Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2015
OR
o 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 001-12669
SOUTH STATE CORPORATION
(Exact name of registrant as specified in its charter)
South Carolina
57-0799315
(State or other jurisdiction of incorporation)
(IRS Employer Identification No.)
520 Gervais Street
Columbia, South Carolina
29201
(Address of principal executive offices)
(Zip Code)
(800) 277-2175
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for 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 x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 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 x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer x
Accelerated Filer o
Non-Accelerated Filer o
Smaller Reporting Company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Indicate the number of shares outstanding of each of issuer’s classes of common stock, as of the latest practicable date:
Class
Outstanding as of July 31, 2015
Common Stock, $2.50 par value
24,201,793
South State Corporation and Subsidiary
June 30, 2015 Form 10-Q
INDEX
Page
PART I — FINANCIAL INFORMATION
Item 1.
Financial Statements
Condensed Consolidated Balance Sheets at June 30, 2015, December 31, 2014 and June 30, 2014
1
Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30, 2015 and 2014
2
Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2015 and 2014
3
Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Six Months Ended June 30, 2015 and 2014
4
Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2015 and 2014
5
Notes to Condensed Consolidated Financial Statements
6-50
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
51-72
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
73
Item 4.
Controls and Procedures
PART II — OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
74
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
75
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets
(Dollars in thousands, except par value)
June 30,
December 31,
2015
2014
(Unaudited)
(Note 1)
ASSETS
Cash and cash equivalents:
Cash and due from banks
$
422,057
229,901
388,852
Interest-bearing deposits with banks
7,097
7,456
6,418
Federal funds sold and securities purchased under agreements to resell
164,228
180,512
194,253
Total cash and cash equivalents
593,382
417,869
589,523
Investment securities:
Securities held to maturity (fair value of $10,114, $10,233, and $11,058, respectively)
9,659
10,389
Securities available for sale, at fair value
841,661
806,766
795,741
Other investments
9,031
10,518
Total investment securities
860,351
826,943
816,648
Loans held for sale
73,055
61,934
56,407
Loans:
Acquired credit impaired (covered of $113,158, $182,464, and $243,942, respectively; non-covered of $710,823, $736,938, and $803,394, respectively), net of allowance for loan losses
823,981
919,402
1,047,336
Acquired non-credit impaired (covered of $8,059, $9,376, and $7,538, respectively; non-covered of $1,163,613, $1,318,623, and $1,440,045, respectively)
1,171,672
1,327,999
1,447,583
Non-acquired
3,788,399
3,467,826
3,174,625
Less allowance for non-acquired loan losses
(34,782
)
(34,539
(35,422
Loans, net
5,749,270
5,680,688
5,634,122
FDIC receivable for loss share agreements
11,035
22,161
43,766
Other real estate owned (covered of $8,172, $16,227, and $21,998, respectively; non-covered of $26,870, $26,499, and $31,735, respectively)
35,042
42,726
53,733
Premises and equipment, net
171,582
171,772
184,113
Bank owned life insurance
100,363
99,140
97,933
Deferred tax assets
45,911
42,692
66,780
Mortgage servicing rights
25,325
21,601
21,015
Core deposit and other intangibles
45,260
49,239
53,371
Goodwill
317,688
Other assets
56,720
71,774
58,587
Total assets
8,084,984
7,826,227
7,993,686
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Noninterest-bearing
1,844,973
1,639,953
1,626,995
Interest-bearing
4,822,555
4,821,092
4,952,847
Total deposits
6,667,528
6,461,045
6,579,842
Federal funds purchased and securities sold under agreements to repurchase
287,903
221,541
280,595
Other borrowings
55,055
101,210
101,045
Other liabilities
50,719
57,511
79,186
Total liabilities
7,061,205
6,841,307
7,040,668
Shareholders’ equity:
Preferred stock - $.01 par value; authorized 10,000,000 shares; no shares issued and outstanding
—
Common stock - $2.50 par value; authorized 40,000,000 shares; 24,197,531, 24,150,702, and 24,130,006 shares issued and outstanding, respectively
60,494
60,377
60,325
Surplus
704,625
701,764
699,324
Retained earnings
260,591
223,156
192,961
Accumulated other comprehensive income (loss)
(1,931
(377
408
Total shareholders’ equity
1,023,779
984,920
953,018
Total liabilities and shareholders’ equity
The Accompanying Notes are an Integral Part of the Financial Statements.
Condensed Consolidated Statements of Income (unaudited)
(Dollars in thousands, except per share data)
Three Months Ended
Six Months Ended
Interest income:
Loans, including fees
79,406
79,322
158,254
161,163
Taxable
3,822
3,997
7,484
7,878
Tax-exempt
1,072
1,071
2,150
2,227
464
441
875
901
Total interest income
84,764
84,831
168,763
172,169
Interest expense:
Deposits
1,737
2,261
3,740
4,654
105
89
201
191
646
1,508
1,497
3,009
Total interest expense
2,488
3,858
5,438
7,854
Net interest income
82,276
80,973
163,325
164,315
Provision for loan losses
3,144
2,169
3,963
3,018
Net interest income after provision for loan losses
79,132
78,804
159,362
161,297
Noninterest income:
Fees on deposit accounts
17,699
17,617
34,192
34,441
Mortgage banking income
7,089
4,683
13,715
7,974
Trust and investment services income
5,051
4,812
9,985
9,355
Securities gains
88
Amortization of FDIC indemnification assets, net
(2,042
(5,815
(5,249
(12,893
Other
2,285
3,014
3,945
6,113
Total noninterest income
30,082
24,399
56,588
45,078
Noninterest expense:
Salaries and employee benefits
39,754
40,276
80,741
79,369
Net occupancy expense
5,046
5,763
10,283
11,371
Information services expense
4,382
4,435
8,340
8,833
Furniture and equipment expense
2,762
3,264
5,907
7,006
Bankcard expense
2,088
4,265
4,344
Branch consolidation expense
2,237
OREO expense and loan related
2,019
1,736
5,033
5,939
Amortization of intangibles
1,964
2,084
3,980
4,188
Professional fees
1,585
1,115
2,994
2,379
Supplies, printing and postage expense
1,430
1,599
3,042
3,182
FDIC assessment and other regulatory charges
1,253
1,267
2,437
2,843
Advertising and marketing
1,009
892
1,864
1,745
Merger and branding related expense
6,510
12,495
5,803
4,860
10,891
9,618
Total noninterest expense
71,529
75,889
142,014
153,312
Earnings:
Income before provision for income taxes
37,685
27,314
73,936
53,063
Provision for income taxes
12,813
9,368
25,138
18,200
Net income
24,872
17,946
48,798
34,863
Preferred stock dividends
1,073
Net income available to common shareholders
33,790
Earnings per common share:
Basic
1.04
0.75
2.04
1.41
Diluted
1.03
0.74
2.02
1.40
Dividends per common share
0.24
0.20
0.47
0.39
Weighted-average common shares outstanding:
23,981
23,892
23,947
23,882
24,258
24,141
24,214
24,126
Condensed Consolidated Statements of Comprehensive Income (unaudited)
(Dollars in thousands)
Other comprehensive income (loss):
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period
(8,226
7,005
(2,953
16,163
Tax effect
3,100
(2,671
1,090
(6,163
Reclassification adjustment for gains included in net income
(88
34
Net of tax amount
(5,126
4,280
(1,863
9,946
Unrealized gains (losses) on derivative financial instruments qualifying as cash flow hedges:
29
(107
(92
(178
(11
41
35
68
Reclassification adjustment for losses included in interest expense
64
140
149
(24
(28
(53
(57
58
(21
30
(18
Changes in pension plan obligation:
Reclassification adjustment for changes included in net income
225
330
450
(86
(127
(171
139
203
279
Other comprehensive income (loss), net of tax
(4,929
4,462
(1,554
10,131
Comprehensive income
19,943
22,408
47,244
44,994
Condensed Consolidated Statements of Changes in Shareholders’ Equity (unaudited)
Six months ended June 30, 2015 and 2014
Accumulated Other
Preferred Stock
Common Stock
Retained
Comprehensive
Shares
Amount
Earnings
Income (Loss)
Total
Balance, December 31, 2013
65,000
24,104,124
60,260
762,354
168,577
(9,723
981,469
Cash dividends on Series A preferred stock at annual dividend rate of 9%
(1,073
Cash dividends declared on common stock at $0.39 per share
(9,406
Employee stock purchases
3,251
8
185
193
Stock options exercised
4,660
12
117
129
Restricted stock awards
22,810
57
Repurchase of Series A preferred stock
(65,000
(1
(64,999
Common stock repurchased
(4,839
(12
(283
(295
Share-based compensation expense
2,007
Balance, June 30, 2014
24,130,006
Balance, December 31, 2014
24,150,702
Cash dividends declared on common stock at $0.47 per share
(11,363
3,366
199
207
30,060
76
863
939
30,605
(76
(17,202
(43
(1,032
(1,075
2,907
Balance, June 30, 2015
24,197,531
Condensed Consolidated Statements of Cash Flows (unaudited)
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
10,531
10,540
Deferred income taxes
(2,320
(80
Gain on sale of securities
Amortization on FDIC indemnification asset
5,249
12,893
Accretion of discount related to performing acquired loans
(3,211
(5,186
Loss on disposal of premises and equipment
301
287
Gain on sale of OREO
(766
(5,368
Net amortization of premium on investment securities
2,210
2,004
OREO write downs
4,314
5,724
Fair Value adjustment for loans held for sale
(189
Originations and purchases of mortgage loans for sale
(506,532
(327,034
Proceeds from sales of mortgage loans for sale Proceeds from sales of mortgage loans for sale
495,506
301,212
Net change in:
Accrued interest receivable
(277
(2,343
Prepaid assets
(972
2,886
FDIC Loss Share Receivable
5,877
29,609
Accrued interest payable
(1,822
(1,106
Accrued income taxes
12,861
11,711
Miscellaneous assets and liabilities
(4,897
(11,640
Net cash provided by operating activities
71,531
63,909
Cash flows from investing activities:
Proceeds from sales of investment securities available for sale
9,315
Proceeds from maturities and calls of investment securities held to maturity
1,535
Proceeds from maturities and calls of investment securities available for sale
96,497
66,645
Proceeds from sales of investment securities held to maturity
411
Proceeds from calls of other investment securities
1,392
Proceeds from sales of other investment securities
95
2,868
Purchases of investment securities available for sale
(136,554
(70,831
Purchases of other investments
(6,186
Net increase in loans
(83,652
(18,716
Recoveries of loans previously charged off
1,598
Purchases of premises and equipment
(7,431
(10,161
Proceeds from sale of credit card loans
20,350
Proceeds from sale of OREO
16,855
36,289
Proceeds from sale of premises and equipment
25
1,437
Net cash provided by (used in) investing activities
(111,175
32,956
Cash flows from financing activities:
Net increase in deposits
206,483
20,639
Net increase in federal funds purchased and securities sold under agreements to repurchase and other short-term borrowings
66,361
69,194
Repayment of other borrowings
(46,395
(1,184
Common stock issuance
Preferred stock repurchase
Common stock repurchase
Dividends paid on preferred stock
Dividends paid on common stock
Net cash provided by financing activities
215,157
13,197
Net increase in cash and cash equivalents
175,513
110,062
Cash and cash equivalents at beginning of period
479,461
Cash and cash equivalents at end of period
Supplemental Disclosures:
Cash Flow Information:
Cash paid for:
Interest
7,259
8,959
Income taxes
14,410
13,039
Schedule of Noncash Investing Transactions:
Real estate acquired in full or in partial settlement of loans (covered of $1,309 and $11,680, respectively; and non-covered of $11,410 and $13,781, respectively)
12,719
25,461
Notes to Condensed Consolidated Financial Statements (unaudited)
Note 1 — Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States (“GAAP”) for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Certain prior period information has been reclassified to conform to the current period presentation, and these reclassifications had no impact on net income or equity as previously reported. Operating results for the three and six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015.
The condensed consolidated balance sheet at December 31, 2014 has been derived from the audited financial statements at that date but does not include all of the information and disclosures required by GAAP for complete financial statements.
Note 2 — Summary of Significant Accounting Policies
The information contained in the consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the Securities and Exchange Commission (the “SEC”) on February 27, 2015, should be referenced when reading these unaudited condensed consolidated financial statements. Unless otherwise mentioned or unless the context requires otherwise, references herein to “South State,” the “Company” “we,” “us,” “our” or similar references mean South State Corporation and its consolidated subsidiaries. References to the “Bank” means South State Corporation’s wholly owned subsidiary, South State Bank, a South Carolina banking corporation.
Subsequent Events
The Company has evaluated subsequent events for accounting and disclosure purposes through the date the financial statements are issued.
Note 3 — Recent Accounting and Regulatory Pronouncements
In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-03, Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs (ASU 2015-03). The update simplifies the presentation of debt issuance costs by requiring that debt issuance costs be presented in the balance sheet as a direct deduction from the carrying amount of debt liability, consistent with debt discounts or premiums. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this update. For public companies, this update will be effective for interim and annual periods beginning after December 15, 2015, and is to be applied retrospectively. Early adoption is permitted. The Company has determined that this guidance will not have a material impact on the Company’s consolidated financial statements.
6
Note 3 — Recent Accounting and Regulatory Pronouncements (Continued)
In February 2015, the FASB issued Accounting Standards Update ASU 2015-02, Amendments to the Consolidation Analysis (“ASU 2015-02”). This ASU affects reporting entities that are required to evaluate whether they should consolidate certain legal entities. Specifically, the amendments: (1) modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities (“VIEs”) or voting interest entities; (2) eliminate the presumption that a general partner should consolidate a limited partnership; (3) affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships; and (4) provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. ASU No. 2015-02 is effective for interim and annual reporting periods beginning after December 15, 2015. The Company is currently evaluating the impact of adopting the new guidance on the consolidated financial statements, but does not expect it to have a material impact.
In November 2014, the FASB issued ASU 2014-16, Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity, a consensus of the FASB Emerging Issues Task Force (“ASU 2014-16”). This ASU clarifies how current U.S. GAAP should be interpreted in subjectively evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. ASU 2014-16 is effective for public business entities for annual periods and interim periods within those annual periods, beginning after December 15, 2015. The adoption of ASU 2014-16 is not expected to have a material impact on the Company’s financial statements.
In August 2014, the FASB issued ASU 2014-14: Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40)—Classification of Certain Government Guaranteed Mortgage Loans upon Foreclosure (“ASU 2014-14”). ASU 2014-14 provides clarifying guidance related to how creditors classify government-guaranteed loans upon foreclosure. ASU 2014-14 requires that a mortgage loan be derecognized and a separate receivable be recognized upon foreclosure if certain conditions are met. Upon foreclosure, the separate receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. ASU 2014-14 became effective for the Company on January 1, 2015 and did not have an impact on the Company’s financial statements.
In June 2014, the FASB issued ASU 2014-12, Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period, a consensus of the FASB Emerging Issues Task Force (“ASU 2014-12”). ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. ASU 2014-12 is effective for annual periods and interim periods within those annual periods, beginning after December 15, 2015. An entity may apply the standards (1) prospectively to all share-based payment awards that are granted or modified on or after the effective date, or (2) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. Earlier application is permitted. The adoption of ASU 2014-12 is not expected to have a material impact on the Company’s financial statements.
In June 2014, the FASB issued ASU 2014-11, Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures (“ASU 2014-11”). ASU 2014-11 aligns the accounting for repurchase to maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements. Going forward, these transactions would all be accounted for as secured borrowings. ASU 2014-11 became effective for the Company on January 1, 2015 and did not have an impact on the Company’s financial statements. See Note 21—Repurchase Agreements for the disclosures required under the provisions of ASU 2014-11.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, Topic 606 (“ASU 2014-09”). The new standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under existing guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016 (the FASB recently approved a one-year deferral of the effective date but has not issued the final ASU at this point), including interim periods within that reporting period. The amendments can be applied retrospectively to each prior reporting period or retrospectively with the cumulative effect of initially applying this new guidance recognized at the date of initial application. The Company is currently evaluating the provisions of ASU 2014-09 to determine the potential impact the new standard will have to the Company’s financial statements.
7
In January 2014, the FASB issued ASU 2014-04, Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure, a consensus of the FASB Emerging Issues Task Force (“ASU 2014-04”). ASU 2014-04 clarifies that an in-substance foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (i) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (ii) the borrower conveying all interest in the residential real estate property to the creditor to satisfy the loan through completion of a deed in lieu of foreclosure or similar legal agreement. ASU 2014-04 also requires disclosure of both the amount of foreclosed residential real estate property held by the creditor and the recorded investment in loans collateralized by residential real estate property that are in the process of foreclosure. ASU 2014-04 became effective for the Company on January 1, 2015 and, although additional disclosures regarding residential real estate foreclosures and properties in process of foreclosure were required, did not have a significant impact on the Company’s financial statements.
In January 2014, the FASB issued ASU No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects (“ASU 2014-01”). ASU 2014-01 amends FASB ASC 323, Investments — Equity Method and Joint Ventures, to permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). ASU 2014-02 became effective for the Company on January 1, 2015 and did not have a significant impact on the Company’s financial statements (see Note 20).
Note 4 — Mergers and Acquisitions
The following mergers and acquisitions are referenced throughout this Form 10-Q:
· Community Bank & Trust (“CBT”) — January 29, 2010 — Federal Deposit Insurance Corporation (“FDIC”) purchase and assumption agreement
· Habersham Bank (“Habersham”) — February 18, 2011 — FDIC purchase and assumption agreement
· BankMeridian, N.A. (“BankMeridian”) — July 29, 2011 — FDIC purchase and assumption agreement
· Peoples Bancorporation, Inc. (“Peoples”) — April 24, 2012 — Whole bank acquisition
· The Savannah Bancorp, Inc. (“Savannah”) — December 13, 2012 — Whole bank acquisition
· Former First Financial Holdings, Inc. (“FFHI”) — July 26, 2013 — Whole bank acquisition, which resulted in the assumption of FDIC purchase and assumption agreements with respect to Cape Fear Bank (“Cape Fear”) — April 10, 2009 and Plantation Federal Bank (“Plantation”) — April 27, 2012
“FDIC purchase and assumption agreement” means that only certain assets and liabilities were acquired by the bank from the FDIC. A “whole bank acquisition” means that the two parties in the transaction agreed to the transaction, and there was no involvement of the FDIC. A “whole bank acquisition with FDIC purchase and assumption agreements” means that the two parties in the transaction agreed to the merger, and there were existing FDIC purchase and assumption agreements.
Note 5 — Investment Securities
The following is the amortized cost and fair value of investment securities held to maturity:
Gross
Amortized
Unrealized
Fair
Cost
Gains
Losses
Value
June 30, 2015:
State and municipal obligations
455
10,114
December 31, 2014:
574
10,233
June 30, 2014:
669
11,058
Note 5 — Investment Securities (Continued)
The following is the amortized cost and fair value of investment securities available for sale:
Government-sponsored entities debt *
132,071
(1,376
130,835
133,921
3,199
(421
136,699
Mortgage-backed securities **
566,625
5,740
(1,443
570,922
Corporate stocks
3,161
497
(453
3,205
835,778
9,576
(3,693
149,720
(1,714
148,197
133,635
4,141
(195
137,581
511,414
7,572
(1,040
517,946
573
(692
797,930
12,477
(3,641
142,310
303
(3,086
139,527
140,075
(593
142,848
503,212
7,910
(1,428
509,694
590
(79
3,672
788,758
12,169
* - The Company’s government-sponsored entities holdings are comprised of debt securities offered by Federal Home Loan Mortgage Corporation (“FHLMC”) or Freddie Mac, Federal National Mortgage Association (“FNMA”) or Fannie Mae, FHLB, and Federal Farm Credit Banks (“FFCB”). Also included in the Company’s government-sponsored entities are debt securities offered by the Small Business Administration (“SBA”), which have the full faith and credit backing of the United States Government.
** - All of the mortgage-backed securities are issued by government-sponsored entities; there are no private-label holdings.
The following is the amortized cost and fair value of other investment securities:
Federal Home Loan Bank stock
7,389
Investment in unconsolidated subsidiaries
1,642
3,034
9
The amortized cost and fair value of debt securities at June 30, 2015 by contractual maturity are detailed below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.
Securities
Held to Maturity
Available for Sale
Due in one year or less
640
655
6,532
6,579
Due after one year through five years
820
855
58,740
59,191
Due after five years through ten years
8,199
8,604
219,093
220,843
Due after ten years
551,413
555,048
Information pertaining to the Company’s securities with gross unrealized losses at June 30, 2015, December 31, 2014 and June 30, 2014, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position is as follows:
Less Than Twelve Months
Twelve Months or More
Securities Available for Sale
Government-sponsored entities debt
513
47,096
32,112
21,044
218
4,162
Mortgage-backed securities
971
123,935
472
22,240
Corporate Stocks
453
1,779
1,687
192,075
2,006
60,293
98
22,896
1,616
82,798
1,444
192
8,269
266
61,508
774
55,960
692
1,538
367
85,848
3,274
148,565
8,491
3,083
82,145
14
7,546
579
35,623
234
82,939
1,194
63,403
79
2,152
101,128
4,856
181,171
10
Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the financial condition and near-term prospects of the issuer, (2) the outlook for receiving the contractual cash flows of the investments, (3) the length of time and the extent to which the fair value has been less than cost, (4) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value or for a debt security whether it is more-likely-than-not that the Company will be required to sell the debt security prior to recovering its fair value, and (5) the anticipated outlook for changes in the general level of interest rates. All debt securities available for sale in an unrealized loss position as of June 30, 2015 continue to perform as scheduled. All equity securities available for sale in an unrealized loss position as of June 30, 2015 continue to pay dividends. As part of the Company’s evaluation of its intent and ability to hold investments for a period of time sufficient to allow for any anticipated recovery in the market, the Company considers its investment strategy, cash flow needs, liquidity position, capital adequacy and interest rate risk position. The Company does not currently intend to sell the securities within the portfolio and it is not more-likely-than-not that the Company will be required to sell the debt securities; therefore, management does not consider these investments to be other-than-temporarily impaired at June 30, 2015. Management continues to monitor all of these securities with a high degree of scrutiny. There can be no assurance that the Company will not conclude in future periods that conditions existing at that time indicate some or all of these securities may be sold or are other than temporarily impaired, which would require a charge to earnings in such periods.
Note 6 — Loans and Allowance for Loan Losses
The following is a summary of non-acquired loans:
Non-acquired loans:
Commercial non-owner occupied real estate:
Construction and land development
368,954
364,221
371,751
Commercial non-owner occupied
351,524
333,590
302,961
Total commercial non-owner occupied real estate
720,478
697,811
674,712
Consumer real estate:
Consumer owner occupied
906,973
786,778
637,071
Home equity loans
300,074
283,934
271,028
Total consumer real estate
1,207,047
1,070,712
908,099
Commercial owner occupied real estate
975,701
907,913
849,048
Commercial and industrial
448,247
405,923
353,211
Other income producing property
163,441
150,928
151,928
Consumer
209,544
189,317
170,982
Other loans
63,941
45,222
Total non-acquired loans
Less allowance for loan losses
Non-acquired loans, net
3,753,617
3,433,287
3,139,203
11
Note 6 — Loans and Allowance for Loan Losses (Continued)
The following is a summary of acquired non-credit impaired loans accounted for under FASB ASC Topic 310-20, net of related discount:
FASB ASC Topic 310-20 acquired loans:
17,762
24,099
35,880
43,123
49,476
50,593
60,885
73,575
86,473
574,697
646,375
698,580
210,734
234,949
248,868
785,431
881,324
947,448
49,334
62,065
68,831
31,762
41,130
41,977
58,987
65,139
71,684
185,273
204,766
231,170
Total FASB ASC Topic 310-20 acquired loans
The unamortized discount related to the acquired non-credit impaired loans totaled $20.2 million, $23.5 million, and $31.6 million at June 30, 2015, December 31, 2014, and June 30, 2014, respectively.
In accordance with FASB ASC Topic 310-30, the Company aggregated acquired loans that have common risk characteristics into pools of loan categories as described in the table below. The following is a summary of acquired credit impaired loans accounted for under FASB ASC Topic 310-30 (identified as credit impaired at the time of acquisition), net of related discount:
FASB ASC Topic 310-30 acquired loans:
Commercial loans greater than or equal to $1 million-CBT
15,373
15,813
19,557
Commercial real estate
288,756
325,109
375,610
Commercial real estate—construction and development
59,819
65,262
85,660
Residential real estate
348,687
390,244
428,811
77,083
85,449
95,089
38,894
44,804
51,677
Single pay
86
91
Total FASB ASC Topic 310-30 acquired loans
828,670
926,767
1,056,495
(4,689
(7,365
(9,159
FASB ASC Topic 310-30 acquired loans, net
Contractual loan payments receivable, estimates of amounts not expected to be collected, other fair value adjustments and the resulting carrying values of acquired credit impaired loans as of June 30, 2015, December 31, 2014 and June 30, 2014 are as follows:
Contractual principal and interest
1,093,583
1,337,703
1,463,643
Non-accretable difference
(64,121
(104,110
(189,514
Cash flows expected to be collected
1,029,462
1,233,593
1,274,129
Accretable yield
(200,792
(306,826
(217,634
Carrying value
Allowance for acquired loan losses
Income on acquired credit impaired loans that are not impaired at the acquisition date is recognized in the same manner as loans impaired at the acquisition date. A portion of the fair value discount on acquired non-impaired loans has been ascribed as an accretable difference that is accreted into interest income over the estimated remaining life of the loans. The remaining nonaccretable difference represents cash flows not expected to be collected.
The following are changes in the carrying value of acquired credit impaired loans:
Six Months Ended June 30,
Balance at beginning of period
1,220,638
Net reductions for payments, foreclosures, and accretion
(98,097
(175,761
Change in the allowance for loan losses on acquired loans
2,676
2,459
Balance at end of period, net of allowance for loan losses on acquired loans
The table below reflects refined accretable yield balance for acquired credit impaired loans:
306,826
250,340
Accretion
(51,220
(54,950
Reclass of nonaccretable difference due to improvement in expected cash flows
15,401
24,675
Other changes, net
(70,215
(2,431
Balance at end of period
200,792
217,634
In the second quarter of 2015, the accretable yield balance declined by $25.5 million as loan accretion (income) was recognized. This was partially offset by improved expected cash flows of $9.5 million.
During the recast in the first quarter of 2015, the accretable yield balance declined significantly by $64.1 million. This decline was primarily the result of an increase in the assumed prepayment speed of certain acquired loan pools from the FFHI acquisition. The actual cash flows were faster than what had been previously expected (assumed) and required an adjustment in the assumed prepayment speed used to forecast expected cash flows. The result was a decrease in the accretable yield balance, however, there was no impairment since this changed the timing and amount of the receipt of future cash on these pools of loans (the Company anticipates receiving the cash sooner than previously expected).
13
Our loan loss policy adheres to generally accepted accounting principles in the United States as well as interagency guidance. The allowance for loan losses is based upon estimates made by management. We maintain an allowance for loan losses at a level that we believe is appropriate to cover estimated credit losses on individually evaluated loans that are determined to be impaired as well as estimated credit losses inherent in the remainder of our loan portfolio. Arriving at the allowance involves a high degree of management’s judgment and results in a range of estimated losses. We regularly evaluate the adequacy of the allowance through our internal risk rating system, outside credit review, and regulatory agency examinations to assess the quality of the loan portfolio and identify problem loans. The evaluation process also includes our analysis of current economic conditions, composition of the loan portfolio, past due and nonaccrual loans, concentrations of credit, lending policies and procedures, and historical loan loss experience. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on, among other factors, changes in economic conditions in our markets. In addition, regulatory agencies, as an integral part of their examination process, periodically review our allowances for losses on loans. These agencies may require management to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. Because of these and other factors, it is possible that the allowances for losses on loans may change. The provision for loan losses is charged to expense in an amount necessary to maintain the allowance at an appropriate level.
The allowance for loan losses on non-acquired loans consists of general and specific reserves. The general reserves are determined by applying loss percentages to the portfolio that are based on historical loss experience for each class of loans and management’s evaluation and “risk grading” of the loan portfolio. Additionally, the general economic and business conditions affecting key lending areas, credit quality trends, collateral values, loan volumes and concentrations, seasoning of the loan portfolio, the findings of internal and external credit reviews and results from external bank regulatory examinations are included in this evaluation. Currently, these adjustments are applied to the non-acquired loan portfolio when estimating the level of reserve required. The specific reserves are determined on a loan-by-loan basis based on management’s evaluation of our exposure for each credit, given the current payment status of the loan and the value of any underlying collateral. These are loans classified by management as doubtful or substandard. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. Generally, the need for specific reserve is evaluated on impaired loans, and once a specific reserve is established for a loan, a charge off of that amount occurs in the quarter subsequent to the establishment of the specific reserve. Loans that are determined to be impaired are provided a specific reserve, if necessary, and are excluded from the calculation of the general reserves.
With the FFHI acquisition, the Company segregated the loan portfolio into performing loans (“non-credit impaired”) and acquired credit impaired loans. The performing loans and revolving type loans are accounted for under FASB ASC 310-20, with each loan being accounted for individually. The allowance for loan losses on these loans will be measured and recorded consistent with non-acquired loans. The acquired credit impaired loans will follow the description in the next paragraph.
In determining the acquisition date fair value of acquired credit impaired loans, and in subsequent accounting, the Company generally aggregates purchased loans into pools of loans with common risk characteristics. Expected cash flows at the acquisition date in excess of the fair value of loans are recorded as interest income over the life of the loans using a level yield method if the timing and amount of the future cash flows of the pool is reasonably estimable. Subsequent to the acquisition date, increases in cash flows over those expected at the acquisition date are reclassified from the non-accretable difference to accretable yield and recognized as interest income prospectively. Decreases in expected cash flows after the acquisition date are recognized by recording an allowance for loan losses. Management analyzes the acquired loan pools using various assessments of risk to determine an expected loss. The expected loss is derived based upon a loss given default based upon the collateral type and/or detailed review by loan officers and the probability of default that is determined based upon historical data at the loan level. Trends are reviewed in terms of accrual status, past due status, and weighted-average grade of the loans within each of the accounting pools. In addition, the relationship between the change in the unpaid principal balance and change in the mark is assessed to correlate the directional consistency of the expected loss for each pool. Offsetting the impact of the provision established for acquired loans covered under FDIC loss share agreements, the receivable from the FDIC is adjusted to reflect the indemnified portion of the post-acquisition exposure with a corresponding credit to the provision for loan losses.
An aggregated analysis of the changes in allowance for loan losses is as follows:
Acquired
Non-credit
Credit Impaired
Loans
Impaired Loans
Three months ended June 30, 2015:
33,538
4,717
38,255
Loans charged-off
(1,680
(558
(2,238
548
Net charge-offs
(1,132
(533
(1,665
Provision (benefit) for loan losses
2,376
533
235
Benefit attributable to FDIC loss share agreements
Total provision for loan losses charged to operations
Provision for loan losses recorded through the FDIC loss share receivable
Reduction due to loan removals
(263
34,782
4,689
39,471
Three months ended June 30, 2014:
34,669
11,046
45,715
(1,889
557
(1,332
2,085
(1,438
647
1,522
84
(1,522
(449
35,422
9,159
44,581
Six months ended June 30, 2015:
34,539
7,365
41,904
(2,676
(2,369
(5,045
50
1,648
(1,078
(2,319
(3,397
1,321
2,319
302
3,942
21
323
(2,978
Six months ended June 30, 2014:
34,331
11,618
45,949
(3,259
1,595
(1,664
2,755
(1,134
1,621
1,397
263
(1,397
(1,325
15
The following tables present a disaggregated analysis of activity in the allowance for loan losses and loan balances for non-acquired loans:
Construction
Commercial
Other Income
& Land
Non-owner
Owner
Home
Producing
Development
Occupied
Equity
& Industrial
Property
Three months ended June 30, 2015
Allowance for loan losses:
Balance, March 31, 2015
5,399
3,131
7,871
7,041
2,785
3,460
1,980
1,422
449
Charge-offs
(55
(72
(546
(44
(122
(116
(714
Recoveries
94
20
67
55
215
Provision (benefit)
(440
(42
1,350
108
138
572
(5
685
4,998
3,038
8,684
7,125
3,983
1,608
459
Loans individually evaluated for impairment
591
27
81
118
19
1,311
Loans collectively evaluated for impairment
4,407
3,011
8,603
7,007
2,867
3,964
1,547
1,606
33,471
5,110
2,610
10,971
6,322
1,011
4,789
69
31,116
363,844
348,914
964,730
900,651
299,840
447,236
158,652
209,475
3,757,283
Three months ended June 30, 2014
Balance, March 31, 2014
3,443
8,317
6,122
2,921
3,441
2,848
1,105
150
(216
(312
(221
(273
(96
(82
(597
97
16
39
38
153
176
31
(58
597
300
257
(331
586
254
6,652
3,398
7,958
6,537
2,975
3,640
2,588
1,270
404
428
112
761
1,431
6,224
3,367
7,846
6,451
3,629
1,827
1,268
33,991
5,678
6,189
11,110
2,505
749
6,400
87
32,718
366,073
296,772
837,938
634,566
352,462
145,528
170,895
3,141,907
Six months ended June 30, 2015
5,666
3,154
8,415
6,866
2,829
3,561
2,232
1,367
(100
(83
(552
(208
(255
(13
(1,421
134
45
110
666
66
532
Provision
(702
(62
805
258
137
(266
1,130
Six months ended June 30, 2014
6,789
3,677
7,767
6,069
2,782
3,592
2,509
937
209
(308
(236
(528
(299
(416
(156
(168
(1,148
242
347
17
40
128
159
420
(71
(390
702
525
569
1,061
195
The following tables present a disaggregated analysis of activity in the allowance for loan losses and loan balances for acquired non-credit impaired loans:
(39
(10
317
178
As of June 30, 2014, the Company had not recorded an allowance for loan losses for acquired non-credit impaired loans.
(367
(1,381
(113
(4
(504
(2
362
1,364
494
The following tables present a disaggregated analysis of activity in the allowance for loan losses and loan balances for acquired credit impaired loans:
Loans Greater
Real Estate-
Than or Equal
Construction and
Residential
to $1 Million-CBT
Real Estate
and Industrial
Single Pay
(64
549
400
3,320
244
219
49
Provision for loan losses before benefit attributable to FDIC loss share agreements
233
236
(17
(138
(22
(264
(66
344
3,184
197
Loans:*
Total acquired loans
311
1,938
1,972
5,190
410
1,119
106
(120
(322
(902
(68
(33
171
336
896
51
(6
(336
(896
(84
(34
(32
(136
815
5,118
385
950
*—The carrying value of acquired credit impaired loans includes a non-accretable difference which is primarily associated with the assessment of credit quality of acquired loans.
18
135
4,387
275
718
70
391
127
284
107
(201
(915
(1,224
(217
(399
(20
1,816
2,244
5,132
538
1,481
104
(123
(196
(613
(105
(175
220
784
(54
101
174
53
24
(176
(220
(784
54
(101
(174
(816
(87
(48
(356
(35
As part of the ongoing monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators, including trends related to (i) the level of classified loans, (ii) net charge-offs, (iii) non-performing loans (see details below), and (iv) the general economic conditions of the markets that we serve.
The Company utilizes a risk grading matrix to assign a risk grade to each of its loans. A description of the general characteristics of the risk grades is as follows:
· Pass—These loans range from minimal credit risk to average, however, still acceptable credit risk.
· Special mention—A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or the institution’s credit position at some future date.
· Substandard—A substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness, or weaknesses, that may jeopardize the liquidation of the debt. A substandard loan is characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
· Doubtful—A doubtful loan has all of the weaknesses inherent in one classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of the currently existing facts, conditions and values, highly questionable and improbable.
The following table presents the credit risk profile by risk grade of commercial loans for non-acquired loans:
Construction & Development
Commercial Non-owner Occupied
Commercial Owner Occupied
Pass
344,314
337,641
338,367
331,279
307,450
271,346
927,678
858,220
809,469
Special mention
16,561
15,466
20,797
16,885
20,596
22,704
34,974
34,737
23,049
Substandard
8,079
11,114
12,587
3,360
5,544
8,911
13,049
14,956
16,530
Doubtful
Commercial & Industrial
Other Income Producing Property
Commercial Total
442,354
397,555
346,958
149,937
135,400
135,345
2,195,562
2,036,266
1,901,485
4,497
6,718
4,775
9,331
10,333
8,763
82,248
87,850
80,088
1,396
1,650
1,478
4,173
5,195
7,820
30,057
38,459
47,326
2,307,867
2,162,575
2,028,899
The following table presents the credit risk profile by risk grade of consumer loans for non-acquired loans:
Consumer Owner Occupied
Home Equity
870,005
746,847
595,420
286,603
269,844
257,102
207,964
188,049
170,077
18,679
22,129
24,567
7,634
8,047
8,618
894
764
634
18,289
17,802
17,084
5,815
6,021
5,285
686
504
271
22
23
Consumer Total
66,644
1,428,513
1,249,962
1,089,243
27,207
30,940
33,820
24,790
24,327
22,640
1,480,532
1,305,251
1,145,726
The following table presents the credit risk profile by risk grade of total non-acquired loans:
Total Non-acquired Loans
3,624,075
3,286,228
2,990,728
109,455
118,790
113,908
54,847
62,786
69,966
The following table presents the credit risk profile by risk grade of commercial loans for acquired non-credit impaired loans:
16,454
22,456
34,870
36,441
42,572
44,020
49,217
61,040
67,527
816
348
6,039
5,822
78
265
310
1,190
827
662
6,274
865
751
760
994
30,641
39,780
40,255
57,578
63,090
66,678
190,331
228,938
253,350
384
448
748
439
1,427
8,464
9,232
737
902
974
970
1,153
3,002
9,210
4,507
6,383
200,968
241,909
268,965
The following table presents the credit risk profile by risk grade of consumer loans for acquired non-credit impaired loans:
569,080
639,555
680,759
197,804
222,653
231,265
182,254
201,636
202,026
1,518
1,241
354
5,482
4,491
2,090
614
619
2,193
4,099
5,579
17,467
7,448
7,805
15,513
2,405
2,511
26,951
949,138
1,063,844
1,114,050
7,614
6,351
4,637
13,952
15,895
59,931
970,704
1,086,090
1,178,618
The following table presents the credit risk profile by risk grade of total acquired non-credit impaired loans:
Total Acquired Non-credit Impaired Loans
1,139,469
1,292,782
1,367,400
9,041
14,815
13,869
23,162
20,402
66,314
The following table presents the credit risk profile by risk grade of acquired credit impaired loans (identified as credit-impaired at the time of acquisition), net of the related discount (this table should be read in conjunction with the allowance for acquired credit impaired loan losses table found on page 18):
Commercial Loans Greater Than
Commercial Real Estate—
or Equal to $1 million-CBT
Commercial Real Estate
Construction and Development
11,134
11,248
12,541
188,260
208,269
225,144
27,777
26,855
33,453
1,044
1,030
1,010
31,654
35,896
37,439
12,666
9,539
11,627
3,195
3,535
6,006
68,842
80,944
113,027
19,376
28,868
40,580
Residential Real Estate
174,893
190,931
225,366
6,099
7,493
27,665
23,956
25,530
29,680
68,017
73,699
43,090
27,079
29,087
6,572
2,428
5,317
3,189
105,777
125,614
160,355
43,905
48,869
60,852
12,510
13,957
18,808
Total Acquired Credit Impaired Loans
43
61
432,162
470,384
553,910
142,888
154,568
102,927
28
253,620
301,815
399,658
The risk grading of acquired credit impaired loans is determined utilizing a loan’s contractual balance, while the amount recorded in the financial statements and reflected above is the carrying value. In an FDIC-assisted acquisition, covered acquired loans are initially recorded at their fair value, including a credit discount due to the high concentration of substandard and doubtful loans. In addition to the credit discount and the allowance for loan losses on covered acquired loans, the Company’s risk of loss is mitigated by the FDIC loss share arrangement.
The following table presents an aging analysis of past due loans, segregated by class for non-acquired loans:
30-59 Days
60-89 Days
90+ Days
Past
Past Due
Due
Current
June 30, 2015
Commercial real estate:
230
1,345
1,663
367,291
1,058
430
1,604
3,092
348,432
Commercial owner occupied
2,061
724
4,211
6,996
968,705
1,523
1,290
2,733
5,546
901,427
803
62
480
298,729
156
241
274
671
447,576
196
716
943
162,498
243
530
209,014
151
63,790
6,206
3,084
11,647
20,937
3,767,462
December 31, 2014
318
1,354
2,111
362,110
1,197
1,432
2,629
330,961
1,106
5,403
6,604
901,309
1,946
501
2,746
5,193
781,585
679
443
519
1,641
282,293
123
990
404,933
570
114
1,319
2,003
148,925
512
120
188,442
65
46
173
45,049
7,153
13,062
22,219
3,445,607
June 30, 2014
1,651
1,035
3,033
368,718
1,377
397
5,318
7,092
295,869
1,173
909
4,587
844,461
462
1,063
1,577
3,102
633,969
959
189
735
1,883
269,145
435
352,776
382
2,630
149,298
277
96
446
170,536
66,522
6,433
3,114
13,784
23,331
3,151,294
The following table presents an aging analysis of past due loans, segregated by class for acquired non-credit impaired loans:
17,722
380
419
48,915
826
2,300
3,231
571,466
164
577
1,332
209,402
224
31,538
109
198
58,789
427
598
1,137
184,136
2,338
3,823
6,581
1,165,091
24,042
414
452
61,613
1,566
2,250
644,125
1,451
866
972
3,289
231,660
250
381
40,749
64,954
885
341
843
2,069
202,697
3,321
1,698
3,664
8,683
1,319,316
228
35,652
248
68,583
2,047
2,128
696,452
71
1,178
247,690
402
231
633
41,344
85
71,599
306
316
842
230,328
903
418
4,021
5,342
1,442,241
The following table presents an aging analysis of past due loans, segregated by class for acquired credit impaired loans:
12,743
1,617
11,590
13,327
275,429
1,900
4,941
7,141
52,678
4,458
1,929
11,802
18,189
330,498
1,696
775
2,332
4,803
72,280
4,894
5,919
32,975
10,419
3,401
38,189
52,009
776,661
2,896
12,917
4,350
723
15,866
20,939
304,170
1,750
8,204
10,406
54,856
7,194
2,856
15,471
25,521
364,723
2,241
2,614
5,961
79,488
451
3,413
4,060
40,744
15,986
5,333
48,464
69,783
856,984
794
5,213
6,007
13,550
7,708
781
17,333
25,822
349,788
2,636
1,484
9,940
14,060
71,600
5,735
2,489
18,971
27,195
401,616
1,587
3,800
91,289
353
2,366
3,296
6,015
45,662
18,813
56,319
82,899
973,596
The following is a summary of information pertaining to impaired non-acquired and acquired loans accounted for under FASB ASC Topic 310-20:
Unpaid
Recorded
Contractual
Investment
Principal
With No
With
Related
Balance
Allowance
7,728
1,721
3,389
3,987
1,649
961
15,589
7,301
3,670
7,157
3,738
2,584
36
1,903
309
5,620
122
4,667
Total impaired loans
42,448
15,038
16,078
7,414
1,528
3,324
4,852
475
4,920
2,539
3,610
77
12,508
3,614
9,160
172
3,393
2,966
144
131
1,625
908
6,280
360
5,138
5,498
60
36,366
10,309
16,776
27,085
1,558
7,251
2,700
2,978
8,236
5,079
1,110
13,293
6,912
4,198
2,763
369
6,612
914
5,486
39,150
15,974
16,744
Acquired credit impaired loans are accounted for in pools as shown on page 12 rather than being individually evaluated for impairment; therefore, the table above excludes acquired credit impaired loans.
26
The following summarizes the average investment in impaired loans, non-acquired and acquired loans accounted for under FASB ASC Topic 310-20, and interest income recognized on these loans:
Three Months Ended June 30,
Average
Investment in
Interest Income
Recognized
5,258
5,869
3,188
6,175
9,634
11,489
6,707
2,533
993
4,728
33
Total Impaired Loans
30,782
33,366
4,981
5,948
3,110
5,469
10,065
166
10,561
4,644
1,858
132
960
592
5,143
5,884
56
29,100
399
30,368
The following is a summary of information pertaining to non-acquired nonaccrual loans by class, including restructured loans:
1,976
2,920
3,259
1,145
2,325
5,496
3,121
5,245
8,755
6,398
6,916
1,198
1,412
1,567
7,596
7,427
8,483
3,421
3,605
4,843
600
682
922
1,348
3,696
337
Restructured loans
8,193
9,425
8,409
Total loans on nonaccrual status
24,087
27,994
34,955
The following is a summary of information pertaining to acquired non-credit impaired nonaccrual loans by class, including restructured loans:
100
645
2,346
3,685
1,082
1,507
3,428
5,192
226
1,078
1,193
5,173
7,538
As of June 30, 2014, the Company did not have any acquired non-credit impaired nonaccrual loans.
In the course of resolving delinquent loans, the Bank may choose to restructure the contractual terms of certain loans. Any loans that are modified are reviewed by the Bank to determine if a troubled debt restructuring (“TDR” or “restructured loan”) has occurred. A TDR is a modification in which the Bank grants a concession to a borrower that it would not otherwise consider due to economic or legal reasons related to a borrower’s financial difficulties. The concessions granted on TDRs generally include terms to reduce the interest rate, extend the term of the debt obligation, or modify the payment structure on the debt obligation.
The Bank designates loan modifications as TDRs when it grants a concession to the borrower that it would not otherwise consider due to the borrower experiencing financial difficulty (FASB ASC Topic 310-40). Loans on nonaccrual status at the date of modification are initially classified as nonaccrual TDRs. Loans on accruing status at the date of concession are initially classified as accruing TDRs if the note is reasonably assured of repayment and performance is expected in accordance with its modified terms. Such loans may be designated as nonaccrual loans subsequent to the concession date if reasonable doubt exists as to the collection of interest or principal under the restructuring agreement. Nonaccrual TDRs are returned to accruing status when there is economic substance to the restructuring, there is documented credit evaluation of the borrower’s financial condition, the remaining balance is reasonably assured of repayment in accordance with its modified terms, and the borrower has demonstrated sustained repayment performance in accordance with the modified terms for a reasonable period of time (generally a minimum of six months). For the three and six months ended June 30, 2015, and 2014, the Company’s TDRs were not material.
Note 7—FDIC Indemnification Asset
The following table provides changes in FDIC indemnification asset:
86,447
Decrease in expected losses on loans
Additional recoveries on OREO
(2,430
(2,846
Reimbursable expenses
587
1,383
Amortization of discounts and premiums, net
Reimbursements from FDIC
(4,013
(26,928
The FDIC indemnification asset is measured separately from the related covered assets. At June 30, 2015, the projected cash flows related to the FDIC indemnification asset for losses on assets acquired were approximately $9.9 million less than the current carrying value. This amount is being recognized as amortization (in non-interest income) over the shorter of the underlying asset’s remaining life or remaining term of the loss share agreements.
Included in the FDIC indemnification asset is an expected “true up” with the FDIC related to both the BankMeridian and Plantation acquisitions. This amount is determined each reporting period and at June 30, 2015 and June 30, 2014 was estimated to be approximately $4.1 million and $3.9 million, respectively, related to the BankMeridian acquisition at the end of the loss share agreement (July 2021) and $3.1 million and $3.1 million, respectively, related to the Plantation acquisition at the end of the loss share agreement (April 2017). The actual payment to the FDIC will be determined at the end of the loss sharing agreement term for each of the five FDIC-assisted acquisitions and is based on the negative bid, expected losses, intrinsic loss estimate, and assets covered under loss share. There was no true up expected from the CBT, Cape Fear, or Habersham FDIC-assisted transactions as of June 30, 2015.
Effective March 31, 2015, the Commercial Shared-Loss Agreement with the FDIC for CBT expired and losses on assets covered under this agreement are no longer claimable after filing the first quarter of 2015 commercial loss share certificate. The carrying value of commercial loans and OREO no longer covered under the CBT loss share agreement as of April 1, 2015 totaled $49.0 million and $2.2 million, respectively. These assets were transferred from the balances of loans and OREO classified as covered to non-covered. The Commercial Shared-Loss Agreement for Cape Fear expired June 30, 2014 and losses on assets covered under this agreement are no longer claimable.
Note 8—Other Real Estate Owned
The following is a summary of information pertaining to OREO:
OREO
Covered OREO
Beginning balance
26,499
16,227
37,398
27,520
64,918
Additions
9,165
3,554
13,781
11,680
Transfers
2,245
(2,245
Write-downs
(1,517
(2,797
(4,314
(2,480
(3,244
(5,724
Sold
(9,522
(6,567
(16,089
(16,964
(13,958
(30,922
Ending balance
26,870
8,172
31,735
21,998
The covered OREO above is covered pursuant to the FDIC loss share agreements and is presented net of the related fair value discount. At June 30, 2015, there were 162 properties included in OREO, with 133 uncovered and 29 covered by loss share agreements with the FDIC. At June 30, 2014, there were 401 properties included in OREO, with 200 uncovered and 201 covered by loss share agreements with the FDIC. At June 30, 2015, the Company had $3.9 million in residential real estate included in OREO and $9.7 million in residential real estate consumer mortgage loans in the process of foreclosure.
Note 9 — Deposits
The Company’s total deposits are comprised of the following:
Certificates of deposit
1,137,553
1,237,140
1,373,498
Interest-bearing demand deposits
2,994,228
2,927,820
2,899,532
Non-interest bearing demand deposits
Savings deposits
687,292
655,132
676,482
Other time deposits
3,482
1,000
3,335
At June 30, 2015, December 31, 2014, and June 30, 2014, the Company had $133.3 million, $128.5 million, and $136.2 million in certificates of deposits greater than $250,000, respectively. At June 30, 2015, December 31, 2014, and June 30, 2014, the Company had $19.4 million, $23.4 million and $29.7 million, in traditional, out-of-market brokered deposits, respectively.
Note 10 — Retirement Plans
The Company and the Bank provide certain retirement benefits to their employees in the form of a non-contributory defined benefit pension plan and an employees’ savings plan. The non-contributory defined benefit pension plan covers all employees hired on or before December 31, 2005, who have attained age 21, and who have completed a year of eligible service. Employees hired on or after January 1, 2006 are not eligible to participate in the non-contributory defined benefit pension plan, but are eligible to participate in the employees’ savings plan. On this date, a new benefit formula applies only to participants who have not attained age 45 or who do not have five years of service.
Effective July 1, 2009, the Company suspended the accrual of benefits for pension plan participants under the non-contributory defined benefit plan. The pension plan remained suspended as of June 30, 2015.
Note 10 — Retirement Plans (Continued)
The components of net periodic pension expense recognized are as follows:
Interest cost
(254
(508
(555
Expected return on plan assets
517
487
1,034
975
Recognized net actuarial loss
(225
(165
(450
(330
Net periodic pension benefit (expense)
90
The Company did not contribute to the pension plan for the three and six months ended June 30, 2015, and does not expect to make any additional contributions during the remainder of 2015. The plans assets currently exceed the projected benefit obligation of the plan, and no additional contributions are required for 2015.
Electing employees are eligible to participate in the employees’ savings plan, under the provisions of Internal Revenue Code Section 401(k), after attaining age 21. Plan participants elect to contribute portions of their annual base compensation as a before tax contribution. Employer contributions may be made from current or accumulated net profits. Participants may elect to contribute 1% to 50% of annual base compensation as a before tax contribution. Employees participating in the plan receive a 100% matching of their 401(k) plan contribution, up to 5% of their salary. Effective January 1, 2015, employees are eligible for an additional 1% discretionary matching contribution contingent upon achievement of the Company’s 2015 financial goals and payable the first quarter of 2016. The Company expensed $1.3 million and $1.2 million for the 401(k) plan during the three months ended June 30, 2015 and 2014, respectively. The Company expensed $2.6 million and $2.4 million for the 401(k) plan during the six months ended June 30, 2015 and 2014, respectively.
Employees can enter the savings plan on or after the first day of each month. The employee may enter into a salary deferral agreement at any time to select an alternative deferral amount or to elect not to defer in the plan. If the employee does not elect an investment allocation, the plan administrator will select a retirement-based portfolio according to the employee’s number of years until normal retirement age. The plan’s investment valuations are generally provided on a daily basis.
Note 11 — Earnings Per Share
Basic earnings per share are calculated by dividing net income available to common shareholders by the weighted-average shares of common stock outstanding during each period, excluding non-vested shares. The Company’s diluted earnings per share are based on the weighted-average shares of common stock outstanding during each period plus the maximum dilutive effect of common stock issuable upon exercise of stock options or vesting of restricted shares. The weighted-average number of shares and equivalents are determined after giving retroactive effect to stock dividends and stock splits.
Note 11 — Earnings Per Share (Continued)
The following table sets forth the computation of basic and diluted earnings per share:
(Dollars and shares in thousands)
Basic earnings per common share:
Weighted-average basic common shares
Basic earnings per common share
Diluted earnings per share:
Effect of dilutive securities
249
267
Weighted-average dilutive shares
Diluted earnings per common share
The calculation of diluted earnings per common share excludes outstanding stock options for which the results would have been anti-dilutive under the treasury stock method as follows:
Number of shares
46,798
22,497
47,865
Range of exercise prices
$61.42-$66.32
$61.49-$66.32
$61.42 - $66.32
$61.49 - $66.32
Note 12 — Share-Based Compensation
The Company’s 2004 and 2012 share-based compensation programs are long-term retention programs intended to attract, retain, and provide incentives for key employees and non-employee directors in the form of incentive and non-qualified stock options, restricted stock, and restricted stock units (“RSUs”).
Stock Options
With the exception of non-qualified stock options granted to directors under the 2004 and 2012 plans, which in some cases may be exercised at any time prior to expiration and in some other cases may be exercised at intervals less than a year following the grant date, incentive stock options granted under the plans may not be exercised in whole or in part within a year following the date of the grant, as these incentive stock options become exercisable in 25% increments pro ratably over the four-year period following the grant date. The options are granted at an exercise price at least equal to the fair value of the common stock at the date of grant and expire ten years from the date of grant. No options were granted under the 2004 plan after January 26, 2012, and the 2004 plan is closed other than for any options still unexercised and outstanding. The 2012 plan is the only plan from which new share-based compensation grants may be issued. It is the Company’s policy to grant options out of the 1,684,000 shares registered under the 2012 plan, of which no more than 817,476 shares can be granted as restricted stock or RSUs.
32
Note 12 — Share-Based Compensation (Continued)
Activity in the Company’s stock option plans is summarized in the following table. All information has been retroactively adjusted for stock dividends and stock splits.
Weighted-
Remaining
Aggregate
Number of
Exercise
Intrinsic
Options
Price
Life (Yrs.)
Value (000’s)
Outstanding at January 1, 2015
294,342
35.91
Granted
26,430
61.74
Exercised
(30,060
31.20
Outstanding at June 30, 2015
290,712
38.74
4.83
10,828
Exercisable at June 30, 2015
232,431
34.45
3.88
9,655
Weighted-average fair value of
options granted during the year
25.08
The fair value of options is estimated at the date of grant using the Black-Scholes option pricing model and expensed over the options’ vesting periods. The following weighted-average assumptions were used in valuing options issued:
Dividend yield
1.40%
1.27%
Expected life
8.5 years
6.3 years
Expected volatility
40.9%
43.8%-44.7%
Risk-free interest rate
1.79%
2.10%
As of June 30, 2015, there was $1.1 million of total unrecognized compensation cost related to nonvested stock option grants under the plans. The cost is expected to be recognized over a weighted-average period of 1.58 years as of June 30, 2015. The total fair value of shares vested during the six months ended June 30, 2015 was $386,000.
Restricted Stock
The Company from time-to-time also grants shares of restricted stock to key employees and non-employee directors. These awards help align the interests of these employees and directors with the interests of the shareholders of the Company by providing economic value directly related to increases in the value of the Company’s stock. The value of the stock awarded is established as the fair market value of the stock at the time of the grant. The Company recognizes expenses, equal to the total value of such awards, ratably over the vesting period of the stock grants. Restricted stock grants to employees typically “cliff vest” after four years. Grants to non-employee directors typically vest within a 12-month period.
Nonvested restricted stock for the six months ended June 30, 2015 is summarized in the following table. All information has been retroactively adjusted for stock dividends and stock splits.
Grant-Date
Fair Value
Nonvested at January 1, 2015
228,907
37.44
67.86
Vested
(41,125
34.94
Nonvested at June 30, 2015
218,387
42.17
As of June 30, 2015, there was $5.1 million of total unrecognized compensation cost related to nonvested restricted stock granted under the plans. This cost is expected to be recognized over a weighted-average period of 2.36 years as of June 30, 2015. The total fair value of shares vested during the six months ended June 30, 2015 was $1.6 million.
Restricted Stock Units
The Company from time-to-time also grants performance RSUs to key employees. These awards help align the interests of these employees with the interests of the shareholders of the Company by providing economic value directly related to the performance of the Company. Performance RSU grants contain a three year performance period. The Company communicates threshold, target, and maximum performance RSU awards and performance targets to the applicable key employees at the beginning of a performance period. Dividends are not paid in respect to the awards during the performance period. The value of the RSUs awarded is established as the fair market value of the stock at the time of the grant. The Company recognizes expenses on a straight-line basis typically over three years based upon the probable performance target that will be met. For the six months ended June 30, 2015, the Company accrued for 96% of the RSUs granted, based on Management’s expectations of performance.
Nonvested RSUs for the six months ended June 30, 2015 is summarized in the following table.
79,308
55.92
38,456
68.10
117,764
59.90
As of June 30, 2015, there was $3.8 million of total unrecognized compensation cost related to nonvested RSUs granted under the plan. This cost is expected to be recognized over a weighted-average period of 1.48 years as of June 30, 2015. There were no shares vested during the six months ended June 30, 2015.
Note 13 — Commitments and Contingent Liabilities
In the normal course of business, the Company makes various commitments and incurs certain contingent liabilities, which are not reflected in the accompanying financial statements. The commitments and contingent liabilities include guarantees, commitments to extend credit, and standby letters of credit. At June 30, 2015, commitments to extend credit and standby letters of credit totaled $1.4 billion. The Company does not anticipate any material losses as a result of these transactions.
The Company has been named as defendant in various legal actions, arising from its normal business activities, in which damages in various amounts are claimed. The Company is also exposed to litigation risk related to the prior business activities of banks acquired through whole bank acquisitions as well as banks from which assets were acquired and liabilities assumed in FDIC-assisted transactions. Although the amount of any ultimate liability with respect to such matters cannot be determined, in the opinion of management, any such liability will not have a material effect on the Company’s consolidated financial statements.
Note 14 — Fair Value
FASB ASC 820, Fair Value Measurements and Disclosures, defines fair value, establishes a framework for measuring fair value under accounting principles generally accepted in the United States, and enhances disclosures about fair value measurements. FASB ASC 820 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions.
The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Available for sale securities, derivative contracts, and mortgage servicing rights are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans, OREO, and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.
FASB ASC 820 establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:
Level 1
Observable inputs such as quoted prices in active markets;
Level 2
Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and
Level 3
Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.
The following is a description of valuation methodologies used for assets recorded at fair value.
Investment Securities
Securities available for sale are valued on a recurring basis at quoted market prices where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable securities. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange and The NASDAQ Stock Market, or U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities and debentures issued by government sponsored entities, municipal bonds and corporate debt securities. Securities held to maturity are valued at quoted market prices or dealer quotes similar to securities available for sale. The carrying value of FHLB stock approximates fair value based on the redemption provisions.
Mortgage Loans Held for Sale
Mortgage loans held for sale are carried at the fair market value. The fair values of mortgage loans held for sale are based on commitments on hand from investors within the secondary market for loans with similar characteristics. As such, the fair value adjustments for mortgage loans held for sale are recurring Level 2.
The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan may be considered impaired and an allowance for loan losses may be established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using estimated fair value methodologies. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At June 30, 2015, substantially all of the impaired loans were evaluated based on the fair value of the collateral because such loans were considered collateral dependent. Impaired loans, where an allowance is established based on the fair value of collateral; require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company considers the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company considers the impaired loan as nonrecurring Level 3.
Note 14 — Fair Value (Continued)
Other Real Estate Owned (“OREO”)
Typically non-covered OREO, consisting of properties obtained through foreclosure or in satisfaction of loans, is reported at fair value, determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources, adjusted for estimated selling costs (Level 2). However, both non-covered and covered OREO are considered Level 3 in the fair value hierarchy because management has qualitatively applied a discount due to the size, supply of inventory, and the incremental discounts applied to the appraisals. Management also considers other factors, including changes in absorption rates, length of time the property has been on the market and anticipated sales values, which have resulted in adjustments to the collateral value estimates indicated in certain appraisals. At the time of foreclosure, any excess of the loan balance over the fair value of the real estate held as collateral is treated as a charge against the allowance for loan losses. Gains or losses on sale and generally any subsequent adjustments to the value are recorded as a component of OREO expense, net of any FDIC indemnification proceeds in the case of covered OREO.
Derivative Financial Instruments
Fair value is estimated using pricing models of derivatives with similar characteristics; accordingly, the derivatives are classified within Level 2 of the fair value hierarchy (see Note 16—Derivative Financial Instruments for additional information).
Mortgage servicing rights (“MSRs”)
The estimated fair value of MSRs is obtained through an independent derivatives dealer analysis of future cash flows. The evaluation utilizes assumptions market participants would use in determining fair value including market discount rates, prepayment speeds, servicing income, servicing costs, default rates and other market driven data, as well as the market’s perception of future interest rate movements. MSRs are classified as Level 3.
Assets and Liabilities Recorded at Fair Value on a Recurring Basis
The tables below present the recorded amount of assets and liabilities measured at fair value on a recurring basis.
Quoted Prices
In Active
Significant
Markets
for Identical
Observable
Unobservable
Assets
Inputs
(Level 1)
(Level 2)
(Level 3)
Derivative financial instruments
2,574
Securities available for sale:
2,980
Total securities available for sale
838,681
942,615
914,310
Liabilities
1,228
2,148
2,817
803,949
892,449
868,031
1,341
1,494
3,447
792,294
874,657
850,195
1,544
37
Changes in Level 1, 2 and 3 Fair Value Measurements
When a determination is made to classify a financial instrument within Level 3 of the valuation hierarchy, the determination is based upon the significance of the unobservable factors to the overall fair value measurement. However, since Level 3 financial instruments typically include, in addition to the unobservable or Level 3 components, observable components (that is, components that are actively quoted and can be validated to external sources), the gains and losses below include changes in fair value due in part to observable factors that are part of the valuation methodology.
There were no changes in hierarchy classifications of Level 3 assets or liabilities for the six months ended June 30, 2015. A reconciliation of the beginning and ending balances of Level 3 assets and liabilities recorded at fair value on a recurring basis for the six months ended June 30, 2015 and 2014 is as follows:
Fair value, January 1, 2015
Servicing assets that resulted from transfers of financial assets
3,921
Changes in fair value due to valuation inputs or assumptions
1,539
Changes in fair value due to increased principal paydowns
(1,736
Fair value, June 30, 2015
Fair value, January 1, 2014
20,729
2,054
(1,076
Fair value, June 30, 2014
There were no unrealized losses included in accumulated other comprehensive income related to Level 3 financial assets and liabilities at June 30, 2015 or 2014.
Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis
The tables below present the recorded amount of assets and liabilities measured at fair value on a nonrecurring basis:
Non-acquired impaired loans
10,079
12,612
8,620
Quantitative Information about Level 3 Fair Value Measurements
Weighted Average
Valuation Technique
Unobservable Input
Nonrecurring measurements:
Impaired loans
Discounted appraisals
Collateral discounts
4.21
%
5.80
4.37
Collateral discounts and estimated costs to sell
17.71
21.89
12.97
Fair Value of Financial Instruments
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those models are significantly affected by the assumptions used, including the discount rates and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. The use of different methodologies may have a material effect on the estimated fair value amounts. The fair value estimates presented herein are based on pertinent information available to management as of June 30, 2015, December 31, 2014 and June 30, 2014. Such amounts have not been revalued for purposes of these consolidated financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and Cash Equivalents — The carrying amount is a reasonable estimate of fair value.
Investment Securities — Securities held to maturity are valued at quoted market prices or dealer quotes. The carrying value of FHLB stock approximates fair value based on the redemption provisions. The carrying value of the Company’s investment in unconsolidated subsidiaries approximates fair value. See Note 5—Investment Securities for additional information, as well as page 37 regarding fair value.
Loans held for sale — The fair values disclosed for loans held for sale are based on commitments from investors for loans with similar characteristics.
Loans — For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans (e.g., one-to-four family residential) and other consumer loans are estimated using discounted cash flow analyses based on the Company’s current rates offered for new loans of the same type, structure and credit quality. Fair values for other loans (e.g., commercial real estate and investment property mortgage loans, commercial and industrial loans) are estimated using discounted cash flow analyses, using interest rates currently being offered by the Company for loans with similar terms to borrowers of similar credit quality. Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.
FDIC Receivable for Loss Share Agreements — The fair value is estimated based on discounted future cash flows using current discount rates.
Deposit Liabilities — The fair values disclosed for demand deposits (e.g., interest and non-interest bearing checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts, and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Federal Funds Purchased and Securities Sold Under Agreements to Repurchase — The carrying amount of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within ninety days approximate their fair values.
Other Borrowings — The fair value of other borrowings is estimated using discounted cash flow analysis on the Company’s current incremental borrowing rates for similar types of instruments.
Accrued Interest — The carrying amounts of accrued interest approximate fair value.
Derivative Financial Instruments — The fair value of derivative financial instruments (including interest rate swaps) is estimated using pricing models of derivatives with similar characteristics.
Commitments to Extend Credit, Standby Letters of Credit and Financial Guarantees — The fair values of commitments to extend credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair values of guarantees and letters of credit are based on fees currently charged for similar agreements or on the estimated costs to terminate them or otherwise settle the obligations with the counterparties at the reporting date.
The estimated fair value, and related carrying amount, of the Company’s financial instruments are as follows:
Carrying
Financial assets:
Cash and cash equivalents
Investment securities
860,806
12,011
848,795
Loans, net of allowance for loan losses
5,805,702
2,615
16,643
13,038
Interest rate swap — non-designated hedge
Other derivative financial instruments (mortgage banking related)
2,418
Financial liabilities:
6,372,390
50,714
Interest rate swap — cash flow hedge
806
Off balance sheet financial instruments:
Commitments to extend credit
31,401
Standby letters of credit and financial guarantees
827,517
13,560
813,957
5,743,017
7,150
16,366
12,923
6,193,580
98,534
4,311
856
313
14,759
817,317
13,965
803,352
5,718,977
18,619
15,667
3,496
12,171
1,309
6,576,138
6,316,613
104,810
4,282
942
416
19,872
42
Note 15 — Accumulated Other Comprehensive Income (Loss)
The changes in each components of accumulated other comprehensive income (loss), net of tax, were as follows:
Unrealized Gains
and Losses
Gains and
on Securities
Losses on
Benefit
Available
Cash Flow
Plans
for Sale
Hedges
Balance at March 31, 2015
(5,175
8,730
(557
2,998
Other comprehensive income (loss) before reclassifications
(5,108
Amounts reclassified from accumulated other comprehensive income (loss)
179
Net other comprehensive income (loss)
Balance at June 30, 2015
(5,036
3,604
(499
Balance at March 31, 2014
(3,585
93
(562
(4,054
4,334
4,268
194
Balance at June 30, 2014
(3,382
4,373
(583
Balance at December 31, 2014
(5,315
5,467
(529
(1,920
366
Balance at December 31, 2013
(5,573
(565
10,000
(110
9,890
92
Note 15 — Accumulated Other Comprehensive Income (Loss) (Continued)
The table below presents the reclassifications out of accumulated other comprehensive income (loss), net of tax:
Amount Reclassified from Accumulated Other Comprehensive Income (Loss)
Accumulated Other Comprehensive
Income (Loss) Component
Income Statement Line Item Affected
Gains and losses on cash flow hedges:
Interest rate contracts
Interest expense
Gains on sales of available for sale securities:
Other noninterest income
Amortization of defined benefit pension items:
Actuarial losses
Total reclassifications for the period
Note 16 — Derivative Financial Instruments
Cash Flow Hedge of Interest Rate Risk
The Company utilizes this interest rate swap agreement to convert a portion of its variable-rate debt to a fixed rate (cash flow hedge). During 2009, the Company entered into a forward starting interest rate swap agreement with a notional amount of $8.0 million to manage interest rate risk due to periodic rate resets on its junior subordinated debt issued by SCBT Capital Trust II, an unconsolidated subsidiary of the Company established for the purpose of issuing trust preferred securities. The Company hedges the variable rate cash flows of subordinated debt against future interest rate increases by using an interest rate swap that effectively fixed the rate on the debt beginning on June 15, 2010, at which time the debt contractually converted from a fixed interest rate to a variable interest rate. This hedge expires on June 15, 2019. The notional amount on which the interest payments are based will not be exchanged. This derivatives contract calls for the Company to pay a fixed rate of 4.06% on $8.0 million notional amount and receive a variable rate of three-month LIBOR on the $8.0 million notional amount.
The Company recognized an after-tax unrealized gain on its cash flow hedge in other comprehensive income of $58,000 and $30,000 for the three and six months ended June 30, 2015, respectively, compared to an after-tax unrealized gain on its cash flow hedge in other comprehensive income of $21,000 and $18,000 for the three and six months ended June 30, 2014, respectively. The Company recognized an $806,000 cash flow hedge liability in other liabilities on the balance sheet at June 30, 2015, compared to a $942,000 liability recognized at June 30, 2014. There was no ineffectiveness in the cash flow hedge during the three and six months ended June 30, 2015 and 2014.
Credit risk related to the derivative arises when amounts receivable from the counterparty (derivatives dealer) exceed those payable. The Company controls the risk of loss by only transacting with derivatives dealers that are national market makers whose credit ratings are strong. Each party to the interest rate swap is required to provide collateral in the form of cash or securities to the counterparty when the counterparty’s exposure to a mark-to-market replacement value exceeds certain negotiated limits. These limits are typically based on current credit ratings and vary with ratings changes. As of June 30, 2015 and 2014, the Company provided $850,000 and $1.1 million of collateral, respectively, which is included in cash and cash equivalents on the balance sheet as interest-bearing deposits with banks. Also, the Company has a netting agreement with the counterparty.
44
Note 16 — Derivative Financial Instruments (Continued)
Non-designated Hedges of Interest Rate Risk
Customer Swap
As of June 30, 2015, the Company has two interest rate swap contracts that were classified as non-designated hedges that were acquired through the merger transaction with Savannah. These derivatives are not designated as hedges and are not speculative in nature. One of the derivatives is an interest rate swap that was executed with a commercial borrower to facilitate a respective risk management strategy and allow the customer to pay a fixed rate of interest to the Company. This interest rate swap was simultaneously hedged by executing an offsetting interest rate swap that was entered into with a derivatives dealer to minimize the net risk exposure to the Company resulting from the transactions and allow the Company to receive a variable rate of interest.
The interest rate swap contract with the commercial borrower requires the borrower to pay or receive from the Company an amount equal to and offsetting the value of the interest rate swap. If the commercial borrower fails to perform and the market value for the interest rate swap with the derivatives dealer is negative (net liability position), the Company would be obligated to pay the settlement amount for the financial derivative with the dealer. If the market value for the interest rate swap with the derivatives dealer is positive (net asset position), the Company would receive a payment for the settlement amount for the financial derivative with the dealer. The settlement amount is determined by the fluctuation of interest rates.
As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. As of June 30, 2015, the interest rate swaps had an aggregate notional amount of approximately $3.9 million and the fair value of these two interest rate swap derivatives are recorded in other assets and in other liabilities for $156,000 on the balance sheet. The net effect of recording the derivatives at fair value through earnings was immaterial to the Company’s financial condition and results of operations during 2015.
The Company also has an agreement with the derivatives dealer in this transaction that contains a provision where if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on this derivatives obligation. As of June 30, 2015, the fair value of the interest rate swap derivative with the derivatives dealer was in a net liability position of $156,000, which excludes any adjustment for nonperformance risk, related to these agreements. As of June 30, 2015, the Company provided $355,000 of collateral, which is included in cash and cash equivalents on the balance sheet as interest-bearing deposits with banks. If the Company had breached any of these provisions at June 30, 2015, it would have been required to settle its obligations under the agreement at the termination value, $162,000.
Mortgage Banking
The Company also has derivatives contracts that are classified as non-designated hedges. These derivatives contracts are a part of the Company’s risk management strategy for its mortgage banking activities. These instruments may include financial forwards, futures contracts, and options written and purchased, which are used to hedge mortgage servicing rights; while when-issued securities are typically used to hedge the mortgage pipeline. Such instruments derive their cash flows, and therefore their values, by reference to an underlying instrument, index or referenced interest rate. The Company does not elect hedge accounting treatment for any of these derivative instruments and as a result, changes in fair value of the instruments (both gains and losses) are recorded in the Company’s consolidated statements of income in mortgage banking income.
Mortgage Servicing Rights
Derivatives contracts related to mortgage servicing rights are used to help offset changes in fair value and are written in amounts referred to as notional amounts. Notional amounts provide a basis for calculating payments between counterparties but do not represent amounts to be exchanged between the parties, and are not a measure of financial risk. On June 30, 2015, the Company had derivative financial instruments outstanding with notional amounts totaling $91.0 million related to mortgage servicing rights. The estimated net fair value of the open contracts related to the mortgage servicing rights was recorded as a loss of $266,000 at June 30, 2015.
Mortgage Pipeline
The following table presents the Company’s notional value of forward sale commitments and the fair value of those obligations along with the fair value of the mortgage pipeline.
Mortgage loan pipeline
114,782
67,201
99,563
Expected closures
86,087
50,760
74,672
Fair Value of mortgage loan pipeline commitments
1,335
1,304
Forward commitments
124,000
81,000
91,000
Fair value of forward commitments
1,099
(313
Note 17 — Capital Ratios
The Company is subject to regulations with respect to certain risk-based capital ratios. These risk-based capital ratios measure the relationship of capital to a combination of balance sheet and off-balance sheet risks. The values of both balance sheet and off-balance sheet items are adjusted based on the rules to reflect categorical credit risk. In addition to the risk-based capital ratios, the regulatory agencies have also established a leverage ratio for assessing capital adequacy. The leverage ratio is equal to Tier 1 capital divided by total consolidated on-balance sheet assets (minus amounts deducted from Tier 1 capital). The leverage ratio does not involve assigning risk weights to assets.
In July 2013, the Federal Reserve announced its approval of a final rule to implement the regulatory capital reforms developed by the Basel Committee on Banking Supervision (“Basel III”), among other changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The new rules became effective January 1, 2015, subject to a phase-in period for certain aspects of the new rules.
As applied to the Company and the Bank, the new rules include a new minimum ratio of common equity Tier 1 capital (“CET1”) to risk-weighted assets of 4.5%. The new rules also raise the minimum required ratio of Tier 1 capital to risk-weighted assets from 4% to 6%. The minimum required leverage ratio under the new rules is 4%. The minimum required total capital to risk-weighted assets ratio remains at 8% under the new rules.
In order to avoid restrictions on capital distributions and discretionary bonus payments to executives, under the new rules a covered banking organization will also be required to maintain a “capital conservation buffer” in addition to its minimum risk-based capital requirements. This buffer will be required to consist solely of common equity Tier 1, and the buffer will apply to all three risk-based measurements (CET1, Tier 1 capital and total capital). The capital conservation buffer will be phased in incrementally over time, beginning January 1, 2016 and becoming fully effective on January 1, 2019, and will ultimately consist of an additional amount of Tier 1 common equity equal to 2.5% of risk-weighted assets.
The Bank is also subject to the regulatory framework for prompt corrective action, which identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized) and is based on specified thresholds for each of the three risk-based regulatory capital ratios (CET1, Tier 1 capital and total capital) and for the leverage ratio.
Note 17 — Capital Ratios (Continued)
The following table presents actual and required capital ratios as of June 30, 2015 for the Company and the Bank under the Basel III capital rules. The minimum required capital amounts presented include the minimum required capital levels as of June 30, 2015 based on the phase-in provisions of the Basel III Capital Rules and the minimum required capital levels as of January 1, 2019 when the Basel III Capital Rules have been fully phased-in. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules.
Minimum Capital
Required to be
Required - Basel III
Considered Well
Actual
Phase-In Schedule
Fully Phased-In
Capitalized
Capital
Ratio
Common equity Tier 1 to risk-weighted assets:
Consolidated
695,107
12.16
257,546
4.50
400,628
7.00
372,011
6.50
South State Bank (the Bank)
725,545
12.68
257,452
400,480
371,874
Tier 1 capital to risk-weighted assets:
745,570
13.03
343,395
6.00
486,476
8.50
457,860
8.00
343,269
486,297
457,692
Total capital to risk-weighted assets:
785,245
13.72
600,941
10.50
572,325
10.00
765,221
13.38
600,720
572,115
Tier 1 capital to average assets (leverage ratio):
9.68
308,071
4.00
385,089
5.00
9.43
307,881
384,851
The following table presents actual and required capital ratios as of December 31, 2014 and June 30, 2014 under the regulatory capital rules then in effect.
Requirement
713,371
13.62
209,491
n/a
700,280
13.37
209,438
314,158
755,484
14.43
418,982
742,393
14.18
418,877
523,596
9.47
301,363
9.30
301,162
376,452
676,812
12.94
209,172
666,432
12.74
209,183
313,774
721,832
13.80
418,344
711,319
13.60
418,366
522,957
8.93
303,089
8.81
302,609
378,261
47
As of June 30, 2015, December 31, 2014, and June 30, 2014, the capital ratios of the Company and the Bank were well in excess of the minimum regulatory requirements and exceeded the thresholds for the “well capitalized” regulatory classification.
Note 18—Goodwill and Other Intangible Assets
The carrying amount of goodwill was $317.7 million at June 30, 2015. The Company’s other intangible assets, consisting of core deposit intangibles, noncompete intangibles, and client list intangibles are included on the face of the balance sheet. The following is a summary of gross carrying amounts and accumulated amortization of other intangible assets:
Gross carrying amount
75,354
Accumulated amortization
(30,094
(26,115
(21,983
Amortization expense totaled $2.0 million and $4.0 million for the three and six months ended June 30, 2015, respectively. Other intangibles are amortized using either the straight-line method or an accelerated basis over their estimated useful lives, with lives generally between two and 15 years. Estimated amortization expense for other intangibles for each of the next five quarters is as follows:
Quarters ending:
September 30, 2015
1,963
December 31, 2015
1,948
March 31, 2016
June 30, 2016
1,592
September 30, 2016
1,591
Thereafter
36,562
Note 19 — Loan Servicing, Mortgage Origination, and Loans Held for Sale
As of June 30, 2015, December 31, 2014, and June 30, 2014, the portfolio of residential mortgages serviced for others, which is not included in the accompanying balance sheets, was $2.5 billion, $2.3 billion, and $2.2 billion, respectively. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts and disbursing payments to investors. The amount of contractually specified servicing fees earned by the Company during the three and six months ended June 30, 2015 and June 30, 2014 was $1.5 million and $3.0 million, and $1.4 million and $2.7 million, respectively. Servicing fees are recorded in mortgage banking income in the Company’s consolidated statements of income.
At June 30, 2015, December 31, 2014, and June 30, 2014, mortgage servicing rights (“MSRs”) were $25.3 million, $21.6 million, and $21.0 million on the Company’s consolidated balance sheets, respectively. MSRs are recorded at fair value with changes in fair value recorded as a component of mortgage banking income in the consolidated statements of income. The market value adjustments related to MSRs recorded in mortgage banking income for the three and six months ended June 30, 2015 were gains of $2.4 million and $1.5 million, respectively, compared to losses for the three and six months ended June 30, 2014 of $483,000 and $692,000, respectively. Since the merger with FFHI, the Company has used various free standing derivative instruments to mitigate the income statement effect of changes in fair value due to changes in market value adjustments and to changes in valuation inputs and assumptions related to MSRs.
The following table presents the changes in the fair value of MSRs and the offsetting hedge.
Increase (decrease) in fair value of MSRs
2,374
(483
Decay of MSRs
(899
(621
Gains (losses) related to derivatives
(1,092
1,140
1,935
Net effect on Statements of Income
383
167
48
Note 19 — Loan Servicing, Mortgage Origination, and Loans Held for Sale (Continued)
The fair value of MSRs is highly sensitive to changes in assumptions and fair value is determined by estimating the present value of the asset’s future cash flows utilizing market-based prepayment rates, discount rates and other assumptions validated through comparison to trade information, industry surveys and with the use of independent third party appraisals. Changes in prepayment speed assumptions have the most significant impact on the fair value of MSRs. Generally, as interest rates decline, mortgage loan prepayments accelerate due to increased refinance activity, which results in a decrease in the fair value of the MSR. During the first half of 2015, interest rates increased and prepayments slowed, which has resulted in an increase in the fair value of the MSR. Measurement of fair value is limited to the conditions existing and the assumptions utilized as of a particular point in time, and those assumptions may not be appropriate if they are applied at a different time. See Note 14—Fair Value for additional information regarding fair value.
The characteristics and sensitivity analysis of the MSR are included in the following table.
Composition of residential loans serviced for others
Fixed-rate mortgage loans
99.3
99.2
99.1
Adjustable-rate mortgage loans
0.7
0.8
0.9
100.0
Weighted average life
7.38 years
6.30 years
6.01 years
Constant prepayment rate
9.0
11.4
12.1
Weighted average discount rate
9.7
9.4
Effect on fair value due to change in interest rates:
25 basis point increase
1,365
50 basis point increase
2,490
2,555
2,499
25 basis point decrease
(1,567
(1,562
(1,470
50 basis point decrease
(3,313
(3,221
(2,736
The sensitivity calculations in the previous table are hypothetical and should not be considered to be predictive of future performance. Changes in fair value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the changes in assumptions to fair value may not be linear. Also, the effects of an adverse variation in a particular assumption on the fair value of the MSRs is calculated without changing any other assumptions, while in reality, changes in one factor may result in changing another, which may magnify or contract the effect of the change.
Custodial escrow balances maintained in connection with the loan servicing were $17.8 million and $15.6 million at June 30, 2015 and June 30, 2014, respectively.
Mandatory cash forwards and whole loan sales were $259.0 million and $455.0 million for the three and six months ended June 30, 2015, respectively, compared to $154.6 million and $270.3 million for the three and six months ended June 30, 2014, respectively. For the three and six months ended June 30, 2015, $204.0 million and $351.1 million, or 78.8% and 77.2%, respectively, were sold with the servicing rights retained by the company compared to $128.2 million and $216.0 million, or 82.9% and 80.0%, for the three and six months ended June 30, 2014, respectively.
Loans held for sale have historically been comprised of residential mortgage loans awaiting sale in the secondary market, which generally settle in 15 to 45 days. Loans held for sale, which consists primarily of residential mortgage loans to be sold in the secondary market, were $73.1 million, $61.9 million, and $56.4 million at June 30, 2015, December 31, 2014, and June 30, 2014, respectively.
Note 20 — Investments in Qualified Affordable Housing Projects
The Company has investments in qualified affordable housing projects (“QAHPs”) that provide low income housing tax credits and operating loss benefits over an extended period. The tax credits and the operating loss tax benefits that are generated by each of the properties are expected to exceed the total value of the investment made by the Company. For the six months ended June 30, 2015, tax credits and other tax benefits of $918,000 and the Company’s share of book losses of $655,000 were recorded. For the six months ended June 30, 2014, the Company recorded tax credits and other tax benefits of $713,000 and the Company’s share of book losses of $304,000. At June 30, 2015 and 2014, the Company’s carrying value of QAHPs was $12.7 million and $14.4 million, respectively, with an original investment of $22.1 million. The Company has $1.7 million and $7.6 million in remaining funding obligations related to these QAHPs recorded
in liabilities at June 30, 2015 and 2014, respectively. None of the original investment will be repaid. The investment in QAHPs is being accounted for using the equity method.
Note 21 — Repurchase Agreements
Securities sold under agreements to repurchase (“repurchase agreements”) represent funds received from customers, generally on an overnight or continuous basis, which are collateralized by investment securities owned or, at times, borrowed and re-hypothecated by the Company. Repurchase agreements are subject to terms and conditions of the master repurchase agreements between the Company and the client and are accounted for as secured borrowings. Repurchase agreements are included in federal funds purchased and securities sold under agreements to repurchase on the condensed consolidated balance sheets.
At June 30, 2015, December 31, 2014 and June 30, 2014, the Company’s repurchase agreements totaled $228.7 million, $160.9 million, and $193.2 million, respectively. All of the Company’s repurchase agreements were overnight or continuous (until-further-notice) agreements at June 30, 2015, December 31, 2014, and June 30, 2014. These borrowings were collateralized with government, government-sponsored enterprise, or state and political subdivision-issued securities with a carrying value of $228.7 million, $160.8 million and $193.2 million at June 30, 2015, December 31, 2014 and June 30, 2014, respectively. Declines in the value of the collateral would require the Company to increase the amounts of securities pledged.
Note 22 — Subsequent Events
Branch Initiatives - Update
On April 22, 2015, the Bank entered into a Purchase Agreement to purchase twelve South Carolina branch locations and one Georgia branch location from Bank of America, N.A. The branches are located in Florence, Greenwood, Orangeburg, Sumter, Newberry, Batesburg-Leesville, Abbeville and Hartsville, South Carolina, as well as Hartwell, Georgia. As a result of the transaction, the Bank will enter into six new markets and three markets which overlap. The Company will pay a 5.5% deposit premium on the 30-day average closing balance of deposits prior to closing. The Company expects the transaction to close on or around August 21, 2015, subject to customary closing conditions. All regulatory approvals have been received.
The Company is also consolidating or selling fourteen branches and ATM locations. Eight of these locations were consolidated during the second quarter and the remaining six will be consolidated or sold during the last half of 2015. The Company has entered into a contract to sell two of the fourteen branches, and expects to receive a 3.5% deposit premium on the 30- day average closing balance of deposits prior to closing. The sale is expected to close in the fourth quarter of 2015, subject to regulatory approval and other customary closing conditions.
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s Discussion and Analysis of Financial Condition and Results of Operations relates to the financial statements contained in this Quarterly Report beginning on page 1. For further information, refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations appearing in the Annual Report on Form 10-K for the year ended December 31, 2014. Results for the three and six month periods ended June 30, 2015 are not necessarily indicative of the results for the year ending December 31, 2015 or any future period.
Overview
We are a bank holding company headquartered in Columbia, South Carolina, and were incorporated under the laws of South Carolina in 1985. We provide a wide range of banking services and products to our customers through our wholly-owned bank subsidiary, South State Bank (the “Bank”), a South Carolina-chartered commercial bank that opened for business in 1934. The Bank also operates Minis & Co., Inc. and First Southeast 401k Fiduciaries, both wholly owned registered investment advisors; and First Southeast Investor Services, a wholly owned limited service broker dealer. The Company does not engage in any significant operations other than the ownership of our banking subsidiary.
At June 30, 2015, we had approximately $8.1 billion in assets and 2,028 full-time equivalent employees. Through the Bank, we provide our customers with checking accounts, NOW accounts, savings and time deposits of various types, brokerage services and alternative investment products such as annuities and mutual funds, trust and asset management services, business loans, agriculture loans, real estate loans, personal use loans, home improvement loans, manufactured housing loans, automobile loans, credit cards, letters of credit, home equity lines of credit, safe deposit boxes, bank money orders, wire transfer services, correspondent banking services, and use of ATM facilities.
We have pursued, and continue to pursue, a growth strategy that focuses on organic growth, supplemented by acquisition of select financial institutions, or branches in certain market areas.
The following discussion describes our results of operations for the three and six months ended June 30, 2015 as compared to the three and six months ended June 30, 2014 and also analyzes our financial condition as of June 30, 2015 as compared to December 31, 2014 and June 30, 2014. Like most financial institutions, we derive most of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we may pay interest. Consequently, one of the key measures of our success is the amount of our net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.
Of course, there are risks inherent in all loans, so we maintain an allowance for loan losses (sometimes referred to as “ALLL”) to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the following section, we have included a detailed discussion of this process.
In addition to earning interest on our loans and investments, we earn income through fees we charge to our customers. We describe the various components of this noninterest income, as well as our noninterest expense, in the following discussion.
The following section also identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information also included in this report.
Recent Events
Branch Initiatives
On April 22, 2015, the Bank entered into a Purchase Agreement to purchase 12 South Carolina branch locations and one Georgia branch location from Bank of America, N.A. The branches are located in Florence, Greenwood, Orangeburg, Sumter, Newberry, Batesburg-Leesville, Abbeville and Hartsville, South Carolina, as well as Hartwell, Georgia. As a result of the transaction, the Bank will enter into six new markets and three markets which overlap. The Company has received all regulatory approvals and expects the transaction to close in the third quarter of 2015, subject to customary closing conditions. The Company will pay a 5.5% deposit premium on the 30-day average closing balance of deposits prior to closing.
During the second quarter of 2015, the Company completed eight of the twelve branch and ATM location consolidations previously announced. The Company expects to complete the remaining four consolidations by the end of 2015. In addition, the Company has entered into a contract to sell two branches with deposits. The Company will receive a 3.5% deposit premium on the 30-day average closing balance of deposits prior to closing. The sale is expected to close in the fourth quarter of 2015, subject to regulatory approval and other customary closing conditions.
Critical Accounting Policies
We have established various accounting policies that govern the application of accounting principles generally accepted in the United States (“GAAP”) in the preparation of our financial statements. Significant accounting policies are described in Note 1 to the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2014. These policies may involve significant judgments and estimates that have a material impact on the carrying value of certain assets and liabilities. Different assumptions made in the application of these policies could result in material changes in our financial position and results of operations.
Allowance for Loan Losses
The allowance for loan losses reflects the estimated losses that will result from the inability of our bank’s borrowers to make required loan payments. In determining an appropriate level for the allowance, we identify portions applicable to specific loans as well as providing amounts that are not identified with any specific loan but are derived with reference to actual loss experience, loan types, loan volumes, economic conditions, and industry standards. Changes in these factors may cause our estimate of the allowance to increase or decrease and result in adjustments to the provision for loan losses. See “Note 6 — Loans and Allowance for Loan Losses” in this Form 10-Q, “Provision for Loan Losses and Nonperforming Assets” in this Management’s Discussion and Analysis of Financial Condition and Results of Operation (“MD&A”) and “Allowance for Loan Losses” in Note 1 to the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2014 for further detailed descriptions of our estimation process and methodology related to the allowance for loan losses.
Goodwill and Other Intangible Assets
Goodwill represents the excess of the purchase price over the sum of the estimated fair values of the tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed in a business combination. As of June 30, 2015, December 31, 2014 and June 30, 2014, the balance of goodwill was $317.7 million. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. The goodwill impairment analysis is a two-step test. The first step, used to identify potential impairment, involves comparing each reporting unit’s estimated fair value to its carrying value, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying value, goodwill is not considered to be impaired. If the carrying value exceeds estimated fair value, there is an indication of potential impairment and the second step is performed to measure the amount of impairment, if any.
If required, the second step involves calculating an implied fair value of goodwill for each reporting unit for which the first step indicated impairment. The implied fair value of goodwill is determined in a manner similar to the amount of goodwill calculated in a business combination, by measuring the excess of the estimated fair value of the reporting unit, as determined in the first step, over the aggregate estimated fair values of the individual assets, liabilities and identifiable intangibles as if the reporting unit was being acquired in a business combination. If the implied fair value of goodwill exceeds the carrying value of goodwill assigned to the reporting unit, there is no impairment. If the carrying value of goodwill assigned to a reporting unit exceeds the implied fair value of the goodwill, an impairment charge is recorded for the excess. An impairment loss cannot exceed the carrying value of goodwill assigned to a reporting unit, and the loss establishes a new basis in the goodwill. Subsequent reversal of goodwill impairment losses is not permitted. Management has determined that the Company has two reporting units.
Our stock price has historically traded above its book value. As of June 30, 2015, book value was $42.31 per common share. The lowest trading price during the first six months of 2015, as reported by the NASDAQ Global Select Market, was $58.84 per share, and the stock price closed on June 30, 2015 at $75.99 per share, which is above book value. In the event our stock was to consistently trade below its book value during the reporting period, we would consider performing an evaluation of the carrying value of goodwill as of the reporting date. Such a circumstance would be one factor in our evaluation that could result in an eventual goodwill impairment charge. We evaluated the carrying value of goodwill as of April 30, 2015, our annual test date, and determined that no impairment charge was necessary. Additionally, should our future earnings and cash flows decline and/or discount rates increase, an impairment charge to goodwill and other intangible assets may be required.
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Core deposit intangibles, client list intangibles, and noncompetition (“noncompete”) intangibles consist of costs that resulted from the acquisition of other banks from other financial institutions. Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in these transactions. Client list intangibles represent the value of long-term client relationships for the wealth and trust management business. Noncompete intangibles represent the value of key personnel relative to various competitive factors such as ability to compete, willingness or likelihood to compete, and feasibility based upon the competitive environment, and what the Bank could lose from competition. These costs are amortized over the estimated useful lives, such as deposit accounts in the case of core deposit intangible, on a method that we believe reasonably approximates the anticipated benefit stream from this intangible. The estimated useful lives are periodically reviewed for reasonableness.
Income Taxes and Deferred Tax Assets
Income taxes are provided for the tax effects of the transactions reported in the accompanying consolidated financial statements and consist of taxes currently due plus deferred taxes related primarily to differences between the basis of available-for-sale securities, allowance for loan losses, accumulated depreciation, net operating loss carryforwards, accretion income, deferred compensation, intangible assets, and pension plan and post-retirement benefits. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The Company files a consolidated federal income tax return with its subsidiary.
The Company recognizes interest and penalties accrued relative to unrecognized tax benefits in its respective federal or state income taxes accounts. As of June 30, 2015, there were no accruals for uncertain tax positions and no accruals for interest and penalties. The Company and its subsidiary file a consolidated United States federal income tax return, as well as income tax returns for its subsidiary in the states of South Carolina, Georgia, North Carolina, Florida, Virginia, Alabama, and Mississippi. The Company’s filed income tax returns are no longer subject to examination by taxing authorities for years before 2010.
Other Real Estate Owned
Other real estate owned (“OREO”), consisting of properties obtained through foreclosure or through a deed in lieu of foreclosure in satisfaction of loans or through reclassification of former branch sites, is reported at the lower of cost or fair value, determined on the basis of current valuations obtained principally from independent sources, adjusted for estimated selling costs. At the time of foreclosure or initial possession of collateral, any excess of the loan balance over the fair value of the real estate held as collateral is treated as a charge against the allowance for loan losses. Subsequent adjustments to this value are described below.
Subsequent declines in the fair value of OREO below the new cost basis are recorded through valuation adjustments. Significant judgments and complex estimates are required in estimating the fair value of OREO, and the period of time within which such estimates can be considered current is significantly shortened during periods of market volatility. In response to market conditions and other economic factors, management may utilize liquidation sales as part of its problem asset disposition strategy. As a result of the significant judgments required in estimating fair value and the variables involved in different methods of disposition, the net proceeds realized from sales transactions could differ significantly from the current valuations used to determine the fair value of OREO. Management reviews the value of OREO periodically and adjusts the values as appropriate. Revenue and expenses from OREO operations as well as gains or losses on sales and any subsequent adjustments to the value are recorded as OREO expense and loan related expense, a component of non-interest expense, and, for covered OREO, offset with an increase in the FDIC indemnification asset.
Business Combinations, Method of Accounting for Loans Acquired, and FDIC Indemnification Asset
We account for acquisitions under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, Business Combinations, which requires the use of the acquisition method of accounting. All identifiable assets acquired, including loans, are recorded at fair value. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk.
Acquired credit-impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality, found in FASB ASC Topic 310-30, Receivables—Loans and Debt Securities Acquired with Deteriorated Credit Quality, formerly American Institute of Certified Public Accountants (“AICPA”) Statement of Position (SOP) 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer, and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loans. Loans acquired in business combinations with evidence of credit deterioration are considered impaired. Loans acquired through business combinations that do not meet the
specific criteria of FASB ASC Topic 310-30, but for which a discount is attributable, at least in part to credit quality, are also accounted for under this guidance. Certain acquired loans, including performing loans and revolving lines of credit (consumer and commercial), are accounted for in accordance with FASB ASC Topic 310-20, where the discount is accreted through earnings based on estimated cash flows over the estimated life of the loan.
In accordance with FASB ASC Topic 805, the FDIC indemnification assets are initially recorded at fair value, and are measured separately from the loan assets and foreclosed assets because the loss sharing agreements are not contractually embedded in them or transferrable with them in the event of disposal. The FDIC indemnification asset is measured at carrying value subsequent to initial measurement. Improved cash flows of the underlying covered assets will result in impairment of the FDIC indemnification asset and amortization through non-interest income over the shorter of the lives of the FDIC indemnification asset or the underlying loans. Impairment of the underlying covered assets will result in improved cash flows of the FDIC indemnification asset and a credit to the provision for loan losses for acquired loans will result.
For further discussion of the Company’s loan accounting and acquisitions, see “Business Combinations and Method of Accounting for Loans Acquired” in our Annual Report on Form 10-K for the year ended December 31, 2014, Note 4—Mergers and Acquisitions to the unaudited condensed consolidated financial statements and Note 6—Loans and Allowance for Loan Losses to the unaudited condensed consolidated financial statements.
Results of Operations
We reported consolidated net income available to common shareholders of $24.9 million, or diluted earnings per share (“EPS”) of $1.03, for the second quarter of 2015 as compared to consolidated net income available to common shareholders of $17.9 million, or diluted EPS of $0.74, in the comparable period of 2014. The $6.9 million increase in consolidated net income available to common shareholders was the net result of the following items:
· An increase in noninterest income totaling $5.7 million due to a $3.8 million reduction in the amortization of the FDIC indemnification asset and a $2.4 million increase in mortgage banking income;
· Noninterest expense declined by $4.4 million in the second quarter to $71.5 million compared to the same quarter in 2014. The largest decrease was in one-time costs (branch consolidation expenses for 2015 and merger and conversion related expenses in 2014) of $4.3 million;
· An increase in the provision for income taxes of $3.4 million due to higher pre-tax income; and
· Diluted EPS was $1.03 compared to $0.74 in the comparable period in 2014 due to the 38.6% increase in net income available to common shareholders.
Our asset quality related to non-acquired loans continues to improve from the end of 2014 and from the end of the first quarter of 2015. Non-acquired nonperforming assets declined from $34.1 million at March 31, 2015 to $30.5 million at June 30, 2015, a $3.6 million decline. Compared to the balance of nonperforming assets at June 30, 2014, nonperforming assets decreased $13.8 million due to a reduction in nonperforming loans of $10.7 million and a reduction in non-acquired OREO of $3.1 million. Our non-acquired OREO decreased by $573,000 from March 31, 2015 to $5.9 million at June 30, 2015. During the second quarter of 2015, total classified assets declined by $9.5 million from March 31, 2015 to $113.7 million at June 30, 2015. Annualized net charge-offs (recoveries) for the second quarter of 2015 were 0.12%, down from net charge-offs in the second quarter of 2014 of 0.17% and up from net recoveries in the first quarter of 2015 of (0.01%).
The allowance for loan losses decreased to 0.92% of total non-acquired loans at June 30, 2015, down from 0.94% at March 31, 2015 and 1.12% at June 30, 2014. The allowance provides 1.41 times coverage of non-acquired nonperforming loans at June 30, 2015, higher than 1.22 times at March 31, 2015, and 1.00 times at June 30, 2014.
During the second quarter of 2015, the Company had net charge-offs related to “acquired non-credit impaired loans” which totaled $533,000, or 0.18% annualized, and accordingly, recorded a provision for loan losses for the same amount. Additionally, we have $5.3 million in nonperforming loans from this loan portfolio, down from $7.4 million at March 31, 2015.
The Company performs ongoing assessments of the estimated cash flows of its acquired credit impaired loan portfolios. In general, increases in cash flow expectations result in a favorable adjustment to interest income over the remaining life of the related loans, and decreases in cash flow expectations result in an immediate recognition of a provision for loans losses, in both cases, net of any adjustments to the receivable from the FDIC for loss sharing for those assets that are covered. When a provision for loan losses (impairments) has been recognized in earlier periods, subsequent improvement in cash flows will result in reversals of those impairments.
These ongoing assessments of the acquired loan portfolio resulted in reduced loan interest accretion due to continued decline in loan balances of both the acquired credit impaired and the acquired non-credit impaired portfolio. The overall credit mark for these loans continued to decline, partially from charge offs and partially from net improvement in expected cash flow. Below is a summary of the second quarter of 2015 assessment of the impact acquired loan portfolio and the related impact on the indemnification asset:
· Removals from the loan pools due to repayments, charge offs, and transfers to OREO or other assets owned through foreclosures resulted in a decline in acquired loan interest income of $1.0 million from the first quarter of 2015, and a decline of $4.8 million compared to the second quarter of 2014, as the acquired loan balances decreased even though the yield improved; and
· The amortization of the indemnification asset also decreased by approximately $1.2 million compared to the first quarter of 2015, and by $3.8 million compared to the second quarter of 2014. This was primarily the result of the expiration of the commercial loss share agreement from the CBT FDIC transaction (which began in January of 2010) that occurred at March 31, 2015. We anticipate a continued decline in the amortization of the indemnification asset in subsequent periods, however, the decline is not expected to be as significant.
The table below provides an analysis of the total loan portfolio yield which includes both non-acquired and acquired loans (credit impaired and non-credit impaired loan portfolios). The acquired loan yield continues to increase due to the continued improvement in overall credit quality of this portfolio and the actual cash flows being faster than previously expected.
Average balances:
Acquired loans, net of allowance for loan losses
2,053,501
2,557,372
2,123,275
2,647,117
Non-acquired loans
3,659,674
3,061,529
3,586,745
2,985,772
Total loans, excluding held for sale
5,713,175
5,618,901
5,710,020
5,632,889
Noncash interest income on acquired loans
2,229
3,158
5,183
Acquired loan interest income
40,283
44,515
81,659
92,598
41,899
46,744
84,817
97,781
36,885
32,143
72,401
62,627
78,784
78,887
157,218
160,408
Non-taxable equivalent yield:
Acquired loans
8.18
7.33
8.06
7.45
4.04
4.07
4.23
5.53
5.63
5.55
5.74
Compared to the balance at March 31, 2015, our non-acquired loan portfolio has increased $202.0 million, or 22.6% annualized, to $3.8 billion, driven by increases in most categories. Consumer real estate lending increased by $62.3 million, or 21.8% annualized; consumer non real estate lending by $14.1 million, or 28.9% annualized; commercial owner occupied loans by $50.5 million, or 21.9% annualized; and commercial and industrial by $40.3 million, or 39.6% annualized. The acquired loan portfolio decreased by $118.2 million in the second quarter of 2015 due to continued payoffs, charge-offs, and transfers to OREO. Since June 30, 2014, the non-acquired loan portfolio has grown by $613.8 million, or 19.3%, driven by increases in most categories. Consumer real estate loans have led the way and increased by $298.9 million, or 32.9%, in the past year.
Non-taxable equivalent net interest income for the quarter increased $1.3 million, or 1.61%, compared to the second quarter of 2014. Non-taxable equivalent net interest margin was flat from the second quarter of 2014 of 4.70% due to the decrease in the rate on interest bearing liabilities offsetting the decrease in yield on interesting earning assets. Compared to the first quarter of 2015, net interest margin (taxable equivalent) decreased by three basis points. The yield on interest earning assets decreased by five basis points primarily due to a $140.3 million decrease in the average balance of the acquired loan portfolio. The rate on interest bearing liabilities decreased by four basis points compared to the first quarter of 2015 from a five basis point decrease in the rates on time deposit balances and a 123 basis point decrease in the rates on other borrowings due to the redemption of $46.3 million of trust preferred securities in the first quarter of 2015.
Our quarterly efficiency ratio decreased to 63.2%, compared to 65.1% in the first quarter of 2015 and from 71.5% in the second quarter of 2014. The decrease in the efficiency ratio compared to the first quarter of 2015 was the result of a $3.6 million increase in noninterest income. The increase in noninterest income was driven by improvement in all categories led by a $1.2 million increase in fees on deposit accounts and the $1.2 million reduction in the amortization of the FDIC indemnification asset. The decrease in the efficiency ratio compared to the second quarter of 2014 was the result of a 23.3% increase in noninterest income and a 5.7% decrease in noninterest expense. Compared to the second quarter of 2014, noninterest expense was down by $4.4 million with a $4.3 million decrease in one-time expenses. Excluding merger and branding related expenses, the efficiency ratio was 61.2% for the second quarter of 2015, compared to 65.1% for the first quarter of 2015 and 65.4% for the second quarter of 2014.
Diluted EPS and basic EPS increased to $1.03 and $1.04, respectively for the second quarter of 2015, from the second quarter 2014 amounts of $0.74 and $0.75, respectively. This was the result of a 38.6% increase in net income available to common shareholders.
Selected Figures and Ratios
Return on average assets (annualized)
1.24
0.91
0.88
Return on average common equity (annualized)
9.78
7.63
9.75
7.27
Return on average equity (annualized)
7.26
Return on average tangible common equity (annualized)*
16.00
16.10
13.12
Return on average tangible equity (annualized)*
12.80
Dividend payout ratio **
23.35
26.89
23.29
27.84
Equity to assets ratio
12.66
11.92
Average shareholders’ common equity (in thousands)
1,020,245
942,935
1,008,934
937,479
Average shareholders’ equity (in thousands)
968,363
* - Ratio is a non-GAAP financial measure. The section titled “Reconciliation of Non-GAAP to GAAP” below provides a table that reconciles non-GAAP measures to GAAP measures.
** - See explanation of the dividend payout ratio below.
· For the three months ended June 30, 2015, return on average tangible equity increased compared to the same period in 2014. The increase was driven by the 35.5% increase in net income available to common shareholders excluding amortization of intangibles. Similarly, return on average assets increased to 1.24%, compared to 0.91% for the three months ended June 30, 2014, due to the growth in net income.
· Dividend payout ratio decreased to 23.4% for the three months ended June 30, 2015, compared with 26.9% for the three months ended June 30, 2014. The decrease from the comparable period in 2014 primarily reflects the higher net income for the three months ended June 30, 2015, compared to the increase of $0.04 per share, or 20.0%, in the cash dividends declared per common share. The dividend payout ratio is calculated by dividing total dividends paid during the quarter by the total net income reported for the same period.
· Equity to assets ratio increased to 12.7% at June 30, 2015, compared with 11.9% at June 30, 2014. The increase in the equity to assets ratio reflects a 1.1% increase in assets compared to a 7.4% increase in equity as a result of the Company’s retained earnings.
· Quarterly average shareholders’ equity increased $77.3 million, or 8.2%, from the quarter ended June 30, 2014 driven by earnings partially offset by dividends paid to shareholders.
Reconciliation of Non-GAAP to GAAP
Return on average tangible equity (non-GAAP)
Effect to adjust for intangible assets
-6.22
-5.99
-6.35
-5.54
Return on average equity (GAAP)
Adjusted average shareholders’ equity (non-GAAP)
656,039
568,914
644,035
592,729
Average intangible assets
364,206
374,021
364,899
375,634
Average shareholders’ equity (GAAP)
Adjusted net income (non-GAAP)
26,168
19,315
51,425
37,615
(1,964
(2,084
(3,980
(4,188
668
715
1,353
1,436
Net income (GAAP)
Return on average common tangible equity (non-GAAP)
-5.85
Return on average common equity (GAAP)
Adjusted average common shareholders’ equity (non-GAAP)
561,845
Average common shareholders’ equity (GAAP)
Adjusted net income available to common shareholders (non-GAAP)
36,542
Net income available to common shareholders (GAAP)
The returns on average tangible equity and average common tangible equity are non-GAAP financial measures. They exclude the effect of the average balance of intangible assets and add back the after-tax amortization of intangibles to GAAP basis net income. Management believes that these non-GAAP measures provide additional useful information, particularly since these measures are widely used by industry analysts following companies with prior merger and acquisition activities. Non-GAAP measures should not be considered as an alternative to any measure of performance or financial condition as promulgated under GAAP, and investors should consider the company’s performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the company. Non-GAAP measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of our results of financial condition as reported under GAAP.
Net Interest Income and Margin
Summary
Our taxable equivalent (“TE”) net interest margin was flat from the second quarter of 2014, due primarily to the seven basis point decline in the yield on interest earning assets, offset by a ten basis point decline in the rate on interest bearing liabilities. The net interest margin decreased by three basis points from the first quarter of 2015 to 4.75%. Yields on average earning assets decreased by five basis points from the first quarter of 2015, while the rate on average interest bearing liabilities decreased by four basis points.
Net interest income increased from the second quarter of 2014 by $1.3 million. This increase was primarily driven by the $598.1 million increase in the average balance of the non-acquired loan portfolio, partially offset by a $503.9 million decrease in the average balance of the acquired loan portfolio and a $46.0 million reduction in the average balance of other borrowings due to the redemption of $46.3 million in trust preferred securities. Certificates of deposit average rate declined by four basis points from the second quarter of 2014 along with the average balance decreasing $255.9 million. Year-over-year interest expense declined $1.4 million, and the cost of funds decreased ten basis points.
Non-TE net interest income
Non-TE yield on interest-earning assets
4.85
4.92
4.87
5.03
Non-TE rate on interest-bearing liabilities
0.19
0.29
0.21
Non-TE net interest margin
4.70
4.72
4.80
TE net interest margin
4.75
4.76
Non-TE net interest income increased $1.3 million, or 1.61%, in the second quarter of 2015 compared to the same period in 2014. Some key highlights are outlined below:
· Average interest-earning assets increased 1.5% to $7.0 billion in the second quarter of 2015 compared to the same period last year due primarily to the increase in non-acquired loans.
· Non-TE yield on interest-earning assets for the second quarter of 2015 decreased 7 basis points from the comparable period in 2014. The decrease since the second quarter of 2014 was driven by a 17 basis point decrease in the yield on non-acquired loans and a 19 basis point decrease in the yield on taxable investment securities portfolio. These decreases were partially offset by an 85 basis point increase in the yield of acquired loans. The loan portfolio continues to remix with 65% of the portfolio being comprised of non-acquired loans and 35% being acquired loans. This compares to 56% and 44% one year ago.
· The average cost of interest-bearing liabilities for the second quarter of 2015 decreased ten basis points from the same period in 2014. The decrease since the second quarter of 2014 was primarily the result of a decline in other borrowings from the redemption of trust preferred securities of $46.3 million in the first quarter of 2015. The average cost decreased from 5.99% in the second quarter of 2014 to 4.71% in the second quarter of 2015. The expected cost of funds on our remaining other borrowings (trust preferred securities), assuming the rate environment remains low, should be approximately 4.50% in the third quarter of 2015. This will result from $20.6 million in trust preferred securities converting from a fixed rate of 5.92% to a floating rate of three month LIBOR plus 159 basis points on September 15, 2015.
· TE net interest margin was flat in the second quarter of 2015 compared to the second of 2014.
The following table presents a summary of the loan portfolio by category:
% of
Acquired loans:
Acquired covered loans:
0.2
20,275
0.4
30,859
0.5
13,726
35,035
0.6
47,017
27,276
55,310
1.0
77,876
1.3
26,267
30,304
36,017
31,979
35,509
33,684
58,246
1.1
65,813
69,701
1.2
21,711
45,986
72,247
4,965
0.1
9,887
11,309
20,820
27,521
Consumer non real estate
0.0
675
1,583
Total acquired covered loans
123,607
2.2
198,491
3.5
260,639
4.5
Acquired non-covered loans:
60,436
65,959
86,830
1.5
176,358
3.0
181,652
3.2
191,637
3.4
236,794
4.0
247,611
4.4
278,467
4.9
754,156
13.0
842,995
14.7
912,346
16.1
267,234
4.6
294,589
5.1
313,318
5.5
1,021,390
17.6
1,137,584
19.8
1,225,664
21.6
166,911
2.9
176,268
3.1
188,490
3.3
57,083
67,028
69,953
133,206
2.3
139,496
2.4
154,100
2.7
261,351
288,288
5.0
326,765
5.8
Total acquired non-covered loans
1,876,735
32.3
2,056,275
35.9
2,243,439
39.5
2,000,342
34.5
2,254,766
39.4
2,504,078
44.0
6.4
6.5
6.1
5.3
12.5
12.2
11.8
15.7
13.7
11.2
5.2
4.8
20.9
18.7
16.0
16.9
15.9
15.0
7.7
7.1
6.2
2.8
2.6
3.6
65.5
60.6
56.0
Total loans (net of unearned income)
5,788,741
5,722,592
5,678,703
Note: Loan data excludes loans held for sale.
Total loans, net of deferred loan costs and fees (excluding mortgage loans held for sale), increased by $110.0 million, or 1.9%, at June 30, 2015 as compared to the same period in 2014. Acquired covered loans decreased by $137.0 million and acquired non-covered loans decreased by $366.7 million due to principal payments, charge offs, and foreclosures. In addition to the reductions for principal payments, charge offs, and foreclosures, the acquired covered loans decreased by $49.3 million in the second quarter of 2015 due to the expiration of the CBT commercial loss share agreement with the FDIC on June 30, 2015. These
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loans were transferred from the covered loan portfolio to the non-covered loan portfolio. Non-acquired loans or legacy loans increased by $613.8 million, or 19.3%, from June 30, 2014 to June 30, 2015. Non-acquired loans have grown to 65.5% of the total loan portfolio compared to 56.0% at June 30, 2014. The increase was driven by loan growth in in almost all categories of non-acquired loans.
Average total loans
5,779,967
5,669,324
5,770,786
5,672,851
Interest income on total loans
Non-TE yield
5.51
5.61
5.73
Interest earned on loans increased in the second quarter of 2015 compared to the second quarter of 2014. Some key highlights for the quarter ended June 30, 2015 are outlined below:
· Our non-TE yield on total loans decreased 10 basis points comparing the second quarter of 2015 to 2014 and average total loans increased 2.0%, as compared to the second quarter of 2014. The increase in average total loans was primarily the result of the growth in non-acquired loans during 2015. These new loans, however, are at lower rates and the average yield was 4.04% in the second quarter of 2015 compared to 4.21% in the second quarter of 2014. The acquired loan portfolio effective yield increased to 8.18%, compared to 7.33% in the second quarter of 2014, as a result of improved cash flows in certain pools.
The balance of mortgage loans held for sale increased $11.1 million from December 31, 2014 to $73.1 million at June 30, 2015, and $16.6 million compared to the balance of mortgage loans held for sale at June 30, 2014 of $56.4 million.
We use investment securities, our second largest category of earning assets, to generate interest income through the deployment of excess funds, to provide liquidity, to fund loan demand or deposit liquidation, and to pledge as collateral for public funds deposits and repurchase agreements. At June 30, 2015, investment securities totaled $860.4 million, compared to $826.9 million at December 31, 2014 and $816.6 million at June 30, 2014. In addition, we continue to slowly increase our investment securities portfolio as we identify securities that meet our strategy and objectives. During the second quarter of 2015, our portfolio increased $35.3 million from the balance at December 31, 2014, primarily as a result of purchases of mortgage-backed securities and government-sponsored debt securities.
Average investment securities
827,463
810,909
821,398
806,113
Interest income on investment securities
5,068
10,105
2.37
2.51
2.53
Interest earned on investment securities decreased 3.4% in the second quarter of 2015 compared to the second quarter of 2014.
The following table provides a summary of the credit ratings for our investment portfolio (including held-to-maturity and available-for-sale securities) at the end of the second quarter of 2015:
Gain
BB or
(Loss)
AAA - A
BBB
Lower
Not Rated
(1,236
143,580
146,813
3,233
142,946
Mortgage-backed securities *
4,297
845,437
851,775
6,338
275,017
570,420
* - Agency mortgage-backed securities (“MBS”) are guaranteed by the issuing GSE as to the timely payments of principal and interest. Except for Government National Mortgage Association (“GNMA”) securities, which have the full faith and credit backing of the United States Government, the GSE alone is responsible for making payments on this guaranty. While the rating agencies have not rated any of the MBS issued, senior debt securities issued by GSEs are rated consistently as “Triple-A.” Most market participants consider agency MBS as carrying an implied Aaa rating (S&P rating of AA+) because of the guarantees of timely payments and selection criteria of mortgages backing the securities. We do not own any private label mortgage-backed securities.
At June 30, 2015, we had 92 securities available for sale in an unrealized loss position, which totaled $3.7 million. At December 31, 2014, we had 66 securities available for sale in an unrealized loss position, which totaled $3.6 million. At June 30, 2014, we had 121 securities available for sale in an unrealized loss position, which totaled $5.2 million.
During the second quarter of 2015 as compared to the second quarter of 2014, the total number of available for sale securities with an unrealized loss position decreased by 29 securities, while the total dollar amount of the unrealized loss decreased by $1.5 million.
All securities available for sale in an unrealized loss position as of June 30, 2015 continue to perform as scheduled. We have evaluated the cash flows and determined that all contractual cash flows should be received; therefore impairment is temporary because we have the ability to hold these securities within the portfolio until the maturity or until the value recovers, and we believe that it is not likely that we will be required to sell these securities prior to recovery. We continue to monitor all of these securities with a high degree of scrutiny. There can be no assurance that we will not conclude in future periods that conditions existing at that time indicate some or all of these securities are other than temporarily impaired, which would require a charge to earnings in such periods. Any charges for OTTI related to securities available-for-sale would not impact cash flow, tangible capital or liquidity.
As securities are purchased, they are designated as held to maturity or available for sale based upon our intent, which incorporates liquidity needs, interest rate expectations, asset/liability management strategies, and capital requirements. We do not currently hold, nor have we ever held, any securities that are designated as trading securities. Although securities classified as available for sale may be sold from time to time to meet liquidity or other needs, it is not our normal practice to trade this segment of the investment securities portfolio. While management generally holds these assets on a long-term basis or until maturity, any short-term investments or securities available for sale could be converted at an earlier point, depending partly on changes in interest rates and alternative investment opportunities.
Other Investments
Other investment securities include primarily our investments in Federal Home Loan Bank of Atlanta (“FHLB”) stock with no readily determinable market value. The amortized cost and fair value of all these securities are equal at June 30, 2015. As of June 30, 2015, the investment in FHLB stock represented approximately $7.4 million, or 0.1% as a percentage of total assets.
Interest-Bearing Liabilities
Interest-bearing liabilities include interest-bearing transaction accounts, savings deposits, CDs, other time deposits, federal funds purchased, and other borrowings. Interest-bearing transaction accounts include NOW, HSA, IOLTA, and Market Rate checking accounts.
Average interest-bearing liabilities
5,186,679
5,335,142
5,170,095
5,371,715
3,857
Average rate
The average balance of interest-bearing liabilities decreased in the second quarter of 2015 compared to the second quarter of 2014 due primarily to the decrease in certificates of deposits and other borrowings. The decrease in interest expense in the second quarter was largely driven by the reduction in certificates of deposits and other borrowings, as well as their rates. Rates continued to decline in most categories, with the exception of savings deposits and federal funds purchased and repurchase agreements, which remained flat. Overall, we experienced an eight basis point decrease in the average rate on all interest-bearing liabilities from the three months ended June 30, 2014. Some key highlights are outlined below:
· Average interest-bearing deposits for the three months ended June 30, 2015 decreased 2.8% from the same period in 2014.
· Interest-bearing deposits decreased 2.6% to $4.8 billion at June 30, 2015 from the period end balance at June 30, 2014 of $5.0 billion. This was the result of a $236.0 million decline in certificates of deposit, which was partially offset by growth in interest-bearing transaction accounts of $131.3 million. The Company continues to monitor and adjust rates paid on deposit products as part of its strategy to manage its net interest margin.
· The average rate on transaction and money market account deposits for the three months ended June 30, 2015 decreased two basis points from the comparable period in 2014.
· Average certificates of deposit and other time deposits decreased 18.0%, down $255.9 million from the average balance in the second quarter of 2014. Interest expense on certificates of deposit and other time deposits decreased $368,000 as a result of the decline in average balances and a four basis point decrease in the average rate to 33 basis points for the three months ended June 30, 2015 as compared to the same period in 2014.
· The average rate on other borrowings experienced a 128 basis point decline to 4.71% for the three months ended June 30, 2015 as compared to the same period in 2014.
Noninterest-Bearing Deposits
Noninterest-bearing deposits are transaction accounts that provide our Bank with “interest-free” sources of funds. Average noninterest-bearing deposits increased $185.0 million, or 11.6%, to $1.8 billion in the second quarter of 2015 compared to $1.6 billion at June 30, 2014. At June 30, 2015, noninterest-bearing deposits had a balance of $1.8 billion, exceeding the June 30, 2014 balance by $218.0 million.
Provision for Loan Losses and Nonperforming Assets
The allowance for loan losses is based upon estimates made by management. We maintain an allowance for loan losses at a level that we believe is appropriate to cover estimated credit losses on individually evaluated loans that are determined to be impaired as well as estimated credit losses inherent in the remainder of our loan portfolio. Arriving at the allowance involves a high degree of management judgment and results in a range of estimated losses. We regularly evaluate the adequacy of the allowance through our internal risk rating system, outside credit review, and regulatory agency examinations to assess the quality of the loan portfolio and identify problem loans. The evaluation process also includes our analysis of current economic conditions, composition of the loan portfolio, past due and nonaccrual loans, concentrations of credit, lending policies and procedures, and historical loan loss experience. The provision for loan losses is charged to expense in an amount necessary to maintain the allowance at an appropriate level.
The allowance for loan losses on non-acquired loans consists of general and specific reserves. The general reserves are determined by applying loss percentages to the portfolio that are based on historical loss experience for each class of loans and management’s evaluation and “risk grading” of the loan portfolio. Additionally, the general economic and business conditions affecting key lending areas, credit quality trends, collateral values, loan volumes and concentrations, seasoning of the loan portfolio, the findings of internal and external credit reviews and results from external bank regulatory examinations are included in this evaluation. Currently, these adjustments are applied to the non-acquired loan portfolio when estimating the level of reserve required. The specific reserves are determined on a loan-by-loan basis based on management’s evaluation of our exposure for each credit, given the current payment status of the loan and the value of any underlying collateral. These are loans classified by management as doubtful or substandard. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. Generally, the need for a specific reserve is evaluated on impaired loans, and once a specific reserve is established for a loan, a charge off of that amount occurs in the quarter subsequent to the establishment of the specific reserve. Loans that are determined to be impaired are provided a specific reserve, if necessary, and are excluded from the calculation of the general reserves.
With the FFHI business combination, the Company segregated the FFHI acquired loan portfolio into performing loans (“non-credit impaired”) and credit impaired loans. The acquired non-credit impaired loans and acquired revolving type loans are accounted for under FASB ASC 310-20, with each loan being accounted for individually. Acquired credit impaired loans are recorded net of any acquisition accounting discounts and have no allowance for loan losses associated with them at acquisition date. The related discount, if applicable, is accreted into interest income over the remaining contractual life of the loan using the level yield method. Subsequent deterioration in the credit quality of these loans is recognized by recording a provision for loan losses through the income statement, increasing the non-acquired and acquired non-credit impaired allowance for loan losses. The acquired credit impaired loans are accounted for in the manner described in the next paragraph.
In determining the acquisition date fair value of acquired credit impaired loans, and in subsequent accounting, the Company generally aggregates purchased loans into pools of loans with common risk characteristics. Expected cash flows at the acquisition date in excess of the fair value of loans are recorded as interest income over the life of the loans using a level yield
method if the timing and amount of the future cash flows of the pool is reasonably estimable. Subsequent to the acquisition date, increases in cash flows over those expected at the acquisition date are recognized as interest income prospectively. Decreases in expected cash flows after the acquisition date are recognized by recording an allowance for loan losses. Evidence of credit quality deterioration for the loan pools may include information such as increased past-due and nonaccrual levels and migration in the pools to lower loan grades. Offsetting the impact of the provision established for the loan, the receivable from the FDIC is adjusted to reflect the indemnified portion of the post-acquisition exposure with a corresponding credit to the provision for loan losses (For further discussion of the Company’s allowance for loan losses on acquired loans, see Note 6—Loans and Allowance for Loan Losses).
During the second quarter of 2015, we decreased the valuation allowance on acquired credit impaired loans slightly by $28,000, which resulted in $236,000 net provision for loan losses on acquired credit impaired loans (net of the impact of the FDIC loss sharing agreements).
63
The following table presents a summary of the changes in the ALLL for the three and six months ended June 30, 2015 and 2014:
Acquired Non-credit
Acquired Credit
3,145
Reductions due to loan removals
Total non-acquired loans:
At period end
Net charge-offs as a percentage of average non-acquired loans (annualized)
0.12
0.17
Allowance for loan losses as a percentage of period end non-acquired loans
0.92
1.12
Allowance for loan losses as a percentage of period end non-performing non-acquired loans (“NPLs”)
141.04
100.31
Provision for loan losses on non-acquired loans
0.06
0.11
The allowance for loan losses as a percent of non-acquired loans reflects the continued decline due primarily to the continued decline in our three-year historical charge off rate. Additionally, our classified loans, nonaccrual loans, and non-performing loans declined during the second quarter of 2015 compared to the same quarter in 2014 and to the first quarter of 2015. Our overall net charge offs (recoveries) for the quarter on non-acquired loans was 12 basis points annualized, or $1.1 million, compared to 17 basis points, or $1.3 million, a year ago, and (0.01) basis point, or ($54,000) in the first quarter of 2015. Excluding acquired assets, nonperforming assets decreased by $13.8 million during the second quarter of 2015 compared to the second quarter of 2014 and decreased by $3.6 million from the first quarter of 2015. The ratio of the ALLL to cover total nonperforming non-acquired loans increased from 100.3% at June 30, 2014 to 141.0% at June 30, 2015.
We decreased the ALLL compared to the second quarter of 2014 due primarily to the improvement in asset quality metrics during the second quarter of 2015. Compared to the first quarter of 2015, the ALLL increased due primarily to larger loans and increases in certain loan types during the second quarter. During the second quarter of 2015, we continued to experience a decline in combined past due and nonaccrual loans, classified assets, and reduced bankruptcies and foreclosures. From a general perspective, we consider three-year historical loss rates on all loan portfolios, except residential lot loans and lot loans held for sale where two-year historical loss rates are applied. We also consider economic risk, model risk and operational risk when determining
the ALLL. All of these factors are reviewed and adjusted each reporting period to account for management’s assessment of loss within the loan portfolio. Overall, the general reserve decreased by $520,000 compared to the balance at June 30, 2014 and increased by $1.4 million from March 31, 2015.
We have adjusted our qualitative factors to account for uncertainty and certain risk inherent in the portfolio that cannot be measured with historical loss rates. We currently view that the low level of net charge offs and historical loss rates may not be indicative of the losses inherent in the overall loan portfolio. Therefore, we have adjusted our qualitative factors to account for the uncertainty which exists in the economy as a whole and within the markets in which we operate.
On a specific reserve basis, the allowance for loan losses decreased $118,000 from March 31, 2015, with loan balances being evaluated for specific reserves increasing from $30.4 million to $31.1 million at June 30, 2015. Specific reserves declined $120,000, to $1.3 million, from June 30, 2014 to June 30, 2015. Loan balances being evaluated for specific reserves also declined from $32.7 million at June 30, 2014. Our practice, generally, is that once a specific reserve is established for a loan, a charge off occurs in the quarter subsequent to the establishment of the specific reserve.
During the three months ended June 30, 2015, the decline in our total nonperforming assets (“NPAs”) was reflective of improvement in the real estate market and economy as a whole within the markets that we serve. We continue to work these loans out of the bank through collections and transfers to OREO. We also continue to see improvement with loans being returned to accrual based upon performance.
The following table summarizes our NPAs for the past five quarters:
March 31,
September 30,
Non-acquired:
Nonaccrual loans
15,894
17,491
18,569
20,419
26,546
Accruing loans past due 90 days or more
204
522
429
358
Restructured loans - nonaccrual
9,879
9,633
Total nonperforming loans
24,661
27,574
28,516
30,481
35,313
Other real estate owned (“OREO”) (2)
5,862
6,435
7,947
9,360
9,003
Other nonperforming assets (3)
Total non-acquired nonperforming assets
30,523
34,074
36,463
39,841
44,316
Acquired non-credit impaired:
7,280
5,359
Total acquired nonperforming loans (1)
5,274
7,380
7,646
5,860
Acquired OREO and other nonperforming assets:
Covered OREO (2)
8,293
12,026
18,961
21,999
Acquired OREO not covered under loss share (2)
20,887
17,635
18,552
22,929
22,732
Other covered nonperforming assets (3)
540
608
694
811
Total acquired OREO and other nonperforming assets
29,720
30,269
35,473
42,530
45,542
Total nonperforming assets
65,517
71,723
79,582
88,231
89,858
Excluding Acquired Assets
Total NPAs as a percentage of total loans and repossessed assets (4)
0.80
0.95
1.05
1.20
1.39
Total NPAs as a percentage of total assets (5)
0.38
0.42
0.51
0.55
Total NPLs as a percentage of total loans (4)
0.65
0.77
0.82
1.11
Including Acquired Assets
1.25
1.38
1.54
1.57
Total NPAs as a percentage of total assets
0.81
0.89
1.02
0.52
0.61
0.63
0.64
0.62
(1) Excludes the acquired loans that are contractually past due 90 days or more totaling $38.2 million, $44.8 million, $48.5 million, $52.5 million, and $56.3 million as of June 30, 2015, March 31, 2015, December 31, 2014, September 30, 2014, and June 30, 2014, respectively, including the valuation discount. Acquired credit impaired loans are considered to be performing due to the application of the accretion method under FASB ASC Topic 310-30. (For further discussion of the Company’s application of the accretion method, see Business Combinations and Method of Accounting for Loans Acquired” in our Annual Report on Form 10-K for the year ended December 31, 2014.
(2) Includes certain real estate acquired as a result of foreclosure and property not intended for bank use of $8.6 million, $8.9 million, $10.0 million, $11.6 million, and $7.9 million as of June 30, 2015, March 31, 2015, December 31, 2014, September 30, 2014, and June 30, 2014, respectively.
(3) Consists of non-real estate foreclosed assets, such as repossessed vehicles.
(4) Loan data excludes mortgage loans held for sale.
(5) For purposes of this calculation, total assets include all assets (both acquired and non-acquired).
Excluding the acquired non-credit impaired loans, total nonperforming loans, including restructured loans, were $24.7 million, or 0.65% of non-acquired loans, a decrease of $10.7 million, or 30.2%, from June 30, 2014. The decrease in nonperforming loans was driven primarily by a decrease in commercial nonaccrual loans of $10.2 million. The remaining decline was due to a decrease in both consumer and restructured nonaccrual loans.
Nonperforming non-acquired loans, including restructured loans decreased by approximately $3.9 million during the second quarter of 2015 from the level at December 31, 2014. This decrease was primarily driven by a decrease in commercial
nonaccrual loans of $3.1 million and a decrease in restructured nonaccrual loans of $1.2 million, partially offset by an increase in loans 90+ days past due and still accruing of $52,000 and an increase in consumer nonaccrual loans of $389,000.
At June 30, 2015, non-acquired OREO decreased by $573,000 from March 31, 2015. At June 30 2015, non-acquired OREO consisted of 41 properties with an average value of $143,000, which is the same as the level from March 31, 2015 when we had 45 properties in non-acquired OREO. In the second quarter of 2015, we added five properties with an aggregate value of $541,000 into non-acquired OREO, and we sold nine properties with a basis of $1.1 million. We wrote down two OREO properties by $58,000 during the second quarter of 2015. Our non-acquired OREO balance of $5.9 million at June 30, 2015 is comprised of 47% in the Low Country/Orangeburg region, 37% in the Coastal region (Beaufort to Myrtle Beach), 8% in the Charlotte region and 8% in the Upstate region (Greenville).
Potential Problem Loans
Potential problem loans (excluding all acquired loans), totaled $6.5 million, or 0.17%, of total non-acquired loans outstanding at June 30, 2015, compared to $6.6 million, or 0.21%, of total non-acquired loans outstanding at June 30, 2014, and compared to $7.6 million, or 0.22% of total non-acquired loans outstanding at December 31, 2014. Potential problem loans related to acquired non-credit impaired loans totaled $8.3 million, or 0.71%, of total acquired non-credit impaired loans at June 30, 2015, compared to $10.4 million, or 0.79%, of total acquired non-credit impaired loans outstanding at December 31, 2014. For the period ended June 30, 2014, there were no acquired non-credit impaired loans that were considered potential problem loans until we completed the evaluation of acquired loans and any related purchase adjustment during the measurement period. All potential problem loans represent those loans where information about possible credit problems of the borrowers has caused management to have serious concern about the borrower’s ability to comply with present repayment terms.
Noninterest Income
Noninterest income increased by $5.7 million, or 23.3%, during the second quarter of 2015 compared to the same period in 2014. The quarterly increase in total noninterest income primarily resulted from the following:
· Amortization of the FDIC indemnification asset improved (declined) by $3.8 million;
· Mortgage banking income increased $2.4 million, or 51.4%, driven primarily from a favorable rate environment and higher volume of loans; and
· Trust and investment services income increased 5.0%, or $239,000, driven primarily by additional trust asset management income; partially offset by
· A decline in loan recoveries of acquired credit impaired loans included in other income of $700,000.
Noninterest income increased by $11.5 million, or 25.5%, during the six months ended June 30, 2015 as compared to the same period in 2014. The increase in total noninterest income primarily resulted from the following:
· Mortgage banking income increased $5.7 million, or 72.0%, resulting from the favorable rate environment and an increase in the volume of loans;
· Trust and investment services income increased 6.7%, or $630,000, driven primarily by additional trust asset management income; and
· The amortization of the FDIC indemnification asset improved (declined) by $7.6 million; partially offset by
· A decline in loan recoveries of acquired credit impaired loans included in other income of $1.7 million.
Note that “Fees on deposit accounts” include service charges on deposit accounts and bankcard income.
Noninterest Expense
Business development and staff related
1,983
4,130
3,695
Supplies, printing and postage
3,820
2,888
6,761
5,923
Noninterest expense decreased $4.4 million in the second quarter of 2015 as compared to the same period in 2014. The quarterly decrease in total noninterest expense primarily resulted from the following:
· Salary and employee benefits were $522,000 lower than last year, due largely lower salaries and benefits resulting primarily from branch consolidations;
· Furniture and equipment expense decreased by $502,000, driven largely by reduced maintenance and repair;
· Net occupancy expense decreased by $717,000, driven largely by the reduced insurance, taxes, and janitorial and landscaping expenses resulting from the consolidation of branches; and
· One-time branch consolidation expenses in 2015 compared to merger and branding expenses in 2014 declined $4.3 million; partially offset by
· Increases in OREO expense and loan related cost, professional fees, advertising and marketing, and other expense.
Noninterest expense decreased by $11.3 million during the second six months ended June 30, 2015 as compared to the same period in 2014. The decrease in total noninterest expense primarily resulted from the following:
· Furniture and equipment expense decreased by $1.1 million driven largely by reduced equipment maintenance and repair expenses;
· One-time expenses of branch consolidation expense in 2015 compared to merge and branding expense in 2014 decreased $10.3 million;
· Net occupancy expense decreased by $1.1 million due to a decline in depreciation expense, maintenance & repairs, property insurance, and janitorial and landscape expenses; and
· OREO and loan related expenses are down $906,000, due primarily to the overall reduction in OREO from prior year; partially offset by
· Increases in compensation expense, business development and staff related, professional fees and other expense.
Income Tax Expense
Our effective income tax rate was 34.00% for the second quarter of 2015 and for the first quarter of 2015, which was down from 34.30% in the second quarter of 2014. For the six months ended June 30, 2015 and 2014, the effective tax rate was 34.00%
and 34.30%, respectively. The decline for all periods was attributable primarily to additional investments in certain qualified tax credit programs.
Capital Resources
Our ongoing capital requirements have been met primarily through retained earnings, less the payment of cash dividends. As of June 30, 2015, shareholders’ equity was $1.0 billion, an increase of $38.9 million, or 3.9%, from $984.9 million at December 31, 2014, and an increase of $70.8 million, or 7.4%, from $953.0 million at June 30, 2014. The driving factor for the increase from year-end was net income of $48.8 million, which was offset by the common dividend paid of $11.4 million. Accumulated other comprehensive gain changed to a comprehensive loss, during the second quarter 2015, with the increased unrealized loss in the AFS securities portfolio during the quarter of $4.9 million, net of tax. The increase from the comparable period of 2014 was primarily the result of net income of $89.4 million and partially offset by dividends paid to common shareholders and a change in accumulated comprehensive gain to a comprehensive loss. Our common equity-to-assets ratio was 12.66% at June 30, 2015, relatively flat compared to 12.58% at December 31, 2014 and increased from 11.92% at the end of the comparable period of 2014.
We are subject to regulations with respect to certain risk-based capital ratios. These risk-based capital ratios measure the relationship of capital to a combination of balance sheet and off-balance sheet risks. The values of both balance sheet and off-balance sheet items are adjusted based on the rules to reflect categorical credit risk. In addition to the risk-based capital ratios, the regulatory agencies have also established a leverage ratio for assessing capital adequacy. The leverage ratio is equal to Tier 1 capital divided by total consolidated on-balance sheet assets (minus amounts deducted from Tier 1 capital). The leverage ratio does not involve assigning risk weights to assets.
As disclosed in our Annual Report on Form 10-K for the year ended December 31, 2014, in July 2013, the Federal Reserve announced its approval of a final rule to implement the regulatory capital reforms developed by the Basel Committee on Banking Supervision (“Basel III”), among other changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The new rules became effective January 1, 2015, subject to a phase-in period for certain aspects of the new rules.
The new capital rules framework requires banking organizations to hold more and higher quality capital, which acts as a financial cushion to absorb losses, taking into account the impact of risk. As applied to the Company and the Bank, the new rules include a new minimum ratio of common equity Tier 1 capital (“CET1”) to risk-weighted assets of 4.5%. The new rules also raise our minimum required ratio of Tier 1 capital to risk-weighted assets from 4% to 6%. Our minimum required leverage ratio under the new rules is 4% (the new rules eliminated an exemption that permitted a minimum leverage ratio of 3% for certain institutions). Our minimum required total capital to risk-weighted assets ratio remains at 8% under the new rules.
In terms of quality of capital, the final rule emphasizes common equity Tier 1 capital and implements strict eligibility criteria for regulatory capital instruments. It also changes the methodology for calculating risk-weighted assets to enhance risk sensitivity.
Under the Basel III rules, accumulated other comprehensive income (“AOCI”) is presumptively included in common equity Tier 1 capital and can operate to reduce this category of capital. The final rule provided a one-time opportunity at the end of the second quarter of 2015 for covered banking organizations to opt out of much of this treatment of AOCI, which election the Bank and the Company have made. As a result, the Company and the Bank will retain the pre-existing treatment for AOCI.
The Company’s and the Bank’s regulatory capital ratios for the following periods are reflected below:
South State Corporation:
Common equity Tier 1 risk-based capital
12.15
Tier 1 risk-based capital
Total risk-based capital
Tier 1 leverage
South State Bank:
Due to the adoption of the new Basel III capital rules in the first quarter of 2015, the June 30, 2015 risk-based capital ratios are not comparable to the December 31, 2014 and June 30, 2014 risk-based capital ratios. The Tier 1 leverage ratio increased compared to December 31, 2014 and June 30, 2014 due to the increase in capital outpacing the increase in our average asset size. Our capital ratios are currently well in excess of the minimum standards and continue to be in the “well capitalized” regulatory classification.
Liquidity
Liquidity refers to our ability to generate sufficient cash to meet our financial obligations, which arise primarily from the withdrawal of deposits, extension of credit and payment of operating expenses. Our Asset/Liability Management Committee (“ALCO”) is charged with monitoring liquidity management policies, which are designed to ensure acceptable composition of asset/liability mix. Two critical areas of focus for ALCO are interest rate sensitivity and liquidity risk management. We have employed our funds in a manner to provide liquidity from both assets and liabilities sufficient to meet our cash needs.
Asset liquidity is maintained by the maturity structure of loans, investment securities and other short-term investments. Management has policies and procedures governing the length of time to maturity on loans and investments. Normally, changes in the earning asset mix are of a longer-term nature and are not utilized for day-to-day corporate liquidity needs.
Our liabilities provide liquidity on a day-to-day basis. Daily liquidity needs are met from deposit levels or from our use of federal funds purchased, securities sold under agreements to repurchase and other short-term borrowings. We engage in routine activities to retain deposits intended to enhance our liquidity position. These routine activities include various measures, such as the following:
· Emphasizing relationship banking to new and existing customers, where borrowers are encouraged and normally expected to maintain deposit accounts with our Bank;
· Pricing deposits, including certificates of deposit, at rate levels that will attract and/or retain balances of deposits that will enhance our Bank’s asset/liability management and net interest margin requirements; and
· Continually working to identify and introduce new products that will attract customers or enhance our Bank’s appeal as a primary provider of financial services.
Our legacy loan portfolio increased by approximately $613.8 million, or approximately 19.3%, compared to the balance at June 30, 2014, and by $320.6 million, or 18.6% annualized, compared to the balance at December 31, 2014. Our investment securities portfolio increased $43.7 million from second quarter 2014 and by $33.4 million compared to fourth quarter 2014. During the second quarter, the Company began the process of increasing the investment portfolio as a percentage to total assets and expects this to continue throughout the remainder of 2015. Total cash and cash equivalents were $593.4 million at June 30, 2015 as compared to $417.9 million at December 31, 2014 and $589.5 million at June 30, 2014.
At June 30, 2015, December 31, 2014 and June 30, 2014, the Company had $19.4 million, $23.4 million and $29.7 million, respectively, in traditional, out-of-market brokered deposits and $71.0 million, $67.5 million, and $81.3 million, respectively, of reciprocal brokered deposits. Total deposits were $6.7 billion, up $87.7 million or 1.3% from June 30, 2014, resulting primarily from increases in core deposits by $323.5 million partially offset by decreases in certificates of deposit by $235.9 million. Other borrowings decreased $46.0 million from the balance at June 30, 2014, due to the redemption of $46.3 million of trust preferred
securities in the first quarter of 2015. To the extent that we employ other types of non-deposit funding sources, typically to accommodate retail and correspondent customers, we continue to take in some shorter maturities of such funds. Our current approach may provide an opportunity to sustain a low funding rate or possibly lower our cost of funds but could also increase our cost of funds if interest rates rise.
Our ongoing philosophy is to remain in a liquid position taking into account our current composition of earning assets, asset quality, capital position, and operating results. Our liquid earning assets include federal funds sold, balances at the Federal Reserve Bank, reverse repurchase agreements, and/or other short-term investments. Cyclical and other economic trends and conditions can disrupt our Bank’s desired liquidity position at any time. We expect that these conditions would generally be of a short-term nature. Under such circumstances, our Bank’s federal funds sold position and any balances at the Federal Reserve Bank serve as the primary sources of immediate liquidity. At June 30, 2015, our Bank had total federal funds credit lines of $376.0 million with no outstanding advances. If additional liquidity were needed, the Bank would turn to short-term borrowings as an alternative immediate funding source and would consider other appropriate actions such as promotions to increase core deposits or the sale of a portion of our investment portfolio. At June 30, 2015, our Bank had $151.7 million of credit available at the Federal Reserve Bank’s Discount Window, but had no outstanding advances as of the end of the quarter. In addition, we could draw on additional alternative immediate funding sources from lines of credit extended to us from our correspondent banks and/or the FHLB. At June 30, 2015, our Bank had a total FHLB credit facility of $923.6 million with total outstanding letters of credit consuming $19.7 million, $132,000 in outstanding advances and $172,000 in credit enhancements from participation in the FHLB’s Mortgage Partnership Finance Program. The Company had a $20.0 million unsecured line of credit with U.S. Bank National Association with no outstanding advances. We believe that our liquidity position continues to be adequate and readily available.
Our contingency funding plans incorporate several potential stages based on liquidity levels. Also, we review on at least an annual basis our liquidity position and our contingency funding plans with our principal banking regulator. The Company maintains various wholesale sources of funding. If our deposit retention efforts were to be unsuccessful, our Company would utilize these alternative sources of funding. Under such circumstances, depending on the external source of funds, our interest cost would vary based on the range of interest rates charged to our Company. This could increase our Company’s cost of funds, impacting net interest margins and net interest spreads.
Loss Share
The following table presents the expected losses on acquired assets covered under loss share agreements as of June 30, 2015:
Incurred *
Incurred **
FDIC
Original
By FFCH
By South State
Estimated
Projected
Threshold
through
Mark ***
or ILE
Gross Losses
Covered Losses
July 26, 2013
for Loans
CBT
233,000
340,039
334,082
313,381
1,135
314,882
Habersham
94,000
124,363
119,978
92,235
1,227
93,741
BankMeridian
70,827
70,190
67,780
30,866
1,731
1,799
34,396
Cape Fear ****
131,000
12,921
8,213
76,122
4,206
481
80,809
Plantation ****
70,178
24,273
16,176
35,190
12,382
3,860
365
51,797
599,005
571,786
546,229
111,312
453,070
8,434
2,809
575,625
* For Cape Fear and Plantation, claimed or claimable loan and OREO losses excluding expenses, net of revenues, from bank failure date through July 26, 2013.
** Claimed or claimable loan and OREO losses excluding expenses, net of revenues, since bank failure date under South State ownership.
*** Represents the estimated losses on OREO at period end. These losses have been recognized to record OREO at net realizable value. These losses are claimable from the FDIC upon sale or receipt of a valid appraisal.
**** For Cape Fear and Plantation, the original estimated gross losses and the original estimated covered losses represent estimated losses subsequent to July 26, 2013.
Under the Habersham and BankMeridian loss share agreements, all losses (whether or not they exceed the intrinsic loss estimate (“ILE”)) are reimbursable by the FDIC at 80% of the losses and reimbursable expenses paid. During the fourth quarter of 2011, the losses and reimbursable expenses claimed under the CBT loss share agreement exceeded the $233.0 million threshold and became reimbursable at 95% rather than 80%. Under the loss sharing agreement for Cape Fear, the Bank assumes $32.4 million of losses and the FDIC reimburses the Bank for 80% of the losses greater than $32.4 million up to $110.0 million. On losses exceeding $110.0 million, the FDIC will reimburse the Bank for 95% of the losses. Under the loss sharing agreement for Plantation, the Bank shares in the losses on certain commercial loans and commercial OREO in three tranches. On losses up to
$55.0 million, the FDIC reimburses the Bank for 80% of all eligible losses; the Bank absorbs losses greater than $55.0 million up to $65.0 million; and the FDIC reimburses the Bank for 60% of all eligible losses in excess of $65.0 million.
The Commercial Shared-Loss Agreements for Cape Fear and CBT expired June 30, 2014 and March 31, 2015, respectively, and losses on assets covered under these agreements are no longer claimable.
Deposit and Loan Concentrations
We have no material concentration of deposits from any single customer or group of customers. We have no significant portion of our loans concentrated within a single industry or group of related industries. Furthermore, we attempt to avoid making loans that, in an aggregate amount, exceed 10% of total loans to a multiple number of borrowers engaged in similar business activities. As of June 30, 2015, there were no aggregated loan concentrations of this type. We do not believe there are any material seasonal factors that would have a material adverse effect on us. We do not have foreign loans or deposits.
Concentration of Credit Risk
We consider concentrations of credit to exist when, pursuant to regulatory guidelines, the amounts loaned to a multiple number of borrowers engaged in similar business activities which would cause them to be similarly impacted by general economic conditions represents 25% of total risk-based capital, or $196.3 million at June 30, 2015. Based on this criteria, the Company had four such credit concentrations for non-acquired loans and acquired non-credit impaired loans at June 30, 2015, including $293.2 million of loans to lessors of residential buildings, $408.8 million of loans to lessors of nonresidential buildings (except mini-warehouses), $220.1 million of loans to religious organizations, and $246.7 million of loans to offices of physicians, dentists and other health practitioners.
Cautionary Note Regarding Any Forward-Looking Statements
Statements included in Management’s Discussion and Analysis of Financial Condition and Results of Operations which are not historical in nature are intended to be, and are hereby identified as, forward-looking statements for purposes of the safe harbor provided by Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934. The words “may,” “will,” “anticipate,” “should,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “may,” and “intend,” as well as other similar words and expressions of the future, are intended to identify forward-looking statements. We caution readers that forward-looking statements are estimates reflecting our judgment based on current information, and are subject to certain risks and uncertainties that could cause actual results to differ materially from anticipated results. Such risks and uncertainties include, among others, the matters described in Item 1A. Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2014, and the following:
· Credit risk associated with an obligor’s failure to meet the terms of any contract with the Bank or otherwise fail to perform as agreed;
· Interest rate risk involving the effect of a change in interest rates on both the Bank’s earnings and the market value of the portfolio equity;
· Liquidity risk affecting our Bank’s ability to meet its obligations when they come due;
· Price risk focusing on changes in market factors that may affect the value of financial instruments which are “marked-to-market” periodically;
· Merger and merger integration risk including potential deposit attrition, higher than expected costs, customer loss and business disruption, including, without limitation, potential difficulties in maintaining relationships with key personnel and other integration related-matters, and the potential inability to identify and successfully negotiate and complete additional successful combinations with potential merger or acquisition partners;
· Transaction risk arising from problems with service or product delivery;
· Compliance risk involving risk to earnings or capital resulting from violations of or nonconformance with laws, rules, regulations, prescribed practices, or ethical standards;
· Controls and procedures risk, including the potential failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures;
· Regulatory change risk resulting from new laws, rules, regulations, proscribed practices or ethical standards, including the possibility that regulatory agencies may require higher levels of capital above the current regulatory-mandated minimums, including the impact of the new capital rules under Basel III and the possibility of changes in accounting principles relating to loan loss recognition;
· Strategic risk resulting from adverse business decisions or improper implementation of business decisions;
· Reputation risk that adversely affects earnings or capital arising from negative public opinion;
72
· Terrorist activities risk that result in loss of consumer confidence and economic disruptions;
· Cybersecurity risk related to our dependence on internal computer systems and the technology of outside service providers, as well as the potential impacts of third-party security breaches, subjects us to potential business disruptions or financial losses resulting from deliberate attacks or unintentional events;
· Noninterest income risk resulting from the effect of final rules amending Regulation E that prohibit financial institutions from charging consumer fees for paying overdrafts on ATM and one-time debit card transactions, unless the consumer consents or opts-in to the overdraft service for those types of transactions; and
· Economic downturn risk resulting in changes in the credit markets, greater than expected non-interest expenses, excessive loan losses and other factors, which risks could be exacerbated by potential negative economic developments resulting from the expiration of the federal tax reductions, and the implementation of federal spending cuts currently scheduled to go into effect.
Additional information with respect to factors that may cause actual results to differ materially from those contemplated by our forward-looking statements may also be included in other reports that the Company files with the Securities and Exchange Commission. The Company cautions that the foregoing list of risk factors is not exclusive and not to place undue reliance on forward-looking statements.
For any forward-looking statements made in this Form 10-Q or in any documents incorporated by reference into this Form 10-Q, we claim the protection of the safe harbor for forward looking statements contained in the Private Securities Litigation Reform Act of 1995. Such forward-looking statements speak only as of the date of this Form 10-Q or the date of any document incorporated by reference in Form 10-Q. We do not undertake to update forward looking statements to reflect facts, circumstances, assumptions or events that occur after the date the forward-looking statements are made. All subsequent written and oral forward looking statements by the Company or any person acting on its behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this Form 10-Q.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have no material changes in our quantitative and qualitative disclosures about market risk as of June 30, 2015 from that presented in our Annual Report on Form 10-K for the year ended December 31, 2014.
Item 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is (i) recorded, processed, summarized and reported as and when required and (ii) accumulated and communicated to our management, including our Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting during the six months ended June 30, 2015, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 1. LEGAL PROCEEDINGS
As of June 30, 2015 and the date of this form 10-Q, we believe that we are not a party to, nor is any of our property the subject of, any pending material legal proceeding other than those that may occur in the ordinary course of our business.
Item 1A. RISK FACTORS
Investing in shares of our common stock involves certain risks, including those identified and described in Item 1A. of our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, as well as cautionary statements contained in this Form 10-Q, including those under the caption “Cautionary Note Regarding Any Forward-Looking Statements” set forth in Part I, Item 2 of this Form 10-Q, risks and matters described elsewhere in this Form 10-Q and in our other filings with the SEC.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) Not applicable
(b) Not applicable
(c) Issuer Purchases of Registered Equity Securities:
In February 2004, we announced a stock repurchase program with no formal expiration date to repurchase up to 250,000 shares of our common stock. There are 147,872 shares that may yet be purchased under that program. The following table reflects share repurchase activity during the second quarter of 2015:
Period
(a) Total Number of Shares (or Units) Purchased
(b) Average Price Paid per Share (or Unit)
(c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs
(d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs
April 1 - April 30
1,151
*
69.11
147,872
May 1 - May 31
71.77
June 1 - June 30
1,352
* These shares were repurchased under arrangements, authorized by our stock-based compensation plans and Board of Directors, whereby officers or directors may sell previously owned shares to the Company in order to pay for the exercises of stock options or for income taxes owed on vesting shares of restricted stock. These shares are not purchased under the plan to repurchase 250,000 shares announced in February 2004.
Item 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
Item 4. MINE SAFETY DISCLOSURES
Item 5. OTHER INFORMATION
Item 6. EXHIBITS
The exhibits required to be filed as part of this Quarterly Report on Form 10-Q are listed in the Exhibit Index attached hereto and are incorporated by reference.
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.
(Registrant)
Date: August 7, 2015
/s/ Robert R. Hill, Jr.
Robert R. Hill, Jr.
Chief Executive Officer
(Principal Executive Officer)
/s/ John C. Pollok
John C. Pollok
Senior Executive Vice President,
Chief Financial Officer, and
Chief Operating Officer
(Principal Financial Officer)
/s/ Keith S. Rainwater
Keith S. Rainwater
Executive Vice President and
Principal Accounting Officer
Exhibit Index
Exhibit No.
Description
Exhibit 31.1
Rule 13a-14(a) Certification of Principal Executive Officer
Exhibit 31.2
Rule 13a-14(a) Certification of Principal Financial Officer
Exhibit 32
Section 1350 Certifications of Principal Executive Officer and Principal Financial Officer
Exhibit 101
The following financial statements from the Quarterly Report on Form 10-Q of South State Corporation for the quarter ended June 30, 2015, formatted in eXtensible Business Reporting Language (XBRL): (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Income, (iii) Condensed Consolidated Statements of Comprehensive Income, (iv) Condensed Consolidated Statements of Changes in Shareholders’ Equity, (v) Condensed Consolidated Statement of Cash Flows and (vi) Notes to Condensed Consolidated Financial Statements.