pbib20160818_10q.htm Table Of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-Q  

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended September 30, 2016

 

Or

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

 

Commission file number: 001-33033

 

PORTER BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

  

  

  

Kentucky

  

61-1142247

(State or other jurisdiction of

incorporation or organization)

  

(I.R.S. Employer

Identification No.)

  

  

2500 Eastpoint Parkway, Louisville, Kentucky

  

40223

(Address of principal executive offices)

  

(Zip Code)

 

(502) 499-4800

(Registrant’s telephone number, including area code)


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes      No  

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer      

Accelerated filer      

Non-accelerated filer  

Smaller reporting company  

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes      No  

 

Indicate the number of shares outstanding of each of the issuer’s class of common stock, as of the latest practicable date.

 

23,156,969 shares of Common Stock and 7,958,000 shares of Non-Voting Common Stock, no par value, were outstanding at October 31, 2016.


 

 
1

Table Of Contents
 

 

INDEX

 

 

  

  

Page

PART I –

FINANCIAL INFORMATION

  

ITEM 1.

FINANCIAL STATEMENTS

3

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

36

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

53

ITEM 4.

CONTROLS AND PROCEDURES

53

  

  

  

PART II –

OTHER INFORMATION

  

ITEM 1.

LEGAL PROCEEDINGS

54

ITEM 1A.

RISK FACTORS

54

ITEM 2.

UNREGISTERED SALES ON EQUITY SECURITIES AND USE OF PROCEEDS

54

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

54

ITEM 4.

MINE SAFETY DISCLOSURES

54

ITEM 5.

OTHER INFORMATION

54

ITEM 6.

EXHIBITS

54

 

 
2

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PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

The following consolidated financial statements of Porter Bancorp, Inc. and subsidiary, PBI Bank, Inc. are submitted:

 

Unaudited Consolidated Balance Sheets for September 30, 2016 and December 31, 2015

Unaudited Consolidated Statements of Operations for the three and nine months ended September 30, 2016 and 2015

Unaudited Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2016 and 2015

Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the nine months ended September 30, 2016

Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2016 and 2015

Notes to Unaudited Consolidated Financial Statements

 

 
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PORTER BANCORP, INC.

Unaudited Consolidated Balance Sheets

(dollars in thousands except share data)

 

 

   

September 30,

2016

   

December

31, 2015

 

Assets

               

Cash and due from banks

  $ 6,266     $ 8,006  

Interest bearing deposits in banks

    57,578       85,329  

Cash and cash equivalents

    63,844       93,335  

Securities available for sale

    142,433       144,978  

Securities held to maturity (fair value of $44,815 and $44,253, respectively)

    41,883       42,075  

Loans held for sale

    134       186  

Loans, net of allowance of $9,489 and $12,041, respectively

    612,208       606,625  

Premises and equipment, net

    18,481       18,812  

Other real estate owned

    7,098       19,214  

Federal Home Loan Bank stock

    7,323       7,323  

Bank owned life insurance

    14,741       9,441  

Accrued interest receivable and other assets

    7,135       6,733  

Total assets

  $ 915,280     $ 948,722  
                 

Liabilities and Stockholders’ Equity

               

Deposits

               

Non-interest bearing

  $ 119,005     $ 120,043  

Interest bearing

    717,939       757,954  

Total deposits

    836,944       877,997  

Federal Home Loan Bank advances

    2,619       3,081  

Accrued interest payable and other liabilities

    7,721       10,577  

Subordinated capital note

    3,375       4,050  

Junior subordinated debentures

    21,000       21,000  

Total liabilities

    871,659       916,705  

Stockholders’ equity

               

Preferred stock, no par

               

Series E - 6,198 issued and outstanding; Liquidation preference of $6.2 million

    1,644       1,644  

Series F - 4,304 issued and outstanding; Liquidation preference of $4.3 million

    1,127       1,127  

Total preferred stockholders’ equity

    2,771       2,771  

Common stock, no par, 86,000,000 shares authorized, 23,156,969 and 20,089,533 voting, and 7,958,000 and 6,858,000 non-voting shares issued and outstanding, respectively

    125,729       120,699  

Additional paid-in capital

    23,969       23,654  

Retained deficit

    (106,923

)

    (110,808

)

Accumulated other comprehensive loss

    (1,925

)

    (4,299

)

Total common stockholders’ equity

    40,850       29,246  

Total stockholders' equity

    43,621       32,017  

Total liabilities and stockholders’ equity

  $ 915,280     $ 948,722  

 

See accompanying notes to unaudited consolidated financial statements.

 

 
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PORTER BANCORP, INC.

Unaudited Consolidated Statements of Operations

(dollars in thousands, except per share data)

 

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2016

   

2015

   

2016

   

2015

 
Interest income                                

Loans, including fees

  $ 7,699     $ 7,895     $ 23,036     $ 23,496  

Taxable securities

    956       986       2,895       3,122  

Tax exempt securities

    153       187       475       580  

Fed funds sold and other

    123       111       415       351  
      8,931       9,179       26,821       27,549  

Interest expense

                               

Deposits

    1,262       1,476       3,850       4,775  

Federal Home Loan Bank advances

    17       23       54       74  

Subordinated capital note

    35       40       112       123  

Junior subordinated debentures

    159       158       500       465  

Federal funds purchased and other

                      1  
      1,473       1,697       4,516       5,438  

Net interest income

    7,458       7,482       22,305       22,111  

Provision (negative provision) for loan losses

    (750

)

    (2,200

)

    (1,900

)

    (2,200

)

Net interest income after provision (negative provision) for loan losses

    8,208       9,682       24,205       24,311  
                                 

Non-interest income

                               

Service charges on deposit accounts

    520       492       1,422       1,376  

Bank card interchange fees

    214       212       637       644  

Other real estate owned rental income

    46       380       451       1,109  

Bank owned life insurance income

    101       65       316       229  

Net gain (loss) on sales of securities, net

    (16

)

          187       1,696  

Gain on extinguishment of junior subordinated debt

          883             883  

Other

    240       178       635       534  
      1,105       2,210       3,648       6,471  

Non-interest expense

                               

Salaries and employee benefits

    3,945       3,920       11,624       11,795  

Occupancy and equipment

    842       815       2,504       2,513  

Professional fees

    374       620       1,251       2,313  

FDIC Insurance

    442       539       1,458       1,673  

Data processing expense

    295       278       887       860  

State franchise and deposit tax

    255       285       765       855  

Other real estate owned expense

    322       5,131       1,284       8,796  

Loan collection expense

    222       321       575       895  

Other

    1,223       1,059       3,599       3,694  
      7,920       12,968       23,947       33,394  

Income (loss) before income taxes

    1,393       (1,076

)

    3,906       (2,612

)

Income tax expense

                21        

Net income (loss)

    1,393       (1,076

)

    3,885       (2,612

)

Less:

                               

Earnings (loss) allocated to participating securities

    46       (45

)

    129       (338

)

Net income (loss) available to common shareholders

  $ 1,347     $ (1,031

)

  $ 3,756     $ (2,274

)

Basic and diluted income (loss) per common share

  $ 0.04     $ (0.04

)

  $ 0.13     $ (0.10

)

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

 
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PORTER BANCORP, INC.

Unaudited Consolidated Statements of Comprehensive Income (Loss)

(in thousands)

                                              

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2016

   

2015

   

2016

   

2015

 

Net income (loss)

  $ 1,393     $ (1,076

)

  $ 3,885     $ (2,612

)

Other comprehensive income (loss):

                               

Unrealized gain (loss) on securities:

                               

Unrealized gain arising during the period

    597       1,227       2,465       794  

Amortization during the period of net unrealized loss transferred to held to maturity

    32       33       96       97  

Reclassification adjustment for losses (gains) included in net income

    16             (187

)

    (1,696

)

Net unrealized gain (loss) recognized in comprehensive income

    645       1,260       2,374       (805

)

Tax effect

                       

Other comprehensive income (loss)

    645       1,260       2,374       (805

)

                                 

Comprehensive income (loss)

  $ 2,038     $ 184     $ 6,259     $ (3,417

)

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 
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PORTER BANCORP, INC.

Unaudited Consolidated Statements of Changes in Stockholders’ Equity

For Nine Months Ended September 30, 2016

(Dollar amounts in thousands except share and per share data)

 

 

    Shares     Amount         
    Common     Preferred           Preferred     Common        
    Common    

Non-Voting

Common

   

Total

Common

    Series E     Series F     Common and Non-Voting Common     Series E     Series F    

Additional

Paid-In

Capital

   

Retained

Deficit

   

Accumulated

Other

Compre-

hensive

Income

(Loss)

    Total  

Balances, January 1, 2016

    20,089,533       6,858,000       26,947,533       6,198       4,304     $ 120,699     $ 1,644     $ 1,127     $ 23,654     $ (110,808

)

  $ (4,299

)

  $ 32,017  

Issuance of unvested stock

    177,290             177,290                                                        

Forfeited unvested stock

    (9,854

)

          (9,854

)

                                                     

Stock-based compensation expense

                                                    315                   315  

Net income

                                                          3,885             3,885  

Net change in accumulated other comprehensive income, net of taxes

                                                                2,374       2,374  

Issuance of stock

    2,900,000       1,100,000       4,000,000                   5,030                                     5,030  

Balances, September 30, 2016

    23,156,969       7,958,000       31,114,969       6,198       4,304     $ 125,729     $ 1,644     $ 1,127     $ 23,969     $ (106,923

)

  $ (1,925

)

  $ 43,621  

 

See accompanying notes to unaudited consolidated financial statements.

 

 
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PORTER BANCORP, INC.

Unaudited Consolidated Statements of Cash Flows

For Nine Months Ended September 30, 2016 and 2015

(dollars in thousands)

 

   

2016

   

2015

 

Cash flows from operating activities

               

Net income (loss)

  $ 3,885     $ (2,612

)

Adjustments to reconcile net income (loss) to net cash from operating activities

               

Depreciation and amortization

    1,141       1,201  

Provision (negative provision) for loan losses

    (1,900

)

    (2,200

)

Net amortization on securities

    965       1,084  

Stock-based compensation expense

    315       313  

Gain on extinguishment of junior subordinated debt

          (883

)

Net loss (gain) on sales of loans held for sale

    (61

)

    216  

Loans originated for sale

    (3,830

)

    (5,290

)

Proceeds from sales of loans held for sale

    3,943       5,289  

Net gain on sales of other real estate owned

    (221

)

    (27

)

Write-down of other real estate owned

    970       7,080  

Net realized gain on sales of available for sale securities

    (187

)

    (1,696

)

Earnings on bank owned life insurance, net of premium expense

    (300

)

    (214

)

Net change in accrued interest receivable and other assets

    (701

)

    893  

Net change in accrued interest payable and other liabilities

    (57

)

    939  

Net cash from operating activities

    3,962       4,093  
                 

Cash flows from investing activities

               

Purchases of available for sale securities

    (18,868

)

    (16,800

)

Sales and calls of available for sale securities

    6,276       44,340  

Maturities and prepayments of available for sale securities

    16,925       16,408  

Proceeds from sale of other real estate owned

    12,340       14,417  

Proceeds from sales of loans not originated for sale

          8,640  

Loan originations and payments, net

    (4,781

)

    (7,029

)

Purchases of premises and equipment, net

    (386

)

    (308

)

Purchase of bank owned life insurance

    (5,000

)

     

Net cash from investing activities

    6,506       59,668  
                 

Cash flows from financing activities

               

Net change in deposits

    (41,053

)

    (48,948

)

Net change in repurchase agreements

          (1,341

)

Repayment of Federal Home Loan Bank advances

    (462

)

    (17,497

)

Advances from Federal Home Loan Bank

          5,000  

Repayment of subordinated capital note

    (675

)

    (675

)

Issuance of common stock

    2,231        

Net cash from financing activities

    (39,959

)

    (63,461

)

                 

Net change in cash and cash equivalents

    (29,491

)

    300  

Beginning cash and cash equivalents

    93,335       80,180  

Ending cash and cash equivalents

  $ 63,844     $ 80,480  
                 

Supplemental cash flow information:

               

Interest paid

  $ 3,933     $ 5,523  

Income taxes paid

    21        

Supplemental non-cash disclosure:

               

Proceeds from common stock issuance directed by investors to pay junior subordinated debt interest

  $ 2,799     $  

Transfer from loans to other real estate

    1,243       4,450  

Financed sales of other real estate owned

    270        

Effect of junior subordinated debt to equity exchange

          4,330  

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 
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PORTER BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

 

 

Note 1 – Basis of Presentation and Summary of Significant Accounting Policies

 

Basis of Presentation – The consolidated financial statements include Porter Bancorp, Inc. (Company) and its subsidiary, PBI Bank (Bank).  The Company owns a 100% interest in the Bank. All significant inter-company transactions and accounts have been eliminated in consolidation.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, the financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the entire year. A description of other significant accounting policies is presented in the notes to the Consolidated Financial Statements for the year ended December 31, 2015 included in the Company’s Annual Report on Form 10-K.

 

Use of Estimates – To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ.

 

Reclassifications – Some items in the prior year financial statements were reclassified to conform to the current presentation. The reclassifications did not impact net income or stockholders’ equity.

 

Adoption of New Accounting Standards – In August 2015, FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606). This ASU is an update to ASU 2014-09, and delays the effective date of ASU 2014-09. The ASU provides guidance on revenue recognition for entities that enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of nonfinancial assets. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additional disclosures are required to provide quantitative and qualitative information regarding the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new guidance is effective for annual reporting periods, and interim reporting periods within those annual periods, beginning after December 15, 2017. Early adoption is not permitted. Management is currently evaluating the impact of the adoption of this guidance on the Company’s financial statements.

 

In January 2016, the FASB issued an update ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this update impact public business entities as follows: 1) Require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. 2) Simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value. 3) Eliminate the requirement to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. 4) Require entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. 5) Require an entity to present separately in other comprehensive income the portion of the total change in fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. 6) Require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements. 7) Clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

 

In February 2016, the FASB issued an update ASU No. 2016-02, Leases (Topic 842). Under the new guidance, lessees will be required to recognize the following for all leases, with the exception of short-term leases, at the commencement date: a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting in largely unchanged. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2018. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

  

 
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In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The amendments are intended to improve the accounting for employee share-based payments and affects all organizations that issue share-based payment awards to their employees. Several aspects of the accounting for share-based payment award transactions are simplified, including the income tax consequences, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but it is not expected to have a material impact.

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The final standard will change estimates for credit losses related to financial assets measured at amortized cost such as loans, held-to-maturity debt securities, and certain other contracts. For estimating credit losses, the FASB is replacing the incurred loss model with an expected loss model, which is referred to as the current expected credit loss (CECL) model. The largest impact will be on the allowance for loan and lease losses. The standard is effective for public companies for fiscal years beginning after December 15, 2019. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements.

 

 

Note 2 – Going Concern Considerations and Future Plans

 

Our consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business for the foreseeable future. However, the events and circumstances described in the Company’s annual report filed on Form 10K for the year ended December 31, 2015 created substantial doubt about the Company’s ability to continue as a going concern at December 31, 2015. Since December 31, 2015, the Company has made significant improvements in its operating results, improved its liquidity position through a capital raise, brought current interest payment obligations on its junior subordinated debt in 2016, reduced non-performing assets, and reduced contingent liability risk as discussed below.

 

For the nine months ended September 30, 2016, we reported net income of $3.9 million compared with net loss of $3.2 million and $11.2 million for the years ended December 31, 2015 and 2014, respectively. Our financial performance has been negatively impacted by the Bank’s elevated level of non-performing assets, although the impact continues to diminish as we have substantially reduced non-performing assets during recent periods. Non-performing loans were 1.62%, 2.28%, and 7.57% of total loans at September 30, 2016, December 31, 2015, and December 31, 2014, respectively. Non-performing assets were 1.88%, 3.51%, and 9.19% of total assets at September 30, 2016, December 31, 2015, and December 31, 2014, respectively. See “Analysis of Financial Condition,” below.

 

On April 15, 2016, we completed a private placement of 2.9 million common shares and 1.1 million non-voting common shares to accredited investors for a total purchase price of $5.0 million. The investors in the private placement directed a portion of the purchase price to pay all deferred interest payments on our trust preferred securities, bringing our interest payments current through the second quarter of 2016. We had deferred interest payable on the junior subordinated debentures held by our trust subsidiaries since the fourth quarter of 2011, requiring our trust subsidiaries to defer distributions on our trust preferred securities held by investors during that period. The remaining proceeds from the private placement totaled approximately $2.2 million and will be used for general corporate purposes and to support the Bank.

 

On June 29, 2016, we notified the trustees of our election to again defer our interest payments effective with the third quarter 2016 payment. We have the ability to defer distributions on our trust preferred securities for 20 consecutive quarters or through the second quarter of 2021. After 20 consecutive quarters, we must pay all deferred distributions or we will be in default.

 

We continue to be involved in various legal proceedings, which are more fully described in Note 13 – “Contingencies”. We are appealing a judgment against us that we believe, after conferring with our legal advisors, we have meritorious grounds on which to prevail. If we do not prevail, the ultimate outcome of this matter could have a material adverse effect on our financial condition, results of operations, or cash flows.

 

PBI Bank is in compliance with each element of its Consent Order with the Federal Depository Insurance Corporation (“FDIC”) and the Kentucky Department of Financial Institutions (“KDFI”) other than the requirement that the Bank maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. As of September 30, 2016, the Bank’s Tier 1 leverage ratio and total risk based capital ratio had improved to 6.97% and 11.18%, respectively, both less than the minimum capital ratios required by the Consent Order, but otherwise compliant with Basel III capital requirements. The Consent Order provides that if the Bank should be unable to reach the required capital levels, and if directed in writing by the FDIC, the Bank would be required to develop, adopt and implement a written plan to sell or merge itself into another federally insured financial institution or otherwise obtain a capital investment sufficient to recapitalize the Bank. The Bank has not been directed by the FDIC to implement such a plan.

 

 
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Table Of Contents
 

 

In order to meet the 9.0% Tier 1 leverage ratio and 12.0% total risk based capital ratio requirements of the Consent Order, the Board of Directors and management are continuing to evaluate and implement strategies to achieve the following objectives:

 

 

Increasing capital, including through the issuance of senior debt, subordinated debt, or equity securities.

 

Continuing to operate the Company and Bank in a safe and sound manner. We have reduced our lending concentrations and the size of our balance sheet while continuing to remediate non-performing loans.

 

Executing on the sale of other real estate owned (“OREO”) and reinvesting the sale proceeds in quality income producing assets.

 

Continuing to improve our internal processes and procedures, distribution of labor, and work-flow to ensure we have adequately and appropriately deployed resources in an efficient manner in the current environment.

 

Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a consent order. Based on individual circumstances, the agencies may issue mandatory directives, impose monetary penalties, initiate changes in management, or take more serious adverse actions such as directing a bank to seek a buyer or taking a bank into receivership.

 

The Consent Order requires the Bank to obtain the written consent of both the FDIC and the KDFI before declaring or paying any future dividends to the Company, which are its principal source of the Company’s revenue. Since the Bank is unlikely to be able to pay dividends to the Company until the Consent Order is satisfied, cash inflows for the Company are limited to the issuance of new debt or the issuance of capital securities. The Company’s liquid assets were $2.2 million as of September 30, 2016. Ongoing operating expenses of the Company are forecast at approximately $1.0 million for the next twelve months.

 

Our consolidated financial statements do not include any adjustments that may result were the Company to become unable to continue as a going concern.

 

 
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Note 3 – Securities

 

The fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:

  

   

Amortized Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Fair Value

 
   

(in thousands)

 

September 30, 2016

                               

Available for sale

                               

U.S. Government and federal agency

  $ 35,235     $ 509     $ (6

)

  $ 35,738  

Agency mortgage-backed: residential

    99,225       2,288       (52

)

    101,461  

State and municipal

    2,153       45             2,198  

Corporate bonds

    3,066       38       (68

)

    3,036  

Total available for sale

  $ 139,679     $ 2,880     $ (126

)

  $ 142,433  

 

   

Amortized Cost

   

Gross

Unrecognized

Gains

   

Gross

Unrecognized

Losses

   

Fair Value

 

Held to maturity

                               

State and municipal

  $ 41,883     $ 2,932     $     $ 44,815  

Total held to maturity

  $ 41,883     $ 2,932     $     $ 44,815  

 

   

Amortized Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Fair Value

 

December 31, 2015

                               

Available for sale

                               

U.S. Government and federal agency

  $ 33,491     $ 146     $ (375

)

  $ 33,262  

Agency mortgage-backed: residential

    102,135       907       (380

)

    102,662  

State and municipal

    6,555       306             6,861  

Corporate bonds

    2,321             (128

)

    2,193  

Total available for sale

  $ 144,502     $ 1,359     $ (883

)

  $ 144,978  

 

   

Amortized Cost

   

Gross

Unrecognized

Gains

   

Gross

Unrecognized

Losses

   

Fair Value

 

Held to maturity

                               

State and municipal

  $ 42,075     $ 2,178     $     $ 44,253  

Total held to maturity

  $ 42,075     $ 2,178     $     $ 44,253  

  

Sales and calls of available for sale securities were as follows:

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2016

   

2015

   

2016

   

2015

 
    (in thousands)     (in thousands)  

Proceeds

  $ 2,555     $ 230     $ 6,276     $ 44,340  

Gross gains

    13             216       1,832  

Gross losses

    29             29       136  

 

The amortized cost and fair value of the debt investment securities portfolio are shown by contractual maturity. Contractual maturities may differ from actual maturities if issuers have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities not due at a single maturity date are detailed separately. 

 

 
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September 30, 2016

 
   

Amortized

Cost

   

Fair

Value

 
   

(in thousands)

 

Maturity

               

Available for sale

               

Within one year

  $ 6,628     $ 6,615  

One to five years

    7,120       7,266  

Five to ten years

    26,706       27,091  

Agency mortgage-backed: residential

    99,225       101,461  

Total

  $ 139,679     $ 142,433  
                 

Held to maturity

               

Within one year

  $ 646       653  

One to five years

    21,365     $ 22,469  

Five to ten years

    18,825       20,506  

Beyond ten years

    1,047       1,187  

Total

  $ 41,883     $ 44,815  

                                                                                                 

Securities pledged at September 30, 2016 and December 31, 2015 had carrying values of approximately $52.5 million and $68.0 million, respectively, and were pledged to secure public deposits.

 

At September 30, 2016 and December 31, 2015, we held securities issued by the Commonwealth of Kentucky or municipalities in the Commonwealth of Kentucky having a book value of $16.5 million and $17.7 million, respectively. Additionally, at September 30, 2016 and December 31, 2015, we held securities issued by the State of Texas or municipalities in the State of Texas having a book value of $4.3 million at each period end. At September 30, 2016 and December 31, 2015, there were no other holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.

 

Securities with unrealized losses at September 30, 2016 and December 31, 2015, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position, are as follows:

 

   

Less than 12 Months

   

12 Months or More

   

Total

 

Description of Securities

 

Fair

Value

   

Unrealized

Loss

   

Fair

Value

   

Unrealized

Loss

   

Fair

Value

   

Unrealized

Loss

 
   

(in thousands)

 

September 30, 2016

                                               

Available for sale

                                               

U.S. Government and federal Agency

  $ 3,373     $ (6

)

  $     $     $ 3,373     $ (6

)

Agency mortgage-backed: Residential

    9,637       (52

)

                9,637       (52

)

Corporate bonds

                1,497       (68

)

    1,497       (68

)

Total temporarily impaired

  $ 13,010     $ (58

)

  $ 1,497     $ (68

)

  $ 14,507     $ (126

)

                                                 

December 31, 2015

                                               

Available for sale

                                               

U.S. Government and federal agency

  $ 7,058     $ (44

)

  $ 14,527     $ (331

)

  $ 21,585     $ (375

)

Agency mortgage-backed: residential

    36,325       (271

)

    3,856       (109

)

    40,181       (380

)

Corporate bonds

    747       (18

)

    1,446       (110

)

    2,193       (128

)

Total temporarily impaired

  $ 44,130     $ (333

)

  $ 19,829     $ (550

)

  $ 63,959     $ (883

)

 

There were no held to maturity securities in an unrecognized loss position at September 30, 2016 or December 31, 2015.

 

The Company evaluates securities for other than temporary impairment (OTTI) on a quarterly basis. Consideration is given to 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, underlying credit quality of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the sector or industry trends and cycles affecting the issuer, and the results of reviews of the issuer’s financial condition. Management currently intends to hold all securities with unrealized losses until recovery, which for fixed income securities may be at maturity. As of September 30, 2016, management does not believe securities within our portfolio with unrealized losses should be classified as other than temporarily impaired.

  

 
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Note 4 – Loans

 

Loans were as follows:

 

September 30,

   

December 31,

 
   

2016

   

2015

 
   

(in thousands)

 

Commercial

  $ 85,000     $ 86,176  

Commercial Real Estate:

               

Construction

    34,178       33,154  

Farmland

    83,320       76,412  

Nonfarm nonresidential

    138,351       140,570  

Residential Real Estate:

               

Multi-family

    36,558       44,131  

1-4 Family

    192,008       201,478  

Consumer

    9,752       10,010  

Agriculture

    41,764       26,316  

Other

    766       419  

Subtotal

    621,697       618,666  

Less: Allowance for loan losses

    (9,489

)

    (12,041

)

Loans, net

  $ 612,208     $ 606,625  

 

The following table presents the activity in the allowance for loan losses by portfolio segment for the three months ended September 30, 2016 and 2015:

 

    Commercial    

Commercial

Real Estate

   

Residential

Real Estate

    Consumer     Agriculture     Other     Total  
    (in thousands)  

September 30, 2016:

                                                       

Beginning balance

  $ 730     $ 5,429     $ 3,778     $ 47     $ 119     $ 1     $ 10,104  

Negative provision

    (195

)

    (436

)

    (142

)

    (26

)

    79       (30

)

    (750

)

Loans charged off

    (15

)

    (232

)

    (131

)

    (21

)

    (5

)

    (1

)

    (405

)

Recoveries

    102       354       27       23       1       33       540  

Ending balance

  $ 622     $ 5,115     $ 3,532     $ 23     $ 194     $ 3     $ 9,489  
                                                         
                                                         

September 30, 2015:

                                                       

Beginning balance

  $ 1,946     $ 9,213     $ 5,060     $ 226     $ 359     $ 5     $ 16,809  

Negative provision for loan losses

    (180

)

    (1,334

)

    (489

)

    (73

)

    (120

)

    (4

)

    (2,200

)

Loans charged off

    (201

)

    (768

)

    (486

)

    (70

)

    (41

)

    (14

)

    (1,580

)

Recoveries

    5       905       144       98       2       15       1,169  

Ending balance

  $ 1,570     $ 8,016     $ 4,229     $ 181     $ 200     $ 2     $ 14,198  

 

 
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The following table presents the activity in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2016 and 2015: 

  

    Commercial    

Commercial

Real Estate

   

Residential

Real Estate

    Consumer     Agriculture     Other     Total  
    (in thousands)  

September 30, 2016:

                                                       

Beginning balance

  $ 818     $ 6,993     $ 3,984     $ 122     $ 122     $ 2     $ 12,041  

Negative provision

    (89

)

    (2,024

)

    458       (259

)

    (1

)

    15       (1,900

)

Loans charged off

    (276

)

    (477

)

    (1,181

)

    (56

)

    (13

)

    (79

)

    (2,082

)

Recoveries

    169       623       271       216       86       65       1,430  

Ending balance

  $ 622     $ 5,115     $ 3,532     $ 23     $ 194     $ 3     $ 9,489  
                                                         
                                                         

September 30, 2015:

                                                       

Beginning balance

  $ 2,046     $ 10,931     $ 5,787     $ 274     $ 319     $ 7     $ 19,364  

Negative provision for loan losses

    (207

)

    (1,657

)

    (269

)

    (51

)

    (13

)

    (3

)

    (2,200

)

Loans charged off

    (675

)

    (2,361

)

    (1,777

)

    (200

)

    (111

)

    (47

)

    (5,171

)

Recoveries

    406       1,103       488       158       5       45       2,205  

Ending balance

  $ 1,570     $ 8,016     $ 4,229     $ 181     $ 200     $ 2     $ 14,198  

  

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of September 30, 2016:

 

    Commercial    

Commercial

Real Estate

   

Residential

Real Estate

    Consumer     Agriculture     Other     Total  
    (in thousands)  

Allowance for loa n losses:

                                                       

Ending allowance balance attributable to loans:

                                                       

Individually evaluated for impairment

  $     $ 41     $ 297     $     $ 1     $     $ 339  

Collectively evaluated for impairment

    622       5,074       3,235       23       193       3       9,150  

Total ending allowance balance

  $ 622     $ 5,115     $ 3,532     $ 23     $ 194     $ 3     $ 9,489  
                                                         
                                                         

Loans:

                                                       

Loans individually evaluated for impairment

  $ 571     $ 6,568     $ 8,940     $ 1     $ 134     $     $ 16,214  

Loans collectively evaluated for impairment

    84,429       249,281       219,626       9,751       41,630       766       605,483  

Total ending loans balance

  $ 85,000     $ 255,849     $ 228,566     $ 9,752     $ 41,764     $ 766     $ 621,697  

 

 
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The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of December 31, 2015: 

 

    Commercial    

Commercial

Real Estate

   

Residential

Real Estate

    Consumer     Agriculture     Other     Total  
    (in thousands)  

Allowance for loan losses:

                                                       

Ending allowance balance attributable to loans:

                                                       

Individually evaluated for impairment

  $     $ 43     $ 385     $     $     $     $ 428  

Collectively evaluated for impairment

    818       6,950       3,599       122       122       2       11,613  

Total ending allowance balance

  $ 818     $ 6,993     $ 3,984     $ 122     $ 122     $ 2     $ 12,041  
                                                         
                                                         

Loans:

                                                       

Loans individually evaluated for impairment

  $ 1,112     $ 12,819     $ 17,673     $ 20     $ 152     $     $ 31,776  

Loans collectively evaluated for impairment

    85,064       237,317       227,936       9,990       26,164       419       586,890  

Total ending loans balance

  $ 86,176     $ 250,136     $ 245,609     $ 10,010     $ 26,316     $ 419     $ 618,666  

 

Impaired Loans

 

Impaired loans include restructured loans and loans on nonaccrual or classified as doubtful, whereby collection of the total amount is improbable, or loss, whereby all or a portion of the loan has been written off or a specific allowance for loss has been provided.

 

The following tables present information related to loans individually evaluated for impairment by class of loans as of September 30, 2016 and December 31, 2015 and for the three and nine months ended September 30, 2016 and 2015:

  

    As of September 30, 2016    

Three Months Ended

September 30, 2016

   

Nine Months Ended

September 30, 2016

 
   

Unpaid

Principal

Balance

   

Recorded

Investment

   

Allowance

For Loan

Losses

Allocated

   

Average

Recorded

Investment

   

Interest

 Income

Recognized

   

Average

Recorded

Investment

   

Interest

 Income

Recognized

 
      (in thousands)  

With No Related Allowance Recorded:

                                                       

Commercial

  $ 784     $ 571     $     $ 659     $     $ 824     $ 1  

Commercial real estate:

                                                       

Construction

                      129       3       195       9  

Farmland

    6,040       4,216             4,404       79       4,299       87  

Nonfarm nonresidential

    4,669       1,354             4,023       2       5,569       308  

Residential real estate:

                                                       

Multi-family

    4,121       4,121             3,254       179       2,235       237  

1-4 Family

    4,185       3,086             3,523       14       6,159       85  

Consumer

    34       1             4             8       8  

Agriculture

    97       69             69             92        

Other

                                         

Subtotal

    19,930       13,418             16,065       277       19,381       735  

With An Allowance Recorded:

                                                       

Commercial

                                         

Commercial real estate:

                                                       

Construction

                                         

Farmland

    614       595       6       600             300        

Nonfarm nonresidential

    403       403       35       405       6       421       18  

Residential real estate:

                                                       

Multi-family

                      2,080             3,133       101  

1-4 Family

    2,179       1,733       297       1,656       20       1,671       74  

Consumer

                                         

Agriculture

    78       65       1       68             34        

Other

                                         

Subtotal

    3,274       2,796       339       4,809       26       5,559       193  

Total

  $ 23,204     $ 16,214     $ 339     $ 20,874     $ 303     $ 24,940     $ 928  

 

 
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Table Of Contents
 

  

   

As of December 31, 2015

   

Three Months Ended

September 30, 2015

   

Nine Months Ended

September 30, 2015

 
   

Unpaid

Principal

Balance

   

Recorded

Investment

   

Allowance

For Loan

Losses

Allocated

   

Average

Recorded

Investment

   

Interest

Income

Recognized

   

Average

Recorded

Investment

   

Interest

Income

Recognized

 
   

(in thousands)

 

With No Related Allowance Recorded:

                                                       

Commercial

  $ 1,558     $ 1,112     $     $ 1,439     $     $ 1,630     $ 5  

Commercial real estate:

                                                       

Construction

    278       262             833       3       2,426       11  

Farmland

    6,004       4,263             4,305       34       4,555       60  

Nonfarm nonresidential

    11,256       7,829             13,347       65       18,133       202  

Residential real estate:

                                                       

Multi-family

    32       32             33             37        

1-4 Family

    14,066       11,756             13,163       96       14,040       340  

Consumer

    118       20             23             25        

Agriculture

    260       152             191             219        

Other

                            1       61       5  

Subtotal

    33,572       25,426             33,334       199       41,126       623  

With An Allowance Recorded: -*---------

                                                       

Commercial

                      4             16        

Commercial real estate:

                                                       

Construction

                                         

Farmland

                                  79        

Nonfarm nonresidential

    574       465       43       2,708       6       5,622       18  

Residential real estate:

                                                       

Multi-family

    4,195       4,195       57       4,216       51       4,237       153  

1-4 Family

    1,690       1,690       328       1,691       29       1,709       68  

Consumer

                                  10        

Agriculture

                                         

Other

                                         

Subtotal

    6,459       6,350       428       8,619       86       11,673       239  

Total

  $ 40,031     $ 31,776     $ 428     $ 41,953     $ 285     $ 52,799     $ 862  

 

Cash basis income recognized for the three and nine months ended September 30, 2016 was $87,000 and $377,000, respectively, compared to $47,000 and $149,000 for the three and nine months ended September 30, 2015.

 

Troubled Debt Restructuring

 

A troubled debt restructuring (TDR) occurs when the Company has agreed to a loan modification in the form of a concession for a borrower who is experiencing financial difficulty. The majority of the Company’s TDRs involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired and the Company has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower.

  

 
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Table Of Contents
 

 

The following table presents the types of TDR loan modifications by portfolio segment outstanding as of September 30, 2016 and December 31, 2015: 

 

   

TDRs

Performing to

Modified

Terms

   

TDRs Not

Performing to

Modified

Terms

   

Total

TDRs

 
   

(in thousands)

 

September 30, 2016

                       

Commercial

                       

Rate reduction

  $     $ 33     $ 33  

Principal deferral

          439       439  

Commercial Real Estate:

                       

Construction

                       

Rate reduction

                 

Farmland

                       

Principal deferral

          2,300       2,300  

Nonfarm nonresidential

                       

Rate reduction

    610             610  

Principal deferral

          607       607  

Residential Real Estate:

                       

Multi-family

                       

Rate reduction

    4,121             4,121  

1-4 Family

                       

Rate reduction

    1,383             1,383  

Total TDRs

  $ 6,114     $ 3,379     $ 9,493  

 

   

TDRs

Performing to

Modified Terms

   

TDRs Not

Performing to

Modified Terms

   

Total

TDRs

 
   

(in thousands)

 

December 31, 2015

                       

Commercial

                       

Rate reduction

  $     $ 68     $ 68  

Principal deferral

          439       439  

Commercial Real Estate:

                       

Construction

                       

Rate reduction

    262             262  

Farmland

                       

Principal deferral

          2,365       2,365  

Nonfarm nonresidential

                       

Rate reduction

    5,637       50       5,687  

Principal deferral

          622       622  

Residential Real Estate:

                       

Multi-family

                       

Rate reduction

    4,195             4,195  

1-4 Family

                       

Rate reduction

    7,346             7,346  

Total TDRs

  $ 17,440     $ 3,544     $ 20,984  

 

At September 30, 2016 and December 31, 2015, 64% and 83%, respectively, of the Company’s TDRs were performing according to their modified terms. The Company allocated $238,000 and $179,000 in reserves to borrowers whose loan terms have been modified in TDRs as of September 30, 2016, and December 31, 2015, respectively. The Company has committed to lend no additional amounts as of September 30, 2016 and December 31, 2015 to borrowers with outstanding loans classified as TDRs.

 

Management periodically reviews renewals/modifications of previously identified TDRs, for which there was no principal forgiveness, to consider if it is appropriate to remove the TDR classification. If the borrower is no longer experiencing financial difficulty and the renewal/modification did not contain a concessionary interest rate or other concessionary terms, management considers the potential removal of the TDR classification. If deemed appropriate, the TDR classification is removed as the borrower has complied with the terms of the loan at the date of renewal/modification and there was a reasonable expectation that the borrower would continue to comply with the terms of the loan subsequent to the date of the renewal/modification. In this instance, the TDR was originally considered a restructuring in a prior year as a result of a modification with an interest rate that was not commensurate with the risk of the underlying loan. Additionally, TDR classification can be removed in circumstances in which the Company performs a non-concessionary re-modification of the loan at terms that were considered to be at market for loans with comparable risk. Management expects the borrower will continue to perform under the re-modified terms based on the borrower’s past history of performance.

  

 
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As of September 30, 2016, the TDR classification was removed from one loan that met the requirements as discussed above. This loan totaled $5.0 million at December 31, 2015. This loan is no longer evaluated individually for impairment. 

 

No TDR loan modifications occurred during the three or nine months ended September 30, 2016 or September 30, 2015. During the first nine months of 2016 and 2015, no TDRs defaulted on their restructured loan within the 12 month period following the loan modification. A default is considered to have occurred once the TDR is past due 90 days or more or it has been placed on nonaccrual.

 

Nonperforming Loans

 

Nonperforming loans include impaired loans not on accrual and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment.

 

The following table presents the recorded investment in nonaccrual and loans past due 90 days and still on accrual by class of loan as of September 30, 2016, and December 31, 2015: 

 

   

Nonaccrual

   

Loans Past Due 90 Days

And Over Still Accruing

 
   

September 30,

2016

   

December 31,

2015

   

September 30,

2016

   

December 31,

2015

 
   

(in thousands)

 

Commercial

  $ 571     $ 1,112     $     $  

Commercial Real Estate:

                               

Construction

                       

Farmland

    4,811       4,263              

Nonfarm nonresidential

    1,147       2,657              

Residential Real Estate:

                               

Multi-family

          32              

1-4 Family

    3,435       5,851              

Consumer

    1       20              

Agriculture

    134       152              

Other

                       

Total

  $ 10,099     $ 14,087     $     $  

 

 
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Table Of Contents
 

 

The following table presents the aging of the recorded investment in past due loans as of September 30, 2016 and December 31, 2015: 

 

   

30 – 59

Days

Past Due

   

60 – 89

Days

Past Due

   

90 Days

And Over

Past Due

   

Nonaccrual

   

Total

Past Due

And

Nonaccrual

 
   

(in thousands)

 

September 30, 2016

                                       

Commercial

  $     $     $     $ 571     $ 571  

Commercial Real Estate:

                                       

Construction

                             

Farmland

    156                   4,811       4,967  

Nonfarm nonresidential

                      1,147       1,147  

Residential Real Estate:

                                       

Multi-family

                             

1-4 Family

    2,087       270             3,435       5,792  

Consumer

    65       3             1       69  

Agriculture

    27                   134       161  

Other

                             

Total

  $ 2,335     $ 273     $     $ 10,099     $ 12,707  

  

   

30 – 59

Days

Past Due

   

60 – 89

Days

Past Due

   

90 Days

And Over

Past Due

   

Nonaccrual

   

Total

Past Due

And

Nonaccrual

 
                                         
   

(in thousands)

 

December 31, 2015

                                       

Commercial

  $ 78     $     $     $ 1,112     $ 1,190  

Commercial Real Estate:

                                       

Construction

                             

Farmland

    456                   4,263       4,719  

Nonfarm nonresidential

    326                   2,657       2,983  

Residential Real Estate:

                                       

Multi-family

                      32       32  

1-4 Family

    2,225       241             5,851       8,317  

Consumer

    41                   20       61  

Agriculture

    7                   152       159  

Other

                             

Total

  $ 3,133     $ 241     $     $ 14,087     $ 17,461  

 

Credit Quality Indicators 

 

We categorize all loans into risk categories at origination based upon original underwriting. Thereafter, we categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends. Additionally, loans are analyzed regularly through our internal and external loan review processes. Borrower relationships in excess of $500,000 are routinely analyzed through our credit administration processes which classify the loans as to credit risk. The following definitions are used for risk ratings:

 

Watch – Loans classified as watch are those loans which have experienced a potentially adverse development which necessitates increased monitoring.

 

Special Mention – Loans classified as special mention do not have all of the characteristics of substandard or doubtful loans. They have one or more deficiencies which warrant special attention and which corrective action, such as accelerated collection practices, may remedy.

 

Substandard – Loans classified as substandard are those loans with clear and defined weaknesses such as a highly leveraged position, unfavorable financial ratios, uncertain repayment sources or poor financial condition which may jeopardize the repayment of the debt as contractually agreed. They are characterized by the distinct possibility we will sustain some losses if the deficiencies are not corrected.

  

Doubtful – Loans classified as doubtful are those loans which have characteristics similar to substandard loans but with an increased risk that collection or liquidation in full is highly questionable and improbable.

  

 
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Table Of Contents
 

 

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be “Pass” rated loans.  As of September 30, 2016, and December 31, 2015, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows: 

 

   

Pass

   

Watch

   

Special

Mention

   

Substandard

   

Doubtful

   

Total

 
   

(in thousands)

 

September 30, 2016

                                               

Commercial

  $ 83,466     $ 525     $     $ 1,009     $     $ 85,000  

Commercial Real Estate:

                                               

Construction

    28,881       5,211             86             34,178  

Farmland

    73,324       2,717             7,279             83,320  

Nonfarm nonresidential

    124,094       11,707       533       2,017             138,351  

Residential Real Estate:

                                               

Multi-family

    28,218       4,485             3,855             36,558  

1-4 Family

    170,439       12,941       70       8,558             192,008  

Consumer

    9,274       399             79             9,752  

Agriculture

    32,613       8,064             1,087             41,764  

Other

    766                               766  

Total

  $ 551,075     $ 46,049     $ 603     $ 23,970     $     $ 621,697  

 

   

Pass

   

Watch

   

Special

Mention

   

Substandard

   

Doubtful

   

Total

 
   

(in thousands)

 

December 31, 2015

                                               

Commercial

  $ 81,570     $ 2,953     $     $ 1,653     $     $ 86,176  

Commercial Real Estate:

                                               

Construction

    27,603       5,289             262             33,154  

Farmland

    65,476       4,844             6,092             76,412  

Nonfarm nonresidential

    111,901       22,687       1,328       4,654             140,570  

Residential Real Estate:

                                               

Multi-family

    35,300       4,879             3,952             44,131  

1-4 Family

    164,490       17,636       67       19,285             201,478  

Consumer

    9,323       474             213             10,010  

Agriculture

    21,402       4,601             313             26,316  

Other

    419                               419  

Total

  $ 517,484     $ 63,363     $ 1,395     $ 36,424     $     $ 618,666  

 

Note 5 – Other Real Estate Owned

 

Other real estate owned (OREO) is real estate acquired as a result of foreclosure or by deed in lieu of foreclosure. It is classified as real estate owned until such time as it is sold. When property is acquired as a result of foreclosure or by deed in lieu of foreclosure, it is recorded at its fair market value less cost to sell. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. Costs incurred in order to perfect the lien prior to foreclosure may be capitalized if the fair value less the cost to sell exceeds the balance of the loan at the time of transfer to OREO. Examples of eligible costs to be capitalized are payments of delinquent property taxes to clear tax liens or payments to contractors and subcontractors to clear mechanics’ liens. Subsequent reductions in fair value are recorded as non-interest expense. 

 

To determine the fair value of OREO for smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. If the internally evaluated market price is below our underlying investment in the property, appropriate write-downs are taken. For larger dollar residential and commercial real estate properties, we obtain a new appraisal of the subject property or have staff from our special assets group or in our centralized appraisal department evaluate the latest in-file appraisal in connection with the transfer to other real estate owned. We typically obtain updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent. 

  

 
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Table Of Contents
 

 

The following table presents the major categories of OREO at the period-ends indicated:

 

   

September 30,

2016

   

December 31,

2015

 
   

(in thousands)

 

Commercial Real Estate:

               

Construction, land development, and other land

  $ 6,781     $ 12,749  

Nonfarm nonresidential

    18       6,967  

Residential Real Estate:

               

1-4 Family

    299       128  
      7,098       19,844  

Valuation allowance

          (630

)

    $ 7,098     $ 19,214  

 

   

For the Three

Months Ended

September 30,

   

For the Nine

Months Ended

September 30,

 
   

2016

   

2015

   

2016

   

2015

 
    (in thousands)     (in thousands)  

OREO Valuation Allowance Activity:

                               

Beginning balance

  $ 441     $ 307     $ 630     $ 1,066  

Provision to allowance

    320       4,450       970       7,080  

Write-downs

    (761

)

    (4,457

)

    (1,600

)

    (7,846

)

Ending balance

  $     $ 300     $     $ 300  

 

Residential loans secured by 1-4 family residential properties in the process of foreclosure totaled $431,000 and $934,000 at September 30, 2016 and December 31, 2015, respectively.

 

Net activity relating to other real estate owned during the nine months ended September 30, 2016 and 2015 is as follows:

 

   

For the Nine

Months Ended

September 30,

 
   

2016

   

2015

 
   

(in thousands)

 

OREO Activity

               

OREO as of January 1

  $ 19,214     $ 46,197  

Real estate acquired

    1,243       4,450  

Valuation adjustment write-downs

    (970

)

    (7,080

)

Net gain on sales

    221       27  

Proceeds from sale of properties

    (12,610

)

    (14,417

)

OREO as of September 30

  $ 7,098     $ 29,177  

 

OREO rental income totaled $46,000 and $451,000 for the three and nine months ended September 30, 2016, respectively, and $380,000 and $1.1 million for the three and nine months ended September 30, 2015, respectively.

 

Expenses related to other real estate owned include:

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2016

   

2015

   

2016

   

2015

 
    (in thousands)     (in thousands)  

Net (gain) loss on sales

  $ (52

)

  $ 16     $ (221

)

  $ (27

)

Provision to allowance

    320       4,450       970       7,080  

Operating expense

    54       665       535       1,743  

Total

  $ 322     $ 5,131     $ 1,284     $ 8,796  

 

 
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Note 6 – Deposits

 

 The following table shows ending deposit balances by category as of:

 

   

September 30,

2016

   

December 31,

2015

 
   

(in thousands)

 

Non-interest bearing

  $ 119,005     $ 120,043  

Interest checking

    88,386       97,515  

Money market

    140,995       125,935  

Savings

    33,816       34,677  

Certificates of deposit

    454,742       499,827  

Total

  $ 836,944     $ 877,997  

 

Time deposits of $250,000 or more were $28.2 million and $28.4 million at September 30, 2016 and December 31, 2015, respectively.

 

Scheduled maturities of all time deposits at September 30, 2016 were as follows (in thousands):

 

Year 1

  $ 293,430  

Year 2

    89,256  

Year 3

    21,352  

Year 4

    41,930  

Year 5

    8,774  
    $ 454,742  

 

Note 7 – Advances from the Federal Home Loan Bank

 

Advances from the Federal Home Loan Bank were as follows:

 

   

September 30,

   

December 31,

 
   

2016

   

2015

 
   

(in thousands)

 

Monthly amortizing advances with fixed rates from 0.00% to 5.25% and maturities ranging from 2017 through 2033, averaging 2.42% at September 30, 2016 and 2.65% at December 31, 2015

  $ 2,619     $ 3,081  

 

Each advance is payable based upon the terms of agreement, with a prepayment penalty. New advances are limited to a one-year maturity or less. No prepayment penalties were incurred during 2016 or 2015. The advances are collateralized by first mortgage loans. The borrowing capacity is based on the market value of the underlying pledged loans. At September 30, 2016, our additional borrowing capacity with the FHLB was $27.7 million. The availability of our borrowing capacity could be affected by our financial condition and the FHLB could require additional collateral or, among other things, exercise its right to deny a funding request, at its discretion.

 

 
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Table Of Contents
 

 

Note 8 – Fair Values Measurement

 

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. We use various valuation techniques to determine fair value, including market, income and cost approaches. There are three levels of inputs that may be used to measure fair values:

 

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets an entity has the ability to access as of the measurement date, or observable inputs.

 

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

 

Level 3: Significant unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

  

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. When that occurs, we classify the fair value hierarchy on the lowest level of input that is significant to the fair value measurement. We used the following methods and significant assumptions to estimate fair value.

 

Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges, if available. This valuation method is classified as Level 1 in the fair value hierarchy. For securities where quoted prices are not available, fair values are calculated on market prices of similar securities, or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Matrix pricing relies on the securities’ relationship to similarly traded securities, benchmark curves, and the benchmarking of like securities. Matrix pricing utilizes observable market inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. In instances where broker quotes are used, these quotes are obtained from market makers or broker-dealers recognized to be market participants. This valuation method is classified as Level 2 in the fair value hierarchy. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators. This valuation method is classified as Level 3 in the fair value hierarchy. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

 

Impaired Loans: An impaired loan is evaluated at the time the loan is identified as impaired and is recorded at fair value less costs to sell. Fair value is measured based on the value of the collateral securing the loan and is classified as Level 3 in the fair value hierarchy. Fair value is determined using several methods. Generally, the fair value of real estate is determined based on appraisals by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.

 

Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. These routine adjustments are made to adjust the value of a specific property relative to comparable properties for variations in qualities such as location, size, and income production capacity relative to the subject property of the appraisal. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

 

We routinely apply an internal discount to the value of appraisals used in the fair value evaluation of our impaired loans. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to 25% for real estate that is determined (1) to have a thin trading market or (2) to be specialized collateral. This is in addition to estimated discounts for cost to sell of six to ten percent.

 

We also apply discounts to the expected fair value of collateral for impaired loans where the likely resolution involves litigation or foreclosure. Resolution of this nature generally results in receiving lower values for real estate collateral in a more aggressive sales environment. We have utilized discounts ranging from 10% to 33% in our impairment evaluations when applicable.

  

 
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Impaired loans are evaluated quarterly for additional impairment. We obtain updated appraisals on properties securing our loans when circumstances are warranted such as at the time of renewal or when market conditions have significantly changed. This determination is made on a property-by-property basis in light of circumstances in the broader economic climate and our assessment of deterioration of real estate values in the market in which the property is located. The first stage of our assessment involves management’s inspection of the property in question. Management also engages in conversations with local real estate professionals, investors, and market participants to determine the likely marketing time and value range for the property. The second stage involves an assessment of current trends in the regional market. After thorough consideration of these factors, management will either internally evaluate fair value or order a new appraisal.

 

Other Real Estate Owned (OREO): OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or internal evaluation less cost to sell. Our quarterly evaluations of OREO for impairment are driven by property type. For smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. Based on these consultations, we determine asking prices for OREO properties we are marketing for sale. If the internally evaluated fair value is below our recorded investment in the property, appropriate write-downs are taken.

 

For larger dollar commercial real estate properties, we obtain a new appraisal of the subject property or have staff in our special assets group or centralized appraisal department evaluate the latest in-file appraisal in connection with the transfer to other real estate owned. In some of these circumstances, an appraisal is in process at quarter end, and we must make our best estimate of the fair value of the underlying collateral based on our internal evaluation of the property, review of the most recent appraisal, and discussions with the currently engaged appraiser. We generally obtain updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent.

 

We routinely apply an internal discount to the value of appraisals used in the fair value evaluation of our OREO. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to 25% for real estate that is determined (1) to have a thin trading market or (2) to be specialized collateral. This is in addition to estimated discounts for cost to sell of six to ten percent.

 

Financial assets measured at fair value on a recurring basis at September 30, 2016 and December 31, 2015 are summarized below:

 

           

Fair Value Measurements at September 30, 2016 Using

 
           

(in thousands)

 

Description

 

Carrying

Value

   

Quoted Prices In Active Markets for Identical Assets

(Level 1)

   

Significant Other Observable Inputs

(Level 2)

   

Significant Unobservable Inputs

(Level 3)

 

Available for sale securities

                               

U.S. Government and federal agency

  $ 35,738     $     $ 35,738     $  

Agency mortgage-backed: residential

    101,461             101,461        

State and municipal

    2,198             2,198        

Corporate bonds

    3,036             3,036        

Total

  $ 142,433     $     $ 142,433     $  

 

           

Fair Value Measurements at December 31, 2015 Using

 
           

(in thousands)

 

Description

 

Carrying

Value

   

Quoted Prices In Active Markets for Identical Assets

(Level 1)

   

Significant Other Observable Inputs

(Level 2)

   

Significant Unobservable Inputs

(Level 3)

 

Available for sale securities

                               

U.S. Government and

                               

federal agency

  $ 33,262     $     $ 33,262     $  

Agency mortgage-backed: residential

    102,662             102,662        

State and municipal

    6,861             6,861        

Corporate bonds

    2,193             2,193        

Total

  $ 144,978     $     $ 144,978     $  

 

There were no transfers between Level 1 and Level 2 during 2016 or 2015.

 

 
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The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the periods ended September 30, 2016 and 2015:

 

   

Other Debt

Securities

 
   

2016

   

2015

 
   

(in thousands)

 

Balances of recurring Level 3 assets at January 1

  $     $ 658  

Total gain (loss) for the period:

               

Included in other comprehensive income (loss)

          (7

)

Balance of recurring Level 3 assets at September 30

  $     $ 651  

 

At September 30, 2015, our other debt security valuation was determined internally by calculating discounted cash flows using the security’s coupon rate of 6.5% and an estimated current market rate of 8.25% based upon the current yield curve plus spreads that adjust for volatility, credit risk, and optionality. We also considered the issuer’s publicly filed financial information as well as assumptions regarding the likelihood of deferrals and defaults. This security was sold in December 2015.

 

Financial assets measured at fair value on a non-recurring basis are summarized below: 

 

           

Fair Value Measurements at September 30, 2016 Using

 
           

(in thousands)

 
Description  

Carrying

Value

   

Quoted Prices In Active Markets for Identical Assets

(Level 1)

   

Significant Other Observable Inputs

(Level 2)

   

Significant Unobservable Inputs

(Level 3)

 

Impaired loans:

                               

Commercial

  $     $     $     $  

Commercial real estate:

                               

Construction

                       

Farmland

    589                   589  

Nonfarm nonresidential

    91                   91  

Residential real estate:

                               

Multi-family

                       

1-4 Family

    1,436                   1,436  

Consumer

                       

Agriculture

    64                   64  

Other

                       

Other real estate owned, net:

                               

Commercial real estate:

                               

Construction

    6,781                   6,781  

Farmland

                       

Nonfarm nonresidential

    18                   18  

Residential real estate:

                               

Multi-family

                       

1-4 Family

    299                   299  

 

 
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Fair Value Measurements at December 31, 2015 Using

 
           

(in thousands)

 
Description   

Carrying

Value

   

Quoted Prices In Active Markets for Identical Assets

(Level 1)

   

Significant Other Observable Inputs

(Level 2)

   

Significant Unobservable Inputs

(Level 3)

 

Impaired loans:

                               

Commercial

  $     $     $     $  

Commercial real estate:

                               

Construction

                       

Farmland

                       

Nonfarm nonresidential

    139                   139  

Residential real estate:

                               

Multi-family

                       

1-4 Family

    1,362                   1,362  

Consumer

                       

Other

                       

Other real estate owned, net:

                               

Commercial real estate:

                               

Construction

    12,344                   12,344  

Farmland

                       

Nonfarm nonresidential

    6,746                   6,746  

Residential real estate:

                               

Multi-family

                       

1-4 Family

    124                   124  

 

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $2.5 million at September 30, 2016 with a valuation allowance of $309,000, resulting in $220,000 and no additional provision for loan losses for the three and nine months ended September 30, 2016, respectively. Impaired loans had a carrying amount of $2.2 million with a valuation allowance of $369,000, and no additional provision for the three and nine months ended September 30, 2015. At December 31, 2015, impaired loans had a carrying amount of $1.8 million, with a valuation allowance of $337,000.

 

OREO, which is measured at the lower of carrying or fair value less estimated costs to sell, had a net carrying amount of $7.1 million as of September 30, 2016, compared with $29.2 million at September 30, 2015 and $19.2 million at December 31, 2015. Fair value write-downs of $761,000 and $1.6 million were recorded on OREO for the three and nine months ended September 30, 2016, respectively, and $4.5 million and $7.8 million for the three and nine months ended September 30, 2015, respectively.

 

The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 2016:

 

  

 

 

Fair Value

 

Valuation Technique(s)

 

Unobservable Input(s)

Range (Weighted Average)

  

 

 

(in thousands)

 

  

 

  

 

  

     

Impaired loans – Residential real estate

 

1,436

 

Sales comparison approach

 

Adjustment for differences between the comparable sales

 

1%

- 22%  (10%)

 

 

 

 

 

 

 

 

 

 

     

Other real estate owned – Commercial real estate

 

$

6,799

 

Sales comparison approach

 

Adjustment for differences between the comparable sales

 

0%

- 20%  (9%)
                         
          Income approach   Discount or capitalization rate   18% - 20% (19%)

 

 
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The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at December 31, 2015:

 

  

 

Fair Value

 

Valuation

Technique(s)

 

Unobservable Input(s)

 

Range (Weighted Average)

  

 

(in thousands)

 

  

 

  

 

  

     

Impaired loans – Residential real estate

 

1,362

 

Sales comparison approach

 

Adjustment for differences between the comparable sales

 

1%

- 16% (7%)

 

 

 

 

 

 

 

 

 

 

     

Other real estate owned – Commercial real estate

 

$

19,090

 

Sales comparison approach

 

Adjustment for differences between the comparable sales

 

0%

- 30% (12%)
          Income approach   Discount or capitalization rate   10% - 20%  (17%)

 

Carrying amount and estimated fair values of financial instruments were as follows for the periods indicated:

 

           

Fair Value Measurements at September 30, 2016 Using

 
   

Carrying

Amount

   

Level 1

   

Level 2

   

Level 3

   

Total

 
   

(in thousands)

 

Financial assets

                                       

Cash and cash equivalents

  $ 63,844     $ 51,594     $ 12,250     $     $ 63,844  

Securities available for sale

    142,433             142,433             142,433  

Securities held to maturity

    41,883             44,815             44,815  

Federal Home Loan Bank stock

    7,323       N/A       N/A       N/A       N/A  

Loans held for sale

    134             134             134  

Loans, net

    612,208                   618,572       618,572  

Accrued interest receivable

    3,067             1,033       2,034       3,067  

Financial liabilities

                                       

Deposits

  $ 836,944     $ 119,005     $ 707,176     $     $ 826,181  

Federal Home Loan Bank advances

    2,619             2,692             2,692  

Subordinated capital notes

    3,375                   3,303       3,303  

Junior subordinated debentures

    21,000                   13,260       13,260  

Accrued interest payable

    590             396       194       590  

 

 

           

Fair Value Measurements at December 31, 2015 Using

 
   

Carrying

Amount

   

Level 1

   

Level 2

   

Level 3

   

Total

 
   

(in thousands)

 

Financial assets

                                       

Cash and cash equivalents

  $ 93,335     $ 79,498     $ 13,837     $     $ 93,335  

Securities available for sale

    144,978             144,978             144,978  

Securities held to maturity

    42,075             44,253             44,253  

Federal Home Loan Bank stock

    7,323       N/A       N/A       N/A       N/A  

Loans held for sale

    186             186             186  

Loans, net

    606,625                   614,162       614,162  

Accrued interest receivable

    3,116             1,111       2,005       3,116  

Financial liabilities

                                       

Deposits

  $ 877,997     $ 120,043     $ 739,152     $     $ 859,195  

Federal Home Loan Bank advances

    3,081             3,076             3,076  

Subordinated capital notes

    4,050                   3,933       3,933  

Junior subordinated debentures

    21,000                   12,810       12,810  

Accrued interest payable

    2,805             422       2,383       2,805  

 

 
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The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

 

(a) Cash and Cash Equivalents

The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2. Non-interest bearing deposits are Level 1 whereas interest bearing due from bank accounts and fed funds sold are Level 2.

 

(b) FHLB Stock

It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

 

(c) Loans, Net

Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

 

(d) Loans Held for Sale

The fair value of loans held for sale is estimated based upon binding contracts and and/or quotes from third party investors resulting in a Level 2 classification.

 

(e) Deposits

The fair values disclosed for non-interest bearing deposits are, by definition, equal to the amount payable on demand at the reporting date resulting in a Level 1 classification. The carrying amounts of variable rate interest bearing deposits approximate their fair values at the reporting date resulting in a Level 2 classification. Fair values for fixed rate interest bearing deposits are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

 

(f) Other Borrowings

The fair values of the Company’s FHLB advances are estimated using discounted cash flow analyses based on the current borrowing rates resulting in a Level 2 classification.

 

The fair values of the Company’s subordinated capital notes and junior subordinated debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

 

(g) Accrued Interest Receivable/Payable

The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification based on the level of the asset or liability with which the accrual is associated.

  

 
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Note 9 – Income Taxes

 

Deferred tax assets and liabilities were due to the following as of:

 

   

September 30,

   

December 31,

 
   

2016

   

2015

 
   

(in thousands)

 

Deferred tax assets:

               

Net operating loss carry-forward

  $ 42,338     $ 38,085  

Allowance for loan losses

    3,321       4,214  

Other real estate owned write-down

    3,293       7,619  

Alternative minimum tax credit carry-forward

    692       692  

Net assets from acquisitions

    673       671  

Net unrealized loss on securities

          166  

New market tax credit carry-forward

    208       208  

Nonaccrual loan interest

    550       549  

Other

    1,796       1,875  
      52,871       54,079  
                 

Deferred tax liabilities:

               

FHLB stock dividends

    928       928  

Fixed assets

    142       176  

Net unrealized gain on securities

    665        

Other

    1,055       865  
      2,790       1,969  

Net deferred tax assets before valuation allowance

    50,081       52,110  

Valuation allowance

    (50,081

)

    (52,110

)

Net deferred tax asset

  $     $  

 

Our estimate of our ability to realize the deferred tax asset depends on our estimate of projected future levels of taxable income. In analyzing future taxable income levels, we considered all evidence currently available, both positive and negative. Based on our analysis, we established a valuation allowance for all deferred tax assets as of December 31, 2011. The valuation allowance remains in effect as of September 30, 2016.

 

The Company does not have any beginning and ending unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. There were no interest and penalties recorded in the income statement or accrued for the three or nine months ended September 30, 2016 or September 30, 2015 related to unrecognized tax benefits.

 

Under Section 382 of the Internal Revenue Code, as amended (“Section 382”), the Company’s net operating loss carryforwards (“NOLs”) and other deferred tax assets can generally be used to offset future taxable income and therefore reduce federal income tax obligations. However, the Company's ability to use its NOLs would be limited if there was an “ownership change” as defined by Section 382. This would occur if shareholders owning (or deemed to own under the tax rules) 5% or more of the Company's increase their aggregate ownership of the Company by more than 50 percentage points over a defined period of time.

 

In 2015, the Company took two measures to preserve the value of its NOLs. First, we adopted a tax benefits preservation plan designed to reduce the likelihood of an “ownership change” occurring as a result of purchases and sales of the Company's common shares. Upon adoption of this plan, the Company declared a dividend of one preferred stock purchase right for each common share outstanding as of the close of business on July 10, 2015. Any shareholder or group that acquires beneficial ownership of 5% or more of the Company (an “acquiring person”) could be subject to significant dilution in its holdings if the Company's Board of Directors does not approve such acquisition. Existing shareholders holding 5% or more of the Company will not be considered acquiring persons unless they acquire additional shares, subject to certain exceptions described in the plan. In addition, the Board of Directors has the discretion to exempt certain transactions and certain persons whose acquisition of securities is determined by the Board not to jeopardize the Company's deferred tax assets. The rights will expire upon the earlier of (i) June 29, 2018, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefits may be carried forward, (iii) the repeal or amendment of Section 382 or any successor statute, if the Board of Directors determines that the plan is no longer needed to preserve the tax benefits, and (iv) certain other events as described in the plan.

 

On September 23, 2015, our shareholders approved an amendment to the Company’s articles of incorporation to further help protect the long-term value of the Company’s NOLs. The amendment provides a means to block transfers of our common shares that could result in an ownership change under Section 382. The transfer restrictions will expire on the earlier of (i) September 23, 2018, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefit may be carried forward, (iii) the repeal of Section 382 or any successor statute if our Board determines that the transfer restrictions are no longer needed to preserve the tax benefits of our NOLs, or (iv) such date as the Board otherwise determines that the transfer restrictions are no longer necessary.

 

 
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The Company and its subsidiaries are subject to U.S. federal income tax and the Company is subject to income tax in the Commonwealth of Kentucky. The Company is no longer subject to examination by taxing authorities for years before 2012.

 

Note 10 – Stock Plans and Stock Based Compensation

 

At the annual meeting on May 25, 2016, shareholders approved the Porter Bancorp, Inc. 2016 Omnibus Equity Compensation Plan (“2016 Plan”), which replaces the Porter Bancorp, Inc. 2006 Stock Incentive Plan (“2006 Employee Plan”) that had expired earlier in 2016. The shares available for issuance under the 2016 Plan total 232,512 shares which represents the number of shares that had previously been authorized by shareholders for issuance under the 2006 Employee Plan. Shares issued to employees under the plan vest annually on the anniversary date of the grant over three to ten years.

 

The Company also maintains the Porter Bancorp, Inc. 2006 Non-Employee Directors Stock Ownership Incentive Plan (“2006 Director Plan”) pursuant to which 89,622 shares remain available for issuance as annual awards of restricted stock to the Company’s non-employee directors. Shares issued annually to non-employee directors have a fair market value of $25,000 and vest on December 31 in the year of grant.

 

On December 4, 2014, the U.S. Treasury sold our Series A preferred shares at a discount to face amount. As a result, restricted shares previously granted to senior executives became subject to permanent transfer restrictions. On March 25, 2015, the Compensation Committee modified the equity compensation arrangements with our four named executive officers to restore the incentive that was intended by including equity grants in their employment agreements. The Compensation Committee and our four named executive officers mutually agreed to terminate 538,479 restricted shares that were subject to permanent restrictions on transfer. We then awarded 800,000 new service-based restricted shares to those executive officers. The new awards are accounted for as a modification and vest over four years, with one-third of the shares vesting on each of the second, third and fourth anniversaries of the date of grant. The modification resulted in incremental compensation expense of approximately $233,000, which is being amortized in accordance with the vesting schedule.

 

The fair value of the 2016 unvested shares issued was $323,000, or $1.82 per weighted-average share. The Company recorded $148,000 and $315,000 of stock-based compensation to salaries and employee benefits for the three and nine months ended September 30, 2016, respectively, and $132,000 and $313,000 for the three and nine months ended September 30, 2015, respectively. We expect substantially all of the unvested shares outstanding at the end of the period will vest according to the vesting schedule. No deferred tax benefit was recognized related to this expense for either period.

 

The following table summarizes unvested share activity as of and for the periods indicated for the Stock Incentive Plan:

 

 

 

Nine Months Ended

September 30, 2016

   

Twelve Months Ended

December 31, 2015

 
   

Shares

   

Weighted

Average

Grant

Price

   

Shares

   

Weighted

Average

Grant

Price

 

Outstanding, beginning

    922,419     $ 0.96       775,492     $ 1.33  

Granted

    177,290       1.82       915,740       0.91  

Vested

    (96,120

)

    1.51       (285,977

)

    1.33  

Terminated

                (450,994

)

    1.25  

Forfeited

    (9,854

)

    1.23       (31,842

)

    1.13  

Outstanding, ending

    993,735     $ 1.06       922,419     $ 0.96  

  

Unrecognized stock based compensation expense related to unvested shares for the remainder of 2016 and beyond is estimated as follows (in thousands):

 

October 2016 – December 2016

  $ 127  

2017

    197  

2018

    190  

2019

    30  

2020 & thereafter

    9  

  

 
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Note 11 – Earnings (Loss) per Share

 

The factors used in the basic and diluted loss per share computations follow:

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2016

   

2015

   

2016

   

2015

 
   

(in thousands, except share and per share data)

 
                                 

Net income (loss)

  $ 1,393     $ (1,076

)

  $ 3,885     $ (2,612

)

Less:

                               

Earnings (losses) allocated to unvested shares

    46       (45

)

    129       (102

)

Earnings (losses) allocated to participating preferred shares

                      (236

)

Net income (loss) attributable to common shareholders, basic and diluted

  $ 1,347     $ (1,031

)

  $ 3,756     $ (2,274

)

                                 

Basic

                               

Weighted average common shares including unvested common shares outstanding

    31,115,223       25,768,887       29,488,087       25,626,610  

Less:

                               

Weighted average unvested common shares

    1,034,143       1,087,340       977,062       1,002,867  

Weighted average Series B preferred

                      890,901  

Weighted average Series D preferred

                      1,419,341  

Weighted average common shares outstanding

    30,081,080       24,681,547       28,511,025       22,313,501  

Basic income (loss) per common share

  $ 0.04     $ (0.04

)

  $ 0.13     $ (0.10

)

                                 

Diluted

                               

Add: Dilutive effects of assumed exercises of common stock warrants

                       

Weighted average common shares and potential common shares

    30,081,080       24,681,547       28,511,025       22,313,501  

Diluted income (loss) per common share

  $ 0.04     $ (0.04

)

  $ 0.13     $ (0.10

)

 

The Company had no outstanding stock options at September 30, 2016 or 2015. A warrant for the purchase of 330,561 shares of the Company’s common stock at an exercise price of $15.88 was outstanding at September 30, 2016 and 2015 but was not included in the diluted EPS computation as inclusion would have been anti-dilutive.

 

Note 12 – Capital Requirements and Restrictions on Retained Earnings

 

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.

 

The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. Banks (Basel III rules) became effective for the Company and Bank on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule, and fully phased in by January 1, 2019. The final rules allowed banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. The Company and the Bank opted out of this requirement. The rules also establish a “capital conservation buffer” of 2.5%, to be phased in over three years, above the regulatory minimum risk-based capital ratios. Once the capital conservation buffer is fully phased in, the minimum ratios are a common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total risk-based capital ratio of 10.5%. The phase-in of the capital conservation buffer requirement begins in January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented in January 2019. An institution is subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.     

 

In its Consent Order with the FDIC and the KDFI, the Bank has agreed to maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. The Consent Order is described in greater detail in Note 2 – “Going Concern and Future Plans”. As of September 30, 2016, the Bank’s Tier 1 leverage ratio and total risk based capital ratio were both less than the minimum capital ratios required by the Consent Order, but otherwise compliant with Basel III capital requirements. The Bank cannot be considered well-capitalized while subject to the Consent Order. We are also restricted from accepting, renewing, or rolling-over brokered deposits without the prior receipt of a waiver on a case-by-case basis from our regulators.

 

 
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On September 21, 2011, we entered into a Written Agreement with the Federal Reserve Bank of St. Louis. In the Agreement, we made formal commitments to use our financial and management resources to serve as a source of strength for the Bank and to assist the Bank in addressing weaknesses identified by the FDIC and the KDFI, to pay no dividends without prior written approval, to pay no interest or principal on subordinated debentures or trust preferred securities without prior written approval, and to submit an acceptable plan to maintain sufficient capital.

 

The following table shows the ratios and amounts of Common Equity Tier 1, Tier 1 capital and total capital to risk-adjusted assets and the leverage ratios for Porter Bancorp, Inc. and the Bank at the dates indicated (dollars in thousands):

 

   

Actual

   

Regulatory Minimums for Capital A

dequacy Purposes

 
   

Amount

   

Ratio

   

Amount

   

Ratio

 

As of September 30, 2016:

                               

Total risk-based capital (to risk-weighted assets)

                               

Consolidated

  $ 77,470       11.57

%

  $ 53,577       8.00

%

Bank

    74,802       11.18       53,523       8.00  

Total common equity Tier I risk-based capital (to risk-weighted assets)

                               

Consolidated

    42,659       6.37       30,137       4.50  

Bank

    63,770       9.53       30,107       4.50  

Tier I capital (to risk-weighted assets)

                               

Consolidated

    56,788       8.48       40,183       6.00  

Bank

    63,770       9.53       40,142       6.00  

Tier I capital (to average assets)

                               

Consolidated

    56,788       6.21       36,601       4.00  

Bank

    63,770       6.97       36,572       4.00  

 

   

Actual

   

Regulatory Minimums for Capital

Adequacy Purposes

 
   

Amount

   

Ratio

   

Amount

   

Ratio

 

As of December 31, 2015:

                               

Total risk-based capital (to risk-weighted assets)

                               

Consolidated

  $ 68,530       10.46

%

  $ 52,436       8.00

%

Bank

    69,250       10.58       52,347       8.00  

Total common equity Tier 1 risk-based capital (to risk weighted assets)

                               

Consolidated

    33,368       5.09

%

    29,495       4.50

%

Bank

    57,873       8.84       29,445       4.50  

Tier I capital (to risk-weighted assets)

                               

Consolidated

    45,174       6.89       39,327       6.00  

Bank

    57,873       8.84       39,260       6.00  

Tier I capital (to average assets)

                               

Consolidated

    45,174       4.74       38,131       4.00  

Bank

    57,873       6.08       38,085       4.00  

 

 
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The Consent Order requires the Bank to achieve the minimum capital ratios presented below:

 

   

Actual as of September 30, 2016

   

Ratio Required by Consent Order

 
   

Amount

   

Ratio

   

Amount

   

Ratio

 
                                 

Total capital to risk-weighted assets

  $ 74,802       11.18

%

  $ 80,284       12.00

%

Tier I capital to average assets

    63,770       6.97       82,287       9.00  

  

Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a Consent Order. Based on individual circumstances, the agencies may issue mandatory directives, impose monetary penalties, initiate changes in management, or take more serious adverse actions. 

 

Kentucky banking laws limit the dividends that may be paid to a holding company by its subsidiary banks without prior approval. These laws limit the amount of dividends that may be paid in any calendar year is the 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. The Bank has agreed with its primary regulators to obtain their written consent prior to declaring or paying any future dividends. As a practical matter, the Bank cannot pay dividends to the Company while subject to the Consent Order.

 

Note 13 – Contingencies

 

We are defendants in various legal proceedings. Litigation is subject to inherent uncertainties and unfavorable rulings could occur. We record contingent liabilities resulting from claims against us when a loss is assessed to be probable and the amount of the loss is reasonably estimable. Assessing probability of loss and estimating probable losses requires analysis of multiple factors, including in some cases judgments about the potential actions of third party claimants and courts. Recorded contingent liabilities are based on the best information available and actual losses in any future period are inherently uncertain.  Currently, we have accrued approximately $2.1 million related to ongoing litigation matters for which we believe liability is probable and reasonably estimable. Accruals are not made in cases where liability is not probable or the amount cannot be reasonably estimated. We disclose legal matters when we believe liability is reasonably possible and may be material to our consolidated financial statements.

 

Signature Point Litigation. On June 18, 2010, three real estate development companies filed suit in Kentucky state court against the Bank and Managed Assets of Kentucky (“MAKY”). Signature Point Condominiums LLC, et al. v. PBI Bank, et al., Jefferson Circuit Court, Case No 10-CI-04295. On July 16, 2013, a jury in Louisville, Kentucky returned a verdict against the Bank, awarding the plaintiffs compensatory damages of $1,515,000 and punitive damages of $5,500,000. The case arose from a settlement in which the Bank agreed to release the plaintiffs and guarantors from obligations of more than $26 million related to a real estate project in Louisville. The plaintiffs were granted a right of first refusal to repurchase a tract of land within the project. In exchange, the plaintiffs conveyed the real estate securing the loans to the Bank. After plaintiffs declined to exercise their right of first refusal, the Bank sold the tract to the third party. Plaintiffs alleged the Bank had knowledge of the third party offer before the conveyance of the land by the Plaintiffs to the Bank. Plaintiffs asserted claims of fraud, breach of fiduciary duty, breach of the duty of good faith and fair dealing, tortious interference with prospective business advantage and conspiracy to commit fraud, negligence, and conspiracy against the Bank.

 

After conferring with its legal advisors, the Bank believes the findings and damages are excessive and contrary to law, and that it has meritorious grounds on which it has moved to appeal. The Bank’s Notice of Appeal was filed on October 25, 2013. After a number of procedural issues were resolved, the Bank filed its appellate brief on September 30, 2014. Appellee’s brief was filed on December 1, 2014. The Appellate Court heard oral arguments on November 16, 2015. We await the Appellate Court’s ruling. We will continue to defend this matter vigorously.

 

In accordance with the guidance provided in ASC 450-20-25, and after consultation with its legal counsel engaged for the appeal of the verdict, the Company concluded that it was not probable the full amount of the compensatory damages awarded by the jury would be overturned. Therefore, a liability was accrued for the full $1.5 million of compensatory damages awarded, plus statutory interest. After conferring with its legal counsel for the appeal, the Company concluded that the jury verdict for punitive damages was contrary to law, unsupported, excessive, and otherwise inappropriate. Based on this advice, the Company concluded it was probable that the verdict amount for $5.5 million in punitive damages would be overturned by the appeals court, and therefore it was not probable that the $5.5 million in punitive damages would become an actual liability. The ultimate outcome of this self-insured matter could have a material adverse effect on our financial condition, results of operations or cash flows.

 

 
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AIT Laboratories Employee Stock Ownership Plan. On August 29, 2014, the United States Department of Labor (“DOL”) filed a lawsuit against the Bank and Michael A. Evans in the U.S. District Court for the Southern District of Indiana. Thomas E. Perez, Secretary of the United States Department of Labor v. PBI Bank, Inc. and Michael A. Evans (Case No. 1:14-CV-01429-SEB-MJD). The complaint alleged that in 2009, the Bank, in the capacity of trustee for the AIT Laboratories Employee Stock Ownership Plan, authorized the alleged imprudent and disloyal purchase of the stock of AIT Holdings, Inc. in 2009 for $90 million, a price allegedly far in excess of the stock’s fair market value. On May 12, 2016, the parties agreed to settle the litigation and executed a written settlement agreement. The Bank agreed to a settlement payment, which, to the extent not paid from insurance proceeds, had been previously reserved for. The court entered an agreed order ending the litigation on May 13, 2016.

 

United States Department of Justice Investigation. On October 17, 2014, the United States Department of Justice (the “DOJ”) notified the Bank that the Bank was the subject of an investigation into possible violations of federal laws, including, among other things, possible violations related to false bank entries, bank fraud and securities fraud.  The investigation concerns allegations that Bank personnel engaged in practices intended to delay or avoid disclosure of the Bank’s asset quality at the time of and following the United States Treasury’s purchase of preferred shares from the Company in November 2008.  The Bank is responding to and cooperating with any requests for information from DOJ. At this time the investigation is ongoing, and DOJ has made no determination whether to pursue any action in the matter.

  

 
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This item analyzes our financial condition, change in financial condition and results of operations. It should be read in conjunction with the unaudited consolidated financial statements and accompanying notes presented in Part I, Item 1 of this report.

 

Cautionary Note Regarding Forward-Looking Statements

 

This report contains statements about the future expectations, activities and events that constitute forward-looking statements. Forward-looking statements express our beliefs, assumptions and expectations of our future financial and operating performance and growth plans, taking into account information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify forward-looking statements.

 

Forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from the expectations of future results we expressed or implied in any forward-looking statements. These risks and uncertainties can be difficult to predict and may be out of our control. Factors that could contribute to differences in our results include, but are not limited to the following:

 

 

Our inability to increase our capital to the levels required by our agreements with bank regulators could have a material adverse effect on our business.

 

 

A significant percentage of our loan portfolio is comprised of non-owner occupied commercial real estate loans, real estate construction and development loans, and multi-family residential real estate loans, all of which carry a higher degree of risk.

 

 

We continue to hold and acquire a significant amount of other real estate owned (“OREO”) properties, which could increase operating expenses and result in future losses.

 

 

Our decisions regarding credit risk may not be accurate, and our allowance for loan losses may not be sufficient to cover actual losses.

 

 

Our ability to pay cash dividends on our common and preferred shares and pay interest on the junior subordinated debentures that relate to our trust preferred securities is currently restricted. Our inability to resume paying interest on our trust preferred securities could adversely affect our common and preferred shareholders.

 

 

While we believe our provision for legal contingencies is adequate, the outcome of legal proceedings is difficult to predict and we may settle legal claims or be subject to judgments for amounts that exceed our estimates.

 

We also refer you to Part II, Item 1A – Risk Factors in this report and to the risks identified and the cautionary statements discussed in greater detail in our December 31, 2015 Annual Report on Form 10-K.

 

Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen these assumptions and bases in good faith and they are reasonable. We caution you however, forward looking statements relying upon such assumptions or bases almost always vary from actual results, and the differences between those statements and actual results can be material. The forward-looking statements included in this report speak only as of the date of the report.  We have no duty, and do not intend to, update these statements unless applicable laws require us to do so.

 

Overview

  

Porter Bancorp, Inc. (the “Company”) is a bank holding company headquartered in Louisville, Kentucky. Our wholly owned subsidiary PBI Bank (“the Bank”) is the eleventh largest bank domiciled in the Commonwealth of Kentucky based on total assets. We operate banking offices in twelve counties in Kentucky. Our markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and Bullitt. We serve south central Kentucky and southern Kentucky from banking offices in Butler, Green, Hart, Edmonson, Barren, Warren, Ohio, and Daviess Counties. We also have an office in Lexington, the second largest city in Kentucky. The Bank is a community bank with a wide range of commercial and personal banking products. As of September 30, 2016, we had total assets of $915.3 million, total loans of $621.7 million, total deposits of $836.9 million and stockholders’ equity of $43.6 million.

 

 
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The Company reported net income of $1.4 million and $3.9 million for the three and nine months ended September 30, 2016, compared with net loss of $1.1 million and $2.6 million for the same periods of 2015. After deductions for earnings allocated to participating securities, net income available to common shareholders was $1.3 million and $3.8 million for the three and nine months ended September 30, 2016, respectively, compared with net loss attributable to common shareholders of $1.0 million and $2.3 million for the three and nine months ended September 30, 2015, respectively.

 

Basic and diluted net income per common share were $0.04 and $0.13 for the three and nine months ended September 30, 2016, respectively, compared with basic and diluted net loss per common share of ($0.04) and ($0.10) for the three and nine months ended September 30, 2015, respectively.

 

We note the following significant items during the nine months ended September 30, 2016:

 

 

On April 15, 2016, we completed the private placement of 2.9 million common shares and 1.1 million non-voting common shares to accredited investors resulting in total proceeds of $5.0 million. The investors in the private placement directed a portion of purchase price to pay all deferred interest payments on junior subordinated debentures, bringing our interest payments current through the second quarter of 2016. The remaining proceeds totaled approximately $2.2 million and will be used for general corporate purposes and to support the Bank.

 

 

We recorded negative provision for loan losses expense of $1.9 million for the nine months ended September 30, 2016, compared to $2.2 million for the nine months ended September 30, 2015, because of declining historical loss rates, improvements in loan quality, and management’s assessment of risk in the loan portfolio. Net loan charge-offs were $652,000 for the first nine months of 2016, compared to $3.0 million for the first nine months of 2015. In the following paragraphs we discuss our improving trends in non-performing loans, past due loans, and loan risk categories during the period, the factors that led to the negative provision expense.

 

 

Non-performing loans decreased $4.0 million to $10.1 million at September 30, 2016, compared with $14.1 million at December 31, 2015. The decrease in non-performing loans was primarily due to $4.0 million in paydowns, $1.3 million in charge-offs, $751,000 in loans returned to accrual status, and $1.2 million in transfers to OREO, which were offset by $3.3 million in loans being placed on nonaccrual.

 

 

Loans past due 30-59 days decreased from $3.1 million at December 31, 2015 to $2.3 million at September 30, 2016, and loans past due 60-89 days increased slightly from $241,000 at December 31, 2015 to $273,000 at September 30, 2016. Total loans past due and nonaccrual loans decreased to $12.7 million at September 30, 2016, from $17.5 million at December 31, 2015.

 

 

All loan risk categories (other than pass loans) have decreased since December 31, 2015. Pass loans represent 88.6% of the portfolio at September 30, 2016, compared to 83.6% at December 31, 2015. During the nine months ended September 30, 2016, the pass category increased approximately $33.6 million, the watch category declined approximately $17.3 million, the special mention category declined approximately $792,000, and the substandard category declined approximately $12.5 million. The $12.5 million decrease in loans classified as substandard was primarily driven by $7.9 million in principal payments received and $8.1 million in loans upgraded from substandard, offset by $6.7 million in loans downgraded to substandard during the nine months ended September 30, 2016.

 

 

Foreclosed properties were $7.1 million at September 30, 2016, compared with $19.2 million at December 31, 2015, and $29.2 million at September 30, 2015. During the first nine months of 2016, the Company acquired $1.2 million and sold $12.6 million of OREO. We incurred OREO losses totaling $749,000 during the first nine months of 2016 compared to $7.1 million during the first nine months of 2015, reflecting gains and losses on sales and fair value write-downs for reductions in listing prices for certain properties and updated appraisals.

 

 

Our ratio of non-performing assets to total assets decreased to 1.88% at September 30, 2016, compared with 3.51% at December 31, 2015, and 4.85% at September 30, 2015.

 

 

Net interest margin increased 20 basis points to 3.45% for the first nine months of 2016 compared with 3.25% for the first nine months of 2015. The increase in margin between periods was due to an increase in the yield on earning assets from 4.03% for the first nine months of 2015 to 4.14% for the first nine months of 2016, coupled with a decrease in the cost of interest bearing liabilities from 0.87% for the first nine months of 2015 to 0.79% in the first nine months of 2016.

 

 
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Average loans receivable declined approximately $19.7 million or 3.1% to $621.8 million for the nine months ended September 30, 2016 compared with $641.5 million for the nine months ended September 30, 2015. This resulted in an interest revenue volume decline of approximately $726,000. The decrease in the cost of interest bearing liabilities was primarily driven by the continued repricing of certificates of deposit at lower rates and the declining volume of certificates of deposit.

 

 

Non-interest income decreased $2.9 million to $3.6 million for the first nine months of 2016, compared with $6.5 million for the first nine months of 2015. The decrease was driven primarily by gains on the sales of securities totaling $187,000 in the first nine months of 2016, compared to $1.7 million in the first nine months of 2015. Additionally, OREO income decreased $658,000 in 2016 as a result of income producing properties being sold. The third quarter of 2015 was also positively impacted by an $883,000 gain on extinguishment of junior subordinated debt. Non-interest expense decreased $9.4 million to $23.9 million for the first nine months of 2016 compared with $33.4 million for the first nine months of 2015, primarily due to OREO expense totaling $1.3 million in the first nine months of 2016, compared to $8.8 million in the first nine months of 2015, as well as professional fees totaling $1.3 million in the first nine months of 2016, compared to $2.3 million in the first nine months of 2015.

 

 

Deposits decreased 4.7% to $836.9 million at September 30, 2016, compared with $878.0 million at December 31, 2015. Certificate of deposit balances decreased $45.1 million during the first nine months of 2016 to $454.7 million at September 30, 2016, from $499.8 million at December 31, 2015. Money market deposits increased 12.0% at September 30, 2016 compared with December 31, 2015.

 

Going Concern Considerations and Future Plans

 

As described in Note 2 – “Going Concern Considerations and Future Plans,” our consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business for the foreseeable future. However, the events and circumstances described in the Company’s annual report filed on Form 10-K for the year ended December 31, 2015 created substantial doubt about the Company’s ability to continue as a going concern at December 31, 2015. Since December 31, 2015, we have made significant improvements in our operating results, improved our liquidity position through a capital raise, brought current interest payment obligations on our junior subordinated debt in 2016, reduced non-performing assets, and reduced contingent liability risk as described below.

 

For the nine months ended September 30, 2016, we reported net income of $3.9 million compared with net loss of $3.2 million and $11.2 million for the years ended December 31, 2015 and 2014, respectively. Our financial performance has been negatively impacted by the Bank’s elevated level of non-performing assets, although the impact continues to diminish as we have substantially reduced non-performing assets during recent periods. Non-performing loans were 1.62%, 2.28%, and 7.57% of total loans at September 30, 2016, December 31, 2015, and December 31, 2014, respectively. Non-performing assets were 1.88%, 3.51%, and 9.19% of total assets at September 30, 2016, December 31, 2015, and December 31, 2014, respectively. See “Analysis of Financial Condition,” below.

 

On April 15, 2016, we completed a private placement of 2.9 million common shares and 1.1 million non-voting common shares to accredited investors for a total purchase price of $5.0 million. The investors in the private placement directed a portion of the purchase price to pay all deferred interest payments on our trust preferred securities, bringing our interest payments current through the second quarter of 2016. We had deferred interest payable on the junior subordinated debentures held by our trust subsidiaries since the fourth quarter of 2011, requiring our trust subsidiaries to defer distributions on our trust preferred securities held by investors during that period. The remaining proceeds from the private placement totaled approximately $2.2 million and will be used for general corporate purposes and to support the Bank.

 

On June 29, 2016, we notified the trustees of our election to again defer our interest payments effective with the third quarter 2016 payment. We have the ability to defer distributions on our trust preferred securities for 20 consecutive quarters or through the second quarter of 2021. After 20 consecutive quarters, we must pay all deferred distributions or we will be in default.

 

We continue to be involved in various legal proceedings, which are more fully described in Note 13 – “Contingencies”. We are appealing a judgment against us that we believe, after conferring with our legal advisors, we have meritorious grounds on which to prevail. If we do not prevail, the ultimate outcome of this matter could have a material adverse effect on our financial condition, results of operations, or cash flows. 

 

PBI Bank is in compliance with each element of its Consent Order with the Federal Depository Insurance Corporation and the Kentucky Department of Financial Institutions other than the requirement that the Bank maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. As of September 30, 2016, the Bank’s Tier 1 leverage ratio and total risk based capital ratio had improved 6.97% and 11.18%, respectively, both less than the minimum capital ratios required by the Consent Order, but otherwise compliant with Basel III capital requirements. The Consent Order provides that if the Bank should be unable to reach the required capital levels, and if directed in writing by the FDIC, the Bank would be required to develop, adopt and implement a written plan to sell or merge itself into another federally insured financial institution or otherwise obtain a capital investment sufficient to recapitalize the Bank. The Bank has not been directed by the FDIC to implement such a plan. 

 

 
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In order to meet the 9.0% Tier 1 leverage ratio and 12.0% total risk based capital ratio requirements of the Consent Order, the Board of Directors and management are continuing to evaluate and implement strategies to achieve the following objectives:

 

 

Increasing capital, including through the issuance of senior debt, subordinated debt, or equity securities.

 

Continuing to operate the Company and Bank in a safe and sound manner.  We have reduced our lending concentrations and the size of our balance sheet while continuing to remediate non-performing loans.

 

Executing on the sale of OREO and reinvesting the sale proceeds in quality income producing assets.

 

Continuing to improve our internal processes and procedures, distribution of labor, and work-flow to ensure we have adequately and appropriately deployed resources in an efficient manner in the current environment.

 

Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a consent order. Based on individual circumstances, the agencies may issue mandatory directives, impose monetary penalties, initiate changes in management, or take more serious adverse actions.

 

The Consent Order requires the Bank to obtain the written consent of both the FDIC and the KDFI before declaring or paying any future dividends to the Company, which are its principal source of the Company’s revenue. Since the Bank is unlikely to be able to pay dividends to the Company until the Consent Order is satisfied, cash inflows for the Company are limited to the issuance of new debt or the issuance of capital securities. The Company’s liquid assets were $2.2 million at September 30, 2016. Ongoing operating expenses of the Company are forecast at approximately $1.0 million for the next twelve months.

 

Our consolidated financial statements do not include any adjustments that may result were the Company to become unable to continue as a going concern.

  

Application of Critical Accounting Policies

 

We continually review our accounting policies and financial information disclosures. Our more significant accounting policies that require the use of estimates and judgments in preparing the financial statements are summarized in “Application of Critical Accounting Policies” in Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation of our Annual Report on Form 10-K for the calendar year ended December 31, 2015. Management has discussed the development, selection, and application of our critical accounting policies with our Audit Committee. During the first nine months of 2016, there were no material changes in the critical accounting policies and assumptions.

 

Results of Operations

 

The following table summarizes components of income and expense and the change in those components for the three months ended September 30, 2016, compared with the same period of 2015:

 

   

For the Three Months

Ended September 30,

   

Change from

Prior Period

 
   

2016

   

2015

   

Amount

   

Percent

 
   

(dollars in thousands)

 
                                 

Gross interest income

  $ 8,931     $ 9,179     $ (248

)

    (2.7

)%

Gross interest expense

    1,473       1,697       (224

)

    (13.2

)

Net interest income

    7,458       7,482       (24

)

    (0.3

)

Provision (negative provision) for loan losses

    (750

)

    (2,200

)

    (1,450

)

    (65.9

)

Non-interest income

    1,105       2,210       (1,105

)

    (50.0

)

Non-interest expense

    7,920       12,968       (5,048

)

    (38.9

)

Net income (loss)

    1,393       (1,076

)

    2,469       229.5  

 

Net income for the three months ended September 30, 2016 totaled $1.4 million, compared with net loss of $1.1 million for the comparable period of 2015. Net interest income decreased $24,000 from the third quarter of 2015 as a result of a decrease in earning assets, offset by an increase in net interest margin. Net interest margin increased 14 basis points to 3.47% in the third quarter of 2016 compared with 3.33% in the third quarter of 2015. The increase in margin between periods was due to an increase in the yield on earning assets from 4.07% for the third quarter of 2015 to 4.15% for the third quarter of 2016, coupled with a decrease in the cost of interest bearing liabilities from 0.83% in the third quarter of 2015 to 0.78% in the third quarter of 2016. Average earning assets decreased from $903.9 million for the third quarter of 2015 to $864.3 for the third quarter of 2016. Non-interest income decreased by $1.1 million to $1.1 million from $2.2 million in the third quarter of 2015. Non-interest income for the third quarter of 2015 was positively impacted by an $833,000 gain on extinguishment of junior subordinated debt. Non-interest expense decreased from $13.0 million in the third quarter of 2015 to $7.9 million in the third quarter of 2016 primarily due to a decrease in OREO expense of $4.8 million commensurate with the significant reduction in foreclosed properties, and a $246,000 decline in professional fees.

 

 
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The following table summarizes components of income and expense and the change in those components for the nine months ended September 30, 2016, compared with the same period of 2015:

 

   

For the Nine Months

Ended September 30,

   

Change from

Prior Period

 
   

2016

   

2015

   

Amount

   

Percent

 
   

(dollars in thousands)

 
                                 

Gross interest income

  $ 26,821     $ 27,549     $ (728

)

    (2.6

)%

Gross interest expense

    4,516       5,438       (922

)

    (17.0

)

Net interest income

    22,305       22,111       194       0.9  

Provision (negative provision) for loan losses

    (1,900

)

    (2,200

)

    (300

)

    (13.6

)

Non-interest income

    3,648       6,471       (2,823

)

    (43.6

)

Non-interest expense

    23,947       33,394       (9,447

)

    (28.3

)

Net income (loss) before taxes

    3,906       (2,612

)

    6,518       249.5  

Income tax expense

    21             21       100.0  

Net income (loss)

    3,885       (2,612

)

    6,497       248.7  

 

Net income for the nine months ended September 30, 2016 totaled $3.9 million, compared with net loss of $2.6 million for the comparable period of 2015. Net interest income increased $194,000 from the first nine months of 2015 as a result of the positive impact of the collection of previously charged-off accrued uncollected interest of approximately $377,000 during the first nine months 2016, offset by a decrease in earning assets for the first nine months of 2016. Net interest margin increased 20 basis points to 3.45% in the first nine months of 2016 compared with 3.25% in the first nine months of 2015. The increase in margin between periods was due to an increase in the yield on earning assets from 4.03% for the first nine months of 2015 to 4.14% for the first nine months of 2016, coupled with a decrease in the cost of interest bearing liabilities from 0.87% in the first nine months of 2015 to 0.79% in the first nine months of 2016. Average earning assets decreased from $923.3 million for the first nine months of 2015 to $874.2 million for the first nine months of 2016. Non-interest income decreased by $2.8 million to $3.6 million from $6.5 million in the first nine months of 2015 primarily due to a decrease in net gain on sales of securities of $1.5 million. Also, non-interest income for the first nine months of 2015 was positively impacted by an $883,000 gain on extinguishment of junior subordinated debt. Non-interest expense decreased from $33.4 million in the first nine months of 2015 to $23.9 million in the first nine months of 2016 primarily due to a decrease in OREO expense of $7.5 million commensurate with the significant reduction in foreclosed properties, a $1.1 million decline in professional fees, and a decline in loan collection expense of $320,000.

 

Net Interest Income – Our net interest income was $7.5 million for the three months ended September 30, 2016, a decrease of $24,000, or 0.3%, compared with $7.5 million for the same period in 2015. Net interest spread and margin were 3.37% and 3.47%, respectively, for the third quarter of 2016, compared with 3.24% and 3.33%, respectively, for the third quarter of 2015. Net average non-accrual loans were $11.0 million and $26.0 million for the third quarters of 2016 and 2015, respectively.

 

Average loans receivable declined approximately $13.9 million for the third quarter of 2016 compared with the third quarter of 2015. This resulted in an interest revenue volume decline of approximately $170,000 as well as a decline in interest recoveries and rate improvements aggregating $26,000 for the quarter ended September 30, 2016 compared with the prior year period. Interest foregone on non-accrual loans totaled $180,000 in the third quarter of 2016, compared with $181,000 in the second quarter of 2016, and $352,000 in the third quarter of 2015.

 

Net interest margin increased 14 basis points from our margin of 3.33% in the prior year third quarter to 3.47% for the third quarter of 2016. The yield on earning assets increased eight basis points and rates paid on interest-bearing liabilities declined five basis points from the third quarter of 2015. The reduction in the cost of interest bearing liabilities was primarily driven by declines in the average rates paid on and volume declines in certificates of deposit between periods.

 

Net interest income was $22.3 million for the nine months ended September 30, 2016, an increase of $194,000, or 0.1%, compared with $22.1 million for the same period in 2015. Net interest spread and margin were 3.35% and 3.45%, respectively, for the first nine months of 2016, compared with 3.16% and 3.25%, respectively, for the first nine months of 2015. Net average non-accrual loans were $12.0 million and $34.5 million for the first nine months of 2016 and 2015, respectively. Cost of funds decreased eight basis points from 0.87% for the first nine months of 2015 to 0.79% for the first nine months of 2016.

 

Average loans receivable declined approximately $19.7 million for the nine months ended September 30, 2016 compared with the first nine months of 2015. This resulted in a decline in interest revenue of approximately $726,000 for the nine months ended September 30, 2016 compared with the prior year period.

Net interest margin increased 20 basis points from our margin of 3.25% in the first nine months of 2015. The yield on earning assets increased 11 basis points from the first nine months of 2015, compared with a 8 basis point decline in rates paid on interest-bearing liabilities. The reduction in the cost of interest bearing liabilities was primarily driven by declines in the average rates paid on and volume declines in and certificates of deposit between periods.

 

 
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Table Of Contents
 

 

 

Average Balance Sheets

 

The following table presents the average balance sheets for the three month periods ended September 30, 2016 and 2015, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

 

   

Three Months Ended September 30,

 
   

2016

   

2015

 
   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

 
   

(dollars in thousands)

 

ASSETS

                                               

Interest-earning assets:

                                               

Loan receivables (1)(2)

  $ 626,095     $ 7,699       4.89

%

  $ 639,954     $ 7,895       4.89

%

Securities

                                               

Taxable

    160,130       956       2.38       165,692       986       2.36  

Tax-exempt (3)

    20,779       153       4.51       24,819       187       4.60  

FHLB stock

    7,323       72       3.91       7,323       73       3.95  

Federal funds sold and other

    49,980       51       0.41       66,069       38       0.23  

Total interest-earning assets

    864,307       8,931       4.15

%

    903,857       9,179       4.07

%

Less: Allowance for loan losses

    (10,135

)

                    (16,818

)

               

Non-interest earning assets

    63,453                       81,432                  

Total assets

  $ 917,625                     $ 968,471                  
                                                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

                                               

Interest-bearing liabilities:

                                               

Certificates of deposit and other time deposits

  $ 455,840     $ 1,009       0.88

%

  $ 546,502     $ 1,267       0.92

%

NOW and money market deposits

    231,601       238       0.41       198,752       192       0.38  

Savings accounts

    33,874       15       0.18       35,348       17       0.19  

Repurchase agreements

                      382              

FHLB advances

    2,672       17       2.53       3,315       23       2.75  

Junior subordinated debentures

    24,598       194       3.14       29,454       198       2.67  

Total interest-bearing liabilities

    748,585       1,473       0.78

%

    813,753       1,697       0.83

%

                                                 

Non-interest-bearing liabilities:

                                               

Non-interest-bearing deposits

    118,611                       112,660                  

Other liabilities

    8,259                       11,138                  

Total liabilities

    875,455                       937,551                  

Stockholders’ equity

    42,170                       30,920                  

Total liabilities and stockholders’ equity

  $ 917,625                     $ 968,471                  
                                                 

Net interest income

          $ 7,458                     $ 7,482          
                                                 

Net interest spread

                    3.37

%

                    3.24

%

                                                 

Net interest margin

                    3.47

%

                    3.33

%

 


(1)

Includes loan fees in both interest income and the calculation of yield on loans.

(2)

Calculations include non-accruing loans averaging $11.0 million and $26.0 million, respectively, in average loan amounts outstanding.

(3)

Taxable equivalent yields are calculated assuming a 35% federal income tax rate.

 

 
41

Table Of Contents
 

 

The following table presents the average balance sheets for the nine month periods ended September 30, 2016 and 2015, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

 

   

Nine Months Ended September 30,

 
   

2016

   

2015

 
   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

 
   

(dollars in thousands)

 

ASSETS

                                               

Interest-earning assets:

                                               

Loan receivables (1)(2)

  $ 621,824     $ 23,036       4.95

%

  $ 641,489     $ 23,496       4.90

%

Securities

                                               

Taxable

    161,232       2,895       2.40       171,960       3,122       2.43  

Tax-exempt (3)

    21,355       475       4.57       25,580       580       4.66  

FHLB stock

    7,323       219       3.99       7,323       219       4.00  

Federal funds sold and other

    62,451       196       0.42       76,966       132       0.23  

Total interest-earning assets

    874,185       26,821       4.14

%

    923,318       27,549       4.03

%

Less: Allowance for loan losses

    (11,138

)

                    (18,030

)

               

Non-interest earning assets

    67,241                       89,067                  

Total assets

  $ 930,288                     $ 994,355                  
                                                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

                                               

Interest-bearing liabilities:

                                               

Certificates of deposit and other time deposits

  $ 471,530     $ 3,108       0.88

%

  $ 572,243     $ 4,173       0.97

%

NOW and money market deposits

    231,213       696       0.40       195,887       544       0.37  

Savings accounts

    34,460       46       0.18       36,003       58       0.22  

Repurchase agreements

                      785       1       0.17  

FHLB advances

    2,827       54       2.55       3,583       74       2.76  

Junior subordinated debentures

    24,822       612       3.29       29,706       588       2.65  

Total interest-bearing liabilities

    764,852       4,516       0.79

%

    838,207       5,438       0.87

%

                                                 

Non-interest-bearing liabilities:

                                               

Non-interest-bearing deposits

    117,377                       112,326                  

Other liabilities

    9,735                       10,946                  

Total liabilities

    891,964                       961,479                  

Stockholders’ equity

    38,324                       32,876                  

Total liabilities and stockholders’ equity

  $ 930,288                     $ 994,355                  
                                                 

Net interest income

          $ 22,305                     $ 22,111          
                                                 

Net interest spread

                    3.35

%

                    3.16

%

                                                 

Net interest margin

                    3.45

%

                    3.25

%

 


(1)

Includes loan fees in both interest income and the calculation of yield on loans.

(2)

Calculations include non-accruing loans averaging $12.0 million and $34.5 million, respectively, in average loan amounts outstanding.

(3)

Taxable equivalent yields are calculated assuming a 35% federal income tax rate.

 

 

 
42

Table Of Contents
 

 

Rate/Volume Analysis

 

 The table below sets forth certain information regarding 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 (changes 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 September 30,

2016 vs. 2015

   

Nine Months Ended September 30

2016 vs. 2015

 
   

Increase (decrease)

due to change in

   

Increase (decrease)

due to change in

 
   

Rate

   

Volume

   

Net

Change

   

Rate

   

Volume

   

Net

Change

 
   

(in thousands)

 

Interest-earning assets:

                                               

Loan receivables

  $ (26

)

  $ (170

)

  $ (196

)

  $ 266     $ (726

)

  $ (460

)

Securities

    (5

)

    (59

)

    (64

)

    (55

)

    (277

)

    (332

)

FHLB stock

    (1

)

          (1

)

                 

Federal funds sold and other

    24       (11

)

    13       93       (29

)

    64  

Total increase (decrease) in interest income

    (8

)

    (240

)

    (248

)

    304       (1,032

)

    (728

)

                                                 

Interest-bearing liabilities:

                                               

Certificates of deposit and other time deposits

    (56

)

    (202

)

    (258

)

    (377

)

    (688

)

    (1,065

)

NOW and money market accounts

    13       33       46       49       103       152  

Savings accounts

    (1

)

    (1

)

    (2

)

    (10

)

    (2

)

    (12

)

Federal funds purchased and repurchase agreements

                            (1

)

    (1

)

FHLB advances

    (2

)

    (4

)

    (6

)

    (5

)

    (15

)

    (20

)

Junior subordinated debentures

    32       (36

)

    (4

)

    131       (107

)

    24  

Total increase (decrease) in interest expense

    (14

)

    (210

)

    (224

)

    (212

)

    (710

)

    (922

)

Increase (decrease) in net interest income

  $ 6     $ (30

)

  $ (24

)

  $ 516     $ (322

)

  $ 194  

 

Non-Interest Income – The following table presents the major categories of non-interest income for the three and nine months ended September 30, 2016 and 2015:

 

   

For the Three Months

Ended September 30,

   

For the Nine Months

Ended September 30,

 
   

2016

   

2015

   

2016

   

2015

 
   

(in thousands)

 
                                 

Service charges on deposit accounts

  $ 520     $ 492     $ 1,422     $ 1,376  

Bank card interchange fees

    214       212       637       644  

Other real estate owned rental income

    46       380       451       1,109  

Bank owned life insurance income

    101       65       316       229  

Net gain (loss) on sales of securities

    (16

)

          187       1,696  

Gain on extinguishment of junior subordinated debt

          883             883  

Other

    240       178       635       534  

Total non-interest income

  $ 1,105     $ 2,210     $ 3,648     $ 6,471  

 

Non-interest income for the third quarter of 2016 decreased by $1.1 million, or 50.0%, compared with the third quarter of 2015. For the nine months ended September 30, 2016, non-interest income decreased by $2.8 million, or 43.6% to $3.6 million compared with $6.5 million for the same period of 2015. The decrease in non-interest income between the three month comparative periods was primarily due to the $883,000 gain on extinguishment of junior subordinated debt recognized in the third quarter of 2015, as well as a decrease of $334,000 in OREO rental income as income producing properties have been sold. The decrease in non-interest income between the nine month comparative periods was primarily due to a $1.5 million decrease in net gain on sales of investment securities, a decrease in OREO income, and the $883,000 gain on extinguishment of junior subordinated debt recognized in the third quarter of 2015.

 

 
43

Table Of Contents
 

 

Non-interest ExpenseThe following table presents the major categories of non-interest expense for the three and nine months ended September 30, 2016 and 2015:

 

   

For the Three Months

Ended September 30,

   

For the Nine Months

Ended September 30,

 
   

2016

   

2015

   

2016

   

2015

 
   

(in thousands)

 
                                 

Salary and employee benefits

  $ 3,945     $ 3,920     $ 11,624     $ 11,795  

Occupancy and equipment

    842       815       2,504       2,513  

Professional fees

    374       620       1,251       2,313  

FDIC insurance

    442       539       1,458       1,673  

Data processing expense

    295       278       887       860  

State franchise and deposit tax

    255       285       765       855  

Other real estate owned expense

    322       5,131       1,284       8,796  

Loan collection expense

    222       321       575       895  

Other

    1,223       1,059       3,599       3,694  

Total non-interest expense

  $ 7,920     $ 12,968     $ 23,947     $ 33,394  

 

Non-interest expense for the third quarter ended September 30, 2016 decreased $5.0 million, or 38.9%, compared with the third quarter of 2015. For the nine months ended September 30, 2016, non-interest expense decreased $9.4 million, or 28.3% to $23.9 million compared with $33.4 million for the first nine months of 2015. The decreases in non-interest expense for the third quarter and nine months ended September 30, 2016 were primarily attributable to decreased OREO expenses commensurate with the significant reduction in foreclosed properties, as well as decreased professional fees.

 

Income Tax Expense Effective tax rates differ from the federal statutory rate of 35% applied to income before income taxes due to the following:

 

   

For the Three Months

Ended September 30,

   

For the Nine Months

Ended September 30,

 
   

2016

   

2015

   

2016

   

2015

 
   

(in thousands)

 
                                 

Federal statutory rate times financial statement income

  $ 487     $ (376

)

  $ 1,367     $ (914

)

Effect of:

                               

Valuation allowance

    (465

)

    689       (1,197

)

    1,228  

Tax-exempt income

    (52

)

    (65

)

    (161

)

    (201

)

Non-taxable life insurance income

    (35

)

    (23

)

    (110

)

    (80

)

Other, net

    65       (225

)

    122       (33

)

Total

  $     $     $ 21     $  

 

 

Analysis of Financial Condition

 

Total assets decreased $33.4 million, or 3.5%, to $915.3 million at September 30, 2016, from $948.7 million at December 31, 2015. This decrease was primarily attributable to a decrease in cash and cash equivalents of $29.5 million which funded the redemption of interest bearing deposits of $27.8 million. There was also a decrease in OREO of $12.1 million, offset by an increase in net loans of $5.6 million and an increase in bank owned life insurance of $5.3 million.

 

Loans ReceivableLoans receivable increased $3.0 million, or 0.5%, during the nine months ended September 30, 2016 to $621.7 million as loan growth outpaced payoffs.

 

 

 
44

Table Of Contents
 

 

Loan Portfolio CompositionThe following table presents a summary of the loan portfolio at the dates indicated, net of deferred loan fees, by type. There are no foreign loans in our portfolio. Except for commercial real estate and 1-4 family residential real estate, there is no concentration of loans in any industry exceeding 10% of total loans, with the exception of loans for retail facilities (included in nonfarm nonresidential commercial real estate below). Those loans totaled $64.4 million at September 30, 2016 and $59.1 million at December 31, 2015.

 

   

As of September 30,

2016

   

As of December 31,

2015

 
   

Amount

   

Percent

   

Amount

   

Percent

 
           

(dollars in thousands)

         
                                 

Commercial

  $ 85,000       13.68

%

  $ 86,176       13.93

%

Commercial Real Estate

                               

Construction

    34,178       5.50       33,154       5.36  

Farmland

    83,320       13.40       76,412       12.35  

Nonfarm nonresidential

    138,351       22.25       140,570       22.72  

Residential Real Estate

                               

Multi-family

    36,558       5.88       44,131       7.13  

1-4 Family

    192,008       30.88       201,478       32.57  

Consumer

    9,752       1.57       10,010       1.62  

Agriculture

    41,764       6.72       26,316       4.25  

Other

    766       0.12       419       0.07  

Total loans

  $ 621,697       100.0

%

  $ 618,666       100.0

%

 

Loan Portfolio by Risk Category – The following table presents a summary of the loan portfolio at the dates indicated, by risk category.

  

    September 30, 2016     June 30, 2016            March 31, 2016        December 31, 2015  
    Loans    

% to

Total

    Loans    

% to

Total

    Loans    

% to

Total

    Loans    

% to

Total

 
    (dollars in thousands)  

Pass

  $ 551,075       88.6

%

  $ 547,853       87.8

%

  $ 534,451       86.2

%

  $ 517,484       83.7

%

Watch

    46,049       7.4       50,024       8.0       59,265       9.6       63,363       10.2  

Special Mention

    603       0.1       622       0.1       1,383       0.2       1,395       0.2  

Substandard

    23,970       3.9       25,637       4.1       24,728       4.0       36,424       5.9  

Doubtful

                                               

Total

  $ 621,697       100.0

%

  $ 624,136       100.0

%

  $ 619,827       100.0

%

  $ 618,666       100.0

%

 

Our loans receivable have increased $3.0 million, or 0.5%, during the nine months ended September 30, 2016. Except for the pass loan category, all loan risk categories have decreased since December 31, 2015. The pass category increased approximately $33.6 million, the watch category decreased approximately $17.3 million, the special mention category declined approximately $792,000, and the substandard category declined approximately $12.5 million. The $12.5 million decrease in loans classified as substandard was primarily driven by $8.1 million in loans upgraded from substandard, $7.9 million in principal payments received, $1.2 million in migration to OREO, and $1.9 million in charge-offs, offset by $6.7 million in loans moved to substandard during the period.

 

Loan Delinquency – The following table presents a summary of loan delinquencies at the dates indicated.

 

   

September 30,

2016

   

June 30,

2016

   

March 31,

2016

   

December 31,

2015

 
   

(in thousands)

 

Past Due Loans:

                               

30-59 Days

  $ 2,335     $ 2,401     $ 1,829     $ 3,133  

60-89 Days

    273       336       62       241  

90 Days and Over

                       

Total Loans Past Due 30-90+ Days

    2,608       2,737       1,891       3,374  
                                 

Nonaccrual Loans

    10,099       11,599       11,119       14,087  

Total Past Due and Nonaccrual Loans

  $ 12,707     $ 14,336     $ 13,010     $ 17,461  

 

 
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Table Of Contents
 

 

During the nine months ended September 30, 2016, nonaccrual loans decreased by $4.0 million to $10.1 million. This decrease was due primarily to $4.0 million in paydowns, $1.3 million in charge offs, $751,000 in loans returned to accrual status and $1.2 million in loans migrating to OREO, offset by $3.3 million in loans being placed on nonaccrual during the period. During the nine months ended September 30, 2016, loans past due 30-59 days decreased from $3.1 million at December 31, 2015 to $2.3 million. Loans past due 60-89 days increased from $241,000 at December 31, 2015 to $273,000 at September 30, 2016. This represents a $766,000 decrease from December 31, 2015 to September 30, 2016, in loans past due 30-89 days. We considered this trend in delinquency levels during the evaluation of qualitative trends in the portfolio when establishing the general component of our allowance for loan losses.

 

Non-Performing AssetsNon-performing assets consist of 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. The following table sets forth information with respect to non-performing assets as of September 30, 2016 and December 31, 2015.

 

   

September 30,

2016

   

December 31,

2015

 
   

(dollars in thousands)

 

Loans past due 90 days or more still on accrual

  $     $  

Nonaccrual loans

    10,099       14,087  

Total non-performing loans

    10,099       14,087  

Real estate acquired through foreclosure

    7,098       19,214  

Other repossessed assets

           

Total non-performing assets

  $ 17,197     $ 33,301  
                 

Non-performing loans to total loans

    1.62

%

    2.28

%

Non-performing assets to total assets

    1.88

%

    3.51

%

Allowance for non-performing loans

  $ 291     $ 295  

Allowance for non-performing loans to non-performing loans

    2.88

%

    2.09

%

 

Nonperforming loans at September 30, 2016, were $10.1 million, or 1.62% of total loans, compared with $14.1 million, or 2.28% of total loans at December 31, 2015, and $17.0 million, or 2.72% of total loans at September 30, 2015.

 

Troubled Debt Restructuring - A troubled debt restructuring (TDR) occurs when the Company has agreed to a loan modification in the form of a concession for a borrower who is experiencing financial difficulty. The majority of the Company’s TDRs involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired, and the Company has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower. If the loan is considered collateral dependent, it is reported net of allocated reserves, at the fair value of the collateral less cost to sell.

 

We do not have a formal loan modification program. Rather, we work with individual borrowers on a case-by-case basis to facilitate the orderly collection of our principal and interest before a loan becomes a non-performing loan. If a borrower is unable to make contractual payments, we review the particular circumstances of the borrower’s situation and negotiate a revised payment stream. In other words, we identify performing borrowers experiencing financial difficulties, and through negotiations, we lower their interest rate, most typically on a short-term basis for three to six months. Our goal when restructuring a credit is to afford the borrower a reasonable period of time to remedy the issue causing cash flow constraints within their business so they can return to performing status over time.

 

Our loan modifications have taken the form of reduction in interest rate and/or curtailment of scheduled principal payments for a short-term period, usually three to six months, but in some cases until maturity of the loan. In some circumstances we restructure real estate secured loans in a bifurcated fashion whereby we have a fully amortizing “A” loan at a market interest rate and an interest-only “B” loan at a reduced interest rate. Our restructured loans are all collateral secured loans. If a borrower fails to perform under the modified terms, we place the loan(s) on nonaccrual status and begin the process of working with the borrower to liquidate the underlying collateral to satisfy the debt.

 

We consider any loan that is restructured for a borrower experiencing financial difficulties due to a borrower’s potential inability to pay in accordance with contractual terms to be a troubled debt restructure. Specifically, we consider a concession involving a modification of the loan terms, such as (i) a reduction of the stated interest rate, (ii) reduction or deferral of principal, or (iii) reduction or deferral of accrued interest at a stated interest rate lower than the current market rate for new debt with similar risk all to be troubled debt restructurings. When a modification of terms is made for a competitive reason, we do not consider that to be a troubled debt restructuring.  A primary example of a competitive modification would be an interest rate reduction for a performing borrower’s loan to a market rate as the result of a market decline in rates.

 

 
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Table Of Contents
 

 

Management periodically reviews renewals/modifications of previously identified TDRs for which there was no principal forgiveness, to consider if it is appropriate to remove the TDR classification. If the borrower is no longer experiencing financial difficulty and the renewal/modification did not contain a concessionary interest rate or other concessionary terms, management considers the potential removal of the TDR classification. If deemed appropriate, the TDR classification is removed as the borrower has complied with the terms of the loan at the date of renewal/modification and there was a reasonable expectation that the borrower would continue to comply with the terms of the loan after the date of the renewal/modification. In this instance, the TDR was originally considered a restructuring in a prior year as a result of a modification with an interest rate that was not commensurate with the risk of the underlying loan. Additionally, TDR classification can be removed in circumstances in which the Company performs a non-concessionary re-modification of the loan at terms that were considered to be at market for loans with comparable risk. Management expects the borrower will continue to perform under the re-modified terms based on the borrower’s past history of performance.

 

If the borrower fails to perform, we place the loan on nonaccrual status and seek to liquidate the underlying collateral for these loans. Our nonaccrual policy for restructured loans is identical to our nonaccrual policy for all loans. Our policy calls for a loan to be reported as nonaccrual if it is maintained on a cash basis because of deterioration in the financial condition of the borrower, payment in full of principal and interest is not expected, or principal or interest has been in default for a period of 90 days or more unless the assets are both well secured and in the process of collection. Changes in value for impairment, including the amount attributed to the passage of time, are recorded entirely within the provision for loan losses. Upon determination that a loan is collateral dependent, the loan is charged down to the fair value of collateral less estimated costs to sell.

 

At September 30, 2016, we had 18 restructured loans totaling $9.5 million with borrowers who experienced deterioration in financial condition compared with 30 loans totaling $21.0 million at December 31, 2015. In general, these loans were granted interest rate reductions to provide cash flow relief to borrowers experiencing cash flow difficulties. Of these loans, three loans totaling approximately $3.3 million were also granted principal payment deferrals until maturity. There were no concessions made to forgive principal relative to these loans, although we have recorded partial charge-offs for certain restructured loans. In general, these loans are secured by first liens on 1-4 residential or commercial real estate properties, or farmland. Restructured loans also include $472,000 of commercial loans. At September 30, 2016, $6.1 million of our restructured loans were accruing and $3.4 million were on nonaccrual compared with $17.4 million and $3.5 million, respectively, at December 31, 2015. There were no new TDRs during the first nine months of 2016 or 2015. During the nine months ended September 30, 2016, TDRs were reduced as a result of $6.5 million in payments. In addition, the TDR classification was removed from one loan that met the requirements as discussed above. This loan totaled $5.0 million at December 31, 2015. This loan is no longer evaluated individually for impairment.

 

The following table sets forth information with respect to TDRs, non-performing loans, real estate acquired through foreclosure, and other repossessed assets.

 

   

September 30,

2016

   

December 31,

2015

 
   

(dollars in thousands)

 

Total non-performing loans

  $ 10,099     $ 14,087  

TDRs on accrual

    6,114       17,440  

Total non-performing loans and TDRs on accrual

  $ 16,213     $ 31,527  

Real estate acquired through foreclosure

    7,098       19,214  

Other repossessed assets

           

Total non-performing assets and TDRs on accrual

  $ 23,311     $ 50,741  
                 

Total non-performing loans and TDRs on accrual to total loans

    2.61

%

    5.10

%

Total non-performing assets and TDRs on accrual to total assets

    2.55

%

    5.35

%

 

See “Note 4 - Loans,” of the notes to the financial statements for additional disclosure related to troubled debt restructuring.

 

Allowance for Loan LossesThe allowance for loan losses is based on management’s continuing review and evaluation of individual loans, loss experience, current economic conditions, risk characteristics of various categories of loans and such other factors that, in management’s judgment, require consideration in estimating loan losses.

 

Management has established loan grading procedures that result in specific allowance allocations for any estimated inherent risk of loss. For loans not individually evaluated, a general allowance allocation is computed using factors developed over time based on actual loss experience. The specific and general allocations plus consideration of qualitative factors represent management’s best estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses.

 

 
47

Table Of Contents
 

 

An analysis of changes in the allowance for loan losses and selected ratios for the three and nine month periods ended September 30, 2016 and 2015, and for the year ended December 31, 2015 follows: 

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

   

Year Ended

December 31,

 
   

2016

   

2015

   

2016

   

2015

    2015  
   

(dollars in thousands)

 

Balance at beginning of period

  $ 10,104     $ 16,809     $ 12,041     $ 19,364     $ 19,364  
                                         

Loans charged-off:

                                       

Real estate

    363       1,254       1,658       4,138       5,050  

Commercial

    15       201       276       675       696  

Consumer

    21       70       56       200       268  

Agriculture

    5       41       13       111       118  

Other

    1       14       79       47        

Total charge-offs

    405       1,580       2,082       5,171       6,132  
                                         

Recoveries

                                       

Real estate

    381       1,049       894       1,591       2,338  

Commercial

    102       5       169       406       723  

Consumer

    23       98       216       158       240  

Agriculture

    1       2       86       5       8  

Other

    33       15       65       45        

Total recoveries

    540       1,169       1,430       2,205       3,309  

Net charge-offs (recoveries)

    (135

)

    411       652       2,966       2,823  

Provision (negative provision) for loan losses

    (750

)

    (2,200

)

    (1,900

)

    (2,200

)

    (4,500 )

Balance at end of period

  $ 9,489     $ 14,198     $ 9,489     $ 14,198     $ 12,041  
                                         

Allowance for loan losses to period-end loans

    1.53

%

    2.27

%

    1.53

%

    2.27

%

    1.95

%

Net charge-offs (recoveries) to average loans (annualized)

    (0.09

)%

    0.25

%

    0.14

%

    0.62

%

    0.44

%

Allowance for loan losses to non-performing loans

    93.96

%

    83.58

%

    93.96

%

    83.58

%

    85.48

%

                                         

Allowance for loan losses for loans individually evaluated for impairment

  $ 339     $ 469     $ 339     $ 469     $ 428  

Loans individually evaluated for impairment

    16,214       34,895       16,214       34,895       31,776  

Allowance for loan losses to loans individually evaluated for impairment

    2.09

%

    1.34

%

    2.09

%

    1.34

%

    1.35

%

                                         

Allowance for loan losses for loans collectively evaluated for impairment

  $ 9,150     $ 13,729     $ 9,150     $ 13,729     $ 11,613  

Loans collectively evaluated for impairment

    605,483       589,519       605,483       589,519       586,890  

Allowance for loan losses to loans collectively evaluated for impairment

    1.51

%

    2.33

%

    1.51

%

    2.33

%

    1.98

%

 

Our loan loss reserve, as a percentage of total loans at September 30, 2016, decreased to 1.53% from 1.95% at December 31, 2015 and from 2.27% at September 30, 2015. The change in our loan loss reserve as a percentage of total loans between periods is attributable to the fluctuation in historical loss experience, qualitative factors, fewer loans migrating downward in risk grade classifications, improved charge-off levels, and negative provision expense. Our allowance for loan losses to non-performing loans was 93.96% at September 30, 2016, compared with 85.48% at December 31, 2015, and 83.58% at September 30, 2015. Net charge-offs in the first nine months of 2016 totaled $652,000 compared to $3.0 million in the first nine months of 2015.    

 

 
48

Table Of Contents
 

 

The following table sets forth the net charge-offs (recoveries) for the periods indicated:

 

   

Nine Months Ended

September 30,

2016

   

Year Ended

December 31,

2015

   

Year Ended

December 31,

2014

 
   

(in thousands)

 

Commercial

  $ 107     $ (27

)

  $ 485  

Commercial Real Estate

    (146

)

    1,225       11,878  

Residential Real Estate

    910       1,487       3,339  

Consumer

    (160

)

    37       167  

Agriculture

    (73

)

    110       17  

Other

    14       (9

)

    (26

)

Total net charge-offs

  $ 652     $ 2,823     $ 15,860  

 

The majority of our nonperforming loans are secured by real estate collateral, and the underlying collateral coverage for nonperforming loans supports the likelihood of collection of our principal. We have assessed these loans for collectability and considered, among other things, the borrower’s ability to repay, the value of the underlying collateral, and other market conditions to ensure the allowance for loan losses is adequate to absorb probable incurred losses. Our allowance for non-performing loans to non-performing loans was 2.88% at September 30, 2016 compared with 2.09% at December 31, 2015, and 2.31% at September 30, 2015.

 

The following table presents the unpaid principal balance, recorded investment and allocated allowance related to loans individually evaluated for impairment in the commercial real estate and residential real estate portfolios as of September 30, 2016 and December 31, 2015.

 

   

September 30, 2016

   

December 31, 2015

 
   

Commercial

Real Estate

   

Residential

Real Estate

   

Commercial

Real Estate

   

Residential

Real Estate

 
   

(in thousands)

 

Unpaid principal balance

  $ 11,726     $ 10,485     $ 18,112     $ 19,983  

Prior charge-offs

    (5,158

)

    (1,545

)

    (5,293

)

    (2,310

)

                                 

Recorded investment

    6,568       8,940       12,819       17,673  

Allocated allowance

    (41

)

    (297

)

    (43

)

    (385

)

                                 

Recorded investment, less allocated allowance

  $ 6,527     $ 8,643     $ 12,776     $ 17,288  
                                 

Recorded investment, less allocated allowance/ Unpaid principal balance

    55.66

%

    82.43

%

    70.54

%

    86.51

%

 

Based on prior charge-offs, our current recorded investment in the commercial real estate and residential real estate segments is significantly below the unpaid principal balance for these loans. The recorded investment net of the allocated allowance was 55.66% and 82.43% of the unpaid principal balance in the commercial real estate and residential real estate segments of the portfolio, respectively, at September 30, 2016.

 

The following table illustrates recent trends in loans collectively evaluated for impairment and the related allowance for loan losses by portfolio segment:

 

   

September 30, 2016

   

June 30, 2016

   

March 31, 2016

   

December 31, 2015

 
   

Loans

   

Allowance

   

% to

Total

   

Loans

   

Allowance

   

% to

Total

   

Loans

   

Allowance

   

% to

Total

   

Loans

   

Allowance

   

% to

Total

 
                                                                                                 

Commercial

  $ 84,429     $ 622       0.74

%

  $ 74,474     $ 730       0.98

%

  $ 82,879     $ 642       0.77

%

  $ 85,064     $ 818       0.96

%

Commercial real estate

    249,281       5,074       2.04       246,341       5,384       2.19       240,319       6,724       2.80       237,317       6,950       2.93  

Residential real estate

    219,626       3,235       1.47       228,952       3,678       1.61       227,435       3,258       1.43       227,936       3,599       1.58  

Consumer

    9,751       23       0.24       9,847       47       0.48       9,921       115       1.16       9,990       122       1.22  

Agriculture

    41,630       193       0.46       38,571       118       0.31       32,654       136       0.42       26,164       122       0.47  

Other

    766       3       0.39       416       1       0.24       383       1       0.26       419       2       0.48  

Total

  $ 605,483     $ 9,150       1.51

%

  $ 598,601     $ 9,958       1.66

%

  $ 593,591     $ 10,876       1.83

%

  $ 586,890     $ 11,613       1.98

%

 

 
49

Table Of Contents
 

 

Our allowance for loan losses for loans collectively evaluated for impairment declined to 1.51% at September 30, 2016 from 2.33% at September 30, 2015 and 1.98% at December 31, 2015. This decline was driven primarily by declining historical loss trends and an improving loan risk category classification mix and volume which are key factors for estimating general reserves. Other factors include the consideration of growth, composition and diversification of our loan portfolio, current delinquency levels, the results of recent regulatory communications and general economic conditions.

 

Provision for Loan LossesA negative provision for loan losses of $1.9 million was recorded for the nine months ended September 30, 2016, compared to negative provision of $2.2 million for the first nine months of 2015. The negative provision for 2016 was driven by declining historical loss rates, improvements in asset quality, and management’s assessment of risk within the portfolio. Except for the pass category, all loan risk categories have decreased since December 31, 2015. The pass category increased approximately $33.6 million, the watch category decreased approximately $17.3 million, the special mention category declined approximately $792,000, and the substandard category declined approximately $12.5 million. Net charge-offs were $652,000 for the nine months ended September 30, 2016, compared with $3.0 million for September 30, 2015. We consider the size and volume of our portfolio as well as the credit quality of our loan portfolio based upon risk category classification when determining the loan loss provision for each period and the allowance for loan losses at period end.

 

Foreclosed Properties – Foreclosed properties at September 30, 2016 were $7.1 million compared with $29.2 million at September 30, 2015 and $19.2 million at December 31, 2015.  See “Note 5 - Other Real Estate Owned,” of the notes to the financial statements. During the first nine months of 2016, we acquired $1.2 million of OREO properties, and sold properties totaling approximately $12.6 million. We value foreclosed properties at fair value less estimated costs to sell when acquired and expect to liquidate these properties to recover our investment in the due course of business.

 

OREO is recorded at fair market value less estimated cost to sell at time of acquisition. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. Subsequent reductions in fair value are recorded as non-interest expense. To determine the fair value of OREO for smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. If the internally evaluated market price is below our underlying investment in the property, appropriate write-downs are recorded. 

 

For larger dollar commercial real estate properties, we obtain a new appraisal of the subject property or have staff in our special assets group or centralized appraisal department evaluate the latest in-file appraisal in connection with the transfer to OREO. In some of these circumstances, an appraisal is in process at quarter end and we must make our best estimate of the fair value of the underlying collateral based on our internal evaluation of the property, our review of the most recent appraisal, and discussions with the currently engaged appraiser. We typically obtain updated appraisals on the anniversary date of ownership unless a sale is imminent.

 

Net gain (loss) on sales, write-downs, and operating expenses for OREO totaled $1.3 million for the nine months ended September 30, 2016, compared with $8.8 million for the same period of 2015. During the nine months ended September 30, 2016, fair value write-downs of $970,000 were recorded to reflect declines in fair value driven by reductions in listing prices and new appraisals compared with $7.1 million for the nine months ended September 30, 2015.

 

LiabilitiesTotal liabilities at September 30, 2016 were $871.7 million compared with $916.7 million at December 31, 2015, a decrease of $45.0 million, or 4.9%. This decrease was primarily attributable to a decrease in deposits of $41.1 million from $878.0 million at December 31, 2015 to $836.9 million at September 30, 2016.

 

Deposits are our primary source of funds. The following table sets forth the average daily balances and weighted average rates paid for our deposits for the periods indicated:

 

   

For the Nine Months

Ended September 30,

2016

   

For the Year

Ended December 31,

2015

 
   

Average

Balance

   

Average

Rate

   

Average

Balance

   

Average

Rate

 
   

(dollars in thousands)

 

Demand

  $ 117,377             $ 113,576          

Interest checking

    96,406       0.13

%

    88,814       0.13

%

Money market

    134,807       0.60       112,350       0.57  

Savings

    34,460       0.18       35,604       0.21  

Certificates of deposit

    471,530       0.88       557,441       0.96  

Total deposits

  $ 854,580       0.60

%

  $ 907,785       0.68

%

 

 
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The following table sets forth the average daily balances and weighted average rates paid for our certificates of deposit for the periods indicated:

 

   

For the Nine Months

Ended September 30,

2016

   

For the Year

Ended December 31,

2015

 
   

Average

Balance

   

Average

Rate

   

Average

Balance

   

Average

Rate

 
   

(dollars in thousands)

 

Less than $100,000

  $ 265,883       0.86

%

  $ 306,941       0.93

%

$100,000 or more

    205,647       0.91       250,500       0.99  

Total

  $ 471,530       0.88

%

  $ 557,441       0.96

%

 

The following table shows at September 30, 2016 the amount of our time deposits of $100,000 or more by time remaining until maturity (in thousands):

  

Maturity Period

 
         

Three months or less

  $ 33,060  

Three months through six months

    65,439  

Six months through twelve months

    33,199  

Over twelve months

    71,265  

Total

  $ 202,963  

  

Liquidity

 

Liquidity risk arises from the possibility we may not be able to satisfy current or future financial commitments, or may become unduly reliant on alternative funding sources. The objective of liquidity risk management is to ensure that we meet the cash flow requirements of depositors and borrowers, as well as our operating cash needs, taking into account all on- and off-balance sheet funding demands. Liquidity risk management also involves ensuring that we meet our cash flow needs at a reasonable cost. We maintain an investment and funds management policy, which identifies the primary sources of liquidity, establishes procedures for monitoring and measuring liquidity, and establishes minimum liquidity requirements in compliance with regulatory guidance. Our Asset Liability Committee regularly monitors and reviews our liquidity position.

 

Funds are available from a number of sources, including the sale of securities in the available for sale investment portfolio, principal pay-downs on loans and mortgage-backed securities, customer deposit inflows, and other wholesale funding. Historically, we also utilized brokered and wholesale deposits to supplement our funding strategy. We are currently restricted from accepting, renewing, or rolling-over brokered deposits without the prior receipt of a waiver on a case-by-case basis from our regulators. At September 30, 2016, we had no brokered deposits.

 

Traditionally, we have borrowed from the FHLB to supplement our funding requirements. At September 30, 2016, we had an unused borrowing capacity with the FHLB of $27.7 million. Our borrowing capacity is under a detailed loan listing requirement and is based on the market value of the underlying pledged loans. Any new advances are limited to a one-year maturity or less.

 

We also have available, on a secured basis, federal funds borrowing lines from a correspondent bank totaling $5.0 million. Management believes our sources of liquidity are adequate to meet expected cash needs for the foreseeable future. However, the availability of these lines could be affected by our financial position. We are also subject to FDIC interest rate restrictions for deposits. As such, we are permitted to offer up to the “national rate” plus 75 basis points as published weekly by the FDIC.

 

Capital

 

Stockholders’ equity increased $11.6 million to $43.6 million at September 30, 2016, compared with $32.0 million at December 31, 2015 due to the issuance of $5.0 in common stock, current year net income of $3.9 million and an increase in the fair value of our available for sale securities portfolio of $2.3 million.

 

 
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The following table shows the ratios of Tier 1 capital and total capital to risk-adjusted assets and the leverage ratios for the Company and the Bank at the dates indicated:

 

                           

September 30, 2016

   

December 31, 2015

 
   

Regulatory Minimums

   

Well-Capitalized

Minimums

   

Minimum Capital

Ratios Under

Consent Order

   

Porter

Bancorp

   

PBI

Bank

   

Porter

Bancorp

   

PBI

Bank

 
                                                         

Tier 1 Capital

    6.0 %     8.0 %     N/A       8.48 %     9.53 %     6.89 %     8.84 %

Common equity Tier I capital

    4.5       6.5       N/A       6.37       9.53       5.09       8.84  

Total risk-based capital

    8.0       10.0       12.0 %     11.57       11.18       10.46       10.58  

Tier 1 leverage ratio

    4.0       5.0       9.0       6.21       6.97       4.74       6.08  

  

Failure to meet minimum capital requirements could result in additional discretionary actions by regulators that, if undertaken, could have a materially adverse effect on our financial condition.  

 

Each of the federal bank regulatory agencies has established risk-based capital requirements for banking organizations. The Basel III regulatory capital reforms became effective for the Company and Bank on January 1, 2015, and include new minimum risk-based capital and leverage ratios. These rules refine the definition of what constitutes “capital” for purposes of calculating those ratios, including the definitions of Tier 1 capital and Tier 2 capital. The final rules allow banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. The Company and the Bank opted out of this requirement. The rules also establish a “capital conservation buffer” of 2.5%, to be phased in over three years, above the regulatory minimum risk-based capital ratios. Once the capital conservation buffer is fully phased in, the minimum ratios are a common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total risk-based capital ratio of 10.5%. The phase-in of the capital conservation buffer requirement begins in January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented in January 2019. An institution is subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions. In addition, our Consent Order calls for the Bank to maintain a ratio of total capital to total risk-weighted assets (“total risk-based capital ratio”) of at least 12.0%, and a ratio of Tier 1 capital to total assets (“leverage ratio”) of 9.0%. The Bank cannot be considered “well-capitalized” while subject to the consent order.

 

 
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Item 3. Quantitative and Qualitative Disclosures about Market Risk 

 

Given a 100 basis point increase in interest rates sustained for one year, base net interest income would decrease by an estimated 0.7% at September 30, 2016, compared with an increase of 0.6% at December 31, 2015, and is within the risk tolerance parameters of our risk management policy. Given a 200 basis point increase in interest rates sustained for one year, base net interest income would decrease by an estimated 1.6% at September 30, 2016, compared with an increase of 1.6% at December 31, 2015, and is within the risk tolerance parameters of our risk management policy.

 

The following table indicates the estimated impact on net interest income under various interest rate scenarios for the twelve months following September 30, 2016, as calculated using the static shock model approach:

 

   

Change in Future

Net Interest Income

 
   

Dollar Change

   

Percentage

Change

 
   

(dollars in thousands)

 

+ 200 basis points

  $ (448

)

    (1.61

)%

+ 100 basis points

    (187     (0.67

- 100 basis points

    (1,129

)

    (4.05

)

- 200 basis points

    (2,729

)

    (9.79

)

  

Item 4. Controls and Procedures

 

As of the end of the quarterly period covered by this report, an evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”)). Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were, to the best of their knowledge, effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms as of such date.

 

There was no change in the Company’s internal control over financial reporting that occurred during the Company’s fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 
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PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings

 

We are defendants in various legal proceedings.  Litigation is subject to inherent uncertainties and unfavorable outcomes could occur. See Footnote 13, “Contingencies” in the Notes to our consolidated financial statements for additional detail regarding ongoing legal proceedings.

 

Item 1A. Risk Factors

 

We refer you to the detailed cautionary statements and discussion of risks that affect our Company and its business in “Item 1A – Risk Factors” of our December 31, 2015 Annual Report on Form 10-K. There have been no material changes from the risk factors previously discussed in those reports.

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

Not applicable.

 

Item 3. Default Upon Senior Securities

 

Not applicable.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 5. Other Information

 

Not applicable

 

Item 6. Exhibits

 

(a)           Exhibits

The following exhibits are filed or furnished as part of this report:

 

Exhibit Number

Description of Exhibit

  

31.1

Certification of Principal Executive Officer, pursuant to Rule 13a - 14(a).

  

31.2

Certification of Principal Financial Officer, pursuant to Rule 13a - 14(a).

  

32.1

Certification of Principal Executive Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

  

32.2

Certification of Principal Financial Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

101

The following financial statements from the Company’s Quarterly Report on Form 10Q for the quarter ended September 30, 2016, formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income (Loss), (iv) Consolidated Statement of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, (vi) Notes to Consolidated Financial Statements.

 

 
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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act if 1934, the Registrant had duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

  

PORTER BANCORP, INC.

  

(Registrant)

  

November 3, 2016

By:

/s/ John T. Taylor

  

  

John T. Taylor

  

  

Chief Executive Officer

  

November 3, 2016

By:

/s/ Phillip W. Barnhouse

 

 

Phillip W. Barnhouse 

  

  

Chief Financial Officer

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