MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
We operate 17 full-service banking centers
in six contiguous counties in central Kentucky along the Interstate 65 corridor and within the Louisville metropolitan area. Our
markets range from Louisville in Jefferson County, Kentucky approximately 40 miles north of our headquarters in Elizabethtown,
Kentucky to Hart County, Kentucky, approximately 30 miles south of Elizabethtown. Our markets are supported by a diversified industry
base and have a regional population of over 1 million. We operate in Hardin, Nelson, Hart, Bullitt, Meade and Jefferson counties
in Kentucky. We control in the aggregate 19% of the deposit market share in our central Kentucky markets outside of Louisville.
We serve the needs and cater to the economic
strengths of the local communities in which we operate, and we strive to provide a high level of personal and professional customer
service. We offer a variety of financial services to our retail and commercial banking customers. These services include personal
and corporate banking services and personal investment financial counseling services.
Through
our personal investment
financial counseling services, we offer a wide variety of non-insured investments including mutual funds, equity investments, and
fixed and variable annuities. We invest in the wholesale capital markets to manage a portfolio of securities and use various forms
of wholesale funding. The security portfolio contains a variety of instruments, including callable debentures, taxable and non-taxable
debentures, fixed and adjustable rate mortgage backed securities, collateralized mortgage obligations and corporate securities.
Our results of operations depend primarily
on net interest income, which is the difference between interest income from interest-earning assets and interest expense on interest-bearing
liabilities. Our operations are also affected by non-interest income, such as service charges, loan fees, gains and losses from
the sale of mortgage loans and revenue earned from bank owned life insurance. Our principal operating expenses, aside from interest
expense, consist of compensation and employee benefits, occupancy costs, data processing expense, FDIC insurance premiums, costs
associated with other real estate and provisions for loan losses.
The discussion and analysis section covers
material changes in the financial condition since December 31, 2013 and material changes in the results of operations for the three
and six month periods ended June 30, 2014 as compared to 2013. It should be read in conjunction with "Management’s Discussion
and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the period ended
December 31, 2013.
PROPOSED SHARE EXCHANGE
On April 21, 2014, we entered into an Agreement
and Plan of Share Exchange (the “Agreement”) with Community Bank Shares of Indiana, Inc. (“CBIN”), whereby
CBIN will acquire all of the outstanding shares of our common stock pursuant to a statutory share exchange (the “Share Exchange”).
It is anticipated that immediately following the Share Exchange, First Financial Service Corporation will merge into CBIN, and
our subsidiary bank, First Federal Savings Bank (the “Bank”) will merge into Your Community Bank, CBIN’s subsidiary
bank (with Your Community Bank as the surviving bank).
Headquartered in New Albany, Indiana, CBIN
had total assets of $875.9 million as of June 30, 2014. CBIN’s two wholly owned subsidiary banks, Your Community Bank and
The Scott County State Bank, operate 24 banking offices in southern Indiana and central Kentucky, including the metro Louisville
market. Its stock trades on the NASDAQ Global Select Market under the symbol “CBIN.”
Subject to the terms and conditions of
the Agreement, when the Share Exchange takes effect (the “Effective Time”), each issued and outstanding share of FFKY
common stock (other than shares for which dissenters’ rights are exercised) will be canceled and converted into the right
to receive 0.153 shares of CBIN’s common stock (the “Exchange Ratio”), plus cash in lieu of any fractional share.
Further, all options to purchase FFKY common stock that are outstanding and exercisable immediately prior to the Effective Time
will be canceled and converted into the right to receive a cash payment as provided in the Agreement.
The Exchange Ratio may be adjusted, as
provided in the Agreement, if, as of the date ten business days prior to the Effective Time, (a) our consolidated net book value
is less than $13,000,000, or (b) the Bank has failed since the date of the Agreement to gain more than $3,000,000 (through payoffs,
paydowns or certain collateral enhancements) with respect to sixteen specifically identified special assets.
The Agreement provides certain termination
rights for both the Corporation and CBIN. If the Agreement is terminated by CBIN, because the Corporation enters into an agreement
for a superior business combination, then the Corporation would be obligated to pay to CBIN a termination fee of $1,500,000. If
the Agreement is terminated by the Corporation, because CBIN fails to meet certain regulatory capital requirements, then CBIN would
be obligated to pay the Corporation a termination fee of $500,000.
The consummation of the Share Exchange
is subject to various conditions, including (i) receipt of the requisite approval of the shareholders of the Corporation and of
CBIN, (ii) receipt of regulatory approvals, (iii) absence of any law or order prohibiting the closing, and (iv) effectiveness
of the registration statement to be filed by CBIN with the SEC to register the shares of CBIN common stock to be issued to Corporation
shareholders in the Share Exchange. In addition, each party’s obligation to consummate the Share Exchange is subject to
certain other customary conditions, including the accuracy of the representations and warranties of the other party and compliance
of the other party with its covenants in all material respects. The parties anticipate completing the Share Exchange in the fourth
quarter of 2014.
OVERVIEW
Net loss attributable to common shareholders
for the quarter ended June 30, 2014 was $2.4 million or $0.48 per diluted common share compared to a net loss attributable to
common shareholders of $1.4 million or $0.29 per diluted common share for the same period in 2013. Net loss attributable to common
shareholders for the six months ended June 30, 2014 was $3.0 million or $0.60 per diluted common share compared to a net loss
attributable to common shareholders of $1.5 million or $0.32 per diluted common share for the same period a year ago.
The net loss attributable to common shareholders
for the six months ended June 30, 2014 included $2.5 million in charges related to non-recurring events. Merger related expense
resulting from the Agreement and Plan of Share Exchange announced on April 21, 2014 was approximately $1.1 million. This includes
$814,000 in compensation expense from the accelerated vesting of stock options and restricted stock awards under the Stock Option
and Incentive Compensation Plan and $257,000 in legal, investment banking, and professional fees related to the merger. Regulatory
related expense was $330,000 for the June 2014 quarter, which includes a civil money penalty assessed from a 2012 exam violation
including restitution to customers. Non-performing asset related charges of $1.1 million also impacted earnings for the six months
ended June 30, 2014.
While still elevated, the level of non-performing
assets is now at manageable levels not seen since the second quarter of 2009. Compared to December 31, 2013, non-performing loans
declined $4.4 million or 26%, non-performing assets declined $4.9 million or 16%, and classified and criticized assets declined
$8.5 million or 15%. We sold nine OREO properties totaling $483,000 during the 2014 period. Non-performing assets were $25.7 million
or 3.20% of total assets at June 30, 2014 compared to $30.6 million or 3.56% of total assets at December 31, 2013. Six commercial
real estate relationships totaling $14.5 million make up 57% of the total non-performing assets. The relationships range in value
from $762,000 to $6.2 million and have an aggregate specific reserve for $2.4 million.
The lower values on appraisals and reviews
of OREO properties resulted in $499,000 in total write downs on OREO for the first half of 2014 compared to $1.3 million in total
write downs recorded during 2013. We believe that we have written down OREO values to levels that will facilitate their liquidation,
as indicated by recent sales.
As economic conditions improved and collateral
values stabilized in 2013 and 2014, our provision for loan losses has been much lower than in previous years. The allowance for
loan losses to total loans was 2.09% at June 30, 2014 compared to 3.25% at June 30, 2013 while net charge-offs to average loans
totaled 0.06% for 2014 compared to 0.19% for 2013. Non-performing loans were $13.0 million or 2.85% of total loans at June 30,
2014 compared to $17.4 million, or 3.73% of total loans for December 31, 2013. The allowance for loan losses to non-performing
loans, which excludes restructured loans on accrual status, was 74% at June 30, 2014 compared to 89% at June 30, 2013.
The net interest margin improved to 2.85%
for the six months ended June 30, 2014 compared to 2.76% for the 2013 six month period. The main driver to the improvement in
the net interest margin for 2014 compared to 2013 is the intentional decrease of $115.7 million in average certificates of deposits
that resulted in a reduction of $1.3 million in related interest expense during the period. We continue to anticipate modest improvement
to the net interest margin over the next several quarters, as we continue to focus on restructuring the balance sheet to decrease
our cost of funds, improve interest income, and reduce our interest rate risk exposure. However, the balance sheet restructuring
may be impacted by the acceleration of loan repayments. Low interest rates, coupled with a competitive lending environment, continue
to be challenging.
REGULATORY MATTERS
Since January 2011, the Bank has operated
under Consent Orders with the FDIC and KDFI. In the most recent Consent Order, the Bank agreed to achieve and maintain a Tier
1 capital ratio of 9.0% and a total risk-based capital ratio of 12.0% by June 30, 2012. The Bank also agreed that if it should
be unable to reach the required capital levels by that date, and if directed in writing by the FDIC, then within 30 days the Bank
would develop, adopt and implement a written plan to sell or merge itself into another federally insured financial institution.
To date the Bank has not received such a written direction. The Consent Order also prohibits the Bank from declaring dividends
without the prior written approval of the FDIC and KDFI and requires the Bank to develop and implement plans to reduce its level
of non-performing assets and concentrations of credit in commercial real estate loans, maintain adequate reserves for loan and
lease losses, implement procedures to ensure compliance with applicable laws, and take certain other actions. A copy of the most
recent Consent Order is included as Exhibit 10.8 to our 2011 Annual Report on Form 10-K filed March 30, 2012.
At June 30, 2014, the Bank’s Tier
1 capital ratio was 8.46% and the total risk-based capital ratio was 14.93%, compared to the minimum 9.00% and 12.00% capital
ratios required by the Consent Order. Our comparable ratios at December 31, 2013 were 7.96% and 13.48%, respectively. For the
seventh consecutive quarter, we have achieved and maintained the required total risk-based capital ratio. Our Tier 1 capital ratio
has also steadily improved, but has yet to reach the Consent Order minimum. We continue to explore strategies to achieve and maintain
the Tier 1 capital ratio as well as to comply with all of the other terms of the Consent Order.
Our plans for 2014 include the following:
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Continuing
to work towards the completion of the merger and Share Exchange with CBIN.
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Continuing
to address all requirements of our Consent Order and formal agreement.
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Continuing
to serve our community banking customers and operate the Corporation and the Bank in
a safe and sound manner. We have worked diligently to maintain the strength of our retail
and deposit franchise.
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Continuing
to reduce expenses and improve our ability to operate in a profitable manner.
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Continuing
to reduce our lending concentration in commercial real estate through expected maturities
and repayments.
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Accelerating
our efforts to dispose of problem assets.
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Continuing
to reduce our inventory of other real estate owned properties.
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While our concerns about economic conditions
in our market continue, we are working towards our long-range objectives including building additional core customer relationships,
maintaining sufficient liquidity and capital levels, improving shareholder value, remediating our problem assets and building
upon the sustained success of our retail franchise.
CRITICAL ACCOUNTING POLICIES
Our accounting and reporting policies
comply with U.S. generally accepted accounting principles and conform to general practices within the banking industry. The preparation
of financial statements in conformity with U.S. generally accepted accounting principles requires us to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments
are based on information available as of the date of the financial statements. Accordingly, as this information changes, the financial
statements could change as our estimates, assumptions, and judgments change. Certain policies inherently rely more heavily 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. We consider our critical accounting policies to include the following:
Allowance for Loan Losses
–
We maintain an allowance we believe to be sufficient to absorb probable incurred credit losses existing in the loan portfolio.
Management, which is comprised of senior officers and certain accounting and credit associates, evaluates the allowance for loan
losses on a monthly basis. We estimate the amount of the allowance using past loan loss experience, known and inherent risks
in the portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of the underlying
collateral, and current economic conditions. While we estimate the allowance for loan losses based in part on historical
losses within each loan category, estimates for losses within the commercial real estate portfolio depend more on credit analysis
and recent payment performance. Allocations of the allowance may be made for specific loans or loan categories, but the entire
allowance is available for any loan that, in management’s judgment, should be charged off.
The allowance consists of specific and
general 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 for certain categories adjusted for current factors. Allowance
estimates are developed with actual loss experience adjusted for current economic conditions. Allowance estimates are considered
a prudent measurement of the risk in the loan portfolio and are applied to individual loans based on loan type.
Based on our calculation, an allowance
of $9.5 million
or 2.09% of total loans was our estimate of probable incurred losses within the loan portfolio as of
June 30, 2014.
This estimate required us to record a provision for loan losses on the income statement of
$100,000 for the 2014 period.
If the mix and amount of future charge off percentages differ significantly from those
assumed by management in making its determination, the allowance for loan losses and provision for loan losses on the income statement
could materially increase.
Impairment of Investment Securities
–
We review all unrealized losses on our investment securities to determine whether the losses are other-than-temporary.
We evaluate our investment securities on at least a quarterly basis, and more frequently when economic or market conditions warrant,
to determine whether a decline in their value below amortized cost is other-than-temporary. We evaluate a number of factors including,
but not limited to: valuation estimates provided by investment brokers; how much fair value has declined below amortized cost;
how long the decline in fair value has existed; the financial condition of the issuer; significant rating agency changes on the
issuer; and management’s assessment that we do not intend to sell or will not be required to sell the security for a period
of time sufficient to allow for any anticipated recovery in fair value.
At June 30, 2014, we own five collateralized
loan obligation (“CLO”) securities subject to the Volcker Rule, with an amortized cost of $14.8 million and a net
unrealized loss of $389,000. Absent changes to the Volcker Rule, we would be required to dispose of these securities before July
2017. We believe the unrealized loss reflected results not from credit risk but from interest rate changes and to the uncertainty
created by the Volcker Rule. In the first quarter of 2014, we sold four of our CLOs and in the second quarter of 2014 we recorded
partial sales on three of our CLOs to confirm their marketability and evaluate our assessment about their market values. We recorded
a loss of $286,000 on these sales.
The term “other-than-temporary”
is not intended to indicate that the decline is permanent, but indicates that the possibility for a near-term recovery of value
is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying
value of the investment. Once a decline in value is determined to be other-than-temporary, the cost basis of the security is written
down to fair value and a charge to earnings is recognized for the credit component and the non-credit component is recorded to
other comprehensive income.
Real Estate Owned
–
The
estimation of fair value is significant to real estate owned-acquired through foreclosure. These assets are recorded at fair value
less estimated selling costs at the date of foreclosure. Fair value is based on the appraised market value of the property based
on sales of similar assets when available. The value may be subsequently reduced if the estimated fair value declines below the
value recorded at the time of foreclosure. Appraisals are performed at least annually, if not more frequently. Typically, appraised
values are discounted for the projected sale below appraised value in addition to the selling cost. With certain appraised values
where management believes a solid liquidation value has been established, the appraisal has been discounted only by the selling
cost. We have dedicated a team of associates and management focused on the continued resolution and work out of other real estate
owned (“OREO”). Appropriate policies, committees and procedures have been put in place to ensure the proper accounting
treatment and risk management of this area.
Income Taxes
–
The provision for income taxes is based on income/(loss) as reported in the financial statements. Deferred income tax
assets and liabilities are computed for differences between the financial statement and tax basis of assets and liabilities that
will result in taxable or deductible amounts in the future. The deferred tax assets and liabilities are computed based on enacted
tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. An assessment is
made as to whether it is more likely than not that deferred tax assets will be realized. A valuation allowance is established
when necessary to reduce deferred tax assets to an amount more likely than not expected to be realized. Income tax expense is
the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.
Tax credits are recorded as a reduction to the tax provision in the period for which the credits may be utilized.
A full valuation allowance related to
deferred tax assets is required when it is considered more likely than not that all or part of the benefit related to such assets
will not be realized. In assessing the need for a full valuation allowance, we considered various factors including our five year
cumulative loss position, the level of our non-performing assets, our inability to meet our forecasted levels of assets and full
year operating results in 2013, 2012 and 2011 and our non-compliance with the capital requirements of our Consent Order. Based
on this assessment, we concluded that a valuation allowance was necessary at June 30, 2014 and December 31, 2013.
RESULTS OF OPERATIONS
Net loss attributable to common shareholders
for the quarter ended June 30, 2014 was $2.4 million or $0.48 per diluted common share compared to a net loss attributable to
common shareholders of $1.4 million or $0.29 per diluted common share for the same period in 2013. Net loss attributable to common
shareholders for the six months ended June 30, 2014 was $3.0 million or $0.60 per diluted common share compared to a net loss
attributable to common shareholders of $1.5 million or $0.32 per diluted common share for the same period a year ago. Factors
contributing to the net loss for the 2014 six month period included the following:
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·
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declining
net interest income mainly driven by a decline of $2.0 million in loan interest income
as a result of a decline of $48.9 million in average loan balances combined with the
continuing low interest rate environment;
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·
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a
$925,000 million increase in provision for loans losses;
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·
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a
decline of $497,000 in securities interest income mainly due to the continued low interest
rate environment;
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·
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a
decline of $428,000 in gains on the sale of mortgage loans due to the decline in refinance
activity;
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a
decrease in net gains of $262,000 on the sale of securities available for sale;
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an
increase of $396,000 in other expense as a result of higher legal expense due to the
Share Exchange and regulatory exam-related expenses of $330,000, and
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·
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an
increase in employee compensation and benefits of $185,000 driven by the immediate vesting
of all outstanding and unvested stock options and restricted stock awards when we entered
into the Share Exchange Agreement with CBIN on April 21, 2014, which resulted in an expense
of over $800,000. This was offset by a decrease in compensation expense related to the
number of employees. Full time equivalent employees decreased from 278 at June 30, 2013
to 269 at June 30, 2014.
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These factors were partially offset by
the following:
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·
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a
decline of $1.5 million in deposit interest expense mainly as a result of an intentional
decrease of $115.7 million in average certificates of deposits and other time deposits
balances combined with a decline of 21 basis points in the cost of these deposits, and
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·
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a
$1.1 million decrease in write downs and sale losses on OREO.
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Net loss attributable to common shareholders
was also increased by the dividends accrued on preferred shares. Our book value per common share decreased from $3.04 at June
30, 2013 to $2.89 at June 30, 2014.
Net Interest Income
–
The largest component of our net income is our net interest income. Net interest income is the difference between interest income,
principally from loans and investment securities, and interest expense, principally on customer deposits and borrowings. Changes
in net interest income result from changes in volume, net interest spread and net interest margin. Volume refers to the average
dollar levels of interest-earning assets and interest-bearing liabilities. Net interest spread refers to the difference between
the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Net interest margin refers
to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning
assets and interest-bearing liabilities.
The majority of our assets are interest-earning
and our liabilities are interest-bearing. Accordingly, changes in interest rates may impact our net interest margin. The
Federal Open Markets Committee (“FOMC”) uses the federal funds rate, which is the interest rate used by banks to lend
to each other, to influence interest rates and the national economy. Changes in the federal funds rate have a direct correlation
to changes in the prime rate, the underlying index for most of the variable-rate loans we issue. The FOMC has held the target
federal funds rate at a range of 0-25 basis points since December 2008. As we are asset sensitive, continued low rates
will negatively impact our earnings and net interest margin.
The large decline in the volume of interest-earning
assets and the change in the mix of interest-earning assets reduced net interest income by $530,000 and $965,000 for the three
and six month 2014 periods compared to the prior year periods. Average interest earning assets decreased $83.1 million and $99.5
million for the quarter and six month 2014 periods compared to 2013 primarily driven by a decrease in average loans. The decrease
in average loans was due to loan principal payments, payoffs, charge-offs and the conversion of nonperforming loans to OREO properties.
In addition, due to the higher regulatory capital ratios required by our Consent Order, we elected not to replace much of this
loan run-off consistent with our efforts to reduce our level of assets and risk-weighted assets. The average loan yield was 4.92%
and 4.97% for the three and six month 2014 periods compared to an average loan yield of 5.31% and 5.30% for the 2013 periods.
Average interest bearing liabilities decreased
$90.9 million and $106.1 million for the quarter and six month 2014 periods compared to 2013 driven by a decrease in average certificates
of deposit. The decrease in average deposits was due an intentional decrease in certificates of deposit as we focus on restructuring
the balance sheet to decrease our cost of funds and improve net interest income.
The tax equivalent yield on earning assets
averaged 3.68% and 3.70% for the three and six month 2014 periods compared to 3.94% and 3.88% for 2013. The decline in the yields
on interest-earning assets were more than offset by a decrease in our cost of funds, which averaged 0.89% and 0.94% for the three
and six month 2014 periods compared to an average cost of funds of 1.16% and 1.21% for the same periods in 2013. Net interest
margin as a percent of average earning assets remained constant at 2.87% for the quarters ended June 30, 2014 and 2013 and increased
9 basis points to 2.85% for the six months ended June 30, 2014 compared to 2.76% for the 2013 six month period.
We anticipate
being able to continue taking advantage of the continued low interest rate environment to reduce our cost of funds, as term deposits
re-price at more favorable terms.
AVERAGE BALANCE SHEET
The following table provides information
relating to our average balance sheet and reflects the average yield on assets and average cost of liabilities for the indicated
periods. Yields and costs for the periods presented are derived by dividing income or expense by the average balances of assets
or liabilities, respectively.
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Quarter Ended June 30,
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2014
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2013
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Average
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Average
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Average
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Average
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(Dollars in thousands)
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Balance
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Interest
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Yield/Cost (5)
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Balance
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Interest
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Yield/Cost (5)
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ASSETS
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Interest earning assets:
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U.S. Treasury and agencies
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$
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67
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$
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1
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5.99
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%
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$
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-
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$
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-
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0.00
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%
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Mortgage-backed securities
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197,419
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952
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1.93
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%
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244,501
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1,031
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1.69
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%
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State and political subdivision securities
(1)
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8,856
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135
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6.11
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%
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15,501
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248
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6.42
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%
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Corporate bonds
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26,554
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185
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2.79
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%
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59,231
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377
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2.55
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%
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Loans
(2) (3) (4)
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459,135
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5,627
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4.92
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%
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499,079
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6,603
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5.31
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%
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FHLB stock
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4,080
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|
42
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4.13
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%
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4,430
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47
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4.26
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%
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Interest bearing deposits
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68,502
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|
71
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0.42
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%
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24,982
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16
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0.26
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%
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Total interest earning assets
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764,613
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7,013
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3.68
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%
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847,724
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8,322
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3.94
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%
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Less: Allowance for loan losses
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(9,583
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)
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(16,156
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)
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Non-interest earning assets
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70,622
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78,642
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Total assets
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$
|
825,652
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$
|
910,210
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|
|
|
|
|
|
|
|
|
LIABILITIES AND
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Savings accounts
|
|
$
|
97,398
|
|
|
$
|
28
|
|
|
|
0.12
|
%
|
|
$
|
91,122
|
|
|
$
|
52
|
|
|
|
0.23
|
%
|
|
NOW and money market accounts
|
|
|
269,733
|
|
|
|
80
|
|
|
|
0.12
|
%
|
|
|
265,784
|
|
|
|
153
|
|
|
|
0.23
|
%
|
|
Certificates of deposit and other time deposits
|
|
|
291,147
|
|
|
|
1,035
|
|
|
|
1.43
|
%
|
|
|
390,885
|
|
|
|
1,569
|
|
|
|
1.61
|
%
|
|
FHLB advances
|
|
|
12,332
|
|
|
|
139
|
|
|
|
4.52
|
%
|
|
|
13,762
|
|
|
|
132
|
|
|
|
3.85
|
%
|
|
Subordinated debentures
|
|
|
18,000
|
|
|
|
251
|
|
|
|
5.59
|
%
|
|
|
18,000
|
|
|
|
341
|
|
|
|
7.60
|
%
|
|
Total interest bearing liabilities
|
|
|
688,610
|
|
|
|
1,533
|
|
|
|
0.89
|
%
|
|
|
779,553
|
|
|
|
2,247
|
|
|
|
1.16
|
%
|
|
Non-interest bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest bearing deposits
|
|
|
86,592
|
|
|
|
|
|
|
|
|
|
|
|
80,433
|
|
|
|
|
|
|
|
|
|
|
Other liabilities
|
|
|
12,834
|
|
|
|
|
|
|
|
|
|
|
|
11,060
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
788,036
|
|
|
|
|
|
|
|
|
|
|
|
871,046
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders' equity
|
|
|
37,616
|
|
|
|
|
|
|
|
|
|
|
|
39,164
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders' equity
|
|
$
|
825,652
|
|
|
|
|
|
|
|
|
|
|
$
|
910,210
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
5,480
|
|
|
|
|
|
|
|
|
|
|
$
|
6,075
|
|
|
|
|
|
|
Net interest spread
|
|
|
|
|
|
|
|
|
|
|
2.79
|
%
|
|
|
|
|
|
|
|
|
|
|
2.78
|
%
|
|
Net interest margin
|
|
|
|
|
|
|
|
|
|
|
2.87
|
%
|
|
|
|
|
|
|
|
|
|
|
2.87
|
%
|
(1)
Taxable equivalent yields are calculated assuming
a 34% federal income tax rate.
(2)
Includes loan fees, immaterial in amount, in both
interest income and the calculation of yield on loans.
(3)
Calculations include non-accruing loans in the average
loan amounts outstanding.
(4)
Includes loans held for sale.
(5)
Annualized
|
|
|
Six Months Ended June 30,
|
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
|
|
Average
|
|
|
(Dollars in thousands)
|
|
Balance
|
|
|
Interest
|
|
|
Yield/Cost (5)
|
|
|
Balance
|
|
|
Interest
|
|
|
Yield/Cost (5)
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest earning assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury and agencies
|
|
$
|
34
|
|
|
$
|
1
|
|
|
|
5.93
|
%
|
|
$
|
3,822
|
|
|
$
|
28
|
|
|
|
1.48
|
%
|
|
Mortgage-backed securities
|
|
|
205,606
|
|
|
|
1,978
|
|
|
|
1.94
|
%
|
|
|
266,443
|
|
|
|
2,241
|
|
|
|
1.70
|
%
|
|
State and political subdivision securities
(1)
|
|
|
10,180
|
|
|
|
288
|
|
|
|
5.71
|
%
|
|
|
15,078
|
|
|
|
421
|
|
|
|
5.63
|
%
|
|
Corporate bonds
|
|
|
32,342
|
|
|
|
477
|
|
|
|
2.97
|
%
|
|
|
50,862
|
|
|
|
651
|
|
|
|
2.58
|
%
|
|
Loans
(2) (3) (4)
|
|
|
461,722
|
|
|
|
11,380
|
|
|
|
4.97
|
%
|
|
|
510,593
|
|
|
|
13,421
|
|
|
|
5.30
|
%
|
|
FHLB stock
|
|
|
4,188
|
|
|
|
87
|
|
|
|
4.19
|
%
|
|
|
4,555
|
|
|
|
98
|
|
|
|
4.34
|
%
|
|
Interest bearing deposits
|
|
|
65,508
|
|
|
|
100
|
|
|
|
0.31
|
%
|
|
|
27,701
|
|
|
|
34
|
|
|
|
0.25
|
%
|
|
Total interest earning assets
|
|
|
779,580
|
|
|
|
14,311
|
|
|
|
3.70
|
%
|
|
|
879,054
|
|
|
|
16,894
|
|
|
|
3.88
|
%
|
|
Less: Allowance for loan losses
|
|
|
(9,719
|
)
|
|
|
|
|
|
|
|
|
|
|
(16,587
|
)
|
|
|
|
|
|
|
|
|
|
Non-interest earning assets
|
|
|
69,639
|
|
|
|
|
|
|
|
|
|
|
|
81,181
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
839,500
|
|
|
|
|
|
|
|
|
|
|
$
|
943,648
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Savings accounts
|
|
$
|
96,360
|
|
|
$
|
62
|
|
|
|
0.13
|
%
|
|
$
|
88,947
|
|
|
$
|
107
|
|
|
|
0.24
|
%
|
|
NOW and money market accounts
|
|
|
275,166
|
|
|
|
168
|
|
|
|
0.12
|
%
|
|
|
272,224
|
|
|
|
355
|
|
|
|
0.26
|
%
|
|
Certificates of deposit and other time deposits
|
|
|
303,863
|
|
|
|
2,186
|
|
|
|
1.45
|
%
|
|
|
419,536
|
|
|
|
3,448
|
|
|
|
1.66
|
%
|
|
FHLB advances
|
|
|
12,350
|
|
|
|
275
|
|
|
|
4.49
|
%
|
|
|
13,168
|
|
|
|
264
|
|
|
|
4.04
|
%
|
|
Subordinated debentures
|
|
|
18,000
|
|
|
|
592
|
|
|
|
6.63
|
%
|
|
|
18,000
|
|
|
|
682
|
|
|
|
7.64
|
%
|
|
Total interest bearing liabilities
|
|
|
705,739
|
|
|
|
3,283
|
|
|
|
0.94
|
%
|
|
|
811,875
|
|
|
|
4,856
|
|
|
|
1.21
|
%
|
|
Non-interest bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest bearing deposits
|
|
|
84,616
|
|
|
|
|
|
|
|
|
|
|
|
79,492
|
|
|
|
|
|
|
|
|
|
|
Other liabilities
|
|
|
12,713
|
|
|
|
|
|
|
|
|
|
|
|
10,727
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
803,068
|
|
|
|
|
|
|
|
|
|
|
|
902,094
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders' equity
|
|
|
36,432
|
|
|
|
|
|
|
|
|
|
|
|
41,554
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders' equity
|
|
$
|
839,500
|
|
|
|
|
|
|
|
|
|
|
$
|
943,648
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
11,028
|
|
|
|
|
|
|
|
|
|
|
$
|
12,038
|
|
|
|
|
|
|
Net interest spread
|
|
|
|
|
|
|
|
|
|
|
2.76
|
%
|
|
|
|
|
|
|
|
|
|
|
2.67
|
%
|
|
Net interest margin
|
|
|
|
|
|
|
|
|
|
|
2.85
|
%
|
|
|
|
|
|
|
|
|
|
|
2.76
|
%
|
(1)
Taxable equivalent yields are calculated assuming
a 34% federal income tax rate.
(2)
Includes loan fees, immaterial in amount, in both
interest income and the calculation of yield on loans.
(3)
Calculations include non-accruing loans in the average
loan amounts outstanding.
(4)
Includes loans held for sale.
(5)
Annualized
RATE/VOLUME ANALYSIS
The table below shows changes in interest
income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (1) changes in rate (changes in rate multiplied by old volume); (2) changes
in volume (change in volume multiplied by old rate); and (3) changes in rate-volume (change in rate multiplied by change in volume).
Changes in rate-volume are proportionately allocated between rate and volume variance.
|
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
|
2014 vs. 2013
|
|
|
2014 vs. 2013
|
|
|
|
|
Increase (decrease)
|
|
|
Increase (decrease)
|
|
|
|
|
Due to change in
|
|
|
Due to change in
|
|
|
|
|
|
|
|
|
|
|
Net
|
|
|
|
|
|
|
|
|
Net
|
|
|
(Dollars in thousands)
|
|
Rate
|
|
|
Volume
|
|
|
Change
|
|
|
Rate
|
|
|
Volume
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury and agencies
|
|
$
|
1
|
|
|
$
|
-
|
|
|
$
|
1
|
|
|
$
|
22
|
|
|
$
|
(49
|
)
|
|
$
|
(27
|
)
|
|
Mortgage-backed securities
|
|
|
136
|
|
|
|
(215
|
)
|
|
|
(79
|
)
|
|
|
294
|
|
|
|
(557
|
)
|
|
|
(263
|
)
|
|
State and political subdivision securities
|
|
|
(11
|
)
|
|
|
(102
|
)
|
|
|
(113
|
)
|
|
|
5
|
|
|
|
(138
|
)
|
|
|
(133
|
)
|
|
Corporate bonds
|
|
|
33
|
|
|
|
(225
|
)
|
|
|
(192
|
)
|
|
|
88
|
|
|
|
(262
|
)
|
|
|
(174
|
)
|
|
Loans
|
|
|
(468
|
)
|
|
|
(508
|
)
|
|
|
(976
|
)
|
|
|
(805
|
)
|
|
|
(1,236
|
)
|
|
|
(2,041
|
)
|
|
FHLB stock
|
|
|
(1
|
)
|
|
|
(4
|
)
|
|
|
(5
|
)
|
|
|
(3
|
)
|
|
|
(8
|
)
|
|
|
(11
|
)
|
|
Interest bearing deposits
|
|
|
14
|
|
|
|
41
|
|
|
|
55
|
|
|
|
10
|
|
|
|
56
|
|
|
|
66
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest earning assets
|
|
|
(296
|
)
|
|
|
(1,013
|
)
|
|
|
(1,309
|
)
|
|
|
(389
|
)
|
|
|
(2,194
|
)
|
|
|
(2,583
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Savings accounts
|
|
|
(27
|
)
|
|
|
3
|
|
|
|
(24
|
)
|
|
|
(53
|
)
|
|
|
8
|
|
|
|
(45
|
)
|
|
NOW and money market accounts
|
|
|
(75
|
)
|
|
|
2
|
|
|
|
(73
|
)
|
|
|
(191
|
)
|
|
|
4
|
|
|
|
(187
|
)
|
|
Certificates of deposit and other time deposits
|
|
|
(165
|
)
|
|
|
(369
|
)
|
|
|
(534
|
)
|
|
|
(393
|
)
|
|
|
(869
|
)
|
|
|
(1,262
|
)
|
|
FHLB advances
|
|
|
22
|
|
|
|
(15
|
)
|
|
|
7
|
|
|
|
28
|
|
|
|
(17
|
)
|
|
|
11
|
|
|
Subordinated debentures
|
|
|
(90
|
)
|
|
|
-
|
|
|
|
(90
|
)
|
|
|
(90
|
)
|
|
|
-
|
|
|
|
(90
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest bearing liabilities
|
|
|
(335
|
)
|
|
|
(379
|
)
|
|
|
(714
|
)
|
|
|
(699
|
)
|
|
|
(874
|
)
|
|
|
(1,573
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in net interest income
|
|
$
|
39
|
|
|
$
|
(634
|
)
|
|
$
|
(595
|
)
|
|
$
|
310
|
|
|
$
|
(1,320
|
)
|
|
$
|
(1,010
|
)
|
NON-INTEREST INCOME AND NON-INTEREST
EXPENSE
The following tables compare the components
of non-interest income and expenses for the periods ended June 30, 2014 and 2013. The tables show the dollar and percentage change
from 2013 to 2014. Below each table is a discussion of significant changes and trends.
|
|
|
Three Months Ended
|
|
|
|
|
June 30,
|
|
|
(Dollars in thousands)
|
|
2014
|
|
|
2013
|
|
|
Change
|
|
|
%
|
|
|
Non-interest income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer service fees on deposit accounts
|
|
$
|
1,350
|
|
|
$
|
1,307
|
|
|
$
|
43
|
|
|
|
3.3
|
%
|
|
Gain on sale of mortgage loans
|
|
|
101
|
|
|
|
161
|
|
|
|
(60
|
)
|
|
|
-37.3
|
%
|
|
Gain on sale of investments
|
|
|
384
|
|
|
|
334
|
|
|
|
50
|
|
|
|
15.0
|
%
|
|
Loss on sale of investments
|
|
|
(356
|
)
|
|
|
(334
|
)
|
|
|
(22
|
)
|
|
|
6.6
|
%
|
|
Loss on sale and write downs of real estate acquired through foreclosure
|
|
|
(496
|
)
|
|
|
(532
|
)
|
|
|
36
|
|
|
|
-6.8
|
%
|
|
Gain on sale on real estate acquired through foreclosure
|
|
|
1
|
|
|
|
150
|
|
|
|
(149
|
)
|
|
|
-99.3
|
%
|
|
Other income
|
|
|
510
|
|
|
|
600
|
|
|
|
(90
|
)
|
|
|
-15.0
|
%
|
|
|
|
$
|
1,494
|
|
|
$
|
1,686
|
|
|
$
|
(192
|
)
|
|
|
-11.4
|
%
|
|
|
|
Six Months Ended
|
|
|
|
|
June 30,
|
|
|
(Dollars in thousands)
|
|
2014
|
|
|
2013
|
|
|
Change
|
|
|
%
|
|
|
Non-interest income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer service fees on deposit accounts
|
|
$
|
2,600
|
|
|
$
|
2,498
|
|
|
$
|
102
|
|
|
|
4.1
|
%
|
|
Gain on sale of mortgage loans
|
|
|
160
|
|
|
|
588
|
|
|
|
(428
|
)
|
|
|
-72.8
|
%
|
|
Gain on sale of investments
|
|
|
532
|
|
|
|
843
|
|
|
|
(311
|
)
|
|
|
-36.9
|
%
|
|
Loss on sale of investments
|
|
|
(567
|
)
|
|
|
(616
|
)
|
|
|
49
|
|
|
|
-8.0
|
%
|
|
Loss on sale and write downs of real estate acquired through foreclosure
|
|
|
(501
|
)
|
|
|
(1,592
|
)
|
|
|
1,091
|
|
|
|
-68.5
|
%
|
|
Gain on sale on real estate acquired through foreclosure
|
|
|
30
|
|
|
|
207
|
|
|
|
(177
|
)
|
|
|
-85.5
|
%
|
|
Other income
|
|
|
1,033
|
|
|
|
1,212
|
|
|
|
(179
|
)
|
|
|
-14.8
|
%
|
|
|
|
$
|
3,287
|
|
|
$
|
3,140
|
|
|
$
|
147
|
|
|
|
4.7
|
%
|
We originate qualified Veterans Affairs
(VA), Kentucky Housing Corporation (KHC), Rural Housing Corporation (RHC) and conventional secondary market loans and sell them
into the secondary market with servicing rights released. Gain on sale of mortgage loans decreased for 2014 due to a decrease
in the volume and the yield earned on loans refinanced, originated and sold compared to 2013.
We invest
in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, obligations
of states and political subdivisions, corporate bonds, mutual funds, stocks and others. During 2014 we recorded a net loss on
the sale of debt investment securities of $35,000 compared to a net gain on sale of debt investment securities of $227,000 for
the 2013 period
.
Losses of $501,000 recorded on the sale
and write down of real estate owned properties reduced non-interest income for 2014. Gains of $30,000 on the sale of nine real
estate owned properties partially offset the losses and write downs.
The decrease in other income for the 2014
period resulted from decreases in income received on real estate owned properties after the sale of these properties.
|
|
|
Three Months Ended
|
|
|
|
|
June 30,
|
|
|
(Dollars in thousands)
|
|
2014
|
|
|
2013
|
|
|
Change
|
|
|
%
|
|
|
Non-interest expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee compensation and benefits
|
|
$
|
4,194
|
|
|
$
|
3,757
|
|
|
$
|
437
|
|
|
|
11.6
|
%
|
|
Office occupancy expense and equipment
|
|
|
696
|
|
|
|
690
|
|
|
|
6
|
|
|
|
0.9
|
%
|
|
Outside services and data processing
|
|
|
941
|
|
|
|
941
|
|
|
|
-
|
|
|
|
0.0
|
%
|
|
Bank franchise tax
|
|
|
279
|
|
|
|
315
|
|
|
|
(36
|
)
|
|
|
-11.4
|
%
|
|
FDIC insurance premiums
|
|
|
454
|
|
|
|
505
|
|
|
|
(51
|
)
|
|
|
-10.1
|
%
|
|
Real estate acquired through foreclosure expense
|
|
|
690
|
|
|
|
524
|
|
|
|
166
|
|
|
|
31.7
|
%
|
|
Loan expense
|
|
|
380
|
|
|
|
385
|
|
|
|
(5
|
)
|
|
|
-1.3
|
%
|
|
Other expense
|
|
|
2,042
|
|
|
|
1,446
|
|
|
|
596
|
|
|
|
41.2
|
%
|
|
|
|
$
|
9,676
|
|
|
$
|
8,563
|
|
|
$
|
1,113
|
|
|
|
13.0
|
%
|
|
|
|
Six Months Ended
|
|
|
|
|
June 30,
|
|
|
(Dollars in thousands)
|
|
2014
|
|
|
2013
|
|
|
Change
|
|
|
%
|
|
|
Non-interest expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee compensation and benefits
|
|
$
|
7,735
|
|
|
$
|
7,550
|
|
|
$
|
185
|
|
|
|
2.5
|
%
|
|
Office occupancy expense and equipment
|
|
|
1,389
|
|
|
|
1,398
|
|
|
|
(9
|
)
|
|
|
-0.6
|
%
|
|
Outside services and data processing
|
|
|
1,917
|
|
|
|
1,804
|
|
|
|
113
|
|
|
|
6.3
|
%
|
|
Bank franchise tax
|
|
|
594
|
|
|
|
630
|
|
|
|
(36
|
)
|
|
|
-5.7
|
%
|
|
FDIC insurance premiums
|
|
|
920
|
|
|
|
1,194
|
|
|
|
(274
|
)
|
|
|
-22.9
|
%
|
|
Real estate acquired through foreclosure expense
|
|
|
776
|
|
|
|
818
|
|
|
|
(42
|
)
|
|
|
-5.1
|
%
|
|
Loan expense
|
|
|
565
|
|
|
|
607
|
|
|
|
(42
|
)
|
|
|
-6.9
|
%
|
|
Other expense
|
|
|
3,258
|
|
|
|
2,862
|
|
|
|
396
|
|
|
|
13.8
|
%
|
|
|
|
$
|
17,154
|
|
|
$
|
16,863
|
|
|
$
|
291
|
|
|
|
1.7
|
%
|
Employee compensation and benefits increased
during 2014 due to the immediate vesting of all outstanding and unvested stock options and restricted stock awards when we entered
into the Share Exchange Agreement with CBIN on April 21, 2014. During the second quarter of 2014 we recorded $814,000 in additional
compensation expense related to the immediate vesting of options and stock awards.
FDIC insurance premiums are based on the
FDIC’s assessment base and rate structure. The assessment base is defined as the average consolidated total assets less
average Tier I Capital. As a result of the decrease in total deposits for 2014, FDIC insurance premiums have been reduced.
Real estate acquired through foreclosure
expense increased for the second quarter of 2014 due to an increase of $458,000 in provision expense based on the contract sales
price of one of our real estate owned properties we agreed to sell.
The increase in other expense for the
2014 period is due to higher legal expense arising from the Share Exchange Agreement and regulatory exam-related expenses. We
recorded a $160,000 civil money penalty assessed from a 2012 FDIC exam violation and a $170,000 restitution of daily overdraft
fees assessed from a 2013 FDIC compliance exam violation during the second quarter of 2014.
Income Taxes
The provision
for income taxes includes federal and state income taxes and in 2014 and 2013 reflects a full valuation allowance against all
of our deferred tax assets.
An income tax benefit of $879,000 and $967,000 was recorded for
the quarter and six month period ended June 30, 2014 compared to income tax expense of $1,000 recorded for both the quarter and
six month 2013 periods. Our June 30, 2014 tax benefit is entirely due to gains in other comprehensive income that are presented
in current operations in accordance with applicable accounting standards. Historically, the fluctuations in effective tax rates
reflect the effect of permanent differences in the inclusion or deductibility of certain income and expenses, respectively, for
income tax purposes.
A valuation allowance related to deferred
tax assets is required when it is considered more likely than not that all or part of the benefit related to such assets will
not be realized. In assessing the need for a valuation allowance, we considered all positive and negative evidence including our
five year cumulative loss position, the level of our non-performing assets, our inability to meet our forecasted levels of assets
and full year operating results in 2013, 2012 and 2011 and the degree of our compliance with the capital requirements of our Consent
Order. Based on this assessment, we concluded that a valuation allowance was necessary at June 30, 2014 and December 31, 2013.
Our future effective income tax rate will fluctuate based on the mix of taxable and tax free investments we make and, to a greater
extent, the impact of changes in the required amount of valuation allowance recorded against our net deferred tax assets and our
overall level of taxable income.
Recording a valuation allowance does not
have any impact on our liquidity, nor does it preclude us from using the tax losses, tax credits or other timing differences in
the future. To the extent that we generate taxable income in a given quarter, the valuation allowance may be reduced to fully
or partially offset the corresponding income tax expense. Any remaining deferred tax asset valuation allowance may be reversed
through income tax expense once we can demonstrate a sustainable return to profitability and conclude that it is more likely than
not the deferred tax asset will be utilized prior to expiration.
ANALYSIS OF FINANCIAL CONDITION
Total assets at June 30, 2014 decreased
$56.3 million compared to total assets at December 31, 2013. The decrease was primarily attributable to a decline of $57.1 million
in available-for-sale securities and a decline of $11.5 million in total loans offset by an increase in cash and cash equivalents
of $16.5 million. Total deposits decreased $59.9 million due to an intentional reduction in certificates of deposit as we focus
on restructuring the balance sheet to decrease our cost of funds and improve net interest income.
Loans
Total loans decreased $11.5 million to
$455.4 million at June 30, 2014 compared to $466.9 million at December 31, 2013. Our commercial real estate portfolio decreased
$12.1 million to $267.8 million at June 30, 2014. The decline in the total loan portfolio is primarily the result of pay-offs,
charge-offs, and loans being transferred to real estate acquired through foreclosure for commercial real estate loans, which together
exceeded the volume of new loans originated. The decline in the loan portfolio was also due, in part, to our ongoing efforts to
resolve problem loans. In addition, we have elected not to replace much of this loan run-off in order to reduce asset size and
increase our regulatory capital ratios in light of the higher regulatory capital requirements imposed by our Consent Order.
|
|
|
June 30,
|
|
|
December 31,
|
|
|
(Dollars in thousands)
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
|
|
Commercial Real Estate:
|
|
|
|
|
|
|
|
|
|
Other
|
|
$
|
249,727
|
|
|
$
|
257,901
|
|
|
Land Development
|
|
|
16,636
|
|
|
|
20,476
|
|
|
Building Lots
|
|
|
1,480
|
|
|
|
1,559
|
|
|
Residential mortgage
|
|
|
98,566
|
|
|
|
99,344
|
|
|
Consumer and home equity
|
|
|
51,473
|
|
|
|
54,010
|
|
|
Commercial
|
|
|
24,479
|
|
|
|
20,621
|
|
|
Indirect consumer
|
|
|
13,075
|
|
|
|
13,041
|
|
|
|
|
|
455,436
|
|
|
|
466,952
|
|
|
Less:
|
|
|
|
|
|
|
|
|
|
Net deferred loan origination fees
|
|
|
(67
|
)
|
|
|
(90
|
)
|
|
Allowance for loan losses
|
|
|
(9,538
|
)
|
|
|
(9,576
|
)
|
|
|
|
|
(9,605
|
)
|
|
|
(9,666
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net Loans
|
|
$
|
445,831
|
|
|
$
|
457,286
|
|
Allowance and Provision for Loan
Losses
Our financial performance depends on the
quality of the loans we originate and management’s ability to assess the degree of risk in existing loans when it determines
the allowance for loan losses. An increase in loan charge-offs or non-performing loans or an inadequate allowance for loan losses
could reduce net interest income, net income and capital, and limit the range of products and services we can offer.
Management, which is comprised of senior
officers and certain accounting and credit associates, evaluates the allowance for loan losses monthly to maintain a level it
believes to be sufficient to absorb probable incurred credit losses existing in the loan portfolio. Periodic provisions to the
allowance are made as needed. The size of the allowance is determined by applying loss estimates to graded loans by categories,
as described below. When appropriate, a specific reserve will be established for individual impaired loans based upon the risk
classification and the estimated potential for loss. In accordance with our credit management processes, we obtain new appraisals
on properties securing our non-performing commercial and commercial real estate loans and use those appraisals to determine specific
reserves within the allowance for loan losses. The Loan Appraisal Committee determines when appraisals must be obtained and reviews
appraisals once received. The Loan Appraisal Committee also reviews all non-accrual and restructured loan relationships. As we
receive new appraisals on properties securing non-performing loans, we recognize charge-offs and adjust specific reserves as appropriate.
In addition, management, which is comprised of senior officers and certain accounting and credit associates, analyzes such factors
as changes in lending policies and procedures; real estate market conditions; underwriting standards; collection; charge-off and
recovery history; changes in national and local economic business conditions and developments; changes in the characteristics
of the portfolio; ability and depth of lending management and staff; changes in the trend of the volume and severity of past due,
non-accrual and classified loans; troubled debt restructuring and other loan modifications; and results of regulatory examinations.
Declines in collateral values, including
commercial real estate, may impact our ability to collect on certain loans when borrowers are dependent on the values of the real
estate as a source of cash flow. While we anticipate that challenges will continue in the foreseeable future as we manage the
overall level of our credit quality, we believe that credit quality and real estate values appear to be stabilizing as compared
to the period before 2012. As a result of the relative stabilization in real estate values during 2013 and 2014, our provision
for loan losses decreased compared to the three prior years.
As discussed in the Regulatory Matters
to this section, we have entered into a Consent Order with bank regulatory agencies. In addition to increasing capital ratios,
we agreed to maintain adequate reserves for loan losses, develop and implement plans to reduce the level of non-performing assets
and concentrations of credit in commercial real estate loans, implement revised credit risk management practices and credit administration
policies and procedures, and report our progress to the regulators.
The following table analyzes our loan
loss experience for the periods indicated.
|
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
(Dollars in thousands)
|
|
2014
|
|
|
2013
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of period
|
|
$
|
9,608
|
|
|
$
|
15,812
|
|
|
$
|
9,576
|
|
|
$
|
17,265
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans charged-off:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage
|
|
|
15
|
|
|
|
-
|
|
|
|
19
|
|
|
|
-
|
|
|
Consumer & home equity
|
|
|
26
|
|
|
|
92
|
|
|
|
68
|
|
|
|
155
|
|
|
Commercial & commercial real estate
|
|
|
268
|
|
|
|
61
|
|
|
|
302
|
|
|
|
546
|
|
|
Total charge-offs
|
|
|
309
|
|
|
|
153
|
|
|
|
389
|
|
|
|
701
|
|
|
Recoveries:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage
|
|
|
12
|
|
|
|
4
|
|
|
|
15
|
|
|
|
4
|
|
|
Consumer & home equity
|
|
|
44
|
|
|
|
48
|
|
|
|
90
|
|
|
|
90
|
|
|
Commercial & commercial real estate
|
|
|
83
|
|
|
|
24
|
|
|
|
146
|
|
|
|
114
|
|
|
Total recoveries
|
|
|
139
|
|
|
|
76
|
|
|
|
251
|
|
|
|
208
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loans charged-off
|
|
|
170
|
|
|
|
77
|
|
|
|
138
|
|
|
|
493
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for loan losses
|
|
|
100
|
|
|
|
212
|
|
|
|
100
|
|
|
|
(825
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
$
|
9,538
|
|
|
$
|
15,947
|
|
|
$
|
9,538
|
|
|
$
|
15,947
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for loan losses to total loans
|
|
|
2.09
|
%
|
|
|
3.25
|
%
|
|
|
2.09
|
%
|
|
|
3.25
|
%
|
|
Annualized net charge-offs to average loans outstanding
|
|
|
0.15
|
%
|
|
|
0.06
|
%
|
|
|
0.06
|
%
|
|
|
0.19
|
%
|
|
Allowance for loan losses to total non-performing loans
|
|
|
74
|
%
|
|
|
89
|
%
|
|
|
74
|
%
|
|
|
89
|
%
|
Provision for loan losses decreased $112,000
to $100,000 for the three months ended June 30, 2014 compared to the same period ended June 30, 2013. Provision for loan losses
increased $925,000 for the six months ended June 30, 2014 compared to the same six month period in 2013. We recorded a reversal
of provision expense for the 2013 six month period due to a decline in the size of our loan portfolio, a lower level of classified
loans compared to 2012, declining historical loss rates, and a reduction in the specific reserves allocated to several relationships
based upon improved credit quality.
The allowance for loan losses was $9.5
million at June 30, 2014, a decrease of $6.4 million compared to 2013.
The decrease was driven by net charge-offs of $4.1
million taken during 2013, including specific reserves of $3.1 million charged off on our collateral dependent loans. The allowance
for loan losses as a percent of total loans was 2.09% for June 30, 2014 compared to 3.25% at June 30, 2013. Specific reserves
allocated to substandard loans made up 33% of the total allowance for loan loss at June 30, 2014 compared to 45% at June 30, 2013.
Net charge-offs for the 2014 period included $6,000 in partial charge-offs compared to partial charge-offs of $417,000 for the
2013 period.
Allowance for loan losses to total non-performing
loans decreased to 74% at June 30, 2014 from 89% at June 30, 2013. The decrease in the coverage ratio for 2014 was driven by a
significant decline in the allowance balance which more than offsets the decline in non-performing loans. The allowance for loan
loss for loans evaluated individually for impairment as a percentage of loans evaluated individually for impairment declined from
17.4% at June 30, 2013 to 9.3% at June 30, 2014, as specific reserves were charged off related to loans evaluated individually
for impairment and deemed collateral dependent during the period. Once charged down to net realizable value, our impairment analysis
for these individually evaluated collateral-dependent loans indicated that no additional reserves were required.
Federal regulations require banks to classify
their own assets on a regular basis. The regulations provide for three categories of classified loans — substandard, doubtful
and loss. In addition, we also classify loans as criticized. Loans classified as criticized have a potential weakness that deserves
management’s close attention.
The following table provides information
with respect to criticized and classified loans for the periods indicated:
|
|
|
June 30,
|
|
|
March 31,
|
|
|
December 31,
|
|
|
September 30,
|
|
|
June 30,
|
|
|
(Dollars in thousands)
|
|
2014
|
|
|
2014
|
|
|
2013
|
|
|
2013
|
|
|
2013
|
|
|
Criticized Loans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Criticized
|
|
$
|
13,799
|
|
|
$
|
18,614
|
|
|
$
|
18,329
|
|
|
$
|
22,456
|
|
|
$
|
27,892
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Classified Loans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Substandard
|
|
$
|
33,528
|
|
|
$
|
34,353
|
|
|
$
|
37,479
|
|
|
$
|
45,798
|
|
|
$
|
41,256
|
|
|
Doubtful
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Total Classified
|
|
$
|
33,528
|
|
|
$
|
34,353
|
|
|
$
|
37,479
|
|
|
$
|
45,798
|
|
|
$
|
41,256
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Criticized and Classified
|
|
$
|
47,327
|
|
|
$
|
52,967
|
|
|
$
|
55,808
|
|
|
$
|
68,254
|
|
|
$
|
69,148
|
|
Total criticized and classified loans
declined by $8.5 million or 15% from December 31, 2013 and by $21.8 million or 32% from June 30, 2013. Contributing to the decline
since December were two commercial real estate relationships totaling $4.6 million that were upgraded from criticized to pass
status. Approximately $29.7 million or 88% of the total classified loans at June 30, 2014 were related to commercial real estate
loans in our market area. Classified consumer loans totaled $411,000, classified mortgage loans totaled $2.6 million and classified
commercial loans totaled $786,000. Our decision to record $100,000 in provision for loan losses during 2014 resulted from the
application of a consistent allowance methodology that is driven by risk ratings and historical loss trends adjusted for qualitative
factors. For more information on collection efforts, evaluation of collateral and how loss amounts are estimated, see “Non-Performing
Assets,” below.
Although we may allocate a portion of
the allowance to specific loans or loan categories, the entire allowance is available for charge-offs. We develop our allowance
estimates based on actual loss experience adjusted for current economic conditions. Allowance estimates represent a prudent measurement
of the risk in the loan portfolio, which we apply to individual loans based on loan type. We have allocated additional resources
to address credit quality and facilitate the structure and processes to diversify and strengthen our lending function. Credit
quality will continue to be a primary focus in 2014 and going forward.
Non-Performing Assets
Non-performing assets consist of certain
non-accruing restructured loans for which the interest rate or other terms have been renegotiated, loans past due 90 days or more
still on accrual, loans on which interest is no longer accrued, real estate acquired through foreclosure, and repossessed assets.
Three bank lots originally acquired for expansion but now held for sale are also classified as non-performing assets. Loans, including
impaired loans, are placed on non-accrual status when they become past due 90 days or more as to principal or interest, unless
they are adequately secured and in the process of collection. Loans are considered impaired when we no longer anticipate full
principal or interest will be paid in accordance with the contractual loan terms. Impaired loans are carried at the present value
of estimated future cash flows discounted at the loan’s effective interest rate, or at the fair value of the collateral
less cost to sell if the loan is collateral dependent.
Non-accrual loans that have been restructured
remain on non-accrual status until we determine the future collection of principal and interest is reasonably assured, which will
require that the borrower demonstrate a period of performance in accordance to the restructured terms of six months or more. Accruing
loans that have been restructured are evaluated for non-accrual status based on a current evaluation of the borrower’s financial
condition and ability and willingness to service the modified debt.
We review our loans on a regular basis
and implement normal collection procedures when a borrower fails to make a required payment on a loan. If the delinquency on a
mortgage loan exceeds 90 days and is not cured through normal collection procedures, or an acceptable arrangement is not worked
out with the borrower, we institute measures to remedy the default, including commencing a foreclosure action. We generally charge
off consumer loans when management deems a loan uncollectible and any available collateral has been liquidated. We handle commercial
business and real estate loan delinquencies on an individual basis. These loans are placed on non-accrual status upon becoming
contractually past due 90 days or more as to principal and interest or where substantial doubt about full repayment of principal
and interest is evident.
We recognize interest income on loans
on the accrual basis except for those loans in a non-accrual of income status. We discontinue accruing interest on impaired loans
when management believes, after consideration of economic and business conditions and collection efforts, that the borrowers’
financial condition is such that collection of interest is doubtful, typically after the loan becomes 90 days delinquent. When
interest accrual is discontinued, existing accrued interest is reversed and interest income is subsequently recognized only to
the extent we receive cash payments and are assured of repayment of all outstanding principal.
We require appraisals and perform evaluations
on impaired assets upon initial identification. Thereafter, we obtain appraisals or perform market value evaluations on
impaired assets at least annually. Recognizing the volatility of certain assets, we assess the transaction and market
conditions to determine if updated appraisals are needed more frequently than annually. Additionally, we evaluate the collateral
condition and value in the event of foreclosure.
We classify real estate acquired as a
result of foreclosure or by deed in lieu of foreclosure as real estate owned until such time as it is sold. We classify new and
used automobile, motorcycle and all-terrain vehicles acquired as a result of foreclosure as repossessed assets until they are
sold. When such property is acquired we record it at fair value less estimated selling costs. We charge any write-down of the
property at the time of acquisition to the allowance for loan losses. Subsequent gains and losses are included in non-interest
income and non-interest expense.
Real estate owned acquired through foreclosure
is recorded at fair value less estimated selling costs at the date of foreclosure. Fair value is based on the appraised market
value of the property based on sales of similar assets. The value may be subsequently reduced if the estimated fair value declines
below the original appraised value. We monitor market information and the age of appraisals on existing real estate owned properties
and obtain new appraisals as circumstances warrant. Real estate acquired through foreclosure was $11.2 million, a decrease of
$414,000 from December 31, 2013 and a decrease of $2.9 million from June 30, 2013. We believe that our level of real estate acquired
through foreclosure has stabilized, as the inflow of properties has slowed down substantially compared to 2013, 2012 and 2011.
All properties held in OREO are listed for sale with various independent real estate agents.
A summary of the real estate acquired
through foreclosure activity is as follows:
|
|
|
June 30,
|
|
|
December 31,
|
|
|
(Dollars in thousands)
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
|
|
Beginning balance, January 1,
|
|
$
|
11,657
|
|
|
$
|
22,286
|
|
|
Additions
|
|
|
1,026
|
|
|
|
8,713
|
|
|
Net proceeds from sale of properties
|
|
|
(483
|
)
|
|
|
(17,076
|
)
|
|
Writedowns
|
|
|
(499
|
)
|
|
|
(2,185
|
)
|
|
Change in valuation allowance
|
|
|
(458
|
)
|
|
|
(81
|
)
|
|
Ending balance
|
|
$
|
11,243
|
|
|
$
|
11,657
|
|
The following table provides information
with respect to non-performing assets for the periods indicated.
|
|
|
June 30,
|
|
|
March 31,
|
|
|
December 31,
|
|
|
September 30,
|
|
|
June 30,
|
|
|
(Dollars in thousands)
|
|
2014
|
|
|
2014
|
|
|
2013
|
|
|
2013
|
|
|
2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructured on non-accrual status
|
|
$
|
5,792
|
|
|
$
|
1,170
|
|
|
$
|
1,310
|
|
|
$
|
7,927
|
|
|
$
|
8,639
|
|
|
Restructured past due 90 days still on accrual
|
|
|
-
|
|
|
|
-
|
|
|
|
4,780
|
|
|
|
4,837
|
|
|
|
-
|
|
|
Past due 90 days still on accrual
|
|
|
-
|
|
|
|
-
|
|
|
|
2,226
|
|
|
|
2,238
|
|
|
|
-
|
|
|
Loans on non-accrual status
|
|
|
7,171
|
|
|
|
7,688
|
|
|
|
9,096
|
|
|
|
6,511
|
|
|
|
9,215
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total non-performing loans
|
|
|
12,963
|
|
|
|
8,858
|
|
|
|
17,412
|
|
|
|
21,513
|
|
|
|
17,854
|
|
|
Real estate acquired through foreclosure
|
|
|
11,243
|
|
|
|
12,260
|
|
|
|
11,657
|
|
|
|
8,859
|
|
|
|
14,169
|
|
|
Real estate owned-bank lots
|
|
|
1,446
|
|
|
|
1,446
|
|
|
|
1,469
|
|
|
|
-
|
|
|
|
-
|
|
|
Other repossessed assets
|
|
|
5
|
|
|
|
32
|
|
|
|
37
|
|
|
|
16
|
|
|
|
37
|
|
|
Total non-performing assets
|
|
$
|
25,657
|
|
|
$
|
22,596
|
|
|
$
|
30,575
|
|
|
$
|
30,388
|
|
|
$
|
32,060
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income that would have been earned on non-performing loans
|
|
$
|
644
|
|
|
$
|
446
|
|
|
$
|
902
|
|
|
$
|
1,127
|
|
|
$
|
946
|
|
|
Interest income recognized on non-performing loans
|
|
|
-
|
|
|
|
-
|
|
|
|
246
|
|
|
|
38
|
|
|
|
-
|
|
|
Ratios: Non-performing loans to total loans
|
|
|
2.85
|
%
|
|
|
1.93
|
%
|
|
|
3.73
|
%
|
|
|
4.52
|
%
|
|
|
3.64
|
%
|
|
Non-performing assets to total loans
|
|
|
5.63
|
%
|
|
|
4.92
|
%
|
|
|
6.55
|
%
|
|
|
6.38
|
%
|
|
|
6.54
|
%
|
Non-performing loans declined by $4.4
million to $13.0 million at June 30, 2014 compared to December 31, 2013 and increased by $4.1 million compared to March 31, 2014.
The change in non-accrual loans from December 31, 2013 was due to the transfer of a non-accrual relationship totaling $725,000
to real estate acquired through foreclosure offset by the transfer of two commercial real estate relationships totaling $4.6 million
from accrual status. Two commercial real estate relationships, one totaling $2.2 million and the other totaling $4.8 million were
transferred from 90 days past due and still on accrual to accrual status as both relationships are performing as to the payment
of principal and interest.
Restructured loans on nonaccrual status
will be placed back on accrual status if we determine that the future collection of principal and interest is reasonably assured,
which requires that the borrower demonstrate a period of performance of at least six months in accordance to the restructured
terms. All non-performing loans are considered impaired.
The following table shows our restructured
loans for the periods indicated.
|
|
|
June 30,
|
|
|
December 31,
|
|
|
(Dollar in thousands)
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
|
|
Restructured loans on non-accrual
|
|
$
|
5,792
|
|
|
$
|
1,310
|
|
|
Restructured past due 90 days still on accrual
|
|
|
-
|
|
|
|
4,780
|
|
|
Restructured loans on accrual
|
|
|
17,746
|
|
|
|
18,963
|
|
|
|
|
|
|
|
|
|
|
|
|
Total restructured loans
|
|
$
|
23,538
|
|
|
$
|
25,053
|
|
Restructured loans on accrual decreased
during 2014 due to the pay-off of a commercial real estate relationship totaling $358,000 and the reclassification of two commercial
real estate loans totaling $4.6 million to non-accrual status offset by the reclassification of a commercial real estate relationship
totaling $4.8 million from past due 90 days still on accrual status.
The terms of our restructured loans have
been renegotiated to reduce the rate of interest or extend the term, thus reducing the amount of cash flow required from the borrower
to service the loans. We anticipate that our level of restructured loans will remain elevated as we identify borrowers in financial
difficulty and work with them to modify to more affordable terms. We have worked with customers when feasible to establish “A”
and “B” note structures. The “B” note is charged-off on our books but remains an outstanding balance for
the customer. These typically carry a very nominal or low rate of interest. The “A” note is a note structured on a
proper basis meeting internal policy standards for a performing loan. After six months of performance, the “A” note
restructured loan is eligible to be placed back on an accrual basis as a performing troubled debt restructured loan.
Investment Securities
Interest on securities provides us our
largest source of interest income after interest on loans, constituting 19.9% of the total interest income for the six months
ended June 30, 2014. The securities portfolio serves as a source of liquidity and earnings, and contributes to the management
of interest rate risk. We have the authority to invest in various types of liquid assets, including short-term United States Treasury
obligations and securities of various federal agencies, obligations of states and political subdivisions, corporate bonds, certificates
of deposit at insured savings institutions and banks, bankers' acceptances, and federal funds. We may also invest a portion of
our assets in certain commercial paper, collateralized loan obligations and corporate debt securities. We are also authorized
to invest in mutual funds and stocks whose assets conform to the investments that we are authorized to make directly. The investment
portfolio decreased by $57.1 million primarily due to sales of corporate bonds and CLOs, which sales were offset by the purchases
of higher yielding investments. Recent purchases have been high cash flow instruments with short average lives in order to decrease
the volatility of the investment portfolio as well as to provide cash flow and limit interest rate risk.
We evaluate investment securities with
significant declines in fair value on a quarterly basis to determine whether they should be considered other-than-temporarily
impaired under current accounting guidance, which generally provides that if a security is in an unrealized loss position, whether
due to general market conditions or industry or issuer-specific factors, the holder of the securities must assess whether the
impairment is other-than-temporary. We consider the length of time and the extent to which the fair value has been less than cost,
the financial condition and near-term prospects of the issuer, and whether management has the intent to sell the debt security
or whether it is more likely than not that we will be required to sell the debt security before its anticipated recovery. In analyzing
an issuer’s financial condition, we may consider whether the securities are issued by the federal government or its agencies,
whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition.
The unrealized losses on our investment
securities were a result of changes in interest rates for fixed-rate securities where the interest rate received is less than
the current rate available for new offerings of similar securities. Because the decline in market value is attributable to changes
in interest rates and not credit quality, and because we do not intend to sell and it is more likely than not that we will not
be required to sell these investments until recovery of fair value, which may be maturity, we did not consider these investments
to be other-than-temporarily impaired at June 30, 2014. See Note 3 – Securities for more information.
At June 30, 2014, we own five collateralized
loan obligation (“CLO”) securities subject to the Volcker Rule, with an amortized cost of $14.8 million and a net
unrealized loss of $389,000. Absent changes to the Volcker Rule, we would be required to dispose of these securities before July
2017. We believe the unrealized loss reflected results not from credit risk but from interest rate changes and to the uncertainty
created by the Volcker Rule. In the first quarter of 2014, we sold four of our CLOs and in the second quarter of 2014 we recorded
partial sales on three of our CLOs to confirm their marketability and evaluate our assessment about their market values. We recorded
a loss of $286,000 on these sales.
Deposits
We rely primarily on providing excellent
customer service and on our long-standing relationships with customers to attract and retain deposits. Market interest rates and
rates on deposit products offered by competing financial institutions can significantly affect our ability to attract and retain
deposits. We attract both short-term and long-term deposits from the general public by offering a wide range of deposit accounts
and interest rates. In recent years market conditions have caused us to rely increasingly on short-term certificate accounts and
other deposit alternatives that are more responsive to market interest rates. We use forecasts based on interest rate risk simulations
to assist management in monitoring our use of certificates of deposit and other deposit products as funding sources and the impact
of the use of those products on interest income and net interest margin in various rate environments.
Historically, we have utilized certificates
of deposit placed by deposit brokers and deposits obtained through the CDARs program to support our asset growth. The CDARS system
enables certificates of deposit that would exceed the current $250,000 FDIC coverage limit on deposits in a single financial institution
to be redistributed to other financial institutions within the CDARS network in increments under the current coverage limit. However,
due to the Bank’s designation as a “troubled institution,” we can no longer accept, renew or roll over brokered
deposits (including deposits obtained through the CDARs program) without prior regulatory approval.
Total deposits decreased $59.9 million
since December 31, 2013. Public funds decreased $24.9 million while retail and commercial deposits decreased $35.0 million. We
have public funds deposits from school boards, water districts and municipalities within our markets. These deposits are larger
than individual retail depositors. However, we do not have a deposit relationship that we believe is significant enough to cause
a negative impact on our liquidity position. Brokered deposits were $22.7 million at June 30, 2014, decreasing by $4.6 million
from $27.3 million at December 31, 2013.
The following table shows the amount of
our brokered deposits by time remaining until maturity.
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
2014
|
|
$
|
4,025
|
|
|
2015
|
|
|
3,258
|
|
|
2016
|
|
|
1,188
|
|
|
2017
|
|
|
-
|
|
|
2018
|
|
|
4,609
|
|
|
2019
|
|
|
9,636
|
|
|
|
|
$
|
22,716
|
|
We are currently a member of Qwickrate,
which is a premier non-brokered market place that we use as an additional low cost funding source. Qwickrate deposits totaled
$18.0 million at June 30, 2014 compared to $18.2 million at December 31, 2013. We do not anticipate a negative impact as a result
of not being able to renew our current $22.7 million of brokered deposits due to additional funding sources such as Qwickrate,
decreased loan generation, continued loan pay downs, and our highly liquid and mostly short-term investment portfolio.
We have deployed additional resources
to try to reduce our cost of funds in this low rate environment. The Consent Order resulted in the Bank being categorized as a
"troubled institution" by bank regulators, which limits the interest rate the Bank can pay on interest bearing deposits.
Unless the Bank is granted a waiver because it resides in a market that the FDIC determines is a high rate market, the Bank is
limited to paying deposit interest rates .75% above the average rates computed by the FDIC. The Bank has elected not to pursue
such a waiver and to adhere to the average rates computed by the FDIC plus the .75% rate cap.
The following table breaks down our deposits.
|
|
|
June 30,
|
|
|
December 31,
|
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
|
|
|
|
|
Non-interest bearing
|
|
$
|
89,196
|
|
|
$
|
78,480
|
|
|
NOW demand
|
|
|
169,761
|
|
|
|
192,514
|
|
|
Savings
|
|
|
95,258
|
|
|
|
90,176
|
|
|
Money market
|
|
|
84,662
|
|
|
|
94,367
|
|
|
Certificates of deposit
|
|
|
284,746
|
|
|
|
327,950
|
|
|
|
|
$
|
723,623
|
|
|
$
|
783,487
|
|
Advances from Federal Home Loan Bank
Deposits are the primary source of funds
for our lending and investment activities and for our general business purposes. We can also use advances (borrowings) from the
Federal Home Loan Bank (FHLB) to compensate for reductions in deposits or deposit inflows at less than projected levels. At June
30, 2014, outstanding FHLB advances totaled $12.3 million, and we had sufficient collateral available to borrow approximately
$6.7 million in additional advances. Advances from the FHLB are secured by our stock in the FHLB, certain securities and substantially
all of our first mortgage loans on an individual basis.
Subordinated Debentures
Two trust subsidiaries of First Financial
Service Corporation have together issued a total of $18 million trust preferred securities. The subsidiaries loaned the sales
proceeds from these issuances to us in exchange for junior subordinated deferrable interest debentures. We are not considered
the primary beneficiary of these trusts, which are variable interest entities. Therefore the trusts are not consolidated in our
financial statements. Rather, the subordinated debentures we have issued to them are shown as a liability. Our investment in the
common stock of the trusts was $310,000.
The subordinated debentures are considered
as Tier 1 capital or Tier 2 capital for the Corporation under current regulatory guidelines. Capital received from the proceeds
of the sale of trust preferred securities cannot constitute more than 25% of the total core capital of the Corporation. The amount
of subordinated debentures in excess of the 25% limitation constitutes Tier 2 capital for the Corporation. We have the option
to defer interest payments on the subordinated debentures from time to time for a period not to exceed five consecutive years.
In 2008, one such trust subsidiary issued
$8.0 million in trust preferred securities and loaned the sales proceeds to us, which we used to finance the purchase of banking
operations in Indiana that we later sold. The subordinated debentures we issued to the trust mature on June 24, 2038, can be called
at par in whole or in part on or after June 24, 2018, and pay a fixed rate of 8% for thirty years.
In 2007, the other trust subsidiary issued
30-year cumulative trust preferred securities totaling $10 million at a 10-year fixed rate of 6.69% adjusting quarterly thereafter
at LIBOR plus 160 basis points. These securities mature on March 22, 2037, and can be called at par in whole or in part on or
after March 15, 2017.
On October 29, 2010, we exercised our
right to defer regularly scheduled interest payments on both issues of junior subordinated notes relating to outstanding trust
preferred securities. We have the right to defer payments of interest for up to 20 consecutive quarterly periods without default
or penalty. Thereafter, we must pay all deferred interest or we will be in default. During the deferral period, the subsidiary
trusts likewise suspended payment of dividends on their trust preferred securities. The regular scheduled interest payments will
continue to be accrued for payment in the future and reported as an expense for financial statement purposes. As of June 30, 2014,
we have deferred a total of fifteen quarterly payments and these accrued but unpaid interest payments totaled $5.1 million.
LIQUIDITY
Liquidity refers to our ability to generate
adequate amounts of cash to meet financial obligations to our customers and shareholders in order to fund loans, respond to deposit
outflows and to cover operating expenses. Maintaining a level of liquid funds through asset/liability management seeks to ensure
that these needs are met at a reasonable cost. Liquidity is essential to compensate for fluctuations in the balance sheet and
provide funds for growth and normal operating expenditures. Our investment and funds management policy identifies the primary
sources of liquidity, establishes procedures for monitoring and measuring liquidity, and establishes minimum liquidity requirements
in compliance with regulatory guidance. Management continually monitors the Bank’s liquidity position with oversight from
the Asset Liability Committee.
Our banking centers provide access to
retail deposit markets. If large certificate depositors shift to our competitors or other markets in response to interest rate
changes, we have the ability to replenish those deposits through alternative funding sources. In addition to maintaining a stable
core deposit base, we maintain adequate liquidity primarily through the use of investment securities. Traditionally, we have also
borrowed from the FHLB to supplement our funding requirements. At June 30, 2014, we had sufficient collateral available to borrow
approximately $6.7 million through additional advances from the FHLB. We believe that we have adequate funding sources through
unpledged investment securities, repayments of loan principal, investment securities pay-downs and maturities and potential asset
sales to meet our foreseeable liquidity requirements.
At the holding company level, the Corporation
uses cash to pay dividends to stockholders, repurchase common stock, make selected investments and acquisitions, and service debt.
The main sources of funding for the Corporation include dividends from the Bank, borrowings and access to the capital markets.
The primary source of funding for the
Corporation has been dividends and returns of investment from the Bank. Kentucky banking laws limit the amount of dividends that
the Bank can pay to the Corporation without prior approval of the KDFI. Under these laws, the amount of dividends that may be
paid in any calendar year is limited to current year’s net income, as defined in the laws, combined with the retained net
income of the preceding two years, less any dividends declared during those periods.
Our Consent Order requires us to obtain
the consent of the Regional Director of the FDIC and the Commissioner of the KDFI to declare and pay cash dividends to the Corporation.
The Corporation has also entered into
a formal agreement with the Federal Reserve to obtain regulatory approval before declaring any dividends on our common or preferred
stock. We will not be able to pay cash dividends on our common stock in the future until we first pay all unpaid dividends on
our Senior Preferred Shares and all deferred distributions on our trust preferred securities. We may not redeem shares or obtain
additional borrowings without prior approval. Because of these limitations, consolidated cash flows as presented in the consolidated
statements of cash flows may not represent cash immediately available to the Corporation. During the first half of 2014, the Bank
did not declare or pay any dividends to the Corporation. Cash held by the Corporation at June 30, 2014 was $91,000 compared to
cash of $147,000 at December 31, 2013.
CAPITAL
Stockholders’ equity increased $2.1
million for the period ended June 30, 2014, primarily due to a decrease in unrealized losses on securities available-for-sale
offset by our net loss recorded during the period. Our average stockholders’ equity to average assets ratio decreased to
4.34% for the six months ended June 30, 2014 compared to 4.40% for the 2013 period.
On January 9, 2009, we sold $20 million
of cumulative perpetual preferred shares, with a liquidation preference of $1,000 per share (“Senior Preferred Shares”)
to the U.S. Treasury (“Treasury”) under the terms of Treasury’s Capital Purchase Program. The Senior Preferred
Shares constitute Tier 1 capital and rank senior to our common shares. The Senior Preferred Shares paid cumulative dividends at
a rate of 5% per year for the first five years and then reset to a rate of 9% per year on January 9, 2014.
We also issued Treasury a warrant to purchase
an amount of our common stock equal to 15% of the aggregate amount of the Senior Preferred Shares, or $3 million. The warrant
entitles Treasury to purchase 215,983 common shares at a purchase price of $13.89 per share. The initial exercise price for the
warrant and the number of shares subject to the warrant were determined by reference to the market price of our common stock calculated
on a 20-day trailing average as of December 8, 2008, the date Treasury approved our application. The warrant has a term of 10 years
and is potentially dilutive to earnings per share.
Effective with the fourth quarter of 2010,
we suspended payment of regular quarterly cash dividends on our Senior Preferred Shares. The dividends are cumulative and will
continue to be accrued for payment in the future and reported as a preferred dividend requirement that is deducted from income
to common shareholders for financial statement purposes.
On April 29, 2013, Treasury sold our Senior
Preferred Shares to six funds in an auction. Following the sale, the full $20 million stated value of our Senior Preferred
Shares remains outstanding and our obligation to pay deferred and future dividends, currently at an annual rate of 9%, continues
until our Senior Preferred Shares are fully retired.
During the first six months of 2014, we
did not purchase any shares of our common stock. Like our agreement with the Federal Reserve, the terms of our Senior Preferred
Shares do not allow us to repurchase shares of our common stock without prior written consent until the Senior Preferred Shares
are fully retired.
Each of the federal bank regulatory agencies
has established minimum leverage capital requirements for banks. Banks must maintain a minimum ratio of Tier 1 capital to adjusted
average quarterly assets ranging from 3% to 5%, subject to federal bank regulatory evaluation of an organization’s overall
safety and soundness.
The following table shows the ratios of
Tier 1 capital, total capital to risk-adjusted assets and the leverage ratios for the Corporation and the Bank as of June 30,
2014.
Capital Adequacy Ratios as of
June 30, 2014
|
|
|
Regulatory
|
|
|
Ratio Required
|
|
|
|
|
|
|
|
|
Risk-Based Capital Ratios
|
|
Minimums
|
|
|
by Consent Order
|
|
|
The Bank
|
|
|
The Corporation
|
|
|
Tier 1 capital
|
|
|
4.00
|
%
|
|
|
N/A
|
|
|
|
13.67
|
%
|
|
|
10.86
|
%
|
|
Total risk-based capital
|
|
|
8.00
|
%
|
|
|
12.00
|
%
|
|
|
14.93
|
%
|
|
|
12.94
|
%
|
|
Tier 1 leverage ratio
|
|
|
4.00
|
%
|
|
|
9.00
|
%
|
|
|
8.46
|
%
|
|
|
6.70
|
%
|
In its 2012 Consent Order, the Bank agreed
to achieve and maintain a Tier 1 capital ratio of 9.0% and a total risk-based capital ratio of 12.0% by June 30, 2012. At June
30, 2014, the Bank’s Tier 1 capital ratio was 8.46% and the total risk-based capital ratio was 14.93% compared to 7.96%
and 13.48% at December 31, 2013. We are continuing our efforts to meet and maintain the required regulatory capital levels and
all of the other consent order issues for the Bank.
The terms of the 2012 Consent Order and
the actions we have taken to attain the capital ratios and meet the other requirements of the Order are described in greater detail
under Regulatory Matters, above.