UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
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 001-37624
EQUITY BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
Kansas
72-1532188
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
7701 East Kellogg Drive, Suite 300
Wichita, KS
67207
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: 316.612.6000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒Yes ☐ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ☒ Yes ☐ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐ Accelerated filer ☒
Non-accelerated filer (Do not check if a smaller reporting company) ☐
Smaller reporting company ☐
Emerging growth company ☒
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ☐ Yes ☒ No
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
Shares outstanding as of
May 1, 2018
Class A Common Stock, par value $0.01 per share
14,609,414
Class B Non-Voting Common Stock, par value $0.01 per share
0
TABLE OF CONTENTS
PART I
Financial Information
5
Item 1.
Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Income
6
Consolidated Statements of Comprehensive Income
7
Consolidated Statements of Stockholders’ Equity
8
Consolidated Statements of Cash Flows
9
Condensed Notes to Interim Consolidated Financial Statements
11
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
34
Overview
Critical Accounting Policies
36
Results of Operations
38
Financial Condition
44
Liquidity and Capital Resources
56
Non-GAAP Financial Measures
59
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
62
Item 4.
Controls and Procedures
64
Part II
OTHER INFORMATION
65
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
Important Notice about Information in this Quarterly Report
Unless we state otherwise or the context otherwise requires, references in this Quarterly Report to “we,” “our,” “us,” “the Company” and “Equity” refer to Equity Bancshares, Inc. and its consolidated subsidiaries, including Equity Bank, which we sometimes refer to as “Equity Bank,” “the Bank” or “our Bank.”
The information contained in this Quarterly Report is accurate only as of the date of this Quarterly Report on Form 10-Q and as of the dates specified herein.
2
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements reflect our current views with respect to, among other things, future events and our financial performance. These statements are often, but not always, made through the use of words or phrases such as “may,” “should,” “could,” “predict,” “potential,” “believe,” “will likely result,” “expect,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “project,” “forecast,” “goal,” “target,” “would” and “outlook,” or the negative variations of those words or other comparable words of a future or forward-looking nature. These forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Accordingly, we caution you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions and uncertainties that are difficult to predict. Although we believe that the expectations reflected in these forward-looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements. When considering forward-looking statements, you should keep in mind the risk factors and other cautionary statements described under the heading “Item 1A - Risk Factors” in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 16, 2018, and in Item 1A – Risk Factors of this Quarterly Report.
There are or will be important factors that could cause our actual results to differ materially from those indicated in these forward-looking statements, including, but not limited to, the following:
•
an economic downturn, especially one affecting our core market areas;
the occurrence of various events that negatively impact the real estate market, since a significant portion of our loan portfolio is secured by real estate;
difficult or unfavorable conditions in the market for financial products and services generally;
interest rate fluctuations, which could have an adverse effect on our profitability;
external economic and/or market factors, such as changes in monetary and fiscal policies and laws, including the interest rate policies of the Board of Governors of the Federal Reserve System (the “Federal Reserve”), inflation or deflation, changes in the demand for loans, and fluctuations in consumer spending, borrowing and savings habits, which may have an adverse impact on our financial condition;
continued or increasing competition from other financial institutions, credit unions, and non-bank financial services companies, many of which are subject to different regulations than we are;
costs arising from the environmental risks associated with making loans secured by real estate;
losses resulting from a decline in the credit quality of the assets that we hold;
inadequacies in our allowance for loan losses, which could require us to take a charge to earnings and thereby adversely affect our financial condition;
inaccuracies or changes in the appraised value of real estate securing the loans that we originate, which could lead to losses if the real estate collateral is later foreclosed upon and sold at a price lower than the appraised value;
the costs of integrating the businesses we acquire, which may be greater than expected;
challenges arising from unsuccessful attempts to expand into new geographic markets, products, or services;
a lack of liquidity resulting from decreased loan repayment rates, lower deposit balances, or other factors;
restraints on the ability of Equity Bank to pay dividends to us, which could limit our liquidity;
the loss of our largest loan and depositor relationships;
limitations on our ability to lend and to mitigate the risks associated with our lending activities as a result of our size and capital position;
additional regulatory requirements and restrictions on our business, which could impose additional costs on us;
increased capital requirements imposed by banking regulators, which may require us to raise capital at a time when capital is not available on favorable terms or at all;
a failure in the internal controls we have implemented to address the risks inherent to the business of banking;
3
inaccuracies in our assumptions about future events, which could result in material differences between our financial projections and actual financial performance;
the departure of key members of our management personnel or our inability to hire qualified management personnel;
disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems;
unauthorized access to nonpublic personal information of our customers, which could expose us to litigation or reputational harm;
disruptions, security breaches, or other adverse events affecting the third-party vendors who perform several of our critical processing functions;
the occurrence of adverse weather or manmade events, which could negatively affect our core markets or disrupt our operations;
an increase in FDIC deposit insurance assessments, which could adversely affect our earnings;
an inability to keep pace with the rate of technological advances due to a lack of resources to invest in new technologies; and
other factors that are discussed in “Item 1A - Risk Factors.”
The foregoing factors should not be construed as exhaustive and should be read in conjunction with other cautionary statements that are included in this Quarterly Report. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Accordingly, you should not place undue reliance on any such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise. New risks and uncertainties arise from time to time, and it is not possible for us to predict those events or how they may affect us. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. All forward-looking statements, expressed or implied, included in this Quarterly Report on Form 10-Q are expressly qualified in their entirety by this cautionary statement. This cautionary statement should also be considered in connection with any subsequent written or oral forward-looking statements that we or persons acting on our behalf may issue.
4
Item 1: Financial Statements
CONSOLIDATED BALANCE SHEETS
March 31, 2018 and December 31, 2017
(Dollar amounts in thousands)
(Unaudited)
March 31,
December 31,
2018
2017
ASSETS
Cash and due from banks
$
42,526
48,034
Federal funds sold
620
4,161
Cash and cash equivalents
43,146
52,195
Interest-bearing time deposits in other banks
3,496
Available-for-sale securities
174,717
162,272
Held-to-maturity securities, fair value of $511,138 and $532,744
522,021
535,462
Loans held for sale
11,112
16,344
Loans, net of allowance for loan losses of $9,316 and $8,498
2,116,008
2,094,781
Other real estate owned, net
7,090
7,907
Premises and equipment, net
62,572
63,449
Bank-owned life insurance
68,690
68,384
Federal Reserve Bank and Federal Home Loan Bank stock
25,437
24,373
Interest receivable
12,450
12,371
Goodwill
103,412
104,907
Core deposit intangibles, net
10,355
10,738
Other
15,556
13,830
Total assets
3,176,062
3,170,509
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Demand
362,786
366,530
Total non-interest-bearing deposits
Savings, NOW and money market
1,284,319
1,238,984
Time
721,192
776,499
Total interest-bearing deposits
2,005,511
2,015,483
Total deposits
2,368,297
2,382,013
Federal funds purchased and retail repurchase agreements
42,101
37,492
Federal Home Loan Bank advances
355,836
347,692
Bank stock loan
2,438
2,500
Subordinated debentures
14,040
13,968
Contractual obligations
1,966
1,967
Interest payable and other liabilities
9,897
10,733
Total liabilities
2,794,575
2,796,365
Commitments and contingent liabilities, see Notes 10 and 11
Stockholders’ equity, see Note 6
Common stock
161
Additional paid-in capital
332,075
331,339
Retained earnings
74,212
65,512
Accumulated other comprehensive loss
(5,185
)
(3,092
Employee stock loans
(121
Treasury stock
(19,655
Total stockholders’ equity
381,487
374,144
Total liabilities and stockholders’ equity
See accompanying condensed notes to interim consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
For the Three Months ended March 31, 2018 and 2017
(Dollar amounts in thousands, except per share data)
Three Months Ended
Interest and dividend income
Loans, including fees
29,048
19,400
Securities, taxable
3,723
2,724
Securities, nontaxable
879
785
Federal funds sold and other
473
306
Total interest and dividend income
34,123
23,215
Interest expense
4,718
2,576
23
12
1,299
502
27
—
269
232
Total interest expense
6,336
3,322
Net interest income
27,787
19,893
Provision for loan losses
1,170
1,095
Net interest income after provision for loan losses
26,617
18,798
Non-interest income
Service charges and fees
1,580
1,182
Debit card income
1,253
1,005
Mortgage banking
313
485
Increase in value of bank-owned life insurance
652
355
Net gain (loss) from securities transactions
(8
13
461
299
Total non-interest income
4,251
3,339
Non-interest expense
Salaries and employee benefits
10,891
7,806
Net occupancy and equipment
1,802
1,499
Data processing
1,674
1,161
Professional fees
715
516
Advertising and business development
619
518
Telecommunications
369
361
FDIC insurance
244
106
Courier and postage
255
226
Free nationwide ATM cost
292
212
Amortization of core deposit intangibles
384
209
Loan expense
346
177
Other real estate owned
268
205
Merger expenses
531
926
1,237
1,304
Total non-interest expense
19,627
15,226
Income before income taxes
11,241
6,911
Provision for income taxes
2,530
2,047
Net income
8,711
4,864
Net income allocable to common stockholders
Basic earnings per share
0.60
0.41
Diluted earnings per share
0.58
0.40
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Other comprehensive income:
Unrealized holding gains (losses) arising during the period on
available-for-sale securities
(2,937
Amortization of unrealized losses on held-to-maturity securities
119
137
Reclassification adjustment for net gains included in net income
(13
Total other comprehensive income (loss)
(2,818
336
Tax effect
714
(129
Other comprehensive income (loss), net of tax
(2,104
207
Comprehensive income
6,607
5,071
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Common Stock
Additional
Accumulated
Employee
Total
Shares
Outstanding
Amount
Paid-In
Capital
Retained
Earnings
Comprehensive
Income (loss)
Stock
Loans
Treasury
Stockholders’
Equity
Balance at January 1, 2017
11,680,308
132
236,103
44,328
(2,702
(242
257,964
Other comprehensive income,
net of tax effects
Stock-based compensation
494
Common stock issued upon
exercise of stock options
40,834
692
Common stock issued under
stock-based incentive plan
1,630
Repayments on employee stock loans
72
Issuance of common stock in
connection with the acquisition
of Prairie State Bancshares, net
of issuance expenses of $329
479,465
14,908
14,913
Balance at March 31, 2017
12,202,237
252,197
49,192
(2,495
(170
279,206
Balance at January 1, 2018
14,605,607
718
1,250
18
2,557
Adoption of ASU 2016-01
reclassifying AFS equity
securities with readily
determined fair value
(11
Balance at March 31, 2018
CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash flows from operating activities
Adjustments to reconcile net income to net cash from operating activities:
Stock based compensation
386
Depreciation
689
585
Net amortization (accretion) of purchase valuation adjustments
(1,047
(1,544
Amortization of premiums and discounts on securities
755
723
Amortization of intangibles
396
211
Deferred income taxes
(19
(53
FHLB stock dividends
(254
(182
Loss (gain) on sales and valuation adjustments on other real estate owned
30
Net loss (gain) on securities transactions
Change in unrealized loss (gain) on equity securities
Loss (gain) on disposal of premise and equipment
(192
Loss (gain) on sales of loans
(256
(412
Originations of loans held for sale
(27,194
(17,230
Proceeds from the sale of loans held for sale
32,682
18,450
Increase in the value of bank owned life insurance
(652
(356
Change in fair value of derivatives recognized in earnings
(4
Net change in:
(80
130
Other assets
1,034
(634
(1,377
450
Net cash provided by (used in) operating activities
14,906
6,502
Cash flows (to) from investing activities
Purchases of available-for-sale securities
(20,498
(13,660
Purchases of held-to-maturity securities
(62,978
Proceeds from sales, calls, pay-downs, and maturities of available-for-sale securities
4,447
6,303
Proceeds from calls, pay-downs and maturities of held-to-maturity securities
13,963
13,383
Net change in interest-bearing time deposits in other banks
1
Net change in loans
(21,903
(3,717
Purchase of premises and equipment
(814
(1,286
Proceeds from sale of premise and equipment
1,194
Proceeds from sale of foreclosed assets
35
Net redemption (purchase) of FHLB and FRB stock
(810
1,467
Proceeds from sale of other real estate owned
1,202
425
Proceeds from bank-owned life insurance death benefits
Cash paid for acquisition of Eastman
(55
Purchase of Prairie, net of cash acquired
(6,744
Net cash provided by (used in) investing activities
(22,893
(66,805
Cash flows (to) from financing activities
Net increase (decrease) in deposits
(13,770
65,238
Net change in federal funds purchased and retail repurchase agreements
4,609
(2,938
Net borrowings (payments) on Federal Home Loan Bank line of credit
8,144
(2,520
Principal payments on bank stock loan
(62
Proceeds from the exercise of employee stock options
Principal payments on employee stock loans
Net change in contractual obligations
(1
(15
Net cash provided by (used in) financing activities
(1,062
60,529
Net change in cash and cash equivalents
(9,049
Cash and cash equivalents, beginning of period
35,095
Ending cash and cash equivalents
35,321
Supplemental cash flow information:
Interest paid
6,021
2,863
Income taxes paid, net of refunds
(78
Supplemental noncash disclosures:
Other real estate owned acquired in settlement of loans
203
Total fair value of assets acquired in purchase of Prairie, net of cash
147,248
Total fair value of liabilities assumed in purchase of Prairie, net of cash
125,591
10
CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
NOTE 1 – BASIS OF PRESENTATION
The interim consolidated financial statements include the accounts of Equity Bancshares, Inc., its wholly owned subsidiary, Equity Bank, and Equity Bank’s wholly owned subsidiary, SA Holdings, Inc. These entities are collectively referred to as the “Company”. All significant intercompany accounts and transactions have been eliminated in consolidation.
The accompanying unaudited condensed interim consolidated financial statements have been prepared in accordance with United States Generally Accepted Accounting Principles (“GAAP”) for interim financial information and in accordance with guidance provided by the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial information. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. In the opinion of management, the interim statements reflect all adjustments necessary for a fair presentation of the financial position, results of operations and cash flows of the Company on a consolidated basis and all such adjustments are of a normal recurring nature. These financial statements and the accompanying notes should be read in conjunction with the Company’s audited financial statements for the year ended December 31, 2017, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 16, 2018. Operating results for the three months ended March 31, 2018, are not necessarily indicative of the results that may be expected for the year ending December 31, 2018, or any other period.
Change in Tax Law:
On December 22, 2017, the President of the United States signed the 2017 Tax Cuts and Jobs Act (“Tax Reform”), which reduced the U.S. federal statutory corporate income tax rate from 35% to 21% beginning in 2018. On the same date, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 118, which specifies that reasonable estimates of the income tax effects of Tax Reform should be used to account for the effects of Tax Reform in the period enactment is required by general accepted accounting principals and also provided for a measurement period that should not extend beyond one year from Tax Reform’s enactment date. The Company has accounted for the effects of Tax Reform using reasonable estimates based on currently available information. This accounting may change due to changes in interpretations the Company has made and the issuance of new tax or accounting guidance.
Adoption of New Accounting Standards:
On January 1, 2018, the Company adopted ASU 2014-09 Revenue from Contracts with Customers and all subsequent amendments to the ASU (collectively, “ASC 606”), which (i) creates a single framework for recognizing revenue from contracts with customers that fall within its scope and (ii) revises when it is appropriate to recognize a gain or loss from the transfer of nonfinancial assets, such as other real estate owned (“OREO”). The majority of the Company’s revenues come from interest income on financial instruments, including loans, leases, securities and derivatives, which are outside the scope of ASC 606. The Company’s services that fall within the scope of ASC 606 are presented with non-interest income and are recognized as revenue as the Company satisfies its obligation to the customer. Services within the scope of ASC 606 include service charges and fees on deposits, debit card income, investment referral income, insurance sales commissions, and other non-interest income related to loans and deposits.
The Company adopted ASC 606 using the modified retrospective method applied to all contracts not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018, are presented under ASC 606, while prior period amounts continue to be reported in accordance with legacy GAAP. The adoption of ASC 606 did not result in a change to the accounting for any of the in-scope revenue streams; as such, no cumulative effect adjustment was recorded.
Except for gains or losses from the sale of OREO, all of the Company’s revenue from contracts with customers within the scope of ASC 606 is recognized in non-interest income. The following table presents the Company’s sources of non-interest income for the three months ended March 31, 2018, and 2017.
Mortgage banking(a)
Increase in bank-owned life insurance(a)
Net gain (loss) from securities transactions(a)
Other(b)
(a) Not within the scope of ASC 606.
(b) The Other category includes investment referral income, insurance sales commissions and other non-interest income related to loans and deposits totaling $402 for the three months ended March 31, 2018, which is within the scope of ASC 606; the remaining balance of $59 for the three months ended March 31, 2018, represents recovery on zero-basis purchased loans, income from equity method investments and other remaining items considered insignificant, which is outside the scope of ASC 606.
A description of the Company’s revenue streams accounted for under ASC 606 follows:
Service Charges and Fees: The Company earns fees from its deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees, which include services such as stop payment charges, statement rendering and ACH fees, are recognized at the time the transaction is executed as that is the point in time the Company fulfills the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are collected through withdrawal from the customer’s account balance.
Debit Card Income: The Company earns debit card income from cardholder transactions conducted through payment processors. Debit card income from cardholder transactions represent a percentage of the underlying transaction value and are recognized concurrently with the transaction processing services provided to the cardholder.
Investment Referral Income: Investment referral services are offered through an unaffiliated registered broker-dealer and investment advisor. Investment referral income consists of transaction-based fees (i.e. trade commissions) and account fees (i.e. custodial fees). The service obligation for transaction-based fees relate to processing of individual transactions and are considered earned at the time the transaction occurs. The Company currently records this income when payment is received and at each month end for current-month transactions. Account fees are considered earned over the period for which the fees relate. These fees are received during the first month of each quarter and represent advance payment for the current quarter. These fees are amortized ratably over the three months during the quarter. Therefore, all account-based fees are currently recorded as performance obligations are satisfied.
Insurance Sales Commissions: Insurance commissions are received based on contracts with insurance companies which provide for a percentage of premiums to be paid to the Company in exchange for placement of policies with customers. The commissions generally relate to a period of one year or less. Under certain contracts, the Company may also assist with claims processing, but this performance obligation is considered insignificant compared to the initial placement of the policy. As such, the performance obligation is considered to have been substantially satisfied at the time of policy placement. While this indicates that all related revenue would be appropriately accrued at policy inception, in some cases recognition occurs over the policy period if received in installments from the insurance company. In no cases would this deferral extend beyond 12 months and the effect is considered immaterial compared to recognition at the time of policy placement. The Company also receives commission based on renewals of policies previously placed. However, additional work is required to process the renewals, resulting in future performance obligations to earn the related revenue. In addition, the occurrence of such renewals is not certain as initial policies are generally for one year or less and the fees earned are not determined until the time of renewal, based on underwriting at that time. As such, the Company has determined that accrual of income, for future renewals, is not appropriate.
Other Non-interest Income: Other non-interest income related to loans and deposits is earned when the specific transaction is processed, similar to service charges and fees.
Gain or Loss on Sale of Other Real Estate: Gain or loss on sale of other real estate is reported in non-interest expense and is netted with other real estate expenses. The Company records a gain or loss from the sale of other real estate when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of other real estate to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the other real estate is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain or loss on sale if a significant financing component is present. As a result, the Company has concluded that ASC 606 will affect the decision to recognize or defer gains on sales of other real estate in circumstances where the Company has financed the sale.
On January 1, 2018, the Company adopted ASU 2016-01Recognition and Measurement of Financial Assets and Financial Liabilities, which addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments. The update eliminated the available-for-sale classification of accounting for equity securities and adjusted fair value disclosures for financial instruments carried at amortized costs so that the disclosed fair values represent an exit price as opposed to an entry price. The impact of adopting this update was the reclassification of $11 of after tax unrealized losses from available-for-sale equity securities with a readily determinable fair value from accumulated other comprehensive income to retained earnings. Also, beginning January 1, 2018, changes in fair value on equity securities with a readily determinable fair value will be reported in net income.
Also on January 1, 2018, the Company adopted ASU 2016-15, Statement of Cash Flows (Topic 230). This update addressed eight specific cash flow issues with the objective of reducing the existing diversity in practice of how certain cash receipts and cash payments are presented and classified in the statement of cash flow. This update had no impact on our Company.
Recent Accounting Pronouncements: In February 2016, FASB issued ASU 2016-02, Leases, with the intention of improving financial reporting about leasing transactions. The ASU requires all lessees to recognize lease assets and lease liabilities on the balance sheet. Lessor accounting is largely unchanged by the ASU, however disclosures about the amount, timing, and uncertainty of cash flows arising from leases are required of both lessees and lessors. The ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach provides for optional practical expedients when applying the ASU to leases that commenced before the effective date of the ASU. The Company is currently evaluating the impact of this new accounting standard on the consolidated financial statements but expects that assets and liabilities will increase to reflect the impact of this standard.
In June 2016, FASB issued ASU 2016-13, Financial Instruments – Credit Losses, which will change how the Company measures credit losses for most of its financial assets. This guidance is applicable to loans held for investment, off-balance-sheet credit exposures, such as loan commitments and standby letters of credit, and held-to-maturity investment securities. The Company will be required to use a new forward-looking expected loss model that is anticipated to result in the earlier recognition of allowances for losses. For available-for-sale securities with unrealized losses, the Company will measure credit losses in a manner similar to current practice, but will recognize those credit losses as allowances rather than reductions in the amortized cost of the securities. In addition, the ASU requires significantly more disclosure including information about credit quality by year of origination for most loans. The ASU is effective for the Company beginning in the first quarter of 2020. Generally, the amendments will be applied through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. The Company is currently gathering the historical loss data by portfolio and class of financial instrument to estimate the life of financial instrument credit loss and is developing the supporting system requirements to routinely generate the reported values. At this time an estimate of the impact to the Company’s financial statements is not known.
In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other, which will simplify the subsequent measurement of goodwill. Goodwill and other intangibles must be assessed for impairment annually. If an entity’s assessment determines that the fair value of an entity is less than its carrying amount, including goodwill, currently, the measurement of goodwill impairment requires that the entity’s identifiable net assets be valued following procedures similar to determining the fair value of assets acquired and liabilities assumed in a business combination. Under ASU 2017-04, goodwill impairment is measured to the extent that the carrying amount of an entity exceeds its fair value. The amendments in this update are effective for the Company’s annual goodwill impairment tests beginning in 2020. The amendments will be applied on a prospective basis. The Company is currently evaluating the impact of this new accounting standard but does not expect a material impact to its financial statements.
In March 2017, the FASB issued ASU 2017-08, Premium Amortization on Purchased Callable Debt Securities, this update shortens the amortization period of certain callable debt securities held at a premium to the earliest call date. The amendments in this update are effective for the Company’s fiscal year beginning after December 15, 2018, and interim periods within that fiscal year; however, early adoption is permitted. If early adoption of this update is elected by the Company, any adjustments will be reflected as of the beginning of the fiscal year. The amendments will be applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption and the Company will be required to provide change in accounting principle disclosures. The Company is currently evaluating the impact of this new accounting guidance and an estimate of the impact to the Company’s financial statements is not known.
14
NOTE 2 – SECURITIES
The amortized cost and fair value of available-for-sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income are listed below.
Amortized
Cost
Gross
Unrealized
Gains
Losses
Fair
Value
Residential mortgage-backed securities (issued by
government-sponsored entities)
179,242
(4,747
174,522
State and political subdivisions
195
179,437
December 31, 2017
163,374
(1,819
161,591
Equity securities
500
(14
486
164,069
(1,833
The amortized cost and fair value of held-to-maturity securities and the related gross unrecognized gains and losses are listed in the following table.
Unrecognized
Held-to-maturity securities
U.S. Government-sponsored entities
999
(21
978
government sponsored entities)
371,254
31
(10,499
360,786
Corporate
22,992
426
(10
23,408
Small Business Administration loan pools
1,884
(29
1,855
124,892
764
(1,545
124,111
1,221
(12,104
511,138
998
985
383,875
573
(4,866
379,582
22,991
23,346
2,048
2,034
125,550
1,694
(447
126,797
2,622
(5,340
532,744
The tables above present unrecognized losses on held-to-maturity securities since date of designation.
15
The fair value and amortized cost of debt securities at March 31, 2018, by contractual maturity, is shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately.
Available-for-Sale
Held-to-Maturity
Within one year
2,915
2,917
One to five years
27,202
27,410
Five to ten years
43,332
43,913
After ten years
77,318
76,112
Mortgage-backed securities
Total debt securities
The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was approximately $570,893 at March 31, 2018 and $570,146 at December 31, 2017.
The following tables show gross unrealized losses and fair value, aggregated by investment category, and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2018 and December 31, 2017.
Less Than 12 Months
12 Months or More
Loss
Residential mortgage-backed (issued by
113,900
(2,368
55,285
(2,379
169,185
Total temporarily impaired securities
78,884
(437
58,540
(1,382
137,424
59,026
(1,396
137,910
164,553
(3,750
188,087
(8,286
352,640
(12,036
5,209
(95
849
1,006
(38
(51
45,721
(799
26,305
(1,084
72,026
(1,883
216,332
(4,657
216,376
(9,429
432,708
(14,086
147,281
(1,263
198,239
(5,030
345,520
(6,293
5,312
(16
1,108
(39
22,100
(123
26,387
(439
48,487
(562
175,619
(1,403
226,719
(5,520
402,338
(6,923
16
The tables above present unrealized losses on held-to-maturity securities since the date of purchase, independent of the impact associated with changes in cost basis upon transfer from the available-for-sale designation to the held-to-maturity designation. As of March 31, 2018, the Company held 37 available-for-sale securities and 397 held-to-maturity securities in an unrealized loss position.
Unrealized losses on securities have not been recognized into income because the security issuers are of high credit quality, management does not intend to sell and it is more likely than not that the Company will not be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates. The fair value is expected to recover as the securities approach maturity.
The proceeds from sales and the associated gains and losses on available-for-sale securities reclassified from other comprehensive income to income are listed below:
Proceeds
3,439
Gross gains
Gross losses
Income tax expense on net realized gains
NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES
Categories of loans at March 31, 2018 and December 31, 2017 are listed below.
Commercial real estate
974,728
987,661
Commercial and industrial
526,129
507,519
Residential real estate
394,142
376,705
Agricultural real estate
92,748
86,486
Consumer
50,477
49,361
Agricultural
87,100
95,547
Total loans
2,125,324
2,103,279
Allowance for loan losses
(9,316
(8,498
Net loans
The Company has participated in mortgage finance loans with another institution, (the “originator”). These mortgage finance loans consist of ownership interests purchased in single family residential mortgages funded through the originator’s mortgage finance group. These loans are typically on the Company’s balance sheet for 10 to 20 days. As of March 31, 2018 and December 31, 2017, the Company had balances of $10,000 and $10,000 in mortgage finance loans classified as commercial and industrial.
From time to time the Company has purchased pools of residential real estate loans originated by other financial institutions to hold for investment with the intent to diversify the residential real estate portfolio. As of March 31, 2018 and December 31, 2017, residential real estate loans include $80,159 and $85,868 of purchased residential real estate loans from these pools of residential real estate loans.
The unamortized balance of merger purchase accounting adjustments related to non-purchase credit impaired loans included in the loan totals above are $5,927 with related loans of $736,999 at March 31, 2018, and $6,842 with related loans of $796,064 at December 31, 2017.
Over-draft deposit accounts are reclassified and included in consumer loans above. These accounts totaled $853 at March 31, 2018 and $741 at December 31, 2017.
17
The following tables present the activity in the allowance for loan losses by class for the three-month periods ended March 31, 2018 and 2017.
Commercial
Real Estate
and
Industrial
Residential
Real
Estate
Allowance for loan losses:
Beginning balance
2,740
2,136
2,262
319
768
273
8,498
291
260
290
288
96
Loans charged-off
(9
(306
(506
Recoveries
128
154
Total ending allowance balance
3,010
2,388
2,442
267
878
331
9,316
March 31, 2017
2,420
1,881
1,765
266
6,432
167
188
316
352
41
(63
(211
(359
(41
(687
68
208
2,592
2,059
1,875
66
391
7,048
The following tables present the recorded investment in loans and the balance in the allowance for loan losses by portfolio and class based on impairment method as of March 31, 2018 and December 31, 2017.
Individually evaluated for impairment
71
315
46
26
548
Collectively evaluated for impairment
2,931
2,329
2,115
233
832
305
8,745
Purchase credit impaired loans
Loan Balance:
2,346
6,825
3,543
447
458
309
13,928
959,128
513,624
388,189
88,526
50,013
83,181
2,082,661
13,254
5,680
2,410
3,775
3,610
28,735
87
741
2,582
2,028
1,815
190
712
236
7,563
28
21
61
83
194
2,728
7,886
4,829
533
556
1,050
17,582
971,376
493,903
369,471
82,493
48,802
90,795
2,056,840
13,557
5,730
2,405
3,460
3,702
28,857
The following table presents information related to impaired loans, excluding purchased credit impaired loans which have not deteriorated since acquisition, by class of loans as of March 31, 2018 and December 31, 2017. The recorded investment in loans excludes accrued interest receivable due to immateriality.
Unpaid
Principal
Balance
Recorded
Investment
Allowance for
Loan Losses
Allocated
With no related allowance recorded:
4,140
1,916
1,878
1,567
8,276
7,402
8,679
8,020
647
388
1,230
969
52
793
456
Subtotal
14,017
10,299
11,847
10,615
With an allowance recorded:
1,280
863
79
4,049
1,597
158
624
605
1,310
1,113
108
3,469
3,273
327
4,868
4,468
362
341
1,266
129
569
460
677
559
272
1,798
1,444
37
6,576
5,797
571
10,215
935
20,593
16,096
25,815
20,830
The tables below present average recorded investment and interest income related to impaired loans for the three months ended March 31, 2018 and 2017. Interest income recognized in the following table was substantially recognized on the cash basis. The recorded investment in loans excludes accrued interest receivable due to immateriality.
As of and for the three months ended
Average
Interest
Income
Recognized
1,742
936
7,711
676
679
621
94
406
231
10,457
2,665
2,538
859
420
3,870
2,698
688
151
509
393
850
8,006
6,212
18,463
8,877
19
The following tables present the aging of the recorded investment in past due loans as of March 31, 2018 and December 31, 2017, by portfolio and class of loans.
30 - 59
Days
Past Due
60 - 89
Greater
Than
90 Days
Past
Due Still On
Accrual
Nonaccrual
Loans Not
735
143
10,896
962,954
558
1,264
12,004
512,303
1,192
183
4,351
388,416
1,244
3,630
87,874
387
49,603
235
3,919
82,938
4,124
1,852
35,260
2,084,088
1,284
22
11,607
974,748
251
13,217
494,045
1,457
1,176
6,148
367,924
123
3,993
82,370
359
112
48,331
415
4,752
90,380
3,889
1,316
40,276
2,057,798
Credit Quality Indicators
The Company categorizes 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, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. Consumer loans are considered pass credits unless downgraded due to payment status or reviewed as part of a larger credit relationship. The Company uses the following definitions for risk ratings:
Pass: Loans classified as pass do not have any noted weaknesses and repayment of the loan is expected. These loans are considered unclassified.
Special Mention: Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date. These loans are considered classified.
Substandard: Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. These loans are considered classified.
Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. These loans are considered classified.
20
The risk category of loans by class of loans is as follows as of March 31, 2018 and December 31, 2017.
Unclassified
Classified
962,124
12,604
505,806
20,323
389,626
4,516
84,363
8,385
49,998
479
82,178
4,922
2,074,095
51,229
971,458
16,203
486,150
21,369
370,151
6,554
77,084
9,402
48,777
584
88,261
7,286
2,041,881
61,398
Purchased Credit Impaired Loans
The Company has acquired loans, for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The table below lists recorded investments in purchase credit impaired loans as of March 31, 2018 and December 31, 2017.
Contractually required principal payments
40,934
41,349
Discount
(12,199
(12,492
Recorded investment
The accretable yield associated with these loans was $2,011 and $1,980 as of March 31, 2018 and December 31, 2017. The interest income recognized on these loans for the three month periods ended March 31, 2018 and 2017 was $565 and $422. For the three month period ended March 31, 2018 there was a reversal of provision for loan losses of $171 recorded for these loans, while for the three month period ended March 31, 2017 there was $69 provision for loan losses recorded.
Troubled Debt Restructurings
The Company had no loans modified under troubled debt restructurings as of March 31, 2018 or December 31, 2017.
NOTE 4 – DERIVATIVE FINANCIAL INSTRUMENTS
The Company is exposed to interest-rate risk primarily from the effect of interest rate changes on its interest-earning assets and its sources of funding these assets. The Company will periodically enter into interest rate swaps or interest rate caps/floors to manage certain interest rate risk exposure.
Interest Rate Swaps Designated as Fair Value Hedges:
The Company periodically enters into interest rate swaps to hedge the fair value of certain commercial real estate loans. These transactions are designated as fair value hedges. In this type of transaction, the Company typically receives from the counterparty a variable-rate cash flow based on the one-month London Interbank Offered Rate (“LIBOR”) plus a spread to this index and pays a fixed-rate cash flow equal to the customer loan rate. At March 31, 2018, the portfolio of interest rate swaps had a weighted average maturity of 8.4 years, a weighted average pay rate of 4.94% and a weighted average rate received of 4.45%. At December 31, 2017, the portfolio of interest rate swaps had a weighted average maturity of 8.7 years, a weighted average pay rate of 4.94% and a weighted average rate received of 4.13%.
Stand-Alone Derivatives:
In 2009, the Company purchased an interest rate cap derivative to assist with interest rate risk management. This derivative is not designated as a hedging instrument but rather as a stand-alone derivative. At March 31, 2018, the interest rate cap had a term of 1.6 years and a cap rate of 4.50%. At December 31, 2017, the interest rate cap had a term of 1.9 years and a cap rate of 4.50%.
Reconciliation of Derivative Fair Values and Gains/(Losses):
The notional amount of a derivative contract is a factor in determining periodic interest payments or cash flows received or paid. The notional amount of derivatives serves as a level of involvement in various types of derivatives. The notional amount does not represent the Company’s overall exposure to credit or market risk, generally, the exposure is significantly smaller.
The following table shows the notional balances and fair values (including net accrued interest) of the derivatives outstanding by derivative type at March 31, 2018 and December 31, 2017.
Notional
Derivative
Assets
Liabilities
Derivatives designated as hedging instruments:
Interest rate swaps
17,113
383
17,231
Total derivatives designated as hedging relationships
Derivatives not designated as hedging instruments:
Interest rate caps/floors
2,497
2,574
Total derivatives not designated as hedging
instruments
19,610
19,805
Cash collateral held by counterparty
(210
Netting adjustments
164
Net amount presented in Balance Sheet
165
For the three-month periods ended March 31, 2018 and 2017, the Company recorded net gains/(losses) on derivatives and hedging activities listed below.
Three months ended
Total net gain (loss) related to fair value hedge
ineffectiveness
Economic hedges:
Total net gains (losses) related to derivatives not
designated as hedging instruments
Net gains (losses) on derivatives and hedging activities
The following table shows the recorded net gains (losses) on derivatives and the related hedged items in fair value hedging relationships and the impact of those derivatives on the Company’s net interest income for the three-month periods ended March 31, 2018 and 2017.
Gain/(Loss)
on Derivatives
on Hedged
Items
Net Fair Value
Hedge
Ineffectiveness
Effect of
Derivatives on
Net Interest
Commercial real estate loans
429
(429
(24
70
(70
(47
NOTE 5 – BORROWINGS
Federal funds purchased and retail repurchase agreements as of March 31, 2018 and December 31, 2017 are listed below.
Federal funds purchased
Retail repurchase agreements
The Company has available federal funds lines of credit with its correspondent banks.
Securities sold under agreements to repurchase (retail repurchase agreements) consist of obligations of the Company to other parties. The obligations are secured by residential mortgage-backed securities held by the Company with a fair value of $44,374 and $44,768 at March 31, 2018 and December 31, 2017. The agreements are on a day-to-day basis and can be terminated on demand.
Year-to-date average daily balance during the period
40,250
25,823
Maximum month-end balance during the period
43,843
Weighted average interest rate at period-end
0.23
%
Federal Home Loan Bank advances as of March 31, 2018 and December 31, 2017 are listed below.
Federal Home Loan Bank line of credit advances
Federal Home Loan Bank fixed rate term advances
Total Federal Home Loan Bank advances
At March 31, 2018, the Company had $355,836 drawn against its line of credit at a weighted average rate of 1.75%. At December 31, 2017, the $347,692 drawn against the Federal Home Loan Bank line of credit was at a weighted average rate of 1.47%.
The advances, Mortgage Partnership Finance credit enhancement obligations and letters of credit were collateralized by certain qualifying loans totaling $547,945 and $478,966 at March 31, 2018 and December 31, 2017. Based on this collateral and the Company’s holdings of Federal Home Loan Bank stock, the Company was eligible to borrow an additional $178,696 and $125,271 at March 31, 2018 and December 31, 2017.
On March 13, 2017, the Company entered into an agreement with an unaffiliated financial institution that provides for a maximum borrowing facility of $30,000, secured by the Company’s stock in Equity Bank. The borrowing facility was renewed on March 12, 2018, and will mature on March 11, 2019. Each draw of funds on the facility will create a separate note that is repayable over a term of five years. Each note will bear interest at a variable interest rate equal to the prime rate published in the “Money Rates” section of The Wall Street Journal (or any generally recognized successor), floating daily. Accrued interest and principal payments will be due quarterly with one final payment of unpaid principal and interest due at the end of the five year term of each separate note. The Company is also required to pay an unused commitment fee in an amount equal to 20 basis points per annum on the unused
portion of the maximum borrowing facility. The outstanding note balance was $2,438 at March 31, 2018, and $2,500 at December 31, 2017. The note matures on January 1, 2023 and at March 31, 2018 the interest rate was 4.75%.
The terms of the borrowing facility require the Company and Equity Bank to maintain minimum capital ratios and other covenants. In the event of default, the lender has the option to declare all outstanding balances immediately due. The Company believes it is in compliance with the terms of the borrowing facility and has not been otherwise notified of noncompliance.
NOTE 6 – STOCKHOLDERS’ EQUITY
Preferred stock
The Company’s articles of incorporation provide for the issuance of 10,000,000 shares of preferred stock. At March 31, 2018 and December 31, 2017, there was no preferred stock outstanding.
The Company’s articles of incorporation provide for the issuance of 45,000,000 shares of Class A voting common stock (“Class A common stock”) and 5,000,000 shares of Class B non-voting common stock (“Class B common stock”), both of which have a par value of $0.01.
The following table presents shares that were issued and were held in treasury or were outstanding at March 31, 2018 and December 31, 2017.
Class A common stock – issued
15,880,457
15,876,650
Class A common stock – held in treasury
(1,271,043
Class A common stock – outstanding
Class B common stock – issued
234,903
Class B common stock – held in treasury
(234,903
Class B common stock – outstanding
Treasury stock is stated at cost, determined by the first-in, first-out method.
24
In May 2015, in connection with the termination of a discontinued restricted stock unit plan (“Plan”). The Company agreed to loan electing participants an amount equal to each participant’s federal and state income tax withholding obligation associated with the stock issued upon Plan termination. These loans totaling $121 at March 31, 2018 and $121 at December 31, 2017, are collateralized with the shares received, have a maturity date of December 31, 2018 and have an interest rate of 1.68%.
Accumulated other comprehensive income (loss)
At March 31, 2018 and December 31, 2017, accumulated other comprehensive income consisted of (i) the after-tax effect of unrealized gains (losses) on available-for-sale securities and (ii) the after-tax effect of unamortized unrealized gains (losses) on securities transferred from the available-for-sale designation to the held-to-maturity designation.
Components of accumulated other comprehensive income as of March 31, 2018 and December 31, 2017 are listed below.
Available-for-
Sale
Securities
Held-to-
Maturity
Net unrealized or unamortized gains (losses)
(4,720
(2,225
(6,945
1,196
564
1,760
(3,524
(1,661
(1,797
(2,344
(4,141
455
594
1,049
(1,342
(1,750
NOTE 7 – REGULATORY MATTERS
Banks and bank holding companies (on a consolidated basis) 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 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. Beginning in January 2016, the implementation of the capital conservation buffer was effective for the Company starting at the 0.625% level and increasing 0.625% each year thereafter, until it reaches 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress and requires increased capital levels for the purpose of capital distributions and other payments. Failure to meet the full amount of the buffer will result in restrictions on the Company's ability to make capital distributions, including dividend payments and stock repurchases, and to pay discretionary bonuses to executive officers.
Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as are asset growth and acquisitions, and capital restoration plans are required.
As of March 31, 2018, management believes that the Company meets all capital adequacy requirements to which they are subject and the most recent notifications from the federal regulatory agencies categorized Equity Bank as well capitalized under the regulatory framework for prompt corrective action, including the capital conservation buffer. To be categorized as well capitalized, Equity Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed Equity Bank’s category.
25
The Company’s and Equity Bank’s capital amounts and ratios at March 31, 2018 and December 31, 2017 are presented in the table below. Ratios provided for Equity Bancshares, Inc. represent the ratios of the Company on a consolidated basis.
Actual
Minimum Required
for Capital Adequacy
Under Basel III
Phase-In
Fully Phased-In
To Be Well
Capitalized Under
Prompt Corrective
Provisions
Ratio
Total capital to risk weighted assets
Equity Bancshares, Inc.
298,567
12.81
230,242
9.88
244,814
10.50
N/A
Equity Bank
286,689
12.29
230,292
244,867
233,207
10.00
Tier 1 capital to risk weighted assets
289,251
12.41
183,611
7.88
198,183
8.50
277,373
11.89
183,650
198,226
186,565
8.00
Common equity Tier 1 capital to risk weighted assets
275,211
11.80
148,637
6.38
163,210
7.00
148,669
163,245
151,584
6.50
Tier 1 leverage to average assets
9.45
122,444
4.00
9.06
122,471
153,089
5.00
288,353
12.54
212,705
9.25
241,449
279,712
12.17
212,682
241,423
229,927
279,855
166,715
7.25
195,459
271,214
166,697
195,438
183,942
265,887
11.56
132,222
5.75
160,966
132,208
160,949
149,452
10.33
108,372
10.01
108,351
135,439
Equity Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval.
NOTE 8 – EARNINGS PER SHARE
The following table presents earnings per share for the three months ended March 31, 2018 and 2017.
Basic:
Weighted average common shares outstanding
14,606,607
11,813,068
Weighted average vested restricted stock units
4,772
751
Weighted average shares
14,611,379
11,813,819
Basic earnings per common share
Diluted:
Weighted average common shares outstanding for:
Dilutive effects of the assumed exercise of stock options
279,539
266,304
Dilutive effects of the assumed vesting of restricted stock units
3,262
1,169
Average shares and dilutive potential common shares
14,894,180
12,081,292
Diluted earnings per common share
Average outstanding stock options of 219,713 and 120,234 for the three-month periods ended March 31, 2018 and 2017 were not included in the computation of diluted earnings per share because the options were antidilutive.
NOTE 9 – FAIR VALUE
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to disclose the fair value of its financial instruments. 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. For disclosure purposes, the Company groups its financial and non-financial assets and liabilities into three different levels based on the nature of the instrument and the availability and reliability of the information that is used to determine fair value. The three levels of inputs that may be used to measure fair values are defined as follows:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
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; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
Level 1 inputs are considered to be the most transparent and reliable. The Company assumes the use of the principal market to conduct a transaction of each particular asset or liability being measured and then considers the assumptions that market participants would use when pricing the asset or liability. Whenever possible, the Company first looks for quoted prices for identical assets or liabilities in active markets (Level 1 inputs) to value each asset or liability. However, when inputs from identical assets or liabilities on active markets are not available, the Company utilizes market observable data for similar assets and liabilities. The Company maximizes the use of observable inputs and limits the use of unobservable inputs to occasions when observable inputs are not available. The need to use unobservable inputs generally results from the lack of market liquidity of the actual financial instrument or of the underlying collateral. Although, in some instances, third party price indications may be available, limited trading activity can challenge the implied value of those quotations.
The following is a description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of each instrument under the hierarchy:
Fair Value of Assets and Liabilities Measured on a Recurring Basis
The fair values of securities available-for-sale are carried at fair value on a recurring basis. To the extent possible, observable quoted prices in an active market are used to determine fair value and, as such, these securities are classified as Level 1. For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities, generally determined by matrix pricing, which is a mathematical technique widely used in the industry to value securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). The Company’s available-for-sale securities, including U.S. Government sponsored agencies, residential mortgage-backed securities (all of which are issued or guaranteed by government sponsored agencies), corporate securities, Small Business Administration securities, and State and Political Subdivision securities are classified as Level 2.
The fair values of derivatives are determined based on a valuation pricing model using readily available observable market parameters such as interest rate yield curves (Level 2 inputs) adjusted for credit risk attributable to the seller of the interest rate derivative. Cash collateral received from or delivered to a derivative counterparty is classified as Level 1.
Assets and liabilities measured at fair value on a recurring basis are below.
(Level 1)
(Level 2)
(Level 3)
Assets:
Available-for-sale securities:
Derivative assets:
Derivative assets
Total derivative assets (included in other assets)
174,718
Liabilities:
Derivative liabilities:
Derivative liabilities
Total derivative liabilities (included in other
liabilities)
U.S. government-sponsored entities
Derivative assets (included in other assets)
Total derivative assets
650
161,787
Interest rate swaps (included in other liabilities)
(46
Total derivative liabilities
There were no material transfers between levels during the three months ended March 31, 2018 or the year ended December 31, 2017. The Company’s policy is to recognize transfers into or out of a level as of the end of a reporting period.
Fair Value of Assets and Liabilities Measured on a Non-recurring Basis
Certain assets are measured at fair value on a non-recurring basis when there is evidence of impairment. The fair value of impaired securities is determined as discussed previously for available-for-sale securities. The fair values of impaired loans with specific allocations of the allowance for loan losses are generally based on recent real estate appraisals of the collateral less estimated cost to sell. Declines in the fair values of other real estate owned subsequent to their initial acquisitions are also based on recent real estate appraisals less selling costs.
Real estate 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. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.
Assets measured at fair value on a non-recurring basis are summarized below.
Impaired loans:
784
546
2,946
950
Other real estate owned:
1,016
86
1,439
4,021
905
1,910
1,018
157
The Company did not record any liabilities for which the fair value was measured on a non-recurring basis at March 31, 2018 or at December 31, 2017.
Valuations of impaired loans and other real estate owned utilize third party appraisals or broker price opinions, and were classified as Level 3 due to the significant judgment involved. Appraisals may include the utilization of unobservable inputs, subjective factors, and quantitative data to estimate fair market value.
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The following table presents additional information about the unobservable inputs used in the fair value measurement of financial assets measured on a nonrecurring basis that were categorized with Level 3 of the fair value hierarchy.
Fair Value
Valuation
Technique
Unobservable
Input
Range
(weighted average)
Impaired loans
5,226
Sales Comparison
Approach
Adjustments for
differences between
comparable sales
15%-26% (5%)
9,280
Measurable inputs for other real estate owned were not material.
Carrying amount and estimated fair values of financial instruments at period end were as follows as of the date indicated.
Carrying
Estimated
Level 1
Level 2
Level 3
Financial assets:
Interest bearing deposits
Loans, net of allowance for loan losses
2,109,732
Federal Reserve Bank and Federal Home
Loan Bank stock
Cash collateral held by derivative counterparty
2,908,771
2,866,175
713,297
Financial liabilities:
2,368,798
Federal funds purchased and retail
repurchase agreements
Interest payable
2,111
2,784,351
2,784,852
161,786
2,098,431
2,901,459
2,878,018
52,845
726,742
2,385,528
1,932
2,787,564
2,791,079
2,791,125
The fair value of off-balance-sheet items is not considered material.
NOTE 10 – COMMITMENTS AND CREDIT RISK
The Company extends credit for commercial real estate mortgages, residential mortgages, working capital financing and loans to businesses and consumers.
Commitments to Originate Loans and Available Lines of Credit: Commitments to originate loans and available lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments and lines of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments and lines of credit may expire without being drawn upon, the total commitment and lines of credit amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the counterparty. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, commercial real estate, and residential real estate. Mortgage loans in the process of origination represent amounts that the Company plans to fund within a normal period of 60 to 90 days, and which are intended for sale to investors in the secondary market.
The contractual amounts of commitments to originate loans and available lines of credit as of March 31, 2018 and December 31, 2017 are listed in the following table.
Fixed
Rate
Variable
Commitments to make loans
33,205
106,910
38,031
67,107
Mortgage loans in the process of origination
16,359
3,638
14,803
9,258
Unused lines of credit
90,486
140,597
87,948
141,026
The fixed rate loan commitments have interest rates ranging from 3.75% to 7.50% and maturities ranging from 1 month to 113 months.
Standby Letters of Credit: Standby letters of credit are irrevocable commitments issued by the Company to guarantee the performance of a customer to a third party once specified pre-conditions are met. Financial standby letters of credit are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. Performance standby letters of credit are issued to guarantee performance of certain customers under non-financial contractual obligations. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loans to customers.
Following are the contractual amounts of standby letters of credit as of March 31, 2018 and December 31, 2017.
Standby letters of credit
5,042
2,705
4,064
3,830
NOTE 11 – LEGAL MATTERS
The Company is party to various matters of litigation in the ordinary course of business. The Company periodically reviews all outstanding pending or threatened legal proceedings and determines if such matters will have an adverse effect on the business, financial condition or results of operations or cash flows. A loss contingency is recorded when the outcome is probable and reasonably able to be estimated. The following loss contingency has been identified by the Company as reasonably possible to result in an unfavorable outcome for the Company or the Bank.
Equity Bank is a party to a February 3, 2015 lawsuit filed against it by CitiMortgage, Inc. The lawsuit involves an alleged breach of contract related to loan repurchase obligations and damages of $2,700 plus pre-judgment and post-judgment interest. In January 2018, judgement was entered by the court dismissing Citi’s claims with regard to six loans and holding Equity Bank liable with regard to six loans. A loss contingency of $477 was recorded at December 31, 2017, in connection with the resolution of this case.
Except for the above mentioned lawsuit, there are no other outstanding claims for potential repurchase or indemnification demands regarding mortgage loans originated by Equity Bank and sold to investors. However, the Company believes there is possible risk it may face similar demands based on comparable demands loan aggregators are facing from their investors, including Government Sponsored Entities such as Freddie Mac and Fannie Mae, and or settlement agreements loan aggregators have entered into with those investors. The amount of potential loss and outcome of such possible litigation, if it were commenced, is uncertain and the Company would vigorously contest any claims.
NOTE 12 – BUSINESS COMBINATIONS
On December 16, 2017, the Company entered into an agreement and plan of reorganization with Kansas Bank Corporation (“KBC”). KBC is the holding company of First National Bank of Liberal (“FNB”), which has four branch locations in Liberal, Kansas, and one location in Hugoton, Kansas. This transaction was approved by regulators, KBC’s stockholders and subsequently closed May 4, 2018. In its March 31, 2018, unaudited Consolidated Report of Condition, FNB reported total assets of $318,375, which included total loans of $160,383 and securities of $116,336. At March 31, 2018, total liabilities of $288,349 were reported by FNB, which included deposits of $288,127. FNB reported $1,002 in net income before income taxes for the three months ended March 31, 2018. Although mark-to-market is not yet complete, the estimated fair value of consideration was $47,021.
Also on December 16, 2017, the Company entered into an agreement and plan of reorganization with Adams Dairy Bancshares, Inc. (“ADBI”). ADBI is the holding company of Adams Dairy Bank (“ADB”), which has one branch location in Blue Springs, Missouri. This transaction was approved by regulators, ADBI’s stockholders and was subsequently closed May 4, 2018. In its March
32
31, 2018, unaudited Consolidated Report of Condition, ADB reported total assets of $120,448, which included total loans of $92,080 and securities of $11,703. At March 31, 2018, total liabilities of $109,651 were reported by ADB, which included deposits of $95,841. ADB reported $520 in net income before income taxes for the three months ended March 31, 2018. Although mark-to-market is not yet complete, the estimated fair value of consideration was $17,417.
Given the recent date of the above closings, the Company has begun the process of fair valuing assets acquired and liabilities assumed, but providing such information is currently not practicable.
During the first quarter of 2018, an adjustment was made to purchase accounting related to the November 2017, merger with Cache Holdings, Inc. (“Cache”) resulting in a $1,500 decrease to goodwill and a corresponding increase to deferred tax assets. Also, during the first quarter of 2018, an additional $55 was paid to stockholders related to the November 2017, merger with Eastman National Bancshares, Inc. (“Eastman”) resulting in an increase to goodwill.
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Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K filed with the SEC on March 16, 2018 and our consolidated financial statements and related notes appearing elsewhere in this Quarterly Report. The following discussion contains “forward-looking statements” that reflect our future plans, estimates, beliefs and expected performance. We caution that assumptions, expectations, projections, intentions or beliefs about future events may, and often do, vary from actual results and the differences can be material. See “Cautionary Note Regarding Forward-Looking Statements.” Also, see the risk factors and other cautionary statements described under the heading “Item 1A: Risk Factors” included in the Annual Report on Form 10-K and in Item 1A of this Quarterly Report. We do not undertake any obligation to publicly update any forward-looking statements except as otherwise required by applicable law.
This discussion and analysis of our financial condition and results of operation includes the following sections:
Overview – a general description of our business and financial highlights;
Critical Accounting Policies – a discussion of accounting policies that require critical estimates and assumptions;
Results of Operations – an analysis of our operating results, including disclosures about the sustainability of our earnings;
Financial Condition – an analysis of our financial position;
Liquidity and Capital Resources – an analysis of our cash flows and capital position; and
Non-GAAP Financial Measures – a reconciliation of non-GAAP measures.
We are a bank holding company headquartered in Wichita, Kansas. Our wholly-owned banking subsidiary, Equity Bank, provides a broad range of financial services primarily to businesses and business owners as well as individuals through our network of 42 full service branches located in Arkansas, Kansas, Missouri and Oklahoma. As of March 31, 2018, we had consolidated total assets of $3.18 billion, total loans held for investment of $2.12 billion (net of allowances), total deposits of $2.37 billion and total stockholders’ equity of $381.5 million. During the three-month periods ended March 31, 2018 and March 31, 2017, net income was $8.7 million and $4.9 million.
Selected Financial Data for the periods indicated (dollars in thousands, except per share amounts) follows.
September 30,
June 30,
Statement of Income Data (for the quarterly period ended)
29,808
24,588
25,082
5,219
4,267
3,883
24,589
20,321
21,199
503
727
628
175
Other non-interest income
4,259
4,104
3,860
3,879
3,326
3,267
1,023
136
Other non-interest expense
19,096
17,451
15,365
14,995
14,300
7,472
7,241
3,198
2,084
3,048
4,274
5,157
6,354
0.32
0.42
0.52
0.31
0.51
Balance Sheet Data (at period end)
27,465
24,212
81,116
92,435
103,178
528,944
532,159
519,239
4,283
3,463
Gross loans held for investment
1,540,761
1,529,396
1,518,576
7,969
7,568
Loans held for investment, net of allowance for loan losses
1,532,792
1,521,828
1,511,528
Goodwill and core deposit intangibles, net
113,767
115,645
70,063
70,306
70,475
Other intangible assets
1,265
1,277
1,290
1,302
1,315
2,405,426
2,408,624
2,399,256
1,868,493
1,819,677
1,821,090
Borrowings
414,415
401,652
235,098
292,302
288,521
2,113,591
2,122,566
2,120,050
291,835
286,058
Tangible common equity*
266,455
257,222
220,482
214,450
207,416
Performance ratios
Return on average assets (ROAA) annualized
1.11
0.85
1.07
0.88
Return on average equity (ROAE) annualized
9.35
5.02
7.08
9.00
7.45
Return on average tangible common equity (ROATCE) annualized*
14.05
7.41
9.71
12.36
10.17
Yield on loans annualized
5.55
5.40
5.30
5.45
5.61
Cost of interest-bearing deposits annualized
0.94
0.87
0.82
0.75
0.72
Net interest margin annualized
3.91
3.79
3.68
3.96
Efficiency ratio*
59.59
60.82
63.54
59.79
61.59
Non-interest income / average assets annualized
0.54
0.67
0.61
Non-interest expense / average assets annualized
2.51
2.91
2.71
2.55
2.76
Capital Ratios
Tier 1 Leverage Ratio
10.32
10.15
10.52
Common Equity Tier 1 Capital Ratio
13.33
13.07
12.72
Tier 1 Risk Based Capital Ratio
14.15
13.89
13.54
Total Risk Based Capital Ratio
14.62
14.34
13.96
Equity / Assets
12.01
12.13
11.88
11.64
Tangible common equity to tangible assets*
8.70
8.42
9.18
8.91
Book value per share
26.09
25.62
23.86
23.44
22.88
Tangible common book value per share*
18.22
17.61
18.03
17.57
17.00
Tangible common book value per diluted share*
17.85
17.29
17.64
17.24
16.66
* The value noted is considered a Non-GAAP financial measure. For a reconciliation of Non-GAAP financial measures see “Non-GAAP Financial Measures” in this Item 2.
Our significant accounting policies are integral to understanding the results reported. Our accounting policies are described in detail in Note 1 to the December 31, 2017 audited financial statements included in our Annual Report on Form 10-K filed with the SEC on March 16, 2018. We believe that of our significant accounting policies, the following may involve a higher degree of judgement and complexity. We have identified the following accounting policies and estimates that, due to the difficult, subjective or complex judgements and assumptions inherent in those policies and estimates and the potential sensitivity of our financial statements to those judgements and assumptions, are critical to an understanding of our financial condition and results of operations. We believe that the judgments, estimates and assumptions used in the preparation of our financial statements are appropriate.
Business Combinations: We apply the acquisition method of accounting for business combinations. Under the acquisition method, the acquiring entity in a business combination recognizes 100% of the assets acquired and liabilities assumed at their acquisition-date fair values. We use valuation techniques appropriate for the asset or liability being measured in determining these fair values. Any excess of the purchase price over amounts allocated to assets acquired, including identified intangible assets and liabilities assumed is recorded as goodwill. Where amounts allocated to assets acquired and liabilities assumed is greater than the purchase price, a bargain purchase gain is recognized. Acquisition-related costs are expensed as incurred.
Loans: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of previous charge-offs and an allowance for loan losses, and for purchased loans, net of unamortized purchase premiums and discounts. Interest income is accrued on the unpaid principal balance.
Purchased Credit Impaired Loans: As a part of acquisitions, we acquired certain loans for which there was, at acquisition, evidence of deterioration of credit quality since origination. These purchased credit impaired loans were recorded at the amount paid, such that there is no carryover of the seller’s allowance for loan losses. After acquisition, losses are recognized by an increase in the allowance for loan losses. Such purchased credit impaired loans are accounted for individually. We estimate the amount and timing of expected cash flows for each loan, and the expected cash flows in excess of the amount paid are recorded as interest income over the remaining life of the loan (accretable yield). The excess of the loan’s contractual principal and interest over expected cash flows is not recorded (non-accretable difference). Over the life of the loan, expected cash flows continue to be estimated. If the present value of the expected cash flows is less than the carrying amount, a loss is recorded. If the present value of the expected cash flows is greater than the carrying amount, it is recognized as part of future interest income.
Nonaccrual Loans: Generally, loans are designated as nonaccrual when either principal or interest payments are 90 days or more past due based on contractual terms unless the loan is well secured and in the process of collection. Consumer loans are typically charged off no later than 180 days past due. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful. When a loan is placed on nonaccrual status, unpaid interest credited to income is reversed against income. Future interest income may be recorded on a cash basis after recovery of principal is reasonably assured. Nonaccrual loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Impaired Loans: A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect all contractual principal and interest due according to the terms of the loan agreement. All loans are individually evaluated for impairment. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or on the value of the underlying collateral if the loan is collateral dependent. We evaluate the collectability of both principal and interest when assessing the need for a loss accrual.
Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
Troubled Debt Restructurings: In cases where a borrower experiences financial difficulties and we make certain concessionary modifications to contractual terms, the loan is classified as a troubled debt restructured loan and classified as impaired. Generally, a nonaccrual loan that is a troubled debt restructuring remains on nonaccrual until such time that repayment of the remaining principal and interest is not in doubt, and the borrower has a period of satisfactory repayment performance.
Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the collectability of a loan balance is unlikely. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. A loan review process, independent of the loan approval process, is utilized by management to verify loans are being made and administered in accordance with company policy, to review loan risk grades and potential losses, to verify that potential problem loans are receiving adequate and timely corrective measures to avoid or reduce losses, and to assist in the verification of the adequacy of the loan loss reserve. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported net at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the sale of the collateral. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, we determine the amount of reserve in accordance with the accounting policy for the allowance for loan losses.
The general component of the allowance for loan losses covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio and class and is based on the actual loss history experienced by us. This actual loss experience is then adjusted by comparing current conditions to the conditions that existed during the loss history. We consider the changes related to (i) lending policies, (ii) economic conditions, (iii) nature and volume of the loan portfolio and class, (iv) lending staff, (v) volume and severity of past due, non-accrual, and risk graded loans, (vi) loan review system, (vii) value of underlying collateral for collateral dependent loans, (viii) concentration levels, and (ix) effects of other external factors.
Goodwill and Core Deposit Intangibles: Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Core deposit intangibles are acquired customer relationships arising from whole bank and branch acquisitions. Core deposit intangibles are initially measured at fair value and then are amortized over their estimated useful lives using an accelerated method. The useful lives of the core deposits are estimated to generally be between seven and ten years. Goodwill and core deposit intangibles are assessed at least annually for impairment and any such impairment is recognized and expensed in the period identified. We have selected December 31 as the date to perform our annual goodwill impairment test. Goodwill is the only intangible asset with an indefinite useful life.
Fair Value: Fair values of assets and liabilities are estimated using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, collateral values and other factors, especially in the absence of broad markets for particular assets and liabilities. Changes in assumptions or in market conditions could materially affect the estimates.
Emerging Growth Company: Pursuant to the JOBS Act, an emerging growth company is provided the option to adopt new or revised accounting standards that may be issued by the FASB or the SEC either (i) within the same periods as those otherwise applicable to non-emerging growth companies or (ii) within the same time periods as private companies. We have irrevocably elected to adopt new accounting standards within the public company adoption period.
We may take advantage of some of the reduced regulatory and reporting requirements that are available to us so long as the Company qualifies as an emerging growth company, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation, and exemptions from the requirements of holding non-binding advisory votes on executive compensation and golden parachute payments.
There have been no material changes in our critical accounting policies from those disclosed in our Annual Report on Form 10-K filed with the SEC on March 16, 2018.
We generate most of our revenue from interest income and fees on loans, interest and dividends on investment securities and non-interest income, such as service charges and fees, debit card income and mortgage banking income. We incur interest expense on deposits and other borrowed funds and non-interest expense, such as salaries and employee benefits and occupancy expenses. On March 10, 2017, we completed our merger with Prairie State Bancshares, Inc. (“Prairie”) of Hoxie, Kansas. The merger with Prairie added an additional three branch locations in western Kansas. Results of operations of Prairie were included in our financial results beginning March 11, 2017. On November 10, 2017, we completed our mergers with Eastman National Bancshares, Inc. (“Eastman”) of Newkirk, Oklahoma, and Cache Holdings, Inc. (“Cache”) of Tulsa, Oklahoma. The merger with Eastman added four branch locations in Ponca City and Newkirk, Oklahoma and the merger with Cache added one branch location in Tulsa, Oklahoma. Results of operations of Eastman and Cache were included in our financial results beginning November 11, 2017.
Changes in interest rates earned on interest-earning assets or incurred on interest-bearing liabilities, as well as the volume and types of interest-earning assets, interest-bearing and non-interest-bearing liabilities and stockholders’ equity, are usually the largest drivers of periodic change in net interest income. Fluctuations in interest rates are driven by many factors, including governmental monetary policies, inflation, deflation, macroeconomic developments, changes in unemployment, the money supply, political and international conditions and conditions in domestic and foreign financial markets. Periodic changes in the volume and types of loans in our loan portfolio are affected by, among other factors, economic and competitive conditions in Arkansas, Kansas, Missouri and Oklahoma, as well as developments affecting the commercial, consumer and real estate sectors within these markets.
Net Income
Three months ended March 31, 2018 compared with three months ended March 31, 2017:
Net income for the three months ended March 31, 2018 was $8.7 million as compared to net income of $4.9 million for the three months ended March 31, 2017. Net income allocable to common stockholders also was $8.7 million for the three months ended March 31, 2018, compared to $4.9 million for the three months ended March 31, 2017, an increase of $3.8 million, or 79.1%. During the three-month period ended March 31, 2018, increases in net interest income of $7.9 million and non-interest income of $912 thousand were partially offset by an increase in non-interest expense of $4.4 million when compared to the three-month period ended March 31, 2017. The changes in the components of net income are discussed in more detail in the following sections of “Results of Operations.”
Net Interest Income and Net Interest Margin Analysis
Net interest income is the difference between interest income on interest-earning assets, including loans and securities, and interest expense incurred on interest-bearing liabilities, including deposits and other borrowed funds. To evaluate net interest income, management measures and monitors (1) yields on loans and other interest-earning assets, (2) the costs of deposits and other funding sources, (3) the net interest spread and (4) net interest margin. Net interest spread is the difference between rates earned on interest-earning assets and rates paid on interest-bearing liabilities. Net interest margin is calculated as net interest income divided by average interest-earning assets. Because non-interest-bearing sources of funds, such as non-interest-bearing deposits and stockholders’ equity also fund interest-earning assets, net interest margin includes the benefit of these non-interest-bearing sources of funds. Net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as a “volume change,” and it is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as a “yield/rate change.”
Three months ended March 31, 2018 compared with three months ended March 31, 2017: The following table shows the average balance of each principal category of assets, liabilities, and stockholders’ equity and the average yields on interest-earning assets and average rates on interest-bearing liabilities for the three months ended March 31, 2018 and 2017. The yields and rates are calculated by dividing annualized income or annualized expense by the average daily balances of the associated assets or liabilities.
Average Balance Sheets and Net Interest Analysis
For the Three Months Ended March 31,
(Dollars in thousands)
Income/
Expense
Yield/
Rate(3)(4)
Interest-earning assets:
Loans(1)
2,122,973
1,403,076
Taxable securities
585,055
2.58
476,563
2.32
Nontaxable securities
114,000
3.13
103,904
3.06
61,932
3.10
52,634
2.36
Total interest-earning assets
2,883,960
4.80
2,036,177
4.62
Non-interest-earning assets:
7,643
8,491
63,164
51,487
Bank owned life insurance
68,430
48,179
Goodwill and core deposit intangible, net
116,634
65,185
Other non-interest-earning assets
29,300
26,734
3,169,131
2,236,253
Interest-bearing liabilities:
Interest-bearing demand deposits
583,495
942
0.65
475,697
0.43
Savings and money market
687,473
1,281
0.76
405,482
440
0.44
1,270,968
2,223
0.71
881,179
Certificates of deposit
772,816
2,495
1.31
576,928
1,634
1.15
2,043,784
1,458,107
FHLB term and line of credit advances
332,438
1.59
255,251
0.80
2,439
4.56
0.00
Subordinated borrowings
13,993
7.78
13,712
6.87
Other borrowings
40,251
20,111
0.25
Total interest-bearing liabilities
2,432,905
1.06
1,747,181
0.77
Non-interest-bearing liabilities and
stockholders’ equity:
Non-interest-bearing checking accounts
346,864
215,142
Non-interest-bearing liabilities
11,467
9,194
Stockholders’ equity
377,895
264,736
Interest rate spread
3.74
3.85
Net interest margin(2)
Total cost of deposits, including non-interest
bearing deposits
2,390,648
1,673,249
0.62
Average interest-earning assets to
interest-bearing liabilities
118.54
116.54
(1)
Average loan balances include nonaccrual loans.
(2)
Net interest margin is calculated by dividing annualized net interest income by average interest-earnings assets for the period.
(3)
Tax exempt income is not included in the above table on a tax equivalent basis.
(4)
Actual unrounded values are used to calculate the reported yield or rate disclosed. Accordingly, recalculations using the amounts in thousands as disclosed in this report may not produce the same amounts.
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Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average interest yields/rates. The following table analyzes the change in volume variances and yield/rate variances for the three-month periods ended March 31, 2018 and 2017.
Analysis of Changes in Net Interest Income
For the Three Months Ended March 31, 2018 and 2017
Increase (Decrease) Due to:
Increase /
Volume(1)
Yield/Rate(1)
(Decrease)
9,852
(204
9,648
667
332
78
60
107
10,657
10,908
610
861
1,156
986
2,142
186
611
797
1,386
1,628
3,014
Net Interest Income
9,271
7,894
The effect of changes in volume is determined by multiplying the change in volume by the previous year’s average rate. Similarly, the effect of rate changes is calculated by multiplying the change in average rate by the prior year’s volume. The changes attributable to both volume and rate, which cannot be segregated, have been allocated to the volume variance and the rate variance in proportion to the relationship of the absolute dollar amount of the change in each.
Net interest income before the provision for loan losses for the three months ended March 31, 2018 was $27.8 million compared with $19.9 million for the three months ended March 31, 2017, an increase of $7.9 million, or 39.7%. Interest income for the three months ended March 31, 2018 was $34.1 million, an increase of $10.9 million, or 47.0%, from $23.2 million for the three months ended March 31, 2017. Interest income increased primarily due to an increase in the average volume of interest-earning assets due in large part to growth in loan balances during the period. Interest expense for the three months ended March 31, 2018 was $6.3 million, an increase of $3.0 million, or 90.7%, from $3.3 million for the three months ended March 31, 2017. The increase in interest expense was due to increases in average volume of interest-bearing liabilities and the average rate paid on interest-bearing liabilities.
Interest income on loans, including loan fees which consist of fees for loan origination, renewal, prepayment, covenant breakage and loan modification, was $29.0 million for the three months ended March 31, 2018; an increase of $9.6 million, or 49.7%, compared with the three months ended March 31, 2017. This increase was due to increases in average loans partially offset by a reduction in average yield on the loan portfolio. The increase in average loan volume was primarily from increases in average loan volume of $371.9 million in commercial real estate loans, $178.6 million in commercial and industrial loans, $100.0 million in agriculture loans and $52.2 million in residential real estate loans. The average yield on loans was 5.55% for the three months ended March 31, 2018 and 5.61% for the three months ended March 31, 2017. The average yield on loans excluding loan fees was 5.24% for the three months ended March 31, 2018 and 5.36% for the three months ended March 31, 2017. The decrease in yield excluding loan fees was primarily due to decreases in average yields on commercial loans and agriculture loans. Interest income on all securities was $4.6 million for the quarter ended March 31, 2018; an increase of $1.1 million when compared to the quarter ended March 31, 2017. The increase was due to the increase in average total securities of $118.6 million and a 22 basis point increase in the average yield on the securities portfolio. The increase in the average volume of securities was largely due to the purchase of additional mortgage-backed securities.
Interest expense was $6.3 million for the three months ended March 31, 2018, an increase of $3.0 million over interest expense of $3.3 million for the three months ended March 31, 2017. The change in interest expense was due to a 29 basis point increase in our cost on interest-bearing liabilities and an increase of $685.7 million in the average volume of these liabilities. Average savings, NOW and money market deposits increased $389.8 million for the three months ended March 31, 2018 when compared to the three months
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ended March 31, 2017, and the average rate on these interest-bearing deposits increased from 0.43% to 0.71% for the same periods. The average balance increase in interest-bearing deposits is the result of the Prairie, Eastman and Cache mergers and actively managing deposits as a funding vehicle and expansion of our customer base. The increase in rate on interest-bearing deposits was the result of actively managing the rates on this funding source to remain competitive in the market place. Average certificates of deposit increased $195.9 million for the three months ended March 31, 2018 compared to the three months ended March 31, 2017, and the average rate increased from 1.15% to 1.31% for the same period. The increase in interest expense on certificates of deposit was primarily due to the rising interest rate environment. Total cost of funds increased 29 basis points to 1.06% for the three months ended March 31, 2018 from 0.77% for the three months ended March 31, 2017.
Net interest margin was 3.91% for the three months ended March 31, 2018; a decrease of five basis points when compared with net interest margin of 3.96% for the three months ended March 31, 2017. The decrease in our net interest margin for the three months ended March 31, 2018 is primarily due to the decrease in average yield on our loan portfolio and an overall decreasing interest rate spread as compared to the three months ended March 31, 2017. These changes resulted in an increase in net interest income of $7.9 million, an increase in average interest-earning assets of $847.8 million and a decrease in net interest margin of five basis points when comparing the three-month periods ended March 31, 2018 and 2017.
Provision for Loan Losses
We maintain an allowance for loan losses for probable incurred credit losses. The allowance for loan losses is increased by a provision for loan losses, which is a charge to earnings, and subsequent recoveries of amounts previously charged-off, but is decreased by charge-offs when the collectability of a loan balance is unlikely. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the loan portfolio, information about specific borrower situations and estimated collateral values, discounted cash flows, economic conditions, and other factors including regulatory guidance, as described in ”Financial Condition—Allowance for loan losses.” As these factors change, the amount of the loan loss provision changes.
Three months ended March 31, 2018 compared with three months ended March 31, 2017: The provision for loan losses for the three months ended March 31, 2018 was $1.2 million compared with $1.1 million for the three months ended March 31, 2017. Net charge-offs for the three months ended March 31, 2018 were $352 thousand compared to net charge-offs of $479 thousand for the three months ended March 31, 2017. For the three months ended March 31, 2018, gross charge-offs were $506 thousand offset by gross recoveries of $154 thousand. In comparison, gross charge-offs were $687 thousand for the three months ended March 31, 2017 offset by gross recoveries of $208 thousand.
Non-Interest Income
The primary sources of non-interest income are service charges and fees, debit card income, mortgage banking income, increases in the value of bank owned life insurance, investment referral income, the recovery of zero-basis purchased loans, and net gain from securities transactions. Non-interest income does not include loan origination or other loan fees which are recognized as an adjustment to yield using the interest method.
Three months ended March 31, 2018 compared with three months ended March 31, 2017: The following table provides a comparison of the major components of non-interest income for the three months ended March 31, 2018 and 2017.
2018 vs. 2017
Change
1,152
428
37.2
248
24.7
(172
-35.5
297
83.7
Investment referral income
93
100
(7
-7.0
Recovery on zero-basis purchased loans
58
11.5
310
133
75.1
Sub-Total
933
28.1
-161.5
912
27.3
For the three months ended March 31, 2018, non-interest income totaled $4.3 million, an increase of $912 thousand, or 27.3%, compared with the three months ended March 31, 2017. The increase was primarily due to increases in service charges and fees, value of bank-owned life insurance, debit card income and other non-interest income, partially offset by a decrease in mortgage banking income. Service charges and fees increased $428 thousand from $1.2 million at March 31, 2017 to $1.6 million at March 31, 2018, the value of bank-owned life insurance increased $297 thousand from $355 thousand at March 31, 2017 to $652 thousand at March 31, 2018, debit card income increased $248 thousand for the same period from $1.0 million at March 31, 2017 to $1.3 million at March 31, 2018, other non-interest income increased $133 thousand from $177 thousand at March 31, 2017 to $310 thousand at March 31, 2018, and mortgage banking income decreased $172 thousand from $485 thousand at March 31, 2017 to $313 thousand at March 31, 2018. Our principal source of service charges and fees is non-sufficient funds charges, which are cyclical in nature and generally fluctuate with the change in volume of transaction deposit accounts and economic conditions impacting our customers. During the first quarter of 2018, $59 thousand, $318 thousand and $24 thousand of the increase in service charges and fees were attributable to the addition of accounts associated with the Prairie, Eastman and Cache mergers. In addition, $172 thousand and $5 thousand of the increase in debit card income were attributable to the higher transaction volumes associated with the Eastman and Cache mergers.
Non-Interest Expense
Three months ended March 31, 2018 compared with three months ended March 31, 2017: For the three months ended March 31, 2018, non-interest expense totaled $19.6 million, an increase of $4.4 million, or 28.9%, compared with the three months ended March 31, 2017. The overall increase was primarily due to increases in salaries and employee benefits of $3.1 million, data processing of $513 thousand, net occupancy and equipment of $303 thousand, professional fees of $199 thousand, amortization of core deposit intangibles of $175 thousand, loan expense of $169 thousand, FDIC insurance of $138 thousand and advertising and business development of $101 thousand. These first quarter 2018 increased expenses were partially offset by a decrease in merger expenses of $395 thousand. Non-interest expense for the three-month period ended March 31, 2018 includes $636 thousand of incremental operating expenses attributable to the three branch locations acquired with the March 2017 Prairie merger, $1.1 million attributable to the four branch locations acquired with the November 2017 Eastman merger, and $832 thousand attributable to the one branch location acquired with the November 2017 Cache merger. These items and other changes in the various components of non-interest expense are discussed in more detail below.
The following table provides a comparison of the major components of non-interest expense for the three months ended March 31, 2018 and 2017.
3,085
39.5
303
20.2
513
44.2
199
38.6
101
19.5
2.2
138
130.2
12.8
80
37.7
169
95.5
Amortization of core deposit intangible
63
30.7
(67
-5.1
4,796
33.5
(395
-42.7
4,401
28.9
Salaries and employee benefits: Salaries and benefits were $10.9 million for the three months ended March 31, 2018, as compared to $7.8 million for the three months ended March 31, 2017. The increase in salaries and benefits of $3.1 million includes approximately $369 thousand directly allocable to the Prairie merger, $613 thousand directly allocable to the Eastman merger and $596 thousand directly allocable to the Cache merger. Included in salaries and employee benefits is stock based compensation
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expense of $680 thousand for the three months ended March 31, 2018 and $112 thousand in the comparable period of 2017. The remaining $954 thousand increase in salaries and benefits reflect cost-of-living/merit raises and the addition of operations staff indirectly attributable to acquisitions.
Net occupancy and equipment: Net occupancy and equipment includes expenses related to the use of premises and equipment, such as depreciation, operating lease payments, repairs and maintenance, insurance, property taxes and utilities, and is net of incidental rental income of excess facilities. Occupancy expenses were $1.8 million for the three months ended March 31, 2018 and $1.5 million for the three months ended March 31, 2017. The 2018 expenses include expenses for three branches that were part of the merger with Prairie, four branches that were part of the merger with Eastman and one branch that was part of the merger with Cache.
Data processing: Data processing expenses were $1.7 million and $1.2 million for the three month periods ended March 31, 2018 and 2017. The increase of $513 thousand was principally due to increased debit card processing costs as usage has increased.
Advertising and business development: Advertising and business development expenses were $619 thousand for the three month period ended March 31, 2018, compared to $518 thousand for the three month period ended March 31, 2017. The $101 thousand increase was largely attributable to the increased coverage area related to the Eastman and Cache mergers.
Telecommunications: Telecommunications expenses were $369 thousand and $361 thousand for the three month periods ended March 31, 2018 and 2017.
Other real estate owned: Other real estate owned expenses, including provision for unrealized losses were $268 thousand for the three months ended March 31, 2018. During the first quarter of 2018 there was a gain on the sale of other real estate owned of $3 thousand. For the three months ended March 31, 2017, other real estate owned expenses, including provision for unrealized losses were $205 thousand.
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Other: Other non-interest expenses, which consist of subscriptions; memberships and dues; employee expenses including travel, meals, entertainment and education; supplies; printing; insurance; account related losses; correspondent bank fees; customer program expenses; losses net of gains on the sale of fixed assets and other operating expenses such as settlement of claims, were $1.2 million for the three months ended March 31, 2018 and $1.3 million for the three months ended March 31, 2017.
Efficiency Ratio
The efficiency ratio is a supplemental financial measure utilized in the internal evaluation of our performance and is not defined under GAAP. For a reconciliation of Non-GAAP financial measures see “Non-GAAP Financial Measures” in this Item 2. Our efficiency ratio is computed by dividing non-interest expense, excluding merger expenses, by the sum of net interest income and non-interest income, excluding net gain from securities transactions. Generally, an increase in the efficiency ratio indicates that more resources are being utilized to generate the same volume of income, while a decrease would indicate a more efficient allocation of resources.
Our efficiency ratio was 59.6% for the three months ended March 31, 2018, compared with 61.6% for the three months ended March 31, 2017. The improvement was primarily due to increased net interest income, as discussed in “Results of Operations – Net Interest Income and Net Interest Margin Analysis.”
Income Taxes
On December 22, 2017, Tax Reform was enacted which reduced the U.S. federal statutory income tax rate, which was applicable to the Company in 2017, of 35% to 21% beginning in 2018. In addition to tax rates, the amount of income tax expense is influenced by the amount of pre-tax income, the amounts of tax-exempt investment income, non-taxable life insurance income, non-deductible expenses and available federal income tax credits.
Three months ended March 31, 2018 compared with three months ended March 31, 2017: For the three months ended March 31, 2018, income tax expense was $2.5 million compared with $2.0 million for the three months ended March 31, 2017. The effective tax rate for the quarter ended March 31, 2018, was 22.5% as compared to 29.6% for the comparable period ended March 31, 2017. The rate reduction provided by Tax Reform reduced the Company’s estimated annual effective tax rate by approximately 11 percentage points in 2018. Partially offsetting the benefit of the rate reduction was a decrease in excess tax benefits associated with the exercise of stock options recorded during the quarter ended March 31, 2018, as compared to the prior year first quarter. Excess tax benefits were $6 thousand in the first quarter of 2018, down $201 thousand from the excess tax benefits recorded in the first quarter of 2017.
Impact of Inflation
Our consolidated financial statements and related notes included elsewhere in this Quarterly Report have been prepared in accordance with GAAP, which requires the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative value of money over time due to inflation or recession.
Unlike many industrial companies, substantially all of our assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates may not necessarily move in the same direction or in the same magnitude as the prices of goods and services. However, other operating expenses do reflect general levels of inflation.
Our total assets increased $5.6 million, or 0.2%, from $3.17 billion at December 31, 2017, to $3.18 billion at March 31, 2018. Our total liabilities decreased $1.8 million, or 0.1%, from $2.80 billion at December 31, 2017 to $2.79 billion at March 31, 2018. Our total stockholders’ equity increased $7.3 million, or 2.0%, from $374.1 million at December 31, 2017 to $381.5 million at March 31, 2018. The increase in total stockholders’ equity was primarily from increases in retained earnings of $8.7 million and additional paid-in capital of $736 thousand; partially offset by an increase in accumulated other comprehensive income of $2.1 million.
Loan Portfolio
Loans are our largest category of earning assets and typically provide higher yields than other types of earning assets. At March 31, 2018, our gross loans held for portfolio totaled $2.13 billion, an increase of $22.0 million, or 1.0%, compared with December 31, 2017. The overall increase in loan volume consisted of $18.6 million from commercial and industrial, $17.4 million from residential real estate, $6.3 million from agricultural real estate, $4.8 million from real estate construction and $1.1 million from consumer;
partially offset by a decrease in loan volume of $17.7 million from commercial real estate and $8.4 million from agricultural. We also had loans classified as held for sale totaling $11.1 million at March 31, 2018 and $16.3 million at December 31, 2017.
Our loan portfolio consists of various types of loans, most of which are made to borrowers located in the Wichita, Kansas City and Tulsa Metropolitan Statistical Areas (“MSAs”), as well as various community markets throughout Arkansas, Kansas, Missouri and Oklahoma. The majority of our loan portfolio consists of commercial and industrial and commercial real estate loans and a substantial portion of our borrowers’ ability to honor their obligations is dependent on local economic conditions in Arkansas, Kansas, Missouri and Oklahoma. As of March 31, 2018, there was no concentration of loans to any one type of industry exceeding 10% of total loans.
At March 31, 2018, total loans were 89.7% of deposits and 66.9% of total assets. At December 31, 2017, total loans were 88.3% of deposits and 66.3% of total assets.
The organic, or non-acquired, changes in our loan portfolio are attributable to our ability to attract new customers from other financial institutions and overall growth in our markets. Several new lenders have been hired in our markets, and we believe these lenders have been successful in transitioning their former clients and attracting new clients. Lending activities originate from the efforts of our lenders, with an emphasis on lending to individuals, professionals, small to medium-sized businesses and commercial companies located in the Wichita, Kansas City and Tulsa MSAs, as well as community markets in Arkansas, Kansas, Missouri and Oklahoma.
We provide commercial lines of credit, working capital loans, commercial real estate-backed loans (including loans secured by owner occupied commercial properties), term loans, equipment financing, acquisition, expansion and development loans, borrowing base loans, real estate construction loans, homebuilder loans, SBA loans, agricultural and agricultural real estate loans, letters of credit and other loan products to national and regional companies, real estate developers, mortgage lenders, manufacturing and industrial companies and other businesses. The types of loans we make to consumers include residential real estate loans, home equity loans, home equity lines of credit, installment loans, unsecured and secured personal lines of credit, overdraft protection and letters of credit.
The following table summarizes our loan portfolio by type of loan as of the dates indicated.
Composition of Loan Portfolio
Percent
24.1
Real estate loans:
783,783
36.9
801,491
38.1
Real estate construction
190,945
9.0
186,170
8.9
18.5
17.9
4.4
4.1
Total real estate loans
1,461,618
68.8
1,450,852
69.0
2.4
4.5
Total loans held for investment
100.0
Total loans held for sale
Total loans (net of allowances)
Commercial and industrial: Commercial and industrial loans include loans used to purchase fixed assets, provide working capital, or meet other financing needs of the business. Our commercial and industrial portfolio totaled $526.1 million at March 31, 2018, an increase of $18.6 million, or 3.7%, compared to December 31, 2017. This increase was a combination of loan originations within our target markets and changes in the balances of revolving lines of credit.
Commercial real estate: Commercial real estate loans include all loans secured by nonfarm nonresidential properties and by multifamily residential properties, as well as 1-4 family investment-purpose real estate loans. Our commercial real estate loans were $783.8 million at March 31, 2018, a decrease of $17.7 million, or 2.2%, compared to December 31, 2017.
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Real estate construction: Real estate construction loans include loans made for the purpose of acquisition, development, or construction of real property, both commercial and consumer. Our real estate construction portfolio totaled $190.9 million at March 31, 2018, an increase of $4.8 million, or 2.6%, compared to December 31, 2017.
Residential real estate: Residential real estate loans include loans secured by primary or secondary personal residences. Our residential real estate portfolio totaled $394.1 million at March 31, 2018, an increase of $17.4 million, or 4.6%, compared to December 31, 2017. Our purchased residential real estate loans totaled $80.2 million at March 31, 2018, a decrease of $5.7 million compared to December 31, 2017. The decrease is mostly attributable to net payment activity in existing residential real estate loans.
Agricultural real estate, Agricultural, Consumer and other: Agricultural real estate loans are loans related to farmland. Agricultural loans are primarily operating lines subject to annual farming revenues including productivity/yield of the agricultural commodities produced. Consumer loans are generally secured by consumer assets, but may be unsecured. Combined these three loan pools decreased $1.1 million, or 0.5%, from $231.4 million at December 31, 2017 to $230.3 million at March 31, 2018. These three loan pools represent 10.9% of our overall loan portfolio.
The contractual maturity ranges of loans in our loan portfolio and the amount of such loans with predetermined interest rates and floating rates in each maturity range as of March 31, 2018 are summarized in the following table.
Loan Maturity and Sensitivity to Changes in Interest Rates
As of March 31, 2018
One year
or less
After one year
through five
years
After five
190,140
206,552
129,437
Real Estate:
111,260
469,133
203,390
77,082
88,796
25,067
13,704
12,049
368,389
37,914
33,671
21,163
Total real estate
239,960
603,649
618,009
9,453
32,585
8,439
64,323
19,387
3,390
503,876
862,173
759,275
Loans with a predetermined fixed interest rate
260,413
543,368
214,173
1,017,954
Loans with an adjustable/floating interest rate
243,463
318,805
545,102
1,107,370
The contractual maturity ranges of loans in our loan portfolio and the amount of such loans with predetermined interest rates and floating rates in each maturity range as of December 31, 2017 are summarized in the following table.
As of December 31, 2017
175,425
198,951
133,143
116,797
464,987
219,707
76,406
76,153
33,611
14,852
12,788
349,065
32,241
32,354
21,891
240,296
586,282
624,274
9,113
31,997
8,251
70,427
19,746
5,374
495,261
836,976
771,042
257,141
532,308
212,711
1,002,160
238,120
304,668
558,331
1,101,119
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, among other factors. Loans are analyzed individually and classified based on credit risk. Consumer loans are considered pass credits unless downgraded due to payment status or reviewed as part of a larger credit relationship. We use the following definitions for risk ratings:
Special Mention: Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of our credit position at some future date. These loans are considered classified.
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The risk category of loans by class of loans is as follows as of March 31, 2018.
Risk Category of Loans by Class
Real estate:
773,764
10,019
188,360
2,585
1,436,113
25,505
82,179
4,921
2,074,096
51,228
The risk category of loans by class of loans is as follows as of December 31, 2017.
787,894
13,597
183,564
2,606
1,418,693
32,159
At March 31, 2018, loans considered unclassified credits increased to 97.6% of total loans, up from 97.1% of total loans at December 31, 2017. Classified loans were $51.2 million at March 31, 2018, a decrease of $10.2 million, or 16.6%, from $61.4 million at December 31, 2017.
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Nonperforming Assets
The following table presents information regarding nonperforming assets at the dates indicated.
Nonaccrual loans
35,261
Accruing loans 90 or more days past due
Restructured loans-accruing
OREO acquired through foreclosure, net
Total nonperforming assets
42,351
48,183
Ratios:
Nonperforming assets to total assets
1.33
1.52
Nonperforming assets to total loans plus OREO
1.99
2.28
Nonperforming assets (“NPAs”) include loans on nonaccrual status, accruing loans 90 or more days past due, restructured loans, and other real estate acquired through foreclosure. See the “Critical Accounting Policies” section for information regarding the review of loans for determining the allowance for loan loss and impairment.
Generally, loans are designated as nonaccrual when either principal or interest payments are 90 days or more past due based on contractual terms, unless the loan is well secured and in the process of collection. Consumer loans are typically charged off no later than 180 days past due. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful. When a loan is placed on nonaccrual status, unpaid interest credited to income is reversed against income. Future interest income may be recorded on a cash basis after recovery of principal is reasonably assured. Nonaccrual loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
We had $35.3 million in nonperforming loans at March 31, 2018, compared with $40.3 million at December 31, 2017. The nonperforming loans at March 31, 2018 consisted of 220 separate credits and 167 separate borrowers. We had seven non-performing loan relationships with an outstanding balance in excess of $1.0 million as of March 31, 2018. There were $5.5 million non-performing loans that were directly related to the Prairie merger, $8.6 million directly related to the Eastman merger and $510 thousand directly related to the Cache merger.
There are several procedures in place to assist us in maintaining the overall quality of our loan portfolio. We have established underwriting guidelines to be followed by lenders, and also monitor delinquency levels for any negative or adverse trends. In accordance with applicable regulation, appraisals or evaluations are required to independently value real estate and, as an important element, to consider when underwriting loans secured in part or in whole by real estate. The value of real estate collateral provides additional support to the borrower’s credit capacity. There can be no assurance, however, that our loan portfolio will not become subject to increasing pressures from deteriorating borrower credit due to general economic conditions.
Potential Problem Loans
Potential problem loans consist of loans that are performing in accordance with contractual terms, but for which management has concerns about the borrower’s ability to comply with repayment terms because of the borrower’s potential financial difficulties. Potential problem loans are assigned a grade of special mention or substandard. At March 31, 2018, the Company had $16.0 million in potential problem loans which were not included in either non-accrual or 90 days past due categories, compared to $21.1 million at December 31, 2017. The reduction in potential problem loans is largely due to ongoing collection efforts.
With respect to potential problem loans, all monitored and under-performing loans are reviewed and evaluated to determine if they are impaired. If we determine that a loan is impaired, then we evaluate the borrower’s overall financial condition to determine the need, if any, for possible write downs or appropriate additions to the allowance for loan losses based on the unlikelihood of full repayment of principal and interest in accordance with the contractual terms or the net realizable value of the pledged collateral.
The Company also monitors the aging of loans less than 90 days past due as reported in “NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES” in the Condensed Notes to Interim Consolidated Financial Statements. There were $4.1 million loans 30-59 days past due and $1.9 million loans 60-89 days past due at March 31, 2018, compared to $3.9 million loans 30-59 days past due and $1.3 million loans 60-89 days past due at December 31, 2017.
49
Please see “Critical Accounting Policies – Allowance for Loan Losses” for additional discussion of our allowance policy.
In connection with our review of the loan portfolio, risk elements attributable to particular loan types or categories are considered when assessing the quality of individual loans. Some of the risk elements include:
Commercial and industrial loans are dependent on the strength of the industries of the related borrowers and the success of their businesses. Commercial and industrial loans are advanced for equipment purchases, to provide working capital, or to meet other financing needs of the business. These loans may be secured by accounts receivable, inventory, equipment, or other business assets. Financial information is obtained from the borrower to evaluate the debt service coverage and ability to repay the loans.
Commercial real estate loans are dependent on the industries tied to these loans as well as the local commercial real estate market. The loans are secured by the real estate, and appraisals are obtained to support the loan amount. An evaluation of the project’s cash flows is performed to evaluate the borrower’s ability to repay the loan at the time of origination and periodically updated during the life of the loan.
Residential real estate loans are affected by the local residential real estate market, the local economy, and movement in interest rates. We evaluate the borrower’s repayment ability through a review of credit reports and debt to income ratios. Appraisals are obtained to support the loan amount.
Agricultural real estate loans are real estate loans related to farmland, and are affected by the value of farmland. We evaluate the borrower’s ability to repay based on cash flows from farming operations.
Consumer loans are dependent on the local economy. Consumer loans are generally secured by consumer assets, but may be unsecured. We evaluate the borrower’s repayment ability through a review of credit scores and an evaluation of debt to income ratios.
Agricultural loans are primarily operating lines subject to annual farming revenues including productivity/yield of the agricultural commodities produced and the market pricing at the time of sale.
Purchased credit impaired loans: As part of previous acquisitions, we acquired certain loans for which there was, at acquisition, evidence of deterioration of credit quality since origination. These purchased credit impaired loans were recorded at the amount paid, such that there is no carryover of the seller’s allowance for loan losses. After acquisition, losses are recognized by an increase in the allowance for loan losses. Purchased credit impaired loans are accounted for individually. We estimate the amount and timing of expected cash flows for each loan, and the expected cash flows in excess of the amount paid are recorded as interest income over the remaining life of the loan (accretable yield). The excess of the loan’s contractual principal and interest over expected cash flows is not recorded (non-accretable difference). Over the life of the loan, expected cash flows continue to be estimated. If the present value of the expected cash flows is less than the carrying amount, a loss is recorded. If the present value of the expected cash flows is greater than the carrying amount, it is recognized as part of future interest income.
The table below shows the contractually required principal loan payments and the associated purchase discount on our purchased credit impaired portfolio.
Recorded Investment in Purchased Credit Impaired Loans
Contractually required payments
Analysis of allowance for loan losses: At March 31, 2018, the allowance for loan losses totaled $9.3 million, or 0.44% of total loans. At December 31, 2017, the allowance for loan losses aggregated $8.5 million, or 0.40% of total loans.
The allowance for loan losses on loans collectively evaluated for impairment totaled $8.7 million, or 0.41%, of the $2.11 billion in loans collectively evaluated for impairment at March 31, 2018, compared to an allowance for loan losses of $7.6 million, or 0.36% of the $2.09 billion in loans collectively evaluated for impairment at December 31, 2017. The increases in the allowance for loan losses as a percentage of total loans and of loans collectively evaluated for impairment principally reflect management’s evaluation of current environmental conditions and changes in the composition and quality of our loan portfolio. Also considered by management in evaluating the allowance for loan losses are applied loss factors which are based in part on historical loss experience.
50
Annualized net losses as a percentage of average loans increased to 0.07% for the three months ended March 31 2018, as compared to 0.14% for the three months ended March 31, 2017.
The following table presents, as of and for the periods indicated, an analysis of the allowance for loan losses and other related data.
Allowance for Loan Losses
As of and for the Three Months
Ended March 31,
Average loans outstanding
Gross loans outstanding at end of period(1)
Allowance for loan losses at beginning of
the period
Charge-offs:
(28
(103
(144
(40
Total charge-offs
Recoveries:
Total recoveries
Net recoveries (charge-offs)
(352
(479
Allowance for loan losses at end of the
period
Ratio of allowance to period-ended loans
0.46
Annualized ratio of net charge-offs
(recoveries) to average loans
0.07
0.14
Excluding loans held for sale.
51
The following table shows the allocation of the allowance for loan losses among our loan categories and certain other information as of the dates indicated. The total allowance is available to absorb losses from any loan category.
Analysis of the Allowance for Loan Losses
% of
Allowance
Balance of allowance for loan losses applicable to:
25.6
25.1
2,292
24.6
7.7
693
8.2
26.2
26.6
2.9
3.8
9.4
3.6
3.2
Total allowance for loan losses
Management believes that the allowance for loan losses at March 31, 2018 was adequate to cover probable incurred losses in the loan portfolio as of such date. There can be no assurance, however, that we will not sustain losses in future periods, which could be substantial in relation to the size of the allowance at March 31, 2018.
We use our securities portfolio to provide a source of liquidity, to provide an appropriate return on funds invested, to manage interest rate risk, to meet pledging requirements and to meet regulatory capital requirements. At March 31, 2018, the carrying amount of investment securities totaled $696.7 million, a decrease of $996 thousand, or 0.1%, compared with December 31, 2017. At March 31, 2018, securities represented 21.9% of total assets compared with 22.0% at December 31, 2017.
At the date of purchase, debt securities are classified into one of two categories, held-to-maturity or available-for-sale. We do not purchase securities for trading purposes. At each reporting date, the appropriateness of the classification is reassessed. Investments in debt securities are classified as held-to-maturity and carried at cost, adjusted for the amortization of premiums and the accretion of discounts, in the financial statements only if management has the positive intent and ability to hold those securities to maturity. Debt securities not classified as held-to-maturity are classified as available-for-sale and measured at fair value in the financial statements with unrealized gains and losses reported, net of tax, as accumulated comprehensive income or loss until realized. Interest earned on securities is included in total interest and dividend income. Also included in total interest and dividend income are dividends received on stock investments in the Federal Reserve Bank of Kansas City and the Federal Home Loan Bank of Topeka. These stock investments are stated at cost.
The following table summarizes the amortized cost and fair value by classification of available-for-sale securities as of the dates shown.
Available-For-Sale Securities
Total available-for-sale securities
The following table summarizes the amortized cost and fair value by classification of held-to-maturity securities as of the dates shown.
Held-To-Maturity Securities
Total held-to-maturity securities
At March 31, 2018 and December 31, 2017, we did not own securities of any one issuer (other than the U.S. government and its agencies or sponsored entities) for which aggregate adjusted cost exceeded 10% of the consolidated stockholders’ equity at the reporting dates noted.
The following tables summarize the contractual maturity of debt securities and their weighted average yields as of March 31, 2018 and December 31, 2017. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Available-for-sale securities are shown at fair value and held-to-maturity securities are shown at cost, adjusted for the amortization of premiums and the accretion of discounts.
Due in one year
Due after one
year through
five years
Due after five
years through
10 years
Due after 10
Yield
Residential mortgage-backed
securities (issued by
3,430
1.82
3.14
150
2.38
170,925
2.98
2.96
State and political subdivisions(1)
—%
3,625
1.78
2.95
Held-to-maturity securities:
U.S. government-sponsored
entities
1.65
9,097
2.61
34,274
2.47
327,883
2.88
2.84
2.74
17,773
4.88
4.39
Small Business Administration
loan pools
2.40
20,985
3.12
25,559
75,433
3.23
3.17
36,300
2.89
77,606
3.24
405,200
2.94
6,540
2.06
36,317
77,756
576,125
696,738
2.97
53
The calculated yield is not presented on a tax equivalent basis.
Residential mortgage-
backed securities
(issued by government-
sponsored entities)
3,461
171
157,939
2.90
2.87
3,656
U.S. government-
sponsored entities
9,203
2.60
23,979
2.52
350,693
2.86
2.83
5,236
17,755
4.69
4.25
Small Business
Administration loan pools
2,871
2.35
21,022
3.02
25,351
3.16
76,306
36,459
67,085
3.34
429,047
2.93
6,527
2.03
36,479
67,256
3.33
586,986
2.92
697,248
Mortgage-backed securities are securities that have been developed by pooling a number of real estate mortgages and which are principally issued by federal agencies such as Ginnie Mae, Fannie Mae and Freddie Mac. Unlike U.S. Treasury and U.S. government agency securities, which have a lump sum payment at maturity, mortgage-backed securities provide cash flows from regular principal and interest payments and principal prepayments throughout the lives of the securities. Premiums and discounts on mortgage-backed securities are amortized and accreted over the expected life of the security and may be impacted by prepayments. As such, mortgage-backed securities which are purchased at a premium will generally produce decreasing net yields as interest rates drop because home owners tend to refinance their mortgages resulting in prepayments and an acceleration of premium amortization. Securities purchased at a discount will reflect higher net yields in a decreasing interest rate environment as prepayments result in an acceleration of discount accretion.
The contractual maturity of mortgage-backed securities is not a reliable indicator of their expected lives because borrowers have the right to prepay their obligations at any time. Monthly pay downs on mortgage-backed securities cause the average lives of these securities to be much different than their stated lives. At March 31, 2018 and December 31, 2017, 91.4% and 93.2% of the mortgage-backed securities held by us had contractual final maturities of more than ten years with a weighted average life of 5.5 years and 5.4 years and a modified duration of 4.8 years and 4.8 years.
Our lending and investing activities are primarily funded by deposits. A variety of deposit accounts are offered with a wide range of interest rates and terms including demand, savings, money market and time deposits. We rely primarily on competitive pricing policies, convenient locations, comprehensive marketing strategy and personalized service to attract and retain these deposits.
54
The following table shows our composition of deposits at March 31, 2018 and December 31, 2017.
Composition of Deposits
of Total
Non-interest-bearing demand
15.3
15.4
Interest-bearing demand
590,929
24.9
550,577
23.1
693,390
29.3
688,407
30.5
32.6
Total deposits at March 31, 2018 were $2.37 billion, a decrease of $13.7 million, or 0.6%, compared to total deposits of $2.38 billion at December 31, 2017. The decrease in total deposits is due to decreases in time deposits of $55.3 million, or 7.1% and non-interest-bearing demand deposits of $3.7 million, or 1.0%, partially offset by increases in interest-bearing demand deposits of $40.4 million, or 7.3% and savings and money market deposits of $5.0 million, or 0.7%. The decrease in time deposits is largely due to a decrease in funds placed in the Certificate of Deposit Account Registry Service (“CDARS”) program and a decrease in public fund balances related to distribution of tax monies at the local level. The increase in interest-bearing demand deposits is primarily the result of growth in public funds customer balances and our ongoing business development efforts.
Included in the savings and money market deposits are brokered deposit balances of $27.7 million as of March 31, 2018 and $23.2 million as of December 31, 2017. These balances represent customer funds placed in the Insured Cash Sweep (“ICS”) service that allows Equity Bank to break large money market deposits into smaller amounts and place them in a network of other ICS banks to ensure FDIC insurance coverage on the entire deposit. Although classified as brokered deposits for regulatory purposes, funds placed through the ICS service are Equity Bank’s customer relationships that management views as core funding. Brokered certificates of deposit as of March 31, 2018 were $26.7 million and $63.0 million at December 31, 2017. These balances were customer funds placed in the CDARS program. CDARS allows Equity Bank to break large time deposits into smaller amounts and place them in a network of other CDARS banks to ensure FDIC insurance coverage on the entire deposit. Although classified as brokered deposits for regulatory purposes, funds placed through the CDARS program are Equity Bank’s customer relationships that management views as core funding.
The following table provides information on the maturity distribution of time deposits of $100 or more as of March 31, 2018 and December 31, 2017.
3 months or less
107,307
133,588
Over 3 through 6 months
87,662
98,523
Over 6 through 12 months
108,555
131,098
Over 12 months
165,318
155,457
Total Time Deposits
468,842
518,666
Other Borrowed Funds
We utilize borrowings to supplement deposits to fund our lending and investing activities. Short-term borrowings and long-term borrowings include federal funds purchased and retail repurchase agreements, FHLB advances, a bank stock loan, and subordinated debentures.
Federal funds purchased and retail repurchase agreements: We have available federal funds lines of credit with our correspondent banks. As of March 31, 2018 and December 31, 2017, there were no federal funds purchased outstanding. Retail repurchase agreements outstanding represent the purchase of interests in securities by banking customers. Retail repurchase agreements are stated at the amount of cash received in connection with the transaction. We do not account for any of our repurchase agreements as sales for accounting purposes in our financial statements. Repurchase agreements with banking customers are settled on the following business day. Retail repurchase agreements are secured by investment securities held by us totaling $44.4 million at March 31, 2018 and $44.8 million at December 31, 2017. The agreements are on a day-to-day basis and can be terminated on
55
demand. At March 31, 2018 and December 31, 2017, we had retail repurchase agreements with banking customers of $42.1 million and $37.5 million.
FHLB advances: FHLB advances include both draws against our line of credit and fixed rate term advances. Each term advance is payable in full at its maturity date and contains provision for prepayment penalties. At March 31, 2018 and December 31, 2017 we had no term advances with the FHLB. Our FHLB borrowings are used for operational liquidity needs for originating and purchasing loans, purchasing investments and general operating cash requirements. Our FHLB borrowings were collateralized by certain qualifying loans totaling $547.9 million at March 31, 2018. Based on this collateral and our holdings of FHLB stock, we were eligible to borrow an additional $178.7 million at March 31, 2018.
Bank stock loan: On December 31, 2017, we had an outstanding balance of $2.5 million on a $30 million borrowing facility from an unaffiliated financial institution, secured by our stock in Equity Bank. The borrowing facility was recently renewed for an additional year and will mature on March 11, 2019. Each draw of funds on the facility will create a separate note that is repayable over a term of five years. Each note will bear interest at a variable interest rate equal to the Prime Rate published in the “Money Rates” section of The Wall Street Journal (or any generally recognized successor), floating daily. Accrued interest and principal payments are due quarterly with one final payment of unpaid principal and interest due at the end of the five year term of each separate note. We are also required to pay an unused commitment fee in an amount equal to 20 basis points per annum on the unused portion of the maximum borrowing facility. The terms of the loan require us and Equity Bank to maintain minimum capital ratios and other covenants. The loan and accrued interest may be pre-paid at any time without penalty. In the event of default, the lender has the option to declare all outstanding balances as immediately due. At March 31, 2018, we had a balance of $2.4 million outstanding with a maturity of January 1, 2023, and a rate of 4.75%.
Subordinated debentures: In conjunction with the 2012 acquisition of First Community Bancshares, Inc., we assumed certain subordinated debentures owed to special purpose unconsolidated subsidiaries that are controlled by us, FCB Capital Trust II (“CTII”) and FCB Capital Trust III (“CTIII”). The trust preferred securities issued by CTII accrue and pay distributions quarterly at three-month LIBOR plus 2.00% on the stated liquidation amount of the trust preferred securities. These trust preferred securities are mandatorily redeemable upon maturity on April 15, 2035 or upon earlier redemption. The trust preferred securities issued by CTIII accrue and pay distributions quarterly at three-month LIBOR plus 1.89% on the stated liquidation amount of the trust preferred securities. These trust preferred securities are mandatorily redeemable upon maturity on June 15, 2037 or upon earlier redemption.
In conjunction with the 2016 acquisition of Community First Bancshares, Inc., we assumed certain subordinated debentures owed to a special purpose unconsolidated subsidiary that is controlled by us, Community First (AR) Statutory Trust I, (“CFSTI”). The trust preferred securities issued by CFSTI accrue and pay distributions quarterly at three-month LIBOR plus 3.25% on the stated liquidation amount of the trust preferred securities. These trust preferred securities are mandatorily redeemable upon maturity on December 26, 2032, or upon earlier redemption.
The subordinated debentures balance, including CTII, CTIII and CFSTI, was $14.0 million at March 31, 2018 and $14.0 million at December 31, 2017.
Liquidity
Market and public confidence in our financial strength and financial institutions in general will largely determine access to appropriate levels of liquidity. This confidence is significantly dependent on our ability to maintain sound asset quality and appropriate levels of capital reserves.
Liquidity is defined as the ability to meet anticipated customer demands for future funds under credit commitments and deposit withdrawals at a reasonable cost and on a timely basis. We measure our liquidity position by giving consideration to both on- and off-balance sheet sources of and demands for funds on a daily, weekly, and monthly basis.
Liquidity risk involves the risk of being unable to fund assets with the appropriate duration and rate-based liabilities, as well as the risk of not being able to meet unexpected cash needs. Liquidity planning and management are necessary to ensure the ability to fund operations in a cost-effective manner and to meet current and future potential obligations such as loan commitments, lease obligations, and unexpected deposit outflows. In this process, we focus on both assets and liabilities and on the manner in which they combine to provide adequate liquidity to meet our needs.
During the three-month periods ended March 31, 2018 and March 31, 2017 our liquidity needs have primarily been met by core deposits, security and loan maturities and amortizing investment and loan portfolios. Other funding sources include federal funds purchased, brokered certificates of deposit, and borrowings from the FHLB.
Our largest sources of funds are deposits and FHLB borrowings and largest uses of funds are loans and securities. Year to date average loans were $2.12 billion as of March 31, 2018, an increase of 34.7% over year to date average loans as of December 31, 2017. Excess deposits are primarily invested in our interest-bearing deposit account with the Federal Reserve Bank of Kansas City, investment securities, federal funds sold or other short-term liquid investments until the funds are needed to fund loan growth. Our securities portfolio has a weighted average life of 5.9 years and a modified duration of 5.1 years at March 31, 2018.
Cash and cash equivalents were $43.1 million at March 31, 2018, a decrease of $9.0 million from the $52.2 million cash and cash equivalents at December 31, 2017. The net cash provided by operating activities of $14.9 million was offset by net cash used in investing activities of $22.9 million and net cash used in financing activities of $1.1 million, resulting in a net decrease of cash and cash equivalents of $9.0 million. Cash and cash equivalents at January 1, 2018 plus liquidity provided by operating activities, pay downs, sales and maturities of investment securities and increase in deposits during the first three months of 2018 were used to originate or purchase loans and to purchase investment securities. We believe that our daily funding needs can be met through cash provided by operating activities, payments and maturities on loans and investment securities, our core deposit base and FHLB advances and other borrowing relationships.
Off-Balance Sheet Items
In the normal course of business, we enter into various transactions, which, in accordance with GAAP, are not included in our consolidated balance sheets. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to extend credit and standby and commercial letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. Our exposure to credit loss is represented by the contractual amounts of these commitments. The same credit policies and procedures are used in making these commitments as for on-balance sheet instruments.
Our commitments associated with outstanding standby and performance letters of credit and commitments to extend credit expiring by period as of March 31, 2018 are summarized below. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements.
Credit Extensions Commitments
1 Year
or Less
More Than
1 Year but
Less Than
3 Years
3 Years or
More but
5 Years
or More
Standby and performance letters of credit
6,259
1,464
7,747
Commitments to extend credit
220,702
39,433
83,704
47,356
391,195
226,961
40,897
83,728
398,942
Standby and Performance Letters of Credit: Standby letters of credit are irrevocable commitments issued by us to guarantee the performance of a customer to a third party once specified pre-conditions are met. Financial standby letters of credit are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. Performance standby letters of credit are issued to guarantee performance of certain customers under non-financial contractual obligations. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loans to customers.
57
Commitments to Extend Credit: Commitments to originate loans and available lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments and lines of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments and lines of credit may expire without being drawn upon, the total commitment and lines of credit amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the counterparty. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, commercial real estate, and residential real estate. Mortgage loans in the process of origination represent amounts that we plan to fund within a normal period of 60 to 90 days, and which are intended for sale to investors in the secondary market.
Capital Resources
Capital management consists of providing equity to support our current and future operations. The federal bank regulators view capital levels as important indicators of an institution’s financial soundness. As a general matter, FDIC-insured depository institutions and their holding companies are required to maintain minimum capital relative to the amount and types of assets they hold. As a bank holding company and a state-chartered-Fed-member bank, the Company and Equity Bank are subject to regulatory capital requirements.
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. Management believes as of March 31, 2018 and December 31, 2017, the Company and Equity Bank meet all capital adequacy requirements to which they are subject.
Failure to meet capital guidelines could subject the institution to a variety of enforcement remedies by federal bank regulatory agencies, including termination of deposit insurance by the FDIC, restrictions on certain business activities and appointment of the FDIC as conservator or receiver. As of March 31, 2018, the most recent notifications from the federal regulatory agencies categorized Equity Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as well capitalized, Equity Bank must maintain minimum total capital, Tier 1 capital, Common Equity Tier 1 capital, and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed Equity Bank’s category.
Total stockholders’ equity was $381.5 million at March 31, 2018, an increase of $7.3 million, or 2.0%, compared with December 31, 2017. The increase was principally attributable to increases in retained earnings of $8.7 million for the three months ended March 31, 2018, and stock based compensation of $718 thousand, partially offset by a change in accumulated other comprehensive income of $2.1 million.
In July 2013, the federal banking agencies published final rules establishing a new comprehensive capital framework for U.S. banking organizations. These rules became effective as applied to the Company and Equity Bank on January 1, 2015, with a phase in period from January 1, 2015 through January 1, 2019. Beginning in January 2016, the implementation of the capital conservation buffer was effective for the Company starting at the 0.625% level and increasing 0.625% each year thereafter, until it reaches 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress and requires increased capital levels for the purpose of capital distributions and other payments. Failure to meet the full amount of the buffer will result in restrictions on the Company's ability to make capital distributions, including dividend payments and stock repurchases and to pay discretionary bonuses to executive officers. The following table provides a comparison of the Company’s and Equity Bank’s leverage and risk-weighted capital ratios as of March 31, 2018, to the minimum and well-capitalized regulatory standards.
Capital Adequacy Analysis
Minimum Required for
Capital Adequacy Under Basel III Phase-In
Capital Adequacy Under Basel III Fully Phased-In
To be Categorized as
Well Capitalized
Under Prompt
Corrective Action
The Company(1)
Total capital (to risk weighted assets)
Tier 1 capital (to risk weighted assets)
Common equity tier 1 capital (to risk weighted
assets)
Tier 1 leverage capital (to average assets)
The Bank(2)
The Federal Reserve may require the Company to maintain capital ratios above the required minimums.
The FDIC may require Equity Bank to maintain capital ratios above the required minimums
We identify certain financial measures discussed in this Quarterly Report as being “non-GAAP financial measures.” In accordance with the SEC’s rules, we classify a financial measure as being a non-GAAP financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that have the effect of excluding or including amounts, that are included or excluded, as the case may be, in the most directly comparable measure calculated and presented in accordance with GAAP as in effect from time to time in the United States in our statements of income, balance sheet or statements of cash flows. Non-GAAP financial measures do not include operating and other statistical measures or ratios or statistical measures calculated using exclusively either financial measures calculated in accordance with GAAP, operating measures or other measures that are not non-GAAP financial measures or both.
The non-GAAP financial measures that we discuss in this Quarterly Report should not be considered in isolation or as a substitute for the most directly comparable or other financial measures calculated in accordance with GAAP. Moreover, the manner in which we calculate the non-GAAP financial measures that we discuss in this Quarterly Report may differ from that of other companies reporting measures with similar names. You should understand how such other banking organizations calculate their financial measures similar or with names similar to the non-GAAP financial measures we have discussed in this Quarterly Report when comparing such non-GAAP financial measures.
Tangible Book Value Per Common Share and Tangible Book Value Per Diluted Common Share: Tangible book value is a non-GAAP measure generally used by financial analysts and investment bankers to evaluate financial institutions. We calculate: (a) tangible common equity as total stockholders’ equity less preferred stock, goodwill, core deposit intangibles, net of accumulated amortization and other intangibles, net of amortization; (b) tangible book value per common share as tangible common equity (as described in clause (a)) divided by shares of common stock outstanding; and tangible book value per diluted common share as tangible common equity (as described in clause (a)) divided by diluted shares of common stock outstanding. For tangible book value, the most directly comparable financial measure calculated in accordance with GAAP is book value.
Management believes that these measures are important to many investors who are interested in changes from period to period in book value per common share exclusive of changes in intangible assets. Goodwill and other intangible assets have the effect of increasing total book value while not increasing our tangible book value.
The following table reconciles, as of the dates set forth below, total stockholders’ equity to tangible common equity, tangible book value per common share, and tangible book value per diluted common share and compares these values with book value per common share.
(Dollars in thousands, except per share data)
Less: goodwill
64,587
64,521
Less: core deposit intangibles, net
5,476
5,719
5,954
Less: mortgage servicing asset, net
Less: naming rights, net
1,249
1,260
1,271
1,282
1,293
Tangible common equity
Common shares issued at period end
12,230,319
12,206,319
RSU shares vested
11,844
Common shares outstanding at period end
14,621,258
Diluted common shares outstanding at period end
14,923,798
14,873,257
12,501,484
12,441,429
12,450,315
Book value per common share
Tangible book value per common share
Tangible book value per diluted common share
Tangible Common Equity to Tangible Assets: Tangible common equity to tangible assets is a non-GAAP measure generally used by financial analysts and investment bankers to evaluate financial institutions. We calculate: (a) tangible common equity as total stockholders’ equity less preferred stock, goodwill, core deposit intangibles, net of accumulated amortization and other intangibles, net of amortization; (b) tangible assets as total assets less goodwill, core deposit intangibles, net of accumulated amortization and other intangibles, net of amortization; and (c) tangible common equity to tangible assets as tangible common equity (as described in clause (a)) divided by tangible assets (as described in clause (b)). For tangible common equity to tangible assets, the most directly comparable financial measure calculated in accordance with GAAP is total stockholders’ equity to total assets.
Management believes that this measure is important to many investors in the marketplace who are interested in the relative changes from period to period in common equity and total assets, each exclusive of changes in intangible assets. Goodwill and other intangible assets have the effect of increasing both total stockholders’ equity and total assets while not increasing tangible common equity or tangible assets.
The following table reconciles, as of the dates set forth below, total stockholders’ equity to tangible common equity and total assets to tangible assets.
Tangible assets
3,061,030
3,053,587
2,334,073
2,337,016
2,327,466
Equity to assets
Tangible common equity to tangible assets
Return on Average Tangible Common Equity: Return on average tangible common equity is a non-GAAP measure generally used by financial analysts and investment bankers to evaluate financial institutions. We calculate: (a) average tangible common equity as total average stockholders’ equity less average goodwill, core deposit intangibles, net of accumulated amortization, mortgage servicing asset, net of amortization, naming rights, net of amortization, and preferred stock; (b) adjusted net income allocable to common stockholders as net income allocable to common stockholders plus intangible asset amortization less tax effect on intangible assets amortization; and (c) return on average tangible common equity as annualized adjusted net income allocable to common stockholders (as described in clause (b)) divided by average tangible common equity (as described in clause (a)). For return on average tangible common equity, the most directly comparable financial measure calculated in accordance with GAAP is return on average equity.
Management believes that this measure is important to many investors in the marketplace who are interested in earnings quality on tangible common equity. Goodwill and other intangible assets have the effect of increasing total stockholders’ equity while not increasing tangible common equity.
The following table reconciles, as of the dates set forth below, return on average stockholders equity and return on average tangible common equity.
Total average stockholders’ equity
337,519
289,007
283,187
Less: average intangible assets
96,620
71,465
71,720
Average tangible common equity
261,261
240,899
217,542
211,467
199,551
Amortization of intangible assets
525
349
256
247
218
Less: tax effect of intangible assets amortization
184
122
90
76
Adjusted net income allocable to common
stockholders
9,052
4,501
5,323
6,515
5,006
Return on total average stockholders’ equity
(ROAE) annualized
Return on average tangible common equity
(ROATCE) annualized
Efficiency Ratio: The efficiency ratio is a non-GAAP measure generally used by financial analysts and investment bankers to evaluate financial institutions. We calculate the efficiency ratio by dividing non-interest expense, excluding merger expenses and loss on debt extinguishment, by the sum of net interest income and non-interest income, excluding net gain from securities transactions and net gain on acquisition. The GAAP-based efficiency ratio is non-interest expenses divided by net interest income plus non-interest income.
In management’s judgment, the adjustments made to non-interest expense and non-interest income allow investors and analysts to better assess operating expenses in relation to operating revenue by removing merger expenses, loss on debt extinguishment and net gain from securities transactions.
The following table reconciles, as of the dates set forth below, the efficiency ratio to the GAAP-based efficiency ratio.
20,718
16,388
15,131
Less: Merger expenses
Non-interest expense, excluding merger expenses
and loss on debt extinguishment
4,035
3,962
Less: net gain from securities transactions
Non-interest income, excluding net gain from
securities transactions
Net interest income plus non-interest income,
excluding net gain from securities transactions
32,046
28,693
24,181
25,078
23,219
Non-interest expense to net interest income
plus non-interest income
61.26
72.21
67.29
60.14
65.54
Item 3: Quantitative and Qualitative Disclosures About Market Risk
Our asset-liability policy provides guidelines to management for effective funds management, and management has established a measurement system for monitoring net interest rate sensitivity position within established guidelines.
As a financial institution, the primary component of market risk is interest rate volatility. Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on most assets and liabilities, and the market value of all interest-earning assets and interest-bearing liabilities, other than those which have a short-term held-to-maturity. Interest rate risk is the potential of economic gains or losses due to future interest rate changes. These changes can be reflected in future net interest income and/or fair market values. The objective is to measure the effect on net interest income (“NII”) and economic value of equity (“EVE”) and to adjust the balance sheet to minimize the inherent risk, while at the same time maximizing income.
We manage exposure to interest rates by structuring the balance sheet in the ordinary course of business. We have the ability to enter into instruments such as leveraged derivatives, interest rate swaps, financial options, financial future contracts or forward delivery contracts for the purpose of reducing interest rate risk; however, currently we do not have a material exposure to these instruments. We also have the ability to enter into interest rate swaps as an accommodation to our customers in connection with an interest rate swap program. Based upon the nature of our operations, we are not subject to foreign exchange or commodity price risk. We do not own any trading assets.
Our exposure to interest rate risk is managed by the Asset Liability Committee (“ALCO”), which is composed of certain members of senior management, in accordance with policies approved by the Board of Directors. The ALCO formulates strategies based on appropriate levels of interest rate risk. In determining the appropriate level of interest rate risk, the ALCO considers the impact on earnings and capital of the current outlook on interest rates, potential changes in interest rates, regional economies, liquidity, business strategies and other factors. The ALCO meets monthly to review, among other things, the sensitivity of assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses, securities purchase and sale activities, commitments to originate loans and the maturities of investment securities and borrowings. Additionally, the ALCO reviews liquidity, projected cash flows, maturities of deposits and consumer and commercial deposit activity.
ALCO uses a simulation analysis to monitor and manage the pricing and maturity of assets and liabilities in order to diminish the potential adverse impact that changes in interest rates could have on net interest income. The simulation tests the sensitivity of NII and EVE. Contractual maturities and repricing opportunities of loans are incorporated in the simulation model as are prepayment assumptions, maturity data and call options within the investment securities portfolio. Assumptions based on past experience are incorporated into the model for non-maturity deposit accounts. The assumptions used are inherently uncertain and, as a result, the model cannot precisely measure the future NII and EVE. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various management strategies.
The change in the impact of net interest income from the base case for March 31, 2018 and December 31, 2017, was primarily driven by the rate and mix of variable and fixed rate financial instruments, the underlying duration of the financial instruments, and the level of response to changes in the interest rate environment. The increase in the level of negative impact to net interest income in the up interest rate shock scenarios are due to the assumed migration of non-term deposit liabilities to higher rate term deposits; the level of fixed rate investments and loans receivable that will not reprice to higher rates; the variable rate Federal Home Loan Bank advances; the variable rate subordinated debentures, and the non-term deposits that are assumed not to migrate to term deposits that are variable rate and will reprice to the higher rates; and a portion of our portfolio of variable rate loans contain restrictions on the amount of repricing and frequency of repricing that limit the amount of repricing to the current higher rates. These factors result in the negative impacts to net interest income in the up interest rate shock scenarios that are detailed in the table below. In the down interest rate shock scenario the main drivers of the negative impact on net interest income are the decrease in investment income due to the negative convexity features of the fixed rate mortgage backed securities; assumed prepayment of existing fixed rate loans receivable; the downward pricing of variable rate loans receivable; the constraint of the shock on non-term deposits; and the level of term deposit repricing. Our mortgage backed security portfolio is comprised of fixed rate investments and as rates decrease the level of prepayments are assumed to increase and cause the current higher rate investments to prepay and the assumed reinvestment will be at lower interest rates. Similar to our mortgage backed securities, the model assumes that our fixed rate loans receivable will prepay at a faster rate and reinvestment will occur at lower rates. The level of downward shock on the non-term deposits is constrained to limit the downward shock to a non-zero rate which results in a minimal reduction in the average rate paid. Term deposits repricing will only decrease the average cost paid by a minimal amount due to the assumed repricing occurring at maturity. These factors result in the negative impact to net interest income in the down interest rate shock scenario.
The change in the EVE from the base case for March 31, 2018 and December 31, 2017 is due to us being in a liability sensitive position and the level of convexity in our pre-payable assets. Generally, with a liability sensitive position, as interest rates increase the value of your assets decrease faster than the value of liabilities and as interest rates decrease the value of your assets increase at a faster rate than liabilities. However, due to the level of convexity in our fixed rate pre-payable assets we do not experience a similar change in the value of assets in a down interest rate shock scenario. Substantially all investments and approximately 47.9% of loans are pre-payable and fixed rate and as rates decrease the level of modeled prepayments increase. The prepaid principal is assumed to reprice at the assumed current rates, resulting in a smaller positive impact to the EVE.
Management utilizes static balance sheet rate shocks to estimate the potential impact on various rate scenarios. This analysis estimates a percentage of change in the metric from the stable rate base scenario versus alternative scenarios of rising and falling market interest rates by instantaneously shocking a static balance sheet. The following table summarizes the simulated immediate change in net interest income for twelve months as of the dates indicated:
Market Risk
Impact on Net Interest Income
Change in prevailing interest rates
+300 basis points
(9.6
)%
(9.8
+200 basis points
(5.7
(5.9
+100 basis points
(2.5
(2.7
0 basis points
-100 basis points
0.9
0.2
Impact on Economic Value
of Equity
(17.4
(15.4
(9.1
(8.5
(1.9
(2.0
(0.1
Item 4: Controls and Procedures
Evaluation of disclosure controls and procedures
An evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q was performed under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management was required to apply judgement in evaluating its controls and procedures. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure and are effective to provide reasonable assurance that such information is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms.
Changes in internal control over financial reporting
There were no changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II—OTHER INFORMATION
Item 1: Legal Proceedings
From time to time we are a party to various litigation matters incidental to the conduct of our business. See “NOTE 11 – LEGAL MATTERS” of the Condensed Notes to Interim Consolidated Financial Statements under Item 1 to this Quarterly report for a complete discussion of litigation matters.
Item 1A: Risk Factors
There have been no material changes in the Company’s risk factors previously disclosed in our Annual Report on Form 10-K filed with the SEC on March 16, 2018.
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
Recent Sales of Unregistered Equity Securities
None
Use of Proceeds
Item 3: Defaults Upon Senior Securities
Item 4: Mine Safety Disclosures
Not applicable.
Item 5: Other Information
Item 6: Exhibits
Exhibit
No.
Description
10.1
Form of Performance-vested Restricted Stock Units Award Agreement (incorporated by reference to Exhibit 10.1 to Equity Bancshares, Inc.’s Current Report on Form 8-K filed with the SEC on March 5, 2018).
10.2
Form of Time-vested Restricted Stock Units Award Agreement (incorporated by reference to Exhibit 10.2 to Equity Bancshares, Inc.’s Current Report on Form 8-K filed with the SEC on March 5, 2018).
10.3
Employment Agreement, dated March 16, 2018, by and between Equity Bank and Craig Anderson (incorporated by reference to Exhibit 10.1 to Equity Bancshares, Inc.’s Current Report on Form 8-K filed with the SEC on March 22, 2018).
31.1*
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1**
Certification of Chief 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 Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*
XBRL Instance Document.
101.SCH*
XBRL Taxonomy Extension Schema Document.
101.CAL*
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF*
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB*
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE*
XBRL Taxonomy Extension Presentation Linkbase Document.
*
Filed herewith.
**
These exhibits are furnished herewith and shall not be deemed “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
May 10, 2018
By:
/s/ Brad S. Elliott
Date
Brad S. Elliott
Chairman and Chief Executive Officer
/s/ Gregory H. Kossover
Gregory H. Kossover
Executive Vice President and Chief Financial Officer
67