488
|
|
|
|
2.0
|
|
|
|
154
|
|
|
|
2.9
|
|
|
|
5,899
|
|
|
|
2.9
|
|
Total
|
|
$
|
27,276
|
|
|
|
2.1
|
%
|
|
$
|
64,248
|
|
|
|
2.4
|
%
|
|
$
|
112,282
|
|
|
|
2.3
|
%
|
|
$
|
219,512
|
|
|
|
2.5
|
%
|
Held to Maturity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
After One But
|
|
|
After Five But
|
|
|
|
|
|
|
|
|
|
|
|
Within One Year
|
|
|
Within Five Years
|
|
|
Within Ten Years
|
|
|
After Ten Years
|
|
(In thousands)
|
|
Amount
|
|
|
Rate
|
|
|
Amount
|
|
|
Rate
|
|
|
Amount
|
|
|
Rate
|
|
|
Amount
|
|
|
Rate
|
|
Obligations of states and political subdivisions
|
|
$
|
-
|
|
|
|
-
|
%
|
|
$
|
-
|
|
|
|
-
|
%
|
|
$
|
1,322
|
|
|
|
4.7
|
%
|
|
$
|
2,156
|
|
|
|
3.3
|
%
|
The calculation of the weighted average interest rates for each category is based on the weighted average
amortized cost of the securities. The weighted average tax rates on exempt state and political subdivisions are computed based on the 2017 marginal corporate Federal tax rate of 35%.
Loans
Loans, net of unearned income,
were $1.0 billion at December 31, 2017, an increase of $64.3 million or 6.6% compared to year-end 2016. While recent loan demand and near term prospects are encouraging, the Company continues a conservative approach to loan originations. The loan portfolio grew in three of the four quarters in 2017, with the majority of the growth occurring during the fourth quarter. Loan payments during the year include $2.3 million related to nonaccrual loans and $725 thousand related to performing restructured loans.
From time to time the Company may pur
chase a limited amount of loans originated by otherwise nonaffiliated third parties. The Company performs its own risk assessment and makes the credit decision on each loan prior to purchase. The Company purchased smaller balance commercial loans totaling $2.8 million and $2.5 million in the aggregate during 2017 and 2016, respectively. The average individual balance of the purchased loans was $123 thousand for 2017 and $120 thousand for 2016
.
The composition of the loan portfolio
is summarized in the table that follows. Based on economic forecasts and other available information, the Company expects continued gradual improvements to the local and regional economy during the coming year. An improving economy, particularly where the labor force participation rates increase, could lead to continued growth in the loan portfolio.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
(In thousands)
|
|
201
7
|
|
|
%
|
|
|
201
6
|
|
|
%
|
|
|
201
5
|
|
|
%
|
|
|
201
4
|
|
|
%
|
|
|
201
3
|
|
|
%
|
|
Real estate
mortgage – construction and land development
|
|
$
|
129,181
|
|
|
|
12.5
|
%
|
|
$
|
120,230
|
|
|
|
12.4
|
%
|
|
$
|
115,516
|
|
|
|
12.0
|
%
|
|
$
|
97,045
|
|
|
|
10.4
|
%
|
|
$
|
101,352
|
|
|
|
10.1
|
%
|
Real estate mortgage
– residential
|
|
|
355,304
|
|
|
|
34.3
|
|
|
|
350,295
|
|
|
|
36.1
|
|
|
|
355,134
|
|
|
|
37.0
|
|
|
|
361,022
|
|
|
|
38.7
|
|
|
|
371,582
|
|
|
|
37.2
|
|
Real estate mortgage
– farmland and other commercial enterprises
|
|
|
432,321
|
|
|
|
41.8
|
|
|
|
400,367
|
|
|
|
41.2
|
|
|
|
386,386
|
|
|
|
40.3
|
|
|
|
375,277
|
|
|
|
40.3
|
|
|
|
418,147
|
|
|
|
41.8
|
|
Commercial, financial, and agricultural
|
|
|
110,542
|
|
|
|
10.7
|
|
|
|
90,848
|
|
|
|
9.4
|
|
|
|
89,820
|
|
|
|
9.4
|
|
|
|
85,028
|
|
|
|
9.1
|
|
|
|
92,827
|
|
|
|
9.3
|
|
Installment
|
|
|
7,915
|
|
|
|
.7
|
|
|
|
9,235
|
|
|
|
.9
|
|
|
|
12,419
|
|
|
|
1.3
|
|
|
|
13,413
|
|
|
|
1.5
|
|
|
|
15,092
|
|
|
|
1.5
|
|
Lease financing
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
158
|
|
|
|
-
|
|
|
|
883
|
|
|
|
.1
|
|
Total
|
|
$
|
1,035,263
|
|
|
|
100.0
|
%
|
|
$
|
970,975
|
|
|
|
100.0
|
%
|
|
$
|
959,275
|
|
|
|
100.0
|
%
|
|
$
|
931,943
|
|
|
|
100.0
|
%
|
|
$
|
999,883
|
|
|
|
100.0
|
%
|
On an average basis, loans represented
63.3% of earning assets for 2017, an increase of 400 basis points compared to 59.3% for 2016. As loan demand changes, available funds are reallocated between temporary investments or investment securities, which typically involve lower credit risk and yields. The Company does not have direct exposure to the subprime mortgage market. The Company does not originate subprime mortgages nor has it invested in bonds that are secured by such mortgages. Subprime mortgage lending is defined by the Company generally as lending to a borrower that would not qualify for a mortgage loan at prevailing market rates or whereby the underwriting decision is based on limited or no documentation of the ability to repay.
The following table presents
the amount of commercial, financial, and agricultural loans and loans secured by real estate outstanding at December 31, 2017 which, based on remaining scheduled repayments of principal, are due in the periods indicated.
Loan Maturities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
Within
One
Year
|
|
|
After One But
Within Five
Years
|
|
|
After
Five
Years
|
|
|
Total
|
|
Real estate
mortgage – construction and land development
|
|
$
|
42,697
|
|
|
$
|
51,408
|
|
|
$
|
35,076
|
|
|
$
|
129,181
|
|
Real estate mortgage
– residential
|
|
|
22,493
|
|
|
|
57,496
|
|
|
|
275,315
|
|
|
|
355,304
|
|
Real estate mortgage
– farmland and other commercial enterprises
|
|
|
27,886
|
|
|
|
158,058
|
|
|
|
246,377
|
|
|
|
432,321
|
|
Commercial, financial, and agricultural
|
|
|
42,265
|
|
|
|
38,765
|
|
|
|
29,512
|
|
|
|
110,542
|
|
Total
|
|
$
|
135,341
|
|
|
$
|
305,727
|
|
|
$
|
586,280
|
|
|
$
|
1,027,348
|
|
The table below presents
the amount of commercial, financial, and agricultural loans and loans secured by real estate outstanding at December 31, 2017 that are due after one year, classified according to sensitivity to changes in interest rates.
Interest Sensitivity
|
|
|
|
|
|
|
|
|
|
|
Fixed
|
|
|
Variable
|
|
(In thousands)
|
|
Rate
|
|
|
Rate
|
|
Due after one but within five years
|
|
$
|
245,791
|
|
|
$
|
59,936
|
|
Due after five years
|
|
|
144,622
|
|
|
|
441,658
|
|
Total
|
|
$
|
390,413
|
|
|
$
|
501,594
|
|
Asset Quality
The Company
’s loan portfolio is subject to varying degrees of credit risk. Credit risk is mitigated by diversification within the portfolio, limiting exposure to any single customer or industry, rigorous lending policies and underwriting criteria, and collateral requirements. The Company maintains policies and procedures to ensure that the granting of credit is done in a sound and consistent manner. The Company’s internal audit department performs loan reviews during the year to evaluate loan administration, credit quality, documentation, compliance with Company loan standards, and the adequacy of the allowance for loan losses.
The provision for loan losses represents charges
or credits made to earnings to maintain an allowance for loan losses at a level considered adequate to provide for probable incurred credit losses at the balance sheet date. The allowance for loan losses is a valuation allowance increased by the provision for loan losses and decreased by net charge-offs. Loan losses are charged against the allowance when management believes the uncollectibility of a loan is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses and related provision for loan losses generally fluctuate relative
to the level of nonperforming and impaired loans, but other factors impact the amount of the allowance. The Company estimates the adequacy of the allowance using a risk-rated methodology based on the Company’s past loan loss experience, known and inherent risks in the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral securing loans, composition of the loan portfolio, current economic conditions, and other relevant factors. This evaluation is inherently subjective as it requires significant judgment and the use of estimates that may be susceptible to change.
The allowance for loan losses consists of specific and genera
l components. The specific component relates to loans that are individually classified as impaired. The general component covers non-impaired loans and is based on historical loss experience adjusted for current risk factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off. Actual loan losses could differ significantly from the amounts estimated by management.
The general portfolio is segre
gated into portfolio segments having similar risk characteristics identified as follows: real estate loans, commercial loans, and consumer loans. Each of these portfolio segments is assigned a loss percentage based on their respective rolling historical loss rates, adjusted for the qualitative risk factors summarized below
.
During the first quarter of 2017, the Company shortened the look-back period it uses to determine historical loss rates to the previous twelve quarters from sixteen quarters. The change in the look-back period is the result of the Company’s ongoing monitoring and evaluation of the adequacy of its allowance for loan losses. The shorter look-back period better reflects the Company’s loss estimates based on current market conditions. Shortening the look-back period increased the allowance for loan losses by $49 thousand compared to the previous sixteen quarter look-back period.
The qualitative risk factors used in the methodology are consistent with the guidance in the most recent Interagency Policy Statement on the Allowance for Loan Losses issued. Each factor is supported by a detailed analysis and is both measureable and supportable. Some factors include a minimum allocation in instances where loss levels are extremely low and it is determined to be prudent from a safety and soundness perspective. Qualitative risk factors that are used in the methodology include the following for each loan portfolio segment:
●
|
Delinquency trends
|
●
|
Management experience risk
|
●
|
Trends in net charge-offs
|
●
|
Concentration of credit risk
|
●
|
Trends in loan volume
|
●
|
Economic conditions risk
|
●
|
Lending philosophy risk
|
|
|
A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according
to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
While
the overall economy experienced further improvement in 2017, the Company continued its steady progress in reducing its level of nonperforming assets. The recessionary period between 2007 and 2009 (the “Recession”) resulted in an accumulation of nonperforming assets and significant deterioration in the Company’s credit quality and collateral values, primarily in residential real estate lending. Credit quality has improved significantly over the last few years, as loan underwriting standards have been strengthened. Additionally, nonperforming asset levels have declined 85% from the peak that occurred in 2010. Overall economic growth is improving and key economic measures have largely recovered from the Recession. In Kentucky, housing starts continue to gradually increase and foreclosure rates are at the lowest rate since 2007. At year-end 2017, the national and Kentucky unemployment rate was 4.1% and 4.4%, respectively.
With the
continued improvement in the credit quality of the loan portfolio, the level of nonperforming assets are at the lowest level since the third quarter of 2007. Nonperforming loans were $15.4 million at year-end, a decrease of $14.0 million for the year and $92.5 million or 85.8% since peaking at $108 million in the first quarter of 2010. The Company includes accruing restructured loans as a component of its nonperforming loans. Such loans were $11.5 million at year-end 2017 and account for 74.7% of nonperforming loans. Of the $11.5 million in accruing restructured loans, $10.3 million consist of two larger-balance credit relationships secured by various types of real estate collateral.
Restructured loans declined $11.5 million or 50.0% during 2017, primarily due to a $10.7 million credit secured by commercial real estate that refinanced during the fourth quarter of 2017 and was upgraded to performing status. Nonaccrual loans were $3.9 million at year-end 2017, down $2.5 million or 39.5% for the year.
N
onperforming assets as a percent of total assets fell 115 basis points to 1.2%. High levels of nonperforming assets generally result in loan charge-offs, provisions for loan losses, and impairment charges on repossessed real estate. The Company works with its loan customers on an individual case-by-case basis in order to maximize loan repayments on its challenged credits and typically does not restructure those that are past due.
Impaired loans are
those in which the Company does not expect to receive full payment under the contractual terms. Impaired loans are measured at the present value of expected future cash flows discounted at the loan’s effective interest rate, at the loan’s observable market price, or at the fair value of the collateral taking into consideration estimated costs to sell if the loan is collateral dependent. Collateral values are updated in accordance with policy guidelines by obtaining independent third party appraisals and monitoring sales activity of similar properties in our market area.
The allowance specifically allocated to impaired loans was $3.2 million or 13.8% of such loans at year-end 2017 compared with $2.9 million or 7.0% a year earlier.
Of the $3.2 million, $2.1 million or 66.6% is attributed to a group of loans to a single creditor with an outstanding balance of $7.5 million secured by a combination of a real estate development and residential real estate properties. This group of collateral dependent loans is classified as performing restructured loans at year-end 2017.
The allowance for loan losses
was $9.8 million, or 0.94% of outstanding loans at year-end 2017. This compares to $9.3 million, or 0.96% of loans outstanding at year-end 2016. The decline in the allowance as a percentage of loans outstanding from the prior year is the result of a credit to the provision for loan losses of $211 thousand and net recoveries of $650 thousand combined with loan growth during the current year.
As a percentage of nonperforming loans, the
allowance for loan losses was 63.7% and 31.8% at year-end 2017 and 2016, respectively. The allowance for loan losses as a percentage of nonaccrual loans increased to 252% at year-end 2017 compared with 145% at year-end 2016. The relatively low amount of the allowance for loan losses as a percentage of nonperforming loans is due mainly to the makeup of nonperforming loans, where performing restructured loans represent 74.7% of total nonperforming loans outstanding at year-end 2017. The allowance attributed to credits that are restructured with lower interest rates generally represents the difference in the present value of future cash flows calculated at the loan’s original effective interest rate and the new lower rate. This typically results in a reserve for loan losses that is less severe than for other loans that are collateral dependent.
Net recoveries
during 2017 include $1.3 million from a real estate development project. The Company recorded a total of $2.1 million in principal charge-offs between 2010 and 2012 related to this project and anticipates it could receive an additional $575 thousand in recoveries related to this credit. The timing and amount of these possible recoveries are subject to change and are dependent on the price and volume of lots sold by the developer, however, the Company expects to receive the recoveries during the first half of 2018.
H
istorical loss rates continued to be low, the effect of the improvement in loss rates on the allowance for loan losses has diminished now that the higher levels experienced during 2008 through the first quarter of 2014 have already rolled out of the three year look-back period used when evaluating the allowance for loan losses. The decrease in historical loss rates and charge-off activity is due primarily to stabilizing real estate values, which serves as collateral for 89% of the Company’s loan portfolio. The rapid declines in real estate values experienced beginning in 2008 and continuing through 2011 have leveled off significantly, and the allowance for loan losses reflects this improvement. The Company has also implemented stronger credit underwriting standards in recent years, which has improved overall credit quality measures.
While historical loss rates may continue improving in the near term due to elevated charge-offs falling out of the look-back period, this improvement may not necessarily correlate to a lower provision for loan losses. Other qualitative factors, such as changes in loan volume, the overall makeup of the portfolio, economic conditions, and other risk factors applied to historical loss rates may offset to some degree the impact of decreases to the historical loss rates.
Certain credit quality measures are summarized in the table that follows for the periods indicated. Several of these measures are at or near the best level in the last three years.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
December 31,
|
|
201
7
|
|
|
201
6
|
|
|
201
5
|
|
|
Three-year
High
1
|
|
|
Three-year
Low
1
|
|
Nonperforming loans
|
|
$
|
15,369
|
|
|
$
|
29,365
|
|
|
$
|
32,211
|
|
|
$
|
36,948
|
|
|
$
|
15,369
|
|
Nonaccrual loans
|
|
|
3,887
|
|
|
|
6,423
|
|
|
|
8,380
|
|
|
|
11,113
|
|
|
|
3,887
|
|
Loans past due 30-89 days and still accruing
|
|
|
2,099
|
|
|
|
2,259
|
|
|
|
588
|
|
|
|
2,719
|
|
|
|
588
|
|
Loans graded substandard or below
|
|
|
30,121
|
|
|
|
37,650
|
|
|
|
44,220
|
|
|
|
50,518
|
|
|
|
30,110
|
|
Impaired loans
|
|
|
23,141
|
|
|
|
41,895
|
|
|
|
37,182
|
|
|
|
45,574
|
|
|
|
23,141
|
|
Loans, net of unearned income
|
|
|
1,035,263
|
|
|
|
970,975
|
|
|
|
959,275
|
|
|
|
1,035,263
|
|
|
|
927,389
|
|
1
Based on quarter-end balances over the previous three years.
The table below summarizes the loan loss experience for the past five years.
Allowance For Loan Losses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, (In thousands)
|
|
201
7
|
|
|
201
6
|
|
|
201
5
|
|
|
201
4
|
|
|
201
3
|
|
Balance of allowance for loan losses at
beginning of year
|
|
$
|
9,344
|
|
|
$
|
10,315
|
|
|
$
|
13,968
|
|
|
$
|
20,577
|
|
|
$
|
24,445
|
|
Loans charged off:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate mortgage
– construction and land development
|
|
|
-
|
|
|
|
-
|
|
|
|
37
|
|
|
|
50
|
|
|
|
251
|
|
Real estate mortgage
– residential
|
|
|
139
|
|
|
|
276
|
|
|
|
696
|
|
|
|
956
|
|
|
|
908
|
|
Real estate mortgage
– farmland and other commercial enterprises
|
|
|
406
|
|
|
|
131
|
|
|
|
-
|
|
|
|
870
|
|
|
|
274
|
|
Commercial, financial, and agricultural
|
|
|
279
|
|
|
|
219
|
|
|
|
91
|
|
|
|
1,630
|
|
|
|
257
|
|
Installment
|
|
|
106
|
|
|
|
114
|
|
|
|
182
|
|
|
|
214
|
|
|
|
281
|
|
Lease financing
|
|
|
-
|
|
|
|
-
|
|
|
|
3
|
|
|
|
32
|
|
|
|
-
|
|
Total loans charged off
|
|
|
930
|
|
|
|
740
|
|
|
|
1,009
|
|
|
|
3,752
|
|
|
|
1,971
|
|
Recoveries of loans
previously charged off:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate mortgage
– construction and land development
|
|
|
1,296
|
|
|
|
51
|
|
|
|
261
|
|
|
|
292
|
|
|
|
70
|
|
Real estate mortgage
– residential
|
|
|
70
|
|
|
|
63
|
|
|
|
155
|
|
|
|
185
|
|
|
|
200
|
|
Real estate mortgage
– farmland and other commercial enterprises
|
|
|
20
|
|
|
|
27
|
|
|
|
47
|
|
|
|
147
|
|
|
|
57
|
|
Commercial,
financial, and agricultural
|
|
|
138
|
|
|
|
180
|
|
|
|
78
|
|
|
|
782
|
|
|
|
143
|
|
Installment
|
|
|
55
|
|
|
|
69
|
|
|
|
112
|
|
|
|
97
|
|
|
|
221
|
|
Lease financing
|
|
|
1
|
|
|
|
23
|
|
|
|
132
|
|
|
|
4
|
|
|
|
12
|
|
Total recoveries
|
|
|
1,580
|
|
|
|
413
|
|
|
|
785
|
|
|
|
1,507
|
|
|
|
703
|
|
Net loan
(recoveries) charge
-
offs
|
|
|
(650
|
)
|
|
|
327
|
|
|
|
224
|
|
|
|
2,245
|
|
|
|
1,268
|
|
Amount credited to provision for loan losses
|
|
|
(211
|
)
|
|
|
(644
|
)
|
|
|
(3,429
|
)
|
|
|
(4,364
|
)
|
|
|
(2,600
|
)
|
Balance at end of year
|
|
$
|
9,783
|
|
|
$
|
9,344
|
|
|
$
|
10,315
|
|
|
$
|
13,968
|
|
|
$
|
20,577
|
|
Average loans net of unearned income
|
|
$
|
987,877
|
|
|
$
|
956,463
|
|
|
$
|
933,260
|
|
|
$
|
968,489
|
|
|
$
|
1,006,662
|
|
Ratio of net
(recoveries) charge-offs during year to average loans, net of unearned income
|
|
|
(.07
|
)%
|
|
|
.03
|
%
|
|
|
.02
|
%
|
|
|
0.23
|
%
|
|
|
0.13
|
%
|
The following table presents an estimate of the allocation of the allowance for loan losses by type for the date
s indicated. Although specific allocations exist, the entire allowance is available to absorb losses in any particular category.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, (In thousands)
|
|
201
7
|
|
|
20
16
|
|
|
20
15
|
|
|
20
14
|
|
|
201
3
|
|
|
|
Amount
|
|
|
% of
Respective
Loan
Category
|
|
|
Amount
|
|
|
% of
Respective
Loan
Category
|
|
|
Amount
|
|
|
% of
Respective
Loan
Category
|
|
|
Amount
|
|
|
% of
Respective
Loan
Category
|
|
|
Amount
|
|
|
% of
Respective
Loan
Category
|
|
Real estate mortgage
– construction and land development
|
|
$
|
1,361
|
|
|
|
1.05
|
%
|
|
$
|
2,059
|
|
|
|
1.71
|
%
|
|
$
|
1,554
|
|
|
|
1.35
|
%
|
|
$
|
1,809
|
|
|
|
1.86
|
%
|
|
$
|
2,567
|
|
|
|
2.53
|
%
|
Real estate mortgage
– residential
|
|
|
3,638
|
|
|
|
1.02
|
|
|
|
3,422
|
|
|
|
.98
|
|
|
|
3,723
|
|
|
|
1.05
|
|
|
|
4,778
|
|
|
|
1.32
|
|
|
|
6,200
|
|
|
|
1.67
|
|
Real estate mortgage
– farmland and other commercial enterprises
|
|
|
3,510
|
|
|
|
.81
|
|
|
|
2,724
|
|
|
|
.68
|
|
|
|
3,896
|
|
|
|
1.01
|
|
|
|
5,955
|
|
|
|
1.59
|
|
|
|
9,949
|
|
|
|
2.38
|
|
Commercial, financial, and agricultural
|
|
|
951
|
|
|
|
.86
|
|
|
|
854
|
|
|
|
.94
|
|
|
|
820
|
|
|
|
.91
|
|
|
|
1,146
|
|
|
|
1.35
|
|
|
|
1,389
|
|
|
|
1.50
|
|
Installment
|
|
|
323
|
|
|
|
4.08
|
|
|
|
285
|
|
|
|
3.09
|
|
|
|
322
|
|
|
|
2.59
|
|
|
|
273
|
|
|
|
2.04
|
|
|
|
452
|
|
|
|
2.99
|
|
Lease financing
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
7
|
|
|
|
4.43
|
|
|
|
20
|
|
|
|
2.27
|
|
Total
|
|
$
|
9,783
|
|
|
|
.94
|
%
|
|
$
|
9,344
|
|
|
|
.96
|
%
|
|
$
|
10,315
|
|
|
|
1.08
|
%
|
|
$
|
13,968
|
|
|
|
1.50
|
%
|
|
$
|
20,577
|
|
|
|
2.06
|
%
|
A
dditional information concerning the Company’s asset quality is presented under the caption
“Nonperforming Assets”
which follows and
“Investment Securities”
beginning on page 48
.
Nonperforming Assets
T
he Company’s nonperforming assets consist of nonperforming loans, OREO, and other foreclosed assets. Nonperforming loans include nonaccrual loans, performing restructured loans, and loans 90 days or more past due and still accruing interest. Nonaccrual loans are considered to be an indicator of potential losses. The accrual of interest on loans is discontinued when it is determined that the collection of interest or principal is doubtful, or when a default of interest or principal has existed for 90 days or more, unless such loan is well secured and in the process of collection.
Restructured loans occur when a lender, because of economic or legal reasons related to a borrower’s financial difficulty, grants a concession to the borrower that it would not otherwise consider. Restructured loans typically include a reduction of the stated interest rate or an extension of the maturity date. The Company gives careful consideration to identifying which of its challenged credits merit a restructuring of terms that it believes will result in maximum loan repayments and mitigate possible losses. Cash flow projections are carefully scrutinized prior to restructuring any credits; past due credits are typically not granted concessions.
Nonperforming assets
were $20.9 million at year-end 2017, a decrease of $19.2 million or 47.9% compared to $40.0 million at year-end 2016. Such assets have been reduced to the lowest level since peaking at $135 million in the first quarter of 2010. Nonperforming assets increased sharply during 2009 mainly as a result of prolonged weaknesses in the overall economy.
N
onperforming assets by category are presented in the table below for the dates indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, (In thousands)
|
|
201
7
|
|
|
201
6
|
|
|
201
5
|
|
|
201
4
|
|
|
201
3
|
|
Loans accounted for on nonaccrual basis
|
|
$
|
3,887
|
|
|
$
|
6,423
|
|
|
$
|
8,380
|
|
|
$
|
11,508
|
|
|
$
|
23,838
|
|
Loans past due 90 days or more and still accruing
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
444
|
|
Restructured loans
|
|
|
11,482
|
|
|
|
22,942
|
|
|
|
23,831
|
|
|
|
24,429
|
|
|
|
26,255
|
|
Total nonperforming loans
|
|
|
15,369
|
|
|
|
29,365
|
|
|
|
32,211
|
|
|
|
35,937
|
|
|
|
50,537
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other real estate owned
|
|
|
5,489
|
|
|
|
10,673
|
|
|
|
21,843
|
|
|
|
31,960
|
|
|
|
37,826
|
|
Other foreclosed assets
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
52
|
|
|
|
-
|
|
Total nonperforming assets
|
|
$
|
20,858
|
|
|
$
|
40,038
|
|
|
$
|
54,054
|
|
|
$
|
67,949
|
|
|
$
|
88,363
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratio of total nonperforming loans to total loans (net of unearned income)
|
|
|
1.5
|
%
|
|
|
3.0
|
%
|
|
|
3.4
|
%
|
|
|
3.9
|
%
|
|
|
5.1
|
%
|
Ratio of total nonperforming
assets to total assets
|
|
|
1.2
|
|
|
|
2.4
|
|
|
|
3.0
|
|
|
|
3.8
|
|
|
|
4.9
|
|
Additional detail
s related to nonperforming loans were as follows at year-end 2017 and 2016:
Nonperforming Loans
|
|
|
|
|
|
|
December 31, (In thousands)
|
|
201
7
|
|
|
201
6
|
|
Nonaccrual Loans
|
|
|
|
|
|
|
|
|
Real estate mortgage
– construction and land development
|
|
$
|
151
|
|
|
$
|
712
|
|
Real estate mortgage
– residential
|
|
|
1,763
|
|
|
|
2,316
|
|
Real estate mortgage
– farmland and other commercial enterprises
|
|
|
1,752
|
|
|
|
3,383
|
|
Commercial, financial, and agriculture
|
|
|
53
|
|
|
|
-
|
|
Installment
|
|
|
168
|
|
|
|
12
|
|
Total nonaccrual loans
|
|
$
|
3,887
|
|
|
$
|
6,423
|
|
|
|
|
|
|
|
|
|
|
Restructured Loans
|
|
|
|
|
|
|
|
|
Real estate mortgage
– construction and land development
|
|
$
|
1,955
|
|
|
$
|
3,637
|
|
Real estate mortgage
– residential
|
|
|
5,326
|
|
|
|
4,006
|
|
Real estate mortgage
– farmland and other commercial enterprises
|
|
|
3,703
|
|
|
|
14,787
|
|
Commercial, financial, and agriculture
|
|
|
370
|
|
|
|
377
|
|
Installment
|
|
|
128
|
|
|
|
135
|
|
Total restructured loans
|
|
$
|
11,482
|
|
|
$
|
22,942
|
|
|
|
|
|
|
|
|
|
|
Past Due 90 Days or More and Still Accruing
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
Total nonperforming loans
|
|
$
|
15,369
|
|
|
$
|
29,365
|
|
N
onperforming loan activity during 2017 was as follows:
|
|
|
|
|
|
|
(In thousands)
|
|
Nonaccrual
Loans
|
|
|
Restructured
Loans
|
|
Balance at December 31, 201
6
|
|
$
|
6,423
|
|
|
$
|
22,942
|
|
Additions
|
|
|
1,541
|
|
|
|
-
|
|
Principal paydowns
|
|
|
(2,283
|
)
|
|
|
(725
|
)
|
Transfers to performing status
|
|
|
(469
|
)
|
|
|
(10,735
|
)
|
Transfers to other real estate owned
|
|
|
(687
|
)
|
|
|
-
|
|
Charge-offs
|
|
|
(638
|
)
|
|
|
-
|
|
Balance at December 31, 201
7
|
|
$
|
3,887
|
|
|
$
|
11,482
|
|
Restructured loans transferred to performing status consists of a single larger-balance
credit secured by commercial real estate that was upgraded as a result of the underwriting and approval of a new loan during the fourth quarter of 2017.
The Company
gives careful consideration to identifying which of its challenged credits merit a restructuring of terms that it believes will result in maximum loan repayments and mitigate possible losses. From time to time the Company may modify a customer’s loan, but such modifications may or may not meet the criteria for classification as a restructured troubled debt. Modifications that do not meet the criteria of a troubled debt include:
|
●
|
repricing a loan to a current market rate of interest to a borrower with good credit and adequate collateral value in order to retain the customer
;
|
|
●
|
changing the payment frequency from monthly to quarterly, semi-annually
, or annually where the loan is performing, the borrower has good credit and adequate collateral value, and the Company believes valid reasons exist for the change; or
|
|
●
|
extending the interest only payment period of a performing loan where the borrower has good credit and adequate collateral value in instances where a project may still be in a phase of development or leasing-up,
and where the Company believes completion will occur in the near future, or such extension is otherwise in the Company’s best interest.
|
As modification
s are made, management evaluates whether the modification meets the criteria to be classified as a troubled debt. These criteria include two components:
|
1.
|
The bank makes a concession on the loan terms that it would not otherwise consider, and
|
|
2.
|
The borrower is experiencing financial difficulty.
|
The Company
’s loan policy provides guidance to its lending personnel regarding restructured loans to ensure those that are troubled debt are properly identified. Additional attention is given to restructured loans through the oversight of the Chief Credit Officer to ensure that modifications meeting criteria for restructured loans are identified and properly reported.
The Company ha
s not engaged in loan splitting. Loan splitting is a practice that may occur in work-out situations whereby a loan is divided into two parts – a performing part and a nonperforming part. This benefits a lender by potentially replacing one impaired loan by one smaller good loan and one smaller bad loan. Overall charge-offs and reserve amounts are potentially reduced and the effects of adverse loan classifications may be diminished.
The Company
’s comprehensive risk-grading and loan review program includes a review of loans to assess risk and assign a grade to those loans, a review of delinquencies, and an assessment of loans for needed charge-offs or placement on nonaccrual status. The Company had loans in the amount of $32.7 million and $44.0 million at year-end 2017 and year-end 2016, respectively, which were performing but considered potential problem loans and are not included in the nonperforming loan totals in the tables above. These loans, however, are considered in establishing an appropriate allowance for loan losses.
Potential problem loans include a variety of borrowers and are secured primarily by various types of real estate including commercial, construction properties, and residential real estate developments. The $11.3 million or 25.7% decrease during the year in the level of potential problem loans is attributed primarily to an overall improvement in credit quality similar to that of the overall portfolio. At December 31, 2017, the five largest potential problem credits were $9.3 million in the aggregate compared to $11.5 million at year-end 2016.
Potential problem loans are identified on the Company
’s watch list and consist of loans that require close monitoring by management. Credits may be considered as a potential problem loan for reasons that are temporary or correctable, such as for a deficiency in loan documentation or absence of current financial statements of the borrower. Potential problem loans may also include credits where adverse circumstances are identified that may affect the borrower’s ability to comply with the contractual terms of the loan. Other factors which might indicate the existence of a potential problem loan include the delinquency of a scheduled loan payment, deterioration in a borrower’s financial condition identified in a review of periodic financial statements, a decrease in the value of the collateral securing the loan, or a change in the economic environment in which the borrower operates. Certain loans on the Company’s watch list are also considered impaired and specific allowances related to these loans are established in accordance with the appropriate accounting guidance.
Other real estate owned includes real estate properties acquired by the Company through
, or in lieu of, actual loan foreclosures. At year-end 2017, OREO was $5.5 million, a decrease of $5.2 million or 48.6% compared to $10.7 million at year-end 2016. OREO has declined $47.1 million or 89.6% from its peak of $52.6 million, which occurred at year-end 2012.
OREO a
ctivity for 2017 was as follows:
|
|
|
|
(In thousands)
|
|
Amount
|
|
Balance at December 31, 201
6
|
|
$
|
10,673
|
|
Transfers from loans
and other increases
|
|
|
821
|
|
Proceeds from sales
|
|
|
(5,419
|
)
|
Gain
on sales, net
|
|
|
208
|
|
Write downs and other decreases, net
|
|
|
(794
|
)
|
Balance at December 31, 201
7
|
|
$
|
5,489
|
|
The
reduction in OREO was driven by sales activity and impairment charges of $5.2 million and $794 thousand, respectively, which more than offset new acquisitions. Property sales during the year include the sale of two residential real estate development property that sold for $2.0 million with a related gain of $147 thousand in the aggregate and three larger-balance commercial real estate development properties which sold for $1.4 million at a related net loss of $62 thousand. Sales of OREO during 2017 include $2.9 million financed by the Company.
Deposits
The Company
’s primary source of funding for its lending and investment activities results from its customer deposits, which consist of noninterest and interest bearing demand, savings, and time deposits. A summary of the Company’s deposits is presented in the table that follows. The decrease in time deposits is a result of the Company’s strong liquidity position and its strategy to lower overall funding costs, mainly by allowing higher-rate certificates of deposit to roll off or reprice at lower interest rates. Many of those balances have been moved into noninterest bearing demand or lower-rate interest bearing demand or savings accounts by the customer. The Company has not sought out or accepted brokered deposits in the past nor does it have plans to do so in the future.
A summary of the Company
’s deposits is as follows for the dates indicated:
|
|
|
|
|
|
|
|
|
|
December 31, (In thousands)
|
|
201
7
|
|
|
201
6
|
|
|
Increase
(Decrease)
|
|
Noninterest Bearing
|
|
$
|
361,855
|
|
|
$
|
334,676
|
|
|
$
|
27,179
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing
|
|
|
|
|
|
|
|
|
|
|
|
|
Demand
|
|
|
379,027
|
|
|
|
348,197
|
|
|
|
30,830
|
|
Savings
|
|
|
416,163
|
|
|
|
416,611
|
|
|
|
(448
|
)
|
Time
|
|
|
222,858
|
|
|
|
270,423
|
|
|
|
(47,565
|
)
|
Total interest bearing
|
|
|
1,018,048
|
|
|
|
1,035,231
|
|
|
|
(17,183
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total deposits
|
|
$
|
1,379,903
|
|
|
$
|
1,369,907
|
|
|
$
|
9,996
|
|
A summary of average balances
for deposits by type and the related weighted average rates paid is as follows for the periods presented:
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
201
7
|
|
|
20
16
|
|
|
20
15
|
|
(In thousands)
|
|
Average
Balance
|
|
|
Average
Rate Paid
|
|
|
Average
Balance
|
|
|
Average
Rate Paid
|
|
|
Average
Balance
|
|
|
Average
Rate Paid
|
|
Noninterest bearing demand
|
|
$
|
347,355
|
|
|
|
-
|
%
|
|
$
|
324,596
|
|
|
|
-
|
%
|
|
$
|
304,516
|
|
|
|
-
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing demand
|
|
|
356,023
|
|
|
|
.16
|
|
|
|
334,818
|
|
|
|
.08
|
|
|
|
334,281
|
|
|
|
.06
|
|
Savings
|
|
|
418,507
|
|
|
|
.11
|
|
|
|
407,353
|
|
|
|
.12
|
|
|
|
385,932
|
|
|
|
.13
|
|
Time
|
|
|
245,215
|
|
|
|
.45
|
|
|
|
296,258
|
|
|
|
.54
|
|
|
|
356,419
|
|
|
|
.64
|
|
Total interest bearing
|
|
|
1,019,745
|
|
|
|
.21
|
|
|
|
1,038,429
|
|
|
|
.23
|
|
|
|
1,076,632
|
|
|
|
.28
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,367,100
|
|
|
|
.16
|
%
|
|
$
|
1,363,025
|
|
|
|
.17
|
%
|
|
$
|
1,381,148
|
|
|
|
.21
|
%
|
Maturities of time deposits of $100,000 or more outstanding at December
31, 2017 are summarized as follows:
|
|
|
|
(In thousands)
|
|
Amount
|
|
3 months or less
|
|
$
|
8,831
|
|
Over 3 through 6 months
|
|
|
11,553
|
|
Over 6 through 12 months
|
|
|
21,903
|
|
Over 12 months
|
|
|
23,305
|
|
Total
|
|
$
|
65,592
|
|
S
ecurities
S
old
U
nder
A
greements to
R
epurchase
S
ecurities sold under agreements to repurchase represent transactions where the Company sells certain of its investment securities and agrees to repurchase them at a specific date in the future. Securities sold under agreements to repurchase are accounted for as secured borrowings and reflect the amount of cash received in connection with the transaction. Information on securities sold under agreements to repurchase is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
201
7
|
|
|
201
6
|
|
|
201
5
|
|
Amount outstanding at year-end
|
|
$
|
34,252
|
|
|
$
|
36,370
|
|
|
$
|
135,827
|
|
Maximum month-end balance during the year
|
|
|
38,079
|
|
|
|
140,218
|
|
|
|
139,474
|
|
Average outstanding
|
|
|
35,063
|
|
|
|
107,179
|
|
|
|
131,551
|
|
Weighted average rate during the year
|
|
|
.22
|
%
|
|
|
2.74
|
%
|
|
|
3.09
|
%
|
Weighted average rate at year-end
|
|
|
.22
|
|
|
|
.36
|
|
|
|
2.97
|
|
The Company entered into a balance sheet leverage transaction in 2007 whereby it
borrowed $200 million through multiple fixed rate repurchase agreements with an initial weighted average cost of 3.95% and used the proceeds to purchase fixed rate Government National Mortgage Association (“
GNMA”) bonds which were pledged as collateral.
During September 2016, the Company prepaid the remaining balance of $100 million on the repurchase agreements, which were due to mature in November 2017.
Other
Borrowings
Other
borrowings consist of long-term Federal Home Loan Bank (“FHLB”) advances and subordinated notes payable to unconsolidated trusts
.
At times the Company’s short-term borrowings include federal funds purchased and FHLB advances. At year-end 2017 and 2016, short-term borrowings consist entirely of securities sold under agreements to repurchase
FHLB
advances to the Company are secured by restricted holdings of FHLB stock which participating banks are required to own as well as certain qualifying mortgage loans as required by the FHLB, consisting primarily of 1-4 family first mortgage loans. FHLB advances are made pursuant to several different credit programs
,
which have their own interest rates and range of maturities. Interest rates on FHLB advances are fixed and range between 2.99% and 5.81% at year-end 2017, with a weighted average rate of 3.27%. Remaining maturities of FHLB advances extend over multiple time periods through 2020, with a weighted average remaining term of
0.
9 years. FHLB advances are generally used to increase the Company’s lending activities and to aid the efforts of its asset and liability management by utilizing various repayment options offered by the FHLB. Long-term advances from the FHLB totaled $3.5 million and $18.6 million at December 31, 2017 and 2016, respectively. This represents a decrease of $15.2 million or 81.3% and is attributed to scheduled repayment activity
.
The Company had FHLB advances of $10.0 million with a fixed interest rate of 3.95% that matured in September, and $5.0 million with a fixed interest rate of 4.45% that matured in February. The Company has not initiated any long-term FHLB borrowings since 2008.
In 2005 and 2007, t
he Company completed a total of three private offerings of trust preferred securities through separate Delaware statutory trusts (the “Trusts”) sponsored by the Company in the aggregate amount of $47.5 million. The combined $25.0 million proceeds from the first two trusts (“Trusts I and II”) established in 2005 were used to fund the acquisition of Citizens Bancorp, Inc. Proceeds from the third trust (“Trust III”) were used primarily to acquire Company shares through a tender offer during 2007. The Company owns all of the common securities of each of Trusts I and Trust III. During 2016, the Company terminated Trust II as a result of the early extinguishment of debt issued by the trust.
The Trusts used the proceeds from the sale of preferred securities, plus capital
of $1.5 million contributed by the Company to establish the trusts, to purchase the Company’s subordinated notes in amounts and bearing terms that parallel the amounts and terms of the respective preferred securities. Amounts and general terms related to the Trusts at year-end 2017 are summarized in the table below.
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
Trust I
|
|
|
Trust III
|
|
Subordinated notes payable
|
|
$
|
10,310
|
|
|
$
|
23,196
|
|
Interest rate terms
|
|
3-month LIBOR +150 BP
|
|
|
3-month LIBOR +132 BP
|
|
Interest rate in effect at year-end
|
|
|
3.19
|
%
|
|
|
2.70
|
%
|
Stated maturity date
|
|
September 30, 2035
|
|
|
November 1, 2037
|
|
The subordinated notes
of the Trusts are redeemable in whole or in part, without penalty, at the Company’s option and are junior in right of payment of all present and future senior indebtedness of the Company. The weighted average interest rate in effect as of the last determination date in 2017 and 2016 was 2.85% and 2.30%, respectively
.
Contractual Obligations
The Company
’s contractual obligations to make future payments as of December 31, 2017 are as follows:
|
|
|
|
|
|
Payments Due by Period
|
|
Contractual Obligations (In thousands)
|
|
Total
|
|
|
One Year
or Less
|
|
|
Over
One
Year to
Three Years
|
|
|
Over
Three
Years to
Five Years
|
|
|
More Than
Five
Years
|
|
Time deposits
|
|
$
|
222,858
|
|
|
$
|
143,185
|
|
|
$
|
57,048
|
|
|
$
|
17,215
|
|
|
$
|
5,410
|
|
Long-term FHLB debt
|
|
|
3,479
|
|
|
|
3,000
|
|
|
|
479
|
|
|
|
-
|
|
|
|
-
|
|
Subordinated notes payable
|
|
|
33,506
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
33,506
|
|
Long-term securities sold under agreements to repurchase
|
|
|
511
|
|
|
|
254
|
|
|
|
257
|
|
|
|
-
|
|
|
|
-
|
|
Unfunded postretirement benefit obligations
|
|
|
17,811
|
|
|
|
517
|
|
|
|
1,105
|
|
|
|
1,259
|
|
|
|
14,930
|
|
Operating leases
|
|
|
1,833
|
|
|
|
408
|
|
|
|
629
|
|
|
|
298
|
|
|
|
498
|
|
Employment agreements
|
|
|
3,242
|
|
|
|
1,462
|
|
|
|
1,780
|
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
$
|
283,240
|
|
|
$
|
148,826
|
|
|
$
|
61,298
|
|
|
$
|
18,772
|
|
|
$
|
54,344
|
|
Long-term FHLB debt represents advances pursuant to several different credit programs. Long-term FHLB debt
,
subordinated notes payable, and securities sold under agreements to repurchase are more fully described under the captions “
S
ecurities Sold Under Agreements to Repurchase
” and
“
Other
Borrowings”
above and in Notes 8 and 9 of the Company’s 2017 audited consolidated financial statements. Payments for borrowings in the table above do not include interest. Postretirement benefit obligations are determined by actuaries and estimated based on various assumptions with payouts projected in the time periods identified above. Estimates can vary significantly each year due to changes in significant assumptions. Operating leases include standard business equipment used in the Company’s day-to-day business as well as the lease of certain branch sites. Operating lease terms generally range from one to five years, with the ability to extend certain branch site leases at the Company’s option. Payments related to leases are based on actual payments specified in the contracts. Employment agreements represent annual minimum base salary amounts payable by the Company to six employees. The Company has employment agreements with its Chief Executive Officer, Chief Operating Officer, Chief Financial Officer, and three other key officers.
Guarantees
During 2007, th
e Parent Company entered into a guarantee agreement whereby it agreed to become unconditionally and irrevocably the guarantor of the obligations of three of its previous subsidiary banks in connection with the $200 million balance sheet leverage transaction. The borrowings were required to be secured by GNMA bonds valued at 106% of the amount outstanding, although the banks typically maintained an amount in excess of the required minimum
.
During September 2016, the Company prepaid the remaining balance of $100 million of the obligation which was due to mature in 2017. Since the debt has been repaid, the Parent Company is no longer obligated as guarantor.
Effects of Inflation
The
majority of the Company’s assets and liabilities are monetary in nature. Therefore, the Company differs greatly from most commercial and industrial companies that have significant investments in nonmonetary assets, such as fixed assets and inventories. However, inflation does have an important impact on the growth of assets in the banking industry and on the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity to assets ratio. Inflation also affects other noninterest expense, which tends to rise during periods of general inflation.
Market Risk Management
Market risk is the risk of loss arising from adverse changes in market prices and rates. The Company
’s market risk is comprised primarily of interest rate risk created by its core banking activities of extending loans and receiving deposits. The Company’s success is largely dependent upon its ability to manage this risk. Interest rate risk is defined as the exposure of the Company’s net interest income to adverse movements in interest rates. Although the Company manages other risks, such as credit and liquidity risk, management considers interest rate risk to be its most significant risk, which could potentially have the largest and a material effect on the Company’s financial condition and results of operations. A sudden and substantial change in interest rates may adversely impact the Company’s earnings to the extent that the interest rates earned on assets and paid on liabilities do not change at the same speed, to the same extent, or on the same basis. Other events that could have an adverse impact on the Company’s performance include changes in general economic and financial conditions, general movements in market interest rates, and changes in consumer preferences. The Company’s primary purpose in managing interest rate risk is to effectively invest the Company’s capital and to manage and preserve the value created by its core banking business.
Management believes the most significant impact on
financial and operating results is the Company’s ability to react to changes in interest rates. Management seeks to maintain an essentially balanced position between interest sensitive assets and liabilities in order to protect against the effects of wide interest rate fluctuations. The Company has an Asset and Liability Management Committee (“ALCO”) which monitors the composition of the balance sheet to ensure comprehensive management of interest rate risk and liquidity.
The Company uses a simulation model as a tool to monitor and evaluate interest rate risk exposure. The model is designed to measure the sensitivity of net interest income and net income to changing interest rates
over future periods. Forecasting net interest income and its sensitivity to changes in interest rates requires the Company to make assumptions about the volume and characteristics of many attributes, including assumptions relating to the replacement of maturing earning assets and liabilities. Other assumptions include, but are not limited to, projected prepayments, projected new volume, and the predicted relationship between changes in market interest rates and changes in customer account balances. These effects are combined with the Company’s estimate of the most likely rate environment to produce a forecast for the next twelve months. The forecasted results are then compared to the effect of a gradual 200 basis point increase and decrease in market interest rates on the Company’s net interest income and net income. Because assumptions are inherently uncertain, the model cannot precisely estimate net interest income and net income or the effect of interest rate changes on net interest income and net income. Actual results could differ significantly from simulated results.
At December 31, 20
17, the model indicated that if rates were to gradually increase by 200 basis points over the next twelve months, then net interest income (TE) and net income would increase 0.84% and 1.99%, respectively, compared to forecasted results. The model indicated that if rates were to gradually decrease by 200 basis points over the next twelve months, then net interest income (TE) and net income would decrease 2.79% and 6.49%, respectively, compared to forecasted results.
In the current low interest rate environment, it is not practical or possible to reduce certain deposit rates by the same magnitude as rates on earning assets. The average rate paid on the Company
’s deposits is already below 2%. This situation magnifies the model’s predicted results when modeling a decrease in interest rates, as earning assets with higher yields have more of an opportunity to reprice at lower rates than lower-rate deposits.
LIQUIDITY
Liquidity measures the ability to meet current and future cash flow needs as they become due. For financial institutions, liquidity reflects the
capacity to meet loan demand, accommodate possible outflows in deposits, and to react and capitalize on interest rate market opportunities. A financial institution’s ability to meet its current financial obligations is dependent upon the structure of its balance sheet, its ability to liquidate assets, and its access to alternative sources of funds. The Company’s goal is to meet its near-term funding needs by maintaining a level of liquid funds through its asset/liability management. For the longer term, the liquidity position is managed by balancing the maturity structure of the balance sheet. This process allows for an orderly flow of funds over an extended period of time. The Company’s ALCO meets regularly and monitors the composition of the balance sheet to ensure comprehensive management of interest rate risk and liquidity.
The Company's objective as it relates
to liquidity is to ensure that it has funds available to meet deposit withdrawals and credit demands without unduly penalizing profitability. In order to maintain a proper level of liquidity, the Bank has several sources of funds available on a daily basis. For assets, those sources of funds include liquid assets that are readily marketable or that can be pledged, or which mature in the near future. These assets primarily include cash and due from banks, federal funds sold, investment securities, and cash flow generated by the repayment of principal and interest on loans and investment securities. For liabilities, sources of funds primarily include the Bank’s core deposits, FHLB and other borrowings
,
and federal funds purchased and securities sold under agreements to repurchase. While maturities and scheduled amortization of loans and investment securities are generally a predictable source of funds, deposit outflows and mortgage prepayments are influenced significantly by general interest rates, economic conditions, and competition in our local markets.
The Company uses a liquidity ratio
metric, which is monitored by ALCO, to help measure its ability to meet its cash flow needs. The liquidity ratio is based on current and projected levels of sources and uses of funds. This measure is useful in analyzing cash needs and formulating strategies to achieve desired results. For example, a low liquidity ratio could indicate that the Company’s ability to fund loans might become more difficult. A high liquidity ratio could indicate that the Company may have a disproportionate amount of funds in low yielding assets, which is more likely to occur during periods of sluggish loan demand or economic difficulties. The Company’s liquidity position, as measured by its liquidity ratio, declined at year-end 2017 when compared to year-end 2016, but is within its ALCO guidelines. The Company’s liquidity ratio, although lower than a year ago, remains well above its policy minimum as a result of its overall net funding position and, until more recently, having relatively slow, quality loan demand
.
As of December 31, 20
17
,
the Company had $406 million of additional borrowing capacity under various FHLB, federal funds, and other agreements. However, there is no guarantee that these sources of funds will continue to be available to the Company, or that current borrowings can be refinanced upon maturity, although the Company is not aware of any events or uncertainties that are likely to cause a decrease in the Company’s liquidity from these sources.
Liquidity a
t the Parent Company level is primarily affected by the receipt of dividends from United Bank, cash and cash equivalents maintained, and borrowings from nonaffiliated sources. Payment of dividends by the Company’s subsidiary bank is subject to certain regulatory restrictions as set forth in national and state banking laws and regulations. Capital ratios at the Company’s subsidiary bank exceed regulatory established “well-capitalized” status at December 31, 2017 under the prompt corrective action regulatory framework
.
The Parent Company’s primary uses of cash include the payment of dividends to its common shareholders, injecting capital into subsidiaries, paying interest expense on borrowings, and payments for general operating expenses
.
The Parent Company had cash
and cash equivalents of $61.6 million at year-end 2017, an increase of $17.3 million or 39.1% compared to $44.3 million at year-end 2016. Significant cash receipts of the Parent Company for 2017 include dividend payments from United Bank of $23 million and management fees from subsidiaries of $551 thousand. Significant cash payments by the Parent Company in 2017 include $3.0 million for the payment of dividends on common stock; $1.5 million to the Bank in connection with the transfer of Parent Company personnel and related liabilities resulting from the consolidation of its subsidiaries; $1.4 million for salaries, payroll taxes, and employee benefits incurred prior to the consolidation of subsidiaries; and $851 thousand for the payment of interest on subordinated notes payable.
Liquid assets consist of cash
and cash equivalents and available for sale investment securities. At December 31, 2017, consolidated liquid assets were $545 million, a decrease of $49.7 million or 8.4% from year-end 2016. The decrease in liquid assets was driven by lower available for sale investment securities of $56.6 million or 11.8%, partially offset by higher money market mutual funds of $18.1 million or 97.7%. Although liquid assets decreased in the comparison, they remain elevated mainly as a result of the Company’s overall net funding position and unsteady, high-quality loan demand. The overall funding position of the Company changes as loan demand, deposit levels, and other sources and uses of funds fluctuate.
Net cash provided by operating activities was
$28.0 million and $20.7 million for 2017 and 2016, respectively. This represents an increase of $7.3 million or 35.2%. Net cash used in investing activities was $11.1 million compared to net cash provided of $87.2 million for 2016. This represents a change of $98.2 million, driven by loan and net investment securities activity.
The Company had net cash outflow related to loans representing overall net principal advances in the current period of $63.2 million compared with $6.0 million for 2016. For investment securities, the Company had net cash proceeds of $53.9 million for 2017, down $37.2 million compared to a year earlier. Net cash inflows represent proceeds from the sale, maturity, and call of investment securities in excess of purchases. The decrease in net cash inflows related to investment securities was driven by additional proceeds related to the series of transactions during the last half of 2016 to deleverage the balance sheet and reposition the investment securities portfolio, as discussed in further detail under the
“Net Interest Income”
captions on page 42.
Net cash used in financing activities was
$10.1 million for 2017, a decrease of $105 million from $115 million for 2016. The decline was driven
primarily by cash payments in the prior year to extinguish long-term debt. During 2016, the Company paid $104 million
to
extinguish long-term securities sold under agreements to repurchase as part of a balance sheet deleveraging transaction. The Company also paid $11.0 million during 2016 to purchase the preferred securities issued by Trust II and subsequently extinguished the subordinated debt issued by the trust. There was no similar transaction in the current year. For 2017, the Company had net repayments of FHLB advances of $15.2 million, up $15.0 million from $160 thousand in 2016. Deposits increased $10.0 million during 2017, compared to an increase of $913 thousand in 2016.
Information relating to
commitments to extend credit is disclosed in Note 15 of the Company’s 2017 audited consolidated financial statements. These transactions are entered into in the ordinary course of providing traditional banking services and are considered in managing the Company’s liquidity position. The Company does not expect these commitments to significantly affect the liquidity position in future periods. The Company has not entered into any contracts for financial derivative instruments such as futures, swaps, options, or similar instruments.
CAPITAL RESOURCES
Shareholders
’ equity was $193 million at year-end 2017, an increase of $9.3 million or 5.0% compared to $184 million at year-end 2016. Net income and other comprehensive income for the period increased shareholders’ equity by $11.7 million and $475 thousand, respectively, partially offset by dividends declared on common stock of $3.2 million. Other comprehensive income includes a $489 thousand decrease in the after-tax amount of the unrealized loss on available for sale investment securities. The decrease in the unrealized loss on available for sale investment securities is attributed to the decline in longer-term market interest rates combined with the overall decline in the outstanding balance of the investment portfolio due to loan demand.
Generally, as market interest rates fall, the value of fixed rate investments such as those held by the Company, increases.
On January 9, 2009, the Company issued
30,000 shares of Series A, no par value cumulative perpetual preferred stock. The Company redeemed 20,000 of the preferred shares during 2014. In June 2015, the Company redeemed the final 10,000 shares at the stated liquidation value of $1,000 per share, plus accrued dividends of $58 thousand. There was no additional debt or equity issued by the Company in connection with any of the shares redeemed.
At December 31, 201
7 and 2016, the Company’s tangible common equity ratio was 11.55% and 11.02%, respectively. The tangible common equity ratio is defined as tangible common equity as a percentage of tangible assets. The 53 basis point increase in the tangible common equity ratio is the result of an increase in tangible common equity of $9.3 million in the comparison. Tangible assets were relatively unchanged.
Consistent with the objective of operating a sound financial organization, t
he Company’s goal is to maintain capital ratios well above the regulatory minimum requirements. The Company's capital ratios as of December 31, 2017 and the regulatory minimums were as follows:
|
|
|
|
|
|
|
|
|
|
|
Farmers Capital
Bank Corporation
|
|
|
Regulatory
Minimum
|
|
Common Equity Tier 1 Risk-based Capital
1
|
|
|
16.56
|
%
|
|
|
4.50
|
%
|
Tier 1 Risk-based Capital
1
|
|
|
19.30
|
|
|
|
6.00
|
|
Total Risk-based Capital
1
|
|
|
20.12
|
|
|
|
8.00
|
|
Tier 1 Leverage Capital
2
|
|
|
13.75
|
|
|
|
4.00
|
|
1
Common Equity Tier 1 (“CET1”) Risk-based, Tier 1 Risk-based, and Total Risk-based Capital ratios are computed by dividing Common Equity Tier 1, Tier 1, or Total Capital, as defined by regulation, by a risk-weighted sum of the assets, with the risk weighting determined by general standards established by regulation.
2
Tier 1 Leverage ratio is computed by dividing Tier 1 Capital by total quarterly average assets, as defined by regulation.
In July 2013, banking regulators issued final rules to bring U.S. banking organization
s into compliance with the Basel III capital framework effective in 2015. The Company remains well-capitalized under the current rules, including meeting the effective minimum capital ratios with a fully phased-in capital conservation buffer. For further information, see discussion in Part I, Item 1 under the caption
“
Capital
”
beginning on page 14 of this Form 10-K.
The table below
represents an analysis of dividend payout ratios and equity to asset ratios for the previous five years.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
201
7
|
|
|
201
6
|
|
|
201
5
|
|
|
201
4
|
|
|
201
3
|
|
Percentage of common dividends declared to net income
|
|
|
27.24
|
%
|
|
|
14.01
|
%
|
|
|
-
|
%
|
|
|
-
|
%
|
|
|
-
|
%
|
Percentage of average shareholders
’ equity to average total assets
|
|
|
11.56
|
|
|
|
10.68
|
|
|
|
9.77
|
|
|
|
9.84
|
|
|
|
9.34
|
|
Subsidiary Bank
United Bank is
subject to capital-based regulatory requirements which place banks in one of five categories based upon their capital levels and other supervisory criteria. These five categories are: (1) well-capitalized, (2) adequately capitalized, (3) undercapitalized, (4) significantly undercapitalized, and (5) critically undercapitalized. To be well-capitalized, a bank must have a CET1 Risk-based Capital ratio of at least 6.5%, a Tier 1 Risk-based Capital ratio of 8%, a Total Risk-based Capital ratio of at least 10%, and a Tier 1 Leverage ratio of at least 5%. As of December 31, 2017, the Company’s subsidiary bank had the following capital ratios for regulatory purposes:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Equity
Tier 1 Risk-based
Capital Ratio
|
|
|
Tier 1 Risk-
based Capital
Ratio
|
|
|
Total Risk-
based Capital
Ratio
|
|
|
Tier 1
Leverage
Capital Ratio
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United
Bank
|
|
|
14.05
|
%
|
|
|
14.05
|
%
|
|
|
14.88
|
%
|
|
|
10.13
|
%
|
Share Buy Back Program
At various times, the
Company’s Board of Directors has authorized the purchase of shares of the Company’s outstanding common stock. No stated expiration dates have been established under any of the previous authorizations. There are 84,971 shares that may still be purchased under the various authorizations, though no shares have been purchased since 2008.
Shareholder Information
As of
February 20, 2018, the Company had 2,949 shareholders of record, which includes individual participants in securities positions listings
.
Common
Stock Price
The Company
’s common stock is traded on the NASDAQ Stock Market LLC exchange in the Global Select Market tier, with sales prices reported under the symbol: FFKT. The table below lists the high and low sales prices of the Company’s common stock for 2017 and 2016, along with dividends declared in each of those periods
.
|
|
|
|
|
|
|
|
|
|
|
|
High
|
|
|
Low
|
|
|
Dividends
Declared
|
|
201
7
|
|
|
|
|
|
|
|
|
|
|
|
|
Fourth Quarter
|
|
$
|
44.30
|
|
|
$
|
38.45
|
|
|
$
|
.125
|
|
Third Quarter
|
|
|
43.45
|
|
|
|
36.10
|
|
|
|
.10
|
|
Second Quarter
|
|
|
42.80
|
|
|
|
37.20
|
|
|
|
.10
|
|
First Quarter
|
|
|
44.25
|
|
|
|
34.05
|
|
|
|
.10
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
201
6
|
|
|
|
|
|
|
|
|
|
|
|
|
Fourth Quarter
|
|
$
|
44.65
|
|
|
$
|
29.24
|
|
|
$
|
.10
|
|
Third Quarter
|
|
|
30.98
|
|
|
|
26.63
|
|
|
|
.07
|
|
Second Quarter
|
|
|
29.00
|
|
|
|
24.71
|
|
|
|
.07
|
|
First
Quarter
|
|
|
27.31
|
|
|
|
24.65
|
|
|
|
.07
|
|
The closing price per share of
the Company’s common stock on December 3
0
, 2017, the last trading day of the Company’s fiscal year, was $38.50
.
Recently Issued Accounting Standards
See Note 1
–
“Summary of Significant Accounting Policies,”
under the caption
“Recently Issued But Not Yet Effective Accounting
Standards
,
”
in the Company’s 2017 audited consolidated financial statements for further information about recently issued accounting pronouncements and their expected impact on the Company’s financial statements.
201
6
Compared to
201
5
The Company reported net income of $16.6 million or $2.21 per common share in 2016 compared to $15.0 million or $
1.95 per common share for 2015. This represents an increase in net income of $1.6 million or 10.8%. On a per common share basis, net income was up $.26 or 13.3%. The increase in net income is primarily attributed to greater noninterest income of $9.0 million or 40.4%, partially offset by an increase in noninterest expense of $3.5 million or 6.0%, and a lower credit to the provision for loan losses of $2.8 million. Non-GAAP adjusted net income, which excludes after-tax consolidation expenses of $697 thousand related to the merger of subsidiaries, was $17.3 million or $2.31 per common share for 2016.
For 2016, net interest income was relatively unchanged from 2015. Interest income declined $1.9 million or 3.0%, but was offset by a decrease in interest expense of $1.9 million or 21.8%. Interest income on loans and investment securities decreased $373 thousand or 0.8% and $1.7 million or 13.1%, respectively. Interest expense on deposits and borrowed funds decreased
$606 thousand or 20.5% and $1.3 million or 22.5%, respectively. As part of its strategy to improve net interest income and net interest margin, the Company completed a series of transactions during the last half of the year to deleverage its balance sheet and reposition its investment securities portfolio. The Company used a mixture of $10.4 million of excess cash and $93.4 million of proceeds from the sale of investment securities to prepay $100 million of high fixed-rate borrowings that were due to mature in November 2017. The Company incurred a prepayment fee of $3.8 million, which was offset by a gain in the same amount on the sale of investment securities.
Interest on deposits decreased due to both rate declines and lower volume, with a significant amount of the decrease related to time deposits. The Company continued to reprice its higher-rate maturing time deposits downward to lower market interest rates or allowing them to mature without renewing. Net interest margin was 3.36% for 2016 compared to 3.29% for 2015. Net interest spread was 3.21% and 3.14%, up seven basis points compared to 2015. Overall cost of funds decreased 12 basis points to 0.56%.
The Company recorded a credit to the provision for loan losses in the amount of $644 thousand and $3.4 million for 2016 and 2015, respectively.
The credit to the provision for loan losses is attributed to continued improvement in the credit quality of the loan portfolio. The decrease in the credit to the provision is mainly driven by a smaller rate of improvement in historical loss rates during 2016 compared to 2015.
Nonperforming loans decreased $2.8 million or 8.8% in 2016, primarily as a result of lower nonaccrual loans of $2.0 million or 23.4%.
Nonperforming loans, watch list loans, and loans graded as substandard or below each improved in the yearly comparison. The ratio of nonperforming loans to total loans at year-end 2016 was 3.0% compared to 3.4% at year-end 2015. The allowance for loan losses was $9.3 million and $10.3 million at year-end 2016 and 2015, respectively. As a percentage of loans, the allowance for loan losses decreased 12 basis points to 0.96% at year-end 2016 compared to 1.08% a year earlier.
Noninterest income for 2016 was $31.2 million, an increase of $9.0 million or 40.4% from 2015. This was driven by a $4.1 million gain on the early extinguishment of debt and higher net gains on the sale of investment securities of $3.8 million related to a balance sheet deleveraging transaction. Noninterest income also includes $1.5 million in payments related to a litigation settlement. These were partially offset by a decrease in allotment processing fees of $1.1 million or 25.2% from lower processing volume. Other significant components of the increase in noninterest income include higher trust income of $291 thousand or 12.3%. Service charges and fees on deposits were up $266 thousand or 3.5%, driven by higher service charges of $329 thousand or 71.9% and higher dormant account fees of $226 thousand or 9.5%, partially offset by lower overdraft fees of $259 thousand or 6.1%.
During the second quarter of 2016, the Company standardized and reduced the number of its deposit account product offerings throughout each of its markets. This contributed to an overall increase in service charges during the year. Net gains on the sale of mortgage loans increased $118 thousand or 14.3% despite lower sales volume of $3.0 million or 7.6%. The decline in sales volume is mainly due to two larger-balance commercial loans with an aggregate balance of $12.3 million sold during 2015.
Total noninterest expenses were $61.4 million for 2016, an increase of $3.5 million or 6.0% compared to $58.0 million a year earlier. The increase in noninterest expenses was mainly attributed to a $3.8 million loss related to the early extinguishment of debt during 2016 and $1.1 million related to the consolidation of the Company
’s subsidiaries. Expenses related to repossessed real estate were up $481 thousand or 28.2%, driven by higher impairment charges of $351 thousand or 31.9% and a higher net loss from property sales of $285 thousand, partially offset by lower development, operating, and maintenance expenses of $155 thousand.
Deposit insurance expense was down $695 thousand or 45.2% mainly due to a combination of lower risk ratings for the Company
’s subsidiary banks and lower assessment rates. Amortization of intangible assets declined $449 thousand or 100% as a result of being fully amortized at year-end 2015. Legal expenses declined $369 thousand or 43.8% mainly due to fees related to a legal settlement during the first quarter of 2015. Salaries and employee benefits were up $288 thousand or 0.9%, which included $601 thousand of severance pay accruals related to the consolidation of subsidiaries. Employee benefits decreased $499 thousand or 8.0%, mainly from lower claims activity related to the Company’s self-funded health insurance plan and lower actuary-determined postretirement benefit expense. Salaries and related payroll taxes were up $185 thousand or 0.7%. Data processing and communication expense increased $348 thousand or 8.1% mainly due to expenses of $165 thousand in 2016 related to the consolidation of subsidiaries and $137 thousand related to a change in card vendor.
Income tax expense was $6.4 million for 2016, an increase of $1.1 million or 21.7% compared to $5.3 million for 2015. The effective income tax rates were 27.9% and 26.1% for 2016 and 2015, respectively. The increase in income tax expense and the effective tax rate for 2016 is attributed to a higher mix of taxable versus tax-exempt sources of revenue, driven by the gain on early extinguishment of debt and the legal settlement.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information required by this item is incorporated by reference to Part II, Item 7 under the caption “
Market Risk Management
” beginning on page 61 of this Form 10-K.