Item 1. Business
GENERAL
Bear State Financial, Inc. Bear State Financial, Inc. (the "Company”, “we”, “us” or “our”) is an Arkansas corporation and bank holding company. The Company was originally incorporated in Texas in January 1996 under the name First Federal Bancshares of Arkansas, Inc. to serve as the unitary holding company of First Federal Bank (“First Federal”). The Company reincorporated from the State of Texas to the State of Arkansas on July 20, 2011. On June 3, 2014, the Company changed its name from First Federal Bancshares of Arkansas, Inc. to Bear State Financial, Inc. and adopted the new NASDAQ ticker symbol “BSF.” On June 13, 2014, the Company completed its acquisition of First National Security Company (“FNSC”), the parent company for First National Bank headquartered in Hot Springs, Arkansas (“First National”) and Heritage Bank, N.A. headquartered in Jonesboro, Arkansas (“Heritage Bank”). On February 13, 2015 First Federal, First National and Heritage Bank were consolidated into a single charter forming Bear State Bank, N.A (“Bear State”). On October 1, 2015, the Company completed its acquisition of Metropolitan National Bank (“Metropolitan”) headquartered in Springfield, Missouri. On February 19, 2016, Metropolitan was consolidated into the Bear State Bank, N.A. charter. Except as the context otherwise requires, any reference in this Annual Report on Form 10-K to the “Bank” means (i) with respect to the period between January 1, 2014 through June 12, 2014, First Federal Bank; (ii) with respect to the period from June 13, 2014 through February 12, 2015, First Federal Bank, First National and Heritage Bank, collectively; (iii) with respect to the period from February 13, 2015 through September 30, 2015 or as of the date hereof, Bear State Bank, N.A.; and (iv) with respect to the period from October 1, 2015 through February 19, 2016, Bear State Bank, N.A. and Metropolitan, collectively.
The primary asset of the Company is the capital stock of the Bank. The business and management of the Company consists of the business and management of the Bank. At December 31, 2015, the Company had $1.9 billion in total assets, $1.7 billion in total liabilities and $223.2 million in stockholders' equity. The Company’s primary regulator is the Federal Reserve Bank (“FRB”).The Company's principal executive office is located at 900 South Shackleford Road, Suite 401, Little Rock, Arkansas 72211, and its telephone number is (501) 320-4904.
Bear State Bank. The Bank is a national banking association conducting business from its home office in Little Rock, Arkansas, 55 banking locations and four loan production offices which are located in various communities in Arkansas, Missouri and Oklahoma.
The Bank is a community-oriented financial institution offering a wide range of retail and business deposit accounts, including noninterest bearing and interest bearing checking accounts, savings and money market accounts, certificates of deposit, and individual retirement accounts. Loan products offered by the Bank include residential real estate, consumer, construction, lines of credit, commercial real estate and commercial business loans. Other financial services include automated teller machines; 24-hour telephone banking; online banking, including account access, bill payment, and e-statements; mobile banking, including remote deposit capture and funds transfer; Bounce ProtectionTM overdraft service; debit cards; and safe deposit boxes.
The Bank is regulated by the Office of the Comptroller of the Currency ("OCC"), which is the Bank's chartering authority and primary regulator. The Bank is also regulated by the Federal Deposit Insurance Corporation (“FDIC”), the administrator of the Deposit Insurance Fund ("DIF"), and is subject to certain reserve requirements established by the Board of Governors of the FRB. The Bank’s deposits are insured by the DIF to the maximum extent permitted by law. The Bank is a member of the Federal Home Loan Bank of Dallas ("the FHLB").
Business Strategy
The Bank’s main goal is to be a high-performing community bank in offering the loan and deposit services described below. Management focuses on building high-quality and profitable banking relationships and providing exceptional service to attract and retain customers; building a performance-based culture; refining and expanding the delivery of commercial banking products; expanding market share in attractive markets; rehabilitating or closing underperforming branch locations; and pursuing opportunities to acquire other financial institutions or branches and to develop or acquire businesses that generate non-interest income.
Lending Activities
General. At December 31, 2015, the Bank’s portfolio of net loans receivable amounted to $1.4 billion or 75.2% of the Company's total assets. Loans collateralized by real estate comprise $1.2 billion or 80.5% of the Bank's total portfolio of loans receivable at December 31, 2015.
Origination, Purchase and Sale of Loans. The lending activities of the Bank are subject to the written, non-discriminatory underwriting standards and policies established by management and approved by the Bank’s Board of Directors. Loan originations are obtained from a variety of sources, including referrals, walk-in customers to the Bank’s branch locations, solicitation by loan officers, advertising and the Bank’s Internet website. From time to time, the Bank may also purchase loan participations from other financial institutions.
To minimize interest rate risk, fixed rate one- to four-family residential mortgage loans with terms of fifteen years or greater are typically sold to specific investors in the secondary mortgage market. The rights to service such loans are typically sold with the loans. This allows the Bank to provide its customers competitive long-term fixed rate mortgage products while not exposing the Bank to undue interest rate risk. These loans are originated in conformance with Fannie Mae, Freddie Mac and the specific investor’s underwriting guidelines. The Bank typically locks and confirms the purchase price of the loan on the day of the loan application, which protects the Bank from market price movements and establishes the price that the Bank will receive at the sale of the respective loan. For the years ended December 31, 2015 and 2014, the Bank’s secondary market loan sales amounted to $110.4 million and $98.3 million, respectively. The Bank is not involved in loan hedging or other speculative mortgage loan origination activities.
In addition to sales of loans in the secondary market, the Bank periodically sells loans or loan participations to other banks in order to comply with the Bank’s loans to one borrower limit or for credit diversification purposes. In such situations, the loans are typically sold with servicing retained. At December 31, 2015 and 2014, the balances of loans sold with servicing retained were approximately $20.4 million and $23.5 million, respectively. Loan servicing fee income for the years ended December 31, 2015 and 2014 was not material.
One- to Four-Family Residential Real Estate Loans. At December 31, 2015, $401.0 million or 27.5% of the Bank’s total loan portfolio consisted of one- to four-family residential real estate loans. Of the $401.0 million of such loans at December 31, 2015, $148.8 million or 37.1% had adjustable rates of interest and $252.3 million or 62.9% had fixed rates of interest. At December 31, 2015, the Bank had $6.5 million of nonaccrual one- to four-family residential real estate loans. See “Nonperforming Assets” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The Bank currently originates both fixed rate and adjustable rate one- to four-family residential mortgage loans to be sold into the secondary market. Loans originated to be held in the Bank’s loan portfolio are typically originated as fixed or adjustable rate simple interest loans with a maturity of up to fifteen years and an amortization period generally not more than fifteen years. The Bank's residential loans typically include "due on sale" clauses.
As of December 31, 2015, the Bank had a loan portfolio of adjustable rate mortgage loans (“ARMs”) totaling $148.8 million as described above. These ARMs provide for an interest rate that adjusts periodically in accordance with a designated index plus a margin. The Bank's adjustable rate loans are assumable (generally without release of the initial borrower), do not contain prepayment penalties and do not provide for negative amortization and typically contain "due on sale" clauses. Adjustable rate loans decrease the risks associated with changes in interest rates but involve other risks, primarily because as interest rates rise, the payment by the borrower rises to the extent permitted by the terms of the loan, thereby increasing the potential for default. At the same time, the marketability of the underlying property may be adversely affected by higher interest rates.
The Bank’s residential mortgage loans generally do not exceed 80% of the lesser of purchase price or appraised value of the collateral. However, pursuant to the underwriting guidelines adopted by the Board of Directors, the Bank may lend up to 100% of the value of the property securing a one- to four-family residential loan with private mortgage insurance or other similar protection to support the portion of the loan that exceeds 80% of the value. The Bank may, on occasion, extend a loan up to 90% of the value of the secured property without private mortgage insurance coverage. However, these exceptions are minimal and are only approved on loans with exceptional credit scores, sizeable asset reserves, or other compensating factors.
The Bank’s home equity and second mortgage loans are fixed rate loans with fully amortized terms of up to fifteen years, variable rate interest only loans with terms up to three years, or home equity lines of credit. The variable rate loans are typically tied to the Wall Street Journal Prime Rate (“Prime Rate”), plus a margin commensurate with the risk as determined by the borrower’s credit score. Home equity lines of credit are typically either fixed rate for a term of no longer than one year or variable rate with terms up to five years. The Bank generally limits the total loan-to-value on these mortgages to 85% of the value of the secured property if the Bank holds the first mortgage and 80% if the first mortgage is held by another party.
Multifamily Residential Real Estate Loans. At December 31, 2015, $74.2 million or 5.1% of the Bank's total loan portfolio consisted of loans collateralized by multifamily residential real estate properties. At December 31, 2015, the Bank had $230,000 of nonaccrual multifamily real estate loans. See “Nonperforming Assets” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The Bank has originated both fixed rate and adjustable rate multifamily loans. Fixed rate loans are generally originated with amortization periods not to exceed 25 years, and typically have balloon periods no longer than ten years. Adjustable rate loans are typically amortized over terms up to 25 years, with interest rate adjustments periodically. The Bank’s loan policy limits loan-to-value percentages on multifamily real estate loans to 80%. It is also the Bank's general policy to obtain loan guarantees on its multifamily residential real estate loans from the principals of the borrower, however, the Bank may waive this requirement in certain circumstances.
The success of such projects is sensitive to changes in supply and demand conditions in the market for multifamily real estate as well as regional and economic conditions generally.
Nonfarm Nonresidential Loans. At December 31, 2015, $487.7 million or 33.5% of the Bank's total loan portfolio consisted of loans collateralized by nonfarm nonresidential properties. At December 31, 2015, the Bank had nonaccrual nonfarm nonresidential loans of $6.6 million. See “Nonperforming Assets” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Many of the Bank’s nonfarm nonresidential loans are collateralized by properties such as office buildings, strip and small shopping centers, churches, convenience stores and mini-storage facilities. Loans to borrowers that are corporations, limited liability companies or other such legal entities are also typically personally guaranteed by the principals of the borrowing entity. The financial strength of the guarantors of the loan is also a primary underwriting factor.
Regulatory guidelines and the Bank’s policies require that properties securing nonfarm nonresidential loans over $250,000 be appraised by licensed real estate appraisers pursuant to state licensing requirements and federal regulations. The Bank underwrites nonfarm nonresidential loans specifically in relation to the type of property being collateralized. Primary underwriting considerations for these loans include the creditworthiness of the borrower, the quality and location of the real estate, the sustainable cash flows of the project, projected occupancy rates, the quality of management involved with the project and the financial strength of the guarantor, if applicable. As part of the underwriting of these loans, the Bank prepares a cash flow analysis that includes a vacancy rate projection, expenses for taxes, insurance, maintenance and repair reserves as well as debt coverage ratios. The Bank’s nonfarm nonresidential loans are generally originated with amortization periods not to exceed 25 years and are structured with three to ten year balloon terms. The Bank attempts to keep maturities of these loans as short as possible in order to enable the Bank to better manage its interest rate risk profile.
Nonfarm nonresidential lending entails additional risks as compared to the Bank’s one- to four-family residential property loans. The repayment on such loans is typically dependent on the successful operation of the real estate project, which is sensitive to changes in supply and demand conditions in the market for commercial real estate, and on regional and economic conditions.
Farmland Loans. At December 31, 2015, farmland loans amounted to $94.2 million or 6.5% of the Bank’s total loan portfolio. At December 31, 2015, the Bank had $973,000 of nonaccrual farmland loans. See “Nonperforming Assets” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The types of credits in this category include loans secured by real estate employed for row crop and livestock production, pasture and grazing, forestry and timber purposes and other similar uses. The terms for these loans are generally five years or less with fixed or floating rates of interest and amortization periods typically not to exceed ten years. The underwriting of these loans is based primarily on the cash flow generated by the intended productive use of the property and the financial strength of the borrowing entity and the guarantors of the loan, if any.
The risks associated with these loans tend to be directly related to the economics of the underlying property use. There are certain macro-level factors, including environmental and weather patterns, national and global supply and demand for the product and the national political environment, that affect the strength of the agricultural, livestock and timber sectors. The experience and success of the borrower in the market segment, the Bank’s history with the borrower and the financial strength of any guarantors are all considered when extending loans in this category. Advance rates on these types of loans generally do not exceed 75% of the value of the real estate.
Construction and Land Development Loans. At December 31, 2015, construction loans, including land loans, amounted to $116.0 million or 8.0% of the Bank’s total loan portfolio. At December 31, 2015, the Bank had $622,000 of nonaccrual construction and land loans. See “Nonperforming Assets” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The Bank’s residential and commercial construction loans generally have fixed interest rates or variable rates that float with the Prime Rate and have typically been issued for terms of twelve to twenty-four months. However, the Bank has originated construction loans with longer terms, although this practice has generally been limited to larger projects that could not be completed in the typical twelve to twenty-four month period. Construction loans are typically made with a maximum loan-to-value percentage of 80% of the appraised value of the proposed project.
The Bank originates residential construction loans to individual homeowners, local builders and developers for the purpose of constructing one- to four-family residences. The Bank typically requires that permanent financing with the Bank or some other lender be in place prior to closing any non-speculative construction loan. At such time, the loan will convert to a permanent loan at the interest rate established at the initial closing of the construction/permanent loan or paid off by another permanent lender.
The Bank has made residential construction loans to local builders for the purpose of construction of speculative and pre-sold one- to four-family residential properties, and for the construction of pre-sold one- to four-family homes. These loans are subject to credit review, analysis of personal and, if applicable, corporate financial statements, and an appraisal of the property. Loan proceeds are disbursed during the construction term after a satisfactory inspection of the project has been made. Interest on these construction loans is due monthly. The Bank may extend the term of a construction loan if the property has not been sold by the maturity date.
The Bank has made commercial construction loans to property developers and investors for the purpose of constructing multifamily residential housing units, stand-alone and multi-tenant retail projects and office buildings. These loans are subject to an assessment of the feasibility of the proposed project based on anticipated cash flows, vacancy and interest rates, an analysis of the forecasted economics of the particular sub-market where the project will be located, a complete credit underwriting of the guarantors of the proposed loan and an appraisal of the project. Loan proceeds are disbursed during the construction term after a review of the status of completion of the project.
Construction lending is generally considered to involve a higher level of risk as compared to other loans. This is due, in part, to the concentration of principal in a limited number of loans and borrowers, and the effects of general economic conditions on developers and builders. In addition, construction loans made on a speculative basis pose a greater potential risk to the Bank than those with a repayment source identified at origination. The Bank analyzes each borrower involved in speculative building and limits the principal amount and/or number of unsold speculative projects at any one time with such borrower.
Commercial Loans. The Bank also offers secured and unsecured commercial loans. Secured commercial loans are primarily collateralized by equipment, inventory and accounts receivable. At December 31, 2015, such loans amounted to $246.3 million or 16.9% of the total loan portfolio. At December 31, 2015, the Bank had nonaccrual commercial loans of $4.2 million. See “Nonperforming Assets” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
This portfolio includes loans with funds used for commercial purposes including loans to finance working capital needs, including agricultural; purchase equipment; support accounts receivable and inventory and other similar business needs.
Primary underwriting considerations for these loans include a review of the historical and prospective cash flows of the borrower and the sustainability of these cash flows, the expected long term viability of the business, the quality and marketability of the collateral (if any) and the financial support offered by any guarantors to the transaction. The Bank's commercial loans are originated with fixed and variable interest rates and maturities between one and five years. These loans are typically based on a maximum fifteen year amortization schedule.
Consumer Loans. The consumer loans offered by the Bank primarily consist of automobile loans, deposit account secured loans, and unsecured loans. Consumer loans amounted to $38.6 million or 2.7% of the total loan portfolio at December 31, 2015, of which $13.3 million consisted of automobile loans and $25.3 million consisted of other consumer loans. At December 31, 2015, the Bank had nonaccrual consumer loans of $187,000. See “Nonperforming Assets” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The Bank's vehicle loans are typically originated for the purchase of new and used cars and trucks. Such loans are generally originated with a maximum term of six years. The Bank may offer extended terms on automobile loans to some customers based upon their creditworthiness.
Other consumer loans consist primarily of deposit account loans and unsecured loans. Loans secured by deposit accounts are generally originated for up to 95% of the deposit account balance, with a hold placed on the account restricting the withdrawal of the deposit account balance.
Consumer loans entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of depreciation, damage or loss. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy laws, may limit the amount which can be recovered on such loans.
Sources of Funds
General. Deposits are the primary source of the Bank's funds for lending and other investment purposes. In addition to deposits, the Bank derives funds from loan principal repayments and prepayments and interest payments, maturities, sales and calls of investment securities, and advances from the FHLB. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. Borrowings are used when funds from loan and deposit sources are insufficient to meet funding needs or for asset/liability management purposes. FHLB advances are the primary source of borrowings.
Deposits. The Bank's deposit products include a broad selection of deposit instruments, including checking accounts, money market accounts, savings accounts and term certificate accounts. Deposit account terms vary, with the principal differences being the minimum balance required, the time period the funds must remain on deposit, early withdrawal penalties and the interest rate.
The Bank considers its primary market area to be Arkansas, Missouri and Southeast Oklahoma. The Bank utilizes traditional marketing methods to attract new customers and deposits. The Bank does not advertise for retail deposits outside of its primary market area. The Bank uses brokered deposits and non-brokered institutional internet certificates of deposit as additional sources of funds to augment the retail CD market. At December 31, 2015, internet certificates of deposit represented approximately 3.5% of deposits and brokered deposits represented approximately 1.4% of deposits.
The Bank has been competitive in the types of accounts and in interest rates it has offered on its deposit products but does not necessarily seek to match the highest rates paid by competing institutions. Although market demand generally dictates which deposit maturities and rates will be accepted by the public, the Bank intends to continue to offer longer-term deposits to the extent possible and consistent with its asset and liability management goals. In addition, the Bank may use brokered deposits when this alternative funding source provides more cost effective deposits with terms that are consistent with its asset and liability management goals.
Borrowed funds. The Bank utilizes FHLB advances in its normal operating and investing activities when this funding source offers cost effective funds that are consistent with the Bank’s asset and liability management goals. The Bank pledges substantially all of its loans under a blanket lien and through certain loans held in custody at FHLB. The Bank’s borrowing capacity with the FHLB is directly tied to the amount of the Bank’s qualifying loans pledged. FHLB advances are subject to prepayment penalties if repaid prior to the maturity date.
At December 31, 2015, the Bank’s unused borrowing availability primarily consisted of (1) $229.4 million of available borrowing capacity with the FHLB, (2) $79.3 million of investment securities available to pledge for federal funds or other borrowings and (3) $102.5 million of available unsecured federal funds borrowing lines. In addition, at December 31, 2015, the Company had available borrowing capacity of $9.6 million with an unaffiliated bank.
Competition
The Bank conducts business through 55 branches in the market areas of Baxter, Benton, Boone, Craighead, Garland, Howard, Little River, Marion, Miller, Mississippi, Montgomery, Pike, Polk, Pulaski, Saline, Scott, Sevier and Washington Counties in Arkansas, Barton, Christian, Greene, Stone, Taney and Webster Counties in Missouri and McCurtain County in Oklahoma. The following table presents the Bank’s and Metropolitan’s, respective market share percentages for total deposits at June 30, 2015, in each county where we have operations. The table also indicates the ranking by deposit size in each market. All information in the table was obtained from SNL Financial, which compiles deposit data published by the FDIC as of June 30, 2015 and updates the information for any bank mergers and acquisitions completed subsequent to the reporting date.
The Bank faces strong competition in its market areas both in attracting deposits and making loans. The most direct competition for deposits has historically come from commercial banks, savings associations and credit unions. In addition, the Bank has faced additional significant competition for investors' funds from short-term money market securities, mutual funds and other corporate and government securities. The ability of the Bank to attract and retain savings and certificates of deposit depends on its ability to generally provide a rate of return, liquidity and risk comparable to that offered by competing investment opportunities. The Bank’s ability to increase checking deposits depends on offering competitive checking accounts and promoting these products through effective channels. Additionally, the Bank offers convenient hours, locations and online services to maintain and attract customers.
The Bank experiences strong competition for loans principally from commercial banks and mortgage companies. The Bank competes for loans through interest rates, loan terms, and fees charged and the efficiency and quality of services provided.
Employees
The Company and the Bank had 541 full-time employees and 45 part-time employees at December 31, 2015, compared to 403 full-time employees and 20 part-time employees at December 31, 2014. The increase in the number of employees is primarily related to the acquisition of Metropolitan. None of our employees is represented by any union or similar group, and the Bank believes that it enjoys good relations with its personnel.
Subsidiaries
The Bank is permitted to invest up to 2% of its assets in the capital stock of, or secured or unsecured loans to, subsidiary service corporations, with an additional investment of 1% of assets when such additional investment is utilized primarily for community development purposes. In addition to investments in service corporations, the Bank is permitted to invest an unlimited amount in operating subsidiaries engaged solely in activities in which the Bank may engage directly. As of December 31, 2015, the Bank does not have any operating subsidiaries.
Available Information
The Company makes available free of charge its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to such reports filed pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable on or through its website located at www.bearstatefinancial.com after filing with the United States Securities and Exchange Commission (“SEC”). Information on, or accessible through, the Company’s website is not a part of and is not incorporated into this Annual Report on Form 10-K and the inclusion of the Company’s website address in this report is an inactive textual reference.
REGULATION
Set forth below is a brief description of those laws and regulations which, together with the descriptions of laws and regulations contained elsewhere herein, are deemed material to an investor's understanding of the extent to which the Company and the Bank are regulated. The description of the laws and regulations hereunder, as well as descriptions of laws and regulations contained elsewhere herein, does not purport to be complete and is qualified in its entirety by reference to applicable laws and regulations.
The Company
General. The Company, as a bank holding company within the meaning of the Bank Holding Company Act ("BHCA"), is subject to FRB regulations, examinations, supervision and reporting requirements. The most recent regulatory examination of the Company by the FRB was conducted during May 2015. As a subsidiary of a bank holding company, the Bank is also subject to certain restrictions in its dealings with the Company and affiliates thereof.
The BHCA limits the activities of the Company and any entities controlled by the Company to the activities of banking, managing and controlling banks, furnishing or performing services for its subsidiaries, and any other activity that the FRB determines to be incidental to or clearly and closely related to banking.
Acquisitions. Under the BHCA, a bank holding company must obtain prior FRB approval before engaging in acquisitions of banks or bank holding companies. In particular, the FRB must generally approve:
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the acquisition of direct or indirect ownership or control of any voting securities of a bank or bank holding company if the acquisition results in the company’s control of more than 5% of the outstanding shares of any class of voting securities of the bank or bank holding company,
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the acquisition by a bank holding company or by a subsidiary thereof, other than a bank, of all or substantially all of the assets of a bank, and
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the merger or consolidation of bank holding companies.
Restrictions on Transactions with Affiliates. Transactions between an insured depository institution and its "affiliates" are subject to quantitative and qualitative restrictions under Sections 23A and 23B of the Federal Reserve Act and OCC regulations. Affiliates generally include, among other entities, the institution’s holding company and companies that are controlled by or under common control with the institution. Generally, Section 23A (i) limits the extent to which the insured depository institution or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10% of such association’s capital stock and surplus, and contains an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus. Section 23B applies to “covered transactions” as well as certain other transactions and requires that all transactions be on terms substantially the same, or at least favorable, to the association or subsidiary as those provided to a non-affiliate. The term “covered transaction” includes the making of loans to, purchase of assets from, issuance of a guarantee to an affiliate and similar transactions. Section 23B transactions also apply to the provision of services and the sale of assets by an insured depository institution to an affiliate.
In addition, Sections 22(g) and (h) of the Federal Reserve Act place restrictions on loans to executive officers, directors and principal stockholders. Under Section 22(h), loans to a director, an executive officer and to a greater than 10% stockholder of an institution (“a principal stockholder”), and certain affiliated interests of either, may not exceed, together with all other outstanding loans to such person and affiliated interests, the institution’s loans to one borrower limit (generally equal to 15% of the institution’s unimpaired capital and surplus). Section 22(h) also requires that loans to directors, executive officers and principal stockholders be made on terms substantially the same as offered in comparable transactions to other persons unless the loans are made pursuant to a benefit or compensation program that (i) is widely available to employees of the institution and (ii) does not give preference to any director, executive officer or principal stockholder, or certain affiliated interests of either, over other employees of the institution. Section 22(h) also requires prior board approval for certain loans. In addition, the aggregate amount of extensions of credit by an institution to all insiders cannot exceed the institution’s unimpaired capital and surplus. Furthermore, Section 22(g) places additional restrictions on loans to executive officers. At December 31, 2015, the Bank was in compliance with the above restrictions.
The Bank
General. The OCC has extensive authority over the operations of national banks. As part of this authority, national banks are required to file periodic reports with the OCC and are subject to periodic examinations by the OCC and the FDIC. The most recent regulatory examination of the Bank by the OCC consisted of full scope examinations during November 2015 for Bear State and August 2015 for Metropolitan.
The OCC's enforcement authority over all national banks and their holding companies includes, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including the filing of misleading or untimely reports with the OCC.
Insurance of Accounts. FDIC insurance covers all deposit accounts, including checking and savings accounts, money market deposit accounts and certificates of deposit. FDIC insurance does not cover other financial products and services that banks may offer, such as stocks, bonds, mutual fund shares, life insurance policies, annuities or securities. The standard insurance amount is $250,000 per depositor, per insured bank, for each account ownership category.
As insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the FDIC. The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is aware of no existing circumstances that would result in termination of the Bank's deposit insurance.
Substantially all of the deposits of the Bank are insured up to applicable limits by the DIF of the FDIC and are subject to deposit insurance assessments to maintain the DIF. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank’s capital level and supervisory rating.
A bank’s assessment is calculated by multiplying its assessment rate by its assessment base. A bank’s assessment base and assessment rate are determined each quarter. The deposit insurance assessment base is defined as average consolidated total assets for the assessment period less average tangible equity capital with potential adjustments for unsecured debt, brokered deposits and depository institution debts. Under the current assessment system for small banks (defined by the FDIC as less than $10 billion in assets), the FDIC assigns an institution to one of four risk categories designed to measure risk, which range from 2.5 to 45 basis points.
FDIC insurance expense totaled $961,000 and $753,000 for the years ended December 31, 2015 and 2014, respectively. FDIC insurance expense includes deposit insurance assessments and Financing Corporation (“FICO”) assessments related to outstanding FICO bonds.
Financial Regulatory Reform
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) into law. The Dodd-Frank Act represented a sweeping reform of the U.S. supervisory and regulatory framework applicable to financial institutions and capital markets in the wake of the global financial crisis, certain aspects of which are described below in more detail. In particular, and among other things, the Dodd-Frank Act: created the Consumer Financial Protection Bureau (the “CFPB”), which is authorized to regulate providers of consumer credit, savings, payment and other consumer financial products and services; narrowed the scope of federal preemption of state consumer laws enjoyed by national banks and federal savings associations and expanded the authority of state attorneys general to bring actions to enforce federal consumer protection legislation; imposed more stringent capital requirements on bank holding companies and subjected certain activities, including interstate mergers and acquisitions, to heightened capital conditions; with respect to mortgage lending, (i) significantly expanded requirements applicable to loans secured by one-to-four family residential real property, (ii) imposed strict rules on mortgage servicing, and (iii) required the originator of a securitized loan, or the sponsor of a securitization, to retain at least 5% of the credit risk of securitized exposures unless the underlying exposures are qualified residential mortgages or meet certain underwriting standards; repealed the prohibition on the payment of interest on business checking accounts; restricted the interchange fees payable on debit card transactions for issuers with $10 billion in assets or greater; in the so-called “Volcker Rule,” subject to numerous exceptions, prohibited depository institutions and affiliates from certain investments in, and sponsorship of, hedge funds and private equity funds and from engaging in proprietary trading; enhanced oversight of credit rating agencies; and prohibited banking agency requirements tied to credit ratings. These statutory changes shifted the regulatory framework for financial institutions, impacted the way in which they do business and have the potential to constrain revenues of financial institutions.
Numerous provisions of the Dodd-Frank Act were required to be implemented through rulemaking by the appropriate federal regulatory agencies. Many of the required regulations have been issued and others have been released for public comment, but are not yet final. Although the reforms primarily targeted systemically important financial service providers, their influence is expected to filter down in varying degrees to smaller institutions over time. Our management will continue to evaluate the effect of the Dodd-Frank Act on the business and operations of the Company and the Bank.
Consumer Laws and Regulations. Banks are subject to certain laws and regulations that are designed to protect consumers. Among the more prominent of such laws and regulations are the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act and consumer privacy protection provisions of the Gramm-Leach-Bliley Act and comparable state laws. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions deal with consumers. With respect to consumer privacy, the Gramm-Leach-Bliley Act generally prohibits disclosure of customer information to non-affiliated third parties unless the customer has been given the opportunity to object and has not objected to such disclosure. Financial institutions are further required to disclose their privacy policies to customers annually.
The Dodd-Frank Act created the CFPB within the Federal Reserve System. The CFPB is tasked with establishing and implementing rules and regulations under certain federal consumer protection laws with respect to the conduct of providers of certain consumer financial products and services. The CFPB has rulemaking authority over many of the statutes governing products and services offered to bank consumers. In addition, the Dodd-Frank Act permits states to adopt consumer protection laws and regulations that are more stringent than those regulations promulgated by the CFPB and state attorneys general are permitted to enforce consumer protection rules adopted by the CFPB against state-chartered institutions. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Depository institutions with less than $10 billion in assets are subject to rules promulgated by the CFPB, but continue to be examined and supervised by federal banking regulatory agencies for consumer compliance purposes.
During 2013, the CFPB issued a series of proposed and final rules related to mortgage loan origination and mortgage loan servicing. In particular, in January 2013, the CFPB issued its final rule, which was effective January 10, 2014, on ability to repay and qualified mortgage standards to implement various requirements of the Dodd-Frank Act amending the Truth in Lending Act. The final rule requires mortgage lenders to make a reasonable and good faith determination, based on verified and documented information, that a borrower will have the ability to repay a mortgage loan according to its terms before making the loan. The final rule also includes a definition of a “qualified mortgage,” which provides the lender with a presumption that the ability to repay requirements has been met. This presumption is conclusive (i.e. a safe harbor) if the loan is a “prime” loan and rebuttable if the loan is a higher-priced, or subprime, loan. The ability-to-repay rule has the potential to significantly affect our business, as a borrower can challenge a loan’s status as a qualified mortgage or that the lender otherwise established the borrower’s ability to repay in a direct cause of action for three years from the origination date, or as a defense to foreclosure at any time. In addition, the value and marketability of non-qualified mortgages may be adversely affected.
Interchange Fees. The Dodd-Frank Act also amended the Electronic Fund Transfer Act to require that the amount of any interchange fee charged for electronic debit transactions by debit card issuers having assets over $10 billion must be reasonable and proportional to the actual cost of a transaction to the issuer, commonly referred to as the “Durbin Amendment”. The FRB has adopted final rules which limit the maximum permissible interchange fees that such issuers can receive for an electronic debit transaction. Although the restrictions on interchange fees do not apply to institutions with less than $10 billion in assets, the price controls could negatively impact bankcard services income for smaller banks if the reductions that are required of larger banks cause industry-wide reduction of swipe fees.
Volcker Rule. The Dodd-Frank Act amended the BHCA to require the federal banking regulatory agencies to adopt rules that prohibit banks and their affiliates from engaging in proprietary trading and investing in and sponsoring a covered fund (such as a hedge fund and/or private equity fund), commonly referred to as the “Volcker Rule.” In December 2013, the federal banking regulatory agencies adopted a final rule construing the Volcker Rule, which became effective April 1, 2014. While banking entities will have until July 21, 2016 to conform their activities to the requirements of the rule, the FRB has announced its intention to grant an extension until July 21, 2017.
The Increasing Regulatory Emphasis on Capital
Regulatory capital represents the net assets of a financial institution available to absorb losses. Because of the risks attendant to their business, depository institutions are generally required to hold more capital than other businesses, which directly affects earnings capabilities. While capital has historically been one of the key measures of the financial health of both bank holding companies and banks, its role became fundamentally more important in the wake of the global financial crisis, as the banking regulators recognized that the amount and quality of capital held by banks prior to the crisis was insufficient to absorb losses during periods of severe stress. Certain provisions of the Dodd-Frank Act and Basel III, discussed below, establish strengthened capital standards for banks and bank holding companies, require more capital to be held in the form of common stock and disallow certain funds from being included in capital determinations. Once fully implemented, these standards will represent regulatory capital requirements that are significantly more stringent than those in place previously.
Required Capital Levels. In July of 2013, the U.S. federal banking agencies approved the implementation of the Basel III regulatory capital reforms in pertinent part, and, at the same time, promulgated rules effecting certain changes required by the Dodd-Frank Act (the “Basel III Rule”). In contrast to previous capital requirements, which were merely guidelines, Basel III was released in the form of regulations by each of the federal regulatory agencies. The Basel III Rule is applicable to all financial institutions that are subject to minimum capital requirements, including federal and state banks and savings and loan associations, as well as to bank and savings and loan holding companies other than “small bank holding companies” (generally bank holding companies with consolidated assets of less than $1 billion).
The OCC has established minimum capital standards for national banks. The minimum capital standards effective for the year ended December 31, 2015 were:
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A minimum ratio of Common Equity Tier 1 Capital to risk-weighted assets of 4.5%;
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A minimum required amount of Tier 1 Capital to risk-weighted assets of 6%;
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A minimum required amount of Total Capital (Tier 1 plus Tier 2) to risk-weighted assets of 8%; and
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A minimum leverage ratio of Tier 1 Capital to total assets equal to 4% in all circumstances.
For these purposes, “Common Equity Tier 1 Capital,” consists primarily of common stock, related surplus (net of treasury stock), retained earnings, and Common Equity Tier 1 minority interests, subject to certain regulatory adjustments. “Tier 1 Capital” consists primarily of common stock and related surplus less intangible assets (other than certain loan servicing rights and purchased credit card relationships). “Total Capital” consists primarily of Tier 1 Capital plus “Tier 2 Capital,” which includes other non-permanent capital items, such as certain other debt and equity instruments that do not qualify as Tier 1 Capital, and a portion of a bank’s allowance for loan and lease losses. Further, risk-weighted assets for the purpose of the risk-weighted ratio calculations consist of balance sheet assets and off-balance sheet exposures to which required risk weightings of 0% to 1250% are applied.
The Basel III Rules also establish a fully-phased “capital conservation buffer” of 2.5% above the new regulatory minimum risk-based capital requirements. The conservation buffer, when added to the capital requirements, results in the following minimum ratios: (i) a common equity Tier 1 risk-based capital ratio of 7.0%, (ii) a Tier 1 risk-based capital ratio of 8.5%, and (iii) a total risk-based capital ratio of 10.5%. The new capital conservation buffer requirement is to be phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase by that amount each year until fully implemented in January 2019. An institution is subject to limitations on certain activities including payment of dividends, share repurchases and discretionary bonuses to executive officers if its capital level is below the buffer amount.
The capital standards described above are minimum requirements under Basel III. Bank regulatory agencies uniformly encourage banks and bank holding companies to be “well-capitalized” and, to that end, federal law and regulations provide various incentives for banking organizations to maintain regulatory capital at levels in excess of minimum regulatory requirements. For example, a banking organization that is “well-capitalized” may: (i) qualify for exemptions from prior notice or application requirements otherwise applicable to certain types of activities; (ii) qualify for expedited processing of other required notices or applications; and (iii) accept, roll-over or renew brokered deposits. Under the capital regulations of the FDIC and FRB, in order to be “well-capitalized,” a banking organization, for the year ended December 31, 2015, must have maintained:
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A ratio of Common Equity Tier 1 Capital to total risk-weighted assets of 6.5% or greater,
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A ratio of Tier 1 Capital to total risk-weighted assets of 8% or greater,
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A ratio of Total Capital to total risk-weighted assets of 10% or greater, and
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A leverage ratio of Tier 1 Capital to total assets of 5% or greater.
The FDIC and FRB guidelines also provide that banks and bank holding companies experiencing internal growth or making acquisitions would be expected to maintain capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the guidelines indicate that the agencies will continue to consider a “tangible Tier 1 leverage ratio” (deducting all intangibles) in evaluating proposals for expansion or to engage in new activities.
Higher capital levels could also be required if warranted by the particular circumstances or risk profile of individual banking organizations. For example, the FRB’s capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 Capital less all intangible assets), well above the minimum levels.
Prompt Corrective Action. A banking organization’s capital plays an important role in connection with regulatory enforcement as well. Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators’ powers depends on whether the institution in question is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” in each case as defined by regulation. Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: (i) requiring the institution to submit a capital restoration plan; (ii) limiting the institution’s asset growth and restricting its activities; (iii) requiring the institution to issue additional capital stock (including additional voting stock) or to sell itself; (iv) restricting transactions between the institution and its affiliates; (v) restricting the interest rate that the institution may pay on deposits; (vi) ordering a new election of directors of the institution; (vii) requiring that senior executive officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from correspondent banks; (ix) requiring the institution to divest certain subsidiaries; (x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing a receiver for the institution.
Other Financial Regulatory Matters
Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank of Dallas, which is one of 11 regional FHLBs. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of directors of the FHLB. At December 31, 2015, the Bank had $53.5 million of outstanding FHLB advances.
As a member, the Bank is required to purchase and maintain stock in the FHLB in an amount equal to the sum of 0.04% of total assets as of the previous December 31 and 4.10% of outstanding advances. At December 31, 2015, the Bank had $3.0 million in FHLB stock, which was in compliance with this requirement. No ready market exists for such stock and it has no quoted market value.
Federal Reserve System. The FRB requires all depository institutions to maintain reserves against their transaction accounts and non-personal time deposits (primarily NOW and regular checking accounts). For 2016: the first $15.2 million of otherwise reservable balances are exempt from the reserve requirements; for transaction accounts aggregating more than $15.2 million to $110.2 million, the reserve requirement is 3% of total transaction accounts; and for net transaction accounts in excess of $110.2 million, the reserve requirement is $2.9 million plus 10% of the aggregate amount of total transaction accounts in excess of $110.2 million. These reserve requirements are subject to annual adjustment by the FRB. Because required reserves must be maintained in the form of vault cash or a noninterest bearing account at an FRB, the effect of this reserve requirement is to reduce an institution's earning assets.
Additionally, each member bank is required to hold stock in its regional federal reserve bank. The stock cannot be sold, traded, or pledged as collateral for loans. As specified by law, member banks receive a six percent annual dividend on their FRB stock.
Concentrated Commercial Real Estate Lending Regulations. The federal banking agencies, including the OCC have promulgated guidance governing financial institutions with concentrations in commercial real estate lending. The guidance provides that a bank has a concentration in commercial real estate lending if (i) total reported loans for construction, land development, and other land represent 100% or more of total capital or (ii) total reported loans secured by multifamily and non-farm nonresidential properties (excluding loans secured by owner-occupied properties) and loans for construction, land development, and other land represent 300% or more of total capital and the bank’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months. If a concentration is present, management must employ heightened risk management practices that address the following key elements, including board and management oversight and strategic planning, portfolio management, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, and maintenance of increased capital levels as needed to support the level of commercial real estate lending. As of December 31, 2015, the Company did not exceed the levels to be considered to have a concentration in commercial real estate lending.
Community Reinvestment Act Requirements. The Community Reinvestment Act requires the Bank to have a continuing and affirmative obligation in a safe and sound manner to help meet the credit needs of its entire community, including low- and moderate-income neighborhoods. Federal regulators regularly assess the Bank’s record of meeting the credit needs of its communities. Applications for acquisitions are affected by the evaluation of a bank’s effectiveness in meeting its Community Reinvestment Act requirements.
Anti-Money Laundering. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “Patriot Act”) is designed to deny terrorists and criminals the ability to obtain access to the U.S. financial system and has significant implications for depository institutions, brokers, dealers and other businesses involved in the transfer of money. The Patriot Act mandates financial services companies to have policies and procedures with respect to measures designed to address any or all of the following matters: (i) customer identification programs; (ii) money laundering; (iii) terrorist financing; (iv) identifying and reporting suspicious activities and currency transactions; (v) currency crimes; and (vi) cooperation between financial institutions and law enforcement authorities.
CAUTIONARY NOTE ABOUT FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains certain forward-looking statements and information relating to the Company and the Bank that are based on the beliefs of management as well as assumptions made by and information currently available to management. As used in this document, the words "anticipate," "believe," "estimate," "expect," "intend," "plan," "seek," "will," "should" and similar expressions, or the negative thereof, as they relate to the Company, the Bank or the management thereof, are intended to identify forward-looking statements.
The statements presented herein with respect to, among other things, the Company’s or the Bank’s plans, objectives, expectations and intentions, anticipated changes in noninterest expenses in future periods, changes in earnings, impact of outstanding off-balance sheet commitments, sources of liquidity and that we have sufficient liquidity, the sufficiency of the allowance for loan losses, expected loan, asset, and earnings growth, growth in new and existing customer relationships, our intentions with respect to our investment securities, the integration of Metropolitan, the Company’s plans to close underperforming branches and financial and other goals and plans are forward looking.
Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. The Company does not undertake and specifically disclaims any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. Our actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:
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Local, regional and national economic and financial conditions, including volatility in interest rates, equity prices and the value of financial assets;
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Volatility in the capital or credit markets;
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The impact of conditions in the real estate market in the areas in which we do business;
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The effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in our market area and elsewhere, including institutions operating regionally, nationally and internationally, together with competitors offering banking products and services by mail, telephone and the Internet;
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Strategic actions, including mergers and acquisitions and our success in integrating acquired businesses, including our success in integrating the operations of Metropolitan into the Company;
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The failure of assumptions underlying the establishment of our allowance for loan and lease losses;
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The occurrence of hostilities, political instability or catastrophic events;
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Developments and changes in laws and regulations, including increased regulation of the banking industry through legislative action and revised rules and standards applied by the OCC, the FRB, the FDIC and other federal and state banking regulators;
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Disruptions to our technology network including computer systems and software, as well as natural events such as severe weather, fires, floods and earthquakes or man-made or other disruptions of our operating systems, structures or equipment; and
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Such other factors as discussed in Part I, Item 1A.
Item 1A. Risk Factors
You should carefully read and consider the risk factors described below as well as other information included in this Annual Report on Form 10-K and the information contained in other filings with the SEC. Any of these risks, if they actually occur, could materially and adversely affect the Company’s business, financial condition, liquidity, results of operations and prospects. Additional risks and uncertainties not presently known by us or that we currently deem to be immaterial may materially and adversely affect us.
Risks Related to Our Business:
Our profitability is dependent on our banking activities.
Because we are a bank holding company, our profitability is directly attributable to the success of our bank subsidiary. Our banking activities compete with other banking institutions on the basis of service, convenience and price. Due in part to regulatory changes and consumer demands, banks have experienced increased competition from other entities offering similar products and services. We rely on the profitability of our bank subsidiary and dividends received from our bank subsidiary for payment of our operating expenses and satisfaction of our obligations. As is the case with other similarly situated financial institutions, our profitability will be subject to the fluctuating cost and availability of funds, changes in the prime lending rate and other interest rates, changes in economic conditions in general and, because of the location of our banking offices, changes in economic conditions in Arkansas, Missouri and Oklahoma in particular.
Changes in interest rates could have a material adverse effect on the Bank’s profitability and asset values.
The operations of financial institutions such as the Bank are dependent to a large extent on net interest income, which is the difference between the interest income earned on interest earning assets such as loans and investment securities and the interest expense paid on interest bearing liabilities such as deposits and borrowings. Changes in the general level of interest rates can affect net interest income by affecting the difference between the weighted average yield earned on interest earning assets and the weighted average rate paid on interest bearing liabilities, or interest rate spread, and the average life of interest earning assets and interest bearing liabilities. Changes in interest rates also can affect our ability to originate loans; the value of our interest earning assets; our ability to obtain and retain deposits in competition with other available investment alternatives; and the ability of borrowers to repay adjustable or variable rate loans. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. As of December 31, 2015, the Bank’s model simulations projected that 100, 200 and 300 basis point increases in interest rates would result in variances in net interest income of less than 1%, relative to the base case over the next twelve months and decreases in interest rates of 100 basis points would result in a positive variance in net interest income of 1.20% relative to the base case over the next twelve months. Based on these measures, the Bank estimates a limited impact on earnings for various interest rate change scenarios. Significant changes in the composition of our rate sensitive assets or liabilities could result in a more unbalanced position possibly causing interest rate changes to have a material impact on our earnings. In addition, earnings may be adversely affected during any period of changes in interest rates due to a number of factors including among other items, call features and interest rate caps and floors on various assets and liabilities, prepayments, the current interest rates on assets and liabilities to be repriced in each period, and the relative changes in interest rates on different types of assets and liabilities.
In addition a significant and prolonged increase in interest rates could have a material adverse effect on the fair value of the investment securities portfolio classified as available for sale and, accordingly, stockholders’ equity. At December 31, 2015 the Bank had investment securities classified as available for sale with a fair value of $198.6 million with a net unrealized gain of $625,000. Based on market rates at December 31, 2015 it was estimated that a 200 basis point increase in rates would have resulted in an approximate 7.8% decrease in the fair value of the securities.
The Company and the Bank face strong competition that may adversely affect profitability.
The Company and the Bank are subject to vigorous competition in all aspects and areas of our business from banks and other financial institutions, including commercial banks, savings and loan associations, savings banks, finance companies, credit unions and other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies and insurance companies, and with non-financial institutions, including retail stores that maintain their own credit programs and governmental agencies that make available low cost or guaranteed loans to certain borrowers. Many of our competitors are larger financial institutions with substantially greater resources, lending limits, and larger branch systems. These competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services. Competition from both bank and non-bank organizations will continue. Our inability to compete successfully could adversely affect profitability, which, in turn, could have a material adverse effect on our financial condition and results of operations.
We could experience deficiencies in our allowance for loan and lease losses.
Management maintains an allowance for loan and lease losses based upon, among other things:
• historical experience;
• repayment capacity of borrowers;
• an evaluation of local, regional and national economic conditions;
• regular reviews of delinquencies and loan portfolio quality;
• collateral evaluations;
• current trends regarding the volume and severity of problem loans;
• the existence and effect of concentrations of credit; and
• results of regulatory examinations.
Based on these factors, management makes various assumptions and judgments about the ultimate collectability of the loans in the portfolio. The determination of the appropriate level of the allowance for loan and lease losses inherently involves a high degree of subjectivity and management must make significant estimates of current credit risks and future trends, all of which may undergo material changes. In addition, the board of directors and the OCC periodically review the allowance for loan and lease losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs. The OCC’s judgments may differ from management. While management believes that the allowance for loan and lease losses is appropriate based on our evaluation, management may determine that an increase in the allowance for loan and lease losses is needed or regulators may require an increase in the allowance. Either of these occurrences could materially and adversely affect the Company’s financial condition and results of operations.
We depend on key personnel for our success.
Our operating results and ability to adequately manage our growth and minimize loan and lease losses are highly dependent on the services, managerial abilities and performance of our current executive officers and other key personnel. We have an experienced management team that our board of directors believes is capable of managing and growing our business. Losses of or changes in our current executive officers or other key personnel and their responsibilities may disrupt our business and could adversely affect our financial condition, results of operations and liquidity. There can be no assurance that we will be successful in retaining our current executive officers or other key personnel, or hiring additional key personnel to assist in executing our growth strategy.
Our business depends on the condition of the local and regional economies where we operate.
All of our banking offices are located in Arkansas, Missouri and Southeast Oklahoma. As a result, our financial condition and results of operations may be significantly impacted by changes in the Arkansas, Missouri and Oklahoma economies. Slowdown in economic activity, deterioration in housing markets or increases in unemployment and under-employment in these areas may have a significant and disproportionate impact on consumer and business confidence and the demand for our products and services, result in an increase in non-payment of loans and leases and a decrease in collateral value, and significantly impact our deposit funding sources. Any of these events could have an adverse impact on our financial position, results of operations and liquidity.
A portion of the loan portfolio is related to commercial real estate and construction activities. Unexpected declines in real estate values and other market uncertainties may negatively impact these loans and could adversely impact results of operations.
As of December 31, 2015, approximately 48% of loans consisted of commercial real estate or construction project loans. Commercial real estate and construction lending are generally considered to involve a higher degree of risk due to a variety of factors, including generally larger loan balances, the dependency on successful completion or operation of the project for repayment, a need for a general stability of interest rates and loan terms that often do not require full amortization of the loan over its term and, instead, provide for a balloon payment at stated maturity.
The Company and the Bank could be materially and adversely affected if any of our officers or directors fails to comply with bank and other laws and regulations.
Like any business, we are subject to risk arising from potential employee misconduct, including non-compliance with policies. Any interventions by regulatory authorities following such employee misconduct may result in adverse judgments, settlements, fines, penalties, injunctions, suspension or expulsion of our officers or directors from the banking industry. In addition to the monetary consequences, these measures could, for example, impact our ability to engage in, or impose limitations on, certain business activities. Significant regulatory action against the Company or the Bank or its officers or directors could materially and adversely affect the Company and the Bank’s business, financial condition or results of operations or cause significant reputational harm.
The Bank may incur increased employee benefit costs which could have a material adverse effect on its financial condition and results of operations.
The Company is a participant in the multiemployer Pentegra Defined Benefit Plan (the “Pentegra DB Plan”). Since the Pentegra DB Plan is a multiemployer plan, contributions of participating employers are commingled and invested on a pooled basis without allocation to specific employers or employees. Assets contributed to a multiemployer plan by one employer may be used to provide benefits to employees of other participating employers. In addition, if a participating employer stops contributing to the plan, the unfunded obligations of the multiemployer plan may be borne by the remaining participating employers.
Although the Pentegra DB Plan has been frozen since July 1, 2010, the Company has continued to incur costs consisting of administration and Pension Benefit Guaranty Corporation insurance expenses as well as amortization charges based on the funding level of the Pentegra DB Plan. The level of amortization charges is determined by the Pentegra DB Plan's funding shortfall, which is determined by comparing the Pentegra DB Plan’s liabilities to the Pentegra DB Plan’s assets. Net pension expense was approximately $138,000 and $3.3 million for the years ended December 31, 2015 and 2014, respectively, and contributions to the Pentegra DB Plan totaled $148,000 and $3.0 million for the years ended December 31, 2015 and 2014, respectively. In the second quarter of 2014, the Company elected to retire certain pension liabilities of the Pentegra DB Plan which resulted in a charge of $2.9 million. Although this election improved the funding status, material increases to the estimated amount of the Bank’s required contribution may occur. Additionally, if the Bank were to terminate its participation in the Pentegra DB Plan, the Bank could incur a significant withdrawal liability. Any of these events could have a material adverse effect on our financial condition, results of operations and liquidity.
An inability to make technological advances may reduce the Company and the Bank’s ability to successfully compete.
The banking industry is experiencing rapid changes in technology. In addition to improving customer services, effective use of technology increases efficiency and enables financial institutions to reduce costs. As a result, the Company and the Bank’s future success will depend in part on the ability to address customers’ needs by using technology. The Company and the Bank may be unable to effectively develop new technology-driven products and services and may be unsuccessful in marketing these products to our customers. Many competitors have greater resources to invest in technology. Any failure to keep pace with technological change affecting the financial services industry could have a material adverse impact on the Company and the Bank’s business, financial condition and results of operations.
The Company and the Bank are subject to security and operational risks relating to technology that could damage our reputation and our business.
Security breaches in internet banking activities could expose the Company and the Bank to possible liability and reputational damage. Any security compromise could also deter customers from using internet banking services that involve the transmission of confidential information. The Company and the Bank rely on standard internet security systems to provide the security and authentication necessary to effect secure transmission of data. These precautions and security measures may not protect systems from compromises or breaches that could result in reputational damage. Additionally, the Company and the Bank outsource data processing to a third party. If the third party provider encounters difficulties or if the Company and the Bank have difficulty in communicating with such third party, it could significantly affect our ability to adequately process and account for customer transactions, which could significantly affect our business operations. The Bank has never incurred a material security breach nor encountered any significant down time with our outsourced partners. The occurrence of any failures, interruptions or security breaches of our systems or those of our third party providers could damage our reputation, result in loss of customer business, subject us to additional regulatory scrutiny or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
The current economic environment could adversely affect the Company’s financial condition and results of operations.
The Company is operating in a challenging and uncertain economic environment, including generally uncertain national and local conditions. Negative developments in the financial services industry from 2008 through 2011 resulted in uncertainty in the financial markets in general and an economic recession. As a consequence of the recession, businesses across a wide range of industries faced numerous challenges, including decreases in consumer spending, consumer confidence and credit market liquidity. While conditions have gradually improved, financial markets have experienced sharp declines in early 2016 and many of these circumstances continue to represent challenges and continue to create a degree of economic uncertainty. In addition, declining oil prices, the implementation of the employer mandate under the Patient Protection and Affordable Care Act and the level of U.S. debt may have a destabilizing effect on financial markets.
As a result of these financial and economic conditions, many lending institutions, including us, experienced declines in the performance of their loans. In addition, the values of real estate collateral supporting many commercial loans and home mortgages declined and may decline again in the future. Bank and bank holding company stock prices were negatively affected, and the ability of banks and bank holding companies to raise capital or borrow in the debt markets became more difficult compared to previous periods. As a result, bank regulatory agencies have been and are expected to continue to be very aggressive in responding to concerns and trends identified in examinations. The impact of legislation enacted in response to these developments may negatively impact our operations by restricting our business operations, including our ability to originate or sell loans, and adversely impact our financial performance or our stock price.
Negative economic developments, including another recession, may affect consumer confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and default rates, which may impact our charge-offs and provision for credit losses. Although economic conditions in our market areas and in the U.S. in general have improved, there can be no assurances that the economic environment will continue to improve or that they will not decline in the future. Declines in real estate values, home sales volumes and financial stress on borrowers as a result of the uncertain economic environment could have an adverse effect on our borrowers or their customers, which could adversely affect our business, financial condition, results of operations and cash flows.
We are subject to environmental liability risks.
A significant portion of our loan and lease portfolio is secured by real property. In the ordinary course of business, we may foreclose on and take title to real properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. Additionally, we have acquired a number of retail banking facilities and other real properties as a result of the FNSC and Metropolitan acquisitions, any of which may contain hazardous or toxic substances. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. We have policies and procedures that require either formal or informal evaluation of environmental risks and liabilities on real property (i) before originating any loan or foreclosure action, except for (a) loans originated for sale in the secondary market secured by one-to-four family residential properties and (b) certain loans where the real estate collateral is second lien collateral. These policies, procedures and evaluations may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have an adverse effect on our financial condition, results of operations and liquidity.
If we do not properly manage our credit risk, our business could be seriously harmed.
There are substantial risks inherent in making any loan or lease, including, but not limited to the following:
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risks resulting from changes in economic and industry conditions;
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risks inherent in dealing with individual borrowers;
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risks inherent from uncertainties as to the future value of collateral; and
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the risk of non-payment of loans and leases.
Although we attempt to minimize our credit risk through prudent loan and lease underwriting procedures and by monitoring concentrations of our loans and leases, there can be no assurance that these underwriting and monitoring procedures will reduce these risks. Moreover, as we expand into new markets, credit administration and loan and lease underwriting policies and procedures may need to be adapted to local conditions. The inability to properly manage our credit risk or appropriately adapt our credit administration and loan and lease underwriting policies and procedures to local market conditions or changing economic circumstances could have an adverse impact on our provision for loan and lease losses and our financial condition, results of operations and liquidity.
We rely on certain external vendors.
We are reliant upon certain external vendors to provide products and services necessary to maintain our day-to-day operations. Accordingly, our operations are exposed to risk that these vendors will not perform in accordance with applicable contractual arrangements or service level agreements. We maintain a system of policies and procedures designed to monitor vendor risks including, among other things, (i) changes in the vendor’s organizational structure, (ii) changes in the vendor’s financial condition and (iii) changes in the vendor’s support for existing products and services. While we believe these policies and procedures help to mitigate risk, the failure of an external vendor to perform in accordance with applicable contractual arrangements or the service level agreements could be disruptive to our operations, which could have a material adverse impact on our business and our financial condition and results of operations.
We may be adversely affected by risks associated with completed and potential acquisitions.
We have pursued and expect to pursue additional acquisition opportunities that we believe support our business strategy and may enhance our profitability. Acquisitions involve numerous risks, including but not limited to the following:
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incurring time and expense associated with identifying and evaluating potential acquisitions and negotiating potential transactions, resulting in our attention being diverted from the operation of our existing business;
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using inaccurate estimates and judgments to evaluate credit, operations, management and market risks with respect to the target institution or assets;
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the risk that the acquired business will not perform to our expectations;
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difficulties, inefficiencies or cost overruns in integrating and assimilating the organizational cultures, operations, technologies, services and products of the acquired business with ours;
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the risk of key vendors not fulfilling our expectations or not accurately converting data;
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entering geographic and product markets in which we have limited or no direct prior experience;
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the potential loss of key employees, customers and deposits of acquired banks;
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the potential for liabilities and claims arising out of the acquired businesses; and
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the risk of not receiving required regulatory approvals or such approvals being restrictively conditional.
Acquisitions of financial institutions also involve operational risks and uncertainties, and acquired companies may have unknown or contingent liabilities with no corresponding accounting allowance, exposure to unexpected asset quality problems that require writedowns or write-offs (as well as restructuring and impairment or other charges), difficulty retaining key employees and customers and other issues that could negatively affect our business. We may not be able to realize any projected cost savings, synergies or other benefits associated with any such acquisition we complete. Acquisitions may involve the payment of a premium over book and market values and, therefore, some dilution of our tangible book value and net income per common share may occur in connection with any future transaction. Failure to successfully integrate the entities we acquire into our existing operations could increase our operating costs significantly and have a material adverse effect on our business, financial condition and results of operations.
We must generally satisfy a number of meaningful conditions prior to completing any acquisition, including, in certain cases, federal and state regulatory approval. Bank regulators consider a number of factors when determining whether to approve a proposed transaction, including the effect of the transaction on financial stability and the ratings and compliance history of all institutions involved, including Community Reinvestment Act compliance, examination results and anti-money laundering and Bank Secrecy Act compliance records of all institutions involved. The process for obtaining required regulatory approvals has become substantially more difficult as a result of the recent financial crisis, which could affect our future business. We may fail to pursue, evaluate or complete strategic and competitively significant business opportunities as a result of our inability, or our perceived inability, to obtain any required regulatory approvals in a timely manner or at all.
In addition, we face significant competition from numerous other financial services institutions, many of which will have greater financial resources than we do, when considering acquisition opportunities. Accordingly, attractive acquisition opportunities may not be available to us. There can be no assurance that we will be successful in identifying or completing any future acquisitions.
Risks Related to Our Industry:
The Company and the Bank operate in a heavily regulated environment, and that regulation could limit or restrict our activities and adversely affect the Company’s financial condition.
The financial services industry is highly regulated and subject to examination, supervision, and comprehensive regulation by various federal and state agencies, including the OCC, the FRB and the FDIC. Compliance with these regulations is costly and may restrict some of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates and locations of offices. The regulators’ interpretation and application of relevant regulations are beyond our control and may change rapidly and unpredictably. Banking regulations are primarily intended to protect depositors. These regulations may not always be in the best interest of investors.
In light of current conditions in the global financial markets and the global economy, regulators have increased their focus on the financial services industry. Over the past several years, the scale of response by U.S. financial regulators has been significant. New legislative proposals continue to be introduced in the U.S. Congress that could further substantially increase regulation of the financial services industry and impose restrictions on the operations and general ability of firms within the industry to conduct business consistent with historical practices, including with respect to compensation, interest rates and the effect of bankruptcy proceedings on consumer real property mortgages. Further, federal and state regulatory agencies may adopt changes to their regulations and/or change the manner in which existing regulations are applied. Management cannot predict the substance or effect of pending or future legislation or regulation or the application of laws and regulation to the Company or the Bank. Compliance with current and potential regulation and scrutiny may significantly increase costs, impede the efficiency of internal business processes, require us to increase regulatory capital and limit our ability to pursue business opportunities in an efficient manner by requiring us to expend significant time, effort and resources to ensure compliance. Additionally, evolving regulations concerning executive compensation may impose limitations that affect our ability to compete successfully for executive and management talent.
In addition, given the current economic and financial environment, our regulators may elect to alter standards or their interpretation of the standards used to measure regulatory compliance or to determine the adequacy of certain risk management or other operational practices for financial services companies. Any alteration to or interpretation of these standards may impact our ability to implement our strategy and could affect us in substantial and unpredictable ways and could have an adverse effect on our business, financial condition and results of operations. Furthermore, the regulatory agencies have discretion in their interpretation of the regulations and laws and their interpretation of the quality of our loan portfolio, securities portfolio and other assets. If any regulatory agency’s assessment of our asset quality differs negatively from ours, additional charges may be required that would have the effect of materially reducing our earnings, capital ratios and stock price.
Many of the provisions in the Dodd-Frank Act have increased, and will likely continue to increase, the Company and the Bank’s regulatory compliance burden and may have other adverse effects, including increasing the costs associated with regulatory examinations and compliance measures. The Company and the Bank are closely monitoring all relevant sections of the Dodd-Frank Act to ensure continued compliance with laws and regulations. While the ultimate effects of the Dodd-Frank Act on the Company and the Bank are still undetermined, the law is likely to result in increased compliance costs, higher regulatory costs, and possible operational restrictions.
Further, the U.S. Congress and state legislatures and federal and state regulatory authorities continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including interpretation and implementation of statutes, regulation or policies, including the Dodd-Frank Act, could affect the Company or the Bank in substantial and unpredictable ways, including limiting the types of financial services and products offered or increasing the ability of non-banks to offer competing financial services and products. While management cannot predict the regulatory changes that may be borne out of the current economic crisis, and cannot predict whether the Company or the Bank will become subject to increased regulatory scrutiny by any of these regulatory agencies, any regulatory changes or scrutiny could increase or decrease the cost of doing business, limit or expand permissible activities, or affect the competitive balance among banks, credit unions, savings and loan associations and other institutions. Management cannot predict whether additional legislation will be enacted and, if enacted, the effect that it, or any regulations, would have on the business, financial condition or results of operations of the Company and the Bank.
The fiscal and monetary policies of the federal government and its agencies could have a material adverse effect on our earnings.
The FRB regulates the supply of money and credit in the U.S. Its policies determine in large part the cost of funds for lending and investing and the return earned on those loans and investments, both of which may affect our net interest income and net interest margin. Changes in the supply of money and credit can also materially decrease the value of financial assets we hold, such as debt securities. The FRB’s policies can also adversely affect borrowers, potentially increasing the risk that they may fail to repay their loans and leases. Changes in such policies are beyond our control and difficult to predict; consequently, the impact of these changes on our activities and results of operations is difficult to predict.
Reductions in interchange fees would reduce our non-interest income.
An interchange fee is a fee merchants pay to the interchange network in exchange for the use of the network’s infrastructure and payment facilitation, and which is paid to debit, credit and prepaid card issuers to compensate them for the costs associated with card issuance and operation. In the case of credit cards, this includes the risk associated with lending money to customers. We earn interchange fees on these card transactions. Merchants, trying to decrease their operating expenses, have sought to, and have had some success at, lowering interchange rates. In particular, the Durbin Amendment to the Dodd-Frank Act limited the amount of interchange fees that may be charged for debit and prepaid card transactions for those card issuers with $10 billion or more in total assets. Several recent events and actions indicate a continuing focus on interchange fees by both regulators and merchants. Beyond pursuing litigation, legislation and regulation, merchants are also pursuing alternate payment platforms as a means to lower payment processing costs. To the extent interchange fees are further reduced, our non-interest income from those fees will be reduced, which could have a material adverse effect on our business and results of operations. In addition, the payment card industry is subject to the operating regulations and procedures set forth by payment card networks, and our failure to comply with these operating regulations, which may change from time to time, could subject us to various penalties or fees or the termination of our license to use the payment card networks, all of which could have a material adverse effect on our business, financial condition or results of operations.
Risks Related to Our Common Stock:
The trading volume of the Company’s common stock is lower than that of other financial services companies and the market price of our common stock may fluctuate significantly, which can make it difficult to sell shares of the Company’s common stock at times, volumes and prices attractive to our stockholders.
The Company’s common stock is listed on the NASDAQ Global Market under the symbol “BSF.” The average daily trading volume for shares of our common stock is lower than larger financial institutions. Because the trading volume of our common stock is lower, and thus has substantially less liquidity than the average trading market for many other publicly traded companies, sales of our common stock may place significant downward pressure on the market price of our common stock. In addition, market value of thinly traded stocks can be more volatile than stocks trading in an active public market.
The market price of our common stock has been volatile in the past and may fluctuate significantly as a result of a variety of factors, many of which are beyond our control. These factors include, in addition to those described elsewhere in this Annual Report on Form 10-K:
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actual or anticipated quarterly or annual fluctuations in our operating results, cash flows and financial condition;
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changes in earnings estimates or publication of research reports and recommendations by financial analysts or actions taken by rating agencies with respect to us or other financial institutions;
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speculation in the press or investment community generally or relating to our reputation or the financial services industry;
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strategic actions by us or our competitors, such as acquisitions, restructurings, dispositions, financings or stock repurchases;
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fluctuations in the stock price and operating results of our competitors;
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abnormally high trading volumes in our common stock;
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future issuances or re-sales of our equity or equity-related securities, or the perception that they may occur;
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proposed or adopted regulatory changes or developments;
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anticipated or pending investigations, proceedings, or litigation or accounting matters that involve or affect us;
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domestic and international economic factors unrelated to our performance; and
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general market conditions and, in particular, developments related to market conditions for the financial services industry.
In addition, in recent years, the stock markets in general have experienced extreme price and volume fluctuations, and market prices for the stock of many companies, including those in the financial services sector, have experienced wide price fluctuations that have not necessarily been related to operating performance. This is due, in part, to investors’ shifting perceptions of the effect of changes and potential changes in the economy on various industry sectors. This volatility has had a significant effect on the market price of securities issued by many companies, including for reasons unrelated to their performance or prospects. These broad market fluctuations may adversely affect the market price of our common stock, notwithstanding our actual or anticipated operating results, cash flows and financial condition. The Company expects that the market price of our common stock will continue to fluctuate due to many factors, including prevailing interest rates, other economic conditions, our operating performance and investor perceptions of the outlook for the Company and the Bank specifically and the banking industry in general.
As a result of the lower trading volume of the Company’s common stock and its susceptibility to market price volatility, stockholders may not be able to resell their shares at times, volumes or prices they find attractive.
Bear State Financial Holdings, LLC holds a controlling interest in the Company’s common stock and may have interests that differ from the interests of other stockholders.
Bear State Financial Holdings, LLC (“BSF Holdings”) currently owns approximately 50% of the outstanding shares of Company common stock. As a result, BSF Holdings is able to control the election of directors, determine corporate and management policies and determine the outcome of any corporate transaction or other matter submitted to Company stockholders for approval. Such transactions may include mergers and acquisitions, sales of all or some of the Company’s assets or purchases of assets, and other significant corporate transactions. BSF Holdings also has sufficient voting power to amend our organizational documents.
The interests of BSF Holdings may differ from those of the Company’s other stockholders, and it may take actions that advance its interests to the detriment of other stockholders.
This concentration of ownership could also have the effect of delaying, deferring or preventing a change in control or impeding a merger or consolidation, takeover or other business combination that could be favorable to the other holders of the Company’s common stock, and the market price of the Company’s common stock may be adversely affected by the absence or reduction of a takeover premium in the trading price.
As a controlled company, the Company is exempt from certain NASDAQ corporate governance requirements, and holders of its common stock may not have all the protections that these rules are intended to provide.
The Company’s common stock is currently listed on the NASDAQ Global Market. NASDAQ generally requires a majority of directors to be independent and requires independent director oversight over the nominating and executive compensation functions. However, under NASDAQ’s rules, if an individual or another entity owns more than 50% of the voting power for the election of directors of a listed company, that company is considered a “controlled company” and is exempt from rules relating to independence of the board of directors and the compensation and nominating committees. The Company is a controlled company because BSF Holdings owns more than 50% of the voting power for the election of directors. Accordingly, the Company is exempt from certain corporate governance requirements, and holders of the Company’s common stock may not have all the protections that these rules are intended to provide. Notwithstanding the Company’s exemption from these requirements, nine of the eleven current directors of the Company are deemed to be independent in accordance with NASDAQ listing requirements.
Shares of Company common stock are not an insured deposit and are subject to substantial investment risk.
Investments in Company common stock are not a savings or deposit account or other obligation of its subsidiary bank and are not insured or guaranteed by the FDIC or any other governmental agency. Investment in Company common stock is inherently risky for the reasons described in this "RISK FACTORS" section and in the documents incorporated by reference, and is subject to the same market forces that affect the market price of common stock of any company. As a result, you may lose some or all of your investment.
Integrating Metropolitan into the operations of the Company and the Bank may be more difficult, costly or time-consuming than expected, and failure to do so quickly and efficiently could reduce the Company’s profitability, affect its stock price and either delay or prevent realization of many of the potential benefits of the acquisition.
The success of the Company following the acquisition of Metropolitan may depend in large part on the ability to integrate the business and culture of Metropolitan into that of the Company. If the Company is unable to successfully integrate the operations of Metropolitan efficiently and timely, the expected benefits of the acquisition may not be realized. It is possible that the integration process following completion of the acquisition could result in the loss of key employees, disruption of each company’s ongoing business or inconsistencies in standards, controls, procedures and policies, any of which could adversely affect the Company’s ability to maintain relationships with the Company’s or Metropolitan’s existing customers and employees or to achieve the anticipated benefits of the acquisition. As with any acquisition, merger or consolidation of banking institutions, there also may be business disruptions that cause the Company and Metropolitan to lose customers. Following the acquisition, the Company may be required to spend additional time and money on operating compatibility, which could otherwise be spent on developing the Company’s business. If the Company and Metropolitan do not integrate operations effectively or efficiently, it could harm the Company’s business, financial condition and results of operations.
Future issuances of additional equity securities could result in dilution of existing stockholders’ equity ownership.
We may determine from time to time to issue additional equity securities to raise additional capital, support growth, or, as we have in recent years, to make acquisitions. Further, we may issue stock options, grant restricted stock awards or other equity awards to retain, compensate and/or motivate our employees and directors. These issuances of our securities could dilute the voting and economic interests of existing stockholders.
Item 1B.
Item 1B. Unresolved Staff Comments.
None
Item 2.
Item 2. Properties.
The executive offices of the Company are located at 900 S Shackleford Road, Suite 401, Little Rock, Arkansas, and are leased from an unaffiliated third party. The Company conducts business through 55 banking locations and four loan production offices which are located in various communities throughout Arkansas, Missouri and Southeast Oklahoma. Approximately 80% of the Company's banking locations are owned and 20% are leased.
The Company believes its facilities in the aggregate are suitable and adequate to operate its banking business. Additional information with respect to premises, equipment and lease commitments is presented in Note 8 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
Item 3.
Item 3. Legal Proceedings.
Neither the Company nor the Bank is involved in any pending legal proceedings other than nonmaterial legal proceedings occurring in the ordinary course of business.
Item 4.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II.
Item 5.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities.
Shares of the Company's common stock are traded under the symbol "BSF" on the NASDAQ Global Market. At March 3, 2016, the Company had 37,560,031 shares of common stock outstanding and had approximately 652 holders of record.
The following table sets forth the reported high and low sales prices of a share of the Company's common stock as reported by NASDAQ for the periods indicated. Information presented below has been adjusted to give effect to the stock dividend paid in December 2014. The Company has not paid cash dividends on its common stock in the past two fiscal years. The Board of Directors may consider paying dividends in the future but has no plans to pay dividends in the short term.
Issuer Purchases of Equity Securities
During the fourth quarter of 2015, we repurchased shares of our common stock as indicated in the following table:
The Board of Directors of the Company approved a stock repurchase program on March 13, 2015 and amended it on June 19, 2015, pursuant to which the Company is permitted to repurchase up to $2 million of its common stock. As of December 31, 2015, approximately $1.7 million remained eligible for repurchase under the program. The stock repurchase program will expire March 13, 2016 but can be renewed annually by the Board of Directors.
Item 6.
Item 6. Selected Financial Data.
The selected consolidated financial and other data of the Company set forth below and on the following page is not complete and should be read in conjunction with, and is qualified in its entirety by, the more detailed information, including the Consolidated Financial Statements and related Notes, appearing elsewhere herein and incorporated by reference herein.
(1) All per share amounts have been adjusted to give effect to the 11% stock dividend paid in December 2014.
(1)
Ratios are based on average daily balances.
(2)
Interest rate spread represents the difference between the weighted average yield on average interest earning assets and the weighted average cost of average interest bearing liabilities, and net interest margin represents net interest income as a percentage of average interest earning assets.
(3)
Noninterest expense to net interest income plus noninterest income.
(4)
Asset quality ratios are end of period ratios.
(5)
Nonperforming assets consist of nonperforming loans and real estate owned. Nonperforming loans consist of nonaccrual loans and accruing loans 90 days or more past due.
(6)
Classified loans consist of loans graded substandard, doubtful or loss.
(7)
Capital ratios are end of period ratios for the Company at December 31, 2015 and 2014 and for First Federal Bank for December 31, 2013 and prior.
(8)
Dividend payout ratio is the total common stock cash dividends declared divided by net income available to common stockholders.
(9)
No cash dividends were paid in 2011, 2012, 2013, 2014 or 2015. However, in 2014 an 11% stock dividend was paid.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Management's discussion and analysis of financial condition and results of operations (“MD&A”) is intended to assist a reader in understanding the consolidated financial condition and results of operations of the Company for the periods presented. The information contained in this section should be read in conjunction with the Consolidated Financial Statements and the accompanying Notes to the Consolidated Financial Statements and the other sections contained herein. References to the Company and the Bank throughout MD&A are made using the first person notations of “we”, “us” or “our”.
2015 OVERVIEW
The Company’s net income was $10.6 million for the year ended December 31, 2015, compared to net income of $24.3 million for the year ended December 31, 2014.
The change in net income for the comparative periods was primarily impacted by:
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Pretax net income increased by $11.5 million for the year ended December 31, 2015 compared to the same period in 2014. The primary reason for this increase was the effect of the FNSC and Metropolitan acquisitions in 2014 and 2015, respectively. The results of operations for the year ended December 31, 2015, include the results of operations of First National and Heritage Bank for the entire year, whereas in 2014 the Company’s results of operations included the results of operations for First National and Heritage Bank only for the period from June 14 through December 31, 2014. The results of operations of Metropolitan were included in the consolidated financial statements of the Company beginning October 1, 2015.
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The provision for income taxes increased $25.2 million for the year ended December 31, 2015 compared to the same period in 2014. The primary reason for this increase was the Company’s recognition of an income tax benefit in 2014 resulting from the reversal of $21.1 million of the Company’s valuation allowance on its net deferred tax asset on the basis of management’s assessment of the amount of its deferred tax assets that are more likely than not to be realized.
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The Company paid approximately $1.2 million in fees related to the termination of existing core data processing and online banking contracts of Metropolitan in 2015 compared to $3.0 million in fees related to the termination of similar contracts of FNSC during of 2014.
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The Company’s election in the second quarter of 2014 to retire certain pension liabilities of the Company’s multiemployer defined benefit plan resulted in a charge of $2.9 million for the year ended December 31, 2014, that did not recur in 2015.
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The Company’s net interest margin for the year ended December 31, 2015 was 3.88% compared to 3.84% for the same period in 2014.
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The yield on interest-earning assets decreased to 4.33% for the year ended December 31, 2015 compared to 4.37% for the same period in 2014. The cost of interest-bearing liabilities decreased to 0.53% for the year ended December 31, 2015 compared to 0.60% for the same period in 2014.
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The Company’s noninterest expenses generally increased in the year ended December 31, 2015 compared to the same period in 2014 due to the addition of the operations of the former First National and Heritage Bank for the full year of 2015 as well as Metropolitan beginning October 1, 2015. The increases were due both to normal operating expenses and continued integration costs.
ACQUISITIONS
Metropolitan National Bank
On October 1, 2015, the Company completed its acquisition of Metropolitan from Marshfield Investment Company (“Marshfield”). Under the terms of the purchase agreement, the Company acquired 100% of the outstanding common stock of Metropolitan and Marshfield received proceeds of approximately $70 million, consisting of 4,610,317 shares of Company common stock valued at approximately $42 million and $28 million in cash. The Company paid $10.1 million of the total cash consideration and Metropolitan paid $17.9 million of the total cash consideration in conjunction with the closing of the acquisition. As of December 31, 2015, Metropolitan conducted business from twelve full service locations throughout Southwest Missouri and one loan production office in Joplin, Missouri and had total assets of $455.5 million. On February 19, 2016, Metropolitan was merged with the charter of Bear State Bank, N.A.
First National Security Company
The Company completed its merger with FNSC and its accompanying acquisition of FNSC’s subsidiaries, including First National and Heritage Bank, on June 13, 2014. On February 13, 2015, First Federal Bank, First National and Heritage Bank were consolidated into a single charter forming Bear State Bank, N.A. The Company has achieved significant operational and organizational improvements as a result of the charter consolidation and technology integration, the benefits of which the Company began to realize in the second quarter of 2015.
RECENT DEVELOPMENTS
On February 19, 2016, the Company converted Metropolitan’s systems to the Company’s core technology platform, and merged Metropolitan’s charter into Bear State Bank. In addition to the Metropolitan integration project, the Company has evaluated its branch network and intends to reduce its total retail branches by up to six. The Company anticipates the integration and branch consolidation project to be substantially completed by the second quarter of 2016.
On February 3, 2016, the Company purchased through one broker in an unsolicited single block trade 448,068 shares of its common stock for a cash purchase price of $8.05 per share, or an aggregate purchase price for all of the shares of approximately $3.6 million. The repurchase was specially approved by the board of directors of the Company, including all of its independent directors, and is in addition to, and will not reduce, the remaining capacity under the Company’s existing share repurchase program previously announced on March 13, 2015, and as amended on June 19, 2015 (the “2015 Repurchase Program”). As of February 3, 2016, the Company’s remaining capacity under the 2015 Repurchase Program was approximately $1.7 million.
CRITICAL ACCOUNTING POLICIES
Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. These policies and the judgments, estimates and assumptions are described in greater detail in subsequent sections of this MD&A and in the Notes to the Consolidated Financial Statements included herein. In particular, Note 1 to the Consolidated Financial Statements - “Summary of Significant Accounting Policies” generally describes our accounting policies. We believe that the judgments, estimates and assumptions used in the preparation of our Consolidated Financial Statements are appropriate given the factual circumstances at the time. However, given the sensitivity of our Consolidated Financial Statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition.
Determination of the adequacy of the allowance for loan and lease losses (“ALLL”). In estimating the amount of credit losses inherent in our loan portfolio, various judgments and assumptions are made. For example, when assessing the condition of the overall economic environment, assumptions are made regarding market conditions and their impact on the loan portfolio. In the event the economy were to sustain a prolonged downturn, the loss factors applied to our portfolios may need to be revised, which may significantly impact the measurement of the ALLL. For impaired loans that are collateral dependent and for REO, the estimated fair value of the collateral may deviate significantly from the proceeds received when the collateral is sold.
Acquired loan amounts deemed uncollectible at acquisition date become part of the fair value calculation and are excluded from the ALLL. Quarterly reviews are completed on acquired loans to determine if changes in estimated cash flows have occurred. Subsequent decreases in the amount expected to be collected may result in a provision for loan and lease losses with a corresponding increase in the ALLL. Subsequent increases in the amount expected to be collected result in a reversal of any previously recorded provision for loan and lease losses and the related ALLL, if any, or prospective adjustment to the accretable yield if no provision for loan and lease losses had been recorded.
Acquired Loans. Acquired loans and leases are recorded at fair value at the date of acquisition. No allowance for loan and lease losses is recorded on the acquisition date as the fair value of the acquired assets incorporates assumptions regarding credit risk. The fair value adjustment on acquired loans without evidence of credit deterioration since origination will be accreted into earnings as a yield adjustment using the level yield method over the remaining life of the loan.
Acquired loans and leases with evidence of credit deterioration since origination such that it is probable at acquisition that the Bank will be unable to collect all contractually required payments are accounted for under the guidance in ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. As of the acquisition date, the difference between contractually required payments and the cash flows expected to be collected is the nonaccretable difference, which is included as a reduction of the carrying amount of acquired loans and leases. If the timing and amount of the future cash flows is reasonably estimable, any excess of cash flows expected at acquisition over the estimated fair value is the accretable yield and is recognized in interest income over the asset's remaining life using a level yield method.
Goodwill and other intangible assets. The Company accounts for acquisitions using the acquisition method of accounting. Under acquisition accounting, if the purchase price of an acquired company exceeds the fair value of its net assets, the excess is carried on the acquirer's balance sheet as goodwill. An intangible asset is recognized as an asset apart from goodwill if it arises from contractual or other legal rights or if it is capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented or exchanged. Intangible assets are identifiable assets, such as core deposit intangibles, resulting from acquisitions which are amortized on a straight-line basis over an estimated useful life and evaluated for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable.
Goodwill is not amortized but is evaluated at least annually for impairment or more frequently if events occur or circumstances change that may trigger a decline in the value of the reporting unit or otherwise indicate that a potential impairment exists. Potential impairment of goodwill exists when the carrying amount of a reporting unit exceeds its fair value. To the extent the reporting unit's carrying amount exceeds its fair value, an indication exists that the reporting unit's goodwill may be impaired, and implied fair value of the reporting unit's goodwill will be determined. If the implied fair value of the reporting unit's goodwill is lower than its carrying amount, goodwill is impaired and is written down to the implied fair value. The loss recognized is limited to the carrying amount of goodwill. Once an impairment loss is recognized, future increases in fair value will not result in the reversal of previously recognized losses.
Valuation of real estate owned. Fair value is estimated through current appraisals, real estate brokers’ opinions or listing prices. As these properties are actively marketed, estimated fair values may be adjusted by management to reflect current economic and market conditions. The estimated fair value of the collateral may deviate significantly from the proceeds received when the collateral is sold.
Valuation of investment securities. The Company has classified all of its investment securities as available for sale. Accordingly, its investment securities are stated at estimated fair value in the consolidated financial statements with unrealized gains and losses, net of related income taxes, reported as a separate component of stockholders’ equity with any related changes included in accumulated other comprehensive income (loss). The Company utilizes independent third parties as its principal sources for determining fair value of its investment securities that are measured on a recurring basis. For investment securities traded in an active market, the fair values are based on quoted market prices if available. If quoted market prices are not available, fair values are based on market prices for comparable securities, broker quotes or comprehensive interest rate tables, pricing matrices or a combination thereof. For investment securities traded in a market that is not active, fair value is determined using unobservable inputs. The fair values of the Company’s investment securities traded in both active and inactive markets can be volatile and may be influenced by a number of factors including market interest rates, prepayment speeds, discount rates, credit quality of the issuer, general market conditions including market liquidity conditions and other factors. Factors and conditions are constantly changing and fair values could be subject to material variations that may significantly impact the Company’s financial condition, results of operations and liquidity.
Valuation of deferred tax assets. We recognize deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. We evaluate our deferred tax assets for recoverability using a consistent approach that considers the relative impact of negative and positive evidence, including our historical profitability and projections of future taxable income. We are required to establish a valuation allowance for deferred tax assets if we determine, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, we estimate future taxable income based on management-approved business plans and ongoing tax planning strategies. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws or variances between our projected operating performance, our actual results and other factors.
RESULTS OF OPERATIONS
Year Ended December 31, 2015 Compared to Year Ended December 31, 2014
Net Interest Income. The Company's results of operations depend primarily on its net interest income, which is the difference between interest income on interest earning assets, such as loans and investments, and interest expense on interest bearing liabilities, such as deposits and borrowings. Net interest income for 2015 was $54.5 million compared to $37.4 million in 2014. The increase in net interest income resulted from changes in interest income and interest expense discussed below.
Interest Income. Interest income for 2015 was $60.8 million compared to $42.5 million in 2014. The increase in interest income in 2015 compared to 2014 was primarily due to increases in the average balances of loans receivable and investment securities as a result of the FNSC and Metropolitan acquisitions, partially offset by a decrease in the average yield earned on loans receivable.
Interest Expense. Interest expense for 2015 was $6.4 million compared to $5.1 million in 2014. The increase in interest expense in 2015 compared to 2014 was primarily due to an increase in the average balances of deposit accounts and borrowings due to the acquisitions of FNSC and Metropolitan, partially offset by a decrease in the average rate paid on deposits.
Rate/Volume Analysis. The table below sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For each category of interest earning assets and interest bearing liabilities, information is provided on changes attributable to (i) changes in volume (changes in average volume multiplied by prior rate); (ii) changes in rate (changes in rate multiplied by prior average volume); (iii) changes in rate-volume (changes in rate multiplied by the change in average volume); and (iv) the net change.
Average Balance Sheets. The following table sets forth certain information relating to the Company's average balance sheets and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing interest income or interest expense by the average balance of assets or liabilities, respectively, for the periods presented. Average balances are based on daily balances during the periods.
________________
(1) Includes nonaccrual loans.
(2) Includes FRB and FHLB stock.
Provision for Loan Losses. The provision for loan losses represents the amount added to the ALLL for the purpose of maintaining the ALLL at a level considered adequate to cover probable credit losses related to specifically identified loans as well as probable credit losses inherent in the remainder of the loan portfolio that have been incurred as of the balance sheet date. The adequacy of the ALLL is evaluated quarterly by management of the Bank based on the Bank’s past loan loss experience, known and inherent risks in the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral and other qualitative factors.
Management determined that a provision for loan losses of $1.8 million was required for the year ended December 31, 2015, to maintain the ALLL at an adequate level. Management determined the necessity of the provision and the amount thereof taking into consideration (i) loans originated by the Bank during the period, (ii) changes in the overall portfolio of nonperforming and classified loans of the Bank, (iii) the credit quality of the Bank’s loan portfolio, (iv) ALLL coverage of classified loans and (v) discount balance of acquired loans. The ALLL as a percentage of loans receivable was 1.0% at December 31, 2015, compared to 1.3% at December 31, 2014. The ALLL plus the discount on acquired loans as a percentage of total loans receivable gross of the acquired loan discount was 2.1% at December 31, 2015, compared to 2.4% at December 31, 2014. The ALLL as a percentage of nonaccrual loans was 75.23% at December 31, 2015, compared to 139.8% at December 31, 2014. The ALLL as a percentage of classified loans was 29.22% at December 31, 2015, compared to 38.8% at December 31, 2014. See “Allowance for Loan and Lease Losses” in the “Asset Quality” section. A quarterly review is completed on purchased credit impaired (“PCI”) loans to determine if changes in estimated cash flows have occurred. Subsequent decreases in the amount expected to be collected may result in a provision for loan and lease losses with a corresponding increase in the ALLL.
Noninterest Income. Noninterest income is generated primarily through deposit account fee income, profit on sale of loans, and earnings on life insurance policies. Total noninterest income increased $3.5 million to $13.5 million for 2015 compared to $10.0 million in 2014. The increase was primarily due to increases in deposit fee income and earnings on life insurance policies attributable to the acquisitions of FNSC and Metropolitan.
Noninterest Expense. Noninterest expense consists primarily of employee compensation and benefits, data processing expense, office occupancy expense, real estate owned expense, and other operating expense. Total noninterest expense increased $8.9 million to $51.0 million in 2015 compared to $42.1 million in 2014. The variances in certain noninterest expense items are further explained in the following paragraphs, with the aggregate expense increase being primarily related to the increase in employee compensation expense, net occupancy expense and other expenses related to the acquisitions and integration of FNSC and Metropolitan. The Company expects that it will incur additional expenses related to its acquisition and integration of Metropolitan during the first quarter of 2016.
Salaries and Employee Benefits. Salaries and employee benefits increased $3.9 million for the year ended December 31, 2015 compared to the same period in 2014. The increase in salaries and employee benefits was primarily due to an increase in personnel attributable to the acquisitions of FNSC and Metropolitan, offset by a decrease in defined benefit pension expense. The decrease in defined benefit pension expense was primarily due to a non-recurring charge of $2.9 million in the second quarter of 2014 due to the Company’s election to retire certain pension liabilities of the Company’s multiemployer defined benefit plan. The changes in the composition of this line item are presented below (in thousands):
Net Occupancy Expense. The increase in net occupancy expense of $2.0 million for the year ended December 31, 2015 compared to the same period in 2014 was primarily related to the acquisitions of FNSC and Metropolitan.
Real Estate Owned, net. The changes in the composition of this line item are presented below (in thousands):
The decrease in loss provisions on real estate owned (“REO”) for 2015 compared to 2014 is due to the Company’s review of REO properties in the second and third quarters of 2014 and its decision to more aggressively market certain properties, resulting in 2014 REO losses. Minimal additional provisions were needed in 2015 above those previously recorded. REO expenses such as taxes, insurance and maintenance as well as rental income are expected to continue to decline as the size of the REO portfolio decreases. Future levels of loss provisions and net gains or losses on sales of REO will depend on market conditions. The acquisition of FNSC and Metropolitan had no material impact on REO, net.
Advertising and Public Relations. The increase in advertising and public relations expense during the year ended December 31, 2015 compared to the same period in 2014 of $1.2 million was primarily due to expenses related to the acquisition and integration of FNSC, rebranding expenses associated with the name change of the combined bank during the first quarter of 2015, and the acquisition of Metropolitan in the fourth quarter of 2015. During the first quarter of 2015, the charters of First Federal Bank, First National and Heritage Bank were merged into a single bank charter forming Bear State Bank, N.A. The Company expects that it will incur additional expenses related to its acquisition and rebranding associated with the name change of Metropolitan during the first quarter of 2016.
Other Noninterest Expenses. Other noninterest expense increased $3.6 million for the year ended December 31, 2015 compared to the same period in 2014, primarily due to the acquisition and integration of FNSC and the recent acquisition of Metropolitan. The changes in other noninterest expenses are presented below (in thousands):
Income Taxes. The provision for income taxes was $4.6 million for the year ended December 31, 2015, compared to a tax benefit of $20.6 million for the year ended December 31, 2014. During 2014, the Company recorded a valuation allowance reversal of $21.1 million on the basis of management’s assessment of the amount of its deferred tax assets that are more likely than not to be realized.
Lending Activities
Loan Composition. The following table sets forth certain data relating to the composition of the Bank’s loan portfolio by type of loan at the dates indicated.
Total loans receivable increased $403.0 million to $1.5 billion at December 31, 2015, compared to $1.1 billion at December 31, 2014. The increase in total loans receivable was primarily due to the acquisition of Metropolitan, with $363.3 million of the Company’s consolidated total loans receivable at December 31, 2015 attributable to Metropolitan loan balances.
Loan Concentrations. Loan concentrations are defined as loans to borrowers engaged in similar business-related activities, which would cause them to be similarly impacted by economic or other conditions. We regularly monitor these concentrations in order to consider adjustments in our lending practices. As of December 31, 2015 and 2014, there was no concentration of loans within any portfolio category to any group of borrowers engaged in similar activities or in a similar business that exceeded 10% of total loans.
Loan Maturity and Interest Rates. The following table sets forth certain information at December 31, 2015, regarding the dollar amount of loans maturing in the Bank’s loan portfolios based on their contractual terms to maturity. Demand loans and loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less. All other loans are included in the period in which the final contractual repayment is due.
(1) Gross of unearned discounts and net deferred loan costs and the ALLL.
The following table sets forth the dollar amount of the Bank’s loans at December 31, 2015, due after one year from such date which have fixed interest rates or which have floating or adjustable interest rates.
(1) Gross of unearned discounts and net deferred loan costs and the ALLL.
Scheduled contractual maturities of loans do not necessarily reflect the actual term of the Bank’s loan portfolios. The average life of mortgage loans is substantially less than their average contractual terms because of loan prepayments.
ASSET QUALITY
Loans are generally placed on nonaccrual status when the loan is 90 days past due or, in the judgment of management, the probability of the full collection of principal and interest is deemed to be sufficiently uncertain to warrant further accrual. When a loan is placed on nonaccrual status, previously accrued but unpaid interest is deducted from interest income. Loans may be reinstated to accrual status when payments are made to bring the loan current and, in the opinion of management, full collection of the remaining principal and interest can be reasonably expected. The Bank may continue to accrue interest on certain loans that are 90 days past due or more if such loans are well secured and in the process of collection.
Real estate properties acquired through foreclosure are initially recorded at fair value less estimated selling costs. Fair value is typically determined based on the lower of a current appraised value or management’s estimate of the net realizable value based on the listing price of the property. Valuations of real estate owned are generally performed at least annually.
Nonperforming Assets. The following table sets forth the amounts and categories of the Company’s nonperforming assets at the dates indicated.
(1) The table above does not include substandard loans which were judged not to be impaired totaling $30.2 million, $24.9 million, $2.9 million, $12.1 million, and $36.1 million at December 31, 2015, 2014, 2013, 2012 and 2011, respectively, or ASC 310-30 purchased credit impaired loans which are considered to be performing at December 31, 2015 and 2014.
(2) Loan balances are presented net of undisbursed loan funds, partial charge-offs, and interest payments recorded as reductions of principal for financial reporting purposes.
The increase in nonperforming assets at December 31, 2015 compared to December 31, 2014, was primarily due to an increase in nonaccrual loans of $9.6 million as further explained below, partially offset by net REO activity as disclosed below.
Interest income recorded during the years ended December 31, 2015, 2014, 2013, 2012 and 2011 for loans in the above table was $14,000, $29,000, $21,000, $518,000 and $715,000, respectively. Under their original terms, these loans would have reported approximately $1.2 million, $745,000, $873,000, $1.5 million and $2.3 million of interest income for the years ended December 31, 2015, 2014, 2013, 2012 and 2011, respectively.
Nonaccrual Loans. The composition of nonaccrual loans by status was as follows as of the dates indicated (dollars in thousands):
The following table presents nonaccrual loan activity for the year ended December 31, 2015 (in thousands):
The increase in nonaccrual loans of $9.6 million during the year was primarily due to one lending relationship consisting of five loans totaling $5.5 million. During the third quarter in 2015, there was a development in the borrower’s business that led to deterioration in the Bank’s future repayment prospects leading the Bank to place the loans on nonaccrual status. The Bank evaluated the collateral securing the loans and recorded an allocation to the ALLL of $336,000 at December 31, 2015. Management is actively working with the borrower to resolve this situation. The increase also included $2.7 million of nonaccrual loans from the Metropolitan acquisition in the fourth quarter of 2015.
Real Estate Owned. Changes in the composition of real estate owned between December 31, 2015 and December 31, 2014 are presented in the following table (dollars in thousands).
(1)
Additions include $97,000 of real estate owned from the Metropolitan acquisition in the fourth quarter of 2015.
(2)
Net sales proceeds include $282,000 of loans made by the Bank to facilitate the sale of real estate owned.
Classified Assets. Federal regulations require that each financial institution risk rate their classified assets into three classification categories - substandard, doubtful and loss. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that some loss will be sustained if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified loss is generally considered uncollectible and of such little value that continuance as an asset is not warranted. As of December 31, 2015 and 2014, the Bank did not have any assets classified as doubtful or loss.
The table below summarizes the Bank’s classified assets as of the dates indicated (dollars in thousands):
(1)
Defined as the ratio of nonperforming loans and real estate owned to the Bank’s Tier 1 capital plus the allowance for loan and lease losses.
(2)
Defined as the ratio of classified assets to the Bank’s Tier 1 capital plus the allowance for loan and lease losses.
The increase in classified assets during the year ended December 31, 2015, was primarily due to the addition of nonaccrual loans and accruing classified loans from the Metropolitan acquisition. Classified assets in the acquired loan portfolio of Metropolitan totaled approximately $14.6 million at December 31, 2015.
Allowance for Loan and Lease Losses. The Bank maintains an allowance for loan and lease losses for known and inherent losses determined by ongoing quarterly assessments of the loan portfolio. The estimated appropriate level of the ALLL is maintained through a provision for loan losses charged to earnings. Charge-offs are recorded against the ALLL when management believes the estimated loss has been confirmed. Subsequent recoveries, if any, are credited to the ALLL.
The ALLL consists of general and allocated (also referred to as specific) loan loss components. For loans that are determined to be impaired that are troubled debt restructurings (“TDRs”) and impaired loans where the relationship totals $250,000 or more, a specific loan loss allowance is established when the discounted cash flows or collateral value of the impaired loan is lower than its carrying value. The general loan loss allowance applies to loans that are not impaired and those impaired relationships under $250,000 and is based on historical loss experience adjusted for qualitative factors.
The ALLL represents management’s estimate of incurred credit losses inherent in the Bank’s loan portfolio as of the balance sheet date. The estimation of the ALLL is based on a variety of factors, including past loan loss experience, the current credit profile of the Bank’s borrowers, adverse situations that have occurred that may affect the borrowers’ ability to repay, the estimated value of underlying collateral, and general economic conditions, including unemployment, bankruptcy trends, vacancy rates and the level and trend of home sales and prices. Losses are recognized when available information indicates that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or conditions change.
A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the note. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the short fall in relation to the principal and interest owed. Each quarter, classified loans where the borrower’s total loan relationship exceeds $250,000 are evaluated for impairment on a loan-by-loan basis. Nonaccrual loans and TDRs are considered to be impaired loans. TDRs are restructurings in which the Bank, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that the Bank would not otherwise consider. Impairment is measured quarterly on a loan-by-loan basis for all TDRs and impaired loans where the aggregate relationship balance exceeds $250,000 by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, if the loan is collateral dependent. Impaired loans under this threshold are aggregated and included in loan pools with their ALLL calculated as described in the following paragraph.
Groups of smaller balance homogeneous loans are collectively evaluated for impairment. Homogeneous loans are those that are considered to have common characteristics that provide for evaluation on an aggregate or pool basis. The Bank considers the characteristics of (1) one- to four-family residential mortgage loans; (2) unsecured consumer loans; and (3) collateralized consumer loans to permit consideration of the appropriateness of the ALLL of each group of loans on a pool basis. The primary methodology used to determine the appropriateness of the ALLL includes segregating impaired loans from the pools of loans, valuing these loans, and then applying a loss factor to the remaining pool balance based on several factors including past loss experience, inherent risks, and economic conditions in the primary market areas.
Acquired loan amounts deemed uncollectible at acquisition date become part of the fair value calculation and are excluded from the ALLL. Quarterly reviews are completed on acquired loans to determine if changes in estimated cash flows have occurred. Subsequent decreases in the amount expected to be collected may result in a provision for loan and lease losses with a corresponding increase in the ALLL. Subsequent increases in the amount expected to be collected result in a reversal of any previously recorded provision for loan and lease losses and related increase in ALLL, if any, or prospective adjustment to the accretable yield if no provision for loan and lease losses had been recorded or if the provision is less than the subsequent increase.
In estimating the amount of credit losses inherent in the loan portfolio, various judgments and assumptions are made. For example, when assessing the condition of the overall economic environment, assumptions are made regarding market conditions and their impact on the loan portfolio. For impaired loans that are collateral dependent, the estimated fair value of the collateral may deviate significantly from the proceeds received when the collateral is sold in the event that the Bank has to foreclose or repossess the collateral.
The Company considers the ALLL totaling approximately $14.6 million to be appropriate based on evaluations of the management of the Bank of the loan portfolio and the losses inherent in the loan portfolio as of December 31, 2015. Actual losses may substantially differ from currently estimated losses. Adequacy of the ALLL is periodically evaluated, and the ALLL could be significantly decreased or increased, which could materially affect the Company’s financial condition and results of operations.
The following table summarizes changes in the ALLL and other selected statistics for the periods indicated.
(1)
Consumer loan charge-offs include overdraft charge-offs of $316,000, $148,000, $125,000, $189,000 and $224,000, for the years ended December 31, 2015, 2014, 2013, 2012 and 2011, respectively. Consumer loan recoveries include recoveries of overdraft charge-offs of $75,000, $47,000, $52,000, $67,000 and $98,000, for the years ended December 31, 2015, 2014, 2013, 2012 and 2011, respectively.
(2)
The allowance for loan losses plus the discount on acquired loans as a percentage of total loans outstanding gross of the acquired loan discount was 2.05% and 2.38% at December 31, 2015 and 2014, respectively. There were no acquired loans for the years ended December 2013, 2012 and 2011.
The following table presents, on a consolidated basis, the allocation of the Bank’s ALLL by the type of loan at each of the dates indicated as well as the percentage of loans in each category to total loans receivable. These allowance amounts have been computed using the Bank’s internal models. The amounts shown are not necessarily indicative of the actual future losses that may occur within a particular category.
Investment Securities
The investment portfolio of the Company is designed primarily to provide and maintain liquidity, to provide collateral for pledging requirements, to complement the Company’s interest rate risk strategy and to generate a favorable return. The Company’s investment policy, as established by the Board of Directors, is currently implemented within the parameters set by the asset/liability management committee. The Company is authorized to invest in obligations issued or fully guaranteed by the U.S. Government, certain federal agency obligations, certain time deposits, negotiable certificates of deposit issued by commercial banks and other insured financial institutions, municipal securities, corporate debt securities, and other specified investments.
Investment securities that management has the positive intent and ability to hold to maturity are classified as held to maturity and are reported at amortized cost. Investment securities classified as available for sale are reported at fair value, with unrealized gains and losses excluded from earnings and reported net of tax in other comprehensive income. At December 31, 2015, all of the Company’s investment securities were classified as available for sale. At December 31, 2015, investment securities with a carrying value of approximately $119.1 million were pledged as collateral for certain deposits in excess of $250,000 and for other purposes, including investment securities with carrying values of approximately $12.1 million and $2.1 million at December 31, 2015 and 2014, respectively, for securities sold under agreements to repurchase. At December 31, 2015, investments in the debt and/or equity securities of any one issuer did not exceed more than 10% of the Company's stockholders' equity.
The following table sets forth the amortized cost (in thousands) of investment securities available for sale that contractually mature during each of the periods indicated and the weighted average yields for each range of maturities at December 31, 2015. Weighted average yields for municipal obligations have not been adjusted to a tax-equivalent basis. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay the obligation without prepayment penalties.
As of December 31, 2015, the Company held approximately $68.4 million of investment securities with issuer call options, of which approximately $26.1 million are callable within one year.
The following table sets forth the carrying value of the Company's investment securities available for sale as of the dates indicated.
The increase in 2015 was due to the acquisition of Metropolitan. Balances of investment securities held by Metropolitan as of December 31, 2015, amounted to $27.1 million. The overall yield of the investment portfolio was 2.06% as of December 31, 2015 compared to 1.71% at December 31, 2014.
DEPOSITS AND BORROWINGS
Deposits. Changes in the composition of deposits between December 31, 2015 and 2014 are presented in the following table (dollars in thousands).
Total deposits increased in the comparison period primarily due to the acquisition of Metropolitan, with $394.5 million of the Company’s total deposits at December 31, 2015 being attributed to balances held by Metropolitan. The offsetting decrease in deposits is due, in part, to management’s efforts to reduce unprofitable to marginally profitable Bear State accounts along with seasonal fluctuations in account balances and personal certificates of deposit being withdrawn during the period.
The following table presents the average balance of each type of deposit and the average rate paid on each type of deposit and/or total deposits for the periods indicated.
The following table sets forth maturities of the Bank’s certificates of deposit of $100,000 or more at December 31, 2015 by time remaining to maturity.
Short Term and Other Borrowings. FHLB advances increased by $10.4 million from December 31, 2014 to December 31, 2015 due primarily to new advances of $39.8 million partially offset by maturing advances in 2015. Other borrowings also increased by $700,000 during the year ended December 31, 2015 as a result of draws of $1.9 million on the Company’s line of credit with an unaffiliated bank, partially offset by repayments of $1.2 million on the Company’s notes payable with an unaffiliated bank.
The following table sets forth information with respect to the Company’s borrowings at and during the periods indicated.
LIQUIDITY AND CAPITAL RESOURCES
The primary source of funds for the Company is the receipt of dividends from the Bank, the receipt of management fees from the Bank, cash balances maintained, and borrowings from an unaffiliated source. Payment of dividends by the Bank is subject to certain regulatory restrictions as set forth in banking laws and regulations.
The Company’s primary uses of cash include injecting capital into subsidiaries, stock repurchases, debt service requirements, and paying for general operating expenses.
The Company's objective as it relates to liquidity is to ensure that the Bank has funding and access to sources of funding to ensure that cash flow requirements for deposit withdrawals and credit demands are met in an orderly and timely manner without unduly penalizing profitability. A major component of our overall asset/liability management efforts surrounds pricing of the liability side to ensure adequate liquidity and proper spread and interest margin management. Reliance on any one funding source is kept to a minimum by prioritizing those sources in terms of both availability and time to activation.
In order to maintain proper levels of liquidity, the Bank has several sources of funds available. Generally the Bank relies on cash on hand and due from banks, federal funds sold, cash flow generated by the repayment of principal and interest on and/or the sale of loans and securities and deposits as its primary sources of funds for continuing operations, to make loans and leases, and acquire investment securities and other assets. Commercial, consumer and public funds customers in our local markets are the principal deposit sources utilized.
At December 31, 2015, the Bank’s unused borrowing availability primarily consisted of (1) $229.4 million of available borrowing capacity with the FHLB, (2) $79.3 million of investment securities available to pledge for federal funds or other borrowings and (3) $102.5 million of available unsecured federal funds borrowing lines. In addition, at December 31, 2015, the Company had available borrowing capacity of $9.6 million with an unaffiliated bank.
At December 31, 2015, the Company’s consolidated liquidity ratio was approximately 8.1% which represents liquid assets as a percentage of deposits and short-term borrowings. As of the same date, the Company’s overall adjusted liquidity ratio was 22.8%, which represents liquid assets plus borrowing capacity with the FHLB and correspondent banks as a percentage of deposit and short-term borrowings. The Company anticipates it will continue to rely primarily on principal and interest repayments on loans and securities and deposits to provide liquidity, as well as other funding sources as appropriate. Additionally, where appropriate, the secondary sources of borrowed funds described above will be used to augment the Company’s primary funding sources. We believe that we have sufficient liquidity to satisfy the current and projected operations of the Company and the Bank.
At December 31, 2015, the Company’s leverage, common equity tier 1, tier 1 risk-based and total risk-based capital ratios were 9.15%, 10.62%, 10.62% and 11.52%, respectively, compared to capital adequacy requirements of 4%, 4.5%, 6% and 8%, respectively. See Note 21 to the Consolidated Financial Statements - “Regulatory Matters” for more information about the Company’s and the Bank’s capital requirements and ratios.
The agreement governing the Company’s revolving credit facility with an unaffiliated bank contains affirmative and negative covenants, including covenants that restrict the ability of the Company and its subsidiaries to, among other things, incur or guarantee indebtedness, incur liens, engage in mergers and acquisitions or other assets, dispose of assets, pay dividends and repurchase or redeem capital stock, make changes in management, and engage in transactions with affiliates. The agreement also contains financial covenants, including a minimum fixed charge coverage ratio of 2.0 to 1.0, a maximum loan to value ratio of 75%, a maximum classified asset ratio of 50% and Tier 1 Leverage ratio of 8%. At December 31, 2015, the Company was in compliance with the applicable covenants imposed by the loan agreement.
OFF-BALANCE SHEET ARRANGEMENTS and CONTRACTUAL OBLIGATIONS
At December 31, 2015, the Bank was contractually obligated to make future minimum payments as follows (in thousands):
At December 31, 2015, the Bank was contractually obligated to fund future obligations at maturity as follows (in thousands):
The Bank’s primary off-balance sheet commitments include unused lines of credit, the unadvanced portion of construction loans, and commercial and standby letters of credit, which have maturity dates rather than payment due dates. These commitments are not required to be recorded on the Company’s balance sheet. Since commitments associated with letters of credit and lending and financing arrangements may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements. See Note 17 to the Consolidated Financial Statements-“Off-Balance Sheet Arrangements and Commitments” for further discussion on these arrangements.
DIVIDENDS
During the year ended December 31, 2014, an 11% stock dividend was distributed by the Company. No dividends were distributed during the year ended December 31, 2015. The Company may not declare or pay cash dividends on its shares of common stock if the effect thereof would cause the Company’s stockholders’ equity to be reduced below applicable regulatory capital maintenance requirements for insured institutions. In addition, federal regulations, as currently applied to the Bank, impose limitations upon payment of capital distributions to the Company. No dividends were available for distribution at December 31, 2015, without prior regulatory approval.
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and related financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in relative purchasing power over time due to inflation.
Unlike most industrial companies, virtually all of the Company’s assets and liabilities are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than does the effect of inflation.
Impact of new accounting standards
See Note 1 to the Consolidated Financial Statements - “Summary of Significant Accounting Policies.”
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
INTEREST RATE SENSITIVITY
Interest rate risk represents the potential impact of interest rate changes on net income and capital resulting from mismatches in repricing opportunities of assets and liabilities over a period of time. A number of tools are used to monitor and manage interest rate risk, including simulation models and interest sensitivity gap analysis. Management uses simulation models to estimate the effects of changing interest rates and various balance sheet strategies on the level of the Company’s net income and capital. As a means of limiting interest rate risk to an acceptable level, management may alter the mix of floating and fixed-rate assets and liabilities, change pricing schedules on assets and liabilities and manage investment maturities during future security purchases.
The simulation model incorporates management’s assumptions regarding the level of interest rates or balance changes for indeterminate maturity deposits for a given level of market rate changes. These assumptions have been developed through anticipated pricing behavior. Key assumptions in the simulation models include the relative timing of prepayments, cash flows and maturities. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of a change in interest rates on net income or capital. Actual results will differ from simulated results due to the timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among other factors.
As of December 31, 2015, the model simulations projected that 100, 200 and 300 basis point increases in interest rates would result in variances in net interest income of 0.09%, (0.14)% and (0.75)%, respectively, relative to the base case over the next twelve months and decreases in interest rates of 100 basis points would result in a positive variance in net interest income of 1.20% relative to the base case over the next twelve months. The likelihood of a 100 basis point decrease in interest rates as of December 31, 2015 is considered remote given current interest rate levels. These are good faith estimates and assume that the composition of our interest sensitive assets and liabilities existing at each year-end will remain constant over the relevant twelve month measurement period and changes in market interest rates are instantaneous, parallel and sustained across the yield curve regardless of duration of pricing characteristics of specific assets or liabilities. Also, this analysis does not contemplate any actions that we might undertake in response to changes in market interest rates. We believe these estimates are not necessarily indicative of what actually could occur in the event of immediate interest rate increases or decreases of this magnitude. As interest-bearing assets and liabilities reprice in different time frames and proportions to market interest rate movements, various assumptions must be made based on historical relationships of these variables in reaching any conclusion. Since these correlations are based on competitive and market conditions, we anticipate that our future results will likely be different from the foregoing estimates, and such differences could be material.
Economic Value of Equity
The values of the Company’s loan and investment portfolios will change as interest rates change. Economic Value of Equity (“EVE”) is the difference between incoming and outgoing discounted cash flows from assets, liabilities, and off-balance sheet contracts.
The following tables set forth, quantitatively, as of December 31, 2015 and 2014, the Company’s estimate of the projected changes in EVE in the event of a 100, 200 and 300 basis point instantaneous, parallel and sustained increase in market interest rates and a 100 basis point instantaneous, parallel and sustained decrease in market interest rates as of December 31, 2015 and 2014. The estimates of the projected changes in each category of the table below as of December 31, 2015 versus December 31, 2014 are reflective of the Company’s acquisition of Metropolitan that was completed on October 1, 2015. The balance sheet of the Company as of December 31, 2015 is asset-sensitive and therefore shows an estimated increase in EVE in a rising interest rate environment and an estimated decrease in EVE in a declining interest rate environment.
Computations of prospective effects of hypothetical interest rate changes are calculated based on numerous assumptions, including relative levels of market interest rates, loan repayments, and deposit runoffs, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions the Company may undertake in response to changes in interest rates.
Management cannot predict future interest rates or their effect on the Company’s EVE. Certain shortcomings are inherent in the method of analysis presented in the computation of EVE. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in differing degrees to changes in market interest rates. Additionally, certain assets, such as adjustable rate loans, have features that restrict changes in interest rates during the initial term and over the remaining life of the asset. Further, in the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in the table.
Item 8.
Item 8. Financial Statements and Supplementary Data.
Report of Independent Registered Public Accounting Firm
Audit Committee, Board of Directors and Stockholders
Bear State Financial, Inc.
Little Rock, Arkansas
We have audited the accompanying consolidated statements of financial condition of Bear State Financial, Inc. (the Company) as of December 31, 2015, and 2014, and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for the years ended December 31, 2015 and 2014. The Company's management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. Our audits included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bear State Financial, Inc. as of December 31, 2015, and 2014, and the results of its operations and its cash flows for the years ended December 31, 2015 and 2014, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Bear State Financial, Inc.'s internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 11, 2016, expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.
/s/ BKD, LLP
Little Rock, Arkansas
March 11, 2016
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Audit Committee, Board of Directors and Stockholders
Bear State Financial, Inc.
Little Rock, Arkansas
We have audited Bear State Financial, Inc.'s (the Company) internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
As permitted, the Company excluded the operations of Metropolitan National Bank (Metropolitan), which was acquired on October 1, 2015 as described in Note 2 of the consolidated financial statements, from the scope of management’s report on internal control over financial reporting. As such, Metropolitan has also been excluded from the scope of our audit of internal control over financial reporting.
In our opinion, Bear State Financial, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of Bear State Financial, Inc. and our report dated March 11, 2016, expressed an unqualified opinion thereon.
/s/ BKD, LLP
Little Rock, Arkansas
March 11, 2016
MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Bear State Financial, Inc. and its subsidiary Bear State Bank, N.A., (collectively referred to as the “Company”) is responsible for the preparation, integrity, and fair presentation of its published financial statements and all other information presented in this annual report. The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and, as such, include amounts based on informed judgments and estimates made by management.
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation and fair presentation of the Company’s financial statements for external purposes in accordance with GAAP and includes those policies and procedures that:
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluations of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management has evaluated the effectiveness of its internal control over financial reporting for financial presentations in conformity with GAAP as of December 31, 2015 based on the control criteria established in a report entitled Internal Control-Integrated Framework (2013 edition), issued by the Committee of Sponsoring Organizations of the Treadway Commission. As permitted by SEC guidance, management excluded from its assessment the operations of the Metropolitan National Bank, which the Company acquired during 2015 and which is described in Note 2 to the Consolidated Financial Statements - “Acquisitions,” due to the timing of the acquisition. The assets acquired in this acquisition and excluded from management’s assessment on internal controls over financial reporting comprised approximately 24% of total consolidated assets at December 31, 2015. Based on its assessment and the application of the specified criteria, management has concluded that the Company’s internal control over financial reporting is effective as of December 31, 2015.
BKD, LLP, the independent registered public accounting firm that audited our Condensed Consolidated Financial Statements included in this Annual Report on Form 10-K, has issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2015 which is included in Item 8. Financial Statements and Supplementary Data.
/s/ Mark McFatridge
Mark McFatridge
Chief Executive Officer
/s/Matt Machen
Matt Machen
Chief Financial Officer
BEAR STATE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2015 AND 2014
(In thousands, except share data)
See notes to consolidated financial statements.
BEAR STATE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2015 AND 2014
(In thousands, except earnings per share and share data)
See notes to consolidated financial statements.
BEAR STATE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 2015 AND 2014
(In thousands)
See notes to consolidated financial statements.
BEAR STATE FINANCIAL, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2015 AND 2014
(In thousands, except share data)
See notes to consolidated financial statements.
BEAR STATE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2015 AND 2014
(In thousands)
(Continued)
BEAR STATE FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2015 AND 2014
(In thousands)
(Concluded)
See notes to consolidated financial statements.
BEAR STATE FINANCIAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2015 AND 2014
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations - Bear State Financial, Inc. (the “Company”) is a bank holding company headquartered in Little Rock, Arkansas. Its subsidiary bank, Bear State Bank, N.A. (the “Bank”), is a community oriented national bank providing a broad line of financial products to individuals and business customers. The Bank operates 55 branches and four loan production offices throughout Arkansas, Missouri and Southeast Oklahoma.
The Company completed its merger with First National Security Company (“FNSC”) and the accompanying acquisition of FNSC’s subsidiaries, including First National Bank of Hot Springs (“First National”) and Heritage Bank, N.A. (“Heritage Bank”), on June 13, 2014. On February 13, 2015, First Federal Bank, First National and Heritage Bank were consolidated into a single charter forming Bear State Bank, N.A. Except as the context otherwise requires, any reference in this Annual Report on Form 10-K to the “Bank” means (i) with respect to the period between January 1, 2014 through June 12, 2014, First Federal Bank; (ii) with respect to the period from June 13, 2014 through February 12, 2015, First Federal Bank, First National and Heritage Bank, collectively; (iii) with respect to the period from February 13, 2015 through September 30, 2015 or as of the date hereof, Bear State Bank, N.A.; and (iv) with respect to the period from October 1, 2015 through February 18, 2016, Bear State Bank, N.A. and Metropolitan, collectively. On October 1, 2015, the Company completed its acquisition of Metropolitan National Bank (“Metropolitan”). On February 19, 2016, Metropolitan was merged into the Bear State Bank, N.A. charter.
Principles of Consolidation-The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries.
Operating Segments-The Company consolidated its subsidiary banks into one bank during the first quarter of 2016 and its operations are organized on a regional basis upon which management makes decisions regarding how to allocate resources and assess performance. Each of the regions provides a group of similar community banking products and services, including loans, time deposits, and checking and savings accounts. The individual regions have similar operating and economic characteristics and will be reported as one aggregated operating segment.
Use of Estimates-The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and such differences could be significant. Valuation of assets acquired and liabilities assumed in business combinations, valuation of real estate owned, fair value of financial instruments, provision of deferred tax assets and the allowance for loan and lease losses are material estimates that are particularly susceptible to significant change in the near term.
Cash and Cash Equivalents-For the purpose of presentation in the consolidated statements of cash flows, cash and cash equivalents includes cash on hand and amounts due from depository institutions, which includes interest bearing amounts available upon demand. At December 31, 2015, cash and cash equivalents included $3.4 million on deposit to meet Federal Reserve Bank requirements.
Investment Securities-The Company classifies investment securities into one of two categories: held to maturity or available for sale. The Company does not engage in trading activities. Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and recorded at cost, adjusted for the amortization of premiums and the accretion of discounts.
Investment securities that the Company intends to hold for indefinite periods of time are classified as available for sale and are recorded at fair value. Unrealized holding gains and losses are excluded from earnings and reported net of tax in other comprehensive income. Investment securities in the available for sale portfolio may be used as part of the Company’s asset and liability management practices and may be sold in response to changes in interest rate risk, prepayment risk, or other economic factors.
Premiums are amortized into interest income using the interest method to the earlier of maturity or call date. Discounts are accreted into interest income using the interest method over the period to maturity. The specific identification method of accounting is used to compute gains or losses on the sales of investment securities.
Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis. In estimating whether impairment is other than temporary, management considers whether the Company intends to sell the security, it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, or the present value of expected cash flows is not sufficient to recover the entire amortized cost. If the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the OTTI is recognized in earnings equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date. If the Company does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the OTTI is separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes.
Other Investments-The Bank is a member of the Federal Home Loan Bank (FHLB) system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. The Bank is a member of and owns stock in the Federal Reserve Bank as well as First National Bankers Bank and Midwest Independent Bank, both institutions that provide correspondent banking services to community banks. Stock in these institutions is classified as other investments and is recorded at redemption value which approximates fair value. The Bank periodically evaluates the restricted stock for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.
Loans Receivable-The Bank originates and maintains loans receivable that are substantially concentrated in its lending markets. The majority of the Bank’s loans are residential mortgage loans and nonfarm nonresidential loans. The Bank’s policies generally call for collateral or other forms of security to be received from the borrower at the time of loan origination. Such collateral or other form of security is subject to changes in economic value due to various factors beyond the control of the Bank.
Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are stated at unpaid principal balances adjusted for any charge-offs, the allowance for loan and lease losses, and any deferred loan fees or costs. Deferred loan fees or costs and discounts on loans are amortized or accreted to income using the level-yield method over the remaining period to contractual maturity.
Mortgage loans originated and committed for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Such loans are generally carried at cost due to the short period of time between funding and sale, generally within thirty days.
Loans are considered past due when the contractual amounts due with respect to principal and/or interest are not received within 30 days of the contractual due date. The accrual of interest on loans is generally discontinued when the loan becomes 90 days past due, or, in management’s opinion, the borrower is judged to be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed against interest income. The interest on these loans is accounted for on the cash basis or cost recovery method until qualifying for return to accrual, except when doubt exists as to ultimate collectability of principal and interest. A loan is generally returned to accrual status when the loan is no longer past due and, in the opinion of management, collection of the remaining balance can be reasonably expected. The Company may continue to accrue interest on certain loans that are 90 days past due or more if such loans are well-secured and in the process of collection.
Acquisition Accounting and Acquired Loans- The Company accounts for its acquisitions under ASC Topic 805, Business Combinations, which requires the use of the purchase method of accounting. All identifiable assets acquired, including loans, are recorded at fair value. Acquired loans and leases are recorded at fair value at the date of acquisition. No allowance for loan and lease losses is recorded on the acquisition date as the fair value of the acquired assets incorporates assumptions regarding credit risk. The fair value adjustment on acquired loans without evidence of credit deterioration since origination are accreted into earnings as a yield adjustment using the effective yield method over the remaining life of the loan.
Acquired loans and leases with evidence of credit deterioration since origination such that it is probable at acquisition that the Bank will be unable to collect all contractually required payments are accounted for under the guidance in ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. As of the acquisition date, the difference between contractually required payments and the cash flows expected to be collected is the nonaccretable difference, which is included as a reduction of the carrying amount of acquired loans and leases. If the timing and amount of the future cash flows is reasonably estimable, any excess of cash flows expected at acquisition over the estimated fair value is the accretable yield and is recognized in interest income over the asset's remaining life using the level yield method.
Acquired loan amounts deemed uncollectible at acquisition date become part of the fair value calculation and are excluded from the allowance for loan and lease losses (“ALLL”). Following acquisition, a regular review is completed on acquired loans to determine if changes in estimated cash flows have occurred. Subsequent decreases in the amount expected to be collected may result in a provision for loan and lease losses with a corresponding increase in the ALLL. Subsequent increases in the amount expected to be collected result in a reversal of any previously recorded provision for loan and lease losses and related increase to ALLL, if any, or prospective adjustment to the accretable yield if no provision for loan and lease losses had been recorded or if the provision is less than the subsequent increase.
Allowance for Loan and Lease Losses-The ALLL is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the ALLL when management believes it is likely that a loan balance is uncollectible. Subsequent recoveries, if any, are credited to the ALLL.
The ALLL represents management’s estimate of incurred credit losses inherent in the Company’s loan portfolio as of the balance sheet date. The estimation of the ALLL is based on a variety of factors, including past loan loss experience, the current credit profiles of the Company’s borrowers, adverse situations that have occurred that may affect borrowers’ ability to repay, the estimated value of underlying collateral, and general economic conditions, including unemployment, bankruptcy trends, vacancy rates, and the level and trend of home sales and prices. Losses are recognized when available information indicates that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or conditions change.
The methodology for estimating the ALLL consists of (1) an allocated allowance on identified impaired loans and leases (sometimes referred to as a specific allowance) and (2) a general allowance on the remainder of the loan and lease portfolio. Although the Bank determines the amount of each component of the ALLL separately, the entire allowance is available to absorb losses in the loan portfolio.
Allocated (Specific) Allowance
Allocated, or specific, allowances represent impairment measurements on certain impaired loans as further described below. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the note. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the short fall in relation to the principal and interest owed. Each quarter, classified loans where the borrower’s total loan relationship exceeds $250,000 are evaluated for impairment on a loan-by-loan basis. Nonaccrual loans and troubled debt restructurings (“TDRs”) are considered to be impaired loans. TDRs are restructurings in which the Bank, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that the Bank would not otherwise consider. Impairment is measured quarterly on a loan-by-loan basis for all TDRs and impaired loans where the aggregate relationship balance exceeds $250,000 by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Impaired loans under this threshold are aggregated and included in loan pools with their ALLL calculated as described in the following paragraph.
Groups of smaller balance homogeneous loans are collectively evaluated for impairment. Homogeneous loans are those that are considered to have common characteristics that provide for evaluation on an aggregate or pool basis. The Bank considers the characteristics of (1) one- to four-family residential mortgage loans; (2) unsecured consumer loans; and (3) collateralized consumer loans to permit consideration of the appropriateness of the allowance for losses of each group of loans on a pool basis. The primary methodology used to determine the appropriateness of the allowance for losses includes segregating certain specific, poorly performing loans based on their performance characteristics from the pools of loans as to type, valuing these loans, and then applying a loss factor to the remaining pool balance based on several factors including past loss experience, inherent risks, and economic conditions in the primary market areas.
General Allowance
The general component of the ALLL is based on historical loss experience adjusted for qualitative factors stratified by loan segments and classes. Management performs a migration analysis of historical losses based on a time frame appropriate to capture relevant loss data for each loan segment. This historical loss factor is adjusted for the applicable qualitative factors. The applied loss factors are reevaluated quarterly to ensure their relevance at each reporting period.
Rate Lock Commitments-The Bank enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding (rate lock commitments) as well as corresponding commitments to sell such loans to investors. Rate lock commitments as well as the related sales commitments on mortgage loans that are intended to be sold are considered to be derivatives. Accordingly, such commitments, along with any related fees received from potential borrowers, are recorded at fair value in derivative assets or liabilities, with changes in fair value recorded in the net gain or loss on sale of mortgage loans. Fair value is based on fees currently charged to enter into similar agreements, and for fixed rate commitments also considers the difference between current levels of interest rates and the committed rates.
Real Estate Owned, Net-Real estate owned represents foreclosed assets held for sale and is initially recorded at estimated fair value less estimated costs to sell, establishing a new cost basis. Subsequent to foreclosure, management periodically performs valuations and the assets are carried at the lower of carrying amount or fair value less costs to sell. Adjustments for losses are charged to operations when the estimated fair value falls below` the carrying value. Costs and expenses related to major additions and improvements are capitalized while maintenance and repairs that do not extend the lives of the respective assets are expensed. At December 31, 2015, the Bank had approximately $1.1 million one- to four-family loans in the process of foreclosure.
Office Properties and Equipment, Net-Land is carried at cost. Buildings and equipment are stated at cost less accumulated depreciation and amortization. The Company computes depreciation using the straight-line method over the estimated useful lives of the individual assets, which range from 3 to 40 years. Leasehold improvements are amortized on the straight-line method over the terms of the related leases, including expected renewals, or over the useful lives of the improvements, whichever is shorter. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized.
Cash Surrender Value of Life Insurance-Cash surrender value of life insurance represents life insurance purchased by the Bank on a qualifying group of officers with the Bank designated as owner and beneficiary of the policies. The yield on these policies is used to offset a portion of employment benefit costs. The policies are recorded on the consolidated statements of financial condition at their cash surrender values with changes in cash surrender values reported in noninterest income. Death benefits in excess of the cash surrender value are recorded in noninterest income at the time of death.
Income Taxes- The Company estimates its income taxes payable based on the amounts it expects to owe to the various taxing authorities (i.e. federal, state and local). In estimating income taxes, management assesses the relative merits and risks of the tax treatment of transactions, taking into account statutory, judicial and regulatory guidance in the context of the Company’s tax position. Management also relies on tax opinions, recent audits, and historical experience.
Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various statement of financial condition assets and liabilities and gives current recognition to changes in tax rates and laws. Deferred tax assets and liabilities are recognized for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for tax credits. Deferred tax assets are evaluated for recoverability using a consistent approach that considers the relative impact of negative and positive evidence, including our historical profitability and projections of future taxable income. A valuation allowance for deferred tax assets is established if, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, future taxable income is estimated based on management-approved business plans and ongoing tax planning strategies. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws or variances between projected operating performance, actual results and other factors.
The Company recognizes a tax position as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The Company has no uncertain tax positions.
Penalties and interest are classified as income tax expense when incurred.
Interest Rate Risk-The Company’s asset base is exposed to risk including the risk resulting from changes in interest rates and changes in the timing of cash flows. The Company monitors the effect of such risks by considering the mismatch of the maturities of its assets and liabilities in the current interest rate environment and the sensitivity of assets and liabilities to changes in interest rates. The Company’s management has considered the effect of significant increases and decreases in interest rates and believes such changes, if they occurred, would be manageable and would not affect the ability of the Company to hold its assets as planned. However, the Company is exposed to significant market risk in the event of significant and prolonged interest rate changes.
Earnings Per Common Share-Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company include shares underlying outstanding stock options, restricted stock units and warrants and are determined using the treasury stock method. The shares used in the calculation of basic and diluted earnings per share have been adjusted to give effect to the 11% common stock dividend paid by the Company in December 2014.
Recent Accounting Pronouncements- In January 2014, the FASB issued ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (Topic 310-40): Receivables - Troubled Debt Restructurings by Creditors, which clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this Update were effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. An entity could have elected to adopt the amendments in this ASU using either a modified retrospective transition method or a prospective transition method. Early adoption was permitted. The Company adopted this ASU beginning January 1, 2015. The adoption of this ASU did not have a material impact on the Company’s financial statements.
In April 2014, the FASB issued ASU 2014-08, Reporting Discontinued Operations and Disclosures of Components of an Entity, which changes the criteria for determining which disposals can be presented as discontinued operations and modifies related disclosure requirements. The guidance applies prospectively to new disposals and new classifications of disposal groups as held for sale after the effective date. The standard was required to be adopted by public business entities in annual periods beginning on or after December 15, 2014, and interim periods within those annual periods. The Company adopted this ASU beginning with the quarter ending March 31, 2015. The adoption of this ASU did not have a material impact on the Company’s financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. ASU 2014-09 provides guidance that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. At its July 9, 2015 meeting, the FASB decided to delay the effective date of the revenue recognition standard by one year. ASU 2014-09 is now effective for annual and interim periods beginning after December 15, 2017. The Company is in the process of evaluating the impact of this ASU on its financial statements.
In January 2015, the FASB issued ASU 2015-01, Income Statement-Extraordinary and Unusual Items, to simplify income statement classification by removing the concept of extraordinary items from U.S. GAAP. As a result, items that are both unusual and infrequent will no longer be separately reported net of tax after continuing operations. The existing requirement to separately present items that are of an unusual nature or occur infrequently on a pre-tax basis within income from continuing operations has been retained and expanded to include items that are both unusual and infrequent. The standard is effective for periods beginning after December 15, 2015. Early adoption is permitted, but only as of the beginning of the fiscal year of adoption. The Company’s adoption of this ASU on January 1, 2016, did not have a material impact on the Company’s financial statements.
In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810) - Amendments to the Consolidation Analysis. The new guidance applies to entities in all industries and the amendments significantly change the consolidation analysis required under U.S. GAAP. It makes targeted amendments to the current consolidation guidance in the investment management industry and ends the deferral granted to investment companies from applying the variable interest entities guidance. The standard is effective for public business entities for annual periods beginning after December 15, 2015. Early adoption is allowed, including in any interim period. The Company’s adoption of this ASU on January 1, 2016, did not have a material impact on the Company’s financial statements.
In April 2015, the FASB issued ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30). To simplify presentation of debt issuance costs, the amendments in this Update require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this Update. For public business entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. An entity should apply the new guidance on a retrospective basis. The Company’s adoption of this ASU on January 1, 2016, did not have a material impact on the Company’s financial statements.
In April 2015, the FASB issued ASU 2015-05, Intangibles - Goodwill and Other Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement. This ASU provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The new guidance does not change the accounting for a customer’s accounting for service contracts. ASU 2015-05 is effective for interim and annual reporting periods beginning after December 15, 2015. Early adoption is allowed, including in any interim period. The Company’s adoption of this ASU on January 1, 2016, did not have a material impact on the Company’s financial statements.
In May 2015, the FASB issued ASU 2015-07, Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities that Calculate Net Asset Value Per Share. This permits a reporting entity, as a practical expedient, to measure the fair value of certain investments using the net asset value per share of the investment. Currently, there is diversity in practice related to how certain investments measured at net asset value with redemption dates in the future are categorized within the fair value hierarchy. The amendments in this ASU remove the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. The amendments also remove the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. The amendments in this ASU were effective for public business entities for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years with early adoption permitted. The Company’s adoption of this ASU on January 1, 2016, did not have a material impact on the Company’s financial statements.
In September 2015, the FASB issued update ASU No. 2015-16, Business Combinations - Simplifying the Accounting for Measurement-Period Adjustments (Topic 805). This update applies to all entities that have reported provisional amounts for items in a business combination for which the accounting is incomplete by the end of the reporting period in which the combination occurs and during the measurement period have an adjustment to provisional amounts recognized. The amendments in this update require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments in this update require that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The amendments in this update require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The amendments in this update are effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The amendments in this update should be applied prospectively to adjustments to provisional amounts that occur after the effective date of this update with earlier application permitted for financial statements that have not been issued. The adoption of this ASU is not expected to have a material impact on the Company’s financial statements.
In January 2016, the FASB issued update ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (Subtopic 825-10). This ASU requires certain equity investments to be measured at fair value with changes in fair value recognized in net income and simplifies the impairment assessment of such investments; eliminates the requirement for public entities to disclose the methods and significant assumptions used to estimate fair value that is required to be disclosed for financial instruments measured at amortized cost; requires public entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets and require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or in the accompanying notes to the financial statements. For public entities, ASU 2016-01 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The adoption of this ASU is not expected to have a material impact on the Company’s financial statements.
In February 2016, the FASB issued update ASU 2016-02, Leases (Topic 842). The update applies to all leases and is intended to increase transparency and comparability among organizations by recognizing lease assets and liabilities on the balance sheet and disclosing key information about leasing arrangements. The previous standards did not require lessees to recognize operating leases on the balance sheet. The update provides for accounting requirements so that lessees will be required to recognize the rights and obligations associated with operating leases. The guidance on lessor accounting was not fundamentally change with this update. For public entities, ASU 2016-02 is effective for interim and annual periods beginning after December 15, 2018, however early adoption is permitted. The Company is in the process of evaluating the impact this ASU will have on its financial statements.
Reclassifications- Various items within the accompanying consolidated financial statements for the previous years have been reclassified to conform to the classifications used for reporting in 2015. These reclassifications had no effect on net earnings.
2.
ACQUISITIONS
Metropolitan National Bank
On October 1, 2015, the Company completed its acquisition of Metropolitan National Bank (“Metropolitan”) of Springfield, Missouri from Marshfield Investment Company (“Marshfield”). Under the terms of the purchase agreement, the Company acquired 100% of the outstanding common stock of Metropolitan and Marshfield received proceeds of approximately $70 million, consisting of 4,610,317 shares of Company common stock valued at approximately $42 million and $28 million in cash. The Company paid $10.1 million of the total cash consideration and Metropolitan paid $17.9 million of the total cash consideration in conjunction with the closing of the acquisition. Metropolitan conducts business from twelve full service locations throughout Southwest Missouri and one loan production office in Joplin, Missouri. The acquisition expanded the Company’s market into Southern Missouri and further diversified the Company’s loan, customer and deposit base.
The following table provides a summary of the assets acquired and liabilities assumed as recorded by Metropolitan, the fair value adjustments necessary to adjust those acquired assets and assumed liabilities to estimated fair value, and the resultant fair values of those assets and liabilities as recorded by the Company. As provided for under GAAP, management has up to 12 months following the date of acquisition to finalize the fair values of the acquired assets and assumed liabilities. Goodwill of $14.5 million, which is the excess of the merger consideration over the estimated fair value of net assets acquired, was recorded in the Metropolitan acquisition and is the result of expected operational synergies, expansion of banking services in Southern Missouri, and other factors. The goodwill recognized by the Company is deductible for income tax purposes.
The following is a description of the fair value adjustments used to determine the fair values of assets and liabilities presented above:
Loans - Fair values for loans were based on a discounted cash flow methodology that considered factors including the type of loan and related collateral, classification status, fixed or variable interest rate, term of loan and whether or not the loan was amortizing, and current discount rates. The discount rates used for loans are based on current market rates for new originations of comparable loans and include adjustments for liquidity concerns. The fair value adjustment reflects the elimination of the recorded allowance for loan and lease losses.
Office properties and equipment - Office properties and equipment were acquired from Metropolitan with a $1.8 million adjustment to market value. This represents the difference between current appraisal value completed in connection with the acquisition and Metropolitan’s book value at the time of acquisition.
Deferred tax asset - Deferred income tax assets are recorded to reflect the differences in the carrying values of the assumed liabilities for financial reporting purposes and the cost basis for federal income tax purposes, at the Company’s statutory federal and state income tax rate of 38.29%.
Core deposit intangible - This intangible asset represents the value of the relationships that Metropolitan had with its deposit customers. The fair value of this intangible asset was estimated based on a discounted cash flow methodology that gave appropriate consideration to expected customer attrition rates, cost of the deposit base, and the net maintenance cost attributable to customer deposits. The Company recorded a $4.8 million core deposit intangible with a weighted average life of 12 years.
Deposits - The weighted average interest rate of Metropolitan’s time deposits was estimated to be slightly above the current market rates, resulting in a fair value adjustment for time deposits of $187,000.
Other liabilities - The adjustment to other liabilities primarily represents the accrual of change in control agreements and an unfavorable lease liability.
Beginning October 1, 2015, the operations of Metropolitan are included in the Company’s consolidated results of operations and contributed $5.6 million of net interest income and $1.0 million of net income for the year ended December 31, 2015. The following pro-forma combined consolidated financial information presents how the combined financial information of the Company and Metropolitan might have appeared had the businesses actually been combined as of the beginning of the reporting period. The following schedule represents the pro-forma combined financial information as of the comparative periods ended December 31, 2015 and 2014, assuming the acquisition was completed as of January 1, 2014, (in thousands, except per share data):
The pro-forma consolidated financial information is presented for illustrative purposes only and does not indicate the financial results of the combined company had the companies actually been combined at the beginning of the period presented and had the impact of possible revenue enhancements and expense efficiencies, among other factors, been considered and, accordingly, does not attempt to predict or suggest future results. It also does not necessarily reflect what the historical results of the combined company would have been had the companies been combined during this period.
First National Security Company
On June 13, 2014, the Company completed its acquisition of FNSC whereby FNSC merged with and into the Company in a transaction valued at approximately $124.4 million. In connection with the merger, former FNSC stockholders received in the aggregate 6,252,400 shares of Company common stock, valued at approximately $50.4 million and $74 million in cash in exchange for 100% of the outstanding shares of FNSC common stock. The Company paid $50 million of the total cash consideration and FNSC paid $24 million of the total cash consideration to its stockholders from funds it received immediately prior to the closing of the acquisition from its subsidiary bank, First National Bank. The acquisition expanded the Company’s market into Northeast and Southwest Arkansas and further diversified the Company’s loan, customer and deposit base.
The following table provides a summary of the assets acquired and liabilities assumed as recorded by FNSC, the fair value adjustments necessary to adjust those acquired assets and assumed liabilities to estimated fair value, and the resultant fair values of those assets and liabilities as recorded by the Company. Goodwill of $25.7 million, which is the excess of the merger consideration over the estimated fair value of net assets acquired, was recorded in the FNSC acquisition and is the result of expected operational synergies, expansion of banking services in Northeast and Southwest Arkansas, and other factors. The goodwill recognized by the Company will not be deductible for income tax purposes.
The following is a description of the fair value adjustments used to determine the fair values of assets and liabilities presented above:
Loans - Fair values for loans were based on a discounted cash flow methodology that considered factors including the type of loan and related collateral, classification status, fixed or variable interest rate, term of loan and whether or not the loan was amortizing, and current discount rates. The discount rates used for loans are based on current market rates for new originations of comparable loans and include adjustments for liquidity concerns. The fair value adjustment reflects the elimination of the recorded allowance for loan and lease losses.
Office properties and equipment - Office properties and equipment were acquired from FNSC with a $2.8 million adjustment to market value. This represents the difference between current appraisal value completed in connection with the acquisition and FNSC’s book value at the time of acquisition.
Deferred tax asset - Deferred income tax assets and liabilities are recorded to reflect the differences in the carrying values of the acquired assets and assumed liabilities for financial reporting purposes and the cost basis for federal income tax purposes, at the Company’s statutory federal and state income tax rate of 38.29%.
Core deposit intangible - This intangible asset represents the value of the relationships that FNSC had with its deposit customers. The fair value of this intangible asset was estimated based on a discounted cash flow methodology that gave appropriate consideration to expected customer attrition rates, cost of the deposit base, and the net maintenance cost attributable to customer deposits. The Company recorded a $7.7 million core deposit intangible with a weighted average life of 12.3 years.
Deposits - The weighted average interest rate of FNSC’s time deposits was estimated to be slightly above the current market rates, resulting in a $366,000 fair value adjustment for time deposits.
Other borrowings - The fair value of Federal Home Loan Bank of Dallas borrowed funds is estimated based on borrowing rates currently available to the Company for borrowings with similar terms and maturities.
Beginning June 14, 2014, the operations of FNSC are included in the Company’s consolidated results of operations and contributed $21.2 million of net interest income and $6.2 million of net income for the year ended December 31, 2014. The following pro-forma combined consolidated financial information presents how the combined financial information of the Company and FNSC might have appeared had the businesses actually been combined as of the beginning of the reporting period. The following schedule represents the pro-forma combined financial information as of the period ended December 31, 2014, assuming the acquisition was completed as of January 1, 2014, (in thousands, except per share data):
The pro-forma consolidated financial information is presented for illustrative purposes only and does not indicate the financial results of the combined company had the companies actually been combined at the beginning of the period presented and had the impact of possible revenue enhancements and expense efficiencies, among other factors, been considered and, accordingly, does not attempt to predict or suggest future results. It also does not necessarily reflect what the historical results of the combined company would have been had the companies been combined during this period.
3.
INTEREST BEARING TIME DEPOSITS IN BANKS
Interest bearing time deposits in banks mature within one to five years and are carried at cost. The scheduled maturities of these deposits at December 31, 2015, by contractual maturity are shown below (in thousands):
4.
INVESTMENT SECURITIES AVAILABLE FOR SALE
Investment securities available for sale consisted of the following at December 31 (in thousands):
The mortgage-backed portfolios at December 31, 2015 and 2014 were composed entirely of residential mortgage-backed securities issued or guaranteed by GNMA, FNMA or FHLMC.
The following tables summarize the gross unrealized losses and fair value of the Company's investments with unrealized losses that are not deemed to be other-than-temporarily impaired (“OTTI”), aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31 (in thousands):
On a quarterly basis, management conducts a formal review of securities for the presence of OTTI. Management assesses whether an OTTI is present when the fair value of a security is less than its amortized cost basis at the balance sheet date. For such securities, OTTI is considered to have occurred if the Company intends to sell the security, if it is more likely than not the Company will be required to sell the security before recovery of its amortized cost basis or if the present values of expected cash flows is not sufficient to recover the entire amortized cost.
The unrealized losses are primarily a result of increases in market yields from the time of purchase. In general, as market yields rise, the fair value of securities will decrease; as market yields fall, the fair value of securities will increase. Management generally views changes in fair value caused by changes in interest rates as temporary; therefore, these securities have not been classified as other-than-temporarily impaired. Additionally, the unrealized losses are also considered temporary because scheduled coupon payments have been made, it is anticipated that the entire principal balance will be collected as scheduled, and management neither intends to sell the securities nor is it more likely than not that the Company will be required to sell the securities before the recovery of the remaining amortized cost amount.
The Company has pledged investment securities with carrying values of approximately $119.1 million at December 31, 2015 and $119.0 million at December 31, 2014, as collateral for certain deposits in excess of $250,000 and for other purposes, including investment securities with carrying values of approximately $12.1 million at December 31, 2015 and $2.1 million at December 31, 2014, for securities sold under agreements to repurchase.
The following table sets forth the amount (dollars in thousands) of investment securities available for sale that contractually mature during each of the periods indicated and the weighted average yields for each range of maturities at December 31, 2015. Weighted average yields for municipal obligations have not been adjusted to a tax-equivalent basis. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay the obligation without prepayment penalties.
As of December 31, 2015 and 2014, investment securities with an amortized cost totaling approximately $68.4 million and $73.1 million, respectively, have call options held by the issuer, of which approximately $26.1 million and $35.0 million, respectively, are or were callable within one year.
Information regarding sales of the Company’s investment securities available for sale for the years ended December 31 is summarized below (in thousands):
5.
LOANS RECEIVABLE
Loans receivable consisted of the following at December 31 (in thousands):
Loan Origination and Underwriting - The Bank employs several tools to manage risk in its loan portfolio. Prior to origination, a borrower’s ability to repay is analyzed by reviewing financial information with a comparison of the sustainability of these cash flows to the proposed loan terms, with consideration given to possible changes in underlying business and economic conditions. The financial strength and support offered by any guarantors to the loan is evaluated and any collateral offered is assessed using internal and external valuation resources. Finally, the credit request is compared against the Bank’s written and Board approved lending policies and standards. The ongoing risk in the loan portfolio is managed through regularly reviewing loans to assess key credit elements, providing for an adequate allowance for loan losses and diversifying the portfolio based on certain metrics including industry type, loan purpose and underlying source of repayment.
Real Estate Loans - The real estate loan portfolio consists primarily of single family residential, commercial real estate and construction loans. Loans in this category are differentiated by whether the property owner or parties unrelated to the borrower occupy the property. This difference can directly affect the sensitivity of the source of loan repayment to changes in interest rates and market conditions, which can impact the underlying collateral value. Therefore, the analysis of these credits focuses on current and forecasted economic trends in certain sub-markets, including residential, industrial, retail, office and multi-family segments. Changes in these segments are influenced by both local and national cycles, which may fluctuate in both similar and opposing directions and sustain for varying durations. These differences provide the Bank with opportunities for diversification of loans by property type, geography and other factors.
Commercial Loans - This portfolio includes loans with funds used for commercial purposes including loans to finance enterprise, including agricultural, working capital needs; equipment purchases; accounts receivable and inventory and other similar business needs. The risk of loans in this category is driven by the cash flow and creditworthiness of the borrowers, the monitoring of which occurs through the ongoing analysis of updated and interim financial information. Also, the terms of these loans are generally shorter than credits secured by real estate, helping to reduce the impact of changes in interest rates on the Bank’s interest rate sensitivity position.
Mortgage loans serviced for others are not included in the accompanying consolidated statements of financial condition. The unpaid principal balances of such loans at December 31, 2015 and December 31, 2014 were $20.4 million and $23.5 million, respectively. Servicing loans for others generally consists of collecting payments and disbursing payments to investors. Servicing income for the years ended December 31, 2015 and 2014 was not significant.
As of December 31, 2015 and 2014, qualifying loans collateralized by first lien one- to four-family mortgages with balances totaling approximately $33.1 million and $41.4 million, respectively, were held in custody by the Federal Home Loan Bank of Dallas and were pledged for outstanding advances or available for future advances. The Bank also pledged substantially all of its remaining loans at December 31, 2015 under a blanket lien with the FHLB.
As of December 31, 2015, the Bank did not have any loans pledged with the Federal Reserve Bank (“FRB”). At December 31, 2014, qualifying loans collateralized by commercial real estate with balances of $6.8 million were pledged at the FRB. No FRB borrowings were outstanding at December 31, 2015 or 2014.
Purchased Loans - The Company evaluated $583.6 million of net loans ($595.1 million gross loans less $11.5 million discount) purchased in conjunction with the acquisition of FNSC in 2014 in accordance with the provisions of FASB ASC Topic 310-20, Nonrefundable Fees and Other Costs. The fair value discount is being accreted into interest income over the weighted average life of the loans using a constant yield method.
The Company evaluated $364.5 million of net loans ($375.0 million gross loans less $10.5 million discount) purchased in conjunction with the acquisition of Metropolitan in 2015 in accordance with the provisions of FASB ASC Topic 310-20, Nonrefundable Fees and Other Costs. The fair value discount is being accreted into interest income over the weighted average life of the loans using a constant yield method.
The Company evaluated $21.1 million of net loans ($26.9 million gross loans less $5.8 million discount) purchased in conjunction with the acquisition of FNSC in 2014 in accordance with the provisions of FASB ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. The following table reflects the carrying amount of purchased credit impaired (“PCI”) loans, which are included in the loan categories above (in thousands):
The following table reflects the carrying amount of the fair value adjustments for purchased loans with evidence of credit deterioration as of June 13, 2014 (in thousands).
The following table documents changes as of December 31, 2015 and 2014 to the amount of accretable yield on loans evaluated in accordance with the provisions of FASB ASC Topic 310-30 (in thousands).
Age analyses of loans as of the dates indicated, including both accruing and nonaccrual loans, are presented below (in thousands):
As of December 31, 2015 and 2014, there were $1.0 million and $2.2 million, respectively, of PCI loans acquired in the merger with FNSC that were 90 days or more past due and accruing. Additionally, there were two non-PCI loans totaling $451,000 and one non-PCI loan of $353,000 past due 90 days and still accruing at December 31, 2015 and 2014, respectively. Restructured loans totaled $1.7 million and $2.5 million as of December 31, 2015 and 2014, respectively, with $1.4 million and $1.9 million of such restructured loans on nonaccrual status at December 31, 2015 and 2014, respectively.
The following table presents age analyses of nonaccrual loans as of December 31, 2015 and 2014 (in thousands):
The following tables summarize information pertaining to impaired loans as of December 31, 2015 and 2014 and for the years then ended (in thousands). The tables below do not include ASC 310-30 purchased credit impaired loans which are disclosed separately in the loans receivable footnote.
Credit Quality Indicators. As part of the on-going monitoring of the credit quality of the Bank’s loan portfolio, the Bank categorizes loans into risk categories based on available and relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Bank analyzes loans individually by assigning a credit risk rating to loans on at least an annual basis for non-homogeneous loans over $250,000. The Bank uses the following definitions for risk ratings:
Pass. Loans rated as pass generally meet or exceed normal credit standards. Factors influencing the level of pass grade include repayment source and strength, collateral, borrower cash flows, existence of and strength of guarantors, industry/business sector, financial trends, performance history, etc.
Special Mention. Loans rated as special mention, while still adequately protected by the borrower’s repayment capability, exhibit distinct weakening trends. If left unchecked or uncorrected, these potential weaknesses may result in deteriorated prospects of repayment. These exposures require management’s close attention so as to avoid becoming adversely classified credits.
Substandard. Loans rated as substandard are inadequately protected by the current sound net worth and paying capacity of the borrower or the collateral pledged, if any. These assets must have a well-defined weakness based on objective evidence and be characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
Doubtful. Loans rated as doubtful have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances.
Loss. Loans rated as a loss are considered uncollectible and of such little value that continuance as an asset is not warranted. A loss classification does not mean that an asset has no recovery or salvage value, but that it is not practical or desirable to defer writing off or reserving all or a portion of the asset, even though partial recovery may be effected in the future.
Based on analyses performed at December 31, 2015 and December 31, 2014, the risk categories of loans are as follows (in thousands):
As of December 31, 2015 and 2014, the Bank did not have any loans classified as doubtful or loss.
Troubled Debt Restructurings. Troubled debt restructurings (“TDRs”) are loans where the contractual terms on the loan have been modified and both of the following conditions exist: (i) the borrower is experiencing financial difficulty and (ii) the restructuring constitutes a concession that the Bank would not otherwise make. The Bank assesses all loan modifications to determine if the modifications constitute a TDR. Restructurings resulting in an insignificant delay in payment are not considered to be TDRs. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length and the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. All TDRs are considered impaired loans. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
The following table summarizes TDRs as of December 31, 2015 and 2014: (dollars in thousands)
No loans receivable were restructured as TDRs during the year ended December 31, 2015. Loans receivable that were restructured as TDRs during the years ended December 31, 2014 were as follows: (dollars in thousands)
__________________________
(1)
Concessions represent skipped payments/maturity date extensions or amortization term extensions.
(2)
The borrower did not have the financial ability to refinance at another bank at renewal.
There were no loans receivable for which a payment default occurred during the years ended December 31, 2015 or 2014 that had been modified as a TDR within 12 months or less of the payment default.
6. ALLOWANCES FOR LOAN AND LEASE LOSSES AND REAL ESTATE LOSSES
The tables below provide a rollforward of the allowance for loan and lease losses ("ALLL") by portfolio segment for the years ended December 31, 2015 and 2014 (in thousands):
The tables below present the allocation of the ALLL and the related loans receivable balances disaggregated on the basis of impairment method by portfolio segment as of December 31, 2015 and 2014 (in thousands):
Activity in the allowance for real estate losses is as follows for the years ended December 31: (in thousands):
7.
ACCRUED INTEREST RECEIVABLE
Accrued interest receivable consisted of the following at December 31 (in thousands):
8.
OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment consisted of the following at December 31 (in thousands):
Depreciation expense for each of the years ended December 31, 2015 and 2014 was approximately $3.3 million and $2.2 million, respectively.
Pursuant to the terms of noncancelable lease agreements in effect at December 31, 2015, pertaining to banking premises and equipment, future minimum rent commitments (in thousands) under various operating leases are as follows:
The leases contain options to extend for periods from one to twenty-five years. The cost of rentals in the renewal periods are not included above except for one lease where there is a loan outstanding between the Bank and the lessor. Total future minimum lease payments for the initial term of this lease and applicable renewal periods reflected in the table total approximately $4.0 million. Total rent expense for the years ended December 31, 2015 and 2014 amounted to $721,000 and $484,000, respectively.
The Company also leases certain of its banking premises to third parties under operating lease agreements. The following is a schedule by years of minimum future rentals receivable on noncancelable operating leases (in thousands):
The leases contain options to extend for periods up to ten years. Such rentals are not included above. Total rental income for the years ended December 31, 2015 and 2014 amounted to $435,000 and $285,000, respectively.
9.
GOODWILL AND CORE DEPOSIT INTANGIBLE - NET
Goodwill represents the excess of the cost over the fair value of net assets acquired in a business combination. Goodwill is not amortized but is tested for impairment at least annually and updated quarterly if necessary. At December 31, 2015, goodwill consisted of $25.7 million related to the FNSC acquisition which is not deductible for tax purposes and $14.5 million related to the Metropolitan acquisition which is deductible for tax purposes. The Company’s core deposit intangible is related to the core deposit premiums of First National, Heritage Bank and Metropolitan. These core deposit intangibles are amortized on a straight line basis over their estimated lives ranging from 12 to 13 years.
Changes in the carrying amount and accumulated amortization of the Company’s core deposit intangible for the years ended December 31 were as follows (in thousands):
The Company’s projected amortization expense is approximately $1.0 million in each of the years ending December 31, 2016 through 2020, and $6.3 million thereafter.
10.
DEPOSITS
Deposits are summarized as follows at December 31 (in thousands):
Overdrafts of checking accounts of $620,000 and $540,000 at December 31, 2015 and 2014, respectively, have been reclassified for financial reporting and are reflected in net loans receivable on the consolidated statements of financial condition.
As of December 31, 2015 and 2014, the Bank had $22.0 million and $22.2 million of brokered deposits, respectively.
The aggregate amount of time deposits in denominations of $100 thousand or more was approximately $254.9 million and $242.6 million at December 31, 2015 and 2014, respectively. The aggregate amount of time deposits in denominations of $250 thousand or more was approximately $87.1 million and $77.5 million at December 31, 2015 and December 31, 2014, respectively.
At December 31, 2015, scheduled maturities of certificates of deposit were as follows (in thousands):
Interest expense on deposits consisted of the following (in thousands):
FDIC insurance covers all deposit accounts, including checking and savings accounts, money market deposit accounts and certificates of deposit. The standard insurance amount is $250,000 per depositor, per insured bank, for each account ownership category.
11.
SHORT TERM BORROWINGS
Short term borrowings consist of repurchase agreements totaling $12.1 million at both December 31, 2015 and 2014, respectively. Securities sold under repurchase agreements generally have maturities of one day and are recorded based on the amount of cash received in connection with the borrowing. Securities pledged as collateral under repurchase agreements are included in investment securities on the Condensed Consolidated Balance Sheets and are disclosed in Note 4. The fair value of the collateral pledged to a third party is continually monitored and additional collateral is pledged or returned, as deemed appropriate.
The remaining contractual maturity of securities sold under agreements to repurchase in the consolidated balance sheets as of December 31, 2015 and 2014 consisted of the following (in thousands):
At December 31, 2015, the Company and the Bank had unused credit lines allowing contingent access to overnight borrowings of up to $102.5 million on an unsecured basis.
12.
OTHER BORROWINGS
Other borrowings are summarized as follows at December 31 (in thousands):
Federal Home Loan Bank. The Bank currently pledges as collateral for FHLB advances certain qualifying one- to four-family mortgage loans and a blanket lien on substantially all remaining loans. Additionally, as of December 31, 2015, the Bank has FHLB letters of credit totaling $56.6 million, which $31.6 million matures in the first quarter of 2016 and $25.0 million matures in the fourth quarter of 2017. The letters of credit were used to secure public deposits and a repurchase agreement as of December 31, 2015.
Notes Payable. The line of credit and note payable to a bank are collateralized by 100% of the stock of the Bank. The loan agreement contains affirmative and negative covenants, including covenants that restrict the ability of the Company and its subsidiaries to, among other things, incur or guarantee indebtedness, incur liens, engage in mergers and acquisitions or other assets, dispose of assets, pay dividends and repurchase or redeem capital stock, make changes in management, and engage in transactions with affiliates. The agreement also contains financial covenants, including a minimum fixed charge coverage ratio of 2.0 to 1.0, a maximum loan to value ratio of 75%, a maximum classified asset ratio of 50% and Tier 1 Leverage ratio of 8%. At December 31, 2015, the Company was in compliance with the applicable covenants imposed by the loan agreement.
At December 31, 2015, scheduled maturities of other borrowings were as follows (in thousands):
13.
INCOME TAXES
The provisions (benefits) for income taxes are summarized as follows at December 31 (in thousands):
The reasons for the differences between the statutory federal income tax rates and the effective tax rates are summarized as follows at December 31 (in thousands):
The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined on the basis of the differences between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities are adjusted through the provision for income taxes.
The Company’s net deferred tax asset account was comprised of the following at December 31 (in thousands):
For the year ended December 31, 2015, the net deferred tax asset decreased by $4.0 million or 19.2% primarily as a result of a decrease of the net operating loss ("NOL") carryforward which was utilized to offset taxable income for the year end December 31, 2015.
A financial institution may, for federal income tax purposes, carryback net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years. At December 31, 2015, the Company had a $25.5 million NOL for federal income tax purposes that will be carried forward. The federal NOL carryforwards, if unused, expire in calendar years 2029 through 2034. The $25.5 million federal NOL includes $6.2 million of IRC Section 382 NOL carryforwards that have an annual limit of $405,000 that can be utilized to offset taxable income. At December 31, 2015, the Company had a $26.8 million NOL for Arkansas state income tax purposes. The state NOL carryforwards, if unused, expire in calendar years 2016 through 2019.
Specifically exempted from deferred tax recognition requirements are bad debt reserves for tax purposes of U.S. savings and loans in the institution’s base year, as defined under Code Section 593(g)(2)(A)(ii). Base year reserves totaled approximately $4.2 million. Consequently, a deferred tax liability of approximately $1.6 million related to such reserves was not provided for in the consolidated statements of financial condition at December 31, 2015 and 2014. Payment of dividends to stockholders out of retained earnings deemed to have been made out of earnings previously set aside as bad debt reserves may create taxable income to the Bank. No provision has been made for income tax on such a distribution as the Bank does not anticipate making such distributions.
The Company evaluates the need for deferred tax asset valuation allowances based on a more likely than not standard as defined by generally accepted accounting principles. In accordance with ASC Topic 740-10, Income Taxes (ASC 740), a valuation allowance is deemed to be needed when, based on the weight of the available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or all of a deferred tax asset will not be realized. The ability to realize deferred tax assets depends on the ability to generate sufficient taxable income within the carryback and carryforward periods provided for in the tax law for each applicable tax jurisdiction. The Company considers the following possible sources of taxable income when assessing the realization of deferred tax assets:
●
Future reversals of existing temporary differences;
●
Future taxable income exclusive of reversing temporary differences and carryforwards;
●
Taxable income in prior carryback years; and
●
Tax planning strategies
The assessment regarding whether a valuation allowance is required or should be adjusted also considers all positive and negative evidence, including but not limited to:
●
Nature, frequency and severity of recent losses;
●
Duration of statutory carryforward periods;
●
Historical experience with tax attributes expiring unused; and
●
Near- and medium-term financial outlook.
For the year ended December 31, 2014 the Company recorded a valuation allowance reversal on the basis of management’s assessment of the amount of its deferred tax assets that are more likely than not to be realized, resulting in a net tax benefit of $21.1 million for the year ended December 31, 2014.
At December 31, 2015 the Company has certain deferred tax assets related to net unrealized built-in losses (“NUBILs”) established under IRC Section 382 on the date of the ownership change of May 3, 2011. If these losses are realized before May 3, 2016 (five years after the ownership change date), then they are not allowed to be taken as a deduction and are therefore permanently lost. The NUBILs at December 31, 2015 amounted to $2.6 million or $0.9 million on a tax effected basis. Since these NUBILs may be lost, the valuation allowance of $0.9 million was not reversed. If any of the NUBILs still remain on the books on May 3, 2016, the valuation allowance on the deferred tax asset can be reversed at that time. During the year ended December 31, 2015, $120,000 of deferred tax assets related to realized built in losses and their associated valuation allowances were reversed.
The Company recognizes interest and penalties related to income tax matters as additional income taxes in the consolidated statements of income. The Company had no interest or penalties related to income tax matters during the years ended December 31, 2015 or 2014. The Company files consolidated income tax returns in the U.S. federal jurisdiction and the state of Arkansas while Bear State Bank files in the state of Oklahoma and Metropolitan National Bank files in the state of Missouri. The Company is subject to U.S. federal and state income tax examinations by tax authorities for tax years ended December 31, 2012 and forward.
14.
STOCK BASED COMPENSATION
2011 Omnibus Incentive Plan- The Company’s 2011 Omnibus Incentive Plan (the “2011 Plan”) was approved by the Company’s stockholders on April 29, 2011 and became effective May 3, 2011. The objectives of the 2011 Plan are to optimize the profitability and growth of the Company through incentives that are consistent with the Company’s goals and that align the personal interests of participants to those of the Company’s stockholders. The 2011 Plan provides for a committee of the Company’s Board of Directors to award nonqualified stock options, incentive stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units, and other awards representing up to 2,144,743 shares of Company stock (adjusted for the 11% stock dividend paid in 2014). Awards may be granted under the 2011 Plan up to ten years following the effective date of the plan. Each award under the 2011 Plan is governed by the terms of the individual award agreement, which specifies pricing, term, vesting, and other pertinent provisions. Shares issued in connection with stock compensation awards are issued from available authorized shares.
Stock Options. Option awards are generally granted with an exercise price equal to the fair market value of the Company’s stock at the date of grant, generally vest based on five years of continuous service and have seven year contractual terms. The fair value of each option award is estimated on the date of grant using the Black-Scholes option valuation model. Expected volatilities are based on implied volatilities from historical volatility of the Company’s stock and other factors. The Company uses historical data to estimate option exercise, employee termination, and expected term of the options within the valuation model. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
A summary of the stock option activity in the Company’s 2011 Plan for the years ended December 31, 2015 and 2014, adjusted for the 11% stock dividend in 2014, is presented below:
The weighted average remaining contractual life of the outstanding options was 3.0 years and the aggregate intrinsic value of the options was approximately $944,000 at December 31, 2015. The weighted average remaining contractual life of options exercisable was 2.9 years and the aggregate intrinsic value of those options was approximately $707,000 at December 31, 2015.
As of December 31, 2015, there was $144,000 of total unrecognized compensation costs related to nonvested stock options under the 2011 Plan. The cost is expected to be recognized over a weighted-average period of 1.3 years. Compensation expense attributable to option awards totaled approximately $148,000 and $149,000 for the years ended December 31, 2015 and 2014, respectively.
Restricted Stock Units. The fair value of each restricted stock unit (“RSU”) award is determined based on the closing market price of the Company’s stock on the grant date and amortized to compensation expense on a straight-line basis over the vesting period. The vesting periods range from one to five years.
A summary of the restricted stock unit activity in the Company’s 2011 Plan for the years ended December 31, 2015 and 2014, adjusted for the 11% stock dividend, is presented below:
As of December 31, 2015, there was $1.7 million of total unrecognized compensation costs related to nonvested RSUs under the 2011 Plan. The cost is expected to be recognized over a weighted-average period of 2.5 years. Compensation expense attributable to awards of RSUs totaled approximately $642,000 and $329,000 for the years ended December 31, 2015 and 2014, respectively.
15.
EMPLOYEE BENEFIT PLANS
401(k) Plan - The Company has established a 401(k) Plan whereby substantially all employees may participate in the Plan. Employees may contribute up to 75% of their salary subject to certain limits based on federal tax laws. The Company matches the first 2% of employee contributions. Compensation expense attributable to matching contributions totaled approximately $309,000 and $243,000 for the years ended December 31, 2015 and 2014, respectively.
Other Postretirement Benefits-The Bank participates in the Pentegra Defined Benefit Plan for Financial Institutions ("The Pentegra DB Plan"), a noncontributory tax-qualified defined-benefit pension plan. The Pentegra DB Plan's Employer Identification Number is 13-5645888 and the Plan Number is 333. The Pentegra DB Plan operates as a multiemployer plan for accounting purposes and as a multiple-employer plan under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. There are no collective bargaining agreements in place that require contributions to the Pentegra DB Plan. No funding improvement plan or rehabilitation plan has been implemented or is pending and the Bank has not paid a surcharge to the Pentegra DB Plan.
The risks of participating in a multiemployer plan are different from single-employer plans in the following aspects:
a.
Assets contributed to the multiemployer plan by one employer may be used to provide benefits to employees of other participating employers.
b.
If a participating employer stops contributing to the plan, the unfunded obligations of the plan may be borne by the remaining participating employers.
The following table presents the funded status (market value of plan assets divided by funding target) as of July 1 for the respective years:
(1)
Market value of plan assets reflects any contributions received through June 30, 2015 and 2014, respectively.
Total contributions made to the Pentegra DB Plan by all participating employers, as reported on Form 5500, equal $190.8 million and $136.5 million for the plan years ending June 30, 2014 and June 30, 2013, respectively. The Bank’s contributions to the Pentegra DB Plan are not more than 5% of the total contributions to the Pentegra DB Plan.
The Pentegra DB Plan provides a retirement benefit and a death benefit. Retirement benefits are payable in monthly installments for life and must begin not later than the first day of the month coincident with or the next month following the seventieth birthday or the participant may elect a lump-sum distribution. Death benefits are paid in a lump-sum distribution, the amount of which depends on years of service. Depending on the Pentegra DB Plan’s funded status, lump-sum distributions may have limitations. The Pentegra DB Plan was frozen effective July 1, 2010, eliminating all future benefit accruals for participants in the Pentegra DB Plan and closing the Pentegra DB Plan to new participants as of that date. The Bank will continue to incur costs consisting of administration and Pension Benefit Guaranty Corporation insurance expenses as well as amortization charges based on the funding level of the Pentegra DB Plan annually. Net pension expense was approximately $138,000 and $3.3 million for the years ended December 31, 2015 and 2014, respectively, and contributions to the Pentegra DB Plan totaled $148,000 and $3.0 million for the years ended December 31, 2015 and 2014, respectively. If the Bank chooses to withdraw from the Pentegra DB Plan, the Bank may be required to pay a significant withdrawal liability.
16.
EARNINGS PER SHARE
Basic earnings per share is computed by dividing reported earnings available to common stockholders by the weighted average number of common shares outstanding. Diluted earnings per share is computed by dividing reported earnings available to common stockholders by the weighted average number of common shares outstanding after consideration of the dilutive effect, if any, of the Company’s outstanding common stock options and warrants using the treasury stock method. The following table reflects the calculation of weighted average shares outstanding for the basic and diluted earnings per share calculations for the years ended December 31:
The calculation of diluted securities for the year ended December 31, 2014 excluded antidilutive stock options representing 47,221 shares. There were no antidilutive securities for the year ended December 31, 2015.
17.
OFF-BALANCE SHEET ARRANGEMENTS AND COMMITMENTS
In the normal course of business and to meet the needs of its customers, the Bank is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments could involve, to varying degrees, elements of credit risk in excess of the amount recognized in the Company’s consolidated statements of financial condition.
The Bank does not use financial instruments with off-balance sheet risk as part of its asset/liability management program or for trading purposes. The Bank’s exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as they do for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the counterparty. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
The funding period for construction loans is generally six to twenty-four months and commitments to originate mortgage loans are generally outstanding for no more than 60 days.
In the normal course of business, the Bank makes commitments to buy or sell assets or to incur or fund liabilities. Commitments include, but are not limited to:
■
the origination, purchase or sale of loans; and
■
the fulfillment of commitments under letters of credit, extensions of credit on lines of credit, construction loans, and under predetermined overdraft protection limits.
At December 31, 2015, the Bank’s off-balance sheet arrangements principally included lending commitments, which are described below. At December 31, 2015, the Company had no interests in non-consolidated special purpose entities.
At December 31, 2015, commitments included:
■
total approved loan origination commitments outstanding amounting to $44.2 million, including approximately $3.4 million of loans committed to sell;
■
rate lock agreements with customers of $10.9 million, all of which have been locked with an investor;
■
funded mortgage loans committed to sell of $7.3 million;
■
unadvanced portion of construction loans of $50.1 million;
■
unused lines of credit of $131.9 million;
■
revolving credit card unused credit of $5.4 million;
■
outstanding standby letters of credit of $3.2 million; and
■
total predetermined overdraft protection limits of $20.4 million.
Total unfunded commitments to originate loans for sale and the related commitments to sell of $3.4 million meet the definition of a derivative financial instrument. The related asset and liability are considered immaterial at December 31, 2015.
Historically, a very small percentage of predetermined overdraft limits have been used. At December 31, 2015, overdrafts of accounts with Bounce ProtectionTM represented usage of 1.6% of the limit.
18.
FAIR VALUE MEASUREMENTS
ASC 820, Fair Value Measurement, provides a framework for measuring fair value and defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 820 describes three levels of inputs that may be used to measure fair value:
Level 1
Unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.
Level 2
Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data at the measurement date for substantially the full term of the assets or liabilities.
Level 3
Unobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.
Financial instruments are broken down by recurring or nonrecurring measurement status. Recurring assets are initially measured at fair value and are required to be remeasured at fair value in the financial statements at each reporting date. Assets measured on a nonrecurring basis are assets that, due to an event or circumstance, were required to be remeasured at fair value after initial recognition in the financial statements at some time during the reporting period.
The following is a description of inputs and valuation methodologies used for assets recorded at fair value on a recurring basis and recognized in the accompanying statements of financial condition at December 31, 2015 and December 31, 2014, as well as the general classification of such assets pursuant to the valuation hierarchy.
Securities Available for Sale
Investment securities available for sale are recorded at fair value on a recurring basis. The fair values used by the Company are obtained from an independent pricing service, which represent either quoted market prices for the identical asset or fair values determined by pricing models, or other model-based valuation techniques, that consider observable market data, such as interest rate volatilities, LIBOR yield curve, credit spreads and prices from market makers and live trading systems. Recurring Level 2 securities include U.S. Treasury securities, U.S. agency securities, residential mortgage-backed securities and municipal bonds. Inputs used for valuing Level 2 securities include observable data that may include dealer quotes, benchmark yields, market spreads, live trading levels and market consensus prepayment speeds, among other things. Additional inputs include indicative values derived from the independent pricing service’s proprietary computerized models. No securities were included in the Recurring Level 3 category at or for the years ended December 31, 2015 and 2014.
The following table presents major categories of assets measured at fair value on a recurring basis as of December 31, 2015 and 2014 (in thousands):
The following is a description of valuation methodologies used for significant assets measured at fair value on a nonrecurring basis.
Impaired Loans Receivable
Loans which meet certain criteria are evaluated individually for impairment. A loan is considered impaired when, based upon current information and events, it is probable the Bank will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the loan agreement. The majority of the Bank’s impaired loans at December 31, 2015 and December 31, 2014 are secured by real estate. Impaired loans are individually measured for impairment by comparing the carrying value of the loan to the discounted cash flows or the fair value of the collateral, less estimated selling costs, as appropriate. Fair value is estimated through current appraisals, real estate brokers’ opinions or listing prices. Fair values may be adjusted by management to reflect current economic and market conditions and, as such, are classified as Level 3. During the reported periods, collateral discounts ranged from 15% to 25% and selling costs were estimated at 8%. Fair value adjustments are made by partial charge-offs and adjustments to the ALLL.
Real Estate Owned, net
Real Estate Owned (“REO”) represents real estate acquired as a result of foreclosure or by deed in lieu of foreclosure and is carried at the lower of cost or fair value less estimated selling costs. Fair value is estimated through current appraisals, real estate brokers’ opinions or listing prices. As these properties are actively marketed, estimated fair values may be adjusted by management to reflect current economic and market conditions and, as such, are classified as Level 3. During the reported periods, collateral discounts ranged from 0% to 25% and selling costs were typically estimated at 8%. Fair value adjustments are recorded in earnings during the period such adjustments are made. REO loss provisions recorded during the years ended December 31, 2015 and 2014 were $47,000 and $1.5 million, respectively.
The following table presents major categories of assets measured at fair value on a nonrecurring basis for the years ended December 31, 2015 and December 31, 2014 (in thousands). The assets disclosed in the following table represent REO properties or collateral-dependent impaired loans that were remeasured at fair value during the year with a resulting valuation adjustment or fair value write-down.
19.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value of financial instruments has been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
The estimated fair values of financial instruments that are reported at amortized cost in the Company’s statement of financial condition, segregated by the level of valuation inputs within the fair value hierarchy used to measure fair value, are as follows (in thousands):
For cash and cash equivalents and federal funds sold, the carrying amount approximates fair value (level 1). For other investment securities, loans held for sale, cash surrender value of life insurance and accrued interest receivable, the carrying value is a reasonable estimate of fair value, primarily because of the short-term nature of the instruments or, as to other investment securities, the ability to sell the stock back to the issuer at cost (level 2). Interest bearing time deposits in banks were valued using discounted cash flows based on current rates for similar types of deposits (level 2). Fair values of impaired loans are estimated as described in Note 15. Non-impaired loans were valued using discounted cash flows. The discount rates used to determine the present value of these loans were based on interest rates currently being charged by the Bank on comparable loans (level 3).
For securities sold under agreements to repurchase, the carrying amount approximates fair value (level 1). The fair value of checking accounts, savings accounts and money market deposits is the amount payable on demand at the reporting date (level 2). The fair value of fixed-maturity certificates of deposit is estimated using the discount rates currently offered by the Bank for deposits of similar terms (level 3). The fair value of other borrowings is estimated using the rates for borrowings of similar remaining maturities at the reporting date (level 2). For accrued interest payable the carrying value is a reasonable estimate of fair value, primarily because of the short-term nature of the instruments (level 2).
The fair value estimates presented herein are based on pertinent information available to management as of December 31, 2015 and December 31, 2014. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since the reporting date and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.
20.
CONTINGENCIES
The Company is a defendant in certain claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated financial statements of the Company.
21.
REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. The Office of the Comptroller of the Currency (“OCC”) is the primary regulator for the Bank. The FRB is the primary regulator for the Company. Failure to meet minimum capital requirements can result in certain mandatory-and possible additional discretionary-actions by regulators that, if undertaken, could have a direct and material effect on the Company’s or the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of tier 1 capital (as defined by regulation) to average assets (as defined by regulation) and common equity tier 1 capital, tier 1 capital and total capital (as defined by regulation) to risk-weighted assets (as defined by regulation). Management believes that the Company and the Bank meet all capital adequacy requirements to which they are subject.
As of the most recent notification from regulatory authorities, the Company and the Bank were categorized as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed any of the Bank’s categorizations.
The actual and required capital amounts (in thousands) and ratios of the Company (Consolidated) and Bear State Bank and Metropolitan as of December 31, 2015 are presented in the following table:
The actual and required capital amounts (in thousands) and ratios of the Company (Consolidated) and First Federal, First National and Heritage Bank as of December 31, 2014 are presented in the following table:
(1)
In the case of First Federal, the ratio is calculated based on adjusted assets at period end.
Private Placement. In connection with the merger with FNSC, on June 13, 2014 the Company sold 2,531,645 shares of Company common stock at a price per share equal to $7.90 in a private placement (the “Private Placement”) to its principal stockholder Bear State Financial Holdings, LLC and certain of its members in their individual capacity (the “Investors”) (including Richard N. Massey, the Company’s Chairman of the Board and Principal Executive Officer, and Scott T. Ford, a director of the Company). Additionally, the Company issued warrants (the “Investor Warrants”) to purchase 177,215 shares of common stock on the same terms as in the Private Placement to the Investors in exchange for their respective commitments to backstop the Private Placement. The pricing of the Private Placement and Investor Warrants was equal to the closing stock price for the Company’s common stock on June 28, 2013, which was the last business day prior to the execution of the merger agreement with FNSC. This price was also used to determine the number of shares issued to FNSC stockholders in the merger.
Authorized Shares. On March 21, 2014, the stockholders of the Company approved a proposal to amend the Company’s Articles of Incorporation to increase the number of authorized shares of common stock from 30,000,000 to 100,000,000. Effective June 3, 2014, the Company filed Amended and Restated Articles of Incorporation (the “Amended Articles”) with the Secretary of State of the State of Arkansas. The Amended Articles increased the number of authorized shares from 30,000,000 to 100,000,000.
Dividends. The Company may not declare or pay cash dividends on its shares of common stock if the effect thereof would cause the Company’s stockholders’ equity to be reduced below applicable regulatory capital maintenance requirements for insured institutions or below the special liquidation account established by the Company in connection with First Federal’s conversion from the mutual holding company structure on May 3, 1996. In addition, federal regulations, as currently applied to the Banks, impose limitations upon payment of capital distributions to the Company. No dividends were available for distribution at December 31, 2015, without prior regulatory approval.
The principal source of the Company’s revenues is dividends from the Bank. Our ability to pay dividends to our stockholders depends to a large extent upon the dividends we receive from the Bank.
On October 22, 2014, the Company’s Board of Directors declared an 11% stock dividend per common share payable on December 15, 2014, to stockholders of record at the close of business on December 1, 2014. Stockholders received 1 additional share of Company common stock for every 9 shares owned. They also received the cash equivalent of any fractional shares to which they were entitled, since no fractional shares were issued.
Repurchase Program. During 2015, the Company repurchased 28,678 shares of its common stock under a share repurchase program that was approved by the Board of Directors on March 13, 2015 and amended on June 19, 2015 ( the “2015 Repurchase Program”), whereby the Company is permitted to repurchase up to $2 million of its common stock. The 2015 repurchase program will expire March 13, 2016 and can be renewed annually by the Board of Directors.
22.
RELATED PARTY TRANSACTIONS
In the normal course of business, the Bank has made loans to its directors, officers, including their immediate families, and their related business interests. In accordance with the Bank’s policies, related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collectability. The aggregate dollar amount of loans outstanding to directors, officers, their immediate families, and their related business interests was approximately $13.8 million and $11.5 million at December 31, 2015 and 2014, respectively and unused lines of credit available to such persons totaled $3.0 million and $2.5 million at December 31, 2015 and 2014, respectively. Deposits from related parties held by the Bank at December 31, 2015 and 2014 amounted to $35.5 million and $13.7 million, respectively.
For the years ended December 31, 2015 and 2014, the Company paid $167,000 and $129,000, respectively, to related parties under the terms of an aircraft time-sharing agreement and service agreements.
In 2014 the Company and its Chairman entered into an aircraft purchase agreement whereby the Company acquired a 75% undivided interest and Mr. Massey acquired a 25% undivided interest in an airplane acquired at a cost of $775,000. The Company’s share is recorded in office properties and equipment on the consolidated statement of financial condition and has a net book value of $521,000 at December 31, 2015. The Company and Mr. Massey also entered into an agreement pursuant to which the parties agreed to apportion the fixed costs of the aircraft on a pro rata basis and each party agreed to pay its own variable costs associated with the use of the aircraft. Variable costs attributable to Mr. Massey's use of the aircraft in connection with Company business, and not in connection with his personal use of the aircraft, were paid by the Company.
23.
SUBSEQUENT EVENTS
On February 19, 2016, the Company converted Metropolitan’s systems to the Company’s core technology platform, and merged Metropolitan’s charter into Bear State Bank. In addition to the Metropolitan integration project, the Company has evaluated its branch network and intends to reduce its total retail branches by up to six. The Company anticipates the integration and branch consolidation project to be substantially completed by the second quarter of 2016.
On February 3, 2016, the Company purchased through one broker in an unsolicited single block trade 448,068 shares of its common stock for a cash purchase price of $8.05 per share, or an aggregate purchase price for all of the shares of approximately $3.6 million. The repurchase was specially approved by the board of directors of the Company, including all of its independent directors, and is in addition to, and will not reduce, the remaining capacity under the Company’s existing 2015 Repurchase Program. As of February 3, 2016, the Company’s remaining capacity under the 2015 Repurchase Program was approximately $1.7 million.
24.
PARENT COMPANY ONLY FINANCIAL INFORMATION
The following condensed statements of financial condition, as of December 31, 2015 and 2014, and condensed statements of income and comprehensive income and of cash flows for each of the two years in the period ended December 31, 2015, for Bear State Financial, Inc. should be read in conjunction with the consolidated financial statements and the notes herein.
BEAR STATE FINANCIAL, INC.
(Parent Company Only)
CONDENSED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2015 AND 2014
(In thousands)
BEAR STATE FINANCIAL, INC.
(Parent Company Only)
CONDENSED STATEMENTS OF INCOME AND
COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 2015 AND 2014
(In thousands)
BEAR STATE FINANCIAL, INC.
(Parent Company Only)
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2015 AND 2014
(In thousands)
******
BEAR STATE FINANCIAL, INC.
SELECTED QUARTERLY OPERATING RESULTS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(1)
Basic and diluted weighted average shares outstanding are summarized below. The shares used in the calculation have been adjusted to give effect to the 11% common stock dividend paid in December 2014.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Not applicable.
Item 9A.
Item 9A. Controls and Procedures.
Our management evaluated, with the participation of our Principal Executive Officer and Principal Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, our Principal Executive Officer and Principal Financial Officer have concluded that our disclosure controls and procedures are operating effectively.
The Company’s management, including the Company’s Principal Executive Officer and the Principal Financial Officer, regularly review our controls and procedures and make changes intended to ensure the quality of our financial reporting. On October 1, 2015, we completed the acquisition of Metropolitan, and as a result, we extended our oversight and monitoring processes that support our internal control over financial reporting during the fourth quarter of 2015 to include the operations of Metropolitan. No change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended December 31, 2015 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information.
Not Applicable.
PART III.
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
The information required by this item is included in the sections titled “Election of Directors,” “Information Regarding the Board and its Committees,” “Executive Officers of the Company,” “Section 16(a) Beneficial Ownership Reporting Compliance,” and “Committees and Meetings of the Board of Directors of the Company” in our definitive proxy statement to be filed pursuant to Regulation 14A of the Exchange Act, for our 2016 Annual Meeting of Stockholders (the “2016 Proxy Statement”), and that information is incorporated herein by reference.
The Board of Directors has adopted a code of ethics for the Company’s executive officers, including the Chief Executive Officer and the Chief Financial Officer, and other financial professionals. These officers are expected to adhere at all times to this code of ethics. Failure to comply with this code of ethics is a serious offense and will result in appropriate disciplinary action. We have posted this code of ethics in the Corporate Governance section of our website at www.bearstatefinancial.com.
We will disclose on our website at www.bearstatefinancial.com, to the extent and in the manner permitted by Item 5.05 of Form 8-K under Section 13 of the Securities Exchange Act of 1934, the nature of any amendment to this code of ethics (other than technical, administrative, or other non-substantive amendments), our approval of any material departure from a provision of this code of ethics, and our failure to take action within a reasonable period of time regarding any material departure from a provision of this code of ethics that has been made known to any of the executive officers noted above.
Item 11.
Item 11. Executive Compensation.
The information required by this item is incorporated herein by reference from the section titled “Executive Compensation” in the 2016 Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Certain portions of the information required by this item are incorporated herein by reference from the section titled “Beneficial Ownership of Common Stock By Certain Beneficial Owners and Management and Related Shareholder Matters” in the 2016 Proxy Statement.
Equity-Based Compensation Plans
The following table contains information regarding shares of our common stock that may be issued upon the exercise of stock awards under our existing equity compensation plans as of December 31, 2015:
(1)
As of December 31, 2015, there were 227,449 shares of our common stock issuable upon the exercise of options granted under the Bear State Financial, Inc. 2011 Omnibus Incentive Plan, which was approved by stockholders in 2011 (the “2011 Plan”). The weighted average exercise price of those outstanding options was $6.68. At December 31, 2015, there were 273,316 shares of our common stock issuable upon vesting of restricted stock units.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by this item is incorporated herein by reference from the section titled “Transactions with Certain Related Persons” and “Election of Directors” in the 2016 Proxy Statement.
Item 14.
Item 14. Principal Accounting Fees and Services.
The information required by this item is incorporated herein by reference from the section titled “Accounting Fees and Services” in the 2016 Proxy Statement.
PART IV.
Item 15.
Item 15. Exhibits, Financial Statement Schedules.
(a) Documents Filed as Part of this Report
(1) Consolidated financial statements of the Company have been included in Part II, Item 8 of this Annual Report on Form 10-K.
(2) All schedules for which provision is made in the applicable accounting regulations of the SEC are omitted because of the absence of conditions under which they are required or because the required information is included in the consolidated financial statements of the Company and related notes thereto.
(3) See Item 15(b) of this Annual Report on Form 10-K.
(b) Exhibit Index.
2.1
Plan of Conversion (incorporated herein by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed with the SEC on July 21, 2011).
2.2
Agreement and Plan of Merger by and between the Company and First National Security Company, dated July 1, 2013 (incorporated herein by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with the SEC on July 3, 2013).
2.3
Stock Purchase Agreement dated as of June 22, 2015 by and between the Company and Marshfield Investment Company (incorporated herein by reference to Exhibit 2.1 to the Company’s Amended Current Report on Form 8-K filed with the SEC on June 25, 2015).
3.1
Amended and Restated Articles of Incorporation of the Company (incorporated herein by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K filed with the SEC on June 3, 2014).
3.2 Amended and Restated Bylaws of the Company (incorporated herein by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K filed with the SEC on June 19, 2014).
10.1
Investment Agreement dated as of January 27, 2011, by and among the Company, First Federal Bank and Bear State Financial Holdings, LLC (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on January 28, 2011).
10.2
First Amendment to Investment Agreement, dated April 20, 2011, by and among the Company, First Federal Bank, and Bear State Financial Holdings, LLC (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report Form 8-K filed with the SEC on April 21, 2011).
10.3†
Bear State Financial, Inc. 2011 Omnibus Incentive Plan (incorporated herein by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on April 29, 2011).
10.4†*
Form of Notice of Performance-Based Restricted Stock Grant, including Form of Performance-Based Restricted Stock Award Agreement.
10.5†*
Form of Notice of Restricted Stock Grant, including Form of Restricted Stock Award Agreement.
10.6†*
Form of Notice of Stock Option Grant, including Form of Stock Option Agreement.
10.7†*
Form of Notice of Restricted Stock Unit Grant, including Form of Restricted Stock Unit Agreement.
10.8
Form of Common Stock Purchase Warrant of the Company (incorporated herein by reference to Exhibit 10.9 to the Company’s Registration Statement on Form S-4 (File No. 333-190845) filed with the SEC on August 27, 2013).
10.9
Form of Registration Rights Agreement by and between the Company and each of the Investors party thereto (incorporated herein by reference to Exhibit 10.10 to the Company’s Registration Statement on Form S-4 (File No. 333-190845) filed with the SEC on August 27, 2013).
10.10
Form of Registration Rights Agreement by and among the Company, Bear State Financial Holdings, LLC and each of the Investors party thereto (incorporated herein by reference to Exhibit 10.12 to the Company’s Registration Statement on Form S-4 (File No. 333-190845) filed with the SEC on August 27, 2013).
10.11†
Employment Agreement, dated October 1, 2015, by and between the Company, Bear State Bank, N.A. and Mark McFatridge (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report Form 8-K filed with the SEC on October 1, 2015).
10.12†
Change in Control Severance Agreement, dated November 18, 2015, by and among the Company, Bear State Bank, N.A. and Tom Fritsche (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report Form 8-K filed with the SEC on November 20, 2015).
10.13†
Change in Control Severance Agreement, dated November 17, 2015, by and among the Company, Bear State Bank, N.A. and Matt Machen (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report Form 8-K filed with the SEC on November 20, 2015).
21.0*
Subsidiaries of the Registrant
23.0*
Consent of BKD LLP
31.1*
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1**
Section 906 Certification of the PEO
32.2** Section 906 Certification of the PFO
101.INS XBRL Instance Document
101.SCH XBRL Taxonomy Extension Schema
101.CAL XBRL Taxonomy Extension Calculation Linkbase
101.LAB XBRL Taxonomy Extension Label Linkbase
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† Management contract or compensatory plan or arrangement
* Filed herewith
** Furnished herewith
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ Mark McFatridge
March 11, 2016
Mark McFatridge
President, Chief Executive Officer and Director
/s/ Matt Machen
March 11, 2016
Matt Machen
Senior Executive Vice President and Chief
Financial Officer
/s/ Sherri Billings
March 11, 2016
Sherri Billings
Executive Vice President and Chief
Accounting Officer
/s/ Richard N Massey
March 11, 2016
Richard N. Massey
Chairman
/s/ W. Dabbs Cavin
March 11, 2016
W. Dabbs Cavin
Executive Vice Chairman
/s/ Daniel C. Horton
March 11, 2016
Daniel C. Horton
Executive Vice Chairman
/s/ K. Aaron Clark
March 11, 2016
K. Aaron Clark
Director
/s/ Frank Conner
March 11, 2016
Frank Conner
Director
/s/ Scott T. Ford
March 11, 2016
Scott T. Ford
Director
/s/ Brock Gearhart
March 11, 2016
Brock Gearhart
Director
/s/ John J. Ghirardelli
March 11, 2016
John J. Ghirardelli
Director
/s/ O. Fitzgerald Hill
March 11, 2016
O. Fitzgerald Hill
Director
/s/ Ian Vaughan
March 11, 2016
Ian Vaughan
Director