Item
2.
|
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|
Macatawa Bank Corporation is a Michigan corporation and a registered bank holding company. It wholly-owns Macatawa Bank, Macatawa Statutory Trust I and Macatawa Statutory Trust II. Macatawa Bank is a Michigan chartered bank with depository accounts insured by the FDIC. The Bank operates twenty-six branch offices and a lending and operational service facility, providing a full range of commercial and consumer banking and trust services in Kent County, Ottawa County, and northern Allegan County, Michigan. Macatawa Statutory Trusts I and II are grantor trusts and issued $20.0 million each of pooled trust preferred securities. These trusts are not consolidated in our Consolidated Financial Statements. For further information regarding consolidation, see the Notes to Consolidated Financial Statements.
At June 30, 2017, we had total assets of $1.76 billion, total loans of $1.25 billion, total deposits of $1.46 billion and shareholders' equity of $170.2 million. During the second quarter of 2017, we recognized net income of $4.8 million compared to net income of $3.7 million in the second quarter of 2016. For the six months ended June 30, 2017, we recognized net income of $9.2 million compared to $7.2 million for the same period in 2016. The Bank was categorized as “well capitalized” under regulatory capital standards at June 30, 2017.
We paid a dividend of $0.03 per share in each quarter of 2016. We increased the dividend to $0.04 per share in the first and second quarters of 2017.
RESULTS OF OPERATIONS
Summary:
Net income for the quarter ended June 30, 2017 was $4.8 million, compared to net income of $3.7 million in the second quarter of 2016. Net income per common share on a diluted basis was $0.14 for the second quarter of 2017 and $0.11 for the second quarter of 2016. For the six months ended June 30, 2017, net income was $9.2 million, compared to $7.2 million for the same period in 2016. Net income per share on a diluted basis for the six months ended June 30, 2017 was $0.27 compared to $0.21 for the same period in 2016.
The increase in earnings in the second quarter of 2017 compared to the second quarter of 2016 was due primarily to increased net interest income and reduced nonperforming asset expenses. Net interest income increased to $12.7 million in the second quarter of 2017 compared to $11.6 million in the same period in 2016. The provision for loan losses was a negative $500,000 for the second quarter of 2017, compared to a negative $750,000 for the second quarter of 2016. Nonperforming asset expenses (including administration costs and losses) were a negative $158,000 for the second quarter of 2017 compared to $460,000 for the second quarter of 2016, primarily as a result of a decrease of $469,000 in writedowns of other real estate owned. We again were in a net loan recovery position for the second quarter of 2017, with $374,000 in net loan recoveries, compared to $580,000 in net loan recoveries in the second quarter of 2016.
The increase in earnings for the six month period ended June 30, 2017 compared to the same period of 2016, was due primarily to increased net interest income and reduced nonperforming asset expenses. Net interest income increased to $25.3 million in the first six months of 2017 compared to $23.3 million in the same period in 2016. Nonperforming asset expenses (including administration costs and losses) were a negative $63,000 for the first six months of 2017 compared to $871,000 for the first six months of 2016, primarily as a result of a net gains on other real estate owned of $385,000 for the first six months of 2017 compared to net losses of $294,000 for the same period in 2016. The provision for loan losses was a negative $1.0 million for the first six months of 2017, compared to a negative $850,000 for the first six months of 2016. We again were in a net loan recovery position for the first half of 2017, with $608,000 in net loan recoveries, compared to $728,000 in net loan recoveries in the first half of 2016. Each of these items is discussed more fully below.
Net Interest Income:
Net interest income totaled $12.7 million for the second quarter of 2017 and $11.6 million for the second quarter of 2016. For the first six months of 2017, net interest income was $25.3 million compared to $23.3 million for the same period in 2016.
Net interest income was positively impacted in the second quarter of 2017 by an increase in average earning assets of $63.3 million compared to the second quarter of 2016. Our average yield on earning assets for the second quarter of 2017 increased 17 basis points compared to the same period in 2016 from 3.41% to 3.58%. Average interest earning assets totaled $1.59 billion for the second quarter of 2017 compared to $1.53 billion for the second quarter of 2016. The net interest margin was 3.24% for the second quarter of 2017 compared to 3.08% for the second quarter of 2016. An increase of $35.2 million in average securities between periods and an increase of $48.5 million in average loans were the primary drivers of the increase. Yield on commercial loans increased from 3.86% for the second quarter of 2016 to 4.02% for the second quarter of 2017. Yield on residential mortgage loans decreased from 3.49% for the second quarter of 2016 to 3.47% for the second quarter of 2017, while yields on consumer loans increased from 3.99% for the second quarter of 2016 to 4.17% for the second quarter of 2017. The December 2016 and March 2017 increases in the federal funds rate had a net positive impact on our net interest margin position as more loans repriced at the higher rate than our funding sources.
Average interest earning assets increased to $1.59 billion for the first six months of 2017, compared to $1.54 billion for the first six months of 2016. Our average yield on earning assets increased 17 basis points for the first half of 2017 in comparison to the same period in 2016. Our net interest margin was 3.25% for the first six months of 2017 compared to 3.09% for the same period in 2016. Net interest margin for the first six months of 2017 benefitted from the December 2016 and March 2017 increases in the federal funds rate. The commercial loan yield in the first six months of 2017 was also positively impacted by the complete payoff of a loan that had been on nonaccrual, resulting in the realization of $267,000 in interest income that had been deferred.
The cost of funds increased to 0.49% and 0.48% in the three and six month periods of 2017 from 0.47% in the same periods of 2016. Increases in the rates paid on our savings and money market accounts in response to the December 2016 and March 2017 federal funds rate increases caused the slight increase in our cost of funds.
The following table shows an analysis of net interest margin for the three month periods ended June 30, 2017 and 2016 (dollars in thousands):
|
|
For the three months ended June 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
Average
Balance
|
|
|
Interest
Earned
or Paid
|
|
|
Average
Yield
or Cost
|
|
|
Average
Balance
|
|
|
Interest
Earned
or Paid
|
|
|
Average
Yield
or Cost
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable securities
|
|
$
|
145,596
|
|
|
$
|
646
|
|
|
|
1.77
|
%
|
|
$
|
132,431
|
|
|
$
|
565
|
|
|
|
1.71
|
%
|
Tax-exempt securities (1)
|
|
|
106,495
|
|
|
|
545
|
|
|
|
3.21
|
|
|
|
84,468
|
|
|
|
441
|
|
|
|
3.37
|
|
Commercial loans (2)
|
|
|
956,815
|
|
|
|
9,730
|
|
|
|
4.02
|
|
|
|
899,336
|
|
|
|
8,768
|
|
|
|
3.86
|
|
Residential mortgage loans
|
|
|
214,857
|
|
|
|
1,863
|
|
|
|
3.47
|
|
|
|
219,301
|
|
|
|
1,917
|
|
|
|
3.49
|
|
Consumer loans
|
|
|
91,157
|
|
|
|
948
|
|
|
|
4.17
|
|
|
|
95,722
|
|
|
|
949
|
|
|
|
3.99
|
|
Federal Home Loan Bank stock
|
|
|
11,558
|
|
|
|
121
|
|
|
|
4.15
|
|
|
|
11,558
|
|
|
|
122
|
|
|
|
4.18
|
|
Federal funds sold and other short-term investments
|
|
|
68,371
|
|
|
|
189
|
|
|
|
1.09
|
|
|
|
88,719
|
|
|
|
111
|
|
|
|
0.49
|
|
Total interest earning assets (1)
|
|
|
1,594,849
|
|
|
|
14,042
|
|
|
|
3.58
|
|
|
|
1,531,535
|
|
|
|
12,873
|
|
|
|
3.41
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest earning assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and due from banks
|
|
|
30,499
|
|
|
|
|
|
|
|
|
|
|
|
26,537
|
|
|
|
|
|
|
|
|
|
Other
|
|
|
98,227
|
|
|
|
|
|
|
|
|
|
|
|
96,253
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
1,723,575
|
|
|
|
|
|
|
|
|
|
|
$
|
1,654,325
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing demand
|
|
$
|
325,429
|
|
|
$
|
68
|
|
|
|
0.08
|
%
|
|
$
|
325,432
|
|
|
$
|
77
|
|
|
|
0.10
|
%
|
Savings and money market accounts
|
|
|
557,075
|
|
|
|
350
|
|
|
|
0.25
|
|
|
|
509,098
|
|
|
|
231
|
|
|
|
0.18
|
|
Time deposits
|
|
|
79,085
|
|
|
|
139
|
|
|
|
0.70
|
|
|
|
85,585
|
|
|
|
131
|
|
|
|
0.62
|
|
Borrowings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other borrowed funds
|
|
|
87,894
|
|
|
|
358
|
|
|
|
1.61
|
|
|
|
102,642
|
|
|
|
458
|
|
|
|
1.77
|
|
Long-term debt
|
|
|
41,238
|
|
|
|
422
|
|
|
|
4.05
|
|
|
|
41,238
|
|
|
|
368
|
|
|
|
3.53
|
|
Total interest bearing liabilities
|
|
|
1,090,721
|
|
|
|
1,337
|
|
|
|
0.49
|
|
|
|
1,063,995
|
|
|
|
1,265
|
|
|
|
0.47
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest bearing demand accounts
|
|
|
458,186
|
|
|
|
|
|
|
|
|
|
|
|
426,588
|
|
|
|
|
|
|
|
|
|
Other noninterest bearing liabilities
|
|
|
6,427
|
|
|
|
|
|
|
|
|
|
|
|
7,078
|
|
|
|
|
|
|
|
|
|
Shareholders' equity
|
|
|
168,241
|
|
|
|
|
|
|
|
|
|
|
|
156,664
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders' equity
|
|
$
|
1,723,575
|
|
|
|
|
|
|
|
|
|
|
$
|
1,654,325
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
12,705
|
|
|
|
|
|
|
|
|
|
|
$
|
11,608
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest spread (1)
|
|
|
|
|
|
|
|
|
|
|
3.09
|
%
|
|
|
|
|
|
|
|
|
|
|
2.94
|
%
|
Net interest margin (1)
|
|
|
|
|
|
|
|
|
|
|
3.24
|
%
|
|
|
|
|
|
|
|
|
|
|
3.08
|
%
|
Ratio of average interest earning assets to average interest bearing liabilities
|
|
|
146.22
|
%
|
|
|
|
|
|
|
|
|
|
|
143.94
|
%
|
|
|
|
|
|
|
|
|
(1)
|
Yields are presented on a tax equivalent basis using a 35% tax rate.
|
(2)
|
Includes loan fees of $157,000 and $114,000 for the three months ended June 30, 2017 and 2016. Includes average nonaccrual loans of approximately $592,000 and $367,000 for the three months ended June 30, 2017 and 2016.
|
The following table shows an analysis of net interest margin for the six month periods ended June 30, 2017 and 2016 (dollars in thousands):
|
|
For the six months ended June 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
Average
Balance
|
|
|
Interest
Earned
or Paid
|
|
|
Average
Yield
or Cost
|
|
|
Average
Balance
|
|
|
Interest
Earned
or Paid
|
|
|
Average
Yield
or Cost
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable securities
|
|
$
|
146,612
|
|
|
$
|
1,285
|
|
|
|
1.75
|
%
|
|
$
|
130,986
|
|
|
$
|
1,115
|
|
|
|
1.70
|
%
|
Tax-exempt securities (1)
|
|
|
107,546
|
|
|
|
1,084
|
|
|
|
3.18
|
|
|
|
84,551
|
|
|
|
874
|
|
|
|
3.28
|
|
Commercial loans (2)
|
|
|
956,484
|
|
|
|
19,387
|
|
|
|
4.03
|
|
|
|
895,287
|
|
|
|
17,660
|
|
|
|
3.90
|
|
Residential mortgage loans
|
|
|
216,050
|
|
|
|
3,743
|
|
|
|
3.47
|
|
|
|
216,182
|
|
|
|
3,801
|
|
|
|
3.51
|
|
Consumer loans
|
|
|
92,263
|
|
|
|
1,865
|
|
|
|
4.08
|
|
|
|
97,695
|
|
|
|
1,929
|
|
|
|
3.97
|
|
Federal Home Loan Bank stock
|
|
|
11,558
|
|
|
|
245
|
|
|
|
4.21
|
|
|
|
11,558
|
|
|
|
246
|
|
|
|
4.21
|
|
Federal funds sold and other short-term investments
|
|
|
56,832
|
|
|
|
281
|
|
|
|
0.98
|
|
|
|
99,092
|
|
|
|
256
|
|
|
|
0.51
|
|
Total interest earning assets (1)
|
|
|
1,587,345
|
|
|
|
27,890
|
|
|
|
3.58
|
|
|
|
1,535,351
|
|
|
|
25,881
|
|
|
|
3.41
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest earning assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and due from banks
|
|
|
28,387
|
|
|
|
|
|
|
|
|
|
|
|
25,784
|
|
|
|
|
|
|
|
|
|
Other
|
|
|
99,424
|
|
|
|
|
|
|
|
|
|
|
|
97,823
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
1,715,156
|
|
|
|
|
|
|
|
|
|
|
$
|
1,658,958
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing demand
|
|
$
|
323,231
|
|
|
$
|
138
|
|
|
|
0.08
|
%
|
|
$
|
330,079
|
|
|
$
|
162
|
|
|
|
0.10
|
%
|
Savings and money market accounts
|
|
|
553,404
|
|
|
|
641
|
|
|
|
0.23
|
|
|
|
511,171
|
|
|
|
469
|
|
|
|
0.19
|
|
Time deposits
|
|
|
78,529
|
|
|
|
259
|
|
|
|
0.67
|
|
|
|
87,931
|
|
|
|
271
|
|
|
|
0.62
|
|
Borrowings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other borrowed funds
|
|
|
93,427
|
|
|
|
740
|
|
|
|
1.57
|
|
|
|
99,282
|
|
|
|
900
|
|
|
|
1.79
|
|
Long-term debt
|
|
|
41,238
|
|
|
|
824
|
|
|
|
3.98
|
|
|
|
41,238
|
|
|
|
733
|
|
|
|
3.52
|
|
Total interest bearing liabilities
|
|
|
1,089,829
|
|
|
|
2,602
|
|
|
|
0.48
|
|
|
|
1,069,701
|
|
|
|
2,535
|
|
|
|
0.47
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest bearing demand accounts
|
|
|
453,583
|
|
|
|
|
|
|
|
|
|
|
|
427,111
|
|
|
|
|
|
|
|
|
|
Other noninterest bearing liabilities
|
|
|
5,454
|
|
|
|
|
|
|
|
|
|
|
|
6,692
|
|
|
|
|
|
|
|
|
|
Shareholders' equity
|
|
|
166,290
|
|
|
|
|
|
|
|
|
|
|
|
155,454
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders' equity
|
|
$
|
1,715,156
|
|
|
|
|
|
|
|
|
|
|
$
|
1,658,958
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
25,288
|
|
|
|
|
|
|
|
|
|
|
$
|
23,346
|
|
|
|
|
|
Net interest spread (1)
|
|
|
|
|
|
|
|
|
|
|
3.10
|
%
|
|
|
|
|
|
|
|
|
|
|
2.94
|
%
|
Net interest margin
|
|
|
|
|
|
|
|
|
|
|
3.25
|
%
|
|
|
|
|
|
|
|
|
|
|
3.09
|
%
|
Ratio of average interest earning assets to average interest bearing liabilities
|
|
|
145.65
|
%
|
|
|
|
|
|
|
|
|
|
|
143.53
|
%
|
|
|
|
|
|
|
|
|
(1)
|
Yields are presented on a tax equivalent basis using a 35% tax rate.
|
(2)
|
Includes loan fees of $366,000 and $358,000 for the six months ended June 30, 2017 and 2016. Includes average nonaccrual loans of approximately $488,000 and $476,000 for the six months ended June 30, 2017 and 2016.
|
Provision for Loan Losses:
The provision for loan losses for the second quarter of 2017 was a negative $500,000 compared to a negative $750,000 for the second quarter of 2016. The negative provisions for loan losses for each period were the result of continued stabilization of real estate values on problem credits, continued improvement in asset quality metrics and net loan recoveries of $374,000 in the second quarter of 2017 and $580,000 in the second quarter of 2016. At June 30, 2017, we had experienced net loan recoveries in twelve of the past thirteen quarters, and in each of the past ten quarters. The provision for loan losses for the first half of 2017 was a negative $1.0 million compared to a negative $850,000 for the same period in 2016.
Gross loan recoveries were $513,000 for the second quarter of 2017 and $616,000 for the same period in 2016. In the second quarter of 2017, we had $139,000 in charge-offs, compared to $36,000 in the second quarter of 2016. For the six months ended June 30, 2017, we experienced gross loan recoveries of $773,000 compared to $840,000 for the same period in 2016. Loan charge-offs were $165,000 for the six months ended June 30, 2017 compared to $112,000 for the same period in 2016. We continue to experience positive results from our collection efforts as evidenced by our net loan recoveries. While we expect our collection efforts to produce further recoveries, they may not continue at the same level we have experienced the past several quarters.
The amounts of loan loss provision in both the most recent quarter and comparable prior year period were the result of establishing our allowance for loan losses at levels believed necessary based upon our methodology for determining the adequacy of the allowance. The sustained lower level of quarterly net charge-offs over the past several quarters had a significant effect on the historical loss component of our methodology. More information about our allowance for loan losses and our methodology for establishing its level may be found under the heading "Allowance for Loan Losses" below.
Noninterest Income:
Noninterest income for the three and six month periods ended June 30, 2017 were $4.5 million and $8.7 million compared to $4.5 million and $9.1 million for the same periods in 2016. The components of noninterest income are shown in the table below (in thousands):
|
|
Three Months
Ended
June 30,
2017
|
|
|
Three Months
Ended
June 30,
2016
|
|
|
Six Months
Ended
June 30,
2017
|
|
|
Six Months
Ended
June 30,
2016
|
|
Service charges and fees on deposit accounts
|
|
$
|
1,110
|
|
|
$
|
1,112
|
|
|
$
|
2,170
|
|
|
$
|
2,159
|
|
Net gains on mortgage loans
|
|
|
476
|
|
|
|
572
|
|
|
|
904
|
|
|
|
1,060
|
|
Trust fees
|
|
|
833
|
|
|
|
788
|
|
|
|
1,611
|
|
|
|
1,496
|
|
Gain as sales of securities
|
|
|
---
|
|
|
|
10
|
|
|
|
3
|
|
|
|
99
|
|
ATM and debit card fees
|
|
|
1,338
|
|
|
|
1,257
|
|
|
|
2,539
|
|
|
|
2,443
|
|
Bank owned life insurance (“BOLI”) income
|
|
|
243
|
|
|
|
158
|
|
|
|
481
|
|
|
|
602
|
|
Investment services fees
|
|
|
250
|
|
|
|
270
|
|
|
|
466
|
|
|
|
573
|
|
Other income
|
|
|
228
|
|
|
|
369
|
|
|
|
535
|
|
|
|
712
|
|
Total noninterest income
|
|
$
|
4,478
|
|
|
$
|
4,536
|
|
|
$
|
8,709
|
|
|
$
|
9,144
|
|
Net gains on mortgage loans were down $96,000 in the second quarter of 2017 compared to the second quarter of 2016 as a result of an overall lower level of volume. Mortgage loans originated for sale in the second quarter of 2017 were $16.7 million, compared to $19.0 million in the second quarter of 2016. Mortgage loans originated for portfolio in the second quarter of 2017 were $12.1 million, compared to $23.1 million in the second quarter of 2016. ATM and debit card fees were up in the three and six months ended June 30, 2017 due to higher volume of usage by our customers. Mortgage loans originated for sale for the first six months of 2017 were $33.7 million, down from $37.9 million in the first six months of 2016. BOLI income in the first six months of 2016 included $290,000 in net benefits from the distribution of a death claim on a covered former employee. Trust fees were up in the first six months of 2017 due to investment market value changes and growth in trust assets.
Noninterest Expense:
Noninterest expense decreased to $10.8 million for the three month period ended June 30, 2017, from $11.5 million for the same period in 2016. Noninterest expense decreased to $21.7 million for the six month period ended June 30, 2017 compared to $23.0 million for the same period in 2016. The components of noninterest expense are shown in the table below (in thousands):
|
|
Three Months
Ended
June 30,
2017
|
|
|
Three Months
Ended
June 30,
2016
|
|
|
Six Months
Ended
June 30,
2017
|
|
|
Six Months
Ended
June 30,
2016
|
|
Salaries and benefits
|
|
$
|
6,153
|
|
|
$
|
6,168
|
|
|
$
|
12,152
|
|
|
$
|
12,355
|
|
Occupancy of premises
|
|
|
991
|
|
|
|
901
|
|
|
|
2,017
|
|
|
|
1,883
|
|
Furniture and equipment
|
|
|
750
|
|
|
|
839
|
|
|
|
1,482
|
|
|
|
1,704
|
|
Legal and professional
|
|
|
197
|
|
|
|
188
|
|
|
|
422
|
|
|
|
347
|
|
Marketing and promotion
|
|
|
225
|
|
|
|
275
|
|
|
|
453
|
|
|
|
550
|
|
Data processing
|
|
|
731
|
|
|
|
688
|
|
|
|
1,413
|
|
|
|
1,347
|
|
FDIC assessment
|
|
|
134
|
|
|
|
220
|
|
|
|
270
|
|
|
|
472
|
|
Interchange and other card expense
|
|
|
324
|
|
|
|
308
|
|
|
|
637
|
|
|
|
594
|
|
Bond and D&O insurance
|
|
|
118
|
|
|
|
131
|
|
|
|
234
|
|
|
|
263
|
|
Net (gains) losses on repossessed and foreclosed properties
|
|
|
(300
|
)
|
|
|
258
|
|
|
|
(385
|
)
|
|
|
294
|
|
Administration and disposition of problem assets
|
|
|
142
|
|
|
|
202
|
|
|
|
322
|
|
|
|
577
|
|
Outside services
|
|
|
408
|
|
|
|
389
|
|
|
|
857
|
|
|
|
758
|
|
Other noninterest expense
|
|
|
919
|
|
|
|
903
|
|
|
|
1,805
|
|
|
|
1,877
|
|
Total noninterest expense
|
|
$
|
10,792
|
|
|
$
|
11,470
|
|
|
$
|
21,679
|
|
|
$
|
23,021
|
|
Most categories of noninterest expense were relatively flat or had reductions compared to the second quarter of 2016 due to our ongoing efforts to manage expenses and scale our operations. Our largest component of noninterest expense, salaries and benefits, decreased by $15,000 in the second quarter of 2017 from the second quarter of 2016. This decrease is largely due to a lower level of costs associated with employee benefits, particularly medical insurance, which were down $28,000 compared to the second quarter of 2017 due to a lower level of claims. Variable based compensation was down $84,000 compared to the second quarter of 2016 and was down $159,000 for the first six months of 2017 compared to the same period in 2016 due to lower mortgage production and brokerage volume. We had 344 full-time equivalent employees at June 30, 2017 compared to 343 at June 30, 2016.
Occupancy expenses were up $90,000 in the second quarter of 2017 and were up $134,000 for the first six months of 2017 compared to the same periods in 2016 due to higher maintenance costs incurred associated with certain branch facilities.
Our FDIC assessment costs decreased by $86,000 in the second quarter of 2017 compared to the same period in 2016 and by $202,000 for the first six months of 2017 due primarily to positive changes in our assessment rates. These costs have been trending down for the past few years and we believe the rate has stabilized and future expense fluctuations will likely be dependent on changes in our asset size.
Costs associated with administration and disposition of problem assets have decreased significantly over the past several years. These expenses include legal costs, repossessed and foreclosed property administration expense and losses on repossessed and foreclosed properties. Repossessed and foreclosed property administration expense includes survey and appraisal, property maintenance and management and other disposition and carrying costs. Losses on repossessed and foreclosed properties include both net gains and losses on the sale of properties and unrealized losses from value declines for outstanding properties. We experienced decreases in each of these three expense categories in the second quarter of 2017 and the first six month of 2017 compared to the same periods in the prior year.
These costs are itemized in the following table (in thousands):
|
|
Three Months
Ended
June 30,
2017
|
|
|
Three Months
Ended
June 30,
2016
|
|
|
Six Months
Ended
June 30,
2017
|
|
|
Six Months
Ended
June 30,
2016
|
|
Legal and professional – nonperforming assets
|
|
$
|
18
|
|
|
$
|
29
|
|
|
$
|
35
|
|
|
$
|
99
|
|
Repossessed and foreclosed property administration
|
|
|
124
|
|
|
|
173
|
|
|
|
287
|
|
|
|
478
|
|
Net (gains) losses on repossessed and foreclosed properties
|
|
|
(300
|
)
|
|
|
258
|
|
|
|
(385
|
)
|
|
|
294
|
|
Total
|
|
$
|
(158
|
)
|
|
$
|
460
|
|
|
$
|
(63
|
)
|
|
$
|
871
|
|
As problem loans move through the collection process, the costs associated with nonperforming assets remained elevated, but have decreased significantly over the past several years. Other real estate owned decreased from $14.1 million at June 30, 2016 to $7.1 million at June 30, 2017. During the second quarter of 2017, we sold our largest individual other real estate owned property (carry value of $3.4 million) for a net gain of $68,000. This property was responsible for a significant portion of our nonperforming asset expense, including maintenance, property taxes and utility costs. With the reductions in other real estate owned properties, we believe we will experience more reductions in these costs going forward.
Losses on repossessed assets and foreclosed properties for the three month period ended June 30, 2017 decreased $558,000 from the same period in 2016. For the first six months of 2017, these expenses decreased $679,000 from the same period in 2016. These decreases were primarily due to a lower level of writedowns of other real estate properties in these periods. In the second quarter of 2016, valuation writedowns totaled $426,000, due primarily to a writedown on our largest other real estate owned property. As discussed above, this property was sold in the second quarter of 2017. Also contributing to the decrease was an increase of $153,000 in net gains on sales of other real estate owned. In the first six months of 2017, we recognized net gains totaling $470,000 on such sales, compared to $260,000 for the same period in 2016.
Federal Income Tax Expense:
We
recorded $2.1 million and $4.1 million in federal income tax expense for the three and six month periods ended June 30, 2017 compared to $1.7 million and $3.1 million, respectively, in the same periods in 2016. Our effective tax rate for the three and six month periods ended June 30, 2017 was 30.90% and 30.75%, compared to 30.96% and 29.83%, respectively, for the same periods in 2016.
FINANCIAL CONDITION
Total assets were $1.76 billion at June 30, 2017, an increase of $18.1 million from $1.74 billion at December 31, 2016. This change reflected increases of $55.5 million in cash and cash equivalents offset by decreases of $29.5 million in our loan portfolio and $3.1 million in other assets. Total deposits increased by $11.3 million and other borrowed funds decreased by $1.4 million at June 30, 2017 compared to December 31, 2016.
Cash and Cash Equivalents:
Our cash and cash equivalents, which include federal funds sold and short-term investments, were $145.3 million at June 30, 2017 compared to $89.8 million at December 31, 2016. The increase in these balances related primarily to the decrease in our total loans and increase in total deposits in the same period.
Securities:
Securities available for sale were $184.8 million at June 30, 2017 compared to $184.4 million at December 31, 2016. The balance at June 30, 2017 primarily consisted of U.S. agency securities, agency mortgage backed securities and various municipal investments. Our held to maturity portfolio decreased from $69.4 million at December 31, 2016 to $68.8 million at June 30, 2017. Our held to maturity portfolio is comprised of state and municipal bonds.
Portfolio Loans and Asset Quality:
Total portfolio loans decreased by $29.5 million in the first six months of 2017 and were $1.25 billion at June 30, 2017 compared to $1.28 billion at December 31, 2016. During the first six months of 2017, our commercial portfolio decreased by $17.6 million, while our consumer portfolio decreased by $7.0 million and our residential mortgage portfolio decreased by $4.9 million. The decrease in the commercial portfolio is seasonal and we expect balances to increase throughout the remainder of 2017. In addition, we have been focusing efforts to increase our consumer and residential mortgage portfolio segments to further diversify our credit risk.
The volume of residential mortgage loans originated for sale in the first six months of 2017 decreased $4.2 million compared to the same period in 2016 due to a higher interest rate environment. Residential mortgage loans originated for sale were $33.7 million in the first six months of 2017 compared to $37.9 million in the first six months of 2016. Mortgage loans originated for portfolio in the first six months of 2017 were $12.1 million, compared to $37.2 million in the first six months of 2016. Mortgage loans originated for portfolio are typically loans that conform to secondary market requirements and have a term of fifteen years or less.
Overall, the commercial loan portfolio decreased $17.6 million in the first six months of 2017. Our commercial and industrial portfolio decreased by $14.1 million and our commercial real estate loans decreased by $3.5 million. Considering our pipeline of commercial credits at June 30, 2017, we expect to achieve measured, high quality loan portfolio growth throughout the remainder of 2017.
Commercial and commercial real estate loans remained our largest loan segment and accounted for approximately 76% of the total loan portfolio at June 30, 2017 and December 31, 2016. Residential mortgage and consumer loans comprised approximately 24% of total loans at June 30, 2017 and December 31, 2016.
A further breakdown of the composition of the loan portfolio is shown in the table below (in thousands):
|
|
June 30, 2017
|
|
|
December 31, 2016
|
|
|
|
Balance
|
|
|
Percent of
Total Loans
|
|
|
Balance
|
|
|
Percent of
Total Loans
|
|
Commercial real estate: (1)
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential developed
|
|
$
|
8,701
|
|
|
|
0.7
|
%
|
|
$
|
11,970
|
|
|
|
0.9
|
%
|
Unsecured to residential developers
|
|
|
4,734
|
|
|
|
0.4
|
|
|
|
4,734
|
|
|
|
0.4
|
|
Vacant and unimproved
|
|
|
38,357
|
|
|
|
3.1
|
|
|
|
40,286
|
|
|
|
3.1
|
|
Commercial development
|
|
|
492
|
|
|
|
---
|
|
|
|
378
|
|
|
|
---
|
|
Residential improved
|
|
|
77,047
|
|
|
|
6.2
|
|
|
|
75,348
|
|
|
|
5.9
|
|
Commercial improved
|
|
|
282,884
|
|
|
|
22.6
|
|
|
|
289,478
|
|
|
|
22.6
|
|
Manufacturing and industrial
|
|
|
102,325
|
|
|
|
8.2
|
|
|
|
95,787
|
|
|
|
7.5
|
|
Total commercial real estate
|
|
|
514,540
|
|
|
|
41.2
|
|
|
|
517,981
|
|
|
|
40.4
|
|
Commercial and industrial
|
|
|
435,218
|
|
|
|
34.8
|
|
|
|
449,342
|
|
|
|
35.1
|
|
Total commercial
|
|
|
949,758
|
|
|
|
76.0
|
|
|
|
967,323
|
|
|
|
75.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage
|
|
|
212,745
|
|
|
|
17.0
|
|
|
|
217,614
|
|
|
|
17.0
|
|
Unsecured
|
|
|
280
|
|
|
|
---
|
|
|
|
396
|
|
|
|
---
|
|
Home equity
|
|
|
81,779
|
|
|
|
6.5
|
|
|
|
88,113
|
|
|
|
6.9
|
|
Other secured
|
|
|
6,793
|
|
|
|
0.5
|
|
|
|
7,366
|
|
|
|
0.6
|
|
Total consumer
|
|
|
301,597
|
|
|
|
24.0
|
|
|
|
313,489
|
|
|
|
24.5
|
|
Total loans
|
|
$
|
1,251,355
|
|
|
|
100.0
|
%
|
|
$
|
1,280,812
|
|
|
|
100.0
|
%
|
(1)
|
Includes both owner occupied and non-owner occupied commercial real estate.
|
Commercial real estate loans accounted for approximately 41% of the total loan portfolio at June 30, 2017 and consisted primarily of loans to business owners and developers of owner and non-owner occupied commercial properties and loans to developers of single and multi-family residential properties. In the table above, we show our commercial real estate portfolio by loans secured by residential and commercial real estate, and by stage of development. Improved loans are generally secured by properties that are under construction or completed and placed in use. Development loans are secured by properties that are in the process of development or fully developed. Vacant and unimproved loans are secured by raw land for which development has not yet begun and agricultural land.
Our consumer residential mortgage loan portfolio, which also includes residential construction loans made to individual homeowners, comprised approximately 17% of portfolio loans at both June 30, 2017 and December 31, 2016. We expect to continue to retain in our loan portfolio certain types of residential mortgage loans (primarily high quality, low loan-to-value loans) in an effort to continue to diversify our credit risk and deploy our excess liquidity. A large portion of our residential mortgage loan production continues to be sold on the secondary market with servicing released.
The volume of residential mortgage loans originated for sale during the first six months of 2017 decreased from the first six months of 2016 as a result of interest rate conditions. We are also experiencing a shift in production to financing new home purchases versus refinancings.
Our portfolio of other consumer loans includes loans secured by personal property and home equity fixed term and line of credit loans. Consumer loans decreased by $7.0 million to $88.9 million at June 30, 2017 from $95.9 million at December 31, 2016, due primarily to a decrease in home equity loans. Consumer loans comprised approximately 7% of our portfolio loans at June 30, 2017 and December 31, 2016.
The following table shows our loan origination activity for portfolio loans during the first six months of 2017 and 2016, broken out by loan type and also shows average originated loan size (dollars in thousands):
|
|
Six months ended June 30, 2017
|
|
|
Six months ended June 30, 2016
|
|
|
|
Portfolio
Originations
|
|
|
Percent of
Total
Originations
|
|
|
Average
Loan Size
|
|
|
Portfolio
Originations
|
|
|
Percent of
Total
Originations
|
|
|
Average
Loan Size
|
|
Commercial real estate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential developed
|
|
$
|
1,494
|
|
|
|
1.1
|
%
|
|
$
|
498
|
|
|
$
|
5,227
|
|
|
|
3.4
|
%
|
|
$
|
871
|
|
Unsecured to residential developers
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
Vacant and unimproved
|
|
|
1,663
|
|
|
|
1.2
|
|
|
|
238
|
|
|
|
221
|
|
|
|
0.2
|
|
|
|
110
|
|
Commercial development
|
|
|
125
|
|
|
|
0.1
|
|
|
|
125
|
|
|
|
2,200
|
|
|
|
1.5
|
|
|
|
2,200
|
|
Residential improved
|
|
|
22,673
|
|
|
|
16.5
|
|
|
|
246
|
|
|
|
37,174
|
|
|
|
24.4
|
|
|
|
409
|
|
Commercial improved
|
|
|
15,144
|
|
|
|
11.0
|
|
|
|
891
|
|
|
|
21,382
|
|
|
|
14.0
|
|
|
|
1,018
|
|
Manufacturing and industrial
|
|
|
5,700
|
|
|
|
4.1
|
|
|
|
814
|
|
|
|
10,956
|
|
|
|
7.2
|
|
|
|
996
|
|
Total commercial real estate
|
|
|
46,799
|
|
|
|
34.0
|
|
|
|
368
|
|
|
|
77,160
|
|
|
|
50.7
|
|
|
|
584
|
|
Commercial and industrial
|
|
|
46,992
|
|
|
|
34.2
|
|
|
|
712
|
|
|
|
18,088
|
|
|
|
11.9
|
|
|
|
266
|
|
Total commercial
|
|
|
93,791
|
|
|
|
68.2
|
|
|
|
486
|
|
|
|
95,248
|
|
|
|
62.6
|
|
|
|
476
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage
|
|
|
21,274
|
|
|
|
15.5
|
|
|
|
239
|
|
|
|
37,201
|
|
|
|
24.4
|
|
|
|
201
|
|
Unsecured
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
12
|
|
|
|
---
|
|
|
|
12
|
|
Home equity
|
|
|
21,177
|
|
|
|
15.4
|
|
|
|
84
|
|
|
|
18,496
|
|
|
|
12.1
|
|
|
|
80
|
|
Other secured
|
|
|
1,235
|
|
|
|
0.9
|
|
|
|
16
|
|
|
|
1,316
|
|
|
|
0.9
|
|
|
|
20
|
|
Total consumer
|
|
|
43,686
|
|
|
|
31.8
|
|
|
|
104
|
|
|
|
57,025
|
|
|
|
37.4
|
|
|
|
118
|
|
Total loans
|
|
$
|
137,477
|
|
|
|
100.0
|
%
|
|
|
224
|
|
|
$
|
152,273
|
|
|
|
100.0
|
%
|
|
|
223
|
|
The following table shows a breakout of our commercial loan activity during the first six months of 2017 and 2016 (dollars in thousands):
|
|
Six Months
Ended
June 30,
2017
|
|
|
Six Months
Ended
June 30,
2016
|
|
Commercial loans originated
|
|
$
|
93,791
|
|
|
$
|
95,248
|
|
Repayments of commercial loans
|
|
|
(88,690
|
)
|
|
|
(79,989
|
)
|
Change in undistributed - available credit
|
|
|
(22,666
|
)
|
|
|
(6,796
|
)
|
Net increase/(decrease) in total commercial loans
|
|
$
|
(17,565
|
)
|
|
$
|
8,463
|
|
Our loan portfolio is reviewed regularly by our senior management, our loan officers, and an internal loan review team that is independent of our loan originators and credit administration. An administrative loan committee consisting of senior management and seasoned lending and collections personnel meets monthly to manage our internal watch list and proactively manage high risk loans.
When reasonable doubt exists concerning collectability of interest or principal of one of our loans, the loan is placed in nonaccrual status. Any interest previously accrued but not collected is reversed and charged against current earnings.
Nonperforming assets are comprised of nonperforming loans, foreclosed assets and repossessed assets. At June 30, 2017, nonperforming assets totaled $7.8 million compared to $12.6 million at December 31, 2016. Additions to other real estate owned in the first six months of 2017 were $60,000, compared to $102,000 in the first six months of 2016. At June 30, 2017, there were no loans in redemption, so we expect there to be few additions to other real estate owned in 2017. Proceeds from sales of foreclosed properties were $5.6 million in the first six months of 2017, resulting in a net realized gain on sale of $470,000. We sold our largest individual foreclosed property in the second quarter of 2017. Proceeds from sales of foreclosed properties were $3.3 million in the first six months of 2016 resulting in a net realized gain on sale of $260,000. Based upon purchase agreements in place at June 30, 2017 and the sale of our largest individual property in the second quarter of 2017, we expect the level of sales of foreclosed properties to be lower in the second half of 2017 than experienced in the first half of 2017.
Nonperforming loans include loans on nonaccrual status and loans delinquent more than 90 days but still accruing. As of June 30, 2017, nonperforming loans totaled $670,000, or 0.05% of total portfolio loans, compared to $300,000, or 0.02% of total portfolio loans, at December 31, 2016.
Nonperforming loans at June 30, 2017 consisted of $436,000 of commercial real estate loans, $6,000 of commercial and industrial loans, and $228,000 of consumer and residential mortgage loans.
Foreclosed and repossessed assets include assets acquired in settlement of loans. Foreclosed assets totaled $7.1 million at June 30, 2017 and $12.3 million at December 31, 2016. Of this balance at June 30, 2017, there were 25 commercial real estate properties totaling approximately $6.9 million. The remaining balance was comprised of 5 residential properties totaling approximately $166,000. All properties acquired through or in lieu of foreclosure are initially transferred at their fair value less estimated costs to sell and then evaluated monthly for impairment after transfer using a lower of cost or market approach. Updated property valuations are obtained at least annually on all foreclosed assets.
At June 30, 2017, our foreclosed asset portfolio had a weighted average age held in portfolio of 5.44 years. Below is a breakout of our foreclosed asset portfolio at June 30, 2017 and December 31, 2016 by property type and the percentages the property has been written down since taken into our possession and the combined writedown percentage, including losses taken when the property was loan collateral (dollars in thousands):
|
|
June 30, 2017
|
|
|
December 31, 2016
|
|
Foreclosed Asset Property Type
|
|
Carrying
Value
|
|
|
Foreclosed
Asset
Writedown
|
|
|
Combined
Writedown
(Loan and
Foreclosed
Asset)
|
|
|
Carrying
Value at
Carrying
Value
|
|
|
Foreclosed
Asset
Writedown
|
|
|
Combined
Writedown
(Loan and
Foreclosed
Asset)
|
|
Single Family
|
|
$
|
56
|
|
|
|
---
|
%
|
|
|
---
|
%
|
|
$
|
136
|
|
|
|
---
|
%
|
|
|
20.3
|
%
|
Residential Lot
|
|
|
120
|
|
|
|
54.0
|
|
|
|
74.9
|
|
|
|
438
|
|
|
|
30.1
|
|
|
|
48.0
|
|
Multi-Family
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
Vacant Land
|
|
|
2,487
|
|
|
|
44.3
|
|
|
|
51.1
|
|
|
|
3,096
|
|
|
|
47.2
|
|
|
|
58.3
|
|
Residential Development
|
|
|
2,260
|
|
|
|
35.7
|
|
|
|
75.7
|
|
|
|
2,570
|
|
|
|
36.2
|
|
|
|
74.2
|
|
Commercial Office
|
|
|
128
|
|
|
|
64.7
|
|
|
|
66.3
|
|
|
|
240
|
|
|
|
49.3
|
|
|
|
51.1
|
|
Commercial Industrial
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
Commercial Improved
|
|
|
2,046
|
|
|
|
9.4
|
|
|
|
29.2
|
|
|
|
5,773
|
|
|
|
48.7
|
|
|
|
51.2
|
|
|
|
$
|
7,097
|
|
|
|
35.0
|
|
|
|
60.9
|
|
|
$
|
12,253
|
|
|
|
45.2
|
|
|
|
60.1
|
|
The following table shows the composition and amount of our nonperforming assets (dollars in thousands):
|
|
June 30,
2017
|
|
|
December 31,
2016
|
|
Nonaccrual loans
|
|
$
|
466
|
|
|
$
|
300
|
|
Loans 90 days or more delinquent and still accruing
|
|
|
204
|
|
|
|
---
|
|
Total nonperforming loans (NPLs)
|
|
|
670
|
|
|
|
300
|
|
Foreclosed assets
|
|
|
7,097
|
|
|
|
12,253
|
|
Repossessed assets
|
|
|
---
|
|
|
|
---
|
|
Total nonperforming assets (NPAs)
|
|
$
|
7,767
|
|
|
$
|
12,553
|
|
|
|
|
|
|
|
|
|
|
NPLs to total loans
|
|
|
0.05
|
%
|
|
|
0.02
|
%
|
NPAs to total assets
|
|
|
0.44
|
%
|
|
|
0.72
|
%
|
The following table shows the composition and amount of our troubled debt restructurings (TDRs) at June 30, 2017 and December 31, 2016 (dollars in thousands):
|
|
June 30, 2017
|
|
|
December 31, 2016
|
|
|
|
Commercial
|
|
|
Consumer
|
|
|
Total
|
|
|
Commercial
|
|
|
Consumer
|
|
|
Total
|
|
Performing TDRs
|
|
$
|
13,920
|
|
|
$
|
9,179
|
|
|
$
|
23,099
|
|
|
$
|
17,786
|
|
|
$
|
12,051
|
|
|
$
|
29,837
|
|
Nonperforming TDRs (1)
|
|
|
319
|
|
|
|
---
|
|
|
|
319
|
|
|
|
141
|
|
|
|
8
|
|
|
|
149
|
|
Total TDRs
|
|
$
|
14,239
|
|
|
$
|
9,179
|
|
|
$
|
23,418
|
|
|
$
|
17,927
|
|
|
$
|
12,059
|
|
|
$
|
29,986
|
|
(1)
|
Included in nonperforming asset table above
|
We had a total of $23.4 million and $30.0 million of loans whose terms have been modified in TDRs as of June 30, 2017 and December 31, 2016, respectively. These loans may have involved the restructuring of terms to allow customers to mitigate the risk of foreclosure by meeting a lower loan payment requirement based upon their current cash flow. These may also include loans that renewed at existing contractual rates, but below market rates for comparable credit. For each restructuring, a comprehensive credit underwriting analysis of the borrower’s financial condition and prospects of repayment under the revised terms is performed to assess whether the structure can be successful and that cash flows will be sufficient to support the restructured debt. An analysis is also performed to determine whether the restructured loan should be on accrual status. Generally, if the loan is on accrual at the time of restructure, it will remain on accrual after the restructuring. In some cases, a nonaccrual loan may be placed on accrual at restructuring if the loan’s actual payment history demonstrates it would have cash flowed under the restructured terms. After six consecutive payments under the restructured terms, a nonaccrual restructured loan is reviewed for possible upgrade to accruing status. In situations where there is a subsequent modification or renewal and the loan is brought to market terms, including a contractual interest rate not less than a market interest rate for new debt with similar credit risk characteristics, the TDR and impaired designations may be removed. Total TDRs decreased by $6.6 million from December 31, 2016 to June 30, 2017. Of this decrease, $2.4 million related to a consumer property that was sold during the period and the remainder of the decrease was primarily due to paydowns on commercial TDRs.
As with other impaired loans, an allowance for loan loss is estimated for each TDR based on the most likely source of repayment for each loan. For impaired commercial real estate loans that are collateral dependent, the allowance is computed based on the fair value of the underlying collateral, less estimated costs to sell. For impaired commercial loans where repayment is expected from cash flows from business operations, the allowance is computed based on a discounted cash flow computation. Certain groups of TDRs, such as residential mortgages, have common characteristics and for them the allowance is computed based on a discounted cash flow computation on the change in weighted rate for the pool. The allowance allocations for commercial TDRs where we have reduced the contractual interest rate are computed by measuring cash flows using the new payment terms discounted at the original contractual rate.
Allowance for loan losses:
The allowance for loan losses at June 30, 2017 was $16.6 million, a decrease of $392,000 from $17.0 million at December 31, 2016. The balance of the allowance for loan losses represented 1.32% of total portfolio loans at both June 30, 2017 and December 31, 2016. The allowance for loan losses to nonperforming loan coverage ratio decreased from 5,654% at December 31, 2016 to 2,473% at June 30, 2017.
The table below shows the changes in these metrics over the past five quarters:
(Dollars in millions)
|
|
Quarter Ended
June 30,
2017
|
|
|
Quarter Ended
March 31,
2017
|
|
|
Quarter Ended
December 31,
2016
|
|
|
Quarter Ended
September 30,
2016
|
|
|
Quarter Ended
June 30,
2016
|
|
Commercial loans
|
|
$
|
949.8
|
|
|
$
|
962.1
|
|
|
$
|
967.3
|
|
|
$
|
923.2
|
|
|
$
|
894.4
|
|
Nonperforming loans
|
|
|
0.7
|
|
|
|
0.4
|
|
|
|
0.3
|
|
|
|
0.2
|
|
|
|
0.3
|
|
Other real estate owned and repo assets
|
|
|
7.1
|
|
|
|
12.1
|
|
|
|
12.3
|
|
|
|
13.1
|
|
|
|
14.1
|
|
Total nonperforming assets
|
|
|
7.8
|
|
|
|
12.5
|
|
|
|
12.6
|
|
|
|
13.3
|
|
|
|
14.4
|
|
Net charge-offs (recoveries)
|
|
|
(0.4
|
)
|
|
|
(0.2
|
)
|
|
|
(1.2
|
)
|
|
|
(0.1
|
)
|
|
|
(0.6
|
)
|
Total delinquencies
|
|
|
0.8
|
|
|
|
0.9
|
|
|
|
1.4
|
|
|
|
0.3
|
|
|
|
1.0
|
|
As discussed earlier, we have had net loan recoveries in twelve of the last thirteen quarters and in each of the last ten quarters. Our total delinquencies have continued to be negligible and were $815,000 at June 30, 2017 and $1.4 million at December 31, 2016. Our delinquency percentage at June 30, 2017 was just 0.07%, well below the Bank’s peers.
These factors all impact our necessary level of allowance for loan losses and our provision for loan losses. The allowance for loan losses decreased $392,000 in the first six months of 2017. We recorded a negative provision for loan losses of $1.0 million for the six months ended June 30, 2017 compared to a negative $850,000 for the same period of 2016. Net loan recoveries were $608,000 for the six months ended June 30, 2017, compared to net recoveries of $728,000 for the same period in 2016. The ratio of net charge-offs to average loans was (0.10)% on an annualized basis for the first six months of 2017, compared to (0.12)% for the first six months of 2016.
We are encouraged by the reduced level of charge-offs over recent quarters. We do, however, recognize that future charge-offs and resulting provisions for loan losses are expected to be impacted by the timing and extent of changes in the overall economy and the real estate markets. We believe we have seen some stabilization in economic conditions and real estate markets. However, we expect it to take additional time for sustained improvement in the economy and real estate markets in order to further reduce our impaired loans.
Our allowance for loan losses is maintained at a level believed appropriate based upon our assessment of the probable estimated losses inherent in the loan portfolio. Our methodology for measuring the appropriate level of allowance and related provision for loan losses relies on several key elements, which include specific allowances for loans considered impaired, general allowance for commercial loans not considered impaired based upon applying our loan rating system, and general allocations based on historical trends for homogeneous loan groups with similar risk characteristics.
Overall, impaired loans declined by $6.2 million to $23.4 million at June 30, 2017 compared to $29.7 million at December 31, 2016. The specific allowance for impaired loans decreased $170,000 to $1.5 million at June 30, 2017, compared to $1.7 million at December 31, 2016. The specific allowance for impaired loans represented 6.5% of total impaired loans at June 30, 2017 and 5.7% at December 31, 2016. The overall balance of impaired loans remained elevated partially due to an accounting rule (ASU 2011-02) adopted in 2011 that requires us to identify classified loans that renew at existing contractual rates as TDRs if the contractual rate is less than market rates for similar loans at the time of renewal.
The general allowance allocated to commercial loans that were not considered to be impaired was based upon the internal risk grade of such loans. We use a loan rating method based upon an eight point system. Loans are stratified between real estate secured and non real estate secured. The real estate secured portfolio is further stratified by the type of real estate. Each stratified portfolio is assigned a loss allocation factor. A higher numerical grade assigned to a loan category generally results in a greater allocation percentage. Changes in risk grade of loans affect the amount of the allowance allocation.
The determination of our loss factors is based upon our actual loss history by loan grade and adjusted for significant factors that, in management's judgment, affect the collectability of the portfolio as of the analysis date. We use a rolling 18 month actual net chargeoff history as the base for our computation. Over the past few years, the 18 month period computations have reflected sizeable decreases in net chargeoff experience. We addressed this volatility in the qualitative factor considerations applied in our allowance for loan losses computation. Adjustments to the qualitative factors also involved consideration of different loss periods for the Bank, including 12, 24, 36, 48 and 60 month periods. We also considered the extended period of improved asset quality in assessing the overall qualitative component. Considering the change in our qualitative factors and our commercial loan portfolio balances, the general allowance allocated to commercial loans was $12.0 million at June 30, 2017 and $12.1 million at December 31, 2016. This resulted in a general reserve percentage allocated at June 30, 2017 of 1.28% of commercial loans, an increase from 1.27% at December 31, 2016. The qualitative component of our allowance allocated to commercial loans was $11.9 million at June 30, 2017 (down from $12.4 million at December 31, 2016).
Groups of homogeneous loans, such as residential real estate and open- and closed-end consumer loans, receive allowance allocations based on loan type. A rolling 12 month (four quarter) historical loss experience period was applied to residential mortgage and consumer loan portfolios. As with commercial loans that are not considered impaired, the determination of the allowance allocation percentage is based principally on our historical loss experience. These allocations are adjusted for consideration of general economic and business conditions, credit quality and delinquency trends, collateral values, and recent loss experience for these similar pools of loans. The homogeneous loan allowance was $3.1 million at both June 30, 2017 and December 31, 2016.
The allowance allocations are not intended to imply limitations on usage of the allowance for loan losses. The entire allowance for loan losses is available for any loan losses without regard to loan type.
Premises and Equipment:
Premises and equipment totaled $48.6 million at June 30, 2017, down $1.4 million from $50.0 million at December 31, 2016. During the second quarter of 2017 we sold a property in Grand Rapids that had been held for future branch expansion for $590,000, recognizing a net loss on sale of $69,000.
Deposits and Other Borrowings:
Total deposits increased $11.3 million to $1.46 billion at June 30, 2017, as compared to $1.45 billion at December 31, 2016. Non-interest checking account balances decreased $19.7 million during the six months of 2017. Interest bearing demand account balances increased $1.8 million and savings and money market account balances increased $25.1 million in the first six months of 2017. Certificates of deposits increased by $4.0 million in the first six months of 2017. We believe our success in maintaining the balances of personal and business checking and savings accounts was primarily attributable to our focus on quality customer service, the desire of customers to deal with a local bank, the convenience of our branch network and the breadth and depth of our sophisticated product line.
Noninterest bearing demand accounts comprised 33% of total deposits at June 30, 2017 and 35% at December 31, 2016. These balances typically increase at year end for many of our commercial customers, then decline in the first quarter. Because of the generally low rates paid on interest bearing account alternatives, many of our business customers chose to keep their balances in these more liquid noninterest bearing demand account types. Interest bearing demand, including money market and savings accounts, comprised 62% of total deposits at June 30, 2017 and 60% at December 31, 2016. Time accounts as a percentage of total deposits were 5% at both June 30, 2017 and December 31, 2016.
Borrowed funds totaled $124.0 million at June 30, 2017, including $82.8 million of Federal Home Loan Bank (“FHLB”) advances and $41.2 million in long-term debt associated with trust preferred securities. Borrowed funds totaled $125.4 million at December 31, 2016, including $84.2 million of FHLB advances and $41.2 million in long-term debt associated with trust preferred securities. Borrowed funds decreased by $1.4 million in the first six months of 2017 due to an annual payment on an amortizing FHLB advance.
CAPITAL RESOURCES
Total shareholders' equity of $170.2 million at June 30, 2017 increased $7.9 million from $162.2 million at December 31, 2016. The increase was primarily a result of net income of $9.2 million earned in the first six months of 2017 and an increase of $1.2 million in accumulated other comprehensive income, partially offset by the payment of $2.7 million in cash dividends to shareholders. The Bank was categorized as “well capitalized” at June 30, 2017.
In July 2013, the Board of Governors of the Federal Reserve Board and the FDIC approved the final rules implementing the Basel Committee on Banking Supervision's capital guidelines for U.S. banks (commonly known as Basel III). Under the final rules, which began for the Company and the Bank on January 1, 2015 and are subject to a phase-in period through January 1, 2019, minimum requirements will increase for both the quantity and quality of capital held by the Company and the Bank. The rules include a new common equity Tier 1 capital to risk-weighted assets ratio (CET1 ratio) of 4.5% and a capital conservation buffer of 2.5% of risk-weighted assets, which when fully phased-in, effectively results in a minimum CET1 ratio of 7.0%. Basel III raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% (which, with the capital conservation buffer, effectively results in a minimum Tier 1 capital ratio of 8.5% when fully phased-in), effectively results in a minimum total capital to risk-weighted assets ratio of 10.5% (with the capital conservation buffer fully phased-in), and requires a minimum leverage ratio of 4.0%. Basel III also makes changes to risk weights for certain assets and off-balance-sheet exposures. We expect that the capital ratios for the Company and the Bank under Basel III will continue to exceed the well capitalized minimum capital requirements.
The following table shows our regulatory capital ratios (on a consolidated basis) for the past several quarters:
Macatawa Bank Corporation
|
|
June 30,
2017
|
|
|
March 31,
2017
|
|
|
Dec 31,
2016
|
|
|
Sept 30,
2016
|
|
|
June 30,
2016
|
|
Total capital to risk weighted assets
|
|
|
15.5
|
%
|
|
|
15.1
|
%
|
|
|
14.9
|
%
|
|
|
15.2
|
%
|
|
|
15.2
|
%
|
Common Equity Tier 1 to risk weighted assets
|
|
|
11.6
|
|
|
|
11.3
|
|
|
|
11.0
|
|
|
|
11.3
|
|
|
|
11.1
|
|
Tier 1 capital to risk weighted assets
|
|
|
14.3
|
|
|
|
14.0
|
|
|
|
13.7
|
|
|
|
14.1
|
|
|
|
14.0
|
|
Tier 1 capital to average assets
|
|
|
12.2
|
|
|
|
12.1
|
|
|
|
12.0
|
|
|
|
12.0
|
|
|
|
11.9
|
|
Approximately $40.0 million of trust preferred securities outstanding at June 30, 2017 qualified as Tier 1 capital.
LIQUIDITY
Liquidity of Macatawa Bank:
The liquidity of a financial institution reflects its ability to manage a variety of sources and uses of funds. Our Consolidated Statements of Cash Flows categorize these sources and uses into operating, investing and financing activities. We primarily focus on developing access to a variety of borrowing sources to supplement our deposit gathering activities and provide funds for our investment and loan portfolios. Our sources of liquidity include our borrowing capacity with the FRB's discount window, the Federal Home Loan Bank, federal funds purchased lines of credit and other secured borrowing sources with our correspondent banks, loan payments by our borrowers, maturity and sales of our securities available for sale, growth of our deposits, federal funds sold and other short-term investments, and the various capital resources discussed above.
Liquidity management involves the ability to meet the cash flow requirements of our customers. Our customers may be either borrowers with credit needs or depositors wanting to withdraw funds. Our liquidity management involves periodic monitoring of our assets considered to be liquid and illiquid, and our funding sources considered to be core and non-core and short-term (less than 12 months) and long-term. We have established parameters that monitor, among other items, our level of liquid assets to short-term liabilities, our level of non-core funding reliance and our level of available borrowing capacity. We maintain a diversified wholesale funding structure and actively manage our maturing wholesale sources to reduce the risk to liquidity shortages. We have also developed a contingency funding plan to stress test our liquidity requirements arising from certain events that may trigger liquidity shortages, such as rapid loan growth in excess of normal growth levels or the loss of deposits and other funding sources under extreme circumstances.
We have actively pursued initiatives to maintain a strong liquidity position. The Bank has reduced its reliance on non-core funding sources, including brokered deposits, and focused on achieving a non-core funding dependency ratio below its peer group average. We have had no brokered deposits on our balance sheet since December 2011. We continue to maintain significant on-balance sheet liquidity. At June 30, 2017, the Bank held $114.1 million of federal funds sold and other short-term investments. In addition, the Bank had available borrowing capacity from correspondent banks of approximately $292.8 million as of June 30, 2017.
In the normal course of business, we enter into certain contractual obligations, including obligations which are considered in our overall liquidity management. The table below summarizes our significant contractual obligations at June 30, 2017 (dollars in thousands):
|
|
Less than
1 year
|
|
|
1-3 years
|
|
|
3-5 years
|
|
|
More than
5 years
|
|
Long term debt
|
|
$
|
---
|
|
|
$
|
---
|
|
|
$
|
---
|
|
|
$
|
41,238
|
|
Time deposit maturities
|
|
|
40,411
|
|
|
|
35,418
|
|
|
|
1,919
|
|
|
|
---
|
|
Other borrowed funds
|
|
|
32,118
|
|
|
|
40,667
|
|
|
|
10,000
|
|
|
|
---
|
|
Operating lease obligations
|
|
|
247
|
|
|
|
399
|
|
|
|
32
|
|
|
|
---
|
|
Total
|
|
$
|
72,776
|
|
|
$
|
76,484
|
|
|
$
|
11,951
|
|
|
$
|
41,238
|
|
In addition to normal loan funding, we also maintain liquidity to meet customer financing needs through unused lines of credit, unfunded loan commitments and standby letters of credit. The level and fluctuation of these commitments is also considered in our overall liquidity management. At June 30, 2017, we had a total of $465.6 million in unused lines of credit, $129.9 million in unfunded loan commitments and $12.5 million in standby letters of credit.
Liquidity of Holding Company:
The primary sources of liquidity for the Company are dividends from the Bank, existing cash resources and the capital markets if the need to raise additional capital arises. Banking regulations and the laws of the State of Michigan in which our Bank is chartered limit the amount of dividends the Bank may declare and pay to the Company in any calendar year. Under the state law limitations, the Bank is restricted from paying dividends to the Company in excess of retained earnings. In 2016, the Bank paid dividends to the Company totaling $6.2 million. In the same period, the Company paid dividends to its shareholders totaling $4.0 million. On February 27, 2017, the Bank paid a dividend totaling $1.8 million to the Company in anticipation of the common share cash dividend of $0.04 per share paid on February 28, 2017 to shareholders of record on February 13, 2017. The cash distributed for this cash dividend payment totaled $1.4 million. On May 30, 2017, the Bank paid a dividend totaling $1.9 million to the Company in anticipation of the common share cash dividend of $0.04 per share paid on May 30, 2017 to shareholders of record on May 15, 2017. The cash distributed for this cash dividend payment totaled $1.4 million. The Company retained the remaining balance in each period for general corporate purposes. At June 30, 2017, the Bank had a retained earnings balance of $43.4 million.
During 2016, the Company received payments from the Bank totaling $7.1 million, representing the Bank’s intercompany tax liability for the 2016 tax year, in accordance with the Company’s tax allocation agreement. During the first six months of 2017, the Company received payments from the Bank totaling $1.0 million, representing the Bank’s intercompany tax liability for the first six months of 2017.
The Company has the right to defer interest payments for 20 consecutive quarters on its trust preferred securities if necessary for liquidity purposes. During the deferral period, the Company may not declare or pay any dividends on its common stock or make any payment on any outstanding debt obligations that rank equally with or junior to the trust preferred securities.
The Company’s cash balance at June 30, 2017 was $5.6 million. The Company believes that it has sufficient liquidity to meet its cash flow obligations.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES:
To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and future results could differ. The allowance for loan losses, other real estate owned valuation, loss contingencies and income taxes are deemed critical due to the required level of management judgment and the use of estimates, making them particularly subject to change.
Our methodology for determining the allowance for loan losses and the related provision for loan losses is described above in the "Allowance for Loan Losses" discussion. This area of accounting requires significant judgment due to the number of factors which can influence the collectability of a loan. Unanticipated changes in these factors could significantly change the level of the allowance for loan losses and the related provision for loan losses. Although, based upon our internal analysis, and in our judgment, we believe that we have provided an adequate allowance for loan losses, there can be no assurance that our analysis has properly identified all of the probable losses in our loan portfolio.
As a result, we could record future provisions for loan losses that may be significantly different than the levels that we recorded in the first six months of 2017.
Assets acquired through or instead of foreclosure, primarily other real estate owned, are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis. New real estate appraisals are generally obtained at the time of foreclosure and are used to establish fair value. If fair value declines, a valuation allowance is recorded through expense. Estimating the initial and ongoing fair value of these properties involves a number of factors and judgments including holding time, costs to complete, holding costs, discount rate, absorption and other factors.
Loss contingencies are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. This, too, is an accounting area that involves significant judgment. Although, based upon our judgment, internal analysis, and consultations with legal counsel we believe that we have properly accounted for loss contingencies, future changes in the status of such contingencies could result in a significant change in the level of contingent liabilities and a related impact to operating earnings.
Our accounting for income taxes involves the valuation of deferred tax assets and liabilities primarily associated with differences in the timing of the recognition of revenues and expenses for financial reporting and tax purposes. At June 30, 2017, we had gross deferred tax assets of $8.3 million, gross deferred tax liabilities of $2.4 million resulting in a net deferred tax asset of $5.9 million.
Accounting standards require that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a "more likely than not" standard. Each reporting period we consider all reasonably available positive and negative evidence and determine whether it is “more likely than not” that we would be able to realize our deferred tax assets
. With the positive results in the first six months of 2017, we concluded at June 30, 2017 that no valuation allowance on our net deferred tax asset was required.
Changes in tax laws, changes in tax rates, changes in ownership and our future level of earnings can impact the ultimate realization of our net deferred tax asset.