UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☑
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the quarterly period ended March 31, 2017
OR
☐
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from _____________ to _______________.
Commission file number 1-13661
STOCK YARDS BANCORP, INC.
(Exact name of registrant as specified in its charter)
Kentucky
61-1137529
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
1040 East Main Street, Louisville, Kentucky 40206
(Address of principal executive offices including zip code)
(502) 582-2571
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ☑ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☑ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer
Accelerated filer
Non-accelerated filer (Do not check if a smaller reporting Company)
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.).
Yes ☐ No ☑
The number of shares of the registrant’s Common Stock, no par value, outstanding as of April 24, 2017 was 22,660,284
Stock Yards Bancorp, inc. and subsidiary
Index
Item
Page
part I – financial information
Consolidated Balance Sheets March 31, 2017 (Unaudited) and December 31, 2016
3
Consolidated Statements of Income (Unaudited) for the three months ended March 31, 2017 and 2016
4
Consolidated Statements of Comprehensive Income (Unaudited) for the three months ended March 31, 2017 and 2016
5
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) for the three months ended March 31, 2017 and 2016
6
Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2017 and 2016
7
Notes to Consolidated Financial Statements (Unaudited)
8
Management’s Discussion and Analysis of Financial Condition and Results of Operations
42
Quantitative and Qualitative Disclosures about Market Risk
65
Controls and Procedures
part II – other information
Unregistered Sales of Equity Securities and Use of Proceeds
66
Exhibits
PART I – FINANCIAL INFORMATION
Glossary of Acronyms and Terms
The following listing provides a comprehensive reference of common acronyms and terms used throughout the document:
ASU
Accounting Standards Update
Bancorp
Stock Yards Bancorp, Inc.
Bank
Stock Yards Bank & Trust Company
BOLI
Bank Owned Life Insurance
BP
Basis Point = 1/100th of one percent
COSO
Committee of Sponsoring Organizations
CRA
Community Reinvestment Act of 1977
Dodd-Frank Act
Dodd-Frank Wall Street Reform and Consumer Protection Act
EPS
Earnings Per Share
FASB
Financial Accounting Standards Board
FDIC
Federal Deposit Insurance Corporation
FHA
Federal Housing Administration
FHLB
Federal Home Loan Bank
FHLMC
Federal Home Loan Mortgage Corporation
FNMA
Federal National Mortgage Association
GNMA
Government National Mortgage Association
WM&T
Wealth management and trust
LIBOR
London Interbank Offered Rate
MSR
Mortgage Servicing Right
OAEM
Other Assets Especially Mentioned
OREO
Other Real Estate Owned
PSU
Performance Stock Unit
RSU
Restricted Stock Unit
SAR
Stock Appreciation Right
SEC
Securities and Exchange Commission
TDRs
Troubled Debt Restructurings
US GAAP
United States Generally Accepted Accounting Principles
VA
U.S. Department of Veterans Affairs
Item 1. Financial Statements
STOCK YARDS BANCORP, INC. AND SUBSIDIARY
Consolidated Balance Sheets
March 31, 2017 (unaudited) and December 31, 2016
(In thousands, except share data)
March 31,
December 31,
2017
2016
Cash and due from banks
Federal funds sold and interest bearing deposits
Cash and cash equivalents
Mortgage loans held for sale
Securities available-for-sale (amortized cost of $556,947 in 2017 and $571,936 in 2016)
Federal Home Loan Bank stock and other securities
Loans
Less allowance for loan losses
Net loans
Premises and equipment, net
Bank owned life insurance
Accrued interest receivable
Other assets
Total assets
Liabilities and Stockholders’ Equity
Deposits:
Non-interest bearing
Interest bearing
Total deposits
Securities sold under agreements to repurchase
Federal funds purchased and other short-term borrowing
Federal Home Loan Bank advances
Accrued interest payable
Other liabilities
Total liabilities
Stockholders’ equity:
Preferred stock, no par value. Authorized 1,000,000 shares; no shares issued or outstanding
Common stock, no par value. Authorized 40,000,000 shares; issued and outstanding 22,660,774 and 22,617,098 shares in 2017 and 2016, respectively
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss
Total stockholders’ equity
Total liabilities and stockholders’ equity
See accompanying notes to unaudited consolidated financial statements.
Consolidated Statements of Income (Unaudited)
For the three months ended March 31, 2017 and 2016
(In thousands, except per share data)
Interest income:
Securities – taxable
Securities – tax-exempt
Total interest income
Interest expense:
Deposits
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Non-interest income:
Wealth management and trust services
Service charges on deposit accounts
Bankcard transactions
Mortgage banking
Securities brokerage
Other
Total non-interest income
Non-interest expenses:
Salaries and employee benefits
Net occupancy
Data processing
Furniture and equipment
FDIC insurance
Amortization of investments in tax credit partnerships
Total non-interest expenses
Income before income taxes
Income tax expense
Net income
Net income per share:
Basic
Diluted
Average common shares:
Consolidated Statements of Comprehensive Income (Unaudited)
(In thousands)
Three months ended
Other comprehensive income, net of tax:
Unrealized gains on securities available for sale:
Unrealized gains arising during the period (net of tax of $370 and $1,968, respectively)
Unrealized gains (losses) on hedging instruments:
Unrealized gains (losses) arising during the period (net of tax of $47 and ($183), respectively)
Other comprehensive income, net of tax
Comprehensive income
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)
Accumulated
Common stock
Additional
other
Number of
paid-in
Retained
comprehensive
shares
Amount
capital
earnings
income (loss)
Total
Balance December 31, 2015
Stock compensation expense
Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon award
Cash dividends, $0.17 per share
Shares cancelled
Balance March 31, 2016
Balance December 31, 2016
Cash dividends, $0.19 per share
Balance March 31, 2017
Consolidated Statements of Cash Flows (Unaudited)
Operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion, net
Deferred income tax provision
Gain on sales of mortgage loans held for sale
Origination of mortgage loans held for sale
Proceeds from sale of mortgage loans held for sale
Bank owned life insurance income
Loss (gain) on the sale of other real estate
Excess tax benefits from share-based compensation arrangements
Increase in accrued interest receivable and other assets
Increase in accrued interest payable and other liabilities
Net cash provided by operating activities
Investing activities:
Purchases of securities available for sale
Proceeds from sale of securities available for sale
Proceeds from maturities of securities available for sale
Net (increase) decrease in loans
Purchases of premises and equipment
Proceeds from sale of foreclosed assets
Net cash provided by (used in) investing activities
Financing activities:
Net increase(decrease) in deposits
Net decrease in securities sold under agreements to repurchase and federal funds purchased
Proceeds from Federal Home Loan Bank advances
Repayments of Federal Home Loan Bank advances
Proceeds (used for) and received from settlement of stock awards
Common stock repurchases
Cash dividends paid
Net cash used in financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental cash flow information:
Income tax payments
Cash paid for interest
Supplemental non-cash activity:
Transfers from loans to other real estate owned
(1)
Summary of Significant Accounting Policies
The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all information and footnotes required by U.S. generally accepted accounting principles (US GAAP) for complete financial statements. The consolidated unaudited financial statements of Stock Yards Bancorp, Inc. (“Bancorp”) and its subsidiary reflect all adjustments (consisting only of adjustments of a normal recurring nature) which are, in the opinion of management, necessary for a fair presentation of financial condition and results of operations for the interim periods.
The unaudited consolidated financial statements include the accounts of Stock Yards Bancorp, Inc. and its wholly-owned subsidiary, Stock Yards Bank & Trust Company (“Bank”). Significant inter-company transactions and accounts have been eliminated in consolidation. In preparing the unaudited consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of related revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, valuation of available-for sale securities, other real estate owned and income tax assets, and estimated liabilities and expense.
A description of other significant accounting policies is presented in the notes to Consolidated Financial Statements for the year ended December 31, 2016 included in Stock Yards Bancorp, Inc.’s Annual Report on Form 10-K. Certain reclassifications have been made in the prior year financial statements to conform to current year classifications.
Interim results for the three month period ended March 31, 2017 are not necessarily indicative of the results for the entire year.
Critical Accounting Policies
The allowance for loan losses is management’s estimate of probable losses inherent in the loan portfolio as of the balance sheet date. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
Management has identified the accounting policy related to the allowance and provision for loan losses as critical to the understanding of Bancorp’s results of operations and discussed this conclusion with the Audit Committee of the Board of Directors. Since the application of this policy requires significant management assumptions and estimates, it could result in materially different amounts to be reported if conditions or underlying circumstances were to change. The provision for loan losses reflects an allowance methodology driven by risk ratings, historical losses, specific loan loss allocations, and qualitative factors. Assumptions include many factors such as changes in borrowers’ financial condition which can change quickly or historical loss ratios related to certain loan portfolios which may or may not be indicative of future losses. In the first quarter of 2017, Bancorp extended the historical period used to capture Bancorp’s historical loss ratios from 24 quarters to 28 quarters. This extension of the historical period was applied to all classes and segments of our portfolio. The expansion of the look-back period for the historical loss rates used in the quantitative allocation caused us to review the overall methodology for the qualitative factors to ensure we were appropriately capturing the risk not addressed in the historical loss rates used in the quantitative allocation. Management believes the extension of the look-back period is appropriate to capture the impact of a full economic cycle and more accurately represents the current level of risk inherent in the loan portfolio. To the extent that management’s assumptions prove incorrect, results from operations could be materially affected by a higher or lower provision for loan losses. The accounting policy related to the allowance for loan losses is applicable to the commercial banking segment of Bancorp. The impact and any associated risks related to this policy on Bancorp’s business operations are discussed in the “Allowance for Loan Losses” section below.
Bancorp’s allowance calculation includes allocations to loan portfolio segments at March 31, 2017 for qualitative factors including, among other factors, local economic and business conditions in each of our primary markets, quality and experience of lending staff and management, exceptions to lending policies, levels of and trends in past due loans and loan classifications, concentrations of credit such as collateral type, trends in portfolio growth, changes in value of underlying collateral for collateral-dependent loans, effect of other external factors such as the national economic and business trends, quality and depth of the loan review function, and management’s judgement of current trends and potential risks. Bancorp utilizes the sum of all allowance amounts derived as described above as the appropriate level of allowance for loan and lease losses. Changes in criteria used in this evaluation or availability of new information could cause the allowance to be increased or decreased in future periods. In addition, bank regulatory agencies, as part of their examination process, may require adjustments to the allowance for loan and lease losses based on their judgments and estimates.
(2) Securities
The amortized cost, unrealized gains and losses, and fair value of securities available-for-sale follows:
(in thousands)
Amortized
Unrealized
Fair
March 31, 2017
Gains
Losses
Government sponsored enterprise obligations
Mortgage-backed securities - government agencies
Obligations of states and political subdivisions
Corporate equity securities
Total securities available for sale
December 31, 2016
U.S. Treasury and other U.S. Government obligations
Corporate equity securities consist of common stock in a publicly-traded business development company.
There were no securities classified as held to maturity as of March 31, 2017 or December 31, 2016.
Bancorp sold no securities in 2016 nor during the three-month period ending March 31, 2017.
A summary of the available-for-sale investment securities by contractual maturity groupings as of March 31, 2017 is shown below.
Securities available-for-sale
Due within 1 year
Due after 1 but within 5 years
Due after 5 but within 10 years
Due after 10 years
Mortgage-backed securities – government agencies
Total securities available-for-sale
Actual maturities may differ from contractual maturities because some issuers have the right to call or prepay obligations. In addition to equity securities, the investment portfolio includes agency mortgage-backed securities, which are guaranteed by agencies such as the FHLMC, FNMA, and GNMA. These securities differ from traditional debt securities primarily in that they may have uncertain principal payment dates and are priced based on estimated prepayment rates on the underlying collateral.
Bancorp pledges portions of its investment securities portfolio to secure public fund deposits, cash balances of certain wealth management and trust accounts, and securities sold under agreements to repurchase. The carrying value of these pledged securities was approximately $355.3 million at March 31, 2017 and $380.4 million at December 31, 2016.
Securities with unrealized losses at March 31, 2017 and December 31, 2016, not recognized in the statements of income are as follows:
Less than 12 months
12 months or more
value
losses
Total temporarily impaired securities
Applicable dates for determining when securities are in an unrealized loss position are March 31, 2017 and December 31, 2016. As such, it is possible that a security had a market value lower than its amortized cost on other days during the past twelve months, but is not in the “Investments with an Unrealized Loss of less than 12 months” category above.
Unrealized losses on Bancorp’s investment securities portfolio have not been recognized as an expense because the securities are of high credit quality, and the decline in fair values is due to changes in the prevailing interest rate environment since the purchase date. Fair value is expected to recover as securities reach their maturity date and/or the interest rate environment returns to conditions similar to when these securities were purchased. These investments consist of 90 and 117 separate investment positions as of March 31, 2017 and December 31, 2016, respectively. Because management does not intend to sell the investments, and it is not likely that Bancorp will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, Bancorp does not consider these securities to be other-than-temporarily impaired at March 31, 2017.
FHLB stock and other securities are investments held by Bancorp which are not readily marketable and are carried at cost. This category includes holdings of Federal Home Loan Bank of Cincinnati (FHLB) stock which are required for access to FHLB borrowing, and are classified as restricted securities.
(3) Loans
Composition of loans, net of deferred fees and costs, by primary loan portfolio class follows:
Commercial and industrial
Construction and development, excluding undeveloped land
Undeveloped land
Real estate mortgage:
Commercial investment
Owner occupied commercial
1-4 family residential
Home equity - first lien
Home equity - junior lien
Subtotal: Real estate mortgage
Consumer
Total loans
The following table presents the balance in the recorded investment in loans and allowance for loan losses by portfolio segment and based on impairment evaluation method as of March 31, 2017 and December 31, 2016.
Type of loan
Construction
and development
Commercial
excluding
and
undeveloped
Undeveloped
Real estate
industrial
land
mortgage
Loans collectively evaluated for impairment
Loans individually evaluated for impairment
Loans acquired with deteriorated credit quality
Allowance for loan losses
At December 31, 2016
Provision (credit)
Charge-offs
Recoveries
At March 31, 2017
Allowance for loans collectively evaluated for impairment
Allowance for loans individually evaluated for impairment
Allowance for loans acquired with deteriorated credit quality
At December 31, 2015
The considerations by Bancorp in computing its allowance for loan losses are determined based on the various risk characteristics of each loan segment. Relevant risk characteristics are as follows:
●
Commercial and industrial loans: Loans in this category are made to businesses. Generally these loans are secured by assets of the business and repayment is expected from the cash flows of the business. A decline in the strength of the business or a weakened economy and resultant decreased consumer and/or business spending may have an effect on the credit quality in this loan category.
Construction and development, excluding undeveloped land: Loans in this category primarily include owner-occupied and investment construction loans and commercial development projects. In most cases, construction loans require only interest to be paid during construction. Upon completion or stabilization, the construction loan may convert to permanent financing in the real estate mortgage segment, requiring principal amortization. Repayment of development loans is derived from sale of lots or units including any pre-sold units. Credit risk is affected by construction delays, cost overruns, market conditions and availability of permanent financing, to the extent such permanent financing is not being provided by Bancorp.
Undeveloped land: Loans in this category are secured by land acquired for development by the borrower, but for which no development has yet taken place. Credit risk is primarily dependent upon the financial strength of the borrower, and can be affected by market conditions and time to develop land for ultimate sale. Credit risk is also affected by availability of development financing, to the extent such financing is not being provided by Bancorp.
Real estate mortgage: Loans in this category are made to and secured by owner-occupied residential real estate, owner-occupied real estate used for business purposes, and income-producing investment properties. For owner occupied residential and commercial real estate, repayment is dependent on financial strength of the borrower. For income-producing investment properties, repayment is dependent on financial strength of tenants in addition to the borrower. Underlying properties are generally located in Bancorp's primary market area. Cash flows of income producing investment properties may be adversely impacted by a downturn in the economy that may cause increased vacancy rates, which in turn, could have an effect on credit quality. Overall health of the economy, including unemployment rates and real estate prices, has an effect on credit quality in this loan category.
Consumer: Loans in this category may be either secured or unsecured and repayment is dependent on credit quality of the individual borrower and, if applicable, adequacy of collateral securing the loan. Therefore, overall health of the economy, including unemployment rates and stock prices, will have a significant effect on credit quality in this loan category.
Bancorp has loans that were acquired for which there was, at acquisition, evidence of deterioration of credit quality since origination and for which it was probable that all contractually required payments would not be collected. The carrying amount of those loans is included in the balance sheet amounts of loans at March 31, 2017 and December 31, 2016. Changes in the fair value adjustment for acquired impaired loans are shown in the following table:
Accretable
discount
Non-
accretable
Balance at December 31, 2015
Accretion
Reclassifications from (to) non-accretable discount
Disposals
Balance at December 31, 2016
Balance at March 31, 2017
The following tables present loans individually evaluated for impairment as of March 31, 2017 and December 31, 2016.
Unpaid
Average
Recorded
principal
Related
recorded
investment
balance
allowance
Loans with no related allowance recorded:
Real estate mortgage
Subtotal
Loans with an allowance recorded:
Total:
Differences between recorded investment amounts and unpaid principal balance amounts less related allowance are due to partial charge-offs which have occurred over the life of loans.
Impaired loans include non-accrual loans and accruing loans accounted for as troubled debt restructurings (TDRs), which continue to accrue interest. Non-performing loans include the balance of impaired loans plus any loans over 90 days past due and still accruing interest. Bancorp had no loans past due more than 90 days and still accruing interest at March 31, 2017, compared with $438 thousand at December 31, 2016, and none at March 31, 2016.
The following table presents the recorded investment in non-accrual loans as of March 31, 2017 and December 31, 2016.
In the course of working with borrowers, Bancorp may elect to restructure the contractual terms of certain loans. Troubled debt restructurings (TDRs) occur when, for economic or legal reasons related to a borrower’s financial difficulties, Bancorp grants a concession to the borrower that it would not otherwise consider.
At March 31, 2017 and December 31, 2016, Bancorp had $988 thousand and $974 thousand of accruing loans classified as TDRs, respectively. Bancorp did not modify and classify any additional loans as TDRs during the three-month period ended March 31, 2016. One commercial loan, with a recorded investment of $38,000 at March 31, 2017 was modified and classified as TDRs in the three-month period ended March 31, 2017. The pre and post-modification balance for this loan was $39,000. The monthly payment amount of this loan was modified to enable the borrower to fulfill the loan agreement. A specific reserve was established for the entire recorded investment of this loan.
No loans classified and reported as troubled debt restructured within the twelve months prior to March 31, 2017 defaulted during the three-month period ended March 31, 2017. Loans accounted for as TDRs include modifications from original terms such as those due to bankruptcy proceedings, certain modifications of amortization periods or extended suspension of principal payments due to customer financial difficulties. Loans accounted for as TDRs are individually evaluated for impairment and, at March 31, 2017, had a total allowance allocation of $339 thousand, compared with $207 thousand at December 31, 2016.
At March 31, 2017 and December 31, 2016, Bancorp did not have any outstanding commitments to lend additional funds to borrowers whose loans have been modified as TDRs.
At March 31, 2017 formal foreclosure proceedings were in process on five consumer mortgage loans with a total recorded investment of $639 thousand, all secured by residential real estate properties. The recorded investments for these properties ranged from $30 thousand to $524 thousand, and these loans were reported as non-accrual as of March 31, 2017.
The following table presents the aging of the recorded investment in loans as of March 31, 2017 and December 31, 2016.
90 or more
days past
> 90 days
30-59 days
60-89 days
due (includes)
Current
past due
non-accrual)
loans
accruing
Consistent with regulatory guidance, Bancorp categorizes loans into credit risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends. Pass-rated loans included all risk-rated loans other than those classified as other assets especially mentioned, substandard, and doubtful, which are defined below:
Other assets especially mentioned (“OAEM”): Loans classified as OAEM have potential weaknesses that deserve management's close attention. These potential weaknesses may result in deterioration of repayment prospects for the loan or of Bancorp's credit position at some future date.
Substandard: Loans classified as substandard are inadequately protected by the paying capacity of the obligor or of collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize repayment of the debt. Default is a distinct possibility if the deficiencies are not corrected.
Substandard non-performing: Loans classified as substandard non-performing have all the characteristics of substandard loans and have been placed on non-accrual status or have been accounted for as troubled debt restructurings. Loans are placed on non-accrual status when prospects for recovering both principal and accrued interest are considered doubtful or when a default of principal or interest has existed for 90 days or more.
Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or repayment in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.
As of March 31, 2017 and December 31, 2016, the internally assigned risk grades of loans by category were as follows:
Substandard
Pass
non-performing
Doubtful
(4)
The composition of the Bank’s deposits outstanding at March 31, 2017 (unaudited) and December 31, 2016 is as follows:
Non-interest bearing demand
Interest bearing deposits:
Interest bearing demand
Savings
Money market
Time deposits of more than $250,000
Other time deposits
Total time deposits
Total interest bearing deposits
Maturities of time deposits of more than $250,000, outstanding at March 31, 2017, are summarized as follows:
3 months or less
Over 3 through 6 months
Over 6 through 12 months
Over 1 through 3 years
Over 3 years
(5)
Securities Sold Under Agreements to Repurchase
Securities sold under agreements to repurchase, which represent excess funds from commercial customers as part of a cash management service, totaled $65.7 million and $67.6 million at March 31, 2017 and December 31, 2016, respectively. Bancorp enters into sales of securities under agreement to repurchase at a specified future date. At March 31, 2017, all of these financing arrangements had overnight maturities and were secured by government sponsored enterprise obligations and government agency mortgage-backed securities which were owned and under the control of Bancorp.
(6)
Federal Home Loan Bank Advances
Bancorp had outstanding borrowings totaling of $50.8 million and $51.1 million at March 31, 2017 and December 31, 2016, respectively, via 14 separate fixed-rate advances. As of March 31, 2017, for two advances totaling $30 million, both of which are non-callable, interest payments are due monthly, with principal due at maturity. For the remaining advances totaling $20.8 million, principal and interest payments are due monthly based on an amortization schedule.
The following is a summary of the contractual maturities and average effective rates of outstanding advances:
Year
Advance
Fixed Rate
%
2020
2021
2024
2025
2026
2028
Advances from the FHLB are collateralized by certain commercial and residential real estate mortgage loans under a blanket mortgage collateral agreement and FHLB stock. Bancorp believes these borrowings to be an effective alternative to higher cost time deposits to manage interest rate risk associated with long-term fixed rate loans. At March 31, 2017, the amount of available credit from the FHLB totaled $500.1 million.
(7) Other Comprehensive Income
The following table illustrates activity within the balances in accumulated other comprehensive income by component, and is shown for the three months ended March 31, 2017 and 2016.
Net unrealized
Minimum
gains on
gains (losses)
pension
securities
on cash
liability
available-for-sale
flow hedges
adjustment
Net current period other comprehensive gain (loss)
Balance at March 31, 2016
Net current period other comprehensive income gain (loss)
(8) Derivative Financial Instruments
Occasionally, Bancorp enters into free-standing interest rate swaps for the benefit of its commercial customers who desire to hedge their exposure to rising interest rates. Bancorp offsets its interest rate exposure on these transactions by entering into offsetting swap agreements with substantially matching terms with approved reputable independent counterparties. These undesignated derivative instruments are recognized on the consolidated balance sheet at fair value. Because of matching terms of offsetting contracts and collateral provisions mitigating any non-performance risk, changes in fair value subsequent to initial recognition are expected to have an insignificant effect on earnings. Exchanges of cash flows related to the undesignated interest rate swap agreements for the first three months of 2017 were offsetting and therefore had no net effect on Bancorp’s earnings or cash flows.
Interest rate swap agreements derive their value from underlying interest rates. These transactions involve both credit and market risk. Notional amounts are amounts on which calculations, payments, and the value of the derivative are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. Bancorp is exposed to credit-related losses in the event of nonperformance by counterparties to these agreements. Bancorp mitigates the credit risk of its financial contracts through credit approvals, limits, collateral, and monitoring procedures, and does not expect any counterparties to fail their obligations.
At March 31, 2017 and December 31, 2016, Bancorp had outstanding undesignated interest rate swap contracts as follows
(dollar amounts in thousands)
Receiving
Paying
Notional amount
Weighted average maturity (years)
Fair value
In 2016, Bancorp entered into an interest rate swap to hedge cash flows of a $10 million rolling fixed-rate three-month FHLB borrowing. The swap began December 6, 2016 and ends December 6, 2021. In 2015, Bancorp entered into an interest rate swap to hedge cash flows of a $20 million rolling fixed-rate three-month FHLB borrowing. The swap began December 9, 2015 and matures December 6, 2020. For purposes of hedging, rolling fixed rate advances are considered to be floating rate liabilities. Interest rate swaps involve exchange of Bancorp’s floating rate interest payments for fixed rate swap payments on underlying principal amounts. These swaps were designated, and qualified, for cash-flow hedge accounting. For derivative instruments that are designated and qualify as cash flow hedging instruments, the effective portion of gains or losses is reported as a component of other comprehensive income, and is subsequently reclassified into earnings as an adjustment to interest expense in periods in which the hedged forecasted transaction affects earnings.
The following table details Bancorp’s derivative position designated as a cash flow hedge, and the fair values as of March 31, 2017 and December 31, 2016.
(dollars in thousands)
Fair Value
Notional
Maturity
Receive (variable)
Pay fixed
assets (liabilities)
amount
date
index
swap rate
12/6/2021
US 3 Month LIBOR
12/6/2020
(9) Goodwill and Intangible Assets
US GAAP requires that goodwill and intangible assets with indefinite useful lives not be amortized, but instead be tested for impairment at least annually. Annual evaluations have resulted in no indication of impairment. Bancorp currently has goodwill in the amount of $682 thousand from the 1996 acquisition of an Indiana bank. This goodwill is assigned to the commercial banking segment of Bancorp.
Bancorp recorded a gross core deposit intangible totaling $2.5 million as a result of its 2013 acquisition of THE BANCorp, Inc. This intangible is being amortized over the expected life of the underlying deposits to which the intangible is attributable. At March 31, 2017, the unamortized core deposit intangible was $1.4 million.
Mortgage servicing rights (MSRs) are initially recognized at fair value when mortgage loans are sold with servicing retained. The MSRs are amortized in proportion to and over the period of estimated net servicing income, considering appropriate prepayment assumptions. MSRs are evaluated quarterly for impairment by comparing carrying value to fair value. Estimated fair values of MSRs at March 31, 2017 and December 31, 2016 were $2.8 million and $2.7 million, respectively. Total outstanding principal balances of loans serviced for others were $365.0 million and $372.2 million at March 31, 2017, and December 31, 2016, respectively.
Changes in the net carrying amount of MSRs for the three months ended March 31, 2017 and 2016 are shown in the following table:
For the three months
ended March 31,
Balance at beginning of period
Additions for mortgage loans sold
Amortization
Balance at end of period
(10) Defined Benefit Retirement Plan
Bancorp sponsors an unfunded, non-qualified, defined benefit retirement plan for three key officers (two current and one retired), and has no plans to increase the number of or benefits to participants. Benefits vest based on 25 years of service. The retired officer and one current officer are fully vested and one current officer will be fully vested in June of 2017. Actuarially determined pension costs are expensed and accrued over the service period, and benefits are paid from Bancorp’s assets. Net periodic benefits costs, which include interest cost and amortization of net losses, totaled $34 thousand and $33 thousand, for the three months ended March 31, 2017 and 2016, respectively.
(11) Commitments and Contingent Liabilities
As of March 31, 2017, Bancorp had various commitments outstanding that arose in the normal course of business, including standby letters of credit and commitments to extend credit, which are properly not reflected in the consolidated financial statements. In management’s opinion, at March 31, 2017 commitments to extend credit of $651.2 million, including standby letters of credit of $14.1 million, represent normal banking transactions. Commitments to extend credit were $628.3 million, including letters of credit of $15.6 million, as of December 31, 2016. Commitments to extend credit are an agreement to lend to a customer as long as collateral is available and there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Commitments to extend credit are mainly comprised of commercial lines of credit, construction and home equity credit lines and credit cards issued to commercial customers. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Bancorp uses the same credit and collateral policies in making commitments and conditional guarantees as for on-balance sheet instruments. Bancorp evaluates each customer’s creditworthiness on a case by case basis. The amount of collateral obtained is based on management’s credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, equipment, and real estate. However, should the commitments be drawn upon and should our customers default on their resulting obligation to us, our maximum exposure to credit loss, without consideration of collateral, is represented by the contractual amount of those instruments. At March 31, 2017, Bancorp has accrued $350 thousand in other liabilities for inherent risks related to unfunded credit commitments.
Standby letters of credit and financial guarantees written are conditional commitments issued by Bancorp to guarantee the performance of a customer to a first party. Those guarantees are primarily issued to support customer commercial transactions. Standby letters of credit generally have maturities of one to two years.
Also, as of March 31, 2017, in the normal course of business, there were pending legal actions and proceedings in which claims for damages are asserted. Management, after discussion with legal counsel, believes the ultimate result of these legal actions and proceedings will not have a material adverse effect on the consolidated financial position or results of operations of Bancorp.
(12) Preferred Stock
Bancorp has a class of preferred stock (no par value; 1,000,000 shares authorized), the relative rights, preferences and other terms of which or any series within the class will be determined by the Board of Directors prior to any issuance. None of this stock has been issued to date.
(13)
Stock Split
On April 29, 2016 Bancorp declared a 3 for 2 stock split effected as a 50% stock dividend to shareholders of record on May 13, 2016, payable May 27, 2016. Share and per share information has been adjusted for this split.
(14) Stock-Based Compensation
The fair value of all awards granted, net of estimated forfeitures, is recognized as compensation expense over the respective service period.
Bancorp currently has one stock-based compensation plan. At Bancorp's 2015 Annual Meeting of Shareholders, shareholders approved the 2015 Omnibus Equity Compensation Plan and authorized the shares available from the expiring 2005 plan for future awards under the 2015 plan. The 2005 Stock Incentive Plan expired in April 2015. No additional shares were made available. Options granted under the 2005 plan expired as of March 31, 2017. SARs granted under the 2005 plan expire as late as 2025. As of March 31, 2017, there were 273,302 shares available for future awards.
Options, which have not been granted since 2007, generally had a vesting schedule of 20% per year and as of March 31, 2017, all have been exercised. Stock appreciation rights (“SARs”) granted have a vesting schedule of 20% per year. Options and SARs expire ten years after the grant date unless forfeited due to employment termination.
Restricted shares granted to officers vest over five years. All restricted shares have been granted at a price equal to the market value of common stock at the time of grant. For all grants prior to 2015, grantees are entitled to dividend payments during the vesting period. For grants in 2015, 2016, and 2017, forfeitable dividends are deferred until shares are vested.
Grants of performance stock units (“PSUs”) vest based upon service and a single three-year performance period which begins January 1 of the first year of the performance period. Because grantees are not entitled to dividend payments during the performance period, the fair value of these PSUs is estimated based upon the fair value of the underlying shares on the date of grant, adjusted for non-payment of dividends. Beginning in 2015, grants require a one year post-vesting holding periods. For 2015, 2016 and 2017, the fair value of such grants incorporates a liquidity discount of 4.80%, 4.50% and 5.12%, respectively, related to the holding period.
Grants of restricted stock units (“RSUs”) to directors are time-based and vest 12 months after grant date. Because grantees are entitled to deferred dividend payments at the end of the vesting period, fair value of the RSUs is estimated based on fair value of underlying shares on the date of grant.
Bancorp has recognized stock-based compensation expense, within salaries and employee benefits for employees, and within other non-interest expense for directors, in the consolidated statements of income as follows:
For three months ended
Stock-based compensation expense before income taxes
Less: deferred tax benefit
Reduction of net income
Bancorp’s net income for the three months ended March 31, 2017 reflected the implementation of ASU 2016-09 which changed the way excess tax benefits and deficiencies related to share-based compensation are recorded. Prior to 2017 these were recorded directly to additional paid-in capital and, thus did not affect earnings. Beginning in 2017 these are recorded as a tax expense or benefit in the income statement, and for the three months ended March 31, 2017 resulted in a $1.0 million increase in net income. This tax benefit is not reflected in the table above.
Bancorp expects to record an additional $2.1 million of stock-based compensation expense in 2017 for equity grants outstanding as of March 31, 2017. As of March 31, 2017, Bancorp has $6.4 million of unrecognized stock-based compensation expense that is expected to be recorded as compensation expense over the next five years as awards vest. Bancorp used cash of $216 thousand during the first three months of 2017 for the purchase of shares upon the vesting of restricted stock units, net of cash received for options exercised. This compares to cash received of $495 thousand during the first three months of 2016 for similar activity.
Fair values of Bancorp’s stock options and SARs are estimated at the date of grant using the Black-Scholes option pricing model, a leading formula for calculating the value of stock options and SARs. This model requires the input of assumptions, changes to which can materially affect the fair value estimate. Fair value of restricted shares is determined by Bancorp’s closing stock price on the date of grant. The following assumptions were used in SAR valuations at the grant date in each year:
Dividend yield
Expected volatility
Risk free interest rate
Expected life of SARs (years)
Dividend yield and expected volatility are based on historical information for Bancorp corresponding to the expected life of options and SARs granted. Expected volatility is the volatility of the underlying shares for the expected term on a monthly basis. The risk free interest rate is the implied yield currently available on U.S. Treasury issues with a remaining term equal to the expected life of the options. The expected life of SARs is based on actual experience of past like-term SARs. Bancorp evaluates historical exercise and post-vesting termination behavior when determining the expected life.
A summary of stock option and SARs activity and related information for the twelve month period ended December 31, 2016 and the three month period ended March 31, 2017 follows:
Weighted
Aggregate
average
Options
intrinsic
remaining
and SARs
Exercise
exercise
fair
contractual
price
life (in years)
Vested and exercisable
Unvested
Total outstanding
Granted
Exercised
Forfeited
Vested year-to-date
Intrinsic value for stock options and SARs is defined as the amount by which the current market price of the underlying stock exceeds the exercise or grant price.
A summary of activity for the periods ending December 31, 2016 and March 31, 2017 for restricted shares of common stock granted to officers is outlined in the following table:
Grant date
weighted-
Number
average cost
Unvested at December 31, 2015
Shares awarded
Restrictions lapsed and shares released
Shares forfeited
Unvested at December 31, 2016
Unvested at March 31, 2017
Bancorp awarded performance-based restricted stock units (“PSUs”) to executive officers of Bancorp, the single three-year performance period for which began January 1 of the award year. The following table outlines the PSU grants.
Vesting
Expected
Grant
period
shares to
year
in years
be awarded
2015
In the first quarter of 2017, Bancorp awarded 4,680 RSUs to directors of Bancorp with a grant date fair value of $220 thousand.
(15) Net Income Per Share
The following table reflects, for the three months ended March 31, 2017 and 2016, net income (numerator) and average shares outstanding (denominator) for basic and diluted net income per share computations:
Average shares outstanding
Dilutive securities
Net income per share, basic
Net income per share, diluted
(16)
Segments
Bancorp’s principal activities include commercial banking and wealth management and trust. Commercial banking provides a full range of loan and deposit products to individual consumers and businesses. Commercial banking also includes Bancorp’s mortgage origination and securities brokerage activity. Wealth management and trust provides financial management services including investment management, trust and estate administration, and retirement plan services.
Financial information for each business segment reflects that which is specifically identifiable or allocated based on an internal allocation method. Income taxes are allocated based on the effective federal income tax rate adjusted for any tax exempt activity. All tax exempt activity and provision for loan losses have been allocated to the commercial banking segment. Measurement of performance of business segments is based on the management structure of Bancorp and is not necessarily comparable with similar information for any other financial institution. Information presented is also not necessarily indicative of the segments’ operations if they were independent entities.
Principally, all of the net assets of Stock Yards Bancorp, Inc. are involved in the commercial banking segment. Bancorp has goodwill of $682,000 related to a bank acquisition in 1996 which has been assigned to the commercial banking segment. Assets assigned to WM&T consist of premises and equipment, net of accumulated depreciation.
Selected financial information by business segment for the three month periods ended March 31, 2017 and 2016 follows:
Wealth
management
banking
and trust
Three months ended March 31, 2017
All other non-interest income
Non-interest expense
Segment assets
Three months ended March 31, 2016
Provision (credit) for loan losses
(17) Income Taxes
Components of income tax expense from operations were as follows:
Current income tax expense
Federal
State
Total current income tax expense
Deferred income tax (benefit) expense
Total deferred income tax expense
Change in valuation allowance
Total income tax expense
An analysis of the difference between statutory and effective income tax rates for the three months ended March 31, 2017 and 2016 follows:
Three months ended March 31,
U.S. federal statutory income tax rate
Tax credits
Tax exempt interest income
Increase in cash surrender value of life insurance
State income taxes, net of federal benefit
Other, net
Effective income tax rate
State income tax expense represents tax owed in Indiana. Kentucky and Ohio state bank taxes are based on capital levels, and are recorded as other non-interest expense.
Bancorp’s results for first quarter 2017 reflect the implementation of Accounting Standards Update 2016-09, which provides guidance for the recognition of excess tax benefits and deficiencies related to share-based payment awards. Effective for fiscal years beginning after December 15, 2016, ASU 2016-09 changes the way these benefits and deficiencies are recorded. Prior to 2017 they were recorded in additional paid-in capital, and therefore did not affect earnings. Beginning in 2017, these amounts are being recorded as tax expense or benefit in the income statement. For the three-month period ending March 31, 2017 Bancorp recorded a benefit of $1.0 million within the provision for income tax expense for such awards.
US GAAP provides guidance on financial statement recognition and measurement of tax positions taken, or expected to be taken, in tax returns. If recognized, tax benefits would reduce tax expense and accordingly, increase net income. The amount of unrecognized tax benefits may increase or decrease in the future for various reasons including adding amounts for current year tax positions, expiration of open income tax returns due to statutes of limitation, changes in management’s judgment about the level of uncertainty, status of examination, litigation and legislative activity and addition or elimination of uncertain tax positions. As of March 31, 2017 and December 31, 2016, the gross amount of unrecognized tax benefits was immaterial to the consolidated financial statements of the Company. Federal and state income tax returns are subject to examination for the years after 2012.
(18) Assets and Liabilities Measured and Reported at Fair Value
Bancorp follows the provisions of authoritative guidance for fair value measurements. This guidance is definitional and disclosure oriented and addresses how companies should approach measuring fair value when required by US GAAP. The guidance also prescribes various disclosures about financial statement categories and amounts which are measured at fair value, if such disclosures are not already specified elsewhere in US GAAP.
Authoritative guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between participants at the measurement date. The guidance also establishes a hierarchy to group assets and liabilities carried at fair value in three levels based upon the markets in which the assets and liabilities trade and the reliability of assumptions used to determine fair value. These levels are:
Level 1: Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3: Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions would reflect internal estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques could include pricing models, discounted cash flows and other similar techniques.
Authoritative guidance requires maximum use of observable inputs and minimum use of unobservable inputs in fair value measurements. Where there exists limited or no observable market data, Bancorp derives its own estimates by generally considering characteristics of the asset/liability, the current economic and competitive environment and other factors. For this reason, results cannot be determined with precision and may not be realized on an actual sale or immediate settlement of the asset or liability.
Bancorp’s investment securities available-for-sale and interest rate swaps are recorded at fair value on a recurring basis. Other accounts including mortgage servicing rights, impaired loans and other real estate owned may be recorded at fair value on a non-recurring basis, generally in the application of lower of cost or market adjustments or write-downs of specific assets.
The portfolio of investment securities available-for-sale is comprised of U.S. Treasury and other U.S. government obligations, debt securities of U.S. government-sponsored corporations (including mortgage-backed securities), obligations of state and political subdivisions and corporate equity securities. U.S. Treasury and corporate equity securities are priced using quoted prices of identical securities in an active market. These measurements are classified as Level 1 in the hierarchy above. All other securities are priced using standard industry models or matrices with various assumptions such as yield curves, volatility, prepayment speeds, default rates, time value, credit rating and market prices for similar instruments. These assumptions are generally observable in the market place and can be derived from or supported by observable data. These measurements are classified as Level 2 in the hierarchy above.
Interest rate swaps are valued using primarily Level 2 inputs. Fair value measurements generally based on benchmark forward yield curves and other relevant observable market data. For purposes of potential valuation adjustments to derivative positions, Bancorp evaluates the credit risk of its counterparties as well as its own credit risk. To date, Bancorp has not realized any losses due to a counterparty’s inability to perform and the change in value of derivative assets and liabilities attributable to credit risk was not significant during 2017.
Below are the carrying values of assets measured at fair value on a recurring basis.
Fair value at March 31, 2017
Assets
Level 1
Level 2
Level 3
Investment securities available-for-sale
Total investment securities available-for-sale
Interest rate swaps
Liabilities
Fair value at December 31, 2016
U.S. Treasury and other U.S. government obligations
Bancorp had no financial instruments classified within Level 3 of the valuation hierarchy for assets and liabilities measured at fair value on a recurring basis at March 31, 2017 or December 31, 2016.
MSRs are recorded at fair value upon capitalization, are amortized to correspond with estimated servicing income, and are periodically assessed for impairment based on fair value at the reporting date. Fair value is based on a valuation model that calculates the present value of estimated net servicing income. The model incorporates assumptions that market participants would use in estimating future net servicing income. These measurements are classified as Level 3. At March 31, 2017 and December 31, 2016 there was no valuation allowance for the mortgage servicing rights, as the fair value exceeded the cost. Accordingly, the MSRs are not included in either table below for March 31, 2017 or December 31, 2016. See Note 9 for more information regarding MSRs.
For impaired loans in the table below, the fair value is calculated as the carrying value of only loans with a specific valuation allowance, less the specific allowance. Fair value of impaired loans was primarily measured based on the value of the collateral securing these loans. Impaired loans are classified within Level 3 of the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory, and/or accounts receivable. Bancorp determines the value of real estate collateral based on independent appraisals performed by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraised values are discounted for costs to sell and may be discounted further based on management’s historical knowledge, changes in market conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the customer’s business. Such discounts by management are subjective and are typically significant unobservable inputs for determining fair value. For other assets, Bancorp relies on both internal and third party assessments of asset value, based on information provided by the borrower, following methodologies similar to those described for real estate. As of March 31, 2017, total impaired loans with a valuation allowance were $2.7 million, and the specific allowance totaled $1.2 million, resulting in a fair value of $1.5 million, compared with total impaired loans with a valuation allowance of $2.7 million, and the specific allowance allocation totaling $1.3 million, resulting in a fair value of $1.4 million at December 31, 2016. Losses represent the change in specific allowances for the period indicated.
Other real estate owned (“OREO”), which is carried at the lower of cost or fair value, is periodically assessed for impairment based on fair value at the reporting date. Fair value is based on appraisals performed by external parties which use judgments and assumptions that are property-specific and sensitive to changes in the overall economic environment. Appraisals may be further discounted based on management’s historical knowledge and/or changes in market conditions from the date of the most recent appraisal. Many of these inputs are not observable and, accordingly, these measurements are classified as Level 3. For OREO in the table below, fair value is the carrying value of only parcels of OREO which have a carrying value equal to appraised value. Losses represent write-downs which occurred during the period indicated. At March 31, 2017 and December 31, 2016, carrying value of all other real estate owned was $4.0 million and $5.0 million, respectively.
Below are the carrying values of assets measured at fair value on a non-recurring basis.
Losses for 3 month
period ended
Impaired loans
Other real estate owned
March 31, 2016
For the securities portfolio, Bancorp monitors the valuation technique used by pricing agencies to ascertain when transfers between levels have occurred. The nature of other assets and liabilities measured at fair value is such that transfers in and out of any level are expected to be rare. For the three months ended March 31, 2017, there were no transfers between Levels 1, 2, or 3. For Level 3 assets measured at fair value on a non-recurring basis as of March 31, 2017, the significant unobservable inputs used in the fair value measurements are presented below.
Significant
Valuation
unobservable
average of
(Dollars in thousands)
Value
technique
input
Impaired loans - collateral dependent
Appraisal
Appraisal discounts
(19) Disclosure of Financial Instruments Not Reported at Fair Value
US GAAP requires disclosure of the fair value of financial assets and liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or nonrecurring basis. Carrying amounts, estimated fair values, and placement in the fair value hierarchy of Bancorp’s financial instruments are as follows:
Carrying
Financial assets
Cash and short-term investments
Loans, net
Financial liabilities
Short-term borrowings
FHLB advances
Cash, short-term investments, accrued interest receivable/payable and short-term borrowings
For these short-term instruments, carrying amount is a reasonable estimate of fair value.
Mortgage loans held for sale are initially recorded at the lower of cost or market value. The portfolio is comprised of residential real estate loans and fair value is determined by market quotes for similar loans based on loan type, term, rate, size and the borrower’s credit score.
For these securities without readily available market values, carrying amount is a reasonable estimate of fair value as it equals the amount due from FHLB or other issuer at upon redemption.
US GAAP prescribes the exit price concept for estimating fair value of loans. Because there is not an active market (exit price) for trading virtually all types of loans in Bancorp’s portfolio, fair value of loans is estimated by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities (entrance price).
Fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. Fair value of fixed-rate certificates of deposits is estimated by discounting future cash flows using the rates currently offered for deposits of similar remaining maturities.
Fair value of FHLB advances is estimated by discounting future cash flows using estimates of current market rate for instruments with similar terms and remaining maturities.
Commitments to extend credit and standby letters of credit
Fair values of commitments to extend credit are estimated using fees currently charged to enter into similar agreements and creditworthiness of customers. Fair values of standby letters of credit are based on fees currently charged for similar agreements or estimated cost to terminate them or otherwise settle obligations with counterparties at the reporting date. Fair value of commitments to extend credit, letters of credit and lines of credit is not presented since management believes the fair value to be insignificant.
Limitations
Fair value estimates are made at a specific point in time based on relevant market information and information about financial instruments. Because no market exists for a significant portion of Bancorp’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Therefore, calculated fair value estimates in many instances cannot be substantiated by comparison to independent markets and, in many cases, may not be realizable in a current sale of the instrument. Changes in assumptions could significantly affect estimates.
(20)
Regulatory Matters
Bancorp and the Bank are subject to various capital requirements prescribed by banking regulations and administered by state and federal banking agencies. Under these requirements, Bancorp and the Bank must meet minimum amounts and percentages of Tier 1, common equity Tier 1, and total capital, as defined, to risk weighted assets and Tier 1 capital to average assets. Risk weighted assets are determined by applying certain risk weightings prescribed by regulation to various categories of assets and off-balance sheet commitments. Capital and risk weighted assets may be further subject to qualitative judgments by regulators as to components, risk weighting and other factors. Failure to meet capital requirements can result in certain mandatory, and possibly discretionary, corrective actions prescribed by regulation or determined to be necessary by regulators, which could materially affect the unaudited consolidated financial statements.
In 2013, the Federal Reserve Board and the FDIC approved rules that substantially amended regulatory risk-based capital rules applicable to Bancorp and the Bank. The rules implemented regulatory capital reforms of the Basel Committee on Banking Supervision reflected in "Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems" (Basel III) and changes required by the Dodd-Frank Act. Basel III regulatory capital reforms became effective for Bancorp and the Bank on January 1, 2015, and include new minimum risk-based capital and leverage ratios. Bancorp and the Bank met all capital requirements to which they were subject as of March 31, 2017.
The following table sets forth consolidated Bancorp’s and the Bank’s risk based capital amounts and ratios as of March 31, 2017 and December 31, 2016.
Actual
Minimum for adequately
capitalized
Minimum for well
Ratio
Total risk-based capital (1)
Consolidated
NA
Common equity tier 1 risk-based capital
Tier 1 risk-based capital (1)
Leverage (2)
Ratio is computed in relation to risk-weighted assets.
(2)
Ratio is computed in relation to average assets.
Not applicable. Regulatory framework does not define well capitalized for holding companies.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This item discusses the results of operations for Stock Yards Bancorp, Inc. (“Bancorp” or “Company”), and its subsidiary, Stock Yards Bank & Trust Company (“Bank”) for the three months ended March 31, 2017 and compares this period with the same period of the previous year. Unless otherwise indicated, all references in this discussion to the Bank include Bancorp. In addition, the discussion describes changes in the financial condition of Bancorp and the Bank that have occurred during the first three months of 2017 compared with same period in 2016. This discussion should be read in conjunction with the consolidated financial statements and accompanying notes presented in Part 1, Item 1 of this report.
This report contains forward-looking statements under the Private Securities Litigation Reform Act that involve risks and uncertainties. Although Bancorp believes assumptions underlying forward-looking statements contained herein are reasonable, any of these assumptions could be inaccurate. Factors that could cause actual results to differ from results discussed in forward-looking statements include, but are not limited to the following: economic conditions both generally and more specifically in markets in which Bancorp and the Bank operate; competition for Bancorp’s customers from other providers of financial services; government legislation and regulation which change from time to time and over which Bancorp has no control; changes in interest rates; material unforeseen changes in liquidity, results of operations, or financial condition of Bancorp’s customers; and other risks detailed in Bancorp’s filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of Bancorp.
Overview of 2017 through March 31
Bancorp completed the first three months of 2017 with net income of $10.8 million, a 9.7% increase over the comparable period in 2016. The increase is primarily due to higher net interest income, higher non-interest income, and a lower effective income tax rate. These increases were partially offset by higher non-interest expense and higher provision for loan losses. Diluted earnings per share for the first three months of 2017 were $0.47, compared with $0.44 for the first three months of 2016. Bancorp's performance for the first three months of 2017 reflected several positive factors, including:
Continued positive effect of strong loan growth over the past 12 months;
Continued high credit quality;
Significant growth in fee income; and
Solid returns on average assets and equity.
As is the case with most banks, Bancorp’s primary revenue sources are net interest income and fee income from various financial services provided to customers. Net interest income is the difference between interest income earned on loans, investment securities and other interest earning assets less interest expense on deposit accounts and other interest bearing liabilities. Loan volume and interest rates earned on those loans are critical to overall profitability. Similarly, deposit volume is crucial to funding loans and rates paid on deposits directly impact profitability. Loan and deposit volumes are influenced by competition, new account acquisition efforts and economic factors including market interest rates, business spending, consumer confidence and competitive conditions within the marketplace.
Net interest income increased $1.7 million, or 7.3%, for the first three months of 2017, compared with the same period in 2016. Net interest margin increased to 3.63% for the first three months of 2017, compared with 3.56% for the same period of 2016.
For the three-month period ended March 31, 2017, Bancorp recorded a $900 thousand provision for loan losses, compared to $500 thousand for the same period in 2016. During its quarterly review of qualitative factors, Bancorp noted a slight elevation in past due loans along with an increase in potential exposure for one pool of classified loans. Due to these increases, Bancorp increased its qualitative allocation for the allowance during the quarter. The provision for loan losses represents a charge to earnings necessary to establish an allowance for loan losses that, in management’s evaluation, is adequate to provide coverage for the inherent losses on outstanding loans.
Total non-interest income in the first three months of 2017 increased $715 thousand, or 7.1%, compared with the same period in 2016, and comprised 30.0% of total revenues, as compared to 30.1% for the same period in 2016. Continuing the trends of 2016, Bancorp’s wealth management and trust division (WM&T) led the increase with a 10.5%, or $482 thousand increase over the same period in 2016.
Total non-interest expense in the first three months of 2017 increased $1.6 million, or 8.2%, compared with the same period in 2016, primarily due to increases in salaries and employee benefits, as well as expenses related to the Bancorp’s continued growth and improvements in technology infrastructure. Amortization expenses for investments in tax-credit partnerships, which had a significant impact on earnings in 2016, decreased by $399 thousand, or 39.3%, in the first three months of 2017, as compared to the same period in 2016. Bancorp's efficiency ratio in the first three months of 2017 was 58.5% compared to 57.9% in the same period in 2016. Excluding amortization of the investments in tax credit partnerships, the adjusted efficiency ratio, a non-GAAP measure, would have been 56.8% and 54.9% for the first three months of 2017 and 2016, respectively. See the Non-GAAP Financial Measures section for details on reconcilement to US GAAP measures.
Bancorp’s effective tax rate decreased to 22.6% in 2017 from 27.2% in 2016. The decrease in the effective tax rate from 2016 to 2017 was largely the result of the adoption of ASU 2016-09 “Compensation – Stock Compensation Improvements to Employee Share-Based Payment Accounting”. The new standard requires excess tax benefits and deficiencies related to share-based payment awards to be reflected in the statement of operations as a component of the provision for income taxes. For the three months ended March 31, 2017 Bancorp recorded a benefit of $1.0 million for such tax benefits against the provision for income tax expense. Prior to adoption of ASU 2016-09 these tax benefits were recorded directly to additional paid-in capital.
Tangible common equity (TCE), a non-GAAP measure, is a measure of a company's capital which is useful in evaluating the quality and adequacy of capital. The ratio of tangible common equity to total tangible assets was 10.48% as of March 31, 2017, compared with 10.26% at December 31, 2016. See the Non-GAAP Financial Measures section for details on reconcilement to US GAAP measures.
On April 29, 2016 Bancorp declared a 3 for 2 stock split effected as a 50% stock dividend to shareholders of record on May 13, 2016, payable May 27, 2016. Share and per share information has been adjusted for this dividend.
The following sections provide more details on subjects presented in this overview.
a) Results Of Operations
Net income of $10.8 million for the three months ended March 31, 2017 increased $956 thousand, or 9.7%, from $9.8 million for the comparable 2016 period. Basic net income per share was $0.48 for the first quarter of 2017, an increase of 9.1% from the $0.44 for the first quarter of 2016. Net income per share on a diluted basis was $0.47 for the first quarter of 2017, an increase of 6.8% from the $0.44 for the same period in 2016. See Note 15 for additional information related to net income per share.
Annualized return on average assets and annualized return on average stockholders’ equity were 1.46% and 13.78%, respectively, for the first quarter of 2017, compared with 1.40% and 13.52%, respectively, for the same period in 2016.
Net Interest Income
The following table presents average balance sheets for the three month periods ended March 31, 2017 and 2016 along with the related calculation of tax-equivalent net interest income, net interest margin and net interest spread for the related periods. See the notes following the tables for further explanation.
balances
Interest
rate
Earning assets:
Securities:
Taxable
Tax-exempt
FHLB stock and other securities
Loans, net of unearned income
Total earning assets
Non-earning assets:
Premises and equipment
Accrued interest receivable and other assets
Interest bearing liabilities:
Interest bearing demand deposits
Savings deposits
Money market deposits
Time deposits
Federal funds purchased and other short term borrowings
Total interest bearing liabilities
Non-interest bearing liabilities:
Non-interest bearing demand deposits
Accrued interest payable and other liabilities
Stockholders’ equity
Net interest spread
Net interest margin
Notes to the average balance and interest rate tables:
Net interest income, the most significant component of the Bank's earnings is total interest income less total interest expense. The level of net interest income is determined by mix and volume of interest earning assets, interest bearing deposits and borrowed funds, and changes in interest rates.
Net interest spread is the difference between taxable equivalent rates earned on interest earning assets less the rate expensed on interest bearing liabilities.
Net interest margin represents net interest income on a taxable equivalent basis as a percentage of average interest earning assets. Net interest margin is affected by both interest rate spread and the level of non-interest bearing sources of funds, primarily consisting of demand deposits and stockholders’ equity.
Interest income on a fully tax equivalent basis includes additional amounts of interest income that would have been earned if investments in certain tax-exempt interest earning assets had been made in assets subject to federal taxes yielding the same after-tax income. Interest income on municipal securities and tax-exempt loans has been calculated on a fully tax equivalent basis using a federal income tax rate of 35%. Approximate tax equivalent adjustments to interest income were $198 thousand and $219 thousand, respectively, for the three month periods ended March 31, 2017 and 2016.
Average balances for loans include the principal balance of non-accrual loans and exclude participation loans accounted for as secured borrowings. These participation loans averaged $15.9 million and $7.0 million, respectively, for the three month periods ended March 31, 2017 and 2016.
Fully taxable equivalent net interest income of $25.4 million for the three months ended March 31, 2017 increased $1.7 million, or 7.2%, from $23.7 million for the same period in 2016. Positive effects of increased average balances on loans, resulting from loan growth in 2016, were partially offset by the negative effect of increasing rates and average balances for money market deposit accounts and increased rates on funding sources. Net interest spread and net interest margin were 3.53% and 3.63%, respectively, for the first quarter of 2017 and 3.49% and 3.56%, respectively, for the first quarter of 2016.
Average earning assets increased $164.6 million or 6.2%, to $2.8 billion for the first three months of 2017 as compared with 2016, reflecting increases in the loan portfolio and available-for-sale investments. Average interest bearing liabilities increased $77.5 million, or 4.1%, to $2.0 billion for the first three months of 2017, as compared with the same period in 2016, primarily due to increases in the volume of interest bearing demand deposits, money market deposit accounts, securities sold under agreements to repurchase, and FHLB advances, partially offset by decreases in time deposits, and other short term borrowing products.
Asset/Liability Management and Interest Rate Risk
Managing interest rate risk is fundamental for the financial services industry. The primary objective of interest rate risk management is to neutralize effects of interest rate changes on net income. By considering both on and off-balance sheet financial instruments, management evaluates interest rate sensitivity with the goal of optimizing net interest income within the constraints of prudent capital adequacy, liquidity needs, market opportunities and customer requirements.
Interest Rate Simulation Sensitivity Analysis
Bancorp uses an earnings simulation model to estimate and evaluate the impact of an immediate change in interest rates on earnings in a one year forecast. The simulation model is designed to reflect dynamics of interest earning assets, interest bearing liabilities and off-balance sheet financial instruments. By estimating effects of interest rate increases and decreases, the model can reveal approximate interest rate risk exposure. This simulation model is used by management to gauge approximate results given a specific change in interest rates at a given point in time. The model is therefore a tool to indicate earnings trends in given interest rate scenarios and may not indicate actual expected results.
The March 31, 2017 simulation analysis, which shows very little interest rate sensitivity, indicates that increases in interest rates of 100 to 200 basis points would have a positive effect on net interest income, and a decrease of 100 basis points in interest rates would have a negative effect on net interest income. If rates rise 200 bp, net interest income increases 1.10%. The relatively small increase in net interest income for the rising rate scenarios is primarily due to the high percentage of non-maturity deposits, which reprice immediately, combined with the short duration of time deposits matched against the loan portfolio. These estimates are summarized below. The scenario of rates decreasing 200 bp is not reasonably possible given current low rates for short-term instruments and most deposits.
Net interest
income %
change
Increase 200 bp
Increase 100 bp
Decrease 100 bp
Decrease 200 bp
Approximately 61% of Bancorp’s loan portfolio has fixed rates and 39% of its loan portfolio is priced at variable rates. With the Prime rate currently at 4%, after the .25% increase in Prime in March 2017, the majority of Bancorp’s variable rate loans now have interest rates at or above their floors. With a further increase in interest rate levels by Prime or Libor, over 90% of the Bank’s variable rate loan portfolio will increase along with those rates. This effect is captured in the simulation analysis above.
Undesignated derivative instruments described in Note 8 to Bancorp’s consolidated financial statements are recognized on the consolidated balance sheet at fair value, with changes in fair value due to changes in prevailing interest rates, recorded in other non-interest income. Because of matching terms of offsetting contracts, in addition to collateral provisions which mitigate the impact of non-performance risk, changes in fair value subsequent to initial recognition have a minimal effect on earnings, and are therefore not included in the simulation analysis results above.
Derivatives designated as cash flow hedges described in Note 8 to Bancorp’s consolidated financial statements are recognized on the consolidated balance sheet at fair value, with changes in fair value due to changes in prevailing interest rates, recorded net of tax in other comprehensive income.
Provision for Loan Losses
The provision for loan losses represents a charge to earnings necessary to establish an allowance for loan losses that, in management’s evaluation, is adequate to provide coverage for inherent losses on outstanding loans. The allowance for loan losses is calculated after considering credit quality factors, and ultimately relies on an overall internal analysis of risk in the loan portfolio. The provision reflects an allowance methodology that is driven by risk ratings, historical losses, and qualitative factors. The 2017 provision reflected a number of factors, primarily qualitative considerations, continued improvement in key metrics, and expansion of the historical look-back period from 24 quarters to 28 quarters. This expansion of the historical period was applied to all classes and segments of our portfolio. The expansion of the look-back period for the historical loss rates used in the quantitative allocation caused us to review the overall methodology for the qualitative factors to ensure we were appropriately capturing the risk not addressed in the historical loss rates used in the quantitative allocation. Management believes the extension of the look-back period is appropriate to ensure capture of the impact of a full economic cycle and more accurately represents the current level of risk inherent in the loan portfolio. Key indicators of loan quality continued to show improvement during 2017, with levels of non-performing loans continuing a five year downward trend. Bancorp considers the present asset quality metrics to be exceptionally strong. Bancorp recorded a $900 thousand provision for loan losses in the first three months of 2017, compared with a provision of $500 thousand for the same period of 2016. During its quarterly review of qualitative factors, Bancorp noted a slight elevation in past due loans along with a potential exposure for one pool of classified loans. Due to this increase, Bancorp increased its qualitative allocation for the allowance during the quarter.
Management uses loan grading procedures which result in specific allowance allocations for estimated inherent risk of loss. For all loans graded, but not individually reviewed for allowance purposes, a general allowance allocation is computed using historical data based on actual loss experience. Specific and general allocations plus consideration of qualitative factors represent management’s best estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses. Based on this detailed analysis of credit risk, management considers the allowance for loan losses adequate to cover probable losses inherent in the loan portfolio at March 31, 2017.
An analysis of the changes in the allowance for loan losses and selected ratios for the three-month periods ended March 31, 2017 and 2016 follows:
Balance at the beginning of the period
Loan charge-offs, net of recoveries
Balance at the end of the period
Average loans, net of unearned income
Provision for loan losses to average loans (1)
Net loan charge-offs to average loans (1)
Allowance for loan losses to average loans
Allowance for loan losses to period-end loans
(1) Amounts not annualized
Loans are charged off when deemed uncollectible and a loss is identified or after underlying collateral has been liquidated; however, collection efforts may continue and future recoveries may occur. Periodically, loans are partially charged off to net realizable value based upon collateral analysis and collection status.
An analysis of net charge-offs by loan category for the three month periods ended March 31, 2017 and 2016 follows:
Three months
Net loan charge-offs (recoveries)
Real estate mortgage - commercial investment
Real estate mortgage - owner occupied commercial
Real estate mortgage - 1-4 family residential
Home equity
Total net loan charge-offs
Non-interest Income and Expenses
The following table sets forth major components of non-interest income and expenses for the three month periods ended March 31, 2017 and 2016.
Change
% Change
Amortization of investment in tax credit partnerships
The largest component of non-interest income is wealth management and trust (“WM&T”) revenue. The magnitude of WM&T revenue distinguishes Bancorp from other community banks of similar asset size. Trust assets under management totaled $2.61 billion at March 31, 2017, a 15.7% increase compared to $2.26 billion at March 31, 2016. Assets under management are stated at market value and while the 2017 increase was partially the result of a rising stock market during the period, primarily it represents a continuance of the 2016 trend for new clients added. WM&T revenue, which constitutes an average of 47% of non-interest income, increased $482 thousand, or 10.5%, for the three months ended March 31, 2017 compared to the same period in 2016. Recurring fees, which generally comprise over 97% of the WM&T revenue, increased $601 thousand, or 13.7%, in 2017, compared to 2016. Recurring fees earned for managing accounts are based on a percentage of market value of the assets under management and are assessed on a monthly basis. Some revenues of the WM&T department, most notably executor, insurance, and some employee benefit plan-related fees, are non-recurring in nature and the timing of these revenues corresponds with the related administrative activities, and is also based on the market value of assets under management. Total non-recurring fees decreased $119 thousand for 2017, compared to 2016. Contracts between WM&T and their clients do not permit performance based fees and accordingly, none of the fees earned by WM&T are performance based. Management believes the WM&T department will continue to factor significantly in Bancorp’s financial results and provide strategic diversity to revenue streams. Management is optimistic that the WM&T department will continue to deliver strong growth in 2017, but increased market volatility could affect short-term results.
The following table provides information regarding assets under management (AUM) by WM&T as of March 31, 2017 and 2016. This table demonstrates that:
• Approximately 80% of our AUM are actively managed.
• Non-managed employee benefit plan accounts consist primarily of participant directed assets.
• The amount of custody and safekeeping accounts is insignificant, and
• The majority of our managed assets are in personal trust, agency, and investment management accounts.
Assets Under Management by Account Type
Managed
Non-managed (1)
Personal trust and agency accounts
Employee benefit and retirement accounts
Defined contribution
Defined benefit
IRAs
Investment management and investment advisor agency accounts
Foundation and endowment trust and agency accounts
Total fiduciary accounts
Custody and safekeeping accounts
Totals
Total managed and non-managed assets
(1) Non-managed assets represent those for which WM&T does not have investment discretion.
The table below presents data regarding WM&T managed assets by class of investment for the periods ending March 31, 2017 and 2016. This table demonstrates that:
•
Managed assets are invested in instruments for which market values can be readily determined.
The majority of these instruments are sensitive to market fluctuations.
The composition of our managed assets is divided approximately 60% in equities and 40% in fixed income securities, and this composition is relatively consistent from year to year, and
No Stock Yards Bank propriety mutual funds exist, and therefore no such investment options are available to our clients.
Managed Assets by Class of Investment
As of March 31,
Non-interest bearing deposits
Interest bearing deposits
US Treasury and government agency obligations
State, county and municipal obligations
Money market mutual funds
Equity mutual funds
Other mutual funds - fixed, balanced, and municipal
Other notes and bonds
Common and preferred stocks
Real estate mortgages
Other miscellaneous assets (1)
Total managed assets
(1) Includes rights, warrants, annuities, insurance policies, unit investment trusts, and oil and gas rights.
The table below provides information regarding fee income earned by Bancorp’s WM&T department for the three-month periods ended March 31, 2017 and 2016. It demonstrates that our fee revenue is earned most significantly from personal trust, agency, and investment management accounts. Fees are based on AUM and tailored for individual accounts and/or relationships. We use a fee structure that considers and tailors based on type of account and other factors. For example, fee structures are in place for investment management, irrevocable trusts, revocable trusts, IRA accounts, and accounts holding only fixed income securities. There are also fee structures for estate settlements, which are non-recurring, and retirement plan services which typically consist of a one-time conversion fee with recurring AUM fees to follow. All fees are based on the market value of each account and are tiered based on account size, with larger relationships paying a lower percentage in fees. Fees are agreed upon at the time the account is opened and these and any subsequent revisions are communicated in writing to the customer. Fees earned are not performance based nor are they based on investment strategy or transactions.
Fiduciary and Related Services Income
Personal trust and agency
Employee benefits and related trust
IRA's
Corporate trust and agency
Investment management and investment advisory agency
Foundation and endowment trust and agency
Custody and safekeeping
Brokerage and insurance
Other Non-interest Income and Non-interest Expense
Service charges on deposit accounts increased $261 thousand, or 12.2%, for the first three months of 2017, as compared with the same periods in 2016. The increases are primarily due to the introduction of a new checking account product during 2016. The income associated with that product was approximately $220 thousand for the first quarter of 2017, as compared to none for the same period in 2016. That product provides ancillary services to customers, while carrying a monthly service charge. A significant component of service charges is related to fees earned on overdrawn checking accounts, which decreased by 2.6%, period to period. Management expects this source of revenue to slowly decline due to anticipated changes in customer behavior and ongoing regulatory restrictions. This component of service charge income is generally driven by transaction volume, which can fluctuate throughout the year. Conversely, Bancorp continues to develop treasury revenue from cash management services offered to commercial customers. This revenue now represents approximately 25% of service charge income, an increase of approximately 15% over the same period in 2016.
Bankcard transaction revenue increased $96 thousand, or 7.3%, in the first three months of 2017, as compared with the same period in 2016. Bankcard transaction revenue primarily represents income the Bank derives from customers’ use of debit and credit cards. Bancorp began offering credit cards to business customers late in 2015. Revenue on credit cards totaled $253 thousand for the first quarter 2017, compared to $142 thousand for the same period in 2016, a 78.2% increase. Bancorp expects volume of credit card transactions to increase as this product is added to the commercial customer base. Interchange income on debit cards decreased period to period, $1.15 million for the first quarter of 2017 as compared to $1.17 million for the first quarter of 2016, a decrease of $15 thousand, or 1.3%, primarily a result of declining interchange rates. Bancorp expects decreases in interchange rates on debit cards to continue as merchants gravitate to lower cost options in a competitive market.
Mortgage banking revenue primarily includes gains on sales of mortgage loans. Bancorp’s mortgage banking department originates residential mortgage loans to be sold in the secondary market. Interest rates on the loans sold are locked with the borrower and investor prior to closing the loans, thus Bancorp bears no interest rate risk related to these loans. The department offers conventional, VA and FHA financing, for purchases and refinances, as well as programs for first-time home buyers. Changes in interest rates on mortgage loans directly impact the volume of business transacted by the mortgage banking department. Mortgage banking revenue decreased $92 thousand, or 11.6%, for the first three months of 2017, as compared with the same periods in 2016, primarily due to lower transaction volume. A shortage of houses for sale is contributing to this lower demand for loans.
Securities brokerage commissions and fees increased $96 thousand, or 21.7%, for the three-month period ended March 31, 2017 as compared with the same period in 2016. These increases correspond primarily to overall brokerage volume. Brokerage commissions and fees earned consist primarily of stock, bond and mutual fund sales as well as wrap fees on accounts. Wrap fees are charges for investment programs that bundle together a suite of services, such as brokerage, advisory, research and management, and are based on a percentage of assets. Bancorp deploys its brokers primarily through its branch network via an arrangement with a third party broker-dealer, while larger managed accounts are serviced in the Bank’s WM&T department.
Bank Owned Life Insurance (BOLI) income totaled $204 thousand and $221 thousand for the first quarter of 2017 and 2016, respectively. BOLI assets represent the cash surrender value for life insurance policies on certain key employees who have provided consent for Bancorp to be the beneficiary of a portion of such policies. BOLI income results from the related change in cash surrender value and any death benefits received under the policies. This income helps offset the cost of various employee benefits.
Other non-interest income decreased $111 thousand, or 20.0%, for the first quarter of 2017 compared with the same period in 2016. Included in this category is swap fee income, which totaled $171 thousand for the first three months of 2016. There was no swap fee income during the first three months of 2017. Opportunities to earn swap fee income are infrequent due to the specialized nature of the transactions. This category includes a variety of other income sources, none of which resulted in individually significant variances.
Salaries and employee benefits increased $1.2 million, or 10.0%, for the first quarter of 2017, compared with the same period in 2016. The increase is largely due to higher compensation expenses, reflecting addition of personnel and increased health care costs. The Bank’s employee health insurance is a self-insured plan and related expenses fluctuate with claims experience. At March 31, 2017, Bancorp had 582 full-time equivalent employees compared with 550 at March 31, 2016.
Net occupancy expense increased $106 thousand, or 7.0%, in the first quarter of 2017, compared with the same period in 2016. The increase was largely due to increased maintenance expense for multiple bank properties and a decrease in sub-lease rents.
Data processing expense increased $324 thousand, or 21.0% in the first quarter of 2017 compared with the same period in 2016. The increase was partially a result of increases in computer infrastructure upgrade and maintenance costs. These expenses include ongoing computer software amortization, equipment depreciation, and expenditures related to investments in technology needed to maintain and improve the quality of delivery channels and internal resources. Other factors contributing to the increase were debit card expenses and WM&T data processing expenses. Debit card expenses increased, over the same period in 2016, as a result of increased third party processing and card issuance costs. Expenses related to WM&T expenses increased primarily due to investment research costs which are typically offset by trading volume discounts. For the first quarter of 2017 these expenses were higher due to lower trading activity.
Furniture and equipment expense decreased slightly for the first three months of 2017, as compared with the same period in 2016. Costs of capital asset additions flow through the statement of income over the lives of the assets in the form of depreciation expense.
FDIC insurance expense decreased $98 thousand, or 29.9%, for the first quarter of 2017 compared with the same period in 2016. The assessment is calculated by the FDIC, and the decline in expense is due primarily to a change in assessment methodology. During 2016 the FDIC revised the assessment criteria to more closely aligning FDIC assessments with each financial institution’s risks. Bancorp benefited from this change.
Amortization of investments in tax credit partnerships decreased $399 thousand for the first quarter of 2017 compared with the same periods of 2016. This expense reflects amortization of investments in partnerships which generate federal income tax credits and vary widely depending upon the timing and magnitude of investments and related amortization. For each of Bancorp’s investments in tax credit partnerships the tax benefit compared with the amortization results in a positive effect on net income. See the Income Taxes section below for details on amortization and income tax impact for these credits.
Other non-interest expenses increased $466 thousand or 17.6% in the first quarter of 2017 compared with the same period in 2016. The increase for the 2017 period was largely due to $334 thousand of net recoveries on sales of foreclosed assets in 2016 compared with none in 2017. Also, as described above, during 2016 Bancorp introduced a checking product that offers benefits to account owners. The expense associated with that product was $60 thousand for the first quarter of 2017 as opposed to none in 2016. Other non-interest expenses also include legal and professional fees, advertising, printing, mail and telecommunications, none of which had individually significant variances.
Income Taxes
For the first three months of 2017, Bancorp recorded income tax expense of $3.1 million, compared with $3.7 million for the same period in 2016. The effective rate for the three month period was 22.6% in 2017 and 27.2% in 2016. The decrease in the effective tax rate from 2016 to 2017 was largely the result of the adoption of ASU 2016-09 “Compensation – Stock Compensation Improvements to Employee Share-Based Payment Accounting”. The new standard requires excess tax benefits and deficiencies related to share-based payment awards to be reflected in the statement of operations as a component of the provision for income taxes. For the three months ended March 31, 2017 Bancorp recorded a benefit of $1.0 million for such excess benefits against the provision for income tax expense. Prior to adoption of ASU 2016-09 these tax benefits were recorded directly to additional paid-in capital. Tax benefits recorded to capital for the three months ended March 31, 2016 was $404 thousand.
Bancorp invests in certain partnerships that yield federal income tax credits. These tax credits contributed, to a lesser degree, to the change in tax expense and effective tax rate, 2016 to 2017. Taken as a whole, the tax benefit of these investments exceeds amortization expense associated with them, resulting in a positive impact on net income.
Commitments
Bancorp uses a variety of financial instruments in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. A discussion of Bancorp’s commitments is included in Note 11.
Other commitments discussed in Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2016, have not materially changed since that report was filed, relative to qualitative and quantitative disclosures of fixed and determinable contractual obligations.
b) Financial Condition
Balance Sheet
Total assets remained unchanged at $3.0 billion at both March 31, 2017 and December 31, 2016. In the first three months of 2017 decreases in both loans and available for sale investments were offset by increased cash held and invested short term. Loans decreased $32.6 million, or 1.4%, primarily as a result of commercial real estate (CRE) loan payoffs, as borrowers moved elsewhere for permanent financing and CRE loans for which collateral was sold. These repayments were largely anticipated. Securities available-for-sale decreased by $13.9 million over the first three months of 2017. The decrease was net of market value changes in the portfolio with unrealized losses at March 31, 2017 of $803 thousand as compared to unrealized losses of $1.9 million at December 31, 2016. Funds from maturing available-for-sale investments were held as cash, or invested short term, to fund future loan growth. Included in securities available-for-sale are short term obligations of U.S. Treasury or U.S. government sponsored entities. These securities, which totaled $100 million at March 31, 2017 and December 31, 2016, normally have a maturity of less than one month, and are purchased at quarter-end as part of a tax minimization strategy.
Total liabilities decreased $12.0 million, December 31, 2016 to March 31, 2017, from $2.73 billion to $2.71 billion, respectively. Total deposits increased $23.7 million or 0.9%, with increases in money market deposits, $21.0 million, or 3.1%; non-interest bearing deposit accounts, $6.4 million or 0.9%; and savings accounts, $6.3 million, or 4.5%. Interest bearing demand deposit accounts decreased $2.5 million, or 0.3%, as did time deposits, $7.5 million, or 3.0%. Securities sold under agreements to repurchase decreased $1.8 million, or 2.8%, due to normal cyclical activity. Federal funds purchased and other short-term borrowing decreased $36.4 million, or 76.8%, period to period. Bancorp uses short-term lines of credit to manage its overall liquidity position. Other liabilities increased $2.9 million or 7.6% largely due to an increase in secured borrowing related to participation loans. See the Elements of Loan Portfolio section below on details related to participations loans.
Elements of Loan Portfolio
The following table sets forth the major classifications of the loan portfolio.
Loans by Type
Undeveloped land (1)
Subtotal: real estate mortgage
Undeveloped land consists of land acquired for development by the borrower, but for which no development has yet taken place.
Bancorp occasionally enters into loan participation agreements with other banks to diversify credit risk. For certain sold participation loans, Bancorp has retained effective control of the loans, typically by restricting the participating institutions from pledging or selling their share of the loan without permission from Bancorp. US GAAP requires the participated portion of these loans to be recorded as secured borrowings. These participated loans are included in the commercial and industrial and real estate mortgage loan totals above, and a corresponding liability is recorded in other liabilities. At March 31, 2017 and December 31, 2016, the total participated portions of loans of this nature were $21.5 million and $15.8 million, respectively.
An allowance for loan losses has been established to provide for probable losses on loans that may not be fully repaid. The allowance for loan losses is increased by provisions charged to expense and decreased by charge-offs, net of recoveries. Loans are typically charged off when management deems them uncollectible and after underlying collateral has been liquidated; however, collection efforts continue and future recoveries may occur. Periodically, loans are partially charged off to the net realizable value based upon evaluation of related underlying collateral, including Bancorp’s bias for resolution.
The allowance methodology is driven by risk ratings, historical losses, and qualitative factors. The level of the 2017 allowance for loan losses reflected a number of factors, primarily qualitative considerations, continued improvement in key metrics, and expansion of the historical look-back period from 24 quarters to 28 quarters. This expansion of the historical period was applied to all classes and segments of our portfolio. The expansion of the look-back period for the historical loss rates used in the quantitative allocation caused us to review the overall methodology for the qualitative factors to ensure we were appropriately capturing the risk not addressed in the historical loss rates used in the quantitative allocation. Management believes the extension of the look-back period is appropriate to ensure capture of the impact of a full economic cycle and more accurately represents the current level of risk inherent in the loan portfolio. Key indicators of loan quality continued to show improvement during 2017, with levels of non-performing loans continuing a five year downward trend. Bancorp considers the present asset quality metrics to be exceptionally strong. During its quarterly review of qualitative factors, Bancorp noted a slight elevation in past due loans along with a potential exposure for one pool of classified loans. Due to this increase, Bancorp increased its qualitative allocation for the allowance during the quarter. Additional information regarding Bancorp’s methodology for evaluating the adequacy of the allowance for loan loss can be read in the Company’s annual 10K.
As of March 31, 2017 the allowance for loan loss was $24.5 million, a $474 thousand increase over the December 31, 2016 balance of $24.0 million. For the comparative periods, the allowance as a percent of average loans was 1.07% and 1.11%, respectively. The allowance as a percent of period end loans, as of each period end, 1.08% and 1.04%, respectively.
Non-performing Loans and Assets
Information summarizing non-performing assets, including non-accrual loans follows:
Non-accrual loans
Troubled debt restructuring
Loans past due 90 days or more and still accruing
Non-performing loans
Foreclosed real estate
Non-performing assets
Non-performing loans as a percentage of total loans
Non-performing assets as a percentage of total assets
Non-performing assets as of March 31, 2017 were comprised of 70 non-accrual loans, ranging in amount from $1 to $953 thousand, and foreclosed real estate held for sale. Foreclosed real estate held at March 31, 2017 included raw land, both residential development and vacant commercial; a manufacturing facility; a commercial building with multiple tenants; and six residential rental properties.
The following table sets forth the major classifications of non-accrual loans:
Non-accrual loans by type
Home equity and consumer loans
c) Liquidity
The role of liquidity management is to ensure funds are available to meet depositors’ withdrawal and borrowers’ credit demands while at the same time maximizing profitability. This is accomplished by balancing changes in demand for funds with changes in the supply of those funds. Liquidity is provided by short-term liquid assets that can be converted to cash, investment securities available-for-sale, various lines of credit available to Bancorp, and the ability to attract funds from external sources, principally deposits. Management believes it has the ability to increase deposits at any time by offering rates slightly higher than market rate.
Bancorp’s most liquid assets are comprised of cash and due from banks, available-for-sale marketable investment securities, federal funds sold and interest bearing deposits with banks. Federal funds sold and interest bearing deposits totaled $45.9 million at March 31, 2017. These investments normally have overnight maturities and are used for general daily liquidity purposes. The fair value of the available-for-sale investment portfolio was $556.1 million at March 31, 2017. The portfolio includes maturities of approximately $183.4 million over the next twelve months, including $100 million of short-term securities which matured in April 2017. Combined with federal funds sold and interest bearing deposits, these offer substantial resources to meet either new loan demand or reductions in Bancorp’s deposit funding base. Bancorp pledges portions of its investment securities portfolio to secure public fund deposits, cash balances of certain wealth management and trust accounts, and securities sold under agreements to repurchase. At March 31, 2017, total investment securities pledged for these purposes comprised 64% of the available-for-sale investment portfolio, leaving $200.8 million of unpledged securities.
Bancorp has a large base of non-maturity customer deposits, defined as demand, savings, money market deposit accounts and time deposits less than or equal to $250,000. At March 31, 2017, such deposits totaled $2.5 billion and represented 99% of Bancorp’s total deposits, as compared to $2.5 billion, or 98% of total deposits at December 31, 2016. Because these deposits are less volatile and are often tied to other products of Bancorp through long lasting relationships they do not put heavy pressure on liquidity. However, many of Bancorp’s customers’ deposit balances are historically high. When market conditions improve, these balances will likely decrease, putting some strain on Bancorp’s liquidity position.
As of March 31, 2017 and December 31, 2016, Bancorp had $498 thousand or 0.02% of total deposits, in brokered deposits.
Included in the total deposit balances at March 31, 2017 is $154.7 million of public funds deposits generally comprised of accounts from local government agencies and public school districts in our markets. As a result of property tax collections in the latter part of each year these accounts provide seasonal excess balances that originate with tax payments and decline leading into the next tax season. While this excess liquidity is maintained in low-yielding short-term investments and consequently results in lower net interest margin, it has a positive impact on net interest income.
Other sources of funds available to meet daily needs include FHLB advances. As a member of the FHLB of Cincinnati, Bancorp has access to credit products offered by the FHLB. Bancorp views these borrowings as a low cost alternative to other time deposits. At March 31, 2017, available credit from the FHLB totaled $500.1 million. Additionally, Bancorp had available federal funds purchased lines with correspondent banks totaling $80 million at March 31, 2017.
Bancorp’s principal source of cash is dividends paid to it as sole shareholder of the Bank. At March 31, 2017, the Bank may pay up to $56.5 million in dividends to Bancorp without regulatory approval subject to the ongoing capital requirements of the Bank.
d) Capital Resources
At March 31, 2017, stockholders’ equity totaled $319.7 million, an increase of $5.8 million since December 31, 2016. See the Consolidated Statement of Changes in Stockholders’ Equity for further detail of the changes in equity since the end of 2015. One component of equity is accumulated other comprehensive income which, for Bancorp, consists of net unrealized gains or losses on securities available-for-sale and hedging instruments, as well as a minimum pension liability, each net of taxes. Accumulated other comprehensive loss was $725 thousand at March 31, 2017 compared with a loss of $1.5 million on December 31, 2016. The $774 thousand positive difference is primarily a reflection of the effect of the changing interest rate environment during the first three months of 2017 as short term rates increased slightly, while long term rates decreased.
The following table sets forth Bancorp’s and the Bank’s risk based capital ratios as of March 31, 2017 and December 31, 2016.
Common equity tier 1 risk-based capital (1)
Under the banking agencies risk-based capital guidelines, assets and credit-equivalent amounts of derivatives and off-balance sheet exposures are assigned to broad risk categories. The aggregate dollar amount in each risk category is multiplied by the associated risk weight of the category. The resulting weighted values are added together, resulting in the Bancorp's total risk-weighted assets. These ratios are computed in relation to average assets.
In 2013, the Federal Reserve Board and the FDIC approved rules that substantially amended the regulatory risk-based capital rules applicable to Bancorp and Bank. The rules implemented the regulatory capital reforms of the Basel Committee on Banking Supervision reflected in "Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems" (Basel III) and changes required by the Dodd-Frank Act. The Basel III regulatory capital reforms became effective for Bancorp and Bank on January 1, 2015, and included new minimum risk-based capital and leverage ratios. The minimum capital level requirements applicable to bank holding companies and banks subject to the rules are:
a common equity tier 1 capital ratio of 4.5%,
a tier 1 risk-based capital ratio of 6% (increased from 4%),
a total risk-based capital ratio of 8% (unchanged from current rules), and
a tier 1 leverage ratio of 4% for all institutions.
The rules also established a "capital conservation buffer" of 2.5%, to be phased in over three years through December 31, 2018, above the new regulatory minimum risk-based capital ratios, and will result in the following minimum ratios once the capital conservation buffer is fully phased in:
a common equity tier 1 risk-based capital ratio of 7.0%,
a tier 1 risk-based capital ratio of 8.5%, and
a total risk-based capital ratio of 10.5%.
The rules allowed banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. Bancorp opted out of this requirement.
As of March 31, 2017, Bancorp meets the requirements to be considered well capitalized under the rules, and is not subject to limitations due to the capital conservation buffer.
e) Non-GAAP Financial Measures
In addition to capital ratios defined by banking regulators, Bancorp considers various ratios when evaluating capital adequacy and overhead, including tangible common equity to tangible assets, tangible common equity per share, and adjusted efficiency ratio, all of which are non-GAAP measures.
Bancorp believes the tangible common equity ratios are important because of their widespread use by investors as means to evaluate capital adequacy, as they reflect the level of capital available to withstand unexpected market conditions. Because US GAAP does not include capital ratio measures, there are no US GAAP financial measures comparable to these ratios.
The following table reconciles Bancorp’s calculation of tangible common equity to amounts reported under US GAAP.
(in thousands, except per share data)
Total equity
Less core deposit intangible
Less goodwill
Tangible common equity
Total tangible assets
Total shareholders' equity to total assets
Tangible common equity ratio
Number of outstanding shares
Book value per share
Tangible common equity per share
In addition to the efficiency ratio normally presented, Bancorp considers an adjusted efficiency ratio. Bancorp believes excluding amortization of investments in tax credit partnerships from non-interest expense in this ratio is important because it provides a meaningful comparison to both prior periods, since amortization expense can fluctuate widely between periods depending upon timing of tax credits, and to other companies who do not invest in these partnerships.
The following table reconciles Bancorp’s calculation of adjusted efficiency ratios to the ratio reported under US GAAP.
(amounts in thousands)
Net interest income (tax-equivalent)
Non-interest income
Total revenue
Efficiency ratio
Less: amortization of investments in tax credit partnerships
Adjusted non-interest expense
Adjusted efficiency ratio
f) Recently Issued Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, which outlines a single comprehensive model for use in accounting for revenue arising from contracts with customers, and supersedes most current revenue recognition guidance. The ASU was originally effective for fiscal years and interim periods beginning after December 15, 2016. In August 2015, FASB issued ASU 2015-14 which delays the effective date. The effective date will be annual reporting periods beginning after December 15, 2017, and the interim periods within that year. Bancorp is reviewing existing contractual arrangements and is evaluating how implementation of ASU 2-14-09 will impact results of operations. Bancorp continues to evaluate and develop processes and controls for ongoing procedural and disclosure requirements of the standard.
In January 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-01, Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities, which requires equity investments to be measured at fair value with changes in fair value recognized in net income. The ASU is effective for fiscal years and interim periods beginning after December 15, 2017. Because Bancorp does not have significant investments in equity securities, the adoption of ASU 2016-01 is not expected to have a significant impact on Bancorp’s operations or financial statements.
In February 2016, FASB issued ASU No. 2016-02, Leases, which requires lessees to recognize the assets and liabilities that arise from leases on the balance sheet. A lessee should recognize on the balance sheet a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for lease term. The new guidance is effective for annual and interim reporting periods beginning after December 15, 2018. The amendment should be applied at the beginning of the earliest period presented using a modified retrospective approach with earlier application permitted as of the beginning of an interim or annual reporting period. Bancorp has evaluated existing lease commitments and does not expect adoption to have a significant impact on Bancorp’s operations or financial statements.
In June 2016, FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments, which significantly changes the way entities recognize impairment of many financial assets by requiring immediate recognition of estimated credit losses expected to occur over their remaining life. This standard will likely have a significant impact on the way Bancorp recognizes credit impairment on loans. Under current US GAAP, credit impairment losses are determined using an incurred-loss model, which recognizes credit losses only when it is probable that all contractual cash flows will not be collected. The initial recognition of loss under CECL differs from current US GAAP because recognition of credit losses will not be based on any triggering event. This should generally result in credit impairment being recognized earlier and immediately after the financial asset is originated or purchased. Bancorp is evaluating existing accounting processes, internal controls, and technology capabilities to determine what changes will be needed to address the new requirements. These processes and controls will require significant judgment, collection and analysis of additional data, and use of estimates. Technology and other resources are being upgraded or modified to capture additional data to support the accounting and disclosure requirements. The new guidance is effective for annual and interim reporting periods beginning after December 15, 2019. As noted above, Bancorp is evaluating the potential impact of adoption of ASU 2016-13.
In August 2016, FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments, which amends guidance in ASC 230 on the classification of certain cash receipts and payments in the statement of cash flows. The primary purpose of the ASU is to reduce the diversity in practice that has resulted from the lack of consistent principles on this topic. The ASU’s amendments add or clarify guidance on eight cash flow issues. The guidance in the ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. Entities must apply the guidance retrospectively to all periods presented but may apply it prospectively from the earliest date practicable if retrospective application would be impracticable. Bancorp does not anticipate that adoption of the ASU will have a significant impact on the consolidated financial statements of the Company.
In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory, which requires entities to recognize at the transaction date the income tax consequences of inter-company asset transfers other than inventory. This ASU is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2017. Entities may early adopt the ASU, but only at the beginning of an annual period for which no financial statements (interim or annual) have already been issued or made available for issuance. Bancorp does not expect adoption of this standard to have a significant impact on the consolidated financial statements of the Company.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which requires companies to include cash and cash equivalents that have restrictions on withdrawal or use in total cash and cash equivalents on the statement of cash flows. This ASU is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, adjustments should be reflected at the beginning of the fiscal year that includes that interim period. Bancorp does not expect adoption of this standard to have a significant impact on the consolidated financial statements of the Company.
In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which provides a new framework for determining whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This ASU is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2017. For all other entities, the ASU is effective for annual periods in fiscal years beginning after December 15, 2018, and interim periods in fiscal years beginning after December 15, 2019. Entities may early adopt the ASU and apply it to transactions that have not been reported in financial statements that have been issued or made available for issuance. Bancorp does not expect adoption of this standard to have a significant impact on the consolidated financial statements of the Company.
In January 2017, the FASB issued ASU 2017-03, Accounting Changes and Error Corrections (Topic 250) and Investments—Equity Method and Joint Ventures (Topic 323): Amendments to SEC Paragraphs Pursuant to Staff Announcements at the September 22, 2016 and November 17, 2016 EITF Meetings (SEC Update), which incorporates into the FASB Accounting Standards Codification® recent SEC guidance about disclosing, under SEC SAB Topic 11.M, the effect on financial statements of adopting the revenue, leases, and credit losses standards. The SEC staff had previously announced that registrants should include the disclosures starting with their December 2017 financial statements. Bancorp is evaluating the potential impact of implementation of this standard on the consolidated financial statements of the Company.
In January 2017, the FASB issued ASU 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which requires an entity to no longer perform a hypothetical purchase price allocation to measure goodwill impairment. Instead, impairment will be measured using the difference between the carrying amount and the fair value of the reporting unit. The changes are effective for public business entities that are SEC filers, for annual and interim periods in fiscal years beginning after December 15, 2019. All entities may early adopt the standard for goodwill impairment tests with measurement dates after January 1, 2017. Bancorp does not expect adoption of this standard to have a significant impact on the consolidated financial statements of the Company.
In February 2017, the FASB issued ASU 2017-05, Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets, which clarifies the guidance in Subtopic 610-20 on accounting for derecognition of a nonfinancial asset. The ASU also defines in-substance nonfinancial assets and includes guidance on partial sales of nonfinancial assets. An entity is required to apply the amendments in this ASU at the same time that it applies ASU 2014-09. Bancorp does not expect adoption of this standard to have a significant impact on the consolidated financial statements of the Company.
In March 2017, the FASB issued ASU 2017-07, Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which requires companies to present the service cost component of net benefit cost in the same line items in which they report compensation cost. Companies will present all other components of net benefit cost outside operating income, if this subtotal is presented. This ASU is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2017. Early adoption is permitted as of the beginning of an annual period for which financial statements (interim or annual) have not been issued or made available for issuance. Bancorp does not expect adoption of this standard to have a significant impact on the consolidated financial statements of the Company.
The FASB also issued a series of other ASUs, which update ASU 2014-09. The effective dates for ASU 2014-09 have been updated by ASU 2015-14, Deferral of the Effective Date. For public business entities, certain employee benefit plans, and certain not-for-profit entities, ASU 2014-09 is effective for annual and interim periods in fiscal years beginning after December 15, 2017. Earlier application is permitted only as of annual and interim periods in fiscal years beginning after December 15, 2016. Bancorp is including these ASUs in its evaluation and implementation efforts relative to ASU 2014-09.
Other ASUs applicable to the implementation of ASU 2014-09:
• ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)
• ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing
• ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients
• ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Information required by this item is included in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Item 4. Controls and Procedures
Disclosure Controls and Procedures
Bancorp maintains disclosure controls and procedures designed to ensure that it is able to collect the information it is required to disclose in the reports it files with the Securities and Exchange Commission (SEC), and to record, process, summarize and disclose this information within the time periods specified in the rules of the SEC.
Based on their evaluation of Bancorp’s disclosure controls and procedures, the Chief Executive and Chief Financial Officers have concluded that, because of the material weakness described in Management’s Report on Internal Control Over Financial Reporting in our Annual Report on Form 10-K for the year ended December 31, 2016, Bancorp’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) were not effective as of March 31, 2017. However, based on a number of factors, we believe that the consolidated financial statements in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial position and results of operation and cash flows for the periods presented in conformity with US GAAP.
Changes in Internal Control over Financial Reporting
With regard to the material weakness, our remediation efforts began during the quarter ended March 31, 2017. We are changing how certain controls are designed, performed and documented. We increased staffing in the internal loan review department, the area responsible for assessment of loan grades. We must now demonstrate the effectiveness of these changes with an appropriate amount of consistency and for a sufficient period of time to conclude that the control is functioning properly. Other than these changes, based on the evaluation of Bancorp’s disclosure controls and procedures by the Chief Executive and Chief Financial Officers, there were no significant changes during the quarter ended March 31, 2017 in Bancorp’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, Bancorp’s internal control over financial reporting.
PART II – OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table shows information relating to the repurchase of shares of common stock by Bancorp during the three months ended March 31, 2017.
Total number of
purchased (1)
Average price
paid per share
shares purchased as
part of publicly
announced plan
Maximum number of
shares that may yet be
purchased under the plan
Jan 1
Feb 1
Mar 1
(1) Activity represents shares of stock withheld to pay taxes due upon exercise of stock appreciation rights, vesting of restricted stock, and vesting of performance stock units.
Item 6. Exhibits
The following exhibits are filed or furnished as a part of this report:
Exhibit
Description of exhibit
31.1
Certifications pursuant to Section 302 of the Sarbanes-Oxley Act by David P. Heintzman
31.2
Certifications pursuant to Section 302 of the Sarbanes-Oxley Act by Nancy B. Davis
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Certifications pursuant to 18 U.S.C. Section 1350
Consolidated Statements of Income
(3)
Consolidated Statements of Comprehensive Income
Consolidated Statements of Changes in Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: May 5, 2017
By:
/s/ David P. Heintzman
David P. Heintzman, Chairman
and Chief Executive Officer
67